Good morning and welcome to the FY18 Third Quarter Earnings Call for Richardson Electronics. My name is Bolt, the Event Manager. And during the presentation, your lines remain on listen-only. [Operator Instructions] I would like to advice all parties that this conference is being recorded for replay purposes. I would now like to turn the call over to your host, Mr. Edward Richardson, CEO. Just bear with us one moment. We are just having a technical issue. Thank you. [Technical Difficulty]

Good morning and welcome to Richardson Electronics conference call for the third quarter of fiscal year 2018. Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, Chief Operating Officer; Greg Peloquin, General Manager of our Power and Microwave Technologies Group; Pat Fitzgerald, General Manager of Richardson Healthcare and Jens Ruppert, General Manager of Canvys. As a reminder, this call is being recorded and will be available for audio playback. I would also like to remind you that we will be making forward-looking statements and they are based on current expectations and involve risks and uncertainties. Therefore, our actual results could be materially different. Please refer to our press release and SEC filings for an explanation of our risk factors. The third quarter was the strongest quarter for Richardson Electronics in several years. We've had quarter-over-quarter as well as year-over-year revenue and operating income gains, thanks to the hard work and sacrifice of the entire Richardson Electronics team. All three business units performed well and we made significant progress with our growth initiatives. Many of our employees have been working around the clock to achieve critical milestones. A strengthening economy and a continued growth in key markets such as the medical, industrial and the semiconductor wafer fabrication market have also helped our improvement. I know Greg, Pat and Jens are excited to tell you about their specific business unit performance. First, Bob Ben will show the highlights of the third quarter and our year to date financials with you.

Thank you, Ed and good morning. I will review our financial results for our third quarter and first nine months of fiscal year 2018 followed by a review of our cash position. Net sales for the third quarter of fiscal year 2018 were 41.6 million compared to the prior year’s third quarter of 32.3 million, which was an increase of 9.3 million or 28.9%. Net sales increased 7.1 million for PMT and 2.7 million for Canvys, partially offset by a decrease of 0.5 million for Richardson Healthcare due to the sale of the PACS display business at the end of fiscal 2017. Other healthcare sales increased by 0.3 million or 15% over last year. Gross margin increased to 33.8% of net sales from 33.1% of net sales in last year's third quarter, primarily due to an improved product mix for both PMT and Canvys. Operating expenses were 13.1 million for the quarter compared to 12.0 million in the third quarter of fiscal 2017. Operating expenses increased due to the additional compensation and other expenses, primarily related to the increase in net sales as well as higher research and development and other expenses for Richardson Healthcare. Operating expenses, as a percent of net sales, however decreased to 31.4% in the current quarter from 37.1% last year. As a result, the company reported a 1.0 million operating income for the third quarter of fiscal 2018 compared to a 1.3 million operating loss in the third quarter of fiscal 2017. Other income for the third quarter of fiscal 2018, primarily interest income, was less than 0.1 million compared to the other expense of 0.1 million, primarily foreign exchange loss for the third quarter of fiscal 2017. There was an income tax provision for the quarter of 0.5 million, which reflected a provision for…

Thank you, Bob and good morning, everyone. In the third quarter of FY18, PMT sales were 31.9 million versus 24.8 million in Q3 FY17. Based on strong bookings, new design wins and our unique business model, our business grew 20.8% over prior year and we ended the third quarter with a healthy 1.1 book to bill ratio. In addition, our gross margin improved to 33.4% compared to 32.6% in Q3 of last year. Our improvement in performance was driven by sales growth within our core electron device business, including engineered solutions as well as growth from our technology partners we have added over the past couple of years. We are taking advantage of our long term customer relationships, while we form new ones with our expanded product range. Favorable market conditions in the industrial, semi fab, wireless infrastructure and power energy markets are helping with our strong results. We’re also implementing numerous internal programs to improve margins, efficiency and inventory turns while taking advantage of our global infrastructure. These actions are also contributing to the company's overall profit improvement. We continue to experience market share gains and revenue growth for products in both the power and microwave group as well as electron device group. This growth is being supported by key technology partners such as Qorvo, CPI, MACOM, Anokiwave, USCI and Telus. More specifically, key market applications include 5G antennas, front end modules and test equipment. Wafer fabs, power management and industrial heating are also effective. We are excited about the 5G development as Qorvo, MACOM and Anokiwave lead the market development of the millimeter wave front end technology for active and passive products, which will power off fixed wireless access. We're starting to see pre-production orders to support this infrastructure rollout. Our list of design wins at major telecom…

Thank you, Greg and good morning, everyone. I'm pleased to report that we completed our accelerated life testing of the new Richardson manufactured CT tubes in the quarter. These tubes performed very well on in-house CT scanners. We filed our initial report with the FDA and received an acknowledgement of our submission and were assigned an assessment number by the FDA to register both our company and the product. In addition, we successfully completed a stage 2 ISO 13485 audit of the CT tube development and manufacturing center and our auditors have recommended us for accreditation. We have now progressed to testing newly manufactured CT tubes in clinical sites and have had a beta tube running in a partner site for nearly four weeks. We have been very disciplined about choosing only good partners to receive these first manufactured CT tubes. We believe these customers will be strong promoters for the product once we release it for sale. If our tubes continue to perform well in beta testing, we expect to release the tubes for sale in May before the end of our fiscal year. Due to the sale of our PACS Display business in late FY17, healthcare sales in the third quarter of fiscal 2018 were 2.2 million, down 19.6% from prior year’s sales of 2.7 million. On a comparable sales basis, sales were up 15% compared to Q3 of last year. Equipment, service training and sales of Richardson certified and refurbished CT tubes in the third quarter were all up compared to prior year, which helped offset some of the lost display revenue. We believe that creating a sustainable supply of CT tubes will ultimately lead to more rapid sales growth in both CT tubes and replacement parts as alternative service providers are able to take system maintenance…

Thanks, Pat and good morning, everyone. Canvys, which includes the engineering, manufacturing and sale of custom displays to original equipment manufacturers and industrial and medical markets, had sales of 7.6 million during the third quarter of fiscal 2018, an increase of 57.2% over the same period last year. Our improvement in performance was primarily driven by an increase in customer demand and addition of new customers and programs globally. I'm also pleased to report that gross margin increased as a percentage of sales to 33.9% from 27.6% the same period last year. The year-over-year gross margin increase was related to a favorable product mix. Backlog remained high at the end of the quarter and we are excited about the continued strong customer demand throughout North America and Europe, driven by a healthy economy. The third quarter of fiscal ’18 was a very successful quarter for us. During the quarter, we received several new orders from existing customers as well a new customers in the medical space. Applications include intravascular imaging systems, which are computer based systems that allows physicians such as interventional cardiologists to acquire images of disease vessels from inside the artery, navigation systems that enable surgeons precisely track the location of surgical instruments throughout a procedure and CCTV systems and intra fraction displays used during radiotherapy. Beyond the one program for surgical displays used in endoscopic procedures, patient monitoring systems that have enhanced patient care and improved clinical performance and patient positioning monitors. While medical remains strong, the industrial market is also experiencing growth. We won several projects in non-medical areas, publications including human machine interfaces for high speed, high acquisition billing machines, wood processing machines and large sized printing machines used to print billboards. Other wins include displays for point of information, POI applications, data prompted displays for well-known use patients and various displays for the transportation market. In the transportation market, our displays are installed in subways or used for railway applications and require very specific certification. The ability to meet these great requirements is another advantage Canvys provides. From the variety of customers and applications and the value of orders from existing as well as new customer, it's certainly clear we offer our customers outstanding product and service. While our sales organization stays focused on new opportunities, I will continue to review and adjust our business strategy with the goal of improving the operating performance of the division. Maximizing cash flow is an ongoing priority. We will continue to work with our partners to appropriately use inventory, while being able to meet the demand of our customers. I will now turn the call back over to Ed.

Thanks, gentlemen. You and your teams have continued to do an outstanding job during the first three quarters of FY18. The fourth quarter also looks strong. Our display business is running well with Jens and team winning new business every quarter. PMT should continue to benefit from a very stable demand for power grid tubes, strengthen the semi fab equipment market and the upside driven by our new power and microwave suppliers. Every day, I review the quote backlog and the volume is growing substantially. The healthcare team is set to grow by having a sustainable supply of CT tubes and the increase in replacement parts and system sales that come with tube availability. A key to further profit improvement is our management’s focus on tight expense control and leveraging our infrastructure. With respect to cash flow, we've made investments in this year in our corporate headquarters and in healthcare, but we're still in a good cash position. Using our foreign tax credits, the recent tax reforms will not result in a significant outlay of cash and will complete the process of repatriating cash. We're not currently considering any acquisition targets, although we are always open to doing so on an opportunistic basis. At this point, we'll be happy to answer a few questions. Nancy, may we please open the lines for questions.

[Operator Instructions] Thank you. So the first question comes from the line of [indiscernible].

Ed, congratulations to yourself and your group on a good quarter right across the board. You’re repatriating all of your cash?

Well, as we can, how much Bob have we repatriated?

Well, Howard, this is Bob Ben. Just recently, this quarter, we repatriated about 1.7 million. We have plans for much more. The thing to keep in mind is that while the payment of US taxes is complete and in fact we didn't pay any tax on that foreign cash again, while that’s known at this time, in order to repatriate the cash from various countries, we still have to go through a legal process of returning the cash either through a dividend or a return of capital or liquidating an entity which of course we would do. In addition to that, we have to consider local country taxes as well. So, we're in process of repatriating a lot of cash and I look forward to reporting to you in the future what our results are, but it does take some time.

In terms of the vacuum tubes, May seems to be earlier than I had expected. Is that a fair comment?

CT tubes, Howard, are you speaking of?

Yeah.

Sure. Pat, do you want to go over it?

Sure. I don't know that that’s sooner than we’ve expected or even what we discussed in prior quarters. That's been our ambition for some time was to be ready to release before the end of our fiscal year. And if everything continues to go well with the beta testing, that's our expectation.

What kind of capacity do you have in terms of production?

I’d probably rather not discuss that kind of thing on an open call, but we have very strong capacity I would say and an ability to address the market needs.

Looking forward, what kind of gross margins could we plug into our numbers for the tubes, on a going-forward basis?

Well, that will be a very dynamic process, because a lot of our costs to begin with is fixed costs. So, we have all of the depreciation associated with capital investments that we've made and even labor in the near term is a fixed cost. So, we're working on those projections now, trying to look ahead in the next fiscal year and there may be a case where initially when the volumes are low, it could be dilutive, but then, I would fully expect over time that that will turn to something where it's a positive benefit, more accretive to margins.

Well, let's take a look a year from now, when you're running a fully – a full line, what kind of gross margins could we look for?

We look forward to that for sure.

I understand that. But if one does an analysis of the company and looks at gross margins, where could we be a year from now in gross margins?

In CT tubes, I would expect a year from now, it should be on par with our current gross margins. I’d say that.

The next question comes from the line of Mark Zinski.

Good morning, everyone and congratulations on the quarter. Pat, I was wondering if I could get some more color on -- and not necessarily new color, but I guess to revisit some of the potential market dynamics of the CT tube business. I guess, first of all, generally speaking, what kind of a price discount would your CT tube be relative to an OEM tube?

Well, we'll come into the market with roughly, let's say, a 20 -- at least a 20% to maybe a 30%, depending on customer and whether they're a partner or not a partner. So, you have to offer some advantage. But of course the big advantage will be for all of the third party servicers and all the healthcare systems out there that have these scanners in their installed base is the ability for them now to service these scanners profitably. So the lack of a third party tube option has meant that so far they've really only taken the systems under service that they needed to, that let's say they got when they picked up the whole healthcare system. So now, we expect that these companies -- now that they have an option are going to go out and seek more scanners. So there's actually not that many tubes that end up getting sold on a transactional basis by the OEM. The customers tend to either to be in some kind of a service contract or they have some kind of an in-house support agreement that allows them to buy the tubes at what seems like a reasonable price today compared to the full list price if they do like a risk pool or something. So our ambition is to ..

And then what’s the whole lifespan projection for your CT tubes?

Well, internal testing has been very good, and we expect our tube to perform comparably to the OEM tube, which right now is we think running somewhere north of two years.

Okay. Great. And then the recent certification process, does that apply globally or just domestically.

That's a great question. So actually, there's different processes required around the world. So our initial report with the FDA and also we have had our UL testing done and we expect to get that certification shortly. That will be sufficient to roll out in the United States and then with our recent completion of ISO 13485, we can, as soon as we have that certificate, we can begin the process of registering for our own CE mark for the European market and then there are various conditions [ph] around the world. So we're now, I would say, in the last few weeks. We're increasingly talking to people in markets where US FDA and the ability to sell in the US is sufficient for those markets and there are other markets like Europe and even Canada requires a registration called [indiscernible]. China is a big market that takes a long time to register for us. So we will begin all these registrations now that product is in production and so I think there will also be some timing where markets will be available to us immediately and others will come over time as we get the proper registrations.

Okay. So like Europe for instance, would you expect to be able to sell into there in 2018 or is that more of a 2019?

All right. Well, we sell today in Europe with certified tubes and we will continue to do so in 2018. As a matter of fact, our strategy is then as we have a good supply of new replacement tubes for the US market, we can shift our supply of certified tubes towards the European market and make sure we're satisfying customers there as well.

Okay. And again what do you think the global estimated market size is for the CT tubes?

For CT tubes in general, it's huge. For this particular one, I guess I’d hate to speculate, but it's thousands and it's probably for all CT tubes, the whole market is probably 50,000 a year.

Okay. Great. And one last question for Greg, I guess on PMT. I guess I'm going to see if I can get you to dissect the growth factors a bit, design wins versus vertical strength. It was at about 50-50?

From a revenue point of view, Mark, this quarter, it is about 50-50, divided up between the wafer fab semiconductor equipment industry, with both components and engineered solutions and tubes and then IG applications and some radar applications using Gann, the new technology partners.

Okay. Great. And that 5G application, do you think that's just in the beginning stages then?

Yeah. For the most part, the backlog that we're getting which is growing immensely, which helps support the strong book to bill for the whole group is prototype orders, production orders, what we see in this summer and this fall.

Thank you. So the next question comes from the line of Eric Landry.

Yeah. I don't know what to say other than fantastic work there to everybody in the box. So Greg, book to bill of 1.1 in the space near 30% growth is definitely impressive. I guess perhaps piggybacking on the prior question, is there any way you could maybe divvy up your business now between what might be termed cyclical and what is in market share gain or growth mode so to speak.

Well, the book to bill of 1.10 for the group is very strong and then as you know, Eric, still a large percent of our business is the MRO tube business, which probably should simply have a book to bill of one. So from a bookings point of view, we’re seeing that growth and which is turning into revenue in the new technology partners and the engineered solutions products for the semiconductor industry. So right now, the growth in dollars is kind of divided up evenly this quarter between new technology partners and the legacy business, mainly focused on the semiconductor wafer fab market for the products we make here.

And I think my understanding is that wafer fab is expected to be strong at least through the end of this calendar year. I think last we talked that was the message.

Yeah. So all the forecast, the updated forecast is the current run rate will continue through 2018. And as we get closer to 2019, we'll get updated forecast, but we should see double digit growth that continue till the end of this calendar year.

Okay. On the 5G, I think last call you mentioned there was more activity over in Asia than here. Is that still the case? And if so, when do you expect things to start to get – to sort of get going in the states?

Yes. So that’s correct. China has put a mandate in that they want to get their infrastructure, their protocol for 5G in place this summer. And so last time we talked on the call and when we came out, we were seeing prototype orders. We're now getting some small production orders or test equipment, front end modules and the antennas that go on these Microsoft play stations and then we're now already getting prototype orders for products for North America and Europe using their 5G protocol, which is different than the protocol in China. So, we were pretty confident as we have gotten prototype orders from people like ZTE and [indiscernible] in China, the major players that sense and we've gotten 18 different customers worldwide that are buying products for prototype orders for their 5G applications.

Okay. So what is the advantage -- so is there going to be pretty big companies and what is the advantage of them going through Richardson rather than just going straight to the OEs?

Well, they are big companies, but there's also a just like we saw when we rolled this out with 3G and 4G years ago, there's a whole group of sub companies that can't get the attention of the manufacturer that need the design resources that Richardson offers in the field. So there are people building a certain section. These people -- these larger OEMs like ZTE want to build systems. So we got a nice order because we’re exclusive with the number of products that have a technology advantage. The balance of our line however to support the second tier people that are selling products to ZTE, AT&T, CommScope all the way down the list and that’s where we’re seeing the traction right now. Whenever there's a big rollout like this with 5G or anything that, there's a whole group of sub companies that are supporting these larger ones who don't have the board level capabilities to do the design and that’s our forward play that’s to bring the unique advantage that we have.

So are you relatively confident that the 5G represents somewhat the same opportunity that the 3G and 4G did to you years ago.

Yeah. When the dust settles, it will be similar type rollout over a year and a half to 2.5 year period that we saw back with 3G and 4G.

Jens, was there any holdovers from the prior quarter that you shipped in the current quarter or anything like that?

[Technical Difficulty] first and second quarter in fiscal year ’18, we increased sales every quarter. So we really did well.

I think this is the -- correct me if I'm wrong, but this is about the third quarter in a row where you’ve mentioned specifically orders of one during the quarter. Is that correct.

Yeah. That’s correct. Even some of the orders are small orders for prototype and stuff like that as you know in the medical area, the product rollouts take two to three years sometimes. So, it’s -- are we adding customers and programs and yeah.

So I think that sort of the turning point for your business came mid to late last summer, right about three quarters ago. Isn’t that correct?

Yeah.

Okay. Has the new orders wins then sustained at the same level or have they tapered off or how has that gone?

I think it's sustained at the same level and when I am looking at my book to bill, the book to bill is close to 1.3 right now. So, it’s very healthy. We had a very strong quarter in Q3 and backlog is up quarter-over-quarter. So it's pretty positive signs.

And I think you also mentioned in quarters past that you signed some multi-year deals. Is that sort of the center of the current stuff you’re signing?

Our business is OEM business and the most OEMs, if they pay and are used for designs and stuff like that, they wouldn’t pay that for one year. So usually, it’s a two year, three year contract and of course we are finding every second year then, renew the contract and customers ask a better pricing of course and stuff like that, but we, yeah. So we are in for the long haul.

Bob, the $11 million liability seems kind of high based upon, I think, it was 40 million you mentioned in overseas cash. I assume there is some other stuff involved?

Yes. That tax will apply to both foreign cash as well as other specified assets and so it was closer to a 75 million base and you paid 15.5% on the cash and 8% on the other assets. So that's how we get to the 11.2 million. It wasn't just on cash, it's also on foreign other assets.

Okay. And I think you mentioned to acquire, call it, that there's still some local tax issues that need to be cleaned up. Is that a cash outflow potentially going forward?

Possibly. Yes. We don't expect large numbers on that, but yes, it could be. For example, this current quarter, I don't think I mentioned it, but we had about 70,000 in the tax expense for our Korean dividend that we're working on. So, there's going to be some small taxes that do apply in local countries.

But nowhere near the 11 million you quoted here?

Oh, no, nowhere near that.

Okay. Great. And then lastly, it was kind of impressive that SG&A only went up, what, 0.5 million bucks in the face of that sales growth. I'm wondering, is there some bonus accrual that needs to take place in the current quarter that hasn't yet this year or you look forward to similar leverage going forward?

Well, the way our incentive plan works, we accrue it from quarter to quarter. However, in the fourth quarter, we do -- we have to review it for salespeople to see what their performance is versus their plan. So we do expect some potential increase there if sales perform as we expect. So I would expect to see some increase in the fourth quarter from what we have here, but again, our incentive plan is based on quarterly results throughout the year.

Okay. Thanks. So Pat, here we are. It looks like we've sort of reached the point where, am I correct in saying that we are or you are, excuse me sort of out of the development stage and now entering what maybe we could generously call production stage.

Yes. Definitely, we are in production now. So we're producing tubes every week and putting them in the inventory in anticipation of the product release and so that train is at the station. So we’re feeling very good about that. Yields are high. So far knock on wood, everything's going very well at the beta side. So we'll see here next time we talk, I guess we will know where we're at.

Is it safe to assume that the offsite testing is not as rigorous as what you had running on the benches for however long it was there?

Well, it's that safe because we were running of course 24/7 in-house and so -- but the reason you do beta testing is to see now with the different duty cycle with them firing it up in the morning and running series of patients and then the equipment sitting idle for some time and then picking up again, but the first site has been running nearly four weeks. So I think we're feeling pretty good that they're not going to be a surprise there, but of course we could see something that we didn't anticipate.

And forgive me for asking a dumb question here, but is it possible that the stopping and starting, the heating and cooling could introduce some sort of a factor that you hadn't analyzed in the factory? In other words, if you are running and not stopped for however long it was and are now in the field, whether starting, heating up, stopping, cooling down and starting and heating up, could that introduce something that you haven't looked at?

It’s possible, although honestly our internal testing, we mapped and tried to simulate a large university hospital, including a cool down time, so that we would allow the tubes to go, to full cool down and then we take them up to a max heat during the internal testing. So I'll never say never and that's why we do beta testing. But, I would say, we feel pretty confident that we've simulated everything properly in the internal testing tube.

Okay. Great. And then how long do you think it will be before you reach full accreditation here in the states with the FDA, your plant, your product everything?

Oh, luckily, that's already done. So we have the -- we filed our initial report. We built our quality system right from the get go to follow section by section the FDA Part 820 regulations and we -- and that was also very helpful for the ISO registrations. So we've now passed the stage to ISO audit with only a handful of minor nonconformities. They told us that we should have the physical certificates probably by the end of May, but we do not require that certificate to begin sales in the US. We already have what we need. It's just a matter of us being confident as Ed has said many times, we only get one chance to get it right. So, we're going that extra mile, but as soon as the company gains that confidence, we're free to sell.

So basically, you've gotten past all of the remaining obstacles for this to become a meaningful business for Richardson? Those are all in the rearview mirror?

I believe so. I believe so.

Okay. Great. I'll let somebody else and just let me say really, really good work there by everyone. Congratulations.

Thanks, Eric.

Thank you. So the next question comes from the line of [indiscernible].

Good morning. I just wanted to thank everyone there for sharing the great success story. I wanted to just kind of get a feel for how that success is going to be shared with the institutional investors that seem to not be aware of what's going on yet there? Are you going to be reaching out to them with on the road presentations or anything like that?

Absolutely. As a matter of fact -- this is Ed Richardson -- Wendy Diddell, COO and I are going to New York next week and we have quite a number of scheduled presentations to make and we've got some good news to talk about, so we are -- and it goes by the word.

That sounds great. I'm looking at the long term chart. Going back maybe 20 years and there's been at least four or maybe five times when the stock has had a very decent run up. But my guess is that the company is at least twice as good today as any one of those peaks. So in conjunction with that, I'm kind of wondering do you feel the company has got at least double the potential now.

Absolutely. We are envisioned today where every one of our business units is hitting on all cylinders when healthcare starts to turn some of the CT tubes and parts in to sales. It's a very stable base. We first have two businesses behind it which is 80% aftermarket and I can tell you from years of history, we've only been in the business 70 years, that the two business may go up or down 5% a year, but that's it and that's what's made the money, that's what it's invested and these other businesses, so you have that as the foundation for the company and now you can see Canvys has really done well and we have got some good traction going. We've got Pat running healthcare and you heard the good news there and Greg is back with us and has bought a lot of good relationships with vendors, so that the power and microwave group is really doing extremely well too. So it's a broad stable base.

Okay. Last question and this is just kind of a speculative outreach there, but I don't know much about 5G. I’ve read a few things of concern, but in conjunction with how the company could potentially be running at full capacity and potentially more shifts, would you consider something like a spinoff or a Dutch auction maybe to limit liability if something was to go wrong with one of the three divisions. And at the same time, be kind of at the forefront of re-emergence of small cap value and growth that you have now.

We’re well satisfied with the base that we have today, but again, backwards, we never say never. If you know the history of the company at one time, we were nearly 700 million in revenue and when we sold the CT, TD division, we also sold RFE. So, we're very opportunistic if we have a chance to monetize something in a profit to shareholders, we will do that.

Okay. Thank you again for sharing. I appreciate it very much.

Thank you. And now, I will turn the call back to Edward Richardson for his closing statement. Thank you.

Okay. Thank you again for joining us and your ongoing support of Richardson Electronics. You're welcome to call us if you have other questions that we're not able to answer on the call. We look forward to discussing our fiscal 2018 year-end and fourth quarter results with you in July. Thanks very much.

Thank you. Ladies and gentlemen, that concludes your call for today. You may now disconnect. Thank you for joining and enjoy the rest of your day.