Richardson Electronics, Ltd. (NASDAQ:RELL) Q2 2017 Results Earnings Conference Call January 5, 2017 10:00 AM ET
Ed Richardson - Chief Executive Officer
Robert Ben - Chief Financial Officer
Wendy Diddell - Chief Operating Officer
Greg Peloquin - General Manager, Power & Microwave Technologies
Pat Fitzgerald - General Manager, Healthcare
Jens Ruppert - General Manager, Canvys
Mark Zinski - 21st Century Equity Research
Eric Landry - BML Capital
Good day ladies and gentlemen and welcome to the FY'17 Second Quarter Earnings Call for Richardson Electronics.
At this time, all participants are in a listen-only mode. [Operator Instructions]
I would now like to turn the conference over to your host for today, Mr. Ed Richardson, CEO. Please proceed, sir.
Good morning and welcome to Richardson Electronics’ conference call for the second quarter of fiscal year 2017.
Joining me today are Robert Ben, Chief Financial Officer; Wendy Diddell, Chief Operating Officer; Greg Peloquin, General Manager of our Power & 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 like to remind you that we'll be making forward-looking statements and they are based on current expectations and involve risks and uncertainties. Therefore, our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of our risk factors.
Our performance in the second quarter gives us reason to be optimistic about Richardson Electronics' strategy and future growth. Sales were up slightly over the first quarter and flat to prior year's second quarter.
Our healthcare division and our power and microwave technology group both had sales gains which helped to offset declines in Canvys, the display business unit.
Our gross margin improved to 32.4% of sales during the second quarter. Margins strengthened in both PMT and Canvys. Our healthcare margin dropped due to our higher percentage of system sales, which typically sell at lower margins and replacement parts.
We’ve certainly preferred larger sales gains, but overall we were pleased with the progress we were making and remain confident that our investments in both healthcare and power management will continue to drive top line growth.
In September we made the difficult decision to implement a reduction in the workforce. We eliminated 29 positions, which will reduce employee-related expenses by $3 million on an annualized basis. These actions resulted in a $1.3 million severance charge in the quarter, which will put us in a better position to achieve our objective to make a profit in the fourth quarter of this fiscal year.
We're also restructuring incentive plans, eliminated merit increases and asked our executive management team members to reduce their compensation. Year-to-date our expenses in these areas are already down $800,000.
In addition to reducing salary and fringe cost, we assigned teams to focus on other cost savings initiatives. In the quarter, we began to see the results of these efforts. Our travel and entertainment expense decreased year-over-year without impacting our customer and supplier interaction.
Our inventory turns improved and inventory on hand decreased. We also had success reducing receivables.
I'll now turn the call over to Bob Ben to share more details regarding our second quarter financial performance. After Bob reviews the numbers, Pat, Greg and Jens will discuss our business unit performance.
Thank you, Ed and good morning. I'll review our financial results for our second quarter and first six months of fiscal 2017, followed by a review of our cash position. Net sales for the second quarter of fiscal year 2017 were $33.8 million compared to the prior year second quarter of $34.1 million.
Net sales decreased $0.5 million for Canvys, partially offset by increases of $0.1 million in both PMT and Richardson Healthcare. Gross margin increased to 32.4% of net sales from 30.6% of net sales in last year's second quarter, reflecting higher PMT and Canvys margins as a result of an improved product mix.
In addition, the Canvys margin benefited from cost reductions on selected products sold. Operating expenses were $13.4 million for the quarter compared to $13.2 million for last year's second quarter. The increase was due to $1.3 million in severance expense associated with reduction in work force during the second quarter of fiscal 2017, mostly offset by reduced salary benefits and incentive compensation expenses.
In addition, IT expenses were lower in the second -- than in the second quarter of fiscal 2016. As a result, our operating loss for the second quarter of fiscal 2017 was $2.4 million compared to a $2.5 million operating loss in the second quarter of fiscal 2016.
However excluding the $1.3 million severance expense, the operating loss would have been $1.1 million for the second quarter of fiscal 2017. Other income for the second quarter of fiscal 2017 including foreign exchange was $0.2 million compared to other income of $0.5 million in the prior year second quarter.
Both interest income and foreign exchange [gain] [ph] were lower than the second quarter of last year. Loss before income taxes was $2.2 million as compared to a loss of $2.0 million in the second quarter of fiscal 2016.
We had an income tax provision for the quarter of $0.3 million, which primarily reflected a provision for foreign income taxes and no U.S. tax benefit due to the valuation allowance recorded against the net operating loss.
Overall we had a net loss of $2.5 million for the second quarter of fiscal 2017 as compared to a net loss of $2.3 million in the second quarter of fiscal 2016.
Turning to a review of the first six months of fiscal year 2017 results, net sales for the first six months of fiscal year 2017 were $67.2 million, a decrease of 5.6% from the first six months of fiscal year 2016 net sales of $71.2 million.
Canvys and PMT net sales decreased by $2.5 million and $1.7 million respectively. Gross margin increased to 31.6% from 30.5%, primarily reflecting improved product mix in both PMT and Canvys. Operating expenses were $25.7 million for the first six months of the fiscal year, which represented an increase of $0.2 million for the first six months of the last fiscal year.
The increase was due to the $1.3 million in severance expense associated with a reduction in work force during the second quarter of fiscal 2017, mostly offset by reduced salary benefits and incentive compensation expenses.
In addition IT expenses were lower than in the first six months of fiscal 2016. Our operating loss for the first six months of fiscal 2017 was $4.5 million compared to an operating loss of $3.5 million for the first six months of fiscal year 2016.
After excluding the severance expense of $1.3 million, the operating loss would have been $3.2 million for the first six months of fiscal year 2017. Other expense for the first six months including foreign exchange was less than $0.1 million compared to other income of $0.5 million for the first six months of fiscal 2016.
Loss before income taxes was $4.5 million as compared to loss of $3.1 million in the first six months of fiscal 2016. We had a tax provision of $0.8 million, which primarily reflected provision for foreign income taxes, an estimate for additional tax due from an audit [indiscernible] and no U.S. tax benefit due to the valuation allowance recorded against the net operating loss.
Overall we had a net loss of $5.4 million for the first six months of fiscal year 2017 as compared to a net loss of $3.7 million in the first six months of fiscal 2016.
Now turning to a review of our cash position, cash and investments as of November 26, 2016 were $62.8 million, which was a decrease of $3.5 million from August 27, 2016. Cash used in operating activities for the second quarter of fiscal year 2017 was $0.3 million compared to $2.3 million in the second quarter of fiscal year 2016.
On a year-to-date basis, cash used in operating activities was $1.9 million as compared to $8.8 million the first six months of fiscal 2016. We had capital expenditures of $1.2 million for the second quarter of fiscal year 2017, compared to $0.8 million in the second quarter of fiscal year 2016.
Approximately $0.8 million relates to our investments in our healthcare strategy. Approximately, $0.2 million relates to our IT platform and another $0.2 million for other projects.
On a year-to-date basis, capital expenditures totaled $3.3 million as compared to $1.8 million in the first six months of fiscal 2016. Lastly, in the second quarter $0.8 million was paid out in dividends and $1.6 million was paid out in the first six months of fiscal 2017.
Now I'll turn the call over to Greg who will discuss the results and plans for our Power and Microwave Technologies group. Greg?
Thanks Bob and good morning, everyone. As we have mentioned in prior calls, the power and microwave technology group or our PMT includes our legacy EDG business plus, our new technology business unit which is starting to the 2015 is the strength our EDG business customers and suppliers to find new technology partners and lock seeking technologies for our global customer base using our current global infrastructure.
In the second quarter of FY'17 we continue to see this strategy gain momentum. Our bookings in the second quarter of this fiscal year were very strong and our booking strength continued into Q3 FY'17.
In the second quarter PMT sales were up slightly versus the prior year. Sales were $25.2 million versus $25.1 million in Q2 FY'17. Gross margin improved to 32.8% from 29.9% last year. The increase in second quarter sales was driven by continued quarter-over-quarter growth with our new technology partners.
Sales of key EDG pipelines also increased in avionics radar applications, [raging in] products and consumables and higher power capacitors for industrial applications. This growth was offset by a decline in products sold in the semiconductor equipment market where billings were soft despite strong bookings and a slowdown in the marine and industrial MRO market.
While the overall crude market is declining, we continue to create new opportunities and capture market share by staying close to the OEMs and end users with our experienced local sales engineers and capitalizing on our global infrastructure.
Even though we are experiencing headwinds each quarter, we are seeing positive signs that we believe will contribute to year-over-year topline growth in PMT and initially sales growth and improved margins, PMT's overall book-to-bill was a positive $1.11 million.
As we view our booking trends in depth we can see that our growth initiatives focusing on new products and technologies and enhance engineering and manufacturing capabilities are helping us keep designing new programs with both current and new customers.
Several of these high volume long-term requirements are for programs for key OEMs. Our manufacturing and engineering solutions product lines which include [indiscernible] microwave generators and custom RF power solutions continue to improve as we invest in new capabilities, while improving our cost structure.
The manufacturing and engineering teams have become an integral part of our sales efforts to support new opportunities and existing customers and new customer applications.
On a geographical basis, sales in both Asia-Pacific and Latin America were stronger in the second quarter than prior year. Our North American and European markets have been negatively impacted by the way for demand from several of our larger OEMs for both engineering and solutions as we look to reduce inventory prior into calendar year end.
However bookings in sales in the third quarter so far have shown good improvement over prior year. We continue to adjust our product mix and cost model to take advantage of the opportunities of combating the headwinds. We work hard throughout the year to reduce our investment in inventory and maximize cash generated by the business.
There is no question that we have an unparalleled capability and global go-to-market strategy that is unique to the RF and power management industry. We are the world leader in manufacturing and distribution of our devices, supporting legacy equipment as well as new equipment for solid state [tubes].
We continue to offer suppliers and customers easy access and support for our products on a global basis. We have design, engineering and manufacturing capabilities to support customer assistance and sub system requirements.
With the new technology group, we have the fast-growing new technology partners to support customers next generation equipment in each RF and power applications. The combination of these factors places us in excellent position to generate improved profitability with topline growth in the future.
With that I'll turn it over to Pat Fitzgerald in Richardson Healthcare.
Thank you, Greg and good morning, everyone. Healthcare sales in the second quarter of fiscal 2017 were $3.2 million up 4.5% over prior year sales of $3.0 million. The sales increase was driven primarily by growth in demand for IMES products.
Gross margin as a percentage of net sales decreased to 36.3% during the second quarter of fiscal 2017 as compared to 46.1% in the same period last year, due to a product mix that included more equipment sales, which generally bring lower margins.
Healthcare providers today are under intense pressure to reduce their costs. They are increasingly exploring options to OEM service contracts that include time and material service, third-party service and asset management providers and in-house service.
As a result of the growing demand for an alternative source to the OEMs for replacement parts and service on a global basis, we estimate the global market for diagnostic imaging replacement parts and service to be between US$7 billion and US$8 billion annually.
Our strategy is to plan significant role in the development and sale of diagnostic imaging replacement parts around the world. The IMES business, which we acquired in June of 2015, provided us with a good foundation in this market and an excellent model for expansion.
The investments we are making in the repair and development of CT tubes and other high value components are the key to the long-term success of the strategy. IMES is focused on providing CT and MRI replacement parts, training and technical support to end user customers who want to maintain their own equipment as well as to third party service organizations.
IMES also buys and sells pre-owned equipment to companies who offer an alternative to new equipment from the OEM. Part sales were down overall in the second quarter compared to prior year. Parts of our demand business and demand can vary significantly from quarter to quarter.
Our IMES growth initiatives, which include part sales in Europe and new product lines like sales and maintenance parts were up but not enough to compensate for slower demand in the U.S. parts market.
Equipment sales in contrast were up in the second quarter. Equipment has traditionally been a key component for the IMES business or was not something we emphasized for acquisition. We have renewed our interest in equipment sales because of the stability it can bring in periods when parts demand is lower and also because of speeds to market for the future.
Customers who buy equipment from us today will come back to us for parts and tubes. The expansion in the IMES business from a geographic and product line point of view continues to be a major focus. We're gaining traction with customers in Europe if they come to realize we carry local stock and can avoid the cost of time delays associated with shipments from the U.S.
Our fill rates for the expansion product lines including payments in total key parts are improving as we gain more experience about which parts of the systems are in higher demand and ensure we have sufficient stock on hand.
Adding MRI coil repair and cryogenic solutions for MRI systems are also generating incremental sales. The company continues to make significant investments in CT and x-ray tube development and manufacturing capabilities. We believe the availability of replacing CT tubes will differentiated us from other part suppliers and provide an economic model that will motivate more hospitals to move away from OEM service and drive growth in parts and tube sales.
OEMs generally put a very high price on key components and CT tubes in an attempt to drive customers towards OEM service contracts. We've made excellent progress on our factory build-out and continue to work on tube repairs in parallel with new tube developers.
Our goal now is to ensure our CT tubes withstand rigorous life testing. We've once chance with our customers to get this right. Releasing repair to our new tubes to market before sufficient validation has been completed will have significant negative long-term consequences.
Sales of our image system demand displays for picture archiving and communication systems or packs and related accessories and equipment for operating rooms. We're down slightly compared to the same period last year.
More hospitals and choosing to replace diagnostic displays on an as needed basis versus a disciplined total refresh approach due to capital budget constraints. Unfortunately this leaves some hospitals exposed to compliance issues as diagnostic displays fall out conformance.
Our marketing efforts as well as pending regulations in some states are creating awareness of this issue. We offer solutions for helping customers with both on site QC/QA checks as well as remote daily calibration and conformance checks using our proprietary calibration software known as CFS. We believe these services put us in a good position to capitalize on future refresh projects.
With IMES parts, CT and x-ray tubes, packs and operating new room displays, wireless VR upgrade solutions as well as power grid tube MRI coil repairs and cryogenic solutions for MRI systems, Richardson Healthcare has established excellent relationships with hospitals and independent service organizations on a global basis.
Over the past two years we've significantly strengthened our value proposition for healthcare providers, looking to lower their cost and increase efficiency. We continue to explore additional acquisitions in this market and are focusing on companies with models that can be expanded internationally.
We are also evaluating additional partnerships and organic investment and product line expansion in segment that we feel are underserved.
I'll now turn the call over to Jens Ruppert to discuss Canvys second quarter results.
Thanks Pat and good morning, everyone. Canvys, which includes the engineering, manufacturing and sales of custom displays to original equipment manufacturers and industrial and medical market and sales of $5.4 million during the second quarter of fiscal 2017 down from $5.9 million into the same period last year but up by $0.8 million from the first quarter of this fiscal year.
Sales increased quarter-over-quarter due to high demand from our customers, but we continue to be challenged by customer consolidation and lower than anticipated [schemes] in the healthcare segments.
Gross margin increased as a percentage of sales to 28.4% from 25.9% in the same period last year. The year-over-year gross margin increase was related to product mix and cost improvements. The division did a good job of controlling cost and we come cleanly to work closely with our Asian partners to deliver the highest quality solutions at competitive pricing for our customers.
Historically Canvys has relied primarily on its outside face works to generate new business. In order to support sales, we've launched new marking campaigns to first improve customer relationship and reach potential customers.
We have taken advantage of commodity signs and technological aspects and focusing on conscious marketing activities to ensure our messages are being received in whatever medium our customers use, Window XP desktop PCs for modern fold devices.
Measuring action and tracking responses are all significantly important. We have statistical tools that allow us to analyze and track the habits of those regions. Now our most recent marketing campaign, we have got to promote our [indiscernible] to channelize the entrance from our contact space.
We sought to underlining the market trends towards the 4K technology as we had stated earlier used as an RC for product that can show higher unit revolutions for critical content and medical application but also have areas. Conversations with these interested parties have been initiated.
During the quarter we have new programs from existing new customers in the medical space for dictations such as laser skin treatment units, sales analysis and customized cash streams to control medical devices and operating room equipment.
We projects in non-medical areas for applications such as patent information systems, machine interphones and [trailer prompting]. It is clear we offer our customers outstanding products and service.
In the second quarter, we made significant staff reductions to improve efficiency. Now we continue to review and access our business strategy with the goal of improving the operating performance of the division, maximizing cash flow and managing inventory closely as an ongoing priority.
I'll now turn the call back over to Ed.
Thank you, Jens. Selling to OEMs creates unique challenges for all of our business units. With the customers development cycles which are subject to changes and priorities and impacted by factors outside our control including economic issues and political headwinds.
However once we win, offering has very long-term commitments from our customers. Richardson Electronics continues to be a company focused on revenue growth and profitability.
In our healthcare business we've not yet seen the impact of our CT tube development program will have on the total business. We do know the growth in sales and profits will be significant. We met with many service providers and end users at the recent RSNA Convention and heard loud and clear where they have issues we can solve.
The healthcare team is working around the clock and making good progress to deliver critical CT tubes. The supply of these tubes will make it feasible for medical institutions to reduce their reliance on OEMs. In the interim, we'll continue to focus on brand and product line expansion and increasing awareness in Europe.
We've aligned ourselves with key suppliers in the power management market. Greg's team is doing an excellent job creating demand for these new technologies and we're beginning to see solid sales growth, which helps offset the ongoing decline in the power grid tube market.
The markets we pursue are not without challenges. We remain diligent and closely monitor our spending particularly with respect to personnel requirements and infrastructure. Cash flows become a key consideration in our decision-making process, whether it's for inventory purchases or capital expenditures.
We'll continue to consider acquisitions, which align with our growth strategies or protect our market share. Our employees are clearly committed to returning Richardson Electronics to profitability. They're challenging the way we've always done business and looking for more ways to improve efficiency throughout the company.
Many have taken on additional responsibilities to ensure we continue to provide our customers and suppliers with the level of service and expertise they've come to expect from Richardson Electronics.
At this point, we'll be happy to answer a few questions. May we open up the lines for questions?
[Operator Instructions] Your first question comes from the line of Mark Zinski. Please proceed.
Yes, good morning, everyone.
Good morning, Mark.
Hey Ed, is it fair to say that you still have Q4 as a goal for profitability?
That's correct. We saw things coming along much slower than we anticipated and that's the reason why we made workforce reduction in September, so that we could be profitable in the fourth quarter.
Okay. And are you seeing any hint of a bottoming in the semi conductor vertical?
Greg, I'll let you answer that.
The fact that we are grabbing market share in the semiconductor group is new. We started in June of last year. We're seeing strong growth in specific markets. So the overall semiconductor market maybe flat to down and has hit the bottom, but there's pockets within the semiconductor market that we address from a niche point of view that are growing and we have like Ed mentioned, the suppliers and the technology to support those and that's what's doing very well for us.
Okay. And then Greg the new technology segment, I believe currently it's not materially impacting sales, but do you have any kind of timeframe where it might start adding some incremental sales?
We may have seen that point in the second quarter and our goal based on internal numbers is for the new technologies group to make up 10% of PMT’s overall business and the whole goal is as we know the percent change and our pockets of growth, the two business is declining.
So we potentially have hit that intercept point if you will where our growth in dollars of the new technologies is higher than the decline in the tube business and that will allow us with control of cost and using the current infrastructure to allow us to grow quarter-over-quarter, year-over-year topline with improved profitability.
That's the financial strategy of it and that's what worked before and we're looking at third quarter being strong so far, five weeks in terms of sales of the new technologies. So we look for growth in the third quarter year-over-year and that's because it appears that the traction in the new technologies group has gotten to the point where it's higher than any declines that we are dealing within the EDT side.
Okay. I guess my next question is focused on Canvys. Jens can you tell me the gross margin improved pretty significantly, which you relate to cost reductions on select products, are those raw material cost improvements or specifically what were those cost reductions?
Mark, I am going to let Wendy answer that.
Yes, to answer the question, we partner with companies as we mentioned in Asia and we were constantly challenging them to give us decent cost reductions on a year-over-year basis. And so you're not really seeing it in raw materials. You're seeing it more in the products that we're [indiscernible].
Okay. I am going to ask you to kind of speculate here, so bear with me. Obviously the -- there's been some pressure with the hospital systems to refresh their system so some CapEx pressure and that's been going on for a while.
In theory if the U.S. does end up providing some corporate income tax relief, the for-profit hospitals, would they benefit enough to potentially see an uplift in spending in pent-up CapEx spending that they've been deferring?
I think both Pat and I can probably take a stab at that. We both have smiles on our faces and hope that that would be the case. In Canvys, I know Jens has discussed that some of the purchases for display specifically for the healthcare OEMs have been off and obviously that is related to a decline in demand for their equipment at the hospital levels and again I think we would all be cautiously optimistic that any change in political policy or tax policy would have a positive impact, Pat?
Yes, I would agree. I certainly think they're also eager to see how they're going to get paid, and whether Obama Care will be repealed and what will replace it, but I think there's a couple of factors going on that will affect their enthusiasm for investment.
Okay. And then Pat can you give me the percentage of healthcare sales that our system versus parts or are you guys not disclosing that?
We don't typically disclose that.
It's not really, this is Bob, Mark. It's not a consistent number from quarter-to-quarter but as Pat did note, it was a higher percentage this quarter. It is our focus going forward too, but we just don't really have those figures.
Okay. And then I guess last question then is in terms of your cash abroad, have you, I think you've been incrementally bringing more cash back domestically. So where are you right now in your broad cash balance roughly?
Okay. Well at the end of the quarter, our U.S. cash position was just under $20 million and we had a total of $62.8 million in cash and investments. So the remainder would be a broad and most of that's in Asia and we do have strategies for repatriating that back to the U.S. with minimal tax consequences and of course we're keeping our eyes on the new administration and whether or not there will be any tax repatriation changes that would be favorable to us and others.
So we feel good about our capabilities to bring back cash overseas to the U.S. at this time.
Okay. Great. That's it for me, thanks.
Your next question comes from Eric Landry. Please proceed.
Good morning. Eric.
So Ed, you have mentioned now for several quarters in a row [indiscernible] at least in the last couple specifically that your growth projects have come along much slower than anticipated.
I'm hoping to find out why that is. Was it a missed forecast at the beginning of this or have there been certain obstacles that have pushed things more into the future and are those going to come later or what exactly is the reason for this much slower than anticipated [indiscernible].
Well I think it's primarily with two other business units. One is healthcare and cost of course and that one is pretty easy to tell you why it's been slower. We are very new in the manufacturing development of CT tubes. We do have excellent engineering team that have a lot of experience in that area, but we had forecasted to be to market with both repaired or remanufactured CT tubes and new tubes much faster than where we are today.
The good news is we have tubes on scanners running like test protocols and so we're really optimistic that we're on track to start having tubes to market. I hate this forecast but by the end of the fiscal year, we hope we'll out there with tubes in the market and that is much slower than what we thought would occur, but good things take a little longer than you might forecast.
I guess we're really optimistic about what that's going to do for our revenue in the future. And then the other side is the PMG or the Power Management Group portion of PMT, which is Greg's responsibility.
I'll let Greg address why it's come longer than we thought, but certainly the inertia today is right on line with what we were forecasting earlier.
Yes, that was explained remark that we had hope to get to that intercept point earlier as soon as the fourth quarter the initial year that we rolled out the group. From a backlog point of who actually and a bookings point of view, we were actually happy with where we're at in terms of what we had forecasted.
But in terms of revenue growth, we saw the second quarter be where we thought it should be and has allowed us to grow the overall group and the third quarter is starting out the same way, but anything specialty on the new technologies that is a pure demand creation design in strategy and those go from anywhere from 12 to 18 months.
We have thought that we would be able to improve that and have more, but if you look at the number of design-ins that the team is working on, the current bookings that the team has done so far this year and the backlog increase from Q1 to Q2.
We're very confined by the end of year we'll be at the numbers that we had forecasted originally. So all things are very positive in terms of getting there by the end of the year.
Greg, are those forecasted numbers public?
I am sorry.
No. They're not. We don't break out PMPs.
But you're confident you'll be there, but we don't know where you'll be.
Okay. Go ahead. Eric we had stopped trying to forecast numbers some time ago.
Yes and I can see why. So Greg, the EDG legacy tube business is declining somewhere in the low single-digits correct, even after the market share gains and the price increases.
And is that a very steady number or is there a chance that that could actually celebrate downward?
I think that's a pretty steady number, but we have seen like you saw in the fourth quarter, there are still pockets of growth out there in the EDG business that will be one hit very large increases within a quarter. So the overall tube business on a global basis is declining in low single digits and the new technologies group based on that percent of the total tube business that we do is growing, growing at a rate that will allow us a group to be topline growth with improved profitability quarter-over-quarter and will allow us to have a large share of being profitable in the fourth quarter as we meant by the internal goals.
Okay. So there is a risk it's likely that the EDG business accelerates that downward trajectory?
Well it's certainly a risk, but it's a very, very stable platform. The business is about 80% after markets, more a replacement in existing equipment on a global basis.
We're selling tubes to some 20,000 customers all over the world. So it's a pretty stable platform and we've been in this business since 1947 and you get some ups and downs, peaks and valleys on the OEM side of the business, which becomes smaller and smaller percent of the business each year but the aftermarket stays pretty flat.
Got you. And so the gross margin has been quite impressive over the last couple quarters. If I take out the fourth quarter of last year, we had that extra $4 million shipments in a long time.
Was there something in there that had bump that up intentionally or is this something we've told you in the future.
Yes, there is a lot more engineering being done. So we get higher margins for that business. As we mentioned in our discussion that the manufacturing investment in those engineers and manufactured products is giving us higher margins than we have historically seen and we're getting paid for our design in and development work at these customers.
Eric, this is Bob Ben. I would also add as was noted in the comments section that the lot of the margin increase was due to improved product mix and of course we can't predict that from quarter to quarter. So while it has been stronger and to Greg's point and pockets of his business, certain product lines sales have increased with higher margins.
We can't say that that's going to continue going forward. I still think we'll see good margins in the second half, but I think the second quarter was a little higher than what we've normally seen but we'll probably see going forward.
Got you. Okay. Great. Bob their CapEx seems a little bit light from what you mentioned on the last call. Has there been a change in plans in the investment rate or has that just been pushed back a little bit?
I am sorry. I didn't hear what you said. Oh CapEx, okay. CapEx for the quarter was $1.2 million and yes, I think I did say last quarter would be a little higher. I expected to continue at the rate that it's at, which is about $1.5 million for each of the next two quarters.
Some of that really just depends on the healthcare spending and where we're at with the prepared tube versus new tube process.
Has there been any change in investment plan in the new tube production?
Not in total spending. No. I think it's just a matter of the timing of the spending, but not in total dollars.
Okay. Ed, is there any chance that the cost-cutting that you guys did in September and the has affected the ability of the company to grow?
We don't think so. I will give the whole team a lot of credit. There are a lot of people that stepped up and take on additional responsibilities and we thought we were in the company in any way we would certainly address it.
The last thing we do is to take people out of sales and marketing that are the front end of the business, the majority of the cuts came internally are the infrastructure.
Lastly. I think we bought IMES. It was somewhere around the $12 million business correct?
And it's now around the $12.5 million business somewhere maybe $13 million, so the growth has not been overly spectacular to say the least and you've talked about your European expansion at the Amsterdam parks. So if you -- is it fair to say that the European expansion is going slower than you had anticipated.
Yes, I would say that. I think we had anticipated just by being there that it would give us a greater access to the market and of course the people who are servicing equipment over there already had supply chain of one type or other, but as people are becoming aware that was there that we have products and stock that may be they no longer need to keep a spare system than the sales on hand.
We're starting to see that business increase. So the thing about Europe is we believe ultimately Europe will be just as strong as the U.S. market that is increasing demand there for alternative service that just hasn't been there like it was in U.S. But eventually it's going to be a very strong market and we intend to be there and be monumental players.
Ed you mentioned the impact that the availability of your CT tubes as an IMES and also are forecast oriented.
Yeah absolutely. The parts business is very much tied to how many people are choosing to move away from the OEM. So at this point there's a certain number of people who have done so even with limited availability of tube options.
And so our belief is that when an alternative tube becomes available, we'll get the lift not only from the tube sales but also far more people will start to service that equipment themselves or use third-party service providers.
So there should be a significant bump up in the parts business once the tubes become available as well.
Okay. Let me sneak one more in there for you guys. So I think Ed mentioned or you did that you'll have tubes in the market by the end of this fiscal year. Did I hear that correctly?
We're hopeful that they’ll be in the market by the end of the fiscal year.
Repaired tubes, right.
So in the insert and repair inside the insert.
That is correct.
Okay. So how long -- once it's proven that it works, once you have it off the bench and in the market in the field, how long before you can ramp up that business to something that is material? Is that another year than to get that thing up and going or how does that timeline look?
No, I think in terms of the healthcare business as we have it now it should become material rather quickly within a quarter or two. You have perhaps the timing issue as people need to decide to take quick offer contract and everything else, but I think that there is more demand out there right now just for the tubes than there is supply.
And so I think you'll see an immediate bump from the tubes themselves and I think over time you'll start to see them in the general part space for those products increase as well.
So the issue right now is you're trying to address every single issue possible to make sure that this is a high quality product before you release anything to the field correct?
Absolutely. The last thing we want to do is introduce a produce and then there is a bunch of early life failures and have a bad fabrication. So...
Okay. And at this point right now there is no indication that there are issues as far as assuming this far along with this on the machine spending that you have seen nothing to indicate that this will not be successful?
We would say that's correct. We're very optimistic. Things are going well that they -- we're still sorting out our processes, but I think we've demonstrated that it can be done.
Okay. Thank you guys. Good luck.
[Operator Instructions] I would now like to turn it back over to Ed Richardson for closing remarks. Please proceed.
Thanks Mark. Thank you again for joining us and for your ongoing support of Richardson Electronics. We look forward to discussing our fiscal 2017 third quarter results with you in April.
Ladies and gentlemen, that concludes today's conference. You may now disconnect. Have a great day.
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