Novanta Inc (NOVT) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Q4 2004 GSI Lumonics earnings conference call. My name is Bill and I will be your conference coordinator for today. At this time all participants are on a listen-only mode. However, we will be facilitating a question and answer session towards the end of today’s conference. If at any time during our conference today you require assistance, please press star followed zero and an operator will be happy to assist you. As a reminder, today’s conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today’s presentation, Mr. Charles Winston, CEO. Please proceed.

Thank you, Operator. Good evening and thank you for attending our fourth quarter conference call. This call is being broadcast live over the Internet in a listen-only mode at www.firstcallevents.com from the specific URL detailed in our press release. As usual, Tom Swain, our VP and CFO joins me this evening to bail me out when the questions get too tough.

Before proceeding, I must mention that certain remarks made during this conference call may constitute forward-looking statements. These statements are based on management’s beliefs, assumptions and current information and as such are subject to risks, uncertainties and changes. Our safe harbor statement that can be found on any of our financial press releases available on our web site applies to this call as well.

As stated in our new release issued at 4:00 p.m. today, GSI’s business in 2004 improved in the fourth quarter and the full year for 2004 compared with the same quarter and the full year in 2003. Comparing the fourth quarter with the same period in the prior year, sales increased over 45%. Earnings per diluted share were $0.21 in the fourth quarter compared with $0.06 prior year. Orders booked were $63.6 million, a decrease of about 2% over the same period the prior year. That excluded the backlog acquired from Westwind.

Backlog decreased 22% to $61.3 million. Cash generated during the quarter from operations was $8.1 million, compared with $13.9 million. Comparing full year over year performance, revenues increased to $330 million from $185.6 million, an increase of 78%. Earnings per diluted share is $0.98 compared with a loss of $0.05 in the prior year. Cash generated from operations in the year was $35.4 million compared with $21.8 million the prior year.

Cash and marketable investments at year end were $90.3 million compared with $106.7 million. Major contributors to this strong growth were the strategic acquisitions of Spectron Lasers, Westwind and MicroE as well as a strong recovery in the semiconductor equipment sales and our expansion into Asia-Pacific The combined Westwind and MicroE acquisitions contributed $79 million during the year. This was the first full year for Westwind which was acquired in December, 2003, while MicroE, acquired in May of 2004, was only a partial year. This was a major part of the Precision Motion Components segment increase in revenue to $152.7 million and operating income to $27.7 million compared with $73.8 million and $15.7 million, respectively, or increases of 107% and 77% respectively.

Laser segment had sales of $47.4 million and operating income of $2.3 million comparing favorably with $33.4 million and $1.1 million respectively for increases of 42% and 119%. This was the first full year for Spectron, as mentioned, acquired in May, 2003, which contributed $5 million to the revenue growth. During the full year 2004, we increased sales of gas lasers as well as gaining a full year benefit for Spectron. For the year, systems contributed revenues of $146.6 million and operating income of $40.3 million compared with $82.7 million and $8 million last year respectively or an increase of 77% in revenues and considerably higher in the income from new products and market recovery.

Third, our strategic initiative to expand in Japan and Asia-Pacific succeeded in generating 41% of total revenues in that region compared with 34% for the region in the prior year. Now let’s look at the individual business segments by reporting segment in the fourth quarter. Laser Systems, which makes semiconductor and electronic production tools, had sales of $35.3 million in the quarter compared with $25.8 million same period prior year or an increase of 37%. Operating income was $9.1 million compared to $5.1 million same period prior year.

We are pleased with the year over year performance in laser systems and experienced only minor order push outs during quarter 4. However, for the first time in a long while, there were no requests for pull ins and more importantly, the order rate declined in response to conditions in the capital equipment sector of the semiconductor industry as recognized in all the financial news. The most significant decline was cited in our last conference call at the end of the third quarter in mixed signal devices where a large capacity expansion that began late in 2003 virtually came to an end in the third quarter of 2004. The ramp was driven by significant increase in production of mobile electronic devices such as cell phones, digital cameras and handheld devices. We expect the industry to remain conservative with respect to new expansion throughout 2005, while the capacity acquired in the prior year is brought to full utilization.

Wafer marking and memory repair had slight declines in orders during the fourth quarter and there was a slight improvement in circuit trim orders as some capacity expansion for [inaudible] products was added in Taiwan. Sales in the laser segment increased to $12 million in the quarter compared to $9.3 million for the same period prior year or an increase of 30%. Operating income was $.5 million compared to $1 million in the same period prior year. It was another good quarter with shipments to customers across a broad range of market sectors.

We continue to focus our efforts in being more responsive to customer needs and market expansion in Asia-Pacific where we believe there is additional opportunity for growth in China reflecting that country’s rapidly expanding industrial infrastructure and the influx of many Western manufacturing facilities many of which require laser based processing tools.

Precision Motion Components segment generated $35.5 million of sales in the fourth quarter compared with $21.5 million during the same period prior year for an increase of 65%. This growth in revenues was primarily due to the acquisitions of Westwind and MicroE. Sales were across a full range of product niches including medical, light industrial, aerospace and electronic applications. Specifically, Westwind had strong demand for PCB drilling spindles, while MicroE demand was driven very heavily by the data storage market or PC sales. In the last conference call you may remember my commenting on quality problems in one particular product line in the Precision Motion segment. I am pleased to report that the technical issues are resolved and we are again receiving orders from major customers. While it will take some time to get back to the sales levels prior to the onset of the problem, we are encouraged by the warm working relationship expressed by our customers as they have assisted us in working through fixing the problem. It was a true test of their confidence in us as they genuinely wanted us to succeed so we could maintain the relationship built up over many years.

Our fourth quarter and full year 2004 performance validates our strategy for meeting the needs of our customers through acquisition of Precision Motion Control and Rotary Motion Technologies as basic building blocks for our future growth. We have expanded our capabilities, added to our diversity of component products, and opened new opportunities for technology synergies. Now here’s Tom with the financial details and highlights.

Thank you, Charles. This quarter we are continuing to see the results of our successful acquisition strategy, focus on operations improvement and working capital management when we look at year over year improvements. On a year to date basis, we have generated $35.4 million from operations compared to only $21 million last year. Cash flow generation is a vital component supporting our continuing acquisition strategy to drive above average growth and particularly the funding of acquisitions from operations cash flow.

Inventory turns in Q4, 2004 compared to the same period last year, improved to 3.2 from 3.0. Days sales outstanding and receivables also improved from 93 days in the fourth quarter of 2003 compared to 69 days in 2004. Our cash and balance sheet position remains very strong with no debt. Subsequent to the year end, we executed a lease on our Farmington Hills facility that allows us to further reduce underutilized facilities and positions us for a positive sale of that facility. Our gross margins were 38.9% for the quarter ended and 39.1% for the same period last year and 40.9% last quarter.

Margins for this quarter, in the same quarter last year benefited by approximately 2 points from nonrecurring adjustments primarily from sales on inventory that had been previously written down. In general, gross margin percentage is lower than expected and reflects the impact of lower volumes, product mix and higher material costs. Currency shifts, particularly in the UK and Japan, continue to have impacts, some of which are offset by hedging gains and losses. Strategically, we are focused on cost reductions through engineering design, outsourcing, and other tactics to improve margins. Those efforts have been successful, however, for the short term, unfavorable factors noted previously have offset any improvements. As a result of these margin pressures, we are reducing our expectations for overall margin improvement to the range of 40 - 43% by the end of 2005 based on current volume level expectation. As compared to last year, the margins this quarter for Laser Systems increased from 39.1% to 42.9% this year due to volume and products mix as well as a benefit from sales of inventory that had been previously written down.

The gross margin for the laser segment is 30.3% for the quarter as compared to 44.2% in the same period last year. The prior year margins benefited from sales of inventory that had been previously written down, causing them to be much higher than normal. However, other factors contributed to this decrease including increased material costs and continuing strengthening of the British pound against the U.S. dollar. Gross margins for the components business is 35.4% for the quarter compared to 34% in the same quarter last year. The margin benefited by 1 point from nonrecurring adjustments in the fourth quarter of 2004.

As a note on operating expenses in general, we do not expect any significant restructuring actions or major adjustments to operations in response to the decline in revenues over the last quarter. Adjustments are always being made on an incremental basis as we identify new efficiencies. However, because we effectively leveraged our resources in the most recent upturn, we do not see the opportunity or requirement for any dramatic changes. We also do not anticipate any unusual inventory write offs as a result of the downturn in revenues, which reflects our improvement in inventory management practices.

On a consolidated basis, research and development expenses have increased to $6.7 million, which is 8.3% of sales as compared to $3.9 million or 7% of sales during the same period last year. We expect to remain in the range of our target business model of 9% revenues for average annual R&D expenses. MicroE added $1.1 million, Westwind contributed $.5 million, and the Laser Systems segment R&D spending increased by 59% or $1 million. Selling, general and administrative expenses increased slightly to $13.6 million from $12.8 million in the same quarter last year. As a percentage of revenues, SG&A fell from 23.4% of revenues last year to 17.1% of revenues in Q4 of 2004. Most of the increase is attributed to the acquisitions which are partially offset by lower spending, particularly in corporate SG&A.

It is estimated that incremental Sarbanes-Oxley compliance costs for the fiscal year 2004 were in the range of $1.5 to $2 million, much of which will continue in future years. In addition to these incremental costs, much of the organization diverted significant time from operations to focus on compliance efforts to meet the deadline. SG&A expenses were lower by about .06 of a million as a result of favorable year end accrual adjustments. And now I turn the comments over to Charles.

Thank you, Tom. We are pleased with the response of the restructured GSI to the market conditions during the past 12 months for several reasons. First, the restructured company responded promptly to significant and rapid increases in customer orders with short lead times between order and delivery. Next, the success of our acquisition strategy was validated by the performance of Spectron, Westwind and MicroE. Integration of MicroE into the components organization is in progress at this time and should provide improved operational efficiencies in the latter part of the year. We will continue our search for key strategic businesses with strong niche market position. Finally, the successful growth in Asia-Pacific is important since we are expanding our production facility in China this year to support more growth in the region as well as improve gross margins to reduce cost of goods. We will be transferring products from the higher cost sights in the United States and the United Kingdom to improve the margins for both Precision Motion and Laser products. This should begin to show impact during the fourth quarter of this year.

We invested heavily in R&D last year with spending for the year at $24 million compared with $14 million the prior year. We have new product development activities in all areas of our business to meet future market needs. In the systems segment, where spending increased 53% over the prior year, we are developing next generation equipment across all product lines to provide performance improvements in wafer trim, improve throughput and accuracy which will enhance the cost and effectiveness of wafer repair, and the developing market for die and marking is where we will improve the performance of our chip scale packaging platform which is currently being used for production at customer sites in Japan, Taiwan and Korea.

Additionally, 4 new laser products are being introduced during the first half of this year which will offer more cost effective solutions with improved margins. Additionally, several new component products are under development for introduction later. Looking forward into 2005, we still remain limited in visibility to about one quarter at best. In view of the slowdown in the order rate during the third and fourth quarters, we are planning for a reduction of total sales year over year by about 10 to 15% for the full company. Therefore, with the reduced revenues in our forecast, we are focusing on managing margins and cash flow in a softer market environment for the foreseeable future until we have some signs of improvement in the market. We expect to remain profitable with positive cash flow throughout the period. At this time, Tom and I are available to answer your questions. Operator, please proceed to the questions.

[OPERATOR INSTRUCTIONS]. And your first question, gentlemen, comes from the line of Jim Ricchiuti of Needham & Company. Please proceed.

Thank you. Good evening. I wonder if you can talk a little bit about the decline, the sequential decline that you saw in the component business. Can you talk about the specific areas of weakening or softness you’re seeing in that area of the business, Chuck?

Yeah, we’re seeing some slowdown, not a dramatic fall off, but some slowdown in the printed circuit board production equipment area which is spindles. We sell spindles, as you know, Westwind drilling spindles. So we’re seeing some moderation of orders. We were at a very, very breakneck pace last year for most of the year and we were running 3 shifts 6 days a week. So we’re seeing some slowing down of the order rate coming in, but it’s being done in a very deliberate, paced way. We’re not seeing just a mad falloff. And then data storage, they had a very large buildup in the middle of the year by the data storage people to supply disc drives for PC sales and laptop sales which was very strong, as you know, in the Christmas season this year. So that’s slowed down. Some of it’s seasonal. Some of it is probably due to slowdowns that is not seasonal. We’re not sure how much of which is which at this point.

Okay, so just as you look at the March quarter in terms of the component business, you probably see a continuation of those trends?

We would expect to see, again, some continuation of the trend in the PCB area. But I think in the data storage side, we’re already at the bottom.

Okay, and that would argue that perhaps the gross margins in this business begin to improve sequentially, just given the mix?

Yes, this is where we’re looking at the combined issue of the drop in volume and then we do have the cost improvement programs that we’re going through. Based on what’s happened with the falloff in volume, we’re projecting the margins to, company wide, run in the 40 to 43% range. When we look at this quarter on a normalized basis, they drop down to 37% across the company and that - - you add back to that 2 points of things that we call nonrecurring or unusual adjustments, so that takes us down to that 37% level. We do expect our cost reductions are going to come in and have impact and that’s what will get us back up to the targeted range of the 40 to 43%. We were thinking 45, but with the drops in volume, that’s pulled us back a little bit.

Tom, can you say what the increase in sales were excluding Westwind and MicroE? Year over year.

The year over year increase in components, without MicroE?

Yeah. Or you could just do - - I was just curious on the overall top line.

Yeah, we don’t break down into the product lines, but obviously the growth drivers were MicroE and components from last year to this year. I think we had $79 million as the number in my statement that is attributed to those two product lines for the year.

For the year, okay. And just one final question if I may. Chuck, I wonder if you could just talk about - - I mean, it sounds like you’re cautious with respect to the systems business. Thus far in the quarter you’re seeing, again, similar types of trends. I wonder how you would characterize the memory repair business through the first two months of the year.

Well again, we don’t want to get into product line detail.

Okay. How about just a - - more broadly speaking then, just the systems business in general - - the order trends through the first 2 months of the year.

Well, we provided the general guidance which we think will be down in the 10 to 15% range. Right now as we look at the different business segments, we think the systems business will probably fall off proportionately more than the others. The same will be true for the lasers. The least fall off will be in the components business. But a lot of these things are in flux so it’s hard to really guess since we’re not looking at a full quarter of orders to know where things will actually be placed in the end. We’re just trying to provide a general guidance now.

That’s actually very helpful. Thank you.

Thank you very much, Sir. Ladies and gentlemen, your next question comes from the line of Jed Dorsheimer of Adams Harkness. Please proceed.

Hi, guys. Thank you. I guess maybe just a follow up on the last question. Is there something that occurred during the quarter where you saw rapid fall off in the memory repair? Because I thought things were going fairly well there.

We haven’t seen a rapid fall off in memory repair. As I said earlier in my remarks, we saw a major fall off in the third quarter from the mixed signal business and the continued deterioration there. I think we’re near the bottom on that and we saw some slight decreases in orders in memory but nothing for us to worry about. That’s going to go up and down a certain amount. There’s a certain degree of fluctuation that goes on order month to month, quarter to quarter.

Gotcha. Any clue - - can you give any specific commentary with respect to, I guess - - asked a different way - - are you still seeing a benefit from the transition in the memory repair to the 300 millimeter?

We are. We’re seeing good order rate coming into memory and we’re also seeing very good order rate coming in on the wafer marking equipment which is driven solely by 300 millimeter. There is some fluctuation up and down quarter to quarter, month to month, based on when orders get placed, but we’re not terribly concerned about that piece of it.

Gotcha. Thanks. Moving over to the components - - the MicroE business, I think your commentary was that that was about sort of an $8.5 million sort of run rate. Is that business changed and how should we view that going forward from a revenue perspective?

Well, that was what we had cited at the time of the acquisition. Certainly that will fluctuate. Like other product lines, they’ve been impacted. Particularly data storage was one of the strong points when we made the acquisition. But we’re not really commenting on that product line as a standalone. It‘s all part of the [inaudible] group.

All right. And I guess the reason for my question is, when I look at the MicroE, my assumption is that that business, I think, had some of the highest margins in the components business, the component line. And I’m curious as to why margins are getting hit a little bit hard in the components, particularly if where you’re seeing a slowdown is in the Westwind basis as I thought that that had some of the lower margins. Could you help me out and just give me some guidance on where I might be making a wrong assumption there?

Well I think I’d approach it this way, Jed, and that is the sales were higher in absolute terms from the Westwind product as you know from when we acquired the company compared with MicroE and the margins were lower for Westwind than MicroE. But MicroE, having less sales in absolute dollars, is taking a harder hit on a drop off in sales than is Westwind.

All right. So in the lower sales rates, are the margins then of the MicroE below the corporate average?

Well, we’re not going to get into that.

Yeah, we don’t go into the product lines.

Again, we’re starting to flirt with bringing in product lines, and we can’t get into that much detail.

All right. As we look at that business going forward, if there isn’t a large snap back in sort of the MicroE, is it fair to say then we should look at this margin levels for the components as sort of a rate going forward for this year at least?

Well, we’ve got - - the thing that gets in the equation here is a lot of shifts in mix. As far as influences on margins overall, we have seen some impact from material price increases. But fundamentally, we came in at an average, if you take the whole company for the quarter, of 37%. This is lower than we expected. There is some volume impact that’s probably a couple of points on the margin as a result of the sales fall off, probably between 1 and 2 points. And so that explains part of it. Some of it is a mix shift and one of the problems is these mix shifts move around quite a bit from quarter to quarter and they can have a 1 to 2 point impact fairly easily. We’re looking at also the effect of material price increases in other things that are coming into the equation. At the same time, we‘ve had programs to reduce costs, and when those come into play and they will start having impact, and some of those have come in and had impact and they’ve been washed out against the negative factors. But we expect the trend as we go forward, we’re gradually going to improve and we’re targeting that 40 to 43% at the current volume levels at the end of the year.

There’s 2 other factors, Jed. I mentioned, we are expanding, dramatically expanding our production facility in China, and moving some of the production, actually some serious levels of production, from Westwind over there and also from the U.S. over there. So that will improve margins. We expect to see that happening in the fourth quarter And assuming that the Westwind orders slow down a little bit further, and that we do gain more traction in our recovery in the other product lines in components where we had some quality problems, basically the scanner product line, which is now fixed and we’re getting orders back in the flow from bigger customers. Assuming that starts to shift, that’s a higher margin also, so that could be some health as we go through each quarter.

Gotcha. Two last questions. One, as we talk about the Westwind business in particular, when I was over at your facility in Poole, I noticed that there were a decent amount of temporary workers in that facility. If that is slowing down, what will the impact be to the SG&A because I saw that SG&A is at that 17%. Going forward, how much will that reduce the SG&A as a percentage of revenue?

Probably you should look at SG&A as relatively fixed. And we did note that we had some credits this quarter. I would look at that level going forward.

In absolute or percentage of sales?

I would tend to think - - because SG&A expenses tends to move much more slowly up and down that they will tend to pretty much be reasonably fixed.

The temporary labor, there was quite a bit of that on the work force for production up in the variable margin line, labor, and those people have been attriting away. We’ve been having attrition in there commensurate with reduction in orders.

I’ll pass it on, thank you.

Thank you very much, Sir. Ladies and gentlemen, again if you have a question, please press start one now. Your next question comes form Susan Streeter of Sprott Securities. Please proceed.

Thanks. Good afternoon. I was just wondering if you could talk a bit about the operating model given that you’ve made a shift in what you anticipate from a gross margin assumption standpoint? I guess, are there other line items then that you would expect to - - obviously, beyond the 17% operating goal becomes that much more challenging?

Yeah, I think the point is we are still leaving the target where it is. I think we’ve got some issues with volume. We’re not sure how long we go through the period that we’re in, but we’re still trying to get through the fundamental business model is getting the gross margin in a 45% and the SG&A at 17. When we go through a downturn, these won’t necessarily hold, but than at the same time, we’re not sure how long the downturn lasts. When we did our planning, we had expected an up tick in the last part of the year and we’re still waiting to see what happens in that regard. We’re just not as optimistic on it.

Okay.

Yeah. The model, Susan, as you recall, was based on our having run rates up above 300 million and growing 330, 350 million. Sustaining that kind of a run rate would allow us to achieve a 45% gross margin and 17% operating was our target. We expect to maintain about the same percentage rate on engineering and try to maintain the gross margins, as Tom said, in the 40 to 43% range. We think it’s going to be tilted in volume terms. And we’re not expecting this, as I mentioned to you on several occasions, we’re not anticipating this to be a very severe fall off as it was in 2001, 2002 in either the amplitude or the duration. We’re expecting this to be not much further on the downside than we’re talking about now, and hopefully a recovery, if not by the end of the year, in the beginning of next year. I guess you would have a better handle on that talking to other people.

Right. Okay, I appreciate that. And just on that tax rate, I think it states in the press release that you expect a more normalized tax rate in fiscal 2005. Should we assume a 35% range?

Yeah, I think it will probably be in the 35 to 38% range, somewhere around there.

On that note, Susan, it’s a pleasure to be paying taxes.

Okay, and just lastly, you talked about trying to transfer some production to areas of Asia. Is that, just so I understand correctly, is that primarily from the component side of your business?

Components and lasers. There are some lasers that we’re going to be building there as well. And we are moving into a larger facility in the April timeframe and shipping equipment over to that facility. We already have a facility there with about 20-odd people. We’re going to be increasing that to 80 to 100 people by the end of the year and producing components and some lasers there. So that should give us some impact on improving the margins. So we’re trying to run counter to the volume decrease.

Okay, thanks. That’s great.

Thank you very much, Ma’am. And again, ladies and gentlemen, if you have a question, please key star one now. And our next question comes from Luigi Dippidi of BMO Nesbitt Burns. Please proceed.

Good afternoon.

Hello, Luigi, how are you?

Good. How are you. We haven’t seen a lot of press releases in terms of your laser systems business recently. Is that due to a fall off in sales or is there some marketer lack there?

I think it more reflects just the general decline in the market.

I think it’s the orders have been smaller. We only announce an order when it’s a significant one, in the $5 million and higher range, so I think we’ve been seeing more orders of 1 or 2 or 3 systems at a time which would be under the radar screen.

I see. Okay. And just one final question. In terms of revenues year over year, you’re expecting to see revenue decline of 10% year over year? Just to clarify?

Yeah, we put it in the range of 10 to 15%.

Okay, thank you.

Thank you very much, Sir. And again, ladies and gentlemen, if you do have a question, please key star one now. At this time, we have no further questions.

Well, in that case, we want to thank everybody once again for attending our conference call and Tom and I look forward to seeing you in person in the near future. And we wish you all a very good evening.

Thank you very much, ladies and gentlemen for your participation on today’s conference call. This concludes the presentation and you may now disconnect. Have a good day.