Novanta Inc (NOVTU) 2011 Q3 法說會逐字稿

Good afternoon. My name is Steve, and I will be your conference operator today. At this time I would like to welcome everyone to the GSI Group third quarter 2011 earnings call. (Operator Instructions). Thank you. I will now turn the call over to Tim Spinella, Assistant Treasurer of GSI Group. Please go ahead.

Thank you very much. Good afternoon, and welcome to GSI Group's third quarter 2011 earnings conference call. With me on the call are John Roush, Chief Executive Officer of GSI Group and Robert Buckley, Chief Financial Officer. If you have not received a copy of our earnings press release you may get one from the Investor section of our website at www.gsig.com. Please note this call is being webcast live and will be archived on our website.

Before we begin, we need to remind everyone of the Safe Harbor for forward-looking statements that we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. We may make some comments today both in our prepared remarks and in our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. You should not rely on any of today's forward-looking statements as representing our views as of any date after today.

During this call we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures we plan to use during this call to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP in the earnings press release, we will provide a reconciliation promptly on the Investor Relations section of our website at www.gsig.com. Now I am pleased to introduce the Chief Executive Officer of GSI Group, John Roush.

Thank you, Tim. Good afternoon, everybody. Welcome to our call. Thank you for your continued interest in the Company.

So I am pleased to report that GSI delivered a strong quarter of financial results in Q3. We had revenue of $93.3 million, earnings per share of $0.26 and adjusted EBITDA of $17.2 million. We are indeed proud of the fact that our results are consistent with our prior Q3 guidance despite the fact that we have seen now a significant downturn in the microelectronics markets that we serve.

We were also very pleased to complete our debt refinancing which closed in October. Despite a somewhat challenging lending market in the late summer, we secured a credit facility with extremely favorable pricing which gives us greater capacity to execute on our strategic initiatives.

In terms of the strategy, I would like to provide some updates on the Company's progress in several areas. In terms of our growth priorities, I did speak on our last call about our strategic focus in three areas. Those would be scanning solutions, fiber lasers and medical components. During the quarter we saw a strong progress in all three areas.

On the laser scanning side we had numerous design wins in promising new application areas. I would say probably the best example was in lithium ion battery production for the automotive market where we won six scanning solution programs with different producers all of whom are using scan lasers to replace traditional stamping processes in the plate fabrication.

We also recently shipped our 1 kilowatt fiber laser which went to an industrial materials processing customer in China. This is an important step in broadening our fiber laser product range which now covers customer needs from 50 watts up to 1 kilowatt. We are seeing significant fiber laser demand often from customers within our own install base of lasers where our detailed knowledge of the applications provides us with an important advantage.

In terms of medical components, we had a number of significant design wins focused on applications such as surgical robotics, bedside patient monitoring, and opthalmology equipment. We expect these programs to ramp up and begin to contribute meaningful revenue over the next several years.

Now shifting to the productivity side, I will note that in recent months we have been reviewing the entire footprint and infrastructure of the Company to map out the optimal structure for GSI going forward. As a result of this process, we are now launching a significant integration and realignment initiative which we are calling 12x12. The purpose of the 12x12 plan is to streamline and simplify our structure by eliminating twelve of our facilities by the end of 2012. This will be accomplished by a combination of site consolidations, closures and proposed divestures. The 12 sites are a mixture of manufacturing and R&D facilities as well as international sales offices.

The 12X12 program has a number of district projects and initiatives within its scope. These various projects will be implemented beginning in Q4 of this year and continuing throughout the course of 2012. We expect to realize as much as $5 million of annualized savings from the overall program. 12x12 is an important step for GSI in rationalizing the Company's historically complex footprint.

We believe it will be highly beneficial for us to operate in a smaller number of locations each of which has greater critical mass. This structure will not only enable us to expand our operating margins, but it will also enable a greater level of collaboration across the organization and it will let us operate in a simpler and more nimble and effective manner. We view this program as realizing much of the potential that was contemplated at the time of the GSI Excel transaction.

So in recent months as we have been developing a tighter focus for our strategic growth priorities and planning for a more streamlined structure, we have been giving careful thought to our core competencies as an organization. It is increasingly clear to us that GSI's ideal focus is in supplying highly engineered precision components and subsystems to OEMs. Our products, technologies, channels to market and business processes are best suited to the OEM markets.

So in keeping with this OEM focus, as we mentioned on the last earnings call, we have placed our two laser systems businesses operating under the Control Laser and the Baublys brand names under strategic review. Following this review we have now concluded that the best course of action for those two businesses is to move forward with a plan to exit these businesses. We're currently exploring our options for the exit of the businesses and will provide a further update at our year end earnings release conference call.

In addition to those two businesses, we are now as of today placing our semiconductor systems business under strategic review. In the coming months we will be exploring our strategic alternatives with respect to that business and will provide updates on the process as appropriate.

So in aggregate the businesses that we now have under strategic review are expected to contribute approximately $60 million to $65 million of revenue in 2011 with operating profitability significantly below the Company's overall average. So with that I would now like to turn things over to our CFO, Robert Buckley, to provide some more detail on the financials. Robert.

Thank you, John, and good afternoon, everyone. I will now provide some additional details in the third quarter results. Despite some strong economic headwinds, the Company delivered on its guidance and demonstrated another solid quarter of financial performance.

For the third quarter of 2011 GSI generated revenue of $93.3 million, an increase of 2%, from $91.5 million in the same period a year ago and within the guidance range we provided in the second quarter.

Our Laser Products division generated revenue of $34.2 million, an 18% increase compared to $29.1 million in the third quarter of 2010. The revenue increase was driven by strong demand in our fiber lasers, industrial lasers and high power solid state lasers which serve a variety of end markets. This was partially offset by weaker demand in our CO2 lasers which suffered from destocking at our OEM customers as a consequence of the economic uncertainty felt over the last few months.

Our precision motion and technology division generated revenue of $48.9 million, a 3% decrease compared to $50.5 million in the third quarter of 2010. The revenue decrease was driven by a decline in our air bearing spindles components business which began to trend down due to a slowdown in the microelectronics markets.

This was partially offset about growth in our optical scanning business known as Cambridge technology. While our optical scanning business also began to experience the same destocking trends at our OEM customers, strong underlying demand in lasers, coupled with continued market penetration of scanning applications, offset these headwinds in the quarter.

Our semiconductor systems division generated revenue of $10.1 million, a 16% decrease compared to $11.9 million in the third quarter of 2010. However, in the third quarter of 2010 the Company recognized $1.5 million of revenue in our semiconductor systems business that had been deferred from orders placed by customers prior to 2009. There were no comparable amounts for the third quarter of 2011. This was partially offset about I sales increases in our memory and wafer market equipment product lines.

Despite the overall weakness in the Microelectronics our semi system has been able has been able to mitigate this through new product introductions most recently penetrating LCD markets. Overall from an end market perspective our businesses saw the greatest weakness from the electronics markets which represented about a third of our business. While sales to industrial markets remained relatively stable, there were pockets of customer destocking trends as customers hedged against the economic uncertainty.

Turning to our profitability. Third quarter gross profit was $40.9 million or 43.9% gross margin. This compares to a similar gross profit in the third quarter of 2010 despite shifts in the overall product mix.

Laser Products third quarter gross profit was $12.9 million reflecting a 37.8% gross margin. This compares to $11.7 million for the third quarter of 2010 40.4% gross margin. The change in gross margin was primarily attributed to less favorable product mix.

Precision Motion and Technologies third quarter gross profit was $23.2 million reflecting a 47.5% gross margin. This compares to a $23.7 million for the third quarter of 2010 or 47% gross margin. The change in gross margin was largely attributed to a change in product line mix helping to offset the drop in volume.

Semiconductor Systems third quarter gross profit was $4.7 million reflecting a 46.9% gross margin. This compared to $5.5 million in the third quarter of 2010 or 45.8% gross margin. The improvement in gross margin was due to better inventory management.

Operating expenses represented 30.4% of sales, down 220 basis points from 32.6% in the same period a year ago.

Third quarter operating income increased to $12.5 million from $11.1 million in the third quarter of 2010. While operating margins increased 130 basis points to 13.4% versus 12.1% of sales in 2010.

Adjusted EBITDA, a non-GAAP financial measure, was $17.2 million. This compares to $16.8 million in the third quarter of last year.

Net income for the third quarter was $8.8 million, up $8.7 million from the third quarter of 2010. Earnings per share in the third quarter were $0.26, up from zero in the third quarter of last year.

Turning to the balance sheet, we finished the third quarter with $50.7 million of cash. This follows the Company's redemption of $35 million in aggregated principle amounts of our outstanding $108.1 million, 12.25% senior secured PIK election notes. This brought our debt balance down to $73 million as of the end of the third quarter.

Consequently, we finished the third quarter with approximately $22.5 million of net debt. This represents a $28.3 million improvement in net debt since year end 2010. As a reminder, net debt is a non-GAAP measure. We define net debt as total debt minus cash and cash equivalents.

In addition, as you saw in our October 19, 2011, press release, we refinanced all of our remaining senior secured PIK election notes through the proceeds from a new $80 million senior secured credit facility with three premier global banks. This new facility substantially lowers our financing costs, greatly improves our overall capital structure, and provides us with greater flexibility both operationally and strategically. We are pleased to have another great milestone achieved and to have established ourselves as an attractive business with a more traditional lending community.

Finally, free cash flow, also a non-GAAP measure, which we define as cash flow from operating activities, less capital expenditures, was $11.9 million in the third quarter of 2011 representing 135% of our reported GAAP net income. This concludes my prepared remarks. I would now like to turn the call back to John Roush.

Thanks, Robert. Now I would like to comment on our business outlook. As I mentioned earlier in my remarks, we were pleased with our results for the third quarter, but we did see a marked deterioration in the microelectronics markets during the quarter. Our semiconductor and PCB related customers began to significantly reduce their orders and their future forecasts during the latter part of Q3.

So based on detailed discussions that we've had with our customers, we now believe this downturn will primarily impact Q4 this year and Q1 of 2012. Thus, we now expect revenue for the full year 2011 to be in the range of $365 million to $370 million with adjusted EBITDA between $63 million and $66 million.

With respect to 2012, it is still early in our planning process and we do face continued economic and market uncertainty. Though we expect some weakness in the microelectronics markets in the early part of next year, at this point all indications are that we can expect 2012 to be a year of continued growth in revenue and profit for GSI. Though the economic scenario could certainly change, our current view of the full year 2012 is that we expect to see mid-single digit revenue growth and adjusted EBITDA growth of at least 10%.

So that now concludes our prepared remarks. I would like to open things up to your questions and when we're done with the questions, I will then briefly wrap up the call. So, operator, we can proceed with questions.

(Operator Instructions). Your first question comes from the line of Lee Jagoda from CGS Securities. Your line is open.

Good afternoon.

Hello.

My first question relates to your 2012 guidance and just to clarify, what base number are you using for 2011?

Our 2011 guidance.

Our 2011 guidance. We that said we expect to end the year with $365 million to $370 million of revenue, so --

So you're including all the businesses currently under strategic review in your 2012 views?

Yes.

Although I would say it is not necessarily the case that you get a materially different growth rate in or out. The strategic review relates more to our view of core competencies and long-term strategic alignment of this company relative to some of the systems business. It isn't the case that they have necessarily a dramatically different growth rate next year.

With that being said, we will update to the degree that those businesses are divested which we haven't concluded on, but if those businesses are divested then we'll update the guidance at that time.

Great.

But those businesses are not being put into discontinued operations or anything, so they're still going to be a part of the numbers and the reporting until such time as there is another event that would indicate otherwise.

Right. Are you also able to give us some segment trends embedded in that revenue view of mid-single digits?

Certainly we can say that anything that is touching microelectronics is going to have some challenges in the early part of the year. So obviously to the extent semiconductor systems is still part of the portfolio, which it is at present, it's got some challenges in the earlier part of 2012. And a number of our other businesses on the component and subsystems side are supplying into either PCB or semiconductor applications and so they're impacted. So you do see that.

Probably less of an impact in the laser businesses. I would say laser was probably more affected not as much by direct exposure to semiconductor, it was really impacted probably more by the destocking phenomenon which I would call that a general hedge on economic concern. At some point, Labor Day and beyond, we started to have customers getting nervous about the economy itself and just thinning out inventories and being much more conservative, so it wasn't directly a tie to semiconductor and electronics.

Great. One more question and I will hop back in the queue. Once the businesses are disposed, if they are in fact disposed of, what would the Company's exposure to microelectronics be after the disposals?

Well, we haven't gone through that analysis yet. The laser system businesses are less exposed to the --

They have some, though. Obviously the semiconductor systems business is a reporting segment, so you can see how big that is. That's essentially 100% microelectronics.

The other businesses have some, but it is limited. There is some failure analysis business that is embedded within laser systems, basically decapsulation, and which is not part of semiconductor production, but those systems are used in failure analysis within semiconductor.

So, so it will change it. We'll have to do kind of the new weighted average, but it will certainly be significantly less if we do ultimately end up exiting semiconductor systems. But that hasn't been concluded yet. What's been decided is that it is under review.

Great. Thanks very much.

Okay. Thanks.

(Operator Instructions). Your next question comes from the line of James Lee from Potrero. Your line is now open.

Just jumped on the call. Apologize if I repeat some of the earlier questions. Regarding guidance, if you exclude the three businesses that are under review, would you say the revenue growth for 2012 will be higher than the single-digit that you guided to?

Yes. I mean, we did kind of comment on that. Let me reiterate for you. The strategic review is really not related to our view of next year's growth. It is much more of a function of the core competencies of the Company and where we want to invest, where we're better able to leverage our capabilities in the end markets and business systems. And the systems businesses really have different needs and different requirements and sort of a different business system that you deploy to be successful. It is not a function of growth.

As we review the operating plans and the forecast across all the businesses, we don't necessarily see the systems business are particularly weak next year. That if you exclude them you get a much different result for everything else. That's not necessarily the case.

There certainly would be less volatility because all of the systems businesses have a lot of volatility, and of course you would have this issue of the earlier in the year some of our microelectronics exposure is concentrated in semiconductor systems, but we do have a fair amount that is in other places.

We said I think in Robert's remarks that microelectronics contributed something like a third of the overall revenue. Semiconductor Systems is not a third of the overall revenue. You can do the math yourself, but it is on the order of a $40 million to $45 million business, so it is only 12%, 13% or something like that. So you still got significant exposure elsewhere.

So I am not sure you really get a different answer materially in what our revenue guidance would be. It is more of a strategic question and a volatility question, and it is also a margin question. Those businesses are lower margin on average than the rest of the Company.

So revenue growth may still be the same, but sounds like if you divest those today, the EBITDA guidance would be a lot higher because the margins are better?

As a percentage it would certainly be higher, Yes. They do have EBITDA, though, so the absolute number just on the face of it, the absolute number doesn't go up if we exclude them. They have positive EBITDA.

Right.

But it is a lower percentage, so it would be accretive to the margin to exclude all of those businesses.

Okay. And then on the cash flow, you guys have done a great job in generating cash flow this year. If I look at 12 months I believe you have about $30 million in free cash flow. And if I add back cash interest that you guys paid, it looks like you guys had about $45 million in unlevered free cash flow generated by the business over the past 12 months. Is this the right level free cash flow we can think about going forward, or even next year given that you also are thinking about EBITDA growth of 10% next year?

I would say that the cash flow as a percent of -- free cash flow as we measured as a percent of our net income wouldn't really change dramatically going into next year, and thereby the generation of cash you have wouldn't change dramatically going into next year. It is going to grow along with the growth in the business itself.

Okay. Great. Lastly, were there any impact on Thailand that's impacted some of your competitors?

Yes. It wasn't a dramatic effect for us, but we did have some impact that we're starting to see now. We do supply some precision optical encoders that is go into basically the disk drive application. They're used to kind of calibrate as they right the tracks in disk drives and they're trying to write them very close together to get more density. They need to track that carefully, and we provide encoders to measure that.

So that business has seen some impact. It is not what I would call extremely material, and it is primarily hitting Q4. It is one of the additional reasons why our guidance is where it is. It is not a huge deal relative to the microelectronics downturn in general which had the bigger effect.

Great. Thank you.

Thank you.

(Operator Instructions). Your next question comes from the line of Chris McDonald with Kennedy Capital. Your line is now open.

Good evening. Thanks for taking my questions. SG&A was down nicely both year-over-year and sequentially, and I was wondering if you could just expand on that a little bit, Robert.

Yes. As you know, we have been running with redundant costs as a consequence of having a number of temporary employees on board. We have completely restaffed the corporate function at this point in time, and so what you are seeing is a pairing back of that redundancy. As I look out, I think the SG&A as a percent of revenue in the third quarter will probably hold true for the rest of the year. Then we're looking at initiatives, obviously 12x12 initiatives drive it down further.

Okay. Great. In the tax refund or the potential tax refund, $19 million or so, can you provide an update on its current possible magnitude and timing?

All I can say is that we're continuing to negotiate with the internal revenue service on trying to receive the money that they owe us. Those discussions are ongoing, and I hope to have further update at our year end.

Okay. Great. And then maybe, John, if you wouldn't mind providing a little more color on what else is going on from a vertical market perspective. You're seeing how the scientific research market might be going. You obviously touched on microelectronics and industrial. But just any other areas where you are seeing particular strength or changes in demand.

Well, I would say the scientific business has done reasonably well for us. It is so episodic that it is really always kind of hard to discern a direct market trend. I don't think we're a big enough player that you could say if we see the business up or down maybe that's correlated to funding trends out of government programs or anything. It is so episodic for us, but it has been relatively healthy.

We've had a good pipeline of opportunities and it is never necessarily a high grower on average. It is always what I characterize as low single-digit growth type of business. But it is holding its own now. So that's scientific.

Industrial I think the underlying demand we're seeing in industrial markets is still decent. The problem is this destocking phenomenon that nobody feels extremely comfortable right now that they're going to have -- there was 2%, 2.5% growth in the US in the quarter and GDP. And everybody is experiencing this kind of sluggish recovery phenomenon.

But people don't know if it is going to last, so they don't want to be sitting on inventory. They don't want to place orders out into the future and be committed. So we see that phenomenon in the industrial markets.

So in some cases we have people say, "look, the business is there but I want to cut back my component orders," and that is the downside of being an OEM provider. There is lots of advantages to being an OEM supplier. The one downside is people can contract their on hand inventory of your product, and it is not even a reflection of their demand, but just more a reflection of their concern. So we see that, but I am reasonably optimistic as we head into next year the industrial markets will be fine. They're not going to be high growth but I think they're going to give us growth.

Medical is an area where we're seeing good traction. We have a pretty small medical business today. It is growing, and it is profitable and it has a ton of opportunity. It really wasn't even seen to be a market of interest in the Company until very recently.

It was just medical business sprinkled here and there in different product lines with no real thought to it, but we're now strategically looking at it and focusing on it. And Jamie Bader, who is the group President of our Precision Motion business, is also kind of taking a role to focus our medical activities. And there is just a ton of opportunities, so I would be very bullish in that area next year.

Okay. Fantastic. Then just one more. With the 1 kilowatt fiber laser actually being delivered, obviously a meaningful accomplishment for the Company. Can you maybe walk through the thought process on the best way to attack that market, and to the extent you're willing to layout, maybe product plans ongoing even further up in power, if that's part of what you're thinking is possible here over the intermediate term would be nice just to get more insight on the strategy as it relates to fiber laser. Thanks.

Sure. Well, I mean, it is a big milestone for us. It has been a couple of years in the making to have a 1 kilowatt product. We were primarily operating in the 400-watt and below type of market. But fiber lasers are modular. If you have more powerful l module you can combine those, and that's how we got ourselves to the kilowatt product.

Really our focus now is primarily working with customers we know and applications we know. We are quite a small player at this time in this market, and so a frontal assault on some of the larger players, on IPG and others, would make no sense. Really we see our role as to work with customers we know on applications we know and maybe even in some cases supplied into those applications with solid state lasers for decades. And to help those customers adapt to the fiber laser which is a different technology. It gives you different beam quality, different thermals, different cost of ownership and all of this and different properties on the material you're processing, whether you're cutting or welding, or what have you. That's really the strategy there.

In terms of how quickly you are going to see us go beyond the kilowatt, well, we do have multi-kilowatt products on the road map. I think the bigger opportunity for us now is to really build out the 1-kilowatt business.

We shipped the first one. We have several other essentially sold systems in the pipeline that we're in the process of fabricating those systems. And I think we really want to over the next year solidify ourselves as a credible supplier of the 1-kilowatt. That's going to be a really important step for us.

And we're working a lot also on the supply chain side, on the IP side, we do have a number of patents and IP of our own in fiber lasers. And so we are working on IP,we're working on the supply chain and manufacturing processes, and we have plenty to do here. I think we have a good line of sight to the goals that we've set for ourselves, and eventually they will include multi-kilowatt. But unlikely next year.

Okay. Great. Thanks a lot, and nice results.

Thank you.

Your next question is from the line of [Steven Merrier from the Merrier Group]. Your line is open.

Thank you, gentlemen. Congratulations on great results. Do you plan on attending any investment conferences in the near future as a way of getting the positive story of GSI out into the public some more?

We do. I will comment on that in just a few minutes in my closing remarks.

Okay. Thank you, John.

Your next question is a follow-up from the line of Lee Jagoda from CJS Securities. Your line is open.

Just looking at your 12x12 plan, is there a way for you to give us a road map to the ramp of facility closures over the next twelve months, and whether or not we should expect any in 2011. And then to follow up on that, could you break down the $5 million of annual cost savings between cost of goods and SG&A?

Not at this time. What I would say is that we're in the early stages of this. We're communicating this internally. We're firming up our plans. We'll have those finalized by the end of the year. I wouldn't expect any site closures this year. As we look forward into earnings release for the year end results, I think you will get a lot more detail at that point.

We have it mapped out, okay, but there is a lot of internal communication that needs to occur and sequencing and prioritization. Not all of the 12 facilities are production facilities. I mean, actually five of them are production facilities of one type or another, and there is a lot of steps that need to be laid out to accomplish all of that.

We'll be communicating that in good time, and a breakout of what the savings is going to be and what the one time costs are. We're not prepared to do that here today.

We look forward to hearing more about it.

Terrific.

(Operator Instructions). There appears to be no further questions. I will turn it back for closing remarks.

Thank you, operator. So as we move onto the final stretch of 2011, I think we can all see that we made significant progress here at GSI this year. We now have a much clearer vision for the Company's growth and a road map for how to streamline our operating structure.

We've put a strong leadership team in place that's capable of delivering on our plans while creating an enthusiastic and high achieving culture across the Company. We're all genuinely excited about the prospects of this company and we have clear priorities. In 2012 we'll take major steps to implement those priorities and realize our vision for the Company.

In closing, I would like to mention that Robert and I will be presenting at the CJS Securities investor conference on January 11 in New York. We look forward to possibly joining some of you there as well as on our fourth quarter 2011 earnings call in March of next year. Thank you all for listening, and thank you very much for your interest in GSI. The call is now adjourned.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.