Novanta Inc (NOVTU) 2012 Q2 法說會逐字稿

Good afternoon. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group second quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions.)

Mr. Tim Spinella, Assistant Treasurer of GSI Group, you may begin your call.

Thank you very much. Good afternoon and welcome to GSI Group's second quarter 2012 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've not received a copy of our earnings press release, you may get one from the Investors 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've 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. So 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 reconciliations promptly on the Investor Relations section of our website at www.gsig.com.

I am now pleased to introduce the Chief Executive Officer of GSI Group, John Roush.

Thank you, Tim. Good afternoon, everybody. Welcome to our call, and thank you for your continued interest in the Company. So as we report our second quarter results, I'll say that it was a challenging quarter in that, on the one hand, the Company did execute very well against the agenda that we had laid out for ourselves, and we are proud of what we accomplished with that. But on the other hand, the market environment that emerged during the second quarter, late in the quarter, was a major disappointment to us, and it has had an impact on our results and our outlook.

So as you take a look at our numbers, it's important for you to note a few key things. First, if you've had a chance to look at our press release, you'll see that we moved our semiconductor system and laser systems businesses to discontinued operations. This obviously does change the baseline level of our numbers, and we'll be commenting about that in some detail on this call. The use of the discontinued operations treatment beginning this quarter reflects the fact that our divestiture processes were far enough along at quarter end that this accounting treatment was appropriate.

The second thing you'll note, as I mentioned, is that our results were impacted by a sudden and significant deterioration in market demand during the quarter. At the end of the first quarter and into the first two months of the second quarter, we had experienced very strong order rates and encouraging signs of recovery in most of our lines of business. However, towards the end of May, we saw order rates significantly deteriorate, first in Europe, then in China. The sudden decline in our OEM customer demand was linked to significant drops in manufacturing activity, which impacted both our industrial and microelectronics markets, as well as some delays in government research funding, which impacted our scientific laser business.

The magnitude of these changes was not originally contemplated in our revenue and earnings guidance. However, despite this weakness, we were able to deliver within our original guidance range, achieving approximately $86 million in sales and over $13 million in EBITDA when adding back the results of our now discontinued operations to make a valid comparison of actual results versus our guidance. We also finished the second quarter with our cash position exceeding our debt balance by $3 million, which was also in line with our expectations.

While we are disappointed in the suddenness and the severity of the market slowdown, it really doesn't deter us from vigorously driving forward with our agenda for the Company. In fact, my view is that the actions we have undertaken across GSI will position us more effectively to cope with this type of market turbulence in the future.

During the quarter we also made significant progress on reducing our operating complexity and our breakeven point. We are on track with virtually every element of the 12-by-12 restructuring program that began in the fourth quarter of 2011. Since the announcement of this program, we have eliminated two sales and service centers in Japan; relocated our scientific laser production activities in East Setauket, New York, to Santa Clara, California; closed our optics production facility in Oxnard, California; put our sales and service office in Mumbai, India, up for sale; launched the consolidation of our sales and service offices in Germany; and have made significant progress in the consolidation of our Lexington, Massachusetts, operation into our Bedford, Massachusetts facility. We remain on track to complete all elements of the 12-by-12 program by year end.

The other major focus area for us is the strategic positioning and the growth potential of our portfolio. Our agenda here is to focus organic growth and acquisition efforts on several key growth platforms -- those would be fiber lasers, scanning solutions, and medical components, as discussed on previous calls -- and also to exit our systems businesses. Taken together, these moves will definitely take us in the direction of being a higher-growth and more stable Company.

The transformation of our portfolio is not something that can happen in a quarter or two. As we sit here today, we still have a Company with a level of volatility or economic sensitivity that's higher than we'd like, but in fact, we are making very good progress on our organic growth investments, as well as our potential acquisitions.

In terms of second quarter revenue, we delivered $70 million on a continuing operations basis, with a book-to-bill ratio of 1.0. We did have a number of businesses that saw strong revenue in the quarter, despite the weak overall market. Our fiber laser business saw revenues more than triple from a year ago, with a book-to-bill ratio of 1.7. Our scanning solutions business grew 15% year over year, with a book-to-bill ratio of 1.6. Our optical encoder business grew 25%, and our color measurement business grew mid-teens percentage on a year-over-year basis. So despite the overall weakness in demand, we were pleased that we saw strength in areas where we have been specifically investing to drive growth.

From an end market perspective, we saw our microelectronics business decline 29% year over year. Scientific was down 25%, industrial was down 7%, and medical was down just 3%, primarily due to a little bit of weakness in Europe, but grew in other geographies.

In terms of profitability, on a continuing operations basis, we had second quarter adjusted EBITDA of $12 million, which is 17% of sales. We are managing our discretionary spending very carefully at this stage, and we're pleased with our level of profitability, given that our sales outlook dropped on the order of $6 million within the quarter itself.

Despite the weak market conditions, the Company executed well on a number of fronts in the quarter. From an organizational perspective, we made several key hires that will strengthen our capability. We brought onboard a Corporate Development leader with a strong background in both investment banking at Morgan Stanley and business development at Boeing. We also hired a corporate leader for our companywide Continuous Improvement Program, an individual with 20 years of operations and continuous improvement experience, including a 12-year tenure with Danaher.

We also hired a Site Operations Leader for our Massachusetts-based operation, an individual who has an extensive background of operational leadership with Ingersoll Rand, GE, and International Paper. These leaders bring significant talent and capabilities to the organization and will help to make GSI a stronger Company for years to come.

We also had three new Directors join our Board during the quarter. Harry Bosco, who was serving as CEO of Opnext prior to their acquisition by Oclaro, joined the Board and brings his extensive leadership experience in technology and business. In addition, Dom Romeo, who served as CFO of IDEX Corporation for seven years, joined our Board. Dom was instrumental in the transformation of that company and previously played senior financial leadership roles in Allied Signal, Honeywell, and several other companies. Finally, Tom Secor joined the Board. Tom previously spent five years with Goldman Sachs and brings to our Board an extensive background in finance and legal matters. And all three of the new Directors serve on additional outside boards.

Finally, as we spoke about in prior earnings releases, acquisitions remain an important part of our growth strategy. During the quarter, we continued to develop our strategic roadmap, and as part of that, we have cultivated a significant pipeline of potential acquisitions. For example, we recently completed an in-depth consulting study on the medical components market. This study identified a number of attractive market adjacencies and potential acquisition targets. Now that we have a strong Corporate Development leader onboard, we are better positioned to drive these deals forward.

As we are increasing our acquisition focus, we remain disciplined in our approach with respect to strategic fit, valuation, and multiple. But improving the portfolio is an important part of our strategy, and acquisitions will play a key role. We have a number of attractive targets in discussions, and we remain confident we will be successful in executing on this element of our strategy.

So with that, I'll now turn it over to Robert Buckley to provide some more details on the financials. Robert?

Thank you, John, and good afternoon, everyone. I'll now provide some additional details on our second quarter 2012 results. In June of 2012, the Company's Board of Directors authorized management to commit to a plan to divest the Company's semiconductor systems and laser system business lines in order to increase the Company's strategic focus on highly engineered precision components and subsystems. The Company expects to exit these businesses within the next 12 months. Therefore, we began accounting for these businesses as discontinued operations in the second quarter of 2012, and all current and prior period income statement information presented has been revised to reflect the results of these businesses as discontinued operations.

During the second quarter of 2012, GSI's continuing operations generated revenue of $70.4 million, a decrease from $82.6 million in the second quarter of 2011. Included in the revenue in the second quarter of 2011 was $4.2 million of net revenue that had been deferred under multiple element arrangements delivered over multiple periods entered in prior to the adoption of ASU 2009-13.

In addition, compared to the second quarter of 2011, our sales were also negatively impacted by the strengthening of the US dollar, particularly against the euro. This had a negative impact on our growth rate of roughly two points compared to the prior year.

As mentioned previously, our reported revenue for the second quarter of 2012 does not include $15.1 million of revenue from our semiconductor systems and laser system business lines, which are now classified as discontinued operations, compared to $18.8 million of revenue for the second quarter of 2011 for discontinued operations.

Sales of our laser product segment for the second quarter of 2012 decreased $12.3 million to $26.3 million. This was primarily due to a significant decline in sales of our specialty lasers sold into scientific markets. This business line was negatively impacted by a delay in government funding to our customers in the scientific market, particularly within Europe. However, this business also experienced some disruption from the Company's 12-by-12 restructuring initiative, resulting in roughly $1 million worth of shipments being delayed until the third quarter.

Although overall laser product sales decreased, we are seeing significant demand from our fiber lasers, which more than tripled in revenue versus the second quarter of 2011. And so a robust booking, achieving a 1.7 book-to-bill despite the macroeconomic environment.

Sales of precision motion and technologies for the second quarter of 2012 decreased 16.3% to $44.1 million. This was primarily due to a decrease in demand in microelectronics markets beginning at the end of 2011, with a particularly strong decline in demand for our printed circuit board spindles. While many of our business lines began experiencing stronger demand, the over 40% decline in our air-bearing spindles business line has more than offset their improvements.

Furthermore, the decrease in sales was also attributed to approximately $3.6 million of net revenue recognized in the second quarter of 2011 related to the adoption of ASU 2009-13.

Turning to our profitability, second quarter gross profit was $30.7 million, or 43.6% gross margin compared to gross profit of $37 million, or 44.8% gross margin, during the same period last year. The drop in gross margin was primarily caused by product mix changes, particularly sharp drops within our Westwind Spindles business, and specialty lasers business, which sells into the scientific market. In addition, we recognized roughly $1.5 million of net gross profit in the second quarter of 2011 related to the adoption of ASU 2009-13.

Laser products' second quarter gross profit was $8.6 million, reflecting a 32.6% gross margin compared to $12.3 million, or 41.1% gross margin, for the same period last year. The decline in gross margin was primarily attributable to a significant ramp-up in manufacturing costs for our fiber laser business line to meet demand expectations for this business over the next 12 months and a drop in manufacturing utilization from the lower specialty laser sales to the scientific market.

Precision motion and technologies' second quarter gross profit was $22.3 million, reflecting a 50.6% gross margin compared to $25.2 million, or 47.9% gross margin, for the same period last year. The reduction in gross profit dollars was primarily driven by the drop in the sales of our Westwind Spindles business. However, the 2.7-point increase in gross margin was attributed to a change in product mix and the completion of amortization of certain intangible assets.

Operating expenses amounted to $25.6 million for the second quarter of 2012, including $2.5 million of restructuring expenses primarily related to our 12-by-12 program. This compares to operating expenses of $25.5 million in the second quarter of 2011.

SG&A expenses for the quarter were $16.8 million, representing a decline of $1.8 million compared to the second quarter of 2011. We achieved these reductions in the wake of significant revenue pressures and while continuing to make significant investments in our people and around our growth initiatives.

As John mentioned earlier, we made considerable progress in our 12-by-12 restructuring program. At this point, all affected sites and employees have been notified, and we are well underway to meeting our cost-saving goals. In addition, we made continued progress with the divestiture process for both semiconductor systems and laser systems. We are committed to selling these business lines and feel confident that they will close within the next 12 months, but ideally, sooner. We are heavily engaged in discussions with a potential buyer for these businesses, so it would not be appropriate to expand on the process or potential proceeds at this time.

In relation to our 12-by-12 restructuring program, we incurred charges of $2.4 million during the second quarter of 2012, comprised of cash-related charges of $1.8 million and non-cash charges of $600,000.

Adjusted EBITDA from continuing operations, a non-GAAP financial measure which includes the adjustments noted in the non-GAAP reconciliation attached to our earnings press release, was $11.9 million in the second quarter of 2012 compared to $15.9 million in the second quarter of 2011. However, included in the adjusted EBITDA in the second quarter of 2011 was $1.5 million of net profit recognized on the $4.2 million of net revenue deferred prior to ASU-2009-13.

The Company reported earnings per share from continuing operations of $0.13 as compared to $0.21 in the second quarter of 2011. GAAP earnings per share were adversely impacted by the cash and non-cash restructuring charges of $2.5 million, primarily related to the Company's 12-by-12 restructuring program.

Turning to the balance sheet, we ended the second quarter of 2012 with $55.8 million of cash and cash equivalents and total gross debt of $53 million, of which $35 million is in the form of an amortizing term loan. Our gross debt carries an approximately 2.9% weighted average interest rate as of June 29 of 2012.

In addition, on July 19 of 2012, we amended our credit agreement to provide the burn-off condition has been met, which eliminates the borrowing-based financial restriction and minimum consolidated EBITDA covenant contained in the agreement.

Finally, operating cash flow from both continuing and discontinued operations was $9.8 million in the second quarter of 2012. We achieved this result despite the surprise drop in sales in the final months of the quarter at a time when we could not avoid the inventory commitments that were made based on higher sales expectations.

Turning to the third quarter of 2012, we expect market conditions to remain largely similar to what we experienced in June and July. However, we have also attempted to reflect the volatility in the macroeconomic environment in our guidance. Therefore, we expect revenues from continuing operations to be in the range of $68 million to $73 million. When comparing this to the third quarter of 2011, it should be noted that the Company recognized in that quarter approximately $1.3 million of net revenue that had been deferred prior to the adoption of ASU-2009-13.

Turning to profit, we expect in the third quarter of 2012 adjusted EBITDA to be in the range of $10 million to $13 million. When comparing it to the third quarter of 2011, it should be noted that the Company recognized $600,000 of gross profit related to ASU-2009-13.

We expect that operating expenses will see a slight decrease from the second quarter of 2012, primarily due to the benefit of the 12-by-12 program, depreciation and amortization in line with our second quarter, a GAAP tax rate of 15% to 18%, and fully diluted shares outstanding of approximately 34 million.

Finally, we expect to incur additional cash restructuring charges of $700,000 to $1.7 million and non-cash restructuring charges of up to $700,000, all related to our 12-by-12 restructuring program.

One final word on the business outlook. Because of the continued uncertainty and volatility in the macroeconomic environment, we believe it is prudent to take additional cost actions in the business above and beyond the cost savings targeted by our 12-by-12 initiative. We are currently projecting an additional $1 million to $2 million in annualized cost savings in the business lines not already targeted by the 12-by-12 program. We expect these actions will further simplify our business model. While we're still working on assessing the overall costs of the restructuring program, we are targeting a one-year payback. As such, we do not expect to see any savings from this program until the fourth quarter of 2012.

This concludes our prepared remarks, and I'd now like to open the call up to questions.

(Operator Instructions.) Lee Jagoda, CJS Securities.

So are the sales of discontinued operations needed before you can go out and make acquisitions?

Lee, it's John. Are you asking whether we need the proceeds from those divestitures to complete acquisitions?

Well, both the proceeds and whether or not you'll be preoccupied with the sale process.

Oh, just in terms of resources and the organizational bandwidth? Yes, I would say the answer to that is no. I mean, we do have a fair amount of resources working on the divestiture program, but those are either people in those businesses or dedicated to those businesses. And it's really a different group that's focusing on the acquisition side. So I think we could do one, perhaps two, acquisitions over the coming months without impacting or getting in the way of the divestitures.

In terms of financing those, obviously, it depends on the size. But generally, I would say the answer is no. We're not sitting waiting for proceeds to come in before we actually pull the trigger on an acquisition. If it's the right fit and it makes sense in the valuation and all that, and it's what we need, we're going to be able to move forward. So, Robert, I don't know if you have any additional comments on acquisition capacity.

No, I think we have enough available cash as well as availability on the current credit agreement to actually fund those transactions.

So the answer is they can have them in parallel from all dimensions.

Okay. And then just looking at your three growth drivers in fiber lasers, scanning solutions, and medical components, if you take out the revenue from the discontinued operations, what percent of revenue do those three growth engines currently make up of your business?

We haven't really disclosed the specific amounts of those, because you're getting down into competitive information that we don't really necessarily want to reveal. So that would be something we would look at in the future to break that out. But it's a smaller piece. These are areas where we're looking for a bigger increment of growth, but not necessarily a big part of the base. And when you're seeing a fiber laser business triple, then that's telling you something about, you know, that it's not that big in terms of its base that it started.

Sure. And one more question and I'll hop back in the queue. As you look at the medical component acquisitions, generally speaking, multiples in that space can be relatively rich. Are there reasons why someone may want to sell to GSI Group rather than just the highest bidder in an auction process?

Yes. We're obviously trying to steer clear of very competitive auctions and very rich valuations. And there are some of those properties in the medical space. But we did very extensive work for several months with a consulting firm that is an expert in the medical technology verticals. But then they used a sort of McKinsey/BCG/Bain style consulting approach. And we went through a whole bunch of the OEM component areas in medical.

So what we're not doing is looking at buying actual medical device companies. We're talking about the key componentry that goes into medical, which is really what we do with precision components. And there I think that some of the valuations are more reasonable. There are areas where they could be quite high, and we're being selective in looking at adjacencies that fit our core competencies, that fit our technology know-how, or fit our channels into the market, our key account relationships. So they somehow are adjacent to something we're doing, and we are finding a number of those opportunities. And they aren't necessarily the things that some may be picturing, where you do have a competitive auction and the multiples go crazy.

It's something we do keep our eye on, but I think there's enough out there that we can do some things that are affordable to us and further our strategy.

Great. Thanks very much.

Jim Ricchiuti, Needham and Company.

A couple of questions, just with respect to the decline that you saw in the precision motion and technologies, 16% year over year. That really suggests that the spindle business had a sharp decline -- I think you said 40%. But I was wondering, were there other components to that decline, just given that some of the other areas were fairly strong?

Yes, I would say the spindles effect was pretty significant in there, and so you're right to point it out. But there were other effects. I mean, a general slowdown in the environment in Europe and China is affecting more parts of that business than just the spindles. For example, the scanner business is a pretty large business with hundreds of active OEM customers, and a number of those are in Europe; quite a few of those are in China. So we saw some generalized slowdown in that area.

But that business was up 15%, though, right?

No, the scanning solutions business was up 15%. There's also a scanning components business, which is quite a bit larger than the solutions part.

Got it.

So we play at two levels of the chain in scanning with a basic galvanometer, which we would call a component, or a scanning head, which we call a solution.

And yet even with that decline, you showed improvement in gross margin. So how should we think about -- was it just the mix really tilted towards your highest-margin products?

Yes, I think that's the easiest way to think about it, is that some of the products that actually ended up being a larger portion of that business are much higher margin.

And within lasers, you called out the specialty laser business declining. It would seem like you would have also seen weakness in the lower-end CO2, the Synrad business. Is that fair to say?

Not so much. A little bit of pressure in CO2. That really came in the final month of the quarter. I would expect that they are certainly seeing pressure in the China market, but the bulk of the decline really happened from our scientific laser or specialty laser business.

The CO2 business, Jim, had really strong orders in the first quarter. And to a certain extent, that buffered them a little bit, because they just were in a better position heading into the second quarter. They did start to get communications from customers of slowing demand, particularly in China, but all in all, were able to realize a decent sales level in the second quarter because of the really strong orders they had earlier. And they're seeing some slowing from their second quarter level into the third quarter that's a carryover of that.

Okay. And for gross margins for laser products, is there any way we can think of that, how much of an impact the growth of the fiber laser business is having on your overall gross margins for lasers, just because it seems like that's a low-margin business, at least at this point. How much was specialty margins contributing to the year-over-year decline? Maybe that's a better way to ask the question.

On a dollar-wise, I would have to get back to you on it. I would say that they were -- I think you rightfully pointed out that the two larger drivers in the overall margin there were the scientific business as well as the fiber laser business. Fiber laser's a little bit more linked to the fact that we've added a lot more manufacturing capacity to that business to meet the demand expectations. And so that will even itself out a lot quicker.

And then scientific is seeing a bit of a recovery there as well, so we expect that business to come back as we get into the third quarter and be a larger contributor. But in a macro sense, fiber lasers does have a negative, or a little bit of a dilutive impact, to our margins. That's a short-term issue. We have programs in place to significantly lower that cost. As we get to 2013, I think we'll be in a pretty solid position to get that back up to the laser products average.

So this is John. I was over and spent some time with the fiber laser business just a week ago or so. And they have brought in a significant amount of labor, about a quarter to a quarter and a half before they really need that labor. They're seeing the order trends, and they're seeing when you have a 1.7 book-to-bill, that says next quarter you need to be producing more stuff. And it's a training curve in fiber lasers that's significant. It's a lot of very small, very precise types of assembly work, and we're fortunate that the labor market availability is pretty good for people who have telecom-related experience or other, have worked with fiber-type processes.

So the people are available and we've got them, but you still have a training curve there, and you can't bring them in and make them productive immediately. And we're experiencing that curve working against us now. But it will get better.

And the weakness that you saw, you began to experience in May, how did the business change through June, and what are you seeing in July? What did you see in July in terms of change? Was it a continuation of the weakness, or are you seeing any signs of areas of the business that have been weak picking up?

I would say there, and first accept that we are trying to be somewhat conservative around the guidance and provide a range and realize that there is some uncertainty here. But our general sense of things is that building off 2Q kind of environment, things are getting sequentially better in most areas, but quite modestly so. So there is not like a big snap-back, but I would say a gradual improvement in most areas.

You know, there's some exceptions. I think I mentioned a few minutes ago that the CO2 business actually has some challenges on a sequential basis. But a lot of the businesses are getting just modestly better. But as we provide guidance, we just have seen that there's a lot of uncertainty right now in the customer base, and people have these memories about 2008 and memories about slowdowns, and they just don't really want to commit to inventory of components until the demand is very firm in their eyes. So we're trying to guard against those scenarios. But we see modest improvements in most parts of the business.

Got it. Is there, just given the way you're seeing the quarter shape up, is it reasonable to assume that the gross margins are basically flat to up slightly? Is that a fair way to look at it?

I'll get back to you on that. I think what we want to make sure that we properly take into account is the dynamic where we are getting a lot of growth out of our growth platforms, which is fantastic, but it's costing us a little bit of money to do that. And unfortunately, when you're facing a downturn, you need to make some decisions around that. So let me get back to you on that.

Okay. And I have a similar question with respect to operating. So I know there are a lot of moving parts right now, just given what you're doing, but again, just trying to get with the move to discontinued ops for the semiconductor and laser systems is one way -- I mean, how should we think about your operating expense line items off the June quarter? Are there any unusual things apart from the restructuring charges you talked about? For instance, should we think about any major changes in SG&A or in R&D?

In terms of SG&A, I would say generally speaking, our operating expenses are going to trend down as we go into Q3. And in relation to Q4, they'll probably level off a little bit as a consequence of sales increasing, so there's a little bit of a variable component there. But for the most part, our operating expenses are well controlled at this point, and I don't see any abnormalities other than the restructuring charges.

Okay, and one final question and I'll jump back. The strength you're seeing in fiber -- it's tough for us, I think, to get our arms around it. I assume it's all just -- and John, I think you mentioned it -- it's off a very low base. But at what point does the fiber lasers, do they become more meaningful from a revenue standpoint as a percent of total revenues? Are we still a couple of quarters away? And where's the strength coming from? What particular verticals?

So there's a few things in there. Fiber laser revenue growth is starting to become significant in the context of the JK Laser system. So historically, that was a business that focused on (inaudible) YAG lasers. And of course, that's been in decline for a while. So what we're now seeing is that the fiber laser growth is far exceeding the decline in the YAG business, so JK as a whole is growing. So fiber might be tripling, but JK as a whole is putting up in excess of 20% growth, the net of the two.

So we had talked about that and at what point we really start to say these numbers are material to the entire Company and we start being more detailed about what they are. So I'd say you're getting to the point where fiber, in a few more quarters, is going to be more than all of what JK was in the past.

And this is going into the existing market's customer base and upselling them on fiber?

It's industrial materials processing, and a lot of it, frankly, is in China and other parts of Asia. And it's for the most part customers we have historical relationships. A typical customer is using our YAG lasers in a given process, and they are interested in fiber lasers because of the lower total cost of ownership, smaller footprint, better beam quality, all the known reasons.

But we bring to the table a lot of experience with that specific application. If somebody's trying to use lasers to cut intricate shapes into some particular piece of metal, and we know that application, so then we can adapt that process to fiber effectively because we have experience with whatever that material is and what that process is, and we know the customers, and we have a working relationship. That's the typical case; not always, but -- and I would say right now, we've just introduced a bunch of products in fiber in the last six months, and we now have a kilowatt-class offering. But we still see a lot of our sales in what I would call medium-power industrial.

And then the kilowatt products are really helping us gain exposure and credibility in the fiber laser, but they have not yet become a huge percentage of our actual revenue.

Got it. Okay, thanks a lot.

Mark Tobin, Roth Capital Partners.

Switching gears and looking at the productivity initiatives and the cost reductions, you highlighted some of the things that you've done and remain to be done. Can you give us a sense of how they phase in over the next 12 months, or even through the end of '13? I guess that would include the 12-by-12 as well as the additional activities that you highlighted.

I think the Q3 guidance already takes into account some of that phase-in. Q4 should have significant more cost savings associated with it as a consequence of the actions, and then there will be a bigger benefit to 2013. We said it was roughly, the 12-by-12 by itself, it was roughly $5 million of annualized cost savings. It's obviously less than that, because we're obviously exiting 2012 on an annualized basis. But I think as you look at 2013, you're looking at $5 million of savings, and 2012 is something less than that.

Yes, and if we take additional actions, that could drive the $5 million up to the $6 million to $7 million range with some other things we'll try to do that don't start phasing in themselves until some time in Q4. But one of the biggest things that we're doing as far as 12-by-12 is the relocation of the Lexington operations to Bedford. And that's approximately a five-mile move for that business. But that's our largest single business in that location, in Lexington. It's a significant amount of revenue, hundreds of employees, and we're the number-one market share player in scanning products and high margins in that business.

So that's an important move, but you just don't do that in a reckless manner, because that business -- we know we'll probably take a small amount of disruption, but we're trying to keep that to an absolute minimum. And so we've staged that out and planned it very carefully. And it happens over the next four or five months and is completed by year end. So we don't really see much benefit at all from that one this year -- maybe a little bit. But it really kicks in next year.

And how much of your Q3 guidance, if any, accounts for some potential disruption? Is that part of the softness there?

Yes, I think what we tried to do is in the guidance for Q3 is take that into account. There's a range there that's provided and so that the bottom of the range would say that everything bad happened. But I don't think that's the way we're looking at it right now. And so for the most part, our guidance reflects the fact that there could be some minor disruption, really not that much, in the third quarter. But it does also take into consideration that there's been some volatility in the macroeconomic sense and that we're trying to make sure that we're prudent with that.

So we had some disruption in the scientific laser move from Long Island to California, and I think as Robert said earlier, we saw on the order of $1 million. It's a challenging move in the sense of highly technical products, a lot of PhD's involved in this process and such. And we relocated a number of those individuals all the way out to California, so a very significant move for the individuals who were affected, and very complex products, a lot of custom or semi-custom products. It isn't a medium-volume production line that's just kicking these things out. It was a lot of complicated projects, and the individuals involved were moving. So in the end, it was, I would say, a $1 million impact is not that bad considering the amount of money we will save over time by eliminating that entire site.

Okay. That's helpful. I'll jump back in the queue. Thank you.

Jack Ripstein, Portrero Capital.

A question about the discontinued ops. Clearly, you moved them into disco ops for this period, so something changed with respect to a technical decision switch. Was it a discussion process with potential buyers? Is there a technical point at which accountants want you to make that move? I'm just curious what prompted this quarter, say, versus last quarter when you were still contemplating the sale.

There is a very specific sort of accounting set of criteria that you evaluate. But really, the short answer to what you're saying is the processes themselves were very, very preliminary three months ago, where we had not had much in the way of contact with buyers. We have sell-side advisors driving these processes, and there's memorandums, and they're reaching out to a large number of buyers. But we're in a way different position right now, where we're in very specific discussions with specific buyers and a lot of negotiations. So it was just, really, in the end, the maturity and the advancement of those processes and the specific decision the Board took to approve that and move down that path, and the criteria weren't met for that.

And after this process, do you see other elements that you would want to move to your discontinued ops or put up for sale? Or is this, post the first year review, kind of it?

In terms of 2012, I think we're going to bite off just about this much. I think we've gotten to the scale now where it's important to execute on the acquisition side to start getting the growth opportunities executed on. And so that's where our bias is going to shift. But to rule out that there wouldn't be other businesses that we'd like to get out of down the road, but that's not going to be where the priority's going to be for the remainder of 2012 and going into 2013.

We do, Jack, and we rack and stack all the businesses in our portfolio in terms of their strategic growth attractiveness, how much profitability and cash they generate, how related they are in terms of a technology or an end market to other things we do. And we look at all the elements, and we have a point of view about all of our businesses.

And I would say there are some where you'd say, in an ideal world, they would be down to where you would say, "That business is a better fit with some other owner rather than us." But there's a practical thing there. I think we got the question earlier on, saying are the divestitures and the acquisitions competing for either capital availability or resources in the organization? And they're not now, but if you were to go and try to do more potential divestitures, then you'd start to say, "Yes, it is a constraint."

Okay, and then one last question. I don't know if you gave it or not, but did you give a book-to-bill for this quarter overall, or just in the segments, or in certain segments?

So the continuing operations, it was 1-to-1; $70 million revenue, $70 million orders. If you were go add back the discontinued operations, it was below 1-to-1. I think the total orders were 80?

0.93.

So 0.93, yes, on a consolidated basis, 0.93.

And how does that compare to the previous quarter?

I don't know if we've broken it out for the discontinued, but on a consolidated basis for Q1, the revenue was $78.8 million, I think it was, and orders were $85 million.

Okay, great. Thank you.

Chris McDonald, Kennedy Capital.

The first one's on the spindle business. Can you talk a little bit about how volatile that business has been in the past, or if you're seeing anything change more structurally, with the softness that you're seeing?

That's a good question. I think the answer to that depends on what time horizon you really want to look at. The printed circuit board and semiconductor capital equipment market has always been fairly volatile. But I would say, going back a decade or whatever, the normal pattern would be every third or fourth year, you might have a severe downturn, and then you'd have several years of much better conditions.

We have been seeing, over the last couple of years, a much greater level of volatility, where you have almost these mini-cycles within a year, where you'll have a couple very strong quarters and then it will collapse and then come back, or there's a lot of information that will come back. But sometimes it doesn't happen. So we're seeing more short-term volatility than we used to.

But there are very big swings in this business where I think, just historically, if you look at it, 2008 might have been something in the $30 millions range, and then it got cut in half to $16 million and then tripled to $48 million in successive years. So this is a business that can go in half and then triple very easily year to year to year. And that's a year look. When you look at quarters, you're seeing something even more volatile.

So John, it seems like this is normal volatility, maybe not a structural shift in the utilization of spindles or alternative technologies or something of that nature?

Well, yes. I mean, I separate those two things. There is a question, and our spindles are used for via hole drilling, and there's larger holes that are drilled mechanically that typically use spindles, and the smaller holes that can be drilled with laser drilling systems. And, by the way, we participate in the laser via hole drilling through both our CO2 laser business and our scanning business. So we actually have products addressing both types of the holes.

But there is this broader trend that says the growth is really in the laser via hole drilling on the smaller holes, and a lot of that is directed at the mobile applications and the tablets and the handsets and all that. The larger hole has been seen to be a flaccidness, maybe zero to 2% growth, and was driven by some of the more traditional electronics and PCs and other types of applications.

So that trend has already been identified and has already been underway for some time. I don't think that those trends are accounting for the business seeing 50% reductions in three or four months. But -- you know.

Okay. And then any update on the collection of the tax credit, the $20-ish million income tax receivable?

You can call your Congressman and ask them. We finalized all discussions with them, for the most part. We have agreement with the field office at this point in time. And what generally happens at this point in the stage is that it gets brought up to Joint Committee, which needs to be reviewed, and that process takes some time. There might be some questions coming out of that; there might be additional requests. But for the most part, it just takes a lot of time. And they haven't provided us with a timeline. We hope to get it collected sooner rather than later. But as soon as we know, we'll let you know.

There isn't a lot we can do to influence it at this point.

Yes.

Okay. Thank you.

Stefan Mykytiuk, Pike Place Capital.

Most of my questions were answered. I guess the last couple of things I had is, Robert, what do you have for CapEx now for 2012 on the continuing ops?

We haven't broken it out specifically, but we're not really spending any CapEx in our discontinued operations business. So the semi systems and laser systems really do not have any material kind of CapEx spend to them.

That's one element of the systems businesses is they are very low-volume, very complex assembly, and there's virtually no capital requirements in those businesses.

Okay. But you feel on the continuing ops, are you still thinking of $5 million, $6 million, or $7 million, something like that, of CapEx?

It would be difficult to cross the $6 million mark.

And a big part of that, as we've said in the past, is IT, really.

Right. Generally speaking, when you look at the full year, I would say more than half of it is IT-related. But in the second quarter, 75% of it was actually spent in some of our growth areas, specifically fiber lasers. We spent a little bit in the consolidation of our scientific laser businesses, and we spent a little bit in our solutions business. But for the most part, it's a 50/50 split between IT and business-related expenditures. And again, the IT-related expenditures are more a factor of what we've inherited.

Okay. And in terms of the cash tax rate, are you still expecting de minimis cash taxes this year?

For the remainder of 2012, yes. Absent any sort of significant gain on sales business or anything of that nature, we shouldn't be paying any taxes.

Okay.

A very minimal amount.

All right. And you talked about maybe your inventories might have been a little high at the end of the second quarter. Is there an opportunity to reduce working capital as you go forward, and especially now that you're getting further along in 12-by-12 and you might have built up some working capital, just to buffer any disruptions from that?

Yes. So absolutely. I think our inventory management in the past has been horrible, and I think we're spending a lot more time on that. John mentioned earlier that we've brought in some outside resources that have a strong operational bias to them, and they're going to help us really drive those numbers down. But there's general opportunity from the fact that we purchased more inventory than we needed in the second quarter, and we'll bleed through that in the third quarter. But there's also a lot of opportunity to drive that further down.

Okay. And then lastly, I think originally you had talked about by Q4 you were going to have the full run rate of the 12-by-12 cost savings, won't you?

By the end of it.

By the end of Q4, after we've exited the Lexington facility and consolidated that business into Bedford.

Okay.

But not in the fourth quarter.

Yes, so all the other facility changes have already occurred, and for the most part, we've completed those. We've exited the facilities. Again, going back to an earlier question, we really shouldn't see that much of a disruption from any of those moves at this point in time. But as we get into the fourth quarter, we're moving our Lexington operations into our Bedford operations, and it's going to take the quarter to complete. And at the end of the quarter, we'll be exiting with those savings.

Okay. But I guess my point is, going from Q3 to Q4, there should be some improvement in the cost structure?

Yes.

Okay, terrific.

Because remember, we are taking an incremental $1 million to $2 million of cost actions in the business, so those aren't going to benefit us in Q3 because they are going to be announced throughout the quarter, but they will have a benefit in Q4.

Yes. I guess what I was getting at is assuming the market environment doesn't improve, there's still a potential for EBITDA to improve going from Q3 to Q4, just on the cost side?

Yes.

Yes, we agree with that.

Okay. Lastly, I guess maybe I'll sneak this one in, if I can, is I think you said medical was down in the quarter, John?

Yes, it's down 3% year over year, and almost all of that was related to some weakness in patient monitoring type of applications in Europe.

Two customers in Europe actually slowed down their purchases from us, and it was all a consequence of the fact that they supply those products into the European market. So that happened fairly late in the quarter, and we expect it to recover.

And the medical business was pretty healthy other than that, so we actually saw some larger declines in the other segments.

So it sounds like you're saying some of that was just a knee-jerk reaction to people get scared, and they just say, "Stop all the spending."

Yes, we're seeing a lot of that, though.

Without naming specific customers, if you look at some of the big medical equipment, patient monitoring types of companies, and they are seeing weakness in Europe, and our components, that slows down and we saw an impact from some of that.

Right.

But I was saying, when it gets really bad, you're down 3%. That's better than being down 29%, which we see in some other segments.

Yes, yes.

Okay, all right. Thanks very much.

Chris McDonald, Kennedy Capital.

Just a couple of quick follow-ups, one on the move to Santa Clara. Is that now complete such that the third quarter won't experience additional inefficiencies?

Yes, it's been fully completed. I think what happened effectively is there was just a couple, or a handful, of orders that resulted in a little bit of a disruption due to bill of material accuracies. But that is now fully complete, and they're fully up and running, and staff have been able to meet the demand. So that business is, looking into the third quarter, is actually going to be doing a lot better.

Okay, and then on the scientific market, I think, John, you said that things actually look like they may be starting to improve a little bit. Was the weakness that you experienced in the quarter tied to specific projects that you can identify, or was it more just broad and general in nature?

I would say that it was fairly broad. It wasn't like one project or two that got held up. And there was quite a few orders that basically got held up. But what was interesting about it is, if you really looked, a bunch of orders got delayed. And I would say that was more than 10 different, distinct orders that got held up. But what really happened is many of them ultimately did come in, but they came in very late in the quarter and couldn't be turned into revenue. So we actually started the third quarter with a pretty good backlog position in scientific.

So it wasn't a total loss. It was like already we could see signs. A lot of those orders were later released. They were just held up for three weeks, but that was a critical three weeks for us. It's that kind of dynamic.

Okay, thank you.

James Gibson, Punch and Associates.

All my questions have been answered. Thank you.

Okay, thanks very much. Okay, well, I guess we will go ahead and wrap up at this point. So all in all, I would have to say the quarter and the near-term economic outlook are a disappointment to us, but in spite of that, GSI, the Company, is very focused and energized and working towards an ultimate goal of building a world-class franchise and being a leader in all of our markets, attracting best-in-class talent, delivering sustainable, profitable growth and strong shareholder returns.

We're early in this game, but we're making good progress in many, many areas. We have put in place a strong leadership team that's capable of delivering on all of our plans, and we're steadfastly committed to delivering on the promise of GSI.

In closing, I would also like to mention that we will be presenting at the upcoming CJS Securities Summer Conference on August 14 in the New York area. We hope to have a chance to meet with some of you there.

In any case, we look forward to joining all of you on our third quarter 2012 earnings call in November. Thank you very much for your interest in GSI, and this call is now adjourned.

This concludes today's conference call. You may now disconnect.