Novanta Inc (NOVTU) 2013 Q2 法說會逐字稿

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group Second Quarter 2013 Earnings Call. (Operator Instructions) I will now turn the call over to Robert Buckley, Chief Financial Officer of GSI Group. You may begin your conference.

Thank you very much. Good afternoon, and welcome to GSI Group's Second Quarter 2013 Earnings Conference Call. With me on the call is John Roush, Chief Executive Officer of GSI Group. If you have not received a copy of our earnings press release, you may get one from the Investor Relations 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. You may--we may make some comments today, both in our prepared remarks and 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 such non-GAAP financial measures 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 measures in the earnings press release, we'll be providing reconciliations promptly on the Investor Relations section of our website.

I'm now pleased to introduce Chief Executive Officer of GSI Group, John Roush.

Thank you, Robert. Greetings, everybody. Welcome to the call. We do appreciate your continued interest in GSI. So today, we're pleased to announce our results for the second quarter, and on the whole, financial performance is very much in line with our expectations. For the most part, we had solid execution and very good cash generation across the Company, despite the sluggish economic recovery we continue to see across most of our end markets. Our revenue was $85.3 million, and our adjusted EBITDA was $12 million. Both of those figures were in the upper portion of the guidance ranges that we had previously communicated.

GAAP earnings per share from continuing operations was $0.02, which was impacted by purchase accounting, as well as restructuring expenses related to our ongoing efforts to streamline and focus the Company. Non-GAAP EPS, which is a new metric we intend to report going forward, was $0.14. Robert will cover EPS results in much more detail in his section.

One of the highlights of the performance was our cash generation and we are very pleased that we were able to generate over $13 million in operating cash flow, and we ended the quarter with just $43 million of net debt. We expect to continue to reduce our net debt through the balance of this year. So during Q2, market conditions were about what we expected. It was still a bit of a mix picture. Our reported revenue was up 21% year-over-year, due to the inclusion of NDS in our results. But on an organic basis, sales declined 1.7%. We were, however, able to generate growth in several areas, including the scanning market, and in spindles, where we experienced some degree of recovery in the PCB drilling market.

Our scientific laser revenue grew slightly on a year-over-year basis, but this was due to revenue recognized from a large contract with the French government that originated two years ago. The underlying scientific market remains very weak for us.

In the quarter, we did have a few different sources of headwinds with respect to growth. Optical encoder revenue was down over 20% versus last year, driven entirely by a difficult comparison from a large one-time upgrade program in 2012 for a data storage customer. All other encoder sales were up in the quarter, and in fact, we are seeing accelerating growth in emerging encoder applications in the medical and industrial automation markets.

We also had a slight decline in our CO2 laser revenue. We are working with our new CO2 management team to bring several new products to market in the coming quarters that will enable us to drive sustainable CO2 laser growth in the future.

Our fiber laser revenue was also down in the quarter, and I will comment on this topic in more detail in a few minutes.

In the medical market, we continue to see good medium term growth potential, but the demand we have seen this year has been a bit unpredictable. At present, we are seeing some customers push out orders based on delays in hospital CapEx spending. This appears to be tightening and there's an increasing portion of the hospital spending that's directed at IT investments rather than equipment. Our overall medical business did not deliver growth in the quarter, and we now expect flat conditions for the balance of the year.

From an orders perspective, the overall Company ran at a book-to-bill ratio of about one in the second quarter, and on a year-to-date basis, we are just slightly over one. Most of our OEM customers are ordering from us on very short lead times, so our visibility is quite limited. Having said that, we do see some overall improvement in demand as we move through the year. In the first half of this year, organic growth was negative, though by less than 1%. In the second half of the year, we expect to see low single digit organic growth with broader contributions to that growth from more of our business lines.

The economic recovery still appears very sluggish from our perspective, but we do see opportunities where we're able to work with our OEM customers to bring new capabilities to the market in growth applications.

I would like to offer you some perspectives on our market outlook for the balance of 2013. We have seen recent improvements in the manufacturing sector in both the U.S. and Europe. China remains a bit of a question mark, but based on these favorable trends, we now expect mid-single-digit organic growth in the second half for our industrial market revenue base, which accounted for 40% of our overall revenue in Q2.

With the limited recovery we are seeing in the PCB drilling market, we now expect the microelectronics market, which was 17% of Q2 sales, to deliver low to mid-single-digit organic growth in the second half.

As discussed, the medical market, which accounted for 36% of Q2 sales, is expected to be flat for the balance of the year.

And also, as I had mentioned, the scientific market, which accounted for 7% of our Q2 sales, faces continued challenges related to government budget constraints, and we expect our second half sales to organically decline by a low teens percentage.

So turning to our growth platform, scanning solutions was clearly the highlight. Our Lightning II all digital scanner continues to generate significant growth in applications such as converting, via hole drilling, and materials processing. This product offers the highest speed and accuracy, as well as the lowest drift available in the industry.

Our scanning solutions orders were up 50% and revenue up 37% on a sequential basis, with the sales being up over 60% versus a year ago. Scanning solutions revenue for us is now at a $17 million annualized run rate with significant future growth opportunity.

On the medical components front, the NDS acquisition integration is largely complete. Sales channel integration with GSI medical products is ongoing and a number of common leads and opportunities have been identified. Our primary priorities for NDS are to bring onboard a permanent business leader and to successfully complete a key new product introduction for the radiology market that is scheduled for Q4 of this year. We expect this new product to contribute several million dollars of incremental annual revenue once it's launched.

We are also pursuing several follow-on acquisition opportunities that we have identified subsequent to the NDS transaction that could further strengthen our market position in medical components. As I mentioned, the medical market itself has been rather inconsistent this year, starting weak, then improving, and now slowing again. NDS sales were approximately $17 million in the second quarter, which was a bit short of our internal projection. We saw a similar shortfall in thermal printers, which by the way, we have recently rebranded as NDS. Overall, hospital CapEx appears to have tightened during the quarter and several customer orders were pushed out.

I'll note that during Q2, we began to ship optical encoders to a large surgical OEM customer for a new system that is targeted for market launch in 2014. This program represents a multi-million-dollar annual growth opportunity for us.

Turning to fiber lasers, our efforts in this area faced increasing challenges within the second quarter. The low cost fiber laser architecture that we have discussed on previous calls has proven to be difficult to manufacture, with yields and reworks significantly impacting the cost savings that we targeted with this architecture. This has delayed the launch timing.

At the same time, we've seen that market price levels have declined more and faster than we had anticipated. The combination of these factors has led us to be much more cautious and selective in pursuing fiber laser revenue, resulting in a decline in our revenue in Q2. We still expect fiber laser revenue to be in the range of $9 million to $10 million this year, but based on all of these developments, we are considering several different options to reduce the operating losses we're incurring with an intention of returning the business to near breakeven profitability on a run rate basis by year-end.

As a company, we continue to make progress in building our organization and talent base. We recently named a new business leader for our JK Laser business that encompasses our fiber laser activities, and we also brought onboard a North American sales leader and a product marketing leader for Cambridge Technology, our scanning business, and a new Director of Financial Planning and Analysis at the corporate office. We continue to find that talent is attracted to the unique opportunities and challenges inherent in being part of the transformation of GSI. Each of these individuals brings new talents, capabilities, and passion into our organization and makes us much stronger as a company and we're better positioned to achieve our ultimate strategic goals.

So with those comments, I'd like to now turn things over to Robert to cover the financial results in more detail. Robert?

Thank you, John. During the second quarter of 2013, GSI generated revenue of $85.3 million, an increase of 21% from $70.4 million in the second quarter of 2012. The NDS acquisition accounted for roughly 23.7% revenue increase year-over-year, while changes in foreign exchange rates adversely impacted revenue causing a roughly 1% decline in revenue. Excluding the impact of the NDS acquisition and changes in foreign exchange rates, the Company's revenue decreased by 1.7%, compared to the second quarter of 2012.

Turning to our segments, sales in our laser products segment for the second quarter of 2013 decreased 0.7% to $46 million, compared to $46.3 million one year ago. Excluding the impact of foreign exchange, laser product segment revenue was flat year-over-year. Sales of our scanning solution products increased by more than 65% year-over-year due to strong demand for our Lightning II digital scanning subsystem. This was offset by a sales decline in our fiber laser products. As John mentioned earlier, due to the competitive dynamics and delays in moving to a lower cost architecture, we have chosen to be more selective in our pursuit of the fiber laser business. We'll be evaluating several different options to improve the profitability of this business with the goal of minimizing losses by the end of the year.

Sales of our precision technology segment for the second quarter of 2013 increased 63.3% to $39.3 million from $24.1 million in 2012. The NDS acquisition added approximately $17 million in sales for this quarter. Changes in foreign currency rates adversely impacted our sales by 1.2% compared to the prior year. Excluding NDS and the impact of foreign exchange rate fluctuations, revenue declined 4.7%. The decline was largely attributed to a decline in sales volumes in our optical encoder product line, which was impacted by an upgrade program for a customer in the data storage market in 2012 that did not repeat in 2013. The decreases were partially offset by an increase in sales volume for our air bearing spindles products, which predominantly serve the mechanical drilling of printed circuit board.

Turning to profitability, second quarter gross profit was $34.5 million, or a 40.4% gross margin, compared to gross profits of $30.7 million, or 43.6% gross margin during the same period last year. Laser products second quarter gross profit was $17.9 million, reflecting a 39% gross margin, compared to $18.9 million, or a 40.7% gross margin for the same period last year. The 1.7 percentage point decline in gross margin was primarily attributed to our fiber laser products. To a lesser extent, gross margins were also adversely impacted by our scientific lasers, a new product introduction, resulting in some near term margin pressures as we ramp up volumes.

Precision technology second quarter gross profit was $16.6 million, reflecting a 42.1% gross margin, compared to $12 million or a 50% gross margin for the same period last year. The NDS acquisition accounted for $5.6 million of the increasing gross profit from the prior year. NDS gross profit included an $800,000 negative impact from the amortization in developed technology and inventory fair value related to the NDS purchase accounting during the second quarter. However, the overall 7.9 percentage point decrease in gross margin was caused by a combination of purchase accounting adjustments as a result of the NDS acquisition and the adverse impact of a loss in sales related to a one-time customer upgrade program in the data storage market.

Operating expenses amounted to $30.2 million in the second quarter of 2013, which included $1.6 million of amortization of intangibles and $1.1 million of restructuring expenses. This compares to operating expenses of $25.6 million in the second quarter of 2012. Second quarter 2012 operating expenses included $700,000 in amortization of intangibles and $2.5 million of restructuring expenses. Our operating expenses increased year-over-year as a result of the acquisition of NDS. Excluding NDS, our operating expenses actually decreased as a result of our restructuring actions taken in the prior year.

Research and development expenses were $6.8 million, or 8% of sales, during the second quarter, compared to $5.6 million, or 8% of sales, during the second quarter of 2012. R&D expenses increased in terms of total dollars during the second quarter due to the acquisition of NDS. This was partially offset by lower employee compensation and professional services as a result of prior restructuring initiatives.

SG&A expenses were $20.6 million, or roughly 24% of sales during the second quarter, compared to $16.8 million, or roughly 24% of sales during the second quarter of 2012. SG&A expenses increased in terms of total dollars due to the acquisition of NDS, but remained flat on a percentage of sales basis. Operating income amounted to $4.3 million, or 5.1% of sales in the second quarter of 2013, compared to $5.1 million or 7.2% of sales in 2012. Laser products operating income for the second quarter of 2013 increased $300,000, or 8.5%, compared to the second quarter of last year.

Precision technologies operating income for the second quarter of 2013 decreased by $1.5 million, or 24% compared to the prior year. The decrease was due to higher amortization of intangibles and inventory fair value step-up related to the acquisition. Excluding this, precision technologies generated operating income as a result of the lower operating expenses.

Adjusted EBITDA, a non-GAAP financial measure, which includes the adjustments noted in the non-GAAP reconciliation attached to our earnings press release, was $12 million in the second quarter of 2013, compared to $11.9 million in the second quarter of 2012. Diluted earnings per share from continuing operations was $0.02 in the second quarter, compared to $0.13 in the second quarter of 2012. The decline in diluted earnings per share is largely a result of higher amortization of intangibles and inventory fair value step-up, charges related to restructuring, fluctuations in foreign exchange rates, and higher income tax provisions.

As mentioned during last quarter's earnings call, we are now providing an adjusted non-GAAP earnings per share metric. Non-GAAP earnings per share that includes the adjustments noted in the non-GAAP reconciliation attached to our earnings press release, was $0.14 in the second quarter of 2013, compared to $0.15 in the second quarter of 2012.

Turning to the balance sheet, as of June 28, 2013, cash was $52.1 million, while total debt was $95.3 million. The weighted average interest rate on the senior credit facility was 2.55%. The Company completed the second quarter of 2013 with approximately $43.2 million of net debt, as defined in the non-GAAP reconciliation table in our earnings release.

Operating cash flow for the second quarter of 2013 was $13.1 million. For the first six months of 2013, operating cash flow was $17.7 million. The improvement in operating cash flow was driven predominantly by better working capital management in the quarter.

Capital expenditures for the first half of 2013 were $2.3 million. We continue to expect CapEx to be between $5 million and $6 million for the full year.

On May 3, 2013, we concluded the sale of the semiconductor systems business to Electro Scientific Industries for $8 million in cash, subject to customary network and capital adjustments. We received net cash proceeds of approximately $5 million after paying restructuring expenses and divestiture related fees. We also completed the sale of our East Setauket, New York facility, resulting in $4.3 million in net cash proceeds in the quarter.

During the fourth quarter of 2012, we reached a settlement agreement with the IRS and the Department of Justice regarding the IRS audits for 2000 through 2008 tax years. This settlement was finally accepted by the Congressional Joint Committee of Taxation during the second quarter of 2013. We expect to receive cash refunds in the amount of $12 million to $13.5 million in the third quarter of 2013. As of today, or the third quarter, we have received a partial refund of $9.8 million. In addition to the cash refund, the Company also expects to realize the benefit related to carryback and carry forward of certain non-net operating losses, which will result in either a refund of tax payments made in the carryback periods or lower income tax payments in the carry forward periods.

Turning to the third quarter of 2013, we expect revenues for our continuing operations to be in the range of $85 million to $87 million. The upper end of this range represents low-single-digit organic growth.

Turning to profit, we expect the third quarter of 2013 adjusted EBITDA to be in the range of $12 million to $13 million. Our operating expenses and gross margins should largely be in line with our second quarter operating expenses and gross margins. We expect our non-GAAP tax rate to be in the 36% to 39% range. I should note that our non-GAAP tax rate is largely impacted by tax planning initiatives not yet executed. We are working aggressively to implement our plans here, and we would expect as a consequence this year a tax rate decline as we enter 2014.

In addition, we continue to expect to pay cash taxes for the year in the range of 15% to 20%. Depreciation and amortization should be around $5 million. We expect $1 million to $1.5 million of restructuring expenses in the second half of 2013 related to our 2013 restructuring plans. And finally, with the receipt of the IRS refund, we expect our third quarter of 2013 net cash position to be roughly $25 million.

For the full year 2013, the Company continues to expect revenue from continuing operations of approximately $345 million, which would reflect a return to organic growth in the second half of 2013, or organic growth in the range of 3% to 4% for the remaining six months of the year. While we're seeing some recovery in our end markets, we remain cautiously optimistic. In addition, we expect full year 2013 adjusted EBITDA of approximately $50 million. This compares to $41.6 million for the full year 2012.

Finally, we expect net debt at the end of the year between $15 million and $20 million, including any debt that may be incurred or assumed in connection with any future acquisitions or share buyback program. This represents a significant reduction in debt following our $82.5 million purchase of NDS Surgical Imaging in the first quarter of this year.

We continue to believe that acquisitions will provide the highest return for our shareholders. Our acquisition pipeline remains full with a number of very attractive acquisition targets, particularly in the medical OEM components space. The cash generated by the business, combined with our available credit facility, gives us plenty of resources to pursue these transactions. However, to the extent that these transactions are not actionable in the next six months, we believe a share repurchase would be attractive at these stock price levels. We do not believe we're at the point of making a final decision on this yet, but we do expect to conclude on this in the second half.

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

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

Hi. Good afternoon.

Hi, Lee.

So Robert, can you just walk us through your assumptions behind the guidance for net debt of less than $20 million at year end, both in terms of the operating and non-operating cash? And more specifically, does it include expected real estate sales?

It does not include expected real estate sales. So the only thing it would take into account is our operating cash flows on a conservative basis, and then the IRS refund.

Some of which is in hand, some of which is not yet in hand.

And how does that tax refund compare to sort of the $15 million to--I guess, $15 million to $17 million range that you had previously spoke about? And the reason I'm asking that is you've got the component that you expect to receive, and then you've got the carryback and carry forward component.

That's correct. So there's--the way to think about it is there's roughly $13 million to $13.5 million worth of cash refunds, and then another $4 million to $5 million worth of carryback and carry forward. And given the profitability performance of the Company, that we look to take advantage of that probably next year, 2014.

Okay, great. And then, just switching gears a little bit, can you talk about the revenue and the losses incurred in fiber in Q2, and maybe provide a little more detail with regards to what it means to be more selective in pursuit of the fiber laser?

Well, I would just say that you're going to see probably the revenue isn't going to be growing a whole lot there. With the cost structure that we have, we're just not taking orders. We are losing something on the order of $1 million a quarter and our goal is to kind of cut that run rate down to--maybe we don't get to breakeven, but we get close to breakeven exiting the year. And that's going to involve controlling costs carefully and a few different options, but just not taking sales at the rate that we thought we could. I mean, we can win some of these orders, but it's just not worth doing. So we'll still end up the year with, as I said, it's somewhere in the $9 million to $10 million range in fiber.

And I guess by keeping fiber lasers, you've got to feel that there is some benefit beyond just achieving breakeven. How do you think about the upside opportunity, again, like you say, at this given cost structure?

Well, I mean, we're thinking through a few different options there. So we haven't made a decision on what exactly we're going to do. There is still an opportunity to possibly get a lower cost architecture in the market, which would then open up the growth opportunity. But it's just sort of a matter of how long that takes and what the ultimate cost is to get to that. It's sort of a time cost relationship. And we're sort of--we've--what we're telling you is we've been rethinking that.

Okay. I'll hop back in queue. Thanks very much.

Thanks, Lee.

(Operator Instructions) The next question is from Joe Bess of Roth Capital Partners. Your line is open.

Hi, Joe.

Good afternoon, gentlemen. Just to piggyback on that last question, to acquire this technology--or lower cost architecture in the market, what would that need to be? What would you guys need to do for that to happen?

Well, I mean, there's several different approaches, but we had developed what we view as a novel approach to how to construct the inner workings of a fiber laser, the diodes and how the light is generated and how that's coupled into the fiber and how the fiber itself is configured, a whole different set of changes to the technology that when you sort of cascade all of that, you take a lot of cost out of the system. What we have found is that it works, but it's not manufacturable thus far. So the question is, can we get through those manufactures issues, in what timeframe, and can we bring partners in to help with some of that.

Okay. And then, the tax credits, when do you expect to receive the remainder of the tax credits?

You mean the carryback and the carry forward NOLs?

So you've received $9 million so far, or $9.8 million, I believe. And then, when are you expecting to get the remainder of the carryback, carry forwards?

Oh, no. So the call it $12 million to $13.5 million of cash refunds, we've received around $10 million thus far. I hope to complete the collection of that before the end of the quarter.

Got you. Great.

Now in the carryback and the carry forwards, I'll be able to take advantage of those in 2014, once we've completed a couple items.

Okay, got you. And then, thinking about acquisitions a little bit more. You talked about the medical OEM space. Are you guys seeing opportunities for acquisitions outside of the medical market? Are you considering kind of the little slower trajectory that you're seeing for the medical growth opportunity? Are there things outside of medical that make sense at this point?

Yes. I mean, Joe, I think that's a fair point. If you just looked at the last couple quarters you might say I'm not sure medical is the most ideal space. But I think when you look a little further out, we definitely believe the demographic factors, the long term growth rates, do support focusing on medical and we're doing that. But we do see other opportunities that kind of relate into some of our more traditional areas where we play, and we're pursuing those, too. So it's probably a mix. It's probably 60% of our pipeline focus is medical and 40% is in some of the other traditional markets that we have in precision tech and laser.

But what I'll tell you is it's not so easily separable. Some of the things we've looked at come with a significant medical exposure, but then some traditional exposure. So it's not necessarily one or the other.

Okay, great. And then, can you talk a little bit more about some of the new products that you have coming out in the back half of the year, and what you think that these might be able to do in terms of incremental growth in 2014?

Yes. Well, we highlighted some of those. I mean, one of the most important new products we have coming out is a radiology product that's coming out in NDS that's I think sort of a multi-million-dollar opportunity for us. We also highlighted a new program we have in optical encoders that we're shipping sort of start-up quantities now, not full rate production quantities. But that's a multi-million-dollar incremental opportunity for us next year. In the scanning area in general there's a whole slew of--they're not necessarily new products. They're sort of more--the model is we have the new product out there. We have the scanner. But with each customer, you adapt that to the application requirements of that particular customer. And there's a lot of work going on with that that could lead to a lot of growth.

So you can point to millions of dollars of opportunity that we have next year. But we all know it's not quite that simple, right, that you also have some of your revenue base that is sunsetting where we've been selling into an application for a long time and it's winding down. So you can't just take this year and add on your NPI, then say we're done. There's always some part--as an OEM supplier, some of what you design into is phasing down. But we definitely see opportunities.

Okay, great. And then, last question. Thinking about NDS and the integration process being largely complete, but there's still remaining some aspects that you can do on the sales side, can you talk a little bit more about those and when you think that those might be achieved?

Yes. I would say for the most part they're not 2013 opportunities. I mean, what you're talking about is when we line up our medical OEM customer base in NDS, in the printers business, and some of other products that sell into medical, which would include scanning and it would include our optical encoders, and it would include our color measurement instrumentation. You can line all of that up and say they all sell into a set of medical customers. And it doesn't line up perfectly. So in some cases we'll have real strength in India, but we don't have much penetration with printers or what have you.

And so, that's what we're in the midst of doing is saying where do we have a real strong relationship in one product and we can pull the other products into that conversation, or do it vice versa. It doesn't--those aren't the kind of things that turn into a production order in months. It's quarters away, because you really face getting the technology in front of the customer, samples, their technical team has to work with that. And then, ultimately, if they do pursue you for a program, it then could be quite a while until you see meaningful revenue. But that's just the revenue acquisition cycle that you have in an OEM business and in a medical business. So the revenue has a long kind of stickiness to it once you're in there, but you're not going to get in in three or four months.

Great. Thank you, guys.

Thank you.

There are no further questions at this time. I will turn the call back over to the presenters.

Thank you, Operator. So in conclusion I would like to say that Q2 results were in line with our expectations. The Company is executing well and making good progress on our strategic goals. The complexion of GSI and the caliber of our team are greatly improved. The financial results were solid. And I would say, with respect to the balance sheet, the progress was very good. We're getting more predictable as a company. And now, with the use of the non-GAAP earnings per share metric, I believe the true economics behind our earnings performances will be somewhat easier for investors to understand.

The economic landscape still has some uncertainty for us, but we generally see an improving picture. We will deliver organic revenue growth in the second half, while continuing to improve the balance sheet and position ourselves for additional milestones in terms of our growth strategy and our transformation of the Company that--you would think of that in terms of acquisitions.

As Robert said, if the acquisitions do not materialize, we will take a serious look at share repurchase. But right now, we're optimistic about the pipeline and the opportunities for the Company. So on behalf of the whole GSI team, I'd like to thank you for your continued interest in the Company. And the call is now adjourned. Thank you very much.

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