Novanta Inc (NOVTU) 2014 Q4 法說會逐字稿

Good afternoon. My name is Chris and I will be your conference operator today. At this time I would like to welcome everyone to the GSI Group 2014 Q4 earnings call.

(Operator Instructions)

Robert Buckley, Chief Financial Officer, you may begin your conference.

Thank you, Chris. Good afternoon and welcome to GSI Group's fourth-quarter and year-end 2014 earnings conference call. I'm Robert Buckley, Chief Financial Officer of GSI Group. If you've not received a copy of our earnings press release, you may obtain 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 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 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 the GAAP measures in the earnings press release, we'll provide 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, and good afternoon everybody. Welcome to the call. I'm very pleased to report that GSI performed well in Q4 and finished 2014 on a positive note.

And I would say, as with most years, things did not develop exactly the way we drew it up on the chalkboard at the beginning of the year, but we accomplished many important things that move us closer to our strategic goals and better position us for future success. We also during the year responded well to several issues that unexpectedly arose, so I'm pleased about that and I'll share some details.

From a financial perspective, I'll give you a few highlights and Robert will go into much more detail in his section. In the fourth quarter we had sales of $94 million, that was up 14% reported and 1% on an organic basis. The Q4 revenue was impacted over $1 million relative to the guidance we had issued in November because of the strengthening US dollar.

The GAAP EPS for the quarter was actually a loss of $0.82, due to the impairment of intangibles that we had announced on January 12 of this year, but non-GAAP EPS was $0.24 in the quarter and adjusted EBITDA came in at $15.3 million. Both figures were above our own expectations as our productivity initiatives enabled us to expand our non-GAAP gross margins by over 70 basis points year-over-year. That margin expansion, along with a generally cautious approach that we took to discretionary expenses in Q4, enabled us to more than offset the negative impact in Q4 of the strengthening US dollar.

For the year, we ended up at $365 million of sales, up 15% reported and 1% on an organic basis. The full-year GAAP EPS was a loss of $0.49, again due to the impairment charge, the non-GAAP EPS was $0.81 for the year. The full-year adjusted EBITDA was more than $56 million which is again slightly above the last guidance we had provided.

Our book to bill ratio was essentially 1 for both Q4 and the full year. We increasingly see our OEM customers operating on shorter and shorter lead times with very limited forward order coverage, so our book to bill generally stays very close to 1 in most periods.

So over the last couple of years we have built a highly capable management team here at GSI and with more time under their belts, they really blossomed as a team in 2014. As a Company we're now gaining greater strategic insight and better allocating our investment resources, while achieving I would say more consistent reliable execution across the Company. As that has been occurring, we've been able to direct more of GSI's talent bandwidth towards growth.

We continue to develop and execute on our strategy to shift the Company more towards an attractive mix of end markets and applications. In 2014 we translated those efforts into comprehensive strategic plans that we put together for our major lines of business. With a more robust road map of new products and a larger and richer pipeline of new business and customer opportunities in specific target applications. Through these efforts we're now able to more clearly understand the nature of the markets we address, and the opportunities that we really have to grow over time.

Based on our updated analysis, in aggregate, GSI served an addressable market of approximately $2 billion. We have approximately 18% share of that market and it appears to be growing at an overall average of 6%. I will note that the fiber laser market is excluded from that analysis based on the large size of the market and our relatively small share.

So our market analysis gives us increased confidence that our medium-term goal of achieving sustainable organic growth in the mid-single digit range is reasonable and achievable. Having said that, I fully recognize we're not currently seeing the organic growth that is consistent with our potential. At one level we were impacted by significant slowdown in the medical market in the second half of 2014. And I'll comment further on that in a few minutes, but as medical capital equipment spending recovers, our growth will increase.

Really in a larger sense, many of our businesses have historically lacked true growth skills and capabilities. The technology expertise is certainly there. What we're still building is a broader capability to identify the right growth applications, target them with differentiated products and solutions, and then deliver those products to market on time, at cost, at quality, at yield, et cetera. So we're working across GSI to structurally build those capabilities.

So as we think about 2015 we have built-in continued increases in growth investments, so that we can have and build the right growth capabilities in key business lines. Given the growth in investments we continue to make, increasing our ability to fund those investments through productivity is a key dimension of our strategy. So during the year we made progress on our operational and productivity programs. We held over two dozen lean events across the company in 2014 and we deployed lean principles across an ever-increasing portion of our production capacity. And we are now seeing improved quality, customer satisfaction and lower work in process inventory.

In addition, last year we brought in a global strategic sourcing leader for the Company and we worked hard to put in place the IT infrastructure to let us measure and optimize our $150 million per year direct material spend in a consolidated and robust manner. For 2015, we've outlined detailed specific productivity targets and programs for each of our production sites, which encompass our own production costs as well as our supply chain. We expect to achieve $6 million this year in productivity savings, based on what we put in place.

In addition, we generated significant free cash flow in 2014, which strengthened our balance sheet and enabled us to significantly delever following our JADAK acquisition early last year. So we ended up the year with only $64 million of net debt, which positioned us well for the acquisition of Applimotion, which we recently announced.

Like most companies, I would say we did have certain challenges that arose during 2014 that we had to overcome. The first area is something we have talked about on past calls, which is gross margin performance. In the first half of 2014 we had challenges in this area. As we previously indicated, it was the result of two different drivers.

First, we had a number of new product launches occurring early in the year. In a number of cases these new products launched with very poor initial yields that were much lower than what we had planned. Second, in that same timeframe, we deployed lean manufacturing in a number of locations and we experienced downtime and disruption as we came up the learning curve with some of our new lean production cells.

Sort of a combined impact of these two areas cost us at least a point of gross margin for the full year, or between $3 million and $4 million. The good news is that we recognized the gross margin issue early and were able to get control of the issue quickly and mobilize and turn things around. Our production and engineering teams had to work hard to get the new product yields up the learning curve. Our continuous improvement team worked with our sites to address material, supply and yield issues in the lean cells. We made significant strides with gross margin in the back half of the year.

We had significant sequential improvements in both Q3 and Q4 in our gross margins, and we achieved 44% gross margin in Q4 which is an attractive level for us. So even though our recovery in the second half was not really enough to make up all of the shortfall we had earlier in the year, our progress is very encouraging. To me it's a sign of our increased maturity as a company that we were able to recognize and respond to this challenge quickly and correct the dynamic we are seeing within the year.

The other major complication we faced during the year was the slowdown in our medical business that occurred in the latter part of 2014, particularly in Q4. Really beginning in late summer 2014 we began to see a general slowdown in orders across numerous medical capital equipment OEM customers, product families and applications. In the latter stages of the year we saw several dozen medical equipment customers reduce their normal monthly delivery quantities by anywhere from 5% to as much as 40%. And nearly all of these cases were single source suppliers so we're confident the slowdown was market based and likely short-term phenomenon.

It's worth reminding you all that the same dynamic have impacted of all of our medical sales, meaning those in our medical technology segment as well as sales to medical customers that occur within precision motion and laser products, in both of those segments. So this is really over 40% of our total revenue.

I'll comment in a few minutes on the strategy and the outlook for our medical business which is ultimately quite positive, but there's no doubt that we faced a difficult medical market in the back half of 2014. As challenging as this dynamic was for us, we were able to respond well as a Company.

Demand increased above our forecast in some of the industrial and microelectronics applications. Again, we quickly recognized the dynamic and were able to shift our priorities and redeploy our production teams to capture increased demand in those other markets, and ultimately deliver revenue and profitability that was in line with our guidance. Again I see a positive side to the challenge. Our leadership team and our organization are increasingly resilient and resourceful.

Our strategic and analytical capabilities are improved so we're better able to discern and adapt to a changing market landscape. And our execution skills are much more robust, so when we need to redirect and redeploy we're able to do it with much greater success. So I'm quite proud of the team for how they responded and managed throughout 2014.

So at this point I'd like to provide some commercial updates on our progress around the Company. And I'd like to start with our precision motion segment which will now include the Applimotion acquisition which we recently announced. So sales of precision motion products increased 8% for the full year, and 10% in Q4 of 2014. The growth was primarily driven by optical encoder products, which are seeing increased demand in applications such as co-ordinate measurements, 3-D scanning, wire bonding and robotics for both industrial and medical markets.

We're preparing to launch two significant new encoder products in early 2015, which will expand our offering and increase growth opportunities. One is a miniaturized version of our encoder platform that will enhance our current market-leading capability to provide submicron resolution in the smallest available footprint in the market. The other product is a contamination resistant optical encoder which will open up new opportunities for us in harsher industrial operating environments.

Our Applimotion acquisition fits closely with our optical encoder products. Applimotion, which was a $13 million cash transaction, plus the working capital adjustment that will occur, the business is based outside Sacramento and supplies very high-performance application-specific motors, as well as precision motion subsystems in high-performance applications. In many cases, Applimotion products are used by the same customers in the same applications as our optical encoders. Our original relationship with Applimotion came through our common customers.

In many cases the motor and encoder products are physically mounted to each other or are used together in the same motion control subassemblies. So there's an opportunity for us to optimize the products to work together, so we can supply integrated solutions and deliver better performance to the customer. The customer bases of the two products partially overlap, but there are key differences. So there is a significant opportunity for us to cross sell the capability of each business to the numerous customers and applications that exist.

So while this is not a huge deal for us, it's a great strategic opportunity to expand our presence in the attractive and growing precision motion space. Applimotion has a great leadership team that founded the business and has built it up, the integration is off to a excellent start.

Sales of our air bearing spindle products, also in precision motion segment, were essentially flat for the full-year, although we did see some nice growth in Q4. Over time we've had success in diversifying our air bearing spindle application mix, such that nearly 40% of revenue now comes from applications other than the traditional via-hole drilling OEMs that were the basis of the business in the past. This improved business mix has significantly improved the predictability of this product line.

So now turning to our laser products segment which remains the largest of our three segments, we had good results. We had mid to high single-digit revenue growth in both Q4 and the full year of 2014. We had 38 new OEM design wins with our low power CO2 products during the year, versus our original goal of 25. We're seeing strong CO2 laser demand in marking and coding applications, driven by the ongoing shift from inkjet to laser marking in food, beverage and pharmaceutical processing plants.

We're also seeing increased CO2 laser opportunities in new applications for us, such as inorganic materials processing for smartphones, apparel and sporting-goods and converting. Our scanning and beam delivery sales increased high single digits year over year in Q4 on the strength of our new ScanMaster controller product offering which enables OEM customers to more effectively design and control our scanning technologies in our applications. As well as our Lightning II all digital scanning solution which provides best in class accuracy speed and drift.

Scanning demand has been strong in industrial applications, but over 25% of the sales come from medical applications such as OCT, [parental] diagnostics and laser surgery. Those did see a demand slowdown in the latter part of 2014, as I mentioned earlier. Our early 2015 trends show improved in medical order rates for scanning products, so we're optimistic about the go forward picture.

Our fiber laser business continued to grow at attractive rates, off of our small base throughout 2014 with full-year sales up just under 50%. We currently offer fiber lasers up to 4 kilowatts, and this business has been slightly profitable since mid-2014. Our current management team has done a strong job of ramping up the business while selectively pursuing the right growth opportunities for us in this increasingly competitive space.

So turning to our medical technology segment, given the reduced demand in order rates that we saw in the latter part of 2014, I think it's important to separate the short-term dynamics from the medium- and long-term perspectives. From a strategic growth standpoint we're very positive about the medical business. We had an excellent year working with customers on new programs.

The JADAK, auto ID business won 66 new OEM programs during the year, versus an original plan of 60. They had 25 wins in Q4 alone, which is an all-time high for the business for a single quarter. Most of these new products -- rather these new programs will turn into production revenue in 2016, or and most likely beyond. But this was an excellent outcome. We're seeing an increase in customer demand for all of our auto ID technologies, including machine vision, 1D and 2D barcode scanning and RFID in particular is gaining momentum in medical applications.

The NDS business had a strong focus on product development pipeline, they showed 10 new products in the fourth quarter and got excellent customer feedback. Their new 27 inch radiance ultra surgical display has the most advanced technology in the industry, including edge to edge Corning gorilla glass, better visualization in high ambient light conditions. The brightest LED backlight in the industry and a faster sterilization process which will improve OR turnaround times between procedures.

NDS also won an award at 2014 Excellence In Surgical Products awards competition. This recognizing the technology and innovation of our expand OR high definition video and audio streaming device. Our medical thermal printers product line, which was recently merged into the JADAK business, is also seeing strong customer interest in new programs, based on their new line of mobile printers that can be adapted for use with existing equipment.

Our medical cross-selling initiative is also gaining traction with our customer teams meeting regularly to share leads and opportunities across the medical business and to plan joint sales calls and tech days at major medical customers. So on the whole we're seeing significant medium-term growth potential in the medical market.

Our larger medical customers have recently communicated improved market conditions and a higher order forecast for 2015. We now have eight weeks of order data in hand and so far we do see improvement. So we're expecting mid-teens reported sales growth for the medical segment in 2015, with organic growth of mid-single digits. Having said all that, I have to be clear that Q4 and late 2014 were a definite challenge for the medical technologies. Reported sales in the segment were up 30% year over year in Q4 and 35% for full-year 2014, but that growth is based on the addition of JADAK, the acquisition into the results.

Segment revenue declined year over year and in Q4, excluding the acquisition. There were two primary drivers. One we've talked about quite a bit, we had the full-year impact of the 2013 OEM dual sourcing that hit NDS in midyear 2013. Second, there was a general slowdown in medical capital equipment orders that I have mentioned earlier, which impacted all of the medical businesses.

The JADAK business, which we acquired in the first quarter, if you viewed it on a standalone basis for the full-year 2014, it had mid single-digit revenue growth, full year. But the business saw the same order rate deceleration that we had in virtually all medical product lines in late 2014. So we definitely faced medical market headwinds, particularly in Q4. We view it as a short-term dynamic.

A number of our OEM customers, medical OEM customers pointed to US electronic health records mandate as a driver of the lower unit volume of their shipments of equipment in Q4. This is likely not the only driver. We believe US Medicare reimbursement changes and other aspects of the US Affordable Care Act have created some disruptions in the capital equipment market that did have an impact on our business.

The silver lining of all this is two-fold. One, we were able to offset the short-term medical slowdown with upsides in our industrial business and still deliver on our guidance, despite the unfavorable currency movement that we saw in late Q4. Second, we're confident in the ultimate opportunities we see in the medical business and our ability to capture them. We have a strong engagement with customers on new programs.

The cycle to revenue in medical equipment can take some time. But we expect this market to deliver attractive growth for us over time. Healthcare trends, including demographics, the growth in procedures, the rising standard of care around the world, will ultimately drive the growth of the medical capital equipment industry. We think medical technology is a good place to play, we're well-positioned and we continue to look to grow this part of the Company going forward. So with that I'd now like to turn it over to Robert to provide more details on the financial performance. So, Robert?

Thank you, John. During the first quarter of 2014, GSI generated revenue of $94 million, an increase of 14% from $82 million in the fourth quarter of 2013. Changes in foreign exchange rates adversely impacted revenue, causing a roughly 2% decrease in reported revenue. Excluding the impact of the JADAK acquisition and changes in foreign exchange rates, the Company's revenue increased by approximately 1% compared to the fourth quarter of 2013.

Growth in our advanced industrial applications was partially offset by year-over-year weakness in medical end market applications. Sales to medical customers were down due to significant US regulatory changes going into effect in 2015, which disrupted hospital capital expenditures in the fourth quarter. The medical market is showing signs of stabilization now, with the majority of our OEM customers are expecting a better outlook for 2015.

Turning to our segments, sales of laser products for the fourth quarter of 2014 increased 7% to $46 million, compared to $43 million in the prior year. The business experienced solid growth across all business lines. While we experienced some weakness in medical end market applications, our laser scanning and beam delivery technologies were up nearly 10%, whereas our laser source technologies were up mid-to-high single digit.

Sales of medical technologies for the fourth quarter 2014 increased 30% to $32 million, compared to roughly $25 million in the prior year. The JADAK acquisition drove the increase in reported revenue. However, sales of our visualization solution sold under the NDS and Dome brands were below fourth quarter 2013 levels.

Sales of precision motion for the fourth quarter 2014 increased 10% to $15 million, from $14 million in the prior year. The business experienced solid growth across all product lines. While the business experienced some weakness in medical end market applications, demands for our products in advanced industrial applications, market share gains and new product introductions, more than offset that weakness.

Turning to profitability, fourth-quarter GAAP gross profit was $40 million, or 42.3% gross margin, compared to $34 million, or 41.6% gross margin in the prior-year comparable period. On a non-GAAP basis, excluding intangible amortization and acquisition fair value adjustments, fourth-quarter non-GAAP gross profit was nearly $41 million, or 44% gross margin compared to a non-GAAP gross profit of $36 million, or 43.3% gross margin during the same period last year. The 70 basis point improvement in non-GAAP gross margin was driven by solid progress with our continuous improvement productivity initiatives across our business lines, and a better mix of higher-margin product sales.

Laser products fourth-quarter non-GAAP gross profit was roughly $20 million, compared to $18 million in the same period last year. Gross margin percentages improved this year to 44% from 41% in the fourth quarter in 2013. The increase in gross margin was primarily driven by cost productivity gains from our continuous improvement program.

Medical technologies fourth-quarter non-GAAP gross profit was $14 million, reflecting a 43% gross margin, compared to $11 million or roughly 45% gross margin in the same period last year. The roughly 200 basis point decrease in gross margin was primarily driven by lower sales volumes of our visualization solutions sold underneath the NDS and Dome brand names.

Non-GAAP gross profit dollars increased $3 million, primarily due to the acquisition of JADAK. Precision motion fourth-quarter non-GAAP gross profit was $7 million, reflecting a 48% gross margin, compared to $6 million or 46% gross margin in the same period last year. Gross margins increased 1.7 percentage points, driven by cost productivity from our continuous improvement program, and a higher-margin product mix of revenue.

GAAP operating expenses amounted to roughly $74 million in the fourth quarter from $27 million in the fourth quarter of 2013. The nearly $47 million increase was primarily driven by a $41 million impairment charge of goodwill and intangibles. Research and development expenses were nearly $8 million, or 8% of sales during the fourth quarter, compared to nearly $6 million or 7% of sales during the fourth quarter of 2013.

R&D expenses increased in terms of total dollars due to the acquisition of JADAK. However, R&D expenses were relatively flat compared to the third quarter of 2014. SG&A expenses were $22 million, or 23% of sales during the fourth quarter, compared to $19 million, or 23% of sales during the first quarter of 2013. SG&A expenses increased in terms of total dollars due to the acquisition of JADAK. However, SG&A expenses were relatively flat compared to the third quarter of 2014.

Non-GAAP operating income was $12.5 million, or 13.3% of sales in the fourth quarter, compared to more than $10.5 million, or 12.8% of sales in the fourth quarter of 2013. Adjusted EBITDA, a non-GAAP financial measure, was $15.3 million in the fourth quarter, compared to $13.6 million in the fourth quarter of 2013. Interest expense was $1.4 million in the fourth quarter 2014, the year-over-year increase being driven by the acquisition of JADAK.

The weighted average interest rate on our senior credit facility was 3.3% for the fourth quarter, compared to 3% in the fourth quarter of 2013. Other income was nearly $1 million in the fourth quarter. This represents earnings from our equity interest in Laser Quantum, a business we hold roughly 41% ownership interest in as of year end.

Diluted earnings per share from continuing operations was $0.82 loss in the fourth quarter, compared to income of $0.14 in the fourth quarter of 2013. The fourth quarter of 2014 includes the previously mentioned NDS impairment charge of $41 million. However, non-GAAP earnings per share as reconciled in our earnings press release, was $0.24 in the fourth quarter of 2014, compared to $0.17 in the fourth quarter 2013, representing a 7% increase year over year.

Turning to the balance sheet, as of December 31, 2014, cash was $51 million while total debt was $115 million. Since acquiring JADAK in March 2014, we've made $22 million of debt repayments, reducing our gross debt from $137 million in the first quarter to $115 million at year end. The company completed the fourth quarter of 2014 with approximately $64 million of net debt. This represents a $41 million decrease in our net debt position, compared to the first quarter of 2014. Operating cash flows from continuing operations for the fourth quarter was $10 million. For the full year of 2014, the Company generated $44 million in cash provided from operating activities and continuing operations.

As we look at the 2015 environment, there are a couple of changes in the last couple of months to take note. About one third of our business is in Europe, which has seen a significant deterioration in its currencies in relation to the US dollar. While we tend to have a US dollar heavy cost structure, the changes in those currency values still present a pretty good size headwind for us going into the year.

In addition, as witnessed in the fourth quarter, the regulatory environment for the US medical market is going through some short-term changes. The US Affordable Care Act, the new electronic medical records systems mandates, and changes in medical reimbursement rates have been disruptive to the medical equipment market in the short term. However, the industry has largely adapted to these changes and we now expect to see more stable order rates from our OEM customers and a return to growth in mid 2015.

Consequentially, for the full year of 2015 we expect revenue from continuing operations of approximately $380 million. This represents year-over-year organic growth of 4% to 5%. Based on what we know, we are expecting foreign-currency translational headwinds to impact reported revenue by approximately $10 million, which is incorporated in this outlook. We continue to gain confidence in the outlook for our businesses and our markets.

As John mentioned earlier, our customer design in activities, our new product development efforts are all making solid progress. Moreover, our continuous improvement productivity program has also taken strong root in our culture and our manufacturing centers, allowing us to better meet the needs of our customers while improving our profitability. As it relates to profitability, for the full-year 2015 we expect to deliver more than 150 basis point improvement in our gross margins, giving us the ability to invest for growth and weather the foreign exchange headwinds.

While delivering 4% to 5% organic growth, we expect to increase our non-GAAP operating income by 10% and expect to deliver $60 million of adjusted EBITDA. With a share count of roughly 35 million and a non-GAAP tax rate of approximately 35%, we expect non-GAAP earnings per share to increase nearly 10% as well. We expect operating cash flow to be strong for the year, despite approximately $3 million to $5 million of planned restructuring, to eliminate redundancy and reorganize to better position ourselves for success.

We also plan to increase our capital expenditures approximately 30% to $7 million for new production tooling to support our new product launches in the year and to start migrating to a more modern ERP environment in a few of our manufacturing facilities. Overall free cash flow, operating cash flow minus capital expenditures, should be relatively flat year over year.

Turning to the first quarter of 2015, we expect revenue from continuing operations of between $88 million and $90 million, which represent a year-over-year organic growth of 2% to 4%. Based on current trends we are expecting approximately $3 million in foreign currency translational headwinds impacting our reported revenue for the quarter. In addition, for the first quarter of 2015 we expect adjusted EBITDA to be in the range of $10.5 million to $11.5 million, with foreign exchange headwinds impacting our profitability slightly.

We continue to take actions to make progress to mitigate the impact, including accelerating cost productivity programs and renegotiating customer and vendor contracts. I should also note that we are ramping our spend in R&D. Which is set around 9% of sales level as we are seeing a significant growth in customer design in activities and demand for our new products. These activities have given us renewed confidence in what to invest in and where to invest in, across our business lines.

We expect to record approximately $3 million in restructuring costs in the first quarter. We also expect depreciation and amortization expense of approximately $4.5 million for the first quarter of 2015 and stock compensation expense of roughly $1.4 million. At the end of the first quarter of 2015, and given the recent closing of the Applimotion acquisition, we expect approximately $118 million of gross debt and approximately $73 million of net debt.

We demonstrated solid financial results in the fourth quarter 2014, despite tougher market conditions in the prior year. We are looking forward to a successful 2015 as we continue to drive our business organically, improve our product offerings and improve operations to drive profitable growth. Finally, we have a strong balance sheet which gives us additional capability to pursue strategic targets and a growth for acquisitions, while further leveraging our base. This concludes our prepared remarks. We'll now open the call up to questions.

(Operator Instructions)

Your first question is from Lee Jagoda of the CJS Securities.

Hi, good afternoon.

Hi Lee.

So John you mentioned that you did the study and defined your addressable market about $2 billion. Can you define that marketing system, broad buckets in as much detail as you'd like back

Well I mean, we have a map of it. Because you're looking at technologies down one side and then you're looking at application areas across the other side, but some of that isn't traditional laser materials, processing applications. You've got a lot of precision motion applications. You have auto ID applications. There's a lot of different things going in there and that's medical and industrial.

So, and it's kind of hard to walk it through verbally what all that is. But the interesting thing is, when you look at and say, okay if you view medical as a broad area and advanced industrial as a broad area, they're both in the range of about $1 billion. What we can access. And they have similar growth rates, frankly.

We're little weighted, sort of 60-40 industrial to medical right now, but it doesn't say that there's a big difference in our growth opportunity across one or the other. But the way we built that up, Lee, is we did strategic plans in all the businesses and then kind of had enough of standardization of how they define it that you could then start to aggregate this stuff.

Okay great. And then just following up on the SG&A side, I would assume that the SG&A as a percent of sales goes up particular because of currency and there's no real significant offset there. You've talked about adding sales and marketing ahead of future growth. Can you talk about some of the initiates you're planning on the sales and marketing side and when we expect to see the acceleration of growth because of those additions?

Well, the first thing to realize is the way we sell. It's a designing process that you could think of that designing process as a year plus or minus, in industrial applications and two years plus in medical applications. So you can't walk in the door and have a meeting and then leave with an order. What you're working towards is a design win. And then when you get the win you still have work to do before you see revenue.

So, we have to add resources ahead of when the demand shows up and it's a one to two year lag on that. So we've made additions. It's not like we're just starting right now adding some of the front end resources. We have been doing it. You kind of have to keep doing it and there's a lag affect. But we didn't get a lot of organic growth in 2014; fair point. We're seeing more flowing in there even in Q1, and as we move through this year we're going to start to see some mid single-digit organic growth opportunities. So I think we're getting some benefit from that and you would see even more next year of course.

The one thing I would add to that is, traditionally as you look at how we've managed our SG&A and even our R&D for that matter, but we've been fairly conservative in adding those resources into that organization. So this is probably the first time as we get into 2015, we have enough confidence that we can start to add those resources and we know where to put them.

Yes, it's a good point what Robert is saying. What we've tended to do is draw up a plan to add a lot of these resources. But we've been conservative, where if the revenue was not happening we'll pull back on it, and preserve the profit margins and all that. And there's goodness in that instinct, but at some point you have to just go for it. Because really there is this lag and we're not going to get a sale of any customer in the first few months or even really in the first 12 months, but we add a sales person.

Occasionally, it happens in some kind of serendipitous way that we walk into an account, and there's some supplier there that's falling down and you can kind of jump in there and take the business over, but that's not our normal way of acquiring business. It's really when the customer's doing R&D and we collaborate and we get incorporated into their new product launch. It just doesn't happen that quickly.

It's fair to say that most of the vast majority of the SG&A and R&D is US-centric and wouldn't be -- you wouldn't get the benefit of the FX that you're getting hit for on the top line?

Well, I would say certainly on the R&D, that's not necessarily the case on the SG&A side, but certainly on the R&D side that's the case. But the vast majority of our centers of excellence reside in the US. From an SG&A perspective it is a little bit of arbitrage that we can play out there. And we continue to look at those opportunities.

Even for business reasons. Nevermind FX reasons. We need to get our sales channels more developed in Asia and even really in Western Europe in some cases. And that actually would play okay when you're seeing the weakening euro or whatever. But we wouldn't do it just for the currency reason. But R&D right now is pretty US dollar-centric. We have on the board some programs to start doing in-country R&D in China, doing perhaps some limited R&D in Europe, but it's not big numbers. That's skewed in a significant way into the US.

Okay great. I will hop back in the queue.

Thanks, Lee.

Your next question is from Jim Ricchiuti with Needham & Company.

Hi, good afternoon. Question on gross margin. Nice improvement that you showed in Q4. How should we think about gross margins over the next couple of quarters?

For the full year we to give guidance around 160 basis points, that was somewhat implied at the gross margins that you see in the fourth quarter. Certainly hold into the first half and then begin to increase as you get in to the back half of the year. So there is continued gains there. When you look at the volume to volume ratio on a year-over-year basis, you should expect to see some margin expansion.

Okay. Thanks. And John, I think you alluded to a bit of an uptick in the medical segment, the medical business orders. Do you expect to see the growth in that business more weighted toward the second half of the year?

Yes Jim, I think that's an accurate way to look at it. Just because there's a little bit of a correction in the system. Being a component supplier you know, when you have a sudden slowdown as you can imagine, equipment is not selling. They already have some inventory of our components. Right?

So then they try to shut off deliveries of the components and then as it starts to trend back, there's always this lag affect. Because we're at the end of the chain. So as they start to see -- they had probably too much inventory of our product at a point in time, so there's a bleed off, they start to pick up in sales but we don't see it right away. Ultimately when they bleed through some of those inventories we'll see the pick back up.

We're getting those positive signals. It is definitely more skewed to the second half than the first half, but some good signs already.

Got it. Just as we look at the portfolio of businesses, there have been some adjustments that you've made, you've been acquisitive. How should we think about the year, both from the standpoint of potential acquisitions that you see in the pipeline, and should we consider that there may be any additional adjustments to the existing portfolio of businesses.

There could be. We're always active. This is something that never stops in terms of cultivating acquisitions, meeting with companies. We source our own deals that we think fit our purposes. We don't respond to the typical sales processes that are happening. And so, you can never stop doing that.

Some things are further along than others. Some transactions are larger and smaller than others. It's difficult to predict, but there's a good likelihood we could have additional transactions happening this year on the acquisition side.

With respect to divestitures, we always evaluate. I use the term we rack and stack the portfolio, and always say, what are your best businesses, most core to what you're doing. Some are in the middle and some are less core and you're always evaluating that. But nothing that we can speak to at this time anyway.

Sure. And I may have missed it, but I think you talked about savings in the area of $6 million and I wasn't sure, again I missed the references. You're geared more toward some of the initiatives you've taken on a procurement front and if that's the case, how should we think about that playing out over the course of the year? Is that something you think will be more impactful in the second half?

Well, the first part of your question, you know the savings are somewhat more skewed to the supply chain because that's where the cost is. We have 70% to 80% of product cost is purchase material, so you've got to work on that to get savings. We are skewed, and you know the $6 million, you could think of it roughly as one third in-house labor, overhead type cost, and one-third in the supply chain. It's labor overhead and cost of poor quality. The internal cost.

The other part is the supply chain. When you drive this, this is all based on plans and efforts that were already being worked on through the course of last year. So you do have the ability to get some of these savings even early in the year, but it builds upon itself as you go through the year. And we now have it in a process. Every one of our sites has specific projects, not just a dollar figure. They've got projects that lead to the dollar figures.

In the supply chain and in their own factory cost structure, and the projects and the savings from those are reviewed every single month and we track against it like it's a normal part of the budget now. It's much further along than we were, say 12 months ago, where we had aspirations and we had efforts and intentions, but it was not structured that way. Our view is, you've got to drive this kind of productivity every year. It's not a one-time event.

And you know, we put in place -- we said, IT but what it really is, we did a spend analytics tool -- we implemented. And that is basically a system that sucks all of your procurement data out of your underlying systems in the factories. Says what parts are you buying, from whom, in what quantities, what supplier, what price are you paying, and brings all that data into one place. And then you can compare notes and see, well, gee, we buy printed circuit boards from 20 different vendors, or 30 different vendors and consolidate that buy in 5 vendors; you could get a savings on that and you can do something about it and then when you do it, you can track it.

So it's called the spend analytics tool. It took a while to implement that. So now you can push a button and get all that data. Look at it weekly and refresh it. So, it's an excellent tool that really now say, what are we spending, where is the spend? How do we go after this and drive it?

This is the same process we've done in other companies. Our team has done it in other companies and once you get that infrastructure it's a big step forward. Your always now negotiating with a lot of information and a lot of knowledge and you know where to focus.

And John, this is being implemented across the business units?

Yes. Because it's a centralized tool, the spend analytics is then mapped to each system in the field that the data pulls into one place, and so all the sites are linked to it.

Every supply chain leader across our sites, every general manager, every production line leader can see the information.

You can imagine we run different ERP systems in a lot of our different factories. So if you don't have this you're on the phone trying to say, hey, where do we buy circuit boards and what do we pay for them? It's highly inefficient to ever try to get real savings out of a process. Now, we can see all that with the push of a button, what do we buy, where, prices, trends, are prices moving up or down.

So you can start to really build a program and say where do we go renegotiate some of this, or look to strategically consolidate the buy. And it tracks how much of what you're buying is coming from low-cost countries and things like that. You know there's a tendency in smaller companies and businesses like we, where our roots are, that everybody buys from vendors that are within an hour's car ride of where the factory is. And you know that's not a way to drive productivity. So now you're able to kind of get at that.

Got it. Thanks very much. That's very helpful.

Thanks Jim.

Your next question is from Keith Maher with Singular Research. Your line is open.

Hello Keith.

I was wondering if you could provide a little bit more detail, financial details on the Applimotion acquisition. If you could share in terms of how much revenue that entails. What kind of margins.

It was more of a technology acquisition, it was relatively small in nature, but that being said we haven't provided a lot, that's not incorporated that much in our guidance at this point in time. Again it's not very big, but we haven't provided a lot because it's a small business that's never prepared its books in anything other than QuickBooks. And certainly not on a GAAP basis. So we have to sort our way through that and get that fixed before we start giving some updates there, but that certainly could surprise with a little bit of upside on the top line.

And it has not closed yet?

It just recently closed. A couple weeks of revenue. Probably, a couple weeks of revenue aboard.

All right. And in general you're not including any acquisitions at this time are you?

No, we're not including any acquisitions or divestitures in our forecast at this time. Certainly, there's plenty of things in the pipeline that we look at as John mentioned before, on both sides, and we'll evaluate it at the time when it's appropriate.

Okay. Great. And with regard to the negative FX you're seeing, you alluded perhaps to maybe trying to raise prices or maybe I misinterpreted that. Is that something that's realistic and I'm thinking of your competitors or --

Yes, that's the issue. What you just said is the issue. That in a number of cases we have direct competitors that are private companies in Germany or in the eurozone that have all their costs in Europe. So if we try to recapture margin by raising the prices, we become uncompetitive with those.

So it's a balancing act. You look at where you may be able to do that, but we don't want to have a short-term knee-jerk reaction that disadvantages us in the longer-term customer relations. We don't want to let the enemy into customers.

Right.

Sometimes you've got to take into consideration there's lots of plays. We tend to be a heavy US dollar cost structure organization, but that doesn't mean we're 100% US dollars. So there's opportunities, even to change the currency in which we transact in that could have a benefit to us.

So we started that in the fourth quarter when we started to see that this trend in Europe was likely going to continue for a little bit. And trying to better match what we transacted versus what we produce and I think we've made some good progress on that. That's incorporated into a forecast for now, but hopefully it provides us with some opportunities as we go throughout the year.

Okay great. And finally, you talked about [right] design wins in the [major] product area. Just curious, how long does it take for those design wins to get into your customer's products and get shipping and driving [revenue]?

Yes. That is the kind of key question. Business like ours that's a highly engineered component business. We don't sell stuff out of a catalog. We don't have finished goods sitting on a shelf waiting for anybody.

What I would say is in the industrial applications, and the CO2 laser is predominately an industrial type of technology, it's shorter. It's still typically averages over a year. But you can have some ramp up. The stages you go through is initial prototype samples and then qualification samples, preproduction samples, where the quantities are a little bit more, and then ultimately production volumes.

You're not going to get to the production volume in less than a year normally, but you can start to see a ramp to that. It's the medical that takes longer because you have a regulatory cycle sometimes in FDA, or 510-k process. So that just takes longer. But with the CO2, some of those can turn into revenue. You'll see something in the first 12 months, but then you'll hit run rate in a year, a year and a half.

And then how long is the lifecycle --

That's another great question. When you're looking at industrial applications, it tends to be about the seven-year type of range. When you're looking at medical though, and we're sitting on platforms that are 10 or longer years, and so it becomes an annuity strength.

So one of the things that you always constantly focusing on is that annuity stream that you have, how much of that is coming up for bleeding off, meaning that they're moving off of that platform into something else. And then how much new business can you get in? I think we finally got ourselves into a position where we're generating more new opportunities that we've seen coming off and so we're feeling better about that.

Okay. Thanks. That's really helpful. That's all I had.

(Operator Instructions)

You next question is from Lee Jagoda with CJS Securities.

Robert, just a couple of bookkeeping items. Your expectation for amortization of purchased intangibles, as well as the GAAP tax rate and the non-GAAP tax rate that you expect, sitting here today.

I'll start backwards, on a non-GAAP tax rate around 35% for 2015. On a GAAP basis, you know it's going to be -- it's difficult to predict. I had an impairment charge that obviously, threw off the 2014 number pretty significantly, so we finished off around 5%. But we were trending before that in the, call it, 35% range as well. Arguably, they should be fairly close on a GAAP and a non-GAAP should be not that different. So you can use those two numbers.

From an amortization of intangibles on a total basis, remember a portion of that goes up in our cost of goods sold. You know we gave in an 8-K release earlier in the year about $11 million as our guidance. And I still see that, so it's sitting somewhere around $11 million. Then depreciation is somewhere around $7 million to $8 million, closer to $8 million.

And of the $11 million, what portion of that goes into cost of goods?

It's about $7 million is going into operating expenses.

Okay.

And there are no further questions at this time. I will turn the call back over to Mr. Roush for any closing remarks.

Okay thank you operator. So as we move forward in 2015 we do see a positive outlook for GSI. We've made tremendous progress as an organization. We're in a better position to drive forward with our strategies and ultimately control our own destiny as a company. We built an outstanding team, a more attractive portfolio, and a solid execution capability that enables us to drive sustainable profitable growth. So the agenda for 2015 is clear.

As demand from medical OEM customers recovers, we need to continue to serve them well, bring new products and technology to market and capture design wins, which are the lifeblood of our business. And those secure our future growth. Demand across our industrial applications has been healthy. We expect that to continue.

We've got to execute on our strategic plans and ensure that we capture the future opportunities we do see across the market. Following the closing of the Applimotion transaction we're now implementing our integration program for the business to bring it together with our encoder business. As we said, there are significant opportunities for the combined business so we need to get aligned quickly to take advantage of those.

On the operational front, as I mentioned earlier, we now have concrete plans and programs to drive productivity and operational improvements in each site. We're moving out of those plans, tracking progress on a monthly basis in operating [renews] and actually expect to see very good impact in 2015. The economic certainty remains a part of the landscape in which we operate. The strengthening of the US dollar is going to have an impact on us like it will on many, if not most global companies. Reducing reported revenue and to an extent, pressuring margin.

We're not deterred by that factor We have confidence in our team, our strategy and our ability to create value. The leadership team here at GSI is fully committed to deliver on our 2015 goals and to strengthen our foundation of the company and ensure our future success. I'm confident we'll get there. I appreciate your interest in GSI and your participation in today's calls, and I look forward to joining all of you in early May on our first-quarter earnings call. Thank you very much.

The call is now adjourned.

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