Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Marc Giles – President, CEO

Michael Elia – Executive Vice President, CFO

John Draczynski – Vice President, Chief Accounting Officer

Analysts

Arnold Ursaner – CJS Securities

[Chris Mancini – Gemco]

Gregg Eisen – ICM Asset Management

Gerber Scientific Inc. (GRB) Q2 2009 Earnings Call December 4, 2008 10:00 AM ET

Operator

Welcome to the Gerber Scientific Inc. second quarter 2009 earnings release conference call. (Operator Instructions) I would like to remind everyone that some of today's remarks and answers during the Q&A will contain certain forward-looking statements as defined in the Federal Securities Laws.

These include statements regarding Gerber's expected financial conditions results of operations cash flow; product launches and planned cost reductions as well as unplanned events and expectations. Our discussion of important risks and uncertainties that could cause Gerber's actual results to differ from the results expected or implied from these forward-looking statements, you should read Gerber's annual report on Form 10-K for the fiscal year ended April 30, 2008 which was filed with the SEC on June 27, 2008 as well as other information included and subsequently filed in quarter reports on Form 10-Q and current reports on 8-K.

These risks include but are not limited to delays in the company's new product development and customizations, intense competition in markets where each of the company's operating segments, technological advances availability and cost of raw materials, or activity in foreign currency exchange rates and fluctuation in interest rates.

At this time for opening remarks and introductions I would like to turn the call over to the company's President and Chief Executive Officer, Mr. Marc Giles.

Marc Giles

Good morning everyone. Welcome to Gerber Scientifics fiscal 2009 second quarter conference call. Joining me on the call today is our Executive Vice President and Chief Financial Officer Mike Elia, and our Vice President and Chief Accounting Officer, John Kraczynski.

Business conditions continued to worsen in the second quarter across all of Gerber's markets due to the global economic recession and credit market crisis. Second quarter revenue was down by 4% and orders down by 14% compared to the second quarter a year ago. The orders decline was almost entirely in equipment and software products. Importantly, over two-thirds of the company's sales are driven by after market service products. Orders from these sources were down a more modest 2%. Again, Gerber technology was particularly hard hit with overall orders down by 23% versus a year ago.

The cost reduction actions we previously announced and that were taken during the quarter were effective in mitigating the business decline and largely as a result, our operating income of $5.4 million inclusive of approximately $1 million in severance charges was roughly equivalent to that of last year's second quarter.

Also, as a result of very close attention, the company was able to generate cash flow from operations net of capital expenditures of $5.2 million versus a use of $8.4 million during the second quarter of last year.

Given the business deterioration experienced in the second quarter, and the lack of good visibility in the market conditions in the near term, we will take additional cost actions that should drive between $5 million and $6 million in savings, including approximately $2.5 million in head count savings to the company during the balance of this fiscal year net of approximately $1.4 million in severance charges to be recorded in the third quarter.

In addition, due to this lack of market visibility, the company is revising downward its earnings guidance. We now expect revenues of between $600 million and $620 million for fiscal 2009. That's revised from our earlier fiscal 2009 guidance of in the range of $660 million to $690 million.

Consequently, we are also reducing our earnings guidance down from a range of $0.72 to $0.82 per diluted share to between $0.50 and $0.65 per diluted share. For comparison, in fiscal year '08, the company reported revenue of $640 million and earnings of $0.61 per diluted share.

Gerber's portfolio of key new products is important to the company's sales volume particularly in this difficult environment. The Solara Ion was a particularly strong contributor to revenue in the second quarter with the new Z7 from Gerber Technology and Gerber Coburn's new Onyx introductions also make important progress in their respective markets.

The company will continue to make the investments necessary in research and development to sustain an exciting new product pipeline.

Regarding the Ion, we shipped 117 units in the second quarter including the 20 delivered to our Spandex and ND Graphics distribution company. It generated just over $7 million in revenue during the quarter. The profitability of the units shipped early in the quarter did not meet our expectations due to some field problems. However, with those issues now largely resolved and having finally completed the ramp up in production capacity we expected, we continue to be very excited about the prospects for this new product line.

The market had definitely slowed considerably for commercial white format ink jet printers due to the economy coupled with the lessened availability of lease credit, and as a result we have reduced our Ion sales outlook for the balance of this fiscal year. Even so, we have excellent lead generation at recent trade shows in the United States at the SGIA show, as well as at shows in Spain, Germany and Italy.

In fact, between Gerber Scientific products and our Spandex and ND Graphics distribution companies, we have booked orders for 46 new Ion systems since the SGIA show in mid October, and as a result, anticipate shipping another 100 to 200 systems during our third and fourth fiscal quarters.

The company did close the previously announced acquisition of Gamma Computer Technology, a relatively small, about $2 million in revenue, technology manufacturing business in China that will enhance Gerber Technology's position in that critical growth market.

In addition, we completed the acquisition of Virtek Vision, headquartered in Waterloo, Canada. This was a sizeable acquisition for us with trailing 12 month revenue through October of '08 of approximately $47 million U.S. and trailing 12 month pro forma EBITDA excluding transaction and public company costs of $4.8 million. For this we paid $29 million U.S. debt of cash or roughly six times trailing 12 month EBITDA. In addition, Virtek was immediately accretive to earnings in the second quarter.

This acquisition is now a unit of Gerber Technology and we are particularly enthusiastic about a leverage in the market place synergies in addition to capturing the identified cost savings.

Manufacturing applications with composite materials are an increasing source of growth for Gerber Technology in transportation, energy, military and other market segments. And Virtek Imaging systems are very often placed adjacent to Gerber Technology cutting systems, and when they're not, we believe that they should be.

We think that providing an integrated technology package including service is a competitive advantage. In addition, we believe that Gerber's worldwide infrastructure can help more rapidly globalize Virtek's business.

At this time, given the economy and the work in front of us to maximize the benefits of the two acquisitions we have recently completed, we have no additional acquisitions in our near term plan.

About our market segments, as mentioned earlier, Gerber Technology orders were off sharply, down 23% when compared to last years second quarter driven by the decline in orders of new equipment and software seats which were down 39%. The markets in Europe and Central Asia dropped precipitously following on the heels of the decline in the far east that we experienced in the first quarter.

Nevertheless, we continue to believe that Gerber Technology is competitively well positioned in this market. While demand was very soft, the data available indicates that we continue to take share from our nearest competitor.

At this point in time we can't predict when a rebound in Gerber Technology's business might occur. One important note is that China, Gerber Technology's largest single geographic market has started to launch vigorous incentives to encourage the rebound of the apparel industry there to spur employment. In addition, Gerber Technology also has an exciting new product in development related to its recent acquisition in China that it plans to launch commercially before the end of the fiscal year.

With regard to our sign making and specialty graphics segment, the slow down in business we saw for Spandex in the first quarter continued in the second quarter resulting in virtually flat revenue when compared to last year. Gerber Scientific product sales were up 6% driven entirely by Ion revenue which more than offset the steep decrease in our thermal systems business.

Profitability was up in this segment by 10% compared to the second quarter of last year driven largely by continued focus on operational improvements and portfolio enhancements at Spandex.

Our customers in this industry segment both in Europe and the United States have been particularly hard hit by the tight credit market for new equipment leases as well as the global economic slowdown. It is impossible to predict with any accuracy when the situation will moderate.

Nevertheless, we feel we are well positioned to capture available business in the market as a result of our new products, particularly the Ion. In addition, we plan to launch extensions to the Ion family of products by fiscal year end that should further invigorate our business.

Our Gerber Coburn business unit, serving the ophthalmic manufacturing industry has been suffering from the weak economic environment reaching back over a year now. Year over year sales declined in this quarter by 16% as the market got even weaker. However, over the past year, Gerber Coburn has managed to keep its expenses down while yet investing in an exciting suite of new products.

As a result of the higher margins generated by their new products, as well as lower expenses, Gerber Coburn's operating profit increased by 16% compared to the same quarter last year to $1.2 million. As with our other segments, we see no near term improvement in this industry.

On a positive note, Gerber Coburn has been able to sustain the introduction of a series of important new products during this challenging time and they are planning yet another new exciting product release by fiscal year end.

The new E2G lens blocking system which is essentially a lens chucking system for when it's generated uses a proprietary environmentally safe, reusable and biodegradable material that will offer the industry the first real alternative to the dangerous cadmium and lead based alloy blocking used for digital lens processing.

This technology was exhibited at the recent Optical Laboratories Association show in Nashville and generated tremendous excitement.

In summary, while suffering the weak economic environment, Gerber Scientific is taking the necessary actions to properly size the company's cost structure, generate positive cash flow from operations and preserve our ability to continue to invest as appropriate and prudent for the long term.

At this point I will turn the call over to Mike, and then John for a more detailed review of second quarter performance.

Michael Elia

As a reminder, a summary of the key financial information discussed on this call is on our web site at www.gerberscientific.com. As Marc said, our consolidated sales for the second quarter of fiscal 2009 were $153.8 million, down 4.3% from the same quarter last year, or down 3.4% on a constant currency basis.

John will discuss the financial performance in more detail in a few minutes, so I just wanted to mention a couple of things about our consolidated and segment performance during the quarter. First, on a consolidated basis, current quarter sales benefited $2.4 million from the Virtek and Gamma acquisitions. New products driven by the Ion also made a healthy contribution.

However, these benefits were offset by lower overall volumes reflecting the general global economic weakness and the credit crunch which are negatively impacting our customers' own performance and their ability to finance equipment purchases.

Consolidated operating profit for the second quarter fiscal 2009 was $5.4 million up about $200,000 from a year ago. In comparison to a year ago, results benefited from the elimination of accrued incentive compensation expense, cost reduction initiatives and incremental operation profit from the acquisitions.

It's important to note we didn't receive the full quarter's benefit of the cost reduction initiatives. While we completed some actions early in the quarter, we continued reducing costs in October as well. As we reported in the press release, we expect our second quarter actions to generate $6 million in salary and wage savings, net of severance for all of fiscal 2009. This equates to about $10 million on an annualized basis excluding severance.

Sequentially, our gross margin was up nearly 200 basis points in the current quarter from the first quarter of fiscal '09. However, it is still off about half a percentage point from a year ago which was principally due to foreign currency exchange fluctuations. On a constant currency basis, our gross margin was 28.6% of sales versus 28.9% a year ago.

The balance of the change from a year ago was due to a less favorable sales mix and about $300,000 of severance costs that will include cost of sales for second quarter cost reduction initiatives.

Diluted EPS for the quarter was $0.26 which included $0.14 for the one time tax benefit mentioned in the press release. Excluding this benefit, diluted EPS for the quarter was $0.12 compared to $0.11 earned in the second quarter of 2008.

Now let's review the performance of each of our segments for second quarter fiscal 2009 and I highlight the changes in product mix and subsequent margin impacts. Let's start with the sign making and specialty graphics segment.

This segment which accounted for 60% of our fiscal 2009 second quarter sales consists of Gerber Scientific products or what we call GSP and Spandex. This second develops and manufactures computerized sign making and graphic design equipment and software. We also provide after market materials and related services. Our primary customers in this segment are sign printing shops and distributors.

This segments total sales were up 1.6% to $1.4 million to $92.4 million in the current quarter a year ago. On a constant currency basis, total sales for this segment were up slightly by $2.7 million.

Distribution sales slowed during the quarter with all the of the sales increase for the segment coming from higher margin products, especially the Ion. Within Gerber Scientific products business, sales were up $1.6 million or 6% in the current quarter.

Second quarter operating profit for this segment increased more than 8% or $247,000 to $3.2 million compared to $2.9 million a year ago. The segment's operating income margin was 3.5% in the current quarter versus 3.2% a year ago. The improvement reflected the incremental profits from the higher sales within our GSP business which was driven by the new Solara Ion.

Unfortunately the increase from Ion sales was partially offset by Ion startup costs and a declining Legacy business. As Marc noted, the start up costs are now relatively behind us.

Our Apparel flexible materials segment which accounted for 30% of the second quarter fiscal '09 sales consists of Gerber Technologies or what we refer to as GT. Including the two new acquisitions, this second develops and manufactures and services a broad line of computerized automated equipment and software used by designers and OEM's in industries such as apparel and retail, industrial fabrics and composites to transportation carriers and furniture.

These products are used to improve efficiency and information management, product design and development for both pre-production and production processes.

In the current quarter this segment recorded sales of $45.9 million, a decrease of 10.7% or $5.5 million from a year ago in the second quarter. Excluding sales from the Gamma and Virtek acquisitions, sales were down 15.3%. Currency fluctuations had little impact on sales in this segment from the same quarter a year ago.

As with the first quarter, lower sales of higher margin software had a significant impact on the segment's top line and bottom line performance. Most of GT's existing apparel customers are cutting back on design staff causing softer sales in the current quarter to drop $2.5 million or 44% from the same quarter last year.

Systems revenue was also off about $2.9 million or 13%, notwithstanding the benefit we received from acquisitions. After market sales and service revenues were up about $600,000 and helped mitigate the lower system and software sales.

Order flow for this segment during the quarter remained weak with orders down about 23% which reflected weakness in our European and Asia markets. On the positive side, the Chinese government plans to end quota restrictions at the year end to try and help stimulate the textile and apparel markets.

Operating profit for this segment in the current quarter was $5 million, down 22.5% or $1.4 million from a year ago. This decline was driven by lower software sales and lower margin in other product categories offset by the affects of the acquisitions. Excluding the affects of the acquisitions, operating profit for this segment was down about 34%.

Finally, our Lens processing segment, which accounted for 10% of second quarter fiscal 2009 sales. This consists of Gerber Coburn of what we refer to as GC which develops and manufactures equipment, supplies and software to product prescription eye wear. It serves a broad range of customers from wholesale lens production laboratories to retail eye wear chains and independent eye care professionals.

For the current quarter of fiscal 2009, sales from this segment were down 15.6% or $2.9 million to $15.6 million from a year ago. Equipment and software sales were down 31% and after market sales down 10% while service revenues were up 9.7%. Operating profit for this segment in the current quarter was $1.2 million, up about $170,000 due primarily to our cost reduction initiatives.

Corporate operating expenses in the current quarter of fiscal 2009 were down $1.2 million from the prior year of $4 million. The prior year expenses included about $1 million of professional fees associated with our adoption of Fasby 48.

As Marc mentioned, we continue to take decisive actions to reduce our spending to combat weak market conditions. We expect our cost reduction actions in December to generate additional salary and wage savings over the remainder of the fiscal year of approximately $2.4 million net of $1.4 million in severance charges.

In addition, we're still in the process of finalizing other cost cutting initiatives that should generate an additional $2.5 million to $3.5 million in savings this fiscal year. On an annualized basis, the head count reductions completed in December will generate additional salary and wage savings of approximately $6.8 million to bring the total salary and wage reductions to date to around $16.8 million on an annualized basis.

We are pleased to report net cash provided by operating activities net of capital expenditures for the second quarter of fiscal 2009 was $5.2 million compared to our cash usage of $8.4 million in the second quarter last year, a swing of $13.6 million. Principal drivers of the change were lower cash requirements for working capital needs versus the prior year.

Our total liquidity as of October 31, 2008 was $31.8 million which consisted of $16.4 million and $15.4 million in availability under our senior revolving credit facility based on the current financial covenants. After funding the Virtek and Gamma acquisitions, we have $78 million drawn under our senior revolving accruing interest at various LIBOR rates plus 175 basis points.

We also have undrawn letter of credits outstanding of $7.6 million and $6 million in industrial development bonds accruing interest that 1.9%.

Total debt net of cash outstanding on October 31, 2008 was $467.6 million. I'll now turn the call over to John to review some additional details on our performance for the quarter and six months as well as selective cash flow and balance sheet details then we'll open it up for your questions.

John Kraczynski

Now I'd like to provide some additional detail on the financial results we just released. On a consolidated basis, orders for the second quarter of fiscal 2009 totaled $138.1 million, down about $21.8 million or 13.6% from the second quarter of fiscal 2008.

From a geographic perspective, 34% of our orders were in North America, 52% were in Europe and 14% were in the rest of the world primarily the Asia Pacific region. Compared with a year ago in the second quarter, there was a modest shift in our orders from the rest of the world region to Europe reflecting the strength of Spandex orders and the decline in China business activity for our apparel and flexible material segment during the second quarter of fiscal 2009. Orders in North America during the second quarter were relatively unchanged as a percentage of total orders compared with the same quarter the prior year.

Equipment and software revenue for the current quarter was $46.8 million down 8.1% from the second quarter of fiscal 2008. After market revenue was $88 million in the second quarter down 3.5% from the same quarter last year and service revenue was $19 million for the current quarter, an increase of 1.8% from the second quarter of last year.

Our gross profit for the second quarter was $43.6 million or 28.4% of sales compared with $46.4 million or 28.9% of sales in the same quarter of fiscal 2008. Gross profit margin was down slightly from the comparable quarter of fiscal 2008 due primarily to the unfavorable impact of foreign currency translation and lower software sales during the second quarter of fiscal 2009.

The most significant driver of the reduction in gross profit of $2.8 million for the second quarter from the comparable quarter of the prior year was a substantially lower overall sales volume. As Mike pointed out in his comments, sequentially, our gross margin improved from 26.5% of sales reported in the first quarter this year.

We expect to continue to see gross margin improvement during the balance of this fiscal 2009 as a result of the full realization of cost reduction initiatives both completed and in process as well as the continued benefits from the implementation of targeted pricing actions. Additionally, we expect the two acquisitions completed during the second quarter to contribute to gross profit and improved margins.

R&D expenditures were $5.8 million in the quarter, declining about $800,000 from $6.6 million in the second quarter of the prior year. The prior year second quarter included additional spending related to development costs of the sign making specialty graphics segments Ion and the ophthalmic lens processing segment to advance lens processing systems, both of which were commercially launched in the first quarter of 2009.

R&D spending is expected to continue at lower levels for the remainder of fiscal 2009 as compared with the later half of fiscal 2008.

Selling, general and administrative expenses for the current quarter were $32.4 million, down about $2.2 million from $34.7 million in the second quarter of last year. As a percent of sales, SG&A expenses declined about a half a percentage point compared with the same period of last year.

The decline in SG&A expense was a result of the cost reduction actions taken at the beginning of the second quarter and the elimination of incentive compensation expense as performance objectives were not achieved for the quarter.

Operating income for the quarter was $5.4 million up about $200,000 compared with $5.2 million in the second quarter of the prior year. Operating margin was 3.5% of sales for the second quarter, up modestly from 3.2% of sales in the second quarter of fiscal 2008, reflecting the cost reduction initiatives completed and lower R&D expense.

Interest expense in the quarter was approximately $860,000, down about $220,000 in the second quarter of fiscal 2008. The reduction in interest expense is the direct result of lower market rates and the new credit facility entered into during January of this year which has a lower overall cost of borrowing primarily as a result of lower deferred financing costs associated with the new facility.

However, the borrowing facility with the funding for the Virtek and Gamma acquisitions during the second quarter are expected to drive an increase in interest expense for the balance of the year.

Our effective tax rate in the second quarter was a tax benefit of 47.4% from the second quarter of fiscal 2008; our effective tax rate was 32.7%. As noted in our earnings release, the overall tax benefit was achieved as a result of the recording of a non recurring tax benefit of $3.4 million associated with the restructuring of two international legal entities which allowed us to reverse a certain valuation reserves. Adjusting for this non recurring benefit, our effective tax rate would have been 35.9% for the quarter.

On a go forward basis for the balance of the fiscal year our effective tax rate is expected to return to a more normal level in the 30% to 34% range.

Now let me provide some additional detail on our cash flow and balance sheet. At the end of the second quarter, our cash balance was $16.4 million compared with $14.5 million at the end of the first quarter and $13.9 million at the end of fiscal 2008. During the quarter we generated $7.9 million of cash flow from operating activities versus the use of cash from operating activities of $5.6 million in the same period the prior year.

The net cash provided by operating activities in the second quarter was generated from operating earnings and net working capital improvements.

Capital expenditures were $2.7 million in the quarter, relatively unchanged from the same period of the prior year. We expect full year CapEx to be in the $7 million to $9 million range as we intend to prudently manage capital spending in the current challenging economic environment.

Depreciation and amortization was $2.4 million for the quarter, level with the second quarter of fiscal 2008. Our debt balance at the end of the second quarter was $84 million compared with a balance of $42 million at the end of the prior fiscal year. The increase from the prior year is principally related to borrowing to fund the acquisitions completed in the second quarter.

Customer receivables at the end of the second quarter were $104.5 million, a decrease of $16.2 million from the prior fiscal year end. The reduction in AR was due to the impact of a stronger U.S. dollar of foreign currency translation during the period as well as the continued good collections process and the lower sales volume in the second quarter as compared with the fourth quarter of the last fiscal year.

Our DSO improved to 61 days compared with 63 days as of the prior fiscal year end despite the weakening economy.

Our inventories at the end of the second quarter were $80.6 million, up from $76.9 million at the end of fiscal 2008, primarily as a result of the two acquisitions completed in the second quarter, offset partially by foreign currency translation as a result of the strengthening U.S. dollar.

As a result of the increase in inventory and lower sales volume in the second quarter, our inventory turns declined from 6.4 times at the end of the fiscal 2008 to 5.5 times in the current second quarter. We will be continuing to closely monitor and manage our inventory levels especially in light of the current economic environment.

Now, I will turn the call back to Marc.

Marc Giles

Now I'd like to open the session up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Arnold Ursaner – CJS Securities.

Arnold Ursaner – CJS Securities

The question I'd like to focus on is the Ion. You mentioned you shipped 117 in the quarter for roughly $7 million of revenue. A $60,000 selling price is lower than where it's been if I'm not mistaken. Did you in fact lower some prices on that product?

Michael Elia

Not really during the quarter. We had, I think the total sales volume was actually $7.2 million or $7.3 million in revenue. We did do some promotional activity in Europe but overall, that's the average sales price through our distribution here in the U.S. and it's actually pretty close to what we would expect.

Arnold Ursaner – CJS Securities

You said you had added 46 orders. Can you give us a sense of the total backlog for the product?

Marc Giles

No, I don't have the total backlog currently for the product available to me at this moment.

Arnold Ursaner – CJS Securities

Along the way you've had some situations where you've had what you would call soft orders, you take an order but it's subject to the client being able to review the product. You showed it at a trade show. Should we assume that these 46 are no longer 'soft orders' but firm orders with either a deposit or a delivery date of some sort?

Marc Giles

That's correct. These are booked orders. We don't do soft, we're not doing anymore soft orders as we have all the demonstration systems out in the field now so customers can come in, see it, test the machine at a distributor's site and make their own decision.

Arnold Ursaner – CJS Securities

Spandex obviously has a lot of feet on the street, should have a pretty good pulse for trends and changes within the industry. Can you give us a feel for sort of what has evolved over the course of the last few months and what they're hearing as they get out in front of clients currently?

Marc Giles

As far as the Ion is concerned, the buzz is still extremely strong and they generated tremendous leads in Europe and very hot prospects, so we feel very good about the prospects there. The demand side, the want side on the Ion is very strong.

Of course, their customers are increasingly experiencing difficulty in getting credits for leasing that's necessary for many of them to purchase the machine. So how that develops will delay customers' ability to have them purchasing the machine and that's primarily why we dropped down our expectations for the second half of the year.

Ion ships, even though the demand on the street is very strong, their ability to get credit, we're concerned about whether they can actually execute in the near term.

Arnold Ursaner – CJS Securities

This question is related to margins. Obviously getting the Ion I know was an aggressive change in the way you manufacture is it something hopefully you are going to implement across more products. Can you give us an update on how that evolved and you might give us an exit margin number for the overall Gerber, maybe by Q4 what sort of operating margin targets you're hoping to exit the year at?

Michael Elia

I don't think we would want to do that. So much of our margin ends up being determined by not only business unit mix revenue but also a specific product within the business unit, so to give an exit gross margin number that is truly a specific meaningful low is very, very difficult.

I will say with regard to the Ion, we started out the quarter not delivering on our gross margin expectations and did in fact end up delivering by the end of the quarter, we were hitting our gross margin expectations which are running around the 40% range and we're seeing the opportunity to achieve lower costs even than that as we go forward. So we're very enthusiastic about the contribution the product can make.

Operator

Your next question comes from [Chris Mancini – Gemco]

[Chris Mancini – Gemco]

Just to follow on those Ion questions, when you talk about your start up costs within Ion, were those in R&D or were any of those in cost of goods sold as well and how much were the start up costs that you say now will be declining?

Marc Giles

When I talk about the start up costs they include both manufacturing and production start up costs as well as field costs related to R&D engineering and service, and making sure that everything is right in the field. Part of that cost is direct. We can firmly measure it and that's in the hundreds of thousands of dollars. I don't have the exact number in front of me.

But the other part of the cost is opportunity cost because we have a lot of people's attention focused on getting those things resolved as opposed to doing other work. So with them freed up, it frees up our ability to redirect those resources to accomplish other things.

[Chris Mancini – Gemco]

Could you give a general idea as to whether they'd be opportunity costs or what the general costs were over the past 12 months?

Marc Giles

Over the past 12 months I'd have to say our total cost would be several million dollars.

[Chris Mancini – Gemco]

When you look at the Ion, what's your pitch? What are your sales guys pitch when they're going to a customer? Is it cost competitive right now and is it in terms of the customers' end production cost, does it make them more competitive? Who are you competing against and can you just talk a little bit about what the pitch is and how you are taking share if you are?

Marc Giles

I'll start of by; I read a technical report the other day, a third party technical report. There's still some skeptics out there as to whether this revolutionary technology will work, but the comment was to the effect of if it works and demonstrates what it can do, it's the most revolutionary new product technology in wide format ink set printing in the last eight years.

Our sales pitch is a game changer. It is a wide format, full flat bed table which means that can hold down high accuracy system that delivers its production rates are as fast or faster than any comparable machine in its range. It prints on the widest range of materials because it uses a new ink that only is used in our system, so it can print on flexible materials as well as rigid materials without any additional high energy curing. It's a very low energy system, and there are patents pending on this unique technology.

It runs about 30% the cost of its nearest competitor so it's a much lower cost entry machine with comparable to much higher speeds that can print on the widest array of materials with the greatest adhesion with high accuracy. It's not for everybody. It's not going to print indoor graphics where people point of purchase where you're very close up, so it's more to the image.

It's truly a fine maker's printer with deep rich colors but not quite the number of pixels that you would get in a different kind of point of purchase printer. That's what's generated so much demand for the product.

[Chris Mancini – Gemco]

When you're looking at the way that your customers finance these purchases generally, how does it work? Are they leasing them and so you're saying that there's a leasing agent and that agent has been unwilling to extend credit to the customer? What's been going on there?

Marc Giles

It's like credit everywhere. It's gotten tighter. It's not that it's not available. It's just that the standards that the customers need to meet have been raised, so it doesn't mean that all customers can't get leases. A lot of them can, and that's why we're still getting good sizable volume of orders. It's just that the market opportunity we believe, based on what we're hearing from our customer base in the street, has shrunk the number of people who can go get it today.

[Chris Mancini – Gemco]

When you see sales going forward in the sign making business specifically, what percentage would you say once the Ion's fully ramped up, would you say would be Ion versus the Legacy products?

Marc Giles

It's going to continue to shift. We expected this year that we would do between $20 million and $30 million of sales which would be roughly for just GSP, not the interrelated, the roughly 30% volume from a dead start. As our thermal systems continue to shrink in volume, we ultimately expect obviously that there's an opportunity to dramatically grow that ink jet sales volume both in terms of systems and in terms of ink.

It shouldn't be, I can't give specific guidance, but you can easily see it becoming half and more of the business over time.

[Chris Mancini – Gemco]

When you look at the Gerber Technology business, you said that you're taking share. Why is that happening and can you give us detail on that?

Marc Giles

The indication we take from the reports of our nearest competitor and we recorded during that time period a reduction of orders about 23% and they reported a reduction of orders of 34%, so we take it based on that since the two of us are by far the largest players in this industry. That and the fact that the indications are that we're taking share even though it's a difficult environment.

We attribute that to our technology offering, to our extensive service offering. It positions us well and particularly our level of investment over the past five years of infrastructure to support our business in the markets that are really growing.

[Chris Mancini – Gemco]

And what do you see China, the government of China doing specifically in the apparel business to try to ramp growth there, get growth going again?

Marc Giles

The biggest things are in the areas of tax rebates so I think it was a year ago, roughly a year ago, the Chinese government lowered the available VAT rebate to apparel exporters to 11%. That's 11% out of the 17% of VAT, value added tax.

More recently this summer, it's done it two or three times, it's now up to 14% and it's expected that in January it will go back to the full rebate of the tax. They also have a cash, I guess you'd call it a cash tax for exporting garment manufacturers where they had to put money on deposit locally with the government when they purchased their incoming input and they could recollect it only after they shipped the product.

That was mean to restrict their cash flow, and at the time, they wanted to put a little bit of a damper on their export volume. They're talking about that's going to go away and will no longer be a requirement. In addition, there's even some rumblings that we're hearing that the government is considering early next year to allow a VAT rebate on purchases of equipment for apparel manufacturing for domestic production of clothing, which would be huge.

So there's a lot of activity. Apparel manufacturing, particularly the sewing end of apparel manufacturing employs huge numbers of people, so it's a very quick way to rapidly employ people in that country.

[Chris Mancini – Gemco]

On the Coburn business, it seems to be down pretty significantly. What's the outlook there? You mentioned a new product. Is that a higher margin product that could be meaningful or what's you take for the rest of the year?

Marc Giles

Gerber Coburn because of the new products that have been coming through that pipeline, their gross margins have improved generally in the range of 400 to 600 basis points over the last couple of years and it's really driven by their new products.

We're very excited about the new product that we're talking about that could be launched, was expected to be launched by the end of this fiscal year. I talked about it, it's called the E2G. What that means, I haven't a clue.

It's the E2G blocker and a blocking system is a lathe has a think called a chuck which holds the piece of metal when it's going to be turned and cut. A lens generator has to hold the lens and turns the lens while the prescription is being generated and it uses in essence what you could consider a glue material to hold the lens to the chucking device and that glue is called the block.

For digital lens processing or free form lens processing, people have been trying to get away from what is in essence banned substance which is the use of lead, cadmium and other banned substances that is currently used in the alloy glue that holds the lens to the chuck for the purpose of generating it. Even in Europe, it's allowed only because there's never been any substitute.

This new product is the first true new blocking material that can replace this dangerous alloy material. As I said, we've gotten tremendous excitement from the industry about the potential of this. And there are 4,000 roughly blocking machines in the world that are consuming a lot of blocking material.

From an economic opportunity on our end its great and over time and we're excited about the prospects for it.

[Chris Mancini – Gemco]

Do you expect that business specifically to be profitable on your operating profit business in 2009?

Marc Giles

Absolutely.

[Chris Mancini – Gemco]

When we look at your liquidity, you obviously just completed the Virtek deal; I guess you said you have $16 million left on your revolver based on the covenants. Is that right?

Marc Giles

Yes.

[Chris Mancini – Gemco]

You were, I guess a good portion of your operating cash for this quarter came from a reduction of working capital. Next quarter, if you don't have that benefit of a reduction in working capital and orders continue to be light, what's the risk here in terms of needing to tap some of that revolver going forward?

Michael Elia

Right now our plan is that, we still have opportunities in inventory reductions and if you look at our payables, we have opportunities there as well. Our third quarter is typically our lowest sales quarter so receivables will likely come down as well, just as the seasonality of our business. We see our way pretty clearly through the third quarter as we see it now.

Marc Giles

The reason that we've taken the very difficult cost actions that we have is to make sure that we keep our earnings where we want them to be and further bolster our cash position as well.

[Chris Mancini – Gemco]

So you don't feel that you'll have any need to tap any more of that revolver by the end of your fiscal year?

Michael Elia

Remember, we still have $16 million of cash as well.

[Chris Mancini – Gemco]

I mean assuming that you want to keep that as some type of buffer. Will you be around later if I have some follow up questions?

Marc Giles

We're always around.

Operator

Your next question comes from Gregg Eisen – ICM Asset Management.

Gregg Eisen – ICM Asset Management

Regarding your revised sales guidance for the year, could you talk about how much of the negative change is coming from each of the segments, how it skews by segment, if you could say generally or as opposed to specifically?

Marc Giles

The biggest piece is our apparel technology, the apparel and special materials business. That's the big driver of the reduced revenue. All of our businesses with the exception of in the sign making segment because of the Ion revenue, we expect to be hit, but the biggest part of our remaining revenue is Gerber Technology, and that's the one that's really suffered and from the first quarter when we saw the dramatic fall off.

Gregg Eisen – ICM Asset Management

Going back to your balance sheet, you talked about pulling cash out of accounts receivable, sales seasonally weak in the third quarter, but could you talk about what do you have in reserves against bad debts or against receivables right now. Are you seeing and stress or slowness on the part of customers given the nature of what's going on? What's your experience?

Michael Elia

Our team does an extremely good job of vetting orders and manages our credit to our customer base right up front so we really haven't, our company hasn't experienced any real change at all in delayed payments or otherwise, at least not outside of the norm.

Gregg Eisen – ICM Asset Management

You've given a number in the past in terms of a percentage of sales coming from new products over the last three years. In fact at your AEA conference presentation I think you gave a number there of 19.1% in the first quarter. I guess that was trending 12 months as of the first quarter. Could you update that for the second quarter?

Marc Giles

I didn't mention it because it was really highly skewed because of the Ion. We were well over 30%. The reduction of our other business of equipment, I think we were between 32% and 35% of our sales were from key new products as a percent of our equipment and software sales, so when I do that calculation I take out the aftermarkets.

Gregg Eisen – ICM Asset Management

Speaking of the aftermarket, you're transferring some of the Ion machines to Spandex who in turn is reselling it to the European market so they'll get credit for the aftermarket sales of the ink into that market, correct? The GSP segment then would be getting the aftermarket sales for Ion ink in the domestic market. Is that correct?

Marc Giles

GSP, Gerber Scientific Products in the source of the ink so they get the credit for any ink revenues to our third party distributors here in the U.S. and other parts of the world. They also get credit for an internal transfer at an internal transfer price of sales of ink to Spandex who in turn turns around and sells it to the end user and gets credit for the difference between what they paid GSP for it and what they sell it for.

Gregg Eisen – ICM Asset Management

On the cost saves and the severance, specifically you said in December you're planning additional severance charges of $1.4 million which would save net of that you'd be saving $2.4 million. Is that for the rest of the fiscal year or annualized?

Marc Giles

That's for the balance of this fiscal year which is five more months.

Gregg Eisen – ICM Asset Management

And then you had future actions that you were anticipating which might produce $2.5 million to $3.5 million in savings?

Marc Giles

Other actions includes, these are actions that we have taken to further reduce our controllable expenses, so other spending that we could take.

Gregg Eisen – ICM Asset Management

The given annualized number of $16.8 million annualized savings to date, does that just include what you've done throughout October but not for December cost savings?

Michael Elia

That includes everything from all the actions in the second quarter and the actions that we just took and that's only the labor savings. We have a lot of other actions as well, but we just highlighted the fact that if you look at it purely from a wage perspective, that's $16.8 million that we've taken out, and I think if you just do the math and look at our normal gross profit margin, that's a substantial sales cushion.

Operator

We have no further questions at this time.

Marc Giles

I want to thank everybody for joining us on our call here today. Clearly the world economic situation as we all very well know is extremely difficult, but I'm confident that we've taken the actions necessary to sustain ourselves and keep ourselves in good competitive position for the foreseeable future, and while we continue to make investment prudently that we continue to make investments in our business whether it be in new product development or acquisitions or operational improvement initiatives, that we think we'll drive success as we come out of this thing on the other side.

I look forward to talking to you again at our third quarter conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Gerber Scientific Inc. F2Q09 (Qtr End 10/31/08) Earnings Call Transcript
This Transcript
All Transcripts