Gerber Scientific, Inc. F3Q09 (Qtr End 01/31/09) Earnings Call Transcript

Mar.19.09 | About: Gerber Scientific (GRB)

Gerber Scientific, Inc. (NYSE:GRB)

F3Q09 (Qtr End 01/31/09) Earnings Call Transcript

March 5, 2009 10:00 am ET

Executives

Marc Giles – President & CEO

Mike Elia – EVP & CFO

John Krawczynski – VP & Chief Accounting Officer

Analysts

Arnie Ursaner – CJS Securities

Jim Ricchiuti – Needham & Company

Chuck Murphy – Sidoti & Company

Chris Mancini – GAMCO

Greg Eisen – ICM Asset Management

Operator

Good day, and welcome to the Gerber Scientific Incorporated third quarter 2009 earnings release conference call. Today's conference is being recorded and broadcast over the Internet.

I would like to remind everyone that some of today's remarks and the answers during the Q&A will include certain forward-looking statements as defined in the federal securities laws. These include statements regarding Gerber's expected financial condition, results of operations, cash flows, product launches and planned cost reductions, as well as other planned events and expectations.

For a discussion of important risks and uncertainties that could cause Gerber's actual results to differ from results expressed or implied in 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 in subsequently filed quarterly reports on Form 10-Q and current report on Form 8-K.

These risks include, but are not limited to, delays in the company's new product development and commercialization; intense competition in markets for each of the company's operating segments; rapid technological advances; availability and cost of raw materials, continuing adverse economic and credit market conditions; volatility in foreign currency exchange rates; and fluctuation in interest rates.

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

Marc Giles

Thank you, operator. Good morning, everyone. We appreciate your continued interest and participation today in Gerber Scientific's fiscal 2009 third-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 Krawczynski. I will be providing a high level of overview of last quarter's performance, current business conditions and our outlook. Mike and John will provide more details regarding specific financial results.

The unprecedented weak global economy has required our team to make deep cost reductions, and they've stepped up to the plate, which allowed us to nearly break even, excluding severance and the non-operating impairment charge mentioned in our release, despite a year-over-year $32 million decline in sales. Sales performance was weak across all of our markets. As expected, sales of equipment of software seats fared the worst and were down 24% from a year ago, as a result of tight credit markets affecting equipment leasing, along with the effects of the global recession. However, it was encouraging to note that orders for this category were up modestly, 9%, sequentially from the second quarter. I can only hope this begins a trend.

Aftermarket sales were also down substantially at 23%, mostly due to a substantial decline in Spandex markets combined with end-of-year inventory and expense controls at our other customers. We have seen some rebound in this category so far this current quarter. Lastly, we've talked before about the importance of our service revenues, which provide a more stable annuity stream, if you will, and as such, are less affected by changing market conditions. Our service revenues were off a more modest 4% in the third quarter and helped to somewhat moderate the impact of the steep decline in our other revenue streams.

Mike will talk about the anomalies in the quarter that negatively impacted our reported results, but I did want to point out that there were a couple of non-cash non-operating items that affected the bottom line results. The supplemental pension plan asset write down alone had an impact of roughly $0.06 per diluted share. In addition, the headcount reductions we made in Q3 generated $1.3 million in one-time severance expenses in the quarter, or roughly $0.03 per diluted share. However, the impact of the headcount reductions to date in fiscal 2009 should generate annualized savings of nearly $17 million.

Our focus on cash continued to yield results as we generated positive cash flow from operations of $1.8 million, net of capital expenditures, and cash from a previous land sale that allowed us to reduce our revolving debt by $9 million in the quarter. I expect that we will continue to drive significant improvement into our balance sheet over the next several quarters.

Another bright spot was the performance of our recent acquisitions, Virtek and Gamma. While sales are somewhat softer than expected when we closed these deals, both continue to deliver on profit expectations. And I am more convinced than ever that these were strategically sound acquisitions that will prove to be very important in enhancing Gerber's technology and market position and resulting gross margin performance.

Another important achievement was the recent completion of an amendment to our credit agreement. The amendment, which we proactively initiated, gives us additional financial flexibility to continue to weather this unprecedented downturn by making certain financial covenants less restrictive. Mike will give you the specific amendment details, but I wanted to comment that we were pleased to have completed this amendment in such a difficult credit environment.

We also continue to see positive market acceptance for our Solara ion wide-format UV inkjet printer, with 53 units shipped during the quarter, which is especially good news given current business conditions. We are also excited about the prospects for our newest Solara ion, which we debuted in late January. While offering similar benefits as the original Solara ion, the latest generation of flatbed UV inkjet printer is offered at a significantly more affordable package, about 30% less than the original ion.

At this price point, we believe there is not a better built, more feature-rich flatbed printer available in the marketplace today, and this new ion can be upgraded to the performance of the original ion down the road if the customer so chooses. With customers in this market slashing capital budgets and conserving cash, we are optimistic that the new ion will offer an attractive alternative in today's tough economy. Even though the environment had deteriorated further from our last conference call, we remain cautiously optimistic that we will meet our goal of 100 or more ions shipped in the second half of the fiscal year.

Overall, our Sign Making and Specialty Graphics segment, which includes Gerber Scientific Products and its Solara ion product line, as well as Spandex, our distribution company, was hit very hard in the quarter, with sales declining 23%. If you will recall, Spandex's sales were essentially flat in the second quarter, after posting steady growth over the past few years. But the recession caught up to Spandex, with reported sales down 24%. On a constant currency basis, revenues for Spandex, which are predominantly euro and pound denominated, were off 11%. While the Solara ion sales made a nice contribution to the top line, it wasn't enough to offset the steep decline in legacy product sales at Gerber Scientific Products.

As consumer spending continues to slide globally for apparel, furniture and automobiles, which are primary markets for Gerber Technology's customers, our Apparel and Flexible Materials segment continues to suffer, with third-quarter sales down 17.5% year-over-year, as reported, but down 40% net of the new acquisitions, Virtek and Gamma. Again, changes to currency exchange rates had a significant impact on reported sales. On a constant currency basis, sales for this segment were off 14.5%.

Currency aside, Gerber Technology's business in China, typically its largest single country market, remained abysmal, with total revenue down almost 50% year-over-year to $4.3 million. With many of our customers closed for an extended time over the holidays and beyond, orders for equipment and software seats were down 85% compared to the same period last year. At this juncture, we can hope that the incentives that the Chinese government recently put in place to spur the apparel industry will begin to have an impact.

Long-term, we continue to believe strongly in this market's growth potential and in fact believe that the current apparel customer shakeout will be a benefit both to Gerber and to the industry as the sector consolidates for strength and efficiency. We will maintain our strategic focus on China. While our business in China has experienced the most dramatic decline, no geographic market was immune, as orders for equipment and software declined by over 65% in the third quarter versus last year. It remains impossible to predict when business in this segment will turn around.

On one pleasant note, the composites market globally continues to hold up, with applications in aerospace, defense and energy, and our acquisition of Virtek is a real advantage in serving these end-user markets. We will continue to focus on the identified Gerber/Virtek marketplace energies to drive revenue growth in these markets.

Gerber Coburn's wholesale lab customers are reporting significantly reduced volumes and lower comparable store sales being reported by major retail eyewear and lens processing customers. As a result, total sales at Coburn were off 22%, or 17% on a constant currency basis. The good news at Coburn, though, is that due to a more favorable mix of higher-margin new products, ongoing cost reduction initiatives and manufacturing efficiency gains, they reported an operating profit of $740,000 as compared to a loss of $340,000 last year in the third quarter, this despite the top-line sales decline.

Regarding Coburn's new product lineup, even in this economy, we installed new ALPS Digital lens processing systems, as well as several new DTL lens generators as replacement machines that can be upgraded to ALPS for the advanced lens processing system later on. In addition, we continued to get great feedback on our new E2G green blocking system, and we see a great market opportunity to replace older technology once launched.

Now at this point, I will turn the call over to Mike and then John for a more detailed review of third-quarter performance. Afterwards, I will provide our current outlook and a summary. Mike?

Mike Elia

Thanks, Marc. As a reminder, most of the financial results that we will be discussing in this morning's call are contained in our earnings press release, and today's web cast presentation will be available on the website at gerberscientific.com. A web cast replay of the call and the transcript will also be available on our website shortly after the call. I am going to review the third-quarter results, take a look at our liquidity and then talk a little bit more about our amendment.

As Marc mentioned, consolidated sales for the third quarter of fiscal 2009 were down 21% to $120.1 million from the same quarter last year, or down 13.3% on a constant currency basis, reflecting the impact of the global recession. Current quarter sales benefited from our recent acquisitions by about $12 million, meaning our organic sales decline was 28.9%, or 21.2% on a constant currency basis.

Our consolidated operating loss in the quarter was essentially breakeven, down from $6.3 million of operating income a year ago in the third quarter. The operating loss in the current quarter reflects the impact of lower sales volume, including a $2.7 million drop in software sales, which nearly all goes to the bottom line. The third-quarter operating loss also included approximately $1 million in additional costs relating to the inventory step-ups as a result of the Gamma and Virtek acquisitions, and about $1.3 million in severance costs.

Partially offsetting the revenue decline were additional operating profits of the recently completed acquisitions and the benefits of our cost reduction efforts. We expect these actions will generate $10.6 million in salary and wage savings alone for all of fiscal 2009, excluding related severance charges of $2.5 million. This is about a $16.8 million annualized run rate.

Our gross margin improved year-over-year from 28.6% of sales last year in the third quarter to 29.6% of sales in the current quarter, reflecting the contribution of higher-margin products of the acquired businesses and margin improvement in our optical lens business. Current quarter gross profit was negatively impacted by about $400,000 of severance expense, $1 million of increased product costs due to the inventory step-ups I mentioned earlier and $3.4 million in foreign currency exchange fluctuations.

On a constant dollar basis, SG&A expense was $32.8 million compared to $30.7 million for the same quarter a year ago. The current quarter included about $900,000 in severance expenses related to the work force reductions and approximately $3.3 million of incremental expense from the acquired companies. We continue to aggressively yet prudently reduce expenses where appropriate across our global infrastructure, and we will continue to seek other cash-generating opportunities that will allow us to weather the economic downturn.

The loss per diluted share in the current quarter was $0.09, and included a $0.06 per share charge relating to a write-down of our supplemental retiree pension plan asset, which is off sharply due to the stock and bond market declines in the US. This write-down was required under FAS 115, and under the regulation, unfortunately, we are not permitted to write up the asset in the event its market value increases. Excluding this charge, the diluted loss per share for the quarter was $0.03 compared to diluted EPS of $0.13 earned in the third quarter of 2008.

Now let's review the performance of each of our segments for the third quarter of fiscal 2009. The Sign Making and Specialty Graphics segment, which accounted for 54% of our fiscal 2009 third-quarter sales, consists of Gerber Scientific Products, which we refer to as GSP, and Spandex. This segment develops and manufactures computerized sign making and graphic design equipment and software. We also provide aftermarket materials and related services. Our primary customers in this segment are sign printing shops and distributors. This segment's total sales were down 23%, or $19.3 million, to $64.7 million in the current quarter. On a constant currency basis, total sales for this segment were down about $10 million.

Distribution sales slowed dramatically late in the third quarter, off 24%, and were impacted by foreign currency exchange. On a constant currency basis, distribution sales were off 11%, with the sales decline affecting all product lines. Solara ion sales contributed about $3.5 million to the segment's top line. However, overall sales at GSP were off 20.3% to about $18.5 million, reflecting lower equipment and software sales for legacy products, as well as lower aftermarket sales.

Third-quarter operating profit for this segment declined 57% to $900,000, principally due to the volume decline and about $1.2 million in lower vendor rebates compared to the prior-year fiscal third quarter. We do, however, expect vendor rebates in the fourth quarter of fiscal 2009 to be higher than what we had in the fourth quarter of fiscal 2008. So essentially, what has happened, is we moved the rebates from the third quarter to the fourth quarter.

Our Apparel and Flexible Materials segment, which accounted for 36% of fiscal 2009 third-quarter sales, consists of Gerber Technology, or what we refer to as GT, and is where the recent acquisitions have been integrated. Including the two new acquisitions, this segment develops, manufactures and services a broad line of computerized and automated equipment and software used by designers and OEMs in industries such as apparel and retail, industrial fabrics and composites, transportation interiors and furniture. These products are used to improve the efficiency and information management, product design and development for both pre-production and production processes.

In the current quarter, this segment recorded sales of $43 million, a decrease of 17.5%, or $9.1 million, from a year ago in the third quarter. GT was hit particularly hard by low orders from the Asian and European markets. The Virtek and Gamma acquisitions contributed $11.9 million to top line sales for this segment in the current quarter. Excluding these sales, GT's base business was off 40.3%, reflecting particular weakness in systems and high margin software sales.

As reported earlier in the year, lower sales of high margin software had a significant impact on the segment's top and bottom line performance. Most of GT's existing apparel customers are cutting back on design staff, causing software sales in the current quarter to drop $2.2 million or 45% from the same quarter last year. Systems revenue was off $4.4 million, or 17%, including the benefit received from acquisitions. Aftermarket sales were off 26%, or $2 million, while service revenues were off a more modest 4%, or about $500,000.

Operating profit for the segment was off $3 million or 52% from the same quarter a year ago, reflecting the impact of lower sales volume and a less favorable mix of high-margin software, moderated by the additional operating income from acquisitions. Excluding the acquisitions, operating profit for this segment was down $3.9 million. The segment's reported operating margin was 6.3%. Adjusted for the acquisitions, operating margin was 5.5% of sales. I want you to keep in mind that third quarter included a million dollars in additional costs relating to the inventory step-ups as a result of the Gamma and Virtek acquisitions. And we expect about another $0.5 million of this step-up will roll out in the fourth quarter.

As Marc mentioned, collectively, the acquisitions are performing at or better than our original projections, which is positive news in this weak environment. While the combined revenues of the recent acquisitions for the current quarter are down 14% from the same quarter a year ago, pre-acquisition adjusted EBITDA increased $1 million to $2.5 million.

Our final reporting segment, Gerber Coburn, or GC, our lens processing business, accounted for 10% of fiscal 2009 third-quarter sales, and develops and manufactures equipment, supplies and software to produce prescription eyewear. It services a broad range of customers, from wholesale lens production laboratories to retail eyewear chains and independent eyewear professionals. For the current quarter of fiscal 2009, sales from this segment were down 21.7% or $3.4 million to $12.4 million from a year ago. Currency exchange had an unfavorable impact of $800,000 on a constant currency basis. Current quarter sales were actually off 17%. Equipment and software sales were down 26%, and aftermarket sales down 25%.

Coburn service revenues were up 4.9%. Gross margin in the current quarter was up 540 basis points, reflecting service and manufacturing cost savings. Operating profit for this segment in the current quarter was $737,000 compared to a loss of $340,000 last year due to improved gross margin and cost reduction initiatives.

Corporate operating expenses in the current quarter of fiscal 2009 were $4.3 million compared to $1.1 million in the year-ago third quarter, reflecting increased self-insurance medical costs and higher pension costs. Additionally, corporate operating expenses in the fiscal 2008 third quarter benefited from the reduction of the incentive compensation accrual of about $2.2 million.

We are pleased to report that net cash provided by operating activities in the current quarter, net of capital expenditures was $1.8 million compared to a cash usage of $2.4 million in the third quarter of last year, or an improvement of $4.2 million. Principal drivers of the change were lower cash requirements for working capital needs versus the prior year and capital expenditures were down a million dollars year-over-year in the current quarter to $1.6 million. Obviously in this environment, we plan to minimize CapEx spending, keeping it at an annual range of about $7 million to $8 million.

During the current quarter, we were able to reduce our outstanding senior revolver debt by $9 million as a result of our positive cash flow generation and the receipt of $1.2 million of a final settlement on previous land sale. We will continue to look at all opportunities to improve our liquidity and generate cash, including potential asset sales, working capital reductions and our access to capital to help us manage through the recession. Our total liquidity as of January 31, 2008 was $30.7 million, which consisted of $10.9 million in cash and $19.7 million in availability under our senior revolving credit facility. We saw $19.8 million in availability under our senior revolving credit facility, based on the current financial covenants.

We have $69 million drawn under our senior revolver accruing interest at various LIBOR rates, plus 225 basis points, undrawn letters of credit outstanding of $7.6 million and $6 million in industrial development bonds accruing interest at 0.52%. Total debt, net of cash outstanding, on January 31, 2009 was $64.1 million.

Okay, before wrapping up, I would like to provide you with the details regarding our amended credit facilities. As Marc mentioned, we proactively initiated this amendment to increase our financial flexibility. Several of the financial covenant tests and definitions were restricted and didn't allow for non-cash adjustments that could have caused us to violate certain financial covenants. As an example, the previous agreement didn't allow us to add back the third-quarter non-cash write-down of our supplemental pension plan assets.

Among many things, we requested a reduction in the size of the facility from $125 million to $100 million. With no need for additional capital beyond the current availability combined with our operating cash flow at the present time, this change allowed us to reduce the unused commitment fees, which increases from a range of 17.5 to 37.5 basis points to a range of 25 to 50 basis points, depending on our funded-debt-to-EBITDA ratio.

The term of the agreement were shortened by one year to January 31, 2012. The interest rate spreads on the loan increase dependent upon the interest rate options and the company's total funded-debt-to-EBITDA ratio. As a result, interest spreads in our previous grid increased approximately 100 basis points, and a new tier was added to accommodate leverage ratio in excess of three times at LIBOR plus 400 basis points.

In terms of our financial covenants, the amended agreement increases the maximum total debt-to-EBITDA ratio from 3 times to 3.7 times for the fiscal 2009 fourth quarter and the fiscal 2010 first and second quarters. Then it scales down to 3.25 for the fiscal 2010 third and fourth quarters, and returns to 3 times for the fiscal 2011 first quarter, and remains there for the remainder of the facility.

The minimum interest coverage was relaxed from the previous 3 times to 2.75 times for the fourth quarter of fiscal 2009, and for fiscal 2010, it was reduced to 2.25 in the first quarter, 2 times in the second quarter, 2.25 in the third quarter and 2.75 in the fourth quarter, returning to 3 times in the first quarter of fiscal 2011 and remaining there for the remainder of the facility. Maximum CapEx was reduced to $10 million from $15 million in the previous agreement.

A new monthly minimum asset coverage ratio was added which requires us to maintain a 1-to-1 ratio of assets to total funded debt. Assets are defined as cash on deposit with lenders or in accounts in Canada, subject to blocked account agreements, plus 55% of consolidated net AR plus 25% of consolidated net inventories, plus $20 million of consolidated fixed assets. Finally, an investment basket was added to allow us up to $2 million in financing for our customers, provided our indebtedness basket is reduced dollar-for-dollar.

I will now turn the call over to John to review some additional performance details that Marc and I haven't already covered, and then we will open the call up for your questions. Thank you.

John Krawczynski

Thank you, Mike, and good morning, everyone. First, let me review orders for the third quarter. On a consolidated basis, orders for the third quarter of fiscal 2009 totaled $113.6 million, down about $39.1 million or 25.6% from the third quarter of fiscal 2008. From a geographic perspective, 38% of our orders were in North America, 53% in Europe and 9% were in the rest of the world, primarily the Asia-Pacific region. Compared with the year ago in the third quarter, there was a modest shift in our orders from the rest-of-the-world region to Europe and North America, reflecting the significant decline in China business activity for our Apparel and Flexible Materials segment during the third quarter of fiscal 2009.

Now let me provide some detail on revenue by product type. In the third quarter, equipment and software revenue was off 24%, or $12.1 million, to $38.2 million. Revenue from aftermarket products was off 23%, or $19 million, to $64.3 million. And service revenue was off 4% or $700,000 to $17.6 million. Mike and Marc have already covered the primary drivers of these revenue declines.

Order backlog was also down significantly at quarter end compared with a year ago due to the market dynamics already discussed. Order backlog from the Sign Making and Specialty Graphics segment was off 46% or $1.9 million to $2.2 million at the end of the third quarter. Backlog from the Apparel and Flexible Materials segment was off 36% or $12.4 million to $21.7 million, and the Ophthalmic Lens Processing segment's backlog was up 31% or $500,000 to $2.1 million.

Now let me just touch on a few income statement and balance sheet items that should be mentioned. Interest expense in the quarter was approximately $900,000, down about $500,000 from the third quarter of fiscal 2008. This reduction was due to lower market rates year-over-year as a result of the new credit facility put in place at the end of January of last year, partially offset by higher average borrowing levels during the quarter, stemming from the Virtek and Gamma acquisitions. As a result of these higher borrowing levels and anticipated higher average borrowing rates under the amended credit agreement, as Mike discussed, we are expecting an increase in interest expense for the balance of the year.

Depreciation and amortization was $2.7 million in the current quarter, about $400,000 higher than a year ago in the third quarter, primarily due to increased amortization expense associated with the acquired intangible assets from the Virtek acquisition. Our effective tax rate in the third quarter was a tax benefit of 42.4%. For the third quarter of fiscal 2008, our effective tax rate was 31.5%. The principal drivers for the tax benefit exceeding the statutory rate of 35% in the current quarter were adjustments in tax contingencies and the impact of international rate differences. 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, depending on performance.

Customer receivables at the end of the third quarter were $83.3 million, a decline of $37.4 million from the prior fiscal year-end. The reduction in AR was due to the lower sales volume in the third quarter, the impact of a stronger US dollar on foreign currency translation during the period, as well as a continued good collections process. Our DSO improved to 62 days in the third quarter from 63 days as of the prior fiscal year-end despite the weakening economy.

Our inventories at the end of the third quarter were $79.3 million, up from $76.9 million at the end of fiscal 2008, primarily as a result of the two acquisitions completed in the third quarter, offset partially by foreign currency translation as a result of the strength in the US dollar. As a result of the increase in inventories and lower sales volume in the third quarter, our inventory turns declined from 6.4 times at the end of fiscal 2008 to 4.2 times in the current third 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?

Marc Giles

Thanks, Mike. Thanks, John. Going into the fourth quarter, visibility remains clouded and our order backlog is down considerably, year-over-year down about 35% at the end of the third quarter. Even though our fourth quarter is normally our seasonally highest-volume quarter of the year, with order backlog down so significantly, we are not planning on any growth in fourth-quarter revenues. Due to the lack of market visibility and low order backlog, the company is revising downward its fiscal 2009 earnings guidance. We now expect revenue between $550 million to $570 million for fiscal 2009. That is revised downward from our earlier fiscal 2009 guidance in the range of $600 million to $620 million. Consequently, we are also reducing our earnings guidance down from a range of between $0.50 and $0.65 per diluted share to between $0.20 and $0.30 per diluted share.

In summary, business conditions are the most difficult we've ever experienced, but our team is executing a near-term strategy focused on three things. One, aggressively managing expenses down, but keeping the necessary talent base intact. Two, generating cash through working capital reductions and exploring additional sales of some assets to further improve liquidity. And three, continuing to invest in our technology and new product pipeline in China and in our key operational improvement initiatives. By doing these things, we expect to be in position to rebound strongly once the economy does turn.

And now I will open the call up to your questions. Operator?

Question-and-Answer-Session

Operator

(Operator instructions). And our first question come from Arnie Ursaner with CJS Securities.

Arnie Ursaner – CJS Securities

Hi, gentlemen. Good morning.

Marc Giles

Good morning, Arnie.

Arnie Ursaner – CJS Securities

I guess the question I am trying to get a little better feel for is obviously the world has slowed down quite dramatically in a lot of your product areas, and many distribution companies are seeing either people not taking on inventory or seeing their customers aggressively reduce inventory. I guess I'm trying to get a feel for how much of your customer inventory – are your customers reducing their inventories at an even greater pace than the slowdown in sales in this current environment?

Marc Giles

I think we saw – I can't say for sure – but based anecdotally, I would say we clearly saw that in the third quarter. We saw a substantial slowdown in our aftermarkets business, even to a certain degree in our spare parts business. Now, spare parts I would attribute to extended factory shutdowns. But the consumables business decline reflected at least domestically a significant burn-off of inventory in our customers.

So whether – how far down that is, whether they burn it down to where they need to be, would be – I would be speculating right now. I will say that it is interesting on the apparel side that Chinese imports – or exports to the US of apparel dropped considerably in November, the November/December time frame, but picked up. We've seen orders pick up at least in January. And I think that our end-users' inventories of apparel have been slashed and burned down to extremely low levels. So that when things do start to move, I would expect we will start to see some business again.

Arnie Ursaner – CJS Securities

And can you – again, one of the broader questions – a lot of the equipment that you sell requires a consumer or your customer to either have financing in place or make some type of capital decision. I am wondering if you have any feel or sense for what percent of your revenues are tied to what I would call a capital decision, where the client might need financing. Do you have any feel for that?

Marc Giles

Yes, I mean our – typically, about a little less than a third of our business is capital equipment systems and software. And at least on the capital equipment systems, probably at least half of that is done through financing, and the other requires some significant capital investment decisions. So that is the part on the increment that has declined so dramatically and is so sensitive to the availability of credit, as well as how the end-users' outlook is.

Arnie Ursaner – CJS Securities

A question for Mike, real quick if I can. I know you gave tremendous detail regarding your refinancing, but I am missing one number that is kind of important. I'm sure you gave it. How much did your rates go up to get this refinancing?

Mike Elia

About 100 basis points in the grid. So it is a grid, Arnie, so you've got to go back and look at the various EBITDA-to-debt ratios. So if you look at – I mean debt-to-EBITDA ratios. If you look at where we were in the last quarter, we were about 2.25; so we figure we are about 3.25 now.

Arnie Ursaner – CJS Securities

That's actually a pretty low rate given the way banks are readjusting these things. That is actually very good work on your part. I'll stop there. Thank you.

Marc Giles

Thanks Arnie.

Operator

We will move next to Jim Ricchiuti of Needham & Company.

Jim Ricchiuti – Needham & Company

I was just wondering if you could perhaps give us a better idea of what your quarterly breakeven might be going forward. I am not sure if we've got all the cost reductions that you've taken in there or if there are additional measures. But if you can give us a rough sense, Mike, what it might look like?

Mike Elia

If you look at this quarter, where we did about $120 million and we essentially broke even, but there was – we obviously had the severance of about $1 million and then we had the Virtek step-up, which was another $1 million. So there were a lot of ins and outs. So I guess I would say if you looked at this quarter and an adjusted quarter, it would probably be around $4 million at $120 million, so $4 million to $6 million at $120 million.

Jim Ricchiuti – Needham & Company

Okay.

Mike Elia

If that helps.

Jim Ricchiuti – Needham & Company

It helps. Marc, can you give us any feel for looking at your customer base – for instance, in the sign making market here in the US, how much of a concern is it – I don't know if you are hearing this from your distributors or not – whether the customer base itself has begun to shrink?

Marc Giles

Yes, it has. It has. There has been shrinkage in the customer base, the sign making customer base, especially some of the smaller ones have gone out of business. So that rate of exit has increased.

Jim Ricchiuti – Needham & Company

Are you seeing any sign of used equipment coming onto the market in this business?

Marc Giles

Not so much – and I shouldn't say that. Of course there is. There is an increased amount of used equipment coming on board and becoming available. So we have seen some of that. You can see that on the websites. And we have seen some increase in used equipment coming on the market in our apparel sector.

Jim Ricchiuti – Needham & Company

That was the next question.

Marc Giles

Yes, yes.

Jim Ricchiuti – Needham & Company

You alluded to – I think a little bit of – if I heard you correctly – a little bit of a rebound at Spandex. Did I hear that correctly? It surprised me, only just given the economic environment we are hearing over there.

Marc Giles

No, no, no. Spandex had a year-over-year decline of about 20%. It's the first time they've had a sales decline in several years now. Currency adjusted, I think it was about 11%, I think.

Jim Ricchiuti – Needham & Company

Right. But I thought – it sounded like thus far in the quarter, you've seen some modest improvement. Maybe I didn't…

Marc Giles

I see what you're saying. Yes, I mean we have seen some modest improvement at Spandex. We've also seen some modest improvement in our aftermarket and consumables business and our other businesses, as well. And seasonally, Spandex, our third quarter, the wintertime, is terrible for them. So we would expect them – they usually get a pretty significant bounce in revenues as they go into Q4 and into the springtime. Obviously, we are not going to see that this year, we don't expect to. But we have seen some improvement and continue to see some improvement as the weather warms.

Jim Ricchiuti – Needham & Company

Okay. On gross margins, had a question about gross margins, and particularly in the service gross margins. Is this a level we should assume going forward?

Marc Giles

On the gross margin side? You know, we are so mix-sensitive, we've got so many different products. But yes, given that the mix stays the same, you should continue to see roughly this level. Obviously, we continue to work at costs decreases on our materials purchases, but that is largely offset by absorption issues because of the decreased volume. So I would expect that these gross margins are roughly right.

Jim Ricchiuti – Needham & Company

Okay. And final question from me, OpEx going forward, can you give us any granularity on how that might look in Q4? It sounds like your R&D potentially could be trending down a little bit more from here.

Marc Giles

Yes. I mean both SG&A expenses and our R&D expenses are trending down on a run rate basis, and as we've continued to take more actions and we don't have offsetting severance and other charges coming through. I would just make one comment on your gross margin question, as well, Jim, is that some of the expenses, like restructuring expenses and something like that, show up in the gross margin line, as well. So they are – if anything, they are probably a little bit on the light side currently; you could see some upside to that, again assuming no significant change in mix.

Jim Ricchiuti – Needham & Company

Okay. Thank you.

Marc Giles

Yes.

Operator

We will move next to Sidoti & Company’s Chuck Murphy.

Chuck Murphy – Sidoti & Company

Good morning, guys.

Marc Giles

Good morning, Chuck.

Chuck Murphy – Sidoti & Company

Could you just tell me for the severance charge, was that all included in SG&A?

Mike Elia

No, there was about $400,000 that was in cost of sales. So it was a total of $1.3 million, $400,000 in cost of sales and about $900,000 in SG&A.

Chuck Murphy – Sidoti & Company

That helps. And for the revised EPS guidance, I am assuming that is GAAP basis?

Marc Giles

That's correct.

Chuck Murphy – Sidoti & Company

Okay. And kind of moving down my list here, I was looking at what you label as the corporate operating expenses. Have you changed what you include in there over the past year?

Mike Elia

No, the big change there is the acquisitions.

Chuck Murphy – Sidoti & Company

Okay.

John Krawczynski

On the corporate operating, I think what you're seeing from last year, Jim, is the benefit of the incentive comp reduction in the third quarter, where we reversed some accruals based upon performance at that point.

Mike Elia

The other thing, too, was that we were required to re-class last year some operating income – some gains on the sale of assets.

John Krawczynski

That's not in corporate, but we did make two re-classifications out of other income and expense up into SG&A for gains on certain asset sales.

Chuck Murphy – Sidoti & Company

Okay, that helps. And my final question was, I think, Marc, you were talking about GT and how tough it was these days in China. I mean any sense that the Chinese New Year had outsized impact?

Marc Giles

Yes. I think it did. Chuck, as you know, you have something along the lines of 25,000 factories, albeit small, but a lot of business, in China. And then we had several with extended shutdowns in the month of January. Then on top of that, you had Chinese Lunar New Year and all that kind of stuff. So there's got to be some rebound coming off of that, but it's a little early to say with any confidence at this point.

Chuck Murphy – Sidoti & Company

Okay. And my final question, Mike, did you mention a maximum debt-to-EBITDA covenant? I heard you talk about the interest coverage. Was there debt to EBITDA?

Mike Elia

Yes, there is, and it varies. Let me just go back, because it changes each quarter. Right now, it is 3.75 for the fourth quarter. And then for fiscal 2010, the first and second quarters, it is also 3.75. And then it scales down to 3.25 for the fiscal 2010 third and fourth quarters. And then in the first quarter of 2011, it returns to 3 times.

Chuck Murphy – Sidoti & Company

Okay, all right. That's all I had. Thanks, guys.

Marc Giles

Thanks, Chuck.

Operator

We will go next to Chris Mancini of GAMCO.

Chris Mancini – GAMCO

Hi guys, thanks.

Marc Giles

Hi.

Chris Mancini – GAMCO

For the Solara ion, you said that 53 units were shipped in the quarter. How many were sold in terms of new sales, in terms of new sales? So were those shipments from past-quarter sales for the most part?

Marc Giles

No, no, those were sales in this quarter.

Chris Mancini – GAMCO

Okay, great. And then in terms of those 53, was the lower-priced ion included in that 53 number?

Marc Giles

No, it hadn't been commercially launched by the end of that quarter, so it was the original ion.

Chris Mancini – GAMCO

Okay. And you can you talk a little bit about what type of customer is going after this new lower-priced product as compared to the other one, and what you saw in terms of the marketplace that made you think that it was a good idea to lower the price point, and I guess, lower the functionality or whatnot? And could you talk just a little bit more about that product?

Marc Giles

Yes, sure. I mean, we launched – it is called the – the new one is called the ion V. And it is a lower performance machine at about a 30% lower price point than the original ion. And really what it does is it makes this kind of technology available to a much broader segment of the sign shop market. And if you recall, they are, by and large – there is about 25,000, for example, of these potential customers in the US. The vast majority, the average revenues may be $500,000 a year, and big ones are a couple of million dollars a year.

So when you start getting down into the smaller shop part of this segment, it is just not possible for them to spend the kind of money on the original ion. So it broadens the potential customer base pretty dramatically by lowering the price. That being said, in this environment, those are the kinds of customers who rely even more on credit than the larger ones. So you've got things working against you there, too. But that was why we did it and why we think it is a good long-term move.

Chris Mancini – GAMCO

And what does this product do relative to – or what can it do? What its functionality is as opposed to the larger, more expensive one?

Marc Giles

It's slower. It does everything virtually that the large one does, but it prints more slowly, and it does not come standard with a roll-to-roll, a flexible material print system, as well as the rigid. The original ion, you can do both. You can print rigid materials and flexible materials on the same system. This unit, you only do rigid materials. Although you can upgrade it, if you want to pay a little bit more money, to include a roll-to-roll as well.

Chris Mancini – GAMCO

Okay, I understand, okay. And then in terms of the credit facility, so right now, do you have $25 million available on this new facility, given your current level of debt is $75 million and then $100 million of availability on the new facility?

Mike Elia

That's correct. I think it is actually – total liquidity is closer to about $30 million, including the cash.

Chris Mancini – GAMCO

Including the cash, okay. And in terms of the – you were talking about the Chinese stimulus and whatnot. Are you seeing anything specifically related to the apparel industry? We've been hearing a lot anecdotally in the market about it, but is there anything that you can point to specifically? And I guess why or why not have or haven't you been seeing an effect of it?

Marc Giles

Yes, I mean, there are specific actions that the Chinese government has taken with regard to the apparel industry. About a year or so ago, they had – their VAT rate is 17%, and they had always offered a rebate against the VAT for export sales of apparel. And beginning about a year ago, they lowered – they ended up lowering their VAT rebate to about 11%. Now, as of I think January 1, they've moved it back up to 15%, and everybody expects it is going to go to a 100% rebate here shortly.

They've also extended VAT rebates now to domestic clothing production, as well, where you can use domestic sales of clothing to offset your VAT when you buy equipment or invest. So the incentives are pretty significant at this juncture, and I would expect that they are going to do even more in terms of direct investment with this latest stimulus that they are talking about, only because apparel is so easy, very quickly to employ lots of people. You can get one spreader and a cutter, and then you need a sewing room with a couple of thousand people in it to keep up with it. So it puts a lot of people to work very, very quickly.

Chris Mancini – GAMCO

I see. Okay, great. Thanks very much.

Marc Giles

Sure.

Operator

(Operator instructions). We will hear next from Greg Eisen of ICM Asset Management.

Greg Eisen – ICM Asset Management

Thanks, good morning. Could you talk a little bit about the aftermarket sales for the new ion machine, and what experience you are seeing in terms of the take-up of the aftermarket products, what contribution it is showing already? And is there anything different about the way the aftermarket is working for the new ion machine versus your prior products or machine?

Marc Giles

Yes, I mean, we are seeing an increasing contribution of ink sales coming through GSP. I mean – and especially since we've started out – the original ion's a pretty high throughput machine, it has been pulling ink volume through pretty quickly, and at a rate that is above what we would have expected, frankly, even on that machine. So we are up around $8,000 to $10,000 run rates per year on the bigger machine. So that is a nice and increasing revenue stream.

Greg Eisen – ICM Asset Management

That would be eight to ten run rate per machine that is installed base?

Marc Giles

That's right.

Greg Eisen – ICM Asset Management

That's pretty good. So you are shipping the ion also into Europe, correct, where Spandex is?

Marc Giles

Yes, actually, the bulk of the sales in the third quarter were in Europe, actually.

Greg Eisen – ICM Asset Management

Any reason for the preference of European customers versus North American customers for the ion?

Marc Giles

Well, we rolled it out earlier here and focused on the US. So actually we rolled it out; it was more of a delayed launch in Europe. So they are just starting to pick up over there. Of course, now they are impacted – feeling the impact of credit and the downturn in the economy, particularly England and Spain, but so we are fighting uphill there now too.

Greg Eisen – ICM Asset Management

You mentioned that the customers are credit dependent. You're not obviously financing machinery off of your balance sheet. But are you – what do you do for your customers to kind of help arrange credit for them?

Marc Giles

We have relationships with leasing companies. As a matter of fact, we are starting a process of starting some additional relationships along those lines now, I won't go into the detail, to further assist leasing of our end-users. And then of course over in Europe, they have – and Spandex has relationships in a country-by-country basis that supports leasing agreements with its customers. So we work arm in arm with our customers, especially these days, to try to find any possible way to finance their purchase.

Greg Eisen – ICM Asset Management

And you gave the backlog numbers by business segment. But can you disclose the number of units of ion on backlog at the end of the quarter?

Marc Giles

I probably could, but I don't know what it is.

Greg Eisen – ICM Asset Management

Okay. And I guess lastly, on the ion again, anecdotally, what are you getting from customer feedback as to their satisfaction with the product?

Marc Giles

It is good now. I mean, we started out the beginning of the fiscal year, our earlier shipments, we had quite a bit of noise. We spent a lot of time with our customers. We continue to spend time with our customers, making sure that things work properly for them. But it has gotten a lot better. So the issues that we suffered from in our first launch are largely gone, and now it is the more typical service issues that we are dealing with.

So it has gotten better and better, and a lot of the feedback anecdotally that we get in terms of the performance of the machine is that it is ‘the’ machine. It is ‘the’ machine. I mean, if you – our competitors are, I think, largely struggling to sell any of these competitive machines. So it appears that in our market segment, if they can get financing or if they can buy a machine, they are going to buy our product. So we are very encouraged by that. But it is just a tough environment right now.

Greg Eisen – ICM Asset Management

So in a weakening market, it sounds like you are implying that you are gaining market share within that segment?

Marc Giles

I don't think there is any question about that.

Greg Eisen – ICM Asset Management

Okay. And I don't know if I was listening close enough, I apologize. But the other than temporary impairment charge, where does that run in the income statement? What line items did that –?

Marc Giles

It is in other income and expense.

Greg Eisen – ICM Asset Management

Okay, great. Thank you.

Operator

Our final question in queue is a follow up question from Jim Ricchiuti.

Jim Ricchiuti – Needham & Company

Yes, just looking at the Q4 guidance, it is a pretty wide range for revenues, which is certainly understandable, given the environment. But what I was curious about, Marc, if you can comment on in which of the business segments do you see the most variability in terms of your guidance?

Marc Giles

I think the one that I am most – I am least comfortable with at this point is the Sign Making and Specialty Graphics segment. And I say that because normally we see a rebound in the spring from the winter doldrums. I don't. And this winter was really bad, in terms of – this third quarter was really bad for our revenues there. So I don't know what is going to happen in the spring. So I don't know whether it continues to decline, whether we get a good bounce, or whether it just stays equal with Q3. And with the financing situation, with credit markets the way they are right now for our customers in that segment, and how – what's going to happen in Europe, has it already hit bottom or not, it is just much more difficult to predict.

Jim Ricchiuti – Needham & Company

Okay. That makes sense. Thank you.

Marc Giles

Sure.

Operator

We have no further questions. I will turn the call back to our presenters for any closing or additional remarks.

Marc Giles

Thank you, operator, and thanks, everyone, for joining us today. And hopefully next time we meet after the close of our fiscal year-end, I will have much better visibility for you. But until that point, we are going to remain focused on generating cash and maintaining our – improving our liquidity. Until then, thank you for joining today. Bye.

Operator

Again, that does conclude today's conference. Thank you all for your participation, and have a great day.

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