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Gerber Scientific Inc. (NYSE:GRB)

F1Q10 Earnings Call

August 27, 2009; 10:00 am ET

Executives

Marc Giles - President & Chief Executive Officer

Mike Elia - Executive Vice President & Chief Financial Officer

John Krawczynski - Vice President & Chief Accounting Officer

Analysts

Arnie Ursaner - CJS Securities

Jim Ricchiuti - Needham & Co.

Garrett King - Truffle Hound Capital

Zahid Siddique - Gabelli & Co.

Graham McClutchy - Deutsche Bank

Operator

Good day everyone and welcome to the Gerber Scientific Inc., first quarter 2010 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 responses during the question-and-answer session will include forward-looking statements as defined in the federal securities laws, regarding Gerber’s expected financial condition results of operations, cash flows, and other matters relating to the business.

For discussion of the important risk of uncertainties that could cause Gerber’s actual results to differ from the results expressed or implied in the forward-looking statements. You should read Gerber’s Annual Report on Form 10-K for the fiscal year ended April 30, 2009 as well as Gerber’s other filings with the Securities and Exchange Commission.

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. Mr. Giles, please go ahead sir.

Marc Giles

Thank you, operator and good morning everybody. We appreciate your continued interest and participation today in Gerber Scientific’s fiscal 2010 first 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’m going to provide a high level of overview of last quarter’s performance, current business conditions and our outlook and then Michael will provide more details regarding financial results and liquidity. While global market conditions continued to be weak in our fiscal 2010 first quarter was sales down by almost 25% compared to a year ago 17% in constant dollars.

We do believe there is growing evidence that our markets have bottomed. Also encouraging with that despite sharply lower revenue we were able to deliver noticeable improvement in most of our financial metrics, including gross profit margin, SG&A as a percent of sales, operating margin and cash generation. If you will recall we said last quarter that, we believe the fourth quarter was likely the bottom of the depressed economic cycle.

On a sequential basis, current quarter sales were essentially flat from our reported fiscal 2009 fourth quarter. Excluding FOBA from both periods, sales from continuing operations on a sequential basis were actually up about 3.5%. Our book-to-bill ratio remained at one and our aftermarket sales were up 7%, encouragingly indicating increased equipment utilization.

We are also seeing increased order activity in some geographic markets activity in China in particular has strengthened. While revenue from China is still well below its peak during our fiscal 2008; on a sequential quarterly basis, revenue was the highest it has been since the second quarter of fiscal year 2009 and up over $1.1 million or 30% versus the fourth quarter driven by improvement in the apparel business there. All these factors cause us to be a bit more optimistic regarding the strength of the market we serve.

From a profitability perspective the company generated operating income more than double the prior year at $3.8 million in the current first quarter versus $1.6 million a year ago, due to both cost savings initiatives and gross margin improvement. Our gross margin was up a 160 basis points, the details of which Mike will provide in a moment. Surprising to say, we’re pleased with this performance in the face of the difficult year-over-year revenue comparison.

Let me touch on a couple of other positives on the quarter before reviewing segment performance. Notwithstanding the weak sales performance, cost savings initiatives and effective working capital management enable the company to generate more than $13 million of operating cash flow after capital expenditures, which allowed us to significantly reduce our outstanding debt.

Equally important, we announced the sale of FOBA, which will generate net proceed to approximately $8 million to $8.5 million. As discussed last quarter, we have been pursuing the potential sale of non-core non-strategic assets that would allow us to generate cash to improve our financial flexibility.

FOBA was acquired as part of the Virtek acquisition and well it is an attractive laser marking and engraving business, it was not a core strategic focus for us. We’ve just received word that this transaction has been cleared by the German Cartel Office and should close in a next week or so. We are also reviewing other non-core asset sales to further reduce our debt and we’ll report those as they occur.

For fiscal Q1, on a consolidated basis equipment and software sales declined 38% in the first quarter from a year ago, while after market revenue was down 22% and service revenue was off 11%. Sales in the sign making segment, which consist of Gerber Scientific products in Spandex were down 23% year-over-year to $73.1 million in the current quarter.

Unfavorable currency rates had a significant impact, so then on a constant dollar comparison basis total sales for the segment were down 13%. All categories within the segment posted significant sales declines during the quarter with equipment posting a largest decline of 35% versus a year ago.

Nonetheless, in the equipment category sales of Solara ion system and related inks contributed about $2.6 million to the segments top line with 31 units shipped in the quarter, which is similar to this products fourth quarter revenue in shipments. Despite the sharp sales decline first quarter operating profit for the Sign Making and Specialty Graphics segment was up 2% to $2.2 million versus a year ago do principally to cost savings initiatives.

Looking ahead, economic uncertainty and tight credit continue to adversely impact the segments revenue. Yet with the improvement, sequential sales performance, which was largely driven by after market sales. We are more optimistic that we are at the bottom of a depressed market cycle.

In the Apparel and Flexible Materials segment, which consist of Gerber Technology and the new acquisitions of Virtek and Gamma and excludes FOBA, business continues to be affected by lower consumer spending for apparel, furniture and automobiles, particularly in the U.S. and Europe. First quarter sales were down 28% year-over-year to $35.1 million. On a constant currency basis, year-over-year sales were off 25% in the first quarter.

The Virtek and Gamma acquisitions contributed $3.8 million in sales in the quarter. Excluding these sales, GT’s base business was off 36% reflecting particular weakness in systems and higher margin software sales. Despite the weak year-over-year sales comparison sequentially Apparel and Flexible Materials segment sales were up 9% from the fourth quarter and operating profit for the segment was up $500,000 or 13% from the same quarter a year ago, reflecting the impact of the cost saving measures.

Gerber Technology’s business in China appears to have churn in the quarter. From a year ago, revenue from China was off about $800,000 in the first quarter. However, on a sequential basis from the fourth quarter, GT’s business in China was up $1.4 million to $4.9 million. We’re optimistic this is the start of a trend in China as this is the largest single geographic market for this business unit.

Unfortunately in Europe, including the growth markets of Eastern Europe, we have yet to see any kind of meaningful improvement, so we are not seeing any continued worsening either. Well our acquisitions Virtek and Gamma contributed positively to our first quarter, the collective revenues declined in the first quarter from their pre-acquisition levels a year ago.

Virtek continues to actively quote in the aerospace and composite markets. However, aerospace contracts are being threatened by possible production delays for new commercial aircraft. On the other hand, Virtek’s PCI business, which serves the housing construction market seems to reviving somewhat, which is a very encouraging development. The story as similar to Gerber Coburn, Coburn’s wholesale lab customers are continuing to report significantly reduced volumes and major retail eyewear and lens processing customers in the U.S. reporting sluggish same store sales.

As a result, for the first quarter of fiscal 2010, sales from this segment were down 26% to a $11.5 million from a year ago and in comparison to Q4, sales were up 18% or $2.5 million. Excluding an unfavorable currency impact of $500,000, current quarter sales were up 23% from a year ago. Despite the sales decline Gerber Coburn made an operating profit of 6% of sales, driven by the management teams aggressive cost management and the improved gross margins.

Operating income for this segment in the current quarter was $695,000 compared to operating income of $115,000 last year. Looking a head, while we do not expect a further decline in Gerber Coburn’s business, it is difficult to see any top line improvement into the retail eyewear market strengthens in the United States.

At this point, I will turn the call over to Mike Elia and then afterward, I will provide our current outlook summary and take your questions. Mike.

Mike Elia

Thanks Marc. As a remainder, a webcast replay of this call and the transcript will be available on our website shortly after the call. As Marc mentioned, we expect the sale of FOBA to close next week. Thus FOBA’s financial results are included in discontinued operations and excluded from the results that I’ll be discussing today.

On a consolidated basis, revenues were down $39.2 million or 24.6% from a year ago. Revenues from recent acquisitions added about $3.8 million or 2.4%, while unfavorable exchange rates reduced revenues approximately $11.6 million or 7.2%. On a constant dollar basis, excluding acquisitions revenues were down $31.4 million or 19.7%.

From year end fiscal 2009, our first quarter consolidated order backlog was up about $500,000 and comparison to our fiscal 2009 year end order backlog in the Sign Making and Specialty Graphics segment was down about $300,000 to $1.6 million. Backlog in the Apparel and Flexible Materials segment excluding FOBA was up about $900,000 to $22.6 million. While the backlog in our Lens Processing segment was flat at $1.2 million.

Compared to the first quarter of last year, consolidated gross profit was down $8.4 million to $33.6 million, due to the lower revenue level. However, due to the efficiency gains cost cutting measures and the effective higher margins from the recent acquisitions. Our gross profit margin was up 160 basis points to 28.1%. On a constant dollar basis and excluding the recent acquisition gross margins improved 90 basis points to 27.4%.

As most of we on this call may recall, we began attacking our cost structure last August in order to combat the impact of lower revenue levels. As a result of these measures we’re able to reduce our first quarter consolidated SG&A by $8.8 million or 25.7% from a year ago. Excluding the additional SG&A of the recent acquisitions, SG&A was down $9.9 million. On a constant dollar basis an excluding the recent acquisitions, first quarter SG&A spending was down $7.7 million.

The bulk of which came from lower payroll and payroll related expenses. We also took actions to limit R&D spending to suggest signing projects and as a result, reported R&D dropped $1.8 million to $4.4 million for the first quarter from a year ago. Excluding the recent acquisitions, R&D expenses dropped $2.2 million. On a consolidated basis, operating income in the current quarter increased $2.2 million from a year ago to $3.8 million.

Operating profit from the recent acquisitions contributed about $600,000 while unfavorable exchange rates reduced operating profit approximately $1.2 million. Thus on a constant dollar basis and excluding the benefit of recent acquisitions, operating profit was $4.4 million up $2.8 million from a year ago due to the gross margin improvement and SG&A reductions.

In the first quarter of 2009, diluted earnings per share from continuing operations was $0.05 per share compared to $0.03 per share a year ago. On a net income basis, diluted EPS for the current quarter was $0.02 per share compared to $0.03 a year ago. However the current first quarter included a $0.03 loss from discontinued operations for the pending sale of FOBA, while there’s no effect on the prior year first quarter because we did not own FOBA during this period.

Now let me just touch on a few balance sheet and cash flow items. Trade receivables at the end of the first quarter were $80.1 million compared to $87.8 million at our fiscal 2009 year end, so a quarter-to-quarter drop of $7.7 million due to the lower volume and effective collections. In fact, DSO decreased to 60 days in the first quarter from 66 days at year end. From a cash flow perspective in the current first quarter, we generated cash of $10.6 million related to accounts receivable.

Inventories at the end of the first fiscal quarter were $69.8 million compared to $72.1 million at year end last year were down $2.3 million. Inventory turns at the end of the first quarter were 4.9 times compared to 4.6 times at year end. From a cash flow perspective, we generated $2.2 million in positive cash flow during the first quarter from a reduction in inventories.

In the current quarter, net cash provided by operating activities net of capital expenditures was $13.3 million compared to a cash usage of $7.2 million in the first quarter of last year. The change was due principally to the reduced operating expenses and effective working capital management.

Capital expenditures were down $1 million year-over-year in the current first to $1.2 million and in this environment; we plan to continue to minimize capital spending and keeping it within an annual range of $7 million to $8 million. As of July 31, 2009 we had $60.5 million in debt. This included $54.5 million drawn under our senior revolver accruing interest at various LIBOR rates plus 400 basis points and $6 million in industrial revenue bonds accruing interest at about 3%.

We also have outstanding $7.6 million of undrawn letters of credit. Total debt net of cash outstanding on April 30, 2009 was $48.9 million. Total liquidity was $21.6 million which consisted of $11.6 million in cash and $10 million in availability under our senior revolving credit facility based on current financial covenants. We’re in compliance with our bank covenants at quarter end.

We’re aggressively working on our 2010 plan to further reduce costs and improve earnings. Though we expect to complete the FOBA sale net week, we continue to review potential non-core asset sales to further improve our flexibility and availability under the existing credit facility. We expect that these asset sales if consummated could generate up to an additional $10 million to $12 million.

I’ll now turn the call back over to Marc and then we will open the call up for questions.

Marc Giles

Thanks Mike. So in summary, here are the takeaways for the quarter and our outlook. Year-over-year quarterly comparisons from last fiscal year will be difficult for at least the next quarter. We believe we’ve reached the bottom of the weak economic cycle and sequentially we should continue to report modest top line growth if the current trends continue.

Visibility remains clouded. However we are seeing increased activity in terms of orders and revenue particularly at GT and Spandex and expect that we will begin to see a modest recovery in the last half of our current fiscal year. If this assessment is correct, we believe that given our reduced cost structure, we are positioned to deliver earnings improvement in this fiscal year versus fiscal 2009, especially in the last half of fiscal 2010.

Having said this though, with the lack of real market visibility, we are still not comfortable providing more detailed guidance but we will resume doing so as soon as business conditions become more predictable.

Now I’ll open up the call to your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Arnie Ursaner - CJS Securities.

Arnie Ursaner - CJS Securities

You weren’t kidding about cost cutting controls down 25% on SG&A is very impressive. On the revenue side, can you comment on where we stand on some of your key products, specifically the Solara ion, where are we on backlog and what other perhaps key new products should we be focused on for the balance of the year?

Marc Giles

From the new product standpoint, we will start with the ion. The market remains very sluggish even equipment sales in this kind of a price range. So, I think the market is just slow I mean we did move 31 units in the quarter. I don’t see any indications at this point in this market that we would expect to see much more than that. We are going to be exhibiting the next generation of the Solara ion, next month at the SGIA show, Sign Graphics Industry Association show.

That’s going to be a higher price point, higher resolution printer that we’re pretty excited for I mean we’re still launching into a difficult market, but we see some pretty good demand for that kind of a printer in the higher end, so we’re excited about previewing that or showing that we’re optimistic that we’ll be able to launch that next generation commercially before the end of the fiscal year although we don’t have a specific time that we’ve communicated as yet.

As far as other products last year Gerber Coburn launched the Advanced Lens Processing System. We’re very excited about the long term prospects of that product technology that again going into the market for capital equipment purchases are sluggish. We did move a couple of those systems today they’re pretty expensive, they’re also a nice margin for us though and that helps Gerber Coburn’s gross margin and helped in this quarter. We have actually installed a few now in Asia and also now in the U.S. as well.

So as the economy begins to improve for capital equipment purchases, that would be another technology to look at. Also from Gerber Coburn, we expect to launch sometime during this fiscal year a next generation Blocking System, which is the E2G, what we think is a revolutionary new blocking material that we think we’ll create extremely high demand in the marketplace for this system and could be from Gerber Coburn’s market a blockbuster actually. So we’re very excited about that.

On the Gerber Technology’s front, of course we launched the Z7 industrial cutter last year. We’ve had pretty good movement on those. That’s another thing that we should watch, is going to be more attuned to the industrial markets as opposed to the apparel markets however, and so we still see pretty slow conditions in the automotive and their supply base. So that’s kind of the overview of products we should watch this year.

Arnie Ursaner - CJS Securities

My final question, if I can. You mentioned you’re seeing, I think some improving trends in both GT and Spandex and I’m trying to kind of get a little bit of feel for that given the summer doldrums. A lot of the business you do in Spandex is in Europe. Can you give us a little more feel for some of the factors that you’re citing for this encouragement?

Marc Giles

It’s really at Gerber Technology, its quote activity has increased, business in China has increased and although it’s got a long way to go, it’s kind of established a pattern now of continued improvement in China and what’s encouraging there is that’s being driven by the apparel industry I mentioned for Gerber Technology, but exports from China continue to be down to the U.S. and to Europe.

So what has happened is its domestic consumption, which now represents I think close to three quarters of total production in China is creating the demand, their own internal demand and that’s having a ripple effect back to suppliers such as us. So when the economy retail sales in the U.S. and Europe do improve for apparel and furniture, I think we will see an additional boost on top of what we’re seeing already. So when that happens, we’re kind of expecting kind of the back half of our fiscal year, so we’re talking kind of December and later, but we do expect to see a boost from that eventually come through.

On the Spandex side, I mean virtually all the sales are in Europe. We have had good sales in Australia, though which is actually posting gains and everybody else is down on a year-over-year basis. Sequentially, Spandex continues to improve and they went down. They took a big hit in the third quarter this last winter and have improved consistently and I attribute a lot of that to the team’s work in driving market share in certain key countries such as the United Kingdom. So I think its attribute to their actions.

Arnie Ursaner - CJS Securities

Two more real quick ones if I can from Michael. Michael, what is your tax rate guidance for the year?

Mike Elia

We’ll say around 30%, 35%. As you know, I mean with the recent accounting changes on the booked side, it’s going to fluctuate quarter-to-quarter.

Arnie Ursaner - CJS Securities

You remind us again of your coverage ratios. With the sale, I guess you do it off trailing 12 months. How much flexibility do you have on any of your covenant issues? I know you have it from and just remind us what that is, please?

Mike Elia

If you pro forma the last quarter were the sale, we’ll have a fair amount of cushion on the EBIT cushion, which is the interest coverage ratio and we’ll have a fair amount of cushion on the leverage ratio. So the covenants are 2.25 for the first fiscal quarter on the interest coverage ratio and 3.75 on the leverage ratio.

Operator

Your next question comes from Jim Ricchiuti - Needham & Co.

Jim Ricchiuti - Needham & Co.

Question on the service gross margin, you showed some nice quarter-on-quarter improvement here. Do you see this as sustainable? Anything contribute to the strength in service margin in the quarter? I know you’ve taken a lot of costs out.

Marc Giles

Yes, that’s the primary driver. Jim, we are seeing some improvement in our direct sales areas in terms of service and support as opposed to our indirect areas and that’s kind of a geographic mix improvement. So that mix shift helps us, but then the bulk of it I believe is a result of the cost actions that we’ve taken. So it’s sustainable to the extent that we carefully manage any cost add backs as business levels improve.

Jim Ricchiuti - Needham & Co.

You provided in some supplemental information this quarter on equipment software aftermarket supplies and service. You also provided it in Q4 and I’m wondering Mike, if you had the data in front of you, if you had those three line items for Q3, I’m just trying to get a sense, if we look at your equipment and software revenue, it looks like it was down about 14% quarter-on-quarter. I’m just trying to get a sense of the trend here and when we might begin to anticipate that? You see that flattening out this quarter perhaps.

Mike Elia

Let me grab some information.

Marc Giles

You’re looking for what kind of trends and the different kinds of revenue?

Jim Ricchiuti - Needham & Co.

Yes, Marc. Basically, looking at that equipment and software revenue line, I think it’s going to be interesting to see how that has been trending. Do you see that’s now flattening out, particularly with what you’re seeing now coming out of China?

Mike Elia

On the sequential quarter basis, it took the biggest drop was in the fiscal fourth quarter of last year and we saw some improvement from fiscal fourth quarter to the fiscal first quarter on the system side. Software followed a similar pattern, but I will mention that in the first quarter, the most current first quarter, because of the revenue recognition rules, we picked up about $0.5 million of software from a large software sale and that actually had occurred about a year ago. I hate to say that, but that’s just the revenue recognition.

Jim Ricchiuti - Needham & Co.

Again, Marc, I just wanted to go back to some of the commentary you made about China, since it is pretty crucial for you guys. How is the visibility there? It sounds like you feel the business is turned. Do you see the momentum more toward the second half of the year or are you just feeling better that business has, we should see some nice progress over the next several quarters?

Marc Giles

It seems like we should continue to see growth and progress there over the next few quarters. Our order rates for new equipment and software sales continue to be improving through to today. So it seems like it’s a pretty solid trend almost getting close to three quarters now of trending improvement in China basically and I would expect to see another quarter of improvement there again in the current quarter in Q2.

I think, what I was saying earlier is we’re really not seeing for lack of a better term, industrial based activity, its apparel based that is driving the improvement there, but it’s still sluggish when it comes to other industrial sectors that we serve and in addition, the other comment I made was it’s really seems to be driven by two factors on the apparel side. One is industrial consumption growth as opposed to export growth, which really hasn’t happened yet.

So as I say, that should be a nice kicker once we start to see improved exports from China to the U.S. and Europe as far as apparel is concerned and then the other kind of more strategic driver, I think we talked about this maybe quite a while ago, is that this economic cycle wreaked havoc on the small players in the apparel industry in China, not even the apparel industry, but in a lot of different industry sectors. So we’ve seen significant industry consolidation.

There are still a lot of players, but there are fewer larger, stronger players today than there were beforehand and that lends itself to more capacity being done through automation. So improves our business and odds for automating production in China by virtue of this industry consolidation, so we’re seeing some of that too. As a matter of fact in this quarter or this past quarter, we took a very substantial order for a series of new cutters from one of the large suppliers to Nike in China. So these are major purchases that we’re seeing.

Jim Ricchiuti - Needham & Co.

A question on expense levels, operating expensive levels, you guys have done a great job there. It’s certainly I think better than we were looking for. As we look out into the latter part of the year, when we potentially see the revenue growth start to pickup. Can you talk a little bit about, how much we might see in the way of add backs? Are some of these expense reductions temporary in nature, that you would think could begin to get restored later in the year if we see the revenue growth pickup?

Marc Giles

Yes, I mean some of this is temporary cost constraints that we would like to add back and we’ll see add back. I don’t have that analysis in front of me, so I can’t give you a good feel for the percentages, but for example, the beginning of this year, we stopped the company match of our 401(k) plan and so that is something that we plan to and will restore.

On the other hand, we froze our pension plan at the end of the fourth quarter and we don’t have any intention of restoring our defined benefit pension plan. So that reduction is permanent, but the 401(k) company match is a temporary cost reduction. We’ve done forced furloughs. We did the forced furlough during the most recent quarter. Obviously, that’s something that as business comes back we will not want to be doing forced furloughs, so those kind of costs will come back.

Then on the other hand, there is a substantial amount of the cost out that we believe is a structural in nature and won’t come back. So it’s a blend.

Jim Ricchiuti - Needham & Co.

Last question just with respect to other asset sales, you talked a little bit in terms of what we might expect and from a dollar standpoint. What is the timing on that? Do you feel that’s something in the next one to two quarters? Is it closer than that?

Marc Giles

I think it’s something that if it’s going to happen is likely to happen in this current quarter Q2. I doubt it will stretch to Q3, but you never know that’s my expectation, if they’re likely to happen soon, I assume at least the one that we’re indicating here.

Operator

Your next question comes from Garrett King - Truffle Hound Capital.

Garrett King - Truffle Hound Capital

Do you have any idea regarding the end markets for your products in China, whether they typically go to like the larger multinational apparel manufacturers like Nike or to smaller domestic Chinese companies?

Marc Giles

Most of the sales that we’re talking about for Gerber Technology and the apparel related sector in China, actually go to large independent Chinese owned manufacturing operations. So when we talk about Nike, Nike sources its product from a variety of suppliers, but doesn’t own any of its own operations or manufacturing operations in China.

So the end user of our equipment is in fact Chinese owned operations. They not tend to be, they’re definitely larger manufacturing operations who have the scale to benefit from automation.

Operator

Your next question comes from Zahid Siddique - Gabelli & Co.

Zahid Siddique - Gabelli & Co.

A couple of questions; first on CapEx, what is the estimate for the year?

Mike Elia

$8 million.

Zahid Siddique - Gabelli & Co.

Above 8, 9?

Mike Elia

$7 million to $8 million.

Zahid Siddique - Gabelli & Co.

Okay $8 million and the other question I have is, about your business in China. In terms of percent of your sales, how much business comes from China?

Marc Giles

I mean normally in a good year, we were doing revenue in China I think in fiscal 2008, we did about $32 million or $33 million in China. So, that was approaching the 5% level. This past year in fiscal ‘09, we were more like around $18 million or so we were down a 30 little bit over by about one third which last year put us more like in about whatever that is, 2.5% to 3% of total sales. So, in that range, so in a good year we should be seeing 5% and growing as that’s the fastest growing market that we have.

Zahid Siddique - Gabelli & Co.

Are there any other China like markets maybe India or Brazil that you guys have a presence in?

Marc Giles

Actually for that end use and related market, Vietnam is currently the number three manufacturer of export apparel in the world and is expected to be number two, overtaking India probably within the next few years and that is why we went direct and invested in Vietnam with the technology center and our own service organization and direct sales of course there.

India is number three and that region tends to be fairly strong. India, Bangladesh, Sri Lanka is traditional apparel manufacturing area and those are strong markets for us as well we go we are indirect; we go through distribution in that segment. Nevertheless that will continue to be a strong segment for us and we have historically done well there. Neither of those areas are anywhere near the size of China, that being said.

So you kind of go from China and then there’s the next tier of Vietnam and then Southwest Asia and then you get into places of far Eastern Europe which has been important, so the Stans and Ukraine and Russia has been an important player. Turkey is another important player where we have a long term presence. So anywhere that there is a significant growth opportunities were there. We’re not there always direct, but we are there.

Zahid Siddique - Gabelli & Co.

Just a last question, could you comment on your European markets and maybe contrast that with the U.S., how the trends in Europe?

Marc Giles

Yes, for our business in Europe, when we talk about the apparel and flexible materials industry, it tanked as hard, if not harder than here in the U.S. So it’s been hit very hard even though the automotive sector and related we didn’t see quite the same level of impact in that one particular sector. We look at the growth markets of Eastern Europe, so that’s kind of pull, and then east in some of the countries I just mentioned, they really took a big hit and we have not seen any meaningful recovery in that area even yet.

So that still got ways to go, I think to come back and we’re really not seeing any particular strength or improvement in either of the European sector or the U.S. sector right now.

Operator

(Operator Instructions) Your final question comes from [Graham McClutchy] - Deutsche Bank.

Graham McClutchy - Deutsche Bank

A couple of specific questions on numbers and then a general question, question on inventories. At today’s level or current level of sales, how low can we reduce inventories?

Marc Giles

We have a challenge that’s in front of our team to take out or buy I think roughly another $5 million of inventory at current revenue levels, that’s our target. The challenge I think is going to be, Graham as we see revenues increase, the challenge in front of the team is to not grow our inventory levels. So to try to get back to at least to the turns before when we’re approaching between $6.5 million and $7 million in the near term, so that’s kind of our goal, is not to add back as things start to increase in the back half of this year.

Graham McClutchy - Deutsche Bank

Could you discuss your efforts in supply chain management, which you’ve talked about over the years? Where do you think you are in terms of progress? Is there any way to put any numbers on that and how much more can we anticipate?

Marc Giles

I think there’s an awful lot more. I think we’ve just started to scratch the surface really. I mean, I think our operations team is doing an excellent job finally in making progress. If you looked at the crawl, walk, run, maybe we’ve started to finally walk. It took a number of years, frankly to get enough focus and to get the right folks in place to get to this point, but we’re walking in.

I begin to see real improvement when I look out in our assembly operations in Thailand, that’s the most noticeable place where you see what’s going on and the benefits there, you see it in the supply chain. I think we reduced our supply base over the past year by almost 40%.

So we have fewer, stronger, better relations and more influence with our key suppliers and we’re beginning to see the benefits of that and material costs helped and in new product development systems and then in costs out right on our assembly floor in terms of efficiency and labor content.

It’s also obviously, one of the fall and since enabling us to get at some of those inventory reduction plans. So we’re beginning to see those things, but I think it’s really just the beginning, Graham. I think over the next few years, I think we have the opportunity to continue to accelerate that.

Graham McClutchy - Deutsche Bank

Can we get a framework on that Marc, for example, might that have contributed 1% to gross margin improvement and how many percentage points of gross margin could that if successful over the next two years add?

Marc Giles

I’m not prepared to lay that out for you today, Graham, I appreciate the question and maybe we’ll take a stab at looking at some kind of metric that we can all track together. It does get a little bit muddy. If you look at gross margin improvement today, we’re getting negatively impacted in a big way by absorption. Our fixed overheads are really a very substantial part, because a lot of it is just facilities.

We have a lot of facilities because of the old sale leaseback that we’re hanging onto that we really don’t even need anymore and that overhead stays in place and wax us pretty good, but the teams through a combination of higher margin gross product, sun setting older, lower margin products; pricing improvements over the last few years, more intelligent pricing actions, and lean implementation and material cost control have at least started, at least indications are we’re able to offset a lot of that. So as volumes comeback, we’d like to see pretty good kick.

Graham McClutchy - Deutsche Bank

So really, where we have to wait for is the dollar volume increases in the second half of the year to see what real impact that’s going to have?

Marc Giles

I wouldn’t anticipate any noticeable, meaningful, sustainable improvement until we see some volume from that.

Graham McClutchy - Deutsche Bank

Next question is apparel software, specifically could you sort of tell us where you stand on that and you see any light at the end of that tunnel?

Marc Giles

I’m sorry. I didn’t understand.

Graham McClutchy - Deutsche Bank

The software programs that you sell specifically in the apparel area, what are you seeing there, because these are nice high margin?

Marc Giles

It’s soft, it continues to be soft and we haven’t seen any kind of significant rebound. We have seen improve outside of China, I would say, but we haven’t seen any significant improvement there. Mike mentioned the large PLM or FLM order that we got that really goes back some time. We just were able to recognize that revenue in the first quarter, but large software sales, people are still hesitant. They’re still shying away if they can from those investments. So the improvement we are seeing tends to be from some smaller shops or some of our traditional customers upgrading where they can or have to.

Graham McClutchy - Deutsche Bank

Marc, could you talk specifically about your competitive position. I can’t remember, if it’s Spanish, French or is it combined in the apparel and flexible materials area? How are you doing versus them? What’s going on with market share? How is pricing stuff like that?

Marc Giles

I think we’re doing well. I don’t think that we’re on the large global scale that we’re losing any market share. I think in fact we gained market share for probably the last year or so up until recently things seem to have stabilized. We definitely continue to gain share in our position in China, which has been the strategic thrust for us versus that competitor in that space and we continue to make progress there.

In terms of Europe, they’re stronger in Europe and we tend to be stronger here in the U.S. We’re not seeing much change either way on that. They do well right now, they have done well, probably better than we have in securing software, continuing software support contracts and that’s something that keeps them going, is an advantage they have, keeps them going financially even though the last couple of quarters.

I think they’ve lost money both in their first and second quarter, so the full half of this year and have reported continued declines in sales and losses in terms of income, but they do have some good decisions and those positions reside in certain countries in Western Europe particularly and with their software support contracts.

Graham McClutchy - Deutsche Bank

Pricing generally?

Marc Giles

Generally, pricing has remained firm. We have not had to do anything in pricing. I think to some extent obviously, the euro dollar exchange rate, the weakened dollar, has helped us sustain that and quite frankly, I think we have a discipline of saying no and that’s not just at GT that we’ve implemented that one of the important changes that have happened over at Spandex, that our management over there has implemented is a more disciplined and rigorous approach to pricing and letting certain customers go away.

Graham McClutchy - Deutsche Bank

In your competitive position in the new Solara markets that you’re entering how what’s happened with the competitive aspect there I think one of the companies was acquired by a major and what’s going on there?

Marc Giles

Really, not a lot of change there Graham, who last couple of quarters there was a large I guess grand format player, so somebody who competed in this space well above us that went bankrupt here in the last quarter, pretty big player about a $200 million inkjet company.

So, I think there is stress throughout the sector because of the decline in capital equipment sales. When it comes to our revenues and our percentage share, I really don’t see much change in the narrow segment that we serve, it just depressed.

Graham McClutchy - Deutsche Bank

Finally could you discuss how the remaining assets that you acquired from Virtek are doing and how that integration is working with the core business you have added that to and…

Marc Giles

I think of that acquisition despite some of the stress that it has put on us when we grew our debt back a year ago as a result is a great strategic acquisition that was done extremely well. Their gross margins are substantially accretive to our own gross margins they have leading positions.

We have programs underway to take advantage of the marketplace synergies the technology synergies that exist those things will be happening, are active now. We’re planning a new product launch from Gerber Technology here this year that’s in beta right now that I haven’t talked about yet and will talk about it later, but that is based on the Gamma acquisition that we’re very excited about and then we have technical integration opportunities that are happening within Virtek’s space.

So as a result of the combined Gerber Technology, Virtek product line for example, we’re getting increased activity in the wind energy construction business. So composites are used in these big wind energy blades and our cutting technology combined with winding technology and laser layout technology is a strong offering for us.

Operator

(Operator Instructions) There are no further questions. I’d like to turn the conference back over to our speakers for any additional or closing remarks.

Marc Giles

Thanks operator. We’re pleased to report our results for this fiscal first quarter. I’ll remind everybody that things remain difficult in terms of visibility and while we’re encouraged that we appear to have bottomed in term of our markets. We don’t see any significant improvement happening as of yet and so what that means that things can be variable and bumpy in our outlook and that’s why we’re not providing an outlook.

Hopefully, things will begin to turn now in this coming quarter and if they do, we’ll look forward to talking to you again at the second quarter conference call. In the meantime, we continue to be very, very focused on managing our costs and balance sheet to make sure we come out of this cycle in as good a shape as we can. Until then, we will look forward to talking to you at the end of the second quarter call. Thanks operator, thanks everybody.

Operator

That concludes today’s teleconference. Thank you for your participation.

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Source: Gerber Scientific Inc. F1Q10 (Qtr End 07/31/09) Earnings Call Transcript
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