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Newport Corp. (NASDAQ:NEWP)

Q4 2013 Results Earnings Conference Call

February 12, 2014 5:00 PM ET

Executives

Robert Phillippy - Chief Executive Officer

Chuck Cargile - Chief Financial Officer

Analysts

Jim Ricchiuti - Needham & Company

Mark Douglass - Longbow Research

Patrick Newton - Stifel

Larry Solow - CJS Securities

Mark Miller - Noble Financial Capital Market

Kevin Casey - Casey Capital

Dave Kang - B. Riley

Operator

Good afternoon. My name is Natasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newport Corporation Fourth Quarter and Year End Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the conference over to Mr. Robert Phillippy, Chief Executive Officer. Please go ahead, sir.

Robert Phillippy

Thank you. Good afternoon. Welcome to Newport's fourth quarter of 2013 conference call. With me is our Chief Financial Officer, Chuck Cargile.

Before we get started, I'd like to remind you that during the course of this conference call, we will be making a number of forward-looking statements that are based on our current expectations and involve various risks and uncertainties that are discussed in our periodic SEC filings.

Although, we believe that the assumptions underlying these statements are reasonable, any of them could prove inaccurate, and there can be no assurance that the results will be realized.

In addition, during this call, we will be discussing certain of our financial results on a non-GAAP basis, excluding items we believe to be outside of our core operating results. We believe that the supplemental presentation of non-GAAP financial information helps to provide insight into the company's core business results, as well as a more meaningful comparison of our financial results between periods. Please refer the press release we issued today for a reconciliation of our results on a GAAP and a non-GAAP basis.

Newport team delivered a strong financial performance in the fourth quarter, with sales, operating income and EPS all exceeding our expectations and all reaching the highest levels of the year. In fact, our non-GAAP operating income of $23.1 million was the highest in our history.

In addition, our orders of $166.8 million were the second highest level of all time and resulted in a book-to-bill ratio of 1.08 and record backlog. These results came from a combination of new business wins, improving conditions in our target markets and crisp operational execution.

Perhaps even more encouragingly, we are now beginning to see the early results of our continued focus and investment in our long-term strategic growth initiatives. So we enter 2014 with the well-honed strategy, a solid financial model and great momentum. As we will discuss later in the call, these factors lead us to expect a very good year.

I’d now like to provide an update on order trends, activities and conditions in each of our target market. Fourth quarter orders from customers in our microelectronics market were the second highest level we have ever achieved at $53.5 million, representing growth of the 105% versus the fourth quarter of 2012 and 44.9% sequentially.

Highlight of this performance was a $14 million collaborative development agreement for opto-mechanical subsystems for next-generation semiconductor equipment. This agreement calls for Newport to design highly engineered application-specific subsystems and to deliver prototypes and related equipment to advance the program.

The program has already been launched and the first prototypes are scheduled to be delivered in mid-2014. Assuming we execute successfully, this program has excellent potential for follow-on business.

Also as part of our strategic initiative to capture increasing share in high-growth mobile device manufacturing applications, our Quasar hybrid fiber laser continues to gain traction and is already becoming a very successful new product.

We have now received a total of over 20 million in orders for this product, which we introduced just one year ago. These orders come from a number of different customers, all with excellent follow-on potential.

The performance and throughput enhancements that are enabled by Quasar’s unique design that proven to be compelling for glass cutting, PCB cutting and drilling, silicon wafer dicing and other precision micromachining applications.

To further extend Quasar’s capabilities, we introduced a new 60-watt version last week at the Photonics West trade show in San Francisco, reinforcing Quasar’s position as the highest power single-mode UV laser in the industry.

As a complement to Quasar, we introduced our new Talon laser at Photonics West. This new 12-watt pulsed UV laser has potentially disruptive cost performance model for fast, accurate and low-cost manufacturing of mobile device components. We are already taking orders for Talon and expect to begin shipping production unit this quarter.

In addition to the share gains from these initiatives, near-term condition in the microelectronics market continued to stabilize and we've now seen an uptick in demand from several, although not all of our key OEM customers.

Orders from customers in our life and health sciences market up $30 million grew by 11% versus the fourth quarter of 2012, the decline slightly sequentially. Market demand for bio-instrumentation applications remained steady and we saw particular strength in orders for bioimaging applications. In both areas we continue to enhance our position with some of our recent product introductions.

Our Q4 results in particular was boosted by a record orders for our insight DeepSee laser, which is the first laser to enable deep 3D imaging of live tissue. We also receive record orders for dental imaging systems, which deploy our patented conoscopic holography technology.

On the new product front, we’ve just introduced the significantly enhanced set of electronic controllers for our picomotor actuator product line, which is widely deployed in this market among others. This adds to the versatility of this product for OEM customers looking for highly precise automatic tuning of their instruments.

Also we continued to expand our offering of products for life and health sciences, with the introduction of our new High Q2 laser. This is an ultracompact air cooled femtosecond laser that provides an ideal solution for a number of bioimaging, nano-surgery, micro-dissection and optogenetics applications.

Going forward we expect the demand environment in this market to continue to improve during the course of 2014, though our order patterns will remain highly variable quarter-to-quarter.

Orders from industrial market customers of $34.5 million were the highest level we’ve ever recorded in the fourth quarter, 23% higher than the fourth quarter of 2012 and 8% higher sequentially.

This result was driven primarily by another outstanding bookings performance for fiber optic device systems from our ILX Lightwave business, which we acquired in January of 2012.

For the year, ILX orders grew 76% to $12.8 million. This growth has reinforced our position as the industry leader in diode laser instrumentation and test systems, and also highlights the effectiveness of our M&A strategy.

We have been very successful in acquiring companies with differentiated and complementary technologies and leveraging the strength of Newport’s global sales channels to scale their business and accelerate their growth.

Another strong contributor to our industrial market orders has been activity in 3D printing applications. During 2013 we received more than 8 million in orders for 3D printing for four additive manufacturing and expect continued growth in 2014. We also achieved record orders for automobile night vision optics for both the fourth quarter and full year of 2013.

While the adoption of automobile thermal imaging technology has been slower than initially anticipated. We continue to believe it holds promise for future growth and we have established our position as a leading supplier for this application.

Fourth quarter orders from customers in our scientific research market of $34.7 million were slightly higher than the fourth quarter of 2012 and 16.9% higher than the very low Q3 2013 level. Although the results did reflect some normal seasonal strength in the fourth quarter, the total orders in sales are still relatively low compared with historical levels.

Government funding constraints both in the U.S., some other parts of the world created difficult environment throughout 2013 in the scientific market. Despite these challenging market conditions, our orders for the full year of 2013 were only 1.2% lower than the prior year.

This market continues to be a remarkably resilient platform for profit and cash generation as well as an important vehicle for identifying new innovations that will transform commercial markets.

Looking forward, we believe that the stability created by the recent budget agreement in the U.S. will have a positive effect on both the funding levels and buying behavior of our U.S. scientific market customers. We therefore expect modest growth in our scientific market business in the U.S. during the course of 2014 although we may experience a slow start to the year due to normal seasonal softness in the first quarter. In other parts of the world, the outlook varies by country, but our overall outlook is positively biased.

We plan to capitalize on this improved market environment by further enhancing our already broad portfolio with a number of new product for our research customers. At the Photonics West Show, we introduced 24 new products, of which 14 were developed for research applications, including our new Vantage external cavity laser from New Focus, a new Oriel LED-based solar simulator, a new Laser Beam Profiler from Ophir Photonics, and several new opto-mechanical and optical components.

Fourth quarter orders from the defense and security customers were $14.1 million, representing a sequential decline of 7% and a decline of 23.3% versus the fourth quarter of 2012. Our business in this market was severely impacted by sequestration during much of 2013.

While we are hopeful that the recent U.S. budget agreement will stabilize and improve the market outlook, this business is OEM driven and will therefore take time to recover. The good news is that we continue to gain traction in this market.

During the fourth quarter, we had several design wins with defense contractors for OEM optics that have total production revenue potential of approximately $6 million per year for three to five-year period beginning in late 2014 and early 2015. These new programs represent some tangible momentum in our long-term initiative to build our presence in this market.

On a regional basis, we achieved sequential orders growth in the fourth quarter in every major geographic region we serve. Our strongest performance was in Europe, which grew by 25.3% sequentially and 34.9% versus the fourth quarter of 2012.

The Asia-Pacific region also delivered a strong performance with orders growth of 10.6% sequentially and 28% versus the fourth quarter of 2012. It is noteworthy that despite the well-publicized economic slowdown in China during the course of 2013, our full year 2013 orders from Greater China market grew by 34.5% to $57.9 million.

As implied by these comments, we are very pleased with our strong finish to the year and the momentum we bring into 2014. In addition, to this financial performance and business momentum, our new product pipeline remains robust and we continue to enhance operational execution. These factors lead us to participate -- lead us to anticipate significant revenue and profit growth in 2014 and beyond.

I will now turn the call over to Chuck to review our financial performance and discuss our outlook for 2014 in more detail. Chuck?

Chuck Cargile

Thank you Bob and thanks all of you for joining us. First I’d like to mention that much of the information we’re discussing during this call is also included in the press release and Form 8-K we issued earlier today.

I encourage you to visit newport.com and specifically the section titled company investor information. There you can see presentations that we've made at recent investor conferences, also historical financial statements and schedules that detail historical trends for our sales and orders by market and the financial performance of our three business groups and also schedules which reconcile the supplemental non-GAAP financial information to the corresponding GAAP measures with details of the items we exclude from our non-GAAP results.

I also encourage you to download our Investor Relations app, which is available for free from the iTunes App Store and the Google Play market.

I’ll now discuss the results for each of our three business groups and key components of our consolidated income statement, balance sheet and cash flows. First, I’ll discuss our Photonics group which delivered excellent segment income this quarter.

Photonics net sales were $59 million in the fourth quarter, reflecting a slight increase both sequentially and year-over-year. Our Photonics group consistently generates impressive income and cash flow and did so again in the fourth quarter.

The segment income of $13.4 million was the highest level of the year and was 22.8% of sales. Ophir Photonics continues to flourish as a New Port. And their sales and profit in 2014 were the highest level in their history.

Even as our Photonics group delivers outstanding financial results, we continue to find additional actions to maintain and improve their profitability. In 2013, we announced our decision to transition manufacturing from our Stratford, Connecticut facility to our facilities in Wuxi, China and the ILX site in Bozeman, Montana. That project is on schedule and is expected to achieve $1 million of annual savings for the Photonics group once it’s completed.

Our Optics group continues to show improved financial results. Their net sales and segment income was the highest levels of the year. The Optics group is the main interface with our customers in regards to the $14 million collaborative development agreement that Bob referenced earlier.

In support of that program, the group is integrating products from four different businesses within our Optics and Photonics groups. This program is truly reflective of the value that Newport can provide to our customers with our knowledge, expertise and broad product offerings.

Also we continue to execute our plan to establish a low-cost optics fabrication including facility in Romania. This is a major investment in 2013 and we expect it to become profitable in the second half of 2014.

Our Spectra-Physics Lasers group delivered an outstanding financial performance in the quarter. Net sales of $48.6 million with the highest level in almost two years and represented increases of 24.7% sequentially and 8.1% year-over-year. Even more notably, our Lasers Group delivered segment income of $8 million or 16.4% sale, both of which are all-time records.

Furthermore, the $8 million of profit reflects growth of a 132% sequentially and 14.5% year-over-year. As Bob discussed, we are very excited about the growth prospects of the number of this group's new products. And when coupled with the strong financial foundation they’ve established, it’s clear to us that 2014 should be a great year for our Lasers Group. In short, all three of our business groups executed well in the fourth quarter and enter 2014 with strong momentum.

Now, I would like to make a few comments about our consolidated financial results for Q4, and our outlook for the first quarter and full year of 2014. Except where otherwise noted, these comments will focus on our non-GAAP results. Our consolidated gross profit of $67.3 million was 9.6% higher sequentially and 5.2% higher than the prior year fourth quarter. The increase in gross profit was solely due to the higher sales levels, as our gross margin actually declined to 43.6% compared with 44.2% in the third quarter and 45.1% in the prior year fourth quarter. This decline is due primarily to three factors.

First, the sales mix. Our fourth quarter sales included a higher mix of sales to OEM, which generally had lower gross margins in sales to end-users at similar operating income. In addition, the mix of sales from our Optics and Lasers Group, which generally had lower gross margins than our Photonics Group, also put downward pressure on the gross margins.

Second, due to the low production levels for most of 2013, we are still expensing some previously capitalized under absorbed overhead. As production levels increase and we burn through these expenses, gross margin will naturally increase. And lastly, we increased our reserves for excess and obsolete inventory of $1.1 million in the fourth quarter of 2013. So, although Q4 gross margin was a little low at target of 45%, we remain confident that 45% is reasonable and achievable later in 2014.

Our SG&A expenses of $31.8 million were 20.6% of sales. As we discussed many times, one of our objectives is to leverage our SG&A expenses as sales increase. In the fourth quarter, we did exactly that. While SG&A expense did increased $1.6 million sequentially and year-over-year, our SG&A as a percent of sales was 20.6%, that marks the lowest level of at least 10 years.

As communicated previously, we expect our quarterly run rate of expenses to be higher in 2014, as we fully fund incentive programs that were not wholly funded in 2012 and 2013. We also anticipate that salaries will increase by an average of about 3% in 2014. And our variable expenses will increase to some degree as sales increase. That said, we’ve proven to be effective at closely monitoring our cost structure and will continue to do so in 2014.

Our fourth quarter operating income was $23.1 million, which marks an all-time record for Newport. Our operating income increased 25.9% sequentially and 6.9% compared with the prior year fourth quarter. Our fourth quarter operating margin of 15% of sale was also the highest level of the year.

Our interest and other expense, net of interest and other income continues to decline as we pay down debt. For the fourth quarter of 2013, it was a $1 million, which is $300,000 below the third quarter of 2013 and $400,000 below the Q4 levels of 2012. Our non-GAAP earnings per diluted share of $0.38 increased $0.07 versus the $0.31 per diluted share we reported in the third quarter of 2013. And was the highest level we’ve reported in over two years.

In the fourth quarter, we generated $23.8 million of cash from operations and we reduced our total indebtedness by $19.2 million. At the end of year, our total cash balance including restricted cash, cash equivalents and marketable securities was $64.2 million and our total debt was $88.5 million. During all of 2013, we reduced our total debt by $95.2 million and we generated $63.9 million of cash from operations. In summary, our Q4 financial performance was the best of the year as each of our business groups delivered solid results.

Now, I will discuss our outlook. We’ve gained momentum in recent quarters and while we’ve not seen this recovery in all of our end markets, input from our customers gives us confidence that business conditions will continue to improve in 2014. Based on this input and our upward backlog and the new program wins we capture, we are increasingly confident that we will achieve significant year-over-year sales and profit growth in 2014.

In the first quarter of 2014, we expect increases in sales and profit compared with the first quarter of 2013, but reductions on a sequential basis due to the normal seasonality, primarily in our scientific research market and also the sale of our MRSI business, which represented $4.6 million in sales in the fourth quarter.

We expect our first quarter net sales to be in the range of $141 million to $147 million. This would reflect an increase of 6% to 11% over the first quarter of 2013. In addition, we expect our non-GAAP operating income and non-GAAP earnings per share in the first quarter to increase significantly compared with the prior year first quarter, due primarily to the higher level of sales.

That concludes our prepared remarks and we'll now address any questions that you have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question comes from the line of Jim Ricchiuti with Needham & Company

Jim Ricchiuti - Needham & Company

Thank you. Good afternoon.

Robert Phillippy

Hi, Jim.

Jim Ricchiuti - Needham & Company

Congrats on the quarter. First question just is regarding the profitability on the segments. The laser business has been more -- you get variability in segment earnings in that segment. It also sounds like you feel like you're gaining momentum on the new product front. Do you feel that the margins that you're showing now are more sustainable, or is there still a potential for more variability quarter-to-quarter?

Robert Phillippy

I think the lasers financial model has improved dramatically and we see that. You mentioned the variability. There is a little bit more variability in that group. And one of the reasons is that they are very dependent upon volume. And so you can when you -- last quarter when the laser business did $39 million versus what the proper leverage they can get when they do like they did this quarter $48.6 million in revenue. So there is a lot of profit leverage that they get.

Also the new products units that they are introducing and shipping, for the most part will have a little bit better margin -- gross margin in some of the old product that they had, so that should help the model as well. So it will continue to be variable based on sales, but the low watermark for lasers had increased significantly over the last couple of years.

Jim Ricchiuti - Needham & Company

Chuck, if we take that segment and look at the improving profitability and OpEx, and just look at your revenue guidance which I guess matches I am looking at 2013, it’s more closely aligned to that Q3 where you generated operating -- non-operating margins of 13.2%. It sounds like just based on the improving profitability that even you could show some improvement above those levels just based on what the various puts and takes in the business. I guess what I am getting to is where you might see non-operating margins going up significantly from Q1 of last year, but it sounds like just with some of the improvements you could show some improvement versus that level of revenues that when you generated 13.2% operating margin?

Charles Cargile

I think that’s right Jim .And we’ve been saying consistently of late that we think 15% was the operating margin that we should be achieving and we’re very pleased that we did that in Q4. And I believe that that continues to be a good target. And so when you mentioned the 13.2%, we think we can do better than that, yes.

Jim Ricchiuti - Needham & Company

Okay. Thanks a lot.

Robert Phillippy

You are welcome.

Operator

Next question comes from the line of Mark Douglass with Longbow Research.

Mark Douglass - Longbow Research

Hi, good afternoon, gentlemen.

Robert Phillippy

Hi, Mark.

Mark Douglass - Longbow Research

It’s been the last week. Talk about the Micro Robotics, when did they close?

Robert Phillippy

January 24th.

Mark Douglass - Longbow Research

January 24th.

Robert Phillippy

Yes.

Mark Douglass - Longbow Research

Okay. A little later than you expected.

Robert Phillippy

Yes. When we gave our guidance in October, we had hoped that we would close that business during the fourth quarter just as we went through all the finalizing documents and getting the deal all tied up and it carried into the first week of January. So we’ve got a full quarter of the revenue in Q4 and that was $4.6 million, and of course none of that will recur now. If they shift anything, it would have been very, very low amount the first couple of weeks of January. It would have been measured in hundreds of thousands of dollars, not millions of dollars.

Mark Douglass - Longbow Research

Right. You mentioned before that there are $12 million in trailing sales in 3Q, exiting’13 was a little bit better than that or…?

Robert Phillippy

Yes. Their Q4 was a little stronger than we had expected kind of partying gift I guess to us they did 4.6 in the quarter and a little over $13 million for 2013 full year and not a breakeven at the operating income line breakeven.

Mark Douglass - Longbow Research

Okay. So everyone get the ones you guided, year-over-year it’s actually better than say 7% since you have that, I don’t know headwinds something like that?

Robert Phillippy

That’s correct.

Mark Douglass - Longbow Research

And then what segment or end market does that one following to?

Robert Phillippy

That would have been a little bit of Micro Electronics, little bit of industrial, and little bit of aerospace as it sounded.

Mark Douglass - Longbow Research

What segments that are following, was it photonics?

Robert Phillippy

It was in the Optics Group.

Mark Douglass - Longbow Research

Okay.

Charles Cargile

Revenue proportionally from every segment, except scientific and probably life sciences I think it will probably be closed.

Mark Douglass - Longbow Research

Okay, that’s helpful. Looking at industrial that was very surprisingly strong, would you say an orders you talked about ILX being a big part of the orders as well as 3D printing. As far as sales growing out here, is it broader than just those two categories, what you saw in the fourth quarter?

Robert Phillippy

Yes. Most of the commentary that I had in the prepared remarks was associated with orders like all of it I think in the industrial market, but most of it is at least close to being applicable on the sales side as well. So strength in ILX was really a fantastic story as they had just a spectacular quarter. We also saw strong activity in 3D printing and we also saw strong activity in automotive night vision optics.

The thing that I didn’t mention in the prepared remarks that I would reinforce here is that what has been consistently a strong performer is the laser measurement business and that’s a pure photonics. As Chuck mentioned that they were achieving record performance in 2013 as part of the Photonics Group and I would jus echo that a lot of that is in the industrial market as we continue to invest to maintain our leadership position in laser measurement. And you remember at the Photonics Quest Show you saw a variety of new laser measurement detectors including the new 100 kilowatt power meter.

Mark Douglass - Longbow Research

Those are pretty much, all of your products within industrial are growing I think kind of double digit rate, it was great broad strength?

Robert Phillippy

That’s fair.

Mark Douglass - Longbow Research

Okay.

Robert Phillippy

Our industrial market has also been a variety of different applications, but there was pretty good strength in several of them at this time.

Charles Cargile

And Mark, it’s been -- it's the stronger 2013 than most of the other businesses. Throughout the year it was -- we had a better success there and book to bill for the full year in industrial was 1.07. So we continue to build momentum there and a lot it comes like busted from the acquisitions that we got.

Mark Douglass - Longbow Research

Okay. Some housekeeping picking 30% for the tax rate in ‘14?

Charles Cargile

Yes.

Mark Douglass - Longbow Research

Okay. And what do you expect on CapEx, D&A?

Charles Cargile

Probably $15 million to $18 million in capital and depreciation and amortization I am going to say let me get back to you on that one.

Mark Douglass - Longbow Research

Okay. Thank you.

Charles Cargile

You are welcome.

Operator

Next question comes from Patrick Newton with Stifel.

Patrick Newton - Stifel

Good afternoon. Thank you for taking my questions. I guess Bob on the Micro Electronics business you spoke at momentum most customers as well as share gains, but is there any particular technology that stands out as driving some of your confidence in the 2014 opportunity?

Robert Phillippy

Well, our technology that is gaining a lot of traction in Micro Electronics applications is half the mechanical subsystems that are application specific, so it’s collaborative design efforts. And we have talked about several of those over the course of two or three quarters in 2013. If you are talking about the semiconductor equipment technology that is driving some of the growth, it’s basically the same types of applications that we’ve always participated in. We are a supplier on an OEM basis to semiconductor equipment builders and we participate in systems that are optically enabled and those are applications like lithography, the metrology, wafer inspector and some packaging applications. So those would be the one that would be foremost in terms of the design wins we can get.

Patrick Newton - Stifel

That’s really helpful. And I guess just a nice segue after that, some of the optical, mechanical comments, with that collaborator during your prepared remarks you talked about the potential follow-on orders? Could you help us understand the potential size of follow-on orders relative to that initial $14 million order?

Robert Phillippy

Yeah, I don't want to quantify it explicitly, but I will say is that it is a program of significant size and scope. And we've said in the prepared remarks that it is for next generation semiconductor equipment in its application, the potential production revenue stream is still some years out. And so it's difficult to just put an exact number on it but if you're doing $14 million worth of collaborative development you could assume that production values would not be this similar.

Patrick Newton - Stifel

Very helpful. And then on I guess for Bob or Chuck, did I hear correctly that $8 million in additive manufacturing orders in the quarter, and could you help us understand how that compares to approximate prior year, so we can get a sense of magnitude of the optic motors?

Robert Phillippy

Yeah, it was $8 million in added manufacturing orders for the year. We announced a fairly good size order a few quarters ago, so that would be inclusive in that total $8 million number. And I don't have right in front of me the number that it is year-over-year but what I would say in general that that's been a growing area of activity for us. And some of those customer relationships that we've communicated previously have been around for a while and we're designed into their applications and their business growth. So that's -- that is not necessarily indicative of new business wins per se but it is growth as an incumbent OEM supplier.

Patrick Newton - Stifel

Okay, and then just Chuck on the modeling side, you alluded to some kind of normal salary increases, I think if we look at Q1 typically there's a step up in OpEx or at least OpEx just looks like sequentially decline in revenues is that a fair assumption for this quarter?

And then given your comments on the MRSI asset being relatively breakeven I would assume that they were dilutive on a gross margin perspective, so is it possible that we'd actually see gross margin increase sequentially on a lower guidance, can you update?

Chuck Cargile

A couple of different thoughts, first on the SG&A, yeah, I mentioned that that was going to go up. We talked about the fact that the last two years, because the financial performance has been less than our expectations and hopes, we've paid out very little in incentive cash incentive compensation, we will start accruing that in the first quarter of this year and when you compare that to last year's first quarter there'll be about an increase of $2.5 million that you would want to put on top of last year's SG&A and then there will be slight increase in salaries and we've got a few more employees today than we had a year ago as we see the ramp up starting to occur.

I think you should probably expect to see on the order of $3.5 million in SG&A compared with last year's first quarter.

Secondly, MRSI, yes it was breakeven. The main thing is to remember the $4.6 million sequentially when you look at the sales guidance, the fact that I think it's – I think the impact on gross margin would be too insignificant to worry about. It wasn't that far below the corporate average and when you look at the amount that it contributed it will probably fall out in the rounding.

Patrick Newton - Stifel

All right, that's fine. I'm sorry, Chuck, you said up $2.5 million sequentially why such a large percentage increase on the SG&A?

Chuck Cargile

The $2.5 million? That's for the incentive compensation.

Patrick Newton - Stifel

Okay, I thought you said incentive compensation was about 3% year-over-year, (inaudible)?

Chuck Cargile

It's not percent. $2.5 million.

Patrick Newton - Stifel

Correct, I thought earlier you had said that the compensation was below 3%, I'm saying that $2.5 million is a significantly high [figure].

Chuck Cargile

Yeah, the salary increases we estimate will on average go up about 3%.

Patrick Newton - Stifel

Okay.

Chuck Cargile

And that's not 3% on total SG&A, that's just the salaries of the employee base.

Patrick Newton - Stifel

Understood, okay. Thank you, guys, good luck.

Chuck Cargile

You're welcome, thank you.

Robert Phillippy

Thank you, Patrick.

Operator

Next question comes from Larry Solow with CJS Securities.

Larry Solow - CJS Securities

Hi, good afternoon, just a couple of quick follow-ups and then a couple of additional questions. So just on the incentive comp, is there looking at SG&A as a whole year-over-year, is it fair to say that $2.5 million is a -- since you're accruing it, it will be about a average $2.5 million a quarter, $10 million for the full year? Is that a good ballpark for the additional incentive comp, assuming you meet your guidance or your…

Chuck Cargile

Somewhere between $8 million and $10 million.

Larry Solow - CJS Securities

Okay, so maybe it's a little bit heavier in the first quarter?

Chuck Cargile

Yeah, I think the main point I'm trying to make is that you should probably expect SG&A to be up on the order $3 million to $3.5 million in Q1 of this year, compared to Q1 last year for the reasons that I gave the largest one of which is incentive comp.

Larry Solow - CJS Securities

Right, and then I guess for full year I know you're not guiding but basically you have bid that, plus you have your salary component which is growing 3% and then some variable compensation on your from your sales guys, on higher sales and is that -- and that basically should that be about the increase?

Robert Phillippy

Yes, and as always we will look for ways to reduce SG&A and we'll certainly look for ways to reduce the percent of SG&A as a percent of sales, we'll continue to do that. So even some of these that will be additive over the course of the year, I'm sure will find ways to mitigate some of the increase.

Larry Solow - CJS Securities

Right. And I think the last question, you had talked about you expected a little bit of a step up in R&D and it did step up a little bit in Q2 but actually stepped up and then it backed down a little bit in Q4, what's your outlook for this R&D as you look out into Q1 and really for the full year?

Chuck Cargile

Yeah, our goal, our target would be to spend more than 9% in R&D but as you can tell the Q4 sales were higher than we expected. So the R&D expense doesn't always catch up immediately to what the sales level is, so it gives us more comfort invest in continuing to invest in R&D. So although we'll be very aggressive to leverage SG&A as a percent of sales our target is to continue to spend R&D as sales increase.

Larry Solow - CJS Securities

In terms of gross margin, I think the issue of higher sales less direct more to your OEM partner, I think it was an issue throughout '13 relative to '12, is that something you expect to continue, and I guess at the end of the day it's not your operating margins it's just similar theme or similar profitable profit level. Is that fair to say?

Chuck Cargile

That's correct, we've long said that our OEM business gives us better long-term growth perspective, also puts a little bit of downward pressure on the gross margin, but generally not on the operating income. Yeah, the other two items that I mentioned, the unabsorbed overhead that's been expensed because of low production early in the year and the one time reserve catch-up for inventory of $1.1 million if you exclude those two items, then the margin -- the gross margin would have been around $45% even with a higher mix of OEM business.

Larry Solow - CJS Securities

So the increased reserve, the $1.1 million, you actually you -- I just want to look back and you did not take that out and charge, that's actually in your numbers.

Chuck Cargile

That's correct.

Larry Solow - CJS Securities

So that, and that was just in this quarter basically or have that been hurting you through other quarters too?

Chuck Cargile

That was incremental to the expense in Q4.

Larry Solow - CJS Securities

Okay, so that completely goes away, so that's and then I guess it sounds like the previously capitalized overhead impact was similar size.

Chuck Cargile

Yeah, it might have been a little bit smaller, but similar.

Larry Solow - CJS Securities

Pretty close. And is that something that you've been sort of writing down at CapEx the last couple of quarters or is that -- is there any more of it left?

Chuck Cargile

Yeah. There'll be a little bit. No, let me preface by saying it depends on the revenue, the production levels.

Larry Solow - CJS Securities

Right. Right.

Chuck Cargile

So if we continue to increase revenue, I would say by the middle of the year, we would have exhausted all those. So there will be some in the first half of the year and it will get increasingly or it will decrease each quarter. And then my hope would be by the middle of this year may be the second half of this year, we wouldn’t have any of that and as a matter of fact we might even start capitalizing positive variances that the production levels are high enough.

Larry Solow - CJS Securities

Okay. Two more bigger picture full year questions, however, you want to answer, I know you don’t give full year guidance, your Q1 generally sequentially is a little bit slower, although, I guess, in ’13 it was maybe exacerbated because the economy and your order flow was improving as the year progress, but you have about 10% year-over-year growth estimate if we exclude the sale of macro robotics business? Is that 10% number give or take something you think is sort of comfortable range if we look out to the full year in sales growth?

Chuck Cargile

Well, we have gotten out of the habit of being specific in the full year guidance. We think if the markets continue to improve the way we have said as a way it indicate that they may that we would have significant growth year-over-year.

Larry Solow - CJS Securities

Okay.

Chuck Cargile

But we are not going to be point specific that has been more harmful and helpful to us.

Larry Solow - CJS Securities

I know, I just put it out there. And then second question on, you talked about this, you obviously had a 15% operating margin adjusted this quarter, usually the back half of the year you generally do better normally because sequentially your sales improve but also your cost as a percent drop? Can you talk about this goal 15% or you mentioned better than 13% and 15% ultimately, is that something you can do in ’14?

Chuck Cargile

I would expected in Q1 it may sit down a little bit.

Larry Solow - CJS Securities

Right.

Chuck Cargile

The revenue comes down a little bit because the inclusion of those SG&A expenses that I have mentioned.

Larry Solow - CJS Securities

Right.

Chuck Cargile

But I would expect over the course of the year, if the revenue increases…

Larry Solow - CJS Securities

Right.

Chuck Cargile

… that we would be able to exceed 15%.

Larry Solow - CJS Securities

For full year, okay, that’s a good number. And then just last question, just on the follow-up, if you happen the DNA, I think if somebody would ask what your full year outlook for’14 and just a housekeeping question, do you have a Q3 number, actually the Q4 actual number.

Chuck Cargile

Yes. Depreciation and amortization for the full year…

Larry Solow - CJS Securities

Right.

Chuck Cargile

…was $30 million.

Larry Solow - CJS Securities

Okay.

Chuck Cargile

And that’s pretty - it’s pretty leveled.

Larry Solow - CJS Securities

Okay. You expected to be about the same in ’14?

Chuck Cargile

Yes. Exactly.

Larry Solow - CJS Securities

Okay. Great. Excellent. Thanks so much.

Chuck Cargile

You’re welcome.

Operator

Next question comes from the Mark Miller with Noble Financial Capital Market.

Mark Miller - Noble Financial Capital Market

Congratulation on your results in the orders. I am still -- I am trying to get over cold, so I have to apologize. Just I was wondering, you said that geographically you were sequentially up at all segments, yet two other laser firms were voicing some concern about what’s going to go in China this year which is good area for you? I am just wondering how you can differentiate those comments?

Robert Phillippy

Yeah. Mark, this is Bob. As I mentioned in the prepared remarks, we had a really strong orders year in Greater China and that was certainly welcome news. We would like to think we had a little something to do with it, that is at the beginning of 2013 as you may recall, we put in place a new and expanded Asia-Pacific regional team to focus much more on the front-end and much more with the local presence than we have in the past and that was part of the organization change we made when we formed the three business groups, we also put in place that regional team to sort of transition from more of an international model as it were to regional and Asia-Pacific centric focus. And like I said, I like to think that we had, we saw some of the results of that during the course of the year.

The other thing that could be a factor as well is that when you talk about some of the other laser companies and some of the other companies in our industry, there is a bit of difference in market mix depending on who you talked to and what application they participate and in what region and that could be a factor as well.

Mark Miller - Noble Financial Capital Market

You mentioned that in defense sector that sequestration will continue to impact and take some time? But again some firms were saying they were starting to see some relief there and I am just wondering that you seem to be more conservative in your guidance. Do you think as we've got a budget pass now, everybody is making happy in Washington for once. Do you think that will improve or reduce the impact of sequestration in certain segments for you?

Chuck Cargile

Yeah, make no mistake the budget passage is very good thing because at the very least, it add some clarity. That said, we don't see a near-term catalyst for significant uptick in our business. Now on the other hand, we don't see a significant downdraft either. But if you think about where our revenues are bouncing in that Defense sector in the $13 million to $15 million range and we don't see anything that's going to be a significant uplift of that. It will bounce around but we don't see a big downdraft or uplift.

Now the other thing that I said in the prepared remarks that I would want to reiterate is that we did have some design wins in Q4 that represents some tangible quantifiable traction that we're making in the market and that was $6 million worth of annual revenue for three to five-year period that will start cutting in, albeit in small numbers at first late in 2014 and in 2015.

So if you just characterize it by a market that sort of bouncing along the bottom, not a lot of significant uplift in the programs that we participate in with our existing business but then layer in some business wins. And we think we're going to be able to grow that going into 2015, but we don't see a near-term market catalyst for it.

Mark Miller - Noble Financial Capital Market

And then finally, a few firms, KLA-Tencor, most notably was saying that these technology challenges in the semi-equipment space that they said that the EUV transition is getting pushed out, 7 nanometers down from 10 than the struggle people are having with devices there pushing out some orders. Are you seeing any impact to your results there?

Robert Phillippy

Most of the programs for next generation technology that you speak of are still in the development phase at this point. So it's not pushing out production revenue of existing programs. Our existing programs are current tools that are in production and those are going to go more with the existing industry cycles.

What we push out of some of the technology transition could cause is a delayed inflection point in some of the programs that we have that are intended to field a new growth. And from having -- had experience with several different of these types of industry transitions in the past, I would say the timing is always a bit uncertain.

It's a combination of the market dynamic together with technical progress because a lot of these things are hard to do. And when they figure out how to do them, it will be incrementally improved manufacturing process and they want to cut it into production as quickly as possible. But the current outlook, certainly our sentiment would align with those of others in the industry to say that some of the current forecasts for cutting in new technologies are still out a few years.

Mark Miller - Noble Financial Capital Market

And then finally I missed your non-GAAP gross margin, was it 45%?

Chuck Cargile

No, in the quarter, the non-GAAP gross margin was 43.6%.

Mark Miller - Noble Financial Capital Market

Thank you.

Robert Phillippy

You're welcome.

Operator

Next question comes from Kevin Casey with Casey Capital.

Kevin Casey - Casey Capital

Hi. I’m just trying to clarify the operating margin goal of 15%, was that a goal for the year or is that a goal exiting the year, and then is that a GAAP or non-GAAP number?

Robert Phillippy

The 15% is a non-GAAP number and it’s a target that we have had for sometime, so we were pleased to have achieved that at the end of Q4 in the year. At this level of sales or even a little bit lower, I would expect 15%. But if we do see better revenue, better topline, I would expect to be able to exceed 15%. So before I establish a new target and new goal, I would like to have us prove that this one is sustainable for a couple of quarters and then we would probably establish a higher level as a goal or a target.

Kevin Casey - Casey Capital

Great. Congratulations on that. And also what is the tax rate, is 30% the number to you?

Robert Phillippy

That’s correct.

Kevin Casey - Casey Capital

Okay. Thank you.

Robert Phillippy

Welcome.

Operator

Our next question is a follow-up question from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

I just had a question on the level of activity that you see from an acquisition standpoint. Clearly you’ve made some real progress in integrating recent acquisitions. What’s the pipeline like and maybe you can talk a little bit about? I know you can’t be specific, but just in general.

Robert Phillippy

Well, as you know for the last seven quarters, we haven’t done any significant acquisitions. We’ve made a lot of progress in integrating the four that we had done in 2011 and early 2012. I think you could tell just by listening to the prepared remarks that we are quite proud of a number of the achievements in those businesses that we’ve acquired. And we have continued to add -- we call the funnel of potential acquisitions.

None have reached a point of closure and partly that’s just due to the position of the sellers. And also I have said over the last year or year and a half, we had a bit of a conservative stance because the markets were challenging for us and we had just refinanced the debt. Turning now, as we look into 2014, I think we can be a little bit more aggressive.

Our markets appear to be stabilizing and improving. Our equity position is a lot better than in two years. So we’ll continue to be diligent and very thoughtful when we look at acquisitions to make sure we make the decisions. But I would like -- I'd hope to see some acquisition activity in 2014.

Jim Ricchiuti - Needham & Company

Okay. Thanks.

Robert Phillippy

You are welcome.

Operator

Our next question is from Dave Kang from B. Riley.

Dave Kang - B. Riley

Thank you. Good afternoon. First question is regarding the $40 million order. Can you just remind us the timeframe for that, recognizing the $40 million?

Robert Phillippy

Yeah, Dave, this is Bob. Whether that’s build in the fourth quarter, a fairly small amount and the rest of it will build during the course of the full year 2014.

Dave Kang - B. Riley

Got it. And then I joined little bit late, but you talked about Quasar, the traction and maybe if you can quantify the opportunities?

Robert Phillippy

Yeah, we did a little bit. I will reiterate those, and then I’ll add a little bit more color to it. So, Quasar continues its track record of enthusiastic customer response. And we've been very excited about it and you’ve heard that from previous calls and this one’s no exception.

So, two new data points related to that. One is that now we have received a total of more than $20 million worth of orders for the product. So that's a pretty good number for us given it was only introduced one-year ago. And then secondly at the Photonics West Show just a few weeks ago, we up the power to 60 watts and that should open up even larger application space for it so.

Dave Kang - B. Riley

And when do we see that 60 watt?

Robert Phillippy

The 60 watt was introduced at Photonics West a few weeks ago. We can start shipping it within a quarter or so.

Dave Kang - B. Riley

Got it. And then also at Photonics West, you also talked about or as far as your presenters talked about laser testers especially for telecom, Datacom. Can you just provide some quantitative information?

Robert Phillippy

Yeah, that was directly correlated, Dave with the ILX comments I made in the prepared remarks. ILX Lightwave is the company we brought on board in the first quarter of 2012. They were about an $8 million business when we bought them. And they are having great success with the combination of their technology, which is pretty differentiated in there. They’ve got some clever design and our channels, which have been affective at expanding their products more globally and with larger customers. And so the results that I gave full year results, I think are $12.8 million and worse for 2013 for ILX in total. And a lot of that, I won’t say all of it because they do have a BenchTop implementation lines. A lot of that comes from test systems.

Dave Kang - B. Riley

Okay. And lastly, you said that scientific is impacted by government funding situation. Yet this segment grew nicely both sequentially in terms of sales and orders. So what were you expecting, I mean, I think you guys did like $62 million in fourth quarter of 2011. I mean, can we get back to that level if things go according to the plan?

Robert Phillippy

Well, first, when we did our guidance in October, we stated that we normally historically have seen a little bit of a stronger Q4 due to seasonality. But we weren’t going to count on that this year because the market has been still disruptive over the last two years. But in fact, we did get a better seasonality. That’s one of the reasons why our revenue was a little bit higher than what we had guided to. And also we expect because of that we’ll probably see a little bit seasonality the other way in Q1 add a little bit downward pressure on the revenue in Q1.

And there’s -- even with the budgets been approved but we’re not going to, at least on our own internal modeling forecast the research market to come back very much. We got ahead of ourselves a couple of years ago and thinking that was going to just be a one or two quarter dynamic and that’s been down for two years. So, I'm not looking forward to 2011 type levels. If they come, that would be great, but we’re not going to count on it in our own internal modeling.

Dave Kang - B. Riley

Got it. Thank you.

Robert Phillippy

You are welcome.

Operator

Thank you. There are no further questions at this time. Are there any closing remarks?

Robert Phillippy

Yes. Just thank you again everyone for your interest in Newport. If you have questions or would like additional information related to any of the topics that we have discussed today, please don't hesitate to contact us. And for investors interested in learning more about the company, we’ve got a few events coming up. Let me list those.

We will be presenting at the Roth Conference in Dana point, California, March 9 to 12. At the Piper Jaffray TMT Conference in New York City on March 11th and at the B. Riley Conference in Santa Monica, California May 19th to 21st. And then finally as always, thanks to our fellow Newport team members around the world for your continued support as we aggressively pursue our strategic objectives. Bye now.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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