Gerber Scientific, Inc. F3Q08 (Qtr End 1/31/08) Earnings Call Transcript

| About: Gerber Scientific (GRB)

Gerber Scientific, Inc. (NYSE:GRB)

F3Q2008 Earnings Call

March 06, 2008 10:00 am ET


Marc Giles – President and Chief Executive Officer

John Krawczynski – Vice President and Chief Accounting Officer


Casey Flavin - CJS Securities

Jim Ricchiuti – Needham & Company

Chuck Murphy – Sidoti and Company


Good day and welcome to Gerber Scientific, Inc. third quarter fiscal 2008 earnings release conference call. (Operators instructions) At this time for opening remarks and instructions I would like to turn over the conference now to the President and Chief Executive Officer Mark Giles.

Marc Giles

Thank you operator. Good morning everyone welcome to Gerber Scientifics’ Fiscal Year 2008 Third Quarter conference call. Joining me on the call today is our Vice President and CAO John Krawczynski.

Overall Gerber posted a solid third quarter performance, consolidated Q3 revenue of $152 million dollars. This was up by 11% versus the third quarter a year ago driven by strong growth again at Spandex, which was up 19.6%, inclusion of our recent acquisition data technology and the favorable translation effective currency. Our book to bill ratio was 1. Reported third quarter operating profit was 6.3 million dollars compared to $4.1 million of the third quarter last year and equals 4.1% of revenue due to higher revenue and control of SG&A expense.

During the quarter we were successful in refinancing our debt and announced a new $125 million senior credit facility that will enhance our financial flexibility and will lower our cost of capital versus our previous loan agreement.

Now talking about key new products.

Sales were strong in key new products in the third quarter and represented 16% of total equipment revenue in the quarter up from 14% in the third quarter of fiscal year 2007. This was largely driven by the success of the new Gerber technology XLC 7000 cutter, which achieved its highest quarterly sales yet at about 3.7 million dollars and more than made up for the decline in Solara 2 sales when compared to a year ago.

We currently have another new multiply cutter in our product development pipeline derived from the successful XLC 7000 called the Z7. Targeting the increasing opportunities we see in the automotive sector. This product is scheduled for launch in the next fiscal year.

Earlier this week we issued a press release in response to a published report from an analyst covering Gerber concerning the new Solara ion. The report expressed concerns that the cause of the delay in launching the ion was due to problems with the systems unique ink and curing technology and that the image qualities of the prints were unacceptably poor.

This report was erroneous. We have been working with a revolutionary new ink, print, and care system for two years have rigorously tested its capabilities. We are fully satisfied that the technology is sound and robust.

In addition we have made hundreds of prints using our system to present to distributors and perspective customers to demonstrate the commercial quality of the print. We have posted a number of domestic prospects at our facility that demonstrates the new ion capabilities. As a result, our preorder level since our last conference call has increased from just over one hundred systems to one hundred and fifty-one systems as of this morning, including 15 demo systems that were sold to our Spandex distribution company.

Let me reiterate that the cause of the commercial launch delay previously announced was a longer then expected process of debugging the electronics that drive the machine, boards and firm ware. We continue to expect volume commercial shipments beginning in the first quarter of our next fiscal year, which begins in May. There remains some likelihood that we will yet begin commercial shipments later in this current quarter. However, we will not ship any commercial systems until we have successfully completed our planned manufacturing validation testing field trials.

Lastly, I should also mention the Gerber’s Coburn’s new free form capable advanced lens processing systems remains on schedule for commercial shipments within the next few months.

Our business in China continued to do well in the quarter with revenue up 12% to 8.5 million dollars versus the third quarter a year ago. Gerber Technology order entry for equipment and software in China was up 13% in the third quarter compared to last year. Year to date is up 24% when compared to the same period last year.

In addition year to date Gerber Coburn sales in China increased to 1.1 million dollars compared to five hundred thousand dollars during the first three quarters a year ago. We expect this growth trend to continue. China continues to grow as the manufacturing export center for us. In this quarter we exported 2.2 million in equipment from our China supply chain compared to 1.1 million in the third quarter a year ago.

Consolidated third quarter gross margin was off from last year by about 60 basis points, driven largely by the relatively faster revenue growth of Spandex at 19.6% versus our manufacturing business at4%. Gross margin was further impacted by the decline in the Gerber Scientific products margin related to the declining legacy business, as well as the impact of lower revenue from Gerber Coburn.

Inventory remained essentially unchanged from the second quarter, despite the negative impact of currency and new product inventory build-up.

Briefly on our market segments, in apparel and flexible materials Gerber Technology sales were up in the third quarter to 52.2 million dollars or 8% higher than a year ago in the third quarter.

An operating profit of $5.6 million dollars was up by 16% when compared to the third quarter of the fiscal year 2007. Despite concerns over the United States and European economies, overall orders were up in the third quarter at Gerber Technology by 14% compared to a year ago.

While orders for equipment and software were up almost 25% during the quarter when compared to the third quarter of fiscal year 2007, orders for equipment and software were particularly strong in Europe, especially Eastern Europe, solid in China, and for the first time this year improved in North America versus the prior year period. This offset weaknesses in other parts of Asia and especially India.

It should also be noted that our largest global competitor in this field reported orders for equipment and software increased by 3% in its most recent quarterly filing. This includes a decrease in both China and the US indicating that overall market demand is perhaps softer than our own solid order entry would indicate.

On the sign making and specialty graphics, reported sales in this segment were up in the third quarter by 18% versus a year ago to 84 million dollars. This was driven by very strong growth in our Spandex business unit. This includes the favorable effects of currency translation and by the acquisition by data technology.

Operating profit in this segment in the third quarter improved by $700,000 dollars or 49% as compared to a year ago from $1.4 million to $2.1 million in this third quarter. This is entirely driven by continued improvement at Spandex. Spandex revenue grew 19.6% when compared to the third quarter a year ago to $60.8 million.

Operating profit increased from one million dollars to $2.6 million. This improvement was partially offset by continued declining profitability at Gerber Scientific Products, which posted an operating loss of $500,000 for the quarter.

We anticipate the trends for both of these businesses to continue through the fourth quarter. Spandex primary markets continue to remain strong and we expect our profit improvement initiatives will continue to drive results. Gerber Scientific Products, the declining legacy business and slowing Solara 2 sales combined with higher expenses associated with Solara ion will continue to depress operating profitability.

In the ophthalmic lens segment, Gerber Coburn sales in the third quarter declined 12% of $2.2 million when compared to a year ago down to $15.8 million, as the market remained very soft, particularly in the US. The significant reduction in revenue resulted in a loss of $340,000 versus a profit of $500,000 a year ago.

In the near term, we anticipate continued softness in the market. We do see some encouraging signs, particularly in our rising after market orders. We expect Gerber Coburn to delivery sequential profit improvement in the fourth quarter, though not to the level of the fourth quarter a year ago.

Before I provide overall insight of the fourth quarter of fiscal 2008, I will turn the call over the John Krawczynski for additional details regarding the third quarter, John.

John Krawczynski

Thank you Marc and good morning everyone. I would like to provide some additional insight into the financial results we just released. Sales for the third quarter were one-$152 million, a decrease of 5.4% from the prior quarter, 10.8% higher than a year ago. Changes in foreign currency have increased our revenues by about $9.6 million in the quarter, excluding the fact that our revenues have grown by 3.9%.

For the first nine months of the fiscal year, sales were $466 million dollars, an increase of 11.1% over the same period fiscal year of 2007. Favorable foreign currency translation increased our revenue by approximately $24.2 million compared with the first nine months of the prior year. The significant revenue increase for both the quarter and the first nine months of the year continues to be driven by the Spandex distribution business unit.

As continued strong market conditions in Europe have contributed to an increase in demand of after market products in sign making, especially in graphics application. Excluding the benefits provided by the favorable foreign currency translation, Spandex achieved increased revenue of $4.1 million and 16.9 million for the third quarter in the first nine months of fiscal 2008 respectively. This is a result of strong after market sales of core vinyl and digital products.

Orders for the quarter were $152.6 million a reduction of about 4.5% from Q2 and 12.7% higher than a year ago. The sequential decline in both orders and revenue followed normal seasonality counts for our company, primarily with respects to the impact of the winter months of a sign making especially graphics. Back orders at the end of the third quarter were $49.5 million, an increase of $700,000 at the end of the second quarter and up $70.6 million in the same period of the prior year. The order backlog at the end of the third quarter does not include any amounts related to the pre-orders for the Solara ion.

On a consolidated basis from a geographic perspective, North America contributed about 31% of our revenue in Q3, Europe 49%, and the rest of the world primarily the Asia Pacific region contributed about 20%. The strength of Spandex performance was the primary reason from a modest increase in the European sales contribution when compared to the prior quarter.

Equipment revenue for the quarter was $50.3 million, a slight decline from Q2 and about 5% higher than the same quarter of last year. After market revenue was $83.3 million up 14% from a year ago, reflecting a strong performance of Spandex. Additionally revenue from our service business for the third quarter is $18.3 million up over 13% in the fiscal 2007.

Overall revenue growth continues to be frugal in many new products that we have brought to the market during fiscal years 2006 and 2007. Our gross profit in the quarter was $43.5 million or 28.6% of revenue. Our gross market performance was down slightly for both Q2 in the same quarter of the prior year. The primary drivers in the lower gross market performance were vigorously making products. As we have discussed Spandex continues to experience revenue growth that has been out pacing our manufacturing businesses with year over year growth approaching 20%.

As a distribution business Spandex traditionally has a substantial lower growth margin contribution rate than our manufacturing operations. This increased rating of the Spandex growth margin continues to be a significant contributing factor of the overall decline. Additionally, our manufacturing operations gross margin while beginning to benefit from our Gerber business system initiatives was down slightly in both Q2 and the third quarter of last year due to product mix. We expect that our manufacturing gross margin will improve in Q4 and throughout fiscal 2009.

Research and development expenditures for the quarter were $6.5 million, about $100,000 lower from the second quarter of fiscal 2008 and $400,000 higher than the third quarter of fiscal 2007. An increased level of R&D spending is primarily related to the development activities associated with the Solara Ion and it is expected to return to more normal levels in the beginning of the first quarter of 2009.

In general are the administrative expenses for the quarter were $30.7 million, down $4 million from the second quarter and about 2.8% higher than a year ago. A year over year increase is substantially due to higher foreign currency translation, decreased expenses for sales and marketing related to new product launches and business expansion. These increases were partially offset by lower bonus expenses and by continued cost control. However, as a percentage of revenue, SG&A cost improved by 1.6% from the same quarter of the prior year. As a result of these factors our operating profits was 6.3 million dollars. This is an increase of 1.1 million dollars in the second quarter to $2.2 million from the third quarter from the prior year.

Our improved out rank performance as compared with the same period in the prior year was primarily as a result in the decreased gross profit contribution from our higher revenue. This is partially offset by an increase in investments in R&D, sales and marketing related to the new products and increased commissions expenses associated with a higher business line.

Interest expense in the third quarter was $1.4 million, which included a non-cash charge of $0.3 million related to the write off of the deferred financing costs associated with refinancing of our credit facility. Excluding this non-return charge, interest expenses were up slightly in Q2 and from the same quarter of last year as a result of higher average of outstanding debt balance.

Third quarter pre-tax earnings were $4.5 million. Our effective tax rate for the quarter was 31.5% when compared with 32.7% in the second quarter. The effective tax refund for the quarter continues to benefit from the generation of earnings in foreign jurisdictions with lower tax rates.

Net income for the quarter was $3.1 million or 0.13 cents for diluted share. For the first nine months of the year net income was $8.4 million or 0.36 cents for diluted share. Both third quarter and year to date earnings for share were reduced by a onetime charge of 0.1 cent per share related to our debt refinancing.

Now let me provide some additional details on the cash balance sheet. At the end of the quarter our cash balance was $12.3 million compared to $14.4 million at ten end of Q2. During the quarter we used approximately $2.4 million and other capital expenditures to support our operation. This is due primarily to cash use for work and capital requirements and we except to see solid cash generation during the fourth quarter.

Our total debt for the quarter is $52 million. Our net debt balance taking into account our cash on hand at the end of the quarter was $39.7 million, about $14.4 million higher then at fiscal year end. This increase is primarily a result of the additional debt with relieved with data technology acquisition and increased spending in capital additions and for working capital purposes.

As Marc Giles mentioned, we completed a refinancing from a former $50 million asset back credit facility at the end of the third quarter of fiscal 2008. We replaced it with a new $125 million secured credit facility under a five year arrangement which matures in January of 2013.

The new credit facility includes an accordion feature allowing the company to borrow up to an additional $25 million. This facility will provide more operating flexibility to the company with a large volume capacity. The company had $71.4 million available for borrowing at ten end of the third quarter under the new credit arrangement.

Interest rates under this facility continue to be market day rates. However, the implacable market now varies based on the companies operating performance. Additionally, the company capitalized lower costs related to this refinancing, which will result in lower interest expenses in the future periods.

The financial covenants under this credit agreement are also less restricted then the previous facility and there are lower administrative costs associated with the ongoing arrangement. The former credit facility was retained in full on January 31st, including both the revolver deck and terminal.

Customers receivables at the end of the third quarter were $105.6 six million, down slightly from our year end level of $106.4 million. Our DSL was 63 days up one day from year end. Inventory at the end of the quarter was $77.3 million, essentially unchanged from the end of Q2 and up $12 million from year end.

Inventories have increased during the year, primarily related to a higher foreign exchange rate, customer service and geographic expansion initiatives. The data technology acquisition with an additional inventory required to support the launch of our new products, the ion and the DTL.

The investment inventories is a significant initiative for the company as we continue to implement lean manufacturing principals while still adjusting to customer service expectations for our after market and service operations. As a result the increase in the inventories our turns declined from 6.7 times at the end of fiscal 2007 to 5.6 times in the third quarter of fiscal 2008.

Capital expenditures were $2.6 million in the quarter compared with 2.8 million in Q2. Current quarter spending continued to be primarily driven by cost related to the implementation of a customer relationship management software tool, which is expect to improve the companies ability to capture, store, and analyzes customer information. We now expect four year cut backs to be in the 8 million dollars to 9 million ranges.

Deprecation was $2.3 million, down slightly from the second quarter. Now I will return the call back to Marc Giles to provide and update on our expectations for the fourth quarter.

Marc Giles

Thanks John. Looking ahead at the fourth quarter, we believe revenues should be in the range of $164 million to $169 million. With the Solara Ion not expected to generate revenue until the first quarter of our next fiscal year, Gerber Scientific Products’ performance will continue to weigh on consolidated gross margins, as will be expected lower sales volume of Gerber Coburn.

Even with those factors in mind, we expect fourth quarter gross margins to improve from Q3. While we will continue to exert tight expense controls in non-critical areas, we expect SG&A to increase in Q4 versus Q3 largely driven by higher employee related compensation associated with the start of the new calendar year.

We will continue to support our investment in sales, marketing, research, and development related to our new products and other growth initiatives. As a result of these factors fourth quarter earning should be in the range of 0.24 cents to 0.30 cents per share. Now I would like to open the meeting for questions.

Question-and-Answer Session


(Operator Instructions)

Your next question comes from the line of Mr. Casey Flavin of CJS Securities.

Casey Flavin - CJS Securities

Hi Marc Giles. Hi John. None of you dispelled the notion that the delayed time launch is due to the cationic in technology. Could you clarify for us if you have any of the units in field testing and what the response has been, if not can you review the fielding testing process and when you expect it to begin?

Marc Giles

There are two phases to our product testing process. There is design validation testing, which we do in house and that is where we run the equipment through its paces to make sure that there are not any designs faults that we need to correct. We go through that process and we are at the end of that process now.

The next phase is called manufactured validation testing and that is an external process. We make the products as they would be made in full production with the suppliers, not by engineers or anything like that. They are installed and ran by our service people. That is done externally and we are about to begin that phase now.

That phase will run for about four weeks. We will run in customer locations for the time period and depending on what if anything is found during that it may run longer. Usually our expectation would be once we complete the design validation testing, we are complete with design changes and we are just focusing on application changes.

Casey Flavin - CJS Securities

Thanks Marc Giles for that update. Are there any products in particular on Spandex that are selling better than others driving the performance there?

Marc Giles

The big change that has been occurring at Spandex from a product portfolio standpoint is what they call their digital line of consumable products. These are largely materials that are designed to be run on ink jet printing machines. That has been the high growth area frankly for the last couple of years within that business. I think for Spandex this year is growing at about 55% year over year. The total volume of that business is about in the area of maybe $35-40 million probably this year.

Within that group of materials what Spandex has done is put together a portfolio of its own branded products. Some of these products we make ourselves, others we source from third parties. They have been very, very successful in being able to drive sales of that product portfolio and we get much higher gross margins on those products than we do from the other digital products that we source.

That is really has been an important driver of Spandex’s growth and Spandex’s profitability improvement, as well as the other initiatives that we have going on, with regards to customer pricing, analysis of improved pricing, improved warehouse and distribution initiatives and so forth, all of which have been contributing to the improvement and profitability.

Casey Flavin - CJS Securities

Great. Given that Q4 is your seasonally strongest quarter, you mentioned that you expect some gross margin improvement. Do you think that you can get back up to that 30% margin level or is it too early based on the product timing?

Marc Giles

I think that it is still too early to say. I think that we will see as we said, we will see improvement and it is our best quarter and we expect obviously the volume improvement alone to help. The off-setting factors and it is really difficult to tell is the incremental impact for example of Gerber Coburn. If that market weakness further and we have continue decline that on the increment could have impact of what we think the gross margin will be.

That is kind of a key swing factor, as always with Gerber Technology it is the mix. It is the mix of software versus multiply-cutters versus single ply cutters, all of which have different margins and are a little bit hard to predict exactly on the increment. With all that said, we would expect to see improvement.

Casey Flavin - CJS Securities

Okay great. You obviously cut your SG&A point quite significantly in the quarter; can you break out where the cost reductions were and how sustainable this is going for?

Marc Giles

We have gotten very aggressive in Q3 on maintaining and executing cost controls, particularly as we saw Gerber Cobrun’s business continue to soften. As we anticipated, which we announced in January as we saw that it is most likely that the new Solara Ion is not going to launch until the first quarter of our next fiscal year. This is going to have an impact obviously on Solara 2 sales, as well as expected margins and revenues at Gerber Scientific Products.

We have tightened our belts pretty significantly, while still feeding our key initiatives. It is sustainable in the long-term? It would probably be not, but we would not expect to have to do that, but we are going to do it during the period until we get our way through this transition. That is a breakout of pieces. It is primarily employee-related costs, but also travel and expenses that are non-critical.

We have been managing those very aggressively as John said because in doing that there are reductions and anticipated incentive compensation. We both changed our structure in that from last year, which has been helping us. We then we adjusted our expectations in terms of incentive pay out based on how we do versus our goals, which we did also last year, so that is hard to compare. It is really just being very, very aggressive on managing our expenses.

Casey Flavin - CJS Securities

Lastly Marc I know that you have some new products coming out in Coburn, but there is some significant softness in the market there. There has been some talk previously about divesting that business. Can you help us think of what sort of value you might be able to see in the market there and is that a thought that you are considering going forward?

Marc Giles

I do not really want to speculate on potential value or anything like that. The product portfolio of the company can always change at anytime as it makes strategic sense. There are no current activities that are ongoing and I think that is about as much as I want to comment on that.

Casey Flavin - CJS Securities

Fair enough thank you.


Your next question comes from the line of Jim Ricchiuti of Needham & Company.

Jim Ricchiuti - Needham & Company

Thank you and good morning. More questions with respect to the ion. You had talked about possibly shipping as many as 400-600 systems next year, are that still a range in shipments that you can see achievable?

Marc Giles

Yes, that is still very definitely our range of units.

Jim Ricchiuti - Needham & Company

Is there any flavor that you can give for 02 you have seen thus far because 150 systems seem like a pretty good order intake? Where is that coming from and how much of that is coming from the US versus Spandex and some of the other markets?

Marc Giles

It is roughly a little over 2/3 from just domestic, North America business and customers who have had a better opportunity to see the system. They were able to get down to our showing down in Orlando back in November and we have not had any other trade shows since. It is easier for them to get here and the rest is primarily I think it is virtually all Europe through Spandex. We have only had the one show in Italy over there, so they have a more limited opportunity to get exposed to the machine.

Jim Ricchiuti - Needham & Company

Okay, just broadly looking at the market that you address, are you seeing any concerns within the customer base for the market with the ion as it relates to the economy?

Marc Giles

Not yet we have not seen anything. I think we lost, I cannot give you an exact number, but maybe 3-5 orders for the system after we announced the day in shipping from people who had work they had to do. They had to go out and buy a competitive system to do the work. That has been very, very minimal. The industry in total still appears to be quite robust and the orders have not really changed and the excited for this system has not changed. We are not seeing any negativity there.

Jim Ricchiuti - Needham & Company

Okay, the same kind of questions that relates to the GT. Is there any evidence on the macro side that it might be softening some of the revenues, just in general the demand for you bigger customers?

Marc Giles

Sure. We really have not felt much, as I say our business continues to be up nicely and it seems to be solid. We see a really strong demand in Western and Eastern Europe. Actually, this quarter we saw growth in both quarters from (inaudible). In Asia it has been less robust. I think Asia overall is up about 4% in orders for that business during the quarter, even though China is up more dramatically, indicating that there could be a softness in other parts of Asia that we have noted before.

That is why I talked about our largest competitor who saw orders increase during a comparable period, about 3% versus ours. This may indicate that there maybe some softness in the environment that we are not experiencing because of our strategic and competitive position.

Jim Ricchiuti - Needham & Company

Okay thanks very much.


(Operator Instructions)

The next call comes from the line of Chuck Murphy of Sidoti and Company

Chuck Murphy – Sidoti and Company

Morning guys, a few non-ion related questions. Could you repeat the sales numbers for GSP and Spandex?

Marc Giles

Spandex revenues are 16.8 million and GSP revenue was 23.2 million.

Chuck Murphy – Sidoti and Company

Okay following up on Jim’s question there. Is it a matter of selling different types of equipment that you think is giving you the advantage versus the competitor for GT or is it selling into different markets? What are your thoughts there?

Marc Giles

I think that we have positioned ourselves very well to succeed in this market. It is a combination of several things. It is a combination of new products like the XLS 50, the XLS 125, XLS 7000, which are all focused on primarily China, but also other places in the developing world where we have seen strong growth. It is a product positioning that we have been able to execute against. It is our service strategy.

We provide services of competitive advantage in this market place, which we think gave us a preferential position. It is a combination of where do go through distributions. We have positioned ourselves with extremely strong and influential distributors in key markets. In some markets particularly here in the US where we have seen improvement. We got a currency advantage as well. It is a combination of all of those factors and we feel very good about our business and its continued growth.

Chuck Murphy – Sidoti and Company

In follow-up to that one, there have been some articles in the paper recently about either the Chinese manufactures struggling because of wage inflation and some of the factories are moving to Vietnam. How does that play into your business there?

Marc Giles

We really have not seen significant or any impact really in our business in China. We think China is strategically positioned in its fundamentals. Its fundamentals being

A: Relative labor cost and advantage being one aspect that would be its vertical integration from raw materials through weaving then into garment production. This gives it a substantial advantage versus other parts of the globe. It has a huge population, especially in Western parts of China to support sewing operations. It is particularly an extremely large domestic market; about 60% of all the clothing produced in China is consumed in China in its Western style. It has tremendous fundamental advantages.

With that said, our places are going to do extremely well and we think that Vietnam is going to be the place over time, while it is miniscule relative to China today. It is going to emerge as perhaps the number 2 behind China or number 3-country in terms of production of apparel globally.

That is why we are directly there within this past year to set-up our own operations so that we are strategically well positioned there. In fact, I will probably be out there in another month or so I believe where we are going to be opening up an advance technology center. It is the first of its kind in Vietnam to position ourselves to customers there.

Chuck Murphy – Sidoti and Company

That is all I had, thanks.


Marc Giles

Thank you operator. Thank you everybody for joining in our conference call this morning. Again, we have a good solid core in Q3 and we are expecting continued improvement ion Q4. Of course the biggest excitement right now in our near term horizon is Solara Ion and obviously we will post any significant events if they happen there. We will keep our shareholders informed and you should look forward to an update on that in the not too distant future. We are very excited about its pending launch and we look forward to talking to you at our year end conference call.

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