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Gerber Scientific, Inc. (NYSE:GRB)

Q1 2009 Earnings Call

August 28, 2008 10:00 am ET

Executives

Marc T. Giles - President and Chief Executive Officer

Michael R. Elia - Executive Vice President and Chief Financial Officer

John J. Krawczynski - Vice President and Chief Accounting Officer

Analysts

Jim Ricchiuti - Needham & Company

Chuck Murphy - Sidoti & Company

Greg Eisen - ICM Asset Management

Beth Lilly - Gabelli

Operator

Good day and welcome to the Gerber Scientific, Incorporated First Quarter 2009 Earnings Release Conference Call. Today’s conference is being recorded and broadcast over the Internet.

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

For discussion of important risks and uncertainties that could cause Gerber’s actual results to differ from the results expressed or implied in these forward-looking statements, you should read Gerber’s annual report on Form 10-K for the fiscal year ended April 30, 2007, which was filed with the SEC on June 27, 2008, as well as other information included and subsequently filed quarterly reports on Form 10-Q and the current reports on Form 8-K.

These risks include, but are not limited to, delays in the company’s new reports on Form 10-Q and current reports on 8-K. These risks include, but are not limited to, delays in the company’s new product development and commercialization, intense competition in markets for each of the company’s operation segments, rapid technological advances, availability and cost of raw materials, volatility in foreign currency exchange rates and the fluctuations in interest rates.

At this time, for opening remarks and introductions, I would now like to turn the conference over to the company’s President and Chief Executive Officer, Mr. Marc Giles. Please go ahead, sir.

Marc T. Giles - President and Chief Executive Officer

Thank you, operator and good morning everyone. Welcome to our fiscal 2009 first quarter conference call. Joining me on the call today is our Executive Vice President and Chief Financial Officer, Mike Elia, who is actually traveling today and joining us from Oakley and our Vice President and Chief Accounting Officer, John Krawczynski.

As we announced earlier this month we experienced a dramatic downturn in our business during our first quarter particularly so in Gerber Technologies market space. Combined with the further softening in the ophthalmic lens market of Gerber Coburn we decided to take immediate cost reduction actions. These cost reduction actions included the elimination of approximately 135 positions globally which we expect will yield over $5 million in savings this fiscal year net of approximately $1 million of severance expenses to be recorded in the second quarter.

Gerber Technologies’ business in the first quarter was particularly impacted by a sudden and precipitous decline in business activity in China, its largest revenue country and a major market for highly profitable new software sales. Orders for equipment and software there declined by 60% year-over-year, overall, orders of Gerber Technology in the first quarter were down by 14% year-over-year including a modest increase in the after market and service business.

Indicating that Gerber Technology continues to perform well in a difficult environment with the orders decline reported by our largest competitor of about 26% during closest comparable period. Looking ahead we do expect based on the information we have available today some slight recovery in this market by late in our fiscal year. We do expect Gerber Technology to further benefit from the growing sales of its new Z7 cutting system introduced in the first quarter. Gerber Technology should in fiscal 2009 with essentially flat sales year-over-year with lower equipment and software revenue offset by modest growth and service in after market revenue.

We expect segment profit to improve from the first quarter based on the cost reduction actions taken in the higher margins of its new products. We made good progress in ramping up our production Solara ion during the first quarter though not as much as we had planned and our backlog at quarter end of over 100 units remains too high. We shipped over 50 systems in the quarter and between 20 and 30 more since then. We expect to ship between 125 and 150 systems in the second quarter as we continue to accelerate production and shorten our delivery times.

This will be important as we will begin to enter the tradeshow seasons in Europe in September and the next large US show will happen at the end of October, at the very end of our second quarter in Atlanta, that’s the SGIA show and we want to be in position to take new business without extended lead times. Along with the ramp of ion shipments continued solid growth at Spandex helped to offset the continued decline of legacy Gerber Scientific products equipment and deliver sales growth of 10% overall in the first quarter versus a year ago in the sign making and graphic segment of our business.

Spandex’s revenue improved 16% in the first quarter versus a year ago and its profit nearly doubled to $3.3 million for the quarter. We are seeing some slowdown in Europe notably Spain and the United Kingdom and expect the consolidated weight of growth to slow at Spandex for the balance of the year. Overall, for this segment we continued to expect the sale between 400 and 600 ion units in this fiscal year and that this incremental profit plus the continued improvement in Spandex’s operating performance should drive significant financial improvement for this segment in fiscal year 2009.

Gerber Coburn experienced further weakening of its market particularly in the US but also in China, we now anticipate Gerber Coburn’s full year revenue to finish below that of last year. However, given the cost reduction actions taken and with increased sales coming from higher margin new products notably the new advanced lens processing system we do expect to report further improved profitability over the last year’s already improved performance.

As previously announced on a company consolidated basis we revised our full year revenue forecast downward between $690 million and $710 million to between and expected $660 million and $690 million for an expected growth rate of between 3% and 8% over last fiscal year. This growth is driven mostly by the expected ramp up of ion sales and to a lesser extent continued growth of Spandex, which should more than offset lower Gerber Coburn sales.

Because of the aggressive cost reduction measures we have put into place and the expected continued ramp up of ion volume and other high margin key new products we anticipate the second quarter to show earnings improvement over the second quarter a year ago and we reaffirm our full year guidance of operating profit between $30 million and $35 million and earnings per share between $0.72 and $0.82 per diluted share.

On a final note accretive bolt-on acquisitions remain essential to our growth plans for Gerber Scientific to that end we are pleased to announce that we are currently in process to acquire a small manufacturing business in China. Though small pre-acquisition revenues have just over US$2 million in 2007, this acquisition provides Gerber Technology with some new products as well as new distribution channels both in China and in other growing markets. We believe that Gerber Technology can leverage both these products and channels to grow the business very rapidly.

This acquisition also expands Gerber Scientific supply chain of manufacturing capacity in China for all business units. We have just received final government approval for this acquisition and should close within the next several weeks.

At this point I would like to turn the call over to Mike and then to John for more detailed review of the quarter. Mike?

Michael R. Elia - Executive Vice President and Chief Financial Officer

Thanks Marc. As a reminder summary of our key financial information that will be discussed along today’s call is on our website, its www.gerberscientific.com. As Marc said, our consolidated sales for the first quarter of 2009 were $158.9 million up 3.4% from the same quarter last year excluding the benefits foreign currency translation, consolidated sales were down 3.9% from a year ago. Consolidated operating profit for the fiscal first quarter of 2009 was $1.6 million down $2.8 million from a year ago.

Judging by revenue in the current quarter as you would have expected a much better operating profit performance however; two significant changes in the makeup of our sales skewed our operating profit in the first quarter. First, sales growth in our Spandex business continues to outpace the growth of our other businesses, which typically produce higher gross margins.

Second, in our Apparel and Flexible Materials segment we saw a significant decline in software sales which typically carry about 90% plus gross margins. To see this more currently let me review the performance of each of our segments for the fiscal first quarter of 2009 which ended July 31, 2008. First our Sign Making and Specialty Graphics segment, which consist of Gerber Scientific products what we refer to as GSP and Spandex. It is through the segment that we develop and manufacture computerized sign making and graphic design equipment and software, we also provide after market materials and related services.

Our primary customers in this segment are sign-printing shops. This segment accounted for 59% our total consolidated sales for this quarter which is up from 56% a year ago. In comparison to the first fiscal quarter last year this segment’s follow sales were up 9.9% or $8.5 million to $94.5 million in the first quarter of this year. A majority of the reported sales increase for this segment came from Spandex, where sales rose 15.9% to $70.4 million from $60.8 million a year ago. This is important because Spandex sells mostly after market products to carry lower gross margins for other business.

After market products include parts, spares, consumables and other materials used by our customers. Excluding the benefit of foreign currency translation, total sales for this segment were down slightly just about $200,000. Operating profit for this segment increased $600,000 to $2.1 million for this quarter compared to $1.5 million a year ago, the improvement reflected the incremental profits from the hire of sales which were partially offset by ion’s start-up costs and declining legacy product business.

Sales in our Apparel and Flexible Materials segment which consist of Gerber Technologies or what we refer to as GT about 31% of total consolidated sales in the current quarter, which is down from 32% a year ago. Through this segment we develop manufacturing service, a broad line of computerized automated equipment and software that perform a variety of tasks for designers and OEMs and many industries including apparel and retail industrial fabrics and composites, transportation interiors, and furniture. These products are used to improve the efficiency of information management, product design and development for both pre-production and production processes.

In the current quarter this segment recorded sales of $48.9 million, a decrease of 1.1% or $500,000 from the fiscal first quarter of 2008. However, in comparison to the same quarter last year software revenues in this segment fell 24% or $11.3 million, and equipment sales were very flat with lower margin products. Our after market sales and services revenues each up $900,000 partially offset the decline in software revenues.

Excluding the benefit of foreign currency translation, total sales for this segment were down $2.5 million from the same quarter a year ago, as Marc mentioned this segment saw a weakness in the order for the current quarter. Orders for the current saw 5.5% from a year ago to $47.9. We believe this to be a cyclical slowdown driven by events affecting China’s apparel industry and that orders and sales were rebound in the second half of this fiscal year.

Operating profit for this segment in the current quarter was $3.7 million down $3.4 million from the year ago. This decline was driven by lower software sales and certain cost increases particularly trade. We continued to see market softness in the prescription lens processing segment, this segment consist of Gerber Coburn or GC and develops and manufactures equipment, supplies, and software to produce prescription spectacle eyewear. Our products are used by a variety of customers ranging from wholesale lens production laboratories to retail eyewear chains and independent eye care professionals. This segment represented about 10% of total consolidated sales in the current quarter, which is down from 12% a year ago.

For the first fiscal quarter of 2009, sales in this segment fell 15.1% to $2.8 million to $15.5 million. Sales were down across all three product categories within this segment, with equipment and software sales down 30.8%, after-market sales down 7.6% and service revenues down 7.30%. Operating profit for this segment in the current quarter was $100,000, down from $1.3 million from a year ago, due primarily to lower sales volume. We have taken some first quarter actions to reduce costs in this segment to return it to a higher level of profitability.

Finally, corporate operating expenses in the first quarter for 2009 were $1.3 million lower than the same period in the prior year. Excluding $1 million in severance charge in the prior year, corporate expenses were lower by about $300,000, primarily reflecting a decrease in incentive compensation.

As Marc mentioned, we took immediate steps in August to reduce our cost to mitigate future market softness and the mix changes we experienced in the fourth quarter. We eliminated over $8 million in annual salaries at a cost of about $1 million. We expect to realize over $5 million of these savings this fiscal year after accounting for the related severance charge.

Consolidated cash flow from operations, net of capital expenditure for the first quarter of 2009, was a use of $7.2 million compared to a source of $3.1 million a year earlier. This use concluded payments of about $3 million for incentive compensation for last year’s performance and an increase in inventories. We have also used $3.8 million of cash to fund an Escrow account for the pending acquisition, Marc just mentioned.

Our total liquidity as of July 31, 2008, was $54.3 million, which consisted of $14.5 million in cash and $39.8 million in availability under our senior credit facility based on current financial covenants. We had $47 million drawn under our senior revolver accruing interest at LIBOR plus 137.5 basis points and had $7.6 million of undrawn letters of credit outstanding. In addition, we had outstanding $60 million in industrial development bonds accruing interest of 2.3%. Total debt net of cash, outstanding at July 31, 2008, was $38.5 million.

With that I will turn the call over to John to review some additional details on our performance for the quarter and full year, as well as selected cash flow and balance sheet details. John?

John J. Krawczynski - Vice President and Chief Accounting Officer

Thank you, Mike and good morning everyone. And now I would like to provide some additional detail from a consolidated perspective on the financial results were just released.

From a geographic perspective, in the first quarter, 32% of our orders were North America, 50% in Europe, and 18% in the rest of the world, primarily the Asia-Pacific region. Compared with the first quarter of fiscal 2008, there is a modest shift in our orders from the rest of world region to Europe, reflecting the strength of Spandex orders, the stable impact of foreign currency translation and the decline in China business activity for our GT business during the first quarter of fiscal 2009. Orders in North America during the first quarter were relatively unchanged as a percentage of total orders compared with the same quarter of the prior year.

Equipment and software revenue for the quarter was $43.1 million, down 9.1% from the first quarter of fiscal 2008. Aftermarket revenue was $96.7 million in the first quarter, 10.1% above the same quarter of the prior year and service revenue was $19.1 million for the quarter, an increase of 3.7% from the first quarter of last year.

Our gross profit in the quarter was $42 million or 26.5% of sales. Gross profit margin was 3.1% percentage points lower than the first quarter of fiscal 2008. The primary causes of the reduction growth margin percentage from the first quarter of prior year were an unfavorable product mix, which affected significant drop in high margin software sale and a larger contribution of lower margin distribution sales due to the strong revenue growth of our Spandex business, which continues to outpace the growth of our higher margin manufacturing businesses. We expect to see gross margin improve during the remainder of fiscal 2009 as production volume increases from the ramp up of the Solara ion, cost reduction initiatives are realized and targeted pricing actions are implemented.

R&D expenditures were $6.2 million in the quarter compared with $6.5 million for the first quarter of the prior year. The prior year first quarter included additional spending related to development cost for the sign making special graphic segment Solara ion and the Ophthalmic Lens Processing segment, Advanced Lens Processing system both of which were commercially launched in the first quarter of fiscal 2009. R&D spending is expected to continue at slightly lower levels for the remainder of fiscal 2009.

Selling, general and administrative expenses for the quarter were $34.2 million as compared with $34.6 million for the similar period of fiscal 2008. SG&A expenses declined by about 1 percentage point as a percentage of revenue compared with the same period of fiscal 2008.

Adjusted for the unfavorable impact of foreign currency translation, SG&A was down $2.4 million from the comparable quarter over the prior year. This reduction was a result of lower severance and incentive compensation expense in the first quarter compared with the same quarter of fiscal 2008.

Operating income for the quarter was $1.6 million compared with $4.4 million in the first quarter of fiscal 2008. Operating margin for the quarter was 1% of revenue as compared with 2.8% of revenue for the first quarter of the prior year, which is primarily result of the lower gross profit contribution previously discussed.

Interest expense in the quarter was approximately $600,000 down about $400,000 in the first quarter of fiscal 2008. Reduction in interest expense and the direct result of lower market rates and the new credit facility entered into during January of this year, which has an overall lower cost of borrowing primarily as a result of lower deferred financing cost associated with this new facility.

Overall, higher average debt levels during the first quarter of fiscal 2009 compared with the first quarter of last year partially offset the impact of the lower rates. The company incurred a $100,000 of other expense in the first quarter compared with other income of $700,000 in the same period of the prior year. Other income in the prior year include the gain of $1 million from the sale of certain assets in the Ophthalmic Lens Processing segment.

Our effective tax rate was 20.6% in the first quarter, which compared favorably with the 31% rate to the same quarter of fiscal 2008. The lower effective tax rate in the first quarter of fiscal 2009 as compared with the US statutory rate of 35% was primarily due to the exclusive from the effective tax rate calculation of income from foreign subsidiaries expected to have net taxable losses for the full year as required by the FAS the interpretation number 18. The effective tax rate for the first quarter should not be considered indicative of the anticipated full year rate for fiscal 2009.

Now let me provide some additional detail on our cash flow from balance sheet. At the end of the first quarter our cash balance is $14.5 million compared with $13.9 million at the end of fiscal 2008. During the quarter, where the use of cash from operating activities of $5 million as compared with cash generated from operating activities of $4.2 million in the same period of the prior year. The use of cash in the first quarter of fiscal 2009 was related to an increase in inventories and reductions in accounts payable and other accrued liabilities during the quarter, partially offset by strong accounts receivable collections stemming from our higher fourth quarter sales.

The inventory increase was attributable to the ramp up of production of the Solara ion and a temporary inventory build in Spandex with the plant shutdown to replace machinery at our Biomanufacturing facility in the UK during August. The reduction in accounts payable and accrued liabilities was due to timing of payments to vendors and payments or incentive compensation earned related to fiscal 2008 performance.

Capital expenditures were $2.2 million in the quarter compared with $1.1 million in the first quarter of fiscal 2008. The increase in spending in the first quarter compared with the same quarter in the prior year relate to continued spending from the implementation of a customer relationship management software tool to enhance the company’s ability to capture, store and analyze customer information. We expect full year CapEx to be in the $9 million to $11 million range.

Depreciation and amortization was $2.4 million for the quarter up slightly from the first quarter of fiscal 2008. Our debt balance at the end of the first quarter was $53 million compared with the balance of $42 million at April 30, 2008. The increase during the first quarter was to support working capital requirements, investments and capital expenditures and the funding of Escrow related to the pending acquisition in China that Marc commented is expected to close during the second quarter.

Customer receivables at the end of the first quarter were $109.8 million a decrease of $11 million from the prior fiscal year end. The reduction AR was due to an effective collection process during the first quarter. Our DSO was 62 days down from 63 days in the fourth quarter of fiscal 2008, and up from 59 days in the first quarter of fiscal 2008.

Our inventories at the end of the first quarter were $81.1 million, $4.2 million of our fiscal year end and $7.1 million higher than a year ago. As a result the increase in inventories, our chance declines for 6.4 times at the end of fiscal 2008 to 5.9 times were first quarter of fiscal 2009.

Now I will turn the call back to Marc. Marc?

Marc T. Giles - President and Chief Executive Officer

Thanks John. And, now I would like to open up the call to questions, operator.

Question-and-Answer Session

Operator

(Operator Instruction). And our first question will come from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti

Thank you. Just question to start with on the ion, you seem to have a pretty good step up in volume that you are anticipating in terms of shipments in Q2, can you give us some comfort as to how you get there I mean, it sounds like, the ramp up has not been quite as significant as you expected. What were some of the obstacles you faced and what gives you the confidence you’re going to be able to ramp up, maybe you can give us some sense as to where you are right now in terms of production?

Marc T. Giles

Sure, excuse me Jim. The ramp up was slower in the first part of the quarter then we expected. We expected that in the July we would be at a much higher point than we were actually in the early part of July, but it was the back part of July where our ramp up really started to take off, so it was a pretty, was kind of a happy step looking quarter and we have been able to maintain that kind of production rate in so for in Q2, through this month so we have done another, I don’t know the exact number but somewhere between 20 and 30 shipments this month. Further it has been accelerating pretty nice there, issues in the first part of the quarter are more getting vendors and quality relationships aligned so that we have the components coming in here that we assemble up meaning our quality requirements and ready to go. I mean, there was some other issues personal training and so for profits documentation that had to be modified based on earnings during the quarter, the biggest piece of just working with our grid vendors to make sure that the components that come in that the quality requirements necessary for the machine and so we had some delays in making that happen, that seems to be mostly behind us now, we continue to work with vendors to make sure that we have adequate supply of quality components but not in an unusual level.

So, I expect that will see continued ramp up over the course of the next couple of months to achieve our ultimate target of about capacity of 20 production units per week, hopefully by the end of the quarter although that’s not built into our forecast but we will be moving in that direction.

Jim Ricchiuti

Yeah, it sounds like Marc, you get at least, get around 50 units a month in the next two months to hit the lower end of your guidance and you still feel that’s based on what you see with your supply chain that’s reasonable?

Marc T. Giles

Yeah, and again I don’t know the exact number but based on our performance so far this month we are delivering to our expectation for this month and then I think each of the next two months or something our plan of somewhere between 50 and 60 units each of the next two months. So, I think that that’s or we believe that that’s quite doable based on where we are today.

Jim Ricchiuti

You know, demand wise what can you tell us about demand, you feel you have been able to maintain any loss sales as a result of the delay in getting the product out?

Marc T. Giles

Yeah, you know, you never know for sure. We haven’t been losing any of the business that we already had and we did take in the modest amount of new business, new orders in the first quarter, but it’s hard taking firm orders and we have the backlog and delivery situation that we have first of all and second of all this is the sweet time for Spandex in our European business. You know, we kind of missed the tradeshows going into the summer because of our delay in getting the product out. So, we really weren’t in the order taking mode and but our lean times here in the US, kind of, put a damper on the new business coming in. But we did take some new business and as we come into next month, I think beginning in the UK, starts the tradeshow season in Europe and Spandex has its demo machine, it has machines in the field at end users that it can point to and then we start with the next big show in the US at the end of October. So, if everything goes fine, we think it’s going to be, we will be burning down our backlog just at the time we are going to be winding to start taking new business, so I am pretty optimistic about that.

Jim Ricchiuti

Yeah, how concerned are you though about just the overall economic environment in the UK, which appears to be deteriorating, just given that you know, Spandex has really been showing pretty nice growth?

Marc T. Giles

Yeah, I mean, we have kind of forecasted that into our plans, we have been seeing the UK begin to deteriorate, as I mentioned also Spain, which actually is not as big as the UK obviously but it’s a pretty strong market for us, and that you know, it has impacted Spandex’s volume somewhat. But I think we’ve got that adequately forecasted, as well as thinking of some additional softening in other European market where Spandex is also of likely to occur over the balance of the year.

Jim Ricchiuti

And just last question from me, just regarding the Apparel and Flexible Materials equipment business. What you are seeing in China, was any of that do you think Olympics related or I guess a follow on to that is if not what gives you the confidence that you see a pick up later in the fiscal year?

Marc T. Giles

Yeah, I think -- actually I do think that the Olympics did negatively impact our business in China for a variety of reasons. So, I think that will help, but even with the Olympics now over, I am not expecting any kind of significant or any really, any improvement in the second quarter. I don’t think we will start to see the rebound until during the third quarter and then through the fourth quarter and you know, basis for that is that we made a round of meetings with all of our largest customers in Southeast Asia who have significant operations in China just to get their sense of what they saw happening and so that’s our first and foremost signal to us about what we can expect. And we are not expecting a dramatic improvement even in the back half of the year, more of a modest improvement, but kind of a steady building improvement. You know, there are other things that kind of reinforce our customer’s inclination of that’s going to happen, you know, the government which about a year ago took down the DAT rebate for exports from, I think it was from 13% down to 10% or 11%, which kind of impacted our end user, our customer’s margin has now reversed that I think a couple of months ago and brought it up to 15%. So, it’s actually gone back the other way after seeing what happened. So, you know, the government is doing some things to try to stimulate business. There are also another development that I think has hurt us in the short-term clearly over the last couple of quarters, but I think holds longer term promise for us is the -- really the elimination or the complete shutting of thousands of smaller apparel operations primarily on the southern coast of China and the absorption of that manufacturing capacity into the larger manufacturers into the north and into the interior, which spells a consolidation process that we think longer term will kind of solidify China’s position as a supplier and obviously reinforce our opportunity as a supplier of automation to those consolidated industries. So, there is some longer term I think benefits to what’s going on in China right now as well.

Jim Ricchiuti

Okay. Thanks a lot for now.

Marc T. Giles

Sure Jim.

Operator

(Operator Instructions). Our next question will come from Chuck Murphy with Sidoti & Company.

Chuck Murphy

Good morning guys.

Marc T. Giles

Morning Chuck.

Chuck Murphy

Could you just talk a little bit about kind of where the job cuts will be made?

Marc T. Giles

Well, the job cuts are done. We did that I believe the first or second week of this month, everything was done. Primarily those, I mean, the cuts were in a variety of places from the finance organization, some in the sales organization where we saw continued slowdown in business, we took some out of, quiet a bit actually out of corporate support spending, some out of administrative and management ranks. So, it’s broad based from a functional standpoint, most of the cuts came in terms of business unit from Gerber Technology and Gerber Coburn and corporate where we saw the biggest downturn in business. We didn’t do anything of -- I don’t think at all frankly in our Spandex business unit because of the growth as well.

Chuck Murphy

Okay, all right, that helps. And as far as your comment earlier that the EPS should be up year-over-year in the second quarter, does that include or exclude the severance charge?

Marc T. Giles

That’s including the severance charge in that estimate, yeah.

Chuck Murphy

Cool, all right. And my final question, I guess, as far as apparel, I mean, I guess, it seemed to me like the bigger issue in the quarter was the product mix. How do you see that playing out of the remainder of the year?

Marc T. Giles

Yeah, I think we’ll see a rebound, a gradual rebound of our product mix over the next few quarters, Chuck. I mean, the downturn in Fareast Asia, particularly in China, as I mentioned earlier, really whacks us with sales of new seats of CAD software and then expansion of businesses. So that’s the first thing that they buy usually buy with CAD station and that’s the fastest growing thing so, and I am not expecting a real rapid return on that at this point, but more again we will start to see that improving the back half of the year. So, I do think we will start to see some improvement on our software business, our pattern making software business. And then also because of the new Z7 cutter, which is just starting to take off, was just launched in the first quarter. That and a couple of other higher margin products that are taking the place of some of our lower margin products there should also boost that. So, I think we will see a gradual return to a more normal mix, although not super fast as the year goes on.

Chuck Murphy

Okay. That’s all I have. Thank you.

Marc T. Giles

Sure, Chuck. Operator?

Operator

We'll go ahead and take a follow up question with Jim Ricchiuti with Needham & Company.

Marc T. Giles

Sure.

Jim Ricchiuti

It looks like based on the operating income guidance that you are giving for the full year Mark, I mean, it seems like you are still anticipating improvement in gross margins and I wonder if you could help us get on around that just given the mix of business.

Marc T. Giles

Sure and you are right, we are anticipating some improvement in gross margin, kind of, within that half a point, may be as much as a full point of gross margin improvement in terms of our forecast for the year and the big driver -- there is really four drivers there. One has to do with the actions that we just took in terms of cost reduction. We took a significant amount of our headcount reduction out of the overhead associated with our manufacturing and supply chain operations given the lower volume and we were very, very aggressive on that front to make sure that we moved beyond where we needed to move to preserve the potential for lower overhead going forward, as well a pricing action I mean, that we took in the beginning of this quarter in response to higher cost that we saw. So, combination of cost reduction and pricing actions as I mentioned to Chuck earlier, we do see an improving mix at Gerber Technology over the course of the year. And then, most importantly, is the ion, the volume of ion and higher gross margins that 400 plus units that we anticipate selling this year is a big piece of our gross margin and operating profit improve.

Jim Ricchiuti

Okay. And what do you guys anticipate the tax rate looking like this year?

Marc T. Giles

You know, I think we are unchanged in terms of our tax rate, we are in that same 32% to 34% range most likely.

Jim Ricchiuti

Okay. So, anything more you can tell us about this small manufacturing operation in China. This is what they expect to close soon?

Marc T. Giles

Yeas, I think we’ll close in the next few weeks though. We’ve actually been working on it for quite a while was all done with the seller for quite a while but there is a rather hard to us government approval process that we went through. But that final approval has been granted and according to buying business in China like this, there is a now a tax order of the seller and then that’s one of the final money changes hands. So, should be within the next couple of weeks but ownership actually will move over to us officially within the next week or so. So, we’ll start to take control of that business. It’s actually an exciting small business opportunity for us, the key, a product line that for competitive reasons I won’t mention right now but there is a key product line that it brings into Gerber Technology’s house with established sales and demand and nice margins that Gerber Technology using its own channel will be able to deliver to customers as well as comes with some established channels particularly in China, the market within China and India and other growth markets that we own quite service wells, certain market segments that they have channels to that Gerber Technology will do to be able to product through. So, we see this as a pure growth opportunity for us and then the footprint that they have in manufacturing today although small, they have a nice established supply chain that they’ve been working for a number of years now that should provide some opportunities or sourcing for us.

Jim Ricchiuti

Would you anticipate this being neutral to your guidance actually for the year?

Marc T. Giles

It will be accretive but we have not included in our outlook.

Jim Ricchiuti

So, you expect it to be accretive and --?

Marc T. Giles

And this in the balance of this fiscal year.

Jim Ricchiuti

Okay. Accretive in the first quarter or looking at beyond maybe into third quarter of the year?

Marc T. Giles

Its third and fourth quarter, our fiscal third and fourth quarter.

Jim Ricchiuti

Yes.

Marc T. Giles

Yes.

Jim Ricchiuti

Okay, thank you.

Marc T. Giles

Sure.

Operator

Our next question will come from Greg Eisen with ICM Asset Management.

Greg Eisen

Thanks, good morning. You said earlier on the call that you projected the ion will ship anywhere from 400 to 600 units this year or sell with uses or by shipping also. Could you describe what the gating factors are that would get you closer to 400 versus the 600 or vice versa and is this more dependent upon the order flow or your production capability or kind of can you tell us how the mix of those two issues go into that?

Marc T. Giles

I think, the most of it is within, frankly is within our control and I mean obviously if we do this quarter, if we do 125 or lower say shipment sales, if we don’t hit that 125 mark, it means pushing out our full scale production capacity out further and that’s the thing more than literal demand it is, our ability to get up, we did get our backlog down and meet the shipment and lead time schedules that the customers demand that’s in our control and if we can’t do that, that’s going to dampen the demand. So, right now that’s the biggest hurdle.

Greg Eisen

Okay. And pricing, in terms of the actual pricing you’re seeing from with customers currently, is it essentially pricing order what you originally expected to be?

Marc T. Giles

Yeah. Actually, we did do a price increase in the spring tied to the, I think it was the ISA tradeshow here in the US, we bumped up the price of the unit, at this point that pricing is held from.

Greg Eisen

It’s held, okay, great. Going back to the China business on the apparel side, the software was slow this quarter. Did I get you correctly and then I hear you correctly earlier in the call that you expect that to rebound in the second half of the year?

Marc T. Giles

Yeah, I think we will see a gradual rebound of our software, I think, Gerber Technology businesses kind of wimpy from time to times anyway, we get these mix swings but taking that off the table clearly the softness in China and other parts of, the decline in China and other parts of South East Asia that business impacted our software sales. So, as we see that business coming back in our third and fourth quarter after pretty much after the end of this calendar year that’s will be the primarily driver for increasing software sales.

Greg Eisen

Okay. So you don’t see it as kind of true recessionary vent that’s, this is going down and staying down until the economy recovers?

Marc T. Giles

No, actually it’s been software sales I don’t mean to imply that they are immune from all economic impacts. So, don’t take me wrong, there is movement. But, they tend to be more consistent, you’ll see bigger swings on equipment from capital purchases in equipment from recessionary moves. This one seems to be tied based on the data that I’ve looked at seems to be tied pretty directly to the drop in orders in China, if software tends to be, you order it, you get it, you ship it pretty much the next day and we saw that 60% drop in business from China that seems to be the biggest driver of the swing.

Greg Eisen

Are you seeing any migration of that customer base to Vietnam or other countries within Asia?

Marc T. Giles

Yeah. The big two right now that are getting overflow from China are Vietnam and Bangladesh. Bangladesh, of course, is coming up on elections and that’s how its going that’s really spells trouble for Bangladesh, I don’t know how much more that will continue to move there. Vietnam has grown nicely but its suffering a little bit from its own inflationary problems right now. So, what we can’t see the movement of some of that business that would normally be done in China and in those two countries. The magnitude of scale difference is staggering, I mean, China does 50 some odd billion dollars a year of export and another $16 billion of domestic production and I think Vietnam will probably will do $7 billion worth of exports this year somewhere in that range. So, we can’t take huge amounts of business from China in any kind of sustained way.

Greg Eisen

Got you. Okay, thank you.

Marc T. Giles

Sure.

Operator

(Operator Instructions). The next question will come from Beth Lilly with Gabelli.

Beth Lilly

Good morning.

Marc T. Giles

Good morning, Beth.

Beth Lilly

I wanted to just talk from a -- in the past you laid out that you think you can drive operating margins to 10% overtime and I wanted to ask a couple questions, one is do you think you can achieve gross margins with your existing mix of businesses? And particularly, what I am getting at is your ophthalmic business continues to generate lower margins and it’s smaller part of the business and I just wanted to explore as you look at where do you kind of take the company and whether or not you are still committed to the 10%, do you think you can do it with the existing mix of assets?

Marc T. Giles

I’m obviously, I’m not going to comment, you know, anyway and kind of company portfolio mix within the corporation you know, one way or the other in terms of intention. But, the answer to your question is yes, I do believe we can, I think everything else aside, the actual hitting of the consolidated 10% operating profit margin is going to be more determined, it is more Spandex to determine because of what represents 40 some odd percent of total company’s sales and we do not anticipate that part of the business achieving 10%. So, it’s really on the back of our other operating businesses and clearly Gerber Technology where we believe as we continue to invest in that business internally and externally will drive to what the operating margins necessary to make than we have their targets.

Gerber Coburn which is you know it’s operating right around 5% operating profit margin right now, we do believe that with specially introduction of new products at very high gross margins this new Advanced Lens Processing System is a very high gross margin product. With any kind of growth, I mean, in current economic environment though pass of any kind of economic live that business should be in the high single digits itself if not 10% even though it’s small ultimately. And so, the big swing factor that is Gerber Scientific products. That’s the business that it didn’t make any money in the first quarter, lost a significant amount of money in the first quarter as declined consistently over the last three years from somewhere in the 7% to 8% operating profit now to the negative operating profit range. And so, that’s the big one, if ion does what we believe it’s going to do, ion and by that I mean the ion family of products that business can be well over 10% operating profit business in the near term. And other than that we are going to have to, we have to rethink how we won Gerber Scientific products and what kind of investments are not we are going to make to be able to won a more legacy orient businesses, so, that’s it entirely different approach. So, that’s why this year that’s such an important year for us, we do establish Gerber Scientific products as in-shed business as we think we can begin to do with ion and then support that with some additional external investment once that’s been established that we think drive the strategy where we were comfortable with the 10% overall operating margins for the business that’s the big swing factor.

Beth Lilly

And are you willing to commit to a timeframe to get to that 10%?

Marc T. Giles

Not, necessarily, that can be right now, Spandex is the only thing that’s growing in the current environment and of course, in a less kind of work against us. Right now, I think if we do what we say, we are doing, the ion by the end of this year I think I will be able to commit to a time line to deliver on that objective that I think we can deliver on. But, I want to see the economy kind of a get a little bit clear first of all this year and I want to demonstrate what we can do with the ion.

Beth Lilly

Okay. Next question is, I wanted to spend a minute and just talk about the addition of Mike as a CFO and he has got big lean efforts going out within the corporation, can you please spend a minute and just talk about one impact you think that’s having on the organization and where the focus is going to be and just overall its seems to me there is just whole another level of financial disappointments being brought into the corporation?

Marc T. Giles

Yeah, I mean there is a whole another way of financial performance improvement that’s ultimately going to be driven by our lean initiative which we have had trouble getting traction on since beginning on this journey a couple of years ago and which is the largely the reason why now we have our new operations personally started in January. Joe now was also added some additional panel in his organization with tremendous experience in lean and in supply chain management and that’s critical because our spend on material spend coming this for a manufacturing business is that biggest piece of our costs. So, getting that straightening on our supply chain, improving our supply chain is critical and Joe and his team have tremendous experience in doing that. So, for example, we are anticipating some real material cost reductions over the course of the next couple of years beginning to get some traction this year.

But that we are not, we don’t factor a lot of that into our forecast because until we start to see and demonstrate the track record success and just assume leave that some upside for us, but over the next few years I would see that as another major driver of our being able to optimize our operating process. Now, Mike coming on board more recently obviously, he is on the phone so I don’t want to speak to highly but he is really, I feel a tremendous addition to this team and I would say that for a few reasons that a unique to him in terms of the skill sets that he brings, one is he has a lengthy background in lean, lean operations are helping to drive lean change as well as lean accounting and designing and providing lean metrics and data and information to support, measure our progress against what were trying to achieve as opposed to strictly GAAP accounting and finance.

Number two, he brings strong focus on cash, which we need in this company probably because of some of his background, his resume and his experience with some private equity just brings a real cash focus to high, run the business and we could use that by if you look at our working capital over the last couple of years we can use that kind of a focus. And he brings some pretty extensive background in M&A activity that should help us accelerate that, we are expecting to be able to accelerate that. So, he brings some real skill set as well that are going to make a big contribution I think to the team and the company.

Beth Lilly

Are you tying compensation to lean activities and working capital and things like that?

Marc T. Giles

Right now we have based two metrics that our -- I will talk both about our bonus plan and then I will talk about our directionally what we wanted -- what we are trying to do with long-term incentive. On our bonus plan there are two components this year, it’s 70% weighted on hitting our operating profit targets, our EBIT targets and its 30% based on hitting specific cash targets tied to our business plan. Our business plans -- so that’s the cash bonus part of our incentive. Longer -- but that’s a part of our three year plan, a three year financial performance plan that is linked to our ability to award equity grants both to myself and rest of the senior managers and that means while hitting our three year plan should indicate to allow us to provide some greater equity incentives at lower percent cost to the company and will try to move in that direction and if we don’t stay to the plan our ability to do that diminishes. So, that’s how we’ve structured our incentive at least for the near -- for the next couple of years.

Beth Lilly

Okay. And then the longer-term is the three year did you say?

Marc T. Giles

Yeah, our current year financial plan is tied to a three year financial plan and so in that sense if we are able to -- each year hit our commitment or hit our target on the three year plan we are going to try to be able to award a greater long-term incentives as the company, then as a percent of its option expense would improve and allow our executives to get a bigger piece of an equity stake.

Beth Lilly

Okay, right. Okay, that’s wonderful. Okay, thanks for your time.

Marc T. Giles

Thanks.

Operator

And it appears, we have no further questions at this time. Mr. Giles, I would like to turn the conference back over to you for any additional or closing remarks.

Marc T. Giles

Thank you, operator. Finally, before I close I just like to reiterate to everybody who is on the call today that we do expect our current fiscal second quarter to deliver improved earnings performance versus the second quarter a year ago. And we are reconfirming our previous earnings guidance for the full fiscal year at between $0.72 and $0.82 per share. That being said, I thank you for joining us on this conference call, I look forward to our second quarter conference call and talking to you then. Good bye.

Operator

This now concludes today’s conference call. We want to thank you for your participation and hope that you have a great day.

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Source: Gerber Scientific, Inc. Q1 2009 Earnings Call Transcript
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