Novanta Inc. (NOVT) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Candace, and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group Second Quarter 2012 Earnings Conference Call. [Operator Instructions] Mr. Tim Spinella, Assistant Treasurer of GSI Group, you may begin your call.

Thank you very much. Good afternoon, and welcome to GSI Group’s second quarter 2012 earnings conference call. With me on the call are John Roush, Chief Executive Officer of GSI Group, and Robert Buckley, Chief Financial Officer. If you’ve not received a copy of our earnings press release, you may get one from the Investors Section of our website at www.gsig.com. Please note this call is being webcast live and will be archived on our website. Before we begin, we need to remind everyone of the Safe Harbor for forward-looking statements that we’ve outlined in our earnings press release issued early this afternoon, and also, those in our SEC filings. We may make some comments today both in our prepared remarks and in our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So you should not rely on any of today’s forward-looking statements as representing our views as of any date after today. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures we plan to use during this call to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website at www.gsig.com. I am now pleased to introduce the Chief Executive Officer of GSI Group, John Roush.

Thank you, Tim. Good afternoon, everybody. Welcome to our call. And thank you for your continued interest in the company. So as we report our second quarter results, I’ll say that, it was a challenging quarter in that, on the one hand, the company did execute very well against the agenda that we had laid out for ourselves, and we are proud of what we accomplished with that. But on the other hand, the market environment that emerged during the second quarter, late in the quarter was a major disappointment to us, and it has had an impact on our results and our outlook. So as you take a look at our numbers, it’s important for you to note a few key things. First, if you’ve had a chance to look at our press release, you’ll see that we moved our semiconductor systems and laser systems businesses to discontinued operations. This obviously does change the baseline level of our numbers, and we’ll be commenting about that in some detail on this call. The use of the discontinued operations treatment beginning this quarter reflects the fact that our divestiture processes were far enough along at quarter-end that this accounting treatment was appropriate. The second thing you’ll note, as I mentioned, is that our results were impacted by a sudden and significant deterioration in market demand during the quarter. At the end of the first quarter and into the first 2 months of the second quarter, we had experienced very strong order rates and encouraging signs of recovery in most of our lines of business. However, towards the end of May, we saw order rates significantly deteriorate, first in Europe, then in China. The sudden decline in our OEM customer demand was linked to significant drops in manufacturing activity, which impacted both our industrial and microelectronics markets, as well as some delays in government research funding, which impacted our scientific laser business. The magnitude of these changes was not originally contemplated in our revenue and earnings guidance. However, despite this weakness, we were able to deliver within our original guidance range, achieving approximately $86 million in sales and over $13 million of EBITDA when adding back to results of our now discontinued operations to make a valid comparison of actual results versus our guidance. We also finished the second quarter with our cash position exceeding our debt balance by $3 million, which was also in line with our expectations. While we are disappointed in the suddenness and the severity of the market slowdown, it really doesn’t deter us from vigorously driving forward with our agenda for the company. In fact, my view is that the actions we have undertaken across GSI will position us more effectively to cope with this type of market turbulence in the future. During the quarter, we also made significant progress on reducing our operating complexity and our breakeven point. We are on track with virtually every element of the 12x12 restructuring program that began in the fourth quarter of 2011. Since the announcement of this program, we have eliminated 2 sales and service centers in Japan, relocated our scientific laser production activities in East Setauket, New York to Santa Clara, California, closed our optics production facility in Oxnard, California, put our sales and service office in Mumbai, India up for sale; launched the consolidation of our sales and service offices in Germany, and have made significant progress in the consolidation of our Lexington, Massachusetts operations into our Bedford, Massachusetts facility. We remain on track to complete all elements of the 12x12 program by year-end. The other major focus area for us is the strategic positioning and the growth potential of our portfolio. Our agenda here is to focus organic growth and acquisition efforts on several key growth platforms. Those would be fiber lasers, scanning solution and medical components as discussed on previous calls, and also, to exit our systems businesses. Taken together, these moves will definitely take us in the direction of being a higher growth and more stable company. The transformation of our portfolio is not something that can happen in a quarter or 2. As we sit here today, we still have a company with a level of volatility or economic sensitivity that’s higher than we like, but in fact, we are making very good progress on our organic growth investments, as well as our potential acquisition. In terms of second quarter revenue, we delivered $70 million on a continuing operations basis, with a book-to-bill ratio of 1.0. We did have a number of businesses that saw strong revenue in the quarter despite the weak overall market. Our fiber lasers business saw revenues more than tripled from a year ago with a book-to-bill ratio of 1.7. Our scanning solutions business grew 15% year-over-year with a book-to-bill ratio of 1.6. Our optical encoder business grew 25% and our color measurement business grew mid-teens percentage on a year-over-year basis. So despite the overall weakness in demand, we were pleased that we saw strength in areas where we have been specifically investing to drive growth. From an end market perspective, we saw our microelectronics business decline 29% year-over-year. Scientific was down 25%, industrial was down 7%, and medical was down just 3%, primarily due to a little bit of weakness in Europe, but grew in other geographies. In terms of profitability, on a continuing operations basis, we had second quarter adjusted EBITDA of $12 million, which is 17% of sales. We are managing our discretionary expenses very carefully at this stage, and we are pleased with our level of profitability given that our sales outlook dropped on the order of $6 million within the quarter itself. Despite the weak market conditions, the company executed well on a number of fronts in the quarter. From an organizational perspective, we made several key hires that will strengthen our capability. We brought on board a corporate development leader with a strong background in both investment banking at Morgan Stanley and business development at Boeing. We also hired a corporate leader for our companywide continuous improvement programs, an individual with 20 years of operations and continuous improvement experience, including a 12-year tenure with Danaher. We also hired a Site Operations Leader for our Massachusetts-based operation, an individual who has an extensive background of operations and leadership with Ingersoll Rand, GE, and International Paper. These leaders bring significant talents and capabilities to the organization that will help to make GSI a stronger company for years to come. We also had 3 new directors join our board during the quarter. Harry Bosco, who was serving as CEO of Opnext prior to their acquisition by Oclaro, joined the board and brings extensive leadership experience in technology businesses. In addition, Dom Romeo who served as CFO of IDEX Corporation for 7 years joined our board. Dom was instrumental in the transformation of that company and previously played senior financial leadership roles in AlliedSignal, Honeywell, and several other companies. Finally, Tom Secor joined the board. Tom previously spent 5 years with Goldman Sachs and brings to our board an extensive background in finance and legal matters. And all 3 of the new directors served on additional outside boards. Finally, as we spoke about in prior earnings releases, acquisitions remain an important part of our growth strategy. During the quarter, we continued to develop our strategic roadmap and as part of that we have cultivated a significant pipeline of potential acquisitions. For example, we recently completed an in-depth consulting study on the medical components market. This study identified a number of attractive market adjacencies and potential acquisition targets. Now that we have a strong Corporate Development leader on board, we are better positioned to drive these deals forward. As we are increasing our acquisition focus, we remain disciplined in our approach with respect to strategic fit, valuation, and multiples, but improving the portfolio is an important part of our strategy and acquisitions will play a key role. We now have a number of attractive targets in discussion, and we remain confident we will be successful in executing on this element of our strategy. So with that, I’ll now turn it over to Robert Buckley to provide some more details on the financials. Robert?

Thank you, John, and good afternoon, everyone. I’ll now provide some additional details on our second quarter 2012 results. In June 2012, the company’s board of directors authorized management to commit to a plan to divest the company’s semiconductor systems and laser systems business lines in order to increase the company’s strategic focus on highly engineered precision components and subsystems. The company expects to exit these businesses within the next 12 months. Therefore, we began accounting for these businesses as discontinued operations in the second quarter of 2012, and all current and prior period income statement information presented has been revised to reflect the results of these businesses as discontinued operations. During the second quarter of 2012, GSI’s continuing operations generated revenue of $70.4 million, a decrease from $82.6 million in the second quarter of 2011. Included in the revenue in the second quarter of 2011 was $4.2 million of net revenue that had been deferred under multiple-element arrangements, delivered over multiple periods, entered into prior to the adoption of ASU 2009-13. In addition, compared to the second quarter of 2011, our sales were also negatively impacted by the strengthening of the U.S. dollar, particularly against the euro. This had a negative impact on our growth rate of roughly 2 points, compared to the prior year. As mentioned previously, our reported revenue for the second quarter of 2012 does not include $15.1 million of revenue from our semiconductor systems and laser systems business lines, which are now classified as discontinued operations, compared to $18.8 million of revenue for the second quarter of 2011 from discontinued operations. Sales of our Laser Products segment for the second quarter 2012 decreased $12.3 million to $26.3 million. This was primarily due to significant decline in sales of our specialty lasers sold into scientific markets. This business line was negatively impacted by delaying government funding to our customers in the scientific market, particularly within Europe. However, this business also experienced some disruption from the company’s 12x12 restructuring initiative, resulting in roughly $1 million worth of shipments being delayed to the third quarter. Although overall Laser Products sales decreased, we’re seeing significant demand from our fiber lasers, which more than tripled in revenue versus the second quarter of 2011, and so robust bookings achieving a 1.7 book-to-bill despite the macroeconomic environment. Sales of precision motion and technologies for the second quarter 2012 decreased 16.3% to $44.1 million. This was primarily due to a decrease in demand in microelectronics markets beginning at the end of 2011, with a particularly sharp decline in demand for our printed circuit board spindles. While many of our business lines began experiencing stronger demand, the over 40% decline in our air bearing spindles business line has more than offset their improvements. Furthermore, the decrease in sales was also attributed to approximately $3.6 million of net revenue recognized in the second quarter of 2011, related to the adoption of ASU 2009-13. Turning to our profitability, second quarter gross profit was $30.7 million, or 43.6% gross margin, compared to gross profit of $37 million, or 44.8% gross margin during the same period last year. The drop in gross margin was primarily caused by product mix changes particularly sharp drops within our Westwind spindles business and specialty lasers business, which sells into the scientific market. In addition, we recognized roughly $1.5 million of net gross profit in the second quarter of 2011, related to the adoption of ASU 2009-13. Laser products’ second quarter gross profit was $8.6 million, reflecting a 32.6% gross margin, compared to $12.3 million, or 41.1% gross margin for the same period last year. The decline in gross margin was primarily attributed with significant ramp-up in manufacturing costs for our fiber laser business line to meet demand expectations for this business over the next 12 months. And the drop in manufacturing utilization from the lower specialty laser sales to the scientific market. Precision Motion and Technologies’ second quarter gross profit was $22.3 million, reflecting a 50.6% gross margin, compared to $25.2 million, or 47.9% gross margin for the same period last year. The reduction in gross profit dollars was primarily driven by the drop in the sales of our Westwind spindles business. However, the 2.7 point increase in gross margin was attributed to a change in product mix and the completion of amortization of certain intangible assets. Operating expenses amounted to $25.6 million for the second quarter of 2012, including $2.5 million of restructuring expenses primarily related to our 12x12 program. This compares to operating expenses of $25.5 million in the second quarter of 2011. SG&A expenses for the quarter were $16.8 million, representing a decline of $1.8 million, compared to the second quarter of 2011. We achieved these reductions in the wake of significant revenue pressures, and while continuing to make significant investments in our people and around our growth initiatives. As John mentioned earlier, we made considerable progress in our 12x12 restructuring program. At this point, all affected sites and employees have been notified, and we are well under way to meeting our cost saving goals. In addition, we made continued progress with the divestiture process for both semiconductor systems and laser systems. We are committed to selling these business lines and feel confident that they will close within the next 12 months, but ideally sooner. We are heavily engaged in discussions with potential buyers for these businesses. So it would not be appropriate to expand on the process or potential proceeds at this time. In relation to our 12x12 restructuring program, we incurred charges of $2.4 million during the second quarter of 2012 comprised of cash-related charges of $1.8 million and non-cash charges of $600,000. Adjusted EBITDA from continuing operations and non-GAAP financial measure, which includes the adjustments noted in the non-GAAP reconciliation attached to our earnings press release, was $11.9 million in the second quarter of 2012, compared to $15.9 million in the second quarter of 2011. However, included in the adjusted EBITDA in the second quarter of 2011 was $1.5 million in net profit recognized on the $4.2 million of net revenue deferred prior to ASU 2009-13. The company reported earnings per share from continuing operations of $0.13 as compared to $0.21 in the second quarter of 2011. GAAP earnings per share were adversely impacted by the cash and non-cash restructuring charges of $2.5 million primarily related to the company’s 12x12 restructuring program. Turning to the balance sheet, we ended the second quarter of 2012 with $55.8 million of cash and cash equivalents and total gross debt of $53 million of which $35 million is in the form of an amortizing term loan. Our gross debt carries an approximately 2.9% weighted average interest rate as of June 29, 2012. In addition, on July 19, 2012, we amended our credit agreement to provide that the burn-off condition has been met, which eliminates the borrowing base financial restriction and minimum consolidated EBITDA covenant contained in the agreement. Finally, operating cash flow for both continuing and discontinuing operations was $9.8 million in the second quarter of 2012. We achieved this result despite the surprise drop in sales in the final month of the quarter at a time when we could not avoid the inventory commitments that were made based on higher sales expectations. Turning to the third quarter of 2012, we expect market conditions to remain largely similar to what we experienced in June and July. However, we have also attempted to reflect the volatility in the macroeconomic environment in our guidance. Therefore, we expect revenues from continuing operations to be in the range of $68 million to $73 million. When comparing this to the third quarter of 2011, it should be noted that the company recognized in that quarter approximately $1.3 million of net revenue that had been deferred prior to the adoption of ASU 2009-13. Turning to profit, we expected the third quarter of 2012 adjusted EBITDA to be in the range of $10 million to $13 million. When comparing it to the third quarter of 2011, it should be noted that the company recognized $600,000 of gross profit related to ASU 2009-13. We expect that operating expenses will see a slight decrease from the second quarter of 2012 primarily due to the benefit of the 12x12 program. Depreciation and amortization in line with our second quarter, a GAAP tax rate of 15% to 18% and fully diluted shares outstanding of approximately 34 million. Finally, we expect to incur additional cash restructuring charges of $700,000 to $1.7 million and non-cash restructuring charges of up to $700,000, all related to our 12x12 restructuring program. One final word on the business outlook. Because of the continued uncertainty and volatility in the macroeconomic environment, we believe it is prudent to take additional cost actions in the business above and beyond the cost savings targeted by our 12x12 initiative. We are currently projecting an additional $1 million to $2 million in annualized cost savings in the business lines not already targeted by the 12x12 program. We expect these actions to further simplify our business model, but we are still working on assessing the overall cost of the restructuring program. We are targeting a one-year payback. As such, we do not expect to see any savings from this program until the fourth quarter of 2012. This concludes our prepared remarks, and I would like to open the call up to questions.

[Operator Instructions] And your first question comes from the line of Lee Jagoda with CJS Securities.

So are the sales of discontinued operations needed before you can go out and make acquisitions?

Yes. Lee, it’s John. I think are you asking whether we need the proceeds from those divestitures to complete acquisitions.

Well, both the proceeds, and whether or not you’ll be preoccupied with the sale process?

Oh, just in terms of resources and organizational kind of bandwidth, yes, I would say the answer to that is, no. I mean, we do have a fair amount of resources working on the divestiture programs, but those are either people in those businesses or sort of dedicated to those businesses. And it’s really a different group that’s focusing on the acquisition side. So I think we could do one, perhaps 2 acquisitions over the coming months without impacting or getting in the way of the divestitures. In terms of financing those, obviously it depends on the size, but generally I would say the answer is, no. We’re not sitting waiting for proceeds to come in before we actually [Audio Gap] acquisition. If it’s the right fit, and it makes sense in the valuation and all that is what we need, we’re going to be able to move forward. So Rob, I don’t know if you have any additional comments on acquisition capacity, but....

No, I think it’s -- we have enough available cash, as well as availability on the current credit agreement to actually fund those transactions.

Right. So the answer is they can have them in parallel from all dimensions.

Okay. And then just looking at your 3 growth drivers, the fiber lasers, scanning solutions and medical components, if you take out the revenue from the discontinued operation, what percent of revenue do those 3 growth engines currently make up of your business?

Well, we haven’t really disclosed the specific amount to those, because you’re getting down in the competitive information that we don’t really necessarily want to reveal. So that would be something we would look at in the future to kind of break that out, but it’s a smaller piece. These are areas where we’re looking for a bigger increment of growth, but not necessarily a big part of the base. I think when you’re seeing a fiber laser business triple, then that’s kind of telling you something about, it’s not that big, in terms of its base that it started from.

Sure. And one more question and I’ll hop back in the queue. As you look at the medical components acquisitions, generally speaking multiples in that space can be relatively rich. Are there reasons why someone may want to sell to GSI group rather than just the highest bidder in an auction process?

Yes, I mean, we are obviously trying to steer clear of very competitive auctions and very rich valuations and there are some of those properties in the medical space, but as we -- we did a very extensive work for several months with a consulting firm that is kind of an expert in the medical technology verticals, but then they used a sort of McKinsey, BCG, Bain style consulting approach. And we went through a whole bunch of the kind of OEM component areas in medical. So what we’re not doing is looking at buying actual medical device companies, right. We’re talking about the key componentry that goes into medical, which is really what we do with precision components. And there it’s -- I think that some of the valuations are more reasonable. There are areas where they could be quite high, and we are being selective and looking at adjacencies that fit our core competencies; that fit our technology know-how or fit our channels into the market, our key account relationships. So they have -- they somehow are adjacent to something we are doing, and we are finding a number of those opportunities, and they aren’t necessarily the things that some may be picturing where you do have a competitive auction and the multiples go crazy. It’s something we do keep our eye on, but I think there’s enough out there that we can do some things that are affordable to us and further our strategy.

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

A couple of questions just with respect to the decline that you saw in the precision motion and technologies, 16% year-over-year. I guess that really suggests that the spindle business had a sharp decline. I think you said 40%, but I was wondering are there other components to that decline just given that some of the other areas were fairly strong?

Yes, I would say the spindles effect was pretty significant in there. And so you’re right to point it out. But there were other effects, I mean; sort of a general slowdown in the environment in Europe and China is affecting more parts of that business than just the spindles. For example, the scanner business is a pretty large business with hundreds of active OEM customers and a number of those are in Europe, quite a few of those are in China. So we saw some generalized slowdown in that area.

But debt was up 15% there, right?

No, the scanning solution business was up 15%. There is also a scanning components business, which is quite a bit larger than the solutions part. We play at 2 levels of the chain in scanning with a basic galvanometer, which we would call a component or a scanning head, which we call a solution.

And yet even with that decline, you showed improvement in gross margins. So how should we think of that? Was it just a mix really tilted toward your highest margin products?

Yes, I think that’s the easiest way to kind of think about it is that, some of the products that actually ended up being a larger portion of that business are much higher margin.

And within lasers, you called out the specialty laser business declining, it would seem like you would have also seen weakness in the lower end CO2, the Synrad business, is that fair to say?

Not so much, a little bit of pressure in CO2, that’s really came in kind of the final month of the quarter. I would expect that -- they are certainly seeing pressure in the China market, but the bulk of the decline really happened from our scientific laser, specialty laser business.

The CO2 business, Jim, had really strong orders in the first quarter. And to a certain extent that buffered them a little bit, because they just were in a better position heading into the second quarter. They did start to get communication from customers of slowing demand, particularly in China, but all in all we’re able to realize a decent sales level in the second quarter because of the really strong orders they had earlier. They are seeing some slowing from their second quarter level into the third quarter, that’s a carryover of that.

Okay. For gross margins for laser products, is there any way we can think of that how much of an impact the growth of the fiber laser business is having on your overall gross margins for lasers, just because it seems like that’s low margin business at least at this point stand from -- how much was specialty margins contributing to the year-over-year decline? Let’s -- maybe that’s a better way to answer the question.

On a dollar wise, I would have to get back to you on, I would say that they were -- I think you rightfully pointed out that the 2 larger drivers in the overall margin there were the scientific business, as well as the fiber laser business. Fiber laser is a little bit more linked to the fact that we’ve added a lot more manufacturing capacity to that business to meet the demand expectations, and so that will even itself out a lot quicker. And then scientific is seeing a bit of a recovery there as well. So we expect that business to come back as we get into the third quarter and be a larger contributor. But in a macro sense fiber lasers does have a negative sort of, little bit of a dilutive impact to our margins. That’s a short-term issue. We have programs in place to significantly lower their costs and as we get into 2013, I think we’ll be in a pretty solid position to get that back up to the laser products average.

So this is John. I was over and spent some time with the fiber laser business just a week ago or so. I mean, they have brought in a significant amount of labor, about a quarter to a quarter and a half before they really need that labor. I mean, they’re seeing the order trends, and they’re seeing you when you have a 1.7 book bill; that says next quarter you need to be producing more stock. And there’s a training curve in fiber lasers that’s significant. It’s a lot of very small, very precise types of assembly work, and we’re fortunate that the labor market availability is pretty good for people who had kind of telecom-related experiences or other have worked with fiber type processes. So the people are available, and we got them, but you still have a training curve there and you can’t kind of bring them in and make them productive immediately. And we’re experiencing kind of that curve working against us, now, but it will get better.

And the weakness that you saw, you began to experience in May, how did the business change through June, and what are you seeing in July -- what did you see in July in terms of change? It was the continuation of the weakness or are you seeing any signs of areas of the business that have been weak picking up?

What I would say there and first accept that we are trying to be somewhat conservative around the guidance and provide a range and realize that there is some uncertainty here, but our general sense of things is, is that building off 2Q kind of environment, things are getting sequentially better in most areas, but quite modestly so. So there is not like a big snapback here, but I would say a gradual improvement in most areas. There is some exception, but I think I mentioned a few minutes ago that the CO2 business actually has some challenges on a sequential basis, but a lot of the business are getting just modestly better, but as we provide guidance, we just have seen that there’s a lot of uncertainty right now in the customer base and people have these memories about 2008 and memories about slowdowns and I just don’t really want to commit to inventory of components until the demand is very firm in their eyes. So we’re trying to guard against those scenarios, but we see modest improvements in most parts of the business.

Got it. Is there, in, just given the way you are seeing the quarter shape up, is it reasonable to assume that the gross margins are basically flat to up slightly, is that a fair way to look at it?

Well, I’ll get back to you on that. I think we want to make sure that we properly take into account is the dynamic where we are getting a lot of growth out of our growth platforms, which is fantastic, but it’s costing us a little bit of money to do that. And unfortunately when you are facing a downturn, you need to make some decisions around that. So let me get back to you on that.

Okay. And I mean, I have a similar question with respect to operating. And I know there are a lot of moving parts right now just given what you’re doing, but again, just trying to deal with the move to discontinued ops for the semiconductor and laser systems, is one way, I mean, how should we think about your operating expense line items off the June quarter. Are there any unusual things apart from the restructuring charges you talked about? For instance, I mean, should we think about any major changes in SG&A or in R&D?

In terms of SG&A, I would say, generally speaking, our operating expenses are going to trend down as we go into Q3. And in relation to Q4, they’ll probably level off a little bit as the consequence of sales increasing, so there is a little bit of a variable component there. But for the most part, our operating expenses are well controlled at this point, and I don’t see any abnormalities other than the restructuring charges.

Okay. And one final question and I’ll jump back. The strength you are seeing in fiber, it’s tough for us, I think, to get our arms around it, I assume it’s all just, John, I think, you mentioned it, it’s off a very low base. But at what point does it -- does the fiber lasers, do they become more meaningful from a revenue standpoint as a percent of total revenues. Are we still a couple of quarters away, and where is the strength coming from, what particular verticals?

So I mean, there is a few things. And there are many, the fiber laser revenue growth is starting to become significant in the context of the JK Laser business. So historically, that was a business that focused on land pumped YAG lasers. And of course, that’s been in decline for a while. So what we’re now seeing is that the fiber laser growth is far exceeding the decline in the YAG business, so JK as a whole is growing. So fiber might be tripling, but JK as a whole is putting up in excess of 20% growth, the net of the 2. So we’d kind of talked about that and at what point we really start to say these numbers are material to the entire company, and we start being more detailed about what they are. So I’d say you’re getting to the point where fiber in a few more quarters is going to be more than all of what JK was in the past, so …

And this is going into the existing markets’ customer base and up-selling them on fiber?

It’s industrial materials processing and a lot of it, frankly, is in China and other parts of Asia. And it’s -- for the most part customers we have historical relationships and, they’re -- a typical customer is using our YAG lasers in a given process. Okay, and they are interested in fiber lasers because of the lower kind of total cost of ownership, smaller footprint, better beam quality, all the known reasons. But we bring to the table a lot of experience with that specific application, like, if somebody is trying to use lasers to cut intricate shapes into some particular piece of metal. And we know that application, so then we can adapt that process of fiber effectively because we have experience with whatever that material is, and what that process is, and we know the customers, and we have a working relationship. That’s the typical case, not always, but -- and I would say right now, we’ve just introduced a bunch of products in fiber in the last 6 months. And we now have a kilowatt class offering, but we still see a lot of our sales in what I’d call medium power industrial. And then the kilowatt products are really helping us gain exposure and credibility in the fiber laser, but they have not yet become a huge percentage of our actual revenue.

And your next question comes from the line of Mark Tobin with ROTH Capital Partners.

I guess switching gears and looking at the productivity initiatives and the cost reductions, you highlighted some of the things that you have done and remain to be done. Can you give us a sense of how they phase in over the next 12 months, or even through the end of 2013, and I guess I would include the 12x12, as well as the additional activities that you highlighted.

Well, I think the Q3 guidance already takes into account some of that phase-in; Q4 should have a significant more cost savings associated with it as a consequence of the actions and then there’d be a bigger benefit into 2013. We said it was roughly 12x12 by itself that was roughly a $5 million of annualized cost savings, it’s obviously less than that because we are obviously exiting 2012 on an annualized basis, but for I think as you look at 2013, you’re looking at $5 million of savings and 2012 is something less than that.

And if we take additional actions that can drive that 5% up to 6% to 7% range with some other things that we’ll try to do that don’t start phasing in themselves until sometime in Q4. But one of the biggest things that we are doing as part of 12x12 is the relocation of the Lexington operations to Bedford, and that’s approximately a 5-mile move for that business, but that’s our largest single business in that location in Lexington; it’s a significant amount of revenue, hundreds of employees, and we are the #1 market share player in scanning prod [Audio Gap] margins in that business. So that’s an important move, but you just don’t do that in a reckless manner, because that business, I mean, we know we’ll probably take a small amount of [Audio Gap] trying to keep that to an absolute minimum. And so we’ve staged that out and planned it very carefully, and that happens, over the next 4, 5 months, and it’s completed by year-end. So we don’t really see much benefit at all from that one this year, maybe a little bit, but it really kicks in next year.

And how much of your Q3 guidance, if any, accounts for some potential disruption? Is that part of the softness there?

Yes, I think what we try to do is in the guidance for Q3 is taken that into account. There is a range there that’s provided, and so that, at the bottom of the range would kind of say that everything bad happened, but I don’t think that’s the way we are looking at it right now. And so for the most part, our guidance reflects the fact that there could be some minor disruptions, really not that much in the third quarter. But it does also take into consideration that there’s been some volatility in the macroeconomic sense, and that we’re trying to make sure that we are prudent with that.

So we had some disruption in the scientific laser move from Long Island to California, and I think as Robert said earlier, it was on the order of a $1 million. Challenging move in the sense of highly technical products, a lot of PhDs involved in this process and such, and we relocated a number of those individuals all of the way out to California. So a very significant move for the individuals who were affected, and very complex products, a lot of custom or semi-custom products. And what it is in the -- medium volume production line. It’s just kicking these things out. It was a lot of complicated projects and the individuals involved were moving. So in the end, it was -- I would say $1 million impact is not that bad considering the amount of money we will save over time by eliminating that entire site.

Your next question comes from the line of Jack Ripsteen with Potrero Capital.

Question about the discontinued ops, clearly you moved them into disco ops for this period. So something changed with respect to technical decision switch -- was it a discussion process with potential buyers, is there a technical point at which accountants want you to make that move? I’m just kind of curious what prompted this quarter, say, versus last quarter when you were still contemplating the sale.

Well, I mean, there is a very specific sort of accounting set of criteria that you evaluate, but really, I mean, the short answer to what you’re saying is the processes themselves were very, very preliminary 3 months ago, where we had not had much in the way of contact with buyers. We have sell-side advisors driving these processes, and there’s memorandums, and they’re reaching out to a large number of buyers, but we’re in a way different position right now in very specific discussions with specific buyers, and a lot of negotiations. So that it was just really in the end, the maturity and the advancement of those processes and the specific decision the board took to approve that and move down that path, and the criteria were met for that.

And after this process, do you see other elements that you’d want to move to either discontinued ops or put up for sale or is this, post the first year review, kind of it?

In terms of 2012, I think we’re going to bite off just about this much. I think we’ve gotten to the scale now where it’s important to execute on the acquisition side to start getting the growth opportunities executed on, and so that’s where our bias is going to shift to. That’s not the rule out that there wouldn’t be other businesses that we’d like to get out of down the road, but that’s not going to be where the priority is going to be for the remainder of 2012 and going into 2013.

We do, Jack, and we rack and stack all the businesses in our portfolio in terms of their strategic growth, attractiveness, how much profitability and cash they generate, how related they are in terms of the technology or an end market to other things we do, and we look at all these elements, and we have a point of view about all of our businesses and I would there are some where you’d say in an ideal world, they would be down to where you would say that business is a better fit with some other owner rather than us. But there’s a practical thing there, I think we got the question earlier on saying, are the divestitures and the acquisitions competing for either capital availability or resources in the organization? And they’re not now, but if you were to go and try to do more potential divestitures, then you start to say, yes, it is a constraint.

Okay. And then one last question, I don’t know if you gave it or not, but did you give a book-to-bill for this quarter overall? Or just in the segments, or in certain segments?

So the, continuing operations it was one-to-one, $70 million revenue, $70 million orders, if you were to go add back to discontinued operations, it was below one-to-one, it was, I think the total orders were 0.93, it’s 0.93, on a consolidated basis, 0.93.

And how does that compare to the previous quarter?

I don’t know if we’ve broken it out for the discontinued, but on a consolidated basis, Q1, the revenue was $78.8 million, I think it was, and orders were $85 million.

Your next question comes from the line of Chris McDonald with Kennedy Capital.

The first one’s on the spindle business, could you talk a little bit about how volatile that business has been in the past, or if you’re seeing anything change more structurally with the softness that you’re seeing?

That’s a good question. I think the answer to that sort of depends on what time horizon you really want to look at. I mean, the printed circuit board and semiconductor capital equipment markets have always been fairly volatile, but I would say going back a decade or whatever, the normal pattern would be every third or fourth year, you might have a severe downturn and then you’d have several years of much [Audio Gap] We have been seeing over the last couple of years a much greater level of volatility where you have almost these mini-cycles within a year, where you will have a couple very strong quarters and then it’ll collapse, and then come back. Or there’s a lot of information, it’ll come back, but sometimes it doesn’t happen. So we’re seeing more kind of short-term volatility than we used to. But there are very big swings in this business where I mean, I think just historically, if you looked at it 2008 might have been something in the $30 million range, and then it was like, it got cut in half to $16 million and then tripled to $48 million in successive years. So this is a business that can go in half and then triple very easily year to year to year. And that’s a year look; when you look at quarters, you’re seeing something even more volatile.

So it’s -- John, it seems like this is kind of a normal volatility, maybe not some structural shift in the utilization spindles or alternative technologies or something of that nature.

Well, yes, I mean, I separate those 2 things. I mean, there is a question and our spindles are used for via hole drilling, right. And there is larger holes that are drilled mechanically that typically use spindles and the smaller holes that can be drilled with laser drilling systems. And by the way, we participate in the laser via hole drilling through both our CO2 laser business and our scanning business. So we actually have product addressing both types of the holes. But there is this broader trend [Audio Gap] the growth is really in the laser via hole drilling on the smaller holes, and a lot of that is directed at the mobile applications and the tablets and the handsets and all that. The larger holes is kind of a -- has been seen to be a flat business, maybe 0% to 2% growth, and was driven by some of the more traditional electronics and PCs and other types of applications. So that trend has already been identified and has already been under way for some time. I don’t think that those trends are accounting for the business seeing 50% reductions in 3, 4 months, but…

Okay. And then, any update on the collection of the tax credit to $20-ish million income tax receivable?

You can call your congressman and ask them. We finalized kind of all discussions with them. For the most part, we have agreement with the field office at this point in time. And -- but generally, what happens at this point in stage is that, it gets brought up to joint committee, which needs to be reviewed, and that process takes some time. There might be some questions coming out of that. It might be additional requests, but for the most part, it just takes a lot of time. And they haven’t provided us with the timeline. We hope to get a collective sooner rather than later, but as soon as we know, we’ll let you know.

There isn’t a lot we can do to influence it at this point.

Yes.

Your next question comes from the line of Stefan Mykytiuk with Pike Place Capital.

Most of my questions were answered, I guess it -- the last couple of things that I had is, Robert, what do you have for CapEx now for the, for 2012 on the continuing ops?

We haven’t broken it out specifically, but we’re not really sending any CapEx in our discontinued operations business. So the semi systems and laser systems really do not have any material kind of CapEx spend to them.

That’s one element of the systems business is they are very low volume, very complex assembly and there’s virtually no capital requirements in those businesses.

Okay, but you -- on the continuing ops are you still thinking of $5 million, $6 million, $7 million something like that of CapEx?

It will be difficult to cross the $6 million dollar mark. It’s probably something less than that, but....

And a big part of that as we’ve said in the past is IT, really.

Right. Generally speaking, when you look at the full year, I would say more than half of it is IT related. But in the second quarter 75% of it was actually spent in some of our growth areas specifically fiber lasers. We’ve spent a little bit in the consolidation of our scientific laser businesses, and we spent a little bit in our solutions business. But for the most part, it’s a 50-50 split between IT and business related expenditures. And again, the IT-related expenditures are more a factor of what we’ve inherited.

Okay. And in terms of the cash tax rate, is it still -- are you still expecting kind of de minimis cash taxes this year?

For the remainder of 2012, yes, absent any sort of significant gain on sales business or anything of that nature, we shouldn’t be paying any taxes. Very minimal amount.

All right. And you talked about maybe your inventories might have been a little high at the end of the second quarter. Is there an opportunity to reduce working capital as you go forward and especially now that you’re getting further along in 12x12 and you might have built up some working capital just to buffer any disruptions from that?

Yes. So I would -- absolutely I think our inventory management in the past has been horrible and I think we are spending a lot more time on that. John mentioned earlier that we bought in some outside resources that have a strong operational bias to them, and they’re going to help us really drive those numbers down. But there is general opportunity from the fact that we purchased more inventory than we needed in the second quarter, and we’d bleed through that in the third quarter, but there is also a lot of opportunity to drive that further down.

Okay. And then lastly, I think originally you had talked about, by Q4 you’re going to have the full run rate of the 12x12 costs savings, won’t you?

By the end of it, by the end of Q4 after we’ve exited the Lexington facility and consolidated that business into Bedford.

But that’s not in the fourth quarter.

So all the other facility changes have already occurred and for the most part, we’ve completed those, we’ve exited the facilities. Again, going back to an earlier question, we really shouldn’t see that much of a disruption for any of those moves at this point in time, but as we get into the fourth quarter, we’re moving our Lexington operations into our Bedford operations; that’s going to take a quarter to complete. And at the end of the quarter, we’ll be exiting with those savings.

Okay. But I guess, my point is, going from Q3 to Q4 there should be some improvement in the cost structure?

Yes.

Yes.

Just as a reminder, we are taking an incremental $1 million to $2 million of cost actions in the business. So those aren’t going to benefit us in Q3, because they are going to be announced throughout the quarter, but they will have a benefit in Q4.

Yes, I guess what I was getting at is assuming the market environment doesn’t improve, there’s still a potential for EBITDA to improve going from Q3 to Q4 just on the cost side.

Yes.

Yes. Yes. We agree with that.

Yes. Okay, okay, Last, I guess maybe I’ll sneak this in if I can is, medical, I think you said medical was down in the quarter, John?

Yes. It’s down 3% year-over-year and almost all of that was related to some weakness in patient monitoring type of applications in Europe.

Two customers in Europe actually slowed down their purchases from us, and that was all consequence of that fact that they supply those products into the European market. So that happened fairly late in the quarter, and we expect it to recover.

But then in the medical business was pretty healthy other than that, so I mean, where as you saw some larger declines in other segments.

So it sounds like you are saying some of that was just a knee jerk reaction to people get scared, and they just kind of say, “Stop all the spending.”

Yes. We’re seeing a lot of that, though.

Yes. I mean, without naming specific customers, if you look at some of the big medical equipment patient monitoring type of companies, and they are seeing weakness in Europe and our components that slows down, and we saw an impact from some of that.

But I would say, when it gets really bad, you are down 3%, that’s better than being down 29%, which we see in some other segments.

And your next question comes from the line of Chris McDonald with Kennedy Capital.

Just a couple quick follow-ups, one on the move to Santa Clara, is that now complete such that the third quarter won’t experience additional inefficiencies?

Yes. I mean, that’s been fully completed. I think what happened effectively is there was just a couple or a handful of orders that resulted in a little bit of a disruption due to billing material accuracies. But that is now fully complete, and they’re fully up and running and staff have been able to meet the demand. So that business is -- looking into the third quarter, it’s actually going to be doing a lot better.

Okay. And then on the scientific market, I think John you’ve said that, things have actually looked like they may be starting to improve a little bit. Was the weakness that you experienced in the quarter tied to specific projects that you can identify or was it more just broad and general in nature?

I would say that it was fairly broad. It wasn’t like one project or 2 that got held up and there was quite a few orders that basically got held up. But what was interesting about it is, if you really looked, that a bunch of orders got delayed and I would say that was more than 10 different distinct orders that got held up. But what really happened is many of them ultimately did come in, but they came in very late in the quarter and couldn’t be turned into revenues. So we actually started the third quarter with a pretty good backlog position in scientific. So it wasn’t a total loss. It was like -- already we can see signs, a lot of those orders were later released. They were just held up for 3 weeks, but that was a critical 3 weeks for us, it’s that kind of dynamic.

And your last question comes from the line of James Gibson with Punch & Associates.

All my questions have been answered.

Oh, okay. Thanks very much. Okay. Well, I guess we’ll go ahead and wrap up at this point. So all-in-all, I would have to say the quarter and the near-term economic outlook are a disappointment to us, but in spite of that GSI as a company is very focused and energized in working towards an ultimate goal of building a world-class franchise and being a leader in all of our markets, attracting best-in-class talent, delivering sustainable profitable growth and strong shareholder returns. We’re early in this game, but we’re making good progress in many, many areas. We’ve put in place a strong leadership team that is capable of delivering on all of our plans. And we’re steadfastly committed to delivering on the promise of GSI. In closing, I’d also like to mention that we will be presenting at the upcoming CJS Securities Summer Conference on August 14 in the New York area. We hope to have a chance to meet with some of you there. In any case, we look forward to joining all [Audio Gap] on our third quarter 2012 earnings call in November. Thank you very much for your interest in GSI. And this call is now adjourned.

This concludes today’s conference call. You may now disconnect.