Robert Buckley - Chief Financial Officer John Roush - Chief Executive Officer.

Lee Jagoda - CJS Securities Jim Richiutti - Needham Michael Kurlancheek - Sidoti Tom Kerr - Singular Research.

Ladies and gentlemen, thank you for standing by, and welcome to the GSI Group's First Quarter 2014 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the call over to Robert Buckley, Chief Financial Officer. You may begin..

Thank you very much. Good afternoon and welcome to GSI Group's first quarter 2014 earnings conference call. I am Robert Buckley, Chief Financial Officer of GSI Group. If you've not received a copy of our earnings press release, you may get one from the Investor Relations 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 earlier this afternoon and also those in our SEC filings.

We may make some comments today both in our prepared remarks and 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 today's forward-looking statements as representing our views as of any date after today.

During this call, we'll be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment in our earnings press release.

To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we'll provide reconciliations promptly on the Investor Relations section of our website. I'm now pleased to introduce Chief Executive Officer of GSI Group, John Roush..

Thank you, Robert. Good afternoon, everybody, and welcome to the call. So I'm happy to be able to tell you that GSI has gotten off to a strong start in 2014. Our customer demand and our order rates were stronger across most of our markets and applications. We completed the JADAK medical acquisition in mid-March.

So it did contribute some sales and income within Q1. And the integration of JADAK has gone extremely well since then. Our revenue and profitability in Q1 both came in slightly ahead of our own expectations, even if you satisfy the contributions that we got from JADAK.

As I had mentioned on recent calls, we now have a stronger, deeper and more capable management team across GSI. This team has enabled us to deliver strong results, while continuing to make progress on our strategic agenda for the company. We continued our ship toward a more attractive mix of end markets and applications.

We continued to invest in product technologies that enable us to capture design wins from major OEMs in our end markets. And we made significant progress on our continuous improvement operational initiative. As I mentioned, we're generally pleased with our financial results.

So I'll only give you a brief summary and Robert will go into more detail in his section. Our Q1 revenue was $79 million, up 5% versus a year ago with JADAK contributing $2 million during the last couple of weeks of March. Adjusted EBITDA was $11.3 million, up slightly from Q1 2013.

Both the revenue and adjusted EBITDA figures were above the high end of our previously communicated guidance ranges, even if you exclude the JADAK contributions. Q1 EPS was $0.08 on a GAAP basis and $0.14 on a non-GAAP basis. At this point, I'd like to provide some commercial updates on our progress across the company.

Overall, we saw an improving demand picture across GSI in Q1. And barring any unforeseen macro headwinds, we expect that improvement to continue throughout this year. Our overall book to bill ratio was 1.08 in Q1, with all three of our reporting segments above 1. Nearly all of our major product lines had year-over-year revenue growth in Q1.

The only meaningful exception was NDS, which is cycling up against the customer dual sourcing event that was communicated a year ago. Obviously the growth that we saw deferred based on the individual product line circumstances, but we did get positive contributions in most areas.

So let me start with the Laser Product segment, which remains the largest of our three segments. Lased-based revenue increased by 10% in the first quarter versus a year ago, with all of the business lines contributing to that growth. The book to bill ratio was 1.04.

Our sealed CO2 laser product line had strong demand during the quarter, with sales increasing 15% versus Q1 a year ago. We also closed on 10 new design wins with OEM customers, which will bolster future sales levels. Nine of those 10 wins were in mid-power applications such as engraving, cutting, marking, wire stripping and leather processing.

We also received major volume orders from a 3D printing OEM in the quarter. CO2 customers showed strong interest in some of our new products, including our mid-power pulsed P250 laser and our Flyer 3D marking head which can be paired with our CO2 lasers ranging from 10 watts to 400 watts.

Our CO2 production site in Mukilteo, Washington, also led with the way within GSI on our journey towards operational excellence by holding three kaizen events during Q1, part of an overall effort to increase gross margins by several percentage points versus a year ago on CO2 products.

Our laser scanning and beam delivery products had 6% growth in revenue, with particularly strong demand for our galvanometers, which had double-digit growth in the quarter.

Over the last year, our standing management team has had significant growth efforts underway to identify and pursue new scanning applications and to launch new products targeted at those applications.

The applications in the focus include ophthalmic imaging of the retina, surgical lasers, dermatology and aesthetic applications, the hole drilling and high-speed marking.

As a result of these efforts, during Q1, we increased our overall laser scanning funnel of future business opportunities by more than 25%, including over 20 potential new medical programs. So the scanning product line is building significant momentum for future growth.

We will be supporting these opportunities with several notable new product launches during the balance of 2014. The overall growth and scale of the scanning business has increased significantly over the last couple of years, which has strained our production capacity and that of our supply base.

Significant internal efforts are underway with respect to lean manufacturing and strategic sourcing to increase capacity, reduce lead times and improve the linearity of our production and shipments within each quarter. Sales of fiber laser products increased double-digit versus Q1 2013 due to increased order volume and several new customer wins.

We continue to participate in this market as a niche player and we see growing demand off of our small base. As I had mentioned on recent calls, our restructuring efforts have significantly improved profitability of this product line and further material cost reductions efforts are planned for the balance of 2014.

Turning to the Medical Technologies segment, the most important development obviously was the JADAK acquisition, which closed on March 14. The integration of JADAK has gone extremely well to date. We've had a full time GSI integration managers stationed on-site since really even before the closing, and this has been a benefit.

But the quality of the JADAK management team and the overall capabilities of the business have really impressed us. JADAK's customer demand is quite healthy and the business is performing well.

Thus we feel quite good about their performance relative to the guidance we had previously provided of $40 million of sales for 2014 for the period of time we were on the business.

If you were to have viewed JADAK as a standalone business in Q1 irrespective of whether we owned it or not for any portion of the quarter, their sales grew 12% versus Q1 2013. And we're expecting a fairly similar result for Q2.

It's also very clear to us that JADAK has a highly attractive medical OEM customer base and an exceptional medical customer sales and growth engine. The addition of the JADAK products and the strength of their team have taken on medical strategy to another level.

We now have a dozen different medical technologies across the company that we can offer to the medical equipment OEMs, and these are used across at least 20 distinct application areas.

Across GSI, we now have supply relationships with most of the leading OEMs in the medical equipment market, and our annualized sales in this area are approximately $170 million. We've now set up the process for our initial strategy to cross-sell all of our medical product lines into our key accounts.

In the first six weeks since we've owned JADAK, we've already identified a funnel with nearly 20 potential new customer designing opportunities for our medical sales teams to pursue based on the key account cross-selling approach. In the quarter, our sales of medical displays were down substantially from Q1 2013 level.

This decline was largely due to the dual sourcing by an OEM customer and that was communicated to us in March 2013, but did not really begin to impact our sales until the second quarter of 2013. So we had a very challenging comparison in the first quarter this year.

NDS did receive FDA approval of two radiology display products, the S10 and the S6c, both of which will improve our product offering in the radiology market and will benefit future revenue.

Our sales of thermal printers for the medical applications were up 12% in Q1 versus prior year, with the book to bill ratio at 1.18, based on stronger order rates across the existing customer base as well as several new OEM design wins that contributed to Q1 sales.

Our thermal printers are used in applications such as patient monitoring, (inaudible) and implantable device monitoring. So moving on to our Precision Motion segment, in the first quarter, sales of motion products increased 12% on a year-over-year basis.

Sales or optical encoders increased 18% on the strength of new program wins in wirebonding and surgical applications. Encoder sales in the medical applications were up substantially versus both the prior year and the prior quarter. Our sales of air bearing spindles also increased in the quarter versus the prior-year level.

Our traditional spindle market and printed circuit boards via hole drilling was positive in Q1 and is expected to remain so throughout 2014. In recent quarters, our team has increasingly focused on developing new spindle applications outside of the printed circuit industry.

These new programs are designed to diversify our spindle revenue base, improving the stability and growth potential of this product line. During Q1, we were awarded several new programs in these areas, with non-PCB spindle sales now approaching 40% of the total.

So with that, I'll turn the call over to Robert to provide more details on financial performance.

Robert?.

Thank you, John. As John mentioned, we had a number of transactions which affected our financial statement. In the first quarter of 2014, we classified the scientific laser business as held for sale.

As a result, certain product period information included in the consolidated financial statements have been reclassified to report the scientific laser business as discontinued operations. It conforms to the current period of presentation.

This means the results we will discuss today in our continuing operation results exclude the scientific laser business. Similarly, our Laser Products segment excludes the scientific laser business.

In addition, on March 14, 2014, we acquired 100% of JADAK, a North Syracuse, New York-based provider of optical data collection and machine vision technologies to OEM medical device manufacturers. The operating results of JADAK have been concluded in our consolidated statements of operations since the acquisition date.

During the first quarter of 2014, GSI generated revenue of $79.1 million, an increase of 5% from $75.1 million in the first quarter of 2013. The JADAK acquisition contributed $2.2 million to the revenue increase year-over-year. Changes in foreign exchange rates favorably impacted revenue, causing a roughly $800,000 increase in revenue.

Excluding the impact of the JADAK acquisition and changes foreign exchange rates, the company's revenue increased by 1.4% compared to the first quarter of 2013. Overall, all but one of our businesses reported growth in the first quarter.

Sales of our Laser Products for the first quarter of 2014 increased nearly 10% to $41.9 million compared to $38.2 million one year ago. Sales of Medical Technologies for the first quarter 2014 decreased 5% to $22.4 million compared to $23.6 million one year ago. The JADAK acquisition added approximately $2.2 million to this quarter.

However, sales of visualization solutions sold under the NDS and Dome brands were well below levels for the same period last year. This was driven by a single customer dual sourcing of products to them, which dramatically reduced our revenues to the business beginning in April of 2013.

Finally, sales of Precision Motion in the first quarter of 2014 increased approximately 12% to $14.9 million from $13.4 million in 2013. First quarter gross profit was $32.1 million or 40.6% gross margin compared to gross profit of $30.6 million or 40.8% gross margin during the same period last year.

Laser Products' first quarter gross profit was $17 million compared to $15.5 million in the same period last year. Gross profit margins of our Laser Products remained flat year-over-year at 40.6%. Gross profit dollars increased $1.5 million or roughly 10% from the same period last year as a result of the sales growth.

Medical Technologies' first quarter gross profit was $8.9 million, reflecting a 39.7% gross margin compared to $9.5 million or roughly 40.2% gross margin for the same period of last year. The JADAK acquisition accounted for an $800,000 increase in gross profit year-over-year.

Excluding the impact of JADAK, gross profit dollars decreased by $1.3 million primarily as a result of the decline in sales volume in our visualization solutions and informatics sold under our NDS brand. This decline was directly associated with the before-mentioned dual sourcing by a single customer.

Precision Motion first quarter gross profit was $6.4 million, reflecting a 43% gross margin, compared to $5.8 million or 43.2% gross margin for the same period last year. Gross profit increased $600,000 or 11% compared to the prior year. The increase is predominantly due to increases in sales volume.

Operating expenses decreased $28 million in the first quarter 2014 from $29.2 million in the first quarter of 2013, a decrease of approximately $1.1 million. Research and development expenses were $5.1 million or 7.4% of sales compared to $5.8 million of 7.7% of sales during the prior year.

The increase in R&D expense as a result of the JADAK acquisition was largely offset by a decrease in R&D project spending primarily due to the timing of such project expenditures. SG&A expenses were $19.6 million or 24.9% of sales during the first quarter compared to $18.7 million or 24.9% of sales during the first quarter 2013.

SG&A expenses increased in terms of total dollars due to the addition of JADAK SG&A expenses and an increase employee compensation expenses as a result of investments we're making to accelerate our progress on our strategic objectives.

Operating income amounted to $4.1 million or 5% of sales compared to $1.5 million or 1.9% of sales in the first quarter of 2013.

Adjusted EBITDA, a non-GAAP financial measure, which includes the adjustments noted in the non-GAAP reconciliation attached to our earnings press release, was $11.3 million in the first quarter of 2014 compared to $11.1 million in the first quarter of 2013.

The increase in adjusted EBITDA was predominantly attributed to the acquisition of JADAK and increases within Laser Products and Precision Motion businesses offset by the before-mentioned single customer dual sourcing decision with our NDS product line.

Our businesses are seeing the benefits from cost reductions from our productivity initiatives, particularly our continuous improvement programs and a better mix of customer and product sales.

With strong growth in nearly all our business lines, we continue to see the benefit of our strategy to focus on more sustainable, predictable and profitable advanced industrial and medical technology markets.

While the decline in the NDS sales caused by the dual sourcing decision by its biggest customer masked some of the progress and success this quarter, we expect to be largely through this challenge in the second quarter and expect more apples to apples comparisons for year-over-year views going forward.

Diluted earnings per share from continuing operations was $0.08 in the first quarter of 2014 compared to $0.05 in the first quarter of 2013, a 60% increase in GAAP earnings per share.

Non-GAAP earnings per share, non-GAAP financial measure, was $0.14 in the first quarter compared to $0.16 in the first quarter of 2013, however, included in the first quarter 2013 results was $1.2 million foreign exchange currency gain. Turning to the balance sheet, as of March 28 of 2014, cash was $31.7 million. Our total debt was $136.6 million.

The increase in our gross debt was attributed to borrowings under our revolving credit facility to pay for the $93.5 million cash purchase price for the acquisition of JADAK and the more than $1 million in associated financing and acquisition related cost.

We completed the first quarter of 2014 with approximately $104.9 million of net debt, as defined in the non-GAAP reconciliation table of our earnings release.

The weighted average interest rate on the senior credit facility was 3.4% during the first quarter of 2014 and our consolidated leverage ratio at the end of the quarter was approximately 2.2 times considering our gross debt and pro forma EBITDA. Operating cash flows from continuing operations for the first quarter of 2014 was $2.8 million.

Our cash flow generation in the quarter was a disappointment. The organization has made tremendous improvements in solving payment terms, reducing past due receivables to low single-digit percentages and lengthening our vendor payment terms, as well as reducing our inventory levels.

Unfortunately, as a consequence of bookings coming in later in the quarter and the overall maturity of the manufacturing competencies, our shipments across many of our businesses were very back-end loaded. While this is mainly a timing related impact to cash, it was still an unacceptable outcome.

To strengthen our result to make the investments necessary to transform our manufacturing capabilities to world class.

Turning to the second quarter of 2014, we expect revenue from continuing operations of $90 million to $95 million, representing year-over-year revenue growth of 13% to 19% on reported basis, and we expect adjusted EBITDA to be in the range of $13 million to $15 million.

We're expecting depreciation and amortization expense for the second quarter of 2014 to be approximately $1.9 million higher than the first quarter 2014 at $6.7 million, the increase driven by the acquisition of JADAK. Included in this figure is an expected acquisition fair value adjustment related to inventory of approximately $500,000.

We expect stock comp expense to be roughly $1 million, excluding the impact of the JADAK earn-out. Earn-out related costs are expected to be approximately $500,000 with another $200,000 remaining restructuring and acquisition related expenses.

We continue to expect our full year 2014 non-GAAP tax rate to be less than 37%, while our cash taxes paid to be less than 30%, driven largely by geographical mix of income. We have a number of projects underway to further reduce our tax rates, but do not expect to start seeing the benefit associated with this planning until 2015.

We look opportunistically at reducing our gross debt balances, ensuring we consider the relatively low 3.4% borrowing rate. Overall, we demonstrated solid financial results in the first quarter of 2014, whilst still investing in our business and positioning us for a stronger year and beyond.

Our businesses are performing as we planned, with strong growing pipeline of new opportunities and potential design-ins. Finally, we expect to deliver a fairly solid second quarter with further progress on the continuous improvement initiatives and strategic objectives. This concludes our prepared remarks. I'll now open the call up to questions..

(Operator Instructions) Your first question comes from the line of Lee Jagoda with CJS Securities..

So in the past, you described your long-term organic growth targets for the business as roughly 5% topline and 10% in the bottomline.

Now that over 40% of the business is medical components, does that shift your view at all with respect to growth?.

Yeah, Lee, I would say it probably does on a kind of medium-term basis. We think the medical business can do better than that. I mean it sort of depends whether you own it. I've seen a couple of recent studies of medical capital equipment in a couple of different public forums that said growth is 6% to 7%, in those areas.

So I don't think you want to get too crazy, but it's probably higher than 5%, right? And then our advanced industrial stuff is a blend of different end markets in there, some low growth ones like the PCB mechanical via hole drilling, but there is some higher growth stuff. So I think that's probably a 4% to 6%. And let's say in medical, it's 6%, 7%.

And when you weight average, I think you would come to out something higher than 5%..

And then just switching gears a little bit, how much of the roughly $5 million of continuous improvement costs that you anticipated for this year were incurred in Q1? And then as a follow-up to that, is it still your expectation that the cost and the benefit you receive should roughly offset each other for the full year?.

I think it's all still valid. I would say the actual savings realized in Q1 was pretty small in the few hundred thousand range. But we're tracking these initiatives. Some of it is supply chain stuff, where you have that in place..

For consuming your old inventory before you can consume the new inventory. So I think based upon the guidance that we provided earlier this year, that hasn't changed. And for the most part, what you're looking at is a back-end loaded savings for the front-end loaded cost associated with the investments..

Your next question comes from the line of Jim Richiutti with Needham..

With respect to some of these productivity initiatives that you have underway, if we think about the margins in the three business areas, where should we begin to see the benefit of these? You talked about some things you're doing in simulated sealed CO2.

As we think of those business units, where should we see the margin improvement from these initiatives? And I realize there are some other things going on as well..

It's fair, Jim. I would just say based on where we've been holding the kaizen events and where we're targeting some of the supply chain sims, it's disproportionately going to hit the laser segment.

I mean there is opportunity in other areas, but I think the medical segment probably a bit more the focus is on growth and it's more balanced between growth and productivity in lasers. We've had a series of kaizen, virtually all been touching in either the CO2 or the scanning business at this point.

And some of the major kind of supply chain and other initiatives are touching those businesses. Over time, that'll probably balance out, but we're not that far along in terms of deploying lean across every single place we do it. We're building up the institutional learnings and capability as we go.

And some of our most experienced people have been deployed thus far in lean and strategic sourcing on the laser side. You said there's $5 million in benefit. I mean we're not actually tracking it that way by segment. But if we said there's $5 million in savings, more than half of that is going to hit lasers..

You mentioned that there were some timing around project spending in R&D. R&D, how should we think about that going forward? I was a little surprised with the level that came in at..

It will tick up a little bit. So as you get into the second quarter, it'll probably stay closer to the 8% to 8.5% and then will come a level out around 8% on a go-forward basis, somewhere around that, with the acquisition of JADAK adding a little bit to that. But you'll see R&D tick up a little bit..

John, you alluded to some non-PCB applications in the spindle business.

Can you expand on that, elaborate on where those applications are coming from and how meaningful they might be?.

Well, I think we kind of said they're starting to get meaningful for the whole spindle business that it's in the range of 40% of the revenue now. It even almost surprised us as it started to blossom. It's in a few different areas. So some of it is in the aerospace industry and actuation and other kind of precision devices on commercial aircraft.

There is some of this in the power generation and the turbine business. Some of it is in polishing and grinding and spraying, even some cutting type applications. It's a variety of things. I mean I think it's really just that team is a very capable team that's been driving the business and their end market got mature on them.

But there's 70 microns and below hole diameters. There's a lot more laser via hole drilling going on. By the way, we're participating in some of that on the laser side of the business. But it's impacted the spindle business. So the very good and capable team you have there, started looking for other opportunities.

And it took a while for those to bear fruit. We've been working on it for a while, but we're starting to see them move the needle on that. And it's beneficial, because the amount of real PCB spindles is not that much. So even if it went in half, which I see no sign of that happening, but it's not all that painful for us.

And 18, 24 months ago, we were sitting on a much higher revenue base in that PCB space, where the downside was more alarming, but it's just not there anymore. Other applications grow, right, so as they come online, I don't think that as volatile and they do grow. Some of them have sort of in the aerospace programs 10-year life on some of this stuff..

Your next question comes from the line of Michael Kurlancheek with Sidoti..

I was just looking at the Q and it appears that the sales of your scientific lasers business closed in May..

That has not closed yet..

It's still in process..

We classified it as a discontinued operations business. So it's a held-for-sale, but negotiations are still in process there. So I wouldn't expect anything at least for now..

So there's about $1.8 million losses in discontinued.

Is that a number we should expect to see in the second quarter? Do you think it'll be above or below that?.

Well, there's two elements that you see flowing through that. One is that the LOI that we have in place is for amounts slightly west than the book value of the business. And so you're writing down on the assets associated with that. The second was there were some losses incurred in the business.

The business itself incurred losses relatively around $1 million in the first quarter. Part of that was just transitioning into a new manufacturing facility out of an old facility. And so there is some interruptions there. It won't sustain those types of losses going into the second quarter. But I wouldn't expect any contributions from this..

And then just in terms of the display sales, I know you guys were feeling a little bit of the dual sourcing effects still to this date.

Do you know when those effects should dissipate?.

Well, it's a timing thing, right? So we got notified in the latter part of March, a year since. And we actually in this call a year ago, we spoke to it. But that was a notification. So the sales to the other vendor began during the course of Q2.

So as you get to that point, now you're cycling up against quarters that were partially or fully impacted by the dual sourcing. Q1 was not at all impacted. So you're comparing 100% share of that customer a year ago than a much smaller share now. I think Q2 will be a lesser effect. And then in the second half, there is no effect..

Right. And the business in the second half is going to start seeing growth on an apples-to-apples comparison at that point in time. And the inherent nature of the business is that we'll have some growth associated to it..

Your next question comes from the line of Tom Kerr with Singular Research..

Maybe just go over sort of M&A market and what you're seeing out there, any opportunistic deals maybe and by each segment, where do you see the most value or opportunities by each of your business segment?.

We do see opportunities. And even though we just closed the deal and we're focused on integrating that and getting that strategy right with JADAK, we continue to look at other things. There is a series of smaller opportunities in the medical space that would be, I think, synergistic to what we have now and we are in discussions on some of those.

These are definitely less than $50 million deal value type of transactions. But I would say we're not limiting ourselves into just the medical space. There are things both within the laser side of things and the precision motion that we've had ongoing discussions with.

The challenge is we typically are sourcing acquisition ideas through our business relationships or through specific strategies. We're not just looking at companies that are for sale. We're trying to cultivate opportunities that may not be for sale. So the timing can be kind of drawn out and unpredictable, privately-held companies.

And so it's really hard to say when we could free up something and do it. I would do it probably as later in the year type of opportunity. But there are some things we're looking at..

And there are currently no further questions..

Okay. Thank you, operator. So in wrapping up the call, I would like to reiterate that we are pleased with Q1 as we see it as a strong start to the year. Each quarter, it's becoming clear to me that GSI is making tremendous progress as an organization.

With an outstanding management team in place and a more attractive portfolio of products and technologies, we're now in a solid position to deliver sustainable profitable growth over time. Our agenda for 2014 is pretty clear.

The integration of the JADAK acquisition is progressing well and the medical strategy and the cost fertilization of our customer channels is gaining momentum. Most, if not all, of our product lines across the company are delivering organic growth as we move through the year.

Our efforts to improve our operational capabilities are bearing fruit in terms of customer satisfaction and also cost and margin productivity. Economic conditions continue to improve at a moderate rate growth. If that remains the case during the balance of the year, we're confident 2014 will be a strong year for GSI.

But irrespective of the economy, I'm confident we can successfully execute on our plans and achieve our ultimate strategic and financial goals. I know I speak for the board and the management team across GSI when I say that we're all passionate about the company's future and we're committed to deliver on the significant potential we see here.

I appreciate your interest in GSI and your participation in today's call. I would also like to note that we will be presenting at two upcoming investor conferences. In two weeks, we'll be at the B. Riley conference in the Los Angeles area. And in July, we'll be at the CJS Securities conference in White Plains, New York.

I look forward to seeing some of you at those events and joining all of you in August on our second quarter earnings call. Thank you very much. This call is now adjourned..

Again, thank you for your participation. This concludes today's call. You may now disconnect..