Nordson Corporation (NDSN) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Nordson Corporation Webcast for Third Quarter Fiscal Year 2013. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call, Mr. Jim Jaye. You may begin, sir.

Thank you, Kevin, and good morning. This is Jim Jaye, Nordson's Director of Investor Relations. I'm here with Mike Hilton, our President and Chief Executive Officer; and Greg Thaxton, our Senior Vice President and Chief Financial Officer. We'd like to welcome you to our conference call today, Friday, August 23, 2013, on Nordson's third quarter results. Our conference call is being broadcast live on our webpage at www.nordson.com/investors, and will be available there for 14 days. There will be a telephone replay of our conference call available until August 30, 2013 by calling (404) 537-3406. You will need to reference ID# 26582072. During this conference call, forward-looking statements may be made regarding our future performance based on Nordson's current expectations. These statements may involve a number of risks, uncertainties and other factors as discussed in the company's filings with the Securities and Exchange Commission that could cause actual results to differ. After our remarks, we'll have a question-and-answer session. I'd now like to turn the call over to Mike Hilton for an overview of our 2013 third quarter results and a bit about our fourth quarter outlook. Please go ahead, Mike.

Thank you, Jim, and good morning, everyone. And thank you for attending Nordson's third quarter 2013 conference call. Let me begin by thanking our global team for delivering a solid quarter in a tough macroeconomic environment and in comparison to a particularly strong period of demand a year ago. We continued to meet our customers' needs at a high-level during the quarter, while also making investments and executing on continuous improvement initiatives that will drive our future success. Sales in the quarter grew by 6% and were primarily driven by the first year effects of acquisitions. Earnings in the quarter were $1.01 per share. On a sequential basis, third quarter sales, operating profit, operating margin, net income and earnings per share all increased over the levels reported in the second quarter. During the quarter, we continued our investments in new products and applications and emerging market expansion and we enhanced customer-facing capabilities. We are balancing these investments, as always, with a prudent approach to discretionary spending. During the quarter, we also announced an agreement to acquire 2 businesses of Munster, Germany-based Kreyenborg Group that will add to our position as a premier supplier of engineered melt stream components to the polymer processing customers worldwide. We'll provide more details on this acquisition later in the call. In addition, our board reiterated its continued confidence in the long-term strength of our company and ongoing commitment to providing value directly to shareholders by recently announcing a 20% increase to our dividend and the authorization of a new $200 million share repurchase program. Looking forward to our fourth quarter, global macroeconomic growth remains modest and has not increased at the pace anticipated by many forecasters earlier this year. Our current backlog and guidance reflects this challenging environment. In a few moments, I'll share additional comments about the current business trends and our outlook, but I'll first turn the call over to Greg Thaxton, our Chief Financial Officer, who will provide more detailed commentary on our third quarter financial results, as well as some comments on our guidance for the fourth quarter of 2013. Greg?

Thank you, and good morning. As Mike described we delivered solid third quarter results, with sales in the quarter of $403 million, an increase of 6% over the prior-year third quarter. This growth included a 7% increase related to the first year effect of acquisitions and a negative 1% impact related to unfavorable effects of currency translation compared to the period a year ago. On a sequential basis, performance in the quarter represents a 5% increase over second quarter sales. Looking at sales performance for the quarter by segment, Adhesive Dispensing sales volume increased 13% as compared to the prior year third quarter, with nearly all of the increase coming from the first year effect of acquisitions. Organic volume growth in legacy packaging and general product assembly product lines was offset by some softness in our nonwovens and polymer processing product lines during the quarter. On a regional basis, Asia Pacific, Japan and Europe all delivered organic volume growth. Sales volume in the Advanced Technology segment decreased 2% in the quarter from the prior year's third quarter, a period in which we delivered organic growth of 33%. Growth in automated and semi-automated dispensing product lines and fluid management components was offset by softness in test and inspection product lines during the quarter. Softness in Asia Pacific offset organic volume growth in the U.S., Europe and Japan. Within the Industrial Coating segment, sales volume in the current quarter increased 10% compared to the prior year third quarter, driven mainly by the first year effect of acquisitions. Organic volume expanded in powder and liquid coating product lines and in Asia Pacific, Europe and the Americas, but was offset by softness in other product lines and regions, mainly large dollar cold material systems serving automotive OEMs. Gross margin in the quarter was 56%, down 1 percentage point from the second quarter due to a higher mix of systems revenue. Operating profit for the third quarter was $93 million, up 13% from the second quarter. Operating margin was 23%, an improvement of 160 basis points over what we delivered in the second quarter of this year, with 53% incremental operating margin upon the increased sales volume. Looking at operating performance on a segment basis, Adhesive Dispensing delivered operating margin of 26% in the third quarter, equal to the performance in the second quarter of FY '13 on slightly lower revenue, and up 2 percentage points from the first quarter performance, with volume leverage driving this increase. The prior year's third quarter performance did not include a full quarter of acquisitions, so sales mix has an impact on operating margin year-to-year. Within the Advanced Technology segment, operating margin for the third quarter was 28%, a 3 percentage point improvement over the level generated in the second quarter, as strong sequential sales growth generated incremental margins of 46%. Excluding the $2 million of incremental spend within this segment associated with the 2 strategic initiatives we've called out in previous quarters, operating margin in the quarter was 30%. As compared to the prior year's third quarter operating margin of 33%, customer mix and product mix where we have successfully penetrated new applications requiring less sophisticated solutions and therefore, lower average selling prices, are impacting margin. The Industrial Coating segment generated operating margin of 13% in the quarter, relatively strong performance given the high mix of engineered systems in the quarter. Continuing down the income statement, reported net income for the quarter was $65 million and GAAP diluted earnings per share were $1.01, a 20% increase over the second quarter. We've included an earnings per share reconciliation schedule in our press release to reconcile between GAAP earnings and normalized earnings per share to exclude certain items. The current quarter's earnings per share include a $0.02 gain related to an asset sale, a $0.01 benefit related to certain tax items and a $0.01 charge for transaction-related fees associated with the Kreyenborg acquisition. Excluding these items, normalized earnings per share in the quarter was $0.99. The current quarter's EBITDA was $109 million, a 2% increase over the third quarter, and a 15% increase over the second quarter of fiscal 2013. We have included a table within our press release reconciling net income to free cash flow before dividends. Cash flow from operations in the quarter was $92 million and third quarter free cash flow before dividends was $85 million, which represents a cash conversion ratio of 130%. As Mike mentioned, during the quarter, we announced an agreement to acquire the polymer processing businesses Kreyenborg Group, which is expected to close during our fourth fiscal quarter. These businesses are highly complementary to our other recent acquisitions in the polymer processing space, and fit our strategy of providing our customers with high-value, mission-critical melt stream components that will enhance the performance of the systems they supply to end users. These businesses also immediately strengthen our relationships with key OEM customers, deepen and expand our product offering, enhance our overall application expertise, expand our addressable market and add recurring revenue opportunities to the portfolio. We expect to build on the current strong performance of these companies by leveraging Nordson's scale, global footprint and continuous improvement competencies. As we described in our July press release, the businesses had sales of approximately EUR 62 million in calendar 2012, and employ about 270 people. For competitive and commercial reasons, we are sensitive to discussing specific financial performance of the businesses. In general, we would describe these properties as high-performing businesses, with EBITDA margins similar to the levels we have previously described for other recent acquisitions in this space. The businesses are headquartered in 2 facilities in Germany, close to key OEM customers, with 3 additional smaller support operations in the U.S., China and Malaysia. Most of the leadership team is expected to remain in place, and more than 1/2 of the sales are to the Europe and Middle East region, with about 1/3 in Asia and the remainder in North America. About 35% of sales are to plastic extrusion end markets, where we have a strong presence; with the remaining portion serving plastic compounding and recycling end markets, which are new spaces for Nordson. Approximately 25% of sales are replacement or recurring revenue. CapEx is similar to Nordson's at between 2% to 3% of sales. We expect the acquisition will be neutral to fiscal year 2013 results, including estimates for nonrecurring charges for short-term purchase accounting related to the step-up in value of acquired inventory. Over the first full year of ownership, Nordson expects the acquisition to be accretive by about $0.07 to $0.09 per share, again, including estimates for short-term purchase accounting charges. We are excited to add these excellent properties to our portfolio. Our strong cash flow also enabled us to continue returning value directly to shareholders through dividends and share repurchases. As Mike noted, on August 16, our board of directors approved a 20% increase to our cash dividend, making this the 50th consecutive year Nordson has increased its annual dividend. And since the start of fiscal year 2011, we have increased our dividend 71%. And the board also authorized a new $200 million share repurchase program. This new program replaces the board's March 2012 $100 million share repurchase program, under which, approximately $41 million in Nordson shares have been purchased. Since the start of fiscal 2011, we have purchased approximately $246 million or 8% of Nordson's outstanding shares at a discount of approximately 35% compared to our third quarter closing price. Even with our investments and acquisitions and share repurchases, we remain very liquid with net debt at 1.22x trailing 12-months EBITDA as of the end of the third quarter. And we have $292 million available from cash in our revolving credit facility. Before moving on to the outlook for the fourth quarter of fiscal 2013, I'll provide comments on recent order trends. As we typically do, we provided our most recent order data, both on a segment and geographic basis, with our press release. These orders are for the latest 12 weeks, as compared to the same 12 weeks of the prior year on a currency-neutral basis and with all fiscal year 2012 acquisitions included in both years. Looking at orders for the 12 weeks ending August 18, 2013, they are flat as compared to the same 12 weeks in the prior year. As the second half of fiscal 2012 was particularly strong for Nordson, most notably in the Advanced Technology and Industrial Coatings segments, we were up against very challenging comparisons. Within the Adhesive Dispensing segment, orders over the last 12 weeks increased 6% compared to the same period in the prior year. Order rates increased in the majority of the segment's product lines, including polymer processing. Order growth was strongest in the Americas, Europe and the U.S. Advanced Technology is the segment with the most challenging comparisons to the prior year and here, orders over the latest 12 weeks are down 7% compared to the same period in the prior year. Positive order growth in consumable single-use plastic dispensing and fluid management product lines, serving a variety of industrial and medical end markets, was offset by slower activity in automated dispensing and test and inspection product lines. Strong order rates in the U.S. were offset by softness in other geographies. Within the Industrial Coating segment, the latest 12-week orders are flat as compared to the prior-year period. Order growth over the prior year on the powder coating, container coating and cold material product lines was offset by softness in other product lines. Order growth was positive in the U.S. and the Americas. Backlog at the end of the third quarter was down 21% compared to the end of the third quarter a year ago. This change reflects the current macroeconomic environment, which has caused some customers to delaying placing orders for larger dollar, platform-driven systems that helped drive backlog in the third quarter a year ago. Let me now turn to the outlook for the fourth quarter of fiscal 2013. Note that this outlook does not include any impact from the Kreyenborg acquisition. As we have now lapped the anniversary date of acquisitions, we no longer report fiscal '12 acquisitions as acquisitive growth. We're forecasting sales to be in the range of $391 million to $408 million, a decrease of 7% to 11% as compared to the fourth quarter a year ago. This range is inclusive of organic volume growth, down 6% to 10%, and a negative 1% currency translation effect based on the current exchange rate environment. On a sequential basis, the midpoint of this guidance reflects a slight decline from the third quarter. At the midpoint of our revenue forecast, we expect operating margin of approximately 22%. We're estimating fourth quarter interest expense of about $3.3 million and an effective tax rate of approximately 30%, resulting in fourth quarter forecasted diluted earnings in the range of $0.80 -- $0.87 per share to $0.98 per share. With regards to capital spending, we are estimating about $45 million for the full year, in line with our beginning of the year guidance and higher than normal due to specific investment programs in the year. In summary, we have delivered solid third quarter performance, continued to invest in strategic initiatives, executed on our acquisition strategy, increased our dividend and expanded our share repurchase program. Our fourth quarter outlook reflects the macroeconomic environment that has gained little to no momentum, and is in comparison to a particularly strong fourth quarter performance a year ago.

Thank you, Greg. Before taking your questions, I'd like to provide some additional comments on our year-to-date performance and fourth quarter outlook. Let me begin, again, by thanking our global team for serving our customers and capturing demand to drive an extended period of very strong growth. Nordson generated organic growth of 8% in the fiscal year 2012 and continued that pace through the first half of fiscal 2013, far exceeding the performance of most other industrial companies and global GDP. Through the first 9 months of our fiscal year, we have delivered organic growth of more than 4%, which has also outpaced the global GDP. On a sequential basis, sales, operating income, operating margin, net income and diluted earnings per share have improved in each quarter of fiscal year 2013. Despite this solid performance, we're not immune to what is going on in the global economy. Global and macroeconomic growth remains modest at this time, and has not increased at the pace anticipated by many forecasters earlier in the year. Uncertainty in the macro environment is not new. What is new at this time is the more pronounced softening of demand we are now seeing in some emerging markets. Part of the softness is being driven by economies transitioning from export and infrastructure-driven growth to consumption-driven growth. Over the long-term, we expect emerging markets will continue to provide excellent growth opportunities for Nordson in all 3 segments. Our current 12-week order rates reflect these near-term conditions and are flat to the prior year's strong performance. The current economic uncertainty has caused some customers to delay the purchase of new systems, especially those requiring larger dollar investments, which has negatively impacted our backlog compared to the end of the third quarter a year ago. As a result, our fourth quarter outlook is disappointing. Near-term, we are responding through more aggressive management of discretionary spending and the delay of nonstrategic initiatives to help offset the current softness in our top line. At the same time, we remind investors that the current outlook is for a single quarter. We are reacting accordingly while maintaining our strategic focus. The fundamentals of our business are intact and we continue to pursue the strategic objectives that will drive shareholder value. These include: market leadership positions, enduring long-term customer relationships, innovative and differentiated technology, direct sales and service, global reach, strong margins and cash flow, a high-level of recurring revenue from parts and consumables, and a talented workforce and a culture of continuous improvement. We will continue to apply our strengths to meet the needs of our customers better than our competitors to deliver superior returns over the long term. At this time, let's turn to your questions.

[Operator Instructions] Our first question comes from Liam Burke with Janney Capital Markets.

Mike, you talked about the test on the ATS side being a little weaker year-over-year. If we could flip over to the end markets, could you just give us some sense as to how the mobile and medical markets are looking for you on the ATS side?

Sure. I'll start with the medical piece. Medical markets have continued to be strong for us across both the dispense platform and the components platform, good progress year-to-date and we're driving growth going forward with a broadening product line and new application. So that's been pretty solid. I'd say, on the mobile side of things, the mobile part of the business has also been pretty strong. We're up against some really tough comparisons relative to last year. So as we got further through the quarter, our order rates didn't quite keep pace with last year. But I'd say, a very strong year in the mobile business, some different applications driving growth there than what we might have seen last year. And we're still looking for some additional growth to come from changes in features and form factor. I'd say, what hasn't come back at all really, and this has affected the test and inspection piece, is the more traditional desktop, server kind of applications that if you went back at the beginning of the year, most of the industry forecasters expected the second half of the year to pick up. We've really not seen that pick up at all, and that's really been the main thing that's affected test and inspection.

Okay. And you touched on emerging markets as they shift from an infrastructure, export to more internal consumer consumption. That should fit in well for Adhesive Systems, where a lot of the systems that you sell into are for consumer applications. Are you seeing a lag there as that transition occurs? Are you seeing any pick up or anything over the next few months or quarters?

Yes, I would say, we're not seeing the pickup as strongly as we would've anticipated. Now part of that is a function of certain end markets like food and beverage consumption, which has really been, globally, pretty flat this year. But I'd say, yes, we're not seeing quite the pickup that we would have anticipated, particularly in China, where there's a strong focus there. So I think what we're looking to see is when that demand comes back, then we'll see the growth there. And I think in the transition, I think you've seen some things recently, for example, where the Chinese consumer is saving more money than spending more money, we're feeling that a little bit.

Our next question comes from Kevin Maczka with BB&T Capital Markets.

First question for me, on margins, it looks like based on your guidance for the year now, EBIT margins are going to come in 300 basis points or more lower than they were last year. And I'm just wondering, I don't think that was the expectation entering the year and I know we had some margin-dilutive M&A and some mix and some increased tech spending. I'm just wondering, can you kind of give a little color on those major buckets that impacted that, particularly, the M&A side? And where I'm going with this is trying to get a sense for next year in terms of what will be better or not recurring, such as the M&A or the tech spend.

Yes and so -- I'll make a couple of comments and then, I'll let Greg kind of take you through the specifics there, Kevin. Yes I think when, like most other people, in the beginning of the year, we were hopeful that the second half of the year was going to see global GDP growth in that 3% plus, 3.5% range, we're not seeing that. We haven't seen the U.S. step-up in our minds, the U.S. is struggling between 1.5% and maybe, 2%. And China, in particular, is softening and nowhere near, I think in this past quarter, the sort of 7.5%, 8% kind of numbers they're targeting. So that, in itself, has impacted what we've seen in our volume growth and you see it in our guidance going forward. So we're not getting, in one respect, the volume leverage that we would have anticipated if the second half of the year had come back the way most people had expected. Now most people are still optimistic that maybe we're delayed a quarter or 2, but it's coming back. But we haven't seen that yet. So that's an overarching backdrop. I'll let Greg talk about the specifics here.

Yes, I think that's certainly 1 important aspect of the story, and the detail of that is, if we need to see the top line growth to help offset what you're going to see on the spend side with an increase in compensation and other cost from year-to-year. So if you don't get that revenue growth, you might see some margin compression. The other 2 aspects, so Kevin, for example, if you look at our 9-month year-to-date or even within the third quarter, the 3 percentage point change from the prior year, it's really an element of that volume story, but it's also 2 other aspects, which is the dilutive effect of acquisitions from year-to-year and then, the step-up in these 2 Advanced Tech initiatives. So if you kind of factor those out through the 9 months, as well as in the quarter, you'd be about neutral to the prior year's margin performance.

Was mix a factor at all, Greg?

Mix is an aspect of that as well. As I called out, both within Industrial Coating and Advanced Technology, mix was an aspect of overall operating margin and it would impact gross margin as well.

Okay. In terms of the Q4 revenue guidance, can you just maybe touch on that again? Your orders in the quarter were flat, same thing, flattish year-to-date. Usually, orders become sales fairly quickly here. I'm just wondering why the 6 -- down 6% to 10% volume in Q4 doesn't seem to jive with flat orders. Can you just comment on that?

Yes, Kevin. It really comes back to the starting backlog. So the starting backlog most of -- maybe not all of those orders there in the starting backlog get converted to revenue, and that's really where we're down sort of 20%, relative to a very strong last year. And if you look at it sort of partway through the quarter, where -- our orders last year were continuing to rise, basically driven by Technology and Industrial Coatings, they really flattened for 4, 5, 6 weeks during the quarter here, and that's really translated into a lower backlog. So it's really the lower backlog that's really driving the estimates on the revenue for the fourth quarter. I think it's encouraging that the order rates are now sort of at where they were last year, which is, as you recall, very strong order rates, up 15 percentage points from the previous year. But it's really been that period of time where the backlog didn't build at the rate equivalent to last year that is impacting our guidance for the fourth quarter.

Our next question comes from Charlie Brady with BMO Capital Markets.

Can we just look at -- you guys -- you break down the sales by geographic region and the orders by segment, but I'm wondering if you'll -- and the volume segment of that, the -- you said acquisitions are kind of baked into that. Can we extract the impact of acquisitions on the sales by geography to get kind of what your base business sales growth was across the geographies?

And are you talking about the third quarter or on a year-to-date basis?

Yes, third quarter.

Yes, third quarter. I'd say, if we look at just organic volume in the third quarter, excluding acquisitions, we did see growth in Europe and Japan in kind of low single-digits and kind of low single-digit declines in the U.S., Americas and Asia Pacific. And I'd say, going forward, Charlie, on the orders going forward, the acquisitions are helpful to the rates that we're showing there. So the biggest impact has really been around Technology and to a lesser extent, Coatings, compared to strong comps last year.

All right. And I don't know if I missed it when you gave out mix. But can you give us the mix for the business and across the 3 segments and most importantly, Adhesive Dispensing between parts and kind of big systems?

Yes, hang on a second, we'll pull that up.

Yes, I think generally speaking, the mix is more product line and customer than parts and systems within the quarter, but I'll let Greg pull the -- pull those specific numbers now. But we do have -- one of the comments that Greg made on the Technology side in this quarter was buy some new applications for our systems business that are good applications but less sophisticated than, say, our most highly -- high-end leading edge technology and so they carry a little different price point, a little different margin point. So we've had some mix effects there like that.

So Charlie, if I -- if I give you these -- the parts and recurring revenue and just for your -- you've got a benchmark out there of kind of the legacy product lines for Nordson. For the legacy product lines in the third quarter, spare parts and recurring revenue was about 43%, and that's down a couple of percentage points from what it was in Q2, it was about 45%. And if I look in the quarter, where the total company on the legacy was about 43%. Adhesives was several percentage points above that, as was Industrial Coating and then, Advanced Technology was a few percentage points below that company average.

That's helpful. Your comment in the release, Mike, about aggressive management of discretionary spending, can you just give us a little more granularity on what you're doing there and what you mean by that?

Sure. If you look at coming into the year, this is a year that we're looking to step up and make some investments, particularly in technology and emerging markets. And in emerging markets, it's mainly the commercial side. Embedded in that was also some step-up to support growth. So what I would say is, the traditional things that we're managing would be things like travel and living expenses, outside support and consulting fees, those kinds of things. But we haven't seen the volume come through. Based on the softer macro environment, we've been holding off some of the expansion efforts that are sort of the typical growth expansion piece. And now we're looking a little bit more closely, in just this very short term, at some other expenses and resources, quite frankly, that we might add or we may hold off a little bit on adding those resources for another quarter or so. So looking at that, what I'd say is the strategic things, like technology investment or specific transitions like we're doing in the technology business to get more capability local on the ground, it's not impacting. But things that will be normal growth support, we're watching pretty closely in terms of what the resource balance looks like.

Our next question comes from Christopher Glynn with Oppenheimer.

From what you mentioned, the plastics orders are positive now. I'm wondering if you could comment on the magnitude, give a sense of your ability to gauge sustainability there? And really, same question for the ADS segment overall, are you seeing more breath, are you seeing kind of a tied sort of thing, or is that tough to call?

Yes, I would say, on the sort of traditional Adhesives pieces here, we're seeing improvement, for example, now in packaging, which is encouraging. And I'd say, some modest improvement in product assembly but, say, in the nonwovens area, which is a little bit more capital-intensive and bigger projects, we've seen customers push some orders off there. Some had very dramatic plans to convert in an increased capacity and they slowed those down a little bit in the short term. And we think that's a short-term phenomenon, not a long-term phenomenon. So I'd say it's a mixed bag. Packaging started the year a little soft, it has picked up. Product assembly has kind of been flattish. Nonwovens is probably a bit off. So it's been a mix. I'd say, on the plastic processing side, we talked about the biaxial film and the issues there in terms of sort of supply and demand and our focus was around other applications. So we've got some new products in on some other film applications that are starting to get some traction. It's early yet, but we've got our first sort of units out there and sold with good, positive reaction. And we've also seen strong growth in our fluid coating business, which is a big expansion of what we used to do traditionally in our own Adhesives business. So those things are encouraging. I’d say the long-term growth rate there is still encouraging and so we like the business going forward. But I'd say, it's been impacted like the other businesses, with kind of the softer macro and the bigger-ticket items in some of the areas, particularly the dyes, and that's what's been hurt the most as customers have sort of delayed some orders and pushed them back into the next quarter or so.

Okay. And then, on the overall mobile cycle there, where you had tough comparisons, what's your thought on if that cycle has kind of mature as pertains to the volume levels that you've now attained?

Well, certainly, we expect the growth in the mobile segment because really, the smartphone piece, to mitigate from what we've seen over the last couple of 3 years because there was a big penetration issue. But last year, some time, I think, across the 50% mark and that's probably 2/3 to 3/4 of what's sold today are some form of smartphones. So you don't quite have the penetration piece. As we've talked about, the things that we look for are feature changes, so you've got the shrink that puts more computing power in there, which is good. But then, the feature changes also drive applications, whether that's things like camera modules, microphones, that kind of stuff. And then, form factor, where the size changes, also drive some additional growth. So it's a function of what the mix is in that area. And then, there's some new applications, some conformal coating applications that we've been involved with this year that we haven't in the past. So we're looking for those additional applications. But I would say, this year hasn't been a huge year from a feature-, function-driven growth, it's been more about sort of penetration. And I think, going forward, what we're looking at and one of the reasons we're making the transition to have capability to design and build all these systems in Asia, is to have the sort of midtier products that, as some of the guys that do things manually today or the different maybe lower-end phones or different lower market share phones today, that we can be in a position to get some of that business as well. Because today, that's either manual or it's, at most, sort of desktop applications. So that's part of our transition. So our view is, you won't see the penetrations continue at the rate it's at. I think from time to time, you'll see these feature changes, the shrinkage piece is always a plus and then, we're looking for new applications and broadening the customer base there is our growth. And then beyond just the mobile piece, we're looking at other areas like MEMs as an area of opportunity.

Our next question comes from John Franzreb with Sidoti & Company.

Mike, I'd like you to expand upon your comment about large system delays. You just touched on the nonwovens piece. Could you talk about it in all 3 business segments? Because it sounds to me that you expected some orders to come in and they're being pushed out, and can you talk about why that's the case and what are you hearing from your customers?

Yes, and so I would say, number one, the general bid activity out there is still reasonably robust. Number two, if you look at operating rates, operating rates are still reasonably robust and we see that in our parts business, which is up. So those are both encouraging. So -- from our standpoint, the baseline is pretty solid. I think 2 things that we're hearing from our customers in North America is an expectation of greater growth that should've come from sort of improved consumer confidence. And we're really not seeing that translate into GDP at the moment. It could be the sequester effects that had people nervous in the short term. But I'd say, in the short term, they're just holding off another quarter or 2 type of thing. It's not, "Hey, I'm not going to do this," it's just not right this minute. And particularly with, I'd say, smaller and mid-tier customers. And then I'd say, we're seeing that sort of similar kind of feedback from some Chinese customers in particular, but other emerging markets, Brazil is struggling a little bit right now as well. We're placing orders, whether that's in the industrial coatings space, which tends to be the engineered systems or whether it's in the sort of back-end traditional electronic space or say, the bigger dyes that we have. It's really a function of near-term consumer confidence. So in China, for example, everybody's cheering yesterday when the PMI got above 50, but that's the first time in 11 months. So I think our view is it's near-term kind of caution and it's not a long-term issue and the long-term fundamentals are still strong. People aren't canceling orders. They're just saying, "Okay, not this quarter. Deliver it next quarter," that kind of thing.

And in that kind of environment, does the price competition become an issue or it has not gotten that weak yet?

We've not seen anything significant in the way of changes in sort of the market dynamics. And at the end of the day, our value proposition is really around having the best technology and the best support and service to create that value proposition. What I would say is, things that would be a no-brainer like, "Hey, we can give you benefits and a payout in 6 to 9 months," some folks are pushing even some of those off another quarter or 2 just to wait and see. So that's a little bit unusual and I think that's really just a reflection of the current environment and I think, particularly, where emerging markets are now. Some encouraging signs from Europe, it's only 1 quarter set of data, so we're not jumping real high here on that but it's 1 quarter of encouraging data. Certainly, the view here in the U.S. is that we would expect to see some things pick up in the next few quarters, provided Washington doesn't get in the way again. And I think China is really focused on trying to move things to the consumer piece and they may have to do some other things in the short term to hit their target, but right now it doesn't feel like they're on track to hit their targets, so I think we still might see some more action there. So our view is it's really more short term.

Switching gears to Advanced Technology in particular, the new product development spend you have going on there. Can you just give us an update on the timing of revenue recognition from that project? Any kind of update would be great.

Yes, it's going to be a next year kind of revenue recognition piece. What I can say is that we have prototypes built and we're testing prototypes so, sort of, typically, these will go through sort of an A series and the B series type of prototyping. But we've got the first prototypes out there and we're testing them with a select group of key customers. And I'd say, to date, the technology has been good in terms of meeting all of our milestones. The customer's initial comments are positive. We've got a ways to go yet to get to, "No kidding, we're going to go ahead and buy these and install them." But it will be 2014, probably, it's more towards the second half.

Okay. And Greg, if you said this, I apologize, the sequential SG&A number on the higher revenue, whatever it was, about a $4 million drop down. What was that from?

You're talking from second to third quarter?

Correct.

Yes. Some of that's going to be, let's say, performance-related spending. So as we're moving through the year and now we've kind of tuned our outlook for a softer year than what we might have expected. You've got some true-up in some of your performance-based spending.

So 4Q, SG&A should be similar to 3Q?

4Q...

Given that we had a bit flat revenue outlook?

Yes, flat revenue outlook. It's likely to be up a bit sequentially, as you get back to your normal spending rate on this new outlook. Through 9 months, there's a bit of kind of a true-up of where we are through 9 months versus where we had been through 6 months.

Our next question comes from Jason Ursaner with CJS Securities.

I'd like to follow up on the commentary before for the automated dispensing portion of the Tech segment in terms of the penetration versus refresh cycle. From an order perspective, you mentioned last year, obviously, was a difficult comp with capacity installations. Expectations have been that even despite that, growing application demand for flip chip could keep orders at that or maybe even higher levels, the timing of orders was a big question, needing to be in place for product launches. So how was that you changed it all, is it the capacity that's in place you used to fulfill more demand than you previously expected? And if orders do materialize, what would lead times look like for that business?

Yes, so I would say, Jason, we did probably expect a bit more robust growth in the mobile segments here this year that we're seeing right now. And I'd say, the flip chip piece is doing just fine in terms of the applications. I'd say, we haven't seen as much sort of form and feature changes than we might have anticipated here, and we supplemented that with some newer applications that we got involved with that we weren't involved with in the past. I'd say, the launch cycles this year from the main guys have been more modest, with some, I think, step-up probably in the next year. But we also see some traction coming from a variety of other suppliers, mostly Asian-based that we're developing relationships with and today, they do things manually. So our hope is that our tiered product approaches will attract some opportunities for them to supplement as they grow and gain share.

And what would the margin profile look like on the more advanced, leading-edge, top-tier supplier versus this mid-tier product?

They'll be higher, it's not like one is 70 and one is 20. They'll be higher but within a reasonable range. But quite frankly, the reason we're building out, as we talked about in Xuzhou, both from a design and engineering and manufacturing capability, is also being able to manufacture locally. So we think those will be good margin opportunities as well but obviously, the more full-featured, the better for us.

Okay. And following up on the questions for -- you said -- with the packaging, was there any clear turnaround from the pressure you've seen earlier in the year after the Freedom launch, and in hindsight, were customers maybe holding off at all there in anticipation of that?

No, I would say, in the beginning of the year, I think if you looked at sort of food and beverage consumption, it was actually negative. And so I think people were holding off because the actual consumption was negative and now that's turned around to be positive. Not largely positive but positive and likely, will be modestly positive for the year. So I think it's really been more of a change in the consumption pattern there. I'd say, with regard to the Freedom launch, we're on track, we expected to sell several hundred here since our launch in May. We have, we've got a lot sort of in the early install and development and some going through full shelf life testing with customers, but the feedback is good. And we really haven't launched the product, we will this fall, into most emerging markets. It really has been U.S. first, then followed about 1 month later in Europe and then, this fall, it will be launched in emerging markets. So I'd say we're on track, but I don't think that's had a huge impact on things. We've really been more of the underlying food and beverage consumption as one of the key indicators.

And for the plastics piece, you mentioned growth. I didn't hear it, but I may have missed it if you gave the magnitude of that growth, but also, how did this break down in terms of replacement versus OEM orders and the mismatch in capacity that you previously talked about? Are you still seeing it at all in that market?

Yes, I would say, the mismatch in capacity is still there, it's in primarily 1 application but it's an important one for the dye business. It's the biaxial film, which is quite frankly, ultimately, will be the highest growth part of the business and the most sophisticated part of the business. But right now that mismatch in capacity, given the softer global demand, is still there and it's probably another few quarters until we see it. And we're working through that. In the interim, what we focused on is other applications, so other types of films that we weren't as exposed to. And we developed products in the last year, placed them now and getting good feedback and continued to work on orders there. The fluid coatings part of the business, which is basically sort of water-based. Applications have been going very strong and that's one that we'll look to expand geographically. And then, I'd say, the other side of that is really, in general, globalizing the business a bit more. We've now -- we've got production capability in China, in Thailand and we're looking to ramp that up as we're able to reduce lead times on the delivery of a number of these products.

Our next question comes from Mark Douglass with Longbow Research.

Greg, so what are your expectations for gross margins in 4Q?

Yes, I think our expectation would be in line with Q3, perhaps, up above that 56%, probably somewhere between 56% and 57%, given the strength and likely a mix impact of Adhesives.

Okay. And then, looking at the 3Q gross margin, I believe you mentioned that a lot of it was weaker than expected, and we were talking about 58% right at the midpoint. Were systems -- system sales were worse than expected? I mean, I'm just trying to...

Mark, I think the comments that I made regarding segment performance where, for example, in Industrial Coating, we had some good growth in our powder systems, those are engineered systems that tend to carry overall lower gross margin. We also have the both products and customer mix effect that we talked about within the Advanced Technology segment. So kind of overall weighting of systems versus parts and then, those particular aspects of the types of systems sold had the biggest impact on gross margin.

Because it seemed like some of the larger systems in ICS were given a longer lead time. So were there several that you shipped in the quarter that you weren't aware of when you gave the initial guidance?

Yes, and you'll see that within some of those systems is, from the time that we issued our guidance, that we've got some of those system orders that come in, they may get out within that current quarter.

Okay. It wasn't related to production hiccups and engineering problems with some of these systems that you were...

No.

Okay. And then -- and Mike, you talked about the last I think these 5, 6 weeks -- the last 12 weeks for your orders, the orders just weren't coming in like you had hoped, has that stabilized here? I mean, are they still getting a little weaker or do you feel like things are pretty -- some of the orders are coming back now and really it is, that it's pretty normal?

We only characterize it, Mark, it's really a function more of last -- the pattern we saw last year, which was continued stronger order growth well into, and really, to the end of the third quarter, which is a little unusual from our typical seasonal pattern. It was largely driven by some bigger industrial coatings projects and some of the mobile launch aspects that went on last year with phones. So what we've seen this year is, the beginning of the quarter trended along that same line, but more flattened out rather than continue to pick up, so the comparison relative to last year and then, the backlog relative to last year, is lower because it didn't continue that trend to pick up. And now we're sort of back to sort of flat with last year and in certain areas, we're encouraged, like Adhesives, is up a bit, that's encouraging relative to where we were. But I think it's really more relative to last year as opposed to being absolutely, significantly down. But we've got a mix. When we give you our order view going forward, Adhesives is up and Technology is down. So we've got some mix effect going on there relative to last year.

Sequentially, it's probably relatively flattish?

Yes, that's kind of a way to think of it, relatively flattish, whereas, it was continuing to pick up last year.

The next question comes from Matt Summerville with KeyBanc.

A couple of questions. If you look, Mike, in the dollar value of orders, if you will, that got pushed to the right in Q2, would you say that dollar value that got pushed to the right in Q3 is similar, greater, less? I guess, I'm trying to get a feel for...

It's probably greater, Matt, not usually greater but it's probably greater. It's really more of what our customer is telling us as we bid some of these opportunities in terms of, "Yes, we want to do this but deliver it, not this quarter but next quarter," type of thing. So I'd say, the dollar value of the orders that got pushed out was maybe a few million dollars, but I'd say, it's more of what we're hearing around even some of the bid activity is just kind of a feeling that there was enough of uncertainty that pushed it out a couple of -- 1 quarter or 2. So it's more about -- and not across-the-board, just in some of the bigger systems where it's a bigger capital deal, where people are looking at their capital expenditures a little bit more closely.

On China, specifically and if we can just try and exclude the mobile dynamic that's occurred over the last year, some of which you've talked through a lot today. If you look at China, do you feel like your business is still getting worse, has it stabilized, do you feel like you have better visibility, worse visibility and how would you describe customer access to capital?

Yes, I would say, we feel like it has stabilized. I'd say, the customer access to capital is reasonable. We had some concerns a little over a year ago when, probably this time a year ago, or when the Chinese government was making about-face in terms of trying to control inflation, that's changed considerably. So it's not so much about access to capital, it's really where they're seeing in terms of local demand. And I think it is tied up in this transition to getting consumers to, no kidding, spend more. What's happening is income's going up in the short term, they're saving more, and they're not necessarily translating that into consumption. That's sort of the macro picture. What our customers are telling us is, I think, it's more -- they more feel like it's bottomed out and stabilized, and we're more encouraged going forward.

Okay. And then, lastly, with respect to EDI and Xaloy, kind of the new platform within Adhesives, how would you characterize kind of year 1 performance in terms of where you were forecasting revenue and EBITDA for the businesses when you bought them? And kind of how that's shaken out and then, maybe, some thoughts on whether or not you've been able to generate meaningful revenue synergies there and how to think about that going forward?

Okay, so I'd say number one, the integration plans went as we expected; and number two, I'd say the cost side of the equation and the continuous improvement side of the equation is on track, and we see more upside there. I'd say, on the revenue said, we expected this to be a growth year, it's not. Instead of up, we're down and so much like our other businesses, we're seeing sort of the negative impact of volume leverage there. It's largely focused around the biax piece that we talked about, but with softening sort of global consumption, there's some -- the same general types of impact we see in our other businesses. I'd say, we feel good about some of the new applications. I'd say, we feel good about the key customer synergies, we're getting -- we've got some orders in to date, sort of cross-selling and we're encouraged by that. I think with this latest addition of Kreyenborg, which does a couple of things for us in terms of giving us sort of high-end technology in the screen changer business, which gets us into the plastic recycle market, we're not in there today, and they're a leader in that, opens things up for us. And then, having the pelletizing capability that goes beyond what Xaloy had to sort of the key technology that's going to grow, which is the underwater pelletizing, we feel good about that. That also links into, actually, some of our material partners, who are in the Adhesives business. In terms of pelletizing the adhesives, so there's some interchange there. And I think that we feel long-term growth rates are really going to be strong and we're well-positioned now with a platform that could be successful. I'd say, we're trying to integrate 4 companies and now a fifth -- and really a fifth and sixth, so that's a challenge and that's the key focus for us over the short term. And some things take a little bit longer, and I think the revenue side of that particularly, as you align selling and engineering organizations. And you look to optimize your product lines to take a little bit longer. But I think we're -- other than the fact that the overall economy's a little bit softer in this particular -- one particular application is soft at the moment, we feel good about the future and what we can bring and how we can be different than other people in there that are primarily component players.

How much of this business is that biax?

It's a significant part of the EDI business that goes into the Extrusion side. Overall, Extrusion, I think, is maybe 50% of the business and so it's a significant part of that 50%, Matt. But there are other types of extrusion, biax is 1 type of film, there are cast films and other types of films that we're introducing these new products in. Biax is the one that's going to grow preferentially the fastest because that's the most sophisticated. When you think about consumer packaging, it's the one with the multilayer oxygen, water, UV protection type barriers that food products need going forward. So that's the one that ultimately, probably, has the highest growth that just in the short term, it's a lot of balance.

Our next question comes from Walt Liptak with Global Hunter Securities.

My question's on the plastics businesses. I'm not sure if it was clear. It sounds like the revenue was down in the quarter, but the orders have picked up, is that right?

Yes.

Okay. Can you talk about the magnitude of both of those, the revenue and the orders?

I'd say, the orders are adding to sort of our order growth by a couple of percentage points, so that's encouraging. The revenues were down -- I probably don't want to really comment specifically on it. But they were down a meaningful amount, particularly in this biax area as compared to the prior year, as compared to the prior year. So we're seeing a fairly good hit there relative to what we expected.

Okay. And with the acquisitions that you've done, you mentioned that the integration is going well in these 5 or 6 companies. I wondered, are these large enough as sort of a group of businesses that could be segmented?

I'd say, we still see a lot of synergies that we're trying to work through with our core Adhesives business, and we've got a lot to do to integrate and bring out all the benefits here and so we see a lot of logic in keeping that together here. When you look at common customers, when you look at the thing I talked about in terms of material supplier relationships and end markets, a lot of this has gone into flexible packaging and the food and beverage piece. So I'd say, our view is it makes sense to keep it where it's at. And the focus, really, in the short term, is taking a bunch of different organizations that all have elements of leading technology and leveraging them across our global infrastructure and introducing, in many cases, the sophisticated continuous improvement capability we have to get to sort of 1 set of coherent platforms, and we'll have product lines within these businesses as well.

Okay, it sounds like you may not want to do this, but I wonder if you could just frame the acquisitions over the last couple of years. How much in total revenue, including Kreyenborg, what's the annualized run rate that you're at and the capital that's been put to work?

I think on a revenue base, we're in the $250 million to $300 million kind of range on the revenue. And I think on the capital, it's probably roughly 2x that if you look at it. So that's kind of what we're looking at for those businesses today.

We do have a follow-up from Charlie Brady with BMO Capital Markets.

Just real quick, just on the Freedom system, you've had a competitor come out with a competing product that's agnostic to the type of adhesives that gets run through that machine. And I'm just wondering, I guess, I really don't know the business well enough, how important or not important is being tied to a specific adhesive manufacturer is that for customers? I mean, does that matter to them in the sales process or is it really more functionality of the equipment itself?

So first, what I would say, Charlie, is the Freedom system incorporates a lot of new technology, it incorporates new applicator and dispense technology, it incorporates new feed technology, and it incorporates the capability to handle a variety of different types of adhesives. The benefits come from the applications, the nozzle, the feed technology, but there are additional benefits depending on the type of adhesives that is used and some of those adhesives are more difficult to manage and melt and perform than others. So when we developed it, we developed the activities with Henkel because we needed a development partner on the new technology and we're working well with them. But we're also working with other adhesive suppliers to utilize our Freedom system in there. The full package of benefits comes from having adhesive that translates into delivering more what they call mileage, think about that as more sticking power with less adhesive. You get a lot of that with some of the benefits that we have on our application and dispense technology and our feed technology, which minimizes churn, impurities. And our dispense technology, which allows them to dot-and-stitch and self-clean and some of the things that we have talked about in the past. So there's a combination there. So we feel like we can process the full slate of adhesives there, but the leading edge ones that have higher mileage are more difficult to process, and our systems are capable of handling that.

I'm not showing any further questions at this time. I would like to turn the conference back over to our host for closing remarks.

Yes, this is Jim. Thanks, everybody, for joining us on the call. As always, I'll be around today to take questions if you want to reach out to me and be available to answer those. So thanks, again, for joining our call.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect, and have a wonderful day.