Nordson Corporation (NDSN) Q1 2014 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Nordson Corporation webcast for the First Quarter and Fiscal Year 2014 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Jim Jaye, Director of Investor Relations. You may begin.

Thank you, Nicole, and good morning to everyone on the call. 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, Wednesday, February 26, 2014 on Nordson's first quarter results. Our conference call is being broadcast live on our webpage at nordson.com/investors, and will be available there for 14 days. There will be a telephone replay of our conference call available until March 5, by calling 404-537-3406. You will need to reference ID number 63062969. 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 will have a question-and-answer session. I'd now like to turn the call over to Mike Hilton for an overview of our first quarter 2014 results, and some comments about our 2014 second quarter outlook. Please go ahead, Mike.

Thank you, Jim, and good morning everyone. And thank you for attending Nordson's first quarter 2014 conference call. Nordson's first quarter results reflect our normal seasonality, lower demand and selected technology end markets and regional variations in the pace of macroeconomic growth. We're encouraged by the solid organic growth in the quarter in our consumer non-durable end markets which make up the largest portion of our revenues. Those results set by softness related primarily to select applications in our electronics end markets. On a geographic basis, conditions remained mixed with organic volume growth during the quarter in the U.S., Americas, and Europe being offset by softness in Japan and Asia Pacific. We've begun and will continue to make near-term adjustments to spending as prudent in this mixed environment. Quite frankly, our top line performance in recent quarters has been below our long-term expectations. At the same time, our global team is strongly positioned to capture demand when and where it occurs. And we remain optimistic about our prospects over the next several quarters. In a few moments, I'll share additional comments about those prospects, current business trends and our near-term outlook. But first, I'll turn the call over to Greg Thaxton, our Chief Financial Officer, who'll provide more detailed commentary on our first quarter financial results as well as some comments on our guidance for the second quarter of 2014. Greg?

Thank you, and good morning to everyone. Sales in the quarter were $359 million, an increase of 4% over the prior year first quarter. Overall, the sales improvement included a 6% increase related to the first-year effect of the Kreyenborg acquisition a 1% decrease in organic volume, and a negative 1% impact related to the unfavorable effects of currency translation primarily related to the devaluation of the Japanese yen. Looking at the sales performance for the quarter by segment, Adhesive Dispensing delivered a relatively strong quarter where overall sales volume increased 4% on an organic basis and 16% due to the first-year effect of the Kreyenborg acquisition as compared to the prior year first quarter. The organic growth was broad-based across most product lines. On a geographic basis, we generated organic growth in all regions except Japan in this segment where this region was impacted by the timing of nonwoven system sales. Overall, we are pleased with the growth rates in the segment. Given the generally soft macroeconomic backdrop and particularly pleased with the return of solid growth in standard systems supporting the rigid packaging needs of consumer non-durable end markets across most, all regions. Sales volume in the Advanced Technology segment decreased 10% in the quarter from the prior-year first quarter. Growth was solid for fluid management components serving medical and general industrial end markets and for test and inspection equipment in electronics end markets. This growth was offset by softness in automated dispensing systems for mobile device and other niche electronic end markets. Going into the quarter, we had fairly strong order growth rates as compared to the prior year. However, during the quarter, the pace of orders for some product lines slowed, which impacted the quarter sales. Michael has more to say about the mobile device end markets and the impact on our business. The softness in mobile demand impacted performance in most all regions within this segment where we otherwise experienced growth in other product lines. Within the Industrial Coating segment, sales volume in the current quarter decreased 3% compared to the prior-year first quarter, a period in which this segment delivered organic growth of 38% over the first quarter of fiscal 2012. Growth in powder and liquid coating product lines for durable goods and markets was offset by softness in other product lines. Organic volume growth in the U.S., in the Americas was offset by softness in other geographies. Gross margin in the first quarter was 54% or 55% excluding a non-recurring charge of approximately $2.3 million related to the short-term purchase accounting associated with a step up in the value of inventory acquired in the Kreyenborg acquisition. As compared to the prior year, gross margin was impacted most in the quarter by the dilutive effect of the Kreyenborg acquisition. Unfavorable absorption due to lower organic volume also impacted total company gross margin. Moving down the income statement, operating profit was $54 million and operating margin was 15% in the first quarter, or 16% excluding the non-recurring charge related to acquired inventory. Negative leverage due to lower sales in Advanced Technology had the biggest unfavorable impact on total company operating margin compared to the prior year. As a reminder, our first-quarter margin is typically our lowest given the seasonality of our business. Sales growth in future quarters should provide considerable leverage on operating margin. Looking at operating performance on a segment basis, Adhesive Dispensing delivered operating margin of 23% in the quarter, or 24% excluding the short-term purchase accounting charges noted previously. Excluding the entire impact of the Kreyenborg acquisition on the quarter, this segment's operating margin improved over the prior year's 24% operating margin with strong incremental margin on the growth and the legacy business. Within the Advanced Technology segment, operating margin for the first quarter was 11%, reflecting the impact of lower volume as compared to the prior year's first quarter. We expect to leverage sequential sales volume growth to generate improved operating margin performance as the year progresses. However, we will continue to manage spending to match the pace of the business. In the Industrial Coating segment, operating margin was 9% in the quarter, also reflective of the lower volume as compared to the prior year's first quarter. This operating margin performance is within our range of expectations for this segment given the quarter's level of revenue and product mix, and we do expect sequential growth in sales along with a leveraged impact on operating margin in the future quarters of fiscal 2014. Continuing down the income statement, reported net income for the quarter was $35 million and GAAP diluted earnings per share were $0.54. As in previous quarters, we have included an earnings per share reconciliation schedule on 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 charge for short-term purchase accounting related to the step-up in the value of the inventory acquired from the Kreyenborg acquisition. The current quarter's EBITDA was $68 million. Cash flow from operations in the first quarter increased 20% over the same period a year ago to $48 million. First quarter free cash flow before dividends was $40 million, 114% of net income, again, representing strong cash conversion. We have included a table with our press release reconciling net income to free cash flow before dividends. We continued our disciplined and balanced approach to capital deployment during the quarter where we return value directly to shareholders through dividends and our share repurchase program totaling $14 million. We had approximately $194 million remaining on our current share repurchase authorization at the end of the first quarter. From a balance sheet perspective, we remain very liquid with net debt at 1.6x trailing 12-month EBITDA as of the end of the first quarter, and we have approximately $310 million available from cash and our current revolving credit facility. Before moving on to our second quarter outlook, let me provide some comments on recent order trends. As we typically do, we've 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 the Kreyenborg acquisition included in both years. Looking at orders for the 12 weeks ending February 16, 2014, they are down 4% as compared to the same 12 weeks in the prior year. Within the Adhesive Dispensing segment, orders over the last 12 weeks increased 5% compared to the same period in the prior year. Order rates increased in all product lines except those serving general products assembly markets and in all regions except Asia Pacific. As noted with our sales growth in the first quarter, we are pleased with this segment's order growth, particularly in light of some market dynamics and macroeconomic trends we've commented on previously. In the Advanced Technology segment, orders over the latest 12 weeks are down 13% compared to the same period in the prior year, most notably in the automated dispense systems associated with mobile and other electronic end markets. Orders for test and inspection systems, surface treatment systems and those product lines serving medical applications were notably strong in the quarter. Within the Industrial Coating segment, the latest 12-week orders are down 17% as compared to the prior year. A large portion of the orders within this segment tend to be larger dollar orders causing swings in order patterns, and these orders tend to have longer lead times. With that, our current forecast does include sequential growth in sales for this segment. These order rates reflect the varying pace of activity we are seeing by end market and region. Strength in consumer non-durable end markets such as packaging and disposable hygiene, flexible packaging and other polymer processing end markets, tests and inspection and medical end markets is being offset by softness in consumer durable and selected electronics end markets. Regionally, Asia Pacific continues to show the most near term softness, but our long-term view for this area continues to be positive. Backlog at the end of the first quarter was up 23% compared to end of the first quarter a year ago. The increase was inclusive of 4% organic growth, and 19% growth due to the Kreyenborg acquisition. Current backlog increased 5% compared to the end of the fourth quarter of fiscal 2013. Let me now turn to the outlook for the second quarter of fiscal 2014. We are forecasting sales growth to be in the range of 5% to 9%, as compared to the second quarter a year ago. This range is inclusive of organic growth of 0% to 4%, and 5% growth on the first year effective acquisitions. The effect of currency translation is expected to be immaterial as compared to the prior year's second quarter based on the current exchange rate environment. And the midpoint of our revenue forecast, we expect gross margin to be 56% and operating margin is forecasted to be approximately 22% and equal to the second quarter a year ago. The short-term charges for acquired inventory are immaterial in the second quarter. At the midpoint of the range, sequential incremental operating margin is approximately 66% reflecting strong leverage on a sequential sales forecast increase of 14%. We're estimating second quarter interest expense of about $3.5 million and an effective tax rate of approximately 30.5% resulting in second quarter forecasted diluted earnings in a range of $0.85 per share to $0.94 per share. At the midpoint of the range, diluted earnings per share would increase approximately 7% over the same period a year ago. In addition to the second quarter outlook, the following fiscal 2014 full year data points may be helpful for modeling purposes. We mentioned during our last call that we are forecasting a full year effective tax rate of about 30% assuming a continuation of the R&D tax credit. As this credit has not yet been extended for 2014, we are now forecasting a full year tax rate of approximately 30.5%. For capital spending in 2014, we are still forecasting normal maintenance capital spending to be in line with 2013 or between $45 million to $50 million about 3% of 2013 sales. In summary, our first quarter reflects our normal seasonality with respect to sales volume along with the impact of both continued challenging macroeconomic conditions and certain unfavorable sector trends particularly in the mobile electronic space. We continue to generate strong levels of free cash flow during the quarter and we remain optimistic about our prospects over the long-term.

Thank you, Greg. Before taking your questions, I'd like to provide some additional comments on our recent performance and outlook. At the midpoint of our second quarter guidance, sequential sales growth would be about 14% and we would expect to leverage this increase volume to deliver significantly higher operating margin and earnings as compared to the first quarter results. While this is encouraging, and acknowledging the macroeconomic environment has been a headwind, our sales growth has been below our long-term expectations in recent quarters. While we continue to manage spending where short-term conditions dictate, we do not intend to offer our basic strategy. Our view is that Nordson will continue to generate long-term value. As we look out over the next several quarters, let me add some specific perspective about why we're encouraged. Our organic growth strategy rest on best-in-class technology, direct customer service, diverse and growing end markets and emerging market penetration. All of these drivers are intact. On the technology side, we continue to introduce innovative products that provide value to our customers. Specific and notable for the first quarter is our patented new Wafer X (sic) X-ray Metrology platform. By focusing on wafer level inspection, this product offering provides a significant new market opportunity and we expect to begin generating revenue from this new platform in the back half of this year. This is one of several recent product introductions over the past year. More fundamentally, we continue to believe in the long-term growth opportunities afforded by our diverse end markets. Food and beverage markets provide excellent prospects for rigid and flexible packaging applications especially in emerging regions. The same is true for our products serving disposable personal hygiene applications. Medical applications are amongst the fastest growing in the company. And while demand in electronics end markets can vary from quarter-to-quarter, industry and technology trends in this space remain in our favor over the next several years. And we are well-positioned geographically to capture the increasing demand from emerging markets that benefit from each of these segments. We supplement our organic growth with strategic acquisitions. Our track record is one of acquiring good companies, improving their performance and fueling their growth. Recently, we had done just that with our acquisitions in the medical space. We are in the midst of doing the same with the suite of companies we have acquired in our polymer product line. While the polymer product line has faced some short-term headwinds in terms of demand driven by market dynamics, we expect performance will improve steadily and contribute long-term value to the shareholders. Overall, we continue to develop our acquisition pipeline and we have the financial and organizational capacity to continue to add properties that fit our strategy. As we look at our operating performance, we still see opportunities to improve margins. Our continuous improvement initiatives span engineering, operations, marketing, sales and functional areas. We also continue to accelerate and institute best practices across the company. We're making good progress, but have additional opportunity especially in the acquired property. Finally, our business continues to generate a high level of cash, which gives us the ability to continue our multi-faceted capital deployment strategy. In addition to funding organic growth initiatives and strategic acquisitions, our strategy includes returning capital directly to shareholders. We have increased our dividend on average, 20% over the last three years as we move to a more reasonable payout ratio. In terms of share repurchases, we have been active under this program at a relatively modest level. We expect to become more aggressive towards completing our repurchase authorization during the balance of the fiscal year. In summary, our core strengths include innovative technology, diverse and growing end markets, direct global customer support, a continuous improvement mindset and strong cash generation for investment. These core strengths will continue to drive long-term value creation for our shareholders. In summary, our fundamentals are intact and have not changed. At this time, let me turn to your questions.

Thank you. [Operator Instructions] And our first question comes from the line of Mark Douglass of Longbow Research. Your line is now open.

Hi. Good morning gentlemen.

Good morning, Mark.

Good morning, Mark.

Can you discuss the – can you kind of reconcile the higher backlog, I mean you're up 4% organically, certainly the Kreyenborg in there, but still significant drop in orders, help us kind of reconcile what's happening with the order rates versus where your backlog is and some of this backlog going into third quarter, which is maybe why we're not seeing it in second quarter, you think it would be a little stronger organically in your second quarter guidance?

Yes. Let me provide some couple of high level comments. If you look at sort of entering this quarter, we had pretty solid order rates, let's say they continued nicely up until we sort of hit the holiday period, and normally we see a pretty significant drop off in the holiday period. And the way I'd characterize that is, we've been a little slow to see that as orders pick up like they naturally do coming out of the holiday period. So we had sort of the western holidays combined with a little earlier Chinese New Year and they've been a little bit slow coming back out. What I would say though is if we look at sort of level of project and prospect activity and bid activity across most of our businesses and most of the geographies, that's pretty solid. We haven't seen all that translate into orders yet, but we're encouraged by what we see across most of the businesses. I'd make one specific comment around mobile. We had some continuing strength last year in the first quarter in terms of orders that we wouldn't necessarily typically see. And typically, we'd see Q2 and Q3 as the period of time where we'd see the mobile orders pickup based on launch, timing of new products. And I'd say we would expect to see that this year. The exact timing whether it's Q2 or Q3, not clear, but based on the projects we're working on, we're encouraged by what we see as the opportunity out there.

Okay. And then, Greg, can you just walk us through how we get to 22% operating margin? And with little shortfall in 1Q that the gross margin of 56% year-over-year is a little - is a percentage point lower than 57% in the second quarter. Are you being aggressive on the target operating margin here? Do you think you're being conservative enough assuming you get into the sales guidance range?

Yes, Mark. I would say I don't think we're being aggressive in our guidance for this margin improvement. What's going to drive this improvement is that 16% or so sequential improvement in volume. And so with the level of gross margins that we deliver, with that kind of volume growth, there is a bit of some mix benefit in each one of the segments that will otherwise raise margins. But it's primarily the increasing volume that's going to improve our absorption rates as well.

Okay. And then just switching gears a little bit on Freedom. Can you talk about the success of the launch just last year relative to other new product launches and has that also done a good job of stemming the entrance of new competitor?

I would say on the Freedom side, we've had good acceptance in the marketplace. I'd say the mix that -- sort of a mix of different types of systems in the highest end systems under a Freedom unit go on to sort of the biggest end customers has been very successful, until some of the mid-Tier customers are testing the product, but didn't any other step up. So I'd say units are probably a little behind. Revenue probably on track, and profitability probably on track, and we're encouraged by the level of acceptance. I'd say from a material standpoint there's still some improvements coming from the adhesive suppliers that will add to the acceptance rate there. But we feel pretty good about that technology. Certainly we treat all of our competitors and potential competitors seriously that's why we continue to be the technology leader and innovate. And I'd say we've been fairly successful so far in what we've seen from Freedom. We have other versions of Freedom coming out to support our OEM in different applications later in the year, but right now I'd say a little behind on units but generally on track and revenue.

Do these have higher than – like legacy products, better margin from legacy products or what can we say?

What I would tell you is it varies on what a customer buys, so the most sophisticated piece includes the full system of the feed systems and the new controls and the new dispense technology and the melting approach. They've got a whole system that tends to give more performance than we get paid for the performance, if their volumes – certain components from that, I'd say it's typical of our historical margins.

Okay. Thank you.

Thank you. Our next question comes from the line of Kevin Maczka of BB&T Capital Markets. Your line is now open.

Thanks. Good morning.

Good morning, Kevin.

Hey, Kevin.

Mike, can you revisit mobile again? It sounds like – I mean, that's clearly been one of the areas of strength for you in the last few years. And it sounds like that surprised to the negative very late in the quarter, but I'm taking from your comment about expecting better order trends in Q2 and Q3. If this isn't an issue that maybe we're not involved in some of the key model or product launches that are coming. So can you just kind of square what happened late in the quarter because maybe I missed it, but I didn't follow that.

Yes. So I think your last comment is correct. So to be blunt, we don't think we're losing share in this – in the market. It really is linked to timing of launches. And if you go sort of year-on-year compared to last year, in the first quarter of last year, we had some, what I would say components related to mobile devices that were new and had some business in the quarter from that and that didn't repeat yet this year. So as we look at where our customers are looking to provide sort of the next launch and as we've said in the past, it's more important about what they change, whether it's the size or features to get more new systems and so it's really a function of new products. We are working with key customers on their new products and we'd expect orders to pick up. We're not 100% sure of how much will come in Q2 versus how much would come in Q3. And if you look back historically, it's been Q2 and Q3 into the early Q4 that have been stronger until the last year we had some additional benefit in Q1. And then from time to time, you can always have some orders here and there, push your core deal from one quarter to another. So yes, it was a little softer in the first quarter than we had seen last year. But if we look at the project activity, we feel encouraged and no, we don't think we're losing any share.

Okay. And then it sounds like you're reacting to some of the softness you'd seen here with new cost actions. Can you say a little bit more about that, and maybe describe what kind of magnitude or what type of initiatives you have? How much did that affect, or does that benefit you in terms of achieving that Q2 guidance or these longer-term type initiatives?

Yes. So just a couple of high level comments. I think we've mentioned the last quarter that we are going to go in the year expecting to start out a little slowly but from a high-level guidance most people expected the global macro to be better in 2014 than 2013. And I would say that's still the case particularly with some improving strength in the U.S. and Europe coming off as zero. I'd say the start is slower like we anticipated and I think people are more cautious in emerging markets. That said, we are watching our discretionary spending. Last quarter we continue to do that. In addition, in some of our businesses we have built in flexible capacity to ramp up and ramp down as business moderate in the short-term and we're taking advantage of that in the short-term. Beyond that, we're looking at attrition and managing attrition, we're looking at when we bring on new hires for various applications. But in a couple of areas, select products and select geographies, we've also done some internal benchmarking and we're putting some plans in place, there'll be a cause to implement those plans and we'll see a net benefit this year, probably not much of an impact in Q2. We'll see a net benefit this year, it's not going to be material benefit but it'll be a net positive benefit.

Okay. So you've always been pretty tight with discretionary spend and you're always looking at other initiatives in the benchmarking and things that you mentioned. But this is not a big new sweeping at cost action in response to a material slowdown in the second half of the quarter?

No, I would say it's more surgical, or we maybe got ahead of ourselves a little bit and we're addressing it to recognize in the current environment.

Okay. Thank you.

Thank you. Our next question comes from the line of Matt Summerville of KeyBanc. Your line is now open.

Good morning.

Hi, Matt.

You mentioned Mike that you've gone through kind of this period of internal investment whether it'd be on product development side with Freedom developing more of a tiered product offering across the businesses, and then you also mentioned that you've been a little bit disappointed with the top line. So I'm wondering if you can kind of reconcile those two comments relating that where things not going right for Nordson in converting those internal efforts to top-line volume?

Yes. So I talked a little bit about Freedom and I think we're pleased with the launch of that. We see that will continue to grow. Remember, we haven't really launched it in Asia yet. We're just doing that in the next few months, so we expect that to continue to trend up. We talked a little bit about the wafer project in my comment. That's the one where we spent a fair bit of money last year on. We've done a lot of testing with customers. We've got some good interest to the first part of Qs that are coming in. So that's encouraging. That's going to be second half of the year orders and then beyond that, but we're encouraged by the customer reaction so far from the launch and that's a brand-new technology area for us. I'd say we have some other areas in the electronics related space that are coming in. Again, the medical space, we've been introducing a number of new products and getting really good traction on that so far. I'd say the areas where things are a little softer – I think geographically, we've seen some softness in Asia and in China particular. And I think some of that is related to sort of macro transition to the consumption-related economy. Now, that said, we have good prospects and projects out there and some of our core businesses like the adhesive packaging and nonwovens businesses have finally ticked up the nice orders there. We've had some anomalies on package – on product assembly with year-on-year kind of timing of orders, but the sort of core packaging has picked up. Similarly, in the coatings business, things like big auto platform, orders can vary year-to-year and we've seen some of that come through in the first quarter. So I would say we're encouraged by what we're seeing on the product piece. We're seeing some select geographic macro impacts, and I think timing on the mobile piece has been a pretty, a big impact here and that reflects over to geography too because most of that is in Asia.

Matt, this is Greg. Just to add a comment on Tiering. I think as we've characterized in the past, we're much further along with that endeavor within the adhesive segment, and are doing very well in those Tiering opportunities particularly in the emerging markets. It's still an area where we have upside within both Advanced Technology and Industrial Coatings. So that's a particularly area where we think we have growth opportunity yet going forward.

Yes. And then I'd say as Industrial Coatings, we're making good progress. I'd say on the Advanced Tech, it was all about building our capability in Suzhou and we're just sort of launching the first products there really in the next couple of months.

And just a follow up on the margin performance in Advanced Tech, I went back and looked at the last time Nordson generated roughly $97 million, $98 million in revenue. That would've been the first quarter of 2011, and I know this isn't completely comparable, but your margins then were 24%. Today they're 11%. I guess I'm trying to understand how you get that sort of – I mean the detrimental year-over-year was 93%. So I guess I'm trying to understand more behind that math there?

Yes. So I think that's an area where we consciously stepped up spending to invest both in technology, and we're in the midst of this transition to the East. Naturally, we've got I'd say some one-time cost there in terms of the technology step up and some one-time costs that weren't in 2011 from the transition over to building our capability in Asia and the revenue is trailing the -- that investment. So we are making some adjustments in the short-term, but in the long-term, that doesn't surprise us given that the revenue would typically trail the introduction of both the capability and new products. I'd say in a very short-term, we had significantly lower orders and it's tough to adjust your fixed cost back in the early short-term and that's part of what you're seeing as well, it's kind of a significant negative incremental margins associated with that.

And then just lastly real quick with the whole mobile space, I mean we know that there's obviously peaks and valleys there, do you think this is nothing more than just a deeper valley, which is going to be followed by a higher peak? Is that the right way to be thinking about this? You're kind of in this deeper low right now and you're going to get that big boom in the back half of the year?

So I think we expect to see orders step up nicely here from the sort of new platform releases. And so the one overarching comment I would make is that we benefit in the last couple of years with the penetration of smartphones and I think as we've talked about in the past, the smartphones are important because of all the functionality in there and the small geography. So if you look at I think, penetration is pretty high on smartphones now. So I'd say going forward, we're likely not to have that benefit by the same silicon people are constantly looking at different form factors and features, and so I think there's a benefit there. And then there's a whole group of new customers who really do think manually today. And so I think a potential upside for us to maybe offset that penetration piece, is to what degree of those other competitors automate. I think from a cost perspective, ultimately they're going to want to do that. But right now they do things fairly manually. So I think in the near term as a question of the timing of that stepping up versus sort of the base business, which is driven by kind of the new product launches and the change in functionality. So I'd say we've benefited nicely from that penetration, and the launch piece has been fairly constant and so there's some other things that people are getting into, like variables that could create some opportunities. So I think we would expect it to be at a significant level going forward year-to-year you could have some swings.

Thanks a lot, guys.

Okay.

Thank you. Our next question comes from the line of Charley Brady of BMO Capital Markets. Your line is now open.

Thanks. Good morning, guys.

Hey, Charley.

On the Advanced Tech, can we just dig into that a little bit more and you covered kind of a mobile side of it, but I wonder you talked about most of the business is up, and mobile is down. Can you give us some more granularity about the various sub-businesses and degree of which they were either plus or minus in the quarter?

Yes. So if I'd look at sort of staying on the system sort of side of things, I'd say the expense base is really largely syntax was off pretty significantly. The March business which is a service trade was up nicely. The test inspection business which includes bond testers and X-ray was up nicely. Particularly encouraging is the bond test piece being up pretty strong which kind of indicates the maybe the semi piece is coming back. We also had some dispense opportunities in more traditional packaging come through which is also another encouraging sign that's not necessarily mobile-related. We're not jumping up ringing the bell yet, but that was encouraging. So on the – now if we go to the EFB side, I'd say the markets that were medical, very strong, the general assembly is strong. I'd say the electronics was just okay. Components were okay, but we had some tabletop-type systems last year that were a little stronger than this year and that's really a mobile effect for the guys that do sort of semi-automation. But I'd say the core EFB-type businesses were strong and the metal piece were strong. Our biggest impact, as Greg talked about earlier, was in sort of the high-end dispense systems that were pretty soft relative to last year.

Okay. And just on the coatings business, did I hear you correctly that you had some slippage from Q1 into, I don't know, Q2 or Q3?

No. I think the way I would describe the coatings business is, if you look at what we typically see, it's a pretty soft Q1 because most of the time, it's linked to capital budgets. We still have time to get formalized till end of January. So typical Q1 will be soft and we pick up Q2, Q3, Q4, with three and four typically being the strongest. Last year was a little unusual. And we had a really strong Q4 and a carryover strong Q1 in terms of revenue and order entry and we've seen a more typical year – this year in terms of the first quarter. So for example, I think Greg mentioned that Q1 was like 38% over the prior year and we're into a more typical year. What I would say is, if we look at orders to-date and backlog in that business, it's filling in pretty nicely for Q2. And we look at prospects going forward, it looks pretty solid. We do have bigger systems in that. So for example, we had some strong auto platform orders last year that didn't come through, again, the order entry rates this year and they are kind of more digital and so it looks – it magnifies sort of the year-over-year difference there. But I think Greg's comments we look at things like powder and some of our liquid business. It's encouraging and when we look sort of the bid activity it's encouraging later in the year. So it's the short-term anomalies, I'd say there more than anything else.

Okay. And just on your year-end guidance organic growth of zero to plus 4%, I guess when we look at the orders down 4%, a fairly decent indicator of kind of more near term sales outlook. So I guess I'm just trying to square the zero to plus 4% with the minus 4% order rate in the most recent 12 weeks. You're really expecting adhesive dispensing to pick up on a sales basis organically higher than that 5% order rate you've seen? Or am I missing something here?

Yes, so I think you need to kind of take into account two things. It's a combination of backlog and recent order rates. So if you look and just go back to the prior quarter, you guys were correctly asking us a different question which is your order rate looked good why are you forecasting what you're forecasting? It was because our backlog was down year-on-year. So right now our backlog is up about 4% I think year-over-year. And that's really the strength that we saw in orders coming through October-November and it kind of tailed off over the holidays. And as I mentioned earlier, it's been a little slow to come back. So if you say that's up plus 4%, and you look at our current order rates, and basically some bid activity we think it's not just sort of plus 4%, minus 4%, that's zero, but it's a little bit better than that we think. So it's kind of that combination of backlog and recent orders that you need to look at to make a judgment. We feel like we've provided through our best guidance here based on what we see and it's a combination of those two.

Okay. Thanks Mike.

Okay.

Thank you. Our next question comes from the line of Jason Ursaner with CJS Securities. Your line is now open.

Good morning.

Hey, Jason.

Hi, Jason.

On the gross margin guidance of 56% at the midpoint, Q1's typically represented the high point of the year for you guys. So just wondering, I mean, is this a negative operating leverage from the tech segment or is there something else going on in terms of mix as you look out to the balance of the year in Q2?

Yes. I mean typically – that's generally correct, Jason, because typically, we have low systems orders and higher parts orders. But that sort of nuance is being overshadowed by – where we're at on the tech mobile side right now and the sort of negative incremental margin in the short-term.

Yes. So our spare parts percentage of sales was pretty consistent with the prior year first quarter. It's primarily the – absorption issue in a couple of the pockets of the business.

Okay. And the guidance is implying SG&A run rate for Q2 that's pretty consistent with Q1. Would you expect a similar run rate on SG&A in the back of your fiscal year given that you're pulling back on some spending? And how much variance is there that's sales-driven for the back half?

Yes. So I would say typically, if you look at our year over the last couple of years, we step up in the first quarter with merits and things like that. And then in the last couple of years where we've been investing, it stepped up. Obviously, we're moderating that step-up and looking at making some other modest changes. So I think the second half of the year, you'll see some moderation there, but there'll be some cost implements so you'll have that muted a little bit. But I wouldn't say we'd see the same step up that we have in the last couple of years.

Yes. We will have the impact if we see as this typical an increasing volume pattern in the back half of the year will have some increase in SG&A that goes with commissions and the like. So generally, we have an increasing spend pattern. In the back half, as Mike I think that'll be muted a bit with some of these actions we're taking.

Okay. And then the adhesive segment, you mentioned that operating margin excluding Kreyenborg was up year-to-year versus 24% last year. I guess I'm just wondering it's still about 1,000 basis points below the margin from the years before that. So is it permanent dilution from the EDI and Xaloy acquisitions, or if we stripped out the plastics with the standard adhesive systems that you mentioned for consumer non-durables, will that still be generating that load in mid-30's operating margin?

Yes. So the core is still going to be above 30. I mean depending what point you pick, we had a couple of quarters there where it's like all time highs. But yes, it's conceptually has not changed. We do have a big mix effect and as we continue to add the acquisitions, we have sort of where we had that same kind of mixed effect. I think what we said to you is we needed, we got businesses that were kind of in the mid-teens on a EBITDA kind of margin that we wanted them to move into the mid-20s and that was going to be a sort of a multi-year program to get there and not wanted, but probably more like three or four. And we're on path to do that. They got hurt a little bit in the short-term because volumes were off in those businesses but we're encouraged right now as orders are trending up nicely, high single digits in the polymer business in this last quarter and that's really without the biax business coming back yet. And some encouraging signs there and that OEMs are starting to work on projects that would probably translate into orders in the back half of this year. So our broadening efforts from a product line standpoint are bearing fruits, so encouraging indications there from an order standpoint that should play out over time.

Okay. And in the tech segment, the challenge in mobile for automated expense, you mentioned unit volume growth slowing from some market saturation but you've also talked about the form factor challenge. So I guess how are you looking at both of those and which is playing a bigger issue with – I guess capacity being sufficient for that market right now?

Well, I'd say the saturation in the short-term, if you think about three or four years ago was 15%, 20% and now it's up closer to 80%, 90% kind of penetration. Varying degrees of the smartphones and fairly cheap low featured to fully featured, but that certainly has an impact. I think things that can't drive it from a form factor or to certain customers go to different geographies and also just their continued push to go thinner. That's a good thing for us if there's a continued push to go thinner for example. And then are there extra capabilities that people want to build in whether that has to do with things like fingerprint centers and that kind of stuff, or other kinds of things that they want to put in the films that's a good thing. I would say if you look at the new guys on the scene which tend to be Taiwanese and Chinese vendors, they're just sort of stepping up into the smartphone space and they do everything manually, as I said, today. So I think the offsetting piece there for the penetration of the smartphone side would be growth in business and share their – convincing those folks to go to a more automated approach. I think things like driving cost and availability of workforce in China will ultimately push them there, but may take a little while to get to that point.

Okay. And the new technology in wafer level inspection is that exclusively on the packaging side or there's also a potential front-end use?

Yes. On the tail-end, generally, it's wafer level packaging, so from the tail-end to the front-end. So if you think about what customers do today is they optically inspect wafers. But as they've gone vertical in particular and reduce – and increase density, optical doesn't work so well and what they've done is historically use X-ray to sample. But as they put more and more value on a wafer, they're looking to do in-line X-ray. And so our offering here is, in effect, the first in-line X-ray, a machine to help multiple-layer chips and high-density wafers. So it's really at the tail-end of the front-end. And what isn't clear yet is, is this going to be a 100% solution, is it still going to be a sampling solution, but an upgraded sampling solution. But there – very encouraged by what we can provide from a capability that they can't get anywhere from optical and it's much better than 3% or 4%sampling kind of approach. So very encouraging early on, obviously this will materialize into orders but the reaction so far is very positive.

Okay, great. Appreciate all the commentary. Thanks.

Yes.

Thank you. Our next question comes from the line of Liam Burke of Janney Capital Markets. Your line is now open.

Thank you. Good morning, Mike. Good morning, Greg.

Good morning.

Mike, sales were up nicely in Europe, and then it looks like orders are doing pretty well, too. Could you give us a sense of what the make up of that businesses, is it systems being sold for export, or are you seeing actual in-demand in the different countries?

Yes, it's a bit of both. I think what you're referring to is particularly in our adhesives area where we have both OEMs for things like nonwoven as well as in our new businesses in the polymer area there are number of OEMs there. You were seeing improvement there. But we're also seeing some improvements in the core adhesive non-durables in Europe. Last year and a half has been pretty soft there and with the zero to minus GDP that's not surprising. And a reduction in things like food and beverage consumption that's packaged, but we're starting to see that turnaround. I'd say even in our technology business, electronics related it's been an improvement there, largely automotive-related and applications we have for the automotive side. And I'd say even some modest improvement in the colorings area from some certain applications. So kind of across the board it's encouraging. We'd like to see more quarters play out to make sure the trend sticks. But if you look at sort of some of the things you're hearing out of Germany, for example, it's been more encouraging in kind of Northern Europe, more encouraging in maybe parts of Eastern Europe, more encouraging. So we're hoping that's a trend that will continue, but it's been pretty much across-the-board in the last quarter or so.

Great. Thank you. And when you purchased the polymer lines, product lines last several years, you had anticipated that it will probably grow at a faster rate than the traditional adhesives business. As we get into the second half of the year, do you expect those growth rates to step up to those types of levels?

Yes. I'd say if you look at the underlying demand for plastic, it's still growing faster than, say, in flexible packaging versus rigid packaging even though we're seeing a bit of the investment cycle versus the consumption cycle impact us, particularly in the biax film which we talked about. So even in this period over the last year to year-and-a-half, the underlying growth of the flexible piece has continued to grow faster than rigid packaging. So we see that underlying demand continuing to grow. I think for us, the big uptick will come when we start to see the biax line being purchased because those are our sophisticated lines. And so I'd say an encouraging sign as we talk to OEMs in particular is that they're starting to see interest from the end customers around putting these new lines in. So I'd say we expect to see orders start to pick up at the second half of the year, and most industry analysts are predicting 2015 and 2016 to be really solid years in this business. So in the interim, what we have done particularly in the parts of our business that are in the extrusion side has come up with new products in three other areas that aren't sort of biax film-related area and we're getting good traction on that right now which is why we're seeing some orders start to tick up there. And then on the new businesses, they've been pretty solid. The ones acquired just last year had been pretty solid from a backlog and from a order entry perspective. So yes, I think that fundamentals of the plastics business and the substitution of plastic and the growth, preferential growth in emerging markets, nothing has changed in that. It's really getting the investment of supply demand imbalance there.

Thank you, Mike.

Okay.

Thank you. Our next question comes from the line of Walter Liptak from Global Hunter. Your line is now open.

Hi. Thanks. Good morning guys.

Hi, Walt.

Good morning, Walt.

Thanks for all the color on the advance tech part of the business. So I want to ask a question on kind of the long-term growth rate based on your comments. If we look at the order trend over the last six data points that you gave us, we're at about flat. And your comments are positive over the next couple of years. What kind of growth rate should we be expecting from advance tech when we kind of roll up the semiconductor part mobile, et cetera, is this a mid-single digit grower in the future?

No, we think it's still sort of in that high single-digit range. First of all, things like medical had grown strongly double digits. Some of our general assembly kind of applications are growing strongly. I think we're expecting to see some improvement in I'd say, the quarter semi piece of our electronics business where we really haven't seen for two years, the analysts project this year to be kind of a mid-single digits growth rate and next year to be a nice double-digit growth – growth rate and you're starting to hear from some of the front-end guys that things are picking up and improving there. And that semi piece of our business we hope to come back. We haven't seen too much activity in the last year on the OED side, but customers are starting to tell us that they expect there'll be placed some more orders this year for the lighting aspect and that'll be starting to impact us probably later in the year and the next year if they're correct. And then I'd say the – we talked about this in the past, there's the whole part of the market that I alluded in the previous comment when we talked about some of these new mobile guys, but other applications for PCs and servers where you've got people that still do things by hand that we'd like to convert to our lower-featured automation platform, and we're only now getting in the position of launching our sort of first offering out of Suzhou and over the next couple of years, we'd expect to have a more fulsome portfolio to offer from a tiering perspective. So we haven't seen that play out. The other things that we talked about like the penetration benefit of smartphones, that's gone away. So we're counting a number of other things to coming into play over the next couple of years to help us get back into more of the higher single-digit range.

Okay, fair enough. When I look at the volatility in the orders, especially over the last two or three quarters, is that something that we should get used to, this lumping – more lumpiness in orders like a little bit less consistent even if we get to that ultimately the high-single digit revenue growth?

Well, I think the biggest variability tend to be in the electronics piece, and electronics in general has a different sort of cycle than regular business cycle or the more steady nature of our sort of consumer non-durable businesses. But I think what you see is more launch-related kind of activity in the mobile space, which is typically, I think, adding a little bit to the volatility in the short-term.

Okay. Thank you.

Thank you.

Thank you. We have a follow-up question from the line of Mark Douglass with Longbow Research. Your line is now open.

Hi. Just real quickly, Greg, what was the pre-tax charge for the inventory step-up and is there any more coming in 2Q? You ended some of these in 2Q last quarter. I'm just wondering if it's all out.

Yes. The pre-tax was about $2.3 million and given actual inventory turns; it's an immaterial amount that will hit in the second quarter. So I'd say those charges are behind us now.

Okay. Thank you.

And, Nicole, with that, I think we're going to have to end our call. This is Jim. Thanks for participating. If you have follow-ups, I'll be around today and be glad to take those. So thank you very much for joining us today.

Yes. Thank you. We really appreciate it.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Have a great day, everyone.