Novanta Inc. (NOVT) Q4 2014 Earnings Report, Transcript and Summary

Good afternoon. My name is Chris and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group 2014 Q4 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Robert Buckley, Chief Financial Officer, you may begin your conference.

Thank you, Chris. Good afternoon and welcome to GSI Group's fourth quarter and year-end 2014 earnings conference call. I am Robert Buckley, Chief Financial Officer of GSI Group. If you have not received a copy of our earnings press release, you may obtain one from the Investor Relations section of our Web site at www.gsig.com. Please note, this call is being webcast live and will be archived on our Web site. Before we begin, we need to remind everyone of the Safe Harbor for forward-looking statements that we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. We may make some comments today both in our prepared remarks and our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So you should not rely on any of today's forward-looking statements as representing our views as of any date after today. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to the GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our Web site. I'm now pleased to introduce Chief Executive Officer of GSI Group, John Roush.

Thank you, Robert, and good afternoon everybody. Welcome to the call. I'm very pleased to report that GSI performed well in Q4 and finished 2014 on a positive note. And I would say as with most years things did not develop exactly the way we drew it up on the chalkboard at the beginning of the year, but we accomplished many important things that move us closer to our strategic goals and better position us for future success. We also during the year responded well to several issues that unexpectedly arose, so I'm pleased about that and I'll share some detail. From a financial perspective, I will give you a few highlights and Robert will go into much more detail in his section. In the fourth quarter, we had sales of $94 million that was up 14% reported and 1% on an organic basis. The Q4 revenue was impacted over $1 million relative to the guidance we had issued in November because of the strengthening U.S. dollar. The GAAP EPS for the quarter was actually a loss of $0.82 due to the impairment of intangibles that we'd announced on January 12 of this year. A non-GAAP EPS was $0.24 in the quarter and adjusted EBITDA came in at $15.3 million. Both figures were above our own expectations as our productivity initiatives enabled us to expand our non-GAAP gross margins by over 70 basis points year-over-year. That margin expansion along with a generally cautious approach that we took to discretionary expenses in Q4 enabled us to more than offset the negative impact in Q4 of the strengthening U.S. dollar. For the year, we ended up at $365 million of sales up 15% reported and 1% in organic basis. The full-year GAAP EPS was a loss of $0.49 again due to the impairment charge. The non-GAAP EPS was $0.81 for the year. And the full-year adjusted EBITDA was more than $56 million, which is again, slightly above the last guidance we had provided. Our book-to-bill ratio was essentially one for both Q4 and the full-year. We increasingly see our OEM customers operating on shorter and shorter lead times with very limited forward order coverage, so our book-to-bill generally stays very close to one in most periods. So over the last couple of years, we have built a highly capable management team here at GSI and with more time under their belts they really blossomed as a team in 2014. As a company, we are now gaining greater strategic insights and better allocating our investment resources, while achieving I would say more consistent and reliable execution across the company. As that has been occurring, we've been able to direct more of GSI's talent bandwidth towards growth. We continue to develop and execute on our strategy to shift the company more toward an attractive mix of end markets and applications. In 2014, we translated those efforts into comprehensive strategic plans, we put together for our major lines of business; with a more robust roadmap of new products and a larger and a richer pipeline of new business and customer opportunities in specific target applications. Through these efforts we are now able to more clearly understand the nature of the markets we address and the opportunities that we really have to grow over time. Based on our updated analysis in aggregate, GSI served as an addressable market of approximately $2 billion. We have approximately 18% share of that market and it appears to be growing at an overall average of 6%. I will note that the fiber-laser market is excluded from that analysis based on the large size of the market and a relatively small share. So our market analysis gives us increased confidence that our medium-term goal of achieving sustainable organic growth in the mid-single-digit range is reasonable and achievable. Having said that, I fully recognize we are not currently seeing the organic growth that's consistent with our potential. At one level, we were impacted by significant slowdown in the medical market in the second half of 2014. And I'll comment further on that in a few minutes, but as medical capital equipment spending recovers our growth will increase. Really in a larger sense many of our businesses have historically lacked true growth skills and capabilities. The technology expertise is certainly there. What we're still building is a broader capability to identify the right growth applications target them with differentiated products and solutions and then deliver those products to market on time at cost, at quality and yields et cetera. So we are working across GSI to structurally build those capabilities. So as we think about 2015, we have built-in continued increases in growth investments so that we can have and build the right growth capabilities in key business lines. Given the growth in investments we continue to make increasing our ability to fund those investments through productivity is a key to managing our strategy. So during the year we made progress on our operational and productivity program. We held over two dozen lean events across the company in 2014 and we deployed lean principles across an ever-increasing portion of our production capacity and we are now seeing improved quality customer satisfaction and lower work in process inventory. In addition, last year we brought in a global strategic sourcing leader for the company and we worked hard to put in place the IT infrastructure to let us measure and optimize our $150 million per year direct material spend in a consolidated and robust manner. For 2015, we've outlined detailed specific productivity targets and programs for each of our production sites which encompass our own production costs as well as our supply chain. We expect to achieve $6 million this year in productivity savings based on what we put in place. In addition we generated significant free cash flow in 2014, which strengthened our balance sheet and enabled us to significantly delever following our JADAK acquisition early last year. So we ended up the year with only $64 million of net debt, which positioned us well for the acquisition of Applimotion, which we recently announced. Like most companies I would say we did have certain challenges that arose during 2014 that we had to overcome. The first area is something we have talked about on past calls, which is gross margin performance. In the first half of 2014, we had challenges in this area. As we previously indicated, it was the result of two different drivers. First, we had a number of new product launches occurring early in the year. In a number of cases these new products launched with a very poor initial yield that were much lower than what we planned. Second, in that same timeframe, we deployed lean manufacturing in a number of locations and we experienced downtime and disruption as we came up the learning curve with some of our new lean production cells. Sort of the combined impact of these two areas costs us at least a point of gross margin for the full-year or between $3 million and $4 million. The good news is that we recognized the gross margin issue early and we are able to get control of the issue quickly and mobilize and turn things around. Our production and engineering teams had to work hard to get the new product yield up the learning curve. Our continuous improvement team worked with our sites to address material supply and yield issues in the lean cells. We made significant strides with gross margin in the back half of the year. We had significant sequential improvements in both Q3 and Q4 in our gross margins and we achieved 44% gross margin in Q4 which is an attractive level for us. So even though our recovery in the second half was not really enough to make up all of the shortfall we had earlier in the year, our progress is very encouraging. To me it's a sign of our increased maturity as a company that we're able to recognize and respond to this challenge quickly and correct the dynamic we are seeing within the year. The other major complication we face during the year was the slowdown in our medical business that occurred in the latter part of 2014 particularly in Q4. Really beginning in late summer 2014, we began to see the general slowdown in orders across numerous medical capital equipment OEM customers', product families and applications. In the latter stages of the year, we saw several dozen medical equipment customers reduce their normal monthly delivery quantities by anywhere from 5% to as much as 40%. And nearly all of these cases were a single source supplier so we are confident to slowdown with market base and likely short-term phenomenon. It's worth reminding you all of this that the same dynamic impacted all of our medical sales meeting those in our medical technology segment as well as sales to medical customers that occur within precision motion and laser products in both of the segments. So this is really over 40% of our total revenue. I will comment in a few minutes on the strategy and the outlook for our medical business, which is ultimately quite positive, but there is no doubt that we faced the difficult medical market in the back half of 2014. As challenging as this dynamic was for us, we were able to respond well as a company. Demand increased above our forecast and some of the industrial and microelectronics applications. Again, we quickly recognized the dynamic and we're able to shift our priorities and redeploy our production teams to capture increased demand in those other markets and ultimately deliver revenue and profitability that was in line with our guidance. Again, I see a positive side to the challenge. Our leadership team and our organization are increasingly resilient and resourceful. Our strategic and analytical capabilities are improved so we are better able to discern and adapt to a changing market landscape. And our execution skills are much more robust, so when we need to redirect and redeploy we're able to do it with much greater success. So I'm quite proud of the team for how they responded and managed throughout 2014. So at this point, I would like to provide some commercial updates on our progress around the company. I'd like to start with our precision motion segment, which will now include the Applimotion acquisition which we recently announced. So sales of precision motion products increased 8% for the full-year and 10% in Q4 of 2014. The growth was primarily driven by optical encoder products, which are seeing increased demand in applications such as coordinate measurements, 3D scanning, wire bonding and robotics for both industrial and medical markets. We are preparing to launch two significant new encoder products in early 2015, which will expand our offering and increase growth opportunities. One is a miniaturized version of our encoder platform that will enhance our current market-leading capability to provide submicron resolution in the smallest available footprint in the market. The other product is a contamination resistant optical encoder, which will open up new opportunities for us in harsher industrial operating environments. Our Applimotion acquisition fits closely with our optical encoder products; Applimotion which was a $30 million cash transaction plus a working capital adjustment that will occur. The business is based outside Sacramento and supplies very high-performance application-specific motors as well as precision motion subsystems in high-performance applications. In many cases, Applimotion products are used by the same customers in the same applications as our optical encoders. Our original relationship with Applimotion came through our common customers. In many cases the motor and encoder products are physically mounted to each other or used together in the same motion control subassemblies. So there's an opportunity for us to optimize the products to work together, so we can supply integrated solutions and deliver better performance to the customer. The customer basis of the two products partially overlap, but they are key differences. So there is a significant opportunity for us to cross-sell the capability of each business to the numerous customers and applications that exists. So while this is not a huge deal for us it's a great strategic opportunity to expand our presence in the attractive and growing precision motion space. Applimotion has a great leadership team that founded the business and as we build it up and the integration is off to an excellent start. Sales of our air bearing spindle products also in the precision motion segment were essentially flat for the full-year although we did see some nice growth in Q4. Over time, we've had success in diversifying our air bearing spindle application mix such as nearly 40% of revenue now comes from applications other than the traditional the hole drilling OEMs that were the basis of the business in the past. This improved business mix has significantly improved the predictability of this product line. So now turning to our laser products segment, which remains the largest of our three segments, we had good results. We had mid-to-high single-digit revenue growth in both Q4 and the full-year of 2014. We had 38 new OEM design wins with our low powered CO2 products during the year versus our original goal of 25. We're seeing strong CO2 laser demand in marking and coding applications driven by the ongoing shift from inkjet to laser markings in food and beverage and pharmaceutical processing plants. We're also seeing increased CO2 laser opportunities in new applications for us such as organic material processing – in organic materials processing for smartphones, apparel and sporting-goods and converting. Our scanning and beam delivery sales increased high-single digit year-over-year in Q4 on the strength of our new ScanMaster controller product offering which enables OEM customers to more effectively design and control our scanning technologies in their applications. As well as our Lightning II all digital scanning solution which provides best-in-class accuracy speed and drift. Scanning demand has been strong in industrial application, but over 25% of the sales come from medical applications such as OCT, parental diagnostics and laser surgery. Those did see a demand slowdown in the latter part of 2014 as I mentioned earlier. Our early 2015 trends show improved medical order rates for scanning products, so we're optimistic about the go forward picture. Our fiber laser business continued to grow at attractive rates off of our small base throughout 2014. With full-year sales up just under 50%. We currently offer fiber lasers up to 4 kilowatts and this business has been slightly profitable since mid-2014. As the current management team has done a strong job of ramping up the business while selectively pursuing the right growth opportunities for us in this increasingly competitive space. So turning to our medical technology segment given the reduced demand and order rates that we saw in the latter part of 2014, I think it's important to separate the short-term dynamics from the medium and long-term's perspectives. From a strategic growth standpoint, we are very positive about the medical business. We had an excellent year working with customers on new programs. The JADAK Auto-ID business won 66 new OEM programs during the year versus an original plan of 60. They had 25 wins in Q4 alone which is an all-time high for the business for a single quarter. Most of these new products rather these new programs will turn into production revenue in 2016 or most likely beyond. But this was an excellent outcome. We are seeing an increasing customer demand for all of our auto-ID technologies including machine vision 1D and 2D barcode scanning and RFID in particular is gaining momentum in medical applications. The NDS business had a strong focus on product development pipeline. It showed 10 new products in the fourth quarter and got excellent customer feedback. Their new 27 inch radiance ultra surgical display has the most advanced technology in the industry including edge-to-edge Croning Gorilla Glass, better visualization in high ambient light conditions the brightest LED backlighting in the industry and a faster sterilization process, which will improve OR turnaround times between procedures. NDS also won an award at 2014 excellence in surgical products awards competition. This recognizing the technology and innovation of our expand OR high-definition video and audio streaming device. Our medical thermal printers' product line, which was recently merged into the JADAK business is also seeing strong customer interest in new programs based on their new line of mobile printers that can be adapted for use with existing equipment. Our medical cross-selling initiative is also gaining traction. As our customer teams meeting regularly to share leads and opportunities across the medical business and to plan joint sales calls and tech days at major medical customers. So on the whole; we're seeing significant medium-term growth potential in the medical market. Our larger medical customers have recently communicated improved market conditions in the higher order forecast for 2015. We now have eight weeks of order data in hand and so far we do see improvements. So we're expecting mid-teens reported sales growth for the medical segment in 2015 with organic growth of mid-single digits. Having said all that, I have to be clear that Q4 and late 2014 were a definite challenge for medical technologies. Reported sales in the segment were up 30% year-over-year in Q4 and 35% for full-year 2014, but that growth is based on the addition of JADAK, the acquisition into the results. Segment revenue declined year-over-year and in Q4 excluding the acquisition. There were two primary drivers. One we talked about quite a bit, we had the full-year impact of the 2013 OEM dual sourcing that hit NDS in mid-year 2013. Second, there was the general slowdown in medical capital equipment orders that I have mentioned earlier which impacted all of the medical businesses. The JADAK business which we acquired in the first quarter if we viewed it on a standalone basis for the full-year 2014 it had mid-single-digit revenue growth full-year. But the business saw the same order rate deceleration that we had in virtually all medical product lines in late 2014. So we definitely faced medical market headwinds particularly in Q4. We view it as a short-term dynamic. A number of our OEM customers, medical OEM customers pointed to U.S. electronic health records mandate as a driver of the lower unit volume of their shipments of equipment in Q4. This is likely not the only driver. We believe the U.S. Medicare reimbursement changes and other aspects of the U.S. Affordable Care Act have created some disruptions in the capital equipment market that did have an impact on our business. This silver lining of all this is two-fold. One, we were able to offset the short-term medical slowdown with upsides in our industrial business and still deliver on our guidance despite the unfavorable currency movement that we saw in late Q4. Second, we're confident and the ultimate opportunities we did see in the medical business and our ability to capture them. They have a strong engagement with customers on new programs. The cycle to revenue in medical equipment can take some time. But we expect this market to deliver attractive growth for us over time. Healthcare trends including demographics, the growth and procedures, the rising standard of care around the world will ultimately drive the growth of the medical capital equipment industry. We think medical technology is a good place to play and we are well-positioned and we continue to look to grow this part of the company going forward. So with that, I would now like to turn it over to Robert to provide more details on the financial performance. So Robert?

Thank you, John. During the fourth quarter of 2014, GSI generated revenue of $94 million an increase of 14% from $82 million in the fourth quarter of 2013. Changes in foreign exchange rates adversely impacted revenue causing a roughly 2% decrease in reported revenue. Excluding the impact of the JADAK acquisition and changes in foreign exchange rates, the company's revenue increased by approximately 1% compared to the fourth quarter of 2013. Growth in our advance industrial applications was partially offset by year-over-year weakness in medical and market applications. Sales to medical customers were down due to significant U.S. regulatory changes going into effect in 2015, which disrupted hospital capital expenditures in the fourth quarter. The medical market is showing signs of stabilization now but the majority of our OEM customers are expecting a better outlook for 2015. Turning to our segments, sales of laser products for the fourth quarter of 2014 increased 7% to $46 million compared to $43 million in the prior year. The business experienced solid growth across all business lines. While we experienced some weakness in medical end-market applications, our laser scanning and beam delivery technologies were up nearly 10% whereas our laser source technologies were up mid-to high single digits. Sales of medical technologies for the fourth quarter 2014 increased 30% to $32 million compared to roughly $25 million in the prior year. The JADAK acquisition drove the increase in reported revenue. However, sales of our visualization solution sold underneath the NDS and Dome brands were below fourth quarter 2013 levels. Sales of precision motion for the fourth quarter of 2014 increased 10% to $15 million from $14 million in the prior year. The business experienced solid growth across all product lines. While the business experienced some weakness in medical end-market applications, demands for our products in advance industrial applications market share gains and new product introductions more than offset that weakness. Turning to profitability, fourth quarter GAAP gross profit was $40 million or 42.3% gross margin compared to $34 million or 41.6% gross margin in the prior-year comparable period. On a non-GAAP basis excluding intangible amortization and acquisition fair value adjustments fourth quarter non-GAAP gross profit was nearly $41 million or 44% gross margin compared to a non-GAAP gross profit of $36 million or 43.3% gross margin during the same period last year. The 70 basis point improvement in non-GAAP gross margin was driven by solid progress with our continuous improvement productivity initiatives across our business lines and a better mix of higher-margin product sales. Laser products fourth quarter non-GAAP gross profit was roughly $20 million compared to $18 million in the same period last year. Gross margin percentages improved this year to 44% from 41% in the fourth quarter in 2013. The increase in gross margin was primarily driven by cost productivity gains from our continuous improvement programs. Medical technologies fourth quarter non-GAAP gross profit was $14 million reflecting a 43% gross margin compared to $11 million or roughly 45% gross margin in the same period last year. The roughly 200 basis point decrease in gross margin was primarily driven by lower sales volumes of our visualization solutions sold underneath the NDS and Dome brandings. Non-GAAP gross profit dollars increased $3 million primarily due to the acquisition of JADAK. In precision motion fourth quarter, non-GAAP gross profit was $7 million reflecting 48% gross margin compared to $6 million or 46% gross margin in the same period last year. Gross margins increased 1.7 percentage points driven by cost productivity from our continuous improvement program in a higher-margin product mix of revenue. GAAP operating expenses amounted to roughly $74 million in the fourth quarter from $27 million in the fourth quarter of 2013. And nearly $47 million increase was primarily driven by a $41 million impairment charge of goodwill and intangibles. Research and development expenses were nearly $8 million or 8% of sales during the fourth quarter compared to nearly $6 million or 7% of sales during the fourth quarter of 2013. R&D expenses increased in terms of total dollars due to the acquisition of JADAK. However, R&D expenses were relatively flat compared to the third quarter of 2014. SG&A expenses were $22 million or 23% of sales during the fourth quarter compared to $19 million or 23% of sales during the fourth quarter of 2013. SG&A expenses increased in terms of total dollars due to the acquisition of JADAK. However, SG&A expenses were relatively flat compared to the third quarter of 2014. Non-GAAP operating income was $12.5 million or 13.3% of sales in the fourth quarter compared to more than $10.5 million or 12.8% of sales in the fourth quarter of 2013. Adjusted EBITDA, a non-GAAP financial measure was $15.3 million in the fourth quarter compared to $13.6 million in the fourth quarter of 2013. Interest expense was $1.4 million in the fourth quarter 2014, the year-over-year increase being driven by the acquisition of JADAK. The weighted average interest rate on our senior credit facility was 3.3% for the fourth quarter compared to 3% in the fourth quarter of 2013. Other income was nearly $1 million in the fourth quarter. This represents earnings from our equity interest in laser quantum, a business we hold roughly 41% ownership interest in as of year-end. Diluted earnings per share from continuing operations was $0.82 loss in the fourth quarter compared to income of $0.14 in the fourth quarter of 2013. The fourth quarter of 2014 includes the previously mentioned NDS impairment charge of $41 million. However, non-GAAP earnings per share as reconciled in our earnings press release was $0.24 in the fourth of 2014 compared to $0.17 in the fourth quarter of 2013 representing a 7% increase year-over-year. Turning to the balance sheet, as of December 31, 2014, cash was $51 million while total debt was $115 million. Since acquiring JADAK in March of 2014, we've made $22 million of debt repayments reducing our gross debt from a $137 million in the first quarter to $115 million at year-end. The company completed the fourth quarter of 2014 with approximately $64 million of net debt. This represents a $41 million decrease in our net debt positions compared to the first quarter of 2014. Operating cash flows from continuing operations for the fourth quarter was $10 million. For the full-year of 2014, the company generated $44 million in cash provided from operating activities and continuing operations. As we look at the 2015 environment there are a couple of changes in last couple of months to take note. About one-third of our business is in Europe, which has seen a significant deterioration in currencies in relation to the U.S. dollar. While we tend to have a U.S. heavy cost structure, the changes in those currency values still present a pretty good size headwind for us going into the year. In addition as witnessed in the fourth quarter, the regulatory environment for the U.S. medical market is going through some short-term changes. The U.S. Affordable Care Act, the new electronic medical records systems mandates and changes in medical reimbursement rates have been disrupted for the medical equipment market in the short-term. However, the industry has largely adapted to these changes and we now expect to see more stable order rates from our OEM customers and return to growth in mid 2015. Consequently, for the full-year of 2015, we expect revenue from continuing operations of approximately $380 million. This represents year-over-year organic growth of 4% to 5%. Based on what we know, we are expecting foreign-currency translational headwinds to impact reported revenue by approximately $10 million, which is incorporated in this outlook. We continue to gain confidence in the outlook for our businesses and our markets. As John mentioned earlier, our customer design and activities, our new product development efforts are all making solid progress. Moreover, our continuous improvements productivity program has also taken strong root in our culture and our manufacturing centers allowing us to better meet the needs of our customers while improving our profitability. As it relates to profitability, for the full-year 2015, we expect to deliver more than 150 basis point improvement in our gross margins giving us the ability to invest for growth and weather the foreign exchange headwinds. While delivering 4% to 5% organic growth, we expect to increase our non-GAAP operating income by 10% and expect to deliver $60 million of adjusted EBITDA. With a share count of roughly $35 million and a non-GAAP tax rate of approximately 35%, we expect non-GAAP earnings per share to increase nearly 10% as well. We expect operating cash flow to be strong for the year despite approximately $3 million to $5 million of planned restructuring to eliminate redundancy and reorganized a better position ourselves for success. We also plan to increase our capital expenditures approximately 30% to $7 million. For new production tooling to support our new product launches in the year and to start migrating to a more modern ERP environment in a few of our manufacturing facilities. Overall, free cash flow, operating cash flow minus capital expenditures should be relatively flat year-over-year. Turning to the first quarter of 2015, we expect revenue from continuing operations of between $88 million and $90 million, which represent a year-over-year organic growth of 2% to 4%. Based on current trends, we are expecting approximately $3 million in foreign currency translational headwinds impacting our reported revenue for the quarter. In addition for the first quarter of 2015, we expect adjusted EBITDA to be in a range of $10.5 million to $11.5 million with foreign exchange headwinds impacting our profitability slightly. We continue to take actions to make progress to mitigate the impact including accelerating cost productivity programs, renegotiating customer and vendor contracts. I should also note that we are ramping up our spend in R&D, which is set around 9% of sales levels as we are seeing a significant growth in customer design and activities and demand for new products. These activities have given us renewed confidence in what to invest in and where to invest in across our business lines. We expect to record approximately $3 million in restructuring costs in the first quarter. We also expect depreciation and amortization expense of approximately $4.5 million for the first quarter of 2015 and stock compensation expense of roughly $1.4 million. At the end of the first quarter of 2015 and given the recent closing of the Applimotion acquisition, we expect approximately $180 million of gross debt and approximately $73 million of net debt. We demonstrated solid financial results in the fourth quarter of 2014 despite tougher market conditions in the prior year. We're looking forward to a successful 2015 as we continue to drive our business organically, improve our product offerings and improve operations to drive profitable growth. Finally, we have a strong balance sheet which gives us additional capability to pursue strategic targets and a growth for acquisitions while further leveraging our base. This concludes our prepared remarks. We will now open the call up to questions.

Thank you. [Operator Instructions] Your first question is from Lee Jagoda with CJS Securities. Your line is open.

Hi. Good afternoon.

Hi, Lee.

So John you mentioned that you did the study and defined your addressable market at about $2 billion. Can you define that market into some broad buckets in as much detail as you'd like?

Well, I mean we have a map of it because you are looking at technologies down one side and then you are looking at application areas across the other side. But some of that is in traditional laser materials processing applications. You've got a lot of precision motion applications. You have auto-ID applications. There is a lot of different things going in there and that's medical and industrial. So and it's kind of hard to walk it through verbally what all that is. But, the interesting thing is, when you look at and say okay, if you view medical as a broad area and advanced industrial is a broad area, they are both in the range of about $1 billion, what we can access. And they have similar growth rates frankly. We are a little weighted sort of 60:40 industrial to medical right now. But it doesn't say that there is a big difference in our growth opportunity across one of the other. But the way we built that up Lee is, we did strategic plans in all the businesses and then kind of had enough of standardization of how they define it. Then you can then start to aggregate the stuff.

Okay, great. And then just following up on the SG&A side, I would assume that the SG&A as a percent of sales goes up particularly because of currency and there's no real significant offset there. You've talked about adding sales and marketing ahead of future growth. Can you talk about some of the initiates you are planning on the sales and marketing side and when we expect to see the acceleration of growth because of those additions?

Well, I mean the first thing to realize is just the way we sell. I mean it's a designing process that you could think of that designing process as a year plus or minus in industrial application then two years plus in medical applications, right? So you can't walk in the door and have a meeting and then leave with an order. What you are working towards is a design win. And then when you get the win, you still have work to do before you see revenue. So we have to add resources ahead of when the demand shows up and it's a one to two-year lag on that. So I mean we have made additions. It's not like we're just starting it right now adding some of those front-end resources we have been doing it. But, you kind of have to keep doing it and there is a lag effect. But, we didn't get a lot of organic growth in 2014 fair point. We're seeing more flowing in there even in Q1 and as we move through this year we are going to start to see some mid single-digit organic growth opportunities. So I think we're getting some benefit from that and you would see even more next year of course.

The one thing I would add to that is, traditionally as you look at how we manage your SG&A and even our R&D for that matter. We've been fairly conservative in adding those resources into that organization. So this is probably the first time as we get into 2015, we have enough confidence, so we can start to add those resources and we know where to put them.

Yes. I mean it's a good point what Robert saying. What we tend to do is, drop a plan to add a lot of these resources. But we've been conservative where if the revenue was not happening, we will go back on it and preserve the profit margins and all that and there's goodness in that instinct. But, at some point you have to just go forward. Because really there is this lag and we're not going to get a sale with any customer in the first few months or even really in the first 12 months that we add a sales person. Occasionally it happens in some kind of serendipitous way that we walk into an account and there is some supplier there that's falling down and you can kind of jump in there and take the business over. But that's not our normal way of acquiring business. It's really when the customer is doing R&D and we collaborate and we get incorporated into their new product launch. It just doesn't happen that quickly.

And is it fair to say that most or the vast majority of the SG&A and R&D is U.S. centric and wouldn't be – you wouldn't get the benefit of the FX that you are getting hit for on the top-line?

Well, I would say it's certainly on the R&D, that is not necessarily the case on the SG&A side, but certainly on the R&D side that's the case.

Okay.

That the vast majority of our centers of excellence reside in the U.S. From an SG&A perspective there is a little bit of arbitrage that we can play out there and we continue to look at those opportunities.

It actually even for business reasons never mind FX reasons. We need to get our sales channels more developed in Asia and even really in Western Europe in some cases. And that actually would play okay when you are seeing the weakening euro or whatever. But we wouldn't do it just for the currency reasons. But, R&D right now is pretty U.S. dollar centric. We have on the Board some programs to start doing in country R&D in China and doing perhaps some limited R&D in Europe, but it's not big numbers. That's skewed in a significant way into the U.S.

Okay, great. I will hop back in the queue and let others ask questions.

Thanks Lee.

Your next question is from Jim Ricchiuti with Needham & Company. Your line is open.

Hi. Good afternoon. Question on gross margins, some nice improvement that you showed in Q4. How should we think about gross margins over the next couple of quarters?

For the full-year we give guidance around 160 basis points that was somewhat applied at the gross margins that you see in the fourth quarter. Certainly hold into the first half and then begin to increase as you get into the back half of the year. So there is continued gains there. When you look at the volume to volume ratio on a year-over-year basis you should expect to see some margin expansion.

Okay. Thanks. And John, I think you alluded to an up tick in the medical segment, the medical business orders. Do you expect to see the growth in that business more weighted toward the second half of the year?

Yes. Jim I think that's an accurate way to look at it. I mean just because I mean there is a little bit of a correction system being a component supplier, when you have a sudden slowdown as you can imagine like your equipment is not selling. They already have some inventory of our components right? So then they try to shut-off deliveries of components and then as it starts to trend back there is always this lag affect because we are at the end of the chain, right? So as they start to see – they had probably too much inventory of our product at a point in time, so there is a bleed-off, they start to pick up in sales, but we don't see it right away. But, ultimately when they bring bleed through some of the inventories both see the pick back up. We're getting those positive signals. It is definitely more skewed to the second half and first half, but some good signs already.

Got it. And just as we look at the portfolio of businesses, there have been some adjustments that you have made you've been acquisitive. How should we think about the year both from the standpoint of potential acquisitions that you see in the pipeline and should we consider that there may be any additional adjustments to the existing portfolio of businesses?

There could be. I mean we are always active. This is something that never stops in terms of cultivating acquisitions meeting with companies. We source our own deals that we think fit our purposes. We don't kind of respond to the typical sales processes that are happening and so that you can never stop doing that. Some things are further long than others. Some transactions are larger and smaller than others. It's difficult to predict. But there is a good likelihood. We could have additional transactions happening this year on the acquisition side. With respect to divestitures; we always evaluated, I used the term we rack and stack the portfolio and always say there are a few, what are your best businesses, most quarters what are you are doing, somewhere in the middle and somewhere last quarter and you are always sort of evaluating that, but nothing that we can speak to it at this time anyway.

Sure. And I may have missed it, but I think you talked about savings in the area of $6 million. And I wasn't sure again I missed the reference, was it geared more toward some of the initiatives you've taken on a procurement front and if that's the case how should we think about that playing out over the course of the year? Is that something you think will be more impactful in the second half?

Well, I mean, the first part of your question, the savings are somewhat more skewed to the supply chain because that's where the cost is. I mean we just have 70% to 80% of product cost is purchase material. So you got to work on that to get savings. And if we are skewed and the $6 million you could think of it roughly as one-third in-house labor overhead type cost and one-third in the supply chain, this labor overhead and cost of poor quality, the internal cost. The other part is the supply chain. When you drive this up – this is all based on planned and efforts that were already being worked on through the course of last year. So you do have the ability to get some of the savings even early in the year, but it builds upon itself as you go through the year. And we now have it in a process; every one of our sites has specific projects not just a dollar figure. They got projects that lead to the dollar figures. In the supply-chain and in their own factory cost structure and the projects and the savings from those are reviewed every single month and we track against it like it’s a normal part of the budget now. I mean it's much further along than we were to say 12 months ago where we had aspirations and we had efforts and intentions, but it's just was not structured that way. Our view is you got to drive this kind of productivity every year. It's not a one-time event. And we put in place – we said IT, but what it really is, we did a spend analytics tool we implemented. And that is basically a system that sucks all of your procurement data out of your underlying systems in that factory. It says what parts are you buying, from whom, in what quantity, what supplier, what price are you paying? And brings all that data into one place and then you can compare notes and see, well, here we buy printed circuit boards from 20 different vendors or 30 different vendors and consolidate that buy in five vendors, you could get a savings on that and you do something about it and then when you do it you can track it. So it's called the spend analytics tool. It took a while to implement that. So now you can push a button and get all the data. Look at it weekly and refresh it. So it's an excellent tool that really now say what are we spending, where is the spend? How do we go after this and drive it. This is the same process we've done in other companies. Our team has done it other companies and once you get that infrastructure, it's a big step forward. You are always now negotiating with a lot of information and a lot of knowledge and you know where to focus.

And John, this has been implemented across the business units?

Yes. Because it's a centralized tool, the spend analytics has been mapped to each system in the field but the data pools into one place and so it's, yes, all the sites are linked to it.

Every supply chain leader across our sites, every general manager, every production line leaders can see the information.

You imagine we run different ERP systems in a lot of our different factories. So if you don't have this, you are on the phone trying to say hey, where do we buy circuit boards and what do we pay for them? And it's highly inefficient to ever try to get real savings out of a process. Now we can see all that with a push of a button, where do we buy where, prices, trends our prices moving up or down or so you can start to really build a program and say where do go renegotiate some of this or looked at strategically consolidate the buy. And it's racked how much of what you are buying is coming from low-cost countries and things like that. There is this tendency in smaller companies and businesses like we where our roots are that everybody buys from vendors that are within an hour's car ride where the factory is. And that's not a way to drive productivity. So now you are able to kind of get out of that.

Got it. Thanks very much. That's very helpful.

Thanks Jim.

Your next question is from Keith Maher with Singular Research. Your line is open.

Hello.

Hi, Keith.

I was wondering if you could provide a little bit more detail – financial details on the Applimotion acquisition just if you could share in terms of how much revenue that entails – what kind of margins?

It was more of a technology acquisition; it was relatively small in nature. But that being said, we haven't provided a lot that's not incorporated that much of our guidance at this point in time. Again, it's not very big, but we haven't provided a lot because it's a small business that's never prepared its books in anything other than QuickBooks and certainly not on a GAAP basis. So we have to sort our way through that and get that fixed before we started giving some updates there, but that certainly could surprise a little bit of upside on the top line.

And it has not closed yet, I guess?

Just recently closed and so its couple of weeks of revenue – probably couple of weeks of revenue for it.

All right. And in general, you are not including any acquisitions at this time are you?

No. We're not including any acquisitions or divestitures in our forecast at this time. Certainly there's plenty of things in the pipeline that we look at as John mentioned before on both sides and we will evaluate it at the time as appropriate.

Okay, great. And with regard to the negative FX you are seeing, I mean a little bit perhaps to maybe trying to raise prices or maybe I misinterpreted that. Is that something that is realistic and I'm just thinking of your competitors or [indiscernible]?

Yes. I mean that's the issue. What you just said is the issue. In a number of cases we have direct competitors that are private companies in Germany or in the Eurozone that have all their costs in Europe. So if we try to recapture margin by raising the prices we become uncompetitive with those. So it's a balancing act. You look at where you maybe able to do that, but we don't want to have a short-term knee-jerk reaction that disadvantages us in the longer-term customer relationships. We don't want to let the enemy into customers.

Right.

Okay.

I think sometimes that you got to take into consideration – there is a lot to place. We tend to be a heavy U.S. dollar cost structure organization. But that doesn't mean that we are 100% U.S. dollars. So there is opportunities even to change the currency in which we transact in that could have a benefit to us. So we started that in the fourth quarter when we started to see this trend in Europe was likely going to continue for a little bit. And try to better match what we transacted versus what we are producing. And I think we made some good progress on that that's incorporated into our forecast for now, but hopefully it provides us with some opportunities as we go throughout the year.

Okay, great. And finally, you are talked about the nice design wins in the laser product area. Just curious how long does it take for those design wins to get into your customers product and get shipping I guess in driving revenue?

Yes. I mean that is the kind of the key question. Business like ours that are highly engineered component business. We owned shelf-stuff out of a catalog. We don't have finished good sitting on a shelf waiting for anybody. What I would say is, in the industrial applications and the CO2 laser is predominately an industrial type of technology, it's shorter. I mean it is still typically averages over a year. But you can have some ramp up. The stages you go through is initial prototype samples and then qualification samples preproduction samples where the quantities are a little bit more and then ultimately production volume. You are not going to get to the production volume in less than a year normally. But you can start to see a ramp to that. It's the medical that takes longer because you have a regulatory cycle sometimes in FDA or 510(k) process. So that just takes longer. But with it – some of those can turn into revenue. You will see something in the first 12 months, but then you will hit a run rate in a year and a year and half.

And then how long is the lifecycle, once you are in?

That's another great question. When you are looking at industrial applications it tends to be – is about the seven-year type of range. When you're looking at medical though and we're sitting in platforms that are 10 or longer years and so it becomes an annuity stream. So one of the things that you always constantly focusing on is that annuity stream that you have how much of that is coming up for bleeding off meaning that they are moving off of that platform into something else. And then how much new business can you get in? I think we finally got ourselves into a position where we are generating more new opportunities than we've seen coming off and so we're feeling better about that.

Okay. Thanks. That's really helpful. That's all I had.

Thank you.

[Operator Instructions] Your next question is again from Lee Jagoda with CJS Securities. Your line is open.

Robert, just a couple of bookkeeping items, your expectation for amortization of purchased intangibles as well as the GAAP tax rate and the non-GAAP tax rate that you expect sitting here today.

I will start back with on a non-GAAP tax rate around 35% for 2015. On a GAAP basis it's going to be – it's difficult to predict. I have an impairment charge that obviously threw-off the 2014 number pretty significantly, so we finish off around 5%. But we were trending before that in the call 35% range as well. Arguably, they should be fairly close on a GAAP and non-GAAP should be not that different, see you can use those two numbers. From an amortization of intangibles on a total basis, portion of that goes up in our cost of goods sold. We gave in an 8-K release earlier in the year about $11 million that is our guidance. And I still see that. So we're sitting somewhere around $11 million then depreciation is somewhere around $7 million to $8 million or closer to $8 million.

And of the 11, what portion of that goes into cost of goods?

It's about – $7 million is going into operating expenses.

Okay.

And there are no further questions at this time. I will turn the call back over to Mr. Roush for any closing remarks.

Okay. Thank you, operator. So as we move forward in 2015, we do see a positive outlook for GSI. We made tremendous progress as an organization. We're in a better position to drive forward with our strategies and ultimately control our own destiny as a company. We built an outstanding team and more attractive portfolio and a solid execution capability that enables us to drive sustainable profitable growth. So the agenda for 2015 is clear. As demand from medical OEM customers recovers, we need to continue to serve them well bring new products and technology to market and capture design winds which are the lifeblood of our business. And those secure our future growth. Demand across our industrial applications has been healthy. We expect that to continue. We got to execute on our strategic plans and ensure that we capture the future opportunities we do see across the market. Following the closing of the Applimotion transaction, we are now implementing our integration program for the business to bring it together with our encoder business. As we said, there are significant opportunities for the combined business, so we need to get aligned quickly to take advantage of those. On the operational front as I mentioned earlier, we now have concrete planned-in programs to drive productivity and operational improvements in each site. We are moving out of these plans, tracking progress on a monthly basis and operating reviews and I should expect to see a very good impact in 2015. The economics uncertainty remains a part of the landscape in which we operate. The strengthening of the U.S. dollar, it's going to have an impact on us like it will on many if not most global companies reducing reported revenue into extent pressuring margin. We are not deterred by that factor. We have confidence in our team, our strategy and our ability to create value. The leadership team here at GSI is fully committed to deliver on our 2015 goals and to strengthen our foundation of the company to ensure our future success. I'm confident we will get there. I appreciate your interest in GSI and your participation in today's call and I look forward to joining all of you in early May on our first quarter earnings call. Thank you very much.

The call is now adjourned.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.