Good day, ladies and gentlemen, and welcome to the Bruker Corporation's quarterly earnings conference call. My name is Jody, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session. If at any time you require operator assistance, please press star followed by zero, and we will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Stacey Desrochers, Treasurer and Director of Investor Relations. Please proceed.
Thank you. Good morning, and welcome to Bruker Corporation's second quarter and first half 2012 financial results conference call. With me on today's call are Frank Laukien, Bruker's President and Chief Executive Officer, and Charlie Wagner, Bruker's EVP and Chief Financial Officer. Before we begin today, let me briefly cover our safe harbor statement. Various remarks that we may make about the company's future expectations, plans, and prospects constitute forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those described in the company's filings with the Securities and Exchange Commission. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.
You should not rely upon these forward-looking statements as representing our views as of any date subsequent to today. In addition to the financial measures prepared in accordance with generally accepted accounting principles, or GAAP, we will discuss certain Non-GAAP financial measures, including adjusted EPS, adjusted operating income, adjusted operating margin, which are Non-GAAP measures that exclude certain items. We exclude these items because they are outside of our normal operations and/or, in certain cases, are difficult to forecast accurately for future periods. We believe that the use of Non-GAAP measures helps investors gain a better understanding of our core operating results and future prospects consistent with how we measure and forecast the company's performance, especially when comparing such results to previous periods or forecasts.
A reconciliation of our GAAP to adjusted numbers can be found in our press release issued earlier today and is located in the investor relations section of our bruker.com website. Today, Frank will provide an update on the business and certain overall Bruker Corporation financial highlights. Charlie will discuss the financial results of our Bruker Scientific Instruments, or BSI segment, and our Bruker Energy and SuperCon Technologies, or BEST segment. I will now turn the call over to our President and CEO, Frank Laukien.
Thank you, Stacey, and good morning, everyone. We appreciate you joining us today. Before I provide a business update and discuss the financial highlights for the second quarter of 2012, I would like to welcome our new sell-side analysts, Sung-Ji Nam from Cantor Fitzgerald, and Ross Muken from ISI Group. Welcome. I also would like to introduce all of you to Bruker's new Executive Vice President and Chief Financial Officer, Mr. Charles Wagner. Charlie brings over 20 years of financial and management experience to his role, including experience as the CFO of two publicly traded companies and expertise in financial analysis, strategic planning, and corporate development. We are very happy to have Charlie with us and look forward to his contributions. Here are the financial highlights for Bruker Corporation.
Our revenue in the second quarter of 2012 was $420.7 million, representing growth of 4.9% over second quarter 2011 revenue of $401.2 million. Without the impact of changes in foreign currency and acquisitions, our organic growth rate was 10.4% in the second quarter. Revenue growth was broad-based, with almost all Bruker businesses and markets contributing to the growth. The one exception was Bruker Optics, where revenues declined in the second quarter. For the first half of 2012, revenue was $826.3 million, corresponding to reported growth of 9.0% and organic growth of 12% over the first half of 2011. The growth in the first half was supported by over 20 new product introductions, which address an expanding array of life science, pharma, biotech, clinical, food and food safety, petrochem, environmental, homeland security, materials and nanoscience, as well as academic research and educational markets.
Our product and innovation leadership are the company's primary growth engine, and our competitive positioning remains fundamentally very sound. While our organic growth rate was solid in the first half of 2012, we did see weakening demand towards the end of the second quarter. Throughout 2011, and even through April of this year, Bruker appeared to be somewhat immune to the apparent European malaise. However, at the end of May and into June of 2012, we began to see softening demand, particularly in Europe and even in strong Bruker countries like Germany. Around the same time, we observed a weakening in global industrial and applied markets, including also a sequential slowdown in the semiconductor and data storage metrology markets, which had been quite robust for Bruker at the beginning of this year. Moving on to profitability.
Adjusted operating income in the second quarter of 2012 was $33.0 million, compared to $50.3 million in the second quarter of 2011. For the first half of 2012, adjusted operating income was $76.6 million, compared to $86.1 million in the first half of 2011. In the second quarter of 2012, our adjusted EPS was $0.12 compared to second quarter 2011 adjusted EPS of $0.19. Adjusted EPS for the first half of 2012 was $0.26, compared to $0.32 in the first half of 2011. We entered 2012 with a target for improving our profitability, so the decline in second-quarter margins and earnings was particularly disappointing. Gross margins were lower year-over-year due to a variety of factors. Mix was certainly a factor, as we saw lower revenues from a high-margin business like Bruker Optics and higher revenues from a low-margin business like CAM.
Some businesses experienced higher materials costs associated with production issues and higher unabsorbed labor costs associated with delays in converting our backlog to revenue. Finally, lower pricing impacted margins in some businesses. Moreover, some of our investments in marketing and sales, field installations, and service have increased our expenses but have not yet resulted in the hoped-for reduction and faster conversion of our high backlog. In prior quarters, we have commented on the impact of the acquired CAM, or Chemical and Applied Markets division, and that business continues to present financial challenges. It is now apparent that the CAM business requires more significant investment than anticipated even earlier this year as we ramp to volume new products released in the past year, invest in research and development of further new CAM products, and strengthen the division's global distribution.
As a result, our CAM division posted an $8 million operating loss in the second quarter of 2012, far higher than what we had anticipated. We are evaluating potential streamlining and cost reduction steps at CAM, while we are also looking forward to launching important additional CAM products over the next 12 months. Overall, as a result of our Q2 profitability decline, we are reviewing Bruker's cost structure for areas of improvement and potential expense savings. As we continue to benefit from a high backlog, we will also look to strengthen our global integrated order execution processes and accelerate order conversion in coming quarters. While some acceleration will come from greater focus on our order execution process, additional lasting improvement will only come from further ERP and IT investments that will give better visibility into our order execution.
On a more positive note, in the first half of 2012, our working capital ratio improved as we achieved a $0.02 per revenue $1 working capital reduction compared to year-end 2011. Similarly, our operating and free cash flow picture has improved dramatically compared to the first half of 2011. Charlie Wagner and I are determined to develop and implement credible plans for margin improvement, which remains our number one priority. While we will take steps to improve our margins in the second half of 2012, we are now no longer in a position to meet our original full-year 2012 margin and EPS goals. Bruker's updated financial goals for 2012, which replace previously announced goals, are: revenue in the range of $1.70 billion-$1.75 billion and adjusted EPS in the range of $0.65-$0.70.
I will now turn the call over to the CFO of Bruker Corporation, Charlie Wagner.
Thanks, Frank, and good morning, everyone. Since Frank already commented on the overall Bruker financial highlights, I will provide a summary of our BSI and BEST segments. During the second quarter of 2012, BSI segment revenue increased by 5.1% to $397 million, compared to $377.9 million in the second quarter of 2011. Excluding the effects of acquisitions and changes in foreign currency, BSI revenue increased organically by 10.2% in the second quarter of 2012. For the first half of 2012, BSI revenues increased by 8.6% to $775.1 million, compared to $713.7 million in the first half of 2011. Again, excluding the effects of acquisitions and changes in foreign currency, BSI revenues increased by 11.2% in the first half of the year. Now moving further down the income statement. Adjusted gross profit margin for BSI in the second quarter was 47.5%, compared to 49.4% in the second quarter of 2011.
First half adjusted gross profit margin for BSI was 48.7%, compared to 49.4% for the first half of 2011. Adjusted BSI operating margin in the second quarter of 2012 was 8.4%, compared to 13.2% in the second quarter of 2011. For the first half of 2012, adjusted operating margin for BSI was 9.9%, compared to 12.3% for the first half of 2011. GAAP net income for the BSI segment in the second quarter of 2012 was $10.1 million, or $0.06 per diluted share, compared to net income of $22.4 million, or $0.13 per diluted share in the second quarter of 2011. GAAP net income for the BSI segment during the first half of 2012 was $27.2 million, or $0.16 per diluted share, compared to net income of $36.5 million or $0.22 per diluted share in the first half of 2011.
Adjusted net income for the BSI segment in the second quarter of 2012 was $20 million, or $0.12 per diluted share, compared to adjusted net income of $32.4 million, or $0.19 per diluted share in the second quarter of 2011. Adjusted net income for the BSI segment during the first half of 2012 was $45.1 million or $0.26 per diluted share, compared to adjusted net income of $56.1 million or $0.34 per diluted share in the first half of 2011. Now let me just spend a couple of minutes on the BEST segment. Revenue for the BEST segment during the second quarter of 2012 was $26 million, a decrease of 7.5% compared to $28.1 million in the second quarter of 2011. Excluding the effects of foreign currency translation, second quarter 2012 revenue increased by 3.2%.
Revenue for the BEST segment during the second half of 2012 increased by 7.5% to $56 million, compared to $52.1 million in the first half of 2011, or by 15.7%, excluding the effects of foreign currency translation. Adjusted operating income for BEST in the second quarter of 2012 was zero, compared to adjusted operating income of $500,000 in the second quarter of 2011. For the first half of 2012, adjusted operating income for BEST was $300,000 , compared to an adjusted operating loss of $100,000 in the first half of 2011. Adjusted net income per share for the second quarter of 2012 for the BEST segment was $0, compared to adjusted net income per share of $0 in the second quarter of 2011.
Adjusted net income per share for the first half of 2012 for BEST was also $0, compared to an adjusted net loss per share of $0.01 in the first half of 2011. The BEST external backlog of $247.6 million as of June 30th, 2012, increased by approximately $76 million or 44% from June 30th, 2011. The increase was primarily driven by several multi-year orders for LTS conductors, as well as an HTS license agreement signed this past quarter. In May, BEST announced a large-scale technology transfer contract to license and transfer knowhow for second generation YBCO ceramic tape, high temperature superconductors, to a subsidiary of the State Atomic Energy Corporation Rosatom. The total contract value exceeds $25 million, and BEST will begin to recognize revenue in the third quarter of 2012 through the end of 2013 or the early part of 2014.
Next, I'll spend a minute to briefly discuss certain cash flow and balance sheet metrics that relate to overall Bruker Corporation. Our GAAP effective tax rate was 45.9% during the first half of 2012, which was negatively impacted by our unbenefited losses in the U.S., resulting from higher corporate costs and from operating losses at our CAM division. Our adjusted tax rate was approximately 33% for the first half of the year of 2012. Cash flow from operations in the first half of 2012 was a source of $41.9 million, compared to a use of cash of $25.6 million in the first half of 2011. Increases in customer deposits and decreases in accounts receivable were a significant source of cash, while inventory increases were a large portion of the use of the cash in the first half of 2012.
Our capital expenditures were $28.7 million in the first half of 2012, compared to $31.2 million in the first half of 2011. Free cash flow, defined as cash flow from operations less capital expenditures, was a source of cash of $13.2 million in the first half of 2012, compared to a use of cash of $56.8 million in the first half of 2011. We ended the second quarter of 2012 with cash equivalents, and restricted cash of $243.6 million and net debt of $77.3 million. Before I open the call up for Q&A, I want to talk briefly about my reasons for joining Bruker. During my time as CFO of Millipore Corporation, I got to know many of the investors and the analysts on this call, so I'm glad to be back in an operating role that allows me to reconnect with all of you.
Shortly after leaving Millipore in 2010, I joined the board and the audit committee of Bruker and have come to know the company quite well over the last couple of years. Quite simply, I've stepped into the operating role, into the CFO role at Bruker because I see a great opportunity to create value in an industry and in a business I really enjoy. Bruker has a strong reputation for producing quality instrumentation and life science tools, and the company is number one in many of the markets it serves. The company's strong brand and product innovation have resulted in consistently high organic growth over several years, and that's no different this past quarter. However, increases in profitability and cash flow have not been consistent over the years.
Those of you that have followed the company for some time know that Bruker has a decentralized structure with considerable autonomy in the operating divisions. This decentralization contributes greatly to Bruker's innovation, entrepreneurial thinking, and customer intimacy at the divisional level. However, the decentralization also results in complexity, limits visibility into business drivers, and limits the company's ability to benefit from economies of scale. Some of these issues were obvious and apparent in our Q2 results. The company's grown rapidly over the past 10 years, but as we approach $2 billion in revenue, it's clearly time to make adjustments to how the company is operated. In the last year, the One Bruker initiative was launched with the intention of achieving a higher level of integration and coordination across the Bruker portfolio without sacrificing the innovation and entrepreneurial spirit that power the company.
Initially, the focus has been on improving ERP systems and beginning to capture economies of scale in procurement and order execution. In 2012 and in planning for 2013, we're going to look for further ways to expand this initiative to make more significant organizational and structural changes to the company. These changes might include reorganization, manufacturing consolidation, and further systems implementation. For the very near term, we'll continue with the One Bruker initiatives that are underway, but we do need some time for more comprehensive evaluation of our strategic and operational plans for the next few years. In future quarters, we'll communicate more broadly about our plan to make Bruker a more profitable and more valuable company. Changing the company will take some time, no doubt, lots of oversight and monitoring, but Frank and I are confident that we can make Bruker a stronger and more profitable company.
I'm personally excited about these opportunities and look forward to helping make Bruker an even better company than it is today. With that, let me turn the call back over to the operator for Q&A.
Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you wish to withdraw your question, please press star followed by two. Questions will be taken in the order received. Please press star one to begin. Our first question comes from Jon Wood from Jefferies. Please proceed.
Hey, morning. Can you hear me?
Yeah, we hear you, Jon.
Hey, morning, Frank. Morning, Charlie.
Morning.
Would love to hear, at what point do you guys feel like you will be in a position to talk about the structural issues that you are going to pursue going forward, whether it be IT investments or fixed asset reductions? When do you all expect to be in a position to communicate empirically what that is going to cost and what that is going to benefit you guys going forward?
Yeah. Jon, work's already underway, and as you might expect, we're not pleased with the Q2 results. We got to look at this in stages. First off, we're looking at immediate, short-term, call it more tactical, changes to the business plan in the second half of the year to ensure that we can deliver on our guidance for the balance of the year. As I mentioned in my comments, the One Bruker initiative has been underway for some time, with a focus on ERP systems and order execution. We've got other plans that are being contemplated right now. I think what you can expect is we'll probably start to make some announcements over the next quarter or two, but that won't necessarily represent a comprehensive plan.
We really need to go through a planning cycle, which is really the second half of this year as we head into 2013, to lay out a more traditional, more comprehensive multi-year view on the actions we hope to undertake. But we're not going to be sitting still until that point. We're continuing with the initiatives we have, and as I mentioned, expect to make other announcements in the near term as well.
Okay. That's great color. Thanks, Charlie. Then for Frank. Frank, if I look at the organic growth rate, obviously it's still double digits in the quarter, with the FX hit a lot bigger than we thought. If you look at the back half of the year, can you just discuss what your updated outlook contemplates in terms of organic growth? If you're willing to quantify the backlog situation in BSI, would love to hear that as well. Thank you.
John, I think with the new guidance of $1.70 billion- $1.75 billion for revenue, that would result in reported growth of about 3%-6%, and if currency, estimated organic growth of about 7%-10%. That's simply the implication mathematically of the guidance that we've given. So organic growth estimate 7%-10% is implied in the guidance that we're giving. These are full-year numbers rather than second half or Q3 numbers. I'm sorry, John, what was your second part of your question?
Yeah, I'd love to hear the backlog. You alluded to it in the prepared remarks, but the BSI business obviously has a ton of backlog and would love to hear any comments on, if you built or burned in the second quarter, and then how you see that situation unfolding over the next two quarters.
Yeah. Our backlog is still very high, and it may have come down just a little bit since the end of Q1, but that was primarily driven by currency. Without going into specific numbers, we are not satisfied with our backlog conversion, and quite honestly, we would've liked to do even more. That's not the only driver in the midst of Q2, but it is certainly one of the contributors. A number of our divisions have done well, much better on order execution, and a number of them have invested but haven't really seen the benefits and results yet. Some of that, ironically, has led to some incremental expense, some incremental OpEx, but not the benefit that you'd expect in faster backlog conversion.
While there's a number of things going on for us in the second half, one of them will be also improving within our operational excellence initiative, implementing and really getting the benefits out of the integrated order execution, which we've implemented now almost everywhere. But in many of the divisions, it's still in its infancy and has not yielded the results yet that we were hoping for.
Thanks a lot, Frank.
You're welcome, Jon.
Your next question comes from Tim Evans from Wells Fargo Securities. Please proceed.
Hi. Thanks. Charlie, welcome, and thanks for the color there on the ERP investment. I was curious if you could talk a little bit about the $25 million BEST, how that revenue will be recognized in 2012, and what kind of profitability you expect on that.
Yeah, we're working through that right now. This contract is large and unique. We are obviously making sure we get the revenue recognition correct. It looks like we'll begin to record revenue in the third quarter. It's a combination of a technology license and then other tangible deliverables. It means the revenue will be kind of multiple element accounting. We'd expect to start to record it in Q3, and it's likely that the first revenue recognized will be license revenue, assuming that we hit our deliverables. As you might expect, that comes through at very high margins. Overall, the contract is very high margin because technology transfer license. Again, if as anticipated, it comes through, in the third quarter, it will have a meaningful impact on Q3.
Obviously, we're expecting a good chunk of that to come in the second half of the year, and that's incorporated in the guidance that we've given.
Okay. Are you willing to kind of quantify what the profitability for the BEST segment might be in the back half?
No, I'm not. But obviously, that would have a significant uplift on the results of the business.
Right.
Important to note, though, that it's not something that we expect to occur over and over again.
Okay. All right, great. Then maybe just if you could comment on what changed between your Analyst Day and today as far as SG&A costs and R&D costs in particular. Did you have visibility on those things at that point and just didn't want to comment because of the policy about changing guidance, or are those things kind of things that caught you off guard a little bit?
This is Frank, and Charlie may have some further comments on that as well. I'll give you some directional indication here. Some of that incremental growth in marketing, selling, in SG&A primarily, was also intended to lead to even more backlog conversion, which somewhat disappointingly didn't all occur in Q2 and in the first half. I would've liked to see more of that. I know our organic growth rate wasn't bad at all in the second quarter and the first half, but we quite honestly would've liked to see more, in which case many of these expenses as a percentage of revenue would've been much more in line. There's a little bit of expense overspending, but many of the divisions have really also adhered reasonably or quite well to the expense planning that we had put in place.
In addition to that, we did see somewhat suddenly, a change in demand pattern in Europe. I know many people had predicted that, but quite honestly at our Analyst Day, we had April data, and April in Germany, Central Europe was all really quite good. Then in Germany in particular, it seems like the German business confidence really plummeted in May, June with people really stepping on the brakes. So a country that's fairly sizable for us as a market of the order of 10%, so that's as big as China or as big as Japan for Bruker, stepped on the brakes rather quickly, it seemed in May, June, and that we had not anticipated or been aware of till really sometime in early June.
It's actually relaxed a little bit towards the end of June, but I hesitate to make any predictions there, nor do I have July data today or anything like that. So that what used to seem to be restricted somewhat to the Mediterranean, clearly went to the biggest economy in Europe and surrounding economies pretty quickly in May and June. So while we have long backlog in some of our delivery items, it takes six or nine or maybe 12 months before we deliver them. We also, in some of our businesses, have revenue that comes in from orders we get 30 or 45 days earlier. Of course, it's a mix, and so some of that demand weakness in the second half of the second quarter does have a little bit of an impact also, of course, on revenue and margins. But again, it's one of several drivers.
Tim, I will just add, and I alluded to it in my comments. Obviously, there are some process improvements we need to make as a company. Bruker has been very growth and revenue-focused, and our ability to have insights into the revenue trend line is greater than, say, the expense trend line in mid-quarter, if you will. One of the things I will be looking at is, it is a function of the way the company is organized, very decentralized, not necessarily fully integrated systems. The process of rolling up insights is a little more difficult than it otherwise could be. So initially, we will be looking at making some process changes to give us better visibility all the way down to operating margin, and then over time, making system investments to do that in an automated and integrated way.
Okay, great. Thank you for the comments.
Your next question comes from Dan Leonard from Leerink Swann. Please proceed.
Hi. Thank you. First question on the CAM.
Dan, we lost you in mid-sentence.
The next question comes from Ross Muken from ISI Group. Please proceed.
Good morning, gentlemen. I am still trying to sort out kind of the sort of components of the delta versus forecast. I know you laid out sort of the various moving parts, but in terms of magnitude, what drove, particularly on the gross margin line, the miss? It seems like CAM was certainly worse, and it sounds like Optics, but I guess, I am trying to tease out sort of what was actually market-related in terms of the European weakening, what was kind of the backlog conversion comment, which I am not still sure I totally understand. I am just trying to figure out, if you had a pie of 100%, how you would sort of allocate that amongst the various buckets of sort of difference.
Yeah, Ross, this is Charlie. It is a good question, and I can answer it for you directionally. Unfortunately, it is all of the above, though. We saw pricing pressure in a couple of businesses, including Bruker BioSpin, and you see that flow through straight to margins around some of the businesses. As I mentioned, we are starting to look at consolidation of manufacturing and other changes and trying to make our order execution process run more smoothly. Part of what we are doing is ERP installations in some of the manufacturing entities. In general, our ability to sort of control the business in the quarter was not where it needed to be.
In some cases, we had staffed up in anticipation of production and burning down the backlog, and then that burn down didn't happen, so you essentially have idle manufacturing resources that are under-absorbed in a few different businesses, so that drives some of it. We had some scrap and write-off issues in the quarter. I wouldn't call that extraordinary, but it certainly contributed. And then mix, Optics is by far our highest margin business, and had a very light quarter. So that miss in Optics was offset by growth in other businesses, but businesses that come through at a much lower margin, like CAM. Without getting precise on splitting up the pie, I can tell you it is four or five different things that contributed to a disappointing gross margin.
That's fair. I guess, Frank Laukien, you've done a good job in terms of making this one of the best sort of R&D engines we see in industry, and obviously the investment required to kind of fuel that has been significant. How are you thinking in the current environment where demand, by all stretches that we look at, is probably incrementally weakening into the third quarter, and then probably for the back half relative to what most of us assumed would happen maybe three to six months ago. How are you thinking about sort of prioritizing the short-term investment needed to reinvigorate some of the acquired businesses and then keep the top-line momentum versus sort of the trade-off of wanting to deliver profitability? Obviously, I know you're not happy with today's result, but there's sort of that shorter-term target versus longer-term strategic investment question I'm sure you've been wrestling with.
Yeah, and I think Charlie Wagner gave you some sort of phased approach to that. Near term, we will be looking at OpEx, at expenses, at headcounts and hiring. We're not prepared to give a number today, but there will be a lot of work on that in the weeks to come. In addition, but more on a, let's say, planning cycle over a couple of quarters, we will be looking at the many growth initiatives and strategic growth initiatives that we have. For instance, in BEST, for instance, in CAM. I'm not talking about the division, of course, but I'm talking about various projects and product lines. It may well be that we may have to take a step back on one or the other growth initiative. It could also be in one of the other divisions.
It's nice to have the growth, but we probably have, right now, we have too many strategic growth initiatives and in different products, and many of them are very dear and very important to us, and we will power through them. Others may well require a review. We may, over the next remainder of the year, I would say, decide that perhaps one or the other, we will not continue with in some markets that perhaps will be developing only in the more distant future. So there are both short-term and longer-term questions. In addition to all of that, I think there are emerging plans, and if anything, they will be accelerated in substantial outsourcing and substantial factory or reorganization, lean manufacturing, some small scale non-strategic divestitures and things like that. So things like this are also on the plate.
It's really three sets of elements plus systems implementation and process improvement that Charlie Wagner has mentioned. Some nearer term. The bigger ones, probably more long-term, 2013.
Great. Thanks, guys.
Your next question comes from Dan Leonard from Leerink Swann.
Hi, thank you. Can you hear me now?
Yes.
Yeah, we got you.
All right. Great. Thanks. Looking for a bit more detail on CAM. What were the revenues in that business in the quarter?
We don't disclose that at this point, Dan.
CAM had good revenue growth, but without going into the details any further.
Well, I'm just trying to better understand. I thought that the facility out in California was running full tilt, and that would be drawing down backlog and reducing the loss in that business, and that it sounds like the revenue line held up on that front.
Just directionally, CAM did not meet its revenue objectives. It had very high growth goals. It grew quite a bit, but it did not grow to the extent that we were hoping for yet.
Okay.
Operationally, it was not running at full tilt. It grew a lot, but that was one of the businesses where we had some trouble in production. Then obviously on top of that, some spending year-over-year to put the business on a good footing contributed to the operating loss that Frank described.
Okay. That is helpful. Thanks. My follow-up question. I am trying to get a better understanding of a lot of the initiatives you are talking about to improve margins, I thought were part of the prior plan to get BSI margins up to 18% over some period of time. Can you help me understand really what is incremental or what the change is from maybe the prior margin improvement plan to what you might consider doing going forward?
Again, very directionally. Clearly, many of these things indeed have been part of our margin improvement plan, and those will generally continue. Given the miss, we will certainly look at additional steps in terms of OPEX and additional steps that we had previously not contemplated.
Okay. Thank you.
Your next question comes from Peter Lawson from Mizuho Securities USA. Please proceed.
Frank, just wondering if you could talk through the dynamics in the BEST business. Looks like strong gross margins despite the less than expected revenue. Just wondering if you can talk through the dynamics there and the, I think 24%-25% gross margins. Is that achievement in the second half on BEST?
Peter. Yes, indeed. BEST was short on revenue, but on the bottom line, nearly where they wanted to be because of better gross margins, as you've pointed out. So that was a positive development. Indeed, I think some of the traditional metallic superconductor or low-temperature superconductor business demand and deliveries have been strong. And they've probably also benefited a little bit from the weaker EUR because, of course, they do all of their manufacturing in Euro countries, in Germany, in this case. So a few trends came together to give BEST a nice gross margin improvement indeed.
Then the comments on the slower than expected backlog conversion, did that hit mostly on the BEST side or the BSI side? Which do you think is quicker to recover?
A little bit on BEST, but primarily on BSI. That was in a number of divisions and groups within the BSI segment. There was some of that in BEST, but primarily in BSI.
Finally around SG&A trended up. Are there any unexpected one-timers in that trending up, or should we expect that to trend up through the second half, or do you think that's kind of controlled?
No, Peter, there weren't any significant one-timers in the adjusted results. It has just trended up. In the first half, obviously, there's some spending in the first half in sales and marketing associated with a lot of technical and trade shows and different things that doesn't necessarily continue into the third quarter and the fourth quarter. But we're looking right now at ways to sort of control or reduce the rate heading into the second half of the year.
Great. Thank you. Good to see you, Charlie, and look forward to working with you again.
All right. Thanks, Peter.
Your next question comes from Amanda Murphy from William Blair. Please proceed.
Hi. Thanks. I had just a follow-up on the pricing commentary that you made. I think you mentioned that you saw some pressure specifically in BioSpin, and is that fair? Can you just give a little more perspective on what's going on there and just at a high level, how you're thinking about pricing just across your business as a whole?
Yes, Amanda, this is Frank. Indeed, as Charlie Wagner has pointed out, some of the growth margin pressure also came from the Bruker BioSpin large division, and there we have seen some average sales pricing pressure and some pricing pressure for competitive reasons. I believe there are also other areas as the world economy and the European economy, in particular, is decelerating or Europe is, I think, already in a recession, most of Europe, a little bit like in 2008, 2009, maybe not to the same extent. We do see a little bit more pricing pressure as apparently a number of competitors at times like this when their growth is not there, tend to resort to a little bit more pricing pressure. That is something we have also begun to observe in the last couple of months at least, and in some areas, longer than that.
But there it may be more of a competitive trend rather than a macroeconomic trend.
Okay. Then, just I guess another CAM question. So, I think last quarter you had talked about benefiting from, I guess this quarter, a full quarter of benefit from the consolidation of the facilities. I am just trying to get a better idea of what is going on there. Obviously, you have talked to some backlog conversion issues, but in terms of the expense structure there, just wondering if you can provide a little more detail sort of with what is going on relative to your expectations last quarter.
Yeah. So CAM did not meet our expectations on the top line. That did not mean CAM did not grow. It actually grew clearly, I mean, it had some of one of the highest growth rates, but not nearly where we expected it to be either in Q2. So yes, that is not a contradiction. We just had pretty high expectations, and it only met those halfway, let us put it this way, in terms of growth. And some of the expenses, of course, at CAM are scaled and targeted to support the faster growth rate. And as that is still a good growth rate, but not the very fast growth rate that we had anticipated, that means we will also be looking at OpEx also in the CAM business. Clearly a growth division, clearly a priority. Many good products that have come out and more to come.
But we will also need to lower our growth expectations for that business, for that division, a little bit and right-size the expenses for that.
How are you thinking about the CAM product line at this point? You had invested quite a bit in it last year. Is that done at this point and now it is more of an operational investment, or do you still need to do some work on the product side?
Oh, yeah. We are still very much in the product ramp-up. So very much product investments. Continued strong product investments will always continue. That is one of the features of Bruker, but I think this particularly strong effort at CAM will continue for approximately another year. Then I think, well, let us talk about that again as we then go into the 2013 business plan and so on.
Okay. Just last one for me. Just thinking about the structure of the business at a higher level, you talked about the benefits of a decentralized structure. I am curious how you are thinking about that going forward. Is that something that you might change, just given some of the expense issues that you have had?
The key, of course, generally will be to maintain the benefits of the entrepreneurial culture with, as Charlie said, great one-on-one customer connections and the innovation engine. But I think there is quite a bit more that we had in the pipeline and more that we will be considering now going forward in sharing resources. Without going into a lot of details, I am not saying we are abandoning our structure and going to something fully integrated, perhaps not as flexible and entrepreneurial anymore, but I think we can make further improvements from the One Bruker initiative, from our operational excellence initiative that has elements in each divisions, but also elements where we take synergies between divisions, and we can get more out of that financially and make this a more valuable company.
Okay. Thanks very much.
Your next question comes from Tycho Peterson from JP Morgan. Please proceed.
Hey, good morning. Thanks for taking my questions. A number of mine have been answered, but maybe just to probe on the comments you made on Optics, Frank. Obviously, it is a smaller business for you guys, but you did call that out as being softer. What was the driver there?
There, it's a little bit product cycle, but mostly there, I think it's the macro economy. They have clearly seen the European slowdown and their inventory reach is not that long. They have more smaller products that they ship in 30 or 45 days and things like that. Yeah, that's a very high gross margin and operating margin division, delightfully so. But when they slow down, it affects our mix, especially if a low gross margin business, at least at this stage. In longer term, we think they'll all be at similar ranges. But for now, CAM is a much lower gross margin business. As we see growth there and slowdown in Bruker Optics, it does affect our gross margin mix.
Okay. Then maybe just stepping back a little bit, you're obviously caught off guard here by the slowdown in Europe, and you've talked a lot on this call about the advantages of having a decentralized structure, but obviously that carries some disadvantages as well. As we think about the guidance that you've laid out for the back half of the year, can you give us a sense as to what makes you think that's achievable? Going forward, do you envision reinstating long-term guidance targets? I think you've kind of officially pulled the long-term guidance you had out previously. But as you lay out the restructuring plan, do you envision kind of reinstating long-term targets as well?
Yeah, Tycho, it's Charlie. I think, to the first part, obviously, given the backlog we've got, even with a kind of a softening macroeconomic outlook, we've got some confidence that we can deliver on shipments and revenues for the balance of the year. Obviously, we need to improve performance in some of our factories, improve order execution performance overall, but we feel like we have the ability to do that. That does give us, maybe relative to some companies, a little bit more confidence in the top-line guidance that we've issued. With that, we also feel then that we can manage expenses more closely in the second half than we've done. If you look at what's implied for operating margins in the second half, it's sequentially much higher than the first half, but it's not a stretch compared to last year.
No doubt, we have to tighten up for sure, but we think that we can do that. Again, it's all predicated on hitting that revenue number, but we do have some confidence in that based on the backlog.
And then on reinstating long-term guidance, is that something you would envision doing in the next six to nine months? Or, how should we just think about your philosophy there?
Yes, absolutely. Obviously, with kind of the trajectory of the first half of this year and even with the initiatives that are underway, the benefits are not coming as quickly as we might have hoped. So we have to regroup a little bit there. I think expand what we are doing, manage it more carefully, and drive it harder. As we get a sense for that over the next six months or so, I absolutely would intend to reinstate some midterm guidance.
And then from a capital deployment strategy, you have obviously got a lot going on with kind of the integrations going forward. How are you thinking about additional M&A at this point? Is it on hold for the foreseeable future? Or will you still look opportunistically at adding on bolt-ons?
The latter. It is not our focus right now. I think we have a lot of internal opportunities for, A, growth, and B, more importantly, margin improvement and operational excellence, working capital improvement. But we do keep our eyes open, and from time to time, there may be additional, so-called smaller bolt-ons. We have the capital to do that, for sure. While it is not a priority for us compared to the other things that are a priority that were previously mentioned, it is something that may well come up from time to time.
Okay. Then last one, just so we understand the backlog conversion issues. It seems like a lot of that is related to NMR, if our understanding is right, and these tend to be kind of longer multi-year lead times. Can you just talk about what has held up kind of improving the backlog conversion? Is it really related to NMR, or are we kind of misunderstanding that?
Some of it is related to Bruker BioSpin, which is NMR, preclinical MRI, EPR, but the magnetic resonance business. Some of it is also part of our Bruker Daltonics group, Bruker AXS, Bruker Elemental divisions. We are not happy with the revenue, with backlog conversion and the revenue generated there. We should be able to do more and integrated order execution and some investments there, actually, including even some expense investments in getting people that can install these systems, because only then do we get acceptance by the customer and revenue recognition are a priority. So this is not just NMR, but NMR was a contributor.
Okay. Thank you.
Your next question comes from Dan Arias from UBS. Please proceed.
Yeah. Hi, good morning. Just wondering if you would be willing to give a feel for revenue growth by geography in the quarter, maybe in terms of ranges. I know you typically don't put too fine of a point on the growth components, but just given the regional differences that we are seeing, it might be helpful as we model going forward.
Maybe more on the orders. Clearly, Europe is the one. Europe, including most of Europe, not only Mediterranean Europe, is the one that has slowed down considerably by the second half of the second quarter. Latin America, India, are actually doing okay for us. Japan has been okay. China is mixed. It's really Europe. In the U.S., there are some trends where growth hasn't been that strong and nothing has changed there politically, as we all know. But demand's been all right, and of course, a lot of the demand is driven by our products and competitive positioning. It's clearly Europe that has changed significantly in the last couple of two to three months, including July now.
Okay, thanks. Charlie, can you give a sense of where margins came in for the BNS business in 2Q? Were they significantly below 20%? I guess going forward, would you be willing to comment broadly on growth expectations there, just given that the trajectory of that business is so different from most of BSI?
Yeah. BNS really was a standout performer in the quarter, both from a growth standpoint and a profitability standpoint. I prefer not to give out detailed profitability information by division for Bruker. But you can assume that of all the businesses, that's the one we are most pleased with in the quarter, both top line and bottom line. It's been a great acquisition and a great performing business.
Okay. Then, I guess, just lastly, I am curious whether any of the changes that are being made or will be made will trigger tax rate alterations. Not sure if I missed comments on taxes, but how should we be looking at that rate in 2012 at this point?
2012, I think, you could assume kind of a continuation of where we have been in the first half. Absolutely, we have tax planning underway, given some of the comments I made earlier about the complexity of the company. That extends all the way down to legal and any structure of the company, and impacts the transfer pricing and other tax planning activities of the company. Those are all under pretty comprehensive review right now. I do see that as a driver of value going forward, although, as you know, it takes quite a while, actually, to realize that, because if you are going to make changes to structure or transfer pricing or where IP is migrated, taxing authorities want to be paid upfront. So it is a long-term structural improvement opportunity for the company, but it is not likely to yield lots of improvement in the next 24 months.
Okay, thanks.
Your next question comes from Isaac Ro from Goldman Sachs. Please proceed.
Hi. Good morning. Thanks for taking the question. I wanted to reconcile your comments on that drop-off that you saw in Europe during the quarter versus what we've seen thus far during earning season from your competitors. Because I think everyone certainly cited some level of pressure, but same time, the velocity of that drop-off and the pricing comments you made were somewhat unique. Just want to make sure you guys are confident there isn't really a market share dynamic going on on an underlying basis beyond the end markets.
Yeah. Isaac, a good question. No, we don't think there is a market or competitive or market share dynamics. Indeed, we've held up perhaps exceptionally well in Europe for a very long time, with strength in Germany and surrounding countries, Central, Eastern Europe. That indeed did slow down. Germany was quite surprising, really. In the middle of May to June, Germany stepped on the brakes hard, it seemed, and we certainly felt that. I cannot comment for others, but we don't think we all of a sudden lost a lot of deals or that our market share changed in Europe. So we think it's really the economic trends.
Okay. Then maybe a follow-up on the long term, Charlie. If we look across the competitive landscape, a lot of your bigger competitors are pretty steadily moving their manufacturing to emerging markets. We really haven't seen what I would call a drop-off in quality or ramifications for that strategic investment. So I'm just wondering, why isn't this the long-term kind of right answer for you guys as well, just given where your current manufacturing and cost base is located?
Yeah. I wouldn't rule it out. We have a long way to go, though. There's lots of consolidation and other improvement opportunities that we'd like to take advantage of. We may kind of indirectly be moving some of our manufacturing to some of those same regions through outsourcing. So, we're starting selectively, but would intend to expand outsourced production as a percentage of Bruker's overall production in coming quarters and in coming years. So, I would absolutely not rule it out. It's just that we're not as far along in that planning, perhaps, as some others. Yeah.
Indeed, there's a lot of ongoing discussions about pretty substantial amounts of non-core manufacturing going to contract manufacturers, many of which, of course, have facilities in various Eastern Europe or Southeast Asia or other lower cost manufacturing regions. You'll see a big push for that. In fact, it may even accelerate.
Okay. Any idea of when you guys might have an update for us on that initiative? Is it sort of like a 2013 analyst meeting kind of thing, or could it be sort of iterative as you go through the process?
Yep. I think we will keep you informed along the way. Like I said, it's not like we're sitting still waiting for a big plan to emerge. So there will be indicators along the way that we'll touch on every quarter. But I would say in terms of expectations around a more comprehensive plan, yeah, it would be the first half of 2013.
Okay. Fair enough. Thank you.
Your next question comes from Jonathan Groberg from Macquarie. Please proceed.
All right. Thanks for fitting me in here. Congratulations, Charlie. I agree with you. There's a tremendous amount of opportunity here. Frank, can you maybe just talk about what were your organic growth expectations heading into 2Q?
They were sort of at the 10%+ range. Of course, currency changes hit us harder on the reported line. We did not convert as much of the backlog as we would've liked to see. I was hoping we would do even better. I know we were doing okay on organic growth. I was hoping we would do even better.
I guess the rationale for the question is organic growth of 10% is pretty good. If you go back even through all of your 2011, it was one of the higher rates, and you had pretty decent margins kind of consistently throughout 2011 through the first quarter. If you look at 2012, I know FX would've hit the top line, but that would've also helped you from a cost perspective, right? All your costs over in Europe. I'm just trying to understand, it's still not clear to me what changed so dramatically in the second quarter.
I wouldn't say that everything you see in the second quarter is a long-term trend. Some of it is, or may be, and some of it may not be. If you recall, we had very good margin trends in the first quarter. Unfortunately, though, they did not all become long-term trends. We'll need to really get a better feel for that. We don't have all the answers right now, but it is clear that based on this, we will be very proactive and taking not only accelerating the initiatives that are underway that would help our margins and working capital in any scenario, but we'll be looking very much at additional OPEX control and also even more aggressive restructuring, outsourcing, and so on.
But while we're in the midst of a lot of that, and some of this will be rolling out sooner, and we'll be updating the street on that quarterly for sure. Some of this may also be medium-term planning that kicks in in 2013 and so on.
If you look ex CAM, I mean the BSI division was down. I think you can blame some of that on pricing. My understanding, like Bruker BioSpin, for example, pricing, that's pretty long-dated stuff. Are these contracts that you wrote 12 months ago that now you're finding out, "Hey, we underpriced these," and this is going to go on for quite a while here over the next 12 months or so as they get installed?
Indeed, some of your observations are correct. Some Bruker BioSpin contracts are six, nine, 12, and sometimes even longer. Some of that competitive pricing pressure we've seen isn't going to evaporate in Q3 or Q4. I think those are slightly longer-term trends. But there's also, of course, many steps in anticipation of that in lowering the cost basis. But quite honestly, that has not kicked in as quickly as we would've liked to see. Selling prices and will be dynamic doesn't mean we're anticipating that as well. But some of what we're doing as countermeasures has not arrived at the same time.
Last one quickly from me. I guess, Charlie, I am just still trying to piece this all together, but big picture is basically as a simple way of thinking about this is some of the improvement that you saw maybe you did not have as good of a handle on as you thought, and it is really just kind of having some visibility, both from a revenue and a pricing and a cost. You just did not really have as much visibility, and that is the main thing that kind of needs to change in order for you to reset this going forward?
I think that is about right. Some of the improvement, let us say last year, some of it was not as sustainable as we thought. Not that it cannot be sustained, but we do not necessarily have kind of the management practices or systems in place to make it happen consistently. Similarly, I do not think that one poor quarter is a death knell for the business. So visibility needs to go up dramatically. Control and consistency needs to go up dramatically because bouncing around is not good for anybody.
Okay, thanks. I agree with you, a lot of opportunity.
Thanks, Jon.
Your next question comes from Derik de Bruin from Bank of America. Please proceed.
Hi, good morning, and welcome back, Charlie.
Hey, Derik.
Hey, so the $0.65-$0.70 adjusted EPS guidance, is that an all-in number that is for BEST and BSI?
Yes.
Okay. You mentioned some weakness in the metrology business. Could you elaborate on that?
Yeah. We had surprising strength in semiconductor and data storage orders at BNS, at Bruker AXS, in the first half of this year. Some of it maybe have nothing to do with the cycle. For instance, as some very large companies invest simply in the next generation of 450 millimeter fabs and so on, they tend to do that through whatever the cycle is. But as we look at other comps in the semiconductor metrology, which it is about a $100 million business for us per year. So it is less than 10%, but it is not insignificant, and clearly that part is slowing down right now, I think that is visible anywhere in that space. We are seeing that as well. So we are anticipating sequentially second half over first half of 2012 less orders.
It is not just by reading other people's press releases, but we see the beginnings of that in our own business. Data storage always reacts very quickly, and semiconductor reacts fairly quickly. Again, some of what we are doing is not cyclical, but some of it, of course, is affected by the cycle, that cycle is slowing down.
Okay. One final question. I just want to go back on this whole order execution. Is it that customers' sites are not ready, you are not getting product ready on time for shipment as promised? I am just still trying to really comprehend what exactly do you mean by order execution in this. Once again, it goes late. How does this change so dramatically from June 1st from the Analyst Day to today? It seems like these would be problems that would be endemic and that should have been, I would not say obvious, but certainly had warning signs.
Well, it is incremental. It is not that dramatic. But it gets compounded with some other issues like the gross margin pressure, some of the OpEx being a little bit on the high side, some tax issues where we have unbenefited tax losses from CAM and so on. So that by itself, those four or five issues coming together make the miss in Q2 more than an incremental miss. We understand that.
The incremental weakness in order execution was one of the incremental pieces in Bruker AXS, in Bruker BioSpin, in Bruker Elemental, also a little bit in BEST. That really became clearer in June. As you can imagine, in the systems business, a lot of the revenue recognition, much more than a third, occurs in the third month, very often close to 50%. Then, again, not to frustrate you, but it is a little bit of all the things that you have mentioned.
In some areas, we were ready, but either the letter of credit or the customer site is not ready. Sometimes, we cannot deliver fast enough. Sometimes it is the full integrated system, quite honestly, the process that we have in place that is not sufficiently integrated and global, and we need to improve that. So it is a mix of those factors, and collectively, they are one of the elements that have led to the Q2 miss, but clearly not the only one.
Yeah, Derek, what I will add is just to try to illustrate it. You think about you have Bruker manufacturing entities, you have Bruker distribution entities, and then you have a customer. So there are a couple of different possible points for communication to break down. Some of it, as Frank described, it is customer sites not being ready. In other cases, it is intelligence not flowing back timely enough from the distribution subs to the manufacturing subs. So what you see is that we do not have as much visibility at the end of the quarter as we would need. What you also see is that the company carries more in transit inventory than most of our peers because that order execution cycle is elongated, and the buffer for that lack of visibility is more inventory.
So it is pretty clear that through streamlining our operational practices and putting more robust systems in place, we need more visibility from the factory to the customer without so many potential breakpoints in between. That is not easily fixed overnight, by the way. But now there is at least a recognition of that problem, the symptoms of that problem, and we are starting to work on it.
And some of our divisions have improved it quite a bit.
Yeah.
Others are still lagging behind and are working hard in fixing that now.
Okay, great. Thank you very much.
Operator, how many more people do we have in the queue?
Yes, one.
Okay, thank you.
The next question comes from Sung-Ji Nam from Cantor Fitzgerald. Please proceed.
Thanks for taking the questions. Most of my questions have been answered. Just a few quick ones. Would you mind breaking out what the acquisition impact was for the quarter and what your assumptions are for the remainder of the year? I know it's pretty small, but I was wondering.
Yeah. Acquisitions contributed one to one and a half percentage points of growth in the quarter.
Okay.
True, I think, for the whole first half of the year. The impact lessens as you get through the balance of the year.
Okay, great. For the CAM division, would you be able to quantify what the incremental investment might be for the year? I know you talked about roughly $10 million in operating loss for the year. I am assuming that is going to be higher, obviously, but was wondering if you could provide quantitatively or qualitatively what the incremental-
I think at this point, we would prefer to study that more closely, and we are also discussing additional steps at CAM in terms of potential restructuring, outsourcing, expense revisions. Rather than giving a forecast on if we did nothing with the status quo, that is not going to happen. So I would like to defer that one, actually. I think we will give you a more meaningful answer in a quarter rather than just giving you a static view right now.
Yeah. I think what we can say is that at mid-year, we've already gone past that $10 million number. So that guidance is no good.
Okay. That's fair. Then finally, in terms of your BEST business, a little softer on the top line this quarter. I know in the past you've broken out guidance for that division. Was wondering if there is additional color for the remainder of the year. Is it on track there? Does it have to do with revenue recognition, or was wondering if you could provide more color there? Obviously, you had more difficult comps this quarter than-
At this point, as we've really only given a full year guidance for the company overall in terms of revenue and adjusted EPS, and have not drilled down into any either segment or into any of the divisions or groups. Given where we're at right now, we would prefer to not drill down on that because the answers to all of that are dynamic as we're looking at. We're not only looking at one or two or three divisions, but I think this is a Bruker overall problem. While some may have contributed more than others, at the end of the day, we're looking in every division, what can we do to improve margins, lower working capital, and yes, where applicable, and BEST is one of those, also improve order execution.
Okay, great. Thank you.
Thank you very much.
At this present time, you have no more audio questions.
Okay. Thank you very much, operator. Thank you to all of the participants for joining us today. This concludes our earnings call, and goodbye, and we are looking forward to speaking to you next quarter or at the conferences in between. Thank you very much. Bye-bye.
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect.