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Executives

Leen Simonet – EVP and CFO

John Ambroseo – President and CEO

Analysts

John Harmon – Needham & Company

Jiwon Lee – Sidoti & Company

David Cardo [ph] – Caroline Company [ph]

Coherent, Inc. (COHR) F4Q08 (Qtr End 09/27/08) Earnings Call Transcript November 5, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Coherent Q4 ’08 Earnings Conference Call hosted by Coherent, Inc. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question-and-answer session.

(Operator instructions) As a reminder, this call is being recorded. I would now like to introduce Ms. Leen Simonet, EVP and Chief Financial Officer. You may begin your conference.

Leen Simonet

Thank you, Anna. Good afternoon and welcome to our fiscal 2008 fourth quarter conference call. On today’s call, I will provide financial information and John Ambroseo, our President and CEO, will provide a business overview.

As a reminder, any guidance and statements in today's conference call pertaining to future guidance, plans, events or performance are forward-looking statements that involve risks and uncertainties, and actual results may differ significantly. We encourage you to refer to the risk disclosures described in the company's reports on Forms 10-K, 10-Q and 8-K, as applicable and is filed from time to time by the company. The full text of today's prepared remarks, which will include references to historical bookings and sales by market, will be made available through the Coherent Investor Relations website. A replay of the webcast will be made available for approximately 90 days following the call.

We reported fourth quarter revenues of $142 million and GAAP net income of $4.1 million, or $0.17 per diluted share. On a pro forma basis, fourth quarter earnings of $8.2 million or $0.34 per diluted share, compared to the previous quarter pro forma income of $0.53 per diluted share, and the prior year fourth quarter pro forma income of $0.39 per diluted share. The current quarter GAAP to pro forma pre-tax reconciliation items include $3.6 million restructuring costs resulting from our manufacturing consolidation programs and a recent headcount reduction effort, $2 million stock-related compensation expense, and $0.3 million litigation charge resulting from last year’s internal stock investigation.

Our adjusted EBITDA percentage for the fourth quarter was 11.6%. This was below our expectations primarily due to the sudden drop in revenues that became apparent during the latter part of September. As previously communicated, the revenue shortfall was a result of customers’ delivery push outs and lower bookings primarily in the microelectronics market.

In response to the uncertain worldwide economic environment, we have taken several actions and recently announced a global headcount reduction of approximately 5.5%, yielding annualized savings of roughly $9 million. This headcount reduction is over and above the impact of the previously communicated Auburn and Munich manufacturing consolidation projects. Combined, the consolidation programs will result in a further reduction of approximately 140 people over the next three quarters.

As a reminder, the annual savings from the footprint reduction programs are in the range of $8 million to $10 million with the full run rate benefits starting in the fourth quarter of fiscal 2009. We are on track to exit Auburn by the end of March 2009 and plan to exit Munich by the end of June 2009.

Net sales for the fourth quarter declined 9.6% sequentially, and 10.6% from the same quarter a year ago. On a year-to-date basis, adjusted for the Q4 ’07 divestiture of our imaging optics product line, net sales increased 2.3%. From a market perspective when comparing year-to-date results, we saw the strongest performance in the OEM Components and Instrumentation market, showing a year-over-year adjusted growth of 10% with medical and bioinstrumentation submarkets growing 25% and 10%, respectively. The scientific market, which benefited from new product introductions, grew at a solid rate of 3.4%. Materials Processing declined slightly due to the more recent weakness in China, and Microelectronics also declined slightly due to larger decreases in the semiconductor market partially offset by an increase in the flat panel display market.

Within Microelectronics, solar revenues remained strong and almost doubled year-over-year. On a quarterly basis, the sequential market comparison shows a continued decline in the advanced packaging and semiconductor businesses, which is in line with the general market downturn. The OEM Components and Instrumentation sequential decrease is primarily related to the exceptionally high medical revenues in the third quarter.

Our fourth quarter sales by significant market application are as follows: Scientific, $30.2 million; Microelectronics, $46.5 million; Material Processing, $23.7 million; OEM Components and Instrumentation, $41.5 million, for a total of $142 million.

The fourth quarter gross profit was $55 million or 38.8% of sales. On a pro forma basis, excluding $2.7 million of restructuring costs and $0.3 million stock compensation charges, gross profit was 40.8% and compares to 42% the same period a year ago, and 45.3% last quarter. When comparing to the fourth quarter a year ago, pro forma gross profit decreased 120 basis points. The margin improvements from the divestiture of imaging optics and the discontinuation of scientific custom laser sales were more than offset by the negative impact of significantly lower volumes and other manufacturing charges. Sequentially, the gross profit percentage declined 380 basis points, net of the one-time customer cancellation fee we received last quarter. This decline is partly the result of a negative product and market mix, and partly the result of lower manufacturing volume and related unabsorbed costs.

Looking forward, we adjusted our manufacturing resources to be aligned with the lower volumes. We implemented general cost control measures, and we continue to focus on executing against our footprint reduction and outsourcing programs. These actions will support improved gross margins despite the lower volume.

Our cash and cash equivalent balance for the quarter was $218.1 million, representing a sequential increase of $20.4 million. Cash flow from operations for the quarter was strong at approximately $25 million, bringing year-to-date cash flow to approximately $68 million or 11% of sales. Compared to the previous quarter, we improved our accounts receivable days’ sales outstanding from 63 to 61 days, reflecting a continued strong performance across the regions. Inventory levels decreased just slightly as we continue building safety stock in preparation for the outsourcing and the various manufacturing consolidation programs in order to mitigate possible execution risks. Capital spending for the quarter was $6.5 million or 4.6% of sales, bringing the year-to-date capital spending to $22.6 million or 3.8% of sales.

Let me now give you the guidance for the first quarter of fiscal 2009. Due to the uncertain conditions in many of our end markets and the resulting cautiousness of our customers, we widened the range of our first quarter revenue estimates. We project our first quarter sales to be in the range of $124 million to $134 million. Including the recently introduced manufacturing spending reductions, we expect pro forma gross profit to be in the range of 41% to 42.5%. The recent actions also reduced our period expenses and we anticipate the pro forma R&D spending to be approximately between 11% to 12% of sales and the pro forma SG&A expenses to be approximately between 21% to 22% of sales. Intangible amortization costs are planned to remain about $2.1 million, and other income is projected to be approximately $1 million.

The pro forma annual tax rate is projected to be around 34%. This excludes an estimated one-time benefit of $1 million, resulting from the retroactive extension of the federal R&D tax credit from December 31, 2007 through December 31, 2009. Capital spending for the full fiscal 2009 is forecast to be about 4% of sales. Stock compensation charges are estimated to be in the range of $2.5 million, of which $0.3 million relates to cost of sales, $0.3 million to R&D, and $1.9 million to SG&A.

The first quarter restructuring costs are estimated to be in the range of $5.5 million, of which $4.5 million relates to the footprint projects and approximately $1 million relates to the headcount reductions we discussed earlier. Of the total $5.5 million, $4 million will be recorded in cost of sales, $0.7 million in R&D, and the remaining $0.8 million in SG&A.

I will now turn over the call to John Ambroseo, our President and CEO.

John Ambroseo

Thanks, Leen. Good afternoon, everyone, and welcome to our fourth fiscal quarter conference call. Before discussing market performance, I would like to revisit some of the points Leen covered in her comments.

The macroeconomic situation continues to evolve and creates churn in the marketplace. As a general statement, customers are adopting a conservative posture and protecting their cash. We have taken a number of actions to ensure that coherent weathers and emerges from this downturn in the best shape possible. We have adjusted manufacturing capacity to reflect our assessment of near- to mid-term demand. We have also curtailed SG&A spending for similar reasons. In certain markets, new product introduction timelines from our customers allow us to stagger R&D programs that were previously running in parallel, thereby reducing our R&D burn rate. Additionally, we have not slowed our efforts to reduce our operating footprint. Our Auburn project is moving forward as planned and we have initiated our exit from our Munich facility. These two projects are pivotal to our EBITDA expansion plans. Ultimately, revenue and mix, not project execution, will determine our EBITDA performance exiting fiscal 2010.

Orders in the fourth fiscal quarter totaled $141.5 million, which were down 5.1% versus the prior quarter and 13.6% versus the prior year period. The book-to-bill for the quarter was 1.0. Orders of $36.8 million in the scientific market were up 23.8% sequentially and 17.4% versus the prior year period. For the full fiscal year, orders were up 13% compared to fiscal 2007. We believe these growth rates are outpacing overall scientific market and reflect the strength of our updated product portfolio. Based on historical trends, the scientific market should be less susceptible to the pressures facing industrial markets. As a perceived safe haven, it is likely to garner more attention from competitors seeking to support their top line. Product differentiation, sustainability and service support have never been more important than they are at this moment.

Fourth quarter bookings benefited from record orders for the Micra and Mantis single-box ultrafast seed lasers and very strong ultrafast amplifier demand. Chameleon orders slowed from previous highs, but we anticipate increased adoption via the introduction of the Chameleon Vision. Launched in August 2008, the Vision is designed to provide brighter images and deeper penetration in multiphoton microscopy. The Vision uses pre-compensation technology to counteract dispersion effects and ensure minimum pulse length at the biological sample being imaged. The Vision is the most compact, powerful and widely tunable system available. It can also compensate for the widest range of microscope dispersion in the market. The Vision closes one of the few remaining gaps in the scientific product lineup.

Orders of $37.8 million for instrumentation and OEM components were down 1.4% from the prior quarter and 25.9% versus the prior year period. When adjusted for the sale of our imaging optics business in September 2007, orders increased slightly from the prior year period.

Fourth quarter orders were slower than anticipated as customers tried to gage the impact of macroeconomic events upon their businesses. In very general terms, the instrumentation and components segment is composed of customers in analytical instrumentation and medical therapeutics. Instrumentation encompasses applications such as DNA sequencing and flow cytometry, which are generally covered by insurance. As such, they usually hold up well for broader economic downturns. We do anticipate instrumentation customers will change their ordering patterns to smaller, more frequent purchases rather than annual or semi-annual orders as a means to more tightly control inventory. Therapeutic applications include skin resurfacing, hair removal, and refractive and non-refractive ophthalmic procedures, which are partially dependent upon discretionary spending. A cautionary view suggests the submarket would trend with the macroeconomy, although some of our customers have expressed more solid outlooks particularly in refractive surgery.

Instrumentation orders were up significantly compared to the prior quarter, bolstered by strong bookings for the Genesis UV OPS laser. New products based on the Genesis platform, which will provide power scaling as well as other wavelengths, are being ready for market release in January 2009.

Although orders for medical OEM lasers were seasonally down, we continue to build a solid beachhead for OPS lasers in non-refractive ophthalmology. The drivers for OPS adoption are the availability of unique wavelengths, optical efficiency, and package size.

Bookings from microelectronics of $50.6 million decreased 12.8% sequentially and 6.7% versus the prior year period. For the full year, microelectronics bookings grew by 8.8%. Over the past year, our microelectronics business has held better than the overall market. Our sustainability is partly due to the fact that our products are used to manufacture devices such as iPhones, HDTV’s and solar cells, all of which have enjoyed strong consumer demand. We have also benefited from our ability to provide lasers with superior reliability and performance into a broad array of applications. These facts notwithstanding, the ongoing credit crisis is impacting our customers in two ways: consumer spending high-end electronics is declining and our customers are having difficulty funding expansion to the credit markets. We expect these factors will lead our customers to maintain a very conservative posture. This means orders will be closely linked to end-user deliveries and inventories will be minimized. Our guess is as good as any as when our recovery will kick in. In the meantime, we will remain focused on customer alignment, we will continue to develop highly differentiated products albeit on evolving timelines, and we will drive operational efficiency.

Orders from semi cap applications were flat on a sequential basis with the ratio of new system orders also advancing from the prior quarter. While these are positive developments, the semi cap outlook seems to weaken with each passing week. Recent design wins may provide us with some insulation, but this market will struggle in the short- to mid-term.

Bookings for lasers used in advanced packaging were down significantly from the previous quarter as global demand for smart phones eased. Credit issues have been particularly troublesome to end customers in this submarket given thin operating margins and high capital needs. We expect our customers to be very focused on cash preservation during this downturn.

Orders for flat panel display manufacturing slowed following a very strong third quarter and were roughly balanced between new systems and service. The most significant development is that new system orders were for OLED production tools. This suggests that excimer laser annealing or ELA is currently winning against other schemes such as solid-phase crystallization (SPC). We expect future investments in capacity expansion will be dependent on a recovering consumer spending.

Bookings for solar cell manufacturing remain strong in the fourth quarter and contributed to three-year bookings CAGR of greater than 150%. We are delighted by this trend, but we must add a cautionary note. The dual effect of lower energy prices and tight credit may slow investments for small development accounts. Nonetheless, higher conversion efficiencies and manufacturing yields are pushing down the breakeven point for solar power versus fossil fuels. In addition, recent initiative and ballot measures reinforce that governments and individuals remain committed to clean, renewable energy. We maintain a positive outlook on this opportunity.

Materials processing orders of $16.4 million decreased 28.9% sequentially and 40% versus the prior year period. For the year, materials processing orders were down 13.3%. In the fourth quarter, a customer pushed out $3.3 million worth of deliveries and was unable to provide new call-off dates. In accordance with our internal policies, these orders were shifted to unscheduled backlog, thereby decreasing bookings for the quarter and the year by the same $3.3 million. In other words, new bookings for the quarter were $19.7 million.

The top-level bookings do not accurately portray the underlying market dynamics. Several applications, including marking and engraving for product security, traceability and serialization, have held up as have high-power markets in cladding, heat treating and welding. The two applications that have shown weakness are textile manufacturing and converting, presumably due to greater dependence on consumer spending and credit facilities.

Between now and the next conference, Leen and I, will be presenting at two conferences in New York: the UBS Investor Conference on November 20, and the Needham Conference during early January. We’ll also be introducing a number of new products at the Photonics West Trade Show in San Jose scheduled for the week of January 26, 2009.

I’ll now turn the call back over to Anna for the question-and-answer session.

We’re waiting for Anna to pick up the call.

Question-and-Answer Session

Operator

(Operator instructions) We’ll move first to John Harmon of Needham & Company.

John Harmon – Needham & Company

Hi, good afternoon.

John Ambroseo

Good afternoon, John.

John Harmon – Needham & Company

A few questions please. I apologize, I don’t know if you gave a backlog number. If you did, could you please repeat it?

John Ambroseo

It is $183.5 million.

John Harmon – Needham & Company

All right, great. Thank you. And regarding the headcount reductions you announced, sorry if I didn’t get it, but when do you see the benefit of that? Is that in the first quarter, and were they across the board or concentrated on any product line or facility?

Leen Simonet

John, the benefits are reflected in the guidance. You will not see a full quarter benefit, partially, and then the full quarterly benefit will appear in Q2.

John Ambroseo

And as far as the distribution, John, we alluded to the fact that we reduced manufacturing capacity. We made changes to SG&A and we made changes to R&D, so they were across the board. They were project-driven rather than market-driven.

John Harmon – Needham & Company

Okay. And then, I guess in SG&A, you’d be doing the normal things such as a hiring freeze, maybe by reducing advertising, things like that?

John Ambroseo

We’re continuing to operate the business and the decisions that we made regarding SG&A reductions were really tied to what we believe the near-term opportunities are, so I think it would be jumping to a conclusion that we’re simply slashing everywhere and we’re going to be retreating from the market, that isn’t the case. We have made what we believe are strategic decisions on what the market opportunities are.

John Harmon – Needham & Company

Okay, understood. And just finally, your sales in China, I was wondering if you could, maybe, ballpark how big they are and what end markets are they focused in? Are they mostly Materials Processing?

John Ambroseo

The direct sales in China are skewed towards Materials Processing and scientific. Those are the two largest markets.

John Harmon – Needham & Company

Okay. Thank you very much.

Operator

We’ll now move on to our next question from Jiwon Lee with Sidoti & Company.

Jiwon Lee – Sidoti & Company

Good afternoon. Thanks for taking my question. The first question is on your Germany consolidation. Can I get some timetable as to when you expect this consolidation to take place and the benefits arising from that particular project please?

John Ambroseo

So, as we announced a few weeks ago, Jiwon, we’re consolidating our Munich facility into our Göttingen facility. Those are both locations that focus on excimer laser technology. The project has already been launched. We expect it to be completed by the end of June of 2009. The savings, if I recall correctly, are between $4.5 million and $5.5 million and the costs are, I think, $6 million to $7 million is what we published, but we will verify that and get back to you. If you go back to a press release that we put out just a few weeks ago, you’ll see those numbers.

Jiwon Lee – Sidoti & Company

Okay. Okay, so nothing’s changed from there?

John Ambroseo

No.

Jiwon Lee – Sidoti & Company

And also, obviously, it’s a difficult time for everyone, and you have previously set this in the 2010 fiscal year EBITDA plan. Now, how should we be looking at potentially a new plan, if you will, or are you retrenching from an earlier plan or have you thought about what the reset plan might be?

John Ambroseo

We’re still very focused on deliverables that we have committed to earlier. I would say it’s a bit too early to pull back from it or to issue new guidance because 2010 – I can’t tell you that we have great visibility on 2010 revenues right now. And as I mentioned during my comments, the EBITDA range for the end of 2010 is going to be highly dependent on revenue and mix. The programs that we had constructed early on to assist us in getting to the EBITDA targets are underway. We’re marching towards those and we have every confidence that we’re going to complete them on time and on budget. Revenue is going to be the big question or, actually, I should say revenue and mix will be the big questions and it’s a little too early to comment on that.

Jiwon Lee – Sidoti & Company

Okay. Okay. And finally, could you give us a little more color on the geographic weaknesses that you see out there? You highlighted China. I mean, I would imagine without the microelectronics, the Asia is really a weaker market, but any additional color that you could provide on this geographic weakness will be helpful. Thanks.

John Ambroseo

I would say that in general, this is a global effect. This is not a regional effect, and digging more into it than that, quite frankly, won’t add a lot more color. You’ve heard lots of companies reporting about what they’re seeing and it is a global event.

Jiwon Lee – Sidoti & Company

Okay, helpful. Thank you.

Operator

(Operator instructions) And we do have a follow-up question from John Harmon with Needham & Company.

John Harmon – Needham & Company

Hi again. Thank you. The first question, certainly, you’re in a time were cash is precious, but I was wondering if you could just review your strategy on how much cash you need to keep with regard to what acquisitions might be available.

John Ambroseo

We’re certainly looking at a variety of uses of cash, including acquisitions. I would say that right now, while there’s a lot of dialogue, the challenge for a lot of companies and boards and managements of these companies is – does today’s price reflect a new valuation paradigm or is it a temporary effect? And at some point, I think there might be capitulation on what the valuation is. I don’t think that we’ve reached that point today, so we will – I guess, that’s a long-winded way of saying we are pursuing discussions but nothing that is advancing to the point that we have high confidence in being able to get it across the finish line. And as far as other uses of cash, right now, I think that many of our shareholders would tell us that preserving cash in this environment is one of the better strategies, and when you look at companies who have committed cash either to acquisitions or other things, they have not gotten any benefit from it. In fact, some of them have been penalized pretty badly.

John Harmon – Needham & Company

Sure. And for Leen, I was wondering if you have an organic revenue growth for the quarter and for the year?

Leen Simonet

We have – I’ll have to calculate it, but I don’t think there is a big difference because we did not do acquisitions in the fourth quarter of ’07 nor did we any do this year.

John Harmon – Needham & Company

Right. Okay. Now, I know you sold the business didn’t you? I’m just waiting for the number. Okay, thank you.

John Ambroseo

John, we highlighted it. That was about a $15 million business that was sold.

Leen Simonet

Right, right.

John Ambroseo

So if you want to plug that in, that will give you a rough estimate.

Leen Simonet

I think I restated the OEM Components and Instrumentation year-on-year growth with 10% and that excluded the (inaudible).

John Harmon – Needham & Company

Okay, I can work backwards from that. Thank you very much.

John Ambroseo

Sure.

Operator

We’ll now move on to David Cardo [ph] with Caroline Company [ph].

David Cardo – Caroline Company

Hi. You were cutting in and out, and can you just tell us the cash generated from operations for the quarter in the fiscal year?

Leen Simonet

The cash from operations for the quarter was $25 million approximately.

David Cardo – Caroline Company

Okay.

Leen Simonet

Which brings the year-to-date to $68 million about 11% of sales.

David Cardo – Caroline Company

Okay. And is the – do you have a, is there a free cash flow number you can share with us?

Leen Simonet

The capital spending for the fourth quarter was $6.5 million, so that would be the $25 million minus the $6.5 million.

David Cardo – Caroline Company

Okay.

Leen Simonet

So that’s $18.5 million, and the capital spending for the year is $22.6 million. So we’ll take the $68 million minus the $22.6 million that would be a little over $45 million.

David Cardo – Caroline Company

Okay, thank you.

Operator

(Operator instructions) It appears there are no further questions at this time. I would like to turn the conference back over to Mr. Ambroseo for any additional or closing remarks.

John Ambroseo

I would like to thank everybody for participating in this call and we hope to see you at one of the upcoming events.

Operator

That does conclude today’s conference. Thank you for your participation and have a great day.

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