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Coherent, Inc. (NASDAQ:COHR)

F2Q2014 Earnings Call

April 30, 2014 4:32 pm ET

Executives

John Ambroseo - President & CEO

Leen Simonet - EVP & CFO

Analysts

Jim Ricchiuti - Needham & Company

Larry Solow - CJS Securities

Mark Douglass - Longbow Research

Patrick Newton - Stifel Nicolaus

Jiwon Lee - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to the Coherent Second Fiscal Quarter Results Conference Call hosted by Coherent, Incorporated. At this time, all participants are in 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, Executive Vice President and Chief Financial Officer. You may begin your conference.

Leen Simonet

Thank you, Regina. Good afternoon and welcome to Coherent's second fiscal 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 any statements in today's conference call pertaining to future guidance, market trends, 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 and critical accounting policies described in the company's reports on Forms 10-K, 10-Q and 8-K, as applicable and as filed from time-to-time by the company.

The full text of today's prepared remarks and trended GAAP and non-GAAP supplemental financial information will be posted on the Coherent's Investor Relations website. A replay of this webcast will also be made available for approximately 90 days following the call.

Let me first give you the financial highlights of the second quarter. Our bookings of $261.8 million were the highest of all time and include the large flat panel display systems order we announced in January during our conference call. Roughly 60% of this order is included in our shippable backlog within the next 12 months. Revenues for the quarter were $199.2 million with corresponding pro forma earnings of $0.82 per diluted share representing a growth of 19% on a sequential revenue growth of 3%.

We ended the quarter with a cash balance of $283.5 million, reflecting a quarterly cash flow from operations of approximately $16 million. Our pro forma EBITDA% for the quarter was 17.7% and compares to 16.4% last quarter and 17% the same quarter a year ago.

Net sales for the second quarter increased $5.7 million or 2.9% sequentially and declined $800,000 or 0.4% compared to the same quarter a year ago. Our backlog, shippable within 12 months, at the end of the second quarter was $308.5 million and flat panel display applications’ backlog is approximately $117.3 million, or 38% of the total.

Geographically, on a trailing 12-month basis, Asia accounted for 50% of the company’s revenues, U.S. 24%, Europe 19% and rest of the world 7%.

Similar to the last quarter, we had one customer in South Korea, an integrator to a large flat panel display manufacturers, who contributed more than 10% of the company’s second quarter revenues.

With respect to the second quarter revenues by major market applications, we achieved double-digit sequential growth of approximately 15% in the OEM Components & Instrumentation market showing equally strong growth in bioinstrumentation and medical applications. Medical posted a record revenue quarter and continues to benefit from growth in new application in part resulting from the Lumera acquisition.

Microelectronics grew 2.4% sequentially. The increase in flat panel display business was partially offset by a revenue decline in advanced packaging due to continued market softness. Materials Processing revenues are similar to last quarter and Scientific revenues declined 6.5% sequentially mostly due to softness in the U.S. and Europe, partially offset by strength in Asia.

Service revenues for the second quarter were $60 million or 30% of sales and compare to $60 million last quarter and $48 million a year ago. Flat panel display service revenues grew about 2% sequentially and grew more than 50% compared to the same quarter last year. On a trailing 12-month basis service revenues represented 29% of the total company revenues.

Revenues by market application are as follows: scientific $31.1 million, microelectronics $94.5 million, materials processing $27.6 million, OEM components and instrumentation $46 million for a total of $199.2 million.

The second quarter pro forma gross profit, excluding $600,000 stock compensation charges and $1.5 million intangibles amortization was $82.8 million, or 41.6% of sales, an increase of 50 basis points from the 41.1% we recorded last quarter and also marking the fourth consecutive quarter of pro forma gross profit percentage increases.

The sequential increase is primarily due to lower product costs in several of our business units. Going forward, we project gross profit to decline in the third quarter primarily due to a negative product mix, however, for the fourth quarter we forecast another step up from the 41.6% we reported for the second quarter.

Our total pro forma operating expenses were 28% of sales, which is in line with our guidance provided during last quarter’s conference call.

Our cash and cash equivalents balance for the quarter was $283.5 million which represents an increase of $9.8 million compared to last quarter. Approximately $187 million or 66% of the cash balance is held internationally, primarily in Europe.

Cash flow from operations for the second quarter was about $16 million bringing the year to date to approximately $44 million. Days’ sales outstanding for the quarter increased to 62 days from 54 days last quarter, and approximately half of the increase is due to less favorable sales linearity, the remaining increase is primarily the result of changes in our regional sales mix.

Inventory turns were unchanged at 2.7 turns when compared to last quarter. The sequential inventory balance increase of $5.5 million relates entirely to the triple Vyper order we received in January. Due to the long manufacturing cycle times for these systems, the inventory build-up typically starts about nine months prior to shipment.

Capital spending was $7.2 million for the quarter and $14 million year to date; both were 3.6% of sales.

Let me give you a recap of our guidance. We expect our third fiscal quarter revenues to be in the range of $197 million to $205 million. As John indicated in our press release, several of the large bookings will start generating revenues in the fourth quarter resulting in our third quarter revenues to be similar to the second quarter revenues. We anticipate our fourth quarter revenues, however, to increase approximately 10% compared to the second quarter we just reported.

We project the third quarter pro forma gross profit percentage to be approximately 41%, slightly down from the second quarter due to a more negative product mix. However, we currently project a pro forma gross profit of approximately 42% for the fourth quarter. As a reminder, the quarterly guidance excludes intangible amortization of $1.5 million and stock compensation costs estimated at $500,000.

We anticipate the third quarter pro forma period expenses to be approximately 27% to 27.5% of sales. And again, this excludes intangibles amortization estimated at $900,000 and stock compensation costs of approximately $4 million. We are assuming a pro forma tax rate of 28% for the remainder of the year. We project our full fiscal 2014 capital spending to be approximately 4% of sales. And we are assuming weighted outstanding shares of 25.1 million for the third quarter.

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 second fiscal quarter conference call. There have been several key developments in the second and the beginning of our third fiscal quarters. We replenished our FPD backlog, scored a key win in sapphire cutting, improved our position in the medical OEM arena and landed additional OEMs in the materials processing market.

The short-term challenge for us is the timing of shipments, especially for the high ASP systems, since customer delivery requests are skewed towards our fourth fiscal quarter and into fiscal 2015. This leads to a flattish third fiscal quarter, but sets us up for a very solid fourth quarter and gives us a strong running start into fiscal 2015.

Second quarter bookings of $261.8 million increased 30% both sequentially and compared to the prior year period. The book-to-bill for the second quarter was 1.31.

Scientific orders in the second quarter of $24.9 million were down 34.8% sequentially and 14.0% versus the prior year period. The bookings results were in-line with our expectations following very strong orders over the previous two quarters. The mix between biological and imaging and applied sciences remains unchanged as does the regional mix.

During last quarter’s call, I mentioned that we were introducing some new products designed and tested to HALT and HAAS standards. The Astrella is a new single-box, ultrafast amplifier that delivers superior performance and reliability. The Fidelitylaser system is a new ultrafast, fiber laser system configured for a range of scientific and commercial applications. We expect this laser to be especially attractive for optogenetics research wherein a Fidelity laser could trigger a neural response and a Chameleonlaser could image the system. Such techniques will be used in Europe’s Human Brain Project and the BRAIN program in the U.S.

Instrumentation and OEM orders of $37.7 million were down 30.1% sequentially and 20.4% versus the prior year period. Coming off outstanding orders in the prior quarter, bookings for medical OEM lasers were solid thanks to improved customer confidence. Lasers for cataract treatment, aesthetic procedures and consumables all contributed to second quarter bookings.

The dental opportunity we’ve been engaged with is also gaining traction and we can now identify the system integrator as VC-backed Convergent Dental. We provide a specially-configured 9 micron laser for their Solea system.

Although bioinstrumentation orders were lower following a record-setting performance last quarter, the outlook remains positive due to higher life sciences investment particularly in Asia, market share gains for OBIS and the planned wavelength and power expansion of our portfolio.

Record microelectronics orders of $171.8 million increased 113.4% sequentially and 89.3% compared to the prior year period. Orders for semicap applications were lower following two strong quarters. Inspection applications for 1X nanometer nodes have led the demand growth over the past nine months. Customer engagement remains high.

The advanced packaging market remained weak due to a combination of capacity and inventory management. Based on information from multiple sources, we believe that orders will begin to pick-up in the fourth quarter of fiscal 2014. We expect the order mix to be different from that prior to the slowdown. Flex packaging relying on pulsed UV lasers should constitute a higher percentage of the market.

We have also been working on dry ablation IC-packaging technique to produce smaller features at lower costs than traditional wet-etch/lithography. The technique is producing promising results at a major chip manufacturer.

As discussed during last quarter’s conference call, we received a record order for excimer laser annealing laser systems for LTPS processing. The bulk of this order including the more advanced triple Vyper/Linebeam 1500s will ship in fiscal 2015. I am also pleased to report that we have received another round of system orders in early Q3 from a different set of end users. These were for Linebeam 750 systems that will be making backplanes for HD LCD mobile displays. Deliveries commence in Q4 '14 and will be completed in fiscal 2015 per the end users’ requests.

We recently completed application development for sapphire cutting that has led to a meaningful order for Pulsed lasers. This is a completive situation against an established supplier. I want to commend our team for their exceptional work. We will begin shipping into this order later in Q3 and complete deliveries in Q4. If the initial installations meet expectations, we should receive a similarly sized follow on order before the end of the current fiscal year.

Materials processing orders of $27.4 million were down 4.8% sequentially and 21.2% versus the prior year period.

The combination of slow growth and tighter inventory controls by customers in China resulted in lower overall materials processing bookings.

There were also a number of bright spots in the market. New environmental regulation is limiting or prohibiting new installations of traditional plating technologies are increasing the prospects for laser cladding in China. Our highlight direct dial system performs very well in cladding application and is qualified with multiple vendors. Volume for our recently released J-Series Diamond C02 lasers is going in the worst pace. Planned expansion of the product line should further enhance the opportunity.

We have also signed up additional fiber laser OEMs in the U.S. and Asia against an ever increasing list of competitors. There were number of new entrants displaying products or prototypes at the Laser China show in Shanghai, including several domestic Chinese companies. Statistically speaking, few of these devices will enjoy commercial success but there are numbers reinforce the need to be vertically integrated.

I will now turn the call back over to Regina for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions).

Your first question today comes from the line of Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Hi. Good afternoon. I was wondering, if you could size the second order that you received in the FPD area?

John Ambroseo

It was comfortably into the eight figures. Jim, I cannot give you more exact number than that.

Jim Ricchiuti - Needham & Company

Okay. And just given all of the activity in this area for you, I'm wondering if you can help us in terms of how we can think about the portion or revenues that are going to be coming from FPD in the second half of the year? And how we should think about fiscal '15, just given the so many unusual order activity you're seeing?

John Ambroseo

I don't think that the second half of fiscal '14 is going to be substantially different from the first half of fiscal '14 as far as FPD revenues go. I mean, there may be some variation but within the normal band of variation. Clearly, in '15 FPD is going to play a larger role because we will be shipping the Linebeam 1500s. And as I said previously, these things sold though have ASPs of about $20 million a piece, so each one of them is a needle mover.

Jim Ricchiuti - Needham & Company

And John, any sense as to when we might see revenue from that tool, that system in fiscal '15?

John Ambroseo

We're scheduled to start shipping them in the first half. And I think if we could ship one in the first quarter the customer would be delighted. And we are certainly working towards that goal. There are still number of steps obviously with materials and other things that we are working on to make that happen. But the plan is to essentially not knock out a quarter until we complete the -- this first round.

Jim Ricchiuti - Needham & Company

Okay. Thanks a lot.

John Ambroseo

Sure.

Operator

Your next question is from the line of Larry Solow with CJS Securities.

Larry Solow - CJS Securities

Hi. Good afternoon. John, I wonder if you could just -- the microelectronics orders obviously were very good, but outside of that would you characterize the pretty size of what drops at least year-over-year across the other verticals as mostly timing related or if you can perhaps just briefly go through each of the other three verticals? And I guess materials processing may be for starters, that sounds like there is some more negative commentary around there versus --

John Ambroseo

Just the materials processing marketing, I had raised the flag last quarter.

Larry Solow - CJS Securities

Right.

John Ambroseo

That we saw softness in China, which is the large market for materials processing. Some of that certainly came to fruition. Although, the -- I have to open my page herein and look the exact number again. The drop on a sequential basis in orders was nominal at about 5%, 4.8% and, obviously, was a much larger drop year-over-year. I do think that that is predominantly due to the softness in the market. I don't believe that it is competitive pressure. As we have talked to the customers and to competitors in the space, we have heard sort of similar stories.

With respect to the orders in instrumentation I'd say its largely timing because we've fallen into this pattern where customers are policing large annual or semiannual orders they come in sometimes they aggregate, sometimes they don't. The vector on that market I think is generally pretty positive however, the sales vector.

To round out the picture for scientific, I would say that we had a pretty good Q4 at Coherent and a surprisingly good Q1. So the fact that there is a bit of a lull in the second quarter is not a shock.

Simply because there is a funding cycle that you go into when you pull in orders, you don’t immediately create the opportunities to pull in more orders if the underlying funding hasn't kicked yet.

Larry Solow - CJS Securities

Okay. And then just a couple quickly. You mentioned I think briefly that the cataract opportunity, any more color on that and ordering --

John Ambroseo

It's picking up nicely. The three areas in the medical space that we have been spending some time on obviously building out cataract and good traction there bringing some new solutions to the marketplace. This dental opportunity is pretty interesting. I got to see the demo of the thing working and listen to some patient testimonials, it was impressive that even children claim it's a pain-free procedure which somewhat hard to believe but I taken it at face value. And then the team has also been working for quite some time on developing consumables for lithotripsy and we have been booking and shipping record numbers of those. And unlike other products that we sell those things are one and done. They are consumable, used on a patient thrown away, and next procedure uses a new one. So that's growing at a reasonably steady pace.

Larry Solow - CJS Securities

Okay. And just lastly on the FPDB sort of the delay or the most delivery occurring in Q4 into 15, is that customer request (inaudible)

John Ambroseo

Larry the beginning of your question broke up. If you please

Larry Solow - CJS Securities

Sure, just the delivery schedule for the majority of the flat panel display orders mostly Q4 or skewed into '15. Is that a combination of a customer request in manufacturing supply – can you hear me? Regina?

Operator

I'm sorry, yes.

John Ambroseo

You are back.

Larry Solow - CJS Securities

Okay. Just real quick on FPD, the sort of delivery timeline, is that a combination of customer request and just manufacturing capacity constraints or more one or the other?

John Ambroseo

I would say on the 750s it's all type of customer requests, we are going to deliver these things when they asked us to deliver them. The supply chain for the 750 is well developed.

The original delivery commitments that we made on 1500s are still intact and they were tied to the time it would take us to order and have fabricated the new lens components for that system. So nothing has changed there. We told the customer they should expect some in the beginning of fiscal '15 at the earliest date and there could be some slippage if we experience any delays in the optics.

Right now, it appears that we are tracking on time, but we are still six months away from having everything together to test the system. So we are taking just injecting a small amount of caution into that because we have got some history and rolling out new products and we know that sometimes you don't hit every day exactly on the head, but they are going to hit in '15. And as I said I think in response to Jim Ricchiuti's question these are needle movers, every one of these things is a needle mover given the ASP.

Larry Solow - CJS Securities

Right. And just predominantly handsets to smartphones?

John Ambroseo

It is going to be all mobile.

Operator

We have on the line now Patrick Newton with Stifel Nicolaus, if you would like to ask a question.

Patrick Newton - Stifel Nicolaus

All right, John, I will take a swag at it. Can you hear me?

John Ambroseo

Yes, we can.

Patrick Newton - Stifel Nicolaus

All right, perfect. One is can you elaborate on the sapphire when you commented on in your prepared remarks? I'd love to hear what drove your solution being selected in this competitive bid that you alluded to? If you could help us understand the order size and then the potential size of the follow on order relative to the initial order?

John Ambroseo

Sure. The answer is to why we are able to get in on that business is pretty simple. We were able to ship the customer a prototype of a soon to be released laser and the performance that they witness from that prototype was far better than anything that they had seen. They claimed that it only cut fast but cut with better edge quality. And as a consequence we won an order. I can't tell you the exact number because we don't give out unit numbers and what not but I can tell you that it was a low 8 figure order.

And if a follow on comes, everything works out accordingly, we would expect an additional low 8 figure order sometime before the end of the fiscal year.

Patrick Newton - Stifel Nicolaus

And this is all coming from the Lumera IP?

John Ambroseo

It was pulse lasers.

Patrick Newton - Stifel Nicolaus

Okay, perfect. And then I guess in your prepared remarks you also discussed the expectation for some mix shift in ATI once this growth returns in that business. And I'm curious if there is any impact to your anticipated margin mix because of this mix shift?

John Ambroseo

Additional revenue will certainly help across the board. The kinds of products that I alluded to particularly UV products these typically carry reasonable gross margins, and we've factored some of that into the comment of what we expect the gross margin to be in the fourth quarter. So to answer to your question, yes, we think it's going to help and yes, we've factored it in to our outlook.

Patrick Newton - Stifel Nicolaus

And Leen, what percentage of your service mix LDUs currently represent?

John Ambroseo

What percentage of the service mix the LDUs currently represent?

Leen Simonet

I don't think we've ever disclosed what our flat panel display service revenue is. It is a significant portion, I mean, this is a sizable portion of the total revenue but we have not disclosed those yet --

Patrick Newton - Stifel Nicolaus

That's what they track --

Leen Simonet

I talked about the growth. So the growth has been taken and I gave you kind of a trend line.

Patrick Newton - Stifel Nicolaus

That's right; it's worth a try, Leen. John, one last one is you had a competitor that announced a kind of new entering to the UV market of Photonics West. I am just curious, if you are seeing any changes in the market dynamics from competition pricing or behavioral perspective as a result?

John Ambroseo

A new competitor entering a UV market.

Patrick Newton - Stifel Nicolaus

(inaudible)

John Ambroseo

That's not exactly a UV -- unique experience, Patrick.

Patrick Newton - Stifel Nicolaus

Well, okay.

John Ambroseo

No, we have not seen much change. What customers are looking for in that space in general, is higher throughput, better yields, better overall cost of ownership and I think Coherent along with several other companies are trying to deliver products that satisfy those conditions. And at least in the most recent quarter, we see they have done a good job and perhaps a better job than any in doing that.

Patrick Newton - Stifel Nicolaus

Great. Thank you for taking my questions.

John Ambroseo

Sure.

Operator

Your next question is from the line of Jiwon Lee with Sidoti & Company.

Jiwon Lee - Sidoti & Company

Thank you. And good afternoon. John, I wonder if you could try to size the potential market for you between glass and the sapphire cutting?

John Ambroseo

Jiwon, I am sorry, you are breaking up on our end. If you could repeat the question?

Jiwon Lee - Sidoti & Company

Sorry. Can you hear me better now? John?

Operator

Okay. Ms. Lee, if you would like to go ahead and speak your question again and then, may be I can try to relay it. It seems like they are having some audio problems on that end.

Jiwon Lee - Sidoti & Company

Okay. Regina, then, could you please relate if they could size the potential market for themselves between glass and sapphire cutting?

Operator

Ms. Lee would like to know if you can size the potential -- what was the rest of it, I am so sorry?

Jiwon Lee - Sidoti & Company

Potential market size for them between glass and sapphire cutting?

Operator

The potential market size between glass and sapphire cutting? Were you able to hear that?

John Ambroseo

Okay.

Operator

Okay. Great.

John Ambroseo

I think the question is the market potential and/or the difference between glass and sapphire cutting, is that correct?

Jiwon Lee - Sidoti & Company

Yes.

Operator

Yes.

John Ambroseo

Ladies and gentlemen, if you can hear me, I apologize for these technical difficulties. Obviously, very frustrating for everyone involved. Rather than continue getting having people frustrated, if any of the analysts have questions please contact Leen and we will do our best to answer those and we will do everything possible to make sure that this does not repeated in a future conference call. Thanks very much for your time. And have a good day.

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