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Executives

John R. Ambroseo - President and CEO

Helene Simonet - EVP and CFO

Analysts

John Harmon - Needham & Company

Jiwon Lee - Sidoti & Company

Sid Parakh - McAdams Wright Ragen

Mark Miller - Brean Murray Carret & Co.

Coherent Inc. (COHR) F2Q08 (Qtr End 3/29/08) Earnings Call April 24, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Coherent second quarter 2008 financial earnings results conference call hosted by Coherent. 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, today's call is being recorded.

Now I'd like to introduce your host for today's call, the Chief Financial Officer of Coherent, Helene Simonet. Please go ahead.

Helene Simonet

Thank you, Audrey. Good afternoon, and welcome to our fiscal 2008 second 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 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 as filed from time to time by the company.

These forward-looking statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act. 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 second quarter revenues of $155.9 million and net income of $6.1 million, or $0.19 per diluted share. Excluding the charges related to the stock option restatement and litigation, the quarterly stock related compensation expense, and a one-time tax charge in connection with dividends from one of our European subsidiaries, the pro-forma net income for the second quarter of fiscal 2008 was $12.8 million, or $0.40 per diluted share compared to a pro-forma net income of $0.30 per diluted share last quarter, and a pro-forma net income of $0.39 per diluted share for the second quarter of fiscal 2007.

During the quarter, we completed the Dutch tender offer and repurchased almost 8 million shares, or 25% of our outstanding shares. The repurchase had no impact on the second quarter earnings since the tender closed late in the quarter.

Our adjusted EBITDA percentage for the second quarter was 14.3%, a nice expansion from the first quarter's 12.4%. In support of our long term adjusted EBITDA goal of 19% to 20%, we just launched one of our key footprint projects. In addition to outsourcing the Auburn Optics manufacturing as announced last week, we are also outsourcing or transferring to other Coherent locations, all other activities currently performed in our Auburn, California facility. We plan on the exiting the Auburn facility no later than the end of the second quarter of fiscal 2009.

The expected annual run rate savings of the entire project are in the range of $3.5 million to $4.5 million, of which approximately 40% will be reflected in gross profits, 20% as a reduction of R&D expenses, and the remaining 40% will result in a reduction of SG&A expenses.

The implementation cost is estimated to be about $6 million, and will be incurred over the next three to four quarters. Upon completion of the project, we anticipate a headcount reduction of about 130. We expect the Auburn exit program to contribute approximately 0.5% to our long term adjusted EBITDA goal.

Net sales for the second quarter grew 8.1% sequentially and increased 2.5% from the same quarter a year ago. From a market perspective, we saw the strongest performance in Microelectronics, resulting in a 9% growth compared to Q2 '07, and 20% growth compared to last quarter, which is mainly the result of increased revenue in the Advanced Packaging and Solar Cell Manufacturing application.

OEM components and instrumentation grew approximately 1% year-over-year and 5% sequentially. In both cases, the growth is primarily the result of increased opthalmic reflective laser business, partially offset by the divestiture of the imaging optics business when comparing to the second quarter of fiscal 2007.

The scientific market grew 2.5% sequentially, and 1% compared to last year, mainly the result of strong sales for pumping applications across our international regions. The decrease in the materials processing market of 4.6% sequentially and 7.2% compared to last year is primarily the result of lower shipments for marking and cutting applications.

The company's sales by significant market applications for the second quarter are as follows. Scientific, 30.9, Microelectronic, 58.6, Material Processing, 23.4. OEM Components and Instrumentation, 43.0, for a total of $155.9 million.

The second quarter gross profits were $67.1 million, or 43% of sales. On a pro-forma basis, excluding stock compensation costs, gross profit of 43.5% compares to a first quarter gross profit of 42.2%. This sequential increase of 1.3 points is primarily the result of favorable product and market mix, lower warranty charges, and better leverage from increased sales volume. Unlike the previous quarter, the recent strengthening of the yen against the dollar mitigated the negative exposure from a strong euro.

When comparing to the second quarter a year ago, pro-forma gross profit increased from 42.8% to 43.5%. This increase was predominantly related to favorable product and market mix, partially offset by the negative impact of a strong euro and slightly higher inventory provisions.

Stock compensation charges for the quarter, including the portion charged to cost of sales amounted to $4.9 million. This is significantly higher than our expected run rate as the company agreed to reimburse our employees for the tax penalties associated with the exercise of certain discounted options.

There will be an additional one-time stock compensation charge of approximately $1.8 million during the third quarter of fiscal 2008, as we are in the process of curing certain outstanding discounted options to comply with regulations. Thereafter, a more normalized stock compensation run rate, including the portion charged to cost of sales is likely to be in the range of $2.5 million per quarter.

Total operating expenses for the quarter, excluding intangible amortization of $2.2 million, and the charges related to the historical financial restatement and litigation of $2.5 million, and excluding stock compensation charges of $4.2 million, was $52.3 million, or 32.1% of sales. This compares to 34.7% in the first quarter of fiscal 2008, and 32.1% in the second quarter of fiscal 2007.

Our cash and cash equivalents balance for the quarter was $184.6 million, representing a sequential increase of approximately $24 million, after taking into account the cash outflow associated with the repurchase of 8 million shares for approximately $228 million.

Cash flow from operations was $15.2 million. Inventory days stood at 67 days, down from 70 days at the end of the first quarter of fiscal 2007. Accounts receivable DSOs stood at 65 days compared to 61 days last quarter, primarily due to solid revenue growth and a regional mix shift towards Asia. Capital spending for the quarter was $4.5 million or 2.9% of sales, bringing the year to date capital spending to approximately $9.2 million or 3.1% of sales.

The guidance for the third quarter is as follows. We project our third quarter sales to be in the range of $156 million to $159 million. We expect pro-forma gross profit to be in the range of 43% to 44%. GAAP gross profit will include stock compensation charges and Auburn restructuring costs of approximately $0.6 million and $1 million respectively.

Pro-forma R&D spending is projected to be approximately 12% of sales. In addition, the third quarter stock compensation charge is estimated to be $0.8 million. Pro-forma SG&A expenses are anticipated to be in the range of 21% to 21.5% of sales. GAAP SG&A expenses will include stock compensation charges and Auburn restructuring costs of approximately $2.7 million and $0.4 million respectively.

Intangible amortization costs are planned to remain about $2.2 million. Other income is projected to be 1% of sales, reflecting reduced interest income following the repurchase of shares. We estimate that the reduction in interest income coupled with lower diluted shares outstanding will result in approximately 90% pro-forma earnings per share accretion. Pro-forma annual tax rate is projected to be approximately 35%, and capital spending for the full fiscal 2008 is anticipated to be approximately 4% of sales.

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

John Ambroseo

Thanks, Helene. Good afternoon, everyone, and welcome to our second fiscal quarter conference call. As you've already heard, the second quarter was chock full of action for us. We were very happy to deliver on our commitment of a substantial share repurchase, the successive completion of a Dutch tender, resulting in approximately a 25% reduction in the number of outstanding shares was terrific.

We remain committed to our long-term EBITDA goal and have taken several steps to achieve it. Our decision to outsource optics manufacturing and exit the Auburn facility creates meaningful cost savings. We have also released our second new product platform in the last six months. We continue to believe that the share count reduction coupled with top-line growth, and achievement of our EBITDA goal will provide a compelling return for our shareholders.

Orders in the second fiscal quarter totaled $148.6 million, which were down 4.1% from the prior quarter, and 2.2% versus the prior year period. The book to bill for the quarter was 0.95.

Orders of $29.9 million in the scientific market decreased 3.3% sequentially and increased 33.2% versus the prior year period. While our market share and order stream for Chameleon remained solid, the second fiscal quarter was marked by a surge in demand for high performance amplifiers. This was due in part to product enhancements which addressed customer needs as well as the release of funding.

During last quarter's conference call, I discussed the release of the Mantis, an ultra-fast laser that incorporates a high power OPS pump laser. I am pleased to report that the order rate is meeting our expectation and product has begun to ship.

Orders of $45 million for instrumentation and OEM components were down 5.4% from the prior quarter, and 21.9% versus the records set in the prior year period. As a reminder, the prior year period included $4.7 million of orders from the thermal energy and optics, a market which we have exited, and several annual orders for bioinstrumentation and medical OEM accounts.

Orders for instrumentation applications were up slightly on a sequential basis, but off from last year's record-setting quarter. Orders for medical OEMs were lower following an all-time high set in the first fiscal quarter. Nonetheless, the market remains very active. We received very good bookings from our practice surgery customers, due in part to ongoing product portfolio consolidation.

In the photocoagulation market, we have secured another major account for the OPSL-577 Laser. We look forward to having all these accounts receive FDA approval. I have also previously reported on a renewed interest in CO2 based skin resurfacing. This has resulted in a meaningful unit volume for our Gem-Series laser whose overall performance characteristics provide the best patient experience.

Bookings for Microelectronics of $49.2 million decreased 8.7% sequentially and increased 16.8% versus the prior year period. Orders from semi-cap applications remained soft due to the downturn in the industry. While we continue to focus on market share gains, we do not expect any appreciable impact before the end of the calendar year.

Demand for lasers used in Via Drilling was very good, due both in from cell phone manufacturing and IC substrate packaging. We are delighted with this outcome but we realize these markets are strongly influenced by consumer spending. As such, we are closely tracking macroeconomic indicators.

Bookings from Laser Direct Imaging slowed, which is reflective of the current market conditions. The long-term key to this market is the dollar per watt and we are aggressively pursuing new product architectures to support this goal.

For the past few quarters, flat panel display manufacturers have made process improvements to increase yields. With capacity absorption maximized, we have received orders for three additional laser systems. Each will be used for SLS processing of TFT and AM OLED panels, and be equipped with an LSX 315C excimer light source and our line-beam delivery optics.

The solar market has been getting plenty of press, especially with oil prices at record highs. We have seen a steady increase in solar applications with the business doubling, each of the last two fiscal years. Solar bookings were up strongly in Q2, and the year-to-date total has already matched the whole of fiscal 2007. Given the industry trend, this growth is likely to be sustained throughout this fiscal year and beyond. It is also noteworthy that we are providing ultraviolet, visible and infrared light sources to this market for a variety of applications in thin film and crystalline silicon processing.

During our first quarter conference call, I made some comments about silicon singulation, including the pending release of a new fiber laser platform. At this week's Japan Laser Expo in Yokohama, we formally launched the Talisker Laser System. It is the first in a series of lasers based on an ultra-fast fiber oscillator that has been designed and built to Telcordia standards.

In the Talisker, the ultra-fast oscillator is mated with a high-power amplifier to produce energetic, short pulses of light resulting in high peak power output. Customer tests have demonstrated several important results including negligible heat affected zones or haze, and the ability to eliminate certain post-machining processes, such as the post scribe plasma processing in the case of silicon scribing.

Customer interest in Talisker is strong for a wide variety of Microelectronics applications, including solar cell manufacturing and precision glass scribing for the latest handheld devices. By applying subsystems from other products within our portfolio, the Talisker is the only laser of its type available in infrared, visible and ultraviolet configurations. Customers have already begun to place orders and revenue shipments will commence in Q3.

Materials processing orders of $24.5 million increased 8.9% sequentially and decreased 17.4% versus the all-time high established in the prior year period. The Materials Processing market is in a very dynamic state. Consumer sentiment in the U.S. has impacted imports, causing orders for new production equipment to weaken. We have seen evidence of this in China.

On the flipside, demand from the Chinese, domestic and European markets has remained strong, partially offsetting the softness in the U.S. Given the regional interdependencies and unclear outlook, we expect customers to adopt a more conservative posture, especially on inventory.

Marking and engraving applications continue to be our prime targets. Specialty marking of glass, diamonds and ID cards performed exceptionally well.

On the product front, our recently released E-Seres CO2 platform is performing well. The integrated design and cost of ownership model have resonated with the customer base. We are receiving first time and repeat orders for this product. We are also seeing increasing demand for our Matrix Series laser platform.

We are pleased with our second quarter results, especially amid the current macroeconomic turbulence, and maintain a cautiously optimistic outlook, given the diversity of our end markets and the strength of our backlog. We will continue to move with all deliberate speed on our product roadmaps and structural changes to achieve our long-term EBITDA target.

I'd also like to extend an invitation to visit us at the Conference on Lasers and Electro-Optics, or CLEO, to be held from May 6 to 8 at the San Jose Convention Center. We are hosting an investor tour on Wednesday, May 7, at 10 am. We'll meet at Coherent's booth number 1740. To register for the tour, please visit the Investor Relations tab at www.coherent.com. I'll now turn the call back over to Audrey to begin the Q&A session.

Questions-and-Answer Session

Operator

(Operator Instructions). We'll take our first question from John Harmon.

John Harmon - Needham & Company

Hi, good afternoon.

John Ambroseo

Hi.

John Harmon - Needham & Company

Congratulations [giving] your guidance. A couple awfully quick questions please. Helene, what number do you compute for your pro-forma EBITDA margin in the quarter?

Helene Simonet

Sorry, what? Repeat, John.

John Harmon - Needham & Company

What number did you get for your pro-forma EBITDA margin in the quarter?

Helene Simonet

For the second quarter, 14.3%.

John Harmon - Needham & Company

Thank you. Just to make sure my model is in line, could you give me a rough figure for share count in Q3?

Helene Simonet

In Q3, what you could do is take diluted shares outstanding for the second quarter, and certainly subtract the almost 8 million, and then you can, depending on what the stock price will do, you have to add a little bit to it.

John Harmon - Needham & Company

Okay --

Helene Simonet

Probably comes out to about $24.2 million roughly.

John Harmon - Needham & Company

Okay, thank you. Helene, in your remarks, you mentioned a non-GAAP EBITDA target margin range of 19% to 20%.

Helene Simonet

I'm sorry, I misspoke. It should have been 19% to 23%.

John Harmon - Needham & Company

I guessed, thank you.

Helene Simonet

No change.

John Harmon - Needham & Company

Just one question and I'll get back in the queue. The expense for your stock option investigation, are you done with that or is that going to still linger around for a while?

Helene Simonet

The portion related to the historical financial restatement is completed.

John Harmon - Needham & Company

Okay, thank you very much.

Operator

Next, we'll hear from Mark Miller.

Mark Miller - Brean Murray Carret & Co.

Again, my congratulations on a good result. Could you give us a --

John Ambroseo

Mark, if we may, Helene was trying to complete her answer to the last question. So she should probably get that out before you go into yours.

Helene Simonet

John, I was saying that the portion related to the restatement is completed. The portions of the litigation has not been closed yet.

John Ambroseo

Thanks, Mark. Go ahead.

Mark Miller - Brean Murray Carret & Co.

Just wondering, could you give us kind of a ballpark, the solar business is really starting to bloom. What are we talking about in magnitude of orders, is it, in terms of the quarter, 5 million, 10 million, in that range?

John Ambroseo

We actually don't release the detailed numbers on that, Mark. I'm sorry.

Mark Miller - Brean Murray Carret & Co.

Okay. Can you give us a little more, in terms of the fiber business? Are you looking at a specific mix for the business? Some people are in a very high power, other people are more in the scribing area, are you going to go more after the fine precision scribing type applications?

John Ambroseo

The product we announced this weekend in Japan, the Talisker is our first formal fiber laser offering, and it is -- I think we would qualify it or categorize it as a specialty laser because it does produce a short pulse output. The intention there is to be applicable to micro-machining applications where the short pulse characteristics really provide a much finer quality process. So we are looking right now at some of these specialty applications but certainly, we wouldn't restrict ourselves to that in the future.

Mark Miller - Brean Murray Carret & Co.

Thank you.

Operator

(Operator Instructions). Next we'll hear from Jiwon Lee of Sidoti.

Operator

(Operator Instructions). We'll hear from Sid Parakh.

Sid Parakh - McAdams Wright Ragen

Hi. Can you hear me?

John Ambroseo

Yes, we can.

Sid Parakh - McAdams Wright Ragen

Hey. One of the things I wanted to get back to was, you know, we've talked about the Excel acquisition and that you were appealing in the German FTC. Based on what I had heard last, you were expecting to hear back sometime in late 2007. Is there any news on that front?

John Ambroseo

We are continuing with the appeal process and there is nothing new to report at this moment.

Sid Parakh - McAdams Wright Ragen

Could you give us any sense of time line as to when you might hear something?

John Ambroseo

As I think I mentioned during a previous call, Sid, we are in the process of discussing the standing of the case. The FCO has taken one position, we have taken another and the court is adjudicating on that right now. We expect to hear something from them, I think in probably a month's time or so, as to whether or not the appeal will have standing.

Sid Parakh - McAdams Wright Ragen

Okay. That's fair. Helene, could you -- maybe I missed the early part of the call but could you talk about how much the Auburn reorganization is actually going to help EBITDA numbers?

Helene Simonet

Yes. It will add approximately 0.5% to our EBITDA.

Sid Parakh - McAdams Wright Ragen

Okay. Assuming where we are today, at say 14.3%, and you add the 0.5, so that gets you closer to about 15. There are still about four to eight percentage points to go. Is it more of similar kind of restructuring? Can you give us any color?

John Ambroseo

Sid, as we previously mentioned, there are a number of factors that are going to contribute to the EBITDA. Material cost reduction, higher product reliability resulting in lower warranty rates. We are trying to push our industry leading standards even higher. There will be some restructuring as the case in Auburn will contribute to that. And obviously, the platform designs that we have been highlighting also contribute to it. So there's not one of thing that drives it, there are several factors that are going to drive it.

Sid Parakh - McAdams Wright Ragen

Okay, that's fair. As far as macro economically, what do you see in the market place? This quarter turned out pretty good based on your guidance. Do you see resurgence in orders with the next couple quarters or is it pretty much the weak condition you are operating in today?

John Ambroseo

We don't give guidance on bookings and I am certainly not going to start doing that here. I think it is fair to say that given the diverse geography that we participate in, and we're somewhat unusual from many of the other folks in this industry, in that we have roughly a third of our business in each of the major geographic territories, we're seeing mixed things. In the US, we are seeing some concerns from customers. I think that's been widely reported. Both on the capital equipment side as well as the consumer side, we are seeing strength in Europe and we are seeing good performance in the domestic markets in Asia.

Sid Parakh - McAdams Wright Ragen

Is the third affair an estimate of this quarter's revenues or so for each geography?

John Ambroseo

The split has been fairly consistent over the last few quarters. I can't tell you if it's going to change dramatically in any of the territories, but that would be a good rule of thumb, just for estimates.

Sid Parakh - McAdams Wright Ragen

Okay, that's fair. That's all I have. Thanks.

John Ambroseo

Sure.

Operator

Next question will come from Jiwon Lee.

Jiwon Lee - Sidoti & Company

Hello. Can you hear me now?

John Ambroseo

Are we doing a Verizon commercial?

Jiwon Lee - Sidoti & Company

Okay, good. The Auburn campus restructuring project, ultimately there would be upto $4.5 million of benefits. Any sense as to how that could be split over time?

John Ambroseo

Over time? I think the guidance that Helene gave was -- that would be the run rate when the project is completed and we've targeted being done with the project no later than the end of March. I'll turn it over to Helene to comment.

Helene Simonet

If you want, you can assume that will start kicking in the second half of fiscal '09 -- towards the end of fiscal '09, the second half.

Jiwon Lee - Sidoti & Company

Okay, that's fair enough. Getting back to this litigation expenses, any sense as to the progress from that end or what we should be expecting on that front, in terms of expenses going forward?

John Ambroseo

Jiwon, I hope you can understand this is an active process right now and we can't comment on it.

Jiwon Lee - Sidoti & Company

Okay, fair enough. That's all for me.

John Ambroseo

Okay, thank you.

Operator

We'll hear from John Harmon.

John Harmon - Needham & Company

Hi again. Just a couple questions about Auburn. First of all, the piece of business that you're outsourcing, is that your last remaining operations in Auburn? I know you sold the building. Will you be completely out when this is done?

John Ambroseo

That is what we've announced. It's optics manufacturing and several other functions, those functions will either move to other Coherent locations or they will be themselves outsourced.

John Harmon - Needham & Company

And Helene, are you going to take the restructuring charge in one piece upfront or during the time you're getting out of the business?

Helene Simonet

It will be expensed during the transition time. We announced that we had about $6 million expenses and I believe if you look at the Q3 guidance, we have about $1.4 million of that during the third quarter. I will tell you later on in which quarters we have those expenses.

John Harmon - Needham & Company

Okay, thank you. I don't know if you have it handy but one figure I don't believe that you gave was year-over-year revenue growth excluding divested businesses, the UK business that you sold.

Helene Simonet

I think it's about 5.5 if you exclude our divestiture of CIOL.

John Harmon - Needham & Company

Okay, great. Thank you very much.

Operator

That does conclude the question and answer session. I'll turn the conference back over to John Ambroseo.

John Ambroseo

I'd like to thank everyone for their participation, and if you have an opportunity to visit us at the CLEO show, we would be happy to host you at the tour. Thanks very much and we'll speak to you in three months.

Operator

Again, that does conclude today's conference call. Thank you for your participation. Have a wonderful day.

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