Coherent Corp (COHR) 2003 Q4 法說會逐字稿

Welcome to the Coherent fourth quarter 2003 earnings results conference call. Today's conference is being recorded. For opening remarks and introductions, I would like to turn the call over to the Chief Financial Officer of Coherent, Helene Simonet. Please go ahead ma'am.

Good afternoon and welcome to our fourth quarter fiscal 2003 conference call. As is customary with our call, I will speak to the results of the fourth quarter, and then John Ambroseo, our CEO, will discuss operational initiatives and also provide a business overview of the Company. We will continue to provide forward-looking financial guidance for the current quarter only. Please remember that the guidance provided is only an estimate and is subject to different risks and uncertainties, such that actual results may differ significantly. Additional information concerning these factors are contained in the Company's filings with the SEC. Listeners are encouraged to refer to the risks disclosure described in the Company's reports on Form 10-K, 10-Q and 8-K, as applicable. Copies are available from the SEC, from the Coherent website or from Coherent Investor Relations. Before I talk about the results, let me remind you that the full text will be made available through the Coherent Investor Relations website.

We reported fourth quarter revenues of 101.5 million and a net loss from continuing operations of 25.7 million, or 86 cents per share. Non GAAP loss from continuing operations was 8.7 million after-tax, or 29 cents per share. GAAP results include impairment and other charges to facilities and equipment of approximately 12.1 million pre-tax, 9.4 million after-tax, or 32 cents per share. These impairments and other charges were incurred in the following areas -- a reorganization of the optics manufacturing business and consolidation of facilities at our Auburn, California site, resulting in a pretax of $3 million, 1.8 million after-tax, or 6 cents per share; a pretax impairment charge of 3.4 million, 4.3 million after-tax, or 14 cents per share, relating to the termination of manufacturing at our facility in Scotland; a pre-tax impairment charge of 2.9 million, 1.8 million after-tax, or 6 cents per share, related to excess manufacturing equipment at our site (indiscernible) site; a pre-tax charge of 0.7 million, 0.4 million after-tax, or 2 cents per share, relating to leased property that formerly housed our active telecom business and still remains vacant; and a pre-tax accrued lease termination charge of 1.7 million, 1 million after-tax, or 3 cents per share, relating to our Santa Clara, California site, home of our former medical business. This facility will come off its synthetic lease during the first quarter of fiscal 2004, resulting in adding approximately 24 million to Coherent's successive balances, with a corresponding amount reflected as additional debt or as a reduction of cash.

GAAP results for the period also include a 1.9 million post-tax charge, or 6 cents per share, for in-process R&D from Coherent's purchase of an additional 34 percent of the outstanding shares of its Lambda subsidiary; a 2.5 million pre-tax charge, 1.3 million after-tax and net of minority interest, or 4 cents per share, of severance costs due to management changes at Lambda Physik; and a $5.6 million tax charge net of minority interest to reflect the establishment of a valuation reserve against Lambda's deferred tax assets. Finally, also included in the fourth quarter GAAP results was a 1.2 million, or 4 cents per share tax benefit, due to the recognition of additional tax refunds available to the Company.

Our overall book to bill was 1.03 to 1, and we also added an additional 3.1 million in backlog, bringing the ending Q4 backlog to 127.7 million. Fourth quarter orders of 104.7 million represented 10.8 percent increase over the corresponding prior year period, and a 1.1 percent increase over the preceding quarter. On a fiscal year basis, orders were up 4.8 percent. Electro-optics segment bookings in Q4 '03 of 88.9 million were up 22.7 percent compared to the corresponding prior year period, up 4.2 percent sequentially, and up 12.2 percent year-over-year. Lambda Physik's orders during Q4 '03 of 15.7 million were negatively impacted by low lithography business. Sales to industrial and scientific customers experienced a nice pickup, which was helped by the post SARS recovery in Asia. The bookings of 15.7 million were 28.5 percent down from the corresponding prior year period and 13.3 percent down sequentially. On a year-to-year comparison, orders were down 21.2 percent. Total Company sales in Q4 '03 were 101.5 million, down 4.6 million from the same quarter a year ago, although it should be noted that the prior year period included a onetime 2 million royalty revenue.

Revenues were up 2.4 percent, or 2.3 million sequentially, and up 2.2 percent, or 8.9 million on a year over year basis. Sales by business segment were as follows -- electro-optics, 83.7 million, an increase of 2.9 million, or 3.7 percent from Q4 '02, and an increase of 0.5 percent from Q3 '03 and up 5.4 percent for the full fiscal year; Lambda Physik, 17.8 million for the quarter, a decrease of 7.6 million or 29.8 percent from Q4 '02, but up 12.3 percent from Q3 '03 and down 8.7 percent for the full fiscal year. The Electro-Optics sales by significant market application for the fourth quarter of fiscal 2003 are as follows, and I will read you the fourth quarter numbers -- scientific and government programs, 29.7; microelectronics, 13.8; material processing, 11.4; components and instrumentation, 26.2; graphic arts and display, 5.6 -- for a total of 83.7 million.

Gross profit of 30.4 million, or 29.9 percent for the fourth quarter, was well below our original guidance of 38 to 40 percent, but came in above our revised guidance of 27 to 29 percent. Gross profit was down compared to the prior quarter's 37.3 percent margin and last year's Q4 margin of 38.1 percent. The breakout in gross margin by segment for the fourth fiscal quarter is as follows -- 32 percent for electro-optics, a decrease of 9 percentage points from Q3; and 20.2 percent for Lambda Physik, an improvement of approximately 2.7 percent sequentially. The shortfall within the electro-optics segment was clearly an area of disappointment to management. Our postmortem of the quarter's results depict the following areas of shortfall -- we experienced a negative product mix which impacted margins by more than three percentage points; in addition, we recorded unfavorable manufacturing absorption variances, further reducing margins by three percent; inventory write-offs in excess of historical trends impacted margins negatively by 1.3 points; and we also saw increased warranty costs, primarily driven by the failure of an externally purchased component. We have identified several events that contributed to the negative results? In hindsight, we initiated to much change into the system and overloaded the organization's capability to manage the business effectively. As we communicated earlier, we have multiple supply chain and integration programs ongoing, impacting each of our business units. At the same time, we are also implementing a global ERP system, which introduced a significant amount of change for many employees. We now have a solid foundation in place for process streamlining and improved global visibility; however, the learning curve was deeper than anticipated. In addition, operations management aggressively focused on reducing inventories and also experienced some management changes in key operating sites.

We have already taken or established a number of actions in response. For example, in conjunction with the ERP implementation, we are delaying new implementation and are refocusing our efforts on stabilizing those recently completed. In addition, we are spending a significant amount of time developing the appropriate monitoring tool, and we are training users to better enable the extraction of data relevant to running the business. Our global manufacturing resources also need to be better aligned with the build plans in each of our manufacturing sites, and this issue is currently being addressed. It is expected that the costs associated with such actions will be recognized over the next two to three quarters, with associated savings being realized in the quarters following recognition. Just this morning, we announced a headcount reduction impacting some of our businesses in California, and the first quarter guidance will include severance costs, net of benefits, of approximately 400 to $500,000.

As mentioned earlier, there were a number of simultaneous programs initiated to improve Coherent's supply chain. Whether the program was aimed to outsource (indiscernible) consolidate manufacturing operations or integrate acquired businesses, all took a significant amount of time and attention to manage. As a consequence, the initiatives took time away from basic blocking and tackling, with the result that some items fell through the cracks. As I said earlier, system implementations will be pushed out, vigorous training and education efforts will be reintroduced, and we will not add new projects until others are completed. Management changes at significant operations also impacted the quarter. The management changes at Lambda that were mentioned in our earnings release came somewhat at the expense of our electro-optics segment, and John will have more to say about this. Within our Lambda Physik segment, gross profit improved to 2.7 percentage points. This improvement was less than expected, as Lambda also saw a negative mix impact during the quarter, partly offset by lower warranty costs. In addition, the purchase price accounting resulted in increased cost of sales for the quarter totaling $550,000.

If I were to summarize the quarter, we were very disappointed with the falling gross margins; however, we will learn from this experience. Operating expenses for the quarter, including intangible amortization but excluding the impairment and other charges of approximately 12.1 million, the IP R&D charge of 1.9 million and the 2.5 million Lambda severance costs, were 42.5 million, or 41.8 percent of sales, compared to an initial guidance range of 38 to 40 percent of sales and a revised guidance range of 41 to 44 percent of sales. R&D spending for the quarter of 14.1 million was 13.9 percent of sales, above the original guidance range of 12 to 13 percent of sales and within the revised range of 13 to 15 percent of sales. Absolute R&D dollar spending was up, primarily as a result of 1.2 million charges related to a special project for a large customer. SG&A spending for the quarter, including amortization of intangibles but excluding Lambda severance costs of 2.5 million and impairment charges of 12.1 million, was 28.4, or 27.9 percent of sales -- close to 1 point higher than the upper end of the original guidance range of 26 to 27 percent. The lower sales level was one of the reasons why SG&A was higher than the original guidance. Also, as a result of the Lambda share purchases, additional amortization of non-goodwill intangibles for two months totaled $0.4 million.

Our ending cash balance for the quarter was 188.6 million, of which 53.9 million was classified as restricted cash. The cash balance of 188.6 million represents a reduction of 36 million compared to Q3 '03. During the quarter, we spent approximately $48 million cash on the purchase of Lambda shares, and we have approximately 8 million left of restricted cash earmarked for the Lambda shares we don't own yet. The remaining 46 million in restricted cash is reserved as a result of our long-term debt arrangement. Cash inflow from operations, net of investment and financing, was 12 million for the quarter. Coherent's book value at the end of September is approximately 18.2 per share.

At the end of Q4 '03, Accounts Receivable days sales outstanding stood at 65 days, compared to 67 days at the end of Q3 '03, marking the third consecutive quarter of improvement. Electro-optics days stood at 61, compared to 62 at the end of Q3 '03. And Lambda receivables days outstanding was 81 days, down nicely from the 96 days outstanding as of the end of June. Inventory days sales outstanding dropped from 96 at the end of Q3 '03 to 89 at year-end. This continues to receive the full attention of management. Within our electro-optics segment, we saw inventory days sales outstanding drop from 73 days to 64. This improvement did not come without cost, as was pointed out earlier; however, we also saw significant improvements as a result of lasting changes in our inventory practices. Inventory levels at Lambda Physik increased slightly as a result of the purchase accounting. Inventory days did improve to 204 days from 221 days at the end of Q3 '03. Capital spending for the quarter was approximately 6.2 percent of sales and well within our guidance range of 6 to 8 percent of sales. Capital spending for the full fiscal year 2003 was 25.7 million, or 6.3 percent of sales.

The following represents management guidance and operating results for the first quarter. As usual, such guidance is limited to current quarter only, as market conditions make it difficult to go much beyond this time frame. As a reminder, our guidance is exclusive of any major restructuring charges. The following guidance is provided.

We expect revenues to be just slightly above Q4 '03. Gross profit will rebound somewhat to the 35 to 37 percent range. I want to point out here that cost of sales will include approximately $800,000 additional cost, due to the purchase accounting impacting inventory at Lambda. R&D spending is expected to be in the range of 13 to 14 percent of sales. SG&A expenses, including intangibles, are anticipated to fall in the range of 28 to 29 percent of sales. Including is the intangibles, which represents approximately 1.7 percent of sales. Other income expense is estimated at zero percent of sales and we expect the annual tax rate to be in the mid-30s. Capital spending will be in the range of 6 to 8 percent of sales.

In summary, we recognize that we have to re-earn your trust. We are introducing the necessary changes to drive towards a quick return to profitability. The challenge alone related to a short-term turnaround at Lambda Physik is a great one, and may well require significant decisions. We have the capability to do this and build the foundation towards a full and sustainable recovery.

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

Good afternoon everyone, and welcome to our fourth quarter conference call. During her presentation, Helene provided a significant amount of detail regarding our poor performance in Q4. I can imagine that many of you are asking how this could have happened, especially given the historical perfectibility of our electro-optics business. The short answer is that we placed to many simultaneous demands on our management team. That list included an ERP implementation, multiple supply chain initiatives and an inventory reduction program. Furthermore, I drew on several resources within our EO segment to help assess and begin course corrections at Lambda Physik. Individually, none of these present a significant challenge to management. However, in our desire to get the restructuring efforts behind us as we prepare to reenter a growth phase, we accelerated the time frame of these activities. The collective effect resulted in a loss of visibility in our business. We have since implemented corrective actions to relieve the overload. We expect our EO gross margins will show significant recovery in Q1 and beyond.

I will now discuss the results of our fourth fiscal quarter. Our book to bill for the EO segment was 1.06. Orders for EO were up 4.2 percent sequentially and 22.7 percent from the prior year period, as well as being up 12.2 percent year-to-date. Bookings in our scientific and government programs business were up 1.2 percent sequentially and 36.3 percent from the prior year period, as well as 16.7 percent year-to-date. Demand for our Workhorse (ph) research tools remained strong, especially for biological imaging. Orders for ultrafast amplifiers were down slightly, which is not unexpected as the distribution agreement with another laser manufacturer unwinds at the end of December. Beginning January 1, 2004, we will manage amplifier sales directly, allowing us to capture the current distributor margin, as well as front end laser sales that accompany about 60 percent of amplifier systems. Our sales force is eagerly awaiting this opportunity.

Orders for our OEM component and instrumentation sector increased 6.8 percent sequentially and 9 percent from the same prior year period, or remained almost flat on a year-to-date basis. In Q4, we continued to capitalize on opportunities in the bioinstrumentation market. We received two annual orders for our Compass and Sapphire series lasers that totaled approximately 1300 units. And as I mentioned in previous calls, this is largely fresh business for us, as these lasers are the technology of choice for new bioinstrumentation platform designs. Bookings within material processing were down 22.1 percent sequentially and down 6.7 from the prior year period. We have observed a seasonal decline in the fourth quarter in prior years. For the full fiscal year, orders were essentially flat. Demand was strongest for products used in textile and nonmetallic processing. Geographically, the Asian market showed strong growth in the first half of FY '03, but experienced midyear softness. Several of our Asian customers found themselves with an inventory surplus. Based upon the current inventory burn rate of our customers, we would expect orders to pick up in this region in late Q1 or early Q2. Bookings in the microelectronics market were up 8.5 percent sequentially and 48 percent from the prior year period, and up 23.8 percent year-to-date. This marked the fourth consecutive quarter of improved bookings directly related to the semiconductor equipment market. We have seen increased activity across a range of applications, including via drilling, wafer inspection and PCB direct write (ph). While order volumes remain modest, the trend is encouraging and consistent with other industry metrics.

Some emerging applications are also gaining momentum. For example, it is projected that within two years, 30 percent of all memory will be stacked. This necessitates the use of thinner wafers, meaning less than 75 micron thickness, which experience poor yields when cut with a diamond saw. Laser cutting has been demonstrated to significantly improve the yield. We estimate that this market is several hundred units per year. Also as a reminder, the products going into microelectronics are typically at the higher end of the performance and price curves, such that we will enjoy the added benefit of margin improvement during a recovery in this market.

We continue to be surprised by the strength in the graphic arts market. Bookings were up 89.6 percent sequentially, up 42.7 percent from the prior year period and up 58.6 percent year-to-date. The trend towards digital printing processes and the photofinishing and digital imaging markets continues to accelerate. We are optimistic regarding two emerging markets -- laser projection cinema and projection television -- both in the display market. All of these markets will be enabled by Coherent's proprietary OPS technology. The paradigm surrounding the trend of digital processing continues to be a function of speed, quality and a more environmentally-friendly practice. Additionally, our customers are benefiting from Coherent's superior performance, reduced downtime and lower overall cost of ownership of our products compared to those of our competitors.

We maintained our investment in research and development during the fourth fiscal quarter. Coherent spent 14.1 million, or 13.9 percent of revenues, on R&D during Q4 2003. We continue to innovate and expand our product portfolio with an emphasis on performance, ease-of-use and reliability. I can assure you that our commercial customers have an insatiable appetite for all three parameters. We are particularly pleased with our efforts in OPS technology, where we continue to push the power curve and broaden the wavelength coverage. We envision that the OPS platform will ultimately serve all five primary markets.

Let me now switch to a discussion of our EO operations. In her presentation, Helene outlined the contributing factors to the gross margin erosion. These included a negative product mix, unfavorable manufacturing absorption variances, inventory write-offs in excess of historical trends and increased warranty. I would like to offer some color commentary on each. Product mix is a vexing issue, since we, as a vendor, ship what the customer requests.

In retrospect, we should have done a much better job of forecasting the mix. Many of the management tools we use for this purpose were retired along with our legacy ERP system, and regrettably, we were not as adept with the new system. We are addressing this deficiency through training and the implementation of new reporting tools. It is our expectation that our visibility will return to and surpass our historical levels, as our new system provides a wealth of data not available from the legacy system. The mix for the current quarter is expected to rebound as a result of the market conditions I previously discussed.

Several factors contributed to the unfavorable manufacturing absorption. We achieved significant inventory reduction in Q4, which contributed to the under-absorption. We have verified that many of the new inventory practices are manageable, with the exception of service stocks, where we dipped too deeply into reserve levels. We have taken the first corrective step and reduced the overhead structure in Santa Clara. Furthermore, as part of its global resource planning, Coherent is initiating a phased exit from its operations in Glasgow, Scotland. We are reviewing a change in ownership proposal under which the facility would continue (technical difficulty) Coherent products through a contract manufacturing agreement. Over time, we would transfer key product or products from Scotland to Santa Clara. In the event that the change of ownership does not proceed as intended, we will continue to operate the Scottish facility until such time as alternative manufacturing has been established at other Coherent locations. We are also addressing redundant manufacturing through product transfers in other areas. These activities will be completed in Q2 '04.

The excess inventory write-offs arose from a project review that led us to conclude the program was not as advanced as we had previously thought. The increased warranty expense arose from the failure of a purchased component in one of our higher volume products. The previous reliability of this component was quite good. It was also unfortunate that the failures occurred outside of the burn-in cycle. We have worked with the vendor to resolve the issue. At this point, we believe we have retrofitted the vast majority of bad components and don't anticipate this to be a recurring problem.

During the Q3 conference call, we announced the reorganization of our U.S.-based optics business, headquartered in Auburn, California, to better align customers, capabilities and capacity. Combined with the outsourcing of electronic assemblies, we are in the process of consolidating our footprint in Auburn from 4 buildings to 2, with a corresponding reduction in square footage from 250,000 square feet to approximately 140,000 square feet. In addition, we will integrate Positive Light into our Santa Clara facility during Q2 '04, thereby enhancing local space utilization. While we have stumbled during the fourth quarter, this is a marathon, not a sprint. We are committed to driving margins into the mid-40s, generating cash and gaining market share.

Let me now turn to Lambda Physik. Presently, Coherent holds about 94.5 percent of the outstanding shares of Lambda Physik AG. We are less than 75,000 shares away from achieving a 95 percent ownership, which would allow us to initiate a squeeze-out resolution under German takeover law. We continue to buy shares -- Lambda shares that is -- in the open market, and we are evaluating next steps in the process. Due to the reduction in the free float, Lambda will be subject to reduced reporting requirements, which will reduce administrative costs. Following the completion of the tender offer which occurred in July, the supervisory board of Lambda Physik appointed me CEO. In this capacity, I have made a number of changes to executive management. The CTO and head of U.S. operations have left the Company, and both positions have been eliminated. Due to the reduction and ultimate elimination of external reporting requirements, the CFO is leaving the Company at the end of this week. I've appointed two veteran Coherent managers at Lambda -- one is Chief Operating Officer and the other as VP for Worldwide Sales and Service. While the tasks ahead are formidable, we are quite pleased with the talent that exists throughout the Lambda organization.

Over the past three months, we have evaluated three areas at Lambda -- engineering programs, product reliability and customer relations. In engineering, the main emphasis has been on the 193 program, since this is the linchpin to our participation in the lithography market. Our goal is to field a high-power device in the fourth calendar quarter of 2004. On the reliability front, we believe we have identified the major culprit impacting tube lifetime. Field deployment of the new tube design will begin in January of 2004. Customer relations have been educational, as there is no shortage of customer feedback. We are working on the sales versions of blocking and tackling, responsiveness and follow-through. The next step in our process is a review of the capacity plan.

Returning to operational performance, Lambda sales for the fourth quarter of 17.8 million were down 12.3 percent sequentially, and down 29.8 percent from a year ago and down 8.7 percent year to date. Q4 orders of 15.7 million were down 13.3 percent sequentially, 28.5 percent from the prior year period and 21.2 percent year to date, largely due to continued weakness in the lithography market. While everyone is waiting for the semiconductor CAPEX bounce, arguments abound over future technologies. Will it be wet or dry lithography? Does 157 play for memory but not for logic chips? And what about EUV? The only certainty in the litho space is the rollout of 193, hence my earlier comment that it is a linchpin for us. On a positive note, Lambda's industrial bookings increased 55.3 percent sequentially and 47.8 percent from the prior year period, as a result of an upturn in lasers used for the production of high-end flat-panel displays. All market indicators point to a growth in the display market for the next year, as digital cameras, color picture-phones and flat screen TVs drive this market.

Finally, let me apologize for any inconvenience that we may have caused as a result of canceling the analyst day which was originally scheduled for the 6th of this month. We will reschedule this event in the near future. I will now turn the call back over to Sherri (ph), and we can begin the question and answer session.

(OPERATOR INSTRUCTIONS). John Harmon.

You were talking about all the programs you are working on simultaneously. Were you able to complete two of the programs you mentioned before, the PCB outsourcing and moving carbon dioxide lasers to Connecticut?

Both of those programs are completed, yes.

Secondly, could you give us a rough estimate of when you think you'll get your business back in order? I know that's a very general way to say it, but when do you think you might be back to profitability? It looks like you won't be there next quarter.

No, we won't. There are two things that need to happen, John. We talked about some of the changes that we need to make to right-size the operations in various places, reducing redundant capacity, etc. Those are being planned and some of them are already being implemented. Secondly, we have a big challenge ahead at Lambda Physik, where we still have to complete a review. And please bear in mind, I am saying that now as the CEO of Lambda, not as the CEO of Coherent. It's still operating as a separate company. The EO piece, I believe, will return to its historical performance much faster than the Lambda piece. We have a bigger challenge there because we do have to gain some revenues to help out with the balancing act. So I would expect the Lambda piece to show for the year -- it's probably going to be on the negative side. And I can't project at this point how fast Coherent will be able to make up that shortfall on the EO side.

Is Lambda going to report their fourth quarter? If not, do you have a breakdown of their revenues by their old segments? Are you going to cease reporting that?

The press release will come out tomorrow morning, I believe, in Germany.

Sorry if you discussed this, but it looks like OEM components were up quite a bit sequentially. Is that a seasonal pop or was there something else there?

For the instrumentation business, we did pick up a tremendous number of bookings, and these came in the form of a couple of annual orders for some of the microlasers that we build. These are the Compass, which are the green lasers, and the Sapphire, which are our blue lasers. We wouldn't expect orders of that volume to occur every quarter, but the business is showing an overall trend of improvement.

Mark Miller.

I was wondering if you could give us a little more color on what's going on in some of the (indiscernible) areas of the semiconductor market for you?

I'm sorry Mark, I couldn't hear the question.

Basically, in terms of the semiconductor market, you say you see some pick up there. I am just wondering if you can give us a little more color in terms of specific areas. Is it metrology? I think you did mention via drilling.

We mentioned via drilling, and I mentioned wafer inspection, as well as PCB direct write. Quite frankly, we are seeing increased activity across virtually every application we participate in. Those are probably three of the stronger ones.

You mentioned on the lithography light switch that you have had a fairly significant advancement, in terms of -- or you are evaluating a new tube. Do you feel that will give you improved lifetimes -- that's one of the key issues there?

To participate in this market, it's just not about performance; it is about reliability. And I think I have been quite candid in the past that Lambda has not produced a product that is up to the reliability standards of the customers. And we have been spending a significant amount of resource, I guess, autopsying systems to determine what the failure mechanisms are, and we have identified a few of them, one being a very significant contributor. We've implemented an engineering change, which is now flowing into the floor. As I mentioned, we expect this to ship LDUs -- or the laser discharge units, the tubes -- starting in January of this new design. And if the in-house data is correct, it should be quite a nice surprise to customers.

(OPERATOR INSTRUCTIONS). There are no further questions. Do you have any closing remarks?

We would like to thank you for participating on the call, and we look forward to speaking to you in January.