Coherent Corp (COHR) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Coherent Second Quarter Fiscal Year 2017 Financial Results Conference Call hosted by Coherent, Inc. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce Bret DiMarco, Executive Vice President and General Counsel. You may begin your conference.

Thank you, Emily, and good afternoon, everyone. Welcome to today's conference call to discuss Coherent's results from its second quarter of fiscal 2017.

On the call, we have John Ambroseo, our President and Chief Executive Officer; and Kevin Palatnik, our Executive Vice President and Chief Financial Officer.

I would like to remind everyone that some information provided during this call may include forward-looking statements, including, without limitation, statements about Coherent's future events, anticipated financial results, business trends and the expected timing and benefits of the integration of our recent Rofin-Sinar transaction. These forward-looking statements may contain such words as expects, will, anticipates, intends or referred to as guidance. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict and may cause actual results to vary significantly. These forward-looking statements reflect beliefs, estimates and predictions as of today, and Coherent expressly assumes no obligation to update any such forward-looking statements. For a description of risks and uncertainties which could impact these forward-looking statements, you are encouraged to review Coherent's periodic SEC filings, including its most recent Form 10-K, Form 10-Q and Forms 8-K.

I will now turn the call over to John Ambroseo.

Thanks, Bret. Good afternoon, everyone, and welcome to our second fiscal quarter conference call. Coherent delivered another record-setting quarter, and we are seeing very strong demand across all our [end] markets. The outstanding operating results have translated into significant cash generation, and we have started to voluntarily pay down the debt associated with the Rofin acquisition. I also want to commend Kevin, Bret and their teams for completing the repricing of the euro-denominated debt. Kevin will provide you with details during his remarks.

The microelectronics market remains on a very positive trajectory. New systems and service orders for FPD applications were robust and benefited from a number and size of screen -- the screen sizes (inaudible) is being addressed by OLEDs, large capacity investments by Chinese manufacturers at Gen 5 and above and high fab utilization, which supports higher service demand.

In addition to annealing, we have been qualified for other laser-based process steps. For example, we received almost $20 million of orders in the second quarter for ultrafast and carbon dioxide lasers used in OLED film cutting.

The FPD outlook is rapidly evolving. The current data being provided by end customers, and that means panel manufacturers, is of the high end of our model and [when] necessitate, capacity expansion in fiscal 2018 at our laser system test facility in Göttingen, our refurbishment center in [Osan] and our optics fabrication site in Richmond.

The Semicap market remains in high gear, and sequential order growth was well into double digits. Similar to the most recent quarters, 3D NAND, logic, no transitions and utilization rates fueled demand. The recent public reports by other institute participants as well as those from market research firms suggest this trend is likely to continue through the rest of the calendar year.

The API market continues its recovery, leading to double-digit sequential order growth. The mix between infrared and ultraviolet is similar to prior quarters, meaning that we haven't seen a change in feature size. This leads to the conclusion that these are pure capacity orders.

We had a breakout quarter on materials processing, with bookings more than doubled from the prior year period. Nearly every application and technology contributed to the outcome. Orders for ultrafast lasers and subsystems, including our first revenue synergy from the Rofin transaction, sharply increased on demand from automotive and machine tool OEMs.

We followed up Q1's record result in medical device manufacturing with another record in Q2. Consumer goods manufacturing was very robust for packaging, converting and marketing using infrared and ultraviolet lasers. Additive manufacturing also did well, especially for polymer materials. We maintain our long-term conviction for this application because additive manufacturing simply makes sense.

After receiving some initial -- I'm sorry, after resolving some initial quality issues, we are making steady progress in high-power fiber lasers. Our first full quarter of engagement led to double-digit order growth, most of which came from cutting and battery welding applications. The prospect list for high-power fiber lasers is expanding steadily. As the interest converts to orders, we will expand capacity for components, integration and testing. Our work to insource [power] production is on schedule, and we expect to have our first articles by the end of the fiscal year.

We are currently spending about $10 million per year on chips for the semiconductor laser modules, including those used in our fiber lasers. Switching to an internal supply would result in very high flow-through to the bottom line. As a reminder, this would be incremental to our net synergy's goal.

Instrumentation and component orders rose significantly on a sequential basis, led by record demand from instrumentation customers, where we capitalized upon a design win for our next-generation sequencer as well as maintaining our market-leading position in cytometry. Bookings for medical OEM lasers and components were also up sharply from aesthetic and surgical applications.

In addition to these positive results, we're enthusiastic about several near-term opportunities, including large-format optics for ground-based astronomy, semiconductor lasers in the aesthetic surgery and fiber diodes and fiber lasers in aerospace and defense.

Orders for research lasers were solid in what is usually a seasonally weak quarter. We did really well on ultrafast amplifiers used in physical sciences research, with the largest contribution coming from China. Biological imaging is a consistent performer, with roughly 60% of sales and orders in this area coming from neuroscience applications. We expect to see higher power and performance lasers, like our Monaco and Fidelity, to become more prevalent as the market shifts to functional studies that interrogate tens or hundreds of neurons at a time and seek to penetrate deeper into tissue using longer wavelengths.

We made good progress on integration and remain on track to meet our schedule and synergies commitment. More importantly, my colleagues have not let the integration interfere with taking care of our customers. I can assure you this is no small feat, and I would like to recognize their hard work and dedication.

With the hours pointing up into the right, we are in a terrific position to grow the business. We are confident that our technology investments are well aligned with markets, and there are future revenue synergies in laser-based tools and subsystems.

I'll now turn the call over to Kevin Palatnik, Coherent's Executive Vice President and Chief Financial Officer.

Thanks, John. Today, I'll first summarize fiscal second quarter 2017 financial results, then move to the outlook for fiscal Q3. I'll discuss primarily non-GAAP financial results and ask that you refer to today's press release for detailed description of our GAAP results as well as a reconciliation between GAAP and non-GAAP financial results.

The non-GAAP adjustments relate to stock-based compensation expense, amortization of intangible assets, purchase accounting, acquisition-related costs, restructuring costs and the related tax adjustments.

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

Fiscal second quarter 2017 financial results for the company's key operating metrics were: total revenue of $422.8 million; non-GAAP gross margin of 48.4%; non-GAAP operating margin of 26.3%; adjusted EBITDA of 29.3%; and non-GAAP EPS of $2.91.

Net sales for fiscal second quarter were $422.8 million, an increase of $77 million or approximately 22% sequentially. Sales came in above our previously guided range as a result of strength across all 4 markets Coherent serves, with sales in the microelectronics and materials processing markets providing the largest contributions.

Please note that Q2 '17 includes a full quarter of Rofin sales, of which the significant majority is included in the materials processing market of our ILS segment.

Our revenue mix by market for fiscal Q2 '17 was microelectronics at 49.9%; materials processing at 30.1%; OEM components and instrumentation at 13%; and scientific and government at 7%.

Geographically, Asia accounted for 59% of revenues in the fiscal second quarter; the U.S., 19%; Europe, 18%; and rest of the world, 4%. Asia includes one territory with revenues greater than 10% of total sales.

Other product and service revenues for fiscal second quarter were $109 million or approximately 26% of sales. Other product revenue consists of spare parts, related accessories and other consumable products and was 23% of sales. Revenue from services and service agreements was approximately 3% of sales.

We had one customer in South Korea, an integrator to large flat panel display manufacturers, that contributed more than 10% of the company's fiscal second quarter revenues.

Fiscal second quarter non-GAAP gross profit, excluding stock-based compensation costs, intangibles amortization, purchase accounting and restructuring, was $204.8 million. At 48.4% of sales for the quarter, non-GAAP gross margin came in above the high end of the guided range. This is primarily a result of our product mix, with a heavier weighting of ELA products and services and lower warranty costs.

Non-GAAP operating margin was 26.3% for fiscal second quarter and was also above the guided range as a result of the compounding effect of higher gross profits, along with lower-than-expected operating expenses. Adjusted EBITDA was 29.3% in fiscal Q2.

Turning to the balance sheet. Nonrestricted cash, cash equivalents and short-term investments were approximately $433 million at the end of fiscal Q2, an increase of approximately $73 million compared to the end of last quarter as a result of a higher net income and FX benefits, along with a myriad of smaller items.

During the quarter, we made a voluntary EUR 30 million payment against our outstanding debt consistent with our priority of using excess cash flow to delever the balance sheet.

In addition, as John noted, we took advantage of the tighter credit market in Europe and repriced the outstanding principal of our debt of approximately EUR 637 million to Euribor, plus 225 bps, which translates to a 3% interest rate, a decrease from the original 4.25%.

International cash, primarily in Europe, was $306 million or approximately 71% of the total cash and short-term investment balance. Approximately 35% of the total cash and short-term investments is denominated in dollars.

Accounts receivable DSO was 54 days, a decrease of 9 days sequentially. The net inventory balance at the end of the second quarter was virtually flat sequentially at approximately $388 million. And capital spending for the quarter was $14.2 million or 3.3% of sales. We expect this current spending rate to increase in the second half of our fiscal year.

Now I'll turn to our outlook for our third fiscal quarter of 2017. Revenue for fiscal Q3 is expected to be in the range of $450 million to $470 million. We expect fiscal Q3 non-GAAP gross margin to be in the range of 47% to 50%. Non-GAAP gross margin excludes intangibles amortization of approximately $11.3 million, inventory step amortization of approximately $4.8 million and stock compensation cost estimated at 700k.

Non-GAAP operating margin for fiscal Q3 is expected to be in the range of 27% to 30%. This excludes intangibles amortization estimated at a total of $15 million, inventory step amortization of $4.8 million and stock compensation expense of a total of approximately $7.1 million. Other income and expense is estimated to be an expense in the range of $8 million to $9 million, primarily related to interest expense and amortization of the debt issuance costs. We do not include transaction gains and losses related to future changes in foreign exchange rates in our outlook.

We expect our non-GAAP tax rate for fiscal Q3 to be approximately 30%. And finally, we're assuming weighted average outstanding shares of 24.9 million for the third quarter.

With regard to our participation at upcoming conferences, we'll be presenting at Benchmarks Investor Conference on June 1 in Chicago, the Stifel Technology Conference in San Francisco on June 5, the Citi Group's Small and Mid Cap Conference in New York on June 8 and the CJS Securities Conference in New York on July 11.

I'll now turn the call back over to the operator for the Q&A session.

(Operator Instructions) Your first question comes from the line of Patrick Newton.

First, I guess, on the FPD side, given your backlog, your install base, and it sounds like another good quarter of orders. I'm curious if you could give us your thoughts on where you are in that process of moving to an 80% shift in OLED for mobile devices. And then looking beyond mobile devices, I'm curious if you're seeing any types of momentum building on the order front for tablets, laptops, auto, et cetera.

So I can -- let me think about how to answer this, Patrick. In terms of the buildout, we're obviously, making a lot of progress. I can't tell you whether it's at 40%, 50%, 60% at this point. That's a little bit more granular than we typically get from the end customers in terms of what is our return on it in production. But clearly, to drive the kinds of numbers that they're talking to us about, as I mentioned in my prepared remarks, it's the number of screens and the size of screens, which really speaks to it going into devices beyond handsets to consume all its incremental capacity.

And in terms of devices -- Patrick, this is Kevin. Beyond mobile handsets, as we discussed in the past, we're still very encouraged in the area of mobile computing defined by laptops and tablets. In the last 6 to 9 months, we've had over half a dozen laptop manufacturers come out with a high-end OLED in their laptops. And also, most recently, within the last couple of months, Samsung -- I forget which model, it might be the S3 that they've announced, will be an OLED-based tablet.

Great. And I guess, on the capacity expansion commentary, some time in fiscal year '18, was that something that was previously planned? Or is it just that the pace of orders is accelerating such that it is not required?

We certainly have visibility to it. It wasn't a firm plan, but as things have been pulled in, yes, we need to make the investments because we can't afford to be the pacing item in the rollout of this technology.

Great. And then, Kevin, I guess, shifting gears to your margin profile, you long ago exceeded your long-term EBITDA target. You had FPD ramping. You had record service level that [I believe] should continue to grow. How should we think about profitability targets and potential margin levels over the next few years?

Yes. It's hard to go out that far, Patrick. As you know, the guidance we gave for Q3, our fiscal Q3, 47% to 50%, I think it will hover within that range. But as John mentioned in his prepared remarks, we're seeing good demand in that space. As that becomes a larger percentage of our business over time, that will put up positive upward pressure on margins. But we don't go that far out, a couple of years' worth. We basically just go out one quarter. So 47% to 50% for GM in terms of outlook.

And Patrick, I would just add a little bit more to that. We're still in the very early stages of the integration. There's still a lot that we don't know, and it is a big part of the business. It's going to have an influence. It would be better for us to have a little bit more data here before we're resetting targets.

That's fair. And I guess, that's a great dovetail to the last question just on Rofin. So you said you're on track or previously discussed, I believe it's $30 million in cost synergies. I'm curious if there's -- as you start to really have the business under your own control for a quarter, are you thinking that there's more synergies that you can wring out of this over the next 2 years? And then on the debt side, Kevin, given that you have the lower rate now, does it change anything with your thought process on aggressively retiring the debt load?

With respect to targets, again, we're 2 quarters into this, not even 2 full quarters into this. Yes, we think that there are upside opportunities in the synergies. We have always thought that, and we signaled that, that there could be upside. But we need to lock down what our commitments are first. And we also need to look at timing because we've always talked about an exit rate at the end of 2 years. We may be able to do things beyond the 2 years. We may be able to do things within 2 years. Again, it's very early days. Once we have good enough data, we will update you.

And on the debt, Patrick, we were very happy with our very successful repricing, lowering the interest rate by 125 bps to effectively 3%. As we did last quarter with a EUR 30 million prepayment, we'll use excess cash in terms of paying down the loan. I didn't forecast that with a specific date and time with being halfway through or even fully paying it off. As excess cash comes within the quarter and we can forecast that, we'll make the appropriate payments. So we're happy with the repricing. We're happy with the EUR 30 million payment we've done in the March month of last quarter, and we'll look forward to what we can do for this quarter and beyond.

Your next question comes from the line of Jim Ricchiuti.

I may have missed it, but did you -- Kevin, did you give a revenue number for Rofin, what it contributed in the quarter?

No, I didn't. And Jim, in terms of Rofin, at this point, as John said, we're well on our way in terms of integration. We've organized into 2 new segments as a company, OLS and ILS. The legacy Rofin sits inside the ILS. That's how we'll file it in the Q. That's how we'll talk about it going forward. So the legacy Rofin sort of goes away. We won't be recording those specific numbers.

Okay. Just with respect to the margins on that business, I know it's early, but what can you say about the overall margin profile of that business? We ask the question because that business historically has had lower margins than yours. But to what extent, with the volumes kicking up, are you seeing some margin left?

Yes. From a margin perspective, Jim, that business, as you know, as a standalone, it was mid- to high-30s where Coherent was mid- to high-40s. We did see some improvement quarter-on-quarter, but beyond that, I won't talk about any specifics. As I mentioned, it will just all get rolled up into ILS.

Okay. And on the display side of the business, can you say if the mix of orders that you're seeing is just -- is skewing more toward the larger systems and that includes even some of the newer players in the market? I'm just trying to get a sense, is that the shift that you're seeing in the market within that particular technology?

We're seeing -- the orders that are coming in at this point are all for Gen 5 and above. So you could think about that as Linebeam 1000s through Linebeam 1500s.

Okay. But can you give any further granularity on that, John?

You mean the split between the different versions?

Yes.

Unfortunately, Jim, we can't. We have -- as we've mentioned in the past, we have gag orders in place, and there are certain versions that only go to a single customer, which means we would be disclosing details about their business, which we can't do.

Okay. And last question, just on the pickup in the industrial business that you're seeing, the materials processing business. Is that just -- from your standpoint, is it fairly broadly based in all of your major geographies? Or are you seeing strength in any particular geography in that part of the business?

It's really across the board. It's been -- most of the technologies in that portfolio and literally all of the geographies. But I think that's also very consistent with what our cohorts in the industry have seen. The reports that have come out from people who participated in materials processing, I think, have generally been positive over the last week or so.

(Operator Instructions) Your next question comes from the line of Larry Solow.

Just a couple of follow-ups. John, on the flat panel side, obviously, pretty hard for you guys to gauge exactly what percentage of the handset market is already converted. But do you think the adoption curve, that 20-80, could that possibly be going faster? And at the end of the day, does that potentially become 95-5 or a 5-95 or beyond that 20-80 at some point?

Let me answer the last part of the question first. We've always had this view that by, I think we said, 2019, it would flip from 20-80 to 80-20. But once you get to that point, the question is, is it even viable to run LCD plans for the remaining 20%? So I think over time, yes, it just makes sense to sweep it all under one technology umbrella rather than trying to run 2 product platforms, especially when one is going to be such limited demand. As far as the rate of change, you're probably reading the same things that everyone else is in the media and assumptions about various products that are going to come out equipped with certain types of screens. That ultimately is going to decide how fast the conversion goes, not how fast everybody is putting equipment out there, because it really requires next-generation devices to be designed with OLED screens in order to support it. They're not going to go in and switch the screens on an existing device. So that wouldn't make any economic sense.

Got it. And then just sticking to the flat panel for one follow-up. On the capacity expansion or the needed investments, it sounds like a high-class problem for you guys. Is it fair to say, you're not -- you don't really necessarily need them today, you're just sort of looking to the future, so the little -- the potential shortage in capacity is not impacting your margin today, and when you add this capacity, maybe a short-term blip as you're adding it, but probably not a material impact on margins, plus or minus the ramp up, and then once you have that capacity installed?

So a couple of things, Larry. We talked about these investments being made in 2018 for future production. The reason that timing exists is that fabs are being built that will house this equipment. So if we ramp today -- again, we have the same problem that we've talked about all along. You're shipping to a dirt lot, that doesn't make any sense. We will make those investments. And these are sort of nominal investments. I mean, it's mostly test equipment. I don't even -- I don't know that you'll actually be able to see much of a difference in terms of our costs.

Okay, that's good to know. Okay, just a couple on Rofin. You mentioned fiber lasers seem to be picking up traction. I know, before you guys acquired Rofin, I think their fiber laser business was doing better, had some good momentum. You did mention, I think, that there was some synergies on the tooling side. Have you seen -- do you think the positive or the gaining of traction, is that particularly just Rofin continuing to do better what they were doing? Or is it a combination of you guys and Rofin that's really driving that or both?

Well, the team that came over, as part of the acquisition, has done a terrific job in developing the technology. As I alluded to in my comments, we had a small hiccup that we had to deal with, a reliability issue, which they worked very diligently to resolve. That's gone very well. And I'd say the big difference is that we have a lot more feet on the street now because we have a combined sales force. So there are many more sales people that are speaking to customers and being able to offer this technology, which is pretty helpful. Some of the structural changes that we made in terms of what matters, we're going out, and we're trying to capture business and market conditions, and it's -- the burden is upon us to make the economics work.

Got it. And then just last question, you mentioned the annual costs, about $10 million on the -- for the, I guess, on the outsourced part of the diode. As you insource that, is it fair to say that you will get most of that $10 million savings or close to that number?

Well, again, our semiconductor operation is no different than any other. Once you get to breakeven, the incremental cost to build devices is material and a little bit of labor. So it tends to be very high throughput. I can't tell you exactly what that number is, but I think if you do a little research and look at other semiconductor operations, it's going to give you a range, and undoubtedly, we will fall in that range.

Your next question comes from the line of Mark Miller.

You seem to be hitting just about on all 8 cylinders. Just curious though, as we go towards the end of the year, what else could really develop more strongly for you besides the areas that are contributing now? Aside from the tablets, the OLEDs and tablets, could it be significantly higher fiber revenues? Could it be alternative laser processing for displays via drilling? I'm just wondering what could be the biggest upside from where we are at now by the end of this year or early 2018.

So clearly, the largest market out there that we're a minor participant in today is the fiber laser market. We're making good strides there, very pleased with the progress. We do have to do more in terms of demonstrating to customers that we are a solution that they want to consider as part of their manufacturing operation. And if we can do that, again, it's market share capture, you're not developing applications, you're not developing markets, you're going out and trying to grab market share. That's probably the single biggest pot that we can grow into. With respect to the consumer electronics market, you may recall from last quarter's conference call, and I alluded to it, again today, that we're seeing a lot of pull-along opportunities in the manufacturing process, and this is more around packaging of the actual smartphone rather than doing the work on any individual component. So some of the orders that I refer to, almost $20 million for film cutting is one example. There are lots of those that are happening, and it's not only around the display, it's actually around the case and security features, other content like cameras, 3D sensors and not making the sensors, but helping package and mount them, et cetera. Lots of that is going on. And then I continue to be very encouraged by what I'm seeing on the subsystem and tool solution part of the business. We are unlocking some opportunities there that I think are pretty interesting. We still have a lot of work to do, but they look encouraging. And combining the tool expertise that the new team brought over, along with their applications knowledge, and now they have a much broader and deeper portfolio of light sources available to them. It opens up some doors that may not have been easily opened before.

Just 2 follow-on questions. Your strategy in fiber, [is basically] better serviceability, or do you have a new angle there? And also, VCSELs, which other people are getting excited about. Just wondering if that could be a twinkle in your eye?

So from the standpoint of fiber lasers, yes, the serviceability continues to be part of the calling card. There's another technology that came over as part of the acquisition called ARM technology, which was developed in the facility in Tampere, and it's Adjustable Radio (sic) [Ring] Mode, I think, is the acronym. And I apologize if I'm going [geek] on everybody, but the concept is actually pretty simple. You pump the clotting, you pump the core of the fiber so you can have a beam that has a variable mode quality, and that allows you to do things that are difficult to do with a fixed mode beam. And in particular, one example, the processing of zinc-coated steel, we've demonstrated some results that people haven't believed. If this turns out to have traction, it's a pretty attractive market. So that's one example of things that we're looking at. And I apologize, the second part of the question, VCSELs. Yes, there's a lot happening with VCSELs. We haven't made any significant investments there. We have enough irons in the fire, I guess, is the way to put it.

Your next question comes from the line of Joan Tong.

You guys might have talked about it, I was just jumping in and out of the call, but I apologize if you did. Can you just like -- I heard there's some noise and news regarding microLED. And I just want to see what's your view on that in terms of like that being an impact of your business going forward.

MicroLEDs in display?

Yes.

We've heard about the technology as well. It's been discussed for quite some time. I have no idea how far along it is. If this is something that is a 1-year, a 5-year, or a 10-year time horizon.

Okay, got it. Because I just heard that there is some news on Apple talking about using that in Apple Watch. But again, speculations, and -- but thanks for the comment. And then regarding your -- obviously, ELA business is very strong, and on the flip side, you have other businesses also going very well. You mentioned that Semicap is being very strong as well as on the OEM component and instrumentations, event packaging as well. So I just wanted to get a sense of how sustainable those strength is and what are some of the comments that you heard from your clients for the rest of the year. And particular, for OEM components and instrumentation, any budgetary concern going forward?

Yes, Joan. It's Kevin. Since you were in and out of the call, let me suggest that you listen to it once it gets posted. John talked to a lot on his trends discussion in each one of the markets that we serve: microelectronics, materials processing and so forth, and really addressed your question in that sense. We do see strength, strength in order, strength in sales across all of the markets we serve. And so from a budgetary standpoint, we don't have any concerns there, but we see continued strength.

And at this time, we have no further questions in the queue. I will turn the call back over to John Ambroseo for any additional or closing remarks.

Thank you, Emily. Again, everyone, thanks for joining us, and we look forward to meeting with you again in a few months.

Thank you.

And this concludes today's conference call. You may now disconnect.