U.S. Markets closed

Edited Transcript of COHR earnings conference call or presentation 30-Apr-19 8:30pm GMT

Q2 2019 Coherent Inc Earnings Call

SANTA CLARA May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Coherent Inc earnings conference call or presentation Tuesday, April 30, 2019 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Bret M. DiMarco

Coherent, Inc. - Executive VP, General Counsel & Corporate Secretary

* John R. Ambroseo

Coherent, Inc. - President, CEO & Director

* Kevin S. Palatnik

Coherent, Inc. - Executive VP & CFO

================================================================================

Conference Call Participants

================================================================================

* Andrew Lodovico DeGasperi

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Blayne Peter Curtis

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Lawrence Scott Solow

CJS Securities, Inc. - MD

* Mark S. Miller

The Benchmark Company, LLC, Research Division - Research Analyst

* Mehdi Hosseini

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Nikolay Todorov

Longbow Research LLC - Analyst

* Tingjia Yuan

Goldman Sachs Group Inc., Research Division - Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Coherent's Second Quarter Fiscal Year 2019 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. Sir, you may begin your conference.

--------------------------------------------------------------------------------

Bret M. DiMarco, Coherent, Inc. - Executive VP, General Counsel & Corporate Secretary [2]

--------------------------------------------------------------------------------

Thank you, Joanna, and good afternoon, everyone. Welcome to today's conference call to discuss Coherent's results from the second fiscal quarter. On the call with me are 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, if any, of such trends. These forward-looking statements may contain such words as project, outlook, future, expects, will, anticipate, believes, intends or referred to as guidance. 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. These forward-looking statements are only predictions and are subject to substantial risks, uncertainties and assumptions that are difficult to predict and may cause actual results, performance or achievement to materially differ from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, risks associated with global demand; acceptance and adoption of our products; the worldwide demand for flat panel displays and adoption of OLED for mobile displays; the pricing and availability of OLED displays; the demand for and use of our products in commercial application; our ability to generate sufficient cash to fund capital spending, operations or debt repayment; our successful implementation of our customer design wins; our and our customers' exposure to risks associated with worldwide economic condition, in particular in China and the Eurozone; our customers' ability to cancel long-term purchase orders; the ability of our customers to accurately forecast their own end markets; our ability to accurately forecast future periods; continued timely availability of products and materials from our suppliers; our ability to timely ship our products and our customers' ability to accept such shipment; our ability to have our customers qualify our products; worldwide government economic policies including trade relations between the U.S. and China and Chinese monetary policy; our ability to integrate the business of Rofin and other acquisitions successfully, manage and integrate our expanded operations and achieve anticipated synergies; as well as other risks identified in the company's SEC filings. For a detailed description of risks and uncertainties, which could impact these forward-looking statements, you should review Coherent's periodic SEC filings, including its most recent Form 10-K, Form 10-Q and Forms 8-K, including the risks identified in today's financial press release.

I will now turn the call over to John Ambroseo, our President and Chief Executive Officer.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Bret. Good afternoon, everyone. Our 4 verticals are very much in line with global trends. The microelectronics business is experiencing a lull in new capacity additions and utilization rates are currently stable. Materials processing demand has shown its dependence on PMI data as well as effects from trade issues. The components market remains robust, especially within aerospace and defense. And in research market, the U.S. and China are facing off for a citation and investment leadership.

The OLED market performance is in line with our previously announced expectations of a down year for capital spending. Scheduled deliveries are continuing and will likely trough in the current fiscal quarter. Service demand is very consistent with fab utilization data, which we believe is influenced by iPhone sales. We would expect service revenue to grow if Apple goes all OLED for this year's product rollout.

Overall customer engagement remains very high and RFQ activity is increasing. Based on historical trends, the conversion of RFQs to orders is typically in a 6 to 9 months range. If that type of trend holds along with increased RFQ activity, this would be consistent with the projected capital spending recovery starting in calendar 2020.

There have been numerous reports about yield improvements for display makers not named Samsung. It's difficult to opine on these reports because each manufacturer has its own criteria. The source of the improvements is usually attributed to improved lamination and fine metal mask alignment. Initial shipments of foldable displays began recently, and it has been a bumpy start based on product reliability. This isn't the first time a new display technology has strolled (sic) [struggled] out of the gate, and we assume that future -- that failure analysis will lead to a solution. These early issues aside, nearly every display manufacturer has announced a plan around foldable displays with product releases in the 2- to 3-year time frame.

We believe our Semicap business has been outperforming a broader wafer fab equipment market for several reasons: Fab utilization remains high, which supports service revenue. Our lead OEMs have gained market share against their competitors and have also continued to invest in next-generation designs. This often drive new system sales. The larger node market is doing well due to demand from IoT and automotive devices. Analysts predict that there's a need for an additional -- for 2,000 additional tools to serve these applications. Refurbishing older tools can provide partial relief. The established players may not want to build legacy tools, so new vendors are considering the space. We are positioned to address the demand either through legacy devices where copy exact is required or a next generation of energy-efficient solid-state alternatives.

The API market has slowed from last year's run rate, which is reflective of an overall industry trend. Initial orders for specific 5G processes are coming in, but vendors are taking a wait-and-see approach until the long-term requirements are better understood.

Materials processing orders improved in the low double-digit range from the previous quarter. We believe part of this can be attributed to seasonality and part to pent-up demand. If we look at it on a regional basis, the U.S. continues to perform well with a PMI number above 50. The Eurozone is struggling and Germany's most recent PMI number is at its lowest level since July 2012. There are conflicting signals in the Chinese market. Trade issues with the U.S. and weak domestic demand persists, but the atmosphere, at least in Shanghai, was upbeat, leading some to project a second half rebound in orders. We are taking a more measured view and believe the recovery will be slow and steady.

OEM components and instrumentations continues to be a bright spot. Bookings increased sequentially and compared to the prior year period. Revenue is currently on track for strong double-digit growth, which would culminate in a record year. The biggest approach -- the biggest contributor to growth is our aerospace and defense business, which we believe will approximately double compared to fiscal '18.

Our leadership positions in bioinstrumentation and medical OEM remain unchallenged. Our customers are seeing growth in emerging markets and new applications. These are encouraging trends, which will benefit from new products that can create greater value for our customers.

I trust that everyone has seen the announcement that I plan to retire no later than April 2021. There's no mystery behind the decision. I'm approaching my 31st anniversary with Coherent and am in my 17th year as CEO. It's time for me to start planning for what's next. The 2-year runway is intended to allow ample time for a search and handoff to my successor. Until then, it's business as usual.

I'll now turn the call over to Kevin Palatnik, our Chief Financial Officer.

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, John. Today, I'll first summarize fiscal second quarter 2019 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 a 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 and restructuring costs, the related tax adjustments and tax adjustments for stock-based compensation.

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 2019 financial results for the company's key operating metrics were total revenue of $372.9 million, non-GAAP gross margin of 38.7%, non-GAAP operating margin of 14.2%, adjusted EBITDA of 18.2% and non-GAAP EPS of $1.61. Total revenue for the fiscal second quarter was $372.9 million and came in slightly above the midpoint of our previously guided range. Our revenue mix by market for Q2 was microelectronics, approximately 45%; materials processing, 28%; OEM components and instrumentation, 18%; and scientific and government, 9%. Geographically, Asia accounted for approximately 51% of revenues in the fiscal second quarter; the U.S., 23%; Europe, 22%; and rest of the world, 4%. Asia includes 3 territories with revenues greater than 10% of total sales. Europe includes 1 territory with revenues greater than 10% of total sales. We have 2 customers, one in South Korea and one in Japan related to large flat panel display manufacturing that each contributed more than 10% of our fiscal second quarter revenues. Other product and service revenue for the fiscal second quarter were $116 million or approximately 31% of total sales. Other product revenue consists of spare parts, related accessories and other consumable products and was approximately 28% of sales. Revenue from services and service agreements was approximately 3% of total sales. Total service revenues were sequentially down by approximately $2 million as our key integrators continue to focus on conserving cash by keeping their service stock to lower threshold amounts.

Fiscal second quarter non-GAAP gross profit, excluding stock-based compensation costs, intangibles, amortization and restructuring, was $144 million. Non-GAAP gross profit was impacted sequentially primarily by volumes and product mix and, to a lesser extent, by the Q1 benefit of the ELA equipment cancellation fee, resulting in non-GAAP gross margin of 38.7% for Q2. Non-GAAP operating expenses increased sequentially by approximately $5 million primarily due to deferred compensation liability increases as well as the decreased number of holidays and vacations taken in the March quarter when compared to our December quarter. This resulted in a non-GAAP operating margin of 14.2% for the fiscal second quarter and also came in slightly above the midpoint of our previously guided range. Adjusted EBITDA was 18.2% in fiscal Q2.

Finally, with regard to our non-GAAP tax rate, we realized the significant decrease in the rate from our previously guided range. For the most part, foreign income is taxed at a higher rate than domestic income. As a result of our geographic mix of income, we realized a more favorable tax rate.

Turning to the balance sheet. Nonrestricted cash, cash equivalents and short-term investments were approximately $349 million at the end of fiscal Q2, an increase of approximately $29 million compared to the end of last quarter. During the quarter, we repurchased shares totaling approximately $26 million. We did not make any voluntary payments against our term loan. The outstanding amount of the term loan in USD is approximately $414 million. Accounts receivable DSO is 76 days compared to 78 days in the prior quarter. The net inventory balance at the end of fiscal second quarter was approximately $484 million, a decrease of $9 million from the prior quarter and capital spending for the quarter was approximately $18 million or 5% of sales.

Now I'll turn to our outlook for our third fiscal quarter 2019. Revenue for fiscal Q3 is expected to be in the range of $335 million to $355 million. We expect fiscal Q3 non-GAAP gross margin to be in the range of 37% to 40%. Non-GAAP gross margin excludes intangibles amortization of approximately $12.3 million and stock compensation cost estimated at $1.3 million. Non-GAAP operating margin for fiscal Q3 is expected to be in the range of 11% to 14%. This excludes intangibles amortization estimated at a total of $14.4 million and stock compensation expense of a total of approximately $9.3 million. Other income and expense is estimated to be an expense in the range of $3 million to $5 million. We do not include transaction gains and losses related to future changes in foreign exchange rates in our OI&E outlook. We expect our fiscal Q3 non-GAAP tax rate to be in the range of 19% to 20%. And finally, we're assuming weighted average outstanding shares of approximately 24.2 million for the fiscal third quarter.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) We have a question coming from the line of Blayne Curtis from Barclays.

--------------------------------------------------------------------------------

Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [2]

--------------------------------------------------------------------------------

I was curious, you saw, you said, a pickup in orders in materials processing. I was just kind of curious in your outlook for June if you can give us some color as to what you expect from -- between your segments. And particularly, in materials processing, if you can just talk about the pricing environment there as well.

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [3]

--------------------------------------------------------------------------------

With regards to materials processing, as John said in his prepared remarks, we did see some double-digit growth in orders, but we're taking a very measured approach going forward when it comes to materials processing. We still see challenges in China even though there was a little bit of ray of sunshine, if you will, there. But again, we're being very measured. So I'm not going to call out materials processing per se as either in absolute terms or a percent of revenues, but we're taking a very measured approach, slow and gradual recovery.

--------------------------------------------------------------------------------

Blayne Peter Curtis, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [4]

--------------------------------------------------------------------------------

And then maybe you can just comment on the microelectronics side, particularly flat panels. I think as you look -- you mentioned China working through yields. Just kind of curious as to the dip here, have you seen any change in plans over the last quarter or so in terms of deployment of these factories?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

So if we look at the -- at what's happening in the microelectronics market but specifically in the displays space, a lot of news coming out of China regarding improvements in yields. As I mentioned in my prepared remarks, it's a little bit tough for us to tell exactly what that means because everybody defines yield in a different way, and it's very dependent on what kind of product they're trying to make, especially when it comes down to things like PPI. That will dictate what customers would be receptive to taking those products. But generally, there's optimism, especially in most of the Chinese manufacturers that they're making headway in cracking the code and a lot of the headways, again, as I mentioned already, in lamination and fine metal mask alignment. Those have been 2 processes that they have had particular challenges with.

We would expect a lot of this capacity to actually serve Chinese handset manufacturers, whether it's better alignment in terms of supply chain costs or pricing, et cetera. We think there's still a fairly long way to go before one or more of these players can challenge for the position with Apple as a supplier, simply because the Apple spec on that display is the most demand there -- among the most demanding in the world.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

Our next question comes from the line of Jim Ricchiuti from Needham & Company.

--------------------------------------------------------------------------------

James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [7]

--------------------------------------------------------------------------------

John, when you talk about the activity or the conversations picking up with respect to new investments that potentially could come online in 2020, very recent conversations, what does that mean? Does that mean since you guys reported your fiscal first quarter? How recent and how serious do you think these conversations are at this point?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [8]

--------------------------------------------------------------------------------

So Jim, I don't think much has changed in displays based in the long term. Because if you go back to commentary that we offered, in fact, years ago, we said follow the fabs. Because as fabs get built, they'll need to buy equipment to run those fabs. So part of this is just reflective of the fact that there are a number of new fabs that are going to come online. Starting, I guess, later this year, they'll probably be completed and then they'll start looking at fab in, what kind of mix of equipment, what size of panels they're going to be manufacturing, all of those decisions.

So the conversations that we've been having with customers is -- are all around those issues, are they going to do a Gen 5.5 fab, are they going to do Gen 6, are they going to do something different, what are the requirements. It is very typical conversation.

From the standpoint of what does recent mean, recent means within the last few weeks. We're in constant dialogue with these customers, and we're always going back and forth on a variety of topics, whether it's capacity, whether it's service requirements, timing, et cetera, because the fabs have to coordinate a tremendous amount of fab in equipment. We're one part of a very large supply chain that has to be coordinated. So again, the conversations are consistent with where they are in their own cycle.

--------------------------------------------------------------------------------

James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [9]

--------------------------------------------------------------------------------

Okay. And you alluded to the fact that on the Semicap portion of the business, you appear to be -- and I think you have been outperforming. Is that -- do you anticipate that remaining the case? It sounds like you have some more unique drivers to that business. Is it your expectation that you can continue to outperform in this area?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [10]

--------------------------------------------------------------------------------

Well, if you look at the different components, right, service demand has remained very high as we've been reporting, it seems like for years, with utilization rates running in the 90s. I think even when they've dipped, they haven't gone much below the high 80s, although I'm making that statement from memory rather than having the data explicitly in front of me. Are there any signals that we see today that would suggest that utilization rates are going to dip precipitously? Today, not. Could it happen? Sure, but we don't see that today. So you say, okay, the service part of the business looks like it's in good shape.

On the capacity side, the 2 things is leading-edge capacity. And there, some of our lead OEM customers have taken share, which is good for us because it means we get a bigger piece of the pie on the leading-edge equipment. And on the legacy stuff, we're one of the few vendors that can actually support that activity. So if there really is a need for 2,000 additional tools to address automotive and IoT, we should have a front-row seat for that. Can I tell you what the explicit timing is? No. Can I tell you that we've got the right toolkit? Yes.

--------------------------------------------------------------------------------

James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [11]

--------------------------------------------------------------------------------

Okay. Fair enough. One last question for me, I'm just kind of curious. What's driving the growth that you're seeing in the aerospace and defense portion of the business? And I don't know if there's a way for you to give us some sense as to the size of that business.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [12]

--------------------------------------------------------------------------------

So we can't comment on the size, but I can tell you that there are a couple of things that are driving it. Number one, we're one of the very few domestically based manufacturers that can provide equipment -- specific equipment into defense applications. And as a consequence, that puts us in a better position to win that business. And we've been weighing our fair share of those opportunities. And after years of making investments, those volumes are starting to pick up as the equipment is being -- or at least systems are being deployed out into the field.

The other thing that we've seen a very nice uptick in is our optics business. You may recall a few years ago, we bought the assets of Tinsley Optics from L-3. And I think this was 3 or 4 years ago. I don't remember the exact timing. And we bought that not only to support our high-end ELA systems, but also because we felt there was an opportunity in large-scale optics. There's a lot going on in ground-based and space-based telescopes, both for civilian and military applications. The same is true there. We're just winning more of that business because of our capabilities and our footprint.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question comes from the line of Patrick Ho from Stifel.

--------------------------------------------------------------------------------

J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [14]

--------------------------------------------------------------------------------

John, maybe as a follow-up to Jim's question on the aerospace and defense uptick that you've seen. Traditionally, aerospace and defense is very project related. It takes years to kind of gestate. Can you give your thoughts on the sustainability of these trends over the next couple of quarters and maybe even into 2020, whether there are more projects that are going to hit the volume basis for you guys?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [15]

--------------------------------------------------------------------------------

So Patrick, I'd say 2 things. First, your comment about the gestation period is correct. These things typically take a long time to work themselves through. There is a desire to have more flexible and energy-efficient platforms being deployed into certain applications. The programs that we're currently working on are for land, sea and air systems. There's an increasing level of activity on future programs as well.

So if you look at the funnel, we have things passing from the top of the funnel to the bottom of the funnel, and that's where you get your volume. But at the same time, we're seeing more projects entering the funnel that we're engaged on. Some of them will lead to funded programs; others will not. I think that's the typical pathway here, but there's definitely an increase of activity in the aerospace and defense space.

--------------------------------------------------------------------------------

J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [16]

--------------------------------------------------------------------------------

Great. That's helpful. And maybe as my follow-up question for Kevin. Gross margins obviously have a lot of moving parts, whether it's absorption, product mix and even customer mix. Given where microelectronics is today, is absorption still the biggest issue that you'll see with gross margins over the next couple of quarters as we model it out?

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [17]

--------------------------------------------------------------------------------

Yes. Patrick, thanks. As you know, volumes both give and take. And on the downside, from an absorption standpoint, you pay for that multiple times over. No matter what you do on the manufacturing side, you're chasing the expense down with volumes deteriorating. It just increases costs on the material side. As volumes come down, your suppliers pass those additional costs on to you as well. So yes, as we look forward, absorption, because of volume degradation, will be impacting us.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

Our next question comes from the line of Brian Lee of Goldman Sachs.

--------------------------------------------------------------------------------

Tingjia Yuan, Goldman Sachs Group Inc., Research Division - Research Analyst [19]

--------------------------------------------------------------------------------

This is Rebecca Yuan on for Brian Lee. So first, it would seem like the displays might be seeing more stable trends. Would you say that this is a fair characterization here? And do you have any updated thoughts as to your original down 15% to 20% guidance for OLED revenue this year?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [20]

--------------------------------------------------------------------------------

So as far as stable trends, I'll refer back to the comment I made during my prepared remarks that we're likely seeing a trough in that business. I don't know that I would say -- I don't know if I would define a trough as stable, but it's a point in time. Certainly, what we're seeing from fab construction, which is a positive signal, the -- but what has to happen is that fab construction has to lead to orders, which then, of course, creates your revenue opportunity.

As far as updating any guidance -- long-term guidance, we're not going to do that. We made the statement last quarter that we were going to focus on quarterly guidance for the foreseeable future, and we're going to stick with that.

--------------------------------------------------------------------------------

Tingjia Yuan, Goldman Sachs Group Inc., Research Division - Research Analyst [21]

--------------------------------------------------------------------------------

Okay. And then just as a follow-up. On the comments you made regarding displays in 2020, can you give us some sense of the geographic mix? Is it all China or mostly China? And then would you anticipate that the 2 orders there will be geared more towards the Linebeam 1000 like they have been in the past? Or are you seeing a trend towards 1500s there by 2020?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [22]

--------------------------------------------------------------------------------

So from the perspective of where most of the fab -- the new fabs will be, I think just counting belly buttons, if you will, it's probably China will lead in the number of new fabs.

As far as the configuration, that's part of the discussion that's still ongoing. I think the decision that the fabs have to make is do they have enough confidence in all of their processes to make the investment in what is largely viewed as the most efficient format, which is a Gen 6 panel size. But in order to make that decision, they have to really be confident that they have all of these issues worked out. If not then, in all likelihood, they would look at a Gen 5 or a Gen 5.5. Early days for that conversation but a very appropriate question.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

Our next question comes from the line of Mehdi Hosseini of SIG.

--------------------------------------------------------------------------------

Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [24]

--------------------------------------------------------------------------------

John, I want to go back to the topic of fab construction. What gives you confidence that these customers don't change the type of OLED fab. We have seen it in Korea where a fab that a couple of years ago was dedicated to RGB OLED for foldable is now going to be have -- used for TV. And in China, do we really know what the end-market application is? And I'm asking this question because I think there's a little bit of misunderstanding of your opportunity as it relates to TV versus handset. And I have a follow-up.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [25]

--------------------------------------------------------------------------------

Sure. So if you look at where the Chinese manufacturers have focused most of their effort today, it's been in the mobile market. And whether that is for handsets or larger formats, it's predominantly in the mobile space.

If you think about the TV market, you're correct there's different -- there are different configurations. There's the metal oxide approach that was -- that's led by LG. Others are looking at that, but they're also looking at some sort of an annealed backplane as one of the possibilities for the TV market.

So you're correct that we don't know explicitly what these fabs will be utilized for. But if you look at where they have the best near-term revenue opportunities, it still appears to be in the mobile space rather than in the TV space. Could that change? Sure. Based on what we're seeing today, it appears more likely than not that it's going to be for mobile applications.

--------------------------------------------------------------------------------

Mehdi Hosseini, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [26]

--------------------------------------------------------------------------------

Sure. Great. And then the follow-up has to do with Rofin, and I apologize in advance if the question has already been asked. I joined the call late. Is there update on the manufacturing facility in Germany? And where are we in having an in-source system solution?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [27]

--------------------------------------------------------------------------------

We are shipping vertically integrated product at this time. However, I think as both Kevin and I have mentioned in previous calls, given the overall slowdown in the market, the overhang on third-party components is going to take longer to unwind than we have projected a year ago. So we still have that third-party inventory to burn off before we will see the full benefit of being vertically integrated.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

Our next question comes from the line of Larry Solow of CJS Securities.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [29]

--------------------------------------------------------------------------------

Just quickly, John, maybe too early to congratulate you, but hopefully, we'll be speaking many more times in the call, but I will throw out that congratulations. Just on the -- speaking to the guidance number that you have given for Q3, what's sort of driving the sequential -- a little bit of a downturn and actually -- the midpoint of the guidance is sort of about down close to 30% year-over-year. Is that just the -- I know you mentioned the equipment -- FPD equipment troughing next quarter, so a little bit of a decline there. What else is sort of -- other things that are driving that down?

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [30]

--------------------------------------------------------------------------------

Yes. Larry, it's Kevin. So as you heard from John's prepared remarks, we expect that OLED or, call it, microelectronics more broadly troughs in the current quarter, the June quarter. We're not quite there yet, so that's a driver of the lower guidance.

And then, again, when it comes to materials processing, between microelectronics and materials processing, round numbers, 80% of our business. With materials processing, as I said earlier, we're taking a very cautious approach where a lot of conflicting factors and data points out there to suggest that there's a turnaround. So we're very measured in that regard as well. Those are the 2 big end markets that are driving the current guidance.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [31]

--------------------------------------------------------------------------------

Okay. That's sort of in the same obviously drivers for the full year. I'm just a little bit surprised by sort of the sequential decline. But okay, fair enough. And then it does seem like you mentioned China and it sounds like at least anecdotally, hopefully, things -- there's improvement in the horizon. What are you seeing, I guess, through this quarter and whatever you can update beyond that in terms of just pricing on the fiber laser side and just overall customer attitude?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [32]

--------------------------------------------------------------------------------

So I'll go back to the LASER Shanghai. It was a very well-attended show, lots of good discussions with customers. Customers were upbeat. I would say that one of the things you always have to look at is the end of last year was so painful in China that any improvement might have an outsized reaction. So it's tough to gauge that.

On the pricing side, it varies by product class. Certainly, in fiber lasers, especially below 4 kilowatts, the pricing continues to be exceedingly aggressive in China where the Chinese manufacturers are working hard to gain more and more share. The international manufacturers are trying to defend their share. It is a challenging situation.

And an observation, not a commentary, but I'd say what's driving Western manufacturers is P&L and what's driving Chinese manufacturers is market share. There's no surprise there. It just leads to very different behavior.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [33]

--------------------------------------------------------------------------------

Right. And the stimulus, has that helped at all? I know maybe too short term to get a read on that, but...

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [34]

--------------------------------------------------------------------------------

Well, the stimulus, this time around if I remember correctly, is predominantly infrastructure. It's on the Belt and Road initiative. And there's been a lot of report on that, a lot of political commentary about the implications of that. Clearly, there'll be some benefit from a utilization perspective because products that are provided by our industry will be used to manufacture construction materials, et cetera. But I don't think it's going to -- that it will have the same type of impact as say the automotive or consumer electronics stimuli that China has employed in the past.

And as I mentioned, I think it was last quarter, debt levels for Chinese consumers are similar to what they are in the West. It's not surprising that the Chinese government is focused on infrastructure because I think it will be tough to get Chinese consumers to double down right now given where their own finances are.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [35]

--------------------------------------------------------------------------------

All right. Okay. And just switching gears quickly back to OLED and the foldable OLED opportunity. Is there a scenario where in 5, 7 years, I don't know exact -- that particular time line that a majority of handsets go to foldable, assuming they can get by this sort of initial issue and then obviously -- supply issues on the front panel are resolved. And then I assume that would drive a considerable amount of demand for your equipment.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [36]

--------------------------------------------------------------------------------

So it's an interesting situation because if you go back a year or 2 ago, it was really Samsung that's the only one that was talking about foldable technology. And it seemed like a very far out approach. Now you have I think a handful, maybe a little less than a handful of manufacturers who are marketing devices. The price points are exceptionally high, it's almost a we-don't-want-you-to-buy-it price. But what's also interesting is as you go around and talk to all these display manufacturers, they all have a plan of attack here. They're not looking to enter the market in the next year. They're looking at 2 or 3 years down the stream to perfect the technology before they put it out into the marketplace. There are certainly compelling aspects to having a larger screen that folds up into your pocket, whether it's for work use or personal use. I think most people can see that. But the price point has to come down fairly dramatically.

And the long-term goal, I think, for many of these manufacturers is to have a foldable display that is priced at what today's high-end display is, so in the $80 or $90 range, and the foldable displays today is probably twice that. It is not at a marketing-enabling price today, but that I don't think was ever the goal. This is a first year demonstration of technology, see what customers have to say about it, and then if successful, roll it out further.

And you're correct, all the equipment manufacturers in the supply chain, this is just the surface area argument. The more surface area you're producing, the more equipment that you need.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [37]

--------------------------------------------------------------------------------

Right. Okay. And then maybe just one last question just to clarify. So the handful of manufacturers slated to come online in 2020 or potentially, speaking of that, are these guys that have been working, I assume, on a smaller basis in R&D that are -- seem to have improved yields enough to expand capacity to build a new fab? Is that where the pool of providers you're speaking to or another area?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [38]

--------------------------------------------------------------------------------

I would say that there's a mix -- there are some who are new to the game or newer to the game. The majority of them are existing players who are seeking to expand capacity because they believe there's a greater revenue opportunity for them.

--------------------------------------------------------------------------------

Lawrence Scott Solow, CJS Securities, Inc. - MD [39]

--------------------------------------------------------------------------------

And I would assume -- and they've improved -- or working on improving yields or towards maybe not competitive to Samsung yet but better -- improving enough to have that opportunity. Is that fair to say?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [40]

--------------------------------------------------------------------------------

Yes. Again Larry, yield is -- we see the reports that everybody sees because if nothing else, these people are pretty prolific in terms of announcing new yield numbers. It's very hard for us to compare one set of yield numbers to another because we don't know what the underlying criteria might be for each of those manufacturers. But if you take it at face value, it looks like there's been a pretty substantial improvement in yields for a lot of these players over the last 12 months, and they're projecting more improvement over the next 12 months.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

Your next question comes from the line of Mark Miller from Benchmark.

--------------------------------------------------------------------------------

Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [42]

--------------------------------------------------------------------------------

John, congratulations on your retirement plans. I thought I'd beat you but maybe not.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [43]

--------------------------------------------------------------------------------

Thank you, Mark.

--------------------------------------------------------------------------------

Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [44]

--------------------------------------------------------------------------------

Just was wondering, could you give us a ballpark figure where utilizations are in the major OLED fabs and where do you think they might be at by the end of the year?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [45]

--------------------------------------------------------------------------------

So it's going to vary pretty dramatically. Even if you look within Samsung, their A2 fab is probably running near capacity, and that's the one that supplies most of their internal demand as well as some external customers. Their A3 fab has been reported as more or less dedicated to Apple. That's running at a much lower number. We're not in a position to tell you what that number is, and it's not our job to disclose it nor is it our right to disclose it.

As far as the other manufacturers, they're focusing more on the yield number right now, so I would suspect that a lot of these fabs are running hotter than their output would suggest simply because they have to overcome yield to manage output.

--------------------------------------------------------------------------------

Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [46]

--------------------------------------------------------------------------------

In terms of OLED screen prices, that's been high for quite a while, but they are coming down. And has that opened up, especially in the mobile device area -- has anybody recently announced a new mobile devices with -- due to the lower screen cost?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [47]

--------------------------------------------------------------------------------

Well, if you look at some of the Chinese handset manufacturers, there is an increasing number of devices available with OLED screens. They -- as far as we can tell -- and I need to think about how to best word this because I don't want to seem flippant about it. As far as we can tell, they are not at the level of an Apple device or a Samsung device in terms of screen quality, but they are certainly at an acceptable level for the consumer. So -- and those pricing -- the pricing there cannot be what it is for an Apple device because if you compare what Huawei or someone else is selling a handset for in China, it's nowhere near what the iPhone X sells for globally. And the screen is one of the biggest elements of the bill of materials, so it has to reflect a lower price. I don't know what that price is at the level of an LCD. It's certainly somewhere between LCD and a high-end OLED.

--------------------------------------------------------------------------------

Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [48]

--------------------------------------------------------------------------------

And finally, did I miss cash flow from operations?

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [49]

--------------------------------------------------------------------------------

Mark, it's Kevin. No. No. That's not something I really promote on the call, but you'll see it in future filings. It was $75 million for the quarter, cash from ops.

--------------------------------------------------------------------------------

Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [50]

--------------------------------------------------------------------------------

$75 million? Okay. It's pretty good.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

Our next question comes from the line of Nick Todorov of Longbow Research.

--------------------------------------------------------------------------------

Nikolay Todorov, Longbow Research LLC - Analyst [52]

--------------------------------------------------------------------------------

First to go on the Semicap utilization. You mentioned that you're seeing high utilization. I'm just wondering in terms of your expectations and kind of your exposure to maybe some of the memory fab utilizations because I mean at least on the headlines and what people are speaking publicly is that utilization or at least output should be coming down here, if not the current, lower in the next quarter or 2. How much of an effect will that have on your Semicap business? And if at all, I mean I guess it depends on how much your exposure is, so maybe you can refresh on your exposure in the semi capital.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [53]

--------------------------------------------------------------------------------

So first of all, comments that were made were backward-looking in terms of what utilization rates are. We don't comment on forward utilization rates. Our crystal ball isn't quite that good. There is, of course, an impact -- if utilization dips in a significant way, we will see an impact on our service business. We don't forecast that going forward, so we can't do that here. But there is a correlation. We've always been clear that there's correlation between utilization and what our service revenue does in the Semicap space.

--------------------------------------------------------------------------------

Nikolay Todorov, Longbow Research LLC - Analyst [54]

--------------------------------------------------------------------------------

Okay. Got it. And Kevin, on the OLED side, I'm assuming that you don't have concrete orders for those new fab that you talked about for 2020 yet. And just I'm curious when you have conversations with customers, what is the contingency that they're looking for to decide and pull the trigger and place those orders for mobile capacity versus a TV, for example, or for that matter, they decide, hey, smartphone units are better than you expected or we think OLED penetration would move to the mid-level of smartphones? What are the kind of contingency and what are they looking for in order to make the decision?

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [55]

--------------------------------------------------------------------------------

Nick, let me try and answer it this way. As John said earlier, those are complicated decisions. They are supplier decisions, which generation of OLED display decisions and so on and so forth. So in terms of lead times, one of your questions, we typically say 6 to 9 months type of lead times, so they need to figure out their fab, their fab in date for construction of the fab. The decisions around which technology, as you know, anything with an LTPS backplane that gets some yield uses our equipment. So if it turns out to be Gen 5, 5.5 or Gen 6, they will put orders on the books. And again, those orders typically 6 to 9 months earlier than when they need it.

But very complicated supply chain logistics that -- in terms of their decision-making, that's something internal. We have some of those discussions just so we could plan our own supply and logistics, but it's not something I can share here.

--------------------------------------------------------------------------------

Nikolay Todorov, Longbow Research LLC - Analyst [56]

--------------------------------------------------------------------------------

Okay. And then maybe lastly, if we can try to dissect this. So you called out this is likely going to be the trough in terms of OLED panel shipments in the June quarter. But is there any way you can address what the delta when we move into the September and the December quarter? Is it rather substantial? We're just trying to understand from a modeling perspective what kind of rebound should we expect to the extent that you can comment.

--------------------------------------------------------------------------------

Kevin S. Palatnik, Coherent, Inc. - Executive VP & CFO [57]

--------------------------------------------------------------------------------

Yes. Nick, I can't comment too much here. As both John and I have said last quarter and this quarter, we're only guiding one quarter out. We're being very measured about that. We do expect to see a trough when it comes to the display business, but that's as far as we're going to go. Going beyond that, we're just not willing to do that at this point.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

Our next question comes from the line of Andrew DeGasperi of Berenberg.

--------------------------------------------------------------------------------

Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [59]

--------------------------------------------------------------------------------

John, maybe can you comment on -- you mentioned Apple going to fill OLED if that's a potential possibility and service revenue may be picking up on that. Do you think that today, Samsung has the capacity to produce all their phones without buying new hardware from you?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [60]

--------------------------------------------------------------------------------

So Andrew, to the best of our knowledge based on what Samsung has said that they can produce somewhere between 400 million and 500 million handset displays, and the variation is really related to the screen size, right? It's a surface area argument, as we've said on previous occasions.

If you do the math around that, it would suggest that they could support their internal consumption as well as their lead customer, and they could do that with existing capacity. They have to run the fabs full out to get -- I assume when they talk about 400 million to 500 million, they're talking about running them full out. They're not talking about running them at a 60% or 70% utilization rate.

--------------------------------------------------------------------------------

Andrew Lodovico DeGasperi, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [61]

--------------------------------------------------------------------------------

Got it. And then secondly, maybe on the welding opportunity. I know China pulled back some subsidies in April. I was just wondering -- one of your peers mentioned that they didn't see anything in terms of a pullback. And then on the investments on the laser side, are you seeing anything on that front?

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [62]

--------------------------------------------------------------------------------

We have not -- if anything, we're getting more and more inquiries on the welding applications.

--------------------------------------------------------------------------------

Operator [63]

--------------------------------------------------------------------------------

At this time, we have no further questions in the queue. I will turn the call back over to John.

--------------------------------------------------------------------------------

John R. Ambroseo, Coherent, Inc. - President, CEO & Director [64]

--------------------------------------------------------------------------------

Thanks, Joanna. I want to thank everybody for participating. If any of you are planning to be at Lasers Munich, please reach out to Kevin, and we'll do our best to give you a tour of the booth. Thanks again.

--------------------------------------------------------------------------------

Operator [65]

--------------------------------------------------------------------------------

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