Coherent, Inc. (COHR) Q1 2019 Earnings Conference Call Transcript

Coherent, Inc. (COHR)
Q1 2019 Earnings Conference Call
Jan. 29, 2018, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants
  
  See all our earnings call transcripts.

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Coherent's First Quarter Fiscal Year 2019 Financial Results Conference Call hosted by Coherent, Inc. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question-and-answer session. If you would like to ask a question, you may press * and the number 1 on your touchtone pad at any time. If anyone should require assistance during the conference, please press *0 on your touchtone pad at any time. 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.

Bret DiMarco -- Executive Vice President and General Counsel

Thank you, Connor, and good afternoon, everyone. Welcome to today's conference call to discuss Coherent's results from its first quarter of fiscal year 2019. 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 benefit, if any, of such trends. These forward-looking statements may contain such words as project, outlook, future, expects, will, anticipates, beliefs, 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 that 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 product in commercial applications, ability to generate sufficient cash to fund capital spending, operations, or debt repayment, our successful implementation of our customer design wins, our ability to successfully rectify execution issues on a going-forward basis, our and our customers' exposure to risks associated with worldwide economic conditions, particularly china, 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 shipments, our ability to have our customers qualify our products, worldwide government economic policies including trade relations between the US on China and China monetary policies, our ability to integrate the business of Rofin and other acquisitions successfully, manage and integrate our expanded operations and achieve anticipated synergies, and 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 Ambroseo -- President and Chief Executive Officer

Thanks, Bret. Good afternoon, everyone. We are currently experiencing a diverse set of market conditions. The materials processing market in China is facing increasing pressure due to a number of factors, but business outside of China is a different story. The flat panel business is in line with industry expectations. The trends in semi, API, and instrumentation are generally positive. We are adjusting our customer engagement and investments accordingly.

Against a challenging backdrop, overall microelectronics bookings posted low double-digit growth on a sequential basis. Several factors contributed to this result. While general semicap spending is slowing, fab utilization remains high, which translated into very strong service renewals. This included leading edge builds for high performance logic and memory production, as well as legacy nodes for IoT and automotive devices.

Some of the lasers used in legacy nodes have reached either end of life or are very difficult to support due to a lack of parts. In anticipation of this, we've developed several solid-state alternatives that dramatically reduce utility costs due to a 1,000-volt increase in electrical efficiency. Demand for these replacement units has been understandably good. The API market experienced even higher sequential growth, signaling that oversupply in microvia is ebbing. Orders also rose for PCB cutting and redistribution layer structuring.

The final contribution came from the solar market. We booked a record order for ultra-fast lasers used in thin film scribing against an incumbent supplier. The end customer expects to further expand capacity over the next four quarters.

The FPD market can best be characterized by its constancy and continuous innovation. Samsung continues to dominate the mobile display market with roughly a dozen other firms trying to close the gap. We recently served Chase Group regarding their R&D commitments and projected timing for future investments. There appears to be little-to-no change in appetite or desire. Timing is subject to improvement in manufacturing levels and funding, whether from government or handset manufacturers.

With a fair amount of future investment coming from China, we've been inquiring whether the country's economic slowdown will effect government support of display manufacturers. The answers vary, but mostly, the funding will be available when they need it.

During last quarter's earnings call, I mentioned that we were negotiating the cancellation of an ELN order. We reached resolution with the customer during our fiscal Q1. While the overall ongoing business framework is confidential, we can disclose that a one-time $7 million upfront fee is included in our first fiscal quarter results. The balance of the business considerations will be recognized over time and will be incorporated into our quarterly guidance.

The Korean government has been closely watching investment and advancement in OLED technology by Chinese display companies. It is probably particularly frustrating that some of the technology have been aided by Korean expats employed by Chinese competitors. As a result, we understand that the Korean government is considering designating the Korean OLED equipment industry as a core technology of Korea. If this happens, it would restrict Chinese manufacturers' abilities to purchase Korean equipment or invest in Korean equipment companies. There are certain techniques like lamination where Korean vendors have a leadership position. Much of the other equipment in OLED fab can be sourced outside Korea, so an embargo might slow, but would not ultimately stop Chinese display manufacturers.

FPD service has been stable for the past few quarters, even though customers have reduced their service inventories. This would suggest utilization rates have been good. There are a large number of OLED equipped devices on display at CES this year ranging from tablets to rollable TVs. Mobile computing displays represent an interesting opportunity for the industry since they consume a total surface area similar to the handset market. Some of the companies exhibiting these devices include Samsung, HP, Dell, Asus, and Lenovo. Shipments should commence in the next few months. If consumer adoption is strong, OLED capacity will likely have to be added to support surface area growth.

OLED and 8K TVs were also in abundance at CES. The most impressive demo was rollable OLED TVs from LG, which won numerous awards. Availability of rollable units may come later this year with a price tag that could exceed $20,000.00. MicroLEDs also made an appearance, predominately in very large formats, up to 219 inches, based upon an eight-by-eight inch tile architecture. The image quality was impressive, as was the size. When commercially available, these displays would be ideal for cinemas and signage. A microLED was on display in the Samsung booth. It was a 75-inch unit and had 4K resolution. Apparently, you could own one for the price of an average single-family home.

As far as bookings trend in instrumentation, OEM components continued in Q1. Bioinstrumentation customers are seeing solid demand from key applications like cytometry and cite double-digit growth in emerging markets as one of the reasons. A light engine, the combination of lasers and wavelength switchable delivery systems, represent an increasing amount of our bioinstrumentation business. Customers can exploit the capabilities of and appreciate their reliability and ease of integration of our light engines. We need a major player to recognize us with their annual innovation award.

Medical OEM customers are also enjoying favorable conditions. Orders were up for dental and neurology products. Demand was stable for esthetic and opthalmic lasers. Stable demand in esthetic is particularly encouraging since it relies on discretionary consumer spending and can be seen a loose proxy for consumer confidence in the Americas and Europe.

Orders for aerospace and defense applications grew by 45% year-over-year. The largest contributions came from US-based directed energy projects and space-based telescope applications. The activity in both areas is on the rise and we are well positioned as a US-based manufacturer.

It was a predictably challenging quarter for the materials processing business as the combination of tariffs, rising Chinese consumer debt, and eroding Chinese consumer confidence in spending have taken a toll on the Chinese economy. The Chinese government has to strike a delicate balance between reigning in debt and providing stimulus, which has been previously effective in driving demand for big-ticket items like autos and appliances. In addition to these macro-factors, a floor in certain fiber lasers continues to further exacerbate the challenges for the laser industry in China.

There are some bright spots, however. Our focus on automotive applications is yielding results. We received significant orders for electro-mobility projects in Asia and Europe. The automotive market continues to perform well and we expect bookings to grow for battery, power train, and body and light projects over the remainder of FY19. We are also pleased by a bookings increase in medical device manufacturing, including a record 10% contribution from China. The Chinese medical device industry is expected to grow by as much as 25%, so this may provide a partial offset for the broader Chinese material processing market.

The question on everybody's mind is, what will 2019 look like? The risk associated with China has increased over the past quarter as we learn more about the evolving underlying situation, particularly in their domestic challenges. Based upon these and other factors, it would be understandable to have a narrow outlook.

On the opposite side of the ledger, there are a number of things that could happen, any one of which could send markets upwards. For example, we could have an end to the trade conflict leading to improved consumer confidence. The Chinese government could institute a stimulus package that encourages investment and/or consumption without piling on debt, and someone other than Samsung could make a breakthrough in OLED yields, which accelerates investment in new capacity. Some of these are more likely than others, all would have a market impact, and all contribute to the uncertainty regarding the outlook for 2019, which makes full-year forecasting very difficult, and as a result, we are not issuing full fiscal year guidance. We will focus on quarterly forecasting for the foreseeable future.

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

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

Thanks, John. Today, I'll first summarize fiscal first quarter 2019 financial results, then move to the outlook for fiscal Q2. 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 the reconciliation between GAAP and non-GAAP financial results.

The non-GAAP adjustments relate to stock-based compensation expense, amortization of intangible assets, restructuring costs, purchase accounting adjustments, 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 first quarter 2019 financial results for the companies key operating metrics were total revenue of $383.1 million, non-GAAP gross margin of 42.6%, non-GAAP operating margin of 20%, adjusted EBITDA of 23.1%, and non-GAAP EPS of $2.09. Total revenue for the fiscal first quarter was $383.1 million. As expected, microelectronics and materials processing sales decreased sequentially by approximately $66 million and $20 million respectively, primarily due to lower Excimer shipments into the FPD market, and decreased shipments of tools and diode components in the materials processing market.

Our revenue mix by market for fiscal Q1 was, microelectronics, approximately 47%, materials processing, 27%, OEM components and instrumentation, 17%, and scientific and government, 9%. Geographically, Asia accounted for approximately 55% of revenues in the fiscal first quarter, the US, 22%, Europe, 19%, and the rest of the world, 4%. Asia includes two territories with revenues greater than 10% of total sales. We had one customer in South Korea related to large flat panel display manufacturing that contributed more than 10% of our fiscal first quarter revenues.

Other product and service revenues for fiscal first quarter of 2019 were $118 million, 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 three percent of sales. Total service revenues were sequentially flat as our key integrators continue to focus on conserving cash by keeping their service stock to lower threshold amounts.

Fiscal first quarter non-GAAP gross profit excluding stock-based compensation costs, intangibles, amortization, restructuring, and purchase accounting was $163 million. Non-GAAP gross profit was impacted sequentially by volumes, product mix and warranty cost, partially offset by the one-time cancellation fee, resulting in non-GAAP gross margin of 42.6% for fiscal Q1.

Non-GAAP operating expenses decreased sequentially by approximately $10 million, primarily due to deferred compensation liability decreases, as well as the increased number of holidays and vacation taken in December, the end of our fiscal Q1. While we experienced a significant operating expense decrease sequentially, it was not enough to offset lower non-GAAP gross profit, resulting in a non-GAAP operating margin of 20% for the fiscal first quarter. Adjusted EBITDA was 23.1% in fiscal Q1.

Turning to the balance sheet, non-restricted cash, cash equivalents, and short-term investments were approximately $320 million at the end of fiscal Q1, an increase of approximately 9 million compared to the end of last quarter. During the quarter, we repurchased shares totaling approximately $25 million and borrowed $40 million against our line of credit. We did not make any voluntary payments against our term loan. The outstanding amount of the term loan in USD is approximately $422 million.

International cash was $219 million, or approximately 68% of the total cash and short-term investment balance. Approximately 37% of total cash in short-term investments is denominated in dollars. Accounts receivable DSO was 78 days compared to 69 days in the prior quarter. The increase is related to large collections that occurred in early January 2019, rather than in December of 2018. The net inventory balance at the end of the fiscal first quarter was approximately $493 million, an increase of $6 million from the prior quarter, and capital spending for the quarter was approximately $23 million or 6% of sales.

Now, I'll turn to our outlook for our second fiscal quarter of 2019. Revenue for fiscal Q2 is expected to be in the range of $360 million to $380 million. We expect fiscal Q2 non-GAAP gross margin to be in the range of 37.5% to 40.5%. Non-GAAP gross margin excludes intangibles amortization of approximately $12.5 million and stock compensation costs estimated at $1.3 million.

Non-GAAP operating margin for fiscal Q2 is expected to be in the range of 12.5% to 15.5%. This excludes intangibles amortization estimated at a total of $15.1 million and stock compensation expense of a total of approximately $8.7 million.

Other income and expense is estimated to be an expense in the range of $5 to $6 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 Q2 non-GAAP tax rate to be in the range of 25% to 26%, and finally, we are assuming weighted average outstanding shares of approximately $24.5 million for the fiscal first quarter.

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

Questions and Answers:

Operator

At this time, I would like to remind everyone, in order to ask a question, press * then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jim Ricchiuti from Needham & Company. Your line is now open.

Jim Ricchiuti -- Needham & Company -- analyst

Hi, good afternoon. Just a question with respect to the decision to move to quarterly guidance only. Can you talk about which verticals you've seen the biggest change in terms of your outlook that you had been providing relative to the current guidance? It sounds like you had a reasonably good bookings quarter in certain verticals. I'm just trying to get a sense of where you're seeing the weakness.

John Ambroseo -- President and Chief Executive Officer

Jim, it's John. I would answer a little bit differently. I would say that there's enough macroeconomic uncertainty that any one of a number of things could happen that could send things sideways. Just in the last few weeks, as an example, the president talked about tariffs of foreign manufactured automobiles. If that happens, and I have no way of predicting whether it will happen, but if it were to happen, the wrench that that throws into the works is pretty significant, and just given some of these very big topics or issues that are being bandied about, trying to understand how all of them or any of them might impact the forecast is challenging.

If you look at our markets, now, to drill down to your question a little bit, if you look at the markets, certainly the one that faces the greatest unknowns right now is materials processing, and that centers a lot on China, obviously, given its importance to that market. The other markets, less so, but it really is macroeconomic factors that has us concerned, rather than specific factors within any of the markets.

Jim Ricchiuti -- Needham & Company -- analyst

That's helpful. If I heard you correctly, I think you said that microelectronics bookings grew double-digits. Did I hear that correctly?

John Ambroseo -- President and Chief Executive Officer

On a sequential basis, yes.

Jim Ricchiuti -- Needham & Company -- analyst

On a sequential basis. You sound like you had some reasonably good booking strength in other verticals. Can you talk a little bit about the sustainability of microelectronics bookings, putting aside the display portion of the business for a moment? Just in light of -- we're hearing mixed things there.

John Ambroseo -- President and Chief Executive Officer

I'm going to repeat myself a little bit here. If you look at our semicap business as an example, we probably did better on a demand basis, and possibly on a revenue basis, than some of the other players in that market. Now, part of that is tied to the fact that utilizations remain high, as I mentioned, and a good portion of our revenue within that space is related to service, so that ties there quite well, and the demand in legacy nodes continues to be strong. People are trying to recommission old products or old equipment and that's led to a refresh cycle, which, fortunately, we had anticipated and positioned ourselves to take advantage of.

I would be remiss if I tried to convince you that the semicap market overall is buoyant. I think we've just done better than many of the other companies in the space just because of alignment that we have right now. Do we expect it to continue that way? I think there are parts of the business that will continue to be strong. Whether there will be sustained demand for leading nodes is a greater question. A lot of the investment right now seems to be service related and getting legacy lines up.

With respect to the advanced packaging market, which more or less mirrors the semicap market, it was a bit of indulgence over the last year. There was some overcapacity that took place. It appears that that's finally winding its way down, and certainly, announcements from US carriers about initial 5G deployment is good, but as I mentioned in previous calls, the first phase of 5G will have a little bit of a benefit because it's more of the same. It's the second phase of 5G that really drives a more substantial upgrade, and as far as we can tell, that's still a couple years away.

Jim Ricchiuti -- Needham & Company -- analyst

Okay, thank you. A quick question, Kevin, can you say how much of a headwind that legacy, Rofin, ERP issue that you had in Europe was in the quarter?

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

In the current quarter zero, we addressed that issue last quarter. From a process standpoint, from a management perspective, that has been rectified.

Jim Ricchiuti -- Needham & Company -- analyst

Okay, terrific. Thank you. I'll jump back in the queue.

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Patrick Ho with Stifel. Your line is open.

Patrick Ho -- Stifel -- analyst

Thank you very much. John, maybe first off in terms of the display business and your longer term outlook of the OLED industry, given some of the concerns and the signs from the high end smartphone market and a potential extending of the replacement cycle for these high end smartphones, has your long-term outlook over the next three to five years changed in the OLED display market, how it may potentially impact the long-term gross prospects of that business?

John Ambroseo -- President and Chief Executive Officer

If you look at it over the longer term, no, I don't think our thinking has changed very much there. If you go back to comments that we made over several years, we said the best possible outcome is one customer leads the way for an extended period of time, others then break the code and have to invest to start to take market share.

It looks like we're much smarter than we probably are because that's the way things are playing out right now, but the longer term really is predicated on breaking into new format sizes and that's why we will really encourage what we saw at CES where so many front line manufacturers were displaying OLED equipped either tablets or laptops and were actually talking about shipment dates, rather than saying, hey, we have this in our portfolio, and that would suggest that some investment will have to take place if that becomes a meaningful part of the market. In the short term, they can probably use some of the capacity that's already in place, at least for small quantities, but if it becomes a bigger part of the market, obviously it's going to pull things along.

The reason we think that's likely to happen is, when you look at how people use those devices, whether it's streaming or gaming, high quality video is a pretty big deal, and given the power intensity of displays, it all fits very well with the advantages or the story behind OLED, so, no, our long-term outlook hasn't changed. Yes, there are some short-term dynamics in the handset market that need to be overcome. I would, however, again reiterate the position in the handset market. Even without handset growth, there's still roughly two-thirds of the handset market that does not have OLED displays and would probably benefit from them or like access to them if there were more than one reliable vendor or more than one reliable manufacturer out there. That's why, going back to one of my first comments, we need somebody to close the gap.

Patrick Ho -- Stifel -- analyst

Great, that's helpful, John. Maybe as my follow up question in terms of gross margins, obviously product and market mix is a key variable in your gross margins, is that the biggest influence in your March quarter outlook or are there other moving pieces that are impacting gross margins, at least for the March quarter.

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

Yeah, Patrick, with regards to Q2 or the March quarter, actually volumes plays a larger variable. We saw pretty significant volumes drop into our fiscal Q1, so effectively, the WIP and the finished goods that were manufactured that roll into Q2 for shipments, they carry much higher costs, and that's a beg determinant of the gross margins that we guided for Q2.

Patrick Ho -- Stifel -- analyst

Great. Thank you very much, guys.

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

Your next question comes from the line of Brian Lee with Goldman Sachs. Your line is open.

Brian Lee -- Goldman Sachs -- Analyst

Yeah, hey, guys. Thanks for taking the question. Maybe first off, John, you mentioned large reform factors. You also specifically called out the rollable TV from LG Electronics at CES and there's chatter across the industry of Samsung potentially reentering OLED TVs with a QD variant. I am just wondering if you can talk maybe at a high-level longer term about your positioning here, if there's visibility to resolution in TVs specifically increasing to the point where your technology would now be needed.

John Ambroseo -- Chief Executive Officer, President, and Director

I'm sorry, you broke up a little bit there. I think what you were asking is our views on TV and whether our technology might be applicable. Does that capture it?

Brian Lee -- Goldman Sachs -- Analyst

Yeah, in a nutshell, as some of these resolutions move up to 4K, and I think there were a handful of AK variants out at CES, as well, if that's your window of opportunity at some point to start supplying ELA technology.

John Ambroseo -- Chief Executive Officer, President, and Director

I'm going to refer back to comments that I've made in prior calls. For the TV market, a 4K device for TV is viewed by many as a benchmark, but the reality is, it's less than a couple hundred PPI, so compared to a smartphone, it's actually a much more simple display. The reason to use annealing in TV is really about refresh rate, because the traditional electronics will limit how fast you can refresh, and if you consider an OLED is capable out of the box at 1,000 times faster refresh rate than an LCD, you're leaving a key advantage or a key benefit on the sidelines. Any conversation around using any form of annealing would really be on refresh rates, and being able to surpass what is currently in the market.

Even if you look at the specs around BLB TVs, and the images from those TVs is beautiful, especially the color gamut, as you would expect from an OLED, but the refresh rates are nothing to get too excited about, and when you start to think about either 8K or very large screens, both of those put even more and more demands on the refresh rate. I've said it, I think, six times now; I hope that I've left the impression that it's an important technical aspect.

Brian Lee -- Goldman Sachs -- Analyst

Okay, fair enough. No, that's helpful. Maybe just a second question on stimulus, it sounds like you're comfortable the funding will be there based on some of the work you've done, but curious if you have a specific view on OLED subsidies in the region, if there's any indication of those losing support in any provinces, and then just how sustainable you think those could be in the current economical ways of that region, say? Thank you.

John Ambroseo -- Chief Executive Officer, President, and Director

Sure, if we look at it from the national perspective, display technology is part of the five-year plan, typically, the government has stuck to its guns with respect to the things that are in the five-year plan. We've questioned customers whether they see any change in position there. They claim not. When you drill down to the regional governments, I think you potentially could have more variation there, and again, when we ask customers about that, they say they believe the funding is going to be there.

It will remain to be seen when rubber hits the road if that is indeed the case. We have no reason to doubt the customer, but we've realized it's a very fluid situation in China and things could change, but clearly, the commitment to being a major player in display is there, and if OLED starts to penetrate some of these other verticals such as laptops and tablets and then becomes a bigger part of TV, it leaves the Chinese manufacturers who currently dominate LCD production in the dust. I guess the question that I would pose to you in reply, how likely is the Chinese government going to allow that to happen?

Brian Lee -- Goldman Sachs -- Analyst

Yep, fair enough. No, thanks for the insight. I appreciate it. I'll pass it on.

John Ambroseo -- Chief Executive Officer, President, and Director

Sure.

Operator

Your next question comes from the line of Blayne Curtis with Barclays. Your line is open.

Blayne Curtis -- Barclays -- Analyst

Hey, guys, thanks for taking my question. I just want to go back to the Q2 guidance. I was trying to discern between your two segments there. If you can provide any color and your down 3% over all, just trying to understand, the material processing continued to slide into March, and then my second question was just understanding your commentary in gross margin. It sounded like overall volumes, but obviously you had higher gross margins back when your business was at a similar revenue rate. I'm just trying to understand that and then any perspective. I know you're not giving clear guide anymore, but any perspective on the recovery if your revenue does stay at this level?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Yeah, so Blayne, from a gross margin standpoint, again, we produced 42.6% non-GAAP in Q1. We're guiding 37.5 to 40.5 for Q2. There are several impacts related to that decrease. The single largest one, though, has to do with volumes, and with volumes, you don't absorb as much as your overhead and call it your fixed cost so that your higher inventory costs that are built in the prior quarter with unfinished goods that get shipped in the following quarter, they just carry higher costs and less meaningful margins. There are other things, warranties. Duties related to importing of goods go higher with higher costs. Ancillary costs that increase, which impact gross margin, but the single largest has to do with volumes, volume degradation.

Blayne Curtis -- Barclays -- Analyst

Any commentary on the segment into March between material processing and microelectronics would be helpful, thanks.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Yeah. Again, Blayne, I think John kicked it off. It's tough to get into the verticals, especially with material processing given its relationship into China and all the uncertainty and doubt with China, so anything we'd say probably would be wrong. We're just not going to go into the verticals. We'll stay at the top with the 360 million to 380 million guide.

Blayne Curtis -- Barclays -- Analyst

Thanks, Kevin.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Thank you.

Operator

Your next question comes from the line of Mehdi Hosseini with SIG. Your line is open.

Mehdi Hosseini -- SIG -- Analyst

Yes, thank you. I have a couple of follow-ups. Kevin, your days of inventory has spiked during the December quarter. It's almost like a multiyear high. What is the mix here and the reason for the sequential increase?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Mehdi, I mentioned DSO of the AR, accounts receivable, on the call. Were you specifically on DSO inventory or AR?

Mehdi Hosseini -- SIG -- Analyst

No, days of inventory.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Okay, in inventory, inventory did rise a little bit quarter on quarter. As you know, revenues came down. We talked about cancelations. John talked about cancelations up front. All that material has already been ordered, so that will impact your metric days of inventory outstanding.

Mehdi Hosseini -- SIG -- Analyst

Okay.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Those were the largest drivers, if you will.

Mehdi Hosseini -- SIG -- Analyst

Would the majority of the sequential increase be the finished good?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

If you break down our inventory, it's about a third material, raw materials, a third WIP, and a third finished goods. It's somewhat equally distributed, but again, related to volumes, it drives costs. If we have cancelations, that's going to carry the inventory longer, and as we look into our fiscal Q2, again, the guide was down a little bit, that's going to mean you're going to burn off inventory that much longer, which increases days of inventory outstanding.

Mehdi Hosseini -- SIG -- Analyst

Okay, that's very clear, and then, last quarter, you talked about adjusting your cost structure. What's the update there and what's been the attraction?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

No change. We said the last quarter for the year we would reduce opex by $10 million to $15 million. A few good surprises in Q1 that affectively go away in Q2, for instance, the holiday and vacations, as you know, the December quarter between Thanksgiving holiday and vacation taking and the December Christmas holidays, both holiday and vacation taken, we don't have that benefit as we look into Q2. That'll drive opex up a little bit and then it is on the press release, you can see the piece parts, but we got a $2 million benefit in pure expense or opex in the December quarter related to our deferred comp plan. That will increase and decrease depending on the overall market. In periods of decrease, we get a credit to expense, in periods of increase, we get a debit to expense, so we did get a benefit from that, and there's an expectation that that will go away, as well, also driving period expense.

Mehdi Hosseini -- SIG -- Analyst

Okay and then just one quick follow up for John. I remember a year or two ago, you were actually capacity constrained and you were beginning to add capacity for OLED application, and I'm assuming that capacity is in place, but not utilized. Is that fungible? Can you reallocate that capacity to other parts of the company or product portfolio that's growing faster?

John Ambroseo -- Chief Executive Officer, President, and Director

Mehdi, the capacity that we put in place, there were three aspects. One was on the service side, which is being utilized because the install base is higher than it was when we made the investment, so we're utilizing that capacity. On the systems side, we didn't add any physical space. We added test equipment, so really, a minimal impact there. Then, the third area was on opex policy and our opex fabrication enrichment, and we have dramatically grown our non-FTD business, particularly for ground-based and space-based telescopes. Again, we're utilizing the capacity there, it's for a different end market.

Mehdi Hosseini -- SIG -- Analyst

Got it, thank you.

John Ambroseo -- Chief Executive Officer, President, and Director

Sure.

Operator

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

Larry Solow -- CJS Securities -- Analyst

Good afternoon. Most of my question is answered. Just a couple John, follow up. Just outside of materials processing, it sounds like more positives than negatives, but if you just had to isolate those segments where there's hopefully less uncertainty, is your outlook basically stable, some pluses and minuses, or a constant from the last couple quarters?

John Ambroseo -- Chief Executive Officer, President, and Director

Again, Larry, if you look at the four end markets, microelectronics, we are enjoying some tail winds in some of those submarkets. I can't say that there are any surprises around flat panels. It's about where we expected it to be. The instrumentation space has been on a good run. It continues to be on a good run. The materials processing market, I think we've flogged that one to death, and then the scientific market, it's stable to slightly up. It's not a big enough piece of the business to cast a swing vote, but I would say, in general, three of the four end markets are doing well. The largest application space is in a down year, we've talked about that for a while, and materials processing is where the turbulence is.

Larry Solow -- CJS Securities -- Analyst

Right, and without one of these potential remedies that you mentioned, whether it be some kind of trade deal or a stimulus in China, without giving guidance, you normally get an improvement in the back half. You're not getting sequential improvement in Q2, which you normally get. Any way you can sort of picture what you frame the back half of the year? If nothing changes, we remain in a similar negative but constant macroeconomic environment.

John Ambroseo -- Chief Executive Officer, President, and Director

Yeah, and Larry, again, it's a great question. I certainly understand why you're asking it. However, since I just said that we were going to stick to quarterly guidance, it really would be flying in the face of that if I were to then turn around and make comments about the second half of the year, so I'm going to have to pass on that one.

Larry Solow -- CJS Securities -- Analyst

Fair enough, I just threw that out there. How about just a housekeeping question? The 7 million in cancelation fee, was that accounted for? Does that all flow to the bottom line? How is that accounted for and is that in a non-GAAP EPS number? I assume so, but --

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Your assumption is correct.

Larry Solow -- CJS Securities -- Analyst

Okay, last question, share repurchases; it doesn't look like there was any activity in the quarter. Is that right?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Share repurchases.

Bret DiMarco -- Executive Vice President and General Counsel

Oh, yeah, Larry, you'll see it in my prepared remarks as it gets posted, but we did $25 million worth of share repurchases.

Larry Solow -- CJS Securities -- Analyst

Oh, there was, OK. Okay, I missed that. Okay, great. Thanks, guys. I appreciate it.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Sure.

Operator

Your next question comes from the line of Mark Miller with Benchmark Company. Your line is open.

Mark Miller -- Benchmark Company -- Analyst

Just wanted to ask you about two trends, a little puzzle. Your semi business was strong, yet as, you noted people have been talking about double-digit declines in the industry. I believe you said that was due to service. Any more color you can give us and do you think that's going to continue?

John Ambroseo -- Chief Executive Officer, President, and Director

On the utilization side, the numbers have remained pretty good. We don't watch them day to day. We look for the regular updates that come from the various tracking agencies. I think the downturn that everybody's pointing to really is capacity expansion because we were on a memory craze for several years, and that has righted itself based on how memory pricing has changed just in the last two or three quarters. Then we were -- and when I say we, I mean the industry, was expecting China sovereign investment to close some of that gap. That hasn't happened as quickly as was expected, and the questions behind that is, is it cash conservation? Is it because they're struggling to get the processes to work? Is it somehow retaliatory for tariffs? Don't know, but we do recognize that our business right now is an outlier compared to the rest of the semi industry and we think we understand the reasons for it, and it really has to do with how we're aligned on the service side and what we've been doing on the legacy end.

Mark Miller -- Benchmark Company -- Analyst

The other question I had was about your other revenues, which were flat, it looks like sequentially. That's kinda puzzling too, at least if you would think of in service, and I forget if you mentioned service specifically, but especially with the reports that some of the smart phone manufacturers or suppliers are being hit with 10 to 20% reductions in expected supply for some of the major smart phone suppliers.

John Ambroseo -- Chief Executive Officer, President, and Director

How do I explain that without violating any customer information? The -- I'm struggling a little bit here Mark, because I want to be very careful about what I disclose. I would say that while production has slowed for installed devices or shippable devices, you still have an aspect of R&D, ongoing R&D by a number of players, and even though they might not be recognized in revenue, they still have to run the beds and run the equipment, and that drives service revenue in the absence of unit sales.

Mark Miller -- Benchmark Company -- Analyst

Okay, just one last question for me. You said that fiber pricing and laser pricing remains aggressive. Is it mainly still in the one to three kilowatts or is that starting to spread to higher powers, a couple firms have introduced higher power lasers. I'm just wondering if that's still confined to lower one to three kilowatt power ranges.

John Ambroseo -- Chief Executive Officer, President, and Director

What we saw in the December quarter was in the one to three, one to four is where the battleground has been. We would expect that to extend to higher powers as people enter that space.

Mark Miller -- Benchmark Company -- Analyst

Just curious, because I heard some conflicting things, sorry for the additional question, in terms of supplying 10 kilowatt fiber lasers, how many people are truly supplying 10 kilowatt fiber lasers or are some just talking about it? I was told there was just two people out there who are really supplying that. I was skeptical about that.

John Ambroseo -- Chief Executive Officer, President, and Director

I think it's probably fair to say that there are a limited number of players that can supply 10-kilowatt reliable fiber lasers. There are lots of companies that will ship a 10-kilowatt fiber laser.

Mark Miller -- Benchmark Company -- Analyst

Okay, got it, thank you.

Operator

Your next question comes from the line of Nik Todorov with Longbow. Your line is open.

Nikolay Todorov -- Longbow Research -- Analyst

Hey guys, good afternoon. Can you give us an update on the FPD consumables inventory? Your customers, do you expect this low inventory management to continue through 2019 or do you think that digestion went at some point?

John Ambroseo -- Chief Executive Officer, President, and Director

I think that the customers will continue to keep an aggressive posture on inventory as a cash conservation method, and we're in position where we can supply on relatively short notice. They're aware of that, so they're trying to strike the right balance.

Nikolay Todorov -- Longbow Research -- Analyst

Okay, and can you talk about the level of activity around FPD outside of Korea, and to the extent possible, can you share with us, when do you expect the trough in terms of customer activities and inquiries to occur or maybe that has already occurred. I was just curious if you can address that.

John Ambroseo -- Chief Executive Officer, President, and Director

Again, Nik, I completely understand the reason for the question, but that really plays into sort of a longer-term outlook, and we've said that we're going to stick to a short-term outlook. I'll just go back to the comments I made. Without being specific around the timing of any orders with any specific customer, I would say the level of activity remains to be positive. We still, as I've said now for a couple quarters in a row, we need someone else to break through on the yield front, and that should be a very nice elixir for the market place.

Nikolay Todorov -- Longbow Research -- Analyst

Okay, and then the materials processing, in the last call you mentioned about -- you talked about aggressive pricing environment in China, can you give us an update if you've seen anything incremental on that front?

John Ambroseo -- Chief Executive Officer, President, and Director

I don't know that it's got incrementally worse. There was a pretty significant step down in average pricing on the one to three, one to four kilowatt market several months ago, and it remains at that level and a lot of that pricing is for high volume customers, customers that are buying one-offs and not getting the same level of pricing as customers that are buying hundreds of lasers, but they're certainly trying to use the pricing for 100-off to drive the pricing for one-off.

Nikolay Todorov -- Longbow Research -- Analyst

Okay, got it, thanks. Lastly, Kevin, can you tell us, what was cash flow from operations in the quarter?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Sure, 51 million end quarter.

Nikolay Todorov -- Longbow Research -- Analyst

Okay, and anyway, can you talk about free cash flow in the year? Do you expect, essentially, working capital to become a cash tail wind for the year?

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Yeah, I'm sorry, Nik. As we've said a couple of times now, in terms of going out for the full year, we're not going to do that. There is too much turbulence ahead of us, so we're going to keep it to just the current quarter.

Nikolay Todorov -- Longbow Research -- Analyst

Okay, understood. Thanks, guys. Good luck.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Thank you.

Operator

Your next question comes from the line of Jim Ricchiuti with Needham & Company. Your line is open.

James Ricchiuti -- Needham & Company -- Analyst

Hey Kevin, can you say what the materials processing business look like outside of China? I mean, in total, it looks like it was down about 19% year over year. I don't know if that's accurate or not, but ex China out of that business look.

Kevin Palatnik -- Chief Financial Officer and Executive Vice President

Yeah, frankly, China is where all of the turbulence is and we did see some push outs in quarter related to that impacting the quarter. As I look around the rest of the world, US was OK, Europe was OK, but just OK. A lot of the materials processing activity is in China, so that sort of sets the stage for the whole vertical. The other pieces or the other geos are relatively minor in relation.

James Ricchiuti -- Needham & Company -- Analyst

Yeah, that makes sense. John, you alluded to some winds in solar, and I'm not sure how significant they are. You also, I think in the press release, talked about some tier-one auto winds. How do we think about that? Do these have the potential to be meaningful down the road? Are they meaningful, some of these winds; are they meaningful now and how much follow on potential is there?

John Ambroseo -- Chief Executive Officer, President, and Director

The solar wind provides a nice short-term top. It's not going to move full year results, but it's a nice one-time pop. The customer is in a position to place orders in the next 12 months and that will really depend on how the market performs, and how we perform in the application on a full deployment mode. I mentioned the auto ones, not because they're big revenue contributors today, but because they have the potential to contribute significant revenue over the next several year. Once you get designed in to these applications repeat business comes on a pretty regular basis and some of these applications, particularly around battery production and electric propulsion or electric motors, these are large scale operations, so if we continue to perform well as we've done so far, it's going to be an attractive piece of business.

James Ricchiuti -- Needham & Company -- Analyst

Okay, that's helpful. Just a last question from me is just, we are seeing some signs of slowing elsewhere outside of China, so I'm wondering, as you look, for instance, at Europe and you hear some signs of further weakness in automotive and potentially some slowing in the US, how would you characterize the demand outlook outside of China if you're able to? Again, not going out that far, I understand you're not giving guidance.

John Ambroseo -- Chief Executive Officer, President, and Director

Yeah, I think the thing to bear in mind with a number of these applications, and I think this is true for the industry, not just Coherent, is that we're playing the role -- I shouldn't say. Maybe that's too strong. We're participating in disruption. The move to electric vehicles away from internal combustion engines, this is generally a growth area regardless of what the overall number looks like because electric vehicles are capturing more and more share as you move along. You can't just look at it and say, OK, what's the automotive market going to do? You have to look at relative share within the market for the technologies where we're playing to see what kind of an impact they're going to have, and clearly, just look at the news about environmental concerns and other things. You can well understand why electric vehicles are going to capture more and more shares moving forward and I think that's a general positive trend for our industry because provide so much credible production equipment.

James Ricchiuti -- Needham & Company -- Analyst

Okay, thank you.

John Ambroseo -- Chief Executive Officer, President, and Director

Sure.

James Ricchiuti -- Needham & Company -- Analyst

Thanks John.

Operator

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

John Ambroseo -- Chief Executive Officer, President, and Director

All right, thanks Connor. I'd like to thank everybody for participating in today's call and we will certainly look forward to updating you in a few months' time. Have a good day.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 54 minutes

Call participants:

Bret DiMarco -- Executive Vice President and General Counsel

John Ambroseo -- President and Chief Executive Officer

Kevin Palatnik -- Executive Vice President and Chief Financial Officer

Jim Ricchiuti -- Needham & Company -- analyst

Patrick Ho -- Stifel -- analyst

Brian Lee -- Goldman Sachs -- Analyst

Blayne Curtis -- Barclays -- Analyst

Mehdi Hosseini -- SIG -- Analyst

Larry Solow -- CJS Securities -- Analyst

Mark Miller -- Benchmark Company -- Analyst

Nikolay Todorov -- Longbow Research -- Analyst

James Ricchiuti -- Needham & Company -- Analyst

More COHR analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.