II-VI Incorporated (IIVI) on Q3 2023 Results - Earnings Call Transcript
Operator: Good day, and thank you for standing by. Welcome to the Coherent Corp. FY2023 Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised this conference is being recorded. I would now like to turn the conference over to your speaker today, Mary Jane Raymond. Please go ahead. Mary Raymond: Thank you, Kevin, and good morning. I’m Mary Jane Raymond, Coherent’s Chief Financial Officer. Welcome to our earnings call today for the third quarter of fiscal year 2023. This call is being recorded on Wednesday, May 10, 2023. With me today on the call is Dr. Chuck Mattera, our Chair and Chief Executive Officer. After our prepared remarks, Chuck and I will be joined by Dr. Giovanni Barbarossa, our Chief Strategy Officer and the President of the Materials Segment; Dr. Mark Sobey, our President of the Laser Segment; and Bob Bashaw, our President. They will participate in the Q&A to discuss our strategy, results, and the exciting prospects across our end markets. For today’s call, the press release and investor presentation are available in the Investor Relations section of our website, coherent.com. Today’s results include certain non-GAAP measures. Non-GAAP financials are not a substitute for, nor are they superior to financials prepared in accordance with GAAP. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today’s documents. I remind you that during this call, we will make certain forward-looking statements. These include, but are not limited to, statements regarding geopolitical and macroeconomic trends, as well as expectations for our revenue, relevant market trends, and financial performance, including our guidance. In addition, we will discuss our progress on integration, including our delivery of the projected synergies and certain restructuring matters. All forward-looking statements are based on today’s expectations, forecasts, and assumptions. They involve risks and uncertainties that could cause actual results to differ materially from our comments today. Our comments should be viewed in the context of the risk factors detailed in our most recent Form 10-K for the fiscal year ended June 30, 2022 and subsequent SEC filings. Coherent assumes no obligation to update the information discussed during this call, except as required by law. With that, let me turn the call over to Dr. Chuck Mattera. Chuck? Vincent Mattera: Thank you, Mary Jane, and thank you all for joining us today. Coherent Corp. posted third quarter revenues of $1.24 billion, 6% below the low-end of our guidance, and 8% lower than the midpoint of our guidance. Revenues were up 4% year-over-year on a pro forma basis. Organic revenue growth was up 6% year-over-year. Our non-GAAP EPS was $0.58. Our operating cash flow was $152 million. We invested $97 million of capital equipment. We generated $55 million of free cash flow and we retired $78 million of our debt. We were intensely focused on controlling costs, managing cash and continuing our disciplined approach to capital allocation during the quarter. The integration of Coherent continues to go well. Our third quarter performance was impacted by some of our larger customers requesting us to delay scheduled shipments primarily in the Networking Segment. Our long-term strategy of market, technology and business diversification is clearly an advantage for us in these market conditions. That diversification together with continued strong market share performance across our core markets help mitigate the impact of the communications market challenges that we experienced in the quarter. Specifically, the solid performance of the Materials Segment, coupled with the solid performance of the legacy Coherent business, now our Lasers Segment, provided diversification and stability by exposing us to multiple and different growth markets. Revenues in the quarter by segment were $551 million for networking, $365 million for lasers and $324 million for materials. Turning to the composition of our sales by our four major markets: 35% was into industrial; 44% into communications; 11% into electronics; and 10% into instrumentation. Regarding the distribution of our revenues by region, North America accounted for 53%, Europe was 20%, Japan and Korea were 14%, China was 11% and 3% went into the rest of the world. In the face of the macro challenges in the quarter, customers are now taking proactive measures to manage inventory and cash. We expect the constrained market conditions to persist into FY2024. With this temporary slowdown in the market, we've wasted no time in aligning our cost structure with market realities. To this end, we are pulling up the schedule for some of the actions planned as part of our multi-year synergy, integration and transformation efforts. We have begun the next phase of the Coherent acquisition integration plan, including those actions involving consolidations and moves to lower-cost sites. These moves, alongside our other actions will keep us on track for delivering the previously announced $250 million synergy plan. We also undertook a number of actions to align our cost with current market realities as we begin the fourth quarter. We are accelerating the restructuring actions we began in Q3 and announced today. It is focused on workforce reductions to reduce costs and expenses and facility rationalization, including the relocation of certain facilities to increase our resiliency and to lower our costs. We are also planning to implement a multi-year digital transformation that will help enable us to improve our manufacturing productivity and efficiency and to provide lower-cost G&A services. We expect to realize $100 million to $125 million of restructuring savings on an annual basis by FY2025. Cumulative savings for the period FY2023 to FY2025 will range from $200 million to $300 million. The cost to achieve these savings will be between $150 million and $200 million. The good news is that it's very clear to me that our continued investment in the markets we serve with best-in-class people and technology has earned us a strategic and highly competitive position at a growing number of customers. We've been planning and executing this evolution for a long time, including the most recent acquisitions of Finisar and Coherent. The power of our diversified and larger scale model is very clear to me. Our work is not done, rather it's just beginning. We are confident that our new product portfolio, technology and manufacturing platforms will be ready as the growth resumes. I also – I am confident in our ability to secure new design wins across our key product lines to drive long-term differentiated performance. We are very well positioned to continue benefiting from strong and durable technology trends that we do not see abating anytime soon. With respect to our four end markets and communications, we experienced a near-term slowdown in the datacom market with some hyperscale and enterprise computing customers and with our telecom and cable TV customers as well as many abruptly shifted their focus in the quarter from managing their supply chain shortages to managing their inventory surpluses. These affected our telecom and datacom businesses about equally. Datacom revenues were $294 million compared to $332 million in Q3 of FY2022. And telecom revenues were $245 million compared to $222 million also in Q3 FY2022. We believe this is a temporary interruption in the growth trajectory of these markets that will continue into FY2024. We also believe that the fundamental growth drivers of our communications market are intact, including increasing Internet traffic, the proliferation of network devices and increased broadband and mobile data rates. While datacom will be partially affected in the short-term by the temporary pullback in investments in infrastructure, including the metaverse, it is expected to come back strongly, driven by the deployments of hyperscale computing and for artificial intelligence and machine learning. In fact, we believe that we are at another inflection point in a decade-long megatrend forming with artificial intelligence and machine learning, and we expect these trends to account for more than half of all datacom transceiver shipments by 2028. Despite the current datacom market reset, our industry-leading position in 200G and above remains very strong. Our leadership in this area derives from the vertical integration of our high-speed lasers, optics and electronics and our transceiver modules, and our ability to scale to meet aggressive volume ramps of the world's leading data center operators. In addition to the growth of our 200G and 400G datacom transceivers, we are accelerating our 800G shipments in anticipation of exponential growth beginning in FY2024. In telecom, we are a vertically-integrated market leader with our Coherent transceivers and disaggregated solutions. Once the growth resumes, we expect all of these products to continue to grow at double-digit percentages annually. We continue to invest in a broad product portfolio to address evolving requirements of our customers who are focusing their resources on developing new platforms, and we are engaged in intense design and activity in response to multiple new opportunities ahead. These opportunities in telecom stemmed from disaggregation and are being increasingly led by hyperscalers who through their continued build-out of metro, regional and submarine networks are also driving paradigm shifts in the transport network architecture. With our existing telecom transceiver portfolio and our differentiated DSP technology roadmap, we plan to launch the first 100G Coherent solution for network edge applications. We expect that the planned $65 billion investment in broadband access from the infrastructure investment and Jobs Act will be a major catalyst for our optical communications business. Finally, as space is the new frontier, we are seeing a strong increase in demand for our differentiated products for satellite communications. In Industrial, our revenues in the quarter were $438 million, down 3% sequentially. However, we saw a sustained strength in semiconductor cap equipment front-end sales, which grew 15% year-over-year and 8% sequentially and includes our EUV lithography products whose sales grew 30% sequentially. Lasers for both semiconductor wafer inspection and spike annealing set quarterly records and have a strong outlook at least through the rest of the calendar year. Our leading display customers lowered their demand outlook by greater than 35% due to a decrease in factory utilization based on lower demand, the lowest in four years. This led to a decrease in our forecasted service business in Korea. In the quarter, a big highlight was that our sales of display spare parts into China surpassed those of Korea for the first time, giving a clear sign of market growth in China even though we see some sluggish demand for mobile devices. We expect these short-term consumer demand and inventory-related headwinds will resolve as we move towards the calendar Q3 release of the next-gen smartphones from industry leaders. Such a trend also aligns with the widely announced new-gen 8.5 fab investments in China that we believe will drive a strong recovery in our OLED business into calendar year 2024. In the month of March, we set an all-time record for sales into the laser aftermarket in North America. We continue to experience strong welding design wins for our kilowatt arm fiber lasers and our highyag beam delivery solutions as a result of the acceleration of EV and battery factories around the world. Instrumentation was up 4% sequentially to $125 million as we continue to set records in this market through strength across the board, led by applications in immunology and laser-assisted procedures. Sales of our ultrafast laser-based advanced imaging systems for neuroscience increased as well, and we had our strongest quarter in scientific since pre-COVID times. We shipped our 100,000th OBIS mini laser, and we added several new design wins for our light engine solutions where we combine the lasers and optics that form the engine of our customers' products. It is our strategy to enable customers to source the entire laser light illumination side of their systems from Coherent, accelerating their time to market, time to quality and time to cost. We believe that we can grow our revenue in the years to come well ahead of the market by expanding this addressable market. At the other end of the optical spectrum, we shipped our 50th meter-class optic for the Thirty Meter Telescope with more than 150 units to go before completion over the next several years. Meanwhile, the James Webb Telescope continues to send back mind-bending images, and we are proud of Coherent's contributions as the prime supplier of the world's most advanced space and terrestrial imaging systems. In electronics, our revenues were $139 million, up 121% year-over-year led by consumer electronics for sensing. Our customer intimacy in this market gives us confidence that the long-term opportunity in consumer electronics is much broader than just VCSELs for 3D sensing. However, we expect lower revenue from just under 10% to 3% or less of our annual revenues for the next 18 to 24 months as some design changes take effect. We believe that sensing will ultimately become ubiquitous in metaverse hardware and wearables as well as in LiDAR and other emerging applications. Our strategic engagements are growing across them all. Regarding our outlook that we will discuss today, it reflects a degree of caution around customer buying patterns in the near-term. While June was traditionally legacy II-VI's strongest quarter, the macro factors we are experiencing, along with seasonality will result in lower revenues sequentially. We will continue to stay focused on cost control, synergy realization and cash generation while we align our cost to market realities. We will work to restructure and transform the company and position our product portfolios for sustainability to enable timely resumption of our growth as the market turns up. Our synergy and restructuring plans will further enhance our competitive position by driving greater scale and focus at existing sites, and affording increased flexibility and efficiency, product roadmap alignment and access to lower cost structures. We have completed a rigorous analysis of these plans, a careful assessment of the effects on our people and believe that these moves will position us to achieve both short and long-term commitments. With respect to our silicon carbide business, it grew more than 40% year-over-year. This business continues to be one of our top priorities. Therefore, our equipment investments in the silicon carbide platform expansion were again about half of our total capital investment. The market is showing signs of a prolonged period of severe capacity constraints forming. We are extremely well positioned as we have steadily gained share and then what we believe will be an underserved market for many years to come. We are increasingly asked by our customers to support a continuously increasing demand, and we have also often been asked by investors what our end game is for this business. Even with the $1 billion investment over 10 years that we announced in August of 2021, the gap between projected supply and demand is accelerating, and so we now believe that the market leader who emerges will be the incumbent who is able to timely close the gap and serve the market needs. This will require a relentless focus on operational excellence and the results orientation that is a natural part of our company culture, and it will also require an even greater commitment to investment. We see a unique opportunity to further accelerate our growth through either accelerated investment and/or deeper strategic partnerships. To that end, we have commenced the review of the strategic alternatives for our silicon carbide business. This review is focused on effectively serving the market at the same time while maximizing long-term shareholder value for our Coherent shareholders by considering a range of potential alternatives. These include a sale, joint venture, minority investment or simply staying the course with the continued execution of our business plan. We remain firmly committed to our customers, employees and our shareholders, and we will continue to invest in capital, capacity and technology innovations, including expanding our portfolio so as to become a full-line supplier of silicon carbide power devices and modules. We can give no assurances as to the outcome of this process. And following our Q&A session today, we do not intend to make any further public comment regarding this matter until we have a material development to disclose. With that, I'll turn it over to Mary Jane. Mary Jane? Mary Raymond: Thank you, Chuck. Our backlog of $2.6 billion landed as we expected it would. Our Q3 non-GAAP gross margin was 37.3%, and the non-GAAP operating margin was 17.5%. Supply chain costs were minimal in Q3. At segment level, the non-GAAP operating margins were 13.6% for Networking, 27.5% for Materials and 14.6% for Lasers. During the quarter, with a sudden downturn in revenue, we carried approximately $15 million of underabsorbed capacity, and the gross margin was also affected by $8 million in FX and $7 million due to mix. Our operating expenses, SG&A plus R&D were 19.8% of sales on a non-GAAP basis. The non-GAAP items were $62 million in amortization, $29 million in stock comp and $16 million of transaction and integration costs. Total stock comp is expected to be $26 million to $30 million in Q4. Synergies have now reached $66 million on an annualized basis, and we are making good progress in all categories. With respect to further details on our cost savings actions, our $100 million to $125 million of targeted cost reductions are in addition to our $250 million of cost synergies. These cost reductions are expected to be at least 130 by fiscal year 2017. The FY2023 through 2025 cumulative savings are expected to be between $200 million and $300 million, and the cost to achieve them are approximately $150 million to $200 million, including severance, retention, new net labor costs in the lower cost locations, facility moves, short-term duplicate costs and lease termination costs, along with IT consolidation. Quarterly non-GAAP EPS was $0.58 against a diluted share count of 141 million shares. GAAP and non-GAAP EPS calculations are on Tables 6 and 7 of our press release. Interest expense in the quarter was $75 million. And for the nine months ended March 31, interest expense was $208 million. Our total interest cost for fiscal year 2023 is expected to be $281 million to $284 million. The March 31 cash balance was $901 million, just $12 million below the 12/31 balance. After paying down $78 million of debt in Q3, our total debt position on March 31 was $4.5 billion. Using the trailing 12 months of adjusted EBITDA on a pro forma basis for the combined company at March 31, the gross leverage was 3.5x, and the net leverage was 2.8x with the synergy credit, including the cost savings and the synergy credit of $312 million that is allowed by our credit facility definition, the growth leverage is 2.9x, and the net leverage is 2.3x. Note that the $38 million of synergies are already in the results. The total of $312 million and $38 million equals $350 million. The additional $100 million of savings is worth two tenths of turn on leverage. Let me just restate the leverage without the synergy credit. As of March 31, the gross leverage was 3.5x, and the net leverage was 2.8x without the synergy credit. With the synergy credit, it's 2.9x gross and the net leverage is 2.3x net. Our effective tax rate in the quarter was 154%, and the non-GAAP tax rate for the quarter was 19%. We expect the tax rate for fiscal year 2023 to be between 30% to 32%, assuming the current mix of earnings and no adoption of new or additional tax release. Turning to the outlook for Q4 FY2023. Our outlook for revenue for the fourth fiscal quarter ending June 30, 2023, is expected to be $1.125 billion to $1.175 billion and earnings per share on a non-GAAP basis to be $0.33 to $0.43 per share. On a full-year basis, our revenue outlook is $5.08 billion to $5.15 billion. Our non-GAAP EPS estimate assumes that the preliminary effects of purchase accounting are added back to the GAAP EPS other than the depreciation that is $5 million per quarter. The share count is 142 million shares for the entire non-GAAP EPS guidance range and both Series A and B are anti-dilutive. This means Series A and B dividends should be deducted from net income and the share should not be included in the share count. The EPS calculation, including the dividend treatment is detailed on Table 8 of the press release for the guidance range. This table also shows the earnings at which the Series B preferred stock is dilutive. All of the foregoing is at today's exchange rates. For the non-GAAP earnings per share, we add back to the GAAP earnings pretax amounts of $190 million to $210 million, including $95 million in amortization, $27 million in stock comp and $70 million to $80 million for integration and restructuring. The actual dollar amount of non-GAAP items, the tax rate, the exchange rates, the purchase price accounting and the share count are all subject to change. As a reminder, our answers today may contain forecasts from which our actual results may differ materially due to a variety of factors. These include changes in mix, customer requirements, supply chain availability, competition and economic conditions to name a few. With that, Kevin, you may open the line for questions. Actually, let me amend one last thing. In our guidance range, the add-back are $95 million in amortization, $27 million in stock comp and $70 million to $85 million for integration and restructuring. All right then. Kevin, you can open the line for questions. Operator: [Operator Instructions] Our first question comes from Ananda Baruah with Loop Capital. Your line is open. Operator: Our next question comes from Simon Leopold with Raymond James. Your line is open. Operator: Our next question comes from Jed Dorsheimer of William Blair. Your line is open. Operator: Our next question comes from Jim Ricchiuti with Needham & Company. Your line is open. Operator: Our next question comes from Christopher Rolland with Susquehanna. Your line is open. Operator: Our next question comes from Samik Chatterjee with JPMorgan Chase. Your line is open. Operator: Our next question comes from Sidney Ho with Deutsche Bank. Your line is open. Operator: Our next question comes from Meta Marshall with Morgan Stanley. Your line is open. Operator: Our next question comes from Mark Miller with The Benchmark Company. Your line is open. Operator: Our next question comes from Ruben Roy with Stifel. Your line is open. Operator: And I'm not showing any further questions at this time. I'd like to turn the call back over to Mary Jane. Mary Raymond: Thank you very much to everyone for joining us today. We appreciate your participation, and we'll talk to you soon. Bye-bye. Operator: Ladies and gentlemen, this does conclude today's conference. You may now disconnect, and have a wonderful day.IIVI Ratings Summary
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II-VI Incorporated Reports Q4 Beat, Guidance Mixed
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Analysts at Deutsche Bank view management's positive commentary on demand dynamics as reassuring, specifically noting the strength in data centers spending and the recovery of industrial demand in China.
The analysts mentioned that they were also pleased with the company's execution in Compound Semis, and view the announced supply agreement with Infineon as an incremental positive for its SiC strategy.
II-VI Incorporated Upcoming Q4 Earnings Preview
Analysts at Deutsche Bank provided their outlook on II-VI Incorporated (NASDAQ:IIVI) ahead of upcoming Q4 results, expecting healthy demand trends for the company's products on solid data centers and enterprise dynamics that should lead to continued revenue growth for its communications business.
The analysts also expect the backlog to continue to grow despite supply shortages appearing to have mildly improved. That said, the analysts believe slowing manufacturing activities and weakness in consumer electronics could be headwinds, and also expect gross margin recovery to be gradual on sustained inflationary pressures.
The analysts lowered their price target to $58 from $75, while reiterating their hold rating. While the analysts believe the company offers great exposure to secular growth themes, in the short term, they have yet to see a clear path for a potential re-rating of the stock given the increased cost of debt and risks to its industrial and consumer segments.
II-VI Incorporated Upcoming Q4 Earnings Preview
Analysts at Deutsche Bank provided their outlook on II-VI Incorporated (NASDAQ:IIVI) ahead of upcoming Q4 results, expecting healthy demand trends for the company's products on solid data centers and enterprise dynamics that should lead to continued revenue growth for its communications business.
The analysts also expect the backlog to continue to grow despite supply shortages appearing to have mildly improved. That said, the analysts believe slowing manufacturing activities and weakness in consumer electronics could be headwinds, and also expect gross margin recovery to be gradual on sustained inflationary pressures.
The analysts lowered their price target to $58 from $75, while reiterating their hold rating. While the analysts believe the company offers great exposure to secular growth themes, in the short term, they have yet to see a clear path for a potential re-rating of the stock given the increased cost of debt and risks to its industrial and consumer segments.
