Business Context and Reporting Period
The filing is II-VI Incorporated’s unaudited Form 10-Q for the three months ended September 30, 2019, the first quarter of fiscal 2020. The filing text identifies the registrant as II-VI Incorporated, not Coherent Corp. II-VI develops engineered materials and optoelectronic components serving industrial, communications, aerospace and defense, consumer electronics, semiconductor equipment, life sciences and automotive markets.
Effective July 1, 2019, II-VI realigned its reporting structure into Compound Semiconductors and Photonic Solutions. On September 24, 2019, it completed its acquisition of Finisar Corporation; Finisar results are included only from the acquisition date and were reported in Unallocated and Other for the quarter.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Revenue | $340.4 million | $314.4 million | Up 8% |
| Gross profit | $123.1 million | $123.9 million | Down $0.8 million |
| Gross margin | 36.2% | 39.5% | Down 3.3 percentage points |
| Operating income (loss) | $(18.5) million | $37.2 million | Declined $55.7 million |
| Net earnings (loss) | $(26.0) million | $26.1 million | Declined $52.1 million |
| Diluted earnings (loss) per share | $(0.39) | $0.40 | Declined $0.79 |
| Cash flow from operations | $(25.6) million | $19.0 million | Declined $44.6 million |
| Capital expenditures | $25.6 million | $35.9 million | Down $10.3 million |
SG&A increased to $105.5 million from $53.5 million, primarily because of Finisar transaction costs. Internal research and development increased to $36.1 million from $33.2 million, remaining 10.6% of revenue.
At September 30, 2019, cash and cash equivalents were $439.6 million, compared with $204.9 million at June 30, 2019. Total debt was $2.378 billion, including $2.333 billion of long-term debt. Aggregate availability under credit lines was $290.0 million.
Current assets were $1.756 billion versus current liabilities of $545.8 million. Inventories increased to $744.4 million from $296.3 million, primarily reflecting the Finisar acquisition and purchase accounting adjustments.
Material Changes Versus the Prior Comparable Period
- Revenue increased 8%, including $22.1 million contributed by Finisar. Photonic Solutions revenue increased 5% to $141.4 million, while Compound Semiconductors revenue decreased 1% to $177.0 million.
- Compound Semiconductors operating income increased 25% to $26.5 million, while Photonic Solutions operating income decreased 18% to $13.0 million because of product mix, pricing pressure and higher research and development spending.
- Gross margin declined because of approximately $7.1 million of acquired Finisar inventory fair-value step-up costs, under-absorption in 3D Sensing and wide-band-gap product lines, customer order delays and production challenges.
- The company recorded $65.5 million of Finisar-related transaction expenses, including investment banking fees, severance and compensation, fair-value adjustments, incremental interest and debt extinguishment costs.
- Cash used in investing activities increased to $1.064 billion, including approximately $1.037 billion paid for Finisar. Financing activities provided $1.327 billion, including new Term A, Term B and revolving facility borrowings.
- Shareholders’ equity increased to $2.131 billion from $1.133 billion, primarily due to shares issued to Finisar stockholders. Shares outstanding increased materially, and treasury shares also increased through employee tax-withholding transactions.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a clear quantitative revenue or earnings outlook. Management cited demand related to optical communications infrastructure and global 5G rollouts, including strength in reconfigurable optical add-drop multiplexer products. Management also cited continued investment in 5G and other developing technologies.
- The new senior credit facilities provide $2.425 billion of total commitments: a $1.255 billion Term A facility, a $720.0 million Term B facility and a $450.0 million revolving facility. Borrowings are secured and subject to leverage and interest-coverage covenants. The company stated that it was in compliance with all financial covenants at September 30, 2019.
- Following the acquisition, the company had approximately $2.5 billion of outstanding debt and identified refinancing, interest-rate, liquidity and covenant risks.
- Holders of approximately $560.1 million of Finisar convertible notes exercised repurchase rights. The notes were repurchased on October 23, 2019 for approximately $561.1 million, funded by a $561.0 million Term A draw. Approximately $14.9 million of the Finisar notes remained outstanding afterward.
- The preliminary Finisar purchase-price allocation includes $759.2 million of goodwill and $827.7 million of acquired intangible assets. The allocation may be revised materially during the measurement period.
- A 100-basis-point increase in rates on variable-rate borrowings would have increased quarterly interest expense by approximately $2.4 million based on September 30, 2019 borrowings.
- The company adopted the new lease accounting standard on July 1, 2019 and recorded approximately $80.1 million of operating lease assets and liabilities at adoption, plus additional lease balances acquired from Finisar.
- Management identified risks from lower demand, customer order delays, manufacturing under-absorption, competitive and pricing pressure, foreign exchange, acquisition integration and substantial leverage. Legal proceedings were not expected to have a material effect, although outcomes remain uncertain.
Investor Verification Items
- Verify the registrant and period: the supplied filing is for II-VI Incorporated, quarter ended September 30, 2019, despite the request metadata naming Coherent Corp.
- Assess the sustainability of Finisar revenue, margins and cash generation after only six days of reported ownership in the quarter.
- Reconcile the $65.5 million of acquisition-related costs and the $7.1 million inventory fair-value step-up with any adjusted or non-GAAP results.
- Monitor debt paydown, variable interest exposure, covenant compliance and liquidity following the Finisar financing and subsequent $561.1 million note repurchase.
- Evaluate inventory growth, customer order delays and manufacturing under-absorption, particularly in 3D Sensing and wide-band-gap products.
- Review the preliminary purchase-price allocation, including goodwill and acquired intangible assets, for measurement-period changes or impairment risk.
- Consider potential dilution from approximately 9.6 million anti-dilutive potential shares, including convertible notes and equity awards.