Filing Scope and Business Context
Registrant: II-VI Incorporated, not Coherent Corp. The provided filing is a Form 10-Q for the quarter ended March 31, 2019, representing fiscal 2019 third-quarter and year-to-date results. The request metadata identifies “Coherent Corp.” and “2018 Q3,” which does not match the filing text.
II-VI develops and manufactures engineered materials, photonic and optoelectronic components for industrial, optical communications, military, semiconductor, medical, consumer electronics, automotive and related applications. Reportable segments are II-VI Laser Solutions, II-VI Photonics and II-VI Performance Products.
Financial Performance and Position
| Metric | Three months ended March 31, 2019 | Three months ended March 31, 2018 | Nine months ended March 31, 2019 | Nine months ended March 31, 2018 |
|---|---|---|---|---|
| Revenue | $342.5 million | $294.7 million | $999.8 million | $837.7 million |
| Gross margin | $127.2 million; 37.2% | $118.3 million; 40.2% | $382.6 million; 38.3% | $333.8 million; 39.8% |
| Earnings before taxes | $27.0 million | $31.2 million | $94.1 million | $88.0 million |
| Net earnings | $24.6 million | $30.1 million | $79.5 million | $60.8 million |
| Diluted EPS | $0.38 | $0.45 | $1.21 | $0.93 |
| Effective tax rate | Not separately stated | Not separately stated | 15.5% | 30.9% |
- Revenue increased 16% for the quarter and 19% year to date.
- Quarterly net earnings declined 18%, while year-to-date net earnings increased 31%, largely reflecting stronger revenue and a substantially lower effective tax rate.
- Quarterly gross margin declined 300 basis points and year-to-date gross margin declined 150 basis points, primarily due to product mix, under-absorption related to delayed 3D sensing programs and production challenges in Performance Products.
- Cash and cash equivalents were $221.2 million at March 31, 2019, compared with $247.0 million at June 30, 2018.
- Total debt obligations, including unamortized debt issuance costs, were $556.5 million at March 31, 2019, compared with $496.5 million at June 30, 2018. Reported debt on the balance sheet was $508.6 million.
- Available borrowing capacity was $171.8 million, down from $246.4 million at June 30, 2018. The company reported compliance with applicable credit-facility covenants.
- Year-to-date operating cash flow was $114.4 million, essentially unchanged from $113.9 million in the prior-year period.
- Year-to-date investing cash outflows were $196.4 million, including $108.2 million of capital expenditures and $83.9 million for acquisitions.
- Year-to-date financing cash inflow was $56.9 million, including $60.0 million of net borrowings.
Material Changes Versus the Prior Comparable Period
- Revenue growth: Optical communications demand, including products supporting China broadband expansion, U.S. metro upgrades, ROADM and 5G deployments, supported consolidated growth. Silicon carbide, power-conversion and military-related demand also increased.
- Segment performance: Quarterly Laser Solutions revenue declined 7% and operating income declined 48% because of weaker Asian semiconductor and industrial capital-equipment demand, softer datacom demand and 3D sensing delays. Photonics revenue increased 36% and operating income increased 48%. Performance Products revenue increased 15%, but operating income declined 6% because of yield and quality issues.
- Expenses: Internal research and development increased to $36.0 million for the quarter and $103.0 million year to date, reflecting investment in 5G and other new technologies. SG&A included $3.9 million of Finisar merger expenses in the quarter and $11.0 million year to date.
- Tax rate: The year-to-date effective tax rate decreased from 30.9% to 15.5%, primarily because the prior-year period included Tax Cuts and Jobs Act transition-tax effects and the current year benefited from valuation-allowance reversals associated with acquisition deferred tax liabilities.
- Acquisitions: II-VI acquired CoAdna for approximately $85.0 million in September 2018, a product line for approximately $10.0 million in November 2018 and Redstone Aerospace for approximately $29.7 million, including the fair value of contingent consideration, in March 2019.
- Accounting: The company adopted ASC 606 revenue recognition on July 1, 2018 using the modified retrospective method. It reported no material opening-equity adjustment or material effect on revenue timing.
Outlook, Transactions, Risks and Unusual Items
- Management expects internal research and development to represent approximately 10% to 13% of revenue during the remainder of fiscal 2019.
- II-VI and Finisar shareholders approved the proposed merger on March 26, 2019. The transaction remained subject to additional closing conditions, including review and approval by China’s State Administration for Market Regulation. Management expected closing around mid-2019 but stated that completion was not assured.
- The proposed transaction contemplated approximately 60% cash and 40% II-VI stock consideration. II-VI arranged $1.625 billion of senior secured facilities and anticipated an additional term B facility of up to $800 million, but the new facilities were not yet available or funded as of March 31, 2019 because merger-related conditions remained unsatisfied.
- Management identified risks related to international operations, foreign exchange, technology development, product acceptance, acquisitions and integration, Finisar completion and financing, supply chains, competition, customer purchasing patterns, data breaches, regulation, trade restrictions, natural disasters and potential goodwill or intangible-asset impairment.
- The company reported continued delays in its 3D sensing program, manufacturing under-absorption, production yield and quality issues, and merger and acquisition-related expenses.
- Variable-rate debt exposure was approximately $207.7 million. A 1% increase in applicable interest rates would have increased interest expense by approximately $1.3 million for the quarter and $3.9 million year to date.
- Foreign currency forward contracts were used to manage exposure to the Japanese yen, Chinese renminbi and other currencies. A 10% yen exchange-rate change would have affected quarterly revenue by an estimated range of negative $2.5 million to positive $3.0 million.
- Management stated that operating cash flow, cash reserves and available borrowing capacity were expected to fund working capital, capital expenditures, scheduled debt payments, research and development, the planned Finisar merger and other objectives over the next twelve months.
- Legal and regulatory proceedings were described as incidental to the business; management believed any resulting liabilities would not materially affect financial condition, liquidity or results of operations.
Most Important Facts to Verify
- Confirm the intended issuer and period: the source is II-VI Incorporated’s March 31, 2019 Form 10-Q, not a Coherent Corp. filing or a 2018 third-quarter filing.
- Verify whether the Finisar merger closed, the final merger consideration, and the final amount and terms of acquisition financing after the reporting date.
- Assess the sustainability of revenue growth in optical communications and 5G against the reported weakness in datacom, Asian capital equipment and 3D sensing.
- Monitor gross-margin recovery, including product mix, 3D sensing capacity utilization and Performance Products yield and quality issues.
- Reconcile reported debt, available liquidity and post-merger leverage with the planned senior secured facilities and Finisar debt refinancing.
- Review acquisition accounting, including preliminary goodwill and intangible-asset valuations for CoAdna, the product line and Redstone, and any subsequent impairment or purchase-price adjustments.
- Evaluate working-capital trends, particularly the increase in accounts receivable and inventory, and the company’s ability to sustain operating cash flow while capital expenditures remain elevated.