Business Context and Reporting Period
This filing is a Form 10-Q for II-VI Incorporated, not Coherent Corp. It covers the three months ended September 30, 2018, the first quarter of fiscal 2019. The company develops and manufactures engineered materials, optoelectronic components, photonic products and related systems for industrial, optical communications, consumer electronics, military, semiconductor, medical and automotive applications.
The company realigned its operating segments effective July 1, 2018: Laser Systems Group moved to II-VI Photonics, and Integrated Photonics, Inc. moved to II-VI Performance Products. Prior-period segment data was restated. The company also acquired CoAdna in September 2018.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $314.4 million | $261.5 million | +20% |
| Gross profit | $123.9 million | $106.0 million | +17% |
| Gross margin | 39.4% | 40.5% | Down 110 basis points |
| Operating income | $37.2 million | $29.8 million | +25% |
| Earnings before taxes | $32.3 million | $26.9 million | +20% |
| Net earnings | $26.1 million | $21.1 million | +24% |
| Diluted EPS | $0.40 | $0.32 | +25% |
| Effective tax rate | 19.1% | 21.4% | Down 230 basis points |
| Operating cash flow | $19.0 million | $12.4 million | +53% |
Revenue growth was driven by optical communications demand in the United States and China, China broadband expansion, datacenter and U.S. metro upgrades, VCSEL demand in consumer electronics and datacom, silicon carbide demand, and military-related optical products.
Internal research and development expense increased to $33.2 million, or 10.6% of revenue, from $25.6 million, or 9.8%. SG&A increased to $53.5 million from $50.6 million, but declined to 17.0% of revenue from 19.3%. SG&A included approximately $1.9 million of CoAdna transaction expenses.
Segment Performance
| Segment | Revenue | Revenue Change | Operating Income | Operating Income Change |
|---|---|---|---|---|
| II-VI Laser Solutions | $106.2 million | +21% | $12.3 million | +356% |
| II-VI Photonics | $135.1 million | +16% | $15.9 million | -21% |
| II-VI Performance Products | $73.1 million | +27% | $9.0 million | +29% |
Cash Flow, Balance Sheet and Liquidity
- Cash and cash equivalents were $271.3 million at September 30, 2018, compared with $247.0 million at June 30, 2018.
- Operating cash flow was $19.0 million. Capital expenditures were $35.9 million, and cash used for acquisitions was $45.2 million.
- Investing cash outflow was $85.6 million, including $4.5 million for a 10% equity investment in a privately held company.
- Financing cash inflow was $93.0 million, primarily reflecting $120.0 million of credit-facility borrowings less $25.0 million of repayments.
- Total debt was $537.1 million, compared with $439.0 million at June 30, 2018. Debt included $345.0 million principal of 0.25% convertible senior notes due 2022, $240.0 million of U.S. credit-facility borrowings, $2.6 million of yen-denominated borrowings and other obligations.
- Available borrowing capacity was $146.3 million, down from $246.4 million at June 30, 2018. The company stated that it was in compliance with its financial covenants.
- Total assets were $1.881 billion and shareholders’ equity was $1.044 billion at September 30, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue increased $52.9 million, or 20%, with growth across most business units.
- Gross margin declined from 40.5% to 39.4%, primarily because of pricing pressure in China and a shift toward lower-margin products.
- Net earnings increased $5.0 million, supported by higher revenue, incremental margin, and a lower effective tax rate, partially offset by increased R&D and interest expense.
- Interest expense increased to $5.6 million from $3.6 million because of higher debt levels. Convertible-note interest included $3.1 million of noncash discount and issuance-cost amortization.
- Comprehensive income decreased to $15.6 million from $32.3 million, primarily because of a $10.7 million foreign-currency translation loss versus a $11.1 million gain in the prior year.
- Accounts receivable increased to $229.1 million from $215.0 million and inventories increased to $265.1 million from $248.3 million at June 30, 2018.
- The company adopted ASC 606 revenue recognition on July 1, 2018 using the modified retrospective method. The adoption did not require an opening equity adjustment and did not materially change revenue recognition.
Guidance, Outlook, Commentary and Risks
- Management expects internal R&D to remain approximately 10% to 11% of revenue during the remainder of fiscal 2019.
- Management stated that operating cash flow, cash reserves and borrowing capacity should fund working capital, capital expenditures, scheduled debt repayments, R&D, share repurchases and growth objectives for the next twelve months.
- The September 2018 acquisition of CoAdna was valued at approximately $85.0 million net of cash acquired. CoAdna contributed approximately $3.0 million of revenue in the quarter; its net earnings contribution was immaterial. Purchase accounting remained preliminary.
- Management identified risks from pricing pressure, product mix, international operations, foreign exchange, technology and product-development execution, customer demand, competition, supply-chain disruptions, acquisitions, goodwill impairment, data breaches, regulation, trade restrictions and trade wars.
- Approximately $215 million of the company’s $271.3 million cash balance was held outside the United States at September 30, 2018. Repatriation plans remained subject to evaluation under the Tax Cuts and Jobs Act.
- The company had $13.8 million of gross unrecognized tax benefits and remained subject to various U.S. and foreign tax examinations.
- Contractual obligations totaled approximately $821.6 million, including $591.5 million of debt obligations, $126.8 million of operating leases, $24.9 million of capital-lease obligations and $40.3 million of purchase obligations.
- A 1% increase in interest rates on variable-rate borrowings would have increased quarterly interest expense by approximately $0.7 million. Foreign-currency movements, particularly involving the yen, renminbi and euro, could materially affect results.
- Management stated that pending legal and regulatory proceedings were not expected to materially affect financial condition, liquidity or results of operations, although outcomes remain uncertain.
Important Facts for Investors to Verify
- Confirm the issuer identity: the supplied filing is for II-VI Incorporated, while the request metadata identifies Coherent Corp.
- Assess whether optical communications pricing pressure in China and lower-margin product mix persist and affect gross margin.
- Review the final purchase-price accounting and subsequent operating performance of CoAdna.
- Monitor leverage, borrowing capacity, variable-rate exposure and the 2022 convertible notes.
- Evaluate whether elevated accounts receivable, inventories and capital expenditures convert into sustained operating cash flow.
- Track the effect of foreign exchange, trade restrictions and international market conditions on revenue and comprehensive income.
- Review the eventual impact of the Tax Cuts and Jobs Act, uncertain tax positions and ongoing tax examinations.
- Confirm whether management’s expectation that liquidity will fund operations, investments and scheduled debt repayments remains valid.