II-VI Incorporated — Form 10-Q Summary
Reporting period: Three months ended September 30, 2016, the first quarter of fiscal 2017. The supplied filing is for II-VI Incorporated, not Coherent Corp.; this company-name discrepancy should be verified.
Business context
II-VI develops and manufactures engineered materials, optical and optoelectronic components, and related products for industrial, optical communications, military, medical, semiconductor, consumer, and other markets. Reportable segments are II-VI Laser Solutions, II-VI Photonics, and II-VI Performance Products. Results include the EpiWorks and ANADIGICS acquisitions completed in fiscal 2016.
Key financial metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Bookings | $244.3 million | $187.2 million | +31% |
| Revenue | $221.5 million | $189.2 million | +17% |
| Gross profit | $87.6 million | $71.2 million | +23% |
| Gross margin | 39.5% | 37.6% | +190 bps |
| Operating income | $23.7 million | $21.7 million | +9% |
| Operating margin | Approximately 10.7% | Approximately 11.5% | Down approximately 80 bps |
| Net earnings | $16.3 million | $17.2 million | -5% |
| Diluted EPS | $0.26 | $0.27 | Down $0.01 |
| Operating cash flow | $19.5 million | $22.2 million | -12% |
| Capital expenditures | $30.0 million | $9.4 million | Significantly higher |
Revenue was geographically concentrated outside the United States: international revenue was $152.2 million versus domestic revenue of $69.3 million. Internal research and development increased to $21.8 million, or 9.8% of revenue, from $13.2 million, or 7.0%.
Liquidity, debt, and balance sheet
- Cash and cash equivalents were $220.1 million at September 30, 2016, compared with $218.4 million at June 30, 2016. Approximately $193 million was held outside the United States.
- Total debt was $250.0 million, up from $235.9 million at June 30, 2016. Net cash exceeded total debt by approximately $29.9 million.
- Available borrowing capacity increased to $178.7 million from $37.7 million following the amended credit facility.
- The July 2016 amended credit facility provides a $325 million revolving facility and a $100 million term loan, maturing July 27, 2021. The term loan requires quarterly $5 million principal installments beginning October 1, 2016, followed by a final maturity payment.
- The company was in compliance with all financial covenants at September 30, 2016. Weighted-average borrowing cost was 2.0% for the quarter.
- Total assets were $1.228 billion and shareholders’ equity was $800.6 million. Inventory increased to $182.6 million from $175.1 million.
Material changes versus the prior comparable period
- Bookings increased 31%, led by II-VI Photonics, whose bookings rose 60% to $104.6 million.
- II-VI Photonics revenue increased 33% to $95.8 million and operating income increased 121% to $13.9 million, driven by China broadband initiatives, data-center expansion, 100G metro deployments, undersea networks, 980nm pumps, and optical amplifiers.
- II-VI Laser Solutions revenue increased 11% to $79.3 million, but operating income declined 45% to $6.7 million. The quarter included $5.8 million of acquisition-related revenue and $1.5 million of acquisition-related operating losses, along with higher research and development spending.
- II-VI Performance Products revenue increased 2% to $46.4 million, while operating income declined 6% to $3.1 million.
- Gross margin improved due to higher volume, operating efficiencies, favorable product mix, and a $1.6 million insurance-proceeds reduction in cost of goods sold related to prior flooding in Fuzhou, China.
- Net earnings declined despite higher revenue and gross profit because of increased research and development spending and a higher effective tax rate. The effective tax rate rose to 31.7% from 22.2%, partly because of increased tax reserves related to ongoing audits.
- Operating cash flow declined while capital expenditures increased substantially to support capacity and technology investments, including high-volume VCSEL capabilities.
Outlook, risks, contingencies, and unusual items
- Management expects internal research and development spending as a percentage of revenue to increase as the company invests in its high-volume VCSEL technology platform and new products.
- Management stated that operating cash flow, cash reserves, and borrowing capacity should fund working capital, capital expenditures, debt repayments, research and development, share repurchases, and growth objectives for the next twelve months.
- The company recognized $1.25 million of contingent consideration income during the quarter from the sale of the ANADIGICS RF business. Up to $5.0 million of such consideration may be earned based on future wafer-supply volumes through December 2017.
- The EpiWorks acquisition includes up to $6.0 million of additional cash earnouts based on capacity, wafer output, and gross-margin targets. The recorded fair value of the earnout liability was $4.4 million at September 30, 2016.
- Contractual obligations totaled $373.5 million, including $250.0 million of debt, $64.9 million of operating leases, $39.9 million of purchase obligations, and $18.7 million of estimated interest payments.
- Key risks include international operations and currency exposure, rapidly changing technology, product acceptance, acquisition integration, goodwill or intangible-asset impairment, economic and industry conditions, intellectual-property protection, regulation, data breaches, supply-chain disruptions, competition, customer purchasing patterns, and catastrophic events.
- Foreign currency forward contracts had a total notional amount of $12.2 million. A 10% change in the yen-dollar exchange rate could have changed quarterly revenue by approximately negative $1.6 million to positive $2.0 million. A 10% euro-dollar change could have changed net earnings by approximately negative $1.9 million to positive $2.4 million.
- Legal proceedings were described as ordinary-course matters that management believes will not materially affect financial condition, liquidity, or results of operations, although unfavorable outcomes remain possible.
- Disclosure controls and procedures were deemed effective, and no material changes to internal control over financial reporting were reported.
Investor verification items
- Verify the apparent mismatch between the requested company, Coherent Corp., and the filing registrant, II-VI Incorporated.
- Assess whether the strong bookings growth, particularly in Photonics, converts into sustained revenue and margin growth.
- Monitor the effect of elevated research and development spending and acquisition-related losses on future profitability.
- Review capital-expenditure requirements and cash conversion, given $30.0 million of quarterly capital expenditures versus $19.5 million of operating cash flow.
- Evaluate leverage, floating-rate exposure, covenant headroom, and the scheduled term-loan repayments.
- Review tax-audit developments, including $7.3 million of gross unrecognized tax benefits and ongoing New Jersey and Vietnam examinations.
- Confirm the accounting and future cash impact of EpiWorks earnouts, ANADIGICS contingent consideration, and the January 2017 capital lease.