II-VI Incorporated Form 10-Q Summary
Filing-period note: The supplied filing is for II-VI Incorporated, not Coherent Corp. It covers the quarter and six months ended December 31, 2017, II-VI’s fiscal 2018 second quarter. The financial statements are unaudited.
Business Context and Reporting Period
II-VI develops and manufactures engineered materials, optoelectronic components and related products for industrial, optical communications, military, consumer electronics, semiconductor equipment, automotive, medical and other applications. Reportable segments are II-VI Laser Solutions, II-VI Photonics and II-VI Performance Products.
The period includes the August 2017 acquisition of II-VI Compound Semiconductor Ltd. and the June 2017 acquisition of Integrated Photonics, Inc. (IPI).
Financial Performance
| Metric | Three Months Ended December 31, 2017 | Three Months Ended December 31, 2016 | Six Months Ended December 31, 2017 | Six Months Ended December 31, 2016 |
|---|---|---|---|---|
| Revenue | $281.5 million | $231.8 million | $543.0 million | $453.3 million |
| Gross margin | 38.9% | 40.7% | 39.7% | 40.1% |
| Earnings before income taxes | $29.9 million | $31.8 million | $56.8 million | $55.7 million |
| Net earnings | $9.6 million | $23.9 million | $30.7 million | $40.2 million |
| Diluted EPS | $0.15 | $0.37 | $0.47 | $0.63 |
| Effective tax rate | Not separately stated | Not separately stated | 45.9% | 27.8% |
- Revenue increased 21% year over year in the quarter and 20% for the six-month period.
- Gross margin dollars increased, but gross margin percentage declined primarily because newer addressable markets had lower margin profiles.
- Quarterly and year-to-date net earnings declined despite revenue growth, primarily because of a provisional $15.8 million tax charge related to the Tax Cuts and Jobs Act, equivalent to approximately $0.24 per diluted share.
- Interest expense increased substantially following higher debt levels, including the convertible notes and borrowings under the credit facility.
Segment Results
| Segment | Q2 Revenue | Year-over-Year Change | Q2 Operating Income | Six-Month Revenue Change |
|---|---|---|---|---|
| II-VI Laser Solutions | $109.8 million | 35% increase | $9.5 million, up 25% | 26% increase |
| II-VI Photonics | $110.5 million | 10% increase | $16.9 million, up 6% | 12% increase |
| II-VI Performance Products | $61.1 million | 24% increase | $6.1 million, up 69% | 24% increase |
Management cited demand in consumer, communications, semiconductor capital equipment, automotive and industrial markets. Laser Solutions revenue benefited from VCSEL, industrial laser and diamond optics demand, while Photonics benefited from datacenter and optical communications demand. Performance Products benefited from silicon carbide and semiconductor equipment demand.
Cash Flow, Liquidity and Capital Structure
- Six-month operating cash flow was $59.7 million, compared with $58.7 million in the prior-year period.
- Investing cash outflow was $209.9 million, including $77.6 million of capital expenditures, $81.0 million for the Compound Semiconductor acquisition and $51.5 million for a 93.8% equity investment in a privately held technology company.
- Financing cash inflow was $126.2 million, principally reflecting issuance of $345.0 million of 0.25% convertible senior notes due 2022 and additional credit-facility borrowings.
- Cash and cash equivalents were $254.5 million at December 31, 2017, down from $271.9 million at June 30, 2017. Approximately $215 million was held outside the United States.
- Total debt obligations were $526.5 million, compared with $343.5 million at June 30, 2017. The debt included $345.0 million principal amount of convertible notes, $75.0 million of term debt, $100.0 million drawn on the revolving facility, $2.7 million of yen-denominated debt and $3.8 million assumed in the IPI acquisition.
- Available borrowing capacity was $225.6 million, compared with $73.5 million at June 30, 2017. The company was in compliance with its credit-facility and yen-facility covenants.
- Capital expenditures were $76.8 million in the first six months, compared with $57.8 million in the prior-year period.
Material Changes and Unusual Items
- The company issued $345 million of 0.25% convertible senior notes due September 2022. Net proceeds were approximately $336 million. The initial conversion price was $47.06 per share, and the notes were not convertible as of December 31, 2017.
- Approximately $49.9 million of the note proceeds funded the repurchase of 1,414,900 common shares.
- The Compound Semiconductor acquisition contributed $1.6 million of revenue and $6.2 million of net loss for the six months. Management stated that approximately $8.0 million had been invested in the business since acquisition to develop new technology platforms.
- The IPI acquisition contributed $10.3 million of revenue and $1.4 million of net earnings for the six months.
- The company recorded a provisional $15.8 million net tax charge under the Tax Cuts and Jobs Act. The estimate remained subject to change during the permitted measurement period.
- A $54.8 million equity-method investment was recorded following the November 2017 acquisition of a 93.8% economic interest. A $2.2 million liability was recorded for the related net put option.
- Goodwill increased to $272.2 million from $250.3 million at June 30, 2017, primarily due to the Compound Semiconductor acquisition and foreign-currency translation.
Outlook, Risks and Contingencies
Management stated that operating cash flow, cash reserves and available borrowing capacity were expected to fund working capital, capital expenditures, scheduled debt repayments, research and development, share repurchases and growth objectives for the next twelve months. No quantitative revenue or earnings guidance was provided in the supplied filing.
- Key risks include integration of recent acquisitions, execution of capacity and technology investments, product-market adoption, changing product mix and potential goodwill or intangible-asset impairment.
- The company is exposed to international operations, foreign-currency movements, interest-rate changes, supply-chain issues, competition, intellectual-property risks, cybersecurity incidents, governmental regulation and adverse economic or industry conditions.
- A 1% increase in interest rates would have increased interest expense by approximately $0.4 million for the quarter and $1.1 million for the six-month period.
- Legal proceedings are described as routine and incidental; management believes any resulting liabilities will not materially affect financial condition, liquidity or results of operations.
- The company expects approximately $1.8 million of additional fiscal 2018 contributions to its Swiss pension plan.
- Revenue recognition under ASC 606 was still under evaluation. The company preliminarily expected accelerated recognition for military-related contracts, which represented approximately 10% of consolidated revenue, but could not yet estimate the overall adoption impact.
Investor Verification Priorities
- Confirm the issuer identity: the supplied filing is II-VI Incorporated, while the request metadata identifies Coherent Corp.
- Separate reported operating performance from the $15.8 million provisional Tax Act charge and assess the eventual finalized tax impact.
- Evaluate whether revenue growth and new-market expansion can offset lower gross margins, higher research and development spending and increased interest expense.
- Review the integration, profitability and required investment levels of Compound Semiconductor Ltd. and IPI.
- Assess leverage, convertible-note dilution risk, debt maturities and compliance with credit covenants.
- Monitor cash conversion, inventory growth, capital expenditure requirements and the concentration of cash held outside the United States.
- Verify the valuation and future obligations associated with the 93.8% equity investment, net put option and contingent earnout arrangements.