Filing Context and Reporting Period
This is II-VI Incorporated’s unaudited Form 10-Q for the quarter and nine months ended March 31, 2020, filed May 11, 2020. The supplied metadata identifies “Coherent Corp.” and “2019 Q3,” but the filing itself identifies the registrant as II-VI Incorporated and the reporting period as fiscal 2020 third quarter. II-VI completed its acquisition of Finisar Corporation on September 24, 2019; reported results include Finisar from the acquisition date.
Financial Performance and Position
| Metric | Q3 FY2020 | Q3 FY2019 | Nine Months FY2020 | Nine Months FY2019 |
|---|---|---|---|---|
| Revenue | $627.0 million | $342.5 million | $1,633.8 million | $999.8 million |
| Gross margin | 39.2% | 37.2% | 31.7% | 38.3% |
| Net earnings (loss) | $5.9 million | $24.6 million | $(118.3) million | $79.5 million |
| Diluted EPS | $0.06 | $0.38 | $(1.43) | $1.21 |
| Operating cash flow | Not separately provided | Not separately provided | $120.5 million | $114.4 million |
- Q3 revenue increased 83%; nine-month revenue increased 63%, primarily reflecting Finisar, demand for optical communications products supporting 5G and data centers, 3D-sensing products, and aerospace and defense activity.
- Q3 gross margin improved 200 basis points year over year. Nine-month gross margin declined because of an $87.7 million Finisar acquired-inventory fair-value adjustment and the lower-margin mix of Finisar transceiver products.
- Q3 operating income was $69.0 million versus $31.1 million. Nine-month operating loss was $28.0 million versus operating income of $107.9 million.
- Research and development was $94.8 million in Q3 and $238.6 million for nine months, reflecting Finisar-related costs and continued investment in 3D sensing, 5G, indium phosphide, LIDAR and other technologies.
- Interest and other expense was $35.7 million in Q3 and $76.6 million for nine months, driven largely by acquisition-related debt. The nine-month period also included $4.0 million of debt extinguishment costs and a $5.0 million investment impairment.
- Cash and cash equivalents were $388.1 million at March 31, 2020, compared with $204.9 million at June 30, 2019. Total assets were $5.11 billion and shareholders’ equity was $2.02 billion.
- Inventories increased to $628.0 million from $296.3 million at June 30, 2019; accounts receivable increased to $496.4 million from $269.6 million.
Cash Flow, Debt and Liquidity
- Operating cash flow was $120.5 million for the first nine months, compared with $114.4 million in the prior-year period.
- Investing cash use was $1.15 billion, including $1.04 billion of net cash paid for Finisar and $108.0 million of capital expenditures.
- Financing cash flow was $1.21 billion, including $2.12 billion of new long-term borrowings, substantially offset by debt repayments, the $560.1 million Finisar Notes repayment and $63.5 million of debt issuance costs.
- Total debt was $2.28 billion at March 31, 2020, including $1.21 billion under the Term A Facility, $716.4 million under the Term B Facility, $90.0 million drawn on the revolving facility, and convertible notes. Aggregate revolving availability was $358.6 million.
- The Senior Credit Facilities provide aggregate commitments of $2.425 billion and are secured by substantially all assets of II-VI and its domestic subsidiaries. The company was in compliance with its financial covenants at March 31, 2020.
- Contractual obligations totaled $3.13 billion, including $2.38 billion of long-term debt obligations, $432.7 million of interest payments, and $189.4 million of lease obligations.
- Management stated that cash, committed borrowing availability and other liquidity arrangements were expected to satisfy working-capital, capital-expenditure, debt-repayment and operating requirements, although COVID-19 effects remained uncertain.
Material Changes and Unusual Items
- Finisar contributed $281.6 million of Q3 revenue and $610.4 million of nine-month revenue. It contributed $23.8 million of Q3 earnings but a $96.5 million nine-month loss, including amortization and restructuring expenses.
- Reported nine-month results included approximately $191.5 million of Finisar-related expenses, including $87.7 million of acquired-inventory fair-value expense, $32.8 million of acquired-intangible amortization, $25.3 million of investment-banker fees, $19.1 million of severance and related compensation, and other transaction and restructuring costs.
- Finisar acquisition accounting remained preliminary. The preliminary allocation included $963.9 million of goodwill and $669.7 million of acquired intangible assets; future measurement-period adjustments could be material.
- The company adopted the new lease standard on July 1, 2019 and recorded operating and finance lease liabilities. Operating lease liabilities were $114.2 million and finance lease liabilities were $23.7 million at March 31, 2020.
- An interest-rate swap with a $1.075 billion notional amount effectively converts part of variable-rate debt to a fixed rate of 1.52%; its March 31, 2020 fair value was a $35.3 million liability.
- Gross unrecognized tax benefits increased to $74.5 million from $11.5 million, largely due to uncertain tax positions assumed in the Finisar acquisition. The company was under examination in several U.S. and foreign jurisdictions.
Outlook, Risks and Management Commentary
- Management cited continuing demand for optical communications products, including transceivers, ROADMs, amplifiers, line cards and wavelength-selective switches, as well as demand in 3D sensing, aerospace and defense.
- COVID-19 caused temporary disruptions in China and affected customers, suppliers and facilities. Approximately 50% of global facilities were subject to government orders and approximately 10% were closed as of the filing; approximately $1.5 million of COVID-related payroll and operating costs were incurred in Q3.
- The company could not reasonably estimate the full financial impact of COVID-19. Principal risks include prolonged restrictions, supply-chain interruptions, workforce constraints, reduced customer demand, transportation disruption, foreign-exchange volatility and broader economic deterioration.
- Foreign-currency losses were $3.6 million in Q3 and $8.1 million for nine months. A 100-basis-point increase in unhedged variable borrowing rates would have increased interest expense by approximately $5.2 million in Q3 and $10.7 million for nine months.
- Management reported effective disclosure controls and procedures. Finisar represented 61.2% of consolidated assets at March 31, 2020 and 44.9% and 37.4% of consolidated revenue for Q3 and nine months, respectively; management intended to exclude Finisar from its fiscal 2020 internal-control effectiveness assessment as permitted by SEC rules.
Investor Verification Points
- Confirm the issuer and period: the filing is for II-VI Incorporated, quarter ended March 31, 2020, not Coherent Corp. or 2019 Q3.
- Assess the sustainability of reported earnings after removing Finisar acquisition costs, inventory fair-value charges, amortization, restructuring and other unusual items.
- Reconcile Finisar’s revenue contribution and preliminary purchase-price allocation as the measurement period is finalized.
- Monitor debt repayment requirements, leverage and interest-coverage compliance, including the 2022 convertible notes and secured-credit-facility covenants.
- Evaluate COVID-19 effects on facility availability, supply chains, customer demand, inventory levels and foreign-exchange losses.
- Review the $74.5 million of unrecognized tax benefits, related examinations and potential cash-tax exposure.
- Track whether operating cash flow remains sufficient to fund capital expenditures, debt service and acquisition integration requirements.