Business Context and Reporting Period
The source is II-VI Incorporated’s Form 10-K for the fiscal year ended June 30, 2019, filed August 16, 2019. The request metadata identifies Coherent Corp. and “2018 Q4,” but the provided filing is not a Coherent filing and does not report a standalone 2018 fourth quarter. II-VI develops and manufactures engineered materials, optoelectronic components, devices and subsystems serving communications, industrial materials processing, aerospace and defense, semiconductor capital equipment, life sciences, consumer electronics and automotive markets.
Fiscal 2019 operations were reported in three segments: II-VI Laser Solutions, II-VI Photonics and II-VI Performance Products. Effective July 1, 2019, the Company reorganized into Compound Semiconductors and Photonic Solutions for fiscal 2020 reporting.
Key Financial Metrics
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Revenue | $1,362.5 million | $1,158.8 million | 18% increase |
| Gross profit | $521.3 million | $462.2 million | 13% increase |
| Gross margin | 38.3% | 39.9% | Down 160 basis points |
| Operating income | $148.7 million | $136.8 million | 9% increase |
| Earnings before income taxes | $128.8 million | $122.2 million | 5% increase |
| Net earnings | $107.5 million | $88.0 million | 22% increase |
| Diluted EPS | $1.63 | $1.35 | 21% increase |
| Operating cash flow | $178.5 million | $161.0 million | 11% increase |
| Capital expenditures | $137.1 million | $153.4 million | 10% decrease |
| Cash and equivalents | $204.9 million | $247.0 million | 17% decrease |
| Total debt | $467.0 million | $439.0 million | 6% increase |
Working capital was $542.3 million at June 30, 2019, compared with $525.4 million in the prior year. The Company reported $211.9 million of available borrowing capacity. Approximately $173 million of cash was held outside the United States. Management stated that operating cash flow, cash reserves and available borrowing capacity were expected to fund working capital, capital expenditures, debt service, research and development, acquisition-related costs and other objectives through at least fiscal 2020.
Fiscal 2019 bookings were approximately $1.4 billion, compared with $1.2 billion in fiscal 2018. Backlog increased to approximately $500 million from $450 million.
Segment Performance
| Segment | Fiscal 2019 Revenue | Fiscal 2018 Revenue | Fiscal 2019 Operating Income |
|---|---|---|---|
| II-VI Laser Solutions | $396.6 million | $405.9 million | $40.3 million |
| II-VI Photonics | $638.8 million | $486.5 million | $81.9 million |
| II-VI Performance Products | $327.0 million | $266.4 million | $42.2 million |
Photonics revenue increased 31%, driven primarily by optical communications demand, including ROADM and related products supporting broadband and 5G network deployments. Performance Products revenue increased 23%, led by SiC products for RF electronics, power conversion and automotive applications, as well as aerospace and defense demand. Laser Solutions revenue declined 2% because of lower industrial demand for CO2 and fiber laser optics and components.
Material Changes Versus the Prior Comparable Period
- Revenue increased 18%, while net earnings increased 22%, primarily from incremental margin on higher sales volume and a lower effective tax rate.
- Gross margin declined to 38.3% from 39.9%. Photonics experienced a lower-margin product mix, while Laser Solutions incurred manufacturing under-absorption associated with delayed and underutilized 3D-sensing capacity.
- Internal research and development expense rose to $139.2 million from $116.9 million, remaining approximately 10% of revenue. Management expects research and development investment to remain within a 10% to 15% revenue range.
- Fiscal 2019 included approximately $18.6 million of acquisition and integration expenses, including approximately $15.6 million related to the pending Finisar transaction.
- The effective tax rate declined to 16.6% from 28.0%. Fiscal 2018 was adversely affected by the Tax Cuts and Jobs Act and transition tax.
- Acquisitions completed during fiscal 2019 included CoAdna, a product line and Redstone Aerospace. Aggregate cash used for business acquisitions was $83.1 million.
- Cash declined by $42.2 million during fiscal 2019 as operating cash flow was more than offset by capital expenditures, acquisitions and other investing and financing uses.
- The Company adopted ASC 606 using the modified retrospective method on July 1, 2018. Management reported no significant impact on fiscal 2019 results, liquidity or financial position.
- The Company expects adoption of the new lease standard in fiscal 2020 to increase assets and liabilities by approximately $90 million to $120 million.
Guidance, Outlook, Commentary and Unusual Items
The filing does not provide a specific fiscal 2020 revenue or earnings forecast. Management described continued investment in 5G, 3D sensing, SiC, optical communications, high-power lasers, aerospace and defense and other engineered-material applications. The Company expects research and development spending to remain approximately 10% to 15% of revenue.
The pending acquisition of Finisar remained subject to outstanding closing conditions, including review and approval by China’s State Administration for Market Regulation. The parties expected completion in the second half of calendar 2019, but stated that completion could be delayed or not occur. The transaction contemplated approximately 60% cash and 40% II-VI stock consideration. Financing arrangements included a $1.255 billion Term A facility, a $450 million revolving facility and a separately committed Term B facility of up to $720 million; no borrowings were outstanding under the new facilities at June 30, 2019 because merger-related funding conditions had not been satisfied.
Existing debt included $345 million principal amount of 0.25% convertible senior notes due 2022, a $115 million revolving credit borrowing, a $45 million term loan, a $2.8 million yen-denominated borrowing and other obligations. The Company was in compliance with its debt covenants. The convertible notes were not convertible as of June 30, 2019 and had a conversion price of approximately $47.06 per share.
Key risks include cyclical demand, customer concentration, international operations, foreign exchange, tariffs and trade restrictions, export controls, dependence on specialized suppliers and complex manufacturing processes, product defects, intellectual property claims, cybersecurity, environmental regulation, tax matters, acquisition integration and the financing and completion of the Finisar transaction. The Company reported no material loss contingency liabilities and stated that pending legal proceedings were not expected to materially affect financial condition, liquidity or results of operations.
Management and Ernst & Young LLP concluded that internal control over financial reporting was effective as of June 30, 2019. The assessment excluded CoAdna and Redstone, which represented approximately $98.1 million of total assets and $15.5 million of revenue for the fiscal year.
Investor Verification Priorities
- Verify the issuer and period: the supplied filing is II-VI Incorporated’s fiscal 2019 Form 10-K, not a Coherent Corp. 2018 fourth-quarter filing.
- Verify the closing status, final consideration, financing and debt impact of the Finisar acquisition.
- Review the decline in gross margin, particularly the Photonics product mix and 3D-sensing capacity utilization issues.
- Assess liquidity after acquisitions, capital expenditures and any financing required for Finisar, including the location and repatriation constraints of foreign cash.
- Review the effect of fiscal 2020 lease accounting adoption and the potential increase of $90 million to $120 million in reported assets and liabilities.
- Evaluate exposure to optical communications, industrial, semiconductor, automotive and aerospace cycles, as well as tariffs, export controls and China regulatory actions.
- Reconcile debt maturities, convertible-note dilution or cash-settlement requirements and compliance with applicable credit-facility covenants.
- Review acquisition-related purchase-price allocations and goodwill and intangible-asset impairment assumptions, which rely on forward-looking revenue and discount-rate estimates.