Business Context and Reporting Period
This Form 10-Q was filed by II-VI Incorporated, not Coherent Corp.; the request metadata identifies Coherent Corp., so the issuer identity should be verified. The report covers the three months ended September 30, 2017, the first quarter of fiscal 2018. II-VI develops and manufactures engineered materials, photonic and optoelectronic components for industrial, optical communications, military, life sciences, semiconductor equipment, medical and consumer markets. Its reportable segments are II-VI Laser Solutions, II-VI Photonics and II-VI Performance Products.
Key Financial Metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $261.5 million | $221.5 million | 18% increase |
| Gross profit / margin | $106.0 million / 40.5% | $87.6 million / 39.5% | Margin up 100 basis points |
| Earnings before taxes | $26.9 million | $23.8 million | 13% increase |
| Net earnings / margin | $21.1 million / 8.1% | $16.3 million / 7.4% | 30% increase |
| Diluted EPS | $0.32 | $0.26 | Increase of $0.06 |
| Operating cash flow | $12.4 million | $19.5 million | Decrease of $7.1 million |
| Capital expenditures | $37.4 million | $30.0 million | Increase of $7.4 million |
Interest expense was $3.6 million, compared with $1.2 million in the prior-year quarter. The effective tax rate declined to 21.4% from 31.7%, primarily reflecting the company’s foreign operations and prior-year U.S. valuation-allowance effects.
Segment Performance
| Segment | Revenue | Revenue Change | Operating Income | Operating Income Change |
|---|---|---|---|---|
| II-VI Laser Solutions | $93.3 million | 18% increase | $3.3 million | 51% decrease |
| II-VI Photonics | $110.6 million | 15% increase | $19.5 million | 40% increase |
| II-VI Performance Products | $57.6 million | 24% increase | $7.0 million | 126% increase |
At September 30, 2017, cash and cash equivalents were $241.3 million, down from $271.9 million at June 30, 2017. Total debt obligations were $471.5 million, compared with $343.5 million at June 30, 2017. Available borrowing capacity increased to $285.6 million from $73.5 million. Total assets were $1.584 billion and shareholders’ equity was $943.8 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was broad-based across all three segments, driven by industrial, communications and semiconductor capital equipment demand.
- Gross margin expanded to 40.5% due to incremental margin on higher volume and favorable product mix.
- Operating cash flow declined because of increased inventory and other working-capital needs and losses and research investment related to the newly acquired compound-semiconductor business.
- In August 2017, the company acquired Kaiam Laser Limited for $79.5 million net of cash acquired. Kaiam contributed $0.6 million of revenue and a $3.7 million net loss in the quarter.
- The company issued $345.0 million principal amount of 0.25% convertible senior notes due 2022, receiving approximately $336 million of net proceeds after discounts and offering expenses.
- Proceeds from the notes were used to repay $257.0 million of revolving-credit borrowings, fund debt issuance costs and repurchase approximately $49.9 million of common stock, or 1,414,900 shares.
- II-VI Photonics included the June 2017 acquisition of Integrated Photonics, Inc., which contributed $5.4 million of revenue and $0.4 million of net earnings in the quarter.
- Foreign-currency translation generated $11.1 million of other comprehensive income, compared with a $0.6 million loss in the prior-year quarter.
Outlook, Commentary, Risks and Unusual Items
Management cited strong demand for extreme ultraviolet lithography diamond optics, industrial lasers, Datacom optics, communications products, silicon carbide substrates, thermal systems and semiconductor equipment components. Management expects continued investment in high-volume VCSEL and other engineered-material platforms, with internal research and development expense expected to remain near the current percentage of revenue. The company also expects to pursue acquisition synergies and improve SG&A leverage during fiscal 2018.
Laser Solutions profitability was pressured by the Kaiam operating loss, $1.0 million of acquisition transaction costs and continued VCSEL investment ahead of anticipated volume shipments. Performance Products operating income included a $0.6 million gain from settlement of a customer dispute.
Management believes operating cash flow, cash reserves and borrowing capacity will fund working capital, capital expenditures, scheduled debt and lease payments, research and development, repurchases and growth objectives for the next twelve months. Approximately $188 million of cash was held outside the United States at September 30, 2017, and the company noted potential tax consequences of repatriation.
- The convertible notes have an initial conversion price of $47.06 per share, mature September 1, 2022 and were not convertible as of September 30, 2017.
- The company was in compliance with the financial covenants under its credit facilities and Yen facility.
- A 1% increase in interest rates would have increased quarterly interest expense by approximately $1.2 million based on the reported borrowing profile.
- Foreign-exchange exposure remains material, particularly for the Japanese Yen, Chinese Renminbi and Euro. A 10% Yen movement could have affected quarterly revenue by approximately $1.7 million to $2.1 million; a 10% Euro movement could have affected net earnings by approximately $1.0 million to $1.2 million.
- Aggregate contractual obligations were $617.6 million, including debt, interest, capital and operating leases and purchase obligations.
- The company identified risks related to international operations, rapidly changing technology, product acceptance, acquisitions and integration, supply chain matters, intellectual property, regulation, cybersecurity, competition, customer purchasing patterns and potential goodwill or intangible-asset impairment.
Facts an Investor Should Verify
- Confirm the correct issuer: the filing text identifies II-VI Incorporated, while the request metadata identifies Coherent Corp.
- Reconcile total debt obligations of $471.5 million with the balance-sheet debt presentation and the $345.0 million convertible-note issuance.
- Assess whether Kaiam’s $3.7 million quarterly loss and VCSEL investment are temporary integration costs or indicators of sustained segment pressure.
- Monitor working-capital growth, particularly the increase in inventories to $224.5 million and the decline in operating cash flow.
- Evaluate the execution and expected returns from the Kaiam and IPI acquisitions, including preliminary purchase-price allocations and contingent earnouts.
- Review the potential effect of future adoption of the revenue-recognition standard, for which the company stated that commercial-business impacts could not yet be estimated.
- Track convertible-note dilution, refinancing or repayment requirements, covenant compliance and the company’s ability to fund capital expenditures and scheduled obligations.