Coherent Corp. (COHR) Earnings Call Transcript & Summary

Great. Good morning. Thank you all for dialing in. I'm Samik Chatterjee. I cover the IT hardware and networking equipment stocks at JPMorgan. We're starting off these sessions for our coverage companies this morning with II-VI. We have the privilege of hosting CEO, Chuck Mattera; and CFO, Mary Jane Raymond for the fireside chat, virtual fireside chat this morning. So thank you both for joining in. Before I start with the Q&A portion, I would like to remind everyone listening in that there is the option that you can send your questions through the Q&A option on the Zoom platform. So if you send it through that, we'll pick it up and try to answer your questions as best as possible.

So let me get started here. Chuck, Mary Jane, thanks for joining the conference. Great set of results yesterday. I was just wondering if you could start with a brief recap for those who haven't maybe caught up with the earnings yesterday, and then we can get started from there.

It's Mary Jane. Yes. So we reported, last night, our press release, our investor presentation and actually our 10-Q are all already filed. So you should be able to find those. And I would imagine that, pretty shortly, the transcript will be up too. So it was a really, really great quarter for II-VI. We ended up having results that were actually 5% above the top end of our guidance of $600 million. We ended up reporting $627 million of revenue, which is somewhere in the neighborhood of about half of what we expected from a COVID impact. And we were only 6% down on what had been a remarkable quarter in the prior -- sequentially prior quarter of $666 million. The bookings were probably the main story. We had $640 million (sic) [ $840 million ] of bookings, and we recorded a backlog that was $893 million. The operating income on a GAAP basis was good, and our net income, our GAAP net income was positive in this quarter. So from a margin point of view, the company's non-GAAP gross margin was 38.3%, which is higher than our stand-alone margin in this quarter, the March 31 quarter of 2019. The non-GAAP operating margin at 13.3% (sic) [ 13.8% ] was equivalent to the company's stand-alone non-GAAP margin also at 12 -- sorry, 3/31 of 2019. We are qualified in Sherman. We are shipping from Sherman. We have also had our first shipments of indium phosphide components, which, for those of you who will remember the basic strategy of Finisar, one of the plans, just one of the plans was that we would begin to sell previously captive components to the merchant market, and that has just begun. So that's exciting because that adds about $2 billion to our composite TAM. Finally, I would also say that the liquidity in the quarter was very good, $746 million. So we have $388 million in cash. We have $358 million available on our revolver. We are well within all of our covenants. And with respect to our synergies, you may remember that we had $35 million as the first year target. And now we're halfway through the first year. Remember, the first year will end on September 23. And at this point, our thinking is that we will probably be, in the first year, about 50% ahead of that -- by the end of the first year, 50% ahead of that $35 million target. We're not changing the full 3-year target of 150 yet on just 6 months into it, but still very, very good progress there. Let me just see if Chuck Mattera, our CEO, would like to add anything.

Thank you very much, Mary Jane, and good morning. Thank you, JPMorgan, for hosting us this morning. It is an exciting time for us after finishing a remarkable quarter. In addition to what Mary Jane summarized for you, I'd like to say that I'm so pleased about the pace of the integration, and it's a remarkable fact the 2 companies have come together just a little more than 6 months ago, operating as if we worked together for 20 years, and it's made all the difference here in the quarter. So we're anxious to take your questions. Samik?

Great. Thank you. Thanks for that brief introduction to the results. Let me just try and break down. You mentioned the COVID impact coming in much lower than you had anticipated in the quarter. If you can break down the supply piece of that. I think if I remember correctly, when you were speaking in calendar 1Q there was kind of the anticipation that we would have supply chain-related constraints. Where do you stand today as you exit into kind of calendar 2Q? And how are you looking at constrains as well as kind of what are the constraints that you've resolved in the meantime?

All right. So -- go ahead.

Mary Jane, please. Go ahead. Go ahead.

When we entered -- when we were giving guidance for this 3/31 quarter, actually, there were a large number of things we were thinking about. Number one, keep in mind that our factory in China was going to be shut for at least 2 weeks. With probably a good 2,000 people still working over Chinese New Year, but we have 12,000 people in China. So the first thing was are the factories even operating. That's number one. Second one was the supply chain, exactly right, Samik. And the third one was a concern about whether or not, when people then began to reaggregate -- so they had been home for their Chinese New Year, many people in a different province. They come back to their working province, recongregate in the factory, we had actually a concern about whether the virus would spike, the very same conversation going on in the United States right now. So a couple of things from that. One, our factory was up and running by the middle of March. We did not see a virus spike in China. As COVID restrictions moved around the world, every one of our factories continued to work. So all of our factories are operating at this point. We did not see a virus spike. We had significant amounts of work done on social distancing, protective equipment, et cetera, et cetera. All of that has worked very well. And from a supply chain point of view, I wouldn't say that we had a significant amount of disruption. Keep in mind, we are our own supply chain to a lot of our factories. And while we have a -- every third day, a report that looks at critical supply constraints that we begin to work, we were not unduly hampered by that. And we do not see that necessarily as a significant problem going into the fourth quarter. But things could change, right? And I would also remark that sitting here on bookings of $840 million and a very, very strong lift that we're seeing on our communications market. Actually, if we see supply chain constraints, it could be just because the market is growing. And we're back to the same place we were in 2016 and '17, which is that we had a lot of our own lines sold out, and some of our suppliers were sold out. Chuck, would you like to add?

I think just in summary, our supply chain is a vertically integrated supplier. We have to manage, for our assembly and testing factories, strategic components we buy both from the outside and that we make inside. So in the March quarter, our main focus was on the strategic supply chain outside the company, and in our June quarter, as the lockdown started in both U.S. and in Europe, and that's where our wafer fabs are. And we started focusing on the impact, or potential impact, to our ability to ship from inside the company. Our guidance with a $50 million range and $650 million to $700 million for this quarter reflects the possibility that we still may have some impact from the supply chain, maybe in the June month. But so far, through April and the first few days of May, we have not experienced a problem, okay?

Okay. Great. So maybe then if we move to the demand side, we have heard about increasing bandwidth needs here from all the telecom service providers as a result of COVID-led disruption. And you mentioned as well, the record backlog that you have. Maybe just share your thoughts about what you're seeing on the demand side for telecom as well as datacom segments and how much do you think is kind of as a consequence of the COVID-led disruption?

This -- we reported in the last 12 months, how our passive component business was already beginning to feel the uptick associated with the 5G turn on. So this has been going on for us for almost a year. In comes Finisar. And in the last 6 months, I think a couple of things have happened. In the December quarter, we had the opportunity to meet and to communicate with all of the customers of Finisar and settle into a set of expectations of each other, that the integration was on its way that the scalable capacity we had in place and our willingness to work hard to be able to ramp for them in the coming 2 to 4 quarters, which would have been the month, the calendar year 2020. I think that positions us really well to be able to take additional business. I think we've won some business from our competitors. I think the baseline demand for 5G the ongoing deployments of the build-out of the legacy networks and market share gains on the telecom side. On datacom, in November, I said that I expect that the datacom market would start to warm up in the second half of the calendar year. I was wrong. It started in the March quarter for us. And it feels quite strong still. So I think what we're seeing is legacy telecom, 5G telecom and datacom all firing at the same time, along with having scalable capacity in the right place at the right time with large and growing customers who are quite satisfied with the broad portfolio and the experience they have in doing business with II-VI.

Maybe if we can dive a bit into the details of the datacom growth, you've now had a couple of quarters of very strong sequential growth in the datacom business. How should we think about the sustainability here? You mentioned you had visibility into that -- it ramping up in the second half. What's driving that visibility? And if you can kind of also share what you're seeing in demand trends from 400 gig versus 100 gig, which remains the mainstay at this point?

Okay. I think the -- our incredible backlog, along with ongoing bookings that are happening right now, meaning in the month of April, the month of May, conversations that are happening in June, and the scheduling of the deliveries in as many as 12 months out, is one evidence. Second evidence is we're being asked in that same set of conversations, how much faster and how much more capacity can we put in place beyond what we already have. Those conversations are not a result of somebody -- in my opinion, not a result of somebody who's trying to double or triple book existing capacity, but is looking out beyond the horizon and seeing a need for even more capacity to satisfy their requirements. That's the essence of it. And our intimacy with very large and growing customers in every region of the world tell us that this is not confined to a customer, a market segment or a region, okay?

Staying on datacom, we've seen the datacom module business being challenging for the companies in relation to margins. You mentioned yesterday, you had strong growth in component sales. But I think at the same time, you mentioned kind of flat 100-gig transceiver sales. So just wanted to understand what -- how to think about the mix of modules versus components in the datacom business. And what are the drivers that you are looking at to improve margins in that business over time?

Okay. All right. So first of all, the transceiver business was the biggest business of Finisar, without a doubt. So we have a large transceiver business in our company today, and datacom transceivers, they were the market maker and number one, and I believe they still are. That is today, means the transceiver business unit of II-VI. I think it's going to be a long time before the magnitude of our component sales approaches the magnitude of our transceivers. Meaning we have a long way to go to increase our component sales, and we're going to do that. As you all know, that's an explicit part of our strategy, is to serve the fullness of the market opportunity in front of us and to fully utilize our assets and our technology for the best possible outcome for II-VI. The costs are -- a large function of the cost are the utilization of our factories. That's number one. So we intend to fully utilize and figure out how to more fully utilize what we have. We'll be slow to add capital. You've seen us being a little bit slower than our published plans to add capital. And we have an intense focus on our cost, our operational excellence and a relentless drive to squeeze more out of what we have. We're going to keep doing that. At the same time, our strategic supply chain organization is doing a fantastic job. We're seeing price reductions in our supply chain that we never would have seen as part of II-VI. The Finisar strategic supply chain organization was well managed, well organized, and we're leveraging it now across the company. And as a large buyer, we're -- with long-term orders from customers, we're also able to negotiate long-term supply agreements with strategic suppliers in order to get the best deals we can to drive the cost down in our existing products, okay?

I would just also say, Samik, just to make sure we're kind of all level set. I mean Chuck answered perfectly, of course, on the components. But I want to make sure we're also kind of together here on something. First of all, our whole company, if you compare it to the 12/31 quarter, right, had declined due to the kind of the disruptions we had earlier in the quarter on COVID. So the fact that transceivers in the quarter were down, they were down exactly as much as the whole rest of the communications business. There was no change there. And if I compare that to what we reported at 12/31, when we were $40 million over the top end of our own forecast, we are still seeing a transceiver business that itself is beginning to recover, even on the module side. So that's actually important. When we talk about datacom, it is a breakthrough because it hadn't been done before to be talking about the start of sales of components. But we are not -- our comments about the rise of datacom here are not limited just to the component sales, we actually are beginning to see, as Chuck said earlier in the call, the refreshing of the sale of the so-called modules as well. And as he said, that helps quite a lot on the margin to be able to have the assets more fully utilized.

And I'm driving this company with its vertically integrated model, and I've issued a challenge to the team that in a relatively short period of time inside our 5-year plan that our transceiver business could be the most profitable business of II-VI. That's how determined we are to be able to make a difference.

Got it. Helpful. So let me move on from the datacom piece to kind of the broader topic of 5G investments that you're benefiting from. You're in a favorable position. But you mentioned a couple of times that you're very confident you'll win share in 5G investments that are happening globally. Maybe just outline what you're seeing that's driving that visibility into share growth. And similarly, kind of how are you looking at the competitive landscape? And what's driving your confidence about the share wins as well?

Our differentiated portfolio for pumps, passive components, amplifiers, switches and line cards, along with the lasers and the transceivers. That's it, in a nutshell. We offer a full line of components for lasers, optics and integrated circuits for what people need to be able to build their equipment for 5G. So we have that view. We have a clear view from our customers and a clear view of their position in the marketplace, including regionally. And our capacity additions, the forecasted additions in our capacity and the growth in the output and the design wins that we have give us great confidence that we're really in a strong differentiated position, Samik.

Maybe if we kind of focus on China as a geography here, as we've kind of gone through this earnings season, multiple other optical companies have mentioned to us expectations that there's an acceleration in 5G infrastructure deployment in China in the back half of the year. Just wanted to get your take on what you're hearing and what your expectations are related to that acceleration in the back half?

I think the comment about the second half of the calendar year is consistent with my earlier remarks about scheduling of orders out -- up to 12 months, conversations about how fast we can take up our capacity beyond the next 12 months. Those are all consistent with it. But I think for a company like ours, we're not able just to take a look only 2 quarters up. That wouldn't be of that much interest to us. What we see is a straight line up to the right on 5G for 3 to 5 years or 5 to 7 years up. And it we'll have some spikes and some peaks and some valleys, but we see it up and to the right for many, many years to come.

Got it. Just diving into the telecom business here. How -- can you break it down in terms of transport versus transmission products? And is there a separate trend that you're seeing individually in those segments? And is that any -- at all an indicator where the different geographies are in terms of their 5G investments?

We have not disclosed that difference between transport versus transmission. I would say, generally, what we have been saying, though, when I look at across our various divisions and their demands for CapEx. I would say that we are seeing demand across the board on all the products that we have. And Chuck may want to add something to this. So that's the first thing. As for, is it one geography or more? I think, first of all, there is -- it does seem to me that there's a view that it's all about China, and China certainly is a big market. And if you think about it, it's perhaps not unusual. It is a physically very big country, but the U.S. market has also been strong. And frankly, Japan remains strong and so does -- and I would say we're seeing some activity, let's call it, in Europe. I don't know that, that's as strong in Europe as it is every place else. But we have seen some relatively general kind of global demand for this on the major markets that are focused on upgrading their infrastructures. Chuck, what would you like to add?

China, very strong. Asia, strong. North America is strong. Europe moderate to strong. And India, at least as end item demand for our customers, seems to be muted at the moment. And likely, whether it be in the second half of this calendar year or in calendar year 2021, likely to begin to increase again. So we think it's just across the board although in some spots, it will be a little bit faster, in other spots, it will take a little bit longer time. But we think it's up and to the right for quite some time to come.

Got it. Let me ask you a kind of broader question here. And given kind of how the optical component industry has been shaped over the kind of past, what we've generally seen is that investors do hesitate to kind of invest in the optical component industry looking at the fragmented base of different suppliers, which makes it a very competitive landscape. We've seen a lot of consolidation in the kind of last couple of years itself, including your acquisition of Finisar. How have the fundamentals of the industry changed and kind of also the fundamentals that II-VI is now, kind of, positioned in to benefit from that? How has that changed? And should that necessarily change investor perception as well about the optical component industry?

Well, first of all, I think let's just talk about II-VI for a minute. I think the fact that we are fundamentally a materials company, and we are fundamentally a company that uses materials to harness and direct light power, that has led to what I think investors sometimes think is very complicated about us, which is our ability to play in multiple end markets. But what's interesting is that those very same materials are often usable, both in optical communications as well as industrial or military, et cetera. All that long story to tell you that we are probably the best diversified bet on optical communications. And when we are supplying components into this market, they have -- we are focused on the ones that are critical. We are focused on the ones that they -- that are enabling. You can't live without. And we're actually focused on the ones that not everybody makes. So our 980 pump is the best example of that, I think. Consequently, I think when people come at the optical communications industry, I think it's important to look at what companies are actually making. If they, for example, are just buying all the components and reassembling them, right? That's not that difficult to copy. But if you think about somebody that's actually creating a laser diode, I'm not saying that someone couldn't figure that out in a lab or a very excellent PhD in chemistry, but it's awful hard to make millions of them, unless you really know how to do it. So I think what people should look at when they're evaluating optical companies is, what do they actually do. And it's not that difficult, I think, to figure out which ones are kind of not only making the critical components, but are actually making them as opposed to just assembling stuff. Having -- and then I think it's important to see how people react to the competitive area. At II-VI, we are a materials company. But if we had a material that didn't end up having a 50-year life, it only had a 15-year life, we wouldn't keep it. We've not had much experience of having to sunset a material, but we did do it once. And we'd probably do it again if basically, what we found was the market is already doing this. It's not that difficult. We don't have that barrier to entry of know-how. I do think the consolidation helps. I think that allows more time with customers. I think that increases the customer intimacy. And I think that allows companies like ours, for example, to really be able to position what we do. Chuck, what would you like to add?

It's an interesting topic. As most of you know, I've been in this optical communications industry for almost 40 years, working, developing, innovating, observing. I would say that there are a few basic tenets over those 40 years. You cannot build any communications networks or have any communications infrastructure without 4 basic components: materials, lasers, optics and integrated circuits. And everyone who builds networks drives their economics to have the most efficient integration of those 4 elements. No matter how much innovation takes place at the subsystem level or at the system level or in the transmission format level, at the end of the day, you got 4 basic elements. You can't build a house without them. And that's what we're focused on. We have the strongest portfolio of technology, IP, of vertical integration, knowledge, trade secrets, scale, differentiation, know-how. And as time to market and time to volume and time to cost advantages continue to accrue to the system-level people, whether they be data center people or telecom people, they will continue to come back to the component in order to develop the next generation of disruption for them. That's where we're focused. And we think that we have an awful lot of room to drive more competitiveness and more enabling technology for the whole marketplace based on our unique characteristics and footprint as it relates to those 4 elements. And we're going to stick to it.

Great. Before I move to the interesting topic of 3D sensing, let me just remind attendees that they can submit a question if they want us to address it. Now just moving to the next topic here. Given the progress you have made with the Sherman plant, how should we kind of think about the prospects of shipping to the primary customer for the upcoming product cycle? And now that you've qualified what are the key drivers of volume allocation to II-VI as a supplier now that you're qualified with that customer?

Okay. We -- first of all, we have been qualified and for those who may not have heard our remarks yesterday, I said that our operations that we have been investing in centered around our Warren, New Jersey wafer fab with inputs from our Champaign, Illinois epitaxial wafer facility as well as our wafer probing facility in Easton, Pennsylvania. That supply chain, all U.S.-based, fully vertically integrated, 6-inch scalable manufacturing, that we have achieved our overall technology objectives, clearly. We have shipped hundreds of millions of VCSEL arrays, produced hundreds of millions of them in that supply chain, and we have a demonstrated process for high-yield and high-reliability, predictable manufacturing. As part of our priorities for the integration with Finisar, we put together the knowledge that we had developed years ahead in that supply chain that I just mentioned, and we covered the ground quite quickly in Sherman. We need to walk before we run, before we sprint, and that's what we're doing in Sherman. So we're off to the races. And for us to be able to achieve our overall business objectives, we need to have more business. In order to have more business, we need to have a broad portfolio, which we have invested in, and we need to be able to win increased share to more fully utilize the assets that we have. We're doing all of those. So we're ramping now, and we have additional and new devices to ramp, both in Sherman and in Warren, as we look out to the second half of this calendar year and the early part of the next calendar year. I think we're well positioned, and our goal is to be able to have the best 3D sensing VCSEL array that money can buy. Highest quality, on time, and a value proposition both for our customer and for us to win enough business to be a great value proposition for our shareholders. We're working on it.

Yes. Moving to the industrial segment. That's one of the segments that broadly investors had expected would be weak in the March quarter. I think overall, you had good performance on that in that segment as well, although I think you mentioned aftermarket was weak. So maybe just kind of, one, firstly, just remind us what that exposure is in terms of the industrial end market. And what are you seeing there with -- obviously, the recovery that you had expected seems to be maybe stretched out a bit more. But what are your current expectations in terms of growth outlook for that business?

Mary Jane, would you like to start out?

All of life would be easy if I could get off mute. Yes, sure. So first of all, the industrial business is 12% of our company. And yes, what was interesting is, if -- for those of you that might remember, in the 12/31 quarter, we saw what we thought was a pickup in the aftermarket because we hadn't seen much demand yet on the component growth that would indicate that we were looking at new laser builds. In this quarter, probably with people, in some cases, not being at work -- and that's what's required to use the laser so that we have to replace the aftermarket components. The component sales, particularly on the key enabling components, they are ones that are fundamentally required to actually make the laser. And that looked to us like it was more laser builds. I would say it's a little bit challenging for us because keep in mind that while we had some competitors, largely makers of new laser systems, reporting declines since the June 30, 2018, quarter, we have not actually seen declines until the September 30, 2019, quarter. So only for the last few quarters. And I think once COVID hit, we did kind of expect, and I think we talked about this at the time that the pickup we saw at the 12/31 quarter and the aftermarket did have some good chance of not actually being completely sequentially continuing even though we do think that's temporary. I mean, first of all, let's be clear, I don't think people are going back to cutting metal with tools. For any of you who ever worked in a factory 20 years ago, I mean, the downtime for that is just ridiculous. So I think laser power, laser cutting, laser utilization and processing is here to stay for absolute sure. But generally, if you think about the economic impacts of COVID, people have to have the money to buy a new car. They have to have the money to buy a new washing machine. I mean, obviously, if the one they have is leaking into the basement, they'll get a new one. But those will tend to be ones that are of the smaller demand, not the ones that would be, "okay, we're going to upgrade the whole house." And the need to cut goods, right, is important. The desire to have consumer goods, for example, that employ laser marking and engraving, all that demand has to happen. And so to some extent, that's the reason we always talk about that the industrial market is really tied to the GDP. It is completely about not only factories being utilized, but people buying those goods such that they need to be made and typically cut with a laser. So I think that's really the parameter that we're watching. Fortunately, as I said earlier, we do tend to sell our materials and components for different kinds of things, and we do see still some very, very good growth on the semiconductor capital equipment side. So that's keeping that factory pretty busy. But generally speaking, I'd say those are the main things that we're thinking about and we're looking at when we get to considering -- when we think industrial will recover.

Great. Unfortunately, we're out of time. But Chuck, Mary Jane, thanks a lot for participating at the conference and making this virtual conference happen. Thank you.

Thank you.

Absolutely. Thanks to JPMorgan. See you soon. Bye-bye.