Coherent Corp. (COHR) Earnings Call Transcript & Summary

Good evening. I'm Samik Chatterjee, the telecom, equipment and IT hardware analyst at JPMorgan. As we get ready to wrap up the CES Tech forum here in 2021, we have II-VI as the next company presenting. Definitely, if I remember kind of a few years ago, a couple of years ago when we hosted II-VI, there were probably still some investors who hadn't looked at II-VI, but II-VI has had a transformative year in 2020, if share price is any indication. And I doubt there's anybody who doesn't know II-VI at this point from the investment community after the year you've had. So it gives me my pleasure to host Chuck Mattera, the CEO; and Mary Jane Raymond, the CFO at our conference. Chuck, Mary Jane, thanks a lot for the time today.

I think given the year you've had, I just wanted to like take the opportunity to start with a 2020 recap or kind of 2020 in hindsight, and kind of just open -- more of an open-ended discussion about as in to start looking at the 2020 performance, strong revenue growth, great margin improvement, how much of that should an investor attribute to kind of stand-alone II-VI delivering on its kind of strategic priorities versus some of the industry tailwinds that are probably helping on that front? And what have you seen in terms of market share gains, et cetera, that's driven that performance in 2020?

Mary Jane, would you like to start?

I can hit some of the highlights on and then leave it to Chuck to give you the more interesting punch line. I mean 2020 was a crazy year, right? I mean we had hardly started, and we were dealing with COVID. Our company started dealing with COVID in January because we have a very large footprint in China. We have about 12,000 people there. And we were already dealing with the economic effects of the second week of Chinese New Year. So I suppose sometimes you end how you start. So we started the year with all noses to the grindstone because we've started right in the middle of COVID. We assumed it would be a big deal. We got ready for it to be a big deal. And we started immediately to look at not only what the safety measures needed to be, but how we would both serve our customers, which included continuing to interact with them, but also interacting with the supply chain. That immediate focus, I think, served us very, very well. That even though we thought we'd have a $50 million revenue impact, it ended up being less than that in the 3/30 quarter. We got -- in the middle of that, we got Sherman qualified, kind of the big surprise we had when we closed Finisar learning that it was not qualified. And we ended up seeing a lot of positive things come to roost in the 6/30 quarter, when 3D sensing was shipping higher than it did in what is historically the largest quarter, that being 12/31, and some really outstanding bookings of another quarter starting with 800 and some fantastic revenue experiencing 20% sequential growth between 3/31 and 6/30. We then came into the 9/30 quarter. And even though it was lower than the 6/30 quarter, which we expected, was a very, very strong quarter, continued on strong margins, continued our process on very good OpEx control. And we lapped the 1-year mark on Finisar having moved the margins actually higher than they were where we last left them as II-VI stand-alone. And my comment to the market had been I expected to reach the II-VI stand-alone margins at the end of 3 years, and we got there in a year. We were 2x the revenue synergies at $80 million from the first year estimate of $35 million. We are seeing the industrial market, probably the one lagging market come back. We had a very successful equity raise. Thank you to our investors. And we began in earnest to work on silicon carbide devices for power electronics. So overall, I'd say it was a big a year. It's a good thing we started with our nose to the grindstone because it never came off.

Chuck, maybe I can follow-up on that. And one of the conversations I have quite frequently with investors is whenever they look at II-VI, they kind of feel like there are multiple irons in the fire that II-VI has. You have a range of kind of businesses you're in, like telecom, datacom and 3D sensing being the ones that investors focus most on, but then there is kind of silicon carbide and a range of other like segments you're in. So as a management team, particularly if we kind of look at the management team, you, Mary Jane, what are -- as we look at just 2021, what are the strategic priorities for the management team in 2021?

Okay. So for us, we have some unfinished business to do with the integration. Just a little bit for us to be able to put ourselves onto a strong footing for information technology. So we have to come to grips with the investment that we need to make to extend the scalability of this platform because we're not done growing. So access to -- real-time access to information in a rational, efficient way. That's a topic. That's an underlying topic as far as the build-out of our infrastructure in this enterprise. But as far as the rest of the business goes, we need to deliver on what we said we were going to deliver on. And we laid out a bold plan even in the face of a trade dispute and a pandemic. And we took no exceptions to anything other than our responsibility to put the assets that we have, those assets that we combine with Finisar together to the market leadership position that we intend to establish and to continue to grow. And we have the company organized. When you say investors are thinking we have a lot of things going on, we absolutely have a lot of things going on. When I joined the company 20 years ago as a Board member, there were 1,000 people and $75 million in sales. And I had a lot of things going on. And at the scale that we're at, we're still small relative to the overall market opportunity that we have. And that's our mindset, where we're kind of stuck in this $10 billion start-up mode, where we have to create value through managing a process for innovation, a process for scale and a process that we have well-honed to disrupt. I mean we are disruptive in the market and we are disruptors. And we have a long-term vision, including, for example, the example you gave on silicon carbide, and we carved out a whole new initiative that's focused on that. And we brought in among the most seasoned communication semiconductor leaders in the world to help us manage it. And we -- so anyway, it's not at all -- it may look complicated or complex. And we're busy, but it's not at all complicated or complex, and we have a 200-person senior leadership team in the company. And we're thinking and acting like owners of II-VI in all of our endeavors. It's pretty exciting.

Mary Jane, if I can kind of throw that same question to you, but also keep kind of with some focus on the cash flow improvement that you've delivered in 2020, there's been sizable improvement in the cash generation. In addition to kind of that being a priority, what are the other priorities in terms of the cost side as well as what -- probably on the cash side, what are the drivers that you can focus on to improve cash generation further?

Right. Well, let's start with the cash flow. So last year, we had probably a little bit north of maybe $130 million to $150 million free cash flow and had not necessarily expected to generate that when we started. And of course, most of it came in the fourth quarter. I think the first priority was -- first of all, cash flow is a high priority. So let's start right there. And the first priority in the cash flow is the continuous education of our organization that cash flow is important. So for most investors, they may not realize this, but inside a company, you can get a management team to do a wonderful job managing the P&L. It's in their face every day, and we put it in their face every quarter, every month. Cash flow is a little bit harder plus it's a derived financial statement, right? So one of the things that we've done in the forecasting process is that we completely change it to require people to forecast the cash flow every month. We need them to practice doing that and really focus on it. And then that, coupled with our very excellent supply chain leader who has really worked on not only our inventory levels, but our terms with all of our suppliers to match those of our customers, I think, have been very, very good. Initial pieces of work to just get cash flow into people's everyday thinking. The largest driver of cash flow, of course, is profitable revenue. And as we now have all of our businesses that we're developing to launch, whether that be 3D sensing or silicon carbide devices beginning to launch. We have the profitable revenue that will generate the related cash flow. So that's probably the first thing for the company. Second of all, I think we continue to work on the readiness of our organization to scale to be a larger size. So that includes helping all of our colleagues on the management ranks as we have new colleagues join us. Being sure that they can join all their other II-VI colleagues and knowing how to read a P&L. Believe it or not, we require general managers to speak to their financials every month and not turn to their controller and do it. So we will continue to drive that because in my mind, that is the single biggest reason that II-VI has never reported a loss. People know what they're looking for, and they know how to make decisions early enough to avoid problems. And then from there, it's probably our ERP systems. Finisar brought us an extremely well deployed Oracle system. We had not really had that in II-VI in the past, and we probably never saw one company-wide, that had been done as well. It was beautifully deployed. So we are probably going to move a lot of the legacy processes of II-VI onto that over the next few years. And that will be a major improvement in the underlying infrastructure of the company.

Got it. Clear. Before I move on to some of the questions, just to note for investors on the line. You can send in your questions on chat, and we'll be happy to ask it on your behalf, definitely encourage you to send any questions and make it interactive. But also keep in mind, companies are in quiet period. So obviously, companies cannot get into specifics around the quarter as well. Chuck, Mary Jane, let's move into kind of some of the end markets here. Particularly if we focus on telecom, you've had a strong last 12 months. But as we look at the underlying market demand, particularly in relation to China, what are your conversations with customers there indicating because some of the recent headlines are starting to suggest some softness there flowing largely as the flow-through of the Huawei restrictions?

Okay. Let me start out with in our communications, optical communications business, since you started out with telecom, half of our business is telecom, half if datacom roughly. Our conversations right up until the end of the calendar year have all been positive and strong as far as the direction goes. The disruption associated with the Huawei band. I would say it's been reacted to in a quick and decisive way. We continue to be sought after to expand our capacity. And whereas there may be some signs that unfold, we're not seeing it now. So I mean I had discussions with senior executives and the largest customers of -- in China in the last 2 months of the calendar year. And they were all pointed in a very positive, favorable and strong endorsement for the value of II-VI and the special relationship that we have developed over the years. And I consider it all to be very, very strong signals for us.

Got it. One of the questions, Chuck, I get often, and I appreciate this might be difficult to quantify, but like people -- investors often hear that in terms of base stations, China is close to deploying 700,000 base stations in 2020. There's probably another kind of the looking at crossing 1 million or kind of round about that number next year. A question that often comes up is how to think about II-VI's content for base station? And I don't know if that's a right way to think about it, but just wanted to see if there's a way to quantify that.

We're not going to give you a number today. We've been asked that before. We have kind of an opportunity with the wireless infrastructure only as it relates to our sales silicon carbide substrates into the broad-based market that may serve the GaN HEMT market that's been well discussed. Most of the 5G opportunity we have and most of the opportunity that's associated with both datacom and telecom around mobility and a broad-based intelligent networking in the cloud, those things revolve around optical communications, components and subsystems. Whether it's for the front haul, the backhaul or the middle haul, the build-out of the fiber optic plant around the base station, we expect to be substantial. And I believe that we're well positioned with the portfolio that we have to be able to lead in that segment. So for us, it's an important driver. But as far as base station content goes, I don't have a figure of merit for you, Sam.

Okay. Can we -- then keeping on the telecom segment for one more question here, kind of compare the -- what you're seeing in China in terms of demand? And how would you compare that to what you're seeing in North America and Europe, particularly when some of the system suppliers like Ciena have called out a slowdown in new deployment activity and kind of they've kind of made that comment over the last couple of quarters. So just wanted to see how you're looking at the contrast between demand in China versus like North America and Europe at this time?

Yes. Well, that comment -- again, that comment is telecom-focused, I think. Isn't it?

Yes.

Okay. And we're thinking about our business as a communications business, not a telecom and not a datacom. I think the -- I would characterize our telecom business as being healthy. Of course, we have customers in North America, but we also have customers in Europe, both. And global customers who are headquartered in Europe as well as in North America and in Japan, mind you. I think some of them are in different cycles. The undersea market that's being deployed largely by Japanese OEMs and that we're really strongly serving and a ROADM market, which is being served not only by Ciena, but importantly, by Ciena, a very important customer to us. But other companies, including those that are well known, headquartered in Europe. The telecom market in China, I believe it remains a solid and steady market. I think the datacom market in both North America and in China is on a -- still on an upstroke.

Okay. Let me just take a question here that's come in from invest -- one of the investors. And I want to take this because before we lose kind of -- move away from this topic completely. Mary Jane, this goes to the ERP transition comments that you made. The question is, can you ask a bit more on the ERP transition? What would be the time line for the transition? And how encompassing of II-VI legacy business do they expect target? I don't know if you can give any new color on that transition of ERP.

Well, I would imagine it's probably something that we would tackle over the next 2 or 3 years. It -- we will transition it throughout the company in an organized manner. I'm not sure why the investors are asking, it would seem like there's kind of a question behind that question. But generally speaking, eventually, we would like to see some of our older systems that were inherited from acquisitions that probably are off support to no longer be in that situation so that we can get them on a common platform. But I'd say, it's probably over the next 2 or 3 years that we'd be looking at doing this.

Yes. Okay. Maybe if I move to datacom and kind of just focusing on the competitive landscape in datacom. We believe some of the other larger players in datacom that you probably compete against are like Intel, nLIGHT. But I just wanted to see if you can give us a overview here of the competitive landscape? And how would you quantify kind of share gains for II-VI over the last few years?

Okay. I think the competitive landscape is a competitive market. Every market that we play in is competitive. And that's why we're focused on a value proposition, on differentiation, on a strategy that has advanced materials is providing a differentiating edge to the things that we do. Those are among the differences between us and some of the people that you mentioned. We have a strong position. I believe that we have -- we've enjoyed the benefit of the tailwind of the market. That's for sure. We've had lots of challenges associated with pandemic, supply chain, an escalating trade war, and we've still been able to grow. And we have -- we've been able to grow. I think there's 2 green arrows up on our ability to win share in the market. And based on our footprint, our combined capabilities, the scale that we have with customers and we have attracted the attention. With new innovations, including in our pluggable optical line system type products, we've attracted the attention of even new customers, including in the data center market, even in China. And I think that we're going to continue to see opportunities for us to grow. That's my expectation.

Okay. Chuck, the datacom market I mean still largely is accounted for by 100-gig, whereas a lot of the discussion now focuses on this transition to 400-gig. A couple of questions there. Where does kind of -- where does the 200-gig, I think you mentioned you're a leader in 200-gig, where does 200-gig fit in that technology road map for a lot of customers? And in relation to 400-gig, as you start transitioning some customers to 400-gig, is there in addition to the revenue opportunity, a margin opportunity as well in making that a premium product in the early years of the cycle?

Well, let's take -- I think there were 2 parts to the question. Let's take the 200G. 200G is not a requirement for people. You can go from 100 to 400 if you want. And 200G has been selected by a, let's call it, a small group of people that have an interest in that architecture and the advantage that it can bring from 100, especially while 400 was being developed. I think it's quite likely that 200 will continue. But the sweet spot in the marketplace today is at 100. And I do believe, despite all the news and the noise associated with 400G even in this calendar year '21 it started without a doubt. But I really believe it will be more of a calendar year '22 phenomenon. And the prices are higher. And the component as a fully vertically integrated module and component maker, our targets are to at least meet, if not exceed, the margins of the previous generation. But there is competition, and we've been clear that Finisar got a little bit behind the scheme at 400G. So the time of the acquisition, they were probably maybe 2 to 4 quarters behind where they really want it to be. So we've had some catch-up to do. And we're investing in scale, both at the laser component and optics component level. And at the module level in order to step up to that 400G opportunity. And I think it's pretty big. We have a compelling story. There's a lot of interest. And we'll have to -- we just going to have to play out, Sam. We'll see how we do. But for sure, we're going to be aggressive in our desire and in our focus to be able to make money at it while we're doing it without a doubt.

Got it. Chuck, based on kind of developments here over the last week. Just want to get your thoughts on Cisco, Acacia and in terms of your read of the market, does that -- does Acacia remaining an independent company in the long run impact the competitive dynamics at all? Or like as simple as asking, like as II-VI, what would you prefer, Acacia being part of Cisco or Acacia being an independent company?

Now it may be surprising to you. But for the amount of attention and the things that I've read in the last few days, it's -- I can see almost an obsession that some people have been speculating one thing or another. It is what's important to us. We love to have -- continue to have Acacia and Cisco as important customers. We had them yesterday, we had them today, and we hope to have them both for tomorrow. And we think that this transformation, this digital transformation and the acceleration of it and all these drivers that we're talking about. We think that the market is going to need a viable ecosystem, and I believe those are 2 great companies. And beyond that, we're not focused on what other people -- we hope other people would do. We've got enough to do to figure out what we need to do to stay ahead. And that's what we're focused on.

Yes. No. Just making -- since we have 5 minutes left here, let me take the investor questions as well. So the question reads, is it logical to assume you would see a period of above seasonal growth trends given backlog and demand environment? Aren't you suited to meet this demand better given your internal supply chain, should we expect upside to drive higher margins and/or create cost inefficiencies near term? So a couple of questions there. I think first, above seasonal revenue growth, is that right to assume? And then does it create margin upside or inefficiency when you have about normal demand?

I would say that we certainly do not have negative cost curves as the volume increases. There's always something somewhere I'm sure, but generally, in the aggregate, that's not what we experienced. Whether it precisely drives the margin depends on what the mix is. And we would expect that we could continue to see demand remaining strong, though I would say, if the market were to take a massive left turn, we could also see some of the bookings debooked, but generally, that has not been our experience. We have tended to be fairly steady if maybe only -- if the market is declining, we usually are at least flat to up a little bit. And that's what we demonstrated in 2008, now past this in prologue, but that's what I'd say so far. Chuck, any thoughts?

That's great, Mary Jane. I mean I understand the question about the inefficiency. And -- but we have a large enterprise, and we're accustomed to dealing with rapidly changing market landscape and coping pretty good with complexity and chaos. We're aligned to this quote massive infusion of demand. We love it. And we think we demonstrated that even with the onset of COVID a year ago. We demonstrated our ability and agility to be able to manage through it professionally, safely and still get on with it through a relentless strive to deliver.

Okay. Chuck, I did want to kind of finish off with a bit of focus on the 3D sensing business, obviously, can't let you go without it. Now execution on -- execution from the Sherman plant has surpassed, I think, investor expectations. That's fair to say. There have been some recent press reports as well indicating II-VI is joining the Apple supply chain for the LiDAR scanner on the iPhones on the world-facing side. So as we kind of think about the primary drivers of the 3D sensing revenue in calendar '21, how should we really be characterizing it? How much of that opportunity is on the front-facing kind of modules? And how much of that should we be expecting from the LiDAR scanner of the world-facing module?

You're, in effect, asking us to talk about our customers, details of our customers' business is not going to happen. But what I am prepared to say is that we are fully equipped and qualified to serve everything that we have in front of us for everything that they need. And we're excited about it. And I think the reports of our increasing success penetration into the broad based market, they're accurate. And I've made it clear that the next time we -- we're on a climb of a mountain. And the next time we get to a plateau when we stop for a drink and a view, that will be our 50-50 point. But we won't be done then. We believe that we have the scale, the capability, all in the United States, a world-class team. And we've demonstrated our deep strategic connection relationship and intent to continue to invest, manage and enable such an incredible market-leading customer and innovator. I'm excited about it. And we'll have more to talk about it when we have the earnings call in February. I can give an update. But I would say, things are just remarkably on track.

Yes. No, great. That's all we have time for. Chuck, Mary James, thank you for the time today. Congratulations on the kind of stellar 2020 and best of luck for 2021. Look forward to hearing soon on the earnings call.

Thank you, Samik. Thank you, investors. Thank you. Thank you.

We'll see you soon, thank you for inviting us.

Thank you. Bye.