Coherent Corp. (COHR) Earnings Call Transcript & Summary

Let me try to summarize the ARM laser itself. We believe as a fiber laser subsystem, its design and its operation is differentiated for multiple variations in process technology and beam control. And in connection with our differentiated welding -- high-power welding heads, which are deployed in automotive factories all around the world already, and for which customers understand the use of plugging in an ARM laser through a cable that we make up to the welding head and then with their process control knowledge and beam control knowledge, that's where our differentiation will be: applications engineering, applications knowledge and service.

And is it reasonable to assume more of this business is going to be generated in China?

Our business plan anticipates that, that we'll be able to take the best of what legacy II-IV and the best of what legacy Coherent had and be able to address what we believe will be a meaningful market that neither company were able to address before the combination. And we've already gotten busy on that. That will be a sustained effort that we make over the next few years, Jim.

Yes. I want to shift to the communications market, which, on a pro forma basis, I guess, is still your largest market, Mary Jane, around 45% pro forma? Is that...

Yes, 44%. Exactly.

Thank you. So this market, communications market, has been very strong for the past 2 years. You've obviously built up a nice backlog in this area of the business. Curious about the backlog, how much of that was also a function of just the supply chain challenges? Just in general talk to us about the -- whether there's been improvement in any of the supply chain areas. You've highlighted ROADMs as being an area where you've had some real pressure in terms of availability. And I've got a follow-up as well.

So I'll just take the part on the supply chain side. So first of all, during the time that the world was very supply-constricted with respect to integrated circuits, we had been working for over 5 years with our customers in communications on longer-dated orders for initially the purpose of planning CapEx and for planning the sustainable use of our capacity. We continue to do that, and perhaps with even more customers, in order to signal to the suppliers the type of demand we were really seeing. So if you are a smaller industry and trying to get integrated circuit, say, compared to the U.S. oil industry, having a 13-week visibility is not all that helpful. So that is a lot of what drove our backlog and our bookings. Because all of those were time dated orders; they all had a firm delivery date. So we have seen the ROADM -- particularly on the ROADM side, the supply chain easing. So the way I would describe it is if you assume that the turnpike is totally blocked traffic, it's a little bit like the shoulder opening, maybe both shoulders, but it is not clear. We are still fighting this on some of the more critical ones, but there is definitely an easing and consequently we saw sequential growth for 2 quarters in a row in our own business. We do have a bit of a ways to go, and we do continue to expect, and from here I'll let Sanjai take it, the communication still has a lot of growth left in it.

Okay.

Yes, I was -- I would just add that both our -- when we look at the communications market, we look at it as datacom and telecom. Both segments of those markets are growing even from calendar '22, '23, and some segments are growing at a much faster clip. High-speed transceivers within datacom defined as 200G and above is actually slated to grow over 10% from CY22 to CY23. And those are sort of the areas where we play in. So our markets are strong, they're growing and we expect to grow faster than the market.

And just given some of the macro concerns, is it -- I don't want to put words in your mouth, but would you characterize the current state of this business as potentially being more resilient in a tougher environment?

Yes, absolutely. Especially the datacom business, the web-scale customers, they plan these upgrades years in advance. So they don't react to -- and for the most part, it's to support their core businesses and its infrastructure like everything else. So they continue to do what they're planning to do, which is plan for many years in advance.

Got it. And just a follow-up question. On the macro environment, obviously, more concerns. We don't know what kind of landing, soft, hard, but we've seen PMI data move around a bit, including in China. And Chuck, maybe you want to take this. As we think of the overall environment, you have a plan that you've put in place, that you've been working on for some time in terms of the integration, and Mary Jane, you may want to talk again also about some of the cost synergies. But how do we think about this plan in what potentially is a more fluid economic environment?

Well, similar to how our communications customers plan their capacity, we plan these synergies fairly well in advance. And the synergies that are expected for the company at $250 million are about $68 million in the first year, $90 million in the second and the balance in the third. For investors who are very tempted to ask us if we're going to -- if we've already changed the number upward, before the company changes the number, we will actually move the time. So that's very similar to what we did in the Finisar case, it was 150, it was 36 months, then we changed it to 24 and then we increased the number. So for right now, we are well on with our first year synergies, and we do not expect to make any changes to any part of the synergy plan or what we've announced about it any time during this year. We are well on with it, I would say. And because we had to file -- refile HSR, both -- general counsels of both companies were very fastidious on being sure we didn't engage in any behaviors that might be disadvantageous. Now as we get to know the people, as normally happens, we find synergies that we thought would be later to come sooner. Some synergies we thought we were -- we would get aren't so easy to get, but there's other ones that were easier than we thought. And so we are well on with them. And I think that while the market is very fluid, at the end of the day, II-VI has distinguished itself in any type of economic situation by just putting its head down and doing the work. So that's what we're on with.

Okay. On the revenue synergy side, you highlighted a couple of areas that seem to suggest some opportunities, display, also with respect to battery welding. How do we think about some of the revenue synergies emerging over the next 1 to 2 years in terms of which areas of the combined business?

Well, Chuck, why don't I start and then I'll let you fill in. So first of all, the company expects to have revenue synergies over a wider variety of markets than perhaps we did with the Finisar acquisition. That is what we mean when we say that we expect the revenue synergies to be a larger component of the overall synergy story. We're in the process of specifically developing those at this point, but I'll just give you a few ideas. The very first example that we gave everyone was II-IV has a larger business in China than the former Coherent did, and the old II-IV had a much -- and the former Coherent had a much larger business in Korea than the former II-IV did. So that was the first example that we gave. But in general, in the sales and service area, the laser segment, which many of you know is how the former Coherent Inc. came into our company, they had a very, very robust and excellent service and sales business, and it's really the service business because that's required for their larger machines. It also drives their aftermarket business. The aftermarket business was an important part of the Materials segment as well. And so we see that larger, more well-established form of go-to-market for services and aftermarket sales being a very, very strong contributor to the revenue synergies. In Life Sciences and Instrumentation, where -- which we call overall Instrumentation, the scientific market is the way that the laser segment historically has actually debuted brand-new types of laser technology. Because the academic community is the one that's really pushing the science. The machines are typically developed for many of those new types of very forward-looking applications that haven't even been conceived of by the commercial market. Once they're proven out, then the laser segment begins to commercialize those. So the important thing is that we expect to continue to use that as an incubator. And more importantly, both companies have a very strong business in instrumentation. That is actually where our Life Sciences business really resides. It's in the instrumentation. Whether it's keeping samples at a specific temperature for the entirety of the test, since heat is a priority pollutant, or whether or not it's dealing with various degrees of certain applications where there is, say, etching which is a very, very shallow cut of a laser, right, where you might be etching or marking DNA, for example. So we expect to see that to be a great contributor. Automotive, for sure, Jim, you already talked with Chuck about this with respect to the ARM laser and the tremendous carefulness that's required in doing laser battery welding. Welding in general is the very last battleground of industrial lasers. A lot of that is still done with the torch. But with respect to a battery for an electric vehicle, it's very important the laser beam itself be very combined, be a very contained laser weld and it also not get very hot. Otherwise, it's actually very dangerous around that battery. We expect that to be a very nice business, as you've just talked to Chuck. Industrial, for sure, many of our customers are the same ones that laser segment has. The old II-IV customers are the same one the laser segment has, and we expect to be able to have a greater share of wallet. And then finally, obviously, in semi-cap as well as display, which are new capabilities brought to us by the Laser segment. So it's a very, very broad expectation we have on being able to grow the revenue together. Chuck, do you want to add anything?

Yes. I was going to add, in the overlapping vertical, which is really industrial and instrumentation, there are simple opportunities like cross-sell, which we are already -- the sales team is already going after. But I think the excitement is really the ability to go up the value chain to integrate the lasers with our materials, with our thermoelectrics, with our filters, our optics, and assemble higher-level solutions for our Life Sciences customers. And we are also doing the same thing on the industrial side, as Chuck mentioned earlier, where we are integrating our sort of very high-end beam delivery systems along with the laser, and offering features that the rest of the market is unable to offer. So that's the upsell part of the strategy as it relates to revenue synergies.

Want to turn to silicon carbide, where there's certainly been a lot of interest, a lot of questions. Coherent has been investing in this business for a long time. II-VI has been investing like over 20 years. Remind us, if you could, just initially, if you could, of the investments you're making in this area. And then I want to talk a little bit more about the broader strategy, if we may.

Okay. Let me do that, Jim. You're right, been investing in it for over 25 years. Our approach to the market starts off with our strategy, which is to leverage our competencies, our strengths and our differentiation. And we're coming to the marketplace at 4 levels of integration over the next 3 to 5 years. First one is in substrates, which we've been at from the beginning. Second one is epitaxial wafers. The third one is power semiconductors devices. And then the fourth one is modules. Let me talk about the first 2. Today, we are a leading supplier of high-quality silicon carbide substrates into the marketplace, both to those people who grow epitaxial wafers and to people who have their own capability in-house, but all of whom ultimately are in the supply chain in the automotive market, by and large, for silicon carbide-based electronic devices. Over the next 3 to 5 years, while we take the GE technology that we've licensed and developed devices and modules over that time period, qualify them in automotive applications, while that development work is going on, we are scaling our materials factories to be able to generate at least 80% of our revenue between now and, say, 2026 and 2027 will come from selling materials, substrates and epitaxial wafers. By that time, we should have begun to see meaningful penetration into the marketplace with devices and modules, but it will be at the tail end of that 3- to 5-year period. However, out to the end of the decade, we think that will shift to a 60-40 mix roughly, materials and substrates and epitaxial wafers and then devices and modules. Okay. In order to get ready for that, this marketplace, which we judged about in the last, well, 12 to 18 months ago, the marketplace has gotten bigger, faster, at least our addressable market. We've had some announcements about long-term supply agreements. We do not announce every purchase order that we get or every engagement that we have with customers. And so -- and some of our customers would not like for us to disclose who they are and what they're up to. But in the last 12 to 18 months, I believe that our engagements with the marketplace, we've gone from about 1/3 of what we believe are the large players in the market to about 2/3. And that acceleration has corresponded to what we believe is a supply-limited environment of high-quality, low-dislocation density silicon carbide substrates for which we are a leader. And so we're sold out. We're trying to keep up with the demands of customers. We're adding capacity. We're stepping up our own investments again in FY '23. And we expect that this year, about 1/3 to 40% of our capital investment in the $550 million to $600 million range that we gave referenced as a guidance in November will be for silicon carbide materials capacity. So that will be the second year in a row. We have more to do. We're really excited about the business. That's for sure. Customers are really excited about us. And we think this marketplace will be undersupplied, underserved and constrained for high-quality substrate materials possibly to the end or through the end of the decade. I hope I answered some of your questions, Jim.

You answered quite a few of them, Chuck. Thank you. And as you know, the question that does come up is this is such a large market. Others are pursuing it, trying some -- you have established players obviously. But there also is -- there are some concerns about potentially new competition coming into this market. I wonder if you'd talk to, and you've been doing this for a while, the complexity of this technology and the challenges of entering this market and scaling and sustaining it.

Yes. Compound semiconductors across the board are just not a -- is just a very complicated technology platform for sure. And why does everybody want them? The reason is because they have capabilities that the silicon technology simply can't do. Despite trillions of dollars and 50 years of investment, it can't be done. The materials drive the business. And these materials are complicated. They require special equipment, special intellectual property, trade secrets, patents, and a trained workforce that has been developing models -- manufacturing models for decades. And we're fortunate that we can say that we have all of that under one roof. I think you can read in the investor press, in the last couple, 3 months or so, we're reminded about how complex this technology is even for experts. And we're humbled by it. But we're focused on it. We feel really good about the team that we have. We have to compete. We're obsessed with customers and about competitors. And our passion for growing this business and making money at it and positioning us as a market leader over the cycle, which we identified through the end of this decade, that's among our most exciting opportunities to change the landscape for the company. That's what I can tell you. We announced it a couple of years ago, 2 August ago, $1 billion investment over a decade. We didn't give out the timing of it, but we are moving at a clip that's a little bit faster and a little bit more accelerated than what we imagined when I first informed investors about the $1 billion over a decade. We are moving quickly.

When you talk about the end of the decade, Chuck, give us a sense of what this is going to represent. Do you think this potentially could represent a total company revenues?

Yes, I'm willing to do that, Jim. It's a -- end of the decade is a while from now. And -- but we do have a long-range plan, we make a 5-year plan and a 10-year plan. And inside our long-range plan, we can see the possibility that this business represents 10% of the total consolidated company by the end of the decade.

And maybe more near term -- we've got only a few more minutes. But yes, we do have a more uncertain economic environment. Mary Jane, maybe this is one for you or Chuck. But I'm wondering, are you thinking about the priorities for cash? You talked about capital being deployed, certainly in the silicon carbide area. But are you thinking any differently about in light of the economic environment?

Actually, yes. We -- so there really are 2 main priorities for the cash ahead of the debt paydown. The first one, of course, is the CapEx. Because the driving of profitable revenue is very, very critical for the income through the cash flow. So that's actually an important part and the reason why CapEx will always remain our #1 priority. But the second one actually was the synergies. Our goal, as we told investors, was not to actually pay a lot of the debt in the first year in order to enact 100% of the synergies in the first year so those that have a longer time line to achieve could at least start. As we've gotten into those, some of them are less cash demanding than we thought. A very clear example would be as members of the former Coherent Inc. team retired, there -- they obviously had their equity vested. That was part of their agreements, et cetera. That actually isn't cash, it's their equity vest. It is a charge to the P&L, but it is not cash. And so we began to look at that and we took that cash and said, okay, we're going to pay the debt with this. And that's what we did. We actually successfully paid debt, during here, the 12/31 quarter and are -- we'll continue to do that through this year.

Okay. We're going to end it there. Chuck, Mary Jane, thank you. Sanjai, thank you. I promise the next time I'll give you a proper introduction.

Thank you, Jim.

Thanks a lot.

Thank you, everyone, for joining us.