Coherent Corp. (COHR) Earnings Call Transcript & Summary

Good day and thank you for standing by. Welcome to the Coherent Corp. FY '23 Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mary Jane Raymond, Chief Financial Officer. Please go ahead.

Thank you, Kevin, and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at Coherent Corp. Welcome to our earnings call today for the second quarter of fiscal year 2023. This call is being recorded on Wednesday, February 8, 2023. With me today on the call is Dr. Chuck Mattera, our Chair and Chief Executive Officer. After our prepared remarks, both Dr. Giovanni Barbarossa, our Chief Strategy Officer and the President of the Materials segment; and Dr. Mark Sobey, the President of the Laser segment, will join us during the Q&A to discuss the unique benefits of our strategy, our results and the exciting prospects across several broad markets. For today's call, the press release and the investor presentation are available in the Investor Relations section of our website, coherent.com. Today's results include certain non-GAAP measures. Non-GAAP financials are not a substitute for, nor are they superior to financials prepared in accordance with GAAP. A detailed reconciliation of these non-GAAP measures to our GAAP results is included in today's documents. I remind you that during this call, we'll make certain forward-looking statements. These include, but are not limited to, statements regarding geopolitical and macroeconomic trends, expectations for our revenue, our market trends and our expected financial performance, including our guidance. In addition, we'll discuss our progress on integration, including our delivery of the projected synergies. All forward-looking statements are based on today's expectations, forecasts and assumptions. They involve risks and uncertainties that could cause actual results to differ materially from our comments today. Our comments should be viewed in the context of the risk factors detailed in our most recent Form 10-K for the fiscal year ended June 30, 2022. Coherent assumes no obligation to update the information discussed during the call, except as required by law. With that, let me turn it over to Dr. Chuck Mattera. Chuck?

Thanks, Mary Jane. Thank you all for joining us today. Coherent Corp. posted a record revenue quarter of $1.37 billion, consistent with the midpoint of our guidance, and grew 70% year-over-year and 2% sequentially. Looking close up at legacy II-VI. Impressively, organic growth was 23% year-over-year and 4% sequentially, while the consolidated pro forma growth was 15% year-over-year. Regarding the composition of our sales by the 4 major markets: Industrial accounted for 33%, communications 44%, 15% from electronics and 9% from instrumentation. Turning to the distribution of our revenues by region. The second quarter was similar to the first quarter. North America accounted for 55%; Europe, 18%; Korea and Japan combined were 13%; China was 11%; and 3% to the rest of the world. Our non-GAAP EPS was $0.95. We continued our disciplined approach to capital allocation during the quarter. We generated $220 million in cash from operations and invested $106 million in capital equipment for $114 million in free cash flow. We also paid off $133 million of the debt. Our investments in our silicon carbide platform were nearly half of our total capital investment as we execute our multiyear road map for the electrification of transportation and renewable energy infrastructure among our commitments to sustainability. Last week, during Photonics West, we had a strong showing of our broad portfolio of new products and technology innovations that are enabling a wide range of applications across our 4 end markets. Our thought leaders presented at various events, workshops and technical sessions, and we had several significant new product announcements. These included the introduction of Python, our next-generation OLED-annealing solid-state laser targeted at new Gen 8 OLED fabs. This is the culmination of 4 years of innovation and development that retained Coherent's position as the annealing process of record while improving performance and significantly reducing cost per panel. We believe our innovations in this system will drive adoption into more price-sensitive displays, such as tablets, laptops, and high-end monitors. To further secure our position as an industry leader in ultrafast cutting of OLED panels, we introduced 2 new ultrafast lasers. We also introduced our next-generation pump laser diodes for fiber lasers with the first semiconductor chip in the industry, to our knowledge, to achieve 50 watts of output power. And we showcased our fully automated contactless laser system for texturing and marketing implantable medical devices. Turning now to our performance by market. Our revenue in electronics grew 131% year-over-year and 11% sequentially, setting another record by hitting the $200 million quarterly mark. Growth was driven primarily from sensing and the seasonal tailwinds of a new product cycle, which we described on our last call. This is the second of the seasonally high 2 quarters and in the second half of the fiscal year, we will enter the seasonally low period, during which we expect to have considerably lower revenue when compared to the first half. Our customer intimacy in this market gives us optimism that the future opportunity in consumer electronics is still much broader than just VCSELs for 3D sensing. We believe that sensing will become ubiquitous in metaverse hardware and wearables and LiDAR and other emerging applications. Our strategic engagements are growing across them all. For our silicon carbide power electronics and wireless semiconductor business, we continue to invest in silicon carbide substrate and epitaxial capacity to accelerate the pace of our shipments as demand continues to exceed our ability to supply. In the electric vehicle market, EVs represented 10% of all vehicles sold globally in calendar year 2022. As EVs continue to grow, industry estimates expect the adoption of silicon carbide electronics will also grow but at twice the rate of the overall EV market. We are steadily gaining share in what we believe will be an underserved market for many years to come, perhaps even through the end of this decade. Communications revenue grew 18% year-over-year and 3% sequentially, led by both telecom and datacom, each of which achieved record revenue. Telecom growth was led by broadband initiatives, which in turn drove demand in the metro edge to access networks. We are encouraged by the opportunity that we expect to result from the U.S.' planned $65 billion investment in broadband access from the Infrastructure Investment and Jobs Act. We expect that it will be a major catalyst for optical communications and specifically our telecom business at all levels of the value chain. As access networks grow, they drive upgrades in the metro, long-haul and submarine networks, all requiring our Coherent transceivers and ROADM integrated product solutions. Our datacom business also hit a quarterly record. Our industry-leading position in 200G and above remains strong at 51% of our datacom transceiver business compared to 33% a year ago. Our leadership in this area stems in part from our vertical integration of our high-speed lasers, optics and electronics in our transceiver modules. In addition to our growth of 200G, 400G datacom transceivers, we continue to see accelerated deployments of 800G transceivers, enabling open AI and machine learning applications. We are ramping our full capacity to meet the growing customer demand over the next few quarters. Our optical communications business was honored yesterday ahead of the Optical Fiber Conference in March with awards for 3 of our products that the 2023 Lightwave Innovation Review singled out. First, our 100G ZR QSFP28, which will enable service providers to upgrade millions of 10G Ethernet links to 100G at the optical network edge; second, our 200G indium phosphide electroabsorption-modulated laser, which is critical for next-generation data center interconnects; and third, our Wavemaker 4000 programmable optical spectrum synthesizer. These awards showcase our innovation leadership across our broad optical communications portfolio. Revenue into the industrial market was mixed. EUV grew 38% year-over-year. Also, we achieved record revenues from products related to precision manufacturing of electric vehicle batteries. In flat panel displays, 1 less large Excimer line Beam system shipment accounted for almost all of the quarterly change in the laser segment revenues. We saw sequential declines in the advanced packaging and interconnect markets, such as printed circuit board via hole drilling and back-end semiconductor applications such as marking. This was offset, however, by strength in the semiconductor front end where we set another quarterly record for shipments of lasers for wafer inspection as well as wafer annealing for logic devices. We also delivered the first full laser and optics subsystem to an industry leader for an exciting new memory application, which had previously been a nonlaser-based solution. We had a record quarter for our advanced materials and metal matrix composites into the front end of the semicap equipment market. These novel materials allow customers to push the performance limits of their wafer fab equipment, including for immersion and EUV lithography and for wafer stages and wafer chucks. We've worked hard throughout the last few years to scale our capacity and our output to allow our customers to mitigate the semiconductor shortages by increasing tool capacity. So we were delighted to be recognized by Applied Materials, the world's leader in wafer fab equipment, with their Supplier Excellence Award for a collaboration. We also had record Excimer laser revenues for a pulse laser deposition equipment, a rapidly growing product line serving the semicap equipment market. Customers are leveraging this new enabling technology for diverse applications from high-temperature superconducting tape for next-generation fusion reactors to 5G filters in mobile phones. We are a market leader and a pioneer in pulse laser deposition. This technology has the promise of enabling the production of novel semiconductor materials through the engineering of atoms and photons, a great example of the synergistic power of our combinations. Our instrumentation business sustained record levels, growing 2% sequentially. While PCR-based COVID testing is tapering off, our growth in bioinstrumentation from other applications allowed this market to maintain the higher level of revenue achieved during the growth for PCR testing. We also had strong revenue for our products in advanced imaging applications for neuroscience and disease studies. These applications require ultra-short pulsed lasers, part of our portfolio where we excel. Before I turn it over to Mary Jane, I imagine that you all have now seen our other exciting news today: our move to list our stock on the New York Stock Exchange on February 23. Nasdaq has served us well since our IPO on October 2, 1987, and we are very appreciative of that support. With our recent growth, our continuing aspirations to be the best at what we do and our global platform, we believe that the New York Stock Exchange complements our new Coherent brand and is the right place for us to be at this time, alongside many of the world's most prestigious companies. With that, I'll turn it over to Mary Jane. Mary Jane?

Thank you, Chuck. Our revenue of $1.37 billion was negatively affected by $6 million from currency compared to Q1 FY '23 with immaterial effects on the EPS. Our backlog was $2.9 billion at 12/31 and remains solid as customers return to more normal patterns of ordering and inventory management. Our Q2 non-GAAP gross margin was 39.8% and the non-GAAP operating margin was 20.3%, both negatively affected by $3 million in currency or 20 basis points compared to Q1. Supply chain costs were $10 million and are not excluded to arrive at the non-GAAP results. At the segment level, the non-GAAP operating margins were 19.4% for networking and 26.2% for materials and 15.7% for lasers. GAAP operating expenses, SG&A plus R&D, were $403 million in Q2. Excluding $90 million of amortization, $29 million of stock comp and $16 million of transaction and integration costs, non-GAAP OpEx was $268 million or 19.6% of revenue. Our total stock comp is expected to be $30 million to $32 million per quarter for each of Q3 and Q4. Synergies have now reached $30 million on an annualized basis, and we are making good progress in all categories. Quarterly GAAP EPS was a loss of $0.58, and non-GAAP EPS was $0.95 with after tax non-GAAP adjustments of $217 million in total. The diluted share count for the GAAP results was 139 million shares. And for the non-GAAP results, the share count was 150 million shares. The GAAP and non-GAAP EPS calculations are on Tables 6 and 7 of our press release. Interest expense in the quarter was $71 million and for the 6 months ended December 31, interest expense was $132 million. Our original outlook for interest cost in August was $274 million on the basis of the 1-month LIBOR reaching 4.2%. It is now forecast on the yield curve to achieve 5.1%. Should that happen on the schedule expected, our goal, along with our debt repayments, will be to limit the change in our initial estimate to $5 million to $7 million for a total of $279 million to $281 million. Our December 31 balance of cash items was $913 million, an increase from the prior quarter of $15 million. After paying down $133 million of debt in Q2, our total debt position on December 31 was $4.6 billion. Using the trailing 12 months of adjusted EBITDA on a pro forma basis for the combined company at December 31, the gross leverage was 3.6x and the net leverage was 2.9x without the synergy credit. Including the synergy credit of $235 million that is allowed by our credit facility definition, the gross leverage is 3x and the net leverage is 2.4x. Note that $15 million of synergies are already in the results. The effective tax rate in the quarter was 32%. The non-GAAP tax rate is 19%. We expect the tax rate for the remainder of fiscal year '23 to be between 18% and 22%, assuming the current mix of earnings, and no adoption of new or additional tax rulings. Returning to -- turning to the outlook for Q3 fiscal year '23. Our outlook for revenue for the third fiscal quarter ended March 31, 2023, is expected to be $1.32 billion to $1.37 billion and earnings per share on a non-GAAP basis to be $0.75 to $0.90 per share. With respect to our expectations on full year revenue, we expect revenue to range from $5.35 billion to $5.55 billion (sic) [ $5.35 billion to $5.5 billion ]. Our non-GAAP EPS estimate assumes the effects of purchase accounting, which are all still preliminary, will be added back to GAAP EPS other than the depreciation that is about $5 million in Q3. The share count is 152 million shares for the entire guidance range. The EPS calculation, including the dividend treatment, is detailed on Table 8 of the press release for the guidance range. This table also shows the earnings at which the Series B preferred stock is dilutive. All of the foregoing is at today's exchange rates at an estimated tax rate of 19%. For the non-GAAP earnings per share, we add back to the GAAP earnings pretax amounts of $140 million to $145 million, consisting of $95 million in amortization, $30 million in stock compensation and $15 million to $20 million for transaction integration and restructuring. The actual dollar amount of non-GAAP items, the tax rate, the exchange rates, the purchase price accounting and the share counts are all subject to change. As a reminder, our answers today during the Q&A may contain forecasts from which our actual results may differ for a variety of factors. These include changes in the mix, customer requirements, supply chain availability, competition and economic conditions. With that, Kevin, you may open the line for questions.

[Operator Instructions] First question comes from Ananda Baruah with Loop Capital.

Congrats on solid results and ongoing strong execution. Two quick ones, if I could. Chuck, are you seeing any, I guess, what you would consider to be meaningful softening in any of the businesses -- in any of the meaningful businesses? And then could you give us an update on supply constraints? And then I have a quick follow-up.

Okay. Well, Ananda, thanks for your question. Let's take the supply chain first. In the second quarter, the supply chain constraints affected us to a level of $67 million. And so that will give you some sense. It's considerably lower than it was a couple of quarters ago. It's definitely getting better, but it did have an impact on us. That's first. Second, I tried to give you the color -- all the color we could about the markets, about the regions, about the products in our prepared comments. And I would say from the last 90 days, if you look at our revenue guidance, the only thing that you can see which is different is that we have a greater confidence on picking up the bottom end of that revenue guidance, and we shaved just a little bit off the top end. And all of that takes into account our best judgments today. And wherever there are small pockets or pockets of slowdown, we have the versatility, the resiliency, the backlog and the determination to blow past them. Okay?

That's very helpful. And as a follow-up, would just love to get a sense where you guys believe legacy Coherent is in the display business cycle. And that's it for me.

Okay. I'll ask Mark to take that one.

Thanks for the question. I think as we discussed in our prior call in November, the Excimer annealing business represents between 20% and 25% of our quarterly revenue, and we're still very much in that phase. So I think the forward-looking growth opportunity that we see in IT displays, specifically tablets and laptops, is in front of us, probably 1 to 2 years out. But we're in a pretty steady phase.

[Operator Instructions] Next question comes from Simon Leopold of Raymond James.

I appreciate the details today. I wanted to see if we could dig into your updates on your exposure to the hyperscalers or webscalers. I'm estimating that they're probably close to 10% of total revenue, maybe a little bit below that, following the integration with the old Coherent. But given some of the capital spending trends, I'm wondering if you can update us on your thoughts of how much of your business is coming from there and what your expectations are for the balance of calendar '23.

Thanks, Simon. I'm going to ask Giovanni to address your question. Thanks for your question.

Thanks, Chuck, and thanks, Simon, for the question. So the -- of course, it does change the percentage of the exposure to hyperscalers quarter-by-quarter. But roughly right, it's about 30% of the total. We said this in the past, it's about, let's say, 30% hyperscalers, 30% what we call cloud -- about maybe a group of 30 customers. And then a long tail does the rest, the rest of the 30%. So we have not really seen any slowdown whatsoever in the -- at least for the second half of the year. We don't really see any slowdown in demand. That could be explained by a number of factors. I probably -- one is the fact that the higher-speed products, let's say, 200G and above, now almost they represents 50% of our total, okay? So that's where most of the investments are growing. Particularly, of course, with the hyperscalers, we tend to innovate and introduce higher data rates and obviously the general cloud or even the long term of the customers. So that's one reason. The other one, as I said earlier in previous quarters, we see still an opportunity to regain share that we think the -- we lost over the past, let's say, 3 years between the transition from Finisar to II-VI and now Coherent. So we -- there's still pockets of markets we think we can to continue to grow our share. So the 2 combined explains why we don't see any slowdown. If anything, we're very -- we're quite bullish about the near-term future.

And just a quick clarification, that 30% value you referenced is 30% of your networking segment?

No. 30% of the datacom.

30% of datacom. And what's that as a percent of networking?

Okay. So that's 30% of 50%. So it will be like 15%.

Our next question comes from James Ricchiuti with Needham.

Just wanted to talk a little bit more about the laser business in that we saw a step down in laser operating margins. I was hoping you can give a little bit more color around what's contributed to that.

Mary Jane, do you want to take it first?

Sure. Generally speaking, what affects any of our segments on the margin is that -- we -- I would say that, that is probably a little bit more pronounced in the laser segment, but it's generally true across all the segments.

And the line being that you alluded to that contributed to some of the mixed results in industrial, is that a case where that ELA tool is slipping a quarter? Or is that potentially going out a little further? And maybe what contributed to that? Is that just customer site not being ready? Or is there some change in potentially seeing some signs of changing demand in the display market near term?

Jim, this is Mark. That's a good question. It wasn't actually -- it wasn't a pushout. We knew we were anticipating to ship one large landing system last [indiscernible] during the quarter. So there was no -- it was really based on customer demand, and so no change there. We had anticipated being able to offset with some other upside business, but as you heard, we still had some supply chain balances that affected some of our other business.

Our next question comes from Dave Kang with B. Riley.

Just wanted to clarify about your comment -- Giovanni, your comments about telecom versus datacom. So it's 50-50 between telecom and datacom, is that what you said about Simon's question?

Yes. I'd say it's about -- to be accurate, it's 54-46. So 54% telecom, 46% telecom.

Got it. And then my question is on the backlog. So it was down a little bit from $3.05 billion to $2.9 billion. Just wondering if sort of backlog apparently peaked already. If you can talk about the expected decay rate, when does it normalize? And also, can you provide the composition of the backlog?

So we don't normally give the composition of the backlog, number one. But two, Dave, you may remember on the last call as well as in various conferences, one of the things that I noted was that investors should not be worried if the backlog starts to go down, we don't necessarily consider it a decay because the goal was to start to ship what's in that backlog. So we are seeing customers returning to more normal patterns of ordering, and that's exactly the behavior we saw in the second quarter was exactly what we expected.

And I would add, Mary Jane -- I would add, Dave, I think that asset to normal ordering patterns will take place over the next few quarters.

Got it. And my follow-up is, Chuck, your commentary about deceleration in some of the -- your end markets. Just wondering if you can specify which end markets are decelerating or expected to decelerate.

Thanks, Dave. I would point to the industrial section in my comments about the back end of the line for the semiconductor equipment. Like that gave you some sense for a little bit of a slowdown as it relates to lasers for via-hole drilling and for marking. And I also balance that with the really substantial growth that we've seen both in EUV, on the industrial side -- in battery welding on the industrial side and then also in our materials for front end of the line equipment in semicap. So it's a mix, and I said so, that's probably the best example.

So just to be clear, you're not throwing in the sensing segment as part of the segment that is slowing?

I also -- in my commentary, Dave, I also pointed to the fact that in the first 2 quarters of our fiscal year, we have seasonal tailwinds. And I also made a clear remark about the second half of the year that we expect to be considerably lower than the first half. Okay?

But that's because of the seasonality, not necessarily the weaker demand, right?

Giovanni, do you want to elaborate on that?

Yes. Sure, Chuck. Dave, of course, the demand is not something that we have seen slowing down. There's -- that's why we talk about seasonality. Seasonality, it's all about introduction of new products from our customers, and we follow the pattern. So it's completely unrelated to demand.

Our next question comes from Samik Chatterjee with JPMorgan.

I have a couple. Maybe if I can start with a question on backlog. And totally understand your sort of view in terms of the backlog will start to moderate a bit as supply improves and order patterns normalize. How are you thinking about backlog related to sort of exiting the year? Does this remain elevated? And just trying to match that up against sort of the decision to take some of the high end of the revenue guide a touch lower. I mean, how does that sort of match up with the backlog still remaining quite high at this point? And I have a follow-up.

First of all, I'd say...

Mary Jane?

Yes. Sure, Chuck. Thanks. I would say that on the one hand, while not necessarily, I know we only have a half to go here forecasting the backlog. Last quarter, I had indicated if we saw a resting backlog over time, not necessarily by 6/30 but over time, coming down more toward 2.5, 2.6, I wouldn't be surprised. But I don't necessarily think it will be at that level by 6/30. So that's the first thing. I would say they're probably, really in some ways, unrelated to each other. We just -- the backlog does remain very high. But do keep in mind that, that backlog is over 12 months. And as we've indicated in the past, typically, the individual items that are in the backlog are timed. They may not necessarily all be times to being shipped by 6/30. So we have some customers who routinely will give us relatively long-dated orders going across the entire 12 months. So it really has nothing so much to do with the backlog coming down a little bit, the change in the top end. It's just more truing up the forecast as we've gone along here.

Got it. And for my follow-up, I think, Chuck and Mary Jane, you both talked about sort of the mix in -- mixed sort of end-market outlook that you're seeing with certain markets remaining very strong, certain sort of pockets of weakness. If we aggregate all that together, like how is the book-to-bill looking, particularly as you sort of go through the last few months of the quarter? Like are we continuing to see sort of a step down in the aggregate book-to-bill? Or is that because of the diversification that you have remaining quite robust?

Well, again, the book-to-bill is not nearly as relevant really right now as the backlog itself. I mean customers are changing their ordering patterns. But generally, I would say there are variations certainly in bookings in particular areas where customers have had given much, much longer-dated orders in now, say, 12 months when their historical ordering pattern is more like 6, so they're returning to 6. But generally speaking, I would say that we're very, very positive about the outlook for the company given the strength of that backlog. Chuck, would you like to add anything to that?

No. I think what we said stands. Over the next few quarters, we can expect it to -- the book-to-bill ratio as we see it to get to more normal patterns that we would have seen before the last couple of years' events, including where the supply chain shortages started.

Our next question comes from Mark Miller with The Benchmark Company.

I just wanted to talk about -- you said that the supply constraints again impacted sales by $67 million. I'm wondering how that broke out between networking and lasers.

It was mostly networking -- thanks for your question, by the way, Good Morning, Mark. It was -- yes, it was nearly all networking, but there was an impact to the lasers segment.

I just was wondering in terms of other expense, it's jumped around the last couple of quarters. Do we expect other expense in the March quarter to be similar to what you saw in December?

I would say that it's probably going to be somewhat lower, probably closer to plus or minus $1 million. It does move around for an awful lot of things, some of which are still related to purchase accounting. But it's probably for Q3, plus or minus $1 million.

Our next question comes from Jed Dorsheimer with William Blair.

I just have one and a follow-up. I guess, Mary Jane or Chuck, did I hear correctly from a CapEx split, the 50% was going to silicon carbide? Could you just clarify that for me?