II-VI Inc (IIVI) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the II-VI Incorporated fiscal year 2016 second-quarter conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Mary Jane Raymond, Chief Financial Officer of II-VI Incorporated. Please go ahead.

Thank you, Candace, and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at II-VI. Welcome to our second-quarter earnings call for fiscal year 2016. With me today on the call is Francis Kramer, our Chairman and Chief Executive Officer, and Dr. Chuck Mattera, our President.

As a reminder, this call is recorded on Tuesday, January 26, 2016.

Any forward-looking statements we may make during this teleconference are given in the context of today only. We do not undertake any obligation to update these statements to reflect events subsequent to today.

With that, let me turn it over to Fran Kramer, our Chairman and CEO.

Thank you, Mary Jane, and thank you, everyone, for joining us. Our second quarter delivered revenue and EPS at the high-end of our range. In fact, EPS was above the top end. Our optical communications business remains strong for us this quarter both in revenue and bookings. Our industrial markets growth was affected by China being slower, but absent that, the divisions serving that industrial market, particularly in the laser solutions segment, remains strong earnings contributors.

We announced earlier in January our intention to acquire two companies to expand our capacity in VCSELs. Neither of these transactions is closed yet, so we will limit what we say other than we are excited to be able to invest ahead of the curve for what we believe will be a significant growth market. The talent and capacity we acquired have the potential to serve multiple II-VI segments, something we look forward to in our acquisitions.

This is the first time in quite a while that II-VI has had a gap between signing and closing an acquisition. We are completing a number of important legal steps for closing, as well as the integration assessment and the purchase price accounting. We intend to include greater details on the financial effects of these transactions at closing and with our third-quarter earnings announcement. For now, as we have been reporting on our last two earnings releases, we expect our existing operations to deliver a good improvement in FY 2016 over FY 2015.

Let me now turn it over to Chuck to comment on our global businesses.

Thanks, Fran. The composition of sales into our top three end markets were 36% into industrial, 36% into communications and 13% into military. Our two smaller and emerging markets of semiconductor capital equipment and life sciences were 15% combined. On a regional basis, the distribution of our revenues for the quarter was 48% from North America, 22% from Europe, 17% from China, 7% from Japan and 6% from the rest of the world.

Now I will discuss some highlights that cross our three segments. Extending the momentum from last quarter, our photonics segment continued to see strong demand, particularly for its optical communications products. Q2 revenue in photonics was up 22% over the same quarter a year ago. Bookings for the quarter were especially strong, up nearly 50% from the same quarter last year. While the bookings growth was driven by increased market demand, share gains and new product introductions, a good portion appears to be related to larger and additional long-term orders from customers becoming concerned about the supply chain constraints.

The broadband China program is continuing to drive orders across our portfolio including for 980-nanometer pumps, optical channel monitors and passive components where we have a significant share. To meet the combined and anticipated sustained demand for our terrestrial and submarine 980 pumps, we are expanding our global 980 pump capacity as we see this demand continuing into next year.

The onset of new [measurable] builds in the US is creating significant pull for our recently released OTDR modules, as well as our amplification and passive components products. Moreover, deployments of 100G, 200G and 400G services for data center interconnects, as well as the general transport markets that are also driving demand for our suite of ultra-compact optical components and amplification solutions for coherent transceivers.

Even though the optical communications market is still subject to cyclical swings, based on the increases in our bookings, our increasing penetration into the high-reliability submarine pump market and the steadily growing data center interconnect markets, we anticipate sustaining strong revenues through our FY 2016.

Turning now to the industrial laser materials processing markets that dominate the laser solutions segment, our revenues in that segment increased 4% compared to last year, despite the effects of the strong dollar. For the high-power CO2 laser optics business worldwide, we now see new laser builds at a ratio of 60% fiber to 40% CO2. Our high-powered infrared optics sales were flat to down in our major markets for the quarter as were our fiber laser cutting and welding heads for automotive manufacturing plants. This is due, we believe, to seasonal factors, as well as to the overall economic slowdown in China, even though the material processing market in China continues to be a growth area for us as we continue to find and grow new opportunities there.

Our aggressive strategy in low-power CO2 laser optics has also helped us maintain a leadership position in that growing segment of the market. Semiconductor laser diode shipments grew 9% compared to the prior year. We expect that continued focus on productivity and managing operating costs, including completing our first move to a lower-cost manufacturing location in the Philippines, will strengthen our competitive position.

Our 1 micron and related product revenues for the industrial materials processing markets grew over 20% compared to last year. We have added capacity in the US and in Asia to improve our customer service, including expanding our training of sales and application engineers to support our broad and growing portfolio of 1 micron products.

In the performance products segment, despite a decline in bookings both sequentially and for the second quarter of last year, we are seeing several good trends. We see renewed orders from our military customers for ISR applications and see growing strength in components for semiconductor capital equipment, where bookings this quarter returned to the highest level we have seen in the last six quarters. Demand for silicon carbide substrates for RF base stations is also strengthening after an inventory correction that affected our shipments in the first quarter. Revenues for this segment increased overall 3% sequentially and were down 2% compared to last year.

Before I turn it over to Mary Jane to walk us through a review of our overall financial performance, I would like to acknowledge our 9000 fully engaged employees worldwide for embarking on a quality transformation across the Company and for their continued dedication to building new and sustainable growth engines for II-VI.

Again, this quarter we saw the combined benefits of our triple play in R&D investments, vertical integration and M&A strategy implemented over the last two years continue to accrue. Those benefits, along with the relentless drive for operational excellence and our unyielding determination to continue to deliver exceptional business results, can be felt in every corner of the Company.

Mary Jane?

Thank you, Chuck and Fran. So margins this quarter remained pretty steady with the gross margin at 37.3%, the EBITDA margin at 19.1% and operating margin at 11.3%. These improved 160, 150 and 200 basis points, respectively, compared to last year.

The photonics 10% operating margin, the strongest we've seen since 2013, is very much influenced by higher volumes in new products. However, about 200 basis points of this improvement are from our work on operational improvements.

Our book-to-bill ratio was 1.08. The backlog today is $256 million, up $15 million from Q1 of FY 2016, and is $66 million in laser solutions, $85 million in photonics and $105 million in performance products.

EPS of $0.30 for this quarter was above the $0.26 top end of our range. $0.03 of this were due to the full-year effect of catching up the R&D tax credit, which was extended in December for the calendar year 2015. This compares to $0.24 a share same time last year, which also included that same R&D tax credit annual catchup. That tax credit, as you know, has now been made permanent. This $0.24 of last year includes the $0.11 benefit of the indemnification settlement that we had again in the second quarter of last year.

Year-to-date our cash flow from operations was $62.3 million, a record for II-VI for the first half. We reduced debt $60 million, bringing our debt level to $146 million. Our interest expense was about $600,000 for this quarter. We purchased no stock in the quarter, and we have purchased about $19 million of our $50 million authorized program. We invested $9.8 million in capital equipment this quarter and expect to spend $50 million to $55 million for this year.

For fiscal year 2016, we expect equity-based compensation to range from $12 million to $13 million. The expense this quarter was $3.7 million, higher than the quarterly average due to some accelerated vesting. The tax rate for the quarter was 14.4%, and for the full year of fiscal year 2016, the tax rate should range from 18% to 20%.

Our outlook, as we noted in our press release, does not include any effects of any acquisitions. We will provide new guidance for the quarter when both the transactions close. The outlook for core operations for the third fiscal quarter ending March 31, 2016, is revenue of $185 million to $195 million and earnings per share of $0.25 to $0.29. This is all at prevailing exchange rates, and all earnings per share comments refer to diluted shares.

Comparable results for the quarter ended March 31, 2015, were revenues of $182.7 million and earnings per share of $0.23 a share.

Before we turn to questions, just to let you know, our third-quarter earnings release date is slated for Tuesday, April 26, 2016.

So with that, operator, you can open the line for questions.

(Operator Instructions) Ted Moreau, Barrington Research.

Congrats on a solid quarter here. So yesterday we heard from ANADIGICS that they have received a higher offer from one of the other parties that was originally interested in the Company. And so I'm just curious as to what are you thinking as far as continuing to pursue ANADIGICS as an acquisition opportunity, and how are you thinking about how much you are willing to pay for that for a potential transaction here?

Yes, we did that or the ANADIGICS got an offer from Party B. And as we see these rather unpredictable offers come in, but it's certainly from that one group, we assess that each time that happens and try to decide which way we are going. Certainly, we are very interested in this business. So that could give you some indication.

We are realizing that this Party B apparently has an offer that has some flaws to it, let's say, and the company selling that business has the decision what they want to do. We are interested to win the business, but at the same time, we should pay the right amount of money for it. So we are feeling we are going to stay right on top of it and watch it every step, and that's about as far as I can go.

I see. Okay. So then if I have it right, it's all about adding VCSEL capacity potentially for VCSEL recognition in consumer electronics and what not. What's giving you the confidence that VCSEL will be utilized in these consumer devices, and what do you see as the timeframe of that potentially happening?

This is Chuck. Ted, a couple of things. Number one, we have ongoing product developments for VCSELs for these applications that are happening today in our laser enterprise division. And so we are engaged in a strategic marketing effort, a technology and product development effort and our channel checks, combined with industry analysts who are forecasting that these applications will grow substantially between now and 2020. I think at least one recent market survey suggests that the market might be as large as $2 billion for these applications.

So it's an exciting, enabling technology, and we are very confident in the technology capability, and the interest and the timing in the market in many ways depends in some measure on the capability of the supply chain, I'm certain. So we see this as a chance for us to expand and to have a scalable expansion capacity to address those markets and to be ready ahead of them as opposed to trying to catch up. Okay?

I see. Thank you. So just to follow up here, is your VCSEL product offering -- is that similar to how we think about like a Finisar product offering or an Avago VCSEL product offering, or are you just providing certain pieces for the entire solution?

We make VCSELs for different applications, including optical communications, including for [Cinting], as you know, for the [MOS] VCSEL and including for next-generation applications including some of the ones that we just spoke about.

Sure. Okay. But you're more intrigued with the consumer electronics opportunity than you are the data center opportunity?

We see a very strong interest and a strong demand and pull for our continued expansion for our capacity for optical communications as well, and that's here and now.

Sure. Okay. Thank you. I'll jump back in the queue. Thanks so much.

Jim Ricchiuti, Needham & Company.

Chuck, maybe this one is for you. You suggested -- when you were talking about the strength in the photonics business, you cited a few things: share gains, new products, some customers placing larger orders, reflecting concerns about possible supply chain constraints. Is there a way for you to maybe give us a little bit more granularity on that? What is one -- was one a bigger factor than the other?

I would say yes. I would say that roughly -- I would put 35% to 50% weighted toward supply chain, one-time supply chain events, and those one-time supply chain events include a customer moving off of a vendor-managed inventory and onto regular commercial buying. Number two, the launch of some of our new products seemed to be attracting the attention and need or desire by some customers for building some safety stock, and also just overall I can tell you that we feel it as well, there are certain elements of the supply chain that are in short supply.

So I would put 35% to 50%, roughly, as supply chain management issues.

Jim, another and maybe the last one, which is over and above what Chuck said but it's in there, is this return to us compared to when we took over. Oclaro had been dealing with that business. Some of those have now returned, and certainly in this submarine communications business, that's one of them.

Got it. That's helpful. With respect to the revenue guidance for the March quarter, if I look at the vertical market breakdown that you provided both for Q1 and Q2, it looks like you show good growth in each of your verticals with the exception of industrial, which looks like it was kind of flattish for the quarter sequentially. And so I'm wondering, as we think about the guidance you are giving for the March quarter, is there anything we should be mindful of in some of these verticals in the quarter coming, that we are in right now, in terms of where we might see a little bit of sequentially down revenues?

I might give a start to an answer there. Certainly, in the second half of the year, Q3 and Q4, we usually see an uptick in our laser solutions business, and we see most of those possibilities exist this year. And the CO2 business, which is one that takes off more in the third and fourth quarter, has been modest over the last six, seven quarters compared to what we have had in the past.

So we check on that using surveys that we do with their aftermarket customers, and we see the aftermarket life just a little slower, driven mostly by the worldwide economy. So it's on a pattern to do better in the second half. However, if this continued slow economy gets worse, we might not get the uptick we are thinking about. But I think we feel pretty good we will.

That would be for that segment. I think Chuck gave a pretty good update on photonics for where we are with that buildout and so on. So the third business for us to comment is performance products. We have some opportunities. We said the trends are good. Certainly the trends are good. And will that translate to orders and deliveries in this second half? We factored them into our best judgment.

Got it. That's helpful, Fran. And just one final question, if I may: the industrial, were you are seeing a little maybe slower sequential improvement, in thinking about the second half, is that more focused in China? It sounds like other parts -- Europe, North America -- remain fairly healthy. Is that fair to say?

I think we've said all along over these last few quarters -- and maybe it has been four, five, six quarters -- yes, they are healthy, they are just not robust. And that's what we -- if that's not robust in the first and second quarter but turned a little bit down because of something we can't predict, that would cause us not to get to those numbers. But I think we feel pretty good. I think all the down risk of the economy getting worse relative to the laser solutions business have factored into our forecasts here.

Okay. Thank you.

Dave Kang, B. Riley.

First of all, Mary Jane, I was hoping to get a number. You said the photonics backlog was $85 million in fiscal second quarter. I was wondering what that number was in fiscal first quarter and also a year-ago period. Do you have that number?

Can shortly. Ask your second question.

Okay. Then, maybe for Chuck, so can you just talk about which products are very strong, which products are tight? Can you talk about capacity situation? Because I know some of your competitors have said that they are pretty tight in capacity and maybe even on allocation.

We are feeling the effects of continued strong demand in China from China broadband and across the board. As you know or as we have talked about in the past, we are a significant supplier of amplifier components into that market.

Yes.

And so pumps and passives are experiencing quite a strong demand for that -- pumps and passives, in general, for that part of the market. The ongoing demands and the baseline demands in North America combined with both the anticipated metro buildouts in North America and also the gradual adoption of 400G in North America and in Europe are driving demand across the board for everything, starting with amplifiers, for the amplifiers.

What about the OTMs? I know that that's a key component for like a ROADM blade. I would say that would be also a good indicator for metro buildout, too. No?

Yes. So Dave, I was about to say amplifiers, optical channel monitors, our new optical time domain reflectometers and tunable optical filters. So the suite of those components that will be deployed, are being deployed alongside amplifiers and in line with the transponders, we are experiencing significant demand across the board.

So how was your capacity -- sorry, go ahead.

Sorry, Dave. And finally, since you asked me, regarding -- earlier Fran made the comment regarding 980 pumps. And that is for the OEM market, for our own internal amplifiers but also for the submarine market, which is growing in response to the large increase in data center interconnect traffic, as you know.

So regarding our capacity, we are managing our capacity very, very closely, very tightly. We have expanded and authorized increased capital investments this year above what we had budgeted. We have turned on our new laser chip on carrier line in the Philippines, offering us expanded capacity, as well as a path for lower costs. And we do have some constraints that we are managing ourselves, but also we are managing our own supply chain constraints as part of that.

Got it.

And I think that the team are doing a great job at it as well.

Sure, sure. And then -- oh, sorry.

With respect to your question about the backlog, so the backlog in the sequential quarter in the first quarter was $61 million compared to this quarter's backlog of $85 million, and it was $54 million in the second quarter of last year.

Got it. That's very helpful. And then Chuck, so just a couple more on the opticals side -- can you just talk about -- you guys went through the annual pricing adjustment, how that was compared in recent years, and can you talk about the lead times, what was it before and what is it now?

I'm not sure, Dave. Can you clarify your question regarding lead time?

Yes, lead times -- typically, in the past, it has been like about four, maybe six weeks. Has that been kind of stretched out to maybe eight weeks or maybe even longer?

I think across the board, across our entire supply chain, Dave, lead times are extremely important to our customers. We stay focused on that. In cases where we are surprised either by sudden demand or by shortages in the supply chain, where we have done everything we possibly can, in that case we may have to extend the lead times. But we are absolutely focused on serving the customer, making sure that we've done everything we can for that.

Regarding pricing, I would say on -- in general, despite the demands, the pricing environment continues to be competitive, and we've had some success in slowing down the price erosion. In some cases, we have actually increased the prices. In other parts of the portfolio, where there were multiple sources that we are competing with, we have stayed on our typical track of 2% to 3% reduction in the quarter.

Got it. Got it. And just lastly, so your bookings were up almost 50% sequentially, but sales were up only -- I'm talking about optical or photonics -- up 50% sequentially, bookings, but the revenue was up only 3% sequentially. Is that because of what? Were you capacity constrained, or can you go over the disconnect between bookings and sales or bookings there for multiple quarters?

It's a great question, David, and you answered it with a great answer. So coming back to my comment earlier and my response to Jim Ricchiuti, 35% to 50%, in that range, of the bookings were really laid out for us over a longer time horizon than we generally get.

So we're delighted to have it, and it will help us improve our planning for the next one or two quarters, and do our best to be able to break the constraints and increase our outlook to keep up with the demand. And I would say we always need to have some headroom because we have been very, very aggressive about positioning both the performance and the ability of our teams to scale to meet market demands, to win business and to take share. So we have been very aggressive about that, and we will continue to be.

And lastly, I promise this is my last question is that I always get asked from accounts about sustainability. Can you just go over -- I'm assuming North America, and you are just getting started as far as the metro. So I think that's quite sustainable. What about China? It seems like that is sort of on-off, on-off.

Right now it's on, and we are expecting, based on our checks, our discussions with our key customers, we are expecting that the momentum that we currently are caught up in and creating should continue at least through this fiscal year. We will have to update you again on April 26, Dave. That's our best view as today.

Thank you.

(Operator Instructions) Mark Miller, The Benchmark Company.

Congratulations on your quarter. From what Mary Jane just said about the photonics backlog sequential improvement, it seems like the other areas went down. I was just wondering in terms of the draw down in the other areas whether there is anything of significance in terms of which area was drawn down more significantly.

Thanks for your question. Give us just a sec.

In terms of whether or not there's a very, very significant movement from the first quarter, not really particularly in laser solutions. As we said, our book-to-bill has been in the 99-100-101 type of range for a long time. And to move some large amount of points on the whole quarter, almost 10 points on the whole quarter, we are really talking about the grade of movement that we ended up seeing in performance products.

So I don't know that we are seeing a really hugely big difference. I think performance products, however, which has our main markets to serve, the semiconductor capital equipment market and the military market, those bookings as a factual matter are very, very lumpy. So, in fact, we spent-- Chuck spent some time talking about the sequential growth in those just in revenue in those markets because some of those bookings were had, say, six months ago.

So it's tough to say we had big, big differences in performance products when the bookings are lumpy, anyway.

You mentioned the cutting head market was flat. Autos has been strong. Is that a seasonal effect, or do you expect that to pick back up?

I do think we think it has a little to do with the economy and how the use of the lasers is -- it goes up and down as the economy does well and people slow down on their capital procurement. The cutting head market, one of them, we think has that. So a little bit of seasonality, but we are coming into the better part of the curve on that here in the first, third and second or the third and fourth quarter. So seasonality, a little economy driven, quite a bit.

Your proposed acquisitions, I'm just wondering how that will -- will that have a significant impact on margins as you go from 3-inch wafers to 6-inch wafers? I'm just wondering what the impact -- I assume that's going to be the principal impact of doing these acquisitions, better margins. I'm just wondering how big an effect that will be.

We are not giving, really, any forward-looking numbers on really any of the parameters for the acquisitions at this point in time. I think, one, it's preliminary. But do we think there is an advantage across a few dimensions, whether they are economic or technical on the 6-inch? Yes, but I think in terms of its exact or even its ballpark movement on the margins, we are not commenting on that, really, at this point.

And finally, the R&D spending went down sequentially. I'm just wondering what the trend is for the rest of the year.

I don't think that you should expect as a conceptual matter that the R&D spending is declining. Sometimes there are slightly seasonal factors of when various things happen or are delivered, particularly among prototypes. But generally speaking, our R&D spending is fairly steady.

Thank you.

Mary Jane, I could add -- just to add, Mark, to what Mary Jane said, our teams more and more in this environment, especially in an environment which is demanding new products and is coming at our customers a little faster than what they expected, we typically will ask for NRE in certain cases. And our teams more and more are finding that they can be successful in that regard as an offset to the R&D expense. So when you see that, it's not necessarily a slowdown of the activity, but in some cases the treatment of how we paid for it, basically.

Thank you.

Thank you and I'm showing no further questions at this time. I'd like to turn the conference back over to Mary Jane Raymond for closing remarks.

Thank you, Candace. Well, first of all, thank you all very much for joining us this morning. If there is a follow-up, anything on what we've already talked about, we would be pleased to talk to you later.

Fran, is there anything you'd like to conclude with?

Just to tell everybody that has been following us, stay tuned for how we proceed on with these acquisitions, and we are upbeat about the third and fourth quarter of our base business. Thanks for attending.

All right. Have a good day. Thanks. Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Have a great day, everyone.