This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk08: Ladies and gentlemen, thank you for standing by and welcome to the 2-6 Incorporated FY22 second quarter earnings call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to turn the call over to your host, Mary Jane Raymond. You may begin.
spk09: Thank you, Kevin, and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at 2-6 Incorporated. Welcome to our earnings call today for the second quarter of fiscal year 2022. With me today on the call are Dr. Chuck Matera, our chair and chief executive officer, and Dr. Giovanni Barbarossa, our chief strategy officer and the president of the compound semiconductor segment. This call is being recorded on Wednesday, February 9th, 2022. Our press release and our updated investor presentation are available on the Investor Relations tab of the website, ii-vi.com. As a reminder, our remarks today may contain forward-looking statements. These remarks are given in the context of today only. They are subject to various risk factors and subject to change, possibly materially. We do not undertake any obligation to update these statements to reflect events subsequent to today, except as required by law. A list of our known material risk factors can be found in our Form 10-K for the year ended June 30th, 2021, together with our subsequent filings with the SEC. Our remarks today do not constitute an offer to sell, nor do they constitute a solicitation of an offer to buy any securities. No offering of securities shall be made except by means of a prospectus meeting the requirements of Section 10 of the United States Securities Act of 1933, as amended. Finally, with respect to today's call, we will also present some non-GAAP measures for which the reconciliations to GAAP are found at the end of each document that includes those measures, such as the press release or the investor presentation. With that, let me turn the call over to Dr. Chuck Matera. Chuck?
spk13: Thanks, Mary Jane. Good morning, everyone, and thanks for joining. During the quarter, we were once again able to look beyond the well-known challenges of the day and got the job done. Clearly, our application-specific materials, components, and subsystem technologies underpinning multiple growth drivers intersected perfectly with the sustained demand that resulted from the strong market momentum. We delivered a solid second quarter as we helped our global customers accelerate their additions of capacity, and enable the availability of new features for mobile, intelligent, and electric infrastructures. Among those drivers, we are underpinning the convergence of communications, computing, and connected consumer and automotive devices. These are revolutionizing how we interact with each other at work, at leisure, and while learning through the Internet of Things and the metaverse. I will have more to say about how we are enabling the electrification of transportation, as well as our vital contributions to the resolution of the IC shortages later in my remarks. Now, to provide further color on the quarter, for the first time in our history, we booked over $1 billion in orders. Our backlog grew 58% year-over-year to a record 1.7 billion and was up 300 million sequentially and 600 million year-over-year. This backlog is supported by our capacity additions along with the planned launches of new products from both segments. This gives us confidence in our double-digit growth projections beyond this fiscal year that we will refer to in today's call. Our revenues were $807 million within our guidance, and but for increased supply line and COVID related constraints that accelerated throughout the quarter, we would have cleared the high end of our revenue guidance. The two largest drivers of the revenue gaps were from RODEMs and transceivers. our non-gap EPS of 92 cents was at the top end of our guidance. This was enabled by a strong focus on controlling cost increases and on ratcheting up factory utilization and output. This cost control, in turn, required a continuous optimization of the supply chain, including building inventories at strategic points along our vertically integrated supply chain. This resulted in our inventory levels increasing again in the quarter as we continued our focus on serving our customers in the face of COVID and to mitigate the impact of the extended lead times and other related disruptions from the supply chain. In communications, we experienced increased demand for Datacom transceivers and open line systems driven by the cloud and large enterprise customers. We continue to make inroads into serving the hyperscalers with our exceptional progress on 200G and 400G output and our early ramps for 800G for very large and growing strategic customers. We also saw a strong increase in demand from the telecom equipment customers and a clear sign of the start of a Rotem demand ramp that we expect will accelerate during calendar year 22 as the increased availability of ICs materializes from legacy supply lines and new ones that we are collaborating with closely along with our customers to accelerate qualification. The beginning of a multi-year upgrade of the U.S. cable TV infrastructure provided for a large and long-term contract and is also among our exciting growth drivers based on major fiber deep initiatives to improve rural broadband access in the US. Turning to the rest of the business, we believe that we are still in the early part of broad and multi-year adoption cycles across all of our other end markets too. Increasingly, our customers are leveraging our breakthrough solutions, our large and resilient footprint, and our manufacturing expertise at scale. Our ongoing investments in R&D facilities expansions and capital equipment reflect our confidence in the long-term nature of our opportunity and our relentless focus on tying together our strategy with our execution. Our capital allocation of R&D and CAPEX this year is more heavily weighted to the compound semiconductor segment given our growth aspirations for FY23 and 24. Now, in industrial, again this quarter, we experienced sustained increases in orders and demand for our laser components, including for CO2 lasers and fiber lasers. We experienced explosive increases in orders from the semi-cap equipment ecosystem, including from equipment OEMs and their Tier 1 suppliers. Our differentiated position met accelerated demand from the OEMs and the semi-cap equipment front end and back end wafer fab and laser based inspection platforms. These expansions have spurred further increases in our already large manufacturing capacity investments, and these will accelerate throughout calendar year 22. We maintain intimate partnerships with leading companies up and down this ecosystem where we are providing unique and vital components which are sourced solely from two six including and especially for the euv lithography tool supply chain this is helping the leading ic producers have confidence in the returns on their investments as they expand the much needed capacity in order to eventually clear the current ic supply chain shortages let me spend a minute on our recent success qualifying 1200-volt silicon carbide MOSFETs for automotive applications using our substrates in the device technology we licensed from GE. I am excited about this important milestone that we met ahead of an aggressive schedule. I am pleased that we also entered into a new agreement with GE to deepen our relationship in order to accelerate the adoption of our silicon carbide technology and products. We will continue to focus on shortening our time to market and underpinning this platform with capacity and diameter expansions to help position our company as a market leader. The electrification of transportation will contribute substantially to the world's net zero sustainability goals, and as part of our corporate social responsibility, we are proudly positioning ourselves to substantially contribute to it. Looking ahead, we expect the totality of the company's investments to contribute to the sustained growth in FY22, and we expect to significantly drive our target of double-digit organic growth in both 2023 and 2024 by a combination of continued market growth and share gains across our photonic solutions and compound semiconductors customers. We will continue to work tirelessly to mitigate the impact to our customers and differentiate ourselves with capacity additions while we maintain a good balance with our short-term cash management objectives. We expect the stress on our supply chain to continue to constrain our output and will have the effect of increasing some of our costs. Therefore, we have a major initiative across the company to increase prices at least as a partial offset. Finally, on the pending acquisition of Coherent. Nearly a year ago, we announced that our analysis pointed to the long-term value of acquiring Coherent. This was part of a strategy to accelerate our penetration into new markets and sustain our profitable revenue growth. We envisioned a combined company that would have access to complementary growth drivers a broader endowment of innovations in scale, and productivity and efficiency gains captured as going forward synergies. This is only one part of the rewards that I believe lie ahead. Pre-closing planning has proceeded nicely, and we are working the final details necessary for a successful integration. The pending acquisition of Coherent has received the approval or indication of imminent approval from three out of four global antitrust regulatory authorities, which approvals are conditions to the closing of the transaction. In China, the remaining jurisdiction, 2-6 and Coherent, are continuing to work constructively with the State Administration for Market Regulation, or SAMR, and we now anticipate closing the acquisition by the middle of the second calendar quarter of 2022. It is a time of great anticipation and responsibility for us. And we are ready and set to go as we gear up to start our engines. With that, I will turn it over to Dr. Giovanni Barbarossa. Giovanni.
spk10: Thank you, Chuck. Our revenue in the industrial market grew 47% over Q2 FY21 and 6% sequentially. we saw strong growth across all industrial applications, particularly in silicon carbide power electronics and fiber lasers. In the quarter, we shipped about 100 megawatts of pump laser power for fiber lasers, setting a new quarterly output and utilization record for our six-inch wafer platform. We were excited to receive the 2021 Supplier Award from Hans Laser in recognition of our world-class products for fiber laser applications, which will continue to drive our growth, particularly after the merger with Coherent. Our communications revenue grew 6% year-over-year with most of the growth from Datacom, and more specifically from our high data rate transceivers. Our Datacom business experienced exceptional growth at 9% sequentially and our transceivers at 200, 400, and 800 gigabits per second grew 25% sequentially, and now represent 30% of our Datacom revenue from about 2% a year ago, a clear sign of share gain across all high data rate transceivers. We are very excited to be able to best support our customers with higher data rates, particularly hyperscalers in their build out of AI superclusters in a market which industry analysts are projecting to grow by 20% in calendar 22 and to continue to experience double digit growth for at least another three to five years. In the same market, we are pleased to report our first design win and revenue from our differentiated clock and data recovery IC. a clear sign of the competitiveness of our captive IC platform, which we made available to the merchant market as part of our integration of Finisar. With regard to transport networks, last quarter we announced our engagement with Windstream Wholesale, and this quarter we are pleased to report the initial shipments of our 400G ZR Plus digital coherent optics in the CurseFP DD form factor, the first of its kind to enable IP over DWDM thanks to its 0 dBm output power performed by our Indu-phosphide component technology. Our consumer market revenue grew 23% sequentially. The competitiveness of our VIXR platform continues to be a winning factor in the market, and we are pleased to report the third consecutive quarter of zero defect parts per million shipped, a world-class quality performance achieved by our team in Sherman, Texas. On the sensing technology front, we've always emphasized the advantages of indium phosphide over gallium arsenide for some application-specific optoelectronics products. And we believe we are leading the consumer electronics and automotive market development with significant customer commitment and investment to date in our NUFOS 5.5s. In the emerging metaverse of virtual and augmented reality applications, customer engagements are gaining momentum, opening up exciting opportunities for our broad spectrum of technology platforms. Specifically, we are very pleased to report that a new customer for AR VR applications has committed to fund us with about $50 million for the development and production of a broad range of new products, including lasers, diffractive optics, and advanced materials. Several strategic customers are beginning to realize the unique value of the one-stop-shop offering we provide with the depth and breadth of our portfolio and the promise of our long-range roadmaps. Our revenue in the semiconductor capital equipment market grew 34% year over year. The demand for our products is strengthening as we expected because of the massive investments underway in new semiconductor wafer fabs worldwide. The industry relies strongly on our highly differentiated materials, including polycrystalline diamond, reaction bonded ceramics, a metal matrix composite for extreme UV and deep UV lithography, as well as wafer stages and chocks for front-end fabric equipment, and specialty thermal management components enabling advanced packaging and testing capabilities. Our silicon carbide revenue grew 11% both year-over-year and sequentially. We saw very strong demand for power electronics applications with revenue doubling sequentially and increasing by an order of magnitude compared to the same quarter in FY21. As Chuck mentioned earlier, our investments in silicon carbide are underway and encompass a variety of applications and vertical end markets. We expect to see our substrate business continue to grow, and I'm proud to report that we have started preproduction of gallon nitride on silicon carbide amplifiers on our 16 substrates in our Warren, New Jersey fab, with full production planned by the end of March. Last but not least, we are pleased to have recently kicked off an exciting partnership with Element 6 to complement our world-leading polycrystalline diamond platform with a single crystal capability that will considerably broaden the range of advanced applications we will be able to sell. With that, let me hand it over to Mary Jane Raymond. Mary Jane?
spk09: Thank you, Giovanni, and good morning. The end market and geographic breakdown of our $807 million of revenue can be found on the fourth page of the investor presentation. Our Q2 non-GAAP gross margin was 40.3%, and the non-GAAP operating margin was 19.7%. Supply chain costs and COVID costs, a total of $9.5 million, are not excluded to arrive at non-GAAP results. At the segment level, the non-GAAP operating margins were 14.6% for photonics and 29.2% for compound semiconductors. Our record backlog of $1.7 billion consists of $1.22 billion for photonics and $484 million for compound semiconductors. As we have stated, this increase in backlog is a function of demand. particularly from the industrial end market and across the communications end market. GAAP operating expenses, SG&A plus R&D, were $213 million in Q2, excluding $10 million of amortization, $17 million of stock comp, $10 million in startup costs, and $10 million of M&A and integration costs, non-GAAP OPEX, was $166 million, or 21% of revenue. Cost synergies for the Finisar acquisition, originally targeted at $150 million, have now reached nearly the $200 million stretch target six months early. Savings in both the cost of sales and OpEx contributed to our over-delivery and contributed to the margins this year so far. Quarterly GAAP EPS was $0.44 and non-GAAP EPS was $0.92 with after-tax non-GAAP adjustments of $57 million in total. The increase in non-GAAP adjustments compared to last quarter includes the initial debt costs largely related to the completion of the placement of the financing for the coherent transaction. The diluted share count for GAAP results was 116 million shares and for non-GAAP the share count was 125 million shares. The GAAP and non-GAAP EPS calculations are in the ending tables of the press release. For the non-operating income or expense, the company has $2 million of non-operating expense this quarter, largely due to a $2 million write-off of disposed equipment. This, we still expect, the normal run rate non-operating income or expense to be $1 million of non-operating income going forward. Pre-tax interest expense was $17 million. This includes $10 million of our underlying interest and $7 million of interest and fees on the debt for the transaction. Cash flow from operations in the quarter was $188 million. and free cash flow was $133 million, including CapEx of $55 million and a strategic inventory build of $50 million in the quarter, $100 million for the first half of the fiscal year to support our growth beginning in the second half of fiscal year 22. For fiscal year 22, we now expect CapEx to be $325 million to $375 million, driven largely by our expansion of silicon carbide and indium phosphide to address the growth in power devices, communications, and consumer applications. We paid down $30 million of our debt in Q2, retired the remainder of the Finisar 2036 notes, and our net cash position is $329 million. The company's liquidity at December 31st was $3.1 billion. The effective tax rate in the quarter was 15% due to ongoing benefits of R&D tax credits and other investment credits. We expect the tax rate to be between 18 and 20% for fiscal year 22. Turning to the outlook for Q3 FY22. Our outlook for revenue. for the third fiscal quarter ending March 31st, 2022 is expected to be 785 million to 825 million and earnings per share on a non-GAAP basis at 75 to 95 cents. The share count is 116 million for the low end and 125 million for both the midpoint and the high end. The EPS calculation, including the dividend treatment, is detailed on Table 8 of the press release for the low, mid, and high points of the guidance. This is at today's exchange rate and an estimated tax rate of 19%. For the non-GAAP earnings per share, we add back to GAAP earnings the pre-tax amounts of $20 million in amortization, $20 million in stock compensation, and 21 to 26 million in transaction, integration, and other related costs. The transaction costs are expected to be higher as we accelerate the planning for Coherent, complete the final year three synergies for Finisar, including our startup costs. The actual dollar amount of non-GAAP items, the tax rate, the exchange rates, and the share counts are all subject to change. Before we go to the Q&A, just as a reminder, our answers today may contain forecasts from which our actual results may differ due to a variety of factors, including but not limited to changes in mix, customer changes, supply chain shortages, both upstream and downstream, competition, changes in regulations, COVID-19 protocols, and general economic conditions. We welcome your questions and expect to end this call not later than 10 a.m. You may open the line for questions.
spk08: Ladies and gentlemen, if you have a question or a comment at this time, please press the star, then the one key on your touch-tone telephone. If your question has been answered, you wish to move yourself from the queue, please press the pound key. Our first question comes from Anand Barua with Loop Capital.
spk03: Hey, good morning, guys. Happy New Year, and thanks for taking the questions. I guess two, if I could. The first one, Chuck, is to your long-term organic growth rate, you know, kind of provision. I don't know if it's quite a guide, but the commentary, and thanks for that. Does that include, clearly it's sort of 2.6 in its current structure, but does that also include double-digit post the closing of coherent, let's call it organic apples. And then I have a quick follow-up. Thanks.
spk13: Good morning, Ananda. Thanks for your question. My commentary is based on and is referenced to the organic growth rate of 2.6 as it's configured today. Would you like to add to that, Mary Jane?
spk03: Excellent. Okay. Cool. And then my follow-up is from the transceiver business, uh really good progress getting to a third of uh of revenue on greater than 100 g um it sounds like sounds like you're constrained there still as well uh i you know but in spite of that and here's really the question um is i believe that your goal was to get to a third of revenue by mid-year this year so is it also accurate that you're over achieving your goal And you mentioned market share gains. So we'd just love to get some context around what you're seeing there. And is it accurate that you're kind of like tracking stronger than you had thought previously, greater than 100G? And then also, any context, guys, on the 100G market? Because we've been hearing that that might kind of be where more of the constraints are taking place, just industry-wise. So we'd love any context on 100G also. Thanks. Thanks.
spk11: Thanks for your question. Let's say that the supply chain has not impaired by any mean our ability to get new design wins and get traction for these higher speed, higher data rate transceivers. The two are definitely decoupled in a way that all depends ultimately on the differentiation and the performance, power consumption, so forth, advantages that we offer to the customer for these higher data rate transceivers. even if there is clearly a market-wide constraint on the supply chain, I think customers still see the ability of 2-6 to provide a broader offering than most can, and they see that very valuable. So that explains our ability to get to a third of the total for high data rate transceiver faster, you know, ahead of our plans. And then, yeah, I mean, the 100G is, as any other speed, is definitely affected by the supply chain, but there isn't really, as you know, the market for 100G substantial is still dominant, and so clearly from a dollar perspective, you know, proportionally, there is a larger impact there. But I think the good news is that that, as I said, the ability to gain share in such a complex situation from a supply chain standpoint, I think comes a long way demonstrating the strength of our platforms.
spk03: That's super helpful, Giovanni. Thanks. Thanks, guys.
spk08: Our next question comes from Medha Marshall with Morgan Stanley.
spk01: Great. Thank you. And congrats on the quarter. A couple of questions. One, Mary Jane, if you could just give some context for the add back of the startup costs and just kind of what that related to and rationale for kind of backing that out of non-GAAP. And then second, you know, you guys had mentioned that you were putting into place some pricing increases. Could you just, you know, give a sense of whether those are across the board or where... where those price increases are kind of being applied and when we should expect to see some of that impact. Thanks.
spk09: Sure. So let's take the second part first. So price increases probably have a couple of different flavors. As Giovanni said, both this quarter and last quarter in the semi-cap equipment market, our components for that are obviously in very high demand. So that's one area more due to demand and the rapid acceleration of designs there. And then in the industrial space, in some of the end markets of our industrial end market, we have had pricing ability for many, many years. So there is the sort of typical pricing ability that the company is able to exercise and in some cases is doing so. The second flavor is actually related to more in communications where we are incurring additional cost for purposes of trying to get components to meet our customers' needs. In that case, I would say that what the company is actually doing is really trying to achieve best value with customers. So in other words, we are not whole cloth passing through those price increases. We are working with each customer individually and in some cases working with customers to actually get more share of wallet of their business rather than pass along a price increase for today. So when I say we are looking to achieve the best value creation with our customers, that's what I mean. It's not really ever a simple matter of we incurred this much, so therefore we're taking prices up to customers this much. And I think that actually that has served us very well during this time for the efforts we've had now for over a year in trying to secure short parts. With respect to the question on the startup costs, so the company is starting up new products in the UK FAB, and those are being excluded from non-GAAP because they're also being excluded to achieve the non-GAAP because they're also expected to be short-term. Giovanni mentioned that we expect to start to ship those products somewhere in the middle of the year. So that's the rationale on that.
spk01: Great. Thank you.
spk09: Sure.
spk08: Our next question comes from Samic Chatterjee with JPMorgan. Your line is open. You can ask your question. Did you want me to go ahead and move on to the next question?
spk09: Sure. Samic, we'll come back to you if you're having a little technical problem. If Joe's on, Joe can also ask. Joe, are you wanting to ask? Otherwise, we'll circle back to you.
spk08: Our next question comes from Paul Silverstein with Cowen.
spk06: Thanks. Mary Jane, I apologize. I think you said it during the call, but can you repeat what was the impact on both revenue and on margins of supply chain? And more importantly, any thoughts you can share with us as you look forward more distantly into the future in terms of where margins can go?
spk09: So with respect to the effect of revenue on the supply chain, actually it was Chuck, if we had not had the supply chain constraints that we did in the quarter, we think we would have been able to clear the top end of the guidance. So if you look at the top end of our guidance, having been 840, you can pretty much back into roughly what was the same number last quarter in the mid-30s. With respect to the margin, well, certainly we would have lost the margin on that volume, but the additional cost to secure parts that are still sitting in the margin, just that cost for supply chain shortages is $5.5 million. So it's about three-quarters, 75 basis points in round numbers. With respect to the question of going forward What do we expect to see? Let me just answer the margin question for that, and then Giovanni and Chuck can probably talk about supply chain generally. But with respect to where margins can go, you can already see, you know, looking at the segment margins and then seeing their effect even with constrained supply chain and COVID and all that jazz, you know, the company achieving 40%. That is largely because of the ongoing strength out of Giovanni's segment which is really 3D sensing, silicon carbide. As we've said for a while now, those markets which are really in their infancy, they carry very nice margins, so the growth in those markets tends to be accretive to margin. I'd say, in addition, we've also, we said last year, don't discount industrial. Industrial is a very strong margin and market for us. is also contributing very, very well. I think as we continue to have the higher speed transceivers make up more of our transceiver content, we have the benefit of those early higher margins as well there. And as the component shortages lessen on rhodums, which is probably the highest margin group of products inside of photonics, Those also come back. So while the company's margin range is still 38 to 42, as I've said before, we're looking forward to big 40 sustainably and then going up from there. So I think ultimately, we've probably all talked about this in the past, the highest gross margin the company ever reported was 45, and there is not a soul in this company that has ever forgotten that.
spk06: Mary Jane, just to be clear, given what you just articulated and the fact that you're currently at 40% and have been for the past several quarters, weren't those higher margin young early products that are not contributing very much today but will contribute more in the future, why wouldn't that drive upside to that 40%?
spk09: Oh, yes. I'm sorry. I do think there is upside to the 40%. I'm just not exactly sure what quarter exactly that will land in. And I do think that notwithstanding that we are already getting that and that's achieving in the 40s, the pressure on the Rotem side from a short parts point of view, the Rotem parts do carry a nice margin in photonics. And I think that 3D sensing and silicon carbide still are really only in the first inning. So, oh, yes, indeed. I do think there is positive upward movement in our margins. I just would not say it's quarter on quarter on quarter. But I do think that we will see that probably an improvement or a good sustaining over the next, say, 18 months as those markets come into their own.
spk06: I appreciate that. One follow-up, Chuck and Giovanni, any insight you can share with us on what's going on in your telecom business? Is that simply supply constraints for the lack of growth, or is there something else going on there?
spk13: Good morning, Paul. Thanks for your question. Well, it's exactly – dominated by supply chain dynamics. And the health of the business and the launch of the new products, the desire for more of what we make is all very clear. Our dashboard is lit up across the board on demand, and we're working the constraints as they relate to the supply chain. That is our focus.
spk06: That's what I would have expected given the strong demand in the market. Thanks, Chuck. Appreciate it.
spk08: Our next question comes from Mark Miller with the Benchmark Company.
spk15: You posted a very impressive increase in your backlog, yet midpoint even guidance for sales for the March quarter is kind of flattish with December. I'm just wondering how does that backlog, in terms of shipping, is it more back in terms of shipments on your backlog?
spk09: I think this is the way you want to think about it, Mark, especially given the 1 billion bookings for this quarter. We have some significant increases in demand from customers. In order for us to make the commitment to build out the capital and, frankly, the engineering, we are increasingly asking customers for not only longer-term views of their strategy, we're asking them for longer-term orders. and that is what we are seeing here. Consequently, the answer to your question is yes, it is more back-end loaded than if you were to assume that the bookings of one quarter are immediately revenue in the next quarter. That's actually not been the case from us for a year, as you already know. I would say that we are looking at that backlog certainly being timed across the year. It's probably fair to say that you know, more than half of it is in the next six months, but a non-trivial amount is still in that latter six months. And if you then think about that in the context of our CapEx, they kind of go together, right, because that is what's allowing us to see that we need to, and we have the ability with the customer backing to put that capital in place.
spk15: That's my second question. I was wondering if you can comment about pricing in both transceiver, the high-end transceiver, and also the VIXL markets.
spk11: Hi, Mark. This is Giovanni. Thanks for your question. We have not seen any unusual ASP pressure as we've seen in the past. I mean, it was pretty much the similar competitiveness around all of the data rates. The major difference, of course, is that As you go up in data rates, you go to the higher speed transceivers, there is substantially less price pressure than for the 100 and, let's say, the legacy products. So that's pretty much the environment we're in. So pretty much the same that we've seen over the past few years. So the constraints of the supply chain have not changed. The outlook in terms of ASP changes over time.
spk08: Our next question comes from Tom O'Malley with Barclays.
spk14: Morning, guys. Thanks for taking my question. My first question is on the cadence of CapEx in the back half of the year. You're sticking with your guidance for, I believe, 325 to 375 for the entire fiscal year. But, you know, coming off of December quarter, where you did, I think, around 60 million or so, that, you know, implies a big acceleration in the back half. Could you give a little color on the cadence of that? Is that evenly spread across the March and June quarter? And then how do you think of that in terms of free cash flow, just given the midpoint of guidance in March this It looks like with that CapEx spend, free cash flows, you know, potentially negative. Would you see the free cash flow going negative or just any color on the cadence of that CapEx?
spk09: Right. So first of all, the CapEx in the cash flow statement, right, is the capital that's already been paid for. So we probably have on a – if we just talk about the capital itself being in place, we probably have about another $50 million of received equipment where the bills are you know, in AP right now, so that comes through the operating cash flow. I think it is a little bit more back-end loaded because it was planned that way, actually. I mean, we were looking for getting the long lead times out there, getting the capacity in place. Is it possible that in one quarter that the free cash flow could go negative? It potentially could, but I'm not sure that we would. I'm pretty sure we'd be working pretty hard not to have that be the case, but at the end of the day, We are looking to be shipping off some of this capital relatively shortly in the middle of the year, which could technically span the last quarter of fiscal year 22, the first quarter of 21, and we're looking forward to being able to get those products delivered to customers.
spk14: That's helpful. And then this one's for Giovanni. You, obviously, some really exciting growth in the high-speed transceivers. On the last call, I believe you mentioned some additional investment potentially in digital silicon. Are you still pursuing that roadmap? Is digital silicon important for you guys at higher speeds? And is that something that you think that you need to have in the future as we move to higher speeds? Thank you.
spk11: Hi, Tom. Thanks for the question. Absolutely.
spk13: Tom, go ahead. The answer is yes. But was there something else you wanted to ask about it? No.
spk14: Just if that was something that you're continuing to invest in. So I guess with absolutely there's continued investment there.
spk13: Tom, we absolutely are. And we have some very major mileposts, and they're exciting, and we're right on track.
spk07: Thanks, Chuck.
spk08: Our next question comes from Simon Leopold with Raymond James.
spk04: Thanks for taking the question. First, a quick clarification and then my question. On the startup cost that you excluded from the pro forma this quarter, I just wanted to check back whether this was related to the expenses you talked about on the August earnings call. You had mentioned a $60 million to $70 million investment in R&D. related primarily to silicon carbide. I want to see if this was the same topic. That's my clarification. In terms of the trending question, I'd like to see if you could elaborate a bit on your hyperscale exposure. Given the really impressive numbers, the one-third of the transceivers, Datacom transceivers coming from 200 to 800 gig, I'm assuming that's heavily biased towards hyperscalers If you could confirm that assumption and discuss how you see that trending for the full calendar year, I'd like to hear that. Thank you.
spk09: So I'll answer the first one. So first of all, no, it is not related to it. So in the first quarter, in the June quarter, we talked about roughly $60 to $70 million for silicon carbide. By the time we got to reporting the 930 quarter, Instead of being about $20 million a quarter in engineering, it was actually closer to $10 million. That is actually a function of how we were able to use the time of the manufacturing engineers that do the design for manufacturability. When we were estimating that cost, we thought we would be taking those guys out of their jobs pretty much full time. As it turned out, we were able to use their time a lot more efficiently than that, and they could continue to cover off other manufacturing that they were doing. But we do use on the shop floor manufacturing engineers to do design for manufacturability in the new product. So for silicon carbide, that number is moderated to something more like 35 or 40, and that is still the run rate, and that is inside the OPEX. It's not excluded. The exclusion of the startup cost is really for one of the last synergies really with Finisart, which is the expansion of the indium phosphide line for other markets. And then for the hyperscalers, Giovanni's got that.
spk11: Yeah, hi, Simon. This is Giovanni. Yeah, definitely. Hyperscalers are for sure a focus in driving the demand for these higher data rate transceivers. And I want to emphasize that we're not done yet in the sense that there is still one or two where we have to keep working and penetrate those accounts where Over the past few years, maybe for a number of reasons, we didn't pay attention to them. And now I think the team is really focused on penetrating those accounts where we don't really have a large share of these products. So that's going to be a focus. What I'm trying to say is that we can see that number easily. I mean, the percentage of the total easily increasing beyond one-third of the total with the higher data rates. On the other hand, of course, this requires substantial investments from our side because we expect those higher data rates to continue to drive the growth and then at some point represent, obviously, the largest portion of the total. And so we continue to invest, but on the other hand, we know that there is a supply chain challenge that will somehow make that growth a little bit more challenging than maybe you would like. But just to summarize, answer to your question, definitely hyperscalers, particularly those that are building these AI superclusters, really focus on higher data rates that fit very well in the architectures for next generation data centers.
spk04: And that would put it in excess of 15% of total revenue, if I'm doing my math correct. Is that right?
spk11: Let's see. I think, yes. Just a second. Yes. About 18%, actually.
spk04: That was my guess. Thank you.
spk11: Okay, Simon. Thank you.
spk08: Our next question comes from Sam McChatterjee with J.P. Morgan.
spk00: Great. Thank you, and sorry about earlier. I guess I wanted to just, if I can ask you about the 1200-volt silicon carbide MOSFET product platform, and if you can sort of walk me through how the roadmap in terms of getting the product now to different customers looks like and eventually getting this on a vehicle. Is it now that you're qualified? I know a typical vehicle takes about like five years to design and get it out on the road, but is this now a catalyst for you to go meet customers with this product? Also, are you looking for more partners outside of GE? So just maybe lay out the roadmap for me a bit in terms of how do we get from here to actually seeing material revenue from this. And I have a quick follow-up. Thank you.
spk13: Okay. Thank you, Samik, for your question. We have, on the basis of achieving this milestone, we've really ratcheted up the effort that we have. The agreement that we just announced with GE brings additional resource to the table for us to be ready to address the customer, the qualification, and the application engineering that will be required. I'm fully expecting that as a result of the increase in the number of FAB starts, the work that we're doing now to shake out the overall process capability and process control, getting the sigmas tied down to where we need them to be, that we'll have the ability by the end of the calendar year, surely as we head into the second half of 23, we should be in a real good position to be entering as a launch point into the marketplace And we will go to those places where, number one, there's a real value proposition for high voltage, high reliability devices. And whereas we will have a longer-term approach to the automotive market, we will also be targeting other applications early on, as well as the automotive applications that we know will take us a little more time But I'm fully expecting that the revenues will begin to accrue in the early part of 2023 based on how our design ends and our design wins that we'll target in the second half of this calendar year. I hope that helps you.
spk00: Yep. Great. Thank you. And just a quick follow-up. Just wanted to see what you're seeing in the pipeline for industrial lasers, what have recent trends been, and How are you thinking just in terms of how sort of think about how long the cycle is on the industrial laser side? Particularly, do we get to a point where this can be a materially stronger growth business given higher use of optical equipment across manufacturing? Thank you.
spk11: Hi, Sameek. This is Jovan. Thanks for your question. So first of all, the welding, battery welding is a substantial driver for our industrial demand, whether we participate directly with our beam delivery systems or we participate to the market indirectly with the sales of pumps and other optics for our fiber laser customers. So it's a really, really strong market right now. And as you know, it's just the very beginning, considering the trends in demand for batteries that we see in the next 10, 20 years is gonna be monotonically growing. We see those applications to be really driving a lot of demand. So that's one. With regard to the, we reached this kind of record, really, of 100 megawatt. And that's a pump laser ship, right? That's really across all of the applications, and they go to a very broad set of fiber laser customers. And I would like to put that in perspective. We think that the leaders in the market for fiber lasers typically would consume no more than 100 megawatts in a year of pump power. So that gives you an order of magnitude of the scale of our pump supply that is required to support tens of fiber laser customers globally, most of which are actually in China, which is a really extremely good market for us. As we emphasize the supplier award from Hans Laser, it's a demonstration of the competitiveness of our platform, deriving from scale, deriving from the wafer size. We believe they are the only one. The only supplier is 6-inch, while most are at 3, some are at 4-inch. And then, of course, the fact that we utilize a fab that works also on data convicts, that works on, you know, telecom pumps and other processes, very well-utilized fabs, makes us incredibly competitive from a dollar-per-watt perspective. So the trends are battery welding and cutting to incredibly strong demand.
spk09: All right. We know we have several of you waiting. We'll try and see if we can get all of you before we close. Go ahead for the next question.
spk08: Our next question comes from Richard Shannon with Greg Howland.
spk05: Well, thanks, guys, for taking the questions. I guess two quick ones here. First of all, just trying to characterize the sales guidance from the March quarter here, and I apologize. I got dropped off the line, so maybe the question is asked here, but Maybe you could characterize the amount of supply constraints affecting sales here relative to the effect that you already saw in the December quarter. Anyway, you can characterize that.
spk09: Okay, it's pretty consistent. Maybe it's actually as high as $50 million. So it's probably at least as high as the last two quarters, which is in the mid-30s, and as high as 50.
spk05: Okay, perfect. Thanks, Mary Jane. Second question is in the photonics group here. Looking at your EBIT and EBIT margin here, it's been kind of flat to maybe actually slightly down the last couple of quarters here. Kind of a two-part question here is, is it fair to assume that most of the margin impact from supply constraints, the expedites, et cetera, have been in the photonics business? And then as we look a little bit longer term, is this a business you think can get to the higher teens or even 20% in a non-supply constrained environment?
spk09: Well, first of all, yes, they are the ones who are enduring most of the supply issues. And as we said earlier, we are not taking those out and getting to their adjusted margins. So that's five and a half. I would also say that they probably are carrying the larger portion of the four that is for COVID, if by no other reason than they have more people. In terms of getting to the 20s, we have never held that we thought photonics actually would be in the 20s. I think in some demand schemes it could be possible, but generally I do think that they have the ability to be in the mid-20s. in the middle upper teens, so to speak, and have been before. But again, as you hit it correctly, it's really the effects of the supply chain and most of the COVID costs, which has got to be, you know, more than about 125 points of margin for them. And rotums are the most affected, so we're also losing the rotum margin.
spk05: Perfect. Thanks, Mary Jane.
spk08: Our next question comes from Jim.
spk09: Sorry. Operator, keep going. We'll try and finish all the questions before we end the call. Go ahead.
spk08: Our next question comes from Jim Ricciardi with Needham & Company.
spk07: Thanks. Good morning. Did you provide a percent of revenue that you generated from the quarter in silicon carbide? I may have missed it. And a quick follow-up.
spk09: Ask your second question. I'll give you the number in a second here.
spk07: Okay, thanks, Jim. Chuck, thanks for that commentary about organic growth, double-digit, fiscal 23, fiscal 24. Talk about, if you would, what you see as the biggest drivers to getting to those growth rates, presumably silicon carbide being one of them.
spk13: Yeah, good morning, Jim. Jim, the answer to your first question was just between 4% and 5% in that range, okay? Yep. As far as the drivers go, well, we have in both of the segments, we have a lot of interesting opportunities. And in the photonic solution segment, which is driven by communications, I think Giovanni's provided great color here this morning with his dialogue with other analysts to give you a sense for where we're headed. In the compound semiconductor segment, I'll turn to Giovanni and just let him make a make an overall broad-based comment about the opportunities that he sees there, which are really exciting, and for which we're investing both R&D and capital this year to drive.
spk11: Yeah, thanks, Jim, for the question. So definitely silicon carbide, as you mentioned, is going to be a driver for the years to come. We are investing capital both for the substrate as well as our ability to make devices you know, starting with the AP up to making devices eventually. So we're investing and I think this will drive growth. We have talked many times about our belief that Indium Phosphide is a very important platform in a number of applications and both communications and sensing, whether it's sensing for automotive, sensing for consumer, sensing for industrial, and that's for sure it's a one very strong driver. The last one, another one which represents a substantial increase versus last year is really in the semi-cap equipment world. So we make a lot of parts. I mean, we have over 100 source-source parts in the EOD tool. And those tools, the demand for those tools, it keeps increasing. And we are very happy to support the code, but it does require investments which explain also the capital needed that Mary Jane talked about. And so semi-cap equipment with parts, with subsystems, but primarily parts that go into tools, whether it's for inspection, whether it's for fabrication, whether it's for packaging, there is a very broad demand. It's a very healthy environment. Customers offer us price increases. to get products as we are sold out. It's a really, really healthy growth for us. And last but not least, I think the general communication as a component supplier, my largest customer is still Sunny, my friend Sunny leading the photonics segment. But we also sell to a lot of transceivers and telecom gear suppliers. around the world, lasers, optics, and photo dyes and so forth. That's also very, very healthy as we continue to drive the growth in the global communications business.
spk08: Thank you. Our next question comes from Harsh Kumar with Piper Sandler.
spk17: Yeah. Hey, Chuck. I had two questions. First, on silicon carbide, I was hoping you could explain to us you know, commercialization by the end of the year versus I think in the commentary, you mentioned that you're basically getting to production by end of March. Um, so I guess I wanted to understand what the difference was and then I had a follow up.
spk13: Okay. Uh, I'm not sure what part of the commentary, um, that may have been misunderstood. So we, we have been, um, um, with our own, uh, press release now designed, What I was referring to in my earlier comments was, number one, let me just repeat what I said. We're in the process now of doing the final manufacturing shakedown so that we can have high confidence and our customers can as well in our quality, our reliability, and as measured by all the details of a manufacturing line. That work is going on with a huge increase in effort right now. I'm expecting that the prototypes and the models that we are already beginning to build will be available in the second half of this calendar year to be going directly to customers with and engaging them in design-in and design-win activities. I think that will take us, knowing the process and the back and forth that has to go on, that's going to be an ongoing process. It's already started by discussion, but I think the models and prototypes that we will generate in the second half of the year should be sufficient for us to begin to generate enough enthusiasm to have orders so that we can begin shipping in the first half of the calendar year next year. We'll try to go faster, but that's the plan.
spk17: Hey, thank you, Chuck. That clarifies that situation. And then my second question was on price increases. At this point, is the plan just to pass on the cost increases, or you guys think you can selectively raise prices above and beyond the cost that you're seeing to be able to help in margins?
spk09: Well, I think I answered that before. In some markets, we do have pricing power and are exercising it. That's not new to today. We've probably had that in the past. And so in that case, we are. In cases where the question is relating to, and that's probably across our end markets, in cases where the question is relating to the pass-through of these excess supply chain costs, we are looking to achieve the best outcome with customers, which in some cases could be trading off a price increase for greater share.
spk17: Got it. Thank you so much.
spk09: Sure. Thank you, Arshad.
spk08: Our next question comes from Sydney Ho with Deutsche Bank.
spk02: Thanks for squeezing me in. A couple of questions on that. Just follow up on the silicon carbide question earlier. I understand it takes time to design and then production RAM and whatnot. What is the realistic revenue target we should be thinking about over the next two to three years or maybe whatever timeframe you want to talk about? And how is the revenue profile going to change over time in terms of substrates versus modules?
spk09: Well, speaking to the larger question, I think what we've said is as we make these investments in silicon carbide, silicon carbide-based products, which would include the substrates, in, say, over the next four or five years, is probably the business that has the most ability to change its percentage of our revenue. So if it's about four today, it would probably start to exceed, let's just say for the sake of discussion, possibly 10% of the revenue, something like that. So it will move as a percentage of revenue. And then the second part of your question was, what is the split between substrates and devices? It really depends on how the market develops. And so I'm not sure that that's a clear prediction we could give right this minute. But the substrate is quite essential for the device being good. And we are very, very good at the substrate. So we do not intend not to keep making that. In other words, we will always make the substrate.
spk13: I would just add, Sydney, that as it relates to our FY23 capital investments in this business, they are 80% or more focused on increasing our capacity for substrate growth and fabrication. And then right on the heels of that are facilities to allow us in the next fiscal year to be adding in MOCVD capabilities so that we can begin adding to the portfolio epitaxial wafers in addition to our power electronic devices.
spk02: Okay? That's helpful. Really quick one. On the consumer business, it has grown sequentially in the December quarter, but not as much as a year ago. Can you give us a little bit of color on that? Was that business also supply constrained? And how should we think about seasonality impacting the next couple of quarters? Thanks.
spk11: Yeah, so I said it is, Giovanni. Thanks for your question. When we say consumer, the greatest portion of the consumer is sensing. And a greater portion of the sensing is 3D sensing. Actually, we like to look at the calendar year, because that's where typically the cycle of the products are linked to. So we go by calendar year. We had an ASP decline. in 3D sensing, which we kind of discussed in the past due to shrinkage of die size. However, when we coupled 3D sensing with sensing, actually the calendar year 20 to 21 was flat. So we were able, and as you know, the last quarter of calendar 21 is the Q2, our fiscal Q2 for 22. We actually saw it's pretty flat demand in terms of units, but because of the ASP decline, we saw only a 10% decline dollar-wise, calendar to calendar, which is actually remarkable, in my opinion, considering what maybe others were expecting. And then the 3D, the sensing in general, was actually, as I said, totally in terms of revenue, was actually flat. So in other words, if we add non-3D sensing to sensing, which, as I said, is the vast majority of the consumer, the calendar-to-calendar was actually flat, which, again, is remarkable considering the ASP decline due to a diet shrinkage.
spk02: Okay, thank you.
spk08: Next question comes from visit Iowa bank of America.
spk12: Thanks for taking my questions. I had that too as well. So I believe Mary Jane, you mentioned there's about a hundred billion of strategic inventory built to support growth in the back. How did you mean in the back half of the calendar year, you know, how much growth and importantly, where will inventory days go over the next several quarters?
spk09: So I don't know that we can speak about inventory over several quarters, but generally speaking, I would say that this build of inventory is really effectively waiting on these short parts. We would expect to see that inventory start to ship out over the next few quarters. But the company, for other reasons, on other products, may decide that it will build some strategic inventory. But generally speaking, what we are really trying to do is be very, very prepared to ship to our customers when these short parts and integrated circuits come in.
spk12: But I thought I heard there was some – you know, growth coming in the back half? Did you mean in the back half of the calendar year? Like, for example, could we see 2.6 potentially exiting this calendar year at the double-digit kind of growth rate that you alluded to?
spk09: We are expecting to see growth in the back half of the year. And I do think that we will see some good growth, but I'm not sure whether or not that will achieve double-digit for the entire year. just from this inventory, but generally speaking, we are expecting growth to accelerate as the year goes on. Okay.
spk12: Thank you.
spk08: Our next question comes from Christopher Roland with Susquehanna.
spk16: Hey, guys. Thanks for squeezing me in. First, as a clarification on the question, in the press release, you had 90 cents as the high end of March EPS. But Mary Jane, you mentioned 95 cents on the call. So just some clarification there. And then secondly, for the VRAR opportunity that you mentioned on the call, I think you also mentioned a 50 million. I don't know if it was a prepayment or an NRE or a preorder. I don't know exactly what that 50 million was. I'm assuming it's for VIXILs or time of flight, and perhaps you can talk about either what's different in the architecture that it would require an NRE, and also any timing on the product launch would be great, too.
spk11: Thanks, Chris, for the question. This is Giovanni here. Yeah, we didn't say NIH, by the way, so I just want to make sure that the $50 million includes a number of funds. And as I said in my preparer mark, it's for an AR, VR application. But I want to emphasize, as I said, in the preparer marks, it's not just about lasers. It's not just about de facto optics. It includes materials. And that's what we offer. And I think it's probably... time that the customers, several customers, are recognizing how unique, in a way, is the breadth of the product portfolio that we offer. So it goes well beyond laser. It goes well beyond de facto optics and so forth. So you need to put together several of our competitors to come up with the same type of offerings that we have. And it's very exciting because it's a new customer, it's a large customer, and it's for AR, VR applications. I can't go into the details, but it's very exciting. It's going to take some time for revenue to materialize, but we think it's a very large opportunity in the future for us.
spk09: And thanks for pointing out the typo, Chris. It's 75 to 95, and the table in the back is the same way, so we'll fix that.
spk16: Thank you. And then on the CDR comments, is this a new product for you guys? I haven't heard you talk about this before. When might that come to market, or is this the type of CDR that would compete with let's say a Semtech, for example, and how big do you think that opportunity could be?
spk11: Chris, just to be clear, it's in the market now. What we send is kit. We are selling it. We're recognizing revenue, and it's a product which Finisa, I mean, sorry, it's a platform that Finisa had for a very long time. The one we are selling is a new design, and we're sending it to the It's part of a portfolio of ICs which were kept captive for the entire lifespan of Finisa, and we decided to strategically make available on the metro market as part of our integration with Finisa. It's a product. It's already there. We are selling it. We are recognizing revenue. It's the first design win. or hopefully a very long list because we have also drivers, we have TIAs, we have complex ICs that we are trying to design in around the globe with transceivers and even, for example, in the 3D sensing world. So anywhere there is a need for IC to drive lasers to amplify detected signals and so forth, we're trying to penetrate the market. And yes, the competitors are pretty much those mentioned.
spk16: Awesome.
spk08: Thank you. And I'm not showing any further questions this time. I'd like to turn the call over to our host for any closing remarks.
spk09: All right. Thank you so much, all, for joining us today. Thanks for hanging in there for a few extra minutes, and we hope you all have a good day. See you soon.
spk08: Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.
Disclaimer