Coherent Corp.

their supply chain shortages to managing their inventory surpluses. These affected our telecom and datacom businesses about equally. Datacom revenues were $294 million compared to $332 million in Q3 of FY22, and telecom revenues were $245 million compared to $222 million also in Q3 FY22. We believe this is a temporary interruption in the growth trajectory of these markets that will continue into FY24. We also believe that the fundamental growth drivers of our communications market are intact, including increasing internet traffic, the proliferation of network devices, and increased broadband and mobile data rates. While Datacom will be partially affected in the short term by the temporary pullback in investments in infrastructure, including the metaverse, it is expected to come back strongly, driven by the deployments of hyperscale computing and for artificial intelligence and machine learning. In fact, we believe that we are at another inflection point in a decade-long megatrend forming with artificial intelligence and machine learning and we expect these trends to account for more than half of all Datacom transceiver shipments by 2028. Despite the current Datacom market reset, our industry-leading position in 200G and above remains very strong. Our leadership in this area derives from the vertical integration of our high-speed lasers, optics, and electronics in our transceiver modules, and our ability to scale to meet aggressive volume ramps of the world's leading data center operators. In addition to the growth of our 200G and 400G DataCom transceivers, we are accelerating our 800G shipments in anticipation of exponential growth beginning in FY24. In telecom, we are a vertically integrated market leader with our coherent transceivers and disaggregated solutions. Once the growth resumes, we expect all of these products to continue to grow at double-digit percentages annually. We continue to invest in a broad product portfolio to address evolving requirements of our customers who are focusing their resources on developing new platforms, and we are engaged in intense design and activity in response to multiple new opportunities ahead. These opportunities in telecom stem from disaggregation and are being increasingly led by hyperscalers who, through their continued build-out of metro, regional, and submarine networks, are also driving paradigm shifts in the transport network architecture. With our existing telecom transceiver portfolio and our differentiated DSP technology roadmap, we plan to launch the first 100G coherent solution for network edge applications. We expect that the planned $65 billion investment in broadband access from the Infrastructure Investment and Jobs Act will be a major catalyst for our optical communications business. Finally, as space is the new frontier, we are seeing a strong increase in demand for our differentiated products for satellite communications. In industrial, Our revenues in the quarter were $438 million, down 3% sequentially. However, we saw sustained strength in semiconductor cap equipment front-end sales, which grew 15% year over year and 8% sequentially, and includes our EUV lithography products, whose sales grew 30% sequentially. Lasers for both semiconductor wafer inspection and spike annealing set quarterly records and have a strong outlook at least through the rest of the calendar year. Our leading display customers lowered their demand outlook by greater than 35% due to a decrease in factory utilization based on lower demand, the lowest in four years. This led to a decrease in our forecasted service business in Korea. In the quarter, a big highlight was that our sales of display spare parts into China surpassed those of Korea for the first time, giving a clear sign of market growth in China, even though we see some sluggish demand for mobile devices. We expect these short-term consumer demand and inventory-related headwinds will resolve as we move towards the calendar Q3 release of the next-gen smartphones from industry leaders. Such a trend also aligns with the widely announced new Gen 8.5 FAB investments in China that we believe will drive a strong recovery in our OLED business into calendar year 24. In the month of March, we set an all-time record for sales into the laser aftermarket in North America. We continue to experience strong welding design wins for our kilowatt ARM fiber lasers, and our high-YAG beam delivery solutions as a result of the acceleration of EV and battery factories around the world. Instrumentation was up 4% sequentially to $125 million as we continue to set records in this market through strength across the board led by applications in immunology and laser-assisted procedures. Sales of our ultra-fast laser-based advanced imaging systems for neuroscience increased as well and we had our strongest quarter in scientific since pre-COVID times. We shipped our 100,000th OBIS mini laser, and we added several new design wins for our light engine solutions where we combine the lasers and optics that form the engine of our customers' products. It is our strategy to enable customers to source the entire laser light illumination side of their systems from Coherent, accelerating their time to market, time to quality, and time to cost. We believe that we can grow our revenue in the years to come well ahead of the market by expanding this addressable market. At the other end of the optical spectrum, we shipped our 50th meter-class optic for the 30-meter telescope with more than 150 units to go before completion over the next several years. Meanwhile, the James Webb telescope continues to send back mind-bending images, and we are proud of Coherent's contributions as the prime supplier of the world's most advanced space and terrestrial imaging systems. In electronics, our revenues were $139 million, up 121% year-over-year, led by consumer electronics for sensing. Our customer intimacy in this market gives us confidence that the long-term opportunity in consumer electronics is much broader than just pixels for 3D sensing. However, we expect lower revenue from just under 10% to 3% or less of our annual revenues for the next 18 to 24 months as some design changes take effect. We believe that sensing will ultimately become ubiquitous in metaverse hardware and wearables as well as in LIDAR and other emerging applications. Our strategic engagements are growing across them all. Regarding our outlook that we will discuss today, it reflects a degree of caution around customer buying patterns in the near term. While June was traditionally Legacy 26's strongest quarter, the macro factors we are experiencing along with seasonality will result in lower revenues sequentially. We will continue to stay focused on cost controls, synergy realization, and cash generation while we align our costs to market realities. We will work to restructure and transform the company and position our product portfolios for sustainability to enable timely resumption of our growth as the market turns up. Our synergy and restructuring plans will further enhance our competitive position by driving greater scale and focus at existing sites and affording increased flexibility and efficiency, product roadmap alignment, and access to lower cost structures. We have completed a rigorous analysis of these plans, a careful assessment of the effects on our people, and believe that these moves will position us to achieve both short and long-term commitments. With respect to our silicon carbide business, it grew more than 40% year over year. This business continues to be one of our top priorities. Therefore, our equipment investments in the silicon carbide platform expansion were, again, about half of our total capital investment. The market is showing signs of a prolonged period of severe capacity constraints forming. We are extremely well positioned, as we have steadily gained share in what we believe will be an underserved market for many years to come. We are increasingly asked by our customers to support a continuously increasing demand, and we have also often been asked by investors what our end game is for this business. Even with the $1 billion investment over 10 years that we announced in August of 2021, the gap between projected supply and demand is accelerating. And so we now believe that the market leader who emerges will be the incumbent who is able to timely close the gap and serve the market needs. This will require a relentless focus on operational excellence and the results orientation that is a natural part of our company culture. and it will also require an even greater commitment to investment. We see a unique opportunity to further accelerate our growth through either accelerated investment and or deeper strategic partnerships. To that end, we have commenced the review of the strategic alternatives for our silicon carbide business. This review is focused on effectively serving the market at the same time while maximizing long-term shareholder value for our coherent shareholders by considering a range of potential alternatives. These include a sale, joint venture, minority investment, or simply staying the course with the continued execution of our business plan. We remain firmly committed to our customers, employees, and our shareholders, and will continue to invest in capital capacity, and technology innovations, including expanding our portfolio so as to become a full-line supplier of silicon carbide-powered devices and modules. We can give no assurances as to the outcome of this process, and following our Q&A session today, we do not intend to make any further public comment regarding this matter until we have a material development to disclose. With that, I'll turn it over to Mary Jane. Mary Jane?

Thank you, Chuck. Our backlog of $2.6 billion landed as we expected it would. Our Q3 non-GAAP gross margin was 37.3%, and the non-GAAP operating margin was 17.5%. Supply chain costs were minimal in Q3. At segment level, the non-GAAP operating margins were 13.6% for networking, 27.5% for materials, and 14.6% for lasers. During the quarter, with the sudden downturn in revenue, we carried approximately $15 million of underabsorbed capacity, and the gross margin was also affected by $8 million in FX and $7 million due to mix. Our operating expenses, SG&A plus R&D, were 19.8% of sales on a non-GAAP basis. The non-GAAP items were 62 million in amortization, 29 million in stock comp, and 16 million of transaction and integration costs. Total stock comp is expected to be 26 to 30 million in Q4. Synergies have now reached $66 million on an annualized basis, and we are making good progress in all categories. With respect to further details, on our cost savings actions, our 100 to 125 million of targeted cost reductions are in addition to our 250 million of cost synergies. These cost reductions are expected to be at least 130 by fiscal year 27. The FY23 through 25 cumulative savings are expected to be between 200 and 300 million dollars and the cost to achieve them are approximately 150 to 200 million, including severance, retention, new net labor costs in the lower-cost locations, facility moves, short-term duplicate costs, and lease termination costs, along with IT consolidation. Quarterly non-GAAP EPS was 58 cents against a diluted share count of 141 million shares. GAAP and non-GAAP EPS calculations are on tables six and seven of our press release. Interest expense in the quarter was $75 million, and for the nine months ended March 31st, interest expense was $208 million. Our total interest cost for fiscal year 23 is expected to be $281 million to $284 million. The March 31st cash balance was $901 million, just $12 million below the 1231 balance. After paying down $78 million of debt in Q3, our total debt position on March 31st was $4.5 billion. Using the trailing 12 months of adjusted EBITDA on a pro forma basis for the combined company at March 31st, The gross leverage was 3.5 times and the net leverage was 2.8 times with the synergy credit, including the cost savings and the synergy credit of $312 million that is allowed by our credit facility definition. The gross leverage is 2.9 times and the net leverage is 2.3 times. Note that the $38 million of synergies are already in the results. The total of $312 and $38 million equals $350. The additional $100 million of savings is worth two-tenths of a turn on leverage. Let me just restate the leverage without the synergy credit. As of March 31st, the gross leverage was three and a half times and the net leverage was 2.8 times without the synergy credit. With the synergy credit, it's 2.9 times gross, and the net leverage is 2.3 times gross. 2.3 times net. Our effective tax rate in the quarter was 154%, and the non-GAAP tax rate for the quarter was 19%. We expect the tax rate for fiscal year 23 to be between 30% to 32%, assuming the current mix of earnings, and no adoption of new or additional tax rulings. Turning to the outlook for Q4 FY23, our outlook for revenue for the fourth fiscal quarter ending June 30, 2023, is expected to be $1.125 billion to $1.175 billion and earnings per share on a non-GAAP basis to be 33 to 43 cents per share. On a full year basis, our revenue outlook is 5.08 to 5.15 billion. Our non-GAAP EPS estimate assumes that the preliminary effects of purchase accounting are added back to the GAAP EPS other than the depreciation that is $5 million per quarter. The share count is 142 million shares for the entire non-GAAP EPS guidance range, and both Series A and B are anti-dilutive. This means Series A and B dividends should be deducted from net income, and the shares should not be included in the share count. 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. For the non-GAAP earnings per share, we add back to the GAAP earnings pre-tax amounts of 190 to 210, including 95 million in amortization, 27 million in stock comp, and 70 to 80 million for integration and restructuring. The actual dollar amount of non-GAAP items, the tax rate, the exchange rates, the purchase price accounting, and the share count are all subject to change. As a reminder, our answers today may contain forecasts from which our actual results may differ materially due to a variety of factors. These include changes in mix, customer requirements, supply chain availability, competition, and economic conditions, to name a few. With that, Kevin, you may open the line for questions. Actually, let me amend one last thing. In our guidance range, the add-back are $95 million in amortization, $27 million in stock comp, and $70 to $85 million for integration and restructuring. All right, then. Kevin, you can open the line for questions.

Ladies and gentlemen, if you have a question or a comment at this time, please press star 1-1 on your telephone. If your question has been answered or you wish to move yourself from the queue, please press star 1-1 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Ananda Bruja with Loop Capital. Your line is open.