Good morning. Welcome to day three of the 25th annual Needham Growth Conference. My name is Jim Ricchiuti, the advanced industrial technologies Analyst at Needham. Pleased to have with us several members of the management team of Coherent, formerly known as II-VI. II-VI, being the Coherent, being the largest laser company in the world, as well as the largest supplier of optical components to the communications industry. Very pleased to have with us the company's CEO, Chuck Mattera, CFO, Mary Jane Raymond. We also have Sanjay, I'm sorry, Sanjay, I may have mispronounced your last name. Please, if you would, Chief Marketing Officer, if you would introduce yourself. Sorry.
Sanjay Parthasarathy.
Thank you.
Thank you.
Thank you. I'm gonna turn this over to Chuck for some opening comments. Chuck, thanks for joining us today. Please.
Good morning. Thank you, Jim, and the Needham team and for our investors for joining. It's an exciting time at Coherent. We closed the acquisition in July, adopted the legacy Coherent name for our company, began the rebranding process as a global leader of materials, networking, and lasers. We had a huge influx of extraordinary and diverse talent. The acquisition also joined two great and complementary companies with over 50 years of innovations that diversified and uniquely scale the combined company, deepening our position within the value chains that we serve in the broad industrial communications, electronics, and instrumentation markets that we'll answer questions around this morning. We believe that the diversification will further reduce any volatility that may come in over time from various markets or regions.
We ended Q1 with record revenues and backlog and tailwinds of our multi-year integration plan that includes $250 million of cost synergies and timely implementation of our organic growth plans and exciting engagements with our strategic accounts. We provided full year revenue guidance for the first time in over five years. They're squarely focused on our capital allocation that includes debt retirement, capital investments, and funding industry-leading technology and product roadmaps to drive profitability and cash generation over the cycle. We've made an impressive transformation over the last decade and now enjoy many unique positions in a $65 billion addressable market.
We expect it'll double in the next five years, driven by several megatrends, including rising demand, new applications for our platforms, increased product complexity, and a growing number of use cases, including those involving electrification, intelligent and mobile networking out to the edge of consumer electronics, including sensors and displays for AR/VR, advanced semiconductor fabrication Industry 4.0, and especially, you know, silicon carbide. We work tirelessly to do what we say we will do. As part of our brand promise, our commitment is evident in our aspirations, our actions, and our results. Jim, thank you for allowing me a few minutes to kick it off.
No, I appreciate that, Chuck. We've got, you know, a lot of ground to cover. We'll see how many of these topics we can hit. Wanted to turn first to the industrial end market, which, on a pro forma basis, you know, close to 40% of the revenues in fiscal 2022 on a pro forma basis. Talk to us a little bit about some of the components of that semi cap, display, and manufacturing. In rough terms, can you give us some sense as to, you know, what that represents of the industrial business?
Okay. Thank you, Jim. Jim, we're gonna work as a team. I think Mary Jane, if you wanna start with that. If there's any specific questions about the market sectors itself, Sanjay will take them on. Okay.
Sure. You're asking about the combined company. The breakdown of the revenue is about 14% is the traditional industrial, what we would have called in the old II-VI, industrial materials processing.
Mm-hmm.
Semi cap and display are each between 7% and 9% of revenue, and the balance is in aerospace and defense.
Terrific. I wanted to focus on a little bit on semi cap and display. Sanjay, please jump in on this as well. We're all hearing about a more uncertain outlook for WFE. At the same time, you know, from this conference, we're still hearing about pretty good demand, at least shipments going out over the next couple of quarters. How are you guys thinking about the overall environment as we look out around some of the concerns people have about WFE coming down in 2023, which most people believe the investment cycle is gonna turn down.
Sanjay, do you wanna take it?
Sure. So, I mean, the most of our equipment, most of the components in our solutions into wafer fab equipment. Wafer fabs are designed, I mean, they're long-term before they prove in. So from a, from an order coverage and from a market demand standpoint, we are sitting quite pretty at least for the next or so. Beyond that, we are excited about new technology platforms that are evolving such as MicroLEDs and other platforms where we have a lot of different processing tools and applications for those platforms. That's our excitement in the future, but short term, we've we are sitting.
We may have broken up there a little bit. Mary Jane, are you able to hear me?
I can hear you, Jim.
Okay.
Yeah.
Okay. On the display side, thank you for touching on that because there are questions. You know, we're all hearing about the weakness in the consumer electronics market, and there's some thought that we're gonna see some of the planned investments on the OLED side of the business getting pushed out, potentially in China, in Korea as well. You guys have built up a pretty sizable backlog, we think in, on the OLED side of the business. How are you thinking about OLEDs, in terms of the current consumer electronics, market environment? Then I wanna focus a little bit on MicroLEDs, where we're getting a lot more questions.
Okay. I'll take that, I'll start out. The display business, the external laser business is a solid business, as you know. It's made up of the benefit of a very strong, broad, and deep portfolio of products and services because the service revenue is on the basis of the deployed systems that went into place over the last five to seven years, service business is very strong. It's steady, it's stable, it's part of our diversification to avoid to smooth out some of the ups and downs. I was just in Asia, five countries, 15 days in December, engaged with customers in every country but China. I'm really pleased.
I was really excited to meet so many customers that depend on Coherent in this marketplace. To engage them in discussions about the short term and the, let's call it mid-term and long-term prospects. Those conversations were around what you could expect, the near-term demand environment for OLEDs, and especially the transition that we expect will take place in some market segments, including large format displays over the next few years. We think it's the next three or four-year transition that'll happen into the MicroLED domain. We said in November, we'll say more about it at Photonics West, I believe, when we meet with investors there. We're engaged with over 25 customers who are evaluating our technology for producing MicroLEDs. It's really an exciting time.
We shipped our first tool into Asia in December. Feedback from customers is that this is a marketplace that they're investing in and that our tools and our capabilities are differentiated. That's gonna go on. We're gonna keep investing in it. In the meanwhile, I think we have a solid business. Even if we see some soft spots over the course of the next two or three or four quarters, we're well equipped to be able to respond and react to the changes in the marketplace. We're not forecasting that or seeing that as of today. Okay?
Chuck, we're familiar with the ELA application on the OLED side of the business for backplanes, but not some of us not as familiar on MicroLEDs because it's such a relatively new market. Talk to us a little bit about how your technology is going to be utilized in that market and your expectations. We've heard some reports, including this week, about possibly MicroLEDs being used in a small display application for a watch. You're suggesting it's also going to be in three to four years used in larger format displays.
Yeah. Sanjay, do you wanna take it? You wanna make some comments on it?
Sure. Sure, Chuck. MicroLEDs is the sort of is the future for display technology. As you said, they're gonna start in some of the smaller displays. AR/VR is another important area for MicroLEDs. Eventually, it will go to larger formats, tablets, and larger displays. We have multiple process tools that are very unique to facilitate the pick and place of the MicroLED assembly platform. We have a Laser Lift-Off tool that Chuck earlier referred to. There is a lot of basically the same technology platform now applied to a different application, namely MicroLED processing.
Jim, I would add that we are planning at Photonics West to put an advertisement in a couple of weeks. We will have an investor engagement, and the leader of our external laser business will be one of the two main presenters at that time. We'll be squarely focused on it. I think you and other investors will be, should be interested in that session.
I look forward to it. Just given your unique position in this market, do you see both these technologies coexisting for some time, OLED?
Yes.
and MicroLED?
Yes.
Okay. Want to switch gears for one second, talk about some other areas of the industrial business where there's some, we think some fairly interesting growth opportunities, and that is in the EV area, notably in battery welding. You guys have a really unique window, I think, on what's happening in the EV market because of what your certainly your investments in the silicon carbide business, which we're gonna talk about as well. On battery welding, EV battery welding, talk to us about what this combination has done in terms of enabling you to go after this market, which most people believe is gonna be pretty significant over the next two years.
Okay. Sanjay, you wanna start?
Yeah. Sure, sure, Chuck. The two companies were actually working together even well before the acquisition. We, legacy II-VI, we had the best heads in the industry, and that combined with the laser from Coherent, we were, as a combined entity, we were able to offer really state-of-the-art solutions into the battery welding market. Battery welding, as you know, is sort of the most sophisticated and very rigorous performance requirements that are needed in welding, and that's the place where we are playing. Chuck, I mean, I guess is there?
Yeah, I'd.
Go ahead.
Thanks. Thanks, Sanjay. That's great. I just add to it, before we were combined, we were addressing the customer was responsible for doing the integration of the fiber laser subsystem plus our laser welding head. Since the combination, we've been able to step in to the shoes of the designer and the integrator at the customer site. Coherent have great insight into applications, great insight into the process, and have stepped in and already begun through the service and field application engineering engagements to be able to provide new insights to the customer, to the user about beam control, beam quality. That's a, that's a function of their own process. We have a lot of excitement about this technology and repeat business that's coming, orders that we're expecting that are...
That will be larger than the combined business was even 12 months ago. It's an exciting time. We think it's a good time to get in because it's still early as the number of battery electric vehicles grows exponentially between now and the end of the decade. We're expecting to continue to invest and differentiate ourselves inside the supply chains of the EV ecosystem, and I think we're off to a really great start.
Chuck, you're already generating revenues, from the ARM technology, the Adjustable Ring Mode welding systems.
Yep.
How do you anticipate that ramping over the next couple of years? I wanna follow up, just talk a little bit about the competitive landscape.
Okay. I would say that I believe that the technology and the products are differentiated in their design, in their manufacturing, in their use, and in their service. I would characterize the opportunity in front of us as a double digit tens of millions of dollars in the current sense, meaning inside the fiscal year. I expect it will grow at a rate that's comparable to the electric vehicle growth rate. I think if you give it three to five years, and if we're successful in penetrating all the market opportunity, including in China, you know, over that three to five -year period, I think it'll be a solid triple digit millions of dollar business for us. That's my best projection as of today, Jim.
Okay. No, thank you. The market right now is our understanding is that there's been one major supplier, fiber laser manufacturer that's been in business for a number of years, that has been pursuing this market for some time. It's clearly a large market, so presumably you feel that it can support multiple players. I wonder if you would just in terms of how you see the competitive differentiation with what's out there?
Let me try to summarize. The ARM laser itself, we believe is as a fiber laser subsystem, its design and its operation is differentiated for multiple variations in process technology, in beam control, and in connection with our differentiated welding, high power welding heads, which is deployed in automotive factories all around the world already, and for which customers understand the use of. Plugging in an ARM laser through a cable that we make up to the welding head, and then with the process control knowledge and beam control knowledge, that's where our differentiation will be. Applications engineering, applications knowledge, and service.
Is it reasonable to assume more of this business is going to be generated in China?
Our business plan anticipates that we'll be able to take the best of what legacy II-VI and the best of what legacy Coherent had and be able to address what we believe will be a meaningful market that neither company were able to address before the combination. We've already gotten busy on that. That'll be a sustained effort that we make over the next few years, Jim.
Yeah. I wanna shift to the communications market, which, on a pro forma basis, I guess, still, your largest market, Mary Jane, around 45% pro forma. Is that?
Yes, 44. Exactly.
Thank you. This market, communications market, has been very strong for the past two years. You've obviously built up a nice backlog in this area of the business. Curious about the backlog. How much of that was also a function of just the supply chain challenges? If just in general, talk to us about about the whether and or there's been improvement in any of the supply chain areas. You've highlighted ROADMs as being an area where you've had some real pressure in terms of availability. I've got a follow-up as well.
I'll just take the part on the supply chain side. First of all, during the time that the world was very supply constricted with respect to integrated circuits, we had been working for over five years with our customers in communications on longer dated orders for initially the purpose of planning CapEx and for planning the sustainable use of our capacity. We continued to do that, and perhaps with even more customers, in order to signal to the suppliers the type of demand we were really seeing. If you are, you know, a smaller industry and trying to get integrated circuits, say, compared to the U.S. auto industry, you know, having a 13-week visibility is not all that helpful. That is a lot of what drove our backlog, and our bookings because, you know, all of those were time-dated orders.
They all had a firm delivery date. We have seen the ROADM, particularly on the ROADM side, the supply chain easing. The way I would describe it is if you assume that the, you know, turnpike is totally blocked traffic, it's a little bit like the shoulder opening, maybe both shoulders, but it is not cleared. We are still fighting this on some of the more critical ones, but there is definitely an easing, and consequently, we saw sequential growth for two quarters in a row in our ROADM business. We do have a bit of a ways to go, and we do continue to expect, and from here, I'll let Sanjay take it, but communication still has a lot of growth left in it.
Sanjay?
Yeah. I would just add that when we look at the communications market, we look at it as data comm and telecom. Both segments of those markets are growing, even from CY 2022- CY 2023, and some segments are growing at a much faster clip. High speed transceivers within data comm defined as 200G and above is actually slated to grow about over 10% from CY 2022- CY 2023. Those are sort of the areas where we play. Our markets are strong, they're growing, and we expect to grow faster than the market.
Yeah, just given some of the macro concerns, is it, I don't wanna put words in your mouth, but would you characterize the current state of this business as potentially being more resilient in a tougher environment?
Yes. Absolutely. especially the data comm business, the web-scale customers, they plan these upgrades, you know, years in advance, so they don't react to. And for the most part, it's to support their core businesses and it's infrastructure like everything else. They continue to do what they're planning to do, which is planned for many years in advance.
Got it. Just a follow-up question on the macro environment, obviously more concerns. We don't know what kind of landing, soft, hard, but, you know, we've seen PMI data move around a bit, including in China. Chuck, maybe you wanna take this. As we think of the overall environment, you have a plan that you've put in place that you've been working on for some time in terms of the integration. Mary Jane, you may wanna talk again also about some of the cost synergies. How do we think about this plan in what potentially is a more fluid economic environment?
Well, similar to how our communications customers plan their capacity, we plan these synergies, you know, fairly well in advance. The synergies that are expected for the company at $250 million are about $68 million in the first year, $90 million in the second, and the balance in the third. For investors who are very tempted to ask us if we've already changed the number upward, before the company changes the number, we will actually move the time. That's very similar to what we did in the Finisar case. It was $150 million, it was 36 months, then we changed it to 24 months, and then we increased the number.
For right now, we are well on with our first-year synergies, and we do not expect to make any changes to any part of the synergy plan or what we've announced about it. Any time during this year. We are well on with it, I would say. Because we had to file, refile HSR, both general counsels of both companies were very fastidious in being sure we didn't, you know, engage in any behaviors that might be disadvantageous. As we get to know the people, as normally happens, you know, we find synergies that we thought would be later could come sooner. Some synergies we felt we would get, you know, aren't so easy to get, but there's other ones that were easier than we thought. We are well on with them.
I think that while the market is very fluid, at the end of the day, you know, II-VI has distinguished itself in any type of economic situation by just putting its head down and doing the work. That's what we're on with.
Okay. The on the revenue synergy side, you know, you highlighted a couple of areas that seem to suggest some opportunities display, also with respect to battery welding. How do we think about some of the revenue synergies emerging over the next one to two years, in terms of which areas of the combined business?
Well, Chuck, why don't I start, and then I'll let you fill in. First of all, the company expects to have revenue synergies over a wider variety of markets than perhaps we did with the Finisar acquisition. That is what we mean when we say that we expect the revenue synergies to be a larger component of the overall synergy story. We're in the process of, you know, specifically developing those at this point, but I'll just give you a few ideas. The very first example that we gave everyone was II-VI has a larger business in China than the former Coherent did, and the former Coherent had a much larger business in Korea than the former II-VI did. That was the first example that we gave.
In general, in the sales and service area, the laser segment, which many of you know, is how the former Coherent, Inc. came into our company. They have a very, very robust and excellent service and sales business, and it's really the service business because that's required for their larger machines. It also drives their aftermarket business. The aftermarket business was an important part of the material segment as well. We see that larger, more well-established form of go-to-market for services and aftermarket sales being a very, very strong contributor to the revenue synergies. In life sciences and instrumentation, where, which we call overall instrumentation, the scientific market is the way that the laser segment historically has actually debuted brand-new types of laser technology.
Because the academic community is the one that's really pushing the science, the machines are typically developed for many of those new types of very forward-looking applications that haven't even been conceived of by the commercial market. Once they're proven out, then the laser segment begins to commercialize those. The important thing is that we expect to continue to use that as an incubator. More importantly, both companies have a very strong business in instrumentation. That is actually where our life sciences business really resides. It's in the instrumentation, whether it's keeping samples at a specific temperature for the entirety of the test, since heat is a priority pollutant, or whether or not it's dealing with various degrees of certain applications where there is, say, etching, which is a very, very shallow cut of a laser, right?
Where you might be etching or marking DNA, for example. We expect to see that be a great contributor. Automotive for sure. Jim, you already talked with Chuck about this with respect to the ARM laser and the tremendous carefulness that's required in doing laser battery welding. Welding, in general, is the very last battleground of industrial lasers. A lot of that is still done with a torch. With respect to a battery for an electric vehicle, it's very important that the laser beam itself be very combined. It be a very contained laser weld, and it also not get very hot. Otherwise, it's actually very dangerous around that battery. We expect that to be a very nice business, as you've just talked to Chuck. Industrial, for sure. Many of our customers are the same ones that the laser segment has.
The old II-VI customers are the same one the laser segment has. We expect to be able to have a greater share of wallet. Finally, obviously, in semi cap as well as display, which are new capabilities brought to us by the laser segment. It's a very broad expectation we have on being able to grow the revenue together. Chuck, do you want to add anything?
I was going to add, in the overlapping verticals, which is really industrial and instrumentation, there are simple opportunities like cross-sell, which we are already, the sales team is already going after. I think the excitement is really the able to go up the value chain to integrate the lasers with our materials, with our thermoelectrics, with our filters, our optics, and assemble higher level solutions for our life sciences customers. We are also doing the same thing on an industrial side, as Chuck mentioned earlier, where we are integrating our sort of very high-end beam delivery systems along with the laser and offering features that the rest of the market is unable to offer. That's the upsell part of the strategy as it relates to the revenue synergies.
Thank you. Wanna turn to silicon carbide, where there's certainly been a lot of interest, a lot of questions. Coherent has been investing in this business for a long time. II-VI has been investing, what, over 20 years. Remind us, if you could, just of, initially, if you could, of the investments you're making in this area. I wanna talk a little bit more about the broader strategy if we may.
Okay. Let me do that, Jim. You're right. Been investing in it for over 25 years. Our approach to the market starts off with our strategy, which is to leverage our competencies, our strengths, and our differentiation. We're coming to the marketplace at four levels of integration over the next three to five years. First one is in substrates, which we've been at from the beginning. Second one is epitaxial wafers. The third one is power semiconductors devices, and then the fourth one is modules. Let me talk about the first two.
Today we are a leading supplier of high quality silicon carbide substrates into the marketplace, both to those people who grow epitaxial wafers and to people who have their own capability in-house, but all of whom ultimately are in the supply chain in the automotive market, by and large, for silicon carbide based electronic devices. Over the next three to five years, while we take the GE technology that we've licensed and develop devices and modules over that time period, qualify them in automotive applications. While that development work is going on, we are scaling our materials factories to be able to generate at least 80% of our revenue between now and say, 2026 and 2027 will come from selling materials, substrates and epitaxial wafers.
By that time, we should have, you know, begin to see meaningful penetration into the marketplace with devices and modules, but it'll be at the tail end of that three to five -year period. Out to the end of the decade, we think that'll shift to a 60/40 mix, roughly, materials and, in that, substrates and epitaxial wafers and then devices and modules. Okay. In order to get ready for that, this marketplace which we judged about in the last, well, 12- 18 months ago, the marketplace has gotten bigger, faster, at least our addressable market. We've had some announcements about long-term supply agreements. We do not announce every purchase order that we get or every engagement that we have with customers.
Some of our customers would not like for us to disclose who they are or what they're up to. In the last 12-18 months, I believe that our engagements with the marketplace have gone through, from about a third of what we believe are the large players in the market to about two-thirds. That acceleration is corresponded to what we believe is a supply limited environment of high quality, low dislocation density, silicon carbide substrates for which we are a leader. We're sold out. We're trying to keep up with the demands of customers. We're adding capacity. We're stepping up our own investments again in FY 2023.
We expect that this year, about a third to 40% of our capital investment in the $550 million-$600 million range that we gave references or guidance in November will be for silicon carbide materials capacity. That'll be the second year in a row we have more to do. We're really excited about the business, that's for sure. Customers are really excited about us, and we think this marketplace will be undersupplied, underserved, and constrained for high quality substrate materials, possibly to the end or through the end of the decade. I hope I answered some of your questions, Jim.
You answered quite a few of them, Chuck. Thank you. As you know, the question that does come up is, this is such a large market, others are pursuing it, trying some. You have established players, obviously, but there also are there some concerns about, you know, potentially new competition coming into this market. I wonder if you'd talk to, and you've been doing this for a while, the complexity of this technology and the challenges of entering this market and scaling and sustaining it.
Yeah. compound semiconductors across the board they're just a very complicated technology platform for sure. Why does everybody want them? The reason is because they have capabilities that silicon technology simply can't do. Despite trillions of dollars in 50 years of investment, can't be done. The materials drive the business, and these materials are complicated. They require special equipment, special intellectual property, trade secrets, patents, and a trained workforce that have been developing models, manufacturing models for decades. We're fortunate that we can say that we have all of that under one roof. I think you can read in the investor press in the last couple of three months or so, we're reminded about how complex this technology is, even for experts.
We're humbled by it, but we're focused on it. We feel real good about the team that we have. We have to compete. We're obsessed with customers and about competitors. Our passion for growing this business and making money at it and positioning us as a market leader over the cycle, which we identify through the end of this decade. That's among our most exciting opportunities to change the landscape for the company. That's what I can tell you. We announced it a couple of years ago, through August to go a billion-dollar investment over a decade. We didn't give out the timing of it, but we are moving at a clip that's a little bit faster and a little bit more accelerated than what we imagined when I first informed investors about the billion over a decade.
We are moving quickly.
When you talk about the end of the decade, Chuck , give us a sense of what this is gonna represent. You think this potentially could represent of total company revenues?
Yeah, I'm willing to do that, Jim. You know, end of the decade is a while from now, but we do have a long range plan. We make a five-year plan and a 10-year plan. Inside our long range plan, we can see the possibility that this business represents 10% of the total consolidated company by the end of the decade.
Maybe more near-term, and we'll we've got only a few more minutes, but, yeah, we do have a more uncertain economic environment. Mary Jane, maybe this is one for you, or Chuck, but I'm wondering, you know, are you thinking about the priorities for cash? You talked about capital being deployed certainly in the silicon carbide area, but are you thinking any differently about, in light of the economic environment?
Actually, yes. There really are two main priorities for the cash ahead of the debt pay down. The first one, of course, is the CapEx, because the driving of profitable revenue is very, very critical for the income through the cash flow. That's actually an important part and the reason why CapEx will always remain our number one priority. The second one actually was the synergies. Our goal, and as we told investors, was not to actually pay a lot of the debt in the first year in order to enact 100% of the synergies in the first year, so those that have a longer timeline to achieve could at least start. As we've gotten into those, some of them are less cash demanding than we thought.
You know, a very clear example would be as members of the former Coherent, Inc. team retired, they obviously had their equity vested. That was part of their agreements, et cetera. That actually isn't cash. It's, their equity vest, it is a charge to the P&L, but it is not cash. We began to look at that, and we took that cash and said, "Okay, we're gonna pay the debt with this." That's what we did. We actually, you know, successfully paid debt during here the 12/31 quarter. We'll continue to do that through this year.
Okay. We're gonna end it there. Chuck, Mary Jane, thank you. Sanjay, thank you. I promise the next time I'll give you a proper introduction.
Thank you, Jim.
Take care.
Thanks a lot.
Thank you everyone for joining us.