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Summary

  • IIVI reported 22% Y/Y revenue growth, 3% organic growth, 33% rise in bookings and lower EPS as optical segment was a drag, but showed promising 8% Q/Q sales growth.
  • Thanks to the lower stock price, the reward-to-risk is more favorable now. I initiate a long thesis with a target price of $18 within two years, offering a ~25% upside.
  • My thesis correctly called to wait for a pullback before buying due to unfavorable reward-to-risk with 16% upside and 60% downside. The downside materialized as the stock dropped ~25%.

II-VI Incorporated (NASDAQ:IIVI) reported results for the fourth quarter of 2014 (SEC filing, earnings call, press release). Revenues increased 22% Y/Y to $187.9M. Revenues resulting from the company's acquisitions completed during fiscal year 2014 were $39.5M and $115.2M for the fourth quarter and fiscal year, respectively. Bookings increased 33% Y/Y to $193.3M million. Organic bookings were up 3% Y/Y. Quarterly diluted EPS was $0.20 versus $0.22 a year ago. For the fiscal year EPS was $0.60 compared to $0.90 a year ago. The revenues from the integrated businesses increased 8% Y/Y. However, the businesses acquired from Oclaro (NASDAQ:OCLR) continue to be a drag on sales growth and earnings. Although the management is not satisfied with the performance of these businesses, the segment showed 8% Q/Q sales improvement, so they seem to be stabilizing. The company's new $50M share repurchase program is designed to "at least partially offset the dilutive effect of the issuance of shares from the Company's current [share-based compensation program]." For Q3 of 2014, IIVI forecasts revenues between $170M and $185M and EPS in the range of $0.14 to $0.20 per share-diluted. This represents a ~18% Y/Y sales growth including the acquisitions, and a ~13% EPS growth for the mid-range $0.17. Given how large the acquisitions were, the growth is rather unimpressive.

As I advised in the conclusion of my original thesis, "most of this growth is already priced in and the 16% upside comes with a downside risk of up to 60%. Investors are advised to dollar-cost-average the purchases or wait for a pullback to achieve a better risk-to-reward setup." By adhering to strict risk-reward discipline advised in the thesis, investors could have avoided a large part of the ~25% stock price drop that came as I correctly feared. In a separate thesis on Oclaro, I correctly noted that IIVI overpaid for the acquisitions of Oclaro's assets as they were barely break-even businesses which turned out to be a drag on IIVI's subsequent performance and contributed to IIVI's share price fall. As I mentioned: "By negotiating the two divestitures [that IIVI bought], Oclaro has pulled off a masterpiece... It also managed to sell barely breaking-even or money-losing business units for a relatively high price-to sales ratio, compared to other businesses in the industry."

But on a positive note, IIVI's stock weakness now offers a more attractive entry point. Therefore, I now initiate a long thesis with a target price of $18 within two years, offering a total upside of ~25%. However, IIVI is still a risky proposition. Investors should fully hedge the downside, for example with put options with a strike price ~15% below the purchase price. IIVI is one of my lower-conviction stock recommendations due to numerous issues, including potential troubles related to past or future acquisitions and relatively high management compensation.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Update: II-VI Incorporated Q4 Organic Sales Grew But EPS Fell As Struggles With The Acquired Optical Businesses Continued

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