Earnings Call Transcript - COHR Q4 2021

Mary Jane Raymond, CFO

Thank you, Regina, and good morning. I’m Mary Jane Raymond, the Chief Financial Officer here at II-VI Incorporated. Welcome to our earnings call today for the fourth quarter of fiscal year 2021. With me today on the call are Dr. Chuck Mattera, our Chief Executive Officer; Dr. Giovanni Barbarossa, our Chief Strategy Officer and the President of the Compound Semiconductor segment; and our President, Bob Basha. This call is being recorded on Tuesday, August 10, 2021. Our press release and our updated investor presentation are available on the Investor Relations tab of the website, ii-vi.com. Just as a reminder, any Forward-Looking Statements we may make today during this teleconference are given in the context of today only. They are subject to various risk factors and are 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. Our list of known material risk factors can be found in our Form 10-K for the year ended June 30, 2020, together with our subsequent filings with the SEC and the Form 10-K for fiscal year 2021 is expected to be filed on or about August 20th. Our remarks today do not constitute an offer to sell or the 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 it over to Dr. Chuck Mattera. Chuck.

Chuck Mattera, CEO

Thanks, Mary Jane. Thank you all for joining us today and for your interest in II-VI. With the fourth surge of COVID clearly upon us, we remain focused on the basics to ensure employee and workplace safety. During the quarter, our supply chain and operations teams collaborated and again averted a potential impact of protracted supply chain issues. Once again, our employees made things happen and got the job done. Indeed, we delivered a great quarter and a great fiscal year. During today’s call, we will elaborate on the excitement of last year and our strong long-term opportunities. Since we signed the merger agreement with Coherent and started our flywheels turning, I have met individually with over 25 of the senior leaders at Coherent. I’m deeply impressed by their core competencies and long-standing contributions to the laser and photonics industries. They respect the challenges that had to be overcome with each successive generation of technology. Their team orientation around innovation and their sense of excitement about the opportunities to continue to transform the world are similar to II-VI, making for a great start. During fiscal year 2021, we celebrated the 50th anniversary since our founding and we passed another important operating milestone having achieved $3 billion in revenue. Only one year after passing the $2 billion mark, an amazing accomplishment despite the challenges, including those associated with operating during a pandemic. Our revenues and our non-GAAP net income both grew just over 30% over fiscal year 2020 and we exited fiscal year 2021 with a record $1.25 billion backlog. Our growth is a testament to our market-focused strategy, our diversified global footprint, the endowment of acquired and developed technology, our agility around large customer intimacy, our ability to operate at scale, a disciplined approach to productivity improvements, and a focus on our talent. Now turning from a summary of the last quarter and last year to a long-term view of our opportunity in the silicon carbide market. We are excited to announce the acceleration of our investments to scale the manufacturing of our silicon carbide substrates, devices, and modules to enable the acceleration of the electrification of the global transportation infrastructure. In fiscal year 2022, we plan to increase our investments to about $200 million in R&D and capital to continue to lay the foundation on which to grow the business to the next level. Our silicon carbide business, which today is less than 5% of our revenue, is targeted to become one of the largest businesses in our company within 10 years. We believe that our investments and opportunities, combined with our ability to execute, will allow us to become well-positioned in this large market with attractive growth dynamics. Accordingly, we are planning incremental R&D investments of about 2% to 3% of revenue for the next few years. We anticipate investing around $1 billion over the next decade as generation 3 semiconductors fabricated from wide-band gap materials, including silicon carbide, grow to underpin a number of important industry transformations and are planning to establish a leadership position long-term. Giovanni, Bob, and Mary Jane will walk through the details of the quarter. And with that, I will turn it over to Dr. Giovanni Barbarossa, our Chief Strategy Officer and President of the Compound Semiconductor sector. Giovanni.

Giovanni Barbarossa, Chief Strategy Officer

Thank you, Chuck. Despite all challenges we faced during the past 12 months, FY 2021 was an exciting year for us, having experienced growth in all of our markets. 3D Sensing posted the highest annual growth, more than doubling to just under 10% of sales, which allowed us to achieve our market penetration and share gain about one year ahead of plan. This journey will continue as we accelerate our innovation road map, including multi-junction VCSELs, photodiodes, metal lenses, and driver electronics and delivering new module functionalities to wafer-scale co-packaging. These modules will provide a compelling value proposition in multiple end markets, including in automotive, where driver and occupancy monitoring systems are increasingly recommended or acquired by U.S. and European transportation safety regulators. The momentum in the communications market continued with a strong 6% growth sequentially and strong bookings in the quarter. In datacom, products for 200G and 400G grew 60% in Q4 sequentially, driven by hyperscale data center upgrades. As the super cycle unfolds, we expect the demand for higher-speed transceivers to be strong for the next five years. We believe the super cycle will benefit those of us who have been investing for decades and can continue to sustain investments required to remain competitive in complex optoelectronic subsystems. At OFC 2021, we demonstrated our 400G and 800G transceivers for next-generation 25.6 and 51.2 terabit per second switches, respectively. While we continue to contribute to industry standards, we are already engaged with strategic customers for the development of 1.6 terabit per second transceivers, which we rely on our breakthrough semiconductor laser technologies capable of operating at 200 per line for all standard datacom reaches. The Q4 bookings for road and products were a record and critical IC shortages for older modules and line cards were overcome during Q4 to post a 9% sequential increase in revenue. Our telecom Magnit pump lasers also experienced record sales in FY 2021. Demonstrating the resilience of our diversification strategy, our industrial laser optics businesses hit an all-time record high for quarterly revenue, growing by 50% in Q4 over the prior year and accounted for 11% of our consolidated revenue. Growth was strong in both CO2 and fiber laser components. Our aftermarket business for industrial lasers posted the highest revenue month in June in our entire 50-year history and presently holds a record backlog with bookings back to pre-COVID levels. The record growth in industrial was enabled by a number of factors, including the recovery of the global industrial market, our market-leading optics, the competitiveness of our six-inch semiconductor laser platform, and the collaboration that we began with Coherent in December of 2020. Our partnership with Coherent core markets, their adjustable ring-mode fiber lasers with our remote laser processing heads. Two best-in-class products that together provide state-of-the-art performance for welding of batteries for electric vehicles. While global IC shortages have been constraining the record growth of some of our product lines, they have, on the other hand, become a multiyear tailwind for our semiconductor capital equipment business. Our semi-cap revenue grew 12% sequentially in the quarter. With a super strong bookings and multiyear visibility, we recently increased our forecast for fiscal year 2022 and beyond with corresponding investments in capacity. This is driven by our expectation of a sustained super cycle build-out of wafer fab capacity over the next few years to enable supply to catch up with demand and to support increased investments in on-shoring wafer fab fiber capacity. We witnessed healthy demand in this market with customers offering substantial price premiums to secure capacity of our metal markets composite and ceramic-based products, and to help us accelerate our new product developments. We expect this market to contribute significantly to our growth for the next few years. And so we are committed to supporting our customers through continued investments in R&D and capacity. Our revenue in Aerospace and Defense, despite the backdrop of moderating market demand, hit a record in FY 2021 and in Q4, with about 15% annual growth in a down market. With the new defense budget, we expect that the demand for components for new systems to address emerging threats will be increasing. Regarding silicon carbide, as we expand our capacity, we expect to take a meaningful share of the market by introducing products that are competitive in cost, performance, and reliability while investing to expand our product offering from substrates, tripitaxel wafers to chips, devices, and ultimately, modules over the next few years. Any way we look at it, FY 2021 was just an amazing year. We look forward to what is to come in FY 2022 as we start our next 50 years and soon to be joined by our Coherent colleagues who are like-minded in believing that the best is yet to come. With that, let me turn it over to Bob. Bob?

Bob Basha, President

Thank you, Giovanni. I will give you a short update on our COVID protocols, supply chain management, facilities planning, and our Coherent integration plan. Our global pandemic response teams, our corporate and business leadership, and all of our worldwide employees are doing a great job maintaining their vigilance and ensuring the safety of all of our employees. Among our many safety protocols that we have had in place since the beginning of the pandemic, we have continued regular PCR and antigen testing of all on-site employees. We require employees and visitors to wear masks in all of our facilities and we maintain social distancing and cleaning protocols in all of our operations worldwide. Our worldwide local pandemic response teams meet regularly at all of our 70-plus facilities worldwide and our corporate pandemic response teams meet at least weekly with our site leaders to offer information, provide guidance, and ensure that all of our facilities and people have the resources that they need. We have also retained and consulted regularly with healthcare professionals in an effort to understand the current dynamics associated with this terrible disease. Because all of our operating plants are considered essential, we remain fully operational in all locations in the world, while most of our administrative staff are still working from home. Supply chain challenges remain daunting and we are being managed 24/7 as an all-hands-on-deck effort to secure our fair share of capacity at our suppliers. Thanks in part to some of our strategic suppliers, who have worked very closely with us during Q4, we overcame the effects of shortages that could have affected revenue as much as $40 million by our estimates. We have been a good customer for many years and actually contributed to the development of many of our strategic suppliers whom we brought together in January to lay out our requirements in anticipation of the current challenge. As we confront the challenges of the fourth surge, our operations in Asia, particularly in the Philippines, Vietnam, and Malaysia are experiencing extended quarantine and isolation periods, which, in addition to supply chain constraints could have an impact on near-term production capacity, including Q1 FY 2022. Besides the potential COVID impact on our ability to produce, we are absorbing about an additional $3 million per quarter than our baseline supply chain costs for components and freight. With respect to our expected growth, we have been actively evaluating our global footprint to accommodate, among other initiatives, the forecasted growth in our silicon carbide electronics business. As we approach the end of the second year of the Finisar integration, we achieved 16% top-line growth, advanced the margins from our Finisar stand-alone position, and delivered $165 million of cost and expense synergies on an annualized basis a year sooner than planned at less than half of the anticipated investment costs to achieve them. We are excited to apply our playbook now as we turn to the Coherent acquisition for which planning has commenced in earnest. With respect to the regulatory process, the applicable antitrust waiting period in the U.S. has already expired, and all of our other regulatory filings are submitted in the required countries, with case workers having been assigned to all. Our exchanges of information have been constructive and typical of our experience. We expect the processes to conclude in an orderly manner. Our current view is that our closing will be during the first fiscal calendar quarter of year 2022 as opposed to the fourth quarter of calendar year 2021. This is based on a better understanding of the agency’s current caseloads and their timelines. We have also begun our integration and synergy planning. The top U.S.-based leaders from both companies have been meeting. We have learned a lot about each other’s jobs, and we are planning to conduct similar networking events in Europe and Asia in the next few months. Throughout II-VI and Coherent, we are excited for the promise that this combination will realize. With that, I will turn it over to Mary Jane.

Mary Jane Raymond, CFO

Thank you, Bob, and good morning. First of all, a sincere thank you to all of our customers who are the underlying driver of our growth. We are honored to support your strategic goals. Our Q4 revenue was $808 million, distributed as follows: 48% in North America, 23% in China, 20% in Europe, 6% in Japan, and 3% in the rest of the world. For the full year, the distribution was 50% North America, 22% China, 18% Europe, 7% Japan, and 3% for the rest of the world. In the quarter, end market revenue distribution was 67% in Communications, 13% in industrial, including automotive, 7% in aerospace and defense, 5% in consumer for semiconductor capital equipment, 3% in life sciences, and the remainder in other end markets. Our non-GAAP gross margin was 38.6%, and the non-GAAP operating margin was 18.4%. Both margins remained well ahead of what II-VI achieved right before the acquisition of Finisar closed. We incurred $4 million of COVID expenses in the quarter, with $2 million included in the non-GAAP figures. This total accounts for lost work time and overtime, collectively putting downward pressure on the gross and operating margins for the quarter. We also incurred $3.3 million to manage supply chain shortages, including expedited freight and unusual price increases above our normal costs. This amount is included in the non-GAAP adjustments. At the segment level, the non-GAAP operating margins were 15.9% for Photonics and 23.7% for compound semiconductors, driven by a strong mix and optimized capacity utilization. Our record backlog of $1.25 billion is made up of $827 million for Photonics and $425 million for compound semiconductors, consisting of orders that will ship over the next 12 months. We have many orders that extend beyond 12 months as customers seek to secure capacity, anticipating what many believe to be a super cycle. GAAP operating expenses, which include SG&A plus R&D, were $211 million in Q4. Excluding $21 million of amortization, $16 million of stock compensation, and $12 million of M&A and integration costs, non-GAAP OpEx was $162 million or 20% of revenue and 600 basis points lower than the OpEx percentage before the acquisition, when it was nearly 26% for II-VI and Finisar combined, excluding amortization, stock compensation, and transaction costs. These improvements stem from our accelerated achievement of synergies, productivity enhancements, and relocating manufacturing to lower-cost areas. Quarterly GAAP EPS was $0.59 and non-GAAP EPS was $0.88, with after-tax non-GAAP adjustments totaling $35 million, including the reversal of positive investment gains. The diluted share count for GAAP results is 116 million shares, and for non-GAAP results, it's 125 million shares. The GAAP and non-GAAP EPS calculations are in the last two tables of our press release. Stock compensation was $19 million for the quarter, with $3 billion in COGS and $16 million in OpEx. We expect stock compensation for Q1 to be $22 million. Cash flow from operations in the quarter was $127 million, and free cash flow was $83 million. We paid down $15 million of our debt in Q4, bringing our net cash position to $175 million. The interest expense for the quarter was $14 million. For the full year, cash flow from operations was $574 million, with free cash flow at $428 million. Days Sales Outstanding were 68 days, and the company’s liquidity at June 30 was $2 billion. Capital expenditures this quarter were $42 million, totaling $146 million for the year. For fiscal year 2022, we expect CapEx to be between $325 million and $375 million. As part of managing our strategic equity investment portfolio, the company reported a $7 million gain on the sale of an equity investment in Sweden and a $3.9 million gain related to the IPO of part of another investment in China, linked to a minority position acquired over a decade ago. Depreciation was $50 million in the quarter, and we anticipate our future depreciation expense to be around $50 million to $55 million per quarter. Foreign exchange had a loss of $1.3 million, primarily due to the Swiss franc and the RMB. The effective tax rate for the quarter was 12%, influenced by ongoing benefits from renewed high-tech status in several countries, lower GILTI income from a favorable earnings mix worldwide, and increased stock compensation exercises. We expect the tax rate to be between 19% and 21% for fiscal year 2022. We incurred $12 million in costs related to M&A, integration, and other expenses, primarily for Coherent and Finisar. Regarding our Series B preferred stock issuance, we recorded a $10 million dividend in Q4, which will be deducted from net income like the $6.9 million dividend for the Series A preferred stock. Looking ahead to Q1 fiscal year 2022, we expect revenue to be between $780 million and $830 million, with non-GAAP earnings per share projected between $0.75 and $0.90 based on 118 million shares. For Q1, both Series A and Series B preferred stock should be anti-dilutive, so deduct $17 million from your calculated non-GAAP net income to find the net income available to common shareholders before dividing by 118 million shares for the non-GAAP EPS calculation. This is based on the current exchange rate and an estimated tax rate of 20%. The EPS range also accounts for our planned investment of up to $20 million for silicon carbide expansion. For non-GAAP earnings per share, we add back to the GAAP earnings pretax amounts of $21 million in amortization, $22 million in stock compensation, and $11 million to $15 million in transaction and integration costs. The estimated share count for Q1 is 111 million shares for GAAP and 118 million shares for non-GAAP. Note that the actual dollar amount of non-GAAP items, the exchange rate, tax rate, and share count may change. Before we move to Q&A, I want to remind everyone that our answers may contain forecasts, and actual results may differ due to various factors, including product mix, customer orders, supply chain challenges, competition, regulatory changes, ongoing COVID-19 requirements, and general economic conditions. We ask that each firm limit its questions to one without follow-ups to allow us to accommodate everyone on this call. We expect to conclude by 10:15 a.m. Regina, please open the line for questions.

Paul Silverstein, Analyst

Thanks, guys. I was hoping you could give us some insight on what you are seeing in China during the quarter, more importantly, looking forward, given some concerns out there in the marketplace.

Giovanni Barbarossa, Chief Strategy Officer

So Paul, thanks for your question. This is Giovanni here. So let me comment on the industrial, if that is what you are referring to. But generally speaking, China has been a strong market for us, particularly industrial. We have seen pretty much all of our fiber laser customers, as an example, have very strong demand. We believe they are gaining share in the world market, and as I explained in my commentary, there have been really record numbers in many ways from the optics for the pumps. And so we have been benefiting from those customers taking share. And so China has been very strong for us. Now moving forward, of course, there is some uncertainty about the evolution of the virus like everywhere else. But we have not seen so far any slowdown in their demand for components, particularly for fiber lasers.

Paul Silverstein, Analyst

And guys, on the optics side, I assume with the 5G awards now having been made, are you expecting a pickup in demand in your communications business in China?

Giovanni Barbarossa, Chief Strategy Officer

Yes. Likewise. Yes, absolutely. So very similar.

Ananda Baruah, Analyst

Hi guys. Congrats on the strong execution this quarter, and I appreciate you taking the question. I mean, somewhat related, just in general, core business shows really good momentum this quarter. And it feels like there might be a pickup in some of those end markets a little bit sooner than expected. Is that accurate? I guess, is that your core view as we head into the September quarter here? And if so, what do you see as the key drivers as we go through the next six months of the year? I appreciate it. Thanks.

Chuck Mattera, CEO

Thanks, Ananda. So there is definitely a super cycle unfolding for upgrades across the world, particularly in North America to which we are participating, as I explained in my commentary about with the 200, 400, next-generation 800, and even 1.6 terabits per second transceivers. So that demand will continue at least for the next five years. The cycle will continue for quite a long time. I think industrial is coming back pretty strong, we have seen a pickup in general demand for our laser components, again, particularly fiber lasers and the same in power electronics driven by electric vehicles, adoption of silicon carbide devices and modules. And so I think those are going to be the strongest that we see. Also, as I mentioned in the prepared remarks, we think that despite the defense budget is kind of almost flat year-over-year, there is going to be an increase, nevertheless, in demand for new designs and new products for emerging threats. And so we will participate in that growth in demand too.

Ananda Baruah, Analyst

Giovanni, you are seeing it like - is demand backdrop a little bit stronger today than maybe you thought it would have been 90 days ago?

Giovanni Barbarossa, Chief Strategy Officer

Yes. But I’m sorry, we need to move to the next analyst. Thank you.

James Ricchiuti, Analyst

Thank you. I think I heard in your opening presentation that you overcame some of the component issues that would have impacted revenues by about $40 million. I’m wondering if there is if you can give us any sense as to what you might have been able to ship in terms of revenue had it not been for the component constraints, and with respect to your fiscal Q1 guidance, what type of revenue headwind are you assuming for components and some of the supply chain constraints?

Mary Jane Raymond, CFO

So for Q1 guidance, I would say that we are looking at probably the same quantum in the first quarter that we were looking at in the fourth quarter. So that is one thing to answer. And I think secondly, as Bob has already said, overcoming $40 million and pretty much a day-to-day hand-to-hand combat, certainly, the demand is there. You can see that really in the book-to-bill. Would you have a view on this, Bob?

Bob Basha, President

No, I agree completely, Mary Jane. A lot of the supply chain challenges really come from the integrated circuit supply chain constraints. And the team has really done a nice job outside of ICs and a real nice job with getting our IC supply chain requirements. So I agree completely.

James Ricchiuti, Analyst

Do you see any improvement as you look out over the balance of fiscal 2022 from the standpoint of supply chain?

Chuck Mattera, CEO

I’m sorry... Mary Jane, your question was, do we see any operation of the supply chain challenges forward?

Mary Jane Raymond, CFO

Yes. Do you see any improvement?

Chuck Mattera, CEO

Yes. Thank you, Jim. This is Chuck. Jim, we don’t have a crystal ball, and the challenge associated with it is it is not only affecting us but of course, it is affecting our customers. And we have to take it - we have a long-term view, we have actions consistent with that long-term view. We have backup plans that we are trying to execute and keep in place and at the end of the day, this is a job that has to be done every single day. And so I’m optimistic that it will eventually clear out. But at the moment, it is not looking like anybody is going to be able to call exactly when.

James Ricchiuti, Analyst

Okay. Thanks very much.

Mary Jane Raymond, CFO

Sure. No problem. Just for our leader board, I’m sorry to have to ask you this, but just to try to get everyone on the call, we probably cannot have follow-ups, but feel free to jump back in line. And if we can do a second round, we would be happy to.

John Marchetti, Analyst

Thanks very much. Mary Jane, I just wanted to ask, in terms of the fiscal 1Q guidance, when we look at the midpoint of the ranges, we have got revenue essentially flattish. We got EPS down but on a lower share count. Can you help us just understand what we are thinking about in terms of gross margin and/or the higher OpEx that you referenced in some of the prepared remarks?

Mary Jane Raymond, CFO

Sure. So first of all, John, being a little newer to our company, the fact that the midpoint would be flat to Q4. Q4 has historically been our largest quarter and largest by a good mile. So historically, we have had Q1 down even in very strong markets. So in 2016, 2017, and 2018, Q1 was down of those years on the prior Q4. So first of all, the revenue is probably holding in very, very well. And then with respect to the midpoint of the guidance, as we described, we did not take out of the non-GAAP range, roughly about $20 million that will be spent on the investments for silicon carbide. So if you tax-effect that and do it, it is in the neighborhood of $0.12, $0.14. So that is really the major difference going forward. And as well as we do expect, as Bob has already said, to continue to have costs to try and battle supply chain shortages as well as dealing with COVID. But the major difference when you look at the midpoint to what we delivered in Q4 was the silicon carbide investment.

Mark Miller, Analyst

Congratulations on your record results. What can you say about, you had very strong 200, 400 gig transceiver sales. What about pricing in that market? Is that pricing improvement with the strong demand?

Giovanni Barbarossa, Chief Strategy Officer

Pricing is the typical communication market pricing we are seeing for the past 20 years. But we try to really focus on the high-end products. For example, on the ZR format, we are focusing on high power versions, so we can eliminate, for example, the entire layer two, doing basically IP over DWDM. And that is enabled by our enuphosphide technology. So we are trying to focus on those factions of the market that offer the best margins and pricing. But the dynamic ASP reduction over time and so forth is pretty much unchanged, still lower pressure. But as I said, by focusing on the high end of the market, we can do better than average, I would say.

Richard Shannon, Analyst

Hi guys, thanks for taking my question. A question for either Chuck or Giovanni on silicon carbide here. You have listed out some what looks like a pretty strong increased investment in silicon carbide, where you have already talked about this market for years here. You have built up a capability across the stack here. Can you talk about and characterize what is driving you to put in a decreased amount of investment? Has this been improvements in internal product technology milestones or conversations with customers, et cetera? Maybe you can just characterize why you are making an increased level of investment on top of what has already been strong one. Thanks.

Chuck Mattera, CEO

Thanks, Richard. Yes, actually, it is all of those things—our confidence in the quality of our material, at this point in time, combined with the investments that we have recently announced in the last 12 months and a very apparent acceleration in the need for silicon carbide and the demand that is coming here inside the next five years. We would like to be well positioned, as I said in my remarks, to lead in this market. And so we are stepping it up, and it couldn’t be more exciting for us. Okay.

Thomas Diffely, Analyst

On those same lines, when you look at the $1 billion investment projected over the next 10 years, from a big picture point of view, is the main focus going to be on increasing your capacity in the space, or is it going to be more on the R&D productization of different silicon carbide pieces?

Chuck Mattera, CEO

Both, Tom. Thanks for your question. We have to do both. The demands over the next 5 to 10 years are going to grow exponentially. And so we need to be in a position to be able to scale everything that we are doing, but we need to get the device and the module technology and all the process technology that we have in place. We need to get that organized. We need to get it qualified and we need to get the platform in place to scale. In the meanwhile, we will be making an even larger investment than what we have been planning to get the silicon carbide substrate capacity in place for what we need and for also what the market needs as well.

Mary Jane Raymond, CFO

I would say on balance in the $1 billion, it probably leaves more to capital than R&D, but Chuck is perfectly correct that we need both of them.

Christopher Rolland, Analyst

Hey guys, thanks for the question. Regarding consumer, it was great doubling for the year that you guys had there, but perhaps you guys can give us a little bit more color on some near-term trends and then your expectations as we move into the back half of the calendar year?

Giovanni Barbarossa, Chief Strategy Officer

Hey Chris, thanks. This is Giovanni. Thanks for your question. So we expect the typical seasonality in the market. And we also expect to materialize some new design wins that will add up to the design wins we are currently selling. And so I think that will be a pressure on price for sure, like typically, they are having a combination of improvements in the experience curve as well as design improvements. And I expect that over time, as I mentioned in my prepared remarks, that market will continue to be a close driver for us. So in the second half of the year, we will - of the calendar year will experience the typical seasonality trend and then will continue to grow year-over-year. So as out of our leadership in a number of parts that support the market lasers, meta lenses, drivers, modules, and so forth.

Samik Chatterjee, Analyst

Hi good morning. I had a quick one for Mary Jane. As thanks for your comments about the incremental investment in the first quarter. Just wondering if you can give us some direction on the magnitude of incremental investments acquired in fiscal year 2022 as we start to think about the margin progression here, particularly if you can also comment on what levers you would have to drive margin progression as you offset some of these incremental investments as well.

Mary Jane Raymond, CFO

Right. So first of all, with respect to fiscal year 2022, Chuck spoke to about $200 million. The way that breaks down is roundabout million in the R&D, particularly with respect to the design for manufacturability, and round about the balance of that $200 million that is CapEx, okay? So that is for this year. With respect to margin improvement overall, I mean, certainly, one of the things we have seen through fiscal year 2021, particularly in Giovanni’s segment, is the manifestation of growth in many of the markets in which we had been investing for a long time, whether that be consumer or silicon carbide, et cetera. So as those laser-based and material businesses, growing material businesses accelerate through growth, we will see better air cover, so to speak, and better mix as it affects the gross margin.

Amanda Scarnati, Analyst

Hi. Just a follow-up question on margin accretion and how - what is the bigger driver here of growing margins? Is it sort of fixing some of these supply chain issues that are somewhat out of your control, or is it more of a mix scenario, and does it look like the December quarter could be a step-up in margins?

Mary Jane Raymond, CFO

Well, first of all, make no mistake about it, mix makes a big difference. And you can see that if you look at the margin profile across the four quarters of the year, whether you look at the gross margin or you look at the segment margins, so mix makes a big difference. I will say that certainly the fact that we are seeing a very nice renaissance here in industrial will continue to help. I mean as much as we might think that is the oldest business into six, it retains one of the best margins in the whole company. So that is a very positive thing. So any of the drivers using our grow materials or laser diodes are very positive additions to the mix. So that is probably the largest driver of the margin. With respect to the supply chain shortages, while we can obviously estimate increased freight or premium pricing or increased long-term commitments to customers, those are things that are very easy to calculate. What isn’t as easy to calculate is the literal all hands on deck, where people are coming out of other functions to work on this that potentially take them away from other improvements that they had been able to make. So I think as the supply chain eases and there is more focus than just being able to ship product. I think that absolutely does help.

Simon Leopold, Analyst

Thanks for taking the question. Just a very, very quick clarification for Mary Jane and then the question. I wasn’t clear if you excluded some charges in your pro forma related to the COVID expenses or are you just were highlighting those. But the question I really would like to ask is to get a little bit of quantification around the hyperscale business you have been doing. It sounds like that has been growing nicely. I just want to get a better idea of what portion of the revenue are you getting from hyperscale now and how does it compare to a year ago? Thank you.

Mary Jane Raymond, CFO

So with respect to COVID, we incurred about $4 million or so and we non-GAAP $2 million of it. So the goal was to try and non-GAAP kind of the surge of it, and that is the same exact thing we did last quarter. With respect to the hyperscale, Giovanni?

Giovanni Barbarossa, Chief Strategy Officer

Yes. I would say that the ratio is increasing, as we mentioned in the past, I think as a result, all the combination with Finisar and the deal pending, meaning customers weighed for the combination to happen. They were on the sideline, and we are kind of gaining share back because of that. Now obviously, we are working together as one company, and there is a very high confidence in the team, which is doing a fantastic job of gaining share, particularly as I mentioned earlier, we have the high-end side of the products. And I would say that of the communication, they feel - let’s say, the transceiver business, I would say that the number is close to 30% and growing. And overtime, there may be a balance between maybe datacom, telecom, or hyperscale or super scale, however you want to define them over time. But I think it just depends on what the definition of hyperscale is, but I think 30% is a good case.

Tim Savageaux, Analyst

Hi good morning. I wanted to come back on the kind of question about the fiscal Q1 guide on a sequential basis because you are - while appreciating historical seasonality, your seasonality has changed a bit, you should be seeing at least some degree of uplift in consumer. And it sounds like from a booking standpoint and just the overall tone of business that datacom and comm should be growing as well. So I guess I got a couple of questions. Should we look at kind of historic seasonality in industrial and other parts of the business is kind of seasonal offsets to that, and perhaps more importantly, are you building in that $40 million component headwind to the guide and to overcome it as you have done this quarter would represent upside.

Mary Jane Raymond, CFO

So yes, to the last question because obviously, the EPS guide goes with the revenue guide, right, on the same kind of range basis. So yes, if we were to be at the top end or over-deliver that by some excellent amount of work by our guys, I would imagine that we would be at the top end of the EPS as well. Second of all, while you are correct that the second half of the calendar year, our Q1 and Q2 are stronger on consumer, there is still a seasonal downtick. And we had a very, very good consumer quarter last year, and it was still down on Q4. But all that to say that generally, we do see a little bit of a step-down in industrial. But at the end of the day, I think no matter how you cut it, we are probably looking at a pretty decent Q1 from a top-line perspective with the excellent work of all of our colleagues around the world. So I hope that answers the composite of your questions, Tim.

Meta Marshall, Analyst

Great, thanks. Giovanni, I just wanted to circle back to your commentary on the 3D sensing market. And just as you talk about growth in fiscal year 2022, is that design like just what drives that? Is it design wins outside of your lead customers' ecosystem, is that product expansion within that ecosystem, or share gains? Like I know, obviously, it is tough to parse out, but if there was a leading factor in what would lead to the growth, that would be helpful. Thanks.

Giovanni Barbarossa, Chief Strategy Officer

Thanks, Meta, for the question. It is a combination. Yes, there is not a single reason. I think the share gains will continue. It will eventually stabilize over time in the next few quarters. And then there are new opportunities in-cabin sensing for automotive. And then, as I said, new design wins. I think there is an expectation that over time, that specific market will continue to grow fast. And there is another factor, which I mentioned in my remarks, which is really what we are selling, not only - so we are increasing the offering from just lasers and filters, which we did in the past to optics, IC drivers, and modules. So altogether, the addressable market is expanding for us and therefore, we expect the revenue to grow too.

Mary Jane Raymond, CFO

Thank you very much, Regina, and thank you to all of you who joined us today. We know this is a busy earnings season for you, and we look forward to talking with all of you as time goes on here. So thank you very much, and have a good day.

Operator, Operator

Ladies and gentlemen, that concludes today’s call. Thank you all for joining. You may now disconnect.