Good day ladies and gentlemen and welcome to the II-VI Incorporated Fiscal Year 2016 Third Quarter Conference Call. [Operator Instructions] I would now like to turn the conference over to Mary Jane Raymond, CFO, you may begin..

Thank You Nicole and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at II-VI Incorporated. Welcome to our third quarter earnings call for fiscal year 2016. With me on the call today is Francis Kramer, our Chairman and CEO and Dr. Chuck Mattera, our President. As a reminder, this call is recorded on Tuesday, April 26, 2016.

Any forward-looking statements we may make during this teleconference are given in the context of today only. We do not undertake any obligation to update these statements to reflect events subsequent to today. With that, let me turn it over to Francis Kramer.

Fran?.

Thank you, Mary Jane and thank you everyone for joining us. In our third quarter, we had record bookings and shipments. Revenue and EPS were above the high-end of our revised range issued on March 16. Our optical communications business remains strong for us this quarter both in revenues and bookings.

The growth from our divisions that serve the industrial laser materials processing market also showed improvement compared to the last few quarters with a 10% increase in bookings even though revenue growth in the quarter was unchanged from the same period last year. We completed both of the acquisitions announced in January 19th.

Our third-quarter results included two months of EpiWorks and 15 days of ANADIGICS. We are looking forward to realizing the growth of these additional platforms will offer us. Excluding the acquisition effects, our book to bill ratio of 1.16 was the strongest since fiscal year '11.

Photonics strength continues at a book to bill ratio of 1.28 and we expect those bookings to contribute to strong revenue and profit into early next fiscal year. Laser Solutions pre-acquisition business had a book-to-bill ratio of 1.14 with particular strength from CO2 laser optics. Performance Products segment book-to-bill ratio was 1.0.

We are optimistic about the continued revenue and earnings growth from the photonics business segment during the next six to nine months. Couple that with the Laser Solutions segment which should experience a solid quarter in its historically strong fourth quarter.

And that means we should deliver a revenue upside as we end fiscal year '16 and start investing to build out capacity for a ramp in the VCSEL laser platform which we expect to have significant results in the next 12 to 24 months. Let me now turn it over to Chuck to comment on the trends in our worldwide businesses and our new acquisitions..

Thanks, Fran. It was an exciting quarter, a clear view of the strength in the existing business and two strategic platform acquisitions that underpin our growth aspirations.

These acquisitions complement the leadership position of our Laser Enterprise division and a rapidly growing semiconductor laser market, a key driver of our investments into a market that industry analysts expect to grow by 2020 to over $5 billion, including a $2 billion VCSEL market.

This quarter the composition of our revenue into our top three end markets was 36% into industrial, 35% into communication and 14% into military. On a regional basis, the distribution of our revenues was 42% from North America, 21% from Europe, 21% from China and 16% from the rest of the world.

This represented a regional distribution that saw a greater content from China, unusual.

Against the backdrop of favorable market demands, a strong global leadership team based in Fuzhou, China, who has always seen the successful integration of several acquisitions, Photonics segment led the way again this quarter with a record revenue of $81-million. That is 25% higher than the same period last year.

The growth was driven by broad-based demand across the whole spectrum of the optical communications markets, including the data center markets. Market catalysts this quarter were the China broadband program that continued from the first half of the year.

Increased demand for the 100G metro deployments in the US, continued demand for our products to serve the data center expansion in the interconnection markets and the cable TV build-outs primarily in the US, and finally the undersea fiber optic communications network markets.

The broad-based market strength is not only driving demand but is also influencing capacity additions and supply chain constraints.

There is particularly strong backlog for many of our new market-leading products, including our proprietary OTDR modules, our low-noise optical amplifiers for 200G and 400G transmission as well as our power efficient and high output power 980 nanometer pumps.

We continue to see robust design-in activity at the line card level, the module level and the component level. This suggests that our strategy to provide our products at multiple levels of integration is being embraced by the market.

Given that historically the broad-based optical and data communications markets undergo cycles of investment, expansion and retrenchment, it is noteworthy that our Q3 results represents the fourth consecutive quarter of growth for us in photonics.

And with the strength in bookings, backlog, the ongoing launch of new products and a growing design-in pipeline, we are optimistic that the strong performance will continue through Q4 and at least the first quarter of FY17.

Turning to the Laser Solutions segment, revenues in that segment were unchanged this quarter compared to the same period last year, but grew 2% in constant currency with a particularly good March. We expect to see a stronger Q4 given the momentum that we saw in bookings in March, a record bookings month for the infrared optics division.

Our marketing strategy and its associated broad-based drive to increase our share in the large segment of low-power CO2 laser optics resulted in good bookings this quarter also. Moving to the Performance Products segment, the bookings were unchanged compared to Q3 of FY15, but revenues grew 12% from the same period last quarter.

Most divisions experienced increased sales this quarter with some recovery in several end markets. We expect Q4 to be a very good quarter for our performance products. I would now like to turn my attention to the two acquisitions we made during the quarter and provide some color on how we see them fitting into the fabric of II-VI’s growth aspirations.

Consistent with our fundamental strategy and made up of an industry leading technical team, EpiWorks, headquartered in Champaign, Illinois, employs over 50 people and is a market leader in engineered materials for optoelectronic devices.

They offered us differentiated technology, a 6-inch diameter epitaxial wafer growth capability, a scalable platform and a time to market advantage.

Their broad product portfolio and the growing end markets that they address are RF wireless, optical and data communications, datacenter interconnect and the emerging 3-D sensing and Internet of Things markets. Our acquisitions of EpiWorks was complemented by our acquisition of ANADIGICS.

ANADIGICS is also part of our strategy, providing us with access to a differentiated technology platform that being a 6-inch gallium arsenide integrated circuit wafer fab. This team has already begun the development that is necessary for the parallel high volume and low cost fabrication of integrated circuits and semiconductor lasers.

Headquartered in Warren, New Jersey, the company employs about 250 people. They are a market leader in the technology, design and manufacturing of products that provide application specific solutions to the wireless, mobility and cable TV markets.

These solutions solve the complex data flow challenges that exist today and that are expected to arise in the future. There is a meaningful intersection between some of the largest customers of ANADIGICS and our photonics segment and in fact, the applications that they sell into are also common.

So when ANADIGICS’ core market dynamics begin to create an underutilized wafer fab, they invested in the development of the technology required to fabricate VCSELs in large volume in effect constructing a platform that would enable renewed growth.

This platform provides us with a running to scale for future applications of the semiconductor laser devices that are designed, developed and marketed by our team at Laser Enterprise headquartered in Zurich.

Demand is stable in both of these newly acquired divisions and consistent with our expectations, including bookings for Q4 and customer design wins of new products.

We have begun our integration efforts, including assessing our options to reduce cost and improve operational efficiencies even in the short term, while we prepare to invest in the development and qualification of our 6-inch VCSEL platform.

In summary then, we added both of these businesses to our portfolio to build out our semiconductor laser platform and we will begin those further investments in the fourth quarter. Before I turn it over to Mary Jane, I would like to say that we are pleased to have announced that Mr.

Gary Kapusta joined II-VI as the Chief Operating Officer of the company, effective February 1st 2016. Gary reports to me and he assumes the COO responsibilities I had had since September of 2013. This important addition enables our leadership team to continue to drive our long term growth.

I would also like to welcome our EpiWorks and ANADIGICS employees to an exciting and rewarding environment with our nearly 9000 fully engaged employees worldwide. So in summary, this quarter, again, we saw the combined benefits of our triple play and R&D investments, vertical integration and M&A strategy, underpinning a global growth strategy.

Those benefits along with a continued strong drive for customer intimacy, product leadership and operational excellence to deliver exceptional business results continue to be felt in every corner of the company.

Mary Jane?.

Thanks, Fran and Chuck. As you can see from the first page of our press release, our reported revenue, gross margin and EPS of $205 million, 37.9% and $0.24 a share are fully US GAAP results. Excluding the acquisition effects and one-time items for the non-GAAP lines, our revenue was $201 million, also a record for II-VI for quarterly revenue.

Gross margin was 38.2% and our EPS was $0.35 a share, one-time items were $0.08 a share.

The acquisitions are recorded in the laser solutions segment because the acquisitions may ask the underlying progress in laser solutions we report on the second page of the press release an adjusted op-income margin of 18.1% to show the underlying progress of the laser solutions segment compared to the last several quarters.

Our book to bill ratio of 1.16, our backlog with that book to bill ratio rose to $300 million, an increase of 17% compared to last year quarter. That backlog consists of $89 million in laser solutions, $107 million in Photonics, and $104 million in performance products. The laser solutions backlog includes $14 million from acquired backlog.

Year-to-date, our cash flow from operations was $81 million. We increased our debt by $116 million bringing our net debt level to $75 million. Our interest expense was about $800,000 for this quarter.

We purchased new stock this quarter since we ran blackout for most of the quarter and today we’ve purchased about $19 million of our $50 million authorization. We invested $13.5 million in capital equipment this quarter and expect to invest $50 million to $60 million for the full year.

For fiscal year ’16, we expect equity-based compensation to range from $12 million to $13 million. Our expense this quarter was $2.5 million. Our tax rate for the quarter was 14%. We expect that for fiscal year ‘16 the tax rate should range from 17% to 20%.

Our outlook for operations for fiscal year - fiscal quarter four without acquisition effects or in another words on a non-GAAP basis for our fourth fiscal quarter ending June 30, 2016 is revenue of $200 million to $210 million and earnings per share of $0.25 to $0.29.

On a continuing consolidated basis, revenue is expected to be $210 million to $225 million and EPS is expected to be $0.22 to $0.24. This excludes one-time items and the effects of our actions underway to improve our operating efficiencies.

This is all of prevailing exchange rates and all of our earnings per share comments are referring to diluted shares. Comparable results for the quarter that ended June 30, 2015 were revenues of $196.7 million and diluted earnings per share of $0.27.

Going forward, actual results may differ from these forecast due to a variety of factors including but not limited to changes in market terms, product demand, competition, and general economic conditions. Before we turn to questions, our fourth-quarter earnings release date is slated for Tuesday, August 2, 2016. Operator you can open the line..

[Operator Instructions] Our first question comes from the line of Jim Ricchiuti of Needham & Company. Your line is now open..

Quick question Mary Jane, I'm wondering if you could give us a sense of relative to your guidance, what the gross margins could look like particularly with the addition of the new businesses..

Well, we don't really give guidance on the gross margins but I would say the range for the year is still expected to be inside the range that we have out there which is 37 to 40..

You guys have been very helpful in terms of providing detail on the end market and I'm wondering with the ANADIGICS and EpiWorks acquisition, if you can give us a sense as to how you see the end-markets for these two businesses evolving over the next year or so, just in light of some of the things they have going on?.

Okay, good morning, Jim, this is Chuck..

Hi, Chuck..

Good morning. Here is maybe a comment about the VCSEL business. It might be helpful; we believe that advancements in VCSEL technology are opening up new applications. There is a number of attractive growth drivers, both from the data com, data center, sensing markets and the like.

To give you a sense the $5 billion market for semiconductor lasers and the $2 billion for VCSELs are expected to continue to grow based on the existing applications that are there and new applications that are being developed.

And I think if you take a longer term view over the next one or two years, those – we expect those applications to begin to drive demand for those devices from the ANADIGICS and EpiWorks combination..

I might add Jim..

Go ahead..

The EpiWorks business is then developing many epitaxial products serving many markets and we expect that to continue to grow, but it fits in line with what we want to do, which was to build a platform for VCSEL. So we have epitaxial process there that we have now put together.

So to the other side of it, ANADIGICS, very big and all the fabrication of devices that will end up having to produce as we think those business will scale up, so that at the same time, they are also in the RF components business, so they have two different businesses.

And the platform that we need is to how to build many devices rather rapidly and that’s what we have acquired there. So we think both will have key mission in this platform and we are organizing ourselves to let’s say further organize it for the flow that we are expecting..

Okay. That’s helpful. And one final question if I may. Just regarding the strength you saw in the industrial market, laser solution, so I think you particularly called out strength in the month of March.

Can you elaborate on what you’re seeing in the market? It sounds like you are seeing relatively good demand in China as well, is that fair to say?.

I’ll take that. This is Fran. Just on the CO2 portion of it, maybe January and February were a little light for us, but really came back heavily in March. And I think it [indiscernible] by CO2 laser utilization around the world and people who are operating those machines and buying premise their replacement parts.

That’s always usually a good business for us in the third and fourth fiscal quarter. So March was a good month in the third quarter and now we are looking to the fourth quarter..

Okay. Thank you..

Thank you. Our next question comes from the line of Christopher Longiaru of Sidoti. Your line is now open..

Hi, Chris. Welcome to the call..

Hi guys, thanks for taking my question. Thank you. So my first question is just – has to do with historically your bookings and your next quarter revenue have been pretty close and you did give kind of a guide that seems to be a little conservative for the June quarter.

So I just want to kind of correlate that with what you’re thinking and the upside ring is that you kind of mentioned in your guide?.

This is Mary Jane. I will start with two things. First of all, as Chuck mentioned, in the optical – in the photonics division, the photonics segment, we are seeing an increase in the order book as people anticipate potential supply chain shortages in place, potentially orders for a longer period of time.

So we are thinking that we have – we can see we have more order coverage selling beyond right the next quarter, that’s probably the first thing.

The second thing is that sequentially, we saw an increase in the bookings in performance products as well compared to say Q3, even though it was flat to last year and the performance products bookings for sure do not all really deliver into the next quarter.

So those are probably the main components of thinking about how the bookings are going to materialize over time..

So the summary of that basically is that most of the jump in bookings that you saw, you expect to ship more into F17 and into 4Q?.

Well, I would say that we expect some of them to ship into F17 and maybe slightly larger, somewhat larger percentage than we may have seen in the past..

Got it, okay.

And then just I know that there is – you guys are looking at the acquisitions, but just in terms of some broad based goals for the operating expenses and timing, can you give us any idea of how to think about that going forward?.

With respect to the acquisitions proper?.

Yes..

I think Chuck probably and Fran probably said as much as we can say now. There's no question that the company is focused on improving the operating efficiencies, but also looking at ways to improve the under-utilization of the wafer fab, so that would have an affect obviously on the take-up of the operating expenses.

And as we look at all the options that we could see with respect to the two acquisitions, I think right now we are kind of in the midst of that, probably can't give any specific guidance on their particular line of SG&A..

Let me add to it, Chris. This is Fran. We're out there with our new businesses and we're analyzing the best way for us to structure the business and we have put together four options that we're evaluating.

We're certainly looking at do we operate the business after we right-size it or do we joint venture with somebody on the RF side or do we shutdown a proportion of that business or sell it off. So all four of these options we're evaluating. We've announced to our people that that's what we're doing at both at the site there in New Jersey.

And it'll take us the better part of this quarter to figure it completely out, but we know we have more cost than what we're used to carry in for this business. So we're working on those options..

Okay, great. That’s helpful. I'll jump back. Thank you very much for taking my questions..

Thank you. Our next question comes from the line of Dave Kang of B. Riley. Your line is now open..

Yes, good morning. Nice quarter. First of all, regarding your photonics division, I was wondering if you can breakout between China and US..

We typically have not been doing that, Dave, at that level of detail. This is Chuck. Good morning, Dave..

Good morning.

So would you say - is China bigger than US or US bigger than China at least --?.

I would say that – here is what I’d like to say is that the demand for our communications products in China remains very strong throughout the third quarter and we believe was and has been the underlying catalyst of demand for our business for the last two or three quarters. It was very, very strong..

Sure.

So China is very strong, but what about the North American market then?.

We have experienced increases in demand and customer activity from china, from the US and from Europe and Japan, Dave..

Got it. And with the ongoing Verizon strike, any kind of prohibitions, any movements out of Verizon supply chain at this point? It’s been I guess two weeks already..

Dave, can you repeat your question, because we missed a few words?.

Yes.

So regarding the Verizon strike, any kind of movements out of the Verizon supply chain, it's been two weeks already?.

I see, Dave. I think we are aware of that and we see that could have some interruption, but we're really much further down the chain and the people that we interact with that are in the food chain, our customers are asking us to stay focused on the things that we need to do to help make them successful and that's what we're doing..

Right.

And since I guess that brings up the next question about the capacity situation, if, let’s say, this strike goes on for maybe a few more weeks and demand out of Verizon softens, I guess you can simply just shift capacity allocation to other customers? Is that pretty much the plan here, because the other demand is so strong?.

Yes, the demand is very strong. As you know, the lead times are - in the market, we understand because we are a customer as well in our supply chain, so lead times have extended. We made that comment last quarter. During this quarter we added a substantial amount of new qualified capacity.

We announced in January that we opened up a new automated module assembly and testing facility in the Philippines for assembling our 980 pump laser chip on carriers and other associated components.

We’ve expanded our capacity for module assembly and testing in Shenzhen and a couple of years out now from the Oclaro acquisitions, we are manufacturing a substantial quantity of our own amplifiers in China.

So we have done those things that we set said for a long, we’re consistent with our own strategy and I feel that we have a real good handle on the capacity utilization and to the extent that there were - there was some weakness, short-term weakness in demand from a particular customer, I'm very confident that we’d be able to retool and switch over to meet the rest of the demand that’s on us Dave..

Just a couple more if I could, any particular products that kind of standout as far as being on allocation, demand is so strong and capacity constraint?.

I'm not going to, I really don't want to comment on that Dave. Lead times have increased, I mean they’re longer than what they had been, longer than what some of our customers would like. But as far as I know, our additions in capacity and capability and having us turn up the utilization of our facilities worldwide in this vertically integrated chain.

I believe that we are keeping everybody hold within the context of their supply chain requirements..

I don't know whether it was you or Mary Jane made comments about customers kind of pulling in orders because of they are concerned about supply constraints. Any risk of double bookings going on here.

How do we know they are not building inventories at this point, your customers that is?.

Well, on the one hand, anything could happen but we do monitor that, we look at how the bookings are materializing, we look at what the deployments of our customers are. We’ve spend a lifetime wanting to be close and being close to our customers to understand what they're doing.

I think they have business plans too, could they be building inventory in some places that may be so but at the end of the day we really look at how the demand is being taken of the bookings we have and at least for this quarter which is reported, we had good delivers of the bookings that we had when we came into the third quarter, so would you add anything Chuck?.

No, I think that's great..

I would add Dave that now this is two solid years we've had a compound annual growth rate in our business Photonics of 20% a year. So that is really solid, we agree with what you're suggesting, you got to watch for the buildup of the inventory, but so far we've been watching it closely and we’re feeling okay..

And lastly, regarding your acquisitions, I think you talked about the integrations and all that but as far as being neutral, when do you think those acquisitions will become neutral to your earnings?.

Well, I think both Chuck and Francis spoke about evaluation we have under way to look at what is the best way to optimize those assets from an earnings point of view and I think it's important to see those play out, so I don't think we’re going to really say more than that right at this exact time..

Thank you. [Operator Instructions] Our next question comes from the line of Jim Ricchiuti of Needham & Company. Your line is now open..

Just wanted to ask you about the fiber portion of the laser solutions business, you clearly saw good strength in CO2.

How is the rest of the business, what are you seeing in them - that area?.

So this is Fran again, the one micron portion of our industrial materials processing ends up being about 20% of our business, it’s quite similar to where we are in CO2. And it's come about by - we have a portfolio, we have three different segments.

In two of our three segments are working in delivering into the one micron business and that would be Photonics, which does a nice job and then the industrial laser business which is more strongly into but you put that all together it’s 20%, it’s not in one segment but we tell you that's how big it is..

And final question from me is you're expecting a nice pickup, it sounds like in performance products, is that just based on backlog and shipment deliveries into the military portion of the business in Q4?.

No. So the performance products has as its largest end market military. That is so, but it has, as we’ve talked, not the only one. The RF market is a very important market in that segment.

Consumer applications for the thermal electric course and other thermal management devices is another very important segment, not to mention semiconductor capital equipment and a few others. So, while not so much expected in the semi-cap area, we have seen some movements in the end markets in a few places, not just military.

So again, sometimes, across all of them, the demand that comes in in the bookings is not immediately delivered in the next quarter, but we do expect to see a pickup in kind of more than one end market..

Yeah. I would add to that Jim that in this quarter for the segment, between what we shipped and the orders we have on hand that we have somewhere in the range of 80% to 90% coverage for what we’re aiming to do and the teams will be working to knock it out of the park and we feel very good about that..

Thank you. [Operator Instructions] Our next question comes from the line of Mark Miller of The Benchmark Company. Your line is now open..

Good morning. Congratulations on your record sales and bookings. You might already expressed, you don’t want to go too much into this, but you’re showing a $0.03 to $0.05 reduction when you include the acquisitions on the earnings estimates for next quarter.

Then, you’re projecting up to a $0.15 per share charge just to ANADIGICS and I’m just wondering this does improve as quarters go on or is this going to be fairly constant over the next three or four quarters of the impact of these acquisitions on earnings?.

Well, first of all, I do think that we will have one-time items continue into the next quarter, simply because we only had EpiWorks for two months and ANADIGICS even shorter, 15 days. But I don’t know that we will have one-time items every quarter or for many, many quarters. That’s the first thing.

The second thing is, as Fran put it very well, we have with both our acquisitions an increase in our level of expenses higher than we’re used to countering and we’ve been pretty focused on Earnings Company for a long time.

So while I expect that it is not an overnight sensation to figure out how to improve the operating results here, we’re committed to making sure that we have the best utilization of these assets and can to the best possible really see them contributing to the profile of II-VI..

Any ballpark estimates in terms of type charge issue you might be taking to improve efficiencies next quarter?.

Well, certainly in this past quarter, we had quite a lot that were just the transaction costs. But I think going forward, we do a lot of things. Just think about the whole spectrum of stuff that can be done from utilizing space better to supply, looking at the supply chain, et cetera.

So I think it could probably run the gamut more along the operating line than precisely having to do with transaction expenses..

Have either of the two firms that you acquired seen an impact as a result of the acquisition, have they lost or have they gained customers or has business been as expected?.

Yes, Mark. This is Chuck. I would say, as expected and we’ve seen a similar pattern with other acquisitions, customers can settle down and the teams also were able to stay focused or regain their focus on the business. I would say, it’s been pretty much business as usual..

Thank you. And I’m showing no further questions at this time. I’d like to hand the call back over to management for any closing remarks..

If there are no other questions from any of you, this concludes our prepared remarks. We remind you that any of the answers to the questions that we’ve given today may have contained some forward-looking statements which are just based on the best of our knowledge today and for which actual results could differ.

We want to thank you all for joining us and Fran for closing comments..

Thanks everybody for joining us. And I hope you get the flavor of the project that we have undertaken with our VCSEL platform and how we’ve gone about it. Quite aggressively to put together these pieces and it will take us some time to play out, but we are quite confident that we have got a good strategy. Thanks everybody..

All right. Have a good day. Bye-bye..

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may disconnect. Have a great day everyone..