Good day ladies and gentlemen and welcome to the II-VI Incorporated FY17 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Ms. Mary Jane Raymond, Chief Financial Officer.

Ma'am, you may begin..

Thank you, Scala 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 2017. With me on the call today is Dr. Chuck Mattera, our President and Chief Executive Officer. And as a reminder, this call is recorded on Tuesday, May 2, 2017.

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

Chuck?.

Thank you Mary Jane, and thank you everyone for joining us. Our third quarter was terrific. The industrial and communication end market were very strong for us across the all three segments. Our revenues of $245 million set a new record, probably EPS of $0.35 per share was in the top end of our guidance.

So our Q3 bookings of $281 million also hit an all-time record for II-VI. Regionally, our revenue distribution was 45% in North America, 21% in Europe, 18% in China, 8% in Japan and 8% for the rest of the world, very similar to the FY16 annual percentages.

By end market, our revenue split this quarter was 45% in communications, 37% in industrial and semi-cap and 10% in military. The comparative full year of FY16 split was 37%, 42%, 13% respectively and $827 million of revenue.

In the communications market we had $110 million in revenue this quarter, 82% of which was in photonics, 10% in laser solutions and 8% in performance products. Revenues into the communications market grew overall 50% year-over-year and 5% sequentially.

All main market drivers we've been discussing are reflected in the strong bookings and revenues, specifically, China broadband, the 100G metro upgrade, CA-TV infrastructure investments, the expansion of the data center communications market, and the growth in undersea fiber optic networks.

Communication products deployed in metro and [indiscernible] network builds including data center interconnects were approximately 67% of our communication sales.

CA-TV network builds for another 10% and then 6% from sub-renetworks, 6% from Datacom including intra datacenter communications and 10% from products used in wireless base stations where our wide gap electronic materials enabled the rapidly growing 4G base station market and paving a way for next-gen 5G deployments.

More than 51% of our communications product revenue in the quarter was derived from incorporation into road assistance. Sales of these products including pump lasers, amplifiers, channel monitors, tunable filters, micro-optics and [indiscernible] grew 25% to 30% year-over-year and 10% to 15% sequentially.

We are a strategic supplier of high performance and high reliability components for customers who build line carts [ph], in those applications our content typically ranges from 20% to 40% of the bond value, usually the largest component of the manufacturing cost.

Our products enabling transponder modules in CFP-2 and CFP-4 transceiver embedded the amplifier solutions for 100G, 200G and 400G coherent transmission made up about 15% to 20% of our communications revenue and grew 48% year-over-year.

We believe that this is going to be driven by the growth in the data center and inter-connect market as well as network infrastructure upgrade markets and is a reflection of our industry leading product portfolio.

At the optical fiber conference we recently announced our new three-pin pump laser which we believe is the smallest on the market along with a miniature filter, both designed to enable even more compact lower power consumption transceiver embedded amplification. We believe the product volume serving this market that will grow about 20% per year.

What's more exciting is that these miniaturized products are not just for coherent transceivers but also for the new category TCI transceivers based on PAM4 [ph] technology.

We acknowledge that throughout this quarter a number of market dynamics bringing into shift there has been a rising concern about slowing in various parts of the market during the apparent need for some customers to reduce inventory.

While we believe it was not a great deal of inventory of our products, customers have directly new pressure on pricing as their demand in the industry supply have come closer to equilibrium.

At the same time we began to see price increases from our supply chain partners who have expanded capacity, who incurred other incremental operating cost as they were to keep up with strong demand.

For II-VI we began working with customers several quarters ago on longer term agreements for them to buy and exchange for longer term agreements for us to supply. We've also worked hard to expand our share, both with existing and new products.

These actions along with what we believe has been a prudent and opportunistic approach to capacity expansion and a constant focus on our supply chain cost served us well and has just closed third quarter. It should have helped us withstand potentially slower demand in Q4.

We are therefore guiding a bit conservatively for Q4 since we know that we're not immune to market factors although we work hard to deliver strong end to fiscal year 2017. And our industrial markets including semiconductor capital equipment focused on at least advanced laser processing.

The quarter's revenue was just under $92 million and was split 70% from laser solutions, 17% performance products, and 13% for photonics.

This revenue grew 5% both year-over-year and sequentially and is split 34% from one micron laser applications, 31% for high power industrial CO2 laser applications, 18% for semiconductor for lithography and 17% for precision laser optics used in applications upto one kilowatt for marking and engraving [ph].

Industrial end markets drove 77% of laser solutions segment revenues and you can see the influence of the market momentum in the 25% sequential bookings growth. The infrared optics division delivered an excellent quarter on record bookings and record revenues and they entered Q4 with a record backlog.

The strong demand for our precision laser optics for upto one kilowatt applications is being driven by the broad-based industrial activity underway around the world as factories -- high volume consumer goods gear up for the next generation of consumer electronics and seasonal increases.

These applications need precision cutting, drilling, marking and engraving. This is also driving demand for our products into the growing EUV application market used to process the next generation of integrated circuits that are expected to be increasingly at the core of these consumer products.

We remain excited about the long-term value of the investments we're making in our optoelectronics device platform. One of the next products from this platform will be vixels [ph] for 3D sensing.

I'm pleased to say that the optoelectronics devices group has passed certain key qualification milestones for mass production of volumes of vixel arrays that are forecasted to be required at the backend of this calendar year with larger volumes anticipated in the next calendar year. Now I will turn it over to Mary Jane for the financial review..

Thanks, Chuck. As a reminder, on the second page of our press release … of our press release, we show the segment details. This page details the bookings revenue and operating income by segment. The company's overall gross margin of approximately 40% is the result of another strong quarter of operating performance.

Currency fluctuations positively contributed about 100 basis points to the gross margin compared to Q3 of fiscal year 2016. But the sequential affect was actually pretty minimal.

The operating margin for this quarter was 11.8% compared to 9.5% of Q3 of FY 2016 and would have been 15.3% without this year's investment in our optoelectronic device platform.

The EBITDA margin was 18.8% for the quarter, as expected it would lower the last quarter Q2 FY 2017, since last quarter had about $4 million net positive onetime items amounting to about 170 basis points. We finished the quarter with a $389 million backlog and solid order coverage for Q4.

The backlog consists of $159 million in photonics, 129 million in performance products, and $101 million in laser solution. Nearly half of that backlog is scheduled to ship in Q4. Our R&D investment this quarter was about 10% of revenue. We invested $8.5 million pretax on our manufacturing readiness programs for VCSEL volume production.

The capital cash flow has been about $57 million for this program year-to-date. As part of our drive to improve profitability, we exercise good control over our SG&A expenses, which were consistent both sequentially and year-over-year, despite an increase in revenue of 6.19%.

The company has other income of $2.2 million made up of a number of smaller onetime items, these include a gain on the sale of one of our facilities in Florida, as part of a facility consolidations in our military business that we completed last year.

A settlement agreement with the former customer and certain income recorded from the sale of the RF business that we completed last year. Other income was partially offset by $1 million of foreign exchange losses, which are classified in non-operating expense. And by increases in equity based compensation, which are recorded in SG&A.

We've $4.5 million in share based consulate quarter. For the full year FY 2017, we expect share based compensation to be between 13 million and15 million, higher than our normal 12 million to 14 million due to more grants outstanding and the increase share price. The year-to-date tax rate of 26%.

The tax rate for the same period last year was 17.1%, and was due to the reversal of 10.48% reserved for expiring [ph] statutes of limitations. The EPS in the quarter $0.35 a share.

EPS was affected in the quarter-by-quarter reaching the next year of commercial terms with customers as volumes and share have increased, as well as pressure from certain suppliers in response to supply chain constraints. Our cash $248 million and our net debt position is $30.5 million.

Interest expense in the quarter was $1.9 million compared to 800,000 in Q3 of FY 2016. With $40 million cash outflow for CapEx score, investments in all our platforms including silicon carbide are driving are expected capital cash outflow for FY 2017 to be about $130 million.

We continue to make improvements throughout the operation to help fund our investment especially in working capital. For example in the quarter, our DSL improved from 61 days to 58 days. We did not repurchase any shares in this quarter and we in fact have not repurchased any shares so forth in FY 2017.

We have $31 million remaining on our $50 million stock repurchase authorization. For FY 2017 our excess cash is focused on funding our investment program, so will obviously monitor or stock buy-back opportunities throughout the rest of this year. Turning to the outlook.

The outlook for the fourth fiscal quarter ending June 30, 2017 is revenue of $245 million to $252 million. And diluted earnings per share of $0.33 to $0.37. Please note that our EPS guidance includes an additional $0.05 for the depreciation expense for our CapEx investment coming online.

The R&D platform investment will remain around $0.10 a share for this upcoming quarter. Our guidance numbers are all given that the prevailing exchange rates, and all of our diluted earnings per share numbers referred to diluted shares. The diluted share count of now 65,010,000 shares.

Results for the same quarter last year for the quarter ended June 30, 2016. Revenue of $241.5 million and diluted earnings per share $0.23.

As we'll discuss in more detail during the Q&A, our actual results may differ from these forecasts due to variety of factors, including but not limited to changes in product demand, customer forecast, competition and general economic conditions. This concludes our prepared remarks.

As we turn to our Q&A, I will remind you that our answers to your questions may contain certain forward-looking statements which were based on our best knowledge today, and for which result may actually differ. Scala, you may open the lines for questions..

[Operator Instructions] And our first question comes from Jim Ricchiuti with Needham & Company, your line is now open..

Thank you, good morning.

Chuck, I will try to let you save your voice, Mary Jane if you want to answer that's fine, but if we -- if we look at the guidance and in terms of how you're characterizing the optical communications market for the June quarter the conservatives, we can't parse through that, how much of that is related to China verses some of the other segments of the market..

First of all, as we discussed the markets around the world including China but including the U.S and Europe are important market to us. I would say that [indiscernible] in any market would have an influence on that. But I don't -- I wouldn't say that our guidance is set this quarter with emphasis primarily on only one major driver..

Okay, and just with respect to the industrial business, you gave some good color on that as well. And I may have missed it but was -- it sounds like this strength you're seeing in that market not only cuts across categories and technologies but also across geographies is that fair to say, was anyone geography particularly strong..

Okay, good morning Jim, this is Chuck. Jim it is broad based in every region..

Okay, and then two very short final question I know you can't talk necessarily about the timing of the VCSEL ramp, you gave some good color on that and I appreciate that. How should we think about the R&D levels associated with this. When would we expect levels to return to maybe normalize R&D levels going forward..

Okay. So first of all one of the things we've talked about with respect to this investment is that the normalization is more a function of the R&D as a percentage of sales that necessarily is a strict dollar value. The company has a history of keeping up with R&D investments as the revenue has grown over time.

But I would say it's -- we've made the investment in anticipation of volume we would have expected it to moderate down in the 2018 fiscal year, but volume does matter. I think if we were to see some dramatic alliance some market for whatever reason we may reconsider that, but we would expect probably to moderate the 7% to 9% range down from 10%..

Having said that Jim, we're expecting more a growth company, we're expecting the revenues to grow, and our organic investment is a key part of our strategy.

The company as we look out in the next two to three years has a great opportunity for transformative penetration into new markets, so we will continue to invest in this platform for successive generations of products..

Okay, fair enough, thanks very much, I'll jump back in the queue, thank you..

Our next question comes from Troy Jensen with Piper, your line is now open..

Hi, just a clarification first Mary Jane, for the 3D sensing business will that be reported in laser solution or the Photonics business..

Laser solution..

If you look at your Laser solutions booking is up fairly materially here in the in -- the on March quarter, did that include any 3D sensing bookings..

We do have some 3D sensing booking but I would not describe that as the majority of it, we have seen as Chuck described pretty extensively, very, very nice pick up in the industrial markets as well..

Great, okay, so most of it come from industrial that's fair. And if you just at your June guidance up slightly on sequential basis. Could you give us any color on Laser solution versus Photonics, are you expecting Photonics to drop significantly, modestly, relatively stable any color, any additional color will be helpful..

Sure, so first of all as you all know we don't give guidance by segment, but to give you some sense I think first of all as has been the case for the last several quarters there a number of things that are driving the company's results and it it's guidance in any given quarter, optocommunications is certainly one of them and as Chuck said, we're preparing to possibly more affected by the market factors that maybe we have been so far, but we also did a lot of work over the last several quarters to try and position ourselves not to have significant rapid fall offs.

So we still see very nice contribution from photonics. In the legislation business the industrial markets are doing very, very nicely and began to show resurgence, even as early as September 30 end of quarter, so we expect to see some nice lift there.

The other one in the performance products business is what we talk about for a while here which is the increasing demand silicon carbide product among other things it including military stepping up a little bit, but the performance products segment also is anticipating some nice growth both in silicon carbide by litigating by capacity in the military market..

Well, thank you, keep up the good work..

Our next question comes from Mark Miller with Benchmark, your line is now open..

Good morning, just going back to the R&D expenses again, you said [indiscernible] scale with sales but trend down to 7.9% of sales, what's kind of the relative time frame for that scaling..

Yes, first of all, I am sorry if I was not terribly clear.

I said that they probably in the range 7% to 9% and as Chuck clarified, that's minority has come a hallmark of this company but in any event I think we would see maybe a little bit of a trend down in the 2018 year, it's a little bit relevant to one volume starts in certain quarters, again not just in VCSELs but silicon carbide etcetera.

And then probably moderate a little bit over time, but I would say very similar to what Chuck has said, that the expansion of capability in a few quarters including in industrial and silicon carbide etcetera, as demand guards [ph] to increase for different types of applications, we would continue to have some investments, possibly not at this level as a percentage of revenue to exploit markets that really had not been that president before..

Sorry if I missed this, but again keen interest in VCSELs and the ramp from what's going on in New Jersey. Again I apologize if I missed it, but you've always in meetings I've had with you indicated it was more the 2018 opportunity, any changes there..

Good morning Mark, this is Chuck. We are still believing that our initial manufacturing ramp will take place by the end of the calendar year 2017, and that will be following on by a larger ramp in calendar year 2018. Still the same..

Okay, so coming up later this year and in the bigger ramps next year. Are you pleased with the progress of the transform in the Jersey facility for your own schedule..

No, Marl, I would say that it's not uncommon at this stage of an initial ramp that we have our challenges, I'm very pleased with the progress that we've made, I believe that will be successful in achieving the initial ramp.

And we will continue to make improvements that we need to be ready to address the larger mines [ph] that come into the marketplace and will compete for in calendar year 2018..

I just want to check something, your backlog was $380 million or $389 million..

389..

Okay, thank you..

Our next question comes from Dave Kang with B. Riley, your line is now open..

Good morning, and Chuck, hopefully you feel better soon.

Just on the optocom segment, is it mostly china as far as the slowdown, can you tell us how about the other markets and more specifically can you just talk about the products you highlighted some of the products that are enjoying strong demand, but what about on the flipside which products seems to be impacted by the slowdown the most..

Dave, let me try to take it. We are running our sample for us and our past components lines at 99% capacity. So from the point of view of a slowdown, when you say slowdown we're running pretty much quarter-over-quarter with our plan almost exactly as we expected.

So we're not much seem more expecting any significant slowdown in any one part of the market that can't be made up mostly from another part.

That's right, with regard to the access market where we have a very small part of our revenues, we have seen that the [indiscernible] to the home market in the third quarter was down 10% to 20% I would say a quarter before. But we did not have any material impact on our outlook in Q4, it does not..

Got it, then I may have missed it Mary Jane, but can you give out the CapEx outlook for the rest of this year so I can --I guess I can back out the first week quarters, of fiscal fourth quarter..

Yes, I said I thought it would be about $130 million..

Got it. Okay. And then on some of your competitors have had a quantified their opportunity, what do you think your market share, any preliminary expectation at this point..

We have not quantified expectations of market share and don't expect to, what I can say is that we have made significant investments in the capacity and the capability to be an important player in this market but ultimately the customer decide the timing, what product is launched and based on that type of variability that exists entirely in the customer's hands, we're not putting expected share numbers out there..

Got it, alright thank you..

[Operator Instructions] And at this time I am sure no further questions, I would like to turn the call over back to Dr. Chuck Mattera for closing remarks..

Hi, it is Mary Jane, I'll give you Chuck, a little bit of a rest on his voice, since his answers your questions are very important but I will say as we conclude our call today Chuck and I would both like to thank the increasing number of top industry analysts who chose to join the call, especially those of you who have to get up early to do, we're happy to have you here and thank you very much.

And more importantly on behalf of the Holy LP [ph] we would like to say that our Q3 FY 2017 results were enabled by the absolutely unyielding enthusiasm sense of urgency and teamwork, by our over 10,000 employees, positively determined to contribute every day to the continued success of II-VI and all of our customers, their dedication, commitment, innovations and hard work, make it possible for us to deliver consistently not only our customer's expectations but our shareholders expectations.

The entire II-VI global team continues to pave the way for future growth with our development and introduction of new products, and by initiating new programs to improve our overall quality and drive operating efficiencies. As of today nearly four weeks into the quarter.

It feels like we're on track to deliver another good quarter ending in June and to cap off a great year, which will be a great estimate to all of the people throughout II-VI who have worked so hard for that.

Thank you to all of you on the phone for your interest in II-VI, we work to position the company to deliver outstanding value to the customers, our shareholders and our employees. If there's nothing more Scala, this will conclude our call for today..

Ladies and gentlemen, thank your participation in today's conference this does conclude our call you may now disconnect. Everyone have a great day..