Good day, ladies and gentlemen. And welcome to the II-VI Incorporated Fiscal Year 2018 Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to turn conference over to Ms. Mary Jane Raymond, Chief Financial Officer. Ma’am, you may begin..

Thanks Brian, and good morning to everyone. I am Mary Jane Raymond, the Chief Financial Officer here at II-VI Incorporated. Welcome to our third quarter earnings call for fiscal year 2018. With me today on the call today is Dr. Chuck Mattera, our President and Chief Executive Officer; Dr.

Giovanni Barbarossa, our Chief Technology Officer and the President of the Laser Solutions segment; and Gary Kapusta, our Chief Operating Officer. This call is being recorded today Tuesday, May 01, 2018. Just as a reminder, 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 subsequent to today. With that, let me turn it over to Dr. Chuck Mattera.

Chuck?.

Thank you, Mary Jane. And thank you to everyone who is joining us, including our two new analysts, who initiated coverage statistic since the last earnings call. Q3 was a strong quarter for II-IV across all of our end markets. When compared to Q3 of FY17, 65% of our year-over-year growth came from our core markets and 35% came from our growth markets.

In our core markets compared to Q3 of FY17, industrial and automotive revenues grew 25% with strength in industrial laser components and silicon carbide substrates for power applications in automotive. Military revenues grew over 50%.

Communications was even with the prior year and grew 4% sequentially despite Chinese New Year, thanks to the hard work of our dedicated team and our customers’ sustained demand throughout Q3.

Sales into the semiconductor capital equipment end market nearly doubled, tracking our growing demand from the EUV lithography tool market, while shipments into the emerging 3D sensing market for consumer applications were lower than expected.

Demand from industrial markets was the strongest contributor to growth this quarter on the basis of absolute revenue. We saw a strong demand globally from all major industrial centers with growth continuing, especially in Europe and Japan.

Our CO2 laser optics business achieved exceptional operating efficiency, delivering a record revenue during the quarter. Sequentially, our Q3 revenue grew 5% over strong Q2 despite some seasonal factors.

The distribution of our Q3 revenue by end market was 38% in communications, including wireless, optical and data communications, 30% in industrial, 12% in military and the remainder in consumer, semiconductor capital equipment, automotive and life sciences.

Our Q3 sales were geographically distributed 44% in North America, 21% in Europe, 20% in China, 8% in Japan and 7% for the rest of the world.

Our sales force across all segments delivered a great bookings result with 1.13 book to bill ratio on increased revenues, and we established the second consecutive record for backlog with 10% sequential growth from $404 million at the end of Q2 to $442 million this quarter, and 14% growth from $389 million from Q3 of FY17, all of which is creating momentum throughout the company.

We are well positioned to finish strong and deliver another good year as we approach the crossing of the annual revenue milestone of $1 billion during Q4. So it sure is an exciting time for II-VI.

It’s clear that our military business is inflecting, so we are accelerating our investments in technology, capacity and products for navigation, tracking and targeting applications on multiple platforms.

We continue to enable productivity gains in communications, industrial, semi cap equipment and automotive factories all around the world based on the breadth and depth of our laser and optics portfolios. We are also positioned to enable multiple technology transitions. Let me add some color on a few of them.

The emerging markets for gain in silicon carbide power semiconductors is expected to reach $1 billion by 2020 based on demand for hybrid electric vehicles, power supplies and photovoltaic inverters.

And adoption in the main powertrain of hybrid electric vehicles and all electric vehicles is expected to lead to $10 billion market by 2027, implying about 35% CAGR from 2017.

We’re excited about our strong position in this ecosystem and will continue to leverage investments we're making for the 4G and 5G markets that are also expected to increase or experience rather accelerated growth.

Regarding the 3D sensing market, we remain bullish despite the current headwinds that we expect to give way to renewed increase in demand beginning the second half of this calendar year.

We believe that the fundamentals of our strategy are intact, and so we are accelerating our technology and product roadmap to enable us to expand the differentiated capability that we have established.

Finally, we are also making good progress in all of our other growth markets too in order to enable II-VI to realize meaningful positions in the supply chains of increasingly large accounts. We remain focused on stepping up our operational excellence, customer intimacy and product and technology leadership.

We are also working hard across all markets to capitalize as quickly as possible on our recent investors and technology platforms, new products and capacity. And we will continue to lack with a great sense of urgency in all that we do. With that, I would like to turn the call over to Gary to discuss some of the highlights for the quarter..

Thank you, Chuck. Silicon carbide substrate revenue was strong in both the power and RF markets this quarter. For Q3, our power substrate sales surpassed RF substrate sales for the first time. The revenue split in Q3, which 52% for power applications and 48% for RF applications.

The key drivers for power are electric vehicles as well as solar and wind power. The RF drivers are 4G and 5G. Sales in silicon carbide substrates are now a full 5% of II-VI’s consolidated revenue. Highlight in the quarter was the military end market.

Shipments into this end market grew 54% compared to Q3 of fiscal year ’17 and 37% sequentially, driving military to 12% of sales this quarter. This growth was driven by windows, domes and optical assemblies for intelligence, surveillance and reconnaissance applications, as well as for missile warning systems.

With the 10% increase in the Department of Defense budget and a differentiated product and technology portfolio, we believe we are well position to address this growing demand. In the communications end market, we continue to be increasingly well positioned to address the growing number of customer inquiries and RFQs that we receive.

The sequential order growth was 18% with a book-to-bill of 1.08 and the backlog grew 7%. Optical China revenue or the portion of the China communications end market grew 22% sequentially, about 3 times the rate of Q2’s sequential growth.

Datacom was 20% of our total communications revenue, driven largely by our success in growing our intra-data center components, including VCSELs along with circulators and optical isolators of the IPI acquisition.

For the rest of the communications market, RF was 8% and optical transport, including undersea and cable TV, comprised the remaining 72% of revenues. Sales to ZTE were about 1% of revenue.

Because ZTE demand was forecasted to increase in Q4, we believe the end market demand will be addressed by other customers of ours and therefore, we are evaluating the disposition of our full stream inventory.

Regarding 5G, we are presently finalizing our roadmaps for the optical infrastructure, but we do not expect to see the benefit of 5G beginning until late in calendar year 2019. We are positioning our investments, including the acquisition of CoAdna to capitalize on these deployments.

With that, I turn it over to Giovanni for the rest of our highlights this quarter..

Thank you, Gary. On March 26th, we announced our intention to acquire CoAdna, a global leader in wavelength selective switches WSS. CoAdna was founded in 2000 and has a world class feed with locations in Sunnyvale, California and Suzhou, China.

The WSS is a key component in converged optical transport architectures to deliver programmability and agility in provisioning and recovery operations. This enables wavelength adds up and routing to be entirely software driven, eliminating the need for manual operations.

As a result, this capability decreases operating expenses and it reduces provisioning time and network recovery times.

CoAdna's WSS modules incorporate II-VI's micro-optic component and have been deployed in conjunction with our optical amplifiers, optical channel monitors and other key II-VI components on several custom-designed ROADM line cards for several years.

We believe that with our manufacturing scale and matched vertical integration and broad product portfolio, we are well positioned to capitalize on the growth in the low port count and ROADM demand, especially in China, driven by metro network upgrade, new data center interconnect architectures and 5G networks as Gary just discussed.

We believe that CoAdna's WSS would be especially valuable in some low port count application where new requirements for flexibility, scalability and reliability can be achieved with optical switching. The combination of the ROADM product portfolio II-VI and CoAdna will create a broad and vertically integrated product offering.

As a business partner for many years, we have an intimate knowledge of CoAdna’s products and technologies and anticipate a smooth and seamless integration of the business upon closing the deal.

For 3D sensing, we’ll establish a solid development and manufacturing platform, even though 3D sensing shipments were lower than forecast this quarter due to reduced customer demand. That said, we are forecasting an increase in demand for the second half as compared to the first half of the calendar year.

We’ve also stepped up our development and qualification efforts for new products and additional capacity. And we continue our engagements with several 3D sensing customers to expand our market penetration and broader portfolio in line with our strategy to diversify the end markets we sell, including the automotive and industrial markets.

We believe that the demand for lasers and optics for 3D sensing will continue to be driven by several irreversible mega trends, such as visual and augmented reality, autonomous vehicles and home automation. And we believe that we will start to see managing these applications and the larger ecosystem overall in late calendar 2019.

The demand for EUV products was very strong. EUV revenue in Q3 increased more than 50% over Q2 FY18. The ramp for EUV products is accelerating and is now well ahead of our forecast.

Demand for our diamond and other infrared optics product is growing and our capacity expansion of diamond crystal growth and thin film coating operations is ahead of schedule. With that, let me turn it over to Mary Jane..

Thanks, Giovanni and hi everyone on the call today. Regarding our Q3 reported financial results, just as a reminder, on the second page of our press release, we show the segment results. That page details by segment the book-to-bill ratio, the revenue, the operating income and the operating income margin.

The Company’s overall gross margin for Q3 was 40.2% and the operating margin was 11.8%. Sequentially, currency depressed the gross margins by 40 basis points and the operating margin by 60 basis points.

Compared to Q3 FY17, the same period last year, the effects of currency reduced gross margin by 70 basis points and the operating margin by 110 basis points. The EBITDA margin was 19% this quarter compared to 19.1% for Q2 of FY18.

The acquisitions of IPI and the UK Fab contributed $5.8 million of revenue combined in the quarter, and were dilutive by $0.05 combined. The $0.03 difference compared to last quarter’s $0.02 dilution is due increased R&D investment for growing customer engagement.

The CoAdna acquisition is expected to close in September of this year, and is expected to be EBITDA breakeven for its full year before purchase price accounting and transitions fees. The CoAdna acquisition will be integrated into the Photonics segment.

With respect to the segment operating margins, Laser Solutions margin advanced 30 basis points sequentially with the ramp of new products and strong demand for core products, offset by an increase in R&D of $2.5 million.

The operating margin for Photonics was 14.3% despite most of the foreign currency exchange impact this quarter affecting this segment, and also due to a somewhat unfavorable mix. Performance products margin was up 200 basis points sequentially to 12%, driven by strong shipments in silicon carbide, military and EUV.

The quarter’s backlog of $442 million consists of $170 million in Performance Products, a $140 million in Photonics and $132 million in Laser Solutions. The backlog contains orders that will shift over the next 12 months.

We have $3.6 million in stock-based compensation for Q3, a decrease from Q3 of FY17’s expense of $4.5 million due primarily to a less volatile stock price than we had at this time last year. We still expect the annual stock-based compensation expense to be about $20 million compared to the FY17 total of $16 million, and the FY16 total of $12 million.

To provide comparability to those who report on a non-GAAP basis, we had $700,000 of stock comp in the cost of sales during the quarter along with $2.9 million of stock-based compensation in SG&A. For the total that I mentioned of $3.6 million, we also had $3.6 million of acquired amortization in SG&A.

Excluding these items, our gross margin would have been 40.3% and our operating margin would have been 14.2% in this quarter Q3 FY18. The Company had other income of $1.5, primarily from equity earnings from our investments. Capital expenditures this quarter were $39 million. We now expect CapEx to be about $165 million for this year.

Our depreciation expense was $16.3 million in the quarter or about 40% higher than Q3 of FY17, driven by our capacity and portfolio investments. With respect to interest and amortization expense related to our convertible debt, the Company has decided to adopt the, If Converted Method, for calculating EPS.

This method adds the shares to the denominator at the first conversion date, which for us, was January 1, 2018 and add-back $2.5 million of interest and amortization only for the EPS calculation. This is the same method I believe that’s used by several of the peers.

There is a new Table 7 in the press release to display this calculation and to compare it to the pre-conversion date methods that we use in Q1 and Q2. All the relevant periods are outlined in Table 7 in the press release.

And before the EPS calculations up in the expenses, our reported interest expense for the quarter was $5 million and compares to $1.9 million from a year ago. The Q3 FY18 tax rate was 3.6% due to a favorable change in our transition tax estimates year-to-date, up $6.5 million. Excluding this, the tax rate would have been 24%.

This rate for the quarter at 24% is higher than we had estimated, and both changes the transition tax estimate and the tax rate in the quarter were due to changes in our outlook for the mix of income, both domestically and internationally, for the full year. We expect the tax rate for Q4 to be between 21% and 23%.

The reported EPS in the quarter was $0.45 a share and $0.36 without the effects of the new tax legislation compared to $0.35 in Q3 of FY17. Our EPS this quarter was negatively affected by $0.01 change in the method of adoption for the convertible debt, $0.02 for currency and $0.03 for the tax rate for the mix of income in the quarter.

Our cash is $263 million and our net debt position is $249 million inclusive of $50 million repayment on the credit facility. We did not repurchase any shares this quarter and we still have $19 million remaining on our authorization. Turning to the outlook.

The outlook for the fourth fiscal quarter ended June 30, 2018, is revenue of $295 million to $305 million and EPS on a GAAP diluted earnings per share basis of $0.37 to $0.43 inclusive of all investments, but excluding any final refinements to the transition tax as we finalize the calculation for year end.

As many of you will remember, some of the provisions of the new tax act are only calculated on the full year end income position. This is of course all stated at today's currency rates, and we are not forecasting the currency in this guidance.

The weighted average share count of actual shares outstanding is 65 million shares and the convert would add back 7.3 million shares for 72.4 million when you add the convert interest back to the income.

For comparison to prior period, the results for the fourth quarter ended June 30, 2017 were revenue of $274 million and GAAP diluted earnings per share of $0.50. This $0.50 includes a favorable net $0.04 for the IPI acquisition items, tax adjustments and foreign currency.

Now, as we turn to the Q&A for this call, remember that our actual results may differ from these forecasts to a variety of factors, including but not limited to, product mix, customer orders and market customers demand, competition and general economic conditions.

I’ll remind you that our answers to your questions may contain certain forward-looking statements, which are based on our best knowledge today, and for which actual results may differ materially. In addition, during the Q&A, we will continue to abide by our customers request to protect their confidentiality.

And with that Brian you can open the line for questions..

Thank you [Operator Instructions]. Our first question comes from the line of Jim Ricchiuti from Needham and Company..

Just wanted to focus a little bit on the Performance Products segment, you alluded to the military market being an inflecting, you’re talking about EUV well ahead of forecast.

Are we -- as you look at that part of your business and given what you're seeing out there, is this the revenue number that you feel is sustainable to even increasing from this point? I mean it sounds like there are pieces of this business that you're seeing some significant inflection.

Is that fair to characterize it that way?.

I think that’s absolutely fair to say that we are seeing the beginnings of nice inflection in a several different market, silicon carbide, EUV and military. I would say just as a reminder, that this is probably is our lumpiest segment with respect to bookings.

So the book to Bill may vary over time, but I think generally speaking based on the demand that we are seeing that’s driving these shipments. We would expect to continue to see some nice overall growth..

And maybe one follow-up and I will jump back in the queue. Little disappointing in terms of the initial ramp on 3D-sensing, yet you sound fairly comfortable that you’re going to see that business begin to scale in the second half.

And I wonder if you could just comment a little bit more about why you feel that way, just given the concerns that some folks have about certain customers and the overall weakness in the smartphone market.

Is it just broadening base of revenues that you're anticipating?.

It’s based on our engagement with customers in the marketplace and on the basis of our communications, not only about the quarter that we were just in but also -- the third quarter but also this fourth quarter, and the activities that we're gearing up to be able to meet in the second half of the year.

It’s possible that we will end up on an arc that’s higher or lower than what we’re currently aiming at. But it’s substantially higher for the second half of the year in terms of our planning and in terms of our executing, and what we will have experienced through June of this year without a doubt..

And our next question comes from the line of Mark Miller from Benchmark Company..

You indicated a significant increase in CapEx, I am assuming that’s three items, the 3D capacity expansion, EUV and also silicon carbide.

Are there other things driving that capacity increase, CapEx increase?.

I would say that it is a little broader than that. I mean you may remember that we’ve talked about when we exited fiscal year ’17 in June that every one of our divisions, which means every end market they serve, beat their forecast. So number one, we are certainly seeing capacity for EUV, silicon carbide, et cetera -- and 3D, which we talked about.

But we are, first of all, for sure seeing increases in capacity demand for the industrial price with CO2 optics. I mean as many of you know, we’ve talked about this before, the corporate staff moved out of the Saxonburg plant in order to allow it to expand. We are also expanding our thin film filters capability around the world.

We are seeing increasing demand, as Gary and Giovanni both noted, for circulators and isolators. And as Chuck noted a little bit earlier, we are seeing a significant uptick in the military business. So generally speaking, I’d say that capital is probably not evenly spaced among them all, but it is certainly spread across the whole company..

You were upbeat about the VCSEL market, the 3D market come back in second half.

Do you anticipate any new calls or programs or have you called for any new programs in the current -- in the prior quarter?.

Mark, I wouldn’t like to be detailing any aspect of our development or qualification plans. We have a lot of activity happening in the qualifications include qualifications of manufacturing equipment, manufacturing processes, new devices, products and the like. It’s a list of all of the above.

And we continue to be engaged on the front end of the development process of additional new customers, bringing in new requirements to us. And it’s a -- there’s a cycle time associated with it.

So we’ve got a lot going on and in every other case, we need to prioritize focus on those things that we believe will bring the greatest, both near term and also long term shareholder value and that’s what we’re doing..

Would that be way off base as I estimated you were calling for anywhere between three and six programs?.

Mark, it depends on the definition of a program.

For sure, we have a number of qualifications going on, and I don’t want to say three to six, but we have a substantial number, single digit number that we’re focused on at the moment to be able to deliver, what we need to deliver in the second half of this year and then be able to create the momentum we want beyond that.

Giovanni?.

Mark, I think what we have seen is really diversification as I tried explain in the script from the consumer electronics to the automotive and even industrial market with 3D sensing applications, so I think it is the engagement is really spread across several markets.

And so the application programs, I would say, are not necessarily focused on any particular market or any particular customer..

Our next question comes from the line of Richard Shannon from Craig-Hallum. Your line is now open..

I’ll maybe ask question on the guidance or for sales for the June quarter here, up a couple of percentage points. Even though your book-to-bill is up or pretty strong at 1.13 across the board here, although now I know performance product tends to book a little bit farther into the future.

But can you give us a sense of conservatism built into this guidance versus bookings patterns that you had in the quarter, because it does seem to be a conservative approach on the service?.

Well, I would say the following. First of all, these are the question we just had earlier with respect to capital.

One of the things that is gating some of our shipments is capacity, so we are in the process of getting that in and are moving along very, very well in those tracks, but that is one thing that it’s possibly metering, let’s say, some of the shipments we might see.

I think also we saw some very, very nice pick-up in optic communications as Chuck described. And that can be a little bit more hard to predict. So I would say you can rest assure that we will deliver a great fourth quarter, maybe not over the guidance but if we can deliver it, that’s different than this guidance we will certainly do it..

If I can follow-up on that Mary Jane.

Can you cite which product areas you’re seeing the most headwinds in terms of capacity?.

I mean, I think as I’ve mentioned earlier, I mean we are out of capacity in fact -- our very original plan for our very original products. So the CO2 optics are being paced, the diamond windows are being paced. We are getting our silicon carbide capacity in by the end of the fourth quarter, the next tranche of it at least.

But right now that market demand is very, very high. I think that’s probably a little bit of the color to give you on some of it..

Let’s here next question from me -- Chuck on 3D sensing, rather question we get from clients are trying to think about how big that business could be, and maybe one way to think about, that will be the easiest way for you to answer it, not infringing on your customers’ right of confidentiality.

Can you give us any sense of what’s your installed capacity is today or in the near future? Just to get some sense of scale. One of your competitors in the space I think in the last earnings call, talked about $1 billion market in the not too distant future. I am wondering maybe if you can compare it to that market estimate that would be great..

As you know, the question about our capacity depends a lot on our utilization and our planning factors. And those planning factors includes our yield, our cycle times, the utilization of our equipment, the size of the guide, the number of devices that you can fit maximum on 150 millimeter wafer.

And so we know that there is a wide variety -- and we’re really, really careful about the same. We’re sure we have underutilized capacity today, and we are planning to fully utilize that capacity.

And in addition to that, we’re adding to it, as we speak in order to be ready for the -- what we believe will be the demand in the second half and into FY19 end point. So I am not going to be make comments about the market. I simply can’t talk about how faster will become $1 billion market.

There’s enough people -- market studies that are out there, Richard, they all seem to be understate the opportunity at least as we understand it. And so we're really excited about it. It’s a long-term investment that we’re making.

And I believe, fully believe that it could be $1 billion market or more like many of our peers doing inside the next one to three years..

And one more question for me, and I’ll jump out of line, on gross margins. You had a good quarter there and even some headwinds that you talked about on your prepared remarks. Wondering how we should think about gross margins in the next few quarters, the puts and takes here.

Performance Products seems to be doing pretty well and that could be a tailwind.

But Mary Jane if you could help us think about whether 40 plus is the new baseline, or could it grow from there? Or should we -- just how should we think about the next few quarters please?.

We didn’t change the gross margin range that we have out for ’18, so that’s the first thing to say, which at the top end 41. I think you have hit a good point there though, Richard, which is that all the divisions beginning to see some significant momentum in volume, helps the gross margin quite a bit.

Volume is rather important, particularly across the growth operations. So I would say that in the aggregate over time, I think we should see that margin expand. But as for example how that will materialize in Q1 of FY19 and Q2 et cetera, we haven’t quite put that out there yet.

But what I would say is I don’t necessarily think that 40 is the top limit and I think the company remains extremely dedicated to moving that gross margin..

And our next question comes from the line of James Kisner from Loop Capital Markets. Your line is now open..

So a quick back in tax rate for a minute, maybe also on the converts as well. So I think you gave us guidance for this coming quarter at 21% to 23%. I think you gave this guidance for the year before that was a bit lower.

I am just wondering can you give us any more forecast for taxes beyond the June quarter, like do you think this 21% to 23% is we should be modeling for a while. And I think if my math is right on the converts you got, I think it’s around $0.0304 or something that’s for the in the shares, and the expenses is that above that EPS.

Is that the right calculation? Thanks..

I think with respect to the tax rate, I think you know that the adoption of the new tax act is still a little bit of work in process at least for us and probably most of the world since we’ve all been granted a year to completely understand how it’s going to apply.

We will always be working to try and get our tax rate as optimized as possible, that’s the first thing. But the mix of income around the world, what’s in the U.S., what’s outside the U.S. has a very, very big effect on the rate.

So I would say that we should consider that we still may see some volatility in the tax rate for the next couple of quarters, while it actually settles down.

But I would say that we have done a very, very nice job around the world, credit to all of our general managers who has worked very hard to achieve the many places around the world high tax status that does help our tax rate quite a bit. And we do expect that overall the changes in the U.S.

tax rate assuming there are no retaliatory taxes, generally speaking, should be good for the company. And then on the convert, how many -- James, tell me your question on that again..

Where is the breakeven I mean new convert methods, I think there’s some level of EPS or earnings or your net income where we should be adding back the share 7 million shares just wondering if you have that point handy..

So if you take the, if converted method, you add the 7.3 million share and then you add back the 2.5 to the numerator, so that’s the cap for this quarter. There is $0.01 difference between if you have done it the other way, which is to not change the share count and leave the interest, et cetera in.

The place this method does help though is going forward when the convert is in the money so stake, you not only, in the prior method, you would not only leave them a numerator you would also add to shares.

So generally speaking, while there is probably about $0.01 difference, maybe as many as three across the year, I would say generally speaking this method, you should not see a material difference just for the adoption of the accounting on the convert..

And just one more last one here just sneaking here, I’ll pass it on. Just when you talk about ramping customers’ engagements and need to increase R&D to capitalize on those, I think you said with respect to the opportunities associated with IPI.

But does that -- is there is rough time line as when you expect those investments to pay out and associated with projects that are going to be booked for revenue in the next couple of quarter and does that change your timing expectations with respect to accretion from the recent acquisitions and these incremental investments? Thanks..

So with respect to the acquisitions, I would say IPI is accretive to that. With respect to the CS fab, as we said we’re working on expanding engagements with customers we have. And Chuck also talked about some of the more emerging markets whether that’s gain, et cetera that we would expect potentially to benefit from that facility.

So it still may be into next year as the market develops as we talked earlier on 3D, the market is developing slower than we had expected. But generally speaking, we will be working to try and get that CS fab to breakeven as quickly as possible. But I do think that it will take into next year..

And our next question comes from line of Dave Kang from B. Riley. Your line is now open..

First question is about the -- you said the Photonics was impacted by unfavorable mix.

Can you just expand that little bit?.

Dave, number one, we had on our submarine 980 pump business. We had lower than expected sales and it was simply a rescheduling to a quarter on the lower sales with high margin product as 980 bumps that was one of the two drivers. The second driver was on thin film filters.

So we did see a decrease in, slight decrease in the volume and that small decrease in volume for filters for high-speed transceivers and the data center that did impact us as well, so those two were I would say the two to stand out..

And then regarding the fiscal fourth quarter revenue assumptions, Mary Jane, you said you’re negated by capacity constraints.

Can you just remind me which segments are being impacted? And then will this condition persist in the next quarter in the September quarter, how should we think about in up quarters?.

So first of all, let’s start with the performance products. The performance products capacity, particularly for silicon carbide, should be in by the end of this calendar year -- this fiscal year by prior June. So we are in the process of completing that tranche of capital.

With respect to EUV, which I think you guys remember, it’s both in performance products and in laser solutions. We are expanding the capacity on particularly diamond, the diamond optics. The CO2 optics, which were in laser solutions also where the diamond optics are, we are expanding that capacity and have been for a while.

We would expect that to be able to come online, but it may not be fully sell until we crossover the fiscal year. The isolator -- the thin-film coating capacity has been going in through this year, and should be completed by probably the middle of the summer.

And let me say here -- and the isolators and circulators as we mentioned I think will probably be in place by the end of our fourth quarter, the June 30 quarter..

Dave, I would just add as look out we’re watching carefully the pressure testing, our 980 pump line, our amplifiers and our tunable filter and OCM line. They feel like they are beginning to pressurize again.

And we’ll keep real close watch on it through May and then again through the middle of June, and we’re doing -- we have one heck of a team across the company in manufacturing and operating team. And we’ll be careful of our adding capacity and getting a little bit more, maybe another 5% to 10% more out of the embedded capacity that we have.

And although we’re not exactly sold out yet, it feels like we’re beginning to move in that direction..

Regarding China, you said order, I believe you said orders were up, 24% sequentially in the press release.

Is that correct, orders?.

Yes..

And then can you just expand a little bit more on which products were strong and just wondering if it’s just a one quarter blip or more sustainable.

Do you have a nice tailwind behind those products?.

I would say, it’s broad based, Dave. Amplifiers, again all the things I just said, pumps, the amplifiers, channel monitors, OTDRs, filters and our ROADM business, there has been some recent announcements about 5G deployments in China, and their ROADM infrastructure.

And anyhow, we view that and we believe our customers view us as important parts of those growing requirements..

And have orders picked up, we’ve talked about ZTE ban and Huawei getting investigated.

Have you seen maybe like orders getting pulled in because of Huawei is getting investigated?.

I would say everything feels like it’s in normal course for us, Dave. I can say we were busy before the ban was announced. And it seems that we’re getting busier..

Our next question comes from the line of Meta Marshall from Morgan Stanley. Your line is now open..

Just one prior question just jumping on Dave’s question.

Is CoAdna’s exposure -- like do they have any additional exposure to ZTE that we should be thinking of or is it that we shouldn’t be thinking of having good discount CoAdna’s numbers? And then second question maybe just as you guys are looking at how 3D, or the direction that certain smartphone makers are making with 3D sensing.

Are you seeing any change between VCSELs and edge emitting lasers, just if you could talk about interest levels in edge emitting lasers versus VCSELs that would be helpful? Thanks..

I’ll take the first part and Giovanni will do the second part. With regard to CoAdna’s business and their exposure to ZTE, I would say this is our understanding for the past business and the current business it’s a very, very small and limited exposure just like the rest of our current footprint. So I’m not expecting anything unusual there.

Giovanni, how about the 3D sensing?.

In terms of the platforms, there is no doubt VCSEL is a build preferred laser platform for 3D sensing applications. I think we have worked with strong customer on DFB lasers, which are edge emitting lasers. We’re also seeing interest in our fiber laser capabilities that’s also pretty new.

And so the overall demand for an engagement on 3D sensing application is just pretty broad based from a technology standpoint, I wouldn’t say that is a clear picture market-by-market for which application is the -- which platform is the most preferred. But for sure in terms of timing, VCSEL is ahead of all the others..

And our next question comes from the line of Troy Jensen of Piper Jaffray. Your line is now open..

So just a quick follow-up on silicon carbide here. This quarter we saw about 21% capacity expansion. Is that the rate we should think about modeling how much you guys can add? I know capacity comes on in tranches.

But would that be a good number to use for sequential assumptions?.

Troy, I want -- if you could repeat your question, we’re struggling to hear it for some reason our connection is not so good..

I was talking about the capacity expansion with the silicon carbide this past quarter….

We can hear you, yes. Thanks..

So past quarter is about 25%, is that the rate that you think you’re going to be adding capacity for silicon carbide going forward?.

Gary, you want to address that?.

As Mary Jane indicated, we’re going to have another tranche of capacity that we’ll be putting in place between now and the end of the fiscal year, which will give us a nice lift and we’re going to continue to add capacity, as it makes sense for us based on our ability negotiate long term contracts with customers.

So it wouldn’t be a linear ramp, but it would be more tranche of capacity tied into our ability to work with customers..

And how about just competition in that category, we just see more and more names that are looking into the space now that’s got such attractive growth opportunities?.

Troy, it’s an attractive market. As you heard me refer to some numbers that came from IHS market study, it’s a market that’s going to be big. And I think from the size, it could be bigger, as bigger than almost any market that we play in sometime in the next five to 10 years. So it’s attractive but it is not so easy like everything else that we do.

It’s very difficult and you have to come at it with a set of advantages. And we have been developing these advantages and accumulating them over the last 20 years. It doesn’t mean that anybody else doesn’t have room for anybody else we think that there will be additional competitors we want to compete.

And so our plan to compete on the basis of our accumulated advantages and the new ones that we are creating, and is our goal to make the best that money can buy, that’s what I can tell you..

And our next question comes from the line of Tim Savageaux from Northland Capital. Your line is now open..

My question, and then I have a follow-up. But principle question is on OpEx spending. Given the adjusting for start comp we’re really in all periods, we gear up about 25% year-over-year and double digits sequentially over the $80 million per quarter level that was higher than I was looking for.

I wonder if you could speak to the drivers of increases in OpEx in Q3.

It looks like that might moderate a bit in Q4, but whether that $80 million per quarter level is a new baseline and what might be driving that OpEx spending?.

We’ve talked before about the goal of the company to try and moderate the rate of the SG&A increase. Some of which this quarter is affected by currency. But I take your point that you have adjusted for that. I think as we continue to look at acquisitions, we may see a little bit of a rise here.

But even if we are able to adjust the growth rate of the SG&A, we have also talked about the fact that we would like to have at least some of it come into the R&D. So as we discussed earlier, we’ve had some R&D investments expanding for increasing in customer engagement.

And I would imagine that we would continue to do that as we move the R&D closer to about 10% than where it has historically been some time back about six or seven. But with respect to the SG&A, that does continue to be an important focus of the company.

And during this quarter, we began to -- we finished the integration of IPI obviously and we’re completing the integration expenses that we have there. But we can at times see increases for that if we continue to do M&A..

And as a quick follow-up on that. I mean the focus of that -- I think you mentioned throughout the call a couple of areas of increased R&D, maybe on the military side.

Should we assume the 3D sensing is a significant focus of any incremental R&D spending, or how would you characterize that?.

We definitely increased our spending in R&D for 3D sensing. As we said, the number of markets that we are addressing is also expanding. So that’s definitely part of it..

And my follow-up was more on the top-line. Obviously, it’s pretty strong, optical communications order number up 36% sequentially. So as you look at your June quarter guidance for the modest overall top line uptick. Any color there with regard to how that might proceed by a business segment.

I am going to assume that communications are optical com or Photonics or wherever that’s all concentrated, it’s likely to have some upward pressure given that order number.

So however you want to slice it whether it’s Laser Solutions, where I’m assuming you’ve got a headwind on the 3D side, but maybe some continued strength in industrial? As you look at that $295 million, say going to $300 million, any commentary on business segment movements sequentially?.

Tim, we’re not going to be able to give you our segment forecast. But I can tell you that I am expecting everybody to be up at least a little and historically performance products ends-up usually with the strongest quarter in the fourth quarter for them. And has a lot do with the timing of the military business.

We have the strong order book as we talked about for EUV in this segment, for silicon carbide in the segment. And I would say that I’m expecting everybody to be up. And somebody is going to come in first place but I am not going to tell you which one I’m expecting to come in first place, but I want them all to compete..

Our next question comes from line of Tom Diffely from D.A. Davidson..

So another question on the silicon carbide market. When you look at in the two main end markets you’re serving there.

What is the relative opportunity for II-VI between EV and 5G?.

So the way we have looked at -- the original studies that we look at, for that the [OA] report, they would size both RF and EV, say by 2022, to be about the same size. I think our view is overtime we may see the EV market outstrip the RF market. But generally speaking in terms of market opportunity, they’re probably about the same size..

And then what about relative timing of projected ramps in those markets?.

Well, for the RF, I mean our shipments in FY17 were entirely in the RF market. And Gary noted that this quarter that power devices for the first time in shipments in the quarter outpaced the RF. So we’re seeing the EV market really beginning to move after being rather not moving as early as 18 months ago..

And then a quick question, I noticed in your most recent investor presentation, you highlighted silicon carbide and 3D sensing as the growth drivers but not EUVs. Did something happen where you’re…..

Not at all. I mean I think part of the reason we just try to make it clear was we get a lot of commentary about trying to make it simpler. EUV is for sure still a growth driver. It’s just a smaller opportunity generally speaking than the other two.

And we were trying to respond to the desire to talk about fewer things, but EUV remains not only a very, very good market for us it has developed very rapidly almost faster than we might have thought it would. So it still remains very, very strong. And as you can see from this quarter, it was a great contributor to the quarter..

And then finally you look at the 20% to 40% of the comps that you already have for the ROADM line cards.

Does the acquisition of CoAdna materially increase this 20% to 40%, or is it more of a technology purchase?.

Well, having the WSS in our portfolio would move that number up, because the estimate of 20% to 40% of content and ROADM was before that..

As Mary Jane said, it’ll definitely increase it just by the dollar value of the CoAdna and WSS, but also the pull-through sales that are around it, the channel monitors, the filters and the like. So we’re excited about that..

Our next question comes from the line of Jim Ricchiuti from Needham and Company. Your line is now open..

Just wanted to ask a question about China, on the industrial side of the business, Chuck. I wonder if you can comment on what you’re seeing both in terms of CO2 as well as fiber components, the fiber and laser component market.

What's your sense of how that market is looking over the next quarter or so?.

Let’s see, strong is what I would say, in both CO2 and in fiber. The fiber laser market feels like it has much momentum as it did maybe two or three, or four quarters ago in China. There’s a lot of activity, industry 4.0 and it’s quite spread deployment of the one micron laser is increasing, on the one hand.

And on the other hand, the deployments of cost effective low power CO2 lasers is also increasing. And in many cases, they can either be application specific competitive or even price competitive against the lower power fiber lasers.

Today, Jim, just FYI, we’ve been talking in the last year or so that roughly 14% to 18% of our consolidated sales end up at CO2 laser optics or another 14% to 18% in one micron fiber lasers direct diode lasers as well.

And right now we’re running just a little bit -- we’re in that range for both and at the moment, we’re about 1 percentage point higher on the one micron than we are in CO2. It’s about 15 and 14, roughly.

So about 13% of our business is into this market and our pull through, especially of our lasers from Laser Enterprise, as well as our optics from Photop and from HIGHYAG and from IR Optics, we have a full line supply for anybody that wants to build power sources, beam delivery systems in China.

But I’d like to make a comment about outside China as well. I mean, we’re enjoying a big interest in our portfolio. And I am hopeful that the world’s industrial markets don’t slow down under any circumstance, because I think it will continue to be good for a company that has ever suite..

I think that brings us to the top of the hour and has us out of time. If there are any other questions we can answer for you as times goes on, we’d be happy to do that. But for now, I’d say this ends our call today. We look forward to updating you on the results of the current quarter we’re in, our Q4 FY18, as well as the full fiscal year of 2018.

During our fourth quarter fiscal conference call which is scheduled at normal time slot of Tuesday, August 7, 2018. I want to thank all of you for joining us today. We were very happy to have you and we’ll see all of you soon, I’m sure. Thanks very much and have a good day..

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes today’s program and you may all disconnect. Everyone, have a great day..