II-VI Inc (IIVI) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the II-VI Incorporated's fiscal year 2016 third-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 be given at that time. (Operator Instructions) As a reminder, this conference call may be recorded.

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 Fran Kramer. Fran?

Thank you, Mary Jane, and thank you, everyone, for joining us. During our third-quarter, we had record bookings and shipments. Revenue and EPS were above the high end of our revised range issued on March.

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 on January 19. Our third-quarter results included two months of EpiWorks and 15 days of ANADIGICS. We're looking forward to realizing the growth that these additional platforms will offer us.

Excluding the acquisition effects, our book-to-bill ratio of 1.16% was the strongest since fiscal year 2011. Photonics strength continues at a book-to-bill ratio of 1.28%, and we expect those bookings to contribute to strong revenue and profits 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's 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 the fiscal year 2016 and start investing to build out capacity for a ramp in the VCSEL laser platform, which we expect will 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 in the 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 communications, 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 than usual.

Against the backdrop of favorable market demands, a strong global leadership team based in Fuzhou, China, who has overseen the successful integration of several acquisitions, our 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 100 G metro deployments in the US; continued demand for our products that serve the data center expansion and 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 200 G and 400 G 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 the 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 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 opto-electronic devices.

They offered us differentiated technology, a six-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, data center interconnect, and the emerging 3-D sensing and Internet of Things markets.

Our acquisition 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 six-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 in 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 dataflow 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 began 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 start 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-ins of new products.

We have begun our integration efforts, including assessing our options to reduce costs and improve operational efficiencies, even in the short-term, while we have prepared to invest in the development and qualification of our six-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 1, 2016. Gary reports to me, and he assumes the COO responsibilities I'd 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 9,000 fully engaged employees worldwide.

So, in summary, this quarter, again, we saw the combined benefits of our triple play in 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, continued 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 full 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 reported in the Laser Solutions segment. Because the acquisitions mask 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 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 of 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 no stock this quarter since we were in blackout for most of the quarter, and to date, 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 2016, 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 2016, the tax rate should range from 17% to 20%.

Our outlook for operations for fiscal year -- fiscal quarter-four, without acquisition effects -- or, in other 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 at 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 forecasts due to a variety of factors, including, but not limited to, changes in market trends, 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 lines.

(Operator Instructions) Jim Ricchiuti, Needham & Company.

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 margin, 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%.

Okay. That's helpful. And you guys have been very helpful in terms of providing detail on the end markets. And, yes, 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.

Yes, good morning. So here is maybe a comment about the VCSEL business that might be helpful. We believe that advancements in VCSEL technology are opening up new applications. There's a number of attractive growth drivers both from the datacom/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.

Okay, thanks -- go ahead.

I might add, Jim, that the EpiWorks business has been developing many epitaxial products serving many markets. And we expect that to continue to grow, but it's in line with what we wanted to do, which was build a platform for VCSELs. So we have an epitaxial process there that we've now put together.

So to the other side of it, ANADIGICS, very big in all of the fabrication of devices that we'll end up having to produce as we think this business will scale. So 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've acquired there.

So we think both will have a key mission in this platform. And we are organizing ourselves to, let's say, further organize it for the flow that we're expecting.

Okay. That's helpful. One final question if I may. Just regarding the strength you saw in the industrial market Laser Solutions -- and 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're 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 our January and February were a little light for us, but really came back heavily in March. And I think you drive it by CO2 laser utilization around the world, and people who are operating those machines and buying from us their replacement parts. But that's always usually a good business for us in the third and fourth fiscal quarters. So March was a good month in the third quarter and now we're looking to the fourth quarter to be good.

Okay. Thank you.

Christopher Longiaru, Sidoti.

Hi, Chris. Welcome to the call.

Hey, guys, thanks for taking my question.

Hi, Chris. Welcome to the call.

Oh, thank you. So my first question is just -- has to do with -- historically, your bookings and your next quarter's 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 range that you kind of mentioned in your guide.

Well, I think -- I'll start -- this is Mary Jane. I'll 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 and place potentially orders for a longer period of time.

So we are thinking that we have -- we can see we have more order coverage going beyond right the next quarter, and 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 FY17 than into 4Q?

Well, I would say that we expect some of them to ship into FY17 and maybe a slightly larger, somewhat larger percentage than we may have seen and pass?

Got it. Okay. And then just -- I know that there's -- 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.

Well, I think Chuck probably -- and Fran both -- probably said as much as we can say now. There is no question that the Company is focused on improving the operating efficiencies but also looking at ways to improve the underutilization of the wafer fab.

So, that would have an effect, 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're kind of in the midst of that, and 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 are evaluating. We're certainly looking at, do we operate the business after we rightsize it? Or do we joint venture with somebody on the RF side? Or do we shut down a portion of that business? Or sell it off?

So, all four of these options we are evaluating. We've announced to our people that that's what we are doing, at both -- at the site there in New Jersey. And it will take us the better part of this quarter to figure it completely out. But we know we have more costs than what we're used to carrying for this business, so we are working on those options.

Okay. Great. That's helpful. I'll jump out. Guys, thank you very much for taking my questions.

Sure.

Dave Kang, B. Riley.

Nice quarter. First of all, regarding your Photonics division, I was wondering if you can break out 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.

Yes. Good morning. So --

So would you say is China bigger than US? Or US bigger than China? At least --

I would say that -- here's what I would like to say is that demand for our communications products in China remained very strong throughout third quarter. And we believe it 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 from Japan, Dave.

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

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

Oh, 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 are 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 sense -- and I guess that brings up the next question about the capacity situation. If, let's say, the strike goes on for maybe a few more weeks, and that demand out of Verizon softens, I guess, you can simply just shift capacity application 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 that 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 a 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 said all along were 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 will be able to retool and switch over to meet the rest of the demand that's on us, Dave.

Got it. Now just a couple more, if I could. Any particular products that kind of stand out as far as being on allocation? Demand is so strong and yet you are capacity constrained?

I'm not going to -- I really don't want to comment on that, Dave.

Okay.

Because lead-times have increased. I mean, they are 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 whole within the context of their supply chain requirements.

And I don't know whether it was you or Mary Jane made comments about customers kind of pulling in orders because of they're 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 spent a lifetime wanting to be close and being close to our customers to understand what they are 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 off the bookings we have. And, at least for this quarter, which we just reported, we had good deliveries off the bookings 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 where 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 are suggesting -- you've got to watch for the build-up of the inventory. But, so far, we've been watching it closely and we're feeling okay.

Got it. 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 Fran spoke about the evaluation we have underway 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. And so I don't think we're going to really say more than that right at this exact time.

Got it. Thank you.

Thank you, Dave.

Jim Ricchiuti, Needham & Company.

Just wanted to ask you about the fiber portion of the Laser Solutions business. Clearly, you saw the good strength in CO2. How is the rest of the business? What are you seeing in that area?

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 -- 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 it. 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.

Okay. And the final question for 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 is, as we've talked, not the only one. The RF market is a very important market in that segment. Consumer applications for the thermoelectric coolers 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 the next quarter. But we do expect to see a pickup in kind of more than one end market.

Yes, I would add to that, Jim, that in this quarter for this segment, between what we've 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.

Okay. Thank you.

(Operator Instructions) Mark Miller, The Benchmark Company.

Congratulations on your record sales and bookings. You might have already expressed -- you don't want to go too much into this, but you are showing a $0.03 to $0.05 reduction when you include the acquisitions on the earnings estimates for next quarter. And you were projecting up to a $15 million -- $0.15 per share charge just due to ANADIGICS. And I'm just wondering, does this improve as quarters go on? Or is this going to be fairly constant over the next three or four quarters, the impact of these acquisitions on earnings?

Well, first of all, I do think that we will have the 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 -- Fran put it very well -- we have, with both our acquisitions, an increase in our level of expenses higher than we're used to carrying. 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 are committed to making sure that we have the best utilization of these assets and can, to the best as possible, really see them contributing to the profile of II-VI.

Do you have any ballpark estimates in terms of the type charges 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 that -- just think a lot about the whole spectrum of things that can be done, from utilizing space better to looking at the supply chain, et cetera. So, I think it could probably run the gamut more along the operating line and 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 are able to stay focused or regain their focus on the business. And I'd say it's been pretty much business as usual.

Thank you.

Thank you.

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 further questions from any of you, this concludes our prepared remarks. We -- I'll 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.

Yes. Thanks, everybody, for joining us. And I hope you get the flavor of the project that we've 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're quite confident that we've 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 all disconnect. Have a great day, everyone.