II-VI Inc (IIVI) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the II-VI Incorporated Fiscal Year 2018 Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

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

Thanks, Brian, and good morning, to everyone. I'm 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 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 1, 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's joining us, including our 2 new analysts who initiated coverage of II-VI since the last earnings call.

Q3 was a strong quarter for II-VI across all of our end markets. When compared to Q3 of FY '17, 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 FY '17, industrial and automotive revenues grew 26%, 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 shipment sent to the emerging 3D sensing market for consumer applications were lower than expected.

Demand from industrial markets was the strongest contributor to grow 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 a 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 results with a 1.13 book-to-bill ratio this quarter on increased revenues and we established the second consecutive record for backlog with a 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 FY '17, 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 market for GaN and 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 oil electric vehicles is expected to lead to a $10 billion market by 2027, implying about a 35% CAGR from 2017.

We're excited about our strong position in this ecosystem, and we'll 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 roadmaps 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 investments in technology platforms, new products and capacity. And we will continue to act with a great sense of urgency in all that we

do.

With that, I'd 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 the RF markets this quarter.

For Q3, our power substrate sales surpassed RF substrate sales for the first time. The revenue split in Q3 was 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 of silicon carbide substrates are now a full 5% of II-VI's consolidated revenue.

A 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 a 10% increase in the Department of Defense budget, and a differentiated product and technology portfolio, we believe we're well positioned 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've received. 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 3x 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 for 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 the 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're 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 26, we announced our intention to acquire CoAdna, a global leader in wavelength selective switches or WSS. CoAdna was founded in 2000 and has a world-class team with locations in Sunnyvale, California and Suzhou, China.

The WSS is a key component in converged optical transport architectures to deliver programmability energy within in provisioning and recovery operations.

This enables wavelength add-drop 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 incorporates II-VI 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, unmatched vertical integration, and broad product portfolio, we are well positioned to capitalize on the growth in the lower port count 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 WSS will be especially valuable in some lower port count application where new requirements for flexibility, scalability and reliability can be achieved with optical switching.

The combination of the load and power portfolio of 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 have established 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 have 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 product portfolio, in line with our strategy to diversify the end markets we serve, 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 virtual and augmented reality, autonomous vehicles and home automation. And we believe we will start to see a merging in 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 FY '18.

The ramp for EUV products is accelerating, it is now well ahead of our forecast.

Demand for our diamond and other infrared optics products 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 result, 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 margin by 40 basis points and the operating margin by 60. Compared to Q3 FY '17, 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 FY '18.

The acquisitions of IPI and the U.K. 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 to 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 first year before purchase price accounting and transaction 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 point 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, $140 million in Photonics and $132 million in Laser Solutions. The backlog contains orders that will ship over the next 12 months.

We had $3.6 million in share-based compensation for Q3, a decrease from Q3 of FY '17'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 share-based compensation expense to be about $20 million compared to the FY '17 total of $16 million and the FY '16 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 sale 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've been 40.3% and our operating margin would have been 14.2% in this quarter Q3 FY '18.

The company had other income of $1.5 million, 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 FY '17, 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 of 2018, and adds 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 other 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 used 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 FY '18 tax rate was 3.6%, due to a favorable change in our transition tax estimate year-to-date of $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 FY '17. Our EPS this quarter was negatively affected by a $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 a $50 million repayment on the credit facility. We did not repurchase any shares this quarter, and we still have $90 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 a 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 55 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 result for the fourth quarter ended June 30, 2017, with 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 due to a variety of factors, including but not limited to, product mix, customer orders, end market customer 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 customer's request to protect their confidentiality.

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

(Operator Instructions) And our first question comes from the line of James Ricchiuti from Needham & Company.

Just -- I wanted to focus a little bit on the Performance Products segment. You alluded to the military market being at an inflection. 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 kind of 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 several different markets, silicon carbide, EUV and military. I would say just as a reminder, that this 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.

Okay. And then one follow-up and I'll jump back in the queue. A 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 a broader broadening base of revenues that you're anticipating?

Jim, this is Chuck. Thanks for your comments and questions. It is 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 -- well, 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 than 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'm assuming that's 3 items, is it 3D capacity expansion, EUV and also silicon carbide or 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. But we are -- and 3D, which we've talked about. But we are, first of all, for sure seeing increases in capacity demand for the industrial price, the 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 filter capability. Around the world, we are seeing increase in 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.

Okay. You were upbeat about the VCSEL market, the 3D market comes back in second half. Do you anticipate any new quals for programs? Or have you qualed 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 got a lot going on. And in every other case, we need to prioritize and 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 if I estimated you were qualling for anywhere between 3 and 6 programs?

Giovanni, do want to comment on that at all?

Okay. So Mark, it depends on the definition of a program. We have -- for sure, we have a number of qualifications going on. And I don't want to say 3 to 6, but we have a substantial number, single-digit number that's -- 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 to be able to create the momentum we want beyond that. Want to add Giovanni? Sorry, Mark.

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

May I ask a question on the guidance for sales for the June quarter here? Up a couple of percentage points. Even though your book-to-bill is up pretty strong at 1.13 across-the-board here. Although now I know Performance Products 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, vis-a- vis a 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 moving along very, very well on those tracks. But that is one thing that is possibly metering, let's say, some of the shipments, we might say, I think also, we saw some very, very nice pick up and in optical 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 from this the guidance, we will certainly do it.

Okay. 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?

Sure. I mean, I think as I mentioned earlier, I mean, we are -- we have-- we are out of capacity in Saxonburg, our very original plant 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, let the next tranche of it, at least. And -- but right now, that market demand is very, very high. We -- I think that's probably a little bit of the color to give you on some of it.

Okay, fair enough. Let's see, your next question from me. Oh, Chuck, on 3D sensing, a lot of the questions I get from clients are, they're trying to think about how big that business could be, and maybe one way to think about this, or maybe an easiest way for you answer it, not infringing on your customers right of confidentiality. Can you give us any sense of what you're 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 their last earnings call talked about $1 billion market in the not too distant future. I'm wondering maybe you can compare it to that market estimate. That'd be great, please?

Okay, Richard, as you know, the question about our capacity depends a lot on our utilization, and our planning factors. And those planning factors include: our yields or cycle times, the utilization of our equipment, the size of the die, the number of devices that you can fit maximum on a 150-millimeter wave or-- and so we know that there's a wide variety and we're really, really careful about it -- about staying in it. For 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 FY '19 and '20. So I'm not going to make a comment about the market. I simply can't talk about how fast it'll become $1 billion market. There's enough people -- market studies that are out there, Richard, they all seem to be understating the opportunity, at least, as we understand it. And so we're really, 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 do, inside the next 1 to 3 years.

Okay, fair enough. And one more question for me, I'll jump out of line on gross margins. Had a good quarter there and even with some headwinds that you talked about on your prepared remarks. Wondering how we should think about gross margins in the next few quarters of puts and takes here? Performance Product seems to be doing pretty well and that could be a tailwind but Mary Jane, if you could help us think about whether 40% pluses is the new baseline or could it growth from there? Or should we -- just how should we think about the next few quarters, please?

Right. So we do -- we didn't change the gross margin range that we have out for '18. So that's the first thing to say, which has the top end of 41%. I think you have hit a good point there though, Richard, which is that, all the division is 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 exactly how that will materialize in Q1 of FY '19 and Q2, et cetera. I -- 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 back gross margin.

And our next question comes from the line of James Kisner from Loop Capital Markets.

So could we dig back in on the tax rate for a minute? Maybe also the converts as well. So I think you gave us guidance for this coming quarter 21% and 23%. I think you gave us guidance for the year before that was a bit lower. I'm just wondering, can you give us any more of a forecast for taxes beyond the June quarter? Like, do you think this 21%, 23% is what we should model for a while. And I think if my math is right, on the converts you got a -- I think it's around $0.344 or something that's where the read out in the shares and interest expenses, is that -- above that EPS, is that the right calculation?

Okay. So I think with respect to the tax rate, I think you know this, that the adoption of the new tax act is still a little bit of a 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've worked very hard to achieve in 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.

Okay. And on the convert hat's the...

Then on the convert, tell me -- I'm so sorry. James, tell me your question on that again?

Like where is the breakeven? I mean, this is if-converted method, so I think there's some big level of EPS or earning, or net income where we should be adding back the shares -- 7 million shares. I was just wondering if you happen to have that point handy?

So if you take the if-converted method, you add the 7.3 million shares and then you add back the 2.5 million to the numerator, so that's the cap for this quarter. And there's a $0.01 difference between, if you had 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 to speak, you're not only -- in the prior method, you would not only leave in the numerator, you would also add the shares. So generally speaking while there's probably about $0.01 difference, maybe as many as $0.03 across the year, I'd say generally speaking, this method, you should not see a material difference just for the adoption of the accounting on the convert.

Okay. So -- and just one more last one here, just sneaking it in there, I'll pass it on. Just when you about ramping customer engagements, and the need to increase R&D to capitalize on those? I think you said it with respect to the opportunities associated with IPI. But does that -- I'm just wondering, is there a kind of rough timeline as when you expect those investments to pay out. Are they associated with the projects that are going to book for revenue in the next couple of quarters and does that change your timing expectation with respect to accretions from the recent acquisitions, these incremental investments?

Right. So with respect to the acquisitions, I would say, IPI is accretive today. With respect to the CS fab -- as we said, we're working on expanding engagement with customers we have and Chuck also talked about some of the more emerging markets whether that's GaN, 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's 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 the line of Dave Kang from B. Riley.

First question is about -- you said Photonics was impacted by unfavorable mix, can you just expand that a little bit?

Yes, Dave, this is Chuck. 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 later quarter. On the lower sales, with a high-margin project -- product as 980 pumps. That was one of the 2 drivers. The second driver was on thin-film filters. So we did see a decrease in -- a slight decrease in the volume, and that small decrease in volume for filters for high-speed transceivers in the data center that did impact us as well. So those 2 were, I would say, the 2 that stand out.

Got it. And then, let's see, 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 out quarters?

Right. So first of all, let's start with Performance Products. The Performance Products capacity, particularly for silicon carbide should be in by the end of this calendar -- sorry, this fiscal year by 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 so 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 see 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 we looked out, we're watching carefully the pressure testing our 980 pump line. Our amplifiers and our tunable filter and OCM lines. They feel like they're 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 a -- we have one heck of a team across the company, a manufacturing and operating team. And we'll be careful about 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.

Got it. Regarding China, you said order -- I believe you said orders were up 24% sequentially, first of all is that correct? Orders?

Right, right.

Right. Yes, Dave.

Yes, and then can you just expand a little bit more on that, which products were strong and just wondering if it's just a one quarter blip or more sustainable -- do you have nice tailwind behind those products?

No, I would say it's broad-based, Dave. The amplifiers -- again, all of the things I've just said, pumps, passives, amplifiers, general monitors, OTDRs, filters, and in our ROADM business, there's been some recent announcements about 5G deployments in China and the 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're talking about ZTE ban and then Huawei getting investigated. Have you seen maybe like, orders are getting pulled in, because Huawei is getting investigated?

I would say, everything feels like it's in normal course for us, Dave. I can say, we're busy. 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.

Just one kind of question jumping on Dave's question. Is CoAdna's exposure -- like do they have any extra additional exposure to ZTE that we should be thinking of? Or is that kind of -- we shouldn't been thinking of having to 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? Or just if you could talk about kind of interest levels on edge-emitting lasers versus VCSEL? That would be helpful.

Okay, Meta, this is Chuck. I think I'll take the first part and Giovanni for the second part. Yes, 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 3D sensors?

Yes, in terms of the platforms, there's no doubt VCSEL is still the preferred laser platform for 3D sensing applications. The -- I think we have worked with some 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, I can't just pinpoint. I wouldn't say that there's a clear picture market by market, which application is the -- which platform is the most preferred. But for sure, with potential timing, VCSEL is ahead of all the others.

And our next question comes from the line of Troy Jensen from Piper Jaffray.

Congrats on a nice quarter and great bookings. So just a quick follow-up on the silicon carbide here. This quarter we saw I believe about 25% capacity expansion. Is that the rate we should think about kind of modeling how much you guys can add? I know capacity comes on in kind of tranches. But with that be a good number to use for sequential assumptions?

Troy, this is Chuck. Troy, I'm wondering if you could repeat your question, we're struggling to hear it for some reason, the connection is not so good.

Yes, sorry. I was talking about capacity expansion with silicon carbide this past quarter...

That's better. We can hear you, yes, thanks.

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

Okay. Gary, you want to address that?

Yes, sure. Yes, 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 would give us a nice lift. And we're going to continue to add capacity as it makes sense for us, based on our ability to negotiate long-term contracts with our 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.

Okay, understood. And how about just competition in that category? I'm just seeing more and more names kind of looking into this space now that it's got such an attractive growth opportunities?

Troy, it's an attractive market. As you heard me refer at this from numbers that came from the IHS Markit study. It's a market that's going to be big, and I think from the size, it could be bigger as we were bigger than almost any market that we play in, sometime in the next 5 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 -- there's not room for anybody else, we think that there will be additional competitors, we love to complete. And it's our plan to compete on the basis of our accumulated advantages and the new ones that we're creating and it's 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.

My question, and then I have a follow-up. But principal question is on OpEx spending. Even adjusting for stock comp, well, really in all periods, but you're up about 25% year-over-year, double-digit, sequentially kind of 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 kind of $80 million per quarter level is kind of a new baseline and what might be driving that OpEx spending?

Sure. Let's -- we've talked before about the goal of the company to try and moderate the weight 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 engagements. And I would imagine that we would continue to do that as we move the R&D closer to about 10% and where it had historically been some time back at about 6% or 7%. But with the 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 had there. But we can, at times, see increases for that, if we continue to do M&A.

Okay, and just a quick follow-up on that. I mean, as a focus on that. I think you mentioned throughout the call, a couple of areas of increased R&D, maybe on the military side. Should we assume that 3D sensing is kind of a significant focus of any incremental R&D spending? Or how would you characterize that?

Well we did 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.

Okay. And my follow-up was more on the top line, obviously it's pretty strong, optical communications, order number up 36% sequentially. Though as you look at kind of your June quarter guidance for sort of a modest overall top line uptick, any color there with regard to how that might proceed via business segment? I'm going to assume that communications or optical comm or Photonics or whatever that's all concentrated is 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, then maybe some continued strength in industrial. As you look at that $295 million, say, go into $300 million, any commentary on business segment movements sequentially?

Okay. Tim, this is Chuck. Tim, we're not going to be able to give you our segment forecast. But I can tell you that I'm 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 it has a lot to do with the timing of the military business. We have a strong order book for -- as we talked about for EUV in the segment for silicon carbide in the segment. I will say that I'm expecting everybody to be up and somebody's going to come in first place. And I'm not going to tell you which one I'm expecting to come in first place because I want them all to compete for that. Okay?

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

So another question on the silicon carbide market. When you look at out of the two main end markets you're serving there, what is the relative opportunity for II-VI between eV and 5G?

Right. Well so the way we've looked at -- the original studies that we looked at for that the Yole report, they would size both of RF and eV, say by 2022, to be about the same size. I think our view is, over time 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 the projected ramps in those markets?

Sure, well, for the RF, I mean, we -- our shipments in FY '17 were entirely in the RF market. And Gary noted that this quarter that power device, for the first time in shipments in this quarter outpaced the RF. So we are seeing the eV market really beginning to move after being rather not moving as early as 18 months ago.

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

Not at all. Yes, not at all. I mean -- I think part of the reason we just try to make it clear once we got 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 remained 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 great a contributor to the quarter.

Great. Okay, and then finally, you look at the 20% to 40% of the contents you already have for the ROADM line cards. Does the acquisition of CoAdna maturely 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 they estimate of 20% to 40% of content in ROADMs was before that.

Tom, it will -- as Mary Jane said, it will definitely increase it just by the dollar value of the CoAdna WSS, but also the pull-through sales that are irrelevant, the channel monitors, the filters and the like. So we're excited about that.

Our next question comes from the line of James Ricchiuti from Needham & Company.

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 CO2 as well as fiber components -- the fiber 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. And in both CO2 and fiber, the fiber laser market feels like it's -- it has as much momentum as it did maybe 2 or 3 or 4 quarters ago in China. There's a lot of activity. Industry 4.0 and its widespread deployment of the 1-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 low-power fiber laser. Today, and Jim, just FYI, we've been talking in the last year or so, we have roughly 14% to 18% of our consolidated sales end up as CO2 laser optics or another 14% to 18% in 1-micron fiber laser -- 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 1-micron than we are in CO2. It's about 15% and 14%, roughly. So about 30% of the -- 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, we -- we're enjoying a big interest in our portfolio. And I'm hopeful that the world's industrial markets don't slow down under any circumstances because I think it'll continue to be good for a company that has our 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 time 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 FY '18 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.