Ladies and gentlemen, thank you for standing by, and welcome to the II-VI Incorporated FY 2020 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] Thank you.Now I'd like to hand the conference over to your first speaker today Ms. Mary Jane Raymond, Chief Financial Officer. Ma'am you may begin.

Thank you, Paul and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at II-VI Incorporated. Welcome to our first quarter earnings call for fiscal year 2020. With me today on the call is Dr. Chuck Mattera, our Chief Executive Officer; and Dr. Giovanni Barbarossa, our Chief Strategy Officer and the President of the Compound Semiconductor segment. This call is being recorded on Tuesday, November 12, 2019.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?

Thanks, Mary Jane. Good morning, and thanks to everyone who are joining us today. Before we begin, I would like to take a minute to thank all of our veterans as they remind us of the importance of dedication and determination over the long-haul and II-VI's strategic position in the aerospace and defense market.As we have many times in the past 20 years, we have started another new chapter in the evolution of II-VI. On September 24, we closed the Finisar transaction, the largest acquisition in our history. Our excitement has only increased since day one as a result of the complementarity of the technology and manufacturing platforms of both companies.Despite some market pauses commensurate with our conservative case and the normal heavy lifting that is needed in the time immediately after an acquisition, we are confident that we will disrupt the status quo.As a result of the acquisition, we are the largest component and subsystem supplier in the global optical communications market and we believe the undisputed leader in Photonic Solutions and Compound Semiconductors. The combination of the semiconductor laser, customized optics and integrated circuit technologies along with the miniaturization and automation platforms of the new company position us well to expand into a larger portion of each of our end markets. For example, we fully expect our industry-leading indium phosphide laser capabilities to enable rapid growth across multiple markets including; optical communications, automotive, hyperscale data center communications, life science diagnostics and consumer electronics applications to name a few.Moreover, we believe that increased scale and quality will ultimately yield lower costs, greater competitiveness and result in more ubiquitous adoption of scale. In fact, we are already seeing tremendous growth in our indium phosphide-based coherent products.Our recent innovations in highly integrated indium phosphide laser components and analog integrated circuits have…

Thank you, Chuck, and good morning. As a result of the combination of II-VI and Finisar, we expect to be ranked number one in the optical communications component market. With the growth of 5G, which expands the world communication infrastructure from the tower to micro core and subsea networks, we are seeing increased demand across our vertically integrated value chain. For example, we are in a sold out position in pumps and demands for submarine pumps alone, now accounts for over $30 million of the backlog.5G is also driving increased demand for coherent transmission. We have an exciting roadmap for coherent communications from components to modules and subsystems. As Chuck mentioned, we are in a leadership position for the next generation of highly integrated modules and we are already seeing meaningful revenue this fiscal year with the forecast anticipated to generate a 10 times growth year-over-year.We are also very excited about our work with customers on component offerings that were previously captive within Finisar, including indium phosphide lasers, detectors, ICs and integrated optical subassemblies.The laser device is for communications alone will enable us to serve a total addressable market previously unserved by Finisar of $1.4 billion by 2023. The designing work will take a number of quarters though we are already shipping samples now. We expect revenue to begin to materialize in Q1 of FY 2021.For ethernet transceivers, those users -- produce -- the data centers, the market has been down about 15% from 2018, but we expect it to recover in calendar 2020 as we have multiple customer depositions underway for revenue in the second half of calendar of 2020.While the mainstay products remain 100G, products for 200G, 400G and 800G will fuel new upgrade cycles in data centers. Our increased debt to empower development has positioned us well…

Thank you, Giovanni, and good morning. So I'm going to do a few things this morning. First, I'll give you a few minutes navigation of the press release. Next, I'll review the highlights of the quarter and close with a discussion of the updated levels of key expenses, the progress on our synergies, the financing and the outlook.So Table one on the second page of the press release, you will see the GAAP results, including six days of Finisar. Table two on the third page, walks you through the buildup of those numbers, starting with the operating result for legacy II-VI, the last time we will report results for legacy II-VI.So the comps across the top are legacy II-VI, Finisar for six days, severance and related costs, acquisition-related costs and then a subtotal column of all the special items of columns two, three and four. The far right column shows the consolidated GAAP results.Table three on page six shows the segment results. The six days of Finisar are in a line called Finisar and Other. This is not to indicate that Finisar will be its own segment, because it will not be. The related nature of Finisar's operations to II-VI's operations results in the right treatment being to merge them into our structure, once we see the dynamic of a full quarter. Finally table four on page seven shows the non-GAAP margin results by segment. We can answer any questions you have on this format when we get to the Q&A.The revenue was $340 million in the quarter, including $22 million from Finisar. Revenue growth was 8%, with organic growth at 1% compared to last Q1. EPS was a loss of $0.39 for GAAP and positive $0.57 for non-GAAP. Non-GAAP adjustments were $59 million on a pre-tax basis and $48…

[Operator Instructions] And our first question will come from Meta Marshall of Morgan Stanley. Your line is open.

Great. Thanks so much. Maybe just starting with kind of looking forward into Q1 and just -- it sounds -- perhaps some of the weakness to expectations is coming from kind of lower ramps on some of the Finisar products, but just any help kind of between legacy II-VI legacy Finisar just looking into Q1. And then second question just -- Compound Semiconductors had a tremendous amount of operating leverage in Q1. Just anything -- any help there as to where you were seeing that leverage would be helpful? Thanks.

I'll answer the first question -- the second question for you and then Chuck and Giovanni can answer the first part of your question. So as you know the 3D Sensing business for both companies is one of the few businesses because of the consumer aspect where a lot of the capacity if not almost all of it needs to go in for qualification. As a result, volume if it lags can cause a dis-leverage, but when it is shipping, is very, very good. And you -- we see this as well even in Photonics where when the volumes are high the operating leverage is very good. So that's not atypical in a capital-intensive company. But I would say that particularly in Compound Semiconductor because of the shipments in 3D Sensing and while down, not dramatically down, just 10% not what some others are reporting with respect to industrial that also helps the margin mix a little bit.

I would add that just to repeat maybe what I said where actually the call -- we're hosting the call today from Warren New Jersey from our 3D Sensing and Compound Semiconductor fab.I said it's going extremely well here. The team here have done really a fantastic job and it's really exciting to see. So I think that's -- we've said all along when we get these fabs drilled to the target utilization that we would be able to have a real nice business and that's what we're seeing.For the rest of your question with regard to the business I think, we tried to give a very clear, transparent and balanced view. Each one of our markets in Q1 whether we talk about our traditional silicon carbide or our industrial laser markets, we experienced softness in the legacy II-VI markets in the first quarter.And with regard to the Finisar -- legacy Finisar business the Web 2.0 scale purchases of transceivers were less than what we expected they would be in the first quarter. And so I would say it's a mix of both legacy and Finisar business that were a little bit softer than what we would have hoped for or expected Meta.

Got it. Thank you so much.

Your next question will come from Jim Ricchiuti from Needham & Company. Your line is open.

Thank you. Good morning. Chuck or Mary Jane, I think you mentioned that there were some areas that you're experiencing very tight capacity where you may even be out of capacity. Can you talk a little bit about where that is? Is that in the power amplifier business?

So I would say probably in a few places yes. So one of the areas is in for optimal communications. We have seen what seems to be the beginning of 5G starting to pick up here and why are we usually see in fact, even in great years, we usually see the Q1 quarter lower than the Q4 quarter.We are out of capacity on several of the key products especially comps. With respect to silicon carbide, we are as we've talked many times continuing to increase that capacity and in particular in this quarter saw a rise as Giovanni mentioned in demand for the semi-insulating substrates which is used for RF.That caused that conversion of some furnaces and we are -- and constrained the capacity in the first quarter. So we're now on with that. And there are probably a few other places here or there but those are probably the two main ones. What you say Chuck?

Yes. Just recapping for legacy II-VI 980 pumps, semi-insulating silicon carbide substrates and on the legacy Finisar side, we are working aggressively to add capacity in our coherent optics and coherent transceiver manufacturing lines to keep pace with the anticipated demands.

And Chuck just with respect to Sherman, you talked about some of the technical issues. I don't know if you could elaborate on that or not but you seem to suggest that you see that being resolved in the March quarter. Is that -- should we think about that as occurring late in the March quarter? Or any additional color you can provide on that?

There's a chance that could go earlier than the end of the March quarter. There's a chance it could take a little bit longer. With these things I can elaborate on it this way simply. This is normal to our semiconductor laser fab. These are issues that as soon as you resolve five or 10 issues, the next one or two pop up in your scene. This is all normal.We've been through this in our history. We take it with our heads up. I can tell you this. If there's any way for it to be a day earlier, I guarantee anybody that we'll make it happen if it's possible. And it is a top priority for us and at the moment, I think we'll suffice it to say, as soon as we possibly can and we're doing it collaboratively with a great customer. As soon as we can we'll get on to it.

But as far as guidance goes it's -- you're baking in later in the quarter?

In the March quarter Jim. That's all I'd like to say.

Okay. Thank you.

Yes.

Your next question will come from Fahad Najam of Cowen. Your line is open.

Good morning, guys. Thank you for taking my question. I'll start off with a few questions at first. Can you help us understand with the summer approval process requiring you to separate the lease. So like it's business of Finisar for a piece of three years. Are you still reiterating your cost synergy targets of $150 million. Can you help us...

Hang on a minute. Fahad hang on a minute. So your question was can we explain the ruling to hold the WSS separate?

No. My question is more what is the impact on your synergy cost targets? You seem to have reiterated your $150 million cost savings targets. Is that, I would assume keeping the wave selective switch business separate for a period of three years would have impacted that. So can help us understand how much of a put and take it's impacting your synergies target?

Okay. Good morning, Fahad. Fahad, it's just -- it's very, very difficult to hear what you're saying or to understand. If there's any way for you to either get switch your headset or whatever your system you're on, please make an adjustment. But I'm going to answer the question that I think I could hear.We started this process with a 150 millimeter -- $150 million of synergies that we have in our plan. We built our objective based on delivering more than that because not everything will hit, not everything will hit exactly on schedule. And we know that we have to run faster just to be able to get to where we want to be and we like to be able to deliver more. That's just our overall culture. That's our attitude. That's the whole place. So for sure, we will have to deal with additional costs that were not in our plan as a result of holding these businesses separate. And we don't know, exactly what they are but we have an estimate of what they are. And that estimate is going to over three years cause us to run even faster, so that we can still deliver on the promise of the synergies. We're not – there's no mulligans here there isn't anything. We have to deliver. So whatever we have to take on we'll take it on. We're going to try to mitigate it all the time, because we're so focused on the cost but we have to do things right. We have to do the right things and we have to go fast. And I'm not at all discouraged about the possibility that there'll be some extra costs. We know that. We're going to have to figure out on how to get some extra revenue or reduce the cost someplace else and we're working on it. Okay?

Okay. Can you guys hear me now better? Is this better?

Yeah. Did you hear what I said Fahad?

Yes, I did. Thank you for your response. If you can quantify what the additional head cost from this keeping the wavelength switch business that will be helpful.

We're not going to do that on this call Fahad.

Okay. If you can also provide us an update on Finisar, I mean, it's been – your Finisar has been quite beautiful three quarters. Can help us update on employee retention key talent retention, especially as it relates to the 3D Sensing. We often hear about people leaving. Can you just give us an update on the employee retention rates?

Yeah. I would say this. It's one heck of an exciting place to work at, and we have a normal attrition rate that we've experienced in running these businesses, and I can tell you that, I know of no corner of the company where the attrition rate is higher than normal. It's probably lower than normal. There is a lot of people that want to come to work here. And I would say that, there's a great interest in people wanting to come to work in such an exciting company, where this roadmap – if nothing is perfect, but we're determined to be able to match the right talent that we need to have in the jobs that we need to have as part of our day one assessment going forward, we've identified a few critical spots of our own assessment and in conjunction with the assessment of some of our customers and we will go and work to fill those. It's at the top objective of us just to retain the top talent that we have and to attract additional people to be able to fuel the growth at this company. I am very, very excited about our engagement with our employees worldwide Fahad.

Super. If I could ask a question –

We probably need to let someone else have a chance, but if we have time for sure. We'll be pleased to take any other questions from you.

All right. This is going to be a short question. On the industrial revenue, if you can just help us what was the amount of revenue that was – the disappointment was due to organic and demand versus you being short in components?

For industrial your question was how much was organic. All of it.

No. What I meant to say – sorry, what I meant to ask was, how much of the weakness in the industrial revenue was as a result of the – you being out of components and shortening of supplies?

On industrial revenue, I think we answered that question. There is a reduction in new systems built and as the GDP in some major industrial countries declines that has an effect on the aftermarket.

Got it.

So, operator let's take the next analyst on the call.

The next question will come from Samik Chatterjee of JPMorgan. Your line is open.

Hi, Samik.

Hi, Mary and hi, Chuck. So, just wanted to see if you can dig a bit deeper into a couple of end markets particularly in optical communications telecom and Datacom. You mentioned this trend you're seeing in telecom related to 5G. So, just want to understand, if it's across all geographies or if – are you seeing a weakness in China? And then on Datacom, is there any visibility at this point in terms of a stabilization in that end market? Or what your plans would be able to be on Finisar business there in terms of you're seeing some competitors switching from modules out to chips, so any thoughts there? Thank you.

Hi, Samik. I would say our telecom business our optical communications business is a strong, and I mean a real driver is to turn on in 5G. I mean, our factories around the world are working feverishly to keep pace with increases in orders, and increases in demand associated with 5G. So that's a key highlight. That's in China. I would say that's across all geographies. It's just been strong. Every geography we report China, U.S., North America, Japan and then the rest of the world too. So that's a real driver. I think that's going to continue.On the Datacom side, our best view is that the market probably will go through another two quarters maybe. And so our model today anticipates that in the second half of the calendar year, we'll begin to see the lift in the Datacom business. In the meanwhile, I said earlier, our coherent optics and coherent transceiver business is experiencing a tremendous amount of interest as is the interest in the indium phosphide base laser component sales.We've had a number of seminars with customers already around the world and there's a great deal of excitement. People are already beginning to dedicate design and qualification resources to be able to get our lasers fit in both form fit and function into their products. And that element of our strategy seems to be right at the -- on day 1, an enthusiasm that people have been waiting for.

Got it. Mary Jane a quick follow-up if I may. You're reiterating a lot of your synergy targets and I understand the headwinds here are from the macro perspective. Are you also reiterating the 10% EPS accretion in the first full year? Or is that something you have to kind of see based on how you deliver on synergies through the year?

Right. I think your latter part of your question probably answered it for yourself. I mean I think we've seen some changes as Chuck summarized at the end of his remarks in at least two of the major end markets, if not really 3 that are causing the ramps -- for the ramps for 3D Sensing for example to be lower than we would have anticipated.Having said that, obviously that would have been affecting the II-VI base business as well changes in the end markets. You can see that from the organic growth in the quarter. So as a result of that, I think what I'd like to really do is, take the time to be through not only the pro forma that was -- is due in about a month's time here, but also to as Chuck put it, have at least one full month of looking at how the company is doing and what we can do to support the accelerated growth we're seeing in some cases on the top line, but also and how we can work more efficiently together to able to see how we think we'll end the year. So I think that's really the best way to think about it exactly as you already have Samik.

Okay. Great. Thank you.

Thank you, Samik.

The next question will come from Simon Leopold of Raymond James. Your line is open.

Thanks for taking the question. I wanted to see if we could dig a little bit more deeply on the trends you're seeing in the -- what used to be Finisar's transreceiver business. I think Giovanni indicated he expected improvement in the second half of 2020. Just want to make sure that's calendar fiscal, but understand what's driving that? Is that about new products or is this something that you see within the demand side? I'd like to get a better understanding of the trajectory of that particular business?

Thank you. Hey Samik, this is quite a busy pipeline of new design wins that the team expects and we think that whether it's 100, whether it's 400, whether it's 800, as I said all of these bandwidth capacities will require new gears and so without going over through the customer list, we obviously we can't. We see that as an opportunity of the business to bounce back a little bit on where it is today.So we're very, very confident that the strength of the team is there, the vertical integration helps a lot. Some of the internally sourced coherent solutions that Chuck mentioned are very competitive. So it's an array of activities going on that we narrated and they are very, very promising from our standpoint. That's why we made a comment.

And maybe just to drill down on one particular area. A number of OEMs have talked about vertically integrating silicon photonics and you've got some other players with silicon photonics. I don't know that we've heard much from Finisar for about a year on this topic, so it's been quiet. How do you compete against those kinds of products? Will you have your own? Or are your costs better? How do we think about that? Thank you.

Okay, thanks Simon. Yes. We have some activities here on Photonics. It's one of the many platforms that the team has been working on over the past few years. Obviously at the same time, I have to say, it's hard to believe that silicon photonics will replace indium phosphide for many applications.And so, in some applications I think there is an advantage even if as you probably know in some demanding applications silicon photonics has to be complemented by an amplifier which we – it creates a great opportunity for our amplifier team to be designed in.In some application maybe you don't need an amplifier and that's something we are working on as a team in II-VI. So again, it's one of the many platforms that we have available to us. We have a number of partners that we working with to deliver the high chips for the right applications and they complement well with the rest of the indium phosphide, as well as the IC platforms that the team has developed over the years.So just -- I think there is some activity going on, but it's just one of many. We are not working on silicon photonics to make our products more attractive. It's just one of many platforms that you need to have at your disposal to deliver the best power money can buy.And that's -- I was Chief Technology agnostic officer and I believe that that's still the case. It doesn't matter what the technology is. I know that's all you have. You would only talk about silicon photonics. If you don't have only that you also talk about silicon photonics. I think that has been Finisar and the II-VI attitude towards that specific platform.

Great. Thank you for taking the question.

Sure.

You’re welcome.

[Operator Instructions] The next question is from Tim Savageaux. Your line is open.

Hi, Tim.

Hi. Sorry about that. Good morning. I'll try to keep it somewhat coherent here, no pun intended. If you look at your total revenue guide for fiscal Q2 a couple of questions about that. I guess about $610 million mid-range. A, you've mentioned the strength in telecom pretty consistently. If you look at both what came over from Finisar and ROADM and the coherent side as well as your overall telecom business, can you give us a sense of that Q2 guide? How much of that is telecom? And I assume you expect that to grow year-over-year. And I will follow-up.

So, it's pretty hard for us. We don't normally break this down by end market. I mean, I do think that we would expect to see some of the growth from that area. But I would say the other things, there are some as we just discussed in the call, some downdrafts we're dealing with whether they be in industrial or as Chuck went into some great detail about the resolving some things from a 3D shipping point of view from Sherman.

Got it. Well, the team said, it could be like 40%, 45% or so, and that's kind of where I was headed. If you look at kind of comparable to last year, it looks like that the comparable guide is down almost 10% high single-digits. And realizing you're going to be wanting to move away from legacy II-VI and Finisar concepts rather quickly given this is the first quarter out of the box, I wonder if you can characterize that high single-digit or nearly 10% decline? Do you expect to see that across the legacy II-VI and Finisar businesses? Or would that be concentrated in datacom in Finisar and maybe industrial at II-VI? Any color there would be appreciated.

Okay. Sure. Well, first of all, I'd say the guide's wide, right? There's still a lot to get underneath. But I would say that if you think about the size of the business that's coming in, it would not be unreasonable to think that some of it would -- datacom side and if not really most of it.I would say that as we look at the opportunities before us, it will be -- I think for all of your benefit important to judge kind of revenue synergies, dis-synergies on a little bit more aggregated basis than one quarter.But I think, you are on the right track, that probably most of it is really still from the Datacom side. Because as Giovanni said, we have seen that market continue to decline. As I think, you guys, have well. And it's more of a calendar 2020, recovery Giovanni talked about more than fiscal.

Great and just very quickly, I missed the Photonics and Compound Semiconductors backlog numbers, if you could repeat that total backlog ex-Finisar. And I have one more question.

Let me start with the ones you're asking. So, it's $334 million for compound semi, its $386 million for Photonics. And then, Finisar brought about $200 million of the backlog, which you'd have to assume, right, just based on how their business has been structured over the years, that most of that is in Photonics.

Got it and final question, if you look at the Q2 bottom-line guide, …

Yeah.

…you're obviously impacted by interest expense. I would gather without any -- too much synergy impact, although, you did talk about hitting the ground running. So, it kind of looks like, we're adding up the respective expense run rate.I assume there's some synergy impact in there. I think, you mentioned, a metric of 20%. I'm not sure if that reflected your expectations for the year or the quarter. But at a high level, how much synergy is contemplated, on the expense side, either in COGS or OpEx in your bottom line guide, for Q2?

Right, okay, so, first of all, I think as you look at the expenses forward right -- so this is why Chuck is talking about, continuing to look at the synergies. But generally speaking, if you think about kind of how the business model was done, the revenue would have been increasing.And so, obviously the OpEx would have had some movement as well to accommodate the increasing revenue. The first thing that we're trying to do is, severely moderate what an increase curve is.But to your question overall, we had originally estimated that in the first year, we'd have about $35 million of synergies. Again, less than, say $50 million, $150 million to buy trade, because we don't necessarily have it for the whole year.So, I think, to try and identify synergies on every single line item after one quarter might be pretty hard. I mean from an executive suite point of view, those people yes are now no longer among us doing very well elsewhere.But for example, on the audit fee the audit fee comes in across the year. So it doesn't all materialize in the first quarter. So in terms of actually realizing, it it'll be realized through the year. Some of the ones we're counting have having been actions and agreed. It doesn't mean they actually hit the second quarter, in the full amount.But generally speaking, I would say that, we're looking at, somewhere of at least in the neighborhood of $30 million to $35 million for the year. And as Chuck said, we will be getting on with that very, very quickly, given that we've also seen some changes in the top line profile for the company in this year already. You want to add?

Thanks.

Sure.

And that concludes our Q&A session. I would now like to hand the conference back to, Ms. Raymond, for closing remarks.

Thank you very much, all of you for joining us. We like to -- we'll update you on our results for sure, when we report out the second fiscal quarter of fiscal year 2020, in early February.And as we indicated, if we have any updates, we're sharing we'll have four investor conference is after Thanksgiving. And we'll be seeing you then. So thank you very much for joining us. And we'll talk to you soon. Bye-bye.

Ladies and gentlemen, this does conclude today's teleconference. You may now disconnect your lines. And thank you for your participation.