Good day, ladies and gentlemen, and welcome to the II-VI Incorporated Fiscal Year 2013 Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for this conference call, Mr. Craig Creaturo. You may begin, sir.

Thank you, Kevin, and good morning, everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Thank you for participating in the Third Quarter Fiscal Year 2013 II-VI Incorporated Investor Teleconference. As a reminder, this teleconference is being recorded on Tuesday, April 23, 2013. The forward-looking statements we may make during this teleconference speak as of today, and we do not undertake any obligation to update these statements to reflect events or circumstances occurring after today. Before we begin the call, we would like to note that we have been made aware of an erroneous EPS estimate that was included in the Thomson Reuters' first call report for II-VI Incorporated for the quarter we just completed. Specifically, an incorrect data point of an analyst estimate for $0.56 per share was included in earlier versions of this report, and this affected both the consensus estimate, as well as the high and low range for the quarter. It appears that this issue has been corrected as of this morning, but we know this has caused some confusion with investors, analysts and news outlets. We point this out to make sure that you are aware that this issue impacted earlier versions of the Thomson Reuters' first call report for II-VI and to lessen the confusion that this issue has caused. I would now like to turn the call to Fran Kramer.

Thank you, Craig. I am Francis Kramer, President and CEO of II-VI Incorporated. As I noted in the press release, we are pleased to deliver our third quarter fiscal year 2013 financial results within the range of our guidance we've previously issued. During the quarter, we made significant progress on integrating our 3 recent acquisitions and we look forward to increasing contributions from each of these businesses in the future. I'll now present you with a review of each of our business segments. First in the IR Optics segment, during the third quarter, bookings were up 15% quarter-over-quarter to $51.2 million. We rebounded from a weak second quarter with North America, Switzerland and U.K. showing significant improvement, world power market also saw a pickup during the quarter. Although Japan showed some improvement from last quarter, booking levels are lower than what we've experienced over the past few years. Our German business continues to be stable, driven by demand for diamond optics and EUV systems. Scan lens bookings remained strong from customers in Taiwan and South Korea as that business shifts away from Japan. For our IR Optics business in the United States, orders from domestic OEMs increased 50% quarter-over-quarter due to new blanket orders from some of our key OEM accounts. Shipments to our domestic OEMs increased 8% from last quarter. Aftermarket bookings increased 15% quarter-over-quarter as a result of improved CO2 laser machine utilization in North America. The outlook for the fourth quarter depends on the near term economic impact of recent government policy decisions and consumer consumption, which drives laser utilization. European bookings for the third quarter were up 14% compared to the second quarter. Our diamond optical windows for the EUV photolithography system business continue to grow as projected. Asian bookings increased 19% from the prior quarter…

Thank you, Fran. Here are the items that I would like to highlight before we open up the question-and-answer portion of the call. As described in today's press release, consolidated bookings for the quarter ended March 31, 2013, were $140.3 million, which was 4% lower than the same quarter last fiscal year. The 3 acquisitions we completed in the December 2012 quarter added about $22 million in bookings during the just completed quarter and nearly an equal amount of revenues. Total company backlog at March 31, 2013, was $194 million, down 2% from the December 31, 2012, backlog. The components of the backlog at March 31, 2013, were: Infrared Optics at $42 million; Near-Infrared Optics at $33 million; Military & Materials at $72 million; and Advanced Products Group at $47 million. The gross margin for the quarter was approximately 35% of total revenues and is expected to remain at this general level during the next quarter. Although this is slightly lower than historical gross margin rates for II-VI, we attribute most of this change to a combination of our recent acquisitions, which carried lower gross margin profiles when compared to some of our historical businesses combined with higher material costs in certain of our business units. During the quarter, the company repurchased 524,000 shares of its common stock for a total amount of $9.1 million at an average price of $17.44 per share. These purchases completed the $25 million board-authorized repurchase program announced in May 2012. Under this program, the company repurchased approximately 1,443,000 shares and an average share price of $17.30 per share. The Board periodically reviews the benefits of share repurchases program and may open up other programs in the future. The year-to-date effective tax rate was 24.9% compared to 21.9% for the same period last fiscal year.…

[Operator Instructions] Our first question comes from Jim Ricchiuti with Needham & Company.

The question I have is just on your industrial business, the markets that you're addressing there. I mean, it seems like the activity you're seeing in the market suggests that the market's holding up fairly well. Looks like you're aftermarket bookings were pretty strong. I mean how would you characterize the business overall, the industrial piece?

I think it's good. This is Fran. And it's lumpy. That's the challenge. Although we had good numbers in 3 out of 4 of the continents, we just see the laser utilization not being as constant as we had expected. But it does add to a nice number, but it does it in steps rather than the consistency that we had maybe in prior years. And so we can't hone in on what's driving that lumpiness except for the manufacturers themselves are uncertain with the economy, so they don't place orders at their usual rate. It's just a start and stop kind of an attitude out there. We think overall, it's good. I can't add any more clarity to it. It's just not -- the demand for their products is whether it's a laser utilization, which is a 80% to 90% of what drives this, they can't predict it and they don't maybe do as many upgrades to their systems, change to their systems as they have. So just spotty, that's the best I can say, maybe volatile. But we do see a good trend, not a great trend.

And just in terms of the bookings as you went through the quarter in the business, is there any color that you could provide there? Or is it just difficult to make any real observations? I mean, how were the bookings later -- toward the latter part of the quarter?

And you do get our press release and all our details on bookings. So you can see that 2 of our business segments were really up nicely quarter-over-quarter and 2 of them were down. So from our overall bookings as the quarter goes by, we did okay all quarter along. But it's these down units that hurts somewhat and the predictability on how to staff or build the capacity due to that volatility has left us a little bit behind in getting to the margins we want. We'd like to run more steady, and when that happens, we have a better margin. But when we're doing this start and stop and maybe 2 of our units have that this quarter. IR had some nice bookings, but also some weak couple of weeks in there. And then your Infrared unit had some dropping off in bookings really as the quarter went by.

Okay. And Craig, just maybe you can take this question. If we look at the range you're providing for earnings in the June quarter, can you talk a little bit about some of the variables there that could get you to the higher end? What needs to happen? And conversely, what is it on the low end that you're concerned about?

Yes, I think we're expecting -- in any of the revenue ranges, we're expecting growth there. So again, that's kind of now apples-to-apples will all 3 acquisitions in the just completed quarter and also the June quarter. I think also too, Jim, we're realizing that we have a lighter tax rate in this quarter, the third quarter, than what we forecasted as the average for the whole fiscal year. So we know that, that's an item that we expect to go up. Again, we're ranging for the whole year to be between that 23% to 25%, but we just came out from a quarter where we did 15%. So we're factoring that into the guidance for Q4 as well. I would say that a little bit of the mix of where the revenue growth will come, to Fran's -- maybe to dovetail on Fran's comments, to the extent that we get a little bit more lift or get a little bit more industrial intake from our Infrared Optics business, that will probably put some more dollars down to the bottom line, that's obviously our most profitable business. To the extent that we see selenium prices, for instance, remain at the lower levels or possibly go down a little bit, that could push us down to the lower side. So I think we try to be sensitive to try to broaden that range out a little bit. I think it's a range that we're comfortable with. But I think also too, we try to factor in maybe a few more scenarios or a few more variables in there and try to give a range that we're comfortable with. But I think those are the kind of the factors that will push us either to the higher side or the lower side of that range.

Our next question comes from Mark Douglass with Longbow Research.

Craig, what were the sales contributions in the quarter for the 3 acquisitions?

The combined -- both bookings and revenues, Mark, they were, combined, about $22 million each. And we will give some more details on each one of those in our Q that we file in a couple of weeks here. But collectively, they were about $22 million.

Okay. That's helpful. And then I missed some of the Q&A, but Fran, did you discuss military and how it's reacting with your Military business to the sequester and how customers are pulling back, or maybe not pulling back, and what's going on there?

No, I did not. But that's a good question. I think we're feeling reasonable about it. We've had some delays, but the orders have come, and are offset there, if there is any timidness on the standard Military business that we've been doing, since the acquisition of LightWorks, we've had a nice offset. Certainly, the program I mentioned in my script that the IRST program's doing well for us at LightWorks. And we expect in the near future, and I can't tell you when, because they really don't know, ut just seems to delay, this large IRST order from Saudi Arabia. And I think that will help us in the Military business. Although it's performing very nicely. Just about what we planned. It's reported in the Military & Materials segment in the segment -- the part of the segment that's had the problem has been the PRM Materials business.

Okay, so at least in the quarter it played out relative to expectations even though the sequester went through?

Correct.

It's fair to say? Okay. And then I just want to see if that's baked into your assumptions for 4Q that things will remain relatively stable there?

Yes, yes.

And then can you remind us, what percentage of M&M is U.S. military?

If you look at the segment as a whole Mark, are you asking just kind of what piece is M&M or what piece is military, sorry?

Yes, exactly. The U.S. Military.

Sure. If you really -- the U.S. Military is really the vast majority of [indiscernible]. We do pickup some foreign military sales from LightWorks. We have had some at EEO but, definitely, LightWorks had a higher concentration of foreign military sales than our EEO business. And if you're asking or I can say that when you look at what we're expecting for revenues for the full fiscal year from that segment, roughly about 75% come from the collection of military businesses, again, EEO, LightWorks, Max Levy and our VLOC business and about 25% comes from the PRM business.

Okay. And of that 25%, the vast majority is U.S. Military?

That is correct.

Okay. And then going through the P&L on margins, would you expect that obviously the sharp declines in tellurium and selenium prices have hurt PRM? But eventually, it looks like the price is being more stable. Are you going to benefit of the margin side as you start rolling in lower input costs, at least in some of the other businesses?

I think that's something that can flow through their market. It does take a while though for that to really happen because remember in our zinc selenide business, our Infrared Optics business, we're procuring the selenium then we're creating the zinc selenide material, qualifying it, polishing it, coating it. It takes quite a while for it to eventually turn into a finished part. But yes, overall, I mean there is a little bit of consolation price that we have for lower price selenium and that is for our Infrared Optics business. We are at a period of time right now though, where that higher selenium from 2, 3 quarters ago is actually negatively impacting our business. But to your point, when we look out 2 or 3 quarters, as that prices decline, that is something that, as we get into the middle part of that by '14 that will actually be a little bit of a tailwind rather than a headwind for us.

So is it later in calendar 2013?

That is correct. That's right.

And finally, we consider stepping up share repurchases in the capital allocation. I realize you find double taxation dividend distasteful, but also would you consider those at all?

Certainly, our Board will be thinking about it, and they always are. And I think the program we just completed was a good investment. And if it happens that we find our way to spend some more money on share repurchases, it could happen. Certainly, we're constantly spending on capital expenditures in these last 3 acquisitions, so we just have to get our treasury on the right spot in order to make that decision. It could happen.

The next question comes from Avinash Kant with D.A. Davidson.

A few questions here. The first one is that could you talk a little bit about the downwards vision to the guidance? Where is it come from?

I think broadly speaking, Avinash, I think there's probably 2 prime areas that we look at, when you look from an operational perspective. I would say, #1, it's our PRM business. As we noted in the release and also in Fran's prepared remarks, we continue to be challenged on the material business and we know that we're not quite getting up to the levels of either shipments or profitability that we had expected. The good news behind that is that we have some new customer arrangements that will help that quite a bit in the future. But that is definitely something that changed between -- over the last 90 days or so as our expectations -- as to how we will finish out the fiscal year. And I'd say the other area is in our telecom Near-Infrared Optics business as well. Again, we're seeing, again to reiterate, a little bit of some of Fran's comments on the same subject. We are seeing a bit of a softness there. We're seeing a bit of softness with those telecom optical component parts that we currently manufacturing and we expect that to continue really for the remainder of the fiscal year. So I think those are probably the 2 areas where we've seen the most change, I'd say, in the last 90 days or so.

And did you give out exactly how big was PRM, Craig, in this quarter? And maybe the year ago fiscal Q3?

We didn't give that detail out. I'm not sure -- I did say that for the full year, when we look out for the full year, that we expect PRM to be roughly about 25% of our total sales. By comparison, if you look back to last year's FY '12, that number would have been more like 40%. So just to give you a perspective that, that business has shrunk quite a bit, not only because of the demand changes but, obviously, the index pricing changes the value of the shipments that we're having as well.

So, Avinash, what Craig was referring to is that it's 25% of our M&M segment revenue.

That's right.

And it had been 40%, so you get a range there. We've really watched the price erosion on selenium and tellurium just take off. We're down in our shipment volume, but our sales dollars are a lot bigger decline.

Right. But with the prices now stabilizing, do you expect further decline in this or just kind of stay at these levels?

It's possible. That's one thing we have to add that there's a volatility on selenium and tellurium. Although we're getting closer and closer to trying to surround it and prevent it from hurting us so much, it's still out there. Since we wrote this script and put this together, I said it was down to $35, now it's down to $34. So volatility on selenium and tellurium, both of them, is a lot more. It could just as easily be turning head upward. That's the challenge for us.

And I think, previous question, you were asked about the military exposure overall and did you talk about what percentage of your revenues came from the U.S. Military in the quarter?

Yes, I think we said that, that -- especially within that Military & Materials segment, Avinash, which is again about 75% composed of military, we would say the vast majority of that, 90% or so, would be attributable to the U.S. military sales rather than foreign military sales. When you look at II-VI as a whole, we'll be right on -- right about 20% or so for the whole year, whole fiscal year will be total military sales, and again I'm including the military that we do and not only the military Materials segment but also in the Infrared Optics segments, as well as what we do in the advanced product segment in that overall total consolidated 20% of our business is military.

And that business you think is stable for the rest of the year?

Yes. Yes, for sure. We have good order coverage and, certainly, the platforms we're on -- are like the IRST, they're in good shape and playing out the next maybe 2 years to 3 years, there'll be a little bit more question as some programs might end up getting reduced in magnitude. But at this moment, we don't see that in FY '14, which is what we're looking forward to starting July 1.

Maybe specific comments, Fran, on the GFF program? How do you see trending compared to the last fiscal year or what's the outlook?

On which program?

GFF.

Okay. Yes, I think we're kind of in a steady-state for that in the rest of '13 and '14, 15 and 16 it's have to be completely played out in Congress and then how our -- what share we'll get of that business, I think ought to be a very high share. But now, it's a little -- we originally felt pretty confident out to the year, maybe 2020, but now, that the sequestration fallout is going to happen and there will be some reductions that,that might come down a little from our expectations, but I think we're good for 1.5 to 2 years. And after that, it just depends. If we wrote to -- the Congress votes to run the production rate -- not as originally expected, but it will gradually trend up. No matter which way it is, it's going to trend up. It's just whether a trend as high as expected or only partially that will affect us.

So you say down from your expectations, but do you think compared to fiscal year '12 you could maintain that level in '13 and '14?

Yes, yes. Yes, sir. We will do '12 again in '13 and '14.

Okay. I think, Greg, you talked about the tax rate for the fiscal year being 23% to 25%. Now, could you talk about what's it going to be in the quarter, up-coming quarter?

It should be right around that same range, Avinash. Our quarter-to-date for the fiscal year, our quarter-to-date effective rate is right around that same range, about 24.9%. So we're seeing, we're coming in 23% to 25%, so we have to have a quarter that would be pretty close to where that average is. So a rate in the 23% to 25% range will get us there.

Avinash, I have a couple of comments. So it's not that they are not opportunities. Certainly, in each in one of the 3 or 4 of our businesses, we have opportunities that are going to shift here in the fourth, in the quarter and then into next year and our model of business, which I commented this personal comfort business is coming on, I think it's going to be really quite strong in the fourth quarter. In our Infrared Optics business, these EUV photolithography systems were really going well there, and I think the diamond business is going to stay and we can see a runway for that for the next 1.5 to maybe 3, 4 years. Then our M Cubed business, again, towards the EUV systems, the move up from 300-millimeter photolithography production work to 450, that's a big project for us. So those 3 will be areas that I think will be very good for us.

And I think you talked about the IR Optics that was pretty strong. And one quick question on that vein actually, maybe I'm going to ask, that the 3 businesses that you acquired recently, they contributed $22 million in revenues and bookings for the current quarter, I think they had $8 million contribution to revenues and bookings to the previous quarter. But what was it in fiscal Q3 of '12?

We had none of it -- we had fiscal Q3 of '12, yes, we had none of those in the prior fiscal year. So all 3 of the acquisitions that we talked about, they contributed this quarter, came on just the most -- just in December of 2012 quarter so they were not there in the March 2012.

Our next question comes from Dave Kang with B. Riley.

So Photop was down, did you gave the actual dollar amount?

I guess, the Near-IR is really the combination of Photop and the Aegis business, that's really the 2 businesses together. So again when you look at the details that we provide for Near-IR, you're looking at really everything that's controlled by our Photop organization. The Near-IR and Photop, fairly synonymous.

And then you said 40G and legacy were down. How much would 40G be and also same question for legacy?

So we don't usually report that, Dave. So I'll just try to give some explanation of it. But the amount we're doing and the optical communications business at Photop, we tend to give a high level review of it but not go into details due to the competitiveness of that business.

Got it. But it sounds like 40G is in decline then, I mean, not even flat, but you expect 40G to continue to decline?

Yes, we think the shift to 100 is coming and even 400 and those customers that were in the 40G space are not getting the business because people are holding this whole project in China that was going to spur the market, the China government has held off on it and I think they are just going to wait for the 100.

Right. Right. And then China mobile, they announced 100G, their plans last -- I think it was this weekend, so I assume there will be some kind of a lift on the second half for you guys?

Sometimes, in China, that does happen that quick. I agree with that comment because things happen there quickly, but we haven't seen it yet.

Got it.

We haven't put it in

Right. And then just wanted to clarify as far as Aegis is concerned, so it was down, but then, did I hear it correct that China was up -- did it double? Did I hear that correctly?

For the Aegis business specifically, Dave, you're asking?

Yes.

Yes, but double for the optical channel monitor price of Aegis. Second or third quarter over second. Yes.

Right. So then is it safe to assume that maybe domestic market was down then if China was up that much?

Yes, and the rest of the world. [indiscernible]

So for China...

I don't have the fact, Dave. So I can only say it. It seems logical but I don't have that fact.

Fair enough. And then going back to China, doubling, I mean, as you know the Chinese they don't use ROADMs so I'm assuming it's a Chinese OEM customer that has increased orders for you and they're probably using that for their foreign customers. Is that a fair assumption?

I can't comment because they do -- all the China manufacturers ship their products all over the world, especially...

Right.

in places like Africa and other countries, not Europe or North America.

Yes, yes. And China also doesn't use ROADMs. So I'm assuming it's going to be Chinese OEM customer, that's what I was trying to get at. But anyway, you've kind of answered it already, but expectations for Photop in this current quarter. Do you expect to be flat to down or is it just down? What's the color there?

I would say flat and some of the products that are in Photop might have some lift, but the ones that are passive optical components to the bigger customers, they might be down.

Our next question comes from Jiwon Lee with Sidoti & Company.

Fran, I just wanted to talk a little bit about HIGHYAG. How did that shape up during the quarter, first of all?

I made some comments, and I want to get my script here. Bookings were about $6.1 million, which is up 23% -- 29% over the second quarter. So good performance. Our business is -- and I made a comment in my script there, that there was softening in bookings toward the end of the quarter or maybe it was -- I didn't really comment, but it was more like the February-ish, early March time period. I think right now, bookings are reasonable, and our business there is a very nice business. We've got very good product and we continue to work in all fields whether it's welding, which is a good product for us, cutting and beam delivery.

Okay, good. And on your outlook, you did mention that the PRM and the optical telecom were the weak spots now. Now, looking out the June quarter, you expect within the revenue guidance delta IR Optics revenue to grow? And where would upper range of the delta come from?

Yes, I do think we expect for the segment lines, Jiwon, I think we have seen some good traction in the Infrared Optics business and in the segment as a whole. I think we are expecting some growth out of that business in the Q4. Again, to the extent that, that takes off a little bit faster than our expectations, which is probably some of the upside for the quarter, that definitely could drop more down into the bottom line to maybe some of our other businesses that are not as profitable. So we are expecting some growth, some Q4 growth, out of the Infrared Optics business.

And maybe a good way to characterize it though, IR fourth quarter over third might be up 2% to 3% on the revenue side. So it's a really a combination of all the other -- especially those 4 items that I highlighted a moment ago on personal comfort, EUV diamond, EUV silicon carbide, those will be the new products for ourselves plus a quarter, another quarter of our 3 new acquisitions.

Okay. And you're guiding the gross margin at least over the next few quarters, if I heard correctly, at about 35% range. How does the margin improve from there?

Yes, I think we're saying, Jiwon, we were just giving comment in 35% for the fourth quarter and I think it does start to improve after, again, we get past some of the purchase accounting items for the acquisitions as we start to get them ingrained and a little bit into some things that we have been working on or are working on to improve the margins on all those businesses. But again, the 3 businesses, we bought solid businesses, good margin businesses. Now each of them, though, not quite up to the corporate averages. So we've got some things that we've been already starting to work on to increase the margins from that level. So I think as we lean in to FY '14, I think you'll see a little bit kind of a slight incremental changes each quarter, is what they would expect and, again, depending upon where the mix of business revenues are, if it's a little more heavily weighted IR Optics, a little higher gross margin. If it's a little weighted towards some other units, a little lower gross margin.

And with the visibility that you have now, how do you see the second half of this year shaping up for you?

So you're referring to calendar year...

Correct.

2H, I think we're getting a little more optimistic. It doesn't seem the economies around the world are trying to stabilize in spite of all the bad news that just keeps on coming. And we haven't put out any guidance or any direction for that time period. But I am optimistic that it will be a little stronger.

Our next question is a follow-up question from Mark Douglass with Longbow Research.

A couple more. Looking at IR Optics, a couple of quarters of some relatively weak margins, at least for that segment. Do you think this kind of mid- to high-20s in the operating margin is sustainable, assuming there's not any down tick in volumes?

I think so. I think so, Mark. When you look back, to your point, where segment earning is about 26% of that segment, earnings as a percent of revenue this quarter. If you go about it was 23 in the prior quarter, 23 in the quarter before that. So I think we're in a level, and again, especially when we had a quarter where we jumped from $45 million in revenues for that segment in the December quarter, up to $53 million, that definitely will help -- that definitely helps the margins as well. So I think we're in the right range there, kind of that low to mid-20s and starting trending more toward the mid-20s, I think the right direction for IR Optics.

Right. Because you were at $51 million to $53 million in 3Q and 4Q of '12, with a margin 27% and 25% and then there's a significant step down in the first half of the fiscal year. I'm just want to make -- try to confirm that the first half market performance is behind us and back to a more normal run rate.

I think, Mark, there's maybe 1/2 to 1 -- 2/3 of that is related to this selenium high class flow into our inventory that's going to pull down. But maybe there's 25 to 30% of that on selling price, I think where we're pricing down a little is there's a little bit more competition now and we're -- that's going to affect us, I think, a little longer-term. It might affect us 1/2 point maybe, longer-term.

Okay .And then finally, did you talk about where you see net CO2 laser deliveries right now?

No, I didn't. But coming down the assembly line, I think last report in February, I said maybe around 4,200. Right now, I think it's running about 4,500, according to our survey. And when we do this survey, which helps us with laser utilization of maybe 50 to 70 companies around the world, users of equipment in Europe, North America and Asia. So I think our number is pretty good. I mean actual laser utilization, we get a feel for that. I'm thinking it's running 4,500.

Okay, you said it was 42 in February?

Well, when we reported in our last quarter report, it would've been February -- or January, sorry, January.

January, right.

Yes.

And I'm not showing any further questions at this time. I would like to turn the conference back over to our host for closing remarks.

If there are no more number questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ending June 30, 2013, is currently scheduled for Thursday, August 1, 2013 before the market opens, with a conference call to follow that same day at 9:00 a.m. Eastern Time. Thank you for participating in today's conference call.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.