Good day, ladies and gentlemen, and welcome to your II-VI Incorporated Fiscal Year 2014 First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Craig Creaturo, Sir, you may begin.

Thank you, Sayeed, and good morning, everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Thank you for participating in the First Quarter Fiscal Year 2014 II-VI Incorporated Investor Teleconference. As a reminder, this teleconference is being recorded on Tuesday, October 29, 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.

Thank you, Craig. I am Francis Kramer, President and CEO of II-VI Incorporated. The first fiscal quarter of fiscal year of 2014 was extremely busy on a number of fronts. We are pleased with the financial results that we delivered for the quarter, the operational improvements that we experienced at several of our units and with our recent acquisition activity. We believe that these actions have placed us on a pathway for sustained profitable growth. For today's call, we have asked our Executive Vice President, Chuck Mattera, to join us to provide our investors with information on the semiconductor laser business that we acquired last month and the fiber amplifier and micro-optics business that we expect to close later this week. Chuck is responsible for the new reportable segment that will reflect the results of these 2 businesses and the acquisition processes for both transactions. Today, I will shorten my prepared comments on our first 4 reportable segments to allow Chuck time to discuss the recent acquisitions. My comments will start as usual with our Infrared Optics business. During this first quarter, bookings were consistent with the first quarter of the prior fiscal year. For our IR Optics business in the Americas, OEM orders increased 3% versus last year, while shipments to our OEMs increased 10% year-over-year. Laser utilization rates were steady in the first 2 months of the quarter and off slightly in the third month reflecting vacation shutdowns, especially in Europe. European bookings were therefore down in the first quarter partially from the summer holiday period when production rates are slower. We're seeing a lull in the activity levels surrounding the EUV photolithography systems, but we expect this to recover in the second half of fiscal year '14. Asian bookings were down 6% for the first quarter of…

Thank you, Fran. I would first like to make some general comments and observations about our most recent acquisitions and how they fit into our overall II-VI growth strategy. Since our founding in 1971, II-VI has been serving its markets with products based on engineered materials and optoelectronic components. We are proud of our heritage and our people who have created the market leader in CO2 laser optics. And we are aware of the role that we continue to play in providing new and world-class products that enable our customers to succeed in their marketplace. Until recently, our business and product portfolio has been expanded by organic investments and complementary acquisitions that continue to sustain our growth by offering high-performance products that are based mostly on passive optical and functional materials and components that are manufactured with various crystal growth fabrication and thin-film coating platforms across the company. While the industrial laser market began to adopt additional laser technologies beyond just CO2, we have been positioning ourselves in the recent past to continue to serve our customers, and we acquired businesses with key strategic technology platforms to serve the broader market of high-power lasers for material processing applications. Based on these and subsequent investments, we are positioned with a diverse product portfolio that many of our businesses now offer into the 1-micron fiber laser and direct diode markets. Because of the successful development of high-performance and high-reliability semiconductor laser components for optical communication networks during the last 30 years, it is beginning to enable new and cost-effective applications of these laser components. We are excited by our most recent strategic acquisition of the II-VI Laser Enterprise business from Oclaro, which, combined with the pending acquisition of the Oclaro optical amplifier business, both complement our broad and growing portfolio of products…

Thank you, Chuck. The next portion of this call will be dedicated to some financial highlights, and we begin this section with a review of our bookings and backlog. As described in today's press release, consolidated bookings for the quarter ended September 30, 2013, were $143.5 million, which was 25% higher than the same quarter last fiscal year. When the impact of the 3 acquisitions we completed in the December 2012 quarter and the semiconductor laser business we acquired in the just-completed quarter are removed, the bookings growth for the quarter would have been 5%. The beginning backlog of the semiconductor laser business of $24 million was not included in the bookings for the quarter. Total company backlog at September 30, 2013, was $200 million. The components of the backlog at September 30, 2013, were infrared optics at $40 million; near-infrared optics at $35 million; Military & Materials at $63 million; Advanced Products Group at $39 million; and active optical products segment at $23 million. Today's press release contain an addition to our segment reporting in the form of a fifth segment, the active optical products segment. For the just-completed quarter, this new segment captured the results of the semiconductor laser business since the date of the acquisition, which was September 12, 2013. On the segment loss for the quarter, $3.5 million related to transaction expenses for this acquisition. The remainder of the segment loss was a result of the impact of purchase accounting as the underlying business that we acquired operated at a break-even level for the first 19 days we owned them. Beginning with the December 2013 quarter, the active optical products segment will also include the results of the optical amplifier and micro-optics business we plan to acquire on November 1, 2013. The gross margin for the…

[Operator Instructions] Our first question comes from Avinash Kant from D.A. Davidson.

A few quick questions. Looks like, of course, this year in fiscal year '14, there's going to be a significant impact from the acquisition and everything else. But if you could give us some idea in terms of where do you think the model will kind of turn out in fiscal year '15 once these acquisitions are already assimilated and where do you think -- if you could talk a little bit about the gross margin, operating margin profile of the company and that will give us some idea in terms of how to model.

Sure. I would say Avinash, again, our guidance that we officially given or given during today's press release will carry us through FY '14. If we look a little bit longer term, as we move in to FY '15, we would have a full year, obviously, of the 2 acquisitions that we -- the one that we've recently completed and the one we expect to complete later this week. I would expect that you will see some noticeable gross margin improvement even at the end of FY '14. In my prepared comments, I noted that we will still have some purchase accounting items that will impact our gross margin by somewhere between 150 to 200 basis points in Q2 in the December quarter of FY -- excuse me, December of '13 quarter. And then we should see an improvement thereafter. I think it's realistic to expect that you'll see kind of a steady evolutionary improvement in our gross margin in FY '15. I think we balanced that out though with, again, some of the comments that Chuck made, noting that we do have some things for the recent acquisitions and things that we will need to invest in and change and make some adjustments relative to certain of the manufacturing processes. But I would say you should see some steady, slight increases in gross margin, and I think that would be ratable throughout FY '15.

So eventually, Craig, do you expect fiscal year '15 gross margin to get to the same level as you were in maybe fiscal year '13 prior to these acquisitions?

Yes, I think that's possible, Avinash. I think, again, in FY '13, we also had some impact of 3 acquisitions and the purchase accounting for that. But when -- I think, when you strip those out, I think the underlying businesses that we have or the core businesses are performing well. We do expect to continue to see some yield improvements and margin improvements from those businesses. And so I do believe we could get back up into the FY '13 range.

And then something similar or maybe...

I think, Avinash, we're really not prepared to go much further than what Chuck -- from what Craig has already said. We are trying to close at the end of the week on the business, the amplifier business. And we've put out the best we can at this moment the longer-term view, as longer-term as we can. I think Craig's general comments were good. We will sure fill that in another quarter.

Right, I understand it's pretty hard to kind of look out that far, but I'm just thinking about the rationale behind the acquisition and how do you see synergies coming out of this acquisition and because my understanding was that the businesses that you're buying should have had lower margins than what you had on a corporate basis. And I'm sure you have some plans to improve that going forward, so that's what I was trying to get some clarity on.

Yes, I think you're right. They are lower margins and what our main company achieves. We do have some synergies and some thoughts to improve them. We will have to work at a little bit more detail in order to give you more detail than what Craig just laid out.

And one question more on the non-acquisition-related stuff. The Infrared Optics booking have been down sequentially in a meaningful way and flattish kind of year-over-year. Where do you see that trending in the December quarter, the guidance that you have given?

Yes. It's not going to be much different than the quarter we just experienced. And I agree with you. They're a little soft, and I think, for us, as we guide, we see the third and fourth quarter to be the upbeat period. And I made the comment about the EUV diamond products being off in the quarter, and that's true when we see it in the second quarter. But third and fourth quarter will be better. And I think the laser utilization patterns that we've been watching for the last 2, 3 years have showed us -- changed it a little bit where the second quarter, the one we're in now, is the lightest quarter, and it comes out better than the third and fourth. So that's what we're guiding toward in the guidance we just gave you.

But Fran, you would say that the utilization rate that you are seeing kind of are similar to what you would have seen last year, too, on a seasonal basis, right?

Correct. Yes, that's what I meant. This first quarter, okay; second quarter, a little light. Third, fourth quarter came back nicely.

And any reason to believe that it would not be the case this year?

No, I think we believe the pattern, but a lot of it does go on consumer spending. And it just seems to follow that pattern in aggregate around the world, and that seemed to be the low point manufacturing of what was people were spending their money on. And Christmas time was produced in the first, second and third quarters, and the fourth quarter was light. It looks that way again this year, but we can't predict all of that because it's such a long supply chain.

And our next question comes from Jiwon Lee from Sidoti & Company.

Yes. Fran, just staying on the IR Optics front, could you give us a little color, in addition to the via hole drilling and the pipeline business being a little bit slow, what you see the high power versus the low power.

Yes, low-power business is hanging in there very nicely. Seems like it had a pickup here during the summer, and we expect it to continue. Well, it's price competitive. That's what I'll have to say, and we're pricing to win more business in China where a lot of the low-power work is going on. And we're actually working to have more low-power optic choices because it is so price competitive, we expect to have a product that will be even in lower price than what we've been pricing the product right now as some of the lasers that we tend to work on in the low power be 80 to 100 watts. That's where we can do pretty well. But price is down in the 60 watt and 40 watts or even lower than what we like, so we will come out with a lower-cost product to serve that business. So marking, engraving, all those type of products are going well right now in China, and that's the place they're being produced and those products sent out to the rest of the world. So I think low power, good, maybe stronger. High power is the one that's dealing with all the goods, durable goods and so on and just the utilization, and that's what's driving our business right now, is CO2 laser utilization starting to be off a little bit. And if it's trended like last year, it'll continue that way over this quarter and picking up in the beginning of this year.

Yes, that's helpful. And talking about your fiscal '14 revenue guidance, correct me if I didn't understand this right, but it looks like even this Oclaro business you're factoring in, you were anticipating a little bit slower ramp into the December quarter and a little bit better ramp in the second half. Could you give us a little bit of a logic and whether or not there is some other dynamics, such as the optical telecom businesses or the IR Optics that's also factoring this revenue guidance?

Yes. I think you're picking up the general pattern there, Jiwon. I think we do have a little bit of a stronger second half for the fiscal year expected, and that really is pretty much across the board for our businesses. I would say maybe with one exception our more consistent Military & Materials business really not showing much of a change when you look first half versus second half. But the other businesses do experience, as well as our most recent acquisition. We are expecting them to increase in the second half of the fiscal year. I think it's just a pattern that we've seen. Part of it is coming off a little bit of a lighter bookings quarter, summertime here, and then moving into the end of the year. Usually that third and fourth quarter, usually, is a little bit typically stronger for most of our businesses, and we think that's also the same pattern that we're going to see for the new acquisitions that we have this fiscal year as well.

Great. And outside of that $2 million in the December quarter for that purchase accounting, are there anything else that's baked into your EPS guidance?

There are, there's other purchasing accounting items in there, Jiwon, other than that. One, I pointed that one out just as more of an example. Obviously, the step-up in the basis for any intangible assets that we have and the rest of this increase in the fair value of the tangible asset, the PP&E that we would acquire, we baked all those into the forecast and that has been included into the guidance that we gave, not only for the December quarter but also for the June fiscal year end. So we know it gets a little tricky to kind of pull those pieces out. For instance, in our -- in the quarter we just completed, our guidance, if you go back to August 1, was that we would do $140 million to $145 million in revenues, and when you back out the benefit that we got from the Laser Enterprise business, we did just a little bit better than that. We did over $146 million in revenues by the same token for earnings per share back on August 1, again, before any of the acquisitions. We said $0.18 to $0.23, and you can see some of the pro forma detail that's in the back half of our press release, but we basically gave $0.21 when you add back not only the $0.05 of transaction costs, but also the operating results of the Laser Enterprise business. So we're pleased with kind of where we've been able to project on a quarterly basis, and we have tried to include the best we can, all of the impact of the financial transactions, purchase accounting, fair valuing, et cetera, that we expect to encounter here in the December quarter or so.

But then all of the [indiscernible] ...

Jiwon, I'd like to add to what Craig said about how our cycle or what we think the pattern will be as the next few years go forward when we have our new businesses. I'm not 100% sure. We know the pattern of our businesses that we've been running, and the businesses we're buying are ones that we've carved out. And they're quite a carve out from what Oclaro had. So to be able to tell us that we've -- to tell you we've got the data, to know how it's behaved over the -- a year in terms of seasonality, we sense there's some seasonality, but please don't hold us to that. But what I want you to hold us to is that we're devoted to serving customers in what we think we've done very well, and we have a very high reputation, especially in our Infrared Optics business and in our Military business for being customer centered and high quality, high ethics and very good in terms of meeting commitments that customers have. That's the attitude we're taking to this business that we've just purchased from Oclaro. Those customers that we're about to become quite intimate with really don't know II-VI like some of our other business people do. And so we want to let them know right now, we intend to be customer-focused and do a high-quality job. So if you can add that to your guidance, that'll be great.

All right, Fran, then let's stay on that -- the strategy and talk a little bit about -- there are 2 pieces of business basically. There is the telecom-related businesses from Oclaro, and there's some laser-related businesses. Talk a little bit about like midterm sort of a growth trajectories for each of these businesses. Where are you more excited about in terms of the revenue?

I want to say first, excited about solving the dilemmas that are serving that business right now. We bought some businesses that have some problems. So we're going to focus for the next 6 or 12 months, whatever it takes, to get both the telecom product line and the high-power laser product line on stable production platforms. And we -- I think we've got the management, and we can do it. But it's going to take time. So that's number one I'm excited to do, and from that, I think you're going to see some earnings come right there. But we're excited on both. Maybe I don't want to downplay either. The amplifier business looks to be a very good business with the 980 pumps that feed it. We like that business a lot, and at the same time, we like the high-power laser business, HPL, a direct diode that feed into the people who are building fiber lasers. It's a very good opportunity for us because those are the customers or a good portion of that business are people that we know from being in the CO2 laser business. So we like them both. I wouldn't want you to think one way or the other. We're going to devote ourselves to both of them.

Perfect. And just lastly, back to Craig. All netted out, you're still expecting fairly earnings neutral contributions from all these businesses, correct?

From the 2 acquisitions, I think we're fairly consistent, Jiwon, with the guidance we gave. If -- on the September 12 release that we had, we expected the Laser Enterprise business to be a little bit of a drag on earnings, somewhere between $0.08 to $0.12. That range included the transaction costs. And then -- and back on the October 10 guidance for the optical amplifier business, again, predicated on the expectation that, that business will close on November 1, and we would include them for 8 months of our fiscal year. We thought that business would be pretty much neutral to earnings and would not impact earnings even when we consider the transaction costs. I would say both of those right now are pretty much right in the same range. I don't think we've really changed those drastically. Obviously, one of the things that will influence those ranges is the allocation of the purchase price and what goes to which buckets as far as items that are either depreciable or amortizable. But for right now we think most both of those ranges, both of those initial ranges, not only for the EPS ranges because also for the revenue ranges we gave for those businesses looked like they're pretty solid, looked like there's not any significant changes there.

[Operator Instructions] Our next question comes from Brad Mas from Needham.

This is Brad filling in for Jim. Just first on in terms of the total provided guidance, which includes the 2 Oclaro acquisitions, can you say if there's been any change to the full year guidance of the core business you provided after Q4?

It's just been a little bit there, Brad. I would say maybe to dovetail a little bit on some of Fran's comments, we've seen a couple of areas where it's been just a little bit lighter. We would point out maybe in our Advanced Products Group just a little bit lighter than what our original expectation was and to a lesser extent, a little bit softer in our HIGHYAG business. I think those are the 2 businesses we probably point to but really not anything drastic from the original guidance that we gave back in August. But we have touched that up and thought through that a little bit further with today's release.

Okay. And then in early August and early part of Q1, you alluded to strong order momentum in the Infrared Optics business. Did you guys see the slowdown in the last 2 months of the quarter?

Yes, really, in the last month of the quarter, it's been down somewhat. And I think just what Craig said because we consolidate and report the IR Optics, including our HIGHYAG group, we put the little slowdown in the IR Optics business along with HIGHYAG. That's why we're seeing a slowdown.

Okay. And then just lastly, regarding the U.S. government shutdown, how are Military bookings leading into the shutdown and then during and since? And have you seen any disruption in the business?

I wouldn't claim anything associated with that, although we have just a little bit off on our Military as we look out into the future, just a little bit here in the third and fourth quarter, a couple of our programs that we were hoping to get shipping on, and they're saying no, they're going to hold -- we're not going to ship right away on that program that I mentioned earlier, the IR -- IRST program.

And then so there's no change to your expectations for modest growth in improving profitability this year?

No, on the core business, correct. Just I don't want to say no. No, it's a slightly lighter forecast for the core business but not a big one.

Well, I was referring to just the Military.

Oh, okay, Military, yes. I don't think we -- we've built into the guidance just a little bit lighter. That's what I would say. And I think to give a good overall comment, we told you the numbers in all 4 business segments in the past. Now we have a fifth one. But the 4 we're talking about just a touch down on each one of them with the major being the 2 that Craig said.

Yes. Brad, to your specific comment, I think back to Fran's point, just to clarify, we are expecting growth within our Military sector.

Oh, yes, yes.

We have a follow-up question from Avinash Kant from D.A. Davidson.

Clarification. So the fiscal year '14 guidance that you have given, Craig, does it include like $0.15 in earnings in Q1 or $0.21 in earnings in Q1?

It was obviously on a GAAP basis there, Avinash, off the 15% that we reported. So both our -- both -- that was on a GAAP basis, the $0.15, as well as our earnings per share guidance in our outlook section of the press release also was on a GAAP basis as well. I didn't -- sorry, I didn't mean to confuse you on that point. I was trying to help our listeners reconcile back to kind of including or excluding the impact of the recent acquisitions in there so.

Do you have an idea of how much is going to be the transaction-related expenses in the December quarter? How much should we expect?

It will not be anywhere near as significant as what we reported during this quarter, Avinash. Again, for this quarter, bottom line tax effective, it was $3.3 million or $0.05 of EPS. It will be a much smaller number than that, but it will be, maybe $0.01 or so of an impact, something like that.

And our next question comes from Dave Kang from B. Riley.

Sorry, I joined late, but Fran, I think you had talked about Fiber-to-the-Home or maybe PON, and then you say something about being slow. Can you just go over that please once more?

Well, I'll have Chuck answer that a little bit clearer probably than I can.

This is Chuck. Yes, so overall -- I'm not sure when you cut in, but overall, the business at Photop is moving right along, and quarter-over-quarter, it will be roughly the same. And -- but the comment that Fran made earlier was regarding our FTTH filter business. Revenues were soft due to broadband China. Pushup, it's been a little bit delayed. As you know, we are a major supplier of Fiber-to-the-Home filters for the passive optical network, and it's just the timing issue, I think, on broadband China.

Okay, so that's in the December quarter, you expect that to be down then?

Yes.

Okay, okay, all right. And then just the manufacturing transition time frame from Oclaro's OCM to Photop, I mean, can you give us a time frame? Are we talking maybe a couple of quarters, 1 year?

I think it's very hard for us to give you that right now just because we're about to close on the amplifier business, which is not really involved in the move of that facility but all the components, the pumps and the parts that we need to move throughout Asia. We're targeting to pull a tighter plan together, and we don't have as tight a plan as we'd like to report right now so have to keep it kind of open.

Okay, okay. And then now that you are -- have a bigger position in the optical component industry, what kind of pricing negotiation or pricing adjustment should we expect in the December, January month when you start to negotiate with your -- for your optical components?

Dave, we won't make a comment about that now either. It's premature. You're right. You know the industry and all that pricing has to be worked, but we won't make any comments about that today.

Okay. And then maybe, Craig, can you give us like a CapEx plan for the near term?

Sure, I would say that the quarter we just completed where we did -- where we had CapEx for the quarter, now this number only included just obviously that first 19 days of the Laser Enterprise acquisition. The quarter that we just completed, we were able to -- we showed about a little bit more than $6 million, $6.5 million of capital spending. That will pick up a little bit from that rate. That will pick up probably more into the $8-ish million per quarter. Some of it is dependent upon how quickly some of these decisions that we make relative to the manufacturing. A little bit of an answer to your prior question that we can give is what we decide as far as where we will manufacture, that definitely will drive some of the capital spending. But I think, overall, with our 2 new businesses added in there, the run rate around the $8 million level is probably a good placeholder, I think, for the rest of the fiscal -- for each quarter of the rest of the fiscal year.

And the last question is for Chuck. Obviously, you made some acquisitions but -- asset acquisitions, but you're still both present in transmission side. Is that something that could be part of II-VI going forward, not now but in the future?

Dave, I would say that we will make the best use of our technology platforms in the best way to serve our customers. We're focused on -- we've got a lot to do to integrate the businesses that we have. And -- but we are thinking about our acquisitions more in terms of platforms and how they might be able to evolve into products over the future.

And I'm showing no further questions at this time, gentlemen.

If there are no more questions, we would like to thank everyone for participating today. Our next earnings release for the quarter ending December 31, 2013, is currently scheduled for Tuesday, January 28, 2014, 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, thank you for participating in today's call. This concludes our program. You may all disconnect, and have a wonderful day.