II-VI Inc (IIVI) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the II-VI Incorporated fiscal year 2012 fourth-quarter and year-end conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder this program is being recorded. I would now like to introduce your host for today's program, Mr. Craig Creaturo, CFO and Treasurer. Please go ahead, sir.

Thank you, Jonathan, and good morning, everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Thank you for participating in the fourth-quarter fiscal year 2012 II-VI Incorporated investor teleconference.

As a reminder, this teleconference is being recorded on Thursday, August 2, 2012. 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'm Francis Kramer, President and CEO of II-VI Incorporated. My prepared remarks today will discuss operational results for each of our businesses. But before we begin, let me provide some general thoughts on the markets and geographies that we service and some overall perspective on the current macroeconomic environment and its impact on our businesses.

During the current quarter, the Company continued to be negatively impacted by the declining pricing of tellurium at its PRM business due to decreased demand in the photovoltaic market. In addition, current quarter declines in pricing of selenium caused by unforeseen reduced demand in Chinese metallurgical applications added to these negative results.

Furthermore, the worldwide economy is facing challenging headwinds due to the uncertainty in Europe and slowing growth in China. This current global economic environment, combined with the unpredictable volatility and pricing of our minor metals, has resulted in a cautious customer base Company-wide.

During our fourth quarter, our infrared optics segment including HIGHYAG, had bookings of $52 million, down 2% compared to the fourth quarter of FY '11 and down 12% compared to the third quarter of FY '12, which was a record quarter. Fourth quarter was a record shipment quarter at over $53 million as we shipped against the high order rate we experienced in the third quarter. Near the end of the quarter and into the month of July, we have seen softening in most markets, with the biggest impact driven by Asia.

We continue to be concerned as this softening is occurring at a time of lower customer spending -- lower consumer spending, vacation shutdowns around the world, and slightly lower laser utilization as inventories worldwide are being adjusted. Still in our IR optics unit at the HIGHYAG group, bookings for the fourth quarter were down 16% quarter over quarter, but up 28% compared to the fourth quarter of FY '11.

We continue to see growth opportunities in all addressable markets, meaning 1 micron welding, beam delivery systems, and 1 micron laser cutting. We have added capacity, are focused on reducing lead times, and are taking advantage of the strong market demand. We had record shipments in the fourth quarter, driven by remote welding heads sold to US auto plants.

For our IR optics business, excluding HIGHYAG, in the US, orders from the domestic OEMs decreased 11% quarter over quarter. This decrease was a result of timing of orders and a decrease in the low-power market. High-power OEM orders remained flat quarter over quarter, which we feel will continue through the first half of fiscal year '13.

The North American aftermarket experienced a 5% decrease quarter over quarter, suggesting laser utilization is slipping. Based on survey feedback from the market, we feel the North American aftermarket will continue at the current pace for the next two quarters.

European bookings for the fourth quarter were down 5% quarter over quarter, but up 15% compared to the fourth quarter of '11. We are starting to see signs of unfavorable economic conditions affecting the high-power OEMs. European aftermarket was down 16% quarter over quarter.

Asian bookings were down 25% quarter over quarter, with all areas in Asia contributing to this decline. In Japan, the high-power business has softened. This was combined with the low-power business already down and resulted in the quarter-over-quarter drop in bookings. Economic conditions and the strong yen are making it difficult for sales outside Japan, resulting in the lower machine builds.

China bookings dropped 15% quarter over quarter and we're down 22% compared to the fourth quarter of '11. The China economy continues to grow, but at a slower pace, and our largest OEM customer has experienced a significant drop in orders, which has impacted bookings. We are actively pursuing new end-user customers and the results have been encouraging. We expect economic conditions to improve in China toward the end of the first half of FY '13.

In summary, our IR optics business segment, including HIGHYAG, continues to see bookings pressure driven by worldwide economic conditions which have impacted our business over the past several weeks. The reduction in laser utilization has impacted Asia, while US and European markets have been flat. Europe, due to our new diamond window product line, which should be strong as initial EUV photo lithography systems hit the market, should be strong in the second half.

Now moving to the near-infrared segment, during the fourth quarter, bookings compared to the same quarter last year were up 50%, to $49 million, and segment revenues were up 12%, to $44 million. The bookings increase was mainly attributable to the timing of certain China and North American telecom orders, which led to increased orders for Aegis-related products and increased demand for green laser devices at Photop.

The revenue increase was generally due to the increased demand for Aegis-related products. Compared to the third quarter of FY '12, bookings were up sequentially 6% driven by the timing of a follow-on order for the current generation of UV filter assemblies. Revenues were up 10% from the third quarter, driven mainly by the increased demand for Aegis optical channel monitors for telecommunication networks and green laser devices at Photop.

Now at Photop, revenues grew 4% from the third quarter, the third consecutive quarter of growth in spite of the broader market softening in the optical component business for telecom. The revenue increase was led by increased customer demand, and our shipments of green laser devices, and display products in our contract manufacturing business. During the fourth quarter, Photop's telecom component business was impacted by a slowdown for a specific customer project in Asia that was delayed due to government-legislated slowdowns in broadband network deployments in that country.

This overall market softening is expected to continue through the first quarter of FY '13. During this period, Photop continues to invest in R&D for key components and sub-assemblies to serve customers in the next generation high-speed network requirements. We continue to experience key design wins that we believe will be needed to drive our future growth.

The Photop laser business surged in the fourth quarter as volume delivery started on green laser devices from a major contract win that was awarded in the third quarter. In addition, Photop booked additional green laser diode orders in the fourth quarter from key customers covering various applications. We project the laser business will continue to ramp up over the next one to two quarters.

The Photop's optics business continued to see growth in the fourth quarter, with gains in medical and industrial accounts after completing the commercial optics transfer from VLOC earlier this calendar year. In addition, revenue for telecom optics increased at customers in China and North America.

Now at Aegis, our employees at Aegis and AOFR and Photop have continued to work tirelessly during the last three quarters to rebuild and re-engineer the Aegis business that was severely impacted by the flooding at a contract manufacturer in Thailand. At Aegis, fourth quarter revenues grew 56% from the third quarter, its second consecutive strong growth quarter. Aegis has seen growth in order trends within its core optical communication markets, as well as its industrial market segments that are addressing the high-power fiber laser markets.

Aegis continues to invest in R&D activities to expand the portfolio of new products, including high-performance optical channel monitors for the ROADM market, 100 GPS, and 400 GPS applications. AOFR is developing a family of high-power fiber laser combiners for use in fiber laser applications. Based on recent work with customers in Asia, North America, and Europe, we expect to be successful in gaining design wins and market share for our line of fiber laser combiner products. We believe these products will be synergistic with a broader fiber laser optics portfolio that Photop is developing.

In the fourth quarter, we achieved an optical channel monitor design win with a major customer in Asia and a fiber laser combiner win with a major customer in Europe.

In VLOC, our fourth-quarter bookings increased by 30% over last year's military-related fourth-quarter bookings and 250% over the third quarter of FY '12. This increase is primarily driven by the timing of a large follow-on order for the current generation of UV filter assemblies. Fiscal year '12 VLOC military bookings finished the year 2% up compared to FY '11. During the quarter, VLOC also received several key prototype and development orders in the near-IR military market space. Leading the way was a prototype order for the next design of the UV filter assemblies, which will extend VLOC's participation in the missile threat detection program.

Additional development orders received in the fourth quarter were YAG slabs for a new countermeasure system utilized to defeat ground threats, a next generation handheld laser designator application. During the quarter, VLOC also won component orders for new foreign military rangefinder and target designator programs. These wins are the result of adding capabilities at VLOC to manufacture more complex products needed to satisfy the next generation military program requirements.

Moving to our Military and Materials business segment, our fourth-quarter bookings were off 24% as compared to a year ago, and sequentially 39%. The drivers for these reductions are lower index prices and product demand for selenium and tellurium. This was partially offset by orders in our military businesses, which increased 25% quarter over quarter, and 43% from the fourth quarter of FY '11.

For the year, fiscal year '12, bookings of $93 million were essentially flat compared to FY '11. Orders from our military businesses increased 19% and offset the downturn in our material business.

Revenue growth for the fourth quarter, as compared to last fiscal year, increased 7%, but fell 15% from the previous quarter. Our military business drove the increase from a year ago and, although military revenue improved 10% from the third quarter, it was not sufficient to offset the decline in the selenium and tellurium business at PRM. For the year, fiscal year '12 segment revenue improved 17%. However, earnings for the segment were severely impacted by the lower selenium and tellurium index prices, and improved profitability in our military businesses were not sufficient to offset this negative impact.

At Exotic Electro-Optics, bookings in the fourth quarter were very strong as compared to both last year's fourth quarter, up 25%, and the previous quarter, up 40%. Although we are pleased with these results, we continue to see some weakness in the market and expect this market to remain extremely competitive as a result of the slowdown in defense spending.

Revenue for the fourth quarter exceeded both the prior-year fourth quarter and the previous quarter by about 12%. For the fiscal year, our bookings improved by 13% and revenue improved by 4%. We continue to maintain a healthy order backlog in this business.

Our Sapphire product line was the main driver of improved bookings and revenue. Our historic military products, which we often refer to as our core military business, were flat, as certain production orders were delayed; but this was offset by wins from new customers. For both the quarter and the year, profits were up nicely, reflecting solid improvements in operational execution and increased product volume.

For the fiscal year, nine new products or capabilities were introduced to the market and several promising orders were placed for opto-mechanical assemblies. In spite of challenging conditions in the defense market, we believe our strong backlog, new products and capabilities recently introduced, several new customer wins, and solid operational performance is a positive indication of future business growth.

At Max Levy, order activity continues to be strong across all product lines and record bookings were achieved in the fourth quarter. Several large military orders spanning EMI gridding, resistive films, and durable pattern coatings on missile radomes accounted for more than two-thirds of the new orders. Quote volume remains strong and interest in high-temperature pattern coatings remains high. Additionally, new and existing customers continue to show interest in funding development work on new programs. Revenue for the quarter was flat compared to the prior quarter and the previous year's fourth quarter.

We experienced some technical challenges in the quarter on our major EMI gridding program, which impacted our production output. The technical challenges were resolved in the quarter and production will resume on plan in the first quarter of FY '13.

At PRM, demand for tellurium remained low due to continued restructuring in the photovoltaic industry, and demand of selenium decreased below expectations due to lower usage in Chinese metallurgical applications. Fourth-quarter bookings were off 87% compared to a year ago, resulting from lower product demand and adjustments to the order backlog related to the eroding index prices.

Fourth-quarter revenue year over year was consistent. For the fiscal year, bookings fell about 18% compared to last year, while revenue grew 28%. Eroding index price of tellurium throughout the year, and to a much lesser extent selenium toward the end of the fiscal year, were the primary drivers of the net operating loss for this business.

The selenium index price decreased 28% in the fourth quarter, from $61 per pound to $44. A write-down in the fourth quarter of our selenium inventory of $900,000 negatively impacted earnings. The selenium market typically experiences a seasonal lull during the fourth quarter, but this year it was compounded with the slower growth in China and the subsequent decrease in manganese output related to weakening demand for stainless steel used in the construction projects in China.

The tellurium index price continued to erode, decreasing 28%, from $160 per KG to $115 during the quarter. A write-down in the fourth quarter of our tellurium industry of $1.2 million negatively impacted earnings. The tellurium index price reflects the lack of tellurium demand from the solar market. We believe this lower demand will continue for the next two to four quarters, and our business has been adjusted to account for this slowing demand.

Startup of our new rare earth production line occurred in the fourth quarter, however it did not meet its production targets due to unforeseen process startup challenges. At this time, we expect shipments to begin on this material in the first quarter of FY '13, with revenues projected to be between $8 million and $10 million during FY '13. Our current order for this product will run through fiscal year '14 and follow-on orders are expected.

In the Advanced Products group, our wide-band gap units product bookings in the fourth quarter were more than four times the prior quarter as a result of a large blanket order. However, total bookings were down 37% year over year. Total revenues for the fourth quarter were up 30% compared to the third quarter and up 14% year over year. For fiscal year '12, DOD program revenue was down, while product revenue for both power and RF products were up.

Fourth-quarter shipments of 100-millimeter diameter semi-insulating substrates for RF applications were up 20%, both from the prior quarter and year over year. Customer demand for both product deliveries and the completion of qualification programs of their devices on our substrates for both the wireless infrastructure market and the defense sector recovered somewhat from a slowdown that we experienced in the prior quarter.

We are currently forecasting slowing demand in the first quarter of FY '13, followed by significant increases in shipments during the second half of FY '13. During the fourth quarter at the CS MANTECH conference, WBG became one of the first silicon carbide vendors in the world to introduce 150-millimeter diameter substrates for the power-device market. We are currently sampling wafers into a number of major OEMs and expect to begin low-volume shipments during the next quarter.

Growth in the power-device market continues to be driven by high-voltage diodes for power factor correction and industrial motor drives, and the promise of more energy efficient products and solutions. Although long-term growth in the inverter market for the solar energy and other renewable energy applications is still expected to be significant, the photovoltaic market has recently softened and is expected to remain soft in the coming quarter.

According to recent industry reports, silicon carbide power electronics are projected to take a 10% to 20% -- 2% share of a greater than $3 billion market over the next several years, which is currently dominated by silicon-based devices. As projected, large volume shipments to one major power device OEM began in the fourth quarter and shipments to a second large OEM are forecasted to begin during the next quarter. In preparation for this forecasted increase in demand, we have continued our manufacturing capacity, expansion, and investments. In June, we moved into our new 10,000-square-foot facility in Starkville, Mississippi, and plan to be fully operational by September 30. This facility will support the expansion of capacity for wafer finishing, cleaning, and packaging.

At Marlow Industries, fourth-quarter bookings were up 31% compared to the prior quarter, due primarily to an increase in orders from the defense market and were down 4% year over year. Marlow's FY '12 bookings were down 15% year over year, due to an overall reduction in defense spending, a soft telecom market, and a significant reduction in the gesture recognition end-market demand. Fourth-quarter revenues were up 9% over the third quarter, due to increased defense market demand, but down 25% year over year, due again to reduced defense spending, softer than expected telecom demand, and major reductions in the gesture recognition orders. FY '12 revenues were down 11% due to these same factors.

We began initial shipments of our recently introduced Climatherm air-to-air high-performance industrial systems. Climatherm products are used to flow air in a controlled environment like an electronic cabinet, food cart, or battery case. We expect this product line to drive significant growth in our industrial market in fiscal year '13.

We continue to see an increase in activity and interest in our EverGen energy harvesting solutions introduced earlier in the year. This product's harvest energy from temperature differences that exist in a variety of different environments like air, liquid, steam, gas, and et cetera, to power wireless sensors and actuators. This will also be a source of additional and emerging growth in fiscal year '13. We have taken cost-cutting measures to mitigate market uncertainties and focus our efforts towards the most promising markets to better position Marlow for increased future growth and efficiency in an increasingly competitive market.

In summary, overall fiscal year 2012 was a year filled with challenging events. We believe that we responded swiftly and positively to the adversity we faced and remain committed to our customers and our long-term growth objectives. With a healthy balance sheet, increasing cash flow from operations, and strategic investment in research and development, we believe the Company is well positioned to capitalize on future opportunities in fiscal year 2013. Craig, this concludes my comments.

Thank you, Fran. Here are the items 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 June 30, 2012, were $142 million, which was 8% above the same quarter last year.

Total Company backlog at June 30, 2012, was $179 million, which was up 3%, or $5 million, from the March 31, 2012, backlog. The components of the backlog at June 30, 2012, were -- Infrared Optics at $48.5 million; Near-Infrared Optics at $48 million; Military & Materials at $58 million; and Advanced Products Group at $24.5 million. The June 30, 2012, backlog is the highest in the Company's history.

The continued decline in the index price for tellurium for the third consecutive quarter and a new decline in the index price for selenium drove a need to make a lower of cost to market inventory write-down for our PRM business, part of the Military & Materials segment, in the June quarter of $2.2 million, or $0.03 per share.

FY '12 saw a continued erosion of the index price of tellurium, with the per-kilogram pricing starting at $300 at the end of fiscal Q1 and moving down to $220, and then to $160, and finally to $115 at the end of Q2, Q3, and Q4, respectively. In the June quarter, the index price for selenium moved from $61 per pound at the beginning of the quarter to $44 per pound at the end of the quarter.

In today's press release, we have enhanced the disclosures around the impact of these write-downs, noting that the total FY '12 impact was $8.3 million, or $0.13 per share. These write-downs were a component of cost of goods sold and negatively impacted overall II-VI gross margins for the quarter and full year by 170 and 165 basis points, respectively, and the segment margin of Military & Materials for the quarter and the full year by 1,000 and 900 basis points, respectively.

We disclosed in today's press release that, as of June 30, 2012, the Company had repurchased $5 million of its stock under the $25 million Board-approved repurchase program that was announced on May 31, 2012. The number of shares repurchased during the June quarter was just over 300,000. This lower number of outstanding shares was included in our updated fiscal year 2013 earnings per share guidance.

It is the intent of the Company to continue with the Board-approved repurchases in fiscal year 2013 in accordance with the 10b-18 rules, but we have not forecasted further decreases in our share count beyond the actual purchases made to date. We plan to report the actual repurchase activity as part of our quarterly earnings releases.

During the quarter ended June 30, 2012, we did not receive any contractual or insurance proceeds from the flooding that impacted the facilities of Aegis's contract manufacturer in Thailand in October, 2011. We have recently completed a comprehensive analysis of the inventory and equipment that was damaged during the flood, including the appropriate evaluations and supplemental information needed to form the basis for our claims.

We continue to work diligently to fully utilize recoveries that are contractually due to Aegis and AOFR, the Australian subsidiary of Aegis. Our guidance for the quarter ending September 30, 2012, and for the year ending June 30, 2013, excludes the recovery of contractual and insurance proceeds because the specific timing and amounts of recoveries remain unknown at the present time.

During the quarter, there were a few items that impacted the other income line item on the income statement in a positive manner. These components included -- foreign exchange gains of $800,000 due to the strengthening of the US dollar against the euro, which drove an increase in the value of the US dollar receivables on the books of our businesses where the functional currency is the euro; interest income of $300,000; equity earnings from a minority interest in Chinese-based Fuxin of $300,000; and miscellaneous other income items of $300,000.

The effective tax rate for the quarter was 23.8% and for the full year was 22.3%. The higher tax rate for the quarter was driven by a slightly higher percentage of US earnings and a lower percentage of international earnings. During the quarter, there were no significant changes to our tax reserves. We expect the income tax rate for fiscal year 2013 to range between 22% and 24%, which is unchanged from the original guidance for this fiscal year that we gave nearly two months ago.

Cash flow from operations generated by the Company during fiscal year 2012 were a record at over $88 million, or 20% higher than the prior year. During the quarter, we generated $30 million in cash from operations. We used that cash to spend $10 million for capital expenditures and $5 million for the share repurchase program.

We also made a $1 million payment on our line-of-credit facility, and the remaining borrowings on this facility of $9 million as of June 30, 2012, carried an interest rate of 0.88%. During the quarter, the Company's cash balance increased by $15 million and now stands at $135 million. This concludes my prepared remarks.

Before we begin the question-and-answer session, I would like to mention that these comments and answers to certain questions contain forward-looking statements which are based on current expectations. Actual results could differ materially. For information about factors that could cause the actual results to differ materially, please refer to the Risk Factors section of our Form 10-K for the fiscal year ended June 30, 2011.

Jonathan, we are ready to begin the question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Jim Ricchiuti from Needham & Co.

Thank you. Good morning.

If we look at your current guidance and compare it with the preliminary outlook you provided in mid-June, what were some of the factors that have contributed to this somewhat more cautious view of the year? I think it sounds like you are seeing some increased commodity price pressure. But what are some of the other factors? It looks like China, as well, may have slowed for you.

I think you're pretty accurate. Certainly, it's the -- minor metals is really 80%, 90% of what changed our guidance. But we did and I tried to make those comments in what we are commenting on is the consumer spending volatility. China, whether they put out a new infrastructure program and things that are offsetting those downward thrusts are -- the business at AEGIS is doing better and our IR business is good and in the second half of the year we will have more of our Diamond product line sales, which is moving into the EUV.

I think we have some down, some up, and our net is really, if you boil it all down, is really affected by that minor metal write-off we had here in the last quarter and we see that coming along maybe again in the -- we have for the forecast no change in minor metals, but it's a concern we always have right now while this lack of demand is faced in the market.

Okay. That's helpful, Fran.

I wonder if you would be willing to talk a little bit about the outlook for the year as a whole for some of the major businesses. I think you've given us some sense as to directionally how things are going, but for instance, if we think of your Military Business all-in, what would you say that Business is going to do versus fiscal '12? And same question for Infrared Optics. It sounds like in the telecommunications market, it looks like you're expecting some continued growth in that market.

I think for us on our Military -- and I'm talking Military, not including the material side -- it would be in the high single-digit year-over-year growth. And that is driven a lot by our Sapphire product and our historical products. It's smaller growth than what we're used to in Military.

Go to the IR business -- probably a little bit bigger than that, driven mainly by the Diamond product in the second half of the year. So you might get to double-digit growth year-over-year on the top line there. Go to our -- you hit it pretty well on the Near-Infrared with our Telecom products. I think that's going to be better. We are off to a good start there.

Then go to our Advanced Products group. That might be a little less growth than what I said; it might be single digits because of the gesture recognition program, which seems to be running out and that's one we did pretty well on in the last two years. I don't think it's going to be that good in this year coming up.

The average, probably the higher performers would be IR, Near-IR, the Military part, and then the ones who would be on the smaller side will be the Materials business and that's really going to net out on what happens on the index prices in APG.

Thanks very much. That's helpful.

Avinash Kant, D.A. Davidson.

Good morning, Fran and Craig.

Question -- a little bit on the margin front, like with the guidance that you are giving at this point, and of course the impact from the metal pricing -- how do you see margins going forward especially in fiscal year '13, both on the growth and operating side?

Sure. I would say that we did factor that in, Avinash, into the guidance. I think, in the more detailed guidance we gave back in June, we were saying gross margins ranging from 38% to 40% of revenues. I think we are still in that range for our current guidance, but I'd say we are trending a little bit toward the lower side of that range.

As Fran mentioned, really, some of the minor metal items going on there for selenium and tellurium, and some other commodity costs -- but I would say still probably around that, still within that same 38% to 40% range, but trending toward the lower side.

Okay, and during the quarter also, when you gave guidance in mid-June, you had kind of accounted for roughly $0.03 in the -- because it's pricing and that seems to be coming in at the end of the quarter, too. So the differential between the guidance and the reporting is coming from --?

I think it was -- I think we were pretty much right there as far as the guidance on the write-offs. I think that was pretty much in line with where we thought. I think we ended up, as the quarter finished out, a little less strength in certain of our product lines -- I would say specifically maybe within our Infrared Optics product line -- maybe a little bit lighter than we had expected toward the end of the quarter. But I would say, all in all, pretty close to what we expected even when we factor in the expected write-off versus the actual write-off of tellurium.

Avinash, I would only add to that just light finish in the fourth quarter would be on our APG. In the past, we've had startup of really heavy work on gesture recognition in June this year. That didn't happen. It is being pushed out some.

Okay. You did talk about Photop, I believe. Did you say you saw Photop continuing to improve? Or it's going to be down some going forward sequentially?

No. They have had an improving trend here in the fourth quarter and we expect to see that for a few quarters. And if there's any more China infrastructure funding, it could do better than Q1, Q2.

Okay. Perfect. Thank you so much.

Mark Douglass, Longbow Research.

Good morning, gentlemen.

Looking at the relative earnings -- at least in IR -- sequential sales improvement, but earnings weakened. Can you talk to that? Did that show up in the gross margin line, the pricing concerns there? And what are you thinking about the gross margin in 2013 in IR?

I would say, overall, Mark, we came -- and just for calibration purposes, I think that the segment margin back in Q3 in the March quarter was about 27%; this quarter about 25%. Still very strong overall. The strongest of the Businesses we have. I think it was a bit higher commodity prices, a little bit more challenging pricing environment within IR, I would say would probably be the two things that added up there.

I would say we still continue to see good market strength and financial performance from HIGHYAG, but I would say a little bit more challenging on the cost side of things in the IR. I would say we're doing well overall on yields from the crystal growth, from a coding and fabrication perspective, but a little more challenged on the cost side and a little bit more challenged maybe on the pricing side.

The only thing I would add is maybe we missed what we thought we would ship in that unit by a few million dollars in the quarter, and that carries easily a 50% variable margin with it. That is probably the final reason why we are light in the dollars we could deliver for margin.

Okay. That's helpful.

In the face of the pricing, demand is mixed across a lot of the businesses. Have you been implementing more cost controls? What -- do you have plans to do more there? I don't see a lot of fixed costs. There's not much you can do about some of the fixed costs, but some of the variable costs? Are you --?

We really have gone into that. I didn't highlight it in this set of comments, but we have made major cost reductions, certainly in our APG unit, our Marlow unit -- all of our units we're really controlling all of those costs and adding to our staff, which in some cases maybe we should, we're being more frugal. Just what you said -- the volatility and the unpredictableness. One of our Businesses will be up, another will be down. This has been going on now for three, four quarters.

We are finding that uncertainty just as strong for the next few quarters so we're having to adjust. So we're keeping our costs under control.

Okay. But no explicit programs?

No, I would say each one of our 11 Businesses has an explicit program. Because we are four different business segments, 11 divisions, each one has a little bit different set of circumstances. But in general, we are applying it over the top of everything, with three or four units getting more of it because their business is more affected.

Okay. Thank you.

Jiwon Lee, Sidoti & Co.

Thank you, and good morning.

Fran, I just wanted to circle back and see if you can elaborate a little bit about the China OEM slowdown. Whether or not that is relatively recent events, and whether or not that relates more to the high-power, or the low- to mid-power?

I think maybe six months, nine months ago, we started to talk about really down being the low-power in China and high-power continued to go recently well. Now, it's almost a flip-flop. The high-power is just slowing quite dramatically for us. Low-power has been back up and it's hanging in there pretty good.

Aftermarket in China is good but not great. We haven't found all the lasers in China that were deployed out there in the last three, four years, so we still have a lot of market opportunity and aftermarket in China. We haven't been able to get as much as quick as we like, because we need to strengthen our sales force there and we have been working at it.

So I think we are coming, but I would say it is high-power OEMs that are not producing right now. It could be just the staffing up that they did in the country there over the last three, four years. There seems to be just a slowing for putting out more capital in terms of big laser systems. That is what we are seeing, and I think it seems to be, China on capital equipment in general right now, letting up a little bit.

Did I hear correctly then, the changes between mid-June and now relates mainly to the IR Optics and maybe some gesture recognition? Or was there something else?

I think it was -- if you are talking about for the guidance, you want to think we were pointing to PRM and factoring those changes in there. And then I think we did note that, secondarily, we've looked at and rethought the guidance for both IR as well as for Marlow, and I think those were really the factors, if you boil it all down, that were the negative factors.

Offsetting that, we have had some positive factors, and we do have some Businesses that look like they will be doing better than what we had forecasted a few months ago. But as far as the negative pieces, those were the three, really, in that order -- PRM, Marlow, and for IR.

That's helpful.

I wonder whether you can discuss a little bit about the revenue assumption you have for your Telecom business, the Photop and AEGIS? And what kind of a margin versus corporate average assumptions you built-in for that business, please?

We usually don't go into that degree of explanation. It's in our overall Photop guidance that we've made comments on. It is improving and it seems to go in a cycle of two to three quarters up and then down two to three.

It's the Telecom business. You know how that rolls; and it's really the Photop Telecom business is quite heavily impacted by what China is doing. Is the government going to stimulate the economy there? We are okay for the first quarter and maybe into the second. We have no visibility on third and fourth.

If they keep at this, it will be very, very good. If they put a little more out it will be very good. But if they decide not to prime the pump some more, we will be turning down a little bit. So it's hard for us to give more guidance.

Our Photop business is tied into the two or three pieces we talk about with the Green Laser, the Telecom Business, and the Optics Business. In general, we are bullish on that right now. We are happier with where we are, knowing -- we are looking at our world in the first half of this fiscal year and the second half; and we see up in the second half in a couple of our areas, be it IR Business, in the Military & Materials Business.

Photop we can't call what the second half is going to be compared to the first. So -- it's the same problem we've been having, which is reasonable visibility on all our Businesses with not so good visibility on our Photop business, which is a higher percent Telecom.

And Fran, on that Businesses, both Photop and AEGIS, you were, a while ago, fairly optimistic about some of the design wins that you had with OEMs. Has that changed a little bit? Or are you just as positive on that, Fran?

I think the design wins that we are the most pushing for are the AEGIS ones, and we've started to see them. In that AEGIS Business, and even the Photop -- between when somebody says, well, we're going to be using this product, and we're going to go system-wide with it -- until it happens, there might be three months, six months, there might even be a year and a half before the orders start to come.

Design wins to orders, yes, with a design win, you get some order a little prototype, and what we're looking for is something coming six months later. So we did have good results with AEGIS this quarter. A few design wins, but also the better orders from the work we had done previously.

Understood. And lastly from me -- obviously it is difficult in this environment, but if you were to think about the upside and the downside to the fiscal '13 outlook, just knowing and seeing what you do now, which area would that be?

You're asking whether we are up or down on our -- on what we've talked about?

Yes.

Oh, Okay. I think we are optimistic that this could be better. It is so driven by the worldwide economy and what happens the second half of the year, but we are seeing a good belief that it's going to get better. Consumer spending, how is it going to be over the holiday -- that will set up the second half of the year there. What's going to happen in our US political scene -- that affects us. But we are more optimistic than pessimistic against the numbers we just gave you.

Terrific. That's all for me. Thank you.

Doug Thomas. Mr. Thomas, please state your company name?

Jet Investment Research. Good morning.

The last question -- or your answers to the last question -- leads in to my question, which is -- and I appreciate the cautious outlook and so forth and the conservative tone. You have a buyback in place. I know you have to measure liquidity and all these other issues, but we have seen this before. The business always bounces back, conditions will improve over time.

Does what you are seeing in the market now make you inclined to want to repurchase more shares under your authorization? And how do you balance that against the other uses of cash here? Because obviously you've got a very strong balance sheet.

I would say, Doug -- and I'll let Fran make some comments as well -- I think we feel like we made good progress on the repurchase program in the quarter we just completed. I think we will be back to that, especially, as you have noted, in light of the strong cash generation we did have for the quarter and for the full year for that matter. I think it is something that would balance out. Obviously, we are very self-sufficient from a cash flow perspective, from capital spending point of view.

We're always looking for acquisitions that might get added into the II-VI organization; that's a potential use of cash; and then share repurchases. And I think our Board does a good job of managing and balancing out between those three demands pretty well. But I think we do see an improving outlook for many of our Businesses and I think we do feel deploying the capital in the repurchase program that is open right now is definitely a good move for us right now.

Fran, I will let you add on to that.

I think Craig hit it right on. Like we said in our announcement, we will be back finishing out our repurchase program. And whether we would do more than that, we are trying to balance. And we think we should be keeping, and we are doing -- we did this past year $40 million in CapEx, and this coming year, we are going to do $35 million to $30 million (sic -- see press release "$40 million"), in that range.

We are going to keep building the Business. If we find the right acquisition, we like having the cash available, but we don't have anything imminent. We're going to keep doing the right thing, which is deciding when we should buy more shares or not, or put it into other investments. And if we don't have the other investment to put it in, then we will have it on the balance sheet.

Okay. I appreciate it. Good call. Good color.

(Operator Instructions)

A follow-up question from Jim Ricchiuti from Needham & Co.

Fran, I was wondering -- you made some commentary around the Green Laser demand that you are seeing at Photop. Can you talk about the applications that are driving that?

I think I'd better not. It's a nice order. It's certainly a -- it's an unusual -- it is a bigger order than what our guys have had before in the Green Laser Business. That's about all I can go to. I really can't say, and that's why I didn't make a comment about it. I think we've got a good product and er were selected over a couple other alternatives. I can't go any further than that -- I'm sorry, Jim.

Okay, but it sounds like it is with one customer.

Yes. Yes. That's fair.

Is there the potential for a good follow-on business? Is that fair to characterize?

I think there could be three-year product deliveries like this and so on, but it would take another order or two. Yes. It is a good, good, good business. I'd like it to be longer but right now we have maybe that amount of visibility to see it out there maybe that far.

Okay. One final question from me -- you guys alluded to the balance sheet and the potential use of cash for acquisitions. How would you characterize the pipeline for opportunities you are seeing?

Good. There are a lot of opportunities that come that are now seen to be auctioned. People are thinking it is time to sell and they aren't the greatest businesses at times to be looking at. So some of them we really have passed on. Even today, we're talking to pass on one. But then we have some ones that we really are quite interested, and maybe moving along well.

And the ones -- whenever I say we're moving along well, when we get to a certain point and decide we're not going go higher on our price, then it falls off our -- what we're working on. So we have some that's right along in the right spot, but whether we could complete it or not depends on how the final things -- due diligence and a negotiation -- would work out. We are very active in it, but we are -- we really want to be selective to add businesses that are material-centered components that are connected to our materials, those type of businesses, and that have a good margin and growth potential.

Okay. Thanks a lot.

Jim Hollister, a private investor.

Good morning, gentlemen.

As I recall, the primary motive of your acquisition of Pacific Rim was to control the price of selenium in the use of your operations. Are there not cross currents in the diminution and price?

It does. You are right. The original purpose of our PRM acquisition, which was now a little bit more than five years ago, was to help with protection for that material. That business has expanded quite a bit since we acquired it. As Fran mentioned, we are moving now into a rare earth material that we are working on as well. So I think overall the purpose of the Business has worked well for us.

You are right, Jim, we somewhat root both ways for selenium because we are such a large consumer of it internally here for Infrared Optics, but it is also -- we do have quite a bit of external sales. Selenium is used for many metallurgical, agricultural applications as well. It is a Business that, unfortunately, because of the decrease in the index pricing, has been falling on some tough times lately. But if you look in totality over the five years that we have owned it, it has been a very strategic acquisition for us overall.

Fran, do you want to add anything to that?

No. I think you hit on to a difficult subject for us because of the way we have to account for these changes in selenium and tellurium is just the way we're doing it. We cannot hedge. There is no way to buy a hedge. It is such a small market. We cannot make any accruals. We know what's going to happen, and we know the price when it's going to go down because the demand fell off in photovoltaic so strongly. We couldn't hedge it. We couldn't provide an accrual for it, so this is the way we must do it.

We have a good optimism that, might be a year or so that, that business is going to come back. Probably the number one photovoltaic application which uses cadmium telluride is showing better results right now just by the leading company that's using that product. So if they are starting to see a little comeback, maybe our chance to get our products selling better and move that price up even a little bit six months out. But you can see it coming, but it's so far out, and we're having to take these write offs.

The only thing I can say, Jim, is the products are written off down to the market price now, and we can make a margin on top of that from what we add to the value of it, because it is the price of the raw material that we bought that we have written down. I think we will have some modest margin if we can just stop this erosion of the index price. Then after that we will be in very, very good shape.

Like Craig said, we've had a very good return on our PRM investment, which we bought very, very low priced at the time we bought it.

Out of curiosity, are you a consumer of tellurium as well?

Yes, we do use some tellurium. Our Marlow Business manufactures gross bismuth telluride, and that is used for all of our thermoelectric coolers. So we do consume tellurium -- not to quite the extent that we consume selenium, but we are a consumer of tellurium as well.

Thank you.

This does conclude the question-and-answer session of today's program. I would like to turn the program back over to management for any further remarks.

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ended September 30, 2012, is currently scheduled for Tuesday, October 23, 2012, before the market opens, with a conference call to follow that same day at 9.00 AM Eastern Time. Thank you for participating in today's conference call.