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II-IV Incorporated (NASDAQ:IIVI)

Q2 2013 Earnings Call

January 22, 2012 9:00 am ET

Executives

Francis Kramer – President, Chief Executive Officer

Craig Creaturo – Chief Financial Officer, Treasurer

Analysts

Avinash Kant – D.A. Davidson & Co.

Jim Ricchiuti – Needham & Co.

Mark Douglass – Longbow Research

Dave Kang – B. Riley Caris

Jiwon Lee – Sidoti & Co.

Operator

Good day ladies and gentlemen and welcome to the II-IV Incorporated Fiscal Year 2013 Second Quarter Earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session with instructions following at that time. If anyone requires assistance, please press star then zero on your touchtone phone. As a reminder, this conference is being recorded.

Now I’ll turn the conference over to your host, Chief Financial Officer and Treasurer, Craig Creaturo. Please begin.

Craig Creaturo

Thank you, Tyrone, and good morning everyone. I am Craig Creaturo, Chief Financial Officer and Treasure of II-IV Incorporated. Thank you for participating in the second quarter fiscal year 2013 II-IV Incorporated investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, January 22, 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.

Francis Kramer

Thank you, Craig. I am Francis Kramer, President and CEO of II-IV Incorporated. As I noted in the press release, our quarter came to an anti-climatic close when we experienced lower sales activity during the last few weeks of the quarter than what we’d anticipated. In spite of this, we can say II-IV had one of its most active quarters ever. It was a quarter in which we completed three acquisitions and each will be a new part of a different business segment within II-IV. Also during the quarter, we significantly expanded our credit facility and settled a contractual obligation that we had been working on since the Thailand flood in October of 2011.

I’ll now turn my attention to a review of each of our business segments. During the second quarter in infrared optics, which includes HIGHYAG, we had bookings of $44.6 million, up 2% compared to the second quarter of FY12. There was a significant shift in the composition of our bookings. Japan bookings were $4.5 million for the quarter, down $2 million year-over-year. This was offset by increased bookings in Germany, Taiwan, Korea and North America. North America bookings increased 4% year-over-year, however was down 16% from the first quarter of fiscal year ’13. We feel this is a result of a decrease in laser utilization driven by the holidays in November and December combined with the business cautiousness over the fiscal cliff, sequestration, and worldwide economic concerns.

For our IR optics business in the U.S., orders and shipments from domestic OEMs decreased 15% quarter-over-quarter. This was a result of timing of blanket orders from both high and low-power OEMs and softer demand for replacement parts from our high-power OEM customers. After-market bookings declined 16% quarter-over-quarter as a result of the declining machine utilization rates. The outlook for the third quarter and 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 second quarter were down 2% compared to the first quarter while the European aftermarket was up 4% quarter-over-quarter, reflecting our increased efforts to expand our support into this region. Our diamond optical windows for the EUV photolithography systems business continued to grow as projected during the quarter.

Asia bookings were down 5% quarter-over-quarter, driven mainly by the softening of the Japanese economy. Both the low and high-power Japanese OEMs have slowed production rates compared to the first quarter. Japan bookings were down 4% from the first quarter of FY13. China bookings were down in the second quarter but indications point toward some recovery during the third quarter. Bookings finished down 26% from the first quarter but up 12% year-over-year. The sales of variable radius mirrors, the aftermarket sales and penetrating the glass tube laser suppliers continues to show positive results.

At HIGHYAG, bookings of 4.7 million for the second quarter were down 30% quarter-over-quarter and year-over-year. We continued to ship from our backlog, which was reduced by 3.9 million in fiscal year ’13. Although we have seen a softening in the bookings, we continue to see growth in 1 micron welding, beam delivery, and 1 micron laser cutting. In order to take advantage of these opportunities, we continue to add manufacturing capacity and increase our staff to serve these markets.

Now moving to the near infrared optics segment, bookings during the second quarter compared to the same quarter last year were up 19% to $35.7 million while segment revenues were up 14% to 37 million. The bookings increase was attributable to increased demand for Photop’s green laser devices along with one month of bookings relating to the acquisition of the assets of Oclaro’s Santa Rosa thin film operation and the Oclaro Interleaver product line that we acquired in December. We are excited to have purchased these assets and to supply Oclaro and other customers solidly as we take over these operations.

The revenue increase was driven by improvements across most of the Photop and Aegis product lines, although the telecom component business did experience a softening during the end of the quarter. Compared to the first quarter of fiscal year ’13, near-IR bookings were up sequentially 2%. Near-IR revenues were down 9% from the first quarter of FY13 due to a softening in the telecom component business. We are pleased with the segment earnings improvement from the near-IR, which is up 115% from the December quarter compared to last year, driven by higher sales volume, better operational execution, and recovery from the Thailand flooding.

At Photop, despite the second quarter revenues being up 10% year-over-year, they decreased 8% sequentially from the first quarter. Revenues were impacted by lower vendor managed inventory demand at the end of the quarter by a major customer, several holiday periods in China, North America and Europe, and general market softening in the telecom component business. During the second quarter, the telecom component business experienced a slowdown in the legacy products for the China and Asia markets in EDFA components, switching, and WDM products. In the telecom related R&D area, Photop made good progress towards the final development of high end components and module products for the next generation high-speed network requirements of its customers, such as 100G ICR, tunable pump splitters, multi-cast switches, and EDFA arrays.

At Photop, we continue the integration with Aegis Lightwave on R&D programs, our initiative to improve customer service, and our efforts to reduce time to market of new products. On January 7, 2013, we completed the move of Aegis Lightwave under the Photop brand identity. Aegis Lightwave Incorporated, based in Woburn, Massachusetts will now operate as Photop Aegis. Its subsidiary, AOFR PTY Limited, based in Australia, has been renamed Photop AOFR PT Limited. The merger will allow us to better serve an expanding global customer base with coordinated sales, marketing, applications engineering, and product development activities using the combined resources, complementary expertise, and global reach of Photop.

The Photop laser business revenues increased by over 10% quarter-over-quarter due to the increasing demand and volume delivery of laser devices in the laser module assemblies, driven by several applications in the life science and the broad industrial markets. Photop’s optics business revenue experienced weakness in the second quarter in telecom and industrial laser optics markets. Fiber-to-the-home filter shipments dropped due to the seasonal demand softening and pricing pressure from competition on the legacy GPON and EPON filter products.

Industrial laser optics revenue decreased slightly during the quarter; however, we also achieved several key wins in optics for new product initiatives in telecom optics, industrial lasers, and instrumentation. These include new products like gratings, f-beta lens, and neocrystals. During the quarter, Photop completed the acquisition of the Oclaro Santa Rosa thin film filter operations and the Oclaro Interleaver product line. The integration of this business is progressing very well. We expect to see growth in the telecom and life science filter businesses as we supply Oclaro and other customers.

Now at Photop Aegis, second quarter revenues were down 19% compared to the first quarter of FY13 but were up 48% over the same quarter one year ago. The sequential quarter-over-quarter decline is a result of reduced demand for Aegis’ legacy products. Aegis continues to see growing demand in China and globally for its high-power laser combiners serving the industrial fiber laser markets. Aegis continues to expand its manufacturing capacity at Photop for its next generation optical channel monitors for the ROAD-M market and for high power fiber laser combiners serving the industrial fiber laser market.

In collaboration with Photop, ongoing investment is being made in low-cost, small form factor and high performance OCMs that address the flexible bandwidth requirements of transmission networks with data rates of 100Gbps, 400 Gbps, and beyond. Similarly, AOFR continues to expand its portfolio of high power fiber laser combiners for fiber laser applications consistent with the broadening of the fiber laser components across Photop.

Also during the quarter, as noted in our press release, final settlement was reached on the fiscal year ’12 Thailand flood-related damages. Craig will touch on this further in his remarks.

Now moving to the military and materials segment, during the second quarter bookings of $27.5 million were lower by 13% compared to a year ago. This shortfall was made up of lower Sapphire bookings in our military segment and lower demand for selenium products in our materials business. Compared to the first quarter, bookings increased by nearly $10 million, of which 70% was attributed to our military businesses and 30% to our materials business.

Revenues for the second quarter of $21.4 million decreased 30% from the second quarter of last fiscal year and 11% from the first quarter of this fiscal year. Both the year-over-year reduction in bookings and the reduction in quarterly revenues are the result of weakness in our materials business. Overall, the booking and revenue outlook for the remainder of this fiscal year as compared to the first half is expected to improve. This is driven by the additional bookings and revenue associated with the acquisition of LightWorks and also increased bookings and shipments for EEO products.

We do continue to see potential softness in the military business related to the federal budget uncertainty and the threat of sequestration. In our materials business, selenium and tellurium demands remain weak and our new product line start-up is slower than anticipated.

So now our military business is comprised of recently the acquisition of LightWorks announced last month, combined with EEO, which is Exotic Electro-Optics, with VLOC and with MLA, which is Max Levy Autograph. LightWorks, based in California, manufactures precision optical systems and components, including visible, infrared and laser-based systems and sub-assemblies addressing the defense, aerospace, industrial and life science markets. We are excited about the opportunities that LightWorks brings to the military business. This acquisition will provide increased market share in intelligence, surveillance and reconnaissance, which we call ISR, and these are defense applications which continue to receive favorable funding the defense budget. LightWorks has a considerable foreign military sales portion to their business that provides a solid base for the next several years.

During the past quarter, the military business had several significant production orders and design wins. These include a production order for missile warning systems, prototype development orders for patterns, ceramic ray domes for high speed missile applications, and infrared windows and optics for ISR applications. In addition, we are pleased to see new activity in our medical assembly business with a development order to support next generation laser eye surgery requirements.

In our materials business at PRM, we continue to experience low demand for our tellurium products due to a slowing in the photovoltaic market attributed to a large build-up of tellurium inventory in the supply chain. Although we were able to offset a significant portion of the shortfall in the photovoltaic business during the first quarter by servicing other markets, that alternative was not available this past quarter. We also experienced lower demand for our selenium product from the agricultural feed market as falling index prices caused buyers to delay purchases in anticipation of further price declines. Additionally, lower than expected output from our new rare earth product line added to the weak performance of this business unit.

The selenium index price decreased from $43 per pound at the beginning of the quarter to $40 at the end. The tellurium index price was volatile during the second quarter, starting at $110 per kilogram, increasing to $120, then slowly dropping back to $110 per kg by the end of the quarter. The changes in index price combined with timing of raw material deliveries resulted in an inventory write-down of $800,000 for the quarter.

We continue to experience production difficulties in our new rare earth product operation. Yields are improving and we are producing and shipping product; however, yields are below expectations and currently not sufficient to achieve our targeted revenue or financial results.

Moving to the advanced product groups, MCubed Technologies Incorporated during the quarter was acquired, and we are excited about it. Bookings for the two months as part of the II-IV organization were in line with expectations. Some softness was experienced in the semiconductor capital equipment sector for silicon carbide components, while the shortfall was fully offset by orders from metal matrix composite components serving customers in the display, defense and industrial markets. Revenue continued to favor the semiconductor sector, which was bolstered by next generation prototype component orders.

On the manufacturing front, work continues on our precision products division expansion within the MCubed Technologies business, with the construction of new clean room manufacturing facilities to support next generation production of the 450 mm semiconductor tool components. Construction at our Newtown, Connecticut facility is anticipated to be completed in February, permitting production to commence at the site during the third quarter of fiscal year ’13.

Development efforts remain focused on next generation semiconductor components and assemblies required to support OEM customers in lithography, inspection and metrology areas. We are also advancing initiatives in the defense and refractory areas material development programs designed to meet greater threat levels or higher temperature operating conditions.

At Marlow Industries, bookings for the second quarter were up 34% year-over-year, primarily due to increases in defense driven product orders which are our legacy products, end-of-life purchases for a major automotive product platform, and new product introductions in the life sciences market. These increases offset reductions in the gesture recognition consumer market. Overall bookings for the quarter were down 7% quarter-over-quarter due to reduced demand in gesture recognition and telecom markets, and were partially offset by the increases in the automotive and life sciences market. Revenues for the second quarter were down 6% primarily due to reductions in the gesture recognition market, driven by weaker consumer demand as well as a reduction in our automotive business as we approach the end of life for this product line and our government R&D contracts. These reductions partially offset the increased revenue in defense that focused on legacy products for repair parts. Revenue increased 4% quarter-over-quarter as stronger revenues in defense and power generation offset the decline in our gesture recognition business.

The personal comfort market continues to develop with the shipments of prototype products to customers. We added another offering to our Climatherm product line this quarter which is aimed at the less than 100 watt cooling market segment. The Climatherm product line continues to sell well in Europe. We had multiple design wins this quarter. We continue to see an increase in activity and interest in our EverGen energy harvesting solutions. With these products, customers can harvest otherwise wasted energy from the temperature differences that exist in a variety of different environments to power wireless sensors and actuators. We have made significant efforts to align our costs with our revenues to mitigate market uncertainties and to focus our efforts toward the most promising markets.

At our Wide Bandgap Materials Group, our year-over-year second quarter bookings were down 70% due to the de-booking of a large blanket order for 100 mm N-type substrates by WBG’s customer, Semi South, which announced during the quarter that it would cease operations. In addition to the impact on bookings, the Semi South closing also had a negative impact on revenue. WBG total revenues for the second quarter were down 40% compared to the previous quarter, and 33% year-over-year.

Shipments for semi-insulating substrates for RF applications were down from the prior quarter. Customer demand for production deliveries and the completion of qualification programs of their devices on our substrates for both the wireless infrastructure market and the defense sector continues to slow. During the second quarter, we did see increasing interest in our 150 mm diameter products and expect shipments of 150 mm N-type silicon carbide substrates to increase in volume as well as increase in the number of customers in the second half of FY13. In the second quarter, we received a large blanket order from a domestic OEM for 150 mm semi-insulating substrates for RF applications.

Growth in the power device market based on the need for large diameter silicon carbide substrates continues to be driven by the promise of more energy efficient products and solutions. The rapid advancement of early introduction of 150 mm diameter substrates should enable device manufacturers to lower their device costs, enable them to manufacture using existing 150 mm diameter silicon and gallium arsenide device processing lines. We believe this will expand the potential market share for silicon carbide devices and accelerate the transition to 150 mm. We continue to add capacity in our Mississippi facility, and in the third quarter we expect delivery of new fabrication, polishing and characterization tools specifically targeted towards increasing our capability for manufacturing 150 mm substrates.

In summary, although we had many challenges during the quarter, we have confidence in the future of II-IV. This confidence has been bolstered by our three recent acquisitions that have been combined under the management of each of three different material-centric business segments. We remain focused, as usual, on our consistent growth and profitability across the multiple markets that we serve. Our quarter cash generation is strong and our product backlog without the effect of recent acquisitions is 9% above last quarter. We are optimistic that the worldwide economies will gradually improve as some of the uncertainty in the U.S. is sorted out.

Craig, this concludes my comments.

Craig Creaturo

Thank you, Fran. Here are the items I would like to highlight before we open the question and answer portion of this call.

As described in today’s press release, consolidated bookings for the quarter ended December 31, 2012 were 127.1 million, 9% higher than the same quarter last fiscal year. In addition, as a result of our three acquisitions completed during the quarter, we acquired 36 million in backlog. Total company backlog at December 31, 2012 was 199 million, up 23% or 38 million from the September 30, 2012 backlog. The components of the backlog at December 31, 2012 were: infrared optics at 44 million, near-infrared optics at 36 million, military and materials at 79 million, and advanced products group at 40 million.

We finalized our settlement during the quarter with the company’s former contract manufacturer in Thailand as a result of the October 2011 flooding. As part of this settlement agreement, the company will receive approximately $5.3 million as a result of damage to our equipment and inventory that was lost in the Thailand flooding event. As of December 31, 2012, we have received 2.8 million in cash and will receive the balance - $2.5 million – no later than April 1, 2013. We recorded $800,000 as a credit to cost of goods sold in the current quarter as the recovery of what was expensed in cost of goods sold in Q2 of FY12 and recognized a balance in other expense in the condensed consolidated statements of earnings.

During the current quarter, the company repurchased 4.9 million of its common stock as part of the $25 million Board-authorized repurchase program announced in May 2012. The number of shares repurchased during the December quarter was 300,000. To date, the company has repurchased approximately 919,000 shares for a total of $15.8 million. It is the intent of the company to continue with the Board-approved purchases for the remainder of fiscal year ’13 in accordance with the 10(b)(18) rules. We have not forecasted further decreases in our share count beyond the actual purchases made to date in the outlook that was included in today’s press release. We plan to continue to report the actual repurchase activity as part of our future quarterly earnings releases.

The year-to-date effective income tax rate was 30% compared to 20% for the same period last fiscal year. The higher effective tax rate is primarily due to a shift in earnings to higher taxing jurisdictions along with some specific items that were required to be recorded in the current quarter that will be recovered before the end of the fiscal year. In spite of the high tax rate during the just-completed quarter, we are still expecting the income tax rate for the fiscal year 2013 to range between 23 and 25%.

During the just-completed quarter, we entered into a new $140 million line of credit facility that has an additional $35 million expandable borrowing option. Interest currently accrues at LIBOR plus 1.25%. We had 121 million borrowed on this facility as of December 31, 2012 to help fund our recent acquisitions as well as our share repurchases. The interest rate on our borrowings at December 31, 2012 was approximately 1.5%.

During the six months ended December 31, 2012, we generated approximately $61 million in cash from operations, a 41% increase from the same period last fiscal year. During the quarter, we used $7 million of our cash for capital expenditures and 5 million for the share repurchase program. We also acquired approximately $6 million in cash as part of the MCubed transaction. During the quarter, our cash balance increased by $10 million and now stands at $163 million with about 70% of this amount residing outside of the United States.

Fran, 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, 2012.

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

Question and Answer Session

Operator

Thank you. [Operator instructions]

Our first question is from Avinash Kant of D.A. Davidson & Company. Your line is open.

Avinash Kant – D.A. Davidson & Co.

Good morning Fran and Craig. I just wanted to check a number, then had a question, actually. The first one to verify, if I looked at all the charges that you had during the quarter, excluding the impact the EPS would have been $0.17, right?

Craig Creaturo

I think that’s right; and again, Avinash, that’s one of the reasons we put all of the details in there and tried to spell them out, but I think you’re doing the math correctly.

Avinash Kant – D.A. Davidson & Co.

Okay. And then could you give us some idea about—you know, you’ve done three acquisitions in the current quarter. If you take the combined contribution of all these three – and maybe you can break it down or kind of give us some idea – how much of it is in the guidance that you’re putting out for fiscal year ’13 that is coming in from all these acquisitions, (talkover) EPS terms.

Craig Creaturo

Sure, and maybe just to give you a perspective on it maybe for the just-completed quarter and then we’ll look out into the guidance for the full year. In the just-completed quarter, in our financials we had MCubed in there for two months, we had the business and product line we bought from Oclaro was in there for one month, and the LightWorks acquisition really made no contribution to speak of in the December quarter. So two months, one month and zero months respectively in the quarter we just completed, and that was total sales-wise and bookings-wise, Avinash, for two months worth of MCubed, one month worth of the businesses we acquired from Oclaro. It was approximately $8 million or so in total revenues and bookings.

When you look into the full fiscal year guidance, we are still on track to do around a similar run rate to what we had anticipated. We do anticipate that we would have for MCubed somewhere around 32 to $34 million or so. That’s pretty consistent with what we said back in the November 1, 2012 press release, and we do think both LightWorks and the businesses we bought from Oclaro, they will contribute but it will be at a much lower run rate than the MCubed transaction itself. That will be somewhere around the 15 million to $20 million range – again, some things are still a little bit new to us as far as both those businesses go. We don’t have quite a track record yet as to how they’ll contribute, but that should generally give you some expectation there.

Avinash Kant – D.A. Davidson & Co.

So that begs one question, though – if you look at the contribution in the quarter that you had for 8 million or so in revenue terms and if you look at the guidance that you had given prior to this quarter that was 128 to 132 million, where did the shortfall come from in the core business?

Craig Creaturo

Yeah, I think it really came really in a couple areas, and our PRM business specifically was probably the biggest shortfall as far as where our expectations were for the quarter and where they actually ended up for the quarter. And then as Fran mentioned in his comments, we did see some softness especially in our industrial businesses, I would say, as he mentioned, in our HIGHYAG and infrared optics businesses specifically, more so right at the end of the quarter, Avinash. It was relatively strong throughout the quarter but really saw a somewhat unusual finish to the quarter – not a lot of activity in the last couple weeks for many of our industrial businesses.

Fran, did you want to add anything?

Avinash Kant – D.A. Davidson & Co.

But have you seen that come back a little bit, the weakness that you saw, or has it stayed at that level from the last quarter?

Francis Kramer

I would say just one that just adds a little bit of bad news to us in the past quarter. We had the telecom component business a little short in December, so you put the three things together that Craig talked about – PRM, a bit in the IR and a bit in telecom – that’s what hit us, and then looking at coming back, the IR business seems stronger so far, but this is a month-to-month—you know, almost a month into it, so I think the IR might be better. No news yet that I can tell you about on either the PRM except that the problems that we did have at PRM in the quarter, the selenium and tellurium index price thing, it remains volatile. But we haven’t had a big shift yet, and our rare earth product line work, as I stated, we’re making some progress, we’re shipping. It’s not enough yet to get it to the level we expect.

So better news in IR, PRM holding its own, and our Photop business, I think it’s going to be about the same. I don’t have a real indicator because telecom has runs on such a short fuse. But we’re in good position with all our customers, and telecom is just I can’t tell you. Our forecast does have a slight improvement as we finish the year at Photop also.

Avinash Kant – D.A. Davidson & Co.

Thanks Fran and thanks Craig. Thank you.

Operator

Thank you. Our next question is from Jim Ricchiuti of Needham & Company. Your line is open.

Jim Ricchiuti – Needham & Co.

Hi, thank you. So if we look at your full-year guidance excluding the acquisitions, it seems like you’re looking for potentially revenues to be down modestly to flat, and I’m trying to get a sense – are the same factors that contributed to the shortfall, revenue shortfall in the December quarter, are they the same factors that you’re seeing for the full-year? Where are you in terms of more cautious for the full year?

Francis Kramer

I think you’re right – we are cautious for the full year, and I tried to state that, that the volatility in selenium/tellurium is something we just can’t predict, and we thought we’d gotten ahead of that but it still continues to jump around; and then the uncertainty in the worldwide economy on how it drives consumer consumption, and that’s really a big factor for laser utilization in the IR business. So those two factors kind of taint our third and fourth quarter forecast. I think we’ll do better at our PRM in controlling the selenium/tellurium exposure we have. In IR, it appears to be trending up for how the confidence is happening because some of our belief on how lasers get utilized relative to consumer consumption, there is a lag and then there is a build-up in the supply chain, which causes some changes on how we receive orders for that business. So it’s harder to predict a little bit now with this volatility in the worldwide economies, but I think we’re feeling better. Our numbers might show it a little bit conservative, but we’re affected by what we’ve been through here in the last couple quarters.

Jim Ricchiuti – Needham & Co.

Got it. And Fran, you also alluded to just some ongoing issues on the new rare earth production line. Can you talk a little bit about that, and to what extent do you think—what’s the timeline, do you think, to get back on track there?

Francis Kramer

Boy, we have been really at this now six, eight months, and we keep coming into one bottleneck and then another. We’re working through them. I think we’ve got one idea that’s going to help our output quite nicely, but it’s not enough to get us to the production rate we need. So I can’t give a good, solid answer, but our belief is maybe within the six months we’ll get to the rate we need to be.

But we have to take them one problem at the time. It’s a processing line, so if you have a bottleneck in the front part of the process, you never get to touch the back end of the process until you get the front one cleared. We have three or four stages, and we’ve been working them—trying to do them simultaneously, but it just hasn’t worked out. We’ve been bottlenecked at the first stage and at the second, and now I think we’re working well on improving the second stage and then so we have the third and fourth stage of the process that are, I think, really yet to be tested. We’re maybe at—you know, something like maybe half where we want to be on the rate through the line.

Jim Ricchiuti – Needham & Co.

Got it. And one final question – just apart from sequestration, you seemed to suggest a little better tone in the second half on the military materials side of the business and your confidence in that. Maybe I’m reading too much into it.

Francis Kramer

I think for our traditional EEO, VLOC, Max Levy businesses, we’re at the same level of confidence on that military business as we’ve been. It’s okay. It’s not booming, but it’s okay. The one that we are getting more confidence on is LightWorks and that acquisition and the amount of business that we think will come with it, and it’s at least half booked that we were counting on and it’s a foreign military sales opportunity that will carry on for some time, which is for us offsetting or helping with this sequestration and the cut-down in U.S. spending. This will be not affected by that.

Jim Ricchiuti – Needham & Co.

Okay, thank you.

Operator

Thank you. Our next question is from Mark Douglass of Longbow Research. Your line is open.

Mark Douglass – Longbow Research

Hi, good morning gentlemen. Craig, so just to get some clarification, the full-year guidance is GAAP at this point?

Craig Creaturo

Yeah, the full-year guidance, Mark, it’s in the—on the outlook page or the guidance page, Page 2 or 3 of the press release. That is GAAP information.

Mark Douglass – Longbow Research

Okay, great. Thank you. And then if we look at HIGHYAG, Fran, is some of the drop-off at the end timing? You know, people finished a lot at the end of year rush, and then the last couple months the equipment bookings just kind of fell off as they digest all the new equipment that was installed in 2012? It seemed like there was a lot installed in 2012, and so then how did the projects or RFQs look at this point versus where you were in December?

Francis Kramer

I think it’s a little bit of just what you said – it’s been very rapid. We’ve ramped up at HIGHYAG very nicely and now we’re getting a little bit of a lull here as people digest and put in the systems that we’ve sold. We’ve sold well into the U.S. for welding applications, and those are automotive. Those might be slowing a little. The rest of the world has done well in some—you know, Japan, certainly Germany where we’re headquartered. But I think it’s kind of the fiber laser deployment rate seems to be flat, and our view of it – and we don’t have a complete view – but our belief is maybe 1,200 high power fiber lasers are going out to the marketplace at the current running rate, which might be consistent with what it was the prior 12 months or so.

So we think fiber laser is getting some real traction, but maybe they’re having a lull right now as the first users put those machines out there and they are trying to digest them. It’s happened to us at HIGHYAG, and we took our forecast down in the third and fourth quarter just because of what we’re seeing.

Mark Douglass – Longbow Research

Okay, that’s helpful. Any market share issues or shifts?

Francis Kramer

On HIGHYAG?

Mark Douglass – Longbow Research

Yes.

Francis Kramer

I’m not able to comment on that. I don’t think we feel we’re losing. You know, we sell at kind of a high-end position on the product we offer into that space, so some of the mid to lower end system applications, there’s a lot of shifting going on. I think a lot of Chinese, Indian, other parts of the world system builders who buy somebody else’s fiber laser and put it on a system are entering the market, but we’re not in that space. We’re watching it.

Mark Douglass – Longbow Research

Okay. And then you mentioned maybe how many high power fibers are getting shipped. What do you think is happening right now in high power CO2, you know, the 2D cutting? Are we closer to 4,500 per year run rate, or what do you see in that market?

Francis Kramer

Yeah, I think you’re right. Last quarter I reported about 4,800 was the annual running rate of CO2. Right now, we would probably say 4,000. You can see from our customers, they are down and I think that’s 90% due to the worldwide economy, laser utilization not being as much so people aren’t buying new; and maybe 10% due to just other alternatives.

Mark Douglass – Longbow Research

Okay. And then one last question, just a little more clarification. When you ranked the revenue guidance dropping, at least (inaudible) organic basis, PRM is the biggest impact. Is most of that still selenium/tellurium, or is that also just—I mean, it seemed like in the second half you are expecting a pretty good ramp in this rare earth, and I’m reading that that’s a pretty significant impact to the guidance.

Francis Kramer

For me—Craig might clear me up a little bit. When I looked at the numbers, it’s about 50% due to the rare earth deal of our being off at PRM, and 50% on selenium/tellurium.

Craig Creaturo

Yeah, I would agree with that, Mark. It’s really a combination of both factors, and again, we’ve seen some price stability relatively speaking in both selenium and tellurium. But really where we have not seen a lot of strength has been especially on the tellurium market. That market demand just has not shown itself just yet. We’ve got some challenges on the selenium side as well, but I think to Fran’s point, I think it is kind of somewhat of an even split between the legacy products, selenium/tellurium, and our rare earth product.

Mark Douglass – Longbow Research

Even though the pricing seems fairly stable, the demand continues to fall, at least year-over-year?

Craig Creaturo

Yeah, and I just don’t sense, Mark, that we see a big break-out on the horizon specifically for the tellurium market. It just doesn’t seem like that’s something that’s imminent, at least in the near term here, so.

Mark Douglass – Longbow Research

Okay, thank you.

Operator

Thank you. Our next question is from Dave Kang of B. Riley Caris. Your line is open.

Dave Kang – B. Riley Caris

Good morning. First, a couple of clarifications. When you said—Fran, when you said Photop was down 8% sequentially, was it revenues or bookings?

Francis Kramer

Gee, let me check my note on that. So Photop was down sequentially? Yeah – revenues.

Dave Kang – B. Riley Caris

Revenues – got it. And then also regarding Photop, you saw a weakness by major OEM or OEMs. Was it singular or plural? I just wanted to clarify that.

Francis Kramer

I think it was a plural comment, Dave. I think it was just kind of something we were seeing. We saw a bit of softness across more than just one OEM at the end of the (talkover).

Dave Kang – B. Riley Caris

Oh, I see. And would you say they are more Chinese-related customers, or--?

Francis Kramer

I think that mix is pretty spread.

Dave Kang – B. Riley Caris

Oh really? Okay. And then I thought you said you expect Photop to be flat, sort of flat this quarter, Q3. I’m hearing China is still soft, so are you counting on some other region, like the U.S., to come back to make up that softness in China, or--?

Craig Creaturo

I think they’re servicing a worldwide customer base, Dave. I think we’ve also anticipated or put into that forecast the recent assets that we acquired from Oclaro and how that will contribute.

Dave Kang – B. Riley Caris

Oh, I see. I see. So you’ve got some acquisitions making up the difference, then?

Craig Creaturo

That is correct. I think the broader point is that I think some of the recent acquisition revenues will help to offset a little bit of this softness that Fran was talking about that we’re seeing, so.

Dave Kang – B. Riley Caris

Okay, So just wanted to clarify as far as the secular trend is concerned then. Then without acquisitions, apples to apples, would you say Photop business would be down sequentially, then?

Francis Kramer

No, I wouldn’t do that. I would say third quarter might be looking like the second, but I think the fourth quarter will be up. It’s such a volatile business, the telecom space, and we see having had a couple down, it looks like the fourth quarter will start back up.

Dave Kang – B. Riley Caris

So why such weakness? I mean, we are hearing all this CAPEX going up and all that, so we were expecting things to improve. Why aren’t the vendors seeing that improvement?

Francis Kramer

I think it’s the delay and the chain reaction as cutbacks happen. We get it a little bit later, and as things turn up we get it a little bit later. So I think it’s having to do with just-yeah, I understand people think it’s going to head up a little bit in telecom. We’re a little more cautious until we get that order, and so we’re putting it in the fourth quarter.

Dave Kang – B. Riley Caris

Mm-hmm, okay. So fourth quarter, June quarter. And then does Photop go through the annual pricing negotiation in early January?

Francis Kramer

It depends. All their accounts are spread around the world. Some ask for price reductions or price work quarterly, if you know what I mean, so I cannot give you a good comment on that.

Dave Kang – B. Riley Caris

I see. So some of your peers are saying 10 to 15%. Where do you think the 2013 annual pricing will be? Still at 10 to 15%, low end, high end? What’s your gut feel?

Francis Kramer

I couldn’t make a good comment there, Dave.

Dave Kang – B. Riley Caris

Okay, great. Thank you.

Operator

Thank you. Again, ladies and gentlemen, if you have a question, please press star then one on your touchtone phone. Again, if you have a question, please press star then one on your touchtone phone.

Our next question is from Jiwon Lee. Your line is open.

Jiwon Lee – Sidoti & Co.

Thank you. Most of my questions were answered, but Fran, I wanted to ask if you could provide some geographic color for your IR optics that you see for the second half of fiscal year.

Francis Kramer

I think it’s going to come—certainly Japan is off so far, so they are going to come a little bit back, there is no doubt about it. So that’s going to have the biggest percent up. The rest of the world, whether it’s China, which is doing well, I think it will be nice. North America – fine. Europe, that’s probably maybe the laggard on percent that we might have them guided to be up in third and fourth quarter.

Jiwon Lee – Sidoti & Co.

Okay. And Fran, on the HIGHYAG side, I wasn’t sure if I heard everything you said on the competition front.

Francis Kramer

Yeah, on the IR business you’re thinking, or any one of them? I don’t think I—

Jiwon Lee – Sidoti & Co.

Specifically on HIGHYAG, please.

Francis Kramer

Oh, in HIGHYAG.

Craig Creaturo

I think Fran’s comments overall, Jiwon, were we’re kind of serving the high end markets there. I don’t think we’re seeing anything. I think Fran was saying we don’t believe we’re losing market share. I think it’s just a little bit of a slower kind of rate of systems add-on components that we manufacture, I think that’s slowed down. We don’t believe that we’re losing market share necessarily.

Jiwon Lee – Sidoti & Co.

Okay, and then on the PRM side of things, just kind of understanding the business environment that you have now, how much would the tellurium pricing have to fall down again for more write-downs?

Craig Creaturo

We’ve kind of marked it down to where—for both the selenium and tellurium, Jiwon, we’ve marked it down to where they ended the quarter and prices were. Again, for tellurium, that was $110 per kilogram, and for selenium that was $40 per pound. So any further changes thereafter, we would need to make adjustments in our inventory, something we do every month, something we’ve been reporting every quarter.

Jiwon Lee – Sidoti & Co.

Okay, my last question – it seems to me that you are expecting some revenue upturn in the March quarter from your commercial IR optics, and the combination of that business rising up a little bit and the acquisitions, especially the MCubed, I guess that’s the primary source of your EPS up even though on an organic basis the revenue seems to be rather flat, correct?

Craig Creaturo

I think that’s a good summation of it, Jiwon. I think you’re right on. Again, I think we also believe too that we had a higher than usual tax rate this quarter. We’re kind of sticking to our overall guidance for the tax rate, so we believe Q3 and Q4 tax rates will be lower than what we’ve experience in the average of Q1 and Q2 here. So we think that’s also a contributing factor that will drop down to the bottom line as well.

Jiwon Lee – Sidoti & Co.

Okay, that’s helpful. Thank you.

Operator

Thank you. I’m showing no further questions at this time. I’d like to turn the conference over to Mr. Creaturo for any closing remarks.

Craig Creaturo

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ending March 31, 2013 is currently scheduled for Tuesday, April 23, 2013 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.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Have a wonderful day.

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