Good day, ladies and gentlemen, and welcome to the II-VI Incorporated Fiscal Year 2016 First Quarter Earnings 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, today’s conference is being recorded. I’d like to introduce your host for today’s conference Ms. Mary Jane Raymond, Chief Financial Officer. Ma'am, please go ahead..

Thank you, Michelle, and good morning. I'm Mary Jane Raymond, the Chief Financial Officer here at II-VI Incorporated. Welcome to our first quarter earnings call for fiscal year 2016. With me on the call today is Francis Kramer, our Chairman and Chief Executive Officer; and Dr. Chuck Mattera, our President and Chief Operating Officer.

As a reminder, this call is recorded on Tuesday, October 27, 2015. Any forward-looking statements we may make during this teleconference are given in the context of today only. We do not undertake any obligation to update these statements to reflect events subsequent to today. With that, let me turn it over to Fran Kramer, our Chairman and CEO..

Thank you, Mary Jane, and thanks to everyone for joining us. We had a good quarter with growth in both bookings and revenues over the first quarter of last year. This year’s first quarter was marked by particularly strong demand from the optical communication markets.

During fiscal year 2016, we expect to make progress across all markets, especially industrial, communications, and military, which makes up over 80% of our revenue. We do see slowing growth in China and continued stagnation in the Eurozone which we are monitoring closely.

We have restarted our review of potential acquisitions and are looking at differentiated opportunities with engineered materials competencies in area where we have unique expertise and have been able to drive significant competitive advantages.

With investments made over the last 18 to 24 months, expansion of our product portfolio and customer base and the improvements in our cost structure, we expect to deliver another year of solid performance with the improvement again year-over-year. Let me turn it now over to Chuck to comment on our global businesses..

industrial was 39%, communications was 35%, life sciences and semiconductor equipment combined was 13%, while the Military was12%. Our sales for the industrial market were concentrated in the laser solutions segment. Our sales to the communications market were concentrated in the Photonics segment.

And our sales to the military and the combined life sciences and semiconductor equipment markets are concentrated in the performance products segment. The growth in the overall communications market drove our consolidated growth and revenues from this end market were up 12% compared to last year.

Our revenues into the combined life sciences and semiconductor equipment market increased 2%, our revenues in the industry market declined 2%, and our sales into the military market declined 3% compared to last year.

During the quarter, we experienced a significant increase in demand from the telecom market, the data com market and from the cable TV infrastructure market. Our sales of silicon carbide substrates for wireless base station applications were flat compared to last year.

We understand that the build out of broadband access in China is a national priority and we experienced a considerable increase in demand for our products to support it during the quarter. We also saw an increased build out of undersea networks and the planning of those networks.

These taken together are driving greater demand for our submarine [indiscernible] receivers and filters, all of which make up our industry-leading offering of a highly liability product portfolio for undersea networks.

Although we have discussed in the past that demand for optical communication products can be lumpy and generally challenging to forecast, based on our current backlog, research results have share allocations awarded to us and the recent channel checks, we believe that we may continue to see steady demand for another one or two quarters from customers in this end market.

Our results also benefited from our integration efforts and our continued focus on product leadership, operational excellence, and customer intimacy.

Our optical communications group has done a great job of integrating the recently acquired businesses, increasing market share at key accounts, developing new products and gaining traction with new Web 2.0 customers. The decline in the industrial markets this quarter was due to unfavorable changes in currency valuations and slower growth in China.

On a constant currency basis, this market grew 3%. Sales of our beam delivery components in the one-micron market were a bright spot, increasing more than 10% compared to Q1, FY15. Overall, we remain excited about the industrial market and we continue to invest in our new product roadmaps across the three segments.

The military market is stabilizing, even though the revenue decline compared to the first quarter of FY15 and increased 9% over Q4 with growing funding for strategic programs and advanced technologies for intelligence, surveillance, and reconnaissance, and for infrared countermeasures systems.

As a result, our outlook for the military business is favorable and we expect moderate growth over the next few quarters. In addition, the consolidation of our Florida operations is complete and should contribute the margin improvement starting next quarter.

Before I turn it over to Mary Jane to walk us through the analytics, I would like to thank our customers for their positive responses to our business model and value propositions.

I would also like to acknowledge all of our fully engaged employees around the world for their tireless dedication every day to building a new II-VI that has as its foundation the same values as the founding company with its focus on manufacturing, innovation, quality, customer satisfaction, and exceptional business results.

I'll now turn it over to Mary Jane, to walk us through a review of our overall financial performance.

Mary Jane?.

Thank you, Chuck and Fran. We did well on our margin delivery this quarter. The gross margin of 37.6% and the operating margin of 11.5% benefited from increased volumes and favorable mix, especially in the Photonics segment. Equally important were the benefit of last year's restructuring program.

This compares to a gross margin of 36.5% and an operating margin of 10.4% in the first quarter of fiscal year ’15. We didn't incur any restructuring charges during the first quarter.

The EBITDA margin at 19.1% showed the largest progress compared to both Q1 last year when the EBITDA margin with 16.8% and compared sequentially to Q4 last year just one quarter ago, when it was 18.9%. About half of the increase compared to the same period last year that is Q1 of last year, is due to currency.

We have mentioned before that volume and mix can have a big effect on our margin. Volume is always important for the efficiency of any materials growth profit. That's particularly true this quarter with Photonics that achieved an 8.8% operating margin in the quarter.

That margin is very strong for Photonics and I caution you it's not the new standard for Photonics. Our focus on margins for the whole Company and by segment is undiminished however. Our book-to-bill ratio is 0.99. The backlog is $239.5 million.

It’s down $2 million from Q4 of FY15 and its $70 million in Laser Solutions, $61.4 million in Photonics and $108.1 million in Performance Products. EPS of $0.27 for this quarter was above the $0.25 top end of our range. One penny was due to currency and one penny was due to favorable mix. This compares to $0.20 a share same time last year.

Our cash flow from operations was $22 million compared to less than $1 million in the same period last year. We reduced debt $13.5 million bringing our debt level to $162 million. We are now in a net cash position with $164 million in cash. Our interest payment is half of what it was last Q1.

We purchased back $5.9 million of stock in the quarter for about 355,000 shares or one half of one percent of the shares outstanding. The average price was $16.43 a share. Our diluted share count at the end of the quarter was $52.7 million. To date we have purchased about $19 million of our $50 million authorized share repurchase program.

We invested $9.4 million in capital this quarter and expect to spend $50 million to $55 million this year. For FY16, our expected equity compensation should range from $11 million to $13 million. Our equity comp expense this Q1 was $4 million. Our tax rate for the quarter was 22%.

For FY16 for the whole year, we expect the tax rate to range from 21% to 23% with no renewal of the R&D tax credit expected.

As I turn to our outlook from the second fiscal quarter that ends on December 31, 2015, the Company currently forecasts revenues to range from $180 million to $192 million and earnings per share to range from $0.21 a share to $0.26 a share diluted a quarter. This is all at prevailing exchange rates.

This guidance balances a number of factors including custom year-end cash flow management, making December one of the most volatile month of the year to forecast for shipments, and overall slowing in China with the potential for some uncertainty in the speed of investments.

Comparable results for the quarter ended December 31, 2014 to the second quarter of last year, were revenues of $176.7 million and adjusted earnings per share of $0.24 excluding a one-time settlement of $0.11 and benefiting from $0.04 from the R&D tax credit that we presently are not expecting in the upcoming second quarter.

Therefore net-net the comparable operating result from Q2 of last year is $0.20 a share. Before we turn to questions, I'll just let you know that our first quarter earnings release date is latest for Tuesday, January 26, 2016. Michelle, you can open the line for questions.

As I remind people that your answer -- our answers to your questions today may contain forward-looking statements, which are based on our best knowledge to date and for which actual results may differ materially. Michelle, over to you..

Thank you. [Operator Instructions] Our first question comes from the line of Jim Ricchiuti with Needham & Company. Your line is open. Please go ahead..

Hi, Jim..

Hi. Good morning.

Why don't we just go back to gross margins and Mary Jane I wonder if you can comment a little bit about how you might see gross margins playing out over the course of the year, just given the way Q1 is unfolded, I think you have suggested that gross margins could be in a range of 36% to 40% or so for the year? Is that right?.

Right. We’ve said 36% to 44% the year..

And days -- go ahead..

No, sorry, finish your question..

No, I was just going to say just given what you’re seeing in the quarter, the mix of the business, the backlog, the bookings then the trends thus far, if you can give us any more color on how you see that margin range playing out?.

So, I mean, probably the best thing to say is last year is well just possibly coincidentally possibly not. You know last year's first quarter had a strong gross margin as well. The middle two quarters are not so much and little bit stronger in the fourth quarter. So I would say again, we had a particularly strong gross margin in the first quarter.

It is not below mark. I probably put it to you that way. We’re still on our 36% to 40% range. I think it will probably vary a little bit across the year.

But it might not be completely unreasonable to assume that the rough pattern of last year could fold with possibly fourth quarter not being up a lot on the first quarter just because the first quarter of this quarter was particularly strong..

I would add -- this is Fran. That our gross margin this quarter was nicely helped by our Photonics segment and Mary Jane cautioned in her comments about the -- that’s [indiscernible] watermark and to see that business stay at that level we will have to have two or three good quarters. It’s unclear if that’s going to be that way..

Now that’s helpful. And I wonder if I could just go back to that brand and maybe we could understand that a little bit more, how you are viewing the Photonics business over the next couple of quarters? It’s -- you had a pretty solid quarter clearly.

How much of that was just mix and how are you seeing the demand trends, particularly, in China?.

Okay. Hey, good morning Jim. This is Chuck..

Hi, Chuck. Thank you..

Yes, I’m happy to address that..

Thanks..

As I said in my comments, we’ve a number of factors that are affecting us favorably. The broadband China build out is driving demand for our -- probably at the end components, our pump lasers, and the suite of passive components that our customers need from us.

We started the quarter with a -- coming off of a -- we have a strong bookings month in June, and so we reported for the segment itself a strong bookings in the fourth quarter of last year. Obviously, the quarter coverage included into the first quarter of what we actually experienced incremental demand during the quarter itself.

And so for all three of our markets and also from both China and in North America and in Europe and in Japan, we were feeling some increase in demand. It feels like things are forming up just in time.

I do expect based on the -- based on all of the process that we were going through with following purchase agreements negotiations, this last month, this month, speaking with customers, and we are expecting that we have a very good chance to have a steady demand for next quarter and the quarter after that.

And we -- the volume, the mix, and the introduction of new products which were also -- we’re being pulled to do on a very aggressive schedule, its working out very well..

Chuck, is it a combination of share gains and just the overall more -- healthier tone to the market? Do you think you’re gaining share here?.

Yes..

And if so, what areas?.

When you say what areas, you mean -- can you be specific about that, Jim?.

Within the Photonics business, I wonder if there -- are there some specific areas that you feel, you may be gaining share? Thank you..

Actually I would say in all areas, to make it simple..

Okay..

Our Photonics segment operates as two different groups. One is a photop group, one is a optical communications group.

As I said, the propensity of our communications business is derived from that segment and I feel very good about the progress that that segment are making and making inroads off into the market with new products and actually selling existing products to new customers. I would say well of the above, Jim..

Okay. Thanks. I will jump in the queue..

Yes, I think Chuck would add or maybe I will that some of the products we had in prior quarters they were losing us money, we are not shipping anymore. We priced out of that business, so I don’t want you to miss the actions we’ve taken should benefit us going forward..

Yes, as well as the restructuring that we did last year coming into this year, so maybe that’s sufficient..

Thank you very much. Yes, thank you..

Sure. You’re welcome..

Thank you. And our next question comes from the line of Ted Moreau with Barrington Research. Your line is open. Please go ahead..

Thank you very much. And I actually like to say thanks for breaking out the end markets, breakouts there that was -- that’s very helpful.

I was just kind of wondering how the macro environment impacts your business, and specifically more in the laser solution side in terms of maybe CO2 versus fiber laser demand dynamic, are you seeing any sort of delay by customers to migrate to fiber, because of the first of all macro conditions or how do you view directionally where those two -- the CO2 and the fiber lasers are going?.

It’s Fran. I will make it and [indiscernible] Chuck would add to it. Yes, I think the transition of new assembly line lasers from CO2 to fiber is across the 50-50 point now. And our business that we’ve set up in the fiber laser side of it, our components are good. Sales there are very good.

I think Chuck mentioned in his script there, or I mentioned in mine, there are softening in China. That was an important place for us to be working and certainly they started very aggressively, now they’ve slowed down or its economy is slowing.

But we expect that to rebound and the overall trend by customers whether they’re going to buy fiber for CO2, it’s time for us to see or to hear our customers some of them do both. So when we hear from them or we’re mostly talking about CO2 because that’s not an area that we’re building a product to compete with our customers.

On the fiber laser side of it, we also see how that business is growing. But it is really dominated by one company and you can watch that company and they are doing well, that our businesses that are in that space are doing very well also.

Our high-end unit when we make cutting edge, we would come out with new laser like cables and [indiscernible] connectors and improved cutting edge all to be in that one-micron space, so that space is I think fine with the exception of China being a little slower..

Okay.

And so on the -- so you said CO2 versus fiber is cross 50-50 facing of your laser solutions, your fiber lasers are now over 50% of your fiber solutions, is that -- [indiscernible] right or is that, is this the market or …?.

Yes, I will comment. Yes, this is Fran. I was making the comment relative to the overall market. The overall business out there. I think if you said that it’s a 6,000 high power CO2 plus fiber unit go to the field each year, it would be 60-40 or maybe something like that, fiber laser is a bigger number..

Okay.

And how is your revenue breaking out between fiber and CO2 lasers right now?.

The number we’ve usually give is of our total company sales. We are in the 15%, 17% of our total sales to turn the one-micron business..

Okay..

[Indiscernible] are very much the passive components equivalent to people’s fiber lasers or the semiconductor lasers that go into them that we sell to those manufacturers..

Sure. Okay.

And then, also in your first response to my initial question here Fran, were you suggesting that the visibility can be challenging to see how a customer -- whether or not a customer is going to order a fiber laser versus a CO2 laser or -- and if so, like I mean, what kind of lead times do you have there? What kind of lead times that they’re requesting, what’s -- can you maybe just kind of dig into that a little bit?.

Okay. To an extent, yes. Remember we're down in the [indiscernible] chain. The only [indiscernible] are building CO2 laser machines or fiber laser machines. We supply to both of those OEM sets.

So our business is about half a step behind and so whether a customer and ultimate user, picked in an auto company or a job shop where they are going to make their buy and they’re not really in -- you are talking about it, they are talking about to the OEMs and the aftermarket system builders. So ours is a half step back.

And we have a reasonable feeling, but not an exact feeling. This is worldwide we’re talking about..

Okay. Sure. And then, on the Photonics business, you guys have indicated that demand should remain steady for the next two quarters and certainly from what we are gathering optical demand seems to be pretty good out there, but it looks like bookings were down sequentially, it looks like maybe 10% and even a little bit year-over-year.

So I mean, we're just kind of trying to figure out -- it seems like a little bit of a disconnect.

Can you kind of walk us through, I mean, where your confidence is coming from on the Photonics business in the coming quarters despite the little bit of bookings deterioration, maybe backlog deterioration?.

Yes. Ted, this is Chuck. I’m happy to add to it. First of all, the bookings in this market can be intent to be lumpy. So that's one thing. So you can't look at it a steady every month, we -- as I’ve said we got a strong bookings month in June in the fourth quarter accounting [ph] us over.

We have overall market demand we believe is increasing not only driven in China, by broadband China, but also new technologies coming into the marketplace even in North America.

We are beginning to hear the talks not only about the large metro deployments that are expected to take place in calendar year ’16 in North America, but even long haul networks in North America in the advent of 400 G systems is looking like to tell in the near horizon.

Those 400 G systems require the amplifiers, and a wide array of components which we make including [indiscernible] optical filters, optical time domain reflectometers for network monitoring. We feel from a new product pipeline and from the overall near-term trends in the market that we’re well positioned to be able to participate in the demand.

In addition to that, the cable TV infrastructure build out, for datacenter interconnect, and for data communications market in North America is strong ….

Okay..

… and we’ve a very, very strong root into that market..

Got it.

Okay and are you inside the datacenter too or primarily more out in the telecom network and in the datacenter interconnect market?.

We were in the telecom network, in the long haul, and in the metro. We were also participating through our customers into the datacenter itself. And as I mentioned in my prepared comments, some of the Web 2.0 customers that are operating their centers and running them are also beginning to talk to us as well about our capabilities..

Sure.

And so are you -- have you shift into Web 2.0 datacenters today and if so, how many of the Web 2.0 players do you think you’re supplying into it? Do you have any of that info?.

I would say that we have some activities with many of the large datacenter customers who are at least in contact with us about our capabilities, our product portfolios and our roadmaps. But our primary channel to that market is through our customers today..

Okay. Got it. Thanks I will pass it along. Good luck..

Sure. Thank you..

Thank you. [Operator Instructions] Our next question comes from the line of Mark Miller with The Benchmark. Your line is open. Please go ahead..

Hi, Mark..

Good morning. Just was wondering if you could give a little more color on laser.

Laser Solution seem to be somewhat weaker, was that China in terms of margins and sales?.

This is Fran. Nice to meet you Mark. The change in laser solutions from fourth quarter to first is rather usual for us. The CO2 laser business tends to slow in the first and second quarter and then improved quite nicely in the third and fourth. So that will be mostly driven by the CO2 business being down.

It really has to do with the aftermarket of running of the lasers around the world and how that replacement parts business happens. Slows down in late summer as the Europeans are on holiday and if that’s okay and September, October, November it shuts down again in December, then runs pretty good in the entire second half January to June..

Okay. We’ve seen some of the largest players in semiconductor cut their capital spending plans for next year.

Are you feeling any impact of that and what’s your feeling for what’s going to happen in semiconductor?.

Okay, Mark. This is Chuck Mattera. And I will take that one. I would say that we have a -- in the second half of the year, we’re expecting that our customers will have an uptick in demand for our -- with our few products, our DUV products. We are not betting on EUV demand in the second half of calendar year ’16.

But what we believe that the technology is entering into a decisive stage for EUV and we think that FY17 will be a year that we maybe can begin to dial that up. So I’d say that overall we’re not taking our view down about our semiconductor business from the second half of the year or for this quarter..

And I don’t know if you ever provided this, but if you can just provide us just a little color on how a fiber laser sales done year-over-year? I imagine they would be up..

Well, Fran you want to …?.

The only thing I would commented -- and we see our business with the components that we supply to fiber laser or disc laser people or even direct diode laser people, up no doubt about it. But for the end products, the end lasers themselves we’re selling to those people that are selling them into the market.

So ours is second hand, but it’s still growing..

I could add to that Fran, I would say just to remind you Mark, we do not make and sell fiber lasers, our customers do. And so we are a full line supplier of components to the marketplace.

And I would say a view from our [indiscernible] view into the market in China, I’d say that if you’re asking about the volumes, I would say that both for the pulse fiber laser market or the mid power fiber laser marketing for the high power fiber laser market in China, our channel checks suggests that the volumes are growing.

Even though they’ve slowed down just in the last quarter and so, year-over-year like that it grow anywhere from 30% to 50%..

Now you also see a contribution down there for auto for your fiber components in the laser [indiscernible]?.

Yes, we do. Indeed we do and as I mentioned in my prepared comments, one of the bright spots in our Laser Solutions segment yet again was our sales of being delivery systems for welding, for cutting, and for connecting up high power lasers to the robots themselves. And that business grew again double-digit more than 10% compared to last year.

And we expect that business to grow at least with the overall growth in the market this year..

Thank you..

Sure..

Thank you. And I'm showing no further questions, and I would like to turn the conference back over to Fran Kramer for any final remarks..

Thank you everyone for attending. We expect another year of good progress here in FY16. We are happy with the -- many of the new products have been out with and Chuck mentioned many of them are in all areas -- all three of our segments. We haven’t gone over those, but we’re working hard on that.

And as Mary Jane said, our intensity to improve margins remains unaffected. We are keeping working on it and our reductions in cost, so we’ve taken during this year I think set us up to have a very good year. Thanks for attending. Bye..

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day..