Below is transcript of the II-VI, Inc. (NASDAQ:IIVI)’s Fiscal Year 2015 Second Quarter Earnings Conference Call, held on January 27, 2015, at 9:00 a.m. EST. Clinton Group, Bryn Mawr Capital and Grt Capital Partners was among II-VI, Inc. (NASDAQ:IIVI) shareholders at the end of the previous quarter.
II-VI, Inc. (NASDAQ:IIVI) is a manufacturing company engaged in development of engineered materials and opto-electronic components products for diversified applications in the industrial, optical communications, military, life sciences, semiconductor equipment, and consumer markets.
Company Representatives:
Vincent Mattera – President
Mary Jane Raymond – Chief Financial Officer
Francis Kramer – Chairman
Analysts:
Avinash Kant – D.A. Davidson & Company
James Ricchiuti – Needham & Company, LLC
Ted Morea – Barrington Research Associates, Inc.
Zach Rodenbough – Sidoti & Company, LLC
Operator
Good day, ladies and gentlemen, and welcome to the II-VI Incorporated Fiscal Year 2015 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will have a question-and-answer session and instructions will follow at that time. as a reminder, this conference call is being recorded.I would now like to turn the call over to Mary Jane Raymond – Chief Financial Officer. Please go head.
Mary Jane Raymond – Chief Financial Officer
Thank you, Nicholas, and good morning. I’m Mary Jane Raymond – Chief Financial Officer here at II-VI Incorporated. Welcome to our second quarter earnings call for fiscal year 2015. 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, January 27, 2015. Any forward-looking statements we may make during this conference or given in the context of today only. We do not undertake any obligation to update these statements to reflect events subsequent to today.
Francis Kramer – Chairman
Thank you, Mary Jane, and thank you, everyone, for joining us. We delivered another solid quarter. Revenues of $176.8 million grew 3% over the second quarter of last year and we’re down 5% on seasonality from the first quarter of this year as we normally experience between the first and second fiscal quarters.EPS was $0.24 without the $0.11 impact of a settlement agreement. This $0.24 includes $0.04of tax benefit for the extension of the R&D tax credit right at the end of the year. The second quarter is typically our lowest quarter due to the holiday season in the U.S. and Europe. We continued making good progress on achieving our key financial metric goals that I have been communicating over the last several earnings calls.
Our Book to Bill ratio was 1.0 or greater in all our segments, contributing to a strong backlog as we enter the second-half of the company’s fiscal year.The Laser Solutions segment revenues of $67.7 million or 38% of the company’s revenues. The operating margin of 18% is consistent with the first quarter and above last year’s first quarter operating margin of 6%. The Photonics segment revenues are $60.9 million or 35% of the company’s revenues. The operating margin declined to 1% compared to the first quarter’s margin of 3%. Photonics’ margins continue to be an area of considerable focus.
The Performance Products segment revenues were $48.2 million or 27% of the company’s revenues. The operating margin of 8.1% is lower than the first quarter that was 8.9% and the year-ago quarter of 11.9%. The largest driver of this change is the reduction in the military business and the cost to move part of the Florida operations into California. We still expect to incur some cost in the second-half of the year to complete this consolidation. We are pleased with the progress we are making and we realize we need to continue. We are revising our margin guidance for the gross margin, EBITDA margin and operating margin to a minimum of 250 basis points for the full fiscal year 2015 over the full-year fiscal year 2014. This represents an improvement of our – above our prior indication.We previously indicated a minimum of 200 basis points exit rate in the fourth quarter FY 2015 over the third quarter FY 2014. Between these same two periods, we now expect a 300 basis point to 400 basis point exit rate improvement. This translates to a minimum of 250 basis points improvement for the full-year. I will now turn the call over to Chuck to discuss our operating highlights. Chuck?
Vincent Mattera- President
Thanks, Fran. In the II-VI Laser Solutions segment, Q2 bookings of $67.5 million were up 9% over last year’s second quarter and down 4% sequentially, while Q2 revenues of $67.7 million were up 6% from last year’s same quarter and down 7% sequentially.
The revenue decrease quarter-over-quarter is typical of Q2 which has been historically Laser Solution’s lowest quarter. Laser utilization in the North American market driven by a steadier U.S. economy was strong during the quarter. We exited the quarter with strong bookings from both the OEMs and the aftermarket.We have also seen an increase in demand for fiber laser wielding heads to auto-assembly plants. The overall demand for our industry leading high-power products for automotive and EUV applications, as well as to our low power products resulted in a 20% increase in North American shipments over Q1 and 30% increase compared to Q2 of FY 2014. As it’s typical in Europe, bookings and revenue were seasonally lower in Q2 compared to Q1 due to the expected slowdown over the holidays.
Our EUV shipments in the region were at record levels and our customer continues to take as much product as we can currently produce. Although at the end of the quarter we saw no unusual signs of slowing demand in the near-term, we are concerned about Europe. Experts point to early warning signs that the economy is slowing as well as the uncertainty around euro currency evaluations and the impact of Swiss monetary policies on our business. Mary Jane will discuss this later in her overview.Turning to Asia, the material processing market continues to be a growth area for us in Japan, Korea and in China. China is moving more rapidly towards adoption of fiber laser technology than any other country. Our low cost fiber laser cutting head is getting strong interesting this market and we continue to field inquiries around related low-cost and low-power objects. We are experiencing strong pricing competition and see many players buying for position in the China market. We are adding resources in the region to better service our customers by enhancing executive relationships and providing quick responses to RFQs and RFIs. Laser diode shipments continue to be strong for both our high power laser diode assemblies as well as our high volume components. Several next generation laser diode products are in qualification that target growth opportunities.
As we look forward to areas we can further improve upon. We will focus on our epitaxial growth in wafer fabrication platforms and contract manufacturing assembly yields.Retuning these manufacturing steps with increases in automation and process control as well as beginning to bring them in-house and under our strict quality and cost controls will be a key initiative over the next 12 months to 24 months for Laser Enterprise. Across all markets and regions our one-micron and related product revenues from this segment reflects sequentially what we’re up 40% compared to Q2 FY 2014. Capacity has been added and we have built inventory in all locations to improve our customer service. We initiated a campaign to increase market share through close cooperation with our leading customers to develop a new portfolio of products. Our II-VI Photonics segment consists of two market focus groups.
The first is our Optical Communications Group, where it designs, manufactures and markets a broad range of optical components, modules and subsystems. We are a leading supplier to customers in the traditional undersea long-haul and metro-telecom markets, and are targeting increased intersection with the emerging growth market segments stemming from data centers, enterprise networks and Web 2.0 applications.The second, the Photop Group is also a vertically integrated business which provides crystals, advanced optics, display products and precision optical assemblies for industrial fiber laser, life sciences and consumer display applications.Photonics bookings of $66 million were up 27% over last year’s second quarter and flat sequentially while revenues of $60.9 million were up 11% to last year’s same quarter and down 4% sequentially. The increases relative to last year are mainly attributable to the timing of acquisitions compared to Q2 of FY 2014.
The sequential revenue decline can mostly be attributed to a weaker demand for our optical amplifiers for optical transmission systems, as customers work through inventory issues and confront the delayed network deployments. We cooperated with our customers to help them manage on forecasted demand changes during December. We also experienced weaker demand than we had forecasted for our products associated with new network deployments, and understand that this was partly affected by constrained wireline investment and project delays the two awards North American carries. Other products such as pump lasers and optical components for telecom, crystals and laser optics for fiber lasers and optical coating filters for fiber to the X broadband network architectures, as well as data center application showed growth over the prior quarter.In particular, the fiber laser market, which has been growing rapidly in China and also in Japan continues to show a strong demand for fiber laser optics, including our micro optics fiber laser pump combiners and filters for a high-power isolators.
The overall market remains strong for QSFP+ and other transceiver products for data centers and enterprise networks, as well as EDFAs and WDM components for cable optical networks. We’re in the final stage of product qualification and are initiating the volume production ramp up of our 40G QSFP+ transceiver products. We are able to leverage our internal technology in micro-optic platform advantages to deliver differentiated solutions, and we’ll continue to invest in QSFP+ transceiver products for 40G and 100G client-side transceivers that will support bandwidth growth, opportunities, in which we will further our ability to serve our data center customers and their cloud applications.
Customer engagements and feedback continue to be positive. We have experienced the significant increase in the number of design in projects with customers across multiple applications and have achieved several design wins associated with new product sales expected to phase in, in the coming 6 to 12 months. Additionally, we were awarded share allocation increases from key customers during the annual share negotiations that concluded this quarter. Finally, in our II-VI Performance Products segment, Q2 bookings of $53.2 million were flat year-over-year and up 17% sequentially. Revenues of $48.2 million were down 9% year-over-year and down 2% sequentially. Bookings were up significantly in our silicon carbide semiconductor device substrate and thermoelectric businesses, both year-over-year and sequentially. Increases were driven by our new Air Force Research Labs contract focused on the development of 150 millimeter and larger diameter silicon carbide semiconductor device substrates and the continued growth and demand for our semi-insulating products enabling the cost effective deployment of 4G wireless base stations around the world.
We closed the major follow-on order for our first betting customer that employees are differentiated thermoelectric solution at the core of its product and experienced increased demand for our thermoelectric products from multiple life science customers who placed significant replacement orders. Bookings in our Military business increased sequentially. We are pleased to announce that a significant long-term contract was received in the quarter for sapphire windows. The initial sapphire window order for $11 million is the first release against this multi-year contract valued at approximately $36 million . The revenue decrease year-over-year and sequentially was driven by a combination of factors.
These include lower defense spending in our Military business, lower rare-earth element sales and significantly reduced shipments in our ceramic silicon carbide semiconductor equipment business. However, we continue to be very encouraged by the strong growth and demand for our 150 millimeter silicon carbide products, which we believe will be a key driver to enable market share growth in major commercial markets for a silicon carbide-based electronic devices. To address the growth in the semiconductor substrate demand, we are nearing completion of major infrastructure expansion of our fiscal growth capacity. In an effort to offset the impact of the slowdown in the semiconductor equipment business, we have diversified our silicon carbide ceramics business and achieved several new product design wins among back-end semiconductor tool suppliers, where precision motion control applications are increasing.
We are now servicing customers in the back-end of the semiconductor [INAUDIBLE]with robotic end effectors, vacuum trucks and thermal transfer components. In addition, we continue to see increased demand in our silicon carbide display business driven by GA-LCD television production in Korea and China. In our Military business, we continue to execute a plan to consolidate our California and Florida operations due to lower market demand, and we are on track to complete these activities in our fiscal fourth quarter. While Military bookings were up from the prior quarter, the outlook for the Military market still remains uncertain and continued program delays are expected. Lastly, in our Performance Metals division, the core business remains stable under the new operating model and has a solid order backlog for the next several quarters. I will now turn it over to Mary Jane, to walk us through a review of our overall financial performance. Mary Jane?
Mary Jane Raymond – Chief Financial Officer
Thank you, Chuck, and thanks, Fran. For the second quarter, our Book to Bill ratio was 1.06. Our backlog is $228 million, compared to $218 million last quarter, the first fiscal quarter of the year.This $228 million consists of $73 million in Laser Solutions, $54 million in Photonics, and$101 million in Performance Products. The gross margin of 35.7% declined 80 basis points compared to the first quarter, but improved $460 basis points compared to the second quarter of last fiscal year. The year-over-year margin increase is a combination of general operating improvements in the recent acquisitions in particular and not having the one-time inventory step-up recorded in last year’s second quarter.
The operating margin of 9.3% declined from Q1 by 110 basis points, but improved by 370 basis points over last year’s quarter. This also is affected most importantly by operating improvements, as well as the absence of the inventory step-up last year. The adjusted EBITDA margin, which excludes the income from the settlement we noted improved 80 basis points over Q1 and 290 basis points over a year ago quarter. The GAAP EPS of$0.35 included a $0.11 on the settlement we noted. This settlement is related to certain payment obligations we had in the purchase agreement for the acquisitions we did last year.
Adjusted EPS excluding this settlement was$0.24 and exceeded our guidance of $0.15 to$0.18. This $0.24 adjusted EPS includes $0.04 of income tax benefit primarily related to the extension of the R&D tax credit. Turning to our cash and capital expenditures, our cash flow from operations was $48 million, compared to $22 million for Q2 of last year. Year-to-date, cash flow from operations is $49 million compared to $56 million last year. The difference to the first-half of 2014 is due to, as Chuck said, are accommodating some of our customer’s changes in schedules in the second quarter. We don’t expect this change to be permanent.Importantly, you can see, we recovered the lagging receivables collection noted during Q1. Regarding other cash items, we paid down $24 million of our debt this quarter, bringing our debt level to $212 million.
We purchased $5 million stock – $5 million of stock and about 373,000 shares at an average price of $13.41 a share. Our total share count now is 62,276,212. During the third quarter, we expect to buy $3 million to$4 million of stock, as we continue to focus on paying down the debt. Regarding property and equipment, we spent$10 million in CapEx for the quarter. We expect to spend about $40 million in fiscal year 2015 on capital equipment not including the $13 million we used to purchase the building in Germany in Q1. Our Reclee compensation in the quarter was $2.8 million. For the full year, we expect the stock comp expense to be $12 million to $13 million.
Our effective tax rate was 10.9% due mostly to the R&D tax credit. In addition, most of the income from the settlement was tax exempt. We expect the year’s tax rate to be between 14% and 16%, this range compares to last year’s rate of 16%, which also benefit from the R&D tax credit.Turning to our outlook, the revenue outlook for Q3 is $174 million to $182 million. This compares to $173.6 million in Q3 of FY 2014. Our EPS is expected to range from $0.18 to $0.24 per share, compared to $0.13 per share in Q3 of FY 2014.During Q3, we expect to incur about $900,000 in restructuring costs for the consolidation of some of our Florida operations into California. We also anticipate some unfavorable effects of the Swiss franc movements. Before we turn to questions, let me just let you know that our third quarter earnings release date is slated for Tuesday, April 28, 2015.With that, I’ll turn it over to the operator to open the line for questions.
Operator
Here comes the questions. And our first question comes from the line of Avinash Kant with D.A. Davidson & Company. Your line is now open. Please proceed with your question.
Avinash Kant – D.A. Davidson & Company
Good morning, Fran, Chuck, and Mary Jane.
Marry Jane Raymond- Chief Financial Officer
Hi, Avinash.
Avinash Kant – D.A. Davidson & Company
So a few questions, the first one is that, you talked a little bit about fiber lasers in your presentation also some of the diode sales. Could you give us an idea of what percentage of your overall sales right now are exposed to fiber lasers?
Francis Kramer – Chairman
We really don’t report it that way, Avinash. It’s stepping up. It’s gaining to become more of our business. But we haven’t collected the data that way. We do have, but we just haven’t showed some reported. When we went to the three segments, we felt like we would be able to give you the best view of the business. But if you – if we keep working it, I guess, maybe, we’ll have to report in another session, but right now today, we’re not prepared.
Avinash Kant – D.A. Davidson & Company
Okay, because earlier you had HIGHYAG, but now, of course, you are more into the diode and other things too, so clearly, your exposure has gone up, and just some rough idea at this point, that’s what where others are looking for?
Francis Kramer – Chairman
So, I think that’s a good question really, and I have to say, I don’t feel, we’re prepared today, but in the 90 days we should be ready for that.
Avinash Kant – D.A. Davidson & Company
Okay, perfect. And, Mary Jane, you just talked about the foreign exchange impact of the Swiss franc. Could you give us some idea in terms of in this quarter, in the December quarter that you just reported, how did foreign exchange impact in different ways, you can talk a little bit about the euro and other currencies too?
Mary Jane Raymond – Chief Financial Officer
Right. So, first of all, the FX in the quarter was probably in the neighborhood of about $0.5 million. With respect to the Swiss [Inaudible]. The euro had obviously a much greater impact on us in the first quarter, as we’ve reported at the time largely due to the inter-company loan we had outstanding, that has now significantly been retired. With respect to the Swiss franc, obviously, where the Swiss franc spun out on the new monetary policy, it kind of ended up back where it was last night. So, while we saw in the first quarter probably a little bit of pick-up of the Swiss franc, we expect to see that down in the third and fourth quarter of this coming year.
Avinash Kant- D.A. Davidson & Company
So, what’s the currency negatively impacting you in the current quarter that you reported?
Mary Jane Raymond- Chief Financial Officer
That was positive – positive up by 100 up.
Avinash Kant- D.A. Davidson & Company
Positive?
Mary Jane Raymond- Chief Financial Officer
Yes.
Avinash Kant- D.A. Davidson & Company
So that, how many do that contribute to the bottom line?
Mary Jane Raymond – Chief Financial Officer
So, it was probably about two-thirds of a penny currency, a little bit under one.
Avinash Kant- D.A. Davidson & Company
Okay. So if I understand it correctly that $0.44 that you’re reporting on an operating basis had$0.04 from the R&D tax credits, right?
Mary Jane Raymond – Chief Financial Officer
Yes.
Avinash Kant- D.A. Davidson & Company
Okay. And then, maybe, less than a penny from the currency?
Mary Jane Raymond – Chief Financial Officer
Right.
Avinash Kant- D.A. Davidson & Company
Okay.
Mary Jane Raymond- Chief Financial Officer
Again a lot of our revenue actually, a lot of the actual product content and the revenue was pricing dollar. So we don’t tend to have large swings in the currency, generally speaking.
Avinash Kant- D.A. Davidson & Company
Okay. One final question, so you talked about the taxes in the current quarter, we understand that benefited from the R&D tax credit. Now, going forward, you’re talking about 14% to 16%. Would you have, kind of, higher tax rate in the beginning and then in the fiscal year-end, you have or December quarter, you have like lower tax rate, is that how we should think of, or it will be continuing?
Mary Jane Raymond – Chief Financial Officer
Well, so are you talking about the four quarters of the fiscal year, how you should think about the pattern across four quarters in the fiscal year?
Avinash Kant- D.A. Davidson & Company
Yes, yes, exactly, exactly.
Mary Jane Raymond – Chief Financial Officer
Yes, okay. So this year it’s probably a little bit indicative. So this first quarter was a little bit higher, because we did take the tax effect of the pay trading some cash. But generally speaking, if, for example, we see the same sort of pattern on the R&D tax credit, where it’s not formerly extended until the end of year, then yes, we do not have that to book in the first quarter of the year.So if that sort of renewal pattern continues, this sort of a pattern is probably what you’ll say that the first quarter is somewhere probably more onan operating basis, call it, 20% to 22% and then might pass down over the rest of the year, which is a little bit the pattern we saw last year.
Avinash Kant- D.A. Davidson & Company
So your guidance assumes that you will have R&D tax credit by the end of the year, again?
Mary Jane Raymond- Chief Financial Officer
The guidance that we had for the second quarter that was set for the second quarter did not assume the R&D tax credit.
Avinash Kant- D.A. Davidson & Company
Okay. But the 14% to 16% forward guidance?
Mary Jane Raymond- Chief Financial Officer
Oh, certainly, well, it’s in there, we have it.
Avinash Kant – D.A. Davidson & Company
Okay, okay, good, good. Thank you so much.
Operator
Thank you. Our next question comes from the line of James Ricchiuti with Needham & Company. You line is now open. Please proceed with your question.
James Ricchiuti- Needham & Company, LLC
Thank you. Good morning. I wanted to follow-up on the bump up in your margin targets by the year. Is there anything you can say, maybe to either isolate or elaborate on which areas you become maybe a little bit more confident in terms of expanding margins?
Francis Kramer – Chairman
I’ll start, maybe, Mary Jane or Chuck will add to it. Certainly, the Laser Solutions business is the one that’s starting to get better traction certainly this year to business is solid, but our laser dide business is, where we’re getting a little more confidence. And if you said, there is an area, where we’re a little bit less confident, might be in our Photonics area. We did have a – the wider quarter here in the second quarter compared to the first and that’s where we’re focused. Our Performance Products segment right on just about where they’ve been in the performance areas, kind of, modulated with the diversity we have in that segment.
Mary Jane Raymond – Chief Financial Officer
I think that, go ahead
James Ricchiuti- Needham & Company, LLC
Please go ahead
Mary Jane Raymond – Chief Financial Officer
I should just say, I think that’s a perfect summary. I mean, I think, in the first quarter, we have the same consistent story that we, kind of, have this quarter. But particularly in the laser diode, the fiber laser, et cetera, that just very, very good focus on operating efficiencies are causing us to now see after couple of quarters of that, that looks to be, at least, steady. And I think the rest of Fran’s comments are exactly on the mark.
James Ricchiuti – Needham & Company, LLC
And then with respect to the Photonics segment, is there anything we can be looking for the next quarter or two that might signal since some signs of improvement there. I mean, it clearly seems that this is going to be a longer turnaround and you’ve already alluded to that. But are there any things in the next one to two quarters that we might be looking for that could see some changes in that business?
Vincent Mattera – President
Jim, this is Chuck. I would say that, increasing demand will be in the near-term is the most important part of our plan, as we’re working the things that we can control in the operations to improve the operating margin those things are happening every day. We – as I indicated in my comments that we have seen a weaker demand for our optical amplifiers, and we’re faced with some customers were telling us that, their customers have delayed network deployments. So an indication that the market, which was little stronger in Q1 than it was in Q2, it warms up, it’s going to be an important part of our near-term picture.
James Ricchiuti – Needham & Company, LLC
Yes, and just with respected to that, Chuck, are you assuming kind of a similar outlook in the optical communications market in terms of a demand picture over the balance of the year?
Vincent Mattera – President
I would say that what I’m thinking is that the current quarter overall might look similar to the prior quarter. And we’re hoping that by the fourth quarter, we’ll start to see some increases.I mean, we’re well positioned. We want some good allocations based on our negotiations, now allocations is a first of the equation, our customers need to have demand and that will catch some of it into our bucket.
James Ricchiuti- Needham & Company, LLC
Got it. And you also, I’m sorry, go ahead, Francis.
Francis Kramer – Chairman
I just want to add, so what Chuck makes all kind of sense on how we see the business. We are going to make some cost reductions in the Photonics group. That’s the only thing that we are not really – we’re not to quite the cost we want to have with this level of business, but increase in the market pressure will fix this, but we cannot wait for that. We’re continuing to work on all avenues including certainly moving our production around.
James Ricchiuti- Needham & Company, LLC
Got it, thanks, Fran. And one final question if I may, I think you alluded to Europe, European concern and I don’t know if that is more just the headlines that we’re all seeing or if you have begun to see any signs of softening across any of the businesses?
Francis Kramer – Chairman
Like Chuck said in his note, we didn’t – as the quarter ended, we didn’t have any turn down there, but we’re watching every bit of news. And when there’s so much turmoil in a region it would be impossible for it not to have an impact on us in the next six months. Maybe it’s not going to be in this quarter, but we just see too many unfavorable issues there.
James Ricchiuti – Needham & Company, LLC
How were the bookings in Europe as you went through the quarter?
Francis Kramer – Chairman
I think they ran the pattern we were expecting. We had a little bit better in October and November, but December was maybe close to just unpleasant, because those last two weeks are really weak. And you’re wondering we’re going to finish the quarter where we expected because they fell up. We’re about – we’re right on where we expected on Europe overall, just December is always weak for us.
Vincent Mattera – President
Yes, I could add, maybe I could add to that, Fran,because I think it’s consistent with the question Jim is asking. I will turn my attention just to the shipments. I will say that in the last couple of weeks of the second quarter we had a, what would seem to be like a lot more activity than what we were expecting. So we had – we worked real hard between Christmas and New Year, to be able to keep pace. And I would say that, that in the first week or two in January in Europe, you could feel a little bit of a slower start.We’re not reading anything into that, but I would say if you look at the pace in the first couple of weeks of January it’s not at the same pace we had in the last couple of weeks of December.
James Ricchiuti – Needham & Company, LLC
Okay. Thanks. Thank you.
Francis Kramer – Chairman
Yes.
Operator
Our next question comes from the line of Ted Morea with Barrington Research. Your line is now open. Please proceed with your question.
Ted Morea – Barrington Research Associates, Inc.
Yes, good morning. Thanks for the questions and congrats on a great quarter. Just wondering, Chuck, you were just talking about the last two weeks of December. What – did you saw the pick-up of activity there? What – could you kind of go through where was the activity stronger and then was it the same activity that kind of slowed or was it different activity that kind of slowed in January?
Vincent Mattera – President
My comment – I was answering Jim’s question, which I understood was about Europe in general.
Ted Morea – Barrington Research Associates, Inc
Right.
Vincent Mattera – President
And my comments about the last two weeks of December, first two weeks of January were predominantly around the Laser Solutions segment.
Ted Morea – Barrington Research Associates, Inc.
Okay. And so – and then within Laser you talked about competitive pressures, but I think largely you’re showing up in China. Has that spread to other regions of the world?
Mary Jane Raymond – Chief Financial Officer
Competitive pressures on our Laser Solutions products in general?
Ted Morea – Barrington Research Associates, Inc.
I’m sorry, the fiber lasers.
Francis Kramer – Chairman
I think we’re seeing more intensity on pricing just because of the substitution of fiber lasers for CO2. CO2 product manufacturers are trying to be more price-competitive, so there is pressure to drive down those component prices.At the same time on the fiber laser because everybody is trying to get that early share, we’re getting pressure there. It’s not – it’s a just a little more intense than it’s been. And I think the most intense is China. Does that flow over to other places in the world? Yes, because they’re trying to sell into China.
Ted Morea – Barrington Research Associates, Inc.
Okay. Okay. And then on Photonics Group, just curious, what do you think your exposure is to the North American Tier 1 carriers? I mean, you’re talking about a little bit of weakness there or at least delays. So just curious like, what percentage of that business is co-related to North American Tier 1s.
Vincent Mattera – President
Well, they’re an important part of our business. We’re designed into virtually all of the optical network equipment companies. So it depends on their ability to capture the business with the carriers. In the end, the carriers will pull everybody forward. That’s probably the best way, I can say it, that’s where we experience some of our push-back in the quarter.
Ted Morea – Barrington Research Associates, Inc.
Okay. And so if we think about maybe that business being a little bit flattish sequentially, what are your assumptions for annual price decline in that business for the calendar year 2015?
Vincent Mattera – President
For the calendar year 2015, I would say more generically because I don’t have calendar year 2015 in front of me. But typically we have been reporting that customers are asking and negotiating for roughly 2% to 3% price downs per quarter. We try to offset that with improvements in our operating efficiency, in our cost reductions in the factory and then introduction of products that have enhanced features, but that’s pretty much the menu.
Ted Morea – Barrington Research Associates, Inc.
Okay. And 2% to 3%, that’s in line with historical figures?
Vincent Mattera – President
In the aggregate, yes.
Ted Morea – Barrington Research Associates, Inc.
Okay. And so final question still on Photonics Group, I think you were talking about some product introductions there and whatnot. Can you talk about on the 40 gig QSFP+ transceivers? What the competitive dynamics are there? And do you need to introduce a multimode fiber product, because I believe you have – it’s currently single-mode, do you have to introduce a multimode product?
Vincent Mattera – President
I would just make a general comment that it’s a strong growing market. There were entrenched suppliers. We have a number of competencies that we feel real strongly about. We have some leading customers and we are [Technical Difficulty] offer a full line of supply of transceivers for 40G and for 100G. And we’re investing accordingly, some of this is – will be based on uptake of our leading customers and the timing associated with multiple qualifications that are in play.
Ted Morea- Barrington Research Associates, Inc.
Okay. And what, what will be the time frame of release of the new products?
Vincent Mattera – President
Yes, it will depend by customer and it will depend by the qualification cycles. But I’m hoping that we will have the beginning of meaningful orders in the next couple of quarters.
Ted Morea- Barrington Research Associates, Inc.
Okay. Sounds good. And sorry, just to – on this one, one more time. Do you need these products to drive, the new product controls to drive revenue growth?
Vincent Mattera – President
Yes, our plan depends on a combination of improving our cost position and deriving the benefit from our product development investments.
Ted Moreau – Barrington Research Associates, Inc.
Okay. All right. Thank you.
Francis Kramer – Chairman
Sure, thank you, Ted.
Operator
Our next question comes from the line of Zach Rodenbough with Sidoti & Company. Your line is now open. Please proceed with your question.
Mary Jane Raymond – Chief Financial Officer
Hi, Zac.
Operator
Or may – Zac, your phone may be on mute.
Zach Rodenbough – Sidoti & Company, LLC
Sorry about that. Good morning, everyone.
Mary Jane Raymond – Chief Financial Officer
It’s okay.
Zach Rodenbough – Sidoti & Company, LLC
My first question is just about the CO2 business. As compared to last year, are you guys seeing demand in revenue for that kind of dropping off as a portion of the Laser Solutions business or is it kind of holding steady here?
Francis Kramer – Chairman
It’s holding steady, maybe a slight incline up. Certainly it’s just a great business. Install base is very good and when the economy is going the way it is here in North America right now and even Europe it really, it does have some growth to it. Japan is not doing so well, but overall, very good quarter for that group.
Zach Rodenbough – Sidoti & Company, LLC
Okay. And is there a chance for you guys to use kind of pricing power there to, I guess, add to your top line growth as this progresses indemand kind of does start to maybe go throughout this cycle?
Francis Kramer – Chairman
That group always is using whatever tool they can to gain market share and they have such a market share and they’re pretty active with it.
Zach Rodenbough – Sidoti & Company, LLC
Okay. Okay. And then last time I think you mentioned HIGHYAG is the main growth driver and laser solutions, and laser enterprise is starting to come on strong. And just wondering where is that standing now? Are you still seeing that level of growth from HIGHYAG, or is that going to level up, does the transition takes hold?And I guess, where is your enterprise starting to experience that same turn around?
Vincent Mattera – President
Okay, Zach, this is Chuck, I’ll make a couple of comments.
Zach Rodenbough – Sidoti & Company, LLCZ
Okay.
Vincent Mattera – President
First of all, on HIGHYAG, the business is really solid, that’s probably the best way to say it.
Zach Rodenbough – Sidoti & Company, LLC
Okay
Vincent Mattera – President
We have a new management team there. They have really done a fantastic job stabilizing the business, building confidence in the customer, doing all the right things to position us for this year and for the long-term. I would say, the – compared to the last quarter, if that’s what you like to compare it to, it’s right in there. It’s – they’re just doing a fine job.On laser enterprise, likewise, I would say the new management team there have the same determination for delivering value. They have created a plan, they’re sticking to it, and we saw a real good performance from them in the quarter.
Zach Rodenbough – Sidoti & Company, LLC
Okay, ok. And then my last question for now is, kind of, where do you expect R&D to go as a percent of revenue, the last few quarters have been up around 7%, is that kind of the new normal with these new businesses, or are you expecting that to eventually go back down to the 45% range?
Marry Jane Raymond- Chief Financial Officer: So I think, first of all, we’re still at about the same rate that you say, I think, that will be the rate for the year. I don’t know that it will trail down to where it was before with, significantly out of capability. But I will say that, we continue to be very, very focused on ensuring the yield out of the engineering, both resources in terms of people as well as money that we put into it.
Vincent Mattera – President
I agree, Mary Jane, I would add that our Chief Technical Officer has a process in place. And one of the things that we will do, I agree that I think that the spending as a percentage of sales will stay in that range. But we will be less patient about the opportunities that we have in front of us. We have a – an ability to be able to make changes in our R&D investment in certain areas, where we see opportunities – new found opportunities that we want to go after.So, I think, there may be some reallocation and refocusing, but overall as a percentage of sales, I think, we’re, like, we’re in the model.
Zach Rodenbough – Sidoti & Company, LLC
okay. And then just finally following on that, where – is very genuinely, where is that focused on right now for that R&D spending, I guess price segment or product offering, what you guys are really focusing on, if you can speak to that?
Francis Kramer – Chairman
Yes, sure, I can give you some sense for it. I would say, the optical communications group inside the company is the group whose value proposition depends on that investment and delivering on it more than any in the short-term and over the long haul. So I would say, in the segment, may be 40%, 40%, 50% of the R&D investment and then maybe roughly equally divided across the other two segments.
Zach Rodenbough – Sidoti & Company, LLC
Okay. That’s all I have for now. Thank you very much.
Mary Jane Raymond – Chief Financial Officer
Sure.
Operator
Thank you. And with no further questions in the queue, I would like to turn the call over to Mary Jane Raymond for any closing remarks.
Mary Jane Raymond – Chief Financial Officer
Okay. Well, first of all, we would like to thank you very much for joining us for the Q&A today. And this call will be recorded and we would like to wish you all a good day and safe in the snow.Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Have a good day, everyone.
