II-VI Inc (IIVI) 2003 Q4 法說會逐字稿

Good morning. My name is Trinity [ph], and I will be your conference facilitator today. At this time, I would like to welcome everyone to the II-VI Incorporated fiscal year fourth quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. You may begin your conference.

Thank you, Trinity [ph], and welcome to the fourth quarter fiscal 2003 II-VI Incorporated investor teleconference. As a reminder, this tele-conference is being recorded on Thursday, August 7, 2003. 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.

Joining me today is Fran Kramer, our president and chief operating officer. The prepared comments for today's teleconference include a review of the fourth quarter and year-end financial results and a business and operational review. Following these prepared comments, we will have a question-and-answer session. Effective July 1, 2002, we updated the reportable segments of the company to reflect several operational changes in our business and to comply with the requirements of Statement of Financial Accounting Standards number 131, disclosures about segments of an enterprise and related information. The reportable segments of our business are as follows -- the infrared optic segment, which includes both II-VI and Laser Power Optics branded products, the near-infrared optic segment, which includes the VLOC subsidiary based in Florida; the military infrared optic segment, which includes the Exotic electro-optics subsidiary based in California; and another segment, which includes the combined operation of the EEV Products Division and the Wide Band Gap Materials Group silicon carbide operations.

Total company bookings for the quarter ended June 30, 2003, increased by 17% to $32.4m as compared to the same quarter last year. Infrared Optics bookings increased 20%; near-infrared bookings increased 10%; and military infrared optics bookings decreased 25%. In addition, the company reported $3.2m of EV PRODUCTS bookings and $600,000 of silicon carbide bookings from the Wide Band Gap Materials group during the quarter. Bookings are defined as customer orders received that are expected to be converted into revenues during the next 12 months. Bookings are adjusted in changes in customer demand or production schedules move a delivery schedule out past 12 months.

Total company revenues of $32.9m for the quarter increased 9% as compared to the same quarter last year, and represented a record quarter for the company, surpassing the $32.5m in revenue recorded during the quarter ended March 31, 2001. Infrared optics revenues for the quarter ended June 30, 2003, increased 10%; near-infrared optics revenues increased slightly; and military infrared optics revenues increased 10% as compared to the same quarter last year. In addition, the company recorded just over $1m of EV PRODUCTS revenues and $1.1m of silicon carbide revenues from the Wide Band Gap Materials group during the quarter.

Gross margin on manufactured products as a percentage of sales for the quarter increased by approximately 6 percentage points from a year ago. The increased sales volume for the quarter as compared to the prior year impacted gross margins in a favorable manner. In addition, the company continues to benefit from the consolidation that was completed late last fiscal year of the infrared optics manufacturing that was previously done in California and from a variety of other programs aimed at increasing production yields and lowering manufacturing costs. Also, the acquisition of a 75% majority interest in II-VI Lot GmbH, which was established to distribute infrared optics in Germany effective July 1, 2002, has added incremental margin to that portion of our business and increased overall gross margins.

Internal research and development expense for the quarter was $714,000 and was lower than the same quarter last year. The lower expense is primarily the result of more external contract support for the company's efforts in silicon carbide that offsets the funding needed to be provided by the company. The external contract revenue for silicon carbide now is approximately $900,000 per quarter. However, in the next few quarters, we expect this funding to decrease to a level closer to a half million dollars per quarter as certain contracts come to a close.

In addition to the efforts in silicon carbide, the company's internal research and development expense reflects efforts focused on corporate research and development activities and the research and development activities of these new products.

Selling, general, and administrative expense for the quarter as a percentage of sales was 21.2% as compared to 19.6% of sales in the same quarter last year. As previously mentioned, II-VI acquired a 75% ownership in II-VI Lot GmbH to distribute infrared optics in Germany. This acquisition has increased the company's direct-selling expense as compared to the prior year. In addition to the acquisition of II-VI Lot GmbH, the company recorded higher salary expenses as compared to the same quarter last year for its worldwide profit-driven bonus programs.

Interest expense for the quarter was $150,000. The majority of the company's debt has LIBOR-based interest rates. These interest rates continue to remain low, and the company's weighted average interest rate currently stands at approximately 2.5%. The lower interest expense also reflects the lower overall debt levels of the company, which will be explained later in these prepared comments.

Other income for the quarter of $97,000 reflects interest income, royalty income, and other income items. Other income was partially offset by the 25% minority interest in II-VI Lot GmbH that is not owned by II-VI and other expense items.

The effective tax rate for the quarter was 32.2% and for the year increased the effective tax rate to 27.6%. The increase in the effective tax rate reflects the completion of an annual external transfer pricing study and the resulting finalization of allocation of profits around the world. The company benefits from lower tax rates on its China and Singapore operations where the tax rates are currently 7.5% and 22%, respectively. The effective tax rate for the upcoming fiscal year is currently expected to range between 27% and 29%. Net earnings for the quarter were $3,626,000 or 25 cents per diluted share and represented a quarterly record for the company. These results compare with net earnings in last year's fourth quarter of $2,016,000, or 14 cents per diluted share. Reflecting on the just-completed fiscal year, the year ended June 30, 2003, saw bookings increase 16% to a record $136.4m, revenues increased 13% to a record $128.2m, and earnings per share increased 59% to a record 81 cents per diluted share as compared to the previous year.

The company's backlog at June 30, 2003, was approximately $57.5m, which was down approximately $500,000 from the March 31, 2003 level. The components of this backlog include infrared optics at $20m; near-infrared optics at $10m; military infrared optics at $19m; EV PRODUCTS at $7.5m; and silicon carbide at $1m. Backlog is defined as bookings that have not been converted into revenues by the end of the reporting period.

Our worldwide employment at June 30, 2003, was 1,094 employees. This number compares with worldwide employment at June 30, 2002, of 973 employees and at March 31, 2003, of 1,061 employees.

During the quarter, the company repaid $2m under its credit facility consisting of the required $1.25m term loan payment and a $750,000 line of credit repayment generated by operating cash flow. The company's total debt at June 30, 2003, was $23.7m, which was down over 30% from $34.6m one year ago.

This concludes the financial review, and Fran will now give a business and operational review.

Thank you, Craig. I'm pleased to report today to our investors, employees, and other constituents, a very successful year of operation. As Craig indicated, fiscal year 2003 sales increased 13% to $128m, and profits increased greater than 50% reaching an earnings-per-share of 81 cents. Our after-tax return on sales was 9%. Strong market conditions continued in the fourth quarter in the industrial carbon dioxide laser optics segment. This represents the fourth successive quarter for solid CO2 laser optics bookings. At the same time, we have continued to watch, for the last four quarters, a delay in the semiconductor industry recovery. The semiconductor equipment doldrums directly affects our VLOC subsidiary, which made up for this challenge by booking an increased amount of military and government-related business this past year. Throughout all of our business units, the military and government component of each unit sales has increased. Offsetting this increase in our EV segment has been a decline or slowing in the new product development that our customers are pursuing due to the weak economy.

In our infrared optics segment, the strong business level was the result of three factors -- first, the after-market, or service parts business, continued with solid, steady requirements whether these orders were direct from the end user to II-VI or whether these requirements came through an OEM; second, the OEM requirements for their assembly lines remained steady at the level they adjusted to over a year ago; and, third, the infrared optics segment does produce certain government and military infrared optics, which has been growing throughout this year. In the fourth quarter, the government and military bookings were 30% of the segment's order intake.

Worldwide, there are approximately 30,000 to 35,000 installed, high-power industrial material processing CO2 laser systems. That compares to 3,000 new CO2 laser systems being manufactured each year, which is down from 4,000 units per year in approximately the year 2000. That decline happened almost three years ago, and OEM output has been steady for the last 12 to 24 months. Since additions to the installed base exceed retirements, the after-market, or service parts portion of our business, is the growing sector.

Other expansion trends in the CO2 laser optics segment include the continued deployment of CO2 lasers into applications and further penetration of existing applications. For example, laser marking is replacing inkjet marking at a rapid rate. Only 10% of the inkjet applications are believed to have been penetrated by the CO2 laser. Therefore, OEMs are projecting this application to grow by 30% to 50% per year. At II-VI the optics for these marking systems represent 7% to 10% of our infrared optics segment sales.

In regards to the infrared optics manufacturing operations, we have benefited substantially from fiscal year 2003 from the consolidation of the Laser Power optics manufacturing site into our Singapore; Suzhou, China; and Saxonburg plants. This consolidation in early fiscal year 2003 has resulted in this business unit realizing gross margins this year significantly in excess of our overall margins. We are now starting to add capacity for this business unit as the excess capacity that existed after the demand contraction has now all been consumed.

In our VLOC near-infrared laser optics and components business unit, fiscal year '03 bookings were up 5% over last year. Fiscal year '03 overall revenues were essentially flat versus the prior year. However, core commercial revenues were actually up 11%, while telecommunication revenues were down 76%. In addition, R&D contract revenues were down 22% due to the successful completion of one of our major contracts.

The military segment of the business experienced the largest growth in fiscal year '03. VLOC was able to capitalize on the increased production of various military systems primarily used for range finding and target designation. Growth was realized on existing programs such as Lantern and CAD as well as newer pre-production and prototype programs such as Viper, AtClear [ph] and ATP. As mentioned, during last quarter's conference call, another military bright spot for VLOC was the production and further development of solar blind filters used for missile plume launch detection systems.

The second-largest growth area for VLOC was for optics and crystals used by medical laser manufacturers. This was driven by increased sales of lasers for cosmetic surgery, ophthalmic procedures, and improved diagnostics. The level of business for the other major markets applied by VLOC, which is industrial lasers and semiconductor-related systems were essentially flat year-to-year although growth was seen over the second half of the year, as VLOC gained market share.

We look forward to continued growth of our VLOC military and medical-related business. In addition, there should be opportunities for increased business within the industrial and semiconductor segments as these markets recover. One key opportunity remains -- the emerging application of multi-kilowatt, industrial YAG lasers in the automotive industry. We continue to make progress with several of the key manufacturers and qualification trials for both materials and optics.

In the fourth quarter, our company's military infrared business, called the Exotic Electro-Optics Division, de-booked $4.4m related to a production portion of the IFTS program for the sapphire window targeting shrouds with Northrop Grumman Corporation. This de-booking resulted from significant modifications to the product specification and statement of work on the targeting shroud portion of the IFTS program. This negotiated settlement was completed in early July. At present, we are delivering to Northrop Grumman navigation pods on this program, and we are submitting a revised quote for the redesign specification and statement of work on the sapphire window targeting pod. Exclusive of the de-booking orders for Exotic Electro-Optics -- orders for Exotic Electro-Optics increased 40% as compared to last year's fourth quarter. But for the year-to-date bookings, we're off by nearly 10%.

During the fourth quarter a $2.6m booking for Javelin Missile Dumps was secured. This order, which will be shipped over the next 12 months will support the recent purchase of this missile system by the United Kingdom. Additionally, significant orders totaling over $2m for optical components for the targeting and night-vision system on the Apache helicopter and other attack helicopters were placed in the quarter.

Revenues for the quarter were up substantially from the third quarter of this year, however, shipment of our sapphire window shrouds were comparable to the prior quarter. Nevertheless, production of these panels has increased as a result of additional equipment capacity and process development efforts during the second half of the fiscal year. Our expectation that future shipments of sapphire window shroud assemblies should increase nicely over the next fiscal year.

The large optics coating facility operated at slightly above breakeven for the quarter. At present, there are no open orders for optics on the AVL program that utilizes our large optics coating facility. We are working with our customer to determine what will happen with this product line over the next six to nine months. One option is that we may exit the large optics coating business.

From an overall standpoint, the financial contribution of our Exotic Electro-Optic Division continues to struggle from development-type contracts, which have negatively impacted operating profits. During the past quarter, nearly $600,000 of additional expenses were recognized on development contracts, which resulted in this division operating at slightly below breakeven.

In our other business segment, EV Products had a difficult quarter. We continued to experience slow development and deployment of new products by our existing and target customers in medical and industrial applications. In contrast, the security and monitoring market segment continues to grow. We are interacting with a growing list of companies to plan instrumentation and systems to improve homeland security. Examples include handheld distributed network covert radiation monitors and baggage and package inspection system. Certain features and benefits are cadmium zinc telluride-based detector devices are proving useful and often are the enabling technology in these systems. We expect this area to steadily grow and help to offset the weakness in other areas in the short term.

Despite the current weakness in demand for new EV products, we are maintaining our cost structure at as low a level as appropriate and continuing to pursue key research and development activities. Our investment in EV as measured by its operating loss in fiscal year 2003 was 50% greater than last year, as a result of economy-driven reductions of customers' new product development efforts. We believe our strategy to invest in EV for its long-term potential is the correct one for II-VI, as we feel this technology ultimately will serve markets in the billion-dollar range.

During the quarter, EV was awarded a half-million-dollar one-year contract from the defense threat reduction agency to perform research and development* on high-performance radiation detection systems for homeland defense. In addition, we expect to receive official award of a contract from the U.S. Army RDEC Division during the first quarter. This multimillion-dollar, multi-year contract will be focused on improving the cadmium zinc telluride material in detector devices that are being designed into next-generation, state-of-the-art, automatic, explosive detection systems.

The complete of the upgrades on one of two of our existing generation-II furnaces to the generation-III design, and we expect to start material production in this furnace during the current quarter. The second furnace will be complete and moved into production at the beginning of the second quarter. This is ahead of schedule by some three or four weeks for both systems. When complete, it will have a total of four generation-III furnaces in full production and contributing to yield improvements and associated cost reductions in all of our product areas.

In our other business segment, we have our Wide Band Gap Materials, or WBG group, which had a record year with bookings of over $3m and revenue just under $4m. For the first time, significant commercial silicon carbide wafer orders were booked and shipped during the most recent fourth quarter. Our customer base increased from five in the third quarter to 13 in the fourth quarter. Feedback from these customers indicates that our 2-inch, semi-insulating product is of exceedingly high quality competitive with the current leading commercial supplier. In the coming quarter, we will begin sampling a 3-inch diameter product. A new DARPA Air Force contract was awarded and booked in the fourth quarter. This program will focus on further improvements in material quality and other crystal growth issues associated with diameter scale-up.

Technology breakthroughs in crystal growth have virtually eliminated primary yield loss mechanisms and dramatically reduced other crystal defect densities such as micro pipes. Our best-in-industry proprietary CMP wafer polish in process continues to improve. Customers have, without exception, commented positively on our wafer surface quality. Our technology has been transitioned from laboratory to pilot production scale, and the process is currently being transferred to our manufacturing group in Pennsylvania.

Over the next six months, we plan to double our crystal growth production capacity with the addition of new custom-designed crystal growth systems. Construction has begun on a new wafering facility in Pennsylvania, which will significantly increase our wafer fabrication and polishing capacity. We continue to enhance our characterization capabilities with the addition of state-of-the-art equipment.

The WBG technology development* and manufacturing scale-up are proceeding well. Customers are placed in repeated and larger orders and silicon carbide commercial books are strong.

We continue to prepare all our business units for an expansion as the worldwide economies move further into a recovery. During the last quarter, we increased our inventory $700,000 to enable rapid deliveries that might be required to maintain our position as a responsive, on-time delivery vendor.

In the first quarter of fiscal year 2004, we project sales in the $31m to $33m range and earnings per share of 17 cents to 22 cents. Our first quarter results are traditionally slightly lower than other quarters due to more European and Japanese vacations and holidays during the quarter. Our forecasted growth in *revenues of 8% to 12% and earnings per share of 88 cents to 96 cents for fiscal year 2004 is based upon the slow or slight improvement continuing in the economies of the world. Breakthroughs in any of our new products, especially from EV or WBG, could favorably affect this forecast while yield difficulties at any unit could have a negative effect.

Craig, that concludes my remarks.

Thank you, Fran. 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 factor section of our Form 10-KA for the fiscal year ended June 30, 2002. Trinity [ph], we are ready to take questions now.

Ladies and gentlemen, we will now begin the question-and-answer session. If you wish to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Pierre Maccagno.

Hi, Craig and Fran, congratulations on the quarter. I wanted to ask you on the gross margins -- that increased quite dramatically. Could you explain a little bit more in detail what really drove that and is that gross margin sustainable into the future or is it going to drop a little bit?

Pierre, the gross margin increase, really, is a reflection primarily of the continued improvement in the infrared optics business, the IR optics business. As Fran mentioned in his comments, we continue to benefit from continuing synergies in that business line of consolidation of operations. If you remember from a year ago, we had done some other things as far as consolidating distributor relationships, closing a facility we had in Mexico, and this was really the first full year and toward the last half of this year, starting to really see the benefit come through in the gross margin line for the infrared optics business. So we think that that level* of business is sustainable, or that level* of gross margin is sustainable. As Fran mentioned, though, we will, in the future, need to add capacity, add capabilities in our IR optics group, because we really have maxed those out. And so I think the gross margins will be in the same range as we have just completed in this fourth quarter but recognize that we may need to, in FY04, have some time to get some additional capacity, around the world, up to speed.

Could you give us an idea of your utilization in the different businesses?

This is Fran. Certainly, our infrared optics factory utilization around our three plants is very high. I don't have an exact number, but in that 90% range, and that would range from the fabrication side of things, the coating business that we do, the production of these materials -- they're all right up there. So if you look back to, let's say, FY01, FY02, we had numbers for our infrared optics business close to what we did this year -- not quite there, but it was that capacity that we had built up that really went idle in FY02, later '02, and now has really been consumed. So I would estimate that at 90% in our EV PRODUCTS group. Maybe we're in the 50%, 60% utilization range -- WBG, our silicon carbide, we're right up there -- 80%, 90%. At VLOC, maybe 70% or 75% range.

I see. So most of the capacity you want to build around the IR. Is it going to be mostly coating and polishing, or is going to be mostly also growing the materials?

Mostly coating, fabrication, and diamond turning. I think last quarter we commented on new equipment we're adding in our diamond turning operation and, you know, there's a trend in the CO2 laser building market to build higher and higher power lasers, and those require, oftentimes, diamond turned components. So we've purchased new machinery that will be coming in soon into our diamond turning operation, and we are adding new coating systems and expanding our factory down in China. I think we mentioned that. So with the equipment coming, that new cadre of personnel that we'll be hiring, usually comes in unskilled, untrained, one to two years to bring it up to speed, so you have some yield fallout on the early startup, which does take a little tick off the gross margin.

And what about the zinc cyanide capacity? You are fine there?

I think we're good. Another climb in our demand will put us into a bit of a challenge, but right now we're in good shape. We had planned ahead, and we were bringing on capacity when the turndown arrived, and now that capacity is in good shape. I would estimate we're maybe 80%, 85% utilized there -- let's say 80%.

Okay, and, finally, your taxes have increased to 32%. Do you see the trends continuing like this for the next year?

I think our guidance, going forward, is the tax rate will range in the 27% to 29% range, going forward. We will still continue to benefit from having our lower taxed operations over in China and Singapore, and as we continue to transfer as much manufacturing to both of those sites as we can and, as Fran mentioned, continuing to expand even further our China operation -- that will continue to help us give a lower tax rate than comparable companies of II-VI, and so we think, going forward, for FY04, it should range in a 27% to 29% range.

So this 32% -- is this -- I mean -- something that just happened this quarter? Can you explain that a little bit more?

The rate for the quarter is adjusting the overall effective rate, which we ended up for the year at 27.6%. So this is just mechanically how we need to get to the right effective rate for the full year.

Just an adjustment, okay.

It also reflects the completion of certain year-end tax studies that we do, and we get those done from an external perspective. It helps us allocate the profits between our main manufacturing facilities.

Okay, well, thank you very much.

Your next question comes from Dave Kang.

Good morning. There has been recent data on GDP and durable goods orders that were certainly encouraging. Is your visibility better, compared with two or three quarters ago?

Slightly better. Maybe we're being a little bit more determined to have a better feeling and project a stronger sense, and that does come from this last three quarters of solid results. Our OEM customers are talking with us again. Nobody is talking, in the OEM down there, assembly line to build more, but they're healthy. Certainly the European OEMs that we have are -- they've throttled themselves back, so we're counting on that continuing around where it's been. So I think we have to say we have a little more visibility. Our projections for growth are predicated on the after-market. That gets a little bit trickier, because it's a real diverse set of people out there running those 30,000 lasers. Some are job shops, some are automotive, and some are up, some are down but right now we're seeing -- just trending upward.

Okay, and the second question is regarding silicon carbide. A recent announcement from Cree -- their pact with Advanced Power -- will that have any impact on your silicon carbide business?

No, we will not. We're working very hard to become a good merchant supplier of the substrate into the marketplace. So that didn't affect us.

And, lastly, going back to gross margin, I may have missed this, but because of your capacity expansion, how will that impact your gross margin, going forward? Thank you.

We think it will, as we add capacity in the current year that we're in now, FY04, that will start to lower our gross margin slightly. I think, as Fran was alluding to, you know, there will be some startup as we expand specifically into coating and diamond turning areas. We don't think it will impact us dramatically, but it will be something that, during this past year, as we control the capital expenditures and investments, we're reaping the results of that now but, again, as Fran mentioned, capacity utilization for the IR optics group is at a pretty high level, and it's time to invest more in that group.

Dave, the thing that we've come to realize, whenever we put on another layer of capacity, machines have a little bit of a startup problem, but also the humans that we bring on, not being as trained, not as experienced, we suffer our yields, you know, some slight downturn, and to project how that suffering will turn into a gross margin effect is hard to do, but there will be some.

Regarding the learning curve, I guess, are we talking about maybe a couple of quarters or more than a couple of quarters?

I think on the learning curve, the learning curve of personnel learning how to coat these optics and how to -- it's very demanding -- how to fabricate them, the diamond turning -- some of our training sessions take two years. So there are some that will go that long. Certainly, we get good, productive work out of personnel after six to nine months.

Okay, and your SG&A was down sequentially -- can you provide more color on that? Thank you.

I think, for the SG&A sequentially down, reflects the finalization of our profit-driven bonus programs and finalization of amounts to be paid out under the various programs we have around the world and adjusting those amounts to their final amounts. That really, probably, was why it was down slightly from the previous quarter.

Your next question comes from Jason Sam.

Hi, Craig. I missed the early part of your call. When you break out revenues and bookings by the segment, did you also break out silicon carbide and EV in terms of separate, distinct segments?

Yeah, we did give a little bit more description on that as far as for revenues for the quarter. EV revenues were just over $1m, and total carbide revenues for the quarter were $1.1m. For bookings for the quarter, EV bookings were $3.2m, and silicon carbide revenues were -- or -- excuse me -- silicon carbide bookings were $600,000.

Your next question comes from Chris Versace.

I guess one of the things, just right off the bat, with your guidance, you said historically you tend to be down sequentially in the September quarter from June, yet last year you guys were not that way. Could you remind us why that was?

I think if you look back to our first quarter, it was actually the lowest earnings quarter for our fiscal year. We earned 15 cents that quarter, and we just finished up with a quarter that's 25 cents. And making more of a -- kind of -- a general statement, or -- historically, there are some years that does not come true or does not hold true to facts. But on the majority of our years, if you look back and see that -- usually that European-Japanese kind of transaction slowdown, or customer slowdown, usually hits us right in the months we're at now, here into August, and we usually start to see a bit of a rebound through that in September. So it maybe doesn't hold true absolutely every year, but, in general terms, that's the reason, Chris, that we put that in there.

Okay. And then if -- you talk about the revenue being impacted positively by the German distributor you guys brought on, can you quantify how much that was in revenue -- what that incremental revenue was?

It was -- in Germany it's our largest area for infrared optic sales. We were able to, during this year, pick up the incremental margin. Instead of selling it to the distributor, we, in essence, now have sold it on to the end customer. So it was probably an additional, I would say, incremental revenues of probably around the $2m mark -- somewhere in that range. Maybe a little bit higher but somewhere in that range.

Okay, and then just one other question on the guidance -- in terms of margin improvement, is it thought that there will be more gross margin-driven or reduction in opex-driven for your guidance for '04?

Chris, what was the last part of your question -- a reduction of what?

Well, I'm just trying to understand, you know, your guidance -- just to see how you guys are getting at it. Obviously, you have your revenues up, but trying to understand -- you see, you know, the EPS improvement -- more gross-margin-driven or more cost-reduction-driven on the operating expense line?

It's a little of both, and we've certainly worked through it all, and we will have some cost containment, let's call it, the same time that we have the growth in sales we're projecting.

If you had to weight them, would you say it's more gross margin than op ex or no?

It's really a tough call there. We're right down the middle, because we do have a mix here between each one of our business units -- which ones we see the growth in and -- I'd say it's a half-and-half -- that's my best judgment, Chris.

Okay, thanks, Fran.

Your next question is from Nathan Churchill.

Good morning, gentlemen. I was wondering, on the SG&A line, you had already addressed why the sequential drop this quarter -- what's a good rate that we could model, going forward, for fiscal '04?

I think where we finished out for the year at about 22% of sales -- that is the new kind of benchmark with our -- as we've talked about a couple of times with the acquisition of the German subsidiary, increasing that up versus historical levels, but where we ended for the year is probably not atypical of where we think we'll be going in the future. So 22%-ish, where we ended this year, is probably pretty reasonable.

Okay. Do you have any large blanket orders coming in the fourth quarter in any of your areas?

Do you mean the first quarter that we're in right now?

No, in the fourth quarter -- you had addressed where the bookings were coming from, but I was just wondering, relative to last year, we saw a couple come in.

They're probably -- one biggie that I think in their EV PRODUCTS group, a $3m booking, three-point-plus. About $2m of that was from one account, and we talk about this -- it's General Electric's division, the Lunar [ph] Group, which makes bone mineral density measurement systems. Now, probably, the biggie for the quarter -- looking back into our IR optics group, there's not one that I recall. I think we're going to get one big one here in the first quarter from a Swiss company, Bystronic, for the IR optics, but I don't recall one other than the one I just mentioned for EV.

Okay, that's helpful. Were there any meaningful currency impacts in the fourth quarter?

No, really, this quarter the effect of foreign currency was less than $50,000 -- really not much of an event for us here in the fourth quarter.

Okay, now what about pricing in the quarter -- anything atypical on that front?

No, I think we did hold our own there. We didn't move in any significant way. Maybe there's a little bit in our VLOC group on one or two jobs, but they were smaller jobs. The IR optics business held pretty steady, EV steady, silicon carbide, our Exotic group, certainly that de-booking of $4.4m, and now we're re-pricing it and re-bidding it here in the first quarter. We'll get that all back from Northrop Grumman, we think, late first quarter or early second. Hopefully, we have better pricing. It will be quite a contest, I think, on the price, though.

Okay. Capital spending -- it sounds like you guys are expecting that to go up in fiscal '04. Can you give us an idea of a range?

I think, our capital spending, we're anticipating it being somewhere -- and, again, this is somewhat of an early guess, and a lot of things can happen to it, but it's -- as Fran was articulating some of the things that we need to do -- increase capacity in our IR group and also the expansion of our silicon carbide, specifically in the growth area, we think that capital expenditures probably range somewhere around the $15m market for FY04.

Okay, last thing -- you had mentioned potentially exiting the large optics coating facility business after you have a chance to examine what the outlook is for the next six to nine months. Can you give us an idea of what the potential cost for that might be and what other areas you might be looking at?

The large optics coating facility, the main capital item in there is owned by the Air Force, so it's in our facility. They pay us a facility charge every month. Exiting that would be something that we would contract for -- work out with the Air Force BO [ph] and should be a non-event relative to a bottom-line effect and it's not for sure that's what we're going to do. You never know -- we're in that mode of talking. We've indicated that it's not an area that fits exactly our strategy because the large optics demand is very sporadic. It's so sporadic that one would have to -- that's what we've had to do is assemble quite a team to do that work. We've turned the team down, slowed it down, slowed it down. Now that we see no follow-on order at this moment, there will be some more ABL work, but it might cause us to be shut down for six or nine months before we take on another job. That's not really the type of business we think we're best for, so we've indicated that.

Understood. Now, those skills that you've gained in that area, to date, do you think those are leverageable in any other areas?

Oh, yes. Some of our skills that we had -- we did have by way of consultants we had on board. Others, a good handful of them, were very high-skilled coating engineers and technicians, and we've already re-de-employed [ph] our current personnel back into our other Exotic coating business. And that's going to be very helpful as we work harder on the sapphire process -- getting our coating there stronger.

Okay, great.

Your next question comes from Jason Sam.

Hey, guys, I got cut off over there. Just a few follow-up questions -- Fran, the IR usage rate -- is that difference between -- you know, because you're mentioning 90-plus-percent. Is there a difference between the furnace usage and back end?

Oh, yeah, the furnace I think I said was 80%, 85%. I might tip more on 80 there. I know we've got lots more room in the furnace side of things than we do at the moment in -- probably our tightest, along that whole process would be, right now, our fabrication -- optics fab. Reasonably tight is the diamond turning. So those are the two front-end steps -- coating tight but not that tight, and then back at the front-end on the materials side, 80% utilized, I'd say.

Oh, okay. So in terms of just pure crystal growth, you've still got some room?

Yes, sir.

Okay, that's great. And so -- now, in terms of if you were to add some more back-end capacity, assuming demand increases more than what you expected, what you're expecting in -- over the next few quarters -- is there any kind of challenges in terms of adding capacity there? Do you need to add additional people, you know, in terms of resource allocation, how are you looking on that front?

Are you referring to the crystal growth side or the fabrication?

Back-end fabrication side.

Oh, yeah, certainly, fabrication is quite labor-driven. So we're in China adding personnel right now, we're in Singapore adding personnel, and our Saxonburg shop, some increases, not a large staff, but also here in Saxonburg we have the diamond turning operation, which is -- it's just a different way to fabricate. So that -- we're adding machine and personnel there. So in all three of our sites, we're out recruiting.

Okay, so then the headcount increase in the last quarter -- was that mainly in China?

Yeah, a significant portion of that was in China, as we had started during the quarter the renovation, or the expansion, of additional square footage in our Suzhou, China, facility and, yes, a lot of the addition, headcount-wise, were to help get ready to staff up our expanded China facility.

Okay. Just to change the subject a little bit -- back to booking and revenues. Now, with the military booking numbers of $4.5m for the quarter, that's net of the $4.4m sapphire contract that you had de-booked, right?

Yes, sir.

So the $4.4m, is that back on the books, or is that a different number?

Say your question one more time, Jason.

So the quarter -- you know, you netted out the $4.4m, so you ended up with $4.5m. So since you work out the issues with Northrop, the $4.4m, is that back on the books or is that a different number?

We're negotiating that right now. I think I mentioned that. If we expect to win that -- if this shroud job, in late first quarter, early second quarter, will put bookings back on for that, and I think it will be -- I can't tell you exactly, Jason, but we might not get as many units, but we will have a higher price, because the design that's come out now is more demanding than before.

I see. So now the reason for the de-booking was that mainly a change in design in the middle of the working order, or was that because of some technical issues?

No, it was a change of the design -- a strengthening, let's say, of the concept by Northrop Grumman.

I see. So is that contract open for bidding again by everybody? Or do you pretty much get, you know, the first dip at it?

They have other bidders. Remember, there are two pieces to it. We are currently going right on producing and shipping to them for the IFTS -- the turret assembly, as it's called -- no change in that everything is going fine. The other portion is the shroud. This shroud is stronger than before, and I think they are going out, getting quotes, and I don't know how it will play out, but it is out on the street again.

I see. But you feel pretty strong that you could close that by the end of the quarter?

I think their timeline is they need to get the order placed as soon as possible, and these kind of contracts are fraught with delay. So if I would say, for sure, it's going to happen by September, it will happen in October. So they do need to place the order, thought, I think, quickly.

I see. So now if, you know, on a worst-case scenario, if you did lose that contract, do you have anything to offset that?

Well, that same capability, where we're polishing these very hard sapphire panels and assembling them into a housing, into a shroud, we are doing right now -- and we're delivering on -- to Lockheed Martin for their ATP program. Follow on for that in Lockheed Martin will be the joint strike fighter, the JSF, which is a sapphire window housing shroud that we've been making for IFTS and ATP are four panels per housing. The JSF is seven panels per, and they're bigger panels yet. So that's going to be an important business for us. The IFTS is a good one that will fit into our ATP, IFTS, and JSF. If we miss the IFTS, which I don't foresee, we would produce probably more ATP or keep right on with that until the JSF comes on.

I see, okay. And one more question -- regarding IR revenue and booking for the quarter -- you know, booking was down sequentially. Is that mainly because of seasonality in terms of Q1 being sort of the seasonally weakest quarter because of Europe and Japan, but, you know, is it also because last quarter you had more blanket orders coming in at the same time?

Yes, it's more the latter, Jason. It's more that we did have some fairly large blanket orders that came in the third quarter. As Fran was mentioning, almost a third -- 30% or so -- of our bookings during this quarter were military orders -- smaller dollars. There weren't any very large blanket orders in there, and as Fran was also alluding to, in the first quarter we are expecting to get a blanket order from one of our larger OEM customers.

Okay, and so in terms of the sequential revenue decline and IR, that's also the same reason, right?

That's right, that's correct.

Okay, so then I take it that even despite the seasonality, from an IR standpoint, then, sequentially, revenue should be up quarter-over-quarter then?

Yeah, again, we go into the quarter having a pretty strong backlog statistically in the IR optics group where our backlog is at the $20m mark. So we are entering into the quarter with a pretty strong backlog that we wanted to be able to ship again. So, yeah, versus where we ended fourth quarter, there is potential we could better that. But, again, a lot of it depends on how the shipments are off to the European and Japanese customers during this first quarter.

Okay, great, and one last question -- I lied about the other one -- last question is relating to -- oh, I lost my train of thought there -- oh -- I'll jump back on the queue. I'll let somebody else jump on.

Okay, thank you.

Thanks.

There are no further questions at this time.

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ending September 30, 2003, is currently scheduled for after the close of the market on Wednesday, October 22, 2003, with a conference call to be conducted the following day, Thursday, October 23, 2003, at 10 a.m. Eastern time. Thank you for participating in today's conference call.

Thank you participating in today's teleconference. You may now disconnect.