II-VI Inc (IIVI) 2004 Q3 法說會逐字稿

Good morning, my name is Brook, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the II-VI, Inc. third quarter investor 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. I would now like to introduce Mr. Craig Creaturo. Chief Accounting Officer and Treasurer. Thank you, Mr. Creaturo, you may begin your conference.

Thank you, Brook. And welcome to the third quarter fiscal 2004 II-VI, Inc. investor teleconference. As a reminder this teleconference is being recorded on Thursday, April 22, 2004. The forward-looking statements we may make during this teleconference speak as of today, and we do not undertake any obligations to update these statements to reflect events or circumstances occurring after today. Joining me today is Carl Johnson, our Chairman and Chief Executive Officer. The prepared comments for today's teleconference include a review of the third quarter financial results and a business and operational review. Following these prepared comments we will have a question-and-answer session.

Total company bookings for the quarter ended March 31, 2004 were a record 41.4 million, and increased 12% as compared to the same quarter last year. Infrared optics bookings increased 5%, near-infrared optics bookings increased 4% and military infrared optics bookings decreased 47% as compared to the same quarter last year. In addition the company recorded approximately 4.7 million of eV Products bookings, and approximately 2.6 million of silicon carbide bookings from the Wide Band Gap Materials 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 if changes in customer demand or production schedules move a delivery past 12 months. For the nine months ended March 31, 2004, overall bookings increased 13% to 117.1 million as compared to the same period last year.

Total company revenues of 39.1 million for the quarter ended March 31, 2004, increased 21% as compared to the same quarter last year. And represented a fourth consecutive record revenue quarter for the company. Infrared optics revenues for the just-completed quarter increased 20%. Near-infrared optics revenues increased 21%, and military infrared optics revenues increased 21% as compared to the same quarter last year. In addition, the company recorded approximately 1.9 million of eV Products revenues and approximately 900,000 of silicon carbide revenues from the Wide Band Gap Materials Group during the quarter.

For the nine months ended March 31, 2004, overall revenues increased 13% to 107.9 million as compared to the same period last year. Gross margin on manufactured products as a percentage of sales for the quarter increased by approximately five percentage points from a year ago. The increased sales volume for the quarter as compared to the prior year was the main factor for the increased gross margin for the quarter. The gross margin improvement for the quarter also reflects a variety of yield improvement and cost reduction programs occurring at our various facilities. Additionally, the gross margin improvement is partially attributable to strong sales of infrared optics in Japan. Sales of our II-VI Japan subsidiary have increased over 35% in the local currency for the nine months ended March 31, 2004, as compared to the same period last year while the strong yen has helped our revenues and gross margins even more.

A final factor in the improved gross margin resulted from our ownership of a new sales and marketing organization in Switzerland for the entire quarter. Effective December 1, 2003, II-VI acquired a 75% interest in II-VI lot Swiss, which is distributing infrared optics in Switzerland. This new subsidiary relationship as opposed to to the prior use of a distributor, has added incremental margin for sales in this country. Internal research and development expense for the quarter was 1,259,000, and was higher than the same quarter last year in terms of both dollars and as a percentage of revenues. The higher expenses primarily the result of lower external contract support for the company's efforts in silicon carbide. This in turn requires more funding to be provided by the company. In addition to 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 eV Products. The internal research and development expense for the fourth quarter of the current fiscal year and the beginning of the next fiscal year should decrease based on the receipt of a significant silicon carbide contract during the just completed quarter which Carl will more fully describe in his prepared comments.

Selling, general and administrative expense for the quarter as a percentage of revenues was 23.4%, as compared to 23.7% of revenues in the same quarter last year. As compared to the second quarter of the current fiscal year, the selling, general and administrative expense for the just-completed quarter increased by approximately 1.4 million. The higher revenue levels achieved during the just-completed quarter, combined with higher compensation expense for the company's worldwide profit-driven bonus programs led to this increase. Interest expense for the quarter was 101,000, which was about 40% lower than interest expense in the same quarter last year. The majority of the company's debt has Libor-based interest rates. These rates continue to remain low, and the company's weighted average interest rate currently is approximately 2.1%. The lower interest expense also reflects lower overall debt levels of the company.

Other expense for the quarter of 105,000 reflects several factors, including foreign currency expense, the 25% minority interest in II-VI lot GMBH and II-VI Lot Swiss, our sales and marketing subsidiaries in Germany and Switzerland respectively, and other expense items. Other expense was partially offset by interest income and other income items. The effective tax rate for the quarter was 33.5%, and was consistent with the rate used in the first two quarters of the fiscal year. The increase in the effective tax rate as compared to the effective rate in effect for the previous year is the result of an expected shift in the mix of U.S. and international earnings as our U.S. operations are expected to increase their pool of earnings as compared to last year. This incremental U.S.-sourced income is taxed at the full U.S. federal and state tax rates. Despite the current year change in our tax rates, the company still benefits from lower tax rates on its China and Singapore operations, where the tax rates are currently 7 1/2 and 22% respectively.

Looking at earnings before income taxes, the results for the quarter were 75% higher than the same quarter last year. Net earnings for the quarter were a record 4,775,000, or 32 cents per diluted share. These results compare with net earnings in last year's third quarter of 3,019,000 or 21 cents per diluted share. For the quarter, average shares outstanding were 14,346,000 while average diluted shares were 14,723,000. For the nine months ended March 31, 2004, average shares outstanding were 14,286,000, while average diluted shares were 14,677,000. The company's backlog at March 31, 2004, was approximately 66 million. Which was up from the December 31, 2003 level. The components of this backlog include: Infrared optics at 22 million, near-infrared optics at 11 million, military infrared optics at 22.5 million, eV Products at 8 million, and silicon carbide at 2.5 million. Backlog is defined as bookings that have not been converted into revenues by the end of the reporting period.

Our worldwide employment at March 31, 2004, was 1,203 employees. This number compares with worldwide employment at December 31, 2003 of 1,167 employees, and June 30, 2003 of 1,094 employees. Approximately two-thirds of our employment increases during the current fiscal year have occurred at our Asian manufacturing sites. During the quarter, the company repaid 2.6 million under its credit facility. The company's total debt at March 31, 2004, was 18.1 million which represents the lowest debt level of the company in over 3 1/2 years. This concludes the financial review and Carl will now give a business and operational review. Carl?

Thank you, Craig. Please let me start by stating the obvious. Business for II-VI is good around the world and in nearly every market sector. The question to explore is: What is behind all of the records? As Craig indicated, our II-VI infrared optics business unit achieved a new bookings record of 23.1 million during the third quarter. The previous purchase record of 22.3 million was set in the first quarter of this fiscal year strong buying patterns by CO2 laser building original equipment manufacturers worldwide enabled the new record bookings level. The U.S. market was particularly strong with new highs being set in both the OEM and after-market segments. OEM, machine builders and laser resonator manufacturers continued to introduce higher powered models. A significant fraction of the laser optic orders received in the quarter were for CO2 layers with output powers of greater than 5-kilowatts. Typically these lasers embody new innovative laser designs and incorporate more complex optical configurations and optical parts.

State-of-the-art diamond turning, fabrication, and measurement equipment are require to manufacture these complex parts and by necessity, these parts are higher priced. At the other end of the power spectrum, the low power market for CO2 laser marking and engraving continues at a torrid pace. New applications such as the marking of perishable foods will again accelerate the growth of laser marking systems. In our VLOC near infrared laser optics business unit, third quarter bookings were up only 4% compared to a year ago. This was due to the timing of $1.5 million contract R&D booking in last year's third quarter. More significantly, commercial bookings increased by 31% during the quarter, compared to a year ago, driven by broad-based growth in the medical, military, and instrumentation market segments. Third quarter revenues were up 20% over the prior year. With increased shipments of the wave plates, standard optics and crystal products used in medical and instrumentation systems driving this growth.

During the third quarter, VLOC completed the transfer of the eV filter technology and equipment that was previously acquired from the Crystal Associates Division of Coherent. As planned low rate shipments from this new product line began in February. We will be working hard over the next several quarters to expand our capacity to meet a rapidly increasing demand for these products. VLOC is leading this initiative with support from our corporate advanced materials development center. Other corporate resources will be engaged as necessary to meet an aggressive eV filter ramp up plan. To this point in fiscal 2004, VLOC has not seen any substantial recovery in optic shipments to the semiconductor market. VLOC is continuing to develop and improve the performance of its products in the multikilowatt YAG laser market and to participate in qualification trials for high ower laser gain and optical components.

We are presently adding manufacturing capacity in Florida, primarily to support anticipated growth in the military market. Similarly, we are adding capacity in China to support projected growth in the medical market along with increased business in the semiconductor and industrial market segments. Significantly during the third quarter, we commissioned our first-ever thin film coating capability in Sucho, China. Shipments of finished, tested antireflection coated near-IR optics from China should begin building during the current quarter. Bookings at Exotic Electrooptics for the third quarter were 3.9 million, which is off from the average booking rate for the first two quarters of $8.3 million. This reflects the lumpiness of the military optics market segment served by EEO. The only significant order that was expected but not received during the quarter was for additional zinc sulfide domes for the Javelin anti-tank missile program. We are currently negotiating another award and expect to receive the resulting order during the current quarter.

The Javelin dome order currently in production is expected to continue through September. So there's no concern at this time about an interruption on our production line. There were no Sapphire Window assembly orders expected or received in the third quarter. The Lockheed Martin Sniper advanced targeting pod continues to perform well and is gaining acceptance throughout the defense industry. We do expect to receive an order for another 20-plus of these units during the fourth quarter. Our development of a Sapphire Window assembly for use on the Joint Strike Fighter is progressing nicely. A proposal for the first set of low-rate initial production window assemblies has been submitted. We expect our proposal to be reviewed and negotiated over the next six months.

Backlog and EEO remains healthy at $22.5 million. 5.1 million of this backlog is related to our Sapphire Window assembly product line, and nearly all of the remaining backlog is for core military products, namely for windows, domes, and other infrared optical components that we are very experienced at manufacturing. Third quarter revenues of $5.8 million increased 20-plus% from the same quarter a year ago. However, compared to the second quarter revenues were off about 10%. This sequential reduction resulted from lower Sapphire based product line shipments and from the previously announced shutdown of our large optics coating facility. During our third quarter, the Department of Defense announced that it was cancelling its Comanche helicopter program.

For the past three years, EEO has been performing on an optical components contract that was tied to Comanche, and as previously reported, EEO has incurred significant losses on this contract. On March 5, we received a stop-work order for this Comanche-associated contract followed by a termination for convenience notice on April 2nd. We must now negotiate a settlement with our contractor relative to our cost on this program. We anticipate that the final resolution of this situation should occur sometime during our fiscal year 2005.

In our compound semiconductor segment, eV products posted strong third quarter bookings at $4.7 million. This represents a new single-quarter record for the eV division. Bookings were led by a yearly blanket order from General Electric for cadmium zinc telluride based bone mineral densitometry detectors. Year-over-year growth in the demand for this product exceeds 20%. We have worked hard to strengthen our relationship with GE as evidenced by our strong performance in the production of detector component for their Prodigy product line and we are pleased to be working together on the detectors for their next generation of medical diagnostic products. We also envision that GE will be a pioneer and a leader in the deployment of CZT based radiation detector technology and other application arenas such as industrial nondestructive testing and Homeland security.

During the third quarter, the eV division also received second-year funding for a previously reported three-year development contract from the U.S. Army. Revenues for the division, while a bit lower than during the second quarter, were in line with our forecast. eV's results for the third quarter represent another solid step toward break even performance. The outlook for bookings and revenues in the fourth quarter are in line with previously reported forecasts. And eVs results for fiscal 2004 are expected to be substantially higher than those of the prior year. Full-year bookings and revenues should grow approximately 40% and 60% respectively.

Also in our compound semiconductor segment, the Wide Band Gap Materials, or WBG group generated revenues and bookings for the third quarter of $900,000 and $2.6 million respectively. Silicon carbide wafer revenues for the quarter increased 60% over those for the second quarter. Product bookings continue to grow at a significant rate with the majority of wafer shipments continuing to be booked and shipped during the same month. Two new silicon carbide wafer customers were added during the quarter as we continued to expand both production capacity and marketing activities. Shipments of 3-inch diameter semi insulating wafers accounted for close to 50% of total wafer sales for the quarter.

Technology development efforts continued to move forward with the emphasis in the areas of material purity, defect density reduction and diameter expansion. Product diversification efforts have been successful, culminating with initial sales of 4H poly-type conducting wafers for power applications. The development of 100-millimeter diameter semi insulating silicon carbide wafers for radio frequency power amplifier applications is proceeding well and we expect to begin sampling products to customers later this calendar year. As a result of these promising development efforts, WBG was awarded a new 12-month duration government contract totaling $1.5 million. This program will focus on the continued development of higher purity and diameter scale up for our new 4H poly-type product line.

Manufacturing scale up efforts continue at a rapid pace -- continued at a rapid pace during the third quarter with the commissioning of several new crystal growth furnaces. These furnaces will increase our production capacity by approximately a factor of two. In addition, the recent purchase of a wafer grinder, several large polish machines, and a four-stage wafer cleaning station, along with an assortment of other production line tools will enable a polishing throughput increase of 700% along with a dramatic reduction in microscale wafer surface contamination. I would be amiss if I did not mention the role being played by our advanced development -- advanced materials development center or AMDC, which is presently included and managed as part of our compound semiconductor segment. The AMDC is underpinning a number of crystal growth and material production thrusts throughout the company. And is heavily involved in the VLOC led, eV filter materials and component initiative.

The materials portion of this initiative is being carried primarily by the AMDC. With the fabrication assembly -- and assembly portion being performed at VLOC. We have identified and engaged a number of UV start-up and scale up challenges, and the obvious teamwork between our AMDC development unit and the VLOC manufacturing unit will be critical in the achieving of quality, delivery and cost targets of this important program. In concluding, I sincerely thank every customer, every vendor, and every employee of each II-VI business unit for the outstanding results achieved in our third quarter. I congratulate all contributors and urge us to maintain the forward momentum that we have generated. Craig, I suggest that we're about ready to take the first question.

Thank you, Carl. 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-K for the fiscal year-ended June 30, 2003. Brook, we are now ready for the first question.

At this time, I would like to remind everyone, in order 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 Tim Slevin with Parker/Hunter.

Good morning. Congratulations on the results, they're pretty darn good. I just had a couple of cleanup questions. Then I'll release and go back into queue. I was wondering in terms of cash flow from operations, in the quarter, what, you know, how did that fare, and capital spending in the quarter as well as the outlook for the balance of the year, and next year?

For cash flow from operations we've tried, TIm, to put some of the pieces in there that would be critical to helping get to those numbers we put in depreciation and amortization in the press release, and we stopped just a little bit short, though, of putting in an actual cash flow statement. But I think the main pieces you can pick out from the press release, I think you should also be aware that we did increase both inventory and accounts receivable balances in this quarter, the accounts receivable balances being primarily because of a fair amount of shipments, this record shipment quarter that we had happened later in the quarter, so that increased our balance in accounts receivable. And inventory build is really just a result of continuing to build for the ongoing revenue level that we're expecting.

So the other question you had about the capital spending, the capital spending that we had during the quarter was just a little bit short of $3.2 million, and for the year to date, just brought that short just a little bit short of 9 million. We think during the upcoming fourth quarter, the current quarter, our capital spending should be maybe around the 4 to $5 million range. We have a few projects that we're starting to ramp up, capacity expansions, and those should be one of the bigger items. Those will be a couple of the bigger items that will be in the capital spending for the fourth quarter.

And, you know guess looking beyond that, you're going to have regular capacity expansions but are there any major -- a lot of the ones I think you all outlined in the talk are in process now, or in progress now, and in terms of silicon carbide expansion and some of the other factors, including the thin film coating in China. So is this kind of a catch-up year for capital spending, and then it moderates or depending on growth, it's going to be a regular continuing thing?

Tim, this year actually is in the second half, it's picking up, and last year, as you recall, '03, and even the front end of this year, we really slowed down because we had actually put excess capacity in place when things slowed down in 2002, '03 from what we had expected. So there definitely is a pick up. And I think we don't have our budget for '05 completed at this time. It's going to come together over the next month or so. But I think next year will be a pretty strong capital investment year, just to keep up with the growth we see coming. There is one major project that we've kicked off here in Saxonburg, and I think the, it's going to spread out over 2 1/2 years, but the total expansion of our thin-film coating activity here in Saxonburg, and additional support areas and office space and so forth, the whole price tag on that is around $14 million. But it will spread out over the next couple of years. There will be some silicon carbide expense. It could amount in the next year something in the 5 to $10 million range. Again, we don't have that nailed down yet for fiscal year '05. Craig may choose to add to this, but I just tried to -- I don't know of any other really major project-type expansions other than those two.

I would just add to that, Tim, that, you know, we're looking at this year ending between 13 and 14 million, and I think we are anticipating that we will be spending that level plus a little bit more. As Carl mentioned, probably a couple of the bigger ones in their coating expansion here in Saxonburg and also expanding the silicon carbide operations, and then I think just in general, overall operational capacity expansions at all of our facilities are planned at some point during FY '05. So we will be embarking on some more capital spending. We're fortunate that our financial strength and cash flow strength has been well, that we are able to continue no pay down debt and we should not have any problems funding those type of higher-level capital expenditures with cash from generated from operations.

Okay. Great. I guess the last question is kind of a broader one in terms of margins. If I look at it, you know, you all have had, you know, really good operating margins in infrared the last couple of years. And those seem to have stabilized. I guess I'd have the question, you know, depending on capacity expansion or, you know, the vagaries of the market, do you feel that that's a comfortable or sustainable level given the increased nature, increased proportion of kind of recurring sales into the after market, either directly or indirectly? And then, even if you have some compression there, if I look, you've had a really nice rebound in the -- in terms of near infrared and military but they're still not where they've been in the past. And you're moving pretty rapidly as well in terms of the emerging markets to move to break even. What's your feeling regarding the sustainability of this, you know, really strong operating income margin that you had in the quarter?

I think we're continuing, Tim, to expect that it's -- we're going to make progress. I think, you know, the history that you've seen over the last, say, six quarters or so, I think we are expecting that that's going to be, you know, in some shape or fashion, our target or our goals for the next few quarters or couple years. As you touched on, in the infrared optics group, we may see a little bit of contraction in that margin potentially as we start to ramp some of these operations up, as we start to get the capital in place and the manpower in place maybe a little bit before the revenues but it's all based on the, our best judgment as to the revenues that are coming shortly thereafter. I think one other thing that's probably worth noting as far as the margin expansion goes, in what you've seen maybe just this fiscal year, if you look at, you know, we've increased revenues by about 13% overall as a company, yet we've held the headcount down and only increased that about 3%. And of that three percentage points as I was mentioning in the prepared comments about two-thirds of that is over in Asia.

That's helping our short-term results, but it is a longer term challenge for us, is to get the right people in the right places, especially here in the United States. To answer your question about the near-infrared and the military, I think that, especially in the near-infrared, we believe we will continue to make progress, margin-wise, and I think the addition of the UV filter business that Carl talked a little bit about will continue to help our margin expansion. We are also continuing to do more of our optics manufacturing in China, that will also help our margin expansion for the near-IR. And for the military, I think we are continuing to focus on doing and performing better on the orders and the contracts, and the programs that we have in place, and I know that's a very big initiative of our overall corporation and probably, you know, specifically of exotic themselves.

The large coatings business that you all are exiting, did that have a pronounced impact on military, you know, getting a bit better in the quarter?

It had a little bit of an impact, TIm, as far as the decreasing revenues but that business was not really a very -- that business was pretty close to break even.

Oh, okay.

For the couple years we had it. So the hit that we took was really on the top line, and not necessarily on the bottom line for the military infrared optics group.

Great. Thank you all.

Your next question comes from Jason Sam with Seidler.

Hi guys.

Good morning.

Congrats on a great quarter by the way.

Thank you very much.

Carl if you could touch on a couple of things for me. First relating to the crystal associate UV filters business?

Yes.

Now, you guys have gradually expanding capacity. Two questions on that. One is: Obviously the demand is coming from the military side. Can you talk a little bit more about the type of programs that they're involved in? And Number 2, what type of revenue potential can we expect to see from that particular business?

Okay. We have to be a little bit careful and speak in generalities about the application. We don't want to go into too much detail. But let me just say -- and that's because we don't want to go too far in discussing military products in this particular forum. But the application is -- to fit into products that our customers make, our defense equipment customers make to protect slow-flying aircraft. And the Army thinks of slow-flying aircraft mainly as helicopters, and the Air Force might and the Navy might think of slow-flying as anything that's below MACH 1. I'm not sure exactly how many platforms this kind of equipment would be tasked to protect, but that's about what I can say in terms of the application. So these UV filters are used in protecting these kinds of platforms from missiles and the like.

In terms of the business, we believe that, of course, it fits in well with the military business that we have, and our attitude toward military business, we like to have something in the range of 15 to 25% of our total effort going toward the military, because it's just healthy the way we run our business. So this helps us there. But there is a limit to the military market. We think that over time, and that means probably a couple of year time period, that this product line could grow to something in the three to $5 million range in terms of the military portion.

There potentially is a commercial application as well. The Department of Homeland security is talking to the same equipment manufacturers that are working on military versions about potentially some kind of probably a maybe lesser-performing and lower cost unit to protect commercial aircraft. That could be potentially -- we don't want to indicate that that's going to happen, we don't know what Homeland security and the air -- commercial airlines will decide to do, but potentially that could be a market that would be considerably larger. I don't really have a number, but it could be considerably larger than the military portion. So it could be, you know, two, three times the size of the military. Craig, do you want to sharpen up any of that?

I would say just that I think everything was -- is exactly as you say, and just one other point for our -- as Carl mentioned in his prepared comments, we just this past quarter started shipping out UV filter-type products, and our expectations for this current year is it would not be a material part our revenue mix. We expect it only to be maybe about a half million dollars. Getting up to that 3 to 4 to $5 million range that Carl talked about, that is coming on the horizon pretty quickly.

So now sorry, just touching on the commercial opportunity a little bit, obviously once you're in the military market the application, you know, it's put through pretty extensive testing so the product itself would work. So now then when you're working with the Homeland security, department, are you making any modifications or are you, you know -- what would be the trigger point? Is it mainly sort of the airlines making up their mind on whether they would do it, or are we waiting for some type of initiatives that would, you know, force them to do it?

Well, let me comment a couple of things. First of all, as is almost always the case, we are making parts that enable our customers to make a component in the system that performs the protection function. So we're a second tier supplier. And sometimes we don't have as sharp a view into the marketplace as the component supplier or the system supplier would. So we're -- we'll try to answer your question as best we can, but just understand that we're the parts guys that make the parts that enable this to be built.

And it will be the same people that are making the product for the military. It will be the same people, it will be a different version, but we don't understand how that version might be different. Of course, the commercial always -- there's an emphasis to make it lower cost in the commercial. But with the higher volume, sometimes that clearly can be done. I really don't -- wish I didn't have to say this, but the -- you ask what would cause the airlines to and the Homeland security or governments around the world to want to protect their commercial fleets, and unfortunately, I think we all know the answer to that, is, boy, if somebody shoots a stinger-type missile at a commercial airplane and makes a hit, that unfortunately is the kind of thing that would trigger a huge concern about protecting airplanes. And I don't wish that to happen, but it's a very difficult thing to even think about, but, you know that would clearly raise everybody's awareness for the need for something.

And so anyway, I don't know what will cause -- short of that, I don't know what would cause the airlines and the Homeland security folks to decide to deploy. I think you're right, there is a lot of testing still that needs to be done. Lot of these Homeland security products are being developed and deployed very quickly. They're not going through as extensive testing of products we historically might have, because there is such a need and so much risk involved in some of these problems. So I'm not sure we've been here before exactly. This is kind of new territory for us as well. I've done the best I can to give you an answer.

That's fine. Carl, with the GE program with the blanket order from GE, are you guys rolling out a new generation of equipment for them? Or is it just increased demand from existing equipment already in the field?

This product that I mentioned by name, the GE Lunar Prodigy product line has been a terrific success for GE. They've gained market share because of it. The performance of it has been a really nice innovation in that bone mineral densitometry market. This order I mentioned is really just to support their prodigy production and the increased deployments of it. We are, as I said, working collaboratively together with them for future generation products but this order is a production order.

Okay. And what's the horizon for this order in terms of is it for '04 or is it longer than that?

The amount we mentioned was for 12 months, forward-looking 12 months.

Okay. Just a quick question for Craig. On the gross margin, on the contract, gross margin improved dramatically. Is that sustainable?

I think, Jason, part of that increase is the lack of additional losses or write-offs that we've historically had in previous quarters. Part of it is coupled with a couple new contracts that we have that have come on recently that are higher-margin, and a little bit of that is passing through a calendar year rate adjustment. So we're -- we would fine tune our rates to get to the actuals, and those rates were, those actual rates were a little bit higher than we had originally budgeted. So I think all those pieces together added up to the healthier gross margin. I don't think at the level that we had for this quarter it's necessarily sustainable at that high of a level. But going forward, we are expecting, especially that we now have the stop work order on the one contracted exotic, and as Carl mentioned also, getting some new contract support for silicon carbide. It should be at least as much as our nine months margin number, maybe in the lower 20s or so.

Okay. And as far as revenue growth for the quarter, can you quantify the impact that the yen effect had on the -- on the business?

Uhm, it's a good question, Jason. We did for this quarter, and I can give you a quantification of how much business we did in Japan, this was definitely a record setting quarter for us as far as revenues in Japan. Not only in yen but also the converted into dollars as well, and overall for II-VI our II-VI Japan subsidiary, we did just a little bit short of $5 million in business for the quarter. That is quite a remarkable feat, again, especially if you go back and look what that business was doing two years ago or so. The impact of the yen, especially for the infrared optics, operating margin, had a couple percentages of impact because, again, we do sell a lot of products through there and we're selling and we're providing those products in dollars, but our Japanese subsidiary, obviously, selling in yen. So it was a noticeable impact to the gross margin.

Okay. Great, thank you.

Your next question comes from Pierre Maccagno with Needham & Company.

Hi, Carl and Craig, congratulations on the quarter.

Thanks, Pierre.

Could you comment on the IR business, what percent of that was OEM and after market, and could we see this is the beginning of recovery then in the laser industry? Is that what you would say about this industry at this point? Or what are your comments?

Okay. I think the OEM business, there's no doubt that it has strengthened. The past two or three-quarters it really really was -- had fallen off, and we were dominated by the after market. I think now the mix has shifted back, I don't have -- I don't really want to quote a number because I didn't prepare that number. I can only say that the OEMs now have perked up. A couple of trade shows we've been to in the last two to four months, they're all talking more positively about the number of machines they're going to build and so forth. So maybe the OEM business is running 25 to maybe 50% in some cases, which -- above what it was a year ago. Let's say.

Now, the other thing that's happening is -- and the marking, I mentioned that it's continuing at a torrid pace. There are more and more marking applications coming to fruition, and being deployed. And I'll mention one specific one. I mentioned in my comments that it's rather fascinating. They're starting to mark perishable foods with CO2, low power CO2 lasers. You think about getting into the food business, the food processing business, they're going to start putting date codes on oranges using laser technology. Because the, Ink, when you put it on with ink it smears. The orange peel is a hard material to get ink to stick on. And wow, you start talking about the number of units that could be deployed over a five or 10-year period to service perishable foods, it's mind-boggling, thousands, and thousands, tens of thousands of units potentially. So you know, just it's amazing, I never would have thought about marking perishable foods with lasers, but it's happening. So there's that dynamic still that the-- (AUDIO PROBLEM) the laser continues to find new applications. Now, it's not high power 5-kilowatt, it's 25 to 100 watt laser where you find a whole brand new application that nobody was thinking about two, three years ago.

Pierre maybe to just add one point on that, regarding the strength, as Carl mentioned in his comments we're also definitely seeing that in the after market as well, and the strong revenues and order bookings in the quarter were definitely attributable to the OEM. But, going along at the same pace or a similar pace is also the after market. And again, internally here, we're getting up to our surpassing record levels of after market sales on a monthly basis.

Your next question is from Dave Kang with Roth Capital Partners.

Good morning, nice quarter, gentlemen. I was hoping if you guys can go over the gross margin and foreign currency situation once more, so as dollar strengthens going forward, how much will it impact your gross margin going forward? Thank you.

Dave, our projections are that as the yen -- if the yen would strengthen, let's say, ten yen more to the dollar, that could be as much as another one percent, to one and a half percentage point gross margin impact to us. Right now, as Carl mentioned, we're finishing up our budgeting process, and although we're not prognosticators on foreign currencies, we would think that we're somewhat tying ourselves into the levels right now, should be about the levels for next year. So we're not necessarily building that, any more improvement in that strength into our guidance that we've given for FY '05 but it could be that much of an impact and again it's not only just the yen impact, of the stronger yen, but it's also that on an equal yen basis or in the same currency basis in Japan, we're selling 35% more product than we did last year. Those two factors together are definitely helping us right now.

Okay. The next question is regarding your bookings for compound semigroup, of 7.3 obviously is a big jump. Will this segment remain lumpy going forward or can it kind of stabilize a little bit?

It will remain lumpy. We are in the silicon carbide area, we're going to still be very active in the contract R&D business for years to come, and it's going to take, I don't know, at least two, three years before the manufactured product revenue is larger than the -- I don't know how long it will take, but it's going to take some time to -- for the manufactured product revenues to grow well beyond the contract R&D revenues. When you're that dependent on contract, they do come in in a very lumpy fashion, maybe one or two quarters a year, you'd book a contract. Well, this was the quarter when we booked a large contract in WBG, and also in eV we booked a large contract.

So you had both of those units booking contracts in this third quarter. And a year ago, if I'm not mistaken, those contracts came in later, they weren't in that third quarter. So it is really, it is very lumpy. The contract business will always remain lumpy. And both eV and WBG are, you know, tens of percents or many tens of percents, of their are or contract-dependent at the moment. Two years from now, it will start to stabilize some because we anticipate that manufactured product revenues will be more steady and more forecastable, frankly.

Okay. And just lastly, on your revenue guidance of 39 to 41 million for this current quarter, bookings were sort of flat on a sequential basis so what are your assumptions, obviously, one assumption is higher bookings for this current quarter. Can you go over some of your other assumptions? Thank you.

As far as the revenue guidance, Dave, we are sitting here with, you know, right on $66 million of backlog. We're seeing good visibility in all areas. We're seeing the additional contract revenue coming on from the contracts that were booked in the third quarter, which really did not have much of an impact on our current quarter, as Carl was mentioning, in the Compound Semiconductor Group. I think it's all those factors in there. I think it's also us looking at the strength of our most recent, couple months and even maybe even the strength of March specifically, and seeing that, you know, that we're pretty well suited backlog-wise and there seems to be still good after market and book and ship type opportunities in almost all of our businesses.

Even though we don't give guidance for bookings, I think we've alluded to the fact that we anticipate some significant military bookings, and we don't anticipate, you know, the lumpiness as we were talking about in the compound semiconductor, we're definitely not expecting that level to repeat itself, but we are expecting higher levels, specifically in the military infrared on optics business, and also looking for similar type bookings as we had this quarter going forward in our other businesses. So all in all we're anticipating a continued strength in the booking order intake, and that's why it's translating into the revenue guidance that we gave.

Fair enough. And lastly regarding your thin film coating in China, will it have any kind of impact on your gross margin going forward? Thank you.

The only coatings that we're going to be doing in the next fiscal year or even the fourth quarter now because we are running over there, we are operating our thin film coating activity, these are just in the near-IR optics product area, so that of course is VLOC. But it will -- we know that producing those products not only the fabrication but also the coating and testing is going to have a very positive impact on the gross margin of the commercial products that we manufacture in the VLOC business unit. I can't quantify that for you.

We don't probably know yet how, it's going to be a mix situation, we'll be making those products in Florida and in Sucho, China, and we don't know yet how quickly we'll be able to get up the learning curve over there and really start producing a significant amount of those products over there, several tens of percents of those products. But we will know that in three to six months. We'll know how well we've done at getting that started up. But Craig, it has to help us with gross margin in the VLOC commercial side.

That's right. And as well we continue to add not only in the coating area but also in the fabrication area in China, and our Asian facility over there is now about 275 employees, that includes the IR optics group but also a larger and larger percentage are dedicated to the near-infrared optics group. So as you said, Carl, we won't, probably a little bit too early to try to quantify that specific impact but we know long term it's the right thing to do.

And just one more. I'm a little perplexed as to why you haven't seen any kind of a recovery from your semiconductor optical market. Is it more of just a time lag factor or is it more of a market share issue? Can you just provide a little bit more color on that situation? Thank you.

Okay. The semiconductor equipment area, we also don't really understand why it's so slow to develop. We don't think it's market share. We think it's that the particular types of semiconductor processing equipment that our products are built into just haven't responded to increased production levels in semiconductor at this time. That said, we know that, for instance, the wave plate business at VLOC we know that some of that product goes into the semiconductor instrumentation but it's a little hard for us to know.

Let me give you a for-instance. ZYGO is a customer of ours that puts wave plates into a number of their different instruments that they build, scientific instruments, industrial gauging instruments, semiconductor processing machinery, and instruments. We don't really know, in that case, what part of our business with ZYGO is going into semiconductors. So maybe we don't have the visibility that we need to really give you a good answer. Again, sometimes the parts manufacturers don't know exactly where all their parts are going. I'm not saying we shouldn't know, but, it's hard for us to know and have precision to the data that we are able to gather. So maybe it's a little better than we think, but that that we can identify going directly to people, we absolutely know it's going into semiconductor processing equipment. It's just it may be growing a little bit but it's not anything dramatic.

All right. Thank you very much.

Your next question comes from Joe Garner with In World Asset Management (ph).

Good morning.

Good morning.

A couple questions for you. First of which, I was wondering if you could -- I guess talk a little bit about the bookings in terms of in a few of the segments the booking growth rates seem to decelerate a little bit yet you've consistently on a historical basis have grown your revenues faster than the booking levels. It seems from your outlook that you're very optimistic on where the revenues would be, I'm just wondering if you can kind of maybe talk a little bit about those booking trends and how they might relate to revenues.

Joe what we're seeing is, I think, as you're pointing out, we're seeing is just what we did this quarter, record level this -- bookings, this quarter being the previous quarter, where we did almost a similar amount of bookings over $40 million in bookings. I think we are, as we've talked in some of the pieces, we're just seeing the overall strength makeup even for the pieces that aren't necessarily so strong on a quarter-to-quarter basis. So for instance, last quarter we didn't have, you know, near the amount of Compound Semiconductor Group bookings, but we still had at that time a record quarter of bookings. This quarter our military infrared optics group was a little less than their average but yet we still had overall record bookings. I think it's just kind of a combination of overall strength that we're seeing, and that's translating into this, you know, that's translating into a higher expected revenue level, not only for the fourth quarter but also put into the guidance that we gave out for fiscal year '05.

Okay. And then another question for you, it seemed like you had some significant positive developments with the silicon carbide business during the quarter, I'm just wondering with the increase in production capacity and so forth, when do you think this business will then start to be a positive contributor to earnings? Are we very far away from that?

We believe that in the last two quarters, we've taken very good steps toward break even, we're not yet at break even, but we're also, we're investing less, if you will. Our business development costs there is substantially down from a year ago because we are -- we have a kind of -- we have a steady, relatively steady load of R&D contracts. But the manufactured product sales have increased a lot over the year. And we see that we need this capacity that we're going to install. It takes a few months to get it in place, and have it be effective. But we think in '05, there, again, we haven't seen the finished budget and sometimes it doesn't come out as quickly as you might want it to, but I would say this, I'm certainly looking for potentially a break even budget for Wide Band Gap in '05. The potential is there if the manufactured product sales come on to complement the R&D contract level, the load of R&D contracts, we believe, will be more or less level from what it's been, maybe even a pickup from what it's been the last 12 months and then you complement that with a manufactured product, it potentially could get past break even and become a small contributor in '05.

Okay. And in the manufactured product sales area, are you starting to see any positive traction in areas like telecommunications?

Ah, there are three or four segments to the present market. We're looking at in the market segment for silicon carbide. I would say that the RF power amplifier market, there's a lot of interest there, a lot of momentum-building. The military side of that would take you over toward microwave radar applications, and it's not telecommunications, but it's kind of next-door technology.

Right.

And then that's one segment, then that's being severed by our 6H poly-type material. And you go to the 4H material being aimed at what would be called the power switching and power control market. And that's a brand-new product line for us. We're new to market there. But over the next couple of years we think that segment will grow nicely, and that we will see multiple customers wanting to have the 4H poly-type products. We don't know whether we'll be able to really serve a role, a useful role in the LED area because the current people using silicon carbide in that area are so dominant and so strong. So we're currently emphasizing the other two market segments.

Okay. Great. Well, congratulations on all the positive news.

Thank you.

Your next question comes from Brandon Seth with FBR.

Hi guys. Just was hoping you could answer, can you give us a little more color on the strength at the end of the quarter? Was it any business segment in particular? As your result exceeded the preannounced numbers? Are you continuing to see this momentum at the end of the quarter coming into this quarter?

Brandon, the strength toward the end of the quarter was really fairly broad-based. I can tell you that, you know, every one of our business units exceeded our expectations for March. I think led by that was a very, very strong performance from our infrared optics group. We are still continuing to see that trend. We, you know, as we talked about and we're going to start to see an additional layer of contract into our business, and for the upcoming fourth quarter, and you know, so that's what we're -- we've got into the expectations for the fourth quarter. But the strength toward the end of the quarter was really broad-based, you couldn't really point to one business unit and say they did, you know, dramatic you know, twice what they expected, but every one of our business units did more than what we had forecasted.

Craig, I might just add to that, I want to say that because of the nature of the -- being in the parts business, you serve a lot of different customers. We may make a certain lens product line that is literally serving 5,000 customers. When you add not just the 100 or so OEM machine builders but the 4,900 users, end users that are out there, so we're really dealing with the law of large numbers. And it's not too much different in the near-IR. Of course, when you get to the military small number of customers, eV Products, small number of customers, WB, small number of customers. But those other two groups, those two businesses, IR and near-IR, there are literally, potentially you could say there's over 50,000, maybe 100,000 customers out there buying our products every quarter.

And I think those applications are in all different kinds of fields from manufacturing of all kinds of different products, and so it's really, when Craig says broad based I just wanted to emphasize how broad-braced we're really talking about. There's industry segment diversification and there's geographical diversification. In these two business units, so that diversification, number 1, makes it hard to identify the specific trends maybe, the other thing is, it makes it very, very broad-based. When Craig says broad based I just wanted to mention, give you some information to how broad based it really is.

Great. Thank you.

Your next question comes from Ken Slevin with Parker/Hunter.

I just wanted to follow up a little bit on Joe's questions regarding the silicon carbide and Wide Band Gap group. Just looking at the market growth for the -- potential market growth for the applications, you know, I guess first off in terms of a break even, break even revenues, are you looking really to need to get to kind of a double of where you are now, or somewhere in that range before it hits break even? And embedded in that with the growth of manufactured products that you're looking for, how long does it take to design in a new material like silicon carbide into RF power amps and so forth? What's kind of the design cycle for that?

I'll answer the first -- try to answer the first part, Tim and I think we're saying Carl's remarks for FY '05, into the silicon carbide or the Wide Band Gap group, we're looking at now having a base level of contract revenues around, you know, the more than $2 million level. And if you add to that basically a double amount of that in product revenues, that's pretty much what we're targeting. That's really where we think the business is geared up to make a pretty good run at returning a profit.

You know, we're going to make progress, we have made progress, I think that the segment earnings that we report, although it's on a combined eV and WBG basis, but a big, you know, a big portion of that is the continued progression of both of those businesses toward break even, as Carl mentioned, we had a really nice quarter contributed from eV. The investment that we had in WBG, this quarter, was a couple hundred thousand dollars less than the previous quarter. We're starting now in the contracts for this higher level of contracts for Q4, so we should even see that loss tighten up. So to answer your question, I'll let Carl answer the second part of your question, but a couple million dollars base load of contracts combined with about 2X that in product revenues that's really about the target that we're shooting for.

Okay. Great.

In terms of entering into a situation where you're -- you've got a new customer and they start to use the product, there are a couple of ways to enter in and become useful to a new customer. One would be if they're already, either they've got an R&D project that's been going for two, three years let's say, and you have an opportunity to go in and enter in as a second source for selling carbide wafers for them, you might find that you could go in and qualify and they're about ready to -- or maybe they have deployed at low volume some new product that they're making, and they're looking for a second source, you could potentially go in and qualify there and get yourself up and running in a matter of a few months. Certainly I think it wouldn't be one or two months, but in something in the three to six month range, you should be able to qualify your product.

In terms of somebody deciding they're going to take this technology and develop a new device and put it into their product line, and they're starting from scratch, you're going to be working with them on an R&D basis for at least two to three years in my mind before they would be able to bring a new product to market. So there's -- that design cycle, maybe we say one to three years, but it's not so quick. So this is -- we've always said that this is a long-term situation, we're going to work away at this and become valuable in this marketplace, but it's going to take time.

And so you're supplying into someone making the power amp component that's going to be then embedded in a final product and so they've made a decision the silicon carbide has attractive attributes and they're trying to get a design win basis themselves into a final finished products, right? That can take some time, but typically you'e trying to insert yourself in a process where they're already sampling, they've gone down the road and they're trying to interest their end customer on a design win basis for this new material or new power amp with its characteristics..

That's true. There's people that have been working on this for a number of years. And you must remember, the U.S. military has been funding device work in this field for over 10 years. Not only the materials work which is our side of the business, but the device work is being -- has been funded for quite some time. And it will continue. DARCA (ph) has just released a very substantial R&D announcement that they're going to fund wasn't it something like $40 million with one type of product, and it's more on the device side than it is on the materials side. And that's for the next two, three years. That they intend to invest that much in what people who are going to be working device programs. So the military wants this to be developed and there's the -- that's the RF power side -- excuse me, the RF power amplifier and radar side, there is also the power switching side that will come in beyond that amount that I just mentioned. I don't know how much more that's going to be. So there's -- that's actually creating a market for us, the fact that DARCA has that program.

Okay. And that -- so a lot of the commercial applications are kind of still to come, or several years down the road but there's still substantial or substantive programs that are in place now that you look at for opportunities?

Yes, sir.

Okay. And just a final question or clarification, when you all were talking about Japan and the impact on gross margin, you were talking about overall gross margin levels for the entire company?

Uhm, I was talking a little bit more specifically, Tim, about the infrared optics group but when we're talking IR, we're pretty much 60% talking about the overall company, too. So it would definitely have a noticeable impact on the overall company but much more so on the infrared optics group itself. My comments were more specific in looking back on my notes here, my comments were more specific to the infrared optics group as that, as a single business.

But it's as much as a point or so for the total gross margin, I guess.

That is correct.

Okay. Great. Thanks.

Your next question comes from Jason Sam with Seidler.

Hey guys. Just a couple of follow-ups. Craig, can you give me a breakout of the segment earnings for eV and silicon carbides?

Jason because of reporting purposes we aggregated those two groups and I unfortunately can't give you any further detail than is already in the press release. We've -- we have for this fiscal year and the last couple fiscal years reported those two groups in aggregate because they really are similar emerging-type businesses, and they're both, you know, so small that some of the information on the individual basis we just thought it was better to combine those two group. In the future, as those groups continue to grow, we may end up doing that. But for right now, I unfortunately have to stick with what was put in the press release for the Compound Semiconductor Group as a whole.

Okay. Carl, for the silicon carbide business, for the quarter, can you give us an idea in terms of what the split was between commercial sales and contract R&D?

Craig, he has the numbers in front him , I'm going to let him give you that.

Jason, almost exactly one-third of the $900,000 of revenues that they had was contract-related and the other two-thirds was product-related.

Okay. And Carl, a question relating to eV, I mean, you know at the end of 2003, I mean, you know, business was -- the visibility was poor and as we're heading -- as we're finishing 2004, fiscal 2004, that business looks like it's going to be, you know, up over 60%, year-over-year. If you were looking back, I mean, did you, you know, did you imagine you would be able to do 60% year-over-year, what was your feel at the beginning of the year? That's what we're looking forward to, fiscal '05, do you have any better feel as the business matures a little bit more in terms of visibility?

Well, you're right, a year ago, we actually, we just said we just don't have the visibility. I think now there are some things that have become more clear to us. We think that the medical will be steady. We think the Homeland security applications have become more clear. I think the Homeland security department has figured out what they want from our customers. Again, we're making parts and components that are going into portable instruments that are going to be used in Homeland security. We believe that that will continue. Certainly for the next 12 to 24 months to be a strong area. And we have on our own, we have developed some products that we're now taking to market in the industrial gauging arena. And we are seeing interest in those products as we show them to -- these would be almost standard products we'll call them.

In the medical and in the Homeland security, people are coming at us and say we want you to make us something that's very customized, to our application. In the -- in this industrial area, we're trying to create a product that we'll be able to use in various industrial nondestructive testing applications, but that this component would be able to use -- be used by at least 10 customers. Without modifying it. So not every single product has to be custom is the idea.

And we're just now rolling out what we call the evaluator 1,000. And already in our development group, the evaluator 2000 and the evaluator 3000, and these would be three different levels of sophistication of an industrial nondestructive testing product that could be used in a number of applications. So let's -- three months from now, six months from now, we'll be able to say how we've done there. But at least we have a strategy to go out and create a product that will be lower-cost because it doesn't have to carry all the burden of a custom product, and get some efficiencies of manufacture and some efficiencies of volume. So I think those are some of the things that are giving us more confidence.

Would we say that we're going to be any specific percentage a year from now above where we are? We don't have that kind of visibility. But we do believe that the market has stabilized in the medical, and it's growing in the Homeland security, and really the wild card right now is how well are we going to do with these standard products that we're going to take into the industrial segment, but it all looks like growth. It just a matter of is it 20% growth or 40% growth, I wouldn't want to say that our plan is going to be any stronger than that. It doesn't mean it couldn't happen but we're -- and I'm not sand bagging either, I'm just saying we're thinking that eV surely has the opportunity to grow somewhere 20 to 40% in '05. Would you agree, Craig?

Yeah, and back to your other question, Jason, about where eV's going to end up versus where we expected, we believe as far as for bookings, revenues and all the way down to earnings, eV's actually going to be very, very close to where we had forecasted or budgeted for, and I think that is coming back to this, just this requisite understanding of that marketplace and that the potential to grow and to be a good business is definitely there. So I don't think the results that are being achieved at eV, they are terrific, but I don't think they're necessarily catching us off guard, I think we've always known it definitely has that potential in it.

Now, so the bottom line is you're very confident that eV's going to grow in '05 over '04, not putting a number to it. what I'm saying is you are confident.

Yeah. I think we're seeing the signs and seeing the order in-take, as Carl mentioned about standard products and a lot of good things that we are doing, we definitely are expecting higher revenues for eV in '05 than we're going to see here in '04.

Now, Carl, just on the Homeland security issue, can you kind of give us an idea in terms of the type of projects you're working on, how many projects you're working on in that area, and, you know, just a little bit more, you know, we don't really talk about it specifically, and I don't know how much you can or cannot talk about it, but if you can give us a little bit more clarity in the type of programs the number of programs and, you know, any additional visibility on that, that would be great.

Yes, let me say that the area that has really strengthened this year is what I would call the portable instrument area where people are looking for something that you can actually stick in a pocket or carry in your hand or put in a briefcase size little bag that you carry with the purpose of identifying a radioactive material. Something that's giving off radioactive protons, gamma rays, that you can detect . And if it's in your pocket it just would say, you would get a sound out of it, and you would look at it, and it wouldn't just tell you that you're in a radiation field, it would tell you, it would identify the material that you're being exposed to. So you would get material identification, in other words U235, U238, weapons grade plutonium or hospital waste. It would identify the material that is radioactive in the vicinity where you are. So all of these instruments that we're talking about, whatever scale it is from the pocket to the briefcase, it's the idea that you can identify the material. That's the feature that cadmium telluride would bring to these instruments, rather than like a geiger counter you just know that there's radiation, but you can't identify what it is. So it's we say ID capability, identification capability.

So we have about 10 customers that are having us make basically a custom enabling part for them, be it a little small part for the pocket dosimeter ort the a pocket unit or maybe a much larger part with a lot higher sensitivity for the briefcase size device. And there's eight other unique products in between. So that gives you an idea of what kind of product it is, what application it's serving and how many, ballpark how many customers there are that are acting in this field. And then the other area that is a more difficult one to tell where it's going to go, is the idea that airport baggage scanning or large cargo containers or railroad cars that you would want to do the identification function right at the airport, when the bag is going through the scanner, you would be wanting to look for either radioactive material or in that case, probably look for plastic explosives.

That would be in some kind of a container or on a truck or in a railroad car. And that's a much larger type of a machine, it's clearly not portable. You know what the size of the machines at the airport are, but those machines don't give you identification. They only give you kind of a gray scale, a black and white, gray scale image of the physical items going through in terms of their density. That's what you're looking at. The idea of using cadmium zinc telluride is not the only way you could do it, but there is a need to have identification capability on those machines as well. But that's a much larger undertaking, much longer to get to market, these are going to be, as you know, very expensive machines. But that technology is being looked at. So that -- but that's just a development project at the moment.

Now, with the portable devices that you're working on with the 10 customers, are you at liberty to ID them or if not, can you kind of give us an idea of a emerging type players, are they established players?

We have generally signed agreements that would say we -- in this kind of a forum it would be inappropriate to discuss customers by name, I will tell you this, there are independent companies that are medium sized, small to medium sized companies that have been in the portable instrument business for a long, long time. They are looking at adopting this technology. You've got divisions of large companies, again, that division maybe has been with that large company for a long time or maybe they've been recently acquired so you've got that type of customer. And you've also got government agencies directly that have come in with their own designs. Again, not being specific exactly what agency, but Department of Energy and Homeland security both have direct interest in these kinds of portable instruments.

Okay. Great.

That's another type of customer that we've done business with.

Thanks, guys.

At this time, there are no further questions. Gentlemen do you have any closing remarks?

Yes. If there are no more questions I would like to thank everyone for participating today. Our next earnings release for the quarter and fiscal year ending June 30, 2004, is currently scheduled for after the close of the market on Wednesday, August 4, 2004, with a conference call to be conducted the following day, Thursday, August the 5th, 2004, at 10:00 a.m. eastern time. Thank you for participating in today's conference call.

Thank you, this concludes the II-VI Incorporated, third quarter investor conference call. You may now disconnect.