II-VI Inc (IIVI) 2005 Q1 法說會逐字稿

Good morning. My name is Sarah and I will be your conference facilitator today. At this time, I would like to welcome everyone to it II-VI fiscal year 2005 first quarter earnings call.

[OPERATOR INSTRUCTIONS].

Thank you. Mr. Creaturo, you may begin your conference.

Thank you, Sarah and welcome to the first quarter fiscal 2005 to 2006 incorporated investor teleconference. As a reminder, this teleconference is being recorded on Thursday, October 21, 2004. The forward-looking statements we may make during this teleconference speak as of today. 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 first 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 September 30, 2004, were 37.5 million, an increased 9% as compared to the same quarter last year.

Infrared optics bookings increased 3%, near infrared optic bookings increase by 54%. Military infrared optics bookings increase 8% and the compound semiconductor group bookings increased 20%, as compared to the same quarter last year. 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 demands or production schedules move the delivery schedule out past 12 months.

To reiterate our comments in the press release, because infrared optics customers based in Switzerland are serviced by the companies majority owned subsidiary II-VI Suisse Sarle , the bookings recorded from that part of the world will occur on a more continual basis, when Lot Swiss was an independent distributor for the company a significant 12-month contract was booked in the first quarter of each fiscal year, including the first quarter of the last fiscal year.

For the just completed quarter, bookings for infrared optics increased over 20% as compared to the same quarter last year. When bookings from Switzerland are renew from both periods. Total company revenues of 40.5 million for the quarter increased 19% as compared to the same quarter last year. Infrared optics revenues for the just completed quarter increased 16%. Year infrared optics revenue increased 28%. Military infrared optics revenues increased 12%. And the compound semi conductor group revenues increased 27% as compared to the same quarter last year.

The company's backlog at September 30, 2004, was approximately 66 million. The components of this backlog include infrared optics at 21.5 million, near infrared optics at 14 million, military infrared optics at 23 million and the compound semiconductor group at 7.5 million. Backlog is defined as bookings that have not been converted into revenues by the end of the reporting period.

Gross margin on manufactured products as a percentage of sales at 46% for the quarter increased by approximately two-and-a-half percentage points from a year ago. The increase margin resulted from a buildup of the worldwide inventory levels, specifically in our infrared optics segment. The increased sales volume for the quarter as compared to the prior year impacted gross margins in a favorable manner. Also, the company continues to increase the amount of manufacturing done at its Singapore and China facilities, which impacts margins in a favorable manner.

Finally, for the just ended quarter, this quarter includes additional gross margin generated by our II-VI lots Swiss subsidiary, where the comparative quarter for the prior year did not, as the effective date of that acquisition was December 1, 2003. Internal research and development expense for the quarter was 1,048,000 and was slightly lower than the same quarter last year in terms of dollars and as a percentage of revenues.

The lower expense levels are primarily the result of higher external contract support for the company's efforts in silicone carbide. In addition to efforts in silicone carbide, the company's internal research and development expense during the quarter reflected ongoing efforts focussed on corporate research and development activities and the research and development activities of even products. The internal research and development expense for the remaining fiscal year 2005 quarters is expected to approximate the first quarter results.

Selling general and administrative expense for the quarter as a percentage of revenue was 22.2% as compared to 24.1% of revenues in the same quarter last year. As compared to the first quarter of the prior fiscal year, the selling, general, and administrative expenses increased approximately 800,000.

The higher revenue levels achieved during the just completed quarter combined with additional selling, general and administrative expense for the II-VI lot Swiss entity led to this dollar increase. The selling, general, and administrative expense in the same quarter last year reflected legal and professional fees of over $700,000 to defend and protect our trade secrets and intellectual property, this level of expense was not needed in the just completed quarter.

Interest expense for the quarter was 63,000, which was lower than the interest expense in the same quarter last year. The majority of the company's death had liable base interest rate, while these rates have started to trend upward recently, the company's weighted average interest rate is relatively low, and currently is approximately 2.5%.

The company's total debt at September 30, 2004, was 15.4 million, which was consistent with the debt level at June 30, 2004. The company's current credit facility is scheduled to expire in August 2005, and we expect to have a new facility in place in the next three to six months. Beginning with the just ended quarter, all borrowings on the current facility have been classified as short-term debt and will continue to be reported in this manner until a new facility is obtained.

Other income for the quarter of 491,000 reflects several factors, including foreign currency transaction gains, interest income, earnings from our one-third ownership in Canadian base 5N plus incorporated and other income items. Other income was partially off set by the 25% minority interest in II-VI lot GMBH, and II-VI lot Swiss our sales and marketing subsidiary, in Germany and Switzerland respectively, and other expense items.

The effective tax rates for the quarter was 27%. The current year effective tax rate as compared to the effective tax rate for the previous year reflects lower tax rates on much of our Singapore operations. The company has entered into a development and expansion initiative during the current year with the Singapore government whereby II-VI Singapore will lower its effective tax rate to around 15%. This tax rate change began July 1, 2004.

Looking at earnings before income taxes, results for the quarter were nearly 8.2 million or 74% higher than the same quarter last year. Net earnings for the quarter were 5,959,000 or $0.40 per diluted share. These results compare with net earnings in last year's first quarter of 3,114,000 or $0.21 per diluted share. For the quarter ended September 30, 2004, average shares outstanding were 14,485,000, while average diluted shares were 14,905,000.

Our worldwide employment at September 30, 2004, was 1,269 employees. This number compares with worldwide employment at June 30, 2004, of 1,242 employees. This concludes the financial review, and Carl will now give a business and operational review. Carl?

Thank you, Craig. Let me start with a welcome to what I believe is a sizable number of new shareholders. Investors that I found II-VI since our last teleconference in August. During the interim, and based on our past performance as well as future prospects, our market capitalization has exceeded $500 million for the first time in history, and this has caused us to become more visible to a new class of investors. Some in this group have chosen to become II-VI shareholders and we are pleased to have caught their attention.

Our commitment to them is to continue our pursuit of 20% per year growth each year in both revenue and earnings for as far as our vision will carry us. We intend to remain a strong and steady growth company in high technology materials, parts, and components businesses. During the first quarter, our II-VI infrared optics business unit experienced strong order patterns in all market segments, and on a worldwide scale. Significant OEM orders were placed by customers in Japan, Germany, and the United States, and we believe this will continue to be the case for the remainder of fiscal year 2005.

Manufacturing companies around the world are continuing to invest in automated high power CO2 laser processing in order to enhance productivity and reduce costs. As well, low power CO2 laser markets are growing at a torrid pace due to the rapid deployment of laser marking, serialization and date coding, and laser via hole drilling of the printed circuit boards used in cell phones, notebook computers, PDAs and electronic games.

Note that in our press release last evening and in Craig's prepared comments today, we have described changes to our Swiss distribution and the impact of these changes on quarterly bookings, specifically without the effects from Switzerland, II-VI infrared bookings for the quarter would have been up by over 20% from the prior year. In order to keep pace with demand, we are busy expanding our II-VI infrared manufacturing capacity. During the first quarter, we added two high speed C and C polishing cells, realigned activities, added production space, and became ISO9001: 2000 certified in China.

We increased fabrication in thin film coating productivities and efficiencies in Singapore and broke ground on a state-of-the-art addition to our Pennsylvania thin film coating facility. In addition, we are continually investing in the expansion of our Pennsylvania based diamond-turning capabilities. For our VLOC, near infrared laser optics business unit, first quarter bookings were up 54% compared to the same quarter a year ago.

The increase in bookings spanned all product lines and was driven by a market share gain for optics used in the YAG laser after market by continued growth in the medical laser market, and by several increased military production orders. An example of our increased military business is a crystal assembly used in hand-held laser designators for our armed forces. This product has transitioned from prototype to initial production, and serves as the good example of our capability to work with all customers through all phases of the product life cycle.

First quarter VLOC revenues were up nearly 30% over the prior year. About half of this growth was in the UV filter product line while the balance was in optics and crystals that support military applications in the industrial after market. VLOC with support from our Pennsylvania based advanced material development center continues to meet aggressive ramp up targets in the UV filter product line, and plans on increasing capacity by at least 50% during the second half of this fiscal year.

The major focus in the other product lines continues to be on adding capacity and improving efficiencies in both Florida and China to keep up with increased demand. As mentioned by Craig, bookings for the quarter at our exotic electro-optics military optics business unit were lower than the prior year primarily due to a stretch out in the delivery schedule of sapphire windows for the joint strike fighter electro-optical targeting system. We have received a contract for the low production phase prototype JSF windscreen, and have initiated the process development that will enable production of these units.

This Lockheed Martin contract provides a second cornerstone in our sapphire window business development plan. The other being, the advanced targeting pod (ph) or sniper program for which we're currently developing a multi-year supply agreement with Lockheed Martin. To be frank, our current focus at exotic electro-optic is more on getting better at what we do, than on addressing growth opportunities. In that vein, we made major progress during the quarter on the installation of a state-of-the-art IFS enterprise resource planning system that will replace an antiquated MRP system that is no longer viable.

The new IFS system will be a measurably more user-friendly and immediately drive data integrity and access, event notification, document management, and shop floor reporting improvements in our heavily contract-oriented work environment. We are in the final stages of the IFS installation and are determined to achieve a go live success on November 1st. In addition, the manufacturing excellence program that we launched last spring continues to advance.

By mid third quarter, we will have launched the new MEP process documentation training and auditing tool that should drive continuous improvements in quality, productivity, and efficiency for years to come. We are confident that our investments in the IFS and MEP initiatives will make us a more valuable supplier to our military optics customers, and enable an electro-optics growth strategy for fiscal 2006.

The first quarter bookings and revenues for our eV Products Cadmium Zinc Telluride based radiation sensor business unit, we are slowed by the lower than expected demand for bone mineral densitometry products from our major customer. Though we expect this situation to persist during the second quarter, we remain confident in the long term prospects of this market segment and continue to invest in new technology and products that will enable next generation medical imaging equipment.

We are continuing to see increased demand for our radiation sensors from customers in the security and monitoring market segment that serves homeland security applications, which combined with stable buying patterns by our nuclear medicine, industrial and research customers should lead to overall increased revenues during the current quarter. We are continuing to develop and bring to market a family of standard radiation sensor products for process control applications in the food packaging, beverage bottling, and inspection industries.

These products which are in various stages of introduction, are expected to further diversify the eV Products portfolio and drive new deployment and growth opportunities, as soon as the fourth quarter of this fiscal year. During the first quarter, our Wide Bandgap Materials business unit, which is focused on the development and manufacture of silicone carbide substrate achieved record revenues up over a 100% from the same period last fiscal year.

Increasing product sales accounted for 40% of the total revenues, and were derived from the RF and military market segment, with participation by a diverse base of existing buyers, and first time inquiries from a number of potential OEM customers. We foresee that contract-based revenues during the current quarter will decrease due to a 3-month delay in the start up of the Darker(ph) phase 2 RF program, which is now targeted for early third quarter.

We continue to take a long-term view of silicone carbide electronic materials, and are making substantial progress in the development of the required manufacturing technology, and the diversification of our product portfolio via focus programs to improve material purity, reduce defect density, and expand substrate diameters. Product diversification continues to focus on the introduction of 4H poly type substrates for high power and high temperature applications.

We are now completing the development of the 4H product family, and this is attracting considerable interest from existing and potential OEM customers. We are presently investing in a Class 100 clean room at our New Jersey technical center that will enable the development of new cleaning and inspection processes capable of meeting the more demanding customer requirements that we expect to evolve overtime.

In addition, our customers are delighted that plans for our Pennsylvania-based manufacturing facility to join the New Jersey technical center in ISO9001:2000 certification by the end of this quarter are continuing on schedule. In summary, we are pleased with our first quarter results, we are thankful to our employees for their high levels of performance. We are confident that our customers will continue to present us growth opportunities and improvement challenges, and we now expect fiscal year 2005 revenues to range from 168 to 173 million dollars in earnings per share to range from $1.48 to $1.55. Craig, that concludes my prepared remarks.

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 confirmation 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 30th, 2004. Sarah, we are ready to take the first question.

[OPERATOR INSTRUCTIONS].

Your first question comes from Chris Versace of FBR.

Congratulations gentleman on a good quarter.

Thanks, Chris.

Just two questions for you. First, if you look at the balance sheet, looks like inventories trended up again quarter over quarter. Can you talk about why that happened, what the strategies are for that? And then just second, on the margins improvement for IR optics, you talked about continuing to increase the amount of offshore manufacturing. Can you kind of compare where that is today versus a year ago and where you think you can take it?

Chris, on your inventory trend, the bulk of the increase was specifically in the infrared optics area. It is fairly broad based. We have mentioned in previous calls that we are experiencing some price increases in certain raw materials and we're seeing that come through because we're now carrying a high amount of those raw terms, doing a similar or just slightly higher level production but as far as dollars is concerned, we need to tie up a bit more up dollars in purchasing these more expensive raw materials specifically in the materials.

Overall, we're also increasing some of our finished goods you deal with a service to demands of our customers. We're also specifically, again, in the infrared optics area, we are also increasing the amount of work in process products that we have as we do anticipate and as our guidance is suggesting, that we'll see higher levels of revenues than we achieved in this past quarter.

So I think it's fairly broad based as far as where the buildup is, and again the reasons are really just at the end of the day servicing the customer and back to your offshore manufacturing, I would say that I will give an answer, and I'll let Carl add to it if he would like to. And if you look the two main areas that we use the offshore manufacturing again, I'll make this comments more specific to the infrared optics group but as far as fabrication would be the first area and coding would be the second area.

Right now fabrication wise our Suzhou facility in China is doing upwards of more than 80% of our fabrication when you look at part basis and that is up significantly say from a year or two years ago. If you look at our coding in the other side of the equation, we would be somewhere in the 60% range of the coding that are done, again, on a part basis, done in Singapore, and that is been fairly consistent, I would say, for at least the last 12 months or so. Carl, do you have seen that.

Yes, I do. Chris good question and thanks for this question. We have been working hard to understand where this market is going and to make sure that we install capacity and really have the capacity to step up to increase demands which we fortunately foresaw. We started over a year ago to build up capacity worldwide at all three of our primary commercial fiberoptics plants, here in Pennsylvania, Singapore, and China. And we've accomplished that.

So the facility expansion is one thing because we've invested in more automated equipment where we've put new equipment in, and that would be both in the fabrication and the coding areas and certainly our facilities are reconfigured a little bit, especially in Asia, to be more efficient. But I want to talk about employee training and skill and then what I would call engineering process development and improvement.

We really have pushed hard on continuous improvement in the last year and our employees have done a lot of training. They've improved their skill levels. Our engineers have tackled some tough engineering process problems, and fortunately, I'm able to report to you that our yields are specially in the what we'll call the more straightforward commercial optics such as AR coated lenses and the like, our yields are doing better than a year ago and that surely does help us in the margin area, and I want to credit it to the hard work of our employees, especially some of the engineering, the really interesting engineering that's been done in our coating areas, by teamwork, good teamwork between our Saxonburg and Singapore based coding engineering groups.

And one thing, if I can add just one more point, Chris, on your question, if you look at the amount of employees that we have in China, we have increased that in the last 12 months by over 33%. So, again, we continue to see China as being an integral part, an ever increasing integral part as they are continuing to service not only the service to infrared optics but also do more and more near infrared optics production that's why we continue to invest and increase the amount of importance that China has on the II-VI family

OK, Just one quick follow up. You mentioned the rising price of Selenium I know on the conference call you talked about actions to offset that the predicting your own price increases. Can you just give a question 30 seconds on how that is trending?

We have needed to pass that additional cost on, and we have done that through the addition of the surcharge on certain products and that overall is being received as well as the price increases repeat I think our customers are understanding that it's nothing obviously that II-VI is doing at just that that's critical raw material has seen some pretty drastic increases in prices. We have been out there talking to all of our major customers about those we're only doing it selectively in the optics and the components that actually have Selenium content towards those and not an across the board increase it's just select and it's based upon the size of the objects that were trying to be as precise as we can be and again, our goal is to just try to offset those costs the best we can.

Thank you.

Your next question comes from Dave Kang with Roth Capital.

Good morning.

Yes, Dave.

Couple of questions, first on tax rates. Should we use 27% for the rest of the year, Craig?

Dave, we do think 27 will be the right rate again, the big driver there or what's developed here in the last seven months or so is getting into a new program in Singapore, and seeing the benefits of that, and we do think 27% will be the effective rate for the year.

Great, and the second question is, is there been any kind of impact in the manufacturing sector because of the oil situation or going forward for that matter?

Dave, I -- this is Carl speaking. I don't think we can make a direct link to anything that we can measure in our business that is threatened or I guess you could say some businesses will probably be aided in some way by this, but we cannot find any direct impact and I can't imagine what it would be. So I think we really just have to say there's no measurable impact.

OK, and third question is that, regarding this three-months delay on the dropper project, you indicated the Silicone Carbide business will be down. Can you quantify what that might be?

I think the right thing to say is that it could affect revenues in that group by a few hundred thousand dollars. We like to have the contract work laid out in front of us pretty well and we thought we knew that some of this would come in the third quarter and we do know -- and I don't want to go into specifics here, but we do know that we will be involved in that program. We know to a degree how much we'll be involved in that and so if we measure the impact of having laid out one quarter, I would guess it's in the range of $300,000 to $400,000.

OK, and just lastly on considering that first quarter is seasonally a week quarter, I'm a little puzzled as to your fairly conservative EPS annual guidance of $1.48 to $1.55. Obviously if that's the case, you are still waiting that the quarterly EPS estimates will be flatter down for the rest of the year. Are you just being overly conservative or are is there any factors of assumptions behind this guidance? Thank you.

Dave, I think it's a combination of us trying to -- I think we're comfortable obviously with the guidance that we put out, we have tried that ranges in such a manner that we given some low side, and high side to it obviously we'll strive to achieve and exceed that but again, as we continue, and maybe this is almost back to the previous question about all the different pieces of II-VI fitting together, try to forecast all the different businesses that we have.

Again, this is not a monolithic entity that we're dealing with heir five distinct businesses that are really at different stages its guidance that we are comfortable with, and we don't apologize for raising the guidance as much as we did, but we do want to put our guidance that were comfortable within and we definitely think we've done that with what wasn't contained in the press release.

Got it. Thank you.

Your next question comes from Sean Chapman (ph) with Bank Capital

Hi just wanted to ask a question I guess I was curious about the bookings. I guess I just wanted I was hoping you guys might elaborate I notice that the bookings were up over the prior year but they were down I guess factoring in the 20% increase they were about 42 million, which was done from the 46 million in the prior quarter. I'm wondering if there's been any kind impact at all from the semi conductor slow down at all in marking optics going into the marking products. I was wondering if you could elaborate on that and talk about kind of market exposure where we should focus on in the future.

I think what we can do is cite two or three things we think happened, when you look sequentially at the fourth quarter of '04 to the first quarter hereof '05. One is, there is a slight seasonality to our business, and I would put that as probably the largest single contributor.

We do have a substantial amount of business in Europe. And both in the Infrared optics, CO2 laser optics and in the YAG related optics products that we sell. And Europe, may be especially this year, seemed like July and August, there was a notable seasonality and our order book slowed down particularly from our European customers during that period. So, that would be the number one thing to cite. I guess a second thing, well, I don't know. I think I will let Craig to hit, to hit may be one or two more.

I would say back in that fourth quarter, Sean, of June 30th, 2004, probably two other items to remember. We did have a fair amount of large military orders during that quarter, and we also took some very large development orders for the -- or not development orders, but initial production orders, and also contract orders related to the UV filter business unit. So, those two are also in those fourth quarter numbers and those didn't repeat near as much here in the first quarter. So I would say it's that combined with what Carl is seeing. The seasonality number one but also in the fourth quarter of last year there was those of couple of unique items that didn't repeat this quarter.

Is it possible to break out the end market exposure?

It really gets tough for us to do that, Sean. Again, many times we are servicing the OEM. We don't have complete accurate visibility into the depths of which market that it's serving. So that gets a little bit tricky for us to do.

I will comment that I don't think that the semiconductor equipment business and the use of marking in the semiconductor industry is all that large of an effect in the overall worldwide product or you know Park marking business. There's a lot of it going on in the semiconductor industry but it's really not the driving part of that industry. I think probably food and beverage is probably bigger than semi conductor.

But there is - I am not down playing it. I am just saying that it's not driving that area. And we do find that the marking business, independent of the ups and down's of any particular segment, is overall going very well. And that would include both CO2 and YAG marking systems because both are used depending what material or product you are marking you might choose one or the other but they are both going very well.

Thanks a lot.

Your next question comes from Tim Slevin with Parker Hunter.

Good morning everyone.

Good morning, Tim.

Just had a couple quick questions or clarifications. In terms of other income, I missed the explanation on that, Craig.

Tim that was fairly broad based. There were a lot of factors in there. The items included we had some foreign currency gains, we had interest income, we picked up some other income items, just miscellaneous income items. We also are fortunate that we were getting some other income from our one-third ownership in 5N plus, which is a materials based company that we have been a one-third owner in for about the last three years or so. That was also fairly significant this past quarter. So, really a combination of those three, four, five factors.

Now, especially in terms of -- you don't expect that I guess to remain at the current level other income?

No. We don't expect it to be near that level, no.

OK. It still should be a -- is it moving into different kind of positive number or hard to say? There's just a lot of moving part there's?

There's a fair amount of moving parts. The foreign currency tends to be the biggest piece that's hard to guess. I say exclusive of that, we are in a other in composition but again the wild card end always ends up being the foreign currency.

OK. And then you know I heard part of the explanation on the bookings, and just wanted to go over that again, if you could. If you are looking at the change relating to you made a change relating to your Swiss subsidiary?

It's just a - it's really the way that those orders are being recorded now. Right now, they are recorded more on a ratable basis. It's all now our close inner workings with the customer. We are getting those orders more on a monthly basis, every couple week basis, if you would. When we had the former relationship with an external distributor, we used to get one very large order in this - in the first quarter.

OK.

And so that relationship has changed. This is really the first year because we did have acquisition beginning at December last year. And that relationship has changed. And I think really that's the reason for it. We are getting still very strong business from Switzerland. We can say it's up year-over-year. But just the way we are needing to record the bookings, that's why we thought it was good to try to describe that and describe that change as the best we could. Carl may be wants to it.

Just to try to put a number to it, Tim, if we booked the business this year, through our subsidiary, the way it was booked last year by our subsidiary - by our independent Swiss distributor with us, if we put it on that kind of apples and apples basis and took the whole order and booked it, we would get not only the full value of the order but we would get the margin that we now own on top of that. And it would a total of between $3 and $4 million.

3 to 4 million?

Yes.

OK. And if - so that was mostly for delivery within the next quarter or something like that typically or did they stock up? Or that was just a blanket order spread over multiple quarters?

It was a blanket order spread over multiple quarters. The distributor wanted to make sure - that

They locked in and reserved production capacity.

Exactly right.

OK. So if I look at it, the appropriate thing would be kind of an adjustment downward last year, in last year's quarter, I guess. Is that right?

That's correct.

OK, and if I -- did you all make an adjusting entry in the second quarter for the remainder of the year when you started to consolidate Swiss lot?

Yes, we did. We went through and canceled the old orders we had with the distributor and then also made some changes. As Carl was mentioning before, now we were able to add the additional incremental margin on those orders as well. So we did that in Q2 of last year. I want to say the net impact of the change was may be less than a million dollars, I don't remember the specific --

-- Oh, really it was only a million? OK, alright.

It was only about a million dollars change.

OK, that's very helpful. And so if I look at it, the sequential decrease from fourth quarter to first quarter is kind of apples to apples, 45.6 down to 47.5, and that's related to as you were saying infrared military?

That's correct.

OK, that's great I appreciate it.

Thanks.

[OPERATOR INSTRUCTIONS].

Your next question comes from Jim Holster, Private Investor.

Good morning gentlemen.

Good morning Jim.

Two quick questions. What is the break out of foreign versus domestic sales?

Jim, let me grab that sheet. The break out for the quarter, we just ended, the total international sales or non-U.S. sales whichever way you like to describe it, was right about 40%. We're seeing a bit more that increase in the U.S. sales specifically, as our exotic business is doing well, I doing well and also the UV filter business. Those are all U.S. based revenues. So right about 40% was the international, the rest was all in the U.S.

Thank you and one more. You have increased capacity in hiring people in China. Is there any -- is there much demand rolling out of China or is it primarily a production facility for shipment elsewhere?

Jim, this is Carl speaking. All of the product that we -- virtually all of the product that we manufacture in our infrared, actually infrared CO2 laser and YAG laser optics business, nearly all of it, the preponderance of that product, has to leave the country and go either to Singapore or back to the United States for finishing, because primarily, we do fabrication there. So we cannot really ship very much of our product into the country.

Now, very recently, within, in fact, the last probably quarter and a half, we have started to do some simple anti-reflection coatings on certain near infrared optics and presumably some of those could go directed, they are coming out of there as finished, tested products, although for the moment we're sending them back to our Florida operation and probably retesting most of them, but we're now getting to the point where they really are capability of finishing a product in that facility that could go to the China market. However, I think the China market for those particular products is probably rather small.

Most of those, I'm sure, are being used by instrument manufacturers here in the United States. Those are primarily wave plate products. Would that be correct, Craig? So, again, the preponderance of what we make there, probably well over 95%, cannot be sold as manufactured there in the China market. Now, that's not to say that some of the finished products that we're making in Singapore and the U.S. aren't going back there as finished products.

We do see the China market business coming on. An example would be the finished YAG rods that go into lasers over there. YAG lasers that are produced in China. We are - we are seeing our China sales increase. Also for CO2 laser optics, our sales in China are increasing with customers there that are either building primarily lower power CO2 lasers or using CO2 lasers in manufacturing.

Thank you very much.

Your next question comes from Robert Bombak (ph) with Babson Capital Management.

Good morning.

Hi, Robert.

I have three questions for you and I'm just going to ask them and then hang up. First, to what extent, if any, do you work with beryllium? Second, I was wondering if you could summarize any changes in the competitive environment. For example, are there any new competitors, have any existing competitors fallen by the wayside or has price competition become more or less tenacious anywhere, and lastly, how is Fran feeling. Thank you.

Let's take the last question first. Fran Kramer, our president and chief operating officer, is doing very, very well. He has got his full travel schedule back. He's here every day or somewhere every day working hard and enthusiastically, as always, and doing a fine job. So thank you for that question and we're very pleased to report that virtually Fran is back 100% and we're so pleased and grateful for that.

Beryllium is not used very much here. I would have to say I'm hard pressed to think of anything other than what I would call an incidental use of beryllium. Possibly, for instance, some of the eV radiation sensor products, probably maybe some of them have a small beryllium window in front of the detector. That's about the only direct use of beryllium that I can think of.

There are some light-weighted framed products that might be used at exotic electro optics for making very light weight part holders or some of the metal component parts of certain components that we might work on could be beryllium, but other than that, I think it's very incidental in our use.

Finally, the question about competitive environment is very, very difficult because we have five different business units that have five different sets of competitors and not to make this a very long answer, I think I would just say that the competitive landscape seems fairly stable. I think we're finding pricing to be reasonably stable.

We're not able to identify any tough new competitors in my mind that have entered into the markets and always price competition is real and has to be managed, but I don't think there's anything all that unusual in the competitive landscape that we could report this quarter. Craig?.

I think you've articulated it. There's nothing that I think has drastically changed in the last day 6 to 12 months, and again, it's somewhat of a broad based question to answer, but I think we are safe to say no drastic changes in the last 6 to 12 months.

I just want to add in concluding, that we believe our competitors are very, very good. We have a lot of respect for our competitors and they are tough.

Great. Thank you.

You have a follow-up question from Tim Slevin with Parker Hunter.

Just a couple of clarifications just again on the tax rates of 27%. That's due to a revision out of Singapore. But if your US source income you have dialed that in regarding the effective tax rate that you are using based upon your expectation for your US business over the course of the year. If it happens it will be a little bit higher, you may have to make some adjustments mid course, I would assume.

That is correct, but we have factored that in, Tim. The higher level of US source, obviously that's a negative tax rate right but that is being more than offset by this tax rate decrease in Singapore.

OK. And then the other question is, you all are, you know, kind of peak margins in Infrared. And you know on an aggregate basis, you are at very high margins. Is the - is your expectation for the second half of the year some moderation or mitigation of that margin and is part of that due to capacity expansion?

Part of that mitigation - we are expecting a little bit of mitigation. I think part of that is the capacity expansion; especially the things that we will do and need do here in our Saxonburg, Pennsylvania facility. I think a little bit of that is also the fact that we will not - we don't believe we will need to build as much inventory as we did this past quarter. So I would say those two factors are probably going to temper our margin expectations for the rest of the year.

OK.

Tim, Carl here. I would like to comment. I know you asked mostly about IR margins but I want to compliment our employees at Exotic Electro-Optics VLOC and eV because all three of those are working very hard and actually being effective at raising their margins on manufactured products and I just want to point out that has been something that they've worked on for years and I can see the positive results of having invested in many different projects and developments and programs that should allow them to create the tools for improving margins.

Yes, absolutely. And I had one question, just one final question, regarding SG&A expense. I typically, if I look at that, it was riding a bit higher than it was in the current quarter, in the last two quarters even though that the level of earnings, you know, was pretty strong in this quarter. My expectation would have been that with the increased earnings there would have been some incremental accruals related to profit sharing and other factors, commissions, etc. Were there other offsetting issues or something that were peculiar to this quarter?

No. I think part of what we do each year is re-calibrate each of the programs that we have. And you are probably seeing a little bit of that re-calibration. Obviously, each year at least we were setting the bar higher and higher each year. So to kind of -- you know you are doing the right analysis, looking backwards into last fiscal year, but as we entered into this new fiscal year, as far as targets for bonus programs and things of that nature, obviously, you know as Carl and his onset were continuing to be a growth driven company so the bar gets set a little bit higher each year. So we have set that and that has been factored in. And so I don't think there's anything else unusual or different in there. I think it's just kind of the re-calibration of some of those programs for the upcoming fiscal year or for the fiscal year that we are in FY05.

So if I look in if you have more flattish kind of quarterly results this year, you know, that's going to be a significant comparative differential versus the second half of last year?

That is correct.

OK. Great. Thank you all.

Your next question comes from Robert Winner with Sidoti.

Hi, Craig, hi Carl. Good morning to you both.

Good morning.

Good morning.

I wanted to kind of follow up on the comments you made about Selenium prices. Could you give a little more color as to when you start seeing these prices increase and why you think the increase is happening. I mean is it a supply side or more of a demand side issue?

The prices started actually probably about a year ago. And they've been very significant. The price increases have been from, I'm thinking, something like $4 up to the low 20s $23 and so forth. And it was very rapid through the middle of our last fiscal year and very substantial. You know, 100% measured from the base price. And of course we have looked at what the drivers are. And it looks like the consumption of Selenium in China is way up and one of the I won't cite too many examples of what those drivers are, but Selenium is used in the manufacturer of plate glass for building covering buildings with glass.

Glass buildings, glass windows, Architectural glass. That would be seemed to be a big driver of the worldwide demand for Selenium that has caused this price increase. And one looks at how much of that will go on for a while in China, and you don't see any real reason for too much abatement. There might be some, but it seems like the demand for architectural glass in China is probably pretty strong.

Do you know of any other Selenium producers coming online, anybody coming into the business just try to you know mitigate this costs a bit?

No. Let me rather work. We are looking at different sources in doing some things internally that may help us in the future, but again, if the prices stay at that level, I am sure there will be some more suppliers coming out. Again that's the primary, as I understand, the primary source of Selenium is in the copper smelting process and that's just not as just to get in it for the Selenium pricing is not probably the driver to get somebody back into that business. So we haven't seen any major changes in the suppliers over this period of time that we have seen an increase -- price increase.

I think there will be some effort to bring more capacity online if this price holds. The longer it holds, the more that's likely. But I don't think we have enough factual information to really be able to give you anything hard. I just don't feel like we have - we hear things but they are not tied down.

OK. Great. All right. Thank you guys.

At this time, there are no further questions.

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ending December 31st, 2004, is currently scheduled for after the close of the market on Wednesday, January 19th, 2005, with a conference call to be conducted the following day, Thursday, January 20th, 2005 at 10:00 a.m. Eastern time. Thank you for participating in today's conference call.

This concludes today's II-VI fiscal year 2005 first quarter earnings call. You may now disconnect.