II-VI Inc (IIVI) 2005 Q3 法說會逐字稿

Good morning. My name is Lisa and I will be your conference facilitator today. At this time I would like to welcome everyone to the II-VI Incorporated Fiscal Year 2005 Third Quarter Earnings 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 "*" then the "1" on your telephone key pad, if you would like to withdraw your question, press the pound key. Thank you. Mr. Creaturo you may begin your conference.

Thank you, Lisa. And welcome to the third quarter fiscal 2005 II-VI Incorporated investor teleconference call. As a reminder this teleconference is been recorded on Thursday April 21, 2005. The forward-looking statements we may make during this teleconference is as of today and we do not undertake any obligation to update these statements to reflect events or circumstances occurring after today.

Joining me today is 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 conduct the question-and-answer session.

Total company bookings for the quarter ended March 31, 2005 were a record 50.5 million and increased 22% as compared to the same quarter last year. Infrared optics booking increased 13%, Near-infrared optics booking increased 41%, military infrared optics booking increased 18% and the compound semiconductor group booking increased to 9.8 million as compared to 7.3 million in the same quarter last year. The results for the 3 months ended March 31, 2005 include a full quarter of operation for the company recently acquired subsidiary Marlow Industries, Incorporated.

For the quarter Marlow recorded 6.3 million in bookings, bookings are defined as customer orders received that are expected to be converted inter revenues during the next 12 months. Bookings are adjusted to changes in customer demand or production schedules, mover delivery schedule of past 12 months.

For the 9 months ended March 31, 2005, overall bookings were 137.3 million, an increase 17% as compared to the same period last year. Total company revenue's were a record 53.3 million for the quarter. An increase of 36%as compared to the same quarter last year. Infrared optics revenues for the just completed quarter increased 12%, near-infrared optics revenue increase 29%, military infrared optics revenues were consistent with the same quarter last year and the compound semiconductor group revenues increased to 12.2 million as compared to 2.9 million in the same quarter of last year.

For the quarter Marlow revenues were 9.3 million. For the quarter, international revenues accounted for approximately 41% of total company revenues. For the nine months ended March 31, 2005. Total company revenues increased 27% to 137 million as compared to the same period last year. For this nine month period international revenues accounted for approximately 40% of total company revenues.

The Company's backlog at March 31, 2005 was approximately 82.5 million, the components of this backlog include, infrared optics at 26 million, near-infrared optics at 15 million, military infrared optics at 20 million and compound semiconductor group at 21.5 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 for the quarter decreased by approximately 6 percentage points from a year ago, while gross margin on manufactured products for the nine months ended March 31, 2005 decreased by approximately 1 percentage point.

The addition of Marlow since December, 2004 has lower gross margins, as the current gross margins of Marlow are lower than the overall gross margin of II-VI before this acquisition. In the infrared optic segment, we are still experiencing margin pressure due to higher raw material cost specifically for selenium while the quarter-over-quarter revenue decreased at the military infrared optics business segment, lower gross margin for that portion of our business.

Internal research and development expense for the quarter was 1,410,000 and was slightly higher than the same quarter last year in dollars while the expense as a percentage of sales decreased slightly. The higher dollar expense is primarily a result of the internal research and development at our Marlow subsidiary.

Selling, general and administrative expense for the quarter as a percentage of revenues was 20.0% which was lower than the 23.4% level from the same quarter last year. For the nine months ended March 31, 2005 selling, general and administrative expense as a percentage of revenues was 21.4% which was lower than the 23.3% level on the same period a year ago.

Overall outside professional services for items such as legal and audit services including external cost for Section 404 of Sarbanes-Oxley have increased over the prior periods. However from a percentage of revenue standpoint the addition of Marlow in this business selling, general and administrative cost structure has lowered it's metrics for II-VI as a whole. Interest expense for the quarter was 421,000 which was higher than the interest expense in the same quarter last year.

The company had a full quarter of the borrowings used for the Marlow acquisition in a just completed quarter. During the quarter $2 million under the company's credit facility was repaid. A majority of the company's debt has LIBOR based interest rate. The company's weighted average interest rate at March 31, 2005 was approximately 3.4%, one year ago at March 31, 2004 the company's weighted average interest rate was approximately 2.1%.

Other income for the quarter of 16,000 reflects several factors, including foreign currency transaction gains, interest income earnings from our minority investment in Canadian based [Five And Plus Incorporated] and other income items. Other income was almost completely offset by the minority interest from the 25% that we do not currently own of II-VI slot Gmbh and II-VI slots [Swiss], our sales and marketing subsidiaries in Germany and Switzerland respectively.

Royalty expense and other expense items. The effective tax rate for the quarter was 27% and with consistent with the rate used in the first two quarters of the fiscal year. The current year effective tax rate as compared to the affective rate in affect for the previous year reflects a lower tax rate on a substantial portion of our Singapore operations.

During the first quarter the fiscal year the company entered into a development and expansion initiative with the Singapore Government where by II-VI Singapore would lower its effective tax rate to around 16%. This tax rate change again July 1, 2004. The American jobs creation act of 2004 provides for a variety of changes in U.S. tax laws, including incentive to repatriate earnings of foreign subsidiaries, phased elimination of the foreign Sales Corporation or extra territorial income benefit and domestic manufacturing and benefits. We are currently evaluating the impact of this legislation on our business including assessing the details of the act, analyzing the funds available for repatriation and assessing the domestic manufacturing benefits.

We have factored on most current understanding of these areas in to our guidance for the next fiscal year, because of several uncertainties including the lack of specific guidance on repatriation of foreign earnings. It is not possible this time to specifically determine what impact this legislation will have on our effective tax rate, beyond the current fiscal year.

Looking at earning before income taxes. The results for the quarter ended March 31, 2005 were 8.6 million, or 19% higher than the same quarter last year. While the results for the nine months ended March 31, 2005 were 24.7 million or 45% higher than the same period in the prior year. Net earnings for the quarter were a record 6,251,000 or 21 cents per diluted share. These results compared with net earnings in the last year's third quarter up 4,775,000 or 16 cents per diluted share. For the quarter, average shares outstanding were 29,153,000, while diluted share outstanding were 29,961,000. Net earnings for the nine months ended March 31, 2005 were 18,013,000 or 50 cents per diluted share. These results compared with net earnings of 11,313,000 or 39 cents per diluted share in the same period last year.

For the nine month ended March 31, 2005, average shares outstanding were 29,079,000, while diluted shares outstanding were 23,921,000. All per share data have been adjusted to account for the two for one stock spread of the company's common shares, which was paid to shareholders of record as of March 2, 2005 and distributed on March 22, 2005. The company made significant progress during the quarter in completing its purchase accounting for the acquisition of Marlow Industries. Specifically the tangible and intangible valuations for the Marlow assets have been completed and certain amounts originally classified as goodwill have been classified as specifically identifiable assets in the balance sheet line item, other intangible assets. As a result of these external valuations, we expect completion of the purchase accounting process during the current quarter.

Our worldwide employment at March 31, 2005 was 1,505 employees. This number compares with worldwide employment at December 31, 2004 up 1,502 employees on June 30, 2004 of 1,242 employees.

As announced on April 4, 2005, II-VI will be working towards the establishment of silicon carbide substrates manufacturing facility in Mississippi. II-VI will locate this new production facility near silicon carbide [inaudible] SemiSouth Laboratories, which is based in Darksville (phonetic), Mississippi. II-VI also announced an investment in SemiSouth. This investment consisted of a $2 million loan, which is convertible into equity under certain circumstances for a non-controlling ownership of SemiSouth.

As noted in our press release beginning in our fiscal year ending June 30, 2006, II-VI will implement statement of financial accounting standards number 123 revised 2004 share based payments beginning in the first quarter of that fiscal year. FAS 123 [are] required expensing the calculated fair value in incentive stock options. And this new requirement is expected to reduce earnings per share in fiscal year 2006, by approximately 6 cents

This concludes the financial review and Carl will now give a business and operational review. Carl?

Thank you, Craig. It is my view that II-VI Incorporated just delivered another solid performance quarter and is continuing to push aggressively and has set a target markets that are both robust and destined to grow. The IR optics business unit third quarter bookings at 26.1 million, set a new quarterly record marginally above the previous high quarter marks set during the second quarter of this year. As Craig stated, IR optics bookings increased 13% compared to the third quarter of last year. US market continued to be strong during this past quarter. For instance, the US OEM segment increased more than 26% compared to the third quarter of last year. The move by CO2 laser manufacturers to higher power machines continues. OEM laser system builders have introduced six kilowatt versions of the metal cutting machines and are developing systems using eight kilowatt lasers to further reduce cut times.

Simultaneously, these customers are seeking greater control over laser beam steering and shaping. The combination of higher powers with the need for better being controlled has heightened the demand for Knobel diamond turned-optics that very few of competitors can fabricate and coat. Additionally with the recent signing of a key patent licensing agreement, we can now design and mark up our own deformable mirrors. One of the products, that enables enhanced beam control. The IR optics quarter outlook for the fourth quarter appears favorable. We expect the US market to remain solid and you will see improvement this quarter in Asian bookings.

So far this fiscal year -- the deployment of high power laser machines has been at it's highest level in several years. If the industrialized economies worldwide continue to grow throughout calendar year 2005, high power laser machine utilization and therefore optics consumption increases will follow. Meanwhile the low power optics market driven by marking and medical applications, continues to grow up rates exceeding 15%. Providing increase demand for the high volume low cost optics produced in our Asian factories.

For our VLOC, [rear inch] red laser optics business unit, third quarter bookings were up 41%, compared to the same quarter a year ago. Year-to-date bookings have increased all of a last year by 40%. Three quarters of this growth relates to the new and expanding UV filter product line.

In addition VLOC experienced improved bookings in it's YAG and other crystal product lines, driven by the military and medical laser markets. VLOC's revenues were up 29% over last year's third quarter and were up 38% for the first nine months of this fiscal year. A little more than half of this growth was in UV filters. The balance was spread across the other product lines led by optic shipments into the YAG laser aftermarket, along with YAG and other crystal shipments into the military and medical markets.

VLOC continues to meet aggressive, ramp up targets in the UV filter product line and it's expanding capacity both in Florida and after II-VI advanced materials development center in Pennsylvania. This capacity is required to meet a projected doubling of production rates, during fiscal year 2006. VLOC is also focused on upgrading its [inaudible] equipment to improve production yields and efficiencies, ss well as on expanding its optics manufacturing capabilities in Asia.

VLOC and II-IV's recent acquisition Marlow industries are currently outfitting a new 35,000 square foot factory located in the Vietnam-Singapore industrial park, near Ho Chi Minh City Vietnam. This factory should be ready for occupancy during the first quarter of fiscal year of 2006.

At our exotic electro-optics, military optics business unit, bookings remained in the $5 million range, consistent with the two prior quarters of this fiscal year. Although the quarterly bookings were 18% above last year's third quarter, the year-to-date bookings are off from last fiscal year by 25%. This is primarily driven by the defense (procreate) cycle for more mature programs. It has also been impacted by increased competition in the military optics market. Large infrared, one of those for unmanned aerial vehicles. Optical components for targeting the navigation systems, and large sapphire windows for the Joint Strike Fighter program made up the major portion of the order book for the third quarter.

Revenues for the quarter of 5.9 million, were comparable with the third quarter of last fiscal year. However, the makeup of the current quarter's revenues has weighted more for our large sapphire window product line.

During last year's third quarter, only 15% of revenues were for sapphire products. While this year revenues related to sapphire windows reached nearly 30%. Sapphire products continue to offer high growth potential, for our exotic electro-optics business units. Margins for the EEO business unit trended downwards for the quarter, due to delays in shipments and reduced production efficiencies. Both attributable to quality issues with certain of our suppliers as well as requirements for additional source inspection support. Significant efforts to enhance our business systems manufacturing processes and quality programs at this location will continue. Going forward, we expect these efforts to yield solid improvements in customer satisfaction and profitability. Our compound semiconductor group now includes Marlow industries which was acquired during December of 2004, as well as the wide band gap electronic materials and EB price business units and our advance material development center that previously formed this group. As mentioned by Craig third quarter bookings for the compound semiconductor group including Marlow industries for the fourth quarter totaled 9.8 million. And nine months bookings totaled 20.6 million including Marlow industries for the past four months. Revenues for the group including for Marlow industries -- including Marlow industries on the same basis totaled 12.2 million for the third quarter and 20.2 million for the nine months.

During the third quarter, our wide band gap material business unit continued it's focus on the development and manufacture of silicon carbide substrates and recognized over 1.7 million of bookings and 1.3 million in revenues. Product bookings continue to grow and represented 65% of our total bookings for the quarter, reflecting our continued success in the OEM market. During the quarter product revenues represented 60% of total revenues. Over 80% of our product sales were to drive from shipments up 3 inch diameter substrates to the RF base station market segment, reflecting continued development activity and interest and wide band gap materials technology in this applications arena. The remainder of our product revenue was derived from shipments of substrates to the high power switching market, which is indicative a solid progress in substrate developments for this segment as well.

During the third quarter II VI was awarded a sub contract or close to $1 million of development front link as a team partner on major multi-year wide band gap initiative. This program is focused on materials optimization, device developments and VOD module demonstrations in the high power radar, electronic warfare, [inaudible] and communications systems application. Other team partners included TriQuint Semiconductor, PIE Systems, Emcore, Lockheed Martin, and Nitronics.

Additional revenue will be realized to the sales of silicon carbide substrates into this program. Earlier this month we announced an initiative with [SemiSoft] Laboratories Incorporated in Mississippi State University to establish a silicon carbide semiconductor substrates manufacturing facility in Starkville Mississippi. This initially will leverage our production capabilities in silicon carbide substrates with the advanced silicon carbide that will tax your material growth technology from [SemiSoft] and the strong research capabilities in the field of silicon carbide device technology at Mississippi State.

Additional technical and operational support will be provided by our New Jersey based wide band gap technical center and headquarters for II VI will in parallels strengthens its research and worldwide marketing capabilities. Anticipating continued success and a market growth. We are preparing to enter a volume production skill of phase for this business. Earlier this month we also disclosed that we made an investment in [SemiSoft] laboratories as Craig already mentioned.

The third quarter bookings for our EB products business unit were 1.6 million and included yearly [blanket] orders and product development contracts for new products in the medical industrial and security market segments. Revenues were 1.6 million marketing and sales activities continue to focus on new accounts in the medical, industrial and security and monitory market segments. The long-term outlook on demand for radiation sensing products continues to be positive and includes several significant opportunities such as in the previously reported area of baggage security systems.

Our advance material development center continues to support [inaudible] business unit as it ramps up the production of it's UV filter materials the AMBC also continues its forward looking work on next generation engineered materials platforms. Including the development of ceramic materials for optical and opto-electronic applications.

For the Marlow Industries business unit third quarter bookings were 6.3 million. Marlow revenues for the third quarter were 9.3 million which represents in over 50% growth from the same period last year revenues increased in the all market segment including defense space and protonics medical and healthcare and industrial. We sense that defense spending on thermo electronic cooling products and solutions remain strong due to a proliferation in next generation night vision in imaging program and applications. Telecom spending is showing signs of stability, despite continued consolidation in this market segment here we are well positioned to capture new business as most major telecom component suppliers are transitioning to Marlow Microtech for their extra small form packages where we have provided the thermo electric solution of choice likewise our medical industrial demand is growing rapidly as a result of competitive replacements and our market leading XLP extended lifetime technology.

The integration on Marlow into II VI continued throughout the third quarter and synergies with II VI are being leveraged to reduce costs and grow revenues. Significant progress has been made in preparation for our aid and expansion into II VI’s new manufacturing facility in Vietnam. We will be moving our non-defense or some of the operations to Vietnam during the first quarter of fiscal year 2006. II VI now has about 70 days to finish it Sarbanes-Oxley Section 404 compliance program. I assure you that we will complete our obligations on time and that I am personally involved in the controls assessment, implementation and certification processes. Led by the internal audit and corporate finance and accounting staffs, our compliance teams worldwide are determined to deliver benefits to our investors as a result of this large time consuming resource sundry and costly exercise.

In closing I want to thank our dedicated employees and demanding customers worldwide for their participation in another successful II VI quarter. We look forward to delivering against our fourth quarter projections for revenues of 52-53 million with earnings per share from 20 cents to 21 cents. We are also excited about delivering against our fiscal year 2006 guidance for revenues of 213-217 million with earnings per share from 83 cents to 87 cents. Craig that concludes my prepared comments.

Thank you, Carl before we begin the question-and-answer session, I would like to mention that these comments and answers to certain questions contains forward-looking statements which are based on current expectations. Actual results could differ materially. 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 30, 2004. Lisa we are ready to take questions now.

At this time I would like to remind everyone, if you would like to ask a question please press “*” 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 Flavin (phonetic) with Parker Hunter.

Just a quick question to open things up, in terms of your guidance that includes 6 cents and in terms of stock option expense?

Tim that is correct.

And is that towards the back half of the year or is that spread evenly across the quarters?

We anticipate that being spread throughout the quarters and it will increase probably slightly just as it has in our performance that we disclosed for the last numerous years, as we issue more stock options during that current year but it should be pretty straight forward throughout the -- pretty ratable throughout the fiscal year.

Okay. In terms of manufacturing margin you had the impact of in total you had the impact of Marlow in for the quarter but, did you have much in the way to of yield issues in the aggregate otherwise?

No I think it was really in the couple other areas other than again the addition of Marlow as you mentioned the doing lower than expected or forecasted sales in our military group where we took up a step back there.

Okay.

And again continuing in the [Infrared] optics business we still continue to perform well but, we're performing in the face of continuing rising material costs there specifically on selenium. So those are really the big pieces, no other significant, either positive or negative items to not Tim relative to yields or throughput or anything like that. Carl, I think will add to this.

It is just a comment on the rising cost of raw materials. It is something we really have to keep our eye on going forward, is starting to show up beyond just selenium, other of raw materials are creeping up but Craig lets try to peg that selenium situation at the moment. I am not mistaken we started out 2 or 3 years ago at around $3 or $4 a pound and now we are up over $50, is that correct?

That is correct.

And that’s that is just a huge amount of increase and I think we have to look at the potential for increased synergy cost now to start pushing other things up.

That's correct

Okay. And in terms of the Saxonburg facility, what do you anticipate to be the impact of the full year of 2006 with respect to manufacturing margin.

We, Tim are getting -- starting to get closer and closer to getting that facility completed. We are looking towards the first quarter, that’s why [inaudible] fixed you really moving production equipments and should have a lot of progress done by the end of that quarter and I think we will start to see the margins pick up and expand, we are using that as a platform for sales expansion as well, again, we probably in the last 3 to 4 to 5 conference calls that our most capacity constraint area here in our IR optics businesses in the coding area and that’s really going to give it a lot of the breathing room wee need to be after other opportunities that quite frankly we haven’t been able to because of the capacity being so constraint. So I would say that into the second, third and fourth quarter, that’s where we are expecting to see the margins improve and really start to get some of the benefit of expanding that facility.

So you see a positive impact relatively quickly offsetting the additional costs?

That is correct, again it will be, it won’t be the first quarter in net sales that will be, second quarter and it should nearly kick into towards the last half of the year.

And full depreciation in that kind of loading into your, your costs of sales is going to occur in second quarter not really in first?

That’s correct.

Okay, the final question is relay with respect to Vietnam; what kind of positive margin impact do you expect to see there or it is that, just that not material, or you expect that not to be that material in 2006?

Tim I think in 2006, because you have always have startup costs, and inefficiency in the startup. I think you are correct that it won’t impact 2006 any material way, but we would say then beyond that we see a very strong improvement, both in our Marlow assembled product areas and also in our VLOC, particular YAG after market optics opportunities in that field. We believe that our margins will substantial improve after that factory is up and running and in addition at Marlow, it's going o allow to address segments for the market that we just haven’t had the cost structure to address before and that should really take the lid of from growth at Marlow, so to speak. It will open up the industrial segment and even parts of the commercial consumer product segment which Marlow because of their base, strong base in Dallas, Texas has not previously been able to really address.

Okay, great and one final question as I exit back in to queue; basic demand across all of your segments and the aggregate appears still to be pretty good and in general you've got a fairly sustained after market replacement business in IR along with expanding applications in near and in IR?

That’s correct and along those lines just to give you a chance to go read something, I just became aware yesterday about our little business note that appeared in photonic spectera that they--

Time [inaudible].

No, it's a laser industry tray journal.

Okay.

And let me give you a web address, www.photonicsspectra, that’s all one word, photonicsspectra.com. and if you go there their page will display the table of contents for their April issue and just go down to the business world section and click on an article entitled 2004 laser shipment climbed 52%; I think you will find there some useful industry information in their stating to just to point you are making that the laser industry is continuing to grow in. We really do see that continuing short of global depression; we see that lasers just are continuing to proliferate in many, many fields and that’s the flavor of that article and we don’t have any reasons to believe it will continue through at least calendar 2005.

Great. Thank you all.

Your next question comes from Dave Kang with Roth Capital.

Good morning, gentlemen.

Hi.

First, I guess, regarding your fourth quarter revenue guidance of 52 to 53 million. My understanding is that the June quarter tends to be seasonally stronger than the much quarter and yet your guidance is kind of flat to slightly down. I guess Marlow had a couple of major contracts in December, so perhaps that's why your March quarter was unusually strong. Is that the case?

We have a little bit of -- with the additional Marlow we have changed our make up a little bit. May typically had especially to address the industrial demand that typically had a strong a far third fiscal quarter, so the quarter that we just ended, and so we don't expect that to repeat it. So I think you are taking up on the piece that's in there and that is that, the industrial demand, there was a little bit more in Marlow, little bit of seasonality if it happens in their business. But we are still expecting to get up close to the record revenues that we had just this quarter, overall.

Got it. And regarding your margin decrease, is possible if you can kind of allocate between Marlow, how much they contributed to the decline as well as maybe perhaps to selenium and other raw materials versus yield efficiencies; is it possible to allocate all that?

Yeah. I can give a little bit of broad help on that. I think the overall impact of Marlow was probably about two thirds or so of that percentage decrease and I think then the other one third really was attributable to deployments performance at our military infrared optics business and also the increase in raw material prices. Those two combined made up that last third.

Sure. I think in the last conference call you said something like in between of selenium, I guess that is every $10 swing that will contribute may be half a point to overall blended gross margins; is it still correct?

Yeah I think that metric you still correctly using and consuming the same amount of selenium as in the past and I think that metric is still correct. I think, back to your point, we have seen our overall cost of selenium just in this quarter increase to almost $10 a pound. So I think you are doing the correct math in that and that metric that we gave out is still fairly accurate.

Okay as far as the Marlow synergies that Carl touched upon little bit, but I guess Marlow is still primarily domestic. But has there been any kind of international opportunity?

I think one of the things that we have been able to do pretty quickly is expose Marlow and it's products to our worldwide distribution network and our subsidiaries in various location in Japan and Germany and other locations, so I think we have done good job of starting to get those organizations in tune with the newest member of our [206] organization. So we started to do more on that side of things, I know that we are not encouraging Marlow to take a little bit further look at this international operations and with the addition of Vietnam coming in we are ever expanding there to look in to the Asian areas as well.

Now David, I think though we have to recognize that to go from our focus on US, the primarily US market to a global mindset and a global actual getting out and covering a global market place, it is still going to take a little bit of time. I think the idea of having our own people over in Vietnam is going to give us reach into the Asian market as Craig said we are getting contacts with the European users of these products especially in the telecom market. But it is going to take some time, I just caution as that we need 2, 3, 4 quarters I think to get that really rolling.

Sure, understood. As far as our semiconductor equipment is concerned, how much is that right now for you guys I know that VLOC sells some into that. And how is the business environment, or just a given intervals a recent increase in CapEx, whether you are seeing some up turn or is it still maybe a couple of quarters out?

I think, we trail that a little bit. We are steady and semiconductor but it's not as you know its not the dominant part of our business, but if the VLOC, its probably around 20% of our business there. If that's the strongest, that we have anywhere selling our division hardly participate but we - that the indicators are certainly that it should improve but I would say I don't think we have actually seen that yet.

Got it. Got it. A couple of our customer related question, regarding EV. I guess and that's what you use, that you were infected by softness from a major medical customer any changes there and also regarding our baggage inspection customer, are there was a little bit delay in the any update on that one?

Yes, the major medical customer continues to be slow, it has stabilized at the lower level what we talked about last time. This quarter was pretty much exactly what we expected. We don't believe that, that's going to change whole lot in the next couple of quarters. There is an effort by that group to introduce a new product and we have to see how that goes over the next couple of quarters. On the baggage inspection front the customer does have a equipment being tested by [TFA] they are learning from those test and getting ready for a bit of a larger test phase, I believe it is that the kind of thing that is fraught with delays but we are hopeful that in the second, third quarter of fiscal 2006, that will actually start to be deployed not in huge numbers but may be in some limited quantity, so of a few per quarter.

Got it. Just a couple of numbers and you guys certainly did a great job in terms of OpEx and managing that, is that sustainable Craig. And then a part of that is how much was Sarbanes on expense for last quarter, how much should we project for this quarter.

I think that the level of OpEx is really, pretty sustainable I think we have not that we have addition of the miler in there we will see the -- really the overall impact that overall is sustainable. As far as the cost, the external cost for Sarbanes, really this quarter you are looking at something in the neighborhood of maybe roughly 200,000 to 250,000, we expect a similar may be slightly higher level as we finish things out, as Carl had mentioned here in the next couple of months or so. So at that level may be a little bit higher is what we are looking at.

Got it. Thank you.

Your next question comes from Terry Ledbeter (phonetic) with Friedberg Investments.

Hi, good morning,

Good morning.

You know my question, kind of to the first is related to the general industrial economy and we are so pretty early in earnings season but, I have seen weakness in some of the other companies I follow. But you don't seem to be expecting any kind of slowdown even in the fourth quarter or next year and I was wondering is that because of [inaudible] was -- really has a nice secular growth trend behind us being a laser company or is that because you are not seeing softness in the industrial economy in general.

Well –we don’t see it yet. We’re aware of what you are saying that kind of softness is out there in their pockets but that are fairly serious. But remember the 40% of our business is outside the United Sates. So we have diversification across many industry segments that’s helpful. We have diversification across larger number of developed industrialized economies around the world and short of everything going down at the same time, we have some protection there. But we're cautious; we do believe that there is a possibility that in the middle of -- by the middle of next fiscal year, we have to be ready for a potential slowdown. We don’t see it yet. Our order books are still pretty good and I can’t explain the whole thing to you, but I think it has something to do with, as I said the diversification across the markets and across the geographical portions of the world.

Well, that’s extremely helpful. My second question is if you could, you touched on the balance, I was wondering if you could going to little more detail on what happened in the military infrared segment and with having losses in that segment.

I think that is a business where we had for the first two quarters of the fiscal year, run at about a $6.5 million level and sales and we had a little bit of dropoff there as we've reported we did about $5.8 million, $5.9 million in sales. I think there were some challenging things that some products that we did not get out of the factory towards the end of March, I think there are really just some things that we were working on but just didn’t quite get to the finish line by the end of the quarter really impacted this specific quarter. The overall backlog of that business is still very healthy, but we are -- we just didn’t quite -- we just didn’t quite execute in that area where we wouldn't like to.

Fair enough. All right, thanks.

At this time there are no further questions.

If there are no further questions, I would like to thank everyone for participating today. Our next earnings release for the quarter and fiscal year ending June 30, 2005 will be scheduled for the week of August 8, 2005 with more specifics to follow as we get closer to this date. Thank you for participating in today’s conference call.

This concludes today’s II-VI Incorporated fiscal year 2005 third quarter earnings conference call. You may now disconnect.