II-VI Inc (IIVI) 2007 Q2 法說會逐字稿

Good morning. My name is Meredith and I will be your conference operator today. At this time, I would like to welcome everyone to the II-VI Inc. fiscal year 2007 second-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 session. (OPERATOR INSTRUCTIONS).

At this time, I would like to turn the conference over to Craig Creaturo, Chief Financial Officer. Please go ahead, sir.

Thank you, Meredith, and welcome to the second-quarter fiscal 2007 II-VI Inc. investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, January 23, 2007.

The forward-looking statements we may make during this teleconference speak as of today. We do not undertake any obligation to update these statements to reflect events or circumstances occurring after today.

Joining me today is Fran Kramer, our President and Chief Operating Officer.

The prepared comments for today's teleconference include a review of the highlights and key points from a financial perspective, and a business and operational review. Following these prepared comments, we will conduct a question-and-answer session.

There are a handful of items that I would like to highlights regarding the financial performance of II-VI during the just-completed quarter and the fiscal year to date. First, with the record level of bookings for the just-completed quarter, the Company's backlog at December 31, 2006, increased by 10% over the September 30, 2006, level and rose to approximately $96 million.

The components of the December 31, 2006, backlog are infrared optics at $25.5 million; near-infrared optics at $31 million, driven by the large UV filter order received in the quarter; military infrared optics at $21.5 million; and the Compound Semiconductor Group at $18 million. Backlog is defined as bookings that have not been converted into revenues by the end of the reporting period.

Second, our improvement in earnings during the quarter over the prior year was broad based, with all of our business segments generating more segment earnings than the prior year. We are especially pleased with the better performance of our near-infrared, military infrared and Compound Semiconductor business units, where the combined segment earnings for the quarter ended December 31, 2006, increased by over $3 million as compared to the same quarter last year and by over $2 million when compared to the quarter ended September 30, 2006.

Third, our gross margin for manufactured products for the quarter increased over 600 basis points when compared to the same quarter last year and by almost 300 basis points when compared to the first quarter of this year. Similar to the comments I just made regarding the segment earnings, the improved results of our combined businesses were the driver of this performance, with the military infrared business segment making the most noticeable gross margin improvements. As was noted in the press release, better operational performance combined with lower scrap costs helped the military infrared business achieve these results.

Fourth, our other income for the quarter of $937,000 was made up of three primary items, each in nearly equal amounts. These three items were, A., foreign currency gains at certain currencies appreciated against the U.S. dollar during the quarter; B., interest income from excess cash reserves and the increasingly higher interest rates that we are earning on those reserves; and C., income for our minority investment in 5N Plus, Inc., a Canadian manufacturing company, in which we own 36%.

Fifth, the tax rate for the quarter was around 29% and brought the year-to-date effective tax rate up to 28%. The slight increase in the tax rate during the quarter as compared to the first quarter is primarily attributable to better actual performance in the second quarter from our U.S.-based operations and expected continuing improvements from these same entities for the rest of the fiscal year.

This improvement is taxed at U.S. federal and state rates that are higher than the rates we enjoy in certain other locations like Singapore and China. We expect the effective tax rate for fiscal year 2007 to approximate the 28% rate used for the year-to-date period.

Sixth, it's also worth emphasizing the improvements in EBITDA that have occurred. Whether it's the nearly $6 million increase in the just-completed quarter versus the same quarter last year or the $2.5 million increase over the first quarter, this level of cash generation has allowed us to aggressively pay down our debt.

During the quarter, we reduced our debt by over $8 million and we now have $44 million available under the new credit facility we put in place in October 2006. We were able to afford $5 million in capital expenditures during the quarter to expand our capacity and capabilities.

Seventh, and finally, we continue to address near-term capacity constraints and are adding capacity in certain locations. To address current demand and beyond, we anticipate needing to spend between $10 million and $12 million for capital expenditures in the second half of fiscal year 2007. We anticipate that our cash generation will be sufficient to address this level of spending, which should total between $18 million and $20 million for the full fiscal year.

This concludes the highlights and key points from a financial perspective, and Fran will now give a business and operational review. Fran?

Thank you, Craig. As Craig has just reported, our second-quarter financial results were very positive. We are pleased with the overall financial performance of the Company and the current outlook for the remainder of the fiscal year. My remarks will touch on the operational highlights that made these financial achievements possible, and also point out areas of opportunity or challenge that we're working to improve. My comments will be brief and can be addressed further in the Q&A session as needed.

One of the most significant events during the quarter was disclosed in our press release dated December 14, when we announce that our VLOC near-infrared optics business unit had completed the successful negotiation of a multiyear sole-source contract with a primary UV filter customer. This contract will require an approximate 50% increase in our UV manufacturing capacity, which was started this quarter at VLOC in Florida and at the Advanced Materials Development Center here in Saxonburg, Pennsylvania. During the quarter, VLOC was awarded and recorded as bookings the initial release against this new contract, totaling $17 million.

Our infrared optics business unit continues to perform well, with year-to-date bookings and revenues up 13% and 14%, respectively, over the comparable periods last year. Replacement optics for carbon dioxide laser-cutting systems and the sheet metal industry continue to be our largest revenue producer. A recent edition of the Industrial Laser Solutions magazine reported that as a result of the continued health of the fabricated sheet metal products market, about 9% more high-powered carbon dioxide lasers were purchased globally in 2006. This significantly contributed to our carbon dioxide laser optics sales growth.

Industrial Laser Solutions also noted that a second year of strength in the Japanese domestic market for CO2 lasers, which was up 14% over 2005, also helped to push the worldwide unit sales growth.

One recent trend that has emerged is the sale of low-power, lower-cost carbon dioxide laser cutting machines to address the Eastern European and [brick] developing markets. These machines will make laser technology more competitive against conventional machine tools such as punch presses, will accelerate the growth in the installed high-powered laser base, and will fuel further increases in replacement optics sales.

Laser market engraving continued to be the largest application for carbon dioxide laser units, showing a strong double-digit growth in 2006. This situation is expected to proliferate in the next several years, as regulatory bodies across multiple industries and countries mandate consumer product [price ability] coating.

On the supply side, zinc selenide and multispectral zinc sulfide material capacity constraints limited our ability to address external material sales opportunities at a time when military and security applications demanded appreciably more of these materials. We continue to produce these materials at full capacity to service our commercial optics business and we are in the process of hiring personnel and adding equipment to increase our capacity.

The Exotic Electro-Optics military infrared optics business units booked $7.6 million of orders in the second quarter, up 26% from last year's second quarter. Significant bookings included sapphire windows for the advanced targeting pod used on the F-16 and F-15 fighter jets, IR windows for the Phalanx Close-In Weapons Systems for U.S. Navy ships, and a contract for the U.S. Air Force to develop advanced manufacturing processes for sapphire windows to support the Joint Strike Fighter program.

In spite of revenues being down from the same quarter last year in the military infrared optics business unit, our year-over-year segment earnings were substantially improved. This improvement in profitability was driven by increased manufacturing yields, resulting in lower scrap and rework costs, overall productivity improvements in several departments and a more favorable product mix with higher shipments of Arrowhead and Apache components.

Shipments of sapphire panels for the Joint Strike Fighter program continue to be delayed pending engineering changes from the customer. While good progress was made to evaluate and develop a process to meet tougher requirements, the customers added new specifications that make fabrication even more difficult. We are in the process of working on a $450,000 cost-plus contract to develop a new manufacturing process to meet the more stringent specifications.

Major challenges for our Compound Semiconductor Group are bookings delays and the financial condition of some of our customers. For our Marlow business, we experienced a delay in booking two major new industrial programs. Also, one of our important industrial customers who manufactures insect control products went into receivership in December and is currently working on a reorganization plan.

Our Vietnam facility that serves both our VLOC near-infrared optics and our Marlow thermoelectric cooling businesses had its operation ISO-certified during the quarter. In addition, we completed a successful facility grand opening, with major account participation, and have aggressively accelerated the transfer of our Marlow telecom products to this plant.

After an initial successful transfer of its industrial debris shield manufacturing, VLOC is now moving tighter tolerance products to Vietnam. This transfer is more difficult than originally expected and has caused a one-quarter slip from our plan.

A major highlight for our Wide Bandgap Group during the quarter was receipt of a $730,000 R&D subcontract from Mississippi State University. This will enable us to focus on the transfer of our manufacturing technology from our WBG tech center in New Jersey to our new production facility in Starkville, Mississippi.

For our eV PRODUCTS business during the quarter, we booked a $1 million blanket order from our largest medical imaging customer for [EV CCT] sensors that enable their growing family of bone densiometry dual x-ray imaging systems. Also during the quarter, significant and substantial progress has been made in solving the previously reported detector fabrication problem encountered at one of our customers. We are planning to resume shipments to the affected customer in the current quarter.

The business activity that focuses almost exclusively on the future of II-VI is our Advanced Materials Development Center, or AMDC. In addition to assisting in the significant ramp-up of the UV filter production schedule, AMDC has been adding engineering talent and continues its forward-looking work on next-generation engineered materials platforms. This includes the development of transparent ceramic materials for future optical and optoelectronic applications for the defense, space, medical and industrial markets.

We're currently positioned with a strong backlog of products for all business units, which gives us solid footing as we head into the second half of the fiscal year 2007. We expect our financial performance and cash generation to continue as we build our existing businesses and look for new opportunities that will grow the Company for the benefit of the shareholders.

Craig, that concludes my prepared comments.

Thank you, Fran. Before we begin the question-and-answer session, I would like to mention that these comments and answers to certain questions contain forward-looking statements, which are based on current expectations. Actual results could differ materially. For information about factors that could cause the actual results to differ materially, please refer to the Risk Factors section of our Form 10-K for the fiscal year ended June 30, 2006.

Meredith, we're ready to begin the question-and-answer session.

(OPERATOR INSTRUCTIONS). Pierre Maccagno, Needham & Co.

Congratulations on the quarter. I'm wondering about the gross margins next quarter based on your guidance. Is that going to be, like, lower margins?

I think the gross margins we've seen, Pierre, are a nice improvement, especially over the first quarter. Referencing back last year, FY '06, our gross margins were right around 41%. Year to date, they're running about 43%. We would expect them to continue in that same general range of our year to date, our 43%-ish or so. We've seen some nice improvements, as we mentioned in the release and also on the call in the prepared remarks, in some of our business units, especially our military infrared optics business unit, so we would expect that continued improvement to continue for the rest of the fiscal year.

I was just wondering, because the earnings, I guess, don't increase as much as I was expecting, so I don't know what -- your SG&A is higher than expected, or R&D -- I don't know -- to get to the range of earnings that you are guiding for.

I can just tell you that it's the same process we go through, looking at each of the business units and trying to look out for the rest of the next quarter and fiscal year as far as where each of the businesses think they will be, so I think it's the same process that we've gone through. We don't anticipate any significant changes downward, if that's where your question is going, on and gross margins. As Fran mentioned, we're thinking we should see some continuing improvement, especially in the near-infrared and also in the military infrared optics business units.

And then regarding the zinc selenide, you said you were limited in your ability to supply. How much business do you think you might have given up?

In these zinc materials, it's pretty accurate. We're running full-out and supplying all of our own commercial needs and selling to people who use it for defense-based applications. We've probably missed year to date maybe a few million dollars' worth of sales. Just the situation with the growth in the CO2 laser field has taken all the capacity we have and we are busily adding capacity right now.

Okay. And then regarding your ASPs, I wanted to get a picture of -- is there much of a difference between high-power and low-power business?

For sure, that's a big difference. I can't state you numbers, but the high-power CO2 laser would be 1- to 2-inch diameter optic. A low-power optic might be in the 3/4-inch diameter range, so you get quite a bit of difference in material content. Labor to fabricate it might be nearly the same, believe it or not. Coatings, nearly the same, but much more particular on tighter specifications on the coatings for high-power. So price this, I'm going to estimate, 2, 2.5 times for high-power over low-power.

Okay, and do you think going forward, is there going to be, like, a shift in product mix here, or what is your view?

Well, the volumes of the low-power continue to grow more rapidly than the high-power, but the dollars on the high-power keep the high-power being a high, high percent of our sales for the infrared optics business.

Are margins similar between both?

Yes, a little lighter on the light -- than the low-power -- a lot of competition -- more competition on the low-power side, just because the absorption specification of those optics is not so critical and a few other people can do that kind of work. But overall, both areas we're very competitive in. Our operations offshore allow us to have dominant share in both low- and high-power CO2 laser optics.

Okay. And just to get -- could you give us a picture of the mix, more or less, between one and the other?

I do not have that in my mind, but dollar value coming from low-power versus high-power, because remember, high-power is both for the assembly line of the OEMs, the system builders' assembly line and the big, big features for the aftermarket, where 80%, 90% of our sales for high-power are used. In the low-power, there's really not a replacement market -- very, very limited. So, just off the top of my head, I'm going to say revenue features for us, low-power, 10%, 15% max of the infrared division. The other 85%, 90% is really the high-power business.

And then the last question is -- so your transfer of Marlow to Vietnam, percentage-wise, so how much of that have you done so far?

We're nicely on track with what we had hoped to accomplish. We had expected these two larger orders that we mentioned on the call that have been delayed, which would go straight into our factory there in Vietnam. And at the same time, the later stage of our transfers into Vietnam, we're working on the telecom products, our thermoelectric coolers for that business.

So I cannot give you a percentage of how much work we had expected to move there versus where we are. We had, when we bought the business, work done in Dallas and in a subcontractor in China. All the work has been moved out of China to Vietnam, and some significant portion out of Dallas. Remember, in Dallas, we do all our defense-based photonics work and some other higher-end products. I can't you a percentage; sorry, I don't know that number, but we're moving along nicely -- the telecom products next for Vietnam.

Lakshminarayana Ganti, Thomas Weisel Partners.

Congratulations on a nice quarter. I was wondering -- your bookings growth for IR optics was only 3%. Was there something unusual there, or is it because of your Q1, where you had an unusually large order growth, that this actually kind of flattened out on a year-on-year comparison? And if you could also break it out, the orders in IR optics segments in terms of geographies, and what you're seeing there.

I'll start out on it, but yes, you hit it pretty well. We had a good, strong first quarter and took in a couple large orders that now were have in our backlog and are busily delivering. Like last year and this year, we're also having a slower mid-December to mid-January order intake period, so it's year over year the same issue, but it continues to be a letup in Asia, Europe, even the U.S. for this -- over Christmas, New Year, and now in Asia, we'll head into the Chinese holiday period.

So a little light in that late second quarter, early third quarter, but for us in our projection, we see very, very strong second-half orders, so the lightness in the second quarter I think would be more than offset by late third- and fourth-quarter orders for the IR business.

Geographically, I could not give you a mix of how much goes where, but I can tell you that it's very, very active. Japan is real strong and Asia is strong, especially in China. Europe is hanging in there very nicely. And the U.S., already here in mid-December -- or mid-January, three weeks into January, has come back very nicely as we watch the leading indicators.

So all three sections of the world are going along nicely and now the group -- we start to watch this brick group, which is really driven now by China, is coming on real strong. So we've watched three areas of the world with 3% to 4% to 5% GDP. Now this fourth area of the world, which is 8%, 9% GDP, and China, we're feeling really quite bullish about how the CO2 laser optics business is being driven.

And you revised your guidance, the topline number for '07, to be $263 million to $266 million versus your earlier guidance of $261 million to $266 million. I was just wondering if you can [quantity] factor the $17 million order that you got in your earlier guidance, or if that's not the case, then why are you so conservative on the top line?

I think we did anticipate, we have always anticipated the level of the UV filter business. I think as that order got finalized and we got a better visibility as far as what the deliveries would be this fiscal year and then on into next year, that was definitely one of the factors that we looked at in the guidance.

And again, as we need to do with our guidance, we're really pooling six different businesses together and looking at all of those on a macro sense and giving one very small short range for this revenue forecast. So we looked at it, really didn't need to change the upside of that, decided to shorten up the bottom side of it just a little bit.

I'll jump back in later if everyone has finished. Thanks a lot.

Dave Kang, Roth Capital.

The first question is regarding the Marlow's two delayed programs, can you quantify that a little bit? And is that -- so what's the status? Is that going to happen this current quarter, or can you give us an update on those two programs, please?

Yes, well, we're always optimistic. They were both development programs where we developed end products that are -- we call it industrial, but they're kind of a commercial product that one would see out there in point of sale and in point of use. I cannot say the customers.

I am expecting orders in the third or fourth quarter. It's been delaying quarter by quarter now for two quarters and if it slipped another one or two, won't surprise us. Total value of that business added up could be on an annual run rate basis $3 million, plus or minus, if you add the two together. It might be more than that. I'm sorry. I don't have the ultimate predictions of those two customers. They put out this new product and they give us a startup plan. If it's bigger than that, it would exceed that number I gave you.

Sure. Secondly, on the [warrant] cost that you guys incurred in fiscal first quarter, it was over $300,000. Where was that number in the second quarter, Craig?

For our EB group, we really did not need to make any significant changes to that reserve. As Fran mentioned, we've made very good progress and we are expecting to resume shipments to that customer in the current quarter, so we didn't really have to make any significant changes to that reserve this quarter.

And then, also, you incurred some thin film coating challenges in the first quarter. Has that been resolved, or what's the status on that?

On that one, we are most directed toward our thin film coating challenge at our YAG business in Florida in that quarter, and it's been -- in some prior quarters, it's been problematic for us. We had a better quarter in YAG, shipping more rods, slightly -- a little better on the coating yield, but it remains a challenge for us. We deliver X number of parts each quarter, and with an EEO [jet], whether it's 10% loss, 15%, all that affects our throughput, and what we've been struggling with is throughput on the YAG business -- I can say slight better on coatings, but not solved.

And Craig, regarding gross margin improvement, I was surprised that you didn't mention selenium. It sounds like all the improvement is from operationally, so will we finally see the selenium making a positive impact maybe this current quarter and maybe fourth quarter, or can you just comment on that, please?

We are on track, Dave, as we've kind of mentioned in previous calls that we thought we would be through some of the higher-dollar selenium inventory that we had in this quarter. That did come to pass, and now we're starting to get into some -- relatively speaking, I guess I should say -- lower-dollar selenium. We should see a little bit of benefit as we head into the second half of this fiscal year, but we did make it through some of the higher-dollar inventory that we bought, say, seven, 10 months ago the peaks when the prices were up around $50. And now our inventory that's going to be going through our cost of goods sold here over the next quarter or two will be at a lower level than that.

So it looks like all the $50 parts have been flushed out. That's what it sounds like.

That is correct.

Okay, and then just lastly for Fran, in terms of your strategy, I'm sure you saw that Newport announcement about their plans to introduce fiber lasers. That's on top of the other guys. So what is your strategy as far as fiber lasers are concerned? You talked about there last quarter. Just give us an update as far as what your strategy going forward is.

Well, like you said, we did address it in the last quarter release, and then this past quarter in New York City at investor conferences, we went through some discussion on it, but this fiber laser is a typical 1 micron laser tool. There's been YAG lasers, there are YAG slab lasers, ceramic slabs, there's disk lasers. All these 1 micron tools are right now welding tools. And in the short run, we can see an effect that that will have on the YAG laser host business that we have in Florida. It will be modest.

At the same time, we're selling components for 1 micron lasers, all different types of optics, so if these components go with YAG lasers, that's one thing. If they go with disk lasers, that's okay with us. If they go with fiber lasers, no problem. So we feel we are high-tech part suppliers for 1 micron lasers.

In the longer term, though, we do see the 1 micron laser, whichever configuration it is, as being additive for our CO2 laser optics business. It's creating some stir in the marketplace and it's creating some aggressiveness and some competition by the CO2 laser OEMs who are positioning their products to be more flexible and therefore are winning more business. So the installed base of CO2 lasers we believe will benefit by this increase in just awareness of laser processing. Increased base, we get more replacement parts business. We see it a very good additive to our business.

So at the moment, we're watching. We are participating in the 1 micron optics, and in many cases or at least a case or two that I can't talk about right now, we're working with our materials that we have to make optics for even fiber laser applications. So 1 micron business is good for us. If there's any particular activity that we think we should engage in by acquiring a business or a product line, we're keeping our eye out for that, but I have no specific at this time.

Just one more question regarding your strong bookings. I guess that's due to UV orders that you received, so is that going to be fairly lumpy going forward?

On, Dave, specifically UV, we've booked that in December of '05. We had a large booking December of '06, and we would expect a booking probably sometime in early FY '08. Maybe it won't make it into the first quarter, but probably should get into the pattern of having that next-year release around the second-quarter timeframe. So I think just the way it's going to work, we probably should be lining up for a large UV order either late in the first quarter or early second quarter, at least for the next few years, as we work through the rest of that contract.

Right. So my question was about total bookings, so is that going to be fairly -- with UV kind of disappearing for the next couple of quarters, is that going to be fairly lumpy going forward?

I think it probably won't be when you compare it to last year, because really, in the third quarter, fiscal quarter last year and fourth quarter and first quarter of this year, even, we really didn't have that much of UV filter orders. So I think it's kind of an isolated -- it's going to be in that -- probably in that second quarter is when we will usually show large bookings, and I don't think it will skew the other quarters.

Jiwon Lee, Sidoti & Company.

Just several questions. Some of them were already answered, but I just want to go back to the booking levels for compound -- the [micron] group. This business is making operating profit for the first time I think in many quarters. But I'm slightly puzzled by sort of the level of the decline in booking for the quarter, and I would like to ask this question to Fran.

What gives you comfort, especially these delayed programs, that you're going to get those orders in the second half of F07, and then based on the current booking level and the backlog figure, I see Marlow potentially doing less than $10 million in sales over the next two quarters or so. And what would that mean for your operating bottom line for this specific group?

I have really good confidence on Marlow making our projections. The two large orders that keep delaying is important to grow our business, but they have enough baseload work and orders that will put them back into -- we did about, Marlow, maybe $7 million in bookings here in the quarter. Their run rate will be maybe one and a quarter, one and a half times that in bookings. That's on businesses that they already have that exist without these two large orders, so that business will be booked more in the third and fourth quarter.

So they're very, very well entrenched into the defense-based and photonics business which maybe was a little light in the second quarter. We will have that in the third and fourth. On top of that, just the medical business, which is very nice, steady-state business, we'll have that in the second half.

So I think the orders being low in the second quarter, combination of the ESD Medical not being there and these two large orders delaying. The two large orders, we cannot predict, third and fourth quarter, but I can predict the other business that I mentioned, so I have good confidence in the second half. Yes, they are profitable, have been profitable every day that we've owned them, and they will have a very, very good second half. More and more products out of Vietnam, less out of Dallas brings our cost of goods sold down and gives us a little bit more margin. I don't know if I can add anything more to your question.

Okay. That's fair enough. And on the military infrared and the rest of the military business, just my rough calculation indicates that more than 30% of your total sales now come from the military business, and it looks like a lot to do with the reduced scrap costs on the military IR side, but also the strong contribution from the UV filters. So in terms of your -- sort of a profit contribution, where we go from here?

Military business, so you're adding the UV business that we have at VLOC with our business in California, plus the portion of our Marlow business that's military. I think you've hit it pretty good. I'm going to make a judgment here, Craig, maybe about 30% total military across the Company.

Correct.

And that weighted average of those military profitability rates, it is slightly lower, certainly, than our commercial business, and I don't see the mix, though, changing, and I do not think the effect of any mix change, whatever it might be, it will vary a couple percent up and down -- it will not change that gross margin prediction that Craig just gave.

Okay. Fair enough.

In aggregate, I'm talking about.

And finally, Fran, the capacity constraint that you try to address and about $12 million past the CapEx you were expecting to spend, a little more color on where you are trying to spend this and were there -- this will be sort of a fourth-quarter kind of backloaded expenditure?

It's going to happen a little bit more in the fourth than the third, but we are off expanding our zinc selenide and zing sulfide capacity. It's a very labor-intensive operation -- or I mean a very capital-intense business there. So, a good percentage of it is going to be in that business.

Second good percentage will be in the UV filter business, where we announced that are ramping up to double the shipment rate. In order to make that, we really have to construct furnaces to grow these three different materials in, and then put the processes in place to fabricate, and we build the assembly on this case, so we have to assemble that. But the most capital is in the growth of zinc selenide, zinc sulfide furnaces and in the growth of these UV filter materials.

Finally, were also adding to our coating capacity just to keep our infrared optics throughput capacity up where it needs to be. We've brought on some new equipment in the fabricating side down in Asia for the IR business in the second quarter. Now here in the third quarter, we will be bringing on a coating chamber, too.

So I would say from a capacity situation, it's this zinc selenide, zinc sulfide material, our UV filter material, and I think we are in better condition than the last quarter on our fabricating and coating of the IR optics business. I think in that area, we finally got the benefit of our last 12 months of building our capacity in the CO2 laser area. That now is on place, so in the next -- in the third and fourth quarter, I think we'll be more aggressive and be able to get some better shipments on the CO2 laser side.

Okay, and two more quick questions, please. The level of the international sales during the quarter?

It was very consistent with first quarter. We did about 44% of our sales for international and that's also our year-to-date number as well.

Okay, and either of you can answer this, but the SG&A line was a little bit better than I expected. Any comment on your future spending needs in terms of the headcount or any other things that we should look out for?

I think there's probably -- again, it's maybe similar to some of the comments we made on the gross margin improvements. I don't know that there's any one, necessarily, item that we could point to. I think it is -- we have seen it tick up a little bit from the levels in FY '06, but that would be expected with some of the growth that has happened. I would say that as compared to a few quarters ago, when we had maybe some excessive legal spending in some other areas, that has not been the case in the last few quarters, so that's helping us a little bit. Some of these unique or onetime type items, we haven't had very many of those recently.

So should we expect those type of levels going forward over the next at least near term?

I think we're right now running right around 22% of sales. I would say that that is probably a pretty good rate. Again, with the expectations of our third quarter being as we're showing in our guidance, really a record revenue quarter, and also the fourth quarter being very healthy, we should see some -- we should get some leverage because of that, and maybe that will trend down a little bit toward where we were last fiscal year. But I think it doesn't -- I don't feel that we're adding extra costs here that would make that number go up significantly. I think if anything, it's probably going to get pushed down just a little.

Fair enough. I think I understand. Thank you.

(OPERATOR INSTRUCTIONS). Chris McDonald, Kennedy Capital.

A question on the UV filter business. Just wondering, over the long term, what do you see for growth opportunities there? It's my understanding that your current business basically is just on one platform. I'm curious to know over the long term what you see for growth opportunities there, both on this program and then potentially on others.

I will try to address that. Certainly, the $17 million order we received currently is probably going to represent, at steady-state, something like 8 months' worth of business. So we're going to have a good three to four years running at that rate, which is in the $23, $25 million a year running rate, on that one program.

It is on more than one platform, a couple of different helicopters that are used in the Gulf War, and they're certainly trying to deploy it, and it has to do with where their priorities are -- right now, low-flying helicopters. Next, they seem to want to put it out onto some low-flying planes, certainly cargo planes delivering goods. But they can only do this number of sets that they're doing per month. That's all that they can bring that down and put that system onto.

So the government -- I mean the Army and Air Force have really come down to this rate at which we're set for the next three years. More platforms, yes, but then you go to more vendors. Right now, we're selling through one vendor. There's maybe a second vendor who can make systems like this, but it's a little less sophisticated. We've approached them and we do supply a component to them.

The final area that looks interesting will be commercial airlines, and maybe you read the headlines -- there's a debate about whether it's best to protect planes in the U.S. from ground positions around our airport or whether it's to put it on commercial planes. The big debate going on there, and we are positioned well, if it would turn out that it needed to build systems to put on commercial planes, but that has not happened. So longer term, you'll have to make a judgment. What I've told you is the best information we have, but I think there is a possibility for an upside just due to this terror situation.

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 March 31, 2007, is tentatively scheduled for before the market opens on Tuesday, April 24, with a conference call to follow that same day at 9AM Eastern Time. Please note that the 9AM Eastern Time conference call will represent a permanent change to our historical 10AM Eastern call time. Thank you for participating in today's teleconference.

This concludes today's conference call. You may now disconnect.