II-VI Inc (IIVI) 2009 Q1 法說會逐字稿

Good morning. My name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the II-VI, Incorporated fiscal year 2009 first quarter earnings conference call. (OPERATOR INSTRUCTIONS). Thank you.

I'll now turn the conference over to Mr. Creaturo. You may begin your conference, sir.

Thank you, Jackie, and good morning, everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI, Incorporated. Welcome to the first-quarter fiscal year 2009 II-VI, Incorporated, investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, October 21, 2008. The forward-looking statements we may make during this teleconference speak as of today, and we do not undertake any obligation to update these statements to reflect events or circumstances occurring after today.

Thank you, Craig, for the introduction. I'm Francis Kramer, President and CEO of II-VI, Incorporated. Our results exceeded expectations for the first quarter of fiscal year 2009, despite the difficult economic conditions we find in the world today. Historically, the fourth quarter of our fiscal year exceeds the first quarter of the subsequent year due to seasonality effects of European holidays and vacations in the months of July and August. The results of our just-completed first quarter suggest that our business level has been very good.

The highlights during the first quarter at our near-infrared business segment focused on our military competencies. The near-infrared business began to leverage its strong quality ratings with key military customers and its high level of competency in optical and crystal component manufacturing and assembly. This has resulted in year-over-year growth in military shipments of 10%; and more importantly, has led to several new product opportunities with major military accounts. These opportunities include critical optical and optical mechanical sub-assemblies for strategic ground base laser designator and range-finder programs, as well as other opportunities such as YAG sub-assemblies for various target acquisition and laser range surveillance systems. It is anticipated that the non-UV filter military business will remain strong for the remainder of the year, with orders expected to increase for the full year fiscal year '09 in excess of 30%.

The UV filler product line shipments continue to meet or exceed the required schedule for deliveries of assemblies to our primary customer. However, as discussed during the last quarter's call, we have seen a reduction in delivery rates for this product line. We have been adjusting our production capacity accordingly, and taking appropriate cost-cutting measures to maintain the profit level of this business as revenues decrease. The near-infrared business continued to utilize its low-cast manufacturing operations in Asia to expand its market share in a somewhat volatile medical laser market. We see this reflected in a slowing of the elective aesthetic laser market in applications such as LASIK eye surgery and skin rejuvenation, while our nonelective surgical laser customers are still anticipating modest growth.

Bookings for the military and materials business segment were lower than expected for the quarter, due to a reduction in the market prices for selenium and tellurium of approximately 15% and a temporary delay of two major orders related to military programs. Selenium and tellurium are a part of the miter metals market, and historically there's been significant price volatility. These prices impact both the cost that we pay for our raw material and our end product selling price, but did not have a negative impact on earnings. The delayed military programs are expected to be received in the second quarter. We have received written confirmation in the form of a letter contract for one of these orders that provides us with funding to procure long lead items. Raw material procurement at Pacific Rare Specialty Metals & Chemicals, which we call PRM, for our selenium and tellurium products has met expectations for the quarter, and we currently have adequate inventory of these raw materials.

Additionally, our order backlog for these products is solid, with approximately 70% of our second quarter through fourth quarter projected revenues under contract. Based on the current market price, revenues for our selenium and tellurium products should grow in excess of 25% over fiscal year 2008. Improved financial performance at PRM led the military and materials segment earnings increase of 90% for the just-completed quarter compared to the same quarter last year. Our military business at Exotic Electro-Optics, which we call EEO, also continues to grow nicely. In spite of the two delayed orders mentioned earlier, order backlog is solid, and we have good visibility of our revenues for the current fiscal year. We expect top-line growth for this business to exceed 15%. This growth is primarily related to future military programs and not directly tied to the current war effort.

In particular, our Sapphire window product line drives a significant portion of our growth. And our Sapphire-based products support Lockheed Martin's advanced targeting pod named ATP Sniper, and the electro-optical targeting system on the joint strike fighter aircraft. Both of these programs are expected to have a solid future. In fact, the joint strike fighter is planned to be the next premiere military fighter aircraft, and production will continue for many years. We have recently submitted multi-year production pricing through the year 2016. In our compound semiconductor group, the wide bandgap materials group continued to make significant and substantial progress again this quarter by further improving manufacturing yields, reducing scrap and increasing throughput.

In order to have the capacity to address the projected demand, we continue to build and install new growth furnaces while accelerating the conversion of existing growth stations to a new design capable of both larger diameter and substantially increased output. Manufacturing operations at our Mississippi facility continue to grow, with labor and capital plans being evaluated to further support a capacity expansion. During the quarter, significant progress towards meeting program milestones on our two DOD contracts has led to substantial and measurable improvement in the quality of our 100-millimeter-diameter substrates for RF and power applications, and has led to a product release of our 6H semi-insulating wafers this quarter and projected release of our 4H conducting wafers in the third quarter of fiscal year 2009.

Also, a significant goal was achieved based on feedback from a large U.S. customer showing results in our 100-millimeter substrates were as good a quality or better than those on our standard three-inch diameter substrates. Additional 100-millimeter substrate orders were recently booked at several large customers, both in the U.S. and Asia. As part of our 4H conducting substrate program, we made several key advances improving our ability to produce three-inch prime quality wafers. Initial wafer samples are currently being evaluated by both our government and commercial customers, and we are on track to begin shipments to a number of commercial customers during the second quarter of fiscal year '09. At Marlow Industries, the first quarter of '09 was another strong quarter for revenues and profits. Bookings of $12.2 million were up over 50% during the quarter compared to the prior year. Revenues for the quarter were $13.8 million, which is down sequentially from our record fourth quarter of fiscal year '08, but were up 50% year over year. This is a result of continued strong sales in the defense, medical, and industrial markets.

The telecom market demand, however, continues to be soft. We are targeting competitive replacements in both Europe and Japan to drive market share growth in this market. Medical market revenues have increased as we fully transitioned a new generation of products for our largest medical customer to our low-cost manufacturing facility in Vietnam. Major new opportunities in the industrial, personal comfort, and automotive markets continue to progress positively. We are in the process of expanding our channels of distribution in Europe and relocating our European office from the UK to Darmstadt, Germany in order to better serve the growing German marketplace while positioning ourselves for growth in Europe overall. We are continuing to expand our manufacturing capacity in Vietnam to address this projected growth. As the market continues to grow, we see the normal competitive price and cost pressures, and will continue to leverage the Vietnam operation and our innovative technology to maintain our competitive edge.

The impact of increased inflation and costs in Vietnam is being closely monitored. As we first announced on April 4th, we are involved in a process to sell our eV products, x-ray and gamma ray, detection business. Our sale process continues to progress and is being led by Roth Capital Partners. Because of the sensitivity of the process, we are not able to articulate further details at this time. In spite of our plans to divest of this business, the business had good operating performance in the just-completed quarter, resulting in a modest loss from discontinued operations as noted in our press release, with revenues increasing 50% from the same quarter last year. The final business to highlight is the infrared optics unit, where core revenues grew 20% year over year, and overall segment revenues, including our new HIGHYAG business that was acquired in January of 2008, grew 29% versus the first quarter of fiscal year '08. Progress at HIGHYAG continued, with operating profit surpassing expectations.

Market development activities continued with a number of European, U.S., and Japanese automobile manufacturers. In addition, new opportunities with fiber lasers, diode lasers, and machine tool suppliers were encouraging. The core IR business order grew 13% during the quarter, led by 42% growth in China. Meanwhile, revenues to U.S. and Japanese OEMs grew 22% and 18%, respectively, versus the prior year. European OEMs were flat to slightly down versus last year, with signs of weakness apparent. A common theme around the world is a high degree of uncertainty over the next six to nine months' business level. This sentiment has evolved rapidly, particularly in the last two weeks. Despite this uncertainty, the Bellwether U.S. after-market bookings rate grew modestly, buoyed by strength in agriculture and energy, and weighted down by weakness in automotive and construction. High-power laser OEMs continue to report sales in the U.S., driven by the U.S. government's provision for accelerated depreciation on capital equipment which ends December 31, 2008.

Zinc selenide production set new records again for the second quarter in a row. You may recall that zinc selenide output grew 40% in the fourth quarter versus the third quarter of fiscal year '08, and this trend continued in the first quarter of this year, with output growing by an additional 12%. All of our new furnaces are in record protection, and the record output of zinc selenide was achieved while dedicating half of the new capacity to zinc sulfide manufacturing. The increase in production was the result of both continued yield and operational process improvements. Orders for zinc selenide and zinc sulfide raw material are expected to double this year as we inform more customers of our increased capacity and seize opportunities in the defense, Homeland Security, and commercial markets.

As I said in our press release, I feel the geographic and market diversity of our product offering is helping offset the macro economic trends in some of the markets we serve. We have expanded the ranges for our guidance for fiscal year 2009 revenues and EPS to reflect the volatility we are sensing. We are closely watching our bookings in all of our business segments, and making cost and personnel adjustments where appropriate. Craig, I believe, will deliver a solid performance in the second quarter consistent with our guidance. That concludes my prepared comments.

Thank you, Fran. Here are the items I would like to highlight before we move into the question-and-answer session portion of the call. We noted in the press release the overall favorable developments that occurred in the quarter in the area of income taxes, and our most recent 10-K filing for the year ended June 30th, 2008. We noted that during July, 2008, the Internal Revenue Service completed its examination of the Company's U.S. federal income tax returns for the fiscal years 2005 and 2006. In accordance with FIN 48, the Company used this updated information to revise its reserves for uncertain tax positions for those two years and recognize previously unrecognized tax benefits during the quarter. This positive news was in part offset by the identification of additional income tax exposure at certain of our foreign locations. As noted in the press release, the net favorable impact of these items during the quarter was approximately $3.6 million, or $0.12 per share diluted. Excluding these items, the Company anticipates its full-year fiscal '09 income tax rate to range between 25% and 27%.

In fiscal year 2008, our bookings from continuing operations outpaced revenues by $29 million. As expected, during the just-completed quarter, revenues exceeded bookings for the first time since the quarter ended June 30th, 2006. We highlighted in the press release the presence of a significant booking of over $13 million that was included in the bookings for the prior quarter ended September 30th, 2007. The impact of the lack of a comparable booking in the current quarter can be seen in the results of the near-infrared optics business segment. As of September 30th, 2008, we have a healthy backlog in all business segments totaling $121 million. The components of this backlog from continuing operations were: Infrared optics at $35.5 million; near-infrared optics at $23.5 million; military and materials at $42 million; and compound semiconductor group at $20 million.

The gross margin from manufactured products as a percentage of revenues from continuing operations for the quarter increased to 43.3%, which was above the 41.1% gross margin in the first quarter of last year and above the 41.8% gross margin in the fourth quarter of last year. Compared to the first quarter of last year, the infrared optics, near-infrared optics, and military and material segment improvements achieved respectable gross image gains. The infrared optics and military and material segment gains were due in part to the 29% revenue increase posted by each of these business segments. The increase in the infrared optics segment gross margin was also the result of improved manufacturing yields compared to the first quarter of last year. The financial position of II-VI continues to strengthen, with quarterly EBITDA increasing by over $3.5 million or 20% from the same quarter last year. We ended the quarter with over $67 million in cash and marketable securities, and under $4 million in debt.

During the quarter, we made an additional equity investment in Fuxin Electronics of $5 million, spent $4.7 million for capital expenditures, made estimated tax payments of over $12 million, and paid out the bonuses and profit sharing contributions that related to the prior fiscal year. We accomplished all of this and only consumed $5 million of cash during the quarter. We have an available but currently unused credit facility that can be used for acquisition and other permitted purposes as needed. Our strong financial position and profile can be used for M&A activities, especially in an environment where targeted Company values have or may be expected to decline. Fran, this concludes my prepared remarks. 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 30th, 2008. Jackie, we are ready to begin the question and answer session.

Okay. At this time, if you'd like to ask a question, press star and the number one on your telephone keypad. We'll pause just a moment to compile the Q&A roster. Your first question comes from the line of Avinash Kant. Your line is open.

Good morning, Fran and Craig.

Good morning.

Had one clarification, of course. When you talk about the tax gains this time, you have given the net number that is $3.6 million. Could you break that out in terms of how much was the gain from the unrecognized taxes and how much was it from the increased taxes from the regions?

The -- Avinash, the details, as you said, net to that total $3.6 million in the 10-K, we noted that the number that was going to be the favorable impact was going to be roughly about $4.5, $4.7 million. And it was pretty close to that number, what was the favorable impact. And then it was offset by -- the difference was the negative impact from the -- from the additional exposure identified during the quarter. So that was about $800,000 or $900,000. So roughly, you know, 4.5 in the positive direction, and roughly, you know, say $900,000 in the negative direction. Those are the two components.

Okay. If I remember correctly, when you talked after the second -- after the June quarter, you had talked about expecting taxes, something around 24%, 25% range. Butt now you're talking about fiscal year '09 being 25% to 27%. Am I right?

That's correct. And that is based, Avinash, on the current expectation of the mix of earnings. It's highly dependent upon where those earnings are generated, something that we continually look at and refine during the year. But right now, we're thinking somewhere in that the 25% to 27% range is our best estimate right now.

And except for the $4.5 million reversal, your taxes with that 900K additional impact, would have been roughly around the same 25% to 27% range, I would believe?

That's right. It would have been somewhere around that range. That's correct.

So as far as extraordinary is concerned, we should consider the 4.5 million as extraordinary for the fiscal year '09, and include the 900 in our numbers?

Well, we wanted to kind of pull both of them out and call both of them out because they're both fairly unique events. We think it's -- we've described them as the net amount, as we did in the press release, because we really thought that it's unusual for both of those items to happen. We had previewed the one that we knew about by the time we filed the K; the other came about during the quarter. We wanted to kind of aggregate those two so that investors would, you know, get a handle on two unique items. The net impact was a very favorable impact, but we wanted to make sure that investors kind of aggregated those two and understood where -- you know, that those were unique tax items for the quarter.

Right. And I do see that it makes a clear difference compared to the first quarter of the last fiscal year. But going forward, if you're going to be at the same tax bracket, I would rather kind of, you know, let it be the way it is. The 900K, I would say. Is that the right way to think about it?

No -- now, we -- we wanted to aggregate them so that, again, the investors can kind of look at those two together. That's -- that was our perspective of it, that they were both -- you know, both unique items, and -- you know, again, how people want to break it out, that's fine. But the way we -- the way we are looking at it, or articulating it, is really the sum of the two pieces together.

And I believe this extraordinary is also included in the fiscal year '09 guidance that you have given on the EPS side?

That is correct.

Okay. Now, a little bit about the -- historically, you had at least 4% to 5% growth on the revenue side to acquisitions. And of course, given the environment at this point and your cash position, is it -- is it wise to expect the same in the fiscal year '09?

Well, we don't -- we don't currently have anything to announce. We're not announcing anything on this call. You are correct that that acquisition theme has been a part of our growth over the years. You know, we are in a good position, as I noted in my comments, to take advantage of those, especially if -- you know, valuations change or get adjusted downward. But we don't have anything to announce right now. But, you know, we understand that our investors have come to expect that we will do them. We are not on a path or trajectory to do them every so often or every so many quarters or years or something like that. But we're trying to identify companies that might be worthwhile for us to add to our group of companies. But again, we don't have anything to announce right now.

One more question --

And our -- in our acquisition and in our investment strategy, we did have, and reported here, that we've increased our position in Fuxin from 10% to 20%, and that allowed us to bring in the earnings that is our share of their earnings we reported in this quarter for the first time. So we'll have a little bit of that help in the future quarters.

Right. And one final question, and I'll let other people get in line. But could you comment a little bit about Europe and how that is working out for you?

Well, our -- we have a sales office right dead in Darmstadt, Germany, where we have a very nice operation. And that deals with the near-infrared business and the infrared business. And now we're opening an office in there also for our Marlow group. Hired a very, very capable individual to run the office and have -- are relocating from the UK to be there on the continent. So we can see a lot of growth opportunities for these thermal electric coolers and the use of the same type of a device for power generation. So with the presence that we're going to build in Germany, I think we'll be able to take care of mainly the continent of Europe and then into eastern Europe where there's great activity, especially in these thermal electrics.

Thanks so much, Fran.

You're welcome.

Okay. Our next question comes from the line of Jiwon Lee. Your line is open.

Thank you, good morning.

Good morning, Jiwon.

Things are certainly uncertain; but with that in mind, Fran, could you give us a little more color on your commercial infrared optics, what you see out there, what your customers are seeing, in two different ways, please? After market versus OEMs, and the geography.

Okay. Let's go maybe in general, overall. The diversity of where these 55,000 high-power lasers are installed around the world creates quite a diverse background on where our orders come from, and only about half to 2/3rds come directly from the people running the lasers. The other half or something like that comes through the OEMs, who are also selling to the after market. So you get the stage set, there's probably 1/3, 1/3, 1/3 of these lasers installed in North America versus Europe versus Asia. And Asia, mainly Japan with China coming on quick. So the down draft that's happening with consumer goods and the things that people are buying, it will take some time before it finds its way down to our after market slowing down. But we -- I think we'd be foolish not to expect that. And whether that takes six to nine months, it's unclear to us. But the people are starting to slow down the use of their laser. They're not running 7 by 24 in some product categories. So the after market at the moment is holding very stable for us.

I think for us to claim that it will remain that way well into the future would be foolish. I believe we will have a let up. That's really -- when you sort through our orders for the commercial CO2 laser optics, that's 85% -- 90% is the after-market demand. It's the -- the OEMs play some of that with us; but the OEMs are only building 5,000 to 5,500 lasers a year, high-power CO2. And that number is heading down, in my opinion, to probably 4,500. They're telling us already a couple of accounts in Europe are saying we're off, and you're starting starting it in Japan also. So got to think that they -- the machines that are being built, moved down the assembly line, 5,500 going to 4,500, it's the install base that's really key for us. And there's this feature that when people turn off their lasers or back off on some shifts, that seems to create us a little bit of an order surge because a laser or a line is down -- let's tear out all the optics, let's retool it, put everything back together, take advantage this down time to do maintenance. That's -- you know, it's not a big deal. But those are the features that we feel in the sentiment for agricultural products and energy products. And that's where a lot of agriculture in the U.S. is headed, is into ethanol and so on. It's going very, very well -- while automotive, as we all know, is in trouble, and construction now has started downward also. Even the -- the people movers or the high lifts or anything like that.

So construction down, automotive down. That will come around to us in -- and I said in my prepared comments, it's unclear whether it's six to nine months out, or sooner or later. But we're -- we're right now in good shape, as I reported. Our guidance is consistent with how we can see the world. But we're aware that two to three quarters out, we cannot see that far.

Okay. And a little more color on the geography, or did you kind of already say that?

Probably the -- the softest area right now that's talking about this -- and you can not get after-market data, so I have to go with OEM data. OEM data, it's softest in Europe; next probably Japan starting to talk pretty much like they're going to hit the wall here and slow down; and the U.S. is last. From the after markets, I do not have a collective view of how it's going. But I can't make a comment about the after market by geography.

I see. Well, that's fair enough. Thank you. And then looking at your revised F '09 guidance, your top line didn't change so much, but especially your bottom end of the EPS guidance dropped, I guess, rather disproportionately. So what kind of a logic went in when you were putting the bottom line of EPS guidance for the rest of the year?

I think it was that -- you're picking up, Jiwon -- we did kind of broaden the ranges out; again, because we are rolling up the individual businesses we have, and there's, you know, individual uncertainty in those forecasts, especially in the second half of the fiscal year. And so I think we just thought it was prudent to kind of broaden it out a little bit. Really, a process not that so much different than we have done in the past. But I think, to Fran's earlier comment, you know, we are just sense something uncertainty, especially in the second half of the year as we kind of head into calendar '09. And we wanted to make sure that the ranges were broad enough to capture that uncertainty.

Fair enough. And then did I miss the comment of how much of the military orders were pushed out to the second quarter? Can you quantify the numbers?

I don't think did I. I said there were two large orders --

Yes --

Large for us is half a million to a $1 million. So probably million five to two million pushout.

Okay. And those were all Sapphire, or were they a combination of germanium or even new (inaudible)?

Yes. One each.

Okay. Fair enough. And finally, a housekeeping question, please. The percentage of the foreign sales for the quarter?

The percentage of foreign sales for the quarter were 49%. And that's upon from the first quarter of last year. We had -- 42% of sales were international. Now it's been raised up to 49%.

Okay. Oh, and then if I can kind of jab it in, I know you guys cannot talk a lot about, you know, sort of the deals that you may see out there. But, you know, what kind of things generally interest you? As you said, things, you know, do get a little more reasonable in valuation, and you have made several smaller acquisitions. So what kind of things really do interest you?

We're -- two or three different areas. But probably, if you wanted to put a banner over it all, would be materials-centered businesses that would be complimentary, or at least require the same skill set we have. And most of our four different businesses are centered around materials. We'd like to find something -- a fifth business that's material-centered. We like ceramics. We also then go away from the materials a little bit to acquisitions that could round out our four existing business segments, and there's some in each category. And the one I'd point to right now that we've been just working on a little at a time is our thermal electric business at Marlow. And there are other businesses we could maybe add to there. But certainly our increases in our Fuxin investment from 10 to 20 has given us a foothold down in the lower end of the thermal electric business. It's not a big, big step, but we want to watch that whole food chain, let's say, from the low end thermal electrics all the way to the top end where we are. Then if we apply that same strategic thinking to our other three businesses, I think we could find an acquisition that makes sense in each one of those other three.

Terrific, thank you very much.

Uh-huh.

(OPERATOR INSTRUCTIONS). And our next question comes from the line of Greg Halter. Your line is open.

Yes. Wondered if you could comment on the share count, which I noticed went down from the prior year -- the prior quarter, actually. Is that just due to the share price decline?

I think it's probably, Greg, more of an impact of a full -- full impact of finishing out of the share repurchase program that we did at the end of last fiscal year. So that -- we really finished that out in the third quarter of last fiscal year, you're getting the full-year impact. And there was a little bit of impact there because of the share count. We -- because of the stock price. But I think mostly it's just that we, you know -- really, it's primarily driven by the impact of the -- the full impact of the finishing out of the share repurchase plan we did last year.

Okay, and discussing the share repurchase, are there any plans to reinstitute or bring in a new plan?

We don't -- Greg, we don't currently have one. Our Board of Directors authorized us to finish the one that was open, and we finished that at the -- toward the end of the third quarter of last fiscal year. But currently we do not have one that's open.

Okay. And I think you may have indicated that your cash flow from operations was a use of $5 million in the quarter. Is that correct?

No. I think, Greg, we were trying to point out just the overall cash impact was a total net use, in spite of doing some investments, capital spending, large tax payments, those things. So we were -- you know, we put in EBITDA information -- and we put the cash flow details in the queue. But I was just really making the comment of the cash change from June to September was a $5 million of the use. And we did a lot of things -- a lot of uses of those cash. And I was trying to identify some of those things. But it all netted to only a $5 million cash change during the quarter.

Okay, okay. And relative to your business being about half foreign now -- foreign sales -- what kind of impact did currency have in the quarter, and what kind would you expect going forward now with the dollar at about $1.03 to the Euro?

To date, it has not been a significant impact to us. You know, if you look around the world, a lot of our European sales -- actually, the majority of our European sales are dollar denominated. So the -- you know, the Euro change does not -- excuse me -- does not impact us there. The yen, we're selling all of our -- all of our sales in Japan are yen-denominated. So to the extent that the yen would strengthen, that's a little bit of a positive impact for us. But again, to date -- and especially in the quarter we just completed -- really not any material change in the yen-to-dollar exchange rate during the past quarter. So the quarter we ended, even if you look back to last fiscal year '08, really this currency change is not really that significant for us. To the extent that, you know, the dollar does strengthen a little bit in Europe, you know, that could have a continuing impact on the Euro-denominated sales. But again, that's a -- that's a very small portion of our overall sales into Europe.

Okay. And what would you anticipate your capital spending to be for the year? Any major -- any major projects there?

We anticipate it to be probably around the $20 millionish dollar range. I think that's one thing as we kind of go further into the year that we will, you know, again, see how the economy is doing and will obviously tailor that. We have quite a bit of flexibility in the components there. We don't have really any significant bricks and mortar-type programs that are going on, with one exception. We are doing a fairly sizable expansion of our PRM facility in the Philippines. But beyond that, there's no significant, you know, multi, multimillion dollar program that has been ramped up. A lot of it is buying equipment, infrastructure for existing operations. And so we will -- we will definitely monitor that. As we showed in the press release, this quarter we did a little bit under $5 million. You know, I would expect us to run roughly around that range for the rest of the fiscal year each quarter. But again, we're going to watch that closely.

Okay. Two other quick ones --

Greg, it would be a little bit unfair not to say that we're probably leaning the number down. As we look into that second half, if we don't take the 20 down by 10%, we just aren't going to prepare ourselves properly for what we think will be out there.

Okay. That's helpful. And two quick ones. On the backlog, a year ago on an adjusted basis for continuing operations, what was that number?

On --

Do you have it?

Yes, I actually -- see if I happen to have it. Actually, I do have it. A year ago, at the end of the first quarter of FY '08, it was about $113 million. So it's up a little bit from that point.

Up about 7% I guess.

Right. The peak that we had of the quarter we -- the June-ended quarter, it was $134 million. Now we're sitting at 121. But a year ago, it was up -- again, it was -- September of '07 was about $113 million.

Okay. And one last one relative to your guidance that you've given, the 179 to 189 for the earnings. Just want to make sure that relative to that tax benefit of $0.12, if you strip that out, you'd be talking 167 to 177? Am I looking at that correctly?

That's correct. That's right.

Okay, thank you.

The next question comes from the line of Chris McDonald. Your line is open.

Hey, Fran and Craig, thanks for taking my question.

Uh-huh.

I just wanted to get an update, or get your sense on where you are with inventory levels on zinc selenide and zinc sulfide materials. I know you had been trying to build some inventory there. Just wanted to know if you were at back to normal levels now with the new capacity coming on line?

We're building up, but we're not back to where we want to be. We really have -- we ran it very, very well to the extent where we actually stopped order taking for merchant sales of the material. So as you might guess, we like to have a very solid amount of material on hand. And we do have three different shops where we have to keep them loaded with material -- that's in (Inaudible), China and Singapore and here in Saxonburg. On top of that, we want to have plenty to make all different types of orders quickly filled to our merchant customers. So we're on our way back, no doubt about it. But we're not there. And I don't have -- I cannot give you a percent back to where we want to be. But we're not even -- we're not the 2/3 of the way back to where we upon to be, I do not feel. So it will take us another quarter or so -- with the mix of how this material gets sold on thickness and on size of the pieces, and then between selenide and sulfide, it takes you a while to build back to the level you're real happy with.

Okay. And the new furnaces are performing more or less like you would expect them to at this point? Is that right?

The new furnaces and our existing furnaces are close. We had a problem a year or so ago, and we improved it six months ago and three months. And we're closing in on having that yield issue behind us, and all the new furnaces are behaving like the old furnaces. So we're in pretty good shape.

Okay.

I never would want to say that we're all the way fixed, because we can improve.

Okay. And then, Fran, if I heard you right, I think you said you'd expect orders for those merchant materials to be close to double what they were last year now that you do have capacity up and yields are improving. Was that right? I just wanted to make sure I --

Yes, exactly. That's why we're targeting -- that's really part of our plan this year, to get back in the merchant supply business.

And so your ability to sell -- just thinking through this -- your ability to sell those materials would be -- at least help offset some of this anticipated after-market weakness as we work our way into 2009, given I think margins tend to be pretty decent on those merchant materials, is that correct?

Yes. That's exactly right. And then remember, we do have this UV filter business that we really enjoyed in '08 and '07 that is coming down now that most of the Apache helicopters have been outfitted. So making up for that revenue that we enjoyed, we're expecting to make some of that up also by this merchant sales of selenide and sulfide.

Okay. And then the schedule for the wind down of the UV filter business, is that more or less in line with what you expected a quarter ago? Or is it faster, slower? Any change there?

Right now, it's right on that pace. I think it will go -- I think we're projecting it -- we're about on track, we do not have a change in plan on that. Our prime customer is keeping us pretty well aware, and I think we need another order to stay on our plan in about five, six months. If that order doesn't come through, it might not have a good tail into FY '10 like we're hoping for. But right now, we're all set, I think, on UV for FY '09.

Okay, great. Thank you. Nice quarter.

Thank you.

Okay, our next question comes from the line of Avinash. Your line is open.

That's right. A few follow-up questions. Now in the guidance with the fiscal year '09, should we expect much changes to the gross margin and the operating margin (inaudible) here at this point?

We don't think there's going to be any drastic changes, Avinash. We are -- we don't, you know, kind of get down to that level of granularity in the guidance. But overall, you know, the way we've modeled it out, we are not modeling out any significant changes in either the gross or operating margin make ups of any of the businesses.

And then how do you think -- of course, zinc prices have been coming down. Have you seen any positive impact from that, especially in the material sales?

No, zinc is such a minor part of the cost in our zinc selenide. It's dominated by selenium.

Okay. Okay. And one broader question. Do you see other technologies coming and competing with you, especially in the IR optics side? There's been some talks about other technologies that could come and actually -- you know, fiber technology that could come and kind of start competing with the CO2 laser side. Do you think that's a possibility?

The fiber laser is continuing to do very, very well in welding applications. So it is -- it's kind of expanded the market for laser processing. The fiber laser coming into the cutting of thick metal has not been a factor to this point. I think it's being worked on. We're aware of it, and that's part of the reason why we've bought this business HIGHYAG so that we can participate. If a fiber laser or a diode laser or even a disc laser heads into the cutting of thick metals, where most of the -- most of the CO2 lasers are positioned -- if it goes there, we want to participate. The physics to make it happen has just not been conquered. But I think we have to be aware that it might happen sometime. So those type of lasers are competing with CO2.

Then the broader question of is there any material or any other type of way to make CO2 lasers operate without the zinc selenide or without the diamond-turn components that we use, I think there's always activity going on to go to higher and higher power CO2 lasers with more reflective optics, and the reflective optics bring us into a little more competition because others besides ourselves can diamond-turn copper mirrors for those type of machines. We're the leader by far in all the diamond-turn copper reflective mirrors with five kilowatt CO2 lasers. But it's possible that we get more competition there. If it's transmissive optics for CO2 lasers, I think we're very strong.

So at this point, have you seen much competition from the fiber lasers in the CO2 side?

I think there are -- there are places where the fiber laser is doing some of the work that a CO2 had done in the past, but not in cutting. So I have to say they're really hitting the welding hard, the engraving, the marking hard. And the engraving and marking, CO2 lasers are very competitive. Those built in China are very, very low cost. So they're -- there's a bit of a mini battle going on in engraving, marking, fiber versus CO2. But I don't think it -- it's not been significant, but that's where the fiber laser is knocking on the door.

Perfect. Thank you so much, Fran.

Uh-huh.

Your next question comes from the line of Joseph Garner. Your line is open.

Good morning, gentlemen. Most of my questions have been answered. The one thing, Fran, if you could help me put into context a little bit more. You talked a bit about the merchant materials business. And I'm wondering historically, how significant had that been for you in the past?

Compared to the CO2 product line, maybe 3%, 4% of the sale of the sales in that area. And that's a rough and tough number. It -- it's important, but I think it can be more important, and I think we have a difficult row to hoe a little, because our customers know that we use our capacity to serve internal needs first and sell in the merchant world second. And with having shut off the merchant world for a while, they are -- you know, they're skeptical.

Sure. Sure. And how long do you think it would take for some of that business to come back on line, given that you had been out of it for a while?

Just depends upon the timing of the programs that are going through, because we also target to sell our material more toward the defense side of things, to optics companies that are producing defense products. We're not really interested to sell it to our competitors. So if a couple nice programs are coming along and they need a lot of material, we'll bid on that, and we'll get right back in pretty quickly. But if there's no program, it will take us a while. Right now, it does appear like the programs are pretty -- our opportunities are good. This Homeland Security -- that is, the IR surveillance systems -- are good opportunities for us.

Okay. And Craig, you commented a little earlier on margins. You weren't expecting any significant change in gross and operating margin. I'm just wondering -- specifically on the gross margin line, there was a -- you had a significant quarter-to-quarter pickup there. So do you believe that 43%-ish gross margin in product sales is sustainable then?

At that level of sales, Joe, I think it is. We are -- you know, again -- we're forecasting a quarter -- the upcoming second quarter where that general sales range, we did, you know, just under $88 million this past quarter. That may -- you know, that is going to come -- based on our guidance, we're expecting that to be, you know, $82 million to $86 million. So we'rre going to get a little -- we're not going to get such the volume impact that we had this quarter. So I don't think it's going to be a drastic change. But -- and back to Fran's earlier comment, especially in the infrared optics business, we have made some nice gains. We will continue to see that throughout the year as that business continues to progress. So we're expecting some gains there. But I think a little bit of the downward pressure -- specifically, Joe, in Q2 -- is going to be a little bit lower of a revenue top line that we're going to have to compete with. So --

Okay. And then as far as operating expenses are concerned, if we get into a little bit more of a challenging business environment, are there things that you can do there in terms of reigning in costs in certain areas to offset any revenue impact you might have?

Yes. And I made a few comments in my prepared comments that we are watching cost very closely, and we're taking actions to keep our UV filter line rate of profitability, for example, in line with what it's been, although it will be at a lower number. So we're making personnel adjustments as we go forward, and trying to stay right on top of that. So, yes, we can make some cost changes. You know, there are some limitations, because we have -- our fixed costs because of the amount of growth furnaces we have in all our different locations, a little higher than what you'd like to have if you had to cut costs. So we're -- we'll try to react quickly, and we are making some adjustments. I don't think I can say that we've got great cost-cutting capacity, but we will be right on it as quickly as we need to.

Okay. And the last question, Fran. You mentioned that the new furnaces are performing well. Safe to assume, then, that you're pleased with the yields that you're getting out of the new furnaces?

Yes.

Yes. We're -- and that's why I made that comment on -- that we're almost where we should be. I don't want to say we're there, because we always need to keep improving. And then this business of growing materials, what amount we yield that's good for our customers, it can always get better if we can figure something more out about the process.

Right. Okay. Thank you very much, and congratulations for a good quarter.

Thank you, Joe.

I have no more questions in queue.

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, 2008, is tentatively scheduled for before the market opens on Tuesday, January 30, 2009, with a conference call to follow that same day at 9:00 a.m. eastern time. Thank you for participating in today's conference call.

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