II-VI Inc (IIVI) 2009 Q4 法說會逐字稿

Good day and welcome to the II-VI Incorporated fourth quarter and fiscal year 2009 conference call. Today's conference is being recorded. Following the prepared remarks, there will be a question and answer session. Instructions will begin at that time. I would now like to turn the call over to Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Please go ahead, sir.

Thank you Kristen, and good morning everyone. I'm Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Welcome to the fourth quarter fiscal year 2009 II-VI Incorporated investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, August 4, 2009.

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

Thank you Craig. I'm Francis Kramer, President and CEO of II-VI Incorporated.

The continued caution of worldwide consumers impacted II-VI again in the fourth quarter. We have seen lower demand levels since we first felt this slowdown back in November of 2008.

In our Infrared Optics business we serve customers that operate high-power CO2 laser systems to manufacture all types of products. An application of particular note is metal cutting. Laser system utilization rates have not risen immeasurably from the 50% utilization rate we reported in April. However, we have seen a modest, sluggish, but nonetheless increase in our aftermarket sales since April.

There are two reasons for this sluggish growth. The first is that we have gained market share by winning new customers. For instance, in the fourth quarter we won a record 84 new US aftermarket customers. Second, we believe that our aftermarket customers have depleted their excess inventories of spare parts and are now buying just what they need and no more.

We also provide spare parts for the installed base of high-power CO2 lasers to our OEM customers, who tend to carry substantial inventories of optics throughout their service networks. Although we also see some sluggish growth in this segment, indicating that an inventory correction has been completed by some OEMs, we are concerned that remote service stocks have now been replenished in anticipation of extended summer shutdowns at central distribution centers.

We expect that complete destocking of the supply chains may well require up to two additional quarters in some cases. We expect that laser utilization will increase later this year, and we are well positioned with favorable inventories strategically located around the world to capture this business.

This year we successfully grew bookings for our high end military components business by 29% and our zinc optical materials business by 55% within the Infrared Optics segment. We have identified additional opportunities for each of these businesses and expect continued but slower growth in the coming year.

In fact, we expect that our higher yields and our previous investments in additional material growth capacity should allow sustained market share gain and steady growth for our materials business for the next several years.

Our bookings growth next year may slow down as one major long-standing military program winds down and we back-fill a new business. Nonetheless, these markets will continue to allow us to diversify beyond our CO2 laser optics business.

In the fourth quarter we saw a few of our low-power CO2 laser OEMs place blanket orders, as their inventory corrections were completed and demand slightly improved. Unlike our high-powered business, most of these optics are used to build new lasers and not used as replacement optics.

An important low-power customer encountered a much slower than expected adoption rate for a new series of lasers, resulting in a debooking of approximately $1.3 million of open orders, our first such debooking or cancellation of any significance since our markets began to soften a year ago. Up to this point, our order cancellation rate for our entire business had remained at its historically very low level.

Another parameter we utilize as an indicator of market sentiment is the number of units per line item ordered. From a high of 27 at the beginning of fiscal year 2009, we hit a low of 11 units per line item in March and have since then seen in increase to 16.

We remain actively involved with a number of OEMs as they intensify their product development efforts in anticipation of a rebound. In particular in the fourth quarter, OEM customers serving the electronic industry were able to introduce new generations of equipment and were encouraged to see semiconductor fabrication utilization rates rising.

Additionally, we see hopeful signs of growth from China as their government stimulus program improves the outlook for both high- and low-power laser systems.

Demand for laser optics for the globally installed base of 55,000 high-powered CO2 laser systems will largely determine our rate of recovery and will be the result of increased laser utilization rates. We do expect August and September to be difficult months due to extended summer shutdowns, and we would expect the end of the calendar to be likewise with -- would be likewise soft due to extended holiday shutdowns.

The commercial business at our VLOC Near-Infrared segment experienced a slowdown in the rate of decline in the fourth quarter. However, compared to the prior fiscal year 2008, commercial bookings were down over 40%, and commercial revenues were down over 25%. This decline was led by industrial and medical market declines of 49% and 36%, respectively.

In the UV Filter business, we continue to meet or exceed the required schedule for deliveries to our primary customer. As we have been mentioning in prior releases, we have seen a reduction in delivery rates for this product line. We anticipate production levels to be similar to the just completed quarter for the next three quarters.

During the quarter, our VLOC Near-Infrared business continued to expand its military opportunities. Year-over-year increases in military related bookings and revenues, excluding UV Filters, were 88% and 28%, respectively. This helped offset a 26% decline in commercial revenue -- in the commercial revenue side of the business caused by the worldwide economic conditions.

During the quarter we continued to ramp up key military programs and increased non-UV shipments by 20% compared to the third quarter of this fiscal year. This was driven by a complicated optical subassembly used in a major, laser-based range finder and target designator system. Also included in this ramp were several crystal base subassemblies used in support of other military target designator and illuminator programs.

The majority of our non-UV military business relates to directly protecting and supporting our troops and should continue to be included in future military budgets. In support of these programs, our VLOC Near-Infrared business continues to add state-of-the-art manufacturing technologies such as the recently acquired magnetorheological finishing -- which is called MRF -- machine used to polish precise geometries required by these program designs.

In our Compound Semiconductor Group, as indicated in the press release, our eV PRODUCTS business was sold on June 12. The Wide Bandgap Materials group of the Compound Semiconductor Group -- work began on the recently awarded $5.2 million DOD program which is focused on the cost-effective manufacturing of high-quality, state-of-the-art 100-millimeter diameter silicon carbide substrates above 6H semi-insulating and 4H n-type. With a new program in place, WBG realized $1.8 million in contract revenue this quarter. Wafer shipments to US DOD customers and revenue derived from contracts were on target for the quarter.

Shipments of our silicon carbide substrates to commercial OEMs in the US and Japan were up 50% compared to the third quarter. The demand for 6H semi-insulating 100-millimeter silicon carbide substrates for RF applications remains consistent with the previous quarter, as we continue to ship substrates to both Japanese and US customers. Feedback on the quality of the 6H semi-insulating 100-millimeter substrates from these customers has been very positive, with customers indicating that the quality is on parity now with our three-inch diameter standard product.

In the first quarter of fiscal year 2010, we will continue to sample 4H 100-millimeter substrates for power applications. We've just received a sizable order from a Japanese OEM power customer to whom we will deliver an initial large lot of 100-millimeter substrates by the end of August.

During the fiscal year through operational and technical improvements, we have achieved a 40% improvement in a combination of yield and productivity of our standard three-inch, 6H semi-insulating product. These same improvements will be required in a timely fashion for our 4H and 6H 100-millimeter products, and we expect the demand for 100-millimeter substrates to grow substantially as our customers complete their line qualifications.

To prepare for this, we have completed the conversion of 100% of our existing crystal growth stations to a new design that is capable of producing large-diameter ingots at higher yields. This planned future capacity has been adequately designed to address the projected demand for 100-millimeter substrates. In addition, our ingot fabrication and polishing steps have been moved onto larger tools for higher throughput and to address demand for tighter substrate specifications.

At Marlow Industries, the fourth-quarter revenues, bookings and profits were up due to increased performance on all product lines. Revenues and bookings were up quarter over quarter by 19% and 17%, respectively. The bookings increase was driven by strong performance in the defense, medical and telecom products, while the revenue growth was enabled by a strong defense market performance in addition to another solid medical market performance.

We're beginning to see an increase in demand from our major telecom customers, consistent with their recent reports of increases in demand from their markets.

For the full-year bookings we are down 13%, primarily due to the soft demand that we experienced in both telecom and automotive products. Some of our major defense contract renewals were delayed and are now expected in the first quarter of fiscal year 2010.

On the other hand, full-year revenues were up 10% in spite of the challenging global economic situation. The revenue increases were driven by strong year-over-year performances in the defense and medical industries, which were up 32% and 12%, respectively.

Marlow began sipping automotive production units during the fourth quarter out of our Vietnam production facility. We also began work on two new major, high-volume consumer market opportunities which we expect to begin to contribute sales in the second half of fiscal year 2010.

We have now completed the transition of our commercial products to our production facility in Vietnam, which serves as our global low-cost and high-volume manufacturing center for all of our markets except for our defense products, which will continue to be built in Dallas due to ITAR requirements.

In our Worldwide Materials Group, which we called WMG, we announced by way of a press release on July 1 that II-VI had formed a Chinese joint venture. The primary products of the joint venture will be both chemical vapor deposited diamond suitable for cutting tool blanks, grinding wheel dressing tools, and heat spreaders for laser diodes. Laser cutting machines for polycrystalline diamond, polycrystalline cubic boron nitrate, chemical vapor deposited diamond, and other super-hard materials will be the second major product group for the joint venture.

The joint venture will be majority-owned by Supower. II-VI will account for its investment in the joint venture under the equity method of accounting. Facility construction for the recently formed II-VI and Beijing Supower joint venture, which is called Langfang Haobo Diamond Co., Ltd., is expected to begin within two months. The facilities will be located in Dachang Industrial Park, which is 40 kilometers east of Beijing.

Our final business to comment on is the Military & Materials business segment. In the materials portion of that segment, PRM revenues and bookings met expectations as the index price movements for both selenium and tellurium metals were minimal compared to the previous two quarters. Throughout the quarter the selenium price index remained stable at $18.50 per pound, while the tellurium price index declined 10% from $150 to $135 per kilogram.

Margins for PRM exceeded expectations in the fourth quarter and was driven by ancillary product sales of precious metals and lower manufacturing costs.

Inventory of raw materials was at a level in line with our demand requirements. The supply of tellurium and selenium raw materials has been tight as copper refining production, the main source of tellurium and selenium containing feedstocks, slowed. Additionally, increased competition for these materials has reduced the discounts to index pricing that we have traditionally been paid, increasing the overall cost of raw material production 10% higher.

Tellurium demand for the photovoltaic markets that we serve remained unchanged in the quarter, and we continue to be optimistic about the long-term growth prospects of tellurium for use in the cadmium telluride based photovoltaic panels.

Although still sluggish, the demand for selenium products in the glass, automotive and the steel industry has stabilized. We continue to expect that orders for selenium will be a large challenge for the business in the first half of fiscal year 2010.

At the Exotic Electro-Optics military business, fiscal year 2009 was a record year for bookings, revenues and earnings. Bookings in fiscal year 2009 were 27% above 2008's levels, while revenues in 2009 were 19% above 2008. In the sapphire business EEO continued to show strong growth with record bookings and revenues. Bookings in sapphire were 45% above 2008 levels, and revenues were 23% above 2008 levels. These strong results were driven by increased statements of ATP Sniper shrouds and initial production ramp-up of the sapphire windows for the Joint Strike Fighter Program.

Negotiations on a multi-year pricing agreement for JSF are now underway. EEO continues to be the sole source supplier for the JSF sapphire windows, which require meeting very challenging fabricating specifications which have evolved as the development of this plane has progressed.

In summary, all of our business segments are --

One, focusing their sales and marketing initiatives on the highest-probability products and accounts.

Two, developing new products that meet the needs of our customers as told to us -- as they tell them to us.

Three, continuing to generate cash and redeploy in the form of capital expenditures smartly, or in the form of working capital, specifically inventory, located any place in the world where we feel it will quickly turn into sales as the unpredictable demand for products materializes.

Four, working to make additional cost reductions, especially in the IR optics business, where sizable reductions have already been made worldwide.

Five, position ourselves to create an even stronger II-VI during and after the economic recovery.

And six and finally, we're looking to make investments and acquisitions that will expand our existing product lines, add new, adjacent product lines, or expand our footprint around the world.

Craig, that concludes my comments.

Thank you Francis. Here are the items I would like to highlight before we move into the question and answer portion of the call. As described in the second information from continuing operations in the press release, bookings from continuing operations for the quarter ended June 30, 2009 were $57.2 million. This is a decrease of 38% when compared to the prior year quarter and a decrease of 8% when compared to the quarter ended March 31, 2009. This level of bookings, combined with the revenue generated for the quarter, reduced the overall backlog from continuing operations at June 30, 2009, to $103 million.

The components of the June 30, 2009 backlog from continuing operations were Infrared Optics at $26.5 million, Near-Infrared Optics at $19.5 million, Military & Materials at $39 million, and Compound Semiconductor Group at $18 million.

As we announced via a press release on June 12, we completed the sale of our x-ray and gamma-ray radiation sensor business, eV PRODUCTS, to Endicott Interconnect Technologies, Inc. eV had been treated as a discontinued operations for accounting purposes. Proceeds from the sale of this business were slightly more than $5 million. When offset by the cash paid for transaction costs of $1.9 million and the capital expenditures of eV of $0.2 million, cash from investing activities from continuing operations was $3 million, as shown in the cash flow statement provided with today's press release.

In addition to the sale transaction, II-VI has agreed to provide certain inventory over the next 12 months and to lease a facility here on our Saxonburg, Pennsylvania campus, as the facility was not an asset of the sale transaction.

During FY 2009, eV operated near breakeven before considering the sale transaction costs, which included employee retention costs, transaction costs including investment banking and legal expenses, and a write-down of the net assets to their realizable value.

We wish the eV employees and Endicott Interconnect Technologies all the best for continued success.

Looking at the gross margin and operating margin levels, both have deteriorated during the just-completed quarter when compared with the same quarter last year. The decrease in revenues between the periods is the main driver for the reduced margin performance and more specifically, the 40% decrease in Infrared Optics revenues. When compared to the March 31, 2009 quarter, the recent quarterly results improved by about 240 basis points at the gross margin for manufactured products level and about 140 basis points at the operating margin level. Both the Near-Infrared Optics and the Compound Semiconductor Group segments recorded sizable sequential operating margin improvements during the just-completed quarter.

Despite the declining revenue and financial performance, our ability to generate cash flow from operations during the just-completed fiscal year was a highlight of FY 2009. We achieved a record level of cash flow from operations during the year. We also continued to slow down our capital spending, as evidenced by our capital spending decline to $3.3 million in the June 30 quarter with approximately one-half of that spending going towards our Military & Materials business segment. During the current quarter, we paid off our line of credit facility, while our cash balance grew to nearly $96 million, the highest in the history of the company.

The updated guidance contained in today's press release gives our current view of the expected financial performance for the quarter ending September 30, 2009. While we would like to be in a position to provide guidance for the fiscal year ending June 30, 2010, you will note in the press release we are unable to do so at this time. Our lower levels of backlog is giving us less visibility than we would like, which is causing us to limit the length of our guidance.

Our industrial business is very dependent on the utilization rates from the worldwide installed base of lasers, and while there may be a bright spot here or there from some geographic locations, the clear pattern of demand beyond the current quarter remains a bit uncertain. We would appreciate that you respect this decision and understand that as soon as our visibility improves, we plan to return to guidance beyond the just upcoming quarter.

Finally, as noted in the press release, Board member and Audit Committee Chairman Duncan Morrison will retire from the Board when his term ends in November. Duncan has served II-VI and its shareholders since 1982 when the company recorded a mere $6 million in revenues. We wish Duncan all the best on his upcoming retirement from the Board, and we're looking forward to continuing the tradition of strong Audit Committee leadership from Board member Wendy DiCicco.

Francis, 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 30, 2008.

Kristen, we are ready to begin the question-and-answer session.

(Operator Instructions). Jiwon Lee, Sidoti & Company.

Thanks for taking my questions. First of all, I just wanted to go back to your first quarter guidance. I was trying to get a little more color as to what kind of a segment revenue assumptions went in, as well as the kind of a margin assumption. I'm asking because in the fourth quarter you pulled a nice margin traction, but it appears that the trend, at least in your mind, will reverse in the September quarter guidance.

I think one of the factors in the guidance is the little bit of seasonality that we usually experience in that quarter, the first quarter, our fiscal first quarter, the September quarter usually is impacted a little bit by our sales over in Europe and specifically within the Infrared Optics business.

In Fran's prepared remarks he noted that we are sensing from some of our customers, especially in that location, that they will take extended or longer shutdowns than they normally do. So we've factored that into the guidance as well.

We've also looked out at each of the businesses and tried to decipher, again, from the order pattern and the backlog that we are seeing, what the levels will be for September. But I think the most influential factor would be kind of what our expectations are for the Infrared Optics business for August and September. Again, the seasonality plus kind of just the general uncertainty that we are seeing, those are two of the main factors for the guidance for the quarter.

And any comment (multiple speakers)

I may go a little further to say that the first quarter, if we weren't looking at what's happening in August with the shutdowns in many factories announced to be two and three weeks, I think we would feel that we might be on a plateau with the fourth quarter. But this August, September uncertainty is where we are really facing something that we have never seen before, where July was a good order month, and it was like everybody was ordering for a big shutdown, and that's what's happening.

So when they come out of that shutdown, if their order book has not improved, late September could also not be too pretty. So we are cautioning and we are really seeing just the first quarter, a different type of drop-off in the first quarter compared to our normal seasonality, but we really think it's going to have a step-down from the fourth quarter.

Okay. Well, that's helpful. And onto the military side of the business, can we talk a little bit specifically about the type of programs, the legacy programs that are ramping down, including the UV [Filters] and the revenue contribution you are expecting, and also some of the programs that are ramping up?

Well maybe first on the UV Filter, that's pretty straightforward. We've had the reduction in that over the last two, two and a half quarters, and we are at a steady state there. So the level of the UV business in the fourth quarter is what we will expect mostly through FY 2010. So I think that reduction is pretty well taken care of.

One I mentioned for our IR Optics division, they have one long-standing program that they have been supplying material for for the last three years, in the neighborhood of a $2 million of material per year, and that's going to drop to probably less than half in FY 2010. So it's a material which the margins are very good on for the IR Optics group, but that program was a imaging system.

We made some materials, sold them to somebody else who produced them and sold them and made an imaging product. It was manufactured in France, believe it or not, and so the optics and the materials that we -- or the materials we provided to somebody else, who made the optics, sold them to the French integrator, and that's now ramped down after four years, a ramping down in FY 2010 to -- I'm going to say half the rate. In maybe '11 and '12 we might see it tail off at half the rate for a few more years. So it's slowing.

Then you go to the other side of our business, which is our business out in California where we are very devoted to the military, and those programs are in many cases in good shape. That was our best growth area this year. EEO grew 10%.

We have a number of nice programs. And I mentioned JSF and ATP Sniper, which are going to go up a little bit, just for us. Maybe the federal announcements or what's happening on their budgets and so on is looking like ATP, which is the F-22. There's still many of those on order, although things are longer-term going to slow on that. But I think that's three, four years out for us.

And then JSF, which is moving nicely. It's in low-rate initial production. Maybe they go as they announce those programs by LRIP 1, 2, 3, 4, 5, but we are only in 2 and 3 right now, so it's very early on. Now, the rate at which those planes will be produced in 2015 and so on, that's what we are preparing ourselves for is to be a -- we hope -- sole-source supplier of these sapphire materials as that ramps up. So that program on the sapphire side is going well for us.

The legacy programs at EEO are good also, a lot of it having to do with reset or refit after Iraq and Afghanistan, and those programs are pretty steady, I would say. And I don't -- we're not seeing a 2010, 2011 drop in those programs. Maybe after that, if somehow these wars end, then the reset would maybe slow us down, but we really do not see it out there till later, 2015 maybe.

So the Sniper and the JSF for the sapphire components that you are in, I think you are still a sole-source there, right?

Yes, on both of those.

Okay. And two more questions please. I kind of missed the cash impact of the eV PRODUCTS sales?

It is listed in the cash flow that's in the press release under the section in the investing activity section, and it's the line item that says discontinued operation -- a little bit more than a net intake of cash of about $3 million.

Okay. That's helpful. And you have nearly $100 million in cash position. Fran, last time we spoke there were a number of opportunities in each of the divisions. Is there updates on how you view these opportunities?

I think we are still in the same hunt for the right place to invest. And again, it's the same -- something in each division. I was thinking we would be able to get closer on something, but changes happen. We like an investment of some nature in Asia, and that takes time to complete. Just a lot of unknowns for us. So we will be very careful and make a good investment.

Then in our -- all our materials businesses, we really, really see a need to do that. Our investment in our -- or joint venture in Langfang Haobo Diamond materials business, that's very critical for us, very strategic. We want to be in the materials business, and that's a way for us to participate in the diamond business, and we think it will help us.

We look into other unique engineered materials, and in that neighborhood of diamond we have considerable interest. So we're looking all the time. In some cases it's just taking more time. In others the price might be too high for us because we want to have a good value when we invest.

Okay. I get back into the queue. Thanks.

(Operator Instructions). Avinash Kant, D. A. Davidson.

Your line is open. You may go ahead.

Due to no response, we'll take our next question from Richard Shannon, Northland Securities.

Maybe kind of a two-sided question here. I didn't -- Fran, I didn't catch in your comments whether you mentioned the percentage of sales that came from military. If you did, I apologize, but what was that number for the June quarter?

Richard, we're still right around that 35% in total mark. We've been kind of at that level for the last couple of quarters. And as Fran was -- we didn't quantify that number for you then. It's a good question. It's right around the same mark we have been. Some of the improvements in revenues that we saw this quarter were on the military. As Fran mentioned, though, there were some that were non-military. That mix really didn't change a whole lot, so roughly about 35%. Again, as a point of reference, roughly about 50% of our products find their way into the industrial market, but the defense is right around 35%.

And then a follow-up on that, I know that typically as your mix of products shifts towards military, it tends to hurt your gross margins, but you obviously don't need to spend as much on the OpEx. Saw quite a nice improvement in the gross margins here in the June quarter. You just mentioned your percentage for military didn't change.

I was just trying to correlate all the comments I heard, mostly from Fran's prepared script. But I would love to understand why the gross margins improved so much. I imagine some of it is cost reductions. But if you can kind of wrap in all your comments together to kind of get a sense of the impact in the June quarter, and then what a sustainable trend going forward?

I think the two most significant factors in the June quarter as compared to the March quarter, we did have some nice operational performance and revenue increases from both our Near-Infrared Optics business as well as the Compound Semiconductor Group. And that is, again, a mix of military, non-military programs.

One of the items that had been a little bit challenging us over the last several quarters and had been the ramp-down of the UV Filter program. As Fran mentioned, now for the next foreseeable few quarters, we are at a more steady state level. So that has not impacted our margins like it had in the past. And again, the higher level of sales we generated in the Compound Semiconductor Group, that also helped get us into higher-level profitability. So those two were ones that had a positive influence on both the gross and the operating margins during the quarter.

Okay. And maybe a question for Fran. You mentioned some comments I think in response to one of the previous questions about kind of ordering from some set of customers, mostly perhaps European, that are already in front of the expected shutdowns here in the August month. Kind of curious if those thoughts -- if those increased orders -- and there's a long time frame for shutdowns hadn't occurred. Would you have a modestly better outlook for the September quarter at all? I just kind of want to get your general thoughts, big picture here. Would we see kind of a bottoming here and an inflection point or not?

Yes. I think we might try to tell you that, because were starting to see just a little -- I called it a sluggish improvement. So we're starting to see that. But I can't sort it from -- have people done all their destocking and they need all the spare parts? Or are they tied up with preparing for this -- I don't want to overdo it, but it's probably a month shutdown. It's not two to three weeks when you put four or five major OEMs who are staggering their two and three weeks off between the first three weeks of August and the last three weeks, it's going to be just -- not an active month for us for Europe and somewhat Japan.

The Japanese -- and they are not big on the holidays like the Europeans, but their amount a staff that are assigned to their assembly lines for CO2 lasers in this summer, it's really quite weak.

So I would like to say we would have probably projected the first quarter, maybe 10% up in sales from what we are trying to guide toward if we didn't see this big hole happening here in August. But I think we have to believe there's something going on. They are preparing for -- to be down for the month.

And remember, all the parts that we sell right now, the bulk of them that we sell to the OEMs, are not for their assembly lines. They are for the people that are using lasers. And it's hard for us to get well calibrated on how heavy lasers are being utilized in some parts of the world. It's just some are running stronger than others, and we get the aggregate result by way of how many optics for the spare parts business the OEMs buy. And that's been really quite cold with a little sluggish improvement happening.

Okay. Appreciate the thoughts there, Fran.

Next question for me on the Marlow business, you mentioned, and have mentioned in the past couple of quarters, about an automotive opportunity here. What's kind of the -- how far in -- how many -- how far into the future is the current programs your on? Is that something that can extend typically more than a year? Or even perhaps even more than two years? And what stage of that ramp are we in here?

Well, I think it's really a good program for us. We're pretty happy that the people we are supplying to, who are the number-one people in the world in car seat heaters, are also looking to cool seats. So they have a great way to enter the market and are entered. They have a few contracts on certain car platforms, and they will be well-positioned because they are already there selling them heaters, and as more models add the cooling feature, we will come right along. So we have a nice teeming with that customer.

Obviously the drawback -- and I don't want to leave a negative on this, but I think we have a good five-year or longer future on the seat cooling. The drawback, obviously, is the whole car industry right now, that the amount of conversion or amount of cars being offered with cooling has slowed so dramatically since the whole rate of car production worldwide has cut back so much.

So although we would've thought last year at this time we would be entering production, it's taken us one year to enter production, just due to a lot of startup problems, but really affected by the rate of car sales. So we got a good, long-term future on that product. We're really happy to have the product, and we will do well producing that out of our Vietnam factory, and we think it's going to be a nice baseload product for us long-term.

Great. And then last question for me. You mentioned, and you have mentioned in the past, M&A as an opportunity to grow beyond organically. What's your overall viewpoint on the markets, especially as it relates to valuations from companies that are out there? Have the expectations come down to the point where they're a little bit more attractive? Or have they remained a little bit higher than what you would like in general?

Well, watch the overall M&A market. That's down for small-cap, small -- $50 million to $200 million acquisitions. I think that's down in the 6, 7 EBITDA kind of range, where it had been 10, so the market in general is down.

Then we go to the half-dozen people that we have been trying to do a deal with. We must be picking the wrong guys, because they are not dropping off like that. If you try to buy anything in Asia, especially in China, it's affected by the China market, which thinks it's not down. So the prices in China seem to be a little -- they are not dropping like we would like to see.

Then the people that we are trying to make an acquisition happen with here in the States, they are also for one reason or the other, not -- they're not -- certainly they are not really in need of the cash, because when we are looking to buy from private individuals, they're not moving for that reason or willing to move saying they need the cash, because they haven't gotten that -- to that point yet.

And the divisions of public companies that are up for sale, I think there it hasn't happened either. One or two that we tried to work with, their sales were down and their overall idea is they are not selling a thing. They are just holding on because they need all the sales they have to carry their costs.

So it's odd. And I really feel in my mind we are -- about four or five candidates that we're talking about, each one is in a different place, and we are continuing to work it. But nothing that is immediately obvious is going to break.

Okay. Great. Thank you very much. I will jump out of line.

(Operator Instructions). Avinash Kant, D. A. Davidson.

Sorry about the previous time. I had some issues with the phone. A few questions here. The first one is that seasonality, clearly looking at the seasonality in the past of the few years, especially the September quarter, it looks like seasonally you have been down sequentially almost 5% to 6% in September. Now, given the guidance at this point, clearly it looks like compared to previous years, you are seeing a bigger shutdown this time around?

Definitely. Yes. Everybody has announced a take-off of two or three weeks.

Right. But the issue seems to be coming a lot from Europe, and do you think that but for the seasonality, there would have started to see some recovery? Or they are still lagging behind in the recovery here?

I think they're lagging behind in the recovery. I think their announcements of what's coming in their auto industry, and a lot of people there have been employed using their time banks and so on. And those are running out. So the amount of money that's moving toward this auto industry in Europe seems to be -- in terms of people buying cars -- seems to be slowing -- or that's an impression we get.

Right. Okay. And in terms of cost cutting, could you give us what was the headcount at the end of this quarter and what's the headcount that you exited with calendar year 2008?

Yes. We did some further reductions, not quite as much as we needed to do in the December quarter and the March quarter. Our total headcount as of the end of June 30, 2009 was just a little bit more than 1900 employees, and that also now excludes -- there was about 63 people at eV that are not our employees anymore. They are still here on this campus employed, which is a good thing, but they are not counted as II-VI employees anymore.

In fact, if you went back to the calendar end of 2008, back to December, that number was about 2350 or so. So there's been quite a number of reductions. I think Fran touched on it. It's been kind of worldwide. It's been scattered where areas -- where there have been slow -- slowing efforts at work, and we've needed to make adjustments pretty much at all of our locations, but right now about 1900 is where we are at.

The 1900 were at the end of June, and you are down 60 more in July? Is that what you are saying? Or --?

That 1900 excludes 60 people -- 60 people was not the result of any cost reduction. They were a result of the sale of the business. So it would have been 1960 if we still would have had eV PRODUCTS. It's 1900 because we don't have eV PRODUCTS.

I see. I see.

Another way to look at it, we reduced our manpower in the IR Optics group by about 35%. We've reduced our manpower in our Near-Infrared Optics unit by 25%. Those are the two units most affected by the downturn in the economy.

We felt like we've been doing that aggressively with maybe our first reduction in November in the one division and another in December. So we've have approximately three different reductions, or three different events in both divisions that have -- we've tried to prune the costs as rapidly and quickly as we could. And we feel like we've been ahead of that reduction in cost, or the results we've delivered might not have been this good.

I see. And Craig, in the guidance for September, if you take the midpoint, what kind of -- are you anticipating some margin decline here, gross margin decline in the September quarter?

We are anticipating a little bit, again, primarily because with the continued cautious expectation for the Infrared Optics business, which even at our lower levels continues to be a strong generator of earnings for us, that is one of the factors that we factored into that is kind of the mix of earnings that will come a little less from the Infrared Optics business, a little more from some of the other businesses that are profitable but not as profitable structure-wise as the Infrared Optics business has been.

And was there some year-end -- like fiscal year-end impact on SG&A in the quarter? Like that could have been down a little bit? Or could go down a little bit in the next quarter?

I don't know if there was much in there. There were not really any significant, again, workforce reductions or unusual things that would crop up into there. We are impacted a little bit by -- and sometimes the fluctuations come through. A lot of our sales and marketing efforts are outside of the US. So a lot of those cost structures for those countries, especially in a quarter like this when the dollar was quite a bit weaker than say in the previous quarter, those expenses will show up in dollars a little bit stronger. So that is one factor there, but other than that, other than just kind of the natural FX, no other significant items in the quarter.

And the tax rate, we should be assuming pretty similar, 26% or so?

Yes. We're thinking for FY 2010 it should be somewhere in that range, somewhere between 26% and 28%. I don't think we are seeing any major changes to the overall tax structure that we have. We are -- there's a tax program or two that we have benefited from in past years that we may not benefit from in future years. We have tried to factor that in, but somewhere in that 26% to 28% is -- we're thinking is the right rate for FY '10.

Okay. And one final question. In terms of utilization rate of the systems that are out there, if you were to leave Europe, have you started to see some improvements in other regions?

Well, for sure you would have to say utilization in China is better. The Chinese, you hear a lot about how their economy is improving, and our people there are saying it is better. We are getting the low-power CO2 optics orders that I mentioned in my script, and some of our higher-power OEMs people over there are starting to buy again -- plus replacement.

So I would say Japan is better. But as a percent of our total business, it's a smaller percent, so it doesn't have a lot of lift to it.

Other places around the globe, you'd think India might be ready to go, but the big laser cutting industry in India is diamond, and all the brooding of diamonds and so on, that just hasn't come back yet because people are not spending the money on the luxury diamonds, shall we say.

So where you think there might be a little pickup, China is the best thing we can report on. After that I think it's a -- it's spread around. If there's a little in South America, maybe. Here in the United States it depends on the industry, and the same in -- Japan is pretty quiet, we have to say. In Europe, quieting down.

Thanks very much.

This does conclude our question-and-answer session. At this time, I would like to turn the conference back over to Mr. Creaturo for any additional or closing remarks.

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter ending September 30, 2009 is tentatively scheduled for before the market opens on Tuesday, October 20, 2009 with a conference call to follow that same day at 9 AM Eastern Time. Thank you for participating in today's conference call.

This does conclude today's conference. Thank you for your participation.