II-VI Inc (IIVI) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to the II-VI, Inc. fiscal year 2010 second-quarter conference call. Today's call is being recorded. I'd now like to turn the conference over to Mr. Scott (sic) Creaturo.

Thank you, Dana, and good morning, everyone. I am Craig Creaturo, Chief Financial officer and Treasurer of II-VI, Inc. Welcome to the second-quarter fiscal year 2010 II-VI, Inc. investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, January 19, 2010. 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. I am Francis Kramer, President and CEO of II-VI, Inc. Our second-quarter EPS of $0.20 is in the middle of our guidance range and represents the results of the quarter after deducting $0.04 for the acquisition costs of Photop Technologies, Inc. In effect we had a 24% EPS quarter excluding the Photop cost, which is a 14% improvement over the first quarter. We feel this is representative of the trend we are experiencing.

We therefore have increased our full-year fiscal year 2010 revenue guidance, including the newly acquired Photop business, to $306 million to $311 million. We expect EPS to range from $0.97 to $1.03; a strong driver for this improved guidance is the 7% quarter-over-quarter bookings increase experienced in the second quarter.

The second-quarter fiscal year '10 infrared optics bookings increased 15% quarter over quarter and have now rebounded 44% from our weakest quarter during the current economic slowdown, which was the third quarter of fiscal year '09. Although orders still remain 26% below our peak in the third quarter of FY '08 of $44 million, the second-quarter fiscal year '10 quarterly bookings improvement was across most geographic -- geographies and products as demand continued to strengthen. Optics used in electronic fabrication in Asia is one notable bright spot.

In the US, new orders from domestic OEMs for the second quarter were almost double the first-quarter level, but down 7% compared to the second quarter of fiscal year '09. Blanket orders from low-power OEMs were brisk in the early part of the quarter and these customers report increased activity in most of their markets. Blanket orders from high-power OEMs in the US were stronger in the latter part of the quarter, driven by their need for replacement service parts.

The new high-power machine build rate in the US remains low, while laser utilization rates for the installed base continues to inch up. The North American aftermarket, which is a leading indicator for our industrial business, was steady in the second quarter with bookings equal to those of the first quarter.

Laser service companies appear to be working closely with end users that are looking for more cost effective solutions for maintaining their machines. Agricultural machinery suppliers are performing best while food, energy, and military equipment suppliers are steady. Housing, construction equipment, and automobile suppliers remain very weak. Barring a decline in the overall economy, we expect this mix of activity to persist for the remainder of our fiscal year.

Zinc selenide and zinc sulfide external raw bookings for the second quarter increased 53% compared to the first quarter, yet were slightly down compared to the second quarter of fiscal year '09. We continue to price aggressively to penetrate key target accounts and we are well positioned to gain additional market share during the remainder of the fiscal year.

In addition, progress was made in marketing larger blanks for multi-spectral zinc sulfide, a key new product offering this year of II-VI. US military optics orders for our infrared optics segment for the second quarter declined compared to the first quarter of fiscal year 2010 and the second quarter of fiscal year '09. Military orders in the second quarter were primarily for aircraft infrared targeting systems.

A few key production programs are winding down and we expect to see new follow-on orders in the third and fourth quarter in this historically lumpy business. The outlook for these two infrared optics product offerings remains positive for the balance of the fiscal year.

European bookings for infrared optics for the second quarter were 12% greater than the first quarter. The sustained modest improvement reflects restocking needs driven by increased high-power laser machine utilization rates and subsequent optic replacements.

Production rates of new machine builds remain low at all European high-power OEMs with some reporting that demand is beginning to edge upwards while others report demand weakening. Low-power OEMs report improved outlook for equipment bound for medical applications.

Japan's bookings increased 43% quarter over quarter with particular strength in products bound for electronic and semiconductor fabrication equipment. Bear in mind that in comparison to the second quarter of fiscal year '09 our current orders for Japan are still down 21%. While the low-power CO2 laser market continues to recover gradually, but steadily, the high-power OEMs in Japan have been slow to show signs of a significant recovery.

China orders for the second quarter were off 28% following our record high level in the third first quarter. Strong optics orders are anticipated for the balance of the fiscal year to satisfy a healthy Chinese market with particular strength in electronics and market.

The IR optics book to bill ratio of 1.04 for the quarter allowed us to grow our backlog by $1.3 million during this period, which is the first quarter we have built infrared optics backlogs since the fourth quarter of fiscal year '08.

During the quarter, the military segment of our VLOC near-infrared business received a $4.7 million Title III award for the development of polycrystalline laser gain materials. This award aligns nicely with our current business strategy. VLOC will team with II-VI's advanced materials development center in Saxonburg, Pennsylvania and with Nanocerox, Inc. in Ann Arbor, Michigan to set up production capabilities of these materials to support the manufacture of high energy laser weapons.

Also in the second quarter VLOC continued to experience increased revenues in the military optical subassembly and components, laser-based rangefinders, target designators, and illuminator systems areas. This quarter's military-related shipments were up nearly 45% compared to last year's second quarter and the year-to-date shipments compared to last year's same period were up 40%.

VLOC continues to address the challenges of this military business ramp up and is focused on processing capacity improvements. An example of this was the receipt of a new ion beam sputtering coating machine received in the second quarter that is now in production adding capacity for military-related coatings.

The commercial business at VLOC continued to see some rebound during the second quarter in the medical and industrial markets for optics and YAG. The applications driving the increase are aesthetic laser systems, industrial marking systems in the use of debris shields in the industrial aftermarket.

On January 4, 2010 we announced that we had completed our acquisition of Photop Technologies, Inc. Photop, headquartered in Fuzhou, China with over 3,000 employees, is a vertically integrated developer and manufacturer of engineered materials, optical components, microchip lasers for visible display applications, and optical modules for use in fiber-optic communication networks and other diverse consumer and commercial applications.

Photop is being led by the experienced management team of John Ling, CEO, and Sunny Sun, President. Photop will now be part of the near-infrared group that includes our VLOC subsidiary. The near-infrared group will be directed by Chuck Mattera, who was recently promoted to Executive Vice President of II-VI, Inc. Chuck also directs the compound semiconductor group.

Within the near-infrared group there are a number of technology and market synergies that the top management of the group has already identified. These will be a key focus of the long-range planning and actions to grow the business of the near-infrared unit. Interactions with both VLOC and Photop customers in the past two weeks have been positive.

We have reassured our key customers and suppliers that we intend to support the Photop management team using the same business model and approach that we use with the other II-VI businesses. With this approach, we expect to grow our near-infrared group as our VLOC and Photop teams have already begun working collaboratively.

In the compound semiconductor group, our Wide Bandgap Materials unit has experienced year-to-date bookings that are 79% greater than this same period last year. This increase was due to renewed and larger annual blanket orders for 6H semi-insulating silicon carbide wafers from US customers as well as large new blanket orders from customers in Japan.

Demand increases were spread over a range of products and applications with large bookings for 2 inch, 3 inch, and 100 millimeter 6H semi-insulating wafers and significant business growth in both the RF and power segments. Product revenues were up quarter over quarter by 13% and up year-to-date by 75% over last year.

Revenue growth was derived from significant increases in the number of wafers shipped to Japan OEMs. 100 millimeter 4H power wafers have been shipped to both European and Japanese OEMs for process qualification. Meanwhile, year-to-date revenue from government contracts was roughly equal to the same period last year and is being driven by the title III contract that we booked in the first quarter of fiscal year 2010 of $5.2 million.

During the second quarter we maintained our focus on both operational and technical improvements as well as cost reduction to enable us to meet anticipated demands. Targeted process improvements in crystal growth, fabrication and polishing resulted in higher yield to customer specifications. Cost reduction was achieved through qualification of new vendors and materials in fabrication and polishing. Additional cost reduction was accomplished through cycle time reduction in both polishing and fabrication.

At Marlow Industries, the second-quarter bookings were up 46% quarter over quarter while revenues were comparable to the first quarter, although short of our expectations as a result of a number of operational challenges that confronted Marlow and some of its customers, including order delays and problems with order fulfillment in the medical and industrial segments. The primary drivers for the bookings increase were major orders in the defense market and a continuing demand increase in the telecom market.

During the quarter Marlow was selected as a strategic supplier for a new high-volume consumer application slated to ramp up in the fourth quarter. We expect global telecom demand to increase -- to continue to increase throughout the year. We're projecting medical revenues to recover to the first-quarter levels over the next two quarters.

Most all of this non-defense manufacturing has now been transitioned to our Vietnam plant and, as a result, our customers worldwide are deriving the benefits of this lower-cost manufacturing platform. Working to maintain the highest standard of quality in the industry, Marlow recently had its ISO 9000 version 2008 recertified.

The final segment to comment on is the Military and Materials segment, which consists of our subsidiaries of Exotic Electro-Optics and Pacific Rare Materials. Both had solid bookings for the quarter. This has been a consistent trend for our military products over the past few quarters, but our PM products are now showing some strength and stability, which we believe is tied to the global economic rebound.

The second-quarter order highlights were -- A, Sapphire windows for the Joint Strike Fighter; B, optical components for the Apache helicopter upgrade which is referred to as the Arrowhead program; and C, optical components for another part of the JSF aircraft which provides situational awareness and missile warning capabilities to the aircraft. This optical components order is a nice win for us in that we're able to replace the incumbent optical supplier.

Segment revenues for the quarter of $15.2 million slightly exceeded our expectations for both subsidiaries. Operational challenges impacted our segment profitability for the quarter. Profitability declined quarter over quarter due to the production cost of our Sapphire windows increasing during the quarter due to process-related issues and due to the volume of selenium and tellurium material production being off during the quarter due to equipment downtime and lower yields related to a new raw material being introduced for tellurium products.

Although production dipped during the quarter, product quality and customer deliveries were not impacted. We believe these production challenges are resolved and will not continue in the third quarter. Despite these challenges, segment earnings for the quarter were up 49% year over year. The outlook for this segment is positive as both subsidiaries expect business expansion going forward.

At Exotic, we have recently broken ground on a new 25,000 square foot building that will be dedicated to Sapphire window production. At PRM, we have secured several new selenium raw material contracts which position us nicely for the next two to three quarters.

With respect to II-VI's interest in Zygo Corporation, I'm not going to be able to discuss that potential transaction during this briefing or answer any questions in the Q&A session. I will be limiting my remarks regarding Zygo to the following.

As you may know, we made a proposal to acquire Zygo for $10 per share payable in cash or up to 50% of the consideration in II-VI common stock. We disclosed this proposal on January 7, 2010. Zygo shareholders would have an election regarding the consideration subject to the stock limitation. If all Zygo shareholders elect to receive consideration cash, we are prepared to support this election.

We believe that the combined companies offer compelling benefits to the shareholders, customers, and employees of both companies. The customers, the shareholders, employees of both companies share a significant common interest. We strongly believe this combination will benefit all the stakeholders of both companies and we're prepared to proceed [expediously] to complete this transaction.

Our hope is that Zygo's Board of Directors will recognize both the immediate and future value of a business combination and our strong preference is to proceed in a cooperative manner. We have great respect for what Zygo has accomplished and are eager to build upon its strengths.

We believe, as we have demonstrated with other acquisitions, we have the ability to assist Zygo in realizing future business opportunities in markets where the competitive landscape is rapidly changing. We feel that we will be able to integrate our teams rapidly and foster a high degree of collaboration and integration from the very start.

For these reasons, among others we have previously discussed in our announcement, we're pursuing this transaction aggressively. As I mentioned, I must limit my remarks on Zygo to these comments and I thank you in advance for your understanding.

Craig, the markets for our commercial products are stabilizing and trending upward. We have completed the Photop acquisition and are in the initial stages of integrating the VLOC subsidiary and the Photop subsidiary into what we envision to be a worldwide leader in the near-infrared market. We're active in the M&A marketplace. I think the solid increase in our full-year EPS guidance is a strong message.

We have enough visibility to project the second half of fiscal year 2010 to be approximately 35% better than the second half of fiscal year '09. That concludes my comments.

Thank you, Fran. Here are the items that I would like to highlight before we open up the question-and-answer portion of the call.

Key sources of information regarding the Photop transaction include -- the press release that we had on January for regarding the completion of the acquisition; the conference call that we had that same day which provided an overview of Photop; and the required SEC filings on forms 8-K and 8-Ka.

Also, Fran noted some of the Photop details during his prepared comments. For that reason we will not repeat the Photop transaction details during this teleconference. My comments regarding Photop today will focus more on the future of this acquisition, which is the largest to date in the history of II-VI, and we'll highlight some additional items of interest.

Photop will be combined with our VLOC business for segment reporting purposes as part of the near-infrared optics segment. With historical gross margins in the 30% range, Photop has similar gross margins to VLOC. As part of our required SEC filings, we will be filing the audited statements of Photop for the year ended December 31, 2009 during the month of March 2010. That information should help you gain a further understanding of the recent historical financial performance of Photop.

We are very pleased that we're able to retain the key employees of Photop as part of this acquisition. As described in the merger agreement for the Photop transaction, which was included in one of our Form 8-K filings, the Photop retention program will drive the payment of $5 million of cash and stock to Photop's employees over the next three years.

20% of this amount will be expensed and paid in cash prior to June 30, 2010, and we have built this expense into our guidance for the fiscal year ending June 30, 2010. The remaining 80% will be paid in II-VI stock over the next three years and this will drive an increase in II-VI's stock-based compensation during that time period beginning with the March 31, 2010 quarter.

In each of the third and fourth quarters of fiscal year 2010, we believe that the stock-based compensation expense for II-VI will be approximately $1.7 million, which is higher than our prior projections as a result of the Photop-related expenses.

As noted in today's press release, the results for the three and six months ended December 31, 2009 include approximately $1.7 million pretax or approximately $1.3 million after-tax expenses relating to the Photop transaction. The after-tax expenses were slightly higher than the $1 million of expenses that we estimated in the January 4 Photop press releases based in a receipt of the actual December invoices and the completion of a preliminary review of the tax deductibility of certain of these transaction-related expenses. These expenses pretax were classified in the near-infrared optics segment for segment reporting purposes.

We want to take a moment and thank those at II-VI who have worked of the Photop transaction to date and I also want to thank in advance those within the II-VI and Photop organizations who will help make the combination of II-VI and Photop live up to the high goals we have established.

As described in the segment information from continuing operations in the press release, bookings from continuing operations for the quarter ended December 31, 2009 were $78.3 million. This was an increase of 16% over the same quarter last year and an increase of 7% or $5 million from the quarter ended September 30, 2009. This builds on the backlog increase we saw in the quarter ended September 30, 2009 and has increased the overall backlog from continuing operations at December 31, 2009 to $120.5 million.

The components of the December 31, 2009 backlog from continuing operations were -- infrared optics at $27 million; near-infrared optics at $25 million; military and materials at $45.5 million; and compound semiconductor group at $23 million.

We have been very pleased with the cash flow generation of the business during the first six months of the fiscal year. We generated nearly $19 million more in cash from operations during the current six-month period than in the same period last fiscal year. Some of the keys to this achievement have come from working capital improvements in our control of inventory and our management of accounts receivable. All these factors led to an increase in cash during the December 31, 2009 quarter of $11 million.

Our recent cash generation was one of the reasons that we were able to fund the initial cash purchase price of the Photop acquisition with cash on hand. The effective tax rate for the quarter was 19% and brought the year-to-date effective tax rate down to 22.2%.

During the quarter we completed the filing of our fiscal year 2009 federal tax return and had some favorable return to provision adjustments as a result of the finalization of the tax return, specifically within the area of the research and development credit that is available to the Company.

We expect the full-year FY10 effective tax rate to range between 23% and 25%. This full-year tax rate incorporates the expected tax rate for Photop for the second half of the fiscal year. Photop currently enjoys a tax rate that is lower than II-VI's overall tax rate as a result of being a foreign-owned high-tech company within China.

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 30, 2009. Dana, we are ready to begin the question-and-answer session.

(Operator Instructions). Mark Douglass, Longbow Research.

Good morning, gentlemen, and congratulations on a good quarter. On the IR optics segment -- Fran, you did a good job explaining the moving parts between the low-power/high-power guys. So just to confirm, high-power OEMs particularly in Europe and Japan, still really aren't seeing anything at this point?

That's correct. (multiple speakers).

Have they given any indication as to -- has visibility improved at all? Are they expecting a pickup maybe more in second quarter? Is it going to be more of a later 2010 event?

I tried to allude to that in my notes, so you'll get both remarks. We're going to turn off our production rate and the other one is going to turn down. Some have been running eight a month and they're going back to six. And then we have another customer in Europe who's just slowing down, just slowing down. So we've got the mix, Europe and Asia. I think it's just a very, very light trend upward if you said that on the OEM assembly line. But the trend that was good for the OEMs was this replacement parts that they're now having to restock.

Right, right. So maybe they had a little bit more backlog they were trying to work through?

Haven't seen it strong enough yet.

Okay, okay, in the military businesses, in particular the Sapphire for Joint Strike Fighter, can you give a little more color on the ramp up expectations for that program?

Well, we are the sole source on these Sapphire pods for JSF. We do have a model of how we're building our capacity. I think this program, JSF, is one that's going to be headline news for a number of years here in the states. And so we've tried to make our model work and still listen to the customer on what they say they're going to need and we work through a prime contractor, not straight to DoD.

But we in our model have figured out or had some built-in delay and we've not assumed all the way to seven, eight years from now that we're the sole source. So we think our assumption and our financial model are pretty reasonable. They're not pessimistic; they're not optimistic. But we do know in the military supply business there will be delays and there are a lot of political activities that change the way it's looked.

But we continue to think that we'll have a good chance to have near sole source on this for a number of years. Maybe it will change two, three, four years out, but we've got a five-year plan that gives us good visibility. We have orders received that take us most of the way there. So our forecast and what I've been telegraphing for our Exotic unit is consistent with how we try to run our business, which is with good thinking, not overly optimistic or pessimistic.

Okay, then just on some financial issues. On infrared optics segment, I'm surprised you didn't get a little more operating leverage there, even the little uptick in volumes. What would you expect as far as what kind of volume levels are necessary to get back to, say, the mid-20 type of margins?

Mark, I think we're projecting in some of our guidance for the remainder of the fiscal year and then as we go on past that that we should get back to those levels here fairly shortly. I think we have had some -- again to your point, we picked up the sales. We've also been, as needed, adding some cost back in the business, not a lot of cost, but some cost back into the business as we prepare for what we think is this ever growing backlog. I think we're also going to start to see some of that pickup as well.

I think Fran mentioned in his comments as well that we are still doing well in the military portion of the infrared optics business and that's driving some of the margin that we're seeing. Although historically that business has not been as profitable as our commercial business, we are gaining some traction there. And again, as we get a little bit higher volumes we're expecting the margins to start to improve readily.

So we're going to see some improvements there we think fairly quickly. And to the extent that we've kind of forecast that -- some of that improvement into our guidance that we put out for the full fiscal year.

Okay, so no production hiccups, at least in the infrared?

No, I would say -- and Fran maybe can comment as well -- but I'd say overall again very -- doing very well there as far as capacity that we have in material yields and things that we have -- that do cause fluctuations. We're not really seeing any of those right now.

Okay, and my last question -- is it safe to assume then that your new cash balance is roughly $50 million at this point?

We do have the cash that we reported, Mark, for December 31. We used $45.6 million of that for the initial funding of the Photop transaction. So if you do that math you're going to put us in really closer to the $70 million-ish mark. But right now suffice it to say that we're definitely -- we're in good shape cash wise even after funding that Photop transaction.

Okay, thank you.

Jiwon Lee, Sidoti & Co.

Yes, good morning. Thanks for taking my question. First of all, just kind of wanting to go back to the full-year guidance increase. If I understand correctly, your sales guidance from early January did not change, but you are raising the EPS guidance. So I'm trying to understand a little bit whether or not any of this increase in EPS guidance is coming from Photop or all of it is really from the better margins on the IR optics front?

Yes, let me just -- our guidance from the January 4 press release which was updated, basically updating our October guidance for the inclusion of Photop had the revenues at that time $293 million to $305 million in revenues. So we did up that during today's release and we've taken that range. Again, it was $293 million to $305 million, now we're moving that upwards and now we're -- we've moved that up to $306 million to $311 million.

The same way for EPS. Back in the January 4 guidance we left it at $0.85 to $0.95 and in today's release obviously we're taking it up to $0.97 to $1.03. So we have moved both the revenue and EPS ranges up. Again, it's been a combination of some of the things that Fran touched on, some of the businesses that are continuing to improve. And also our visibility has improved a bit as that backlog has grown for a second straight quarter.

So most -- if I understand you correctly, most of the increase is from your existing businesses performing better?

Yes, and I probably could have been clearer, Jiwon. Really our guidance change for today, we're not making any assumption changes for Photop. Our assumptions that we released for the first time for Photop back on January 4 are the same general assumptions that we have today. We repeated a little bit of that in the quote that was in the press release today and that is we do expect Photop to generate between $29 million and $31 million of revenues in the second half of our fiscal year.

Okay.

Jiwon, we did make the comment that certainly we thought it would be EPS neutral for the year. So we did have the $0.04 impact on Photop closing costs in the second quarter and we'll get that $0.04 back in the third and fourth quarter.

That's very helpful, Fran. And in terms of your IR optics, obviously the business obviously improved there. What kind of little more specifically geographic and market wise assumption is built into the guidance for the second half?

It is almost equal across all four markets that we think there's a trend upward, modest as it is, but that's US or North America, Europe, Asia meaning China and Japan meeting exactly Japan. So those are kind of our four key markets right now. Every one of them has an upward trend to it. Not dynamic or dramatic, but good.

So it's right across all those geographies and it's strongest -- probably the strongest uplift in those numbers will be in the spare parts high-power OEM business across all markets, that's for more laser utilization. Although also improving is the low-power across all four markets. And the one that has no movement at all that we see is the OEM assembly line, high-power OEM.

Okay, that's helpful. And as those businesses pick up, are you able to maintain the cost structure that you put in?

Yes, we can do that. We're obviously expecting just a slight improvement. Going on Mark's prior comment, we think we have a little leverage to come here and we've built into the third- and fourth-quarter guidance.

And lastly, what kind of a margin upside could we expect from the military now that you have sort of I guess fixed the yield issues and the selenium issues that you had in the December quarter?

Yes, well, segment earnings wise is the way we report it. I think the segment earnings that we've shown this quarter is -- it's up from where we've been just a little bit and I think that's going to continue. We've built our guidance on just a hair better than that. That's probably the best way to look at it, segment earnings.

One more question. Remind us again what VLOC's gross margin structure is please.

Jiwon, it's typically been right around the overall 2.6 corporate averages. Again, it is a mix of -- you've got good content of military business in there. It's somewhat close to where the Photop gross margins are as well, as we mentioned in today's call. Typically Photop's gross margins have been kind of in the 30%-ish range. And those are kind of right around the same general range of VLOC.

So VLOC a little bit of a different mix of products. Again, more recently slanted toward military a little bit lower margin, but overall generally comparable margins between those two groups.

I may have more questions, but I'm going to hop off for now. Thanks.

Dave Kang, B. Riley.

Yes, good morning. First of all, Craig, the $1.3 million acquisition-related expenses, how do they split up? I assume most of it is SG&A or are some of them shown in COGS?

Dave, all of that does come through the SG&A line.

Okay. And then on the Photop 30%, so what should we expect as far as our blended gross margin going forward as well as OpEx? How do they change with Photop?

Well again, typical with several of the historical acquisitions that we've done, we have acquired a business that the current gross margin structure is a little bit lower than the overall II-VI structure. As Fran mentioned, there are definitely some things we've already started working on as far as synergies between the VLOC and Photop organizations.

So I think suffice it to say that obviously it's been a very well-run, a very consistently profitable business that we bought and a lot of that credit really goes to the Photop management team. But I think we also recognize that hopefully we collectively can make some improvements there and move that up.

Again, as far as the dynamic of it, we are taking on quite a bit of revenue from the Photop transaction, as we said in our guidance, $29 million to $31 million in the second half of the year. That dynamic will shift the margin structure to six overall, downward a little bit because of that -- because of combining Photop.

But overall I think we're more focused on kind of the consistent profitability model that has been inherent with the Photop business and the things that we hopefully can do over the next quarter or years or quite awhile to figure out how to continue to improve that. So I think we're satisfied with where they've been and obviously it's a great place to start. And I think we definitely have some ideas as to how we can improve that over the long term.

Okay, and did you talk about depreciation and amortization going forward as well as CapEx?

Dave, we didn't make any comments on either. In today's release we put out both of those metrics for the quarter we just completed, so we would be right around $4 million of depreciation and amortization and we put out -- we spent this quarter about $4 million, just a little bit more than $4.1 million of CapEx.

I think we are continuing to be selective and prudent I think in the CapEx. We are, though, seeing definitely better signs in some of our businesses and are starting to pull in things that we maybe had planned for FY11 or beyond. We're starting to see a need for that equipment or production capacity. We're starting to see those little bit earlier.

So we think that's kind of it will be at a probably consistent level similar to where we have been this past quarter. So over the next few quarters you could probably project out or we would probably project out around that $4 million to $4.5 million to $5 million run rate.

The depreciation and amortization from the existing businesses will also be at a similar rate, about $4 million. One of the dynamics that we will have that will change that is once we complete our studies and evaluations of both the tangible and intangible assets that we acquired in the Photop transaction, at this point right now obviously this early in the acquisition process we're not able to give any further or better guidance in there.

We have tried to factor a little bit of that into the guidance, but overall giving you a better perspective of where it's going to go. It will definitely go up from kind of where we're at at the $4 million rate. I would say we'll hopefully have some more details by the time we have our third-quarter release as to how the Photop acquisition has changed that.

Okay. And Fran, I think you talked about Marlow's situation. What were some issues? I think I missed that one.

I think we had some customer delays that impacted us and we also had some problems with our production, filling orders for the medical group and for the industrial segment. Not major problems, but those that we'll get worked out have been working on, should get us back on track with the medical business here in the third and fourth quarter. And that would be probably the slight miss of our own expectations of what we would've liked to ship versus what we did.

Okay, and lastly -- I'm not sure how much you can talk about, but has there been any kind of a -- what's the latest as far as on Zygo? Are there any kinds of milestones that you can share besides your prepared remarks at this point?

I have to go back to my script there, Dave, and I said I'm not going to be able to discuss the potential transaction during this briefing or answer any questions in the Q&A. So that's where I have to stay at this moment.

Okay, fair enough. Thank you.

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

Good morning, Fran and Craig. One or two quick questions. Could you give us the headcount at the end of the quarter?

The headcount -- we at II-VI -- so again, this would be excluding the Photop transaction, we were just right on 2,000 employees worldwide. That is a -- we touched on a little bit. We have been doing some selective kind of adding into certain departments and certain areas that are starting to get a little bit busier, we've done some of that during the quarter. That has pushed our worldwide employment up right around the 2,000 employee level. Again, that does not include any of the Photop employees in that number.

Including the Photop that number would come out to --?

That number would be a little bit more than 5,000 or so. Right now Photop's current employment is a little bit more than 3,000 total employees.

Okay. And there were some questions about the Joint Strike Fighter program. There's been some word out there that the rate of amp may be coming down some now. I know that you have had modest expectations from that -- the growth assumptions in that business, but have you heard something like that or do you think that some of the growth assumptions would be coming down there in the near term?

I tried to make that comment earlier, Avinash, that our planning has been built on there would be delays and that we would not ultimately be the sole source. So I feel we're right on track. The delays will continue to be talked about and the quantities might be knocked down. I think the one release on this was JSF and the procurement of that unit by the UK, that this foreign military interest might be waning for the UK group. So we know there will be more of that and we've factored that into how we're building our plan.

Okay. And defense was what percentage of your business this quarter you said roughly?

Defense, Avinash? Did you ask what was our portion of the defense business?

Yes.

For this quarter it was probably still pretty close to the overall -- what we did in last fiscal year, so probably still right around that 40% level. Again, we are seeing the infrared optics business start to pick up and that will change that mix a little bit. Also going forward the Photop acquisition will change that mix and push that number down as well. But for the quarter we just completed still right around that 40% range.

All right. And I believe in terms of tax rate, you said Photop's tax rates were lower than the corporate rate that you have had? That should bring your tax rate down some going forward? And you also said the margin structure may come down some. That means the operating margin of Photop is also below the corporate average at this point?

It is, Avinash. And again, back to similar comments for the gross margin -- again, it's been a very consistently run business and profitable and again some things that we think that can be added because of the II-VI involvement we think we'll definitely be able to make some improvements there. But overall both those metrics lower than the overall corporate metrics for II-VI.

Right, and one final question. I think you did talk about stock based comp going up. So if I got it right, the stock-based comp was roughly running around $1.7 million or so per quarter in the later half of this fiscal year, and that will go up some, right?

Yes, the quarter we just completed it was a little bit under $1.7 million, Avinash. We had just -- the quarter we just completed, the December quarter, we're guiding to roughly about that same amount in both the March quarter and the June quarter. In the quarter we just completed we did have some additional share-based compensation for a couple unique items, one -- including which we had some accelerated vesting for one of our retiring Board members as well.

But we also have adjusted some of the financial forecasts for our non-options, our performance shares for instance. Because the prospects of the business continue to get better, we needed to recognize a little bit more compensation. So we made those adjustments and recognized that expense during the December quarter. And then going forward adding in the Photop stock-based compensation, that's where we think it will be, roughly about $1.7 million for both the march and the June quarter.

Okay, but that has to go up after the June quarter you said, right?

I think, again, Avinash, we will watch and kind of continue that. We will start picking up some of this additional Photop-related stock-based compensation. We will start that in March and that $1.7 million for March and June, it includes that extra expense with a pickup for Photop.

Okay, so $1.7 million includes that?

That's correct, that's right.

Okay. And one final question of course about the sustainability of the order. You have seen bookings improve and you talked about some of the improvements coming more from the low-power side and less from the high-power side. Do you think that the low-power business would actually lead and eventually lead to the high-power business coming up overall? Or in terms of the body language of the customers lately, what have you been seeing? Have you seen a gradual or continued improvement or you have seen kind of no clear direction at this point?

I think the most important segment for us, although low-power is growing faster at the moment, it's not the significant part of our business. The significant part is the aftermarket business. The laser -- high-power laser utilization rate is the key feature for us and I expect that will continue to inch up. Low-power is more marking, engraving, that business is doing better. But I think laser utilization is still low.

It's getting better and I think it's going to continue to get better. It's going to take some time to get back to its old rates. And until that gets back to a better mix of laser utilization, we're not expecting the OEM main assembly of high-power lasers to come back in a big way. So the key is that laser utilization rate.

So do you have an idea, Fran, what's the utilization rate of lasers at this point roughly and what was it maybe a quarter ago?

I really can't get you a number of that. It's so hard for us to do that. We'd love to be able to have a barometer and track it, but we've not been able, all 50,000, 55,000 high-power CO2 lasers around the world and who's running one ship versus two? We have -- we would like to have a real answer here, but we just see it getting a little better, but can't tell you a number.

Perfect, thank you so much.

Mark Douglass, Longbow Research.

Craig, just on the stock expense again -- are you still running a lot of those costs through the IR optics segment?

Mark, that is correct. I think right now all of the -- historically at least through December 31 all of the stock-based compensation does run through the segment earnings of the infrared optics business. That is correct.

Okay, so that probably also explains maybe why it was a pickup here in stock expense. That might have adjusted the IR optics margin a little bit.

That is correct. Mark, that is the same phenomenon as well. Also in the first quarter, as you may recall, we had had some higher stock-based compensation in that quarter as well. But yes, that does flow into the infrared optics segment.

Okay, thanks.

And with no further questions in the queue, I'd like to turn the conference back over 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 March 31, 2010 is likely to be early in the week of April 26 with a conference call to follow that same day as the press release. Thank you for participating in today's conference call.

That does conclude today's presentation. We thank you for your participation.