II-VI Inc (IIVI) 2012 Q1 法說會逐字稿

Good morning. My name is Marianne and I will be your conference operator today. At this time I would like to welcome everyone to the II-VI Incorporated fiscal year 2012 first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. (Operator Instructions). I would now like to turn the call over to Chief Financial Officer and Treasurer, Craig Creaturo. Sir, you may begin.

Thank you Marianne and good morning everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI Incorporated. Thank you for participating in the first quarter, fiscal year 2012 II-VI Incorporated investor teleconference. This teleconference is being recorded on Tuesday, October 25th, 2011. 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 Incorporated. My prepared comments today will discuss operational results of each of our businesses. The order of today's remarks will follow in the same order as our segment report, so I will start with the IR optics. During the first quarter in the IR optics segment, bookings including HIGHYAG were $51 million, up 24% compared to the first quarter of FY 2011. Although bookings showed a significant increase year-over-year, we did experience a 3% decrease compared to the last two quarters of fiscal year 2011. During the quarter we continued to see steady demand from our high powered laser OEMs and after-market customers. The slight decrease compared to the past two quarters is driven by softening in international low power and U.S. military segments.

New orders from domestic OEM's from the first quarter increased 39% from the first quarter of fiscal year 2011. High and low powered laser OEMs continue to order at a steady rate. We did not see many large blanket orders during the past quarter as our customers have continued to demand shorter lead times. We have been able to capitalize on this due to our flexible inventory. The North American after-market, which is a good indicator of laser system utilization had a record bookings quarter up $5 million, which is an increase of 6% quarter-over-quarter and 26% versus the first quarter of fiscal year 2011. Even with continued quarterly bookings records, some customers are expressing concern about the long-term strength in manufacturing. U.S. military orders for our infrared optic segments decreased 74% quarter-over-quarter and 40% compared to the first quarter of fiscal year 2011.

We had strong bookings in the fourth quarter of fiscal year 2011 for two key programs that we probably will not see orders again for until the end of fiscal year 2012. Based on continued reductions in military spending, we do anticipate decreases in order levels in fiscal year 2011 versus fiscal year 2012. European bookings for the first quarter were up 11% quarter-over-quarter and up 39% as compared to the first quarter of fiscal year 2011.

New machine builds by high powered laser OEMs started to flatten during the last quarter. We believe our customers' inventories are now at optimal levels which they continue to monitor closely. Laser utilization rates are steady reflecting the economic conditions in Europe. Japan bookings in the first quarter were 6% lower quarter-over-quarter and 4% lower compared to the same quarter last year. The high powered Japanese laser OEMs have returned to pre-earthquake production levels by low power laser manufacturers who are mainly producing via hole drilling systems have slowed down manufacturing due to the reduced demand related to the printed circuit board industry.

China bookings in the first quarter were down 7% quarter-over-quarter, but up 30% compared to the same quarter last year. The demand in China has slowed over the past quarter compared to the growth levels we experienced in the prior two quarters. At HIGHYAG, bookings for the first quarter were up 14% quarter-over-quarter and up 80% compared to the first quarter fiscal year 2011. The one micron market growth rate is accelerating in Asia. Asian customers are demanding shorter lead times and reduced prices. Manufacturers are having issues sourcing components due to extended lead times and due to their own internal manufacturing capacity. Small one micron users are finding it difficult to get products as capacity is directed toward servicing larger customers.

While we have seen HIGHYAG bookings slow toward the end of the first quarter, our outlook for growth in fiscal year 2012 remains strong. In summary our infrared optics customers are starting to become extremely cautious. They are making plans to tighten their belts, watch inventories monitor costs and are prepared to react quickly in changes in the economic environment. IR bookings started to slow -- started slowing during the last week of September and have continued at a reduced rate in October. Moving to the Near-Infrared Optics segment, during the first quarter bookings compared to the first quarter of last year were up 13% to $38.4 million and revenues were up 3% to $38 million.

Compared to the fourth quarter of last year, Q1 bookings were up sequentially by 17% driven by timing of certain telecom-related orders, and the inclusion of the results of Aegis. While revenues were down slightly, driven reduced by reduced demand and shipment of military products at VLOC more than offsetting Aegis' revenue contribution. Backlog in the Near-Infrared segment as of September 30th was $41 million compared to $38 million at June 30th. In the Photop portion of the Near-Infrared segment the telecom continued to be soft in the first quarter in its primary markets although the business certainly is not experiencing any declines further than that started about two to three quarters ago.

The remaining Photop lines of business held steady with the prior quarter although we have a little less order coverage and visibility to new orders in our display optics business. Photop is using this period of slower growth in telecom to continue its investments in key R&D projects. These projects include optical switching and router modules for customers on data networks, coherent mixers and integrated coherent receivers for 40g and 100g optical networks and critical passive components for advanced optics and fiber laser optics in areas such as TGG crystals, SAC collimating lenses and beam combiners.

In telecom, one of our more profitable products has experienced two quarters of order intake problems. We believe we have nearly replaced all that business with much lower margin business which should be delivered during the balance of fiscal year 2012. Also during the quarter, Photop made substantial progress in further integration expansion of commercial optics as we head into the final phase of the transition of all of our commercial Near-IR product business from VLOC to Photop. We expect that this transition will help simplify both the customer interface and experience as we build a single global sales force and an expanded footprint for Photop's supply chain and product realization.

We have seen increased interest in European and American optics companies in Photop's capabilities and expect to leverage our world class team for further penetration into these large and diversified addressable markets. Meanwhile, we also expect this will help our VLOC unit grow its military products and assemblies business to increase focus, reduce prototyping cycle time and further development of its technology and product road maps. During the quarter, we have incurred some increased costs associated with the transition including those associated with product qualification and components and assemblies requiring increasingly stringent specifications.

Three new coders were added at Photop to assist in this qualification process to add further capacity. Based on our current order backlog customer focus, we expect the December quarter's revenues will be up slightly from the just completed September quarter. Similar to our other II-IV businesses that address the broad telecom end markets our Aegis Lightwave business has also experienced softness and decreased visibility in its core telecom markets. This reflects softening demand for new and upgraded ROADM systems as well as continued inventory corrections at major customers that began earlier this calendar year.

Despite the softening in the market, Aegis continued to invest in research and development activities to expand the pipeline of new products including high performance optical channel monitors for the ROADM market, and high-power fiber combiners for use in high-power fiber laser applications. Furthermore we expect that Aegis will be successful in gaining further design wins from its line of fiber laser combiner products and they will be potentially synergistic with a broader fiber laser optics portfolio. Based on our customer interactions we believe our ROADM and amplifier customers will have worked through their excess inventory by the mid-point of this quarter and are planning that those booking levels will begin to rise again during the quarter.

Within the Near-infrared optic segment, there were a number of technology and market synergies between Aegis and Photop that have already been identified. These synergies are a key focus of the long-range actions to grow the business of the Near-IR segment, and the Aegis and Photop teams have already begun their long-range planning process while VLOC and Photop transitions should allow us to improve our overall efficiency and speed to market in both the commercial and advanced optics segment, as well as in the Near-IR products and assemblies markets. Aegis historically has used contract manufacturing services from Fabrinet for production of its optical channel monitoring and optical coupler products. This facility had fared well from the recent flooding in Thailand, but over this past weekend we received word the flooding has now impacted this location in Chokchai. Fabrinet has been issuing press releases and making SEC filings on this situation.

We are in the process of evaluating how long production may be impacted and determining alternatives to production that may be available by utilizing Aegis' manufacturing capabilities in the U.S. and Australia. Aegis has begun to communicate with customers regarding this situation. We are also working to determine what impact the Fabrinet situation may have on Photop since Photop is a supplier to Fabrinet for many of the products they sub-contract manufacture for their customers. In the VLOC portion of our Near-infrared segment, first quarter bookings were up compared to last year's first quarter, but down compared to the just ended fourth quarter.

VLOC experienced strong bookings for industrial and medical debris shield products. These are consumable optics used to shield the laser during operation. The demand in the industrial laser manufacturing segment of the business was driven by orders from customers in Europe and China which address a variety of production applications from automotive welding to manufacture of consumer products. In the medical market, demand came from the aesthetic and refractive surgery portions of the business. The opthalmic segment of the medical market continues to be an exciting growth area as new laser-based cataract surgeries are becoming an available alternative to the aging population. Currently there are about 10 million cataract surgeries performed worldwide annually. Approximately four million of these are performed domestically.

The laser-based surgery is just beginning to penetrate this market. In VLOCs military market first quarter bookings increased by 60% compared to last year's first quarter. Driven by the timing of an order for UV filter assemblies which go into systems used to protect our military aircraft and troops from the threat of enemy missiles. During the quarter VLOC received an order for supporting the development of the next generation of the UV filter products. Although the UV filter bookings were strong compared to the same time period last year, we expect a reduced order rate for this product line for the balance of fiscal year 2012.

As government budget constraints and the uncertainty of funding levels are rationalized, our order pattern will be more volatile. We continue to work with key military customers on new components and sub assemblies for a variety of applications such as intelligence, surveillance, reconnaissance and target designation from unmanned aerial vehicles. Moving to the Military & Materials segment, for the first quarter, the segment bookings growth was strongest compared to a year ago up 30%, but off from the previous quarter by 15%. This sequential reduction in quarterly bookings is attributable to delayed orders from the defense industry at EEO and lower metal index prices at PRM. Revenue growth for the quarter improved from last year by 18% and sequentially by 10%.

The year-over-year growth was supported by both businesses while the sequential growth for the segment was driven by selenium and tellurium products at PRM. At EEO and Max Levy, we continue to see some weakness in orders as a result of a slow down in the defense market. Orders for the quarter were below expectations primarily due to delays in order placement by our customers. Very few orders have been lost to competitors. The major orders we are expecting are from programs which are not being considered for cost reductions. Most cases we have either a sole source position or are one of two qualified suppliers with a long history of good quality and delivery performance.

This past quarter our EEO subsidiary won a supplier excellence award from Raytheon Corporation for quality and delivery performance in the top 1% of all their suppliers. We continue to believe our bookings from the defense market will increase at a double-digit rate because our optical components are directly supporting intelligence, surveillance and reconnaissance, which is called the acronym ISR, applications which remain an important spending line in all defense budgets. We previously reported that EEO has expanded their product offering from optical components to optical assemblies, and have won orders to build prototype products for hand-held target designator and surveillance applications.

During this past quarter, EEO received its ISO13485 certification which is necessary to manufacture and sell medical device assemblies and was awarded a prototype order for an optical assembly used by a major medical equipment provider for an eye surgery application. We believe this is a nice, long-term growth opportunity for our EEO subsidiary.

At Max Levy Autograph we have rapidly expanded production operations to support increased demand on grids on optical windows which will improve yields and cycle time at EEO. The EEO-Max Levy business is the only large optical window supplier to the defense market. With this internal grid capability and we believe it is a strong competitive advantage. Demand for PRM products remain strong and the custom orders exceeded expectation primarily driven by the Chinese market. Additionally PRM provides selenium and tellurium products to our Marlow and II-IV infrared businesses which ultimately lowers the cost of producing our thermo electric coolers and our zinc-selenide optics. Revenues for the quarter were up from both the comparable quarter last year and sequentially.

The expected softness in the metals index price we reported last quarter became a reality during the first quarter. During the quarter the tellurium index price dropped 17% from $375 per kg to $310 per kg, and currently here late in October tellurium is at $300 per kilogram. The selenium index price was more volatile beginning the quarter at $57 per pound, dropping to $52 per pound in August and then rebounding to $56 per pound at the end of the quarter. Currently selenium is at $63 per pound. Going forward we expect selenium prices to strengthen. It is unclear what will happen with tellurium in the short-term given the state of the photo-voltaic market.

Over the long-term we expect the index price to increase. Three items negatively impacted earnings at PRM for this quarter. First the decline of the tellurium index price required an inventory write off. Second, the rise in raw material costs due to the current competitive environment affected our cost, and a provision for a bad debt related to the bankruptcy filing of a photo-voltaic customer affected us.

As mentioned on previous calls, the supply tightness in competition for selenium and tellurium raw materials is a significant challenge we continue to face. In the long-term we feel we have a solid strategy and will continue to develop long-term relationships with additional suppliers by offering opportunities to expand the selenium and tellurium availability from their production operations. In the second quarter, expect delays in the timing of raw material receipts to negatively impact our production volume and therefore earnings at PRM.

In the advanced products group, formerly named the compound semi-conductor group, our Wide Bandgap unit's bookings were down 91% from the previous quarter and 80% year-over-year due to the compounded effect of receiving two large orders for $5.8 million in the fourth quarter of fiscal year 2011 that were expected in this quarter, combined with a delay in a $1.2 million order received in the first quarter that was received in the first month of the second quarter of fiscal year 2012. Revenues for the first quarter of 2012 were $4.5 million, down 6% compared to the fourth quarter of fiscal year 2011 but up year-over-year. DOD program revenue was reduced sharply in this quarter as planned, however revenue from commercial shipments of substrates of both power and RF products were increased by 14% over the previous quarter.

Shipments of 100 millimeter diameter semi-insulating substrates for RF applications have continued to increase at a rate of 50% quarter-over-quarter. Primary market for these substrates remains defense dominated. However, customer demand for both product deliveries and qualification of devices for commercial applications has continued to increase over the previous four quarters.

In the RF device market, applications include 3G and 4G wireless base stations and high linearity line amplifiers for cable TV. We currently see some softening in the wireless infrastructure market as well as in the defense sector at least into the second quarter caused by the uncertainties in the economy, cutbacks in defense spending and inventory adjustments at some customers. We are forecasting flat shipments of 100 millimeter semi-insulating substrates during the second quarter.

Growth in the power device market continues to be driven by high voltage diodes for power-factor correction and industrial motor drives as well as inverters for solar energy and other green energy applications. We are now qualified at two major power device OEMs and are forecasting an increase in shipment volumes of 100 millimeter end-type substrates beginning in the third quarter of fiscal year 2012.

In anticipation of further increases in demand for our silicon-carbide products we continue to add infrastructure to accommodate additional crystal growth capacity. We recently completed crystal growth manufacturing -- a crystal growth manufacturing area which doubled our previous floor space and is now 60% occupied with new furnaces. We expect it to be fully occupied by the end of the calendar year completing a three-fold increase in crystal growth capacity. Construction of our new 10,000 square foot polishing and fabrication facility in Mississippi continues on schedule. They will accommodate a significant increase in process capacity and capability for wafer diameters up to 150 millimeters, and is planned to be operational by the fourth quarter of fiscal year 2012.

At Marlow, bookings for the first quarter were $20 million up 52% from the previous quarter and up 15% year-over-year. The bookings increase was driven primarily by gesture recognition and also medical and telecom. Telecom demand is up quarter-over-quarter, but still remains unpredictable. Revenues for the first quarter for Marlow were $21.2 million which represents a 35% increase over the fourth quarter and an 11% increase year-over-year. The revenue growth was driven by a combination of gesture recognition, telecom medical and automotive. Gesture recognition revenues were up significantly due to the major production ramp quarter in the consumer electronic cycle. Demand for the new automotive seat cooling program remains strong.

Our Vietnam high volume low cost factory produced over 4.5 million units during the first quarter and continues to strengthen our competitive position in the global market. We will continue to add to Vietnam's capability and capacity over the next three quarters. We continue to work a number of new product development programs in both our traditional and emerging markets. Gesture recognition will begin ramping down in the next quarter due to the post seasonal ramp and the normal consumer electronic cycle.

In conclusion, despite the current economic uncertainties II-VI is well-positioned to take advantage of long-term opportunities and to respond to changing global conditions. We have refined our strategies for the remainder of fiscal year 2012 based upon how we see economic activity and funding conditions at this juncture. We will make swift adjustment to our plans if indicators should turn up or down significantly in the future. Craig, that concludes my remarks. Thank you.

Thank you, Frank. Here are the items I would like to highlight before we open up the question and answer portion of the call. In today's press release you will note a few subtle, but important changes to our prior reports. Our compound semi-conductor group has been renamed advanced products group to help avoid confusion about the end market that these businesses serve. Also we have ceased to break out the bookings and revenues of Photop now that all the current and prior periods contain financial results from that acquired business. In addition we have streamlined the consolidated statement of earnings by eliminating a separate line item for contract, research and development revenues and the related expenses because of the lack of materiality of each of these income statement items.

During the quarter the remaining component of the Aegis evaluation process, a working capital calculation was determined. This finalized the total consideration paid for Aegis at $54.5 million in cash. As part of the Aegis transaction, II-IV acquired $8.3 million in cash. The net purchase price, net of cash acquired of just over $46 million is included in the investing activity section of the condensed consolidated statement of cash flow that was included in today's press release. As part of the transaction II-VI assumed $1.3 million of debt, and this was paid off immediately after the transaction closed. This is shown in the financing activity section of the cash flow statement. During the quarter ended September 30th, 2011 we made good progress in the evaluation work needed to account for the Aegis transaction. Our preliminary valuation work identified $14 million of identifiable and tangible assets and $21 million of goodwill.

This valuation work also included a write up of Aegis' inventory to fair market value that impacted gross margin negatively by about $200,000 during the quarter. As described in today's press release, consolidated bookings for the quarter ended September 30th, 2011 were $130.2 million while consolidated revenues for the quarter were $138.4 million. The beginning backlog for the recent acquisition of Aegis Lightwave was $3.1 million. This amount was not included in the quarterly bookings, but is included in the backlog calculations. Total company backlog at September 30th, 2011 was $171 million.

The components of the September 30th, 2011 backlog were Infrared Optics at $44 million, Near-Infrared Optics at $41 million, Military & Materials at $59 million and advanced products group at $27 million. Other income during the just completed quarter was $1.6 million. The main driver of this other income was the sale of some precious metals during the quarter which resulted in a gain. In addition to this one-time activity, the company recognized over $300,000 of equity earnings for its minority ownership investments which helped offset foreign currency losses of nearly an equal amount. During the quarter our cash position decreased by $38.7 million.

The cash used for the Aegis transaction, the $12.7 million spent for capital expenditures and the $1.3 million of the payoff of the debt assumed in the Aegis transaction were partially offset by $7 million drawn on our line of credit facility and over $14 million of cash generated from operations. The borrowings on our line of credit arrangement had an interest rate of 0.86% as of September 30th, 2011. Of our worldwide cash balance, only about one-third of this amount resides here in the U.S.

The effective income tax rate for the quarter was 23.9%. During the next two quarters we expect the income tax rate to be reduced from this amount due to a few specific tax activities in certain countries while we expect the June 2012 quarter to have an effective rate that is similar to the just completed quarter. Overall for fiscal year 2012, we expect an effective tax rate between 19% and 21% consistent with our prior forecast.

As mentioned in the press release and in Fran's' prepared remarks the cautious tone and behavior of our industrial and military customers have influenced our outlook for the remainder of the fiscal year. While we are not experiencing order cancellations, we have started to see, especially in the past few weeks, smaller orders for shorter periods of time from select customers as their visibility is impacted by U.S. and world events and factors. Our consolidated outlook is a combination of the forecasts of 10 businesses of different sizes which service a variety of end markets.

The downward adjustments we have made to our updated guidance have been influenced mostly by demand adjustments from our telecom businesses, Infrared Optics customers and UV filter needs as well as margin pressure. And as noted in the press release, information that was made available from Fabrinet regarding the flooding situation in Thailand was not contemplated in our updated outlook. 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 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 factor section of our form 10-K fiscal year-ended June 30th, 2011. Marianne, we are ready to begin the question-and-answer session.

Thank you. (Operator Instructions). We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Avinash Kant of D. A. Davidson and Company.

Good morning, Fran and Craig.

(Multiple speakers) Good morning.

A few questions. So if I understand typically in the first quarter you do have a little bit higher share based comp. So given the updated guidance for fiscal year 2012 can you give us the gross margins and operating expenses, how should we think of that?

Yes, Avinash to your point about the share base comp, you are right. The first quarter historically has been our highest quarter. As noted in the press release the share base comp for the quarter was about $4.6 million. For the full year we are now expecting that full year amount to be about $12 million. So roughly about $3 million or so each in the next three quarters is what you should expect on a share base comp. From the gross margin standpoint we have seen a pull back in our gross margins as noted in the overall details from the press release today. We showed a gross margin that was just slightly below 40%. We do expect that margin pressure to be with us. Fran mentioned specifically at Photop for instance we have products that are replacing, same revenue level but at a lower margin level as well. We are experiencing higher costs in certain of our other businesses including our Infrared Optics business. So we think that is the number that will be -- we will see some pressure on the gross margin and then vicariously the operating margin over the next few quarters or so.

And any idea in terms of directionality throughout the quarter? Like do you think the December quarter being stabilizing and then things improving from there? Or how do you think revenues will trend throughout the fiscal year?

I think we have put together -- our guidance for Q2 would say that we're going to show revenues that have a comparable amount, maybe down slightly amount from the quarter we just completed. Again in the guidance that we put out, we said the range was $133 million to $138 million. That would be again pretty comparable just down a little bit from what we just completed. And then to get to the full year guidance that we gave for the revenues, we would expect and we do expect some increases in both the March and June quarters from those levels.

And a quick question on China, what was China as an overall percentage of revenues in the quarter? And how was it doing sequentially and year-over-year?

I would say that the health overall of the China market I think continues to be strong. I know in the prepared remarks, one data point we tend to look to and from, would be from the Infrared Optics standpoint. And I think overall the health of that market has been fairly significant. If you look at our -- just as a point of reference, last year's revenues, roughly $128 million of our revenues from last fiscal year. So just a little bit less than 25% of our revenues were from China, have the origination in China. I think that number, Avinash, for this quarter was comparable roughly about a quarter of our total revenues finding their way into China.

I think I saw -- I heard a number like down 7% sequentially in China. That was only specific to one segment or overall?

That was IR Optics down 7% quarter-over-quarter. Year-over-year up 30%. So it was a slower quarter for order intake and for the IR group. But overall it still remains to be a very, very good market.

And in terms of directionality what do you get and feel from the last few months? How are you thinking about the Chinese market? is it slowing down, staying stable?

High power is growing well, stable to growth, low power is flat to slowing. They've been hot on building the low power -- whether it was low power CO2 or YAG, they have been on the low power build in China for the last three years, and it seems to be slowing there as other places we are seeing low power slowing.

But the high power and medium power is fine?

Good, very good.

Thanks so much, Fran.

You are welcome.

Your next question comes from the line of Jim Ricchiuti of Needham & Company.

Thank you, good morning. I was hoping to get a better understanding of the military business overall. It looks like -- and is it true it is somewhere around 25% of revenues? What I was hoping for is to just get some sense as you look at the business for the year as a whole, how do you see the military business? Flat, down slightly?

I think we'd have to tell you -- I tried to do that in our last quarter, but we have military business in all four of our segments. So infrared business made the comments there that slowing where we had the lower order intake by maybe 70% here in this quarter, for Infrared segment, military business may be 5% to 8% of it. That's where it is. I think it's slowing, but we had enough orders from the orders we took earlier on two or three difficult-to-make parts, that we're about the only who can make it here in the Infrared. And that order will run all year in terms of finishing the revenues flat. The second segment to talk about is the Near Infrared group down in VLOC. One of the main line products there is the UV filter business. And I made some comments that the UV rate -- we got the nice orders earlier here in the year, but the rest of the fiscal year orders will be slim if any. So again we will have to be producing what we have in UV finishing out the year.

Our Near Infrared group has products that we have been working to bring in, and we have a couple that are very good, and a couple we are working to get in. So our military business which is what we are moving toward in VLOC is tougher than where we would like it to be. And we might have to say -- I think we will hold it flat, but it is going to be a tough job because the UV business which is slowing. The third group and I made the comments on our strictly military business is out at EEO. That unit is doing well. I think we made the comment that we see double-digit growth in that business. The fourth and final group that is big into military would be the Marlow Industries having good success in military. Maybe a program that has been a heritage program that wrapped up with the others that are staying pretty constant. So from Marlow I would say flat on the military side. You put that whole picture together for all four of the units and weigh them and so on and I think we have a military that is flat. It is going to be tough for us to swim uphill. The only case where we can will be at EEO where we will be on key programs that we do not feel will be cost reduced in the budget work.

That is helpful. And Craig, I know it is a fast-moving situation at Fabrinet, but is there anyway you can perhaps size the exposure in the December quarter just so that we can have some way of thinking about the potential downside?

I think to help put in perspective and Fran's comments, the majority of our most recent acquisition, Aegis and a majority of their products have found their way through Fabrinet from a contract manufacturing perspective. As Fran mentioned, really the specific products including the optical channel monitors that are manufactured.. That is a big touch point for us into Fabrinet. We do have alternatives as far as manufacturing is available at Aegis' other locations. And obviously we have inventory that we will need to work through as well.

The other touch point that Fran mentioned too was that for Photop, we sell into Fabrinet but we also sell to them or they are a destination point let's say for some of our other customers who use Fabrinet for other contract manufacturing relationships. And as noted in Fabrinet's press release they have two facilities, Jim, so we are really -- the one facility that we are focused on is the facility where historically the Aegis manufacturing production has been done.

It is definitely a situation we have been paying attention to quite a bit. Unfortunately things went awry for Fabrinet over the weekend with the flooding of that one facility. We have obviously been in contact with them, and we are now as Fran mentioned in his comments in contact with Aegis' customers to prioritize things and plan out for the quarter. I would say we will try to keep an update on that situation and put out further information, but again with the relatively short nature of that situation relative to today's conference call, I think that is the additional clarification, or that is hopefully additional clarification I can give to you. I think again as we said, we are just not able to assess right now how that will impact us.

Again to your point in the December quarter, but even long-term in the Fabrinet press release they did believe that facility that has impacted the Chokchai facility, we will remain without production for the rest of December, and that is something we have to take into consideration is we are trying to figure out how we will service our customers with that challenge. And Fran, do you want to --

Yes, just to add a little bit there, Jim, just to give you an explanation, Aegis designs and prototypes and produces the optical channel monitor and in their engineering in the facilities in Boston. So they are set up to do a little prototyping, but then they set up offshore. So to set up in Boston to make some of these products, it is doable, but that will be different than what has been done there before. But that might be an option. Then you go down to our Australian facility where we design the couplers, the same situation exists. It can do the prototyping for couplers and design improvement and then it is sent to Fabrinet to be produced.

There may be prototyping capability there. So to return to the engineering centers to do more than prototyping, it is a doable thing, but it hasn't been thought out or conceived yet. That might be our option. The little option is to take the rest of the quarter -- That's 70 days. I don't know if we can survive how it is, if Fabrinet cannot produce at this time. We have to be working hard on this. And we will.

Then we go to the Photop situation where we make components to go into the assemblies that Fabrinet makes for other customers. We have the inventory consigned right there in the flooded area, so that product is sitting in the water and we will have to make more ahead of time. When they get started up again we can get it over there quickly. But we will have some impact, I think. I am not trying to exaggerate it or downplay it, just telling you about the lay of the land and that's how I think it is.

That's helpful, Fran. And last question and I will jump back in the queue and I don't know if it is possible to -- with the same exercise on the military business if you exclude Aegis from the equation this year, how do you see your telecom business? Flat, up slightly?

I think if you could exclude it, I think we will have to go to flat. If we say up slightly it will have to come in the fourth quarter. We will do better, and we said that in the second quarter over the first. Remember, telecom visibility is tough to have. Third and fourth quarter is a gamble on where things are. If the inventory stays out of the supply chain to the whole consumption side of telecom, then I think we will be having a little up. But if somebody starts building inventory and slows down on these deployments, we will have another slow down. And myself, I have to say I knew how to predict this cycle. We are trying to get our hands around it. But everybody has worked in this industry has tried for quite a while. And it is difficult.

Fair enough. Thank you.

And your next question comes from the line of Jason Rogers of Great Lakes Review.

Good morning.

Good morning.

Could you talk about that one-time charge as far as what the amount was in the quarter?

Jason, you are referring to the one from the bankruptcy, is that --

Correct.

Yes, it was a bankruptcy. The amount of it was $500,000 and it was for a solar customer who we had supplied selenium to, a customer who uses that in a -- for CIGS -- copper, indium, gallium, selenium -- and relatively new customer of our PRM business, but unfortunately based on their recent bankruptcy, they -- we had to make a provision for that. Fran, do you want to add anything to that?

I would only add because it is a bankrupt company, certainly some of the processes will be auctioned off. We are hoping to stay close to it and find out who picks it up because we would like to be a supplier to that CIGS vendor to the photo-voltaic industry.

Okay, and do you have an estimate for what CapEx and D&A will be for fiscal 2012?

I would say for CapEx, Jason, we finished the last fiscal year, fiscal year 2011, a little more than $40 million in CapEx. I would say that as we refined and looked at our CapEx spending plan, I think we will be similar this year around the $45 million to $50 million mark. Some of that investment Fran touched on a little bit in his prepared comments. Some of that investment is for that commercial business transition from VLOC to Photop and the build out that we need for that. We will be up a little bit. That's down a little bit from our prior projections for the year, Jason, but somewhere between the $45 and $50 million mark is what we're expecting. You turn to depreciation and amortization, again as a point of reference last year fiscal year 2011, the D&A for us was approximately $29 million. We think that will move up to probably closer to $35 million or so. The majority of that change really is related to the full year amortization of the intangibles that we acquired as part of the Aegis transaction.

Thank you.

Your next question comes from the line of Jiwon Lee of Sidoti & Company.

Good morning.

(Multiple Speakers) Good morning.

Wanted to go back and talk a little bit about the IR Optics, Fran. Overall across geography, the weaknesses you are seeing on the IR Optics front, is that mostly related to the low power or the weakness in the low power optics order mainly related to the Chinese situation?

I would say low power is across the globe just because of the whole via hole drilling business is stalled right now. So that affects most all. Some of the low power business that was for engraving and that business had more or less shifted into China for lower cost yet, and that right now is stalling off too. Low power down, high power good in the U.S. and Europe and Japan was off a little bit. China is very good. Mostly low power, but when you take across all the low power plus high power and the margin is a little bit challenged as we have this much higher cost selenium we have been buying over time that is now creeping out of our inventory and into our product. The pressure on margin is there across the globe obviously.

That's helpful, thanks. On the telecom side, if you exclude any potential impact from the situation in Thailand, I believe you are guiding the December quarter outlook sequentially up. First of all, is that correct? And if that is the case, on what ground you are expecting revenue to improve a little bit in the December quarter?

Maybe for clarification and we will let Fran give you a little more detail, Jiwon, on telecom. The quarter we just completed we had revenues $138.4 million. The guidance today on page three of the press release, we are saying the December quarter is $133 to $138. We could get up to a comparable amount. But the range would be down just slightly. Fran would you like to make additional comments on that telecom?

I think the telecom mix issue is the important thing. This trade out of one high margin product out for another, which we're in the middle of making that change. That has been affecting us. Go on down and make some more comments, Craig, on quarter-over-quarter relative EPS.

And again, Jiwon, the quarter we just completed and obviously we did $.29 cents and then that guidance for the quarter is for the December quarter. The quarter we just started is $.26 to $.30 cents. Overall a couple things we will see different, we will see a little bit less share-based compensation as we mentioned. We will avoid a couple of the one-time items that have happened within this quarter as well, and we are also projecting a slightly better tax rate, effective tax rate, a slightly lower effective tax rate for Q2. But again, when you add all of those up, they are pretty much barely able to or probably not quite able to counterbalance to Fran's point this little bit of mix shift we are seeing in the telecom customers replacing some revenue dollars with lower margin product and also some of the constraints that we are seeing from other businesses including our Infrared Optics business.

And then if you could talk about, and maybe you did, the Aegis revenue for the September quarter, and lastly how we could be thinking about the gesture recognition as a revenue stream moving forward?

I would say for Aegis we did not disclose that separately, Jiwon. We will not be doing that relative to the materiality of that business relative to the entire II-VI business. For gesture recognition, it is a point of reference the last fiscal year from Marlow. About 25% of their business was derived from the gesture recognition from consumer applications, primarily dominated by gesture recognition. I would say that we believe that number will -- that percentage from Marlow will be fairly consistent. As Fran mentioned, we are up in that product line this quarter over the same quarter last year. We do have a good outlook for that business. Again high volume manufacturing business is well suited for our Vietnam operations, but should be roughly the same comparable amount of Marlow sales in fiscal year 2012 as fiscal year 2011.

Thank you very much.

And your next question comes from the line of Mark Douglass of Longbow Research.

Good morning, gentlemen.

Good morning.

Sorry I missed a lot of the call, so hopefully I don't repeat what you have already said. Looking at IR Optics, so selenium and I assume copper, too, was the head wind in the quarter. When do you expect those to flow through the P&L and get back to maybe some lower cost running the P&L?

The problem with selenium, I reported, and maybe you missed it, but selenium has trended down and then trended back up in the quarter, so it is now up at $63 a pound. With that number coming into our inventory I think it is going to stay at this higher number for eight, 10 months. We carry about that much of the selenium or more as we really want to be protected against any problems here. So it is going to go on the selenium I really don't see it going down for the next 12 months is probably the best statement. Copper, we don't stock ourselves up with so much copper, so it will fluctuate more with copper prices, but right now still hanging up there because maybe we have two, three months of inventory that are at a high price, and it is the grade of copper we buy, there is only one or two producers. So we are paying a higher price for it, and it is staying up also. I can't comment on perfect information there because it is a little bit on the lot buy basis.

And then Craig, how much was the pre-tax related charges to Aegis and then after tax?

For -- one unique item we pointed out on the call, Mark, was we had about $200,000 of an item that only impacted -- will only impact the September quarter and that is writing up Aegis' inventory to fair market value and letting that flow through during the quarter, that was $200,000. Overall combined with the rest of the expenses, Aegis was just really at a slight loss for this quarter. Really a very slight loss. I would say that's probably impacted mostly by some of the things we have changed from the purchase accounting in this -- especially in this fair market value write up I just talked about as well.

And then finally currency, is that going to be a head wind for you in fiscal 2012 or are you going to be fairly neutral to earnings?

This quarter market was relatively neutral. We had some equity earnings from our minority investments from the two joint ventures we have in China. And the earnings we got from those two businesses pretty much offset the foreign currency loss we had for the quarter, the foreign currency loss which was roughly $300,000 or so. It was not a big impact to the current quarter -- the quarter we just completed the September quarter and as best we can we are not projecting in our forecast, we do not contemplate either a significant tail wind or head wind from currency. We think it will be relatively neutral like it was this quarter.

Thank you.

At this time there are no further questions. (Operator Instructions) And there are no responses.

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, 2011 is currently scheduled for Tuesday, January 24th, 2012, before the market opens. We will have a conference call to follow that same day at 9AM Eastern Time. Thank you for participating in today's conference call.

Thank you for participating in today's conference. You may now disconnect.