II-VI Inc (IIVI) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the II-VI Incorporated fiscal year 2012 third quarter earnings call. At this time, all participants are in a listen-only mode. Later, we will come to the question-and-answer session, and instructions will follow at that time. (Operator Instructions).

As a reminder, today's call is being recorded. I would now like to turn the conference over to your host, Mr. Craig Creaturo. Sir, you may begin.

Thank you, Shannon and good morning, everyone. I am Craig Creaturo, Chief Financial Officer and Treasurer of II-VI incorporated. Thank you for participating in the third quarter fiscal year 2012 II-VI Incorporated investor teleconference. As a reminder, this teleconference is being recorded on Tuesday, April 24, 2012.

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 remarks today will discuss operational results of each of our businesses. The order of today's remarks will follow the same as our segment reporting. So we'll begin with IR optics. During the third quarter, our Infrared Optics segment established a new quarterly record for bookings which, including HIGHYAG, were $59 million, up 13% compared to the third quarter of FY '11 and up 35% compared to the second quarter of FY '12.

Increases across all segments driven by higher laser utilization and increased activity in the low power CO2 laser market. At HIGHYAG, bookings for the third quarter were up 8% quarter-over-quarter and 47% compared to the third quarter of FY '11. We continue to see growth opportunities in all segments, including one micron welding being delivery components and one micron laser cutting. We're adding manpower and manufacturing capacity, focusing on reducing lead times and taking advantage of the strong market demand.

For the IR Optics business excluding HIGHYAG, in the U.S. orders from domestic OEMs increased 70% quarter-over-quarter. The significant increase was a result of a strong rebound in bookings from our low-power OEM customers, bookings from our high-power OEMs in the U.S. increased 8% quarter-over-quarter. The North American aftermarket, which I always report as a bellwether of laser utilization, experienced a 19% increase quarter-over-quarter.

The result is -- the increase is a result of strengthening U.S. manufacturing. US military orders more than doubled quarter-over-quarter and in the fourth quarter, should also be strong with orders expected from two key programs. Record European bookings for the third quarter were up 45% quarter-over-quarter and 19% compared to the third quarter of FY '11. The strong growth was largely driven by increased OEM bookings for diamond windows.

II-VI has invested significantly in the development of this new technology and is seeing strong demand for this new product. European aftermarket remains healthy with bookings up 9% quarter-over-quarter and 32% compared to the third quarter of FY '11. Asian bookings were up 25% quarter-over-quarter with all areas in Asia contributing to the rebound from a weak second quarter.

In Japan, March was the strongest booking month of the quarter, driven by a large blanket order from an OEM service group. The high-power market remains steady while the low-power business continued to experience softness, especially at semiconductor suppliers. China bookings grew 60% quarter-over-quarter but were down 8% compared to the third quarter of FY '11.

We have seen moderate improvement in the third quarter in the low-power market related to marking and engraving. The economy continues to grow at a slower pace than what was forecasted in the fiscal year. Similar to Japan, the via hole drilling business remains down compared to FY '11.

Bookings in the other Asian countries of Korea and Taiwan were up 83% quarter-over-quarter and 25% compared to the third quarter of FY '11. The majority of this is related to orders for scan lenses for via hole drilling business that is starting to develop in these countries. In summary, our IR Optics business segment is well positioned to meet our customer's needs as these markets and product lines strengthen,

U.S. markets are stable, Asia is expected to grow, and in Europe, the new diamond window product line should be strong as initial EUV photo lithography systems hit the market. Based on a positive book-to-bill ratio of 1.17 in the third quarter, we're optimistic that we will see continued strong business in FY '13 in the IR segment. During the third quarter, our Near-Infrared Optics segment compared to the same quarter last year were down 2% to $46.1 million and segment revenues were down 6% to $39.7 million.

The bookings decrease is mainly attributable to the timing of large orders for UV filter assemblies. The revenue decrease was due to overall softening of the VLOC military shipments. Compared to the second quarter of FY '12, third quarter bookings up were up sequentially by 32%, driven by telecom-related orders, green diode laser orders, and commercial optics. Revenues were up 1% sequentially over the second quarter, near IR backlog is $43 million at the end of the third quarter.

At Photop, the third quarter renews were up 11% from second quarter, the second consecutive quarter with double-digit growth. The main increase came from Telecom and % from the Fiber-To-The-Home products, commercial optics, and green diode laser business. During the third quarter, the Telecom business continued to experience growth on key components for 40G and 100G optical networks and enterprise networks.

The Fiber-To-The-Home deployment in China remains strong. Photop further strengthened its leading position as the number one passive optical network filter supplier. In addition, Photop won a major contract from a key customer in the green diode laser business and started volume deliveries.

In the commercial optics area, after the completion of the transfer of this business from VLOC at the end of the second quarter, the sales interface with the customers in U.S., Europe, and Japan has been well-established under Photop and the business is running efficiently.

At AEGIS Lightwave, as we have previously reported, Fabrinet, our contract manufacturer, experienced flooding of their manufacturing facility at the Chakchai campus in Thailand. After completing our assessment of the options for quickly reestablishing high quality, cost-effective manufacturing capabilities, AEGIS is partnering with Photop to manufacture the majority of its products while also working with Fabrient to manufacture a few key components.

Our team has established high-volume manufacturing capabilities at both sites along with low-volume manufacturing in the U.S. and Australia. Numerous AEGIS customers have fully audited and qualified these manufacturing lines during the just-completed quarter and in the upcoming quarter, we project that AEGIS will have fully reestablished its entire core manufacturing capabilities.

AEGIS has seen growth in order trends within its core optical communications markets and expects demand for its Telecom products to increase during the current quarter, driven by demand for new and upgraded ROADM systems and other advanced optical transmission systems.

AEGIS continues to invest in research and development activities beyond the pipeline of new products, including high-performance optical channel monitors for the ROADM market, 100GPS and NOW 400GPS applications. Through its AOFR subsidiary, the Company is also developing a family of high-power fiber laser combiners for use in high-power fiber laser applications. Notably, one of AOFR's customers recently qualified our fiber laser combiners for theory kilowatt and higher applications.

Furthermore, we expect to be successful in gaining design wins from our line of fiber laser combiner products and that we believe will be synergistic with a broader fiber optics portfolio. Overall, based on our customer interactions, we believe most of them have worked through their excess inventory that accumulated by the middle of calendar year 2011.

Within the Near-Infrared optics segment, there are a number of technology and market synergies between AEGIS and Photop that have been identified and are in the initial phases of development. These synergies are a key focus of the long-range actions to grow these businesses. At VLOC, we have successfully completed the transition of the commercial business to Photop. Effective January 1, VLOC has concentrated its resources on serving the markets dedicated to defense, security and aerospace.

This redefined direction should allow VLOC to grow in this very challenging market by focusing on the manufacturing products and customer relationships necessary to gain and expand into new applications with a unique and singular focus on the military market.

At VLOC, third quarter bookings decreased by 72% over last year's military-related third quarter bookings and 66% over the prior quarter of FY '12. This decrease is primarily driven by the timing of large orders for UV filter assemblies. Fiscal year '12 military bookings are running behind last year through 3/4 by about 7%.

During the quarter, VLOC received several key development orders consisting of a complex optical prism assembly for a system that allows ground troops to detect laser light and VLOC-grown crystal material that is built into numerous military laser platforms and a new configuration of a neodymium YAG slab for a handheld pointer and tracker device. VLOC also received a legacy production order for optical components and laser crystals used in a laser-based countermeasure system for military aircraft.

These wins are the results of adding capabilities at VLOC to grow and manufacture more complex products needed to satisfy the next generation military program requirements and improve our legacy productsand are the kind of program wins that are necessary for VLOC to grow in the current military procurement budget environment. For the third quarter, our military and materials based segment bookings were up 21%, compared to a year ago. Driven primarily by selenium product demand and orders from defense contractors. Sequentially bookings improved 9% as a result of strong demand for selenium products.

Renew growth for the quarter was 20% compared to last year and 15% sequentially. At Exotic Electro-Optics, we continued to see some weakness in orders as a result of a slowdown in the defense market; although, orders for both the quarter and year-to-date exceed last year by 18% and 9% respectively. Orders for the quarter were below expectations primarily due to delays in order placement by our customers.

Few orders have been lost to competitors and most of the delayed orders are expected to be awarded to EEO in the next three to four months. As previously reported, the accumulated quarter weakness was slightly -- has slightly reduced our fiscal year '12 revenue projections, and we expect our year-over-year revenue growth at EEO to be 5% as compared to our original plan of 10%. Productivity improvements alone with cost-cutting efforts are expected to improve earnings by 20% as compared to last fiscal year.

EEO released four new products and capabilities at a recent trade show and has begun to see associated orders. Our efforts to grow the optical assembly business has seen steady progress. This past quarter, we were awarded prototype orders for two different scanner systems and a telescope. At Max Levy, results were in line with expectations and interest in our products has improved, which is reflected in the volume of customer inquiries and product quotations.

MLA was recently qualified on a major targeting pod program is ramping to production volumes. EMI grid production is up 58% from the first half of this fiscal year and will double by October 2012. Additional capital equipment has been ordered and facility improvements have been initiated to support the production plan. Shipments of durable pattern coatings for missile radon applications are increasing with strong backlog through the calendar year.

MLA has developed a unique technology for creating temperature-resistant pattern coatings on complex surfaces for high-speed missile applications and high-temperature applications in general. This technology is generating new opportunities by enabling next generation missile and aircraft programs to operate at higher speeds and in extreme temperature environments.

At PRM, bookings and revenues were strong and up nicely on a sequential year-over-year basis. The index price of selenium remained flat during the quarter at $60 per pound. Overall demand for selenium has remained resilient, and selenium raw materials continue to be scarce. This combination of stable demand and supplied nightness for selenium has kept the index price relatively unchanged in the third quarter.

Last quarter, we announced entry into a new business to produce a rare Earth metal for a non-photovoltaic green energy application. Our production line is now installed and will soon be in start-up operation. We plan to begin shipping product this quarter and expect this product line to generate an additional annual revenue stream of $8 to $10 million. This business is covered under a two-year contract and received our first order during the March quarter.

The tellurium index price continued to erode, decreasing 27% from $220 per kilogram to $160 per kilogram during the quarter. Right down in the third quarter of our tellurium inventory has negatively affected PRM's earnings for the quarter by $3.6 million. During this fiscal year, the tellurium index price has declined from $400 per kilogram to $160 per kilogram at the end of March. Approximately 20% of this decline, or $45 per kilogram, has taken place in the past 60 days and is primarily driven by the turmoil in the photovoltaic market related to increased competition, excess production capacity, and severe price pressure.

We believe there has been a build-up of tellurium inventory in the photovoltaic supply chain, which will take time to be consumed at current demand levels. Our photovoltaic business outlook has been adjusted to account for this swelling demand. We will appropriately adjust our tellurium raw material procurement activity to properly size our supply chain to the long-term product demand.

Additionally, cost-saving programs have been implemented over the past six months to adjust to the current tellurium market conditions. In the Advanced Products Group, our Wide Bandgap units product bookings in the third quarter were down 66% quarter-over-quarter and 72% year-over-year. The large differences in bookings from Q2 to Q3 are the result of a delay in the booking of two large blanket orders expected to be received in the fourth quarter.

Revenues for the second quarter were down 7% compared to the previous quarter and down 4% year-over-year. Of this year-over-year decrease, DOD program revenue was down 41% while product revenue from commercial shipments of substrates are both power on the RF products are up 17%. As expected, shipments of 100-millimeter diameter semi-insulating substrates for our RF applications were down 30% quarter-over-quarter but up over 50% year-over-year as customer demand for both product deliveries and qualification of devices on our substrates for commercial and defense applications slowed for the first time in two years.

We recently predicted a slowdown in consumption for the third quarter and into the fourth for both the wireless infrastructure market and the defense sector caused by uncertainties in the economy, cutbacks in defense spending, and inventory adjustments at certain of our customers. We continue to forecast a reduction in shipments of 100-millimeter semi-insulating substrates through the fourth quarter of this fiscal year. 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 renewable energy applications.

According to a new report by Lux Research, gallium nitrite and silicon carbide power electronics are set to take a 22% share of a $3.2 billion market currently dominated by silicon over the next several years. Although increased shipments to power customers have been pushed back in recent months, we continue to forecast significant growth in the coming fiscal year. As expected, shipments to one major power device OEM were delayed until Q4 but have now started.

Shipments to a second large OEM are forecasted to be delayed until the first quarter of FY '13 due to inventory build-up at their site. We're forecasting continued recovery and shipment volumes for both 100-millimeter N-type substrates and 100-millimeter semi-insulating substrates beginning in fiscal '13. In preparation for this, we have continued to add infrastructure to accommodate additional crystal growth and fabrication capacity.

We plan to move into our new 10,000 square foot facility in Starkville, Mississippi in the later half of Q4. This facility will support the expansion of capacity, wafer finishing, cleaning and packaging. The third quarter was a challenging quarter for Marlow industries. Bookings were up 14% from the previous quarter driven by demand increases in the medical, automotive and defense markets but down 30% year-over-year due specifically to a major reduction in gesture recognition and item demand and continued softness in the telecom market.

We're expecting higher bookings in defense market, which did not materialize due to delays in government funding releases to some of our major defense customers. We're expecting these orders to be released in Q4 of FY '12. Revenues for the third quarter of FY '12 were down 16% from the previous quarter and 17% year-over-year. The lower revenues were again driven by reductions in gesture recognition demand, continued push outs in the telecom market, delays in the defense bookings, and delays in the roll out of our new industrial air-to-air system.

As we go forward, our level of customer-driven new products and development is at an all-time high. During the quarter, we made initial shipments of 15,000 units of a new power generation application that powers a fan to increase the efficiency of portable-cook stoves. We just launched our new Climatherm air-to-air high performance systems and expect good market acceptance of this product offering beginning later this quarter and significant industrial market growth in the coming year. Lastly, to mitigate near-term revenue softness, we have taken cost-cutting measures to better position ourselves for increased future growth and efficiency in an increasingly competitive market.

In summary, our bookings are gaining momentum, and we have made significant progress in restoring AEGIS's manufacturing capacity to pre-flood levels. However, we continue to be exposed to falling tellurium prices and shifting military order demand patterns. Both our infrared optics business segment and our near-infrared optics segment had strong bookings in the third quarter, and we will capitalize on this momentum in the fourth quarter and take actions on the challenges that lie ahead. Our business fundamentals are strong and are positioned for growth. Craig that, concludes my remarks.

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. As described in today's press release, consolidated bookings for the quarter ended March 31, 2012, were a record $145.8 million, which was 2% above the same quarter last year, the prior high point for bookings.

Total company backlog at March 31, 2012, was $174 million, which was up 8% or $13 million from the December 31, 2011 backlog. The components of the backlog at March 31, 2012 were; Infrared Optics at $49.5 million, Near-Infrared Optics at $43 million, Military and Materials at $63.5 million, and Advanced Products Group at $18 million. A declining index price for tellurium drove the need to make a lower cost in the market inventory adjustment for our PRM business, part of the Military and Materials segment, in the March quarter of $3.6 million after tax. During the March quarter, we saw declining market prices for the minor metal tellurium.

The market price was $220 per kilogram on January 1, 2012, and during the quarter, this price decreased 27% to $160 per kilogram. This significant price reduction created a write-down that impacted our earnings per share by $0.06 during the quarter. This write-down was a component of cost of goods sold and directly impacted overall II-VI gross margins for the quarter by 285 basis points and the segment margin of the Military and Materials segment by 1400 basis points. If tellurium prices recede from current prices, further inventory adjustments would be required.

Fran covered the details of our manufacturing actions to recover from the flooding that occurred at the facilities of AEGIS's contract manufacturer in Thailand in October of 2011. During the quarter, we received $250,000 of proceeds from business interruption insurance that was available to AEGIS and this was a component of other income for the quarter. Our guidance for the quarter ending June 30, 2012, does not anticipate any significant insurance proceeds will be received in this quarter but instead will be received in fiscal 2013.

We continue to work diligently to fully utilize recoveries that are contractually due to AEGIS and AOFR, the Australian subsidiary of AEGIS. During the quarter, there were a few items that impacted other expense-income net in a positive manner. The largest item was the recognition of a gain of $1 million on the sale of our 40% minority investment in China-based [Hapo].

Additional components of other income were; interest income of $0.3 million, deferred compensation gains from increases in the investment and that plan excluding II-VI stock of $0.3 million, equity earnings from an investment in China-based [Hushen] of $0.3 million, and the previously-mentioned insurance proceeds of $250,000. The effective income tax rate for the quarter was 25.8%, which increased a year-to-date rate to 21.9%. The higher tax rate for the quarter was driven by higher percentages of U.S. earnings and lower percentages of International earnings.

For example, the tellurium write-down PRM drove that business to a loss during the quarter, which is in a country that we pay approximately an [8% ]effective tax rate. During the quarter, we did have some reductions in our tax reserves due to the expiration of statutes of limitations and this reduced income tax expense for the quarter by $800,000.

We expect the income tax rate to range between 26% and 29% for the fourth quarter of fiscal year 2012, which will pull the full-year effective rate up to between 23% and 24%. During the quarter, we generated nearly $15 million in cash from operations. We use that cash plus cash on hand to pay down our debt by $7 million, make the final earn out payment for the Photop transaction of $6 million, and spend $9.7 million for capital expenditures.

The borrowings under our line of credit facility totaled $10 million as of March 31, 2012, at an interest rate of 0.88%. The current plan to provide our initial guidance for fiscal year 2013 is to do so with a separate announcement near the middle of June, similar to the process we adopted last year. This announcement will be made after the completion of our fiscal year 2013 budgeting process and will provide initial targets for earnings and revenue and earnings per share for the full year.

Based on feedback we received last year, we believe this timing is an appropriate middle ground to initiate our guidance for the upcoming fiscal year because such an announcement today would precede the completion of our board-approved budgeting process and an announcement as part of our August Press Release and conference call would be more than one month into fiscal year 2013. Fran, this concludes my prepared remarks.

Before we begin the question-and-answer session, I would like to mention 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, 2011. Shannon, we are ready to begin the question-and-answer session.

(Operator Instructions). Our first question comes from Jim Ricchiuti from Needham and Company. You may begin.

Thank you, good morning. If we look at the guidance that you're providing for the June quarter, which is clearly lower than what you were thinking initially, three months or so ago, is most of that revision related to exotic? Is it -- it sounds like it is also the PV market being weaker. I'm just wondering what the factors might be in terms of the June quarter outlook. Thank you.

Jim, I'll start, and I'll let Fran maybe add to that. I think if you look at the fourth quarter now versus where it was back say 90 days ago, I think we have factored in the changes at PRM, specifically with the lower tellurium pricing and how that is impacting the overall demand for that market. I think we're also seeing a reduction of where we thought Marlow would be. I would say, as Fran mentioned, Q3 was kind of a tough quarter for them, and we think the challenges will be you know, still persistent in the fourth quarter. And I think those are probably at least two of the areas I would mention and I'll let Fran in on the discussion. Those are two of the areas where we make changes from our prior guidance.

I think you're right on. Those are the ones on the downside. I think we have EEO and California kind of flat quarter-over-quarter and VLOC on our military work there, coast to flat with the upticks at IR and our near IR group at really the Photop group. Slight recovery happening with AEGIS. So, a nice mix of things. Unfortunately, there are the two downers that Craig mentioned, the pricing on tellurium at PRM and our decreased volume at Marlow.

Jim, to round out the discussion, we are still seeing, and I think even seeing now stronger signs of growth in our two largest businesses, our Infrared Optics business and our Photop business so I would say that it has not been all negative changes. We've had some positive changes as well, especially from two of our largest businesses, too.

Right. So you guys actually touched on my next question in terms of the areas that are a little stronger. So, if we look at the IR business, I think previously you had been talking about the second half of the fiscal year being up 6% to 7% over the first half. Has that changed meaningfully in terms of the strength you're seeing now in orders?

I would say it is that number. We're within our ability to predict. I would hope it would be better than 7 but it is really, really doing well right now.

Then on the military side, it looks like all in military perhaps flat to down? In terms of fiscal to full fiscal year.

Yes. That's a good way to put it.

Okay, thanks very much.

Mm-hmm.

Thank you. Our next question comes from Avinash Kant with D.A. Davidson and Company. You may begin.

Good morning, Fran and Craig. One or two questions. The first one was that when you issued the guidance for fiscal Q3, had you anticipated the tellurium write-downs you ended up taking in the quarter?

Good morning, Avinash.

One or two questions. The first one is that when you issued the guidance for fiscal Q3 had you anticipated the tellurium write downs that you ended up taking in the quarter?

No, Avinash. By the time we had come out with that guidance in the middle part of January, third week of January, we had seen just a slight change in the tellurium pricing from $220 at the beginning of the quarter to basically about $210 or so by that time. In Fran's comments, he noted that really the bulk of the change we saw during the quarter, $45 of that change of the $60, really happened in the last 60 days. And so we did not anticipate -- we anticipated a little bit of a change because of the tellurium pricing. But by the time we had announced, pricing had not fallen down to the $160 per kilogram level where we ended the quarter.

So, basically, if I do the math from where the prices were at that time, you could not have anticipated more than a penny-worth of impact while you ended up taking almost $0.06 in the quarter. Am I right in that understanding?

You're right on there, Avinash. We took into consideration based on the data we had at the time we made that announcement but like we just said, a lot of those pricing changes happened after that announcement.

Okay. And now going forward, the reduction in the full year fiscal year 2012 guidance, is it also primarily because -- do you expect more tellurium price declines or charges as a result or you're not modeling anything from here on?

I think we're in a somewhat similar situation, Avinash, to what the situation we were in back for the January quarter. We have seen a little bit of further price decrease, maybe $5 to $10 per kilogram since the end of the quarter. We factored that into the guidance. We have not factored anything else into the guidance for the fourth quarter.

Okay. So the decline in guidance is primarily because of the factors you talked about like Marlow and VLOC and all those?

That is correct. Marlow, PRM, I think more specifically. Those are the two that have changed the most since the last forecast.

Okay. In the last quarter's comments, you had talked about JSF and specifically, you had talked about visibility in the JSF program being two years out or so. Are you still sticking to that statement?

I think our visibility on JSF is diminishing. I think the two-year ideas may be shrinking to a year, year and a half. The current run rate. After that, we just don't know the whole JSF thing, as you know, is tied in this federal budget issue. So our customers are obviously not knowing what to tell us. So, I think our two years is getting shorter to visibility to a year, year and a half.

I think you had said up until 2013 or so. Is that still valid?

I wouldn't want you to leave the thoughts right now to us running at our current rate much past FY '14 maybe into the first half of FY '14.

Okay, so until the fist half of FY '14, you see this cut in run rate, right?

Yep.

Okay. The book-to-bill, of course, very strong in the quarter. And looks like you must be expecting good bookings. What are the trends there, especially -- I know you talked about China and Europe. Would you give us an idea, not specifically to just IR Optics, but overall bookings, how was the trend from China and Europe on a sequential and year-over-year basis?

I think very good. Certainly when we have China to the rest of the world with our Photop group doing so well here quarter-to-date and last quarter, coupled with IR, very good. Our worldwide challenge, and it is not a big part of the total, with our Marlow group and it is a little bit seasonal for our Marlow group, too. We've had traditionally stronger bookings first quarter with the toy season coming on. And right now, we're in the fourth quarter which is not necessarily helped by that. So, I would say worldwide, the bookings are good. Europe -- every group that sells into Europe is doing well including Photop and including IR. Asia, I made those comments. So overall, I think the comments I made would pretty well cover that question.

Perfect. Perfect. Thank you so much, Fran.

You're welcome.

Thank you. Our next question comes from Mark Douglas with Longbow Research. You may begin.

Hi, good morning, everybody.

Morning.

Good morning.

Can you quantify the impact in timing of your cost-cutting measures? Doesn't seem to be going on right now but what kind of savings do you think you would have or is this just to offset some of weakness and is that more a 4Q event or is it going to be a fiscal '13 event?

Let me make a first comment and then Craig may add to it. Because we have a very diverse operation with four reporting segments and 11 businesses, the comments we make at one unit on cost cutting might be just the opposite of what we're doing in another. So, obviously you can see us headed up in cost for IR and Photop. And we're making some cost reductions at Marlow and VLOC. So, it is really not possible -- it is possible to make the comment, but I wouldn't want to make it now because I haven't prepared that analysis.

Okay.

Craig, you have anything else to add?

Yeah I would just say, Mark, that Fran is right on. The one specifically that we talked about was really embedded in the PRM comments that is being careful about -- and kind of doing some cost reductions within the PRM business and cost savings programs. Part of that is not necessarily personnel-related. Part of that is procurement strategy and other areas that we've decided to take a different stance on than we've had in the past. To quantify it by business units to Fran's point, they could be probably a little bit more detailed than we were prepared to talk about today, but I think it's really Marlow and PRM I think are probably a couple of the larger areas where we're definitely being very careful on the cost and/or making some cost reductions.

Okay. And then you know, Defense continues to have some issues and seems to be a common theme the last couple quarters of the delays. Do you think you're being sufficiently conservative here in the opportunities even with new products and programs versus the challenges that continue order delays from the customers?

I think we have been. I think we're prepared to be surprised either way. Some of these orders we're thinking are going to Q1 might come in Q4 but other ones we were expecting in Q4 slip again. I feel like we've tried to measure that and balance it. We think we've judged it as best we could. There could be a surprise either way that the bigger deal for us is the prime contractors. Some of them are getting their money and some aren't. So, we don't know which ones will be able to move on orders and which ones will not. We have four or five important ones and each one acts on their own based upon when they get their money. I think it is a good estimate. I would say good.

Okay. And then you know, just looking at the orders were up nicely again. Are some of those blanket orders that might ship into '13? It seems given the order strength, especially in your two biggest segments, which really seem to drive a lot of the business, it is a little surprising the 4Q guide isn't a little higher. Is that the right way to think about it? Might be some blanket orders in there?

I think, Mark, by definition, we don't book anything that won't ship out within 12 months of when we receive the order. Infrared Optics, we are seeing a little bit stronger pattern of blanket orders and a little bit longer orders. Both of which are great signs for that business; so that's a very positive thing. But to your point, some of the $59 million in bookings that we took in in the quarter for Infrared Optics, some of that will end up shipping out in FY '13. By contract for Near-IR, a lot of that is much quicker turn business. So the Photop business and also AEGIS in there as well, I think you're seeing faster turns, I would say that the bulk of that increase you're seeing should turn into higher revenues in Q4. Definitely some will go into FY '13, but by in large, the length of the backlog for Infrared is longer than it is for near Infrared. Some of the Near-Infrared, you'll see those bookings translate into revenues a little bit sooner.

Thank you.

To add to that, Mark, in the Infrared segment, this diamond window business that we've booked here in the third quarter is going to play out over the coming year, and it's the first of what we think will be big shipments for that product line as we go forward. So those bookings have not been in our order intake in the past. We've been working at this for five, six years. Now that the photo lithography business looks like it is ready to be debuted, we think it will be a nice addition for our products for that unit.

This is EUV, correct?

Yes.

Great. Thank you.

Thank you. Our next question comes from Dave Kang with B. Riley. You may begin.

Good morning. First, Craig, question on your tax rate. I believe you said 26% to 29% for Q4. Should we be using that for next fiscal year as well? Or what's your guidance on that?

That's a good question, Dave. 26% to 29% in the fourth quarter. We're saying the full-year rate will be 23% to 24%. We'll probably try to give some more details on that, FY '13, as we get closer to that. But it really is dependent upon the mix of earnings. We're very fortunate to have some low tax jurisdictions that we do a lot of business in.

I would say next year looking out, I think it is probably, Dave, going to be closer to that 23% to 24% for next year. Not probably quite as high as the 26% to 29% that we're going to experience in Q4. So, I think we're experiencing -- expecting some good growth especially from a location like Photop where their effective tax rate is about 15%. That should help out keeping our overall tax rates right around the mid-20s or so.

Okay. And Fran, next question is on your green leisure diodes, can you go over what kind of applications are we talking about and the number of customers that's involved?

I really -- I don't have the exact details of that but I think there are two customers that I think I've heard about and I cannot tell you the applications only because I really don't know. I can find out and tell you, Dave. Okay, Dave

Okay, that's fine. We got into the Telecom side. It seems like Photop is doing well whereas Marlow is not. Can you just go over the discrepancy between Photop and Marlow. Obviously they're addressing the different segments within the Telecom industry.

Yeah, in the Photop business, which is the passive component, high percent of their business is into the China deployment for such systems, and they're well-positioned so that's why their business growth, I think, is strongest.

Okay.

Marlow, they're across the world on thermal electric coolers, on certain active devices. When those are not being deployed, it appears there's some slow there. Our business at Marlow is not as good. And it is very -- you know, when we talk about up and down on Marlow, it might be 10% to 15% up or 10% to 15% down so it is not a big swing. It is a nice, steady business for us but it is not flat. Down 15% maybe a quarter-over-quarter when we make a comment that business is off there.

So, sounds like just overall Telecom, sounds like China is doing well and the rest of the world is not. Is that a fair -- or is that too general of a statement?

I think it might be too general. I'm not able to give you that answer. I can tell you China is very, very good for us right now.

Mm-hmm. And then let's see. Sounds like AEGIS, as far as production is concerned, you're running from two sites, Photop and Fabrinet. Is that over a long-term plan? Or what is your long-term strategy?

I think right now, that's how we have to leave it. We're running both places because we want to get caught up. If we end up getting caught up quicker than what our orders require, we're going to have to phase back. Our plan would be to run at Photop and phase back at Fabrinet.

How will that impact your AEGIS margins in the near term as you run from two separate sites?

It will hurt a little. That's for sure. That has been a little bit of our guidance knowing that our AEGIS group is still and they will be recovering into next quarter and maybe early first quarter from the flood because of just what you said. It is a double cost and setting up at a new site, the subcontract manufacturer we had at Fabrinet was very efficient. They had done it for a number of years. So, our own production at Photop will take a little bit of time to get to the cost level.

For Q4, what kind of revenue should we be expecting from AEGIS? Can we expect pre-flood level type of revenues or any color as far as that's concerned for AEGIS.

Dave, I think they will be back. The first quarter that we had for AEGIS is September 2011 quarter, and we had previously reported that they were about $5 million. We do expect they will be back to those levels by the June 2012 quarter. So, as Fran mentioned, really our manufacturing capacity pretty much right there, demand is coming back as well, too. So, we'll be back revenue-wise to where we left off. Again, little bit of -- it has been a challenge here for the last six months but now starting to get back to growing the business about a year ago.

It sounds like you didn't lose any market share because -- during -- because of the floods.

I don't think we can say that, Dave. I think we're just sorting it out.

Got it.

It will take us a little bit more -- a few more quarters to give a good answer on that.

The last question is regarding your IR sector, sounds like it is -- the strength is more on the low power rather than high power. Is that correct?

No, no, no. It is motor on the high-power. I only made the comments about low-power coming back.

Oh, I see, I see.

Remember in the second quarter, it was pretty weak. In the third quarter, we got some more business there. Low-power for engraving, marking, sometimes the via hole drilling. But it is really solid and steady. On laser utilization with high-power lasers.

Got it. Thank you.

You're welcome.

Thank you. (Operator Instructions). Our next question comes from just Jiwon Lee with Sidoti & Company. You may begin.

Thank you and good morning.

Good morning.

Good morning.

Just wanted to ask Fran this question again. Within Military and Materials, the revenue split. If you think about between Military versus Material, how is that fully changing year-over-year?

It is really hard for me to give you an answer there because we usually don't break Military from Materials. And when the Materials segment se prices like it did in FY '11, it is a good share. But now what we're going to see here average over FY '12 due to the tellurium pullback, I think our EEO business a little bigger. Go ahead, Craig, if you have details.

Yeah, just to add on that Fran's comments, Jiwon, which were all right on, I think this time last year, we had probably a pretty even split if you look at revenues between our EEO business, including Max Levy, and our PRM business. And this year, it is probably more like 60/40 split I would say. To Fran's point, a lot of that is really driven by the index pricing, more specifically the tellurium pricing. And I think going forward, we expect those groups to be kind of somewhat equivalent size-wise when you look over the longer term forecast. But right now, Fran's point, the climb in PRM pushed that down to roughly about 40% or so in that segment.

That's helpful. And the tellurium pricing trending further down, at least that's your expectations. How much would the price have to fall from the current level of $160 per kilo to allow another inventory write-down provisions perhaps down the road?

It is a process, Jiwon, that we go through each month. Again, we have reference to obviously the market pricing and again, the components of that lower cost for market calculation, relatively detailed as far as what we go through to determine is there a write-down or not. I would just say, suffice it to say, that if we continue to experience a decline in tellurium pricing, that one would expect that we would have some type of write-off or write-down for our tellurium inventory that we carry.

I can't really give you a rule of thumb. I can't give you kind of a -- if pricing goes down X, our write-down would be Y. It is a little more dynamic than that because we're constantly having material come in. We're shipping material out. We're using new material versus reprocessed or residual material. So, it is a relatively complex calculation that we go through. But I think again, directionally, if the tellurium pricing continues to go down it probably is likely that we would need to do some type of write-down, and we would do so if needed.

And then on your fiscal '12 guidance, I wonder how much about revenue contribution are you blending for Photop and AEGIS together?

I would say Jiwon, it may be just -- because we're careful on kind of the specifics of that on a go-forward basis, I would say that if you looked at the bookings trend that we have seen in Near-Infrared Optics, especially this quarter, if you look at the revenue trend, we're seeing them trend up. We are expecting a higher level of revenues in Q4 for that group, for that segment than we had in Q3. So, I'm probably best to directionally tell you that we are expecting both AEGIS and Photop to be up revenue-wise in Q4 versus Q3.

And some of the new products they're introducing on Photop and AEGIS, I believe they're largely proprietary? Right?

Yes, for sure. But did I give a hint to those certainly in the 40G, 100G and in the optical channel monitoring business, which is a business that AEGIS has really been working hard in. So, that would be the neighborhoods.

Okay. And then Fran, on the higher optics, the high-power relative strength, did you break down how the OEM versus the after-market were trending across Europe, North America, and Asia?

No, I didn't make a comment there. But it's about the same trend as what we had last quarter. Maybe 5,000 high-power lasers coming down the assembly line on and annual rate right now. Just about like last quarter and in the neighborhood of 60,000 to 65,000 installed high-power lasers around the world doing work where we sell the parts into the after-market.

So, I would say the mix is going to be about the same. I think the platforms are the same and it is in a nice trend right now. The world seems to be reasonably productive and laser utilization is good to very good. We sample it to try to keep ourselves tuned up to how much after-market business there are. I would say it's maybe up a few percent, laser utilization, I mean.

Okay, that's helpful. Let me see. There was one more question that I wanted to ask you. Oh, how do you view your balance sheet now and sort of acquisition strategies?

I think we're pleased where it's at, Jiwon. We're continuing to pay down the little bit of debt we took on from the AEGIS transaction. We've only got about $10 million worth of debt. Very low cost, under 1% borrowing cost. We've got quite a bit of capacity. Continuing to generate cash. Definitely continue to be active in the M&A opportunities.

Obviously don't have anything that we're ready to announce or talk about but I think we've seen it I think an active environment probably would be the best way to say it with some good opportunities that might be of interest to us. We're fairly selective and picky when it comes to those types of transactions. We are -- we've got -- I would say good activity level, good level of activity on M&A, and we think we have the balance sheet to support execution on a good idea when we see it.

One last question if I may, please. I don't know if I heard your comments on the one HIGHYAG business, the one micron business.

I made comments about that. It certainly has been a good business this year, and we have the year-over-year bookings up there for the third quarter about 47%. So we're seeing growth and our growth mostly, I tried to list them in priority as; first and one micron welding, second in beam delivery systems, and then third would be in one micron laser cutting. So those are the areas in the categories in which we see our product being demanded.

Your year-over-year revenue growth will be sort of -- kind of similar to the order growth you saw in the high XI, correct?

Oh, I think so. Yes.

Okay. Terrific. Thanks so much.

You're welcome.

Thank you. Our next question comes from Jason Rogers with Great Lakes review. You may begin.

Just one question. Most have been answered. Looking at Cap Ex and DNA, I was wondering where you expect that to end up for the year and if you have any early thoughts for fiscal 2013. Thanks.

Jason, I think we had a pattern over the last four quarters, we've been spending right between $10 and $12 million in Cap Ex per quarter. I think that's probably the right range to think about for Q4. I would say in certain areas, we've seen a little bit of pickup in that. As Fran was mentioning about making sure that we're properly equipped, especially for Photop and for IR Optics, I think we've seen a little more capital spending activity in those businesses recently. That might push us to the high side of that guidance.

From a depreciation amortization standpoint, right now we're running just under $9 million per quarter. I think that's about where we'll be for Q4 as well. So don't anticipate any significant changes there. And I'm sorry, I should say that's depreciation and amortization combined, again looking at Q4 should be about $9 million or so. Leaning into FY '13, I would say that we're going to see some uptick in the depreciation amortization. I don't really have a number that's quantifiable or probably comfortable quantifying that at this time.

Capital spending, I would say that we're probably going to see I would say similar -- probably a little bit higher amount of capital spending in FY '13 than FY '12. Again, without getting into specifics, I think directionally, we'll see a little bit higher levels of spending for certain projects that we're undertaking. This fiscal year, we really did not have a lot of bricks and mortar type projects going on. A lot of it was incremental equipment that was purchased.

I do sense that we will -- we have started to think about and may be into a few more larger capital items in FY '13 and FY '12. So directionally, I think it will be up a little bit. Overall, total capital spending in FY '13 versus '12.

Thank you. Our next question comes from Jim Hollister with private investor. You may begin.

Good morning. I'm always excited by the possibilities of coming out of the labs. The diamond window business, what's the source of demand for that and how much competition do you have?

Okay, there are probably two other people who can make this free-standing diamond, and I think all three of us can do a nice job with it. It is really to the first application is in a high-power CO2 laser output windows. The windows that we would produce out of zinc selenide probably can handle four kilowatts -- it can do five. But now we're seeing some that are six and seven so there are a couple customers that will use diamond for that.

And then that was the first application we've been selling for about a year hasn't been bringing in the big dollars. The EUV -- Extreme UV Photo lithography application that's being developed in the world requires within the product itself that's handling 10.6-micron energy, it will have powers in there of maybe 40- to 50-kilowatts. That's a huge amount of power. Zinc selenide wouldn't hold up.

The beam is rather large. Three to four inches in diameter. So large free-standing windows to handle that power, that's the real application. And out of three vendors, I think there are two that are possibly going to do it. We are providing the thin film coatings for all three vendors to handle those kinds of powers. So, we have a very good position. And I think in the longer term, if this application in the semiconductor field goes well, it will be very, very important to us.

Thank you very much.

You're welcome, Jim.

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over for closing remarks.

If there are no more questions, I would like to thank everyone for participating today. Our next earnings release for the quarter and fiscal year ending June 30, 2012, is currently scheduled for Thursday, August 2, 2012, before the market opens with a conference call to follow that same day at 9 AM Eastern Standard Time. Thank you for participating in today's conference call.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day.