FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2004
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period
from to .
---------- --------
Commission File Number: 0-16195
II-VI INCORPORATED
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-1214948
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
375 Saxonburg Boulevard
Saxonburg, PA 16056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 724-352-4455
N/A
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days.
Yes x No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date:
At May 7, 2004, 14,373,472 shares of Common Stock, no par
value, of the registrant were outstanding.
II-VI INCORPORATED
INDEX
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets - March 31, 2004
and June 30, 2003. . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Earnings - Three months
ended March 31, 2004 and 2004. . . . . . . . . . . . . . 4
Consolidated Statements of Earnings - Nine months
ended March 31, 2004 and 2003. . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows - Nine months
ended March 31, 2004 and 2003. . . . . . . . . . . . . . 6
Notes to Consolidated Financial Statements. . . . . . . .7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . .19
Item 3. Quantitative and Qualitative Disclosures about
Market Risk. . . . . . . . . . . . . . . . . . . . . . .26
Item 4. Controls and Procedures. . . . . . . . . . . . . . . . .27
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 27
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
II-VI Incorporated and Subsidiaries
Consolidated Balance Sheets (Unaudited)
($000)
March 31, June 30,
2004 2003
-------- --------
Assets
Current Assets
Cash and cash equivalents $ 16,440 $ 15,583
Accounts receivable - less allowance
for doubtful accounts and warranty
returns of $1,332 at March 31, 2004
and $1,266 at June 30, 2003 25,023 22,086
Inventories 29,233 24,384
Deferred income taxes 2,888 3,794
Prepaid and other current assets 1,573 1,968
-------- --------
Total Current Assets 75,157 67,815
Property, Plant & Equipment, net 60,828 57,954
Goodwill, net 28,987 28,987
Investment 1,829 1,792
Other Intangible Assets, net 6,038 4,643
Other Assets 2,151 1,602
-------- --------
$174,990 $162,793
======== ========
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable $ 6,483 $ 6,115
Accrued salaries and wages 3,643 2,809
Accrued bonuses 5,245 5,244
Income taxes payable 2,342 1,945
Accrued profit sharing contribution 1,218 1,263
Other accrued liabilities 5,063 3,316
Current portion of long-term debt 7,550 6,923
-------- --------
Total Current Liabilities 31,544 27,615
Long-Term Debt - less current portion 10,500 16,782
Deferred Income Taxes 6,123 5,579
Other Liabilities 1,938 1,296
-------- --------
Total Liabilities 50,105 51,272
Commitments and Contingencies
Shareholders' Equity
Preferred stock, no par value;
authorized - 5,000,000 shares; none issued - -
Common stock, no par value; authorized
- 30,000,000 shares; issued - 15,438,442
shares at March 31, 2004; 15,268,876
shares at June 30, 2003 41,419 39,430
Accumulated other comprehensive income 1,231 930
Retained earnings 84,145 73,071
-------- --------
126,795 113,431
Less treasury stock, at cost, 1,068,880 shares 1,910 1,910
-------- --------
Total Shareholders' Equity 124,885 111,521
-------- --------
$174,990 $162,793
======== ========
- - See notes to consolidated financial statements.
-3-
II-VI Incorporated and Subsidiaries
Consolidated Statements of Earnings (Unaudited)
($000 except per share data)
Three Months Ended
March 31,
2004 2003
-------- --------
Revenues
Net sales:
Domestic $16,436 $12,493
International 20,038 16,812
-------- --------
36,474 29,305
Contract research and development 2,655 3,051
-------- --------
39,129 32,356
-------- --------
Costs, Expenses & Other Expense (Income)
Cost of goods sold 19,525 17,238
Contract research and development 1,808 2,826
Internal research and development 1,259 435
Selling, general and administrative 9,152 7,664
Interest expense 101 174
Other expense (income), net 105 (93)
-------- --------
31,950 28,244
-------- --------
Earnings Before Income Taxes 7,179 4,112
Income Taxes 2,404 1,093
-------- --------
Net Earnings $ 4,775 $ 3,019
======== ========
Basic Earnings Per Share $ 0.33 $ 0.21
======== ========
Diluted Earnings Per Share $ 0.32 $ 0.21
======== ========
- - See notes to consolidated financial statements.
-4-
II-VI Incorporated and Subsidiaries
Consolidated Statements of Earnings (Unaudited)
($000 except per share data)
Nine Months Ended
March 31,
2004 2003
-------- --------
Revenues
Net sales:
Domestic $ 47,003 $ 41,880
International 54,496 45,532
-------- --------
101,499 87,412
Contract research and development 6,359 7,946
-------- --------
107,858 95,358
-------- --------
Costs, Expenses & Other Expense (Income)
Cost of goods sold 56,582 52,865
Contract research and development 5,175 7,202
Internal research and development 3,713 1,946
Selling, general and administrative 25,160 21,551
Interest expense 352 699
Other expense (income), net (135) 394
-------- --------
90,847 84,657
-------- --------
Earnings Before Income Taxes 17,011 10,701
Income Taxes 5,698 2,707
-------- --------
Net Earnings $ 11,313 $ 7,994
======== ========
Basic Earnings Per Share $ 0.79 $ 0.57
======== ========
Diluted Earnings Per Share $ 0.77 $ 0.56
======== ========
- - See notes to consolidated financial statements.
-5-
II-VI Incorporated and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($000)
Nine Months Ended
March 31,
2004 2003
------- -------
Cash Flows from Operating Activities
Net earnings $11,313 $ 7,994
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation 6,768 6,869
Amortization 472 382
(Gain) loss on foreign currency
remeasurements and transactions (77) 137
Net loss on disposal or writedown of assets 122 137
Deferred income taxes 1,452 567
Increase (decrease) in cash from changes in:
Accounts receivable (2,342) (462)
Inventories (3,142) (3,052)
Accounts payable 469 1,764
Other operating net assets 3,381 4,331
------- -------
Net cash provided by operating activities 18,416 18,667
------- -------
Cash Flows from Investing Activities
Additions to property, plant and equipment (8,889) (4,053)
Purchases of businesses (2,554) (2,755)
Dividend from unconsolidated business 8 9
Proceeds from sale of fixed assets - 617
------- -------
Net cash used in investing activities (11,435) (6,182)
------- -------
Cash Flows from Financing Activities
Payments on short-term borrowings, net (1,000) (5,069)
Payments on long-term borrowings (5,036) (3,802)
Proceeds from exercise of stock options 942 340
Dividends paid to minority owners of
majority-owned subsidiary (95) -
Payment for redemption of Shareholders Rights Plan (144) -
------- -------
Net cash used in financing activities (5,333) (8,531)
------- -------
Effect of exchange rate changes on cash
and cash equivalents (791) (368)
Net increase in cash and cash equivalents 857 3,586
Cash and Cash Equivalents at Beginning of Period 15,583 9,610
------- -------
Cash and Cash Equivalents at End of Period $16,440 $13,196
======= =======
Non-cash transactions:
Accrued purchase price for assets acquired $ 1,200 $ -
======= =======
Cash paid for interest $ 400 $ 779
======= =======
Cash paid for income taxes $ 2,966 $ 905
======= =======
- - See notes to consolidated financial statements.
-6-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
Note A - Basis of Presentation
The consolidated financial statements for the three and nine month
periods ended March 31, 2004 and 2003 are unaudited. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation for the periods presented
have been included. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of
America have been condensed or omitted. These consolidated financial
statements should be read in conjunction with the consolidated
financial statements and notes thereto in the Corporation's annual
report on Form 10-K for the year ended June 30, 2003. The consolidated
results of operations for the three and nine month periods ended March
31, 2004 and 2003 are not necessarily indicative of the results to be
expected for the full year.
Note B - Contract Receivables
The components of contract receivables, which are a component of
accounts receivable, net, were as follows ($000):
March 31, June 30,
2004 2003
--------- -------
Billed
Completed Contracts $ 105 $ 75
Contracts in Progress 1,488 1,526
------- -------
1,593 1,601
Unbilled 880 1,988
------- -------
$ 2,473 $ 3,589
======= =======
Note C - Inventories
The components of inventories were as follows ($000):
March 31, June 30,
2004 2003
--------- -------
Raw materials $ 6,564 $ 5,729
Work in progress 14,258 11,034
Finished goods 8,411 7,621
--------- -------
$29,233 $24,384
========= =======
-7-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note D - Property, Plant and Equipment
Property, plant and equipment at cost consist of the following ($000):
March 31, June 30,
2004 2003
--------- --------
Land and land improvements $ 1,453 $ 1,453
Buildings and improvements 32,617 31,642
Machinery and equipment 80,706 72,424
--------- --------
114,776 105,519
Less accumulated depreciation 53,948 47,565
--------- --------
$ 60,828 $ 57,954
========= ========
Note E - Goodwill and Intangible Assets
As of June 30, 2001, the Company had goodwill and other intangible
assets, net of accumulated amortization, of $33.3 million, which was
subject to the transitional assessment provisions of Statement of
Financial Accounting Standards (SFAS) No. 142. A discounted cash flow
model was used to determine the fair value of the reporting units for
purposes of testing goodwill for impairment. The discount rate used
was based on a risk-adjusted weighted average cost of capital for the
Company. The Company completed its initial impairment test of goodwill
prior to December 31, 2001. The results of this test indicated that
the Company's goodwill was not impaired as of July 1, 2001, and,
therefore, no impairment loss was recorded.
The Company completed a discounted cash flow and comparable market
capitalization analysis by identified reporting units of the Company
which had recorded goodwill as of June 30, 2003 and 2002. Based on the
results of these analyses, the Company's goodwill of $29.0 million was
not impaired as of June 30, 2003 or 2002.
The gross carrying amount and accumulated amortization of the Company's
intangible assets other than goodwill as of March 31, 2004 and June 30,
2003 were as follows ($000):
March 31, 2004 June 30, 2003
----------------------------------- ------------------------------------
Gross Net Gross Net
Carrying Accumulated Book Carrying Accumulated Book
Amount Amortization Value Amount Amortization Value
-------- ------------ ----- -------- ------------ -----
Patents $2,681 $ (639) $2,042 $1,867 $ (493) $1,374
Trademark 1,491 (273) 1,218 1,491 (217) 1,274
Customer Lists 3,430 (789) 2,641 2,360 (557) 1,803
Other 750 (613) 137 750 (558) 192
------ -------- ------ ------ -------- ------
Total $8,352 $ (2,314) $6,038 $6,468 $ (1,825) $4,643
====== ======== ====== ====== ======== ======
During the quarter ended December 31, 2003, the Company, as part of the
acquisition of II-VI LOT Suisse S.a.r.l. (see Note P), recorded
approximately $983,000 of intangible assets consisting of customer
lists and related information. The intangible assets relating to the
customer list acquired during the quarter are being amortized over a
ten-year useful life.
-8-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note E - Goodwill and Intangible Assets, Cont'd.
Amortization expense recorded on the intangible assets was $183,000 and
$472,000, for the three and nine month periods ended March 31, 2004
respectively, and $127,000 and $382,000 for the three and nine month
periods ended March 31, 2003 respectively. Included in the gross
carrying amount and accumulated amortization of the Company's customer
lists component of intangible assets is the effect of the foreign
currency translation of the portion relating to the Company's German
and Switzerland distributors. At March 31, 2004, the estimated
amortization expense for existing intangible assets for each of the
five succeeding fiscal years is as follows:
Year Ended June 30,
- --------------------------------------------------------------------
($000)
Remaining fiscal 2004 $170
2005 678
2006 624
2007 527
2008 518
2009 518
====================================================================
Note F - Debt
The components of debt were as follows ($000's):
March 31, 2004 June 30, 2003
Line of credit, interest at the LIBOR Rate, as defined,
plus 1.00% and 1.25%, respectively $ 3,500 $ 4,500
Term loan, interest at the LIBOR Rate, as defined,
plus 1.00% and 1.25%, respectively, payable in quarterly
installments through August 2005 11,250 16,250
Pennsylvania Industrial Development Authority
(PIDA) term note, interest at 3.00%, payable in
monthly installments through October 2011 416 452
Yen denominated term note, interest at the Japanese Yen Base Rate,
as defined, plus 1.49%, principal payable in full in September 2007 2,884 2,503
- ---------------------------------------------------------------------- ---------------- -------------
Total debt 18,050 23,705
Current portion of long-term debt (7,550) (6,923)
- ---------------------------------------------------------------------- ---------------- -------------
Long-term debt $ 10,500 $ 16,782
====================================================================== ================ =============
The Company has a $45.0 million secured credit agreement, which it
obtained in connection with the Company's acquisition of Laser Power
Corporation in fiscal 2001. The facility has a five-year term
effective August 14, 2000 and contains a term option in the original
amount of $25 million and a $20 million line of credit option. The
facility is collateralized by the Company's accounts receivable and
inventories, a pledge of all of the capital stock of each of the
Company's domestic subsidiaries, and a pledge of 65% of the stock of
the Company's foreign subsidiaries. Additionally, the facility is
subject to certain restrictive covenants, including those related to
minimum net worth, leverage and interest coverage. This facility has
an interest rate range of LIBOR plus 0.88% to LIBOR plus 1.50%. The
weighted average interest rate of borrowings under the credit agreement
was 2.14% and 2.62% at March 31, 2004 and June 30, 2003, respectively.
The Company had available $16.5 million and $15.5 million under its
line of credit as of March 31, 2004 and June 30, 2003, respectively.
On March 19, 2004, the Company amended the credit facility to modify
certain restrictive covenants, including the replacement of the fixed
charge ratio with a minimum consolidated debt service coverage ratio.
All other substantial terms and conditions of the credit facility
remain unchanged.
-9-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
The Company has a 300 million Yen loan. The loan matures on September
25, 2007. Interest is at a rate equal to the Japanese Yen base rate,
as defined in the loan agreement, plus 1.49%. The Japanese Yen base
rate was 0.06% at March 31, 2004 and June 30, 2003.
Note G - Earnings Per Share
The following table sets forth the computation of earnings per share
for the periods indicated. Weighted average shares issuable upon the
exercise of stock options that were not included in the calculation
because they were antidilutive were immaterial for all periods
presented:
Three Months Ended Nine Months Ended
March 31 March 31,
(000 except per share data) 2004 2003 2004 2003
- ---------------------------- ------------------- -----------------
Net earnings $ 4,775 $ 3,019 $11,313 $ 7,994
Divided by:
Weighted average shares 14,346 14,090 14,286 14,054
- ---------------------------- ------- ------- ------- ------
Basic earnings per share $ 0.33 $ 0.21 $ 0.79 $ 0.57
- ---------------------------- ------- ------- ------- ------
Net earnings $ 4,775 $ 3,019 $11,313 $ 7,994
Divided by:
Weighted average shares 14,346 14,090 14,286 14,054
Dilutive effect of common
stock equivalents 377 370 391 328
- ---------------------------- ------- ------- ------- ------
Diluted weighted average
common shares 14,723 14,460 14,677 14,382
- ---------------------------- ------- ------- ------- ------
Diluted earnings per share $ 0.32 $ 0.21 $ 0.77 $ 0.56
- ---------------------------- ------- ------- ------- ------
Note H - Comprehensive Income
The components of comprehensive income were as follows for the periods
indicated ($000):
Three Months Ended Nine Months Ended
March 31, March 31,
------------------- -----------------
2004 2003 2004 2003
- ---------------------------- ------ ------ ------- ------
Net earnings $4,775 $3,019 $11,313 $7,994
Other comprehensive income (loss):
Foreign currency translation adjustments (261) 30 301 7
net of income tax expense (benefit) of
($131) and $152, respectively, for the
three and nine months ended
March 31, 2004 and $11 and $2,
respectively, for the three and nine
months ended March 31, 2003.
- ---------------------------- ------ ------ ------- ------
Comprehensive income $4,514 $3,049 $11,614 $8,001
- ---------------------------- ------ ------ ------- ------
-10-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note I - Segment Reporting
The Company reports its segments using the "management approach" model
for segment reporting. The management approach model is based on the
way a company's management organizes segments within the company for
making operating decisions and assessing performance. Reportable
segments are based on products and services, geography, legal
structure, management structure or any other manner in which management
segregates a company.
The Company's reportable segments offer similar products to different
target markets. The segments are managed separately due to the
production requirements and facilities that are unique to each segment.
The Company has the following reportable segments: Infrared Optics,
which is the Company's II-VI and Laser Power infrared optics and
material products businesses; Near-Infrared Optics, which is the
Company's VLOC subsidiary; and Military Infrared Optics, which is the
Company's Exotic Electro-Optics subsidiary. The Compound Semiconductor
Group, (formerly "Other") is primarily the aggregation of the Company's
eV PRODUCTS division, the Company's Wide Bandgap Materials (WBG) group,
the Company's Advanced Material Development Center (AMDC) group, which
is responsible for the corporate research and development activities
and remaining corporate activities.
The Infrared Optics segment is divided into the geographic locations in
the United States, Singapore, China, Germany, Switzerland, Japan,
Belgium and the United Kingdom. An Executive Vice-President of the
Company directs the segment, while each geographic location is directed
by a general manager, and is further divided into production and
administrative units that are directed by managers. The Infrared
Optics segment designs, manufactures and markets optical and electro-
optical components and materials sold under the II-VI and Laser Power
brand names and used primarily in high-power CO2 lasers.
The Near-Infrared Optics segment is located in the United States. The
Near-Infrared Optics segment is directed by a general manager. The
Near-Infrared Optics segment is further divided into production and
administrative units that are directed by managers. The Near-Infrared
Optics segment designs, manufactures and markets near-infrared and
visible-light products for industrial, scientific and medical
instruments and laser gain material and products for solid-state YAG
and YLF lasers at the Company's VLOC subsidiary.
The Military Infrared Optics segment is located in the United States.
The Military Infrared Optics segment is directed by a general manager
with oversight by a Corporate Vice-President. The Military Infrared
Optics segment is further divided into production and administrative
units that are directed by managers. The Military Infrared Optics
segment designs, manufactures and markets infrared products for
military applications under the Exotic Electro-Optics brand name.
The Compound Semiconductor Group is located in the United States. The
Compound Semiconductor Group segment is directed by a Group Vice-
President. The Company's eV PRODUCTS division manufactures and markets
solid-state x-ray and gamma-ray detection materials and products for
use in medical, security monitoring, industrial, environmental and
scientific applications. The Company's WBG group manufactures and
markets single crystal silicon carbide substrates for use in solid-
state lighting, wireless infrastructure, RF electronics and power
switching industries. The Company's AMDC group directs the corporate
research and development initiatives.
The accounting policies of the segments are the same as those of the
Company. Substantially all of the Company's corporate expenses are
allocated to the segments. The Company evaluates segment performance
based upon reported segment earnings or loss, which is defined as
earnings before income taxes, interest and other income or expense.
Inter-segment sales and transfers have been eliminated.
-11-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note I - Segment Reporting, Cont'd.
The following table summarizes selected financial information of the
Company's operations by segment ($000's):
Three Months Ended March 31, 2004
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Totals
- ----------------------------- -------- ------------- -------- ------------- ----------
Revenues $23,625 $ 6,775 $ 5,847 $ 2,882 $ 39,129
Segment earnings (loss) 6,532 659 276 (82) 7,385
Interest expense - - - - (101)
Other expense, net - - - - (105)
Earnings before income taxes - - - - 7,179
Depreciation and amortization 1,091 608 360 436 2,495
Segment assets 77,333 26,864 39,909 30,884 174,990
Expenditures for property,
plant and equipment 1,685 465 370 650 3,170
Equity investment - - - 1,829 1,829
Goodwill, net 5,516 1,927 21,544 - 28,987
Three Months Ended March 31, 2003
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- ----------------------------- -------- ------------- -------- ------------- ----------
Revenues $19,715 $ 5,647 $ 4,788 $ 2,206 $ 32,356
Segment earnings (loss) 5,462 393 (453) (1,209) 4,193
Interest expense - - - - (174)
Other income, net - - - - 93
Earnings before income taxes - - - - 4,112
Depreciation and amortization 1,084 512 418 354 2,368
Segment assets 67,188 23,543 38,125 29,352 158,208
Expenditures for property,
plant and equipment 629 48 271 253 1,201
Equity investment - - - 1,792 1,792
Goodwill, net 5,516 1,927 21,544 - 28,987
12
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note I - Segment Reporting, Cont'd.
Nine Months Ended March 31, 2004
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- ----------------------------- -------- ------------- -------- ------------- ---------
Revenues $63,422 $17,907 $18,046 $8,483 $107,858
Segment earnings (loss) 17,141 1,351 515 (1,779) 17,228
Interest expense - - - - (352)
Other income, net - - - - 135
Earnings before income taxes - - - - 17,011
Depreciation and amortization 2,986 1,747 1,127 1,380 7,240
Expenditures for property,
plant and equipment 3,832 1,188 1,379 2,490 8,889
Nine Months Ended March 31, 2003
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- ----------------------------- -------- ------------- -------- ------------- ---------
Revenues $55,641 $16,793 $16,381 $6,543 $95,358
Segment earnings (loss) 14,109 1,151 38 (3,504) 11,794
Interest expense - - - - (699)
Other expense, net - - - - (394)
Earnings before income taxes - - - - 10,701
Depreciation and amortization 3,279 1,617 1,257 1,098 7,251
Expenditures for property,
plant and equipment 1,747 368 921 1,017 4,053
13
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note J - Derivative Instruments
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended by SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the effective date of
SFAS No. 133", and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities", were effective for the
Company as of July 1, 2000. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and hedging activities.
It requires that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. The Company was not required to record any
transition adjustments as a result of adopting these standards.
The Company from time to time purchases foreign currency forward
exchange contracts, primarily in Japanese Yen, that permit it to sell
specified amounts of these foreign currencies expected to be received
from its export sales for pre-established U.S. dollar amounts at
specified dates. These contracts are entered into to limit
transactional exposure to changes in currency exchange rates of export
sales transactions in which settlement will occur in future periods and
which otherwise would expose the Company, on the basis of its aggregate
net cash flows in respective currencies, to foreign currency risk.
The Company recorded the fair value of contracts with a notional amount
of approximately $4.7 million and $2.2 million as of March 31, 2004 and
June 30, 2003, respectively. These amounts were recorded in Other
accrued liabilities as of March 31, 2004 and in Prepaid and other
current assets as of June 30, 2003 on the Consolidated Balance Sheets.
The Company does not account for these contracts as hedges as defined
by SFAS No. 133 and records the change in the fair value of these
contracts in the results of operations as they occur. The change in
the fair value of these contracts decreased net earnings by $34,000 and
increased net earnings by $40,000 for the three months ended March 31,
2004 and March 31, 2003, respectively. The change in the fair value of
these contracts decreased net earnings by $113,000 and increased net
earnings by $25,000 for the nine months ended March 31, 2004 and 2003,
respectively.
To satisfy certain provisions of its credit agreement (see Note F), on
March 9, 2004 the Company entered into a one-year interest rate cap
with a notional amount of $5.6 million replacing an interest rate cap
that expired on March 6, 2004. These agreements were entered into to
limit interest rate exposure on one-half of the remaining outstanding
balance of the Company's term loan under the credit agreement. The
floating rate option for the cap agreement is the one-month LIBOR rate
with a cap strike rate of 2.00%. At March 31, 2004 the one-month LIBOR
rate was 1.09%. The Company has elected not to account for these
agreements as hedges as defined by SFAS No. 133 but instead recorded
the unrealized change in the fair value of these agreements as an
increase or decrease to interest expense in the results of operations.
The effect of the interest rate cap on net earnings for the three and
nine months ended March 31, 2004 was immaterial.
14
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note K - Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure." SFAS No. 148 amends
SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition to SFAS No. 123's fair value method
of accounting for stock-based employee compensation should a company
elect this accounting method. SFAS No. 148 also amends the disclosure
provisions of SFAS No. 123 and Accounting Principles Board (APB)
Opinion No. 28, "Interim Financial Reporting," to require disclosure in
the summary of significant accounting policies of the effects of an
entity's accounting policy with respect to stock-based employee
compensation on reported net income and earnings per share in annual
and interim financial statements. While SFAS No. 148 does not amend
SFAS No. 123 to require companies to account for employee stock options
using the fair value method, the disclosure provisions of SFAS No. 148
are applicable to all companies with stock-based employee compensation,
regardless of whether they account for that compensation using the fair
value method of SFAS No. 123 or the intrinsic value method specified in
APB Opinion No. 25, "Accounting for Stock Issued to Employees."
The Company uses the intrinsic value approach of APB Opinion No. 25 for
stock options granted to officers and key employees. All options
granted under the plan had an exercise price equal to the fair market
value of the underlying common stock on the date of grant.
In accordance with the disclosure requirements of SFAS No. 148, the
following pro forma information adjusts previously reported net
earnings, basic earnings per common share and diluted earnings per
common share to reflect the fair value recognition provisions of SFAS
No. 123.
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003
--------------------------------- ---------------------------------
Basic Diluted Basic Diluted
Earnings Earnings Earnings Earnings
Net Per Common Per Common Net Per Common Per Common
(000 except per share data) Earnings Share Share Earnings Share Share
- --------------------------- --------------------------------- -------------------------------
Net earnings and earnings
per common share, as reported $4,775 $0.33 $0.32 $3,019 $0.21 $0.21
Add: Stock-based employee
compensation cost, net of
related tax effects, recorded
in the financial statements - - - - - -
Deduct: Stock-based employee
compensation cost, net of
related income tax effects,
that would have been included
in the determination of net
earnings if the fair value
method had been applied to
all awards (180) (0.01) (0.01) (145) (0.01) (0.01)
------- ------ ------ ------- ------ ------
Pro forma net earnings and
earnings per common share $4,595 $0.32 $0.31 $2,874 $0.20 $0.20
======= ====== ====== ======= ====== ======
15
II-VI Incorporated and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited),
Continued
Note K - Stock-Based Compensation, Cont'd.
Nine Months Ended Nine Months Ended
March 31, 2004 March 31, 2003
--------------------------------- ---------------------------------
Basic Diluted Basic Diluted
Earnings Earnings Earnings Earnings
Net Per Common Per Common Net Per Common Per Common
(000 except per share data) Earnings Share Share Earnings Share Share
- --------------------------- --------------------------------- -------------------------------
Net earnings and earnings
per share, as reported $11,313 $0.79 $0.77 $7,994 $0.57 $0.56
Add: Stock-based employee
compensation cost, net of
related tax effects, recorded
in the financial statements - - - - - -
Deduct: Stock-based employee
compensation cost, net of
related tax effects, that
would have been included in
the determination of net
earnings if the fair value
method had been applied to
all awards (525) (0.04) (0.04) (426) (0.03) (0.03)
------- ------ ------ ------- ------ ------
Pro forma net earnings and
earnings per share $10,788 $0.75 $0.73 $7,568 $0.54 $0.53
======== ====== ====== ======= ====== ======
The pro forma adjustments were calculated using the Black-Scholes
option pricing model under the following weighted-average assumptions
in each period:
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
March 31, 2004 March 31, 2003 March 31, 2004 March 31, 2003
------------------ ------------------ ----------------- -----------------
Risk free interest rate 3.52% 3.80% 3.59% 3.80%
Expected volatility 65% 29% 63% 29%
Expected life of options 7.04 years 7.0 years 7.04 years 7.0 years
Expected dividends none none none none
In March 2004, the FASB issued an Exposure Draft titled "Share-Based
Payment an amendment of FASB Statements No. 123 and 95". The Exposure
Draft would require the recognition of compensation expense over the
vesting period for all share-based payments, including stock options,
based on the fair value of the payment at the grant date. The Exposure
Draft is not final and is subject to a comment period that will end
June 30, 2004. Although the Exposure Draft and its eventual effective
date are still subject to revision, the proposed effective date of the
Exposure Draft is for fiscal years beginning after December 15, 2004.
Once finalized, the Company will adopt the provisions of the Exposure
Draft upon its effective date.
Note L - Warranty Reserve
The Company records a warranty reserve as a charge against earnings
based on a percentage of sales utilizing actual returns over the last
twelve months.
16
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
The following table summarizes the change in the carrying value of the
Company's warranty reserve as of and for the nine months ended March
31, 2004 and as of and for the year ended June 30, 2003 ($000).
Nine Months Ended Year Ended
March 31, 2004 June 30, 2003
- ----------------------------------------------------------------------
($000)
Balance - Beginning of Period $504 $419
Expense and writeoffs, net 36 85
Other - -
- ----------------------------------------------------------------------
Balance - End of Period $540 $504
- ----------------------------------------------------------------------
Note M - Investment in 5N Plus, Inc.
The Company has a 33% equity ownership interest in 5N Plus, Inc. which
is a supplier to the Company. 5N Plus, Inc. is based in Montreal,
Canada. The investment is accounted for under the equity method of
accounting and is shown as Investment on the accompanying Consolidated
Balance Sheets.
At March 31, 2004 and June 30, 2003, the Company had outstanding notes
receivable of approximately $0.5 million and $0.5 million respectively
from equipment and supply agreements with 5N Plus, Inc. Payments on
these notes are made quarterly with interest calculated at the Canadian
Prime Rate plus 1.5% on the unpaid balance.
The Company's pro rata share of the earnings from this investment and
the interest received from these agreements did not have a material
effect on the Company's results of operations in either the three or
nine months ended March 31, 2004.
Note N - New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, "Consolidation of Variable Interest Entities."
Interpretation No. 46 requires unconsolidated variable interest
entities to be consolidated by their primary beneficiaries if the
entities do not effectively disperse the risks and rewards of ownership
among their owners and other parties involved. The provisions of
Interpretation No. 46 were applicable immediately to all variable
interest entities created after January 31, 2003 and variable interest
entities in which an enterprise obtains an interest after that date.
For variable interest entities created before this date, the provisions
have been deferred to be effective. In December 2003, the FASB
substantially revised Interpretation No. 46. This revision,
Interpretation No. 46R, exempts many entities that meet the definition
of a business. Based on the results of our evaluation of the revised
interpretation, this interpretation has no financial impact on the
Company's financial position or results of operations.
Note O - Acquisition of Certain Coherent Assets
On September 11, 2003, the Company entered into an agreement to acquire
certain assets, equipment, intellectual property and rights from
Coherent, Inc. (Coherent) relating to Coherent's business of growing
and fabricating materials used for ultra-violet (UV) filters. UV
filters assist aircraft in the early detection of missile threats.
Under the terms of this asset purchase the Company will pay $2.0
million to Coherent. The payment of the purchase price is subject to
certain terms and conditions, including delivery of the equipment and
qualification of materials. The major assets to be acquired are
equipment, inventory and a patent for crystal growth. As of March 31,
2004, the Company had paid $0.8 million of the purchase price and
expects to pay the remaining $1.2 million by June 30, 2004.
17
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note P - Acquisition of II-VI LOT Suisse S.a.r.l.
During the quarter ended December 31, 2003, the Company reached an
agreement with LOT - Oriel Laser Optik Technologies Holding GmbH and
LOT - Oriel Laser Optik GmbH & Co. KG of Darmstadt, Germany
(collectively LOT) to establish a new European entity, II-VI LOT Suisse
S.a.r.l. (II-VI LOT Suisse) to distribute infrared optics in
Switzerland. Prior to this acquisition, the distribution of the
Company's products in Switzerland was handled by LOT for over 25 years.
II-VI and LOT created II-VI LOT Suisse to better service the needs of
customers in Switzerland. The Company purchased a 75% controlling
interest in II-VI LOT Suisse for approximately $1.8 million. The major
assets acquired were inventory of approximately $771,000 and intangible
assets consisting of customer lists and related information of
approximately $983,000 that are being amortized over a ten-year useful
life. II-VI LOT Suisse is based in Morges, Switzerland and will
provide distribution, marketing and laser specific know-how needed to
sell infrared optics in Switzerland to OEM and aftermarket customers.
The results of II-VI LOT Suisse, net of minority interest, for the
three and nine month periods ended March 31, 2004 are included in the
Company's consolidated financial statements and are included in the
Infrared Optics segment.
At any time after December 1, 2006, the Company has a call option to
purchase the remaining interest in II-VI LOT Suisse and LOT has a put
option to require the purchase of the remaining interest in II-VI LOT
Suisse. The price of the remaining interest is determined by a fixed
formula based on the average sales of II-VI LOT Suisse for the three
fiscal years prior to the exercise of the option.
Note Q - Legal Proceedings
During the quarter ended September 30, 2003, the Company was awarded a
jury verdict in the amount of $0.8 million in a trade secret lawsuit
which it had initiated. In addition, the Company was initially
entitled to punitive damages and reimbursement of its attorneys' fees
and costs at the discretion of the court. On April 27, 2004, the court
denied the award relating to punitive damages and reimbursement of its
attorneys' fees and costs. This award is subject to post-trial motions
and possible appeals. As such, the Company has not made any
adjustments to its financial position or results of operations for this
contingent gain.
Note R - Termination of II-VI Incorporated Shareholder Rights Plan
During the quarter ended March 31, 2004, the Board of Directors of II-
VI Incorporated terminated the Company's Shareholder Rights Plan. In
accordance with the Plan, the Company redeemed the Rights at a
redemption price of $0.01 per right. The Company paid $144,000 to
shareholders of record as of February 27, 2004 for the redemption of
the Rights and recorded this payment similar to a dividend during the
current quarter.
18
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Management's Discussion and Analysis contains forward-looking
statements as defined by Section 21E of the Securities Exchange Act of
1934, as amended, including the statements regarding projected growth
rates, markets, product development, financial position, capital
expenditures and foreign currency exposure. Forward-looking statements
are also identified by words such as "expects," "anticipates,"
"intends," "plans," "projects" or similar expressions.
Actual results could materially differ from such statements due to the
following factors: materially adverse changes in economic or industry
conditions generally (including capital markets) or in the markets
served by the Company, the development and use of new technology and
the actions of competitors.
There are additional risk factors that could affect the Company's
business, results of operations or financial condition. Investors are
encouraged to review the risk factors set forth in the Company's most
recent Form 10-K as filed with the Securities and Exchange Commission
on September 26, 2003.
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with generally accepted accounting principles and the
Company's discussion and analysis of its financial condition and
results of operations requires the Company's management to make
judgments, assumptions, and estimates that affect the amounts reported
in its consolidated financial statements and accompanying notes. Note
A of the Notes to Consolidated Financial Statements in the Company's
most recent Form 10-K describes the significant accounting policies and
methods used in the preparation of the Company's consolidated financial
statements. Management bases its estimates on historical experience
and on various other assumptions that it believes to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities. Actual
results may differ from these estimates.
Management believes the Company's critical accounting policies are
those related to revenue recognition, allowance for doubtful accounts,
warranty reserves, inventory valuation, valuation of long-lived assets
including acquired intangibles and goodwill, accrual of bonus and
profit sharing estimates, accrual of income tax liability estimates,
workers compensation accrual for our self insurance program, and
accounting for stock-based compensation. Management believes these
policies to be critical because they are both important to the
portrayal of the Company's financial condition and results of
operations, and they require management to make judgments and estimates
about matters that are inherently uncertain.
As of March 31, 2004, there have been no significant changes with
regard to the critical accounting policies disclosed in Management's
Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K for the year ended June
30, 2003.
19
Results of Operations
Overview ($000's except per share data)
Three Months Ended % Nine Months Ended %
March 31, Increase March 31, Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
------------------ -------- ----------------- --------
Bookings $41,381 $37,072 12% $117,073 $103,978 13%
Revenues 39,129 32,356 21% 107,858 95,358 13%
Segment earnings 7,385 4,193 76% 17,228 11,794 46%
Net earnings 4,775 3,019 58% 11,313 7,994 42%
Diluted earnings per share 0.32 0.21 52% 0.77 0.56 38%
Net earnings for the third quarter of fiscal 2004 were $4,775,000
($0.32 per share-diluted) on revenues of $39,129,000. This compares to
net earnings of $3,019,000 ($0.21 per share-diluted) on revenues of
$32,356,000 in the third quarter of fiscal 2003. For the nine months
ended March 31, 2004, net earnings were $11,313,000 ($0.77 per share-
diluted) on revenues of $107,858,000. This compares to net earnings of
$7,994,000 ($0.56 per share-diluted) on revenues of $95,358,000 for the
same period last fiscal year. Stronger revenues were realized in all
of the Company's reporting segments. The increase in revenues for the
third quarter of fiscal 2004 compared to the same period last fiscal
year was primarily due to stronger shipments of infrared optics to OEM
and aftermarket customers in Japan, Europe and the United States. More
specifically, sales from our Japan subsidiary have increased over one-
third compared to the same period last year.
Bookings for the third quarter of fiscal 2004 increased 12% to
$41,381,000 compared to $37,072,000 for the same period last fiscal
year. The increase was attributable to stronger demand from Infrared
Optic's OEM and aftermarket customers and a one-year order of
approximately $3.2 million received by the Company's eV PRODUCTS
division for bone mineral densitometry detectors. Bookings for
contract research and development for the third quarter of fiscal year
2004 were $2,900,000 compared to $2,400,000 for the same period last
fiscal year. Order bookings for research and development for the
current fiscal third quarter included a $2,000,000 contract from the
United States Air Force Research Laboratory received by the Company's
Wide Bandgap Materials (WBG) group and $900,000 for the first twelve
months of a contract from the United States Army received by the
Company's eV PRODUCTS division. Both the WBG group and eV PRODUCTS
division are included in the Company's Compound Semiconductor Group.
Bookings are defined as customer orders received that are expected to
be converted to revenues over the next twelve months. For long-term
customer orders, the Company does not include in bookings the portion
of the customer order that is beyond 12 months due to the inherent
uncertainty of an order that far out in the future.
Order bookings for the nine months ended March 31, 2004 increased 13%
to $117,073,000 as compared to $103,978,000 for the same period last
fiscal year. The Company has experienced strong bookings for the
Infrared Optics and Military Infrared Optics product lines. Bookings
for contract research and development for the nine months ended March
31, 2004 were $4,800,000 compared to $8,300,000 for the same period
last fiscal year. Contract research and development in the prior
fiscal year included a Title III contract received by the Company's WGB
group of approximately $2,000,000 and a Yttrium Vanadate contract
received by the Company's Near Infrared Optics segment of approximately
$2,500,000, which were not repeated during the current fiscal year.
Segment earnings, which is defined as earnings before income taxes,
interest and other income or expense, for the third quarter of fiscal
2004 increased 76% to $7,385,000 compared to $4,193,000 for the same
period last fiscal year primarily due to higher gross margins from
increased manufacturing at our Asian facilities, particularly at our
recently expanded China facility. Additionally, higher sales volume,
relating to sales of infrared optics and continuing strong sales in
Japan, where the strong Yen has helped gross margins. In addition,
20
manufacturing yield improvements and cost reduction programs also
contributed to the overall improved segment earnings. Segment earnings
for the nine months ended March 31, 2004 increased 46% to $17,228,000
compared to $11,794,000 for the same period last fiscal year. The
increase in segment earnings is the result of the same factors noted
for the third quarter of fiscal 2004.
Reconciliation of Segment Earnings to Earnings Before Income Taxes
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ -----------------
2004 2003 2004 2003
------ ------ ------- -------
Total Segment Earnings $7,385 $4,193 $17,228 $11,794
Interest expense 101 174 352 699
Other (income) expense, net 105 (93) (135) 394
Earnings before income taxes $7,179 $4,112 $17,011 $10,701
Bookings, revenues and segment earnings (loss) for the Company's
reportable segments are discussed below.
Infrared Optics (000's)
Three Months Ended % Nine Months Ended %
March 31, Increase March 31, Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
------------------ -------- ----------------- --------
Bookings $23,113 $22,083 5% $67,288 $61,226 10%
Revenues 23,625 19,715 20% 63,422 55,641 14%
Segment earnings 6,532 5,462 20% 17,141 14,109 21%
Bookings for the third quarter of fiscal 2004 for Infrared Optics
increased 5% to $23,113,000 from $22,083,000 in the third quarter of
last fiscal year. This increase was attributable to strong demands
from Infrared Optics OEM and aftermarket customers. The remaining
quarter over quarter improvement was due to stronger order volume from
customers in both the United States and Japan. Bookings for the nine
months ended March 31, 2004 increased 10% to $67,288,000 from
$61,226,000 for the same period last fiscal year. During this period,
the OEM manufacturers of both high-power, multi-kilowatt lasers for
cutting, welding, drilling and heat treating applications and lower-
power lasers for engraving and marking are requesting products in
higher quantities as compared to the same period of the prior fiscal
year.
Revenues for the third quarter of fiscal 2004 for Infrared Optics
increased 20% to $23,625,000 from $19,715,000 in the third quarter of
last fiscal year. This increase was primarily attributable to
increased shipment volume to both OEM and aftermarket customers. The
Infrared Optics business continues to strengthen as the U.S. and
Japanese economies rebound. Revenues for the nine months ended March
31, 2004 increased 14% to $63,422,000 from $55,641,000 for the same
period last fiscal year as the stronger bookings has translated into
stronger revenues for the current period as compared to the same period
of the prior fiscal year.
Segment earnings for the third quarter increased 20% to $6,532,000 from
$5,462,000 in the third quarter of last fiscal year. Segment earnings
for the nine months ended March 31, 2004 increased 21% to $17,141,000
compared to $14,109,000 for the same period last fiscal year. The
improvement in segment earnings for the current fiscal three and nine
month periods as compared to the same period of the last fiscal year
was due to a combination of increased sales volume including sales from
our II-VI Japan subsidiary, where the strong Yen has helped gross
margins, an increased level of manufacturing at the Company's Asian
facilities in Singapore and China, and productivity improvements
occurring at our various manufacturing facilities.
21
Near-Infrared Optics (000's)
Three Months Ended % Nine Months Ended %
March 31, Increase March 31, Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
------------------ -------- ----------------- --------
Bookings $7,051 $6,839 3% $18,624 $18,689 0%
Revenues 6,775 5,647 20% 17,907 16,793 7%
Segment earnings 659 393 68% 1,351 1,151 17%
Bookings for the third quarter of fiscal 2004 for Near-Infrared Optics
increased 3% to $7,051,000 from $6,839,000 in the third quarter of last
fiscal year. During the third quarter of the last fiscal year a
$1,500,000 contract booking was received. Excluding this contract
booking, bookings increased by 32%, driven by broad-based growth in the
medical, military and instrumentation market segments. Bookings for the
nine months ended March 31, 2004 remain constant at $18,624,000
compared to $18,689,000 for the same period last fiscal year.
Revenues for the third quarter of fiscal 2004 for Near-Infrared Optics
increased 20% to $6,775,000 compared to $5,647,000 in the third quarter
of last fiscal year due to increased shipments of the waveplates,
standard optics and crystal products used in medical, instrumentation,
and industrial markets. Revenues for the nine months ended March 31,
2004 increased 7% to $17,907,000 compared to $16,793,000 for the same
period last fiscal year. During the third quarter ended March 31,
2004, this segment completed the implementation of a new product line,
ultra-violet filters, used to assist aircraft in the early detection of
missile threats and began shipment of these products. Crystal growth
and fabrication capacity expansion will occur over the next several
quarters to meet a rapidly growing demand for these products at a level
commensurate with market demands.
Segment earnings for the third quarter of fiscal 2004 increased 68% to
$659,000 from $393,000 in the third quarter of last fiscal year. The
improvement reflected overall stronger gross margins resulting from the
increased sales volume for the current three month period. Segment
earnings for the nine months ended March 31, 2004 increased 17% to
$1,351,000 compared to $1,151,000 for the same period last fiscal year.
Cost reductions, a result of yield improvements and the higher revenue
levels were sufficient to increase segment earnings for the comparable
nine-month period.
Military Infrared Optics (000's)
Three Months Ended % Nine Months Ended %
March 31, Increase March 31, Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
------------------ -------- ----------------- --------
Bookings $3,878 $7,300 (47%) $20,542 $18,603 10%
Revenues 5,847 4,788 22% 18,046 16,381 10%
Segment earnings (loss) 276 (453) N/A 515 38 1,255%
Bookings for the third quarter of fiscal 2004 for Military Infrared
Optics decreased 47% to $3,878,000 as compared to $7,300,000 in the
third quarter of last fiscal year. The overall decrease in bookings
was due to delays of several expected bookings, including approximately
$2,600,000 for Javelin missile domes. Bookings for the nine months
ended March 31, 2004 were $20,542,000 compared to $18,603,000 for the
same period last year, an increase of 10%. The bookings increase for
the nine months illustrates the continual strong demand for our
military products including replacement products for these components
used in the war in Iraq.
Revenues for the third quarter of fiscal 2004 for Military Infrared
Optics increased 22% to $5,847,000 compared to $4,788,000 in the third
quarter last fiscal year. Contributing to the increase in the revenues
for the quarter ended March 31, 2004 was the continued progress of the
segment's sapphire window assembly. The higher revenues are also a
direct result of more orders for replacement parts for military
applications resulting from the
22
Iraq war. Revenues for the nine months ended March 31, 2004 increased
10% to $18,046,000 compared to $16,381,000 for the same period last
fiscal year and were impacted by the same factors as those described for
the quarter.
Segment earnings for the third quarter of fiscal 2004 increased to
$276,000 compared to segment loss of $453,000 for the same period last
fiscal year. Segment earnings for the nine months ended March 31, 2004
increased to $515,000 from $38,000 for the same period last fiscal
year. The improvement in segment earnings for the three and nine month
periods of the current fiscal year as compared to the last fiscal year
was primarily due to losses recognized in the prior fiscal year from
activities performed on a fixed price percentage of completion
contract. During the third quarter ended March 31, 2004, the Company
received a "stop-work order" relating to this contract.
Compound Semiconductor Group (000's)
Three Months Ended % Nine Months Ended %
March 31, Increase March 31, Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
------------------ -------- ----------------- --------
Bookings $7,339 $ 850 763% $10,619 $5,460 94%
Revenues 2,882 2,206 31% 8,483 6,543 30%
Segment earnings (loss) (82) (1,209) (93%) (1,779) (3,504) (49%)
The Company's Compound Semiconductor Group (formerly "Other") includes
the combined operations of the Company's eV PRODUCTS division, the
Company's Wide Bandgap Materials (WBG) group, the Company's Advanced
Material Development Center (AMDC) group and remaining corporate
activities.
Combined bookings for the third quarter of fiscal 2004 from these
operations were $7,339,000 as compared to $850,000 in the third quarter
of last fiscal year. The increase in bookings was partially due to the
receipt of a $3,200,000 one-year order for medical imaging detectors.
The Group received two contract research and development bookings
totaling $2,900,000 to further the development of military and homeland
security applications for the Group. Bookings for the nine months ended
March 31, 2004 for this group were $10,619,000 as compared to
$5,460,000 for the same period last fiscal year also due to the receipt
of the above-mentioned bookings.
Revenues for the third quarter from these operations were $2,882,000
compared to $2,206,000 in the third quarter of the last fiscal year.
Revenues for the nine months ended March 31, 2004 for these operations
increased 30% to $8,483,000 as compared to $6,543,000 for the same
period last fiscal year. The higher revenues for both the three and
nine month periods were a direct result of higher shipments of hand-
held spectrometers for Homeland Security applications, increased
shipments of medical imaging detectors, higher levels of research and
development billings by the Company's eV PRODUCTS division and
increased shipments of silicon carbide (SiC) substrates from the WBG
group.
The segment loss for the third quarter of fiscal 2004 of $82,000
decreased from the segment loss of $1,209,000 in the third quarter of
the prior fiscal year. The segment loss for the nine months ended
March 31, 2004 decreased to $1,779,000 compared to $3,504,000 for the
same period last fiscal year. The decrease in the loss for both the
three and nine month periods were attributable to improved incremental
gross margin on increased revenues of these operations in addition to
improved operational efficiencies which have lowered operating expenses
primarily in the area of crystal growth
Overall
Manufacturing gross margin, which is defined as net sales less cost of
goods sold, for the third quarter of fiscal 2004 was $16,949,000 or 46%
of revenues compared to $12,067,000 or 41% of revenues for the same
period last fiscal year. Manufacturing gross margin for the nine
months ended March 31, 2004 was $44,917,000 or 44% of revenue compared
to $34,547,000 or 40% of revenues for the same period last fiscal year.
The increased sales volume for the current three and nine month periods
as compared to the same periods last fiscal year, the
23
increase in the amount of manufacturing performed at the Company's
Singapore and China facilities and the increase in sales at our
II-VI Japan subsidiary, with the strengthening of the Yen, all
impacted gross margins favorably.
Contract research and development gross margin, which is calculated as
contract research and development revenues less contract research and
development expenses, for the third quarter of fiscal 2004 was $847,000
or 32% of research and development revenues compared to a gross margin
of $225,000 or 7% of research and development revenues for the same
period last fiscal year. The increase in the contract research and
development gross margin for the three months ended March 31, 2004
compared to contract research and development gross margin for the same
period last fiscal year was due to losses recognized in the prior
fiscal year from activities performed on a fixed price percentage of
completion contract in the Military Optics segment. Contract research
and development gross margin for the nine months ended March 31, 2004
was $1,184,000 or 19% of research and development revenue compared to a
gross margin of $744,000 or 9% of research and development revenue for
the same period last fiscal year. The contract research and development
revenues and costs are a result of development efforts in the Near-
Infrared Optics and the Military Infrared Optics segments as well as
activities in the eV PRODUCTS division and the WBG group for the
current quarter. The decreased revenues level for the three month and
nine month periods as compared to the same periods last fiscal year is
primarily due to lower contract activity in the Near-Infrared Optics
segment and the WBG group during the current fiscal year. Contract
research and development gross margin is a result of cost plus fixed
fee, cost reimbursement and percentage of completion contract
activities.
Company-funded internal research and development expenses for the third
quarter of fiscal 2004 were $1,259,000 or 3% of revenue compared to
$435,000 or 1% of revenues for the same period last fiscal year.
Company-funded internal research and development expenses for the nine
months ended March 31, 2004 were $3,713,000 or 3% of revenues compared
to $1,946,000 or 2% of revenues. The higher expense is primarily the
result of lower external contract support for the Company's efforts in
silicon carbide.
Selling, general and administrative expenses for the third quarter of
fiscal 2004 were $9,152,000 or 23% of revenues compared to $7,664,000
or 24% of revenues for the same period last fiscal year. Selling,
general and administrative expenses for the nine months ended March 31,
2004 were $25,160,000 or 23% of revenues compared to $21,551,000 or 23%
of revenues for the same period last fiscal year. The dollar increase
for the three and the nine months periods as compared to the same
periods last fiscal year reflect increased salary expenses as compared
to the same periods last fiscal year for the Company's worldwide profit
driven bonus program.
Interest expense for the third quarter of fiscal 2004 was $101,000
compared to $174,000 for the same period last fiscal year. For the
nine months ended March 31, 2004, interest expense was $352,000
compared to $699,000 for the same period last fiscal year. The lower
interest expense reflects lower LIBOR based interest rates as well as
lower overall debt levels of the Company at December 31, 2003 and March
31, 2004 as compared to the same periods last fiscal year.
Other expense for the third quarter of fiscal 2004 was $105,000
compared to other income of $93,000 for the same period last fiscal
year. These expense items included foreign currency losses, the
minority interests in our majority-owned subsidiaries in Germany and
Switzerland and other expense items. Other expenses were partially
offset by interest income and other income items. Other income for the
nine months ended March 31, 2004 of $135,000 compared to $394,000 of
other expenses for the same period last fiscal year. The nine month
change was primarily due to the specific items mentioned above for the
quarter ended March 31, 2004 and foreign currency gains as a result of
the U.S. dollar's performance relative to other currencies in the
current fiscal year as compared to foreign currency losses in the same
period last fiscal year.
The Company's year-to-date effective income tax rate is 33.5% compared
to an effective income tax rate of 25.3% for the same period in fiscal
2003. The increase in the effective tax rate as compared to the
effective tax rate in effect for the previous year is the result of an
expected shift in the mix of taxable earnings to higher tax rate
jurisdictions.
24
Liquidity and Capital Resources
Historically, our primary source of cash has been provided through
operations. Other sources of cash include proceeds received from the
exercise of stock options, as well as through long-term borrowings.
Our historical uses of cash have been for capital expenditures,
purchases of businesses and payment of principal and interest on
outstanding debt obligations. Supplemental information pertaining to
our sources and uses of cash is presented as follows:
Nine Months Ended
March 31,
2004 2003
--------------------
(000's)
Net Cash provided by
operating activities $18,416 $18,667
Proceeds from exercise
of stock options 942 340
Additions to property,
plant and equipment 8,889 4,053
Purchases of businesses 2,554 2,755
Net payments on
long-term borrowings 6,036 8,871
In the first nine months of fiscal 2004, net cash provided by operating
activities of $18.4 million and $0.9 million of proceeds from the
exercise of stock options was used primarily to fund expenditures of
$8.9 million for property, plant and equipment, $1.8 million for the
acquisition of a 75% majority interest in II-VI LOT Suisse S.a.r.l.,
$0.8 million for the purchase of assets related to the ultra-violet
filters product line and $6.0 million to pay down debt. Cash generated
for the first nine months of fiscal 2004 plus cash on hand at the
beginning of the fiscal year resulted in a cash position of $16.4
million at March 31, 2004.
The Company had available $16.5 million under its line of credit option
of the credit facility as of March 31, 2004. The Company is obligated
to pay $1.9 million on the first day of each fiscal quarter until the
term loan portion of the credit facility, which was $11.3 million as of
March 31, 2004, is repaid. At March 31, 2004, $14.8 million remained
outstanding on the credit facility.
Our cash position, borrowing capacity and debt obligations are as
follows:
March 31, June 30,
2004 2003
--------- --------
(000's)
Cash and cash equivalents $16,440 $15,583
Available borrowing capacity
under existing credit facility 16,500 15,500
Total debt obligations 18,050 23,705
The Company believes cash flow from operations, existing cash reserves
and available borrowing capacity will be sufficient to fund its working
capital needs, capital expenditures, scheduled debt payments and
internal growth for fiscal 2004.
25
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Exchange Risks
The Company is exposed to market risks arising from adverse changes in
foreign currency exchange rates and interest rates. In the normal
course of business, the Company uses a variety of techniques and
derivative financial instruments as part of its overall risk management
strategy primarily focused on its exposure to the Japanese Yen. No
significant changes have occurred in the techniques and instruments
used other than those described below.
The Company also has transactions denominated in Euros and Pounds
Sterling. Changes in the foreign currency exchange rates of these
currencies did not have a material impact on the results of operations
for the period ended March 31, 2004.
In the normal course of business, the Company enters into foreign
currency forward exchange contracts with its banks. The purpose of
these contracts is to hedge ordinary business risks regarding foreign
currencies on product sales. Foreign currency exchange contracts are
used to limit transactional exposure to changes in currency rates. The
Company enters into foreign currency forward contracts that permit it
to sell specified amounts of foreign currencies expected to be received
from its export sales for pre-established U.S. dollar amounts at
specified dates. The forward contracts are denominated in the same
foreign currencies in which export sales are denominated. These
contracts provide the Company with an economic hedge in which
settlement will occur in future periods and which otherwise would
expose the Company to foreign currency risk. The Company monitors its
positions and the credit ratings of the parties to these contracts.
While the Company may be exposed to potential losses due to risk in the
event of non-performance by the counterparties to these financial
instruments, it does not anticipate such losses. The Company entered
into a low interest rate, 300 million Yen loan with PNC Bank in
September 2002 in an effort to minimize the foreign currency exposure
in Japan. A change in the interest rate of 1% for this Yen loan would
have changed the interest expense by approximately $7,000 and $20,000
for the three months and nine months ended March 31, 2004,
respectively, and a 10% change in the Yen to dollar exchange rate
would have changed revenues by approximately $494,000 and $1,314,000
for the three and nine months ended March 31, 2004, respectively.
For II-VI Singapore Pte., Ltd. and its subsidiaries, the functional
currency is the U.S. dollar. Gains and losses on the remeasurement of
the local currency financial statements are included in net earnings.
Foreign currency remeasurement gains were $321,000 and $745,000 for the
three and nine month periods ended March 31, 2004 and $55,000 and
$175,000 for the three and nine month periods ended March 31, 2003.
For all other foreign subsidiaries, the functional currency is the
local currency. Assets and liabilities of those operations are
translated into U.S. dollars using period-end exchange rates; while
income and expenses are translated using the average exchange rates for
the reporting period. Translation adjustments are recorded as
accumulated other comprehensive income within shareholders' equity.
Interest Rate Risks
On March 9, 2004, the Company entered into a one-year interest rate
cap, replacing an existing interest rate cap that matured on March 5,
2003, with a notional amount of $5.6 million as required under the
terms of its current credit agreement in order to limit interest rate
exposure on one-half of the then outstanding balance of the term loan.
During the nine months ended March 31, 2004, the Company decreased its
borrowings by $6.0 million. As of March 31, 2004, the total borrowings
of $18.1 million include $11.3 million under the term loan option, $3.5
million under the line of credit option, $2.9 million Japanese Yen loan
and a $0.4 million Pennsylvania Industrial Development Authority (PIDA)
term note. As such, the Company is exposed to changes in interest
rates. A change in the interest rate of 1% would have changed the
interest expense by approximately $48,000 and $157,000 for the three
and nine months ended March 31, 2004, respectively.
26
Item 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this quarterly report on Form
10-Q, the Company's management evaluated, with the participation of
Carl J. Johnson, the Company's Chairman and Chief Executive Officer and
Craig A. Creaturo, the Company's Chief Accounting Officer and Treasurer
(and principal financial officer), the effectiveness of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)). The Company's disclosure controls were
designed to provide reasonable assurance that information required to
be disclosed in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the
Securities and Exchange Commission. It should be noted that the design
of any system of controls is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote. However, the
controls have been designed to provide reasonable assurance of
achieving the controls' stated goals. Based on that evaluation,
Messrs. Johnson and Creaturo concluded that the Company's disclosure
controls and procedures are effective at the reasonable assurance
level. There were no changes in the Company's internal control over
financial reporting that occurred during the Company's most recent
fiscal quarter that have materially affected or are reasonably likely
to materially affect the Company's internal control over financial
reporting.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.01 Second Amendment to Credit Agreement Filed herewith.
by and among II-VI Incorporated,
its subsidiary guarantors, various
lenders and PNC Bank, National
Association dated as of March 19, 2004.
31.01 Certification of the Chief Executive Filed herewith.
Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
of 1934, as amended, and Section 302
of the Sarbanes-Oxley Act of 2002
31.02 Certification of the principal financial Filed herewith.
officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
of 1934, as amended, and Section 302
of the Sarbanes-Oxley Act of 2002
27
32.01 Certification of the Chief Executive Filed herewith.
Officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as
amended, and 18 U.S.C. S.S. 1350 as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.02 Certification of the principal financial Filed herewith.
officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as
amended, and 18 U.S.C. S.S. 1350 as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
On January 22, 2004, the registrant filed a report on
Form 8-K for the event dated January 21, 2004, covering
Item 12 thereof.
On January 30, 2004, the registrant filed a report on
Form 8-K for the event dated January 29, 2004, covering
Item 5 thereof.
On February 17, 2004, the registrant filed a report on
Form 8-K for the event dated February 13, 2004, covering
Item 5 thereof.
On March 23, 2004, the registrant filed a report on
Form 8-K for the event dated March 22, 2004, covering
Item 5 thereof.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
II-VI INCORPORATED
(Registrant)
Date: May 12, 2004 By: /s/ Carl J. Johnson
==========================
Carl J. Johnson
Chairman and Chief Executive Officer
Date: May 12, 2004 By: /s/ Craig A. Creaturo
==========================
Craig A. Creaturo
Chief Accounting Officer and Treasurer
29
EXHIBIT INDEX
-------------
Exhibit Number Description of Exhibit
- -------------- ----------------------
10.01 Second Amendment to Credit Agreement Filed herewith.
by and among II-VI Incorporated,
its subsidiary guarantors, various
lenders and PNC Bank, National
Association dated as of March 19, 2004.
31.01 Certification of the Chief Executive Filed herewith.
Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
of 1934, as amended, and Section 302
of the Sarbanes-Oxley Act of 2002
31.02 Certification of the principal financial Filed herewith.
officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
of 1934, as amended, and Section 302
of the Sarbanes-Oxley Act of 2002
32.01 Certification of the Chief Executive Filed herewith.
Officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as
amended, and 18 U.S.C. S.S. 1350 as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.02 Certification of the principal financial Filed herewith.
officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as
amended, and 18 U.S.C. S.S. 1350 as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002