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 September 30, 2003
[ ] 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
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 November 7, 2003, 14,272,601 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 - September 30, 2003
and June 30, 2003. . . . . . . . . . . . . . . . . . . . . . . . . .3
Consolidated Statements of Earnings - Three months ended
September 30, 2003 and 2002. . . . . . . . . . . . . . . . . . . . .4
Consolidated Statements of Cash Flows - Three months ended
September 30, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements. . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . . . . 16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 4. Controls and Procedures. . . . . . . . . . . . . . . . . .23
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . .24
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
II-VI Incorporated and Subsidiaries
Consolidated Balance Sheets (Unaudited)
($000)
September 30, June 30,
2003 2003
------------ --------
Current Assets
Cash and cash equivalents $ 14,256 $ 15,583
Accounts receivable -
less allowance for doubtful
accounts and warranty
returns of $1,313 at
September 30, 2003 and
$1,266 at June 30, 2003 22,747 22,086
Inventories 25,851 24,384
Deferred income taxes 3,173 3,794
Prepaid and other current assets 1,724 1,968
------------ --------
Total Current Assets 67,751 67,815
Property, Plant & Equipment, net 59,286 57,954
Goodwill, net 28,987 28,987
Investment 1,776 1,792
Intangible Assets, net 5,355 4,643
Other Assets 1,938 1,602
------------ --------
$165,093 $162,793
============ ========
Current Liabilities
Accounts payable $ 6,958 $ 6,115
Accrued salaries and wages 3,185 2,809
Accrued bonuses 2,384 5,244
Income taxes payable 1,214 1,945
Accrued profit sharing contribution 346 1,263
Other accrued liabilities 4,668 3,316
Current portion of long-term debt 7,549 6,923
------------ --------
Total Current Liabilities 26,304 27,615
Long-Term Debt 15,358 16,782
Deferred Income Taxes 6,226 5,579
Other Liabilities 1,627 1,296
Total Liabilities 49,515 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 - 15,339,281 shares at
September 30, 2003; 15,268,876
shares at June 30, 2003 40,316 39,430
Accumulated other comprehensive income 987 930
Retained earnings 76,185 73,071
------------ --------
117,488 113,431
Less treasury stock, at cost,
1,068,880 shares 1,910 1,910
------------ --------
Total Shareholders' Equity 115,578 111,521
------------ --------
$165,093 $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
September 30,
2003 2002
---------- ----------
Revenues
Net sales:
Domestic $ 17,367 $ 14,154
International 14,686 15,055
---------- ----------
32,053 29,209
Contract research and development 2,041 2,362
---------- ----------
34,094 31,571
---------- ----------
Costs, Expenses & Other Income
Cost of goods sold 18,066 18,087
Contract research and development 1,991 2,244
Internal research and development 1,087 959
Selling, general and administrative 8,226 7,195
Interest expense 134 278
Other income, net (91) (114)
---------- ----------
29,413 28,649
---------- ----------
Earnings Before Income Taxes 4,681 2,922
Income Taxes 1,567 716
---------- ----------
Net Earnings $ 3,114 $ 2,206
========== ==========
Basic Earnings Per Share $ 0.22 $ 0.16
========== ==========
Diluted Earnings Per Share $ 0.21 $ 0.15
========== ==========
- - See notes to consolidated financial statements.
-4-
II-VI Incorporated and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($000)
Three Months Ended
September 30,
2003 2002
-------- --------
Cash Flows from Operating Activities
Net earnings $ 3,114 $ 2,206
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation 2,227 2,336
Amortization 131 85
Gain on foreign currency remeasurements
and transactions (83) (128)
Net loss on disposal or writedown of assets 34 49
Deferred income taxes 1,268 590
Increase (decrease) in cash from changes in:
Accounts receivable (150) 528
Inventories (907) (336)
Accounts payable 940 934
Other operating net assets (4,196) (1,098)
-------- --------
Net cash provided by operating activities 2,378 5,166
-------- --------
Cash Flows from Investing Activities
Additions to property, plant and equipment (2,753) (1,766)
Purchases of businesses (200) (3,205)
Dividend from (investment in)
unconsolidated business 8 9
Disposals of property, plant and equipment - 574
-------- --------
Net cash used in investing activities (2,945) (4,388)
-------- --------
Cash Flows from Financing Activities
Proceeds (payments) on short-term borrowings 250 (500)
Proceeds from long-term borrowings - 431
Payments on long-term borrowings (1,262) (1,267)
Proceeds from sale of common stock 418 11
-------- --------
Net cash used in financing activities (594) (1,325)
-------- --------
Effect of exchange rate changes on cash
and cash equivalents (166) 312
Net decrease in cash and cash equivalents (1,327) (235)
Cash and Cash Equivalents
at Beginning of Period 15,583 9,610
-------- --------
Cash and Cash Equivalents at End of Period $ 14,256 $ 9,375
======== ========
Non-cash transactions:
Accrued purchase price for assets acquired $ 1,800 $ -
======== ========
Cash paid for interest $ 158 $ 373
======== ========
Cash paid for income taxes $ 727 $ 76
======== ========
- - See notes to consolidated financial statements.
-5-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
Note A - Basis of Presentation
---------------------
The consolidated financial statements for the three-month periods ended
September 30, 2003 and 2002 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 to shareholders on Form 10-K for the
year ended June 30, 2003. The consolidated results of operations for the
three-month periods ended September 30, 2003 and 2002 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):
September 30, June 30,
2003 2003
------------ ---------
Billed
Completed Contracts $ - $ 75
Contracts in Progress 1,793 1,526
------------ ---------
1,793 1,601
Unbilled 2,002 1,988
------------ ---------
$ 3,795 $ 3,589
============ =========
Note C - Inventories
-----------
The components of inventories were as follows ($000):
September 30, June 30,
2003 2003
------------ ---------
Raw materials $ 6,797 $ 5,729
Work in progress 11,946 11,034
Finished goods 7,108 7,621
------------ ---------
$ 25,851 $ 24,384
============ =========
-6-
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):
September 30, June 30,
2003 2003
------------ ---------
Land and land improvements $ 1,453 $ 1,453
Buildings and improvements 31,976 31,642
Machinery and equipment 75,663 72,424
------------ ---------
109,092 105,519
Less accumulated depreciation 49,806 47,565
------------ ---------
$ 59,286 $ 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 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 have recorded goodwill as of June 30, 2003 and 2002. Based on the
results of these analyses, the Company's goodwill 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 September 30, 2003 and June
30, 2003 were as follows ($000):
September 30, 2003 June 30, 2003
----------------------------------- ------------------------------------
Gross Net Gross Net
Carrying Accumulated Book Carrying Accumulated Book
($000) Amount Amortization Value Amount Amortization Value
Patents $2,681 $ (527) $2,154 $1,867 $ (493) $1,374
Trademark 1,491 (236) 1,255 1,491 (217) 1,274
Customer Lists 2,392 (621) 1,771 2,360 (557) 1,803
Other 750 (575) 175 750 (558) 192
------ ------- ------ ------ ------- ------
Total $7,314 $(1,959) $5,355 $6,468 $ (1,825) $4,643
Amortization expense recorded on the intangible assets for the three
months ended September 30, 2003 and 2002 was $131,000 and $85,000,
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 remeasurement of the portion
relating to the Company's German distributor. At September 30, 2003, the
estimated amortization expense for existing intangible assets for each of
the five succeeding fiscal years is as follows ($000):
-7-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note E - Goodwill and Intangible Assets, Cont'd.
---------------------------------------
Year Ended June 30,
- ---------------------------------------------------
Remaining fiscal 2004 $435
2005 580
2006 527
2007 428
2008 420
Note F - Debt
----
The components of debt were as follows ($000's):
September 30, June 30,
2003 2003
- -------------------------------------------------------------------------
Line of credit, interest at the
LIBOR Rate, as defined, plus 1.00%
and 1.25%, respectively $4,750 $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 15,000 16,250
Pennsylvania Industrial Development Authority
(PIDA) term note, interest at 3.00%, payable
in monthly installments through October 2011 440 452
Yen denominated term note, interest at the
Japanese Yen Base Rate, as defined, plus 1.49%,
principal payable in full in September 2007 2,717 2,503
- -------------------------------------------------------------------------
Total debt 22,907 23,705
Current portion of long-term debt (7,549) (6,923)
- -------------------------------------------------------------------------
Long-term debt $15,358 $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 2.37% and 2.62% at
September 30, 2003 and June 30, 2003, respectively. The Company had
available $15.3 million and $15.5 million under its line of credit as of
September 30, 2003 and June 30, 2003, respectively.
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 0.07% at September 30, 2003 and June 30, 2003, respectively.
-8-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
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
($000 except per share data):
Three Months Ended
September 30
- ----------------------------------------------------------
Net earnings $ 3,114 $ 2,206
Divided by:
Weighted average common
shares outstanding 14,228 14,034
- ----------------------------------------------------------
Basic earnings per share $ 0.22 $ 0.16
- ----------------------------------------------------------
Net earnings $ 3,114 $ 2,206
Divided by:
Weighted average common
shares outstanding 14,228 14,034
Dilutive effect of
stock options 411 337
- ----------------------------------------------------------
Dilutive weighted average
common shares 14,639 14,371
- ----------------------------------------------------------
Diluted earnings per share $ 0.21 $ 0.15
- ----------------------------------------------------------
Note H - Comprehensive Income
--------------------
The components of comprehensive income were as follows for the periods
indicated ($000):
Three Months Ended
September 30,
-------------------
2003 2002
- ------------------------------------------------------------------
Net earnings $ 3,114 $ 2,206
Other comprehensive income (loss):
Foreign currency translation adjustments,
net of income tax expense (benefit) of $19
and $(35), respectively 57 (144)
- ------------------------------------------------------------------
Comprehensive income $ 3,171 $ 2,062
- ------------------------------------------------------------------
-9-
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 "Other" category is primarily the
aggregation of the Company's eV PRODUCTS division, the Company's Wide
Bandgap (WBG) Materials group, the Company's corporate research and
development group and remaining corporate activities.
The Infrared Optics segment is divided into the geographic locations in
the United States, Singapore, China, Germany, Japan, Belgium and the
United Kingdom. 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.
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.
All entities comprised in the "Other" category are located in the United
States. 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 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.
-10-
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 September 30, 2003
-------------------------------------------------------------------
Infrared Near-Infrared Military-Infrared
Optics Optics Optics Other Total
- -----------------------------------------------------------------------------------------------------
Revenues $ 19,906 $ 5,951 $ 5,682 $ 2,555 $ 34,094
Segment earnings (loss) 5,451 544 (6) (1,265) 4,724
Interest expense - - - - (134)
Other expense, net - - - - 91
Earnings before income taxes - - - - 4,681
Depreciation and amortization 944 547 398 469 2,358
Segment assets 69,915 26,442 39,538 29,198 165,093
Expenditures for property,
plant and equipment 839 410 322 1,267 2,838
Equity investment - - - 1,776 1,776
Goodwill 5,516 1,927 21,544 - 28,987
- ------------------------------ -------- -------- -------- -------- --------
Three Months Ended September 30, 2002
-------------------------------------------------------------------
Infrared Near-Infrared Military-Infrared
Optics Optics Optics Other Total
- -----------------------------------------------------------------------------------------------------
Revenues $ 18,354 $ 5,467 $ 5,794 $ 1,956 $ 31,571
Segment earnings (loss) 4,231 362 257 (1,764) 3,086
Interest expense - - - - (278)
Other expense, net - - - - 114
Earnings before income taxes - - - - 2,922
Depreciation and amortization 1,056 552 424 389 2,421
Segment assets 63,121 25,436 38,033 26,398 152,988
Expenditures for property,
plant and equipment 652 185 394 535 1,766
Equity investment - - - 1,722 1,722
Goodwill 5,516 1,927 21,544 - 28,987
- ------------------------------ -------- -------- -------- -------- --------
-11-
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 $3.4 million and $2.2 million as of September 30, 2003
and June 30, 2003, respectively. These amounts were recorded in Other
accrued liabilities as of September 30, 2003 and in Prepaid and other
current assets as of June 30, 2003 on the Consolidated Balance Sheet.
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 increased (decreased) net earnings by $(137,000) and
$65,000 for the three months ended September 30, 2003 and 2002,
respectively.
To satisfy certain provisions of its credit agreement (see Note F), on
March 6, 2003 the Company entered into a one-year interest rate cap with
a notional amount of $8.8 million replacing an interest rate cap that
expired on March 5, 2003. 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 3.00%. At September 30, 2003 the one-month LIBOR rate was
1.12%. 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 months ended September
30, 2003 was immaterial.
-12-
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
September 30, 2003 September 30, 2002
--------------------------------- ---------------------------------
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
- --------------------------- --------------------------------- -------------------------------
<s> <c> <c> <c> <c> <c> <c>
Net earnings and earnings
per common share, as reported $ 3,114 $ 0.22 $ 0.21 $ 2,206 $0.16 $0.15
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 (170) (0.01) (0.01) (143) (0.01) (0.01)
- --------------------------- --------- ------ -------- -------- ------ -------
Pro forma net earnings and
earnings per common share $ 2,944 $ 0.21 $ 0.20 $ 2,063 $0.15 $0.14
========= ====== ======== ======== ====== =======
-13-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note K - Stock-Based Compensation, Cont'd.
---------------------------------
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
September 30, 2003 September 30, 2002
- ----------------------------------------------------------------------
Risk free interest rate 3.63% 3.80%
Expected volatility 61% 43%
Expected life of options 7.04 years 7.00 years
Expected dividends none none
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. If actual returns are not consistent with the historical data
used to calculate these estimates, net sales could either be understated
or overstated.
The following table summarizes the change in the carrying value of the
Company's warranty reserve as of and for the three months ended September
30, 2003 and as of and for the year ended June 30, 2003 ($000).
Three Months Ended Year Ended
September 30, 2003 June 30, 2003
- ----------------------------------------------------------------------
($000)
Balance - Beginning of Period $504 $419
Expense and writeoffs, net 12 85
Other - -
- ----------------------------------------------------------------------
Balance - End of Period $516 $504
- ----------------------------------------------------------------------
Note M - 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 are applicable immediately to all variable interest entities created
after January 31, 2003 and variable interest entities in which an
enterprise obtains an interest in after that date, and for variable
interest entities created before this date, the provisions have been
deferred to be effective October 1, 2003. We are currently evaluating
the provisions of this interpretation; however, we do not believe they
will have a material impact on our accounting for existing investments.
Note N - 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 September 30, 2003, the Company had
paid $200,000 of the purchase price.
-14-
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note O - 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 instituted. In addition, the Company may be entitled to
punitive damages and reimbursement of its attorneys' fees and costs at
the discretion of the court. 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.
-15-
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 of 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 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 September 30, 2003, there have been no significant changes with
regard to the critical accounting policies disclosed in Management's
Discussion and Analysis in our Annual Report on Form 10-K for the Year
ended June 30, 2003.
-16-
Results of Operations
- ---------------------
Overview
Net earnings for the first quarter of fiscal 2004 were $3,114,000 ($0.21
per share-diluted) on revenues of $34,094,000. This compares to net
earnings of $2,206,000 ($0.15 per share-diluted) on revenues of
$31,571,000 in the first quarter of fiscal 2003. The increase of 8% in
revenues for the first quarter of fiscal 2003 compared to the same period
last fiscal year is primarily due to stronger shipments of infrared and
near-infrared optics to both OEM and aftermarket customers.
Bookings for the first quarter of fiscal 2004 remained steady at
$34,582,000 compared to $34,873,000 for the same period last fiscal year.
Infrared and military infrared optics bookings strengthened while near-
infrared optics decreased primarily due to the receipt of a $2.5 million
Yttrium Vanadate research and development bookings recorded in the first
quarter of last fiscal year. Bookings for contract research and
development for the first quarter of fiscal year 2004 were $1,312,000
compared to $5,390,000 for the same period last fiscal year. Contract
research and development bookings in the first quarter of the prior
fiscal year included the Title III contract at the Company's Wide Bandgap
group of approximately $2.0 million and the Yttrium Vanadate contract at
the Company's Near-Infrared Optics segment of approximately $2.5 million.
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 twelve months due to the inherent
uncertainty of an order that far out in the future.
Segment earnings, which is defined as earnings before income taxes,
interest and other income or expense, for the first quarter of fiscal
2004 increased 53% to $4,724,000 compared to $3,086,000 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. Higher sales volume coupled with
manufacturing yield improvements also contributed to the improved segment
earnings.
Bookings, revenues and segment earnings or (loss) for the Company's
reportable segments are discussed below. See also the segment reporting
discussion in Note I of the notes to consolidated financial statements.
Infrared Optics
Bookings for the first quarter of fiscal 2004 for Infrared Optics
increased 7% to $22,324,000 from $20,768,000 in the first quarter of last
fiscal year. This increase was attributable in part to an increase in
U.S. OEM orders this fiscal quarter as well as stronger aftermarket order
intake in the current fiscal quarter compared to the last fiscal quarter.
The remaining quarter over quarter improvement was due to stronger order
volume from customers in Japan partially offset by weaker European
activity due to the European vacation period during July and August.
Orders received for laser markings applications continued to gain
momentum during the current fiscal quarter.
Revenues for the first quarter of fiscal 2004 for Infrared Optics
increased 8% to $19,906,000 from $18,354,000 in the first quarter of last
fiscal year. This increase was primarily attributable to increased
shipment volume for both OEM and aftermarket customers. The infrared
optics business continues to strengthen as the U.S. and Japan economies
rebound.
Segment earnings for the first quarter increased 29% to $5,451,000 from
$4,231,000 in the first quarter of last fiscal year. The improvement in
segment earnings for the current fiscal three month period as compared to
the same period of the last fiscal year was due to a combination of
increased sales volume and the increased level of manufacturing at the
Company's Asian facilities in Singapore and China.
Near-Infrared Optics
Bookings for the first quarter of fiscal 2004 for Near-Infrared Optics
decreased 33% to $4,610,000 from $6,900,000 in the first quarter of last
fiscal year. The decrease was due to the receipt of a large research and
-17-
development contract during the first quarter of last fiscal year.
Commercial bookings for the first quarter of fiscal 2004 in the product
lines used in the medical, semiconductor and defense applications
increased 5% from bookings in the first quarter of last fiscal year.
Revenues for the first quarter for Near-Infrared Optics increased 9% to
$5,951,000 compared to $5,467,000 in the first quarter of last fiscal
year due to increased shipments in the optics and cavities product lines
used in military and semiconductor applications.
Segment earnings for the first quarter of fiscal 2004 increased 50% to
$544,000 from $362,000 in the first quarter of last fiscal year. This
improvement reflected overall stronger gross margins in both the
commercial and contract research and development areas.
Military Infrared Optics
Bookings for the first quarter of fiscal 2004 for Military Infrared
Optics increased 33% to $6,105,000 as compared to $4,576,000 in the first
quarter of last fiscal year. The overall increase in bookings was due to
increased domes, windows and other component parts bookings offset by a
decrease in our sapphire product line. A Javelin missile dome order was
received in the current quarter of which the first twelve months of
anticipated shipments was recorded in accordance with the Company's
bookings policy. The decrease in the sapphire activity was primarily due
to the IFTS program booked in fiscal year 2003 with no comparable order
in the first quarter of fiscal year 2004.
Revenues for the first quarter of fiscal 2004 for Military Infrared
Optics remained steady at $5,682,000 compared to $5,794,000 in the first
quarter of the last fiscal year.
For the first quarter of fiscal 2004, the Military Infrared Optics
segment incurred a segment loss of $6,000 compared to segment earnings of
$257,000 in the first quarter of the prior fiscal year. The additional
production and development costs incurred during the ramping up of the
sapphire business more than offset the segment earnings that resulted
from the domes, windows and other component parts business.
Other
The Company's Other category includes the combined operations of the
Company's eV PRODUCTS division, the Company's Wide Bandgap Materials
(WBG) group and the Company's corporate research and development group.
Combined bookings for the first quarter of fiscal 2004 from these
operations decreased 41% to $1,543,000 as compared to $2,629,000 in the
first quarter of last fiscal year. The decrease in bookings was due to
the receipt of the Title III research and development contract awarded to
the WBG group in the first quarter of last fiscal year not recorded in
the current fiscal first quarter. The decrease was partially offset by
the recording of the first year of a three year U.S. Army research and
development contract awarded to the Company's eV PRODUCTS division.
Revenues for the first quarter from these operations increased 31% to
$2,555,000 compared to $1,956,000 in the first quarter of the last fiscal
year. The higher revenues are a direct result of the higher shipments of
hand-held spectrometers for Home Land Security applications, the
increased shipments of bone-mineral densitometer detectors and the higher
level of research and development billings by the Company's eV PRODUCTS
division.
The segment loss for the first quarter of fiscal 2004 of $1,265,000
decreased 28% from the segment loss of $1,764,000 in the first quarter of
the prior fiscal year. The decrease in the loss was primarily a result
of the incremental gross margin on increased revenues of these
operations.
Overall
Manufacturing gross margin, which is defined as net sales less cost of
goods sold, for the first quarter of fiscal 2004 was $13,987,000 or 44%
of revenues compared to $11,122,000 or 38% of revenues for the same
-18-
period last fiscal year. The increased sales volume for the current
three month period as compared to the same period last fiscal year and
the increase in the amount of manufacturing done at the Company's
Singapore and China facilities impacted gross margins favorably.
Contract research and development gross margin, which is calculated as
contract research and development revenues less expenses, for the first
quarter of fiscal 2004 was $50,000 or 2% of research and development
revenues compared to a gross margin of $118,000 or 5% of research and
development revenues 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 period as compared to the same period 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 a blend of cost plus
fixed fee, cost reimbursement and percentage of completion contract
activities.
Company-funded internal research and development expenses for the first
quarter of fiscal 2004 were $1,087,000 compared to $959,000 for the same
period last fiscal year. Expenses for both periods were 3% 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 first quarter of
fiscal 2004 were $8,226,000 or 24% of revenues compared to $7,195,000 or
23% of revenues for the same period last fiscal year. The dollar and
percentage increases for the quarter as compared to the same period last
fiscal year reflect increased legal and professional fees during the
quarter to defend and protect its trade secrets and intellectual property
(see Note O to the notes to consolidated financial statements). In
addition to the increase in legal and professional fees, the Company
recorded higher salary expenses as compared to the same quarter last
fiscal year for its worldwide profit driven bonus program.
Interest expense for the first quarter of fiscal 2004 was $134,000
compared to $278,000 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 September 30, 2003 as
compared to the same period last fiscal year.
Other income for the first quarter of fiscal 2004 was $91,000 compared to
other income of $114,000 for the same period last fiscal year. These
income items included foreign currency gains, interest income, royalty
income and other income items. Other income was partially offset by the
minority interest in II-VI/L.O.T. and other expense items.
The Company's year-to-date effective income tax rate is 33% compared to
an effective income tax rate of 25% 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.
Liquidity and Capital Resources
- -------------------------------
In the first three months of fiscal 2004, net cash provided by operating
activities of $2.4 million and cash on hand was used primarily to fund
$2.8 million in property, plant and equipment, and to pay down $1.0
million of debt. Cash transactions for the first three months of fiscal
2004 plus cash on hand at the beginning of the fiscal year resulted in a
cash position of $14.3 million at September 30, 2003.
The Company had available $15.3 million and $15.5 million under its line
of credit option of the credit facility as of September 30, 2003 and June
30, 2003, respectively. The Company is obligated on the first day of
each fiscal quarter to pay $1.9 million on the first day of each fiscal
quarter thereafter until the term loan is repaid. At September 30, 2003,
$15 million remained outstanding on the term loan (see Note F to the
notes to consolidated financial statements).
-19-
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
-20-
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 September 30, 2003.
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 a 10% change in the Yen to dollar exchange rate
would have changed revenues by approximately $374,000 for the quarter
ended September 30, 2003.
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 $100,000 and $65,000 for the
quarters ended September 30, 2003 and 2002, respectively.
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 rate; 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 6, 2003, the Company entered into an interest rate cap,
replacing an existing interest rate cap that matured on March 5, 2003,
with a notional amount of $8.8 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. In the fiscal
quarter ended September 30, 2003, the Company decreased its borrowings by
$0.8 million. As of September 30, 2003, the total borrowings of $22.9
million include $15.0 million under the term loan option, $4.8 million
under the line of credit option, $2.7 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 $58,000 for the fiscal quarter ended September 30, 2003.
-21-
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.
-22-
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
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
(b) Reports on Form 8-K.
On August 7, 2003, the registrant filed a report
on Form 8-K for the event dated August 6, 2003,
covering Item 12 thereof.
-23-
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: November 13, 2003 By: /s/ Carl J. Johnson
Carl J. Johnson
Chairman and Chief Executive Officer
Date: November 13, 2003 By: /s/ Craig A. Creaturo
Craig A. Creaturo
Chief Accounting Officer and Treasurer
-24-
EXHIBIT INDEX
Exhibit Description
Number of Exhibit
------- -----------
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
-25-