INTERMAGNETICS
[GRAPHIC]-------------------
GENERAL CORPORATION
October 28, 2004
Mr. John Hartz
Senior Assistant Chief Accountant
United States Securities and Exchange Commission
Washington, DC 20549-0510
RE: FORM 10-K FOR THE YEAR ENDED MAY 30, 2004
GENERAL
1. We note that you have referred to experts under Critical Accounting
Policies ("These provisions are based upon, in part, the advice from
environmental engineers..."); Note B ("The Company obtained an
independent valuation from a nationally recognized valuation firm...);
and Note E ("The value of the options has been determined by an
independent valuation consultant...". Delete your reference to these
experts or identify them in future filings. We remind you that if you
refer to and identify these experts, you must include their consents
when the reference is included in a filing in the 1933 Act environment.
Refer to Section 436(b) of Regulation C.
RESPONSE:
The Company will revise future filings to delete any reference to the
advice of experts unless consents are included in accordance with
Section 436(b) of Regulation C.
ITEM 1. BUSINESS DESCRIPTION
Energy Technology Segment
2. On page 14, you mention that SuperPower, SEI and BOC have agreed to
share costs that are not covered by third party funding. In future
filing, please clarify whether or not there are any minimum commitments
under this agreement. If so, ensure that your contractual obligations
table adequately addresses these commitments.
RESPONSE:
In future filings we will state that these contracts are essentially
fixed price best efforts and, as such, do not require any minimum
commitments.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
3. In future filings, please consider the guidance presented in Release
No. 33-8350: Interpretation - Commission Guidance Regarding
Management's Discussion and Analysis of Financial Condition and Results
of Operations in future filings. Some areas to expand include:
o Expand on risks faced in the industry
o Quantify in more detail results of operations, such as changes in
sales year over year
o Improve organization to include headings and subheadings
o Focus on trends and events in business
RESPONSE:
We have reviewed Release No. 33-8350 and we will expand and quantify
our MD&A as appropriate. Additionally, we will include headings and
subheadings and focus on trends relevant to our business.
Results of Operations
4. You indicate on page 28 that 2004 margins in Energy Technology
increased over 2003 because of "the receipt of about $1.2 million of
funding for costs incurred in the prior year." Based upon your stated
accounting policies, it is unclear to us how the funding of costs
impacts your gross margins. Please advise and revise future filings to
clarify.
RESPONSE:
The above referenced funding was 100% gross profit because we incurred
the associated expense in a period before the funding was approved. For
example: during fiscal 2004 two government contracts were negotiated
with a provision to bill for costs expensed in fiscal 2003 that related
to the contracts desired result. These costs were not billable under
any other contracts that existed during fiscal 2003. Although the
Company had no responsibility to continue working on the project once
funds were exhausted, the Company decided the advancement of the
science was important enough to continue to support development of the
technology. In future filings the Company will more clearly describe
the transaction that gave rise to the margin improvement.
5. It is unclear to us what you mean by "...a decrease in our net
investment in the Energy Technology segment of about $805,000..." in
your discussion of fiscal year 2004 operating income. Please advise and
revise your future filings to clarify.
RESPONSE:
The Company internally views its contribution to the Energy Technology
Segment as an investment or commitment to developing the technology
rather than an operating loss. For example, whenever this segment's net
operating loss is reduced from period to period we view that as a
reduction in our "net investment". In future filings we will describe
the "net investment" with net operating loss parenthetically along side
as follows "net investment (net operating loss)".
6. We note your second pro forma presentation on page 32 includes
adjustments that may not be factually supportable and directly
attributable to the transaction. We also note that you may have
inappropriately eliminated nonrecurring charges incurred by Invivo.
Refer to Rule 11-02 of Regulation S-X and ensure that future filings
only include pro forma financial information that complies with this
guidance.
RESPONSE:
We believe these measures provide shareholders and prospective
shareholders with important information that is more representative of
the Company's performance. This information is provided to allow the
reader to understand the effectiveness or ineffectiveness of the
operating unit by giving a more detailed explanation of expenses. In
the future, however, the Company will include only such pro forma
information that complies with rule 11-02 of Regulation S-K.
7. We note your presentation of the non-GAAP measure operating income
excluding internal acquisition and integration costs. We note that you
incur similar costs in the first quarter of fiscal year 2005. As such,
it does not appear that this measure fully complies with Item
10(e)(ii)(B) of Regulation S-K. Please do not present such measure in
future filings.
RESPONSE:
Again, we present this information for clarification and as comparison
for the benefit of the reader and believe it accurately portrays the
underlying performance of the Company. That being said, we will no
longer present such measures in future filings.
Liquidity and Capital Resources - Contractual Obligations
8. You indicate under the section MRI Segment - Raw Materials and
Inventory that the Company has long-term supply agreements with two of
its vendors. However, we note that the purchase commitments presented
in the contractual obligations table only go through the end of fiscal
year 2005. Please ensure that future filings include any minimum
purchase requirements under these agreements.
RESPONSE:
The contracts discussed in this section do not contain minimum purchase
commitments. Rather, these are requirement contracts that commit these
vendors to supply materials as needed by Intermagnetics. We will
continue to ensure that our filings include the effect of minimum
purchase requirements, if any, in our supply agreements.
9. In future filings, include your interest commitments under your
interest-bearing debt in this table, or provide textual discussion of
this obligation below the table. If you provide a textual discussion,
the discussion should quantify the interest payments using the same
time frames stipulated in the table. In addition, address your funding
obligations under your pension plans. Refer to footnote 46 to Release
33-8350 "Interpretation: Commission Guidance Regarding Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
RESPONSE:
In future filings we will provide appropriate disclosure regarding
interest payments in the liquidity table. Additionally, the Company
will address the funding obligation under our pension plans.
Critical Accounting Policies and Estimates - Goodwill
10. As Goodwill has significantly increased over the prior years, in future
filings please identify and expand upon and identify your "significant
judgments" used by management to test for impairment.
RESPONSE:
Due to recent acquisitions goodwill has increased significantly in
fiscal 2004 and 2005. In future filings we will disclose our
significant judgments used to test impairment and, to the extent we
obtain their consent, our utilization of a qualified independent
consultant, Standard and Poor's Corporate Value Consulting, to support
our testing methodologies. We will expand our disclosure as follows:
Goodwill and other long-lived assets are reviewed for impairment
whenever events such as significant changes in the business climate,
plant closures, changes in product offerings, or other circumstances
indicate that the carrying amount may not be recoverable. The Company
performs a test for goodwill impairment annually during the second
quarter of each fiscal year. The determination of whether these assets
are impaired involves significant judgments such as long term revenue
projections, weighted average cost of capital, product cost reductions,
market penetration and sufficient Product Research and Development to
keep pace with market demand. Changes in strategy and/or market
conditions may result in adjustments to recorded asset balances.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Income Statement - Stock Based Compensation
11. In future filings, charges for noncash compensation should be
classified based on the nature of the cost (i.e. selling, general and
administrative).
RESPONSE:
In future filings non cash compensation will be classified based on the
nature of the cost as follows:
Product research and development $x,xxx
Selling, general and administrative:
Non-cash stock based compensation x,xxx
Other selling, general and administrative x,xxx
Amortization of Intangibles x,xxx
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x,xxx
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Note A - Significant Accounting Policies - Revenue Recognition
12. We note that you net the revenues you have earned under research and
development contracts and long-term development contracts against your
research and development costs. Differentiate for us your accounting
for (i) research and development contracts with the federal government,
(ii) research and development contracts for other customers and (iii)
long-term development contracts. Provide the authoritative literature
that supports your accounting for each of these types of contracts.
RESPONSE:
The following is the differentiation of the accounting of the various
revenue contracts and the supporting literature:
(i) The nature of our contracts with the US Government is that of a
contractor performing work on a Cost type Best- Efforts
contract. Per AICPA Guide: Audits of Federal Government
Contractors, Chapter 3, paragraph 3.50, Intermagnetics is
providing a Fixed-Price Best-Efforts R&D Cost-Sharing
arrangement. However, per paragraph 3.55, conditions relating to
the requirement to net the external funds received against our
research and development expenses are not met. The products we
are developing under these contracts are first generation high
temperature superconducting devices and second generation high
temperature superconducting wire. Typically, the customers for
these products are from the power generation and transmission
markets. The Federal Government is not expected to be the sole
or principal ultimate customer of the products directly
resulting from this R&D activity. Therefore per paragraph 3.55,
the conditions necessary to net funds against R&D expenses do
not exist. As a result, Intermagnetics must use the basic
accounting policy for government contracts. Intermagnetics
recognized the funding received from the US Government as
contract revenue, based on costs incurred to date plus earned
profit. Per SOP 81-1, this is consistent with the
percentage-of-completion method used to recognize contract
revenue.
(ii) To enhance our largest customer's competitiveness in the market
place, the Company enters into Research and Development
contracts with that customer to develop more functionality or
abilities that improve the performance and utility of the
products we provide. We have also entered into contracts with
other Magnetic Resonance Imaging system integrators providing
these types of services. Throughout this development process,
revenue is being recognized on a percent-of-completion method.
The costs incurred, as services are performed, provide a
reasonable estimate of results of completion and a reliable
measure of progress. Typically the milestone value does not
determine the value recognized as revenue. Most often programs
are invoiced at cost incurred plus earned profit which is less
than the milestone value primarily as a result of the program
progressing to schedule. The funding provided by these contracts
is not related to any future steady state production version of
the developed product. Pricing for the production version of the
developed product is negotiated separately. Therefore, this
revenue is for services performed and as such represent a
separate earnings process. Additionally, there are no continuing
performance obligations related to these services. The Company's
only obligation is to successfully complete the milestone. As
such, we believe the appropriate authoritative literature
regarding this type of contract is also SOP 81-1 and we use the
percentage-of-completion method to recognize this type of
contract revenue. See example below the next paragraph.
(iii) Under long-term development we typically are developing newer
more advanced products for our customers. These products are
revolutionary not evolutionary in nature and typically take
longer to develop than developing functionality, ability or
performance enhancements. However, the conditions are
essentially the same as item (ii) above. As such, throughout
this development process, revenue is again being recognized on a
percent-of-completion method. The costs incurred, as services
are performed, provide a reasonable estimate of results of
completion and a reliable measure of progress. Typically the
milestone value plus earned profit does not determine the value
recognized as revenue. Most often programs are invoiced at cost
incurred plus earned profit which is less than the milestone
value primarily as a result of the program progressing to
schedule. The funding provided by these contracts is not related
to any future steady state production version of the developed
product. Pricing for the production version of the developed
product is negotiated separately. Therefore, this revenue is for
services performed and as such represent a separate earnings
process. Additionally, there are no continuing performance
obligations related to these services. The Company's only
obligation is to successfully complete the milestone. As such,
we believe the appropriate authoritative literature regarding
this type of contract is also SOP 81-1 and we use the
percentage-of-completion method to recognize this type of
contract revenue.
13. Notwithstanding the above comment, if it is appropriate to record the
federal government funding you receive as an offset to your R&D
expense, (i) do not refer to such funding as "sales," (ii) remove this
disclosure from your revenue recognition accounting policy and (iii)
provide the disclosures required by paragraphs 3.56 of the AICPA Audit
and Accounting Guides - Audit of Federal Government Contractors.
RESPONSE:
Respectfully, we believe, based on the answer to 12.(i) above we do not
meet the requirements of paragraph 3.50 of the AICPA Audit and
Accounting Guides - Audit of Federal Government Contracts. As a result,
we further believe that: (i) referring to the funding received from the
Federal Government as "sales" is appropriate, (ii) the disclosure in
our revenue recognition accounting policy is appropriate and (iii) we
are not required to provide the disclosure required by paragraph 3.56
of the AICPA Audit and Accounting Guides - Audit of Federal Government
Contracts.
14. We note that when it appears probable that estimated costs will exceed
funding and the company is not successful in securing additional
funding, the company records the estimated additional expense before it
is incurred. For each type of contract addressed above, provide us the
authoritative literature you relied on and identify the nature of the
costs you accrue. Also quantify for us the amounts accrued in each
period presented.
RESPONSE:
For contracts referred to in item 12.(i), (Fixed-Price Best-Efforts R&D
Cost-Sharing Arrangements) we estimate the cost to complete and compare
it to the contract value. When it is evident the cost to complete is in
excess of the available funding the Company will accrue the estimated
overrun for labor, material and overhead and record that amount in cost
of sales. Frequently the Company is committed to maintaining a customer
relationship and / or advancing the science. As a result we deliver to
the final specification under the contract. The overrun amount is
evaluated monthly and adjusted for any appropriate change. If
additional funding is received the amount of funding is included in
revenue without any additional cost associated with that funding. When
we do not deem the science important enough to our business plan we
discontinue any further work on the project and negotiate the close out
of the contract with the appropriate government agency or customer.
Because we are the world leaders of second generation superconductivity
research we are usually able to find additional funding from a third
party or the respective government agency. During fiscal 2004 the
Company recognized expense of approximately $600,000 related to a
government contract for which the costs exceeded the funding. During
fiscal 2002 and 2003 no such overruns occurred. For contracts referred
to in item 12. (ii) and 12.(iii) as stated above "Typically the
milestone value does not determine the value recognized as revenue.
Most often programs are invoiced at cost incurred plus earned profit
which is less than the milestone value primarily as a result of the
program progressing to schedule." We believe the appropriate
authoritative literature regarding this type of contract is also SOP
81-1 and we use the percentage-of-completion method to recognize this
type of contract revenue.
Finally we would like to note that the revenue related to Funded
Research and Development was less the 10% of total revenue in each
fiscal year reported.
Note D - Long-Term Debt
15. The company discloses that its credit facility "contains a prepayment
provision whereby certain amounts borrowed must be repaid upon the
occurrence of certain specified events and conditions, including under
certain circumstances issuance of any equity, proceeds from the
issuance of any additional debt, certain asset sales..." In future
filings, please expand this disclosure by specifying the significant
events and conditions, circumstances and what amounts must be repaid.
RESPONSE:
In the future we will expand our disclosure to identify the significant
events, conditions, circumstances and amounts that are required to be
repaid under the credit facility when a prepayment is required.
Note E - Shareholders' Equity
16. In future filings provide the disclosures required by paragraph 2(e) of
SFAS 148 your Summary of Significant Accounting Policies footnote.
RESPONSE:
In future filings we will expand our disclosure to reflect the
requirements of paragraph 2(e) of SFAS No. 148 as follows:
STOCK-BASED COMPENSATION:
The intrinsic value method of accounting under the provisions of APB
No. 25, "Accounting for Stock Issued to Employees", is used for
stock-based compensation plans. Under the intrinsic value method,
compensation cost is measured as the excess, if any, of the quoted
market price of the stock at the grant date over the amount an employee
must pay to acquire the stock.
The following pro forma net income and earnings per share information
has been determined as if the Company had accounted for stock-based
compensation awarded under its stock option plans using the fair
value-based method.
(Dollars in Thousands, Except Per Share Amounts)
Fiscal Year Ended
----------------------------------------
May 30, May 25, May 26,
2004 2003 2002
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Net income (as reported) $ 14,860 $ 14,917 $ 20,589
Add recorded non-cash stock compensation 375 368 367
Less non-cash stock compensation under SFAS No. 123, net of tax (2,345) (2,211) (2,329)
-------- -------- --------
Pro forma Net Income $ 12,890 $ 13,074 $ 18,627
Earnings per Common Share (as reported):
Basic $ 0.59 $ 0.60 $ 0.84
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Diluted $ 0.58 $ 0.58 $ 0.80
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Earnings per Common Share (pro forma):
Basic $ 0.51 $ 0.53 $ 0.76
======== ======== ========
Diluted $ 0.51 $ 0.51 $ 0.72
======== ======== ========
The weighted average fair value of each option granted under the 1990
Stock Option Plan and the 2000 Stock Option and Award Plan during
fiscal years 2004, 2003 and 2002 was $12.301, $8.377 and $10.431,
respectively. The fair value of each option grant was estimated on the
date of the grant using the Black-Scholes Model with the following
weighted average assumptions. The risk-free interest rates for fiscal
years 2004, 2003 and 2002 were 4.7%, 3.0%, and 3.2%, respectively. The
expected volatility of the market price of the Company's Common Stock
for fiscal years 2004, 2003 and 2002 grants was 65.1%, 68.6% and 73.3%,
respectively. The expected average term of the granted options for
fiscal 2004, 2003 and 2002 was 7.9 years, 7.1 years and 5.1 years,
respectively. There was no expected dividend yield for the options
granted for fiscal years 2004, 2003 and 2002.
FORM 10-Q FOR THE QUARTER ENDED AUGUST 29, 2004
17. Amend your Form 10-Q to include the revised Item 307 of Regulation S-K
language in Item 4. Controls and Procedures. Refer to Rule 33-8238.
RESPONSE:
The Company will amend the quarter ended August 29, 2004 Form 10-Q to
include the revised Item 307 of Regulation S-K language in Item 4.
Controls and Procedures.
FORM 8-K/A#1 DATED SEPTEMBER 29, 2004
18. Amend your Form 8-K to include the unaudited condensed consolidated
financial statements of MRID that comply with the form and content
requirements of Rule 10-01(c) of Regulation S-X.
RESPONSE:
We will amend the form 8-K dated September 29, 2004 to comply with the
requirements of 10-01(c) of Regulation S-K.
Sincerely,
/s/ Glenn H. Epstein
Chairman & Chief Executive Officer