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 December 31, 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 February 6, 2004, 14,338,382 shares of Common Stock, no
par value, of the registrant were outstanding.
II-VI INCORPORATED
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INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets - December 31, 2003
and June 30, 2003. . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Earnings - Three months ended
December 31, 2003 and 2002. . . . . . . . . . . . . . . . . .4
Consolidated Statements of Earnings - Six months ended
December 31, 2003 and 2002. . . . . . . . . . . . . . . . . .5
Consolidated Statements of Cash Flows - Six months ended
December 31, 2003 and 2002. . . . . . . . . . . . . . . . . .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. . . . . . . . . . . . . . . . . . . . . .25
Item 4. Controls and Procedures. . . . . . . . . . . . . . 26
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of
Security Holders. . . . . . . . . . . . . . . . . . . . . . 26
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)
December 31 , June 30,
2003 2003
------------ --------
Current Assets
Cash and cash equivalents $ 15,259 $ 15,583
Accounts receivable - less
allowance for doubtful accounts
and warranty returns of $1,298 at
December 31, 2003 and $1,266 at
June 30, 2003 21,126 22,086
Inventories 28,067 24,384
Deferred income taxes 3,489 3,794
Prepaid and other current assets 1,750 1,968
------------ --------
Total Current Assets 69,691 67,815
Property, Plant & Equipment, net 59,920 57,954
Goodwill, net 28,987 28,987
Investment 1,785 1,792
Intangible Assets, net 6,309 4,643
Other Assets 2,189 1,602
------------ --------
$ 168,881 $162,793
============ ========
Current Liabilities
Accounts payable $ 5,461 $ 6,115
Accrued salaries and wages 3,132 2,809
Accrued bonuses 3,563 5,244
Income taxes payable 1,779 1,945
Accrued profit sharing contribution 698 1,263
Other accrued liabilities 5,782 3,316
Current portion of long-term debt 7,549 6,923
------------ --------
Total Current Liabilities 27,964 27,615
Long-Term Debt 13,057 16,782
Deferred Income Taxes 6,186 5,579
Other Liabilities 1,933 1,296
Total Liabilities 49,140 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 - 15,362,611 shares at
December 31, 2003; 15,268,876
shares at June 30, 2003 40,645 39,430
Accumulated other comprehensive income 1,492 930
Retained earnings 79,514 73,071
------------ --------
121,651 113,431
Less treasury stock, at cost,
1,068,880 shares 1,910 1,910
------------ --------
Total Shareholders' Equity 119,741 111,521
------------ --------
$168,881 $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
December 31,
2003 2002
---------- ----------
Revenues
Net sales:
Domestic $ 13,201 $ 15,233
International 19,772 13,665
---------- ----------
32,973 28,898
Contract research and development 1,662 2,533
---------- ----------
34,635 31,431
---------- ----------
Costs, Expenses & Other Income
Cost of goods sold 18,991 17,540
Contract research and development 1,376 2,132
Internal research and development 1,367 552
Selling, general and administrative 7,782 6,692
Interest expense 117 247
Other (income) expense, net (149) 601
---------- ----------
29,484 27,764
---------- ----------
Earnings Before Income Taxes 5,151 3,667
Income Taxes 1,727 898
---------- ----------
Net Earnings $ 3,424 $ 2,769
========== ==========
Basic Earnings Per Share $ 0.24 $ 0.20
========== ==========
Diluted Earnings Per Share $ 0.23 $ 0.19
========== ==========
- - See notes to consolidated financial statements.
4
II-VI Incorporated and Subsidiaries
Consolidated Statements of Earnings (Unaudited)
($000 except per share data)
Six Months Ended
December 31,
2003 2002
---------- ----------
Revenues
Net sales:
Domestic $ 30,568 $ 29,387
International 34,458 28,720
---------- ----------
65,026 58,107
Contract research and development 3,703 4,895
---------- ----------
68,729 63,002
---------- ----------
Costs, Expenses & Other Income
Cost of goods sold 37,057 35,627
Contract research and development 3,367 4,376
Internal research and development 2,454 1,511
Selling, general and administrative 16,008 13,887
Interest expense 251 525
Other (income) expense, net (240) 487
---------- ----------
58,897 56,413
---------- ----------
Earnings Before Income Taxes 9,832 6,589
Income Taxes 3,294 1,614
---------- ----------
Net Earnings $ 6,538 $ 4,975
========== ==========
Basic Earnings Per Share $ 0.46 $ 0.35
========== ==========
Diluted Earnings Per Share $ 0.45 $ 0.35
========== ==========
- - See notes to consolidated financial statements.
5
II-VI Incorporated and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
($000)
Six Months Ended
December 31,
2003 2002
-------- --------
Cash Flows from Operating Activities
Net earnings $ 6,538 $ 4,975
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation 4,456 4,628
Amortization 289 255
(Gain) loss on foreign currency
remeasurements and transactions (188) 138
Net loss on disposal or writedown of assets 114 50
Deferred income taxes 912 36
Increase (decrease) in cash from changes in:
Accounts receivable 1,634 884
Inventories (2,020) (1,881)
Accounts payable (731) 471
Other operating net assets (396) 2,089
-------- --------
Net cash provided by operating activities 10,608 11,645
-------- --------
Cash Flows from Investing Activities
Additions to property, plant and equipment (5,719) (2,852)
Purchases of businesses (1,954) (2,755)
Dividend from unconsolidated business 8 9
Proceeds from sale of fixed assets - 574
-------- --------
Net cash used in investing activities (7,665) (5,024)
-------- --------
Cash Flows from Financing Activities
Payments on short-term borrowings, net (250) (1,319)
Payments on long-term borrowings (3,147) (2,534)
Proceeds from exercise of stock options 586 44
Dividends paid to minority owners
of majority-owned subsidiaries (95) -
-------- --------
Net cash used in financing activities (2,906) (3,809)
-------- --------
Effect of exchange rate changes on cash
and cash equivalents (361) 379
Net increase (decrease) in cash
and cash equivalents (324) 3,191
Cash and Cash Equivalents at
Beginning of Period 15,583 9,610
-------- --------
Cash and Cash Equivalents at End of Period $15,259 $12,801
======== ========
Non-cash transactions:
Accrued purchase price for assets acquired $ 1,800 $ -
======== ========
Cash paid for interest $ 280 $ 638
======== ========
Cash paid for income taxes $ 2,079 $ 436
======== ========
- - 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 six month
periods ended December 31, 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 on Form 10-K for
the year ended June 30, 2003. The consolidated results of operations
for the three and six month periods ended December 31, 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):
December 31, June 30,
2003 2003
------------ ---------
Billed
Completed Contracts $ - $ 75
Contracts in Progress 1,400 1,526
------------ ---------
1,400 1,601
Unbilled 626 1,988
------------ ---------
$ 2,026 $ 3,589
============ =========
Note C - Inventories
The components of inventories were as follows ($000):
December 31, June 30,
2003 2003
------------ ---------
Raw materials $ 6,694 $ 5,729
Work in progress 12,514 11,034
Finished goods 8,859 7,621
------------ ---------
$ 28,067 $ 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):
December 31, June 30,
2003 2003
------------ ---------
Land and land improvements $ 1,453 $ 1,453
Buildings and improvements 32,117 31,642
Machinery and equipment 78,596 72,424
------------ ---------
112,166 105,519
Less accumulated depreciation 52,246 47,565
------------ ---------
$ 59,920 $ 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 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 December 31, 2003 and June
30, 2003 were as follows ($000):
December 31, 2003 June 30, 2003
----------------------------------- ------------------------------------
Gross Net Gross Net
Carrying Accumulated Book Carrying Accumulated Book
Amount Amortization Value Amount Amortization Value
-------- ------------ ----- -------- ------------ -----
Patents $2,681 $ (588) $2,093 $1,867 $ (493) $1,374
Trademark 1,491 (255) 1,236 1,491 (217) 1,274
Customer Lists 3,528 (703) 2,825 2,360 (557) 1,803
Other 750 (595) 155 750 (558) 192
------ -------- ------ ------ -------- ------
Total $8,450 $ (2,141) $6,309 $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 O), 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 $158,000 and
$289,000, for the three and six month periods ended December 31, 2003
and $169,000 and $255,000 for the three and six month periods ended
December 31, 2002. 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 distributor. At December
31, 2003, 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 $388
2005 678
2006 624
2007 527
2008 518
- --------------------------------------------------------------------
Note F - Debt
The components of debt were as follows ($000's):
December 31, 2003 June 30, 2003
Line of credit, interest at the LIBOR Rate, as defined,
plus 1.00% and 1.25%, respectively $ 4,250 $ 4,500
Term loan, interest at the LIBOR Rate, as defined, 13,125 16,250
plus 1.00% and 1.25%, respectively, payable in quarterly
installments through August 2005
Pennsylvania Industrial Development Authority
(PIDA) term note, interest at 3.00%, payable in
monthly installments through October 2011 428 452
Yen denominated term note, interest at the Japanese Yen Base Rate,
as defined, plus 1.49%, principal payable in full in September 2007 2,803 2,503
- ---------------------------------------------------------------------- ---------------- -------------
Total debt 20,606 23,705
Current portion of long-term debt (7,549) (6,923)
- ---------------------------------------------------------------------- ---------------- -------------
Long-term debt $ 13,057 $ 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 2.16% and
2.62% at December 31, 2003 and June 30, 2003, respectively. The Company
had available $15.7 million and $15.5 million under its line of credit
as of December 31, 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 December 31, 2003 and June 30, 2003.
9
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 Six Months Ended
December 31 December 31,
- ---------------------------- ------------------- -----------------
(000 except per share data) 2003 2002 2003 2002
Net earnings $ 3,424 $ 2,769 $ 6,538 $ 4,975
Divided by:
Weighted average shares 14,285 14,039 14,256 14,036
- ---------------------------- ------- ------- ------- ------
Basic earnings per share $ 0.24 $ 0.20 $ 0.46 $ 0.35
- ---------------------------- ------- ------- ------- ------
Net earnings $ 3,424 $ 2,769 $ 6,538 $ 4,975
Divided by:
Weighted average shares 14,285 14,039 14,256 14,036
Dilutive effect of common
stock equivalents 386 369 400 352
- ---------------------------- ------- ------- ------- ------
Diluted weighted average
common shares 14,671 14,408 14,656 14,388
- ---------------------------- ------- ------- ------- ------
Diluted earnings per share $ 0.23 $ 0.19 $ 0.45 $ 0.35
- ---------------------------- ------- ------- ------- ------
Note H - Comprehensive Income
The components of comprehensive income were as follows for the periods
indicated ($000):
Three Months Ended Six Months Ended
December 31, December 31,
------------------- -----------------
2003 2002 2003 2002
- ---------------------------- ------ ------ ------ ------
Net earnings $3,424 $2,769 $6,538 $4,975
Other comprehensive income (loss):
Foreign currency translation adjustments 505 121 562 (23)
net of income tax expense (benefit) of
$254 and $283, respectively, for the
three and six months ended
December 31, 2003 and $30 and ($6),
respectively, for the three and six
months ended December 31, 2002.
- ---------------------------- ------ ------ ------ ------
Comprehensive income $3,929 $2,890 $7,100 $4,952
- ---------------------------- ------ ------ ------ ------
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 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, Switzerland, 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.
The Compound Semiconductor Group is 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.
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 December 31, 2003
-------------------------------------------------------------------
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- -----------------------------------------------------------------------------------------------------
Revenues $19,891 $ 5,181 $ 6,517 $ 3,046 $ 34,635
Segment earnings (loss) 5,158 148 245 (432) 5,119
Interest expense - - - - (117)
Other income, net - - - - 149
Earnings before income taxes - - - - 5,151
Depreciation and amortization 951 592 369 475 2,387
Segment assets 72,143 26,439 38,648 31,651 168,881
Expenditures for property,
plant and equipment 1,308 313 687 573 2,881
Equity investment - - - 1,785 1,785
Goodwill, net 5,516 1,927 21,544 - 28,987
Three Months Ended December 31, 2002
-------------------------------------------------------------------
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- -----------------------------------------------------------------------------------------------------
Revenues $17,572 $ 5,679 $ 5,799 $ 2,381 $ 31,431
Segment earnings (loss) 4,416 396 234 (531) 4,515
Interest expense - - - - (247)
Other expense, net - - - - (601)
Earnings before income taxes - - - - 3,667
Depreciation and amortization 1,139 553 415 355 2,462
Segment assets 64,683 24,808 37,671 28,965 156,127
Expenditures for property,
plant and equipment 466 135 256 229 1,086
Equity investment - - - 1,760 1,760
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.
Six Months Ended December 31, 2003
-------------------------------------------------------------------
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- -----------------------------------------------------------------------------------------------------
Revenues $39,797 $11,132 $12,199 $5,601 $68,729
Segment earnings (loss) 10,609 692 239 (1,697) 9,843
Interest expense - - - - (251)
Other income, net - - - - 240
Earnings before income taxes - - - - 9,832
Depreciation and amortization 1,895 1,139 767 944 4,745
Expenditures for property,
plant and equipment 2,147 723 1,009 1,840 5,719
Six Months Ended December 31, 2002
-------------------------------------------------------------------
Military Compound
Infrared Near-Infrared Infrared Semiconductor
Optics Optics Optics Group Total
- -----------------------------------------------------------------------------------------------------
Revenues $35,926 $11,146 $11,593 $4,337 $63,002
Segment earnings (loss) 8,647 758 491 (2,295) 7,601
Interest expense - - - - (525)
Other income, net - - - - (487)
Earnings before income taxes - - - - 6,589
Depreciation and amortization 2,195 1,105 839 744 4,883
Expenditures for property,
plant and equipment 1,118 320 650 764 2,852
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 $4.8 million and $2.2 million as of December 31, 2003
and June 30, 2003, respectively. These amounts were recorded in Other
accrued liabilities as of December 31, 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 net earnings by $58,000 and decreased
net earnings by $80,000 for the three months ended December 31, 2003 and
December 31, 2002, respectively. The change in the fair value of these
contracts decreased net earnings by $79,000 and $16,000 for the six
months ended December 31, 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 December 31, 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 and six months ended
December 31, 2003 had no financial impact.
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
December 31, 2003 December 31, 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
- --------------------------- --------------------------------- -------------------------------
Net earnings and earnings
per common share, as reported $3,424 $0.24 $0.23 $2,769 $0.20 $0.19
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 (171) (0.01) (0.01) (143) (0.01) (0.01)
------- ------ ------ ------- ------ ------
Pro forma net earnings and
earnings per common share $3,253 $0.23 $0.22 $2,626 $0.19 $0.18
======= ====== ====== ======= ====== ======
15
II-VI Incorporated and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited), Continued
Note K - Stock-Based Compensation, Cont'd.
Six Months Ended Six Months Ended
December 31, 2003 December 31, 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
- --------------------------- --------------------------------- -------------------------------
Net earnings and earnings
per share, as reported $6,538 $0.46 $0.45 $4,975 $0.35 $0.35
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 (342) (0.02) (0.02) (281) (0.02) (0.02)
------- ------ ------ ------- ------ ------
Pro forma net earnings and
earnings per share $6,196 $0.44 $0.43 $4,694 $0.33 $0.33
======= ====== ====== ======= ====== ======
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 Six Months Ended Six Months Ended
December 31, 2003 December 31, 2002 December 31, 2003 December 31, 2002
------------------ ------------------ ----------------- -----------------
Risk free interest rate 3.63% 3.80% 3.61% 3.80%
Expected volatility 64% 66% 64% 43%
Expected life of options 7.04 years 7.00 years 7.04 years 7.00 years
Expected dividends none none 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.
The following table summarizes the change in the carrying value of the
Company's warranty reserve as of and for the six months ended December
31, 2003 and as of and for the year ended June 30, 2003 ($000).
Six Months Ended Year Ended
December 31, 2003 June 30, 2003
- ----------------------------------------------------------------------
($000)
Balance - Beginning of Period $504 $419
Expense and writeoffs, net 24 85
Other - -
- ----------------------------------------------------------------------
Balance - End of Period $528 $504
- ----------------------------------------------------------------------
16
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
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 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 has 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 will have no financial effect on the Company's financial
position or results of operations.
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 December 31, 2003, the Company had
paid $0.2 million of the purchase price.
Note O - 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 II-VI Incorporated and Laser Power
Corporation products 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 both II-VI Incorporated and Laser Power Corporation
products in Switzerland to OEM and aftermarket customers. The results
of II-VI LOT Suisse, net of minority interest, for the three and six
month periods ended December 31, 2003 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 based upon 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.
17
II-VI Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited), Continued
Note P - 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.
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 December 31, 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.
19
Results of Operations
Overview
Net earnings for the second quarter of fiscal 2004 were $3,424,000
($0.23 per share-diluted) on revenues of $34,635,000. This compares to
net earnings of $2,769,000 ($0.19 per share-diluted) on revenues of
$31,431,000 in the second quarter of fiscal 2003. For the six months
ended December 31, 2003, net earnings were $6,538,000 ($0.45 per share-
diluted) on revenues of $68,729,000. This compares to net earnings of
$4,975,000 ($0.35 per share-diluted) on revenues of $63,002,000 for the
same period last fiscal year. Stronger revenues were realized in the
majority of the Company's reporting segments. The increase in revenues
for the second quarter of fiscal 2004 compared to the same period last
fiscal year is primarily due to stronger shipments to OEM customers in
Japan, Europe and the United States.
Bookings for the second quarter of fiscal 2004 increased 28% to
$41,110,000 compared to $32,033,000 for the same period last fiscal
year. The increase was primarily attributable to stronger market
demands from OEM and aftermarket customers in the industrial carbon
dioxide (CO2) laser optics market, an increase in the Near-Infrared
Optics segment relating to a new product line and stronger performance
in the Military Infrared Optics segment due to increased demands
resulting from the war in Iraq. During the quarter ended December 31,
2003 the Company acquired a 75% ownership in a Switzerland distributor
(see Note O to the Consolidated Financial Statements) and as part of
this transaction the backlog of customer orders were transferred
resulting in a bookings addition of approximately $2.1 million.
Bookings for contract research and development for the second quarter of
fiscal year 2004 were $737,000 compared to $502,000 for the same period
last fiscal year. 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 six months ended December 31, 2003 increased 13%
to $75,692,000 as compared to $66,906,000 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 six months ended December 31,
2003 were $2,049,000 compared to $5,892,000 for the same period last
fiscal year. Contract research and development in 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,
which were large, one-time contracts.
Segment earnings, which is defined as earnings before income taxes,
interest and other income or expense, for the second quarter of fiscal
2004 increased 13% to $5,119,000 compared to $4,515,000 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 relating to sales
of infrared optics in Japan, where the strong Yen has helped gross
margins, coupled with manufacturing yield improvements and cost
reduction programs also contributed to the improved segment earnings.
Segment earnings for the six months ended December 31, 2003 increased
29% to $9,843,000 compared to $7,601,000 for the same period last fiscal
year. Improvements were experienced in the Infrared Optics business
while the results of the Company's eV PRODUCTS operations, included in
the Other segment, were driven by higher sales for CdZnTe based hand-
held spectrometers and continued demand for bone-mineral densitometer
detectors.
Bookings, revenues and segment earnings or (loss) for the Company's
reportable segments are discussed below.
Infrared Optics
Bookings for the second quarter of fiscal 2004 for Infrared Optics
increased 19% to $21,851,000 from $18,375,000 in the second quarter of
last fiscal year. This increase was attributable in part to an increase
in OEM activity in Japan, Europe and the United States as well as
stronger aftermarket order intake in the current fiscal quarter compared
to the last fiscal quarter. The increase is also attributable to
recording $2.1 million of bookings from a recently acquired Switzerland
distributor (see Note O to the Consolidated Financial Statements and the
20
discussion above). Bookings for the six months ended December 31, 2003
increased 13% to $44,175,000 from $39,143,000 for the same period last
fiscal year. Sales at the Company's Infrared Optics business
particularly in industrial material processing, are increasing as CO2
lasers are operating more hours per week, thereby increasing our
aftermarket opportunity. We have also made improvements in our
worldwide distribution channels, which also allow us to continue to
strengthen our infrared optics market. In addition, orders received for
laser markings applications continued to gain momentum during the
current fiscal quarter.
Revenues for the second quarter of fiscal 2004 for Infrared Optics
increased 13% to $19,891,000 from $17,572,000 in the second 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 Japanese
economies rebound. Revenues for the six months ended December 31, 2003
increased 11% to $39,797,000 from $35,926,000 for the same period last
fiscal year as the stronger order intake has translated into stronger
revenues for the current period as compared to the same period of the
prior fiscal year.
Segment earnings for the second quarter increased 17% to $5,158,000 from
$4,416,000 in the second quarter of last fiscal year. Segment earnings
for the six months ended December 31, 2003 increased 23% to $10,609,000
compared to $8,647,000 for the same period last fiscal year. The
improvement in segment earnings for the current fiscal three and six
month periods as compared to the same period of the last fiscal year was
due to a combination of increased sales volume primarily in 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 yield improvement and cost reduction programs
occurring at our various facilities.
Near-Infrared Optics
Bookings for the second quarter of fiscal 2004 for Near-Infrared Optics
increased 41% to $6,963,000 from $4,950,000 in the second quarter of
last fiscal year. The increase was primarily due to booking $1.7
million of business in a new product line, ultra-violet filters used to
assist aircraft in the early detection of missile threats, along with a
growth in the core optics business. Bookings for the six months ended
December 31, 2003 were $11,573,000 compared to $11,850,000 for the same
period last fiscal year, a decrease of 2%. The decrease was due to the
receipt of a large research and development contract during the first
quarter of last fiscal year.
Revenues for the second quarter of fiscal 2004 for Near-Infrared Optics
decreased 9% to $5,181,000 compared to $5,679,000 in the second quarter
of last fiscal year due to decreased market demands for Yttrium Aluminum
Garnet (YAG) products as well as lower contract research and development
revenue due to lower overall contract activity. Revenues for the six
months ended December 31, 2003 were essentially flat at $11,132,000
compared to $11,146,000 for the same period last fiscal year.
Segment earnings for the second quarter of fiscal 2004 decreased 63% to
$148,000 from $396,000 in the second quarter of last fiscal year.
Segment earnings for the six months ended December 31, 2003 decreased 9%
to $692,000 compared to $758,000 for the same period last fiscal year.
The primary contributor to this decrease in segment earnings was a
reduction in contract research and development revenues from the same
six month period last fiscal year.
Military Infrared Optics
Bookings for the second quarter of fiscal 2004 for Military Infrared
Optics increased 57% to $10,559,000 as compared to $6,727,000 in the
second quarter of last fiscal year. The overall increase in bookings
was due to strong bookings of our "core military products" for
traditional window, dome and other miscellaneous optics for programs
such as the Javelin Missile, Apache Helicopter and countermeasure
systems. The war in Iraq has impacted the demand for these products
through increased use of spares and repairs to damaged equipment. Also
during the quarter the Company received an order for sapphire window
shrouds for Advanced Targeting Pods relating to the government's Sniper
Program. Bookings for the six months ended December 31, 2003 were
$16,664,000 compared to $11,303,000 for the same period last year, an
increase of 47%. The bookings increase for the six months illustrates
the strong demand for our military products.
21
Revenues for the second quarter of fiscal 2004 for Military Infrared
Optics increased 12% to $6,517,000 compared to $5,799,000 in the second
quarter last fiscal year. Revenues for the six months ended December
31, 2003 increased 5% to $12,199,000 compared to $11,593,000 for the
same period last fiscal year.
Segment earnings for the second quarter of fiscal 2004 were essentially
flat at $245,000 compared to $234,000 for the same period last fiscal
year. Decreased gross margins negatively impacted segment earnings in
the current quarter due to recognition of an additional $175,000 of cost
to complete a certain fixed-price contract which is currently in a loss
position. Segment earnings for the six months ended December 31, 2003
decreased to $239,000 from $491,000 for the same period last fiscal
year. In addition, for the six months of fiscal 2004 segment earnings
were negatively impacted by the additional production and development
costs incurred during the ramping up of the sapphire business.
Compound Semiconductor Group
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 and the Company's corporate
research and development group.
Combined bookings for the second quarter of fiscal 2004 from these
operations decreased 12% to $1,737,000 as compared to $1,981,000 in the
second quarter of last fiscal year. The decrease in bookings was due to
the receipt of a contract to support or develop nuclear material
detection for the U.S. Army in the second quarter of last fiscal year.
Bookings for the six months ended December 31, 2003 for these groups
decreased 29% to $3,288,000 as compared to $4,610,000 for the same
period last fiscal year primarily due 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.
Revenues for the second quarter from these operations increased 28% to
$3,046,000 compared to $2,381,000 in the second quarter of the last
fiscal year. Revenues for the six months ended December 31, 2003 for
these operations increased 29% to $5,601,000 as compared to $4,337,000
for the same period last fiscal year. The higher revenues are a direct
result of the higher shipments of hand-held spectrometers for Homeland
Security applications, increased shipments of bone-mineral densitometer
detectors and a higher level of research and development billings by the
Company's eV PRODUCTS division.
The segment loss for the second quarter of fiscal 2004 of $432,000
decreased 19% from the segment loss of $531,000 in the second quarter of
the prior fiscal year. The segment loss for the six months ended
December 31, 2003 decreased 26% to $1,697,000 compared to $2,295,000 for
the same period last 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 second quarter of fiscal 2004 was $13,982,000 or 42%
of revenues compared to $11,358,000 or 39% of revenues for the same
period last fiscal year. Manufacturing gross margin for the six months
ended December 31, 2003 was $27,969,000 or 43% of revenue compared to
$22,480,000 or 39% of revenues for the same period last fiscal year. The
increased sales volume for the current three and six month periods as
compared to the same periods last fiscal year, the increase in the
amount of manufacturing done 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 second quarter of fiscal 2004 was $286,000
or 17% of research and development revenues compared to a gross margin
of $401,000 or 16% of research and development revenues for the same
period last fiscal year. Contract research and development gross margin
22
for the six months ended December 31, 2003 was $336,000 or 9% of
research and development revenue compared to a gross margin of $519,000
or 11% 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 six 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 a blend of cost plus fixed fee, cost reimbursement
and percentage of completion contract activities.
Company-funded internal research and development expenses for the second
quarter of fiscal 2004 were $1,367,000 or 4% of revenue compared to
$552,000 or 2% of revenues for the same period last fiscal year.
Company-funded internal research and development expenses for the six
months ended December 31, 2003 were $2,454,000 or 4% of revenues
compared to $1,511,000 or 2% of revenues. The higher expense is
primarily the result of lower external contract support for the
Company's efforts in silicon carbide and the Near Infrared Optics
segment.
Selling, general and administrative expenses for the second quarter of
fiscal 2004 were $7,782,000 or 22% of revenues compared to $6,692,000 or
21% of revenues for the same period last fiscal year. Selling, general
and administrative expenses for the six months ended December 31, 2003
were $16,008,000 or 23% of revenues compared to $13,887,000 or 22% of
revenues for the same period last fiscal year. The dollar and percentage
increases for the three and the six months periods as compared to the
same periods last fiscal year reflect increased legal and professional
fees to defend and protect its trade secrets and intellectual property.
In addition to the increase in legal and professional fees, the Company
recorded higher salary expenses as compared to the same quarters last
fiscal year for its worldwide profit driven bonus program.
Interest expense for the second quarter of fiscal 2004 was $117,000
compared to $247,000 for the same period last fiscal year. For the six
months ended December 31, 2003, interest expense was $251,000 compared
to $525,000 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 and December
31, 2003 as compared to the same periods last fiscal year.
Other income for the second quarter of fiscal 2004 was $149,000 compared
to other expense of $601,000 for the same period last fiscal year.
These income items included foreign currency gains, interest income, and
other income items. Other expenses for the period ended December 31,
2002 included foreign currency losses and, the write-off of an
investment. Other income for the six months ended December 31, 2003 of
$240,000 compared to $487,000 of other expenses for the same period last
fiscal year. The six month change was primarily due to the specific
items mentioned above for the quarter ended December 31, 2003 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% 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 six months of fiscal 2004, net cash provided by operating
activities of $10.6 million, $0.6 million of proceeds from the exercise
of stock options and cash on hand was used primarily to fund
expenditures of $5.7 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., $0.2 million for the purchase of assets related to the
ultra-violet filters product line and $3.4 million to pay down debt.
Cash transactions for the first six months of fiscal 2004 plus cash on
hand at the beginning of the fiscal year resulted in a cash position of
$15.3 million at December 31, 2003.
23
The Company had available $15.7 million and $15.5 million under its line
of credit option of the credit facility as of December 31, 2003 and June
30, 2003, respectively. The Company is obligated to pay $1.9 million on
the first day of each fiscal quarter until the term loan is repaid. At
December 31, 2003, $13.1 million remained outstanding on the term loan.
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.
24
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 December 31, 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 $13,000 for the three
months and six months ended December 31, 2003 and a 10% change in the
Yen to dollar exchange rate would have changed revenues by approximately
$446,000 and $820,000 for the three and six months ended December 31,
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 $324,000 and $424,000 for the
three and six month periods ended December 31, 2003 and $55,000 and
$120,000 for the three and six month periods ended December 31, 2002.
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. During the
six months ended December 31, 2003, the Company decreased its borrowings
by $3.4 million. As of December 31, 2003, the total borrowings of $20.6
million include $13.1 million under the term loan option, $4.3 million
under the line of credit option, $2.8 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 $54,000 and $111,000 for the three and six
months ended December 31, 2003, respectively.
25
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 7, 2003, the Company held its annual meeting of
shareholders. The three matters voted upon at the annual meeting were
(1) the election of two directors for a term to expire in 2006, (2) the
ratification of the Board of Directors' selection of Deloitte & Touche
LLP as auditors for the fiscal year ending June 30, 2004 and (3) a
shareholder proposal regarding the Company's Shareholder Rights Plan.
Each of the Company's nominees for director were elected or reelected at
the annual meeting. The following is a separate tabulation with respect
to each director:
Votes For Votes Withheld Total Votes
---------- -------------- -----------
Marc Y.E. Pelaez 12,941,966 450,853 13,392,819
Duncan A.J. Morrison 10,717,675 2,673,944 13,391,619
The total number of votes cast on the ratification of the appointment of
Deloitte & Touche LLP as auditors for the year ending June 30, 2004 was
13,393,619 with 9,742,780 votes for, 3,639,872 votes against and 10,967
votes abstaining.
The total number of votes cast on a shareholder proposal regarding the
Company's Shareholder Rights Plan was 11,249,875 with 5,927,859 votes
for 5,257,884 votes against and 64,132 votes abstaining.
There were no broker non-votes on these matters.
The Board of Directors of II-VI Incorporated has reviewed its
Shareholder Rights Plan in light of the above mentioned approval of the
shareholder proposal and intends to announce its conclusions no later
than February 27, 2004.
26
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 October 23, 2003, the registrant filed a report on Form 8-K for the
event dated October 22, 2003, covering Item 12 thereof.
On November 12, 2003, the registrant filed a report on Form 8-K for the
event dated November 11, 2003 covering Item 5 thereof.
27
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: February 13, 2004 By: /s/ Carl J. Johnson
Carl J. Johnson
Chairman and Chief Executive Officer
Date: February 13, 2004 By: /s/ Craig A. Creaturo
Craig A. Creaturo
Chief Accounting Officer and Treasurer
28
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
29