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IIVI > SEC Filings for IIVI > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for II-VI INC


8-Nov-2012

Quarterly Report


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 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 August 28, 2012, and herein.

Introduction

II-VI Incorporated ("II-VI," the "Company," "we," "us" or "our"), the worldwide leader in engineered materials and opto-electronic components, is a vertically-integrated manufacturing company that creates and markets products for diversified markets including industrial manufacturing, military and aerospace, high-power electronics, optical communications, medical and thermoelectronics applications.

The Company generates revenues, earnings and cash flows from developing, manufacturing and marketing engineered materials and opto-electronic components for precision use in industrial, military, optical communications, photovoltaic, medical and consumer applications. We also generate revenue, earnings and cash flows from government-funded research and development contracts relating to the development and manufacture of new technologies, materials and products.

Our customer base includes original equipment manufacturers ("OEMs"), laser end users, system integrators of high-power lasers, manufacturers of equipment and devices for industrial, optical communications, security and monitoring applications, U.S. government prime contractors, various U.S. government agencies and thermoelectric solutions suppliers.

Effective July 1, 2012, the Company changed its reportable segments in accordance with how the Company's chief operating decision maker receives and reviews financial information. Effective July 1, 2012, VLOC has been included in the Military & Materials operating segment for financial reporting purposes. Prior to July 1, 2012, the Company's VLOC business unit was included in the Near-Infrared Optics operating segment. The Company has revised the consolidated segment information for all periods presented in this Form 10-Q to reflect this reclassification.

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America and the Company's discussion and analysis of its financial condition and results of operations require the Company's management to make judgments, assumptions and estimates that affect the amounts reported in its condensed consolidated financial statements and accompanying notes. Note 1 of the Notes to Consolidated Financial


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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 estimates are those related to revenue recognition, allowance for doubtful accounts, warranty reserves, inventory valuation, valuation of long-lived assets including acquired intangibles and goodwill, accrual of bonus and profit sharing estimates, accrual of income tax liability estimates and accounting for share-based payments. Management believes these estimates 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.

The Company recognizes revenues in accordance with U.S. GAAP. Revenues for product shipments are realizable when we have persuasive evidence of a sales arrangement, the product has been shipped or delivered, the sale price is fixed or determinable and collectability is reasonably assured. Title and risk of loss passes from the Company to its customer at the time of shipment in most cases with the exception of certain customers. For these customers title does not pass and revenue is not recognized until the customer has received the product at its physical location. The Company's revenue recognition policy is consistently applied across the Company's segments, product lines and geographical locations. Further, we do not have post shipment obligations such as training or installation, customer acceptance provisions, credits and discounts, rebates and price protection or other similar privileges. Our distributors and agents are not granted price protection. Our distributors and agents, who comprise less than 10% of consolidated revenue, have no additional product return rights beyond the right to return defective products that are covered by our warranty policy. We believe our revenue recognition practices are consistent with Staff Accounting Bulletin ("SAB") 104 and that we have adequately considered the requirements of Accounting Standards Codification ("ASC") 605 Revenue Recognition. Revenues generated from transactions other than product shipments are contract-related and have historically accounted for less than 5% of the Company's consolidated revenues.

We establish an allowance for doubtful accounts and warranty reserves based on historical experience and believe the collection of revenues, net of these reserves, is reasonably assured. Our allowance for doubtful accounts and warranty reserve balances at September 30, 2012 were $2.0 million and $1.3 million, respectively. Our reserve estimates have historically been proven to be materially correct based upon actual charges incurred. The company had one customer that represented 13% of total accounts receivable as of September 30, 2012.

New Accounting Standards

See "Note 2. Recent Accounting Pronouncements," to our unaudited financial statements in Part I, Item 1 of this Quarterly Report for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.


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Results of Operations ($000's except per-share data)

The following tables set forth bookings and select items from our Condensed
Consolidated Statements of Earnings for the three months ended September 30,
2012 and 2011, respectively:



                                                  Three Months Ended              Three Months Ended
                                                  September 30, 2012              September 30, 2011

Bookings                                      $   114.4                       $   130.2


                                                                 % of                            % of
                                                               Revenues                        Revenues
Total Revenues                                $   132.3            100.0 %    $   138.4            100.0 %
Cost of goods sold                                 83.5             63.1           83.4             60.2

Gross margin                                       48.8             36.9           55.0             39.8

Operating Expenses:
Internal research and development                   5.6              4.2            5.2              3.7
Selling, general and administrative                26.7             20.1           26.8             19.4
Interest and other, net                            (0.7 )           (0.5 )         (1.6 )           (1.1 )

Earnings before income tax                         17.3             13.1           24.6             17.8
Income taxes                                        4.2              3.2            5.9              4.3

Net earnings                                       13.1              9.9           18.7             13.5
Net earnings attributable to noncontrolling
interest                                            0.4              0.3            0.1              0.1

Net earnings attributable to II-VI
Incorporated                                  $    12.7              9.6      $    18.6             13.4

Diluted earnings per-share                    $    0.20                       $    0.29

Executive Summary

During the three months ended September 30, 2012, the Company began to see slowing order patterns across the majority of its business units as further political and economic uncertainty worldwide resulted in a reduction of orders from an already cautious customer base. Net earnings attributable to II-VI Incorporated for the three months ended September 30, 2012 decreased to $12.7 million ($0.20 per-share diluted) compared to $18.6 million ($0.29 per-share diluted) for the same period last fiscal year. Revenues decreased slightly from the same period last fiscal year, while gross margin was negatively impacted by PRM due to lower selling prices of tellurium and selenium shipped to customers, as well as changes in product mix at Marlow and unfavorable absorption of manufacturing overhead costs combined with higher raw material input prices at several of the Company's business units. The negative impacts on gross margin were somewhat offset by a favorable change in product mix at the Company's Photop and Aegis business units. The Company continued to invest resources in research and development activities at Photop and Aegis while managing worldwide operating costs to ensure proper alignment with current revenue levels.

Consolidated

Bookings. Bookings for the three months ended September 30, 2012 decreased 12.1% to $114.4 million, compared to $130.2 million 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 twelve months, due to the inherent uncertainty of an order that far out in the future. The decline in overall bookings levels is attributable to lower orders in the Infrared Optics, Military & Materials and Advanced Products Group segments, offset somewhat by bookings increases at Photop and Aegis within the Company's Near-Infrared Optics segment. The decreased bookings at Infrared Optics was mostly attributable to reduced demand from Japanese OEMs in the high-power CO2 laser market, while slowing demand for Marlow's gesture recognition product line within the Advanced Products Group continued to put downward pressure on bookings. Within the Military & Materials segment, PRM experienced lower bookings as a result of reduced orders and pricing for selenium and tellurium while bookings at VLOC were unfavorably impacted by the timing of receipt of a large UV Filter military order. The Company's Photop and Aegis subsidiaries within the Near-Infrared Optics segment offset a portion of the bookings declines due to increased order intake from large optical communication customers in Asia.

Revenues. Revenues for the three months ended September 30, 2012 decreased 4.4% to $132.3 million, compared to $138.4 million for the same period last fiscal year. The decrease in revenues was attributable to PRM and VLOC within the Military & Materials segment and Marlow within the Advanced Products Group segment. These decreases in revenue were somewhat offset by higher revenue at Photop and Aegis within the Near-Infrared Optics segment. PRM revenue decreased as a result of


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lower shipment volumes and selling prices to customers for both its selenium and tellurium minor metals while revenue at VLOC decreased as a result of lower product demand for military applications. Marlow experienced lower shipment volume of gesture recognition product as a result of decreased demand, while higher revenue levels at Photop and Aegis were the result of increased sales volumes to multiple Asian optical communication customers.

Gross margin. Gross margin for the three months ended September 30, 2012 was $48.8 million or 36.9% of total revenues, compared to $55.0 million or 39.8% of total revenues, for the same period last fiscal year. The decline in gross margin was mostly due to a reduction in the selling prices at PRM of both tellurium and selenium as well as the decline in gesture recognition shipment volume at the Company's Marlow business unit which typically yields a high margin profile. Gross margin within the Company Infrared Optics segment was also impacted by higher input prices of raw materials used in production. Somewhat offsetting these negative impacts on gross margin was a shift in product mix at Photop and Aegis, which realized higher margins on a large concentration of optical communication and high-power fiber laser couplers and combiners, respectively.

Internal research and development. Company-funded internal research and development expenses for the three months ended September 30, 2012 were $5.6 million, or 4.2% of revenues, compared to $5.2 million, or 3.7% of revenues, for the same period last fiscal year. This increase in Company-funded internal research and development expenses was primarily the result of ongoing research and development investment at Photop and Aegis within the Near-Infrared optics segment. Photop is focusing research and development efforts on optical communication and commercial optic markets, specifically regarding components and module products that will be utilized by customers to satisfy future high-speed network requirements. Aegis continues to invest in new product development of high performance flexible bandwidth optical channel monitors and high-power fiber laser couplers and combiners.

Selling, general and administrative. Selling, general and administrative expenses for the three months ended September 30, 2012 were $26.7 million or 20.1% of revenues, compared to $26.8 million, or 19.4% of revenues, for the same period last fiscal year. Selling, general and administrative expense as a percentage of revenues increased slightly during the three months ended September 30, 2012 compared to the same periods last fiscal year, mostly as a result of incremental operating costs outpacing revenues.

Interest and other, net. Interest and other, net for the three months ended September 30, 2012 was income of $0.7 million. Included in interest and other, net for the three months ended September 30, 2012 are earnings from the Company's equity investment in Fuxin, net interest income on excess cash reserves and unrealized gains on the deferred compensation plan that were somewhat offset by foreign currency losses. The majority of interest and other, net for the three months ended September 30, 2011 was the result of a $1.4 million gain related to the sale of precious metals inventory, earnings of equity investments, net interest income on excess cash reserves, foreign currency losses and unrealized losses on the deferred compensation plan.

Income taxes. The Company's year-to-date effective income tax rate at September 30, 2012 was 24.2%, compared to an effective tax rate of 23.9% for the same period last fiscal year. The variation between the Company's effective tax rate and the U.S. statutory rate of 35% is primarily due to the Company's foreign operations which are subject to income taxes at lower statutory rates.

Segment Reporting

Effective July 1, 2012, the Company's VLOC business unit has been included in the Military & Materials operating segment for financial reporting purposes in accordance with how the Company's chief operating decision maker receives and reviews financial information. Prior to July 1, 2012, VLOC was included in the Near-Infrared Optics operating segment. The Company has revised the consolidated segment information to reflect this reclassification for all periods presented in Part I, Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q.

Bookings, revenues and segment earnings for the Company's reportable segments are discussed below. Segment earnings differ from income from operations in that segment earnings exclude certain operational expenses included in other expense (income) - net as reported. Management believes segment earnings to be a useful measure as it reflects the results of segment performance over which management has direct control and is used by management in its evaluation of segment performance. See "Note 10. Segment Reporting," to our unaudited financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information on the Company's reportable segments and for the reconciliation of segment earnings to net earnings.


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Infrared Optics (millions)




                                   Three Months Ended             %
                                      September 30,            Increase
                                   2012           2011        (Decrease)

              Bookings           $    47.5       $  51.1               (7 )%
              Revenues           $    51.6       $  50.8                1 %
              Segment earnings   $    11.8       $  12.4               (4 )%

The Company's Infrared Optics segment includes the combined operations of Infrared Optics and HIGHYAG.

Bookings for the three months ended September 30, 2012 for Infrared Optics decreased 7% to $47.5 million, compared to $51.1 million for the same period last fiscal year. The decrease in bookings for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily driven by decreased demand from OEMs for new high-power CO2 laser systems in Japan and Europe somewhat offset by increased orders at HIGHYAG for one-micron beam delivery system welding heads. The stagnant Japanese economy as well as fiscal uncertainty in Europe, has contributed to the lower demand for new high-power CO2 laser systems in these geographic locations.

Revenues for the three months ended September 30, 2012 for Infrared Optics increased 1% to $51.6 million, compared to $50.8 million for the same period last fiscal year. This slight increase in revenue reflects higher shipment volume at HIGHYAG for one-micron laser welding heads, somewhat offset by decreased revenue within Infrared Optics as a result of cautious buying patterns from customers in Asia and Europe.

Segment earnings for the three months ended September 30, 2012 for Infrared Optics decreased 4% to $11.8 million, compared to $12.4 million for the same period last fiscal year. The decrease in segment earnings for the three months ended September 30, 2012 compared to the same periods last fiscal year was primarily due to lower gross margins caused by higher raw material input prices.

Near-Infrared Optics (millions)



                                     Three Months Ended
                                        September 30,              %
                                     2012           2011       Increase

                Bookings           $    35.1       $  31.8            10 %
                Revenues           $    40.6       $  31.0            31 %
                Segment earnings   $     7.7       $   2.6           202 %

The Company's Near-Infrared Optics segment includes the combined operations of Photop and Aegis.

Bookings for the three months ended September 30, 2012 for Near-Infrared Optics increased 10% to $35.1 million, compared to $31.8 million for the same period last fiscal year. The increase in bookings for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily driven by increased order intake at both Photop and Aegis for green laser devices and optical channel monitors, respectively.

Revenues for the three months ended September 30, 2012 for Near-Infrared Optics increased 31% to $40.6 million, compared to $31.0 million for the same period last fiscal year. The increase in revenues for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily driven by higher shipment volumes at Photop to large Chinese optical communication customers as well as increased revenues earned by providing contract manufacturing services.

Segment earnings for the three months ended September 30, 2012 for Near-Infrared Optics increased 202% to $7.7 million, compared to $2.6 million for the same period last fiscal year. The increase in segment earnings was driven by the incremental revenues at Photop as well as higher gross margins as a shift in product mix to optical communication products with higher margin profiles more than offset increased spending on research and development activities.


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Military & Materials (millions)



                                       Three Months Ended
                                          September 30,               %
                                       2012            2011      (Decrease)

           Bookings                  $    17.7        $ 26.4             (33 )%
           Revenues                  $    23.9        $ 30.8             (22 )%
           Segment (loss) earnings   $    (2.1 )      $  2.1            (202 )%

The Company's Military & Materials segment includes the combined operations of
EEO, PRM, VLOC, and MLA.

Bookings for the three months ended September 30, 2012 for Military & Materials decreased 33% to $17.7 million, compared to $26.4 million for the same period last fiscal year. The decrease in bookings for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily driven by reduced demand at both PRM and VLOC. Bookings at PRM were negatively impacted due to reduced orders for selenium and tellurium as well as lower index pricing of these materials. At VLOC, continued pressure and propositions to reduce U.S. defense spending as well as the timing of UV Filter orders had a negative impact on bookings.

Revenues for the three months ended September 30, 2012 for Military & Materials decreased 22% to $23.9 million, compared to $30.8 million for the same period last fiscal year. The decrease in revenues for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily due to lower shipments at VLOC resulting from reduced military orders as well as lower product demand for both tellurium and selenium at PRM.

Segment (loss) earnings for the three months ended September 30, 2012 for Military & Materials was a segment loss of $2.1 million, compared to segment earnings of $2.1 million for the same period last fiscal year. The unfavorable change in segment (loss) earnings for the three months ended September 30, 2012 was mostly due to the aforementioned reduced revenues as well as reduced gross margins at VLOC and PRM. The unfavorable gross margin change at VLOC was mostly due to unfavorable absorption of manufacturing overhead costs while PRM's gross margin was negatively impacted by lower selling prices of tellurium to customers.

Advanced Products Group (millions)



                                       Three Months Ended
                                          September 30,               %
                                       2012            2011      (Decrease)

           Bookings                  $    14.0        $ 21.0             (33 )%
           Revenues                  $    16.2        $ 25.8             (37 )%
           Segment (loss) earnings   $    (0.8 )      $  6.0            (114 )%

The Company's Advanced Products Group includes the combined operations of Marlow, WBG and WMG.

Bookings for the three months ended September 30, 2012 for the Advanced Products Group decreased 33% to $14.0 million, compared to $21.0 million for the same period last fiscal year. The decrease in bookings for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily due to a significant reduction in demand for Marlow's gesture recognition product line.

Revenues for the three months ended September 30, 2012 for the Advanced Products Group decreased 37% to $16.2 million, compared to $25.8 million for the same period last fiscal year. The decrease in revenues for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily due to lower shipment volumes of gesture recognition and telecommunication products at Marlow.

Segment (loss) earnings for the three months ended September 30, 2012 decreased 114% to a segment loss of $0.8 million, compared to segment earnings of $6.0 million for the same period last fiscal year. The unfavorable change in segment
(loss) earnings for the three months ended September 30, 2012 compared to the same period last fiscal year was primarily due to the lower revenues as well as declining gross margin at Marlow resulting from unfavorable product mix as gesture recognition sales with higher margin profiles have relented.


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Liquidity and Capital Resources

Historically, our primary source of cash has been provided through operations. Other sources of cash include proceeds received from the exercises of stock options and long-term borrowings. Our historical uses of cash have been for capital expenditures, purchases of businesses, payment of principal and interest on outstanding debt obligations and purchases of treasury stock. Supplemental information pertaining to our sources and uses of cash for the periods indicated is presented as follows:

Sources (uses) of Cash (millions):

                                                       Three Months Ended
                                                          September 30,
                                                       2012           2011

        Net cash provided by operating activities    $    23.2       $  14.3
        Proceeds from exercises of stock options           1.1           0.2
        Purchase of business, net of cash acquired          -          (46.1 )
        Additions to property, plant and equipment        (5.9 )       (12.7 )
        Net proceeds on long-term borrowings               5.0           5.7
. . .
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