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IIVI > SEC Filings for IIVI > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for II-VI INC


9-May-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including 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.

Although our management considers these expectations and assumptions to be reasonable, actual results could materially differ from any such forward-looking statements included in this report or otherwise made by our management due to the following factors, among other; 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 materially 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 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on August 28, 2012.

In addition, the Company operates in a highly competitive and rapidly changing environment; therefore, new risk factors can arise, and it is not possible for management to predict all such risk factors, nor to assess the impact of all such risk factors on the Company's business or the extent to which any individual risk factor, or combination of risk factors, may cause results to differ materially from those contained in any forward-looking statement. The forward-looking statements included in this Quarterly Report on Form 10-Q are based only on information currently available to the Company and speak only as of the date of this report. The Company do not assume any obligation and do not intend to update any forward-looking statements, whether as a result of new information, future developments or otherwise, except as may be required by the securities laws, and the Company cautions you not to rely on them unduly.

Investors should also be aware that while the Company does communicate with securities analysts, from time to time, such communications are conducted in accordance with applicable securities laws and investors should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report.

Introduction

II-VI Incorporated and Subsidiaries ("II-VI," "II-VI Incorporated," 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, semiconductor 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 Quarterly Report on 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 Statements included in the Company's most recent Annual Report on 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.


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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.

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 March 31, 2013 was $1.6 million and $1.2 million, respectively. Our reserve estimates have historically been proven to be materially correct based upon actual charges incurred. The Company has one customer that represented 10% and 12%, respectively, of total accounts receivable as of March 31, 2013 and June 30, 2012.

The Company records a slow moving inventory reserve as a charge against earnings for all products on hand for more than twelve months to eighteen months depending on the products that have not been sold to customers or cannot be further manufactured for sale to alternative customers. An additional reserve is recorded for product on hand that is in excess of product sold to customers over the same periods noted above. If actual market conditions are less favorable than projected, additional inventory reserves may be required. Our inventory reserve balance at March 31, 2013 was $7.8 million.

New Accounting Standards

See "Note 2. Recent Accounting Pronouncements," to our unaudited financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q 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 (millions, except per-share data)

The following tables set forth bookings and select items from our Condensed
Consolidated Statements of Earnings for the three and nine months ended
March 31, 2013 and 2012, respectively:



                                                Three Months Ended                Three Months Ended
                                                  March  31, 2013                   March  31, 2012

Bookings                                    $   140.3                         $   145.8


                                                                % of                              % of
                                                              Revenues                          Revenues
Total Revenues                              $   145.2             100.0 %     $   132.6             100.0 %
Cost of goods sold                               94.2              64.9            86.6              65.3

Gross margin                                     51.0              35.1            46.0              34.7

Operating Expenses:
Internal research and development                 5.8               4.0             5.7               4.3
Selling, general and administrative              27.2              18.7            23.3              17.6
Interest and other, net                          (1.0 )            (0.6 )          (2.3 )            (1.7 )

Earnings before income tax                       19.0              13.1            19.3              14.6
Income taxes                                      2.9               2.0             5.0               3.8

Net earnings                                     16.1              11.1            14.3              10.8
Net earnings attributable to
noncontrolling interests                          0.2                -              0.3                -

Net earnings attributable to II-VI
Incorporated                                $    15.9              11.0 %     $    14.0              11.0 %

Diluted earnings per share                  $    0.25                         $    0.22

                                                 Nine Months Ended                Nine Months Ended
                                                  March  31, 2013                  March  31, 2012

Bookings                                     $   381.9                        $   392.9


                                                                % of                             % of
                                                              Revenues                         Revenues
Total Revenues                               $   403.4            100.0 %     $   397.7            100.0 %
Cost of goods sold                               256.7             63.6           253.2             63.7

Gross margin                                     146.7             36.4           144.5             36.3

Operating Expenses:
Internal research and development                 17.0              4.2            15.9              4.0
Selling, general and administrative               80.2             19.9            74.4             18.7
Interest and other, net                           (6.0 )           (1.5 )          (5.3 )           (1.3 )

Earnings before income tax                        55.5             13.8            59.5             15.0
Income taxes                                      13.8              3.4            13.0              3.3

Net earnings                                      41.7             10.3            46.5             11.7
Net earnings attributable to
noncontrolling interests                           0.9              0.2             0.6              0.2

Net earnings attributable to II-VI
Incorporated                                 $    40.8             10.1 %     $    45.9             11.5 %

Diluted earnings per share                   $    0.64                        $    0.71

Executive Summary

During the three and nine months ended March 31, 2013, the Company continued to be challenged by a cautious customer base world-wide. Weak demand from Japanese markets for replacement optics and new CO2 laser deployments negatively impacted our Infrared Optics segment, while a near-term demand shift in the telecommunication market in China from 40G to 100G optical components


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offset new orders received from the recently acquired Oclaro thin-film filter business and product line within the Near-Infrared Optics segment. The Company's Marlow business unit within the Advanced Products Group segment received an initial production order for a product related to the personal comfort market, while the recent acquisition of M Cubed also contributed to favorable order patterns in that segment. The Company's Military & Materials segment was impacted by its PRM business unit, which continued to face challenges related to the low demand and index pricing of its selenium and tellurium materials while our recently acquired LightWorks business unit helped offset weakness in other military businesses within the segment. Net earnings attributable to II-VI Incorporated for the three months ended March 31, 2013 increased to $15.9 million ($0.25 per-share diluted) compared to $14.0 million ($0.22 per-share diluted) for the same period last fiscal year. The increased earnings for the three months ended March 31, 2013 compared to the same period last fiscal year is mostly the result of an income tax benefit recorded during the three months ended March 31, 2013 related to the extension of the research and development tax credit in the U.S. combined with other interim tax adjustments. Net earnings attributable to II-VI Incorporated for the nine months ended March 31, 2013 decreased to $40.8 million ($0.64 per-share diluted) compared to $45.9 million ($0.71 per-share diluted) for the same period last fiscal year. The decrease in net earnings for the nine months ended March 31, 2013, compared to the same period last fiscal year was mostly attributable to increased selling, general and administrative expenses from our recently acquired subsidiaries as well as $1.3 million of transaction costs incurred in connection with the current fiscal year acquisitions.

Consolidated

Bookings. 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 extends that far out in the future. Bookings for the three months ended March 31, 2013 decreased 4% to $140.3 million, compared to $145.8 million for the same period last fiscal year. Excluding bookings from the current fiscal year acquisitions of approximately $22 million, bookings for the three months ended March 31, 2013 decreased 19% when compared to the same period last fiscal year. Bookings for the nine months ended March 31, 2013 decreased 3% to $381.9 million, compared to $392.9 million for the same period last fiscal year. Excluding bookings from current fiscal year acquisitions of approximately $27 million, bookings decreased 10% when compared to the same period last fiscal year. The reduced bookings levels for the three and nine months ended March 31, 2013, compared to the same periods last fiscal year were primarily a result of lower pricing and order volumes of selenium and tellurium at PRM, reduced near-term telecom demand for optical components produced at Photop as well as decreased order intake for laser optics within Infrared Optics specific to lower demand from Japanese OEMs for new high-power CO2 laser systems. Somewhat offsetting these decreased bookings were favorable bookings at Marlow due to the receipt of an initial production order for a product used in the personal comfort market.

Revenues. Revenues for the three months ended March 31, 2013 increased 9% to $145.2 million, compared to $132.6 million for the same period last fiscal year. Excluding revenues from current year acquisitions of approximately $22 million, revenues for the three months ended March 31, 2013 decreased 7% when compared to the same period last fiscal year, mostly due to lower shipment volumes and selling prices to customers for both selenium and tellurium. Revenues for the nine months ended March 31, 2013 increased 1% to $403.4 million, compared to $397.7 million for the same period last fiscal year. Excluding revenues from current year acquisitions of approximately $30 million, revenues for the nine months ended March 31, 2013 decreased 6% when compared to the same period last fiscal year. The majority of the decrease in revenues was attributable to the previously mentioned revenue decrease at PRM combined with reduced shipments at Marlow for its gesture recognition product line which is nearing the end of its product life cycle. Somewhat offsetting the decreased revenue at PRM and Marlow was increased shipment volume for remote welding heads at HIGHYAG within the Infrared Optics segment.

Gross margin. Gross margin for the three months ended March 31, 2013 was $51 million or 35.1% of total revenues, compared to $46 million, or 34.7% of total revenues, for the same period last fiscal year. Gross margin for the nine months ended March 31, 2013 was $146.7 million, or 36.4% of total revenues, compared to $144.5 million, or 36.3% of total revenues, for the same period last fiscal year. Overall, gross margin as a percentage of revenues for the three and nine months ended March 31, 2013 was consistent with the prior year periods. The Company did experience some gross margin compression from the Infrared Optics segment due to higher input prices of raw materials used in production. In addition, the current year acquisitions have products which carry lower gross margin profiles than certain of the Company's historical businesses. This gross margin compression was mostly offset by Photop and Photop Aegis, which realized higher margins from increased revenues and a larger concentration of high-margin optical communication products. In addition, Photop and Photop Aegis benefited from increased operating efficiency, which allowed the businesses to realize favorable absorption of manufacturing overhead costs when compared to the prior year period, which was severely impacted by the October 2011 Thailand flood.

Internal research and development. Company-funded internal research and development expenses for the three months ended March 31, 2013 were $5.8 million or 4.0% of revenues, compared to $5.7 million or 4.3% of revenues, for the same period last fiscal year. Company-funded internal research and development expenses for the nine months ended March 31, 2013 were $17.0 million, or 4.2% of revenues, compared to $15.9 million, or 4.0% of revenues, for the same period last fiscal year. The Company continues to invest in new product development across the majority of its business units, including its current year acquisitions which contributed the majority of the increased research and development spending when compared to the same periods last fiscal year.


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Selling, general and administrative. Selling, general and administrative expenses for the three months ended March 31, 2013 were $27.2 million or 18.7% of revenues, compared to $23.3 million or 17.6% of revenues, for the same period last fiscal year. Selling, general and administrative expenses for the nine months ended March 31, 2013 were $80.2 million or 19.9% of revenues, compared to $74.4 million or 18.7% of revenues, for the same period last fiscal year. Selling, general and administrative expense as a percentage of revenues increased during the three months ended March 31, 2013 compared to the same periods last fiscal year, mostly as a result of integrating the current fiscal year acquisitions. Selling, general and administrative expense as a percentage of revenues increased during the nine months ended March 31, 2013 compared to the same periods last fiscal year, mostly as a result of pre-tax transaction expenses incurred of $1.3 million related to the three acquisitions that were completed during the quarter ended December 31, 2012.

Interest and other, net. Interest and other, net for the three and nine months ended March 31, 2013 was income of $1.0 million and $6.0 million, respectively. Included in interest and other, net for the three and nine months ended March 31, 2013 were earnings from the Company's equity investment in Fuxin, interest income on excess cash reserves, gains on the Company sponsored deferred compensation plan and net foreign currency gains and losses. The majority of interest and other, net for the three months ended March 31, 2013 were gains on the Company's deferred compensation plan of $0.3 million, equity investment earnings of $0.2 million and net foreign currency gains of $0.1 million. Interest expense for the three months ending March 31, 2013 was mostly offset by interest income on excess cash reserves. The majority of interest and other, net for the nine months ended March 31, 2013 was the result of $4.4 million of other income related to the contractual settlement related to the Thailand flooding that occurred in October 2011, gains on the Company's deferred compensation plan of $0.6 million, equity investment earnings of $0.8 million and interest income on excess cash reserves that more than offset interest expense. These favorable items were somewhat offset somewhat by foreign currecy losses of $0.6 million. Included in interest and other, net for the three months ended March 31, 2012 is a $1.0 million gain related to the Company's sale of its equity investment in Haobo. In addition, the Company benefited from unrealized gains on the Company's deferred compensation plan, business interruption insurance proceeds at AOFR from the Thailand flooding and earnings from the Company's equity investment in Fuxin. The majority of interest and other, net for the nine months ended March 31, 2012 was the result of the aforementioned $1.0 million gain on the sale of Haobo, a $1.4 million gain related to the sale of precious metals inventory, earnings of equity investments and net interest income on excess cash reserves.

Income taxes. The Company's year-to-date effective income tax rate at March 31, 2013 and 2012 was 24.9% and 21.9%, respectively. The variations between the Company's effective tax rates and the U.S. statutory rate of 35.0% were primarily due to the consolidation of the Company's foreign operations, which are subject to income taxes at lower statutory rates. A change in the mix of pre-tax income from these various tax jurisdictions could have a material impact on the Company's effective tax rate. During the nine months ended March 31, 2013, the Company experienced a shift in pre-tax earnings to higher tax jurisdictions resulting in a higher effective tax rate when compared to the same period last fiscal year. In addition, the Company recorded a $1.3 million tax benefit during the three months ended March 31, 2013 as a result of the extension of the research and development tax credit in the U.S.

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 11. Segment Reporting," to our unaudited financial statements included 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.

Infrared Optics (millions)




                                        Three Months Ended             %               Nine Months Ended             %
                                            March  31,              Increase               March  31,             Increase
                                        2013           2012        (Decrease)           2013         2012        (Decrease)

Bookings                              $    51.2       $  59.1              (13 )%    $    143.3     $ 154.0               (7 )%
Revenues                              $    52.9       $  50.7                4 %     $    149.9     $ 148.2                1 %
Segment earnings                      $    14.0       $  13.8                1 %     $     36.3     $  37.7               (4 )%

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

Bookings for the three months ended March 31, 2013 for Infrared Optics decreased 13% to $51.2 million, compared to $59.1 million for the same period last fiscal year. Bookings for the nine months ended March 31, 2013 for Infrared Optics decreased 7% to $143.3 million, compared to $154.0 million for the same period last fiscal year. The decrease in bookings for the three and nine months


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ended March 31, 2013 compared to the same periods last fiscal year was primarily driven by decreased demand from OEMs for new high-power CO2 laser systems in Japan as well as a short-term softening in demand for HIGHYAG's one-micron laser welding and cutting heads.

Revenues for the three months ended March 31, 2013 for Infrared Optics were $52.9 million, increasing 4% from revenues of $50.7 million for the same period last fiscal year. Revenues for the nine months ended March 31, 2013 for Infrared Optics were $149.9 million, increasing 1% from revenues of $148.2 million for . . .

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