10-Q 1 r10q-33103.txt 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 March 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 N/A (Former name, former address and former fiscal year, if changed since last report) 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 May 7, 2003, 14,133,276 shares of Common Stock, no par value, of the registrant were outstanding. II-VI INCORPORATED INDEX ----- Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets - March 31, 2003 and June 30, 2002 . . . . . . . . . . . . .3 Condensed Consolidated Statements of Earnings - Three and Nine months ended March 31, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . . . . . .4 Condensed Consolidated Statements of Cash Flows - Nine months ended March 31, 2003 and 2002 . . . . . . . . 6 Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . .7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . .17 Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . .24 Item 4. Controls and Procedures . . . . . . . . . . . . . . . . .24 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . 25 PART I - FINANCIAL INFORMATION Item 1. Financial Statements II-VI Incorporated and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited) ($000) March 31, June 30, 2003 2002 --------- -------- Assets Current Assets Cash and cash equivalents $ 13,196 $ 9,610 Accounts receivable, net 21,811 21,541 Inventories 23,673 19,741 Deferred income taxes 3,589 3,457 Other current assets 1,974 1,488 --------- -------- Total Current Assets 64,243 55,837 Property, Plant & Equipment, net 57,315 60,711 Goodwill, net 28,987 28,987 Intangible Assets, net 4,514 3,233 Investments 1,781 1,850 Other Assets 1,368 1,283 --------- -------- $158,208 $151,901 ========= ======== Liabilities and Shareholders' Equity Current Liabilities Accounts payable $ 5,564 $ 3,970 Accrued salaries, wages and bonuses 7,840 4,976 Income taxes payable 2,224 1,012 Accrued profit sharing contribution 831 736 Current portion of long-term debt 6,300 5,068 Other current liabilities 4,008 4,329 --------- -------- Total Current Liabilities 26,767 20,091 Long-Term Debt--less current portion 19,448 29,435 Deferred Income Taxes 4,579 3,881 Other Liabilities 1,041 834 Shareholders' Equity Preferred stock, no par value; authorized - 5,000,000 shares; unissued - - Common stock, no par value; authorized - 30,000,000 shares; issued - 15,194,138 shares at March 31, 2003; 15,101,450 shares at June 30, 2002 38,552 37,840 Accumulated other comprehensive income 286 279 Retained earnings 69,445 61,451 --------- -------- 108,283 99,570 Less treasury stock, at cost - 1,068,880 shares 1,910 1,910 --------- -------- 106,373 97,660 --------- -------- $158,208 $151,901 ========= ======== - See notes to condensed consolidated financial statements. II-VI Incorporated and Subsidiaries Condensed Consolidated Statements of Earnings (Unaudited) ($000 except per share data) Three Months Ended March 31, 2003 2002 -------- -------- Revenues Net sales: Domestic $12,493 $13,406 International 16,812 12,750 -------- -------- 29,305 26,156 Contract research and development 3,051 1,285 -------- -------- 32,356 27,441 -------- -------- Costs, Expenses & Other Income Cost of goods sold 17,238 18,122 Contract research and development 2,826 1,726 Internal research and development 435 1,153 Selling, general and administrative 7,664 4,824 Interest expense 174 313 Other income, net (93) (353) -------- -------- 28,244 25,785 -------- -------- Earnings Before Income Taxes 4,112 1,656 Income Taxes 1,093 492 -------- -------- Net Earnings $ 3,019 $ 1,164 ======== ======== Basic Earnings Per Common Share $ 0.21 $ 0.08 ======== ======== Diluted Earnings Per Common Share $ 0.21 $ 0.08 ======== ======== - See notes to condensed consolidated financial statements. II-VI Incorporated and Subsidiaries Condensed Consolidated Statements of Earnings (Unaudited) ($000 except per share data) Nine Months Ended March 31, 2003 2002 -------- -------- Revenues Net sales: Domestic $41,880 $41,829 International 45,532 36,284 -------- -------- 87,412 78,113 Contract research and development 7,946 5,467 -------- -------- 95,358 83,580 -------- -------- Costs, Expenses & Other Income Cost of goods sold 52,865 52,475 Contract research and development 7,202 4,603 Internal research and development 1,946 3,488 Selling, general and administrative 21,551 15,345 Interest expense 699 1,213 Other expense (income), net 394 (1,013) -------- -------- 84,657 76,111 -------- -------- Earnings Before Income Taxes 10,701 7,469 Income Taxes 2,707 2,221 -------- -------- Net Earnings $ 7,994 $ 5,248 ======== ======== Basic Earnings Per Common Share $ 0.57 $ 0.38 ======== ======== Diluted Earnings Per Common Share $ 0.56 $ 0.37 ======== ======== - See notes to condensed consolidated financial statements. II-VI Incorporated and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) ($000) Nine Months Ended March 31, 2003 2002 -------- -------- Cash Flows from Operating Activities Net earnings $ 7,994 $ 5,248 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 6,869 6,201 Amortization 382 312 Loss (gain) on foreign currency remeasurement 137 (185) Net loss on disposal or sale of Property, Plant and Equipment 137 - Deferred income taxes 567 (544) Increase (decrease) in cash from changes in: Accounts receivable (462) 2,263 Inventories (3,052) 2,124 Accounts payable 1,764 (457) Other operating net assets 4,331 (3,321) -------- -------- Net cash provided by operating activities 18,667 11,641 -------- -------- Cash Flows from Investing Activities Additions to property, plant and equipment (4,053) (6,938) Purchase of business (2,755) (2,172) Dividend from (investment in) unconsolidated business 9 (1,541) Proceeds from sale of Property, Plant and Equipment 617 121 -------- -------- Net cash used in financing activities (6,182) (10,530) -------- -------- Cash Flows from Financing Activities (Payments of) proceeds from short-term borrowings - net (5,069) 3,000 Payments on long-term borrowings (3,802) (2,567) Proceeds from sale of common stock 340 279 -------- -------- Net cash (used in) provided by financing activities (8,531) 712 -------- -------- Effect of exchange rate changes on cash and cash equivalents (368) (289) Net increase in cash and cash equivalents 3,586 1,534 Cash and Cash Equivalents at Beginning of Period 9,610 8,093 -------- -------- Cash and Cash Equivalents at End of Period $13,196 $ 9,627 ======== ======== Cash paid for interest $ 779 $ 1,231 Cash paid for income taxes $ 905 $ 724 -See notes to condensed consolidated financial statements. II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Note A - Basis of Presentation --------------------- The condensed consolidated financial statements for the three and nine month periods ended March 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. These interim statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto contained in the Company's 2002 Annual Report to Shareholders. The consolidated results of operations for the three and nine month periods ended March 31, 2003 and 2002 are not necessarily indicative of the results to be expected for the full year. Certain amounts from the prior period financial statements have been reclassified to conform with current period presentation. Note B - Inventories ----------- The components of inventories are as follows ($000): March 31, June 30, 2003 2002 -------- ------- Raw materials $ 4,121 $ 4,638 Work in progress 10,934 8,958 Finished goods 8,618 6,145 -------- ------- $23,673 $19,741 ======== ======= Note C - Property, Plant and Equipment ----------------------------- Property, plant and equipment (at cost/valuation) consist of the following ($000): March 31, June 30, 2003 2002 -------- -------- Land and land improvements $ 1,453 $ 1,551 Buildings and improvements 31,359 30,008 Machinery and equipment 71,709 73,041 -------- -------- 104,521 104,600 Less accumulated depreciation 47,206 43,889 -------- -------- $ 57,315 $ 60,711 ======== ======== II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note D - Contract Receivables -------------------- The components of contract receivables, which are a component of accounts receivable, net, are as follows ($000): March 31, June 30, 2003 2002 -------- ------- Billed Completed Contracts $ 10 $ 5 Contracts in Progress 872 1,978 -------- ------- 882 1,983 Unbilled 2,745 1,598 -------- ------- $ 3,627 $ 3,581 Note E - Debt ---- The Company has a $45.0 million secured credit facility. The facility has a five-year term which expires on August 14, 2005 and contains term and line of credit borrowing options. The facility is collateralized by the Company's accounts receivable and inventory, a pledge of all of the capital stock of each of the Company's existing direct and indirect 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 average interest rate as of March 31, 2003 was 2.61%. As of March 31, 2003, the total borrowings of $22.8 million under this facility consisted of $17.5 million under the term loan option and $5.3 million under the line of credit option. In September 2002, the Company replaced its 237 million Yen loan with 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%. As of March 31, 2003, the Japanese Yen base rate was 0.07% resulting in a total interest rate of 1.56%. II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note F - Earnings Per Common Share ------------------------- The following table sets forth the computation of earnings per share for the periods indicated:
Three Months Ended Nine Months Ended March 31, March 31, (000 except per share data) 2003 2002 2003 2002 -------------------------------------- -------- -------- ------- ------- Net earnings $ 3,019 $ 1,164 $ 7,994 $ 5,248 Divided by: Weighted average shares outstanding 14,090 13,983 14,054 13,945 -------------------------------------- -------- -------- ------- ------- Basic earnings per common share $0.21 $0.08 $0.57 $0.38 -------------------------------------- -------- -------- ------- ------- Net earnings $ 3,019 $ 1,164 $ 7,994 $ 5,248 Divided by: Weighted average shares outstanding 14,090 13,983 14,054 13,945 Dilutive effect of common stock equivalents 370 391 328 392 -------------------------------------- -------- -------- ------- ------- Diluted weighted average common shares 14,460 14,374 14,382 14,337 -------------------------------------- -------- -------- ------- ------- Diluted earnings per common share $0.21 $0.08 $0.56 $0.37 -------------------------------------- -------- -------- ------- -------
Common shares issuable upon the exercise of stock options that were not included in the calculation because they were antidilutive, were immaterial for the three and nine months ended March 31, 2003 and 2002. Note G - Comprehensive Income -------------------- The components of comprehensive income were as follows for the periods indicated ($000):
Three Months Ended Nine Months Ended March 31, March 31, 2003 2002 2003 2002 -------------------------------------- -------- -------- ------- ------- Net earnings $3,019 $1,164 $7,994 $5,248 Foreign currency translation adjustments, net of tax 30 (48) 7 149 -------------------------------------- -------- -------- ------- ------- Comprehensive income $3,049 $1,116 $8,001 $5,397 -------------------------------------- -------- -------- ------- -------
II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note H - Segment Reporting ----------------- Effective July 1, 2002, the Company changed its segment reporting to reflect certain operational changes and to better reflect how the Company manages its businesses. Prior period segment information has been restated. The Company has the following reportable segments: Infrared Optics, which is primarily the Company's II-VI and Laser Power infrared optics and material products businesses; Near-Infrared Optics, which is primarily the Company's VLOC subsidiary; and Military Infrared Optics, which is primarily the Company's Exotic Electro-Optics subsidiary. The "Other" category is primarily the aggregation of the Company's eV PRODUCTS division, the Company's Wide Band Gap (WBG) Silicon Carbide development group, the Company's corporate research and development group and certain other remaining corporate activities. 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 profit or loss from operations. Intersegment sales and transfers have been eliminated. The following table summarizes selected financial information of the Company's operations by segment ($000's):
Three Months Ended March 31, 2003 ----------------------------------------------------------- Near- Military Infrared Infrared Infrared Optics Optics Optics Other Totals ----------------------------------------------------------- Net revenues $19,715 $ 5,647 $ 4,788 $ 2,206 $ 32,356 Income (loss) from operations 5,462 393 (453) (1,209) 4,193 Interest expense - - - - (174) Other income, net - - - - 93 Earnings before income taxes - - - - 4,112 Depreciation and amortization 1,084 512 418 354 2,368 Capital expenditures 629 48 271 253 1,201 Goodwill 5,516 1,927 21,544 - 28,987 Segment assets 67,188 23,543 38,125 29,352 158,208
Three Months Ended March 31, 2002 ----------------------------------------------------------- Near- Military Infrared Infrared Infrared Optics Optics Optics Other Totals ----------------------------------------------------------- Net revenues $15,061 $ 5,612 $ 5,170 $ 1,598 $ 27,441 Income (loss) from operations 2,928 155 (192) (1,275) 1,616 Interest expense - - - - (313) Other income, net - - - - 353 Earnings before income taxes - - - - 1,656 Depreciation and amortization 936 532 382 300 2,150 Capital expenditures 868 83 56 704 1,711 Goodwill 5,516 1,698 21,544 - 28,758 Segment assets 57,367 27,539 38,731 27,079 150,716
II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note H - Segment Reporting, Cont'd. --------------------------
Nine Months Ended March 31, 2003 ----------------------------------------------------------- Near- Military Infrared Infrared Infrared Optics Optics Optics Other Totals ----------------------------------------------------------- Net revenues $55,641 $16,793 $16,381 $6,543 $95,358 Income (loss) from operations 14,109 1,151 38 (3,504) 11,794 Interest expense - - - - (699) Other expense, net - - - - (394) Earnings before income taxes - - - - 10,701 Depreciation and amortization 3,279 1,617 1,257 1,098 7,251 Capital expenditures 1,747 368 921 1,017 4,053
Nine Months Ended March 31, 2002 ----------------------------------------------------------- Near- Military Infrared Infrared Infrared Optics Optics Optics Other Totals ----------------------------------------------------------- Net revenues $45,525 $16,872 $16,027 $5,156 $83,580 Income (loss) from operations 8,854 701 931 (2,817) 7,669 Interest expense - - - - (1,213) Other income, net - - - - 1,013 Earnings before income taxes - - - - 7,469 Depreciation and amortization 2,894 1,633 1,216 770 6,513 Capital expenditures 4,214 644 683 1,397 6,938
II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note I - Derivative Instruments ---------------------- Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. 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 a 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 $2.8 million as of March 31, 2003. 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 $40,000 and $11,000 for the three months ended March 31, 2003 and 2002, respectively. The change in the fair value of these contracts increased net earnings by $25,000 and decreased net earnings by $10,000 for the nine months ended March 31, 2003 and 2002, respectively. To satisfy certain provisions of its credit facility (See Note E), on March 6, 2003 the Company entered into a one-year interest rate cap expiring March 6, 2004, with a notional amount of $8.8 million replacing an interest rate cap with a notional amount of $12.5 million that expired on March 5, 2003. These agreements were entered into to limit interest rate exposure on one-half of the outstanding balance of the term loan, currently at $17.5 million. The floating rate option for the cap agreement is the one-month LIBOR rate with a cap strike rate of 3.00%. The one-month LIBOR rate was 1.30% on March 31, 2003. The Company has elected not to account for this agreement as a hedge as defined by SFAS No. 133, and recorded the unrealized change in the fair value of this agreement as an increase or decrease to interest expense in the results of operations. The effect of this instrument on net earnings for the three and nine months ended March 31, 2003 was immaterial. Note J - Acquisition of II-VI/L.O.T. --------------------------- During the quarter ended September 30, 2002, the Company reached an agreement with L.O.T. - Oriel Laser Optik Technologies Holding GmbH and L.O.T. - Oriel Laser Optik GmbH & Co. KG of Darmstadt, Germany (collectively L.O.T.) to establish a new European entity to distribute II-VI Incorporated and Laser Power Corporation products in Germany. Approximately 10% of the Company's total sales are in Germany. Prior to this acquisition, the distribution of the Company's products in Germany was handled by L.O.T. for over 25 years. II-VI and L.O.T. created II-VI/L.O.T. GmbH (II-VI/L.O.T.) to better service the needs of customers in Germany. The Company purchased a 75% controlling interest in II-VI/L.O.T. for approximately $2.8 million. The major assets acquired were inventory of approximately $1.2 million and intangible assets (customer lists and related information) of approximately $1.6 million that are being amortized over a ten-year useful life. II-VI/L.O.T. is based in Darmstadt, Germany and will provide distribution, marketing and laser specific know-how needed to sell both II-VI Incorporated and Laser Power Corporation products in Germany to OEM and aftermarket customers. The results of II-VI/L.O.T., net of minority interest, for the three and nine month periods ended March 31, 2003 are included in the Company's consolidated financial statements for the three and nine month periods ended March 31, 2003, and are included in the infrared optics segment. At any time after July 1, 2005, the Company has a call option to purchase the remaining interest in II-VI/L.O.T. and L.O.T. has a put option to the Company to require the purchase of the remaining interest in II-VI/L.O.T. The price of the remaining interest is based upon a fixed formula based on the average sales of II-VI/L.O.T. for the three fiscal years prior to the exercise of the option. II-VI Incorporated and Subsidiaries Notes to Condensed 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 continues to use 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. Therefore, compliance with SFAS No. 123, as amended by SFAS No. 148 had no financial impact on the financial position or results of operations for the three and nine months ended March 31, 2003. 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 March 31, 2003 March 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 $ 3,019 $ 0.21 $ 0.21 $ 1,164 $0.08 $0.08 Add: Stock-based employee compensation cost, net of related tax effects, recorded in the financial statements 0 0.00 0.00 0 0.00 0.00 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 (145) (0.01) (0.01) (158) (0.01) (0.01) --------------------------- --------- ------ -------- -------- ------ ------- Pro forma net earnings and earnings per common share $ 2,874 $ 0.20 $ 0.20 $ 1,006 $0.07 $0.07 ========= ====== ======== ======== ====== =======
II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note K - Stock-Based Compensation, Cont'd. ---------------------------------
Three Months Ended Three Months Ended March 31, 2003 March 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 $ 7,994 $ 0.57 $ 0.56 $ 5,248 $ 0.38 $ 0.37 Add: Stock-based employee compensation cost, net of related tax effects, recorded in the financial statements 0 0.00 0.00 0 0.00 0.00 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 applied to all awards (426) (0.03) (0.03) (474) (0.04) (0.04) --------------------------- --------- ------ -------- -------- ------ ------- Pro forma net earnings and earnings per common share $ 7,568 $ 0.54 $ 0.53 $ 4,774 $ 0.34 $ 0.33 ========= ======= ======== ======== ====== =======
Note L - Goodwill and Other Intangible Assets ------------------------------------ The Company is currently amortizing its acquired intangible assets with definite lives over periods ranging from 5 to 20 years. The Company ceased amortization of goodwill at the beginning of fiscal 2002 when it adopted SFAS No. 142, "Goodwill and Other Intangible Assets." The Company evaluates its goodwill on an annual basis. The Company completed a discounted cash flow and comparable market capitalization analysis by identified reporting units of the Company which have recorded goodwill as of June 30, 2002. Based on the results of this analysis, the Company's goodwill was not impaired as of June 30, 2002. There were no changes in the carrying value of goodwill as of and for the periods ended March 31, 2003. As part of the acquisition of II-VI/L.O.T. (See Note J) identifiable intangible assets (customer lists and related information) of approximately $1.6 million were recorded July 1, 2002. The gross carrying amount and accumulated amortization of the Company's intangible assets, other than goodwill, as of March 31, 2003 and June 30, 2002, are as follows ($000):
March 31, 2003 June 30, 2002 ------------------------------- -------------------------------- Gross Net Gross Net Carrying Accumulated Book Carrying Accumulated Book Amount Amortization Value Amount Amortization Value -------- ------------ ----- -------- ------------ ------- Patents $1,867 $ (460) 1,407 $1,793 $ (357) $1,436 Trademark 1,491 (199) 1,292 1,491 (143) 1,348 Customer Lists 2,839 (1,024) 1,815 1,250 (801) 449 -------- ------------ ------ -------- ------------ ------- Total $6,197 $(1,683) $4,514 $4,534 $(1,301) $3,233 ======== ============ ====== ======== ============ =======
II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note L - Goodwill and Other Intangible Assets, Cont'd. --------------------------------------------- Amortization expense recorded on the intangible assets for the three and nine months ended March 31, 2003, was $127,000 and $382,000, respectively, and $95,000 and $312,000, respectively for the three and nine months ended March 31, 2002. At March 31, 2003, estimated future amortization expense for existing intangible assets for each of the five succeeding fiscal years is as follows ($000): Year Ended June 30, -------------------------------------- ($000) Remaining fiscal 2003 $122 2004 498 2005 498 2006 446 2007 347 2008 302 Note M - New Accounting Pronouncements ----------------------------- In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company evaluated its existing leased and owned properties for potential asset retirement obligations under SFAS 143. Based on this review, the Company identified obligations primarily related to disposal of certain materials utilized in its manufacturing process. The adoption of SFAS 143 did not have a material effect on the Company's financial position or results of operations for the three and nine months ended March 31, 2003, respectively. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which provides guidance that will eliminate inconsistencies in the accounting for the impairment or disposal of long-lived assets under existing accounting pronouncements. The provisions of this standard must be applied for fiscal periods beginning after December 15, 2001. The Company adopted SFAS 144 in the first quarter of fiscal 2003. The adoption of SFAS 144 had no financial impact on the financial position or results of operations for the three and nine months ended March 31, 2003. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullified Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between SFAS 146 and Issue 94-3 relates to SFAS 146 requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company did not have any exit or disposal activities which would require the application of the requirements of this standard, therefore, the adoption of this standard had no financial impact on the financial position or results of operations for the three and nine months ended March 31, 2003. II-VI Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited), Continued Note M - New Accounting Pronouncements, Cont'd. -------------------------------------- In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," requiring increased disclosures regarding certain guarantees and requiring the recognition at fair value in the balance sheet of certain guarantees. Interpretation No. 45 is required to be adopted for interim financial statements ending after December 15, 2002. The Company records a warranty reserve as a charge against earnings based on a percentage of sales utilizing actual returns over the last twelve months. If actual returns are not consistent with the historical data used to calculate these estimates, net sales could either be understated or overstated. The following table summarizes the change in the carrying value of the Company's warranty reserve as of and for the nine months ended March 31, 2003 and as of and for the year ended June 30, 2002 ($000).
June 30, 2002 March 31, 2003 Balance Expense Other Writeoffs Balance ------------- ------- ------- --------- ----------------- Consolidated: Warranty Reserve $419 $107 - - $526
June 30, 2001 June 30, 2002 Balance Expense Other(1) Writeoffs Balance ------------- ------- ------- --------- ----------------- Consolidated: Warranty Reserve $334 $(3) $88 - $419
(1) Reclassification of the Laser Power Corporation warranty reserve from other current liabilities. 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/A as filed with the Securities and Exchange Commission on September 27, 2002. 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 2002 Form 10-K/A 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, accrual of bonus and profit sharing estimates and accrual of income tax liability estimates. Management believes these policies to be critical because they are both important to the portrayal of the Company's financial condition and results of operation, and they require management to make judgments and estimates about matters that are inherently uncertain. Additional information about these critical accounting policies may be found in the Company's 2002 Form 10-K/A in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the heading "Critical Accounting Policies." We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is established or determinable and collectibility is probable. Revenue, other than for contract research and development, for all business segments is recognized from the sale of products at the point of passage of title, which is at the time of shipment. We follow the guidelines of Statement of Position 81-1 "Accounting for Performance of Construction - Type and Certain Production-Type Contracts" for our long-term contracts related to research and development. Revenue and profits on each long-term contract are accounted for using the percentage-of-completion method of accounting, whereby revenue and profits are recognized throughout the performance period of the contract. Percentage-of-contract is determined by relating the actual cost of work performed to date to the estimated total cost for each contract. The estimated total cost for each contract is periodically reevaluated and revised, when necessary, throughout the life of the contract. Losses on contracts are recorded in full when identified. The Company records an allowance for doubtful accounts receivable as a charge against earnings. The allowance is an estimate for potential non-collection of accounts receivable based on historical experience. The Company has not experienced a non-collection of accounts receivable materially affecting its financial position or results of operations as of and for the period ended March 31, 2003. If the financial condition of the Company's customers were to deteriorate causing an impairment of their ability to make payments, additional provisions for bad debts may be required in future periods. The Company records a warranty reserve as a charge against earnings based on a percentage of sales utilizing actual returns over the last twelve months. If actual returns are not consistent with the historical data used to calculate these estimates, net sales could either be understated or overstated. The Company records a slow moving inventory reserve as a charge against earnings for all products on hand that have not been sold to customers in the past twelve months. An additional reserve is recorded for product on hand that is in excess of product sold to customers over the past twelve months. If actual market conditions are less favorable than projected, additional inventory reserves may be required. The Company tests goodwill on at least an annual basis for impairment. Other intangible assets are amortized over their estimated useful lives. The determination of related estimated useful lives of other intangible assets and whether goodwill is impaired involves judgments based upon long-term projections of future performance. A discounted cash flow model is used to determine the fair value of the reporting units for purposes of testing goodwill for impairment. Based on the results of the most recently completed analysis, the Company's goodwill was not impaired as of June 30, 2002. No event has occurred as of or for the period ended March 31, 2003 that would give management an indication that an impairment charge was necessary that would adversely affect the Company's financial position or results of operations. The Company records bonus and profit sharing estimates as a charge against earnings based on a percentage of operating income. These estimates are adjusted to actual based on final results of operations achieved during the fiscal year. Certain bonuses are paid quarterly at a level of 75% of the current year to date operating income with final payment in August of the subsequent fiscal year. Other bonuses and profit sharing are paid annually in August of the subsequent fiscal year. The Company records an estimated income tax liability to recognize the amount of income taxes payable or refundable for the current year and deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or income tax returns. Judgment is required in estimating the future income tax consequences of events that have been recognized in the Company's financial statements or the income tax returns. The Company uses the intrinsic value approach specified in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," for stock options granted to officers and key employees, and therefore does not record compensation costs based upon the fair value of options at the date of grant. See Note K of the notes to condensed consolidated financial statements. From time to time, estimated accruals are recorded as a charge against earnings based on known circumstances where it is probable that a liability has been incurred or is expected to be incurred and the amount can reasonably be estimated. New Accounting Pronouncements ----------------------------- See Note M of the notes to condensed consolidated financial statements for information regarding new accounting pronouncements. Results of Operations --------------------- Overview Net earnings for the third quarter of fiscal 2003 were $3,019,000 ($0.21 per share-diluted) on revenues of $32,356,000. This compares to net earnings of $1,164,000 ($0.08 per share-diluted) on revenues of $27,441,000 in the third quarter of fiscal 2002. For the nine months ended March 31, 2003, net earnings were $7,994,000 ($0.57 per share- diluted) on revenues of $95,358,000. This compares to net earnings of $5,248,000 ($0.37 per share-diluted) on revenues of $83,580,000 for the same period last fiscal year. The increase of 18% in revenues for the third quarter of fiscal 2003 compared to the same period last fiscal year is primarily due to stronger shipments of commercial infrared optics to both OEM and aftermarket customers and the integration of the Company's sales and marketing distribution activity in Germany through a new consolidated subsidiary, II-VI/L.O.T., (See Note J of the notes to the condensed consolidated financial statements). Bookings for the third quarter of fiscal 2003 increased 2% to $37,072,000 compared to $36,467,000 for the same period last fiscal year. The increase for the three month and nine month periods was primarily attributable to stronger market demand in the infrared optics market. Bookings for contract research and development for the third quarter of fiscal year 2003 were $2,414,000 compared to $2,236,000 for the same period last fiscal year. Order bookings for the nine months ended March 31, 2003 increased 16% to $103,978,000 as compared to $89,453,000 for the same period last fiscal year. The increase for the three month and nine month periods was primarily attributable to stronger market demand in the infrared optics market. Bookings for contract research and development for the nine months ended March 31, 2003 were $8,306,000 compared to $8,706,000 for the same period last fiscal year. Bookings are defined as customer orders received that are expected to be converted to sales revenue over the next 12 months. For long-term customer orders, the Company takes the view of not including 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. Income from operations, which is defined as earnings before income taxes, interest and other income or expense, for the third quarter of fiscal 2003 increased 159% to $4,193,000 compared to $1,616,000 for the same period last fiscal year primarily due to higher gross margins from improved manufacturing synergies and cost controls in the Infrared Optics segment and higher sales volume from all segments with the exception of the Military Infrared Optics segment. Income from operations for the nine months ended March 31, 2003 increased 54% to $11,794,000 compared to $7,669,000 for the same period last fiscal year. Improvement was experienced in the Infrared and Near-Infrared Optics segments which was partially offset by lower income from operations in the Military Infrared Optics segment and the Company's Other category. Bookings, revenues and income or (loss) from operations for the Company's reportable segments are discussed below. Certain amounts from prior years have been reclassified to conform with the segment reporting presentation adopted in fiscal 2003. See also the segment reporting discussion in Note H of the notes to condensed consolidated financial statements. Infrared Optics Bookings for the third quarter of fiscal 2003 for Infrared Optics increased 48% to $22,083,000 from $14,951,000 in the third quarter of last fiscal year. This increase was attributable in part to the receipt of approximately $3.5 million in blanket orders received from one domestic OEM customer and two OEM customers in Europe and China. The remaining quarter over quarter improvement was due to overall increases in order volume from OEM and aftermarket customers worldwide. Bookings for the nine months ended March 31, 2003 increased 51% to $61,226,000 from $40,646,000 for the same period last fiscal year. During the quarter, the OEM manufacturers of both high-power, multi- kilowatt lasers for cutting, welding, drilling and heat treating applications and lower-power lasers for engraving and marking requested products at a rate more consistent with fiscal year 2001 business levels explaining the increase in order bookings over the same period last fiscal year. Revenues for the current fiscal quarter for Infrared Optics increased 31% to $19,715,000 from $15,061,000 in the third quarter of last fiscal year. This increase was primarily attributable to increased shipments to several of the Company's international OEM customers. Revenues for the nine months ended March 31, 2003 increased 22% to $55,641,000 from $45,525,000 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. Income from operations for the third quarter increased 87% to $5,462,000 from $2,928,000 in the third quarter of last fiscal year. Income from operations for the nine months ended March 31, 2003 increased 59% to $14,109,000 compared to $8,854,000 for the same period last fiscal year. The improvement in income from operations for the current fiscal three and nine month periods as compared to the same periods of the last fiscal year was due to a combination of increased sales volume, operational consolidation and the acquisition of a majority interest in a distributor in Germany, which is described in Note J of the notes to condensed consolidated financial statements. Near-Infrared Optics Bookings for the third quarter of fiscal 2003 for Near-Infrared Optics increased 52% to $6,839,000 from $4,513,000 in the third quarter of last fiscal year. The increase was primarily due to stronger demand in commercial bookings in the product lines used in defense applications, and the receipt of $1.5 million in contract bookings in the current quarter. Bookings for the nine months ended March 31, 2003 increased 5% to $18,689,000 as compared to $17,860,000 for the same period last fiscal year. The increase in bookings for the nine months ended March 31, 2003 as compared to the same period of the last fiscal year was primarily due to stronger demand in commercial bookings in product lines used in defense applications. Revenues for the third quarter for Near-Infrared Optics were $5,647,000 compared to $5,612,000 in the third quarter of last fiscal year. Revenues for the nine months ended March 31, 2003 were $16,793,000 compared to $16,872,000 for the same period last fiscal year. Income from operations for the third quarter of fiscal 2003 more than doubled to $393,000 from $155,000 in the third quarter of last fiscal year. This improvement reflected overall stronger gross margins and improved product yields. Income from operations for the nine months ended March 31, 2003 increased 64% to $1,151,000 compared to $701,000 for the same period last fiscal year. Cost reductions particularly in the materials area as a result of yield improvements were sufficient to increase gross margins despite the essentially flat revenues for the comparable nine month periods. Military Infrared Optics Bookings for the third quarter of fiscal 2003 for Military Infrared Optics were $7,300,000 as compared to $11,019,000 in the third quarter of last fiscal year. The 34% reduction in bookings is due to a large initial order in the third quarter of last fiscal year for the Northrop Grumman IFTS program focused on sapphire window assemblies that did not occur in fiscal 2003 and a twelve month order from Lockheed Martin for Javelin missile domes in the third quarter of fiscal 2002 as compared to a six month order during the third quarter of the current fiscal year. Bookings for the nine months ended March 31, 2003 were $18,603,000 compared to $23,251,000 for the same period last fiscal year, a decrease of 20%. The reduction in orders as compared to the same period last fiscal year is primarily due to the quarterly changes described above. Revenues for the third quarter of fiscal 2003 for Military Infrared Optics decreased 7% to $4,788,000 compared to $5,170,000 in the third quarter of the last fiscal year. A missile domes program in the third quarter of the prior fiscal year is no longer active for the third quarter of the current fiscal year. Revenues for the nine months ended March 31, 2003 increased 2% to $16,381,000 from $16,027,000 for the same period last fiscal year. Revenues from the Air Borne Laser (ABL) contract were the major contributor to the increase as compared to the same period of the last fiscal year which was partially offset by decreases in revenues from core military products. During the third quarter, Military Infrared Optics experienced a $453,000 loss from operations compared to a loss from operations of $192,000 in the third quarter of the last fiscal year. Deteriorating gross margins in the current quarter relating to contract execution contributed to the loss from operations. Income from operations for the nine months ended March 31, 2003 decreased to $38,000 from $931,000 for the same period last fiscal year. The consolidation of the commercial operations in the fourth quarter of fiscal year 2002 from Laser Power Corporation to other II-VI facilities decreased gross margins in the remaining military focused business segment due to the absorption of costs previously allocated to the Infrared Optics segment. Higher costs negatively impacted income from operations in the current quarter and nine month periods relating to revisions in estimated costs to complete certain fixed price government contracts. Other Other bookings, revenues and operating losses primarily includes the combined operations of the Company's eV PRODUCTS division, the Company's Wide Band Gap (WBG) Silicon Carbide operations and the Company's corporate research and development group. Combined bookings for the third quarter of fiscal 2003 for eV PRODUCTS division and the WBG group decreased to $850,000 as compared to $5,984,000 in the third quarter of last fiscal year. The decrease in the current quarter was due to eV PRODUCTS division booking several large blanket orders during the same quarter a year ago. Bookings for the nine months ended March 31, 2003 for these groups decreased to $5,460,000 compared to $7,696,000 for the same period last fiscal year primarily due to the several large orders received by both groups during the prior nine month fiscal period that were absent in the same period this fiscal year. Revenues for the third quarter from these operations increased 38% to $2,206,000 compared to $1,598,000 in the third quarter of the last fiscal year. Revenues for the nine months ended March 31, 2003 for these operations increased 27% to $6,543,000 as compared to $5,156,000 for the same period last fiscal year. The higher revenues are a direct result of the higher contract billings, particularly in the contract research and development area of the WBG group, during this fiscal period that were not in last fiscal year. The loss from operations for the third quarter of fiscal 2003 of $1,209,000 decreased from the operating loss of $1,275,000 in the third quarter of the prior fiscal year. The decrease in the loss was attributable to more external contract support of the Company's efforts in silicon carbide, which offsets the funding needed to be provided by the Company for this activity. The loss from operations for the nine months ended March 31, 2003 for these operations increased to $3,504,000 as compared to $2,817,000 for the same period last fiscal year. The increase in the loss was due to lower revenues and gross margin for the eV PRODUCTS division and unallocated corporate costs absorbed and reported in this segment primarily related to internal research and development. Overall Manufacturing gross margin, which is defined as net sales less cost of goods sold, for the third quarter of fiscal 2003 was $12,067,000 or 41% of revenues compared to $8,034,000 or 31% of revenues for the same period last fiscal year. Manufacturing gross margin for the nine months ended March 31, 2003 was $34,547,000 or 40% of revenues compared to $25,638,000 or 33% of revenues for the same period last fiscal year. The increased sales volume for the three and nine month periods as compared to the same periods last fiscal year, the operational consolidation in the infrared optics commercial business, the acquisition of a majority interest in a distributor in Germany and lower material costs as a result of yield improvements all contributed to the increased gross margin. Contract research and development gross margin, which is calculated as contract research and development revenues less expenses, for the third quarter of fiscal 2003 was $225,000 or 7% of research and development revenues compared to a gross margin loss of $441,000 or 34% of research and development revenues for the same period last fiscal year. Contract research and development gross margin for the nine months ended March 31, 2003 was $744,000 or 9% of research and development revenues compared to $864,000 or 16% of research and development revenues for the same period last fiscal year. The contract research and development revenues and costs are a result of development efforts in the Near-Infrared Optics and the Military Infrared Optics segments as well as activities in the eV PRODUCTS division and the WBG group for the current quarter and nine month periods ended March 31, 2003. The increased revenues level for the three and nine month periods as compared to the same periods last fiscal year is primarily due to revenues from a new development contract in 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. The negative gross margin in the third quarter of the prior fiscal year was due to losses recognized from activities performed on a fixed price percentage of completion contract in the Military Infrared Optics segment. Company-funded internal research and development expenses for the third quarter of fiscal 2003 were $435,000 or 1% of revenues compared to $1,153,000 or 4% of revenues for the same period last fiscal year. The significantly lower expense is a direct result of more external contract support of the Company's efforts in silicon carbide, which offsets the funding needed to be provided by the Company for this activity. In last year's third quarter, the Company had reported its first full quarter of results that included all the costs of the former Litton Systems, Inc. Silicon Carbide Group, acquired in the second quarter of last fiscal year, but the Company did not have contract revenues to offset these additional costs. In contrast, contract revenue for silicon carbide is now approximately $1.0 million per quarter. Company-funded internal research and development expenses for the nine months ended March 31, 2003 were $1,946,000 or 2% of revenues compared to $3,488,000 or 4% of revenues for the same period last fiscal year. These expenditures for the three and nine month periods reflect continued silicon carbide crystal growth technology and processing development. These expenditures also include corporate research and development activities in addition to the research and development activities of the eV PRODUCTS division. Selling, general and administrative expenses for the third quarter of fiscal 2003 were $7,664,000 or 24% of revenues compared to $4,824,000 or 18% of revenues for the same period last fiscal year. Selling, general and administrative expenses for the nine months ended March 31, 2003 were $21,551,000 or 23% of revenues compared to $15,345,000 or 18% of revenues for the same period last fiscal year. The dollar and percentage increases for the quarter and nine month periods as compared to the same periods last fiscal year reflect costs associated with the acquisition, during the first quarter of this fiscal year, of a majority interest in a distributor in Germany (See Note J of the notes to the condensed consolidated financial statements). While this acquisition has increased the Company's direct selling expense for the quarter and nine months by approximately 2% of sales as compared to the prior year, this expense increase has been offset by the additional gross margin on sales to end customers in Germany. In addition to the acquisition of II-VI/L.O.T., the Company recorded higher salary expenses as compared to the same quarter last fiscal year for its world-wide profit driven bonus program. Interest expense for the third quarter of fiscal 2003 was $174,000 compared to $313,000 for the same period last fiscal year. For the nine months ended March 31, 2003, interest expense was $699,000 compared to $1,213,000 for the same period last fiscal year. The decrease in interest expense reflects lower LIBOR based interest rates, as well as lower overall debt levels of the Company at March 31, 2003 as compared to the same period last fiscal year. Other income for the third quarter of fiscal 2003 was $93,000 compared to other income of $353,000 for the same period last fiscal year. These income items included foreign currency gains, interest income, royalty income and other income items. Other income was partially offset by the minority interest in II-VI/L.O.T. and other expense items. Other expense for the nine months ended March 31, 2003 of $394,000 compared to other income of $1,013,000 for the same period last fiscal year. The nine month change in 2003 was primarily due to the minority interest in II-VI/L.O.T., the write-off of an investment in the second quarter of the current fiscal year and foreign currency losses as a result of the U.S. dollar's performance relative to other currencies in the current fiscal year as compared to foreign currency gains in the same period last fiscal year. The Company's year-to-date effective income tax rate is 25% compared to an effective income tax rate of 30% for the same period in fiscal 2002. The income tax rate reflects the Company's continued benefit from lower tax rates on its Singapore and China operations and a favorable mix of U.S. and foreign income. Liquidity and Capital Resources ------------------------------- In the first nine months of fiscal 2003, net cash provided by operating activities of $18.7 million and proceeds from sale of fixed assets of $0.6 million were used primarily to fund an investment of $4.2 million in property, plant and equipment, to finance a $2.8 million acquisition for a 75% majority ownership of II-VI/L.O.T. and to pay down $8.9 million of debt. Cash transactions for the first nine months of fiscal 2003 plus cash on hand at the beginning of the fiscal year resulted in a cash position of $13.2 million at March 31, 2003. The Company had available $14.8 million and $9.3 million under its line of credit option of the credit facility as of March 31, 2003 and June 30, 2002, respectively. The Company is obligated on the first day of each fiscal quarter to pay $1.25 million against its term loan option through July 1, 2003 and $1.88 million on the first day of each fiscal quarter thereafter until the term loan is repaid (See Note E to the notes to condensed consolidated financial statements). The Company believes internally generated funds, existing cash reserves and available borrowing capacity will be sufficient to fund its working capital needs, capital expenditures and scheduled debt payments for fiscal 2003. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Market Risks ------------ The Company is exposed to market risks arising from adverse changes in interest rates and foreign currency exchange rates. In the normal course of business, the Company uses a variety of techniques and 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 has transactions denominated in Euros and Pounds Sterling. Changes in the foreign currency exchange rates did not have a material impact to the results of operations for the period ended March 31, 2003. For the quarter ended March 31, 2003, the Company decreased its borrowings by $5.0 million. As of March 31, 2003, the total borrowings of $25.8 million include $17.5 million under the term loan option, $5.3 million under the line of credit option, $2.5 million Japanese Yen loan and a $0.5 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 $71,000 and $227,000 for the three and nine month periods ended March 31, 2003. To satisfy certain provisions of its term loan option of the credit facility relating to mitigating interest rate risk, on March 6, 2003 the Company entered into an interest rate cap for a one-year period with a notional amount of $8.8 million. See Note I of the notes to condensed consolidated financial statements. Item 4. CONTROLS AND PROCEDURES (a) Disclosure Controls and Procedures. ---------------------------------- Within 90 days before filing this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. 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), reviewed and participated in this evaluation. Based on this evaluation, Messrs. Johnson and Creaturo concluded that, as of the date of their evaluation, the Company's disclosure controls were effective. (b) Internal Controls. Since the date of the evaluation described above, there have not been any significant changes in the Company's internal accounting controls or in other factors that could significantly affect those controls. PART II - OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. -------- 99.01 Certification Filed herewith. Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Carl J. Johnson 99.02 Certification Filed herewith. Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Craig A. Creaturo (b) Reports on Form 8-K. On April 23, 2003, the registrant filed a report on Form 8-K for the events dated April 23, 2003, covering Item 9 thereof. 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: May 14, 2003 By: /s/ Carl J. Johnson Carl J. Johnson Chairman and Chief Executive Officer Date: May 14, 2003 By: /s/ Craig A. Creaturo Craig A. Creaturo Chief Accounting Officer and Treasurer CERTIFICATIONS I, Carl J. Johnson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of II-VI Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. May 14, 2003 By: /s/ Carl J. Johnson Carl J. Johnson Chairman and Chief Executive Officer I, Craig A. Creaturo, certify that: 1. I have reviewed this quarterly report on Form 10-Q of II-VI Incorporated; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. May 14, 2003 By: /s/ Craig A. Creaturo Craig A. Creaturo Chief Accounting Officer and Treasurer EXHIBIT INDEX ------------- Exhibit Number Description of Exhibit -------------- ---------------------- 99.01 Certification Pursuant Filed herewith. to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Carl J. Johnson 99.02 Certification Pursuant Filed herewith. to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of 2002 for Craig A. Creaturo