Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1. Basis of Presentation
The condensed consolidated financial statements of II-VI Incorporated (“II-VI”, the “Company”, “we”, “us” or “our”) for the three and nine months ended March 31, 2022 and 2021 are unaudited. In the opinion of management, all adjustments considered necessary for a fair presentation for the periods presented have been included. All adjustments are of a normal recurring nature unless disclosed otherwise. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K dated August 20, 2021. The condensed consolidated results of operations for the three and nine months ended March 31, 2022 are not necessarily indicative of the results to be expected for the full fiscal year. The Condensed Consolidated Balance Sheet information as of June 30, 2021 was derived from the Company’s audited consolidated financial statements.
The Company is closely monitoring the ongoing impact of the COVID-19 pandemic and related factors on all aspects of our business, including the impact to our employees, suppliers and customers, as well as the impact to the countries and markets in which II-VI operates. In particular, the Company is continuing to focus intensely on mitigating any resulting adverse impacts on our foreign and domestic operations, starting by prioritizing the safety of our employees, suppliers and customers.
We previously classified intangible asset amortization expense within Selling, general and administrative (“SG&A”) expenses in our Condensed Consolidated Statements of Earnings. Amortization expense on the developed technology intangible assets is now classified within Cost of goods sold, with amortization expense on customer lists and trade names remaining within SG&A expenses in our Condensed Consolidated Statements of Earnings. Prior period amounts have been conformed to the current period presentation, which resulted in an increase to Cost of goods sold and a decrease to SG&A expenses of $10 million and $29 million for the three and nine months ended March 31, 2021, respectively.
Note 2. Recently Issued Financial Accounting Standards
Debt - Debt with Conversion and Other Options and Derivatives and Hedging - Contracts in Entity's Own Equity
In August 2020, the Financial Accounting Standards Board (the "FASB") issued ASC Update No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40) ("ASU 2020-06"). The update simplifies the accounting for convertible instruments by eliminating two accounting models (i.e., the cash conversion model and beneficial conversion feature model) and reducing the number of embedded conversion features that could be recognized separately from the host contract. ASU 2020-06 also enhances transparency and improves disclosures for convertible instruments and earnings per share guidance. The Company adopted this standard as of July 1, 2021. The Company elected to use the modified retrospective method to report the effect of the changes. Adoption of the standard affected the Company's currently outstanding 0.25% convertible senior notes due 2022 (the "II-VI Convertible Notes"). Refer to Note 8. Debt for the impact of the adoption on the II-VI Convertible Notes.
Note 3. Pending Coherent Acquisition
On March 25, 2021, II-VI, Coherent, Inc., and Watson Merger Sub Inc., a wholly owned subsidiary of II-VI (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). Pursuant to the terms of the Merger Agreement, and subject to the conditions set forth therein, Merger Sub will be merged with and into Coherent, and Coherent will continue as the surviving corporation in the merger and a wholly owned subsidiary of II-VI (the “Merger”).
Pursuant to the terms of the Merger Agreement, and subject to the conditions set forth therein, at the effective time of the Merger (the “Effective Time”), each share of common stock of Coherent, par value $0.01 per share (the “Coherent Common
Stock”), issued and outstanding immediately prior to the Effective Time will be canceled and extinguished and automatically converted into the right to receive the following consideration (collectively, the “Merger Consideration”):
(A) $220.00 in cash, without interest (the "Cash Consideration"), and
(B) 0.91 of a validly issued, fully paid and nonassessable share of common stock of II-VI, no par value per share ("II-VI Common Stock").
Pursuant to the terms of the Merger Agreement, each Coherent restricted stock unit award (a “Coherent RSU”), other than Director RSUs (as defined below), outstanding immediately prior to the Effective Time will be automatically converted into time-based restricted stock units denominated in shares of II-VI Common Stock entitling the holder to receive, upon settlement, a number of shares of II-VI Common Stock equal to the number of shares of Coherent Common Stock subject to the Coherent RSU multiplied by the sum of (A) 0.91, and (B) the quotient obtained by dividing the Cash Consideration by the volume weighted average price of a share of II-VI Common Stock for a 10-trading day period ending prior to the closing of the Merger (the “Closing”). For Coherent RSUs subject to performance-based vesting conditions and metrics, the number of shares of II-VI Common Stock subject to the converted Coherent RSUs will be determined after giving effect to the Coherent Board of Directors’ determination of the number of Coherent RSUs earned, based on the greater of the target or actual level of achievement of such goals or metrics immediately prior to the Effective Time.
The converted Coherent RSUs generally will be subject to the same terms and conditions that applied to the awards immediately prior to the Effective Time, provided that any Coherent RSUs subject to performance-based vesting conditions will be subject solely to time-and service-based vesting. Each Coherent RSU that is outstanding as of the date of the Merger Agreement and as of immediately prior to the Effective Time will be entitled to the following vesting acceleration benefits:
(A) for any holder of Coherent RSUs who is a participant under Coherent’s Change of Control and Leadership Change Severance Plan (the “CIC Plan”), the acceleration benefits under the CIC Plan upon such participant’s involuntary termination of employment in accordance with the terms and conditions set forth therein; and
(B) for any holder who is not a participant in the CIC Plan, upon his or her termination of employment by Coherent, II-VI or their respective subsidiaries without “cause” within the period beginning immediately following the date of the Closing and ending on December 31, 2022 (a “Qualifying Termination”), 50% of the total number of converted Coherent RSUs that otherwise would have vested during calendar year 2022 under the applicable vesting schedule in effect on the Closing had such holder remained employed with Coherent, II-VI or their respective subsidiaries through the last applicable vesting date for such award in calendar year 2022 (and reduced by the total number of converted Coherent RSUs that vested in calendar year 2022 prior to such Qualifying Termination).
Each Coherent RSU granted to a non-employee member of Coherent’s Board of Directors (“Director RSUs”) (whether or not vested) that is outstanding immediately prior to the Effective Time will automatically vest in full and be canceled and converted into the right to receive the Merger Consideration as if such Director RSU had been settled in shares of Coherent Common Stock immediately prior to the Effective Time.
The Boards of Directors of II-VI and Coherent unanimously approved the Merger and the Merger Agreement. II-VI filed with the Securities and Exchange Commission (the "SEC") a registration statement on Form S-4 relating to the Merger, and the SEC declared that registration statement to be effective on May 6, 2021. Shareholders of II-VI and stockholders of Coherent voted to approve proposals related to the Merger at special meetings held on June 24, 2021 by the respective companies.
The completion of the Merger is subject to the termination or expiration of any applicable waiting period (or extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder, and the approval by the State Administration for Market Regulation in China, along with the satisfaction and completion of other customary closing conditions. Subject to the satisfaction or waiver of each of the closing conditions, II-VI anticipates that the Merger will be completed by the end of the second calendar quarter of 2022. However, it is possible that factors outside the control of both companies could result in the Merger being completed later or not at all.
In connection with entering into the Merger Agreement, II-VI has obtained a fully underwritten financing commitment pursuant to a commitment letter (the “Commitment Letter”), dated as of March 25, 2021, as further amended and restated on April 21, 2021, with JPMorgan Chase Bank, N.A., Citigroup Global Markets Inc., MUFG Bank, Ltd., MUFG Securities Americas Inc., PNC Capital Markets LLC, PNC Bank, National Association, HSBC Securities (USA) Inc., HSBC Bank USA, National Association, Citizens Bank, N.A., Mizuho Bank, Ltd., BMO Capital Markets Corp., Bank of Montreal, TD Securities (USA) LLC, The Toronto-Dominion Bank, New York Branch, TD Bank, N.A. and First National Bank of Pennsylvania (collectively,
the “Commitment Parties”) pursuant to which the Commitment Parties have committed to provide up to $5.1 billion in debt financing. II-VI and the Commitment Parties amended and restated the Commitment Letter on October 25, 2021 (the "Amended and Restated Commitment Letter") to effect certain amendments thereto, including to reduce the total amounts of commitments thereunder to $4.99 billion. The obligation of the Commitment Parties to provide the debt financing provided for in the Amended and Restated Commitment Letter is subject to a number of customary conditions. Subject to the terms of the Amended and Restated Commitment Letter, the commitment parties thereto committed to provide a senior unsecured bridge loan facility in an aggregate principal amount of $990 million (the "Bridge Loan Commitment"). As a result of the issuance of the Senior Notes (defined in Note 8), the Bridge Loan Commitment was terminated, such that the total amounts of commitments under the Amended and Restated Commitment Letter are $4.0 billion.
On December 10, 2021, II-VI issued $990 million of the Senior Notes. The Senior Notes are guaranteed by each of the Company’s domestic subsidiaries that guarantee its obligations under its existing credit agreement. The Senior Notes were offered and sold either to persons reasonably believed to be “qualified institutional buyers” pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), or to persons outside the United States under Regulation S of the Securities Act. Interest on the Senior Notes will be payable on December 15 and June 15 of each year, commencing on June 15, 2022, at a rate of 5.000% per annum. The Senior Notes will mature on December 15, 2029.
As of December 10, 2021, the New Term Facilities and the New Revolving Credit Facility (as defined in Note 8) contemplated by the Amended and Restated Commitment Letter have been fully priced and allocated. The Company intends to borrow under the New Term Facilities and to use the net proceeds from the issuance and sale of the Senior Notes in connection with the Merger. The New Revolving Credit Facility is expected to be available concurrently with the Closing.
In connection with entering into the Merger Agreement, II-VI entered into an Amended and Restated Investment Agreement, dated as of March 30, 2021, (the “Investment Agreement”), with BCPE Watson (DE) SPV, LP, an affiliate of Bain Capital Private Equity, LP (the “Investor”). Pursuant to the terms of the Investment Agreement, on March 31, 2021, II-VI issued, sold, and delivered to the Investor 75,000 shares of a new Series B-1 Convertible Preferred Stock of the Company, no par value per share (“II-VI Series B-1 Convertible Preferred Stock”), for $10,000 per share (the “Equity Per Share Price”), resulting in an aggregate purchase price of $750 million. Subject to the terms and conditions of the Investment Agreement, among other things, the Company and the Investor also agreed that the Company would issue, sell and deliver to the Investor:
•105,000 shares of a new Series B-2 Convertible Preferred Stock of the Company, no par value per share ("II-VI Series B-2 Convertible Preferred Stock," and together with the II-VI Series B-1 Convertible Preferred Stock, “New II-VI Convertible Preferred Stock”), for a purchase price per share equal to the Equity Per Share Price, resulting in an aggregate purchase price of $1.05 billion, immediately prior to the Closing; and
•immediately prior to the Closing, if elected by the Company and agreed by the Investor, up to an additional 35,000 shares of II-VI Series B-2 Convertible Preferred Stock (the "Upsize Shares") for a purchase price per share equal to the Equity Per Share Price, resulting in an aggregate maximum purchase price for the Upsize Shares of $350 million.
Following the Company’s provision of notice to the Investor of its election to offer the Upsize Shares, the Investor informed the Company on June 8, 2021 of its agreement to purchase the Upsize Shares from the Company immediately prior to the Closing, increasing the Investor’s total equity commitment to II-VI pursuant to the Investment Agreement to $2.15 billion.
The expenses associated with the Merger for the three and nine months ended March 31, 2022 have not been allocated to an Operating Segment, and are presented in the Unallocated and Other in Note 13. Segment Reporting.
Note 4. Revenue from Contracts with Customers
The Company believes that disaggregating revenue by end market provides the most relevant information regarding the nature, amount, timing, and uncertainty of revenues and cash flows.
The following tables summarize disaggregated revenue for the three and nine months ended March 31, 2022 and 2021 ($000):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | Nine Months Ended March 31, 2022 | |
| Photonic
Solutions | | Compound
Semiconductors | | | | | | Total | | Photonic
Solutions | | Compound
Semiconductors | | | | | Total | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Industrial | $ | 18,372 | | | $ | 82,421 | | | | | | | $ | 100,793 | | | $ | 53,372 | | | $ | 251,721 | | | | | | $ | 305,093 | | | | | | | | |
| Communications | 531,256 | | | 34,006 | | | | | | | 565,262 | | | 1,519,733 | | | 94,813 | | | | | | 1,614,546 | | | | | | | | |
| Aerospace & Defense | — | | | 45,096 | | | | | | | 45,096 | | | — | | | 136,405 | | | | | | 136,405 | | | | | | | | |
| Consumer | 2,194 | | | 41,773 | | | | | | | 43,967 | | | 6,615 | | | 164,615 | | | | | | 171,230 | | | | | | | | |
| Semiconductor | 3,111 | | | 36,670 | | | | | | | 39,781 | | | 10,288 | | | 97,359 | | | | | | 107,647 | | | | | | | | |
| Other | 12,857 | | | 19,968 | | | | | | | 32,825 | | | 38,774 | | | 55,959 | | | | | | 94,733 | | | | | | | | |
| Total Revenues | $ | 567,790 | | | $ | 259,934 | | | | | | | $ | 827,724 | | | $ | 1,628,782 | | | $ | 800,872 | | | | | | $ | 2,429,654 | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2021 | | Nine Months Ended March 31, 2021 | |
| Photonic
Solutions | | Compound
Semiconductors | | | | | Total | | Photonic
Solutions | | Compound
Semiconductors | | | | Total | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Industrial | $ | 12,081 | | | $ | 77,160 | | | | | | $ | 89,241 | | | $ | 33,305 | | | $ | 192,508 | | | | | $ | 225,813 | | | | | | | | |
| Communications | 476,234 | | | 34,130 | | | | | | 510,364 | | | 1,403,960 | | | 105,702 | | | | | 1,509,662 | | | | | | | | |
| Aerospace & Defense | — | | | 51,686 | | | | | | 51,686 | | | — | | | 147,317 | | | | | 147,317 | | | | | | | | |
| Consumer | 2,402 | | | 65,544 | | | | | | 67,946 | | | 5,924 | | | 237,011 | | | | | 242,935 | | | | | | | | |
| Semiconductor | 2,082 | | | 27,648 | | | | | | 29,730 | | | 6,717 | | | 77,005 | | | | | 83,722 | | | | | | | | |
| Other | 15,182 | | | 19,083 | | | | | | 34,265 | | | 38,681 | | | 49,755 | | | | | 88,436 | | | | | | | | |
| Total Revenues | $ | 507,981 | | | $ | 275,251 | | | | | | $ | 783,232 | | | $ | 1,488,587 | | | $ | 809,298 | | | | | $ | 2,297,885 | | | | | | | | |
"Other" revenue included in the tables above include revenue from the life science/medical and automotive end markets.
Contract Liabilities
Payments received from customers are based on invoices or billing schedules as established in contracts with customers. Contract liabilities relate to billings in advance of performance under the contract. Contract liabilities are recognized as revenue when the performance obligation has been performed. During the nine months ended March 31, 2022, the Company recognized revenue of $9 million related to customer payments that were included as contract liabilities in the Condensed Consolidated Balance Sheet as of June 30, 2021. The Company had $65 million of contract liabilities recorded in the Condensed Consolidated Balance Sheet as of March 31, 2022.
Note 5. Inventories
The components of inventories were as follows ($000): | | | | | | | | | | | |
| March 31,
2022 | | June 30,
2021 |
| Raw materials | $ | 316,342 | | | $ | 211,890 | |
| Work in progress | 386,042 | | | 336,391 | |
| Finished goods | 177,126 | | | 147,547 | |
| $ | 879,510 | | | $ | 695,828 | |
Note 6. Property, Plant and Equipment
Property, plant and equipment consists of the following ($000): | | | | | | | | | | | |
| March 31,
2022 | | June 30,
2021 |
| Land and improvements | $ | 20,208 | | | $ | 20,454 | |
| Buildings and improvements | 425,996 | | | 419,157 | |
| Machinery and equipment | 1,632,459 | | | 1,483,183 | |
| Construction in progress | 206,971 | | | 136,544 | |
| Finance lease right-of-use asset | 25,000 | | | 25,000 | |
| 2,310,634 | | | 2,084,338 | |
| Less accumulated depreciation | (990,443) | | | (841,432) | |
| $ | 1,320,191 | | | $ | 1,242,906 | |
Note 7. Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill were as follows ($000): | | | | | | | | | | | | | | | | | |
| Nine Months Ended March 31, 2022 |
| Photonic Solutions | | Compound Semiconductors | | Total |
| Balance-beginning of period | $ | 1,053,028 | | | $ | 243,699 | | | $ | 1,296,727 | |
| | | | | |
| | | | | |
| Foreign currency translation | (857) | | | (3,221) | | | (4,078) | |
| Balance-end of period | $ | 1,052,171 | | | $ | 240,478 | | | $ | 1,292,649 | |
The gross carrying amount and accumulated amortization of the Company’s intangible assets other than goodwill as of March 31, 2022 and June 30, 2021 were as follows ($000):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2022 | | June 30, 2021 |
| Gross
Carrying
Amount | | Accumulated
Amortization | | Net
Book
Value | | Gross
Carrying
Amount | | Accumulated
Amortization | | Net Book Value |
| Technology | $ | 475,864 | | | $ | (135,542) | | | $ | 340,322 | | | $ | 476,200 | | | $ | (106,802) | | | $ | 369,398 | |
| Trade Names | 22,719 | | | (7,247) | | | 15,472 | | | 22,660 | | | (6,233) | | | 16,427 | |
| Customer Lists | 467,436 | | | (165,640) | | | 301,796 | | | 469,154 | | | (136,519) | | | 332,635 | |
| Other | 1,569 | | | (1,569) | | | — | | | 1,576 | | | (1,576) | | | — | |
| Total | $ | 967,588 | | | $ | (309,998) | | | $ | 657,590 | | | $ | 969,590 | | | $ | (251,130) | | | $ | 718,460 | |
Note 8. Debt
The components of debt as of the dates indicated were as follows ($000): | | | | | | | | | | | |
| March 31,
2022 | | June 30,
2021 |
Term A Facility, interest at LIBOR, as defined, plus 1.375% | $ | 1,010,875 | | | $ | 1,057,412 | |
| | | |
| Debt issuance costs, Term A Facility and Revolving Credit Facility | (20,080) | | | (25,191) | |
| | | |
| | | |
5.000% Senior Notes | 990,000 | | | — | |
| Debt issuance costs and discount, Senior Notes | (12,183) | | | — | |
0.50% convertible senior notes, assumed in the Finisar acquisition | — | | | 14,888 | |
0.25% convertible senior notes | 344,951 | | | 344,969 | |
Debt issuance costs and discount, 0.25% convertible senior notes | (859) | | | (16,937) | |
| | | |
| Total debt | 2,312,704 | | | 1,375,141 | |
| Current portion of long-term debt | (1,383,959) | | | (62,050) | |
| Long-term debt, less current portion | $ | 928,745 | | | $ | 1,313,091 | |
Senior Credit Facilities
The Company currently has Senior Credit Facilities (as defined below) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and an L/C Issuer, and the other lenders party thereto.
The credit agreement governing the Senior Credit Facilities (the "Credit Agreement") provides for senior secured financing of $2.425 billion in the aggregate, consisting of
(i)Aggregate principal amount of $1,255 million for a five-year senior secured first-lien term A loan facility (the “Term A Facility”),
(ii)Aggregate principal amount of $720 million for a seven-year senior secured term B loan facility (the “Term B Facility” and together with the Term A Facility, the “Term Loan Facilities”), which was repaid in full during the quarter ended September 30, 2020, and
(iii)Aggregate principal amount of $450 million for a five-year senior secured first-lien revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facilities, the “Senior Credit Facilities”).
The Credit Agreement also provides for a letter of credit sub-facility not to exceed $25 million and a swing loan sub-facility initially not to exceed $20 million.
The Company is obligated to repay the outstanding principal amount of the Term A Facility in quarterly installments equal to 1.25% of the initial aggregate principal amount of the Term A Facility, with the remaining outstanding balance due and payable on the fifth anniversary of September 24, 2019 (the "Closing Date"). The Company is obligated to repay the outstanding principal amount of the Revolving Credit Facility, if any, on the fifth anniversary of the Closing Date. Notwithstanding the foregoing, all amounts outstanding under the Senior Credit Facilities will become due and payable 120 days prior to the maturity of the II-VI Convertible Notes if (i) the II-VI Convertible Notes remain outstanding and (ii) the Company has insufficient cash and borrowing availability under the Revolving Credit Facility to repay the principal amount of the II-VI Convertible Notes. The II-VI Convertible Notes are included in the current portion of long-term debt. The Company has sufficient cash to repay the principal amount of the II-VI Convertible Notes, therefore the Senior Credit Facilities remain classified as long-term obligations in the Condensed Consolidated Balance Sheet.
The Company’s obligations under the Senior Credit Facilities are guaranteed by the Company’s material existing or future direct and indirect domestic subsidiaries, including Finisar Corporation ("Finisar") and its domestic subsidiaries (collectively, the “Guarantors”), subject to certain exceptions. Borrowings under the Senior Credit Facilities are secured by a first priority lien in substantially all of the assets of the Company and the Guarantors, subject to certain exceptions, including that no real property secures the Senior Credit Facilities.
Amounts outstanding under the Senior Credit Facilities will bear interest at a rate per annum equal to an applicable margin over a eurocurrency rate or an applicable margin over a base rate determined by reference to the highest of (a) the federal funds rate plus 0.50%, (b) Bank of America, N.A.’s prime rate and (c) a eurocurrency rate plus 1.00%, in each case as calculated in accordance with the terms of the Credit Agreement. The applicable interest rate would increase under certain circumstances
relating to events of default. The Company has entered into an interest rate swap contract to hedge its exposure to interest rate risk on its variable rate borrowings under the Senior Credit Facilities. Refer to Note 15 for further information regarding this interest rate swap.
The Credit Agreement contains customary affirmative and negative covenants with respect to the Senior Credit Facilities, including limitations with respect to liens, investments, indebtedness, dividends, mergers and acquisitions, dispositions of assets and transactions with affiliates. The Company is obligated to maintain a consolidated interest coverage ratio (as calculated in accordance with the terms of the Credit Agreement) as of the end of each fiscal quarter of not less than 3.00 to 1.00. The Company is obligated to maintain a consolidated total net leverage ratio (as calculated in accordance with the terms of the Credit Agreement) of not greater than (i) 5.00 to 1.00 for the first four fiscal quarters after the Closing Date, commencing with the first full fiscal quarter after the Closing Date, (ii) 4.50 to 1.00 for the fifth fiscal quarter through and including the eighth fiscal quarter after the Closing Date, and (iii) 4.00 to 1.00 for each subsequent fiscal quarter. As of March 31, 2022, the Company was in compliance with all financial covenants under the Credit Agreement.
In addition, on December 2, 2021, the Company entered into an amendment to the Credit Agreement, by and among the Company, Bank of America, N.A., as administrative agent, and the lenders party thereto, related to the offering of the Senior Notes (as defined below).
Allocation and Pricing of New Senior Credit Facilities
As of December 10, 2021, a new term loan A credit facility (the "New Term A Facility") in an aggregate principal amount of $850 million, a new term loan B credit facility (the "New Term B Facility" and, together with the New Term A Facility, the “New Term Facilities”) in an aggregate principal amount of $2,800 million, and a new revolving credit facility (the “New Revolving Credit Facility”) in an aggregate principal amount of $350 million, in each case as contemplated under the Amended and Restated Commitment Letter, have been fully priced and allocated. The New Term Facilities are expected be funded concurrently with the Closing. The New Revolving Credit Facility is expected to be available concurrently with the Closing. The New Term A Facility and the New Revolving Credit Facility will each bear interest at LIBOR subject to a 0.00% floor plus a range of 1.75% to 2.50%, based on the Company’s total net leverage ratio. The New Term A Facility and the New Revolving Credit Facility borrowings are initially expected to bear interest at LIBOR plus 2.00%. The New Term B Facility will bear interest at LIBOR (subject to a 0.50% floor) plus 2.75%. In relation to the New Term B Facility, the Company incurred expense of $14 million in the three months ended March 31, 2022, which is included in interest expense in the Condensed Consolidated Statements of Earnings. The definitive documentation for the New Term Facilities and the New Revolving Credit Facility is expected to include customary LIBOR replacement provisions.
The Company capitalized approximately $17 million of debt issuance costs during the nine months ended March 31, 2022. These capitalized costs are presented within the prepaid and other current assets and other long-term assets captions in the Condensed Consolidated Balance Sheet. Amortization of debt issuance costs related to the New Term Facilities for the three and nine months ended March 31, 2022 totaled $2 million and $3 million, respectively, and is included in interest expense in the Condensed Consolidated Statements of Earnings.
5.000% Senior Notes due 2029
On December 10, 2021, the Company issued $990 million aggregate principal amount of 5.000% Senior Notes due 2029 (the "Senior Notes") pursuant to the indenture, dated as of December 10, 2021 (the "Indenture"), between the Company and U.S. Bank National Association, as trustee (the "Trustee"). The Senior Notes are guaranteed by each of the Company’s domestic subsidiaries that guarantee its obligations under the Senior Credit Facilities. Interest on the Senior Notes will be payable on December 15 and June 15 of each year, commencing on June 15, 2022, at a rate of 5.000% per annum. The Senior Notes will mature on December 15, 2029.
The Company intends to use the proceeds from the offering of the Senior Notes, together with other financing sources (including the New Term Facilities and cash on hand), to fund the cash consideration, the repayment of certain indebtedness and certain fees and expenses in connection with the Merger. If (i) the Merger has not been consummated on or prior to 11:59 p.m., Eastern Time, on December 15, 2022 or (ii) the Company informs the Trustee, in writing or otherwise announces in writing that the Merger is no longer being pursued and/or the Merger Agreement has been terminated, the Company will be required to redeem all of the outstanding Senior Notes at a redemption price equal to 100% of the principal amount of the Senior Notes, plus accrued and unpaid interest, if any, to, but excluding, the applicable redemption date (the "Special Mandatory Redemption Date"). Pursuant to the terms of the Indenture, prior to the earlier of (i) the date of the consummation of the Merger and (ii) the Special Mandatory Redemption Date, the gross proceeds from the Senior Notes cannot be used for any purpose, and therefore $990 million of restricted cash is classified within cash, cash equivalents, and restricted cash on the Condensed Consolidated Balance Sheet at March 31, 2022.
On or after December 15, 2024, the Company may redeem the Senior Notes, in whole at any time or in part from time to time, at the redemption prices set forth in the Indenture, plus accrued and unpaid interest, if any, to, but excluding, the applicable redemption date. In addition, at any time prior to December 15, 2024, the Company may redeem the Senior Notes, at its option, in whole at any time or in part from time to time, at a redemption price equal to 100% of the principal amount of the Senior Notes redeemed, plus a “make-whole” premium set forth in the Indenture, plus accrued and unpaid interest, if any, to, but excluding, the applicable redemption date. Notwithstanding the foregoing, at any time and from time to time prior to December 15, 2024, the Company may redeem up to 40% of the aggregate principal amount of the Senior Notes using the proceeds of certain equity offerings as set forth in the Indenture, at a redemption price equal to 105.000% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the applicable redemption date.
The Indenture contains customary covenants and events of default, including, default relating to among other things, payment default, failure to comply with covenants or agreements contained in the Indenture or the Senior Notes and certain provisions related to bankruptcy events. As of March 31, 2022, the Company was in compliance with all covenants under the Indenture.
Bridge Loan Commitment
Subject to the terms of the Amended and Restated Commitment Letter, the commitment parties thereto committed to provide, in addition to the New Term Facilities and the New Revolving Credit Facilities, a senior unsecured bridge loan facility in an aggregate principal amount of $990 million (the "Bridge Loan Commitment"). As a result of the issuance of the Senior Notes, the Bridge Loan Commitment was terminated, such that the total amounts of commitments under the Amended and Restated Commitment Letter are $4.0 billion. During the three months ended March 31, 2022, there was no expense incurred related to the Bridge Loan Commitment. During the nine months ended March 31, 2022, the Company incurred expenses of $3 million related to the Bridge Loan Commitment, which is included in interest expense in the Condensed Consolidated Statements of Earnings.
0.50% Finisar Convertible Notes
On November 1, 2021, Finisar delivered to holders of all outstanding 0.50% Convertible Senior Notes due 2036 issued by Finisar (the "Finisar Notes") a notice of redemption pursuant to which Finisar provided notice that it would redeem on December 22, 2021 all of the Finisar Notes that were not repurchased by Finisar on December 15, 2021 pursuant to the terms of the Finisar Notes and that remained outstanding on December 22, 2021. On December 15, 2021, Finisar repurchased $14.6 million aggregate principal amount of Finisar Notes that were tendered for repurchase by holders of Finisar Notes. Each holder of Finisar Notes that remained outstanding after the repurchase on December 15, 2021 had the option to elect to receive (i) a redemption price equal to 100% of the principal amount of the redeemed Finisar Notes, plus accrued and unpaid interest on the redeemed Finisar Notes or (ii) to convert all or any portion of the Finisar Notes held by such holder in accordance with the terms of the Finisar Notes until the close of business on December 21, 2021. Based on the elections of such holders, the Company issued 45 shares of common stock and paid approximately $0.3 million in the aggregate on December 22, 2021 to settle the conversion of the Finisar Notes that were converted and to redeem all remaining outstanding Finisar Notes.
0.25% Convertible Senior Notes
In August 2017, the Company issued and sold $345 million aggregate principal amount of the II-VI Convertible Notes in a private placement to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended.
Originally, the Company had separately accounted for the value of the conversion option as an equity component, and the resulting debt discount was amortized as additional non-cash interest expense.
With the adoption of ASU 2020-06 on July 1, 2021, the Company reversed that accounting, electing to use the modified retrospective method. The adoption resulted in an increase of $15 million to the current portion of long-term debt, a decrease of $3 million to deferred income taxes, and a decrease of $11 million to shareholders' equity.
The initial conversion rate is 21.25 shares of II-VI Common Stock per $1,000 principal amount of II-VI Convertible Notes, which is equivalent to an initial conversion price of $47.06 per share of II-VI Common Stock. Throughout the term of the II-VI Convertible Notes, the conversion rate may be adjusted upon the occurrence of certain events. The if-converted value of the II-VI Convertible Notes amounted to $531 million as of March 31, 2022 and $532 million as of June 30, 2021 (based on the Company’s closing stock price on the last trading day of the fiscal periods then ended).
Prior to the close of business on the business day immediately preceding June 1, 2022, the II-VI Convertible Notes will be convertible only under the following circumstances:
(i) during any fiscal quarter commencing after the fiscal quarter ending on December 31, 2017 (and only during such fiscal quarter), if the last reported sale price of the II-VI Common Stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
(ii) during the five business day period immediately after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of II-VI Convertible Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the II-VI Common Stock and the conversion rate on each such trading day; or
(iii) upon the occurrence of certain specified corporate events.
On or after June 1, 2022 until the close of business on the business day immediately preceding September 1, 2022 ( the "Maturity Date") holders may convert their II-VI Convertible Notes at any time, regardless of the foregoing circumstances. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of II-VI Common Stock or a combination of cash and shares of II-VI Common Stock, at the Company’s election.
Holders of the II-VI Convertible Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a II-VI Convertible Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than cancelled, extinguished or forfeited. Notes were convertible during the quarter ended March 31, 2022; conversions were immaterial. Because the last reported sale price of II-VI Common Stock for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the calendar quarter ended March 31, 2022 was equal to or greater than 130% of the applicable conversion price on each applicable trading day, the II-VI Convertible Notes are convertible at the option of the holders thereof during the fiscal period ranging from April 1, 2022 to May 31, 2022. As of June 1, 2022, the II-VI Convertible Notes become convertible regardless of compliance with any other conversion trigger until the close of business on the business day immediately preceding the Maturity Date.
The following tables set forth total interest expense recognized related to the II-VI Convertible Notes for the three and nine months ended March 31, 2022 and March 31, 2021 ($000):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | 2022 | | 2021 | | 2022 | | 2021 |
0.25% contractual coupon | | $ | 216 | | | $ | 216 | | | $ | 656 | | | $ | 656 | |
| Amortization of debt discount and debt issuance costs including initial purchaser discount | | 508 | | | 3,410 | | | 1,433 | | | 10,262 | |
| Interest expense | | $ | 724 | | | $ | 3,625 | | | $ | 2,089 | | | $ | 10,918 | |
| | | | | | | | |
The effective interest rates on the liability component for the three and nine months ended March 31, 2022 and 2021 presented were 1% and 5%, respectively.
Aggregate Availability
The Company had aggregate availability of $450 million under its Revolving Credit Facility as of March 31, 2022.
Note 9. Income Taxes
The Company’s year-to-date effective income tax rate at March 31, 2022 was 18% compared to an effective tax rate of 17% for the same period in 2021. The variations between the Company’s effective tax rate and the U.S. statutory rate of 21% were due to tax rate differentials between U.S. and foreign jurisdictions.
U.S. GAAP prescribes the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements which includes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As of March 31, 2022 and June 30, 2021, the Company’s gross unrecognized income tax benefit, excluding interest and penalties, was $40 million and $38 million, respectively. The Company has classified the uncertain tax positions as non-current income tax liabilities, as the amounts are not expected to be paid within one year. If recognized, $34 million of the gross unrecognized tax benefits at March 31, 2022 would impact the effective tax
rate. The Company recognizes interest and penalties related to uncertain tax positions in the income tax provision in the Condensed Consolidated Statements of Earnings. The amount of accrued interest and penalties included in the gross unrecognized income tax benefit was $3 million at both March 31, 2022 and June 30, 2021. Fiscal years 2018 to 2021 remain open to examination by the Internal Revenue Service, fiscal years 2017 to 2021 remain open to examination by certain state jurisdictions, and fiscal years 2011 to 2021 remain open to examination by certain foreign taxing jurisdictions. The Company is currently under examination in New York for the years ended June 30, 2018 through June 30, 2019 and under examination for certain subsidiary companies in California for the years ended April 30, 2017 through April 28, 2019; India for the year ended March 31, 2016; Philippines for the years ended June 30, 2018 through June 30, 2019; Germany for the years ended June 30, 2012 through June 30, 2018; and Switzerland for the years ended June 30, 2020 through June 30, 2021. The Company believes its income tax reserves for these tax matters are adequate.
Note 10. Leases
The Company’s lease liabilities are recognized based on the present value of the remaining fixed lease payments, over the lease term, using a discount rate of similarly secured borrowings available to the Company. For the purpose of lease liability measurement, the Company considers only payments that are fixed and determinable at the time of commencement. Any variable payments that depend on an index or rate are expensed as incurred. The Company accounts for non-lease components, such as common area maintenance, as a component of the lease, and includes it in the initial measurement of leased assets and corresponding liabilities. The Company’s lease terms and conditions may include options to extend or terminate. An option is recognized when it is reasonably certain that II-VI will exercise that option.
The Company’s lease assets also include any lease payments made and exclude any lease incentives received prior to commencement. Leased assets are tested for impairment in the same manner as long-lived assets used in operations.
The following table presents lease costs, which include short-term leases, lease term, and discount rates ($000): | | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | Nine months ended March 31, 2022 |
| Finance Lease Cost | | | |
| Amortization of right-of-use assets | $ | 417 | | | $ | 1,255 | |
| Interest on lease liabilities | 298 | | | 907 | |
| Total finance lease cost | $ | 715 | | | $ | 2,162 | |
| Operating lease cost | 9,240 | | | 27,635 | |
| Sublease income | — | | | 507 | |
| Total lease cost | $ | 9,955 | | | $ | 29,290 | |
| | | |
| Cash Paid for Amounts Included in the Measurement of Lease Liabilities | | | |
| Operating cash flows from finance leases | $ | 298 | | | $ | 907 | |
| Operating cash flows from operating leases | 8,899 | | | 26,565 | |
| Financing cash flows from finance leases | 332 | | | 954 | |
| | | |
| Weighted-Average Remaining Lease Term (in Years) | | | |
| Finance leases | 9.8 | | |
| Operating leases | 6.7 | | |
| | | |
| Weighted-Average Discount Rate | | | |
| Finance leases | 5.6 % | | |
| Operating leases | 5.8 % | | |
| | | | | | | | | | | |
| Three Months Ended March 31, 2021 | | Nine Months Ended March 31, 2021 |
| Finance Lease Cost | | | |
| Amortization of right-of-use assets | $ | 417 | | | $ | 1,250 | |
| Interest on lease liabilities | 315 | | | 957 | |
| Total finance lease cost | $ | 732 | | | $ | 2,207 | |
| Operating lease cost | 9,212 | | | 27,147 | |
| Sublease income | 368 | | | 1,103 | |
| Total lease cost | $ | 9,576 | | | $ | 28,251 | |
| | | |
| Cash Paid for Amounts Included in the Measurement of Lease Liabilities | | | |
| Operating cash flows from finance leases | $ | 315 | | | $ | 957 | |
| Operating cash flows from operating leases | 9,150 | | | 26,003 | |
| Financing cash flows from finance leases | 298 | | | 849 | |
Note 11. Equity and Redeemable Preferred Stock
Mandatory Convertible Preferred Stock
In July 2020, the Company issued 2,300,000 shares of 6.00% Series A Mandatory Convertible Preferred, no par value per share (“Mandatory Convertible Preferred Stock”).
Unless previously converted, each outstanding share of Mandatory Convertible Preferred Stock will automatically convert on the Mandatory Conversion Date (as defined in the Statement with Respect to Shares establishing the Mandatory Convertible Preferred Stock) into a number of shares of II-VI Common Stock equal to not more than 4.6512 shares and not less than 3.8760 shares (the "Minimum Conversion Rate"), depending on the applicable market value of the II-VI Common Stock, subject to certain anti-dilution adjustments.
Other than in the event of one of certain fundamental changes, a holder of Mandatory Convertible Preferred Stock may, at any time prior to July 1, 2023, elect to convert such holder's shares, in whole or in part, at a Minimum Conversion Rate per share of Mandatory Convertible Preferred Stock, subject to certain anti-dilution adjustments.
If one of certain fundamental changes occurs on or prior to July 1, 2023, holders of the Mandatory Convertible Preferred Stock will have the right to convert their shares of Mandatory Convertible Preferred Stock, in whole or in part, into shares of II-VI Common Stock at the conversion rate determined in accordance with the terms of the Mandatory Convertible Preferred Stock during the period beginning on, and including, the effective date of such change and ending on, and including, the date that is 20 calendar days after the effective date of such fundamental change (or, if later, the date that is 20 calendar days after holders receive notice of such fundamental change, but in no event later than July 1, 2023). Holders who convert their shares of the Mandatory Convertible Preferred Stock during that period will also receive a dividend make-whole amount and, to the extent there is any, the accumulated dividend amount, in each case as calculated in accordance with the terms of the Mandatory Convertible Preferred Stock.
The Company recognized $7 million and $21 million of preferred stock dividends for the three and nine months ended March 31, 2022, respectively, associated with the Mandatory Convertible Preferred Stock, which were presented as a reduction to retained earnings on the Condensed Consolidated Balance Sheet as of March 31, 2022.
The following table presents dividends per share and dividends recognized for the three and nine months ended March 31, 2022: | | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | Nine Months Ended
March 31, 2022 |
| Dividends per share | $ | 3.00 | | | $ | 9.00 | |
| Mandatory Convertible Preferred Stock dividends ($000) | $ | 6,900 | | | $ | 20,700 | |
Redeemable Convertible Preferred Stock
In March 2021, the Company issued 75,000 shares of II-VI Series B-1 Convertible Preferred Stock, no par value per share. Refer to Note 3. Pending Coherent Acquisition for additional information.
The shares of II-VI Series B-1 Convertible Preferred Stock are convertible into shares of II-VI Common Stock as follows:
•at the election of the holder, at a conversion price of $85 per share (“Conversion Price”) after the earliest to occur of (i) the issuance of shares of II-VI Series B-2 Convertible Preferred Stock upon the Closing, (ii) the termination of the Merger Agreement or (iii) the delivery by II-VI to the Investor of an offer to repurchase the II-VI Series B-1 Convertible Preferred Stock upon the occurrence of a Fundamental Change (as defined in the Statement with Respect to Shares establishing the New II-VI Convertible Preferred Stock); and
•at the election of the Company, any time following March 31, 2024 at the then-applicable Conversion Price if the volume-weighted average price of II-VI Common Stock exceeds 150% of the then-applicable Conversion Price for 20 trading days out of any 30 consecutive trading days.
The issued shares of II-VI Series B-1 Convertible Preferred Stock currently have voting rights, voting as one class with the II-VI Common Stock, on an as-converted basis, subject to limited exceptions.
On or at any time after March 31, 2031:
•each holder has the right to require the Company to redeem all of their II-VI Series B-1 Convertible Preferred Stock, for cash, at a redemption price per share equal to the sum of the Stated Value for such shares (as defined in the Statement with Respect to Shares establishing the New II-VI Convertible Preferred Stock) plus an amount equal to all accrued or declared and unpaid dividends on such shares that had not previously been added to the Stated Value (such price the “Redemption Price,” and such right the “Put Right”); and
•the Company has the right to redeem, in whole or in part, on a pro rata basis from all holders based on the aggregate number of shares of II-VI Series B-1 Convertible Preferred Stock outstanding, for cash, at the Redemption Price.
In connection with any Fundamental Change, and subject to the procedures set forth in the Statement with Respect to Shares establishing the New II-VI Convertible Preferred Stock, the Company must, or will cause the survivor of a Fundamental Change to, make an offer to repurchase, at the option and election of the holder thereof, each share of II-VI Series B-1 Convertible Preferred Stock then-outstanding at a purchase price per share in cash equal to (i) the Stated Value for such shares plus an amount equal to all accrued or declared and unpaid dividends on such shares that had not previously been added to the Stated Value as of the date of repurchase plus (ii) if prior to March 31, 2026, the aggregate amount of all dividends that would have been paid (subject to certain exceptions), from the date of repurchase through March 31, 2026.
If the Company defaults on a payment obligation with respect to the II-VI Series B-1 Convertible Preferred Stock and such default is not cured within 30 days, the dividend rate will increase to 8% per annum and will be increased by an additional 2% per annum each quarter the Company remains in default, not to exceed 14% per annum.
The II-VI Series B-1 Convertible Preferred Stock is redeemable for cash outside of the control of the Company upon the exercise of the Put Right, and upon a Fundamental Change, and is therefore classified as mezzanine equity.
The II-VI Series B-1 Convertible Preferred Stock is initially measured at fair value less issuance costs, accreted to its redemption value over a 10-year period (using the effective interest method) with such accretion accounted for as deemed dividends and reductions to Net Earnings Available to Common Shareholders.
The Company recognized $10 million and $30 million of preferred stock dividends for the three and nine months ended March 31, 2022, respectively, which were presented as a reduction to retained earnings on the Condensed Consolidated Balance Sheet as of March 31, 2022.
The following table presents dividends per share and dividends recognized for the three and nine months ended March 31, 2022:
| | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | Nine Months Ended
March 31, 2022 | | |
| Dividends per share | $ | 137 | | | $ | 403 | | | |
| Dividends ($000) | 9,732 | | | 28,743 | | | |
| Deemed dividends ($000) | 516 | | | 1,490 | | | |
Note 12. Earnings Per Share
Basic earnings per common share is computed by dividing net earnings available to common shareholders by the weighted-average number of shares of common stock outstanding during the period.
Diluted earnings per common share is computed by dividing the diluted earnings available to common shareholders by the weighted-average number of shares of common stock and potentially dilutive shares of common stock outstanding during the period. The dilutive effect of equity awards is calculated based on the average stock price for each fiscal period, using the treasury stock method. For the three and nine months ended March 31, 2022, diluted shares outstanding include the dilutive effect of the potential shares II-VI Common Stock issuable from stock options, performance and restricted shares, as well as the shares of II-VI Common Stock issuable upon conversion of outstanding convertible debt.
Potentially dilutive shares whose effect would have been anti-dilutive are excluded from the computation of diluted earnings per common share. For the three and nine months ended March 31, 2022, diluted earnings per share excluded the potentially dilutive effect of the Series A Mandatory Convertible Preferred Stock and the Series B Convertible Preferred Stock (under the If-Converted method), as their effects were anti-dilutive.
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three and nine months ended March 31, 2022 ($000):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
March 31, | | Nine Months Ended March 31, | | |
| 2022 | | | 2021 | | 2022 | | 2021 | | | | |
| Numerator | | | | | | | | | | | | |
| Net earnings | $ | 49,002 | | | | $ | 81,092 | | | $ | 191,123 | | | $ | 215,258 | | | | | |
| Deduct Series A preferred stock dividends | (6,900) | | | | (6,900) | | | (20,700) | | | (20,240) | | | | | |
| Deduct Series B dividends and deemed dividends | (10,248) | | | | (113) | | | (30,233) | | | (113) | | | | | |
| Basic earnings available to common shareholders | $ | 31,854 | | | | $ | 74,079 | | | $ | 140,190 | | | $ | 194,905 | | | | | |
| | | | | | | | | | | | |
| Effect of dilutive securities: | | | | | | | | | | | | |
| Add back interest on II-VI Convertible Notes (net of tax) | $ | 571 | | | | $ | 3,066 | | | $ | 1,650 | | | $ | 9,199 | | | | | |
| | | | | | | | | | | | |
| Diluted earnings available to common shareholders | $ | 32,425 | | | | $ | 77,145 | | | $ | 141,840 | | | $ | 204,103 | | | | | |
| | | | | | | | | | | | |
| Denominator | | | | | | | | | | | | |
| Weighted average shares | 106,323 | | | | 104,767 | | | 106,079 | | | 103,883 | | | | | |
| Effect of dilutive securities: | | | | | | | | | | | | |
| Common stock equivalents | 3,296 | | | | 4,203 | | | 3,001 | | | 3,424 | | | | | |
| II-VI Convertible Notes | 7,330 | | | | 7,331 | | | 7,330 | | | 7,331 | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Diluted weighted average common shares | 116,949 | | | | 116,302 | | | 116,410 | | | 114,637 | | | | | |
| | | | | | | | | | | | |
| Basic earnings per common share | $ | 0.30 | | | | $ | 0.71 | | | $ | 1.32 | | | $ | 1.88 | | | | | |
| | | | | | | | | | | | |
| Diluted earnings per common share | $ | 0.28 | | | | $ | 0.66 | | | $ | 1.22 | | | $ | 1.78 | | | | | |
The following table presents potential shares of II-VI Common Stock excluded from the calculation of diluted earnings per share as their effect would have been anti-dilutive for the three and nine months ended March 31, 2022 (000):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
March 31, | | Nine Months Ended
March 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Common stock equivalents | 2 | | | 14 | | | 12 | | | 154 | |
| Series A Mandatory Convertible Preferred Stock | 8,915 | | | 8,915 | | | 8,915 | | | 8,915 | |
| | | | | | | |
| | | | | | | |
| Series B Redeemable Preferred Stock | 9,217 | | | 98 | | | 9,105 | | | 33 | |
| Total anti-dilutive shares | 18,134 | | | 9,027 | | | 18,032 | | | 9,102 | |
Note 13. Segment Reporting
The Company reports its business segments using the “management approach” model for segment reporting. This means that the Company determines its reportable business segments based on the way the chief operating decision-maker organizes business segments within the Company for making operating decisions and assessing financial performance.
The Company reports its financial results in the following two segments: (i) Compound Semiconductors, and (ii) Photonic Solutions, and the Company’s chief operating decision-maker receives and reviews financial information based on these segments. The Company evaluates business segment performance based upon segment operating income, which is defined as earnings before income taxes, interest and other income or expense. The segments are managed separately due to the market, production requirements and facilities unique to each segment.
The accounting policies are consistent across each segment. To the extent possible, the Company’s corporate expenses and assets are allocated to the segments. The expenses associated with the pending acquisition of Coherent for the three and nine months ended March 31, 2022 have not been allocated to an Operating Segment, and are presented in Unallocated and Other.
The following tables summarize selected financial information of the Company’s operations by segment ($000):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 |
| Photonic
Solutions | | Compound
Semiconductors | | Unallocated
& Other | | Total |
| Revenues | $ | 567,790 | | | $ | 259,934 | | | $ | — | | | $ | 827,724 | |
| Inter-segment revenues | 10,039 | | | 73,251 | | | (83,290) | | | — | |
| Operating income | 54,604 | | | 61,768 | | | (9,604) | | | 106,768 | |
| Interest expense | — | | | — | | | — | | | (43,499) | |
| Other expense, net | — | | | — | | | — | | | (241) | |
| Income taxes | — | | | — | | | — | | | (14,027) | |
| Net earnings | — | | | — | | | — | | | 49,002 | |
| Depreciation and amortization | 44,402 | | | 28,415 | | | — | | | 72,817 | |
| Expenditures for property, plant & equipment | 18,415 | | | 75,887 | | | — | | | 94,302 | |
| Segment assets | 4,991,163 | | | 2,776,033 | | | — | | | 7,767,196 | |
| Goodwill | 1,052,171 | | | 240,478 | | | — | | | 1,292,649 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2021 |
| Photonic
Solutions | | Compound
Semiconductors | | Unallocated
& Other | | Total |
| Revenues | $ | 507,981 | | | $ | 275,251 | | | $ | — | | | $ | 783,232 | |
| Inter-segment revenues | 12,209 | | | 61,272 | | | (73,481) | | | — | |
| Operating income | 48,286 | | | 52,522 | | | (15,728) | | | 85,080 | |
| Interest expense | — | | | — | | | — | | | (13,034) | |
| Other income, net | — | | | — | | | — | | | 21,432 | |
| Income taxes | — | | | — | | | — | | | (12,387) | |
| Net earnings | — | | | — | | | — | | | 81,092 | |
| Depreciation and amortization | 41,060 | | | 26,925 | | | — | | | 67,985 | |
| Expenditures for property, plant & equipment | 16,364 | | | 9,639 | | | — | | | 26,002 | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended March 31, 2022 |
| Photonic
Solutions | | Compound
Semiconductors | | Unallocated
& Other | | Total |
| Revenues | $ | 1,628,782 | | | $ | 800,872 | | | $ | — | | | $ | 2,429,654 | |
| Inter-segment revenues | 35,979 | | | 243,889 | | | (279,868) | | | — | |
| Operating income | 160,863 | | | 168,688 | | | (29,511) | | | 300,041 | |
| Interest expense | — | | | — | | | — | | | (72,752) | |
| Other income, net | — | | | — | | | — | | | 5,535 | |
| Income taxes | — | | | — | | | — | | | (41,701) | |
| Net earnings | — | | | — | | | — | | | 191,123 | |
| Depreciation and amortization | 129,388 | | | 84,147 | | | — | | | 213,535 | |
| Expenditures for property, plant & equipment | 55,277 | | | 140,714 | | | — | | | 195,991 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended March 31, 2021 |
| Photonic
Solutions | | Compound
Semiconductors | | Unallocated
& Other | | Total |
| Revenues | $ | 1,488,587 | | | $ | 809,298 | | | $ | — | | | $ | 2,297,885 | |
| Inter-segment revenues | 27,866 | | | 193,171 | | | (221,037) | | | — | |
| Operating income | 147,159 | | | 173,494 | | | (15,728) | | | 304,925 | |
| Interest expense | — | | | — | | | — | | | (45,833) | |
| Other income, net | — | | | — | | | — | | | 246 | |
| Income taxes | — | | | — | | | — | | | (44,081) | |
| Net earnings | — | | | — | | | — | | | 215,258 | |
| Depreciation and amortization | 119,510 | | | 80,360 | | | — | | | 199,870 | |
| Expenditures for property, plant & equipment | 62,450 | | | 42,881 | | | — | | | 105,331 | |
Note 14. Share-Based Compensation
The Company’s Board of Directors amended and restated the II-VI Incorporated 2018 Omnibus Incentive Plan, which was approved by the shareholders at the Annual Meeting in November 2018. The II-VI Incorporated Amended and Restated 2018 Omnibus Incentive Plan (the “Plan”) was approved by the shareholders at the Annual Meeting in November 2020. The Plan provides for the grant of non-qualified stock options, stock appreciation rights, restricted shares, restricted share units, deferred shares, performance shares and performance share units to employees, officers and directors of the Company. The maximum number of shares of II-VI Common Stock authorized for issuance under the Plan is limited to 9,550,000 shares of II-VI Common Stock, not including any remaining shares forfeited under the predecessor plans that may be rolled into the Plan. The Plan has vesting provisions predicated upon the death, retirement or disability of the grantee.
Share-based compensation expense for the periods indicated was as follows ($000):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Stock Options and Cash-Based Stock Appreciation Rights | | $ | 1,635 | | | $ | 1,328 | | | $ | 4,107 | | | $ | 8,662 | |
| Restricted Share Awards and Cash-Based Restricted Share Unit Awards | | 13,317 | | | 12,089 | | | 44,449 | | | 37,972 | |
| Performance Share Awards and Cash-Based Performance Share Unit Awards | | 2,614 | | | 3,320 | | | 8,380 | | | 13,684 | |
| | | | | | | | |
| | $ | 17,566 | | | $ | 16,737 | | | $ | 56,936 | | | $ | 60,318 | |
Note 15. Fair Value of Financial Instruments
The FASB defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous markets for the asset and liability in an orderly transaction between market participants at the measurement date. The Company estimates fair value of its financial instruments utilizing an established three-level hierarchy in accordance with U.S. GAAP. The hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as follows:
•Level 1 –Valuation is based upon unadjusted quoted prices for identical assets or liabilities in active markets.
•Level 2 –Valuation is based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments.
•Level 3 –Valuation is based upon other unobservable inputs that are significant to the fair value measurements.
The classification of fair value measurements within the hierarchy is based upon the lowest level of input that is significant to the measurement.
The Company entered into an interest rate swap with a notional amount of $1,075 million to limit the exposure to its variable interest rate debt by effectively converting it to a fixed interest rate. The Company receives payments based on the one-month LIBOR and makes payments based on a fixed rate of 1.52%. The Company receives payments with a floor of 0.00%. The interest rate swap agreement has an effective date of November 24, 2019, with an expiration date of September 24, 2024. The initial notional amount of the interest rate swap is scheduled to decrease to $825 million in June 2022 and will remain at that amount through the expiration date. The Company designated this instrument as a cash flow hedge and deemed the hedge relationship effective at inception of the contract. The fair value of the interest rate swap of $18 million is recognized in the Condensed Consolidated Balance Sheet within other assets as of March 31, 2022. Changes in fair value are recorded within accumulated other comprehensive income on the Condensed Consolidated Balance Sheet and reclassified into the Condensed Consolidated Statement of Earnings as interest expense in the period in which the underlying transaction affects earnings. Cash flows from hedging activities are reported in the Condensed Consolidated Statements of Cash Flows in the same classification as the hedged item, generally as a component of cash flows from operations. The fair value of the interest rate swap is determined using widely accepted valuation techniques and reflects the contractual terms of the interest rate swap including the period to maturity, and while there are no quoted prices in active markets, it uses observable market-based inputs, including interest rate curves. The fair value analysis also considers a credit valuation adjustment to reflect nonperformance risk of both the Company and the single counterparty. The interest rate swap is classified as a Level 2 item within the fair value hierarchy.
On February 23, 2022, the Company entered into an interest rate cap ("the Cap") with an effective date of July 1, 2023. The Cap manages the Company's exposure to interest rate movements on a portion of the Company's floating rate debt. The Cap provides the Company with the right to receive payment if one-month LIBOR exceeds 1.85%. Beginning in July 2023, the Company will begin to pay a fixed monthly premium based on an annual rate of 0.853% for the Cap. The Cap will carry a notional amount ranging from $500 million to $1,500 million. The fair value of the interest rate cap of $11 million is recognized in the Condensed Consolidated Balance Sheet within other assets as of March 31, 2022.
The Cap is designed to mirror the terms of the Company's Credit Agreement as of the effective date, or its direct replacement. The Company designated the Cap as a cash flow hedge of the variability of the LIBOR-based interest payments on the Term
Loans. Every period over the life of the hedging relationship, the entire change in fair value related to the hedging instrument will first be recorded within accumulated other comprehensive income. Amounts accumulated in accumulated other comprehensive income will be reclassified into interest expense in the same period or periods in which interest expense is recognized on the Credit Agreement, or its direct replacement. The fair value of the Cap is determined using widely accepted valuation techniques and reflects the contractual terms of the Cap including the period to maturity, and while there are no quoted prices in active markets, it uses observable market-based inputs, including interest rate curves. The Cap is classified as a Level 2 item within the fair value hierarchy.
The Company estimated the fair value of the II-VI Convertible Notes based on quoted market prices as of the last trading day prior to March 31, 2022; however, the II-VI Convertible Notes have only a limited trading volume and as such this fair value estimate is not necessarily the value at which the II-VI Convertible Notes could be retired or transferred. The Company concluded that this fair value measurement should be categorized within Level 2. The carrying value of the II-VI Convertible Notes is net of unamortized discount and issuance costs. See Note 8. Debt for details on the Company’s debt facilities.
The Company estimated the fair value of the Senior Notes based on quoted market prices as of the last trading day prior to March 31, 2022; however, the Senior Notes have only a limited trading volume and as such this fair value estimate is not necessarily the value at which the Senior Notes could be retired or transferred. The Company concluded that this fair value measurement should be categorized within Level 2. The carrying value of the Senior Notes is net of unamortized discount and issuance costs. See Note 8. Debt for details on the Company’s debt facilities.
The fair value and carrying value of the II-VI Convertible Notes and Senior Notes were as follows at March 31, 2022 ($000): | | | | | | | | | | | |
| Fair Value | | Carrying Value |
| II-VI Convertible Notes | $ | 539,879 | | | $ | 344,092 | |
| Senior Notes | 973,121 | | | 977,817 | |
The fair values of cash and cash equivalents are considered Level 1 among the fair value hierarchy and approximate fair value because of the short-term maturity of those instruments. The Company’s borrowings including its lease obligations and the Senior Notes, excluding the II-VI Convertible Notes are considered Level 2 among the fair value hierarchy and their principal amounts approximate fair value.
The Company, from time to time, purchases foreign currency forward exchange contracts, that permit it to sell specified amounts of these foreign currencies expected to be received from its export sales, for pre-established U.S. dollar amounts at specified dates. These contracts are entered into to limit transactional exposure to changes in currency exchange rates of export sales transactions in which settlement will occur in future periods and which otherwise would expose the Company, on the basis of its aggregate net cash flows in respective currencies, to foreign currency risk. At March 31, 2022, the Company had foreign currency forward contracts recorded at fair value. The fair values of these instruments were measured using valuations based upon quoted prices for similar assets and liabilities in active markets (Level 2) and are valued by reference to similar financial instruments, adjusted for credit risk and restrictions and other terms specific to the contracts. Realized losses related to these contracts for both the three and nine months ended March 31, 2022 were $2 million, and were included in other expense in the Condensed Consolidated Statements of Earnings.
Note 16. Share Repurchase Programs
In August 2014, the Company’s Board of Directors authorized the Company to purchase up to $50 million of II-VI Common Stock through a share repurchase program (the “Program”) that calls for shares to be purchased in the open market or in private transactions from time to time. The Program has no expiration and may be suspended or discontinued at any time. Shares purchased by the Company are retained as treasury stock and available for general corporate purposes. The Company did not repurchase any shares pursuant to this Program during the quarter ended March 31, 2022. As of March 31, 2022, the Company has cumulatively purchased 1,416,587 shares of II-VI Common Stock pursuant to the Program for approximately $22 million. The dollar value of shares as of March 31, 2022 that may yet be purchased under the Program is approximately $28 million.
Note 17. Accumulated Other Comprehensive Income
The changes in accumulated other comprehensive income (“AOCI”) by component, net of tax, for the nine months ended March 31, 2022 were as follows ($000): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Foreign
Currency
Translation
Adjustment | | Interest
Rate
Swap | | Interest
Rate
Cap | | Defined
Benefit
Pension Plan | | Total
Accumulated Other
Comprehensive
Income |
AOCI - June 30, 2021 | $ | 55,395 | | | $ | (31,773) | | | $ | — | | | $ | (9,355) | | | $ | 14,267 | |
| Other comprehensive income (loss) before reclassifications | (11,461) | | | 24,852 | | | 8,916 | | | — | | | 22,307 | |
| Amounts reclassified from AOCI | — | | | 11,543 | | | — | | | — | | | 11,543 | |
| Net current-period other comprehensive income (loss) | (11,461) | | | 36,395 | | | 8,916 | | | — | | | 33,850 | |
| AOCI - March 31, 2022 | $ | 43,934 | | | $ | 4,622 | | | $ | 8,916 | | | $ | (9,355) | | | $ | 48,117 | |