Lasers and razors Featured

8:00pm EDT October 20, 2004
II-VI Inc.

The name doesn't reveal much about the company. Knowing that it's derived from two groups of elements on the Periodic Table of the Elements doesn't give much of a clue about what it does, either.

It doesn't get any easier when you find out that, among other things, II-VI -- pronounced "two six" --grows crystals from compounds formed by those elements, from common ones like sulfur to the less familiar telluride and yttrium, and cuts, grinds, polishes and coats them to produce optical devices for use in laser beam devices of all types.

Fran Kramer, II-VI's president and COO, likens what the company does to a razor blade manufacturer, producing the disposable components for the shaving device, thereby ensuring future sales for its products.

"The real consumption and the reason our business keeps growing is because of the aftermarket business," says Kramer. "What really propels our business is the installed base of lasers worldwide."

That's because, like razor blades, laser optics wear out or get contaminated and need to be replaced. In a booming economy, plants run extra shifts or longer shifts, thereby using their laser equipment more and wearing out the optical components faster.

"When the economy gets going, lasers are used more hours in the day, and they consume more optics," says Kramer.

And the increasing use of lasers in industrial, military and medical applications -- hundreds of the parts in an automobile are fabricated with lasers, for example -- and the spread of laser device manufacturers globally are driving II-VI's business. The production of more powerful lasers that require more expensive optics components are beefing up sales as well.

Without a hint from its name, even the scientifically challenged can understand the business side of what II-VI does. Founded in 1971, the company has turned a profit every year since 1973. It has posted a 20 percent average revenue growth since 2000, and a 24 percent increase in average cash flow during the same period. And, unlike some technology companies, its growth lines tend to be smooth upward curves rather than jagged up and down patterns.

Publicly traded since 1987, II-VI has posted that kind of performance by taking large pieces of the markets where it does business, making strategic acquisitions, developing critical expertise in materials and rewarding its 1,250 employees for performance in what Carl Johnson, II-VI founder, chairman and CEO, describes as a "risk-and-reward" culture.

II-VI employees earn a significant portion of their annual compensation in incentives, awarded based on the company's overall financial outcomes. Johnson sees the arrangement, adopted early on by II-VI, as a way to leverage the efforts of employees to maximize the company's performance.

"The employees are deciding to do a lot of the right things," Johnson says. "They're treated like significant shareholders in the business."

II-VI employees, say both Johnson and Kramer, understand clearly the relationship between profitability and bottom line performance and the effect both have on their paychecks. For fiscal 2004, the payout in incentives to employees amounted to about 26 percent of their total compensation.

Says Kramer: "Some of our hourly workers could better read a profit and loss statement than you or I could."

II-VI works with complex and sophisticated processes to produce its products, none of them patent-protected but virtually all of them trade secrets. Many of the materials it uses are hard to produce, expensive and available through a limited number of suppliers.

To reduce its costs and ensure quality and supply, II-VI has developed the expertise to produce some of these materials in-house. For instance, it produces all the zinc selenide and zinc sulfide -- two critical components required in the manufacture of infrared laser components -- it uses.

"Nice markets to be in"

The largest chunk of II-VI's $151 million in revenue comes from its infrared optics business, which accounted for $88 million in sales in fiscal 2004 and serves primarily the industrial market, providing optics for manufacturing devices that use lasers. The infrared optics business, the largest segment of II-VI's business, has grown even during recent economic downturns.

Its near-infrared optics segment serves the military, industrial and medical laser industries, and accounted for 2004 sales of $26 million. Military infrared optics provided $25 million in sales for 2004, about 15 percent of that as a result of repairs and replacement to hardware damaged or expended in the Iraq war. The company's compound semiconductor group brought in $12 million.

"They're all very nice markets to be in, and we're at a niche or a level in each of these businesses that we're kind of below the big companies' radar screen," says Kramer.

II-VI has bolstered its growth and market share through strategic acquisitions that have added to its technology and global manufacturing capabilities. Its acquisitions are often small divisions of large companies, like the purchase in 2001 of SiC Group, a start-up research company, from Litton Systems Inc.

In 2000, it acquired Laser Power Corp. of Temecula, Calif., a former competitor that derived more than half of its revenue from sales to the military. The Laser Power purchase boosted II-VI's revenue in its infrared optics segment, its largest, by 42 percent in fiscal 2003, its first full year of operation under II-VI ownership.

II-VI divided Laser Power's operations across two of its own divisions and spread its manufacturing over several of its existing locations.

"With that acquisition of Laser Power four years ago, we could see very well how we could take the business out of California, move it to China, Singapore and here, and we've made very good profits on that business," says Kramer.

Kramer says a half dozen companies are possible acquisitions on II-VI's radar, and it may pick off others in the near future.

"I think we've digested the last few, so I think we're really, really ready to roll again," says Kramer.

But don't expect II-VI to buy up everything in sight that looks like an optics business. Any purchase needs to be a good deal as well as have a strategic value or the potential to increase market share.

"Our acquisition strategy is fairly patient as far as us having a firm belief in what we should pay or shouldn't pay, and if it's not in that range, we just step away," says Craig Creaturo, II-VI's chief accounting officer.

Laser wars

As the laser device industry expands globally, particularly in China, II-VI will use its experience gained in other markets to take advantage of the changing international business landscape. In the early 1980s, II-VI placed manufacturing plants in Germany and Japan to serve the growing laser manufacturing industry in those countries.

It developed a system that allowed it to turn around orders from Japanese customers in three weeks and at a cost lower than was available from domestic suppliers. II-VI essentially blocked the optics industry in Japan from gaining a foothold beyond its shores and captured approximately 55 percent of the market for laser optics there.

In Europe and the United States, it has garnered a similar share, essentially by manufacturing close to its customers.

The manufacturing of laser devices is spreading across the globe, particularly in China, where II-VI operates a plant. Kramer says II-VI is focusing on China and is taking the same aggressive approach to gaining market share as it has in the United States, Japan and Europe. Kramer says II-VI is essentially on the same track in China as it was in Europe and Japan in the 1980s. And, as in Japan and Europe, II-VI will have to demonstrate superior quality and competitive pricing in China to be successful.

"The bigger war for the lower-priced lasers that are used for marking, engraving and light cutting of plastics will be fought in China, so we have to be there and have our parts into everybody's laser," says Kramer.

And returning to the analogy he drew earlier, he emphasizes the value of II-VI being close to its market.

Says Kramer: "We have to be in those countries to sell those razor blades."

How to reach: II-VI Inc., www.II-VI.com