COHERENT CORP. - Annual Report: 2018 (Form 10-K)

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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

for the fiscal year ended June 30, 2018

for the transition period from                     to                     .

Commission File Number: 0-16195

II-VI INCORPORATED

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 724-352-4455

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes  ☒    No  ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.     Yes   ☐    No   ☒

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   ☒    No   ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment  to this Form 10-K.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐    No  ☒

Aggregate market value of outstanding Common Stock, no par value, held by non-affiliates of the Registrant at December 29, 2017, was approximately $2,867,219,000 based on the closing sale price reported on the Nasdaq Global Select Market. For purposes of this calculation only, directors and executive officers of the Registrant and their spouses are deemed to be affiliates of the Registrant.

Number of outstanding shares of Common Stock, no par value, at August 22, 2018, was 63,595,874.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement, which will be issued in connection with the 2018 Annual Meeting of Shareholders of II-VI Incorporated, are incorporated by reference into Part III of this Annual Report on Form 10-K.

Forward-Looking Statements

This Annual Report on Form 10-K (including certain information incorporated herein by reference) contains forward-looking statements made pursuant to Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). The statements in this Annual Report on Form 10-K that are not purely historical, but are forward-looking statements, including, without limitation, statements regarding our expectations, assumptions, beliefs, intentions or strategies regarding the future.  In some cases, these forward-looking statements can be identified by terminology such as, “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “intends,” “estimates,” “predicts,” “projects,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Forward-looking statements address, among other things, our assumptions, our expectations, our assessments of the size and growth rates of our markets, our growth strategies, our efforts to increase bookings, sales and revenues, projections of our future profitability, cash generation, success of our research, development and engineering investments, results of operations, capital expenditures, our financial condition, our ability to integrate acquired businesses or other “forward-looking” information and include statements about revenues, costs, investments, earnings, margins, or our projections, actions, plans or strategies.

The forward-looking statements in this Annual Report on Form 10-K involve risks and uncertainties, which could cause actual results, performance or trends to differ materially from those expressed in the forward-looking statements herein or in previous disclosures. We believe that all forward-looking statements made by us have a reasonable basis, but there can be no assurance that these expectations, beliefs or projections will actually occur or prove to be correct, at least on the timetable of our expectations. Actual results could differ materially. We claim the protection of the safe harbor for forward-looking statements contained in the PSLRA for our forward-looking statements.

The following factors, among others, in some cases have affected and in the future could affect our financial performance and actual results, and could cause actual results for fiscal 2019 and beyond to differ materially from those expressed or implied in any forward-looking statements included in this Annual Report on Form 10-K or otherwise made by our management:

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The foregoing and additional risk factors are described in more detail herein under Item 1A. “Risk Factors”. All such factors, as well as factors described or referred to in other filings we make with the Securities and Exchange Commission (the “SEC”) from time to time, should be considered in evaluating our business and prospects. Many of these factors are beyond our reasonable control. In addition, we operate in a highly competitive and rapidly changing environment, and, therefore, new risk factors can arise and be present without market players like us knowing until a substantial amount of time has passed. It is not possible for management to predict all such risk factors, assess the impact of all such risk factors on our business nor estimate the extent to which any individual risk factor, or combination of risk factors, nor to mitigate them all and therefore they may cause results to differ materially from those contained in any forward-looking statement. The forward-looking statements included in this Annual Report on Form 10-K speak only as of the date of this Annual Report on Form 10-K. We do not assume any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or developments, or otherwise, except as may be required by the securities laws. We caution you not to rely on them unduly.

II-VI Incorporated does communicate with securities analysts from time to time and those communications are conducted in accordance with applicable securities laws. Investors should not assume that II-VI Incorporated agrees with any statement or report issued by any analyst, irrespective of the content of the statement or report.

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PART I

Definitions

II-VI Incorporated (“II-VI,” the “Company,” “we,” “us,” or “our”) was incorporated in Pennsylvania in 1971. Our headquarters are located at 375 Saxonburg Boulevard, Saxonburg, Pennsylvania 16056. Our telephone number is 724-352-4455. Reference to “II-VI,” the “Company,” “we,” “us,” or “our” in this Annual Report on Form 10-K, unless the context requires otherwise, refers to II-VI Incorporated and its wholly-owned subsidiaries. The Company’s name is pronounced “Two Six Incorporated.” The name II-VI refers to Groups II and VI on the Periodic Table of Elements from which II-VI originally designed and produced infrared optics for high-power CO₂ lasers used in materials processing. We address 7 major markets. The majority of our revenues are attributable to the sale of engineered materials and optoelectronic components, devices and subsystems for the industrial materials processing, optical communications and military markets. Reference to “fiscal” or “fiscal year” means our fiscal year ended June 30 for the year referenced.

The following acronyms are defined for reference: 3 dimensional (“3D”); 4th generation (“4G”) wireless; 5th generation (“5G”) wireless; bismuth telluride (“Bi₂Te₃”); cadmium telluride (“CdTe”); carbon monoxide (“CO”); carbon dioxide (“CO₂”); chemical vapor deposited (“CVD”) materials including diamond; wavelength division multiplexing (“WDM”); dense wavelength division multiplexing (“DWDM”); extreme ultraviolet (“EUV”) lithography; gallium arsenide (“GaAs”); gallium nitride (“GaN”); gigabit Ethernet (“GbE”); gigabit per second (“Gb/s”); indium phosphide (“InP”); infrared (“IR”); light detection and ranging (“LiDAR”); near infrared (“NIR”); nanometers (“nm”); original equipment manufacturer (“OEM”); organic light-emitting diode (“OLED”); optical time domain reflectometer (“OTDR”); research, development and engineering (“RD&E”); radio frequency (“RF”); reconfigurable optical add/drop multiplexer (“ROADM”); silicon carbide (“SiC”); ultraviolet (“UV”); vertical cavity surface emitting laser (“VCSEL”); zinc selenide (“ZnSe”); and zinc sulfide (“ZnS”).

General Description of Business

We develop, manufacture and market engineered materials, optoelectronic components and devices for precision use in industrial materials processing, optical communications, military, consumer electronics, semiconductor equipment, life sciences and automotive applications and markets. We use advanced engineered materials growth technologies coupled with proprietary high-precision fabrication, micro-assembly, optical thin-film coating and electronic integration to manufacture complex optoelectronic devices and modules. Our products are deployed in a variety of applications, including (i) laser cutting, welding and marking operations; (ii) 3D sensing consumer applications; (iii) optical, data and wireless communication products; (iv) strategic military applications including intelligence, surveillance and reconnaissance; (v) semiconductor processing and tooling; and (vi) thermoelectric cooling and power generation solutions.

Through RD&E and acquisitions, II-VI has expanded its portfolio of materials. We believe that the materials that we grow and fabricate are differentiated by one or a combination of unique optical, electrical, thermal and mechanical properties. II-VI’s optics are shaped by precision surfacing techniques to meet the most stringent requirements for flat or curved geometries, functionalized with smooth or structured surfaces, or with patterned metallization. Proprietary processes developed at our global optical coating centers differentiate our products’ durability against high energy lasers and extreme operating environments. Optical coatings also provide the desired spectral characteristics ranging from the ultraviolet to the far-infrared. II-VI leverages these capabilities to deliver miniature- to large-scale precision optical assemblies, including in combination with thermal management components, integrated electronics, and/or software.

II-VI also offers a broad portfolio of compound semiconductor lasers that are used in a variety of applications in most of our end markets. These compound semiconductor lasers enable high-power lasers for materials processing, optical signal amplification in terrestrial and submarine communications networks, high bit rate server connectivity between and within datacenters, fast and accurate measurements in biomedical instruments, consumer electronics and optical communications network monitoring.  

II-VI continues to work to perfect its operational capabilities, develop next generation products, and invest in new technology platforms. With a strategic focus on fast growing and sustainable markets, II-VI pursues its vision of enabling the world to be safer, healthier, closer and more efficient.

Information Regarding Market Segments and Foreign Operations

Financial data regarding our revenues, results of operations, industry segments and international sales for the three years ended June 30, 2018 are set forth in the Consolidated Statements of Earnings and in Note 12 to the Company’s Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K and are incorporated herein by reference. We also discuss certain Risk Factors set forth in Item 1A of this Annual Report on Form 10-K related to our foreign operations, which are incorporated herein by reference.

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Bookings and Backlog

We define our bookings as customer orders received that are expected to be converted to revenues over the next 12 months. For long-term customer orders, to address the inherent uncertainty of orders that extend far into the future, the Company records only those orders which are expected to be converted into revenues within 12 months from the end of the reporting period. Bookings are adjusted if changes in customer demands or production schedules cause the expected time of a delivery to extend beyond 12 months. For the year ended June 30, 2018, our bookings were approximately $1.2 billion compared to bookings of approximately $1.1 billion for the year ended June 30, 2017.

We define our backlog as bookings that have not been converted to revenues by the end of the reporting period. As of June 30, 2018, our backlog was approximately $450 million, compared to approximately $400 million as of June 30, 2017.

Global Operations

II-VI is headquartered in Saxonburg, PA, with RD&E, manufacturing and sales facilities worldwide. Our U.S. production and research and development operations are located in Pennsylvania, California, New Jersey, Texas, Mississippi, Massachusetts, Connecticut, Delaware, New York, Florida and Illinois and our non-U.S. production operations are based in China, Singapore, Vietnam, the Philippines, Germany, Switzerland and the United Kingdom. We also utilize contract manufacturers and strategic suppliers. In addition to sales offices at most of our manufacturing sites, we have sales and marketing subsidiaries in Hong Kong, Japan, Germany, China, Switzerland, Belgium, the United Kingdom, Italy, South Korea, and Taiwan. Approximately 68% of our revenues for the fiscal year ended June 30, 2018, were generated from sales to customers outside of the United States.

Employees

The table below summarizes the number of our employees as of June 30, 2018 in the main functions. We have a long-standing practice of encouraging active employee participation in areas of operations and quality management. We believe our relations with our employees are good. We reward substantially all our employees with some form of variable compensation based on achievement of performance goals. There are approximately 265 employees located in the United States and the Philippines who are covered under collective bargaining agreements. The Company’s collective bargaining agreement in the Philippines expires in June 2019. The collective bargaining agreement covering certain U.S. based employees expires in January 2021. There are 730 employees of Photop in China who work under contract manufacturing arrangements for customers of the Company.

Manufacturing Processes

Our success in developing and manufacturing many of our products depends on our ability to manufacture and to tailor the optical and physical properties of technically-challenging materials and components. The ability to produce, process and refine these complex materials and to control their quality and in-process yields is an expertise of the Company that is critical to the performance of our customers’ instruments and systems. In the markets we serve, there are a limited number of high-quality suppliers of many of the components we manufacture and there are very few industry-standard products.

Our network of worldwide manufacturing sites allows us to manufacture our products in regions that provide cost-effective advantages. We employ numerous advanced manufacturing technologies and systems at our manufacturing facilities. These include metal organic chemical vapor deposition and molecular beam epitaxy reactors, automated Computer Numeric Control optical fabrication, high throughput thin-film coaters, nano-precision metrology and custom-engineered automated furnace controls for crystal growth processes. Manufacturing products for use across the electro-magnetic spectrum requires the capability to repeatedly produce products with high yields to atomic tolerances. II-VI continuously updates its comprehensive quality management systems that feature manufacturing quality best practices. II-VI is committed to delivering products within specification, on time and with high quality, with a goal of fully satisfying customers and continually improving.

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Sources of Supply

Among the major feed stock and raw materials we use include zinc, selenium, ZnSe, ZnS, hydrogen selenide, hydrogen sulfide, tellurium, yttrium oxide, aluminum oxide, iridium, platinum, bismuth, silicon, thorium fluoride, antimony, carbon, graphite, GaAs,  InP, copper, germanium, molybdenum, quartz, optical glass, diamond, and other materials.

The continued high-quality of and access to these materials is critical to the stability and predictability of our manufacturing yields. We test materials at the onset and throughout the production process. Additional research and capital investment may be needed to better define future material specifications. We have not experienced significant production delays due to shortages of materials. However, we do occasionally experience problems associated with vendor-supplied materials not meeting contract specifications for quality or purity. As discussed in greater detail in Item 1A – Risk Factors, of this Annual Report on Form 10-K, significant failure of our suppliers to deliver sufficient quantities of necessary high-quality materials to our specifications on a timely basis could have a materially adverse effect on our results of our operations.

Business Units

The Company’s organizational structure is divided into three reporting segments for the purpose of making operational decisions and assessing financial performance: (i) II-VI Laser Solutions, (ii) II-VI Photonics, and (iii) II-VI Performance Products. These segments, and the units within the segments, are reflected in the organization chart below:

II-VI Laser Solutions designs, manufactures and markets optical and electro-optical components and materials sold under the II-VI Infrared brand name that are used primarily in high-power CO₂ lasers, fiber-delivered beam delivery systems and processing tools and direct diode lasers for industrial lasers sold under the II-VI HIGHYAG, direct diode laser modules, sub-systems and systems sold under the II-VI SUWTECH and II-VI DIRECTPHOTONICS brand names and super-hard materials processing laser systems sold under the II-VI LASERTECH brand names. II-VI Laser Solutions also manufactures compound semiconductor epitaxial wafers under the II-VI EPIWORKS brand name for applications in optical components, wireless devices, and high-speed communication systems and manufactures 6-inch gallium arsenide wafers allowing for the production of high-performance lasers optoelectronics and integrated circuits in high volume sold under the II-VI Laser Enterprise,  II-VI EpiWorks, II-VI Compound Semiconductor Ltd. and II-VI OptoElectronic Devices Division brand names.  

II-VI Photonics manufactures crystal materials, optics, microchip lasers and optoelectronic modules for use in optical communication networks and other diverse consumer, life sciences and commercial applications.  In addition, the segment also manufactures pump lasers, optical isolators, and optical amplifiers and micro-optics for optical amplifiers for both terrestrial and submarine applications within the optical communications market.

II-VI Performance Products designs, manufactures and markets infrared optical components and high-precision optical assemblies for military, medical and commercial laser imaging applications.  In addition, the segment designs, manufactures and markets unique silicon carbide engineered materials for thermoelectric devices and subsystems for silicon carbide applications servicing the semiconductor equipment, military, communications, automotive and life science markets.

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II-VI’s segments are organized by business unit at the group or division level. Each of these business units develops and markets products as described below.

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Our Markets

Our market-focused businesses are organized by technology and products. Our businesses are composed of the following primary markets: Communications, Materials Processing, Military, Semiconductor Equipment, Life Sciences, Consumer Electronics and Automotive.

Communications Market

II-VI’s optical communications products and technologies enable the next generation of high-speed optical transmission systems, networks, and datacenter solutions necessary to meet the accelerating global bandwidth demand. At the core of both terrestrial and undersea optical networks, our market-leading 980 nm pump lasers boost the power of the optical signal in the fiber optic cable at intervals along the way to enable a larger number of high speed signals to be transmitted over longer distances. Our latest generation of 980 nm pump lasers along with miniature tunable filters and hybrid passives are part of our ultra-compact family of components critical to a new generation of small size, long reach DWDM transmission modules operating at 100, 200 and 400 Gb/s.

Customers continue to rely on us for our industry-leading optical amplification and embedded monitoring solutions for their next generation ROADM systems to compensate for the inherent signal loss and to monitor the signal integrity. Our proprietary OTDR modules allow systems to automatically detect and pinpoint issues along the transmission path in real time. The accelerating adoption of applications such as cloud computing are driving the rapid growth of datacenter buildouts. Our high-speed 25 Gb/s VCSELs enable intra-datacenter transceivers to transmit and receive signals. Our miniature WDM thin film filter assemblies are used to increase the bandwidth within 100 GbE transceivers by combining wavelengths at the transmitter end and separating them out at the receiver end.

In mobile wireless applications, II-VI supplies base SiC substrates to customers who manufacture RF power amplifier devices that are embedded in remote radio heads in 4G wireless bases stations to boost the power of RF signal before it reaches the antenna. These devices are also widely expected to be embedded in next generation active antennas for 5G wireless, where multiple devices per antenna will be required to enable higher bandwidth. SiC has a high number of intrinsic physical and electronic advantages, such as high thermal conductivity, that enable them to operate at high-power levels and still dissipate the excess heat generated.

Materials Processing Market

Our industrial laser optics and solutions for the materials processing market remain in strong demand. There continues to be a steady global demand to support existing installations and new deployments of CO₂ and fiber laser systems. Our vertically integrated and market leading ZnSe optics and components, due to their inherent low loss at around 10 micron wavelength, have enabled high-power CO₂ laser systems for many decades and remain critical to the steady stream of new deployments as well as to continued operation, serving as replacement optics, of the installed base of CO₂ lasers. II-VI continues to introduce products that address new and growing applications for low-power CO₂ lasers, such as cutting textiles, leather, wood and other organic materials, for which the CO₂ laser’s 10 micron wavelength is ideally suited. CO₂ lasers are also at the core of EUV lithography systems, which are now emerging on the market to enable a new generation of smaller and more powerful personal integrated circuits for the internet of things computing devices.  

Over the past several years, fiber laser-based systems operating at one micron wavelength in pulsed or continuous mode have taken a central role in nearly all materials processing segments, and especially for precision machining such as marking and micro drilling. From the laser chips that generate the input optical power to the beam delivery systems that direct the output optical power to the target, II-VI supplies a broad set of laser optics and fused fiber products that enable many functions within these systems. The same set of II-VI products is also at the core of existing and emerging direct diode laser systems. II-VI is also driving innovation with a direct-diode laser engine small enough to be mounted on a robotic arm so that the end user can apply square beams directly to the work piece at wavelengths optimized for aluminum processing.

Another emerging and fast growing application is the processing of displays for consumer electronics, including those based on the OLED technology that are scribed with CO lasers and sealed with UV lasers. II-VI’s broad portfolio of coated optics and crystal materials serve all of these growing laser markets.    

Military Market

Our focus in the military market is enabling lasers for targeting, night vision, navigation, as well as intelligence, surveillance and reconnaissance systems. Multiple fighter jets are equipped with our large area sapphire windows that surround advanced electro-optical targeting and imaging systems. Infrared domes are used on missiles with infrared guidance systems ranging from small, human-portable designs to larger designs mounted on helicopters, fixed-wing aircraft and ground vehicles. High-precision domes are an integral component of a missile’s targeting system, providing efficient tactical capability, while serving as a protective cover to its internal components.

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Rotary and fixed-wing aircraft also use missile warning systems to protect against shoulder fired human-portable missiles. Our competencies in material growth for UV crystals and our optical assembly capabilities provide significant support to these missile warning systems. A key attribute of several of these systems is the ability to filter electro-magnetic interference using micro-fine conductive mesh patterns. This technology is also applied to non-optical applications for absorbing and transmitting energy from the surfaces of aircraft and missiles.

Many military systems employ laser designation and range-finding capabilities supported by our semiconductor lasers bars and solid state laser host crystals and laser optics, all manufactured in-house, as well as our competency in short wave infrared and visible optics. Our thermoelectric coolers are used to increase thermal imaging sensitivity, or to maintain a constant window temperature in various visible and infrared applications.  

We provide a range of battlefield-ready technologies for soldier equipment and specifically designed variants for law enforcement. Our precision patterned reticles are embedded in rifle scopes. Our reaction bonded boron carbide materials are shaped into torso plates and employed as in-aircraft cabin and protective body armor. Our thermo-electric coolers are used to regulate the soldier’s body heat. They are also used to convert heat produced by battlefield fuel burners into electrical power, for example to extend battery life on the battlefield.  

We maintain engineering and manufacturing facilities in the United States with strictly controlled access that are dedicated to our U.S. government supported contracts.  

Semiconductor Capital Equipment Market

Semiconductor equipment requires advanced materials to meet the need for tighter tolerances, enhanced thermal stability, faster wafer transfer speeds and reduced stage settling times. Our metal matrix composites and reaction bonded ceramics enable these applications thanks to their optimum combination of light weight, strength, hardness and coefficient of thermal expansion.  Our reaction bonded SiC materials are used to manufacture wafer chucks, light weight scanning stages and high temperature, corrosion resistant wafer support systems. Our cooled SiC mirrors and precision patterned reticles are used in the illumination systems of lithography tools.  

In the emerging market of EUV lithography systems, CO₂ lasers are used to generate extreme ultraviolet light. These CO₂ lasers and beam delivery systems leverage our broad portfolio of CO₂ laser optics, CdTe Modulators, high power damage resistant polycrystalline CVD diamond windows to route the powerful laser beam to a tin droplet from which EUV light will emanate. Due to their very high mechanical and thermal performance characteristics, our reaction bonded SiC are used in structural support systems that are integral to EUV lithography optics to meet critical requirements for optical system stability.

Life Sciences Market

The majority of our business in the life sciences end market is in analytical tools. Many analytical tools found in modern biotech laboratories are based on some form of interaction with light. This applies to flow cytometry, cell sorting, confocal microscopy, DNA genome sequencing, Raman spectroscopy, fluorescence spectroscopy and particle sizing to name a few. Our multi-colored laser engines along with our broad portfolio of application-specific optics, filters and gratings are embedded in these analytical tools.  We also supply objective lenses, precision patterned reticles and assemblies for microscopes.

Genome sequencing involves temperature cycling DNA in flow cells with a high degree of temperature uniformity and precision. We believe that our thermal engines are the state of the art in chiller technology, and they achieve what we believe to be industry-leading temperature control and uniformity across large areas. Our green lasers are used to excite the fluorescence of DNA to reveal its structure. Our flow cells are micro-machined with a high degree of precision to insure the smooth flow of sample fluids undergoing analysis. Our thermal engines are also used in a multitude of other biomedical applications, for example to measure substance concentration in complex mixtures, to protect blood supplies and to perform heating- and cooling-based physical therapy.

Clinical procedures are increasingly performed with tools that embed our lasers and optics. For example, our semiconductor laser bars are used in hair and wrinkle removal procedures and our custom designed lens assemblies are used for laser eye surgery. We continue to leverage our core lasers, optics and temperature control expertise into new applications to grow our business in life sciences.

Consumer Electronics Market

II-VI manufactures low cost VCSELs, VCSEL arrays and low angle shift filters for the consumer electronics market. Our VCSEL products leverage our world-class 6-inch GaAs platform, combining our epitaxial wafer growth and wafer fabrication capabilities.

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Our VCSELs, unlike many on the market, have already been designed into consumer products such as the computer mouse as well as for menu navigation in smart phones and in car steering wheels. Our VCSELs are also widely deployed in datacenters and in the emerging market for HDMI optical cables. This expertise in VCSEL technology is being leveraged for the emerging 3D sensing market. With our acquisitions of 6-inch epitaxy and wafer capabilities, we have invested significantly to round out our capacity expansion.

Automotive Market

Power conversion electronics for high-efficiency electric vehicles need a combination of high-power density, high-efficiency and high-temperature operation that are only afforded by advanced material systems based on SiC substrates. Our SiC substrates are available in large diameters and have what we believe to be best-in-class quality and low defect levels.

Our thermoelectric modules are used to cool batteries to extend their operating life. They are also more efficient than resistive heaters when used in heated car seats and extend an electric vehicle’s range of travel in cold environments.

To operate safely, self-driving cars will rely on control systems that are informed by a comprehensive number of sensors. One such sensor is based on LiDAR, which employs semiconductor lasers to properly identify and measure the distance to obstacles ahead. Our GaAs-based semiconductor laser platform, which already enables a broad portfolio of products in communications and materials processing, is now being scaled further for consumer electronics, and will be leveraged to deliver a highly reliable and cost-effective laser product for this emerging market.  

Marketing and Sales

We market our products through direct sales forces and through representatives and distributors around the world. Our market strategy is focused on understanding our customers’ requirements and building market awareness and acceptance of our products. New products are continually being produced and introduced to our new and established customers in all markets.

The Company is centralizing its worldwide marketing and sales functions across the Company’s business units. Sales offices have been strategically established to best serve and distribute products to our worldwide customer base. There are significant cooperation, coordination and synergies among our business units, which capitalize on the most efficient and appropriate marketing channels to address diverse applications within our markets.

Our sales forces develop effective communications with our OEM and end-user customers worldwide. Products are actively marketed through targeted mailings, telemarketing, select advertising, attendance at trade shows and customer partnerships. Our sales force includes a highly-trained team of applications engineers to assist customers in designing, testing and qualifying our parts as key components of our customers’ systems. As of June 30, 2018, we employed approximately 263 individuals in sales, marketing and support.

We do business with a number of customers in the defense industry, who in turn generally contract with a governmental entity, typically a U.S. governmental agency. Most governmental programs are subject to funding approval and can be modified or terminated without warning by a legislative or administrative body.

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Customers

The representative groups of customers by segments are as follows:

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Competition

We believe we are a global leader in many of our product families. We compete partly on the basis of our reputation for offering highly engineered products, product and technology roadmaps, intellectual property, ability to scale, quality, delivery time, technical support and pricing. We believe that we compete favorably with respect to these factors and that our vertical integration, manufacturing facilities and equipment, experienced technical and manufacturing employees and worldwide marketing and distribution channels provide us with competitive advantages. The representative groups of our competitors by segment are as follows:

In addition to competitors who manufacture products similar to those we produce, there are other technologies and products available that may compete with our technologies and products.

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Our Strategy

Our strategy is to grow businesses with world-class engineered material capabilities to advance our current customers’ strategies, penetrate new markets through innovative technologies and platforms, and enable new applications in large and growing markets. A key strategy of ours is to develop and manufacture high-performance materials and in certain cases components from those materials that are differentiated from those produced by our competitors. We focus on providing components that are critical to the heart of our customers’ assembly lines, for products serving the applications mentioned above.

We have grown substantially the number and size of our key accounts. Now, a substantial portion of our business is based on sales orders with market leaders, which enable our forward planning and production efficiencies. We intend to continue capitalizing and executing on this proven model, participating effectively in the growth of the markets discussed above, and continuing our focus on operational excellence as we execute our primary business strategies:

Research, Development and Engineering

During the fiscal year ended June 30, 2018, the Company continued to identify, invest in and focus our research and development on, new products in an effort to accelerate our organic growth.  This approach is managed under a disciplined innovation program that we refer to as the “II-VI Phase Gate Process.”

From time to time, the ratio of externally funded contract activity to internally funded contract activity varies due to the unevenness of government funded research programs and changes in the focus of our internally funded research programs. We are committed to having the right mix of internally and externally funded research that ties closely to our long-term strategic objectives.

We devote significant resources to RD&E programs directed at the continuous improvement of our existing products and processes and to the timely development of new technologies, materials and products. We believe that our RD&E activities are essential to establish and maintain a leadership position in each of the markets we serve. As of June 30, 2018, we employed 1,513 people in RD&E functions, 1,439 of whom are engineers or scientists. In addition, certain manufacturing personnel support or participate in our research and development efforts on an ongoing basis. We believe this interaction between the development and manufacturing functions enhances the direction of our projects, reducing costs and accelerating technology transfers.

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During the fiscal year ended June 30, 2018, we focused our RD&E investments in the following areas:

The development of our products and manufacturing processes is largely based on proprietary technical know-how and expertise. We rely on a combination of contract provisions, trade secret laws, invention disclosures and patents to protect our proprietary rights. We have entered into selective intellectual property licensing agreements. We have asserted in the past, and expect that we will continue to assert and vigorously protect our intellectual property rights. We have a total of approximately 800 patents globally.  

Internally funded research and development expenditures were $117.2 million, $96.8 million and $60.4 million for the fiscal years ended June 30, 2018, 2017 and 2016, respectively. For these same periods, externally funded research and development expenditures were $12.7 million, $8.7 million and $9.5 million, respectively and were included in Cost of goods sold in the Consolidated Statements of Earnings.

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Export and Import Compliance

We are required to comply with various export/import control and economic sanction laws, including:

Foreign governments have also implemented similar export and import control regulations, which may affect our operations or transactions subject to their jurisdiction. For additional discussions regarding our import and export compliance, see the discussion set forth in Item 1A – Risk Factors of this Annual Report Form on Form 10-K.

Trade Secrets, Patents and Trademarks

Our use of trade secrets, proprietary know-how, trademarks, copyrights, patents and contractual confidentiality and IP ownership provisions help us develop and maintain our competitive position with respect to our products and manufacturing processes. We aggressively pursue process and product patents in certain areas of our businesses. We have entered into selective intellectual property licensing agreements. We have confidentiality and non-competition agreements with certain personnel. We require that our U.S. employees sign a confidentiality and non-competition agreement upon their commencement of employment with us.

The design, processes and specialized equipment utilized in our engineered materials, advanced components and subsystems are innovative, complex and difficult to duplicate. However, there can be no assurance that others will not develop or patent similar technology, or that all aspects of our proprietary technology will be protected. Others have obtained patents covering a variety of materials, devices, equipment, configurations and processes, and others could obtain patents covering technology similar to ours. We may be required to obtain licenses under such patents, and there can be no assurance that we would be able to obtain such licenses, if required, on commercially reasonable terms, or that claims regarding rights to technology will not be asserted that may adversely affect our results of operations. In addition, our research and development contracts with agencies of the U.S. Government present a risk that project-specific technology could be disclosed to competitors as contract reporting requirements are fulfilled.

Executive Officers of the Registrant

The executive officers of the Company and their respective ages and positions as of June 30, 2018 are set forth below. Each executive officer listed has been appointed by the Board of Directors to serve until removed or until such person’s successor is appointed and qualified.

Vincent D. Mattera, Jr. Dr. Mattera initially served as a member of the II-VI Board of Directors from 2000-2002. Dr. Mattera joined the company as a Vice President in 2004 and served as Executive Vice President from January of 2010 to November of 2013, when he became the Chief Operating Officer. In November of 2014, Dr. Mattera became the President and Chief Operating Officer, and was reappointed to the Board of Directors. In November of 2015, he became the President of II-VI. In September of 2016, Dr. Mattera became the Company’s third President and Chief Executive Officer in 45 years. During his career at II-VI he has assumed

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successively broader management roles, including as a lead architect of the Company’s diversification strategy. He has provided vision, energy and dispatch to the Company’s growth initiatives including overseeing the acquisition-related integration activities in the US, Europe, and Asia-especially in China-thereby establishing additional platforms. These have contributed to a new positioning of the Company into large and transformative global growth markets while increasing considerably the global reach of the Company, deepening the technology and IP portfolio, broadening the product roadmap and customer base, and increasing potential of II-VI.

Prior to joining II-VI as an executive, Dr. Mattera had a continuous 20 year career in the Optoelectronic Device Division of AT&T Bell Laboratories, Lucent Technologies and Agere Systems during which he led the development and manufacturing of semiconductor laser based materials and devices for optical and data communications networks. Dr. Mattera has 34 years of leadership experience in the compound semiconductor materials and device technology, operations and markets that are core to II-VI’s business and strategy.  Dr. Mattera holds a B.S. in chemistry from the University of Rhode Island (1979), and a Ph.D. degree in chemistry from Brown University (1984). He completed the Stanford University Executive Program (1996).

Mary Jane Raymond has been Chief Financial Officer and Treasurer of the Company since March 2014. Previously, Ms. Raymond was Executive Vice President and Chief Financial Officer of Hudson Global, Inc. (NASDAQ: HSON) from 2005 to 2013. Ms. Raymond was the Chief Risk Officer and Vice President and Corporate Controller at Dun and Bradstreet, Inc., from 2002 to 2005. Additionally, she was the Vice President, Merger Integration, at Lucent Technologies, Inc., from 1997 to 2002 and held several management positions at Cummins Engine Company from 1988 to 1997. Ms. Raymond holds a B.A. degree in Public Management from St. Joseph’s University, and an MBA from Stanford University.

Giovanni Barbarossa joined II-VI in 2012 and has been the President, Laser Solutions Segment, since 2014, and the Chief Technology Officer since 2012. Dr. Barbarossa was employed at Avanex Corporation from 2000 through 2009, serving in various executive positions in product development and general management, ultimately serving as President and Chief Executive Officer. When Avanex merged with Bookham Technology, forming Oclaro, Dr. Barbarossa became a member of the Board of Directors of Oclaro and served as such from 2009 to 2011. Previously, he had management responsibilities at British Telecom, AT&T Bell Labs, Lucent Technologies, and Hewlett-Packard. Dr. Barbarossa graduated from the University of Bari, Italy, with a B.S. degree in Electrical Engineering, and holds a Ph.D. in Photonics from the University of Glasgow, U.K.

Gary A. Kapusta joined II-VI in February 2016 and has served since then as the Company’s Chief Operating Officer. Prior to his employment with the Company, Mr. Kapusta served in various roles at Coca-Cola, including as President & Chief Executive Officer, Coca-Cola Bottlers’ Sales & Services L.L.C.; President, Customer Business Solutions; and Vice President, Procurement Transformation, Coca-Cola Refreshments. He joined Coca-Cola following a 19 year career at Agere Systems, Lucent Technologies, and AT&T. Mr. Kapusta graduated from The University of Pittsburgh with B.S. and M.S. degrees in Industrial Engineering, and holds an MBA from Lehigh University.  Jo Anne Schwendinger has served as the Company’s Chief Legal and Compliance Officer and Secretary since March 2017. Ms. Schwendinger also served as the Company’s General Counsel and Secretary from when she joined the Company in March 2017 until November 2017. Prior to her employment with the Company, Ms. Schwendinger practiced law with the law firm Blank Rome, LLP from August 2016 until February 2017. Previously, Ms. Schwendinger served in various legal roles at Deere & Company from February 2000 until August 2016, including Regional General Counsel-Asia-Pacific and Sub-Saharan Africa and Assistant General Counsel. Ms. Schwendinger holds a Bachelor’s degree from the Université d'Avignon et des Pays de Vaucluse, a Master’s degree from the Université de Strasbourg, and a Juris Doctor degree from the University of Pittsburgh Law School.

David G. Wagner has been employed by the Company since 2008, and has been the Vice President, Human Resources since 2011.  Prior to his employment with the Company, Mr. Wagner was employed with Owens Corning (NYSE:OC) from 1985 through 2008, serving in various human resource management positions, ultimately becoming the Vice President, Human Resources, for Owen Corning’s global sales force.  Mr. Wagner graduated with a B.S. degree in Human Resources Management from Juniata College in 1985. Mr. Wagner has announced his intention to retire from the Company, effective in 2019, as of a date to be determined.

Availability of Information

Our Internet address is www.ii-vi.com. Information contained on our website is not part of, and should not be construed as being incorporated by reference into, this Annual Report on Form 10-K. We post the following reports on our website as soon as reasonably practical after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”): our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and any amendments to those reports or statements filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. In addition, we post our proxy statements on Schedule 14A related to our annual shareholders’ meetings as well as reports filed by our directors, officers and 10% beneficial owners pursuant to Section 16 of the Exchange Act. In addition, all filings are available via the SEC’s website (www.sec.gov). We also make our corporate governance documents available on our website, including the Company’s Code of Business Conduct and Ethics, governance guidelines and the charters for our board committees. All such documents are located on the Investors page of our website and are available free of charge.

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We caution our investors that our performance is subject to risks and uncertainties. The following material risk factors may cause our future results to differ materially from those projected in any forward-looking statement. You should carefully consider these factors, as well as the other information contained in this Annual Report on Form 10-K when evaluating an investment in our securities.

Investments in Future Markets of Potential Significant Growth May Not Result in Expected Returns

We have initiated investment programs with the goal of gaining a greater share of end markets using semiconductor lasers and other components including those used for 3D sensing.  We cannot guarantee that our investments in capital and capabilities will be sufficient.  The potential end markets, as well as our ability to gain market share in such markets, may not materialize on the timeline anticipated or at all.  We cannot be sure of the end market price, specification or yield for products incorporating our technologies. Our technologies could fail to fulfill, partially or completely our target customers’ finalized specifications.  We cannot guarantee the end market customers’ acceptance of our technologies. Further, we may be unable to fulfill the terms of our contracts with our target customers, which could result in penalties of a material nature, including consequential damages, loss of market share and loss of reputation.

Our Competitive Position Depends on Our Ability to Develop New Products and Processes

To meet our strategic objectives, we must develop, manufacture and market new products and continue to update our existing products and processes to keep pace with market developments to address increasingly sophisticated customer requirements. Our success in developing and selling new and enhanced products and processes depends upon a variety of factors including strategic product selection, efficient completion of product design and development, timely implementation of manufacturing and assembly processes, effective sales and marketing, high-quality and successful product performance in the market.

The introduction by our competitors of products or processes using new developments better or faster than ours could render our products or processes obsolete or unmarketable.  We intend to continue to make significant investments in RD&E to achieve our goals.  There can be no assurance that we will be able to develop and introduce new products or enhancements to our existing products and processes in a manner which satisfies customer needs or achieves market acceptance. The failure to do so could have a material adverse effect on our ability to grow our business and maintain our competitive position and on our results of operations and/or financial condition.  

Our Competitive Position May Still Require Significant Investments

We continuously monitor the marketplace for strategic opportunities, and our business strategy includes expanding our product lines and markets through both internal product development and acquisitions.  Consequently, we expect to continue to consider strategic acquisition of businesses, products or technologies complementary to our business.  This may require significant investments of management time and financial resources.  If market demand is outside our organic capabilities, if a strategic acquisition is required and we cannot identify one or execute on it, and/or if financial investments that we undertake distract management, do not result in the expected return on investment, expose us to unforeseen liabilities or jeopardize our ability to comply with our credit facility covenants due to any inability to integrate the business, adjust to operating a larger and more complex organization, adapt to additional political and other requirements associated with the acquired business, retain staff, or work with the customers or otherwise we could suffer a material adverse effect on our business, results of operations or financial condition.

Our Future Success Depends on Continued International Sales, and Our Global Operations are Complex, and Present Multiple Challenges to Manage

Sales to customers in countries other than the United States accounted for approximately 68%, 69% and 63% of revenues during the years ended June 30, 2018, 2017 and 2016, respectively. We anticipate that international sales will continue to account for a significant portion of our revenues for the foreseeable future. If we do not maintain our current volume of international sales, we could suffer a material adverse effect on our business, results of operations and/or financial condition.

We manufacture products in the United States, China, Singapore, Vietnam, the Philippines, Germany, Switzerland, and the United Kingdom and through a contract manufacturer in Thailand.  We also maintain direct sales offices in Hong Kong, Japan, Germany, China, Switzerland, Belgium, the United Kingdom, China, Italy, South Korea, and Taiwan.  Our operations vary by location and are influenced on a location-by-location basis by local customs, languages and work practices, as well as different local weather conditions, management styles and education systems. In addition, multiple complex issues may arise concurrently in different countries, potentially hampering our management’s ability to respond in an effective and timely manner. Any inability to respond in an effective and timely manner to issues in our global operations could have a material adverse effect on our business, results of operations or financial condition.

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Foreign Currency Risk May Negatively Affect our Revenues, Cost of Sales and Operating Margins and Could Result in Foreign Exchange Losses

We conduct our business and incur costs in the local currency of most countries in which we operate. Our net sales outside the United States represented a majority of our total sales in each of the last three fiscal years. We incur currency transaction risk whenever one of our operating subsidiaries enters into either a purchase or a sales transaction using a different currency from the currency in which it operates or holds assets or liabilities in a currency different than its functional currency. Changes in exchange rates can also affect our results of operations when the value of sales and expenses of foreign subsidiaries are translated to U.S. dollars. We cannot accurately predict the impact of future exchange rate fluctuations on our results of operations. Further, given the volatility of exchange rates, we may not be able to effectively manage our currency risks, and any volatility in currency exchange rates may increase the price of our products in local currency to our foreign customers or increase the manufacturing cost of our products, either of which may have an adverse effect on our financial condition, cash flows and profitability.

Any Inability to Access Financial Markets from Time to Time to Raise Required Capital, Finance Our Working Capital Requirements or Our Acquisition Strategies, or Otherwise to Support our Liquidity Needs Could Negatively Impact our Ability to Finance our Operations, Meet Certain Obligations or Implement our Growth Strategy

We occasionally borrow under our existing credit facilities to fund operations, including working capital investments, and to finance our acquisition strategies. In the past, market disruptions experienced in the United States and abroad have materially impacted liquidity in the credit and debt markets, making financing terms for borrowers less attractive, and, in certain cases, have resulted in the unavailability of certain types of financing. Uncertainty in the financial markets may negatively impact our ability to access additional financing or to refinance our existing credit facilities or existing debt arrangements on favorable terms or at all, which could negatively affect our ability to fund current and future expansion as well as future acquisitions and development. These disruptions may include turmoil in the financial services industry, volatility in the markets where our outstanding securities trade, and general economic downturns in the areas where we do business. If we are unable to access funds at competitive rates, or if our short-term or long-term borrowing costs increase, our ability to finance our operations, meet our short-term obligations and implement our operating strategies could be adversely affected.  

In the future we may be required to raise additional capital through public or private financing or other arrangements. Such financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could harm our business and prospects. Additional equity financing may be dilutive to the holders of our common stock, and debt financing, if available, may involve restrictive covenants that may limit our ability to undertake certain operational activities that we otherwise would find to be desirable. Further, debt service obligations associated with any such debt financing could reduce our profitability. If we cannot raise funds on acceptable terms, we may not be able to grow our business or respond to competitive pressures.

We May Incur Substantially More Indebtedness

We and our subsidiaries may be able to incur substantial additional indebtedness in the future, including secured indebtedness, subject to the restrictions contained in our debt instruments.  We are not restricted under the terms of the indenture governing our outstanding convertible senior notes from incurring additional indebtedness, securing existing or future indebtedness, recapitalizing our debt obligations or taking a number of other actions that are not limited by the terms of the indenture.  Our credit facility currently restricts our ability to incur additional indebtedness, including secured indebtedness, but if our credit facility matures or is repaid, we may not be subject to such restrictions under the terms of any subsequent indebtedness.

We May Not Be Able to Settle Conversions of Our Convertible Senior Notes in Cash or to Repurchase the Notes in Accordance with Their Terms

Holders of our outstanding convertible senior notes have the right to require us to repurchase all or a portion of their notes upon the occurrence of a fundamental change (as defined in the indenture governing the notes) at a repurchase price equal to 100% of the principal amount of the notes to be repurchased, plus accrued and unpaid interest, if any.  In addition, upon conversion of the notes, unless we elect to deliver solely shares of our common stock to settle such conversions (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of notes surrendered therefor or pay cash with respect to notes being converted.

In addition, our ability to repurchase or to pay cash upon conversion of the notes may be limited by law, regulatory authority or agreements governing our future indebtedness.  Our failure to repurchase notes at a time when the repurchase is required by the governing indenture or to pay any cash upon conversion of the notes as required would constitute a default under the indenture. A default under the indenture or the fundamental change itself also could lead to a default under agreements governing our credit facility and any of our future indebtedness.  If the payment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the notes or to pay cash upon conversion of the notes.

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The Conditional Conversion Feature of Our Outstanding Convertible Senior Notes, if Triggered, May Adversely Affect Our Financial Condition and Operating Results

In the event the conditional conversion feature of the notes is triggered, holders of notes will be entitled to convert the notes at any time during specified periods at their option.  If one or more holders elect to convert their notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity.

We May Fail to Accurately Estimate the Size and Growth of Our Markets and Our Customers’ Demands

We make significant decisions based on our estimates of customer requirements.  We use our estimates to determine the levels of business we seek and accept, production schedules, personnel needs and other resource requirements.

Customers may require rapid increases in production on short notice.  We may not be able to purchase sufficient supplies or allocate sufficient manufacturing capacity to meet such increases in demand. Rapid customer ramp-up and significant increases in demand may strain our resources or negatively affect our margins.  Inability to satisfy customer demand in a timely manner may harm our reputation, reduce our other opportunities, damage our relationships with customers, reduce revenue growth, and/or incur contractual penalties.

Alternatively, downturns in the industries in which we compete may cause our customers to significantly reduce their demand.  With respect to orders we initiate with our suppliers to address anticipated demand from our customers, certain suppliers may have required non-cancelable purchase commitments or advance payments from us, and those obligations and commitments could reduce our ability to adjust our inventory or expense levels to declining market demands. Unexpected decline in customer demands can result in excess or obsolete inventory and result in additional charges.  Because certain of our sales, research and development and internal manufacturing overhead expenses are relatively fixed, a reduction in customer demand likely would decrease our gross margins and operating income.   

We May Encounter Increased Competition

We may encounter substantial competition from other companies in the same market, including established companies with significant resources. Some of our competitors may have financial, technical, marketing or other capabilities that are more extensive than ours.  They may be able to respond more quickly than we can to new or emerging technologies and other competitive pressures. We may not be able to compete successfully against our present or future competitors.  Our failure to effectively compete could have a material adverse effect on our business, results of operations or financial condition.

There Are Limitations on the Protection of Our Intellectual Property and We May From Time to Time be Involved in Costly Intellectual Property Litigation or Indemnification

We rely on a combination of trade secret, patent, copyright and trademark laws combined with employee confidentiality, noncompetition and nondisclosure agreements to protect our intellectual property rights. There can be no assurance that the steps taken by us will be adequate to prevent misappropriation of our technology or intellectual property. Furthermore, there can be no assurance that third-parties will not assert infringement claims against us in the future.

Asserting our intellectual property rights or defending against third-party claims could involve substantial expense.  In the event a third-party were successful in a claim that one of our processes infringed its proprietary rights, we could be required to pay substantial damages or royalties, or spend substantial amounts in order to obtain a license or modify processes so that they no longer infringe such proprietary rights.  Any such events could have a material adverse effect on our business, results of operations or financial condition.

A Significant Portion of Our Business is Dependent on Cyclical Industries

Our business is dependent on the demand for products produced by end-users of industrial lasers, optical communication products and components for 3D sensing. Many of these end-users are in industries that have historically experienced a highly cyclical demand for their products. As a result, demand for our products is subject to these cyclical fluctuations. Fluctuations in demand could have a material adverse effect on our business, results of operations or financial condition.

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Changes in Laws and Regulations Governing Data Privacy and Data Protection Could Have a Material Adverse Impact on our Business

We are subject to many data privacy, data protection, and data breach notification laws, including the European Union General Data Protection Regulation (“GDPR”), which became effective in May of 2018. While we have taken measures to assess the requirements of, and to comply with, the GDPR, as well as new and existing data-related laws and regulations of other jurisdictions, these measures may be challenged, including by authorities that regulate data-related compliance. We could incur significant expense in facilitating and responding to investigations, and if the measures we have taken prove to be inadequate, we could face fines, penalties or damages, and incur reputational harm, which could have a material adverse impact on our business.

Data Breach Incidents and Breakdown of Information and Communication Technologies Could Disrupt our Operations and Impact Our Financial Results

In the course of our business, we collect and store sensitive data, including intellectual property (both our own and that of our customers), as well as proprietary business information. We could be subject to service outages or breaches of security systems which may result in disruption, unauthorized access, misappropriation, or corruption of this information. Security breaches of our network or data, including physical or electronic break-ins, vendor service outages, computer viruses, attacks by hackers or similar breaches can create system disruptions, shutdowns, or unauthorized disclosure of confidential information. Although we have not experienced an incident, if we are unable to prevent such security or privacy breaches, our operations would be disrupted or we could suffer legal claims, loss of reputation, financial loss, property damage, or regulatory penalties because of lost or misappropriated information.

Global Economic Downturns May Adversely Affect Our Business, Operating Results and Financial Condition

Current and future conditions in the global economy have an inherent degree of uncertainty. As a result, it is difficult to estimate the level of growth or contraction for the global economy as a whole. It is even more difficult to estimate growth or contraction in various parts, sectors and regions of the economy, including industrial, military, optical communications, telecommunications, semiconductor, and medical and life science markets in which we participate. All aspects of our company forecast depend on estimates of growth or contraction in the markets we serve.  Thus, prevailing global economic uncertainties render estimates of future income and expenditures very difficult to make.

Global economic downturns may affect industries in which our customers operate. These changes could include decreases in the rate of consumption or use of our customers’ products. Such conditions could have a material adverse effect on demand for our customers’ products, and in turn, on demand for our products.

Adverse changes may occur in the future as a result of declining or flat global or regional economic conditions, fluctuations in currency and commodity prices, wavering confidence, capital expenditure reductions, unemployment, decline in stock markets, contraction of credit availability or other factors affecting economic conditions. For example, factors that may affect our operating results include disruption in the credit and financial markets in the United States, Europe and elsewhere, adverse effects of slowdowns in the European and Chines economies, slowdown in the Chinese economy, reductions or limited growth in consumer spending or consumer credit, global trade tariffs and other adverse economic conditions that may be specific to the Internet, e-commerce and payments industries.

These changes may negatively affect sales of products and increase exposure to losses from bad debt and commodity prices, the cost and availability of financing, and costs associated with manufacturing and distributing products. Any economic downturn could have a material adverse effect on our business, results of operations or financial condition.

We Are Subject to Complex and Rapidly Changing Governmental Import and Export Regulations

We are subject to the passage of and changes in the interpretation of regulation by U.S. government entities at the federal, state and local levels and non-U.S. agencies, including, but not limited to, the following:

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Failure to comply with any of these laws and regulations could result in civil and criminal, monetary and non-monetary penalties, disruptions to our business, limitations on our ability to import and export products and services and damage to our reputation.

Changes in U.S. Trade Policies Could Impact the Company’s International Operations and the Cost of Imported Goods into the U.S., Which May Narrow the Size of Our Markets, Materially Impact Our Revenues or Increase Our Operating Costs and Expose Us to Contract Litigation

On March 23, 2018, President Trump announced new steel and aluminum tariffs, and on April 15, 2018, the U.S. Department of Commerce issued a denial order against two companies in the telecommunications market. Other international trade actions and initiatives also have been announced, notably the imposition by the U.S. of additional tariffs on products of Chinese origin, and China’s imposition of additional tariffs on U.S.-origin goods. If we cannot obtain relief from, or if we cannot take other action to mitigate the impact of, these additional duties, our business and profits may be materially and adversely affected. Further changes in U.S. trade policy, or additional sanctions, could result in retaliatory actions by other countries that could materially and negatively impact the volume of economic activity in the U.S., which, in turn, may decrease our access to customers and markets, reduce our revenues, and increase our operating costs.

We Have Entered into Supply Agreements which Commit Us to Supply Products on Specified Terms

We have supply agreements with some customers which require us to supply products and to allocate sufficient capacity to make these products.  We have also agreed to pricing schedules and methodologies which could result in penalties if we fail to meet development, supply, capacity and quality commitments.  Failure to do so may cause us to be unable to generate the amount of revenue or the level of profitability we expect from these arrangements.  Our ability to realize a profit under some of these agreements will be subject to the level of customer demand, the cost of maintaining facilities and manufacturing capacity, and supply chain capability.

If we fail to fulfill our commitments under these supply agreements, our business, after using all remedies available, financial conditions and results of operations may suffer a material adverse effect.

We Depend on Highly Complex Manufacturing Processes That Require Feeder Materials, Components and Products from Limited Sources of Supply

Our operations are dependent upon a supply chain of difficult-to-make or difficult-to-refine products and materials.  Some of our product inflow is subject to yield reductions from growth or fabrication losses, and thus the quantities we may receive are not consistently predictable.  Customers may also change the specification for a product that our suppliers cannot meet.

We also make products for which the Company is one of the world’s largest suppliers.  We use high-quality, optical grade ZnSe in the production of many of our IR optical products. We are a leading producer of ZnSe for our internal use and for external sale. The production of ZnSe is a complex process requiring a highly controlled environment. A number of factors, including defective or contaminated materials, could adversely affect our ability to achieve acceptable manufacturing yields of high quality ZnSe. Lack of adequate availability of high quality ZnSe could have a material adverse effect upon our business. There can be no assurance that we will not experience manufacturing yield inefficiencies which could have a material adverse effect on our business, results of operations or financial condition.

We produce hydrogen selenide gas which is used in our production of ZnSe. There are risks inherent in the production and handling of such material. Our lack of proper handling of hydrogen selenide could require us to curtail our production of hydrogen selenide. Our potential inability to internally produce hydrogen selenide could have a material adverse effect on our business, results of operations or financial condition.

In addition, we produce and use other high purity and relatively uncommon materials and compounds to manufacture our products including, but not limited to, ZnS, GaAs, Yttrium Aluminum Garnet, Yttrium Lithium Fluoride, Calcium Fluoride, Germanium, Selenium, Telluride, Bismuth Telluride and SiC. A significant failure of our internal production processes or our suppliers to deliver sufficient quantities of these necessary materials on a timely basis could have a material adverse effect on our business, results of operations or financial condition.

Our Global Operations Are Subject to Complex Legal and Regulatory Requirements

We manufacture products in the United States, China, Singapore, Vietnam, the Philippines, Germany, Switzerland, and the United Kingdom and through a contract manufacturer in Thailand.  We also maintain direct sales offices in Hong Kong, Japan, Germany, China, Switzerland, Belgium, the United Kingdom, Italy, South Korea and Taiwan.  Operations outside of the United States are subject to many legal and regulatory requirements, some of which are not aligned with others.  These include tariffs, quotas, taxes and other market barriers, restrictions on the export or import of technology, potentially limited intellectual property protection, customs

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import and export requirements, anti-corruption and anti-bribery laws, foreign exchange controls and cash repatriation restrictions, foreign investment rules and regulations, data privacy requirements, anti-competition laws, employment and labor laws, pensions and social insurance,  and environmental health, and safety laws and regulations.

Compliance with these laws and regulations can be onerous and expensive, and requirements differ among jurisdictions.  New laws, changes in existing laws and abrogation of local regulations by national laws result in significant uncertainties in how they will be interpreted and enforced. Failure to comply with any of these foreign laws and regulations could have a material adverse effect on our business, results of operations or financial condition.

We Use and Generate Potentially Hazardous Substances that Are Subject to Stringent Environmental Regulations

Hazardous substances used or generated in some of our research and manufacturing facilities are subject to stringent environmental regulation. We believe that our handling of such substances is in material compliance with applicable local, state and federal environmental, safety and health regulations at each operating location. We invest substantially in proper personal protective equipment, process controls including monitoring and specialized training to minimize risks to employees, surrounding communities and the environment that could result from the presence and handling of such hazardous substances. When exposure problems or potential exposure problems have been uncovered, corrective actions have been implemented and re-occurrence has been minimal or non-existent.

We have in place an emergency response plan with respect to our generation and use of the hazardous substances Hydrogen Selenide, Hydrogen Sulfide, Arsine and Phosphine. Special attention has been given to all procedures pertaining to this gaseous material to minimize the chances of its accidental release into the atmosphere.

With respect to the manufacturing, use, storage and disposal of the low-level radioactive material Thorium Fluoride, our facilities and procedures have been inspected and licensed by the Nuclear Regulatory Commission. Thorium-bearing by-products are collected and shipped as solid waste to a government-approved low-level radioactive waste disposal site in Clive, Utah.

The generation, use, collection, storage and disposal of all other hazardous by-products, such as suspended solids containing heavy metals or airborne particulates, are believed by us to be in material compliance with regulations. We believe that we have obtained all of the permits and licenses required for operation of our business.

We do not carry environmental impairment insurance. Although we do not know of any material environmental, safety or health problems in our properties or processes or products, there can be no assurance that problems will not develop in the future which could have a material adverse effect on our business, results of operations or financial condition.

We May Be Adversely Affected by Climate Change Regulations

In many of the countries in which we operate, government bodies are increasingly enacting legislation and regulations in response to potential impacts of climate change. These laws and regulations may be mandatory. They have the potential to impact our operations directly or indirectly as a result of required compliance by our customers or our supply chain. Inconsistency of regulations may also affect the costs of compliance with such laws and regulations. Assessments of the potential impact of future climate change legislation, regulation and international treaties and accords are uncertain, given the wide scope of potential regulatory change in countries in which we operate.

We may incur increased capital expenditures resulting from required compliance with revised or new legislation or regulations, added costs to purchase or lower profits from sales of our products, allowances or credits under a “cap and trade” system, increased insurance premiums and deductibles as new actuarial tables are developed to reshape coverage, a change in competitive position relative to industry peers, and changes to profit or loss arising from increased or decreased demand for goods produced by us and indirectly, from changes in costs of goods sold.

Some Systems That Use our Products Are Complex in Design, and Our Products May Contain Defects that Are Not Detected Until Deployed Which Could Increase Our Costs, Reduce Our Revenues, Cause Us to Lose Key Customers and May Expose Us to Litigation Arising From Derivative Lawsuits Related to Consumer Products

Some systems that use our products are inherently complex in design and require ongoing maintenance. Our customers may discover defects in our products after the products have been fully deployed and operated under peak stress conditions. In addition, some of our products are combined with products from other vendors which may contain defects. Should problems occur, it may be difficult to identify the source of the problem. If we are unable to correct defects or other problems, we could experience, among other things loss of customers, increased costs of product returns and warranty expenses, damage to our brand reputation, failure to attract new customers or achieve market acceptance, diversion of development and engineering resources, or legal action by our customers.

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The occurrence of any one or more of the foregoing factors could have a material adverse effect on our business, results of operations or financial condition.

Unfavorable Changes in Tax Rates, Tax Liabilities or Tax Accounting Rules Could Negatively Affect Future Results

As a global company, we are subject to taxation in the United States and various other countries and jurisdictions. As such, we must exercise a level of judgment in determining our worldwide tax liabilities. Our future tax rates could be affected by changes in the composition of earnings in countries with differing tax rates or changes in tax laws. Changes in tax laws or tax rulings may have a significantly adverse impact on our effective tax rate. For example, proposals for fundamental U.S. international tax reform, if enacted, could have a significant adverse impact on our effective tax rate.

The enactment of the Tax Cuts and Jobs Act (the “Act”) in December 2017 significantly affected U.S. tax law by changing how the U.S. imposes tax on multinational corporations. The U.S. Department of Treasury has broad authority under the Act to issue regulations and interpretive guidance. We have applied available guidance to estimate our tax obligations, but new guidance issued by the U.S. Treasury Department may cause us to make adjustments to our tax estimates in future periods. The Securities and Exchange Commission has issued Staff Accounting Bulletin No. 118 (“SAB 118”) acknowledging that companies will potentially encounter situations for which the analysis of certain income tax effects of the Act will be incomplete by the time financial statements are required to be issued for reporting periods that include the enactment date. In these situations, SAB 118 provides that reasonable estimates may be made for certain effects of the Act. We have recorded provisional amounts using reasonable estimates based on the guidance in SAB 118 and we anticipate adjustments to such estimates as additional analysis is completed and new regulations and guidance are issued.

In addition, we are subject to regular examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of favorable or unfavorable outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Although we believe our tax estimates are reasonable, there can be no assurance that any final determination will not be materially different than the treatment reflected in our historical income tax provision and accruals, which could materially and adversely affect our business, results of operation or financial condition.

Increases in Commodity Prices May Adversely Affect Our Results of Operations and Financial Condition

We are exposed to a variety of market risks, including the effects of increases in commodity prices. Our businesses purchase, produce and sell high-purity selenium and other raw materials based upon quoted market prices from minor metal exchanges. The negative impact from increases in commodity prices may not be recovered through our product sales which could have a material adverse effect on our net earnings and financial condition.

Natural Disasters or Other Global or Regional Catastrophic Events Could Disrupt Our Operations, Give Rise to Substantial Environmental Hazards and Adversely Affect Our Results

We may be exposed to business interruptions due to catastrophe, natural disaster, pandemic, terrorism or acts of war that are beyond our control. Disruptions to our facilities or systems, or to those of our key suppliers, could also interrupt operational processes and adversely impact our ability to manufacture our products and provide services and support to our customers. As a result, our business, results of operations or financial condition could be materially adversely affected.

Our Success Depends on Our Ability to Attract, Retain and Develop Key Personnel and Requires Continued Good Relations With Our Employees

We are highly dependent upon the experience and continuing services of certain scientists, engineers, production and management personnel. Competition for the services of these personnel is intense.  There can be no assurance that we will be able to retain or attract the personnel necessary for our success. The loss of the services of our key personnel could have a material adverse effect on our business, results of operations or financial condition.

Our Stock Price Has Been Volatile in the Past and May Be Volatile in the Future

The market price for our common stock on The Nasdaq Global Select Market varied between a high of $53.08 and a low of $34.00 in the fiscal year ended June 30, 2018. We expect that this volatility will continue. Factors that could cause fluctuation in our stock price include, among other things, general economic and market conditions, actual or anticipated variations in operating results, changes in financial estimates by securities analysts, our inability to meet or exceed securities analysts’ estimates or expectations, conditions or trends in the industries in which our products are purchased, announcements by us or our competitors of significant acquisitions, strategic partnerships, divestitures, joint ventures or other strategic initiatives, capital commitments, additions or departures of key personnel,  sales of our common stock or equity-linked securities and issuance of shares of our common stock in connection with conversions of our outstanding convertible senior notes.

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Many of these factors are beyond our control. However, these factors could cause the market price of our common stock to decline, regardless of our actual operating performance. In addition, in recent years, the stock market in general, and The Nasdaq Stock Market and the securities of technology companies in particular, have experienced extreme price and volume fluctuations. These fluctuations have often been unrelated or disproportionate to the operating performance of individual companies. These broad market fluctuations have in the past, and may in the future, materially and adversely affect our stock price, regardless of our operating results. This volatility may affect the price at which our shareholders can sell our common stock.

Some Anti-takeover Provisions Contained in Our Articles of Incorporation and By-laws, as Well as Provisions of Pennsylvania Law, Could Impair a Takeover Attempt, Which Could Also Reduce the Market Price of Our Common Stock

Our articles of incorporation and by-laws contain provisions that could make us a less attractive target for a hostile takeover and could make more difficult or discourage a merger proposal, a tender offer or a proxy contest. Such provisions include:

In addition, the Pennsylvania Business Corporation Law (the “BCL”) contains provisions that may have the effect of delaying or preventing a change in control of us or changes in our management. Many of these provisions are triggered if any person or group acquires, or discloses intent to acquire, 20% or more of a corporation’s voting power, subject to certain exceptions. These provisions:

Regardless of the amount of a person’s holdings, if a shareholder or shareholder group (including affiliated persons) would be a party to certain proposed transactions with us or would be treated differently from other shareholders of ours in certain proposed transactions, the BCL requires approval by a majority of votes entitled to be cast by all shareholders other than the interested shareholder or affiliate group, unless the transaction is approved by independent directors or other criteria are satisfied. Furthermore, under the BCL, a “short-form” merger of II-VI cannot be implemented without the consent of our board of directors.

In addition, as permitted by Pennsylvania law, an amendment to our articles of incorporation or other corporate action that is approved by shareholders may provide mandatory special treatment for specified groups of non-consenting shareholders of the same class. For example, an amendment to our articles of incorporation or other corporate action may provide that shares of common stock held by designated shareholders of record must be cashed out at a price determined by the corporation, subject to applicable dissenters’ rights.

Furthermore, the BCL provides that directors may, in discharging their duties, consider, to the extent they deem appropriate, the effects of any action upon shareholders, employees, suppliers, customers and the communities in which its offices are located. Directors are not required to consider the interests of shareholders to a greater degree than other constituencies’ interests. The BCL expressly provides that directors do not violate their fiduciary duties solely by relying on “poison pills” or the anti-takeover provisions of the BCL. We do not currently have a “poison pill.”  

All of these provisions may limit the price that investors may be willing to pay for shares of our common stock.

Because We Do Not Currently Intend to Pay Dividends, Holders of Our Common Stock Will Benefit from an Investment in Our Common Stock Only If It Appreciates in Value, and by the Intended Anti-Dilution Actions of Our Share-Buyback Program

We have never declared or paid any dividends on our common stock, and do not expect to pay cash dividends in the foreseeable future.  We currently anticipate that we will retain any future earnings to support operations and to finance the development of our business. As a result, the success of an investment in our common stock will depend entirely upon future appreciation in its value. There is no guarantee that our common stock will maintain its value or appreciate in value.  

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None.

Information regarding our principal U.S. properties at June 30, 2018 is set forth below:

We also maintain some additional small research and development, distribution, and administrative facilities in leased space in the United States.

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Information regarding our principal foreign properties at June 30, 2018 is set forth below:

We also maintain some additional small distribution facilities in leased space in Belgium, Italy, Japan, South Korea, Taiwan, and the United Kingdom.

The square footage listed for each of the above properties represents facility square footage, except in the case of the Philippines location, which includes land.

The Company and its subsidiaries are involved in various claims and lawsuits incidental to its business. The resolution of each of these matters is subject to various uncertainties, and it is possible that these matters may be resolved unfavorably to the Company. Management believes, after consulting with legal counsel, that the ultimate liabilities, if any, resulting from such legal proceedings will not materially affect the Company’s financial condition, liquidity or results of operations.

Not applicable.

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PART II

The Company’s common stock is traded on the Nasdaq Global Select Market (“Nasdaq”) under the symbol “IIVI.” The following table sets forth the range of high and low trading prices per share of the Company’s common stock for the fiscal periods indicated, as reported by Nasdaq.  

On August 22, 2018, the last reported sale price for the Company’s common stock was $47.15 per share. As of such date, there were approximately 806 holders of record of our common stock. The Company historically has not paid cash dividends and does not presently anticipate paying cash dividends in the future.

ISSUER PURCHASES OF EQUITY SECURITIES

In August 2017, in conjunction with the Company’s offering and sale of our outstanding convertible notes, the Company’s Board of Directors authorized the Company to purchase up to $50 million of its common stock with a portion of the net proceeds received from the offering and sale of the Notes. The shares that were purchased by the Company pursuant to this authorization were retained as treasury stock and are available for general corporate purposes. The Company purchased 1,414,900 shares of its common stock for approximately $49.9 million pursuant to this authorization.

In August 2014, the Company’s Board of Directors authorized the Company to purchase up to $50 million of its 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 are available for general corporate purposes. As of June 30, 2018, the Company has cumulatively purchased 1,316,587 shares of its common stock pursuant to the Program for approximately $19.0 million. The dollar value of shares as of June 30, 2018 that may yet be purchased under the Program is approximately $31.0 million.

The following table provides information with respect to purchases of the Company’s equity securities during the quarter ended June 30, 2018.

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The information incorporated by reference in Item 12 of this Annual Report on Form 10-K, from our 2018 Proxy Statement under the heading “Equity Compensation Plan Information,” is hereby also incorporated by reference into this Item 5.

PERFORMANCE GRAPH

The following graph compares cumulative total shareholder return on the Company’s common stock with the cumulative total shareholder return of the Nasdaq Composite Index and with a peer group of companies constructed by the Company for the period from June 30, 2013, through June 30, 2018. The Company’s current fiscal year peer group includes Cabot Microelectronics Corporation, Franklin Electric Co., Inc., MKS Instruments, Inc., Silicon Laboratories, Lumentum Holdings Inc., Finisar Corp, Coherent, Inc. and Corning Inc.

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Five-Year Financial Summary

The following selected financial data for the five fiscal years presented are derived from the Company’s audited Consolidated Financial Statements. The data should be read in conjunction with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K.

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Forward-Looking Statements

Certain statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements. Forward-looking statements are also identified by words such as “expects,” “anticipates,” “believes,” “intends,” “plans,” “projects” or similar expressions. Actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including those potential risks set forth in Item 1A, of this Annual Report on Form 10-K, which are incorporated herein by reference.

Overview

II-VI Incorporated (“II-VI,” the “Company,” “we,” “us” or “our”), a worldwide leader in engineered materials and optoelectronic components, is a vertically integrated manufacturing company that develops innovative products for diversified applications in the industrial materials processing, optical communications, military, consumer electronics, semiconductor equipment, life science and automotive applications . The Company produces a wide variety of application-specific photonic and electronic materials and components, and deploys them in various forms, including integration with advanced software.

The Company generates revenues, earnings and cash flows from developing, manufacturing and marketing engineered materials and optoelectronic components and devices for precision use in industrial materials processing, optical communications, consumer electronics, semiconductor equipment, life sciences and automotive applications. We also generate revenue, earnings and cash flows from government funded research and development contracts relating to the development and manufacture of new technologies, materials and products.

Our customer base includes OEMs, laser end-users, system integrators of high-power lasers, manufacturers of equipment and devices for the industrial, optical communications, military, semiconductor, medical and life science markets, consumer, U.S. government prime contractors, various U.S. Government agencies and thermoelectric integrators.

As we grow, we are focused on scaling our Company and deriving the benefits of vertical integration as we strive to be a best in class competitor in all of our highly competitive markets. The Company may elect to change the way in which the Company operates or is organized in the future to enable the most efficient implementation of its strategy.

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) 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 1 of the Notes to our Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K describes the significant accounting policies and accounting methods used in the preparation of the Company’s Consolidated Financial Statements. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

Management believes the Company’s critical accounting estimates are those related to revenue recognition, inventory valuation, business combinations, impairment of goodwill and indefinite-lived intangible assets, accrual of income taxes and accounting for share-based compensation. Management believes these estimates to be critical because they are both important to the portrayal of the Company’s financial condition and results of operations, and they require management to make judgments and estimates about matters that are inherently uncertain.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors and the Audit Committee has reviewed the related disclosure. In addition, there are other items within our consolidated financial statements that require estimation, but are not deemed critical as described above. Changes in estimates used in these and other items could have a material impact on the consolidated financial statements.

Revenue Recognition

Revenues for product shipments are realizable when we have persuasive evidence of a sales arrangement, the product has been shipped or delivered, the sales price is fixed or determinable and collectability is reasonably assured. Title and risk of loss passes from the Company to its customer at the time of shipment in most cases, with the exception of certain customers for whom customer’s title does not pass and revenue is not recognized until the customer has received the product at its physical location.

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The Company’s revenue recognition policy is consistently applied across the Company’s segments, product lines and geographical locations. Further, for the periods covered herein, we did not have post shipment obligations such as training or installation, customer acceptance provisions, credits and discounts, rebates and price protection or other similar privileges. Our distributors and agents are not granted price protection. Our distributors and agents, who generate less than 10% of consolidated revenue, have no additional product return rights beyond the right to return defective products covered by our warranty policy. We believe that our revenue recognition practices are consistent with Staff Accounting Bulletin 104 and that we have adequately considered the requirements of Accounting Standards Codification 605 Revenue Recognition. Revenues generated from transactions other than product shipments are contract-related and have historically accounted for approximately 1% of the Company’s consolidated revenues.

Inventory

The Company generally records an inventory adjustment as a charge against earnings for all products on hand for more than 12 to 24 months, depending on the products that have not been sold to customers or cannot be further manufactured for sale to alternative customers. An additional charge may be recorded for products on hand that are in excess of product sold to customers over the same periods noted above. If actual market conditions are less favorable than projected, additional inventory adjustments may be required. The Company’s inventory adjustments have historically been proven to be materially correct based upon actual write-offs incurred.

Business Acquisitions

The Company accounts for business acquisitions by establishing the acquisition-date fair value as the measurement for all assets acquired and liabilities assumed. Certain provisions of U.S. GAAP prescribe, among other things, the determination of acquisition-date fair value of consideration paid in a business combination (including contingent consideration) and the exclusion of transaction and acquisition-related restructuring costs from acquisition accounting.

Goodwill and Indefinite-Lived Intangibles

The Company tests goodwill and indefinite-lived intangible assets for impairment annually, and when events or changes in circumstances indicate that goodwill or indefinite-lived intangible assets might be impaired. Other intangible assets are amortized over their estimated useful lives. The determination of the estimated useful lives of other intangible assets and whether goodwill or indefinite-lived intangibles are impaired requires us to make judgments based on long-term projections of future performance. Estimates of fair value are based on our projection of revenues, operating costs and cash flows of each reporting unit, considering historical and anticipated results and general economic and market conditions and their projections. The fair values of the reporting units are determined using a discounted cash flow analysis based on historical and projected financial information as well as market analysis. The annual goodwill impairment analysis considers the financial projections of the reporting unit based on our most recently completed long-term strategic planning processes and also considers the current financial performance compared to our prior projections of the reporting unit. Changes in our internal structuring, financial performance, judgments and projections could result in an impairment of goodwill or indefinite-lived intangible assets. As of June 30, 2018, no reporting units are at risk for impairment, as the fair value of the reporting units substantially exceeds the carrying values.

The Company has the option to perform a qualitative assessment of goodwill prior to completing the quantitative assessment described above, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the quantitative assessment. Otherwise, the Company will forego the quantitative assessment process and does not need to perform any further testing. The Company did not use the optional qualitative assessment during the years ended June 30, 2018 and 2017.

As a result of the purchase price allocations from our acquisitions, and due to our decentralized structure, our goodwill is included in multiple reporting units which are the same as the Company’s operating segments. Due to the cyclical nature of our business, and the other factors described in the section on Risk Factors set forth in Item 1A of this Annual Report on Form 10-K, the profitability of our individual reporting units may periodically be affected by downturns in customer demand, operational challenges and other factors. These factors may have a relatively more pronounced impact on the individual reporting units as compared to the Company as a whole, and might adversely affect the fair value of the individual reporting units. If material adverse conditions occur that impact one or more of our reporting units, our determination of future fair value might not support the carrying amount of one or more of our reporting units, and the related goodwill would need to be impaired. Based upon our annual quantitative goodwill and indefinite-lived intangible assets impairment tests, the Company did not record any impairments of goodwill or indefinite-lived intangible assets for the fiscal year ended June 30, 2018.

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0.25% Convertible Senior Notes

Our 0.25% convertible senior notes are accounted for in accordance with ASC 470, Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement). ASC Subtopic 470-20 requires the issuer of convertible debt that may be settled in shares or cash upon conversion at the issuer’s option, such as these notes, to account for the liability (debt) and equity (conversion option) components separately. The value assigned to the debt component is the estimated fair value as of the issuance date of a similar debt instrument without the conversion option. The amount of the equity component is calculated by deducting the fair value of the liability component from the principal amount of the convertible debt instrument. The resulting debt discount is amortized as additional non-cash interest expense over the expected life of the notes utilizing the effective interest method. Although ASC 470 has no impact on our actual past or future cash flows, it requires us to record non-cash interest expense as the debt discount is amortized.

Income Taxes

The Company prepares and files tax returns based on its interpretation of tax laws and regulations and records estimates based on these judgments and interpretations. In the normal course of business, the Company’s tax returns are subject to examination by various taxing authorities, which may result in future tax, interest and penalty assessments by these authorities. Inherent uncertainties exist in estimates of many tax positions due to changes in tax law resulting from legislation, regulation and/or as concluded through the various jurisdictions’ tax court systems. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The amount of unrecognized tax benefits is adjusted for changes in facts and circumstances. For example, adjustments could result from significant amendments to existing tax law and the issuance of regulations or interpretations by the taxing authorities, new information obtained during a tax examination, or resolution of an examination. The Company believes that its estimates for uncertain tax positions are appropriate and sufficient to pay assessments that may result from examinations of its tax returns. The Company recognizes both accrued interest and penalties related to unrecognized tax benefits in income tax expense.

Management evaluates the realizability of deferred tax assets for each jurisdiction in which it operates. If the Company experiences cumulative pretax income in a particular jurisdiction in a three-year period including the current and prior two years, management normally concludes that the income tax assets will more likely than not be realizable and no valuation allowance is recognized, unless known or planned operating developments, or changes in tax laws, would lead management to conclude otherwise. However, if the Company experiences cumulative pretax losses in a particular jurisdiction in a three year period, management then considers a series of factors in the determination of whether the deferred tax assets can be realized. The Company has recorded valuation allowances against certain of its deferred tax assets, primarily those that have been generated from net operating losses in certain foreign taxing jurisdictions and acquired U.S. carryforwards. In evaluating whether the Company would more likely than not recover these deferred tax assets, it has not assumed any future taxable income or tax planning strategies in the jurisdictions associated with these carry-forwards where history does not support such an assumption. Implementation of tax planning strategies to recover these deferred tax assets or future income generation in these jurisdictions could lead to the reversal of these valuation allowances and a reduction of income tax expense.

Share-Based Compensation

The Company recognizes share-based compensation expense over the requisite service period of the individual grantees, which generally equals the vesting period. The Company utilizes the Black-Scholes valuation model for estimating the fair value of share-based equity expense, using assumptions such as the risk-free interest rate, expected stock price volatility, expected stock option life and expected dividend yield. The risk-free interest rate is derived from the average U.S. Treasury Note rate during the period, which approximates the rate in effect at the time of grant related to the expected life of the options. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the options. The expected life calculation is based on the observed time to post-vesting exercise and/or forfeitures of options by our employees. The dividend yield is zero, based on the fact the Company has never paid cash dividends and has no current intention to pay cash dividends in the future.

Fiscal Year 2018 Compared to Fiscal Year 2017

The Company aligns its organizational structure into the following three reporting segments for the purpose of making operational decisions and assessing financial performance: (i) II-VI Laser Solutions, (ii) II-VI Photonics, and (iii) II-VI Performance Products. The Company is reporting financial information (revenue through operating income) for these reporting segments in this Annual Report on Form 10-K.

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The following table sets forth select items from our Consolidated Statements of Earnings for the years ended June 30, 2018 and June 30, 2017 ($ in millions except per share information):

Executive Summary

Net earnings for fiscal year 2018 were $88.0 million ($1.35 per-share diluted), compared to $95.3 million ($1.48 per-share diluted) for the same period last fiscal year. The decrease in net earnings during current fiscal year from fiscal year 2017 was primarily driven by provisions under the Act and the Company’s related actions.  Under the Act, the Company’s effective tax rate for fiscal year 2018 was 28.0% compared to 19.8% in fiscal year 2017; the Company recorded an additional $8.0 million of income tax expense, primarily relating to withholding taxes on future repatriation of foreign earnings.  The Company also increased its investment in internal research and development relating to its new optoelectronic laser platform with the acquisition of Kaiam Laser Limited, and it ramped up its investment in other operations to address market shifts to new technologies driven by advanced engineered materials.  Fiscal year 2017 was favorably impacted by other income relating to earn-out and technology transfer income the Company received as part of the sale of the RF business of ANADIGICS.  The Company recognized $7.0 million or $0.09 per share diluted of other income related to these transactions in fiscal year 2017.

Consolidated

Revenues. Revenues for the year ended June 30, 2018 increased 19% to $1,158.8 million, compared to $972.0 million for the prior fiscal year. The increase in revenues during the current fiscal year was driven by strong demand from customers across all of the Company’s business segments.  In particular, II-VI Laser Solution realized a 26% revenue growth from the prior year, driven by increased demand from industrial based customers for CO₂, fiber and direct diode optics and components.  This segment also recorded increased shipments of its VCSELs products addressing the growing consumer electronics, datacom and other developing end markets.  II-VI Performance Products recorded a 24% revenue increase during the current fiscal year, driven by strengthening demand for SiC substrate products addressing RF electronics and high-power switching and power conversion systems for automotive, communication and military markets.

Gross margin. Gross margin for the year ended June 30, 2018 was $461.3 million, or 39.8%, of total revenues, compared to $388.3 million, or 39.9%, of total revenues for the same period last fiscal year. Gross margin as a percentage of revenues was consistent with the prior fiscal year due to a balance of operating efficiencies and investments to expand capacity. The Company’s II-VI Photonic’s gross margin was negatively impacted by both product mix and the effects of foreign currency.

Internal research and development. Company-funded internal research and development (“IR&D”) expenses for the fiscal year ended June 30, 2018 were $117.2 million, or 10.1% of revenues, compared to $96.8 million, or 10.0% of revenues, last fiscal year. The increase in IR&D expenses is primarily the result of the current year acquisition of Kaiam Laser Limited, acquired in August 2017, which contributed $14.6 million of expense.  The Company continues to ramp its investment in new material-based technologies addressing growing market trends in consumer electronics, communications and automotive markets.  

Selling, general and administrative. Selling, general and administrative (“SG&A”) expenses for the year ended June 30, 2018 were $208.8 million, or 18.0% of revenues, compared to $176.0 million, or 18.1% of revenues, last fiscal year. SG&A expenses includes $3.7 million and $2.5 million, respectively, for the combined acquisitions of II-VI Integrated Photonics Inc. (“IPI”), acquired in June 2017, and Kaiam Laser Limited, acquired in August 2017.  Exclusive of these acquisitions, the increase in SG&A is primarily due to increased operating costs to support the Company’s growing revenue and infrastructure base, as well as its ongoing merger and acquisition strategy. The Company is working to identify and capitalize on synergies created from the Company’s recent acquisitions and is working to improve the SG&A leverage in the upcoming fiscal 2019 and beyond.

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Interest and other, net. Interest and other, net for the year ended June 30, 2018 was expense of $13.1 million compared to income of $3.3 million last fiscal year. Included in interest and other, net were interest expense on long-term borrowings, earnings from equity investments, interest income on excess cash reserves, unrealized gains and losses on the Company’s deferred compensation plan, and foreign currency gains and losses. Interest expense increased $11.5 million due to the higher levels of the Company’s outstanding debt. The majority of the interest expense increase was related to the Company’s $345.0 million convertible debt issued in August 2017. The Company recognized $10.8 million of interest and amortization of debt discounts and issuance costs. Other income last fiscal year included approximately $7.0 million of income from earn-out and technology transfer agreements from the Company’s sale of its ANADIGICS’ RF business.

Income taxes. The Company’s year-to-date effective income tax rate at June 30, 2018 was 28.0%, compared to an effective tax rate of 19.8% last fiscal year. The variation between the Company’s effective tax rate and the U.S. statutory rate was primarily due to the Company’s foreign operations, which are subject to income taxes at lower statutory rates. The increase in the current fiscal year’s effective tax rate is the result of approximately $8.0 million of increased income tax expense relating to repatriation on foreign source earnings.

Segment Reporting

Revenues and operating income for each of the Company’s reportable segments are discussed below. Operating income differs from income from operations in that operating income excludes certain operational expenses included in other expense (income) – net, as reported. Management believes operating income to be a useful measure for investors, as it reflects the results of segment performance over which management has direct control and is used by management in its evaluation of segment performance. See “Note 12. Segment and Geographic Reporting,” to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information on the Company’s reportable segments and for the reconciliation of operating income to net earnings, which is incorporated herein by reference.

II-VI Laser Solutions ($ in millions)

The Company’s II-VI Laser Solutions segment includes the combined operations of II-VI Infrared Optics, II-VI HIGHYAG, II-VI Laser Enterprise, II-VI Laser Systems Group, II-VI OED, II-VI EpiWorks, and Kaiam Laser Limited (now operating under II-VI Compound Semiconductors, Ltd.). The Company acquired II-VI Compound Semiconductors, Ltd. in August 2017.

Revenues for the fiscal year ended June 30, 2018 for II-VI Laser Solutions increased 26% to $428.0 million, compared to revenues of $339.3 million last fiscal year. The increase in revenues during the current fiscal year was the result of increased demand from industrial based customers for the Company’s CO₂, fiber and direct diode laser optics and components.  In addition, the segment has also seen increased demand for its CVD diamond optics used in the EUV lithography markets, as well as VCSELs used in consumer electronics, datacom and other end markets.

Operating income for the fiscal year ended June 30, 2018 for II-VI Laser Solutions increased 19% to $36.8 million, compared to $30.9 million last fiscal year. The increase in operating income during the current fiscal year was the result of incremental margins realized from increased capacity utilization, increase in mix of higher margin products, offset somewhat by greater investment in growth markets.

II-VI Photonics ($ in millions)

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The Company’s II-VI Photonics segment includes the combined operations of II-VI Photop and II-VI Optical Communications. The above operating results for the year ended June 30, 2018 include the Company’s recent acquisition of IPI which was acquired in June 2017.

Revenues for the year ended June 30, 2018 for II-VI Photonics increased 11% to $464.4 million, compared to $418.5 million for last fiscal year. Included in the current year’s revenues were $19.3 million of revenues from the above acquisition.  Exclusive of IPI, the increase in revenues was primarily attributed to increased demand of optics and optic assemblies for applications for industrial laser products.  In addition, the segments realized increase demand for transport and amplification component products, including its 980 nm pumps.

Operating income for the year ended June 30, 2018 for II-VI Photonics increased 7% to $67.7 million, compared to an operating income of $63.0 million last fiscal year. The increase in operating income was primarily due to incremental margin realized on increased revenues but significantly offset by mix shifts and negative foreign exchange effects.  

II-VI Performance Products ($ in millions)

The Company’s II-VI Performance Products segment includes the business units of II-VI Marlow, II-VI M Cubed, II-VI Advanced Materials, II-VI Optical Systems and II-VI Performance Metals.

Revenues for the year ended June 30, 2018 for II-VI Performance Products increased 24% to $266.4 million, compared to $214.2 million for last fiscal year. The increase in revenues during the current fiscal year was primarily driven by increased demand for SiC products addressing RF electronics and high-power switching and power conversion systems for automotive and communication markets.  In addition, the segment has seen increased demand for products and components for the semiconductor capital equipment and military markets. 

Operating income for the year ended June 30, 2018 for II-VI Performance Products increased 43% to $30.8 million, compared to $21.6 million for last fiscal year. The increase in operating income during the current fiscal year was primarily driven by incremental margin realized by increased sales volume, as well as favorable product mix toward higher margin products.

Fiscal Year 2017 Compared to Fiscal Year 2016

The following table sets forth select items from our Consolidated Statements of Earnings for the years ended June 30, 2017 and 2016. ($ millions, except per share information):

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Consolidated

Revenues. Revenues for the year ended June 30, 2017 increased 18% to $972.0 million, compared to $827.2 million for the fiscal year ended June 30, 2016. The Company had seen continued increased demand from the optical communications customer base as a result of the continuation of the China broadband initiative, datacenter and U.S. metro upgrade cycles (including cable television). In addition, the Company’s II-VI Laser Solutions segment saw increased demand for its products addressing CO₂, laser optics, one-micron laser and diamond optic products.   

Gross margin. Gross margin as a percentage of revenues for the year ended June 30, 2017 was $388.3 million or 39.9%, compared to $312.8 million or 37.8% for the fiscal year ended June 30, 2016. The improvement in gross margin was primarily driven by incremental margins realized on the Company’s higher revenue levels, which increased approximately $145.0 million from the prior year, as well as favorable product mix primarily in the II-VI Photonics segment.

Internal research and development. Company-funded internal research and development expenses for the year ended June 30, 2017 were $96.8 million, or 10.0% of revenues, compared to $60.4 million, or 7.3% of revenues, for the fiscal year ended June 30, 2016. The increase in internal research and development expense for fiscal year 2017 was the result of the Company’s continued investments in the development of the technology required to produce new optoelectronic devices in large volume for future applications, as well as new product introductions across the Company’s segments.

Selling, general and administrative. SG&A expenses for the fiscal year ended June 30, 2017 were $176.0 million, or 18.1% of revenues, compared to $160.6 million, or 19.4% of revenues, for the fiscal year ended June 30, 2016. The increase in SG&A in absolute dollars was the result of a higher revenue base requiring more SG&A support. The Company experienced favorable leverage as a result of capitalizing on synergies created from the Company’s acquisitions over the past several years.   

Interest and other, net. Interest and other, net for the year ended June 30, 2017 was income of $3.3 million compared to expense of $1.9 million for the year ended June 30, 2016. Included in interest and other, net were interest expense on borrowings, interest income on excess cash reserves, foreign currency gains and losses and contingent earnout and technology transfer income from the sale of the ANADIGICS RF business that occurred in June 2016. In particular, for the fiscal year ended June 30, 2017, other income consisted primarily of foreign currency gains of $1.3 million, income from the residual agreements on the sale of the RF business noted above of $7.0 million, and interest income of $0.9 million on the Company’s excess cash reserves, offset by interest expense of $6.8 million on outstanding borrowings. The fiscal year ended June 30, 2016 expense of $1.9 million included $3.1 million of interest expense on the Company’s outstanding borrowings, offset by $1.2 million of interest income on the Company’s excess cash reserves. The increase in interest expense in fiscal year 2017 was the result of higher levels of outstanding borrowings.

Income taxes. The Company’s year-to-date effective income tax rate at June 30, 2017 was 19.8%, compared to an effective tax rate of 27.3% for the fiscal year ended June 30, 2016. The variation between the Company’s effective tax rate and the U.S. statutory rate of 35% was primarily due to the Company’s foreign operations, which are subject to income taxes at lower statutory rates. The lower year-to-date effective tax rate was primarily driven by the reversal of certain valuation allowances triggered by the acquisition of IPI, which generated deferred tax liabilities that offset the previously reserved deferred tax asset.

II-VI Laser Solutions ($ in millions)

Revenues for the year ended June 30, 2017 for II-VI Laser Solutions increased 12% to $339.3 million, compared to $303.0 million for fiscal year ended June 30, 2016. Revenues included $24.0 million for fiscal 2017 and $13.9 million for fiscal year 2016, respectively, attributed to the acquisitions. Exclusive of acquisitions, the increase in revenues for the fiscal year ended June 30, 2017 was the result of higher demand for high- and low-power laser optics, one-micron laser applications, and semiconductor photolithography tools and precision optics in laser applications up to 1 kilowatt for marking and engraving.  

Operating income for the year ended June 30, 2017 for II-VI Laser Solutions decreased 15% to $30.9 million, compared to $36.2 million for fiscal year June 30, 2016. Operating income was impacted by the segment’s ongoing internal research and development investments for its new optoelectronic laser platform. During fiscal year 2017, this expense increased approximately $30.2 million over fiscal year 2016.

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II-VI Photonics ($ in millions)

Revenues for the year ended June 30, 2017 for II-VI Photonics increased 28% to $418.5 million, compared to $325.9 million for the fiscal year ended June 30, 2016. The Company realized increased revenues from the broadband China initiative as China continued expansion of its geographical broadband networks. In addition, increased market share gains in the datacenter communications market and undersea fiber optic networks and new product introductions fueled the higher revenues during the fiscal year ended June 30, 2017.

Operating income for the year ended June 30, 2017 for II-VI Photonics increased 67% to $63.0 million, compared to an operating income of $37.8 million for the fiscal year ended June 30, 2016. The increase in operating income was primarily due to incremental margin realized on the higher revenue volume as well as higher margin product mix, including terrestrial and submarine 980nm pumps and amplifiers, and new product introductions which have higher margin profiles.

II-VI Performance Products ($ in millions)

Revenues for the year ended June 30, 2017 for II-VI Performance Products increased 8% to $214.2 million, compared to $198.3 million for fiscal year June 30, 2016. The increase in revenues for the year ended June 30, 2017 was driven by continued growth in the 4G base station market which was expanding geographically. Revenue growth was also driven by increasing demand for 150mm power device products as the market entered the manufacturing phase in the transition from 100mm to 150mm SiC substrates. In addition, the segment’s semiconductor product offerings experienced increased demands as EUV lithography ramped as part of its anticipated adoption. 

Operating income for the year ended June 30, 2017 for II-VI Performance Products increased 21% to $21.6 million, compared to $17.8 million for fiscal year June 30, 2016. Incremental margins on higher segment revenues led by SiC substrate revenues contributed to the increased operating income. 

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LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary sources of cash have been provided through operations and long-term borrowings. Other sources of cash include proceeds received from the exercise of stock options and sales of equity investments and businesses. Our historical uses of cash have been for capital expenditures, investments in research and development, business acquisitions, payments of principal and interest on outstanding debt obligations, payments in satisfaction of employees’ minimum tax obligations and purchases of treasury stock. Supplemental information pertaining to our sources and uses of cash is presented as follows:

Sources (uses) of Cash (millions):

Net cash provided by operating activities:

Net cash provided by operating activities was $161.0 million and $118.6 million for the fiscal years ended June 30, 2018 and 2017, respectively. The increase in cash provided by operations during the current fiscal year was due to a combination of higher non-cash items such as depreciation, amortization, and share-based compensation expense and better working capital management of accounts payable, income tax payable and other operating net assets.

Net cash provided by operating activities was $118.6 million and $123.0 million for the fiscal years ended June 30, 2017 and 2016, respectively. The decrease in cash provided by operating activities during the fiscal year 2017 was due to increased working capital requirements to support higher revenue growth mainly relating to increased inventory build to address product demand as well as higher levels of accounts receivable from the revenue growth.  

Net cash used in investing activities:

Net cash used in investing activities was $285.0 million and $177.2 million for the fiscal years ended June 30, 2018 and 2017, respectively. The increase in cash used in investing activities was the result of a higher level of investments in property, plant & equipment to continue to build capacity to meet the growing demand for the Company’s product portfolio.  In addition, the Company completed several strategic investments in both wholly- and majority-owned investments during the current fiscal year, totaling approximately $132.6 million.

Net cash used in investing activities was $177.2 million and $135.2 million for the fiscal years ended June 30, 2017 and 2016, respectively. The increase in cash used in investing activities was the result of increased levels of capital expenditures of $138.5 million in fiscal year 2017 compared to $58.2 million in fiscal year 2016 was primarily driven by additional capital expenditures to increase the Company’s capability to produce new optoelectronic devices as it accelerates its new technology investment platform. Additionally, during fiscal year 2017, the Company purchased IPI, located in Hillsborough, New Jersey, for $39.4 million, net of cash acquired and certain assets of DirectPhotonics Industries GmbH, located in Berlin, Germany, for $0.6 million.

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Net cash provided by financing activities:

Net cash provided by financing activities was $97.0 million for the year ended June 30, 2018 compared to net cash provided by financing activities of $111.6 million for the year ended June 30, 2017. During the current fiscal year, the Company completed its offering and sale of $345 million aggregate principal amount of convertible notes.  In addition, the Company borrowed $100 million on its revolving credit facility to fund its investments in capital expenditures and research and development to address new and growing technology platforms.  The net proceeds from the convertible debt offering as well as cash generated from operations was used to repay $272 million on the revolver, $20 million on the term loan and $10.1 million of convertible debt issuance costs.  The Company also utilized $49.9 million of convertible debt proceeds to repurchase 1,414,900 of its common stock.  The Company realized $10.5 million of proceeds received from the exercise of stock options offset, by $6.6 million of cash payments in satisfaction of employees’ minimum tax obligations on the vesting of the Company’s restricted and performance shares during the current fiscal year.

Net cash provided by financing activities was $111.6 million for the year ended June 30, 2017 compared to net cash provided by financing activities of $61.5 million for the year ended June 30, 2016. During fiscal year 2017, the Company borrowed $129.0 million to finance its current year acquisitions and investments in capital expenditures for its new VCSEL investment platform and other growth platforms. The Company also received $15.1 million of proceeds from stock option exercises. Offsetting the increase in cash were payments made on outstanding borrowings of $25.0 million, $4.1 million of minimum tax withholding obligations on the vesting of employees’ restricted and performance shares, $2.0 million of payments on contingent earnout arrangements and $1.4 million of debt issuance costs associated with the Amended Credit Facility (as defined below) entered into on July 28, 2016.

0.25% Convertible Senior Notes

On August 24, 2017, the Company entered into a purchase agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated, as representative of the several initial purchasers named therein (collectively, the “Initial Purchasers”), to issue and sell $300 million aggregate principal amount of our 0.25% convertible senior notes due 2022 (the "Notes") in a private placement to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended. In addition, we granted the Initial Purchasers a 30-day option to purchase up to an additional $45 million aggregate principal amount of the Notes (the “Over-Allotment Option”).

On August 29, 2017, the Initial Purchasers exercised their Over-Allotment Option to purchase the entire $45 million in aggregate principal amount of additional Notes. The Notes mature on September 1, 2022, unless earlier repurchased by the Company or converted by holders in accordance with the terms of the Notes. Interest is payable semi-annually in arrears on March 1 and September 1 of each year, beginning on March 1, 2018.

The sale of the Notes to the Initial Purchasers settled on August 29, 2017, and resulted in approximately $336 million in net proceeds to the Company after deducting the initial purchasers’ discount and the offering expenses. The net proceeds from the offering and sale of the Notes were used, in part, to repurchase approximately $49.9 million of our common stock. The Company used the remaining net proceeds to repay $252 million on its revolving credit facility and to pay debt issuance costs of $10.1 million.

The Notes are governed by an Indenture between the Company, as issuer, and U.S. Bank, National Association, as trustee. The Notes are our senior unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of our indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries. In the event of our bankruptcy, liquidation, reorganization or other winding up, our assets that secure secured debt will be available to pay obligations on the Notes only after all indebtedness under such secured debt has been repaid in full from such assets. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at the Company’s election.

As a result of our cash conversion option, the Company separately accounted for the value of the embedded conversion option as a debt discount. The value of the embedded conversion option was determined based on the estimated fair value of the debt without the conversion feature, which was determined using an expected present value technique (income approach) to estimate the fair value of similar nonconvertible debt; the debt discount is being amortized as additional non-cash interest expense over the term of the Notes using the effective interest method with an effective interest rate of 4.5% per annum.

The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The initial conversion rate is 21.25 shares of common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of $47.06 per share of common stock. Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of

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certain events. The if-converted value of the Notes amounted to $318.5 million as of June 30, 2018 (based on the Company’s closing stock price on the last trading day of the year ended June 30, 2018).

Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than cancelled, extinguished or forfeited.

Prior to the close of business on the business day immediately preceding June 1, 2022, the Notes will be convertible only upon satisfaction of at least one of the conditions as follows:

On or after June 1, 2022 until the close of business on the business day immediately preceding the maturity date, holders may convert all or any portion of their Notes, in multiples of $1,000 principal amount, at the option of the holder regardless of the foregoing circumstances.

As of June 30, 2018, the Notes are not convertible. The Notes will become convertible upon the satisfaction of at least one of the above conditions. In accounting for the transaction costs related to the Note issuance, the Company allocated the total amount of offering costs incurred to the debt and equity components based on their relative values. Offering costs attributable to the debt component, totaling $8.4 million, are being amortized as non-cash interest expense over the term of the Notes, and offering costs attributable to the equity component, totaling $1.7 million, were recorded within Shareholders' equity.

The Company was in compliance with all the covenants set forth under the indenture.

The following table sets forth total interest expense recognized related to the Notes for the fiscal year ended June 30, 2018 (representing an effective interest rate of 4.5%):

The unamortized discount amounted to $49.3 million as of June 30, 2018 and is being amortized over 4 years.

Amended Credit Facility

On July 28, 2016, the Company amended and restated its existing credit agreement. The Third Amended and Restated Credit Agreement (the “Amended Credit Facility”) provides for a revolving credit facility of $325 million, as well as a $100 million term loan. The term loan is being repaid in consecutive quarterly principal payments on the first business day of each January, April, July and October, with the first payment having commenced on October 1, 2016, as follows: (i) twenty consecutive quarterly installments of $5 million and (ii) a final installment of all remaining principal due and payable on the maturity date of July 27, 2021. Amounts borrowed under the revolving credit facility are due and payable on the maturity date. The Amended Credit Facility is unsecured, but is guaranteed by each existing and subsequently acquired or organized wholly-owned domestic subsidiary of the Company. The Company has the option to request an increase to the size of the revolving credit facility in an aggregate additional amount not to exceed $100 million. The Amended Credit Facility has a five-year term through July 27, 2021 and has an interest rate of either a Base Rate Option or a Euro-Rate Option, plus an Applicable Margin, as defined in the agreement governing the Amended Credit Facility. If the Base Rate option is selected for a borrowing, the Applicable Margin is 0.00% to 1.25% and if the Euro-Rate Option is selected for a borrowing, the Applicable Margin is 1.00% to 2.25%. The Applicable Margin is based on the ratio of the Company’s consolidated indebtedness to consolidated EBITDA. Additionally, the Credit Facility is subject to certain covenants, including those relating to minimum interest coverage and maximum leverage ratios. As of June 30, 2018, the Company was in compliance with all financial covenants under its Amended Credit Facility.

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Yen Loan

The Company’s yen denominated line of credit is a 500 million Yen ($4.5 million) facility. The Yen line of credit matures in August 2020. The interest rate equal to LIBOR, as defined in the loan agreement, plus 0.625% to 1.75%. At June 30, 2018 and 2017, the Company had 300 million yen outstanding under the line of credit. Additionally, the facility is subject to certain covenants, including those relating to minimum interest coverage and maximum leverage ratios. As of June 30, 2018, the Company had $2.7 million outstanding and was in compliance with all covenants under its Yen facility.

Aggregate Availability

The Company had aggregate availability of $246.4 million and $73.5 million under its lines of credit as of June 30, 2018 and 2017, respectively. The amounts available under the Company’s lines of credit are reduced by outstanding letters of credit. As of June 30, 2018 and 2017, total outstanding letters of credit supported by the credit facilities were $0.4 million and $1.3 million, respectively.

Weighted Average Interest Rate

The weighted average interest rate of total borrowings was 1.3% and 2.2% for the years ended June 30, 2018 and 2017, respectively. The weighted average of total borrowings for the fiscal years ended June 30, 2018 and 2017 was $476.6 million and $272.1 million, respectively.

Share Repurchase Programs

In August 2017, in conjunction with the Company’s offering and sale of the Convertible Notes, the Company’s Board of Directors authorized the Company to purchase up to $50 million of its common stock with a portion of the net proceeds received from the offering and sale of the Notes. The shares that were purchased by the Company pursuant to this authorization were retained as treasury stock and are available for general corporate purposes. The Company purchased 1,414,900 shares of its common stock for approximately $49.9 million pursuant to this authorization.

In August 2014, the Company’s Board of Directors authorized the Company to purchase up to $50 million of its 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. As of June 30, 2018, the Company has cumulatively purchased 1,316,587 shares of its common stock pursuant to the Program for approximately $19.0 million

Our cash position, borrowing capacity and debt obligations are as follows (in millions):

The Company believes cash flow from operations, existing cash reserves and available borrowing capacity from its credit facilities will be sufficient to fund its needs for working capital, capital expenditures, repayment of scheduled long-term borrowings and capital lease obligations, investments in internal research and development, share repurchases, internal and external growth objectives at least through fiscal year 2019. The Company expects to complete its acquisition of CoAdna, Inc., a publically traded company on the Taiwan Stock Exchange, on or about September 1, 2018. The purchase price will be approximately $85.0 million, net of any cash acquired and will be financed by a combination of cash on hand and borrowings on the Company’s Amended Credit Facility.

The Company’s cash and cash equivalent balances are generated and held in numerous locations throughout the world, including amounts held outside the United States. As of June 30, 2018, the Company held approximately $218 million of cash and cash equivalents outside of the United States. Cash balances held outside the United States could be repatriated to the United States. The recently enacted Act created significant changes to the taxation of undistributed foreign earnings and has changed our future intentions regarding repatriation of earnings. The Company is currently evaluating the full impact of the Act and may update future cash repatriation intentions.

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Off-Balance Sheet Arrangements

The Company’s off-balance sheet arrangements include the operating lease obligations and the purchase obligations disclosed in the contractual obligations table below, as well as letters of credit as discussed in Note 7 to the Company’s Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The Company enters into these off-balance sheet arrangements to acquire goods and services used in its business.

Tabular Disclosure of Contractual Obligations

Pension obligations are not included in the table above. The Company expects defined benefit plan employer contributions to be $2.7 million in 2019. Estimated funding obligations are determined by asset performance, workforce and retiree demographics, tax and employment laws and other actuarial assumptions which may change the annual funding obligations. The funded status of our defined benefit plans is disclosed in Note 15 to the Company’s Consolidated Financial Statements.

The gross unrecognized income tax benefits at June 30, 2018, which are excluded from the above table, were $10.3 million. The Company is not able to reasonably estimate the amount by which the liability will increase or decrease over time; however, at this time, the Company does not expect a significant payment related to these obligations within the next fiscal year.

MARKET RISKS

The Company is exposed to market risks arising from adverse changes in foreign currency exchange rates and interest rates. In the normal course of business, the Company uses certain techniques and derivative financial instruments as part of its overall risk management strategy, primarily focused on its exposure to the Japanese Yen, Chinese Renminbi and the Euro. The Company also has transactions denominated in Euros, British Pounds Sterling, Chinese Renminbi and Swiss Francs. No significant changes have occurred in the techniques and instruments used other than those described below.

Foreign Exchange Risks

In the normal course of business, the Company enters into foreign currency forward exchange contracts with its financial institutions. The purpose of these contracts is to hedge ordinary business risks regarding foreign currencies on product sales and other transactions denominated in currencies other than the U.S. dollar. Foreign currency exchange contracts are used to limit transactional exposure to changes in currency rates.

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Japanese Yen

The Company enters into foreign currency forward contracts that permit it to sell specified amounts of Japanese Yen expected to be received from its export sales for pre-established U.S. dollar amounts at specified dates. The forward contracts are denominated in the same foreign currencies in which export sales are denominated. These contracts provide the Company with an economic hedge in which settlement will occur in future periods, thereby limiting the Company’s exposure. These contracts had a total notional amount of $12.0 million and $12.7 million at June 30, 2018 and 2017, respectively.

A 10% change in the yen to U.S. dollar exchange rate would have changed revenues in the range from a decrease of approximately $8.1 million to an increase of approximately $9.9 million for the year ended June 30, 2018.

During June 2018, the Company entered into a $7.0 million month-to-month forward contract that matured on June 29, 2018, to limit exposure to the Yen. Upon expiration of this contract, the Company recorded a loss of $0.2 million in the Consolidated Statement of Earnings.

Chinese Renminbi

During June 2018, the Company entered into a $43.5 million month-to-month forward contract that matured on June 29, 2018, to limit exposure to the Chinese Renminbi. Upon expiration of this contract, the Company recorded a loss of $1.2 million in the Consolidated Statement of Earnings.

Euro

The Company has short-term intercompany notes that are denominated in U.S. dollars with certain European subsidiaries. A 10% change in the Euro to dollar exchange rate would have changed net earnings in the range from a decrease of $0.5 million to an increase of $0.6 million for the year ended June 30, 2018.

The Company monitors its positions and the credit ratings of the parties to these contracts. While the Company may be exposed to potential losses due to risk in the event of non-performance by the counterparties to these financial instruments, it does not currently anticipate such losses.

Assets and liabilities of foreign operations are translated into U.S. dollars using the period-end exchange rates, while income and expenses are translated using the average exchange rates for the reporting period. Translation adjustments are recorded as accumulated other comprehensive income within shareholders’ equity.

Interest Rate Risks

As of June 30, 2018, the Company’s total borrowings of $496.5 million consisted of $147.7 million variable rate debt borrowings from a line of credit of $80.0 million denominated in U.S. dollars, a term loan denominated in U.S. dollars of $65.0 million, a line of credit borrowing of $2.7 million denominated in Japanese yen. As such, the Company is exposed to changes in interest rates. A change in the interest rate of 100 basis points on these variable rate borrowings would have resulted in additional interest expense of $1.5 million for the fiscal year ended June 30, 2018.

Discount Rate Risks

As of June 30, 2018, a 10% change in the Company’s discount rate used to determine the pension benefit obligation of the Switzerland Defined Benefit Plan would have had an immaterial impact on the Consolidated Financial Statements.

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management’s Responsibility for Preparation of the Financial Statements

Management is responsible for the preparation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements were prepared in accordance with the accounting principles generally accepted in the United States of America and include amounts that are based on the best estimates and judgments of management. The other financial information contained in this Annual Report on Form 10-K is consistent with the consolidated financial statements.

Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance concerning the reliability of the financial data used in the preparation of the Company’s consolidated financial statements, as well as reasonable assurance with respect to safeguarding the Company’s assets from unauthorized use or disposition.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement presentation and other results of such systems.

Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2018. In making this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework (2013). Management’s evaluation included reviewing the documentation of its controls, evaluating the design effectiveness of controls and testing their operating effectiveness. Management excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Kaiam Laser Limited, Inc., which was acquired in August 2017. The recent acquisition excluded from management’s assessment of internal controls over financial reporting represented approximately $107.2 million and $98.1million of total assets and net assets, respectively, as of June 30, 2018 and approximately $3.4 million and $12.5 million of total revenues and net loss, respectively, for the fiscal year then ended. Based on the evaluation, management concluded that as of June 30, 2018, the Company’s internal controls over financial reporting were effective.

Ernst & Young LLP, an independent registered public accounting firm, has issued its report on the effectiveness of our internal control over financial reporting as of June 30, 2018. Its report is included herein.

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of II-VI Incorporated and Subsidiaries

Opinion on Internal Control over Financial Reporting

We have audited II-VI Incorporated and Subsidiaries’ internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, II-VI Incorporated and Subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of June 30, 2018, based on the COSO criteria.

As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Kaiam Laser Limited, Inc., which is included in the June 30, 2018 consolidated financial statements of the Company and constituted $107.2 million and $98.1 million of total and net assets, respectively, as of June 30, 2018 and $3.4 million and $12.5 million of revenues and net loss, respectively, for the fiscal year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Kaiam Laser Limited, Inc.  

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of June 30, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended June 30, 2018, and the related notes and the financial statement schedule listed in the Index at Item 15(a)(2) and our report dated August 28, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  

Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Ernst & Young LLP  

Pittsburgh, Pennsylvania

August 28, 2018

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of II-VI Incorporated and Subsidiaries

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of II-VI Incorporated and Subsidiaries (the Company) as of June 30, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended June 30, 2018, and the related notes and the financial statement schedule listed in the Index at Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2018, in conformity with U.S. generally accepted accounting principles.  

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated August 28, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Ernst & Young LLP  

We have served as the Company’s auditor since 2008.

Pittsburgh, Pennsylvania

August 28, 2018

47

II-VI Incorporated and Subsidiaries

Consolidated Balance Sheets

($000)