II(-VI) Much Weirdness

Make up your mind, Mr. Market.

When laser equipment maker and Motley Fool Hidden Gems recommendation II-VI (Nasdaq: IIVI  ) reported its first-quarter results for fiscal 2008 yesterday, investors threw a veritable hissy fit.

They seemed perturbed by the fact that the firm managed to meet analysts' desired $0.32-per share earnings estimate squarely, despite selling only $72.7 million worth of goods. (This further illustrates the patent silliness of the concept of a "revenue miss." Can someone please explain what's wrong with earning more by selling less?)

And today, with the market in free fall, what do investors do with II-VI? They bid it up 3%. Crazy.

Wrong yesterday, right today
So which face of the now-confirmed schizophrenic Mr. Market are we to believe? Personally, I think investors are getting it as right today as they got it wrong yesterday. Here's why, in a nutshell:

Reining in costs
II-VI grew its sales 20% year over year in Q1, translating that to 28% profits improvement, despite raw materials costs outpacing sales gains, 21% to 20%. The company accomplished this feat through stringent cost control. Selling, general, and administrative expenses grew a bare 7% -- but this story gets even better.

Remember how I complained about the dearth of research and development expenditures last year? Well, II-VI turned on a dime in Q1 and ramped R&D spending 50% year over year last quarter.

That's good news for two reasons. First, it shows that, just like at EMC (NYSE: EMC  ) earlier this year, an apparent disinterest in research has given way to strong investment in this tech company's future. Second, the fact that II-VI expanded its R&D spending yet managed to hold its operating costs increase to just 15% -- a slower rate than sales growth -- permitted margins to expand. At 18.2% for the quarter, II-VI's operating margin exceeds those of Rohm and Haas (NYSE: ROH  ) , fellow Hidden Gems pick Rofin-Sinar (Nasdaq: RSTI  ) , and Raytheon (NYSE: RTN  ) , and is nearly twice that of DRS Technologies (NYSE: DRS  ) .

Sales on the horizon
The other reason for optimism today is that we're seeing bigger things for tomorrow. Sales growth of 20% is swell, but even better is management's observation that it booked 27% more new business in Q1 2008 than one year ago. To me, that promises accelerated sales growth down the road, and with its costs contained, I think we can all guess what that means for II-VI's profits.


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