Laser maker and Motley Fool Hidden Gems recommendation II-VI (NASDAQ:IIVI) reports its first quarterly results of fiscal 2008 tomorrow. Want to know what Wall Street expects to see? Read on. Want to know what really matters? Read on a bit more.

What analysts say:

  • Buy, sell, or waffle? Half a dozen analysts follow II-VI (pronounced two-six), unanimously voting the stock a buy.
  • Revenue. On average, they're looking for 21% sales growth to $73.6 million.
  • Earnings. Profits are predicted to rise even faster, up 28% to $0.32 per share.

What management says:
Earlier this month, II-VI announced the purchase of Germany's HIGHYAG Lasertechnologie GmbH, a maker of "tools for laser materials processing" and "beam delivery systems." While II-VI kept mum on the financial specifics of the deal, it doesn't look to be huge in monetary terms; HIGHYAG booked only $6.2 million in revenue last year. The real value of the deal to II-VI seems to be that it will "expand its product offerings of laser optics and components." The purchase is expected to close within the next six months, and II-VI promised to update its guidance based on HIGHYAG's contributions when it closes.

And the best news? That would be the fact that in buying 74.9% of HIGHYAG, II-VI is leaving the remaining 25.1% (presumably a "blocking stake," although I admit to an ignorance of German securities law) in the hands of HIGHYAG's CEO. I expect this will ensure that II-VI doesn't lose the man who made HIGHYAG into the kind of company II-VI would want to own in the first place.

What management does:
Gross margins at II-VI have settled in the 41% range, while operating margins continue to march upward. Judging from last year's financials, it looks like most of II-VI's operating margin improvement came from lower raw material costs relative to pricing power. Sales were up 13% year over year in fiscal 2007, while cost of goods sold rose only 10%.

Margins

3/06

6/06

9/06

12/06

3/07

6/07

Gross

40.5%

40.2%

40.3%

41.6%

41.8%

41.7%

Op.

16.4%

16.6%

16.7%

18.1%

17.8%

18.4%

Net

11.5%

4.6%

4.8%

6.2%

7.1%

14.4%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
I love what I'm seeing with II-VI's margins, generally, but one thing does worry me. For the first time in four years, research and development spending declined last year. As I've mentioned in past columns -- for example, on EMC (NYSE:EMC) and Ciena (NASDAQ:CIEN), and in an interview with Corning's (NYSE:GLW) CEO -- it worries me whenever a high-tech firm seems to be skimping on R&D. These firms need to invest heavily in research and development to stay ahead of the competition. (At II-VI, competitors include formidable names such as Goodrich (NYSE:GR), Raytheon (NYSE:RTN), and Northrop Grumman (NYSE:NOC).)

Now, I admit that this may be a bit nitpicky, and that in II-VI's case, buying a company with complementary products such as those HIGHYAG offers may act as a proxy for in-house research and development work. If that's the case, then the R&D issue may turn out to be a red herring. Still, over future quarters, this is one line item of the income statement that we'll want to read closely.