Item 1. Business
Background
The Company was formed on May 19, 1995 and acquired ownership, primarily by
merger of affiliated companies that were previously under common ownership and
management (the "Predecessors"). Unless the context otherwise requires, the
"Company" refers to Advanced Lighting Technologies, Inc., its subsidiaries and
the Predecessors. Industry data in this Report with respect to the lighting
industry is reported on a calendar year basis and includes the industrial,
commercial and residential sectors but not the automotive sector. Unless
otherwise stated herein, such industry data is derived from selected reports
published by the National Electrical Manufacturers Association ("NEMA").
The Company
Advanced Lighting Technologies, Inc. is an innovation-driven designer,
manufacturer and marketer of metal halide and other lighting products that
participates in the global lighting market. Metal halide lighting combines
superior energy efficient illumination with long lamp (i.e., light bulb) life,
excellent color rendition and compact lamp size. The Company believes that it is
the only designer and manufacturer in the world focused primarily on metal
halide lighting. As a result of this unique focus, the Company has developed
substantial expertise in all aspects of metal halide lighting. The Company
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believes that this focus enhances its responsiveness to customer demand and has
contributed to its technologically advanced product development and
manufacturing capabilities.
The Company has derived a substantial portion of its net sales from
international business. Revenues from customers outside of the United States
represented approximately 50% of net sales for fiscal 2004. The Company's
operations in India now produce about two-thirds of its component products sold
worldwide. International markets represent long-term attractive opportunities
for metal halide lighting products due to the increasing demand for
energy-efficient lighting products. The energy efficiency of metal halide
lighting is especially desirable in developing nations such as China due to the
relatively higher cost of energy and the high cost of power plant construction
in these countries.
In the United States, the metal halide market is the fastest growing segment of
the lighting market, demonstrated by metal halide lamp sales having grown at a
compound annual rate of approximately 10% in the past decade, although growth
has varied substantially from year to year. In recent years, sales of metal
halide products in calendar year 2003 were comparable to those in fiscal 2000,
primarily due to the weakness of the U.S. economy over that past several years.
However, sales in calendar 2002 and calendar 2003 were up 3% per year over the
sales in the previous calendar year. In light of these results, the Company
believes the U.S. metal halide industry is beginning to recover and that sales
of metal halide lighting will begin to grow moderately. The Company's strong
market position, new product development capabilities, and participation in
international markets have enabled the Company to increase its revenues in its
core metal halide operations at rates in excess of the growth of the domestic
metal halide market. The Company has integrated vertically to design,
manufacture and market a broad range of metal halide products, including
materials used in the production of lamps, and lamps and other components for
lighting systems as well as metal halide lighting systems. The Company's
materials and components are used in the manufacture of its own lighting systems
for sale to end-users and are sold to third-party manufacturers for use in the
production of their metal halide products.
Metal Halide
Invented approximately 40 years ago, metal halide is the newest of all major
lighting technologies and can produce the closest simulation to sunlight of any
available lighting technology. Metal halide lighting is currently used primarily
in commercial and industrial applications such as manufacturing facilities and
distribution centers, outdoor site and landscape lighting, sports facilities and
large retail spaces such as superstores. In addition, due to metal halide's
superior lighting characteristics, the Company believes many opportunities exist
to "metal halidize" applications currently dominated by older incandescent and
fluorescent lighting technologies. For example, a 100-watt metal halide lamp,
which is approximately the same size as a household incandescent lamp, produces
as much light as five 100-watt incandescent lamps and as much as three 34-watt,
four-foot long fluorescent lamps. However, metal halide lamps are not compatible
with the substantial installed base of incandescent and fluorescent lighting
fixtures. While metal halide systems generally offer lower costs over the life
of a system, the installation of a metal halide lighting system typically
involves higher initial costs than incandescent and fluorescent lighting
systems.
While domestic sales of incandescent and fluorescent lamps have grown at a
compound annual rate of approximately 2% over the past decade, domestic metal
halide lamp sales have grown at a compound annual rate of approximately 10% over
the same period, making metal halide the fastest growing segment of the
approximately $2.4 billion domestic lamp market. In 2003, metal halide accounted
for approximately 10.5% of domestic lamp sales by dollar volume.
The Company believes that the growth of metal halide lighting noted above has
occurred primarily in commercial and industrial applications. In recent years,
metal halide systems have been introduced in
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fiber optic, electronic display projectors and automotive headlamp applications,
and the Company expects that these and other applications will continue to drive
growth in metal halide lighting. The Company believes that additional
opportunities for metal halide lighting exist in other applications where energy
efficiency and light quality are important. As a result of the Company's
dominant position in metal halide materials, the Company expects to benefit from
continued growth in metal halide markets. In addition, the Company expects to be
a leader in metal halide's continued market expansion by providing innovative
metal halide system components and integrated systems.
Recent Developments
Emergence from Bankruptcy
On December 10, 2003, Advanced Lighting Technologies, Inc. and six of its United
States subsidiaries, (collectively, the "Debtors"), completed their previously
announced financial restructuring when their Fourth Amended Chapter 11 Plan of
Reorganization (the "Final Plan") under the U.S. Bankruptcy Code (the
"Bankruptcy Code") became effective and was substantially consummated. ADLT's
non-U.S. operating subsidiaries and Deposition Sciences, Inc., a U.S.
subsidiary, were not a part of the proceedings under the Bankruptcy Code.
The Debtors filed for reorganization under the Bankruptcy Code on February 5,
2003 (the "Filing"). From February 5, 2003 to December 10, 2003, the Debtors
operated their businesses as debtors-in-possession under court protection from
their creditors and claimants. Following approval by the creditors, preferred
shareholders and the common shareholders of the Predecessor Company entitled to
vote on the reorganization plan, on December 8, 2003, the Bankruptcy Court
entered an order confirming the Final Plan. On December 10, 2003, the Effective
Date of the Final Plan occurred and the reorganization of the Company was
substantially completed.
Pursuant to the terms of the Final Plan, Saratoga Lighting Holdings, LLC
("Saratoga") received, in exchange for cancellation of its holdings of the
Predecessor Company's Series A Preferred Stock and Common Stock, and an $18
million cash investment, new redeemable preferred stock of the Reorganized
Company, with an initial liquidation preference of $29 million, and
approximately 91% of the common stock of the Reorganized Company (on a diluted
basis, assuming issuance of common stock of the Reorganized Company to its
senior management pursuant to the new management incentive plan). Under the
management incentive plan, shares equal to approximately 9% of the common stock
of the Reorganized Company have been issued. The Final Plan also provided
management fees to an affiliate of Saratoga. The fees consist of a one-time
advisory fee of $1.8 million that was paid in July 2004 from excess working
capital, and a quarterly management fee of $150,000 payable in advance. The
advisory fee is included in payables to related parties.
The Final Plan provided that the holders of the Predecessor Company's Common
Stock (other than Saratoga and the Predecessor Company's Chief Executive
Officer) receive the benefit of certain equity investments held by the
Predecessor Company in Fiberstars, Inc. and Hexagram, Inc., as well as a
possible future payment, based on 3% of amounts received by Saratoga after
providing Saratoga with a return of capital plus an agreed rate of return, as
more fully described in the Final Plan. Options and warrants to purchase
Predecessor Company Common Stock which were not exercised prior to the Effective
Date were cancelled.
Effective December 10, 2003, the Predecessor Company's secured banking facility
was amended and restated to provide financing for the Reorganized Company
following emergence from bankruptcy (the amended facility is referred to as the
"Bank Credit Facility"). The Bank Credit Facility is a $30 million
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facility that consists of a term loan that requires monthly principal payments
of $183,000 ($9.9 million outstanding at June 30, 2004) with a revolving credit
loan, subject to availability, making up the remainder of the facility.
Availability under the revolving credit loan was $15.6 million and no balance
was outstanding on the revolving credit loan at June 30, 2004. Interest rates on
the revolving credit loan are based on Libor plus 2.75% or Prime plus .75%
(5.00% at June 30, 2004). Interest rates on the term loan are based on Libor
plus 3.50% or Prime plus 1.50% (5.75% at June 30, 2004). The final maturity of
the revolving credit facility and the term loan is December 10, 2008. The
financing arrangements are described in greater detail in Note E, "Financing
Arrangements."
With respect to the Predecessor Company's $100 million 8% Senior Notes due 2008
(the "Old Notes"), the Company had not made the semi-annual interest payments
due on September 16, 2002, March 15, 2003, and September 15, 2003. The Company
had continued to accrue interest on the Old Senior Notes at 8% through December
31, 2003, and accrued and unpaid interest on the Old Senior Notes would have
been $14.4 million as of that date. The Final Plan provided that the Old Notes
be exchanged for an aggregate principal amount of $114.4 million 11% Senior
Notes due 2009 (the "New Notes"). The New Notes bear interest at 11% from
January 1, 2004, and become due on March 31, 2009. Upon the Effective Date of
the Final Plan, pursuant to the approval of the Plan by holders of the Old
Senior Notes, all then existing defaults under the Indenture relating to the Old
Senior Notes were waived.
Saratoga Investment
Saratoga acquired all of the Common and Preferred shares owned by GE on August
15, 2003. As a result, Saratoga held 1,429,590 shares of Company Common Stock
and 761,250 shares of the Company's then existing Old Preferred Stock. Saratoga
received, in exchange for cancellation of its holdings of the Predecessor
Company's Common Stock and Old Preferred Stock, and an $18 million cash
investment, new redeemable preferred stock (the "New Series A Preferred") of the
Reorganized Company, with an initial liquidation preference of $29 million, and
approximately 91% of the common stock of the Reorganized Company (on a diluted
basis, assuming issuance of common stock of the Reorganized Company to its
senior management pursuant to the new management incentive plan). Under the
management incentive plan, shares equal to approximately 9% of the common stock
of the Reorganized Company have been issued.
The New Series A Preferred has a liquidation preference of $1,000 per share,
plus dividends at the rate of 8% per annum, when and if declared. The cumulative
undeclared dividends were $1.3 million as of June 30, 2004. The initial carrying
amount of the New Series A Preferred was set at $29 million, the estimated fair
value at the date of issuance. The Holder of the New Series A Preferred may, by
notice, require the Company to redeem the outstanding New Series A Preferred
within 21 days following the occurrence of certain corporate events. The Company
may redeem the New Series A Preferred in whole, but not in part, at any time.
The redemption price for the New Series A Preferred is equal to the liquidation
preference amount for such shares. The New Series A Preferred shares are each
entitled to one vote on each matter presented to shareholders of the Company, as
well as one vote on each matter required to be voted upon by the New Series A
Preferred as a class. As a consequence, the New Series A Preferred represents
approximately 96.3% of the voting power of the Company at June 30, 2004. As of
June 30, 2004, Saratoga held 98.8% of the voting power of the Company.
Executive Offices
The Company's principal executive offices are located at 32000 Aurora Road,
Solon, Ohio 44139 and its telephone number is 440/519-0500.
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Lighting Industry and Opportunities in Metal Halide Lighting
The Company currently produces metal halide lighting products primarily for
commercial and industrial applications. Until recently, metal halide technology
served primarily the industrial and outdoor sectors, which the Company
estimates, represents approximately one-third of U.S. lighting fixture sales.
However, with the miniaturization of metal halide lamps and fixtures and the
recognition of the benefits of metal halide technology, including improved light
color, energy efficiency, lower operating temperature and safety of metal halide
products relative to other technologies, significant opportunities for growth
exist. Key factors driving growth in the metal halide industry include:
Demand for Specialized Lamps. The demand for specialized metal halide lamps has
increased as the Company's original equipment manufacturer ("OEM") and lighting
agent customers have recognized the benefits associated with using specialized
metal halide products. Although GE, Philips and Sylvania are the lighting
industry leaders, these companies have traditionally focused on the larger
incandescent and fluorescent markets and have limited production of metal halide
lamps to general applications, such as commercial and industrial applications.
While these standard-type metal halide lamps represent a substantial majority of
total metal halide lamp sales, they do not afford the OEM or lighting agent
complete flexibility in designing lighting contract bids. When an agent places
his bid for a lighting contract, he may specify the Company's specialized metal
halide lamps that give better light and greater energy savings in an attempt to
differentiate his bid from a competitor who only specifies standard products.
Development of New and Advanced Metal Halide Power Supplies. Historically, the
introduction of new metal halide lamps and systems has been constrained by the
lack of complementary metal halide power supplies. Significant engineering
expertise is required to adapt existing power supplies for new metal halide
products. The Company believes that while domestic sales of metal halide power
supplies approximated $200 million in 2003, power supply manufacturers, like
lamp manufacturers, have focused on the larger fluorescent power supply market
and, to a lesser extent, on the standard-type metal halide lamp market rather
than development of new power supply products for specialized metal halide
products and applications. Since the Company acquired its power supply
manufacturing operations in 1997, the development of appropriate power supply
sources focused on metal halide has enhanced the expansion of metal halide
applications, reduced the development time required to introduce new metal
halide products and improved the reliability and durability of existing metal
halide products.
Opportunity for Integrated Metal Halide Systems. Metal halide systems for
commercial and industrial applications are assembled primarily by fixture
manufacturers, lighting agents, and intermediaries who are limited in their
ability to integrate different components that comprise a metal halide system.
The Company believes that significant growth opportunities exist through the
packaging of compatible, reliable system components for OEM customers from a
single supplier. In addition, the Company believes that metal halide systems
have significant potential to displace older lighting technologies in
traditional applications. Other more recent applications for metal halide
systems include fiber optic systems and automotive headlamps.
International Demand for Metal Halide. International markets represent long-term
attractive opportunities for metal halide products as developing nations
continue to build infrastructure to support their growing economies. Facilities
such as train stations, airports, government buildings, highways and factories
all require substantial lighting for which metal halide products are well
suited. In addition, given the high energy efficiency of metal halide and the
high cost of energy in developing nations (including the high cost of power
plant construction), the Company believes that the international metal halide
market will grow faster than the United States market in the long term.
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Strategy - Lighting
The Company believes that metal halide technology represents the best lighting
technology for a wide variety of applications, many of which are not yet served
by an appropriate metal halide product. As the principal supplier of metal
halide materials to the metal halide lamp industry, the Company expects to
benefit from continued growth in metal halide markets. The Company also expects
to lead metal halide's continued market expansion, by providing innovative metal
halide system components and systems through the operating and growth strategies
highlighted below.
The Company's strategic objective for lighting is to remain focused on the metal
halide market and expand its leadership position in the metal halide lighting
industry by: (i) continuing to use its vertical integration to introduce new
products and applications; (ii) using its experience and technology to
continually reduce cost and improve quality to improve cash flow from
operations; (iii) strengthening the Company's relationships with OEMs and
lighting agents to increase the number of metal halide applications and the
penetration of the Company's products in new metal halide installations; and
(iv) seeking to demonstrate the superiority of metal halide lighting solutions,
thereby stimulating domestic and international demand for the Company's
products.
The Company has sought to achieve its strategic objective through internal
growth, acquisitions and strategic investments, and focus on cost and quality.
The Company's acquisitions and investments have been made in businesses that,
when combined with the Company's existing capabilities and metal halide focus,
are intended to provide technological, product or distribution synergies and
offer the potential to enhance the Company's competitive position or accelerate
development of additional metal halide market opportunities. In the future, the
Company expects to achieve its strategic objectives primarily through internal
growth and focus on cost and quality. However, to the extent its capital
resources allow, the Company may consider other possible acquisition and
strategic investment opportunities.
Operating Strategy - Lighting
The Company focuses its resources primarily on designing, manufacturing and
marketing metal halide materials, system components, and systems. By focusing on
metal halide, the Company believes it has developed unique design, manufacturing
and marketing expertise. Such expertise provides the Company with significant
competitive advantages, which enable the Company to deliver highly customized
products to meet customer needs. The Company's experienced workforce is
dedicated to improving metal halide lighting products, production processes and
developing new applications for this technology. In order to increase the number
of metal halide applications and the penetration of the Company's products, the
Company pursues the following operating strategies:
Continue to Use Vertical Integration
The Company began operations as a manufacturer of metal halide salts and
expanded into production of system components, initially lamps. The Company has
expanded its focus to include magnetic and electronic power supplies. The
Company has broadened its materials manufacturing capabilities to include
filtering and optical coatings for lighting applications. Through this vertical
integration, the Company is able to develop and package complementary system
components which enable metal halide lighting to penetrate applications and
markets currently served by older technologies. The Company will continue to use
vertically integrated operations where we have competitive advantages based on
patent-protected technology and first-to-market product leadership.
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Improve Operating Cash Flow
In the past the Company depended on outside capital sources to fund growth. In
order to reduce this dependence and to improve its operating results, the
Company continues to focus primarily on its metal halide products and to use its
experience in the design and manufacture of metal halide materials, components
and systems and focused metal halide technology to reduce operating costs by
improving production processes and product quality without substantial capital
investment. The Company has also transferred a significant portion of its
component manufacturing to India resulting in further significant reductions in
its production cost. Management believes that achieving cost and quality goals
will enhance operating cash flow to allow for profitable growth in a tight
capital environment. The anticipated improvements should also improve overall
financial performance, which will improve the Company's access to capital for
future investments in its business.
Strengthen OEM and Lighting Agent Relationships
The Company concentrates on developing strong relationships with lighting
fixture OEMs by providing the key system components for a lighting fixture,
either alone or packaged as a unit, tailored to meet their needs. Historically,
the Company provided specialized lamps tailored to meet OEM needs. With its
ability to design and manufacture power supplies, the Company expects to better
meet OEM needs by packaging the principal system components (lamps, power
supplies, switches and controls) for a lighting fixture. Frequent interaction
with OEMs serves dual purposes, providing the Company with valuable ideas for
new component products and providing OEMs with the information necessary to
market the Company's new products. Lamps and power supplies designed for a
specific fixture are included with the fixture when sold by the OEM, increasing
distribution of the Company's products. The Company also enters into agreements
with lighting agents to pay commissions for selling the Company's lamps. These
commissions provide the agent an incentive to include the Company's metal halide
lamps in its bids on a construction or renovation project.
Seek to Demonstrate Superiority of Metal Halide Lighting Solutions
The Company seeks to demonstrate the superiority of metal halide lighting
solutions to its customer base, including OEMs, lighting agents and contractors,
thereby stimulating domestic and international demand for the Company's
products. The Company believes that metal halide lighting systems have
significant potential to displace older lighting technologies in traditional
applications, as well as more recent applications such as fiber optic systems
and automotive headlamps.
Long-Term Growth Strategy - Lighting
The Company is continuing to introduce more products for new applications and to
expand the distribution channels for its products. The key elements of the
Company's long-term growth strategy include:
Introduce New Products and Systems
The Company believes it has introduced a majority of the new lamps in the
domestic, metal halide lamp industry since 1985. As applications become
increasingly complex, the advantage of simultaneous design of components as an
integrated system is becoming more significant. The Company now manufactures and
markets complementary component packages for OEMs. The Company intends to
develop, manufacture and market additional types of high performance and
technologically advanced metal halide materials, components and systems.
Capitalizing on its expanding production and design capability and
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unique metal halide focus, the Company expects to work with others in the
further development of additional specialty systems, such as fiber optic
lighting systems.
Increase Sales of Existing Products
By expanding existing relationships and developing new relationships with
lighting agents and OEMs, the Company expects to increase sales of existing
specialty lamps and power supplies. The Company also expects its sales of
replacement lamps, as well as power supplies, to increase as the installed base
of fixtures for the Company's specialty lamps and power supplies increases. The
Company expects to increase sales in the replacement lamp market, in part
through a novel direct marketing approach to end users. The Company prints its
toll-free phone number and web site on most lamps, and customers can order
replacement lamps directly from the Company for express delivery. In addition,
this interaction with customers provides the Company with the opportunity to
market additional metal halide products.
Increase Participation in International Markets
The Company has and plans to continue to increase its participation in
international markets in three ways. First, the Company directly exports its
products to countries that do not impose restrictive tariffs, local content laws
and other trade barriers. The primary countries and regions in which the Company
directly markets products are the United Kingdom, Western Europe, Australia,
Canada, China and Japan. Second, the Company has pursued and may pursue
strategic acquisitions and has built or may build manufacturing facilities in
international markets. Third, in countries that impose trade restrictions, the
Company has sold production equipment or has entered into joint ventures with
local lamp manufacturers. Purchasers of production equipment have become
customers for the Company's metal halide salts, lamp components and other
materials. The Company has existing joint ventures in China and Korea.
Products
The Company designs, manufactures and sells metal halide materials, components
and systems, which are used in a wide variety of applications and locations
including:
- floodlighting - sports arena lighting - general lighting
- architectural area lighting - commercial downlighting - industrial highbays
- general industrial lighting - airport and railway station lighting - tunnel lighting
- billboard and sign lighting - gas station canopy lighting - indirect indoor sports and office lighting
- site lighting - interior downlighting - parking garage lighting
- soffit lighting - decorative lighting - security lighting
- hazardous location lighting - retail store downlighting and track lighting - landscape lighting
- accent lighting
The Company also designs, manufactures and sells thin film deposition equipment
for the lighting, telecommunications, ophthalmic and optics industries.
Materials
The Company produces and sells metal halide salts, electrodes, amalgams and
getters. Metal halide salts are the primary ingredients within the arc tube of
metal halide lamps, which determine the lighting characteristics of the lamp.
Electrodes form the electrical connections within the lamp. Amalgams are
chemicals that are used in the arc tubes of high pressure sodium ("HPS") lamps
and in fluorescent lamps.
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Getters are devices required to be included in each metal halide lamp to prevent
impurities from interfering with lamp operation.
The Company produces over 300 different metal halide salts that can be used in
metal halide lamps to produce different lighting characteristics. In addition to
meeting its own needs, the Company believes it produces all of the metal halide
salts used in metal halide lamps manufactured in the United States, including
those manufactured by GE, Philips and Sylvania, and 80% of the metal halide
salts used in metal halide lamps manufactured overseas. The Company serves all
major lamp manufacturers, each of which uses different metal halide salts. The
Company vigorously guards each customers' specific formulas from other
customers, including the Company's own lamp engineers. Because of its ability to
produce these ultra pure metal halide doses, the Company has also been called
upon by its lamp manufacturer customer base to produce most of the amalgams used
in the domestic production of HPS lighting and, most recently, to develop and
supply a new amalgam for fluorescent applications.
The Company also produces optical thin film coatings, including coatings for
lighting applications with particular emphasis on coatings on lamp burners, as
well as antireflection coatings, and coatings for telecommunications products,
multilayer magnetic films and emissivity modification films for classified
government applications, and infrared multilayer optical films on flexible
polymeric substrates. Through a reactive sputtering process, these coatings are
chemically bonded to a product surface. When used in lighting applications,
these coatings can significantly improve the optical performance of the light
source, protect the system and its components from harmful ultra-violet and
infrared radiation, and increase the energy efficiency of the entire system.
Components and Systems
A metal halide lighting system consists of at least a lamp and power supply, but
may include a fixture, electronic controls, optical systems, housing, support
systems or any other necessary components assembled into a product for an end
user. The Company believes it will be able to combine its metal halide expertise
and manufacturing capabilities to assist and encourage its customers to design,
develop, produce and market metal halide systems for innovative applications.
The Company's component products include specialty and standard lamps, magnetic
and electronic power supplies, system controls and fiber optic components.
Specialty lamps are lamps designed and manufactured for particular OEM
applications. Standard lamps are high-volume lamps, which the Company primarily
manufactures at its lamp manufacturing facility in India or sources from other
lamp manufacturers. Power supplies are devices that regulate power and are
necessary for operation of HID and fluorescent lamps. System controls are
electrical components included in fixtures and systems.
The Company believes it differentiates itself from other metal halide lamp
manufacturers by offering a wider variety of lamps, many of which have been
customized to offer a specific solution to a lighting problem. Since 1985, the
Company believes that it has introduced a majority of the new lamps in the
domestic, metal halide lamp industry. Currently, the Company offers
approximately 400 lamps ranging from 50 watts to 2,000 watts. In certain
instances, the Company produces these products for its competitors on a private
label basis in order to capture sales through competitors' distribution
channels. The Company also sells standard-type lamps, which it manufactures at
its factory in India or sources from other manufacturers.
In fiscal 1999, the Company introduced its new line of Uni-FormŪ pulse start
products. Uni-FormŪ pulse start products are a new generation of metal halide
components and systems which permit (a) increased light output with lower power
utilization, (b) faster starting, (c) a quicker restart of lamps
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which have been recently turned off, and (d) better color uniformity. In fiscal
2001, the Company began to offer an expanded line of Uni-FormŪ pulse start
lighting components and systems. As part of the expanded line, the Company
offers unique retrofit kits that enable customers to convert to
second-generation metal halide products without having to replace the entire
lighting system. Many utility companies are offering rebates to their customers
who purchase the energy-efficient retrofit kits in order to encourage energy
conservation.
The Company also manufactures magnetic power supplies for HID lighting systems,
currently offering over 450 power supply products. The Company also sells
electronic power supplies and controls for metal halide lighting systems.
The Company also believes that it has a significant opportunity to work with
others on the application of metal halide technology to fiber optic lighting
systems. Because of metal halide lighting's ability to produce varied lighting
effects, it is particularly well suited to be adapted as the light source for
fiber optic lighting systems. Fiber optic lighting systems are currently used in
accent applications, such as swimming pool lighting or as replacement lighting
for neon lighting. In applications such as these, it is important that
electricity and heat be located separately from the desired point of light
emission.
Production Equipment
The Company has the expertise to manufacture and sell turnkey lamp production
manufacturing groups The Company has sold equipment to various unrelated
entities in China. A metal halide lamp production equipment group consists of up
to 50 different production machines. Each lamp production equipment group sells
for between approximately $1.0 million to $5.0 million. In order to maintain
manufacturing flexibility, the Company must continually update its own component
production equipment, through the internal design and fabrication of production
equipment. The Company has leveraged its manufacturing expertise by selling lamp
production equipment groups in international markets to independent companies or
to joint ventures with local lamp manufacturers. In connection with each lamp
production equipment group sale, the Company is required to provide lamp designs
and specifications, and production training, at the same time, creating a
customer for its materials products.
The Company also manufactures and markets turnkey deposition equipment to
produce thin film coatings for a variety of applications. These systems employ
sputtering technology to place optically precise thin coatings on lighting
components and other materials. When the Company sells a system to a customer,
the Company will either operate the system for the customer at the Company's
facility or transfer the system to the customer's facility.
International Sales
International sales aggregated $37.9 million (51% of net sales) for the six
months ended June 30, 2004, $34.8 million (49% of net sales) for the six months
ended December 31, 2003, $75.5 million (52% of net sales) for fiscal 2003, and
$62.2 million (37% of net sales) for fiscal 2002. For information regarding the
Company's international operations, see Note M to "Notes to Consolidated
Financial Statements."
Product Design and Development
Management believes one of its key strengths is its ability to design and
develop new products. The Company has dedicated research and development efforts
in each of its product lines having invested $19.3 million or 4.2% of net sales
into research and development over the last three full fiscal years. In the six
months ended June 30, 2004, the Company invested $2.8 million (3.8% of net
sales) in research
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and development; in the six months ended December 31, 2003, $3.1 million (4.4%
of net sales); in fiscal 2003, $6.5 million (4.5% of net sales); and in fiscal
2002, $6.9 million (4.2% of net sales). The Company has developed new
applications for metal halide lighting, improved the quality of its materials,
and introduced new specialized products, such as the Uni-FormŪ pulse start
products. Uni-FormŪ pulse start products are a new generation of metal halide
components and systems which permit (a) increased light output with lower power
consumption, (b) faster starting, (c) a quicker restart of lamps which have been
recently turned off, and (d) better color uniformity. Historically, the
Company's efforts primarily have been focused on the development of materials
and system components.
Materials
The Company is focused on improving the purity of, and production processes for,
metal halide salts. The Company pursues these efforts proactively as well as in
response to customer requests for specific metal halide salts. The Company
focuses on designing and developing improved electrodes, amalgams and getters
used in lamp manufacturing. The Company also expects to continue producing thin
film coatings primarily for lighting applications with particular emphasis on
coatings on lamp burners, as well as developing related software, and reliable,
cost-effective application processes.
Components and Systems
The Company's product design and development has focused on developing
innovative components to meet the specialized needs of various customers,
including lighting fixture OEMs. The Company's product design teams work
together with OEMs on the design, development and commercialization of new
system components. Such collaborative development efforts have resulted in the
design of improved metal halide lamps with reduced wattage, better energy
efficiency, smaller size and increased life expectancy.
Marketing and Distribution
The marketing and distribution of the Company's diverse range of commercial
products varies by individual product and by product category, as described
below. All sales data are exclusive of inter-company sales.
Materials
The Company markets materials (metal halide and other salts) and thin-film
coatings directly to other high intensity discharge lamp manufacturers,
primarily GE, Philips and Sylvania for use in their manufacture of lamps. The
Company also markets lamp materials to its joint venture partners. In addition,
the Company works very closely with its customers to manufacture materials
according to their specifications. Certain customer-developed materials are
considered proprietary to the Company's customers. Other lamp components
manufactured by the Company are used primarily in the manufacture of its own
lamps. The principal customers for the thin-film coating products of the Company
include major lamp manufacturers. In addition, the Company markets its thin-film
coatings to government suppliers for use in aerospace applications and to fiber
optic telecommunications systems manufacturers. Sales of materials accounted for
approximately 25.5% of the Company's revenues for the six months ended June 30,
2004, 24.3% for the six months ended December 31, 2003, 20.5% in fiscal 2003 and
15.5% in 2002.
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System Components
Electrical distributors typically market only standard-type lamps, and the
Company believes that its specialty lamp products do not lend themselves to the
traditional marketing channels associated with standard-type lamp products.
Accordingly, the Company has adopted innovative marketing techniques for its
lamps. As a result, in initial distribution, the Company markets its metal
halide system components through OEMs, which generally have been involved in the
design of the lamp, and commissioned lighting agents, who package the Company's
lamps and power supplies in their bids on construction or renovation projects.
Due to the fact that the Company's lamps are produced to the specifications
required to match a particular fixture or use by an OEM, the Company's lamp will
generally be included with the fixture each time the fixture is sold. The
Company intends to market complementary lamps and power supplies as a package to
provide better service to its OEM customers and lighting agents, as well as to
increase sales.
The Company also has distributed its metal halide lamps through lighting agents.
Unlike GE, Philips and Sylvania, which each have extensive local distributor
relationships, the Company has entered into agency agreements with lighting
agents who represent a full line of fixture manufacturers, under which the agent
receives a commission for selling the Company's lamps. The Company believes it
is the only major lamp manufacturer to distribute its products through lighting
agents. This relationship allows the lighting agent to package the Company's
metal halide lamps with the other products included in its bid on a project. By
bidding a more complete or unique package, the lighting agent has a competitive
advantage over less complete bids and, if selected, earns a commission on
Company lamps sold, which agents generally do not receive from other lamp
suppliers.
The Company intends to increase its sales of replacement lamps through direct
marketing by exploiting both the Company's internally developed capabilities.
Since 1994, the Company has printed its toll-free number on most lamps that it
sells, allowing a customer to call the Company, rather than an electrical
distributor, to order a replacement lamp. This enables the customer to speak to
a more knowledgeable representative, thereby increasing the accuracy and
efficiency of service to the end user. This interaction also allows the Company
to suggest enhanced products better suited for the end user's needs. In
addition, the Company telemarkets replacement lamps in connection with catalogue
distributions. Lamps are delivered by express courier to end users, thereby
providing service efficiency comparable to local electrical distributors.
Replacement lamps are typically sold at a higher gross margin than lamps sold
initially through OEMs or lighting agents.
In addition to packaging power supplies with lamps, the Company is continuing
direct marketing to OEMs and sales through electrical distributors. Sales of
system components accounted for approximately 66.1% of the Company's revenues
for the six months ended June 30, 2004, 66.6% for the six months ended December
31, 2003, 66.1% in fiscal 2003 and 55.4% in fiscal 2002.
Systems
Several of the Company's foreign operations market Ruud Lighting systems. Prior
to the sale of the Company's fixture subsidiaries in December 2001, most of the
Company's commercial lighting system sales were made by these subsidiaries and
were marketed primarily under the trade name "Ruud Lighting." Ruud Lighting
marketed and distributed its products primarily by direct marketing to lighting
contractors. In addition to fixture products that are sold by some of the
Company's foreign operations including fixtures purchased from Ruud Lighting,
the Company's remaining system products are "retrofit kits," which combine the
Company's lamps, power supplies and/or other components in a single system.
These retrofit kits allow an end user to replace the lighting system within an
installed fixture to improve
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lighting and/or energy efficiency with minimal out-of-pocket cost. By marketing
these retrofit metal halide systems, the Company believes it may capture a
greater market share in the metal halide industry. See also "Recent
Developments."
Systems accounted for approximately 5.7% of the Company's revenues for the six
months ended June 30, 2004, 6.5% for the six months ended December 31, 2003,
6.2% in fiscal 2003 and 26.6% in fiscal 2002.
Production Equipment
The Company's production equipment is manufactured for internal use and is
marketed to existing companies for turnkey production of thin-film coatings and
metal halide lamps. External sales of production equipment accounted for
approximately 2.7% of the Company's revenues for the six months ended June 30,
2004, 2.6% for the six months ended December 31, 2003, 7.2% in fiscal 2003 and
2.5% in fiscal 2002.
Manufacturing and Operations
The Company's lamp manufacturing facility in Chennai (Madras), India operates
six days a week, 16 hours a day, with the Company's lamp manufacturing employees
working in two eight-hour shifts each day. The Company's lamp manufacturing
facility in Solon, Ohio operates five days a week with one full shift and a
partial second shift. The manufacturing of metal halide lamps consists of three
primary processes. First, the quartz arc tube is shaped, electrodes for carrying
the current are installed, the metal halide salt dose is introduced and the arc
tube is sealed. The process is performed at high temperatures in carefully
controlled conditions to ensure that the arc tube is properly sealed and that no
impurities enter the arc tube. Second, the arc tube is mounted inside a
borosilicate glass container and sealed. Finally, the lamp is finished by adding
an electrical contact. Although light output of metal halide lamps is not
affected by ambient temperatures, an outer bulb is used to prevent contact with
the arc tube, which operates at extremely high temperatures. Quartz and
borosilicate glass are used in the production of metal halide lamps because of
their durability and ability to retain shape and function at extremely high
temperatures. Finished lamps are inspected, tested and then shipped in
accordance with customer instructions. The Solon facility also houses research
and development operations and lamp production equipment operations.
The Company produces magnetic power supplies at its facility in Amherst, Nova
Scotia, which operates five days a week with one full shift and a partial second
shift. The Company also produces magnetic power supplies at its facility in
Chennai (Madras) India, which operates six days a week with two full shifts. The
manufacture of magnetic power supplies is a combination of batch and production
line processes. The production line process starts with a coil winding
department, progresses to an in-line coil and core operation and then to final
assembly. Subassemblies for ignitors and capacitors are located off-line in a
batch operation for inclusion in final assembly.
The Company produces all of the metal halide salts it uses and sells at its
facility in Urbana, Illinois. The Urbana facility, with approximately 90
employees working a single shift, also produces precision metal pieces and
high-speed dispensers for salts and metal pieces that are used by the Company
and sold to other metal halide lamp manufacturers.
At the Company's facility in Santa Rosa, California, the Company produces
optical thin film coatings for a variety of applications, as well as equipment
for deposition of thin film coatings. The facility operates five days per week
with three eight-hour shifts per day. Coatings and systems are produced in
accordance with exacting customer specifications. Management believes that its
optical coatings operation has
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expertise over a broad range of thin film deposition technologies allowing
application of the coating technology most suitable for a particular client
need.
Raw Materials and Suppliers
The Company sources its raw materials from a variety of suppliers. Presently, it
sources most of its quartz tubing and borosilicate glass bulbs for lamps from GE
and Osram-Sylvania. Although an interruption in these supplies could disrupt the
Company's operations, the Company believes that alternative sources of supply
exist and could be arranged prior to the interruption having a material adverse
effect on the Company's operations or sales. The materials for the Company's
power supply products are readily available on the open market. The Company also
purchases certain of its industrial standard-type lamps from GE.
Most of the raw materials used in the production of metal halide salts can be
sourced from several suppliers. The Company has been the dominant supplier of
metal halide salts to the metal halide lamp industry for many years. Therefore,
the Company has focused on addressing any circumstance that could jeopardize the
continued production of these vital materials. In this regard the Company has a
40% ownership interest in Aldrich-APL LLC, a manufacturer and distributor of
ultra-pure inorganics and metals for high-technology applications, which serves
as one of the Company's raw materials suppliers. Since the Company is the
primary supplier of metal halide salts to the metal halide lamp industry, any
disruption in supply would also affect each producer of the affected lamp type.
Raw materials and components for coatings and equipment are sourced from outside
suppliers. The Company has multiple qualified sources for critical materials and
components.
Competition
General
Metal halide systems compete with other types of lighting technology for many
applications. The Company's metal halide lamps compete with lamps produced by
other metal halide lamp manufacturers, primarily GE, Philips and Osram-Sylvania.
Metal halide technology is the newest of all lighting technologies and although
the market awareness and the uses of metal halide lamps continue to grow,
competition exists from older technologies in each metal halide application.
Materials
The Company produces materials that are used by the Company and virtually all
other manufacturers of metal halide lamps. In metal halide salts, where the
Company has successfully used its technology focus and manufacturing capability
to develop superior products, the Company believes it has no competitors in the
United States and only several smaller competitors internationally. The
competition in salts is based on the technological ability to develop salt
formulation for customers and maintain product uniformity and purity. The
Company believes it is the leading producer of salts because it is the leader in
uniformity and purity. In other materials categories, the Company's chief
competition is internal production by GE, Philips and Sylvania. The competition
in these products is based primarily on price and delivery, with some
competition based on technological ability to create solutions for unique
applications. The Company's products compete most effectively for external sales
where they are created for unique applications.
The Company's optical coatings unit has one or two principal competitors in each
of its traditional markets (lighting, coating equipment and
government/aerospace). The Company believes that
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competition in thin film coatings is generally based on quality of coatings,
technological expertise to design and deliver customized coating solutions and
customer service. The Company believes that it competes successfully on the
basis of all three of these measures. While competition is strenuous with these
existing competitors, management believes that the high technical content of the
products and services in these markets make entry by new thin film coating
manufacturers relatively difficult.
System Components
GE, Philips and Sylvania are the Company's principal competitors in the
production of metal halide lamps. Although GE, Philips and Sylvania have focused
their efforts on the larger incandescent and fluorescent markets, all three
companies produce metal halide lamps. These three companies have emphasized
sales of a relatively small variety of standard-type metal halide lamps, such as
those found in the most common commercial and industrial applications, which the
Company believes represents approximately 75% of the total metal halide lamp
segment.
Although the Company believes its technical and engineering expertise in the
production of specialty metal halide lamps and its unique marketing approach
give it a competitive advantage in this market, the Company's three primary
competitors have significantly longer operating histories, substantially greater
financial, technical and other resources and larger marketing and distribution
organizations than the Company and could expand their focus into specialty
lamps.
The Company does not believe that the foreign lamp manufacturers to whom the
Company has sold lamp production equipment compete with the Company's specialty
products. Due to the technical and engineering expertise required to produce a
new type of metal halide lamp, these purchasers have typically only produced the
standard-type lamps in which the Company has trained them. Although these
purchasers could potentially produce specialty lamp types to compete with the
Company, these purchasers would need to develop or acquire the expertise
required to produce specialty metal halide lamps.
The Company's power supply products compete primarily with products of two
manufacturers, Advance Transformer, a subsidiary of Philips, and
Universal/MagneTek, both headquartered in the United States. Both these
companies have focused on the large fluorescent power supply market whereas the
focus of the Company's power supply operations has been in HID magnetic power
supplies for use primarily in metal halide applications. Competition in power
supplies has traditionally depended on price and delivery, which has resulted in
the failure to develop power supplies to optimize metal halide lighting systems.
The Company's power supply operations intend to compete on the ability to
deliver power supplies that are designed to enhance performance of metal halide
lighting systems.
Systems
Lighting systems compete on the basis of system cost, operating cost, quality of
light and service. The Company feels that metal halide systems compete
effectively against other technologies in each of these areas in many
applications. The lighting systems market is highly fragmented. Competitors
generally market their systems through distributors and lighting agents.
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Intellectual Property
The Company relies primarily on trade secret, trademark, and patent laws to
protect its rights to certain aspects of its products, including proprietary
manufacturing processes and technologies, product research and concepts and
trademarks, all of which the Company believes are important to the success of
its products and its competitive position. In the past, the Company has
successfully taken legal action to enjoin misappropriation of trade secrets by
other parties. Any litigation involving misappropriation of the Company's trade
secrets or other intellectual property rights could require the Company to
increase significantly the resources devoted to such efforts. The patent
positions of companies such as the Company can be highly uncertain and involve
complex legal and factual questions, and therefore the breadth of claims allowed
in such patents and their enforceability cannot be predicted. Nevertheless, as
an innovation-driven designer and manufacturer, the Company will continue to
develop new products and processes and will seek to protect its rights through
the continued use of patents and other means.
Environmental Regulation
The Company's operations are subject to federal, state, local and foreign laws
and regulations governing, among other things, emissions to air, discharge to
waters and the generation, handling, storage, transportation, treatment and
disposal of waste and other materials as well as laws relating to occupational
health and safety. The Company believes that its business, operations and
facilities are being operated in compliance in all material respects with
applicable environmental and health and safety laws and regulations, many of
which provide for substantial fines and criminal sanctions for violations.
However, the operations of manufacturing plants entail risks in these areas,
which could potentially result in significant expenditures in order to comply
with evolving environmental and health and safety laws, regulations or
requirements that may be adopted or imposed in the future.
The Company believes that the overall impact of compliance with regulations and
legislation protecting the environment will not have a material effect on its
future financial position or results of operations. Capital expenditures and
operating expenses in fiscal 2004, fiscal 2003 and fiscal 2002 attributable to
compliance with such legislation were not material.
Employees
As of June 30, 2004, the Company had approximately 1,480 full-time employees,
consisting of employees engaged in the designing, manufacturing and marketing of
materials (170 employees), system components and systems (1,278 employees), and
production equipment (20 employees) and 12 employees in corporate/administrative
services. The Company believes that its employee relations are good. The
Company's employees are not represented by any collective bargaining
organization, and the Company has never experienced a work stoppage.
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