UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission files number: 0-2537
OPTICAL COATING LABORATORY, INC.
(Exact name of Registrant as specified in its charter)
Delaware 68-0164244
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2789 Northpoint Parkway
Santa Rosa, California 95407-7397
(Address of principal executive offices) (Zip code)
707-545-6440
(Registrant's telephone number including area code)
Not applicable
(Former name, former address, and former fiscal year, if changed since
last report)
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 [X] No [ ]
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of
securities under a plan confirmed by a court. Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
TITLE OUTSTANDING
----- -----------
Common Stock, $.01 par value 13,975,646 at May 31, 1999
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------
APRIL 30, OCTOBER 31,
ASSETS 1999 1998
=============================================================================
(Amounts in thousands) (Unaudited)
CURRENT Cash and cash equivalents............... $34,978 $40,880
ASSETS Accounts receivable, net of allowance for
doubtful accounts of $2,005 and $1,831. 35,835 38,585
Inventories............................. 20,958 25,233
Income taxes receivable................. 1,543
Deferred income tax assets.............. 5,358 9,311
Other current assets.................... 1,840 1,822
------- --------
Total Current Assets 100,512 115,831
OTHER Goodwill................................ 17,305 910
ASSETS Deferred income tax assets.............. 716
Property, plant and equipment held for sale 493 3,183
Other assets............................ 13,293 3,241
PROPERTY, Land and improvements................... 9,109 9,116
PLANT AND Buildings and improvements.............. 36,989 36,171
EQUIPMENT Machinery and equipment ................ 132,282 123,261
Construction-in-progress................ 11,596 12,722
------- --------
189,976 181,270
Less accumulated depreciation........... (93,066) (91,565)
------- --------
Property, plant and equipment-net .... 96,910 89,705
------- --------
Total Assets..................... $228,513 $213,586
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT Accounts payable....................... $ 9,569 $ 8,423
LIABILITIES Accrued expenses....................... 7,958 9,935
Accrued compensation expenses.......... 10,164 10,365
Income taxes payable................... 178 708
Current maturities on long-term debt... 4,148 6,026
Notes payable.......................... 4,483
Deferred revenue....................... 5,483 761
------- -------
Total Current Liabilities ...... 37,500 40,701
NONCURRENT Accrued postretirement health benefits
LIABILITIES and pension liabilities............... 2,300 2,241
Deferred revenue....................... 900
Deferred income tax liabilities........ 9,308 3,528
Long-term debt ........................ 58,187 52,373
Minority interest...................... 12,520
Commitments and contingencies
STOCKHOLDERS'Common stock, $.01 par value; authorized
EQUITY 30,000,000 shares; issued and outstanding
12,637,000 and 12,087,000 shares...... 126 121
Paid-in capital........................ 82,440 69,993
Retained earnings...................... 38,026 31,951
Accumulated other comprehensive income (274) 158
------- --------
Stockholders' Equity.................. 120,318 102,223
------- --------
Total Liabilities and Stockholders' Equity $228,513 $213,586
======== ========
The accompanying notes are an integral part of these financial
statements.
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
-------------------------------------------
<PAGE>
(Unaudited)
For the three and six month periods ended April 30, 1999 and 1998
(Amounts in thousands, except per share amounts)
THREE MONTHS SIX MONTHS
------------ -----------
1999 1998 1999 1998
REVENUES Revenues....................... $83,994 $64,345 $153,845 $117,718
Cost of sales.................. 57,650 42,484 106,282 78,719
------- ------- -------- --------
Gross Profit................ 26,344 21,861 47,563 38,999
COSTS AND Operating Expenses:
EXPENSES Research and development ..... 5,450 4,026 10,094 7,847
Selling and administrative.... 11,205 11,171 21,398 20,659
Amortization of intangibles... 580 198 797 398
Loss on asset disposal........ 934 934
Legal settlement, net......... (2,960)
In process research and develop-
ment charges 2,906
------ ------ ------ ------
Total Operating Expenses...... 18,169 15,395 33,169 28,904
------ ------ ------ ------
Income From Operations...... 8,175 6,466 14,394 10,095
Nonoperating Income (Expense):
Interest income .............. 304 81 622 165
Interest expense.............. (1,028) (927) (1,987) (1,735)
------ ----- ------ ------
EARNINGS Income before provision for income taxes
and minority interest......... 7,451 5,620 13,029 8,525
Provision for income taxes..... 2,683 2,163 5,737 3,325
Minority interest.............. 408 491 555
----- ----- ------ ------
Net Income.................. 4,768 3,049 6,801 4,645
Dividend on convertible redeem-
able preferred stock.......... 125 250
------ ------ ------ ------
Net Income Applicable to
common stock............. $4,768 $2,924 $6,801 $4,395
====== ====== ====== ======
Net Income Per Share, Basic... $ .38 $ .27 $ .55 $ .41
====== ====== ====== ======
Net Income Per Share, Diluted. $ .34 $ .25 $ .51 $ .38
====== ====== ====== ======
Weighted Average Number of Common
Shares Used to Compute Basic
Earnings Per Share........... 12,400 10,903 12,273 10,767
====== ====== ====== ======
Weighted Average Number of Common
Shares Used to Compute Diluted
Earnings Per Share........... 13,827 11,553 13,350 11,478
====== ====== ====== ======
The accompanying notes are an integral part of these financial
statements.
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
(Unaudited)
For the three and six month periods ended April 30, 1999 and 1998
THREE MONTHS SIX MONTHS
------------ -------------
(Amounts in thousands) 1999 1998 1999 1998
OPERATIONS Cash Flows From Operations:
<PAGE>
Cash received from customers...... $65,336 $54,208 $118,544 $96,270
Interest received................. 212 67 583 118
Cash paid to suppliers and
employees....................... (40,993)(43,918) (81,259)(90,848)
Interest paid..................... (1,580) (613) (2,103) (1,421)
Income taxes paid, net of refunds. 660 174 (176) 146
------- ------- ------- -------
Net Cash Provided By (Used For)
Operations.................... 23,635 9,918 35,589 4,265
------- ------- ------- -------
INVESTMENTS Cash Flows From Investments:
Purchase of plant and equipment... (6,462) (4,065) (11,517) (8,326)
Purchase of remaining interest in
Flex Products................... (30,035)
Purchase of OPKOR, net of cash
acquired........................ (305) (305)
Proceeds from sale of MMG assets.. 4,084 4,084
Proceeds from sale of equipment... 945 162 1,193 216
------ ------ ------- ------
Net Cash Used For Investments... (1,738) (3,903) (36,580) (8,110)
------ ------ ------- ------
FINANCING Cash Flows From Financing:
Proceeds from long-term debt...... 1,121 3,044 1,168 9,818
Repayment of long-term debt....... (3,838) (6,686) (5,239)(13,250)
Repayment of notes payable........ (192) (9)
Proceeds from exercise of stock
options......................... 1,476 304 2,325 638
Proceeds from note to minority
stockholder..................... 800
Purchase of note from minority
stockholder..................... (2,400) (2,600)
Payment of dividend on preferred stock (83) (208)
Payment of dividend on common stock (726) (636)
------ ------ ------ ------
Net Cash Used For Financing..... (1,241) (3,613) (4,872) (5,447)
------ ------ ------ ------
Effect of exchange rate changes
on cash......................... (2) 29 (39) (75)
------ ------ ------ ------
Increase (decrease) in cash and
cash equivalents................ 20,654 2,431 (5,902) (9,367)
Cash and cash equivalents at
beginning of period............. 14,324 3,419 40,880 15,217
------ ------ ------ ------
Cash and cash equivalents at
end of period.................. $34,978 $ 5,850 $34,978 $ 5,850
======= ======= ======= =======
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
-----------------------------------------------
(Unaudited)
For the three and six months ended April 30, 1999 and 1998
THREE MONTHS SIX MONTHS
------------- ------------
(Amounts in thousands) 1999 1998 1999 1998
ADJUSTMENTS
Reconciliation of Net Income
To Cash Flows From Operations:
Net income....................... $4,768 $3,049 $6,801 $4,645
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization ... 3,513 3,130 6,498 6,115
Minority interest in earnings of
subsidiaries.................... 408 491 557
Loss on disposal of equipment ... 1,065 159 1,374 313
Accrued postretirement health
benefits........................ 27 40 55 80
Other non-cash adjustments to net
income.......................... (78) (264) 687 207
Change in:
Accounts receivable.............. 3,753 787 2,848 (2,577)
Inventories...................... 351 (2,276) 2,558 (4,280)
Income taxes receivable and
income taxes payable........... 2,650 1,688 196 1,923
Deferred income tax assets and
liabilities..................... 1,068 473 10,226 1,074
Other current assets and other
assets and investments.......... (980) 124 (1,272) (950)
<PAGE>
Accounts payable, accrued expenses
and accrued compensation expenses 6,669 2,315 (495) (4,193)
Deferred revenue................. 829 285 5,622 1,351
------ ----- ------ -----
Total adjustments.............. 18,867 6,869 28,788 (380)
------ ----- ------ -----
Net Cash Provided By Operations $23,635 $9,918 $35,589 $ 4,265
======= ====== ======= =======
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In the first quarter of fiscal 1999 and in the first quarter of fiscal
1998, the Company issued 39,914 and 39,292 shares of common stock to
the OCLI 401(k)/Employee Stock Ownership Plan at fair market value to
satisfy a portion of its Company contributions.
In February 1999, the Company purchased OPKOR Inc. (OPKOR) for $9.0
million plus annual contingent payments in OCLI common stock based on
profits of the acquired entity. The initial $9.0 million was paid in
the form of $1.8 million in cash and 267,285 shares of OCLI common
stock. Cash and non-cash components of the acquisition were as
follows:
Fair value of assets acquired, including intangibles $13,615
Liabilities assumed (4,980)
-------
Initial consideration plus acquisition expenses 8,635
Fair value of OCLI common stock issued to sellers (7,200)
Cash acquired (1,130)
-------
Net cash paid $ 305
=======
The accompanying notes are an integral part of these financial
statements.
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
---------------------------------------------------------
AND COMPREHENSIVE INCOME
------------------------
For the three and six month periods ended April 30, 1999 and 1998
(Unaudited)
PREFERRED STOCK COMMON STOCK
----------------- --------------- PAID-IN RETAINED
(Amounts in thousands) SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS
==============================================================================
BALANCE AT NOVEMBER 1, 1998 12,087 $ 121 $69,993 $31,951
Shares issued to Employee
Stock Ownership Plan 40 933
Exercise of stock options,
including tax benefit 88 1 1,194
Dividend on common stock (726)
Net income 2,033
Other comprehensive income,
net of taxes:
Foreign currency trans-
lation adjustment
BALANCE AT JANUARY 31, 1999 12,215 122 72,120 33,258
Shares issued to Employee Stock
Ownership Plan
Exercise of stock options,
including tax benefit 155 1 3,123
Issuance of shares for
acquisition 267 3 7,197
Dividend on common stock
Net income 4,768
Other comprehensive income,
net of taxes:
Foreign currency trans-
lation adjustment
BALANCE AT APRIL 30, 1999 12,637 $ 126 $82,440 $38,026
ACCUMULATED
OTHER
COMPREHENSIVE COMPREHENSIVE
INCOME INCOME
============================================================================
BALANCE AT NOVEMBER 1, 1998 $ 158
Shares issued to Employee
Stock Ownership Plan
Exercise of stock options,
including tax benefit
Dividend on common stock
Net income $ 2,033
Other comprehensive income,
net of taxes
Foreign currency translation
adjustment (127) (127)
BALANCE AT JANUARY 31, 1999 31 1,906
Shares issued to Employee Stock
Ownership Plan
Exercise of stock options, including
tax benefit
Issuance of shares for acquisition
Dividend on common stock
Net income 4,768
Other comprehensive income, net
of taxes
Foreign currency translation
adjustment (305) (305)
Comprehensive income three
months ended April 30, 1999 4,463
BALANCE AT APRIL 30, 1999 $(274) $6,369
PREFERRED STOCK COMMON STOCK
--------------- --------------- PAID-IN RETAINED
(Amounts in thousands) SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS
=============================================================================
BALANCE AT NOVEMBER 1, 1997 6 $5,559 10,599 $ 106 $55,723 $26,217
Shares issued to Employee
Stock Ownership Plan 39 1 555
Exercise of stock options
including tax benefit 33 383
Dividend on common stock (125)
Dividend on preferred stock (636)
Net income 1,596
Other comprehensive income,
net of taxes
Foreign currency translation
adjustment
BALANCE AT JANUARY 31, 1998 6 5,559 10,671 107 56,661 27,052
Shares issued to Employee
Stock Ownership Plan
Exercise of stock options,
including tax benefit and
note receivable to related
party 808 8 6,304
Conversion of preferred stock
to common stock (6) (5,559) 599 6 5,595
Dividend on preferred stock (125)
Dividend on common stock
Net income 3,049
Other comprehensive income,
net of taxes
Foreign currency translation
adjustment
BALANCE AT APRIL 30, 1998 0 $ 0 $12,078 $ 121 $68,560 $29,976
ACCUMULATED
NOTE OTHER
RECEIVABLE FROM COMPREHENSIVE COMPREHENSIVE
RELATED PARTY INCOME INCOME
============================================================================
BALANCE AT NOVEMBER 1, 1997 $ (642)
Shares issued to Employee
Stock Ownership Plan
Exercise of stock options,
including tax benefit
Dividend on preferred stock
Dividend on common stock
Net income 1,596
Other comprehensive income,
net of taxes
Foreign currency translation
adjustment (942) (942)
BALANCE AT JANUARY 31, 1998 (1,584) 654
Shares issued to Employee
Stock Ownership Plan
Exercise of stock options,
including tax benefit and
note receivable to related
party
Conversion of preferred stock
to common stock
Dividend on preferred stock
Dividend on common stock
Net income 3,049
Other comprehensive income,
net of taxes
Foreign currency translation
adjustment 350 350
Comprehensive income three
months ended April 30, 1998 3,399
BALANCE AT APRIL 30, 1998 $(1,234) $4,053
OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
Three and Six Month Periods Ended April 30, 1999 and 1998
(Unaudited)
1. GENERAL
- ------------
NATURE OF OPERATIONS. OCLI designs, develops and manufactures
multi-layer thin film coatings which control and enhance light by
altering the transmission, reflection and absorption of its various
wavelengths to achieve a desired effect such as anti-reflection, anti-
glare, electromagnetic shielding, electrical conductivity and abrasion
resistance. OCLI markets and distributes components to original
equipment manufacturers (OEMs) of optical and electro-optical systems
and sells its Glare/Guard(R) brand ergonomic computer display products
through resellers and office retailers. OCLI's products are found in
many applications including computer monitors, flat panel displays,
telecommunication systems, office equipment, medical/analytical
equipment and instruments, projection imaging systems, satellite power
systems and aerospace and defense systems. Through its wholly owned
<PAGE>
subsidiary, Flex Products, Inc. (Flex), the Company designs and
manufactures thin film coatings on flexible substrates using high
vacuum roll-to-roll processes. Flex supplies critical pigments for use
in anti-counterfeiting applications, energy conserving window film for
residential and commercial applications and ChromaFlair(R) light
interference pigments for commercial paints.
INTERIM FINANCIAL INFORMATION. The Condensed Consolidated Balance
Sheet as of April 30, 1999, the Condensed Consolidated Statements of
Income for the three and six month periods ended April 30, 1999 and
1998, the Condensed Consolidated Statements of Stockholders' Equity
and Other Comprehensive Income for the three and six month periods
ended April 30, 1999 and 1998 and the Condensed Consolidated
Statements of Cash Flows for the three and six month periods ended
April 30, 1999 and 1998, have been prepared by the Company without
audit. In the opinion of management, all adjustments consisting of
normal recurring accruals, necessary to present fairly the financial
position, results of operations and cash flows at April 30, 1999 and
for all periods presented have been made.
The results of operations for the period ended April 30, 1999 are not
necessarily indicative of the operating results anticipated for the
full year.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. It is suggested
that these condensed consolidated financial statements be read in
conjunction with the financial statements and notes included in the
Company's Annual Report on Form 10-K for the year ended October 31,
1998, and other disclosures, including Risk Factors, included in the
Company's Registration Statement on Form S-3 (Registration No. 333-
76853) filed May 21, 1999.
2. COMPREHENSIVE INCOME
- -------------------------
In the first quarter of 1999, the Company adopted the provisions of
SFAS No. 130 "Reporting Comprehensive Income," which required the
Company to report, by major component and in total, all changes to
equity from non owner sources. The Company's Condensed Consolidated
Statement of Stockholders' Equity has been changed to Condensed
Consolidated Statements of Stockholders' Equity and Comprehensive
Income. Comprehensive income consists of foreign currency translation
adjustments which are reported as a separate component of equity.
Accumulated comprehensive income presented on the Condensed
Consolidated Balance Sheets and the Condensed Consolidated Statements
of Stockholders' Equity and Comprehensive Income consists of
cumulative foreign currency translation adjustments.
3. LOSS ON ASSET DISPOSAL
- ----------------------------
In the fourth quarter of fiscal 1998, due to excess capacity, the
Company removed from service and began negotiations for the sale of a
large continuous coating machine. As sales price estimates at that
time and for subsequent quarters exceeded the carrying amount of the
equipment, losses were previously not recorded. In the second quarter
of 1999, due to the need for manufacturing space, the Company made the
<PAGE>
decision to accelerate the sale of the machine and to sell the machine
for less than book value, if necessary. Consequently, the machine,
with a carrying value of $1.4 million was sold for $460,000 net of
removal and shipping costs and the Company recognized a loss of
$934,000 on the sale of the machine.
4. LEGAL SETTLEMENT
- ---------------------
On January 15, 1999, the Company announced that it had settled a
lawsuit with Optical Corporation of America and certain of its
shareholders regarding a failed merger in fiscal 1996. The Company
received cash, net of related legal expenses, of $3.0 million, which
was recorded as a benefit in the six month period ended April 30,
1999.
5. DISPOSALS AND ACQUISITIONS
- -------------------------------
In the first quarter of 1999, Glas-Trosch GmbH, a privately held glass
company in Switzerland, purchased the business and operating assets
(inventory, equipment, furniture, two buildings, workforce, customer
lists and other related intangibles) of the Company's manufacturing
subsidiary in Germany (MMG) for $4.3 million. As the Company had
previously recorded an impairment loss to reduce MMG's assets to fair
value on a liquidation basis, no gain or loss was recognized on the
sale. An office building in Germany, with a carrying value of
$493,000, which was not part of the sale, is being held for sale.
In connection with the sale of MMG, the Company also received $1.2
million for a three-year covenant not to compete and $600,000 for a
three-year license and supply agreement that incorporates the use of
the OCLI name. The $1.8 million received for those contracts is being
recognized as revenue over the three-year terms of the agreements.
In December 1998, the Company acquired the 40% minority interest in
Flex held by SICPA Holding S.A. for $30 million, bringing the
Company's ownership in Flex to 100%. The transaction was recorded as
a purchase in the first quarter of fiscal year 1999 based on data
provided in an independent valuation. Pursuant to this transaction,
the Company recorded a charge for in-process research and development
of $2.9 million, goodwill of $9.8 million which will be amortized
over 15 years, and identifiable intangibles of $10.1 million which
will be amortized over useful lives ranging from 11 to 15 years.
Goodwill and identifiable intangibles are included in other assets.
In connection with the Company's acquisition of the 40% interest in
Flex, the Company purchased SICPA's $2.4 million dollar working
capital loan and the License and Supply Agreement between Flex and
SICPA that runs through October 31, 2009, was modified to increase
SICPA's minimum purchase requirements in association with Flex's
commitment to put in place additional capacity to manufacture
optically variable pigment.
In February 1999, the Company purchased OPKOR Inc. (OPKOR), an optical
design and manufacturing company specializing in precision polymer
optic components and assemblies, for $9.0 million plus annual
contingent payments in our common stock based on profits of the
<PAGE>
acquired entity. The initial $9.0 million was paid in the form of
$1.8 million in cash and 267,285 shares of OCLI common stock. The
cumulative amount of the contingent payments cannot exceed the lower
of 267,285 shares or the number of shares equal in value to $18.0
million. Pursuant to this transaction, the Company recorded goodwill
of $7.0 million that is being amortized over 10 years.
6. EARNINGS PER SHARE
- -----------------------
The following is a reconciliation of the numerators and denominators
of the basic and diluted earnings per share computations for the three
and six month periods ended April 30, 1999 and 1998:
(Amounts in thousands, except per share amounts)
THREE MONTHS SIX MONTHS
------------- --------------
1999 1998 1999 1998
BASIC SHARES:
Average common shares outstanding 12,400 10,903 12,273 10,767
====== ====== ====== ======
Net income $4,768 $3,049 $6,801 $4,645
Less dividend on convertible redeemable
preferred stock (125) (250)
------ ------ ------ ------
Net income applicable to common stock $4,768 $2,924 $6,801 $4,395
====== ====== ====== ======
Net income per common share, basic $ 0.38 $ 0.27 $ 0.55 $ 0.41
====== ====== ====== ======
DILUTED SHARES:
Average common shares outstanding 12,400 10,903 12,273 10,767
Dilutive effect of employee stock options 1,427 650 1,077 711
------ ------ ------ ------
Average shares outstanding, diluted 13,827 11,553 13,350 11,478
====== ====== ====== ======
Net income applicable to common stock $4,768 $2,924 $6,801 $4,395
====== ====== ====== ======
Net income per share, diluted $ 0.34 $ 0.25 $ 0.51 $ 0.38
====== ====== ====== ======
In the second quarter of fiscal 1999, the Company restructured the
equity of Flex. As a result of this restructuring, in order to make
the option holders whole under the provisions of Flex's option plan,
the Company exchanged options for the exercise of 928,200 shares of
Flex at a weighted average exercise price of $4.54 per share for
options to exercise 324,157 shares of Company common stock at a
weighted average exercise price of $12.99 per share. The exchange was
based on the ratio of the market value per share of Flex (based on an
independent valuation) to the market value of Company common stock on
the date of the equity restructuring. The per share exercise price
for each converted Flex option was based on the share of Company
common stock on the date of the equity restructuring.
Options to purchase 21,500 shares of common stock at a weighted
average price of $45.32 that were outstanding during the second
<PAGE>
quarter of 1999 and options to purchase 66,500 shares of common stock
at a weighted average price of $32.17 that were outstanding during the
six month period ended April 30, 1999 were not included in the
computation of diluted earnings per share because the exercise price
was greater than the average market price of the common shares. The
options, which expire in 2006, were still outstanding at April 30,
1999.
On May 26, 1999, the Company completed a public offering for the sale
of 1.3 million shares of OCLI common stock. The proceeds of the
offering, net of discounts, offering fees and estimated expenses, were
$85.9 million.
7. RESTRUCTURING PAYMENTS
- ---------------------------
In fiscal 1998, the Company accrued $586,000 of restructuring
expenses, all of which have been paid prior to April 30, 1999.
8. LONG-TERM DEBT
- -------------------
The Company has certain financial covenants and restrictions under its
bank credit arrangements and unsecured senior notes. In January 1999,
the Company and the bank executed an amendment to the Company's credit
agreement which removed the impairment loss and restructuring charges
recorded in fiscal year 1998 from the Company's financial covenant
calculation.
In February 1999, the Company and the bank executed an amendment to
the Company's credit agreement increasing the amount available under
its revolving line of credit from $20 million to $40 million.
In March 1999, the Company replaced the credit facilities of its
subsidiary in Japan with an $8.3 million two year revolving credit
facility of which $5.4 million is outstanding at April 30, 1999. The
term of the facility expires on March 15, 2001 with principal to be
paid by that date. Interest at the Tokyo Interbank Offer Rate plus
1.25 percent (currently 1.6% per year) is payable quarterly. In
addition, the Japanese subsidiary has a $1.7 million accounts
receivable discounting facility under which there were no borrowings
at April 30, 1999.
On April 30, 1999, OPKOR, the Company's new subsidiary, was out of
compliance with one of its debt covenants for which the bank issued a
waiver dated April 30, 1999. On May 27, 1999, the Company and the
bank entered into an amendment changing the covenant requirements
under the loan agreement expected to bring OPKOR into compliance in
future periods. The $2.5 million note, which is guaranteed by one of
OPKOR's customers, carries interest at a rate of 5.72% with monthly
payments of interest only until January 1, 2000 when it will convert
to a monthly amortizing term loan if the bank and the guarantor do not
extend the note.
9. FINANCIAL DERIVATIVES AND HEDGING
- --------------------------------------
<PAGE>
The Company from time to time enters into derivative transactions in
order to hedge foreign currency risk on existing commitments, open
receivables, payables and debt instruments when the currency risk is
considered material to the Company. In addition, the Company may
enter into interest rate swaps or similar instruments in order to
reduce interest rate risk on its debt instruments. The Company does
not enter into derivatives for trading purposes.
At April 30, 1999, the Company had outstanding foreign currency
forward contracts for the principal and interest payments under a $3.2
million loan denominated in German marks and for the principal and
interest payments under an intercompany note receivable denominated in
British Pounds. The notional amounts, carrying amounts and fair
values of the Company's derivative position at April 30, 1999 are
included in the table below:
ESTIMATED FAIR
VALUE OF
FOREIGN
NOTIONAL CARRYING EXCHANGE
(Amounts in thousands) AMOUNT AMOUNT CONTRACT
============================================================================
Foreign currency forward exchange
contracts:
Deutsche Marks $ 3,608 $ 0 $ (50)
British Pounds 2,760 0 124
10. INVENTORIES
- ------------------------
Inventories consisted of the following:
APRIL 30, OCTOBER 31,
(Amounts in thousands) 1999 1998
============================================================================
Raw materials and supplies $ 6,324 $ 7,138
Work-in-process 10,110 13,148
Finished goods 4,524 4,947
------- -------
Total inventories $20,958 $25,233
======= =======
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CERTAIN STATEMENTS UNDER THE CAPTIONS, "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS","RISK FACTORS" AND
ELSEWHERE IN THIS FILING ON FORM 10-Q ARE "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED (THE "SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE FORWARD-LOOKING
STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, STATEMENTS ABOUT OUR PLANS,
OBJECTIVES, EXPECTATIONS AND INTENTIONS AND OTHER STATEMENTS CONTAINED
IN THIS FILING ON FORM 10-Q THAT ARE NOT HISTORICAL FACTS. WHEN USED
IN THIS FILING ON FORM 10-Q, THE WORDS "EXPECT," "ANTICIPATE,"
"INTEND," "PLAN," "BELIEVE," "SEEK," "ESTIMATE" AND SIMILAR
EXPRESSIONS ARE GENERALLY INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. BECAUSE THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES, THERE ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY THESE
FORWARD-LOOKING STATEMENTS, INCLUDING OUR PLANS, OBJECTIVES,
EXPECTATIONS AND INTENTIONS AND OTHER FACTORSDISCUSSED UNDER "RISK FACTORS"
AND IN INFORMATION CONTAINED IN OUR PUBLICLY AVAILABLE FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. WE ASSUME NO OBLIGATION TO UPDATE SUCH
FORWARD-LOOKING STATEMENTS OR TO UPDATE THE REASONS ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING
STATEMENTS.
OVERVIEW
We are a worldwide leader in optical thin film coating technologies with
over 50 years of experience developing thin film coating processes for
government and industry. We have built a portfolio of products that
incorporate high performance optical thin films used to manage light. Our
products control, enhance and modify the behavior of light by utlizing its
reflection, absorption and transmission properties to achieve commercially
important effects such as high reflectivity, anti-glare and spectral
filtering. By integrating superior process capabilities with advanced
product design, se provide complete optical solutions that address a range
of end-market applications in growing markets.
Our products control, enhance and modify the behavior of light by
utilizing its reflection, absorption and transmission properties to
achieve commercially important effects such as high reflectivity,
anti-glare and spectral filtering. By integrating superior process
capabilities with advanced product design, we provide complete optical
solutions that address a range of end-market applications.
TELECOMMUNICATIONS. We manufacture and sell optical components for
fiber optic communications systems including WDM products. We also
sell optical components used on satellites for solar power generation,
thermal control and other functions.
LIGHT INTERFERENCE PIGMENTS. Through Flex, we manufacture and sell
optically variable pigments used to prevent counterfeiting of the
world's currencies and other value documents and for use in paints for
automobiles and other consumer products.
DISPLAY. We manufacture and sell optical components used in cathode
ray tube (CRT) displays, flat panel displays and projection display
products such as large-screen projection televisions and business
projection systems. We are also developing optical components for
next generation computer monitors.
AEROSPACE AND INSTRUMENTATION. We manufacture and sell optical
components, including precision polymer optics, used in defense and
aerospace products, automated data collection products, and medical,
scientific and analytical instruments.
OFFICE AUTOMATION. We manufacture and sell optical components,
including precision polymer optics, for scanners, printers and other
office products.
RESULTS OF OPERATIONS
REVENUES. Revenues for the second quarter of fiscal 1999 were $84.0
million, an increase of $19.6 million or 31% over revenues of $64.3
million in the second quarter of fiscal 1998. Revenues for the first
six months of fiscal 1999 were $153.8 million, an increase of $36.1
million, or 31%, over revenues of $117.7 million in the first six
months of fiscal 1998. In the first quarter of fiscal 1999, we sold
the assets of our manufacturing subsidiary in Germany (MMG) and, in
the second quarter of fiscal 1999, we purchased an optical design and
manufacturing company, OPKOR Inc. (OPKOR). See "Divestitures,
Investments and Acquisitions" below. Adjusted for OPKOR in fiscal
1999 and MMG in fiscal 1998, revenues for the second quarter of fiscal
1999 would have increased $22.7 million, or 37%, over revenues of
$61.1 million in the second quarter of fiscal 1998 and revenues for
the first six months of fiscal 1999 would have increased $42.1 million
<PAGE>
or 38% over revenues for the first six months of 1998. The adjusted
revenue increase in the second quarter of fiscal 1999 over the same
period of last year was a result of increased revenues of $14.0
million in our telecommunications markets, increased revenues of $6.9
million in our light interference pigment markets, increased revenues
of $1.7 million in our aerospace and instrumentation markets and
increased revenues of $826,000 in our office automation markets,
offset by decreased revenues of $658,000 in our display markets. The
adjusted revenue increase for the first six months of 1999 compared to
the same period of last year resulted from increased revenues of $26.9
million in our telecommunications markets, increased revenues of $12.4
million in our light interference pigment markets, increased revenues
of $2.5 million in our aerospace and instrumentation markets and
increased revenues of $373,000 in our office automation markets,
offset by decreased revenues of $55,000 in our display markets. All
of the revenue increases and decreases were primarily due to changes
in volume.
GROSS PROFIT. Gross profit for the second quarter of fiscal 1999 was
$26.3 million, or 31.4% of revenues, compared to $21.9 million, or
33.9% of revenues, for the second quarter of fiscal 1998. Gross
profit for the first six months of fiscal 1996 was $47.6 million, or
30.9% of revenues, compared to $39.0 million, or 33.1% of revenues,
for the first six months of fiscal 1998. Adjusted for OPKOR in fiscal
1999 and MMG in fiscal 1998, gross profit for the second quarter of
1999 would have been $26.2 million, or 31.4% of revenues, compared to
gross profit of $25.6 million, or 34.5% of revenues, for the second
quarter of 1998 and gross profit for the first six months of fiscal
1999 would have been $47.5 million, or 30.9% of revenues, compared to
gross profit of $37.6 million, or 33.7% of revenues, for the first six
months of fiscal 1998. The 1999 gross profit percentage decrease is
primarily due to the increase in sales in our telecommunications
business which has gross margins lower than our average.
RESEARCH AND DEVELOPMENT. Research and development expenditures in
the second quarter of 1999 were $5.5 million compared to research and
development expenditures in the second quarter of 1998 of $4.0
million. Research and development expenditures for the first six
months of 1999 were $10.1 million compared to $7.8 million for the
first six months of fiscal 1998. MMG's and OPKOR's research and
development expenditures were not material. The second quarter and
year to date increase in 1999 over the same periods of last year is
primarily due to expenditures for telecommunications product
development.
SELLING AND ADMINISTRATIVE. Selling and administrative expenses in
the second quarter of fiscal 1999 and the second quarter of fiscal
1998 were $11.2 million. Adjusted for OPKOR in fiscal 1999 and MMG in
fiscal 1998, selling and administrative expenses would have been $11.1
million for the second quarter of fiscal 1999, an increase of
$655,000, or 6%, over selling and administrative expenses of $10.5
million in the second quarter of fiscal 1998 and selling and
administrative expenses would have been $21.3 million for the first
six months of fiscal 1999, an increase of $2.2 million, or 11%, over
selling and administrative expenses of $19.1 million for the first six
months of fiscal 1998. The fiscal 1999 adjusted second quarter and
year-to-date increases result primarily from increased sales and
marketing expenses for our light interference pigment products.
<PAGE>
LOSS ON ASSET DISPOSAL. In the second quarter of fiscal 1999, we sold
one of our continuous coating machines that had previously been taken
out of service due to excess capacity. We recorded a loss of
$934,000 in the second quarter of fiscal 1999 in connection with this
sale.
LEGAL SETTLEMENT. In the first quarter of fiscal 1999, we settled a
lawsuit with Optical Corporation of America (OCA) and certain of its
stockholders regarding a failed merger. A benefit of $3.0 million is
reflected in our operating expenses for the first six months of fiscal
1999 for the cash proceeds from the settlement, net of applicable
legal expenses.
IN-PROCESS RESEARCH AND DEVELOPMENT CHARGES. In the first quarter of
fiscal 1999, we purchased the 40% interest in Flex held by SICPA for
$30.0 million. The transaction was recorded as a purchase in the
first quarter of fiscal 1999. In connection with the transaction, a
charge for in-process research and development is reflected in our
operating expenses for the first six months of fiscal 1999.
AMORTIZATION OF INTANGIBLES. We recorded amortization of intangibles
of $580,000 in the second quarter of fiscal 1999 compared to $198,000
in the second quarter of fiscal 1998 and $797,000 in the first six
months of fiscal 1999 compared to $398,000 for the first six months of
fiscal 1998. Adjusted for MMG in 1998 and OPKOR in 1999, our
intangible amortization would have been $520,000 in the second quarter
of fiscal 1999 and $105,000 in the second quarter of fiscal 1998.
Adjusted for OPKOR in fiscal 1999 and MMG in fiscal 1998, our
intangible amortization would have been $737,000 in the first six
months of fiscal 1999 and $209,000 in the first six months of fiscal
1998. The adjusted increase in the second quarter and year to date
periods of fiscal 1999 is due to amortization of goodwill and
identifiable intangibles in connection with the purchase of SICPA's
interest in Flex.
INCOME FROM OPERATIONS. As a result of the foregoing changes in
revenue, gross profit and operating expenses, our income from
operations was $8.2 million for the second quarter of fiscal 1999
compared to $6.5 million for the second quarter of fiscal 1998 and
$14.4 million for the first six months of fiscal 1999 compared to
$10.1 million for the first six months of fiscal 1998.
INTEREST INCOME AND EXPENSE. Interest income for the second quarter
of fiscal 1999 was $304,000 compared to interest income of $81,000 for
the second quarter of fiscal 1998. Interest income for the first six
months of fiscal 1999 was $622,000 compared to interest income of
$165,000 for the first six months of fiscal 1998. The increase in
interest income in quarter and year to date periods of 1999 is due to
higher average cash balances in 1999. Interest expense, net of
capitalized interest, for the second quarter of fiscal 1999 was $1.0
million compared to $927,000 for the second quarter of fiscal 1998.
Interest expense, net of capitalized interest, for the first six
months of 1999 was $2.0 million compared to $1.7 million for the first
six months of fiscal 1998. Capitalized interest for the second
quarter of fiscal 1999 was $86,000 compared to $262,000 for the second
quarter of fiscal 1998. Capitalized interest for the first six months
of fiscal 1999 was $246,000 compared to $348,000 for the first six
<PAGE>
months of fiscal 1998. The capitalized interest decrease in fiscal
1999 was primarily due to construction-in-progress that was put into
service during the first quarter of 1999.
PROVISION FOR INCOME TAXES AND MINORITY INTEREST. Our effective
income tax rate was 36.0% for the second quarter of fiscal 1999
compared to 38.5% for the second quarter of fiscal 1998. Our
effective tax rate was 44.0% for the first six months of fiscal 1999
compared to 39.0% for the first six months of fiscal 1998. Adjusted
for the effect of the in-process research and development charge, for
which no tax benefit was recorded, our effective income tax rate for
the first six months of fiscal 1999 would have been 36.0%. The
quarter and year-to-date 1999 effective tax rates are lower than the
statutory rate due to the realization of greater benefits from foreign
sales corporations and business tax credits. Minority interest was
zero in the second quarter of fiscal 1999 compared to $408,000 in the
second quarter of fiscal 1998 and $491,000 in the first six months of
1999 compared to $555,000 in the first six months of fiscal 1998. In
the first six months of fiscal 1999, minority interest was recorded up
to the date of purchase of the remaining interest in Flex Products,
Inc. (Flex). In the second quarter and first six months of fiscal
1998, minority interest represents the share of net income of Flex
accruing to its 40% stockholder, SICPA, and the portion of operating
results of OCLI Asia attributable to its Japanese partner. We
purchased the minority interest in OCLI Asia in the fourth quarter of
fiscal 1998.
NET INCOME APPLICABLE TO COMMON STOCK. We had net income applicable to
common stock of $4.8 million, or $.34 per share on a diluted basis,
for the second quarter of fiscal 1999 compared to $2.9 million, or
$.25 per share on a diluted basis, for the second quarter of fiscal
1998. We had net income applicable to common stock of $6.8 million,
or $.51 per share on a diluted basis, for the first six months of
fiscal 1999 compared to $4.4 million, or $.38 per share on a diluted
basis, for the first six months of fiscal 1998.
FINANCIAL CONDITION AND LIQUIDITY
As of April 30, 1999 we had cash and cash equivalents totaling $35.0
million, a decrease of $5.9 million from $40.9 million as of October
31, 1998. We used $30.0 million to purchase the minority interest in
Flex, we invested $11.5 million in plant and equipment, we used $4.2
million to pay down debt, we used $300,000 for the purchase of OPKOR
(net of OPKOR's cash balance), we used $726,000 to pay dividends and
we used $2.4 million to purchase a portion of Flex's working capital
loan from SICPA. These expenditures were offset by $36.8 million of
cash generated by operations, proceeds received from the sale of MMG
assets of $4.1 million and proceeds from option exercises and related
tax benefits of $2.3 million. $1.4 million of our debt payments were
to pay down the debt of OPKOR, leaving $2.5 million of acquired debt
after those payments.
In the first six months of fiscal 1999, our working capital, excluding
cash and short-term investments, decreased $12.9 million from $34.3
million to $21.3 million. This decrease was primarily due to
decreased inventory of $4.3 million, decreased accounts receivable of
$2.8 million and increased deferred revenue of $4.7 million. $1.7
million of the fiscal year-to-date inventory decrease results from the
<PAGE>
sale of MMG assets while the remainder results from increased sales in
the first six months of 1999. The fiscal year-to-date accounts
receivable decrease is due to the collection of MMG accounts
receivable. The deferred revenue increase is primarily due to
invoicing provisions for light interference pigment.
In January 1999, we executed amendments to our credit agreement
increasing the amount available under our revolving line of credit
from $20.0 million to $40.0 million and removing the impairment loss
and restructuring charges recorded in fiscal 1998 from our financial
covenants.
In March 1999, we replaced the credit facilities of our subsidiary in
Japan with a two-year revolving credit facility with a Japanese bank
of approximately $8.7 million. The term of the facility expires on
March 15, 2001 with principal to be paid by that date. Interest at
the Tokyo Interbank Offer Rate plus 1.25 percent (currently 1.6% per
year) is payable quarterly. In addition, our Japanese subsidiary has a
$1.7 million accounts receivable discounting facility under which
there were no borrowings at April 30, 1999.
On April 30, 1999, OPKOR, our new subsidiary, was out of compliance
with one of its debt covenants for which the bank issued a waiver
dated April 30, 1999. On May 27, 1999, we executed an amendment
changing the covenant requirements under the loan agreement expected
to bring OPKOR into compliance in future periods. The $2.5 million
note, which is guaranteed by one of OPKOR's customers, carries
interest at a rate of 5.72% with monthly payments of interest only
until January 1, 2000 when it will convert to a monthly amortizing
term loan if the bank and the guarantor do not extend the note.
In the first six months of fiscal 1999, demand for light interference
pigment exceeded capacity resulting in an inventory decrease of $1.7
million to satisfy excess demand. Existing backlog and projected
orders at Flex are expected to fill available capacity for light
interference pigment for the remainder of fiscal 1999. We have
initiated a capacity expansion at Flex that is expected to begin
production in the second half of fiscal 2000. The estimated cost of
this expansion is $14.0 million for which we have firm purchase
commitments outstanding of approximately $5.8 million. Including
commitments for the above expansion, as of April 30, 1999, our total
capital commitments are approximately $8.2 million.
On May 26, 1999, we completed a public offering for the sale of 1.3
million shares of OCLI common stock. The proceeds of the offering,
net of discounts, offering fees and estimated expenses, were $85.9
million.
We believe that cash on hand at April 30, 1999, cash anticipated to be
generated from future operations, available funds from revolving
credit arrangements and the proceeds from the aforementioned public
offering will be sufficient for us to meet our working capital,
capital expenditure, acquisition and debt service requirements and
dividend payments as declared for at least the next twelve months.
IMPACT OF YEAR 2000
<PAGE>
The "Year 2000 Issue" is the result of computer programs that were
written using two digits rather than four digits to define the
applicable year. If our computer programs with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using
"00" as the year 1900 rather than the Year 2000. This could result in
system failures or miscalculations causing disruption of operations
including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business
activities.
We have identified our Year 2000 risk in three components: internal
business software; internal non-financial software and imbedded chip
technology; and external noncompliance by customers and suppliers.
INTERNAL BUSINESS SOFTWARE. During fiscal 1997, as part of a business
modernization program intended to reduce cycle time and improve
profitability, we purchased an Enterprise Resource Planning System
(ERP system) that the software vendor has indicated is Year 2000
compliant. The total hardware, software and installation cost of the
ERP system was $4.0 million, all of which had been spent as of April
30, 1999. We are in the implementation phase for this system and
other ancillary financial systems with full implementation scheduled
for September 30, 1999. Based on this schedule, we expect to be in
full compliance with our internal financial systems before the Year
2000. However, if, due to unforeseen circumstances, the
implementation is not completed on a timely basis, the Year 2000 could
have a material impact on our operations. Contingency plans have been
established in a few areas where we feel there is some risk that the
system will not be implemented before the Year 2000. Those plans
include adapting some of our currently existing systems to be Year
2000 compliant. The cost of making those adaptations are not expected
to be material and will be expensed in the period incurred.
INTERNAL NON-FINANCIAL SOFTWARE AND IMBEDDED CHIP TECHNOLOGY. We have
taken an inventory of our non-financial software and equipment that
may be affected by the Year 2000, and we are in the process of testing
those items that we believe are critical to our operations. At this
time, we estimate the cost of Year 2000 testing and remediation of our
non-financial software and equipment to be approximately $350,000.
Full Year 2000 compliance for our internal non-financial software and
imbedded chip technology is scheduled for September 30, 1999.
However, if due to unforeseen circumstances, we are unable to achieve
Year 2000 compliance for our major non-financial systems and imbedded
chip technology, the Year 2000 could have a material impact on our
operations. We are currently working on contingency plans to address
unforeseen issues that may arise with internal non-financial software
and imbedded chip technology.
EXTERNAL NON-COMPLIANCE BY CUSTOMERS AND SUPPLIERS. We have
identified and contacted our critical suppliers, service providers and
contractors to determine the extent to which our interface systems are
vulnerable to those third parties' failure to remediate their own Year
2000 issues. We are continuing to monitor the progress of third
parties that are critical to our business; however, we cannot be
assured that customers' and suppliers' representations are accurate or
that they will reach Year 2000 compliance in a timely manner. If we
determine that the progress of specific suppliers, service providers
or contractors toward Year 2000 compliance is insufficient, we intend
<PAGE>
to change to other providers that have demonstrated Year 2000
readiness. However, we cannot be assured that we will be successful
in finding such alternative suppliers, service providers and
contractors. In the event that any of our significant customers and
suppliers are not successful or timely in achieving Year 2000
compliance and we are unable to replace them with new customers or
alternate suppliers, our business or operations could be adversely
affected.
DIVESTITURES, INVESTMENTS AND ACQUISITIONS
SALE OF MMG. In the first quarter of fiscal 1999, Glas-Trosche GmbH,
a privately held company in Switzerland, purchased the business,
operating assets and other related intangibles of MMG for $4.3
million. We retained ownership of an office building with an
appraised value of $493,000 and accounts receivable and cash totaling
$3.4 million. Third party liabilities of MMG were $4.5 million, which
were paid from the asset sale proceeds, cash on hand and collection of
accounts receivable. Since the assets were sold for the recorded
value, adjusted for the impairment loss recorded in fiscal 1998, no
gain or loss was recognized in connection with the sale.
In connection with the sale of MMG, we also received $1.2 million for
a three-year covenant not to compete and $600,000 for a three-year
license and supply agreement that incorporates the use of the OCLI
name. The $1.8 million received under those contracts is being
recognized as revenue over the three-year terms of the agreements.
INVESTMENT IN FLEX. In December 1998, we purchased SICPA's 40%
interest in Flex for $30.0 million in cash, increasing our ownership
to 100%, and we purchased SICPA's $2.4 million working capital loan.
This transaction was recorded as a purchase in the first quarter of
fiscal 1999. As a result, we recorded a charge for in-process
research and development of $2.9 million, goodwill of $9.8 million
that is being amortized over 15 years and identifiable intangibles
(included in other assets) of $10.1 million that are being amortized
over useful lives ranging from 11 to 15 years. The License and Supply
Agreement between Flex and SICPA that runs through October 31, 2009
was modified to increase SICPA's minimum purchase requirements in
association with Flex's commitment to put in place additional capacity
to manufacture light interference pigments.
PURCHASE OF OPKOR INC. In February 1999, we purchased OPKOR, an
optical design and manufacturing company specializing in precision
polymer optic components and assemblies, for $9.0 million plus annual
contingent payments in our common stock based on profits of the
acquired entity. The initial $9.0 million was paid in the form of
$1.8 million in cash and 267,285 shares of our common stock. The
cumulative amount of the contingent payments cannot exceed the lower
of another 267,285 shares or the number of shares equal in value to
$18.0 million. This transaction was recorded as a purchase in the
second quarter of fiscal 1999 and, as a result, we recorded goodwill
of $7.0 million that is being amortized over 10 years.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
<PAGE>
There have been no significant changes in market risk since October
31, 1998.
RISK FACTORS
WE RELY HEAVILY ON JDS FOR THE DESIGN, PACKAGING, ASSEMBLY, TESTING,
DISTRIBUTION, SALES AND MARKETING OF CERTAIN OF OUR TELECOMMUNICATIONS
PRODUCTS.
. We rely on JDS to design, package, assemble, distribute, sell and
market our products. Under the terms of our agreements, JDS has
primary responsibility for the design, packaging and assembly of
WDM products covered by these agreements. JDS also has exclusive
sales, marketing and distribution responsibilities for such
products. If JDS is unable to successfully distribute, market and
sell our products, we may be unable to find a substitute
distribution, marketing or sales partner or develop these
capabilities ourselves. We also rely on JDS for significant
financial and technical contributions to these programs.
. We lack control over management decisions. We share with JDS the
responsibility for making certain management decisions as they
relate to the WDM products covered by the agreements. Certain
decisions are made by a management committee that has equal
representation from JDS and ourselves. Our interests may not always
be aligned. If we disagree with JDS on specific matters or general
program direction, a neutral party will make the decision. Such a
decision may not be in our best interests.
. Our share of profits could be reduced. Under our agreements with
JDS, if the majority of the WDM products covered by the agreements
incorporate wavelength discrimination components not originating
from us, our share of the profits under the agreements will be
significantly reduced. In addition, we share any losses incurred
under the agreements.
. JDS can terminate our agreements or fail to perform. JDS can
terminate the agreements without cause beginning in 2015. If JDS
terminates the agreements or fails to provide adequate resources to
the program, we cannot be certain that we could obtain substitute
resources or a substitute partner to commercialize our products.
. JDS intends to merge with Uniphase. JDS recently announced an
intended merger with Uniphase Corporation. We cannot be certain
what effect, if any, this merger will have on us.
WE RELY EXCLUSIVELY ON SICPA'S USE OF OUR LIGHT INTERFERENCE PIGMENTS
TO PRODUCE OPTICALLY VARIABLE INK FOR THE SECURITY MARKET.
We have a strategic alliance with SICPA for the marketing and sale of
our light interference pigments used in connection with currency,
stamps, credit cards, passports and other specified value documents.
Under a license and supply agreement, we rely exclusively on SICPA to
market and sell these products worldwide. We currently do not plan to
develop our own marketing and sales organization for our light
interference pigments for use in connection with such value documents.
SICPA has the right to terminate the agreement if we breach it. If
SICPA terminates our agreement or if it is unable to successfully
<PAGE>
market and sell our light interference pigments for the applications
covered by the agreement, our business may be harmed and we may be
unable to find a substitute marketing and sales partner or develop
these capabilities ourselves. Also, if SICPA fails to meet its minimum
purchase requirements under the agreement for any reason, our
operating results would be adversely affected.
WE MUST KEEP PACE WITH CHANGING TECHNOLOGICAL AND CUSTOMER
REQUIREMENTS TO REMAIN COMPETITIVE.
The market for our products, particularly in the telecommunications
and display markets, is characterized by the existence of many
competing technologies, rapid technological change, frequent new
product introductions and enhancements, changes in customer demands
and evolving industry standards. Our existing products could be
rendered obsolete if we fail to remain competitive in any of these
ways. We have also found that the life cycles of our products are
difficult to estimate, primarily because they may vary according to
the particular application or vertical market segment. We believe that
our future success will depend upon our ability to continue to enhance
our current product line while we develop and introduce new products
that keep pace with competitive and technological developments. We
also must introduce these products in a timely manner to meet our
customers' changing needs. These developments require us to continue
to make substantial product development investments. Because of these
and other market conditions, we can not be certain that we will be
able to make the technological improvements or the research
investments necessary to offer our products in a timely or effective
manner.
We expect that new technologies will emerge as competition in the
telecommunications equipment industry increases and the need for
higher and more cost-effective bandwidth transmission expands. If
alternatives to our thin film filter-based products, such as products
based on planar waveguide, fiber grating or other technologies, are
adopted by our customers, our telecommunications business would
suffer.
The light interference pigments market is also susceptible to changing
technology and customer requirements. Growth in the demand for our
ChromaFlair(R) product within the consumer markets will depend upon our
ability to develop a more cost-effective process to manufacture our
light interference pigment products. Also, the trend toward electronic
currency, such as pre-paid or "smart cards," may decrease the market
for our light interference pigments used on paper currency.
WE DEPEND ON THE TELECOMMUNICATIONS INDUSTRY FOR GROWTH IN THE SALES
OF OUR WDM AND SATELLITE PRODUCTS.
Our ability to grow our WDM and satellite products businesses depends
in part on the continued growth and success of the telecommunications
industry. Recently, telecommunications markets around the world have
been deregulating and opening to global competition. This deregulation
generally has resulted in increased competition and demand for
telecommunications products and services. Additionally, the growing
volume of data, voice and video traffic has increased bandwidth
demand. These trends have driven increased demand for our WDM and
<PAGE>
satellite products. However, such trends may not continue in a manner
that is favorable to us.
The rate at which long distance carriers and other fiber optic network
operators have built new fiber optic networks or installed new systems
in their existing fiber optic networks has fluctuated in the past and
may continue to fluctuate in the future. These fluctuations may result
in reduced demand for new or upgraded fiber optic systems that utilize
our products. We can not be certain that technological or other
developments in the telecommunications industry will favor growth in
the markets served by our products. Moreover, as the
telecommunications industry consolidates and realigns to accommodate
technological and other developments, there is a risk that certain of
our customers and telecommunication service providers may consolidate
or align themselves together in a manner adverse to our business
interests.
Growth of our satellite component business depends on growth in the
number of satellite launches. In 1999, 2000, 2003 and 2004, the number
of launches per year are expected to decrease from 1998 figures.
Continuation of this trend would have an adverse effect on our
satellite business.
WE DEPEND ON THE PROJECTION DISPLAY AND FLAT PANEL DISPLAY MARKETS FOR
GROWTH IN THE SALES OF OUR DISPLAY PRODUCTS.
Our ability to grow our display products business depends
significantly on the continued growth and success of the projection
and flat panel display markets. Advances in the technology used in
computer monitors, televisions, conference room projectors and other
display devices have led to increased demand for flat panel displays
and projection displays. We cannot be certain that growth in these
markets will continue or that technological or other changes in this
industry will result in continued growth. In addition, the display
market is subject to pricing pressure, consolidation and realignment
as industry participants try to position themselves to take advantage
of the changing competitive landscape. There is a risk that any
consolidations and realignments may adversely affect our business, and
pricing pressure will adversely affect our operating results.
WE DEPEND ON OUR OEM CUSTOMERS FOR THE SALE OF OUR PRODUCTS AND FOR
INFORMATION RELATING TO THE DEVELOPMENT OF NEW PRODUCTS.
We sell a substantial portion of our products to a relatively small
number of original equipment manufacturers (OEMs). The timing and
amount of sales to these customers ultimately depend on sales levels
and shipping schedules for the OEM products into which our products
are incorporated. We have no control over the shipping dates or volume
of products shipped by our OEM customers, and we cannot be certain
that our OEM customers will continue to ship products that incorporate
our products at current levels or at all. Failure of these OEMs to
achieve significant sales of products incorporating our products and
fluctuations in the timing and volume of such sales could be harmful
to our business. In addition, failure of our OEM customers to inform
us of changes in their production needs in a timely manner can hinder
our ability to effectively manage our business.
<PAGE>
In addition, we rely on our OEM customers to inform us of
opportunities to develop new products that serve end user demands. If
our OEM customers do not present us with market opportunities early
enough for us to develop products to meet end user needs in a timely
fashion or if the OEMs fail to anticipate end user needs at all, we
may fail to develop new products or modify our existing products for
our end user markets. In addition, if our OEM customers fail to
accurately anticipate end user demands, we may spend resources on
products that are not commercially successful.
ACQUIRING COMPLEMENTARY COMPANIES WILL EXPOSE US TO ADDITIONAL RISKS.
From time to time, we intend to acquire companies with products and
services complementary to our own that we believe can help us
commercialize our products quickly and efficiently. These
acquisitions and any future acquisitions will expose us to increased
risks and costs, including the following:
. failure to retain customers;
. integrating new operations and technologies;
. assimilating and retaining new personnel; and
. diverting financial and management resources from existing
operations.
We may not be able to generate sufficient profits from any of these
acquisitions to offset the associated acquisition costs. We will also
be required to maintain uniform standards of quality and service,
controls, procedures and policies. We may have difficulty assimilating
and maintaining uniformity over OPKOR's operations because it is
located in Rochester, New York, which is far from our California
headquarters. Our failure to maintain any of these standards may hurt
relationships with customers, employees and new management personnel.
In addition, our future acquisitions may result in additional stock
issuances that could be dilutive to our stockholders.
WE MAY NOT BE ABLE TO ENTER INTO STRATEGIC ALLIANCES TO EFFECTIVELY
COMMERCIALIZE OUR PRODUCTS.
As we develop optical products, we often rely on strategic alliances
with other companies in a particular market to commercialize our
products in a timely or effective manner. Our current strategic
alliance partners provide us with assistance in the marketing, sales
and distribution of our diverse line of products. We may be unable to
find appropriate strategic alliances in markets in which we have
little experience, which could prevent us from bringing our products
to market in a timely manner, or at all. In our decorative pigments
business, we may form alliances that would help us penetrate the
automotive and other industries. If we do not enter into effective
alliances, our ChromaFlair(R) products may not achieve satisfactory
market penetration.
OUR FAILURE TO MANAGE GROWTH COULD ADVERSELY AFFECT US.
The recent accelerated growth of our business has placed, and is
expected to continue to place, a strain on our limited personnel,
<PAGE>
management and other resources. In particular, the growth of our
telecommunications business related to fiber optic networks and our
light interference pigments business related to security and value
documents has required us to allocate significantly increased amounts
of manufacturing capabilities, personnel and other resources to those
markets. In addition, our ability to manage and allocate resources is
complicated by the number, diversity and complexity of our product
lines. Our management, personnel, systems, procedures and controls may
be inadequate to support our existing and future operations. If
required to manage future growth, the implementation of management
systems can be time consuming and costly. In order to manage future
growth effectively, we will need to attract, train, integrate,
motivate, manage and retain employees successfully to continue to
improve our operational, financial and management systems.
WE MUST MANAGE OUR MANUFACTURING OPERATIONS AND FACILITIES EFFECTIVELY
TO MEET CHANGING CAPACITY REQUIREMENTS.
We currently manufacture all of our products at our facilities in
Santa Rosa, California, Hillend, Scotland and Atsugi, Japan. We are
currently experiencing manufacturing capacity constraints and we are
in the process of expanding our manufacturing capacity at these
facilities. In addition, many of our customers have requested that we
build manufacturing capabilities that are near or on their facilities
to provide just-in-time production capabilities. If our plans to
expand our manufacturing capacity are not implemented on a timely
basis, we could face production shortfalls. In addition, we may be
required to make additional capital investments in new or existing
manufacturing facilities. Rapid increases in production levels to meet
unanticipated demand could result in higher costs for components and
subassemblies and higher overtime costs and other expenses. These
higher expenditures could lower our profit margins. Further, if
production is increased rapidly, there may be decreased manufacturing
yields, which may also lower our margins.
In order to meet forecasted demand, we will need to increase our
manufacturing capability for light interference pigments. We currently
intend to begin operating our third light interference pigment
production machine in the middle of 2000. In the past, we have
experienced significant problems during the initial phases of
operating a new machine, which required us to take substantial write-
offs of inventory and incur substantial expenses to solve these
problems. If we encounter similar problems with this new machine, our
production capability and our operating results will suffer.
Many of our machines are the only manufacturing sources for particular
products and are running at or near capacity. We do not have plans to
develop redundancy for much of our production capability. Therefore, a
breakdown or catastrophic damage to certain machines would severely
and adversely affect our business. In addition, it can take up to two
years to replace certain production machines.
We are expanding our manufacturing capabilities and expending capital
in anticipation of a level of customer orders that may not be
achieved. If demand falls below our forecast, we could have excess
production or excess capacity. Excess production could result in
higher inventories of our products. If we were unable to sell these
inventories, we would be forced to write off such inventories as
<PAGE>
obsolete products. Excess manufacturing capacity could lead to higher
production costs and lower margins.
We have in the past and may in the future experience difficulties in
the management of our manufacturing facilities located overseas
because of the distance from our headquarters and difference in time
zone. To the extent that we expand our overseas manufacturing
capabilities, these issues will be increased.
OUR OPERATING RESULTS MAY FLUCTUATE.
Our quarterly revenues and bookings are likely to fluctuate
significantly in the future due to a number of factors, many of which
are outside our control. Factors that could affect our revenues and
bookings include the following:
. variations in the size or timing of orders and shipments of our
products;
. new product introductions by competitors;
. delays in introducing new products or components;
. delays of orders forecasted by our customers;
. delays in planned manufacturing capacity upgrades;
. delays by our customers in the completion of upgrades of
telecommunications infrastructure;
. variations in capital spending budgets of telecommunications
service providers; and
. delays in obtaining regulatory approval for commercial deployment
of certain telecommunications and other products.
A significant portion of our operating expenses are relatively fixed
in nature. Changes in revenue may cause significant fluctuations in
our operating results from quarter to quarter.
To achieve our revenue objectives, we depend on obtaining orders for
shipment in the same quarter. Furthermore, our agreements with our
customers generally do not contain binding purchase commitments and
provide that our customers may change delivery schedules and cancel
orders within specified timeframes without significant penalty. We
generally recognize revenue upon shipment of products to the customer
except in the case of JDS, where we recognize revenue upon shipment by
JDS to their customers. Refusal of customers or end users to accept
shipped products, returns of shipped products or delays or
difficulties in collecting accounts receivable could result in
significant charges against income. We may be unable to obtain
sufficient orders in any quarter, or anticipate the cancellation or
deferral of such orders in a quarter.
We have experienced and expect to continue to experience seasonality
in our business. Our sales have been affected by a seasonal decrease
in demand in the last quarter of each calendar year, which coincides
with the first quarter of our fiscal year, due to year-end
<PAGE>
fluctuations in orders and operations of our customers, a fewer number
of workdays during the winter holiday season, and the significant
seasonality of consumer electronics products for which we provide
components. We expect this trend to continue, although other trends
may emerge. These trends, or other fluctuations in the timing of
customer orders, may cause quarterly or annual fluctuations.
WE ARE DEPENDENT ON A SMALL NUMBER OF CUSTOMERS IN CERTAIN INDUSTRIES.
We believe that a substantial majority of our revenues will continue
to be derived from sales to a relatively small number of customers for
the foreseeable future. In addition, we believe that sales to these
customers will be focused on a small number of applications. The loss
of a significant customer for any reason or reduced production by a
customer, could result in a significant loss of revenue. In addition,
some of our products are sold to customers in industries, such as
consumer products, that experience significant fluctuations in demand
based on economic conditions, consumer demand and other factors that
are beyond our control. There can be no assurance that we will be able
to increase or maintain our levels of sales in periods of economic
stagnation or downturn. In the past, OEMs have reduced the amount of
purchases of our products in an effort to reduce their costs in
response to economic crises.
WE ARE DEPENDENT ON KEY SUPPLIERS OF RAW MATERIALS.
We manufacture all of our products using materials procured from
third-party suppliers. Certain of these materials are obtained from a
single source and others are available from limited sources. In
addition, some of the components are custom parts produced to our
specifications. For example, we currently rely on Corning Incorporated
to supply a special grade microsheet flat glass that is used in some
of our products. Other materials are procured from single-source
suppliers even though other suppliers are available. Any interruption
in the operations of vendors of single-sourced materials could
adversely affect our ability to meet our scheduled product deliveries
to customers. Delays in key component or product deliveries may occur
due to shortages resulting from a limited number of suppliers, the
financial or other difficulties of such supplier or a limitation in
component product availability. If we are unable to obtain a
sufficient supply of materials from our current sources, we could
experience difficulties in obtaining alternative sources quickly or in
altering product designs to use alternative materials. Resulting
delays or reductions in product shipments could damage customer
relationships. Further, a significant increase in the price of one or
more of these materials could have a material adverse effect on our
operating results.
In addition, we are an extremely large consumer of electricity.
Unforeseen increases in the cost of electricity or interruptions or
reductions in our current supply of electricity could materially
affect our ability to manufacture our products in a cost-effective or
timely manner.
The sales cycle for our products is lengthy and subject to delays
beyond our control, which may adversely impact our results of
operations.
<PAGE>
The sales cycle associated with our products typically is lengthy,
often lasting three to fifteen months. Our customers usually conduct
significant technical evaluations of our products prior to the
commitment of capital and other resources. In addition, purchasing
decisions may be delayed because of our customers' internal budget
approval procedures. Furthermore, end users of our products may have
lengthy testing and approval processes that will delay purchases of
our products by our customers. For example, countries adopting
security measures for their currency often will consider and test
alternatives to our light interference pigments prior to making a
purchasing decision. Because of the lengthy sales cycle and the large
size of customers' orders, if orders forecasted for a specific
customer for a particular quarter do not occur in that quarter, our
operating results for that quarter could be materially adversely
affected.
WE ARE DEPENDENT ON KEY PERSONNEL WITH EXPERTISE IN THE MANAGEMENT OF
LIGHT.
Due to the specialized nature of our business, we are highly dependent
on the continued service of, and on the ability to attract and retain,
qualified engineering, sales, marketing and senior management
personnel in the area of light management. The competition for such
personnel is intense. The loss of any key employees or management
could have a material adverse effect on our business and operating
results. In addition, if we are unable to hire additional qualified
personnel as needed, we may not be able to adequately manage and
complete our existing sales commitments and to bid for and execute
additional sales. We may not be able to continue to attract and retain
the qualified personnel necessary for the development of our business.
We must provide significant training for our growing employee base due
to the highly specialized nature of our technological expertise in the
area of light management and thin film optical coating. Our current
engineering personnel may be inadequate, and we may fail to assimilate
and train new employees successfully. Highly skilled employees with
the education and training that we require, especially employees with
significant experience and expertise in thin film optical coating and
fiber optics, are in high demand. Once trained, our employees may be
hired by our competitors.
We do not have "key person" insurance coverage for the loss of any of
our employees. Any officer or employee of our company can terminate
his or her relationship with us at any time. Except for three
employees of our OPKOR Inc. subsidiary, none of our employees are
bound by any non-competition agreements with us.
OUR PRODUCTS ARE SUBJECT TO GOVERNMENTAL AND INDUSTRY REGULATIONS,
CERTIFICATIONS AND APPROVALS.
The commercialization of our products may be delayed or made more
costly due to required government and industry approval processes. In
the past, the United States federal government has attempted to
restrict the export of our satellite-related products to certain
<PAGE>
foreign countries for reasons of national security. Development of
applications for our ChromaFlair(R) products may require significant
testing that could delay our sales. For example, certain uses in
cosmetics may be regulated by the Food and Drug Administration, which
has extensive and lengthy approval processes. Durability testing by
the automobile industry of our pigments used with automotive paints
can take up to three years. If we change a product for any reason
including technological changes or changes in the manufacturing
process, prior approvals or certifications may be invalid and we may
need to go through the approval process again. Additionally, some of
our telecommunications products may need to obtain Bellcore
certification. This certification process can last six months or
longer. If we are unable to obtain these or other government or
industry certifications in a timely manner, or at all, our results
could be adversely affected.
THERE ARE MANY RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.
We expect sales to customers outside of the United States to continue
to represent a significant percentage of our revenues for the
foreseeable future. International sales are subject to a number of
risks, including the following:
. changes in foreign government regulations and standards;
. export license requirements, tariffs, taxes and other trade
barriers;
. requirements or preferences of foreign nations for domestic
products;
. fluctuations in currency exchange rates relative to the U.S.
dollar;
. difficulty in collecting accounts receivable;
. difficulty in managing foreign operations; and
. political and economic instability.
If our customers or end users of our products are impacted by currency
devaluations or general economic crises, such as the economic crisis
currently affecting many Asian and Latin American economies, their
ability to purchase our products could be materially adversely
affected. Payment cycles for international customers typically are
longer than those for customers in the United States. Foreign markets
for our products may develop more slowly than currently anticipated
for a variety of reasons. These reasons include environmental issues,
economic downturns, the availability of favorable pricing for other
communications services or the availability and cost of related
equipment.
WE HAVE SIGNIFICANT EXPOSURE TO FOREIGN INVESTMENTS.
We have significant capital investments in Scotland and Japan. We
record changes in the value of those countries' currencies relative to
the U.S. dollar as direct charges or credits to equity. In addition to
<PAGE>
our manufacturing operations in Scotland and Japan, we also have a
sales presence in other European and Asian countries. A significant
weakening of the currencies in Europe or Asia in relation to the U.S.
dollar could reduce the reported results of those operations. In
addition, our export sales could be subject to competitive price
pressures if the U.S. dollar was to strengthen compared to the
currency of foreign competitors.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL
PROPERTY RIGHTS.
Our success and ability to compete are significantly dependent on our
proprietary technology. We rely on a combination of patent, trade
secret, copyright and trademark laws and contractual restrictions to
establish and protect proprietary rights in our products. Our pending
patent applications may not be granted. Even if they are granted, the
claims covered by the patents may be reduced from those included in
our applications. Any patent might be subject to challenge in court
and, whether or not challenged, might not be broad enough to prevent
third parties from developing equivalent technologies or products. We
have entered into confidentiality and invention assignment agreements
with our employees, and we enter into non-disclosure agreements with
some of our suppliers, distributors and customers so as to limit
access to and disclosure of our proprietary information. These
statutory and contractual arrangements may not prove sufficient to
prevent misappropriation of our technology or to deter independent
third-party development of similar technologies. In addition, the laws
of some foreign countries might not protect our products or
intellectual property rights to the same extent as do the laws of the
United States. Protection of our intellectual property might not be
available in every country in which our products might be
manufactured, marketed or sold.
WE MAY BE SUBJECT TO FUTURE CLAIMS OF INFRINGEMENT OF INTELLECTUAL
PROPERTY RIGHTS OF THIRD PARTIES.
We may in the future receive notices of claims of infringement of
other parties' patent, trademark, copyright and other intellectual
property rights. Any such claims, even those without merit, could be
time consuming to defend, result in costly litigation, divert
management's attention and resources or cause us to enter into
unfavorable royalty or licensing agreements. The assertion of such
claims could have a material adverse effect on our business.
OUR INDUSTRIES ARE HIGHLY COMPETITIVE WITH MANY ESTABLISHED
COMPETITORS, WHO MAY INCLUDE OUR CUSTOMERS, STRATEGIC ALLIANCE
PARTNERS AND SUPPLIERS.
The markets for our products are intensely competitive and
characterized by rapidly changing technology. We currently experience
competition from numerous companies in each of the markets in which we
participate.
In the fiber optic communications market, we face competition from E-
Tek Dynamics, Inc. and DiCon Fiberoptics, Inc., as well as other WDM
component vendors for the sale of WDM products. In the optical switch
markets, we will compete with these same companies, and potentially
with JDS, our strategic partner for our WDM business. In the
<PAGE>
satellites market, we compete with Pilkington Aerospace, a division of
Pilkington plc.
We face competition with our light interference pigments in the
security and value documents market from alternative technologies such
as holograms, embedded threads and watermarks. In the decorative
applications market for our light interference pigments, we compete
with providers of lower cost, lower performance special effects
pigments such as BASF AG and Merck KGaA. These companies are also
important customers for decorative pigments.
In the display market, we have a large number of domestic and foreign
competitors for our Glare/Guard(R) anti-glare optical filters. Companies
that purchase coated glass and assemble and sell filters in
competition with us include Fellowes Manufacturing Company, Polaroid
Corporation, ACCO Brands, Inc. and Minnesota Mining and Manufacturing
Company (3M). Certain of these companies purchase private label
products from us for resale in competition with our Glare/Guard(R)
product line. In the flat panel display market, we face competition
from Japanese coating companies such as Nidek Co., Ltd., Toppan
Printing Co., Ltd. and Tore. In projection display components, our
competition includes Viratec Thin Films, Inc., Balzers and Leybold
Group, Nitto Optical Co., Ltd., Nikon Corporation and Fuji
Photo-Optical.
Competitors in any portion of our business are also capable of rapidly
becoming competitors in other portions of our business. Our existing
and potential customers are often our current and potential
competitors. These companies may develop or acquire additional
competitive products or technologies in the future and thereby reduce
or cease their purchases from us. Additionally, we compete with large,
diversified companies such as BASF and Merck KGaA that are also our
suppliers. We may also face competition in the future from these and
other parties that develop fiber optic components based upon the
technologies similar to or different from the technologies employed by
us.
We expect competition in general to intensify substantially,
particularly in the expanding telecommunications and special effects
pigments markets. We further expect competition to be broadly based on
varying combinations of manufacturing capacity, ability to deliver
products on time, and technical features, each of which may render our
existing products non-competitive, obsolete or unmarketable. The
development of new high-precision products is a complex and uncertain
process requiring high levels of innovation and highly skilled
assembly and manufacturing processes, as well as the accurate
anticipation of technological and market trends. Many of our
competitors have substantially greater financial, technical,
manufacturing, marketing and other resources with which to develop new
technologies and to promote their products. We may be unable to
identify, develop, manufacture, market or support new or enhanced
products successfully or on a timely basis. We also may be unable to
respond effectively to product announcements by competitors,
technological changes or emerging industry standards. We also face
competition from numerous smaller companies.
WE FACE RISKS RELATING TO THE YEAR 2000 ISSUE.
<PAGE>
The "Year 2000" issue is the result of computer programs that were
written using two digits rather than four digits to define the
applicable year. If our computer programs with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using
"00" as 1900 rather than the Year 2000. This could result in system
failures or miscalculations causing disruption of operations,
including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business
activities.
We have identified our Year 2000 risk in three components: internal
business software; internal non-financial software and imbedded chip
technology; and external noncompliance by customers and suppliers. We
are in the process of installing an enterprise resource planning
system and we currently expect to be in full compliance with our
internal financial systems before the Year 2000. However, if, due to
unforeseen circumstances, the implementation is not completed on a
timely basis, the Year 2000 could have a material impact on our
operations. If we are unable to achieve Year 2000 compliance for our
major non-financial systems, the Year 2000 could have a material
impact on our operations.
Any failure of third-party networks, systems or services upon which
our business depends could have a material adverse impact on our
business. We also rely on other systems and services that third
parties provide to our customers. As a result, the success of our plan
to address Year 2000 issues depends in part on parallel efforts being
undertaken by other third parties. We have begun to identify and
initiate communications with third parties whose networks, systems or
services are critical to our business to determine the status of their
Year 2000 compliance. We cannot assure you that all such parties will
provide accurate and complete information, or that all their networks,
systems or services will achieve full Year 2000 compliance in a timely
fashion. In the event that any of our significant customers and
suppliers do not successfully and timely achieve Year 2000 compliance,
and we are unable to replace them with new customers or alternate
suppliers, our business or operations could be adversely affected.
Although we believe that all of our current products are Year 2000
compliant, we cannot be certain that there will not be claims against
us, particularly since we have been in business for over 50 years. The
outcome and the costs involved in defending such claims could have an
adverse effect on our business. In addition, responding to customer
inquiries regarding Year 2000 issues has created a burden on our
internal resources.
OUR MANUFACTURING FACILITIES ARE CONCENTRATED IN AN AREA SUSCEPTIBLE
TO EARTHQUAKES.
Our headquarters and most of our manufacturing facilities are
concentrated in an area where there is a risk of significant
earthquake activity. Substantially all of the production equipment
that currently accounts for our revenues, as well as planned
additional production equipment, is or will be located in a known
earthquake zone. In addition, much of our plant and equipment was
built a number of years ago and are not in compliance with current
seismic codes. We cannot predict the extent of the damage that our
facilities and equipment would suffer in the event of an earthquake or
<PAGE>
how such damage would affect our business. We currently maintain
earthquake insurance in the amount of $20.9 million with a deductible
of five percent of insured value. However, we cannot be certain if
this type of insurance will be available in the future at reasonable
rates, or at all, or if this insurance will be sufficient to cover all
damages that we may suffer as a result of an earthquake.
OUR BUSINESS IS SUBJECT TO THE RISKS OF PRODUCT RETURNS, PRODUCT
LIABILITY AND PRODUCT DEFECTS.
Products as complex and precise as ours frequently contain undetected
errors or flaws, especially when first introduced or when new versions
are released. The occurrence of errors could result in product returns
and other losses to us or to our customers. Some of our products are
used in applications that have severe consequences if our products or
the products in which our products are incorporated should fail. Such
failure also could result in the loss of or delay in market acceptance
of our products. Due to the recent introduction of some of our
products, we have limited experience with the problems that could
arise with these products.
Our purchase agreements with our customers typically contain
provisions designed to limit our exposure to potential product
liability claims. However, the limitation of liability provision
contained in our purchase agreements may not be effective as a result
of federal, state or local laws or ordinances or unfavorable judicial
decisions in the United States or other countries. We have not
experienced any material product liability claims to date, but the
sale and support of our products entails the risk of such claims. In
addition, any failure by our products to properly perform could result
in claims against us by our customers. We maintain insurance to
protect against certain claims associated with the use of our
products, but our insurance coverage may not adequately cover any
claim asserted against us. In addition, even claims that ultimately
are unsuccessful could result in our expenditure of funds in
litigation and loss of management time and resources.
OUR MANUFACTURING PROCESSES MAY EXPOSE US TO ENVIRONMENTAL
LIABILITIES.
We are subject to various federal, state, local and foreign
environmental laws and regulations, including those governing the use,
discharge and disposal of hazardous substances in the ordinary course
of our manufacturing process. In the past, we have found ground water
contamination at our facilities and have had to spend substantial
amounts of money to contain and monitor the contamination. Although we
believe that our current manufacturing operations comply in all
material respects with applicable environmental laws and regulations,
environmental legislation has been enacted and may in the future be
enacted or interpreted to create environmental liability with respect
to our facilities or operations. We cannot be certain that
environmental claims will not be asserted against us in the future.
SOME ANTI-TAKEOVER PROVISIONS MAY AFFECT THE PRICE OF OUR COMMON
STOCK.
The Board of Directors has the authority to issue up to 100,000 shares
of preferred stock and to determine the rights, preferences and
<PAGE>
privileges of those shares without any further vote or action by the
stockholders. Of these 100,000 shares, 10,000 shares are currently
designated "Series A Preferred Stock" in connection with our
stockholders' rights plan described below, and 15,000 shares were
designated "Series B Cumulative Convertible Preferred Stock," of which
6,650 shares remain available for future issuance. The rights of the
holders of common stock may be adversely affected by the rights of the
holders of any preferred stock that may be issued in the future. Some
provisions of our certificate of incorporation and bylaws could have
the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting common stock. These include
provisions that limit the ability of stockholders to take action by
written consent, call special meetings, remove a director for cause,
amend the by-laws or approve a merger with another company.
We are subject to the provisions of Section 203 of the Delaware
General Corporation Law, an anti-takeover law. In general, the statute
prohibits a publicly-held Delaware corporation from engaging in a
"business combination" with an "interested stockholder" for a period
of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is
approved in a prescribed manner. For purposes of Section 203, a
"business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested
stockholder, and an "interested stockholder" is a person who, together
with affiliates and associates, owns (or within three years prior, did
own) 15.0% or more of the corporation's voting stock.
We have a stockholders' rights plan, commonly referred to as a
"poison pill," that makes it difficult, if not impossible, for a
person to acquire control of us without the consent of our Board of
Directors.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1996
Except for historical information contained in this report, matters
discussed in this report are forward-looking statements that involve
risks and uncertainties. Actual results my vary significantly based
on a number of factors including, but not limited to, product
development, commercialization and technological difficulties;
manufacturing cost, yield and throughput issues associated with
initiating production at new facilities; the impact of competitive
products and pricing; changing customer requirements and buying
patterns; timely availability and acceptance of new products; change
in economic conditions of the various markets that we serve; and Year
2000 issues.
INDEPENDENT ACCOUNTANTS' REVIEW
The April 30, 1999 condensed consolidated financial statements
included in this filing on Form 10-Q have been reviewed by Deloitte &
Touche LLP, independent accountants, in accordance with established
professional standards and procedures for such a review.
<PAGE>
The report of Deloitte & Touche LLP commenting on their review
follows.
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors
and Stockholders of
Optical Coating Laboratory, Inc.
Santa Rosa, California
We have reviewed the accompanying condensed consolidated balance sheet
of Optical Coating Laboratory, Inc. and subsidiaries as of April 30,
1999, and the related condensed consolidated statements of income and
of cash flows for the three-month and six-month periods ended April
30, 1999 and 1998 and the related condensed consolidated statements of
stockholders' equity and comprehensive income for the six-month
periods ended April 30, 1999 and 1998. These financial statements are
the responsibility of the Company's management.
We conducted our review in accordance with standards established by
the American Institute of Certified Public Accountants. A review of
interim financial information consists of applying analytical review
procedures to financial data and making inquiries of persons
responsible for financial and accounting matters. It is substantially
less in scope than an audit in accordance with generally accepted
auditing standards, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to such condensed consolidated financial
statements for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of Optical Coating
Laboratory, Inc. and subsidiaries as of October 31, 1998, and the
related consolidated statements of income, stockholders' equity, and
cash flows for the year then ended (not presented herein); and in our
report dated December 22, 1998 (January 8, 1999 as to Note 5), we
expressed an unqualified opinion on those consolidated financial
statements based on our audit. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheet as of
October 31, 1998 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been
derived.
Deloitte & Touche LLP
San Jose, California
May 19, 1999
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
<PAGE>
There have been no material changes in legal proceedings since
those reported in the Registrant's Form 10-K for the year ended
October 31, 1998.
ITEM 2. CHANGES IN SECURITIES
Effective February 22, 1999, the Company acquired all the outstanding
shares of OPKOR Inc., an optical design and manufacturing company
specializing in precision optic components and assemblies, for $1.8
million in cash and 267,285 shares of common stock of the Company
issued to the former stockholders of OPKOR. The shares of common
stock were issued pursuant to an exemption from registration under
Section 4(2) of the Securities Act of 1933, as amended. Of those
267,285 shares issued, 138,000 shares were subsequently registered for
resale on May 21, 1999 under the Company's Registration Statement on
Form S-3 (Registration No. 333-76853).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
No disclosure required.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders was held on April 1, 1999.
(b) The management nominees for director listed in the proxy
statement were elected as follows:
NOMINEES FOR DIRECTOR VOTES FOR VOTES WITHHELD
===================== ========== ==============
Herbert M. Dwight, Jr. 11,462,541 67,021
Charles J. Abbe 9,239,211 136,346
Douglas C. Chance 9,237,506 138,051
Shoei Kataoka 9,223,741 151,816
John McCullough 9,194,197 181,360
Julian Schroeder 9,238,171 137,386
Renn Zaphiropoulos 9,234,433 141,124
(c) Approval of the 1999 Employee Stock Purchase Plan:
For 9,946,326
Against 205,022
Abstain 59,676
Not Voted 2,002,962
Approval of the 1999 Incentive Compensation Plan:
For 8,845,052
Against 1,298,596
Abstain 67,375
Not Voted 2,002,963
Ratification of the appointment of Deloitte & Touche LLP as the
independent auditors of the Company for the year ending October
31, 1999:
For 11,472,650
Against 17,075
Abstain 61,459
Not Voted 662,802
ITEM 5. OTHER INFORMATION
No disclosure required.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.0 Fourth Amendment, dated as of May 25, 1999 to Credit Agreement
dated as of July 31, 1998 among the Registrant, Bank of
America National Trust and Savings Association, as Agent,
Letter of Credit Issuing Bank and The Other Financial
Institutions Party Thereto.
15 Letter of Deloitte & Touche LLP regarding unaudited interim
financial information.
27 Financial Data Schedule for the three months ended April 30,
1999.
(b) Reports on Form 8-K filed for the three months ended April 30,
1999:
Form 8-K dated May 19, 1999 reporting under Item 5 the Registrant's
second quarter 1999 earnings.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
OPTICAL COATING LABORATORY, INC.
June 14, 1999 By: /s/ CRAIG B. COLLINS
- ------------------ --------------------------------
Date Craig B. Collins, Vice President,
Finance and Chief Financial Officer
(Principal Financial Officer)
<PAGE>
FOURTH AMENDMENT TO CREDIT AGREEMENT
------------------------------------
THIS FOURTH AMENDMENT TO CREDIT AGREEMENT ("Amendment"), dated as
of May 11, 1999, is entered into by and among OPTICAL COATING
LABORATORY, INC. (the "Company"), the several financial institutions
party to the Credit Agreement (collectively, the "Banks"), and BANK OF
AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as agent for itself
and the Banks (the "Agent") and as letter of credit issuing bank.
RECITALS
--------
A. The Company, Banks, and Agent are parties to a Credit
Agreement dated as of July 31, 1998, as amended by a Waiver and First
Amendment to Credit Agreement dated as of January 8, 1999, effective
as of October 31, 1998, a Second Amendment to Credit Agreement dated
as of January 31, 1999 and a Third Amendment to Credit Agreement dated
as of February 26, 1999 (as so amended, the "Credit Agreement")
pursuant to which the Banks have extended certain credit facilities to
the Company.
B. The Company has requested that the Banks agree to a certain
amendment of the Credit Agreement.
C. The Banks are willing to amend the Credit Agreement, subject
to the terms and conditions of this Amendment.
NOW, THEREFORE, for valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereto hereby
agree as follows:
1. Defined Terms. Unless otherwise defined herein, capitalized
terms used herein shall have the meanings, if any, assigned to them in
the Credit Agreement.
2. Amendment to Credit Agreement. Section 8.09 of the
Credit Agreement shall be amended by deleting the word "and" at the
end of subsection (b) thereof and inserting the following at the end
of subsection (c) thereof:
";and
(d) Guaranty Obligations of the Company with respect to the
obligations of Flex Products under the Master Equipment Lease
Agreement No. 32089 dated June 19, 1996 between Flex Products and
Fleet Capital Corporation, along with the two Schedules thereto dated
June 19, 1996, as such lease agreement is in effect on the date hereof
and without giving effect to any amendments, modifications or
supplements (including by way of new Schedules) thereto after the
date hereof, but after giving effect to the Consent and Amendment
Agreement dated as of April 26, 1999 among Flex Products and Fleet
Capital Corporation, a copy of which the Company has provided to the
Agent and the Banks."
3. Representations and Warranties. The Company hereby
represents and warrants to the Agent and the Banks as follows:
(a) No Default or Event of Default has occurred and is
continuing.
(b) The execution, delivery and performance by the Company
of this Amendment have been duly authorized by all necessary corporate
and other action and do not and will not require any registration
with, consent or approval of, notice to or action by, any Person
(including any Governmental Authority) in order to be effective and
enforceable. The Credit Agreement as amended by this Amendment
constitutes the legal, valid and binding obligations of the Company,
enforceable against it in accordance with its respective terms, except
as enforceability may be limited by applicable bankruptcy, insolvency,
or similar laws affecting the enforcement of creditors' rights
<PAGE>
generally or by equitable principles relating to enforceability,
without defense, counterclaim or offset.
(c) All representations and warranties of the Company
contained in the Credit Agreement are true and correct on and as of
the date hereof, except to the extent such representations and
warranties expressly refer to an earlier date, in which case they are
true and correct as of such earlier date.
(d) The Company is entering into this Amendment on the
basis of its own investigation and for its own reasons, without
reliance upon the Agent and the Banks or any other Person.
4. Effective Date. This Amendment will become effective as of
the date first above written, or, if later, the date on which the
Agent has received from the Company and the Majority Banks a duly
executed original (or, if elected by the Agent, an executed facsimile
copy) of this Amendment.
5. Reservation of Rights. The Company acknowledges and agrees
that the execution and delivery by the Agent and the Banks of this
Amendment shall not be deemed to create a course of dealing or
otherwise obligate the Agent or the Banks to enter into amendments
under the same, similar or any other circumstances in the future.
6. Miscellaneous.
(a) Except as herein expressly amended, all terms,
covenants and provisions of the Credit Agreement are and shall remain
in full force and effect and all references therein and in the other
Loan Documents to such Credit Agreement shall henceforth refer to the
Credit Agreement as amended by this Amendment. This Amendment shall
be deemed incorporated into, and a part of, the Credit Agreement.
This Amendment is a Loan Document.
(b) This Amendment shall be binding upon and inure to the
benefit of the parties hereto and their respective successors and
assigns. No third party beneficiaries are intended in connection with
this Amendment.
(c) This Amendment shall be governed by and construed in
accordance with the law of the State of California.
(d) This Amendment may be executed in any number of
counterparts, each of which shall be deemed an original, but all such
counterparts together shall constitute but one and the same
instrument. Each of the parties hereto understands and agrees that
this document (and any other document required herein) may be
delivered by any party thereto either in the form of an executed
original or an executed original sent by facsimile transmission to be
followed promptly by mailing of a hard copy original, and that receipt
by the Agent of a facsimile transmitted document purportedly bearing
the signature of a Bank or the Company shall bind such Bank or the
Company, respectively, with the same force and effect as the delivery
of a hard copy original. Any failure by the Agent to receive the hard
copy executed original of such document shall not diminish the binding
effect of receipt of the facsimile transmitted executed original of
such document of the party whose hard copy page was not received by
the Agent, and the Agent is hereby authorized to make sufficient
photocopies thereof to assemble complete counterparty documents.
(e) This Amendment, together with the Credit Agreement,
contains the entire and exclusive agreement of the parties hereto with
reference to the matters discussed herein and therein. This Amendment
supersedes all prior drafts and communications with respect thereto.
This Amendment may not be amended except in accordance with the
provisions of Section 11.01 of the Credit Agreement.
<PAGE>
(f) If any term or provision of this Amendment shall be
deemed prohibited by or invalid under any applicable law, such
provision shall be invalidated without affecting the remaining
provisions of this Amendment or the Credit Agreement, respectively.
(g) The Company covenants to pay to or reimburse the Agent,
within five Business Days after demand, for all costs and expenses
(including reasonable Attorney Costs) incurred in connection with the
development, preparation, negotiation, execution and delivery of this
Amendment.
IN WITNESS WHEREOF, the parties hereto have executed and
delivered this Amendment as of the date first above written.
OPTICAL COATING LABORATORY, INC.
By: /s/ Jeffrey M. Ryan
---------------------------------
Name: Jeffrey M. Ryan
-------------------------------
Title: Assistant Treasurer
------------------------------
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION,
as Agent
By: /s/ Christine Cordi
---------------------------------
Name: Christine Cordi
-------------------------------
Title: Vice President
------------------------------
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION,
as Issuing Bank and as a Bank
By: /s/ Thomas K. McComas
---------------------------------
Name: Thomas K. McComas
-------------------------------
Title: Vice President
------------------------------
ABN AMRO BANK N.V.
By: /s/Gina M. Brusatori
---------------------------------
Name: Gina M. Brusatori
-------------------------------
Title: Group Vice President
------------------------------
By: /s/ Dianne D. Berkley
---------------------------------
Name: Dianne D. Berkley
-------------------------------
Title: Group Vice President
------------------------------
<PAGE>
LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION
EXHIBIT 15.
To the Board of Directors
and Stockholders of
Optical Coating Laboratory, Inc.
Santa Rosa, California
We have made a review, in accordance with standards established by the
American Institute of Certified Public Accountants, of the unaudited
interim financial information of Optical Coating Laboratory, Inc. and
subsidiaries for the periods ended April 30, 1999 and 1998, as
indicated in our report dated May 19, 1999; because we did not perform
an audit, we expressed no opinion on that information.
We are aware that our report referred to above, which is indicated in
your Quarterly Report on Form 10-Q for the quarter ended April 30,
1999 is incorporated by reference in Registration Statement No. 33-
41050, No. 33-26271, No. 33-12276, No. 33-65132, No. 33-60891, No.
333-13013 and No. 333-69157 on Forms S-8 and Registration Statement
No. 33-61177, No. 33-65319 and No. 333-76853 on Forms S-3.
We also are aware that the aforementioned report, pursuant to Rule
436(c) under the Securities Act of 1933, is not considered a part of
the Registration Statement prepared or certified by an accountant or a
report prepared or certified by an accountant within the meaning of
Sections 7 and 11 of that Act.
DELOITTE & TOUCHE LLP
San Jose, California
June 14, 1999
<PAGE>
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