<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 28, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-22068
LEVEL ONE COMMUNICATIONS, INCORPORATED
State: California I.R.S. Employer ID No.: 33-0128224
Address: 9750 Goethe Road, Sacramento, CA 95827
Telephone:(916) 855-5000
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 periods 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
----- -----
The number of Common Shares of the registrant outstanding on August 11, 1998,
was 35,168,142.
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<TABLE>
<CAPTION>
INDEX
Page
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<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 28, 1998,
and December 28, 1997 ...................... 3
Consolidated Statements of Income for the Three and
Six Months ended June 28, 1998, and June 29,
1997 ...................... 4
Consolidated Statements of Cash Flows for the Three
and Six Months ended June 28, 1998, and June 29,
1997 ...................... 5
Notes to Financial Statements ...................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ..................... 14
Item 2. Changes in Securities ..................... 15
Item 6. Exhibits and Reports on Form 8-K ..................... 15
Signatures ..................... S-1
</TABLE>
2
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LEVEL ONE COMMUNICATIONS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
June 28, 1998, and December 28, 1997
<TABLE>
<CAPTION>
(in thousands) June 28, 1998 December 28, 1997
----------------- ------------------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 16,069 $ 25,234
Short-term investments 103,017 112,560
Trade accounts receivable, net of allowance for doubtful accounts 35,931 30,080
of $493 and $343 for 1998 and 1997, respectively
Other receivables 7,278 2,472
Inventories 23,909 26,118
Deferred income tax benefit 3,035 4,050
Other current assets 2,831 2,502
------------- ------------
Total current assets 192,070 203,016
Property and equipment, net 38,542 31,795
Long-term investments 49,383 21,559
Foundry deposits 16,781 14,000
Other assets 5,059 7,327
------------- ------------
Total assets $ 301,835 $ 277,697
============= =============
Current Liabilities:
Current portion of capital lease obligations $ 1,209 $ 1,201
Accounts payable 21,548 20,614
Accrued payroll costs 6,513 4,591
Deferred distributor revenues 3,240 2,490
Other accrued liabilities 8,769 7,881
------------- ------------
Total current liabilities 41,279 36,777
Convertible subordinated notes 115,000 115,000
Capital lease obligations, less current portion 1,625 2,175
Deferred lease expense 218 300
------------- ------------
Total liabilities 158,122 154,252
Shareholders' Equity:
Common Stock, no par value 97,426 91,897
Authorized - 236,250 shares
Outstanding - 31,133 and 30,751 shares
for 1998 and 1997, respectively
Unrealized gain on investments 4 18
Retained earnings 46,283 31,530
------------- ------------
Total shareholders' equity 143,713 123,445
------------- ------------
Total liabilities and shareholders' equity $ 301,835 $ 277,697
============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
3
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LEVEL ONE COMMUNICATIONS, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
June 28, 1998, and June 29, 1997
(unaudited)
<TABLE>
<CAPTION>
(in thousands, expect per share amounts) Three Months Ended Six Months Ended
-------------------------------- ---------------------------------
June 28, 1998 June 29, 1997 June 28, 1998 June 29, 1997
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues $60,362 $ 32,642 $116,969 $ 62,749
Cost of revenues 25,002 13,566 48,493 26,466
---------- ---------- ---------- ----------
Gross margin 35,360 19,076 68,476 36,283
Research & development 10,632 6,738 21,174 13,079
Sales & marketing 9,007 4,754 17,708 9,053
General & administrative 5,813 2,221 9,275 4,023
---------- ---------- ---------- ----------
Total operating expenses 25,452 13,713 48,157 26,155
---------- ---------- ---------- ----------
Operating income 9,908 5,363 20,319 10,128
Interest income 2,478 475 4,227 953
Interest expense (1,690) (6) (2,659) (150)
Other income 112 23 132 55
---------- ---------- ---------- ----------
Income before provision for income taxes 10,808 5,855 22,019 10,986
Provision for income taxes 3,566 1,932 7,266 3,605
---------- ---------- ---------- ----------
Net income $ 7,242 $ 3,923 $ 14,753 $ 7,381
========== ========== ========== ==========
Basic earnings per share $ .23 $ .13 $ .48 $ .24
Diluted earnings per share $ .22 $ .12 $ .44 $ .23
The accompanying notes are an integral part of these statements.
</TABLE>
4
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LEVEL ONE COMMUNICATIONS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For Six Months Ended
------------------------------------
(In thousands) June 28, 1998 June 29, 1997
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 14,735 $ 7,380
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 6,001 4,516
Changes in assets and liabilities:
Trade receivables (5,851) (2,564)
Inventories 2,209 (7,486)
Deferred tax assets 1,015 322
Other current assets (3,573) 471
Accounts payable and accrued liabilities 4,494 5,704
Deferred lease expense (82) (68)
---------- ----------
Net cash provided by operating activities 18,948 8,275
---------- ----------
Cash flows from investing activities:
Purchase of short-term investments (20,796) (30,341)
Proceeds from sales and maturities of short-term investments 30,339 21,719
Purchase of long-term investments (31,609) (7,740)
Proceeds from sales and maturities of long-term investments 3,785 10,630
Purchase of property and equipment (12,272) (7,888)
Payments for foundry deposits and other assets (2,551) (103)
---------- ----------
Net cash provided by investing activities (33,104) (13,723)
---------- ----------
Cash flows from financing activities:
Net principal payments under capital lease obligations (542) (567)
Proceeds from issuance of stock, net of
repurchases and costs of issuance 5,533 2,199
---------- ----------
Net cash used in financing activities 4,991 1,632
---------- ----------
Decrease in cash and cash equivalents (9,165) (3,816)
Cash and cash equivalents at beginning of period 25,234 20,251
---------- ----------
Cash and cash equivalents at end of period $ 16,069 $ 16,435
========== ==========
Supplementary disclosure of cash and noncash transactions
Cash payments for:
Interest $ 1,687 $ 295
Income taxes 227 80
The accompanying notes are an integral part of these statements.
</TABLE>
5
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LEVEL ONE COMMUNICATIONS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying audited and unaudited financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six month periods ended June
28, 1998, are not necessarily indicative of the results that may be expected for
the year ending December 27, 1998. The information reported in this Form 10-Q
should be read in conjunction with the financial statements and footnotes
contained in the Company's Form 10-K filed with the Securities and Exchange
Commission for the year ended December 28, 1997, and subsequent filings with the
Securities and Exchange Commission.
All share and per share numbers in this Report reflect the effect of a 3-for-2
stock split effected on March 30, 1998.
NOTE 2 - COMPREHENSIVE INCOME
On December 29, 1997, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement
establishes standards for the reporting and display of comprehensive income and
its components in the financial statements. Comprehensive income is defined as
the change in equity of a business enterprise during a period from transactions
and other events and circumstances from nonowner sources. For the Company,
comprehensive income includes net income reported on the income statement and
changes in the fair value of its available-for-sale securities reported as a
separate component of shareholders' equity. The Company's total comprehensive
income for the period ended June 28, 1998 was $7,238 million and $3,911 million
for the period ended June 29, 1997.
NOTE 3 - EARNINGS PER SHARE
6
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The following is a reconciliation of the numerator (income) and denominator
(shares) of basic and diluted earnings per share for the periods ending June 28,
1998 and June 29, 1997.
<TABLE>
<CAPTION>
Per Share
(in thousands, except earnings per share) Income Shares Amount
----------- ------------ ------------
<S> <C> <C> <C>
Quarter Ending:
Net income:
June 28, 1998 $ 7,242
June 29, 1997 3,923
Basic EPS: income available to
common shareholders
June 28, 1998 $ 7,242 30,988 $0.23
June 29, 1997 3,923 30,288 0.13
Effect of dilutive securities:
Convertible debentures:
June 28, 1998 $ 854 4,313
June 29, 1997 - -
Options:
June 28, 1998 - 2,100
June 29, 1997 - 1,801
Diluted EPS: income available to common
stockholders plus assumed conversions
June 28, 1998 $ 8,096 37,401 $0.22
June 29, 1997 3,923 32,089 0.12
- ------------------------------------------------------------------------------------------------------
<CAPTION>
Year-To-Date
<S> <C> <C> <C>
Net income:
June 28, 1998 $ 14,753
June 29, 1997 7,381
Basic EPS: income available to
common shareholders
June 28, 1998 $ 14,753 30,903 $0.48
June 29, 1997 7,381 30,136 0.24
Effect of dilutive securities:
Convertible debentures:
June 28, 1998 $ 1,708 4,313
June 29, 1997 - -
Options:
June 28, 1998 - 2,157
June 29, 1997 - 1,781
Diluted EPS: income available to common
stockholders plus assumed conversions
June 28, 1998 $ 16,461 37,373 $0.44
June 29, 1997 7,381 31,917 0.23
</TABLE>
7
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Note 4 - Inventories
Inventories are stated at the lower of cost (first in, first out) or market and
include materials, labor and manufacturing overhead costs. Inventories as of
June 28, 1998 and December 28, 1997 consisted of:
(in thousands)
June 28, 1998 December 28, 1997
--------------- -------------------
Raw materials $ 5,465 $ 8,829
Work-in-process 10,417 13,135
Finished goods 8,027 4,154
---------- ----------
Total inventories $ 23,909 $ 26,118
========== ==========
Note 5 - Property and Equipment
Property and equipment are recorded at cost and depreciation is provided on a
straight-line basis over their estimated useful lives; property and equipment
consists of the following:
(in thousands)
June 28, 1998 December 28, 1997
--------------- -------------------
Machinery and equipment $ 40,155 $ 36,22
Furniture and fixtures 25,151 18,06
Leasehold improvements 4,638 3,38
---------- ----------
69,943 57,67
Less-Accumulated depreciation (31,402) (25,876)
---------- ----------
$ 38,542 $ 31,795
========== ==========
Note 6 - Convertible Subordinated Notes
The Company sold $115 million of 4% convertible subordinated notes during 1997.
The notes will mature on September 1, 2004. Unless previously redeemed or
repurchased, the notes are convertible at any time through the close of business
on the final maturity date of the notes, into common stock of the Company, at a
conversion price of $26.67 per share. Interest on the notes is payable
semi-annually, commencing March 1, 1998. Total interest accrued on the
convertible subordinated notes at June 28, 1998 was approximately $1,500,000.
After September 2000, the notes are redeemable at the option of the Company, in
whole or in part. The notes may be redeemed for either cash or common stock at a
repurchase price of 105% of the principal amount of the notes to be repurchased
plus accrued and unpaid interest to the repurchase date.
The notes are unsecured obligations of the Company and are subordinated to all
existing and future senior indebtedness of the Company. The indenture contains
no limitations on the incurrence of additional indebtedness or other liabilities
by the Company.
Note 7 - Subsequent Event
8
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On July 6, 1998, the Company completed a business combination with Acclaim
Communications Incorporated ("Acclaim") which is a provider of Fast Ethernet and
Gigabit Ethernet switches and integrated Multi Service access products. The
combination was a stock for stock merger that will be accounted for as a
"pooling-of-interests." Accordingly, the Company's historical consolidated
financial statements presented in the future will be restated to include the
financial position and results of operations of Acclaim. As a result of the
merger, the outstanding shares of Acclaim capital stock and options and warrants
to purchase Acclaim capital stock were converted into the right to receive an
aggregate of 5,000,000 shares of the Company's common stock worth approximately
$125 million as of the merger date.
The following unaudited pro forma summary presents the consolidated results of
operations of the company as if the merger had occurred on June 29, 1997.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------------- ----------------------------------
June 28, 1998 June 29, 1997 June 28, 1998 June 29, 1997
--------------- --------------- ---------------- ----------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Revenues $ 60,497 $ 32,642 $ 117,127 $ 62,749
Net income 3,943 2,727 9,657 4,989
Earnings per share:
Basic $ 0.11 $ 0.08 $ 0.27 $ 0.14
Diluted $ 0.11 $ 0.07 $ 0.27 $ 0.14
</TABLE>
The above amounts are based on certain assumptions and estimates which the
company believes are reasonable. The pro forma results do not necessarily
represent results which would have occurred if the business combination had
taken place at the date and on the basis assumed above. The effects of
anticipated changes in accounting methods and elimination of intercompany
transactions are expected to be immaterial.
The Company's acquisition transactions costs incurred as of June 28, 1998
totaled $1.8 million and are included in general and administrative costs in
the accompanying consolidated statements of income.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The following information should be read in conjunction with the unaudited
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report on Form 10-Q, the Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's Form
10-K for the period ended December 28, 1997 filed with the Securities and
Exchange Commission on March 27, 1998, and any subsequent filings with the
Securities and Exchange Commission.
This report contains forward-looking statements that involve risks and
uncertainties. The statements contained in this report that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including without limitation statements regarding the Company's
expectations, beliefs, intentions or strategies regarding the future. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. The Company's actual
results could differ materially from those anticipated in these forward-looking
statements. See "Factors That May Affect Future Results".
RESULTS OF OPERATIONS
Revenues
Revenues increased 85% to $60.4 million in the second quarter of 1998 compared
to revenues of $32.6 million for the same quarter of 1997. Revenues increased
by 7% from $56.6 million in the first quarter of 1998. During the quarter, sales
to D-link, Inc. represented 11% of total revenues. The increased revenues
reflect unit sales growth due to the continued market acceptance of the
Company's products in both the networking and transmission markets.
International revenues were $23.2 million or 39% of revenues and $10.8 million
or 33% of revenues, respectively, for the second quarter of 1998 and 1997. All
sales are denominated in U.S. dollars, thereby eliminating the impact of
foreign currency exchange rate fluctuations on revenues.
9
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Gross Margin
Product gross margin is affected by several factors, including average selling
prices, the mix between older and newer products, test equipment utilization,
manufacturing yields, timing of cost reductions and the mix between direct and
distributor sales. Margins on domestic and international sales are similar. At
58.6%, gross product margins for the second quarter of 1998 were up slightly
from the first quarter of 1998 and up from 58.1% for the second quarter of 1997.
Gross product margins for the first six months of 1998 was 58.5% versus 57.8%
for the first six months of 1997, the increase is due to the impact of cost
reductions implemented during the second half of 1997 and the first half of
1998.
RESEARCH AND DEVELOPMENT
Research and development expenses were $10.6 million or 17.6% of revenues in the
second quarter of 1998 versus $6.7 million or 20.6% of revenues in the second
quarter of 1997. For the first six months of 1998 research and development
expenses were $21.2 million or 18.1% of revenues versus $13.1 million or 20.8%
of revenues for the first six months of 1997. The dollar increase in research
and development expense is due to additions to the Company's design engineering
staff and related new product design expenses.
SALES AND MARKETING
Sales and marketing expenses were $9.0 million or 14.9% of revenues in the
second quarter of 1998 versus $4.7 million or 14.6% of revenues in the second
quarter of 1997. Sales and marketing expenses for the first six months of 1998
were $17.7 million or 15.1% of revenues versus $9.1 million or 14.4% of revenues
for the same period in 1997. The increased expenditures are primarily
attributable to the expansion of the Company's sales and marketing staffs and
their related costs.
General and Administrative
General and administrative expenses for the second quarter were $5.8 million or
9.6% of revenues versus $2.2 million or 6.8% of revenues for the second quarter
of 1997. For the first six months of 1998 general and administrative expenses
were $9.3 million or 7.9% of revenues versus $4.0 million or 6.4% for the same
period in 1997. During the second quarter of 1998 the Company incurred a $1.8
million one time charge for transaction costs associated with the acquisition of
Acclaim Communications, Inc. Excluding the one time charge, expenses for the
second quarter of 1998 were $4.0 million or 6.6% of revenues and $7.5 million or
6.3% of revenues for the first six months of 1998.
Liquidity and Capital Resources
The Company's principal sources of liquidity as of June 28, 1998, consisted of
$119.1 million of cash, cash equivalents and short-term investments. Working
capital was $150.8 million at June 28, 1998 and $166.2 million at December 28,
1997. During the first six months of 1998, the Company generated $18.9 million
of cash from operating activities, as compared to $8.3 million in the same
period in 1997. In both periods, net cash generated from operations during the
period was primarily due to net income before depreciation and amortization
expense. This was offset by the net changes during the period for inventories,
accounts receivable, and accounts payable. These changes are due primarily to
expansion of the Company's business, and do not reflect material changes in the
way the Company conducts operations. The Company spent $12.3 million for capital
expenditures during the first six months of 1998 as compared to $7.9 million for
the same period in 1997.
10
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Management believes that, in addition to current financial resources, adequate
capital resources are available to satisfy the Company's investment and capital
programs. Management believes that the Company's cash flow is sufficient to
maintain its current operations.
Factors That May Affect Future Results
The following factors may have an impact on the Company's business:
Manufacturing Risks
The Company does not manufacture the silicon wafers used for its products. The
Company's wafers are manufactured by foundries located in the United States,
Europe and Asia. The Company depends upon these suppliers to produce wafers at
acceptable yields and to deliver them in a timely manner at competitive prices.
The Company may sustain an adverse impact on operating results from problems
with the cost, timeliness, yield and quality of wafer deliveries from suppliers.
From time to time, the available industry-wide foundry capacity can fluctuate
significantly. During periods of constrained supply, the Company may experience
difficulty in securing an adequate supply of wafers, and/or its suppliers may
increase wafer prices. The Company's operating results depend, in substantial
part, on its ability to maintain or increase the capacity available from its
existing or new foundries. In 1994 and 1995, the Company experienced increased
costs and delays in customer shipments as a result of a foundry reducing
shipments to the Company without prior notice, requiring the Company to transfer
products to a new foundry. Although the Company believes that it has planned to
meet customer demand, there can be no assurances that unforeseen demand,
supplier interruptions or other changes will not have a material impact on the
Company's business.
Manufacturing process technologies are subject to rapid change. Other companies
in the industry have experienced difficulty in migrating to new manufacturing
processes, and, consequently, have suffered reduced yields, delays in product
deliveries and increased expense levels. The Company's business, financial
condition and results of operations could be materially adversely affected if
any such transition is substantially delayed or inefficiently implemented.
The Company is also dependent upon third-party assembly companies that package
or test the Company's devices. The Company depends upon these suppliers to
produce products in a timely manner and at competitive prices. The Company may
sustain an adverse financial impact from problems with the cost, timeliness,
yield and quality of product deliveries from these suppliers.
Operating Results
The semiconductor industry is characterized by rapid technological change,
intense competitive pressure and cyclical market patterns. The Company's results
of operations are affected by a wide variety of factors, including general
economic conditions, semiconductor industry environment, changes in average
selling prices, the timing of new product introductions (by the Company and its
customers), use of new technologies, the ability to safeguard patents and
intellectual property, and rapid change of demand for products. The level of net
revenues in any specific quarter can also be affected by the level of orders
placed during that quarter. The Company attempts to respond to changes in market
conditions as soon as possible; however, the rapidity of their onset may make
prediction of and reaction to such events difficult. Due to the foregoing and
other factors, past results, such as those described in this report, may not be
predictive of future performance.
11
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Dependence on New Products
The Company's future success depends on its ability to timely develop and
introduce new products which compete effectively. Because of the complexity of
its products, the Company may experience delays in completing development and
introduction of new products, and, as a result, not achieve the market share
anticipated for such products. The Company's strategy is to develop products for
the fastest growing segments of the communications market. The Company conducts
its own analysis of market trends and reviews forecasts and information provided
by industry analysts. Market conditions may change rapidly as technology,
economic, or user-preference conditions cause different communications
technologies to experience growth other than that forecast by the Company or
others. There can be no assurance that the Company will successfully identify
new product opportunities and bring new products to market in a timely manner,
that products or technologies developed by others will not render the Company's
products or technologies obsolete or noncompetitive, or that the Company's
products will be selected for design into the products of its targeted
customers. In addition, the average selling price for any particular product
tends to decrease over the product's life. To offset such price decreases, the
Company relies primarily on obtaining yield improvements and corresponding cost
reductions in the manufacture of existing products and on introducing new
products which incorporate advanced features and other price/performance factors
such that higher average selling prices and higher margins are achievable
relative to existing product lines. To the extent that cost reductions and new
product introductions with higher margins do not occur in a timely manner, or
the Company's products do not achieve market acceptance, the Company's operating
results could be materially affected.
Management of Growth; Dependence on Key Personnel
The Company is currently experiencing a period of significant growth which has
placed, and could continue to place, a significant strain on the Company's
personnel and other resources. The Company's ability to manage its growth
effectively will require continued expansion and refinement of the Company's
operational, financial, management and control systems, as well as a significant
increase in the Company's development, testing, quality control, marketing,
logistics and service capabilities, any of which could place a significant
strain on the Company's resources. The Company's success also depends to a
significant extent upon its ability to retain and attract key personnel.
Competition for such personnel is intense and there can be no assurance that the
Company will be able to retain and attract key personnel. If the Company's
management is unable to manage growth effectively, maintain the quality and
marketability of the Company's products and retain, hire and integrate key
personnel, the Company's business, financial condition and results of operations
could be materially adversely affected.
Intellectual Property
The Company relies upon patent, trademark, trade secret and copyright law to
protect its intellectual property. There can be no assurance that such
intellectual property rights can be successfully asserted or will not be
invalidated, circumvented or challenged. Litigation, regardless of its outcome,
could result in substantial cost and diversion of resources for the Company. Any
infringement claim or other litigation against or by the Company could have a
material effect on the Company's financial condition and results of operations.
In November 1995, the Company commenced infringement litigation against a
competitor. See "Legal Proceedings".
Semiconductor Industry
The semiconductor industry has historically been cyclical and subject to
significant economic downturns at various times. The Company may experience
substantial period-to-period fluctuations in operating results due to general
semiconductor industry conditions, overall economic conditions or other factors.
In addition, the securities of many high technology companies have historically
been subject to extreme price and volume fluctuations, factors which may affect
the market price of the Company's Common Stock. As is common in the
semiconductor industry, the Company frequently ships more product in the third
month of a quarter than in the
12
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other months. If a disruption in the Company's production or shipping occurs
near the end of a quarter, the Company's revenues for that quarter could be
materially affected.
The Company must order wafers and build inventory in advance of product
shipments. There is risk that the Company could produce excess or insufficient
inventories of particular products because the Company's markets are volatile
and subject to rapid technology and price changes. This inventory risk is
heightened because certain of the Company's customers place orders with long
lead times which may be subject to cancellation or rescheduling by that
customer. To the extent the Company produces excess or insufficient inventories
of particular products, the Company's revenues and earnings could be adversely
affected.
Increased demand for semiconductor products may result in a reduction in the
availability of wafers from foundries. Such capacity limitations may adversely
affect the Company's ability to deliver products on a timely basis and affect
the Company's margins. Additionally, the Company believes that during periods of
strong demand and/or restricted semiconductor capacity, customers will over-
order to assure an adequate supply. Certain of the Company's customers may
cancel or postpone orders without notice if product becomes available elsewhere.
Shortages of components from other suppliers could cause the Company's customers
to cancel or delay programs incorporating the Company's products, resulting in
the cancellation or delay of orders for the Company's products.
Intense Competition
The semiconductor industry is intensely competitive. The Company's competition
consists of semiconductor companies and semiconductor divisions of vertically
integrated companies. In the telecom market, the Company's principal competitors
are Rockwell International, Inc., Crystal Semiconductor, Inc. (a subsidiary of
Cirrus Logic, Inc.) ("Crystal"), Dallas Semiconductor, Inc., Lucent Technologies
Inc. ("Lucent"), PMC-Sierra Inc. and Siemens A.G. In the networking market, the
Company's principal competitors are Advanced Micro Devices, Inc., Broadcom
Corporation, Crystal, Integrated Circuit Systems, Inc., Lucent, Micro Linear
Corp., National Semiconductor Corporation, Quality Semiconductor, Inc., Seeq
Technologies, Inc. and Texas Instruments, Inc. Many of these competitors have
longer operating histories, greater name recognition, access to larger customer
bases and significantly greater financial and other resources than the Company
with which to pursue engineering, manufacturing, marketing and distribution of
products.
The ability of the Company to compete successfully in the rapidly evolving area
of high performance integrated circuit technology depends on factors both within
and outside of the Company's control. Such factors include, without limitation,
success in designing and manufacturing new products, implementing new
technologies, intellectual property programs, product quality, reliability,
price, efficiency of production, and general economic conditions. There is no
assurance that the Company will be able to compete successfully against current
and future competitors. Increased competition may result in price erosion,
reduced gross margins and loss of market share, any of which may have a material
adverse effect on the Company's business, financial condition and results of
operations.
International Operations
Due to its reliance on international sales and foreign third-party manufacturing
and assembly operations, the Company is subject to the risks of conducting
business outside of the United States including government regulatory risks,
political, social and economic instability, potential hostilities and changes in
diplomatic and trade relationships. There can be no assurance that one or more
of the foregoing factors will not have a material adverse effect on the
Company's business, financial condition or operating results. The recent
economic downturn in several Asian countries has not affected the Company in a
material way, but there can be no assurances that continued economic problems in
Asia or any other region of the world will not affect the Company.
13
<PAGE>
Increased Leverage
As a result of the Company's sale in August and September 1997 of its 4%
Convertible Subordinated Notes due 2004 (the "Notes"), the Company has incurred
approximately $115.0 million in additional indebtedness which increases the
ratio of its long-term debt to its total capitalization from 3.0%, at June 29,
1997, to 44.8%, at June 28, 1998. This increased leverage will increase the
Company's interest expense substantially. The degree to which the Company will
be leveraged could adversely affect the Company's ability to obtain additional
financing for working capital, acquisitions or other purposes and could make it
more vulnerable to economic downturns and competitive pressures. The Company's
increased leverage could also adversely affect its liquidity, as a substantial
portion of available cash from operations may have to be applied to meet debt
service requirements and, in the event of a cash shortfall, the Company could be
forced to reduce other expenditures and/or forego potential acquisitions to be
able to meet such requirements.
Volatility of Notes and Stock Price
Economic and other external factors, many of which are beyond the control of the
Company, may have a significant impact on the Company's business and on the
market price of its Notes and the Common Stock. Such factors include, without
limitation, fluctuations in product revenues and net income of the Company or
its competitors, shortfalls in the Company's operating results from levels
forecast by securities analysts, announcements concerning the Company, its
competitors or customers, announcements of technological innovations by the
Company, its competitors or its customers, the introduction of new products or
changes in product pricing policies by the Company, its competitors or its
customers, market conditions in the industry and the general state of the
securities market. In addition, the stock prices of many technology companies
fluctuate significantly for reasons that may be unrelated or disproportionate to
operating results. These fluctuations, as well as general economic, political
and market conditions such as recession or international instability, may
adversely affect the market price of the Company's Notes and the Common Stock.
Year 2000 Compliance
The Company has reviewed its exposure to risks that could be caused if internal
computer systems do not correctly recognize date information when the year
changes to 2000. Management believes that the likelihood of a material adverse
impact due to problems with internal systems or products sold to customers is
remote and expects that the cost of remedying internal systems that currently
cannot process the date change will not have a material effect on the Company's
financial position or overall trends in results of operations. The Company is
also contacting critical suppliers of products and services to determine that
the supplier's operations and the products and services they provide are year
2000 compliant. There can be no assurance that another company's failure to
ensure year 2000 capability would not have an adverse effect on the Company.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 28, 1995, the Company initiated a patent infringement suit against
Seeq Technologies, Inc. in United States District Court for the Northern
District of California. The suit relates to two Level One patents, No.
5,267,269 and No. 5,249,183, and to certain Seeq products used in Ethernet
system products. The suit seeks damages and injunctive relief, Seeq has denied
the allegations. On January 21, 1998, the Court denied Seeq's motion to declare
claims of the Level One patents invalid. The Court also permitted Seeq to amend
its counterclaim to include a claim that certain of the Company's products
infringe Seeq's U.S. Patent 5,504,738; the Company has denied these allegations.
Trial is set for August 1998. Although the Company does not believe such
litigation will have a material impact on the Company, litigation, regardless of
its outcome, could result in substantial cost and diversion of resources of the
Company. See "Factors That May Affect Future Results".
14
<PAGE>
There are no other material pending legal proceedings, other than routine
litigation incidental to the Company's business, to which the Company is a party
or of which any of its property is the subject.
ITEM 2. CHANGES IN SECURITIES
On March 3, 1998, the Company's Certificate of Incorporation was amended to
effect a 3-for-2 stock split to shareholders of record on March 9, 1998. The
split was effective March 30, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - 27.1--Financial Data Schedule, June 28, 1998
(b) Reports on Form 8-K - Agreement and Plan of Reorganization filed
on July 17, 1998
15
<PAGE>
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.
LEVEL ONE COMMUNICATIONS, INCORPORATED
Date: August 12, 1998 By: /s/ Robert S. Pepper
-- --------------------------------
Robert S. Pepper, Ph.D.
Chairman of the Board of Directors,
President and Chief Executive Officer
(Principal Executive Officer)
Date: August 12, 1998 By: /s/ John Kehoe
-- ------------------------
John Kehoe
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)
S-1
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
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