<PAGE> 1
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 JUNE 30, 1996
_________________________________________________
OR
____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________________ to _______________________
Commission File Number 0-25688
SDL, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0331449
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
80 Rose Orchard Way, San Jose, CA 95134-1365
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (408) 943-9411
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 ______
The number of shares outstanding of the issuer's common stock as of July 24,
1996 was 13,003,033.
<PAGE> 2
SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Income for
the three and six months ended June 30, 1996 and 1995 4
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1996 and 1995 5
Notes to Condensed Consolidated 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 17
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS - EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
---- ----
(UNAUDITED) (1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,613 $ 2,793
Short-term investments 7,515 8,515
Receivable from common stock offering 38,475 --
Accounts receivable, net 13,336 13,535
Inventories 12,623 9,006
Deferred income taxes 1,314 989
Prepaid expenses and other current assets 1,596 502
--------- --------
Total current assets 80,472 35,340
Property and equipment, net 18,344 16,470
Purchased intangibles, net 2,444 2,766
Deferred income taxes 1,840 1,840
Other assets 256 227
--------- --------
$ 103,356 $ 56,643
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable $ 6,836 $ 6,257
Accrued payroll and related expenses 1,814 1,990
Accrued warranty 416 442
Unearned revenue 1,500 972
Acquisition obligations 2,790 1,592
Other accrued liabilities 1,518 1,438
--------- --------
Total current liabilities 14,874 12,691
Deferred acquisition obligations -- 2,680
Other long-term liabilities 676 772
Stockholders' equity:
Common stock, $0.001 par value, 21,000,000 shares authorized;
12,742,948 outstanding (10,628,115 at December 31, 1995) 13 11
Treasury stock -- (33)
Additional paid-in-capital 105,577 63,034
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (17,440) (22,028)
Cumulative translation adjustment (7) (6)
--------- --------
88,143 40,978
Less: common stockholders' notes receivable (337) (478)
--------- --------
Total stockholders' equity 87,806 40,500
--------- --------
$ 103,356 $ 56,643
========= ========
</TABLE>
(1) The balance sheet at December 31, 1995 has been derived from the audited
financial statements at that date. See accompanying notes.
3
<PAGE> 4
SDL, INC.
CONDENSED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- ---------------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Total revenues:
Product revenue $ 18,541 $ 10,411 $ 35,889 $ 19,063
Research revenue 3,065 2,103 6,139 3,963
--------- --------- --------- ---------
21,606 12,514 42,028 23,026
Cost of revenues:
Cost of product revenue 11,647 6,138 22,152 11,235
Cost of research revenue 2,111 1,489 4,353 2,899
--------- --------- --------- ---------
Gross margin 7,848 4,887 15,523 8,892
Operating expenses:
Research and development 1,358 953 3,045 1,677
Selling, general and administrative 2,984 1,871 5,795 3,292
--------- --------- --------- ---------
Operating income 3,506 2,063 6,683 3,923
Interest income (expense), net 124 112 269 (312)
---------- ---------- ---------- -----------
Income before income taxes 3,630 2,175 6,952 3,611
Provision for income taxes 1,201 805 2,364 1,336
--------- --------- --------- ---------
Net income $ 2,429 $ 1,370 $ 4,588 $ 2,275
========= ========= ========= =========
Net income per share $ 0.20 $ 0.12 $ 0.38 $ 0.24
========== ========== ========== ==========
Shares used in computing
net income per share 12,383 11,205 12,228 9,633
========= ========= ========= =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
SDL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------------------
1996 1995
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 4,588 $ 2,275
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2,327 1,270
Loss on disposal of equipment 62 --
Deferred income taxes (325) 135
Deferred rent (30) (35)
Accrued interest -- (452)
Changes in operating assets and liabilities:
Accounts receivable 199 (2,295)
Inventories (3,617) (598)
Accounts payable 579 3,345
Income taxes payable 2,539 (163)
Accrued payroll and related expenses (176) 253
Accrued warranty (26) --
Unearned revenue 528 744
Other accrued liabilities 80 213
Other (29) (58)
-------- ---------
Total adjustments 2,111 2,359
-------- ---------
Net cash provided by operating activities 6,699 4,634
INVESTING ACTIVITIES:
Acquisition of property and equipment, net (3,941) (4,950)
Sales (purchases) of short-term investments, net 1,000 (9,000)
Payments on acquisition obligations (1,482) --
-------- --------
Net cash used in investing activities (4,423) (13,950)
FINANCING ACTIVITIES:
Payments of bank debt -- (2,592)
Payments of subordinated debt -- (21,580)
Proceeds from issuance of common stock -- 34,771
Common stock offering costs (483) --
Repurchase of common stock -- (33)
Issuance of stock pursuant to employee stock plans 886 40
Payments on stockholders' notes receivable 141 2
--------- --------
Net cash provided by financing activities 544 10,608
--------- --------
Net increase in cash and cash equivalents 2,820 1,292
Cash and cash equivalents at beginning of period 2,793 632
-------- --------
Cash and cash equivalents at end of period $ 5,613 $ 1,924
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for income taxes $ -- $ 1,362
Cash paid for interest $ -- $ 894
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
Conversion of convertible redeemable preferred stock to common stock $ -- $ 10,896
Stock issued for stockholders' notes receivable $ -- $ 36
Stock issued for receivables from common stock offering $ 38,475 $ --
</TABLE>
See accompanying notes.
5
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SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated 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 only of normal
recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six month periods
ended June 30, 1996 are not necessarily indicative of the results that
may be expected for the year ended December 31, 1996. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Registrant Company's annual report on Form 10-K
for the year ended December 31, 1995.
The consolidated financial statements include the accounts of SDL, Inc.
(the Company) and its wholly owned subsidiary SDL Optics, Inc. (SDL
Optics). Intercompany accounts and transactions have been eliminated in
consolidation.
The functional currency of the Company's foreign subsidiary is the U.S.
dollar. Subsidiary financial statements are remeasured into U.S. dollars
for consolidation. Foreign currency transaction gains and losses were
immaterial for all periods presented.
2. NET INCOME PER SHARE
Net income per share is computed using the weighted average number of
shares of common stock outstanding and dilutive common equivalent shares
from stock options (using the treasury stock method).
3. STOCK SPLIT AND COMMON STOCK OFFERING
In May 1996, the Board of Directors authorized a three-for-two split of
its Common Stock, effected in the form of a 50% stock dividend, which was
paid on June 12, 1996 to stockholders of record on May 15, 1996. All
share and per share data in these financial statements have been
retroactively adjusted to reflect the stock split.
On June 26, 1996, the Company issued 1,500,000 shares of common stock in
a follow-on public stock offering at a per share price of $27.00. Net
proceeds to the Company approximated $37,992,000 and were receivable from
the Company's Underwriters at June 30, 1996.
6
<PAGE> 7
4. SHORT-TERM INVESTMENTS
Available for sale short-term investments consist of the following (in
thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Tax-exempt auction rate preferred stocks $6,000 $7,000
Municipal bonds 1,515 1,515
------- -------
$7,515 $8,515
====== ======
</TABLE>
Tax-exempt auction rate preferred stock contains contractual maturities
of less than one year. Municipal bonds mature within one year.
Both realized and unrealized gains and losses on the sale of
available-for-sale securities were immaterial for the three and six
months ended June 30, 1996 and 1995.
5. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Raw materials $ 5,626 $ 4,151
Work in process 6,997 4,855
-------- --------
$12,623 $ 9,006
======= =======
</TABLE>
No significant amounts of finished goods are maintained.
6. COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS
The following is a summary of research and product contract activity
related to uncompleted long-term contracts from the inception of the
contracts (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Costs incurred on uncompleted long-term contracts $51,658 $41,460
Estimated earnings 3,309 2,533
-------- ---------
Revenue recognized on uncompleted long-term contracts 54,967 43,993
Less billings to date 53,545 42,477
-------- --------
Unbilled costs and estimated earnings $ 1,422 $ 1,516
======== =========
</TABLE>
7
<PAGE> 8
The above balances are included in accounts receivable in the
accompanying balance sheets. Unbilled costs and estimated earnings on
uncompleted long-term contracts are generally billable in the subsequent
year.
Revenue recognized on long-term contracts included in total revenues was
approximately $6.0 million and $11.8 million for the three and six month
periods ended June 30, 1996 and approximately $4.2 million and $8.2
million for the comparable 1995 periods.
7. CONTINGENCIES
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
8. SUBSEQUENT EVENT
On July 1, 1996, the Underwriters of the June 26, 1996 follow-on public
stock offering exercised their over-allotment option to purchase 255,000
additional shares of the Company's common stock. Net proceeds to the
Company approximated $6,541,000.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SDL designs, manufactures and markets semiconductor optoelectronic integrated
circuits (OEICs), semiconductor lasers, fiber optic related products and
optoelectronic based systems. The Company's revenue consists of product and
research revenue. The Company's product revenue is primarily derived from the
sale of standard and customized products to a variety of customers, in volumes
ranging from single products sold to numerous organizations, to high unit
volumes sold to certain original equipment manufacturer (OEM) customers. As a
result, product gross margins tend to fluctuate based on the mix of products
sold in any reported period. From the original products introduced in 1984, the
Company has expanded its product offering to over 200 standard products in
addition to providing custom design and packaging for OEM customers. OEM
customers often fund the design or customization as well as the manufacturing
and testing of their volume products. The primary applications for the Company's
products include telecommunications, CATV, satellite communications, printing,
medical, data storage, sensor, defense, materials processing and instrument
markets.
The Company's research revenue is derived from customer-funded research
programs. The Company's research and engineering staff, which currently includes
over 40 Ph.D.s, provides state-of-the-art research and proof-of-concept
prototypes over a broad range of semiconductor OEIC and laser technologies. The
Company has been issued over 50 U.S. patents and has approximately 40 U.S.
patent applications pending. Customer-funded research revenue is typically based
on material and labor costs incurred, plus coverage for overhead and operating
expenses, and in most cases, an additional profit component. Cost-based pricing
has generally resulted in lower gross margins for research revenue as compared
to that of product revenue. The Company typically retains rights to the
technology developed under customer-funded research programs and therefore is
able to leverage these programs to continue to broaden its product and
technology offerings. All internally-funded research and development costs are
expensed in the period incurred.
On November 30, 1995, the Company and its subsidiary, SDL Optics, acquired the
net assets of Seastar Optics, Inc., which was accounted for under the purchase
method of accounting. SDL Optics' operating results are included in the
accompanying consolidated financial statements from that date.
Certain of the statements contained in this Management's Discussion and Analysis
of Financial Condition and Results of Operations may be forward-looking
statements regarding the Company's business, operations and prospects. The
Company's actual results could differ materially from those in such
forward-looking statements. See "Risk Factors."
RESULTS OF OPERATIONS
REVENUE. Total revenue for the quarter ended June 30, 1996 increased 73% to
$21.6 million compared to $12.5 million in the June 1995 quarter and was 6%
above total revenue recorded
9
<PAGE> 10
during the March 1996 quarter. Total revenue for the six months ended June 30,
1996 increased 83% to $42.0 million over the same six month period in 1995. The
increase in revenue during 1996 has been driven by demand for the Company's
semiconductor lasers and optoelectronic solutions, SDL Optics' sales of
communications products, and to a lesser extent, growth in research revenue.
Revenue from products within the fiber-based communications market, including
telecommunications, CATV, satellite communication and LANs grew 77% over that
reported during the second quarter of 1995, and represented approximately 53% of
total revenue reported during the three months ended June 30, 1996. Research
revenue grew compared to both the corresponding 1995 periods and the March 31,
1996 quarter, but at a slower rate than that of product revenue. For the three
and six months ended June 30, 1996, research revenue represented 14% and 15%,
respectively, of total revenue as compared to 17% for both the corresponding
1995 periods.
International revenue as a percentage of total revenue for the six months ended
June 30, 1996 decreased to 16% compared to 25% for the corresponding 1995
period. The decline in the percentage of total international revenue resulted
from a large percentage of SDL Optics' revenue occuring within the domestic
communications markets.
Approximately 18% of the Company's revenue for both the three and six months
ended June 30, 1996 was received from Lockheed Martin. This compares to
approximately 15% and 17 % of revenue for the comparable 1995 three and six
month periods. Several new programs for Lockheed Martin initiated during the
second quarter of 1996 resulted in the increase in revenue from this customer.
There can be no assurances that the application markets for SDL's products will
grow in future periods at historical percentage rates. Further, there can be no
assurance that the Company will be able to increase or maintain its market share
in the future or to sustain historical growth rates.
GROSS MARGIN. Gross margins decreased from 38.6% and 39.1% of total revenue for
the three and six months ended June 30, 1995, to 36.3% and 36.9% in the
comparable 1996 periods. While slight gross margin improvements were realized
for research revenue during the second quarter of 1996, the Company experienced
manufacturing capacity constraints, and lower than expected production yields on
several of its product lines. This, in turn, contributed to the lower gross
margins realized during the three and six months ended June 30, 1996 as compared
to the corresponding prior year periods. The Company is actively addressing
yield issues, and to relieve capacity constraints, additional manufacturing
equipment has been ordered and clean room renovation is in process. The
additional capacity should become available during the fourth quarter of 1996.
See "Risk Factors Manufacturing Risks."
The Company's gross margin can be affected by a number of factors, including
product mix, pricing pressures, and product yield. Generally, the cost of newer
products tends to be higher as a percentage of product revenue than that of more
mature, higher volume products. In addition, the cost of research revenue is
significantly higher as a percentage of revenue, as research revenue is
typically based on costs incurred rather than market pricing. As a result of
these factors, gross margin fluctuations are difficult to predict and there can
be no assurance that the Company will maintain gross margins at current levels
in future periods.
10
<PAGE> 11
RESEARCH AND DEVELOPMENT. The Company's total research and development
activities consist of customer-funded research programs and internally-funded
research and development. Total research and development activities during the
three and six months ended June 30, 1996 increased to $3.5 million and $7.4
million, respectively, compared to $2.4 million and $4.6 million for the
corresponding 1995 periods. Research revenue growth, together with increased
spending on new product development, cost reduction and reliability improvement
projects and the acquisition of the SDL Optics business primarily influenced the
1996 growth in total research and development activities. As a percentage of
total revenue, total cost of research and development activities decreased to
18% for the six months ended June 30, 1996 from 20% for the corresponding six
month period of 1995. The high relative growth in total revenue for the reported
periods is the primary reason for the decreased ratio of total Company cost of
research and development activities on a year-over-year basis. Accordingly, the
level of research and development may vary based on future levels of
customer-funded research and development.
SELLING, GENERAL AND ADMINISTRATIVE. The increase of selling, general and
administrative expense (SG&A) for the three and six months ended June 30, 1996
as compared to the corresponding 1995 periods resulted primarily from the
continuing expansion of the Company's business, headcount increases, ongoing
litigation expense, and to a lesser extent, the acquisition of the SDL Optics
business. SG&A decreased for the three and six month periods as a percentage of
total revenue despite higher levels of litigation expense incurred during 1996
compared to 1995. The Company expects that SG&A expenses will continue to
increase to support the Company's current and expected future volumes of
business. However, there can be no assurances that current SG&A levels as a
percentage of total revenue are indicative of future SG&A as a percentage of
total revenue. For the next several quarters, it is expected that litigation
expense will remain at approximately the level recorded during the most recent
three month period.
INTEREST INCOME (EXPENSE), NET. The Company recorded net interest income for the
three and six months ended June 30, 1996. The level of interest income
generating investments and their relative interest rates were comparable during
the second quarter of both 1996 and 1995. The Company incurred net interest
expense for the six month period ended June 30, 1995 as a result of its
subordinated and bank debt, which remained outstanding for substantially all of
the first quarter of 1995. This debt was repaid with proceeds of the Company's
initial public stock offering in March 1995.
PROVISION FOR INCOME TAXES. The annualized estimated effective tax rate was 34%
and 37% for the six month periods ended June 30, 1996 and 1995, respectively.
The reduction in the effective tax rate is attributable to the benefits of tax
exempt interest income, state tax credits, as well as a reduction in the
valuation allowance.
11
<PAGE> 12
LIQUIDITY AND CAPITAL RESOURCES
Net cash from operating activities was $6.7 million for the six months ended
June 30, 1996. In addition, the Company spent $3.9 million for planned
facilities expansion and capital equipment purchases during the 1996 six month
period and made a $1.5 million payment on the acquisition obligation related to
SDL Optics. As a result, the Company increased cash, cash equivalents and
short-term investments to $13.1 million at June 30, 1996 as compared to $11.3
million at December 31, 1995.
On June 26, 1996, the Company issued 1,500,000 shares of common stock in a
follow-on public stock offering at a per share price of $27.00. Net proceeds to
the Company approximated $37,992,000 and were receivable from the Company's
Underwriters at June 30, 1996. On July 1, 1996, the Underwriters exercised their
over-allotment option to purchase 255,000 additional shares of the common stock.
Net proceeds to the Company approximated $6,541,000. The net proceeds of this
offering are expected to be used to expand the Company's manufacturing
facilities, to acquire capital equipment, to fund possible acquisitions of
complementary businesses, products and technologies, and for general corporate
purposes including working capital. Pending such uses, the net proceeds will be
invested in investment-grade, income producing investments with maturities of up
to two years.
The Company has an $8 million secured line of credit, which expires in January
1997. Any borrowings under this line would be limited to 80% of eligible
accounts receivable, as defined in the credit agreement (approximately $6.5
million was available for borrowings under the line at June 30, 1996), and bear
interest at the bank's prime rate (8.25% at June 30, 1996). The credit agreement
contains affirmative and negative covenants and, among other things, requires
the Company to maintain certain financial ratios and restricts the ability to
pay cash dividends.
The Company has future cash requirements to complete its acquisition of the SDL
Optics business of (i) $1.5 million payable on March 31, 1997, for which the
Company was contingently liable for a letter of credit at June 30, 1996 and (ii)
$1.2 million in cash or common stock of the Company (at the Company's option) on
March 31, 1997.
The Company currently expects to spend approximately $12 million for capital
equipment purchases and leasehold improvements during 1996.
The Company believes that current cash balances, cash generated from operations,
credit available under the bank line of credit and cash available through the
equity markets will be sufficient to fund capital equipment purchases,
acquisitions of complementary businesses, products or technologies and working
capital requirements at least through 1997. However, there can be no assurances
that events in the future will not require the Company to seek additional
capital sooner or, if so required, that adequate capital will be available on
terms acceptable to the Company.
12
<PAGE> 13
RISK FACTORS
The statements contained in this Report on Form 10-Q 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 statements regarding the Company's expectations, hopes,
intentions, beliefs or strategies regarding the future. Forward looking
statements include SDL's liquidity, anticipated cash needs and availability, and
anticipated expense levels under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations". 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 statement. It is important to note that the Company's
actual results could differ materially from those in such forward looking
statements. Among the factors that could cause actual results to differ
materially are the factors detailed below. You should also consult the risk
factors listed from time to time in the Company's Reports on Form 10-Q, 8-K,
10-K and Annual Reports to Stockholders.
MANUFACTURING RISKS. The Company relies on its own production capability in
computer-aided chip and package design, wafer fabrication, wafer processing,
device packaging, hybrid microelectronic packaging, printed circuit board
testing, final assembly and testing of products. Because the Company
manufactures, packages and tests these components, products and systems at its
own facilities, and such components, products and systems are not readily
available from other sources, any interruption in manufacturing resulting from
shortages of parts or equipment, fire, natural disaster, equipment failures, or
otherwise would have a material adverse effect on the Company's business and
results of operations. In particular, a significant portion of the Company's
production relies or occurs on equipment for which the Company does not have a
backup. In order to alleviate, at least in part, this situation, the Company is
in the process of remodeling its front-end wafer fabrication facility. This
might cause downtime on existing equipment. Also, there can be no assurance that
the new facility and equipment will not experience start-up and yield problems.
In the event of any disruption in production by one of these machines, the
Company's business and results of operations could be materially adversely
affected. Furthermore, the Company has a limited number of employees dedicated
to the operation and maintenance of its equipment, the loss of whom could affect
the Company's ability to effectively operate and service such equipment. The
Company is experiencing, and may in the future experience, lower than expected
production yields on many of its products, including some of its key product
lines. This reduction in yields adversely affects gross margins and delayed
component, product and system shipments. There can be no assurance that the
Company's manufacturing yields will be acceptable to ship products on time in
the future. To the extent the Company continues to experience lower than
expected manufacturing yields or experiences any shipment delays,the Company
could lose customers, could experience reduced or delayed customer orders and
cancellation of existing backlog, and the Company's business and results of
operations would be materially adversely affected.
13
<PAGE> 14
MULTISITE OPERATIONS; NEED TO MANAGE GROWTH. The Company has on occasion been
unable to manufacture certain products in quantities sufficient to meet the
demand of its existing customer base and of new customers. As a result, the
Company expanded its facilities by relocating its assembly, test and packaging
operations to another building and is in the process of remodeling its original
manufacturing facilities and adding new manufacturing equipment and obtaining
additional facilities. In addition, the Company and its subsidiary, SDL Optics,
acquired the business of a company located in Victoria, British Columbia,
Canada. Prior to these developments, the Company had no experience in managing
operations in multiple sites and no assurance can be given that the Company will
not experience unexpected delays, inefficiencies or management problems arising
out of its multisite operations. Such delays or inefficiencies could materially
adversely affect the Company's business and results of operations.
The recent growth in the Company's revenue and expansion in the scope of its
operations has placed a considerable strain on its management, financial,
manufacturing and other resources and has required the Company to implement and
improve a variety of operating, financial and other systems, procedures and
controls. In addition, the Company has hired a new Vice President of
Manufacturing who will replace the former Vice President who recently resigned.
There can be no assurance that any existing or new systems, procedures and
controls will be adequate to support the Company's operations or that its
systems, procedures and controls will be designed, implemented or improved in a
cost effective and timely manner. Any failure to implement, improve and expand
such systems, procedures and controls in an efficient manner at a pace
consistent with the Company's business could have a material adverse effect on
the Company's business and results of operations.
TECHNOLOGY AGREEMENT. At the time of its formation, the Company entered into a
technology agreement with Spectra-Physics, Inc. ("Spectra-Physics") and Xerox
Corporation ("Xerox"), (the "Technology Agreement") pursuant to which SDL
granted to Spectra-Physics and Xerox an irrevocable, royalty-free, worldwide,
non-exclusive license to patented and non-patented technology developed by SDL.
In March 1995, Spectra-Physics filed suit against SDL in the Santa Clara County,
California Superior Court, seeking, among other things, to enforce the claims of
Spectra-Physics and its affiliated company, Opto Power Corporation ("Opto
Power"), to SDL patented and non-patented technology developed through at least
June 1993. The Company believes that as a result of events subsequent to the
entry into the Technology Agreement, there are questions concerning
Spectra-Physics' or Opto Power's continuing rights, if any, to such technology.
The Company has answered the complaint and has filed a cross-complaint against,
among others, Spectra-Physics and Opto Power seeking a declaration of the
parties' rights under the Technology Agreement, damages and an injunction
against further requests by Spectra-Physics and Opto Power of the transfer of
SDL technology.
In addition, the Company has named Xerox as an additional cross defendant on the
claims for a declaratory judgment seeking an interpretation of the Technology
Agreement with respect to the treatment of Xerox technical information. Xerox
has filed a cross complaint against the Company Spectra-Physics and Opto Power
seeking a declaratory judgment that Spectra-Physics and Opto Power have no
license to, and that the Company may not disclose without Xerox' consent, Xerox
technical information. Xerox also asserts a breach of contract claim against the
Company for the alleged failure to transfer technology to Xerox pursuant to the
Technology Agreement. Xerox
14
<PAGE> 15
seeks unspecified damages from the Company and specific performance of the
Technology Agreement.
Discovery is proceeding. Trial of the matter is scheduled for January 21, 1997.
The Company believes that it has meritorious defenses to Spectra-Physics', Opto
Power's and Xerox's claims. There can be no assurance, however, that the Company
will achieve a successful result in this litigation. The litigation has involved
and is expected to continue to involve significant expense to the Company and to
divert the attention of the Company's technical and management personnel, and
the outcome could have a material adverse effect on the Company's business and
results of operations. If the Company does not prevail in such litigation, the
Company could face monetary damages and could be required to license and to
transfer valuable SDL trade secrets and technology to Spectra-Physics and
possibly to Opto Power, which is currently manufacturing optoelectronic devices
that compete with a number of the Company's products. Such a result could
significantly impair the Company's competitive advantage in certain technology
areas with respect to a number of products and could have a material adverse
effect on the Company's business and results of operations.
RISK OF PATENT INFRINGEMENT CLAIM. The semiconductor optoelectronics,
communications, information and laser industry is characterized by frequent
litigation regarding patent and other intellectual property rights. From time to
time, the Company has received, and may receive in the future, notice of claims
of infringement of other parties' proprietary rights. In 1985, the Company first
received correspondence from Rockwell International Corporation ("Rockwell")
alleging that a fabrication process used by the Company infringes Rockwell's
patent rights. In August 1993, Rockwell sued the Federal government alleging
infringement of these patent rights with respect to the contracts the Federal
government has had with at least 15 companies, including the Company (the
"Government Lawsuit"). The Federal government has asserted that, if it is held
liable to Rockwell for infringement of Rockwell's patent rights in connection
with some of its contracts with the Company, then the Company will be liable to
indemnify the Federal government for a portion of its liability. The Company has
intervened as a party in the Government Lawsuit. In February 1995, Rockwell
asserted its prior allegations and threatened to file suit against the Company
for injunctive relief and damages if the Company did not enter into an agreement
to license rights to the process that Rockwell claims to hold. In May 1995,
Rockwell filed such a suit against the Company in the United States District
Court for the Northern District of California (the "District Court Action"). The
District Court Action has been stayed pending the completion of certain
proceedings in the Government Lawsuit. The Company believes that it has
meritorious defenses to Rockwell's allegations, including among others, that the
Company's process does not infringe Rockwell's patent upon which its claim is
based and that such patent is invalid.
DEPENDENCE ON EMERGING APPLICATIONS. The Company's current products serve many
applications in the communications, information and light source replacement
markets. In many cases, the Company's products are substantially completed, but
the customer's product is not yet completed, and the applications are emerging
or are otherwise in new markets. In addition, the Company and certain of its
customers are currently in the process of developing new products, in various
stages of development, testing and qualification, sometimes in emerging
applications or
15
<PAGE> 16
new markets. A substantial portion of the Company's products address markets
that are not now and may never become substantial commercial markets. The
Company has experienced, and is expected to experience, technological and
pricing constraints that may preclude development of markets and fluctuation in
customer orders. No assurances can be given that the Company or its customers
will continue their existing product development efforts, or if continued that
such efforts will be successful, that markets will develop for any of the
Company's or customer's products, that the Company's products will be accepted
in end-user markets, that the Company's technology or pricing will enable such
markets to develop, or that the Company's and its customer's products will not
be superseded by other technology or products.
DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. In 1995 and the first six
months of 1996, the Company derived approximately 45% and 41%, respectively, of
its revenue directly and indirectly from a variety of Federal government
sources. The Company received approximately 19% and 18% of its revenue for
fiscal 1995 and the first six months of 1996, respectively, from Lockheed Martin
through several government and commercial programs. The demand for certain of
the Company's services and products is directly related to the level of funding
of government programs. The Company believes that the success and further
development of its business is dependent, in significant part, upon the
continued existence and funding of such programs and upon the Company's ability
to participate in such programs. For example, substantially all of the Company's
research revenue for 1995 and the first six months of 1996 was funded by Federal
programs. Most of the Company's Federally-funded programs are subject to renewal
every one or two years, so that continued work by the Company under these
programs in future periods is not assured. Federally-funded programs are subject
to termination for convenience of the government agency, at which point the
Company would be reimbursed for related allowable costs incurred to the
termination date. Federally-funded contracts are subject to audit of pricing and
actual costs incurred which have resulted, and could result in the future, in
price adjustments. Before the end of 1996, the Company expects to lose
eligibility for new U.S. Small Business Innovative Research contracts. Such
contracts accounted for approximately 5% of revenue in 1995 and the first six
months of 1996.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ROCKWELL LITIGATION. In 1985, Rockwell International Corportion (Rockwell)
asserted, and in 1995 filed suit against the Company alleging that a Company
fabrication process infringed certain Rockwell patent rights. Rockwell is
seeking to permanently enjoin the Company from infringing Rockwell's alleged
patent rights and is seeking unspecified actual and treble damages plus costs.
The Company has answered Rockwell's complaint asserting that Rockwell's patent
is invalid, not infringed and unenforceable. In addition, the Federal
government, which is a defendant in a suit brought by Rockwell relating to
certain of the same alleged patent rights, asserted that the Company may be
liable to indemnify the Federal government for certain of Rockwell's claims. The
Company has intervened in Rockwell's suit against the Federal government.
In the Government lawsuit, on March 4, 1996, Rockwell filed a motion for summary
judgment that its patent is not invalid. The Company and the Government filed
oppositions to that motion along with cross-motions for summary judgment that
Rockwell's patent is invalid. Briefing on these motions and cross-motions will
be completed in mid-August. No date has been set for a hearing on these motions
and cross-motions.
SPECTRA-PHYSICS LITIGATION. In 1995, Spectra-Physics, Inc. (Spectra) and others
filed suit against the Company alleging that the Company was refusing to comply
with its alleged obligations to transfer and license Company technology to them.
These parties are seeking declaratory relief, specific performance and
unspecified actual and punitive damages. The Company has answered these claims
denying them and has cross-complained against Spectra and certain others seeking
declaratory relief, damages and injunctive relief.
Since the Company's December 31, 1995 Form 10-K disclosure regarding the
Spectra-Physics litigation, the Company's cross-claims for damages against Ciba
have been dismissed. Some, but not all, of the Company's cross-claims against
Spectra and Opto Power have also been dismissed. The parties also have engaged
in the court-ordered mediation. That mediation was unsuccessful in reaching a
resolution of the disputes. The trial date has been continued to January 21,
1997. All parties have filed motions for summary adjudication of various issues
in the case. The motions pertaining to claims between the Company, Xerox,
Spectra-Physics and Opto Power are scheduled for hearing on October 1, 1996.
The Company is vigorously contesting these claims. Although the outcome of these
matters cannot be determined at this time, management does not believe that
their outcome will have a material adverse effect on the Company's financial
position, results of operations and cash flows and has made no provision for the
ultimate outcome of these matters in its financial statements. However, based on
future developments, the Company's estimate of the outcome of these matters
could change in the near term.
17
<PAGE> 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders on May 13, 1996. The
stockholders voted on proposals to:
1. Elect two Class 2 Directors of the Company.
2. Ratify the appointment of Ernst & Young as the Company's
auditors for 1996.
The proposals were approved by the following votes:
1. Election of Directors
Director For Withheld
-------- --- --------
John P. Melton 5,310,572 19,585
Mark B. Myers 5,310,572 19,585
2. Ratify appointment of Ernst & Young
For Against Abstain
--- ------- -------
5,305,505 4,380 20,272
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Lists of Exhibits
Number Exhibit Description
------ -------------------
11.1 Computation of Net Income
per Common and Common Equivalent Share
(b) Reports on Form 8-K
None
18
<PAGE> 19
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.
SDL, INC.
---------
Registrant
August 12, 1996 /s/Gregory C. Lindholm
----------------------
Gregory C. Lindholm
Vice President, Finance
Chief Financial Officer and Treasurer
(duly authorized officer, and principal
financial and accounting officer)
19
<PAGE> 1
EXHIBIT 11.1
SDL, INC.
COMPUTATION OF NET INCOME PER
COMMON AND COMMON EQUIVALENT SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY
Weighted average number of
common shares outstanding 11,097 9,590 10,925 8,088
Incremental common shares
attributable to shares issuable under
employee stock plans 1,286 1,615 1,303 1,545
-------- -------- -------- --------
Total shares 12,383 11,205 12,228 9,633
======= ======== ======= ========
Net income
Amount $ 2,429 $ 1,370 $ 4,588 $ 2,275
======= ======= ======= =======
Per share $ 0.20 $ 0.12 $ 0.38 $ 0.24
======== ======== ======== ========
</TABLE>
Fully diluted computation not presented since such amounts differ by less than
3% of the net income per share amount shown above.
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINIANCIAL INFORMATION EXTRACTED FROM
JUNE 30, 1996 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000934741
<NAME>SDL, Inc.
<MULTIPLIER> 1000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<EXCHANGE-RATE> 1
<CASH> 5613
<SECURITIES> 7515
<RECEIVABLES> 13715
<ALLOWANCES> 379
<INVENTORY> 12623
<CURRENT-ASSETS> 80472
<PP&E> 33042
<DEPRECIATION> 14698
<TOTAL-ASSETS> 103356
<CURRENT-LIABILITIES> 14874
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 87793
<TOTAL-LIABILITY-AND-EQUITY> 103356
<SALES> 35889
<TOTAL-REVENUES> 42028
<CGS> 22152
<TOTAL-COSTS> 26505
<OTHER-EXPENSES> 8840
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (269)
<INCOME-PRETAX> 6952
<INCOME-TAX> 2364
<INCOME-CONTINUING> 4588
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4588
<EPS-PRIMARY> 0.38
<EPS-DILUTED> 0.38
</TABLE>
