<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 SEPTEMBER 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 October 29,
1996 was 13,166,008.
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SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Income for
the three and nine months ended September 30, 1996 and 1995 4
Condensed Consolidated Statements of Cash Flows for
the nine months ended September 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 6. Exhibits 18
SIGNATURES 19
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS - EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995(1)
---- -------
(UNAUDITED)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 4,536 $ 2,793
Short-term investments 35,199 8,515
Accounts receivable, net 12,779 13,535
Inventories 13,113 9,006
Deferred income taxes 1,514 989
Prepaid expenses and other current assets 1,917 502
--------- ---------
Total current assets 69,058 35,340
Property and equipment, net 20,656 16,470
Investments 17,585 --
Purchased intangibles, net 2,282 2,766
Deferred income taxes 1,840 1,840
Other assets 491 227
--------- ---------
$ 111,912 $ 56,643
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,123 $ 6,257
Accrued payroll and related expenses 3,049 1,990
Unearned revenue 1,267 972
Acquisition obligations 2,747 1,592
Other accrued liabilities 1,720 1,880
--------- ---------
Total current liabilities 15,906 12,691
Deferred acquisition obligations -- 2,680
Other long-term liabilities 636 772
Stockholders' equity:
Common stock, $0.001 par value, 21,000,000 shares authorized;
13,091,008 outstanding (10,628,115 at December 31, 1995) 13 11
Treasury stock -- (33)
Additional paid-in-capital 112,197 63,034
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (16,497) (22,028)
Cumulative translation adjustment (6) (6)
--------- ---------
95,707 40,978
Less: common stockholders' notes receivable (337) (478)
--------- ---------
Total stockholders' equity 95,370 40,500
--------- ---------
$ 111,912 $ 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
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1996 1995 1996 1995
---- ---- ---- ----
Total revenue:
<S> <C> <C> <C> <C>
Product revenue $ 15,823 $ 11,727 $ 51,712 $ 30,790
Research revenue 3,546 2,357 9,685 6,320
-------- -------- -------- --------
19,369 14,084 61,397 37,110
Cost of revenue:
Cost of product revenue 11,606 6,865 33,758 18,101
Cost of research revenue 2,893 1,756 7,246 4,654
-------- -------- -------- --------
Gross margin 4,870 5,463 20,393 14,355
Operating expenses:
Research and development 1,560 993 4,605 2,669
Selling, general and administrative 2,768 2,134 8,240 5,428
Amortization of purchased intangibles 161 -- 484 --
-------- -------- -------- --------
Operating income 381 2,336 7,064 6,258
Interest (income) expense, net (570) (219) (839) 93
-------- -------- -------- --------
Income before income taxes 951 2,555 7,903 6,165
Provision for income taxes 8 945 2,372 2,281
-------- -------- -------- --------
Net income $ 943 $ 1,610 $ 5,531 $ 3,884
======== ======== ======== ========
Net income per share $ 0.07 $ 0.14 $ 0.43 $ 0.38
======== ======== ======== ========
Shares used in computing
net income per share 14,142 11,711 12,866 10,326
======== ======== ======== ========
</TABLE>
See accompanying notes.
4
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1996 1995
-------- --------
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 5,531 $ 3,884
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 3,683 1,914
Deferred income taxes (525) 425
Deferred rent (50) (70)
Accrued interest -- (452)
Changes in operating assets and liabilities:
Accounts receivable 756 (4,558)
Inventories (4,107) (1,596)
Accounts payable 866 2,910
Income taxes payable 2,987 511
Accrued payroll and related expenses 1,059 887
Unearned revenue 295 360
Other accrued liabilities (145) 376
Other (1,067) (140)
-------- --------
Total adjustments 3,752 567
-------- --------
Net cash provided by operating activities 9,283 4,451
INVESTING ACTIVITIES:
Acquisition of property and equipment, net (7,385) (6,842)
Sales (purchases) of short-term investments, net (26,684) (21,099)
Purchases of investments (17,585) --
Payments on acquisition obligations (1,525) --
-------- --------
Net cash used in investing activities (53,179) (27,941)
FINANCING ACTIVITIES:
Payments of bank debt -- (2,592)
Payments of subordinated debt -- (21,580)
Proceeds from issuance of common stock 44,676 47,383
Repurchase of common stock -- (33)
Issuance of stock pursuant to employee stock plans 822 238
Payments on stockholders' notes receivable 141 155
-------- --------
Net cash provided by financing activities 45,639 23,571
-------- --------
Net increase in cash and cash equivalents 1,743 81
Cash and cash equivalents at beginning of period 2,793 632
-------- --------
Cash and cash equivalents at end of period $ 4,536 $ 713
======== ========
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
</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 nine month periods
ended September 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 and subsidiary's annual report
on Form 10-K for the year ended December 31, 1995.
The consolidated financial statements include the accounts of SDL, Inc.
(SDL or 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. In
addition, SDL's Underwriters exercised their over-allotment option to
purchase 255,000 additional shares of the Company's common stock. Net
proceeds to the Company approximated $44,676,000.
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4. INVESTMENTS
Available for sale investments consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Tax-exempt auction rate preferred stocks $25,623 $7,000
Municipal bonds 27,161 1,515
-------- -------
$52,784 $ 8,515
======= =======
</TABLE>
Tax-exempt auction rate preferred stock contains contractual maturities
of less than one year. Municipal bonds have maturities ranging from nine
months to two years of which $17,585,000 is included in investments in
the accompanying balance sheet at September 30, 1996.
Both realized and unrealized gains and losses on the sale of
available-for-sale securities were immaterial for the three and nine
months ended September 30, 1996 and 1995.
5. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Raw materials $ 5,693 $ 4,151
Work in process 7,420 4,855
-------- --------
$ 13,113 $ 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 activity related to the Company's
uncompleted long-term contracts, from inception of the contracts (in
thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Costs incurred on uncompleted long-term contracts $ 35,211 $ 15,655
Estimated earnings 2,331 740
--------- ---------
Revenue recognized on uncompleted long-term contracts 37,542 16,395
Less billings to date 35,931 14,879
-------- ---------
Unbilled costs and estimated earnings for uncompleted
long-term contracts $ 1,611 $ 1,516
========= =========
</TABLE>
The above balances are included in accounts receivable in the
accompanying balance sheets. Unbilled costs and estimated earnings on
uncompleted long-term contracts are
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generally billable in the subsequent year.
Revenue recognized on long-term contracts included in total revenues was
approximately $7.0 million and $18.8 million for the three and nine month
periods ended September 30, 1996 and approximately $5.8 million and $13.5
million for the comparable 1995 periods.
7. CONTINGENCIES
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
8
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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, LAN,
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 over 45 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 three and nine months ended September 30, 1996
increased 38% and 65% to $19.4 million and $61.4 million, respectively, compared
to the corresponding September 1995 periods. The increase in revenue during 1996
as compared to 1995, has been driven by continuing demand for the Company's
semiconductor lasers and optoelectronic solutions, SDL Optics' communication
product sales, and to a lesser extent, growth in research
9
<PAGE> 10
revenue. Revenue from products within the fiber-based communications market,
including telecommunications, CATV, satellite communication and LANs grew 58%
over that reported for the nine months ended September 30, 1995, and represented
approximately 50% of total revenue reported year-to-date through September 30,
1996. Research revenue grew 50% and 53% compared to both the corresponding 1995
periods. For the three and nine months ended September 30, 1996, research
revenue represented 18% and 16%, respectively, of total revenue as compared to
17% for both the corresponding 1995 periods.
Total revenue for the third quarter of 1996 decreased 10% from total revenue
reported during the June 1996 quarter. Reduced shipments of certain products
experiencing yield problems primarily contributed to this sequential revenue
decline; offset marginally by the growth in research revenue from that reported
for the second quarter of 1996. See "Risk Factors - Manufacturing Risks".
International revenue as a percentage of total revenue for the nine months ended
September 30, 1996 decreased to 15% compared to 24% for the corresponding 1995
period. Total international revenue has declined due to SDL's acquisition of the
SDL Optics business, a former international customer of SDL, and a large
percentage of SDL Optics' revenue occurs within the U.S. communications markets.
Approximately 25% and 20% of total revenue for both the three and nine months
ended September 30, 1996, respectively, was received from Lockheed Martin. This
compares to approximately 19% and 18 % of revenue for the comparable 1995 three
and nine month periods. The percentage increase in revenue reported for this
customer results from several new programs initiated during the second quarter
of 1996, and reduced product revenue due to production yield problems
experienced during the quarter ended September 30, 1996.
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 margin was 25.1% for the three months ended September 30,
1996 compared to 38.8% in the third quarter of 1995 and 36.3% in the second
quarter of 1996. The Company experienced manufacturing capacity constraints and
production yield problems on several of its product lines which impacted gross
margin reported for the third quarter of 1996. Cost of revenue increased in part
because: (i) fixed manufacturing costs were allocated over a reduced quarterly
revenue base, (ii) variable manufacturing costs for product lines with low
production yields were significantly higher for product manufactured and shipped
during the quarter, and (iii) manufacturing engineering costs incurred during
the quarter were higher compared to prior quarters as engineering resources were
required to research and address SDL's production yield problems. This, in turn,
contributed to the lower gross margins realized during the three and nine months
ended September 30, 1996 as compared to the corresponding quarterly periods. The
Company is actively addressing its yield issues, and to relieve capacity
constraints, additional manufacturing equipment is being installed and clean
room renovation is in process. The additional capacity should become available
during the first quarter of 1997 pending the results of product qualification
tests. See "Risk Factors - Manufacturing Risks."
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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.
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 nine months ended September 30, 1996 increased to $4.5 million and
$11.9 million, respectively, compared to $2.7 million and $7.3 million for the
corresponding 1995 periods. Research revenue growth, together with increased
spending on new product development, cost reduction, yield and reliability
improvement projects and SDL Optics' research and development 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 19% for the nine months ended September 30, 1996 from 20% for the
corresponding nine 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. Selling, general and administrative expense
(SG&A) increased during the three and nine months ended September 30, 1996 as
compared to corresponding 1995 periods due to the continuing expansion of the
Company's business, headcount increases, ongoing litigation expense, and to a
lesser extent, SDL Optics' SG&A. SG&A decreased for the three and nine month
periods as a percentage of total revenues despite decreased revenue growth
reported for the quarter ended September 30, 1996 and higher levels of
litigation expense incurred during 1996 compared to 1995. The Company expects
that SG&A 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 revenues are indicative of future
SG&A as a percentage of total revenues. For the next several quarters, it is
expected that litigation expense will increase from the level recorded during
the most recent three month period as the Company prepares for the
Spectra-Physics trial, which is scheduled for January 1997.
INTEREST (INCOME) EXPENSE, NET. The Company recorded net interest income for the
three and nine months ended September 30, 1996. Net interest income for the
three months ended September 30, 1996 increased over that of the comparable
prior year period and the preceding 1996 quarter as the Company invested the
cash received from its June 1996 follow-on public stock offering in interest
income generating investments. The Company incurred net interest expense for the
nine month period ended September 30, 1995 as a result of 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 30%
and 37% for the nine months ended September 30, 1996 and 1995, respectively. The
projected effective tax rate for 1996 is less than 1995 due to the benefits of
tax-exempt interest income and state tax
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credits, as well as a reduction in the valuation allowance. The estimated
effective tax rate for 1996 was reduced from 34% to 30% in the third quarter of
this year. This reduction is attributable to the reinstatement of the federal
research credit, and the incremental effects of anticipated state tax credits,
tax-exempt interest income, and the reduction in the valuation allowance on a
lower taxable income base.
LIQUIDITY AND CAPITAL RESOURCES
Cash from operating activities was $9.3 million for the nine months ended
September 30, 1996. The Company spent $7.4 million for planned facilities
expansion and capital equipment purchases during the 1996 nine month period and
made a $1.5 million payment on the acquisition obligation related to SDL Optics.
In addition, SDL received $45.5 million through the issuance of common stock,
which primarily resulted in the increase of cash, cash equivalents and
investments to $57.3 million at September 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. In addition, the
Company's Underwriters exercised their over-allotment option to purchase 255,000
additional shares of the common stock. Net proceeds to the Company approximated
$44,676,000. 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 three 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 September 30, 1996), and
bear interest at the bank's prime rate (8.25% at September 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 September 30, 1996 and
(ii) $1.2 million in cash or common stock of SDL (at the Company's option) on
March 31, 1997.
The Company currently expects to spend approximately $11 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
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additional capital sooner or, if so required, that adequate capital will be
available on terms acceptable to the Company.
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 experienced lower than expected production yields on some of its
products, including certain key product lines during the third quarter of 1996.
While the Company has been aggressively addressing these problems, solutions on
certain product lines have proven to be more difficult to identify and implement
than anticipated. This reduction in yields has adversely affected gross margins,
delayed component, product and system shipments and, to a certain extent, new
orders booked. 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 continue to lose customers
and experience reduced or delayed customer orders and cancellation of existing
backlog. In such event, the Company's business and results of operations would
be materially adversely affected.
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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 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. Legal expenses related to this litigation are increasing
substantially as the Company prepares for trial. The Company expects the
increase in legal expenses related to this litigation to be sustained at least
through the currently scheduled trial date. Such expenses 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 have a material adverse effect on the
Company's business and results of operations.
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
14
<PAGE> 15
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. Currently, several of the Company's customers are testing a new
pump module product for potential volume applications. However, other customers
have delayed orders for SDL's standard pump module product because of their
desire to switch to the new product. No assurances can be given that the Company
or its customers will continue their product development testing 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 nine
months of 1996, the Company derived approximately 45% and 42%, respectively, of
its revenue directly and indirectly from a variety of Federal government
sources. The Company received approximately 19% and 20% of its revenue for
fiscal 1995 and the first nine 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 nine 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. During the fourth quarter of 1996, the Company expects to
lose its eligibility for awards of new U.S. Small Business Innovative Research
(SBIR) contracts. Previously awarded SBIR contracts will not terminate upon
reaching ineligibility for new contract awards, but, depending on the contract,
can continue through contract completion, which can be up to two years from the
initial contract award date. SBIR contracts accounted for approximately 5% and
6% of revenue in 1995 and for the first nine months of 1996, respectively.
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.
15
<PAGE> 16
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. 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.
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.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ROCKWELL LITIGATION. In 1985, Rockwell International Corporation (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. The action has been stayed pending
proceeding in the Government lawsuit, described below.
Rockwell also brought suit against the Federal government, relating to certain
of the same alleged patent rights (the "Government lawsuit"). The Federal
government has 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 Federal 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
were 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 OptoPower 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 OptoPower were heard on November 1, 1996. The court has not
yet issued a ruling.
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 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
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
November 11, 1996 ___________________________
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY
Weighted average number of
common shares outstanding 13,032 10,179 11,627 8,784
Incremental common shares
attributable to shares issuable under
employee stock plans 1,110 1,532 1,239 1,542
------- ------- ------- -------
Total shares 14,142 11,711 12,866 10,326
======= ======= ======= =======
Net income
Amount $ 943 $ 1,610 $ 5,531 $ 3,884
======= ======= ======= =======
Per share $ 0.07 $ 0.14 $ 0.43 $ 0.38
======= ======= ======= =======
</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 FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER 1,
30, 1996 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS
</LEGEND>
<CIK> 0000934741
<NAME> SDL, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 4,536
<SECURITIES> 35,199
<RECEIVABLES> 13,174
<ALLOWANCES> 395
<INVENTORY> 13,113
<CURRENT-ASSETS> 69,058
<PP&E> 36,486
<DEPRECIATION> 15,830
<TOTAL-ASSETS> 111,912
<CURRENT-LIABILITIES> 15,906
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 95,357
<TOTAL-LIABILITY-AND-EQUITY> 111,912
<SALES> 51,712
<TOTAL-REVENUES> 61,397
<CGS> 33,758
<TOTAL-COSTS> 41,004
<OTHER-EXPENSES> 13,329
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (839)
<INCOME-PRETAX> 7,903
<INCOME-TAX> 2,372
<INCOME-CONTINUING> 5,531
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,531
<EPS-PRIMARY> 0.43
<EPS-DILUTED> 0.43
</TABLE>
