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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
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 August 1,
1997 was 13,533,790.
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SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Operations for
the three and six months ended June 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1997 and 1996 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 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 17
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- -----------
<S> <C> <C>
(UNAUDITED) (1)
ASSETS
Current assets:
Cash and cash equivalents $ 2,297 $ 2,605
Short-term investments 9,400 45,353
Accounts receivable, net 18,699 11,816
Inventories 12,495 13,441
Prepaid expenses and other current assets 4,734 3,902
----------- -----------
Total current assets 47,625 77,117
Property and equipment, net 24,707 22,020
Long-term investments 10,700 10,325
Other assets 4,279 4,380
----------- -----------
$ 87,311 $ 113,842
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 8,765 $ 6,777
Accrued payroll and related expenses 1,986 2,185
Unearned revenue 942 455
Accrued warranty 809 404
Income taxes payable 495 --
Accrued legal expenses 945 411
Acquisition obligations -- 2,712
Other accrued liabilities 1,109 930
----------- -----------
Total current liabilities 15,051 13,874
Other long-term liabilities 907 741
Commitments and contingencies -- --
Stockholders' equity:
Common stock 13 13
Additional paid-in-capital 115,560 114,421
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (43,969) (14,951)
----------- -----------
71,604 99,483
Less: stockholders' notes receivable (251) (256)
----------- -----------
Total stockholders' equity 71,353 99,227
----------- -----------
$ 87,311 $ 113,842
=========== ===========
</TABLE>
(1) The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date.
See accompanying notes.
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Total revenue:
Product revenue $ 18,182 $ 18,541 $ 34,957 $ 35,889
Research revenue 3,388 3,065 7,629 6,139
-------- -------- -------- --------
21,570 21,606 42,586 42,028
Cost of revenue:
Cost of product revenue 14,974 11,647 25,860 22,152
Cost of research revenue 3,359 2,111 6,491 4,353
-------- -------- -------- --------
Gross margin 3,237 7,848 10,235 15,523
Operating expenses:
Research and development 2,473 1,358 5,309 3,045
Selling, general and administrative 30,178 2,823 34,075 5,472
Amortization of purchased intangibles 163 161 324 323
-------- -------- -------- --------
Operating income (loss) (29,577) 3,506 (29,473) 6,683
Interest income, net 430 124 1,061 269
Loss on sale of securities (324) -- (324) --
-------- -------- -------- --------
Income (loss) before income taxes (29,471) 3,630 (28,736) 6,952
Provision for income taxes -- 1,201 228 2,364
-------- -------- -------- --------
Net income (loss) $(29,471) $ 2,429 $(28,964) $ 4,588
======== ======== ======== ========
Net income (loss) per share $ (2.19) $ 0.20 $ (2.16) $ 0.38
======== ======== ======== ========
Shares used in computing
net income (loss) per share 13,462 12,383 13,400 12,228
======== ======== ======== ========
</TABLE>
See accompanying notes.
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net (loss) income $(28,964) $ 4,588
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization 2,603 2,327
Loss on disposal of equipment -- 62
Deferred income taxes 477 (325)
Deferred rent -- (30)
Changes in operating assets and liabilities:
Accounts receivable (6,883) 199
Inventories 946 (3,617)
Accounts payable 1,988 579
Income taxes payable (278) 2,539
Accrued payroll and related expenses (199) (176)
Unearned revenue 487 528
Accrued warranty 405 --
Accrued legal expenses 534 --
Other accrued liabilities 179 80
Other (381) (55)
-------- --------
Total adjustments (122) 2,111
-------- --------
Net cash provided by (used in) operating activities (29,086) 6,699
INVESTING ACTIVITIES:
Acquisition of property and equipment, net (5,000) (3,941)
Payments on acquisition obligations (2,712) (1,482)
Sale of investments, net 35,525 1,000
-------- --------
Net cash provided by (used in) investing activities 27,813 (4,423)
FINANCING ACTIVITIES:
Common stock offering costs -- (483)
Issuance of stock pursuant to employee stock plans 960 886
Payments on stockholders' notes receivables 5 141
-------- --------
Net cash provided by financing activities 965 544
Net increase (decrease) in cash and cash equivalents (308) 2,820
Cash and cash equivalents at beginning of period 2,605 2,793
-------- --------
Cash and cash equivalents at end of period $ 2,297 $ 5,613
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES:
Unrealized loss on marketable securities $ 53 $ --
Stock issued for receivables from common stock offering $ -- $ 38,475
SUPPLEMENT DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
Cash paid for interest $ -- $ --
</TABLE>
See accompanying notes.
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SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1997
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 six-month period ended June 30, 1997 are not necessarily indicative of
the results that may be expected for the year ended December 31, 1997. 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, 1996.
The consolidated financial statements include the accounts of SDL, Inc. and
its wholly owned subsidiary, 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 are
included in interest income and were immaterial for all periods presented.
2. NET INCOME (LOSS) PER SHARE
Net income per share for 1996 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). Net loss per share
for 1997 is computed using the weighted average number of shares of common
stock outstanding.
3. RECENT PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December
31, 1997. At that time, the Company will be required to change the method
currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per
share, the dilutive effect of stock options will be excluded. The impact is
expected to result in an increase in primary earnings per share for the
three and six months ended June 30, 1996 of $0.02 and $0.04 per share,
respectively, with no impact for the three and six months ended June 30,
1997. The impact of Statement 128 on the calculation of fully diluted
earnings per share for these quarters is not expected to be material.
In June 1997, the Financial Accounting Standards Board issued Statement
Number 130, Reporting Comprehensive Income. This statement requires that
all items that are to be required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This
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statement is effective for fiscal years beginning after December 15, 1997,
and will be adopted by the company for the year ended December 31, 1998.
In addition, during June 1997, the Financial Accounting Standards Board
issued Statement Number 131, Disclosures About Segments of an Enterprise
and Related Information. This statement replaces Statement Number 14 and
changes the way public companies report segment information. This statement
is effective for fiscal years beginning after December 15, 1997 and will be
adopted by the company for the year ended December 31, 1998.
4. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
---------- ----------
<S> <C> <C>
Raw materials $ 5,060 $ 6,653
Work in process 7,435 6,788
---------- ----------
$ 12,495 $ 13,441
========== ==========
</TABLE>
No significant amounts of finished goods are maintained.
5. 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,
1997 1996
---------- ----------
<S> <C> <C>
Costs incurred on uncompleted long-term contracts $ 56,971 $ 40,007
Estimated earnings 5,202 2,803
---------- ----------
Revenue recognized on uncompleted long-term contracts 62,173 42,810
Less billings to date 59,078 41,906
---------- ----------
Total unbilled costs and estimated earnings $ 3,095 $ 904
========== ==========
</TABLE>
Of the above balances, $3.0 million and $0.6 million are included in
accounts receivable in the accompanying balance sheets at June 30, 1997 and
December 31, 1996, respectively. Unbilled costs and estimated earnings on
uncompleted long-term contracts are generally billable within one year.
Revenue recognized on long-term contracts included in total revenue was
approximately $5.5 million and $11.5 million for the three and six months
ended June 30, 1997 and $6.0 million and $11.8 million of for the three and
six months ended June 30, 1996.
6. CONTINGENCIES
Trial of the Spectra-Physics v. SDL, Inc. litigation began before the Santa
Clara County California Superior Court on May 7, 1997. On May 19, 1997,
before the trial was concluded, the Company, Spectra-Physics and its
subsidiary Opto Power Corporation, and Xerox Corporation made a
comprehensive settlement of their disputes.
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During the second quarter of fiscal 1997, the Company included
approximately $27.5 million in general and administrative expenses for
settlement and related legal costs associated with the resolution of the
dispute with Spectra-Physics, Inc.
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
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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 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 60 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 55 U.S. patents and has approximately 70 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 than for
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.
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, 1997 was $21.6 million,
comparable to that reported for the corresponding 1996 quarter. Sequentially,
total revenue increased 3% over revenue reported in the March 1997 quarter. For
the six months ended June 30, 1997, total revenue increased to $42.6 million
from $42.0 million reported for the comparable prior year period. Second quarter
1997 product revenue was primarily impacted by the longer than expected
qualification process by new telecommunications customers for one of the
Company's 980nm pump module products. This longer than expected qualification
process, in combination with the transitional gap in new product shipments
during the first quarter of 1997, resulted in a 3% decrease in product revenue
reported for the six months ended June 30, 1997 when compared to the same six
month period in 1996. Information based products within the fiber-based
telecommunications, satellite communications, printing, data storage and
displays markets continued to represent approximately 70% of product revenue for
both the three and six month periods of 1997 and 1996, respectively. The balance
is represented by products within the light replacement market. Research revenue
reported for the three and six months ended June 30, 1997, represented 16% and
18% of total revenue, respectively, compared to 14% and 15% for the
corresponding 1996 periods. Reduced product revenue during the first half of
1997 resulted in this percentage increase for research revenue.
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International revenue, as a percentage of total revenue, remained at 16% for
both the 1997 and 1996 six month reporting periods.
Approximately 19% and 18% of the Company's revenue for the six months ended June
30, 1997 and 1996 was received from Lockheed Martin. The combination of several
new programs for Lockheed Martin initiated during the first half of 1997
resulted in this percentage increase of revenue from Lockheed Martin.
There can be no assurance 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 to 15% and 24% for the three and six
months ended June 30, 1997 from 36% and 37% in the comparable 1996 periods.
Second quarter 1997 product gross margins were impacted by start-up costs for
the expansion of the Company's wafer fab and packaging capacities, together with
write-offs totaling $1.4 million for excess and obsolete inventory related to
the transition to new processes, designs and equipment. Additional reserves of
approximately $1.6 million related to changes in estimable reimbursable costs
also impacted gross margins for the three months ended June 1997.
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. Research and development expense for the three and six
months ended June 30, 1997 increased to $2.5 million and $5.3 million,
respectively, compared to $1.4 million and $3.0 million for the corresponding
1996 periods. Research and development expense as a percentage of total revenue
was 12% and 7% for the six months ended June 30, 1997 and 1996, respectively.
The increased research and development spending during the first half of 1997,
as compared to the year earlier period, is primarily a result of increased
manufacturing process development efforts, together with the development of new
communications products. The Company believes these investments will further
improve manufacturing yields and gross margins, as well as lead to several new
product introductions, some of which were introduced during the first half of
1997. The level of research and development incurred in future periods may vary.
In addition, there can be no assurance that expenditures for manufacturing
improvements or for other advanced research projects will be successful, or that
improved processes or commercial products will result from these projects.
SELLING, GENERAL AND ADMINISTRATIVE. The increase of selling, general and
administrative expense (SG&A) for the three and six months ended June 30, 1997
resulted primarily from a charge of approximately $27.5 million recorded in the
second quarter of 1997 for the settlement and related legal costs associated
with the Spectra-Physics vs. SDL, Inc. legal dispute and, to a lesser extent,
the continuing expansion of the Company's business and headcount increases. When
settlement and related legal costs are excluded, SG&A as a percentage of total
revenue, was 12% for the three and six months ended June 30, 1997 as compared to
11% for the corresponding three and six month periods in 1996. The Company
expects that SG&A, exclusive of the settlement and related legal costs for the
Spectra-Physics dispute, will continue to increase to support the Company's
current and expected future volumes
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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.
INTEREST INCOME, NET. Net interest income for the three and six months ended
June 30, 1997 increased over that of the corresponding 1996 periods due to the
investment of cash received from the Company's June 1996 follow-on public
offering. Net interest income will decline in future periods as a result of the
decrease in investments related to the payment of $27.5 million in settlement
and related legal costs associated with the resolution of the Spectra-Physics
legal dispute in the second quarter of fiscal 1997.
LOSS ON SALE OF SECURITIES. The early liquidation of investment securities to
pay for the settlement and related legal costs of the Spectra-Physics legal
dispute resulted in a loss on the sale of securities during the second quarter
of 1997.
PROVISION FOR INCOME TAXES. The income tax provision for the six months ended
June 30, 1997 of $228,000 consists principally of foreign income taxes and state
minimum taxes. No income tax benefit has been recognized for the loss incurred
for the six months ended June 30, 1997. Although realization is not assured, the
Company continues to believe that it will generate future taxable income
sufficient to realize the benefit of the $3 million of net deferred tax assets
previously recognized. The amount of the net deferred tax assets considered
realizable could be reduced in the near term if estimates of future taxable
income are reduced. Management intends to evaluate the realizability of the net
deferred tax assets each quarter to assess the need for the valuation allowance.
The effective tax rate for the six months ended June 30, 1996 was 34%, which
differed from the combined federal and state statutory tax rate of 40% primarily
due to the benefits of tax-exempt interest income and state tax credits, as well
as a reduction in the valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
The payment of settlement and related legal costs of $27.5 million to conclude
the Spectra-Physics legal dispute primarily contributed to the use of cash by
the Company's operating activities for the six months ended June 30, 1997. The
settlement payment was funded through sale of the Company's investment
securities. In addition, the Company paid $5.0 million for planned facilities
expansion and capital equipment purchases and completed its acquisition of the
SDL Optics business through a cash payment of $2.7 million. As a result, cash,
cash equivalents, short-term investments and long-term investments decreased
from $58.3 million at December 31, 1996 to $22.4 million at June 30, 1997.
The Company currently expects to spend approximately $9.0 million for capital
equipment purchases and leasehold improvements during the second half of 1997.
The Company believes that current cash balances, cash generated from operations,
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.
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
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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, anticipated expense levels, realizability of deferred tax assets,
future gross margins, improvements in manufacturing yields, introduction of new
products, continuing expansion of the Company's business, retention of rights
under research and development programs, and ability to leverage such programs
to broader product and technology offerings, 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 SDL 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 manufacture of semiconductor OEIC and laser components,
products and systems such as those sold by the Company is highly complex and
precise, requiring production in a highly controlled and clean environment.
Changes in the Company's or its suppliers' manufacturing processes, designs,
equipment or the inadvertent use of defective or contaminated materials by the
Company or its suppliers has in the past and could in the future adversely
affect the Company's ability to achieve acceptable manufacturing yields and
product reliability. To the extent the Company does not achieve such yields or
product reliability, its operating results and customer relationships would be
adversely affected.
The Company relies almost exclusively on its own production capability in
computer-aided chip and package design, wafer fabrication, wafer processing,
device packaging, hybrid microelectonic 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 facility, 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,
poor yields 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 part of its front-end wafer fabrication
and packaging facilities. The Company incurred additional start-up costs from
the expansion of its wafer fab capacity during the second quarter of 1997.
Front-end production activities were operated in parallel to allow adequate time
for customer acceptance and to validate yields, thereby increasing production
costs. There can be no assurances that the Company will not experience further
start-up costs and yield problems in fully utilizing its increased wafer
capacity. 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, 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 its
products, including certain key product lines, during the second half of 1996.
Certain of these lower yields have continued into the first half of 1997. While
the Company continues to aggressively address these problems, solutions on
certain product lines have proven to be more difficult to identify and implement
than anticipated. This reduction in yields adversely affected gross margins,
delayed components, 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 at profitable margins 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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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 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 and qualifying a new pump module for potential volume
applications. No assurances can be given that the Company or its customers will
continue their existing product development and new product qualification
efforts, or if continued, that such efforts will be successful, that markets
will develop for any of the Company's or customer's products, or that such
products will not be superseded by other technology or products.
DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. The Company derived
approximately 42%, 43% and 45 %, of its revenue directly and indirectly from a
variety of Federal government sources during the first half of 1997 and fiscal
1996 and 1995, respectively. The Company received approximately 19%, 21% and 19%
of its revenue from Lockheed Martin through several government and commercial
programs for the first half of 1997, and fiscal 1996 and 1995. Almost all of the
Company's revenue from Lockheed Martin during these periods was, and during the
remainder of 1997 is expected to be, derived from Federally-funded 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 1996 and 1995 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. The Federal government has in the past, and could in the
future, challenge the Company's accounting methodology for computing indirect
rates and allocating indirect costs to government contracts. The Federal
government is currently challenging certain of the Company's allowable costs and
indirect rates. A change in the Company's accounting practices in this area
could result in reduced profit margins on government contracts. During the
fourth quarter of 1996, the Company exceeded the maximum number of employees
allowed under eligibility requirements for the U.S. government's Small Business
Innovative Research (SBIR) programs and will no longer be able to compete for
research contract awards within SBIR programs. Previously awarded SBIR contracts
will not terminate 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 6%, 6% and 5% of revenue in the first
half of 1997, and fiscal 1996 and 1995, respectively.
NEED TO MANAGE GROWTH. The Company has on occasion been unable to manufacture
certain products in quantities sufficient to meet demand of its existing
customer base and new customers. The recent 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
13
<PAGE> 14
existing or new systems, procedures or 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.
The future success of the Company is dependent, in part, on its ability to
attract, assimilate and retain additional employees, including certain key
personnel. The Company will continue to need a substantial number of additional
personnel, including those with specialized skills, to commercialize its
products and expand all areas of its business in order to continue to grow. The
Company intends to hire a significant number of additional personnel in 1997 and
beyond. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to attract, assimilate or retain additional highly
qualified personnel.
14
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. Information disclosed in the Company's Form 10-K for
the year ended December 31, 1996 under heading Part I Item 3, Legal Proceedings,
is incorporated herein by this reference.
Since the date of that disclosure, Rockwell has filed an appeal of the Court's
order granting the Company's motion for summary judgment on the ground that
Rockwell's patent was invalid. The appeal is currently pending before the United
States Circuit Court of Appeals for the Federal Circuit.
Trial of the Spectra-Physics v. SDL, Inc. litigation began before the Santa
Clara County California Superior Court on May 7, 1997. On May 19, 1997, before
the trial was concluded, the Company, Spectra-Physics ("Spectra") and its
subsidiary Opto Power Corporation ("Opto Power"), and Xerox Corporation
("Xerox") made a comprehensive settlement of their disputes.
Pursuant to the principal terms of the Release and Settlement Agreement (the
"Agreement") entered into by the parties on May 19, 1997, the parties agreed as
follows:
(a) The Company made a one-time payment to Spectra in full settlement of
Spectra's claims against the Company. This payment has been recorded in
the Company's financial statements for the quarter ended June 30, 1997.
(b) The Company confirmed the validity of Spectra's license to the Company's
patents applied for or issued prior to June 25, 1993 as listed in the
Agreement.
(c) Spectra has no license to the Company's non-patented technical
information except that which Spectra used in its catalog products
before May 19, 1997.
(d) The Agreement confirms Spectra's rights to sublicense the Company's
patents and technical information (as described above in (b) and (c)) to
its subsidiaries, but only so long as they are subsidiaries of Spectra.
(e) The Company has no obligation to transfer or disclose any of the
Company's technical information to Spectra or Opto Power.
(f) The Company and Xerox, on the one hand, and Spectra and Opto Power, on
the other hand, entered into mutual general releases and agreed to
dismiss all claims against one another with prejudice.
On May 17, 1997, the Company and Xerox separately agreed to settle claims
asserted between them in the Spectra-Physics litigation.
ITEM 2. CHANGES IN SECURITIES. Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not Applicable
15
<PAGE> 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company held
its Annual Meeting of Stockholders on May 12, 1997. The stockholders voted on
proposals to:
1. Elect two Class 3 Directors of the Company
2. Ratify the appointment of Ernst & Young, LLP as the Company's
auditors for 1997.
The proposals were approved by the following votes:
1. Election of Directors
<TABLE>
<CAPTION>
Director For Withheld
-------- --- --------
<S> <C> <C>
Frederic N. Schwettman 9,882,116 64,710
Anthony B. Holbrook 9,921,866 24,960
</TABLE>
2. Ratify appointment of Ernst & Young, LLP
<TABLE>
<CAPTION>
For Against Abstain
--- ------- -------
<S> <C> <C>
9,920,456 10,501 15,869
</TABLE>
ITEM 5. OTHER INFORMATION. Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Lists of Exhibits
<TABLE>
<CAPTION>
Number Exhibit Description
------ -------------------
<S> <C>
11.1 Computation of Net Income (Loss)
per Common and Common Equivalent Share
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
16
<PAGE> 17
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 11, 1997 /s/Gregory C. Lindholm
----------------------------------------
Gregory C. Lindholm
Vice President, Finance
Chief Financial Officer and Treasurer
(duly authorized officer, and principal
financial and accounting officer)
17
<PAGE> 18
Index to Exhibits
<TABLE>
<CAPTION>
Number Exhibit Description
------ -------------------
<S> <C>
11.1 Computation of Net Income (Loss)
per Common and Common Equivalent Share
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 11.1
SDL, INC.
COMPUTATION OF NET INCOME (LOSS) 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,
-------- --------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
PRIMARY
Weighted average number of
common shares outstanding 13,462 11,097 13,400 10,925
Incremental common shares
attributable to shares issuable under
employee stock plans -- 1,286 -- 1,303
-------- -------- -------- --------
Total shares 13,462 12,383 13,400 12,228
======== ======== ======== ========
Net income (loss) $(29,471) $ 2,429 $(28,964) $ 4,588
======== ======== ======== ========
Net income (loss) per share $ (2.19) $ 0.20 $ (2.16) $ 0.38
======== ======== ======== ========
</TABLE>
There are no incremental common shares attributable to shares issuable under
employee stock plans due to the net loss incurred during the three and six
months ended June 30, 1997. These incremental shares would be anti-dilutive.
A fully diluted computation is not presented since such amounts differ by less
than 3% of the net income per share amount shown above.
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE 30,
1997 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> APR-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 2,297
<SECURITIES> 9,400
<RECEIVABLES> 18,699
<ALLOWANCES> 0
<INVENTORY> 12,495
<CURRENT-ASSETS> 47,625
<PP&E> 43,983
<DEPRECIATION> 19,276
<TOTAL-ASSETS> 87,311
<CURRENT-LIABILITIES> 15,051
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 71,340
<TOTAL-LIABILITY-AND-EQUITY> 71,353
<SALES> 18,182
<TOTAL-REVENUES> 21,570
<CGS> 14,974
<TOTAL-COSTS> 18,333
<OTHER-EXPENSES> 32,814
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (106)
<INCOME-PRETAX> (29,471)
<INCOME-TAX> 0
<INCOME-CONTINUING> (29,471)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (29,471)
<EPS-PRIMARY> (2.19)
<EPS-DILUTED> (2.19)
</TABLE>
