<PAGE> 1
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 March 31, 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)
<TABLE>
<S> <C>
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)
</TABLE>
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
May 1, 1997 was 13,451,793.
<PAGE> 2
SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
Condensed Consolidated Balance Sheets at
March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income for
the three months ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for
the three months ended March 31, 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 8
---------------------------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 16
</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>
MARCH 31, DECEMBER 31,
1997 1996
---- ----
(UNAUDITED) (1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,063 $ 2,605
Short-term investments 30,809 45,353
Accounts receivable, net 16,091 11,816
Inventories 13,025 13,441
Prepaid expenses and other current assets 4,540 3,902
-------- --------
Total current assets 69,528 77,117
Property and equipment, net 23,765 22,020
Long-term investments 18,807 10,325
Other assets 3,788 4,380
-------- --------
$115,888 $113,842
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,384 $ 6,777
Accrued payroll and related expenses 2,934 2,185
Unearned revenue 545 455
Acquisition obligations 2,698 2,712
Other accrued liabilities 1,872 1,745
-------- --------
Total current liabilities 15,433 13,874
Other long-term liabilities 840 741
Commitments and contingencies -- --
Stockholders' equity:
Common stock 13 13
Additional paid-in-capital 114,719 114,421
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (14,866) (14,951)
-------- --------
99,866 99,483
Less: stockholders' notes receivable (251) (256)
-------- --------
Total stockholders' equity 99,615 99,227
-------- --------
$115,888 $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.
3
<PAGE> 4
SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------------
1997 1996
---- ----
<S> <C> <C>
Total revenue:
Product revenue $16,775 $17,348
Research revenue 4,241 3,074
------- -------
21,016 20,422
Cost of revenue:
Cost of product revenue 10,886 10,505
Cost of research revenue 3,132 2,242
------- -------
Gross margin 6,998 7,675
Operating expenses:
Research and development 2,836 1,687
Selling, general and administrative 3,897 2,650
Amortization of purchased intangibles 161 161
------- -------
Operating income 104 3,177
Interest income, net 631 145
------- -------
Income before income taxes 735 3,322
Provision for income taxes 228 1,163
------- -------
Net income $ 507 $ 2,159
======= =======
Net income per share $ 0.04 $ 0.18
======== =======
Shares used in computing net income per share 14,265 12,074
======== =======
</TABLE>
See accompanying notes.
4
<PAGE> 5
SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1997 1996
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 507 $ 2,159
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization 1,250 1,100
Deferred income taxes 477 (140)
Deferred rent -- (20)
Changes in operating assets and liabilities:
Accounts receivable (4,275) 1,241
Inventories 416 (1,546)
Accounts payable 607 (1,136)
Income taxes payable (271) 1,588
Accrued payroll and related expenses 749 408
Unearned revenue 90 (37)
Other accrued liabilities (69) 166
Other 132 (342)
------- -------
Total adjustments (894) 1,282
------- -------
Net cash provided by (used in) operating activities (387) 3,441
INVESTING ACTIVITIES
Acquisition of property and equipment, net (2,869) (2,057)
Payments of acquisition obligations (14) (1,490)
(Purchase) sale of investments, net 5,641 (500)
------- -------
Net cash provided by (used in) investing activities 2,758 (4,047)
FINANCING ACTIVITIES
Issuance of stock pursuant to employee stock plans 82 148
Payments on stockholders' notes receivable 5 91
------- -------
Net cash provided by financing activities 87 239
------- -------
Net increase (decrease) in cash and cash equivalents 2,458 (367)
Cash and cash equivalents at beginning of period 2,605 2,793
------- -------
Cash and cash equivalents at end of period $ 5,063 $ 2,426
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash received for income taxes $ -- $ 400
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
Unrealized loss on marketable securities $ 421 $ --
</TABLE>
See accompanying notes.
5
<PAGE> 6
SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 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 three-month period ended March
31, 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 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. 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 first quarter ended March 31, 1996 of 0.02 per
share, with no impact for the quarter ended March 31, 1997. The impact
of Statement 128 on the calculation of fully diluted earnings per share
for these quarters is not expected to be material.
6
<PAGE> 7
4. STOCK SPLIT
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.
5. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
<S> <C> <C>
Raw materials $ 6,330 $ 6,653
Work in process 6,695 6,788
-------- ---------
$13,025 $13,441
======= =======
</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>
March 31, December 31,
1997 1996
---- ----
<S> <C> <C>
Costs incurred on uncompleted long-term contracts $50,739 $40,007
Estimated earnings 5,250 2,803
--------- ---------
Revenue recognized on uncompleted long-term contracts 55,989 42,810
Less billings to date 52,858 41,906
--------- --------
Total unbilled costs and estimated earnings $ 3,131 $ 904
========= =========
</TABLE>
Of the above balances, $3.0 million and $0.6 million are included in
accounts receivable in the accompanying balance sheets at March 31, 1997
and December 31, 1996, respectively. Unbilled costs and estimated
earnings on uncompleted long-term contracts are generally billable within
one year.
Approximately $6.0 million and $5.8 million of revenue recognized on
long-term contracts is included in total revenue for the three month
periods ended March 31, 1997 and 1996, respectively.
7
<PAGE> 8
7. CONTINGENCIES
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
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 approximately 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 50 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 March 31, 1997 increased 3% to
$21.0 million compared to $20.4 million in the corresponding 1996 quarter.
Total revenue reported for the March quarter was at approximately the same
level as total revenue reported in the December 1996 quarter. Revenue growth
was impacted during the first three months of 1997 in part by a
8
<PAGE> 9
transitional gap in new product shipments to a major customer, and defective
piece parts caused by a supplier contamination problem. Product revenue
reported for the first quarter of 1997 declined 3% and 7% compared to product
revenue for the first and fourth quarters of 1996, respectively.
Information-based products within the fiber-based telecommunications, satellite
communications, printing, medical and industrial markets continued to represent
approximately 70% of product revenue with the balance represented by products
within the light replacement market. Research revenue continued to grow
compared to both the corresponding prior year quarter and the December 31, 1996
quarter. Reduced product revenue during the first quarter of 1997 resulted in
research revenue representing 20% of total revenue compared to 15% and 14% for
the three months ended March 31, 1996 and December 31, 1996, respectively.
International revenue as a percentage of total revenue for the three months
ended March 31, 1997 declined to 15% from 17% for the corresponding 1996
quarter. This decrease was primarily a result of the reduced product shipments
during the March 1997 quarter.
Approximately 18% and 17% of total revenue for the three month periods ended
March 31, 1997 and 1996, respectively, was received 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. Total gross margin was 33.3% for the three months ended March
31, 1997 compared to 37.6% and 33.8% for the quarters ended March 31 and
December 31, 1996. Improvements in manufacturing yields and production costs
were offset by: (i) a shift in quarterly revenue mix to a higher ratio of
research revenue compared to product revenue and (ii) increased overhead costs
related to qualifying new equipment in anticipation of increased production
volumes.
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 quarter
ended March 31, 1997 grew 68% to $2.8 million compared to $1.7 million in the
corresponding 1996 quarter. Research and development expense as a percentage
of total revenue was 13% and 8% for the three months ended March 31, 1997 and
1996, respectively. Certain budgeted research and development spending for
manufacturing process improvement and the development of new communication
products were accelerated to the first quarter of 1997. The Company believes
these investments will improve manufacturing yields and gross margins, as well
as lead to additional new product introductions later in 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.
9
<PAGE> 10
SELLING, GENERAL AND ADMINISTRATIVE. The increase of selling, general and
administrative expense (SG&A) for the three months ended March 31, 1997 as
compared to the March 1996 quarter resulted primarily from ongoing litigation
expense, and to a lesser extent, the continuing expansion of the Company's
business and headcount increases. SG&A increased approximately $0.6 million from
that of the December 1996 quarter, almost all of which was litigation related
expense. When litigation expenses are excluded, SG&A decreased as a percentage
of total revenue for the first quarter of 1997 compared to the first quarter of
1996. The Company expects that SG&A, excluding litigation 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 quarter, it is expected that
litigation expense will increase from the level recorded during the three month
period ended March 31, 1997, as the Company prepares for and conducts the trial
phase of the Spectra-Physics dispute, which began on May 7, 1997. See
"Risk Factors" and "Legal Proceedings."
INTEREST INCOME, NET. Net interest income for the three months ended March 31,
1997 increased over that of the March 1996 quarter due to the investment of
cash received from the Company's June 1996 follow-on public offering.
PROVISION FOR INCOME TAXES. The estimated annualized effective tax rate was
31% and 35% for the three month periods ended March 31, 1997 and 1996,
respectively. The reduction in the effective tax rate is attributable to the
incremental benefits of state tax credits, tax-exempt interest income, and a
reduction in the valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
Increased trade receivables at March 31, 1997, resulting from the higher volume
of product shipments during the month of March 1997, and lower net income for
the first quarter of 1997 primarily contributed to the use of cash by the
Company's operating activities for the first quarter of 1997. In addition,
the Company spent $2.9 million for planned facilities expansion and capital
equipment purchases during the quarter. As a result, cash, cash equivalents,
short-term investments and long-term investments decreased from $58.3 million
at December 31, 1996 to $54.7 million at March 31, 1997.
The Company has future cash requirements to complete its acquisition of the SDL
Optics business of (i) $1.5 million, for which the Company was contingently
liable for a letter of credit at March 31, 1997 and (ii) $1.2 million in cash
or common stock of the Company (at the Company's option). Subsequent to the end
of its first quarter of 1997, the Company paid $2.7 million in completing these
acquisition related payments.
The Company currently expects to spend approximately $15.0 million for capital
equipment purchases and leasehold improvements during 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
10
<PAGE> 11
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 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 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 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 of 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 facility. This might cause downtime on existing equipment.
Also, there can be no assurance that 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, 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 quarter of 1997.
While the Company has aggressively addressed these problems, solutions on
certain product lines have proven to be more difficult to identify
11
<PAGE> 12
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.
TECHNOLOGY AGREEMENT. As a part of its formation, the Company entered into a
Technology Agreement with Xerox Corporation (Xerox) and Spectra-Physics, Inc.
(Spectra-Physics) pursuant to which, among other things, SDL granted to
Spectra-Physics and Xerox an irrevocable, royalty-free worldwide, non-exclusive
license to certain patented and non-patented technology developed by SDL. On
March 20, 1995, Spectra-Physics initiated a lawsuit against the Company in Santa
Clara County, California Superior Court, alleging that the Company was refusing
to comply with its obligations under the Technology Agreement. Spectra-Physics
claims that the Technology Agreement requires the Company to transfer and
license to Spectra-Physics all patented and non-patented technology developed by
the Company during a time period extending from the founding of the Company in
1983 until at least June 1993. Spectra-Physics asserts claims against the
Company for declaratory relief and breach of contract.
On June 27, 1995, Spectra-Physics filed a first amended complaint, adding Opto
Power Corporation (Opto Power), an affiliate of Spectra-Physics and a
competitor of the Company, as a plaintiff. Opto Power's claims are based in
part on its assertion that it is entitled to access to the Company's technology
as a third party beneficiary of the Technology Agreement, because the Agreement
is alleged to give Spectra-Physics the right to sublicense its subsidiaries.
Spectra-Physics and Opto Power seek remedies of unspecified actual damages,
specific performance and a declaratory judgment regarding the parties' rights
and duties under the Technology Agreement.
The Company answered the First Amended Complaint denying the plaintiffs' claims
and filed a cross-complaint seeking declaratory relief regarding its
obligations under the Technology Agreement against Spectra-Physics and Opto
Power.
Trial of the matter began on May 7, 1997. The Company believes that it has
meritorious defenses to the claims of Spectra-Physics and Opto Power. 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
significant monetary damages and could be required to transfer and license
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 and with respect to
a number of products and could have a material adverse effect on the Company's
business and results of operations. See "Legal Proceedings."
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
12
<PAGE> 13
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 a new pump module 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
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, or that such products will not be superseded by other technology or
products.
DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. In the first quarter of
1997 and fiscal 1996 and 1995, the Company derived approximately 43%, 43% and
45%, respectively, of its revenue directly and indirectly from a variety of
Federal government sources. The Company received approximately 18%, 21% and
19% of its revenue for the first quarter of 1997, and fiscal 1996 and 1995,
respectively, from Lockheed Martin through several government and commercial
programs. 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. 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 5%, 6% and 5% of revenue in the first quarter 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 existing or new systems,
procedures or controls will be adequate to support the Company's operations or
that its systems, procedures and
13
<PAGE> 14
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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
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
damages. The Company has answered these claims denying them and has
cross-complained against Spectra and certain others seeking declaratory relief.
Since the Company's December 31, 1996 Form 10-K disclosure regarding the
Spectra-Physics litigation, written orders reflecting the court's December 19,
1996 and February 7, 1997 rulings have been entered, Spectra's motion that, as a
matter of law, the Company's agreement with Spectra required the Company to
transfer SDL-developed technology to Spectra was denied, and trial of this
matter began on May 7, 1997.
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
business, as measured by 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.
ITEM 2. CHANGES IN SECURITIES. Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable
ITEM 5. OTHER INFORMATION. Not Applicable
14
<PAGE> 15
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
per Common and Common Equivalent Share
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
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
May 12, 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)
15
<PAGE> 16
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- ------------
<S> <C>
11.1 Computation of Net Income per Common and Common
Equivalent Share
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 11.1
SDL, INC.
COMPUTATION OF NET INCOME PER
COMMON AND COMMON EQUIVALENT SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1997 1996
---- ----
<S> <C> <C>
PRIMARY
Weighted average number of common shares outstanding 13,331 10,754
Incremental common shares attributable to
shares issuable under employee stock plans 934 1,320
------- -------
Total shares 14,265 12,074
======= =======
Net income
Amount $ 507 $ 2,159
======= =======
Per share $ 0.04 $ 0.18
======= =======
</TABLE>
Fully diluted computation not presented since such amounts differ by less than
3% of the net income per share amount shown above.
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MARCH 31,
1997 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 5,063
<SECURITIES> 30,809
<RECEIVABLES> 16,857
<ALLOWANCES> (766)
<INVENTORY> 13,025
<CURRENT-ASSETS> 69,528
<PP&E> 41,850
<DEPRECIATION> (18,085)
<TOTAL-ASSETS> 115,888
<CURRENT-LIABILITIES> 15,433
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 99,602
<TOTAL-LIABILITY-AND-EQUITY> 115,888
<SALES> 16,775
<TOTAL-REVENUES> 21,016
<CGS> 10,886
<TOTAL-COSTS> 14,018
<OTHER-EXPENSES> 6,894
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (631)
<INCOME-PRETAX> 735
<INCOME-TAX> 228
<INCOME-CONTINUING> 507
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 507
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
</TABLE>
