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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-25688
SDL, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 77-0331449
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
80 ROSE ORCHARD WAY, SAN JOSE, CALIFORNIA 95134
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (408) 943-9411
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
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None N/A
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$0.001 par value
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 / /.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing sale price of the Common Stock on February 10,
1997, as reported by Nasdaq was $155,104,580. Shares of Common Stock held by
each officer and director and by each person who owns 5 percent or more of the
outstanding Common Stock have been excluded from this computation in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not a conclusive determination for other purposes.
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(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
As of February 10, 1997 the registrant had outstanding 13,354,299 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 1997 Annual Meeting of
Stockholders (the Proxy Statement) are incorporated by reference in Part III of
this Form 10-K Report.
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PART I
ITEM 1. BUSINESS
INTRODUCTION
SDL is a leading designer, manufacturer and marketer of semiconductor
optoelectronic integrated circuits (OEICs) and high power semiconductor lasers.
The Company believes its leadership in these markets is demonstrated by the
Company's numerous awards for product technology and design, substantial market
share, and significant breadth of product offerings. The Company pioneered the
design of, and commercially developed, the first OEIC containing multiple
semiconductor lasers. Semiconductor OEICs integrate two or more semiconductor
lasers or other optical or electronic elements onto a single chip. Semiconductor
OEICs are revolutionizing the type and number of applications that can be served
by optoelectronics. The Company has over 200 standard and custom products, as
well as systems, which are used in a diversity of markets such as cable
television (CATV), telecommunications, satellite communications, LAN, printing,
medical, data storage, sensor, defense, materials processing and instrument
markets. The Company is also currently being funded to develop or customize
products for local area network (LAN), display and entertainment markets.
INDUSTRY BACKGROUND
The communications and information industries have historically relied on
electricity for the transmission, display, storage, processing and generation of
information. A significant portion of transmission of information, such as
telephone or CATV signals, is still accomplished by sending electrical signals
through coaxial cables or twisted pair copper wires. Data storage is often
performed by electromagnetic writing on magnetic tape or disc. Display of
information is commonly achieved by impinging electrons onto a phosphorescent
screen in a cathode ray tube (CRT).
Although these functions historically have been accomplished
electronically, electronic solutions are subject to inherent performance
limitations. For example, transmission of information via copper wires or
coaxial cables is limited to short distances by the capacitance of the wire
transmission medium, is characterized by limited data transfer rates, and is
subject to electronic noise and signal interference. Recording information on
magnetic media is limited by the medium's size and storage density. CRT displays
are heavy, bulky and fragile. Today, communications and information markets are
demanding faster data transmission, greater storage density and lighter, more
durable displays.
To overcome the limitations of electronic information transmission, storage
and display, the communications and information industries are utilizing
advanced light source and laser technologies. Light generally can carry more
information at less expense and greater speed, and can store more information in
a given space with greater precision. New forms of display are more reliable,
smaller, lighter and more efficient. Enabled by the development of advanced
light source and laser technology, light is beginning to replace electronic
devices in communications and information industries.
Light is also providing advances in other industries. Laser light is used
in materials processing, welding and heat treatment, in surgical devices, and in
environmental sensors. Laser welding and cutting can speed production lines.
Laser surgery has been found to reduce bleeding and shorten recovery times.
Laser satellite sensors use light to probe the earth's atmosphere for holes in
the ozone layer and global atmospheric pollutants.
Light for these markets has traditionally been supplied by solid state or
gas lasers, light emitting diodes (LEDs) and incandescent lamps. Solid state
lasers are specialized glass or crystals typically illuminated by a
high-intensity incandescent lamp. Solid state and gas lasers are used in
surgical devices and materials processing. LEDs serve to display information and
to illuminate. Incandescent lamps are used to illuminate liquid crystal
displays. Significant shortcomings exist, however, with most of the traditional
technology available for laser, LED and incandescent lamp applications. Solid
state lasers are limited by their dependence on inefficient and unreliable
incandescent lamps. Gas lasers are large, expensive, inefficient and fragile.
LEDs generally have low power output and cannot be tightly focused.
Incandescent lamps are fragile, inefficient and have relatively short operating
lives.
These markets demand an advanced light source; however, different
applications require different light source properties. For example, the most
important properties for CATV applications are high speed modulation,
reliability and
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high power. In LANs, the most important properties are high speed modulation,
reliability and low cost. Displays require small, lightweight, reliable,
efficient and multicolor light sources. Materials processing requires high
power, focusability and reliability. Data storage applications require
focusability, low cost, small size, light weight and reliability. Such an
advanced light source should therefore be highly reliable, highly efficient,
small, rugged, light weight, capable of being modulated at high speed,
focusable, low voltage and capable of generating the full color spectrum.
Using its advanced semiconductor laser and OEIC technology, the Company
designs and manufactures products to overcome the limitations of traditional
electronic and optical technology. With increased levels of semiconductor-based
optoelectronic integration, the Company miniaturizes and generally reduces the
cost while increasing the functionality of what previously were large, bulky and
expensive components. The Company believes that, just like silicon integrated
circuits, advanced semiconductor OEICs will represent an increasing portion of
the electronic or optical system's value. Semiconductor OEICs have the potential
to effectively meet many of the market needs for an advanced light source.
A semiconductor OEIC integrates two or more semiconductor lasers or other
optical or electronic elements such as lenses, light detectors, mirrors, light
modulators, switches and light amplifiers onto a single chip. Semiconductor
OEICs and lasers are built in semiconductor crystals. They can be miniaturized,
allowing lasers to be made as small as a grain of salt. Semiconductor lasers are
now widely used in electronic and optical systems such as compact audio disk
players and laser printers. In many applications, semiconductor OEICs and lasers
offer advantages over traditional light sources.
As with silicon integrated circuits, SDL's advanced semiconductor OEICs and
lasers provide functionality that cannot be achieved with conventional
electronic or optical components. In the communications and information markets
the Company's products improve the transmission, storage and display of
information by replacing electronic technology. Also, the Company's products
replace traditional light sources in applications such as materials processing,
surgical lasers, environmental sensors, and defense and scientific uses. The
Company is seeking to achieve additional technological advances that would
create new applications for semiconductor OEICs, such as optical satellite
communications, higher speed fiber optic local area networks, and generation of
red, green and blue light on a single semiconductor chip for miniature display
systems and value added opto electronic systems based on semiconductor lasers.
PRODUCTS
The Company produces over 200 standard products and develops custom
products for specific customer applications. SDL's products include: (i) "single
mode" semiconductor OEICs and lasers, (ii) "multimode" semiconductor OEICs and
lasers, (iii) fiber-coupled products and (iv) systems incorporating or
interfacing with the Company's semiconductor OEIC and laser products. Prices for
the Company's products range from a few dollars to tens of thousands of dollars.
SINGLE MODE PRODUCTS
"Single mode" refers to the ability of the semiconductor OEIC or laser to
focus the light it generates to a tiny spot (known as a diffraction limited
spot) approximately 100 times smaller than the diameter of a human hair.
Diffraction limited spots have a dimension of approximately the wavelength of
such light. Single mode products allow greater voice and data rates to be
transmitted over optical fiber. Single mode products also allow data storage on
and retrieval from regions the size of the laser's diffraction limited spot. The
next generation of this technology is expected to allow greater amounts of
information to be stored in an even smaller physical space. Currently, such
products primarily use infrared lasers, emitting at a wavelength of
approximately 780 nanometers (nm). Using a single mode blue laser emitting at a
wavelength of 430 nm would allow the storage and retrieval of approximately four
times more information in the same space. A red laser operating at 630 nm would
allow storage and retrieval of approximately two times the data of an infrared
laser or half the data of a blue laser.
MULTIMODE PRODUCTS
In contrast to single mode products, "multimode products" cannot be focused
to diffraction limited spots. Rather, multimode products generally emit higher
power light within a narrow spectrum and can be sufficiently focused to allow
replacement of traditional lasers, LEDs and high intensity incandescent lamps in
certain applications. By integrating large numbers of multimode lasers on a
single chip, multimode laser products can achieve effective power output
comparable to
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all but the highest power gas lasers. Since the Company's multimode products are
generally more reliable, smaller, lower voltage, more efficient, higher power
and/or lower cost than traditional light sources, multimode products are used in
applications such as laser surgery, printing, materials processing and pumping
of solid state lasers for use in telecommunication and CATV transmitters, laser
sensors, materials processing, defense and scientific applications.
FIBER COUPLED PRODUCTS
Light from both "single mode" and "multimode" products is often coupled
into a transparent single mode or multimode optical fiber, respectively, prior
to sale to a customer application. The acquisition of SDL Optics allows SDL to
sell "single mode" fiber coupled products in addition to the "multimode" fiber
coupled products sold previously. New single mode fiber coupled products made by
SDL Optics include the 980 nm pump module for excitation of optical fiber
amplifiers.
SYSTEM PRODUCTS
In addition to producing semiconductor OEICs and lasers, the Company
manufactures electronic systems which provide control, power and interface
functions for its semiconductor OEICs, lasers and fiber optic products. The
Company presently markets fourteen such systems. A recently introduced fiber LAN
transmitter/receiver system offers 1.2 gigabit per second transmission over a
wider range of environmental conditions than any other product known to the
Company. Eight additional systems are sold primarily to scientific and
engineering development laboratory users who do not wish to provide their own
electronic control units. These include a line of high-power, wavelength tunable
and wavelength stabilized products for scientific, pollution sensing and
chemical monitoring applications. The Company also produces three different
fiber coupled optical power delivery systems. These fiber-optic power delivery
systems are used in laser surgery, materials processing, marking, scribing,
soldering and pumping of solid state lasers.
CUSTOMERS
The Company received approximately 21 percent and 19 percent of its 1996
and 1995 revenue, and expects to receive over 10 percent of its 1997 revenue,
from Lockheed Martin Corporation (Lockheed Martin) through several government
and commercial programs. Almost all of the Company's revenue from Lockheed
Martin during 1995 and 1996 was, and during 1997 is expected to be, derived from
Federally-funded programs. See "Factors Affecting Earnings and Stock Price --
Dependence Upon Government Programs and Contracts."
TECHNOLOGY
The Company's leadership in developing and delivering certain semiconductor
OEICs, lasers and systems is based upon the Company's expertise in the
technologies set forth below. The Company has a significant portfolio of
proprietary technology, and has been issued over 55 U.S. patents and has
approximately 50 U.S. patent applications pending. In addition, the Company has
a royalty-free, non-exclusive license to approximately 100 Xerox U.S. patents
related to optoelectronics and lasers.
The word "laser" is an acronym for "light amplification by stimulated
emission of radiation." Light amplification in semiconductors occurs when
electric current is injected at high density into a small portion of the
semiconductor chip. Stimulated emission occurs when the light generated by the
current is partially reflected by mirrors, further stimulating the production of
light. At a threshold level of current, light radiates at high efficiency.
Semiconductor lasers are believed to be the smallest, most efficient laser or
light source known today.
ADVANCED SEMICONDUCTOR OEIC AND LASER DESIGNS
The Company has developed advanced application specific semiconductor OEIC
and laser designs. Specifically, the Company believes that it has developed
single mode OEIC chip designs that emit five times higher optical power levels
than any other commercial single mode laser. The Company's most powerful
multimode OEIC contains the equivalent of 1,000 semiconductor lasers.
Two-dimensional arrays of these multimode OEICs are currently available at 5,000
watts of peak power and 1,400 watts of average power from a four centimeter by
four centimeter array.
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ADVANCED SEMICONDUCTOR MANUFACTURING TECHNOLOGY
The Company's semiconductor products and custom chips are based on the
elements indium, aluminum, gallium, arsenic and phosphorous. These elements form
compound semiconductors such as indium phosphide and gallium aluminum arsenide.
The composition ratio of these elements determines the wavelength of light
generated. Semiconductor OEIC and laser designs are processed via photomasking,
etching, implantation, metallization and other techniques commonly used in the
silicon integrated circuit industry. The Company has modified and adapted these
techniques to its own manufacturing processes, and protects these modifications
as trade secrets.
MICROELECTRONIC PACKAGING
The Company provides its customers with a variety of microelectronic
packages. Package options include photodetectors for monitoring light output
power, thermoelectric coolers for controlling the ambient temperature within the
package, and optical fibers for low loss light transmission. Heat removal is a
key packaging aspect for the Company's high power products. The Company has
developed patented techniques for efficiently removing heat from the light-
producing region of the chip.
Maintaining the brightness and intensity of the semiconductor OEIC or laser
is important in many applications. For example, the Company couples light from
micron sized lasers into micron sized optical fibers by tightly aligning the
laser and the fiber, thereby maintaining brightness. The Company has developed
miniaturized "optical bench" technology, consisting of the laser chip or
multi-element laser array and an arrangement to rigidly hold a single fiber or
an array of optical fibers while maintaining alignments of less than one micron.
The optical bench is integrated inside a hermetically sealed package to provide
freedom from adverse environmental gases and water vapor.
SPACE QUALIFICATION/RELIABILITY
The Company has developed high-reliability device and packaging capability
and a quality assurance system that has been certified by satellite systems
companies for use in space. The Company believes that few of its competitors
have similar space-qualified optoelectronic device and packaging capability,
providing the Company with an advantage over many of its competitors in
satellite markets. The Company believes that the space qualification of certain
of its products demonstrates to customers in other markets where reliability is
key to system performance, such as telecommunications, that the Company's
products are highly reliable, providing product differentiation and a
competitive advantage in those markets.
RESEARCH AND DEVELOPMENT
Research and development in the semiconductor OEIC and laser industry is
characterized primarily by design and product engineering that enables new
functionality or improved performance. The Company believes that its ability to
successfully compete will be substantially dependent on its ability to design,
develop and introduce on a timely basis new product offerings. The Company also
focuses on reducing the cost of existing manufacturing processes, developing new
process capabilities and adding new features to existing products.
In 1996, 1995 and 1994, the Company spent approximately $6.7 million, $4.0
million and $2.8 million, respectively, on internally-funded research and
development. The Company expects that it will continue to spend substantial
funds on research and development activities.
The Company receives research and development funding from Fortune 500
companies, major international corporations, smaller domestic and international
companies, and multiple U.S. government agencies. Under such programs, the
Company may bill the customer for a fixed non-recurring engineering charge or
may bill for actual burdened costs. On many of these programs, the Company teams
with its customers or suppliers to present a vertically integrated system
solution. Certain of these programs also require research and development
cost-sharing by the Company.
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The Company's product development strategy emphasizes a broad line of
standard products that are based on customer input and requests, as well as
custom product design. The Company often develops new products at the customer's
system-design stage in order to optimize compatibility with the customer's
system and to better ensure market acceptance.
The Company has successfully introduced what it believes to be leading edge
products. Over a twelve-year period, the Company received 20 new product awards
from the three leading industry trade journals, more such awards over that time
period than any other company in the industry. There can be no assurance that
the Company will succeed in identifying new product opportunities, or in
developing and bringing to market any such new products, or that the Company
will be able to respond effectively to technological advances by others. There
also can be no assurance that the Company's new products will be accepted by the
Company's end markets. Moreover, the end markets for the Company's new standard
products are subject to rapid technological change and there can be no assurance
that, as such markets change, the Company's product offerings will remain
current. See "Factors Affecting Earnings and Stock Price -- Competition."
MANUFACTURING
The Company's manufacturing operations are located at the Company's
headquarters in San Jose, California, at a nearby facility in Santa Clara,
California and in Victoria, British Columbia, Canada. The Company's
manufacturing operation is vertically integrated and has capabilities in
computer-aided chip and package design, wafer fabrication, wafer processing,
device packaging, hybrid microelectronic packaging, printed circuit board
testing, and final assembly and testing. Many of the functions within the
Company's manufacturing operation are computer monitored or controlled, which
are designed to enhance reliability and yield. The Company employs flexible
manufacturing techniques, allowing the Company to switch readily, reliably and
efficiently from one product to another. The Company believes that its flexible
manufacturing capability differentiates it from its competitors.
The Company's semiconductor OEICs and lasers are fabricated using many
proprietary processes and customized manufacturing equipment. Therefore, almost
all steps in the manufacturing of the semiconductor OEICs are performed by the
Company. Any interruption in manufacturing resulting from shortages of parts or
equipment, earthquake, fire, equipment failures or otherwise could 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. See "Factors
Affecting Earnings and Stock Price--Manufacturing Risks" and "Factors Affecting
Earnings and Stock Price -- Need to Manage Growth." Outside contractors and
suppliers are used to supply raw materials, packages and standard components,
and to assemble printed circuit boards. The Company depends on single or a
limited number of suppliers. The Company generally purchases these single or
limited source products through standard purchase orders or one year supply
agreements. The Company seeks to maintain a sufficient safety stock to overcome
shipping delays or supply interruptions by its suppliers. The Company also
endeavors to maintain ongoing communications with its suppliers to guard against
interruptions in supply and has, to date, generally (although not always) been
able to obtain sufficient supplies in a timely manner. Operating results could
be adversely affected by a stoppage or delay of supply, substitution of more
expensive or less reliable alternate parts, receipt of defective parts or
contaminated materials, an increase in the pricing of such parts, or the
Company's inability to obtain reduced pricing from its suppliers in response to
competitive pressures. See "Factors Affecting Earnings and Stock Price --
Dependence on Single Source and Other Third Party Suppliers."
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, adding new
manufacturing equipment and obtaining additional facilities. In addition, in
November 1995, the Company and its subsidiary, SDL Optics, acquired the business
of Seastar, located in Victoria, British Columbia, Canada. Prior to the
developments, the Company had no experience in managing operations in multiple
sites and no assurance can be given that the Company will not experience
unexpected delays, inefficiencies or management problems arising out of its
multisite operations. Such delays or inefficiencies could materially adversely
affect the Company's business and results of operations. The Company is
experiencing, and may in the future experience, lower than expected production
yields on many of its products, including some of its key product lines. This
reduction in yields adversely affects gross margins and delays component,
product and system shipments. There can be no assurance that the Company will be
able to achieve
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acceptable manufacturing yields or ship products on time in the future. See
"Factors Affecting Earnings and Stock Price -- Manufacturing Risks" and "Factors
Affecting Earnings and Stock Price -- Need to Manage Growth."
ENVIRONMENTAL REGULATIONS
The Company is subject to a variety of federal, state and local laws and
regulations concerning the storage, use, discharge and disposal of toxic,
volatile, or otherwise hazardous or regulated chemicals or materials used in its
manufacturing processes. Further, the Company is subject to other safety,
labeling and training regulations as required by local, state and federal law.
The Company has established an environmental and safety compliance program to
meet the objectives of applicable federal, state and local laws. This compliance
program is administered by the environmental and safety department of the
Company and includes monitoring, measuring and reporting compliance,
establishing safety programs and training Company personnel in environmental and
safety matters. There can be no assurance that changes in regulations and laws
will not have an adverse economic effect on the Company. Further, such
regulations could restrict the Company's ability to expand its operations. Any
failure by the Company to obtain required permits or operate within regulations
for, control the use of, or adequately restrict the discharge of hazardous or
regulated substances or materials under present or future regulations could
subject the Company to substantial liability, require costly changes in the
Company's manufacturing processes or facilities or cause its operations to be
suspended.
BACKLOG
As of December 31, 1996, the Company's total backlog was approximately
$37.2 million, as compared to approximately $35.7 million at December 31, 1995.
This increase is primarily due to orders placed during 1996. Orders constituting
the Company's backlog are generally subject to delivery rescheduling, price
renegotiations and cancellation at the option of the buyer without significant
penalty. A significant portion of the Company's business, in line with that of
much of the semiconductor industry, is characterized by short lead-time orders
and quick delivery schedules.
COMPETITION
The Company's various markets are highly competitive. The Company faces
current or potential competition from four primary sources: (i) direct
competitors, (ii) potential entrants, (iii) suppliers of potential new
technologies and (iv) suppliers of existing alternative technologies.
The Company offers a range of components, products and systems, and has
numerous competitors worldwide in various segments of its markets. In high power
laser and light source replacement markets, its direct competitors include Opto
Power and Sony. In its single mode laser markets, its competitors include Sanyo
and Philips among others. In its fiber amplifier pump market, IBM is the
Company's primary competitor, with other competitors emerging, some of which are
licensing technology from IBM. SDL Optics has multiple competitors in its single
mode pump module product lines, including Lasertron and Nortel, which are also
licensing IBM chip technology. In 1995, several new start-ups began shipping
products in these markets. The Company often competes with David Sarnoff
Research Laboratories, among others, for research contract funding. The Company
also sells its products to current competitors and companies with the capability
of becoming competitors. If the markets for the Company's products continue to
grow, new competitors are likely to emerge and present competitors may increase
their market share.
Potential new technologies may emerge to compete with the Company's
products. For example, the Company is attempting to develop blue semiconductor
lasers based on gallium nitride technology. Blue semiconductor lasers have been
demonstrated based on an alternative technology, which the Company is not
presently pursuing. Although such alternative technology has, to date, exhibited
poor reliability, rapid advances in that technology could render obsolete any
gallium nitride based lasers developed by the Company. Additionally, many other
companies around the world are working to develop or have developed blue gallium
nitride lasers. In most of the Company's product lines, both the Company and
competitors are working to develop new technologies, or improvements and
modifications to existing technologies, which will obsolete present products.
There can be no assurances that the Company will continue its development
efforts, or that such efforts, if continued, will be successful. In addition,
there can be no assurances that markets will develop for any such products, or
that any such products would be competitive with other technologies or products
that may be developed by others.
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The Company also competes with alternate existing technologies. For
example, the Company makes semiconductor laser products for powering CATV and
telecommunications optical amplifiers. These optical amplifiers compete with
electronic repeaters which utilize semiconductor laser transmitters and
photo-sensitive receivers.
Many of the Company's competitors have significantly greater financial,
technical, manufacturing, marketing, sales and other resources than SDL. In
addition, many of these competitors may be able to respond more quickly to new
or emerging technologies, evolving industry trends and changes in customer
requirements and to devote greater resources to the development, promotion and
sale of their products than the Company. There can be no assurance that the
Company's current or potential competitors will not develop or acquire products
comparable or superior to those developed by the Company, combine or merge to
form significant competitors, or adapt more quickly than the Company to new
technologies, evolving industry trends and changing customer requirements.
Increased competition has resulted and could, in the future, result in price
reductions, reduced margins or loss of market share, any of which could
materially and adversely affect the Company's business and results of
operations. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company would not have a material adverse effect on its
business and results of operations. The Company expects that both direct and
indirect competition will increase in the future. Additional competition could
adversely affect the Company's results of operations through price reductions
and loss of market share. In addition, the Company is currently involved in
litigation with Spectra-Physics and Opto Power regarding claimed rights to
certain SDL technology. If the Company does not prevail in such litigation, the
Company could be required to transfer and license SDL trade secrets and
technology to Spectra-Physics and its subsidiaries, that may include 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 a number of 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 "Factors Affecting Earnings
and Stock Price -- Technology Agreement," "Factors Affecting Earnings and Stock
Price -- Competition" and "Legal Proceedings."
INTELLECTUAL PROPERTY
The Company has been a leader in the development of new technologies in the
optoelectronics field and as such, has actively sought to patent its inventions.
The Company frequently reviews its inventions and attempts to determine which
inventions will provide substantial differentiation between the Company's
products and those of its competitors. In certain cases, the Company may also
choose to keep an invention or a process as a trade secret. Trade secrets are
routinely employed in the Company's manufacturing processes. The Company has
entered into non-disclosure agreements to protect its proprietary technology
with its employees and consultants, and in some instances with its suppliers and
customers.
To date, the Company has been issued over 55 U.S. patents on devices,
processes, packages and systems. No patent has less than seven years of life
remaining before expiration and the average remaining life is approximately 12
years. Approximately 50 additional patent applications are pending. The Company
also has a royalty-free license to approximately 100 Xerox U.S. patents. It also
has four royalty-bearing licenses from third parties. Management believes that
the breadth of its issued and pending patents and licenses will allow the
Company to compete effectively in its present and future businesses. However,
because of rapid technological developments in the communications, electronics,
optics and semiconductor industries and the broad and rapidly developing patent
coverage, the patent position of any manufacturer, including the Company, is
subject to uncertainties and may involve complex legal and factual issues.
Consequently, although the Company holds certain patents, is licensed under
other patents and is currently prosecuting additional patent applications, there
can be no assurance that patents will issue from any pending applications or
that claims allowed by any existing or future patents issued or licensed to the
Company will not be challenged, invalidated, or circumvented, or that any rights
granted thereunder will provide adequate protection to the Company. Moreover,
the Company may be required to participate in interference proceedings to
determine the priority of inventions, which could result in substantial cost to
the Company. See "Factors Affecting Earnings and Stock Price -- Dependence on
Proprietary Technology."
Due to collaborative efforts with others, some of the Company's pending
patent applications are filed under undivided joint ownership. Approximately 15
of the Company's issued inventions were developed under Federal government
funding and contain a provision for a non-exclusive, royalty-free license for
Federal government use.
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The Company participates in a number of research or product development
consortia in which the Company has agreed to grant other partners or consortia
members, along with the Federal government, a non-exclusive license to
technologies developed with consortia funding. Some of these cross-license
grants are royalty-free while others provide for market rate license fees. In
certain situations, these consortia require the Company to invest its own
research and development funds to match Federal government funds. The inventions
of the Company and other consortia or team members made with matching research
and development funds are also often subject to such cross-license grant
provisions. Joint inventions made in such collaborations are normally jointly
owned.
The Company has registered the letters SDL and its logo with the U.S.
Patent and Trademark Office as trademarks.
As part of its formation, the Company entered into the Technology Agreement
with Spectra-Physics and Xerox pursuant to which, among other things, SDL
granted to Spectra-Physics and Xerox an irrevocable, royalty-free, worldwide,
non-exclusive license to patented and non-patented technology developed by SDL.
Spectra-Physics and Opto Power have filed suit against SDL seeking, among other
things, to enforce claims to SDL patented and non-patented technology developed
through at least June 1993. 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 its
subsidiaries, including Opto Power, which is currently manufacturing
optoelectronic devices and systems that currently compete with a number of the
Company's products. See "Factors Affecting Earnings and Stock Price --
Technology Agreement" and "Legal Proceedings."
In March 1995, Xerox formally requested transfer of SDL technology under
the Technology Agreement, but advised the Company that, in connection with such
transfer, Xerox currently intends to use the SDL technology for Xerox' internal
research and development, laser printing, image projection and other activities
in the document processing field. Xerox further indicated to the Company that
Xerox did not currently intend to become a supplier of products that would be
competitive with the Company's current product offerings. SDL agreed to a
limited technology transfer for those purposes. Xerox subsequently asserted a
breach of contract claim against the Company in December 1995 claiming
unspecified damages and seeking specific performance of the Technology
Agreement. No assurance can be given, however, that Xerox and such subsidiaries
or affiliates as specified in the Technology Agreement will not in the future
offer products competitive with the Company's products, which products could
include or be based on SDL Technology.
FACTORS AFFECTING EARNINGS AND STOCK PRICE.
The statements contained in this Report on Form 10-K 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, beliefs,
intentions or strategies regarding the future. Forward looking statements
include: discussion of the Company's OEIC market leadership and the descriptions
of the future use of OEICs and light as a replacement for existing technologies
under the headings "Introduction" and "Industry Background;" statements
regarding expected revenues from material customers under the heading
"Customers", statements regarding future products or product development under
the headings "Business -- Products" and "Business -- Technology;" statements
regarding the success and amount of historical and future research and
development spending and the Company's product development strategy under the
heading "Research and Development;" statements regarding reliability, yield and
the future flexibility of the Company's manufacturing processes and continuing
remodeling of its manufacturing facilities under the heading "Manufacturing;"
statements regarding the adequacy of cash resources in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and statements
regarding litigation currently pending against the Company and the Company's
defenses thereto under the headings "Business -- Competition," "Business --
Intellectual Property" and "Legal Proceedings." 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 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 a highly
complex and precise process, requiring production in a highly controlled and
clean
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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 exclusively 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 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 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 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 and implement
than anticipated. This reduction in yields 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.
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 breach of contract, promissory estoppel and fraud.
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.
Discovery is being completed. Trial of the matter is presently scheduled
for April 21, 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
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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 license and to transfer 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 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 addresses 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, 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 1996, 1995 and 1994,
the Company derived approximately 43 percent, 45 percent and 36 percent,
respectively, of its revenue directly and indirectly from a variety of Federal
government sources. Direct sources included Federal agencies such as NASA,
Defense Advanced Research Projects Agency (DARPA), Air Force, Navy, Army,
Department of Defense (DoD), Department of Commerce (DoC), National Institute of
Standards and Technology (NIST), National Science Foundation (NSF) and
Department of Energy (DoE). Indirect funding includes standard and custom
product sales to, and subcontracts under, customers' prime contracts and
subcontracts with various Federal agencies. The Company received approximately
21 percent and 19 percent of its revenue for 1996 and 1995, respectively, from
Lockheed Martin through several government and commercial programs. Almost all
of the Company's revenue from Lockheed Martin during 1995 and 1996 was, and
during 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, 1995 and 1994 was funded by
Federal programs. There can be no assurance that the Federal government will
have the available resources to fund such programs, that such programs will
continue to be funded even if government agencies have available financial
resources, or that the Company will continue to be awarded contracts under such
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 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 the 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 this
government program. 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 percent and 5 percent of revenue in 1996 and 1995,
respectively.
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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. 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 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, 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.
Risk of Patent Infringement Claims. 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 and licensing offers to
commercialize third party patent rights. In addition, there can be no assurance
that additional infringement claims (or claims for indemnification resulting
from infringement claims) will not be asserted against the Company, or that
existing claims or any other assertions will not result in an injunction against
the sale of infringing products or otherwise materially adversely affect the
Company's business and results of operations.
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. Those allegations have led to
two lawsuits, which are currently pending. The first lawsuit was filed in August
1993, when Rockwell sued the Federal government in the United States Court of
Federal Claims, alleging infringement of these patent rights with respect to the
contracts the Federal government has had with at least 15 companies, including
SDL, Rockwell International Corporation v. The United States of America, No.
93-542C (U.S. Ct. Fed. Cl.) (the Government Lawsuit). The Company was not
originally named as a party to the Government Lawsuit. However, 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 on certain contracts. In June 1995, after Rockwell
filed a second lawsuit (the California Lawsuit described below), the Company
filed a motion to intervene in the Government Lawsuit. That motion was granted
on August 17, 1995. Upon intervening, the Company filed an answer to Rockwell's
complaint, alleging that Rockwell's patent is invalid, that Rockwell's patent is
not infringed by the Company, that Rockwell's patent is unenforceable under the
doctrine of inequitable conduct, and that Rockwell's action is barred by the
doctrines of laches and equitable estoppel. After extensive discovery, both the
Government and the Company moved for summary judgment on the ground that
Rockwell's patent was invalid. By order dated February 5, 1997, the Court of
Federal Claims granted those motions and entered judgment in favor of the
Government and the Company. Rockwell has 60 days from the date judgment was
entered to decide whether it will appeal the Court's decision.
As noted above, the Company's decision to intervene in the Government
Lawsuit was made after Rockwell, in May 1995, filed suit against the Company in
the Northern District of California, alleging that the Company had infringed the
Rockwell patent in connection with the Company's manufacture and sale of
products to customers other than the United States. Again, the complaint alleges
that a fabrication process used by the Company infringes the Rockwell patent.
(Rockwell International Corporation v. SDL, Inc., No. C95-01729 MHP (U.S. Dist.
Ct., N.D. Cal.). By its complaint, Rockwell seeks a permanent injunction against
the Company enjoining it from infringement of the Rockwell patent, damages in an
unspecified amount for the Company's alleged past infringement of the patent,
treble damages and attorneys' fees. The complaint was served on the Company on
June 30, 1995, and the Company filed an answer to the complaint on August 18,
1995, alleging that Rockwell's patent is invalid, that Rockwell's patent is not
infringed by the Company, that Rockwell's patent is unenforceable under the
doctrine of inequitable conduct, and that Rockwell's action is barred by the
doctrines of laches and equitable estoppel. Prior to filing its answer, on
August 11, 1995, the Company filed
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a motion to stay this action based upon the pendency of the Government Lawsuit.
The District Court granted the Company's motion to stay on September 15, 1995.
There have been no further proceedings in this action. 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, as was found by The Court of
Federal Claims in the Government Lawsuit. However, the resolution of
intellectual property disputes is often fact intensive and, therefore, the
results are inherently uncertain. There can be no assurance that Rockwell will
not ultimately prevail in this dispute, including no assurance that the
favorable decision by the Court of Federal Claims will not be reversed on
appeal. If Rockwell were to prevail, it could be awarded substantial monetary
damages and/or an injunction against the sale of infringing products by the
Company. If such an injunction were entered, the Company may seek to obtain a
license to use Rockwell's patent. There can be no assurance, however, that a
license would be available on reasonable terms or at all. The award of monetary
damages against the Company, or the grant of an injunction and failure to obtain
a license to use Rockwell's patent on commercially reasonable terms could have a
material adverse effect on the Company's business and results of operations.
Rockwell is significantly larger than the Company and has significantly greater
resources with which to pursue such litigation. If the favorable decision of the
Court of Federal Claims were reversed on appeal, then litigation of Rockwell's
claim against the Company would be expected to involve significant expense to
the Company and to divert the attention of the Company's technical and
management personnel and could have a material adverse effect on the Company's
business and results of operations.
Competition. The Company's various markets are highly competitive. The
Company faces current or potential competition from four primary sources: (i)
direct competitors, (ii) potential entrants, (iii) suppliers of potential new
technologies and (iv) suppliers of existing alternative technologies. The
Company offers a range of components, products and systems and has numerous
competitors worldwide in various segments of its markets. As the markets for the
Company's products grow, new competitors have recently emerged and are likely to
continue to do so in the future. The Company also sells products and services to
companies with which it presently competes or in the future may compete. In most
of the Company's product lines, both the Company and competitors are working to
develop new technologies, or improvements and modifications to existing
technologies, which will obsolete present products. Many of the Company's
competitors have significantly greater financial, technical, manufacturing,
marketing, sales and other resources than SDL. In addition, many of these
competitors may be able to respond more quickly to new or emerging technologies,
evolving industry trends and changes in customer requirements and to devote
greater resources to the development, promotion and sale of their products than
the Company. There can be no assurance that the Company's current or potential
competitors have not already or will not in the future develop or acquire
products or technologies comparable or superior to those developed by the
Company, combine or merge to form significant competitors, or adapt more quickly
than the Company to new technologies, evolving industry trends and changing
customer requirements. Increased competition has resulted and could, in the
future, result in price reductions, reduced margins or loss of market share, any
of which could materially and adversely affect the Company's business and
results of operations. There can be no assurance that the Company will be able
to compete successfully against current and future competitors or that
competitive pressures faced by the Company would not have a material adverse
effect on its business and results of operations. The Company expects that both
direct and indirect competition will increase in the future. Additional
competition could have a material adverse effect on the Company's results of
operations through price reductions and loss of market share. See "Technology
Agreement" and "Business -- Competition."
Dependence on Proprietary Technology. The Company's future success and
competitive position is dependent in part upon its proprietary technology, and
the Company relies in part on patent, trade secret, trademark and copyright law
to protect its intellectual property. There can be no assurance that any of the
55 patents owned or approximately 100 patents licensed by the Company will not
be invalidated, circumvented, challenged or licensed to others, that the rights
granted thereunder will provide competitive advantages to the Company or that
any of the Company's approximately 50 pending or future patent applications will
be issued with the scope of the claims sought by the Company, if at all.
Furthermore, there can be no assurance that others will not develop technologies
that are similar or superior to the Company's technology, duplicate the
Company's technology or design around the patents owned by the Company, or
patent or assert patents on technology which the Company might use or intend to
use. In addition, effective copyright and trade secret protection may be
unavailable, limited or not applied for in certain foreign countries. Certain of
the Company's technology is licensed on a non-exclusive basis from Xerox and
other third parties which may license such technology to others, including
competitors of the Company. Under the Technology Agreement, Xerox and
Spectra-Physics, and their subsidiaries or, in the case of Xerox, an affiliate,
may have royalty-free, worldwide license rights to all or some of the Company's
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technology. There can be no assurance that steps taken by the Company to protect
its technology will prevent misappropriation of such technology. In addition,
litigation has been necessary and may be necessary in the future to enforce the
Company's patents and other intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others or to defend against claims of infringement or invalidity. Such
litigation has resulted in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business and results of
operations. Moreover, the Company may be required to participate in interference
proceedings to determine the propriety of inventions which could result in
substantial cost to the Company. See " -- Technology Agreement" and "Business --
Intellectual Property."
Dependence on Single Source and Other Third Party Suppliers. The Company
depends on a single or limited number of outside contractors and suppliers for
raw materials, packages and standard components, and to assemble printed circuit
boards. The Company generally purchases these single or limited source products
through standard purchase orders or one year supply agreements and has no
long-term guaranteed supply agreements with such suppliers. The Company seeks to
maintain a sufficient safety stock to overcome short-term shipping delays or
supply interruptions by its suppliers. The Company also endeavors to maintain
ongoing communications with its suppliers to guard against interruptions in
supply and has, to date, generally been able to obtain sufficient supplies in a
timely manner. However, the Company's business and results of operations have in
the past been and could in the future be adversely affected by a stoppage or
delay of supply, substitution of more expensive or less reliable parts, receipt
of defective parts or contaminated materials, an increase in the price of such
supplies or the Company's inability to obtain reduced pricing from its suppliers
in response to competitive pressures. For example, the Company is currently
negotiating with several suppliers to accelerate the delivery schedule for parts
from the estimated delivery schedules given by such suppliers and with one other
supplier, who had been a sole source of a particular part, to continue supplying
such part. If these suppliers are not able to accelerate delivery as requested
by the Company, the Company's operating cost may be increased or a portion of
the Company's manufacturing line might be shut down for a period of time,
delaying delivery of the Company's products to its customers and consequently
creating customer dissatisfaction. Any significant interruption in delivery of
such parts could have a material adverse effect on the Company's business and
results of operations.
Customer Order Fluctuations. The Company's product revenue is subject to
fluctuations in customer ordering practices. Occasionally, some of the Company's
customers have ordered more products than they need in a given period, thereby
building up inventory and delaying placement of subsequent orders until such
inventory has been reduced. Also, customers have occasionally placed large
orders which they have subsequently canceled. Such cancellations can have
adverse effects on the Company's business and results of operations because the
Company may have incurred inventory or other expenses in preparing to fill such
orders prior to their cancellation. Virtually all of the Company's backlog is
subject to cancellation. Cancellation of significant portions of the Company's
backlog, or delays in scheduled delivery dates, could have a material adverse
effect on the Company's business and results of operations.
International Distribution Risks. International revenue accounted for
approximately 15 percent, 23 percent and 25 percent, of the Company's total
revenue in 1996, 1995 and 1994, respectively. International revenue carries a
number of inherent risks, including reduced protection for intellectual property
rights in some countries, the impact of recessionary environments in economies
outside the United States, generally longer receivable collection periods,
changes in regulatory environments, tariffs and other potential trade barriers.
In addition, certain of the Company's international revenue is subject to export
licensing and approvals by the DoC or other U.S. governmental agencies. Although
to date the Company has experienced little difficulty in obtaining such licenses
or approvals, the failure to obtain such licenses or approvals or comply with
such regulations in the future could have a material adverse effect on the
Company's business and results of operations.
The Company currently uses local distributors in key industrialized
countries and local representatives in smaller markets. Although the Company has
formal distribution contracts with certain of its distributors and
representatives, many of the Company's relationships are currently on an
informal basis. Most of the Company's international distributors and
representatives offer only the Company's products; however, certain distributors
offer competing products and there can be no assurance that additional
distributors and representatives will not also offer products that are
competitive with the Company's products. There can be no assurance that the
Company's international distributors and representatives will enter into formal
distribution agreements at all or on acceptable terms, will not terminate
informal or contractual relationships, will continue to sell the Company's
products or that the Company will provide the distributors and resellers
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with adequate levels of support. The loss of, or a significant reduction in
revenue through, a significant number of the Company's international
distributors and representatives would have a material adverse effect on the
Company's business and results of operations.
Dependence on Key Employees. The Company's future performance also depends
in significant part upon the continued service of its key technical and senior
management personnel. The loss of the services of one or more of the Company's
officers or other key employees could have a material adverse effect on the
Company's business, operating results and financial condition. While many of the
Company's current employees have many years of service with the Company, there
can be no assurance that the Company will be able to retain its existing
personnel. If the Company is unable to retain and hire additional personnel, the
Company's business and results of operations could be materially and adversely
affected. See " -- Need to Manage Growth."
Risks of Acquisitions. The Company's strategy involves the acquisition and
integration of additional companies' products, technologies and personnel. The
Company has limited experience in acquiring outside businesses. Acquisition of
businesses requires substantial time and attention of management personnel.
Further, integration of newly established or acquired businesses is often
disruptive. If the Company acquires one or more businesses in the future, there
can be no assurance that the Company will identify appropriate targets, will
acquire such businesses on favorable terms, or will be able to successfully
integrate such businesses into its business. Failure to do so could materially
adversely affect the Company's business, financial condition and results of
operations.
Potential Volatility of Stock Price. Factors such as announcements of
technological innovations, large customer orders, order cancellations or new
products by the Company, its competitors or third parties, possible acquisition
of SDL by a third party, production problems as well as quarterly variations in
the Company's actual or anticipated results of operations and developments in
litigation involving the Company, may cause the market price of the Company's
Common Stock to fluctuate significantly. Furthermore, the stock market has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices of many high technology companies and which have
often been unrelated to the operating performance of such companies. These broad
market fluctuations may adversely affect the market price of the Company's
Common Stock. Many companies in the semiconductor, communications, information
and laser industries, including the Company, have in the past year experienced
historical highs in the market prices of their stock. The prices for several of
these companies have subsequently decreased significantly. There can be no
assurance that the market price of the Company's Common Stock will not
experience significant fluctuations in the future, including fluctuations that
are unrelated to the Company's performance.
EMPLOYEES
As of December 31, 1996, the Company employed 510 persons, including 329 in
manufacturing, 128 in engineering, research and development, 19 in sales and
marketing, and 34 in general and administrative capacity. The Company also
employs, from time to time, a number of temporary employees and consultants on a
contract basis. As of December 31, 1996, the Company employed 22 such persons.
None of the Company's employees is represented by a labor union. The Company has
not experienced any work stoppages and considers its relations with its
employees to be good.
ITEM 2. PROPERTIES
The Company leases two adjacent buildings comprising approximately 64,000
square feet of office and manufacturing space in San Jose, California. These
facilities serve as the Company's headquarters and include manufacturing,
marketing, research, engineering and administrative functions. The present
leases expire in November 2001. The Company has renewal options to extend these
leases through November 2016.
In January 1995, the Company leased an additional 50,000 square feet of
manufacturing and office space in Santa Clara, California, approximately three
miles from its headquarters. This lease expires in March 2002. The Company has
renewal options to extend this lease through 2017 and has exercised an option
for an adjacent additional 50,000 square feet which it expects to occupy in late
1997.
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In April 1996, the Company leased an additional 10,000 square feet of
office space in Santa Clara, California. This lease expires in April 1999.
SDL Optics leases 21,000 square feet of manufacturing and office space, and
adjacent parking space, in Saanichton, British Columbia, Canada. These
facilities serve as SDL Optics' headquarters and include manufacturing,
marketing, research, engineering and administrative functions. The present
leases expire in August 1998. SDL Optics has two one-year renewal options under
each lease and an option to purchase the manufacturing and office space during
the initial or renewal term of the lease for that facility.
ITEM 3. LEGAL PROCEEDINGS
Rockwell litigation. In 1985, the Company first received correspondence
from Rockwell alleging that a fabrication process used by the Company infringes
Rockwell's patent rights. Those allegations have led to two lawsuits, which are
currently pending. The first lawsuit was filed in August 1993, when Rockwell
sued the Federal government in the United States Court of Federal Claims,
alleging infringement of these patent rights with respect to the contracts the
Federal government has had with at least 15 companies, including the Company,
Rockwell International Corporation v. The United States of America, No. 93-542C
(U.S. Ct. Fed. Cl.) (the Government Lawsuit). The Company was not originally
named as a party to the Government Lawsuit. However, 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 on certain contracts. In June 1995, after Rockwell filed a second
lawsuit (the California Lawsuit described below), the Company filed a motion to
intervene in the Government Lawsuit. That motion was granted on August 17, 1995.
Upon intervening in the Government Lawsuit, the Company filed an answer to
Rockwell's complaint, alleging that Rockwell's patent is invalid, that
Rockwell's patent is not infringed by the Company, that Rockwell's patent is
unenforceable under the doctrine of inequitable conduct, and that Rockwell's
action is barred by the doctrines of laches and equitable estoppel. After
extensive discovery, both the Government and the Company moved for summary
judgment on the ground that Rockwell's patent was invalid. By order dated
February 5, 1997, the Court of Federal Claims granted those motions and entered
judgment in favor of the Government and the Company. Rockwell has 60 days from
the date judgment was entered to decide whether it will appeal the Court's
decision.
As noted above, the Company's decision to intervene in the Government
Lawsuit was made after Rockwell filed suit against the Company in the Northern
District of California in May 1995, alleging that the Company had infringed the
Rockwell patent in connection with the Company's manufacture and sale of
products to customers other than the United States. Again, the complaint alleges
that a fabrication process used by the Company infringes the Rockwell patent.
(Rockwell International Corporation v. SDL, Inc., No. C95-01729 MHP (U.S. Dist.
Ct., N.D. Cal.)). By its complaint, Rockwell seeks a permanent injunction
against the Company enjoining it from infringement of the Rockwell patent,
damages in an unspecified amount for the Company's alleged past infringement of
the patent, treble damages and attorneys' fees. The complaint was served on the
Company on June 30, 1995, and the Company filed an answer to the complaint on
August 18, 1995, alleging that Rockwell's patent is invalid, that Rockwell's
patent is not infringed by the Company, that Rockwell's patent is unenforceable
under the doctrine of inequitable conduct, and that Rockwell's action is barred
by the doctrines of laches and equitable estoppel. On August 11, 1995, prior to
filing its answer, the Company filed a motion to stay this action based upon the
pendency of the Government Lawsuit. The District Court granted the Company's
motion to stay on September 15, 1995. There have been no further proceedings in
this action.
See "Factors Affecting Earnings and Stock Price--Risk of Patent
Infringement Claims."
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, as was found by The Court of Federal Claims in the Government Lawsuit.
However, the resolution of intellectual property disputes is often fact
intensive and, therefore, the results are inherently uncertain. There can be no
assurance that Rockwell will not ultimately prevail in this dispute, including
no assurance that the favorable decision by the Court of Federal Claims will not
be reversed on appeal. If Rockwell were to prevail, it could be awarded
substantial monetary damages and/or an injunction against the sale of infringing
products by the Company. If such an injunction were entered, the Company may
17
<PAGE> 18
seek to obtain a license to use Rockwell's patent. There can be no assurance,
however, that a license would be available on reasonable terms or at all. The
award of monetary damages against the Company, or the grant of an injunction and
failure to obtain a license to use Rockwell's patent on commercially reasonable
terms could have a material adverse effect on the Company's business and results
of operations. If the favorable decision of the Court of Federal Claims were
reversed on appeal, then litigation of Rockwell's claim against the Company
would be expected to involve significant expense to the Company and to divert
the attention of the Company's technical and management personnel and could have
a material adverse effect on the Company's business and results of operations.
The Spectra-Physics litigation. On March 20, 1995, Spectra-Physics
initiated a lawsuit against the Company in the Santa Clara County, California
Superior Court, Case No. CV 748185, alleging that the Company was refusing to
comply with its obligations under an agreement entered into by the Company,
Spectra-Physics and Xerox as part of the formation of the Company in 1983 (the
Technology Agreement). Spectra-Physics claims that the Technology Agreement
requires the Company to transfer and license to Spectra 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. In its
original complaint, Spectra-Physics asserted causes of action against the
Company for declaratory relief, breach of contract, specific performance,
promissory estoppel and fraud.
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 were based 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. Opto Power's
claims against the Company were for breach of contract, specific performance and
declaratory relief. In addition to a declaratory judgment and specific
performance, Spectra-Physics and Opto Power sought unspecified damages and
punitive damages.
The Company answered the first amended complaint denying the plaintiffs'
claims and filed a cross-complaint against Spectra-Physics and Opto Power for
declaratory relief and breach of the Technology Agreement. Finally, the Company
and Xerox both filed cross-complaints seeking declaratory judgment regarding
interpretation of the Technology Agreement with respect to the treatment of
Xerox technical information, and Xerox has asserted a breach of contract claim
against the Company for the Company's alleged failure to transfer SDL-developed
technology to Xerox pursuant to the Technology Agreement. The Company has
answered denying Xerox's breach of contract claim.
The Company, Spectra-Physics and Xerox each moved for summary adjudication
on their declaratory relief claims regarding interpretation of the Technology
Agreement. On December 19, 1996, the Court orally denied the Company's motion
that, (i) as a result of breaches by Spectra-Physics, the Technology Agreement
was no longer in effect and (ii) in any event, the Technology Agreement, on its
face, provided Spectra only with a license to use SDL technology and no right to
compel a transfer of SDL technology to plaintiffs. At the same hearing, the
Court also orally denied Spectra's motion that, as a matter of law, the
Technology Agreement obligated the Company to transfer to Spectra-Physics and
Opto Power both SDL-developed technology and Xerox technology. The Court,
however, orally granted Xerox's motion that Spectra-Physics and Opto Power are
not entitled to receive any Xerox technology, including that Xerox technology
used by the Company in manufacturing its products. In rulings on motions heard
on February 7, 1997, the Court orally indicated that it will grant motions
dismissing the Company's claims for damages against Spectra-Physics and Opto
Power and the Company's affirmative defenses. The Court also orally indicated
that it would dismiss Spectra-Physics' claims against the Company for promissory
estoppel and fraud and its claims for punitive damages. No written orders
reflecting the December 19 or the February 7 rulings have yet been entered.
Spectra-Physics and Opto Power have indicated that they will make another motion
that, as a matter of law, the Technology Agreement requires the Company to
transfer SDL- developed technology to Spectra-Physics and Opto Power. That
motion is scheduled for hearing on March 24, 1997.
Discovery is close to completion. Trial of the matter is presently
scheduled for April 21, 1997. The Company believes that it has meritorious
defenses to Spectra-Physics's and Opto Power's claims. There can be no
assurance, however, that the Company will achieve a successful result in this
litigation. The litigation has involved and is expected to continue to involve
significant expense to the Company and to divert the attention of the Company's
technical and management personnel, and the outcome could have a material
adverse effect on the Company's business and results of operations. If the
Company does not prevail in such litigation, the Company could face monetary
damages and could be required to
18
<PAGE> 19
license and to transfer 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 would have a material adverse
effect on the Company's business and results of operations.
See "Factors Affecting Earnings and Stock Price--Technology Agreement."
In addition, the Company is involved in various legal proceedings arising
in the ordinary course of its business.
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICE OF COMMON STOCK
The Company's common stock is traded on the Nasdaq National Market System
under the symbol SDLI. The high and low sales prices are as reported by the
Nasdaq National Market System.
PRICE RANGE OF COMMON STOCK
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Q1 1996 $22.67 $15.00
Q2 1996 $32.00 $19.50
Q3 1996 $29.00 $17.63
Q4 1996 $26.50 $16.25
Q1 1995 (from March
16, 1995) $19.50 $16.33
Q2 1995 $20.00 $16.00
Q3 1995 $23.00 $17.67
Q4 1995 $18.17 $13.50
</TABLE>
The Company has not paid cash dividends on its Common Stock and does not
plan to pay cash dividends to its stockholders in the near future. The Company
presently intends to retain its earnings to finance further growth of its
business.
As of December 31, 1996, the Company had approximately 3,400 stockholders
of record.
19
<PAGE> 20
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company is qualified by
reference to and should be read in conjunction with the consolidated financial
statements of the Company, including the notes thereto, and Management's
Discussion and Analysis of Financial Condition and Results of Operations.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
1996 1995 (2) 1994 1993 1992 (3)
---- -------- ---- ---- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenue......................... $ 82,475 $ 53,894 $ 33,024 $ 27,702 $ 27,982
Cost of revenue................. 54,956 33,390 19,991 16,879 18,540
-------- -------- -------- -------- --------
Gross margin.................... 27,519 20,504 13,033 10,823 9,442
Research and development........ 6,681 3,994 2,781 3,047 2,130
Selling, general, and
administrative............... 12,166 7,649 4,574 3,583 4,734
In-process research and
development.................. -- 10,010 -- -- --
-------- -------- -------- -------- --------
Operating income (loss)......... 8,672 (1,149) 5,678 4,193 2,578
-------- -------- -------- -------- --------
Net income (loss)............... $ 7,121 $ (2,819) $ 2,195 $ 1,150 $ 489
======== ======== ======== ======== ========
Net income (loss) per share..... $ 0.54 $ (0.31) $ 0.29 $ 0.15 $ 0.08
Shares used in per share
calculation (1).............. 13,199 9,228 7,548 7,509 5,992
Cash dividend on common stock... -- -- -- -- --
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------------
1996 1995 (2) 1994 1993 1992 (3)
---- -------- ---- ---- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Working capital................ $ 63,243 $ 22,649 $ 5,556 $ 6,425 $ 6,540
Total assets................... $113,842 $ 56,643 $ 23,799 $ 19,612 $ 19,216
Long-term debt (less current
portion)..................... $ -- $ -- $ 22,519 $ 24,821 $ 26,266
Convertible redeemable
preferred stock.............. $ -- $ -- $ 10,545 $ 10,470 $ 10,071
Stockholders' equity (net
capital deficiency).......... $ 99,227 $ 40,500 $(18,269) $(20,464) $(21,608)
</TABLE>
- ----------------------
(1) See Note 1 of Notes to Financial Statements for a description of the method
used to determine the number of shares used in computing net income (loss)
per share.
(2) The results of operations for the year ended December 31, 1995 include a
one-time write-off of in-process research and development of approximately
$10 million in connection with the acquisition of Seastar Optics.
(3) The Statement of Operations data for the year ended December 31, 1992 has
been derived from the unaudited financial statements of the Company and
include all adjustments, consisting only of normal recurring adjustments,
which the Company considers necessary for a fair presentation of the data.
20
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
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 Optic's 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 "Factors Affecting Earnings and Stock Price."
The following table sets forth certain operating results expressed as a
percentage of total revenue for the periods indicated.
21
<PAGE> 22
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996 1995 1994
- ----------------------- ---- ---- ----
<S> <C> <C> <C>
Revenue:
Product revenue............................. 84.6% 84.0% 83.6%
Research revenue............................ 15.4 16.0 16.4
----- ----- -----
Total revenue............................ 100.0% 100.0% 100.0%
Cost of revenue:
Cost of product revenue (1)................. 65.0 59.3 57.2
Cost of research revenue (1)................ 75.5 75.7 77.4
---- ---- ----
Total cost of revenue.................... 66.6 62.0 60.5
---- ---- -----
Gross margin............................. 33.4 38.0 39.5
Operating Expenses:
Research and development.................... 8.1 7.4 8.4
Selling, general, and administrative........ 14.8 14.2 13.9
In-process research and development......... - 18.5 -
---- ---- -----
Total operating expenses................. 22.9 40.1 22.3
---- ---- -----
Operating income (loss).................. 10.5 (2.1) 17.2
Interest (income) expense, net................ (1.8) (0.2) 6.3
---- ---- -----
Income (loss) before income taxes............. 12.3 (1.9) 10.9
Provision for income taxes.................... 3.7 3.3 4.3
---- ---- -----
Net income (loss)............................. 8.6% (5.2)% 6.6%
==== ==== =====
</TABLE>
- ----------------------
(1) Cost of product revenue and cost of research revenue are stated as a
percentage of product revenue and research revenue, respectively.
RESULTS OF OPERATIONS
Revenue. The Company's total revenue increased 53 percent during 1996 to
$82.5 million and 63 percent during 1995 to $53.9 million. This increase in
revenue over the two year period has been driven by continuing demand for SDL's
semiconductor laser and optoelectronic solutions in fiber-based
telecommuncation, satellite communication, printing, medical and industrial
markets, growth in research program revenue and, during 1996, communication
product sales from SDL Optics. Information based products represented
approximately 70 percent, 70 percent and 60 percent of the Company's total
revenue for 1996, 1995 and 1994, respectively. The balance represented products
for the light replacement markets. New product introductions, improvements
within existing products and expansions of the markets in which SDL participates
were the primary reasons for the growth in product revenue. Product revenue has
continued to grow at a faster rate than research revenue, 54 percent vs. 47
percent during 1996 and 64 percent vs. 59 percent during 1995. Product revenue
represented 85 percent of total revenue in 1996 compared to 84 percent in 1995
and 1994. There can be no assurances that the application markets for SDL's
products will grow in future periods at historical percentages, further, there
can be no assurances that the Company will be able to increase or maintain its
market share in the future or to sustain historical growth rates.
International revenue represents 15 percent, 23 percent and 25 percent of
total revenue for 1996, 1995 and 1994, respectively. SDL's acquisition of the
SDL Optics business, a former international customer of SDL, and the large
percentage of SDL Optics revenue occurring within the U.S. communications
market, primarily attributed to the decreased year-over-year percentages for
international revenue.
Approximately 21 percent and 19 percent of 1996 and 1995 revenue was
received from Lockheed-Martin through numerous government and commercial
programs. Several new programs initiated during 1996 contributed to the slight
percentage increase in 1996 revenue from this customer. Most of the revenue from
Lockheed-Martin during this two-year period was, and during 1997 is expected to
be, derived from Federally-funded programs, which are subject to renewal
22
<PAGE> 23
every one or two years and to termination for convenience by the government
agency. It is expected that revenue received under these current Lockheed-Martin
programs will decrease as a percentage of the Company's total 1997 revenue. The
loss of the Company's contracts with Lockheed-Martin could have an adverse
effect on the Company's results of operations.
During the fourth quarter of 1996, the Company exceeded the maximum number
of employees allowed under eligibility requirements for the government's Small
Business Innovative Research (SBIR) programs and will no longer be able to
compete for research contract awards within this government program. Previously
awarded SBIR contracts can continue through contract completion, which can be up
to two years from the initial contract award date. SBIR contracts accounted for
approximately 6 percent and 5 percent of total revenue in 1996 and 1995,
respectively.
The Company derived 43 percent, 45 percent and 36 percent of its 1996, 1995
and 1994 revenue, directly or indirectly from a variety of Federal government
sources. 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, 1995 and 1994 was
funded by Federal programs. There can be no assurances that such programs will
continue to be funded even if government agencies have available financial
resources or that the Company will continue to be awarded contracts under such
programs.
Gross margin. Gross margin as a percentage of total revenue was 33 percent
in 1996, as compared to 38 percent and 40 percent for 1995 and 1994,
respectively. The significant decline in gross margin during 1996, compared to
1995 and 1994, resulted primarily from volume discounts on certain products and
production yield issues on several of the Company's product lines during the
third quarter of 1996. The gross margin for product revenue decreased during the
September 1996 quarter, in part due to: (i) fixed manufacturing costs allocated
over a smaller manufactured product base, (ii) significantly higher variable
manufacturing costs for product lines with low production yields and (iii)
higher levels of manufacturing engineering costs incurred as engineering
resources were required to research and address SDL's production yield problems.
While improved production yields were realized during the Company's December
1996 quarter, the Company's quarterly gross margin was impacted, to a lesser
extent, with higher incremental manufacturing engineering costs, as compared to
prior 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 is
expected to become available during the first quarter of 1997 pending the
results of product qualification tests. See "Factors Affecting Earnings and
Stock Price - Manufacturing Risks".
Gross margin as a percentage of total revenue was 38 percent in 1995
compared to 40 percent in 1994. Lower product gross margins offset the slight
increase in research gross margins in 1995 compared to the prior year period.
1995 gross margins declined primarily due to a higher percentage of cost
reimbursable revenue, which includes a product customization program for
Lockheed-Martin.
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 has tended 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 achieve or maintain gross
margins at historical levels in future periods.
Research and development. The Company's future results depend, to a
considerable extent, on its ability to maintain a competitive advantage in the
products it provides. For this reason SDL believes it is critical to continue to
make investments in research and development to ensure the flow of innovative,
productive, high-quality products. Research and development expense grew 67
percent during 1996 and 44 percent during 1995 to $6.7 million and $4.0 million,
respectively. Research and development as a percentage of total revenue was 8
percent, 7 percent and 8 percent for 1996, 1995 and 1994, respectively. During
1996, the Company increased research and development investments within the
areas of new product and systems development, product cost reduction and, yield,
reliability and manufacturing process improvement programs. It is expected that
the Company will continue to invest increasing amounts in research and
23
<PAGE> 24
development during 1997 as a number of new products are scheduled for
introduction during the first half of the year, together with specific programs
designed to improve product and process yield issues within manufacturing. The
level of total 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 to $12.2 million in 1996, from $7.6 million in 1995 and
$4.6 million in 1994. These year-over-year increases were primarily a result of
the continuing expansion of the Company's business, headcount increases and
ongoing litigation costs incurred during 1996 and 1995 and amortization expense
resulting from the acquisition of SDL Optics beginning in December 1995. SG&A
has remained constant at approximately 14 percent of total revenue for all three
years reported, despite increasing levels of litigation expense incurred during
1996 and 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 as a percentage of total revenue
are indicative of future SG&A as a percentage of total revenue. It is expected
that litigation expense will remain at approximately the level recorded during
the three months ended December 1996 for the first half of 1997.
In-process research and development. The acquisition of Seastar resulted in
a one-time write-off of purchased in- process research and development during
the fourth quarter of 1995.
Interest (income) expense, net. The Company recorded net interest income
during 1996 and 1995 compared to net interest expense during 1994 due primarily
to the repayment of the outstanding subordinated and bank debt balances,
effective with the Company's March 1995 initial public stock offering. Net
interest income for 1996 increased over that of 1995 due to the investment of
cash received from the Company's June 1996 follow-on public stock offering in
interest income generating investments.
Provision for income taxes. Excluding the impact of the one-time in-process
research and development write-off in 1995, the effective tax rates for 1996,
1995 and 1994 were 30 percent, 37 percent and 39 percent, respectively. The tax
rate for 1996 is less than 1995 due to incremental benefits of state tax credits
and tax-exempt interest income, as well as a reduction in the valuation
allowance. Excluding the impact of the one-time write-off, the Company's
effective tax rate for 1995 was lower than 1994 due to increased benefits of
state tax credits and tax-exempt interest income, offset by reduced benefits
from the Company's foreign sales corporation.
A valuation allowance has been established to offset a portion of the
deferred tax asset attributable to the 1995 in- process R&D charge. Due to the
period over which this tax benefit will be recognized, sufficient uncertainty
exists regarding the realizability of a portion of these assets, and
accordingly, a valuation allowance is required.
The realization of the Company's net deferred tax assets, which relate
primarily to temporary differences, is dependent on generating sufficient
taxable income during the periods in which the temporary differences are
expected to reverse. Although realization is not assured, management believes it
is more likely than not that the net deferred tax assets will be realized. The
amount of the net deferred tax assets considered realizable, however, could be
reduced in the near term if estimates of future taxable income during the
reversal period are reduced. Management intends to evaluate the realizability of
the net deferred tax asset each quarter to assess the need for a valuation
allowance.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial data
for the four quarters of each of 1995 and 1996. The Company believes that all
necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts below to present fairly the selected quarterly
information when read in conjunction with the Financial Statements and the Notes
thereto included elsewhere herein. The results of operations for any quarter are
not necessarily indicative of results that may be expected for any future period
or for the entire year.
24
<PAGE> 25
<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------------------------------------------------------------
1995 1996
------------------------------------------------ ---------------------------------------------
MAR.31 JUNE 30 SEPT. 30 DEC. 31(2) MAR. 31 JUNE 30 SEPT. 30 DEC. 31
------ ------- -------- ---------- ------- ------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue................. $ 10,512 $ 12,514 $ 14,084 $ 16,784 $ 20,422 $ 21,606 $ 19,369 $ 21,078
Cost of revenue......... 6,507 7,627 8,621 10,635 12,747 13,758 14,499 13,952
-------- -------- -------- -------- -------- -------- -------- --------
Gross margin............ $ 4,005 $ 4,887 $ 5,463 $ 6,149$ 7,675 $ 7,848 $ 4,870 $ 7,126
Operating income
(loss)................ $ 1,860 $ 2,063 $ 2,336 $ (7,408) $ 3,177 $ 3,506 $ 381 $ 1,608
Net income (loss)....... $ 905 $ 1,370 $ 1,610 $ (6,704) $ 2,159 $ 2,429 $ 943 $ 1,590
======== ======== ======== ======== ======== ======== ======== ========
Net income (loss) per
share................... $ 0.11 $ 0.12 $ 0.14 $ (0.63)$ 0.18 $ 0.20 $ 0.07 $ 0.11
======== ======== ======== ======== ======== ======== ======== ========
Shares used in
per share
calculation(1)....... 8,062 11,205 11,711 10,560 12,073 12,383 14,142 14,196
</TABLE>
- ----------------------
(1) See Note 1 of Notes to Financial Statements for a description of the method
used to determine the number of shares used in computing net income (loss)
per share.
(2) The results of operations for the quarter ended December 31, 1995 include a
one-time write-off of in-process research and development of approximately
$10 million in connection with the acquisition of Seastar Optics.
LIQUIDITY AND CAPITAL RESOURCES
Cash from operating activities was $12.1 million for the year ended
December 31, 1996. Cash provided by operating activities was primarily
attributable to higher levels of net income, depreciation, amortization, stock
option tax benefits, and accounts receivable collections, offset primarily by
increases in inventories. The Company spent $9.9 million for facilities
expansion and capital equipment purchases during 1996 and made a $1.6 million
payment on the acquisition obligation related to SDL Optics. In addition, SDL
received $46.2 million through the issuance of common stock, which primarily
resulted in the increase of cash, cash equivalents and investments to $58.3
million at December 31, 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
$44.7 million. 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 future cash requirements to complete its acquisition of the
SDL Optics business of (i) $1.5 million payable on March 31, 1997, 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 $15 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 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.
25
<PAGE> 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
1. Financial Statements.
Index to consolidated financial statements of SDL, Inc.:
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Operations - Years Ended December 31,
1996, 1995 and 1994
Consolidated Statements of Stockholders' Equity - Years Ended
December 31, 1996, 1995, and 1994
Consolidated Statements of Cash Flow - Years Ended December 31,
1996, 1995, and 1994
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Auditors.
2. Financial Statement Schedules.
Index to financial statement schedule:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements
or notes thereto.
26
<PAGE> 27
SDL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1996 1995
---- ----
(In thousands, except share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................... $ 2,605 $ 2,793
Short-term investments.............................. 45,353 8,515
Accounts receivable, net............................ 11,816 13,535
Inventories......................................... 13,441 9,006
Prepaid expenses and other current assets........... 3,902 1,491
--------- ---------
Total current assets..................................... 77,117 35,340
Property and equipment, net.............................. 22,020 16,470
Long-term investments.................................... 10,325 --
Other assets............................................. 4,380 4,833
--------- ---------
Total assets............................................. $ 113,842 $ 56,643
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 6,777 $ 6,257
Accrued payroll and related expenses................... 2,185 1,990
Unearned revenue....................................... 455 972
Acquisition obligations................................ 2,712 1,592
Other accrued liabilities.............................. 1,745 1,880
--------- ---------
Total current liabilities................................ $ 13,874 $ 12,691
Deferred acquisition obligations......................... -- 2,680
Other long-term liabilities.............................. 741 772
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares - 1,000,000; none issued and
outstanding....................................... -- --
Common stock, $0.001 par value:
Authorized shares - 21,000,000;
issued and outstanding shares - 13,306,110 and
10,628,115 at December 31, 1996 and 1995,
respectively .................................. 13 11
Additional paid-in capital............................... 114,421 62,995
Accumulated deficit, $26.3 million relating to the
repurchase of common stock in 1992 and $5.8 million
relating to a recapitalization in 1992................... (14,951) (22,028)
--------- ---------
99,483 40,978
Less common stockholders' notes receivable............... (256) (478)
--------- ---------
Total stockholders' equity............................... 99,227 40,500
--------- ---------
Total liabilities and stockholders' equity............... $ 113,842 $ 56,643
========= =========
</TABLE>
See accompanying notes.
27
<PAGE> 28
SDL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
---- ---- ----
(In thousands, except per share data)
<S> <C> <C> <C>
Revenues:
Product revenue ........................ $ 69,772 $ 45,277 $ 27,597
Research revenue ....................... 12,703 8,617 5,427
-------- -------- --------
Total revenue ............................ 82,475 53,894 33,024
Cost of revenue:
Cost of product revenue ................ 45,365 26,871 15,790
Cost of research revenue ............... 9,591 6,519 4,201
-------- -------- --------
Gross margin ............................. 27,519 20,504 13,033
Operating expenses:
Research and development ............... 6,681 3,994 2,781
Selling, general, and administrative ... 12,166 7,649 4,574
In-process research and development .... -- 10,010 --
-------- -------- --------
Operating income (loss) .................. 8,672 (1,149) 5,678
Interest (income) expense, net ........... (1,501) (118) 2,079
-------- -------- --------
Income (loss) before income taxes ........ 10,173 (1,031) 3,599
Provision for income taxes ............... 3,052 1,788 1,404
-------- -------- --------
Net income (loss) ........................ $ 7,121 $ (2,819) $ 2,195
======== ======== ========
Net income (loss) per share .............. $ 0.54 $ (0.31) $ 0.29
======== ======== ========
Shares used in computing net income (loss)
per share ............................... 13,199 9,228 7,548
======== ======== ========
</TABLE>
See accompanying notes.
28
<PAGE> 29
SDL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL STOCKHOLDER'S TOTAL
------------------- PAID-IN ACCUMULATED NOTES STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT RECEIVABLE EQUITY
------ ------ ----------- ----------- ------------- ------------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994 .......... 4,447,838 $ 4 $ 1,482 $ (21,404) $ (546) $(20,464)
Issuance of stock pursuant to
employee stock option plans ....... 32,610 -- 11 -- -- 11
Compensation on stock options ..... -- -- 1 -- -- 1
Repurchase of common stock ........ (2,601) -- (12) -- -- (12)
Net income ........................ -- -- -- 2,195 -- 2,195
---------- ------- ---------- --------- ------ --------
Balance at December 31, 1994 ........ 4,477,847 4 1,482 (19,209) (546) (18,269)
Issuance of stock pursuant to
employee stock plans .............. 566,793 1 795 -- (54) 742
Conversion of preferred stock to
common stock ...................... 1,385,302 2 10,894 -- (346) 10,550
Proceeds from issuance of common
stock (less offering expenses of
$1,441) 4,200,000 4 47,378 -- -- 47,382
Purchase of treasury stock ........ (1,827) -- (33) -- -- (33)
Payments on stockholders' notes
receivable ........................ -- -- -- -- 468 468
Income tax benefit from exercise of
employee stock options ............ -- -- 2,479 -- -- 2,479
Net loss .......................... -- -- -- (2,819) -- (2,819)
.. ---------- ------- --------- --------- ------ ---------
Balance at December 31, 1995 ........ 10,628,115 11 62,995 (22,028) (478) 40,500
Issuance of stock pursuant to
employee stock plans .............. 921,168 -- 1,509 -- -- 1,509
Proceeds from issuance of common
stock (less offering expenses of
$362) 1,755,000 2 44,650 -- -- 44,652
Issuance of treasury stock ........ 1,827 -- 33 -- -- 33
Payments on stockholders' notes
receivable ........................ -- -- -- -- 222 222
Income tax benefit from exercise of
employee stock options ............ -- -- 5,234 -- -- 5,234
Unrealized loss on investments .... -- -- -- (44) -- (44)
Net income ........................ -- -- -- 7,121 -- 7,121
---------- ------- ---------- --------- ------ --------
Balance at December 31, 1996 ........ 13,306,110 $ 13 $ 114,421 $ (14,951) $ (256) $ 99,227
========== ======= ========== ========= ====== ========
</TABLE>
See accompanying notes.
29
<PAGE> 30
SDL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) .......................................................... $ 7,121 $ (2,819) $ 2,195
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization ......................................... 4,948 2,840 2,365
In-process research and development ................................... -- 10,010 --
Deferred income taxes ................. ............................... (223) (1,373) (112)
Changes in operating assets and liabilities:
Accounts receivable ................................................. 1,719 (4,245) (2,194)
Inventories ......................................................... (4,435) (3,610) (199)
Accounts payable .................................................... 520 2,672 1,001
Accrued payroll and related expenses ................................ 195 620 729
Unearned revenue .................................................... (517) 529 138
Other accrued liabilities ........................................... (135) 999 420
Other ............................................................... 2,879 1,255 1,084
--------- --------- ---------
Total adjustments .......................................................... 4,951 9,697 3,232
--------- --------- ---------
Net cash provided by operating activities .................................. 12,072 6,878 5,427
Investing activities
Acquisition of property and equipment, net ................................. (9,909) (8,518) (3,617)
Purchase of investments .................................................... (100,620) (50,815) --
Sales and maturities of investments ........................................ 53,413 42,300 --
Acquisition of Seastar Optics .............................................. (1,560) (12,076) --
--------- --------- ---------
Net cash used in investing activities ...................................... (58,676) (29,109) (3,617)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt ................................... -- -- 2,784
Payments of long-term debt ................................................. -- (2,592) (4,402)
Payments of subordinated debt .............................................. -- (21,580) --
Proceeds from issuance of common stock ..................................... 44,652 47,382 --
Reissuance (repurchase) of treasury stock .................................. 33 (33) (12)
Issuance of stock pursuant to employee stock plans ......................... 1,509 745 50
Payments on stockholders' notes receivable ................................. 222 470 36
--------- --------- ---------
Net cash provided by (used in) financing activities ........................ 46,416 24,392 (1,544)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ....................... (188) 2,161 266
Cash and cash equivalents at beginning of period ........................... 2,793 632 366
--------- --------- ---------
Cash and cash equivalents at end of period ................................. $ 2,605 $ 2,793 $ 632
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for income taxes ............................................... $ 170 $ 1,362 $ 1,614
Cash received from income taxes refunded ................................. $ 773 $ -- $ 14
Cash paid for interest ................................................... $ -- $ 927 $ 709
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
Conversion of convertible redeemable preferred stock to common stock
$ -- $ 10,896 $ --
Stock issued for stockholders' notes receivable .......................... $ -- $ 59 $ 271
</TABLE>
See accompanying notes.
30
<PAGE> 31
SDL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
SDL, Inc. (the Company), a Delaware corporation, designs, manufactures, and
markets semiconductor optoelectronic integrated circuits (OEICs), semiconductor
lasers, fiber optic related products, and optoelectronic systems. The Company's
revenue is derived from: (i) the sale of standard and customized products to a
diverse worldwide customer base utilizing various market applications and, (ii)
customer-funded research programs, principally through various government
agencies. The Company was incorporated on March 28, 1983.
Basis of Presentation
The consolidated financial statements include the accounts of SDL, Inc. and its
wholly-owned subsidiary, SDL Optics, Inc. 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 other (income) expense and were immaterial for
all periods presented. The Company's fiscal year ends on December 31. The
Company utilizes a four-four-five quarterly cycle; as a result, a fiscal quarter
may not end on the same day as the calendar quarter.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
three months or less when purchased to be cash equivalents.
Investments
Effective January 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and
Equity Securities." In accordance with the Statement, the Company has classified
its entire investment portfolio as available-for-sale. Available-for-sale
securities are stated at fair market value. The amortized cost of debt
securities is adjusted for amortization of premiums and accretion of discounts
to maturity. Such amortization is included in interest income. Realized gains
and losses are included in other (income) expense. The cost of securities sold
is based on the specific identification method.
Inventories
Inventories are stated at the lower of cost (first-in, first-out basis) or
market. The market value is based upon estimated net realizable value.
Equipment and Leasehold Improvements
Property and equipment are stated at cost. Equipment and fixtures are
depreciated using the straight-line method over estimated useful lives ranging
from two to eight years. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful lives or the
remaining lease terms.
Effective January 1, 1996, the Company adopted Statement of Financial Accounting
Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." SFAS 121 requires
recognition of impairment of long-lived assets in the event the net book value
of such assets exceeds the future undiscounted cash flows attributable to such
assets. The adoption of SFAS 121 did not have a material impact on the Company.
31
<PAGE> 32
Goodwill and Purchased Intangibles
Goodwill and other purchased intangibles are being amortized using the
straight-line method over three to seven years.
Revenue Recognition
Revenue recognition is based on the terms of the underlying sales agreements
(purchase orders or contracts). Revenue for product sales is recognized upon
shipment. Revenue for costs incurred plus specified fee contracts is recognized
on the percentage-of-completion method. Revenue for fixed price milestone
contracts is recognized upon the completion of the milestone. Customers entering
into long-term contracts with the Company include the U.S. government, prime or
subcontractors for which the U.S. government may be the end customer, and other
domestic and international end-users.
Concentrations
Customer - The Company received approximately 21 and 19 percent of its
1996 and 1995 revenue from Lockheed-Martin through several government
and commercial programs. Almost all of the Company's revenue from this
customer during 1996 and 1995 was derived from Federally-funded
programs. Most of the Company's Federally-funded programs are subject
to renewal every one or two years and to termination for convenience by
the government agency. The loss of the Company's contracts with
Lockheed-Martin, or other major customers, could have an adverse effect
on the Company's results of operations. No customers accounted for more
than 10 percent of net revenue for 1994. Individual customers include
commercial companies and government agencies.
Dependence Upon Government Programs and Contracts - In 1996, 1995, and
1994, the Company derived approximately 43 percent, 45 percent, and 36
percent, respectively, of its revenue directly and indirectly from a
variety of Federal government sources. 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,
1995, and 1994 was funded by Federal programs. There can be no
assurance that such programs will continue to be funded even if
government agencies have available financial resources or that the
Company will continue to be awarded contracts under such programs.
Approximately 6 percent of the Company's 1996 revenue was received
through certain Federal government programs which required that
participants meet specific eligibility requirements. During the fourth
quarter of 1996, the Company exceeded the maximum number of employees
allowed under these eligibility requirements and the Company will no
longer be able to compete for future research contract awards under
these government programs. Loss of eligibility under these programs
does not disqualify the Company from contracts awarded prior to the
loss of eligibility. Loss of eligibility under these programs could
require increased internally funded research and development spending.
Dependence on Single Source and Other Third Party Suppliers - The
Company depends on a single or limited number of outside contractors
and suppliers for raw materials, packages and standard components, and
to assemble printed circuit boards. The Company generally purchases
these single or limited source products through standard purchase
orders or one-year supply agreements and has no long-term guaranteed
supply agreements with such suppliers. While the Company seeks to
maintain a sufficient safety stock of such products and also endeavors
to maintain ongoing communications with its suppliers to guard against
interruptions or cessation of supply, the Company's business and
results of operations have in the past been and could in the future be
adversely affected by a stoppage or delay of supply, substitution of
more expensive or less reliable products, receipt of defective parts or
contaminated materials, an increase in the price of such supplies, or
the Company's inability to obtain reduced pricing from its suppliers in
response to competitive pressures.
Credit Risk - The Company performs ongoing credit evaluations of its
customers' financial condition and generally requires no collateral
from its customers. The Company maintains reserves for potential credit
losses. Although such losses have been within management's expectations
to date, there can be no assurance that such reserves will continue to
be adequate.
32
<PAGE> 33
Principal Business and Export Sales
The Company's operations are conducted in one principal line of business, the
design, manufacture, and sale of semiconductor optoelectronic integrated
circuits, semiconductor lasers, fiber optic products, and optoelectronic
systems. The Company has operations in the United States and Canada.
All sales to international customers constitute export sales and are denominated
in U.S. dollars. Export sales to Europe totaled approximately $4.2 million, $4.3
million, and $4.2 million for 1996, 1995, and 1994, respectively. Export sales
to the Pacific Rim and Canada totaled approximately $8.0 million, $7.9 million,
and $4.2 million for 1996, 1995, and 1994, respectively. Revenues from
international operations are primarily derived from sales to customers in the
United States and comprised approximately 12 percent of consolidated revenues in
1996. Operating income, identifiable assets and transfers to and from
international operations were not significant in 1996.
Net Income (Loss) Per Share
Except as noted below, net income per share is computed using the weighted
average number of shares of common stock outstanding and dilutive common
equivalent shares from convertible redeemable preferred stock (using the
as-if-converted method) and from stock options (using the modified treasury
stock method). Pursuant to the Securities and Exchange Commission regulations,
options granted by the Company at prices below the actual offering price during
the twelve-month period prior to the initial public offering have been included
in the calculation of common and common equivalent shares as if they were
outstanding for all periods presented (using the treasury stock method and the
initial public offering price).
Net loss per share for 1995 is computed using the weighted average number of
shares of common stock outstanding.
In May 1996, the Board of Directors authorized a three-for-two split of its
common stock, effected in the form of a 50 percent stock dividend, which was
paid on June 12, 1996 to stockholders of record on May 5, 1996. All share and
per share data in these financial statements have been retroactively adjusted to
reflect the stock split.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year presentation.
2. INVESTMENTS
Available-for-sale investments consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Tax-exempt auction rate preferred stock $29,725 $7,000
Municipal bonds 25,953 1,515
------- ------
$55,678 $8,515
======= ======
</TABLE>
Tax-exempt auction rate preferred stock contains contractual maturities of less
than one year. Municipal bonds have maturities ranging from six months to two
years of which approximately $10.3 million is included in long-term investments
in the accompanying balance sheet at December 31, 1996.
Both realized and unrealized gains and losses on the sale of available-for-sale
securities were immaterial for the years ended December 31, 1996 and 1995.
33
<PAGE> 34
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Trade receivables $ 10,559 $ 9,872
Receivables under long-term contracts:
Billed 1,449 2,632
Unbilled costs and estimated earnings, current portion 588 1,516
-------- --------
12,596 14,020
Allowance for doubtful accounts (780) (485)
-------- --------
$ 11,816 $ 13,535
======== ========
</TABLE>
The majority of unbilled costs and estimated earnings on uncompleted long-term
contracts are billable in the subsequent year.
The following is a summary of research and product contract activity related to
uncompleted long-term contracts from the inception of the contracts:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Costs incurred on uncompleted long-term
contracts $40,007 $15,655
Estimated earnings 2,803 740
------- -------
Revenue recognized on uncompleted long-term
contracts 42,810 16,395
Less billings to date 41,906 14,879
------- -------
Total unbilled costs and estimated earnings $ 904 $ 1,516
======= =======
</TABLE>
Approximately $25.2 million, $19.7 million, and $7.7 million of revenue
recognized on long-term contracts is included in total revenues for 1996, 1995,
and 1994, respectively.
Pursuant to the retainage provisions in certain long-term contracts, a specified
portion of billed receivables do not become due and payable until completion of
a final audit by the Defense Contract Audit Agency. Such retainage amounts are
included in other assets in the accompanying balance sheets.
4. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Raw materials $ 6,653 $ 4,151
Work-in-process 6,788 4,855
------- -------
$13,441 $ 9,006
======= =======
</TABLE>
34
<PAGE> 35
No significant amounts of finished goods or work-in-process related to long-term
contracts are maintained.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Machinery and equipment $27,019 $20,807
Leasehold improvements 5,975 5,209
Furniture and fixtures 718 646
Construction-in-progress 5,304 3,310
------- -------
39,016 29,972
Less accumulated depreciation and amortization 16,996 13,502
------- -------
$22,020 $16,470
======= =======
</TABLE>
6. GOODWILL AND PURCHASED INTANGIBLES
Purchased intangibles consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Goodwill $ 910 $ 910
Other purchased intangibles 1,910 1,910
------ ------
2,820 2,820
Less accumulated amortization 699 54
------ ------
$2,121 $2,766
====== ======
</TABLE>
Amortization expense is included in selling, general, and administrative
expenses.
7. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Current:
Federal $ 2,617 $ 2,853 $ 1,185
State 312 308 331
Foreign 346 -- --
------- ------- -------
3,275 3,161 1,516
Deferred:
Federal (371) (1,180) (111)
State 148 (193) (1)
------- ------- -------
(223) (1,373) (112)
------- ------- -------
$ 3,052 $ 1,788 $ 1,404
======= ======= =======
</TABLE>
35
<PAGE> 36
The tax benefits resulting from the exercise of nonqualified stock options and
the disqualifying disposition of shares acquired under the Company's incentive
stock option and employee stock purchase plans were $5.3 million and $2.5
million in 1996 and 1995, respectively. Such benefits were credited to
additional paid-in capital.
The difference between the provision for income taxes and the amount computed by
applying the Federal statutory income tax rate (35 percent) to income before
taxes is explained below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Tax at Federal statutory rate $ 3,560 $ (361) $ 1,260
State income tax, net of Federal
tax benefit 299 (192) 215
Change in valuation allowance (262) 2,402 --
Tax-exempt interest income (455) (148) --
Benefit of foreign sales corporation (62) (8) (63)
Other (28) 95 (8)
------- ------- -------
Provision for income taxes $ 3,052 $ 1,788 $ 1,404
======= ======= =======
</TABLE>
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------
1996 1995
------- -------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Reserves and other accrued expenses
not yet deductible for tax $ 1,066 $ 1,095
Inventory valuation accounts 1,080 692
Intangible assets 3,627 3,984
Tax credit carryforward 346 --
Other 44 171
------- -------
Total deferred tax assets 6,163 5,942
Valuation allowance (2,062) (2,402)
------- -------
Net deferred tax assets 4,101 3,540
Deferred tax liabilities:
Depreciation (685) (616)
Other (364) (95)
------- -------
Total deferred tax liabilities (1,049) (711)
------- -------
Net deferred tax assets $ 3,052 $ 2,829
======= =======
</TABLE>
The valuation allowance decreased by approximately $0.3 million in 1996 and
increased by $2.4 million in 1995. The valuation allowance relates to a portion
of the deferred tax asset attributable to the write-off of purchased research
and development. Due to the extended period over which this tax benefit may be
recognized, sufficient uncertainty exists regarding the realizability of a
portion of these assets, and accordingly, a valuation allowance is required.
As of December 31, 1996, the Company had a federal tax credit carryforward of
approximately $0.4 million. The tax credit carryforward will expire in 2001, if
not utilized.
The realization of the Company's net deferred tax assets, which relate primarily
to temporary differences, is dependent on generating sufficient taxable income
during the periods in which the temporary differences are expected to reverse.
36
<PAGE> 37
Although realization is not assured, management believes it is more likely than
not that the net deferred tax assets will be realized. The amount of the net
deferred tax assets considered realizable, however, could be reduced in the near
term if estimates of future taxable income during the reversal period are
reduced. Management intends to evaluate the realizability of the net deferred
tax asset each quarter to assess the need for a valuation allowance.
8. STOCKHOLDERS' EQUITY
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 percent 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.
Common Stock Offerings
On March 15, 1995, the Company issued 3,600,000 shares of common stock in
conjunction with its initial public offering at a per share price of $10.67. Net
proceeds to the Company amounted to approximately $34.8 million. Of the net
proceeds, approximately $21.6 million and $2.4 million were used to repay the
entire principal amount outstanding under the Company's subordinated notes due
in 1997, and the Company's bank line of credit and term loan, respectively.
Concurrent with the offering, a 3.4-for-1 split of the Company's common stock
was authorized and all of the convertible redeemable preferred stock was
converted into 1,385,302 shares of common stock.
On August 1, 1995, the Company issued 600,000 shares of common stock in a
follow-on public stock offering at a per share price of $23.00, resulting in net
proceeds to the Company of approximately $12.6 million.
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 $44.7 million.
Stockholders' Notes Receivable Certain exercises of stock options occurred in
conjunction with the issuance of full-recourse stockholders' notes receivable.
The notes bear interest between 5 percent and 8 percent per annum with annual
interest payments. The principal on the notes is due five years after issuance
between 1997 and 2001.
9. STOCK-BASED COMPENSATION PLANS
Stock Option Plans
The 1992 Stock Option Plan provides for the granting of incentive stock options
and nonqualified options to purchase up to 4,558,125 shares of the Company's
common stock to officers, directors and key employees at exercise prices of not
less than fair value on the date of grant as determined by a committee of the
Board of Directors. Options granted are immediately exercisable; however,
unexercised options and shares purchased upon the exercise of the options are
subject to vesting over a one- to five-year period. Shares that are not vested
at the date of termination of employment may be repurchased by the Company at
the original exercise price. No further options will be granted under the 1992
Stock Option Plan.
The Company's 1995 Stock Option Plan was approved by the Board of Directors in
January 1995 and by the stockholders in February 1995. The purposes of the 1995
Option Plan are to give the Company's employees and others who perform
substantial services to the Company incentive, through ownership of the
Company's common stock, to continue in service to the Company, and to help the
Company compete effectively with other enterprises for the services of qualified
individuals. The 1995 Stock Option Plan permits the grant of incentive stock
options to employees, including officers and directors who are employees, and
the award of nonqualified stock options to the Company's employees, officers,
Directors, independent contractors, and consultants. The number of shares
available for grant was initially 712,500 shares. Beginning on the first day of
each fiscal year, the number of shares reserved for grant will be increased by 5
percent of the number of shares of common stock outstanding as of the end of the
preceding fiscal year. Options granted under the 1995 Stock
37
<PAGE> 38
Option Plan are subject to vesting over a one- to five-year period and must
generally be exercised by the optionee during the period of employment or
service with the Company or within a specified period following termination of
employment or service. Options currently expire no later than ten years from the
date of grant.
The Company has reserved 2,686,499 shares of common stock for future issuance
under its Stock Option Plans as of December 31, 1996.
Information with respect to stock option activity is summarized as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
---------------------------------
AVAILABLE FOR NUMBER OF
GRANT SHARES PRICE PER SHARE
------------- ---------- ----------------
<S> <C> <C> <C>
Balance at December 31, 1993 368,516 2,877,815 $ 0.34 - $ 4.90
Options granted (159,722) 159,722 $ 3.53 - $ 5.10
Options canceled 54,413 (54,413) $ 0.34 - $ 3.53
Options exercised -- (191,046) $ 0.34 - $ 1.96
-------- ----------
Balance at December 31, 1994 263,207 2,792,078 $ 0.34 - $ 4.90
Shares authorized 712,500 --
Options granted (663,339) 663,339 $ 6.08 - $23.00
Options canceled 73,539 (73,539) $ 0.34 - $19.50
Options exercised -- (521,015) $ 0.34 - $ 5.10
Option authorization canceled (255,557) --
-------- ----------
WEIGHTED-
AVERAGE
EXERCISE PRICE
----------------
Balance at December 31, 1995 130,350 2,860,863 $ 3.59
Options granted (373,642) 373,642 $ 20.53
Options canceled 182,274 (182,274) $ 15.32
Options exercised -- (821,569) $ 0.70
Additional options authorized 531,375 --
Option authorizations canceled (14,520) --
-------- ---------- ----------------
Balance at December 31, 1996 455,837 2,230,662 $ 6.48
======== ==========
</TABLE>
The following table summarizes information about options outstanding at December
31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS Exercisable
- ------------------------------------------------------------- -------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
- ----------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C>
$0.34 to 5.10 1,388,641 5.69 years $ 0.80 1,270,667 $ 0.62
6.08 to 10.67 336,246 8.18 9.77 96,479 9.32
15.00 to 17.17 215,633 8.90 16.09 39,793 15.79
18.83 to 23.00 194,467 9.15 20.55 20,552 20.92
24.50 to 30.00 95,675 9.51 27.06 -- --
--------- ---------
$0.34 to 30.00 2,230,662 6.84 $ 6.48 1,427,491 $ 1.92
========= =========
</TABLE>
38
<PAGE> 39
Employee Stock Purchase Plan
To provide employees with an opportunity to purchase common stock of the Company
through payroll deductions, the Company established the 1995 Employee Stock
Purchase Plan (the ESPP) and initially reserved 450,000 shares of common stock
for issuance to participants. Under the ESPP, the Company's employees, subject
to certain restrictions, may purchase shares of common stock at the lesser of 85
percent of the fair market value at either the beginning of each two-year
offering period or the end of each six-month purchase period within the two-year
offering period. Under the ESPP, the Company sold 110,658 and 48,584 shares in
1996 and 1995, respectively.
Stock-Based Compensation
The Company has elected to following Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and related interpretations
in accounting for its employee stock-based awards because, as discussed below,
the alternative fair value accounting provided for under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123), requires use of option valuation models that were not developed for use in
valuing stock-based awards to employees. Under APB 25, the Company generally
recognizes no compensation expense with respect to such awards.
Pro forma information regarding net income and earnings per share is required by
SFAS 123 as if the Company has accounted for its stock-based awards to employees
granted subsequent to December 31, 1994 under the fair value method. The fair
value for these awards was estimated at the date of grant using a Black-Scholes
option pricing model. The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock
price volatility. Since the Company's stock-based awards have characteristics
significantly different from those of traded options, and since changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock-based awards. The fair value of
the Company's stock-based awards to employees was estimated assuming no expected
dividends and the following weighted-average assumptions:
<TABLE>
<CAPTION>
OPTIONS ESPP
---------------------- --------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Expected Life 3 years 3 years 6 months 6 months
Expected Volatility 0.60 0.60 0.72 0.46
Risk Free Interest Rate 6.04% 6.26% 5.45% 5.95%
</TABLE>
For the purpose of pro forma disclosures, the estimated fair value of the above
stock-based awards is amortized to expense to expense over the awards' vesting
period. The Company's pro forma information follows (in thousands, except for
per share information):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Pro forma net income (loss) $ 5,947 $ (3,241)
Pro forma net income (loss) per share $ 0.45 $ (0.35)
</TABLE>
Because SFAS 123 is applicable only to options granted subsequent to December
31, 1994, its pro forma effect will not be fully reflected until approximately
1999.
Weighted-average fair value of options granted during 1996 was $9.65. The
weighted-average fair value of ESPP rights granted in 1996 was $3.97.
10. ACQUISITION OF SEASTAR OPTICS, INC.
On November 30, 1995, the Company acquired certain assets and assumed certain
liabilities of Seastar Optics, Inc. (Seastar), a British Columbia corporation
and a wholly-owned subsidiary of The Axys Group Ltd. The assets acquired
39
<PAGE> 40
consisted of accounts receivable, inventory, equipment, research and development
in process, patents and other intellectual property rights, and all other
tangible and intangible assets used by Seastar in the operation of its business.
The transaction has been accounted for under the purchase method of accounting.
The purchase price consisted of (i) cash in the amount of $12.1 million paid at
closing, (ii) a letter of credit in the face amount of $1.5 million placed into
escrow at the closing, (iii) $1.1 million, as adjusted, payable upon completion
of an audit of the assets transferred, (iv) $1.2 million payable in cash or
stock of the Company (at the Company's option) on March 31, 1997, and (v) the
value of assumed liabilities. Acquisition and other costs totaled $0.5 million.
11. COMMITMENTS
The Company leases all of its facilities and certain equipment under operating
leases. The operating facilities leases contain renewal options. The future
minimum rental payments as of December 31, 1996, under operating leases are as
follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
1997 $1,744
1998 2,040
1999 1,896
2000 1,902
2001 1,879
Thereafter 307
------
Total $9,768
======
</TABLE>
Rental expense was approximately $1.4 million, $1.0 million, and $0.7 million
for 1996, 1995, and 1994, respectively.
12. CONTINGENCIES
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 sought to permanently enjoin
the Company from infringing Rockwell's alleged patent rights and sought
unspecified actual and treble damages plus costs. The Company answered
Rockwell's complaint asserting, among other defenses, that Rockwell's patent is
invalid. In addition, the Federal government, which is a defendant in a suit
brought by Rockwell relating to certain of the same alleged patent rights,
asserted that the Company may be liable to indemnify the Federal government for
certain of Rockwell's claims. The Company intervened in Rockwell's suit against
the Federal government. Rockwell's suit against the Company was stayed in 1995
pending resolution of Rockwell's suit against the Federal government. On
February 5, 1997, the court in the Federal government suit declared the Rockwell
patent invalid and entered judgment in favor of the Company and the Federal
government. Although this judgment is subject to appeal by Rockwell, the Company
believes the judgment in favor of the Company will also result in a favorable
disposition of Rockwell's suit against the Company.
In 1995, Spectra-Physics, Inc. (Spectra) and others filed suit against the
Company alleging that the Company was refusing to comply with alleged
obligations to transfer and license Company technology to them. These parties
sought declaratory relief, specific performance and unspecified actual and
punitive damages. The Company answered these claims denying them and
cross-complained against Spectra and certain others seeking declaratory relief,
damages and injunctive relief. On December 19, 1996 and February 7, 1997, the
court orally indicated that it intends to dismiss Spectra's claim for punitive
damages and the Company's claims for damages and injunctive relief and has set
the matter for trial in April 1997.
The Company is vigorously contesting the Spectra claim. Although the outcome of
the Spectra matter cannot be determined at this time, management does not
believe that its outcome will have a material adverse effect on the Company's
financial position, results of operations and cash flows and has made no
provisions for the ultimate outcome of these matters in its financial
statements. However, based on future developments such as additional rulings
from the court and the progress of preparation for the scheduled trial, the
Company's estimate of the outcome of these matters could change in the near
term.
40
<PAGE> 41
13. EMPLOYEE BENEFIT PLAN
In 1990, the Company established the SDL, Inc. Profit Sharing and Saving Plus
Plan (the Plan) that covers substantially all U.S. full-time employees and is
qualified under Sections 401(a) and 401(k) of the Internal Revenue Code.
Participants may defer up to 10 percent of their pre-tax earnings (up to the
Internal Revenue Service limit) as well as up to 5 percent of their after-tax
earnings. The Company matches 50 percent of employee contributions up to a
maximum of 5 percent of the participant's pre-tax earnings. The participants' as
well as the Company's matching contributions are fully vested. Company
contributions to the Plan were approximately $0.4 million, $0.3 million, and
$0.2 million for 1996, 1995, and 1994, respectively.
41
<PAGE> 42
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
SDL, Inc.
We have audited the accompanying consolidated balance sheets of SDL,
Inc., as of December 31, 1996 and 1995, and the related consolidated statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
SDL, Inc. at December 31, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
ERNST & YOUNG LLP
San Jose, California
January 29, 1997,
except for Note 12, as to which
the date is February 7, 1997
42
<PAGE> 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
Company's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements: Index is included in Part II, Item 8 of this
report on page 26.
2. Financial Statement Schedules: Index is included in Part II, Item 8 of
this report on page 26.
3. Exhibits.
3.1 Form of Registrant's Restated Certificate of Incorporation.(1)
3.2 Form of Registrant's Amended and Restated Bylaws.(1)
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Specimen Common Stock certificate.(1)
10.3* Form of Registrant's 1995 Stock Option Plan, including forms
of option agreements thereunder.(1)
10.4* Form of Registrant's 1995 Employee Stock Purchase Plan, as
amended.
43
<PAGE> 44
10.5 Technology Agreement between Xerox Corporation,
Spectra-Physics, Inc. and the Registrant effective March 31,
1983 and Amendment No. 1 thereto, dated March 31, 1988.(1)
10.10 Lease Agreement between Rose Orchard I a Joint Venture and the
Registrant, dated May 16, 1986, as amended October 24,
1989.(1)
10.11 Lease Agreement between Rose Orchard I a Joint Venture and the
Registrant, dated April 28, 1989, as amended October 24,
1989.(1)
10.12* Employment Agreement between Donald R. Scifres and the
Registrant, dated July 17, 1992, and amendments thereto, dated
February 19, 1993 and July 29, 1994.(1)
10.13* Form of Employment Agreement between officers of the
Registrant and the Registrant.(1)
10.14 Lease Agreement between Triangle Development Company and
Registrant dated January 13, 1995, and Addendum thereto, dated
January 13, 1995.(1)
11.1 Computation of Net Income (Loss) Per Share
21.1 Subsidiaries
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial data schedule
(b) Reports on Form 8-K.
Not applicable.
- ----------
(1) Incorporated by reference to identically numbered Exhibit to the Company's
Registration Statement on Form S-1 (Commission File No. 33-87752), which
became effective on March 15, 1995.
* Management contracts or compensatory plans or arrangements.
44
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
February 21, 1997 By: /s/ Gregory C. Lindholm
-------------------
Gregory C. Lindholm
Vice President, Finance
Chief Financial Officer and Treasurer
(duly authorized officer and principal financial
and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Donald R. Scifres Chairman of the Board, President and Chief Executive February 21, 1997
-------------------------- Officer (Principal Executive Officer)
Donald R. Scifres
/s/ John P. Melton Vice President, Business Operations and Director February 21, 1997
--------------------------
John P. Melton
/s/ Gregory C. Lindholm Vice President, Finance February 21, 1997
-------------------------- Chief Financial Officer and Treasurer (Principal Financial
Gregory C. Lindholm and Accounting Officer)
/s/ Keith B. Geeslin Director February 21, 1997
--------------------------
Keith B. Geeslin
/s/ Anthony B. Holbrook Director February 21, 1997
--------------------------
Anthony B. Holbrook
/s/ Mark B. Myers Director February 21, 1997
--------------------------
Mark B. Myers
/s/ Frederic N. Schwettmann Director February 21, 1997
--------------------------
Frederic N. Schwettmann
</TABLE>
45
<PAGE> 46
SCHEDULE II
SDL, INC.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END OF
OF PERIOD ADDITIONS DEDUCTIONS OTHER PERIOD
--------- --------- ---------- ----- ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts receivable
Year ended December 31, 1994.................. $111 $ 97 $ -- $ -- $208
==== ==== ==== ==== ====
Year ended December 31, 1995.................. $208 $188 $(21)(1) $110(2) $485
==== ==== ==== ==== ====
Year ended December 31, 1996.................. $485 $355 $(60)(1) $ -- $780
==== ==== ==== ==== ====
</TABLE>
- ----------
(1) Uncollectible accounts written off.
(2) Represents Seastar's allowance for doubtful accounts as of the
acquisition date.
S-1
<PAGE> 47
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBER EXHIBIT TITLE NUMBERED PAGE
3.1 Form of Registrant's Restated Certificate
of Incorporation.(1) N/A
3.2 Form of Registrant's Amended and Restated
Bylaws.(1) N/A
4.1 Reference is made to Exhibits 3.1 and 3.2. N/A
4.2 Specimen Common Stock certificate.(1) N/A
10.3* Form of Registrant's 1995 Stock Option
Plan, including forms of option
agreements thereunder.(1) N/A
10.4* Form of Registrant's 1995 Employee Stock
Purchase Plan, as amended
10.5 Technology Agreement between Xerox
Corporation, Spectra-Physics, Inc. and
the Registrant effective March 31, 1983 and
Amendment No. 1 thereto, dated March 31,
1988.(1) N/A
10.10 Lease Agreement between Rose Orchard I a
Joint Venture and the Registrant, dated
May 16, 1986, as amended October 24,
1989.(1) N/A
10.11 Lease Agreement between Rose Orchard I a
Joint Venture and the Registrant, dated
April 28, 1989, as amended October 24,
1989.(1) N/A
10.12* Employment Agreement between Donald R.
Scifres and the Registrant, dated July
17, 1992, and amendments thereto, dated
February 19, 1993 and July 29, 1994.(1) N/A
10.13* Form of Employment Agreement between
officers of the Registrant and the
Registrant.(1) N/A
10.14 Lease Agreement between Triangle
Development Company and Registrant
dated January 13, 1995, and Addendum
thereto, dated January 13, 1995.(1) N/A
11.1 Computation of Net Income (Loss) Per Share
21.1 Subsidiaries
23.1 Consent of Ernst & Young LLP, Independent
Auditors
27.1 Financial data schedule
(1) Incorporated by reference to identically numbered Exhibit to the
Company's Registration Statement on Form S-1 (Commission File No.
33-87752), which became effective on March 15, 1995.
* Management contracts or compensatory plans or arrangements.
<PAGE> 1
Exhibit 10.4
SDL, INC.
1995 EMPLOYEE STOCK PURCHASE PLAN
(AMENDED AND RESTATED AS OF FEBRUARY 18, 1997)
The following constitute the provisions of the 1995 Employee Stock
Purchase Plan of SDL, Inc.
1. PURPOSE. The purpose of the Plan is to provide employees of the
Company and its Designated Subsidiaries with an opportunity to purchase Common
Stock of the Company. It is the intention of the Company to have the Plan
qualify as an "Employee Stock Purchase Plan" under Section 423 of the Code. The
provisions of the Plan, accordingly, shall be construed so as to extend and
limit participation in a manner consistent with the requirements of that section
of the Code.
2. DEFINITIONS.
(a) "Accrual Period" shall mean a period of approximately six
months, commencing on April 10 and October 10 of each year and terminating on
the last Trading Day immediately preceding the next following October 10 or
April 10, respectively; provided, however, that the first Accrual Period shall
commence on the Effective Date and shall end on the last Trading Day immediately
preceding October 10, 1995.
(b) "Board" shall mean the Board of Directors of the Company.
(c) "Code" shall mean the Internal Revenue Code of 1986, as
amended.
(d) "Common Stock" shall mean the common stock of the Company.
(e) "Company" shall mean SDL, Inc., a Delaware corporation.
(f) "Compensation" shall mean an Employee's base salary plus
shift differential and overtime from the Company or one or more Designated
Subsidiaries, including such amounts of base salary, shift differential and
overtime as are deferred by the Employee (i) under a qualified cash or deferred
arrangement described in Section 401(k) of the Code, (ii) to a plan qualified
under Section 125 of the Code, or (iii) to any other qualified or non-qualified
plan intended to defer the receipt of compensation. Compensation does not
include bonuses, reimbursements or other expense allowances, fringe benefits
(cash or noncash), moving expenses, and welfare benefits.
(g) "Designated Subsidiaries" shall mean the Subsidiaries
which have been designated by the Board from time to time in its sole discretion
as eligible to participate in the Plan.
-1-
<PAGE> 2
(h) "Effective Date" shall mean March 15, 1995. However,
should any Designated Subsidiary become a Participating Company in the Plan
after such date, then such entity shall designate a separate Effective Date with
respect to its employee-participants.
(i) "Employee" shall mean any individual who is engaged in the
rendition of personal services to the Company or a Designated Subsidiary for
Compensation. For purposes of the Plan, the employment relationship shall be
treated as continuing intact while the individual is on sick leave or other
leave of absence approved by the Company. Where the period of leave exceeds 90
days and the individual's right to reemployment is not guaranteed either by
statute or by contact, the employment relationship for purposes of the Plan will
be deemed to have terminated on the 91st day of such leave.
(j) "Enrollment Date" shall mean the first day of each
Purchase Period.
(k) "Exercise Date" shall mean the last day of each Accrual
Period.
(l) "Fair Market Value" shall mean, as of any date, the value
of Common Stock determined as follows:
(1) If the Common Stock is listed on any established
stock exchange or a national market system, including without limitation the
National Market System of the National Association of Securities Dealers, Inc.
Automated Quotation ("Nasdaq") System, its Fair Market Value shall be the
average of the closing sales prices for such stock (or the closing bid, if no
sales were reported), as quoted on such exchange (or the exchange with the
greatest volume of trading in the Common Stock) or system on the last three
Trading Days prior to the date of such determination, as reported in The Wall
Street Journal or such other source as the Board deems reliable, or;
(2) If the Common Stock is quoted on the Nasdaq
system (but not on the National Market system thereof) or is regularly quoted by
a recognized securities dealer but selling prices are not reported, its Fair
Market Value shall be the average of the mean between the high and low asked
prices for the Common Stock on the last three Trading Days prior to the day of
such determination, as reported in The Wall Street Journal or such other source
as the Board deems reliable, or;
(3) In the absence of an established market for the
Common Stock, the Fair Market Value thereof shall be determined in good faith by
the Board.
(m) "Participant" means an Employee of the Company or
Designated Subsidiary who is actively participating in the Plan.
(n) "Plan" shall mean this Employee Stock Purchase Plan.
(o) "Plan Administrator" shall mean either the Board or a
committee of the Board that is responsible for the administration of the Plan.
-2-
<PAGE> 3
(p) "Purchase Period" shall mean a purchase period established
pursuant to Section 4 hereof.
(q) "Purchase Price" shall mean an amount equal to 85% of the
Fair Market Value of a share of Common Stock on the Enrollment Date or on the
Exercise Date, whichever is lower.
(r) "Reserves" shall mean the number of shares of Common Stock
covered by each option under the Plan which have not yet been exercised and the
number of shares of Common Stock which have been authorized for issuance under
the Plan but not yet placed under option.
(s) "Subsidiary" shall mean a corporation, domestic or
foreign, of which not less than 50% of the voting shares are held by the Company
or a Subsidiary, whether or not such corporation now exists or is hereafter
organized or acquired by the Company or a Subsidiary.
(t) "Trading Day" shall mean a day on which national stock
exchanges and the Nasdaq System are open for trading.
3. ELIGIBILITY.
(a) GENERAL. Any Employee who is employed by the Company on a
given Enrollment Date shall be eligible to participate in the Plan for the
Purchase Period commencing with such Enrollment Date.
(b) LIMITATIONS ON GRANT AND ACCRUAL. Any provisions of the
Plan to the contrary notwithstanding, no Employee shall be granted an option
under the Plan (i) if, immediately after the grant, such Employee (taking into
account stock owned by any other person whose stock would be attributed to such
Employee pursuant to Section 424(d) of the Code) would own stock and/or hold
outstanding options to purchase stock possessing five percent (5%) or more of
the total combined voting power or value of all classes of stock of the Company
or of any Subsidiary of the Company, or (ii) which permits his or her rights to
purchase stock under all employee stock purchase plans of the Company and its
Subsidiaries to accrue at a rate which exceeds Twenty-Five Thousand Dollars
($25,000) worth of stock (determined at the Fair Market Value of the shares at
the time such option is granted) for each calendar year in which such option is
outstanding at any time. The determination of the accrual of the right to
purchase stock shall be made in accordance with Section 423(b)(8) of the Code
and the regulations thereunder.
(c) OTHER LIMITS ON ELIGIBILITY. Notwithstanding Subsection
(a) above, the following Employees shall not be eligible to participate in the
Plan for any relevant Purchase Period: (i) Employees whose customary employment
is 20 hours or less per week; (ii) Employees whose customary employment is for
not more than 5 months in any calendar year; and (iii) Employees who are subject
to rules or laws of a foreign jurisdiction that prohibit or make impractical the
participation of such Employees in the Plan.
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<PAGE> 4
4. PURCHASE PERIODS.
(a) The Plan shall be implemented by overlapping Purchase
Periods until such time as (i) the maximum number of shares of Stock available
for issuance under the Plan shall have been purchased or (ii) the Plan shall
have been sooner terminated in accordance with Section 19 hereof. Each Purchase
Period shall be of such duration (which, except for the initial Purchase Period,
shall not exceed twenty-four months per Purchase Period) as determined by the
Plan Administrator prior to the commencement of the Purchase Period. The initial
Purchase Period shall begin on the Effective Date and, except as provided
herein, shall end on the Trading Day immediately preceding April 10, 1997.
Subsequent Purchase Periods will commence on each succeeding April 10 or October
10 in each calendar year during which the Plan remains in existence.
(b) A Participant shall be granted a separate option for each
Purchase Period in which he/she participates. The option shall be granted on the
first Trading Day of the Purchase Period and shall be automatically exercised in
successive semi-annual installments on the last day of each Accrual Period
ending within the Purchase Period.
(c) An Employee may participate in only one Purchase Period at
a time. Accordingly, except as provided in Section 4(d), an Employee who wishes
to join a new Purchase Period must withdraw from the current Purchase Period in
which he/she is participating and must also enroll in the new Purchase Period
prior to the commencement date for that period.
(d) If on the first day of any Accrual Period in a Purchase
Period in which an Employee is participating in the Plan, the Fair Market Value
of the Company's Common Stock is less than the Fair Market Value of the
Company's Common Stock on the first day of the first Accrual Period within the
Purchase Period (after taking into account any adjustment during the Purchase
Period pursuant to Section 18(a)), the Purchase Period shall be terminated
automatically and the Employee shall be enrolled automatically in the new
Purchase Period which has its first Accrual Period commencing on that date,
provided the Employee is eligible to participate in the Plan on that date and
has not elected to terminate participation in the Plan.
(e) Except as specifically provided herein, the acquisition of
Common Stock through participation in the Plan for any Purchase Period shall
neither limit nor require the acquisition of Common Stock by a Participant in
any subsequent Purchase Period.
5. PARTICIPATION.
(a) An eligible Employee may become a Participant in the Plan
by completing (i) a subscription agreement authorizing payroll deductions in the
form of Exhibit A to this Plan or (ii) a subscription agreement authorizing
direct contributions to the Plan in the form of Exhibit B to this Plan and
filing it with the Company's payroll office at least fifteen (15) business days
prior to the Enrollment Date for the Purchase Period in which such participation
will commence, unless a later time for filing the subscription agreement is set
by the Board for all eligible Employees with respect to a given Purchase Period.
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<PAGE> 5
(b) If elected, payroll deductions for a Participant shall
commence with the first payroll following the Enrollment Date and shall end on
the last complete payroll period during the Purchase Period, unless sooner
terminated by the Participant as provided in Section 10.
6. PAYROLL DEDUCTIONS.
(a) At the time a Participant files his/her subscription
agreement, he/she may elect (i) to have payroll deductions made on each pay day
during the Purchase Period in an amount not exceeding ten percent (10%) of the
Compensation which he/she receives on each pay day during the Purchase Period or
(ii) to be authorized to contribute to his/her account an amount not exceeding
ten percent (10%) of the aggregate Compensation which he/she receives during
each Accrual Period of the Purchase Period.
(b) All payroll deductions made for a Participant shall be
credited to his/her account under the Plan and will be withheld in whole
percentages only. A Participant who elects payroll deductions may not make any
additional payments into such account. If elected, a Participant's direct
contributions will be authorized in whole percentages only and the full amount
authorized must be deposited to his/her account at least fifteen (15) business
days prior to each Exercise Date, unless a later time is established by the
Board for all eligible Employees with respect to a given Purchase Period. A
Participant's failure to make a timely account contribution will be deemed an
election by the Participant to withdraw from the Plan under Section 10.
(c) A Participant may discontinue his/her participation in the
Plan as provided in Section 10, or may decrease the rate of his/her payroll
deductions or amount of direct contributions during the Purchase Period by
completing or filing with the Company a new subscription agreement authorizing a
decrease in payroll deduction rate or amount of direct contribution. The
decrease in rate shall be effective with the first full payroll period following
ten (10) business days after the Company's receipt of the new subscription
agreement unless the Company elects to process a given change in participation
more quickly. The decrease in amount of direct contributions will be effective
for the Exercise Dates that occur following fifteen (15) business days after the
Company's receipt of the new subscription agreement unless the Company elects to
process a given change in participation more quickly. A Participant may increase
the rate of his/her payroll deductions or amount of direct contributions for a
future Purchase Period by filing with the Company a new subscription agreement
authorizing an increase in payroll deduction rate or amount of direct
contributions within ten (10) business days (unless the Company elects to
process a given change in participation more quickly) before the commencement of
the upcoming Purchase Period. A Participant's subscription agreement shall
remain in effect for successive Purchase Periods unless terminated as provided
in Section 10. The Board shall be authorized to limit the number of
participation rate or amount of direct contribution changes during any Purchase
Period. A Participant may change his account contribution from payroll deduction
to direct contribution or from direct contribution to payroll deduction by
filing with the Company a new subscription agreement authorizing the change in
account contribution method. The change in account contribution method will be
effective with the first day of the next Accrual Period that occurs ten (10) or
more business days after the
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<PAGE> 6
Company's receipt of a new subscription agreement unless the Company elects to
process a given change in participation more quickly.
(d) Notwithstanding the foregoing, to the extent necessary to
comply with Section 423(b)(8) of the Code and Section 3(b) herein, a
Participant's payroll deductions or authorized direct contributions may be
decreased to 0% or $0 at such time during any Purchase Period which is scheduled
to end during the current calendar year (the "Current Purchase Period") that the
aggregate of all payroll deductions or authorized direct contributions which
were previously used to purchase stock under the Plan in a prior Purchase Period
which ended during that calendar year plus all payroll deductions or authorized
direct contributions accumulated with respect to the Current Purchase Period
equal $21,250. Payroll deductions or authorization to make direct contributions
shall recommence at the rate or amount provided in such Participant's
subscription agreement at the beginning of the first Purchase Period which is
scheduled to end in the following calendar year, unless terminated by the
Participant as provided in Section 10.
7. GRANT OF OPTION. On the first Trading Date of each Purchase Period,
each eligible Employee participating in such Purchase Period shall be granted an
option to purchase on each Exercise Date of such Purchase Period (at the
applicable Purchase Price) up to a number of shares of the Company's Common
Stock determined by dividing such Employee's payroll deductions or direct
contributions accumulated prior to such Exercise Date and retained in the
Participant's account as of the Exercise Date by the applicable Purchase Price;
provided that such purchase shall be subject to the limitations set forth in
Sections 3(b) and 12 hereof. Exercise of the option shall occur as provided in
Section 8, unless the Participant has withdrawn pursuant to Section 10, and the
option, to the extent not exercised, shall expire on the last day of the
Purchase Period.
8. EXERCISE OF OPTION. Unless a Participant withdraws from the Plan as
provided in Section 10 below, his/her option for the purchase of shares will be
exercised automatically on each Exercise Date, and the maximum number of full
shares subject to option shall be purchased for such Participant at the
applicable Purchase Price with the accumulated payroll deductions or direct
contributions made to his/her account. No fractional shares will be purchased;
any payroll deductions or authorized direct contributions accumulated in a
Participant's account which are not sufficient to purchase a full share shall be
carried over to the next Purchase Period, if the Participant elects to
participate in the next Purchase Period, or returned to the Participant. Any
amount remaining in a Participant's account following the purchase of shares on
the Exercise Date which exceeds the cost of one full share of Common Stock on
the Exercise Date shall be returned to the Participant and shall not be carried
over to the next Purchase Period. During a Participant's lifetime, a
Participant's option to purchase shares hereunder is exercisable only by
him/her.
9. DELIVERY. Upon receipt of a request from a Participant after each
Exercise Date on which a purchase of shares occurs, the Company shall arrange
the delivery to such Participant, as appropriate, of a certificate representing
the shares purchased upon exercise of his/her option.
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<PAGE> 7
10. WITHDRAWAL; TERMINATION OF EMPLOYMENT.
(a) A Participant may withdraw all but not less than all the
payroll deductions or direct contributions credited to his/her account and not
yet used to exercise his/her option under the Plan at any time by giving written
notice to the Company in the form of Exhibit C to this Plan. All of the
Participant's payroll deductions or direct contributions credited to his/her
account will be paid to such Participant promptly after receipt of notice of
withdrawal, such Participant's option for the Purchase Period will be
automatically terminated, and no further payroll deductions or direct
contributions for the purchase of shares will be made or authorized during the
Purchase Period. If a Participant withdraws from a Purchase Period, payroll
deductions will not resume or direct contributions will not be accepted at the
beginning of the succeeding Purchase Period unless the Participant delivers to
the Company a new subscription agreement.
(b) Upon a Participant's ceasing to be an Employee for any
reason or upon termination of a Participant's employment relationship (as
described in Section 2(i)), the payroll deductions or direct contributions
credited to such Participant's account during the Purchase Period but not yet
used to exercise the option will be returned to such Participant or, in the case
of his/her death, to the person or persons entitled thereto under Section 14,
and such Participant's option will be automatically terminated.
11. INTEREST. No interest shall accrue on the payroll deductions or
direct contributions of a Participant in the Plan.
12. STOCK.
(a) The maximum number of shares of the Company's Common Stock
which shall be made available for sale under the Plan shall be 300,000 shares,
subject to adjustment upon changes in capitalization of the Company as provided
in Section 18. If on a given Exercise Date the number of shares with respect to
which options are to be exercised exceeds the number of shares then available
under the Plan, the Company shall make a pro rata allocation of the shares
remaining available for purchase in as uniform a manner as shall be practicable
and as it shall determine to be equitable.
(b) A Participant will have no interest or voting right in
shares covered by his/her option until such shares are actually purchased on the
Participant's behalf in accordance with the applicable provisions of the Plan.
No adjustment shall be made for dividends, distributions or other rights for
which the record date is prior to the date of such purchase.
(c) Shares to be delivered to a Participant under the Plan
will be registered in the name of the Participant or in the name of the
Participant and his/her spouse.
13. ADMINISTRATION. The Plan shall be administered by the Board of the
Company or a committee of members of the Board appointed by the Board. The Board
or its committee shall have full and exclusive discretionary authority to
construe, interpret and apply the terms of the Plan, to determine eligibility
and to adjudicate all disputed claims filed under the Plan. Every
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<PAGE> 8
finding, decision and determination made by the Board or its committee shall, to
the full extent permitted by law, be final and binding upon all parties.
14. DESIGNATION OF BENEFICIARY.
(a) Each Participant will file a written designation of a
beneficiary who is to receive any shares and cash, if any, from the
Participant's account under the Plan in the event of such Participant's death
subsequent to an Exercise Date on which the option is exercised but prior to
delivery to such Participant of such shares and cash. In addition, a Participant
may file a written designation of a beneficiary who is to receive any cash from
the Participant's account under the Plan in the event of such Participant's
death prior to exercise of the option. If a Participant is married and the
designated beneficiary is not the spouse, spousal consent shall be required for
such designation to be effective.
(b) Such designation of beneficiary may be changed by the
Participant (and his or her spouse, if any) at any time by written notice. In
the event of the death of a Participant and in the absence of a beneficiary
validly designated under the Plan who is living at the time of such
Participant's death, the Company shall deliver such shares and/or cash to the
executor or administrator of the estate of the Participant, or if no such
executor or administrator has been appointed (to the knowledge of the Company),
the Company, in its discretion, may deliver such shares and/or cash to the
spouse or to any one or more dependents or relatives of the Participant, or if
no spouse, dependent or relative is known to the Company, then to such other
person as the Company may designate.
15. TRANSFERABILITY. Neither amounts credited to a Participant's
account nor any rights with regard to the exercise of an option or to receive
shares under the Plan may be assigned, transferred, pledged or otherwise
disposed of in any way (other than by will, the laws of descent and distribution
or as provided in Section 14 hereof) by the Participant. Any such attempt at
assignment, transfer, pledge or other disposition shall be without effect,
except that the Company may treat such act as an election to withdraw funds from
an Purchase Period in accordance with Section 10.
16. USE OF FUNDS. All payroll deductions and direct contributions
received or held by the Company under the Plan may be used by the Company for
any corporate purpose, and the Company shall not be obligated to segregate such
payroll deductions and direct contributions.
17. REPORTS. Individual accounts will be maintained for each
Participant in the Plan. Statements of account will be given to Participants at
least annually, which statements will set forth the amounts of payroll
deductions, direct contributions, the Purchase Price, the number of shares
purchased and the remaining cash balance, if any.
18. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION, DISSOLUTION; OR MERGER
OR ASSET SALE.
(a) CHANGES IN CAPITALIZATION. Subject to any required action
by the shareholders of the Company, the Reserves, as well as the price per share
of Common Stock
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<PAGE> 9
covered by each option under the Plan which has not yet been exercised, shall be
proportionately adjusted for any increase or decrease in the number of issued
shares of Common Stock resulting from a stock split, reverse stock split, stock
dividend, combination or reclassification of the Common Stock, or any other
increase or decrease in the number shares of Common Stock effected without
receipt of consideration by the Company; provided, however, that conversion of
any convertible securities of the Company shall not be deemed to have been
"effected without receipt of consideration." Such adjustment shall be made by
the Board, whose determination in that respect shall be final, binding and
conclusive. Except as expressly provided herein, no issue by the Company of
shares of stock of any class, or securities convertible into shares of stock of
any class, shall affect, and no adjustment by reason thereof shall be made with
respect to, the number or price of shares of Common Stock subject to an option.
The Board may, if it so determines in the exercise of its sole discretion, make
provision for adjusting the Reserves, as well as the price per share of Common
Stock covered by each outstanding option, in the event the Company effects one
or more reorganizations, recapitalizations, rights offerings or other increases
or reductions of shares of its outstanding Common Stock.
(b) CHANGE IN OWNERSHIP, DISSOLUTION OR LIQUIDATION. In the
event of a proposed sale of all or substantially all of the assets of the
Company, the merger of the Company with or into another corporation, in which
the Company will not be the surviving corporation (other than a reorganization
effectuated primarily to change the state in which the Company is incorporated),
or a reverse merger in which the Company is the surviving corporation but in
which securities possessing more than fifty percent (50%) of the total combined
voting power of the Company's outstanding securities are transferred to a person
or persons different from the person or persons holding those securities
immediately prior to the transfer, each option under the Plan shall be assumed
or an equivalent option shall be substituted by such successor corporation or a
parent or subsidiary of such successor corporation, unless the Board determines,
in the exercise of its sole discretion and in lieu of such assumption or
substitution, to shorten the Purchase Period then in progress by setting a new
Exercise Date (the "New Exercise Date"). If the Board shortens the Purchase
Period then in progress in lieu of assumption or substitution in the event of a
merger or sale of assets, the Board shall notify each Participant in writing, at
least ten (10) days prior to the New Exercise Date, that the Exercise Date for
his/her option has been changed to the New Exercise Date and that his/her option
will be exercised automatically on the New Exercise Date, unless prior to such
date he/she has withdrawn from the Purchase Period as provided in Section 10.
For purposes of this Section, an option granted under the Plan shall be deemed
to be assumed if, following the sale of assets or merger, the option confers the
right to purchase, for each share of option stock subject to the option
immediately prior to the sale of assets or merger, the consideration (whether
stock, cash or other securities or property) received in the sale of assets or
merger by holders of Common Stock for each share of Common stock held on the
effective date of the transaction (and if such holders were offered a choice of
consideration, the type of consideration chosen by the holders of a majority of
the outstanding shares of Common Stock); provided, however, that if such
consideration received in the sale of assets or merger was not solely common
stock of the successor corporation or its parent (as defined in Section 424(e)
of the Code), the Board may, with the consent of the successor corporation and
the Participant, provide for the consideration to be received upon exercise of
the option to be solely common stock of the successor corporation or its parent
equal in fair market
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<PAGE> 10
value to the per share consideration received by holders of Common Stock in the
sale of assets or merger.
19. AMENDMENT OR TERMINATION.
(a) The Board of Directors of the Company may at any time and
for any reason terminate or amend the Plan. Except as provided in Section 18, no
such termination can affect options previously granted, provided that an
Purchase Period may be terminated by the Board of Directors on any Exercise Date
if the Board determines that the termination of the Plan is in the best
interests of the Company and its shareholders. Except as provided in Section 18,
no amendment may make any change in any option theretofore granted which
adversely affects the rights of any Participant. To the extent necessary to
comply Section 423 of the Code (or any successor rule or provision or any other
applicable law or regulation), the Company shall obtain shareholder approval in
such a manner and to such a degree as required.
(b) Without shareholder consent and without regard to whether
any Participant rights may be considered to have been "adversely affected," the
Board (or its committee) shall be entitled to change the Purchase Periods, limit
the frequency and/or number of changes in the amount withheld during Purchase
Periods, establish the exchange ratio applicable to amounts withheld in a
currency other than U.S. dollars, permit payroll withholding in excess of the
amount designated by a Participant in order to adjust for delays or mistakes in
the Company's processing of properly completed withholding elections, establish
reasonable waiting and adjustment periods and/or accounting and crediting
procedures to ensure that amounts applied toward the purchase of Common Stock
for each Participant properly correspond with amounts withheld from the
Participant's Compensation or contributed directly by a Participant, and
establish such other limitations or procedures as the Board (or its committee)
determines in its sole discretion advisable which are consistent with the Plan.
20. NOTICES. All notices or other communications by a Participant to
the Company under or in connection with the Plan shall be deemed to have been
duly given when received in the form specified by the Company at the location,
or by the person, designated by the Company for the receipt thereof.
21. CONDITIONS UPON ISSUANCE OF SHARES. Shares shall not be issued with
respect to an option unless the exercise of such option and the issuance and
delivery of such shares pursuant thereto shall comply with all applicable
provisions of law, domestic or foreign, including, without limitation, the
Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as
amended, the rules and regulations promulgated thereunder, and the requirements
of any stock exchange upon which the shares may then be listed, and shall be
further subject to the approval of counsel for the Company with respect to such
compliance. As a condition to the exercise of an option, the Company may require
the person exercising such option to represent and warrant at the time of any
such exercise that the shares are being purchased only for investment and
without any present intention to sell or distribute such shares if, in the
opinion of counsel for the Company, such a representation is required by any of
the aforementioned applicable provisions of
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<PAGE> 11
law. In addition, no options shall be exercised or shares issued hereunder
before the Plan shall have been approved by shareholders of the Company as
provided in Section 23.
22. TERM OF PLAN. The Plan shall become effective upon the earlier to
occur of its adoption by the Board of Directors or its approval by the
shareholders of the Company. It shall continue in effect for a term of ten (10)
years unless sooner terminated under Section 19.
23. SHAREHOLDER APPROVAL. Continuance of the Plan shall be subject to
approval by the shareholders of the Company within twelve (12) months before or
after the date the Plan is adopted. If such shareholder approval is obtained at
a duly held shareholders' meeting, it must be obtained by the affirmative vote
of the holders of a majority of the outstanding shares of the Company, or if
such shareholder approval is obtained by written consent, it must be obtained by
the unanimous written consent of all shareholders of the Company; provided,
however, that approval at a meeting or by written consent may be obtained by a
lesser degree of shareholder approval if the Board determines, in its discretion
after consultation with the Company's legal counsel, that such a lesser degree
of shareholder approval will comply with all applicable laws and will not
adversely affect the qualification of the Plan under Section 423 of the Code.
24. NO EMPLOYMENT RIGHTS. The Plan does not, directly or indirectly,
create any right for the benefit of any employee or class of employees to
purchase any shares under the Plan, or create in any employee or class of
employees any right with respect to continuation of employment by the Company or
a Designated Subsidiary, and it shall not be deemed to interfere in any way with
the Company's or a Designated Subsidiary's right to terminate, or otherwise
modify, an employee's employment at any time.
25. EFFECT OF PLAN. The provisions of the Plan shall, in accordance
with its terms, be binding upon, and inure to the benefit of, all successors of
each employee participating in the Plan, including, without limitation, such
employee's estate and the executors, administrators or trustees thereof, heirs
and legatees, and any receiver, trustee in bankruptcy or representative of
creditors of such employee.
26. GOVERNING LAW. The law of the State of California will govern all
matters relating to this Plan except to the extent it is superseded by the laws
of the United States.
27. EFFECTIVE DATE OF AMENDMENT AND RESTATEMENT OF THE PLAN. The Plan
was adopted initially by the Board on January 23, 1995 and approved by the
shareholders on February 28, 1995. This amendment and restatement of the Plan
adopted by the Board on February 18, 1997 shall be effective for Purchase
Periods that commence on or after the Board's adoption of this amendment and
restatement of the Plan.
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<PAGE> 12
EXHIBIT A
SDL, INC.
1995 EMPLOYEE STOCK PURCHASE PLAN
SUBSCRIPTION AGREEMENT-PAYROLL DEDUCTION
___ Original Application Enrollment Date: _________
___ Change in Payroll Deduction Rate
___ Change of Beneficiary(ies)
___ Change in Method of Account Contribution
1. I, ________________________, hereby elect to participate in the SDL,
Inc. 1995 Employee Stock Purchase Plan (the "Employee Stock Purchase Plan") and
subscribe to purchase shares of the Company's Common Stock in accordance with
this Subscription Agreement and the Employee Stock Purchase Plan.
2. I hereby authorize payroll deductions from each paycheck in the
amount of % of my Compensation on each payday (not to exceed 10%) during the
Purchase Period in accordance with the Employee Stock Purchase Plan. (Please
note that no fractional percentages are permitted.)
3. I understand that the payroll deductions shall be accumulated for
the purchase of shares of Common Stock at the applicable Purchase Price
determined in accordance with the Employee Stock Purchase Plan. I understand
that if I do not withdraw from an Purchase Period, any accumulated payroll
deductions will be used to automatically exercise my option.
4. I have received a copy of the complete "SDL, Inc. 1995 Employee
Stock Purchase Plan." I understand that my participation in the Employee Stock
Purchase Plan is in all respects subject to the terms of the Plan. I understand
that the grant of the option by the Company under this Subscription Agreement is
subject to obtaining shareholder approval of the Employee Stock Purchase Plan.
5. Shares purchased for me under the Employee Stock Purchase Plan
should be issued in the name(s) of:
_________________________________
_________________________________
6. I understand that if I dispose of any shares received by me pursuant
to this Plan within 2 years after the Enrollment Date (the first day of the
Purchase Period during which I purchased such shares) or within 1 year after the
Exercise Date (the date I purchased such shares), I will be treated for federal
income tax purposes as having received ordinary income at the time of such
disposition in an amount equal to the excess of the fair market value of the
shares at the time such shares were delivered to me over the price which I paid
for the shares. I HEREBY
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<PAGE> 13
AGREE TO NOTIFY THE COMPANY IN WRITING WITHIN 30 DAYS AFTER THE DATE OF ANY SUCH
DISPOSITION AND I WILL MAKE ADEQUATE PROVISION FOR FEDERAL, STATE OR OTHER TAX
WITHHOLDING OBLIGATIONS, IF ANY WHICH ARISE UPON THE DISPOSITION OF THE COMMON
STOCK. The Company may, but will not be obligated to, withhold from my
compensation the amount necessary to meet any applicable withholding obligation
including any withholding necessary to make available to the Company any tax
deductions or benefits attributable to sale or early disposition of Common Stock
by me. If I dispose of such shares at any time after the expiration of the
2-year and 1-year holding periods described above, I understand that I will be
treated for federal income tax purposes as having received income only at the
time of such disposition, and that such income will be taxed as ordinary income
only to the extent of an amount equal to the lesser of (1) the excess of the
fair market value of the shares at the time of such disposition over the
purchase price which I paid for the shares, or (2) 15% of the fair market value
of the shares on the first day of the Purchase Period. The remainder of the
gain, if any, recognized on such disposition will be taxed as capital gain. I
also understand that the foregoing income tax consequences are based on current
federal income tax law and that the Company is not responsible for advising me
of any changes in the applicable tax rules.
7. I hereby agree to be bound by the terms of the Employee Stock
Purchase Plan. The effectiveness of this Subscription Agreement is dependent
upon my eligibility to participate in the Employee Stock Purchase Plan.
8. In the event of my death, I hereby designate the following as my
beneficiary(ies) to receive all payments and shares due me under the Employee
Stock Purchase Plan.
NAME (Please print): _______________________________________________________
(First) (Middle) (Last)
Relationship: _______________________________________________________
Address: _______________________________________________________
_______________________________________________________
_______________________________________________________
Employee's Social
Security Number: _______________________________________________________
Employee's Address: _______________________________________________________
_______________________________________________________
_______________________________________________________
A-2
<PAGE> 14
I UNDERSTAND THAT THIS SUBSCRIPTION AGREEMENT SHALL REMAIN IN EFFECT THROUGHOUT
SUCCESSIVE PURCHASE PERIODS UNLESS TERMINATED BY ME.
Employee Signature: ____________________________________________________
Dated: ____________________________________________________
Signature of spouse
if beneficiary is
other than spouse: ____________________________________________________
Dated: ____________________________________________________
A-3
<PAGE> 15
EXHIBIT B
SDL, INC.
1995 EMPLOYEE STOCK PURCHASE PLAN
SUBSCRIPTION AGREEMENT-DIRECT CONTRIBUTION
___ Original Application Enrollment Date: _________
___ Change in Payroll Deduction Rate
___ Change of Beneficiary(ies)
___ Change in Method of Account Contribution
1. I, ________________________, hereby elect to participate in the SDL,
Inc. 1995 Employee Stock Purchase Plan (the "Employee Stock Purchase Plan") and
subscribe to purchase shares of the Company's Common Stock in accordance with
this Subscription Agreement and the Employee Stock Purchase Plan.
2. I hereby elect to contribute to my account under the Employee Stock
Purchase Plan in the amount of ____% of my aggregate Compensation paid to me
during each Accrual Period (not to exceed 10%) of the Purchase Period in
accordance with the Employee Stock Purchase Plan. I will contribute the above
amount no later than fifteen (15) business days prior to each Exercise Date
under the Employee Stock Purchase Plan. I acknowledge that the failure to make a
timely account contribution in the full amount specified above will be deemed an
election by me to withdraw from the Employee Stock Purchase Plan. (Please note
that no fractional percentages are permitted).
3. I understand that the amount of my contributions shall be applied
for the purchase of shares of Common Stock at the applicable Purchase Price
determined in accordance with the Employee Stock Purchase Plan. I understand
that if I do not withdraw from an Purchase Period, any contributions to my
account will be used to automatically exercise my option. I understand that
interest will not be paid on amounts contributed to my account under the
Employee Stock Purchase Plan.
4. I have received a copy of the complete "SDL, Inc. 1995 Employee
Stock Purchase Plan." I understand that my participation in the Employee Stock
Purchase Plan is in all respects subject to the terms of the Plan. I understand
that the grant of the option by the Company under this Subscription Agreement is
subject to obtaining shareholder approval of the Employee Stock Purchase Plan.
5. Shares purchased for me under the Employee Stock Purchase Plan
should be issued in the name(s) of:
_________________________________
_________________________________
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<PAGE> 16
6. I understand that if I dispose of any shares received by me pursuant
to this Plan within 2 years after the Enrollment Date (the first day of the
Purchase Period during which I purchased such shares) or within 1 year after the
Exercise Date (the date I purchased such shares), I will be treated for federal
income tax purposes as having received ordinary income at the time of such
disposition in an amount equal to the excess of the fair market value of the
shares at the time such shares were delivered to me over the price which I paid
for the shares. I HEREBY AGREE TO NOTIFY THE COMPANY IN WRITING WITHIN 30 DAYS
AFTER THE DATE OF ANY SUCH DISPOSITION AND I WILL MAKE ADEQUATE PROVISION FOR
FEDERAL, STATE OR OTHER TAX WITHHOLDING OBLIGATIONS, IF ANY WHICH ARISE UPON THE
DISPOSITION OF THE COMMON STOCK. The Company may, but will not be obligated to,
withhold from my compensation the amount necessary to meet any applicable
withholding obligation including any withholding necessary to make available to
the Company any tax deductions or benefits attributable to sale or early
disposition of Common Stock by me. If I dispose of such shares at any time after
the expiration of the 2-year and 1-year holding periods described above, I
understand that I will be treated for federal income tax purposes as having
received income only at the time of such disposition, and that such income will
be taxed as ordinary income only to the extent of an amount equal to the lesser
of (1) the excess of the fair market value of the shares at the time of such
disposition over the purchase price which I paid for the shares, or (2) 15% of
the fair market value of the shares on the first day of the Purchase Period. The
remainder of the gain, if any, recognized on such disposition will be taxed as
capital gain. I also understand that the foregoing income tax consequences are
based on current federal income tax law and that the Company is not responsible
for advising me of any changes in the applicable tax rules.
7. I hereby agree to be bound by the terms of the Employee Stock
Purchase Plan. The effectiveness of this Subscription Agreement is dependent
upon my eligibility to participate in the Employee Stock Purchase Plan.
8. In the event of my death, I hereby designate the following as my
beneficiary(ies) to receive all payments and shares due me under the Employee
Stock Purchase Plan.
NAME (Please print): _______________________________________________________
(First) (Middle) (Last)
Relationship: _______________________________________________________
Address: _______________________________________________________
_______________________________________________________
_______________________________________________________
Employee's Social
Security Number: _______________________________________________________
Employee's Address: _______________________________________________________
_______________________________________________________
_______________________________________________________
B-2
<PAGE> 17
I UNDERSTAND THAT THIS SUBSCRIPTION AGREEMENT SHALL REMAIN IN EFFECT THROUGHOUT
SUCCESSIVE PURCHASE PERIODS UNLESS TERMINATED BY ME.
Employee Signature: ____________________________________________________
Dated: ____________________________________________________
Signature of spouse
if beneficiary is
other than spouse: ____________________________________________________
Dated: ____________________________________________________
B-3
<PAGE> 18
EXHIBIT C
SDL, INC.
1995 EMPLOYEE STOCK PURCHASE PLAN
SUBSCRIPTION AGREEMENT
NOTICE OF WITHDRAWAL
The undersigned participant in the Purchase Period of the SDL, Inc.
1995 Employee Stock Purchase Plan which began on _________________, 19___ (the
"Enrollment Date"), hereby notifies the Company that he or she hereby withdraws
from the Purchase Period. He or she hereby directs the Company to pay to the
undersigned as promptly as practicable all the amounts credited to his or her
account with respect to such Purchase Period. The undersigned understands and
agrees that his or her option for such Purchase Period will be automatically
terminated. The undersigned understands further that no further payroll
deductions will be made and no contributions will be authorized for the purchase
of shares in the current Purchase Period and the undersigned shall be eligible
to participate in succeeding Purchase Periods only by delivering to the Company
a new Subscription Agreement.
Name and Address
of Participant: _______________________________________________________
_______________________________________________________
_______________________________________________________
Signature: _______________________________________________________
Date: _______________________________________________________
C-1
<PAGE> 1
EXHIBIT 11.1
SDL, INC.
COMPUTATION OF NET INCOME (LOSS) PER
COMMON AND COMMON EQUIVALENT SHARE
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
PRIMARY (1) 1996 1995 1994
------- ------- ------
<S> <C> <C> <C>
Weighted average number of common shares
outstanding 12,012 9,228 5,738
Incremental common shares attributable to
shares issuable under employee stock plans
(2) 1,187 -- 1,723
Common and common equivalent related to
stock and option issuance in accordance with
SAB No. 55, 64 and 83 -- -- 87
------- ------- ------
Total shares 13,199 9,228 7,548
======= ======= ======
NET INCOME (LOSS)
Amount $ 7,121 $(2,819) $2,195
======= ======= ======
Per Share $ 0.54 $ (0.31) $ 0.29
======= ======= ======
</TABLE>
(1) Fully diluted computation not presented since such amounts differ by
less than 3 percent of the net income per share amount shown above.
(2) Common equivalent shares relating to shares issuable under employee
stock plans are not included in the 1995 calculation due to their
anti-dilutive effect on the loss per share.
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF SDL, INC.
The following are the material subsidiaries of the Registrant as of December 31,
1996, all of which are included in the Registrant's Consolidated Financial
Statements. The Registrant beneficially owns 100 percent of the outstanding
voting securities of these subsidiaries.
Name Jurisdiction of Incorporation
- ---- -----------------------------
SDL Optics, Inc. British Columbia, Canada
<PAGE> 1
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 Nos. 33-90848 and 33-92200) pertaining to the 1995 Stock Option Plan, 1995
Employee Stock Purchase Plan, 1992 Stock Option Plan and the Amended and
Restated 1984 Incentive Stock Option Plan of SDL, Inc. of our report dated
January 29, 1997 (except for Note 12, as to which the date is February 7, 1997)
with respect to the consolidated financial statements and schedule of SDL, Inc.
included in the Annual Report (Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
San Jose, California
February 19, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DECEMBER 31,
1996 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-K.
</LEGEND>
<CIK> 0000934741
<NAME> SDL. INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 2,605
<SECURITIES> 45,353
<RECEIVABLES> 12,596
<ALLOWANCES> 780
<INVENTORY> 13,441
<CURRENT-ASSETS> 77,117
<PP&E> 39,016
<DEPRECIATION> 16,996
<TOTAL-ASSETS> 113,842
<CURRENT-LIABILITIES> 13,874
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 99,214
<TOTAL-LIABILITY-AND-EQUITY> 113,842
<SALES> 69,772
<TOTAL-REVENUES> 82,475
<CGS> 45,365
<TOTAL-COSTS> 54,956
<OTHER-EXPENSES> 18,847
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,501)
<INCOME-PRETAX> 10,173
<INCOME-TAX> 3,052
<INCOME-CONTINUING> 7,121
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,121
<EPS-PRIMARY> 0.54
<EPS-DILUTED> 0.54
</TABLE>
