<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________________ to _______________________
Commission File Number 0-25688
SDL, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0331449
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
80 Rose Orchard Way, San Jose, CA 95134-1365
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (408) 943-9411
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock as of October 24,
1997 was 13,639,300.
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SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Operations for
the three and nine months ended September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 1997 and 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)0
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED) (1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,347 $ 2,605
Short-term investments 9,500 45,353
Accounts receivable, net 20,185 11,816
Inventories 12,635 13,441
Prepaid expenses and other current assets 2,864 3,902
--------- ---------
Total current assets 49,531 77,117
Property and equipment, net 25,686 22,020
Long-term investments 11,726 10,325
Other assets 4,276 4,380
--------- ---------
$ 91,219 $ 113,842
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,921 $ 6,777
Accrued payroll and related expenses 3,454 2,185
Unearned revenue 1,215 455
Accrued warranty 602 404
Income taxes payable 734 --
Accrued legal expenses 726 411
Acquisition obligations -- 2,712
Other accrued liabilities 1,347 930
--------- ---------
Total current liabilities 15,999 13,874
Other long-term liabilities 1,026 741
Commitments and contingencies
Stockholders' equity:
Common stock 14 13
Additional paid-in-capital 115,702 114,421
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (41,478) (14,951)
--------- ---------
74,238 99,483
Less: stockholders' notes receivable (44) (256)
--------- ---------
Total stockholders' equity 74,194 99,227
--------- ---------
$ 91,219 $ 113,842
========= =========
</TABLE>
(1) The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date.
See accompanying notes.
3
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Total revenue:
Product revenue $ 19,724 $ 15,823 $ 54,681 $ 51,712
Research revenue 4,227 3,546 11,856 9,685
-------- -------- -------- --------
23,951 19,369 66,537 61,397
Cost of revenue:
Cost of product revenue 13,140 11,606 39,000 33,758
Cost of research revenue 3,185 2,893 9,676 7,246
-------- -------- -------- --------
Gross margin 7,626 4,870 17,861 20,393
Operating expenses:
Research and development 2,340 1,560 7,649 4,605
Selling, general and administrative 2,799 2,768 36,874 8,240
Amortization of purchased intangibles 163 161 487 484
-------- -------- -------- --------
Operating income (loss) 2,324 381 (27,149) 7,064
Interest income, net 266 570 1,327 839
Loss on sale of securities -- -- (324) --
-------- -------- -------- --------
Income (loss) before income taxes 2,590 951 (26,146) 7,903
Provision for income taxes 139 8 367 2,372
-------- -------- -------- --------
Net income (loss) $ 2,451 $ 943 $(26,513) $ 5,531
======== ======== ======== ========
Net income (loss) per share $ 0.17 $ 0.07 $ (1.97) $ 0.43
======== ======== ======== ========
Shares used in computing
net income (loss) per share 14,431 14,142 13,449 12,866
======== ======== ======== ========
</TABLE>
See accompanying notes.
4
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net (loss) income $(26,513) $ 5,531
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 4,130 3,683
Deferred income taxes 477 (525)
Deferred rent -- (50)
Changes in operating assets and liabilities:
Accounts receivable (8,369) 756
Inventories 806 (4,107)
Accounts payable 1,144 866
Income taxes payable 2,022 2,987
Accrued payroll and related expenses 1,269 1,059
Unearned revenue 760 295
Accrued warranty 198 --
Accrued legal expenses 315 --
Other accrued liabilities 417 (145)
Other (586) (1,067)
-------- --------
Total adjustments 2,583 3,752
-------- --------
Net cash provided by (used in) operating activities (23,930) 9,283
INVESTING ACTIVITIES:
Acquisition of property and equipment, net (7,344) (7,385)
Payments on acquisition obligations (2,712) (1,525)
Sales (purchases) of investments, net 34,438 (44,269)
-------- --------
Net cash provided by (used in) investing activities 24,382 (53,179)
FINANCING ACTIVITIES:
Issuance of stock pursuant to employee stock plans 1,078 822
Proceeds from issuance of common stock -- 44,676
Payments on stockholders' notes receivables 212 141
-------- --------
Net cash provided by financing activities 1,290 45,639
Net increase in cash and cash equivalents 1,742 1,743
Cash and cash equivalents at beginning of period 2,605 2,793
-------- --------
Cash and cash equivalents at end of period $ 4,347 $ 4,536
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES:
Unrealized loss on marketable securities $ 14 $ --
SUPPLEMENT DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ -- $ --
Cash paid for interest $ -- $ --
</TABLE>
See accompanying notes.
5
<PAGE> 6
SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 1997
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the nine-month period ended September 30,
1997 are not necessarily indicative of the results that may be expected
for the year ended December 31, 1997. For further information, refer to
the consolidated financial statements and footnotes thereto included in
the Registrant Company's Annual Report on Form 10-K for the year ended
December 31, 1996.
The consolidated financial statements include the accounts of SDL, Inc.
and its wholly owned subsidiary, SDL Optics. Intercompany accounts and
transactions have been eliminated in consolidation.
The functional currency of the Company's foreign subsidiary is the U.S.
dollar. Subsidiary financial statements are remeasured into U.S. dollars
for consolidation. Foreign currency transaction gains and losses are
included in interest income and were immaterial for all periods presented.
2. NET INCOME (LOSS) PER SHARE
Net income per share for the three and nine months ended Sepetember 30,
1996 and the three months ended September 30, 1997 is computed using the
weighted average number of shares of common stock outstanding and dilutive
common equivalent shares from stock options (using the treasury stock
method). Net loss per share for the nine months ended September 30, 1997
is computed using the weighted average number of shares of common stock
outstanding.
3. RECENT PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share, which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change
the method currently used to compute earnings per share and to restate all
prior periods. Under the new requirements for calculating primary earnings
per share, the dilutive effect of stock options will be excluded. The
implementation of the new requirement is expected to result in an increase
in primary earnings per share for the three and nine months ended
September 30, 1996 of $0.01 and $0.05 per share, respectively, and $0.01
for the three months ended September 30, 1997. There is no impact on the
primary loss per share calculation for the nine months ended September 30,
1997. The impact of Statement 128 on the calculation of fully diluted
earnings per share for these periods is not expected to be material.
6
<PAGE> 7
In June 1997, the Financial Accounting Standards Board issued Statement
Number 130, Reporting Comprehensive Income. This statement requires that
all items that are to be required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. This statement is effective for fiscal years beginning after
December 15, 1997, and will be adopted by the Company for the year ended
December 31, 1998.
In addition, during June 1997, the Financial Accounting Standards Board
issued Statement Number 131, Disclosures About Segments of an Enterprise
and Related Information. This statement replaces Statement Number 14 and
changes the way public companies report segment information. This
statement is effective for fiscal years beginning after December 15, 1997
and will be adopted by the Company for the year ended
December 31, 1998.
4. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
Raw materials $ 4,970 $ 6,653
Work in process 7,665 6,788
-------- --------
$12,635 $13,441
======= =======
</TABLE>
No significant amounts of finished goods are maintained.
5. COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS
The following is a summary of research and product contract activity
related to uncompleted long-term contracts from the inception of the
contracts (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
Costs incurred on uncompleted long-term contracts $62,125 $40,007
Estimated earnings 5,140 2,803
------- -------
Revenue recognized on uncompleted long-term contracts 67,265 42,810
Less billings to date 61,945 41,906
------- -------
Total unbilled costs and estimated earnings $ 5,320 $ 904
======= =======
</TABLE>
Of the above balances, $5.1 million and $0.6 million are included in
accounts receivable in the accompanying balance sheets at September 30,
1997 and December 31, 1996, respectively. Unbilled costs and estimated
earnings on uncompleted long-term contracts are generally billable within
one year.
Revenue recognized on long-term contracts included in total revenue was
approximately $7.4 million and $19.2 million for the three and nine months
ended September 30, 1997 and $7.0 million and $18.8 million for the three
and nine months ended September 30, 1996.
7
<PAGE> 8
6. CONTINGENCIES
Trial of the Spectra-Physics v. SDL, Inc. litigation began before the
Santa Clara County California Superior Court on May 7, 1997. On May 19,
1997, before the trial was concluded, the Company, Spectra-Physics and its
subsidiary Opto Power Corporation, and Xerox Corporation made a
comprehensive settlement of their disputes.
During the second quarter of fiscal 1997, the Company included
approximately $27.5 million in general and administrative expenses for
settlement and related legal costs associated with the resolution of the
dispute with Spectra-Physics, Inc.
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SDL designs, manufactures and markets semiconductor optoelectronic integrated
circuits (OEICs), semiconductor lasers, fiber optic related products and
optoelectronic systems. The Company's revenue consists of product and research
revenue. The Company's product revenue is primarily derived from the sale of
standard and customized products to a variety of customers, in volumes ranging
from single products sold to numerous organizations to high unit volumes sold to
certain original equipment manufacturer (OEM) customers. As a result, product
gross margins tend to fluctuate based on the mix of products sold in any
reported period. From the original products introduced in 1984, the Company has
expanded its product offering to over 200 standard products in addition to
providing custom design and packaging for OEM customers. OEM customers often
fund the design or customization as well as the manufacturing and testing of
their volume products. The primary applications for the Company's products
include telecommunications, CATV, satellite communications, LAN, printing,
medical, data storage, sensor, defense, materials processing and instrument
markets.
The Company's research revenue is derived from customer-funded research
programs. The Company's research and engineering staff, which currently includes
over 60 Ph.D.s, provides state-of-the-art research and proof-of-concept
prototypes over a broad range of semiconductor OEIC and laser technologies. The
Company has been issued over 65 U.S. patents and has approximately 78 U.S.
patent applications pending. Customer-funded research revenue is typically based
on material and labor costs incurred, plus coverage for overhead and operating
expenses, and in most cases, an additional profit component. Cost-based pricing
has generally resulted in lower gross margins for research revenue than for
product revenue. The Company typically retains rights to the technology
developed under customer-funded research programs and therefore is able to
leverage these programs to continue to broaden its product and technology
offerings. All internally-funded research and development costs are expensed in
the period incurred.
Certain of the statements contained in this Management's Discussion and Analysis
of Financial Condition and Results of Operations may be forward-looking
statements regarding the Company's business, operations and prospects. The
Company's actual results could differ materially from those in such
forward-looking statements. See "Risk Factors."
RESULTS OF OPERATIONS
REVENUE. Total revenue for the quarter ended September 30, 1997 was $24.0
million, compared to $19.4 million for the corresponding 1996 quarter.
Sequentially, total revenue increased 11% from that reported in the June 1997
quarter. For the nine months ended September 1997, total revenue increased to
$66.5 million from $61.4 million reported for the comparable prior year period.
Third quarter 1997 revenue growth primarily resulted from strong customer demand
for 980 nm pump modules generated by the Company's new product offerings.
Revenue growth for the nine months ended September 1997 compared to the
corresponding 1996 period is attributed directly to the increase in revenue
reported for the third quarter of 1997.
For the nine months ended September 1997, information based products within the
fiber-based telecommunications, satellite communications, printing, data storage
and displays markets represented approximately 73% of product revenue as
compared to 67% for the corresponding prior year period. The balance is
represented by products within the light replacement market. Research revenue
represented 18% of total revenue for the nine months of 1997 compared to 16% for
the prior year period.
9
<PAGE> 10
International revenue, as a percentage of total revenue, was 17% for the nine
months ended September 1997 compared to 15% for the corresponding 1996 period.
Approximately 19% and 20% of the Company's revenue for the nine months ended
September 1997 and 1996 was received from Lockheed Martin. Increased demand for
the Company's fiber based products from other customers during the third quarter
of 1997 contributed to the percentage decline in the total revenue derived from
Lockheed Martin.
There can be no assurance that the application markets for SDL's products will
grow in future periods at historical percentage rates. Further, there can be no
assurance that the Company will be able to increase or maintain its market share
in the future or to sustain historical growth rates.
GROSS MARGIN. The Company's gross margin for the three and nine months ended
September 30, 1997 was 32% and 27% , respectively, compared to 25% and 33% in
the corresponding prior year periods. Increased sales volume and higher
incremetal product throughput over a relatively fixed manufacturing cost base
primarily contributed to the third quarter 1997 gross margin improvements
compared to both the third quarter of 1996 and the second quarter of 1997.
Gross margin for the nine months ended September 1997 was impacted by i)
start-up costs for the expansion of the Company's wafer fab and packaging
capacities, ii) write-offs totaling $1.4 million relating to the transition to
new manufacturing process, designs and equipment and, iii) $1.6 million related
to changes in estimable reimbursable costs. All of these additional production
costs were incurred during the second quarter of 1997.
The Company's gross margin can be affected by a number of factors, including
product mix, pricing pressures and product yield. Generally, the cost of newer
products tends to be higher as a percentage of product revenue than that of more
mature, higher volume products. In addition, the cost of research revenue is
significantly higher as a percentage of revenue, as research revenue is
typically based on costs incurred rather than market pricing. As a result of
these factors, gross margin fluctuations are difficult to predict and there can
be no assurance that the Company will maintain gross margins at current levels
in future periods.
RESEARCH AND DEVELOPMENT. Research and development expense for the three and
nine months ended September 30, 1997 increased to $2.3 million and $7.6 million
respectively, compared to $1.6 million and $4.6 million for the corresponding
1996 periods. Research and development expense as a percentage of total revenue
was 12% and 8% for the nine months ended September 30, 1997 and 1996 ,
respectively. The increased research and development spending during 1997, as
compared to the year earlier period, is primarily a result of increased
manufacturing process development efforts, together with the development of new
communications and laser system products. The Company believes these investments
will further improve manufacturing yields and gross margins, as well as lead to
new product introductions, some of which have already been introduced during the
first nine months of 1997.
The level of research and development incurred in future periods may vary. In
addition, there can be no assurance that expenditures for manufacturing
improvements or for other advanced research projects will be successful, or that
improved processes or commercial products will result from these projects.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense
(SG&A) was approximately $2.8 million for the three months ended September 1997
and 1996. When settelment and related legal costs are excluded from comparable
quarterly periods, SG&A increased 14% over the corresponding 1996 quarter and
remained flat with that of the preceding June 1997 quarter. The year
10
<PAGE> 11
over year increase in SG&A resulted primarily from the continued expansion of
the Company's business and headcount increase within sales and marketing.
The increase of SG&A for the nine months ended September 1997 resulted primarily
from a charge of approximately $27.5 million recorded in the second quarter of
1997 for the settlement and related legal costs associated with the
Spectra-Physics vs. SDL, Inc. legal dispute and, to a lesser extent, the
continuing expansion of the Company's business and headcount increases.
The Company expects that SG&A, exclusive of the settlement and related legal
costs for the Spectra-Physics dispute, will continue to increase to support the
Company's current and expected future volumes of business. However, there can be
no assurances that current SG&A levels as a percentage of total revenue are
indicative of future SG&A as a percentage of total revenue.
INTEREST INCOME, NET. Net interest income for the three months ended September
30, 1997 decreased from that of the corresponding 1996 quarter due to a
reduction in interest income generating investments resulting from the payment
of $27.5 million in settlement and related legal costs associated with the
resolution of the Spectra-Physics legal dispute in the second quarter of fiscal
1997.
Net interest income for the nine months ended September 1997 increased over the
corresponding 1996 period due to the investment of cash received from the
Company's June 1996 follow-on public offering.
LOSS ON SALE OF SECURITIES. The early liquidation of investment securities to
pay for the settlement and related legal costs of the Spectra-Physics legal
dispute resulted in a $324,000 loss on the sale of securities during the second
quarter of 1997.
PROVISION FOR INCOME TAXES. The income tax provision for the three and nine
months ended September 30, 1997 of $139,000 and $367,000 consists principally of
foreign income taxes and state minimum taxes. No income tax benefit has been
recognized for the loss incurred for the nine months ended September 1997.
Although realization is not assured, the Company continues to believe that it
will generate future taxable income sufficient to realize the benefit of the
$3.0 million of net deferred tax assets previously recognized. The amount of the
net deferred tax assets considered realizable could be reduced in the near term
if estimates of future taxable income are reduced. Management intends to
evaluate the realizability of the net deferred tax assets each quarter to assess
the need for the valuation allowance.
The effective tax rate for the nine months ended September 1996 was 30%, which
differed from the combined federal and state statutory tax rate of 40% primarily
due to the benefits of tax-exempt interest income and state tax credits, as well
as a reduction in the valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
The payment of settlement and related legal costs of $27.5 million to conclude
the Spectra-Physics legal dispute primarily contributed to the use of cash by
the Company's operating activities for the nine months ended September 30, 1997.
The settlement payment was funded through sale of the Company's investment
securities. Excluding this $27.5 million payment, cash provided by operating
activities was $3.6 million for the nine months ended September 30, 1997. In
addition, the Company paid $7.3 million for planned facilities expansion and
capital equipment purchases and completed its acquisition of the SDL Optics
business through a cash payment of $2.7 million. As a result, cash, cash
equivalents, short-term investments and long-term investments decreased from
$58.3 million at December 31, 1996 to $25.6 million at September 30, 1997.
The Company currently expects to spend approximately $3.0 million for capital
equipment purchases and leasehold improvements during the fourth quarter of
1997.
11
<PAGE> 12
The Company believes that current cash balances, cash generated from operations,
and cash available through the equity markets will be sufficient to fund capital
equipment purchases, acquisitions of complementary businesses, products or
technologies and working capital requirements at least through 1997. However,
there can be no assurances that events in the future will not require the
Company to seek additional capital sooner or, if so required, that adequate
capital will be available on terms acceptable to the Company.
RISK FACTORS
The statements contained in this Report on Form 10-Q that are not purely
historical are forward looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, hopes,
intentions, beliefs or strategies regarding the future. Forward looking
statements include SDL's liquidity, anticipated cash needs and availability,
anticipated expense levels, realizability of deferred tax assets, future gross
margins, improvements in manufacturing yields, introduction of new products,
continuing expansion of the Company's business, retention of rights under
research and development programs, and ability to leverage such programs to
broader product and technology offerings, under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations." All
forward looking statements included in this document are based on information
available to the Company on the date hereof, and SDL assumes no obligation to
update any such forward looking statement. It is important to note that the
Company's actual results could differ materially from those in such forward
looking statements. Among the factors that could cause actual results to differ
materially are the factors detailed below. You should also consult the risk
factors listed from time to time in the Company's Reports on Form 10-Q, 8-K,
10-K and Annual Reports to Stockholders.
MANUFACTURING RISKS. The manufacture of semiconductor OEIC and laser components,
products and systems such as those sold by the Company is highly complex and
precise, requiring production in a highly controlled and clean environment.
Changes in the Company's or its suppliers' manufacturing processes, designs,
equipment or the inadvertent use of defective or contaminated materials by the
Company or its suppliers has in the past and could in the future adversely
affect the Company's ability to achieve acceptable manufacturing yields and
product reliability. To the extent the Company does not achieve such yields or
product reliability, its operating results and customer relationships would be
adversely affected.
The Company relies almost exclusively on its own production capability in
computer-aided chip and package design, wafer fabrication, wafer processing,
device packaging, hybrid microelectonic packaging, printed circuit board
testing, final assembly and testing of products. Because the Company
manufactures, packages and tests these components, products and systems at its
own facility, and such components, products and systems are not readily
available from other sources, any interruption in manufacturing resulting from
shortages of parts or equipment, fire, natural disaster, equipment failures,
poor yields or otherwise would have a material adverse effect on the Company's
business and results of operations. In particular, a significant portion of the
Company's production relies or occurs on equipment for which the Company does
not have a backup. In order to alleviate, at least in part, this situation, the
Company is in the process of remodeling part of its front-end wafer fabrication
and packaging facilities. As a result, at times, parallel front-end production
activities have been necessary to provide adequate time for customer acceptance
and to validate yields, thereby increasing production costs. There can be no
assurances that the Company will not experience further start-up costs and yield
problems in fully utilizing its increased wafer capacity. In the event of any
disruption in production by one of these machines, the Company's business and
results of operations could be materially adversely affected. Furthermore, the
Company has a limited number of employees dedicated to the operation and
maintenance of its equipment, loss of whom could affect the Company's ability to
effectively operate and service such equipment.
12
<PAGE> 13
The Company experienced lower than expected production yields on some its
products, including certain key product lines, during the second half of 1996,
certain of which have continued into the third quarter of 1997. While the
Company continues to aggressively address these problems, solutions on certain
0product lines have proven to be more difficult to identify and implement than
anticipated. This reduction in yields adversely affected gross margins, delayed
components, product and system shipments and, to a certain extent, new orders
booked. There can be no assurance that the Company's manufacturing yields will
be acceptable to ship products on time at profitable margins in the future. To
the extent the Company continues to experience lower than expected manufacturing
yields or experiences any shipment delays, the Company could continue to lose
customers and experience reduced or delayed customer orders and cancellation of
existing backlog. In such event, the Company's business and results of
operations would be materially adversely affected.
DEPENDENCE ON EMERGING APPLICATIONS. The Company's current products serve many
applications in the communications, information and light source replacement
markets. In many cases, the Company's products are substantially completed, but
the customer's product is not yet completed, and the applications are emerging
or are otherwise in new markets. In addition, the Company and certain of its
customers are currently in the process of developing new products, in various
stages of development, testing and qualification, sometimes in emerging
applications or new markets. A substantial portion of the Company's products
address markets that are not now, and may never become substantial commercial
markets. The Company has experienced, and is expected to experience,
technological and pricing constraints that may preclude development of markets
and fluctuation in customer orders. Currently, several of the Company's
customers are testing and qualifying a new pump module for potential volume
applications. No assurances can be given that the Company or its customers will
continue their existing product development and new product qualification
efforts, or if continued, that such efforts will be successful, that markets
will develop for any of the Company's or customer's products, or that such
products will not be superseded by other technology or products.
NEED TO MANAGE GROWTH. The Company has on occasion been unable to manufacture
certain products in quantities sufficient to meet demand of its existing
customer base and new customers. The recent expansion in the scope of its
operations has placed a considerable strain on its management, financial,
manufacturing and other resources and has required the Company to implement and
improve a variety of operating, financial and other systems, procedures and
controls. There can be no assurance that any existing or new systems, procedures
or controls will be adequate to support the Company's operations or that its
systems, procedures and controls will be designed, implemented or improved in a
cost-effective and timely manner. Any failure to implement, improve and expand
such systems, procedures and controls in an efficient manner at a pace
consistent with the Company's business could have a material adverse effect on
the Company's business and results of operations.
The future success of the Company is dependent, in part, on its ability to
attract, assimilate and retain additional employees, including certain key
personnel. The Company will continue to need a substantial number of additional
personnel, including those with specialized skills, to commercialize its
products and expand all areas of its business in order to continue to grow. The
Company intends to hire a significant number of additional personnel in 1997 and
beyond. Competition for such personnel is intense, and there can be no assurance
that the Company will be able to attract, assimilate or retain additional highly
qualified personnel.
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.
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
13
<PAGE> 14
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 had 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.
DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. The Company derived
approximately 41%, 43% and 45%, of its revenue directly and indirectly from a
variety of Federal government sources during the first nine months of 1997 and
fiscal 1996 and 1995, respectively. The Company received approximately 19%, 21%
and 19% of its revenue from Lockheed Martin through several government and
commercial programs for the first nine months of 1997, and fiscal 1996 and 1995.
Almost all of the Company's revenue from Lockheed Martin during these periods
was, and during the remainder of 1997 is expected to be, derived from
Federally-funded programs. The demand for certain of the Company's services and
products is directly related to the level of funding and the Company's
performance 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 and perform well in such programs. Substantially all of the
Company's research revenue for 1996 and 1995 was funded by Federal programs.
Most of the Company's Federally-funded programs are subject to renewal every one
or two years, so that continued work by the Company under these programs in
future periods is not assured. Federally-funded programs are subject to
termination for convenience of the government agency, at which point the Company
would be reimbursed for related allowable costs incurred to the termination
date. Federally-funded contracts are subject to audit of pricing and actual
costs incurred, which have resulted, and could result in the future, in price
adjustments. The Federal government has in the past, and could in the future,
challenge the Company's accounting methodology for computing indirect rates and
allocating indirect costs to government contracts. The Federal government is
currently challenging certain of the Company's allowable costs and indirect
rates. A change in the Company's accounting practices in this area could result
in reduced profit margins on government contracts. During the fourth quarter of
1996, the Company exceeded the maximum number of employees allowed under
eligibility requirements for the U.S. government's Small Business Innovative
Research (SBIR) programs and will no longer be able to compete for research
contract awards within SBIR programs. Previously awarded SBIR contracts will not
terminate but, depending on the contract, can continue through contract
completion, which can be up to two years from the initial contract award date.
SBIR contracts accounted for approximately 7%, 6% and 5% of revenue in the first
nine months of 1997, and fiscal 1996 and 1995, respectively.
RISK OF PATENT INFRINGEMENT CLAIM. The semiconductor optoelectronics,
communications, information and laser industry is characterized by frequent
litigation regarding patent and other intellectual property rights. From time to
time, the Company has received, and may receive in the future, notice of claims
of infringement of other parties' proprietary rights 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 of 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 this regard see
Legal Proceedings.
14
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. Information disclosed in the Company's Form 10-K for
the year ended December 31, 1996 under heading Part I Item 3, Legal Proceedings,
is incorporated herein by this reference.
Since the date of that disclosure, Rockwell has filed an appeal of the Court's
order granting the Company's motion for summary judgment on the ground that
Rockwell's patent was invalid. The appeal is currently pending before the
United States Circuit Court of Appeals for the Federal Circuit.
ITEM 2. CHANGES IN SECURITIES. Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not Applicable
ITEM 5. OTHER INFORMATION. Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Lists of Exhibits
<TABLE>
<CAPTION>
Number Exhibit Description
----- -------------------
<S> <C>
11.1 Computation of Net Income (Loss)
per Common and Common Equivalent Share
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
15
<PAGE> 16
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SDL, INC.
Registrant
November 10, 1997 /s/ JOHN P. MELTON
----------------------------------
John P. Melton
Executive Vice President
Finance and Administration
(duly authorized officer, and principal
financial and accounting officer)
16
<PAGE> 17
Exhibit Number Description
- -------------- -----------
11.1 Computation of Net Income (Loss)
per Common and Common Equivlent Share
27.1 Financial Data Schedule
17
<PAGE> 1
EXHIBIT 11.1
SDL, INC.
COMPUTATION OF NET INCOME (LOSS) PER
COMMON AND COMMON EQUIVALENT SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
PRIMARY
Weighted average number of
common shares outstanding 13,546 13,032 13,449 11,627
Incremental common shares
attributable to shares issuable under
employee stock plans 885 1,110 * 1,239
-------- -------- -------- --------
Total shares 14,431 14,142 13,449 12,866
======== ======== ======== ========
Net income (loss) $ 2,451 $ 943 $(26,513) $ 5,531
======== ======== ======== ========
Net income (loss) per share $ 0.17 $ 0.07 $ (1.97) $ 0.43
======== ======== ======== ========
</TABLE>
A fully diluted computation is not presented since such amounts differ by less
than 3% of the net income per share amount shown above.
* There are no incremental common shares attributable to shares issuable under
employee stock plans due to the net loss incurred during the nine months
ended September 30, 1997. These incremental shares would be anti-dilutive.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1997 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FORM 10-Q.
</LEGEND>
<CIK> 0000934741
<NAME> SDL, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 4,347
<SECURITIES> 9,500
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 12,635
<CURRENT-ASSETS> 49,531
<PP&E> 46,325
<DEPRECIATION> (20,639)
<TOTAL-ASSETS> 91,219
<CURRENT-LIABILITIES> 15,999
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 74,180
<TOTAL-LIABILITY-AND-EQUITY> 74,194
<SALES> 19,724
<TOTAL-REVENUES> 23,951
<CGS> 13,140
<TOTAL-COSTS> 16,325
<OTHER-EXPENSES> 5,302
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (266)
<INCOME-PRETAX> 2,590
<INCOME-TAX> 139
<INCOME-CONTINUING> 2,451
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,451
<EPS-PRIMARY> 0.17
<EPS-DILUTED> 0.17
</TABLE>
