<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 June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to _______________________
Commission File Number 0-25688
SDL, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0331449
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
80 Rose Orchard Way, San Jose, CA 95134-1365
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (408) 943-9411
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock as of August 4,
1998 was 13,870,604.
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SDL, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations for
the three and six months ended June 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities and Use of Proceeds 15
Item 3. Defaults upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 17
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
--------------------------
(UNAUDITED) (1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,945 $ 4,593
Short-term investments 12,475 10,400
Accounts receivable, net 20,504 19,960
Inventories 15,844 13,938
Prepaid expenses and other current assets 2,937 2,738
--------- ---------
Total current assets 54,705 51,629
Property and equipment, net 28,743 26,298
Long-term investments 12,043 11,613
Note due from related party 524 536
Other assets 4,317 4,148
--------- ---------
$ 100,332 $ 94,224
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,098 $ 8,469
Accrued payroll and related expenses 3,271 2,945
Income taxes payable 687 828
Unearned revenue 193 393
Acquisition obligations 650 650
Other accrued liabilities 2,434 2,332
--------- ---------
Total current liabilities 14,333 15,617
Other long-term liabilities 2,390 2,020
Commitments and contingencies
Stockholders' equity:
Preferred stock -- --
Common stock 14 14
Additional paid-in-capital 117,756 116,409
Accumulated other comprehensive income (134) (208)
Accumulated deficit ($32,084 relating to the repurchase
of common stock and recapitalization in 1992) (33,981) (39,586)
--------- ---------
83,655 76,629
Less: Stockholders' notes receivable (46) (42)
--------- ---------
Total Stockholders' equity 83,609 76,587
--------- ---------
$ 100,332 $ 94,224
========= =========
</TABLE>
(1) The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date.
See accompanying notes.
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Total revenue:
Product revenue $ 22,848 $ 18,182 $ 44,988 $ 34,957
Research revenue 2,962 3,388 6,179 7,629
-------- -------- -------- --------
25,810 21,570 51,167 42,586
Cost of revenue:
Cost of product revenue 14,431 14,974 29,209 25,860
Cost of research revenue 2,464 3,359 4,836 6,491
-------- -------- -------- --------
Gross margin 8,915 3,237 17,122 10,235
Operating expenses:
Research and development 2,696 2,473 5,172 5,309
Selling, general and administrative 3,194 30,178 6,083 34,075
Amortization of purchased intangibles 193 163 389 324
-------- -------- -------- --------
Operating income (loss) 2,832 (29,577) 5,478 (29,473)
Interest income and other, net 309 106 582 737
-------- -------- -------- --------
Income (loss) before income taxes 3,141 (29,471) 6,060 (28,736)
Provision for income taxes 235 -- 455 228
-------- -------- -------- --------
Net income (loss) $ 2,906 $(29,471) $ 5,605 $(28,964)
======== ======== ======== ========
Net income (loss) per share - basic $ 0.21 $ (2.19) $ 0.41 $ (2.16)
======== ======== ======== ========
Net income (loss) per share - diluted $ 0.20 $ (2.19) $ 0.38 $ (2.16)
======== ======== ======== ========
Number of weighted average shares - basic 13,830 13,462 13,769 13,400
Number of weighted average shares - diluted 14,700 13,462 14,623 13,400
</TABLE>
See accompanying notes.
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SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS - UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------
1998 1997
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net (loss) income $ 5,605 $(28,964)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities
Depreciation and amortization 3,635 2,603
Deferred income taxes -- 477
Changes in operating assets and liabilities
Accounts receivable (544) (6,883)
Inventories (1,906) 946
Accounts payable (1,371) 1,988
Income taxes payable (141) (278)
Accrued payroll and related expenses 326 (199)
Unearned revenue (200) 487
Other accrued liabilities 102 179
Other (448) 558
-------- --------
Total adjustments (547) (122)
-------- --------
Net cash provided by (used in) operating activities 5,058 (29,086)
-------- --------
INVESTING ACTIVITIES:
Acquisition of property and equipment, net (5,690) (5,000)
Payments on acquisition obligations -- (2,712)
Sale (purchase) of investments, net (2,363) 35,525
-------- --------
Net cash provided by (used in) investing activities (8,053) 27,813
FINANCING ACTIVITIES:
Issuance of stock pursuant to employee stock plans 1,347 960
Payments on stockholders' notes receivables -- 5
-------- --------
Net cash provided by financing activities 1,347 965
Net decrease in cash and cash equivalents (1,648) (308)
Cash and cash equivalents at beginning of period 4,593 2,605
-------- --------
Cash and cash equivalents at end of period $ 2,945 $ 2,297
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES:
Unrealized gains (loss) on marketable securities $ 142 $ (53)
SUPPLEMENT DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes $ 575 $ --
</TABLE>
See accompanying notes.
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SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended June 30,
1998 are not necessarily indicative of the results that may be expected
for the year ended December 31, 1998. 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, 1997.
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 other, net and were immaterial for all
periods presented.
The Company operates and reports financial results on a fiscal year of 52
or 53 weeks ending on the Friday closest to December 31. The second
fiscal quarter of 1998 and 1997 ended on July 3, 1998 and June 27, 1997,
respectively. For ease of discussion and presentation, all accompanying
financial statements have been shown as ending on the last day of the
calendar month.
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2. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted net
income (loss) per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $ 2,906 $(29,471) $ 5,605 $(28,964)
======== ======== ======== ========
Denominator:
Denominator for basic net income (loss) per
share-weighted average shares 13,830 13,462 13,769 13,400
Incremental common shares attributable to shares
issuable under employee stock plans 870 -- 854 --
-------- -------- -------- --------
Denominator for diluted net income (loss) per share
adjusted weighted average shares and assumed
conversions 14,700 13,462 14,623 13,400
======== ======== ======== ========
Net income (loss) per share - basic $ 0.21 $ (2.19) $ 0.41 $ (2.16)
======== ======== ======== ========
Net income (loss) per share - diluted $ 0.20 $ (2.19) $ 0.38 $ (2.16)
======== ======== ======== ========
</TABLE>
3. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 (SFAS 130),"Reporting Comprehensive
Income." SFAS 130 establishes new rules for the reporting and display
of comprehensive income and its components; however, the adoption of
this statement had no impact on the Company's net income or
stockholders' equity. SFAS 130 requires unrealized gains or losses on
the Company's available-for-sale securities and foreign currency
translation adjustments, which have been consistently included in
stockholders' equity and excluded from net income, to be included in
comprehensive income. Prior year financial statements have been
reclassified to conform to the requirements of SFAS 130.
Total comprehensive income amounted to approximately $3.0 million for
the second quarter 1998 compared to a comprehensive loss of $29.1
million for the second quarter of 1997. For the six months ended June
30, 1998, comprehensive income amounted to $5.7 million compared to a
$29.1 million comprehensive loss for the six months ended June 30,
1997.
4. RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131 (SFAS 131),
"Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes new requirements for the reporting of
information regarding operating segments, products, services,
geographic areas and major customers. The Company will provide the
disclosures required by SFAS 131 in its Form 10-K for the year ended
December 31, 1998.
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5. INVENTORIES
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
------- -------
<S> <C> <C>
Raw materials $ 7,051 $ 6,087
Work in process 8,793 7,851
------- -------
$15,844 $13,938
======= =======
</TABLE>
No significant amounts of finished goods are maintained.
6. SHAREHOLDER RIGHTS PLAN
The Company has adopted a Shareholder Rights Plan (Rights Agreement).
Pursuant to the Rights Agreement, rights were distributed at the rate of
one right for each share of Common Stock owned by the Company's
stockholders of record on November 17, 1997. The rights expire on
November 5, 2007 unless extended or earlier redeemed or exchanged by the
Company.
Under the Rights Agreement, each right entitles the registered holder to
purchase one-hundredth of a Series B Preferred share of the Company at a
price of $110. The rights will become exercisable only if a person or
group acquires beneficial ownership of 15% or more of the Company's
common stock or commences a tender offer or exchange offer upon
consummation of which such person or group would beneficially own 15% or
more or the Company's common stock.
7. CONTINGENCIES
See Part II, Item 1, Legal Proceedings for discussion of legal matters.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SDL designs, manufactures and markets semiconductor optoelectronic integrated
circuits (OEICs), semiconductor lasers, fiber optic related products and
optoelectronic systems. The Company's revenue consists of product and research
revenue. The Company's product revenue is primarily derived from the sale of
standard and customized products to a variety of customers, in volumes ranging
from single products sold to numerous organizations to high unit volumes sold to
certain original equipment manufacturer (OEM) customers. As a result, product
gross margins tend to fluctuate based in part 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, 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 80 U.S. patents and has approximately 90 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.
The Company operates and reports financial results on a fiscal year of 52 or 53
weeks ending on the Friday closest to December 31. The second fiscal quarter of
1998 and 1997 ended on July 3, 1998 and June 27, 1997, respectively. For ease of
discussion and presentation, all accompanying financial statements have been
shown as ending on the last day of the calendar month.
RESULTS OF OPERATIONS
REVENUE. Total revenue for the quarter ended June 30, 1998 increased 20% to
$25.8 million compared to $21.6 million in the corresponding 1997 quarter. For
the six months ended June 30, 1998, total revenue increased to $51.2 million
from $42.6 million reported for the comparable period. Product revenue reported
for the second quarter of 1998 increased 26% compared to product revenue for the
second quarter of 1997. The growth in revenue resulted primarily from continued
strong demand for SDL's 980 nm pump modules, used in the fiber optics
communication markets, and to a lesser extent, the Company's new materials
processing products. Research revenue declined both in dollars and as a
percentage of total revenue compared to the corresponding quarter and six month
period ended June 30, 1997. This downward trend is a result of the Company
continuing to focus its longer term strategy on commercial product
opportunities. Revenue derived directly or indirectly from government sources
declined to 33% of total revenue reported for the first six months of 1998,
compared to 42% for the first six months of 1997. Additionally, revenue received
from Lockheed Martin decreased to 15% of total revenue during the six month
period ended June 30, 1998 compared to 19% in the prior period.
International revenue as a percentage of total revenue for the six months ended
June 30, 1998 increased to 20% from 16% for the corresponding 1997 period.
Increased international marketing efforts primarily resulted in this
international revenue growth.
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There can be no assurance that the application markets for SDL's products will
grow in future periods at historical percentage rates. Further, there can be no
assurance that the Company will be able to increase or maintain its market share
in the future or to sustain historical growth rates.
GROSS MARGIN. Gross margins increased to 34.5% and 33.5% for the three and six
months ended June 30, 1998 from 15.0% and 24.0% in the comparable 1997 periods.
Increased volume of 980 nm product during the second quarter and first half of
1998 combined with lower period costs and a more favorable mix of commercial
product revenue resulted in improvements in gross margin in 1998 as compared to
1997. These favorable factors were partially offset by lower margins on Federal
government contracts due to lower indirect rates. Gross margins reported for the
first half of 1997 were adversely impacted by start-up costs for the expansion
of the Company's wafer fab and packaging capacities, together with write-offs
totaling $1.4 million for excess and obsolete inventory and additional reserves
of $1.6 million for changes in estimable reimbursable costs.
The Company's gross margin can be affected by a number of factors, including
product mix, pricing pressures, and product yield. Generally, the cost of newer
products tends to be higher as a percentage of product revenue than that of more
mature, higher volume products. In addition, the cost of research revenue is
significantly higher as a percentage of revenue, as research revenue is
typically based on costs incurred rather than market pricing. As a result of
these factors, gross margin fluctuations are difficult to predict and there can
be no assurance that the Company will maintain gross margins at current levels
in future periods.
RESEARCH AND DEVELOPMENT. Research and development expense for the three and six
months ended June 30, 1998 was $2.7 million and $5.2 million, respectively,
compared to $2.5 million and $5.3 million for the corresponding 1997 periods.
Research and development expense as a percentage of total revenue was 10% and
12% for the six months ended June 30, 1998 and 1997, respectively. The 1997
research and development spending was focused on addressing manufacturing
process improvements, primarily production yields, and to a lesser extent, new
product development. Conversely, during 1998 the emphasis of research and
development has been to bring new communication, laser and system products to
market.
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. As reported, selling, general and
administrative expense (SG & A) for the three months ended June 1998 and 1997
was $3.2 million and $30.2 million, respectively. Excluding the settlement and
related legal costs of approximately $27.5 million in the quarter and six month
period ended June 30, 1997, associated with the Spectra Physics vs. SDL, Inc.
legal dispute, SG & A increased on an absolute basis and as a percentage of
revenue for both the three and six month period ended June 30, 1998 compared to
that of the prior year primarily due to expansion of the Company's sales and
marketing efforts. The Company expects quarterly G&A spending through the second
half of 1998 to remain relatively flat with that of the first half of the year,
with sales and marketing spending increasing to support the Company's current
and expected future volume of business.
INTEREST INCOME AND OTHER, NET. Net interest income for the three and six months
ended June 30, 1998 was $0.3 million and $0.6 million, respectively, compared to
$0.1 million and $0.7 million for the corresponding 1997 periods. The early
liquidation of investment securities to pay for the settlement and related legal
costs of the Spectra Physics vs. SDL, Inc. legal dispute resulted in a loss on
the sale of securities during the second quarter of 1997. Lower average cash,
cash equivalents and investments during 1998 resulted in lower interest income
for the first half of 1998 compared to the same six months of 1997.
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PROVISION FOR INCOME TAXES. The income tax provision for the six months ended
June 30, 1998 of $455,000 consists principally of foreign income taxes and
Federal and state minimum taxes. The Company has benefited from previously
unrecognized federal and state net operating loss carryforwards. The income tax
provision for the six months ended June 30, 1997 of $228,000 consisted
principally of foreign income taxes and state minimum taxes.
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 or increased in
the near term if estimates of future taxable income are changed. Management
intends to evaluate the realizability of the net deferred tax assets each
quarter to assess the need for the valuation allowance.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating and financing activities generated cash and cash
equivalents of $6.4 million during the six months ended June 30, 1998. The
Company acquired capital equipment and funded facilities expansion for $5.7
million. As a result of these activities, cash, cash equivalents and investments
increased from $26.6 million at December 31, 1997 to $27.5 million at June 30,
1998.
The Company currently expects to spend approximately $7.0 million for capital
equipment purchases and leasehold improvements during the remainder of 1998.
The Company believes that current cash balances, cash generated from operations,
and cash available through the equity markets and banks will be sufficient to
fund capital equipment purchases, acquisitions of complementary businesses,
products or technologies and working capital requirements for the foreseeable
future. However, there can be no assurances that events in the future will not
require the Company to seek additional capital or, if so required, that adequate
capital will be available on terms acceptable to the Company.
IMPACT OF YEAR 2000
The Company is in the process of addressing the conversion to enterprise
resource planning software programs, supporting the Company's manufacturing,
finance, distribution / logistics and human resource operations. The total cost
of this conversion, which will also make all of the Company's computer systems
Year 2000 compliant is estimated at approximately $2.5 million, which includes
$1.5 million for the purchase of new software and hardware that will be
capitalized and $1.0 million that will be expensed as incurred. The Company
expects the conversion to be completed during the second quarter of 1999.
11
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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 the Company's long-term strategic focus on commercial product
opportunities, the levels of expenditures on selling, general and administration
activities, the ability to realize the benefit of net deferred tax assets, the
expected completion date of software conversion, as well as the Company's
liquidity and anticipated cash needs and availability 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 Forms 10-Q,
8-K, 10-K and Annual Reports to Stockholders.
MANUFACTURING RISKS. The manufacture of semiconductor OEIC and laser components,
products and systems such as those sold by the Company is highly complex and
precise, requiring production in a highly controlled and clean environment.
Changes in the Company's or its suppliers' manufacturing processes or the
inadvertent use of defective or contaminated materials by the Company or its
suppliers has in the past and could in the future adversely affect the Company's
ability to achieve acceptable manufacturing yields and product reliability. To
the extent the Company does not achieve such yields or product reliability, its
operating results and customer relationships would be adversely affected.
The Company relies almost exclusively on its own production capability in
computer-aided chip and package design, wafer fabrication, wafer processing,
device packaging, hybrid 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 of equipment, fire, natural disaster, equipment failures,
poor yields or otherwise would have a material adverse effect on the Company's
business and results of operations. In particular, a significant portion of the
Company's production relies or occurs on equipment for which the Company does
not have a backup. To alleviate, at least in part, this situation, the Company
remodeled its front-end wafer fabrication facility and its packaging and test
facility. During this time, front-end production activities were operated in
parallel to allow adequate time for customer acceptance and to validate yields,
thereby increasing production costs. There can be no assurances that the Company
will not experience further start-up costs and yield problems in fully utilizing
its increased wafer capacity. In the event of any disruption in production by
one of these machines, the Company's business and results of operations could be
materially adversely affected. Furthermore, the Company has a limited number of
employees dedicated to the operation and maintenance of its equipment, loss of
whom could affect the Company's ability to effectively operate and service such
equipment.
The Company experienced lower than expected production yields on some of its
products, including certain key product lines during 1997 and the first half of
1998. 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.
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DEPENDENCE ON EMERGING APPLICATIONS AND NEW PRODUCTS. The Company's current
products serve many applications in the communications, materials processing,
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. The Company
believes that rapid customer acceptance of its new products are key to the
Company's financial results. 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 continue to experience,
competitive, technological and pricing constraints that may preclude development
of markets and fluctuation in customer orders. Currently, several of the
Company's customers are testing pump modules, amplifiers and marking systems
among other new products for potential volume applications. No assurances can be
given that the Company or its customers will qualify these new products, 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
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. The Company may also be unable to develop new products on a timely
schedule or be able to manufacture such new products at an acceptable cost so as
to maintain profitability.
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.
DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. The Company derived
approximately 33%, 38%, and 43% during the first half of 1998 and during fiscal
1997 and 1996, respectively, of its revenue directly and indirectly from a
variety of Federal government sources. The Company received approximately 15%,
19% and 21% of its revenue for the first half of 1998, and fiscal 1997 and 1996,
respectively, from Lockheed Martin through several government and commercial
programs. Almost all of the Company's revenue from Lockheed Martin during these
periods was, and during the remainder of 1998 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
13
<PAGE> 14
the Company's ability to participate in such programs. For example,
substantially all of the Company's research revenue for 1998, 1997 and 1996 was
funded by Federal programs. Most of the Company's Federally-funded programs are
subject to renewal every one or two years, so that continued work by the Company
under these programs in future periods is not assured. Federally-funded programs
are subject to termination for convenience of the government agency, at which
point the Company would be reimbursed for related allowable costs incurred to
the termination date. Federally-funded contracts are subject to audit of pricing
and actual costs incurred, which have resulted, and could result in the future,
in price adjustments. 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 government is
currently challenging certain indirect cost allocations. While management
believes that amounts recorded on its financial statements are adequate to cover
all related risks, the government has not concluded its investigation or agreed
to a settlement with the Company. Although the outcome of this 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. However, based on future developments, the Company's
estimate of the outcome of these matters could change in the near term. In
addition, 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 is no longer 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 3%, 5% and 6% of revenue in the first
half of 1998, and fiscal years 1997 and 1996, respectively.
NEED TO MANAGE GROWTH. The Company has on occasion been unable to manufacture
certain products in quantities sufficient to meet demand of its existing
customer base and new customers. The 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.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not
applicable
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, 1997 under heading Part I Item 3, Legal Proceedings,
is incorporated herein by this reference. Since the date of that disclosure, in
regards to the litigation with Rockwell discussed therein, the United States
Court of Appeals for the Federal Circuit issued an opinion vacating the Court of
Federal Claims' grant of the Company's motion for summary judgment of invalidity
based on obviousness. The Federal Circuit held that the Court of Federal Claims
had erred in finding that there were no genuine disputes of material fact
concerning the obviousness of the Rockwell patent, and that the resolution of
these disputes requires a trial. The Federal Circuit thus remanded the case back
to the trial court for further proceedings. The Federal Circuit also affirmed
the Court of Federal Claims' denial of the Company's motion for summary judgment
of invalidity based on anticipation, as well as the Court of Federal Claims'
claim construction.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company held
its Annual Meeting of Stockholders on May 14, 1998. The stockholders voted on
proposals to:
1. Elect two Class 1 Directors of the Company.
2. Approve an amendment to the 1995 Employee Stock Purchase Plan to
increase the number of shares reserved for issuance thereunder
from 450,000 shares to 850,000 shares.
3. Ratify the appointment of Ernst & Young, LLP as the Company's
auditors for 1998.
The proposals were approved by the following votes:
1. Election of Directors
Director For Withheld
Donald R. Scifres 11,440,657 48,198
Keith B. Geeslin 11,439,607 49,248
2. Amendment to 1995 Employee Stock Purchase Plan
For Against Abstain
10,667,645 786,349 34,861
3. Ratify appointment of Ernst & Young LLP
For Against Abstain
11,448,570 7,329 32,956
15
<PAGE> 16
ITEM 5. OTHER INFORMATION.
Any stockholder proposal submitted outside the processes of Rule
14a-8, under the Securities Exchange Act for presentation to
Registrants 1999 Annual Meeting of Stockholders will be
considered untimely for the purposes of Rules 14a-4 and 14a-5 if
notice thereof is received by the Registrants after March 3,
1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) List of Exhibits
Number Exhibit Description
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
16
<PAGE> 17
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SDL, INC.
Registrant
August 12, 1998 /s/ Michael Foster
-----------------------------------------
Michael Foster
Chief Financial Officer
(duly authorized officer, and principal
financial and accounting officer)
17
<PAGE> 18
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE 30,
1998 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-Q
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 2,945
<SECURITIES> 12,475
<RECEIVABLES> 21,439
<ALLOWANCES> 935
<INVENTORY> 15,844
<CURRENT-ASSETS> 54,705
<PP&E> 54,113
<DEPRECIATION> 25,370
<TOTAL-ASSETS> 100,332
<CURRENT-LIABILITIES> 14,333
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 83,595
<TOTAL-LIABILITY-AND-EQUITY> 100,332
<SALES> 44,988
<TOTAL-REVENUES> 51,167
<CGS> 29,209
<TOTAL-COSTS> 34,045
<OTHER-EXPENSES> 11,644
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,060
<INCOME-TAX> 455
<INCOME-CONTINUING> 5,605
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,605
<EPS-PRIMARY> 0.41<F1>
<EPS-DILUTED> 0.38
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
