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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 JANUARY 2, 1998 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 of (IRS Employer
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
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(Title of Class)
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. [ ]
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates of the Registrant, based on the closing sale price of the
Common Stock on February 13, 1998, as reported by Nasdaq was $162,065,480.
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 13, 1998 the registrant had outstanding 13,700,835 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 1998 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), high power semiconductor lasers and
fiber optic based systems incorporating 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, local area network (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 fiber optic LAN, and display 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, marking, welding, and heat treatment, in surgical
devices, and in environmental sensors. Laser marking, 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, OEIC, and fiber optics
technology, the Company designs and manufactures products to overcome the
limitations of traditional electronic and optical technology. With increased
levels of semiconductor-based optoelectronic and fiber optic 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 in conjunction with new fiber optics technologies will
represent an increasing portion of the electronic or optical system's value.
Semiconductor OEICs and semiconductor lasers in conjunction with fiber optics
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. They are also widely used in
fiber optic telephone and CATV communications systems. In many applications,
semiconductor OEICs, lasers and fiber optics offer advantages over traditional
light sources.
As with silicon integrated circuits, SDL's advanced semiconductor OEICs,
lasers and fiber optics provide functionality that cannot be achieved with
conventional electronic or optical components. In the communications and
information markets the Company's products improve the amplification,
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, such as
optical satellite communications, higher speed fiber optic local area networks,
and generation of red, green or blue light on a semiconductor chip for miniature
display systems.
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, laser and fiber optic
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 to focus the light from the
semiconductor OEIC or laser 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.
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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 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 high power versions of 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 18 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. A fiber amplifier, coupled to a wavelength tunable semiconductor laser,
provides what the Company believes is the highest power tunable light source in
the key 1550 nm range of wavelengths serving the rapidly growing wavelength
division multiplexing (WDM) fiber optic market. Fiber amplifiers are also being
developed to boost the light intensity in satellite to satellite communications
systems. Eight of the Company's system products 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 five different fiber
coupled optical power delivery systems including an award winning fiber laser
system. 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 19 percent, 21 percent, and 19
percent of its 1997, 1996, and 1995 revenue, respectively, from Lockheed Martin
Corporation (Lockheed Martin) through several government and commercial
programs. Almost all of the Company's revenue from Lockheed Martin during 1997,
1996 and 1995 was 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 70 U.S. patents and has
approximately 86 U.S. patent applications pending. In addition, the Company has
a royalty-free, non-exclusive license to approximately 50 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
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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.
Fiber lasers and fiber amplifiers are specially doped optical fibers
which can generate or amplify laser light. Fiber lasers and fiber amplifiers,
unlike semiconductor lasers, cannot be excited directly by electrical current.
Instead, light from a semiconductor laser is used to excite or pump a fiber
laser or fiber amplifier. Fiber lasers are being deployed in materials
processing and thermal printing systems. Fiber amplifiers are finding
applications in multichannel WDM and CATV fiber optic communication systems.
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
high power single mode chip designs that emit higher optical power levels than
any other commercial single mode laser. These are used to pump fiber amplifiers.
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.
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.
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RESEARCH AND DEVELOPMENT
Research and development in the semiconductor OEIC, laser and fiber
optics 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 1997, 1996 and 1995, the Company spent approximately $9.8 million,
$6.7 million and $4.0 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, development, or product customization
funding from Fortune 500 companies, major international corporations, smaller
domestic and international companies, and multiple. Federal 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.
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 13 year period, the Company received over 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--Dependence on Emerging Applications."
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 near 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, lasers and fiber optic products 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
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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 and remodeled its facilities in
1997 and intends to further expand and remodel its manufacturing facilities in
the near future. In addition, the Company has a subsidiary, SDL Optics, located
near Victoria, British Columbia, Canada. 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 has experienced, 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 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, 1997, the Company's total backlog was approximately
$43.1 million, as compared to approximately $37.2 million at December 31, 1996.
This increase is primarily due to orders placed during 1997. 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 and communications industries, 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, Uniphase is the
Company's primary competitor, with other competitors emerging. SDL Optics has
multiple competitors in its single mode pump module product lines, including
Lasertron and Nortel. In 1997, several new
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start-ups began shipping products in these markets. The Company also is
broadening its product offering in the systems area and moving into new markets
with many new competitors. 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 has announced the demonstration of high power
blue ultraviolet semiconductor lasers based on gallium nitride. 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.
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. See "Factors Affecting Earnings and Stock Price -
Competition."
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, or
represent substantial advancement, 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 70 U.S. patents, domestic and
foreign, on devices, processes, packages and systems. No patent has less than
six years of life remaining before expiration and the average remaining life is
approximately 12 years. Approximately 86 additional patent applications are
pending. The Company also has a royalty-free license to approximately 50 Xerox
U.S. patents. It also has five royalty-bearing licenses under which the Company
licenses additional patents 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
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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--Risk of Patent
Infringement Claims and--Dependence on Proprietary Technology."
Due to collaborative efforts with others, some of the Company's pending
patent applications or issued patents are filed under undivided joint ownership.
Approximately 39 of the Company's issued patents and pending applications were
developed under Federal government funding and contain a provision for a
non-exclusive, royalty-free license for Federal government use.
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.
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: the Company's expected future levels of research and development (R&D)
expenditures, under the heading "Business-Research and Development;" the
Company's ability to switch readily, reliably and efficiently from manufacture
of one product to another, under the heading "Business-Manufacturing," the
Company's ability to compete effectively in the future, under the heading
"Business-Intellectual Property;" the effect of R&D expenditures on
manufacturing yields, gross margin and product introduction, the amount of
future R&D and selling, general and administrative (SG&A) expenditures, the
amount and realizability of the Company's net deferred tax assets, the amount
and timing of capital equipment and leasehold improvements expenditures, the
sufficiency of anticipated cash resources to meet the Company's future cash
needs, and the expense, timing and impact of Year 2000 issues and solutions, all
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 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, laser and
fiber optic based components, products and systems such as those sold by the
Company is a highly complex and precise processes, requiring production in
highly controlled and clean environments. 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
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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. To alleviate,
at least in part, this situation, the Company recently remodeled its front-end
wafer fabrication facility and its packaging and test facility. The Company
incurred additional start-up costs from the expansion of its wafer fabrication
capacity during 1997. Front-end production activities were operated in parallel
to allow adequate time for customer acceptance and to validate yields, thereby
increasing production costs. There can be no assurances that the Company will
not experience further start-up costs and yield problems in fully utilizing its
increased wafer capacity. In the event of any disruption in production by one of
these machines, the Company's business and results of operations could be
materially adversely affected. Furthermore, the Company has a limited number of
employees dedicated to the operation and maintenance of its equipment, 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 1996 and 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.
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 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.
Dependence Upon Government Programs and Contracts. In 1997, 1996
and 1995, the Company derived approximately 38 percent, 43 percent and 45
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
19 percent and 21 percent of its revenue for 1997 and 1996, respectively, from
Lockheed Martin through several government and commercial programs. Almost all
of the Company's revenue from Lockheed Martin during 1996 and 1997 was, and
during 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 the
Company's ability to participate in such programs. For example, substantially
all of the Company's research revenue for 1997, 1996 and 1995 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. SDL is engaged in various cost-reimbursement type contracts
with the U.S. Government. These contracts utilize allowable costs plus contract
fee to determine revenue. 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
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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 the eligibility
requirements for the Federal government's Small Business Innovative Research
(SBIR) programs and is no longer 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 5 percent and 6 percent of revenue in
1997 and 1996, respectively.
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 result in fluctuation in customer orders. Currently, several of the
Company's customers are testing a new pump module for potential volume
applications. No assurances can be given that the Company or its customers will
qualify the new product, 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 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."
Risk of Patent Infringement Claims. The semiconductor, optoelectronics,
communications, information and laser industries are 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
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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 appealed the
Court's decision to the U.S. Circuit Court for the Federal Circuit. Oral
argument on the appeal is scheduled for March 3, 1998.
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 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.
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.
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
70 patents owned or approximately 50 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 86 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,
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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. 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
"Business -- Intellectual Property."
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 "Business --
Competition."
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.
International Distribution Risks. International revenue accounted for
approximately 17 percent, 15 percent and 23 percent, of the Company's total
revenue in 1997, 1996 and 1995, respectively. International revenue carries a
number of inherent risks, including reduced protection for intellectual property
rights in some countries, the impact of unstable 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 Federal governmental agencies.
Although to date the Company has experienced little difficulty in obtaining such
licenses or approvals, the failure to obtain such licenses or
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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, some 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 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.
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. Since the Company has acquired or in the future may acquire one or
more businesses, 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, customer order delays or
cancellations, customer qualification delays or new products by the Company, its
competitors or third parties, possible acquisition of SDL by a third party,
merger or acquisition announcements, 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 have in the past year experienced historical
highs in the market prices of their stock. The prices for several of these
companies, as well as the Company, 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, 1997, the Company employed 625 people, including 401
in manufacturing, 148 in engineering, research and development, 26 in sales and
marketing, and 50 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, 1997, the Company employed 22 such people.
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. During 1997, the Company exercised an option for an
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adjacent additional 50,000 square feet which it expects to occupy in 1998. This
lease, including the additional space, expires in March 2002. The Company has
renewal options to extend this lease through 2017.
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 appealed the
Court's decision to the U.S. Circuit Court for the Federal Circuit. Oral
argument on the appeal is scheduled for March 3, 1998.
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
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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. 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.
In addition, the Company is involved in various legal proceedings
arising in the ordinary course of its business.
17
<PAGE> 18
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 under
the symbol SDLI. The high and low sales prices are as reported by the Nasdaq
National Market.
PRICE RANGE OF COMMON STOCK
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Q1 1997 $29.00 $14.00
Q2 1997 $21.50 $ 8.00
Q3 1997 $25.25 $16.00
Q4 1997 $22.38 $13.50
Q1 1996 $22.67 $15.00
Q2 1996 $32.00 $19.50
Q3 1996 $29.00 $17.63
Q4 1996 $26.50 $16.25
</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 any earnings to finance further growth of its
business.
As of January 2, 1998, the Company had approximately 5,000 stockholders
of record.
18
<PAGE> 19
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,
---------------------------------------------------------------
1997(1)(2)(3) 1996 1995 (1) 1994 1993
------------ --------- ---------- ---------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenue ...................... $ 91,364 $ 82,475 $ 53,894 $ 33,024 $ 27,702
Cost of revenue .............. 65,154 54,956 33,390 19,991 16,879
-------- -------- -------- -------- --------
Gross margin ................. 26,210 27,519 20,504 13,033 10,823
Research and development ..... 9,794 6,681 3,994 2,781 3,047
Selling, general, and
administrative ............. 41,280 12,166 7,649 4,574 3,583
In-process research and
development ................ 753 -- 10,010 -- --
-------- -------- -------- -------- --------
Operating income (loss) ...... (25,617) 8,672 (1,149) 5,678 4,193
Net income (loss) ............ $(24,679) $ 7,121 $ (2,819) $ 2,195 $ 1,150
Net income (loss) per share-
basic(4) ..................... $ (1.83) $ 0.59 $ (0.31) $ 0.38 $ 0.20
Net income (loss) per
share-diluted(4) ........... $ (1.83) $ 0.54 $ (0.31) $ 0.29 $ 0.15
Weighted average
shares -basic(4) ............ 13,497 12,012 9,228 5,738 5,657
Weighted average
shares-diluted(4) ............ 13,497 13,199 9,228 7,461 7,421
Cash dividend on
common stock ................ $ -- $ -- $ -- $ -- $ --
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ----------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Working capital ............ $ 36,012 $ 63,243 $ 22,649 $ 5,556 $ 6,425
Total assets ............... $ 94,224 $113,842 $ 56,643 $ 23,799 $ 19,612
Long-term debt (less current
portion) ................. $ -- $ -- $ -- $ 22,519 $ 24,821
Convertible redeemable
preferred stock(5) ....... $ -- $ -- $ -- $ 10,545 $ 10,470
Stockholders' equity (net
capital deficiency) ...... $ 76,587 $ 99,227 $ 40,500 $(18,269) $(20,464)
</TABLE>
- ----------------------
(1) The results of operations for the years ended December 31, 1995 and 1997
include a one-time write-off of in-process research and development of
approximately $10.0 million and $0.8 million, respectively, in connection
with the acquisition of Seastar Optics and Mr. Laser, Inc.
(2) In 1997, the Company changed from a calendar year end to a 52-53 week year
ending on the Friday closest to December 31. Fiscal year 1997 ended January
2, 1998. For ease of discussion and presentation all fiscal year ends are
referred to as ending on December 31.
(3) The results of operations for the year ended December 31, 1997 include a
one-time charge totaling $27.5 million related to costs associated with
the litigation settlement and related legal costs of the Spectra-Physics
legal dispute. See Note 13 of Notes to Consolidated Financial Statements.
(4) The earnings per share amounts prior to 1997 have been restated to comply
with Statement of Financial Accounting Standards No. 128, Earnings Per
Share. For further discussion of earnings per share and the impact of
Statement No. 128, see the Notes to Consolidated Financial Statements.
(5) See Note 9 of Notes to Consolidated Financial Statements for discussion of
preferred stock conversion.
19
<PAGE> 20
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 70 U.S. patents and has approximately 86 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.
In November 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.
In November 1997, the Company acquired all the outstanding shares of Mr.
Laser, Inc., which was accounted for under the purchase method of accounting.
Mr. Laser's operating results are included in the accompanying consolidated
financial statements from that date.
In 1997, the Company changed its year-end from a calendar year ending
December 31, to a 52-53 week year ending on the Friday closest to December 31.
The Company's fiscal 1997 ended January 2, 1998. For ease of discussion and
presentation, all fiscal year ends are referred to as ending on December 31.
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."
20
<PAGE> 21
The following table sets forth certain operating results expressed as a
percentage of total revenue for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997(1)(2) 1996 1995(2)
- ----------------------- ---------- ---- -------
<S> <C> <C> <C>
Revenue:
Product revenue................... 84.0% 84.6% 84.0%
Research revenue.................. 16.0 15.4 16.0
----- ----- -----
Total revenue................. 100.0% 100.0% 100.0%
Cost of revenue:
Cost of product revenue (3)....... 69.7 65.0 59.3
Cost of research revenue (3)...... 79.6 75.5 75.7
----- ----- -----
Total cost of revenue......... 71.3 66.6 62.0
----- ----- -----
Gross margin.................. 28.7 33.4 38.0
Operating Expenses:
Research and development.......... 10.7 8.1 7.4
Selling, general, and administrative 45.2 14.8 14.2
In-process research and development 0.8 - 18.5
----- ----- -----
Total operating expenses...... 56.7 22.9 40.1
----- ----- -----
Operating income (loss)....... (28.0) 10.5 (2.1)
Interest income, net.................. 1.5 1.8 0.2
----- ----- -----
Income (loss) before income taxes..... (26.5) 12.3 (1.9)
Provision for income taxes............ 0.5 3.7 3.3
----- ----- -----
Net income (loss)..................... (27.0)% 8.6% (5.2)%
===== === ====
</TABLE>
- ----------------------
(1) The results of operations for the years ended December 31, 1995 and 1997
include a one-time write-off of in-process research and development of
approximately $10.0 million and $0.8 million, respectively, in connection
with the acquisition of Seastar Optics and Mr. Laser, Inc., respectively.
(2) The results of operations for the year ended December 31, 1997 includes a
one-time charge of $27.5 million related to costs associated with the
litigation settlement and related legal costs of the Spectra Physics legal
dispute. See Note 13 of Notes to Consolidated Financial Statements.
(3) 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 recorded an 11 percent increase in revenue to $91.4 million
during 1997, following a 53 percent increase in 1996 revenue to $82.5 million.
Continued demand for the Company's semiconductor laser and optoelectronic
solutions, primarily within the fiber-based communications market, has provided
this revenue growth over the past two years. Revenue generated from SDL's 980 nm
pump module increased 242 percent from 1996 to 1997. Revenue from non-government
product applications grew 19 percent during 1997 to represent 62 percent of
revenue compared to 57 percent and 55 percent of revenue during 1996 and 1995,
respectively. Research revenue grew 15 percent during 1997 and accounted for 16
percent and 15 percent of revenue for 1997 and 1996, respectively. There can be
no assurances that the applications 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.
The Company derived 38 percent, 43 percent, and 45 percent of its 1997, 1996 and
1995 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 1997, 1996 and 1995 was
funded by Federal programs. There can be no assurances that such programs will
continue to be
21
<PAGE> 22
funded even if government agencies have available financial resources or that
the Company will continue to be awarded contracts under such programs.
Approximately 19 percent, 21 percent and 19 percent of 1997, 1996 and 1995
revenue was received from Lockheed-Martin through numerous government and
commercial programs. While absolute dollar revenue from Lockheed-Martin
increased during 1997, the percentage of revenue decreased due to the growth in
SDL's non-government product applications revenue. Most of the revenue from
Lockheed-Martin during this three year period was, and during 1998 is expected
to be, derived from Federally-funded programs, which are subject to renewal
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 continue to decrease as a percentage of the Company's total 1998
revenue. A 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 is no longer 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 5 percent and 6 percent of total revenue in 1997 and 1996,
respectively.
International revenue represents 17 percent, 15 percent, and 23 percent of total
revenue for 1997, 1996, and 1995, 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 contributed to the decreased 1997 and 1996 percentages for
international revenue compared to 1995.
Gross margin. Gross margin as a percentage of revenue was 29 percent in 1997,
compared to 33 percent and 38 percent for 1996 and 1995, respectively. The
decline in gross margin during 1997, as compared to 1996 and 1995 primarily
resulted from: (i) start-up costs for expansion of the Company's wafer fab and
transition of the various product lines to the new fabrication equipment, (ii)
higher incremental manufacturing engineering costs, (iii) inventory write-offs
in the June quarter totaling $1.4 million for the transition to new
manufacturing processes, designs and equipment, and (iv) a reserve of $1.6
million related to changes in estimable reimbursable costs in the June quarter.
Increased product throughput during the second half of 1997 improved product
gross margins to 33 percent for the six months ended December 1997. See "Factor
Affecting Earnings and Stock Price - Manufacturing Risks."
Gross margin as a percentage of revenue was 33 percent in 1996, compared to 38
percent for 1995. Gross margin for 1996 was impacted by production yield issues
on several of the Company's product lines during the third quarter of 1996 and,
to a lesser degree, volume discounts on certain products. 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.
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. Considering 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 SDL believes it is critical to make investments in
research and development to maintain its competitive advantage in innovative,
productive and high-quality products. Research and development grew to $9.8
million during 1997 compared to $6.7 million and $4.0 million during 1996 and
1995. Research as a percentage of revenue was 11 percent, 8 percent and 7
percent for 1997, 1996 and 1995, respectively. The growth in 1997 research and
development resulted primarily from increased manufacturing process development
efforts, together with the development of new communications and laser system
products. The Company believes these investments in research and development
will further improve manufacturing yields and gross margin, as well as lead to
new product introductions, some of which having already been introduced during
1997. It is expected that the Company will continue to invest increasing amounts
22
<PAGE> 23
for research and development during 1998 in continuing to improve product and
manufacturing process yield issues, together with the introduction of new
products. Research and development may vary based on future levels of customer
funded research and development.
Selling, general and administrative (SG&A). During the second quarter of 1997
the Company recorded a $27.5 million charge for the settlement and related legal
costs associated with the Spectra-Physics vs. SDL, Inc. legal dispute. Excluding
the settlement and related legal costs, SG&A expense, as a percentage of revenue
was 15 percent for 1997, compared to 15 percent and 14 percent in 1996 and 1995,
respectively. The year-over-year increases in SG&A are primarily attributed to
the continuing expansion of the Company's business, headcount growth and
increasing legal costs in defense of the Spectra-Physics lawsuit during 1996 and
1997, and amortization expense resulting from the acquisition of Seastar Optics
beginning in December 1995. The Company expects that SG&A amounts, exclusive of
the settlement and related legal costs, will continue to increase to support the
Company's current and expected future volumes of business, including the
expansion of SDL's domestic and international sales and marketing efforts.
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.
In-process research and development. The acquisition of Mr. Laser, Inc. during
1997 and Seastar Optics during 1995 resulted in the write-off of purchased
in-process research and development of $0.8 million and $10.0 million,
respectively.
Interest income, net. During 1997 the Company liquidated a portion of its
interest income generating investments for payment of $27.5 million in
settlement and related legal costs associated with the resolution of the
Sprectra-Physics legal dispute. The early liquidation of certain of these
investment securities resulted in a loss of approximately $0.3 million, which is
included within interest income on the statement of operations. Excluding that
loss, interest income recorded during 1997 increased slightly from that recorded
during 1996. Interest income increased significantly during 1996 as compared to
1995 as a result of the repayment of the outstanding subordinated and bank debt
balances effective with the Company's March 1995 initial public stock offering,
combined with the investment in income generating investments of cash received
from the Company's June 1996 follow-on public stock offering.
Provision for Income Taxes. The income tax provision for the year ending
December 31, 1997 of $417,000 primarily consists of current foreign income taxes
for the earnings of SDL Optics. No income tax benefit has been recognized for
the 1997 loss incurred because realization of deferred tax assets arising as a
result of the loss sustained is dependent upon future taxable income, the amount
and timing of which are uncertain. Accordingly, a valuation allowance has been
established to offset the deferred tax assets resulting from the loss.
The effective tax rate for the years ending December 31, 1996 and 1995 were 30
percent and 37 percent respectively. The tax rate for 1996 is less than that for
1995 due to the incremental benefits of state tax credits and tax-exempt
interest income, as well as reduction in the valuation allowance.
Although realization is not assured, the Company continues to believe that it
will generate future taxable income sufficient to realize the benefit of the $3
million of net deferred tax assets previously recognized. The amount of the net
deferred tax assets considered realizable could be reduced 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 on a quarterly
basis to assess the need for the valuation allowance.
Quarterly Results of Operations
The following tables set forth certain unaudited quarterly financial data for
the four quarters of each 1997 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.
23
<PAGE> 24
<TABLE>
<CAPTION>
QUARTERS ENDED
1997 1996
---------------------------------------------- ----------------------------------------------
JUNE 30
MAR. 31 (1)(2) SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
------- ------ -------- ------- ------- ------- -------- -------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue ........... $ 21,016 $ 21,570 $ 23,951 $ 24,827 $ 20,422 $ 21,606 $ 19,369 $ 21,078
Cost of revenue ... 14,018 18,333 16,325 16,478 12,747 13,758 14,499 13,952
-------- -------- -------- -------- -------- -------- -------- --------
Gross margin ...... $ 6,998 $ 3,237 $ 7,626 $ 8,349 $ 7,675 $ 7,848 $ 4,870 $ 7,126
Operating income
(loss) .......... $ 104 $(29,577) $ 2,324 $ 1,532 $ 3,177 $ 3,506 $ 381 $ 1,608
Net income (loss).. $ 507 $(29,471) $ 2,451 $ 1,834 $ 2,159 $ 2,429 $ 943 $ 1,590
======== ======== ======== ======== ======== ======== ======== ========
Net income (loss)
per share-basic(3) $ 0.04 $ (2.19) $ 0.18 $ 0.13 $ 0.20 $ 0.22 $ 0.07 $ 0.12
======== ======== ======== ======== ======== ======== ======== ========
Net income (loss)
per share-
diluted(3) ....... $ 0.04 $ (2.19) $ 0.17 $ 0.13 $ 0.18 $ 0.20 $ 0.07 $ 0.11
======== ======== ======== ======== ======== ======== ======== ========
Weighted average
shares-basic(3).. 13,331 13,462 13,546 13,643 10,754 11,097 13,032 13,166
Weighted average
shares-diluted(3) 14,265 13,462 14,431 14,444 12,074 12,383 14,142 14,196
</TABLE>
- ----------------------
(1) The results of operations for the quarter ended June 30, 1997 include a
one-time write-off of in-process research and development of approximately
$0.8 million in connection with the acquisition of Mr. Laser, Inc.
(2) The results of operations for the quarter ended June 30, 1997 include a
one-time charge totaling $27.5 million for the settlement and related legal
costs associated with the Spectra-Physics vs. SDL, Inc. legal dispute. See
Note 13 of Notes to Consolidated Financial Statements.
(3) The 1996 and first three quarters of 1997 earnings per share amounts have
been restated to comply with Statement of Financial Accounting Standards
No. 128, Earnings per Share.
LIQUIDITY AND CAPITAL RESOURCES.
The payment of settlement and related legal costs of $27.5 million to conclude
the Spectra-Physics legal dispute resulted in the use of cash by the operating
activities for the year ended December 31, 1997. The settlement payment was an
operating use of cash and was funded through sale of the Company's investment
securities. An increase in the days of sales outstanding in accounts receivable
in 1997, as compared with 1996, also contributed to a use of operating cash in
1997. A government required change in the Company's billing procedures for cost
reimbursement contracts was principally responsible for the increase in accounts
receivable at December 1997. In addition, the Company received $2.1 million from
the issuance of stock under employee stock plans, which was offset by
investments of $9.4 million for planned facilities expansion and capital
equipment purchases and a cash payment of $2.7 million which completed the SDL
Optics acquisition. As a result, cash, cash equivalents, short-term investments
and long-term investments decreased from $58.3 million at December 31, 1996 to
$26.6 million at December 31, 1997.
In June 1996, the Company issued 1,755,000 shares of common stock in a follow-on
public stock offering at a per share price of $27.00. Net proceeds to the
Company were approximately $44.7 million.
The Company currently expects to spend approximately $17 million for capital
equipment purchases and leasehold improvements during 1998.
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 1998. However,
there can be no assurances that events in
24
<PAGE> 25
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.
IMPACT OF YEAR 2000
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs have time-sensitive software that recognize a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
As newer, more functional software solutions are currently available and are
Year 2000 compliant, the Company has concluded that the conversion to
enterprise resource planning software programs, supporting the Company's
manufacturing, finance, distribution / logistics and human resource operations,
is more cost effective. The total cost of this conversion, which will also make
all of the Company's computer systems Year 2000 complaint 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. To date, the Company has incurred and expensed
approximately $50,000 and capitalized approximately $70,000 relating primarily
to the assessment of the Year 2000 issue and the development of a modification
plan and purchase of new software.
The project is estimated to be completed not later than March 31, 1999, which is
prior to any anticipated impact on the Company's computer systems. The Company
believes that with conversions to new software, the Year 2000 Issue will not
pose significant operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 issue could have a material impact on the operations of the Company.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company's
interface systems are vulnerable to those third parties' failure to remediate
their own Year 2000 issues. The Company's total Year 2000 project cost and
estimates to complete include the estimated costs and time associated with the
impact of third party Year 2000 issues based on presently available information.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted and would not have an
adverse effect on the Company's systems. The Company has determined it has no
exposure to contingencies related to the Year 2000 issue for the products it has
sold or will sell in the future.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources and other factors. However,
there can be no guarantee that these estimates factors that might and cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, and similar uncertainties.
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, 1997 and 1996
Consolidated Statements of Operations - Years Ended December 31,
1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity - Years Ended
December 31, 1997, 1996, and 1995
Consolidated Statements of Cash Flow - Years Ended December 31, 1997,
1996, and 1995
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,
1997 1996
--------- ---------
(In thousands, except
share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ...................................... $ 4,593 $ 2,605
Short-term investments ......................................... 10,400 45,353
Accounts receivable, net ....................................... 19,960 11,816
Inventories .................................................... 13,938 13,441
Prepaid expenses and other current assets ...................... 2,738 3,902
--------- ---------
Total current assets ............................................. 51,629 77,117
Property and equipment, net ...................................... 26,298 22,020
Long-term investments ............................................ 11,613 10,325
Note due from related party ...................................... 536 --
Other assets ..................................................... 4,148 4,380
--------- ---------
Total assets ..................................................... $ 94,224 $ 113,842
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................... $ 8,469 $ 6,777
Accrued payroll and related expenses ........................... 2,945 2,185
Income taxes payable ........................................... 828 --
Unearned revenue ............................................... 393 455
Acquisition obligations ........................................ 650 2,712
Other accrued liabilities ...................................... 2,332 1,745
--------- ---------
Total current liabilities ........................................ 15,617 13,874
Other long-term liabilities ...................................... 2,020 741
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 - 13,674,534 and 13,306,110 in
1997 and 1996, respectively ................................ 14 13
Additional paid-in capital ..................................... 116,268 114,421
Accumulated deficit, $26.3 million relating to the repurchase of
common stock in 1992 and $5.8 million relating to a
recapitalization in 1992 ...................................... (39,653) (14,951)
--------- ---------
76,629 99,483
Less common stockholders' notes receivable ..................... (42) (256)
--------- ---------
Total stockholders' equity ....................................... 76,587 99,227
--------- ---------
Total liabilities and stockholders' equity ....................... $ 94,224 $ 113,842
========= =========
</TABLE>
See accompanying notes.
27
<PAGE> 28
SDL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C>
Revenue:
Product revenue .................... $ 76,750 $ 69,772 $ 45,277
Research revenue ................... 14,614 12,703 8,617
-------- -------- --------
Total revenue ........................ 91,364 82,475 53,894
Cost of revenue:
Cost of product revenue ............ 53,523 45,365 26,871
Cost of research revenue ........... 11,631 9,591 6,519
-------- -------- --------
Total cost of revenue ................ 65,154 54,956 33,390
-------- -------- --------
Gross margin ......................... 26,210 27,519 20,504
Operating expenses:
Research and development ........... 9,794 6,681 3,994
Selling, general, and administrative 41,280 12,166 7,649
In-process research and development 753 -- 10,010
-------- -------- --------
Total operating expense .............. 51,827 18,847 21,653
-------- -------- --------
Operating income (loss) .............. (25,617) 8,672 (1,149)
Interest income, net ................. 1,355 1,501 118
-------- -------- --------
Income (loss) before income taxes .... (24,262) 10,173 (1,031)
Provision for income taxes ........... 417 3,052 1,788
-------- -------- --------
Net income (loss) .................... $(24,679) $ 7,121 $ (2,819)
======== ======== ========
Net income (loss) per share-basic .... $ (1.83) $ 0.59 $ (0.31)
======== ======== ========
Net income (loss) per share-diluted .. $ (1.83) $ 0.54 $ (0.31)
======== ======== ========
Number of weighted average
shares-basic ........................ 13,497 12,012 9,228
======== ======== ========
Number of weighted of average
shares-diluted ...................... 13,497 13,199 9,228
======== ======== ========
</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 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
Issuance of stock
pursuant to
employee stock plans . 368,424 1 1,847 -- -- 1,848
Payments on
stockholders' notes
receivable ........... -- -- -- -- 214 214
Unrealized loss on
investments .......... -- -- -- (23) -- (23)
Net income ............. -- -- -- (24,679) -- (24,679)
----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31,
1997 .................. 13,674,534 $ 14 $ 116,268 $ (39,653) $ (42) $ 76,587
=========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes.
29
<PAGE> 30
SDL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1997 1996 1995
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ............................... $ (24,679) $ 7,121 $ (2,819)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization ............... 5,800 4,948 2,840
In-process research and development ......... 753 -- 10,010
Deferred income taxes ....................... -- (223) (1,373)
Changes in operating assets and liabilities:
Accounts receivable ....................... (8,076) 1,719 (4,245)
Inventories ............................... (485) (4,435) (3,610)
Accounts payable .......................... 1,599 520 2,672
Income taxes payable ...................... 2,392 -- --
Accrued payroll and related expenses ...... 730 195 620
Unearned revenue .......................... (62) (517) 529
Other accrued liabilities ................. 339 (135) 999
Other ..................................... 435 2,879 1,255
--------- --------- ---------
Total adjustments ............................... 3,425 4,951 9,697
--------- --------- ---------
Net cash provided by (used in) operating
activities ............................... (21,254) 12,072 6,878
INVESTING ACTIVITIES
Acquisition of property and equipment, net ...... (9,407) (9,909) (8,518)
Purchase of investments ......................... (57,064) (100,620) (50,815)
Sales and maturities of investments ............. 90,707 53,413 42,300
Acquisition of Businesses ....................... (3,055) (1,560) (12,076)
--------- --------- ---------
Net cash provided by (used in) investing
activities ............................... 21,181 (58,676) (29,109)
FINANCING ACTIVITIES
Issuance of stock pursuant to employee stock
plans ......................................... 1,847 1,509 745
Payments on stockholders' notes receivable ...... 214 222 470
Payments of long-term debt ...................... -- -- (2,592)
Payments of subordinated debt ................... -- -- (21,580)
Proceeds from issuance of common stock .......... -- 44,652 47,382
Reissuance (repurchase) of treasury stock ....... -- 33 (33)
--------- --------- ---------
Net cash provided by financing activities ....... 2,061 46,416 24,392
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents ................................... 1,988 (188) 2,161
Cash and cash equivalents at beginning of period 2,605 2,793 632
--------- --------- ---------
Cash and cash equivalents at end of period ...... $ 4,593 $ 2,605 $ 2,793
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for income taxes .................... $ 1 $ 170 $ 1,362
Cash received from income taxes refunded ...... $ 1,941 $ 773 $ --
Cash paid for interest ........................ $ -- $ -- $ 927
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
Conversion of convertible redeemable preferred
stock to common stock ...................... $ -- $ -- $ 10,896
Stock issued for stockholders' notes receivable $ -- $ -- $ 59
</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.
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. Beginning with 1997, the Company operates and reports
financial results on a fiscal year of 52 or 53 weeks ending on the Friday
closest to December 31. Accordingly, fiscal 1997 ended on January 2, 1998 and
was a 53 week year with the fourth fiscal quarter having 14 weeks. For ease of
discussion and presentation all years are referred to as ending on December 31.
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 at the time of purchase to be cash equivalents. Cash
equivalents are carried at cost, which approximates fair value.
Investments
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.
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 cost incurred and fixed price contracts with the Company include the U.S.
government,
31
<PAGE> 32
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 19 percent, 21 percent and
19 percent of its 1997, 1996, and 1995, respectively, revenue from
Lockheed-Martin through several government and commercial programs.
Almost all of the Company's revenue from this customer during 1997, 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.
Dependence Upon Government Programs and Contracts - In 1997, 1996, and
1995, the Company derived approximately 38 percent, 43 percent, and 45
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 1997, 1996, and
1995 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 5 percent of the Company's 1997 revenue and 6 percent of
revenue in 1996 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 is no longer 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 international
operations in Canada.
All sales to international customers constitute export sales and are denominated
in U.S. dollars. Export sales to Europe totaled approximately $7.9 million, $4.2
million, and $4.3 million for 1997, 1996, and 1995, respectively. Export sales
to the Pacific Rim totaled approximately $7.3 million, $8.0 million, and $7.9
million for 1997, 1996, and 1995, respectively.
Net Income (Loss) Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share. Statement 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to the Statement 128 requirements.
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Numerator:
Net income (loss) $(24,679) $ 7,121 $ (2,819)
======== ======== ========
Denominator:
Denominator for basic earnings per
share-weighted average shares 13,497 12,012 9,228
Incremental common shares attributable to
shares issuable under employee stock plans(1) -- 1,187 --
-------- -------- --------
Denominator for diluted earnings per share -
adjusted weighted average shares and
assumed conversions 13,497 13,199 9,228
======== ======== ========
Net income (loss) per share - basic $ (1.83) $ 0.59 $ (0.31)
Net income (loss) per share - diluted $ (1.83) $ 0.54 $ (0.31)
</TABLE>
(1) Potential common shares relating to shares issuable under employee stock
plans are not included in the 1997 or 1995 calculation due to their
anti-dilutive effect on the loss per share.
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.
Recent Pronouncements
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.
33
<PAGE> 34
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.
2. INVESTMENTS
Available-for-sale investments consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Tax-exempt auction rate preferred stock $ 8,400 $29,725
Municipal bonds 13,613 25,953
------- -------
$22,013 $55,678
======= =======
</TABLE>
Tax-exempt auction rate preferred stock contains contractual redemptions of less
than one year. Municipal bonds have maturities ranging from approximately six
months to two years of which approximately $11.6 million and $10.3 million are
included in long-term investments in the accompanying balance sheet at December
31, 1997 and 1996, respectively.
Realized losses on the sale of available-for-sale securities were $0.3 million
in 1997. Realized gains and losses on the sale of available-for-sale securities
were immaterial for 1996. Unrealized losses on available-for-sale securities
were immaterial in 1997 and 1996.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------
1997 1996
------- --------
(In thousands)
<S> <C> <C>
Trade receivables $17,334 $ 10,559
Receivables under long-term contracts:
Billed 765 1,449
Unbilled costs and estimated earnings,
current portion 3,051 588
------- --------
21,150 12,596
Allowance for doubtful accounts (1,190) (780)
------- --------
$19,960 $ 11,816
======= ========
</TABLE>
The majority of unbilled costs and estimated earnings on uncompleted cost
incurred and fixed price contracts are billable in the subsequent year.
34
<PAGE> 35
Pursuant to the retainage provisions in certain long-term contracts, a specified
portion of 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,
-------------------
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Raw materials $ 6,087 $ 6,653
Work-in-process 7,851 6,788
------- -------
$13,938 $13,441
======= =======
</TABLE>
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,
-------------------
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Machinery and equipment $37,946 $27,019
Leasehold improvements 7,697 5,975
Furniture and fixtures 846 718
Construction-in-progress 1,934 5,304
------- -------
48,423 39,016
Less accumulated depreciation and amortization 22,125 16,996
------- -------
$26,298 $22,020
======= =======
</TABLE>
35
<PAGE> 36
6. GOODWILL AND PURCHASED INTANGIBLES
Purchased intangibles consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1996
------ ------
(In thousands)
<S> <C> <C>
Goodwill $1,363 $ 910
Other purchased intangibles 1,945 1,910
------ ------
3,308 2,820
Less accumulated amortization 1,370 699
------ ------
$1,938 $2,121
====== ======
</TABLE>
Amortization expense is included in selling, general, and administrative
expenses. See Note 10, Acquisitions.
7. NOTE DUE FROM RELATED PARTY
On May 1, 1997 the Company loaned an officer $612,000 secured by a deed of
trust. The note is due on the tenth anniversary of the date of the note,
however; certain amounts may be forgiven. After five years continuous employment
with the Company, $200,000 will be forgiven. After ten years continuous
employment with the Company, an additional $200,000 will be forgiven. Other
terms provide for mandatory prepayment if certain events of default occur. The
note shall bear interest at 8% only in the event of a default. The amount
expected to be forgiven is being amortized to compensation expense over ten
years.
8. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Current:
Federal $ -- $ 2,617 $ 2,853
State -- 312 308
Foreign 417 346 --
------- ------- -------
3,275 3,161
Deferred:
Federal -- (371) (1,180)
State -- 148 (193)
------- ------- -------
-- (223) (1,373)
------- ------- -------
$ 417 $ 3,052 $ 1,788
======= ======= =======
</TABLE>
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 zero, $5.2 million and $2.5
million in 1997, 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:
36
<PAGE> 37
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Tax at federal statutory rate $(8,492) $ 3,560 $ (361)
State income tax, net of federal
tax benefit -- 299 (192)
Non-deductible in-process, research
and development write-off 264 -- --
Net operating loss not benefited 9,057 -- --
Temporary difference not benefited -- -- 2,402
Tax-exempt interest income (453) (455) (148)
Benefit of foreign sales corporation -- (62) (8)
Other 41 (290) 95
------- ------- -------
Provision for income taxes $ 417 $ 3,052 $ 1,788
======= ======= =======
</TABLE>
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------
1997 1996
-------- --------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 9,680 $ --
Reserves and other accrued expenses
not yet deductible for tax 2,070 1,066
Inventory valuation accounts 1,584 1,080
Intangible assets 3,838 3,627
Tax credit carryforward 970 346
Other 52 44
-------- --------
Total deferred tax assets 18,194 6,163
Valuation allowance (14,030) (2,062)
-------- --------
Net deferred tax assets 4,164 4,101
Deferred tax liabilities:
Depreciation (550) (685)
Other (562) (364)
-------- --------
Total deferred tax liabilities (1,112) (1,049)
-------- --------
Net deferred tax assets $ 3,052 $ 3,052
======== ========
</TABLE>
The valuation allowance increased by approximately $12.0 million in 1997 and
decreased by $0.3 million in 1996. Approximately $3.3 million of the valuation
allowance is related to the benefits of stock option deductions, which will be
credited to paid-in capital when realized.
As of December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $26 million and $15 million, respectively, and
federal and state tax credit carryforwards of approximately $0.6 million and
$0.6 million, respectively. The net operating loss and credit carryforwards will
expire at various dates beginning in years 2001 through 2012, if not utilized.
Management has determined, based on the Company's history of prior operating
earnings, its expectations for the future, and the extended period over which
the benefits of certain deferred tax assets will be realized, that a partial
valuation allowance should be provided. The realization of the Company's net
deferred tax assets, which relate primarily to temporary differences, net
operating loss carryforwards and tax credit carryforwards is dependent on
generating sufficient
37
<PAGE> 38
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.
9. 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 1998 and 2001.
10. STOCK-BASED COMPENSATION PLANS
Stock Option Plans
The 1992 Stock Option Plan provided 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 were 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 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 Option Plan are
subject to vesting over a one- to five-year period and must generally be
exercised by the optionee
38
<PAGE> 39
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 3,102,070 shares of common stock for future issuance
under its Stock Option Plans as of December 31, 1997.
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, 1994 263,207 2,792,078 $ 0.34 - $ 4.90
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
Additional options authorized 712,500 --
Option authorization canceled (255,557) --
--------- ---------
</TABLE>
<TABLE>
<CAPTION>
Weighted-
Average
Exercise Price
-------------
<S> <C> <C> <C>
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
Options granted (552,645) 552,645 $16.06
Options canceled 140,268 (140,268) $16.79
Options exercised -- (249,734) $ 2.33
Additional options authorized 665,305 -- $ --
---------- ----------
Balance at December 31, 1997 708,765 2,393,305 $ 8.51
========== ==========
</TABLE>
The following table summarizes information about options outstanding at December
31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------- -----------------------------
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ------------------ ------------- ------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
$ 0.34 - $ 5.10 1,173,616 4.7 years $ 0.77 1,151,048 $ 0.69
$ 5.11 - $10.67 281,910 7.1 $ 9.94 145,890 $ 9.73
$10.68 - $17.17 536,998 8.9 $14.83 76,943 $15.99
$17.18 - $23.00 319,694 8.7 $20.39 57,710 $20.46
$23.01 - $30.00 81,087 8.5 $26.93 22,873 $27.08
--------- ---------
$ 0.34 - $30.00 2,393,305 6.6 $ 8.51 1,454,464 $ 3.60
========= =========
</TABLE>
39
<PAGE> 40
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 118,690, 110,658 and 48,584
shares in 1997, 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 compensation plans. 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 employee stock options granted
subsequent to December 31, 1994 under the fair value method. The fair value for
these options 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 vale 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
-------------------------------------- ------------------------------------
1997 1996 1995 1997 1996 1995
---------- --------- ----------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Expected Life 4 years 3 years 3 years 6 months 6 months 6 months
Expected Volatility 0.66 0.60 0.60 0.82 0.72 0.46
Risk Free Interest Rate 6.17% 6.04% 6.26% 5.64% 5.45% 5.95%
</TABLE>
For the purpose of pro forma disclosures, the estimated fair value of the above
stock-based awards is amortized over the awards' vesting period. The Company's
pro forma information follows (in thousands, except for per share information):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------ -------
<S> <C> <C> <C>
Pro forma net income (loss) $(27,523) $5,947 $(3,241)
Pro forma net income (loss) per share - basic $ (2.04) $ 0.50 $ (0.35)
Pro-forma net income (loss) per share - diluted $ (2.04) $ 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 1997, 1996 and 1995 were
$8.92, $9.65 and $5.80, respectively. The weighted-average fair value of ESPP
rights granted in 1997, 1996 and 1995 were $5.64, $3.97 and $2.01, respectively.
40
<PAGE> 41
11. ACQUISITIONS
In November 1997, the Company acquired all of the outstanding stock of Mr.
Laser, Inc., a company involved in the design and development of compact laser
marking systems. The acquisition was accounted for under the purchase method of
accounting. The total purchase price was approximately $1,202,000, which
includes related transaction costs of $22,000, $187,000 for net acquired
liabilities and $650,000 for future cash payments. The Company recorded $753,000
as in-process research and development for development projects that had not yet
reached technologic feasibility. To determine the value of in-process research
and development, the Company considered, among other factors, the state of
development of the compact laser marking system, the costs needed to complete
development, and the expected income and risks associated with the inherent
difficulties and uncertainties in completing development. Purchase price in
excess of amounts allocated to in-process research and development and net
acquired liabilities was approximately $453,000 and was allocated to goodwill.
Goodwill is being amortized straight-line over a three year life. Mr. Laser's
operating results are included in the accompanying consolidated financial
statements from November 1997. The results of Mr. Laser prior to the acquisition
were not material to the Company's consolidated results of operations.
In November 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
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.
On March 31, 1997, the Company paid the final acquisition obligation of $2.7
million.
12. 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, 1997, under operating leases are as
follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Year Amount
----------- --------
<S> <C>
1998 $2,040
1999 1,896
2000 1,902
2001 1,879
2002 307
Thereafter --
------
Total $8,024
=======
</TABLE>
Rental expense was approximately $1.7 million, $1.4 million, and $1.0 million
for 1997, 1996 and 1995, respectively.
13. 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. In
February 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. Rockwell has appealed the Court's decision to the U. S. Circuit
court for the Federal Circuit. Oral argument on the appeal is scheduled for
March 3, 1998. 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
41
<PAGE> 42
a material adverse effect on the Company's business and results of operations.
The Company believes the judgment in favor of the Company will also result in a
favorable disposition of Rockwell's suit against the Company.
Trial of the Spectra-Physics vs. 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.
SDL is engaged in various cost-reimbursement type contracts with the Federal
government. These contracts utilize allowable costs plus contract fee to
determine revenue. 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. 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.
14. 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 $0.5 million, $0.4 million, and
$0.3 million for 1997, 1996, and 1995, respectively.
15. GEOGRAPHIC INFORMATION
Information regarding geographic areas of the years ended December 31, 1997 and
1996 is as follows (in thousands):
<TABLE>
<CAPTION>
DOMESTIC INTERNATIONAL
OPERATIONS OPERATIONS ELIMINATIONS TOTAL
---------- ----------- ------------ -----
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Sales to unaffiliated customers $ 76,505 $14,859 $ -- $ 91,364
Intercompany transfers 5,628 874 (6,502) --
------- ------- ------- -------
Total revenue $ 82,133 $15,733 $(6,502) $ 91,364
======== ======= ======= ========
Operating income(loss)(1) $ (26,067) $ 953 $ (503) $(25,617)
======== ======= ======= ========
Identifiable assets $ 92,541 $10,311 $(8,628) $ 94,224
======== ======= ======= ========
</TABLE>
(1) The results of operations for the year ended December 31, 1997 include a
one-time charge totaling $27.5 million related to costs associated with the
litigation settlement and related legal costs of the Spectra-Physics legal
dispute.
42
<PAGE> 43
<TABLE>
<CAPTION>
DOMESTIC INTERNATIONAL
OPERATIONS OPERATIONS ELIMINATIONS TOTAL
---------- ----------- ------------ -----
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Sales to unaffiliated customers $ 72,657 $ 9,818 $ -- $ 82,475
Intercompany transfers 3,185 183 (3,368) --
-------- -------- -------- --------
Total revenue $ 75,842 $ 10,001 $ (3,368) $ 82,475
======== ======== ======== ========
Operating income(loss) $ 7,951 $ 989 $ (268) $ 8,672
======== ======== ======== ========
Identifiable assets $112,079 $ 5,394 $ (3,631) $113,842
======== ======== ======== ========
</TABLE>
Operating results in Canada were not material in 1995.
43
<PAGE> 44
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, 1997 and 1996, and the related consolidated statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, 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 30, 1998
44
<PAGE> 45
SCHEDULE II
SDL, INC.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
BALANCE BALANCE
AT AT
BEGINNING END OF
OF PERIOD ADDITIONS DEDUCTIONS(1) OTHER PERIOD
---------- --------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts
receivable
Year ended December 31, 1995 $ 208 $ 188 $ (21) $110(2) $ 485
====== ====== ====== ==== ======
Year ended December 31, 1996 $ 485 $ 355 $ (60) $ -- $ 780
====== ====== ====== ==== ======
Year ended December 31, 1997 $ 780 $ 442 $ (32) $ -- $1,190
====== ====== ====== ==== ======
</TABLE>
- ----------
(1) Uncollectible accounts written off.
(2) Represents Seastar's allowance for doubtful accounts as of the acquisition
date.
45
<PAGE> 46
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)
4.3 Rights Agreement, dated as of November 6, 1997, between the
Company and ChaseMellon Shareholder Services, L.L.C.
together with: Exhibit A, Form of Rights Certificate;
Exhibit B, Summary of Rights to Purchase Preferred Stock;
and Exhibit C Form of Certificates of Designation of the
Series B Preferred Stock.(2)
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.
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)
46
<PAGE> 47
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)
10.16 Promissory Note Secured by Deed of Trust dated May 1, 1997
made by Gregory P. Doughtery and Nancy E. Dougherty payable
to the Company.
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 8-1 (Commission File No. 33-87752), which
became effective on March 15, 1995.
(2) Incorporated by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A (Commission File No. 000-25688), filed with the
SEC on November 7, 1997.
* Management contracts or compensatory plans or arrangements.
47
<PAGE> 48
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/ Vincent A. Mc Cord
--------------------------------------
Vincent A. Mc Cord
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 February 21, 1997
- --------------------------- Executive Officer (Principal Executive Officer)
Donald R. Scifres
/s/ John P. Melton Executive Vice President, Secretary and Director February 21, 1997
- ---------------------------
John P. Melton
/s/ Vincent A. McCord Chief Financial Officer and Treasurer February 21, 1997
- --------------------------- duly authorized officer and principal financial
Vincent A. McCord 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>
48
<PAGE> 49
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
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)
4.3 Rights Agreement, dated as of November 6, 1997, between
the Company and ChaseMellon Shareholder Services, L.L.C.
together with: Exhibit A, Form of Rights Certificate;
Exhibit B, Summary of Rights to Purchase Preferred Stock;
and Exhibit C Form of Certificate of Designation of the
Series B Preferred Stock.(2)
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
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)
10.16 Promissory Note Secured by Deed of Trust dated May
1, 1997 made by Gregory P. Dougherty and Nancy E.
Dougherty payable to the Company.
21.1 Subsidiaries
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial data schedule
</TABLE>
- ----------
(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).
(2) Incorporated by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A (Commission File No. 000-25688), filed with the SEC
on November 7, 1997.
* Management contracts or compensatory plans or arrangements.
49
<PAGE> 1
EXHIBIT 10.16
PROMISSORY NOTE
SECURED BY
DEED OF TRUST
$612,000 Dated as of May 1, 1997
FOR VALUE RECEIVED, Gregory P. Dougherty ("Employee") and
Nancy E. Dougherty (the "Employee" and Nancy E. Dougherty are sometimes
collectively referred to herein as "Borrower"), husband and wife, residing at
5380 Arozzo Drive, San Jose, California promise to pay to the order of SDL,
Inc., a Delaware corporation ("Lender"), at its offices located at 80 Rose
Orchard Way, San Jose, California 95134, or such other place as Lender may
designate from time to time, the principal sum SIX HUNDRED TWELVE THOUSAND AND
NO/100 DOLLARS ($612,000). Borrower shall not be obligated to pay interest
thereunder except as provided below.
1. Payment Provisions.
1.1 Payment. The principal amount of this Note shall be due
and payable in full on the tenth (10th) anniversary of the date of this
Promissory Note Secured by Deed of Trust ("Note") or in such amounts and on such
earlier date(s) as provided by the terms of that certain written employment
agreement between the Lender and Employee, as amended from time to time, or in
such amounts and on such earlier date(s) as otherwise provided herein.
1.2 Voluntary Prepayment. Borrower reserves the right to
prepay the outstanding principal amount of this Note in full or in part at any
time during the term of this Note without notice and without premium or penalty.
1.3 Mandatory Prepayment
(a) If Lender makes any cash payment to Employee under
the terms of stock option appreciation guarantee set forth in the second
paragraph of the offer letter the employee of February 21, 1997, Employee shall
prepay at the time of such payment, or promptly thereafter, such portion of the
amount due under this Note as is equal to the net after tax proceeds of such
cash payment.
(b) If Lender makes any bonus payments to Employee, then
Employee shall prepay at the time of such payment, or promptly thereafter, such
portion of the amount due under this Note as is equal to fifty (50) of the net
after tax proceeds of such cash payment.
1.4 Loan Forgiveness;
(a) After Employee has remained in continuous employment
with Lender for a period of five (5) years from the date of first employment at
Lender, the principal amount owed under the terms of this Note shall be reduced
by two hundred thousand dollars ($200,000).
(b) After Employee has remained in continuous employment
with Lender for a period of ten (10) years from the date of first employment at
Lender, the principal amount owed under terms of this Note shall be reduced by
an additional two hundred thousand dollars ($200,000).
<PAGE> 2
1.5 Due on Sale. In the event that the Property (as defined
below) or any portion thereof, or any interest therein is sold, agreed to be
sold, conveyed or alienated by Borrower, or by operation of law or otherwise,
the outstanding principal amount of this Note, irrespective of the maturity date
set forth herein, at the option of Lender and without demand or notice shall
immediately become due and payable.
1.6 Payment Method. All payments shall be made in lawful
money of the United States of America.
2. Security. Payment of this Note is secured by that certain Deed
of Trust with Assignment of Rents (the "Deed Trust") of even date herewith,
executed by Borrower and encumbering that certain real property known as 3580
Arozzo Drive, San Jose, California (the "Property") as a second priority lien.
3. Governing Law. The terms of this Note shall be construed in
accordance with the laws of the State of California. This Note has been
delivered to Lender and accepted by Lender in the State of California. If there
is a lawsuit on this Note, Borrower shall submit, at Lender's request, to the
jurisdiction of the courts of Santa Clara County, California.
4. Amendments/Waivers. Any term of this Note may be amended or
waived only upon the written consent of the Borrower and Lender.
5. Default. All of the following shall be deemed events of
default under this Note. Upon the occurrence of any such event of default, at
the option of Lender (except with respect to the default described in subsection
(c) below, in which case acceleration shall be automatic), the entire principle
balance owing hereunder shall at once become due and payable without notice of
default or other notices or demands of any kind whatsoever, all of which are
hereby expressly waived by Borrower and such principal amount shall, at the
option of Lender, bear interest at the rate of eight percent (8%) (the "Default
Rate"), until paid, such interest to be compounded annually and Borrower shall
have and may exercise any and all rights and remedies available to it at law or
equity, Lender's failure to exercise such option to accelerate shall not be
construed a as waiver of the provisions hereof as regarding any subsequent
event.
(a) Borrower fails to make payment of the full principal
amount of this Note as and when the same becomes due and payable in accordance
with the terms hereof; or
(b) Borrower fails to pay any amounts owed under Section
1.1 and/or Section 1.3 hereof; or
(c) Borrower receives a notice of a default under the
deed of trust secured by a first priority lien on the Property ("First Deed of
Trust"), which notice of default must be promptly delivered to Lender. The
parties agree that a request for notice of default of the First Deed of Trust
shall be recorded concurrently with the Deed of Trust hereunder; or
(d) Borrower fails fully and timely to perform or observe
any other obligation or term of this Note, the Deed of Trust, the First Deed of
Trust on its part to be performed or observed in accordance with the term hereof
or thereof; or
(e) Borrower is the subject of an order for relief by a
bankruptcy court, or is unable or admits in writing Borrower's inability to pay
Borrower's debts as they mature, or make an assignment for the benefit of
creditors; or Borrower applies for or consents to the appointment of any
receiver, trustee, custodian, conservator, liquidator, rehabilitator, or similar
officer for Borrower or for all or any part of Borrower's property; or any
receiver, trustee, custodian, conservator, liquidator, rehabilaitator or similar
officer is
<PAGE> 3
appointed without the application of consent of Borrower, and the appointment
continues undischarged or unstayed for sixty (60) calendar days; or Borrower
institutes or consents to any bankruptcy, insolvency or similar proceeding
relating to Borrower or to all or any part of Borrower's property under the laws
of any jurisdiction; or any similar proceedings is instituted without the
consent of Borrower and continues undismissed or unstayed for sixty (60)
calendar days; or any judgment, warrant, writ of attachment of execution, or
similar process is issued or levied against all or any part of the property of
Borrower and is not released, vacated or fully bonded within thirty (30)
calendar days after its issue or levy; or
(f) All or a substantial portion of the Property is
condemned, seized or appropriated by a governmental body or agency.
6. Exercise of Power of Lender. No single or partial exercise of
any power hereunder or under the Deed of Trust shall preclude other or further
exercises thereof or the exercise of any other power. Lender shall at all times
have the right to proceed against any portion of the security for this Note in
such order and in such manner as Lender may consider appropriate, without
waiving any rights with respect to any of the security. Any delay or omission on
the part of Lender in exercising any right hereunder or under the Deed of Trust
shall not operate as a waiver of such right, or of any other right under this
Note on the Deed of Trust.
7. Successors and Assigns. This Note shall inure to the benefit
of Lender and its successors and assigns. The obligations of Borrower hereunder
shall not be assignable.
<PAGE> 4
8. Liability for Costs and Expenses. In the event of default
under this Note, Borrower will be liable for all costs and expenses of
collection, including reasonable attorney's fees, incurred in collecting the
money due hereunder, whether such items are incurred in or out of litigation, in
or out of a bankruptcy case or proceeding, or otherwise.
9. Waiver. Borrower waives diligence, presentment, protest and
demand and also notice of protest, demand, dishonor and nonpayment of this Note.
No extension of time for the payment of this Note shall affect the original
liability under this Note of Borrower. The pleading of any statute of
limitations as a defense to any demand against Borrower is expressly waived by
Borrower to the full extent permitted by law.
10. Setoff. The obligation to pay Borrower shall be absolute and
unconditional and the rights of Borrower shall not be subject to any defense,
setoff, counterclaim or recoupment or by reason of any indebtedness or liability
at any time owing by Lender to Borrower.
11. Payment Notice. This Note is subject to Section 2966 of the
notice to Borrower, or its successor in interest, of prescribed information at
least ninety (90) days and not more than one hundred fifty (150) days before any
balloon payment is due.
IN WITNESS WHEREOF, this Promissory Note Secured by Deed of Trust
is executed and delivered as of the date first set forth above.
BORROWER:
/s/ Gregory P. Dougherty
---------------------------
Gregory P. Dougherty
/s/ Nancy E. Dougherty
----------------------------
by her attorney in fact
Nancy E. Dougherty
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF SDL, INC.
The following are the material subsidiaries of the Registrant as of December 31,
1997, 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, In 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 30, 1998, 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, 1997.
ERNST & YOUNG LLP
San Jose, California
March 2, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DECEMBER 31,
1997 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
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0
0
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