<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported): May 18, 1999
COMMISSION FILE NUMBER: 0-25688
SDL, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 77-0331449
- ------------------------------------- ----------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
80 ROSE ORCHARD WAY, SAN JOSE, CALIFORNIA 95134
- ------------------------------------------------------------- ----------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (408) 943-9411
ITEM 5. Other Events
SDL, Inc. ("the Company") has included herein the consolidated balance sheets of
the Company as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. The Company has also included
herein the condensed consolidated balance sheet of the Company as of March 31,
1999 and the related condensed consolidated statements of income and cash flows
for the three months ended March 31, 1999 and 1998. These financial statements
give retroactive effect to the merger of the Company and IOC International plc
on May 18, 1999, which transaction has been accounted for as a pooling of
interests.
<PAGE> 2
SELECTED SUPPLEMENTAL FINANCIAL DATA
The following selected supplemental financial data of the Company is
qualified by reference to and should be read in conjunction with the
supplemental consolidated financial statements of the Company, including the
notes thereto, and Management's Discussion and Analysis of Financial Condition
and Results of Operations. The following selected supplemental financial data of
the Company includes the operating results of IOC International plc for all
periods. The Company merged with IOC International plc in May 1999, in a
transaction accounted for as a pooling of interest.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1998(2) 1997(1)(2)(3) 1996 1995 (1) 1994
--------- ------------- --------- --------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenue ................................... $ 112,792 $ 102,119 $ 88,224 $ 56,429 $ 34,581
Cost of revenue ........................... 74,061 71,245 57,075 34,608 20,743
--------- --------- --------- --------- ---------
Gross margin .............................. 38,731 30,874 31,149 21,821 13,838
Research and development .................. 12,659 11,325 7,566 4,331 2,986
Selling, general, and
administrative .......................... 17,593 43,669 13,439 8,308 5,184
In-process research and development ....... -- 753 -- 10,010 --
Amortization of purchased
intangibles and goodwill ................ 777 671 645 54 --
--------- --------- --------- --------- ---------
Operating income (loss) ................... 7,702 (25,544) 9,499 (882) 5,668
Net income (loss) ......................... $ 7,903 $ (24,353) $ 8,139 $ (2,685) $ 2,044
Net income (loss) per share-basic(4) ...... $ 0.28 $ (0.87) $ 0.33 $ (0.14) $ 0.17
Net income (loss) per share-diluted(4) .... $ 0.26 $ (0.87) $ 0.30 $ (0.14) $ 0.13
Weighted average shares-basic(4) .......... 28,718 27,888 24,756 18,784 11,710
Weighted average shares-diluted(4) ........ 30,362 27,888 27,238 18,784 15,156
</TABLE>
<TABLE>
<CAPTION>
----------------------------------------------------------------
AS OF DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance sheet data:
Working capital ........................... $ 63,705 $ 44,173 $ 74,272 $ 25,113 $ 5,681
Total assets .............................. 132,060 112,431 129,429 60,570 25,195
Long-term debt (less current portion) ..... 2,028 2,380 247 1,526 23,889
Convertible redeemable
preferred stock ......................... -- -- -- -- 10,545
Stockholders' equity (net
capital deficiency) ..................... $108,206 $ 89,282 $111,220 $ 42,162 $(18,923)
</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 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 1998 and 1997
ended January 1, 1999 and January 2, 1998, respectively. 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.
(4) In May 1999, the Company authorized a two-for-one split of its common
stock, effected in the form of a stock dividend, which was paid on June 2,
1999 to stockholders of record on May 14, 1999. All of the share and per
share data in the selected supplemental financial data have been
retroactively adjusted to reflect the stock split.
2
<PAGE> 3
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) 1. INDEX TO FINANCIAL STATEMENTS AND REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the years ended December 31, 1998, 1997, and 1996.
Supplemental Consolidated Balance Sheets as of December 31, 1998 and 1997.
Supplemental Consolidated Statements of Operations for the years ended
December 31, 1998, 1997, and 1996.
Supplemental Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997, and 1996.
Supplemental Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997, and 1996.
Notes to Supplemental Consolidated Financial Statements.
Report of Ernst & Young LLP, Independent Auditors.
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the three months ended March 31, 1999 and 1998.
Supplemental Condensed Consolidated Balance Sheets as of March 31, 1999
and 1998.
Supplemental Condensed Consolidated Statements of Income for the three
months ended March 31, 1999 and 1998.
Supplemental Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 1999 and 1998.
Notes to Supplemental Condensed Consolidated Financial Statements as of
March 31, 1999.
(a) 2. FINANCIAL STATEMENT SCHEDULES. The following supplemental financial
statement schedule is filed as part of this Report on Form 8-K and should be
read in conjunction with the Supplemental Consolidated Financial Statements of
SDL, Inc.:
Schedule II--Valuation and Qualifying Accounts.
3
<PAGE> 4
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
Supplemental Consolidated Financial Statements or notes thereto.
(a) 3. EXHIBITS.
<TABLE>
<S> <C>
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Arthur Andersen LLP, Independent Auditors
27.1 Financial data schedules
99.1 Report of Arthur Andersen LLP, Independent Auditors
</TABLE>
4
<PAGE> 5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
SDL designs, manufactures and markets semiconductor lasers, fiber optic
related products and optoelectronic systems. Since 1996, the Company strategy
has strongly focused on providing solutions for optical communications. The
Company's optical communications products power the transmission of data, voice
and Internet information over fiber optic networks to meet the needs of
telecommunications, dense wavelength division multiplexing, cable television and
satellite communications applications. With the increased focus on commercial
communications products, the proportion of SDL's revenue derived from U. S.
government related projects has declined from 40% in 1996 to 26% in 1998. SDL's
optical products also serve a wide variety of non-communications applications,
including materials processing, printing, medical and scientific
instrumentation. 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. The Company's revenue
also includes revenue from customer-funded research programs.
Because of the diversity of products, customers and applications, gross
margins tend to fluctuate based in part on the mix of revenue in each reported
period. SDL's revenue growth in 1997-1998 was constrained by a shortage in
qualified manufacturing capacity, especially in the wafer fabrication area. The
Company's new U.S. wafer fabrication facility received full qualification in
June 1998, allowing a faster ramp-up in production.
In 1997, SDL 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 1998 and 1997 ended January 1, 1999 and January 2, 1998,
respectively. For ease of discussion and presentation, all fiscal year-ends are
referred to as ending on December 31.
In February 1999, the Company acquired the fiber laser business of
Polaroid for $5.2 million cash.
In May 1999, the Company merged with IOC International plc. ("IOC")
through the issuance of 1,130,098 shares of common stock. The merger was
accounted for as a pooling of interests and accordingly all prior period
financial statements have been restated to combine the operating results of IOC
and the Company for all periods presented. IOC's fiscal year end was September
30. The accompanying supplemental statements of operations for the years ended
December 31, 1998, 1997 and 1996 combine the operating results of IOC for the
years ended September 30, 1998, 1997 and 1996 with the operating results of the
Company for the years ended December 31, 1998, 1997 and 1996, respectively.
Management's Discussion and Analysis reflects the pooled entity. The comparisons
to prior periods below should be read in light of this fact.
In May 1999, the Company authorized a two-for-one split of its common
stock, effected in the form of a stock dividend, which was paid on June 2, 1999
to stockholders of record on May 14, 1999. All of the share and per share data
in the supplemental consolidated financial statements have been retroactively
adjusted to reflect the stock split.
Certain of the statements contained in this Management's Discussion and
Analysis of Financial Condition and Results of Operations are forward-looking
statements regarding the Company's business, operations and prospects. The
Company's actual results could differ materially from those in such
forward-looking statements. See "Factors Affecting Earnings and Stock Price."
The following table sets forth certain operating results expressed as a
percentage of total revenue for the periods indicated.
5
<PAGE> 6
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997(1)(2) 1996
- --------------------------------------------- ------ ------------ ------
<S> <C> <C> <C>
Revenue:
Product revenue ......................... 91.3% 85.7% 85.6%
Research revenue ........................ 8.7 14.3 14.4
------ ------ ------
Total revenue ....................... 100.0 100.0 100.0
Cost of revenue:
Cost of product revenue (3) ............. 64.6 68.1 62.9
Cost of research revenue (3) ............ 76.9 79.6 75.5
------ ------ ------
Total cost of revenue ............... 65.7 69.8 64.7
------ ------ ------
Gross margin ........................ 34.3 30.2 35.3
Operating Expenses:
Research and development ................ 11.2 11.1 8.6
Selling, general, and administrative .... 15.6 42.8 15.2
In-process research and development ..... -- 0.7 --
Amortization of purchased
intangibles and goodwill ................ 0.7 0.7 0.7
------ ------ ------
Total operating expenses ............ 27.5 55.2 24.5
------ ------ ------
Operating income (loss) ............. 6.8 (25.0) 10.8
Interest income, net ........................ 1.2 1.6 1.9
------ ------ ------
Income (loss) before income taxes ........... 8.0 (23.4) 12.7
Provision for income taxes .................. 1.0 0.4 3.5
------ ------ ------
Net income (loss) ........................... 7.0% (23.8)% 9.2%
====== ====== ======
</TABLE>
- ----------
(1) The results of operations for the years ended December 31, 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 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.
(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 a 10 percent increase in revenue to $112.8 million
during 1998, following a 16 percent increase in 1997 revenue to $102.1 million.
Product revenue reported in 1998 increased 18 percent or $15.5 million,
following a 16 percent or $12.0 million increase in 1997. The 1998 and 1997
increases in product revenue resulted primarily from growth in dense wavelength
division multiplexing (DWDM) product sales caused by a continued strong demand
for SDL's 980nm pump module. Research revenue decreased 33 percent or $4.8
million during 1998 as a result of the Company continuing to focus on commercial
product opportunities. Research revenue grew 15 percent during 1997 and
accounted for 14 percent of revenue for both 1997 and 1996. 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 26 percent, 34 percent, and 40 percent of its 1998, 1997 and
1996 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 government 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, a majority of the Company's research revenue for 1998, 1997, and 1996
was funded by Federal programs. There can be no assurances that such programs
will
6
<PAGE> 7
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. It is expected that the Federal government funding of the Company will
continue to decrease in 1999.
Approximately 13 percent, 17 percent, and 20 percent of 1998, 1997 and 1996
revenue was received from Lockheed-Martin through numerous government and
commercial programs. Most of the revenue from Lockheed-Martin during this three
year period was, and during 1999 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 revenue and in total dollars. A
loss of the Company's contracts or failure to win new contracts with
Lockheed-Martin could have an adverse effect on the Company's results of
operations.
Revenues from customers outside of the United States represented 27 percent, 25
percent, and 21 percent of total revenue for 1998, 1997, and 1996, respectively.
The 1998 growth was primarily in Canada, due to the growth in the communications
market business, where revenue increased 199 percent compared to 1997.
Gross margin. Gross margin as a percentage of revenue was 34 percent in 1998,
compared to 30 percent and 35 percent for 1997 and 1996, respectively. The
increase in gross margin during 1998 as compared to 1997 resulted from: (i)
increased yields and volumes from the new wafer fab and reduction of costs
related to the 980nm pump module, and (ii) a more favorable mix in the ratio of
commercial product revenue as compared to revenue derived from U.S. government
sources. The decline in gross margin during 1997 as compared to 1996 primarily
resulted from: (i) start-up costs for expansion of the Company's U.S. wafer fab
and transition of the various product lines to the new fabrication equipment,
and (ii) changes in estimable reimbursable costs in the June quarter.
The Company's gross margin can be affected by a number of factors, including
product mix, customer mix, applications 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. The Company's future results depend, to a considerable
extent, on its ability to maintain a competitive advantage in the products it
provides. For this reason, SDL believes it is critical to continue to make
investments in research and development to promote the flow of innovative,
productive, and high-quality products. Research and development increased to
$12.7 million compared to $11.3 million and $7.6 million during 1998, 1997 and
1996, respectively. Research and development as a percentage of revenue was 11
percent, 11 percent and 9 percent in 1998, 1997 and 1996, respectively. The 1998
research and development emphasis has been to bring new communication products
to market. The 1997 research and development spending was on manufacturing
process development efforts, together with the development of new communications
and laser system products.
The Company is committed to continuing its significant research and development
expenditures and expects that the absolute dollar amount of research and
development expenses will increase as it invests in developing new products,
expanding and enhancing its existing product lines, and reducing its costs,
although research and development expenses may vary as a percentage of revenue.
Selling, general and administrative (SG&A). Selling, general and administrative
(SG&A) expense of $17.6 million or 16 percent of revenue represents a decrease
of $26.1 million from 1997. Excluding non-recurring amounts of approximately
$27.5 million for the settlement and related legal costs incurred in 1997 for
the Spectra-Physics vs. SDL, Inc. legal dispute, SG&A increased $1.4 million and
$2.7 million from 1997 and 1996, respectively. Excluding non-recurring amounts,
the increase in SG&A expense during 1998 was primarily due to continued
expansion of the Company's sales and marketing staff and the commencement of the
implementation process for the Company's new enterprise resource planning
software. 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.
7
<PAGE> 8
In-process research and development. The acquisition of Mr. Laser, Inc. during
1997 resulted in the write-off of purchased in-process research and development
of $0.8 million. In the future, additional in-process research and development
write-offs can be anticipated as the Company may from time to time acquire
companies or new product lines.
Amortization of purchased intangibles and goodwill. Amortization expense of
$777,000 represents an increase of $106,000 and $132,000 compared to 1997 and
1996, respectively. The increase in 1998 compared to 1997 and 1996 is a result
of the acquisition of Mr. Laser in November 1997.
Interest income, net. Interest income decreased slightly during 1998 compared to
1997 as result of lower average cash and investment balances during 1998. 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 Spectra-Physics legal dispute. The early
liquidation of certain of these investment securities resulted in a realized
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.
Provision for Income Taxes. The income tax provision for the years ending
December 31, 1998 and December 31, 1997 of $1.1 million and $0.4 million,
respectively, consist primarily of current foreign income taxes for the earnings
of SDL Optics and federal and state minimum taxes. The federal and state tax
provisions were reduced due to the utilization of previously unbenefitted net
operating loss carryforwards. The deferred income tax benefit for 1998 and 1997
has been limited because realization of the deferred tax asset is dependent upon
future taxable income, the amount and timing of which are uncertain.
Accordingly, a partial valuation allowance has been established to record a net
deferred tax asset that the Company believes is more likely than not to be
realized.
The effective tax rate for the year ending December 31, 1996 was 27%. This rate
was lower than the statutory rate due primarily to the benefits of State tax
credits, tax-exempt interest income, and utilization of previously unbenefitted
foreign operating loss carryforwards.
Although realization is not assured, the Company believes that it will generate
future taxable income sufficient to realize the benefit of the $4.0 million of
net deferred tax assets recorded. 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.
8
<PAGE> 9
Supplemental Quarterly Results of Operations
The following tables set forth certain unaudited supplemental quarterly
financial data for the four quarters of 1998 and 1997. 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 Supplemental 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.
The following table of supplemental quarterly results of operations combine the
operating results of IOC for the eight quarters ended September 30, 1998 with
the operating results of the Company for the eight quarters ended December 31,
1998. IOC's net loss for the three months ended December 31, 1998 was not
combined with SDL's net income for this quarter, but rather will be included as
an adjustment to stockholders' equity in the Company's financial results for the
three months ended March 31, 1999.
<TABLE>
<CAPTION>
QUARTERS ENDED
1998 1997
-------------------------------------------- ----------------------------------------------
MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30(1) SEPT. 30 DEC. 31(2)
-------- -------- -------- -------- -------- ---------- -------- ----------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue .................... $ 26,913 $ 28,386 $ 26,958 $ 30,535 $ 23,340 $ 24,552 $ 27,088 $ 27,139
Cost of revenue ............ 18,668 19,593 17,498 18,302 15,254 19,818 18,135 18,038
-------- -------- -------- -------- -------- -------- -------- --------
Gross margin ............... $ 8,245 $ 8,793 $ 9,460 $ 12,233 $ 8,086 $ 4,734 $ 8,953 $ 9,101
Operating income
(loss) ................... $ 1,358 $ 1,166 $ 2,031 $ 3,147 $ 419 $(29,321) $ 2,313 $ 1,045
Net income (loss) .......... $ 1,421 $ 1,228 $ 2,110 $ 3,144 $ 831 $(29,125) $ 2,515 $ 1,426
======== ======== ======== ======== ======== ======== ======== ========
Net income (loss)
per share-basic(3) ....... $ 0.05 $ 0.04 $ 0.07 $ 0.11 $ 0.03 $ (1.05) $ 0.09 $ 0.05
======== ======== ======== ======== ======== ======== ======== ========
Net income (loss) per
share-diluted(3) ......... $ 0.05 $ 0.04 $ 0.07 $ 0.10 $ 0.03 $ (1.05) $ 0.08 $ 0.05
======== ======== ======== ======== ======== ======== ======== ========
Weighted average
shares-basic(3) .......... 28,320 28,564 28,672 29,338 27,554 27,828 27,996 28,190
Weighted average
shares-diluted(3) ........ 29,994 30,304 30,240 30,938 29,442 27,828 29,766 29,894
</TABLE>
- ----------
(1) 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.
(2) The results of operations for the quarter ended December 31, 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.
(3) In May 1999, the Company authorized a two-for-one split of its common
stock, effected in the form of a stock dividend, which was paid on June 2,
1999 to stockholders of record on May 14, 1999. All of the share and per
share data in the supplemental quarterly results of operations have been
retroactively adjusted to reflect the stock split.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $10.4 million of cash from operating activities during
1998 principally from net income from operations adjusted for non-cash
depreciation and amortization changes. These were offset by an increase in
accounts receivables and inventories. In addition, the Company received $10.0
million for the issuance of stock, which was offset by investments of $14.1
million for facilities expansion and capital equipment purchases. As a result
cash, cash equivalents, and marketable securities increased from $33.6 million
at December 31, 1997 to $38.9 million at December 31, 1998.
9
<PAGE> 10
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 operating
activities for the year ended December 31, 1997. An increase in accounts
receivable in 1997, as compared with 1996, also contributed to a use of
operating cash in 1997. In addition, the Company received $1.9 million from the
issuance of stock under employee stock plans, which was offset by investments of
$11.7 million for 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, and marketable securities decreased from $68.5
million at December 31 1996 to $33.6 million at December 31, 1997.
The Company currently expects to spend in the range of $23 million to $27
million for capital equipment purchases and leasehold improvements during 1999.
The Company believes that current cash balances, cash generated from operations,
and cash available through the bank and equity markets will be sufficient to
fund capital equipment purchases, acquisitions of complementary businesses,
products or technologies and working capital requirements for the foreseeable
future. However, there can be no assurances that events in the future will not
require the Company to seek additional capital sooner or, if so required, that
adequate capital will be available on terms acceptable to the Company.
IMPACT OF YEAR 2000
Like many other companies, the year 2000 computer issue creates risks for SDL.
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. If internal systems do not correctly
recognize and process date information beyond the year 1999, there could be a
material adverse impact on the Company's business and results of operations.
To address these year 2000 issues within its internal systems, the Company has
established a task team and initiated a comprehensive program designed to deal
with the most critical systems first. Assessment and remediation are proceeding
in tandem, and the Company currently plans to have changes to critical systems
completed and tested by mid-1999. These activities are intended to encompass all
systems software applications in use by the Company, including front and
back-end manufacturing, facilities, sales, finance and human resources.
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 project is estimated to be completed during the quarter ended
June 30, 1999. In addition, as a contingency plan, the Company's existing
management information software applications have been successfully upgraded to
a year 2000 compliant version.
Assessment and remediation of year 2000 issues in tertiary business information
systems is on-going. Well over 80% of the Company's investment in desktop PC
hardware is known to be year 2000 compliant. Additionally, the Company has
concluded that the purchase of newer, more functional software for its network
server applications is more cost effective than upgrading its existing software
to a year 2000 compliant version. Completing the remediation of the Company's
tertiary business information systems is not expected to be a significant burden
on the Company.
To date, based on its current manufacturing process, SDL believes it has no
material exposure to contingencies directly related directly to the Year 2000
issue for the products it has sold or will sell in the future.
SDL is also actively working with critical suppliers of products and services to
determine that the suppliers' operations and the products and services they
provide are year 2000 compatible or to monitor their progress toward year 2000
compatibility. In addition, the Company has commenced work on various types of
contingency planning to address potential problem areas with internal systems
and with suppliers and other third parties. It is expected that assessment,
remediation and contingency planning activities will be on-going throughout 1999
with the goal of appropriately resolving all material internal systems and third
party issues.
The costs incurred to date related to these programs are less than $1.9 million.
The Company currently expects that the total cost of these programs, including
both incremental spending and redeployed resources, will total approximately
$3.0
10
<PAGE> 11
million which includes $1.8 million for the purchase of new software and
hardware that will be capitalized and $1.2 million that will be expensed as
incurred. The Company expects that operating activities will fund the year 2000
costs. In some instances, the installation schedule of new software and hardware
in the normal course of business is being accelerated to also afford a solution
to year 2000 capability issues. The Company has not delayed any non year 2000
projects. The costs of these projects and dates 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.
Based on currently available information, management does not believe that the
year 2000 matters discussed above related to internal systems or products sold
to customers will have a material adverse impact on the Company's financial
condition or overall trends in results of operations; however, it is uncertain
to what extent the Company may be affected by such matters. Any failure to
timely, successfully and cost-effectively assess, remediate and resolve the
Company's year 2000 issues, including those regarding its own as well as
suppliers' and third parties' internal systems, products, services and
contingency plans, may have a material adverse effect on the Company's business
and results of operations. The Company is continuing its efforts to ensure year
2000 readiness, and there can be no assurance that there will not be new year
2000 issues not identified above and significant delays in or increased costs
associated with such efforts which could have a material adverse effect on the
Company's business and results of operations.
Interest Rate Risk
The Company's cash equivalents and short-term and long-term marketable
securities are subject to market risk and changes in interest rates. The
Company's marketable securities are managed by outside professional managers
within guidelines established by the Company. The guidelines, which include
security type, credit quality, and maturity, are intended to limit market risk
by restricting the Company's high quality debt instruments. Due to the
relatively short-term duration of our investments at December 31, 1998, a 1%
(100 basis point) increase in short-term interest rates would not have a
significant impact on the market value of our investments. The Company's
investments in debt securities are classified as available-for-sale; therefore,
gains and losses due to changes in interest rates are included in other
accumulated comprehensive income unless such securities are sold prior to
maturity. The Company generally holds securities until maturity and carries the
securities at fair value.
11
<PAGE> 12
SDL, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1998 1997
--------- ---------
(In thousands, except
share data)
except per share data)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 17,023 $ 6,170
Short-term marketable securities ..................................... 17,635 14,953
Accounts receivable, net ............................................. 23,042 21,570
Inventories .......................................................... 21,288 15,184
Prepaid expenses and other current assets ............................ 3,875 5,020
--------- ---------
Total current assets ................................................... 82,863 62,897
Property and equipment, net ............................................ 39,848 32,351
Long-term marketable securities ........................................ 3,552 11,613
Restricted cash ........................................................ 722 886
Note due from related party ............................................ 512 536
Other assets ........................................................... 4,563 4,148
========= =========
Total assets ........................................................... $ 132,060 $ 112,431
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................... $ 10,014 $ 9,658
Accrued payroll and related expenses ................................. 2,354 2,945
Income taxes payable ................................................. 1,890 828
Unearned revenue ..................................................... 643 393
Current portion of capital leases .................................... 1,098 669
Other accrued liabilities ............................................ 3,159 4,231
--------- ---------
Total current liabilities .............................................. 19,158 18,724
Long-term liabilities:
Capital leases ..................................................... 1,416 1,533
Notes payable ...................................................... 612 847
Other long-term liabilities ........................................ 2,668 2,045
--------- ---------
Total long-term liabilities ............................................ 4,696 4,425
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares - 1,000,000; none issued ......................... -- --
Common stock, $0.001 par value:
Authorized shares - 70,000,000;
issued and outstanding shares - 29,698,160 and 28,252,626 in
1998 and 1997, respectively ........................................ 15 14
Additional paid-in capital ........................................... 138,895 128,694
Accumulated other comprehensive income ............................... 887 70
Accumulated deficit, $26.3 million relating to the repurchase of
common stock in 1992 and $5.8 million relating to a
recapitalization in 1992 ........................................... (31,551) (39,454)
--------- ---------
108,246 89,324
Less common stockholders' notes receivable ........................... (40) (42)
--------- ---------
Total stockholders' equity ............................................. 108,206 89,282
--------- ---------
Total liabilities and stockholders' equity ............................. $ 132,060 $ 112,431
========= =========
</TABLE>
See accompanying notes.
12
<PAGE> 13
SDL, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands, except per share data)
<S> <C> <C> <C>
Revenue:
Product revenue .......................................... $ 103,012 $ 87,505 $ 75,521
Research revenue ......................................... 9,780 14,614 12,703
--------- --------- ---------
Total revenue .............................................. 112,792 102,119 88,224
Cost of revenue:
Cost of product revenue .................................. 66,540 59,614 47,484
Cost of research revenue ................................. 7,521 11,631 9,591
--------- --------- ---------
Total cost of revenue ...................................... 74,061 71,245 57,075
--------- --------- ---------
Gross margin ............................................... 38,731 30,874 31,149
Operating expenses:
Research and development ................................. 12,659 11,325 7,566
Selling, general, and administrative ..................... 17,593 43,669 13,439
In-process research and development ...................... -- 753 --
Amortization of purchased intangibles and goodwill ....... 777 671 645
--------- --------- ---------
Total operating expense .................................... 31,029 56,418 21,650
--------- --------- ---------
Operating income (loss) .................................... 7,702 (25,544) 9,499
Interest expense ........................................... (440) (248) (196)
Interest income and other, net ............................. 1,724 1,856 1,888
--------- --------- ---------
Income (loss) before income taxes .......................... 8,986 (23,936) 11,191
Provision for income taxes ................................. 1,083 417 3,052
--------- --------- ---------
Net income (loss) .......................................... $ 7,903 $ (24,353) $ 8,139
========= ========= =========
Net income (loss) per share-basic .......................... $ 0.28 $ (0.87) $ 0.33
========= ========= =========
Net income (loss) per share-diluted ........................ $ 0.26 $ (0.87) $ 0.30
========= ========= =========
Number of weighted average shares-basic .................... 28,718 27,888 24,756
========= ========= =========
Number of weighted average shares-diluted .................. 30,362 27,888 27,238
========= ========= =========
</TABLE>
See accompanying notes.
13
<PAGE> 14
SDL, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other Stockholder's Total
------------------------ Paid-In Comprehensive Accumulated Notes Stockholders'
Shares Amount Capital Income Deficit Receivable Equity
----------------------------------------------------------------------------------------------
(In thousands, except share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 as
previously reported ................. 21,256,230 $ 11 $ 62,995 $ (6) $ (22,022) $ (478) $ 40,500
Adjustment in connection with
IOC pooling of interest ........... 35,320 -- 3,222 66 (1,626) -- 1,662
--------------------------------------------------------------------------------------------
Balance at December 31, 1995 as
restated ............................ 21,291,550 11 66,217 60 (23,648) (478) 42,162
Net income ........................ -- -- -- -- 8,139 -- 8,139
Cumulative translation adjustment . -- -- -- (258) -- -- (258)
Unrealized loss on investments .... -- -- -- (44) -- -- (44)
----------
Comprehensive Income .............. 7,837
----------
Dividend released ................. -- -- -- -- 408 -- 408
Issuance of stock pursuant to
employee stock plans ............ 1,842,336 -- 1,509 -- -- -- 1,509
Proceeds from issuance of
common stock (less offering
expenses of $362) ............... 4,363,718 2 53,813 -- -- -- 53,815
Reissuance of treasury stock ...... 3,654 -- 33 -- -- -- 33
Payments on stockholders' notes
receivable ...................... -- -- -- -- -- 222 222
Income tax benefit from exercise
of employee stock options ....... -- -- 5,234 -- -- -- 5,234
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 ....... 27,501,258 13 126,806 (242) (15,101) (256) 111,220
Net loss .......................... -- -- -- -- (24,353) -- (24,353)
Cumulative translation adjustment . 335 335
Unrealized loss on investments .... -- -- -- (23) -- -- (23)
----------
Comprehensive loss ................ (24,041)
----------
Issuance of stock pursuant to
employee stock plans ............ 751,368 1 1,888 -- -- -- 1,889
Payments on stockholders' notes
receivable ...................... -- -- -- -- -- 214 214
--------------------------------------------------------------------------------------------
Balance at December 31, 1997 ....... 28,252,626 14 128,694 70 (39,454) (42) 89,282
Net Income ........................ -- -- -- -- 7,903 -- 7,903
Cumulative translation adjustment . -- -- -- 748 -- -- 748
Unrealized gain on investments .... -- -- -- 69 -- -- 69
----------
Comprehensive Income .............. 8,720
----------
Proceeds from issuance of
common stock, net ............... 217,644 -- 5,522 -- -- -- 5,522
Issuance of stock pursuant to
employee stock plans ............ 1,227,890 1 4,461 -- -- -- 4,462
Payments on stockholders' notes
receivable ...................... -- -- -- -- -- 2 2
Income tax benefit from exercise
of employee stock options ....... -- -- 218 -- -- -- 218
--------------------------------------------------------------------------------------------
Balance at December 31, 1998 ...... 29,698,160 $ 15 $ 138,895 $ 887 $ (31,551) $ (40) $ 108,206
===========================================================================================
</TABLE>
See accompanying notes.
14
<PAGE> 15
SDL, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) .......................................... $ 7,903 $ (24,353) $ 8,139
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization .......................... 8,696 6,427 5,310
In-process research and development .................... -- 753 --
Deferred income taxes .................................. (948) -- (223)
Changes in operating assets and liabilities:
Accounts receivable .................................. (1,472) (7,939) 626
Inventories .......................................... (6,104) (845) (5,027)
Accounts payable ..................................... 356 1,371 1,638
Accrued payroll and related expenses ................. (591) 730 195
Income taxes payable ................................. 1,280 2,392 --
Unearned revenue ..................................... 250 (62) (517)
Other accrued liabilities ............................ (1,072) 860 193
Other ................................................ 2,059 (1,421) 2,087
--------- --------- ---------
Total adjustments .......................................... 2,454 2,266 4,282
--------- --------- ---------
Net cash provided by (used in) operating activities ........ 10,357 (22,087) 12,421
INVESTING ACTIVITIES
Acquisition of property and equipment, net ................. (14,075) (11,732) (11,455)
Purchase of marketable securities .......................... (76,426) (57,064) (105,316)
Sales and maturities of marketable securities .............. 81,874 90,850 53,413
Acquisition of businesses .................................. -- (3,055) (1,560)
--------- --------- ---------
Net cash provided by (used in) investing activities ........ (8,627) 18,999 (64,918)
FINANCING ACTIVITIES
Issuance of stock pursuant to employee stock plans ......... 4,462 1,889 1,509
Issuance of common stock ................................... 5,522 -- 53,815
Payments on stockholders' notes receivable ................. 2 214 222
Dividend released .......................................... -- -- 408
(Increase) decrease in restricted cash ..................... 164 (886) --
Payments on capital leases ................................. (1,027) (136) (199)
Other ...................................................... -- -- (24)
--------- --------- ---------
Net cash provided by financing activities .................. 9,123 1,081 55,731
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ....... 10,853 (2,007) 3,234
Cash and cash equivalents at beginning of year ............. 6,170 8,177 4,943
--------- --------- ---------
Cash and cash equivalents at end of year ................... $ 17,023 $ 6,170 $ 8,177
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for income taxes ............................... $ 843 $ -- $ 170
Cash received from income taxes refunded ................. $ 214 $ 1,941 $ 773
Cash paid for interest ................................... $ 463 $ 204 $ 170
Capital equipment lease additions ........................ $ 1,340 $ 2,016 $ 433
</TABLE>
See accompanying notes.
15
<PAGE> 16
SDL, INC.
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1998
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
SDL, Inc. (the Company), a Delaware corporation, designs, manufactures, and
markets 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 SDL and its wholly-owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated. The Company has operations in the United States and international
operations in Canada and the United Kingdom.
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; fiscal 1998 ended on January 1, 1999
and was a 52 week year. For ease of discussion and presentation all years are
referred to as ending on December 31.
As more fully described in Note 17, the Company merged with IOC International
plc. ("IOC") in May 1999 in a pooling of interests transaction. The consolidated
financial statements for fiscal 1998, 1997 and 1996 have been restated to
include the financial position, results of operations and cash flows of IOC.
There were no transactions between IOC and the Company prior to the combination
and no significant adjustments were necessary to conform IOC's accounting
policies to those of the Company. Because of differing year ends, financial
information relating to SDL's fiscal years ended December 31, 1998, 1997, and
1996 has been combined with financial information relating to IOC's fiscal years
ended September 30, 1998, 1997, and 1996, respectively. IOC's net loss for the
three months ended December 31, 1998 was not combined with SDL's net income, but
rather will be included as an adjustment to stockholders' equity in the
Company's financial results for the three months ended March 31, 1999. These
supplemental consolidated financial statements will become the historical
financial statements upon the issuance of the financial statements for the
quarter ended June 30, 1999.
Certain amounts in prior year financial statements and notes thereto have been
reclassified to conform to current year presentation.
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.
Marketable Securities
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 interest income
and other, net. The cost of securities sold is based on the specific
identification method.
16
<PAGE> 17
Inventories
Inventories are stated at the lower of standard cost (which approximates actual
costs on a first-in, first-out basis) or market. The market value is based upon
estimated net realizable value.
Property and Equipment
Property and equipment are stated at cost. Equipment and fixtures are
depreciated using the straight-line method over estimated useful lives ranging
from three to eight years. Property and equipment assets held under capital
leases, are capitalized as tangible fixed assets and are depreciated over the
shorter of the lease term and their useful lives. 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, prime or subcontractors for which the U.S. government may be the end
customer, and other domestic and international end-users.
Concentrations
Dependence Upon Government Programs and Contracts - In 1998, 1997, and
1996, the Company derived approximately 26 percent, 34 percent, and 40
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 1998, 1997, and
1996 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.
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.
Principal Business and Export Sales
The Company's operations are conducted in one principal line of business, the
design, manufacture, and sale of semiconductor lasers, fiber optic products and
optoelectronic systems. The Company has operations in the United States
17
<PAGE> 18
and international operations in Canada and the United Kingdom. All sales are
denominated in U.S. dollars, except for sales in the United Kingdom, which are
primarily denominated in British Pound Sterling.
All U.S. operations sales to international customers constitute export sales.
Export sales from the United States to Europe totaled approximately $9.3
million, $5.9 million, and $3.9 million for 1998, 1997, and 1996, respectively.
Export sales from the United States to the Pacific Rim totaled approximately
$8.9 million, $6.9 million, and $6.0 million for 1998, 1997, and 1996,
respectively.
Foreign Currency Translation
The functional currency of the Company's Canadian subsidiary is the U.S. dollar.
These financial statements are remeasured into U.S. dollars for consolidation.
The functional currency of the Company's United Kingdom subsidiary is the
British Pound Sterling. As such, all assets and liabilities are translated at
the exchange rate on the balance sheet date. Revenues and costs and expenses are
translated at weighted average rates of exchange prevailing during the period.
Translation adjustments are recorded in accumulated other comprehensive income
as a separate component of stockholders' equity. Foreign currency transaction
gains and losses are included in interest income and other, net and were
immaterial for all periods presented.
Net Income (Loss) Per Share
In May 1999, the Company's stockholders approved a two-for-one split of its
common stock, effected in the form of a stock dividend, which was paid on June
2, 1999 to stockholders of record on May 14, 1999. All share and per share data
in these financial statements have been retroactively adjusted to reflect the
stock split.
The following table sets forth the computation of basic and diluted net income
(loss) per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Numerator:
Net income (loss) $ 7,903 $ (24,353) $ 8,139
========= ========= =========
Denominator:
Denominator for basic earnings per
share-weighted average shares 28,718 27,888 24,756
Incremental common shares attributable to
shares issuable under employee stock plans(1) 1,644 -- 2,482
--------- --------- ---------
Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions 30,362 27,888 27,238
========= ========= =========
Net income (loss) per share - basic $ 0.28 $ (0.87) $ 0.33
========= ========= =========
Net income (loss) per share - diluted $ 0.26 $ (0.87) $ 0.30
========= ========= =========
</TABLE>
- --------------
(1) Potential common shares relating to shares issuable under employee stock
plans are not included in the 1997 calculation due to their anti-dilutive
effect on the loss per share.
Options to purchase 124,726 shares of common stock were not included in the
computation of the 1998 diluted earnings per share because the options' exercise
price was greater than the average market price of common shares.
Comprehensive Income
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS 130
establishes new rules for the reporting and display of comprehensive
18
<PAGE> 19
income and its components; however, the adoption of this statement had no impact
on the Company's net income or stockholders' equity. SFAS 130 requires
unrealized gains or losses on the Company's available-for-sale securities and
foreign currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income. Comprehensive income consists of net income and other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of SFAS 130.
Accumulated other comprehensive income presented in the accompanying
consolidated balance sheets consists of the accumulated net unrealized gains and
losses on available-for-sale marketable securities and foreign currency
translation adjustments, net of the related tax effect for all periods
presented. The tax effects for other comprehensive income were immaterial for
all periods presented.
Segments of an Enterprise
Effective January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement of Financials Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information (Statement
131). Statement 131 superseded FASB Statement No. 14, Financial Reporting for
Segments of a Business Enterprise. Statement 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports.
Statement 131 also establishes standards for related disclosures about products
and services, geographic areas, and major customers. The adoption of Statement
131 did not affect results of operations or financial position, but did affect
the disclosure of segment information. See Note 14.
Statement of Position 98-1
In March 1998, the Accounting Standards Executive Committee of the AICPA issued
Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. The SOP, which has been adopted
prospectively as of September 30, 1998, requires the capitalization of certain
costs incurred in connection with developing or obtaining internal use software.
Prior to adoption of SOP 98-1, the Company expensed all internal use software
related costs as incurred. The effect of adopting the SOP was to increase net
income for the year ended December 31, 1998 by $71,000.
Recent Financial Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, which is required
to be adopted in years beginning after June 15, 1999. Management does not
anticipate that the adoption of the new Statement will have a significant effect
on earnings or the financial position of the Company.
2. MARKETABLE SECURITIES
Available-for-sale marketable securities consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998 GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Medium term notes $10,091 $ 1 $ 25 $10,067
Commercial Paper 4,959 20 -- 4,979
Tax-exempt auction rate preferred stock 5,950 -- -- 5,950
Money Market Funds 10,336 -- -- 10,336
------- ------- ------- -------
$31,336 $ 21 $ 25 $31,332
======= ======= ======= =======
Included in cash and cash equivalents $10,145
Included in short-term marketable securities 17,635
Included in long-term marketable securities 3,552
</TABLE>
19
<PAGE> 20
<TABLE>
<S> <C> <C> <C> <C>
-------
$31,332
=======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997 GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Municipal bonds $13,686 $ 1 $ 74 $13,613
Tax-exempt auction rate preferred stock 8,400 -- -- 8,400
Money Market Funds 7,061 -- -- 7,061
------- ------- ------- -------
$29,147 $ 1 $ 74 $29,074
======= ======= ======= =======
Included in cash and cash equivalents $ 2,508
Included in short-term marketable securities 14,953
Included in long-term marketable securities 11,613
-------
$29,074
=======
</TABLE>
The following is a summary of contractual maturities of the Company's marketable
securities (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
AMORTIZED ESTIMATED
COST FAIR VALUE
----------- ------------
<S> <C> <C>
Money Market Funds $10,336 $10,336
Amounts maturing within one year 17,436 17,444
Amounts maturing after one year 3,564 3,552
------- -------
$31,336 $31,332
------- -------
</TABLE>
Realized losses on the sale of available-for-sale securities were $0.1 million
and $0.3 million in 1998 and 1997, respectively.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Trade receivables $ 21,460 $ 18,944
Receivables under long-term contracts:
Billed 1,865 765
Unbilled costs and estimated earnings, current portion 722 3,051
-------- --------
24,047 22,760
Allowance for doubtful accounts (1,005) (1,190)
======== ========
$ 23,042 $ 21,570
======== ========
</TABLE>
The majority of unbilled costs and estimated earnings on uncompleted cost
incurred and fixed price contracts are billable in the subsequent year.
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 total
approximately $0.5 million in 1998 and 1997 and are included in other assets in
the accompanying balance sheets.
20
<PAGE> 21
4. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Raw materials $ 7,849 $ 7,030
Work-in-process 13,439 8,154
------- -------
$21,288 $15,184
======= =======
</TABLE>
No significant amounts of finished goods or work-in-process related to long-term
contracts are maintained.
5. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
Property and equipment consist of the following: AS OF DECEMBER 31,
-------------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Machinery and equipment $ 55,777 $ 43,016
Leasehold improvements 8,773 7,947
Furniture and fixtures 3,157 2,874
Construction-in-progress 3,980 2,434
-------- --------
71,687 56,271
Less accumulated depreciation and amortization (31,839) (23,920)
-------- --------
$ 39,848 $ 32,351
======== ========
</TABLE>
Included in property and equipment are assets acquired under capital lease
obligations with a cost and related accumulated depreciation of approximately
$4.2 million and $0.9 million, respectively, at December 31, 1998, and
approximately $3.0 million and $0.4 million, respectively, at December 31, 1997.
6. GOODWILL AND PURCHASED INTANGIBLES
Purchased intangibles, which are included in other assets, consist of the
following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Goodwill $ 1,363 $ 1,363
Other purchased intangibles 1,945 1,945
------- -------
3,308 3,308
Less accumulated amortization (2,147) (1,370)
------- -------
$ 1,161 $ 1,938
======= =======
</TABLE>
See Note 11, 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
21
<PAGE> 22
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,
---------------------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Current:
Federal $ 181 $ -- $ 2,617
State 26 -- 312
Foreign 1,824 417 346
------- ------- -------
2,031 417 3,275
Deferred:
Federal (948) -- (371)
State -- -- 148
------- ------- -------
(948) -- (223)
------- ------- -------
$ 1,083 $ 417 $ 3,052
======= ======= =======
</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 $0.2 million, zero and $5.2
million in 1998, 1997 and 1996, respectively. Such benefits were credited to
additional paid-in capital.
Pre-tax income (loss) from foreign operations was $(0.3) million, $1.4 million
and $1.9 million in 1998, 1997 and 1996, respectively.
The difference between the provision for income taxes and the amount computed by
applying the Federal statutory income tax rate to income before taxes is
explained below:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Tax at federal statutory rate $ 3,145 $(8,378) $ 3,917
State income tax, net of federal
tax benefit 17 -- 299
Non-deductible in-process, research
and development write-off -- 264 --
Net operating loss not benefited (utilized) (2,061) 8,943 (357)
Valuation allowance (216) -- --
Tax-exempt interest income (124) (453) (455)
Other 322 41 (352)
------- ------- -------
Provision for income taxes $ 1,083 $ 417 $ 3,052
======= ======= =======
</TABLE>
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 10,712 $ 9,995
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C> <C>
Reserves and other accrued expenses
not yet deductible for tax 1,832 2,070
Inventory 3,088 1,584
Intangible assets 4,157 3,838
Tax credit carryforward 1,800 970
Other -- 52
-------- --------
Total deferred tax assets 21,589 18,509
Valuation allowance (16,708) (14,345)
-------- --------
Net deferred tax assets 4,881 4,164
Deferred tax liabilities:
Depreciation (743) (550)
Other (138) (562)
-------- --------
Total deferred tax liabilities (881) (1,112)
-------- --------
Net deferred tax assets $ 4,000 $ 3,052
======== ========
</TABLE>
The valuation allowance increased by approximately $2.4 million and $12.3
million in 1998 and 1997, respectively. Approximately $7.6 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, 1998, the Company had federal, state, and foreign net
operating loss carryforwards of approximately $26.0 million, $4.8 million, and
$5.1 million, respectively, and federal and state tax credit carryforwards of
approximately $0.9 million and $1.3 million, respectively. The federal and state
net operating loss and credit carryforwards will expire at various dates
beginning in years 2001 through 2018, if not utilized. The foreign net operating
loss carryforwards have no expiration date.
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 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
Common Stock Offerings
On June 26, 1996, the Company issued 3,000,000 shares of common stock in a
follow-on public stock offering at a per share price of $13.50. In addition,
SDL's Underwriters exercised their over-allotment option to purchase 510,000
additional shares of the Company's common stock. Net proceeds to the Company
approximated $44.7 million.
In July 1998, the Company issued 217,644 shares of common stock at a per share
price of $31.24. Net proceeds to the Company approximated $5.5 million.
Shareholder Rights Plan
The Company has adopted a Shareholder Rights Plan (Rights Agreement). Pursuant
to the Rights Agreement, rights were distributed at the rate of one right for
each share of Common Stock owned by the Company's stockholders of record on
November 17, 1997. The rights expire on November 5, 2007 unless extended or
earlier redeemed or exchanged by the Company. Under the Rights Agreement, each
right entitles the registered holder to purchase one-hundredth of a Series B
Preferred share of the Company at a price of $55. The rights will become
exercisable only if a person or group acquires beneficial ownership of 15
percent or more of the Company's common stock or commences a tender offer or
exchange offer upon consummation of which such person or group would
beneficially own 15 percent or more or the Company's common stock.
Stockholders' Notes Receivable
23
<PAGE> 24
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 beginning in 1999 through 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 9,116,250 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 1,425,000 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 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 6,796,870 shares of common stock for future issuance
under its Stock Option Plans as of December 31, 1998.
Information with respect to stock option activity is summarized as follows:
<TABLE>
<CAPTION>
Outstanding Options
-------------------------------
Weighted-
Available Number Average
for Grant of Shares Exercise Price
---------- ---------- --------------
<S> <C> <C> <C>
Balance at December 31, 1995 260,700 5,832,260 $ 1.80
Options granted (769,428) 769,428 11.04
Options canceled 364,548 (364,548) 7.66
Options exercised -- (1,643,774) 0.35
Additional options authorized 1,084,894 -- --
Option authorizations canceled (29,040) -- --
---------- ---------- ----------
Balance at December 31, 1996 911,674 4,593,366 3.38
Options granted (1,115,018) 1,115,018 8.30
Options canceled 280,536 (280,536) 8.40
Options exercised -- (513,988) 1.18
Additional options authorized 1,340,338 -- --
---------- ---------- ----------
Balance at December 31, 1997 1,417,530 4,913,860 4.44
Options granted (1,320,952) 1,320,952 11.73
Options canceled 313,760 (313,760) 9.92
Options exercised -- (929,200) 2.03
</TABLE>
24
<PAGE> 25
<TABLE>
<S> <C> <C> <C>
Additional options authorized 1,394,680 -- --
---------- ---------- ----------
Balance at December 31, 1998 1,805,018 4,991,852 $ 6.47
========== ========== ==========
</TABLE>
The following table summarizes information about options outstanding at December
31, 1998:
<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>
$ 0.17 - $ 2.55 1,734,514 3.7years $ 0.42 1,734,514 $ 0.42
2.56 - 5.50 474,818 6.1 5.01 368,942 4.94
5.51 - 8.00 673,390 8.2 6.80 214,692 7.06
8.01 - 10.50 941,358 8.4 9.30 240,338 9.22
10.51 - 12.50 985,548 9.0 12.01 80,082 11.40
12.51 - 15.00 106,626 7.5 13.82 51,850 13.87
15.01 - 19.82 18,100 10.0 19.82 -- --
19.83 - 61.99 57,498 9.1 35.16 27,476 35.08
--------- ---------
$ 0.17 - $61.99 4,991,852 6.7 $ 6.21 2,717,894 $ 3.03
========= =========
</TABLE>
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 900,000 shares of common stock
for issuance to participants. In May 1998, 800,000 additional shares of common
stock were reserved 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 298,690,
237,380, and 221,316 shares in 1998, 1997 and 1996, respectively.
Stock-Based Compensation
The Company has elected to follow 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 value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock-based awards. The fair value of
the Company's stock-based awards to employees was estimated assuming no expected
dividends and the following weighted-average assumptions:
<TABLE>
<CAPTION>
Options ESPP
-------------------------------------- ------------------------------------
1998 1997 1996 1998 1997 1996
---------- --------- ----------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Expected Life 4 years 4 years 3 years 6 months 6 months 6 months
Expected Volatility 0.72 0.66 0.60 0.84 0.82 0.72
</TABLE>
25
<PAGE> 26
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Risk Free Interest Rate 5.15% 6.17% 6.04% 5.06% 5.64% 5.45%
</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>
1998 1997 1996
-----------------------------------------------
<S> <C> <C> <C>
Pro forma net income (loss) $ 6,789 $ (27,523) $ 5,947
Pro forma net income (loss) per share - basic $ 0.24 $ (0.99) $ 0.24
Pro-forma net income (loss) per share - diluted $ 0.22 $ (0.99) $ 0.22
</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 1998, 1997 and 1996 were
$6.51, $4.46 and $4.83, respectively. The weighted-average fair value of ESPP
rights granted in 1998, 1997 and 1996 were $3.77, $2.82 and $1.99, respectively.
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. At the time of acquisition, 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 beginning with November 1997. The results of Mr. Laser prior to the
acquisition were not material to the Company's consolidated results of
operations.
12. COMMITMENTS AND NOTES PAYABLE
The Company has entered into certain capital leases for equipment. The leases
are secured by the related equipment and restricted cash of $722,000 as of
December 31, 1998. This cash has been classified as restricted cash on the
balance sheet. The Company also leases all of its facilities and certain
equipment under operating leases. The operating facilities leases contain
renewal options. The future minimum lease payments as of December 31, 1998,
under the related leases are as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
------- -------
<S> <C> <C>
Fiscal Year
1999 $ 1,305 $ 2,307
2000 1,049 2,328
2001 319 2,298
2002 159 692
2003 42 293
-----------------------
Minimum payments 2,874 $ 7,918
=======
Less interest (360)
-------
Present value of minimum payments 2,514
Less current portion (1,098)
-------
Long-term portion $ 1,416
=======
</TABLE>
Rental expense was approximately $2.5 million, $2.2 million and $1.5 million,
for 1998, 1997 and 1996, respectively.
26
<PAGE> 27
The Company has entered into certain loan agreements. These loans are repayable
in equal annual installments ending September 30, 2001. The interest rate is the
higher of 3% above LIBOR or 10%.
13. CONTINGENCIES
In 1985, Rockwell International Corporation (Rockwell) asserted, and in 1995
filed suit in the Northern California Federal District Court 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. Rockwell's suit was stayed in
1995 pending resolution of another suit, involving the same patent, brought by
Rockwell against the Federal government, and in which SDL had intervened. The
suit between the Federal government and Rockwell was resolved in January 1999,
by way of a settlement payment from the Federal government to Rockwell. The
Company did not participate in the settlement. As a result of that settlement,
the Company anticipates that the stay of Rockwell's suit against the Company
will be lifted. A status conference is scheduled in that case for March 8, 1999.
The resolution of this litigation is fact intensive so that the outcome cannot
be determined and remains uncertain. If Rockwell prevailed in the litigation, it
could be awarded monetary damages against the Company. The Company believes,
however, that it has meritorious defenses to the Rockwell's allegations in the
litigation.
Shortly after the aforementioned suit between Rockwell and the Federal
government was filed, the Federal government had notified the Company that, if
the Federal government were liable to Rockwell, then the Federal government
might seek indemnification for a portion of its liability from the Company. The
Federal government never stated the amount of the Company's alleged indemnity
obligation, nor has it ever repeated its assertion that the Company might have
some indemnity obligation to the Federal government.
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 affect on the Company's financial position, results of
operations or cash flows. Nevertheless, based on future developments, the
Company's estimate of the outcome of these matters could change in the near
term.
During the first half of 1998, supplies of modulators to a customer were
withdrawn due to an apparent design problem. It was expected that the
replacement modulators would be shipped during the second half of the year. The
estimated rework costs of $0.6 million were recorded in the second quarter, but
the costs were reversed in the forth quarter since the customer did not return
the related modulators. The order has since been cancelled by the customer.
While there has been no formal legal claim against the Company, the customer has
requested the return of $1.2 million for receivables paid for earlier
deliveries. The Company has rejected this request and is confident that if a
formal legal claim is received it can be successfully defended.
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.
14. SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
Reportable Segments
27
<PAGE> 28
SDL has three reportable segments: communications, research, and printing and
materials processing. The communications business unit develops, designs,
manufactures and distributes lasers for applications in the telecom, cable
television, satellite and dense wavelength division multiplexing markets. The
research business unit conducts research, development or product customization,
involving both communications and printing and material processing applications,
for Fortune 500 companies, major international customers, smaller domestic and
international companies, and multiple Federal government agencies. The operating
results of the research business unit include solely the results generated from
that business unit. Research revenue on the Consolidated Statement of Operations
included research, development, and product customization conducted by all
segments of the Company. The printing and materials processing business unit
develops, designs, manufacturers and distributes lasers for applications in the
surface heat treating, product labeling, digital imaging, digital proofing, and
thermal printing solutions markets.
The operating segments reported below are the segments of the Company for which
separate financial information is available and for which operating income/loss
amounts are evaluated regularly by executive management in deciding how to
allocate resources and in assessing performance. The accounting policies of the
operating segments are the same as those described in the summary of accounting
policies.
The Company's reportable segments are business units that offer different
products. The reportable segments are each managed separately because they
manufacture and distribute distinct products with different applications. The
Company does not allocate assets to its individual operating segments.
Information about reported segment income or loss is as follows (in thousands):
<TABLE>
<CAPTION>
PRINTING AND
COMMUNICATION MATERIAL
YEAR ENDED DECEMBER 31, 1998: PRODUCTS RESEARCH PROCESSING TOTAL
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 62,045 $ 7,354 $ 43,393 $112,792
Amortization 645 -- 132 777
Segment Operating Income $ 2,791 $ 135 $ 4,776 $ 7,702
----------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PRINTING AND
COMMUNICATION MATERIAL
YEAR ENDED DECEMBER 31, 1997: PRODUCTS RESEARCH PROCESSING TOTAL
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 49,109 $ 11,020 $ 41,990 102,119
Amortization 645 -- 26 671
In Process R&D -- -- 753 753
Segment Operating Income (Loss) $ 2,730 $ 138 $ (912) $ 1,956
-----------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PRINTING AND
COMMUNICATION MATERIAL
YEAR ENDED DECEMBER 31, 1996: PRODUCTS RESEARCH PROCESSING TOTAL
------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue from external customers $41,306 $11,900 $35,018 $88,224
Amortization 645 -- -- 645
Segment Operating Income $ 4,631 $ 518 $ 4,350 $ 9,499
------------------------------------------------------
</TABLE>
A reconciliation of the totals reported for the operating segments to the
applicable line items in the consolidated financial statements is as follows (in
thousands):
28
<PAGE> 29
<TABLE>
<CAPTION>
OPERATING INCOME (LOSS) 1998 1997 1996
-----------------------------------------
<S> <C> <C> <C>
Total operating income from operating segments: $ 7,702 $ 1,956 $ 9,499
Spectra Physics Lawsuit and related legal costs -- (27,500) --
-----------------------------------------
Total consolidated operating income (loss): $ 7,702 $(25,544) $ 9,499
=========================================
</TABLE>
Geographic Information
Information regarding geographic areas for the years ended December 31, 1998,
1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31, 1998 Long-Lived
Revenue(a) Assets
------------- ------------
<S> <C> <C>
United States $ 82,882 $ 33,624
Canada 6,503 3,016
United Kingdom 4,340 6,917
Germany 4,771 --
France 4,308 --
Japan 6,886 --
Other foreign countries 3,102 --
-------- --------
Total $112,792 $ 43,557
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1997 Long-Lived
Revenue(a) Assets
------------ ------------
<S> <C> <C>
United States $ 76,171 $ 28,249
Canada 2,175 1,366
United Kingdom 10,851 6,054
Germany 2,936 --
France 3,221 --
Japan 4,123 --
Other foreign countries 2,642 --
-------- --------
Total $102,119 $ 35,669
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1996 Long-Lived
Revenue(a) Assets
------------- ------------
<S> <C> <C>
United States $69,979 $23,777
Canada 1,144 1,075
United Kingdom 5,903 2,340
France 3,329 --
Japan 3,740 --
Other foreign countries 4,129 --
------- -------
Total $88,224 $27,192
</TABLE>
- --------------
(a) Revenue is attributed to countries based on the location of customers.
Major Customers
The Company received approximately 13 percent, 17 percent and 20 percent of its
1998, 1997, and 1996, respectively, revenue from Lockheed-Martin through several
government and commercial programs. Sales to Lockheed-Martin are reported in the
communication products and printing and material processing segments. Almost all
of the Company's revenue from this customer during 1998, 1997 and 1996 was
derived from Federally-funded programs. Most of the
29
<PAGE> 30
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 or failure to win new contracts with Lockheed-Martin, or
other major customers, could have an adverse effect on the Company's results of
operations.
15. 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 20 percent of their pre-tax earnings (up to the
Internal Revenue Service limit). 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 $0.6 million,
$0.5 million, and $0.4 million for 1998, 1997, and 1996, respectively.
16. STOCK SPLIT
In May 1999, the Company authorized a two-for-one split of its common stock,
effected in the form of a stock dividend, which was paid on June 2, 1999 to
stockholders of record on May 14, 1999. All of the share and per share data in
these financial statements have been retroactively adjusted to reflect the stock
split.
17. BUSINESS COMBINATION
On May 18, 1999, the Company merged with IOC, a United Kingdom-based
manufacturer of lithium niobate components for long haul fiber optic
transmission systems. The Company has exchanged 1,130,098 shares of SDL common
stock and reserved 116,974 shares for IOC options assumed by the Company. Merger
related expenses of approximately $2.1 million will be recorded in the second
quarter of fiscal 1999. Separate revenue and net income (loss) amounts of the
merged entities are presented in the following table (in thousands):
<TABLE>
<CAPTION>
Years Ended
December 31,
1998 1997 1996
---------------------------------------------
<S> <C> <C> <C>
Total revenues:
SDL $ 106,138 $ 91,364 $ 82,475
IOC 6,654 10,755 5,749
---------------------------------------------
Combined $ 112,792 $ 102,119 $ 88,224
Net income (loss):
SDL $ 12,823 $ (24,679) $ 7,121
IOC (4,920) 326 1,018
---------------------------------------------
Combined $ 7,903 $ (24,353) $ 8,139
</TABLE>
18. SUBSEQUENT EVENTS (UNAUDITED)
In February 1999, the Company acquired the fiber laser business of Polaroid for
$5.2 million cash. The business acquired included all the physical assets,
intellectual property, including the assignment of 38 patents and the licensing
of 22 patents in the fiber laser area, and the ongoing operation of the fiber
manufacturing facilities and fiber laser subsystem. The acquisition will be
accounted for under the purchase method of accounting and the Company wrote-off
in-process research and development up to $1.5 million in the first quarter of
1999. The results of the fiber laser business are not material to the Company's
historical consolidated results of operations.
In May 1999, the Company's stockholders approved an increase in the Company's
authorized shares of its common stock to 70 million shares.
30
<PAGE> 31
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
SDL, Inc.
We have audited the supplemental consolidated balance sheets of SDL,
Inc. (formed as a result of the consolidation of SDL, Inc. and IOC International
plc) as of December 31, 1998 and 1997 and the related supplemental consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
supplemental financial statement schedule listed in the index at Item 7. The
supplemental consolidated financial statements give retroactive effect to the
merger of SDL, Inc. and IOC International plc on May 18, 1999, which has been
accounted for using the pooling of interests method as described in the notes to
the supplemental consolidated financial statements. These supplemental financial
statements are the responsibility of the management of SDL, Inc. Our
responsibility is to express an opinion on these supplemental financial
statements based on our audits. We did not audit the financial statements of IOC
International plc which statements reflect total assets constituting 15% for
1998 and 16% for 1997 of the related supplemental consolidated net loss totals,
and which reflect net income constituting approximately 43% of the related
supplemental consolidated financial statement totals for the three year period
ended December 31, 1998. Those statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to data
included for IOC International plc, is based solely on the report of the other
auditors.
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 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 and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors,
the supplemental financial statements referred to above present fairly, in all
material respects, the consolidated financial position of SDL, Inc. at December
31, 1998 and 1997, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, after
giving retroactive effect to the merger of IOC International plc, as described
in the notes to the supplemental consolidated financial statements, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
San Jose, California
January 29, 1999, except for Note 16,
as to which the date is May 14, 1999 and
except for paragraph 4 of Note 1 and Note 17,
as to which the date is May 18, 1999
31
<PAGE> 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
In May 1999, the Company merged with IOC International plc. ("IOC") through the
issuance of 1,130,098 shares of common stock. The merger was accounted for as a
pooling of interests and accordingly all prior period financial statements have
been restated to combine the operating results of IOC and the Company for all
periods presented. IOC's fiscal year end was September 30. The accompanying
supplemental statements of operations for the three months ended March 31, 1998
combine the operating results of IOC for the three months ended December 31,
1997 with the operating results of the Company for the three months ended March
31, 1998. IOC's results of operations for the three months ended March 31, 1999
has been combined with SDL's results of operations for the three months ended
March 31, 1999. Management's Discussion and Analysis reflects the pooled entity.
The comparisons to prior periods below should be read in light of this fact.
RESULTS OF OPERATIONS
Revenue. Total revenue for the quarter ended March 31, 1999 increased 40% to
$37.7 million compared to $26.9 million in the corresponding 1998 quarter.
Product revenue reported for the first quarter of 1999 increased 55% compared to
product revenue for the first quarter of 1998. The increase in product revenue
resulted primarily from growth in dense wavelength division multiplexing (DWDM)
product sales caused by a strong demand for SDL's 980nm pump laser product
(including submarine fiber products). DWDM product revenue increased 172% from
the prior year quarter. Research revenue declined both in dollars and as a
percentage of total revenue compared to the corresponding first quarter of 1998.
This downward trend in research revenue has resulted as the Company continues to
focus its longer-term strategy on commercial communication product
opportunities. Revenue derived directly or indirectly from U.S. government
sources declined to 16% of total revenue reported for the first three months of
1999, compared to 29% for the first quarter of 1998.
Revenues from customers outside of the United States represented 31% and 25% of
total revenues for the first quarter of 1999 and 1998, respectively. Virtually
all of this export growth was into the European region, where revenue was up
187% over the prior year and represented 26% of the first quarter 1999 revenue.
There can be no assurance that the application markets for SDL's products will
grow in future periods at historical percentage rates. Further, there can be no
assurance that the Company will be able to increase or maintain its market share
in the future or to sustain historical growth rates.
Gross Margin. Excluding one-time charges of $0.7 million for the fiber laser
business acquisition, first quarter 1999 gross margin was 41% compared with 31%
for the first quarter of 1998. Three factors contributed to the
quarter-over-quarter increase in gross margin. These were: (i) a more favorable
mix of DWDM product sales as compared to revenue derived from U.S. government
contracts and non-communication sales; (ii) increased yields and volumes from
the Company's wafer fab; and, (iii) reduction of costs related to the 980nm pump
lasers.
The Company's gross margin can be affected by a number of factors, including
product mix, customer mix, applications 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. The Company incurred research and development expense
of $3.8 million and $2.9 million for the quarters ended March 31, 1999 and 1998,
respectively. Research and development expense as a percentage of total revenue
was 10% and 11% for the March 1999 and 1998 quarters, respectively. The higher
levels of 1999 spending were focused on bringing new communication products to
market. Approximately 80% of the 1999 research and development spending was for
new product development in the communications market.
The Company is committed to continuing its significant research and development
expenditures and expects that the absolute dollar amount of research and
development expenses will increase as it invests in developing new products,
32
<PAGE> 33
expanding and enhancing its existing product lines, and reducing its costs,
although research and development expenses may vary as a percentage of revenue.
Selling, General and Administrative. For the three months ended March 31, 1999,
selling, general and administrative (SG&A) expense was $5.7 million or 15% of
revenue, compared to $3.8 million or 14% of revenue for the corresponding 1998
three month period. The increase in SG&A was principally the result of higher
personnel-related costs to support the increased level of sales and operations,
implementation of the Company's new enterprise resource planning software and
other information system projects. 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 Company's acquisition of the fiber
laser business from Polaroid during the first quarter 1999 resulted in the
write-off of purchased in-process research and development of $1.5 million. In
the future, additional in-process research and development write-offs can be
anticipated to the extent the Company may from time to time acquire companies or
new product lines.
Interest Income and other, net. Net interest income and other, net for the three
months ended March 31, 1999 was $286,000 compared to $293,000 recorded in the
March 1998 quarter. Lower average cash and investment balances during the first
quarter of 1999 offset by lower returns on investments in the first quarter of
1998 resulted in interest income and other, net to be relatively unchanged.
Provision for Income Taxes. The Company recorded a provision for income taxes of
$1,161,000 and $230,000 for the three months ended March 31, 1999 and 1998,
respectively. Excluding the impact of the in-process research and development
charge in 1999, the effective tax rate for the first quarter 1999 was 22%,
compared to 14% for the corresponding quarter of 1998. In 1998, the Company
benefited from previously unrecognized tax loss carryforwards, generated from
the 1997 legal settlement, which reduced the federal and state provisions to
minimum tax levels offset partially by unbenefitted foreign tax losses
generated. The increase in the 1999 tax rate is primarily attributable to the
Company's utilization of the remainder of federal and state tax loss
carryforwards.
Although realization is not assured, the Company believes that it will generate
future taxable income sufficient to realize the benefit of the $4.0 million of
net deferred tax assets recorded. 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.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1999, the Company's combined balance of cash, cash equivalents
and marketable securities was $26.4 million. Cash used by operating activities
is primarily the result of increases in accounts receivable and inventories and
a decrease in accounts payable offset by net income before depreciation and
amortization expense.
Cash used in investing activities was $10.3 million in the three months ended
March 31, 1999. The Company incurred capital expenditures of $7.4 million for
facilities expansion and capital equipment purchases to expand its manufacturing
capacities primarily for its communication products. The Company currently
expects to spend $15 million to $19 million for capital equipment purchases and
leasehold improvements during the remainder of 1999. In addition, the Company
acquired Polaroid's fiber laser business during the first quarter of 1999 which
resulted in cash payments of $5.1 million.
The Company generated $2.4 million from financing activities during the first
quarter of 1999 from the exercise of employee stock options offset by capital
lease payments.
The Company believes that current cash balances, cash generated from operations,
and cash available through the bank and equity markets will be sufficient to
fund capital equipment purchases, acquisitions of complementary businesses,
products or technologies and working capital requirements for the foreseeable
future. However, there can be no assurances that events in the future will not
require the Company to seek additional capital sooner or, if so required, that
adequate capital will be available on terms acceptable to the Company.
33
<PAGE> 34
IMPACT OF YEAR 2000
Like many other companies, the year 2000 computer issue creates risks for SDL.
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. If internal systems do not correctly
recognize and process date information beyond the year 1999, there could be a
material adverse impact on the Company's business and results of operations.
To address these year 2000 issues within its internal systems, the Company has
established a task team and initiated a comprehensive program designed to deal
with the most critical systems first. Assessment and remediation are proceeding
in tandem, and the Company currently plans to have changes to critical systems
completed and tested by mid-1999. These activities are intended to encompass all
systems software applications in use by the Company, including front and
back-end manufacturing, facilities, sales, finance and human resources.
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 project is estimated to be completed during the quarter ended
June 30, 1999. In addition, as a contingency plan, the Company's existing
management information software applications have been successfully upgraded to
a year 2000 compliant version.
Assessment and remediation of year 2000 issues in tertiary business information
systems is on-going. Well over 80% of the Company's investment in desktop PC
hardware is known to be year 2000 compliant. Additionally, the Company has
concluded that the purchase of newer, more functional software for its network
server applications is more cost effective than upgrading its existing software
to a year 2000 compliant version. Completing the remediation of the Company's
tertiary business information systems is not expected to be a significant burden
on the Company.
To date, based on its current manufacturing process, SDL believes it has no
material exposure to contingencies directly related directly to the Year 2000
issue for the products it has sold or will sell in the future.
SDL is also actively working with critical suppliers of products and services to
determine that the suppliers' operations and the products and services they
provide are year 2000 compatible or to monitor their progress toward year 2000
compatibility. In addition, the Company has commenced work on various types of
contingency planning to address potential problem areas with internal systems
and with suppliers and other third parties. It is expected that assessment,
remediation and contingency planning activities will be on-going throughout 1999
with the goal of appropriately resolving all material internal systems and third
party issues.
The costs incurred to date related to these programs are less than $2.7 million.
The Company currently expects that the total cost of these programs, including
both incremental spending and redeployed resources, will total approximately
$3.0 million, which includes $1.8 million for the purchase of new software and
hardware that will be capitalized and $1.2 million that will be expensed as
incurred. The Company expects that operating activities will fund these year
2000 remediation costs. In some instances, the installation schedule of new
software and hardware in the normal course of business is being accelerated to
also afford a solution to year 2000 capability issues. The Company has not
delayed any non-year 2000 projects as a consequence of its year 2000 remediation
efforts. The costs of these projects and dates 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.
Based on currently available information, management does not believe that the
year 2000 matters discussed above related to internal systems or products sold
to customers will have a material adverse impact on the Company's financial
condition or overall trends in results of operations; however, it is uncertain
to what extent the Company may be affected by such matters. Any failure to
timely, successfully and cost-effectively assess, identify, remediate and
resolve the Company's year 2000 issues, including those regarding its own as
well as suppliers' and third parties' internal systems, products, services and
contingency plans, may have a material adverse effect on the Company's business
and results of operations. The Company is continuing its efforts to ensure year
2000 readiness, and there is risk that there may be new year 2000 issues
34
<PAGE> 35
not identified above and significant delays in or increased costs associated
with such efforts which could have a material adverse effect on the Company's
business and results of operations.
35
<PAGE> 36
SDL, INC.
SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
----------- ------------
(unaudited) (1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 6,747 $ 17,023
Short-term marketable securities ..................................... 18,994 17,635
Accounts receivable, net ............................................. 28,729 23,042
Inventories .......................................................... 24,296 21,288
Prepaid expenses and other current assets ............................ 3,485 3,875
--------- ---------
Total current assets ................................................... 82,251 82,863
Property and equipment, net ............................................ 44,460 39,848
Long-term marketable securities ........................................ -- 3,552
Restricted cash ........................................................ 686 722
Note due from related party ............................................ 504 512
Other assets ........................................................... 7,031 4,563
--------- ---------
Total assets ........................................................... $ 134,932 $ 132,060
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................... $ 8,557 $ 10,014
Accrued payroll and related expenses ................................. 2,696 2,354
Income taxes payable ................................................. 1,452 1,890
Unearned revenue ..................................................... 618 643
Current portion of capital leases .................................... 1,077 1,098
Other accrued liabilities ............................................ 3,875 3,159
--------- ---------
Total current liabilities .............................................. 18,275 19,158
Long-term liabilities
Capital leases ..................................................... 825 1,416
Notes payable ........................................................ 580 612
Other long-term liabilities ........................................ 3,291 2,668
--------- ---------
Total long-term liabilities ........................................... 4,696 4,696
Commitments and contingencies
Stockholders' equity:
Preferred stock ...................................................... -- --
Common stock ......................................................... 15 15
Additional paid-in capital ........................................... 141,911 138,895
Accumulated other comprehensive income ............................... 138 887
Accumulated deficit, $26.3 million relating to the repurchase of
common stock in 1992 and $5.8 million relating to a
recapitalization in 1992 ........................................... (30,063) (31,551)
--------- ---------
112,001 108,246
Less common stockholders' notes receivable ........................... (40) (40)
--------- ---------
Total stockholders' equity ............................................. 111,961 108,206
--------- ---------
Total liabilities and stockholders' equity ............................. $ 134,932 $ 132,060
========= =========
</TABLE>
- --------------
(1) The balance sheet at December 31, 1998 has been derived from the audited
supplemental financial statements at that date.
See accompanying notes
36
<PAGE> 37
SDL, INC.
SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data - unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1999 1998
<S> <C> <C>
Total revenue:
Product revenue $36,690 $23,696
Research revenue 976 3,217
------- -------
37,666 26,913
Cost of revenue:
Cost of product revenue 22,130 16,296
Cost of research revenue 903 2,372
------- -------
Gross margin 14,633 8,245
Operating expenses:
Research and development 3,781 2,861
Selling, general and administrative 5,680 3,830
Amortization of purchased intangibles and goodwill 179 196
In-process research and development 1,495 --
------- -------
Operating income 3,498 1,358
Interest income and other, net 286 293
------- -------
Income before income taxes 3,784 1,651
Provision for income taxes 1,161 230
------- -------
Net income $ 2,623 $ 1,421
======= =======
Net income per share - basic $ 0.09 $ 0.05
======= =======
Net income per share - diluted $ 0.08 $ 0.05
======= =======
Number of weighted average shares - basic 30,088 28,320
Number of weighted average shares - diluted 32,148 29,994
</TABLE>
See accompanying notes.
37
<PAGE> 38
SDL, INC.
SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands - unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------
1999 1998
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 2,623 $ 1,421
IOC net loss for the three months ended December 31, 1998 (1,136) --
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,189 2,264
In-process research and development 1,495 --
Changes in operating assets and liabilities:
Accounts receivable (5,687) 1,427
Inventories (2,029) (773)
Accounts payable (1,457) 678
Accrued payroll and related expenses 342 (56)
Income taxes payable (438) (269)
Unearned revenue (25) (22)
Other accrued liabilities 472 (933)
Long-term liabilities 623 161
Other (387) 2,983
-------- --------
Total adjustments (3,902) 5,460
-------- --------
Net cash provided by (used in) operating activities (2,415) 6,881
INVESTING ACTIVITIES
Acquisition of property and equipment, net (7,393) (4,583)
Acquisition of the fiber laser business of Polaroid (5,055) --
Sale of investments, net 2,147 4,126
-------- --------
Net cash used in investing activities (10,301) (457)
FINANCING ACTIVITIES
Issuance of stock pursuant to employee stock plans 3,016 286
Payments on capital leases (380) (402)
Decrease in restricted cash 36 --
Other (232) --
-------- --------
Net cash provided by (used in) financing activities 2,440 (116)
-------- --------
Net increase (decrease) in cash and cash equivalents (10,276) 6,308
Cash and cash equivalents at beginning of period 17,023 6,170
-------- --------
Cash and cash equivalents at end of period $ 6,747 $ 12,478
======== ========
SUPPLEMENT DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for income taxes $ 1,804 $ 473
Cash paid for interest $ 289 $ 258
</TABLE>
See accompanying notes.
38
<PAGE> 39
SDL, INC.
NOTES TO SUPPLEMENTAL CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 1999
1. Basis of Presentation and Business Activities
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended March 31,
1999 are not necessarily indicative of the results that may be expected
for the year ended December 31, 1999. For further information, refer to
the consolidated financial statements and footnotes thereto included in
the Registrant Company's Annual Report on Form 10-K/A for the year ended
December 31, 1998.
The consolidated financial statements include the accounts of SDL, Inc.
and its wholly owned subsidiary, SDL Optics and IOC International plc.
Intercompany accounts and transactions have been eliminated in
consolidation.
The functional currency of the Company's Canadian subsidiary is the U.S.
dollar. These financial statements are remeasured into U.S. dollars for
consolidation. The functional currency of the Company's United Kingdom
subsidiary is the British Pound Sterling. As such, all assets and
liabilities are translated at the exchange rate on the balance sheet date.
Revenues and costs and expenses are translated at weighted average rates
of exchange prevailing during the period. Translation adjustments are
recorded in accumulated other comprehensive income as a separate component
of stockholders' equity. Foreign currency transaction gains and losses are
included in interest income and other, net and were immaterial for all
periods presented.
The Company operates and reports financial results on a fiscal year of 52
or 53 weeks ending on the Friday closest to December 31. The first fiscal
quarter of 1999 and 1998 ended on April 2, 1999 and April 3, 1998,
respectively. For ease of discussion and presentation, all accompanying
financial statements have been shown as ending on the last day of the
calendar month.
As more fully described in Note 9, the Company merged with IOC
International plc. ("IOC") in May 1999 in a pooling of interests
transaction. The condensed consolidated financial statements for the three
months ended March 31, 1999 and 1998 have been restated to include the
financial position, results of operations and cash flows of IOC. There
were no transactions between IOC and the Company prior to the combination
and no significant adjustments were necessary to conform IOC's accounting
policies. Because of differing year ends, financial information relating
to SDL's fiscal quarter ended March 31, 1998 has been combined with
financial information relating to IOC's fiscal quarter ended December 31,
1997. IOC's net loss for the three months ended December 31, 1998 was not
combined with SDL's net income, but rather was included as an adjustment
to stockholders' equity in the Company's financial results for the three
months ended March 31, 1999. IOC's results of operations for the three
months ended March 31, 1999 has been combined with SDL's results of
operations for the three months ended March 31, 1999. These supplemental
condensed consolidated financial statements will become the historical
financial statements upon the issuance of the financial statements for the
quarter ended June 30, 1999.
2. Net Income Per Share
In May 1999, the Company authorized a two-for-one split of its common
stock, effected in the form of a stock dividend, which was paid on June 2,
1999 to stockholders of record on May 14, 1999. All of the share and per
share data in these financial statements have been retroactively adjusted
to reflect the stock split.
39
<PAGE> 40
The following table sets forth the computation of basic and diluted net
income per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
For the quarter ended
March 31,
----------------------
1999 1998
----------------------
<S> <C> <C>
Numerator:
Net income $ 2,623 $ 1,421
======= =======
Denominator:
Denominator for basic net income per share-
weighted average shares 30,088 28,320
Incremental common shares attributable to shares
issuable under employee stock plans 2,060 1,674
------- -------
Denominator for diluted net income per share-adjusted
weighted average shares and assumed conversions 32,148 29,994
======= =======
Net income per share - basic $ 0.09 $ 0.05
======= =======
Net income per share - diluted $ 0.08 $ 0.05
======= =======
</TABLE>
3. Inventories
The components of inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
----------------------------------
1999 1998
----------------------------------
<S> <C> <C>
Raw materials $11,864 $ 7,849
Work in process 12,432 13,439
------- -------
$24,296 $21,288
======= =======
</TABLE>
4. Comprehensive Income
Accumulated other comprehensive income presented in the accompanying
consolidated balance sheet consists of the accumulated net unrealized gains
and losses on available-for-sale marketable securities and foreign currency
translation adjustments, net of the related tax effect. The tax effects for
other comprehensive income were immaterial for all periods presented.
Total comprehensive income amounted to approximately $1.9 million for the
first quarter 1999 compared to a comprehensive income of $1.9 million for
the first quarter of 1998.
5. Segment Reporting
40
<PAGE> 41
SDL has three reportable segments: communications, research, and printing
and materials processing. The communications business unit develops,
designs, manufactures and distributes lasers for applications in the
telecom, cable television, satellite and dense wavelength division
multiplexing markets. The research business unit conducts research,
development or product customization, involving both communications and
printing and material processing applications, for Fortune 500 companies,
major international customers, smaller domestic and international
companies, and multiple Federal government agencies. The operating results
of the research business unit include the results generated from that
business unit which includes some revenue classified as product revenue.
The printing and materials processing business unit develops, designs,
manufacturers and distributes lasers for applications in the surface heat
treating, product labeling, digital imaging, digital proofing, and thermal
printing solutions markets.
The operating segments reported below are the segments of the Company for
which separate financial information is available and for which operating
income/loss amounts are evaluated regularly by executive management in
deciding how to allocate resources and in assessing performance. The
accounting policies of the operating segments are the same as those
described in the summary of accounting policies.
The Company's reportable segments are business units that offer different
products. The reportable segments are each managed separately because they
manufacture and distribute distinct products with different applications.
The Company does not allocate assets to its individual operating segments.
Information about reported segment income or loss is as follows (in
thousands):
<TABLE>
<CAPTION>
Printing and
Communication Material
Quarter ended March 31, 1999: Products Research Processing Total
------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 27,313 $ 1,255 $ 9,098 $ 37,666
Amortization 78 -- 101 179
Segment Operating Income (loss) $ 5,877 $ (217) $ 33 $ 5,693
------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Printing and
Communication Material
Quarter ended March 31, 1998: Products Research Processing Total
------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 12,508 $ 2,059 $ 12,346 $ 26,913
Amortization 155 -- 41 196
Segment Operating Income $ (526) $ 201 $ 1,683 $ 1,358
------------------------------------------------------------
</TABLE>
A reconciliation of the totals reported for the operating segments to the
applicable line items in the consolidated financial statements is as
follows (in thousands):
<TABLE>
<CAPTION>
For the quarter ended
March 31,
Operating Income 1999 1998
-----------------------
<S> <C> <C>
Total operating income from operating segments: $ 5,693 $ 1,358
In-Process R&D and related costs: (2,195) --
-----------------------
Total consolidated operating income: $ 3,498 $ 1,358
=======================
</TABLE>
6. Acquisitions
41
<PAGE> 42
In February 1999, the Company acquired the fiber laser business of Polaroid
for $5.3 million, which includes related transaction costs of $0.1 million.
The business acquired includes all the physical assets, intellectual
property, including the assignment of 38 patents and the licensing of 22
patents in the fiber laser area, and the ongoing operation of the fiber
manufacturing facilities and fiber laser subsystem. The acquisition was
accounted for under the purchase method of accounting. The Company recorded
$1.5 million as in-process research and development for development
projects that had not yet reached technological feasibility. Intangible
assets are being amortized straight-line over a seven year life. In
addition, the Company recorded $0.7 million to accrue for certain
pre-existing obligations to integrate the fiber laser business. The results
of the fiber laser business are not material to the Company's historical
consolidated results of operations.
The purchase price allocation for the fiber laser business acquisition was
recorded as follows (in thousands):
<TABLE>
<S> <C>
Inventory ........................................... $ 979
Property and equipment .............................. 229
Intangibles ......................................... 2,596
In-process research and development ................. 1,495
------
Net assets acquired ................................. $5,299
Liabilities ......................................... $ 244
Cash paid, including transaction costs .............. 5,055
------
Total purchase price ................................ $5,299
</TABLE>
7. Contingencies
In 1985, Rockwell International Corporation (Rockwell) asserted, and in 1995
filed suit in the Northern California Federal District Court 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. Rockwell's suit was stayed in 1995 pending resolution of another
suit, involving the same patent, brought by Rockwell against the Federal
government, and in which SDL had intervened. The suit between the Federal
government and Rockwell was resolved in January 1999, by way of a settlement
payment from the Federal government to Rockwell. The Company did not
participate in the settlement. As a result of that settlement, the Company
anticipates that the stay of Rockwell's suit against the Company will be
lifted. A status conference is scheduled in that case for March 8, 1999. The
resolution of this litigation is fact intensive so that the outcome cannot
be determined and remains uncertain. If Rockwell prevailed in the
litigation, it could be awarded monetary damages against the Company. The
Company believes, however, that it has meritorious defenses to the
Rockwell's allegations in the litigation.
Shortly after the aforementioned suit between Rockwell and the Federal
government was filed, the Federal government had notified the Company that,
if the Federal government were liable to Rockwell, then the Federal
government might seek indemnification for a portion of its liability from
the Company. The Federal government never stated the amount of the Company's
alleged indemnity obligation, nor has it ever repeated its assertion that
the Company might have some indemnity obligation to the Federal government.
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 affect on the
Company's financial position, results of operations or cash flows.
42
<PAGE> 43
Nevertheless, based on future developments, the Company's estimate of the
outcome of these matters could change in the near term.
During the first half of 1998, supplies of modulators to a customer were
withdrawn due to an apparent design problem. It was expected that the
replacement modulators would be shipped during the second half of the year.
The estimated rework costs of $0.6 million were recorded in the second
quarter, but the costs were reversed in the forth quarter since the customer
did not return the related modulators. The order has since been cancelled by
the customer. While there has been no formal legal claim against the
Company, the customer has requested the return of $1.2 million for
receivables paid for earlier deliveries. The Company has rejected this
request and is confident that if a formal legal claim is received it can be
successfully defended.
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.
8. Subsequent Events
In May 1999, the Company authorized a two-for-one split of its common stock,
effected in the form of a stock dividend, which was paid on June 2, 1999 to
stockholders of record on May 14, 1999. All of the share and per share data
in the supplemental condensed consolidated financial statements have been
retroactively adjusted to reflect the stock split.
In May 1999, the Company's stockholders approved an increase in the
Company's authorized shares of its common stock to 70 million shares.
9. Business Combination
On May 18, 1999, the Company merged with IOC, a United Kingdom-based
manufacturer of lithium niobate components for long haul fiber optic
transmission systems. The Company has exchanged 1,130,098 shares of SDL
common stock and reserved 116,974 shares for IOC options assumed by the
Company. Merger related expenses of approximately $2.1 million will be
recorded in the second quarter of fiscal 1999. Separate unaudited revenue
and net income (loss) amounts of the merged entities are presented in the
following table (in thousands):
<TABLE>
<CAPTION>
Three Months Three Months Three Months
Ended Ended Ended
March 31, Dec. 31, March 31,
1999 1998 1998
------------ ------------ ------------
<S> <C> <C> <C>
Total revenues:
SDL ................... $ 35,730 -- $ 25,357
IOC ................... 1,936 $ 1,491 1,556
-------- --------
Combined .............. $ 37,666 $ 26,913
Net income (loss):
SDL ................... $ 3,010 -- $ 2,699
IOC ................... (387) $ (1,136) (1,278)
-------- --------
Combined .............. $ 2,623 $ 1,421
</TABLE>
IOC's net loss for the three months ended December 31, 1998 was not combined
with SDL's net income, but rather was included as an adjustment to stockholders'
equity in the Company's financial results for the three months ended March 31,
1999.
43
<PAGE> 44
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.
June 28, 1999 By: /s/Michael L. Foster
--------------------
Michael L. Foster
Chief Financial Officer and Secretary
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
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) PERIOD
----------- ----------- --------------- --------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts receivable
Year ended December 31, 1996 ............ $ 485 $ 355 $ (60) $ 780
======== ======== ======== ========
Year ended December 31, 1997 ............ $ 780 $ 442 $ (32) $ 1,190
======== ======== ======== ========
Year ended December 31, 1998 ............ $ 1,190 $ 943 $ (1,128) $ 1,005
======== ======== ======== ========
</TABLE>
1) Uncollectible accounts written off.
45
<PAGE> 46
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ -----------
<S> <C>
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Arthur Andersen LLP, Independent Auditors
27.1 Financial data schedules
99.1 Report of Arthur Andersen LLP, Independent Auditors
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-90848, 33-92200, 333-57683) pertaining to the 1995 Stock
Option Plan, 1995 Employee Stock Purchase Plan, 1992 Stock Option Plan and the
Amended and Restated 1984 Incentive Stock Option Plan of SDL, Inc. of our report
dated January 29, 1999 (except for Note 16, as to which the date is May 14, 1999
and except for paragraph 4 of Note 1 and Note 17, as to which the date is May
18, 1999), with respect to the supplemental consolidated financial statements
and schedule of SDL, Inc. included in this Current Report on Form 8-K, filed
with the Securities and Exchange Commission.
/s/ Ernst & Young LLP
San Jose, California
June 25, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
As independent auditors, we hereby consent to the incorporation by reference in
the Registration Statements (Form S-8 Nos. 33-90848, 33-92200, 333-57683)
pertaining to the 1995 Stock Option Plan, 1995 Employee Stock Option Plan, 1992
Stock Option Plan and the Amended and Restated 1984 Incentive Stock Option Plan
of SDL, Inc of our report dated 15 December 1998, with respect to the
consolidated financial statements of IOC International plc as at 30 September
1998 and 1997 and for the three years ended 30 September 1998 (not presented
herein, but as included within the Registration Statement of SDL, Inc on Form
S-4 No 333-75639). It should be noted that we have not audited any financial
statements of the company subsequent to 30 September 1998 or performed any audit
procedures subsequent to the date of our report.
Arthur Andersen
Chartered Accountants
Cambridge, England
25 June 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
MARCH 31, 1999, MARCH 31, 1998, DECEMBER 31, 1998, DECEMBER 31, 1997, AND
DECEMBER 31, 1996 SUPPLEMENTAL FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FORM 8-K
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998 DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1999 JAN-01-1998 JAN-01-1998 JAN-01-1997 JAN-01-1996
<PERIOD-END> MAR-31-1999 MAR-31-1998 DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 6,747 12,478 17,023 6,170 8,177
<SECURITIES> 18,994 13,339 17,635 14,953 50,049
<RECEIVABLES> 28,729 20,993 24,047 22,760 14,343
<ALLOWANCES> 0 850 1,005 1,190 780
<INVENTORY> 24,296 15,957 21,288 15,184 14,327
<CURRENT-ASSETS> 82,251 64,991 82,863 62,897 4,248
<PP&E> 79,309 60,883 71,687 56,271 42,524
<DEPRECIATION> 34,849 26,014 31,839 23,920 18,164
<TOTAL-ASSETS> 134,932 114,664 132,060 112,431 129,429
<CURRENT-LIABILITIES> 18,275 18,149 19,158 18,724 16,092
<BONDS> 0 0 0 0 0
0 0 0 0 0
0 0 0 0 0
<COMMON> 15 14 15 14 13
<OTHER-SE> 111,946 91,475 108,191 89,268 111,207
<TOTAL-LIABILITY-AND-EQUITY> 134,932 114,664 132,060 112,431 129,429
<SALES> 36,690 23,696 103,012 87,505 75,521
<TOTAL-REVENUES> 37,666 26,913 112,792 102,119 88,224
<CGS> 22,130 16,296 66,540 59,614 47,484
<TOTAL-COSTS> 23,033 18,668 74,061 71,245 57,075
<OTHER-EXPENSES> 11,135 6,887 31,029 56,418 21,650
<LOSS-PROVISION> 0 0 0 0 0
<INTEREST-EXPENSE> 289 258 440 248 196
<INCOME-PRETAX> 3,784 1,651 8,986 (23,936) 11,191
<INCOME-TAX> 1,161 230 1,083 417 3,052
<INCOME-CONTINUING> 2,623 1,421 7,903 (24,353) 8,139
<DISCONTINUED> 0 0 0 0 0
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> 2,623 1,421 7,903 (24,353) 8,139
<EPS-BASIC> 0.09 0.05 0.28 (0.87) 0.33
<EPS-DILUTED> 0.08 0.05 0.26 (0.87) 0.30
</TABLE>
<PAGE> 1
EXHIBIT 99.1
REPORT OF INDEPENDENT AUDITORS
To IOC International plc:
We have audited the consolidated balance sheet of IOC International plc as of 30
September 1998 and 1997 and the related profit and loss accounts and cash flow
statements for each of the three years in the period ended 30 September 1998.
These financial statements are not presented separately herein, but are
presented on pages III-3 to III-18 of the Registration Statement of SDL, Inc on
Form S-4 No 333-75639.
Respective responsibilities of directors and auditors
The company's directors are responsible for the preparation of the financial
statements. It is our responsibility to form an independent opinion, based on
our audit, on those statements and to report our opinion to you.
Basis of opinion
We conducted our audit in accordance with United Kingdom Generally Accepted
Auditing Standards issued by the Auditing Practices Board, which do not differ
in any significant respect from United States Generally Accepted Auditing
Standards. An audit includes examination, on a test basis, of evidence relevant
to the amounts and disclosures in the financial statements. It also includes an
assessment of the significant estimates and judgements made by the directors in
the preparation of the financial statements, and of whether the accounting
policies are appropriate to the circumstances of the company consistently
applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of affairs of the group as at 30 September 1998 and 30 September 1997, and of
the group's loss or profit and cash flows for each of the years ended 30
September 1998, 1997 and 1996, in accordance with Generally Accepted Accounting
Principles in the United Kingdom.
Reconciliation to US GAAP
Accounting practices used by the group in preparing the accompanying financial
statements conform with Generally Accepted Accounting Principles in the United
Kingdom, but do not conform with accounting principles generally accepted in the
United States. A description of these differences and a reconciliation of net
loss or profit and shareholders' equity to United States Generally Accepted
Accounting Principles is set out in note 24.
Arthur Andersen
Chartered Accountants
Cambridge, England
15 December 1998