-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LlxCXwQcdD5RMxpValkT4rhHmyPQv3KX9HYZBxCok1MuUESZNUZLllM6BY68GA9v XtV+SkjRLiccvBsYWXvVKA== 0000929624-98-001383.txt : 19980813 0000929624-98-001383.hdr.sgml : 19980813 ACCESSION NUMBER: 0000929624-98-001383 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980628 FILED AS OF DATE: 19980812 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEVEL ONE COMMUNICATIONS INC /CA/ CENTRAL INDEX KEY: 0000908985 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330128224 STATE OF INCORPORATION: CA FISCAL YEAR END: 0101 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22068 FILM NUMBER: 98684095 BUSINESS ADDRESS: STREET 1: 9750 GOETHE RD CITY: SACRAMENTO STATE: CA ZIP: 95627 BUSINESS PHONE: 9168555000 MAIL ADDRESS: STREET 1: 9750 GOETHE ROAD CITY: SACREMENTO STATE: CA ZIP: 95827 10-Q 1 FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: June 28, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 0-22068 LEVEL ONE COMMUNICATIONS, INCORPORATED State: California I.R.S. Employer ID No.: 33-0128224 Address: 9750 Goethe Road, Sacramento, CA 95827 Telephone:(916) 855-5000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- The number of Common Shares of the registrant outstanding on August 11, 1998, was 35,168,142.
INDEX Page ---- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of June 28, 1998, and December 28, 1997 ...................... 3 Consolidated Statements of Income for the Three and Six Months ended June 28, 1998, and June 29, 1997 ...................... 4 Consolidated Statements of Cash Flows for the Three and Six Months ended June 28, 1998, and June 29, 1997 ...................... 5 Notes to Financial Statements ...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................... 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings ..................... 14 Item 2. Changes in Securities ..................... 15 Item 6. Exhibits and Reports on Form 8-K ..................... 15 Signatures ..................... S-1
2 LEVEL ONE COMMUNICATIONS, INCORPORATED CONSOLIDATED BALANCE SHEETS June 28, 1998, and December 28, 1997
(in thousands) June 28, 1998 December 28, 1997 ----------------- ------------------ (unaudited) ASSETS Current Assets: Cash and cash equivalents $ 16,069 $ 25,234 Short-term investments 103,017 112,560 Trade accounts receivable, net of allowance for doubtful accounts 35,931 30,080 of $493 and $343 for 1998 and 1997, respectively Other receivables 7,278 2,472 Inventories 23,909 26,118 Deferred income tax benefit 3,035 4,050 Other current assets 2,831 2,502 ------------- ------------ Total current assets 192,070 203,016 Property and equipment, net 38,542 31,795 Long-term investments 49,383 21,559 Foundry deposits 16,781 14,000 Other assets 5,059 7,327 ------------- ------------ Total assets $ 301,835 $ 277,697 ============= ============= Current Liabilities: Current portion of capital lease obligations $ 1,209 $ 1,201 Accounts payable 21,548 20,614 Accrued payroll costs 6,513 4,591 Deferred distributor revenues 3,240 2,490 Other accrued liabilities 8,769 7,881 ------------- ------------ Total current liabilities 41,279 36,777 Convertible subordinated notes 115,000 115,000 Capital lease obligations, less current portion 1,625 2,175 Deferred lease expense 218 300 ------------- ------------ Total liabilities 158,122 154,252 Shareholders' Equity: Common Stock, no par value 97,426 91,897 Authorized - 236,250 shares Outstanding - 31,133 and 30,751 shares for 1998 and 1997, respectively Unrealized gain on investments 4 18 Retained earnings 46,283 31,530 ------------- ------------ Total shareholders' equity 143,713 123,445 ------------- ------------ Total liabilities and shareholders' equity $ 301,835 $ 277,697 ============= ============= The accompanying notes are an integral part of these statements.
3 LEVEL ONE COMMUNICATIONS, INCORPORATED CONSOLIDATED STATEMENTS OF INCOME June 28, 1998, and June 29, 1997 (unaudited)
(in thousands, expect per share amounts) Three Months Ended Six Months Ended -------------------------------- --------------------------------- June 28, 1998 June 29, 1997 June 28, 1998 June 29, 1997 -------------- ------------- ------------- -------------- Revenues $60,362 $ 32,642 $116,969 $ 62,749 Cost of revenues 25,002 13,566 48,493 26,466 ---------- ---------- ---------- ---------- Gross margin 35,360 19,076 68,476 36,283 Research & development 10,632 6,738 21,174 13,079 Sales & marketing 9,007 4,754 17,708 9,053 General & administrative 5,813 2,221 9,275 4,023 ---------- ---------- ---------- ---------- Total operating expenses 25,452 13,713 48,157 26,155 ---------- ---------- ---------- ---------- Operating income 9,908 5,363 20,319 10,128 Interest income 2,478 475 4,227 953 Interest expense (1,690) (6) (2,659) (150) Other income 112 23 132 55 ---------- ---------- ---------- ---------- Income before provision for income taxes 10,808 5,855 22,019 10,986 Provision for income taxes 3,566 1,932 7,266 3,605 ---------- ---------- ---------- ---------- Net income $ 7,242 $ 3,923 $ 14,753 $ 7,381 ========== ========== ========== ========== Basic earnings per share $ .23 $ .13 $ .48 $ .24 Diluted earnings per share $ .22 $ .12 $ .44 $ .23 The accompanying notes are an integral part of these statements.
4 LEVEL ONE COMMUNICATIONS, INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS
For Six Months Ended ------------------------------------ (In thousands) June 28, 1998 June 29, 1997 --------------- --------------- Cash flows from operating activities: Net income $ 14,735 $ 7,380 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,001 4,516 Changes in assets and liabilities: Trade receivables (5,851) (2,564) Inventories 2,209 (7,486) Deferred tax assets 1,015 322 Other current assets (3,573) 471 Accounts payable and accrued liabilities 4,494 5,704 Deferred lease expense (82) (68) ---------- ---------- Net cash provided by operating activities 18,948 8,275 ---------- ---------- Cash flows from investing activities: Purchase of short-term investments (20,796) (30,341) Proceeds from sales and maturities of short-term investments 30,339 21,719 Purchase of long-term investments (31,609) (7,740) Proceeds from sales and maturities of long-term investments 3,785 10,630 Purchase of property and equipment (12,272) (7,888) Payments for foundry deposits and other assets (2,551) (103) ---------- ---------- Net cash provided by investing activities (33,104) (13,723) ---------- ---------- Cash flows from financing activities: Net principal payments under capital lease obligations (542) (567) Proceeds from issuance of stock, net of repurchases and costs of issuance 5,533 2,199 ---------- ---------- Net cash used in financing activities 4,991 1,632 ---------- ---------- Decrease in cash and cash equivalents (9,165) (3,816) Cash and cash equivalents at beginning of period 25,234 20,251 ---------- ---------- Cash and cash equivalents at end of period $ 16,069 $ 16,435 ========== ========== Supplementary disclosure of cash and noncash transactions Cash payments for: Interest $ 1,687 $ 295 Income taxes 227 80 The accompanying notes are an integral part of these statements.
5 LEVEL ONE COMMUNICATIONS, INCORPORATED NOTES TO FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION The accompanying audited and unaudited 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 of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 28, 1998, are not necessarily indicative of the results that may be expected for the year ending December 27, 1998. The information reported in this Form 10-Q should be read in conjunction with the financial statements and footnotes contained in the Company's Form 10-K filed with the Securities and Exchange Commission for the year ended December 28, 1997, and subsequent filings with the Securities and Exchange Commission. All share and per share numbers in this Report reflect the effect of a 3-for-2 stock split effected on March 30, 1998. NOTE 2 - COMPREHENSIVE INCOME On December 29, 1997, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. For the Company, comprehensive income includes net income reported on the income statement and changes in the fair value of its available-for-sale securities reported as a separate component of shareholders' equity. The Company's total comprehensive income for the period ended June 28, 1998 was $7,238 million and $3,911 million for the period ended June 29, 1997. NOTE 3 - EARNINGS PER SHARE 6 The following is a reconciliation of the numerator (income) and denominator (shares) of basic and diluted earnings per share for the periods ending June 28, 1998 and June 29, 1997.
Per Share (in thousands, except earnings per share) Income Shares Amount ----------- ------------ ------------ Quarter Ending: Net income: June 28, 1998 $ 7,242 June 29, 1997 3,923 Basic EPS: income available to common shareholders June 28, 1998 $ 7,242 30,988 $0.23 June 29, 1997 3,923 30,288 0.13 Effect of dilutive securities: Convertible debentures: June 28, 1998 $ 854 4,313 June 29, 1997 - - Options: June 28, 1998 - 2,100 June 29, 1997 - 1,801 Diluted EPS: income available to common stockholders plus assumed conversions June 28, 1998 $ 8,096 37,401 $0.22 June 29, 1997 3,923 32,089 0.12 - ------------------------------------------------------------------------------------------------------ Year-To-Date Net income: June 28, 1998 $ 14,753 June 29, 1997 7,381 Basic EPS: income available to common shareholders June 28, 1998 $ 14,753 30,903 $0.48 June 29, 1997 7,381 30,136 0.24 Effect of dilutive securities: Convertible debentures: June 28, 1998 $ 1,708 4,313 June 29, 1997 - - Options: June 28, 1998 - 2,157 June 29, 1997 - 1,781 Diluted EPS: income available to common stockholders plus assumed conversions June 28, 1998 $ 16,461 37,373 $0.44 June 29, 1997 7,381 31,917 0.23
7 Note 4 - Inventories Inventories are stated at the lower of cost (first in, first out) or market and include materials, labor and manufacturing overhead costs. Inventories as of June 28, 1998 and December 28, 1997 consisted of: (in thousands) June 28, 1998 December 28, 1997 --------------- ------------------- Raw materials $ 5,465 $ 8,829 Work-in-process 10,417 13,135 Finished goods 8,027 4,154 ---------- ---------- Total inventories $ 23,909 $ 26,118 ========== ========== Note 5 - Property and Equipment Property and equipment are recorded at cost and depreciation is provided on a straight-line basis over their estimated useful lives; property and equipment consists of the following: (in thousands) June 28, 1998 December 28, 1997 --------------- ------------------- Machinery and equipment $ 40,155 $ 36,22 Furniture and fixtures 25,151 18,06 Leasehold improvements 4,638 3,38 ---------- ---------- 69,943 57,67 Less-Accumulated depreciation (31,402) (25,876) ---------- ---------- $ 38,542 $ 31,795 ========== ========== Note 6 - Convertible Subordinated Notes The Company sold $115 million of 4% convertible subordinated notes during 1997. The notes will mature on September 1, 2004. Unless previously redeemed or repurchased, the notes are convertible at any time through the close of business on the final maturity date of the notes, into common stock of the Company, at a conversion price of $26.67 per share. Interest on the notes is payable semi-annually, commencing March 1, 1998. Total interest accrued on the convertible subordinated notes at June 28, 1998 was approximately $1,500,000. After September 2000, the notes are redeemable at the option of the Company, in whole or in part. The notes may be redeemed for either cash or common stock at a repurchase price of 105% of the principal amount of the notes to be repurchased plus accrued and unpaid interest to the repurchase date. The notes are unsecured obligations of the Company and are subordinated to all existing and future senior indebtedness of the Company. The indenture contains no limitations on the incurrence of additional indebtedness or other liabilities by the Company. Note 7 - Subsequent Event 8 On July 6, 1998, the Company completed a business combination with Acclaim Communications Incorporated ("Acclaim") which is a provider of Fast Ethernet and Gigabit Ethernet switches and integrated Multi Service access products. The combination was a stock for stock merger that will be accounted for as a "pooling-of-interests." Accordingly, the Company's historical consolidated financial statements presented in the future will be restated to include the financial position and results of operations of Acclaim. As a result of the merger, the outstanding shares of Acclaim capital stock and options and warrants to purchase Acclaim capital stock were converted into the right to receive an aggregate of 5,000,000 shares of the Company's common stock worth approximately $125 million as of the merger date. The following unaudited pro forma summary presents the consolidated results of operations of the company as if the merger had occurred on June 29, 1997.
Three Months Ended Six Months Ended -------------------------------- ---------------------------------- June 28, 1998 June 29, 1997 June 28, 1998 June 29, 1997 --------------- --------------- ---------------- ---------------- (in thousands, except per share amounts) Revenues $ 60,497 $ 32,642 $ 117,127 $ 62,749 Net income 3,943 2,727 9,657 4,989 Earnings per share: Basic $ 0.11 $ 0.08 $ 0.27 $ 0.14 Diluted $ 0.11 $ 0.07 $ 0.27 $ 0.14
The above amounts are based on certain assumptions and estimates which the company believes are reasonable. The pro forma results do not necessarily represent results which would have occurred if the business combination had taken place at the date and on the basis assumed above. The effects of anticipated changes in accounting methods and elimination of intercompany transactions are expected to be immaterial. The Company's acquisition transactions costs incurred as of June 28, 1998 totaled $1.8 million and are included in general and administrative costs in the accompanying consolidated statements of income. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following information should be read in conjunction with the unaudited interim financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q, the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Form 10-K for the period ended December 28, 1997 filed with the Securities and Exchange Commission on March 27, 1998, and any subsequent filings with the Securities and Exchange Commission. This report contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including without limitation statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. The Company's actual results could differ materially from those anticipated in these forward-looking statements. See "Factors That May Affect Future Results". RESULTS OF OPERATIONS Revenues Revenues increased 85% to $60.4 million in the second quarter of 1998 compared to revenues of $32.6 million for the same quarter of 1997. Revenues increased by 7% from $56.6 million in the first quarter of 1998. During the quarter, sales to D-link, Inc. represented 11% of total revenues. The increased revenues reflect unit sales growth due to the continued market acceptance of the Company's products in both the networking and transmission markets. International revenues were $23.2 million or 39% of revenues and $10.8 million or 33% of revenues, respectively, for the second quarter of 1998 and 1997. All sales are denominated in U.S. dollars, thereby eliminating the impact of foreign currency exchange rate fluctuations on revenues. 9 Gross Margin Product gross margin is affected by several factors, including average selling prices, the mix between older and newer products, test equipment utilization, manufacturing yields, timing of cost reductions and the mix between direct and distributor sales. Margins on domestic and international sales are similar. At 58.6%, gross product margins for the second quarter of 1998 were up slightly from the first quarter of 1998 and up from 58.1% for the second quarter of 1997. Gross product margins for the first six months of 1998 was 58.5% versus 57.8% for the first six months of 1997, the increase is due to the impact of cost reductions implemented during the second half of 1997 and the first half of 1998. RESEARCH AND DEVELOPMENT Research and development expenses were $10.6 million or 17.6% of revenues in the second quarter of 1998 versus $6.7 million or 20.6% of revenues in the second quarter of 1997. For the first six months of 1998 research and development expenses were $21.2 million or 18.1% of revenues versus $13.1 million or 20.8% of revenues for the first six months of 1997. The dollar increase in research and development expense is due to additions to the Company's design engineering staff and related new product design expenses. SALES AND MARKETING Sales and marketing expenses were $9.0 million or 14.9% of revenues in the second quarter of 1998 versus $4.7 million or 14.6% of revenues in the second quarter of 1997. Sales and marketing expenses for the first six months of 1998 were $17.7 million or 15.1% of revenues versus $9.1 million or 14.4% of revenues for the same period in 1997. The increased expenditures are primarily attributable to the expansion of the Company's sales and marketing staffs and their related costs. General and Administrative General and administrative expenses for the second quarter were $5.8 million or 9.6% of revenues versus $2.2 million or 6.8% of revenues for the second quarter of 1997. For the first six months of 1998 general and administrative expenses were $9.3 million or 7.9% of revenues versus $4.0 million or 6.4% for the same period in 1997. During the second quarter of 1998 the Company incurred a $1.8 million one time charge for transaction costs associated with the acquisition of Acclaim Communications, Inc. Excluding the one time charge, expenses for the second quarter of 1998 were $4.0 million or 6.6% of revenues and $7.5 million or 6.3% of revenues for the first six months of 1998. Liquidity and Capital Resources The Company's principal sources of liquidity as of June 28, 1998, consisted of $119.1 million of cash, cash equivalents and short-term investments. Working capital was $150.8 million at June 28, 1998 and $166.2 million at December 28, 1997. During the first six months of 1998, the Company generated $18.9 million of cash from operating activities, as compared to $8.3 million in the same period in 1997. In both periods, net cash generated from operations during the period was primarily due to net income before depreciation and amortization expense. This was offset by the net changes during the period for inventories, accounts receivable, and accounts payable. These changes are due primarily to expansion of the Company's business, and do not reflect material changes in the way the Company conducts operations. The Company spent $12.3 million for capital expenditures during the first six months of 1998 as compared to $7.9 million for the same period in 1997. 10 Management believes that, in addition to current financial resources, adequate capital resources are available to satisfy the Company's investment and capital programs. Management believes that the Company's cash flow is sufficient to maintain its current operations. Factors That May Affect Future Results The following factors may have an impact on the Company's business: Manufacturing Risks The Company does not manufacture the silicon wafers used for its products. The Company's wafers are manufactured by foundries located in the United States, Europe and Asia. The Company depends upon these suppliers to produce wafers at acceptable yields and to deliver them in a timely manner at competitive prices. The Company may sustain an adverse impact on operating results from problems with the cost, timeliness, yield and quality of wafer deliveries from suppliers. From time to time, the available industry-wide foundry capacity can fluctuate significantly. During periods of constrained supply, the Company may experience difficulty in securing an adequate supply of wafers, and/or its suppliers may increase wafer prices. The Company's operating results depend, in substantial part, on its ability to maintain or increase the capacity available from its existing or new foundries. In 1994 and 1995, the Company experienced increased costs and delays in customer shipments as a result of a foundry reducing shipments to the Company without prior notice, requiring the Company to transfer products to a new foundry. Although the Company believes that it has planned to meet customer demand, there can be no assurances that unforeseen demand, supplier interruptions or other changes will not have a material impact on the Company's business. Manufacturing process technologies are subject to rapid change. Other companies in the industry have experienced difficulty in migrating to new manufacturing processes, and, consequently, have suffered reduced yields, delays in product deliveries and increased expense levels. The Company's business, financial condition and results of operations could be materially adversely affected if any such transition is substantially delayed or inefficiently implemented. The Company is also dependent upon third-party assembly companies that package or test the Company's devices. The Company depends upon these suppliers to produce products in a timely manner and at competitive prices. The Company may sustain an adverse financial impact from problems with the cost, timeliness, yield and quality of product deliveries from these suppliers. Operating Results The semiconductor industry is characterized by rapid technological change, intense competitive pressure and cyclical market patterns. The Company's results of operations are affected by a wide variety of factors, including general economic conditions, semiconductor industry environment, changes in average selling prices, the timing of new product introductions (by the Company and its customers), use of new technologies, the ability to safeguard patents and intellectual property, and rapid change of demand for products. The level of net revenues in any specific quarter can also be affected by the level of orders placed during that quarter. The Company attempts to respond to changes in market conditions as soon as possible; however, the rapidity of their onset may make prediction of and reaction to such events difficult. Due to the foregoing and other factors, past results, such as those described in this report, may not be predictive of future performance. 11 Dependence on New Products The Company's future success depends on its ability to timely develop and introduce new products which compete effectively. Because of the complexity of its products, the Company may experience delays in completing development and introduction of new products, and, as a result, not achieve the market share anticipated for such products. The Company's strategy is to develop products for the fastest growing segments of the communications market. The Company conducts its own analysis of market trends and reviews forecasts and information provided by industry analysts. Market conditions may change rapidly as technology, economic, or user-preference conditions cause different communications technologies to experience growth other than that forecast by the Company or others. There can be no assurance that the Company will successfully identify new product opportunities and bring new products to market in a timely manner, that products or technologies developed by others will not render the Company's products or technologies obsolete or noncompetitive, or that the Company's products will be selected for design into the products of its targeted customers. In addition, the average selling price for any particular product tends to decrease over the product's life. To offset such price decreases, the Company relies primarily on obtaining yield improvements and corresponding cost reductions in the manufacture of existing products and on introducing new products which incorporate advanced features and other price/performance factors such that higher average selling prices and higher margins are achievable relative to existing product lines. To the extent that cost reductions and new product introductions with higher margins do not occur in a timely manner, or the Company's products do not achieve market acceptance, the Company's operating results could be materially affected. Management of Growth; Dependence on Key Personnel The Company is currently experiencing a period of significant growth which has placed, and could continue to place, a significant strain on the Company's personnel and other resources. The Company's ability to manage its growth effectively will require continued expansion and refinement of the Company's operational, financial, management and control systems, as well as a significant increase in the Company's development, testing, quality control, marketing, logistics and service capabilities, any of which could place a significant strain on the Company's resources. The Company's success also depends to a significant extent upon its ability to retain and attract key personnel. Competition for such personnel is intense and there can be no assurance that the Company will be able to retain and attract key personnel. If the Company's management is unable to manage growth effectively, maintain the quality and marketability of the Company's products and retain, hire and integrate key personnel, the Company's business, financial condition and results of operations could be materially adversely affected. Intellectual Property The Company relies upon patent, trademark, trade secret and copyright law to protect its intellectual property. There can be no assurance that such intellectual property rights can be successfully asserted or will not be invalidated, circumvented or challenged. Litigation, regardless of its outcome, could result in substantial cost and diversion of resources for the Company. Any infringement claim or other litigation against or by the Company could have a material effect on the Company's financial condition and results of operations. In November 1995, the Company commenced infringement litigation against a competitor. See "Legal Proceedings". Semiconductor Industry The semiconductor industry has historically been cyclical and subject to significant economic downturns at various times. The Company may experience substantial period-to-period fluctuations in operating results due to general semiconductor industry conditions, overall economic conditions or other factors. In addition, the securities of many high technology companies have historically been subject to extreme price and volume fluctuations, factors which may affect the market price of the Company's Common Stock. As is common in the semiconductor industry, the Company frequently ships more product in the third month of a quarter than in the 12 other months. If a disruption in the Company's production or shipping occurs near the end of a quarter, the Company's revenues for that quarter could be materially affected. The Company must order wafers and build inventory in advance of product shipments. There is risk that the Company could produce excess or insufficient inventories of particular products because the Company's markets are volatile and subject to rapid technology and price changes. This inventory risk is heightened because certain of the Company's customers place orders with long lead times which may be subject to cancellation or rescheduling by that customer. To the extent the Company produces excess or insufficient inventories of particular products, the Company's revenues and earnings could be adversely affected. Increased demand for semiconductor products may result in a reduction in the availability of wafers from foundries. Such capacity limitations may adversely affect the Company's ability to deliver products on a timely basis and affect the Company's margins. Additionally, the Company believes that during periods of strong demand and/or restricted semiconductor capacity, customers will over- order to assure an adequate supply. Certain of the Company's customers may cancel or postpone orders without notice if product becomes available elsewhere. Shortages of components from other suppliers could cause the Company's customers to cancel or delay programs incorporating the Company's products, resulting in the cancellation or delay of orders for the Company's products. Intense Competition The semiconductor industry is intensely competitive. The Company's competition consists of semiconductor companies and semiconductor divisions of vertically integrated companies. In the telecom market, the Company's principal competitors are Rockwell International, Inc., Crystal Semiconductor, Inc. (a subsidiary of Cirrus Logic, Inc.) ("Crystal"), Dallas Semiconductor, Inc., Lucent Technologies Inc. ("Lucent"), PMC-Sierra Inc. and Siemens A.G. In the networking market, the Company's principal competitors are Advanced Micro Devices, Inc., Broadcom Corporation, Crystal, Integrated Circuit Systems, Inc., Lucent, Micro Linear Corp., National Semiconductor Corporation, Quality Semiconductor, Inc., Seeq Technologies, Inc. and Texas Instruments, Inc. Many of these competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial and other resources than the Company with which to pursue engineering, manufacturing, marketing and distribution of products. The ability of the Company to compete successfully in the rapidly evolving area of high performance integrated circuit technology depends on factors both within and outside of the Company's control. Such factors include, without limitation, success in designing and manufacturing new products, implementing new technologies, intellectual property programs, product quality, reliability, price, efficiency of production, and general economic conditions. There is no assurance that the Company will be able to compete successfully against current and future competitors. Increased competition may result in price erosion, reduced gross margins and loss of market share, any of which may have a material adverse effect on the Company's business, financial condition and results of operations. International Operations Due to its reliance on international sales and foreign third-party manufacturing and assembly operations, the Company is subject to the risks of conducting business outside of the United States including government regulatory risks, political, social and economic instability, potential hostilities and changes in diplomatic and trade relationships. There can be no assurance that one or more of the foregoing factors will not have a material adverse effect on the Company's business, financial condition or operating results. The recent economic downturn in several Asian countries has not affected the Company in a material way, but there can be no assurances that continued economic problems in Asia or any other region of the world will not affect the Company. 13 Increased Leverage As a result of the Company's sale in August and September 1997 of its 4% Convertible Subordinated Notes due 2004 (the "Notes"), the Company has incurred approximately $115.0 million in additional indebtedness which increases the ratio of its long-term debt to its total capitalization from 3.0%, at June 29, 1997, to 44.8%, at June 28, 1998. This increased leverage will increase the Company's interest expense substantially. The degree to which the Company will be leveraged could adversely affect the Company's ability to obtain additional financing for working capital, acquisitions or other purposes and could make it more vulnerable to economic downturns and competitive pressures. The Company's increased leverage could also adversely affect its liquidity, as a substantial portion of available cash from operations may have to be applied to meet debt service requirements and, in the event of a cash shortfall, the Company could be forced to reduce other expenditures and/or forego potential acquisitions to be able to meet such requirements. Volatility of Notes and Stock Price Economic and other external factors, many of which are beyond the control of the Company, may have a significant impact on the Company's business and on the market price of its Notes and the Common Stock. Such factors include, without limitation, fluctuations in product revenues and net income of the Company or its competitors, shortfalls in the Company's operating results from levels forecast by securities analysts, announcements concerning the Company, its competitors or customers, announcements of technological innovations by the Company, its competitors or its customers, the introduction of new products or changes in product pricing policies by the Company, its competitors or its customers, market conditions in the industry and the general state of the securities market. In addition, the stock prices of many technology companies fluctuate significantly for reasons that may be unrelated or disproportionate to operating results. These fluctuations, as well as general economic, political and market conditions such as recession or international instability, may adversely affect the market price of the Company's Notes and the Common Stock. Year 2000 Compliance The Company has reviewed its exposure to risks that could be caused if internal computer systems do not correctly recognize date information when the year changes to 2000. Management believes that the likelihood of a material adverse impact due to problems with internal systems or products sold to customers is remote and expects that the cost of remedying internal systems that currently cannot process the date change will not have a material effect on the Company's financial position or overall trends in results of operations. The Company is also contacting critical suppliers of products and services to determine that the supplier's operations and the products and services they provide are year 2000 compliant. There can be no assurance that another company's failure to ensure year 2000 capability would not have an adverse effect on the Company. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On November 28, 1995, the Company initiated a patent infringement suit against Seeq Technologies, Inc. in United States District Court for the Northern District of California. The suit relates to two Level One patents, No. 5,267,269 and No. 5,249,183, and to certain Seeq products used in Ethernet system products. The suit seeks damages and injunctive relief, Seeq has denied the allegations. On January 21, 1998, the Court denied Seeq's motion to declare claims of the Level One patents invalid. The Court also permitted Seeq to amend its counterclaim to include a claim that certain of the Company's products infringe Seeq's U.S. Patent 5,504,738; the Company has denied these allegations. Trial is set for August 1998. Although the Company does not believe such litigation will have a material impact on the Company, litigation, regardless of its outcome, could result in substantial cost and diversion of resources of the Company. See "Factors That May Affect Future Results". 14 There are no other material pending legal proceedings, other than routine litigation incidental to the Company's business, to which the Company is a party or of which any of its property is the subject. ITEM 2. CHANGES IN SECURITIES On March 3, 1998, the Company's Certificate of Incorporation was amended to effect a 3-for-2 stock split to shareholders of record on March 9, 1998. The split was effective March 30, 1998. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - 27.1--Financial Data Schedule, June 28, 1998 (b) Reports on Form 8-K - Agreement and Plan of Reorganization filed on July 17, 1998 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEVEL ONE COMMUNICATIONS, INCORPORATED Date: August 12, 1998 By: /s/ Robert S. Pepper -- -------------------------------- Robert S. Pepper, Ph.D. Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer) Date: August 12, 1998 By: /s/ John Kehoe -- ------------------------ John Kehoe Senior Vice President and Chief Financial Officer (Principal Financial Officer) S-1 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL STATEMENTS FOR THE PERIOD ENDED JUNE 28, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-29-1997 JUN-28-1998 16,069 103,017 36,424 493 23,909 192,070 38,542 31,402 301,835 41,279 115,000 0 0 97,426 46,286 301,835 60,362 60,362 25,002 25,002 25,452 0 1,690 10,808 3,566 7,242 0 0 0 7,242 0 .22
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