-----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, FOQa0iYfbQ61LzK/EyNiuIqMAXtYxFyfL2+tZrWRd5mpcFVgsABC7ODNt3hLE3vQ qAin3uEZwnIAbzTf1OXjIA== 0000891618-96-001667.txt : 19960911 0000891618-96-001667.hdr.sgml : 19960911 ACCESSION NUMBER: 0000891618-96-001667 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960812 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SDL INC CENTRAL INDEX KEY: 0000934741 STANDARD INDUSTRIAL CLASSIFICATION: 3674 IRS NUMBER: 770331449 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25688 FILM NUMBER: 96608245 BUSINESS ADDRESS: STREET 1: 80 ROSE ORCHARD WAY CITY: SAN JOSE STATE: CA ZIP: 95134 BUSINESS PHONE: 4089439411 MAIL ADDRESS: STREET 1: 80 ROSE ORCHARD WAY CITY: SAN JOSE STATE: CA ZIP: 95134 10-Q 1 FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 1996 _________________________________________________ OR ____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________________ to _______________________ Commission File Number 0-25688 SDL, INC. (Exact name of registrant as specified in its charter) Delaware 77-0331449 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 80 Rose Orchard Way, San Jose, CA 95134-1365 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (408) 943-9411 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ___X___ No ______ The number of shares outstanding of the issuer's common stock as of July 24, 1996 was 13,003,033. 2 SDL, INC. INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at June 30, 1996 and December 31, 1995 3 Condensed Consolidated Statements of Income for the three and six months ended June 30, 1996 and 1995 4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1996 and 1995 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 6. Exhibits and Reports on Form 8-K 18 SIGNATURES 19
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SDL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS - EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31, 1996 1995 ---- ---- (UNAUDITED) (1) ASSETS Current assets: Cash and cash equivalents $ 5,613 $ 2,793 Short-term investments 7,515 8,515 Receivable from common stock offering 38,475 -- Accounts receivable, net 13,336 13,535 Inventories 12,623 9,006 Deferred income taxes 1,314 989 Prepaid expenses and other current assets 1,596 502 --------- -------- Total current assets 80,472 35,340 Property and equipment, net 18,344 16,470 Purchased intangibles, net 2,444 2,766 Deferred income taxes 1,840 1,840 Other assets 256 227 --------- -------- $ 103,356 $ 56,643 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,836 $ 6,257 Accrued payroll and related expenses 1,814 1,990 Accrued warranty 416 442 Unearned revenue 1,500 972 Acquisition obligations 2,790 1,592 Other accrued liabilities 1,518 1,438 --------- -------- Total current liabilities 14,874 12,691 Deferred acquisition obligations -- 2,680 Other long-term liabilities 676 772 Stockholders' equity: Common stock, $0.001 par value, 21,000,000 shares authorized; 12,742,948 outstanding (10,628,115 at December 31, 1995) 13 11 Treasury stock -- (33) Additional paid-in-capital 105,577 63,034 Accumulated deficit ($32,084 relating to the repurchase of common stock and recapitalization in 1992) (17,440) (22,028) Cumulative translation adjustment (7) (6) --------- -------- 88,143 40,978 Less: common stockholders' notes receivable (337) (478) --------- -------- Total stockholders' equity 87,806 40,500 --------- -------- $ 103,356 $ 56,643 ========= ========
(1) The balance sheet at December 31, 1995 has been derived from the audited financial statements at that date. See accompanying notes. 3 4 SDL, INC. CONDENSED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- --------------------------- 1996 1995 1996 1995 ---- ---- ---- ---- Total revenues: Product revenue $ 18,541 $ 10,411 $ 35,889 $ 19,063 Research revenue 3,065 2,103 6,139 3,963 --------- --------- --------- --------- 21,606 12,514 42,028 23,026 Cost of revenues: Cost of product revenue 11,647 6,138 22,152 11,235 Cost of research revenue 2,111 1,489 4,353 2,899 --------- --------- --------- --------- Gross margin 7,848 4,887 15,523 8,892 Operating expenses: Research and development 1,358 953 3,045 1,677 Selling, general and administrative 2,984 1,871 5,795 3,292 --------- --------- --------- --------- Operating income 3,506 2,063 6,683 3,923 Interest income (expense), net 124 112 269 (312) ---------- ---------- ---------- ----------- Income before income taxes 3,630 2,175 6,952 3,611 Provision for income taxes 1,201 805 2,364 1,336 --------- --------- --------- --------- Net income $ 2,429 $ 1,370 $ 4,588 $ 2,275 ========= ========= ========= ========= Net income per share $ 0.20 $ 0.12 $ 0.38 $ 0.24 ========== ========== ========== ========== Shares used in computing net income per share 12,383 11,205 12,228 9,633 ========= ========= ========= =========
See accompanying notes. 4 5 SDL, INC. CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS - UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------------- 1996 1995 ---- ---- OPERATING ACTIVITIES: Net income $ 4,588 $ 2,275 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,327 1,270 Loss on disposal of equipment 62 -- Deferred income taxes (325) 135 Deferred rent (30) (35) Accrued interest -- (452) Changes in operating assets and liabilities: Accounts receivable 199 (2,295) Inventories (3,617) (598) Accounts payable 579 3,345 Income taxes payable 2,539 (163) Accrued payroll and related expenses (176) 253 Accrued warranty (26) -- Unearned revenue 528 744 Other accrued liabilities 80 213 Other (29) (58) -------- --------- Total adjustments 2,111 2,359 -------- --------- Net cash provided by operating activities 6,699 4,634 INVESTING ACTIVITIES: Acquisition of property and equipment, net (3,941) (4,950) Sales (purchases) of short-term investments, net 1,000 (9,000) Payments on acquisition obligations (1,482) -- -------- -------- Net cash used in investing activities (4,423) (13,950) FINANCING ACTIVITIES: Payments of bank debt -- (2,592) Payments of subordinated debt -- (21,580) Proceeds from issuance of common stock -- 34,771 Common stock offering costs (483) -- Repurchase of common stock -- (33) Issuance of stock pursuant to employee stock plans 886 40 Payments on stockholders' notes receivable 141 2 --------- -------- Net cash provided by financing activities 544 10,608 --------- -------- Net increase in cash and cash equivalents 2,820 1,292 Cash and cash equivalents at beginning of period 2,793 632 -------- -------- Cash and cash equivalents at end of period $ 5,613 $ 1,924 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for income taxes $ -- $ 1,362 Cash paid for interest $ -- $ 894 SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES Conversion of convertible redeemable preferred stock to common stock $ -- $ 10,896 Stock issued for stockholders' notes receivable $ -- $ 36 Stock issued for receivables from common stock offering $ 38,475 $ --
See accompanying notes. 5 6 SDL, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 1996 are not necessarily indicative of the results that may be expected for the year ended December 31, 1996. For further information, refer to the consolidated financial statements and footnotes thereto included in the Registrant Company's annual report on Form 10-K for the year ended December 31, 1995. The consolidated financial statements include the accounts of SDL, Inc. (the Company) and its wholly owned subsidiary SDL Optics, Inc. (SDL Optics). Intercompany accounts and transactions have been eliminated in consolidation. The functional currency of the Company's foreign subsidiary is the U.S. dollar. Subsidiary financial statements are remeasured into U.S. dollars for consolidation. Foreign currency transaction gains and losses were immaterial for all periods presented. 2. NET INCOME PER SHARE Net income per share is computed using the weighted average number of shares of common stock outstanding and dilutive common equivalent shares from stock options (using the treasury stock method). 3. STOCK SPLIT AND COMMON STOCK OFFERING In May 1996, the Board of Directors authorized a three-for-two split of its Common Stock, effected in the form of a 50% stock dividend, which was paid on June 12, 1996 to stockholders of record on May 15, 1996. All share and per share data in these financial statements have been retroactively adjusted to reflect the stock split. On June 26, 1996, the Company issued 1,500,000 shares of common stock in a follow-on public stock offering at a per share price of $27.00. Net proceeds to the Company approximated $37,992,000 and were receivable from the Company's Underwriters at June 30, 1996. 6 7 4. SHORT-TERM INVESTMENTS Available for sale short-term investments consist of the following (in thousands):
June 30, December 31, 1996 1995 ---- ---- Tax-exempt auction rate preferred stocks $6,000 $7,000 Municipal bonds 1,515 1,515 ------- ------- $7,515 $8,515 ====== ======
Tax-exempt auction rate preferred stock contains contractual maturities of less than one year. Municipal bonds mature within one year. Both realized and unrealized gains and losses on the sale of available-for-sale securities were immaterial for the three and six months ended June 30, 1996 and 1995. 5. INVENTORIES The components of inventories consist of the following (in thousands):
June 30, December 31, 1996 1995 ---- ---- Raw materials $ 5,626 $ 4,151 Work in process 6,997 4,855 -------- -------- $12,623 $ 9,006 ======= =======
No significant amounts of finished goods are maintained. 6. COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS The following is a summary of research and product contract activity related to uncompleted long-term contracts from the inception of the contracts (in thousands):
June 30, December 31, 1996 1995 ---- ---- Costs incurred on uncompleted long-term contracts $51,658 $41,460 Estimated earnings 3,309 2,533 -------- --------- Revenue recognized on uncompleted long-term contracts 54,967 43,993 Less billings to date 53,545 42,477 -------- -------- Unbilled costs and estimated earnings $ 1,422 $ 1,516 ======== =========
7 8 The above balances are included in accounts receivable in the accompanying balance sheets. Unbilled costs and estimated earnings on uncompleted long-term contracts are generally billable in the subsequent year. Revenue recognized on long-term contracts included in total revenues was approximately $6.0 million and $11.8 million for the three and six month periods ended June 30, 1996 and approximately $4.2 million and $8.2 million for the comparable 1995 periods. 7. CONTINGENCIES See Part II, Item 1, Legal Proceedings for discussion of legal matters. 8. SUBSEQUENT EVENT On July 1, 1996, the Underwriters of the June 26, 1996 follow-on public stock offering exercised their over-allotment option to purchase 255,000 additional shares of the Company's common stock. Net proceeds to the Company approximated $6,541,000. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SDL designs, manufactures and markets semiconductor optoelectronic integrated circuits (OEICs), semiconductor lasers, fiber optic related products and optoelectronic based systems. The Company's revenue consists of product and research revenue. The Company's product revenue is primarily derived from the sale of standard and customized products to a variety of customers, in volumes ranging from single products sold to numerous organizations, to high unit volumes sold to certain original equipment manufacturer (OEM) customers. As a result, product gross margins tend to fluctuate based on the mix of products sold in any reported period. From the original products introduced in 1984, the Company has expanded its product offering to over 200 standard products in addition to providing custom design and packaging for OEM customers. OEM customers often fund the design or customization as well as the manufacturing and testing of their volume products. The primary applications for the Company's products include telecommunications, CATV, satellite communications, printing, medical, data storage, sensor, defense, materials processing and instrument markets. The Company's research revenue is derived from customer-funded research programs. The Company's research and engineering staff, which currently includes over 40 Ph.D.s, provides state-of-the-art research and proof-of-concept prototypes over a broad range of semiconductor OEIC and laser technologies. The Company has been issued over 50 U.S. patents and has approximately 40 U.S. patent applications pending. Customer-funded research revenue is typically based on material and labor costs incurred, plus coverage for overhead and operating expenses, and in most cases, an additional profit component. Cost-based pricing has generally resulted in lower gross margins for research revenue as compared to that of product revenue. The Company typically retains rights to the technology developed under customer-funded research programs and therefore is able to leverage these programs to continue to broaden its product and technology offerings. All internally-funded research and development costs are expensed in the period incurred. On November 30, 1995, the Company and its subsidiary, SDL Optics, acquired the net assets of Seastar Optics, Inc., which was accounted for under the purchase method of accounting. SDL Optics' operating results are included in the accompanying consolidated financial statements from that date. Certain of the statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations may be forward-looking statements regarding the Company's business, operations and prospects. The Company's actual results could differ materially from those in such forward-looking statements. See "Risk Factors." RESULTS OF OPERATIONS REVENUE. Total revenue for the quarter ended June 30, 1996 increased 73% to $21.6 million compared to $12.5 million in the June 1995 quarter and was 6% above total revenue recorded 9 10 during the March 1996 quarter. Total revenue for the six months ended June 30, 1996 increased 83% to $42.0 million over the same six month period in 1995. The increase in revenue during 1996 has been driven by demand for the Company's semiconductor lasers and optoelectronic solutions, SDL Optics' sales of communications products, and to a lesser extent, growth in research revenue. Revenue from products within the fiber-based communications market, including telecommunications, CATV, satellite communication and LANs grew 77% over that reported during the second quarter of 1995, and represented approximately 53% of total revenue reported during the three months ended June 30, 1996. Research revenue grew compared to both the corresponding 1995 periods and the March 31, 1996 quarter, but at a slower rate than that of product revenue. For the three and six months ended June 30, 1996, research revenue represented 14% and 15%, respectively, of total revenue as compared to 17% for both the corresponding 1995 periods. International revenue as a percentage of total revenue for the six months ended June 30, 1996 decreased to 16% compared to 25% for the corresponding 1995 period. The decline in the percentage of total international revenue resulted from a large percentage of SDL Optics' revenue occuring within the domestic communications markets. Approximately 18% of the Company's revenue for both the three and six months ended June 30, 1996 was received from Lockheed Martin. This compares to approximately 15% and 17 % of revenue for the comparable 1995 three and six month periods. Several new programs for Lockheed Martin initiated during the second quarter of 1996 resulted in the increase in revenue from this customer. There can be no assurances that the application markets for SDL's products will grow in future periods at historical percentage rates. Further, there can be no assurance that the Company will be able to increase or maintain its market share in the future or to sustain historical growth rates. GROSS MARGIN. Gross margins decreased from 38.6% and 39.1% of total revenue for the three and six months ended June 30, 1995, to 36.3% and 36.9% in the comparable 1996 periods. While slight gross margin improvements were realized for research revenue during the second quarter of 1996, the Company experienced manufacturing capacity constraints, and lower than expected production yields on several of its product lines. This, in turn, contributed to the lower gross margins realized during the three and six months ended June 30, 1996 as compared to the corresponding prior year periods. The Company is actively addressing yield issues, and to relieve capacity constraints, additional manufacturing equipment has been ordered and clean room renovation is in process. The additional capacity should become available during the fourth quarter of 1996. See "Risk Factors Manufacturing Risks." The Company's gross margin can be affected by a number of factors, including product mix, pricing pressures, and product yield. Generally, the cost of newer products tends to be higher as a percentage of product revenue than that of more mature, higher volume products. In addition, the cost of research revenue is significantly higher as a percentage of revenue, as research revenue is typically based on costs incurred rather than market pricing. As a result of these factors, gross margin fluctuations are difficult to predict and there can be no assurance that the Company will maintain gross margins at current levels in future periods. 10 11 RESEARCH AND DEVELOPMENT. The Company's total research and development activities consist of customer-funded research programs and internally-funded research and development. Total research and development activities during the three and six months ended June 30, 1996 increased to $3.5 million and $7.4 million, respectively, compared to $2.4 million and $4.6 million for the corresponding 1995 periods. Research revenue growth, together with increased spending on new product development, cost reduction and reliability improvement projects and the acquisition of the SDL Optics business primarily influenced the 1996 growth in total research and development activities. As a percentage of total revenue, total cost of research and development activities decreased to 18% for the six months ended June 30, 1996 from 20% for the corresponding six month period of 1995. The high relative growth in total revenue for the reported periods is the primary reason for the decreased ratio of total Company cost of research and development activities on a year-over-year basis. Accordingly, the level of research and development may vary based on future levels of customer-funded research and development. SELLING, GENERAL AND ADMINISTRATIVE. The increase of selling, general and administrative expense (SG&A) for the three and six months ended June 30, 1996 as compared to the corresponding 1995 periods resulted primarily from the continuing expansion of the Company's business, headcount increases, ongoing litigation expense, and to a lesser extent, the acquisition of the SDL Optics business. SG&A decreased for the three and six month periods as a percentage of total revenue despite higher levels of litigation expense incurred during 1996 compared to 1995. The Company expects that SG&A expenses will continue to increase to support the Company's current and expected future volumes of business. However, there can be no assurances that current SG&A levels as a percentage of total revenue are indicative of future SG&A as a percentage of total revenue. For the next several quarters, it is expected that litigation expense will remain at approximately the level recorded during the most recent three month period. INTEREST INCOME (EXPENSE), NET. The Company recorded net interest income for the three and six months ended June 30, 1996. The level of interest income generating investments and their relative interest rates were comparable during the second quarter of both 1996 and 1995. The Company incurred net interest expense for the six month period ended June 30, 1995 as a result of its subordinated and bank debt, which remained outstanding for substantially all of the first quarter of 1995. This debt was repaid with proceeds of the Company's initial public stock offering in March 1995. PROVISION FOR INCOME TAXES. The annualized estimated effective tax rate was 34% and 37% for the six month periods ended June 30, 1996 and 1995, respectively. The reduction in the effective tax rate is attributable to the benefits of tax exempt interest income, state tax credits, as well as a reduction in the valuation allowance. 11 12 LIQUIDITY AND CAPITAL RESOURCES Net cash from operating activities was $6.7 million for the six months ended June 30, 1996. In addition, the Company spent $3.9 million for planned facilities expansion and capital equipment purchases during the 1996 six month period and made a $1.5 million payment on the acquisition obligation related to SDL Optics. As a result, the Company increased cash, cash equivalents and short-term investments to $13.1 million at June 30, 1996 as compared to $11.3 million at December 31, 1995. On June 26, 1996, the Company issued 1,500,000 shares of common stock in a follow-on public stock offering at a per share price of $27.00. Net proceeds to the Company approximated $37,992,000 and were receivable from the Company's Underwriters at June 30, 1996. On July 1, 1996, the Underwriters exercised their over-allotment option to purchase 255,000 additional shares of the common stock. Net proceeds to the Company approximated $6,541,000. The net proceeds of this offering are expected to be used to expand the Company's manufacturing facilities, to acquire capital equipment, to fund possible acquisitions of complementary businesses, products and technologies, and for general corporate purposes including working capital. Pending such uses, the net proceeds will be invested in investment-grade, income producing investments with maturities of up to two years. The Company has an $8 million secured line of credit, which expires in January 1997. Any borrowings under this line would be limited to 80% of eligible accounts receivable, as defined in the credit agreement (approximately $6.5 million was available for borrowings under the line at June 30, 1996), and bear interest at the bank's prime rate (8.25% at June 30, 1996). The credit agreement contains affirmative and negative covenants and, among other things, requires the Company to maintain certain financial ratios and restricts the ability to pay cash dividends. The Company has future cash requirements to complete its acquisition of the SDL Optics business of (i) $1.5 million payable on March 31, 1997, for which the Company was contingently liable for a letter of credit at June 30, 1996 and (ii) $1.2 million in cash or common stock of the Company (at the Company's option) on March 31, 1997. The Company currently expects to spend approximately $12 million for capital equipment purchases and leasehold improvements during 1996. The Company believes that current cash balances, cash generated from operations, credit available under the bank line of credit and cash available through the equity markets will be sufficient to fund capital equipment purchases, acquisitions of complementary businesses, products or technologies and working capital requirements at least through 1997. However, there can be no assurances that events in the future will not require the Company to seek additional capital sooner or, if so required, that adequate capital will be available on terms acceptable to the Company. 12 13 RISK FACTORS The statements contained in this Report on Form 10-Q that are not purely historical are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions, beliefs or strategies regarding the future. Forward looking statements include SDL's liquidity, anticipated cash needs and availability, and anticipated expense levels under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations". All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statement. It is important to note that the Company's actual results could differ materially from those in such forward looking statements. Among the factors that could cause actual results to differ materially are the factors detailed below. You should also consult the risk factors listed from time to time in the Company's Reports on Form 10-Q, 8-K, 10-K and Annual Reports to Stockholders. MANUFACTURING RISKS. The Company relies on its own production capability in computer-aided chip and package design, wafer fabrication, wafer processing, device packaging, hybrid microelectronic packaging, printed circuit board testing, final assembly and testing of products. Because the Company manufactures, packages and tests these components, products and systems at its own facilities, and such components, products and systems are not readily available from other sources, any interruption in manufacturing resulting from shortages of parts or equipment, fire, natural disaster, equipment failures, or otherwise would have a material adverse effect on the Company's business and results of operations. In particular, a significant portion of the Company's production relies or occurs on equipment for which the Company does not have a backup. In order to alleviate, at least in part, this situation, the Company is in the process of remodeling its front-end wafer fabrication facility. This might cause downtime on existing equipment. Also, there can be no assurance that the new facility and equipment will not experience start-up and yield problems. In the event of any disruption in production by one of these machines, the Company's business and results of operations could be materially adversely affected. Furthermore, the Company has a limited number of employees dedicated to the operation and maintenance of its equipment, the loss of whom could affect the Company's ability to effectively operate and service such equipment. The Company is experiencing, and may in the future experience, lower than expected production yields on many of its products, including some of its key product lines. This reduction in yields adversely affects gross margins and delayed component, product and system shipments. There can be no assurance that the Company's manufacturing yields will be acceptable to ship products on time in the future. To the extent the Company continues to experience lower than expected manufacturing yields or experiences any shipment delays,the Company could lose customers, could experience reduced or delayed customer orders and cancellation of existing backlog, and the Company's business and results of operations would be materially adversely affected. 13 14 MULTISITE OPERATIONS; NEED TO MANAGE GROWTH. The Company has on occasion been unable to manufacture certain products in quantities sufficient to meet the demand of its existing customer base and of new customers. As a result, the Company expanded its facilities by relocating its assembly, test and packaging operations to another building and is in the process of remodeling its original manufacturing facilities and adding new manufacturing equipment and obtaining additional facilities. In addition, the Company and its subsidiary, SDL Optics, acquired the business of a company located in Victoria, British Columbia, Canada. Prior to these developments, the Company had no experience in managing operations in multiple sites and no assurance can be given that the Company will not experience unexpected delays, inefficiencies or management problems arising out of its multisite operations. Such delays or inefficiencies could materially adversely affect the Company's business and results of operations. The recent growth in the Company's revenue and expansion in the scope of its operations has placed a considerable strain on its management, financial, manufacturing and other resources and has required the Company to implement and improve a variety of operating, financial and other systems, procedures and controls. In addition, the Company has hired a new Vice President of Manufacturing who will replace the former Vice President who recently resigned. There can be no assurance that any existing or new systems, procedures and controls will be adequate to support the Company's operations or that its systems, procedures and controls will be designed, implemented or improved in a cost effective and timely manner. Any failure to implement, improve and expand such systems, procedures and controls in an efficient manner at a pace consistent with the Company's business could have a material adverse effect on the Company's business and results of operations. TECHNOLOGY AGREEMENT. At the time of its formation, the Company entered into a technology agreement with Spectra-Physics, Inc. ("Spectra-Physics") and Xerox Corporation ("Xerox"), (the "Technology Agreement") pursuant to which SDL granted to Spectra-Physics and Xerox an irrevocable, royalty-free, worldwide, non-exclusive license to patented and non-patented technology developed by SDL. In March 1995, Spectra-Physics filed suit against SDL in the Santa Clara County, California Superior Court, seeking, among other things, to enforce the claims of Spectra-Physics and its affiliated company, Opto Power Corporation ("Opto Power"), to SDL patented and non-patented technology developed through at least June 1993. The Company believes that as a result of events subsequent to the entry into the Technology Agreement, there are questions concerning Spectra-Physics' or Opto Power's continuing rights, if any, to such technology. The Company has answered the complaint and has filed a cross-complaint against, among others, Spectra-Physics and Opto Power seeking a declaration of the parties' rights under the Technology Agreement, damages and an injunction against further requests by Spectra-Physics and Opto Power of the transfer of SDL technology. In addition, the Company has named Xerox as an additional cross defendant on the claims for a declaratory judgment seeking an interpretation of the Technology Agreement with respect to the treatment of Xerox technical information. Xerox has filed a cross complaint against the Company Spectra-Physics and Opto Power seeking a declaratory judgment that Spectra-Physics and Opto Power have no license to, and that the Company may not disclose without Xerox' consent, Xerox technical information. Xerox also asserts a breach of contract claim against the Company for the alleged failure to transfer technology to Xerox pursuant to the Technology Agreement. Xerox 14 15 seeks unspecified damages from the Company and specific performance of the Technology Agreement. Discovery is proceeding. Trial of the matter is scheduled for January 21, 1997. The Company believes that it has meritorious defenses to Spectra-Physics', Opto Power's and Xerox's claims. There can be no assurance, however, that the Company will achieve a successful result in this litigation. The litigation has involved and is expected to continue to involve significant expense to the Company and to divert the attention of the Company's technical and management personnel, and the outcome could have a material adverse effect on the Company's business and results of operations. If the Company does not prevail in such litigation, the Company could face monetary damages and could be required to license and to transfer valuable SDL trade secrets and technology to Spectra-Physics and possibly to Opto Power, which is currently manufacturing optoelectronic devices that compete with a number of the Company's products. Such a result could significantly impair the Company's competitive advantage in certain technology areas with respect to a number of products and could have a material adverse effect on the Company's business and results of operations. RISK OF PATENT INFRINGEMENT CLAIM. The semiconductor optoelectronics, communications, information and laser industry is characterized by frequent litigation regarding patent and other intellectual property rights. From time to time, the Company has received, and may receive in the future, notice of claims of infringement of other parties' proprietary rights. In 1985, the Company first received correspondence from Rockwell International Corporation ("Rockwell") alleging that a fabrication process used by the Company infringes Rockwell's patent rights. In August 1993, Rockwell sued the Federal government alleging infringement of these patent rights with respect to the contracts the Federal government has had with at least 15 companies, including the Company (the "Government Lawsuit"). The Federal government has asserted that, if it is held liable to Rockwell for infringement of Rockwell's patent rights in connection with some of its contracts with the Company, then the Company will be liable to indemnify the Federal government for a portion of its liability. The Company has intervened as a party in the Government Lawsuit. In February 1995, Rockwell asserted its prior allegations and threatened to file suit against the Company for injunctive relief and damages if the Company did not enter into an agreement to license rights to the process that Rockwell claims to hold. In May 1995, Rockwell filed such a suit against the Company in the United States District Court for the Northern District of California (the "District Court Action"). The District Court Action has been stayed pending the completion of certain proceedings in the Government Lawsuit. The Company believes that it has meritorious defenses to Rockwell's allegations, including among others, that the Company's process does not infringe Rockwell's patent upon which its claim is based and that such patent is invalid. DEPENDENCE ON EMERGING APPLICATIONS. The Company's current products serve many applications in the communications, information and light source replacement markets. In many cases, the Company's products are substantially completed, but the customer's product is not yet completed, and the applications are emerging or are otherwise in new markets. In addition, the Company and certain of its customers are currently in the process of developing new products, in various stages of development, testing and qualification, sometimes in emerging applications or 15 16 new markets. A substantial portion of the Company's products address markets that are not now and may never become substantial commercial markets. The Company has experienced, and is expected to experience, technological and pricing constraints that may preclude development of markets and fluctuation in customer orders. No assurances can be given that the Company or its customers will continue their existing product development efforts, or if continued that such efforts will be successful, that markets will develop for any of the Company's or customer's products, that the Company's products will be accepted in end-user markets, that the Company's technology or pricing will enable such markets to develop, or that the Company's and its customer's products will not be superseded by other technology or products. DEPENDENCE UPON GOVERNMENT PROGRAMS AND CONTRACTS. In 1995 and the first six months of 1996, the Company derived approximately 45% and 41%, respectively, of its revenue directly and indirectly from a variety of Federal government sources. The Company received approximately 19% and 18% of its revenue for fiscal 1995 and the first six months of 1996, respectively, from Lockheed Martin through several government and commercial programs. The demand for certain of the Company's services and products is directly related to the level of funding of government programs. The Company believes that the success and further development of its business is dependent, in significant part, upon the continued existence and funding of such programs and upon the Company's ability to participate in such programs. For example, substantially all of the Company's research revenue for 1995 and the first six months of 1996 was funded by Federal programs. Most of the Company's Federally-funded programs are subject to renewal every one or two years, so that continued work by the Company under these programs in future periods is not assured. Federally-funded programs are subject to termination for convenience of the government agency, at which point the Company would be reimbursed for related allowable costs incurred to the termination date. Federally-funded contracts are subject to audit of pricing and actual costs incurred which have resulted, and could result in the future, in price adjustments. Before the end of 1996, the Company expects to lose eligibility for new U.S. Small Business Innovative Research contracts. Such contracts accounted for approximately 5% of revenue in 1995 and the first six months of 1996. 16 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ROCKWELL LITIGATION. In 1985, Rockwell International Corportion (Rockwell) asserted, and in 1995 filed suit against the Company alleging that a Company fabrication process infringed certain Rockwell patent rights. Rockwell is seeking to permanently enjoin the Company from infringing Rockwell's alleged patent rights and is seeking unspecified actual and treble damages plus costs. The Company has answered Rockwell's complaint asserting that Rockwell's patent is invalid, not infringed and unenforceable. In addition, the Federal government, which is a defendant in a suit brought by Rockwell relating to certain of the same alleged patent rights, asserted that the Company may be liable to indemnify the Federal government for certain of Rockwell's claims. The Company has intervened in Rockwell's suit against the Federal government. In the Government lawsuit, on March 4, 1996, Rockwell filed a motion for summary judgment that its patent is not invalid. The Company and the Government filed oppositions to that motion along with cross-motions for summary judgment that Rockwell's patent is invalid. Briefing on these motions and cross-motions will be completed in mid-August. No date has been set for a hearing on these motions and cross-motions. SPECTRA-PHYSICS LITIGATION. In 1995, Spectra-Physics, Inc. (Spectra) and others filed suit against the Company alleging that the Company was refusing to comply with its alleged obligations to transfer and license Company technology to them. These parties are seeking declaratory relief, specific performance and unspecified actual and punitive damages. The Company has answered these claims denying them and has cross-complained against Spectra and certain others seeking declaratory relief, damages and injunctive relief. Since the Company's December 31, 1995 Form 10-K disclosure regarding the Spectra-Physics litigation, the Company's cross-claims for damages against Ciba have been dismissed. Some, but not all, of the Company's cross-claims against Spectra and Opto Power have also been dismissed. The parties also have engaged in the court-ordered mediation. That mediation was unsuccessful in reaching a resolution of the disputes. The trial date has been continued to January 21, 1997. All parties have filed motions for summary adjudication of various issues in the case. The motions pertaining to claims between the Company, Xerox, Spectra-Physics and Opto Power are scheduled for hearing on October 1, 1996. The Company is vigorously contesting these claims. Although the outcome of these matters cannot be determined at this time, management does not believe that their outcome will have a material adverse effect on the Company's financial position, results of operations and cash flows and has made no provision for the ultimate outcome of these matters in its financial statements. However, based on future developments, the Company's estimate of the outcome of these matters could change in the near term. 17 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Stockholders on May 13, 1996. The stockholders voted on proposals to: 1. Elect two Class 2 Directors of the Company. 2. Ratify the appointment of Ernst & Young as the Company's auditors for 1996. The proposals were approved by the following votes: 1. Election of Directors Director For Withheld -------- --- -------- John P. Melton 5,310,572 19,585 Mark B. Myers 5,310,572 19,585 2. Ratify appointment of Ernst & Young For Against Abstain --- ------- ------- 5,305,505 4,380 20,272 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Lists of Exhibits Number Exhibit Description ------ ------------------- 11.1 Computation of Net Income per Common and Common Equivalent Share (b) Reports on Form 8-K None 18 19 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SDL, INC. --------- Registrant August 12, 1996 /s/Gregory C. Lindholm ---------------------- Gregory C. Lindholm Vice President, Finance Chief Financial Officer and Treasurer (duly authorized officer, and principal financial and accounting officer) 19 EX-11.1 2 COMPUTATION OF INCOME (LOSS) PER SHARE 1 EXHIBIT 11.1 SDL, INC. COMPUTATION OF NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS - UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 1996 1995 1996 1995 ---- ---- ---- ---- PRIMARY Weighted average number of common shares outstanding 11,097 9,590 10,925 8,088 Incremental common shares attributable to shares issuable under employee stock plans 1,286 1,615 1,303 1,545 -------- -------- -------- -------- Total shares 12,383 11,205 12,228 9,633 ======= ======== ======= ======== Net income Amount $ 2,429 $ 1,370 $ 4,588 $ 2,275 ======= ======= ======= ======= Per share $ 0.20 $ 0.12 $ 0.38 $ 0.24 ======== ======== ======== ========
Fully diluted computation not presented since such amounts differ by less than 3% of the net income per share amount shown above. 20 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINIANCIAL INFORMATION EXTRACTED FROM JUNE 30, 1996 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000934741 SDL, Inc. 1000 U.S. DOLLARS 6-MOS DEC-31-1996 JAN-01-1996 JUN-30-1996 1 5613 7515 13715 379 12623 80472 33042 14698 103356 14874 0 0 0 13 87793 103356 35889 42028 22152 26505 8840 0 (269) 6952 2364 4588 0 0 0 4588 0.38 0.38
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