-----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, SqRlxVYePQwST4UZUA+EaJyFE57SfHCs4FVKiIYen7IBLUiT12Iv6GtJ3j/fy2vU gN14t7dweUS2E3wUOYsXkw== 0000934741-99-000005.txt : 19990513 0000934741-99-000005.hdr.sgml : 19990513 ACCESSION NUMBER: 0000934741-99-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990512 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SDL INC CENTRAL INDEX KEY: 0000934741 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770331449 STATE OF INCORPORATION: DE FISCAL YEAR END: 0101 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-25688 FILM NUMBER: 99618205 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 FOR PERIOD ENDED MARCH 31, 1999 UNITED STATES SECURITIES & 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 March 31, 1999 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 May 6, 1999 was 14,835,532. SDL, INC. INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at March 31, 1999 and December 31, 1998 Condensed Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998 Notes to Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item. 3 Quantitative and Qualitative Disclosures about Market Risk PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SDL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
March 31, December 31, 1999 1998 ------------ ------------ (unaudited) (1) ASSETS Current Assets: Cash and cash equivalents ....................... $4,305 $13,370 Short-term investments .......................... 15,053 12,494 Accounts receivable, net ........................ 27,593 22,070 Inventories ..................................... 22,651 19,679 Prepaid expenses and other current assets ....... 3,181 3,306 ------------ ------------ Total current assets .............................. 72,783 70,919 Property and equipment, net ....................... 38,217 32,931 Long-term investments ............................. -- 3,552 Note due from related party ....................... 504 512 Other assets ...................................... 7,031 4,563 ------------ ------------ Total assets ...................................... $118,535 $112,477 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ................................ $7,981 $9,385 Accrued payroll and related expenses ............ 2,696 2,354 Income taxes payable ............................ 1,565 1,890 Unearned revenue ................................ 618 643 Other accrued liabilities ....................... 2,873 2,289 ------------ ------------ Total current liabilities ......................... 15,733 16,561 Long-term liabilities ............................. 3,580 2,669 Commitments and contingencies Stockholders' equity: Preferred stock.................................. -- -- Common stock..................................... 15 15 Additional paid-in capital ...................... 123,044 120,033 Accumulated other comprehensive income........... (50) (4) Accumulated deficit, $26.3 million relating to the repurchase of common stock in 1992 and $5.8 million relating to a recapitalization in 1992 ...................... (23,747) (26,757) ------------ ------------ 99,262 93,287 Less common stockholders' notes receivable ...... (40) (40) ------------ ------------ Total stockholders' equity ........................ 99,222 93,247 ------------ ------------ Total liabilities and stockholders' equity ........ $118,535 $112,477 ============ ============
(1) The balance sheet at December 31, 1998 has been derived from the audited financial statements at that date. See accompanying notes. SDL, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED)
Three Months Ended March 31, ------------------- 1999 1998 --------- --------- Total revenue: Product revenue..................... $34,754 $22,140 Research revenue.................... 976 3,217 --------- --------- 35,730 25,357 Cost of revenue: Cost of product revenue............. 20,773 14,778 Cost of research revenue............ 903 2,372 --------- --------- Gross margin.......................... 14,054 8,207 Operating expenses: Research and development.............. 3,348 2,476 Selling, general and administrative... 5,018 2,889 Amortization of purchased intangibles. 179 196 In-process research and development... 1,495 -- --------- --------- Operating income...................... 4,014 2,646 Interest income and other, net........ 270 273 --------- --------- Income before income taxes............ 4,284 2,919 Provision for income taxes............ 1,274 220 --------- --------- Net income............................ $3,010 $2,699 ========= ========= Net income per share - basic.......... $0.21 $0.20 ========= ========= Net income per share - diluted........ $0.19 $0.19 ========= ========= Number of weighted average shares - basic...................... 14,479 13,708 Number of weighted average shares - diluted.................... 15,509 14,545
See accompanying notes SDL, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS - UNAUDITED)
Three Months Ended March 31, -------------------- 1999 1998 --------- --------- OPERATING ACTIVITIES: Net income............................................. $3,010 $2,699 --------- --------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization..................... 2,293 1,904 In-process research and development.............. 1,495 -- Changes in operating assets and liabilities: Accounts receivable............................ (5,523) 783 Inventories.................................... (1,993) (589) Accounts payable............................... (1,404) 227 Accrued payroll and related expenses........... 342 170 Income taxes payable........................... (325) (269) Unearned revenue........................... (25) (22) Other accrued liabilities...................... 340 (79) Other long-term liabilities.................... 911 161 Other.......................................... 82 (224) --------- --------- Total adjustments...................................... (3,807) 2,062 --------- --------- Net cash provided by (used in) operating activities.... (797) 4,761 --------- --------- INVESTING ACTIVITIES: Acquisition of property and equipment, net............ (7,171) (3,679) Acquisition of the fiber laser business of Polaroid... (5,055) -- Sale of investments, net.............................. 947 3,261 --------- --------- Net cash used in investing activities.................. (11,279) (418) --------- --------- FINANCING ACTIVITIES: Issuance of stock pursuant to employee stock plans.... 3,011 286 --------- --------- Net cash provided by financing activities.............. 3,011 286 --------- --------- Net increase (decrease) in cash and cash equivalents.. (9,065) 4,629 Cash and cash equivalents at beginning of period....... 13,370 4,593 --------- --------- Cash and cash equivalents at end of period............. $4,305 $9,222 ========= =========
See accompanying notes. SDL, INC. NOTES TO 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. Intercompany accounts and transactions have been eliminated in consolidation. The functional currency of the Company's foreign subsidiary is the U.S. dollar. Subsidiary financial statements are remeasured into U.S. dollars for consolidation. Foreign currency transaction gains and losses are included in interest income. 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. In March 1999, the Board of Directors authorized a two-for-one stock split to be effected in the form of a stock dividend. The split is subject to stockholders approval of an increase in the Company's authorized shares of Common Stock to 70 million shares. Stockholders will vote on the proposed increase in the authorized capital at the Company's annual meeting of stockholders to be held on May 13, 1999. On March 31, 1999, the Company announced the signing of a Merger Agreement, providing for the pending merger with IOC International plc (IOC). IOC is a publicly held United Kingdom company (United Kingdom Alternative Investment Market symbol "IOC") that designs and manufactures lithium niobate opto-electronic devices for long haul fiber optic transmission systems. The merger with IOC will be accounted for as a pooling of interest transaction and is subject to a number of contingencies including approval by stockholders of IOC and certain closing conditions. As a result, there can be no assurance that such merger will be consummated. The Merger Agreement provides for the Company to acquire the whole of the share capital of IOC in exchange for new SDL Common Stock on the basis of 1.815 shares of new SDL Common Stock for every 100 IOC shares (before taking account of SDL's intention to declare a two-for-one stock split by the way of a stock dividend). 2. Net Income Per Share The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
Three Months Ended March 31, ------------------- 1999 1998 --------- --------- Numerator: Net income........................ $3,010 $2,699 ========= ========= Denominator: Denominator for basic net income per share - weighted average shares.......................... 14,479 13,708 Incremental common shares attributable to shares issuable under employee stock plans........................... 1,030 837 --------- --------- Denominator for diluted net income per share adjusted weighted average shares and assumed conversions............. 15,509 14,545 ========= ========= Net income per share - basic...... $0.21 $0.20 ========= ========= Net income per share - diluted.... $0.19 $0.19 ========= =========
3. Inventories The components of inventories consist of the following (in thousands):
March 31, December 31, 1999 1998 ------------ ------------ Raw materials ............. $10,548 $6,620 Work-in-process............ 12,103 13,059 ------------ ------------ $22,651 $19,679 ============ ============
No significant amounts of finished goods are maintained. 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, 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 $3.0 million for the first quarter 1999 compared to a comprehensive income of $2.7 million for the first quarter of 1998. 5. Segment Reporting 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):
Printing Communica- and tion Material Products Research Processing Total ---------- --------- ----------- ---------- Quarter ended March 31, 1999: Revenue from external customers... $25,377 $1,255 $9,098 $35,730 Amortization...................... 78 -- 101 179 Segment Operating Income.......... $6,393 ($217) $33 $6,209 Printing Communica- and tion Material Products Research Processing Total ---------- --------- ----------- ---------- Quarter ended March 31, 1998: Revenue from external customers... $10,952 $2,059 $12,346 $25,357 Amortization...................... 155 -- 41 196 Segment Operating Income (Loss)... $762 $201 $1,683 $2,646
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):
Quarters Ended March 31, ---------------------- 1999 1998 ----------- ---------- Operating Income (Loss) Total operating income from operating segments............................... $6,209 $2,646 In-process R&d and related costs.......... (2,195) -- ----------- ---------- Total consolidated operating income (loss).. $4,014 $2,646 =========== ==========
6. Acquisitions 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): Inventory ................. $979 Property and equipment..... 229 Intangibles................ 2,596 In-process R&D............. 1,495 ------------ Net assets acquired........ $5,299 ============ Liabilities................ $244 Cash paid, including transaction costs.......... 5,055 ------------ Total purchase price....... $5,299 ============ 7. Contingencies See Part II, Item 1, Legal Proceedings in the Company's Form 10-K for the year ended December 31, 1998 for discussion of legal matters. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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. In the quarter ended March 31, 1999, the Company derived 72% of its revenue from optical communication markets. With the increased focus on commercial communications products, the proportion of SDL's revenue derived from U. S. government related projects has declined from 43% in fiscal 1996 to 17% in the first quarter of 1999. 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 in part by a shortage in qualified manufacturing capacity, especially in the wafer fabrication area. The Company's new wafer fabrication facility received qualification in June 1998, for certain key product lines, allowing a faster ramp-up in production in the quarter ended March 31, 1999. 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. RESULTS OF OPERATIONS Revenue. Total revenue for the quarter ended March 31, 1999 increased 41% to $35.7 million compared to $25.4 million in the corresponding 1998 quarter. Sequentially, total revenue increased 22% over the $29.4 million reported for the December 1998 fourth quarter. Product revenue reported for the first quarter of 1999 increased 57% 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 204% 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 17% of total revenue reported for the first three months of 1999, compared to 31% for the first quarter of 1998. Revenues from customers outside of the United States represented 27% and 21% 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 323% over the prior year and represented 22% 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 41.3% compared with 32.4% 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 $3.3 million and $2.5 million for the quarters ended March 31, 1999 and 1998, respectively. Research and development expense as a percentage of total revenue was 9% and 10% 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, 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 $5.0 million or 14% of revenue, compared to $2.9 million or 11% 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 $270,000 compared to $273,000 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 $1,274,000 and $220,000 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 7.5% 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. The increase in the 1999 tax rate is primarily attributable to the Company's utilization of the remainder of 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 $19.4 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 $11.3 million in the three months ended March 31, 1999. The Company incurred capital expenditures of $7.2 million for facilities expansion and capital equipment purchases to expand its manufacturing capacities primarily for its communication products. The Company currently expects to spend approximately $13 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 $3.0 million from financing activities during the first quarter of 1999 from the exercise of employee stock options. 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 $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 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. RISK FACTORS The statements contained in this Report on Form 10-Q that are not purely historical are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions, beliefs or strategies regarding the future. Forward-looking statements include the Company's long-term strategic focus on commercial communication product opportunities, the ability to realize the benefit of net deferred tax assets, statements regarding the Company's year 2000 plans, the impact and expenses of year 2000 issues, the Company's year 2000 readiness, and the Company's liquidity and anticipated cash needs and availability under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations." All forward-looking statements included in this document are based on information available to the Company on the date hereof, and SDL assumes no obligation to update any such forward looking statement. It is important to note that the Company's actual results could differ materially from those in such forward-looking statements. Among the factors that could cause actual results to differ materially are the factors detailed below. You should also consult the risk factors listed in the Company's Registration Statement on Form S-4 filed with the SEC on April 2, 1999, as amended, and from time to time in the Company's Reports on Forms 10-Q, 8-K, 10-K, 10-K/A and Annual Reports to Stockholders. Manufacturing Risks The manufacture of semiconductor lasers and related products and systems that we sell is highly complex and precise, requiring production in a highly controlled and clean environment. Changes in the manufacturing processes or the inadvertent use of defective or contaminated materials by us or our suppliers have in the past and could in the future significantly impair our ability to achieve acceptable manufacturing yields and product reliability. If we do not achieve acceptable yields or product reliability, our operating results and customer relationships will be adversely affected. We rely almost exclusively on our own production capability in: o computer-aided chip and package design, o wafer fabrication, o wafer processing, o device packaging, o hybrid microelectronic packaging, o printed circuit board testing, and o final assembly and testing of products. Because we manufacture, package and test these components, products and systems at our own facility, and because these components, products and systems are not readily available from other sources, our business and results of operations will be significantly impaired if our manufacturing is interrupted by any of the following: o shortages of parts or equipment, o equipment failures, o poor yields, o fire or natural disaster, o labor or equipment shortages, or o otherwise. A significant portion of our production relies or occurs on equipment for which we do not have a backup. To alleviate, at least in part, this situation, we remodeled our front-end wafer fabrication facility and our packaging and test facility. We cannot assure you that we will not experience further start- up costs and yield problems in fully utilizing our increased wafer capacity targeted by these remodeling efforts. In addition, we are deploying a new manufacturing execution software system designed to further automate and streamline our manufacturing processes, and there may be unforeseen deficiencies in this system which could adversely affect our manufacturing processes. In the event of any disruption in production by one of these machines or systems, our business and results of operations could be materially adversely affected. Furthermore, we have a limited number of employees dedicated to the operation and maintenance of our equipment, loss of whom could affect our ability to effectively operate and service our equipment. We experienced lower than expected production yields on some of our products, including certain key product lines during 1997 and the first half of 1998. This reduction in yields: o adversely affected gross margins, o delayed component, product and system shipments, and o to a certain extent, delayed new orders booked. Although more recently, our yields have improved, we cannot assure you that yields will continue to improve or not decline in the future, nor that in the future our manufacturing yields will be acceptable to ship products on time. To the extent that we experience lower than expected manufacturing yields or experience any shipment delays, gross margins will likely be significantly reduced and we could lose customers and experience reduced or delayed customer orders and cancellation of existing backlog. We presently are ramping production of some of our product lines by: o changing our shift schedules and equipment coverage, o hiring and training new personnel, o acquiring new equipment, and o expanding our packaging facilities and capabilities. Difficulties in starting production to meet expected demand and schedules have occurred in the past and may occur in the future including the following: o quality problems could arise, yields could fall, and gross margins could be reduced during such a ramp. o aggressive volume pricing for large long-term orders has been provided to certain customers. o cost reductions in manufacturing are required to avoid a drop in gross margins for certain products sold to customers receiving volume pricing. These cost reductions may not occur rapidly enough to avoid a decrease in gross margins on products sold under volume pricing terms. In that event, our business and results of operations would be materially adversely affected. Competition Our various markets are highly competitive. We face current or potential competition from four primary sources: o direct competitors, o potential entrants, o suppliers of potential new technologies, and o suppliers of existing alternative technologies. We offer a range of components, products and systems and have numerous competitors worldwide in various segments of our markets. As the markets for our products grow, new competitors have recently emerged and are likely to continue to do so in the future. We also sell products and services to companies with which we presently compete or in the future may compete and certain of our customers have been or could be acquired by, or enter into strategic relations with our competitors. In most of our product lines, our competitors and we are working to develop new technologies, or improvements and modifications to existing technologies, which will obsolete present products. Many of our competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do. In addition, many of these competitors may be able to respond more quickly to new or emerging technologies, evolving industry trends and changes in customer requirements and to devote greater resources to the development, promotion and sale of their products than we. We cannot assure you that: o our current or potential competitors have not already or will not in the future develop or acquire products or technologies comparable or superior to those that we developed, o combine or merge with each other or our customers to form significant competitors, o expand production capacity to more quickly meet customer supply requirements, or o adapt more quickly than we do to new technologies, evolving industry trends and changing customer requirements. Increased competition has resulted and could, in the future, result in price reductions, reduced margins or loss of market share, any of which could materially and adversely affect our business and results of operations. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures we face will not have a material adverse effect on our business and results of operations. We expect that both direct and indirect competition will increase in the future. Additional competition could have an adverse material effect on our results of operations through price reductions and loss of market share. Dependence on Emerging Applications and New Products Our current products serve many applications in the communications and materials processing and printing markets. In many cases, our products are substantially completed, but the customer's product incorporating our products is not yet completed or the applications or markets for the customer's product are new or emerging. In addition, some of our customers are currently in the process of developing new products that are in various stages of development, testing and qualification, and sometimes are in emerging applications or new markets. We believe that rapid customer acceptance of our new products is key to our financial results. A substantial portion of our products address markets that are not now, and may never become, substantial commercial markets. We have experienced, and are expected to continue to experience, fluctuation in customer orders and competitive, technological and pricing constraints that may preclude development of markets for our products and our customers' products. Our customers are often required to test and qualify laser pump modules, transmitters, and marking systems among other new products for potential volume applications. We cannot assure you that: o we or our customers will continue their existing product development efforts, or if continued that such efforts will be successful, o markets will develop for any of our technology or that pricing will enable such markets to develop, or o other technology or products will not supersede our products or our customer's products. We may also be unable to develop new products on a timely schedule. Moreover, even if we are successful in the timely development of new products that are accepted in the market, we often experience lower margins on these products. The lower margins are due to lower yields and other factors, and thus we may be unable to manufacture and sell new products at an acceptable cost so as to achieve acceptable gross margins. Need To Manage Growth We have on occasion been unable to manufacture products in quantities sufficient to meet demand of our existing customer base and new customers. The expansion in the scope of our operations has placed a considerable strain on our management, financial, manufacturing and other resources and has required us to implement and improve a variety of operating, financial and other systems, procedures and controls. In addition, we are currently deploying a new enterprise resource planning system and manufacturing execution system. We cannot assure you that any existing or new systems, procedures or controls will be adequate to support our operations or that our 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 our business could have a material adverse effect on our business and results of operations. Our future success is dependent, in part, on our ability to attract, assimilate and retain additional employees, including certain key personnel. We will continue to need a substantial number of additional personnel, including those with specialized skills, to commercialize our products and expand all areas of our business in order to continue to grow. Competition for such personnel is intense, and we cannot assure you that we will be able to attract, assimilate or retain additional highly qualified personnel. Risks of Acquisitions Our strategy involves the acquisition and integration of additional companies' products, technologies and personnel. We have limited experience in acquiring outside businesses. Acquisition of businesses requires substantial time and attention of management personnel and may require additional equity or debt financings. Furthermore, integration of newly established or acquired businesses is often disruptive. Since we have acquired or in the future may acquire one or more businesses, we cannot assure you that we will: o identify appropriate targets, o acquire such businesses on favorable terms, o be able to successfully integrate or attain the anticipated synergies expected by bringing such organizations into our business, or o be able to improve or even maintain the operating results of such businesses. Failure to do so could significantly impair our business, financial condition and results of operations and a have a material adverse effect on our business and results of operations. Dependence Upon Government Programs And Contracts The Company derived approximately 17%, 28%, and 38% of its revenue during the first quarter of 1999, fiscal 1998, and fiscal 1997, respectively, directly and indirectly from a variety of Federal government sources. The Company received approximately 13%, 14% and 19% of its revenue for the first quarter of 1999, and fiscal 1998, and fiscal 1997, respectively, from Lockheed Martin through several U.S. government and commercial programs. Almost all of the Company's revenue from Lockheed Martin during these periods was derived from Federally- funded programs. Revenue from certain of these Lockheed Martin programs are expected to decrease in the near term. The demand for certain of our services and products is directly related to the level of funding of government programs. We believe that the success and further development of our business is dependent, in significant part, upon the continued existence and funding of such programs and upon our ability to participate in such programs. For example, Federal programs funded substantially all of our research revenue for 1998, 1997 and 1996. Most of our Federally-funded programs are subject to renewal every one or two years, so that continued work by us 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 we would be reimbursed for related allowable costs incurred to the termination date. Federally-funded contracts are subject to audit of pricing and actual costs incurred, which have resulted, and could result in the future, in price adjustments. The Federal government has in the past, and could in the future, challenge our accounting methodology for computing indirect rates and allocating indirect costs to government contracts. The government is currently challenging certain indirect cost allocations. While we believe that amounts recorded on our financial statements are adequate to cover all related risks, the government has not concluded its investigation or agreed to a settlement with us. Although the outcome of this matter cannot be determined at this time, we do not believe that its outcome will have a material adverse effect on our financial position, results of operations and cash flows. However, based on future developments, our estimate of the outcome of these matters could change in the near term. In addition, a change in our accounting practices in this area could result in reduced profit margins on government contracts. Dependence on Key Employees Our future performance also depends in significant part upon the continued service of our key technical and senior management personnel. The loss of the services of one or more of our officers or other key employees could significantly impair our business, operating results and financial condition. While many of our current employees have many years of service with us, there can be no assurance that we will be able to retain our existing personnel. If we are unable to retain and hire additional personnel, our business and results of operations could be materially and adversely affected. See also "Our acquisition strategy poses several risks" above. Risk of Patent Infringement Claims The semiconductor, optoelectronics, communications, information and laser industries are characterized by frequent litigation regarding patent and other intellectual property rights. From time to time we have received and may receive in the future, notice of claims of infringement of other parties' proprietary rights and licensing offers to commercialize third party patent rights. In addition, we cannot assure you that: o additional infringement claims (or claims for indemnification resulting from infringement claims) will not be asserted against us, or o that existing claims or any other assertions will not result in an injunction against the sale of infringing products or otherwise significantly impair our business and results of operations. In 1985, we first received correspondence from Rockwell International Corporation alleging that we used a fabrication process that infringes Rockwell's patent rights. Those allegations led to two related lawsuits, one of which is still pending. The first lawsuit was filed in August 1993, when Rockwell sued the Federal government in the United States Court of Federal Claims, alleging infringement of these patent rights with respect to the contracts the Federal government has had with at least 15 companies, including us (Rockwell International Corporation v. The United States of America, No. 93-542C (US Ct. Fed. Cl.)). We were not originally named as a party to this lawsuit. However, the Federal government has asserted that, if we were held liable to Rockwell for infringement of Rockwell's patent rights in connection with some of its contracts with us, then we would be liable to indemnify the Federal government for a portion of its liability on certain contracts. In June 1995, after Rockwell filed a second lawsuit, we filed a motion to intervene in the lawsuit filed in August 1993. That motion was granted on August 17, 1995. Upon intervening in the Federal government's lawsuit, we filed an answer to Rockwell's complaint, alleging that: o Rockwell's patent was invalid and that we did not infringe Rockwell's patent, o Rockwell's patent was unenforceable under the doctrine of inequitable conduct, and o Rockwell's action is barred by the doctrines of laches and equitable estoppel. After extensive discovery, we moved, as did the Federal government, for summary judgment on the ground that Rockwell's patent was invalid. By order dated February 5, 1997, the Court of Federal Claims granted those motions and entered judgment in our favor and in favor of the Federal government. However, Rockwell appealed the Court of Federal Claims' decision, and on June 15, 1998, the United States Court of Appeals for the Federal Circuit issued an opinion vacating the judgment that had been entered in our favor and in favor of the Federal government. The US Circuit Court for the Federal Circuit held that the Court of Federal Claims had erred in finding that there were no genuine disputes of material fact concerning the obviousness of the Rockwell patent, and that the resolution of these disputes requires a trial. The Federal Circuit: o remanded the case back to the trial court for further proceedings, and o affirmed the Court of Federal Claims' denial of our motion for summary judgment of invalidity based on anticipation, as well as the Court of Federal Claims' claim construction. Subsequent to the Federal Circuit's action, the United States agreed to pay Rockwell $16.9 million in settlement of the lawsuit filed in August 1993. We did not participate in the settlement. The Federal government has not again raised the issue of our potential indemnity obligation. As noted above, we made our decision to intervene in the lawsuit filed on August 1993 after Rockwell filed suit against us in the Northern District of California in May 1995, alleging that we had infringed the Rockwell patent in connection with our manufacture and sale of products to customers other than the United States. Again, the complaint alleges that we used a fabrication process that infringes the Rockwell patent (Rockwell International Corporation v. SDL, Inc., No. C95-01729 MHP (US Dist.Ct., N.D. Cal.)). By its complaint, Rockwell seeks a permanent injunction against us to: o enjoin us from infringement of the Rockwell patent, o require us to pay damages in an unspecified amount for our alleged past infringement of the patent, treble damages and attorneys' fees. The complaint was served on us on June 30, 1995, and we filed an answer to the complaint on August 18, 1995, alleging that: o Rockwell's patent is invalid, o we did not infringe Rockwell's patent, o Rockwell's patent is unenforceable under the doctrine of inequitable conduct, and o Rockwell's action is barred by the doctrines of laches and equitable estoppel. On August 11, 1995, prior to filing our answer, we filed a motion to stay this action based upon the pendency of the lawsuit brought by the federal government. The District Court granted our motion to stay on September 15, 1995. Subsequent to the settlement of this lawsuit, the District Court lifted this stay, and discovery has re-commenced for the lawsuit filed on May 1995. Although the Court of Federal Claims ruled in our favor, finding the patent invalid on motion for summary judgment, the Court of Appeals for the Federal Circuit reversed the summary judgment ruling, meaning that the issue of validity needed to go to trial. Such a trial would now occur before a jury in California. The judge has also required that a settlement conference between Rockwell and SDL be scheduled in June 1999 in order to see if the parties can resolve the dispute before trial. We believe that we have meritorious defenses to Rockwell's allegations. It should be noted that the resolution of intellectual property disputes is often fact intensive and, therefore, the results are inherently uncertain. There can be no assurance that Rockwell will not ultimately prevail in this dispute. If Rockwell were to prevail, Rockwell could be awarded substantial monetary damages and/or an injunction against us for the sale of infringing products. If this injunction were entered, we may seek to obtain a license to use Rockwell's patent. We cannot assure you, however, that a license would be available on reasonable terms or at all. The award of monetary damages against us, or the grant of an injunction and failure to obtain a license to use Rockwell's patent on commercially reasonable terms could have a material adverse effect on our business and results of operations. Litigation of Rockwell's claim against us is expected to involve significant expense to us and could divert the attention of our technical and management personnel and could have a material adverse effect on our business and results of operations. In addition, we are involved in various legal proceedings arising in the ordinary course of our business. Customer Order Fluctuations Our product revenue is subject to fluctuations in customer orders. Occasionally, some of our customers have ordered more products than they need in a given period, thereby building up inventory and delaying placement of subsequent orders until such inventory has been reduced. We may also build inventory in anticipation of receiving new orders in the future. Also, customers have occasionally placed large orders that they have subsequently cancelled. In addition, due to the fact that our sales of our 980 nm pump module products comprise a significant portion of our total revenues, our revenues are particularly susceptible to customer order fluctuations for this product. These fluctuations, cancellations and the failure to receive new orders can have adverse effects on our business and results of operations. We may also have incurred significant inventory or other expenses in preparing to fill such orders prior to their cancellation. Virtually our entire backlog is subject to cancellation. Cancellation of significant portions of our backlog, or delays in scheduled delivery dates, could have a material adverse effect on our business and results of operations. Dependence of Proprietary Technology Our future success and competitive position is dependent in part upon our proprietary technology, and we rely in part on patent, trade secret, trademark and copyright law to protect our intellectual property. There can be no assurance that: o any of the 127 patents owned or approximately 134 patents licensed by us will not be invalidated, circumvented, challenged or licensed to others, o the rights granted under the patents will provide competitive advantages to us, o any of our approximately 90 pending or future patent applications will be issued with the scope of the claims sought by us, if at all, or o that others will not develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents we own, or patent or assert patents on technology which we might use or intend to use. In addition, effective copyright and trade secret protection may be unavailable, limited or not applied for in certain foreign countries. Our technology is licensed on a non-exclusive basis from Xerox and other third parties that may license such technology to others, including our competitors. There can be no assurance that steps we take to protect our technology will prevent misappropriation of such technology. In addition, litigation has been necessary and may be necessary in the future: o to enforce our patents and other intellectual property rights, o to protect our trade secrets, o to determine the validity and scope of the proprietary rights of others, or o to defend against claims of infringement or invalidity of intellectual property rights developed internally or acquired from third parties. Litigation of this type has resulted in substantial costs and diversion of resources and could have a material adverse effect on our business and results of operations. Moreover, we may be required to participate in interference proceedings to determine the propriety of inventions. These proceedings could result in substantial cost to us. Competition Our various markets are highly competitive. We face current or potential competition from four primary sources: o direct competitors, o potential entrants, o suppliers of potential new technologies, and o suppliers of existing alternative technologies. We offer a range of components, products and systems and have numerous competitors worldwide in various segments of our markets. As the markets for our products grow, new competitors have recently emerged and are likely to continue to do so in the future. We also sell products and services to companies with which we presently compete or in the future may compete and certain of our customers have been or could be acquired by, or enter into strategic relations with our competitors. In most of our product lines, our competitors and we are working to develop new technologies, or improvements and modifications to existing technologies, which will obsolete present products. Many of our competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do. In addition, many of these competitors may be able to respond more quickly to new or emerging technologies, evolving industry trends and changes in customer requirements and to devote greater resources to the development, promotion and sale of their products than we. We cannot assure you that: o our current or potential competitors have not already or will not in the future develop or acquire products or technologies comparable or superior to those that we developed, o combine or merge with each other or our customers to form significant competitors, o expand production capacity to more quickly meet customer supply requirements, or o adapt more quickly than we do to new technologies, evolving industry trends and changing customer requirements. Increased competition and customer demands have resulted and could, in the future, result in price reductions, reduced margins or loss of market share, any of which could materially and adversely affect our business and results of operations. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures we face will not have a material adverse effect on our business and results of operations. We expect that both direct and indirect competition will increase in the future. Additional competition could have an adverse material effect on our results of operations through price reductions and loss of market share. International Distribution Risks Revenues from customers outside of the United States accounted for approximately 27 percent, 24 percent and 17 percent, of our total revenue in the first quarter of 1999, fiscal 1998 and 1997, respectively. International revenue carries a number of inherent risks, including: o reduced protection for intellectual property rights in some countries, o the impact of unstable environments in economies outside the United States, o generally longer receivable collection periods, o changes in regulatory environments, o tariffs, and o other potential trade barriers. In addition, some of our international revenue is subject to export licensing and approvals by the Department of Commerce or other Federal governmental agencies. Although to date, we have experienced little difficulty in obtaining such licenses or approvals, the failure to obtain these licenses or approvals or comply with such regulations in the future could have a material adverse effect on our business and results of operations. We currently use local distributors in key industrialized countries and local representatives in smaller markets. Although we have formal distribution contracts with some of our distributors and representatives, some of our relationships are currently on an informal basis. Most of our international distributors and representatives offer only our products; however, certain distributors offer competing products and we cannot assure you that additional distributors and representatives will not also offer products that are competitive with our products. We cannot assure you that our international distributors and representatives will enter into formal distribution agreements at all or on acceptable terms, will not terminate informal or contractual relationships, will continue to sell our products or that we will provide the distributors and resellers with adequate levels of support. Our business and results of operations will be affected adversely if we lose a significant number of our international distributors and representatives or experience a decrease in revenue from these distributors and representatives. Environmental Risks We are subject to a variety of federal, state and local laws and regulations concerning the storage, use, discharge and disposal of toxic, volatile, or otherwise hazardous or regulated chemicals or materials used in our manufacturing processes. Further, we are subject to other safety, labeling and training regulations as required by local, state and federal law. We have established an environmental and safety compliance program to meet the objectives of applicable federal, state and local laws. Our environmental and safety department administers this compliance program which includes monitoring, measuring and reporting compliance, establishing safety programs and training our personnel in environmental and safety matters. We cannot assure you that changes in these regulations and laws will not have an adverse economic effect on us. Further, these local, state, and federal regulations could restrict our ability to expand our operations. If we do not: o obtain required permits for, o operate within regulations for, o control the use of, or o adequately restrict the discharge of hazardous or regulated substances or materials under present or future regulations, we may be required to pay substantial penalties, to make costly changes in our manufacturing processes or facilities or to suspend our operations. Dependence on Single Source And Other Third Party Suppliers We depend on a single or limited number of outside contractors and suppliers for raw materials, packages and standard components, and to assemble printed circuitboards. We generally purchase these products through standard purchase orders or one-year supply agreements. We do not have long-term guaranteed supply agreements with these suppliers. We seek to maintain a sufficient safety stock to overcome short-term shipping delays or supply interruptions by our suppliers. We also endeavor to maintain ongoing communications with our suppliers to guard against interruptions in supply. To date, we have generally been able to obtain sufficient supplies in a timely manner. However, our business and results of operations have in the past been and could be impaired by: o a stoppage or delay of supply, o substitution of more expensive or less reliable parts, o receipt of defective parts or contaminated materials, and o an increase in the price of such supplies or our inability to obtain reduced pricing from our suppliers in response to competitive pressures. Potential Volatility of Stock Price The market price of our Common Stock may fluctuate significantly because of: o announcements of technological innovations, o large customer orders, o customer order delays or cancellations, o customer qualification delays, o new products by us, our competitors or third parties, o possible acquisition of us by a third party, o merger or acquisition announcements, o production problems, o quarterly variations in our actual or anticipated results of operations, and o developments in litigation in which we are or may become involved. Furthermore, the stock market has experienced extreme price and volume volatility, which has particularly affected the market prices of many high technology companies. This volatility has often been unrelated to the operating performance of such companies. This broad market volatility may adversely affect the market price of our Common Stock. Many companies in the optical communications industry have in the past year experienced historical highs in the market prices of their stock. We cannot assure you that the market price of our Common Stock will not experience significant volatility in the future, including volatility that is unrelated to our performance. Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not applicable PART II. OTHER INFORMATION Item 1. Legal Proceedings. Not Applicable Item 2. Changes in Securities and Use of Proceeds. Not Applicable Item 3. Defaults upon Senior Securities. Not Applicable Item 4. Submission of Matters to a Vote of Security Holders. Not Applicable Item 5. Other Information. Not Applicable Item 6. Exhibits and Reports on Form 8-K. (a) List of Exhibits Number Exhibit Description 27.1 Financial Data Schedule (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended March 31, 1999. 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 May 12, 1999 /s/ Michael L. Foster --------------------------------------- Michael L. Foster Vice President, Finance Chief Financial Officer (Duly Authorized Officer, and Principal Financial and Accounting Officer) EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MARCH 31, 1999 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 4,305 15,053 27,593 0 22,651 72,783 38,217 0 118,535 15,733 0 0 0 15 99,207 118,535 34,754 35,730 20,773 21,676 10,040 0 0 4,284 1,274 3,010 0 0 0 3,010 0.21 0.19
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