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1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington,WASHINGTON, D.C. 20549
Form----------- FORM 10-Q
(MARK ONE)
[X](Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
March 31,June 30, 2000
or
[ ]OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934For the transition period from
________to __________________________ to __________________ Commission
file number:File Number 0-25688SDL, INC. (Exact name of
Registrantregistrant as specified in its charter)
Delaware77-0331449 (State orOther Jurisdictionother jurisdiction ofIncorporation or Organization)(I.R.S. Employer Identification No.)incorporation or organization) 80 Rose Orchard Way, San Jose, CA 95134-1365
(Address of principal executiveoffices, including zipoffices) (Zip code)
(408) 943-9411(Registrant'sRegistrant's telephone number, including areacode)code (408) 943-9411 Indicate by check mark whether the
Registrant:registrant (1) has filed all reports required to be filed by Section 13 or15 (d)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.[X]Yes[ ]X No----- ----- The number of shares outstanding of the issuer's common stock as of
May 10,July 31, 2000 was76,549,877.86,545,529.
2 SDL, INC. FORM 10-Q
INDEX
2
Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at June 30, 2000 and December 31, 1999 3 Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and 1999 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 34 PART II. OTHER INFORMATION Item 1. Legal Proceedings 35 Item 2. Changes in Securities and Use of Proceeds 35 Item 3. Defaults upon Senior Securities 35 Item 4. Submission of Matters to a Vote of Security Holders 35 Item 5. Other Information 36 Item 6. Exhibits and Reports on Form 8-K 36 SIGNATURES 38 3 PART I. FINANCIAL INFORMATION
ItemITEM 1.Financial Statements (unaudited):
Condensed Consolidated Balance Sheets - March 31, 2000 and December 31, 1999
Condensed Consolidated Statements of Operations - three months ended March 31, 2000 and 1999
Condensed Consolidated Statements of Cash Flows - three months ended March 31, 2000 and 1999
Notes To Condensed Consolidated Financial Statements
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Results of Operations
Liquidity and Capital Resources
Impact of Year 2000
Risk Factors
Item 3: Quantitative and Qualitative Disclosures about Market Risks
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
Item 2: Changes in Securities
Item 3: Defaults Upon Senior Securities
Item 4: Submission of Matters to a Vote of Security Holders
Item 5: Other Information
Item 6: Exhibits and Reports on Form 8-K
SIGNATURESFINANCIAL STATEMENTS SDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)March 31, December 31, 2000 1999 ------------ ------------ (unaudited) (1) ASSETS Current Assets: Cash and cash equivalents .................... $238,239 $153,016 Short-term marketable securities ............. 76,903 161,120 Accounts receivable, net ..................... 49,652 41,445 Inventories .................................. 36,971 32,070 Prepaid expenses and other current assets .... 3,628 3,659 ------------ ------------ Total current assets ........................... 405,393 391,310 Property and equipment, net .................... 65,670 59,772 Long-term marketable securities ................ 0 -- Restricted cash ................................ 680 686 Goodwill and other intangibles, net............. 93,258 2,948 Other assets ................................... 15,271 6,237 ------------ ------------ Total assets ................................... $580,272 $460,953 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ............................. $19,151 $18,277 Accrued payroll and related expenses ......... 4,118 10,717 Income taxes payable ......................... 8,854 1,093 Current portion of capital leases ............ 874 1,011 Other accrued liabilities .................... 7,498 4,950 ------------ ------------ Total current liabilities ...................... 40,495 36,048 Long-term liabilities: Capital leases ............................... 860 965 Other long-term liabilities .................. 13,667 3,792 ------------ ------------ Total long-term liabilities .................... 14,527 4,757 Commitments and contingencies Stockholders' equity: Preferred stock............................... -- -- Common stock.................................. 73 72 Additional paid-in capital ................... 518,191 425,993 Accumulated other comprehensive income........ 216 1,557 Retained Earnings (Accumulated deficit)....... 6,770 (7,474) ------------ ------------ Total stockholders' equity ..................... 525,250 420,148 ------------ ------------ Total liabilities and stockholders' equity ..... $580,272 $460,953 ============ ============
(1) The balance sheet at December 31, 1999 has been derived from the audit financial statements at that date.
See accompanying notes 3
June 30, December 31, 2000 1999 ----------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents .............................. $ 295,160 $ 153,016 Short-term marketable securities ....................... 83,624 161,120 Accounts receivable, net ............................... 67,024 41,445 Inventories ............................................ 46,971 32,070 Prepaid expenses and other current assets .............. 6,052 3,659 ----------- --------- Total current assets ..................................... 498,831 391,310 Property and equipment, net .............................. 86,036 59,772 Goodwill and other intangibles, net ...................... 2,942,641 2,948 Other assets ............................................. 8,452 6,923 ----------- --------- Total assets ............................................. $ 3,535,960 $ 460,953 =========== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ....................................... $ 25,092 $ 18,277 Accrued payroll and related expenses ................... 33,624 10,717 Income taxes payable ................................... 5,428 1,093 Other accrued liabilities .............................. 21,877 5,961 ----------- --------- Total current liabilities ................................ 86,021 36,048 Long-term liabilities .................................... 4,966 4,757 Commitments and contingencies Stockholders' equity: Common stock ........................................... 86 72 Additional paid-in capital ............................. 3,508,966 425,993 Accumulated other comprehensive income (loss) .......... (118) 1,557 Accumulated deficit, $26.3 million relating to the repurchase of common stock in 1992 and $5.8 million relating to a recapitalization in 1992 ............... (63,961) (7,474) ----------- --------- Total stockholders' equity ............................... 3,444,973 420,148 ----------- --------- Total liabilities and stockholders' equity ............... $ 3,535,960 $ 460,953 =========== ========= 4 SDL, INC.
Inc. CONDENSED CONSOLIDATED STATEMENTS OFINCOME
OPERATIONS (in thousands, except per share data - unaudited)Three Months Ended March 31, -------------------- 2000 1999 --------- ---------- Revenue................................ $72,206 $37,666 Cost of revenue........................ 37,616 23,033 --------- ---------- Gross margin......................... 34,590 14,633 Operating expenses: Research and development............ 5,903 3,781 Selling, general and administrative. 7,298 5,680 In-process research and development. 1,200 1,495 Amortization of purchased intangibles........................ 1,744 179 --------- ---------- Total operating expenses.............. 16,145 11,135 --------- ---------- Operating income ..................... 18,445 3,498 Interest income and other, net........ 4,485 286 --------- ---------- Income before income taxes............ 22,930 3,784 Provision for income taxes............ 8,686 1,161 --------- ---------- Net income............................ $14,244 $2,623 ========= ========== Net income per share - basic.......... $0.20 $0.04 ========= ========== Net income per share - diluted........ $0.19 $0.04 ========= ========== Number of weighted average shares - basic...................... 72,019 60,176 ========= ========== Number of weighted average shares - diluted.................... 76,507 64,296 ========= ==========
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands - unaudited)
Three Months Ended March 31, -------------------- 2000 1999 --------- --------- OPERATING ACTIVITIES: Net income............................................ $14,244 $2,623 --------- --------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation ..................................... 3,148 3,010 Amortization of intangibles....................... 1,744 179 Stock-based compensation.......... 654 68 In-process research and development............... 1,200 1,495 Changes in operating assets and liabilities: Accounts receivable............................ (6,578) (5,687) Inventories.................................... (3,236) (2,029) Accounts payable............................... (1,532) (1,457) Accrued payroll and related expenses........... (6,748) 342 Income taxes payable........................... 7,761 (438) Other accrued liabilities...................... (486) 447 Long-term liabilities.......................... (962) 623 Other.......................................... (552) (428) --------- --------- Total adjustments..................................... (5,587) (3,875) --------- --------- Net cash provided by (used in) operating activities.... 8,657 (1,252) --------- --------- INVESTING ACTIVITIES: Acquisition of property and equipment, net............ (6,479) (7,393) Acquisition of the fiber laser business of Polaroid... -- (5,055) Acquisition of Queensgate, net of cash acquired....... (3,988) -- Sale (purchase) of marketable securities, net......... 83,013 2,147 --------- --------- Net cash provided by (used in) investing activities.... 72,546 (10,301) --------- --------- FINANCING ACTIVITIES: Issuance of stock pursuant to employee stock plans.... 4,385 3,016 Payments on capital leases............................ (371) (380) Decrease (increase) in restricted cash................ 6 36 Other................................................. -- (232) --------- --------- Net cash provided by financing activities.............. 4,020 2,440 --------- --------- Net increase (decrease) in cash and cash equivalents... 85,223 (9,113) Net cash activity of IOC for the three months ended December 31, 1998....................... -- (1,163) Cash and cash equivalents at beginning of period....... 153,016 17,023 --------- --------- Cash and cash equivalents at end of period............. $238,239 $6,747 ========= =========
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31,
June 30, 2000
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 adjustments) considered necessary for a fair presentation have
been included. Operating results for the threesix month period ended March 31,June 30,
2000 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2000. For further information, refer to
the consolidated financial statements and footnotes thereto included in
the Registrant's Annual Report on Form 10-K for the year ended December
31, 1999.
The condensed consolidated financial statements include the accounts of
SDL, Inc. and its wholly owned subsidiaries, SDL Optics, SDL Integrated
Optics, SDL Queensgate, SDL Veritech and SDL Queensgate.PIRI. Intercompany accounts
and transactions have been eliminated in consolidation.
The functional currency of the Company's Canadian subsidiary (SDL Optics) is the U.S. dollar. The financial statements of the Canadian subsidiary are remeasured into U.S. dollars for the purposes of consolidation using the historical exchange rates in effect at the date of the transactions. Remeasurement gains and losses are recorded in the income statement and have not been material to date. The functional currency of the Company's United Kingdom subsidiaries is the British Pound Sterling. All assets and liabilities of the Company's United Kingdom subsidiaries (SDL Integrated Optics and SDL Queensgate) are translated at the exchange rate on the balance sheet date. Revenues and costs and expenses are translated at weighted average rates of exchange prevailing during the period. Translation adjustments are recorded in accumulated other comprehensive income as a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in interest income and other, net and were immaterial for all periods presented.
The Company operates and reports financial results on a fiscal year of 52
or 53 weeks ending on the Friday closest to December 31. The firstsecond fiscal
quarter of 2000 and 1999 ended on March 31,June 30, 2000 and AprilJuly 2, 1999,
respectively. For ease of discussion and presentation, all accompanying
financial statements have been shown as ending on the last day of the
calendar quarter.
In December 1999, the Company authorized a two-for-one split of its
common stock, effected in the form of a 100 percent stock dividend,
which was paid on March 14, 2000 to stockholders of record on
February 29, 2000. All of the share and per share data in these
financial statements have been retroactively adjusted to reflect the
stock split.
In February 2000, the Company's stockholders approved an increase in
the Company's authorized shares of its common stock from 70 million
shares to 140 million shares.
On March 8, 2000, Queensgate Instruments Limited ("Queensgate") was
acquired by SDL in a transaction accounted for as a purchase. Queensgate
was a privately held company and is located in Bracknell, United Kingdom.
Queensgate designs, develops, manufactures and markets optical network
monitoring modules for long haul terrestrial fiber optic transmission
systems. The acquisition agreement provided for initial consideration of
$3 million of cash and 347,962 shares of the Company's common stock with a
fair value of approximately $77 million, and contingent payments of up to
an additional $150 million in common stock based on Queensgate's pretax
profits for the 10 months ending December 31, 2000 and the twelve months
ending December 31, 2001. In addition, SDL issued options in exchange for
outstanding Queensgate options with the number of shares and the exercise
price appropriately adjusted by the exchange ratio. On June 26, 2000, SDL
signed a supplementary agreement with the prior shareholders and
option-holders of Queensgate extinguishing all rights to future contingent
payments in exchange for 465,102 shares of SDL stock with a fair value of
approximately $130.4 million which increased goodwill. See noteNote 6,
Acquisitions.
a Merger Agreement
with JDS Uniphase Corporation. See Note 8, "Subsequent Events."
As a result of the substantial increase in the market price of the
Company's Common Stock beginning in the fourth quarter of 1998, and the
resulting increased levels of employee participation in the Company's
Employee Stock Purchase Plan ("ESPP"), The
non-cash charge to operating results is based on the difference between
the purchase price and the fair value of the common stock for the last
share authorization.
In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB 101"). The SAB summarizes certain of the
Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. SAB 101 provides that if
registrants have not applied the accounting therein they should implement
the SAB and report a change in accounting principle. SAB 101, as
subsequently amended, will be effective for the Company no later than the
7
income (loss) per share
The following table sets forth the computation of basic and diluted net
(loss) income per share (in thousands, except per share amounts):
share.
3. Inventories The components of inventories consist of the following (in thousands):
income (loss)
Accumulated other comprehensive income (loss) presented in the
accompanying consolidated balance sheet consists of the accumulated net
unrealized gains and losses on available-for-sale marketable securities
and foreign currency translation adjustments, net of the related tax
effects. The tax effects for other comprehensive income (loss) were
immaterial for all periods presented.
Total comprehensive For first half of 2000, comprehensive loss
amounted to $58.2 million compared to comprehensive income of $5.3 million
for the corresponding 1999 period.
8
reporting
SDL has two reportable segments: communications and industrial laser. The
communications business unit develops, designs, manufactures and
distributes lasers, modulators, drivers, receiver circuits, network
monitors, amplifiers, multiplexers, demultiplexers, modules and subsystems
for applications in the telecom, cable television, satellite and dense
wavelength division multiplexing markets. The recent acquisitions, PIRI,
Veritech and Queensgate, are included with the communication segment. The
industrial laser business unit develops, designs, manufacturers and
distributes lasers and subsystems for applications in the surface heat
treating, product marking, 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):
9
During the first 6. Acquisitions Queensgate Overview
On March 8, 2000 Queensgate merged with SDL in a transaction accounted for
as a purchase. Queensgate was a privately held company and is located in
Bracknell, United Kingdom. Queensgate designs, develops, manufactures and
markets optical network monitoring modules for long haul terrestrial fiber
optic transmission systems. The merger agreement provided for initial
consideration of $3 million of cash and 347,962 shares of the Company's
common stock with a fair value of On June
26, 2000, SDL signed a supplementary agreement with the prior shareholders
and option-holders of Queensgate extinguishing all rights to future
contingent payments in exchange for 465,102 shares of SDL stock with a
fair value of $130.4 million in order to minimize potential conflicts in
management priorities. This additional payment was recorded as goodwill in
the quarter ended June 30, 2000.
Valuation Methodology
In accordance with the provisions of Accounting Principle Board Opinion
No. 16 (APB No. 16), Business Combinations, all identifiable assets,
including identifiable intangible assets, were assigned a portion of the
cost of the acquired business (purchase price) on the basis of 10
The economic and competitive environment in which the Company and
Queensgate operate was also considered in the valuation.
Specifically, in-process research and development, core technology and
existing technology was identified and valued through extensive interviews
and discussion with the Company and Queensgate's management. The valuation
of in-process research and development included an analysis of data
provided by Queensgate concerning the products in development, their
respective stage of development, the time and resources needed to complete
them, their expected income generating ability, target markets and
associated risks. The Income Approach, which included an analysis of the
markets, cash flows, and risks associated with achieving such cash flows,
was the primary technique utilized in valuing the in-process research and
development, core technology and existing technology. Tradename was valued
using the Brand Savings approach and workforce was valued using the
estimated cost of recruiting and training replacement workers.
The total purchase cost and purchase price allocation of the Queensgate
merger is as follows (in thousands):
The Income Approach used by the Company to value in-process research and
development, core technology and existing technology included assumptions
relating to revenue estimates, operating expenses, income taxes and
discount rates.
Revenue
Revenue estimates were developed based on: (i) aggregate revenue growth
rates for the business as a whole, (ii) individual product revenues, (iii)
growth rates for the telecommunications industry, (iv) the aggregate size
of the telecommunication industry, (v) anticipated product development and
introduction schedules, (vi) product sales cycles, and (vii) the estimated
life of a product's underlying technology.
Operating Expenses
Operating expenses used in the valuation analysis of Queensgate included:
cost of goods sold, selling, general and administrative expenses, and
research and development expenses.
In developing future expense estimates, an evaluation of both the Company
and Queensgate's overall business model, specific product results,
including both historical and expected direct expense levels, as
appropriate, and an assessment of general industry metrics was conducted.
Cost of goods sold
Costs of goods sold, expressed as a percentage of revenue, for the core,
existing and in-process technologies ranged from 61 percent for the twelve
months ending March 31, 2001 to 53 percent in fiscal 2002 and beyond.
Selling, general and administrative expenses
Selling, general and administrative expenses, expressed as a percentage of
revenue, for the core, existing, and in-process technologies ranged from
17 percent for the twelve months ending March 31, 2001 to 11 percent in
fiscal 2002 and beyond.
Research and development expense
Research and development expense consists of the costs associated with
activities undertaken to correct errors or keep products updated with
current information, also referred to as "maintenance" research and
development. Maintenance research and development includes all activities
undertaken after a product is available for general release to customers
to keep the product updated with current customer specifications. These
activities include routine changes and additions. The maintenance research
and development expense was estimated to be 1 percent of revenue for the
core, existing, and in-process technologies throughout the estimation
period.
Effective tax rate
The effective tax rate was determined based on federal and state statutory
tax rates and was determined to be 41 percent.
Discount rate
The discount rate for Queensgate's core, existing, and in-process
technologies were 18 percent, 14 percent and 20 percent, respectively. In
the selection of the appropriate discount rates, consideration was given
to (i) the weighted average cost of capital and (ii) the weighted average
return on assets. The discount rate utilized for the in-process technology
was determined to be higher than the Company's weighted average cost of
capital because the technology had not yet reached technological
feasibility as of the date of valuation. In utilizing a discount rate
greater than the Company's weighted average cost of capital, management
has reflected the risk premium associated with achieving the forecasted
cash flows associated with these projects.
The in-process research and development was comprised of one project
related to the next generation channel monitoring products and amounted to
$1.2 million of the total purchase price and was charged to expense during
the quarter ended March 31, 2000. The estimated cost of completion of the
in-process research and development project is $0.2 The core technology represents Queensgate trade secrets and patents
developed through years of experience designing and manufacturing optical
network monitoring modules. This know-how enables the Company to develop
new and improve existing optical network monitoring modules, processes,
and manufacturing equipment. The Company expects to amortize the core
technology of approximately $12.0 million on a straight-line basis over an
average estimated remaining useful life of 5 years.
The trade names include the Queensgate trademark and trade name as well as
all branded Queensgate products. The Company expects to amortize the trade
names of approximately $2.0 million on a straight-line basis over an
estimated remaining useful life of 5 years.
12
Goodwill, which represents the excess of the purchase price of an
investment in an acquired business over the fair value of the underlying
net identifiable assets, Veritech
Overview
On April 3, 2000, Veritech was acquired by the Company in a transaction
accounted for as a purchase. The Company issued 3,000,000 shares of the
Company's common stock with a fair value of approximately $621 million in
the purchase. Veritech was a privately held company and is located in
South Plainfield, New Jersey. Veritech designs, develops, manufactures and
markets optoelectronic modules for long haul undersea and terrestrial
fiber optic transmission systems.
Valuation Methodology
In accordance with the provisions of Accounting Principle Board Opinion
No. 16 (APB No. 16), Business Combinations, all identifiable assets,
including identifiable intangible assets, were assigned a portion of the
cost of the acquired business (purchase price) on the basis of their
respective fair values. This included the portion of the purchase price
properly attributable to incomplete research and development projects that
should be expensed according to the requirements of Interpretation 4 of
Statement of Financial Accounting Standards No. 2.
Intangible assets were identified through: (i) analysis of the acquisition
agreement, (ii) consideration of the Company's intentions for future use
of the acquired assets; and (iii) analysis of data available concerning
the business products, technologies, markets, historical financial
performance, estimates of future performance and the assumptions
underlying those estimates.
The economic and competitive environment in which the Company and Veritech
operate was also considered in the valuation.
Specifically, in-process research and development, core technology and
existing technology was identified and valued through extensive interviews
and discussion with the Company and Veritech management. The valuation of
in-process research and development included an analysis of data provided
by Veritech concerning the products in development, their respective stage
of development, the time and resources needed to complete them, their
expected income generating ability, target markets and associated risks.
The Income Approach, which included an analysis of the markets, cash
flows, and risks associated with achieving such cash flows, was the
primary technique utilized in valuing the in-process research and
development and core/existing technology. The design tools and device
library was valued using the replacement cost approach. The workforce was
valued using the estimated cost of recruiting and training replacement
workers.
13
Polaroid Corporation's fiber laser business In February 1999, the Company acquired the fiber laser business of
Polaroid Corporation for $5.3 million in cash, which includes related
transaction costs of $0.1 million. The business acquired included all the
physical assets, intellectual property, including the assignment of 38
patents and the licensing of 22 patents in the fiber laser and fiber
amplifier 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-process research and development was identified and
valued through analysis of data provided by Polaroid concerning
developmental products, their stage of development, the time and resources
needed to complete them, their expected income generating ability, target
markets and associated risks. The Income Approach, which includes an
analysis of the markets, cash flows, and risks associated with achieving
such cash flows, was the primary technique utilized in valuing purchased
research and development project. The Company considered, among other
factors, the importance of each project to the overall development plan,
and the projected incremental cash flows from the projects when completed
and any associated risks. The projected incremental cash flows were
discounted back to their present value using a discount rate In addition, the Company recorded $0.7 million to accrue for certain
18
CONTINGENCIES
In 1985, Rockwell International Corporation (Rockwell) asserted, and in 1995
filed suit in the Northern California Federal District Court against the Company
alleging, that a Company fabrication process infringed certain patent rights set
forth in a patent owned by Rockwell. Rockwell sought to permanently enjoin the
Company from infringing Rockwell's alleged patent rights and sought unspecified
actual and treble damages for willful infringement plus costs. The Company
answered Rockwell's complaint asserting, among other defenses, that Rockwell's
patent is invalid. Rockwell's suit was stayed in 1995 pending resolution of
another suit, involving the same patent, brought by Rockwell against the Federal
government, and in which SDL had intervened. The suit between the Federal
government and Rockwell was resolved in January 1999, by way of a settlement
payment of $16.9 million from the Federal government to Rockwell. The Company
did not participate in the settlement. As a result of that settlement, the suit
was dismissed and the stay of Rockwell's suit against the Company was lifted and
the California suit was reactivated. Thereafter, Rockwell filed motions for
partial summary judgment alleging that the Company has infringed certain claims
of the Rockwell patent and that certain invalidity evidence presented by the
Company is not applicable, which motions the Company vigorously opposed in
court. A decision on the motions was rendered in the beginning of February 2000.
The District Court ruled that the Company infringed the specified claims of
Rockwell's patent. The District Court also ruled that the Company could not make
the invalidity argument specified by Rockwell's motion. Additional motions were
considered by the Court in June, 2000. The Court granted another motion brought
by Rockwell, further limiting the grounds on which the Company can argue that
Rockwell's patent is invalid. The Court also denied a motion brought by the
Company for a ruling that Rockwell's damages were limited by the doctrine of
laches. The Court held that there were factual issues raised by the issue of
laches that would require trial. The District Court's ruling prevents the
Company from defending against Rockwell's lawsuit on the ground that the Company
does not infringe Rockwell's patent. The District Court's ruling will also
prevent the Company from making 8. March 2000.
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 quarter.
RESULTS OF OPERATIONS Revenue. Total revenue for the quarter ended and
fiber optic communications revenue grew by 36 percent sequentially and by 189
percent over the prior year quarter.
Revenues for the three and six months ended Gross Margin. Gross margin increased costs and
higher warranty provisions on certain industrial laser products.
20
Research and Development. Research and development expense was Selling, General and Administrative. Selling, general and administrative (SG&A)
expense was In-process research and development. During March 2000, the Company acquired
Queensgate Instruments, Limited which resulted in the write-off of purchased
in-process research and development (IPR&D) of $1.2 million. During April 2000,
the Company acquired Veritech Microwave which resulted in the write-off of IPR&D
of $25.1 million. During June 2000, the Company acquired Photonic Integration
Research, Inc. which resulted in the write-off of IPR&D of $1.1 million. The
Company's acquisition of the fiber laser business from Polaroid during the first
quarter 1999 resulted in the write-off of purchased IPR&D of $1.5 million.
The fair value of the IPR&D for each of the acquisitions was determined using
the income approach, which discounts expected future cash flows from projects
under development to their net present value. Each project was analyzed to
determine the technological innovations included; the utilization of core
technology; the complexity, cost and time to complete the remaining development
efforts; any alternative future use or current technological feasibility; and
the stage of completion. Future cash flows were estimated based on forecasted
revenues and costs, taking into account the expected life cycles of the products
and the underlying technology, relevant market sizes and industry trends.
Discount rates were derived from a weighted average cost of capital analysis,
adjusted to reflect the relative risks inherent in each entity's development
process, including the probability of achieving technological success and market
acceptance. The IPR&D charge includes the fair value of IPR&D completed. The
fair value assigned to developed technology is included in identifiable
intangible assets, and no value is assigned to IPR&D to be completed or to
future development. The Company believes the amounts determined for IPR&D, as
well as developed technology, are representative of fair value and do not
21
Amortization of Purchased Intangibles We have acquired three companies during
fiscal 2000 that generated approximately $3.0 billion in identified intangibles
and goodwill. Amortization of purchased intangibles during the three and six
months ended June 30, 2000 was $71.6 million and $73.4 million, respectively,
compared to $0.2 million and $0.4 million for the corresponding 1999 periods.
The increase in amortization of purchased intangibles is primarily due to the
intangible assets generated from the acquisitions of PIRI and Veritech during
the three months ended June 30, 2000.
Interest Income, net. Net interest income for the three and months ended offering and cash flow from operations during fiscal 2000.
Provision for Income Taxes. The Company recorded a provision for income taxes of
carryforwards in 1999.
LIQUIDITY AND CAPITAL RESOURCES As of inventory.
Cash The Company generated 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, 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.
BUSINESS ACQUISITIONS Queensgate
The Income Approach used by the Company to value in-process research and
development, core technology and existing technology included assumptions
relating to revenue estimates, operating expenses, income taxes and discount
rates.
Revenue estimates were developed based on: (i) aggregate revenue growth rates
for the business as a whole, (ii) individual product revenues, (iii) growth
rates for the telecommunications industry, (iv) the aggregate size of the
telecommunication industry, (v) anticipated product development and introduction
schedules, (vi) product sales cycles, and (vii) the estimated life of a
product's underlying technology.
22
Operating expenses used in the valuation analysis of Queensgate included: cost
of goods sold, selling, general and administrative expenses, and research and
development expenses.
In developing future expense estimates, an evaluation of both the Company and
Queensgate's overall business model, specific product results, including both
historical and expected direct expense levels, as appropriate, and an assessment
of general industry metrics was conducted.
The effective tax rate was determined based on federal and state statutory tax
rates and was determined to be 41 percent.
The discount rate for Queensgate's core, existing, and in-process technologies
were 18 percent, 14 percent and 20 percent, respectively. In the selection of
the appropriate discount rates, consideration was given to (i) the weighted
average cost of capital and (ii) the weighted average return on assets. The
discount rate utilized for the in-process technology was determined to be higher
than the Company's weighted average cost of capital because the technology had
not yet reached technological feasibility as of the date of valuation. In
utilizing a discount rate greater than the Company's weighted average cost of
capital, management has reflected the risk premium associated with achieving the
forecasted cash flows associated with these projects.
The in-process research and development was comprised of one project and
amounted to $1.2 million of the total purchase price and was charged to expense
during the quarter ended March 31, 2000. The estimated cost of completion of the
in-process research and development project is $0.2 million.
Veritech
The Income Approach used by the Company to value in-process research and
development and core\existing technology included assumptions relating to
revenue estimates, operating expenses, income taxes and discount rates.
Revenue estimates were developed based on: (i) aggregate revenue growth rates
for the business as a whole, (ii) individual product revenues, (iii) growth
rates for the telecommunications industry, (iv) the aggregate size of the
telecommunication industry, (v) anticipated product development and introduction
schedules, (vi) product sales cycles, and (vii) the estimated life of a
product's underlying technology.
The estimated product development cycle for the new product was 17 months.
Operating expenses used in the valuation analysis of Veritech included: cost of
goods sold, selling, general and administrative expenses, and research and
development expenses.
In developing future expense estimates, an evaluation of both the Company and
Veritech's overall business model, specific product results, including both
historical and expected direct expense levels, as appropriate, and an assessment
of general industry metrics was conducted.
The effective tax rate was determined based on federal and state statutory tax
rates and was determined to be 41 percent.
The discount rate for Veritech's core/existing, and in-process technologies were
14 percent and 20 percent, respectively. In the selection of the appropriate
discount rates, consideration was given to (i) the weighted average cost of
capital and (ii) the weighted average return on assets. The discount rate
utilized for the in-process technology was determined to be higher than the
Company's weighted average cost of capital because the technology had not yet
reached technological feasibility as of the date of valuation. In utilizing a
discount rate greater than the Company's weighted average cost of capital,
management has reflected the risk premium associated with achieving the
forecasted cash flows associated with these projects.
The in-process research and development was comprised of one project and
amounted to $25.1 million of the total purchase price and was charged to expense
during the quarter ended June 30, 2000. The estimated cost of completion of the
in-
23
In prior years, the Company discussed the nature and progress of its plans to
become year 2000 ready. In late 1999, the Company completed its remediation and
testing of systems. As a result of those planning and implementation efforts,
the Company experienced no significant disruptions in mission critical
information technology and 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, plans,
intentions, beliefs or strategies regarding the future. Forward-looking
statements include statements regarding research and development expenditures,
capital equipment purchases and leasehold improvement expenditures, WE HAVE EXPERIENCED AND COULD AGAIN EXPERIENCE MANUFACTURING PROBLEMS, WHICH
COULD INCREASE OUR COSTS, REDUCE OUR YIELDS AND DELAY OUR PRODUCT SHIPMENTS.
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:
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:
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 over the past 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
25
Difficulties in starting production to meet expected demand and
schedules have occurred in the past and may occur in the future including the
following:
We have announced a program to increase our manufacturing capacity by a
factor of five over the next twelve to eighteen months. This is a very ambitious
program and there is substantial risk to achieving the objective. If
manufacturing capacity is not expanded to meet customer delivery requirements ,
our business and results of operation would be materially adversely affected.
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.
WE DEPEND ON LIMITED- OR SINGLE-SOURCE SUPPLIERS FOR NECESSARY MATERIALS, WITH
WHOM WE DO NOT HAVE LONG-TERM GUARANTEED SUPPLY AGREEMENTS. ANY INABILITY OR
UNWILLINGNESS OF OUR SUPPLIERS TO MEET OUR MANUFACTURING REQUIREMENTS WOULD
DELAY OUR PRODUCTION AND PRODUCT SHIPMENTS AND HARM OUR BUSINESS.
We depend on a single or limited number of outside contractors and
suppliers for raw materials, packages and standard components, and to assemble
printed circuit boards. 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:
OUR GROWTH AND EXPANSION ARE STRAINING OUR RESOURCES AND NECESSITATING THE
IMPLEMENTATION OF EXPANDED SYSTEMS, PROCEDURES AND CONTROLS, AND HIRING OF
ADDITIONAL EMPLOYEES. ANY FAILURE TO DO SO SUCCESSFULLY COULD HARM OUR BUSINESS.
The expansion in the scope of our operations through internal growth and
acquisitions 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. We
have on occasion been unable to manufacture products in quantities sufficient to
meet the demands of our existing customer base and new customers. We have
recently deployed a new enterprise resource planning system and manufacturing
execution system. We cannot assure you that any existing or new systems,
procedures or controls will adequately 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 harm our business and results of operations.
We will continue to need a substantial number of additional personnel,
including those with research and development expertise, to commercialize and
develop our products and expand all areas of our business in order to continue
to grow. We may not be able to attract, assimilate and retain additional
personnel, including key personnel. Competition for such personnel is intense,
and we expect demand for such personnel to exceed supply for the foreseeable
future.
26
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 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 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.
WE WILL REPORT OPERATING LOSSES FOR THE FORESEEABLE FUTURE AS A RESULT OF
ACCOUNTING CHARGES RELATED TO ACQUISITIONS.
We will report operating losses for the foreseeable future as a result
of accounting charges for amortization of intangible assets and for acquisitions.
In March 2000, WE WILL INCUR SIGNIFICANT EXPENSES RELATED TO THE ISSUANCE OF STOCK UNDER OUR
EMPLOYEE STOCK PLANS, WHICH WILL CONTRIBUTE TO OUR EXPECTED OPERATING LOSSES.
We incurred $4.8 million in the second quarter of 2000 and expect to
incur approximately 2000, we began presenting
earnings in our press releases that exclude non-cash expenses related to the
issuance of stock under our employee stock plans.
OUR ACQUISITIONS MAY NOT BE SUCCESSFUL DUE TO THE COMPLEXITIES OF IDENTIFYING,
MANAGING AND INTEGRATING OTHER BUSINESSES.
Our strategy involves the acquisition and integration of additional
companies' products, technologies and personnel. We have limited experience in
acquiring Furthermore, acquisitions involve numerous operational risks, including:
Specifically, in connection with our most recent acquisitions, we are
currently engaged in expansion of certain facilities in order to integrate and
rationalize the operations at the acquired companies.
If we are unable to successfully address any of these risks or fail to
complete the facility expansions successfully and on schedule, our business
could be materially and adversely affected.
IF THE MERGER WITH JDS UNIPHASE IS NOT COMPLETED OR IS DELAYED, OUR STOCK PRICE
AND FUTURE BUSINESS AND OPERATIONS COULD BE MATERIALLY HARMED.
Completion of the merger with JDS Uniphase is subject to several
conditions, including approval by our stockholders and the stockholders of JDS
Uniphase and the receipt of all required regulatory approvals and the expiration
of all applicable waiting periods. We cannot assure you that the merger with JDS
Uniphase will be completed or that it will be completed in the expected time
period. If the merger with JDS Uniphase is not completed or its completion is
substantially delayed, we may be subject to the following material risks, among
others:
o we will be required to pay JDS Uniphase a termination fee of $1
billion if:
(1) an acquisition proposal has been made to us or our
stockholders or any person has publicly announced an
intention to make an acquisition proposal with respect to
us; and
(2) JDS Uniphase terminates the merger agreement because our
board of directors amends or modifies or takes certain other
actions with respect to its recommendation to our SDL
stockholders or we take or fail to take certain actions with
respect to a competing transaction; and
(3) an acquiring party has acquired, directly or indirectly,
within 12 months of such termination, a majority of the
voting power of our outstanding securities or all or
substantially all of our assets or there has been
consummated a merger, consolidation or similar business
combination between us and an acquiring person;
o we will also be required to pay JDS Uniphase a termination fee of
$1 billion if:
(1) the merger agreement has been terminated by us in order to
enter into a binding written agreement concerning a
transaction that constitutes a superior proposal; and
(2) an acquiring party has acquired, directly or indirectly,
within 12 months of such termination, a majority of the
voting power of our outstanding securities or all or
substantially all of our assets or there has been
consummated a merger, consolidation or similar business
combination between us and an acquiring person;
o if the merger agreement with JDS Uniphase is terminated under
specified circumstances, we may be required to pay JDS Uniphase
$10,000,000 as a reasonable estimate of JDS Uniphase's
out-of-pocket expenses with respect to the merger;
o the price of our common stock may decline to the extent that the
current market price of our common stock reflects an assumption
that the merger with JDS Uniphase will be completed;
o our costs related to the merger, including, without limitation,
certain legal, accounting and financial advisors fees, which are
substantial will still have to be paid even if the merger is not
completed;
o if the merger is terminated and our board of directors determines
to seek another merger or business combination, it is not certain
that we will be able to find a partner willing to pay an
equivalent or more attractive price than that which would be paid
in the merger with JDS Uniphase. In addition, while the merger
agreement with JDS Uniphase is in effect, we are generally
prohibited from soliciting, initiating, encouraging or otherwise
facilitating or entering into competing transactions, such as a
merger, sale of assets or other business combination, with any
party other than JDS Uniphase, which limits our strategic
options;
o we will not experience the benefits of the merger, including,
among other things, expected synergies and cost savings, expanded
product offerings, increased research and development efforts and
faster time to market for new products; and
o our industry is undergoing increased consolidation and we will be
faced with competition from organizations some of which will have
greater financial, marketing and technical resources than we do.
A DECREASE IN DEMAND FOR DWDM PRODUCTS GENERALLY, OR ANY FAILURE TO SUCCESSFULLY
DEVELOP PRODUCTS IN RESPONSE TO EVOLVING OR NEW TECHNOLOGIES, WOULD
SIGNIFICANTLY DECREASE OUR REVENUES.
A majority of our revenues are derived from sales of products which rely
on DWDM technology. As the market for DWDM products grew last year, our revenues
from the sale of our DWDM products increased significantly and we
28
A LARGE PORTION OF OUR REVENUES IS DERIVED FROM SALES TO A FEW CUSTOMERS, WHO
COULD CEASE PURCHASING FROM US AT ANY TIME.
A relatively limited number of OEM customers accounted for a substantial
portion of revenue from communication products in fiscal 1999. IF WE DO NOT DEVELOP AND QUALIFY NEW PRODUCTS IN A TIMELY MANNER THAT OUR
CUSTOMERS USE IN THEIR PRODUCTS, OR IF OUR CUSTOMERS DO NOT SUCCESSFULLY DEVELOP
NEW PRODUCTS, OUR BUSINESS AND OPERATING RESULTS WOULD BE HARMED.
We believe that rapid customer acceptance and qualification of our new
products is key to our financial results. Substantial portions 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, delays
in qualification, fluctuation in customer orders and competitive, technological
and pricing constraints that may preclude development of markets for our
products and our customers' products.
We may difficult process. We cannot assure you that:
- we or our customers will continue their existing product
development efforts, or if continued that such efforts will be
successful,
- markets will develop for any markets.
ANY LOSS OF, OR INABILITY TO ATTRACT, KEY PERSONNEL WOULD HARM US.
Our future performance WE HAVE BEEN AND CONTINUE TO BE SUBJECT TO TIME-CONSUMING AND COSTLY PATENT
INFRINGEMENT CLAIMS AND JUDGMENTS, WHICH COULD HARM OUR BUSINESS AND RESULTS OF
OPERATIONS.
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 In 1985, currently ongoing.
Rockwell's patent expired in January 2000 so The resolution of this litigation 31
ANY INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS COULD
HARM OUR COMPETITIVE POSITION.
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. In addition, effective copyright and trade secret protection may be
unavailable, limited or not applied for in certain foreign countries. 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.
In addition, some of our international revenue is subject to export
licensing and approvals by the Department of Commerce or other Federal
governmental agencies. 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
32
WE ARE REQUIRED TO COMPLY WITH EXTENSIVE ENVIRONMENTAL REGULATIONS, WHICH COULD
BE COSTLY AND COULD RESTRICT OUR ABILITY TO EXPAND OUR OPERATIONS.
We, as well as If we are unable to successfully address any of these risks, our
business could be materially and adversely affected.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE EXTREMELY VOLATILE DUE TO
FACTORS BEYOND OUR CONTROL.
The market price of our common stock may fluctuate significantly because
of:
- announcements of technological innovations,
- large customer orders,
- customer order delays or cancellations,
- customer qualification delays,
- new products by us, our competitors or third parties,
- possible acquisition of us or our customers or our competitors by a
third party,
- merger or acquisition announcements, by us or others,
- production problems,
- stock compensation charges due to stock option plans or stock
purchase plans,
- quarterly variations in our actual or anticipated results of
operations, and
- 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. The market price of our common stock may
experience significant volatility in the future, including volatility that is
unrelated to our performance.
33
The Company's market risk disclosures set forth in Item 7A of its Annual Report
on Form 10-K for the year ended December 31, 1999 have not changed
significantly.
34
Proceeds.
(c)(1) On March 8, 2000 the Company acquired all of the outstanding
share capital of Queensgate Instruments Limited located in the United
Kingdom ("Queensgate") in exchange for the issuance of 347,962 shares of
the Company's Common Stock plus an earnout of up to an additional
3,990,000 shares. On June 26, 2000, SDL signed a supplementary agreement
with the prior shareholders and option-holders of Queensgate
extinguishing all rights to future contingent payments in exchange for
465,102 shares of SDL stock. The shares of the Company's Common Stock
were (2) On April 3, 2000, the Company acquired by merger all of the
outstanding share capital of Veritech Microwave, Inc., located in New
Jersey ("Veritech") in exchange for the issuance of up to a maximum of
3,000,000 shares of the Company's Common Stock. The shares of the
Company's Common Stock were issued to the shareholders of Veritech
pursuant to the exemption from the registration requirements of the 1933
Act set forth in Section 3(a)(10) of the 1933 Act.
At the 8-K.
36
We filed a report on Form 8-K on April 11, 2000 and June 16, 2000
reporting the acquisition of Veritech Microwave, Inc.
("Veritech") pursuant to an Agreement and Plan of Merger dated as
of February 28, 2000 among SDL, VMI Acquisition Corporation,
Veritech and certain shareholders of Veritech.
We filed a report on Form 8-K on June 14, 2000 reporting the
acquisition of Photonic Integration Research, Inc. ("PIRI")
pursuant to a Stock Purchase Agreement (the "Agreement") dated as
of May 10, 2000, among SDL and the shareholders of PIRI.
We filed a report on Form 8-K on July 11, 2000, reporting the
Agreement and Plan of Reorganization and Merger among JDS
Uniphase Corporation and SDL, Inc.
37
SDL, INC.
---------------------------------------
Registrant
August 1, 2000
/s/ Michael Foster
---------------------------------------
Michael L. Foster
Vice President, Finance
Chief Financial Officer
(duly authorized officer, and principal
financial and accounting officer)
38
In"Acquisitions."
6
will bewas accounted for under the purchase method of accounting. The Company believes it may
write-off significant amounts related to in-process research and
development during the second quarter of fiscal 2000.
In MaySee Note 6,
"Acquisitions."
On June 2 2000, the Company entered into an agreement to acquireacquired Photonic Integration Research, Inc.
(PIRI) for 10,200,0008,461,663 shares of the Company's common stock with a fair
value of approximately $1.8$2.1 billion and a $31.25$31.7 million cash payment.
PIRI, a privately held company located in Columbus, Ohio, is a leading
manufacturer of arrayed waveguide gratings (AWGs) that enable the routing
of individual wavelength channels in fiber optic systems. These products
are used in optical multiplexing (mux) and demultiplexing (demux)
applications for dense wavelength division multiplexed (DWDM) fiber optic
systems. The acquisition is anticipated
to close in the second quarter of fiscal 2000 and will bewas accounted for under the purchase method of
accounting. TheSee Note 6, "Acquisitions."
On July 10, 2000, the Company believes it may
write-off significant amounts related to in-process research and
development whenannounced the acquisition is completed and that quarterly
amortizationsigning of purchased intangibles will also be substantial.
it is currently
contemplated that the number of shares issuable
pursuant to the Company's ESPP in fiscal 2000 will exceedexceeded the number of
shares that were available under the Plan at the beginning of the October
1998 employee purchase period. As a result, the Company incurred a $4.7
million non-cash charge to operating results in the second quarter of 2000
and expects to incur a non-cash chargescharge to operating results aggregatingof
approximately $12.1 million. These charges will occur primarily$8.0 million in the second and
third quartersquarter of fiscal 2000. secondfourth quarter of 2000. The Company does not believe that adoption of SAB
101 will have a material impact on its financial condition or results of
operations.
Income Per Share
Three Months Ended
March 31,
-------------------
2000 1999
--------- ---------
Numerator:
Net income........................ $14,244 $2,623
========= =========
Denominator:
Denominator for basic net income
per share - weighted average
shares.......................... 72,019 60,176
(1) Potential common shares relating to shares issuable under employee stock
plans........................... 4,488 4,120
--------- ---------
Denominator for diluted net
income per share adjusted
weighted averageplans of 4,227 shares and assumed conversions............. 76,507 64,296
========= =========
Net income4,357 shares, respectively, are not included in the
three months and six months ended June 30, 2000 calculation due to their
anti-dilutive effect on the loss per share - basic...... $0.20 $0.04
========= =========
Net income per share - diluted.... $0.19 $0.04
========= =========
March 31, December 31,
2000 1999
------------ ------------
Raw materials ............. $12,956 $15,115
Work-in-process............ 21,174 14,615
Finished Goods............. 2,841 2,340
------------ ------------
$36,971 $32,070
============ ============
4. Comprehensive Incomeincomeloss amounted to approximately $12.9$71.2 million for the
firstsecond quarter 2000 compared to a comprehensive income of $1.9$3.1 million for
the firstsecond quarter of 1999. Reporting
Communica-
tion Industrial
Products Laser Total
---------- --------- -----------
Quarter ended March 31, 2000:
Revenue from external customers... $60,876 $11,330 $72,206
Segment Operating Income (loss)... $23,245 ($1,856) $21,389
Communica-
tion Industrial
Products Laser Total
---------- --------- -----------
Quarter ended March 31, 1999:
Revenue from external customers... $28,568 $9,098 $37,666
Segment Operating Income ......... $5,738 $134 $5,872
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):
For the three months
ended March 31,
----------------------
2000 1999
----------- ----------
Operating Income
Total operating income from operating
segments............................... $21,389 $5,872
Amortization of intangibles............... (1,744) (179)
In-process R&D and related costs.......... (1,200) (2,195)
----------- ----------
Total consolidated operating income ........ $18,445 $3,498
=========== ==========
Major Customers
three monthshalf of 2000, four communication product customers and
their affiliates accounted for 1715 percent, 1612 percent, 1312 percent and 1311
percent of revenues, respectively. During fiscal 1999, three communication
product customers and their affiliates accounted for 15 percent, 11
percent and 11 percent of revenues, respectively.
approximately
$77$77.4 million, and contingent payments
of up to an additional $150 million in common stock based on Queensgate's
pretax profits for the 10 months ended December 31, 2000 and the twelve
months ended December 31, 2001. In addition, SDL issued options in
exchange for outstanding Queensgate options with the number of shares and
the exercise price appropriately adjusted by the exchange ratio. thetheir
respective fair values. This included the portion of the purchase price
properly attributable to incomplete research and development projects that
should be expensed according to the requirements of Interpretation 4 of
Statement of Financial Accounting Standards No. 2.
Value of securites issued......... $77,376
Cash.............................. 3,000
Assumption of Queensgate options.. 1,502
----------
81,878
Estimated transaction costs...... 1,125
----------
Total purchase cost.............. 83,003
Annual
Amount Amortization
Purcahse price allocation:
Tangible net deficit........... (1,570) n/a n/a
Tradename...................... 2,000 400 5 years
Core technologoy............... 12,000 2,400 5 years
Existing technology............ 6,200 1,240 5 years
In process technology.......... 1,200 n/a n/a
Workforce...................... 1,500 300 5 years
Goodwill....................... 70,353 14,071 5 years
Deferred tax liabilities....... (8,680) n/a n/a
---------- ------------
Total estimated purchase
price allocation............. 83,003 18,411
The purchase price allocation is preliminary and, therefore, subject to
change based on the Company's final analysis and receipt of a final
report by a valuation specialist used by the Company to assist in the
purchase price allocation.
Assumptions
The estimated product development cycle for the new product was11
months.
million.million and is
expected to be completed in December 2000. The acquired existing
technology is comprised of products in Queensgate portfolio that are
already technologically feasible. The Company expects to amortize the
acquired existing technology of approximately $6.2 million on a
straight-line basis over an estimated remaining useful life of 5 years.
over 100 skilled employees
across Queensgate's GeneralExecutives, Direct Production, Indirect Production,
Overhead, Engineers, and Administration, Research and
Development, Sales and Marketing, and Manufacturing groups.Central. The Company expects to amortize the
assembled workforce of approximately $1.5 million on a straight-line basis
over an estimated remaining useful life of 5 years.
iswill be amortized on a straight-line basis over
an estimated useful life of 5 years.
Assumptions
The Income Approach used by the Company to value in-process research and
development and core\existing technology included assumptions relating to
revenue estimates, operating expenses, income taxes and discount rates.
Revenue
Revenue estimates were developed based on: (i) aggregate revenue growth
rates for the business as a whole, (ii) individual product revenues, (iii)
growth rates for the telecommunications industry, (iv) the aggregate size
of the telecommunication industry, (v) anticipated product development and
introduction schedules, (vi) product sales cycles, and (vii) the estimated
life of a product's underlying technology.
Operating Expenses
Operating expenses used in the valuation analysis of Veritech included:
cost of goods sold, selling, general and administrative expenses, and
research and development expenses.
In developing future expense estimates, an evaluation of both the Company
and Veritech's overall business model, specific product results, including
both historical and expected direct expense levels, as appropriate, and an
assessment of general industry metrics was conducted.
Cost of goods sold
Costs of goods sold, expressed as a percentage of revenue, for the
core/existing and in-process technologies was 28 percent throughout the
estimation period.
Selling, general and administrative expenses
Selling, general and administrative expenses, expressed as a percentage of
revenue, for the core/existing, and in-process technologies was 6.6
percent throughout the estimation period.
Research and development expense
Research and development expense consists of the costs associated with
activities undertaken to correct errors or keep products updated with
current information, also referred to as "maintenance" research and
development. Maintenance research and development includes all activities
undertaken after a product is available for general release to customers
to keep the product updated with current customer specifications. These
activities include routine changes and additions. The maintenance research
and development expense was estimated to be 1 percent of revenue for the
core/ existing and in-process technologies throughout the estimation
period.
14
The purchase price allocation is preliminary and, therefore, subject to
change based on the Company's final analysis and receipt of a final report
by a valuation specialist used by the Company to assist in the purchase
price allocation.
Assumptions
The Income Approach used by the Company to value in-process research and
development and existing technology included assumptions relating to
revenue estimates, operating expenses, income taxes and discount rates.
Revenue
Revenue estimates were developed based on: (i) aggregate revenue growth
rates for the business as a whole, (ii) individual product revenues, (iii)
growth rates for the telecommunications industry, (iv) the aggregate size
of the telecommunication industry, (v) anticipated product development and
introduction schedules, (vi) product sales cycles, and (vii) the estimated
life of a product's underlying technology.
16
acquisitionacquisitions had taken place on
January 1, 1999 and excludes the write-off of purchased in process
research and development of $1.2$27.4 million:
(In thousands, For the three months
except per share amounts) ended March 31,
---------------------------
2000 1999
------------ ------------
Revenues.......................... $73,897 $40,122
Net income (loss)................. $11,901 ($5,126)
Earnings (loss) per share-basic... $0.16 ($0.08)
Earnings (loss) per share-diluted. $0.15 ($0.08)
These pro-forma results of operations have been prepared for comparative
purposes only and do not purport to be indicative of the results of
operations which actually would have resulted had the acquisition occurred
on the date indicated, or which may result in the future.
of 25 percent. This
discount rate was determined
after consideration of the Company's weighted average cost of capital and
the weighted average return on assets. Associated risks include the
inherent difficulties and uncertainties in completing each project and
thereby achieving technological feasibility, anticipated levels of market
acceptance and penetration, market growth rates and risks related to the
impact of potential changes in future target markets.
pre-
existingpre-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.
Inventory ................. $979
Property and equipment..... 229
Intangibles................ 2,596
In-process R&D............. 1,495
---------
Net assets acquired........ $5,299
=========
Liabilities assumed........ $94
Cash paid, including
transaction costs.......... 5,205
---------
Total purchase price....... $5,299
=========
7. Contingenciesonesome (but not all) of its invalidity arguments.
NoA trial date has been set and additional discovery, which had been stayed pending the
decisionin April 2001. Discovery on the Rockwell's motions,several matters is
necessary prior to trial.currently ongoing. Despite the District Court's decisions on Rockwell's motions,
the Company believes that Rockwell is not entitled to any damages because the
patent is invalid and unenforceable, and because Rockwell is guilty of laches
and equitable estoppel. Rockwell's patent expired in January 2000, so that it is
no longer possible for Rockwell to obtain an injunction stopping the Company
from using the fabrication process allegedly covered by Rockwell's patent. While
the Company believes that it has meritorious defenses to Rockwell's lawsuit,
there can be no assurance that Rockwell will not ultimately prevail in this
dispute. The resolution of this litigation is fact intensive so that the outcome
cannot be determined and remains uncertain. If Rockwell prevailed in the
litigation, Rockwell could be awarded substantial monetary damages. The award of
monetary damages against the Company, including past damages, could have a
material adverse effect on the Company's results of its operations. Litigation
and trial of Rockwell's claim against the Company is also expected to involve
significant expense to the Company and could divert the attention of the
Company's technical and management personnel. However, because the patent
expired in January 2000, the Company will not need a license regardless of the
outcome of the litigation.
Subsequent EventsIn AprilSUBSEQUENT EVENTS
On July 10, 2000, the Company acquired Veritech Microwave, Inc.
("Veritech")announced the signing of a Merger Agreement with
JDS Uniphase Corporation. Upon completion of this transaction, the Company's
stockholders would receive 3.8 shares of JDS Uniphase common stock for 3,000,000 shareseach
share of SDL common stock they own, and the Company would become a wholly-owned
subsidiary of JDS Uniphase. Completion of the transaction is subject to the
approval of the Company's common stock with a
fair value of approximately $621 million. Veritech was a privately held
company located in South Plainfield, New Jersey. Veritech designs,
develops, manufacturesstockholders, as well as customary closing conditions
and markets optoelectronic modules for long haul
undersea and terrestrial fiber optic transmission systems. The
acquisitionregulatory approvals. Accordingly there can be no assurance that the
transaction will be accounted for under the purchase method of
accounting. The Company believes it may write-off significant amounts
related to in-process research and development during the second quarter
of fiscal 2000.
In Maycompleted. On July 11, 2000, the Company entered into anfiled a press
release announcing the transaction and the merger agreement as exhibits to acquire Photonic
Integration Research, Inc. (PIRI) for 10,200,000 sharesForm
8-K. Those documents contain the specific terms and conditions of the
Company's
commontransaction. See the section entitled "Risk Factors" in Item 2, specifically the
risk factor captioned, "If the merger with JDS Uniphase is not completed or is
delayed, our stock with a fair value of approximately $1.8 billionprice and a $31.25
million cash payment. PIRI, a privately held company located in
Columbus, Ohio,future business and operations could be materially
harmed."
19
leading manufacturer of arrayed waveguide gratings
(AWGs) that enable the routing of individual wavelength channelsleader in fiber
optic systems. Theseproviding products are used infor optical multiplexing (mux)communications and
demultiplexing (demux) applications for dense wavelength division
multiplexed (DWDM) fiber optic systems. The acquisition is anticipated
to close in the second quarter of fiscal 2000related markets worldwide. We design, manufacture and will be accounted for
under the purchase method of accounting. The Company believes it may
write-off significant amounts related to in-process research and
development when the acquisition is completed and that quarterly
amortization of purchased intangibles will also be substantial.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of OperationsSDL designs, manufactures and marketsmarket semiconductor
lasers, fiber optic related products and optoelectronic modules and systems. Since 1996, the
Company strategy has strongly focused on providing solutions for optical
communications. The Company's optical communication dense wavelength
division multiplexing (DWDM)Our
products powerenable the transmission of data, voice, and Internet information over
fiber optic networks to meet the needs of telecommunications, data communications,telecommunication, cable television
and satellitemetro communications applications.applications primarily using technologies relating to
dense wavelength division multiplexing, or DWDM. Our products allow customers to
meet the growing need for bandwidth by expanding their fiber optic communication
networks more quickly and efficiently than by using conventional electronic and
optical technologies.
The demand for DWDM solutionsproducts has accelerated significantly in 1999recent years due
to the technology's unique ability to expand network bandwidth and provide muchallows for
faster transmission of data, voice and video signals. With the qualification of
the Company'sour new wafer fabrication facility in the first half of 1998, and expansion ofimproved
yields and expanded assembly and test capacity in 1999 and the first quarterhalf of
2000, the Company waswe were able to successfully rampincrease capacity and achieve significant
revenue and profit growth. Revenue from fiber optic communications products increased by
179 percent in 1999 compared to 1998; this continued in the firstsecond quarter of
2000 as fiber communication revenue rose 3560 percent sequentially. SDL products were also ablecompared to
capture a strong position in the undersea fiber optic communications
market, where Company revenue increased from less than 1 percent of total
revenue in 1998 to 31 percent of total revenue in the first
quarter of 2000. SDL'sOur optical products also serve a wide variety of
non-
communicationsnon-communications applications, including materials processing and high
resolution printing. BecauseIn addition to internal growth, we have recently sought to
expand our technologies and product offerings through selected strategic
acquisitions, such as our acquisitions of the diversity of products, customersPhotonic Integration Research, Inc.,
or PIRI, in June 2000; Veritech Microwave, Inc., or Veritech, in April 2000; and
applications, gross margin tends to fluctuate basedQueensgate Instruments, Limited, or Queensgate, in part on the mix of
revenue in each reported period.
firstsecond fiscal quarter of
2000 and 1999 ended on March 31,June 30, 2000 and AprilJuly 2, 1999, respectively. For ease of
discussion and presentation, all accompanying financial statements have been
shown as ending on the last day of the calendar month.
March 31,June 30, 2000 increased 92156 percent
to $72.2$110.5 million compared to $37.7$43.2 million in the corresponding 1999 quarter.
DemandFor the first half of 2000, total revenue increased 126 percent to $182.7
million from $80.8 million reported for the comparable period. The increase in
revenue for the second quarter and first half of 2000 was driven by demand for
the Company's dense wavelength division multiplexing (DWDM) products provided substantially all of the revenue
growth during the three months ended March 31, 2000 compared to the three
months ended March 31, 1999.products. Revenue
generated from SDL's DWDM products, including 980nm undersea pump lasers and
terrestrial pump modules, lithium niobate light modulators and drivers, light
amplifiers, fiber gratings, andreceiver circuits, optical network monitoring
products and arrayed waveguide gratings, increased 163242 percent from the prior
year quarter. Undersea DWDM revenue is up over twelve
times410 percent from that of the prior year quarter. During the three months ended
March 31, 2000, the communication products represented 83 percent of total
revenue compared to 73 percent in the
prior year quarter. Results of the firstsecond quarter 2000 include thethree full months of
results of Queensgate from the closingQueensgate and Veritech acquisitions and four weeks of its acquisition on March 8th. SDL Queensgate contributed $0.9 million
to consolidatedresults
from PIRI. Excluding these three acquired businesses, total revenue forincreased by
31 percent sequentially and by 116 percent over the prior year quarter, ended March 31, 2000.
March 31,June 30, 2000 are not considered
indicative of the results to be expected for any future period. In addition,
there can be no assurance that the market for our products will grow in future
periods at its historical percentage rate or that certain market segments will
not decline. Further, there can be no assurance that we will be able to increase
or maintain our market share in the future or to achieve historical growth
rates.
9 percentage points from the prior
year quarter to 4850 percent and 49 percent for the three
and six months ended March 31,June 30, 2000 comparedfrom 42 percent and 41 percent in comparable
1999 periods. Excluding non-cash stock compensation charges of $2.8 million,
gross margin increased to 3953 percent and 51 percent for the three and six months
ended June 30, 2000 from the prior year quarter.42 percent and 41 percent in comparable 1999 periods.
The increase in gross margin was primarily due to the following: (i) a more
favorable mix of higher margin DWDM revenue especially increased shipments of pump
lasers for undersea fiber systems, as compared to revenue derived from
lower margin industrial laser and satellite communication revenue, and
(ii)
reduction of costs due to increased yields and factory volume.volume, and (iii) strong
gross margins from our newly acquired businesses, Veritech and PIRI. These
favorable factors were partially offset by higher employee benefit costs.
$5.9$8.6 million, or
8 percent of revenue for the quarter ended March 31,June 30, 2000 as compared to $3.8$4.3
million, or 10 percent of revenue for the quarter ended March 31,June 30, 1999. For the
first half of 2000, research and development was $14.5 million, or 8 percent of
revenue as compared to $8.1 million, or 10 percent of revenue for the
corresponding 1999 period. Excluding non-cash stock compensation charges of $1.0
million, research and development expense was $7.6 million, or 7 percent of
revenue for the quarter ended June 30, 2000 as compared to $4.3 million, or 10
percent of revenue for the quarter ended June 30, 1999. For the first half of
2000, excluding non-cash stock compensation charges of $1.0 million, research
and development was $13.5 million, or 7 percent of revenue as compared to $8.1
million, or 10 percent of revenue for the corresponding 1999 period. The
increase in research and development spending is primarily due to the continued
development and enhancement of the Company's fiber optic communication products.
The decline in research and development expenses as a percent of revenues was
due to revenue growing rapidly making it difficult to scale research and
development programs at the same ratio as our revenue growth. The Company
expects to commit substantial resources to product development in future
periods. As a result, the Company expects research and development expenses to
continue to increase in absolute dollars in future periods, although research
and development expenses may vary as a percentage of revenue.
$7.3$13.5 million, or 1012 percent of revenue for the quarter ended March 31,June
30, 2000 as compared to $5.7$6.4 million, or 15 percent of revenue for the quarter
ended March 31,June 30, 1999. For the first half of 2000, SG&A expense was $20.8 million,
or 11 percent of revenue compared to $12.1 million, or 15 percent of revenue.
Excluding non-cash stock compensation charges of $1.0 million, SG&A expense was
$12.6 million, or 11 percent of revenue for the quarter ended June 30, 2000 as
compared to $6.3 million, or 15 percent of revenue for the quarter ended June
30, 1999. For the first half of 2000, excluding non-cash stock compensation
charges of $1.8 million, SG&A expense was $19.2 million, or 11 percent of
revenue compared to $11.9 million, or 15 percent of revenue. The increase in
SG&A spending was primarily due to the following: (i) significantly higher
payroll taxes on stock option exercises; (ii) higher personnel-related costs to
support the growth in revenues and operations; (ii) increased
professional service expenses;(iii) and (iii) increase in non-cash stock
compensation charges of $0.6 million.higher internal and
external sales commissions. These factors were partially offset by charges
incurred related to the implementation of the Company's enterprise resource
planning software during the prior year quarter.first half of 1999. 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 the second quarter of 2000, an
IPR&D write-off is anticipated related to the Company's acquisition of
Veritech Microwave, Inc. and Photonic Integration Research, Inc.
March 31,June
30, 2000 was $4.5$5.0 million and $9.5 million, respectively, compared to $0.3
million and $0.6 million for the corresponding 1999 period.periods. The increase in
interest income was primarily due to the interest earned on interest bearing
securities purchased with proceeds from the Company's September 1999 stock
offering.
$8.7$11.2 million and $19.8 million for the three and six months ended March 31, 2000.ending June 30,
2000, respectively. Excluding the impact of thenon-deductible in-process research
and development charge in
2000,charges and goodwill amortization and merger expense, the
effective tax rate for the first three monthshalf of 2000 was 36is 36.5 percent, compared to 3122
percent for the first three monthshalf of fiscal year 1999. The increase in the 2000 tax
rate is primarily attributable to the Company's utilization of the remainder of
federal and state tax loss carryforwards.
March 31,June 30, 2000, the Company's combined balance of cash, cash equivalents
and marketable securities was $315.1$378.8 million. Operating activities generated
$8.7$86.0 million during the threesix months ended March 31,June 30, 2000 primarily the result of
net income,the following: (i) strong earnings before non-cash expensesaccounting charges for
depreciation, IPR&D, stock based compensation, and amortization of intangibles,
(ii) tax benefit from employee stock options, and an(iii) increase in income taxes payableaccrued
payroll. These cash inflows were partially offset by increases in accounts
receivable and inventory and decreases in
accrued payroll and accounts payable.
used inprovided by investing activities was $72.5$41.8 million in the threesix months ended
March 31,June 30, 2000. The Company incurred capital expenditures of $6.5$16.5 million for
facilities expansion and capital equipment purchases to expand its manufacturing
capacities for its fiber optic communication products. The Company currently
expects to spend approximately $50$40 million for capital equipment purchases and
leasehold improvements during the remainder of 2000. During the first threesix months
of 2000, the Company invested excess net cash of $83.0$80.5 million in short term
investments. In addition, the Company acquired Queensgate, Veritech, and PIRI
during the first quarterhalf of 2000 resulting in net cash payments of $3.9$22.2 million.
$4.4$14.3 million from financing activities during the first
three monthshalf of 2000 from the issuance of stock under employee stock plans, offset by
capital lease payments.
non-
informationnon-information technology systems and believes those
systems successfully responded to the Year 2000 date change. The Company
expensed approximately $1.6 million in connection with remediating its systems.
The Company is not aware of any material problems resulting from Year 2000
issues, either with its products, its internal systems, or the products and
services of third parties. The Company will continue to monitor its mission
critical computer applications and those of its suppliers and vendors throughout
the year 2000 to ensure that any latent Year 2000 matters that may arise are
addressed promptly.
expected effective tax rate, expected
expenditures during 2000, sufficiency
of cash an 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 (MD&A)." 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
24
Manufacturing Risks3three years. This reduction in yields:
Dependence on Single Source and Other Third Party Suppliers and
certainsome 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 are working
to develop new technologies, or improvements and modifications to existing
technologies, which will obsoletemake our present products.products obsolete. Many of our
competitors have significantly greater financial, technical, manufacturing,
marketing, sales and other resources than we do.
us.we can. We cannot assure you that:
Potential Volatility of Stock PriceThe market price of our Common Stock may fluctuate significantly
because of:
announcements of technological innovations,
large customer orders,
customer order delays or cancellations,
customer qualification delays,
new products by us, our competitors or third parties,
possible acquisition of us or our customers or our competitors by a
third party,
merger or acquisition announcements, by us or others,
production problems,
stock compensation charges due to stock option plans or
stock purchase plans,
quarterly variations in our actual or anticipated results of
operations, and
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.
Future Operating Resultsin processin-process
research and development related to acquisitions and
expenses related to the issuance of stock pursuant to our employee stock
plans. In the first quarter of 2000, we began presenting earnings in
our press release that exclude acquisition costs and expenses related to
the issuance of stock pursuant to our employee stock plans.
the Companywe acquired Queensgate Instruments, Limited
("Queensgate") for initial consideration of $3$3.0
million ofin cash and 347,962 shares of the Company'sour common stock with a fair value of
approximately $77 million, and contingent payments of up to an additional $150
million in common stock based on Queensgate's pretax profits for the ten months
ended December 31, 2000 and the twelve months ended December 31, 2001. On June
26, 2000, we signed a supplementary agreement with the prior shareholders and
option-holders of Queensgate extinguishing all rights to future contingent
payments in exchange for 465,102 shares of SDL stock with a value of $130.4
million. In addition,April 2000, we closed theacquired Veritech
Microwave, Inc. ("Veritech") acquisition in April 2000. We entered
into an agreement to acquire Veritech in February 2000 for 3,000,000 shares of the Company'sour common
stock with a fair value of approximately $621 million. We also entered into an agreement to acquire Photonic
Integration Research, Inc. (PIRI)In June 2000, we acquired
PIRI for 10,200,0008,461,663 shares of the Company'sour common stock with a fair value of approximately
$1.8$2.1 billion and a
$31.25$31.7 million cash payment in May 2000 and expect to close the
acquisition in June 2000.cash. The acquisitions will be accounted for
under the purchase method of accounting. Under purchase accounting, we will
record the market value of our common sharesstock issued in connection with the
purchases and the amount of direct transaction costs as the cost of acquiring
the companies. That cost will be allocated to the individual assets acquired and
liabilities assumed, including various identifiable intangible assets such as
in-process research and development, acquired technology, acquired trademarks
and trade names and acquired workforce, based on their respective fair values.
We will allocate the excess of the purchase cost over the fair value of the net
assets to goodwill. Approximately $831 million is expected to be amortized and
expensed through April 2005, related to the acquisitions of Veritech and
Queensgate, and approximately $2.2 billion is expected to be amortized
27
non-
cashnon-cash expenses that will result in a
net loss for the foreseeable future, which could have a material adverse effect onadversely affect the market
value of our stock.
$12.1$8.2 million primarily in the 2nd and
3rd quartersthird quarter of fiscal 2000 of non-cash
expenses relating to shares issued under our 1995 Employee Stock Purchase Plan.
These expenses are a result of demand for shares during the purchase period for
the two years ending in October 2000 exceeding the number of shares that were
authorized at the beginning of the purchase period. In addition, stock options
exercised by employees of our United Kingdom subsidiary may result in
significant expenses. Under United Kingdom law, we are required to pay national
insurance tax on the gain on stock options exercised by employees in the United
Kingdom. Based on the stock price at March 31,June 30, 2000, we have a $6.1$6.5 million
contingent liability that will be charged to operations in the period that the
options are exercised. The options were granted to United Kingdom employees
beginning in May 1999, and have a 10 year10-year option exercise period and vest 25%
per year of employment. The expenses related to issuance of stock pursuant to
our employee stock plans could have a material adverse effect on the market
value of our stock. RisksBeginning in the first quarter of Acquisitionsoutsideother businesses. We regularly review
acquisition and investment prospects that would complement our existing
product offerings, augment our market coverage, secure supplies of
critical materials or enhance our technological capabilities. Acquisitions or investments could result in a number
of financial consequences, including:
Customer Order FluctuationsVirtuallyAlmost all of 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
onmaterially harm our business and results of
operations.
Risks from Customer ConcentrationDuring fiscalIn 1999, three
communication product customers and their affiliates respectively accounted for
15 percent, 11 percent and 11 percent of revenues, respectively.revenues. For the first half of 2000,
four communications product customers and their affiliates, respectively, would
account for 15 percent, 12 percent, 12 percent and 11 percent of our revenues.
Our recent acquisition of PIRI will increase our customer concentration, as the
substantial majority of PIRI's sales in 1999 were made
29
Such fluctuationsLoss or reduction in orders
from our key customers could have a material adverse effect ondecrease our business,revenues and harm our operating
results
or financial condition.results. We expect that revenue to a limited number of customers will continue
to account for a high percentage of the net sales for the foreseeable future.
Moreover, there can be no assurance
thatOur current customers willmay not continue to place orders or that we will be
able tomay not obtain new
orders from new communication customers.
Dependence on Emerging Applications and New ProductsOur current products serve many applications in the communications and
industrial laser 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.
Our customers and we are often required to test and qualify pump lasers
and modules, modulators, amplifiers, network monitors, receivers and transmitters
among other new products for potential volume applications. In the communications
market qualification is an especially costly, time consuming and difficult
process. We cannot assure you that:
we or our customers will continue their existing product development
efforts, or if continued that such efforts will be successful,
markets will develop for any of our technology or that pricing will
enable such markets to develop,
other technology or products will not supersede our products or our
customer's products, or
we or our customers will be able to qualify products for certain
customers or markets.
also be unable to develop or qualify new products on a timely
schedule. Moreover, evenEven 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 acceptableanticipated gross margins.
Need To Manage GrowthWe have on occasion been unable to manufactureOur current products serve many applications in quantities
sufficient to meet demandthe communications
market. 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 existing customer base and new
customers. The expansioncustomers are currently in the scopeprocess of our operations has placed a
considerable strain on our management, financial, manufacturingdeveloping new
products that are in various stages of development, testing and other resourcesqualification,
and has requiredsometimes are in emerging applications or new markets, which may require us
to implementdevelop products for use in our customers' products.
Our customers and improve a variety
of operating, financialwe are often required to test and qualify pump lasers
and modules, modulators, amplifiers, network monitors, receivers and
transmitters among other systems, proceduresnew products for potential volume applications. In the
communications market qualification is an especially costly, time consuming and
controls. In
addition, we have recently deployed a new enterprise resource planning
system and manufacturing execution system.
existing or new systems, procedures or
controls will adequately supportof our operationstechnology or that our systems,
procedures and controlspricing will
be designed, implementedenable such markets to develop, other technology 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. Weproducts will
continue to need a substantial number of additional
personnel, including those with specialized skills, to commercializenot supersede our products and expand all areas ofor our business in order to continue to
grow. Competition for such personnel is intense, andcustomer's products, or
- we cannot assure
you that weor our customers will be able to attract, assimilatequalify products for certain
customers or retain additional
highly qualified personnel.
Dependence on Key Employees 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
additionalor replace our key personnel, our business and results of
operations could be materially and adversely affected.
Risk of Patent Infringement Claimsaddition, we cannot assure
you that:
will notmay be asserted against us,
or
that- existing claims or anymay significantly impair our business and results
of operations, and
30
will notmay result in an injunction against the sale of
infringing products or otherwise significantly impair our business
and results of operations.
we first received correspondence from Rockwell International Corporation allegingalleged 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 StatesU.S. Court of Federal Claims by Rockwell against
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 us (Rockwell International Corporation v.
The United States of America, No. 93-542C (US Ct. Fed. Cl.)). WeSDL and other
companies. Although we were not originally named as a party to this lawsuit. However,lawsuit, the
Federal government asserted that if the Federal government were held liable to
Rockwell for infringement of Rockwell's patent in connection with some
of its contracts with us, then we might be liable to indemnify the Federal
government for a portion of itsany liability on certain contracts.
In June 1995,it might have to Rockwell, and we filed a motionwere
permitted to intervene in the lawsuit filed in August 1993 after1995.
Rockwell filed athe second lawsuit against us in May 1995 in California. That motion was granted on August 17, 1995. Upon
interveningFederal
District Court in the Federal government's lawsuit, we filed an answer to
Rockwell's complaint in that lawsuit, alleging that:
Rockwell's patent was invalid and that we did not infringe Rockwell's
patent,
Rockwell's patent was unenforceable under the doctrine of inequitable
conduct, and
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 could not be decided by summary
judgment but instead requires a trial. The Federal Circuit:
remanded the case back to the Court of Federal Claims for further
proceedings, and
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 first lawsuit and the
first lawsuit was dismissed by the Court of Federal Claims in January
1999. We did not participate in the settlement. Since the settlement,
the Federal government has not again raised the issue of our potential
indemnity obligation to them.
As noted above, we made our decision to intervene in the first lawsuit
filed after Rockwell filed the second lawsuit against us in the Northern
District of California, alleging that we had infringed the Rockwell
patentused a fabrication process 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 processFederal government that infringes the Rockwell patent
(Rockwell International Corporation v. SDL, Inc., No. C95-01729 MHP (US
Dist.Ct., N.D. Cal.)). By its complaint,patent. Rockwell sought a judgment
against us to:
the fabrication processes allegedly
covered by Rockwell's patent, The complaint was served on us on June 30, 1995, and we filed an answerOur answers to the complaint on August 18, 1995, allegingRockwell's complaints in both lawsuits asserted several
defenses, including that:
iswas invalid,
iswas unenforceable under the doctrine of
inequitable conduct, and
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 the first lawsuit,
the District Court lifted this stay, andAfter extensive discovery recommenced in the
second lawsuit.
Although the Court of Federal Claims ruled in our favor in the first lawsuit, findingwe and the patent invalid on motionFederal
government moved for summary judgment on the ground that Rockwell's patent was
invalid. In February 1997, the court decided in our favor and in favor of the
Federal government. However, Rockwell appealed the decision, and in May 1998 the
U.S. Court of Appeals for the Federal Circuit reversedvacated the summarylower court's judgment
ruling, meaningand remanded the case back to the lower court for further proceedings.
The Federal government subsequently agreed to pay Rockwell $16.9 million
in settlement of the first lawsuit, which as a result was then dismissed by the
lower court in January 1999. We did not participate in the settlement. The
government thus far has not made any further assertions that we must indemnify
it for amounts paid to Rockwell.
As a consequence of the May 1998 decision by the Court of Appeals in the
first lawsuit, the issue of validity needs to go to trial. Suchin the second lawsuit must be decided in a
trial would now occur beforeby jury, which is currently scheduled to commence in April 2001.
Following a jurycourt-ordered settlement conference in California. The California judge
also required that a settlement conferenceJune 1999 between
Rockwell and SDL be
scheduled in order to see if the parties can resolve the dispute before
trial,us, at which conference occurred in the first part of June 1999. The
partieswe were unable to successfully resolve the lawsuit.
Later in June 1999,settle this lawsuit, Rockwell filed a motionmoved
for summary judgment, relative to certain claims in the Rockwell patent. That motion soughtseeking to have the court summarily find us to have
infringed those claims. Rockwell filed a separate motion seeking to haveIn February 2000, the court summarily find
that we could not argue that Rockwell's patent was invalid on a particular
ground. A decision on the motions was rendered in the beginning of February
2000. The District Court ruled that the Company infringed the specified
claims of Rockwell's patent. The District Court also ruled that we could not make the invalidity argument specified byhad infringed
Rockwell's motion.
The District Court'spatent. This ruling will preventprevents us from defending against Rockwell's
lawsuit on the ground that we do not infringe Rockwell's patent. The District Court's ruling willcourt has
granted other summary judgment motions brought by Rockwell which also prevent us from making
one (but not all) oflimit the
defenses we may assert at trial. However, we intend to pursue our invalidity arguments, unless itremaining
defenses mentioned above. A trial date has been set in April 2001. Discovery on
several matters is changed.
However, the District Court's ruling has no effect on our other pending
defenses, as outlined above. We believe that these defenses in the
litigation of patent invalidity, inequitable conduct, laches and
equitable estoppel are meritorious and we will pursue these defenses.
that it isRockwell can no longer
possible for Rockwell to obtain an injunction stoppingprevent us from using the fabrication process allegedly covered by Rockwell's
patent.
is fact intensivewill depend on the resolution of
various factual disputes, so that the outcome cannot be determined and remains
uncertain. If Rockwell prevailed in
the litigation, it could be awarded monetary damages against the
Company. Although we believe that we have meritorious defenses to
Rockwell's allegations, there can be no assurance that Rockwell will notmay ultimately prevail in this dispute. If Rockwell were to
prevail, Rockwell could be awarded substantial monetary damages, including past
damages, against us for the sale of infringing products. The award of monetary damages against
us, including past damages,products, which could have a material adverse effect onharm our
business and results of operations. Litigation and trial 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 onharm our business
and results of operations.
Dependence on Proprietary TechnologyThere
can be no assurance that:
will notcould be invalidated,
circumvented, challenged or licensed to others,
willmay not provide a competitive
advantagesadvantage to us,
any of- our approximately 170 pending or future patent applications willmay not
be issued with the scope of the claims sought by us, if at all, or
that- others will notmay develop technologies that are similar or superior to our
technology, duplicate our technology or design around the patents
we own, or obtain a license to the patents we own or license, or
patent or assert patents on technology that we might use or intend
to use.
AWe expect
that a significant portion of our revenues will be derived from technology is
licensed on a non-exclusive basis from NTT, 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 rights will prevent
misappropriation of such technology. In addition, litigation has been necessary
and may be necessary in the future:
International Distribution RisksRevenuesBECAUSE WE SELL OUR PRODUCTS TO CUSTOMERS OUTSIDE THE UNITED STATES, WE FACE
FOREIGN BUSINESS AND ECONOMIC RISKS THAT COULD HARM US.
We derived approximately 55 percent of our revenue from customers
outside of the United States accounted for
approximatelyin the first half of 2000, 41 percent in 1999, 27
percent in 1998, and 25 percent of our total
revenue in fiscal 1999, 1998 and 1997, respectively.1997. International revenue carries a number
of inherent risks, including:
Although to date, we have experienced little
difficulty in obtaining such licenses or approvals, theAny 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.
representatives or inrepresentatives. In any event we or our distributors or representatives may
desiresdesire to terminate certain distributorsdistributor or representativesrepresentative relationships. Such a
termination may result in monetary expenses or a loss of revenue. 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 Risksour acquisitions,the companies we acquire, 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 changesChanges in these regulations and laws will not
have an adverse economic effect on us or our acquisitions. Further,could harm us. In
addition, these
local, state, and federal regulations could restrict our ability to expand our operations.
If we do not:
or
orand 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.
II:II. OTHER INFORMATIONITEM
Item 1. LEGAL PROCEEDINGSInformation disclosed inLegal Proceedings.
In the Company's Form 10-K for the year ended
December 31, 1999 under heading Part I Item 3, Legal Proceedings, is
incorporated hereinpatent infringement suit brought by this reference. As reported in the disclosure,Rockwell against the Company,
soughtadditional motions for partial summary judgment were considered by the
Court in June, 2000. The Court granted a motion brought by Rockwell,
further limiting the grounds on which the Company can argue that
Rockwell's patent is invalid. Other grounds remain on which the Company
intends to have the court in the Rockwell matter reconsider
its decision with respect to a particular invalidity argumentargue that the court had ruled uponpatent is invalid. The Court also denied a
motion brought by the Company for a ruling that Rockwell's damages were
limited by the doctrine of laches. The Court held that there were
factual issues raised by the issue of laches that would require trial.
The Company intends to pursue that issue at trial. The Court has a set
trial date in February 2000. Since the dateApril 2001. Discovery on several matters is currently
ongoing.
Item 2. Changes in Securities and Use of the
disclosure, the court has denied our request.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS issued and
the earnout shares, if any, will be issued to the shareholders of Queensgate pursuant to exemptions
from the registration requirements of the Securities Act of 1933, (the
"1933 Act") set forth in Regulation S, Section 4(2) and Regulation D
under the 1933 Act. The Company relied on the exemption set forth in
Regulation S for the issuance of shares of the Company's Common Stock to
Queensgate shareholders resident outside of the United States and on the
exemption set forth in Section 4(2) of the 1933 Act and in Regulation D
under the 1933 Act for the issuance of shares of the Company's Common
Stock to one Queensgate shareholder located in the United States. The
Company shares issued and issuable pursuant to the
earnout, if any, to the Queensgate shareholders have been
registered by the Company on Form S-3 (File No. 333-32068) for resale by
the Queensgate shareholders.
ITEM(3) On June 2, 2000, the Company acquired Photonic Integration Research,
Inc. ("PIRI") pursuant to a Stock Purchase Agreement (the "Agreement")
dated as of May 10, 2000, among SDL and the shareholders of PIRI. PIRI,
located in Columbus, Ohio, is a leading manufacturer of arrayed
waveguide gratings that enable the routing of individual wavelength
channels in fiber optic systems. SDL has issued 8,461,663 shares of SDL,
Inc. stock and transferred $31.7 million in cash derived from operating
income, in exchange for all of the stock of PIRI.
Item 3. DEFAULTS UPON SENIOR SECURITIES Defaults upon Senior Securities. Not applicable
ITEMApplicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A SpecialSubmission of Matters to a Vote of Security Holders.
The Company's Annual Meeting of Stockholders (the "Special Meeting") of the Company
was held on February 28,May 18, 2000.
SpecialAnnual Meeting the following item wasitems were put to a vote of the
stockholders:
An35
CertificatesCertificate of Incorporation to increase the aggregate number
of authorized shares of common
stock which the Company is authorized to issue from 70 million to 140
million shares.
The proposal was approved by the following votes:
Common Stock.
For Against Abstain
- ------------- ------------- -------------
30,698,080 36,579 47,826
ITEM--------------------------------------------------------------
57,908,227 2,163,526 51,052
4. To ratify the appointment of Ernst & Young LLP as the
Company's independent auditors for 2000.
For Against Abstain
--------------------------------------------------------------
60,063,327 16,490 42,988
Item 5. OTHER INFORMATION Other Information. Not applicable
ITEMApplicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits and Reports on Form 8-K.
(a) List of Exhibits
(b) - Financial Data Schedule
Reports on Form 8-K
INC.
SIGNATURES
SDL, INC.
(Registrant)Dated: May 12, 2000
By:
/s/ Michael L. Foster
Michael L. Foster
Vice President, Finance
Chief Financial Officer
(Duly Authorized Officer, and Principal
Financial and Accounting Officer)