of operations which actually would have resulted had the acquisition occurred on the date indicated, or which may result in the future.10q doc
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 1999March 31, 2000or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number: 0-25688
SDL, INC. (Exact name of Registrant as specified in its charter)
Delaware 77-0331449 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
80 Rose Orchard Way, San Jose, CA 95134-1365
(Address of principal executive offices, including zip code)(408) 943-9411
(Registrant's telephone number, including area code)Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
The number of shares outstanding of the issuer's common stock as of
October 29, 1999May 10, 2000 was35,366,634.76,549,877.
SDL, INC.
FORM 10-Q
INDEXPART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets -
September 30, 1999March 31, 2000 and December 31,19981999Condensed Consolidated Statements of Operations - three
and ninemonths endedSeptember 30,March 31, 2000 and 1999and 1998Condensed Consolidated Statements of Cash Flows -
ninethree months endedSeptember 30,March 31, 2000 and 1999and 1998Notes 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
SIGNATURES
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTSSDL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)September 30,March 31, December 31, 2000 19991998------------ ------------ (unaudited) (1) ASSETS Current Assets: Cash and cash equivalents....................... $206,056 $17,023.................... $238,239 $153,016 Short-term marketable securities................ 86,293 17,635............. 76,903 161,120 Accounts receivable, net........................ 42,685 23,042..................... 49,652 41,445 Inventories..................................... 30,008 21,288.................................. 36,971 32,070 Prepaid expenses and other current assets....... 3,946 3,875.... 3,628 3,659 ------------ ------------ Total current assets.............................. 368,988 82,863........................... 405,393 391,310 Property and equipment, net....................... 53,431 39,848.................... 65,670 59,772 Long-term marketable securities................................... 0 --3,552Restricted cash................................... 703 722 Note due from related party ....................... 488 512................................ 680 686 Goodwill and other intangibles, net............. 93,258 2,948 Other assets...................................... 7,178 4,563................................... 15,271 6,237 ------------ ------------ Total assets...................................... $430,788 $132,060................................... $580,272 $460,953 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................ $12,165 $10,014............................. $19,151 $18,277 Accrued payroll and related expenses............ 6,415 2,354......... 4,118 10,717 Income taxes payable............................ 4,157 1,890 Unearned revenue ................................ 125 643......................... 8,854 1,093 Current portion of capital leases............... 1,082 1,098............ 874 1,011 Other accrued liabilities....................... 6,319 3,159.................... 7,498 4,950 ------------ ------------ Total current liabilities......................... 30,263 19,158...................... 40,495 36,048 Long-term liabilities: Capital leases.................................. 460 1,416 Notes payable ................................... -- 612............................... 860 965 Other long-term liabilities..................... 4,250 2,668.................. 13,667 3,792 ------------ ------------ Total long-term liabilities....................... 4,710 4,696.................... 14,527 4,757 Commitments and contingencies Stockholders' equity: Preferredstock..................................stock............................... -- -- Commonstock..................................... 35 15stock.................................. 73 72 Additional paid-in capital...................... 414,924 138,895................... 518,191 425,993 Accumulated other comprehensiveincome........... 360 887 Accumulated deficit, $26.3 million relating to the repurchase of common stock in 1992 and $5.8 million relating to a recapitalization in 1992 ...................... (19,469) (31,551) ------------ ------------ 395,850 108,246 Less common stockholders' notes receivable ...... (35) (40)income........ 216 1,557 Retained Earnings (Accumulated deficit)....... 6,770 (7,474) ------------ ------------ Total stockholders' equity........................ 395,815 108,206..................... 525,250 420,148 ------------ ------------ Total liabilities and stockholders' equity........ $430,788 $132,060..... $580,272 $460,953 ============ ============(1) The balance sheet at December 31,
19981999 has been derived from theauditedaudit financial statements at that date.
See accompanying notes.SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data - unaudited)Three Months EndedNine Months Ended September 30, September 30,March 31, ----------------------------------------2000 19991998 1999 1998--------- -------------------- --------- Total revenue: Product revenue..................... $46,383 $24,498 $124,910 $73,618 Research revenue.................... 1,124 2,460 3,434 8,639Revenue................................ $72,206 $37,666 Cost of revenue........................ 37,616 23,033 --------- -------------------- --------- 47,507 26,958 128,344 82,257 Cost of revenue: Cost of product revenue............. 25,778 15,750 71,808 49,175 Cost of research revenue............ 878 1,748 2,854 6,584 --------- ---------- ---------- --------- 26,656 17,498 74,662 55,759 --------- ---------- ---------- ---------Grossmargin.......................... 20,851 9,460 53,682 26,498margin......................... 34,590 14,633 Operating expenses: Research and development............5,237 3,200 13,310 9,3425,903 3,781 Selling, general and administrative.6,527 4,036 18,650 12,019 Merger costs........................ -- -- 2,677 --7,298 5,680 In-process research and development.-- --1,200 1,495--Amortization of purchased intangibles........................210 193 599 5821,744 179 --------- -------------------- ---------Total operating expenses..............11,974 7,429 36,731 21,94316,145 11,135 --------- -------------------- ---------Operating income .....................8,877 2,031 16,951 4,55518,445 3,498 Interest incomenet.................. 589 330 1,172 927and other, net........ 4,485 286 --------- -------------------- ---------Income before income taxes............9,466 2,361 18,123 5,48222,930 3,784 Provision for income taxes............2,082 251 4,905 7238,686 1,161 --------- -------------------- ---------Net income............................$7,384 $2,110 $13,218 $4,759$14,244 $2,623 ========= ==================== =========Net income per share - basic..........$0.23 $0.07 $0.43 $0.17$0.20 $0.04 ========= ==================== =========Net income per share - diluted........$0.22 $0.07 $0.40 $0.16$0.19 $0.04 ========= ==================== =========Number of weighted average shares - basic......................32,093 28,672 31,043 28,51972,019 60,176 ========= ==================== =========Number of weighted average shares - diluted....................34,146 30,240 33,085 30,17976,507 64,296 ========= ==================== =========See accompanying notes.
SDL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands - unaudited)NineThree Months EndedSeptember 30,March 31, -------------------- 2000 19991998--------- --------- OPERATING ACTIVITIES: Net income............................................$13,218 $4,759$14,244 $2,623 --------- --------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciationand amortization..................... 8,388 6,470..................................... 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............................(19,524) 37(6,578) (5,687) Inventories....................................(7,580) (3,057)(3,236) (2,029) Accounts payable...............................2,020 (1,048)(1,532) (1,457) Accrued payroll and related expenses...........4,061 374(6,748) 342 Income taxes payable...........................2,267 (106) Unearned revenue............................... (518) 2217,761 (438) Other accrued liabilities......................3,603 (1,524)(486) 447 Long-term liabilities..........................1,581 1,338(962) 623 Other..........................................(911) 1,234(552) (428) --------- --------- Total adjustments.....................................(5,118) 3,939(5,587) (3,875) --------- --------- Net cash provided by (used in) operatingactivities.............. 8,100 8,698activities.... 8,657 (1,252) --------- --------- INVESTING ACTIVITIES: Acquisition of property and equipment, net............(21,356) (10,957)(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.........(65,797) 7,72983,013 2,147 --------- --------- Net cashused inprovided by (used in) investingactivities.................. (92,208) (3,228)activities.... 72,546 (10,301) --------- --------- FINANCING ACTIVITIES: Issuance of stock pursuant to employee stock plans....9,743 1,609 Proceeds from issuance of common stock................ 266,301 --4,385 3,016 Payments on capital leases............................(850) (986)(371) (380) Decrease (increase) in restricted cash................3 (49) Payments on stockholders' note receivable............ 56 36 Other................................................. --Payments on notes payable............................. (898) (448)(232) --------- --------- Net cash provided by financing activities..............274,304 1264,020 2,440 --------- --------- Net increase (decrease) in cash and cashequivalents.............. 190,196 5,596equivalents... 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 17,0236,170--------- --------- Cash and cash equivalents at end of period.............$206,056 $11,766$238,239 $6,747 ========= =========See accompanying notes.
SDL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999March 31, 20001. 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
nine-monththree month period endedSeptember 30, 1999March 31, 2000 are not necessarily indicative of the results that may be expected for the yearendedending December 31,1999.2000. For further information, refer to the consolidated financial statements and footnotes thereto included in theRegistrant Company'sRegistrant's Annual Report on Form10-K/A10-K for the year ended December 31,1998 and Form 8-K filed with the SEC on June 29,1999.The consolidated financial statements include the accounts of SDL, Inc. and its wholly owned subsidiaries, SDL Optics, SDL Integrated Optics and SDL
Integrated Optics.Queensgate. 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.
TheseThe financial statements of the Canadian subsidiary are remeasured into U.S. dollars forconsolidation.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 Kingdomsubsidiarysubsidiaries is the British Pound Sterling.As such, allAll 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
thirdfirst fiscal quarter of19992000 and19981999 ended onOctober 1,March 31, 2000 and April 2, 1999,and October 2, 1998,respectively. For ease of discussion and presentation, all accompanying financial statements have been shown as ending on the last day of the calendarmonth.quarter.In
MayDecember 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 onJune 2, 1999March 14, 2000 to stockholders of record onMay 14, 1999.February 29, 2000. All of the share and per share data in these financial statementshashave been retroactively adjusted to reflect the stock split.In
May 1999,February 2000, the Company's stockholders approved an increase in the Company's authorized shares of its common stock from 70 million shares to70140 million shares.On March 8, 2000 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. See note 6, Acquisitions.
In April 2000, the Company acquired Veritech Microwave, Inc. ("Veritech") for 3,000,000 shares 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, manufactures and markets optoelectronic modules for long haul undersea and terrestrial fiber optic transmission systems. The acquisition will be accounted for under the purchase method of accounting. The Company
mergedbelieves it may write-off significant amounts related to in-process research and development during the second quarter of fiscal 2000.In May 2000, the Company entered into an agreement to acquire Photonic Integration Research, Inc. (PIRI) for 10,200,000 shares of the Company's common stock with
IOC International plc. ("IOC")a fair value of approximately $1.8 billion and a $31.25 million cash payment. PIRI, a privately held company located inMay 1999Columbus, 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 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.As a
poolingresult ofinterests transaction. The condensed consolidated financial statements forthethree and nine months ended September 30,substantial increase in the market price of the Company's Common Stock beginning in the fourth quarter of 1998,have been restated to include the financial position, results of operations and cash flows of IOC. There were no transactions between IOCand theCompany prior to the combination and no significant adjustments were necessary to conform IOC's accounting policies. Becauseresulting increased levels ofdiffering year ends, financial information relating to SDL's three and nine months ended September 30, 1998 has been combined with financial information relating to IOC's three and nine months ended June 30, 1998. IOC's net loss for the three months ended December 31, 1998 was not combined with SDL's net income, but rather was included as an adjustment to stockholders' equityemployee participation in the Company's Employee Stock Purchase Plan ("ESPP"), it is currently contemplated that the number of shares issuable pursuant to the Company's ESPP in fiscal 2000 will exceed 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 expects to incur non-cash charges to operating results aggregating approximately $12.1 million. These charges will occur primarily in the second and third quarters of fiscal 2000.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
resultsstatements. 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 thethree months ended March 31, 1999. IOC's resultsCompany no later than the second quarter ofoperations for the three and nine months ended September 30, 1999 has been combined with SDL's results of operations for the three and nine months ended September 30, 1999.
In September 1999, the Company issued 3,392,500 shares of common stock, including the underwriters' exercise of their over-allotment option for 442,500 shares, priced at $82.00 per share. Net proceeds to the Company were approximately $266.3 million.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that derivatives be recognized in the balance sheet at fair value and specifies the accounting for changes in fair value. In June 1999, the FASB issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133" to defer the effective date of SFAS 133 until fiscal years beginning after June 15,2000. The Companygenerallydoes notuse derivativebelieve that adoption of SAB 101 will have a material impact on its financialinstruments and the impactcondition or results ofSFAS 133 is not anticipated to be material when adopted.operations.2. Net Income Per Share
The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
Three Months EndedNine Months Ended September 30, September 30,March 31, --------------------------------------2000 19991998 1999 1998 --------- ------------------ --------- Numerator: Net income........................$7,384 $2,110 $13,218 $4,759 ========= =========$14,244 $2,623 ========= ========= Denominator: Denominator for basic net income per share - weighted average shares..........................32,093 28,672 31,043 28,51972,019 60,176 Incremental common shares attributable to shares issuable under employee stock plans...........................2,053 1,568 2,042 1,660 --------- ---------4,488 4,120 --------- --------- Denominator for diluted net income per share adjusted weighted average shares and assumed conversions.............34,146 30,240 33,085 30,179 ========= =========76,507 64,296 ========= ========= Net income per share - basic......$0.23 $0.07 $0.43 $0.17 ========= =========$0.20 $0.04 ========= ========= Net income per share - diluted....$0.22 $0.07 $0.40 $0.16 ========= =========$0.19 $0.04 ========= =========3. Inventories
The components of inventories consist of the following (in thousands):
September 30,March 31, December 31, 2000 19991998------------ ------------ Raw materials .............$11,251 $7,849$12,956 $15,115 Work-in-process............15,293 13,43921,174 14,615 Finished Goods.............3,464 --2,841 2,340 ------------ ------------$30,008 $21,288$36,971 $32,070 ============ ============4. Comprehensive Income
Accumulated other comprehensive income presented in the accompanying consolidated balance sheet consists of the accumulated net unrealized gains and losses on available-for-sale marketable securities and foreign currency translation adjustments, net of the related tax effects. The tax effects for other comprehensive income were immaterial for all periods presented.
Total comprehensive income amounted to approximately
$7.7$12.9 million for thethirdfirst quarter19992000 compared to a comprehensive income of$2.5$1.9 million for thethirdfirst quarter of1998. For nine months ended September 30, 1999, comprehensive income amounted to $13.0 million compared to $5.5 million for the corresponding 1998 period.1999.5. Segment Reporting
SDL has
threetwo reportable segments: communicationsresearch,andprinting and materials processing.industrial laser. The communications business unit develops, designs, manufactures and distributes lasers, modulators, drivers, modules and subsystems for applications in the telecom, cable television, satellite and dense wavelength division multiplexing markets. Theresearch business unit conducts research, development or product customization, involving both communications and printing and material processing applications, for Fortune 500 companies, major international customers, smaller domestic and international companies, and multiple Federal government agencies. Research revenue on the Consolidated Statement of Income includes research, development, and product customization conducted by all the segments of the Company. The printing and materials processingindustrial laser business unit develops, designs, manufacturers and distributes lasers and subsystems for applications in the surface heat treating, productlabeling,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):
PrintingCommunica-andtionMaterialIndustrial ProductsResearch ProcessingLaser Total ---------- --------- ---------------------Quarter endedSeptebmer 30,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...$32,109 $972 $14,426 $47,507 Amortization...................... 78 -- 132 210 Segment Operating Income (loss)... $9,911 ($533) ($501) $8,877 Printing Communica- and tion Material Products Research Processing Total ---------- --------- ----------- ---------- Quarter ended September 30, 1998: Revenue from external customers... $13,718 $2,048 $11,192 $26,958 Amortization...................... 155 -- 38 193$28,568 $9,098 $37,666 Segment Operating Income .........$616 $92 $1,323 $2,031 Printing Communica- and tion Material Products Research Processing Total ---------- --------- ----------- ---------- Nine months ended September 30, 1999: Revenue from external customers... $90,751 $3,605 $33,988 $128,344 Amortization...................... 234 -- 365 599 Segment Operating Income (loss)... $24,330 ($735) ($1,772) $21,823 Printing Communica- and tion Material Products Research Processing Total ---------- --------- ----------- ---------- Nine months ended September 30, 1998: Revenue from external customers... $41,069 $6,166 $35,022 $82,257 Amortization...................... 465 -- 117 582 Segment Operating Income (loss)... ($11) $563 $4,003 $4,555$5,738 $134 $5,872A 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 theninethree months endedSeptember 30,March 31, ---------------------- 2000 19991998----------- ---------- Operating Income Total operating income from operating segments...............................$21,823 $4,555 Merger costs.............................. (2,677) --$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 ........$16,951 $4,555$18,445 $3,498 =========== ==========Major Customers
During the first three months of 2000, four communication product customers and their affiliates accounted for 17 percent, 16 percent, 13 percent and 13 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.
6.
Mergers &Acquisitions
IOC International plc.Queensgate
Overview
On
May 18, 1999, the CompanyMarch 8, 2000 Queensgate merged withIOC,SDL in a transaction accounted for as a purchase. Queensgate was a privately held company and is located in Bracknell, UnitedKingdom-based manufacturer of lithium niobate componentsKingdom. Queensgate designs, develops, manufactures and markets optical network monitoring modules for long haul terrestrial fiber optic transmissionsystems in a poolingsystems. The merger agreement provided for initial consideration ofinterests transaction. The Company exchanged 1,130,098$3 million of cash and 347,962 shares ofSDLthe Company's common stock with a fair value of approximately $77 million, andreserved 116,974contingent 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 sharesfor IOC options assumedand the exercise price appropriately adjusted by theCompany. Merger related expensesexchange ratio.Valuation Methodology
In accordance with the provisions of
$2.7 millionAccounting Principle Board Opinion No. 16 (APB No. 16), Business Combinations, all identifiable assets, including identifiable intangible assets, wererecordedassigned a portion of the cost of the acquired business (purchase price) on the basis of the 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 Queensgate operate was also considered in the
second quartervaluation.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
fiscal 1999. Combinedin-process research andseparate unaudited resultsdevelopment included an analysis ofSDLdata provided by Queensgate concerning the products in development, their respective stage of development, the time andIOC forresources needed to complete them, their expected income generating ability, target markets and associated risks. The Income Approach, which included an analysis of theperiods prior tomarkets, cash flows, and risks associated with achieving such cash flows, was theacquisition wereprimary 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):
Nine Months Ended September 1999 1998Value of securites issued......... $77,376 Cash.............................. 3,000 Assumption of Queensgate options.. 1,502 ---------- 81,878 Estimated transaction costs...... 1,125 ---------- Totalrevenues: Priorpurchase 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 18,411The purchase price allocation is preliminary and, therefore, subject to
April 1, 1999:.. SDL................... $35,730 $76,738 IOC................... 1,936 5,519 Combinedchange 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, 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.
The estimated product development cycle for the new product was 12 months.
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,
afterincluding 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,
1999.. 90,678 -- ---------- ---------- $128,344 $82,2572001 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 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 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. 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.
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.
The acquired assembled workforce is comprised of over 100 skilled employees across Queensgate's General and Administration, Research and Development, Sales and Marketing, and Manufacturing groups. 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.
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, is amortized on a straight-line basis over an estimated useful life of 5 years.
The following unaudited pro forma information presents the results of operations of the Company as if the acquisition had taken place on January 1, 1999 and excludes the write-off of purchased in process research and development of $1.2 million:
(In thousands, For the three months except per share amounts) ended March 31, --------------------------- 2000 1999 ------------ ------------ Revenues.......................... $73,897 $40,122 Net income (loss): Prior................. $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
April 1, 1999:.. SDL................... $3,010 $8,704 IOC................... (387) (3,945) Combinedbe indicative of the resultsafter March 31, 1999.. 10,595 -- ---------- ---------- $13,218 $4,759
Polaroid Corporation's fiber laser business Polaroid's
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 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.
In addition, the Company recorded $0.7 million to accrue for certain 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.
The purchase price allocation for the fiber laser business acquisition was recorded as follows (in thousands):
Inventory ................. $979
Property and equipment..... 229
Intangibles................ 2,596
In-process R&D............. 1,495
---------------------
Net assets acquired........ $5,299
============
Liabilities................ $244=========
Liabilities assumed........ $94
Cash paid, including
transaction costs.......... 5,055
------------5,205
---------
Total purchase price....... $5,299
=====================
7. Contingencies
In 1985, Rockwell International Corporation (Rockwell) asserted, and in
1995 filed suit in the Northern California Federal District Court against
the Company alleging, that a Company fabrication process infringed
certain 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
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. Limited discovery has been conducted
by the parties in preparation of the case for trial.Thereafter, Rockwell has
also
filed motions for partial summary judgement relative to certain patent
claims of Rockwell's patentjudgment 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 will vigorously opposeopposed 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. 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 one (but not all) of its invalidity arguments. No trial date has
been set and additional discovery, which had been stayed pending the
decision on the Rockwell's motions, is necessary prior to trial. 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, it could be awarded monetary damages against the
Company. While we believe that we have meritorious defenses to
Rockwell's allegations, there can be no assurance that Rockwell will
not ultimately prevail in this dispute. If Rockwell were to prevail,
Rockwell
could be awarded substantial monetary damages and/or an
injunction against us for the sale of infringing products. If this
injunction were entered, we may seek to obtain a license to use
Rockwell's patent until the January 2000 expiration date of the
patent. We cannot assure you, however, that a license would be
available on reasonable terms or at all.damages. The award of monetary
damages against us,the Company, including past damages, or the failure to obtain a license
to use Rockwell's patent on commercially reasonable terms could have a
material adverse effect on our business andthe Company's results of operations.
Litigation and trial of Rockwell's claim against usthe Company
is also expected to involve significant expense to usthe Company and could
divert the attention of ourthe Company's technical and management personnel and could have a material
adverse effect on our business and results of operations.
Shortly afterpersonnel.
However, because the aforementioned suit between Rockwell and the Federal
government was filedpatent expired in 1993, the Federal government had notifiedJanuary 2000, the Company that if the Federal government were liable to Rockwell, then
the Federal government might seek indemnification forwill not
need a portion of its
liability from the Company. Since the Federal government's settlement
with Rockwell in January 1999, it has never stated the amount of the
Company's alleged indemnity obligation, nor has it repeated its
assertion that the Company might have some indemnity obligation to the
Federal government.
SDL is engaged in various cost-reimbursement type contracts with the
Federal government. These contracts utilize allowable costs plus
contract fee to determine revenue. Federally-funded contracts are
subject to audit of pricing and actual costs incurred, which have
resulted and could result in the future, in price adjustments. The
government has in the past and could in the future, challenge the
Company's accounting methodology for computing indirect rates and
allocating indirect costs to government contracts. The government is
currently challenging certain indirect cost allocations. While
management believes that amounts recorded on its financial statements
are adequate to cover all related risks, the government has not
concluded its investigation or agreed to a settlement with the
Company. Although the outcome of this matter cannot be determined at
this time, management does not believe that its outcome will have a
material adverse affect on the Company's financial position, results
of operations or cash flows. Nevertheless, based on future
developments, the Company's estimatelicense regardless of the outcome of these matters
could changethe litigation.
8. Subsequent Events
In April 2000, the Company acquired Veritech Microwave, Inc. ("Veritech") for 3,000,000 shares 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, manufactures and markets optoelectronic modules for long haul undersea and terrestrial fiber optic transmission systems. The acquisition 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 May 2000, the Company entered into an agreement to acquire Photonic
Integration Research, Inc. (PIRI) for 10,200,000 shares of the Company's
common stock with a fair value of approximately $1.8 billion and a $31.25
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 near term.second quarter of fiscal 2000 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 In addition, the Company is involved in other legal controversies
arising in the ordinary course of business.
SDL designs, manufactures and markets 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 communicationscommunication dense wavelength
division multiplexing (DWDM) products power the transmission of data,
voice and Internet information over fiber optic networks to meet the
needs of telecommunications, dense wavelength
division multiplexing,data communications, cable television and
satellite communications applications. DuringThe demand for DWDM solutions
accelerated significantly in 1999 due to the technology's unique ability
to expand network bandwidth and provide much faster transmission of data,
voice and video signals. With the qualification of the Company's new
wafer fabrication facility in the first nine monthshalf of 1998 and expansion of
yields and assembly and test capacity in 1999 and the first quarter of
2000, the Company derived
72% of itswas able to successfully ramp capacity and achieve
significant revenue and profit growth. Revenue from optical communication markets. With the
increased focus on commercialfiber optic
communications products the proportion of
SDL's revenue derived from U. S. government related projects has declined
from 40%increased by 179 percent in fiscal 19961999 compared to 11% during1998;
this continued in the first nine monthsquarter of 1999.2000 as fiber communication
revenue rose 35 percent sequentially. SDL products were also able 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's optical products also serve a wide variety of non-communicationsnon-
communications applications, including materials processing printing, medical and scientific instrumentation. From the original products introduced in
1984, the Company has expanded its product offering to over 150 standard
products in addition to providing custom design and packaging for OEM
customers. The Company's revenue also includes revenue from customer-
funded research programs.
high
resolution printing. Because of the diversity of products, customers and
applications, gross margins tendmargin tends to fluctuate based in part on the mix of
revenue in each reported period. SDL's revenue growth in 1997-1998 was constrained in
part by a shortage in qualified manufacturing capacity, especially in the
wafer fabrication area. The Company's new wafer fabrication facility
received qualification in June 1998, for certain key product lines,
allowing a faster ramp-up in production.
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 thirdfirst
fiscal quarter of 19992000 and 19981999 ended on October 1,March 31, 2000 and April 2,
1999, and October 2,
1998, respectively. For ease of discussion and presentation, all
accompanying financial statements have been shown as ending on the last
day of the calendar month.
RESULTS OF OPERATIONS
Revenue. Total revenue for the quarter ended September 30, 1999March 31, 2000 increased 76%92
percent to $47.5$72.2 million compared to $27.0$37.7 million in the corresponding
19981999 quarter. For the first nine months of 1999, total
revenue increased 56% to $128.3 million from $82.3 million reportedDemand for the comparable period. Product revenue was $46.4 million and $124.9
million for the third quarter and first nine months of 1999,
respectively, which represents increases of 89% and 70% when compared
with the corresponding periods in 1998. The increase in product revenue
for the third quarter and first nine months of 1999 was primarily due to
increased sales of $20.3 million and $52.2 million, respectively,Company's dense wavelength division
multiplexing (DWDM) products provided substantially all of the Company'srevenue
growth during the three months ended March 31, 2000 compared to the three
months ended March 31, 1999. 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
opticgratings, and optical network monitoring products, increased 163 percent
from the prior year quarter. Undersea DWDM revenue is up over twelve
times that of the prior year quarter. During the three months ended
March 31, 2000, the communication products. Research revenue declined
both in dollars and as a percentageproducts represented 83 percent of total
revenue compared to 73 percent in the third quarter and first nine months of 1998. This downward trend in
research revenue is a resultprior year quarter. Results of
the Company's continued longer-term
strategy focusfirst quarter 2000 include the results of Queensgate from the closing
of its acquisition on commercial communication product opportunities.
Revenue derived directly or indirectly from U.S. government sources
declinedMarch 8th. SDL Queensgate contributed $0.9 million
to 5% and 11% of totalconsolidated revenue for the third quarter and first
nine months of 1999, respectively, compared to 25% and 28% for the
corresponding periods in 1998.ended March 31, 2000.
ResultsRevenues for the three and nine months ended September 30, 1999March 31, 2000 are not considered
indicative of the results to be expected for any future period
or for the entire year.period. In
addition, there can be no assurance that the market for the Company'sour 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
the Companywe will be able to increase or maintain itsour market share in the future or
to achieve historical growth rates.
Gross Margin. Gross marginsmargin increased 9 percentage points from the prior
year quarter to 44% and 42%48 percent for the three and
nine months ended September 30, 1999March 31, 2000
compared to 39 percent from 35% and 32% in the comparable
1998 periods. Three factors contributed to theprior year quarter. The increase in
gross margins. These were:margin was primarily due to the following: (i) a more favorable mix
of higher margin fiber
optic communication product sales,DWDM revenue, especially increased shipments of pump
lasers for undersea fiber cable,systems, as compared to revenue derived from
lower margin U.S. government contractsindustrial laser and non-communication product
sales;satellite communication revenue, and
(ii) increased unit volume resulting in better utilization of
fixed costs; and, (iii) reduction of costs relateddue to 980nm pump lasers.increased yields and factory volume.
These favorable factors were partially offset by warranty provisions and
declining average selling prices on certain products due to long-term
contract arrangements.higher employee benefit
costs.
The Company's gross margin can be affected by a number of factors,
including product mix, customer mix, applications mix, pricing pressures
and product yield. Generally, the cost of newer products has tended to
be higher as a percentage of product revenue than that of more mature, higher
volume products. In addition, the cost of research revenue is
significantly higher as a percentage of revenue, as research revenue is
typically based on costs incurred rather than market pricing. Considering these factors, gross margin fluctuations
are difficult to predict and there can be no assurance that the Company
will achieve or maintain gross marginsmargin percentages at historical levels in
future periods.
Research and Development. Research and development expense was $5.2$5.9
million, or 11%8 percent of revenue for the quarter ended September 30, 1999March 31, 2000 as
compared to $3.2$3.8 million, or 12%10 percent of revenue for the quarter ended
September 30, 1998. For the first nine months of 1999, research and
development expense was $13.3 million, or 10% of revenue as compared to
$9.3 million, or 11% of revenue for the corresponding 1998 period.March 31, 1999. The increase in research and development spending is
primarily due to
increased expenditures associated with the continued development and enhancement of the
Company's fiber optic communication products.
The Company is committedexpects to
continuing its significant research andcommit substantial resources to product development expenditures andin future periods. As
a result, the Company expects that the absolute dollar amount of research and development expenses willto
continue to increase as it invests in developing new products and processes, expanding and enhancing its
existing product lines, and reducing its costs,absolute dollars in future periods, although
research and development expenses may vary as a percentage of revenue.
Selling, General and Administrative. Selling, general and administrative
(SG&A) expense was $6.5$7.3 million, or 14%10 percent of revenue for the quarter
ended September 30, 1999March 31, 2000 as compared to $4.0$5.7 million, or 15%15 percent of
revenue for the quarter ended September 30, 1998.March 31, 1999. The increase in SG&A
spending was primarily due to the following: (i) higher personnel-related
costs to support the growth in revenues and operations; (ii) increased
professional service expenses; and, (iii) expansionincrease in non-cash stock
compensation charges of the information
systems infrastructure$0.6 million. These factors were partially
offset by charges incurred related to manage the Company's growth. For the first
nine months of 1999, SG&A expense was $18.7 million as compared to $12.0
million for the corresponding 1998 period. SG&A expense, as a percentage
of revenue, was 15% for both periods. SG&A spending increased during
the first nine months of 1999 primarily due to continued expansion of the
Company's business and personnel and the implementation of the Company's
new enterprise resource planning software.software during the prior year quarter.
There can be no assurances that current SG&A levels as a percentage of
total revenue are indicative of future SG&A as a percentage of total
revenue.
In-process research and development. 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. The Company's acquisition of the fiber laser business from
Polaroid during the first quarter 1999 resulted in the write-off of
purchased in-process research and developmentIPR&D of $1.5 million. In the future, additional in-process research and development
write-offs can besecond quarter of 2000, an
IPR&D write-off is anticipated related to the extentCompany's acquisition of
Veritech Microwave, Inc. and Photonic Integration Research, Inc.
The fair value of the Company mayIPR&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
time acquire companiescomplete 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 exceed the
amounts an independent party would pay for these projects. Failure to
deliver new product lines.
Merger Costs. Inproducts to the quarter ended June 30, 1999,market on a timely basis, or to achieve
expected market acceptance or revenue and expense forecasts, could have
a significant impact on the Company recorded
merger related costsfinancial results and operations of $2.7 million in connection with the
acquisition
of IOC in a transaction accounted for as a pooling of interest. The
costs incurred related primarily to printing, filing fees and
professional fees for legal and accounting services.acquired businesses.
Interest Income, net. Net interest income for the three and nine months ended
September 30, 1999March 31, 2000 was $0.6$4.5 million and $1.2 million, respectively, compared to $0.3 million and $0.9 million for the
corresponding 1998
periods.1999 period. 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.
Provision for Income Taxes. The Company recorded a provision for income
taxes of $4.9 million and $0.7$8.7 million for the ninethree months ended September 30, 1999 and 1998, respectively.March 31, 2000.
Excluding the impact of the in-process research and development charge and IOC merger costs in
1999,2000, the effective tax rate for the first ninethree months of 19992000 was 22%,36
percent, compared to 13%31 percent for the first ninethree months of 1998. In 1998, the Company
benefited from previously unrecognized tax loss carryforwards, generated
from a 1997 legal settlement, which reduced the federal and state
provisions to minimum tax levels offset partially by unbenefited foreign
tax losses generated.1999. The
increase in the 19992000 tax rate is primarily attributable to the Company's
utilization of the remainder of federal and state tax loss carryforwards.
Although realization is not assured, the Company believes that it will
generate future taxable income sufficient to realize the benefit of the
$4.0 million of net deferred tax assets recorded. The amount of the net
deferred tax assets considered realizable could be reduced or increased
in the near term if estimates of future taxable income are changed.
Management intends to evaluate the realizability of the net deferred tax
assets on a quarterly basis to assess the need for the valuation
allowance.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1999,March 31, 2000, the Company's combined balance of cash, cash
equivalents and marketable securities was $292.3$315.1 million. Cash provided
by operatingOperating
activities isgenerated $8.7 million during the three months ended March 31,
2000 primarily the result of net income, non-cash expenses for
depreciation and amortization, and increasesan increase in accrued
payroll and accrued liabilitiesincome taxes payable
offset by increases in accounts receivable and inventory.inventory and decreases in
accrued payroll and accounts payable.
Cash used in investing activities was $92.2$72.5 million in the ninethree months
ended September 30, 1999.March 31, 2000. The Company incurred capital expenditures of $21.4$6.5
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 $9$50
million for capital equipment purchases and leasehold improvements during
the remainder of 1999.2000. During the first ninethree months of 1999,2000, the
Company invested excess net cash of $65.8$83.0 million in short term
investments. In addition, the Company acquired Polaroid's fiber laser businessQueensgate during the
first quarter of 1999 which resulted2000 resulting in net cash payments of $5.1$3.9 million.
The Company generated $274.3$4.4 million from financing activities during the
first ninethree months of 1999 primarily2000 from the issuance of stock under employee
stock plans, and a public offering of the Company's common stock,
offset by capital lease and notes payable payments.
The Company believes that current cash balances, cash generated from operations, and cash available through the bank and equity markets will be sufficient to fund capital equipment purchases, acquisitions of complementary businesses, 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.
The estimated product development cycle for the new product was 12 months.
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.
IMPACT OF YEAR 2000
Like many other companies,In prior years, the Company discussed the nature and progress of its
plans to become year 2000 computer issue creates risks for
SDL. Someready. In late 1999, the Company completed its
remediation and testing of the Company's older computer programs were written using
two digits rather than four to define the applicable year.systems. As a result of those computer programs have time-sensitive software that recognize a
date using "00" as the year 1900 rather than the year 2000. If internal
systems do not correctly recognizeplanning and
process date information beyond
the year 1999, there could be a material adverse impact on the Company's
business and results of operations.
To address these year 2000 issues within its internal systems,implementation efforts, the Company has established a task teamexperienced no significant
disruptions in mission critical information technology and initiated a comprehensive program
designed to deal with the most criticalnon-
information technology systems first. Assessment and remediation are proceeding in tandem, and the Company has most changes to
criticalbelieves those systems completed. These activities are intended to encompass
all systems software applications in use by the Company, including front
and back-end manufacturing, facilities, sales, finance and human
resources.
As newer, more functional software solutions were currently available and
were Year 2000 compliant, the Company has concluded that the conversion
to enterprise resource planning software programs supporting the
Company's manufacturing, finance, distribution / logistics and human
resource operations was more cost effective. The conversion project was
completed during the quarter ended June 30, 1999.
Assessment and remediation of year 2000 issues in tertiary business
information systems is on-going. The Company has determined that over
90% of the Company's desktop PC hardware systems are known to be year
2000 compliant. Additionally, the Company has concluded that the
purchase of newer, more functional software for its network server
applications is more cost effective than upgrading its existing software
to a year 2000 compliant version. Completing the remediation of the
Company's tertiary business information systems is not expected to be a
significant burden on the Company.
To date, based on its evaluations of its current manufacturing process,
SDL believes it has no material exposure to contingencies directly
related directlysuccessfully
responded to the Year 2000 issue for thedate 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, it has soldits internal systems, or
will sell in the future.
SDL is also actively working with critical suppliers of products and
services to determine that the suppliers' operations and the
products and services they provide are year 2000 compatible orof third parties. The Company will continue to
monitor their
progress toward year 2000 compatibility. In addition, the Company has
commenced work on various typesits mission critical computer applications and those of contingency planning to address
potential problem areas with internal systems. It is expected that
assessment, remediationits
suppliers and contingency planning activities will be on-
goingvendors throughout the fourth quarter of 1999 with the goal of resolving
all material internal systems and third party issues.
The costs incurred to date related to these programs are approximately
$3.9 million. The Company currently expects that the total cost of these
programs, including both incremental spending and redeployed resources,
will total approximately $4.2 million, which includes $2.6 million for
the purchase of new software and hardware that will be capitalized and
$1.6 million that will be expensed as incurred. The Company expects
that operating activities will fund these year 2000 remediation costs.
In some instances, the installation schedule of new software and hardware
in the normal course of business is being accelerated to also afford a
solution to year 2000 capability issues. The costs of these projects and
dates on which the Company believes it will complete the year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the
continued availability of certain resources and other factors.
Based on currently available information, management does not believeto ensure that the yearany latent
Year 2000 matters discussed above related to internal systems or
products sold to customers will have a material adverse impact on the
Company's financial condition or overall trends in results of operations;
however, it is uncertain to what extent the Companythat may be affected by
such matters. Any failure to timely, successfully and cost-effectively
assess, identify, remediate and resolve the Company's year 2000 issues,
including those regarding its own as well as suppliers' and third
parties' internal systems, products, services and contingency plans, may
have a material adverse effect on the Company's business and results of
operations and could expose us to year 2000 related litigation and
claims. The Company is continuing its efforts to ensure year 2000
readiness, and there is risk that there may be new year 2000 issues not
identified above and significant delays in or increased costs associated
with such efforts which could have a material adverse effect on the
Company's business and results of operations.arise are addressed promptly.
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, the ability to realize the benefit of net
deferred tax assets, capital equipment purchases and leasehold
improvement expenditures, the Company's yearexpected effective tax rate, expected
expenditures during 2000, plans, the impact and
expensessufficiency of year 2000 issues, completion of assessment and remediation of
year 2000 issues, future liability related to year 2000 issues, the
Company's year 2000 readiness,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 factors that could cause actual results to differ materially
are the risks discussed above in the MD&A particularly the risks related to the
year 2000 problem, and the factors detailed below.
You should also consult the risk factors listed in the Company's
Registration Statement on Form S-410-K filed with the SEC on April 2, 1999, as amended,March 30, 2000,
and from time to time in the Company's Reports on Forms 10-Q, 8-K, 10-K, 10-K/A and
Annual Reports to Stockholders.
Manufacturing Risks
The manufacture of semiconductor lasers and related products and systems that we sell is highly complex and precise, requiring production in a highly controlled and clean environment. Changes in the manufacturing processes or the inadvertent use of defective or contaminated materials by us or our suppliers have in the past and could in the future significantly impair our ability to achieve acceptable manufacturing yields and product reliability. If we do not achieve acceptable yields or product reliability, our operating results and customer relationships will be adversely affected. We rely almost exclusively on our own production capability in:
o- computer-aided chip and package design,
o- wafer fabrication,
o- wafer processing,
o- device packaging,
o- fiber production and grating fabrication,
- hybrid microelectronic packaging,
o- module assembly,
- printed circuit board testing, and
o- final assembly and testing of products.
Because we manufacture, package and test these components, products and systems at our own facility, and because these components, products and systems are not readily available from other sources, our business and results of operations will be significantly impaired if our manufacturing is interrupted by any of the following:
o- shortages of parts or equipment,
o- equipment failures,
o- poor yields,
o- fire or natural disaster,
o- delays in bringing new facilities on line,
- labor or equipment shortages, or
o- otherwise.
A significant portion of our production relies or occurs on equipment for which we do not have a backup. To alleviate, at least in part, this situation, we remodeled our front-end wafer fabrication facility and our packaging and test facility. We cannot assure you that we will not experience further start-up costs and yield problems in fully utilizing our increased wafer capacity targeted by these remodeling efforts. In addition, we are deploying a new manufacturing execution software system designed to further automate and streamline our manufacturing processes, and there may be unforeseen deficiencies in this system which could adversely affect our manufacturing processes. In the event of any disruption in production by one of these machines or systems, our business and results of operations could be materially adversely affected. Furthermore, we have a limited number of employees dedicated to the operation and maintenance of our equipment, loss of whom could affect our ability to effectively operate and service our equipment. We experienced lower than expected production yields on some of our products, including certain key product lines over the past 3 years. This reduction in yields:
o- adversely affected gross margins,
o- delayed component, product and system shipments, and
o- to a certain extent, delayed new orders booked.
Although more recently, our yields have improved, we cannot assure you that yields will continue to improve or not decline in the future, nor that in the future our manufacturing yields will be acceptable to ship products on time. To the extent that we experience lower than expected manufacturing yields or experience any shipment delays, gross margins will likely be significantly reduced and we could lose customers and experience reduced or delayed customer orders and cancellation of existing backlog. We presently are ramping production of some of our product lines by:
o- changing our shift schedules and equipment coverage,
o- hiring and training new personnel,
o- acquiring new equipment, and
o- expanding our
packagingfacilities and capabilities.
Difficulties in starting production to meet expected demand and schedules have occurred in the past and may occur in the future including the following:
o- quality problems could arise, yields could fall, and gross margins could be reduced during such a
ramp.ramp, or
o aggressive volume pricing for large long-term orders has been provided to certain customers.
o- cost reductions in manufacturing are required to avoid a drop in gross margins for certain products sold to customers receiving volume pricing.
These costCost 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.
Dependence on Single Source and Other Third Party Suppliers
We depend on a single or limited number of outside contractors and suppliers for raw materials, packages and standard components, and to assemble printed 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:
- a stoppage or delay of supply,
- substitution of more expensive or less reliable parts,
- receipt of defective parts or contaminated materials, and
- an increase in the price of such supplies or our inability to obtain reduced pricing from our suppliers in response to competitive pressures.
Competition
Our various markets are highly competitive. We face current or potential competition from four primary sources:
o- direct competitors,
o- potential entrants,
o- suppliers of potential new technologies, and
o- suppliers of existing alternative technologies.
We offer a range of components, products and systems and have numerous
competitors worldwide in various segments of our markets. As the markets
for our products grow, new competitors have recently emerged and are
likely to continue to do so in the future. We also sell products and
services to companies with which we presently compete or in the future
may compete and certain of our customers have been or could be acquired
by, or enter into strategic relations with our competitors. In most of
our product lines, our competitors and we are working to develop new
technologies, or improvements and modifications to existing
technologies, which will obsolete present products. Many of our
competitors have significantly greater financial, technical,
manufacturing, marketing, sales and other resources than we do.
In addition, many of these competitors may be able to respond more
quickly to new or emerging technologies, evolving industry trends and
changes in customer requirements and to devote greater resources to the
development, promotion and sale of their products than we.us. We cannot
assure you that:
o- our current or potential competitors have not already or will not in the future develop or acquire products or technologies comparable or superior to those that we developed,
o- combine or merge with each other or our customers to form significant competitors,
o- expand production capacity to more quickly meet customer supply requirements, or
o- adapt more quickly than we do to new technologies, evolving industry trends and changing customer requirements.
Increased competition has resulted and could, in the future, result in price reductions, reduced margins or loss of market share, any of which could materially and adversely affect our business and results of operations. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures we face will not have a material adverse effect on our business and results of operations. We expect that both direct and indirect competition will increase in the future. Additional competition could have an adverse material effect on our results of operations through price reductions and loss of market share.
Potential Volatility of Stock Price
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. 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 Results
We will report operating losses for the foreseeable future as a result of accounting charges for amortization of intangible assets and for in 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.
In March 2000, the Company acquired Queensgate Instruments, Limited ("Queensgate") 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 ten months ended December 31, 2000 and the twelve months ended December 31, 2001. In addition, we closed the 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's common stock with a fair value of approximately $621 million. We also entered into an agreement to acquire Photonic Integration Research, Inc. (PIRI) for 10,200,000 shares of the Company's common stock with a fair value of approximately $1.8 billion and a $31.25 million cash payment in May 2000 and expect to close the acquisition in June 2000. The acquisitions will be accounted for under the purchase method of accounting. Under purchase accounting, we will record the market value of our common shares 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. The amortization of goodwill and other intangible assets and the write-off of in-process research and development will result in significant non- cash expenses that will result in a net loss for the foreseeable future, which could have a material adverse effect on the market value of our stock.
We expect to incur approximately $12.1 million, primarily in the 2nd and 3rd quarters 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 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, 2000, we have a $6.1 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 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.
Risks of Acquisitions
Our strategy involves the acquisition and integration of additional companies' products, technologies and personnel. We have limited experience in acquiring outside businesses. 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:
- potentially dilutive issuances of equity securities;
- large one-time write-offs;
- reduced cash balances and related interest income;
- higher fixed expenses which require a higher level of revenues to maintain gross margins;
- the effect of local laws and taxes in foreign subsidiaries;
- the incurrence of debt and contingent liabilities; and
- amortization expenses related to goodwill and other intangible assets.
Furthermore, acquisitions involve numerous operational risks, including:
- difficulties in the integration of operations, personnel, technologies, products and the information systems of the acquired companies;
- diversion of management's attention from other business concerns;
- diversion of resources from our existing businesses, products or technologies;
- risks of entering geographic and business markets in which we have no or limited prior experience; and
- potential loss of key employees of acquired organizations.
If we are unable to successfully address any of these risks, our business could be materially and adversely affected.
Customer Order Fluctuations
Our product revenue is subject to fluctuations in customer orders. Occasionally, some of our customers have ordered more products than they need in a given period, thereby building up inventory and delaying placement of subsequent orders until such inventory has been reduced. We may also build inventory in anticipation of receiving new orders in the future. Also, customers have occasionally placed large orders that they have subsequently cancelled. In addition, due to the fact that our sales of 980 nm pump lasers products comprise a significant portion of our total revenues, our revenues are particularly susceptible to customer order fluctuations for these products. These fluctuations, cancellations and the failure to receive new orders can have adverse effects on our business and results of operations. We may also have incurred significant inventory or other expenses in preparing to fill such orders prior to their cancellation. Virtually our entire backlog is subject to cancellation. Cancellation of significant portions of our backlog, or delays in scheduled delivery dates, could have a material adverse effect on our business and results of operations.
Risks from Customer Concentration
A relatively limited number of OEM customers accounted for a substantial portion of revenue from communication products in fiscal 1999. During fiscal 1999, three communication product customers and their affiliates accounted for 15 percent, 11 percent and 11 percent of revenues, respectively. Revenue to any single customer is also subject to significant variability from quarter to quarter. Such fluctuations could have a material adverse effect on our business, operating results or financial condition. 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 that current customers will continue to place orders or that we will be able to obtain new orders from new communication customers.
Dependence on Emerging Applications and New Products
Our current products serve many applications in the communications and
materials processing and printingindustrial 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.
We believe that rapid customer acceptance and qualification of our new
products is key to our financial results. In the communications market
qualification is an especially costly, time consuming and difficult
process. A substantial portionSubstantial 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.
WeOur customers and our customerswe are often required to test and qualify laser pump lasers
and modules, modulators, amplifiers, transmitters,network monitors, receivers and marking systemstransmitters
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:
o- we or our customers will continue their existing product development efforts, or if continued that such efforts will be successful,
o- markets will develop for any of our technology or that pricing will enable such markets to develop,
o- other technology or products will not supersede our products or our customer's products, or
o- we or our customers will be able to qualify products for certain customers or markets.
We may also be unable to develop or qualify new products on a timely schedule. Moreover, even if we are successful in the timely development of new products that are accepted in the market, we often experience lower margins on these products. The lower margins are due to lower yields and other factors, and thus we may be unable to manufacture and sell new products at an acceptable cost so as to achieve acceptable gross margins.
Need To Manage Growth
We have on occasion been unable to manufacture products in quantities
sufficient to meet demand of our existing customer base and new
customers. The expansion in the scope of our operations has placed a
considerable strain on our management, financial, manufacturing and
other resources and has required us to implement and improve a variety
of operating, financial and other systems, procedures and controls. In
addition, we have currentlyrecently 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 be adequate toadequately support our operations or that our systems,
procedures and controls will be designed, implemented or improved in a
cost-effective and timely manner. Any failure to implement, improve and
expand such systems, procedures and controls in an efficient manner at a
pace consistent with our business could have a material adverse effect
on our business and results of operations.
Our future success is dependent, in part, on our ability to attract, assimilate and retain additional employees, including certain key personnel. We will continue to need a substantial number of additional personnel, including those with specialized skills, to commercialize our products and expand all areas of our business in order to continue to grow. Competition for such personnel is intense, and we cannot assure you that we will be able to attract, assimilate or retain additional highly qualified personnel.
Risks of Acquisitions
Our strategy involves the acquisition and integration of additional
companies' products, technologies and personnel. We have limited
experience in acquiring outside businesses. Acquisition of businesses
requires substantial time and attention of management personnel and may
require additional equity or debt financings. Furthermore, integration of
newly established or acquired businesses is often disruptive. Since we
have acquired or in the future may acquire one or more businesses, we
cannot assure you that we will:
o identify appropriate targets,
o acquire such businesses on favorable terms,
o be able to successfully integrate or attain the anticipated synergies
expected by bringing such organizations into our business,
o retain the employees required to successfully operate and grow the
business, or
o be able to improve or even maintain the operating results of such
businesses.
Failure to do so could significantly impair our business, financial
condition and results of operations and a have a material adverse effect
on our business and results of operations.
Dependence Upon Government Programs And Contracts
The Company derived approximately 11%, 26%, and 34% of its revenue
during the first nine months of 1999, fiscal 1998, and fiscal 1997,
respectively, directly and indirectly from a variety of Federal
government sources. The Company received approximately 8%, 13% and 17% of
its revenue for the first nine months of 1999, and fiscal 1998, and
fiscal 1997, respectively, from Lockheed Martin through several U.S.
government and commercial programs. Almost all of the Company's revenue
from Lockheed Martin during these periods was derived from Federally-
funded programs. Revenue from certain of these Lockheed Martin programs
are expected to decrease in the near term.
The demand for certain of our services and products is directly related
to the level of funding of government programs. We believe that the
success and further development of our business is dependent, in
significant part, upon the continued existence and funding of such
programs and upon our ability to participate in such programs. For
example, Federal programs funded substantially all of our research
revenue for 1998, 1997 and 1996. Most of our Federally-funded programs
are subject to renewal every one or two years, so that continued work by
us under these programs in future periods is not assured. Federally-
funded programs are subject to termination for convenience of the
government agency, at which point we would be reimbursed for related
allowable costs incurred to the termination date.
Federally-funded contracts are subject to audit of pricing and actual
costs incurred, which have resulted, and could result in the future, in
price adjustments. The Federal government has in the past, and could in
the future, challenge our accounting methodology for computing indirect
rates and allocating indirect costs to government contracts. The
government is currently challenging certain indirect cost allocations.
While we believe that amounts recorded on our financial statements are
adequate to cover all related risks, the government has not concluded its
investigation or agreed to a settlement with us. Although the outcome of
this matter cannot be determined at this time, we do not believe that its
outcome will have a material adverse effect on our financial position,
results of operations and cash flows. However, based on future
developments, our estimate of the outcome of these matters could change
in the near term. In addition, a change in our accounting practices in
this area could result in reduced profit margins on government contracts.
Dependence on Key Employees
Our future performance also depends in significant part upon the
continued service of our key technical and senior management personnel.
The loss of the services of one or more of our officers or other key
employees could significantly impair our business, operating results and
financial condition. While many of our current employees have many years
of service with us, there can be no assurance that we will be able to
retain our existing personnel. If we are unable to retain and hire
additional personnel, our business and results of operations could be
materially and adversely affected.
See also "Our acquisition strategy
poses several risks" above.
Risk of Patent Infringement Claims
The semiconductor, optoelectronics, communications, information and laser industries are characterized by frequent litigation regarding patent and other intellectual property rights. From time to time we have received and may receive in the future, notice of claims of infringement of other parties' proprietary rights and licensing offers to commercialize third party patent rights. In addition, we cannot assure you that:
o- additional infringement claims (or claims for indemnification resulting from infringement claims) will not be asserted against us, or
o- that existing claims or any other assertions will not result in an injunction against the sale of infringing products or otherwise significantly impair our business and results of operations.
In 1985, we first received correspondence from Rockwell International
Corporation alleging that we used a fabrication process that infringes
Rockwell's patent rights. Those allegations led to two related lawsuits,
one of which is still pending. The first lawsuit was filed in August
1993, when Rockwell sued the Federal government in the United States
Court of Federal Claims, alleging infringement of these patent rights
with respect to the contracts the Federal government has had with at
least 15 companies, including us (Rockwell International Corporation v.
The United States of America, No. 93-542C (US Ct. Fed. Cl.)). We were
not originally named as a party to this lawsuit. However, the Federal
government has asserted that, if wethe Federal government were held liable to
Rockwell for infringement of Rockwell's patent rights in connection with some
of its contracts with us, then we wouldmight be liable to indemnify the
Federal government for a portion of its liability on certain contracts.
In June 1995, we filed a motion to intervene in the lawsuit filed in August 1993 after Rockwell filed a second lawsuit against us in May, 1995 in California. That motion was granted on August 17, 1995. Upon intervening in the Federal government's lawsuit, we filed an answer to Rockwell's complaint in that lawsuit, alleging that:
o- Rockwell's patent was invalid and that we did not infringe Rockwell's patent,
o- Rockwell's patent was unenforceable under the doctrine of inequitable conduct, and
o- Rockwell's action is barred by the doctrines of laches and equitable estoppel.
After extensive discovery, we moved, as did the Federal government, for
summary judgment on the ground that Rockwell's patent was invalid. By
order dated February 5, 1997, the Court of Federal Claims granted those
motions and entered judgment in our favor and in favor of the Federal
government. However, Rockwell appealed the Court of Federal Claims'
decision, and on June 15, 1998, the United States Court of Appeals for
the Federal Circuit issued an opinion vacating the judgment that had
been entered in our favor and in favor of the Federal government. The US
Circuit Court for the Federal Circuit held that the Court of Federal
Claims had erred in finding that there were no genuine disputes of
material fact concerning the obviousness of the Rockwell patent, and
that the resolution of these disputes could not be decided by summary
judgementjudgment but instead requires a trial. The Federal Circuit:
o- remanded the case back to the
trial courtCourt of Federal Claims for further proceedings, and
o- affirmed the Court of Federal Claims' denial of our motion for summary judgment of invalidity based on anticipation, as well as the Court of Federal Claims' claim construction.
Subsequent to the Federal Circuit's action, the United States agreed to pay Rockwell $16.9 million in settlement of the 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
patent in connection with our manufacture and sale of products to
customers other than the United States. Again, the complaint alleges
that we used a fabrication process that infringes the Rockwell patent
(Rockwell International Corporation v. SDL, Inc., No. C95-01729 MHP (US
Dist.Ct., N.D. Cal.)). By its complaint, Rockwell seekssought a permanent
injunctionjudgment
against us to:
o- permanently enjoin us from
infringement ofusing theRockwellfabrication processes allegedly covered by Rockwell's patent,
o- require us to pay damages in an unspecified amount for our alleged past infringement of the patent, treble damages and attorneys' fees.
The complaint was served on us on June 30, 1995, and we filed an answer to the complaint on August 18, 1995, alleging that:
o- Rockwell's patent is invalid,
o- we did not infringe Rockwell's patent,
o- Rockwell's patent is unenforceable under the doctrine of inequitable conduct, and
o- Rockwell's action is barred by the doctrines of laches and equitable estoppel.
On August 11, 1995, prior to filing our answer, we filed a motion to
stay this action based upon the pendency of the lawsuit brought by the
federalFederal 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, and discovery re-commencedrecommenced in the
second lawsuit.
Although the Court of Federal Claims ruled in our favor in the first
lawsuit, finding the patent invalid on motion for summary judgment, the
Court of Appeals for the Federal Circuit reversed the summary judgment
ruling, meaning that the issue of validity neededneeds to go to trial. Such a
trial would now occur before a jury in California. The California judge
also required that a settlement conference between Rockwell and SDL be
scheduled in order to see if the parties can resolve the dispute before
trial, which conference occurred in the first part of June 1999. The
parties were unable to successfully resolve the lawsuit.
Later in June 1999, Rockwell filed a motion for summary judgementjudgment
relative to certain patent claims in their patent rights seekingthe Rockwell patent. That motion sought
to have the court summarily find us to have infringed those claims, whichclaims.
Rockwell filed a separate motion will be vigorously opposed byseeking to have the Company. The hearingcourt summarily find
that we could not argue that Rockwell's patent was invalid on the motion was
held in October. Noa particular
ground. A decision on the issues has been made. Regardlessmotions was rendered in the beginning of the outcome of the decision of this motion,February
2000. The District Court ruled that the Company believesinfringed the specified
claims of Rockwell's patent. The District Court also ruled that itswe
could not make the invalidity argument specified by Rockwell's motion.
The District Court's ruling will prevent us from defending against
Rockwell's lawsuit on the ground that we do not infringe Rockwell's
patent. The District Court's ruling will also prevent us from making
one (but not all) of our invalidity arguments, unless it 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 be
pursued at trial.pursue these defenses.
Rockwell's patent expired in January 2000 so that it is no longer possible for Rockwell to obtain an injunction stopping us from using the fabrication process allegedly covered by Rockwell's patent.
The resolution of this litigation is fact intensive so that the outcome
cannot be determined and remains uncertain. If Rockwell prevailed in
the litigation, it could be awarded monetary damages against the
Company. WhileAlthough we believe that we have meritorious defenses to
Rockwell's allegations, there can be no assurance that Rockwell will not
ultimately prevail in this dispute. If Rockwell were to prevail,
Rockwell could be awarded substantial monetary damages and/or an injunction against us for
the sale of infringing products. If this injunction were entered, we may
seek to obtain a license to use Rockwell's patent until the January 2000
expiration date of the patent. We cannot assure you, however, that a
license would be available on reasonable terms or at all. The award of monetary damages against
us, including past damages, or the failure to
obtain a license to use Rockwell's patent on commercially reasonable
terms could have a material adverse effect on our
business and results of operations. Litigation 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 on our business and results of
operations.
In addition, we are involved in various legal proceedings and controversies arising in the ordinary course of our business.
Customer Order Fluctuations
Our product revenue is subject to fluctuations in customer orders.
Occasionally, some of our customers have ordered more products than they
need in a given period, thereby building up inventory and delaying
placement of subsequent orders until such inventory has been reduced. We
may also build inventory in anticipation of receiving new orders in the
future. Also, customers have occasionally placed large orders that they
have subsequently cancelled. In addition, due to the fact that our sales
of our 980 nm pump module products comprise a significant portion of our
total revenues, our revenues are particularly susceptible to customer
order fluctuations for this product. These fluctuations, cancellations
and the failure to receive new orders can have adverse effectsDependence on our
business and results of operations. We may also have incurred significant
inventory or other expenses in preparing to fill such orders prior to
their cancellation. Virtually our entire backlog is subject to
cancellation. Cancellation of significant portions of our backlog, or
delays in scheduled delivery dates, could have a material adverse effect
on our business and results of operations.
Dependence of Proprietary Technology
Our future success and competitive position is dependent in part upon our proprietary technology, and we rely in part on patent, trade secret, trademark and copyright law to protect our intellectual property. There can be no assurance that:
o- any of the over 200 patents, domestic and foreign, owned or approximately
12595 patents licensed by us will not be invalidated, circumvented, challenged or licensed to others,
o- the rights granted under the patents will provide competitive advantages to us,
o- any of our approximately
150170 pending or future patent applications will be issued with the scope of the claims sought by us, if at all, or
o- that others will not develop technologies that are similar or superior to our technology, duplicate our technology or design around the patents we own, or obtain a license to the patents we own or license, or patent or assert patents on technology
whichthat we might use or intend to use.
In addition, effective copyright and trade secret protection may be
unavailable, limited or not applied for in certain foreign countries. OurA
portion of our technology is licensed on a non-exclusive basis from
Xerox and other third parties that may license such technology to
others, including our competitors. There can be no assurance that steps
we take to protect our technology will prevent misappropriation of such
technology. In addition, litigation has been necessary and may be
necessary in the future:
o- to enforce our patents and other intellectual property rights,
o- to protect our trade secrets,
o- to determine the validity and scope of the proprietary rights of others, or
o- to defend against claims of infringement or invalidity of intellectual property rights developed internally or acquired from third parties.
Litigation of this type has resulted in substantial costs and diversion of resources and could have a material adverse effect on our business and results of operations. Moreover, we may be required to participate in interference proceedings to determine the propriety of inventions. These proceedings could result in substantial cost to us.
International Distribution Risks
Revenues from customers outside of the United States accounted for
approximately 3741 percent, 27 percent and 25 percent, of our total
revenue in the first nine months offiscal 1999, fiscal 1998 and 1997, respectively. International
revenue carries a number of inherent risks, including:
o- reduced protection for intellectual property rights in some countries,
o- the impact of unstable environments in economies outside the United States,
o- generally longer receivable collection periods,
o- changes in regulatory environments,
o- tariffs, and
o- other potential trade barriers.
In addition, some of our international revenue is subject to export licensing and approvals by the Department of Commerce or other Federal governmental agencies. Although to date, we have experienced little difficulty in obtaining such licenses or approvals, the failure to obtain these licenses or approvals or comply with such regulations in the future could have a material adverse effect on our business and results of operations.
We currently use local distributors in key industrialized countries and local representatives in smaller markets. Although we have formal distribution contracts with some of our distributors and representatives, some of our relationships are currently on an informal basis. Most of our international distributors and representatives offer only our products; however, certain distributors offer competing products and we cannot assure you that additional distributors and representatives will not also offer products that are competitive with our products. Certain of our acquisitions have contracts with distributors or representatives that may have conflicts with our existing distributors and representatives or in any event may desires to terminate certain distributors or representatives 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 Risks
We, as well as our acquisitions, are subject to a variety of federal,
state and local laws and regulations concerning the storage, use,
discharge and disposal of toxic, volatile, or otherwise hazardous or
regulated chemicals or materials used in our manufacturing processes.
Further, we are subject to other safety, labeling and training
regulations as required by local, state and federal law. We have
established an environmental and safety compliance program to meet the
objectives of applicable federal, state and local laws. Our environmental
and safety department administers this compliance program which includes
monitoring, measuring and reporting compliance, establishing safety
programs and training our personnel in environmental and safety matters.
We cannot assure you that changes in these regulations and laws will not
have an adverse economic effect on us.us or our acquisitions. Further, these
local, state, and federal regulations could restrict our ability to
expand our operations. If we do not:
o- obtain required permits for,
o- operate within regulations for,
o- control the use of, or
o- adequately restrict the discharge of hazardous or regulated substances or materials under present or future regulations, we may be required to pay substantial penalties, to make costly changes in our manufacturing processes or facilities or to suspend our operations.
Dependence on Single Source And Other Third Party Suppliers
We depend on a single or limited numberIf we are unable to successfully address any of outside contractors and
suppliers for raw materials, packages and standard components, and to
assemble printed circuitboards. We generally purchase these products
through standard purchase orders or one-year supply agreements. We do not
have long-term guaranteed supply agreements with these suppliers. We seek
to maintain a sufficient safety stock to overcome short-term shipping
delays or supply interruptions by our suppliers. We also endeavor to
maintain ongoing communications with our suppliers to guard against
interruptions in supply. To date, we have generally been able to obtain
sufficient supplies in a timely manner. However,risks, our business
and results
of operations have in the past been and could be impaired by:
o a stoppage or delay of supply,
o substitution of more expensive or less reliable parts,
o receipt of defective parts or contaminated materials,materially and
o an increase in the price of such supplies or our inability to obtain
reduced pricing from our suppliers in response to competitive
pressures.
Potential Volatility of Stock Price
The market price of our Common Stock may fluctuate significantly because
of:
o announcements of technological innovations,
o large customer orders,
o customer order delays or cancellations,
o customer qualification delays,
o new products by us, our competitors or third parties,
o possible acquisition of us by a third party,
o merger or acquisition announcements,
o production problems,
o quarterly variations in our actual or anticipated results of
operations, and
o developments in litigation in which we are or may become involved.
Furthermore, the stock market has experienced extreme price and volume
volatility, which has particularly affected the market prices of many
high technology companies. This volatility has often been unrelated to
the operating performance of such companies. This broad market volatility
may adversely affect the market price of our Common Stock. Many companies
in the optical communications industry have in the past year experienced
historical highs in the market prices of their stock. We cannot assure
you that the market price of our Common Stock will not experience
significant volatility in the future, including volatility that is
unrelated to our performance.affected.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's market risk disclosures set forth in Item 7A of its Annual
Report on Form 10-K/A10-K for the year ended December 31, 19981999 have not
changed significantly.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicableInformation disclosed in the Company's Form 10-K for the year ended
December 31, 1999 under heading Part I Item 3, Legal Proceedings, is
incorporated herein by this reference. As reported in the disclosure,
the Company sought to have the court in the Rockwell matter reconsider
its decision with respect to a particular invalidity argument that the
court had ruled upon in February 2000. Since the date of the
disclosure, the court has denied our request.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable(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. The shares of the Company's Common Stock were 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.
(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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
A Special Meeting of Stockholders (the "Special Meeting") of the Company was held on February 28, 2000.
At the Special Meeting, the following item was put to a vote of the stockholders:
An amendment to the Company's Amended and Restated Certificates of Incorporation to increase the aggregate number of 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:
For Against Abstain
- ------------- ------------- -------------
30,698,080 36,579 47,826
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits
Exhibit 27.1 - Financial Data Schedule
(b) Reports on Form 8-K
Not applicable
We filed a report on Form 8-K on March 21, 2000 reporting the acquisition of all of the outstanding share capital of Queensgate Instruments Limited pursuant to a Share Purchase Agreement dated March 8, 2000 among SDL and the shareholders and optionholders of Queensgate Instruments Limited.
We filed a report on Form 8-K on April 11, 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.
SDL, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| SDL, INC. |
| (Registrant) |
Dated: November 2, 1999May 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) |