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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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(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 28, 1997
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
COMMISSION FILE NO. 0-11007
EMULEX CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 51-0300558
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(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
3535 HARBOR BOULEVARD
COSTA MESA, CALIFORNIA 92626
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(Address of principal executive offices) (Zip Code)
(714) 662-5600
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(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.Yes X No
As of November 7, 1997, the registrant had 6,109,847 shares of common stock
outstanding.
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EMULEX CORPORATION AND SUBSIDIARIES
INDEX
PAGE
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 28, 1997 and June 29, 1997 2
Condensed Consolidated Statements of Operations
Three months ended September 28, 1997
and September 29, 1996 3
Condensed Consolidated Statements of Cash Flows
Three months ended September 28, 1997
and September 29, 1996 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 6
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
September 28, June 29,
1997 1997
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ASSETS
Current assets:
Cash and cash equivalents $ 1,638 $ 484
Accounts and notes receivable, net 12,513 14,785
Inventories, net 12,870 12,713
Prepaid expenses 1,392 1,066
Income taxes receivable and other assets 379 280
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Total current assets 28,792 29,328
Property, plant and equipment, net 6,746 6,961
Prepaid expenses and other assets 803 886
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$36,341 $37,175
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of capitalized
lease obligations $ 82 $ 125
Accounts payable 2,870 4,294
Accrued liabilities 6,056 6,120
Deferred income taxes -- 320
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Total current liabilities 9,008 10,859
Capitalized lease obligations,
excluding current installments 65 79
Deferred revenue -- 6
Deferred income taxes 2,348 1,955
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Total liabilities 11,421 12,899
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Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000
shares authorized (150,000 shares designated as
Series A Junior Participating Preferred Stock);
none issued and outstanding -- --
Common stock, $0.20 par value; 20,000,000 shares
authorized; 6,107,493 and 6,100,546 issued
and outstanding at September 28, 1997 and
June 29, 1997, respectively 1,221 1,220
Additional paid-in capital 7,317 7,283
Retained earnings 16,382 15,773
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Total stockholders' equity 24,920 24,276
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$36,341 $37,175
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See accompanying notes to condensed consolidated financial statements.
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EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three Months Ended
-------------------------------
September 28, September 29,
1997 1996
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Net revenues $ 15,007 $ 15,952
Cost of sales 8,836 10,482
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Gross profit 6,171 5,470
Operating expenses:
Engineering and development 2,393 2,500
Selling and marketing 2,014 2,079
General and administrative 1,101 1,243
Consolidation charges -- 1,280
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Total operating expenses 5,508 7,102
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Operating income (loss) 663 (1,632)
Nonoperating income 14 206
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Income (loss) before income taxes 677 (1,426)
Income tax provision (benefit) 68 (485)
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Net income (loss) $ 609 $ (941)
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Net income (loss) per common and common
equivalent share $ 0.10 $ (0.16)
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Weighted average number of common
and common equivalent shares 6,312 5,998
======== ========
See accompanying notes to condensed consolidated financial statements.
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EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months Ended
-----------------------------
September 28, September 29,
1997 1996
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Cash flows from operating activities:
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Net income (loss) $ 609 $ (941)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 601 711
Loss on disposal of property, plant and equipment 4 21
Provision for doubtful accounts 28 31
Changes in assets and liabilities:
- ----------------------------------
Accounts receivable 2,244 (962)
Inventories (157) 2,885
Accounts payable (1,424) (3,072)
Accrued liabilities (64) (806)
Income taxes receivable 58 (143)
Deferred revenue (6) --
Deferred income taxes 1 --
Prepaid expenses and other assets (328) (97)
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Net cash provided by (used in) operating activities 1,566 (2,373)
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Cash flows from investing activities:
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Net proceeds from sale of property, plant and equipment -- 1
Additions to property, plant and equipment (390) (696)
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Net cash used in investing activities (390) (695)
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Cash flows from financing activities:
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Principal payments under capital leases (57) (76)
Proceeds from note payable to bank, net -- 2,000
Proceeds from issuance of common stock 35 52
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Net cash provided by (used in ) financing activities (22) 1,976
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Net increase (decrease) in cash and cash equivalents 1,154 (1,092)
Cash and cash equivalents at beginning of period 484 1,635
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Cash and cash equivalents at end of period $ 1,638 $ 543
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Supplemental disclosures:
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Cash paid during the period for:
Interest $ 9 $ 66
Income taxes 10 1
See accompanying notes to condensed consolidated financial statements.
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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
1. In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (which are normal
recurring accruals) necessary to present fairly the financial position as of
September 28, 1997 and June 29, 1997, and the results of operations for the
three months ended September 28, 1997 and September 29, 1996, and the
statements of cash flows for the three months then ended. Interim results
for the three months ended September 28, 1997 are not necessarily indicative
of the results that may be expected for the year ending June 28, 1998. The
interim financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the fiscal year ended June 29,
1997. References to dollar amounts are in thousands, except share data,
unless otherwise specified.
2. Inventories
Inventories, net, are summarized as follows:
September 28, June 29,
1997 1997
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Raw materials $ 6,406 $ 7,932
Work-in-process 3,327 2,012
Finished goods 3,137 2,769
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$12,870 $12,713
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3. Net Income (Loss) per Share
Net income (loss) per common and common equivalent share was computed based
on the weighted average number of common and common equivalent shares
outstanding during the periods presented. The Company has granted certain
stock options which have been treated as common share equivalents in
computing both primary and fully diluted income per share. Common stock
equivalents have been excluded from the calculation of both primary and
fully diluted loss per share for the three months ended September 29, 1996,
as the effect would have been antidilutive. The primary and fully diluted
income (loss) per share computations are approximately the same.
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EMULEX CORPORATION AND SUBSIDIARIES
PART I.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (dollars in thousands)
FORWARD LOOKING STATEMENTS
Except for the historical information contained herein, the discussion in this
Form 10-Q in general may contain certain forward-looking statements. In
addition, when used in this Form 10-Q, the words "projected," "in the opinion,"
"believes," "expects" and similar expressions are intended to identify
forward-looking statements. Actual future results could differ materially from
those described in the forward-looking statements as a result of factors
discussed in "Business Environment and Risk Factors" set forth herein, and in
the Company's most recently filed Annual Report on Form 10-K. The Company
cautions the reader, however, that these lists of risk factors may not be
exhaustive. The Company undertakes no obligation to publicly release the results
of any revisions to these forward-looking statements that may be made to reflect
any future events or circumstances.
COMPANY OVERVIEW
Emulex Corporation is a leading designer and manufacturer of high-performance
network connectivity products including fibre channel, printer servers and
network access products. The Company's hardware and software-based networking
solutions improve communication in computer networks and enhance data flow
between computers and peripherals.
RESULTS OF OPERATIONS
The following table sets forth the percentage of net revenues represented by
selected items from the unaudited Condensed Consolidated Statements of
Operations. This table should be read in conjunction with the Condensed
Consolidated Financial Statements included elsewhere herein.
Percentage of Net Revenues
For the Three Months Ended
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September 28, September 29,
1997 1996
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Net revenues 100.0% 100.0%
Cost of sales 58.9 65.7
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Gross profit 41.1 34.3
Operating expenses:
Engineering and development 16.0 15.7
Selling and marketing 13.4 13.0
General and administrative 7.3 7.8
Consolidation charges -- 8.0
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Total operating expenses 36.7 44.5
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Operating income (loss) 4.4 (10.2)
Nonoperating income 0.1 1.3
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Income (loss) before income taxes 4.5 (8.9)
Income tax provision (benefit) 0.4 (3.0)
----- -----
Net income (loss) 4.1% (5.9)%
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NET REVENUES
Net revenues for the quarter ended September 28, 1997 were $15,007, a decrease
of $945, or 6 percent, from $15,952 for the comparable quarter of the previous
fiscal year. This decrease in net revenues was the result of a reduction in
distribution net revenues of $1,437, partially offset by in increase in net
revenues of $427 from sales to original equipment manufacturers ("OEMs") and $65
from sales to end users.
From a product line perspective, net revenues for the first quarter of fiscal
1998 from the Company's fibre channel product line increased $3,989, or 336
percent, to $5,175 compared to $1,186 for the same period of the prior fiscal
year as OEMs in this emerging market have begun to take volume shipments. Net
revenues from the Company's printer server product line decreased $2,617, or 32
percent, to $5,578 in the current quarter, compared to $8,195 in the comparable
period of the previous fiscal year. This decrease in revenues occurred in both
OEM printer servers and the distribution printer server products. The decrease
in OEM printer server revenues was primarily due to lower shipments to two large
printer server OEMs which were partially offset by increased shipments to other
OEMs. The Company believes the decrease in net revenues from distribution sales
of printer servers was primarily the result of a combination of lower average
selling price and decreased demand for after-market solutions, as more OEMs are
shipping network-ready printers. Net revenues from Emulex's network access
products decreased $1,523, or 28 percent, to $3,933 for the first quarter of
fiscal 1998. The decrease in network access products revenues was primarily due
to anticipated maturation of certain of the Company's network access products
combined with decreased shipments to Reuters as the current project with the
Company approach end of life. Net revenues from other miscellaneous product
lines decreased $794, or 71 percent, to $321 in the first quarter of the current
fiscal year compared to $1,115 in the same quarter of fiscal 1997. The first
quarter of the prior fiscal year included end-of-life sales of an OEM storage
product.
Although fibre channel represented 35 percent of net revenues for the quarter
ended September 28, 1997, the market is an emerging technology and there can be
no assurance that the Company's products will adequately meet the requirements
of the market, or achieve market acceptance. Because the Company's fibre channel
products are designed to provide both an input/output and a networking
connection between computers and storage devices, the future revenues of the
fibre channel product line depend on the availability of other fibre channel
products not manufactured or sold by the Company. Furthermore, the Company's
fibre channel products are dependent upon components supplied by third parties
for this emerging technology and there can be no assurance that these components
will be available at a competitive price and in the quantities desired, or if
available, will function as needed.
GROSS PROFIT
For the quarter ended September 28, 1997, gross profit increased $701, or 13
percent, to $6,171 compared to $5,470 in the same quarter of the previous fiscal
year. Gross profit as a percentage of net revenues increased to 41 percent from
34 percent for the comparable period of last year. The improvement in gross
profit is primarily due to a product mix that contained a greater percentage of
higher margin products and reduced manufacturing spending in the first quarter
of fiscal 1998 compared to the same period of the prior fiscal year.
OPERATING EXPENSES
Operating expenses for the quarter ended September 28, 1997 decreased by $1,594,
or 22 percent, to $5,508 versus $7,102 for the comparable period of the prior
fiscal year. Operating expenses for the first quarter of fiscal 1997 included
$1,280 of consolidation charges. Excluding these charges from the prior year,
operating expenses for the first quarter of fiscal 1998 decreased $314, or 5
percent, from the comparable period of the prior fiscal year as the Company
continued to benefit from the expense controls implemented a year ago during the
consolidation of operations combined with reduced staffing levels. Engineering
and development expenses decreased $107, or 4 percent, to $2,393 for the first
quarter of fiscal 1998. Selling and marketing expenses for the quarter decreased
$65, or 3 percent, to $2,014 compared to the same period of fiscal 1997. General
and administrative expenses for the quarter ended September 28, 1997 were
$1,101. This represents a decrease of $142, or 11 percent, compared to first
quarter of the prior fiscal year primarily due to reduced staffing levels.
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NONOPERATING INCOME
Nonoperating income for the quarter ended September 28, 1997 was $14, a decrease
of $192 compared to the same period of the prior fiscal year. This decrease was
primarily due to nonrecurring interest income of $238 associated with prior
years' tax returns recognized in the first quarter of the prior fiscal year.
This decrease was partially offset by an increase in interest income and a
decrease in interest expense related to financing activities, as well as a small
currency exchange gain in the current quarter.
INCOME TAXES
The Company's current Puerto Rico tax exemption grants for property and
municipal license tax and for income and tollgate tax expire at the end of
calendar years 1997 and 1999, respectively. The Company is currently negotiating
with the Puerto Rican government to extend these exemption grants through 2007.
Although there can be no assurance, the Company believes it will negotiate a
renewal of these exemption grants with terms and conditions which are not
materially different from the Company's current exemption grants. However, if
the Company is unable to obtain a renewal of these exemption grants or if the
terms and conditions are materially less favorable than those currently in
effect, the Company's business, results of operations, financial condition
and/or liquidity would be materially adversely affected.
The Company is currently undergoing an examination by the California Franchise
Tax Board for the Company's California income tax returns for years 1989, 1990
and 1991. In the opinion of management, this examination will not have a
material adverse effect on the Company's consolidated financial position.
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. ("Statement") 128, "Earnings Per
Share". Statement 128 specifies new standards designed to improve the earnings
per share ("EPS") information provided in financial statements by simplifying
the existing computational guidelines, revising the disclosure requirements and
increasing the comparability of EPS data on an international basis. Some of the
changes made to simplify the EPS computations include: (a) eliminating the
presentation of primary EPS and replacing it with basic EPS, with the principal
difference being that the common stock equivalents are not considered in
computing basic EPS, (b) eliminating the modified treasury stock method and the
three percent materiality provision, and (c) revising the contingent share
provisions and the supplemental EPS data requirements. Statement 128 also makes
a number of changes to existing disclosure requirements. Statement 128 is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods. The Company has not yet determined the impact
of the implementation of Statement 128.
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive Income".
The new statement is effective for both interim and annual periods beginning
after December 15, 1997. The Company has not yet determined the impact of
adopting this new standard on the consolidated financial statements.
In June 1997, the FASB issued Statement 131, "Disclosure about Segments of an
Enterprise and Related Information". The new statement is effective for fiscal
years beginning after December 15, 1997. The Company has not yet determined the
impact of adopting this new standard on the consolidated financial statements
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased by $1,154 during the first
quarter of fiscal 1998 from $484 to $1,638 as of September 28, 1997. Operating
activities, which include changes in working capital balances, provided $1,566
of cash and cash equivalents for the quarter compared to using $2,373 of cash
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and cash equivalents during the first quarter of the prior fiscal year.
Investing activities, which were limited to the acquisition and disposition of
property, plant and equipment, used $390 of cash and cash equivalents in the
quarter compared to using $695 in the comparable period of fiscal 1997. Net
financing activities, which were limited to payments under capital lease
obligations, proceeds from a note payable to a bank and proceeds from the
exercise of employee stock options, used $22 of cash and cash equivalents during
the first quarter of fiscal 1998 compared to providing $1,976 of cash and cash
equivalents in the prior year.
In addition to its cash balances, the Company has a line of credit of up to
$10,000 with Silicon Valley Bank which is available through September 1998,
unless extended by the parties. There were no borrowings outstanding under this
line at September 28, 1997 or June 29, 1997. Under the terms of the line of
credit, the Company has granted Silicon Valley Bank a security interest in its
accounts receivable, inventories, equipment and other property. The line of
credit with Silicon Valley Bank requires the Company to satisfy certain
financial and other covenants and conditions, including prescribed levels of
tangible net worth, profitability and liquidity. In the event the Company fails
to comply with any financial or other covenant in its loan agreement with
Silicon Valley Bank, the line of credit could become unavailable to the Company.
In addition, after borrowings have been made under the line of credit, a failure
to continue to satisfy such covenants would constitute an event of default,
giving rise to the various remedies available to a secured lender. The Company
was in compliance with all covenants of the line of credit as of September 28,
1997, however there can be no assurance that the Company will continue to
satisfy the financial and other covenants and conditions of the line of credit
or that the line of credit will continue to be available to meet the Company's
liquidity requirements. The Company anticipates that borrowings under the line
of credit will be required periodically during the next twelve months.
The Company believes that its existing cash balances, facilities and equipment
leases, anticipated cash flows from operating activities and available
borrowings under its line of credit will be sufficient to support its working
capital needs and capital expenditure requirements for the next twelve months.
However, the Company has periodically experienced reductions in revenue levels,
significant losses from operations and large fluctuations in the timing of
significant customer orders on a quarterly basis. The Company's ability to meet
its future liquidity requirements is dependent upon its ability to operate
profitably or, in the absence thereof, to draw on its line of credit and to
arrange additional financing. If the Company were to experience losses at the
rate experienced in 1996 and the first quarter of 1997, additional debt or
equity financing would be required within three to nine months. There can be no
assurances that revenues will remain at current levels or improve or that the
Company would be profitable at such revenue levels. In addition, there can be no
assurances that the Company may not be required to utilize its line of credit
even during profitable periods for various reasons including, but not limited
to, the timing of component purchases and/or customer orders and shipments.
Furthermore, there can be no assurances that future requirements to fund
operations will not require the Company to draw on its line of credit again or
seek additional financing, or that such line of credit or additional financing
will be available on terms favorable to the Company and its stockholders, or at
all.
BUSINESS ENVIRONMENT AND RISK FACTORS
RECENT HISTORY OF LOSSES; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company incurred net losses of $9,288 in fiscal 1996 and $941 in the first
quarter of fiscal 1997. Results for the first quarter included consolidation
charges of $1,280. While the Company generated net income for the year ended
June 29, 1997 and for the first quarter of fiscal 1998, there can be no
assurances that revenues will remain at current levels or return to the levels
experienced in previous years or that the Company would be profitable at such
revenue levels.
The Company's revenues and results of operations have varied on a quarterly
basis in the past and are expected to vary significantly in the future.
Accordingly, the Company believes that period to period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. The Company's revenue and results of
operations are difficult to
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forecast and could be adversely affected by many factors, including, among
others, the size, timing and terms of individual transactions; the relatively
long sales and deployment cycles for the Company's products, particularly
through its OEM channel; changes in the Company's operating expenses; the
ability of the Company to develop and market new products; market acceptance of
new products, particularly in the fibre channel market; timing of introduction
or enhancement of products by the Company or its competitors; the level of
product and price competition; the ability of the Company to expand its OEM and
distributor relationships; activities of and acquisitions by competitors;
changes in printer server, network access and fibre channel technology and
industry standards; changes in the mix of products sold, since the Company's
network access and fibre channel host adapter products typically have higher
margins than the Company's printer server and fibre channel hub products;
changes in the mix of channels through which products are sold; levels of
international sales; seasonality, since the Company typically experiences lower
demand for its products in Europe in the first fiscal quarter; personnel
changes; changes in customer budgeting cycles; foreign currency exchange rates;
and general economic conditions. As a result of the foregoing or other factors
in some future period, the Company's results of operations could fail to meet
the expectations of public market analysts or investors, and the price of the
Company's common stock could be materially adversely affected.
Because the Company generally ships products within a short period after receipt
of an order, the Company typically does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter. Typically, the Company generates a large percentage of its
quarterly revenues in the last month of the quarter. Adding further to the
variability of sales are certain large OEM customers that tend to order
sporadically and whose purchases can vary significantly from quarter to quarter.
A small variation in the timing of orders is likely to adversely and
disproportionately affect the Company's quarterly results of operations as the
Company's expense levels are based, in part, on its expectations of future sales
and only a small portion of the Company's expenses vary directly with its sales.
Therefore, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. Accordingly, any shortfall of
demand in relation to the Company's quarterly expectations or any delay of
customer orders would have an immediate and adverse impact on the Company's
quarterly results of operations, financial condition and/or liquidity.
Reliance on OEMs, Distributors and Key Customers
In the first quarter of fiscal 1998, the Company derived approximately 28
percent of its revenue from distributors and 66 percent from OEMs. In fiscal
1997, the Company derived approximately 31 percent of its revenue from
distributors and 64 percent from OEMs. The Company's agreements with
distributors and OEMs are typically non-exclusive and in many cases may be
terminated by either party without cause, and many of the Company's distributors
and OEMs carry competing product lines. There can be no assurance that the
Company will retain its current OEMs or distributors or that it will be able to
recruit additional or replacement OEMs or distributors. The loss of important
distributors or OEMs would adversely affect the Company's business, results of
operations, financial condition and/or liquidity. The Company negotiates
individual agreements with the majority of its OEMs and distributors. Although
these agreements are substantially standardized, due to the individual
negotiations variances do occur. However, these agreements generally provide for
discounts based on expected or actual volumes of products purchased or resold by
the reseller in a given period and do not require minimum purchases. Certain of
these agreements provide manufacturing rights and access to source code upon the
occurrence of specified conditions or defaults. The Company expects that certain
of its OEMs will in the future develop competitive products and, if they do so,
they may decide to terminate their relationship with the Company. Any reduction
or delay in sales of the Company's products by its OEMs or distributors could
have a material adverse effect on the Company's business, results of operations,
financial condition and/or liquidity.
Sequent Computer Systems accounted for 20 percent of the Company's net revenues
during the quarter ended September 28, 1997. Furthermore, the Company's top five
customers accounted for 43 percent of fiscal 1998 first quarter net revenues.
The Reuters project which accounted for 2 percent of revenues in the quarter
ended September 28, 1997, is expected to be completed by the end of calendar
1997. After that time, revenues from Reuters will be dependent upon the
extension of the existing project or the award of new design wins on future
projects.
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The Company's revenues are significantly dependent upon the ability and
willingness of its OEMs to timely develop and promote products that incorporate
the Company's technology. The ability and willingness of these OEMs to do so is
based upon a number of factors such as: the timely development by the Company
and the OEMs of new products with new functionality, increased speed and
enhanced performance at acceptable prices to end users; development costs of the
OEMs; compatibility with both existing and emerging industry standards;
technological advances; patent and other intellectual property issues and
competition generally. No assurance can be given as to the ability or
willingness of the Company's OEMs to continue developing, marketing and selling
products incorporating the Company's technology. Since the Company's business is
dependent on its relationships with its OEMs and distributors, the inability or
unwillingness of any of the Company's significant customers to continue their
relationships with the Company and to develop and promote products incorporating
the Company's technology would have a material adverse effect on the Company's
business, results of operations, financial condition and/or liquidity.
Concentration of OEM Customers
Historically, revenues from the Company's top OEM customers have accounted for a
significant portion of net revenues. In the first quarter of fiscal 1998, the
Company's top five OEM customers accounted for 41 percent of the Company's net
revenues. Although the Company has attempted to expand its base of OEMs, there
can be no assurance that its revenues in the future will not be similarly
derived from a limited number of OEM customers. The Company's largest OEM
customers vary to some extent from year to year as product cycles end,
contractual relationships expire and new products and customers emerge. Many of
the arrangements with the Company's OEMs are provided on a project-by-project
basis, are terminable with limited or no notice, and, in certain instances, are
not governed by long-term agreements. The Company also is subject to a credit
risk associated with the concentration of its accounts receivable from these
OEMs. No assurance can be given as to the ability or willingness of any of the
Company's OEMs to continue utilizing the Company's products and technology. Any
loss or significant decrease in the Company's current OEMs or any failure of the
Company to replace its existing OEMs, or any delay in or failure to receive the
payments due to the Company from such OEMs would have a material adverse effect
on the Company's business, results of operations, financial condition and/or
liquidity.
Dependence on Emerging Fibre Channel Market and Acceptance of Fibre Channel
Standard
The Company has invested and continues to invest substantially in the
engineering of products to address the fibre channel market, which is at an
early stage of development, is rapidly evolving and is attracting an increasing
number of market entrants. The Company's investment in fibre channel designs was
over 70% of the Company's engineering and development expenditures for the
quarter ended September 28, 1997. The Company's future success in the fibre
channel market will depend to a significant degree upon broad market acceptance
of fibre channel technology. Competing or alternative technologies, including
Gigabit Ethernet, are being or are likely in the future to be promoted by
current and potential competitors of the Company, some of which have
well-established relationships with current and potential customers of the
Company, extensive knowledge of the markets served by the Company, better name
recognition and more extensive development, sales and marketing resources than
the Company. The Company's success will be dependent in part on the ability of
the Company's OEM customers, as well as the Company, to develop new products
that provide the functionality, performance, speed and network connectivity
demanded by the market at acceptable prices, and to convince end users to adopt
fibre channel. While the Company has secured numerous design wins for its fibre
channel products from its OEM customers, nearly all of these customers are
currently developing systems that incorporate the Company's products, and only a
limited number of OEM customers have shipped products that incorporate the
Company's fibre channel products. To the extent these customers are unable to or
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otherwise do not deploy or ship systems that incorporate the Company's products,
or if these systems are not commercially successful, this would have a material
adverse effect on the Company's business, results of operations, financial
condition and/or liquidity. The Company believes the fibre channel market will
continue to expand, and that the Company's investment in the fibre channel
market represents a significant portion of the Company's opportunities for
revenue growth in the future. However, there can be no assurance that customers
will choose the Company's technology for use, or that fibre channel products
will gain market acceptance. If the fibre channel market fails to develop,
develops more slowly than anticipated or attracts competitors, or if the
Company's products do not achieve market acceptance, the Company's business,
results of operations, financial condition and/or liquidity would be materially
adversely affected.
Competition
The Company's products are targeted at the fibre channel, printer server and
network access markets. The markets for the Company's products are highly
competitive and are characterized by rapid technological advances, price
erosion, frequent new product introductions and evolving industry standards. In
the fibre channel market, the Company primarily competes against Adaptec,
Hewlett-Packard, QLogic Corporation, Symbios Logic, and to a lesser extent
against several smaller companies. In the printer server market, the Company
competes directly against a number of smaller companies and indirectly against
Hewlett-Packard and Lexmark, the two largest printer vendors, who primarily use
their own internally developed printer servers. In the network access market,
the Company competes against the numerous networking companies who offer network
access solutions. The Company expects that other companies will enter its
markets, particularly the new and evolving fibre channel market. Furthermore,
the Company's OEM customers may in the future develop competitive products and
may then decide to terminate their relationships with the Company. The Company's
current and potential competition consists of major domestic and international
companies, many of which have substantially greater financial, technical,
marketing and distribution resources than the Company, as well as emerging
companies attempting to obtain a share of the existing market. The Company's
competitors continue to introduce products with improved price/performance
characteristics, and the Company will have to do the same to remain competitive.
Increased competition could result in significant price competition, reduced
profit margins or loss of market share, any of which would have a material
adverse effect on the Company's business, results of operations, financial
condition and/or liquidity. There can be no assurance that the Company will be
able to compete successfully against either current or potential competitors in
the future.
Rapid Technological Change and New Product Development
The markets for the Company's products are characterized by rapidly changing
technology, evolving industry standards and frequent introduction of new
products and enhancements. The Company believes that its future success will
depend in large part on its ability to enhance its existing products and to
introduce new products on a timely basis to meet changes in customer
preferences, emerging technologies and evolving industry standards. There can be
no assurance that the Company will be successful in developing, manufacturing
and marketing new products or product enhancements that respond to technological
changes or evolving industry standards, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products or that its new products will
adequately meet the requirements of the marketplace and achieve market
acceptance. There can be no assurance that the Company will be able to develop
or license from third parties the underlying core technologies necessary for new
products and enhancements. A key element of the Company's strategy is the
development of multiple ASICs to increase system performance and reduce
manufacturing costs, thereby enhancing the price/performance of the Company's
printer server and fibre channel products. There can be no assurance the Company
will be successful at developing and incorporating ASICs effectively and on
time. Additionally, there can be no assurance that services, products or
technologies developed by others will not render the Company's products or
technologies uncompetitive or obsolete. If the Company is unable, for
technological or other reasons, to develop new products or enhancements of
existing products in a timely manner in response to changing market conditions
or customer preferences, the Company's business, results of operations,
financial condition and/or liquidity would be materially adversely affected.
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The Company has in the past engaged and expects that it will continue in the
future to engage in joint development projects with third parties. Joint
development creates several risks for the Company, including loss of control
over the development of aspects of the jointly developed product and over the
timing of product availability. There can be no assurance that joint development
activities will result in products, or that any products developed will be
commercially successful.
Risks Associated with Product Development; Product Delays
The Company in the past has experienced delays in product development, and the
Company may experience similar delays in the future. Prior delays have resulted
from numerous factors such as changing OEM product specifications, difficulties
in hiring and retaining necessary personnel, difficulties in reallocating
engineering resources and other resources limitations, difficulties with
independent contractors, changing market or competitive product requirements and
unanticipated engineering complexity. In addition, the Company's software and
hardware have in the past, and may in the future, contain undetected errors or
failures that become evident upon product introduction or as product production
volume increases. There can be no assurance, despite testing by the Company and
its OEMs, that errors will not be found, that the Company will not experience
development challenges resulting in unanticipated problems or delays in the
acceptance of products by the Company's OEMs or shipment of the OEMs' products,
or that the Company's new products and technology will meet performance
specifications under all conditions or for all anticipated applications. Given
the short product life cycles in the Company's product markets, any delay or
unanticipated difficulty associated with new product introductions or product
enhancements would have a material adverse effect on the Company's business,
results of operations, financial condition and/or liquidity.
Reliance on Third Party Suppliers
The Company relies on third party suppliers who supply the components used in
the Company's products. Most components are readily available from alternate
sources. However, the unavailability of certain components from current
suppliers, especially custom components fabricated for the Company, such as
ASICs, could result in delays in the shipment of the Company's products, as well
as additional expense associated with obtaining and qualifying a new supplier or
redesigning the Company's product to accept more readily available components.
In addition, certain key components used in the Company's products are available
only from single sources and the Company does not have long-term contracts
ensuring the supply of such components. Furthermore, the components used for the
Company's fibre channel products are based on an emerging technology and may not
be available with the performance characteristics and in the quantities required
by the Company. As the Company typically attempts to maintain less than 90 days
supply of such components, there can be no assurance that the components will be
available to meet the Company's future requirements at favorable prices, if at
all. The Company also relies on third party suppliers for some of the software
incorporated in some of the Company's products. These software items are not
generally readily available from alternate sources. The Company's future
inability to obtain components or software or to redesign its products to accept
alternatives, in a timely manner, would materially adversely affect the
Company's business and financial condition. In addition, any significant
increase in prices or inability to ship products due to a lack of components or
software could adversely affect the Company's business, results of operations,
financial condition and/or liquidity.
Dependence on Key Personnel
The Company's success depends to a significant degree on the performance and
continued service of its senior management and certain key employees. The
Company's future success also depends upon its ability to attract, train and
retain highly qualified technical, sales and marketing and managerial personnel.
An increase in technical staff with experience in highspeed networking
applications will be
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required as the Company further develops its fibre channel product line.
Competition for such highly skilled employees with technical, management,
marketing, sales, product development and other specialized skills is intense
and there can be no assurance that the Company will be successful in recruiting
and retaining such personnel. In addition, there can be no assurance that
employees will not leave the Company and, after leaving, compete against the
Company. The loss of key management, technical and sales personnel would have a
material adverse effect on the Company's business, results of operations,
financial condition and/or liquidity.
Risks Associated with International Operations and Regulatory Standards
For the quarter ended September 28, 1997, sales in the United States, Europe and
in the Pacific Rim countries accounted for 75 percent, 20 percent and 5 percent
of the Company's net revenues, respectively. The Company expects that sales in
the United States and Europe will continue to account for the substantial
majority of the Company's revenues for the foreseeable future. There can be no
assurance that the Company will achieve significant penetration in other
markets.
All of the Company's sales are currently denominated in U.S. dollars. An
increase in the value of the U.S. dollar relative to foreign currencies would
make the Company's products more expensive and therefore potentially less
competitive in those markets. Additional risks inherent in the Company's
international business activities generally include unexpected changes in
regulatory requirements, tariffs and other trade barriers, cost and risks of
localizing products for foreign countries, longer accounts receivable payment
cycles, potentially adverse tax consequences, repatriation of earning and the
burdens of complying with a wide variety of foreign laws. In addition, revenues
of the Company earned in various countries where the Company does business may
be subject to taxation by more than one jurisdiction, thereby adversely
affecting the Company's earnings. There can be no assurance that such factors
will not have an adverse effect on the Company's future international sales and
consequently, the Company's business, results of operations, financial condition
and/or liquidity.
Risks Associated With Puerto Rican Manufacturing Facility
The Company's primary manufacturing operation is located in Dorado, Puerto Rico,
an area which is subject to hurricanes at certain times of the year. Damage to
this facility or an interruption in the ability to receive components or ship
products to its customers would have a material adverse impact on the Company's
business, results of operations, financial condition and/or liquidity. In
addition, the economic viability of the Company's Puerto Rican manufacturing
facility depends in great part upon the availability of favorable tax treatment
for such operations under current tax laws. Such laws are subject to change and
may be limited or phased-out by Congress at any time.
The Company's current Puerto Rico tax exemption grants for property and
municipal license tax and for income and tollgate tax expire at the end of
calendar years 1997 and 1999, respectively. The Company is currently negotiating
with the Puerto Rican government to extend these exemption grants through 2007.
Although there can be no assurance, the Company believes it will negotiate a
renewal of these exemption grants with terms and conditions which are not
materially different from the Company's current exemption grants. However, if
the Company is unable to obtain a renewal of these exemption grants or if the
terms and conditions are materially less favorable than those currently in
effect, the Company's business, results of operations, financial condition
and/or liquidity would be materially adversely affected.
Dependence on Proprietary Technology
Although the Company believes that its continued success will depend primarily
on continuing innovation, sales, marketing and technical expertise and the
quality of product support and customer relations, the Company's success is
dependent in part on the proprietary technology contained in its products. The
Company currently relies on a combination of patents, copyrights, trademarks,
trade secret laws and contractual provisions to establish and protect
proprietary rights in its products. There can be no assurance that the steps
taken by the Company in this regard will be adequate to deter
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misappropriation or independent third party development of its technology.
Although the Company believes that its products and technology do not infringe
proprietary rights of others, there can be no assurance that third parties will
not assert infringement claims or that the Company will not be required to
obtain licenses of third party technology. Any such claims, with or without
merit, could be time consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or licensing
agreements. No assurance can be given that any necessary licenses will be
available or that if available, such license can be obtained on commercially
reasonable terms. The failure to obtain such royalty or licensing agreements on
a timely basis would have a material adverse effect on the Company's business,
results of operations, financial condition and/or liquidity.
Possible Volatility of Stock Price
As is the case with many technology based companies, the market price of the
Company's common stock has been, and is likely to continue to be, extremely
volatile. Factors such as new product introductions by the Company or its
competitors, fluctuations in the Company's quarterly operating results, the gain
or loss of significant contracts, pricing pressures, changes in earnings
estimates by analysts, and general conditions in the computer and communications
markets, among other factors, may have a significant impact on the market price
of the Company's common stock. In addition, the stock market recently has
experienced significant price and volume fluctuations which have particularly
affected the market price for many high technology companies like the Company.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27.1 -- Financial Data Schedule
(b) The registrant has not filed any reports on Form 8-K during
the period for which this report is filed.
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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.
Date: November 11, 1997
EMULEX CORPORATION
By: /s/ PAUL F. FOLINO
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Paul F. Folino
President and Chief
Executive Officer
By: /s/ MICHAEL J. ROCKENBACH
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Michael J. Rockenbach
Vice President Finance and
Acting Chief Financial Officer
(Principal Financial & Chief
Accounting Officer)
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EXHIBIT INDEX
Exhibit
Number Description
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27.1 Financial Data Schedule