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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 DECEMBER 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)
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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 February 4, 1998, the registrant had 6,132,086 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
December 28, 1997 and June 29, 1997 2
Condensed Consolidated Statements of Operations
Three and six months ended December 28, 1997
and December 29, 1996 3
Condensed Consolidated Statements of Cash Flows
Six months ended December 28, 1997
and December 29, 1996 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 17
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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)
December 28, June 29,
1997 1997
------------ ---------
ASSETS
Current assets:
Cash and cash equivalents $ 1,704 $ 484
Accounts and notes receivable, net 12,156 14,785
Inventories, net 14,852 12,713
Prepaid expenses 1,260 1,066
Income taxes receivable 134 280
------- -------
Total current assets 30,106 29,328
Property, plant and equipment, net 6,608 6,961
Prepaid expenses and other assets 797 886
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$37,511 $37,175
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of capitalized lease obligations $ 70 $ 125
Accounts payable 4,072 4,294
Accrued liabilities 4,981 6,120
Deferred income taxes 139 320
------- -------
Total current liabilities 9,262 10,859
Capitalized lease obligations, excluding current installments 46 79
Deferred revenue -- 6
Deferred income taxes 2,052 1,955
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11,360 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; 6,131,109 and 6,100,546 issued and
outstanding at December 28, 1997 and June 29,
1997, respectively 1,226 1,220
Additional paid-in capital 7,435 7,283
Retained earnings 17,490 15,773
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Total stockholders' equity 26,151 24,276
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$37,511 $37,175
======= =======
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 Six Months Ended
-------------------------- --------------------------
December 28, December 29, December 28, December 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
Net revenues $ 15,493 $ 16,058 $ 30,500 $ 32,010
Cost of sales 8,618 10,112 17,454 20,594
-------- -------- -------- --------
Gross profit 6,875 5,946 13,046 11,416
Operating expenses:
Engineering and development 2,803 2,201 5,196 4,701
Selling and marketing 1,985 1,935 3,999 4,014
General and administrative 1,116 1,189 2,217 2,432
Consolidation charges -- -- -- 1,280
-------- -------- -------- --------
Total operating expenses 5,904 5,325 11,412 12,427
-------- -------- -------- --------
Operating income (loss) 971 621 1,634 (1,011)
Nonoperating income (expense) 51 (80) 65 126
-------- -------- -------- --------
Income (loss) before income taxes 1,022 541 1,699 (885)
Income tax provision (benefit) (86) 54 (18) (431)
-------- -------- -------- --------
Net income (loss) $ 1,108 $ 487 $ 1,717 $ (454)
======== ======== ======== ========
Basic earnings (loss) per common share $ 0.18 $ 0.08 $ 0.28 $ (0.08)
======== ======== ======== ========
Diluted earnings (loss) per share $ 0.18 $ 0.08 $ 0.27 $ (0.08)
======== ======== ======== ========
Common shares used in the calculations
of basic earnings (loss) per share 6,118 6,030 6,110 6,014
======== ======== ======== ========
Shares used in the calculations of diluted
earnings (loss) per share 6,330 6,300 6,321 6,014
======== ======== ======== ========
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)
Six Months Ended
----------------------------
December 28, December 29,
1997 1996
------------ ------------
Cash flows from operating activities:
- ------------------------------------
Net income (loss) $ 1,717 $ (454)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,216 1,396
Loss on disposal of property, plant and equipment 97 74
Provision for doubtful accounts 60 64
Changes in assets and liabilities:
Accounts receivable 2,569 (1,047)
Inventories (2,139) 3,291
Income tax receivable 146 (81)
Prepaid expenses and other assets (190) 25
Accounts payable (222) (3,701)
Accrued liabilities (1,139) (1,249)
Deferred income taxes 1 (17)
Deferred revenue (6) --
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Net cash provided by (used in) operating activities 2,110 (1,699)
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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 (960) (1,073)
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Net cash used in investing activities (960) (1,072)
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Cash flows from financing activities:
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Principal payments under capital leases (88) (152)
Proceeds from note payable to bank, net -- 1,000
Proceeds from issuance of common stock 158 288
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Net cash provided by financing activities 70 1,136
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Net increase (decrease) in cash and cash equivalents 1,220 (1,635)
Cash and cash equivalents at beginning of period 484 1,635
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Cash and cash equivalents at end of period $ 1,704 $ --
======= =======
Supplemental disclosures:
- ------------------------
Cash paid during the period for:
Interest $ 140 $ 110
Income taxes 24 23
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 December 28, 1997 and June 29, 1997, and the results of operations for
the three and six months ended December 28, 1997 and December 29, 1996 and
the statements of cash flows for the six months then ended. Interim results
for the three and six months ended December 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:
December 28, June 29,
1997 1997
------------ --------
Raw materials $ 6,551 $ 7,932
Work-in-process 5,144 2,012
Finished goods 3,157 2,769
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$14,852 $12,713
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3. Earnings (Loss) per Share
Effective December 28, 1997, the Company adopted Statement of Financial
Accounting Standards No. ("Statement") 128, "Earnings Per Share". In
accordance with Statement 128, primary earnings per share have been
replaced with basic earnings per share and fully diluted earnings per share
have been replaced with diluted earnings per share which includes
potentially dilutive securities such as outstanding stock options. Prior
periods have been restated to conform to Statement 128; however, as the
Company had a net loss for the six month period ended December 29, 1996,
the basic loss per share is no different than the primary loss per share
previously presented for that period.
Basic earnings (loss) per share is computed by dividing income available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings (loss) per share is
computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding during the period
increased to include the number of additional common shares that would have
been outstanding if the dilutive potential common shares had been issued.
The dilutive effect of outstanding stock options is reflected in diluted
earnings per share by application of the treasury stock method. The
following table sets forth the computation of basic and diluted earnings
(loss) per share:
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Three Months Ended Six Months Ended
---------------------------- ----------------------------
December 28, December 29, December 28, December 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
Numerator:
Net income (loss) $ 1,108 $ 487 $ 1,717 $ (454)
======= ======= ======= =======
Denominator:
Denominator for basic earnings (loss)
per share - weighted average shares
outstanding 6,118 6,030 6,110 6,014
Effect of dilutive securities:
Dilutive options outstanding 212 270 211 --
------- ------- ------- -------
Denominator for diluted earnings (loss)
per share - adjusted weighted average
shares 6,330 6,300 6,321 6,014
======= ======= ======= =======
Basic earnings (loss) per share $ 0.18 $ 0.08 $ 0.28 $ (0.08)
======= ======= ======= =======
Diluted earnings (loss) per share $ 0.18 $ 0.08 $ 0.27 $ (0.08)
======= ======= ======= =======
Options to purchase 209,862 shares of common stock at prices in excess of $16.51
per share were outstanding at December 28, 1997, but were not included in the
computation of diluted earnings per share for the three month period then ended.
Furthermore, options to purchase 210,862 shares of common stock at prices in
excess of $16.33 per share were outstanding at December 28, 1997, but were not
included in the computation of diluted earnings per share for the six month
period then ended. Additionally, options to purchase 208,018 shares of common
stock at prices in excess of $16.67 per share were outstanding at December 29,
1996, but were not included in the computation of diluted earnings per share for
the three month period then ended. These options were excluded from the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the common shares during the
respective periods, and therefore, the effect would be antidilutive. As the
Company had a net loss for the six month period ended December 29, 1996, all
793,543 outstanding stock options were excluded from the calculation of diluted
loss per share, because the effect would have been antidilutive.
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Part I. Item 2.
EMULEX CORPORATION AND SUBSIDIARIES
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 discussions 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", "anticipates",
"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 expressly disclaims any obligation or undertaking to
release publicly any updates or changes 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 server 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. The Company markets to original equipment
manufacturers ("OEMs") and end users through its own worldwide selling
organizations, as well as two-tier distribution partners.
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 unaudited
Condensed Consolidated Financial Statements included elsewhere herein.
Percentage of Net Revenues Percentage of Net Revenues
For the Three Months Ended For the Six Months Ended
--------------------------- ---------------------------
December 28, December 29, December 28, December 29,
1997 1996 1997 1996
------------ ------------ ------------ -----------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales 55.6 63.0 57.2 64.3
----- ----- ----- -----
Gross profit 44.4 37.0 42.8 35.7
Operating expenses:
Engineering and development 18.1 13.7 17.0 14.7
Selling and marketing 12.8 12.0 13.1 12.5
General and administrative 7.2 7.4 7.3 7.6
Consolidation charges -- -- -- 4.0
----- ----- ----- -----
Total operating expenses 38.1 33.1 37.4 38.8
----- ----- ----- -----
Operating income (loss) 6.3 3.9 5.4 (3.1)
Nonoperating income (expense) 0.3 (0.5) 0.2 0.4
----- ----- ----- -----
Income (loss) before income taxes 6.6 3.4 5.6 (2.7)
Income tax provision (benefit) (0.6) 0.4 -- (1.3)
----- ----- ----- -----
Net income (loss) 7.2% 3.0% 5.6% (1.4)%
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NET REVENUES
Net revenues for the three and six month periods ended December 28, 1997 were
$15,493 and $30,500, respectively, compared to $16,058 and $32,010,
respectively, for the same periods of the prior fiscal year. These amounts
represent a decrease in net revenues of $565, or 4 percent, for the three month
period and $1,510, or 5 percent, for the six month period from the comparable
periods of fiscal 1997. These decreases in net revenues were primarily the
result of reductions in distribution net revenues of $1,785, or 30 percent, for
the three month period and $3,222, or 28 percent, for the six month period
compared to the prior fiscal year. A significant portion of these decreases in
distribution sales was offset by increases in net revenues from sales to OEMs of
$1,606, or 17 percent, for the three month period and $2,033, or 11 percent, for
the six month period. The Company's net revenues from sales to end users also
decreased by $386 for the three month period and $321 for the six month period
compared to fiscal 1997.
From a product line perspective, net revenues from the Company's fibre channel
product line increased $2,827, or 137 percent, for the three month period and
$6,816, or 209 percent, for the six month period ended December 28, 1997,
compared to the same periods of the prior fiscal year as OEMs in this emerging
market have begun to take volume shipments. The Company expects that future
revenue from this product line will be a function of both continued demand from
OEMs which are currently shipping fibre channel product, as well as launches of
new fibre channel based systems by some of the Company's other OEMs. Net
revenues from the Company's printer server product line decreased $1,689, or 22
percent, for the three month period and $4,306, or 27 percent, for the six month
period of the current fiscal year versus the comparable periods of the prior
fiscal year. These decreases in printer server revenues are primarily the result
of lower distribution sales which the Company believes are principally 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. The
Company also experienced lower shipments of printer server products to two major
OEMs during the first quarter of fiscal 1998 which contributed to the decrease
for the six month period. Net revenues from Emulex's network access products
decreased $1,541, or 27 percent, for the three month period and $3,064, or 27
percent, for the six month period of fiscal 1998 compared to fiscal 1997. These
decreases in network access net revenues are primarily due to decreased
shipments to Reuters, as the current project with the Company approaches end of
life, and the maturation of certain of the Company's network access products.
Net revenues from other miscellaneous product lines decreased $162 and $956 for
the three and six month periods ended December 28, 1997, respectively, compared
to the prior fiscal year. The first quarter of the prior fiscal year included
end-of-life sales of an OEM storage product in net revenues from other
miscellaneous product lines.
Although Fibre Channel represented 32 percent of net revenues for the three
month period and 33 percent for the six month period ended December 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 the
competitive price and in the quantities desired, or if available, will function
as needed.
GROSS PROFIT
For the three and six month periods ended December 28, 1997, gross profit
increased by $929, or 16 percent, to $6,875 and by $1,630, or 14 percent, to
$13,046, respectively. Gross profit as a percentage of net revenues increased to
44 percent for the quarter compared to 37 percent in the comparable quarter of
last fiscal year. For the six month period, gross profit as a percentage of net
revenues increased to 43 percent from 36 percent in the comparable period of
fiscal 1997. The improvement in gross profit is primarily due to a product mix
that contained a greater percentage of higher margin products and continued
improvement in manufacturing efficiencies for the six month period of fiscal
1998 compared to the same period of the prior fiscal year.
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OPERATING EXPENSES
Operating expenses for the quarter ended December 28, 1997 increased by $579, or
11 percent, from the comparable quarter a year earlier. For the first six months
of fiscal 1998, operating expenses decreased by $1,015, or 8 percent, compared
to the same period of fiscal 1997. Included in the six month period of fiscal
1997 were consolidation charges of $1,280 recognized during the first quarter of
fiscal 1997. Excluding these charges, operating expenses increased $265, or 2
percent, for the six month period ended December 29, 1997 from the comparable
six month period of fiscal 1997. A substantial portion of the increased
operating expenses was due to an increase in engineering and development
expenses of $602, or 27 percent, and $495, or 11 percent, for the three and six
month periods, respectively, compared to the corresponding periods of the prior
fiscal year as the Company expanded its fibre channel development efforts.
Additionally, selling and marketing expenses increased $50 and decreased $15 for
the three and six month periods, respectively, of fiscal 1998 compared to fiscal
1997. These increases in operating expenses were partially offset by declines in
general and administrative expenses in comparison to a year earlier by $73, or 6
percent, for the three month period and by $215, or 9 percent, for the six month
period.
NONOPERATING INCOME (EXPENSE)
Nonoperating income (expense) for the three month period ended December 28, 1997
increased by $131 to $51 compared to the same period of the prior fiscal year.
The quarter ended December 28, 1997 included a higher level of interest income
and a lower level of interest expense associated with the Company's improved
cash position, as well as a $37 gain related to the sale of certain property in
Puerto Rico. Nonoperating income for the six month period ended December 28,
1997 was $65, a decrease of $61 from the same period of the prior fiscal year.
The prior year's six month period included $238 of interest income associated
with prior years' tax returns. Excluding this nonrecurring interest income from
the prior year, nonoperating income increased $177. This increase resulted from
the gain on the sale of certain property by the Company's Puerto Rican
subsidiary, a small currency exchange gain, a higher level of interest income
and a lower level of interest expense.
INCOME TAXES
The Company's current Puerto Rican tax exemption grants for property and
municipal license tax expired at the end of calendar year 1997. Furthermore, the
Company's current Puerto Rican tax exemption grant for income and tollgate tax
expires at the end of calendar year 1999. The Company is currently negotiating
with the Puerto Rican government to extend these exemption grants through 2007,
and the Company is able to continue to operate under the terms of the old grants
pending the resolution of the negotiations with the Puerto Rican government.
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 addition, the Company is also currently undergoing an examination
by the Internal Revenue Service related to the Company's Puerto Rican
subsidiary's 1995 U.S. tax return. The Company does not anticipate that these
examinations will be resolved this fiscal year. Furthermore, in the opinion of
management, the outcome of these examinations will not have a material adverse
effect on the Company's consolidated financial position.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive Income".
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.
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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 $1,220 to $1,704 during the
six month period ended December 28, 1997. Operating activities, which include
changes in working capital balances, provided $2,110 of cash and cash
equivalents compared to using $1,699 in the six month period of the prior fiscal
year. Investing activities, which were limited to the acquisition and
disposition of property, plant and equipment, used $960 of cash and cash
equivalents in the current six month period compared to using $1,072 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, provided $70 of
cash and cash equivalents during the six month period of fiscal 1998 compared to
providing $1,136 of cash and cash equivalents for the same period of fiscal
1997.
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. At the end of the second quarter of fiscal 1998,
there were no borrowings outstanding under the line of credit. 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 in the future would
constitute an event of default, giving rise to the various remedies available to
a secured lender. As of December 28, 1997, the Company was in compliance with
all the covenants of the line of credit; 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 may be required periodically during the
next nine 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 borrow on its line of credit and to
arrange additional financing. If the Company were to experience losses at the
rate experienced in fiscal 1996 and the first quarter of fiscal 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 assurance that future requirements to
fund operations will not require the Company to borrow 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.
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BUSINESS ENVIRONMENT AND RISK FACTORS
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. While the Company generated net income for the year
ended June 29, 1997 and for the first two quarters of fiscal 1998, 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.
The Company's revenues and results of operations have varied on a quarterly
basis in the past and there can be no assurances that the Company's revenues and
results of operations will not 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 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, its
OEMs 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,
financial condition and/or liquidity 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 second quarter of fiscal 1998, the Company derived approximately 26
percent of its revenue from distributors and 71 percent from OEMs. For the first
six months of fiscal 1998, the Company derived approximately 27 percent of its
revenue from distributors and 69 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
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agreements are substantially standardized, due to the individual negotiations,
variances do occur. Furthermore, some of these agreements may 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 could in the future develop competitive products and, if they were
to do so, they could 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 and IBM Corporation accounted for 16 percent and 11
percent, respectively, of the Company's net revenues during the quarter ended
December 28, 1997. Furthermore, the Company's top five customers accounted for
49 percent of fiscal 1998 second quarter net revenues. The Reuters project which
accounted for approximately 7 percent of revenues in the quarter ended December
28, 1997, is expected to be completed by the end of fiscal 1998. 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.
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 second quarter of fiscal 1998, the
Company's top five OEM customers accounted for 49 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 period to period 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. 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. The Company also is subject to a credit risk
associated with the concentration of its accounts receivable from these OEMs.
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 December 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
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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 technology. 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 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 and profitability 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, Gadzoox Microsystems, Vixel
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.
Additionally, it is not uncommon, especially with an emerging technology, for
OEMs to arrange second source agreements for their fibre channel requirements.
Furthermore, the Company's OEM customers may in the future develop competitive
products or purchase from the Company's competitors, 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 introductions 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
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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 that the
Company will be successful at developing and incorporating ASICs effectively and
in a timely manner. 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.
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 resource 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.
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.
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 ship product due to a lack of components or software or to redesign
its products to accept alternatives, in a timely manner, or any resulting
significant increase in prices would materially adversely affect the Company's
business, results of operations, financial condition and/or liquidity.
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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, marketing and managerial personnel. An
increase in technical staff with experience in highspeed networking applications
will be 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 December 28, 1997, sales in the United States, Europe and
the Pacific Rim countries accounted for 65 percent, 28 percent and 7 percent of
the Company's net revenues, respectively. For the six month period ended
December 28, 1997, sales in the United States, Europe and the Pacific Rim
countries accounted for 70 percent, 24 percent and 6 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 earnings 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 a material 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. Recent changes, unless amended,
resulting from the Small Business Protection Act of 1996 will limit the
Company's favorable U.S. tax treatment related to the Company's Puerto Rican
operations beginning in fiscal year 2002. Furthermore, such laws are subject to
change and may be limited or phased-out by Congress at any time.
The Company's current Puerto Rican tax exemption grants for property and
municipal license tax expired at the end of calendar year 1997. Furthermore, the
Company's current Puerto Rican tax exemption grant for income and tollgate tax
expires at the end of calendar year 1999. The Company is currently negotiating
with the Puerto Rican government to extend these exemption grants through 2007,
and the Company is able to continue to operate under the terms of the old grants
pending the resolution of the negotiations with the Puerto Rican government.
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
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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 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
licenses can be obtained on commercially reasonable terms. The failure to obtain
such royalty or licensing agreements on a timely basis and on commercially
reasonable terms 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.
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PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of the Company was held on November 20, 1997.
There were 6,107,993 shares of the Company's common stock issued, outstanding
and entitled to vote at the meeting as of the record date, October 6, 1997.
Proxies representing 5,826,904 common shares were received and tabulated. The
following members were elected to the Company's Board of Directors to hold
office for the ensuing year:
Nominee In Favor Withheld
- ------- --------- --------
Fred B. Cox 5,751,179 75,725
Paul F. Folino 5,750,979 75,925
Michael P. Downey 5,750,479 76,425
Robert H. Goon 5,750,779 76,125
Don M. Lyle 5,750,879 76,025
Furthermore, the stockholders of the Company approved an amendment of the
Company's Employee Stock Option Plan which increased the number of shares
covered by that plan by 200,000 shares. The amendment was approved with
5,228,038 shares voting for approval, 232,935 shares voting against approval,
35,415 shares abstaining and 330,516 non-voted shares.
The stockholders of the Company also approved the 1997 Stock Option Plan for
Non-Employee Directors which allows for a maximum of 100,000 shares of common
stock of the Company to be issued pursuant to exercise of stock options granted
under this plan to directors who are not employees of the Company or any of its
subsidiaries. The 1997 Stock Option Plan for Non-Employee Directors was approved
with 4,984,207 shares voting for approval, 467,821 shares voting against
approval, 44,360 shares abstaining and 330,516 non-voted shares.
In addition, the stockholders of the Company ratified the selection of KPMG Peat
Marwick LLP as the Company's independent public accountants for fiscal year
1998. The number of shares voted for ratification was 5,780,284. The number of
shares voted against ratification was 22,050. The number of shares abstaining
was 24,570.
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: February 9, 1998
EMULEX CORPORATION
By: /s/ Paul F. Folino
-------------------------------
Paul F. Folino
President and Chief Executive
Officer
By: /s/ Michael J. Rockenbach
-------------------------------
Michael J. Rockenbach
Vice President and
Chief Financial Officer
(Principal Financial & Chief
Accounting Officer)
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INDEX TO EXHIBIT
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule