1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------------------
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 29, 1998
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NO. 0-11007
EMULEX CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 51-0300558
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
3535 HARBOR BOULEVARD
COSTA MESA, CALIFORNIA 92626
(Address of principal executive offices) (Zip Code)
(714) 662-5600
(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 May 7, 1998, the registrant had 6,132,641 shares of common stock
outstanding.
================================================================================
2
EMULEX CORPORATION AND SUBSIDIARIES
INDEX
PAGE
----
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 29, 1998 and June 29, 1997 2
Condensed Consolidated Statements of Operations
Three and nine months ended March 29, 1998
and March 30, 1997 3
Condensed Consolidated Statements of Cash Flows
Nine months ended March 29, 1998 and March 30, 1997 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 6. Exhibits and Reports on Form 8-K 17
1
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
March 29, June 29,
Assets 1998 1997
- ------ ----------- -----------
Current assets:
Cash and cash equivalents $ 1,951 $ 484
Accounts and notes receivable, net 13,142 14,785
Inventories, net 11,350 12,713
Prepaid expenses 560 1,066
Income tax receivable 139 280
----------- -----------
Total current assets 27,142 29,328
Property, plant and equipment, net 4,766 6,961
Intangibles, net 250 --
Prepaid expenses and other assets 108 886
----------- -----------
$ 32,266 $ 37,175
=========== ===========
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Current installments of capitalized lease obligations $ 73 $ 125
Accounts payable 5,574 4,294
Accrued liabilities 5,300 6,090
Accrued consolidation charge 5,699 30
Deferred income taxes 260 320
----------- -----------
Total current liabilities 16,906 10,859
Capitalized lease obligations, excluding current installments 27 79
Deferred revenue -- 6
Deferred income taxes 1,931 1,955
----------- -----------
18,864 12,899
----------- -----------
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;
6,132,583 and 6,100,546 issued and outstanding at
March 29, 1998 and June 29, 1997, respectively 1,227 1,220
Additional paid-in capital 7,440 7,283
Retained earnings 4,735 15,773
----------- -----------
Total stockholders' equity 13,402 24,276
----------- -----------
$ 32,266 $ 37,175
=========== ===========
See accompanying notes to condensed consolidated financial statements.
2
4
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
March 29, March 30, March 29, March 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
Net revenues $ 15,019 $ 17,011 $ 45,519 $ 49,021
Cost of sales 10,816 10,012 28,270 30,606
----------- ----------- ----------- -----------
Gross profit 4,203 6,999 17,249 18,415
Operating expenses:
Engineering and development 2,918 2,640 8,114 7,341
Selling and marketing 1,890 1,896 5,889 5,910
General and administrative 1,135 1,138 3,352 3,570
Consolidation charge 10,993 -- 10,993 1,280
----------- ----------- ----------- -----------
Total operating expenses 16,936 5,674 28,348 18,101
----------- ----------- ----------- -----------
Operating income (loss) (12,733) 1,325 (11,099) 314
Nonoperating income (expense) (11) (99) 54 27
----------- ----------- ----------- -----------
Income (loss) before income taxes (12,744) 1,226 (11,045) 341
Income tax provision (benefit) 11 123 (7) (308)
----------- ----------- ----------- -----------
Net income (loss) $ (12,755) $ 1,103 $ (11,038) $ 649
=========== =========== =========== ===========
Earnings (loss) per share:
Basic $ (2.08) $ 0.18 $ (1.80) $ 0.11
=========== =========== =========== ===========
Diluted $ (2.08) $ 0.18 $ (1.80) $ 0.10
=========== =========== =========== ===========
Number of shares used in per share computations:
Basic 6,132 6,061 6,118 6,030
=========== =========== =========== ===========
Diluted 6,132 6,298 6,118 6,284
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
3
5
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine Months Ended
----------------------
March 29, March 30,
1998 1997
-------- -------
Cash flows from operating activities:
Net income (loss) $(11,038) $ 649
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation, amortization and impairment 2,904 2,028
Loss on disposal of property, plant and equipment 427 56
Provision for doubtful accounts 91 97
Changes in assets and liabilities:
Accounts receivable 1,552 (1,052)
Inventories 1,363 2,803
Prepaid expenses 1,194 1
Income tax receivable 141 33
Other assets 5 57
Accounts payable 1,280 (4,290)
Accrued liabilities (790) (529)
Accrued consolidation charge 5,669 130
Deferred revenue (6) 130
Deferred income taxes 1 (38)
-------- -------
Net cash provided by operating activities 2,793 75
-------- -------
Cash flows from investing activities:
Net proceeds from sale of property, plant and equipment -- 58
Additions to property, plant and equipment (1,136) (1,533)
Additions to intangibles (250) --
-------- -------
Net cash used in investing activities (1,386) (1,475)
-------- -------
Cash flows from financing activities:
Principal payments under capital leases (104) (207)
Proceeds from note payable to bank, net -- 500
Proceeds from issuance of common stock 164 468
-------- -------
Net cash provided by financing activities 60 761
-------- -------
Net increase (decrease) in cash and cash equivalents 1,467 (639)
Cash and cash equivalents at beginning of period 484 1,635
-------- -------
Cash and cash equivalents at end of period $ 1,951 $ 996
======== =======
Supplemental disclosures:
Cash paid during the period for:
Interest $ 164 $ 168
Income taxes 38 32
See accompanying notes to condensed consolidated financial statements.
4
6
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 March 29, 1998, and June 29, 1997, and the results of operations for the
three and nine months ended March 29, 1998, and March 30, 1997, and the
statements of cash flows for the nine months then ended. Interim results
for the three and nine months ended March 29, 1998, 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:
March 29, June 29,
1998 1997
------- -------
Raw materials $ 5,603 $ 7,932
Work-in-process 4,501 2,012
Finished goods 1,246 2,769
------- -------
$11,350 $12,713
======= =======
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.
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:
5
7
Three Months Ended Nine Months Ended
--------------------- ---------------------
March 29, March 30, March 29, March 30,
1998 1997 1998 1997
--------- ------ --------- ------
Numerator:
Net income (loss) $ (12,755) $1,103 $ (11,038) $ 649
========= ====== ========= ======
Denominator:
Denominator for basic earnings (loss) per
share - weighted average shares outstanding 6,132 6,061 6,118 6,030
Effect of dilutive securities:
Dilutive options outstanding -- 237 -- 254
--------- ------ --------- ------
Denominator for diluted earnings (loss) per
share - adjusted weighted average shares 6,132 6,298 6,118 6,284
========= ====== ========= ======
Basic earnings (loss) per share $ (2.08) $ 0.18 $ (1.80) $ 0.11
========= ====== ========= ======
Diluted earnings (loss) per share $ (2.08) $ 0.18 $ (1.80) $ 0.10
========= ====== ========= ======
As the Company had a net loss for the three and nine month periods ended
March 29, 1998, all 963,791 outstanding stock options were excluded from
the calculation of diluted loss per share, because the effect would have
been antidilutive. Options to purchase 197,425 shares of common stock at
prices in excess of $16.48 per share were outstanding at March 30, 1997,
but were not included in the computation of diluted earnings per share for
the three month period then ended. Furthermore, options to purchase 289,325
shares of common stock at prices in excess of $15.71 per share were
outstanding at March 30, 1997, but were not included in the computation of
diluted earnings per share for the nine 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.
4. Consolidation Charge
On March 25, 1998, the Company announced plans to outsource the
manufacturing of its product lines to K*TEC Electronics. In conjunction
with this decision, the Company recorded a $10,993 consolidation charge
during the third quarter of 1998. The consolidation charge primarily
consists of accruals for costs expected to be incurred during the next
three to six months as the Company completes this manufacturing transition.
These charges include approximately $4,010 for severance and related costs,
$1,370 for impairment of property, plant and equipment, $3,775 for
reductions in inventory and prepaid expenses related to streamlining
product offerings, $225 for equipment and office leases and $1,613 related
to the closure of the company's Puerto Rico manufacturing facility and
other miscellaneous costs. The Company anticipates a worldwide reduction of
approximately 130 full-time employees, or 48% of the workforce, and 45
temporary workers in Puerto Rico. The majority of the headcount reduction
is in the manufacturing area; however, selected reductions will also be
made in other areas related to the streamlining of product offerings.
6
8
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 "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 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 Nine Months Ended
-------------------------- --------------------------
March 29, March 30, March 29, March 30,
1998 1997 1998 1997
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales 72.0 58.9 62.1 62.4
----- ----- ----- -----
Gross profit 28.0 41.1 37.9 37.6
Operating expenses:
Engineering and development 19.4 15.5 17.8 15.0
Selling and marketing 12.6 11.1 12.9 12.1
General and administrative 7.6 6.7 7.4 7.3
Consolidation charge 73.2 -- 24.2 2.6
----- ----- ----- -----
Total operating expenses 112.8 33.3 62.3 37.0
----- ----- ----- -----
Operating income (loss) (84.8) 7.8 (24.4) 0.6
Nonoperating income (expense) (0.1) (0.6) 0.1 0.1
----- ----- ----- -----
Income (loss) before income taxes (84.9) 7.2 (24.3) 0.7
Income tax provision (benefit) -- 0.7 (0.1) (0.6)
----- ----- ----- -----
Net income (loss) (84.9)% 6.5% (24.2)% 1.3%
===== ===== ===== =====
7
9
NET REVENUES
Net revenues for the three and nine month periods ended March 29, 1998, were
$15,019 and $45,519, respectively, compared to $17,011 and $49,021,
respectively, for the same periods of the prior fiscal year. These amounts
represent decreases in net revenues of $1,992, or 12 percent, for the three
month period, and $3,502, or 7 percent, for the nine month period, from the
comparable periods of fiscal 1997. These decreases in net revenues were
principally the result of reductions in distribution net revenues of $911, or 22
percent, for the three month period and $4,133, or 26 percent, for the nine
month period compared to the prior fiscal year. Net revenues from sales to OEMs
for the three month period decreased by $786, or 6 percent, from the comparable
period of the prior fiscal year. This decrease in OEM sales is primarily due to
lower shipments to Reuters, as its current project with the Company approaches
end of life, and was only partially offset by increases in shipments to other
OEMs. For the nine month period, net revenues from sales to OEMs increased by
$1,247, or 4 percent, from the comparable period of the prior fiscal year. The
Company's net revenues from sales to end users also decreased by $295, or 38
percent, for the three month period and $616, or 26 percent, for the nine month
period compared to the corresponding periods of fiscal 1997.
From a product line perspective, net revenues from the Company's fibre channel
product line increased by $1,316, or 43 percent, to $4,378 for the three month
period and increased by $8,132, or 129 percent, to $14,449 for the nine month
period ended March 29, 1998, 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
continued demand from OEMs which are currently shipping fibre channel product,
launches of new fibre channel based systems by some of the Company's other OEMs,
achievement of additional design wins and increased distribution sales. Net
revenues from the Company's printer server product line decreased by $356, or 5
percent, to $6,883 for the three month period and decreased by $4,662, or 20
percent, to $18,553 for the nine month period of fiscal 1998 from the comparable
periods of fiscal 1997. These decreases in printer server revenues are primarily
the result of lower distribution sales which the Company believes is 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 nine month period. Net revenues from the Company's network
access products decreased by $2,783, or 44 percent, to $3,501 for the three
month period and decreased by $5,847, or 33 percent, to $11,683 for the nine
month period of fiscal 1998 compared to the same period of the prior fiscal
year. These decreases in network access net revenues are principally the result
of lower shipments to Reuters, as discussed above, and the maturation of certain
of the Company's network access products. Net revenues from other miscellaneous
product lines decreased by $169, or 40 percent, to $257 for the three month
period and by $1,125, or 57 percent, to $834 for the nine month period of fiscal
1998 compared to fiscal 1997. 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 sales represented 29 percent of revenues in the three
month period and 32 percent for the nine month period ended March 29, 1998, 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
competitive prices and in the quantities desired or, if available, will function
as needed.
GROSS PROFIT
For the three and nine month periods ended March 29, 1998, gross profit
decreased by $2,796, or 40 percent, to $4,203, and by $1,166, or 6 percent, to
$17,249, respectively, compared to the same periods of the prior fiscal year. In
conjunction with the planned closure of its Puerto Rican manufacturing
operations and transition to subcontracted manufacturing, during the three month
period ended March 29, 1998, the Company recorded
8
10
$1,899 of incremental excess and obsolete inventory reserves. Excluding this
incremental inventory reserve charge, gross profit would have been $6,102, a
decrease of $897, or 13 percent, for the three month period and $19,148, an
increase of $733, or 4 percent, for the nine month period compared to the
corresponding periods of fiscal 1997. Gross profit as a percentage of net
revenues, excluding the incremental inventory reserves of $1,899, remained
relatively unchanged at 41 percent for the three month periods of fiscal 1998
and fiscal 1997. However, gross profit as a percentage of net revenues,
excluding the incremental inventory reserves, increased in the current fiscal
year's nine month period to 42 percent compared to 38 percent for the nine month
period of the prior fiscal year. The improvement in gross profit for the nine
month period is principally due to a product mix that contained a greater
percentage of higher margin products.
OPERATING EXPENSES
During the three month period ended March 29, 1998, the Company initiated a
program to outsource the manufacturing of its product lines to K*TEC
Electronics, a state-of-the-art contract manufacturer with advanced
manufacturing capabilities which the Company requires for its new generation
fibre channel designs. The Company made this strategic decision in an attempt to
reduce required future capital expenditures and production costs, as well as to
take advantage of K*TEC Electronics' consolidated purchasing power and materials
management capabilities. In conjunction with this transition to subcontracted
manufacturing, the Company plans to close its Puerto Rican manufacturing
facility, streamline its offerings of some of its more mature products,
primarily in the network access product lines, and close selected domestic sales
offices. The Company recorded a $10,993 consolidation charge during the three
month period ended March 29, 1998, in connection with the planned closure of its
manufacturing operations and related streamlining of its product lines.
The consolidation charge primarily consists of accruals for costs expected to be
incurred during the next three to six months as the Company completes this
manufacturing transition. These charges include approximately $4,010 for
severance and related costs, $1,370 for impairment of property, plant and
equipment, $3,775 for reductions in inventory and prepaid expenses related to
streamlining product offerings, $225 for equipment and office leases and $1,613
related to the plant closure and other miscellaneous costs. The Company
anticipates a worldwide reduction of approximately 130 full-time employees, or
48% of the workforce, and 45 temporary workers in Puerto Rico. The majority of
the headcount reduction is in the manufacturing area; however, selected
reductions will also be made in other areas related to the streamlining of
product offerings.
Operating expenses increased by $11,262 and $10,247 for the three and nine month
periods of fiscal 1998, respectively, versus the comparable periods of fiscal
1997. Included in the three and nine month periods of fiscal 1998 are $10,993 of
consolidation charges as discussed above. Included in the nine month period of
fiscal 1997 are $1,280 of consolidation charges the Company incurred to reduce
its ongoing expense base and focus its activities in the fibre channel, printer
server and wide area networking markets. Excluding these consolidation charges,
operating expenses for the three month period ended March 29, 1998, were $5,943,
an increase of $269, or 5 percent, from the comparable period of the prior
fiscal year. For the nine month period ended March 29, 1998, excluding these
consolidation charges, operating expenses were $17,355, an increase of $534, or
3 percent, from the comparable period of the prior fiscal year. These increases
in operating expenses were due to increases in engineering and development
expenses of $278, or 11 percent, for the three month period and $773, or 11
percent, for the nine month period, compared to the corresponding periods of the
prior fiscal year as the Company continued to expand its fibre channel
development efforts. These increases in engineering and development expenses
were partially offset by decreases in selling and marketing expenses, as well as
general and administrative expenses. For the three and nine month periods of
fiscal 1998, selling and marketing expenses decreased by $6 and $21,
respectively, compared to fiscal 1997. General and administrative expenses
decreased by $3 and $218, for the three and nine month periods, respectively,
compared to fiscal 1997.
NONOPERATING INCOME (EXPENSE)
Nonoperating expense for the three month period ended March 29, 1998, decreased
by $88 to $11 compared to the same period of the prior fiscal year. This
improvement was primarily the result of less interest expense and more interest
income associated with the Company's improved cash position during the three
month period of the current fiscal year compared to the prior fiscal year.
Nonoperating income for the nine month period ended
9
11
March 29, 1998, increased by $27 to $54 from the corresponding period of the
prior fiscal year. The prior fiscal year's nine month period included $238 of
interest income associated with prior years' tax returns. Excluding this
nonrecurring interest income from the prior fiscal year, nonoperating income
increased by $265. This increase resulted from the gain on the sale of certain
property by the Company's Puerto Rican subsidiary and a small currency exchange
gain, as well as a higher level of interest income and a lower level of interest
expense associated with the Company's improved cash position during the nine
month period of the current fiscal year.
INCOME TAXES
For the quarter ended March 29, 1998, the Company booked a tax provision for
payments due under the Alternative Minimum Tax calculation and for foreign tax
returns. In the three month period ended March 30, 1997, the Company had an
effective tax rate of 10 percent. 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.
It is management belief that 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.
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 $1,467, to $1,951, during the
nine month period ended March 29, 1998. Operating activities, which include
changes in working capital balances, provided $2,793 of cash and cash
equivalents compared to providing $75 in the nine month period of the prior
fiscal year. Investing activities, which were limited to the acquisition and
disposition of property, plant and equipment and the acquisition of intangibles,
used $1,386 of cash and cash equivalents in the current nine month period
compared to using $1,475 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 stock
options, provided $60 of cash and cash equivalents during the nine month period
of fiscal 1998 compared to providing $761 of cash and cash equivalents for the
same period of fiscal 1997. The Company anticipates a total of approximately
$5,810 in cash will be used over the next six months in conjunction with the
transfer of manufacturing. This includes $4,010 for severance and related costs,
$225 for equipment and office leases and $1,575 in expenses related to the plant
closure and other miscellaneous costs.
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 third 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 March 29, 1998, 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
10
12
Company's liquidity requirements. The Company anticipates that borrowings under
the line of credit may 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 borrow on its line of credit and/or to
arrange additional financing. If the Company were to continue to experience
losses at the rate experienced in the current fiscal year, additional debt or
equity financing may be required within the next twelve 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 inventory purchases, customer orders and shipments and/or
expenditures related to the transition to outsourcing manufacturing as the
Company closes its Puerto Rican manufacturing operations. 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.
BUSINESS ENVIRONMENT AND RISK FACTORS
HISTORY OF LOSSES; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company incurred a net loss of $12,755 for the quarter ended March 29, 1998,
which included $1,899 of incremental inventory reserves and $10,993 of
consolidation charges in conjunction with the planned closure of the Company's
Puerto Rican manufacturing operations. While the Company generated net income
for the preceding five quarters, 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 the 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
11
13
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 third quarter of fiscal 1998, the Company derived approximately 22
percent of its revenue from distributors and 75 percent from OEMs. For the first
nine months of fiscal 1998, the Company derived approximately 25 percent of its
revenue from distributors and 71 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. 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.
IBM Corporation accounted for 15 percent of the Company's net revenues during
the quarter ended March 29, 1998. Furthermore, the Company's top five customers
accounted for 40 percent of fiscal 1998 third quarter net revenues. The Reuters
project which accounted for approximately 5 percent of fiscal 1998 third quarter
net revenues, is expected to be essentially 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/or 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 third quarter of fiscal 1998, the
Company's top five OEM customers accounted for 40 percent of the Company's net
revenues. Although the Company has attempted to expand its base of OEMs, there
can be
12
14
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 65% of the Company's engineering and development expenditures for the
quarter ended March 29, 1998. 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 and Small Computer Systems Interface ("SCSI"), 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 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
13
15
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 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 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 could 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 or available in a timely fashion.
14
16
Reliance on Third Party Suppliers
The Company relies on third party suppliers who supply the components to the
Company and its subcontracted manufacturer which are 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. Additionally, as the Company transitions the production of its
product lines to a subcontracted manufacturer, the Company plans to maintain
only a minimal supply of certain key components. Furthermore, the Company will
now rely on its contract manufacturer to complete the majority of the component
purchases. Consequently, there can be no assurance that the necessary 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.
Risks Associated with the Transition to Subcontracted Manufacturing
As the Company moves the production of its product lines from its Puerto Rican
manufacturing subsidiary to a contract manufacturer over the next three to six
months, the Company will be in a state of transition. Consequently, any
unanticipated delays or issues related to events such as the transfer of test
equipment, supply of components, unavailability of finished goods in-transit
from one location to the other, loss of key personnel and completion of the
remaining production at the Puerto Rican subsidiary, as well as any
unanticipated events, could have a material adverse effect on the Company's
business, results of operations, financial condition and/or liquidity.
Furthermore, if for any reason, the Company's selected contract manufacturer is
unable, unwilling or experiences any significant delays in completing the
production runs for the Company during the transition period or in the future,
the Company's resulting inability to ship product and/or costs to qualify and
shift production to an alternative manufacturing facility would have a material
adverse effect on 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. This is
especially critical as the Company transitions the manufacturing of its products
from its Puerto Rican subsidiary to a contract manufacturer. 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 March 29, 1998, sales in the United States, Europe and the
Pacific Rim countries accounted for 61 percent, 27 percent and 12 percent of the
Company's net revenues, respectively. For the nine month
15
17
period ended March 29, 1998, sales in the United States, Europe and the Pacific
Rim countries accounted for 67 percent, 25 percent and 8 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
Although the Company is in the process of transitioning the manufacturing of its
product lines from its Puerto Rican manufacturing facility to a contract
manufacturer located in Texas, the Company expects this transition to occur over
the next three to six months. Consequently, some production and a significant
portion of the Company's inventory is still located at the Company's subsidiary
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.
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
16
18
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.
17
19
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: May 11, 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)
18
20
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule