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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 26, 2000
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
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(Registrant's telephone number, including area code)
-----------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
As of May 4, 2000, the registrant had 36,112,075 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
March 26, 2000 and June 27, 1999 2
Condensed Consolidated Statements of Income
Three and nine months ended March 26, 2000
and March 28, 1999 3
Condensed Consolidated Statements of Cash Flows
Nine months ended March 26, 2000
and March 28, 1999 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 22
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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)
March 26, June 27,
Assets 2000 1999
-------- --------
Current assets:
Cash and cash equivalents $ 16,269 $ 22,284
Investments 103,701 83,164
Accounts and other receivables, net 24,711 17,088
Inventories, net 12,127 11,083
Prepaid expenses 945 475
Deferred income taxes 594 244
-------- --------
Total current assets 158,347 134,338
Property and equipment, net 3,703 3,168
Long term investments 52,039 32,216
Deferred income taxes and other assets 3,719 269
-------- --------
$217,808 $169,991
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 19,895 $ 11,395
Accrued liabilities 7,266 4,291
Income taxes payable and other current liabilities 608 358
-------- --------
Total current liabilities 27,769 16,044
Deferred income taxes 216 2,054
-------- --------
27,985 18,098
-------- --------
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, $0.10 par value; 120,000,000 shares
authorized; 35,954,056 and 33,933,888 issued
and outstanding at March 26, 2000 and
June 27, 1999, respectively 3,595 3,393
Additional paid-in capital 152,783 138,300
Retained earnings 33,445 10,200
-------- --------
Total stockholders' equity 189,823 151,893
-------- --------
$217,808 $169,991
======== ========
See accompanying notes to condensed consolidated financial statements.
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EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
------------------------- -------------------------
March 26, March 28, March 26, March 28,
2000 1999 2000 1999
--------- -------- --------- --------
Net revenues $36,518 $18,235 $99,017 $ 48,032
------- ------- ------- --------
Cost of sales 19,149 10,826 53,058 28,772
Cost of sales - inventory charges related
to consolidation -- -- -- 1,304
------- ------- ------- --------
Total cost of sales 19,149 10,826 53,058 30,076
------- ------- ------- --------
Gross profit 17,369 7,409 45,959 17,956
------- ------- ------- --------
Operating expenses:
Engineering and development 3,586 3,080 10,735 8,381
Selling and marketing 2,492 1,695 7,270 5,134
General and administrative 1,884 1,146 5,121 3,032
Consolidation charges, net -- -- -- (987)
------- ------- ------- --------
Total operating expenses 7,962 5,921 23,126 15,560
------- ------- ------- --------
Operating income 9,407 1,488 22,833 2,396
Nonoperating income 2,405 17 6,276 67
------- ------- ------- --------
Income before income taxes 11,812 1,505 29,109 2,463
Income tax provision 4,134 150 5,864 246
------- ------- ------- --------
Net income $ 7,678 $ 1,355 $23,245 $ 2,217
======= ======= ======= ========
Net income per share:
Basic $ 0.21 $ 0.06 $ 0.66 $ 0.09
======= ======= ======= ========
Diluted $ 0.20 $ 0.05 $ 0.61 $ 0.08
======= ======= ======= ========
Number of shares used in per share computations:
Basic 35,754 24,632 35,149 24,589
======= ======= ======= ========
Diluted 38,430 27,647 38,173 27,026
======= ======= ======= ========
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)
Nine Months Ended
----------------------
March 26, March 28,
2000 1999
--------- ---------
Cash flows from operating activities:
Net income $ 23,245 $ 2,217
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,154 1,172
Loss (gain) on disposal of property, plant and
equipment 28 (749)
Impairment of intangibles 175 --
Provision for doubtful accounts 398 44
Deferred income taxes (5,643) --
Changes in assets and liabilities:
Accounts receivable (8,021) (4,588)
Inventories (1,044) 1,181
Prepaid expenses and other assets (640) (130)
Accounts payable 8,500 4,839
Accrued liabilities 2,975 (2,722)
Income taxes payable 11,483 214
--------- -------
Net cash provided by operating activities 32,610 1,478
Cash flows from investing activities:
Net proceeds from sale of property, plant and equipment 30 2,995
Additions to property and equipment (1,735) (1,375)
Purchases of investments (474,713) --
Maturities of investments 434,353 --
--------- -------
Net cash provided by (used in) investing activities (42,065) 1,620
--------- -------
Cash flows from financing activities:
Principal payments under capital leases (13) (56)
Net proceeds from issuance of common stock under stock
option plans 3,453 153
--------- -------
Net cash provided by financing activities 3,440 97
--------- -------
Net increase (decrease) in cash and cash equivalents (6,015) 3,195
Cash and cash equivalents at beginning of period 22,284 1,776
--------- -------
Cash and cash equivalents at end of period $ 16,269 $ 4,971
========= =======
Supplemental disclosures:
Cash paid during the period for:
Interest $ 15 $ 58
Income taxes 28 53
During the nine months ended March 26, 2000, the Company recognized a credit to
additional paid-in capital and a debit in income taxes payable of $11,232
related to the tax benefit from exercises of stock options under the Company's
stock option plans.
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
March 26, 2000, and June 27, 1999, and the results of operations for the
three and nine months ended March 26, 2000, and March 28, 1999, and the
statements of cash flows for the nine months then ended. Certain
reclassifications have been made to the Condensed Consolidated Statements of
Operations for the three and nine months ended March 28, 1999, to conform to
the presentation for the three and nine months ended March 26, 2000. Interim
results for the three and nine months ended March 26, 2000, are not
necessarily indicative of the results that may be expected for the year
ending July 2, 2000. 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 27, 1999. References to dollar and share amounts are in
thousands, except per share data, unless otherwise specified.
2. Inventories
Inventories, net, are summarized as follows:
March 26, June 27,
2000 1999
--------- --------
Raw materials $ 924 $ 805
Finished goods 11,203 10,278
------- -------
$12,127 $11,083
======= =======
3. Earnings per Share
Basic net income per share is computed by dividing income by the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed by dividing income by the weighted average
number of common shares outstanding during the period increased to include,
if dilutive, 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 net
income per share by application of the treasury stock method. The following
table sets forth the computation of basic and diluted net income per share:
Three Months Ended Nine Months Ended
------------------------- ------------------------
March 26, March 28, March 26, March 28,
2000 1999 2000 1999
--------- --------- --------- ---------
Numerator:
Net income $ 7,678 $ 1,355 $23,245 $ 2,217
======= ======= ======= =======
Denominator:
Denominator for basic net income per
share - weighted average shares outstanding 35,754 24,632 35,149 24,589
Effect of dilutive securities:
Dilutive options outstanding 2,676 3,015 3,024 2,437
------- ------- ------- -------
Denominator for diluted net income per
share - adjusted weighted average shares 38,430 27,647 38,173 27,026
======= ======= ======= =======
Basic net income per share $ 0.21 $ 0.06 $ 0.66 $ 0.09
======= ======= ======= =======
Diluted net income per share $ 0.20 $ 0.05 $ 0.61 $ 0.08
======= ======= ======= =======
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Options to purchase 113 shares of common stock at prices in excess of
$141.77 per share were outstanding at March 26, 2000, but were not included
in the computation of diluted earnings per share for the three month period
then ended. Furthermore, options to purchase 378 shares of common stock at
prices in excess of $82.13 per share were outstanding at March 26, 2000, but
were not included in the computation of diluted earnings per share for the
nine month period then ended. Options to purchase 93 shares of common stock
at prices in excess of $8.99 per share were outstanding at March 28, 1999,
but were not included in the computation of diluted earnings per share for
the three month period then ended. Additionally, options to purchase 314
shares of common stock at prices in excess of $5.57 per share were
outstanding at March 28, 1999, 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 prices were greater than the average market
price of the common shares during the respective periods, and therefore, the
effect would be antidilutive.
4. Accrued Liabilities
Components of accrued liabilities are as follows:
March 26, June 27,
2000 1999
--------- --------
Payroll and related costs $3,826 $1,849
Warranty and related reserves 1,053 868
Unearned revenue 902 951
Other 1,485 623
------ ------
$7,266 $4,291
====== ======
5. Common Stock Splits
On August 30, 1999, the Company completed a two-for-one stock split,
effected in the form of a stock dividend of one share of Emulex Common Stock
for each share of common stock outstanding to stockholders of record on
August 16, 1999. All share, per share and related data presented in the
condensed consolidated financial statements and footnotes have been
retroactively adjusted to reflect this stock split. As the par value of the
Company's common stock remained at $0.20 per share, all periods presented
reflect a reclass from additional paid-in capital to common stock.
Additionally, on December 15, 1999, the Company completed another
two-for-one stock split, and the par value of the Company's common stock
changed from $0.20 per share to $0.10 per share. All share and per share
data presented in the condensed consolidated financial statements and
footnotes have also been retroactively adjusted to reflect this stock split.
6. Consolidation Charges
On March 25, 1998, the Company announced plans to outsource the
manufacturing of its product lines to K*TEC Electronics, a division of Kent
Electronics Corporation. 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. This announcement resulted,
among other things, in the decision to close the Company's Puerto Rico
manufacturing subsidiary and to close selected sales offices. As a result of
these actions, the Company anticipated a worldwide reduction of
approximately 130 full-time employees and 45 temporary workers in Puerto
Rico. During the nine months ended March 28, 1999, the Company sold the land
and buildings at its former manufacturing facility in Puerto Rico. This sale
resulted in a gain of $777. No impairment had previously been recognized
related to the land and buildings. Additionally, as the Company essentially
completed this consolidation plan including all remaining headcount
reductions, the Company recognized additional inventory charges related to
consolidation of $1,304 during the nine months ended March 28, 1999, related
to the streamlining of the Company's products. When the initial
consolidation charge was taken, management of the Company believed this
inventory would be sold at positive margins. However, as the Company neared
the closure of the manufacturing facility, it determined this inventory was
no longer saleable and these additional reductions in inventory were
recorded. Additionally, during the nine months ended March 28, 1999, the
Company recognized a net reduction in other accrued consolidation charges of
$210 based on management's periodic review of the adequacy of the remaining
consolidation accrual. As of June 27, 1999, this consolidation plan was
substantially complete.
7. Commitments and Contingencies
The Company is currently undergoing an examination by the California
Franchise Tax Board for the Company's 1989, 1990 and 1991 California income
tax returns. The Company is also undergoing examination by the Internal
Revenue Service of Emulex Caribe's 1995 U.S. tax return. It is management's
belief that the outcome of these examinations will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or liquidity.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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,"
"intends," "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 Management's Discussion and Analysis of Financial Condition and
Results of Operations set forth below, as well as in "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. References contained
herein to "Emulex," the "Company," "we," "our" and "us" refer to Emulex
Corporation and its subsidiaries.
COMPANY OVERVIEW
Emulex Corporation is a leading designer, developer and supplier of a broad line
of fibre channel host adapters, hubs, Application Specific Integrated Circuits
("ASICs") and software products that enhance access to, and storage of,
electronic data and applications. We believe that we are the only company that
designs, develops and markets both fibre channel host adapters and hubs, two of
the core components of a complete fibre channel solution. Our products are based
on internally developed ASIC technology, are deployable across a variety of
heterogeneous network configurations and operating systems, and support
increasing volumes of stored data. Over the course of our history, we have also
designed, developed and marketed traditional networking products such as printer
servers and network access products, including communications servers and wide
area network ("WAN") adapters. 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 Income.
This table should be read in conjunction with the Condensed Consolidated
Financial Statements included elsewhere herein. References to dollar amounts are
in thousands, except per share data, unless otherwise specified.
Percentage of Net Revenues Percentage of Net Revenues
For the Three Months Ended For the Nine Months Ended
-------------------------- --------------------------
March 26, March 28, March 26, March 28,
2000 1999 2000 1999
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Cost of sales 52.4 59.4 53.6 59.9
Cost of sales - inventory charges related
to consolidation -- -- -- 2.7
----- ----- ----- -----
Total cost of sales 52.4 59.4 53.6 62.6
----- ----- ----- -----
Gross profit 47.6 40.6 46.4 37.4
----- ----- ----- -----
Operating expenses:
Engineering and development 9.8 16.9 10.8 17.5
Selling and marketing 6.8 9.3 7.3 10.7
General and administrative 5.2 6.2 5.2 6.2
Consolidation charges, net -- -- -- (2.0)
----- ----- ----- -----
Total operating expenses 21.8 32.4 23.3 32.4
----- ----- ----- -----
Operating income 25.8 8.2 23.1 5.0
Nonoperating income 6.5 0.1 6.3 0.1
----- ----- ----- -----
Income before income taxes 32.3 8.3 29.4 5.1
Income tax provision 11.3 0.9 5.9 0.5
----- ----- ----- -----
Net income 21.0% 7.4% 23.5% 4.6%
===== ===== ===== =====
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THREE MONTHS ENDED MARCH 26, 2000, COMPARED TO THREE MONTHS ENDED MARCH 28, 1999
Net Revenues. Net revenues for the three months ended March 26, 2000, were
$36,518, an increase of $18,283, or 100 percent, from $18,235 for the three
months ended March 28, 1999. Net revenues for the quarter ended March 26, 2000,
consisted of $24,960 from sales to OEMs, $11,498 from sales sold through
distribution channels and $60 from sales directly to end users. This represents
an increase in OEM sales of $10,442, or 72 percent, and an increase in
distribution sales of $8,077, or 236 percent, compared to the same relative
quarter of the prior fiscal year. These increases in net revenues were partially
offset by a decrease in end-user sales of $236, or 80 percent.
Net revenues for the third fiscal quarter ended March 26, 2000, increased
$2,915, or nine percent, to $36,518 from $33,603 for the second fiscal quarter
ended December 26, 1999. This sequential growth from the previous quarter is
primarily due to increased sales of the Company's fibre channel products. There
can be no assurance that the Company will continue to achieve these growth
rates, or favorable increases at all, when compared to the preceding quarter or
the comparable period of the prior year.
From a product line perspective, net revenues generated from the Company's fibre
channel products for the third quarter of fiscal 2000 ended March 26, 2000, were
$30,976, or 85 percent of revenue. This represents an increase of $19,640, or
173 percent, from the comparable quarter of fiscal 1999. This increase in net
revenues from the Company's fibre channel products is primarily the result of
the increased size of the market for fibre channel products and the increased
market acceptance of the Company's fibre channel products. The Company's revenue
in this emerging market has continued to be generated from OEMs taking product
directly and through distribution channels. Net revenues from the Company's
traditional networking products for the third quarter of fiscal 2000 were
$5,542, or 15 percent of revenue. This represents a decrease of $1,357, or 20
percent, compared to the corresponding quarter of fiscal 1999. This decrease in
net revenues from the Company's traditional networking products was principally
due to ongoing maturation of these products and a decrease in the Company's
focus on these products. The Company expects that these products will show
continued maturation through calendar 2000.
As the market for Emulex's traditional networking products matures and as Emulex
focuses more of its resources on the fibre channel market, the Company expects
that fibre channel product sales will represent a larger percentage of revenues
and that total sales of its traditional networking products will decrease. The
Company anticipates that future revenue from its fibre channel products will be
a function of continued demand from OEMs that are currently shipping fibre
channel products, launches of new fibre channel-based systems by the Company's
current OEMs, additional design wins and increased distribution sales as this
emerging market continues to develop. Although fibre channel represented 85
percent of the Company's net revenues for the quarter ended March 26, 2000, the
market is still in the early stages of its development, and there can be no
assurance given that the Company's products will continue to 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 Company's
future revenues from its fibre channel products depend on the availability of
other fibre channel products not manufactured or sold by the Company.
Furthermore, the Company's fibre channel products are dependent upon components
supplied by third parties for this emerging technology, and there can be no
assurance that these components will be available at a competitive price and in
the quantities desired or, if available, will function as needed.
In the quarter ended March 26, 2000, sales to IBM, including Sequent, accounted
for 16 percent; sales to EMC, including Data General and McDATA, accounted for
15 percent; sales to Avnet accounted for 14 percent; sales to Compaq accounted
for 12 percent; and sales to Bell Microproducts accounted for 12 percent of the
company's net revenues. No other customer accounted for more than 10 percent of
net revenues during this period. For the quarter ended March 28, 1999, sales to
IBM, including Sequent, accounted for 30 percent; sales to Compaq accounted for
13 percent; and sales to EMC, including Data General and McDATA, accounted for
12 percent of the Company's net revenues. No other customer accounted for more
than 10 percent of net revenues during this period. Sales to the Company's top
five customers accounted for 68 percent of net revenues for the third quarter of
fiscal 2000 compared to 64 percent in the comparable period of fiscal 1999.
Domestic net revenues were $24,793, or 68 percent of total net revenues, for the
three months ended March 26, 2000, and $12,664, or 69 percent of total net
revenues, for the three months ended March 28, 1999. This increase in domestic
revenues of $12,129, or 96 percent, is principally due to the increasing level
of fibre channel product shipments during the current fiscal year. The increase
in fibre channel shipments is primarily the result of the
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increased size of the market for fibre channel products and the increased market
acceptance of the Company's fibre channel products. International net revenues
were $11,725, or 32 percent of total net revenues, for the three months ended
March 26, 2000, and $5,571, or 31 percent of net revenues, for the three months
ended March 28, 1999. This increase in international revenues of $6,154, or 110
percent, is also principally due to the increasing level of fibre channel
product shipments during the current fiscal year.
Gross Profit. Cost of products sold includes the cost of production of finished
products, as well as support costs and other expenses related to inventory
management, manufacturing quality and order fulfillment. For the three months of
fiscal 2000 ended March 26, 2000, gross profit increased $9,960, or 134 percent,
to $17,369 from $7,409 for the comparable quarter of the prior fiscal year.
Gross margin increased to 48 percent for the quarter ended March 26, 2000,
compared to 41 percent in the same relative quarter of fiscal 1999, due to the
increasing mix of higher margin fibre channel products relative to the Company's
lower margin traditional networking products.
Engineering and development. Engineering and development expenses consist
primarily of salaries and related expenses for personnel engaged in the design,
development and technical support of the Company's products. These expenses
include third-party fees paid to consultants, prototype development expenses and
computer services costs related to supporting computer tools used in the design
process. Engineering and development expenses were $3,586 and $3,080 for the
quarters ended March 26, 2000, and March 28, 1999, representing 10 percent and
17 percent of net revenues, respectively. Engineering and development expenses
increased by $506, or 16 percent, from the third quarter of fiscal 1999 to the
third quarter of fiscal 2000 as the Company increased its investment in its
fibre channel product development. Even though the Company has continued to
increase its investment in fibre channel product development, it has not
increased as quickly as revenue has expanded. Consequently, engineering and
development has decreased as a percentage of revenue. Because of the technical
nature of the Company's products, engineering support is a critical part of the
Company's strategy during both the development of its products and the support
of its customers from product design through deployment into the market.
Management intends to continue to make significant investments in the technical
support and enhancement of the Company's current products, as well as the
continued development of new products in the fibre channel market. Engineering
and development expenses can fluctuate from quarter to quarter depending on
several factors, including new product introduction schedules, hiring patterns
and depreciation of capital equipment.
Selling and marketing. Selling and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged in the
marketing and sales of the Company's products, as well as trade shows, product
literature and promotional support costs. Selling and marketing expenses were
$2,492 and $1,695 for the quarters ended March 26, 2000, and March 28, 1999,
representing seven and nine percent of net revenues, respectively. Selling and
marketing expenses for the third quarter of fiscal 2000 increased by $797, or 47
percent, from the comparable period of fiscal 1999. This increase was primarily
due to increased salaries and commissions associated with the higher revenues
and increased promotion and advertising costs. However, as a portion of the
selling and marketing expenses is fixed, the expenses have not expanded at the
same rate as the Company's net revenues. Consequently, as a percentage of net
revenues, selling and marketing expenses have decreased slightly.
General and administrative. General and administrative expenses consist
primarily of salaries and related expenses for executives, financial accounting
support, human resources, administrative services, professional fees and other
associated corporate expenses. General and administrative expenses were $1,884
and $1,146 for the quarters ended March 26, 2000, and March 28, 1999,
representing five and six percent of net revenues, respectively. General and
administrative expenses increased by $738, or 64 percent, for the third quarter
of fiscal 2000 compared to the equivalent quarter of fiscal 1999 primarily due
to higher compensation associated with the higher revenues. Similar to selling
and marketing expenses, these expenses have not expanded at the same rate as the
Company's net revenues. Consequently, as a percentage of net revenues, general
and administrative expenses have also decreased slightly.
Nonoperating Income. Nonoperating income consists primarily of interest income.
The Company's nonoperating income increased $2,388 to $2,405 for the third
quarter of fiscal 2000 compared to $17 for the third quarter of fiscal 1999.
This increase in nonoperating income is primarily due to an increase in interest
income associated with the investments of the funds the Company received from
the secondary offering of common stock completed during the fourth quarter of
fiscal 1999.
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Income Taxes. For the quarter ended March 26, 2000, the Company recorded a 35
percent tax provision in the amount of $4,134. For the quarter ended March 28,
1999, the Company recorded a 10 percent tax provision in the amount of $150. The
lower effective tax rate in 1999 was due to utilization of net operating loss
carryforwards which were held net of a substantial valuation allowance. During
the quarter ended March 26, 2000, the large difference between the exercise
prices of the Company's stock options and the related market prices created a
significant tax deduction, and as such it was determined that it was not more
likely than not that the remaining deferred tax assets would be realized. As a
result, no valuation allowance was released for the quarter ended March 26, 2000
which resulted in the 35 percent tax provision. Management is continuing to
analyze the Company's effective tax rate in light of the current year and
projected results of operations. Though this analysis for the fourth quarter of
fiscal 2000 is not yet complete, management currently expects the Company's
effective tax rate to equal or exceed 35 percent for the fourth quarter of
fiscal 2000 and through fiscal 2001. (See discussion of Income Taxes for nine
months ended March 26, 2000.)
The Company is currently undergoing an examination by the California Franchise
Tax Board for the Company's 1989, 1990 and 1991 California income tax returns.
The Company is also undergoing examination by the Internal Revenue Service of
Emulex Caribe's 1995 U.S. tax return. It is management's belief that the outcome
of these examinations will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
NINE MONTHS ENDED MARCH 26, 2000, COMPARED TO NINE MONTHS ENDED MARCH 28, 1999
Net Revenues. Net revenues for the nine months ended March 26, 2000, were
$99,017, an increase of $50,985, or 106 percent, from $48,032 for the nine
months ended March 28, 1999. Net revenues for the nine months ended March 26,
2000, consisted of $71,714 from sales to OEMs, $26,993 from sales sold through
distribution channels and $310 from sales directly to end users. This represents
an increase in OEM sales of $36,025, or 101 percent, and an increase in
distribution sales of $15,765, or 140 percent, compared to the same relative
period of the prior fiscal year. These increases were partially offset by a
decrease in end-user sales of $805, or 72 percent.
From a product line perspective, net revenues generated from the Company's fibre
channel products for the first nine months of fiscal 2000 ended March 26, 2000,
were $80,899, or 82 percent of net revenues. This represents an increase of
$56,253, or 228 percent, from the comparable period of fiscal 1999. This
increase in net revenues from the Company's fibre channel products is primarily
the result of the increased size of the market for fibre channel products and
the increased market acceptance of the Company's fibre channel products. The
Company's revenue in this emerging market has continued to be generated from
OEMs taking product directly and through distribution channels. Net revenues
from the Company's traditional networking products for the first nine months of
fiscal 2000 were $18,118, or 18 percent of net revenues. This represents a
decrease of $5,268, or 23 percent, compared to the corresponding period of
fiscal 1999. This decrease in net revenues from the Company's traditional
networking products was principally due to ongoing maturation of these products
and a decrease in the Company's focus on these products. The Company expects
that these products will show continued maturation through calendar 2000.
In the nine months ended March 26, 2000, sales to Compaq accounted for 20
percent; sales to EMC, including Data General and McDATA, accounted for 17
percent; sales to IBM, including Sequent, accounted for 15 percent; and sales to
Avnet accounted for 13 percent of the Company's net revenues. No other customer
accounted for more than 10 percent of net revenues during this period. For the
nine months ended March 28, 1999, sales to IBM, including Sequent, accounted for
26 percent; and sales to EMC, including Data General and McDATA, accounted for
10 percent of the Company's net revenues. No other customer accounted for more
than 10 percent of net revenues during this period. Sales to the Company's top
five customers accounted for 73 percent of net revenues for the first nine
months of fiscal 2000 compared to 56 percent in the comparable period of fiscal
1999.
Domestic net revenues were $69,195, or 70 percent of total net revenues, and
$32,117, or 67 percent of total net revenues, for the nine months ended March
26, 2000, and March 28, 1999, respectively. This increase in domestic revenues
of $37,078, or 115 percent, is principally due to the increasing level of fibre
channel product shipments during the current fiscal year. The increase in fibre
channel shipments is primarily the result of the increased size of the market
for fibre channel products and the increased market acceptance of the Company's
fibre channel products. International net revenues were $29,822, or 30 percent
of total net revenues, and $15,915, or 33 percent of total net revenues, for the
nine months ended March 26, 2000, and March 28, 1999, respectively. This
increase in international revenues of $13,907, or 87 percent, is also
principally due to the increasing level of fibre channel product shipments
during the current fiscal year. Although both domestic and international
revenues have increased, domestic revenues have become a larger percent of net
revenues due to the heavier concentration of fibre channel shipments to domestic
OEMs.
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Gross Profit. For the nine months ended March 26, 2000, gross profit increased
$28,003, or 156 percent, to $45,959 from $17,956 for the comparable nine months
of fiscal 1999. Gross margin increased to 46 percent for the nine month ended
March 26, 2000 compared to 37 percent for the respective nine month period of
fiscal 1999. During the nine month period of fiscal 1999, the Company recorded
$1,304 of inventory charges related to consolidation in cost of sales. When the
initial consolidation charge, which is discussed in more detail below, was taken
in fiscal 1998, management believed this inventory would be sold at positive
margins. However, as the Company neared the closure of its manufacturing
facility, management determined this inventory was no longer saleable, and these
additional reductions in inventory were recorded. Excluding this charge, gross
profit for the nine months ended March 28, 1999 would have been $19,260 and
gross margin would have been 40 percent. This improvement in gross margin from
the corresponding period of fiscal 1999 is primarily due to a continuing shift
in product mix towards the Company's higher margin fibre channel products.
Engineering and development. Engineering and development expenses were $10,735
and $8,381 for the nine months ended March 26, 2000, and March 28, 1999,
representing 11 percent and 17 percent of net revenues, respectively.
Engineering and development expenses increased by $2,354, or 28 percent, for the
first nine months of fiscal 2000 compared to the first nine months of fiscal
1999 as the Company increased its investment in its fibre channel product
development. Even though the Company has continued to increase its investment in
fibre channel product development, it has not increased as quickly as revenue
has expanded. Consequently, engineering and development has decreased as a
percentage of revenue. Because of the technical nature of the Company's
products, engineering support is a critical part of the Company's strategy
during both the development of its products and the support of its customers
from product design through deployment into the market. Management intends to
continue to make significant investments in the technical support and
enhancement of the Company's current products, as well as the continued
development of new products in the fibre channel market.
Selling and marketing. Selling and marketing expenses were $7,270 and $5,134 for
the nine months ended March 26, 2000, and March 28, 1999, representing seven
percent and 11 percent of net revenues, respectively. Selling and marketing
expenses for the first nine months of fiscal 2000 increased by $2,136, or 42
percent, from the comparable period of fiscal 1999. This increase was primarily
due to increased salaries and commissions associated with the higher revenues
and increased promotion and advertising costs. However, as a portion of the
selling and marketing expenses is fixed, these expenses have not expanded at the
same rate as the Company's net revenues. Consequently, as a percentage of net
revenues, selling and marketing expenses have decreased.
General and administrative. General and administrative expenses were $5,121 and
$3,032 for the nine months ended March 26, 2000, and March 28, 1999,
representing five percent and six percent of net revenues, respectively. General
and administrative expenses increased by $2,089, or 69 percent, for the first
nine months of fiscal 2000 compared to the equivalent period of fiscal 1999,
primarily due to higher compensation associated with the higher revenues.
Similar to selling and marketing expenses, these expenses have not expanded at
the same rate as the Company's net revenues. Consequently, as a percentage of
net revenues, general and administrative expenses have decreased slightly.
Consolidation Charges. On March 25, 1998, the Company announced plans to
outsource the manufacturing of its product lines to K*TEC Electronics, a
contract manufacturing division of Kent Electronics 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. This announcement resulted in, among other things, the
decision to close the Company's Puerto Rico manufacturing subsidiary and to
close selected sales offices. During the nine month period ended March 28, 1999,
as the Company was completing this consolidation plan, the Company completed the
sale of the land and buildings at its former manufacturing facility in Puerto
Rico. The sale resulted in a gain of $777. No impairment had previously been
recognized related to the land and buildings. Also in conjunction with the
closure of the Company's Puerto Rico manufacturing operations, during the nine
months ended March 28, 1999, the Company recorded additional reductions in
inventory related to the streamlining of its product lines of $1,304 in cost of
sales. When the initial consolidation charge was taken in fiscal 1998,
management believed this inventory would be sold at positive margins. However,
as the Company neared the closure of the manufacturing facility, management
determined that this inventory was no longer saleable and these additional
reductions in inventory were recorded. Furthermore, during the first nine months
of fiscal 1999, the Company recorded a net reduction of other accrued
consolidation charges of $210 based on management's review of the adequacy of
the remaining consolidation accrual. The Company substantially completed this
consolidation plan in fiscal 1999.
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Nonoperating Income. The Company's nonoperating income increased $6,209 to
$6,276 for the first nine months of fiscal 2000 compared to $67 for the first
nine months of fiscal 1999. This increase in nonoperating income is primarily
due to an increase in interest income associated with the investments of the
funds the Company received from the secondary offering of common stock completed
during the fourth quarter of fiscal 1999.
Income Taxes. For the nine months ended March 26, 2000, the Company recorded a
20 percent tax provision in the amount of $5,864. The Company's effective tax
rate of 20 percent for this period includes a benefit in the first and second
quarters of fiscal 2000 for the reduction of the valuation allowance held
against certain net operating loss carryforwards, as discussed in the following
paragraph. For the nine months ended March 28, 1999, the Company recorded a 10
percent tax provision in the amount of $246. The Company's effective tax rate of
10 percent for this period of fiscal 1999 is primarily due to utilization of
certain net operating losses as discussed previously.
For the quarters ended September 26, 1999 and December 26, 1999, the Company's
deferred tax valuation allowance was reduced by $2,321 and $3,323, respectively,
due to the assessment of the recoverability of a portion of the Company's net
operating loss carryforwards due to the profitability levels being incurred by
the Company. For the quarter ended March 26, 2000, despite the continued levels
of profitability, the large difference between the exercise prices of the
Company's stock options and the related market prices created a significant tax
deduction, and as such it was determined that it was not more likely than not
that the remaining deferred tax assets would be realized. As a result, no
valuation allowance was released for the quarter ended March 26, 2000.
YEAR 2000
Many existing computer systems and applications use two digits rather than four
to define the applicable year. These programs were designed without considering
the impact of the change from 1999 to 2000. The Company has continued to monitor
this situation and has determined, to date, that no material issues have
resulted from the date change. Furthermore, the Company's remediation and
preparation for the date change did not have a material effect on the Company's
business, financial condition or results of operations.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
133, "Accounting for Derivative Instruments and Hedging Activities." The new
statement established accounting and reporting standards for derivative
instruments and for hedging activities and is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. The Company does not expect the
adoption of Statement 133 to have a material impact on the Company's results of
operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin 101 (SAB101) "Revenue Recognition in Financial Statements." This Staff
Accounting Bulletin summarizes certain of the staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. The Company does not expect the issuance of SAB101 to have a
material impact on the Company's results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents decreased by $6,015 during the first
nine months of fiscal 2000 from $22,284 as of June 27, 1999, to $16,269 as of
March 26, 2000. This decrease in cash and cash equivalents is primarily due to
the Company's investing activities, and is partially offset by an increase in
cash and equivalents provided by operating activities. Operating activities;
which include net income of $23,245, increases in income taxes payable of
$11,483 and accounts payable of $8,500, offset by an increase in accounts
receivable of $8,021, as well as changes in other working capital balances;
provided $32,610 of cash and cash equivalents for the nine month period of
fiscal 2000. Operating activities provided $1,478 of cash and cash equivalents
during the comparable nine month period of fiscal 1999. Investing activities,
which include purchases of investments of $474,713, maturities of investments of
$434,353, as well as the acquisition and disposition of property, plant and
equipment, used $42,065 of cash and cash equivalents during the nine month
period ended March 26, 2000 compared to using $1,620 in the comparable period of
fiscal 1999. The Company completed the sale of its production equipment and its
former manufacturing facility in Puerto Rico during the nine month period of
fiscal 1999. The Company received net proceeds of $2,447 in cash and recognized
a gain of $777 associated with the sale of this manufacturing facility.
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Net financing activities, which were limited to payments under capital lease
obligations and proceeds from the exercise of stock options, provided $3,440 of
cash and cash equivalents during the first nine months of fiscal 2000 compared
to providing $97 of cash and cash equivalents in the same relative period of the
prior fiscal year.
As part of the Company's continued investment in fibre channel product
development, the Company expects to increase its capital expenditures, most
notably for engineering and development. The Company believes that its existing
cash balances, facilities and equipment leases and anticipated cash flows from
operating activities will be sufficient to support its working capital needs and
capital expenditure requirements for at least the next 12 months.
RISK FACTORS
WE HAVE EXPERIENCED LOSSES IN OUR HISTORY.
We have experienced losses in our history, most recently a net loss of $10,838
for the fiscal year ended June 28, 1998. This net loss in 1998 included $5,314
of inventory charges related to consolidation and $7,231 of consolidation
charges in conjunction with the closure of our Puerto Rico manufacturing
operations and selected sales offices. While we have generated net income for 13
of the last 14 quarters through the quarter ended March 26, 2000, we cannot be
certain that revenues will remain at current levels or improve or that we will
be profitable at such revenue levels.
OUR OPERATING RESULTS ARE DIFFICULT TO FORECAST AND MAY BE ADVERSELY AFFECTED BY
MANY FACTORS.
Our revenues and results of operations have varied on a quarterly basis in the
past and potentially may vary significantly in the future. Accordingly, we
believe that period-to-period comparisons of our results of operations are not
necessarily meaningful, and you should not rely on such comparisons as
indications of our future performance. Our revenues and results of operations
are difficult to forecast and could be adversely affected by many factors,
including, among others:
o The size, timing and terms of customer orders;
o The relatively long sales and deployment cycles for our products,
particularly those sold through our OEM sales channels;
o Changes in our operating expenses;
o Our ability to develop and market new products;
o The ability of our contract manufacturer to produce and distribute our
products in a timely fashion;
o The market acceptance of our new fibre channel products;
o The timing of the introduction or enhancement of products by us, our OEM
customers and our competitors;
o The level of product and price competition;
o Our ability to expand our relationships with OEMs and distributors;
o Activities of, and acquisitions by, our competitors;
o Acquisitions made by us;
o Changes in technology, industry standards or consumer preferences;
o Increases in interest rates;
o Changes in the mix of products sold, as our fibre channel adapter
products typically have higher margins than our traditional networking
products and our fibre channel hubs;
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o Changes in the mix of sales channels;
o The level of international sales;
o Seasonality;
o Personnel changes;
o Changes in customer budgeting cycles;
o Foreign currency exchange rates; and
o General economic conditions.
As a result of these and other factors, our business, results of operations and
financial condition could be materially adversely affected.
There are other factors that contribute to the variability of our sales as well.
Historically, we have generally shipped products quickly after we receive
orders, meaning that we do not always have a significant backlog of unfilled
orders. As a result, our revenues in a given quarter may depend substantially on
orders booked in that quarter. Also, we have typically generated a large
percentage of our quarterly revenues in the last month of the quarter.
Additionally, individual OEM customer purchases can vary significantly from
quarter to quarter.
A decrease in the number of orders we receive is likely to adversely and
disproportionately affect our quarterly results of operations. This is because
our expense levels are partially based on our expectations of future sales and
our expenses may be disproportionately large as compared to sales in a quarter
with reduced orders. Hence, we may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Any shortfall in
sales in relation to our quarterly expectations or any delay of customer orders
would likely have an immediate and adverse impact on our business, quarterly
results of operations and financial condition.
OUR BUSINESS DEPENDS UPON THE DEVELOPMENT OF THE FIBRE CHANNEL MARKET, AND OUR
REVENUES WILL BE LIMITED IF SUCH DEVELOPMENT DOES NOT OCCUR OR OCCURS MORE
SLOWLY THAN WE ANTICIPATE.
The size of our potential market is dependent upon the broad acceptance of fibre
channel technology as an alternative to other technologies traditionally
utilized for network and storage communications. The fibre channel market, while
rapidly evolving and attracting an increasing number of market participants, is
still at an early stage of development. We believe the fibre channel market will
continue to expand and that our investment in the fibre channel market
represents our greatest opportunity for revenue growth and profitability in the
future. However, we cannot be certain that fibre channel products will gain
broader market acceptance or that customers will choose our technology and
products. Fibre channel products accounted for 85 percent of net revenues in the
quarter ended March 26, 2000. If the fibre channel market fails to develop,
develops more slowly than anticipated or attracts more competitors than we
expect (as discussed below), our business, results of operations and financial
condition would be materially adversely affected. A similar result would occur
if our products do not achieve market acceptance.
Alternative technologies such as SCSI compete with fibre channel technology for
customers. Some SCSI technology companies already have well-established
relationships with our current and potential customers, have extensive knowledge
of the markets we serve and have better name recognition and more extensive
development, sales and marketing resources than we have. Our success also
depends both on our own ability and on the ability of our OEM customers to
develop fibre channel solutions that are competitive with other technologies.
Ultimately, our business depends upon our ability, along with the ability of our
OEM customers, to convince end users to adopt fibre channel technology.
While we have secured numerous design wins for our fibre channel products from
OEM customers, nearly all of these customers are still at the very early stages
of initial commercial shipments or at the developmental stage of incorporating
fibre channel into their systems. Only a portion of OEM customers are in full
commercial production of products that incorporate our fibre channel products.
If our developmental and early stage customers are unable to or otherwise do not
ship systems that incorporate our products, or if their shipped systems are not
commercially successful, our business, results of operations and financial
condition would be materially adversely affected.
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THE LOSS OF ONE OR MORE CUSTOMERS COULD HARM OUR REVENUES.
For the nine months ended March 26, 2000, sales to our top customer, Compaq,
represented 20 percent of our net revenues. Additionally, sales to EMC,
including Data General and McDATA, were 17 percent; sales to IBM, including
Sequent, were 15 percent; and sales to Avnet were 13 percent of our net revenues
for the nine months ended March 26, 2000. In the prior fiscal year's comparable
period, sales to IBM, including Sequent, represented 26 percent and sales to
EMC, including Data General and McData accounted for 10 percent of our net
revenues. Sales to our top five customers accounted for 73 percent of net
revenues for the nine months ended March 26, 2000, and for 56 percent of net
revenues for the nine months ended March 28, 1999. Although we have attempted to
expand our base of customers, our revenues in the future may nonetheless be
similarly derived from a limited number of customers, especially given the
consolidation the industry has recently experienced.
THE FAILURE OF ONE OR MORE OF OUR SIGNIFICANT CUSTOMERS TO MAKE TIMELY PAYMENTS
COULD ADVERSELY AFFECT OUR BUSINESS.
We are also subject to credit risk associated with the concentration of our
accounts receivable from our customers. If we were to lose one of our current
significant customers or did not receive their payments due to us, we could
experience a material adverse effect on our business, results of operations and
financial condition.
THE LOSS OF ONE OR MORE OF OUR OEM OR DISTRIBUTOR CUSTOMERS COULD ADVERSELY
AFFECT OUR BUSINESS.
We rely almost exclusively on OEMs and sales through distribution channels for
our revenue. For the nine months ended March 26, 2000, we derived approximately
72 percent of our net revenues from OEMs and 27 percent from sales through
distribution. In the comparable period of fiscal 1999, we derived approximately
74 percent of our net revenues from OEMs and 23 percent from distribution sales.
We cannot be certain that we will retain our current OEM and distributor
customers or that we will be able to recruit additional or replacement
customers. As is common in an emerging technology industry, our agreements with
OEMs and distributors are typically non-exclusive, have no volume commitments,
and often may be terminated by either party without cause. Indeed, many of our
OEM and distributor customers carry or utilize competing product lines. If we
were to suddenly lose one or more important OEM or distributor customers to a
competitor, our business, results of operations and financial condition could be
materially adversely affected.
SOME OF OUR OEM CUSTOMERS COULD BECOME COMPETITORS.
Some of our OEM customers could develop products internally that would replace
our products. The resulting reduction in sales of our products to our OEM
customers could have a material adverse effect on our business, results of
operations and financial condition.
OUR INDUSTRY IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND WE MUST KEEP PACE
WITH THE CHANGES TO SUCCESSFULLY COMPETE.
The markets for our products are characterized by rapidly changing technology,
evolving industry standards and the frequent introduction of new products and
enhancements. Our future success depends in a large part on our ability to
enhance our existing products and to introduce new products on a timely basis to
meet changes in customer preferences and evolving industry standards. We cannot
be certain that we will be successful in developing, manufacturing and marketing
new products or product enhancements that respond to such changes in a timely
manner and achieve market acceptance. We also cannot be certain that we will be
able to develop the underlying core technologies necessary to create new
products and enhancements, or that we will be able to license the core
technologies from third parties.
A key element of our business strategy is to develop multiple ASICs in order to
increase system performance and reduce manufacturing costs, thereby enhancing
the price/performance of our fibre channel products. We cannot be certain that
we will be successful at developing and incorporating ASICs effectively and in a
timely manner. Additionally, changes in technology and consumer preference could
potentially render our current products uncompetitive or obsolete. If we are
unable, for technological or other reasons, to develop new products or enhance
existing products in a timely manner in response to technological and market
changes, our business, results of operations and financial condition would be
materially adversely affected.
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THE FAILURE OF OUR OEM CUSTOMERS TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE
COULD ADVERSELY AFFECT OUR BUSINESS.
Our revenues depend significantly upon the ability and willingness of our OEM
customers to develop and promote on a timely basis products that incorporate our
technology. The ability and willingness of OEM customers to develop and promote
such products is based upon a number of factors, such as:
o The timely development by us and our OEM customers of new products with
new functionality, increased speed and enhanced performance at acceptable
prices;
o The development costs facing our OEM customers;
o The compatibility of new products with both existing and emerging
industry standards;
o Technological advances;
o Intellectual property issues; and
o Competition in general.
We cannot be certain of the ability or willingness of our OEM customers to
continue developing, marketing and selling products that incorporate our
technology. Our business is dependent on our relationships with our OEM and
distributor customers, so the inability or unwillingness of any of our
significant customers to develop or promote products that use our technology
would have a material adverse effect on our business, results of operations and
financial condition.
A SIGNIFICANT PERCENTAGE OF OUR REVENUES ARE FROM PRODUCT LINES THAT ARE BEING
PHASED OUT.
We have shifted the focus of our business to fibre channel technology. However,
our revenues still depend significantly on sales of our traditional networking
products. These traditional networking products accounted for 18 percent of our
net revenues for the first nine months of fiscal 2000. If the maturation of
these products were to occur faster than we anticipate, our business, results of
operations and financial condition could be materially adversely affected.
OUR MARKETS ARE HIGHLY COMPETITIVE.
The markets for our products are highly competitive and are characterized by
rapid technological advances, price erosion, frequent new product introductions
and evolving industry standards. Our current and potential competition consists
of major domestic and international companies, many of which have substantially
greater financial, technical, marketing and distribution resources than we have.
We expect that an increasing number of companies will enter the markets for our
fibre channel products. Furthermore, larger companies in other related
industries may develop or acquire technologies and apply their significant
resources, such as distribution channels and brand recognition, to acquire
significant market share. Emerging companies attempting to obtain a share of the
existing markets act as potential competition as well. Our competitors continue
to introduce products with improved price/performance characteristics, and we
will have to do the same to remain competitive. Increased competition could
result in significant price competition, reduced revenues, lower profit margins
or loss of market share, any of which would have a material adverse effect on
our business, results of operations and financial condition. We cannot be
certain that we will be able to compete successfully against either current or
potential competitors in the future.
In the fibre channel market, we compete primarily against Agilent, Gadzoox,
Interphase, JNI, LSI Logic, QLogic, Vixel and, to a lesser extent, several
smaller companies. In the printer server market, we compete against
Hewlett-Packard, Intel, Lexmark and a number of smaller companies. In the
network access market, we compete against numerous networking companies who
offer network access solutions. As is common in an emerging technology industry
with non-exclusive development arrangements, many of our OEM customers arrange
second source agreements to meet their requirements. Furthermore, in the future
our OEM customers may develop products that compete with ours or purchase such
products from our competitors and may terminate their relationships with us as a
result.
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A DECREASE IN THE AVERAGE UNIT SELLING PRICES OF OUR FIBRE CHANNEL PRODUCTS
COULD ADVERSELY AFFECT OUR BUSINESS.
As the market for fibre channel products matures, it is likely that we will
experience downward pressure on the average unit selling prices of our fibre
channel products. To the extent that average unit selling prices of our fibre
channel products decrease without a corresponding decrease in the costs of such
products, our gross margins and financial performance could be materially
adversely affected.
DELAYS IN PRODUCT DEVELOPMENT COULD ADVERSELY AFFECT OUR BUSINESS.
We have experienced delays in product development in the past and may experience
similar delays in the future. Given the short product life cycles in the markets
for our products, any delay or unanticipated difficulty associated with new
product introductions or product enhancements could have a material adverse
effect on our business, results of operations and financial condition. Prior
delays have resulted from numerous factors, such as:
o Changing OEM product specifications;
o Difficulties in hiring and retaining necessary personnel;
o Difficulties in reallocating engineering resources and other resource
limitations;
o Difficulties with independent contractors;
o Changing market or competitive product requirements;
o Unanticipated engineering complexity;
o Undetected errors or failures in software and hardware; and
o Delays in the acceptance or shipment of products by OEM customers.
OUR JOINT DEVELOPMENT ACTIVITIES MAY RESULT IN PRODUCTS THAT ARE NOT
COMMERCIALLY SUCCESSFUL OR THAT ARE NOT AVAILABLE IN A TIMELY FASHION.
We have engaged in joint development projects with third parties in the past and
we expect to continue doing so in the future. Joint development creates several
risks for us, including the loss of control over development of aspects of the
jointly-developed products and over the timing of product availability.
Accordingly, we face the risk that joint development activities will result in
products that are not commercially successful or that are not available in a
timely fashion.
THE LOSS OF THIRD-PARTY SUPPLIERS OR OUR CONTRACT MANUFACTURER COULD ADVERSELY
AFFECT OUR BUSINESS.
We rely on third-party suppliers for components which are used in our products,
and we have experienced delays or difficulty in securing components in the past.
Delays or difficulty in securing components may be caused by numerous factors
including, but not limited to:
o Discontinued production by a vendor;
o Natural disasters;
o Disruption in shipping channels;
o Difficulties associated with foreign operations, and
o Market shortages.
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Additionally, key components that we use in our products may only be available
from single sources with which we do not have long-term contracts. In
particular, Intel is currently our sole supplier for microprocessors used in our
fibre channel products. IBM, Finisar and Hewlett-Packard are currently our sole
suppliers for components that enable some of our fibre channel products to
connect to networks. Motorola is currently our sole supplier of a memory device
incorporated into our fibre channel products. In addition, we rely on LSI Logic,
Chip Express, Quicklogic and VLSI to manufacture ASICs for our products. The
components we use for our fibre channel products are based on an emerging
technology and may not be available with the performance characteristics or in
the quantities that we require. Our future inability to supply products due to a
lack of components or our inability to redesign products to accept alternatives
in a timely manner would materially adversely affect our business, results of
operations and financial condition.
Because we transitioned the production of our products to a contract
manufacturer, K*TEC Electronics, a division of Kent Electronics Corporation, we
plan to maintain only a minimal supply of product components. We now rely on
K*TEC Electronics to complete the majority of the component purchases for our
products. Consequently, we cannot be certain that the necessary components will
be available to meet our future requirements at favorable prices, if at all.
Moreover, because we rely on K*TEC Electronics to manufacture, store and ship
our products, if K*TEC Electronics is unable or unwilling to complete production
runs for us in the future, or experiences any significant delays in completing
production runs or shipping product, the manufacturing and sale of our products
would be temporarily suspended. An interruption in supply of our products and
the cost of qualifying and shifting production to an alternative manufacturing
facility would have a material adverse effect on our business, results of
operations and financial condition.
A DECREASE IN THE DEMAND FOR HIGH PERFORMANCE COMPUTER AND STORAGE SYSTEMS COULD
ADVERSELY AFFECT OUR BUSINESS.
A significant portion of our products are currently used in high-performance
computer and storage systems. Our fibre channel growth has been supported by
increasing demands for sophisticated networking and data storage solutions which
support enterprise computing requirements, including on-line transaction
processing, data mining, data warehousing, multimedia and Internet applications.
Should there be a slowing in the growth of demand for such systems, our
business, results of operations and financial condition could be materially
adversely affected.
THE INADEQUACY OF OUR INTELLECTUAL PROPERTY PROTECTIONS COULD ADVERSELY AFFECT
OUR BUSINESS.
We believe that our continued success depends primarily on continuing
innovation, marketing and technical expertise, as well as the quality of product
support and customer relations. At the same time, our success is partially
dependent on the proprietary technology contained in our products. We currently
rely on a combination of patents, copyrights, trademarks, trade secret laws and
contractual provisions to establish and protect our intellectual property rights
in our products. For a more complete description of our intellectual property,
you should read "Business--Intellectual Property" in the Company's Annual Report
on Form 10-K for fiscal 1999. We cannot be certain that the steps we take to
protect our intellectual property will adequately protect our proprietary
rights, that others will not independently develop or otherwise acquire
equivalent or superior technology, or that we can maintain such technology as
trade secrets. In addition, the laws of some of the countries in which our
products are or may be developed, manufactured or sold may not protect our
products and intellectual property rights to the same extent as the laws of the
United States or at all. Our failure to protect our intellectual property rights
could have a material adverse effect on our business, results of operations and
financial condition.
THIRD-PARTY CLAIMS OF INFRINGEMENT OF THEIR INTELLECTUAL PROPERTY COULD
ADVERSELY AFFECT OUR BUSINESS.
We believe that our products and technology do not infringe on the intellectual
property rights of others or upon intellectual property rights that may be
granted in the future pursuant to pending applications. We occasionally receive
communications from third parties alleging patent infringement, and there is
always the chance that third parties may assert infringement claims against us.
Any such claims, with or without merit, could result in costly litigation, cause
product shipment delays or require us to enter into royalty or licensing
agreements. However, we have in the past and may be required in the future to
obtain licenses of technology owned by other parties. We cannot be certain that
the necessary licenses will be available or that they can be obtained on
commercially reasonable terms. If we were to fail to obtain such royalty or
licensing agreements in a timely manner and on reasonable terms, our business,
results of operations and financial condition would be materially adversely
affected.
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THE LOSS OF KEY TECHNICAL PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS.
Our success depends to a significant degree upon the performance and continued
service of engineers involved in the development of our fibre channel technology
and technical support of fibre channel products and customers. Our future
success depends upon our ability to attract, train and retain such personnel. We
will need to increase the number of technical staff members with experience in
high-speed networking applications as we further develop the fibre channel
product line. Competition for such highly skilled employees in our industry is
intense, and we cannot be certain that we will be successful in recruiting and
retaining such personnel. In addition, employees may leave our company and
subsequently compete against us. The loss of these key technical employees could
have a material adverse effect on our business, results of operations and
financial condition.
OUR INTERNATIONAL BUSINESS ACTIVITIES SUBJECT US TO RISKS THAT COULD ADVERSELY
AFFECT OUR BUSINESS.
During the nine months ended March 26, 2000, sales in the United States
accounted for 70 percent of our net revenues, sales in Europe accounted for 26
percent of our net revenues, and sales in the Pacific Rim countries accounted
for four percent of our net revenues. During the comparable nine month period in
fiscal 1999, sales in the United States accounted for 67 percent of net
revenues, sales in Europe accounted for 28 percent of our net revenues, and
sales in the Pacific Rim countries accounted for five percent of our net
revenues. We expect that sales in the United States and Europe will continue to
account for the substantial majority of our revenues for the foreseeable future.
We encounter risks inherent in international operations. All of our sales are
currently denominated in U.S. dollars. As a result, if the value of the U.S.
dollar increases relative to foreign currencies, our products could become less
competitive in international markets. Our international business activities
could be limited or disrupted by any of the following factors:
o The imposition of governmental controls and regulatory requirements;
o The costs and risks of localizing products for foreign countries;
o Restrictions on the export of technology;
o Financial and stock market dislocations;
o Increases in interest rates;
o Longer accounts receivable payment cycles;
o Potentially adverse tax consequences;
o The repatriation of earnings;
o The burden of complying with a wide variety of foreign laws;
o Trade restrictions; and
o Changes in tariffs.
In addition, the revenues we earn in various countries in which we do business
may be subject to taxation by more than one jurisdiction, thereby adversely
affecting our earnings. These factors could harm future sales of our products to
international customers and have a material adverse effect on our business,
results of operations and financial condition.
EXPORT RESTRICTIONS MAY ADVERSELY AFFECT OUR BUSINESS.
Our fibre channel products are subject to U.S. Department of Commerce export
control restrictions. Neither we nor our customers may export such products
without obtaining an export license. These U.S. export laws also prohibit the
export of our fibre channel products to a number of countries deemed by the
United States to be hostile. These
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restrictions may make foreign competitors facing less stringent controls on
their products more competitive in the global market than we or our fibre
channel customers are. The U.S. government may not approve any pending or future
export license requests. In addition, the list of products and countries for
which export approval is required, and the regulatory policies with respect
thereto, could be revised. The sale of our fibre channel products could be
harmed by our failure or the failure of our customers to obtain the required
licenses or by the costs of compliance.
OUR BUSINESS MAY BE HARMED BY YEAR 2000 ISSUES.
Many existing computer systems and applications use two digits rather than four
to define the applicable year. These programs were designed without considering
the impact of the change in the century. To date, we have not experienced any
significant impact from the change to Year 2000. Our Year 2000 assessment and
remediation processes have not generated any material expenditures to date, and
we do not currently foresee any in the future. The Company believes it has fully
addressed all areas of this issue, including internal systems, products and
third parties; however, if any significant issues were to be identified in the
future, there can be no assurance given that our business, results of operations
and financial condition would not be materially adversely affected.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND SUCH ADDITIONAL FINANCING MAY
NOT BE AVAILABLE.
We currently anticipate that our available cash resources will be sufficient to
meet our expected working capital and capital expenditure requirements for at
least the next 12 months. However, we cannot assure you that such resources will
be sufficient for anticipated or unanticipated working capital and capital
expenditure requirements. We may need to raise additional funds through public
or private debt or equity financings in order to:
o Take advantage of unanticipated opportunities, including more rapid
international expansion or acquisitions of complementary businesses or
technologies;
o Develop new products or services; or
o Respond to unanticipated competitive pressures.
We may also raise additional funds through public or private debt or equity
financings if such financings become available on favorable terms. We cannot
assure you that any additional financing we may need will be available on terms
favorable to us, or at all. If adequate funds are not available or are not
available on acceptable terms, we may not be able to take advantage of
unanticipated opportunities, develop new products or services or otherwise
respond to unanticipated competitive pressures. In any such case, our business,
results of operations and financial condition could be materially adversely
affected.
POTENTIAL ACQUISITIONS MAY BE MORE COSTLY OR LESS PROFITABLE THAN ANTICIPATED.
We may pursue acquisitions that could provide new technologies, products or
service offerings. Future acquisitions may involve the use of significant
amounts of cash, potentially dilutive issuances of equity or equity-linked
securities, incurrence of debt, or amortization of expenses related to goodwill
and other intangible assets. In addition, acquisitions involve numerous risks,
including:
o Difficulties in the assimilation of the operations, technologies,
products and personnel of the acquired company;
o The diversion of management's attention from other business concerns;
o Risks of entering markets in which we have no or limited prior
experience; and
o The potential loss of key employees of the acquired company.
We currently have no commitments or agreements with respect to any such
acquisition. In the event that such an acquisition does occur and we are unable
to successfully integrate businesses, products, technologies or personnel that
we acquire, our business, results of operations and financial condition could be
materially adversely affected.
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OUR STOCK PRICE IS VOLATILE.
The stock market in general, and the stock prices in technology-based companies
in particular, have experienced extreme volatility that often has been unrelated
to the operating performance of any specific public companies. The market price
of our common stock has fluctuated in the past and is likely to fluctuate in the
future as well. Any of the following factors could have a significant impact on
the market price of our common stock:
o Quarterly variations in operating results;
o Announcements of new products by us or our competitors;
o The gain or loss of significant customers;
o Changes in analysts' earnings estimates;
o Pricing pressures;
o Short-selling of our common stock;
o General conditions in the computer, storage or communications markets; or
o Events affecting other companies that investors deem to be comparable to
us.
In the past, companies that have experienced volatility in the market price of
their stock have been the object of securities class action litigation. If we
were the object of securities class action litigation, it could result in
substantial costs and a diversion of management's attention and resources.
WE DO NOT PLAN TO PAY CASH DIVIDENDS ON OUR COMMON STOCK.
We have never paid cash dividends on our common stock and do not anticipate
paying any cash dividends in the foreseeable future. We intend to retain future
earnings, if any, to finance the growth and expansion of our business and for
general corporate purposes.
OUR STOCKHOLDER RIGHTS PLAN, CERTIFICATE OF INCORPORATION AND DELAWARE LAW COULD
ADVERSELY AFFECT THE PERFORMANCE OF OUR STOCK.
Our stockholder rights plan and provisions of our certificate of incorporation
and of the Delaware General Corporation Law could make it more difficult for a
third party to acquire us, even if doing so would be beneficial to our
stockholders. The stockholder rights plan and these provisions of our
certificate of incorporation and Delaware law are intended to encourage
potential acquirers to negotiate with us and allow our board of directors the
opportunity to consider alternative proposals in the interest of maximizing
stockholder value. However, such provisions may also discourage acquisition
proposals or delay or prevent a change in control, which could harm our stock
price. You should read Note 9 to the Consolidated Financial Statements contained
in the Company's most recently filed form 10-K, our certificate of incorporation
and Delaware law for more information on the anti-takeover effects of provisions
of our stockholder rights plan.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
At March 26, 2000, the Company's investment portfolio consisted of fixed income
securities, excluding those classified as cash equivalents, of $155,740. The
Company has the positive intent and ability to hold these securities to
maturity. Currently, the carrying amount of these securities approximates fair
market value. However, the fair market value of these securities is subject to
interest rate risk and would decline in value if market interest rates
increased. If market interest rates were to increase immediately and uniformly
by 10 percent from the levels existing as of March 26, 2000, the decline in the
fair market value of the portfolio would not be material to the Company's
financial position, results of operations and cash flows.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 3.1 Certificate of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on
Form 10-K for fiscal 1997).
Exhibit3 .2 Bylaws of the Registrant, as amended (incorporated by reference
to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K
for fiscal 1997).
Exhibit 3.3 Certificate of Amendment of Certificate of Incorporation of the
Registrant.
Exhibit 4.1 Certificate of Designations of Series A Junior Participating
Preferred Stock (incorporated by reference to Exhibit 4 to the
Registrant's Current Report on Form 8-K filed February 2,
1989).
Exhibit 4.2 Rights Agreement, dated January 19, 1989, as amended
(incorporated by reference to Exhibit 4 to the Registrant's
Current Report on Form 8-K filed February 2, 1989).
Exhibit 4.3 Certificate regarding extension of Final Expiration Date of
Rights Agreement, dated January 18, 1999 (incorporated by
reference to Amendment No. 1 to the Company's Registration
Statement on Form S-3 filed April 26, 1999).
Exhibit 27.1 Financial Data Schedule.
(b) The registrant has not filed any reports on Form 8-K during the quarter 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: May 9, 2000
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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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
----------- -----------
Exhibit 3.1 Certificate of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on
Form 10-K for fiscal 1997).
Exhibit 3.2 Bylaws of the Registrant, as amended (incorporated by reference
to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K
for fiscal 1997).
Exhibit 3.3 Certificate of Amendment of Certificate of Incorporation of the
Registrant.
Exhibit 4.1 Certificate of Designations of Series A Junior Participating
Preferred Stock (incorporated by reference to Exhibit 4 to the
Registrant's Current Report on Form 8-K filed February 2,
1989).
Exhibit 4.2 Rights Agreement, dated January 19, 1989, as amended
(incorporated by reference to Exhibit 4 to the Registrant's
Current Report on Form 8-K filed February 2, 1989).
Exhibit 4.3 Certificate regarding extension of Final Expiration Date of
Rights Agreement, dated January 18, 1999 (incorporated by
reference to Amendment No. 1 to the Company's Registration
Statement on Form S-3 filed April 26, 1999).
Exhibit 27.1 Financial Data Schedule.