UNITED STATES
FORM 10-Q
| (Mark One) | ||
| [X] | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 | |
OR
| [ ] | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 | |
Commission File No. 001-31353
EMULEX CORPORATION
| Delaware (State or other jurisdiction of incorporation or organization) |
51-0300558 (I.R.S Employer Identification No.) |
| 3535 Harbor Boulevard Costa Mesa, California (Address of principal executive offices) |
92626 (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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of November 5, 2003, the registrant had 82,859,725 shares of common stock outstanding.
EMULEX CORPORATION AND SUBSIDIARIES
INDEX
| PAGE | |||||
Part I. FINANCIAL INFORMATION |
|||||
Item 1. Financial Statements |
|||||
Condensed Consolidated Balance Sheets
September 28, 2003 and June 29, 2003 |
2 | ||||
Condensed Consolidated Statements of Income
Three months ended September 28, 2003,
and September 29, 2002 |
3 | ||||
Condensed Consolidated Statements of Cash Flows
Three months ended September 28, 2003
and September 29, 2002 |
4 | ||||
Notes to Condensed Consolidated Financial Statements |
5 | ||||
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations |
13 | ||||
Item 3. Quantitative and Qualitative Disclosures about Market Risk |
35 | ||||
Item 4. Controls and Procedures |
36 | ||||
Part II. OTHER INFORMATION |
|||||
Item 1. Legal Proceedings |
37 | ||||
Item 6. Exhibits and Reports on Form 8-K |
37 | ||||
Signatures |
39 | ||||
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
| September 28, | June 29, | |||||||||
| 2003 | 2003 | |||||||||
Assets |
||||||||||
Current assets: |
||||||||||
Cash and cash equivalents |
$ | 72,181 | $ | 136,971 | ||||||
Restricted cash |
43,156 | 9,342 | ||||||||
Investments |
228,399 | 239,302 | ||||||||
Accounts and other receivables, net |
52,747 | 46,678 | ||||||||
Litigation settlements receivable |
13,095 | 13,095 | ||||||||
Inventories, net |
12,479 | 10,998 | ||||||||
Prepaid expenses |
5,279 | 5,516 | ||||||||
Deferred income taxes |
28,384 | 36,330 | ||||||||
Total current assets |
455,720 | 498,232 | ||||||||
Property and equipment, net |
34,251 | 26,585 | ||||||||
Investments |
216,625 | 234,847 | ||||||||
Goodwill |
397,256 | 397,256 | ||||||||
Other intangibles, net |
25,617 | 27,067 | ||||||||
Other assets |
3,262 | 5,782 | ||||||||
| $ | 1,132,731 | $ | 1,189,769 | |||||||
Liabilities and Stockholders’ Equity |
||||||||||
Current liabilities: |
||||||||||
Accounts payable |
20,645 | 11,298 | ||||||||
Accrued liabilities |
15,973 | 18,806 | ||||||||
Accrued litigation settlements |
39,500 | 39,500 | ||||||||
Income taxes payable |
11,368 | 5,457 | ||||||||
Total current liabilities |
87,486 | 75,061 | ||||||||
Convertible subordinated notes |
114,648 | 208,518 | ||||||||
Deferred income taxes |
3,486 | 4,260 | ||||||||
Total liabilities |
205,620 | 287,839 | ||||||||
Commitments and contingencies (note 7) |
||||||||||
Subsequent events (note 9) |
||||||||||
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; 240,000,000 shares authorized;
82,616,687 and 82,465,813 issued and outstanding at
September 28, 2003, and June 29, 2003, respectively |
8,262 | 8,247 | ||||||||
Additional paid-in capital |
909,857 | 907,976 | ||||||||
Deferred compensation |
(2,462 | ) | (3,159 | ) | ||||||
Retained earnings (accumulated deficit) |
11,454 | (11,134 | ) | |||||||
Total stockholders’ equity |
927,111 | 901,930 | ||||||||
| $ | 1,132,731 | $ | 1,189,769 | |||||||
See accompanying notes to condensed consolidated financial statements.
2
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(unaudited)
| Three Months Ended | ||||||||||
| September 28, | September 29, | |||||||||
| 2003 | 2002 | |||||||||
Net revenues |
$ | 84,577 | $ | 70,425 | ||||||
Cost of sales |
28,327 | 27,882 | ||||||||
Gross profit |
56,250 | 42,543 | ||||||||
Operating expenses: |
||||||||||
Engineering and development |
16,344 | 13,673 | ||||||||
Selling and marketing |
4,602 | 4,664 | ||||||||
General and administrative |
3,657 | 2,746 | ||||||||
Amortization of other intangibles |
1,450 | 1,453 | ||||||||
Total operating expenses |
26,053 | 22,536 | ||||||||
Operating income |
30,197 | 20,007 | ||||||||
Nonoperating income: |
||||||||||
Interest income |
2,498 | 3,702 | ||||||||
Interest expense |
(1,033 | ) | (1,804 | ) | ||||||
Gain on repurchase of convertible subordinated notes |
4,665 | 28,729 | ||||||||
Other income (expense), net |
106 | (30 | ) | |||||||
Total nonoperating income |
6,236 | 30,597 | ||||||||
Income before income taxes |
36,433 | 50,604 | ||||||||
Income tax provision |
13,845 | 18,623 | ||||||||
Net income |
$ | 22,588 | $ | 31,981 | ||||||
Net income per share: |
||||||||||
Basic |
$ | 0.27 | $ | 0.39 | ||||||
Diluted |
$ | 0.27 | $ | 0.37 | ||||||
Number of shares used in per share computations: |
||||||||||
Basic |
82,541 | 81,844 | ||||||||
Diluted |
87,472 | 89,166 | ||||||||
See accompanying notes to condensed consolidated financial statements.
3
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
| Three Months Ended | |||||||||||
| September 28, | September 29, | ||||||||||
| 2003 | 2002 | ||||||||||
Cash flows from operating activities: |
|||||||||||
Net income |
$ | 22,588 | $ | 31,981 | |||||||
Adjustments to reconcile net income to net cash
provided by operating activities: |
|||||||||||
Depreciation and amortization of property and equipment |
2,874 | 2,532 | |||||||||
Gain on repurchase of convertible subordinated notes |
(4,665 | ) | (28,729 | ) | |||||||
Increase in restricted cash related to litigation
settlements |
(39,500 | ) | — | ||||||||
Stock-based compensation |
597 | 846 | |||||||||
Amortization of other intangibles |
1,450 | 1,453 | |||||||||
Loss (gain) on disposal of property and equipment |
(1 | ) | 24 | ||||||||
Deferred income taxes |
7,172 | 16,918 | |||||||||
Tax benefit from exercise of stock options |
751 | 287 | |||||||||
Provision for doubtful accounts |
34 | 56 | |||||||||
Changes in assets and liabilities: |
|||||||||||
Accounts and other receivables |
(6,103 | ) | (4,318 | ) | |||||||
Inventories |
(1,481 | ) | (3,543 | ) | |||||||
Prepaid expenses and other assets |
755 | 749 | |||||||||
Accounts payable |
9,347 | 3,938 | |||||||||
Accrued liabilities |
(2,724 | ) | (1,026 | ) | |||||||
Income taxes payable |
5,911 | 1,371 | |||||||||
Net
cash provided by (used in) operating activities |
(2,995 | ) | 22,539 | ||||||||
Cash flows from investing activities: |
|||||||||||
Net proceeds from sale of property and equipment |
6 | — | |||||||||
Additions to property and equipment |
(10,545 | ) | (2,358 | ) | |||||||
Decrease in restricted cash related to the construction escrow
account |
5,686 | 284 | |||||||||
Purchases of investments |
(114,918 | ) | (228,771 | ) | |||||||
Maturities of investments |
144,043 | 159,139 | |||||||||
Net
cash provided by (used in) investing activities |
24,272 | (71,706 | ) | ||||||||
Cash flows from financing activities: |
|||||||||||
Proceeds from issuance of common stock under stock option plans |
1,245 | 181 | |||||||||
Repurchase of convertible subordinated notes |
(87,312 | ) | (104,169 | ) | |||||||
Net cash used in financing activities |
(86,067 | ) | (103,988 | ) | |||||||
Net decrease in cash and cash equivalents |
(64,790 | ) | (153,155 | ) | |||||||
Cash and cash equivalents at beginning of period |
136,971 | 282,561 | |||||||||
Cash and cash equivalents at end of period |
$ | 72,181 | $ | 129,406 | |||||||
Supplemental disclosures: |
|||||||||||
Cash paid during the period for: |
|||||||||||
Interest |
$ | 1,826 | $ | 3,052 | |||||||
Income taxes |
11 | 502 | |||||||||
See accompanying notes to condensed consolidated financial statements.
4
EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
| 1. | Summary of Significant Accounting Policies and Basis of Presentation | |
| 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 its financial position as of September 28, 2003, and June 29, 2003, and its condensed consolidated statements of income for the three months ended September 28, 2003, and September 29, 2002, and its condensed consolidated statements of cash flows for the three month periods then ended. Interim results for the three months ended September 28, 2003, are not necessarily indicative of the results that may be expected for the year ending June 27, 2004. 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, 2003. | ||
| Recently Adopted Accounting Standards | ||
| The Emerging Issues Task Force (“EITF”) recently reached a consensus on its tentative conclusions for EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides accounting guidance for customer solutions where delivery or performance of products, services and/or performance may occur at different points in time or over different periods of time. Companies are required to adopt this consensus for fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on the Company’s financial position, results of operations or liquidity. | ||
| In April 2003, the Financial Accounting Standards Board, (“FASB”) issued Statement 149, an amendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which requires prospective application for contracts entered into or modified after June 30, 2003, except for contracts that exist in fiscal quarters that began prior to June 15, 2003, and for hedging relationships designated after June 30, 2003. For existing contracts in fiscal quarters that began prior to June 15, 2003, the provisions of this Statement that relate to Statement 133 implementation issues should continue to be applied in accordance with their respective effective dates. Statement 149 requires that contracts with comparable characteristics be accounted for similarly. The adoption of this pronouncement did not have a material impact on the Company’s financial position, results of operations or liquidity. | ||
| In May 2003, the FASB issued Statement 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” Statement 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. Statement 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for public companies during the first interim period beginning after June 15, 2003. The adoption of this pronouncement did not have a material impact on the Company’s financial position, results of operations or liquidity. | ||
| Stock-Based Compensation | ||
| In December 2002, the FASB issued Statement 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Statement 148 amends the disclosure requirements in Statement 123, “Accounting for Stock-Based Compensation” for annual periods ending after December 15, 2002, and for interim periods beginning after December 15, 2002. The Company adopted the disclosure provisions of Statement 148 during the three months ended March 30, 2003. Effective for financial statements for fiscal years ending after December 15, 2002, Statement 148 also provides three alternative transition methods for companies that choose to adopt the fair value measurement provisions of Statement 123. Should the Company be required to adopt the fair value measurement provisions of Statement 123 and Statement 148, it would have a material non-cash impact on the Company’s results of operations. However, the Company has no plans to adopt the fair value measurement provisions of Statement 123 unless required to under new accounting standards and, as such, the adoption of Statement 148 did not have a material impact on the Company’s financial position, results of operations or liquidity. |
5
EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
| The Company accounts for its stock-based awards to employees using the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25 and related Interpretations. Stock-based awards to non-employees, if any, are recorded using the fair value method. Had the Company determined compensation cost based on the fair value at the grant date for all its stock options under Statement 123, the Company’s net income would have been the pro forma amounts indicated below: |
| Three Months Ended | |||||||||
| September 28, | September 29, | ||||||||
| 2003 | 2002 | ||||||||
| (In thousands, except per share data) | |||||||||
Net income as reported |
$ | 22,588 | $ | 31,981 | |||||
Add: Total employee stock-based compensation expense included
in net income as reported, net of related tax effects |
596 | 845 | |||||||
Deduct: Total employee stock-based compensation expense
determined under fair value method for all awards, net of related
tax effects |
(7,976 | ) | (9,263 | ) | |||||
Pro forma net income |
$ | 15,208 | $ | 23,563 | |||||
Pro forma net income per share |
|||||||||
Basic – as reported |
$ | 0.27 | $ | 0.39 | |||||
Basic – pro forma |
$ | 0.18 | $ | 0.29 | |||||
Diluted – as reported |
$ | 0.27 | $ | 0.37 | |||||
Diluted – pro forma |
$ | 0.18 | $ | 0.28 | |||||
| The fair value of each option granted during the three months ended September 28, 2003, and September 29, 2002, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: |
| Three Months Ended | ||||||||
| September 28, | September 29, | |||||||
| 2003 | 2002 | |||||||
Risk-free interest rate |
2.3 | % | 2.3 | % | ||||
Stock volatility |
117.7 | % | 98.5 | % | ||||
Dividend yield |
0.0 | % | 0.0 | % | ||||
Average expected lives (years) |
2.6 | 3.7 | ||||||
Weighted-average fair value per option granted |
$ | 15.64 | $ | 11.51 | ||||
| The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely-tradable, fully-transferable options without vesting restrictions, which significantly differ from the Company’s stock option plans. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated fair value on the grant date. |
6
EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
| 2. | Inventories | |
| Inventories, net, are summarized as follows: |
| September 28, | June 29, | |||||||
| 2003 | 2003 | |||||||
| (in thousands) | ||||||||
Raw materials |
$ | 6,004 | $ | 3,802 | ||||
Finished goods |
6,475 | 7,196 | ||||||
| $ | 12,479 | $ | 10,998 | |||||
| Starting in late September 2001, some of the Company’s major customers made announcements that general economic conditions, exacerbated by the increase in economic uncertainty in the aftermath of the terrorist events of September 11, 2001, were having a negative impact on their financial results. The announcements made, and forecasts received, indicated deteriorating demand for the Company’s one gigabit per second (“Gbps”) products as these customers were expected to migrate to two Gbps products for future purchases. As a result, the Company recorded an excess and obsolete inventory charge totaling $13.6 million during the three months ended September 30, 2001. After initially recording its one Gbps reserve in September 2001, the Company has subsequently reduced this reserve by a total of $8.7 million through September 28, 2003, as previously-reserved inventory has been sold. Overall, the Company has been able to recover a significant portion of this reserved inventory that was not expected based on the Company’s forecasts and the forecasts received from its customers when this excess and obsolete inventory charge was recorded. In addition to the sale of some of this previously-reserved product, the Company has also scrapped $3.4 million of this reserved inventory and negotiated and paid cancellation charges of $0.2 million through September 28, 2003, related to this excess and obsolete inventory charge since it was initially recorded. As of September 28, 2003, the remaining reserve for one Gbps products was $1.3 million. However, as with all inventory, the Company regularly compares forecasted demand for its one Gbps products against inventory on hand and open purchase commitments and accordingly, the Company may have to record reductions to the carrying value of excess and obsolete inventory if forecasted demand decreases. As of September 28, 2003, the Company had unreserved one Gbps inventory on hand of approximately $0.9 million. | ||
| 3. | Goodwill and Other Intangibles | |
| Goodwill and other intangibles, net, are as follows: |
| September 28, | June 29, | ||||||||
| 2003 | 2003 | ||||||||
| (in thousands) | |||||||||
Intangible assets not subject to amortization: |
|||||||||
Goodwill |
$ | 397,256 | $ | 397,256 | |||||
Intangible assets subject to amortization: |
|||||||||
Core technology and patents |
$ | 40,600 | $ | 40,600 | |||||
Accumulated amortization, core technology and patents |
(14,983 | ) | (13,533 | ) | |||||