<PAGE> 1
UNITED STATES
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 August 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from ________ to ________
----------------
Commission File Number 000-22565
ASPEC TECHNOLOGY, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0298386
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
830 E. ARQUES AVENUE, SUNNYVALE, CA 94086
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (408) 774-2199
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 Par Value
Indicate by check mark whether the Registrant (1) has filed all reports 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 [ ]
The number of shares of the Registrant's Common Stock outstanding as of
August 31, 1998 was 28,416,027.
<PAGE> 2
ASPEC TECHNOLOGY, INC.
FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
a) Condensed Consolidated Statements of Income for the three and
nine months ended August 31, 1998 and 1997...................................................3
b) Condensed Consolidated Balance Sheets at August 31, 1998 and
November 30, 1997........................................................................... 4
c) Condensed Consolidated Statements of Cash Flows for the nine
months ended August 31, 1998 and 1997........................................................5
d) Notes to Condensed Consolidated Financial Statements.........................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .........10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..............................................................................20
Item 6. Exhibits and Reports on Form 8-K...............................................................21
SIGNATURES..................................................................................................22
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ASPEC TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 8,659 $ 5,297 $ 19,116 $ 14,249
Cost of revenue 4,473 2,498 10,687 6,226
-------- -------- -------- --------
Gross profit 4,186 2,799 8,429 8,023
-------- -------- -------- --------
Operating expenses:
Research and development 966 317 1,930 903
Sales and marketing 1,729 1,814 4,456 5,164
General and administrative 1,257 340 2,850 1,270
Write-off of purchased technology -- -- 700 --
-------- -------- -------- --------
Total operating expenses 3,952 2,471 9,936 7,337
-------- -------- -------- --------
Income (loss) from operations 234 328 (1,507) 686
Interest income, net 690 24 1,030 152
-------- -------- -------- --------
Income (loss) before income taxes 924 352 (477) 838
Provision for income taxes 349 141 82 335
-------- -------- -------- --------
Net income (loss) 575 211 (559) 503
Accretion of redeemable preferred stock -- 207 4,328 613
-------- -------- -------- --------
Income (loss) attributable to common
stockholders $ 575 $ 4 $ (4,887) $ (110)
======== ======== ======== ========
Basic earnings (loss) per share $ 0.02 $ 0.00 $ (0.20) $ (0.01)
======== ======== ======== ========
Shares used in basic per share calculation 27,917 21,197 24,347 21,401
======== ======== ======== ========
Diluted earnings (loss) per share $ 0.02 $ 0.00 $ (0.20) $ (0.01)
======== ======== ======== ========
Shares used in diluted per share calculation 28,726 22,420 24,347 21,401
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
ASPEC TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
ASSETS
AUGUST 31, NOV. 30,
1998 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and equivalents $ 45,081 $ 2,524
Accounts receivable (net of allowances of $1,000 and $300)
Billed 8,471 6,996
Unbilled 3,969 948
Prepaid expenses 1,097 507
Inventory 112 --
Deferred income taxes 3,761 2,730
-------- --------
Total current assets 62,491 13,705
Property and equipment - net 12,538 4,105
Other assets 4,783 243
-------- --------
TOTAL $ 79,812 $ 18,053
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 3,972 $ 801
Accrued liabilities 2,627 2,344
Income taxes payable 361 321
Customer advances 6,831 7,127
-------- --------
Total current liabilities 13,791 10,593
Deferred income taxes 235 --
Other liabilities - long term 1,048 35
-------- --------
Total liabilities 15,074 10,628
Series A redeemable preferred stock -- 14,168
Redeemable common stock -- 7,116
Stockholders' equity (deficiency):
Common stock 86,219 2,914
Stockholders' notes receivable (194) (301)
Deferred stock compensation (93) (165)
Retained earnings (deficit) (21,194) (16,307)
-------- --------
Total stockholders' equity (deficiency) 64,738 (13,859)
-------- --------
TOTAL $ 79,812 $ 18,053
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
ASPEC TECHNOLOGY, INC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
AUGUST 31,
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (565) $ 503
Adjustments from operating activities:
Write-off of purchased technology 700 --
Depreciation and amortization 2,375 1,114
Deferred income taxes (1,079) --
Stock compensation expense 74 94
Changes in assets and liabilities
Accounts receivable:
Billed (1,204) (476)
Unbilled (3,021) (762)
Prepaid expenses (572) (178)
Inventory (13) --
Accounts payable 2,986 311
Accrued liabilities (307) (112)
Income taxes payable 40 (3,439)
Customer advances (296) 2,035
-------- --------
NET CASH USED FOR OPERATING ACTIVITIES (464) (1,541)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (10,413) (2,522)
Cash acquired, net of cash payments for purchase of SIS Microelectronics 26 --
Other assets 40 (298)
-------- --------
NET CASH USED FOR INVESTING ACTIVITIES (10,479) (2,820)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock 72,226 --
Redemption of redeemable preferred stock (18,495) --
Repayment of borrowings (314) --
Repurchase of common stock (24) --
Collection of stockholder notes receivable 107 95
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 53,500 95
-------- --------
Net increase (decrease) in cash and equivalents 42,557 (4,266)
Cash and equivalents, beginning of period 2,524 6,341
-------- --------
CASH AND EQUIVALENTS, END OF PERIOD $ 45,081 $ 2,075
======== ========
Supplemental disclosure of cash flow information:
Cash paid for income taxes $ 1,101 $ 4,392
======== ========
Accretion of redeemable preferred stock $ 4,328 $ 613
======== ========
The Company purchased all of the capital stock of SIS Microelectronics for Aspec
stock of $4,000,000 plus transaction costs of $148,000. In conjunction with the
acquisition, assets acquired and liabilities assumed were
as follows:
Fair value of assets acquired, including purchased technology $ 4,390
Liabilities assumed 942
--------
Net assets acquired 3,448
Purchased technology (expensed) 700
--------
Purchase price $ 4,148
========
Purchase of Equipment for Long-term note $ 1,000
========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
ASPEC TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. RESTATEMENT OF FINANCIAL RESULTS
In October 1998, Aspec Technology, Inc. ("Aspec" or the "Company") announced
that, after consultation with its new independent accountants,
PricewaterhouseCoopers LLP ("PwC"), it had determined to restate its financial
results for the fiscal years ended November 30, 1996 and 1997 and for the fiscal
quarters ended February 28, 1998 and May 31, 1998. The restatement relates
principally to the timing of revenue recognized on certain of the Company's
contracts. In the Company's Registration Statement on Form S-1 (file no.
333-22913) which was declared effective by the Securities and Exchange
Commission on April 27, 1998 (the "Registration Statement"), the Company
previously reported financial results for each quarter of fiscal 1997.
The following table summarizes the results for the fiscal quarter ended
August 31, 1997 and the nine months ended August 31, 1997 as reported in or
derived from results reported in the Registration Statement compared to the
restated results included elsewhere in this Form 10-Q:
<TABLE>
<CAPTION>
QUARTER ENDED
AUGUST 31, 1997
-----------------------
AS REPORTED RESTATED
----------- --------
<S> <C> <C>
Revenue $5,105 $5,297
Income (loss) from operations 136 328
Provision for income taxes 64 141
Net income (loss) 96 211
Income (loss) attributable to common (111) 4
stockholders
Net income (loss) per share $ 0.00 $ (0.00)
======= ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
AUGUST 31, 1997
-----------------------
AS REPORTED RESTATED
----------- --------
<S> <C> <C>
Revenue $15,825 $14,249
Income (loss) from operations 2,262 686
Provision for income taxes 966 335
Net income (loss) 1,448 503
Income (loss) attributable to common 835 (110)
stockholders
Net income (loss) per share $ 0.00 $ (0.01)
======= ========
</TABLE>
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and in accordance with
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three and nine-month periods ended
August 31, 1998 are not necessarily indicative of the results that may be
expected for the fiscal year ending November 30, 1998 or for any other period.
6
<PAGE> 7
3. EARNINGS PER SHARE (EPS) DISCLOSURES
The Company has adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS 128). All earnings per share (EPS) data for prior
periods have been restated to conform with SFAS 128.
SFAS 128 requires a dual presentation of basic and diluted EPS. Basic EPS
excludes dilution and is computed by dividing net income attributable to common
stockholders by the weighted average of common shares outstanding (excluding
shares subject to repurchase rights) for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock. Such securities are
not included in loss periods as they would be antidilutive.
A reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
1998 1997 1998 1997
-------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net income (loss) attributable to common stockholders $ 575 $ 4 $ (4,887) $ (110)
-------- -------- -------- --------
Denominator-basic EPS common stock outstanding 27,917 21,197 24,347 21,401
-------- -------- -------- --------
Basic earnings (loss) per share $ 0.02 $ 0.00 $ (0.20) $ (0.01)
-------- -------- -------- --------
Denominator-Diluted EPS:
Denominator-Basic EPS 27,917 21,197 24,347 21,401
Effect of dilutive securities:
Weighted average common shares subject
to repurchase rights 527 919 -- --
Weighted average common share
equivalents related to stock
purchase rights and options 282 304 -- --
-------- -------- -------- --------
28,726 22,420 24,347 21,401
-------- -------- -------- --------
Diluted earnings (loss) per share $ 0.02 $ 0.00 $ (0.20) $ (0.01)
-------- -------- -------- --------
</TABLE>
4. NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which requires an enterprise to report, by major components and as a single
total, the change in net assets during the period from nonowner sources; and
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas and major customers. Adoption of these statements
will not impact the Company's financial position, results of operations or cash
flows. Both statements are effective for fiscal years beginning after December
15, 1997, with earlier application permitted.
5. BUSINESS COMBINATIONS
In April 1998, the Company completed its purchase of SIS Microelectronics,
Inc. ("SIS Microelectronics"), an engineering design services company located in
Longmont, Colorado in exchange for the issuance of an aggregate 400,000 shares
of Common Stock. As part of this transaction, which was accounted for using the
purchase method of accounting, the Company recorded approximately $0.7 million
of in-process research and development in the second quarter of fiscal 1998. The
Company also recorded $3.3 million of goodwill in connection with this
transaction which is being evenly amortized over a five-year period.
7
<PAGE> 8
6. STOCKHOLDERS' EQUITY
On May 1, 1998, the Company completed the public offering of 6,000,000 shares
of Common Stock through a Registration Statement declared effective by the
Securities and Exchange Commission on April 27, 1998.
In May and June 1996, the Company issued an aggregate of 130,378 shares of
its Series A Redeemable Preferred Stock. The aggregate liquidation and
redemption value of the Series A Redeemable Preferred Stock was approximately
$18.5 million at May 6, 1998. In connection with the redemption of all
outstanding shares of such Series A Redeemable Preferred Stock from the proceeds
of the Company's initial public offering in May 1998, as required by the terms
of such shares, the difference between the book value and the redemption value
of approximately $4.1 million was recorded as accretion for Preferred Stock when
determining income attributable to common stockholders and earnings per share.
This $4.1 million of accretion was recorded in the second quarter of fiscal 1998
when the offering was completed.
During May and June 1996, the Company sold an aggregate of 4,778,804 shares
of redeemable common stock to the preferred stock investors for net proceeds of
approximately $7,116,000. Under a stockholder rights agreement, these investors
had a put option, exercisable at any time after the seventh anniversary of the
agreement, to require the Company to repurchase for cash all of the common
shares held by such investors at a price determined based upon the then market
value of the Company divided by the number of common shares outstanding. This
right terminated upon the IPO. The holders of these shares have certain
registration rights.
7. CONTINGENCIES
On July 1, 1998, a class action lawsuit, Howard Jones, et al. v. Aspec
Technology, Inc., et al., No. CV-775037, was filed in the Superior Court for the
State of California, County of Santa Clara. The Complaint alleges that Aspec and
certain of its officers and directors violated California state securities and
common law by making false and misleading statements about Aspec's financial
condition between April 28, 1998 and June 25, 1998. This action is purportedly
brought on behalf of all persons who purchased Aspec stock during that period.
On July 2, 1998, July 27, 1998, and August 17, 1998, three substantially
similar complaints were filed in state court against similar defendants,
entitled respectively, William Neuman, et al. v. Aspec Technology, Inc., et al.,
No. CV-775089, Martin L. Klotz, on behalf of the Martin Klotz Defined Benefit
Profit Sharing Plan, et al. v. Aspec Technology, Inc., et al., No. CV-775591,
Glen O.Ressler and Thelma M. Ressler, et al. v. Aspec Technology, Inc., et al.,
No. CV-776065. The Klotz complaint also alleges violations of Sections 11, 12,
and 15 of the Securities Exchange Act of 1934. The complaints seek unspecified
damages. The Company expects these complaints to be consolidated, and expects to
file a demurrer 30 days after consolidation.
Certain of the Company's current and former officers and directors are
also named as defendants in a derivative lawsuit, which was filed on November
12, 1998, in the Superior Court of Santa Clara County. The derivative complaint
was based on factual allegations substantially similar to those alleged in the
class action lawsuits.
Certain provisions of the Company's Certificate of Incorporation and
indemnification agreements between the Company and its officers require the
Company to advance to such officers ongoing legal expenses of defending the
above lawsuits and may require the Company to indemnify them against judgments
rendered on certain claims. The Company expects to incur significant legal
expenses on its behalf and on behalf of such officers in connection with this
litigation. In addition, defending this litigation has resulted, and will likely
continue to result, in the diversion of management's attention from the day to
day operations of the Company's business. There can be no assurance that this
stockholder litigation will be resolved in the Company's favor. An adverse
result, settlement or prolonged litigation would have a material adverse effect
on the Company's business, financial condition or results of operation.
On October 16, 1998, plaintiffs agreed to voluntarily dismiss Kassover,
et al. v. Aspec Technology, Inc., et al, No. C 98-2604VRW, which was filed on
June 30, 1998 in the United States District Court for the Northern District of
California against Aspec and certain of its officers and directors. The
Complaint alleges that defendants violated Sections 11, 12, and 15 of the
Securities Exchange Act of 1934 by failing to disclose certain facts about
Aspec's financial condition between April 28, 1998 and June 30, 1998. On October
20, 1998, the Court dismissed the purported class action without prejudice.
8
<PAGE> 9
On September 4, 1998, the Company received an informal request for
information from the NASDAQ Listing Investigations Staff. NASDAQ requested
information concerning the Company's financial accounting and internal controls.
The Company has provided information in response to the informal inquiry.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
are based on current expectations and include various risks and uncertainties
that could cause actual results to differ materially from those projected in the
forward-looking statements. Such risks and uncertainties are set forth below and
under "Other Factors Affecting Future Operating Results."
As a result of the restatement of the Company's financial statements for the
first and second quarters of fiscal 1998 and the fiscal years 1996 and 1997,
certain information contained in this item has been changed from that which was
reported previously in the Company's Registration Statement (see Note 1 of Notes
to Condensed Consolidated Financial Statements). Readers should carefully review
the "Revenues" and "Other Factors Affecting Future Operating Results" sections
included herein to reflect current events.
COMPANY OVERVIEW
Aspec was founded in December 1991 to develop, market and support
semiconductor intellectual property ("SIP") to enable customers to develop
complex ICs. Through fiscal 1992, the Company was principally engaged in the
development of its first products and the establishment of customer
relationships. The Company recognized its initial revenue in fiscal 1993 as SIP
products were completed for customers designing gate array-based ASICs. In
fiscal 1993, 1994 and 1995, a substantial portion of the Company's revenue was
derived from the license of SIP products to vertically integrated semiconductor
manufacturers that were seeking to enter the merchant ASIC market. During these
years, the Company also expanded its development efforts. By fiscal 1996, the
Company had enhanced its SIP products for gate array-based ICs and had developed
SIP products for standard cell-based ICs supporting a number of foundry
processes. These developments allowed the Company to expand its customer base to
include other integrated semiconductor companies, fabless semiconductor
companies, electronics systems manufacturers and distributors that sell to such
entities.
Revenue consists primarily of license fees for the Company's SIP products. A
license is required for each foundry used by the customer as well as for each
process technology employed. The Company also realizes revenue from service and
maintenance fees. Typically a customer licenses a bundle of products which is
accompanied by documentation and training. The license of the Company's products
typically involves a lengthy sales cycle of up to 12 months because the license
generally involves a significant commitment of capital by the customer and
because Aspec's SIP is either replacing a customer's proprietary SIP or
introducing entirely new SIP. These SIP products are licensed to customers on a
per design basis, a per site basis or an enterprise basis. The price for a
typical bundle of products ranges from approximately $200,000 on a per design
basis to over $2.0 million on an enterprise basis. Late in the third quarter of
fiscal 1998, one of the Company's competitors announced an agreement with a
major foundry whereby the foundry acquired cell libraries for a minimal up-front
fee coupled with a future royalty. This change in industry pricing practice is
expected to have a material adverse effect on the Company's revenue beginning in
the fourth quarter of fiscal 1998.
A significant portion of the Company's revenue is recognized on a percentage
of completion method based upon actual costs incurred. The completion period
typically ranges from three months to a year. Accordingly, revenue in any
quarter is dependent on progress towards completion of projects by the Company.
The Company has in the past experienced delays in the progress of certain
projects, and there can be no assurance that such delays will not occur with
respect to future projects. Any delay or failure to achieve such progress could
result in a delay in the ability to bill for or collect payment for work
previously performed, damage to customer relationships and the Company's
reputation, diversion of engineering resources or a delay in the market
acceptance of the Company's products, any of which could have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, these contracts may generally be canceled without cause, and if a
customer cancels or delays performance under any such contracts, the Company's
business, operating results and financial condition could be materially
adversely affected.
Engineering efforts devoted to developing products for which revenue is
recognized on a percentage of completion basis are recorded as cost of revenue.
Engineering efforts devoted to developing the Company's core technology and
products not requiring adaptation are recorded as research and development
expense. As a result of its engineering efforts, the Company has developed a
substantial base of technology, which the Company is able to reuse in other
product offerings. The Company expects to continue to devote significant
resources to its various engineering efforts.
10
<PAGE> 11
A significant portion of the Company's revenue is derived from customers
outside the United States, and the Company anticipates that international
revenue will continue to account for a significant portion of its total revenue.
Revenue from customers outside the United States, substantially all of whom are
located in Asia, accounted for 54.1%, 65.4% and 52.8% of revenue in fiscal 1995,
1996 and 1997, respectively and 48.8% and 56.9% of revenue for the first nine
months of fiscal 1997 and 1998, respectively. Although the Company does not
believe that it experienced any material adverse impact in revenue as a result
of the financial dislocations that occurred in certain Asian countries during
1997 and 1998, it has experienced a lengthening of the payment period for
accounts receivables from certain Asian-based customers. At August 31, 1998,
approximately 67.5% of the Company's accounts receivable (including unbilled
receivables) were from Asian-based customers. Although the Company currently
believes, based in part on continuing discussions with these customers, that its
existing accounting reserves are adequate given the estimated exposure related
to all of its accounts receivable, there can be no assurance that such
accounting reserves will prove to be adequate nor that present or future
dislocations in Asian countries or elsewhere or other factors will not have a
material adverse effect on the Company's ability to collect its accounts
receivable or on its business, operating results and financial condition.
The Company's international business involves a number of risks, including
the impact of possible recessionary environments in foreign economies, political
and economic instability, exchange rate fluctuations, longer receivables
collection periods and greater difficulty in accounts receivable collection from
distributors and customers, difficulty in managing distributors or sales
representatives, unexpected changes in regulatory requirements, reduced or
limited protection for intellectual property rights, export license
requirements, tariffs and other trade barriers and potentially adverse tax
consequences. Although the Company prices its products and services in United
States dollars, currency exchange fluctuations could have a material adverse
effect on the Company's business to the extent that the Company's pricing is not
competitive with products priced in local currencies. The Company does not
currently hedge against foreign currency fluctuations. See "Other Factors
Affecting Future Operating Results --Risks Associated With International
Operations."
In May and June 1996, the Company issued an aggregate of 130,378 shares of
its Series A Redeemable Preferred Stock. The aggregate liquidation and
redemption value of the Series A Redeemable Preferred Stock was approximately
$18.5 million at May 6, 1998. In connection with the redemption of all
outstanding shares of such Series A Redeemable Preferred Stock from the proceeds
of the Company's initial public offering in May 1998, as required by the terms
of such shares, the difference between the book value and the redemption value
of approximately $4.1 million was recorded as accretion for Preferred Stock when
determining income attributable to common stockholders and earnings per share.
This $4.1 million of accretion was recorded in the second quarter of fiscal 1998
when the offering was completed. See Note 6 of Notes to Condensed Consolidated
Financial Statements.
As part of the Company's strategy to expand its engineering design services
capability, in March 1998, the Company entered into an agreement to acquire SIS
Microelectronics in exchange for the issuance of an aggregate of 400,000 shares
of Common Stock. SIS Microelectronics is an engineering design services company
located in Longmont, Colorado, has 17 employees and recorded revenues of
approximately $1.7 million for its fiscal year ended December 31, 1997. The
acquisition was completed in April 1998, was accounted for using the purchase
method and resulted in a charge to in-process research and development of $0.7
million in the Company's fiscal quarter ended May 31, 1998. The Company recorded
$3.3 million of goodwill as part of this acquisition which will be amortized
evenly over a five-year period. The Company has no prior experience with
acquisitions and there can be no assurance that the Company will be able to
retain the key employees of SIS Microelectronics or successfully integrate the
operations of SIS Microelectronics. See "Other Factors Affecting Future
Operating Results -- Risks Associated With SIS Microelectronics Acquisition;
Other Potential Acquisitions."
11
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected statements
of operations data as a percentage of revenue:
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
AUGUST 31, AUGUST 31,
-------------------- --------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue 100% 100% 100% 100%
Cost of revenue 52 47 56 44
---- ---- ---- ----
Gross profit 48 53 44 56
Operating expenses:
Research and development 11 6 10 6
Sales and marketing 20 34 23 36
General and administrative 14 6 15 9
Write-off of purchased technology -- -- 4 --
---- ---- ---- ----
Total operating expenses 45 46 52 51
---- ---- ---- ----
Income (loss) from operations 3 7 (8) 5
Interest income, net 8 0 5 1
---- ---- ---- ----
Income (loss) before income taxes 11 7 (3) 6
Provision for income taxes 4 3 0 2
---- ---- ---- ----
Net income (loss) 7 4 (3) 4
Accretion of redeemable preferred stock -- 4 23 4
---- ---- ---- ----
Income (loss) attributable to common stockholders 7% 0% (26)% 0%
==== ==== ==== ====
</TABLE>
Revenues. Revenue increased by 63% from $5.3 million in the quarter ended
August 31, 1997 to $8.7 million in the quarter ended August 31, 1998. Revenue
increased by 34% from $14.2 million in the nine-month period ended August 31,
1997 to $19.1 million in the nine-month period ended August 31, 1998. The growth
in revenue in the first nine months of fiscal 1998 compared with the same period
in fiscal 1997 was primarily attributable to the Company's continued expansion
of its sales of standard cell-based products to a broader customer base. The
growth in revenue in the third quarter of fiscal 1998 compared to the same
period in fiscal 1997 was primarily due to $2.8 million of revenue from a
distributor agreement that was terminated during the quarter. The Company does
not expect any future revenue from this customer. The nonrecurring nature of
this revenue and the shift in industry pricing practice from up-front license
fees to a royalty based model will have a material adverse impact on the
Company's revenue in future quarters.
International revenue accounted for 56.9% of revenue in the nine-month period
ended August 31, 1998 compared to 48.8% of revenue in the nine-month period
ended August 31, 1997. International revenue accounted for 57.8% of revenue
during the quarter ended August 31, 1998 compared to 36.8% of revenue during the
quarter ended August 31, 1997.
Cost of revenue. Cost of revenue primarily represents the costs of personnel
and other operating expenses incurred in the development and production of SIP
products to customer specifications. Cost of revenue increased by 79% from $2.5
million in the quarter ended August 31, 1997 to $4.5 million in the quarter
ended August 31, 1998. Cost of revenue increased by 72% from $6.2 million in the
nine-month period ended August 31, 1997 to $10.7 million in the nine-month
period ended August 31, 1998. Cost of revenue as a percentage of revenue was 47%
and 52% for the quarters ended August 31, 1997 and 1998, respectively, and 44%
and 56% for the nine-month periods ended August 31, 1997 and 1998, respectively.
The absolute dollar increases in cost of revenue and the increases in cost of
revenue as a percentage of revenue in the third quarter and first nine months of
fiscal 1998 compared with the same periods in fiscal 1997 were due to (i) hiring
of additional engineering personnel and related expenses associated with
customer funded development programs, (ii) start-up costs associated with the
Company's chip design service group, (iii) costs of the additional personnel who
joined the Company as a result of the acquisition of SIS Microelectronics and
(iv) costs of rework resulting from process technology changes implemented by
semiconductor foundries for which the Company had developed process-related
performance data which required recalculation and/or recharacterization. Due
primarily to these four factors, the Company's gross margin percentage was
adversely effected in the quarter and nine-month periods ended August 31, 1998.
The Company expects cost of revenue as a percentage of revenue to fluctuate in
future periods depending on the mix between development program revenues and
revenues from previously developed products.
Research and development. Research and development expenses represent the
cost of engineering personnel and other operating expenses incurred in the
development and enhancement of the Company's core technology and products not
requiring significant adaptation. Research and development expenses increased by
205% from $0.3 million in the quarter ended August 31, 1997 to $1.0 million in
the quarter ended August 31, 1998. Research and development expense increased by
114% from $0.9 million in the nine-month period ended August 31, 1997 to $1.9
million in the nine-
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<PAGE> 13
month period ended August 31, 1998. Research and development expense as a
percentage of revenue was 6% and 11% for the quarters ended August 31, 1997 and
1998, respectively, and 6% and 10% for the nine-month periods ended August 31,
1997 and 1998, respectively. The absolute dollar increases in research and
development expenses and the increases in research and development costs as a
percentage of revenue in the third quarter and first nine months of fiscal 1998
compared with the same periods in fiscal 1997 were due to increases in
engineering personnel, including additional SIS Microelectronics personnel, and
related expenses. The Company expects research and development expense to
increase in absolute dollars in the fourth quarter. The expected increase in the
Company's research and development expense would have a material adverse effect
on the Company's business, operating results and financial condition if the
Company's revenue does not also increase.
Sales and marketing. Sales and marketing expenses consist of salaries,
commissions paid to internal sales and marketing personnel and sales
representatives, promotional costs and related operating expenses. Sales and
marketing expenses decreased by 5% from $1.8 million in the quarter ended August
31, 1997 to $1.7 million in the quarter ended August 31, 1998. Sales and
marketing expenses decreased by 14% from $5.2 million in the nine-month period
ended August 31, 1997 to $4.5 million in the nine-month period ended August 31,
1998. Sales and marketing expense as a percentage of revenue was 34% and 20% for
the quarters ended August 31, 1997 and 1998, respectively, and 36% and 23% for
the nine-month periods ended August 31, 1997 and 1998, respectively. The
absolute dollar decreases in sales and marketing expenses in the third quarter
and first nine months of fiscal 1998 compared with the same periods in fiscal
1997, were due to higher Asian representative sales commissions in the third
quarter and first nine months of fiscal 1997 that did not recur in the fiscal
1998 periods and due to reduced personnel costs as certain field application
engineers were transferred into engineering, as well as decreased advertising
and sales promotions. The Company expects sales and marketing expense to
increase in absolute dollars in the fourth quarter. The expected increase in the
Company's sales and marketing expense would have a material adverse effect on
the Company's business, operating results and financial condition if the
Company's revenue does not also increase.
General and administrative. General and administrative expenses increased by
270% from $0.3 million in the quarter ended August 31, 1997 to $1.3 million in
the quarter ended August 31, 1998. General and administrative expenses increased
by 124% from $1.3 million in the nine-month period ended August 31, 1997 to $2.9
million in the nine-month period ended August 31, 1998. These increases resulted
primarily from addition of new management and administrative personnel and
increased administrative costs. Also, beginning in the second quarter of fiscal
1998, the Company began amortizing the goodwill associated with the SIS
acquisition over a five-year period. General and administrative expenses as a
percentage of revenue was 6% and 14% for the quarters ended August 31, 1997 and
1998, respectively, and 9% and 15% for the nine-month periods ended August 31,
1997 and 1998, respectively. The increase in general and administrative expense
as a percentage of revenue in the first nine months of fiscal 1998 was primarily
attributable to a $0.4 million increase in the Company's bad debt reserve
recorded in the first quarter of fiscal 1998, as well as an $0.3 million
increase in the third quarter of fiscal 1998. The Company expects general and
administrative expense to increase in absolute dollars in the fourth quarter.
The expected increase in the Company's general and administrative expense would
have a material adverse effect on the Company's business, operating results and
financial condition if the Company's revenue does not also increase.
The $0.7 million written off to purchased technology in the second quarter of
fiscal 1998 related to the acquisition of SIS Microelectronics (see Note 5 to
the Condensed Consolidated Financial Statements). The Company recorded $3.3
million of goodwill as part of this acquisition which will be amortized evenly
over a five-year period.
Interest income, net. Interest income, net increased from $24,000 in the
quarter ended August 31, 1997 to $0.7 million in the quarter ended August 31,
1998. Interest income increased from $0.15 million in the nine-month period
ended August 31, 1997 to $1.0 million in the nine-month period ended August 31,
1998. The absolute dollar increases in interest income in the third quarter and
first nine months of fiscal 1998 compared with the same periods in fiscal 1997,
were due to interest income earned on the proceeds from the Company's initial
public offering which was completed in May 1998.
Provision for income taxes. The provision for income taxes was $0.1 million
and $0.3 million for the quarters ended August 31, 1997 and 1998, respectively,
and $0.3 million and $0.1 million in the nine-month periods ended August 31,
1997 and 1998, respectively. Excluding the impact of the one-time non-deductible
write-off of purchased technology, the effective tax rate remained constant at
38% in the third quarter and the first nine months of fiscal 1998, compared with
40% in both the third quarter and first nine months of fiscal 1997. The
provision for income taxes differs from the statutory rate applied to pretax
income because the write-off of purchased technology is not deductible for
income tax purposes. State taxes, net of federal benefit, and the foreign sales
corporation benefit also impacted the provision for income taxes.
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<PAGE> 14
Liquidity and Capital Resources
The Company has funded its operations primarily from license revenue and the
net proceeds of $71.9 million from its initial public offering of Common Stock
in May 1998.
The Company's operating activities utilized net cash of $1.5 million in the
nine-month period ended August 31, 1997 and utilized net cash of $0.5 million in
the nine-month period ended August 31, 1998. Net cash used for operating
activities in both periods was mainly due to increases in accounts receivable.
Net cash used in investing activities was $2.8 million and $10.5 million in
the nine-month periods ended August 31, 1997 and 1998, respectively. Investing
activities consisted primarily of net purchases of property and equipment.
Net cash provided by financing activities was $95,000 and $53.5 million in
the nine-month periods ended August 31, 1997 and 1998, respectively. In the nine
month period ended August 31, 1998, financing activities consisted primarily of
the sale of the Company's Common Stock in its initial public offering.
At August 31, 1998, the Company had cash and equivalents of $45.1 million. As
of August 31, 1998, the Company had retained deficit of $21.2 million and
working capital of $48.7 million. The Company anticipates approximately $2.0
million for capital expenditures over the next 12 months.
The Company intends to continue to invest in the development of new products
and enhancements to its existing products. The Company's future liquidity and
capital requirements will depend upon numerous factors, including the costs
incurred in connection with the defense, settlement or payment of any damages
with respect to the class action lawsuits pending against the Company and
related parties, the costs and timing of the Company's product development
efforts and the success of these development efforts, the costs and timing of
the Company's sales and marketing activities, the extent to which the Company's
existing and new products gain market acceptance, competing technological and
market developments, the costs involved in maintaining and enforcing patent
claims and other intellectual property rights, the level and timing of license
revenue, available borrowings under line of credit arrangements and other
factors. The Company believes that its current cash and investment balances
together with any cash generated from operations will be sufficient to meet the
Company's operating and capital requirements for at least the next 12 months.
Other Factors Affecting Future Operating Results
Restatement of Financial Statements. As previously announced, the Company's
restatement of its consolidated financial statements for fiscal years 1996 and
1997 and the first and second quarters of fiscal 1998 reflects reductions in
reported earned revenue for those years and resulted in a loss from operations
for the first and second quarters of fiscal 1998. The Company anticipates
significantly reduced revenues and a significant operating loss for the fourth
quarter of fiscal 1998. The Company's public announcement of the pending
restatement of its financial statements, the delay in reporting its third
quarter results for fiscal 1998 while the restatement was being compiled and the
related uncertainty regarding the Company's business have adversely affected the
Company's financial condition and the price of the Company's common stock. These
factors and other matters described herein have had, and will continue to have,
a material adverse effect on the Company's business, including its financial
condition and results of operations.
Fluctuations in Future Operating Results; Dependence Upon Timely Project
Completion. The Company's operating results have fluctuated in the past and are
expected to fluctuate significantly on a quarterly and annual basis in the
future as a result of a number of factors including the size and timing of
customer orders; the Company's ability to achieve progress on percentage of
completion contracts; the continuation of the shift in industry pricing practice
from up-front license fees to a royalty based model; the length of the Company's
sales cycle; the timing of new product announcements and introductions by the
Company and its competitors; the Company's ability to successfully develop,
introduce and market new products and product enhancements; market acceptance of
the Company's products; the cancellation or delay of orders from major
customers; the level of changes to customer requirements due to process specific
changes requested by customers or changes in design rules or process
technologies at semiconductor foundries, the Company's ability to retain its
existing personnel and hire additional personnel; and general economic
conditions. These and other factors could have a material adverse effect on the
Company's business, operating results and financial condition.
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<PAGE> 15
A significant portion of the Company's revenue is recognized on a percentage
of completion method based upon actual costs incurred. The completion period
typically ranges from three months to a year. Accordingly, revenue in any
quarter is dependent on progress towards completion of the project by the
Company. The Company has in the past experienced delays in the progress of
certain projects and there can be no assurance that such delays will not occur
with respect to future projects. Any delay or failure to achieve such progress
could result in a delay in the ability to bill for or collect payment for work
previously performed, damage to customer relationships and the Company's
reputation, diversion of engineering resources or a delay in the market
acceptance of the Company's products, any of which could have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, these contracts may generally be canceled without cause, and if a
customer cancels or delays performance under any such contracts, the Company's
business, operating results and financial condition could be materially
adversely affected. A customer's license of the Company's products may involve a
significant commitment of capital with the attendant delays frequently
associated with authorization procedures for capital expenditures within
customer organizations. The Company's operating expenses will be based in part
on the Company's expectations of future revenue from product licenses.
Accordingly, if the Company does not realize its expected revenues, its
business, operating results and financial condition would be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on Emergence of Merchant SIP Market. The market for merchant SIP
is new and emerging. The Company's ability to achieve revenue growth and
profitability in the future will depend on the continued development of this
market and, to a large extent, on the level of demand for complex ICs, including
system-on-a-chip designs. There can be no assurance that the merchant SIP market
will continue to develop or grow at a rate sufficient to support the Company's
business. If this market fails to grow or develops slower than expected, the
Company's business, operating results and financial condition would be
materially adversely affected. To date, the Company's SIP products have been
licensed only by a limited number of customers. Many of the Company's existing
and potential customers currently rely on SIP developed internally or offered by
other vendors. The Company's future growth will be dependent on the adoption of,
and increased reliance on, merchant SIP by both existing and potential
customers. Moreover, if the Company's products do not achieve broad market
acceptance, the Company's business, operating results and financial condition
would be materially adversely affected. In this regard, late in the third
quarter of fiscal 1998, one of the Company's competitors announced an agreement
with a major foundry whereby the foundry acquired cell libraries for a minimal
up-front fee coupled with a future royalty. This change in industry pricing
practice is expected to have a material adverse effect on the Company's revenue
beginning in the fourth quarter of fiscal 1998.
Management of Growth; Retention of Key Personnel. The growth of the Company's
business and expansion of its customer base has placed, and is expected to
continue to place, a significant strain on the Company's management and
operations. A number of key members of the Company's management have left the
Company to pursue other opportunities. The Company's future success will depend
on its ability to identify, attract, hire and retain skilled employees and to
hire replacements for employees that leave the Company. In this regard, the
Company is actively recruiting several additional engineering personnel. The
Company's failure to continue to expand its engineering organization in a timely
manner could result in delays in the progress on percentage of completion
contracts and the Company's research and development efforts, either of which
could have a material adverse effect on the Company's business, operating
results and financial condition.
The Company has experienced substantial growth in the number of its employees
and the burden placed upon its financial, accounting and operating systems,
resulting in increased responsibility for both existing and new management
personnel. In this regard, the number of employees at the Company increased from
121 at November 30, 1997 to 187 at August 31, 1998. The Company is in the
process of hiring additional accounting and financial personnel and in
establishing and upgrading its financial and accounting systems and procedures
to support its growth. Because experienced accounting and financial personnel
are in great demand, there can be no assurance that the Company will be able to
identify, attract and retain such personnel. The Company's future operating
results will depend on the ability of its management and other key employees to
implement and improve its systems for operations, financial control and
information management, and to recruit, train and manage its overall employee
base. In particular, the Company's ability to effectively manage and support any
future growth will be substantially dependent on its ability to improve its
financial and management controls, reporting and order entry systems and other
procedures on a timely basis. The Company also expects to increase its customer
support operations to the extent the installed base of the Company's products
continues to grow and to recruit additional personnel to expand its design
services capabilities. There can be no assurance that the Company will be able
to manage or continue to manage its recent or any future growth successfully or
to implement and maintain adequate financial and management controls and
procedures, and any inability to do so would have a material adverse effect on
the Company's business, operating results and financial condition.
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<PAGE> 16
Risks Associated With SIS Microelectronics Acquisition; Other Potential
Acquisitions. As part of the Company's strategy to expand its engineering design
services capability, in April 1998, the Company acquired SIS Microelectronics in
exchange for the issuance of an aggregate of 400,000 shares of Common Stock. SIS
Microelectronics is an engineering design services company located in Longmont,
Colorado, has 17 employees and recorded revenues of approximately $1.7 million
for its fiscal year ended December 31, 1997. The acquisition was accounted for
using the purchase method and resulted in a charge to in-process research and
development of $0.7 million in the Company's fiscal quarter ended May 31, 1998.
The remaining $3.3 million of the purchase price was charged to goodwill and
will be amortized over a five-year period. The Company has no prior experience
with acquisitions and there can be no assurance that the Company will be able to
retain the key employees of SIS Microelectronics or successfully integrate the
operations of SIS Microelectronics.
From time to time, the Company expects to evaluate other potential
acquisitions to build its SIP expertise. There can be no assurance that the
Company will be able to identify attractive acquisition candidates, that it will
be able to successfully complete any such acquisition or that it will be able to
integrate any acquired company with its other operations. In connection with the
acquisition of SIS Microelectronics or potential acquisitions of other
companies, the failure to successfully and efficiently integrate new employees
and operations of the acquired company with the Company's existing employees and
operations or to successfully manage an acquired company located in a different
geographical location could materially adversely effect the Company's business,
operating results and financial condition.
Risks Associated with Engineering Services Business. One of the Company's
strategies is to increase its revenue from collaborative engineering services.
The engineering services business is subject to a number of risks, including
potential competition from numerous other engineering service companies and the
ability to attract and retain qualified engineering personnel. There can be no
assurance that the Company can successfully expand its collaborative engineering
services, and the failure to do so could have a material adverse effect on the
Company's business, operating results and financial condition.
Dependence Upon Continuous Product Development; Risk of Product Delays. The
Company's customers operate in the semiconductor industry, which is subject to
rapid technological change, frequent introductions of new products, short
product life cycles, changes in customer demands and requirements and evolving
industry standards. The introduction of products embodying new technologies and
the emergence of new industry standards can render existing products obsolete
and unmarketable. Accordingly, the Company's future success will depend on its
ability to continue to enhance its existing products and to develop and
introduce new products that satisfy increasingly sophisticated customer
requirements and that keep pace with product introductions by EDA tool
companies, emerging process technologies and other technological developments in
the semiconductor industry. Any failure by the Company to anticipate or respond
adequately to changes in technology or customer requirements, or any significant
delays in product development or introduction, would have a material adverse
effect on the Company's business, operating results and financial condition. In
this regard, the Company's gross margin was adversely effected in the quarters
ended May 31, 1998, and August 31, 1998 in part due to process technology
changes implemented by the semiconductor foundries for which the Company had
developed process-related performance data which required recalculation and/or
recharacterization. There can be no assurance that the Company will be
successful in its product development efforts, that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and sale of new or enhanced products or that such new or enhanced
products will achieve market acceptance. The Company has in the past experienced
delays in the release dates of certain of its products. If release dates of any
new significant products or product enhancements are delayed, the Company's
business, operating results and financial condition would be materially
adversely affected. The Company could also be exposed to litigation or claims
from its customers in the event it does not satisfy its delivery commitments.
There can be no assurance that any such claim will not have a material adverse
effect on the Company's business, operating results and financial condition.
Customer Concentration; Dependence on Customers in Asia. The Company has been
dependent on a relatively small number of customers for a substantial portion of
its annual revenue. In fiscal 1995, Samsung Electronics, National Semiconductor
and Yamaha accounted for 18.2%, 17.3% and 15.1%, respectively, of the Company's
revenue. In fiscal 1996, Yamaha accounted for 10.4% of the Company's revenue,
and the Company's six largest customers accounted for 50.0% of the Company's
revenue. In fiscal 1997, Tritech accounted for 10.3% of revenue, and seven
customers located in Asia accounted for 41.1% of revenue and seven domestic
customers accounted for 26.6% of revenue. The Company anticipates that the
majority of its revenue will be derived from a relatively small number of
customers through at least fiscal 1998 and that sales to customers in Asia will
continue to account for a significant portion of the Company's revenue. None of
the Company's customers has a written agreement with the Company that obligates
it to license additional products or to renew its maintenance agreement, and
there can be no assurance that any customer will license additional SIP products
or renew its maintenance agreement. The loss of one or more of the Company's
major customers, or reduced orders by
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<PAGE> 17
one or more of such customers, could materially adversely affect the Company's
business, operating results and financial condition. In the third quarter of
fiscal 1998, the Company recognized approximately $2.9 million of revenue from a
distributor agreement that was terminated during the quarter. The Company does
not expect any future revenue from this customer. The nonrecurring nature of
this revenue will have a material adverse impact on the Company's future
revenue.
Risks Associated With International Operations. A significant portion of the
Company's revenue is derived from customers outside the United States, and the
Company anticipates that international revenue will continue to account for a
significant portion of its total revenue. Revenue from customers outside the
United States, substantially all of whom are located in Asia, accounted for
54.1%, 65.4% and 52.8% of revenue in fiscal 1995, 1996, 1997, respectively and
56.8% and 57.8% of revenue for the first nine months and third quarter of fiscal
1998, respectively. Although the Company does not believe that it experienced
any material adverse impact in revenue as a result of the financial dislocations
that occurred in certain Asian countries during 1997 and 1998, it has
experienced a lengthening of the payment period for accounts receivables from
certain Asian-based customers. At August 31, 1998, approximately 67.5% of the
Company's accounts receivable (including unbilled receivables) were from
Asian-based customers. Although the Company currently believes, based in part on
continuing discussions with these customers, that its existing accounting
reserves are adequate given the estimated exposure related to all of its
accounts receivable, there can be no assurance that such accounting reserves
will prove to be adequate nor that present or future dislocations in Asian
countries or elsewhere or other factors will not have a material adverse effect
on the Company's ability to collect its accounts receivable or on its business,
operating results and financial condition.
The Company's international business involves a number of risks, including
the impact of possible recessionary environments in foreign economies, political
and economic instability, exchange rate fluctuations, longer receivables
collection periods and greater difficulty in accounts receivable collection from
distributors and customers, difficulty in managing distributors or sales
representatives, unexpected changes in regulatory requirements, reduced or
limited protection for intellectual property rights, export license
requirements, tariffs and other trade barriers and potentially adverse tax
consequences. Although the Company prices its products and services in United
States dollars, currency exchange fluctuations could have a material adverse
effect on the Company's business to the extent that the Company's pricing is not
competitive with products priced in local currencies. The Company does not
currently hedge against foreign currency fluctuations.
Export Control Matters. In May 1997, the Company was advised by the U.S.
Department of Commerce, Bureau of Export Administration (the "DOC") and the
United States Attorney's Office for the Northern District of California that an
investigation had been initiated with respect to the possible violation of U.S.
export laws by the Company and certain of its employees. In August 1997, the
Company was orally informed that the investigation had been closed, and no
action has been brought against the Company or, to the Company's knowledge, its
employees or former employees. The investigation and related diversion of
management time and attention and legal and other costs and expenses had a
material adverse impact on the Company's business and results of operations in
the second and third quarters of fiscal 1997. Although the Company engaged
special counsel with expertise in export matters and has taken steps to help
ensure compliance with export laws, there can be no assurance that the Company
will not be subject to the same or a similar investigation in the future.
Dependence Upon Semiconductor and Electronics Industries. The Company is
dependent upon the semiconductor and electronics industries. Each of these
industries is characterized by rapid technological change, short product life
cycles, fluctuations in manufacturing capacity and pricing and gross margin
pressures. Each of these industries is highly cyclical and has periodically
experienced significant downturns, often in connection with or in anticipation
of decline in general economic conditions during which the number of new IC
design projects often decreases. Revenue from new licenses of the Company's
products is influenced by the level of design efforts by its customers, and
factors negatively affecting any of these industries could have a material
adverse effect on the Company's business, operating results and financial
condition. In this regard, the shift in industry practice from payment of
up-front license fees to a royalty based model will have a material adverse
impact on the Company's revenue in future periods. The Company's business,
operating results and financial condition may also fluctuate in the future from
period to period as a consequence of general economic conditions in the
semiconductor or electronics industry.
Competition. Although the market for merchant SIP is new and emerging and the
Company has few direct competitors, the Company expects that the market for its
products will become increasingly competitive in the future. The Company's
current competitors include Artisan Components, Inc., Cascade Design Automation
(a subsidiary of Oki Semiconductor Ltd.), Compass Design Automation (a division
of Avant!), Mentor Graphics and Silicon Architects (a division of Synopsys).
Duet Technology, Inc., a design services company, acquired Cascade Design
Automation. The Company also experiences significant indirect competition from
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<PAGE> 18
the engineering departments of potential customers that maintain and develop
internally developed SIP. Certain of the Company's other potential customers
rely on proprietary SIP developed and maintained by ASIC vendors. In addition,
certain semiconductor foundries currently offer or may in the future offer one
or more elements of a SIP solution including cell libraries acquired from the
Company's competitors. The Company's potential competitors also include a number
of large vertically integrated semiconductor companies and numerous EDA software
companies that may develop SIP products that compete with those of the Company.
To the extent the Company expands its capability to offer design services, it
could also experience competition from numerous small design engineering firms
and from large public companies that also offer such services. Increased
competition has resulted in a shift from up-front license fees to a royalty
based model and in price reductions and reduced operating margins which have
materially adversely affect the Company's business, operating results and
financial condition. Many of the Company's potential competitors have
significantly greater financial, technical, marketing and other resources than
the Company. As a result, they may be able to respond more quickly to new or
emerging technologies and to changes in customer requirements, or to devote
greater resources to the development, promotion and sale of their products than
can the Company. There can be no assurance that the Company will be able to
compete successfully against current or future competitors or that competitive
pressures will not materially adversely affect the Company's business, operating
results and financial condition. The Company believes the principal elements of
competition in its market are the range of EDA tools and process technologies
supported, technological leadership, product functionality, the level of
technical support provided, software reliability and price. The Company believes
that it competes favorably with respect to each of these factors.
Limited Protection of Proprietary Rights. The Company's success is dependent
on its ability to protect its proprietary technology. The Company relies upon a
combination of copyright, patent, trade secret and trademark laws to protect its
proprietary technology. The Company enters into confidentiality agreements with
its employees, distributors and customers and limits access to and distribution
of the source code to its software and other proprietary information. There can
be no assurance that the steps taken by the Company in this regard will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. Any such misappropriation of
the Company's technology or development of competitive technologies could have a
material adverse effect on the Company's business, operating results and
financial condition. Despite the Company's efforts to protect its proprietary
rights, there can be no assurance that the Company will be able to protect its
proprietary rights against unauthorized third-party copying or use, and attempts
may be made to copy or reverse engineer aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. Policing the
unauthorized use of the Company's products is difficult and the Company could
incur substantial costs in protecting and enforcing its intellectual property
rights. Litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's trade secrets or to
determine the validity and scope of the proprietary rights of others. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, operating
results and financial condition.
As of August 31, 1998, the Company held six U.S. patents which expire from
2013 to 2015 and had two U.S. patent applications pending. The Company also has
12 patent applications pending in various foreign jurisdictions. The Company
expects to continue to file patent applications where appropriate to protect its
proprietary technologies; however, the Company believes that its continued
success depends primarily on factors such as the technological skills and
innovation of its personnel rather than on its patents. The Company has
registered the trademarks Aspec Technology, ABOND, HDEA and Mastergen and has
one trademark application pending in the United States. The process of seeking
patent and trademark protection can be expensive and time consuming. There can
be no assurance that patents or trademarks will issue from pending or future
applications or that, if issued, such patents or trademarks will not be
challenged, invalidated or circumvented, or that rights granted thereunder will
provide meaningful protection or other commercial advantage to the Company.
Moreover, there can be no assurance that any patent or trademark rights will be
upheld in the future or that the Company will be able to preserve any of its
other intellectual property rights. In addition, the laws of certain countries
in which the Company's products are distributed do not protect the Company's
products and intellectual property rights to the same extent as the laws of the
United States. Accordingly, effective trademark, copyright and patent protection
may be unavailable in certain foreign countries.
As is common in the technology industry, the Company may from time to time
receive notices from third parties claiming infringement by the Company's
products of third-party proprietary rights. While the Company is not currently
subject to any such claim, the Company believes that its products could
increasingly be subject to such claims as the market for its products grows and
as more competitors enter the market. Any such claim, with or without merit,
could result in significant litigation costs and require the Company to enter
into royalty and licensing agreements, which could have a material adverse
effect on the Company's business,
18
<PAGE> 19
operating results and financial condition. Such royalty and licensing
agreements, if required, may not be available on terms acceptable by the Company
or at all.
Potential for Product Defects. Complex products such as those offered by the
Company may contain undetected errors, defects or "bugs." There can be no
assurance that, despite significant testing by the Company and by current and
potential customers, errors will not be found in products or enhancements to
existing products after commencement of commercial shipments. The Company does
not presently maintain insurance with respect to potential damages due to errors
or defects in its products. Although the Company has not experienced material
adverse effects resulting from any such errors or defects to date, there can be
no assurance that errors or defects will not be discovered in the future,
potentially causing delays in product introduction and shipments or requiring
design modifications that could materially adversely affect the Company's
business, operating results and financial condition.
Dependence on Key Personnel. The Company's business depends in significant
part on the continued service of the Company's executive officers and other
senior management and key employees, including certain technical, managerial and
marketing personnel. In this regard, a number of key members of the Company's
management have left the Company to pursue other opportunities. The loss of the
services of any of these individuals or groups of individuals could have a
material adverse effect on the Company's business, operating results and
financial condition. None of the Company's executive officers has an employment
agreement with the Company. The Company believes that its future business
results will also depend in significant part upon its ability to identify,
attract, motivate and retain additional highly skilled technical, managerial and
marketing personnel. Competition for such personnel in the computer software
industry is intense. The Company is currently engaged in a search for several
additional engineering personnel. There can be no assurance the Company will be
successful in identifying, attracting and retaining such personnel, and the
failure to do so could have a material adverse effect on the Company's business,
operating results and financial condition.
Year 2000 Compliance. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, in less than two years,
computer systems and software used by many companies may need to be upgraded to
comply with such "Year 2000" requirements.
In terms of the effect of Year 2000 issues on the Company's product
offerings, the software and library products, which comprise almost all of the
Company's revenue, do not have specific date dependence and, therefore, are not
subject to Year 2000 issues. The customer's operating systems that run Aspec's
software and libraries may have issues that could hamper their operations. In
this event, sales to these customers may be reduced until the customer has
addressed his internal issues. Aspec sales and customer support personnel will
work on Year 2000 issues to the extent allowed by the customer. All of Aspec's
software development, whether done internally, or, in some instances, by outside
subcontractors, is performed on workstations manufactured by Sun Microsystems.
The Company is in the process of upgrading all workstations to the operating
system specified by Sun Microsystems as Year 2000 compliant. The Company expects
to complete this upgrade by June 1999 at a cost of approximately $300,000. If
this upgrade cannot be completed in time, the Company would be forced to
purchase new workstations. Costs to do this could run as high as $1.5 million.
The Company is in the process of determining whether there may be additional
Year 2000 issues with various computer software programs purchased from outside
vendors for software development and for accounting. It has identified the
appropriate personnel to complete the evaluations and expects to have these
reviews completed by March 1999.
Volatility of Share Price. Since the Company's initial public offering in
April 1998, the market price of the Company's Common Stock has been highly
volatile and is expected to be significantly affected by factors such as actual
or anticipated fluctuations in the Company's operating results, the Company's
failure to meet or exceed published earnings estimates, changes in earnings
estimates or recommendations by securities analysts, announcements of
technological innovations, new products or new contracts by the Company or its
existing or potential competitors, developments with respect to patents,
copyrights or proprietary rights, conditions and trends in the EDA,
semiconductor or electronics industries, adoption of new accounting standards
affecting the software industry, general market conditions and other factors. In
addition, the stock market has from time to time experienced significant price
and volume fluctuations that have particularly affected the market prices for
the common stocks of technology companies which have often been unrelated to the
operating performance of such companies. These broad market fluctuations may
materially adversely affect the market price of the Common Stock. In June 1998,
securities class action litigation was filed against the Company and certain of
its executive officers and directors. Such litigation could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect upon the Company's business, operating
results and financial condition. See "Part II - Item 1 - Legal Proceedings."
19
<PAGE> 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On July 1, 1998, a class action lawsuit, Howard Jones, et al. v. Aspec
Technology, Inc., et al., No. CV-775037, was filed in the Superior Court for the
State of California, County of Santa Clara. The Complaint alleges that Aspec and
certain of its officers and directors violated California state securities and
common law by making false and misleading statements about Aspec's financial
condition between April 28, 1998 and June 25, 1998. This action is purportedly
brought on behalf of all persons who purchased Aspec stock during that period.
On July 2, 1998, July 27, 1998, and August 17, 1998, three substantially
similar complaints were filed in state court against similar defendants,
entitled respectively, William Neuman, et al. v. Aspec Technology, Inc., et al.,
No. CV-775089, Martin L. Klotz, on behalf of the Martin Klotz Defined Benefit
Profit Sharing Plan, et al. v. Aspec Technology, Inc., et al., No. CV-775591,
Glen O.Ressler and Thelma M. Ressler, et al. v. Aspec Technology, Inc., et al.,
No. CV-776065. The Klotz complaint also alleges violations of Sections 11, 12,
and 15 of the Securities Exchange Act of 1934. The complaints seek unspecified
damages. The Company expects these complaints to be consolidated, and expects to
file a demurrer 30 days after consolidation.
Certain of the Company's current and former officers and directors are
also named as defendants in a derivative lawsuit, which was filed on November
12, 1998, in the Superior Court of Santa Clara County. The derivative complaint
was based on factual allegations substantially similar to those alleged in the
class action lawsuits.
Certain provisions of the Company's Certificate of Incorporation and
indemnification agreements between the Company and its officers require the
Company to advance to such officers ongoing legal expenses of defending the
above lawsuits and may require the Company to indemnify them against judgments
rendered on certain claims. The Company expects to incur significant legal
expenses on its behalf and on behalf of such officers in connection with this
litigation. In addition, defending this litigation has resulted, and will likely
continue to result, in the diversion of management's attention from the day to
day operations of the Company's business. There can be no assurance that this
stockholder litigation will be resolved in the Company's favor. An adverse
result, settlement or prolonged litigation would have a material adverse effect
on the Company's business, financial condition or results of operation.
On October 16, 1998, plaintiffs agreed to voluntarily dismiss Kassover,
et al. v. Aspec Technology, Inc., et al, No. C 98-2604VRW, which was filed on
June 30, 1998 in the United States District Court for the Northern District of
California against Aspec and certain of its officers and directors. The
Complaint alleges that defendants violated Sections 11, 12, and 15 of the
Securities Exchange Act of 1934 by failing to disclose certain facts about
Aspec's financial condition between April 28, 1998 and June 30, 1998. On October
20, 1998, the Court dismissed the purported class action without prejudice.
On September 4, 1998, the Company received an informal request for
information from the NASDAQ Listing Investigations Staff. NASDAQ requested
information concerning the Company's financial accounting and internal controls.
The Company has provided information in response to the informal inquiry.
20
<PAGE> 21
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the fiscal quarter
ended May 31, 1998:
1. Form 8-K filed June 29, 1998 related to the Company's acquisition of SIS
Microelectronics.
2. Form 8-K filed August 10, 1998 related to the resignation of Deloitte &
Touche LLP as the Company's independent accountants.
3. Form 8-K filed September 2, 1998 related to the retention of
PricewaterhouseCoopers LLP as the Company's new independent accountants.
4. Form 8-K filed October 14, 1998 related to a press release announcing
that Deloitte & Touche LLP had withdrawn its audit report.
5. Form 8-K filed October 14, 1998 related to the expected restatement of
the Company's financial results.
21
<PAGE> 22
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.
ASPEC TECHNOLOGY, INC.
Date: December 17, 1998 By: /s/ CONRAD DELL'OCA
------------------------------------
Conrad Dell'Oca
President and Acting
Principal Accounting Officer
22
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBITS
<S> <C>
27.1 Financial Data Schedule
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> NOV-30-1998
<PERIOD-START> DEC-01-1997
<PERIOD-END> AUG-31-1998
<CASH> 45,081
<SECURITIES> 0
<RECEIVABLES> 12,440
<ALLOWANCES> (1,000)
<INVENTORY> 112
<CURRENT-ASSETS> 62,491
<PP&E> 18,204
<DEPRECIATION> (5,666)
<TOTAL-ASSETS> 79,812
<CURRENT-LIABILITIES> 13,791
<BONDS> 0
0
0
<COMMON> 86,219
<OTHER-SE> (21,481)
<TOTAL-LIABILITY-AND-EQUITY> 79,812
<SALES> 19,116
<TOTAL-REVENUES> 19,116
<CGS> 10,687
<TOTAL-COSTS> 10,687
<OTHER-EXPENSES> 9,936
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9
<INCOME-PRETAX> (477)
<INCOME-TAX> 82
<INCOME-CONTINUING> (559)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (565)
<EPS-PRIMARY> (0.20)
<EPS-DILUTED> (0.20)
</TABLE>
