<PAGE>
================================================================================
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 period ended June 30, 1998
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number: 000-23649
ARTISAN COMPONENTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0278185
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
1195 Bordeaux Drive
Sunnyvale, California 94089
(Address of principal executive offices)
Telephone Number (408) 734-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
As of June 30, 1998 there were 13,295,092 shares of the Registrant's Common
Stock outstanding.
================================================================================
<PAGE>
ARTISAN COMPONENTS, INC.
Form 10-Q
INDEX
Page No.
--------
Cover Page..................................................................1
Index.......................................................................2
PART I - Financial Information
ITEM 1 - Financial statements
Condensed balance sheets -- June 30, 1998 and September 30, 1997.......3
Condensed statements of operations
Three months and nine months ended June 30, 1998 and 1997...4
Condensed statements of cash flows -- nine months ended
June 30, 1998 and 1997.....................................5
Notes to condensed financial statements................................6
ITEM 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations........................9
PART II - Other Information
ITEM 2 - Changes in Securities and Use of Proceeds....................26
ITEM 6 - Exhibits.....................................................26
Signatures.................................................................27
2
<PAGE>
ARTISAN COMPONENTS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
------------- --------------
1998 1997(1)
------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................... $ 343 $ 1,069
Contract receivables (net of allowance of
$275 and $275 at June 30, 1998 and
September 30, 1997, respectively)................ 5,939 2,834
Marketable securities............................. 45,134 2,499
Prepaid expenses and other current assets......... 999 564
------- -------
Total current assets............................ 52,415 6,966
Marketable securities............................... - 986
Property and equipment, net......................... 5,522 3,969
Deferred tax asset.................................. 6 6
Other assets........................................ 473 84
------- -------
Total assets.................................... $58,416 $12,011
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses............. $ 1,965 $ 631
Accrued warranty.................................. 189 165
Deferred tax liability............................ 384 384
Deferred revenue.................................. 1,755 1,434
------- -------
Total current liabilities....................... 4,293 2,614
Deferred rent....................................... 38 49
Deferred revenue.................................... 187 -
------- -------
Total liabilities............................... 4,518 2,663
------- -------
Stockholders' Equity:
Convertible Preferred Stock, $0.001 par value:
Authorized: 5,000 and 3,436 shares at
June 30, 1998 and September 30,
1997, respectively;
Issued and outstanding: None and 3,386 at
June 30, 1998 and September 30, 1997,
respectively;.................................... - 7,564
Common Stock, $0.001 par value:
Authorized: 50,000 shares;
Issued and outstanding: 13,295 and 5,644
shares at June 30, 1998 and September 30,
1997, respectively............................... 13 6
Warrant............................................ - 125
Additional paid in capital......................... 51,603 688
Retained earnings.................................. 2,282 965
------- -------
Total stockholders' equity...................... 53,898 9,348
------- -------
Total liabilities and stockholders' equity...... $58,416 $12,011
======= =======
</TABLE>
- ------------
(1) Derived from the Company's audited Balance Sheet as of September 30, 1997.
The accompanying notes are an integral part of these condensed financial
statements.
3
<PAGE>
ARTISAN COMPONENTS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- -----------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue....................... $ 4,322 $ 2,738 $11,411 $ 5,893
Cost and expenses:
Cost of revenue............. 1,283 937 3,383 1,863
Product development......... 915 489 2,629 1,330
Sales and marketing......... 1,122 620 2,924 1,324
General and administrative.. 474 415 1,367 916
------- ------- ------- -------
Total cost and expenses.... 3,794 2,461 10,303 5,433
------- ------- ------- -------
Operating income.............. 528 277 1,108 460
Other income.................. 429 87 736 219
------- ------- ------- -------
Income before provision for
income taxes................. 957 364 1,844 679
Provision for income taxes.... 237 124 526 233
------- ------- ------- -------
Net income.................... $ 720 $ 240 $ 1,318 $ 446
======= ======= ======= =======
Basic earnings per share...... $0.06 $ 0.04 $ 0.14 $ 0.08
======= ======= ======= =======
Diluted earnings per share.... $0.05 $ 0.02 $ 0.11 $ 0.05
======= ======= ======= =======
Shares used in computing:
Basic earnings per share.... 12,957 5,590 9,485 5,404
Diluted earnings per share.. 14,548 9,932 12,356 9,566
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
4
<PAGE>
ARTISAN COMPONENTS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
JUNE 30,
------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating
activities:
Net income....................... $ 1,318 $ 446
Adjustments to reconcile net
income to net cash provided by
operating activities:
Depreciation and
amortization.................. 1,330 470
Gain on sale of fixed
assets........................ (60) -
Provision for doubtful
accounts...................... - 175
Issuance of Common Stock to
employees as a stock bonus.... - 77
Compensation expense for
options granted............... 57 29
Changes in assets and
liabilities:
Contract receivables......... (3,105) (1,589)
Deferred revenue............. 508 1,263
Prepaid expenses and other
assets...................... (824) (63)
Deferred rent................ (11) 26
Deferred taxes............... - -
Accounts payable and
other liabilities........... 1,350 296
------- -------
Net cash provided by
operating activities...... 563 1,130
------- -------
Cash flows from investing
activities:
Acquisition of property and
equipment....................... (2,895) (1,482)
Proceeds from sale of property
and equipment................... 80 -
Purchase of marketable
securities...................... (41,649) (2,957)
------- -------
Net cash used in
investing activities...... (44,464) (4,439)
------- -------
Cash flows from financing
activities:
Net proceeds from issuance of
Series B Preferred Stock and
Warrant......................... - 4,211
Proceeds from issuance of
Common Stock.................... 43,175 15
------- -------
Net cash provided by
financing activities...... 43,175 4,226
------- -------
Net (decrease) increase in cash
and cash equivalents.............. (726) 917
Cash and cash equivalents,
beginning of period............... 1,069 709
------- -------
Cash and cash equivalents, end of
period............................ $ 343 $ 1,626
======= =======
CASH PAID FOR:
Income taxes..................... $ 26 $ 2
======= =======
SUPPLEMENTAL DISCLOSURE OF
NONCASH ACTIVITIES:
Fixed asset acquisitions in
exchange for accounts payable. $ 8 $ 754
======= =======
Issuance of Common Stock to em-
ployees as a stock bonus........ $ - $ 77
======= =======
Compensation expense for op-
tions granted................... $ 57 $ 29
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed
financial statements.
5
<PAGE>
ARTISAN COMPONENTS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION:
The accompanying unaudited condensed financial statements of ARTISAN
COMPONENTS, INC. (the "Company") have been prepared in accordance with generally
accepted accounting principles ("GAAP") for interim financial information and in
accordance with the rules and regulations of the Securities and Exchange
Commission. 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. The year end
balance sheet data was derived from the audited financial statements and does
not include all disclosures required by GAAP. Operating results for the three
and nine month periods ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 30, 1998 or
any other future period. The unaudited, condensed, interim financial statements
contained herein should be read in conjunction with the audited financial
statements and footnotes for the year ended September 30, 1997 included in the
Company's Registration Statement on Form S-1 (Reg. No. 333-50243).
2. EARNINGS PER SHARE (EPS) DISCLOSURES:
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, Earnings Per Share ("SFAS 128") effective December 31, 1997.
SFAS 128 requires the presentation of basic and diluted earnings per share.
Basic EPS is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
is computed giving effect to all dilutive potential common shares that were
outstanding during the period. Dilutive potential common shares consist of the
incremental common shares issuable upon the conversion of convertible preferred
stock (using the "if converted" method) and exercise of stock options and
warrants for all periods. All prior period earnings per share amounts have been
restated to comply with SFAS 128.
6
<PAGE>
ARTISAN COMPONENTS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
2. EARNINGS PER SHARE (EPS) DISCLOSURES (con't):
In accordance with the disclosure requirements of SFAS 128, a reconciliation
of the numerator and denominator of basic and diluted EPS is provided as follows
(in thousands, except per share amounts).
<TABLE>
<CAPTION>
Nine Months
Three Months Ended
Ended June 30, June 30,
---------------- --------------
1998 1997 1998 1997
------- ------- ------ ------
(Unaudited)
<S> <C> <C> <C> <C>
Numerator--Basic and Diluted EPS
Net income....................... $ 720 $ 240 $ 1,318 $ 446
======= ======= ======= ======
Denominator--Basic EPS
Common stock outstanding......... 12,957 5,590 9,485 5,404
------- ------- ------- ------
Basic earnings per share.......... $ 0.06 $ 0.04 $ 0.14 $ 0.08
======= ======= ======= ======
Denominator--Diluted EPS
Denominator--Basic EPS........... 12,957 5,590 9,485 5,404
Effect of Dilutive Securities:
Common stock options........... 1,591 956 1,309 1,086
Convertible preferred stock.... - 3,386 1,562 3,076
------- ------- ------- ------
14,548 9,932 12,356 9,566
------- ------- ------- ------
Diluted earnings per share........ $ 0.05 $ 0.02 $ 0.11 $ 0.05
======= ======= ======= ======
</TABLE>
3. NEW ACCOUNTING STANDARDS:
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for reporting and displaying comprehensive income and its components in the
financial statements. It does not, however, require a specific format for the
financial statement, but requires the Company to display an amount representing
total comprehensive income for the period in the financial statement. SFAS No.
130 is effective for the Company's 1999 fiscal year that commences October 1,
1998.
7
<PAGE>
ARTISAN COMPONENTS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS -- CONTINUED
(Unaudited)
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards for
reporting information about operating segments in annual financial statements
and requires the reporting of selected information about operating segments in
interim financial reports issued to stockholders. SFAS No. 131 is effective for
the Company's 1999 fiscal year that commences October 1, 1998. The Company is
currently studying the impact of these pronouncements.
4. STOCKHOLDERS' EQUITY:
On February 6, 1998, the Company completed the public offering of 3,015,000
shares of Common Stock through a Registration Statement declared effective by
the Securities and Exchange Commission on February 2, 1998. In connection with
such public offering, certain stockholders of the Company sold an additional
320,000 shares of the Company's Common Stock.
On May 5, 1998, the Company completed the public offering of 956,190 shares of
Common Stock through a Registration Statement declared effective by the
Securities and Exchange Commission on April 29, 1998. In connection with such
offering, certain stockholders of the Company sold an additional 2,343,810
shares.
8
<PAGE>
ARTISAN COMPONENTS, INC.
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 statements include those in
the third paragraph under "Overview" regarding estimates for project completion,
the statements in the fourth paragraph under "Overview" regarding royalties, the
statements in the fifth paragraph under "Overview" regarding customer
concentration and dependence on a limited number of customers, the statements in
the sixth paragraph in "Overview" regarding international revenue, the
statements in the seventh paragraph in "Overview" regarding product
concentration, the statements in the eighth paragraph in "Overview" regarding
growth in expenses, the statements in the ninth paragraph in "Overview"
regarding project delays, the statements in the sixth paragraph under "Liquidity
and Capital Resources" regarding the sufficiency of the Company's available
resources to meet working capital and capital expenditure requirements, the
statements in the seventh paragraph in "Liquidity and Capital Resources"
regarding future fund raising activities and the statements below under "Factors
Affecting Future Operating Results" among others. These forward looking
statements are based on current expectations and entail 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 under "Factors Affecting Future Operating Results."
OVERVIEW
Artisan Components, Inc. ("Artisan" or the "Company") is a leading
developer of high performance, low power and high density embedded memory and
other intellectual property ("IP") components for the design and manufacture of
complex integrated circuits ("ICs"). The Company licenses its products to
semiconductor manufacturers and fabless semiconductor companies for the design
of ICs used in complex, high volume applications, such as portable computing
devices, cellular phones, consumer multimedia products, automotive electronics,
personal computers and workstations.
Revenue consists of license fees received under the terms of license
agreements with customers to provide the Company's IP component products.
Typically, a customer licenses one or more products that are accompanied by
layout databases, views to support a customer's IC design tool environment and
design methodology documentation. The license of the Company's products
typically involves a sales cycle of six to 12 months and often coincides with a
customer's migration to a new manufacturing process. The Company's contracts
generally require a customer to pay a license fee to Artisan ranging from
approximately $300,000 to $700,000 for each product delivered under a contract.
A contract typically calls for an upfront payment of approximately one third of
the full contract value with the remainder due upon delivery, generally three to
six months later. See "Factors Affecting Future Operating Results--Lengthy Sales
Cycle and Design Process."
9
<PAGE>
To date, the substantial majority of the Company's revenue has been
recognized on a percentage of completion method. Provisions for estimated losses
on the uncompleted contracts are recognized in the period in which the
likelihood of such losses is determined. As the completion period for a project
generally ranges from three to six months, revenue in any quarter is dependent
on the Company's progress toward completion of the project. There can be no
assurance that the Company's estimates will be accurate, and, in the event they
are not, the Company's business, operating results and financial condition in
subsequent periods could be materially adversely affected.
Currently, license fees represent substantially all of revenue. Beginning
in late fiscal 1996, however, the Company began implementation of a royalty
based business model that is intended to generate revenue from both license
fees and future royalties. Royalties will be based on per unit sales of ICs
and will generally vary in proportion to the silicon area of an IC occupied by
the Company's IP components. To date, the Company has received no royalty
revenue, and it does not anticipate receiving any until late fiscal 1999 due
to the typical length of time required for the Company to design a component
for a customer and for such customer to manufacture and bring to market a
product incorporating such component. There can be no assurance that the
Company will be successful in expanding the number of royalty bearing
contracts with customers. The Company generally licenses its products on a
nonexclusive, worldwide basis to major semiconductor manufacturers and grants
these manufacturers the right to distribute the Company's IP components to
their internal design teams and to fabless semiconductor companies that
manufacture at the same facility. Given that Artisan provides its products
early in the customer's IC design process, there will be a significant delay
between the delivery of a product and the generation of royalty revenue. There
can be no assurance that the Company will receive any royalty revenue or that,
if it does, the amount will be significant. See "Factors Affecting Future
Operating Results--Dependence on New Business Model."
The Company has been dependent on a relatively small number of customers
for a substantial portion of its annual revenue, although the customers
comprising this group have changed from time to time. In the three month period
ended June 30, 1998, Siemens AG ("Siemens"), Newport Wafer Fab, Ltd. ("Newport")
and ATI Technologies, Inc. ("ATI") accounted for 17%, 14% and 13% of revenue,
respectively. In the nine month period ended June 30, 1998, Newport, Taiwan
Semiconductor Manufacturing Corporation ("TSMC"), ATI, OKI Electric Industry
Co., Ltd. ("OKI"), and SGS-THOMSON MICROELECTRONICS S.r.l. ("SGS-THOMSON")
accounted for 12%, 12%, 11%, 10% and 10% of revenue, respectively. The Company
anticipates that its revenue will continue to depend on a limited number of
major customers for the foreseeable future, although the companies considered to
be major customers and the percentage of revenue represented by each major
customer may vary from period to period depending on the addition of new
contracts and the number of designs utilizing the Company's products. See
"Factors Affecting Future Operating Results--Customer Concentration; Limited
Customer Base."
A substantial portion of the Company's revenue is derived from customers
outside the United States. In the three and nine month periods ended June 30,
1998, revenue from customers outside the United States, primarily in Asia and
Europe, represented approximately 73% and 74%, respectively, of the Company's
revenue. The Company anticipates that international revenue will remain a
substantial portion of its revenue in the future. To date, all of the revenue
from international customers has been denominated in U.S. dollars. See "Factors
10
<PAGE>
Affecting Future Operating Results--Risks Associated with International
Customers."
The Company derives substantially all of its revenue from sales of its
memory and standard cell products that, together, accounted for 98% of revenue
in each of the three and nine month periods ended June 30, 1998. The Company
expects that memory products, in combination with standard cell products, will
continue to account for a substantial portion of the Company's revenue for the
foreseeable future. There can be no assurance that the Company will continue to
derive revenue from memory or standard cell products and a decline in revenue
from such products would have a material adverse effect on the Company's
business, operating results and financial condition. The Company's future
financial performance will depend in significant part on the successful
development, introduction and customer acceptance of new products.
Since the Company's inception in April 1991, each of the Company's cost and
expense categories has progressively increased as the Company has added
personnel and increased its activities in these areas. The Company intends to
continue making significant expenditures, particularly those associated with
engineering and sales and marketing, and expects that these costs and expenses
will continue to be a significant percentage of revenue in future periods.
Whether such expenses increase or decrease as a percentage of revenue will be
substantially dependent upon the rate of change of the Company's revenue.
The Company in the past has experienced delays in the progress of certain
projects, and there can be no assurance that such delays will not occur in the
future. Any delay or failure to achieve such progress could result in damage to
customer relationships and the Company's reputation, under-utilization 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, the Company's
contracts with customers generally may 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. The Company's costs and expenses will be based in part on
the Company's expectations of future revenue from license fees. Accordingly, if
the Company does not realize its expected revenue, its business, operating
results and financial condition could be materially adversely affected. See
"Factors Affecting Future Operating Results--Fluctuations in Operating Results."
In connection with the grant of options for the purchase of 96,200 shares of
Common Stock to employees during the period from December 1996 through March
1997, the Company recorded aggregate deferred compensation of approximately
$198,000 representing the difference between the deemed fair value of the Common
Stock and the option exercise price at the date of grant. Such deferred
compensation will be amortized over the vesting period relating to the options,
of which approximately $12,000 and $36,000 was amortized during three and nine
month periods ended June 30, 1998, respectively. All of such amounts were
recorded in product development expenses. In addition, the amortization will
result in charges over the next 11 quarters aggregating approximately $12,000
per quarter, all of which will be recorded in product development expenses.
11
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected statements
of operations data as a percentage of revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue....................... 100.0% 100.0% 100.0% 100.0%
Cost and expenses:
Cost of revenue............. 29.7 34.2 29.7 31.6
Product development......... 21.2 17.9 23.0 22.6
Sales and marketing......... 26.0 22.6 25.6 22.5
General and
administrative............. 10.9 15.2 12.0 15.5
-------- -------- -------- --------
Total cost and expenses. 87.8 89.9 90.3 92.2
-------- -------- -------- --------
Operating income.............. 12.2 10.1 9.7 7.8
Other income, net............. 10.0 3.2 6.5 3.7
-------- -------- -------- --------
Income before provision for
income taxes................. 22.2 13.3 16.2 11.5
Provision for income taxes.... 5.5 4.5 4.6 3.9
-------- -------- -------- --------
Net income.................... 16.7% 8.8% 11.6% 7.6%
======== ======== ======== ========
</TABLE>
12
<PAGE>
Revenue
Revenue increased by 57.9% from $2.7 million in the three month period ended
June 30, 1997 to $4.3 million in the three month period ended June 30, 1998.
Revenue increased by 93.6% from $5.9 million in the nine month period ended June
30, 1997 to $11.4 million in the nine month period ended June 30, 1998. The
growth in revenue in the three and nine month periods ended June 30, 1998 as
compared with the same periods in fiscal 1997 was primarily attributable to
increased licensing of the Company's memory and standard cell products, which
more than offset a decline in the sale of I/O products.
Cost and Expenses
Engineering costs are allocated between cost of revenue and product
development expenses. Engineering efforts devoted to developing products for
specific customer projects are recognized as cost of revenue. The balance of
engineering costs, incurred for general development of the Company's technology,
is charged to product development. Engineering costs generally are charged as
incurred and do not necessarily correspond to the recognition of revenue under
related contracts. Engineering costs increased by 54.1% from $1.4 million in the
three month period ended June 30, 1997 to $2.2 million in the three month period
ended June 30, 1998. Engineering costs increased by 88.3% from $3.2 million in
the nine month period ended June 30, 1997 to $6.0 million in the nine month
period ended June 30, 1998. Engineering costs as a percentage of revenue
declined from 52.1% and 54.2% in the three and nine month periods ended June 30,
1997, respectively, to 50.9% and 52.7% in the three and nine month periods ended
June 30, 1998, respectively. The absolute dollar increases in engineering costs
in the three and nine month periods ended June 30, 1998, as compared with the
same periods in fiscal 1997, were due primarily to an increase in engineering
headcount and, to a lesser extent, purchases of computer equipment, software
tools and networking infrastructure and equipment and legal costs associated
with the Company's patent program.
Cost of Revenue. Cost of revenue increased by 36.9% from $937,000 in
the three month period ended June 30, 1997 to $1.3 million in the three
month period ended June 30, 1998. Cost of revenue increased by 81.6% from
$1.9 million in the nine month period ended June 30, 1997 to $3.4 million
in the nine month period ended June 30, 1998. Cost of revenue as a
percentage of revenue was 34.2% and 29.7% for the three month periods
ended June 30, 1997 and 1998, respectively. Cost of revenue as a
percentage of revenue was 31.6% and 29.7% for the nine month periods ended
June 30, 1997 and 1998, respectively. The absolute dollar increases in
cost of revenue in the three and nine month periods ended June 30, 1998,
as compared with the same periods of fiscal 1997, were due to increases in
headcount and costs associated with delivering product to, and supporting,
a growing customer base.
Product Development Expenses. Product development expenses increased by
87.1% from $489,000 in the three month period ended June 30, 1997 to
$915,000 in the three month period ended June 30, 1998. Product
development expenses increased by 97.7% from $1.3 million in the nine
month period ended June 30, 1997 to $2.6 million in the nine month period
ended June 30, 1998. Product development expenses as a percentage of
revenue increased from 17.9% to 21.2% in the three month periods ended
June 30, 1997 and 1998, respectively. Product development expenses as a
percentage of revenue rose from 22.6% to 23.0% for the nine month periods
ended June 30, 1997 and 1998, respectively. The increases in product
development expenses in the three and nine month periods ended June 30,
1998, as compared with the same periods in fiscal 1997, were attributable
13
<PAGE>
to an increase in engineering headcount and, to a lesser extent, purchases of
computer equipment, software tools and networking infrastructure and equipment
and legal costs associated with the Company's patent program.
Sales and Marketing Expenses. Sales and marketing expenses include
salaries, commissions, travel expenses and costs associated with trade shows,
advertising and other marketing efforts. Costs of pre-sale customer support are
also charged to sales and marketing. Sales and marketing expenses increased by
81.0% from $620,000 in the three month period ended June 30, 1997 to $1.1
million in the three month period ended June 30, 1998. Sales and marketing
expenses increased by 120.8% from $1.3 million in the nine month period ended
June 30, 1997 to $2.9 million in the nine month period ended June 30, 1998.
Sales and marketing expense as a percentage of revenue increased from 22.6% and
22.5% for the three and nine month periods ended June 30, 1997, respectively, to
26.0% and 25.6% for the three and nine month periods ended June 30, 1998,
respectively. The increases in absolute dollars in sales and marketing expenses
in the three and nine month periods ended June 30, 1998, as compared with the
same periods in fiscal 1997, were primarily attributable to increases in sales
headcount and commissions expense to support an expanded customer coverage model
and increases in marketing headcount and promotional activity.
General and Administrative Expenses. General and administrative expenses
increased by 14.2% from $415,000 in the three month period ended June 30, 1997
to $474,000 in the three month period ended June 30, 1998. General and
administrative expenses increased by 49.2% from $916,000 in the nine month
period ended June 30, 1997 to $1.4 million in the nine month period ended June
30, 1998. As a percentage of revenue, general and administrative expenses
decreased from 15.2% and 15.5% in the three and nine month periods ended June
30, 1997, respectively, to 10.9% and 12.0% in the three and nine month periods
ended June 30, 1998, respectively. The absolute dollar increases in general and
administrative expenses in the third quarter and first nine months of fiscal
1998, as compared with the same periods in fiscal 1997, were primarily due to
increases in general and administrative personnel and increases in professional
services fees.
Other Income
Other income increased by 393.1% from $87,000 in the three month period
ended June 30, 1997 to $429,000 in the three month period ended June 30, 1998.
Other income increased by 236.1% from $219,000 in the nine month period ended
June 30, 1997 to $736,000 in the nine month period ended June 30, 1998. Other
income as a percentage of revenue increased from 3.2% to 10.0% for the three
month periods ended June 30, 1997 and 1998, respectively. Other income as a
percentage of revenue rose from 3.7% to 6.5% for the nine month periods ended
June 30, 1997 and 1998, respectively. The growth in other income in the three
and nine month periods ended June 30, 1998, as compared with the same periods
in fiscal 1997, primarily reflects interest income earned on the proceeds from
the Company's February 1998 initial public offering and the Company's April
1998 secondary offering.
Income Taxes
The provision for income taxes was $124,000 and $237,000 for the three
month periods ended June 30, 1997 and 1998, respectively. The provision for
income taxes was $233,000 and $526,000 in the nine month periods ended June 30,
1997 and 1998, respectively. The effective tax rate decreased from 34.1% to
24.8% for the three month periods ended June 30, 1997 and 1998, respectively.
14
<PAGE>
For the nine month periods ended June 30, 1997 and 1998, the effective tax rate
decreased from 34.3% to 28.5%, respectively. The decrease in effective tax rates
for the respective periods was primarily due to the Company investing the
proceeds from its public offerings in securities that are exempt from federal
taxation.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations primarily from license revenue
received from inception to June 30, 1998, the net proceeds of $27.1 million from
its February 1998 initial public offering of Common Stock, the net proceeds of
$15.8 million from its April 1998 secondary offering of Common Stock and, to a
lesser extent, the proceeds of approximately $7.7 million from the sale of
Preferred Stock and a warrant.
The Company's operating activities provided net cash of $1.1 million in the
nine month period ended June 30, 1997 and provided net cash of $563,000 in the
nine month period ended June 30, 1998. Net cash provided by operating activities
in both periods was due primarily to net income plus depreciation and
amortization, and additionally, for the nine months ended June 30, 1998, to an
increase in accounts payable and accrued expenses.
Net cash used in investing activities was $4.4 million and $44.5 million in
the nine month periods ended June 30, 1997 and 1998, respectively. In the nine
month period ended June 30, 1997, investing activities consisted primarily of
net purchases of marketable securities and purchases of property and equipment.
In the nine month period ended June 30, 1998, investing activities consisted of
$41.6 million in purchases of marketable securities using proceeds of the
Company's initial public offering and secondary offering, and $2.9 million in
purchases of property and equipment.
Net cash provided by financing activities was $4.2 million and $43.2
million in the nine month periods ended June 30, 1997 and 1998, respectively. In
the nine month period ended June 30, 1997, financing activities consisted
primarily of the sale of the Company's Series B Preferred Stock. In the nine
month period ended June 30, 1998, financing activities consisted primarily of
the sale of the Company's Common Stock in its February 1998 initial public
offering and in its April 1998 secondary offering.
At June 30, 1998, the Company had cash, cash equivalents and current
marketable securities of $45.5 million. As of June 30, 1998, the Company had
retained earnings of $2.3 million and working capital of $48.1 million,
including a short term component comprised of deferred revenue of $1.8 million.
The Company anticipates spending approximately $4.3 million for capital
expenditures over the next 12 months.
The Company intends to continue to invest heavily 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 and timing of expansion of product development efforts and the success
of these development efforts, the costs and timing of expansion of 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
15
<PAGE>
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.
However, there can be no assurance that the Company will not require additional
financing within this time frame. The Company's forecast period of time through
which its financial resources will be adequate to support its operations is a
forward looking statement that involves risks and uncertainties, and actual
results could vary. The factors described in this paragraph will affect the
Company's future capital requirements and the adequacy of its available funds.
From time to time, the Company may be required to raise additional funds
through public or private financing, strategic relationships or other
arrangements. There can be no assurance that such funding, if needed, will be
available on terms attractive to the Company, or at all. Furthermore, any
additional equity financing may be dilutive to stockholders, and debt financing,
if available, may involve restrictive covenants. Strategic arrangements, if
necessary to raise additional funds, may require the Company to relinquish its
rights to certain of its technologies or products. The failure of the Company to
raise capital when needed could have a material adverse effect on the Company's
business, operating results and financial condition. See "Factors Affecting
Future Operating Results--Future Capital Needs; Uncertainty of Additional
Funding."
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for reporting and displaying comprehensive income and its components in the
financial statements. It does not, however, require a specific format for the
financial statement, but requires the Company to display an amount representing
total comprehensive income for the period in the financial statement. SFAS No.
130 is effective for the Company's 1999 fiscal year that commences October 1,
1998.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards for
reporting information about operating segments in annual financial statements
and requires the reporting of selected information about operating segments in
interim financial reports issued to stockholders. SFAS No. 131 is effective for
the Company's 1999 fiscal year that commences October 1, 1998. The Company is
currently studying the impact of these pronouncements.
FACTORS AFFECTING FUTURE OPERATING RESULTS
FLUCTUATIONS IN OPERATING RESULTS. The Company's operating results have
fluctuated in the past as a result of a number of factors including the
relatively large size and small number of customer orders during a given
period; the timing of customer orders; delays in the design process due to
changes by a customer to its order after it is placed; the Company's ability
to achieve progress on percentage of completion contracts; the length of the
Company's sales cycle; the Company's ability to develop, introduce and market
new products and product enhancements; the timing of new product announcements
and introductions by the Company and its competitors; market acceptance of the
Company's products; the demand for semiconductors and end user products that
incorporate semiconductors; and general economic conditions. The Company's
future operating results may fluctuate from quarter to quarter and on an
annual basis as a result of these and other factors, in particular the
relatively large size and small number of customer orders during a given
16
<PAGE>
period and the rate of royalties recognized in a given period. Accordingly, it
is likely that in some future quarter the Company's operating results will be
below the expectations of public market analysts and investors. In such event,
the price of the Company's Common Stock would likely decline, perhaps
substantially.
Revenue in any quarter is dependent on a number of factors, and is not
predictable with any degree of certainty. Since the Company's expense levels
are based in part on management's expectations regarding future revenue, if
revenue is below expectations in any quarter, the adverse effect may be
magnified by the Company's inability to adjust spending in a timely manner to
compensate for any revenue shortfall. The Company also intends to increase its
sales and marketing expenses in an attempt to broaden its market coverage. The
Company's costs and 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 revenue, its business, operating results
and financial condition could be materially adversely affected.
The Company's sales cycle can be lengthy and is subject to a number of
risks over which the Company has little or no control. As a result of the
significant dollar amounts represented by a single customer order, the timing of
the receipt of an order can have a significant impact on the Company's revenue
for a particular period. In addition, because the Company's revenue is
concentrated among a small number of customers, a decline or a delay in the
recognition of revenue from one customer in a period may cause the Company's
business, operating results and financial condition in such period to be
materially adversely affected and may lead to significant fluctuations from
quarter to quarter. Any significant or ongoing failure to obtain new orders from
customers would have a material adverse effect on the Company's business,
operating results and financial condition.
To date, a substantial majority of the Company's revenue has been
recognized on a percentage of completion method. Provisions for estimated losses
on the uncompleted contracts are recognized in the period in which the
likelihood of such losses is determined. As the completion period ranges from
three to six months, the revenue in any quarter is dependent on the Company's
progress toward completion of the project. There can be no assurance that the
Company's estimates will be accurate, and, in the event they are not, the
Company's business, operating results and financial condition in subsequent
periods could be materially adversely affected. From time to time, the Company
experiences delays in the progress of certain projects, and there can be no
assurance that such delays will not occur in the future. Any delay or failure to
achieve such progress could result in damage to customer relationships and the
Company's reputation, under-utilization 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, the Company's contracts with customers
generally may 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.
DEPENDENCE ON EMERGENCE OF MERCHANT IP COMPONENT MARKET AND BROAD MARKET
ACCEPTANCE OF THE COMPANY'S PRODUCTS. The market for merchant IP components
has only recently begun to emerge. The Company's ability to achieve sustained
revenue growth and profitability in the future will depend on the continued
development of this market and, to a large extent, on the demand for complex
single chip system ("System-on-a-Chip") ICs. There can be no assurance that the
17
<PAGE>
merchant IP component and System-on-a-Chip markets will continue to develop or
grow at a rate sufficient to support the Company's business. If either of these
markets 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 IP products have been licensed only by a
limited number of customers. The vast majority of the Company's existing and
potential customers currently rely on components developed internally and/or by
other vendors. The Company's future growth, if any, is dependent on the adoption
of, and increased reliance on, merchant IP components 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.
COMPETITION. The Company's strategy of targeting semiconductor
manufacturers that participate in, or may enter, the System-on-a-Chip market
requires the Company to compete in intensely competitive markets. Within the
merchant segment of the IP component market, the Company competes primarily
against Aspec Technology, Inc., Avant! Corporation, Duet Corporation, Mentor
Graphics Corporation and the Silicon Architects group of Synopsys, Inc. In
addition, the Company may face competition from consulting firms and companies
that typically have operated in the generic library segment of the IP market and
that now seek to offer customized IP components as enhancements to their generic
solutions. The Company also faces significant competition from the internal
design groups of the semiconductor manufacturers that are expanding their
manufacturing capabilities and portfolio of IP components to participate in the
System-on-a-Chip market. These internal design groups compete with the Company
for access to the parent's IP component requisitions and may eventually compete
with the Company to supply IP components to third parties on a merchant basis.
There can be no assurance that internal design groups will not expand their
product offerings to compete directly with those of the Company or will not
actively seek to participate as merchant vendors in the IP component market by
selling to third party semiconductor manufacturers or, if they do, that the
Company will be able to compete against them successfully. In addition to
competition from companies in the merchant IP component market, the Company
faces competition from vendors that supply electronic design automation ("EDA")
software tools, including certain of those mentioned above, and there can be no
assurance that the Company will be able to compete successfully against them.
The Company expects competition to increase in the future from existing
competitors and from new market entrants with products that may be less
expensive than the Company's IP components or that may provide better
performance or additional features not currently provided by the Company.
Many of the Company's current and potential competitors have substantially
greater financial, technical, manufacturing, marketing, distribution and other
resources, greater name recognition and market presence, longer operating
histories, lower cost structures and larger customer bases than the Company. As
a result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements. In addition, certain of the Company's
principal competitors offer a single vendor solution, since, in the case of EDA
tools companies, they maintain their own EDA design tools and IP libraries or,
in the case of internal design groups, they provide IP components developed to
utilize the qualities of a given manufacturing process, and may therefore
benefit from certain capacity, cost and technical advantages. The Company's
ability to compete successfully in the emerging market for IP components will
depend upon certain factors, many of which are beyond the Company's control
including, but not limited to, success in designing new products; implementing
new designs at smaller process geometries; access to adequate EDA tools (many
18
<PAGE>
of which are licensed from the Company's current or potential competitors);
the price, quality and timing of new product introductions by the Company and
its competitors; the emergence of new IP component interchangeability
standards; the widespread licensing of IP components by semiconductor
manufacturers or their design groups to third party manufacturers; the ability
of the Company to protect its intellectual property; market acceptance of the
Company's IP components; success of competitive products; market acceptance of
products using System-on-a-Chip ICs; and industry and general economic
conditions. There can be no assurance that the Company will be able to compete
successfully in the emerging merchant IP component market.
DEPENDENCE ON SEMICONDUCTOR MANUFACTURERS; DEPENDENCE ON SEMICONDUCTOR AND
ELECTRONICS INDUSTRIES. The Company's success is substantially dependent both
on the adoption of the Company's technology by semiconductor manufacturers and
on an increasing demand for products requiring complex System-on-a-Chip ICs,
such as portable computing devices, cellular phones, consumer multimedia
products, automotive electronics, personal computers and workstations. The
Company is subject to many risks beyond its control that influence the success
of its customers, including, among others, competition faced by each customer
in its particular industry, market acceptance of the customer's products that
incorporate the Company's technology, the engineering, sales and marketing
capabilities of the customer, and the financial and other resources of the
customer.
The semiconductor and electronics products industries are characterized by
rapid technological change, frequent introductions of new products, 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 declines in general economic conditions during which the
number of new IC design projects often decreases. Revenue from licenses of the
Company's products is influenced by the level of design efforts by its
customers and factors negatively affecting these industries could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's business, operating results and financial
condition may fluctuate in the future from period to period as a consequence
of general economic conditions in the semiconductor and electronics
industries.
DEPENDENCE ON NEW BUSINESS MODEL. The Company has historically generated
revenue from license fees. Beginning in late fiscal 1996, however, the Company
began implementation of a royalty based business model that is intended to
generate revenue from both license fees and future royalties. The Company is
still in the process of implementing this royalty based business model. The
Company believes the introduction, as opposed to the operation, of the royalty
based business model has been a limited success in that the majority of the
Company's licensees, including all new licensees with whom the Company has
contracted since August 1996, have agreed to a royalty based model. However,
certain licensees, which have previously contracted with the Company based on
the older model, have resisted conversion to a royalty based model. As a result,
the Company believes that until all of its customers have adopted the royalty
based model, the introduction of such model can only be described as a limited
success. There can be no assurance that the Company will be able to complete the
implementation of the royalty based model successfully, or that, when fully
implemented, this model will have the anticipated benefits. The failure of the
Company to implement its new business model successfully could have a material
adverse effect on the Company's business, operating results and financial
19
<PAGE>
condition. To date, the Company has received no royalty revenue, and it does
not anticipate receiving any prior to late fiscal 1999 due to the typical length
of time required for the Company to design a component for a customer and for
such customer to manufacture and bring to market a product incorporating such
component. There can be no assurance that the Company will ever receive any
royalty revenue or that, if it does, the amount will be significant. See "--
Dependence on Semiconductor Manufacturers; Dependence on Semiconductor and
Electronics Industries" and "--Customer Concentration; Limited Customer Base."
The Company believes that its long term success will be substantially
dependent on future royalties. However, even if the Company successfully
implements its new business model, the Company will face risks inherent in
such a model. In particular, the Company's ability to forecast royalty revenue
will be limited by factors that are beyond the Company's ability to control or
assess in advance. Royalties, if any, will be recognized in the quarter in
which the Company receives a royalty report from its customers and will be
dependent upon fluctuating sales volumes. In addition, under the royalty based
business model, the Company's revenue will be dependent upon the sales by its
customers of products that incorporate the Company's technology. Even if the
Company's technology is adopted, there can be no assurance that it will be
used in a product that is ultimately brought to market, achieves commercial
acceptance or results in significant royalties to the Company. The Company
will also face risks relating to the accuracy and completeness of the royalty
collection process.
CUSTOMER CONCENTRATION; LIMITED CUSTOMER BASE. The Company has been
dependent on a relatively small number of customers for a substantial portion
of its annual revenue, although the customers comprising this group have
changed from time to time. In the three month period ended June 30, 1998,
Siemens, Newport and ATI accounted for 17%, 14% and 13% of revenue,
respectively. In the nine month period ended June 30, 1998, Newport, TSMC, ATI,
OKI and SGS-THOMSON accounted for 12%, 12%, 11%, 10% and 10% of revenue,
respectively. The Company anticipates that its revenue will continue to depend
on a limited number of major customers for the foreseeable future, although the
companies considered to be major customers and the percentage of revenue
represented by each major customer may vary from period to period depending on
the addition of new contracts and the number of designs utilizing the Company's
products. None of the Company's customers has a written agreement with the
Company that obligates it to license future generations of products or new
products, and there can be no assurance that any customer will license IP
components from the Company in the future. In addition, there can be no
assurance that any of the Company's customers will ship products incorporating
the Company's technology or that, if such shipments occur, they will generate
significant revenue. The loss of one or more of the Company's major customers,
reduced orders by one or more of such customers or the failure of a customer to
ship products containing the Company's IP components could materially adversely
affect the Company's business, operating results and financial condition.
The Company faces numerous risks in successfully obtaining orders from
customers on terms consistent with the Company's business model, including,
among others, the lengthy and expensive process of building a relationship
with a potential customer before reaching an agreement with such party to
license the Company's products; persuading large semiconductor manufacturers
to work with, to rely for critical technology on, and to disclose proprietary
information to, a smaller company, such as the Company; and persuading
potential customers to bear certain development costs associated with
development of customized components. There are a relatively limited number of
20
<PAGE>
semiconductor manufacturers to which the Company can license its technology in
a manner consistent with its business model and there can be no assurance that
such manufacturers will rely on merchant IP components or adopt the Company's
products. See "--Competition."
PRODUCT CONCENTRATION. The Company derives substantially all of its revenue
from sales of its memory and standard cell products that, together, accounted
for 98% of revenue in each of the three and nine month periods ended June 30,
1998. The Company expects that memory products, in combination with standard
cell products, will continue to account for a substantial portion of the
Company's revenue, for the foreseeable future. There can be no assurance that
the Company will continue to derive revenue from memory or standard cell
products and a decline in revenue from such products would have a material
adverse effect on the Company's business, operating results and financial
condition. The Company's future financial performance will depend in significant
part on the successful development, introduction and customer acceptance of new
products. See "--New Product Development and Technological Change."
LENGTHY SALES CYCLE AND DESIGN PROCESS. The license of the Company's
products typically involves a significant commitment of capital by the
customer and a purchase will often be timed to coincide with a customer's
migration to a new manufacturing process. Potential customers generally commit
significant resources to an evaluation of available IP solutions and require
the Company to expend substantial time, effort and resources to educate them
about the value of the Company's products. A variety of factors, including
factors over which the Company has little or no control, may cause potential
customers to favor an alternate solution or to delay or forego a license of
the Company's products. As a result of these and other factors, the sales
cycle for the Company's products is long, typically ranging from six to 12
months. The Company's ability to forecast the timing and scope of specific
sales is limited, and delay of or failure to complete one or more large
contracts could have a material adverse effect on the Company's business,
operating results and financial condition and could cause the Company's
operating results to fluctuate significantly from quarter to quarter.
Once the Company receives and accepts an order from a customer, the Company
must commit significant resources to customizing its products for the customer's
manufacturing process. This customization is complex and time consuming and is
subject to a number of risks over which the Company has little or no control,
including the customer's adjustments and alterations of its manufacturing
process or the timing of migration to a new process. Typically, this
customization takes from three to six months to complete. Delays in product
customization could have a material adverse effect on the Company's business,
operating results and financial condition and could cause the Company's
operating results to vary significantly from quarter to quarter.
RISKS ASSOCIATED WITH INTERNATIONAL CUSTOMERS. A substantial portion of the
Company's revenue is derived from customers outside the United States. In
the three and the nine month periods ended June 30, 1998, revenue derived from
customers outside the United States, primarily in Asia and Europe, represented
approximately 73% and 74%, respectively, of the Company's revenue. The Company
anticipates that international revenue will remain a substantial portion of
revenue in the future. To date, all of the revenue from international customers
has been denominated in U.S. dollars. In the event that the Company's
competitors denominate their sales in a currency that becomes relatively
inexpensive in comparison to the U.S. dollar, the Company may experience fewer
orders from international customers whose business is based primarily on the
21
<PAGE>
less expensive currency. During the three months ended June 30, 1998, the
Company experienced delays in the receipt of orders expected from existing and
prospective customers, particularly in Japan. There can be no assurance that
the deferred orders will be placed in future periods, if at all. There can be no
assurance that present or future dislocations with respect to the Asian
financial markets will not have a material adverse effect on the Company's
business, operating results and financial condition. The Company intends to
continue to expand its sales and marketing activities in Asia and Europe. The
Company's expansion of its international business involves a number of risks
including the impact of possible recessionary environments in economies outside
the United States; political and economic instability; exchange rate
fluctuations; longer accounts receivable collection periods; greater difficulty
in accounts receivable collection; 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. There can be no assurance that the Company will be
able to sustain or increase revenue derived from international customers or that
the foregoing factors will not have a material adverse effect on the Company's
business, operating results and financial condition.
NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The Company's customers
compete 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 development of new manufacturing processes, 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 new product
introductions, emerging manufacturing process technologies and other
technological developments in the semiconductor industry. Any failure by the
Company to anticipate or respond adequately to changes in manufacturing
processes 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. There can be no
assurance 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. Any delay in release dates of new or enhanced products could
materially adversely affect the Company's business, operating results and
financial condition. The Company could also be exposed to litigation or claims
from its customers in the event that it does not satisfy its delivery
commitments. There can be no assurance that any such claim would not have a
material adverse effect on the Company's business, operating results and
financial condition.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends in large part on
the continued contributions of its key management, engineering, sales and
marketing personnel, many of whom are highly skilled and would be difficult to
replace. None of the Company's senior management or key technical personnel is
bound by an employment contract. In addition, the Company does not currently
maintain key man life insurance covering its key personnel. The Company believes
that its success depends to a significant extent on the ability of its
management to operate effectively, both individually and as a group. Competition
for highly skilled managerial, engineering, sales and marketing and finance
personnel is intense, and there can be no assurance that the Company will be
22
<PAGE>
successful in attracting and retaining such personnel. The loss of the services
of any of the key personnel, the inability to attract or retain qualified
personnel in the future or delays in hiring required personnel, particularly
engineers, could have a material adverse effect on the Company's business,
operating results and financial condition.
MANAGEMENT OF GROWTH. The ability of the Company to license its products
and manage its business successfully in a rapidly evolving market requires an
effective planning and management process. The Company's rapid growth has
placed, and is expected to continue to place, a significant strain on the
Company's managerial, operational and financial resources. From September 30,
1997 to June 30, 1998, the Company grew from 56 to 82 fulltime employees. The
Company's customers rely heavily on the Company's technological expertise in
designing, testing and manufacturing products incorporating the Company's IP
components. Relationships with new customers generally require significant
engineering support. As a result, any increase in the demand for the Company's
products will increase the strain on the Company's personnel, particularly its
engineers. The Company's financial and management controls, reporting systems
and procedures are also limited. Although some new controls, systems and
procedures have been implemented, the Company's future growth, if any, will
depend on its ability to continue to implement and improve operational,
financial and management information and control systems on a timely basis,
together with maintaining effective cost controls and any failure to do so would
have a material adverse effect on the Company's business, operating results and
financial condition. Further, the Company will be required to manage multiple
relationships with various customers and other third parties and must
successfully implement its new business model. There can be no assurance that
the Company's systems, procedures or controls will be adequate to support the
Company's operations or that the Company's management will be able to achieve
the rapid execution necessary to offer its services and products successfully
and to implement its business plan. The Company's inability to manage any future
growth effectively would have a material adverse effect on the Company's
business, operating results and financial condition.
RISKS ASSOCIATED WITH PROTECTION OF INTELLECTUAL PROPERTY. The Company
relies primarily on a combination of nondisclosure agreements and other
contractual provisions and patent, trademark, trade secret and copyright law
to protect its proprietary rights. Failure of the Company to enforce its
patents, trademarks or copyrights or to protect its trade secrets could have a
material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that such intellectual property
rights can be successfully asserted in the future or will not be invalidated,
circumvented or challenged. From time to time, third parties, including
competitors of the Company, may assert patent, copyright and other
intellectual property rights to technologies that are important to the
Company. There can be no assurance that third parties will not assert
infringement claims against the Company in the future, that assertions by
third parties will not result in costly litigation or that the Company would
prevail in any such litigation or be able to license any valid and infringed
patents from third parties on commercially reasonable terms. Litigation,
regardless of the outcome, could result in substantial cost and diversion of
resources of the Company. Any infringement claim or other litigation against
or by the Company could materially adversely affect the Company's business,
operating results and financial condition.
In certain instances, the Company has elected to rely on trade secret law
23
<PAGE>
rather than patent law to protect its proprietary technology. However, trade
secrets are difficult to protect. The Company seeks to protect its proprietary
technology and processes, in part, by confidentiality agreements with its
employees and customers. There can be no assurance that these contracts will
not be breached, that the Company will have adequate remedies for any breach,
or that the Company's trade secrets will not otherwise become known or be
independently discovered by competitors. In addition, effective trade secret
protection may be unavailable or limited in certain foreign countries.
In addition, there can be no assurance that competitors of the Company, many
of which have substantial resources and have made substantial investments in
competing technologies, do not have, or will not seek to apply for and obtain,
patents that will prevent, limit or interfere with the Company's ability to
make, use or sell its products either in the United States or in international
markets. There can be no assurance that the Company will not in the future
become subject to patent infringement claims and litigation or interference
proceedings declared by the United States Patent and Trademark Office ("USPTO")
to determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings and related legal
and administrative proceedings are both costly and time consuming. Any such suit
or proceeding involving the Company could have a material adverse
effect on the Company's business, operating results and financial condition.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company
intends to continue to invest heavily 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 and
timing of expansion of product development efforts and the success of these
development efforts, the costs and timing of expansion of 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
the Company's current cash 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. However, there can be no assurance
that the Company will not require additional financing within this time frame.
The Company's forecast period of time through which its financial resources will
be adequate to support its operations implies assumptions about its business
that are forward looking and that involve risks and uncertainties, and actual
results could vary. The factors described in this paragraph will affect both the
Company's future capital requirements and the adequacy of its available funds.
From time to time, the Company may be required to raise additional funds through
public or private financing, strategic relationships or other arrangements.
There can be no assurance that such funding, if needed, will be available on
terms attractive to the Company, or at all. Furthermore, any additional equity
financing may be dilutive to stockholders, and debt financing, if available, may
involve restrictive covenants. Strategic arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain of
its technologies or products. The failure of the Company to raise capital when
needed could have a material adverse effect on the Company's business, operating
results and financial condition.
POTENTIAL VOLATILITY OF STOCK PRICE. The trading price of the Company's
Common Stock has in the past been and could in the future be subject to
significant fluctuations in response to quarterly variations in the Company's
24
<PAGE>
results of operations, announcements regarding the Company's product
developments, announcements of technological innovations or new products by the
Company, its customers or competitors, release of reports by securities
analysts, changes in security analysts' recommendations, developments or
disputes concerning patents or proprietary rights or other events. Also, at some
future time, the Company's revenues and results of operations may be below the
expectations of public market securities analysts or investors, resulting in
significant fluctuations in the market price of the Company's Common Stock. In
addition, the securities markets have from time to time experienced significant
price and volume fluctuations which have particularly affected the market prices
for high technology companies and which often are unrelated and disproportionate
to the operating performance of particular companies. These broad market
fluctuations as well as general economic, political and market conditions, may
adversely affect the market price of the Company's Common Stock. In the past,
following periods of volatility in the market price of a company's stock,
securities class action litigation has occurred against that company. Such
litigation could result in substantial costs and would at a minimum divert
management's attention and resources, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
RISKS ASSOCIATED WITH THE YEAR 2000. The Year 2000 issue is the result of
computer programs being written using two digits rather than four digits to
define the applicable year. In other words, date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. The
Company has begun to conduct an analysis to determine the extent to which its
major suppliers' systems (insofar as they relate to the Company's business) are
subject to the Year 2000 issue. The Company is currently unable to predict the
extent to which the Year 2000 issue will affect its suppliers, or the extent to
which it would be vulnerable to its suppliers' failure to remediate any Year
2000 issues on a timely basis. The failure of a major supplier subject to the
Year 2000 issue to convert its systems on a timely basis or a conversion that is
incompatible with the Company's systems could have a material adverse effect on
the business, financial condition or results of operations of the Company.
The Company's products work in combination with semiconductor designs and
planning tools in environments developed by other vendors and interact with
other operating environments. It is likely that, commencing in the year 2000,
the functionality of certain operating environments will be adversely affected
when one or more component products of the environment is unable to process
four-digit characters representing years and, therefore, the operating
environment would not be in "Year 2000 compliance." The Company believes its
products are in Year 2000 compliance, but has not conducted any formal audit of
its products with respect to Year 2000 compliance. Nor can there be any
assurance that the Company's fully compliant products will be able to function
properly when integrated with other vendors' noncompliant component products.
The Company has initiated an audit to identify Year 2000 dependencies in
the Company's internal systems and intends to implement changes to its internal
information systems to make them Year 2000 compliant in the normal course of
improvements to those systems. While the Company currently expects that the year
2000 will not pose significant operational problems, delays in the
implementation of new information systems or a failure to fully identify all
Year 2000 dependencies in the Company's systems could have material adverse
consequences, including delays in the delivery or sale of products.
25
<PAGE>
ITEM 2. Changes in Securities and Use of Proceeds
On February 6, 1998, the Company completed the sale of 3,015,000 Common
Shares at a per share price of $10.00 in a firm commitment underwritten public
offering, and certain stockholders of the Company sold 320,000 shares of the
Company's Common Stock in connection with the offering. The offering was
effected pursuant to a Registration Statement on Form S-1 (Registration No. 333-
41219), which the United States Securities and Exchange Commission declared
effective on February 2, 1998. The offering was underwritten by Deutsche Morgan
Grenfell Inc., Hambrecht & Quist LLC and Wessels, Arnold & Henderson, L.L.C.
Of the $30,150,000 in aggregate proceeds raised by the Company in
connection with the February 1998 offering, (i) approximately $2,110,500 was
paid to the underwriters in connection with underwriting discounts, and (ii)
approximately $947,000 was paid by the Company in connection with offering
expenses, including legal, printing, and filing fees. The Company did not
receive any of the proceeds of or pay the underwriting discount in connection
with the shares sold by the selling stockholders. There were no direct or
indirect payments to directors or officers of the Company or any other person or
entity. None of the offering proceeds have been used for the construction of
plant, building or facilities or the purchase or installation of machinery or
equipment or for purchases of real estate or the acquisition of other
businesses. The Company is currently investing the net offering proceeds for
future use as additional working capital. Such net proceeds have been invested
in short-term, interest-bearing, investment grade securities. A portion of the
net proceeds may be used for the acquisition of technologies, businesses or
products that are complementary to those of the Company.
Between March 31, 1998 and June 30, 1998, the Company issued 21,754 shares
of unregistered common stock upon the exercise of outstanding options to 16
employees at an average exercise price of $0.48 per share. The sale of the
above securities was deemed to be exempt from registration under the Securities
Act of 1933, as amended (the "Securities Act"), in reliance on Rule 701
promulgated under Section 3(b) of the Securities Act, as transactions not
involving a public offering or transactions pursuant to compensatory benefit
plans and contracts relating to compensation as provided under Rule 701. Each
recipient had adequate access, through his or her relationship with the Company,
to information about the Company.
ITEM 6: Exhibits
(a) Exhibits
27.1 Financial Data Schedule
26
<PAGE>
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.
Dated: August 14, 1998
ARTISAN COMPONENTS, INC.
(Registrant)
/s/ Mark R. Templeton
--------------------------------------------
Mark R. Templeton
Chief Executive Officer
/s/ Robert D. Selvi
--------------------------------------------
Robert D. Selvi
Vice President, Finance and Chief Financial Officer
27
<PAGE>
INDEX TO EXHIBITS
EXHIBITS
- --------
27.1 Financial Data Schedule
28
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 343
<SECURITIES> 45,134
<RECEIVABLES> 6,214
<ALLOWANCES> (275)
<INVENTORY> 0
<CURRENT-ASSETS> 52,415
<PP&E> 8,167
<DEPRECIATION> (2,645)
<TOTAL-ASSETS> 58,416
<CURRENT-LIABILITIES> 4,293
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 53,885
<TOTAL-LIABILITY-AND-EQUITY> 58,416
<SALES> 11,411
<TOTAL-REVENUES> 11,411
<CGS> 3,383
<TOTAL-COSTS> 10,303
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (736)
<INCOME-PRETAX> 1,844
<INCOME-TAX> 526
<INCOME-CONTINUING> 1,318
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,318
<EPS-PRIMARY> .14
<EPS-DILUTED> .11
</TABLE>
