UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarter Ended September 30, 1996. Commission File
No. 0-13442
MENTOR GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)
Oregon 93-0786033
(State or other jurisdiction of (IRS Employer
Identification No.)
incorporation or organization)
8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777
(Address including zip code of principal executive offices)
Registrant's telephone number, including area code: (503) 685-7000
NO CHANGE
Former name, and former
fiscal year, if changed since last report
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
Number of shares of common stock, no par value, outstanding as of
October 31, 1996: 64,494,404
MENTOR GRAPHICS CORPORATION
Index to Form 10Q
PART I FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Consolidated Statements of Operations for the three 3
months ended September 30, 1996 and 1995
Consolidated Statements of Operations for the nine 4
months ended September 30, 1996 and 1995
Consolidated Balance Sheets as of September 30, 1996 5
and December 31, 1995
Consolidated Statements of Cash Flows for the 6
nine months ended September 30, 1996 and 1995
Notes to Consolidated Financial Statements 7-10
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 11-20
PART II OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Mentor Graphics Corporation
Consolidated Statements of Operations
(In thousands, except net income per share)
(Unaudited)
Three Months Ended
September 30,
1996 1995
Revenues:
System and software $ 47,849 $ 55,918
Service and support 52,944 51,504
Total revenues 100,793 107,422
Cost of revenues:
System and software 8,878 8,938
Service and support 22,981 20,867
Total cost of revenues 31,859 29,805
Gross margin 68,934 77,617
Operating expenses:
Research and development 21,364 21,926
Marketing and selling 34,935 33,116
General and administration 9,869 9,093
Merger and acquisition related charges 2,830 --
Total operating expenses 68,998 64,135
Operating income (loss) (64) 13,482
Other income, net 938 991
Income before income taxes 874 14,473
Provision for income taxes 800 2,094
Net income $ 74 $ 12,379
Net income per common and
common equivalent share $ -- $ .19
Weighted average number of common and
common equivalent shares outstanding 65,002 65,596
See accompanying notes to unaudited consolidated financial statements.
Mentor Graphics Corporation
Consolidated Statements of Operations
(In thousands, except net income per share)
(Unaudited)
Nine Months Ended
September 30,
1996 1995
Revenues:
System and software $ 174,876 $ 165,270
Service and support 152,249 147,154
Total revenues 327,125 312,424
Cost of revenues
System and software 30,103 27,159
Service and support 68,706 60,178
Total cost of revenues 98,809 87,337
Gross margin 228,316 225,087
Operating expenses:
Research and development (R&D) 66,593 63,983
Marketing and selling 105,406 100,983
General and administration 29,850 28,033
Restructure costs -- (2,040)
Merger and acquisition related
charges 19,663 800
Total operating expenses 221,512 191,759
Operating income 6,804 33,328
Other income, net 2,577 4,605
Income before income taxes 9,381 37,933
Provision for income taxes 3,010 5,956
Net income $ 6,371 $ 31,977
Net income per common and
common equivalent share $ .10 $ .49
Weighted average number of common and
common equivalent shares outstanding 65,301 64,844
See accompanying notes to unaudited consolidated financial statements.
Mentor Graphics Corporation
Consolidated Balance Sheets
(In thousands)
(Unaudited)
As of As of
September 30, 1996 December 31, 1995
ASSETS
Current assets:
Cash and cash equivalents $ 163,499 $ 186,676
Short-term investments 34,456 25,320
Trade accounts receivable, net 98,677 96,962
Other receivables 6,526 3,464
Prepaid expenses and other 19,053 15,161
Total current assets 322,211 327,583
Property, plant and equipment, net 100,828 99,605
Cash and investments, long-term 30,000 30,000
Other assets 45,923 38,184
Total $ 498,962 $ 495,372
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ 7,926 $ 9,358
Accounts payable 12,548 9,589
Income taxes payable 14,322 14,542
Accrued and other liabilities 45,710 53,020
Deferred revenue 31,693 27,583
Total current liabilities 112,199 114,092
Long-term debt 52,027 52,942
Other long-term deferrals 1,385 2,112
Total liabilities 165,611 169,146
Stockholders' equity:
Common stock 296,206 294,917
Retained earnings 24,986 17,715
Foreign currency translation
adjustment 12,159 13,594
Total stockholders' equity 333,351 326,226
Total $ 498,962 $ 495,372
See accompanying notes to unaudited consolidated financial statements.
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
1996 1995
Operating Cash Flows:
Net income $ 6,371 $ 31,977
Adjustments to reconcile net income to
net cash provided (used) by operating
activities:
Depreciation and amortization of
property, plant & equipment 16,164 18,723
Deferred taxes (53) (2,172)
Amortization of other assets 7,701 7,490
Charge for in-process R&D 14,553 400
Restructure costs -- (2,040)
Changes in operating assets
and liabilities:
Trade accounts receivable, net (1,816) 6,948
Prepaid expenses and other assets (3,983) 967
Accounts payable 549 (4,127)
Accrued liabilities (10,633) (2,519)
Other liabilities and deferrals 1,782 2,819
Net cash provided by operating
activities 30,635 58,466
Investing Cash Flows:
Purchases of short-term
investments, net (7,878) (20,766)
Purchases of property and equipment (16,772) (15,694)
Capitalization of software
development costs (4,328) (5,595)
Purchase of businesses (21,646) (4,151)
Net cash used by investing activities (50,624) (46,206)
Financing Cash Flows:
Proceeds from issuance of common stock 8,339 15,384
Repurchase of common stock (8,875) (2,250)
Increase (decrease) in short-term
borrowings (1,397) 406
Repayment of long-term debt (915) (1,148)
Net cash provided (used) by
financing activities (2,848) 12,392
Effect of exchange rate changes on
cash and cash equivalents (340) 159
Net change in cash and cash equivalents (23,177) 24,811
Cash and cash equivalents at beginning
of period 186,676 143,662
Cash and cash equivalents at end
of period $ 163,499 $ 168,473
See accompanying notes to unaudited consolidated financial statements
MENTOR GRAPHICS CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)
(1) General - The accompanying financial statements have been prepared
in conformity with generally accepted accounting principles.
However, certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the United States
Securities and Exchange Commission. In the opinion of management,
the statements include all adjustments necessary for a fair
presentation of the results of the interim periods presented.
Certain reclassifications have been made in the accompanying
financial statements for 1995 to conform with the 1996
presentation.
(2) Business Acquisitions - On January 31, 1996, the Company issued
6,223 shares of its common stock for all outstanding common stock
of Microtec Research, Inc. (Microtec). In addition, the Company
reserved 688 shares of its common stock for previously outstanding
options to purchase Microtec common stock. These options vest and
become exercisable under the terms of the respective, original
Microtec stock option agreements. The Company accounted for this
transaction as a pooling of interests and accordingly, the
Company's consolidated financial statements have been restated to
include the results of Microtec for all periods presented.
Microtec is primarily engaged in developing and marketing embedded
operating systems and products to optimize the development and
operation of embedded systems across hardware/software boundaries.
Microtec's integrated software product solutions enable embedded
systems developers to increase productivity, thereby decreasing
costs of product development and reducing time-to-market for new
products.
On April 1, 1996, the Company completed the acquisition of dQdt,
Inc. (dQdt). dQdt is primarily engaged in developing and
marketing digital signal processing intellectual property
products. The total purchase price including merger related costs
and the re-issuance of 138 shares of Company treasury stock (with
a market value of $1,825) was $2,303. The cost of the acquisition
was allocated on the basis of estimated fair value of the assets
and liabilities assumed. This allocation resulted in a charge for
in-process R&D of $1,323 and technology capitalization of $980.
The charge for in-process R&D was a result of allocating a portion
of the acquisition cost to dQdt's in-process product development
that had not reached technological feasibility.
On June 3, 1996, the Company completed the acquisition of Seto
Software GmbH (Seto). Seto is primarily engaged in developing and
marketing personal computer-based layout tools used in the printed
circuit board design process. The total purchase price including
merger related costs was $3,495. The cost of the acquisition was
allocated on the basis of estimated fair value of the assets and
liabilities assumed. This allocation resulted in a charge for in-
process R&D of $1,747, goodwill capitalization of $225 and
technology capitalization of $1,523. The charge for in-process
R&D was a result of allocating a portion of the acquisition cost
to Seto's in-process product development that had not reached
technological feasibility.
On May 31, 1996, the Company completed the acquisition of Meta
Systems, Inc. (Meta). Meta is primarily engaged in developing and
marketing logic emulation products. The total purchase price
including merger related costs was $13,741. The cost of the
acquisition was allocated on the basis of estimated fair value of
the assets and liabilities assumed. This allocation resulted in a
charge for in-process R&D of $9,353, goodwill capitalization of
$3,297 and technology capitalization of $1,091. The charge for
in-process R&D was a result of allocating a portion of the
acquisition cost to Meta's in-process product development that had
not reached technological feasibility.
On August 30, 1996, the Company issued 2,133 shares of its common
stock for all outstanding common stock of Interconnectix, Inc.
(Interconnectix). In addition, the Company reserved 112 shares
of its common stock for previously outstanding options to purchase
Interconnectix common stock. These options vest and become
exercisable under the terms of the respective, original
Interconnectix stock option agreements. The Company accounted for
this transaction as a pooling of interests and accordingly, the
Company's consolidated financial statements have been restated to
include the results of Interconnectix for all periods presented.
Interconnectix is primarily engaged in developing and marketing
interconnect synthesis software for the design of high-speed,
high-performance digital systems.
On September 17, 1996, the Company completed the acquisition of
Royal Digital Centers, Inc. (Royal Digital). Royal Digital is
primarily engaged in developing and marketing technology that
integrates printed circuit board computer-aided design tools with
computer-aided manufacturing systems. The total purchase price
including merger related costs was $4,680. The cost of the
acquisition was allocated on the basis of estimated fair value of
the assets and liabilities assumed. This allocation resulted in a
charge for in-process R&D of $2,130 and technology capitalization
of $2,550. The charge for in-process R&D was a result of
allocating a portion of the acquisition cost to Royal Digital's
in-process product development that had not reached technological
feasibility.
The capitalized technology costs for dQdt, Seto, Meta and Royal
Digital will be amortized over a three year period to system and
software cost of revenues. The goodwill costs for Seto and Meta
will be amortized over a three year period to R&D expense.
Financial results for dQdt, Seto, Meta and Royal Digital
subsequent to the acquisition date have been included in the
consolidated statements of operations and cash flows. The
separate operational results of dQdt, Seto, Meta and Royal Digital
were not material compared to the Company's overall results of
operations, and accordingly pro-forma financial statements which
include these entities have been omitted.
(3) Capitalization of Software Development Costs - During the first
nine months of 1996 and 1995, respectively $4,328 and $5,595 of
new product development costs were capitalized and included in
other assets on the consolidated balance sheets. Amortization of
previously capitalized software development costs amounted to
$4,604 and $4,161 for the nine months ended September 30, 1996 and
1995, respectively, and is included in system and software cost of
revenues on the consolidated statements of operations.
(4) Supplemental Disclosures of Cash Flow Information - The following
provides additional information concerning cash flow and non-cash
investing activities:
Nine Months Ended
September 30,
1996 1995
Interest paid $ 1,623 $ 1,712
Income taxes paid, net of refunds $ 1,309 $ 6,109
Issuance of common stock for
purchase of business $ 1,825 $ --
(5) Commitments and contingencies - The Company is involved in
various administrative matters and litigation. Management
believes that the ultimate outcome resulting from known matters
will not have a material adverse impact on the Company's
consolidated financial position or results of operations.
During 1995, the Company filed suit in United States (U.S.)
Federal District Court against Quickturn Design Systems, Inc.
(competitor) for declarative judgment on non-infringement,
invalidity and unenforceability of three of the competitor's
patents in anticipation of acquiring Meta. In January 1996, the
competitor filed an administrative complaint with the International Trade
Commission (ITC),a federal administrative agency, seeking to hinder
the distribution of the Meta technology in the United States.
Early in the third quarter of 1996, the ITC issued a temporary ruling
allowing the importation of this technology to the U.S., but requiring
posting of a bond for each sale. The required amount of the bond
for each sale and the likelihood of the Company losing the posted amounts is
uncertain at this time. There has been no final decision on the
Company's declaratory judgment claims and the Company has applied
for U.S. patent protection of certain aspects of this technology.
While the outcome of this matter is uncertain at this time,
management believes it will prevail. (Dean to help update)
(6) Net Income per Common and Common Equivalent Share - Net income per
common and common equivalent share was calculated on the basis of
the weighted average number of common shares outstanding plus
dilutive common stock equivalents related to stock options
outstanding.
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition
(All numerical references are in thousands, except for percentages)
RESULTS OF OPERATIONS
BUSINESS ACQUISITIONS
In January 1996, the Company completed the acquisition of Microtec
Research, Inc. (Microtec), pursuant to a merger accounted for as a
pooling of interests. Accordingly, the results of Microtec are included
in the Company's consolidated financial statements for all periods
presented. A total of 6,223 shares of the Company's common stock were
issued in the transaction. Merger expenses of $4,410 were incurred
associated with the elimination of duplicate facilities, severance costs
related to the termination of certain employees, the write-off of
certain property and equipment and legal and accounting fees associated
with administration of the merger activities.
In August 1996, the Company completed the acquisition of Interconnectix,
Inc. (Interconnectix), pursuant to a merger accounted for as a pooling
of interests. Accordingly, the results of Interconnectix are included
in the Company's consolidated financial statements for all periods
presented. A total of 2,133 shares of the Company's common stock were
issued in the transaction. Merger expenses of $700 were incurred
associated primarily with severance costs and legal and accounting fees
associated with administration of the merger activities.
The Company acquired dQdt Inc. (dQdt), Meta Systems, Inc. (Meta), Seto
Software GmbH (Seto), and Royal Digital Centers, Inc. (Royal Digital) in
April 1996, May 1996, June 1996 and September 1996, respectively. These
acquisitions were accounted for as purchases and accordingly, their
results of operations are included in the Company's results of
operations from the date of acquisition. The cost of each acquisition
was allocated on the basis of estimated fair value of the assets and
liabilities assumed. These allocations resulted in a charge for in-
process research and development of $14,553, goodwill capitalization of
$3,522 and technology capitalization of $6,144.
REVENUES AND GROSS MARGINS
System and Software
System and software revenues for the quarter ended September 30, 1996
totaled $47,849, representing a decrease of $8,069 or 14% from the third
quarter of 1995. Revenues declined in all regions due partially to
slowdowns in spending by telecommunications and semiconductor customers.
In addition, the decline in sales of more mature products in the third
quarter of 1996 was higher than expected and sales of the Company's newer
products did not fully offset this decline.
The rate of increase in sales of new products has been adversely affected in
part by turnover Microtec sales personnel and the ability of the
distribution channel to assimilate the volume of new
products. Japanese sales were negatively affected by a strengthening
of the U.S. dollar as compared to the yen. See geographic
revenue information below for further details of the effects of
foreign currencies on revenue.
System and software revenues during the first nine months of 1996
improved by $9,606 or 6% compared to the same period last year. Software
product revenue accounted for approximately 80% of the increase while
the decline in workstation hardware product revenue was more than offset
by emulation hardware revenue resulting from the acquisition of Meta.
System and software revenues were higher in the first nine months of
1996 due primarily to the Company's newer product offerings. In the
last year, the Company has added new hardware/software co-verification,
library and data management products and products that operate
on the Windows 95 and Windows NT operating systems. The Company
has also added many new products through business combinations during
the past two years. In addition, the Company's more mature product
offerings grew in the first half of 1996 while the volume increases of newer
product offerings were higher.
System and software gross margins for the third quarter of 1996
decreased to 81% compared to 84% for the same period of 1995. For the
first nine months of 1996, system and software gross margins were 83%
compared to 84% for the same period in 1995. The quarter to quarter
decline in system and software gross margins is primarily attributable
to lower revenue volumes in the third quarter of 1996 versus the same
period a year ago, higher costs for third party royalties and
higher costs for amortization of previously capitalized software
development and capitalized purchased technology. System and software
gross margin levels are dependent on such factors as third party
software content for which royalties are paid, lower margin hardware
revenue levels, and amortization of previously capitalized software
development costs and purchased technology costs. Amortization of
previously capitalized software development costs to system and
software cost of revenues was $1,464 and $4,604 for the third quarter
and first nine months of 1996, respectively, compared to $1,385 and
$4,161 for the same periods a year ago. Purchased technology amortization
to system and software cost of goods sold was $804 and $2,160 for the
third quarter and first nine months of 1996, respectively, compared to
$555 and $1,803 for the same periods a year ago. Due to the acquisition
of Royal Digital previously discussed, amortization of purchased technology
is expected to increase by approximately $500 per quarter.
Sales of emulation systems, which are the result of the Company's
acquisition of Meta, are expected to have a negative impact on system
and software product gross margins over time. Meta products include
hardware which does not yield gross margins as high as software product
sales. The impact of emulation systems sales on system and software
cost of revenues and gross margins was offset by the decline in
workstation hardware revenues during the first nine months of 1996
compared to the same period last year.
Service and Support
Service and support revenues for the third quarter of 1996 were $52,944,
representing an increase of 3% from the comparable quarter of 1995. For
the first nine months of 1996, service and support revenues totaled
$152,249, representing an increase of 3% from the same period of 1995.
Growth in software support revenue is attributable to growth in the
Company's installed customer base, and continued success of the
Company's software support programs. Professional and other service
revenues for the third quarter of 1996 were approximately $12,500, a
decrease of 4% from the comparable quarter of 1995. For the first nine
months of 1996, professional and other service revenues were
approximately $37,300 compared to $38,800 for the same period in 1995.
The year to year decline in professional and other service revenue is
attributable to a process of realigning the core consulting business to
better support the Company's integrated systems design strategy. This
required an internal focus of resources which caused lower billable
hours for revenue generating services. In the third quarter of 1996,
the core consulting practice revenue levels improved. Offsetting this
improvement was lower custom design professional service revenue which
is attributable in part to the same market conditions discussed above
under system and software revenues.
Service and support gross margins were 57% and 59% for the quarters
ended September 30, 1996 and 1995, and 55% and 59% for the first nine
months of 1996 and 1995, respectively. Service and support gross
margins were favorably impacted by higher software support revenue
volume and unfavorably impacted by professional service margins.
Professional service gross margins were approximately break-even for the
third quarter of 1996 and year to date as the revenue levels were not in
line with the cost structure of the business. The Company's primary
focus will be on improvement of the revenue level through more efficient
utilization of consultants to improve gross margins in the coming
quarters.
Geographic Revenue Information
Domestic revenue from unaffiliated customers including service and
support revenue decreased by 4% as compared to the third quarter of
1995. International revenues from unaffiliated customers including
service and support revenue represented 46% and 48% of total revenue for
the third quarters of 1996 and 1995, respectively. European and
Japanese revenues decreased approximately 10% and 8%, respectively in
the third quarter of 1996 compared to the same period in 1995. European
revenues decreased approximately 2% and Japanese revenues increased
approximately 3% for the first nine months of 1996 compared to the same
period a year ago. For the third quarter of 1996 compared to the same
period a year ago, a stable U.S. dollar did not materially impact
European revenues, but a stronger U.S. dollar negatively impacted
Japanese revenues by approximately 11%. For the first nine months of
1996 compared to the same period of 1995, a stronger U.S. dollar
negatively impacted revenues by approximately 2% and 16% in Europe and
Japan, respectively. Exclusive of such currency trends, year to date
1996 Japanese revenue was favorably impacted by improving economic
conditions and more product offerings as previously discussed. Since
the Company generates approximately half of its revenues outside of the
United States and expects this to continue in the future, revenue
results should continue to be impacted by the effects of future foreign
currency fluctuations.
OPERATING EXPENSES
The following summarizes R&D expenses:
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
Gross R&D $ 23,208 $ 24,080 $ 70,921 $ 69,578
Capitalized R&D (1,844) (2,154) (4,328) (5,595)
Net R&D $ 21,364 $ 21,926 $ 66,593 $ 63,983
Gross R&D expense was 23% and 22% of revenue for the third quarter of
1996 and 1995, respectively and 22% of revenue for the nine months of
1996 and 1995. The increase in R&D as a percent of revenue is primarily
the result of lower revenue levels during the comparable periods.
Higher gross R&D expenses for the first nine months of 1996 are
attributable to relocation of some of the Company's engineering team and
accelerating depreciation of file-server equipment used by the Company's
engineers. During the first quarter of 1996, the Company accelerated
depreciation on the remaining book value of its Wilsonville file-server
environment which resulted in a charge to R&D of approximately $500.
The Company also consolidated certain engineering activities from New
Jersey to Wilsonville to improve productivity of certain development
activities and reduce future operating costs of such activities.
Capitalization of software development costs was lower in the first nine
months of 1996 compared to the same period of the prior year due to
timing and content of product development activities. In the first
quarter of 1996, the Company's product development efforts were focused
on improvement of existing functionality versus new product
enhancements. Significant product enhancement projects began to reach
capitalization milestones in the second and third quarters of 1996,
resulting in higher capitalized software development costs.
Marketing and selling expense totaled $34,935 and $33,116 or 35% and 31%
of revenue for the third quarter of 1996 and 1995, respectively.
Marketing and selling expense totaled $105,406 and $100,983 or 32% of
revenue for the nine months of 1996 and 1995. The quarter to quarter
increase in marketing and selling as a percent of revenue is the result
of lower revenue levels during the comparable periods, cost increases as
a result of the purchases of dQdt, Meta and Seto and an increased number
of new product offerings during the quarter. A stronger U.S. dollar
during the third quarter of 1996 compared to the same period a year ago
reduced expenses by approximately 4% and 20% in Europe and Japan,
respectively. For the first nine months of 1996 compared to the same
period of 1995, a stronger U.S. dollar reduced expenses by approximately
3% and 17% in Europe and Japan, respectively.
General and administrative expense totaled $9,869 and $9,093 or 10% and
9% of revenue for the third quarter of 1996 and 1995, respectively.
General and administrative expense totaled $29,850 and $28,033 or 9% of
revenue for the nine months of 1996 and 1995. The increase in general
and administrative costs as compared to revenue quarter to quarter is a
result of a decline in revenues during the comparable periods. On an
absolute dollar basis, the increase in general and administrative costs
is attributable to business purchases previously discussed.
MERGER RELATED CHARGES
During the third quarter of 1996, the Company incurred merger related
charges of $2,830 as a result of the write-off of in-process R&D
associated with the purchase of Royal Digital of $2,130 and merger
related charges relating to the acquisition of Interconnectix of $700.
The charge for in-process R&D is a result of allocating a portion of the
acquisition cost to Royal Digital's in-process product development that
had not reached technological feasibility. During the second quarter of
1996, the Company incurred merger related charges of $12,423 as a result
of the write-off of in-process R&D associated with the purchases of
dQdt, Seto and Meta. During the first quarter of 1996, the Company
incurred merger related charges of $4,410 as a result of the merger with
Microtec. The second quarter 1995 merger related costs of $800 are the
result of the acquisitions of Axiom Datorer Skandinavien AB and Exemplar
Logic, Inc.
OTHER INCOME (EXPENSE)
During the third quarter and the first nine months of 1996, other income
was $938 and $2,577, compared to other income of $991 and $4,605 for the
same periods of 1995, respectively. Included in other income are
external legal counsel costs associated with the Quickturn Design
Systems, Inc. litigation (See Note 5 of Notes to Consolidated Financial
Statements), totaling approximately $500 and $3,100 for the third
quarter and first nine months of 1996 compared to zero for the
comparable periods of the prior year.
Interest income from investments was $2,454 and $7,161 for the third
quarter and first nine months of 1996, respectively, compared to $2,019
and $6,112 for the same periods of 1995. The increase in interest
income is primarily attributable to higher average interest rates paid
on cash, cash equivalents and short term investments outstanding during
the comparable quarters. During the third quarter and first nine months
of 1996, interest expense amounted to $609 and $1,740, respectively,
down from $683 and $1,828 for the comparable periods in 1995. The
decrease in interest expense is due to lower average debt outstanding
offset by higher average interest rates for the comparable periods.
PROVISION FOR INCOME TAXES
The provision for income taxes amounted to $800 for the quarter ended
September 30, 1996, as compared to $2,094 for the same period in 1995.
For the first nine months of 1996, the provision for income taxes was
$3,010 compared to $5,956 for the same period a year ago. The
acquisitions of dQdt, Meta, Seto and Royal Digital resulted in one-time
non-tax deductible charges of $14,553 which increased the Company's
anticipated effective tax rate for the year. The third quarter 1996 tax
accrual also includes a catch-up adjustment to align the year to date
effective rate with the current estimated year-end effective rate. The
Company can incur pre-tax losses in tax-free jurisdictions while
experiencing pre-tax gains in taxable jurisdictions which should
negatively impact the overall effective tax rate. The Company's income
tax position for each year combines the effects of available tax
benefits in certain countries where the Company does business, benefits
from available net operating loss carry forwards, and tax expense for
subsidiaries with pre-tax income. As such, the Company's income tax
position and resultant effective tax rate is uncertain for the remainder
of 1996.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS
The Company experienced a net loss from foreign currency transactions of
$22 and $509 during the third quarter and first nine months of 1996,
respectively, compared to a net loss of $335 and $181 during the same
periods a year ago. These amounts are comprised of realized gains and
losses on cash transactions involving various foreign currencies, and
unrealized gains and losses related to foreign currency receivables and
payables resulting from exchange rate fluctuations between the various
currencies in which the Company operates. Foreign currency gains and
losses are included as a component of other income. The "foreign
currency translation adjustment", as reported in the equity section of
the consolidated balance sheet at September 30, 1996, decreased to
$12,159 from $13,594 at the end of 1995. This reflects the decrease in
the value of net assets denominated in foreign currencies against the
U.S. dollar since year-end 1995.
During the balance sheet period from December 31, 1995 to September 30,
1996, the U.S. dollar strengthened approximately 4% against the European
currencies and 8% against the Japanese yen. For the nine months of 1996
compared to the same period of 1995, a stronger U.S. dollar negatively
impacted revenues by approximately 2% and 16% in Europe and Japan,
respectively. In addition, for the nine months of 1996 compared to the
same period of 1995, a stronger U.S. dollar reduced expenses by
approximately 3% and 17% in Europe and Japan, respectively. Generally,
a strengthening of the U.S. dollar makes the Company's products more
expensive in foreign markets, which has a negative impact on the
Company's revenues over time. In addition, a strengthening U.S. dollar
results in lower reported revenues and operating expenses due to
translation of local currency activity to U.S. dollars for consolidated
financial reporting.
The Company generally realizes approximately half of its revenue outside
the United States and expects this to continue in the future. As such,
the Company's business and operating results may be impacted by the
effects of future foreign currency fluctuations.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND INVESTMENTS
Total cash and short-term investments at September 30, 1996 were
$197,955 compared to $211,996 at the end of 1995. Cash provided by
operations was $30,635 for the first nine months of 1996 compared to
$58,466 during the same period of 1995. Cash provided by operations was
negatively impacted by net income of $6,371 for the first nine months of
1996 compared to $31,977 for the same period of 1995. In addition,
trade receivables increased by $1,816 and accrued and other liabilities
decreased by $10,633 offset by increased accounts payable of $549. Cash
and short-term investments at September 30, 1996 were negatively
impacted by new business investments of $21,646, decreased short-term
borrowings of $1,397, investment in property, plant and equipment of
$16,772, repurchase of common stock of $8,875, offset by proceeds from
the issuance of common stock of $8,339.
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable increased to $98,677 at September 30, 1996
from $96,962 at year-end 1995. This increase was attributable to an
increase in late quarter shipments in the third quarter of 1996 compared
to the fourth quarter of 1995. As a result, a lower percent of
shipments made during the third quarter of 1996 were converted into cash
collections before the period ended.
OTHER ASSETS
Other assets increased to $45,923 at September 30, 1996 from $38,184 at
year-end 1995. This increase was partially attributable to purchased
technology of $6,144 and goodwill capitalization of $3,522 relating to
the purchases of dQdt, Seto, Meta and Royal Digital offset by other
purchased technology and goodwill amortization of $7,701. Net
capitalized software development costs decreased by $276 as
capitalization and amortization were $4,328 and $4,604, respectively,
during the first nine months of 1996.
CAPITAL RESOURCES
Total capital expenditures increased to $16,772 through September 30,
1996, compared to $15,694 for the same period of 1995. The increase in
capital expenditures is primarily a result of costs associated with a
new global information system. These expenditures will continue as the
year progresses. The Company anticipates that current cash balances,
anticipated cash flows from operating activities, and existing credit
facilities will be sufficient to meet its working capital needs for at
least the next twelve months.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
The statements contained in this report that are not statements of
historical fact are forward looking statements that involve a number of
risks and uncertainties. Moreover, from time to time the Company may
issue other forward looking statements. The following discussion
highlights factors that could cause actual results to differ materially
from the forward looking statements. The forward looking statements
should be considered in light of these factors.
The Company competes in the highly competitive and dynamic EDA
(electronic design automation) industry. The Company's success is
dependent upon its ability to develop and market products that are
innovative, cost-competitive and that meet customers' expectations, and
to deliver those products to its customers in a timely manner.
Competition in the EDA industry is intense, which can create adverse
effects including, but not limited to, price reductions, lower product
margins, loss of market share and additional working capital
requirements.
A material amount of the Company's software product revenue is usually
the result of current quarter order performance and the Company books
the majority of its orders in the last month of each quarter. In
addition, the Company's revenue often includes multi-million dollar
contracts. The timing of the completion of these contracts and the
terms of delivery of software, hardware and other services can have a
material impact on revenue recognition for a given quarter. The
combination of these factors impairs and delays the Company's ability to
identify shortfalls or overages from quarterly revenue targets.
The Company generally realizes approximately half of its revenue outside
the United States and expects this to continue in the future. As such,
the Company's business and operating results can be impacted by the
effects of foreign currency fluctuations. In order to hedge the impact
of foreign currency fluctuations, the Company enters into foreign
currency forward contracts. However, significant changes in exchange
rates may have a material adverse impact on the Company's results of
operations. International operations subject the Company to other risks
including, but not limited to, changes in regional or worldwide economic
or political conditions, government trade restrictions, limitations on
repatriation of earnings, licensing and intellectual property rights
protection.
The Company is currently reorganizing its professional services business
to better support its integrated systems design strategy. This required
an internal focus of resources which caused lower billable hours for
revenue generating services in the first nine months of 1996. In
addition, business reorganizations can increase personnel management
complexities including retention and hiring of key technical and
management positions. While the Company will look to improve the
utilization of its consultants, there can be no assurance that the
challenges of the reorganization will be effectively met.
The Company's operating expenses are generally committed in advance of
revenue and are based to some degree on future revenue expectations.
Operating expenses are incurred in order to generate and sustain higher
future revenue levels. If the revenue does not materialize as expected,
the Company's results of operations can be adversely impacted.
Acquisitions of complementary businesses are an integral part of the
Company's overall business strategy. There are several risks associated
with this strategy including integration of sales channels, training and
education of sales force for new product offerings, integration of
product development efforts, retention of key employees, integration of
systems of internal controls, and integration of information systems.
All of these factors can impair the Company's ability to forecast, to
meet quarterly revenue and earnings targets, and to effectively manage
the business for long-term growth. While the Company is aware of and is
addressing such issues, there can be no assurance that these challenges
will be effectively met.
As a result of the acquisition of Meta, the Company has entered the
hardware development and assembly business which results in several new
issues that the Company must effectively manage. Some of the issues
include its ability to procure hardware components on a timely basis,
ability to assemble and ship systems on a timely basis with appropriate
quality control, new distribution and shipment processes, inventory
management issues and new demands on the sales force.
The Company is currently involved in the replacement of its financial
information systems, based primarily on software from SAP. The
implementation phase of new information systems can cause significant
disruptions to the Company's work efficiency. There can be no assurance
that the project will be completed within budgeted time or dollar
parameters.
The Company has been successful at recruiting and retaining necessary
personnel to research and develop products that satisfy customers needs.
There can be no assurance that the Company can continue to recruit and
retain such personnel.
Generally accepted accounting principles require management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities and contingencies at the date of the financial statements
and the reported amounts of revenue and expenses during the reporting
periods. Actual results could differ from those estimates.
Due to the factors above, as well as other market factors outside the
Company's control, the Company's future earnings and stock price may be
subject to significant volatility. Past financial performance should
not be considered a reliable indication of future performance. The
investment community should use caution in using historical trends to
estimate future results or trends. In addition, if future results vary
significantly from expectations of analysts, the Company's stock price
could be adversely impacted.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in various administrative matters and
litigation. Management believes that the ultimate outcome resulting
from known matters will not have a material adverse impact on the
Company's consolidated financial position or results of operations.
During 1995, the Company filed suit in United States (U.S.) Federal
District Court against Quickturn Design Systems, Inc. (competitor)
seeking a declarative judgment on non-infringement, invalidity and
unenforceability of three of the competitor's patents in anticipation of
acquiring Meta. In January 1996, the competitor filed an
administrative complaint with the International Trade Commission (ITC),
a federal administrative agency, seeking to hinder the
distribution of the Meta technology in the United States. Early in the
third quarter of 1996, the ITC issued a temporary ruling allowing the
importation of this technology to the U.S., but requiring posting of a
bond for each sale. The required amount of the bond for each sale and
the likelihood of the Company losing the posted amounts is uncertain at
this time. There has been no final decision on the Company's
declaratory judgment claims and the Company has applied for U.S. patent
protection of certain aspects of this technology. While the outcome of
this matter is uncertain at this time, management believes it will
prevail.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits: None.
(b) No reports on Form 8-K were filed by the registrant
during the quarter ended September 30, 1996.
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, on November 13, 1996.
MENTOR GRAPHICS CORPORATION
(Registrant)
R. Douglas Norby
R. Douglas Norby
Senior Vice President, and
Chief Financial Officer
Richard Trebing
Richard Trebing
Corporate Controller, and
Chief Accounting Officer
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