UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the Quarter Ended September 30, 1997. Commission File No. 0-13442
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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
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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,
1997: 65,183,220
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MENTOR GRAPHICS CORPORATION
Index to Form 10-Q
PART I FINANCIAL INFORMATION Page Number
Item 1. Financial Statements
Consolidated Statements of Operations for the three 3
months ended September 30, 1997 and 1996
Consolidated Statements of Operations for the nine 4
months ended September 30, 1997 and 1996
Consolidated Balance Sheets as of September 30, 1997 5
and December 31, 1996
Consolidated Statements of Cash Flows for the 6
nine months ended September 30, 1997 and 1996
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 8-16
PART II OTHER INFORMATION
Item 1. Legal Proceedings 17
SIGNATURES 18
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Operations
(In thousands, except net income per share)
(Unaudited)
Three Months Ended
September 30,
1997 1996
-----------------------------------
<S> <C> <C>
Revenues:
System and software $ 58,190 $ 47,849
Service and support 57,816 52,944
----------- -----------
Total revenues 116,006 100,793
----------- -----------
Cost of revenues:
System and software 13,312 8,878
Service and support 25,052 22,981
----------- -----------
Total cost of revenues 38,364 31,859
----------- -----------
Gross margin 77,642 68,934
Operating expenses:
Research and development 28,780 21,364
Marketing and selling 36,612 34,935
General and administration 11,191 9,869
Merger and acquisition related charges -- 2,830
----------- -----------
Total operating expenses 76,583 68,998
----------- -----------
Operating income (loss) 1,059 (64)
Other income, net 1,077 938
----------- -----------
Income before income taxes 2,136 874
Provision for income taxes 235 800
----------- -----------
Net income $ 1,901 $ 74
=========== ===========
Net income per common and
common equivalent share $ .03 $ --
=========== ===========
Weighted average number of common and
common equivalent shares outstanding 65,956 65,002
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
3
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Operations
(In thousands, except net income (loss) per share)
(Unaudited)
Nine Months Ended
September 30,
1997 1996
-----------------------------------
<S> <C> <C>
Revenues:
System and software $ 170,067 $ 174,876
Service and support 162,136 152,249
----------- -----------
Total revenues 332,203 327,125
----------- -----------
Cost of revenues
System and software 43,319 30,103
Service and support 80,542 68,706
----------- -----------
Total cost of revenues 123,861 98,809
----------- -----------
Gross margin 208,342 228,316
Operating expenses:
Research and development (R&D) 82,960 66,593
Marketing and selling 113,464 105,406
General and administration 31,612 29,850
Special charges 8,560 --
Merger and acquisition related charges -- 19,663
----------- -----------
Total operating expenses 236,596 221,512
----------- -----------
Operating income (loss) (28,254) 6,804
Other income, net 2,954 2,577
----------- -----------
Income (loss) before income taxes (25,300) 9,381
Provision (benefit) for income taxes (2,784) 3,010
------------ -----------
Net income (loss) $ (22,516) $ 6,371
============ ===========
Net income (loss) per common and
common equivalent share $ (.35) $ .10
=========== ===========
Weighted average number of common and
common equivalent shares outstanding 64,901 65,301
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Balance Sheets
(In thousands)
As of As of
September 30, 1997 December 31, 1996
------------------ -----------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 122,232 $ 165,406
Short-term investments 18,875 31,673
Trade accounts receivable, net 101,059 108,957
Other receivables 6,791 6,697
Prepaid expenses and other 23,592 25,459
----------- -----------
Total current assets 272,549 338,192
Property, plant and equipment, net 107,486 102,253
Cash and investments, long-term -- 30,000
Other assets 25,663 42,914
----------- -----------
Total $ 405,698 $ 513,359
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ --- $ 9,055
Accounts payable 9,872 15,003
Income taxes payable 13,536 19,598
Accrued and other liabilities 51,274 61,623
Deferred revenue 31,762 32,065
----------- -----------
Total current liabilities 106,444 137,344
Long-term debt 145 52,441
Other long-term deferrals 3,491 3,934
----------- -----------
Total liabilities 110,080 193,719
----------- -----------
Stockholders' equity:
Common stock 298,808 297,756
Retained earnings (deficit) (12,730) 9,786
Foreign currency translation adjustment 9,540 12,098
----------- -----------
Total stockholders' equity 295,618 319,640
----------- -----------
Total $ 405,698 $ 513,359
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
5
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
1997 1996
-------------------------------------
<S> <C> <C>
Operating Cash Flows:
Net income (loss) $ (22,516) $ 6,371
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization of property, plant and equipment 22,374 16,164
Deferred taxes (115) (53)
Amortization 9,232 7,701
Write-down of assets 7,468 14,553
Disposition of subsidiaries 5,395 ---
Changes in operating assets and liabilities:
Trade accounts receivable 6,121 (1,816)
Prepaid expenses and other assets 1,096 (3,983)
Accounts payable (4,927) 549
Accrued liabilities (12,060) (10,633)
Other liabilities and deferrals (6,180) 1,782
-------------- -------------
Net cash provided by operating activities 5,888 30,635
------------- -------------
Investing Cash Flows:
Net maturities (purchases) of short-term investments 12,442 (7,878)
Purchases of property, plant and equipment (26,749) (16,772)
Capitalization of software development costs --- (4,328)
Purchase of businesses (2,393) (18,606)
Purchase of technologies (600) (3,040)
-------------- --------------
Net cash used by investing activities (17,300) (50,624)
-------------- --------------
Financing Cash Flows:
Proceeds from issuance of common stock 5,935 8,339
Repurchase of common stock (5,785) (8,875)
Repayment of short-term borrowings (8,808) (1,397)
Repayment of long-term debt (52,296) (915)
Decrease in cash and investments long-term 30,000 ---
------------- -------------
Net cash used by financing activities (30,954) (2,848)
-------------- --------------
Effect of exchange rate changes on cash and cash equivalents (808) (340)
-------------- --------------
Net change in cash and cash equivalents (43,174) (23,177)
Cash and cash equivalents at beginning of period 165,406 186,676
------------- -------------
Cash and cash equivalents at end of period $ 122,232 $ 163,499
============= =============
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
6
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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 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 1996 to conform with the 1997 presentation.
(2) Special Charge - During the first three months of 1997 the Company recorded
a special charge of $8,560. The charge consisted of disposals of
subsidiaries and related employee terminations, early termination of an
interest rate swap agreement, and recognition of the impairment in value of
certain goodwill and purchased technology. It is expected that all of the
costs associated with the subsidiary disposals and employee terminations
will be disbursed by the end of 1997.
(3) Supplemental Disclosures of Cash Flow Information - The following provides
additional information concerning cash flow and non-cash investing
activities:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
-------------------------------------
<S> <C> <C>
Interest paid $ 751 $ 1,623
Income taxes paid, net of refunds $ 2,741 $ 1,309
Issuance of common stock for
purchase of business $ -- $ 1,825
</TABLE>
7
<PAGE>
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
REVENUES AND GROSS MARGINS
System and Software
System and software revenues for the third quarter of 1997 totaled $58,190,
representing an increase of $10,341 or 22% from the same period of 1996. System
and software revenues for the first nine months of 1997 totaled $170,067,
representing a decrease of $4,809 or 3% from the same period of 1996. The
increase in system and software revenues during the third quarter of 1997 is
attributable to continued growth of the Company's newer product offerings while
declines of older integrated circuit (IC) product offerings were slower compared
to the same period a year ago. These older IC products represent less than 30%
of the system and software revenue category. In addition, system and software
revenues experienced a significant shortfall in the third quarter of 1996
resulting in a favorable comparison to the current period.
System and software revenues were lower for the first nine months of 1997 due in
part to an accelerated decline of the Company's older IC products. The rate of
decline of revenues for these older IC products will continue to negatively
impact system and software revenue growth. The rate of expected increases in
revenue from newer product offerings to offset these declines is difficult to
predict. Also, see Geographic Revenue Information for discussion of the impact
of foreign currency fluctuations.
In August 1997, a US district court temporarily enjoined the Company from
selling the SimExpress accelerated verification products made by its Meta
Systems subsidiary in the US. This ruling effectively reduces the available
market for SimExpress systems sales by approximately 50%. While the level of
SimExpress systems sales are not a significant component of system and software
revenue, the ruling will negatively impact the growth of the Company's newer
product offerings in the near term. See Legal Proceedings below for further
discussion.
System and software gross margins were 77% and 75% for the third quarter and
first nine months of 1997, compared to 81% and 83% for the same periods a year
ago. The decrease in gross margins for the third quarter of 1997 versus the same
period of 1996 is due to higher royalty costs, a one-time inventory adjustment
and higher purchased technology amortization. Increased royalty costs are
attributable to a write-off of costs associated with a non-refundable royalty
contract where the committed costs are not expected to be recovered. The Company
incurred an inventory write-down of all US SimExpress systems inventory as a
result of the August 1997 US District court ruling temporarily prohibiting sales
in the US and temporarily prohibiting export of the majority of this inventory
outside the US. A final ruling on this matter should be made in 1998. See Legal
Proceedings below for further details.
8
<PAGE>
Purchased technology amortization to system and software cost of goods sold was
$1,265 and $4,568 for the third quarter and first nine months of 1997,
respectively, compared to $804 and $2,160 for the same periods of 1996,
respectively. The increase in amortization of purchased technology is
principally attributable to five business acquisitions since June 1996 accounted
for as purchases.
In addition to the items discussed above, the decrease in gross margins for the
first nine months of 1997 is due to a first quarter write-down of certain
previously capitalized software development costs which totaled $5,358 and sales
of SimExpress systems made by Meta Systems which, because of their hardware
content, yield lower gross margins. The Company recognized an impairment in
value of certain previously capitalized software development costs in the first
quarter of 1997 primarily as a result of the accelerated decline in sales of
older software product offerings discussed above. These costs were determined to
be unrecoverable and were charged to system and software cost of revenues during
the first quarter. All remaining previously capitalized software development
costs will be fully amortized by the end of 1997 to recognize the change in
estimated useful lives of these older technologies. Amortization of previously
capitalized software development costs to system and software cost of goods sold
was $1,345 and $4,428 for the third quarter and first nine months of 1997,
respectively, compared to $1,464 and $4,604 for the same periods of 1996,
respectively.
Service and Support
Service and support revenues for the third quarter and nine months ended
September 30, 1997, totaled $57,816 and $162,136 respectively, representing an
increase of $4,872 or 9% and $9,887 or 6% from the same periods of 1996. The
revenue increase in the third quarter and first nine months of 1997 is primarily
attributable to increased consulting services revenue. The overall increase for
the first nine months of 1997 was partially offset by a first quarter decline in
consulting services revenue principally due to adjusting the Company's revenue
recognition policy to recognize revenue only on completion of contract
milestones. Previously, the Company used either the percent completion method or
the contract milestone method to recognize consulting service revenues. The
impact of this restriction on future consulting services revenues is not
expected to be significant.
Service and support gross margins were 57% and 50% for the third quarter and
first nine months of 1997, compared to 57% and 55% for the same periods a year
ago. The decrease in gross margins for the comparable nine month periods is due
primarily to lower than anticipated levels of consulting services revenue in the
first quarter of 1997 without a corresponding decrease in costs, including the
revenue adjustment previously discussed. Consistent with consulting and training
business models, gross margins generated by the Company's consulting service
activities have been and are expected to continue to be lower than software
support. Service and support gross margins are expected to continue to be lower
than historical levels as growth in the consulting service business is expected
to be higher than growth in software support.
9
<PAGE>
Geographic Revenue Information
Domestic revenue compared to total revenue from unaffiliated customers including
service and support revenue for the third quarter and first nine months of 1997
was 53% and 55% compared to 52% and 52% for the comparable periods of 1996. The
increase in domestic revenue volume is attributable to growth of third party
distributors in the US and the strengthening of the US dollar against the
Japanese yen during the comparable periods. From the third quarter of 1996
compared to the same period of 1997, European and Japanese revenue increased
approximately 13% and 10%, respectively. From the first nine months of 1996
compared to the same period of 1997, European and Japanese revenue decreased
approximately 2% and 12%, respectively. A stronger US dollar in 1997 negatively
impacted international revenues, most significantly in Japan where the Yen
weakened against the US dollar from the third quarter and first nine months of
1997 compared to the same periods a year ago by approximately 9% and 12%,
respectively. 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 foreign currency
fluctuations.
OPERATING EXPENSES
Research and development expenses totaled $28,780 and $21,364 or 25% and 21% of
revenue for the third quarters of 1997 and 1996, respectively and $82,960 and
$66,593 or 25% and 20% of revenue for the first nine months of 1997 and 1996,
respectively. These increases are attributable to five prior year acquisitions
accounted for as purchases discussed above, engineering expansion at certain
recently acquired subsidiaries, prototype costs for next generation SimExpress
systems in the third quarter of 1997 and lower capitalization of software
development costs.
Capitalization of software development costs was zero in the third quarter and
first nine months of 1997 compared to $1,844 and $4,578 for the comparable
periods of 1996. This decrease in capitalization is due to timing and content of
product development activities which resulted in a lower level of costs eligible
for capitalization. Based on these lower eligible costs, product development
activities have been expensed on a current basis. The Company does not expect
any significant capitalization for the remainder of 1997.
Marketing and selling expenses totaled $36,612 and $34,935 or 32% and 35% of
revenue for the third quarters of 1997 and 1996, respectively and $113,464 and
$105,406 or 34% and 32% of revenue for the first nine months of 1997 and 1996,
respectively. These increases are attributable to five prior year acquisitions
accounted for as purchases discussed above, increased volumes of sales through
independent distributors and lower revenue for the first nine months of 1997.
The Company has experienced lower expenses in marketing and selling from the
first quarter to the second and third quarters of 1997 as a result of a focused
effort to manage discretionary spending. General and administration expenses
totaled $11,191 and $9,869 or 10% of revenue for the third quarters of 1997 and
1996, respectively and $31,612 and $29,850 or 10% and 9% of revenue for the
first nine months of 1997 and 1996, respectively.
10
<PAGE>
MERGER RELATED CHARGES
In the first quarter of 1996, the Company completed a merger with Microtec
Research, Inc. which was accounted for as a pooling of interests and included a
one time merger related charge of $4,410. In the second quarter of 1996, the
Company completed acquisitions of Meta Systems, SRL, dQdt, Inc. and Seto
Software GmbH which were accounted for as purchases and resulted in charges for
in-process R&D of $12,423. In the third quarter of 1996, the Company completed
the acquisition of Royal Digital Centers, Inc. which was accounted for as a
purchase and resulted in a charge for in-process R&D of $2,830. Also in the
third quarter of 1996, the Company completed a merger with Interconnectix, Inc.
which was accounted for as a pooling of interests and included a one time merger
related charge of $700. No such merger related charges have been incurred in the
first nine months of 1997.
SPECIAL CHARGES
During the first quarter of 1997 the Company recorded a special charge of
$8,560. The charge consisted of disposals of subsidiaries and related employee
terminations, early termination of an interest rate swap agreement, and
recognition of the impairment in value of certain goodwill and purchased
technology. It is expected that all of the costs associated with the subsidiary
disposals and employee terminations will be disbursed by the end of 1997.
OTHER INCOME (EXPENSE)
During the third quarter and the first nine months of 1997, other income was
$1,077 and $2,954, respectively, compared to other income of $938 and $2,577 for
the same periods of 1996, respectively. Interest income from investments was
$1,959 and $5,560 for the third quarter and first nine months of 1997,
respectively, compared to $2,454 and $7,161 for the same periods of 1996. During
the third quarter and first nine months of 1997, interest expense amounted to
$94 and $469, respectively, down from $609 and $1,740 for the comparable periods
in 1996. The decrease in interest income and interest expense is primarily
attributable to lower average cash, cash equivalent and short term investments
outstanding during the comparable quarters due to pay-down of short term lines
of credit and the long term revolving credit facility. Included in other income
(expense) are external legal costs associated with the Quickturn Design Systems,
Inc. litigation which total $740 and $2,230 for the third quarter and first nine
months of 1997, respectively, compared to $500 and $3,100 for the comparable
periods in 1996.
11
<PAGE>
PROVISION (BENEFIT) FOR INCOME TAXES
The benefit for income taxes amounted to $(2,784) for the nine months ended
September 30, 1997, as compared to a provision of $3,010 for the same period in
1996. 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. Due to the impact of the first quarter loss on
the projected mix of pre-tax income and losses among various tax jurisdictions,
the Company expects a tax rate of approximately 11% for the remaining quarter of
1997. The Company's tax rate remains sensitive to the shifts in income and
losses among various tax jurisdictions previously discussed.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS
The Company experienced a net gain from foreign currency transactions of $311
and $15 during the third quarter and first nine months of 1997, respectively,
compared to a net loss of $22 and $509 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, 1997, decreased to $9,540
from $12,098 at the end of 1996. This reflects the decrease in the value of net
assets denominated in foreign currencies against the US dollar since year-end
1996.
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.
12
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 128, "Earnings per Share". This
Statement establishes a different method of computing net income per share than
is currently required under the provisions of Accounting Principles Board
Opinion No. 15. Under SFAS No. 128, the Company will be required to present both
basic net income per share and diluted net income per share. Basic net income
per share is expected to be comparable or slightly higher than the currently
presented net income per share as the effect of dilutive stock options will not
be considered in computing basic net income per share. Diluted net income per
share is expected to be comparable or slightly lower than the currently
presented net income per share.
The Company plans to adopt SFAS No. 128 in the fourth quarter of 1997 and at
that time all historical net income per share data presented will be restated to
conform to the provisions of this Statement.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income", which establishes requirements for disclosure
of comprehensive income. The objective of SFAS No. 130 is to report all changes
in equity that result from transactions and economic events other than
transactions with owners. Comprehensive income is the total of net income and
all other non-owner changes in equity. The Company has not quantified the effect
of adoption of SFAS No. 130.
The Company plans to adopt SFAS No. 130 in the first quarter of 1998 and at that
time earlier financial statements will be reclassified for comparative purposes.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND INVESTMENTS
Total cash and short-term investments at September 30, 1997 were $141,107
compared to $197,079 at the end of 1996. Cash provided by operations was $5,888
for the first nine months of 1997 compared to $30,635 during the same period of
1996. During the first nine months of 1997, cash provided by operations was
negatively impacted by the net loss from operations and payments related to
special charges taken in the fourth quarter of 1996 and the first quarter of
1997. Cash also decreased as expenditures for property, plant and equipment
exceeded depreciation by $4,375. Cash used by financing activities was
negatively impacted by the pay-down of short term lines of credit and the long
term revolving credit facility totaling $61,104 offset by the release of cash
held as collateral previously classified as long term on the consolidated
balance sheets.
13
<PAGE>
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable decreased to $101,059 at September 30, 1997 from
$108,957 at year-end 1996. Average days sales outstanding in accounts receivable
improved from 81 days at the end of 1996 to 78 days at the end of the third
quarter of 1997.
OTHER ASSETS
Other assets decreased to $25,663 at September 30, 1997 from $42,914 at year-end
1996. Previously capitalized software development costs decreased by $9,786 as a
result of current quarter amortization and a write-down in recognition of
impaired value previously discussed. In addition, regular amortization of
goodwill and purchased technology further reduced the balance in 1997.
CAPITAL RESOURCES
Total capital expenditures increased to $26,749 through September 30, 1997,
compared to $16,772 for the same period of 1996. The increase in capital
expenditures is a result of costs associated with leasehold improvements related
to moving the Microtec facility closer to the Company's other development site
in the San Jose area where costs are expected to be more favorable. In addition,
the Company further invested in its global information and sales force
automation systems. 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) and integrated systems design industries. 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.
14
<PAGE>
A material amount of the Company's software product revenue is usually the
result of current quarter order performance of which the majority is usually
booked 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 revenues 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. 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 has experienced declines in revenues from its older software product
offerings. There can be no assurances that expected increases in revenue from
newer software products will be sufficient to offset these declines.
The Company is currently addressing staffing needs and operations issues of its
consulting services business in an attempt to better focus on ASIC and IC design
methodologies and improve profitability. Business reorganizations can increase
personnel management complexities including retention and hiring of key
technical and management personnel. While the Company will attempt to improve
the utilization of its consultants and pricing of its services, there can be no
assurance that the challenges will be effectively met.
The Company's operating expenses are generally committed in advance of revenue
and are based to a large 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 a 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 the 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.
15
<PAGE>
As a result of the acquisition of Meta Systems, the Company has entered the
hardware development and assembly business. Some additional issues must be
managed by the Company, such as: procuring hardware components on a timely
basis, assembling and shipping systems on a timely basis with appropriate
quality control, developing new distribution and shipment processes, managing
inventory, developing new processes to deliver customer support of the hardware
and placing new demands on the sales force.
The Company has recently added new re-usable intellectual property products and
consulting services to its portfolio of offerings to address this emerging
market. As with all markets, there is inherent uncertainty regarding the overall
rate of growth. Specifically, growth in the re-usable intellectual property
market is subject to significant uncertainties and risks as market participants,
including the Company, seek to gain customer acceptance for the overall concept
of incorporating these re-usable intellectual property designs into their
products, identify and develop the correct products to meet evolving customer
demands, and identify and implement effective distribution models for this new
class of products.
The Company has been able to recruit and retain 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.
The Company is involved in various administrative matters and litigation. There
can be no assurance that various litigation and administrative matters will not
have a material adverse impact on the Company's consolidated financial position
or results of operations. See Legal Proceedings below for further discussion.
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.
16
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings
During 1995, the Company filed suit in US Federal District Court in Portland,
Oregon, against Quickturn Design Systems, Inc. (Quickturn) for a declaratory
judgment of non-infringement, invalidity and unenforceability of three of
Quickturn's patents. These patents relate to products of Meta System SRL (Meta),
a French company acquired by the Company in 1996 that manufactures and sells
computers used for accelerated verification of hardware designs. Quickturn filed
a counterclaim against the Company alleging infringement of six of Quickturn's
patents, including the three patents subject to the declaratory judgment action.
The counterclaim seeks a permanent injunction prohibiting sales of the Company's
SimExpress products in the US, compensatory and punitive damages and attorneys'
fees. In October 1997, Quickturn also filed an action against Meta and the
Company in a German court alleging infringement by SimExpress of a German
patent. In addition, Quickturn filed an administrative complaint with the US
International Trade Commission (ITC) in 1996 seeking to prohibit the
distribution of SimExpress products in the US. In August 1996, the ITC issued a
ruling effectively prohibiting the importation of this technology into the US.
In August 1997, the ITC Administrative Law Judge recommended the imposition of
evidentiary and monetary sanctions against the Company and Meta; this order has
been appealed and no dollar amount of monetary sanctions has been set. In August
1997, the US District Court in Portland, Oregon, granted Quickturn a preliminary
injunction prohibiting the Company from selling its SimExpress version 1.0 and
1.5 accelerated verification systems in the US. The injunction also prohibits
the Company from shipping current US inventory modified in the US to any of the
Company's non-US locations. The Company is allowed to continue to support
current US customers with certain maintenance and repair services. A trial in
the US District Court action is set for the first quarter of 1998, in which
Quickturn is seeking a permanent injunction, compensatory damages, punitive
damages, and attorneys' fees. An unfavorable ruling in this trial could involve
substantial cost to the Company and effectively prevent the Company from
manufacturing and selling its existing accelerated verification of hardware
design products in the United States market.
17
<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.
Date: November 13, 1997
MENTOR GRAPHICS CORPORATION
(Registrant)
GREGORY K. HINCKLEY
-----------------------------------------
Gregory K. Hinckley
Executive Vice President and
Chief Operating Officer/
Chief Financial Officer
18
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