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 June 30, 1998. 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 July 31, 1998:
65,396,338
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MENTOR GRAPHICS CORPORATION
Index to Form 10-Q
PART I FINANCIAL INFORMATION Page Number
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Item 1. Financial Statements
Consolidated Statements of Operations for the three 3
months ended June 30, 1998 and 1997
Consolidated Statements of Operations for the six 4
months ended June 30, 1998 and 1997
Consolidated Balance Sheets as of June 30, 1998 5
and December 31, 1997
Consolidated Statements of Cash Flows for the 6
six months ended June 30, 1998 and 1997
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 8-13
PART II OTHER INFORMATION
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Item 1. Legal Proceedings 14-15
Item 4. Submission of Matters to a Vote of Security Holders 15
SIGNATURES 16
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2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
THREE MONTHS ENDED JUNE 30, 1998 1997
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<S> <C> <C>
IN THOUSANDS, EXCEPT PER SHARE DATA
REVENUES:
System and software........................................ $ 63,854 $ 56,437
Service and support........................................ 55,263 58,201
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Total revenues....................................... 119,117 114,638
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COST OF REVENUES:
System and software........................................ 8,134 10,854
Service and support........................................ 24,925 26,816
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Total cost of revenues............................... 33,059 37,670
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Gross margin......................................... 86,058 76,968
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OPERATING EXPENSES:
Research and development................................... 29,323 26,903
Marketing and selling...................................... 40,301 37,102
General and administration................................. 10,781 10,132
Special charges............................................ 4,532 -
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Total operating expenses............................. 84,937 74,137
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OPERATING INCOME.............................................. 1,121 2,831
Other income (expense), net................................ (90) 1,362
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Income before income taxes........................... 1,031 4,193
Income taxes............................................... 227 461
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Net income........................................... $ 804 $ 3,732
============ ============
Net income per share:
Basic................................................ $ 0.01 $ 0.06
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Diluted.............................................. $ 0.01 $ 0.06
============ ============
Weighted average number of shares outstanding:
Basic................................................ 65,009 64,825
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Diluted.............................................. 65,817 64,825
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SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
3
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
SIX MONTHS ENDED JUNE 30, 1998 1997
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<S> <C> <C>
IN THOUSANDS, EXCEPT PER SHARE DATA
REVENUES:
System and software....................................... $ 122,060 $ 111,877
Service and support....................................... 105,065 104,320
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Total revenues...................................... 227,125 216,197
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COST OF REVENUES:
System and software....................................... 14,390 30,007
Service and support....................................... 49,472 55,490
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Total cost of revenues.............................. 63,862 85,497
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Gross margin........................................ 163,263 130,700
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OPERATING EXPENSES:
Research and development.................................. 57,728 54,180
Marketing and selling..................................... 79,255 76,852
General and administration................................ 21,286 20,421
Special charges........................................... 10,307 8,560
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Total operating expenses............................ 168,576 160,013
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OPERATING LOSS............................................... (5,313) (29,313)
Other income (expense), net............................... (3,213) 1,877
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Loss before income taxes............................ (8,526) (27,436)
Income tax benefit........................................ (1,876) (3,019)
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Net loss............................................ $ (6,650) $ (24,417)
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Net loss per share:
Basic............................................... $ (0.10) $ (0.38)
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Diluted............................................. $ (0.10) $ (0.38)
============ ============
Weighted average number of shares outstanding:
Basic............................................... 64,802 64,848
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Diluted............................................. 64,802 64,848
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SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
4
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Balance Sheets
AS OF AS OF
JUNE 30, 1998 DECEMBER 31, 1997
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<S> <C> <C>
IN THOUSANDS (Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 121,443 $ 84,402
Short-term investments.................................... 17,116 52,658
Trade accounts receivable, net............................ 107,896 106,010
Other receivables......................................... 6,840 6,282
Prepaid expenses and other................................ 17,211 12,906
Deferred income taxes..................................... 9,729 10,081
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Total current assets................................ 280,235 272,339
PROPERTY, PLANT AND EQUIPMENT, NET........................... 98,986 103,452
OTHER ASSETS, NET............................................ 28,177 26,511
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Total assets........................................ $ 407,398 $ 402,302
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 10,566 $ 11,125
Income taxes payable...................................... 18,392 23,000
Accrued payroll and related liabilities................... 24,531 31,055
Accrued liabilities....................................... 32,311 30,119
Deferred revenue.......................................... 41,502 28,849
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Total current liabilities........................... 127,302 124,148
LONG-TERM DEBT............................................... 121 120
OTHER LONG-TERM DEFERRALS.................................... 488 497
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Total liabilities................................... 127,911 124,765
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MINORITY INTEREST............................................ 941 -
STOCKHOLDERS' EQUITY:
Common stock.............................................. 296,868 291,263
Deficit................................................... (28,171) (21,521)
Foreign currency translation adjustment................... 9,849 7,795
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Total stockholders' equity.......................... 278,546 277,537
Total liabilities and stockholders' equity.......... $ 407,398 $ 402,302
============ ============
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SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(Unaudited)
SIX MONTHS ENDED JUNE 30, 1998 1997
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<S> <C> <C>
IN THOUSANDS
OPERATING CASH FLOWS:
Net loss..................................................... $ (6,650) $ (24,417)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
Depreciation and amortization of
property, plant and equipment........................... 13,858 14,133
Deferred taxes............................................ 619 (214)
Amortization of other assets.............................. 2,118 6,755
Write-down of assets...................................... 2,693 7,468
Business disposals........................................ 4,488 -
Changes in operating assets and liabilities:
Trade accounts receivable, net............................ (232) (2,679)
Prepaid expenses and other................................ (5,777) 1,613
Accounts payable.......................................... 1 (4,924)
Accrued liabilities and payroll........................... (7,162) (123)
Other liabilities and deferrals........................... 7,704 (3,155)
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Net cash provided (used) by operating activities............. 11,660 (5,543)
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INVESTING CASH FLOWS:
Net maturities of short-term investments.................. 36,063 14,377
Purchases of property, plant and equipment, net .......... (11,051) (22,901)
Purchase of businesses.................................... (4,000) (2,393)
Purchase of technologies.................................. - (600)
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Net cash provided (used) by investing activities............. 21,012 (11,517)
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FINANCING CASH FLOWS:
Proceeds from issuance of common stock.................... 5,605 4,265
Repayment of short-term borrowings........................ (205) (8,053)
Repayment of long-term debt............................... 2 (52,115)
Repurchase of common stock................................ - (3,964)
Decrease in cash and investments, long-term............... - 30,000
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Net cash provided (used) by financing activities............. 5,402 (29,867)
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Effect of exchange rate changes on cash and cash equivalents. (1,033) 1,087
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Net change in cash and cash equivalents...................... 37,041 (45,840)
Cash and cash equivalents at beginning of period............. 84,402 165,406
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Cash and cash equivalents at end of period................... $ 121,443 $ 119,566
============ ============
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SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
6
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MENTOR GRAPHICS CORPORATION
Notes to Consolidated Financial Statements
(In thousands)
(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 1997 to conform with the 1998 presentation.
(2) SPECIAL CHARGES - During the first six months of 1998 the Company recorded
special charges of $10,307. The charges consisted of three subsidiary
divestitures, related employee terminations, and the recognition of
impairment in value of certain assets. Substantially all of these costs
were disbursed in the first six months of 1998. During the first six months
of 1997 the Company recorded special charges of $8,560. The charges
consisted of subsidiary closures and related employee terminations, early
termination of an interest rate swap agreement, and recognition of the
impairment in value of goodwill and purchased technology. Substantially all
of these costs were disbursed in 1997.
(3) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - The following provides
additional information concerning cash flow activities:
<TABLE>
<CAPTION>
Six months ended June 30, 1998 1997
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<S> <C> <C>
Interest paid....................................... $ 282 $ 657
Income taxes paid, net of refunds................... $ 1,380 $ 2,513
</TABLE>
(4) COMPREHENSIVE INCOME - In June 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No.
130, "Reporting Comprehensive Income." This Statement establishes standards
for the reporting and display of comprehensive income and its components.
The Company adopted SFAS No. 130 on January 1, 1998. The impact on the
Company's Consolidated Financial Statements is not material and as a result
no disclosures have been made.
(5) SOFTWARE REVENUE RECOGNITION - In October 1997, the AICPA issued Statement
of Position (SOP) 97-2, "Software Revenue Recognition", which supercedes
SOP 91-1. The Company adopted SOP 97-2 for software transactions entered
into beginning January 1, 1998. SOP 97-2 generally requires revenue earned
on software arrangements involving multiple elements to be allocated to
each element based on the relative fair values of the elements. The revenue
allocated to software products generally is recognized upon delivery of the
products. The revenue allocated to post-contract customer support generally
is recognized ratably over the term of the support and revenue allocated to
service elements generally is recognized as the services are performed. The
impact on the Company's Consolidated Financial Statements is not material.
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 three months and six months ended June 30,
1998 totaled $63,854 and $122,060, respectively, representing an increase of
$7,417 or 13 percent and $10,183 or 9 percent from the same periods of 1997.
Compared to the respective prior periods, software product revenues increased
during the second quarter and first six months of 1998 and accelerated
verification systems revenues also increased in the second quarter of 1998,
while accelerated verification system revenues were lower overall for the six
month period. These increases occurred despite the weakening of the Japanese Yen
versus the U.S. dollar which negatively impacted revenues. See "Geographic
Revenues Information" for further discussion. The increase in software product
revenues is attributable to growth of the Company's newer product offerings year
over year. Accelerated verification revenue improved in the second quarter
compared to the first quarter of 1998 as next generation systems began shipping.
For the first half of 1998 versus the same period a year ago, the decline in
accelerated verification system sales was primarily due to the timing of this
product release where customers elected to wait for its availability. This
product is not available in U.S. markets due to a 1997 court ruling. See "Part
II - Item 1. Legal Proceedings" for further discussion.
System and software gross margins were 87 and 88 percent for the second quarter
and first six months of 1998, respectively, compared to 81 and 73 percent for
the same periods a year ago. Gross margins were significantly higher for the
1998 periods due to lower third party product sales for which royalties are
paid, lower purchased technology and capitalized software development costs
amortization, and a write-down of certain previously capitalized software
development costs in 1997. For the second quarter and first six months of 1998,
there was no amortization of previously capitalized software development costs
to system and software cost of revenues, compared to $1,645 and $3,083 for the
same periods of 1997, respectively. In addition, 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. These costs, which totaled $5,348,
were determined to be unrecoverable and were charged to system and software cost
of revenues during the quarter. Purchased technology amortization to system and
software cost of goods sold was $739 and $1,615 for the second quarter and first
six months of 1998, respectively, compared to $1,580 and $3,321 for the same
periods of 1997, respectively. The decrease in amortization of purchased
technology is attributable to lower levels of purchased technology in the last
two years.
SERVICE AND SUPPORT
Service and support revenues for the three months and six months ended June 30,
1998 totaled $55,263 and $105,065, respectively, representing a decrease of
$2,938 or 5 percent and an increase of $745 or 1 percent from the same periods
of 1997. The revenue decrease in the second quarter of 1998 is primarily
attributable to decreased consulting services revenue and partially offset by
increased software support revenue. For the first six months of 1998, the
decline in consulting services revenues was approximately offset by increased
software support revenues. The increase in software support revenues is
attributable to a higher contract renewal rate as a result of ongoing efforts to
decrease delinquencies compared to the prior year. The decline in professional
service revenues is largely due to contract delays for certain large consulting
engagements and marshalling resources from other engagements to ensure their
availability to service these accounts.
8
<PAGE>
Service and support gross margins were 55 and 53 percent for the second quarter
and first six months of 1998, compared to 54 and 47 percent for the same periods
a year ago. The increase in overall service and support gross margins is
attributable to higher software support revenues, approximately flat software
support cost of revenues and significantly lower professional service cost of
revenues during the 1998 periods. The reduction in professional service cost of
revenues is attributable to cost control measures initiated in 1997.
GEOGRAPHIC REVENUES INFORMATION
Domestic revenues from unaffiliated customers including service and support
revenues for the second quarter and first six months of 1998 were 55 and 52
percent of total revenues compared to 58 and 53 percent of total revenues for
comparable periods of 1997. From the second quarter and the first six months of
1997 to the comparable periods of 1998, European revenues increased
approximately 18 and 24 percent, respectively. From the second quarter and the
first six months of 1997 to the comparable periods of 1998, Japanese revenues
increased approximately 8 percent and decreased approximately 6 percent,
respectively. Increased revenues in Europe are attributable to economic strength
in the region. A stronger U.S. dollar in 1998 negatively impacted revenues in
Asia Pacific between the comparable periods, most significantly in Japan where
the Yen weakened against the U.S. dollar by approximately 13 percent in the
second quarter of 1998 and 10 percent for the first six months of 1998. In
addition, the economic slow down in Asia Pacific further impacted revenues in
the first six months of 1998 compared to the same period last year. Since the
Company generates approximately half of its revenues outside of the United
States, revenue results should continue to be impacted by the effects of future
foreign currency fluctuations.
OPERATING EXPENSES
Research and development expenses totaled $29,323 and $26,903 or 25 and 23
percent of revenues for the second quarters of 1998 and 1997, respectively and
$57,728 and $54,180 or 25 percent of revenues for the first six months of 1998
and 1997. Marketing and selling expenses totaled $40,301 and $37,102 or 34 and
32 percent of revenues for the second quarters of 1998 and 1997, respectively
and $79,255 and $76,852 or 35 and 36 percent of revenues for the first six
months of 1998 and 1997, respectively. General and administration expenses
totaled $10,781 and $10,132 or 9 percent of revenues for the second quarters of
1998 and 1997, respectively and $21,286 and $20,421 or 9 percent of revenues for
the first six months of 1998 and 1997, respectively. The overall absolute dollar
increase in regular operating expenses is attributable to increased investment
in research and development activities and higher marketing and selling costs
based on revenue volumes for the 1998 periods.
SPECIAL CHARGES
During the first six months of 1998 the Company recorded special charges of
$10,307. The charges primarily consisted of three subsidiary divestitures,
related employee terminations, and the recognition of impairment in value of
certain assets. Substantially all of these costs were disbursed in the first six
months of 1998. During the first six months of 1997 the Company recorded special
charges of $8,560. The charges consisted of subsidiary closures and related
employee terminations, early termination of an interest rate swap agreement, and
recognition of the impairment in value of goodwill and purchased technology.
Substantially all of these costs were disbursed in 1997.
9
<PAGE>
OTHER INCOME (EXPENSE)
Other income (expense), net totaled $(90) and $(3,213) for the second quarter
and the first six months of 1998 compared to $1,362 and $1,877 for the same
periods of 1997. Other income (expense) was negatively impacted by increased
legal costs associated with the ongoing patent litigation with Quickturn Design
Systems, Inc. (Quickturn) which totaled $1,161 and $5,854 in the second quarter
and the first six months of 1998, respectively compared to $700 and $1,490 for
comparable periods of 1997. The increase in the first six months of 1998 is
attributable to the one-time expense of certain intellectual property rights
purchased from Aptix Corporation as a basis for a patent infringement lawsuit
filed jointly by a subsidiary of the Company and Aptix against Quickturn. See
"Part II - Item 1. Legal Proceedings" for further discussion. Interest income
from investments was $1,767 and $3,711 for the second quarter and the first six
months of 1998, compared to $1,806 and $3,601 for comparable periods of 1997.
During the second quarter and the first six months of 1998, interest expense
amounted to $193 and $289, respectively compared to $108 and $375 for the
comparable periods in 1997.
PROVISION (BENEFIT) FOR INCOME TAXES
The benefit for income taxes amounted to $1,876 for the six months ended June
30, 1998, as compared to a benefit of $3,019 for the same period in 1997. 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. The Company's tax rate remains sensitive to the shifts in
income and losses among various tax jurisdictions and as a result, the effective
tax rate for the remaining two quarters of 1998 is difficult to predict.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS
The Company experienced a net gain (loss) from foreign currency transactions of
$(145) and $152 during the second quarter and the first six months of 1998
compared to a net (loss) of $(138) and $(487) for comparable periods of 1997.
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 June 30, 1998, increased to $9,849 from
$7,795 at the end of 1997. This reflects the increase in the value of net assets
denominated in foreign currencies against the U.S. dollar since year-end 1997.
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.
10
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LIQUIDITY AND CAPITAL RESOURCES
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CASH AND INVESTMENTS
Total cash and short-term investments at June 30, 1998 were $138,559 compared to
$137,060 at the end of 1997. Cash provided by operations was $11,660 for the
first six months of 1998, compared to cash (used) by operations of $(5,543)
during the same period of 1997. Cash (used) by investing activities, excluding
short-term investments was $(15,051) and $(25,894) for the first half of 1998
and 1997, respectively. Investing activities in the first quarter of 1998
included a cash payment of $4,000 for a controlling interest in the Company's
Korean distributor which was more than offset by a decrease in capital
expenditures for the comparative periods. Cash provided (used) by financing
activities was $5,402 for the first six months of 1998 compared to $(29,867)
during the same period of 1997. The use of cash in 1997 was due to the pay-down
of short term lines of credit and the long term revolving credit facility
totaling $(52,115) offset by the release of cash held as collateral previously
classified as long term on the consolidated balance sheets.
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable increased to $107,896 at June 30, 1998 from $106,010
at year-end 1997. Average days sales outstanding in accounts receivable
increased from 76 days at the end of 1997 to 82 days at the end of the second
quarter of 1998. This increase in average trade receivables days sales
outstanding is principally attributable to contract sales where the Company
provided certain customers extended payment terms.
OTHER ASSETS
Other assets increased to $28,177 at June 30, 1998 from $26,511 at year-end
1997. The increase is due to goodwill of approximately $4,000 generated from the
purchase of a controlling interest in the Company's Korean distributor and an
increase of approximately $2,500 in the long-term portion of term contract
receivables, offset by purchased technology amortization.
CAPITAL RESOURCES
Total capital expenditures decreased to $11,051 through June 30, 1998, compared
to $22,901 for the same period of 1997. The capital expenditures in the first
six months of 1997 were leasehold improvements for new facilities, and global
information systems and sales force automation projects. Expenditures in the
first six months of 1998 did not include any individually significant projects.
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.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133 also requires that changes in the derivative's fair value be
recognized currently in results of operations unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. The Company does not expect SFAS No. 133 to have a material
impact on its Consolidated Financial Statements.
11
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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 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 customer expectations. 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 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
U.S. and expects this to continue in the future. As such, the effects of foreign
currency fluctuations can impact the Company's business and operating results.
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.
In addition, recent significant declines in the value of the currencies of many
countries in the Asia Pacific region have affected the Company's sales in the
region. The overall instability of Asian currency and stock market economies
could adversely affect the economic health of the entire region and could have
an adverse effect 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. There can be no
assurance that these challenges will be effectively met.
12
<PAGE>
As a result of the acquisition of Meta Systems, the Company has entered the
hardware development and assembly business. Some additional issues include:
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 reusable intellectual property products and
consulting services to its portfolio of offerings. As with all markets, there is
inherent uncertainty regarding the overall rate of growth. Specifically, growth
in the reusable intellectual property market is subject to significant
uncertainties and risks as market participants seek to gain customer acceptance
for the overall concept of incorporating these reusable intellectual property
designs into their products 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, market, sell and service 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 "Part II - Item 1. Legal Proceedings" for further
discussion.
The Company has conducted a review of its products, information technology and
facilities computer systems to identify all software that could be affected by
the "Year 2000" issue and has developed or is developing implementation plans to
address this issue. The Company has announced that its current release of
software products is Year 2000 compliant. In addition, the Company expects all
other Year 2000 conversion projects to be completed on a timely basis. While the
Company does not believe its computer systems or applications currently in use
will be adversely affected by the upcoming change in the century, the Company
has not made an assessment as to whether any of its customers, suppliers or
service providers will be so affected. Failure of the Company's software or that
of its customers, suppliers or service providers could have a material adverse
impact on the Company's business, financial condition and result of operations.
Provided the Company's "Year 2000" projects are completed on a timely basis, the
expense of these projects, and its related effect on the Company's earnings, is
not expected to be material.
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.
13
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During 1995, the Company filed suit in U.S. 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 Systems 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 U.S., compensatory and punitive
damages and attorneys' fees.
Quickturn filed an administrative complaint with the U.S. International Trade
Commission (ITC) in 1996 seeking to prohibit the distribution of SimExpress
products in the U.S. In August 1996, the ITC issued a ruling effectively
prohibiting the importation of this technology into the U.S. 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
U.S. 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 U.S. The injunction also prohibits
the Company from shipping current U.S. inventory modified in the U.S. to any of
its non-U.S. locations. 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 December 1997, the ITC issued a Cease and Desist Order prohibiting the
Company from importing SimExpress products or components, and from providing
repair or maintenance services to existing U.S. customers. That order took
effect in 1998. A trial in the U.S. District Court action will likely occur
during the fourth quarter of 1998, in which Quickturn will seek 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 U.S. market.
In February 1998, Meta filed a patent infringement action against Quickturn in
the U.S. District Court for the Northern District of California in San Jose,
California. The complaint, which is based on a patent that Meta has the right to
enforce, seeks damages for infringement as a result of Quickturn's manufacture
and sale of certain emulation equipment. Meta, which has been joined in the suit
by Aptix Corporation of San Jose, California, will ultimately seek an injunction
prohibiting further infringement by Quickturn. A trial date in the U.S. District
Court has not been set at this time.
On or about August 6, 1998, three shareholders of Exemplar Logic, Inc.
("Exemplar"), a corporation owned more than 90% by the Company, filed an action
in the Superior Court of California for the County of Alameda against the
Company, Exemplar and certain employees of the Company who have served as
directors of Exemplar. The complaint alleges that the Company breached a
contract with Exemplar which provides that, under certain circumstances, the
Company will take reasonable steps to support Exemplar in its efforts to
complete an initial public offering, that the Company has breached its alleged
fiduciary duty as a majority shareholder of Exemplar, that the Company made
false and misleading representations and concealments that defrauded Exemplar
and that the Company conducted unfair business practices against Exemplar under
California law. The complaint seeks compensatory and exemplary damages and to be
declared a class action. The Company intends to defend against the action
vigorously and does not believe that the outcome of the suit will have a
material adverse effect on its financial condition, results of operations or
liquidity.
14
<PAGE>
On July 2, 1998, the Company filed an action for declaratory judgment in the
Federal District Court for the District of Oregon against Armagan Akar, a former
employee of Mentor Graphics Singapore Ptd. Ltd. (MG Singapore), a wholly owned
subsidiary of the Company. The declaratory judgment action requests the Oregon
federal court to determine the obligations of Company and MG Singapore to Mr.
Akar in connection with a dispute regarding Mr. Akar's termination from MG
Singapore. On or about July 27, 1998, Mr. Akar filed an action in the Superior
Court of California for the County of Santa Clara alleging wrongful termination
of employment. The complaint alleges that the Mr. Akar's employment was
terminated following his claimed notification to the Company and MG Singapore of
violations of the Federal Corrupt Practices Act occurring in the Company's
operations located in the Peoples' Republic of China. Mr. Akar also alleges that
one or more employees of MG Singapore made defamatory statements about him in
connection with the termination of his employment. Mr. Akar seeks compensatory
and exemplary damages. The Company intends to vigorously contest Mr. Akar's
action and allegations, and does not believe that the outcome of the suit will
have a material adverse effect on the Company's financial condition, results of
operations or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders
The 1998 Annual Meeting of Shareholders of the Company was held pursuant to
notice at 5:00 p.m. Pacific time on May 19, 1998 at the Company's offices in
Wilsonville, Oregon. There were present at the meeting, in person or represented
by proxy, the holders of approximately 60,800,000 shares of the outstanding
common stock, which represented approximately 95% of the outstanding shares. The
voting information set forth below was provided by American Stock Transfer &
Trust Company, the Company's Transfer Agent for its common stock, as Inspector
of Election. The matter voted on at the meeting and the votes cast is as
follows:
Issue: Election of Nominees for Directors. The nominees for directors listed
below and presented to the meeting were elected directors of the Company upon
each receiving the affirmative vote of the holders of approximately 99% of those
shares represented at the meeting, to serve until the next annual meeting of
shareholders and until their successors shall have been elected and qualified.
Election of Directors For Withheld
--------------------- --- --------
Jon A. Shirley 60,787,854 353,790
Marsha B. Congdon 60,776,866 364,778
James R. Fiebiger 60,787,769 353,875
David A. Hodges 60,787,854 353,790
Walden C. Rhines 60,787,469 354,175
Fontaine K. Richardson 60,787,771 353,873
15
<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.
MENTOR GRAPHICS CORPORATION
(Registrant)
GREGORY K. HINCKLEY
-----------------------------------------
Gregory K. Hinckley
Executive Vice President and
Chief Operating Officer/Chief
Financial Officer
16
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