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, 1999. 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
incorporation or organization) Identification No.)
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 30, 1999:
66,915,544
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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, 1999 and 1998
Consolidated Statements of Operations for the six 4
months ended June 30, 1999 and 1998
Consolidated Balance Sheets as of June 30, 1999 5
and December 31, 1998
Consolidated Statements of Cash Flows for the 6
six months ended June 30, 1999 and 1998
Notes to Consolidated Financial Statements 7-8
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 9-15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 16-17
PART II OTHER INFORMATION
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Item 1. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 19
SIGNATURES 19
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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, 1999 1998
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In thousands, except per share data
<S> <C> <C>
Revenues:
System and software........................................ $ 66,670 $ 63,854
Service and support........................................ 52,837 55,263
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Total revenues........................................ 119,507 119,117
---------- ----------
Cost of revenues:
System and software........................................ 6,968 8,134
Service and support........................................ 21,960 24,925
---------- ----------
Total cost of revenues................................ 28,928 33,059
---------- ----------
Gross margin.......................................... 90,579 86,058
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Operating expenses:
Research and development................................... 27,687 29,323
Marketing and selling...................................... 41,465 40,301
General and administration................................. 10,890 10,781
Special charges............................................ 5,256 4,532
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Total operating expenses.............................. 85,298 84,937
---------- ----------
Operating income ............................................... 5,281 1,121
Other expense, net......................................... (5,687) (90)
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Income (loss) before income taxes..................... (406) 1,031
Income tax expense (benefit)............................... (89) 227
---------- ----------
Net income (loss)..................................... $ (317) $ 804
========== ==========
Net income (loss) per share:
Basic................................................. $ .00 $ .01
========== ==========
Diluted............................................... $ .00 $ .01
========== ==========
Weighted average number of shares outstanding:
Basic................................................. 66,355 65,009
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Diluted............................................... 66,355 65,817
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</TABLE>
3
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
Six months ended June 30, 1999 1998
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In thousands, except per share data
<S> <C> <C>
Revenues:
System and software........................................ $ 139,410 $ 122,060
Service and support........................................ 102,670 105,065
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Total revenues........................................ 242,080 227,125
---------- ----------
Cost of revenues:
System and software........................................ 14,414 14,390
Service and support........................................ 44,342 49,472
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Total cost of revenues................................ 58,756 63,862
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Gross margin.......................................... 183,324 163,263
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Operating expenses:
Research and development................................... 56,556 57,728
Marketing and selling...................................... 83,780 79,255
General and administration................................. 23,786 21,286
Special charges............................................ 21,831 10,307
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Total operating expenses.............................. 185,953 168,576
---------- ----------
Operating loss.................................................. (2,629) (5,313)
Other expense, net......................................... (8,508) (3,213)
---------- ----------
Loss before income taxes.............................. (11,137) (8,526)
Income tax benefit......................................... (2,450) (1,876)
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Net loss.............................................. $ (8,687) $ (6,650)
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Net loss per share:
Basic................................................. $ (.13) $ (.10)
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Diluted............................................... $ (.13) $ (.10)
========== ==========
Weighted average number of shares outstanding:
Basic................................................. 66,225 64,802
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Diluted............................................... 66,225 64,802
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</TABLE>
4
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Balance Sheets
As of As of
June 30, 1999 December 31, 1998
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In thousands (Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents.................................. $ 113,573 $ 118,512
Short-term investments..................................... 3,383 19,073
Trade accounts receivable, net............................. 117,100 125,844
Other receivables.......................................... 7,467 7,575
Prepaid expenses and other................................. 12,955 23,503
Deferred income taxes...................................... 10,759 10,937
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Total current assets.................................. 265,237 305,444
Property, plant and equipment, net.............................. 87,213 95,214
Term receivables, long-term..................................... 45,453 36,430
Other assets, net............................................... 25,892 27,035
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Total assets.......................................... $ 423,795 $ 464,123
============ ============
Liabilities and Stockholders' Equity Current liabilities:
Short-term borrowings ..................................... $ - $ 24,000
Accounts payable........................................... 6,826 10,101
Income taxes payable....................................... 17,183 20,408
Accrued payroll and related liabilities.................... 27,646 41,958
Accrued liabilities........................................ 35,748 33,295
Deferred revenue........................................... 43,747 36,484
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Total current liabilities............................. 131,150 166,246
Other long-term deferrals....................................... 1,295 1,425
Commitments and contingencies................................... - -
Minority interest............................................... 1,286 1,170
Stockholders' Equity:
Common stock............................................... 308,350 303,352
Accumulated deficit........................................ (30,933) (22,246)
Accumulated other comprehensive income - foreign currency
translation adjustment................................... 12,647 14,176
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Total stockholders' equity................................. 290,064 295,282
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Total liabilities and stockholders' equity............ $ 423,795 $ 464,123
============ ============
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</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(Unaudited)
Six months ended June 30, 1999 1998
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In thousands
<S> <C> <C>
Operating Cash Flows:
Net loss........................................................ $ (8,687) $ (6,650)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization of
property, plant and equipment............................ 11,540 13,858
Deferred taxes............................................. 244 619
Amortization of other assets............................... 1,695 2,118
Write-down of assets....................................... 18,134 2,693
Business disposals......................................... 4,497 4,488
Gain on sale of investments................................ (3,669) -
Changes in operating assets and liabilities:
Trade accounts receivable.................................. 6,230 (232)
Prepaid expenses and other................................. 5,871 (5,777)
Term receivables, long-term ............................... (9,351) -
Accounts payable........................................... (3,227) 1
Accrued liabilities........................................ (18,683) (7,162)
Other liabilities and deferrals............................ 4,365 7,704
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Net cash provided by operating activities....................... 8,959 11,660
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Investing Cash Flows:
Net maturities of short-term investments................... 15,690 36,063
Purchases of property, plant and equipment, net ........... (7,825) (11,051)
Purchases of equity interests.............................. (7,572) (4,000)
Proceeds from sale of property, plant and equipment........ 2,020 -
Proceeds from sale of investments.......................... 8,191 -
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Net cash provided by investing activities....................... 10,504 21,012
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Financing Cash Flows:
Proceeds from issuance of common stock..................... 5,764 5,605
Repayment of short-term borrowings......................... (24,000) (205)
Repayment of long-term debt................................ - 2
Repurchase of common stock................................. (5,998) -
------------ ------------
Net cash provided (used) by financing activities................ 24,234) 5,402
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Effect of exchange rate changes on
cash and cash equivalents ................................. (168) (1,033)
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Net change in cash and cash equivalents......................... (4,939) 37,041
Cash and cash equivalents at beginning of period................ 118,512 84,402
------------ ------------
Cash and cash equivalents at end of period...................... $ 113,573 $ 121,443
============ ============
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</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 1998 to conform with the 1999 presentation.
(2) Special Charges - During the first six months of 1999 the Company recorded
special charges of $21,831. The charges consisted of acquisition related
costs attributable to the purchase of the minority interest of a
subsidiary, costs attributable to the terminated tender offer for Quickturn
Design Systems, Inc. (Quickturn) net of a gain from the sale of acquired
stock, two subsidiary divestitures and related employee terminations.
Substantially all of these costs were disbursed in the first half of 1999.
In January of 1999, the Company completed the purchase of the remaining
minority interest of its then 84% owned subsidiary, Exemplar Logic, Inc.
(Exemplar) for cash and stock options valued at $13,003. The cost of the
acquisition was allocated on the basis of the estimated fair value of
assets assumed. This allocation resulted in charges for in process R&D and
compensation and other related costs of $624 and $6,951, respectively. In
addition, capitalized goodwill and technology allocations were $4,452 and
$976, respectively. The goodwill and technology will be amortized to R&D
over five years and system and software product cost of goods sold over
three years, respectively.
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 half of 1998.
(3) Supplemental Disclosures of Cash Flow Information - The following provides
additional information concerning cash flow activities:
<TABLE>
<CAPTION>
Six months ended June 30, 1999 1998
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<S> <C> <C>
Interest paid.......................................... $ 412 $ 282
Income taxes paid, net of refunds...................... $ 1,201 $ 1,380
Issuance of stock options for purchase of
minority interest of subsidiary...................... $ 5,232 $ -
---------------------------------------------------------------------------------
</TABLE>
(4) Comprehensive Loss - The following provides a summary of comprehensive
loss:
<TABLE>
<CAPTION>
Three months ended March 31, 1999 1998
------------------------------------------------------------------------------------
<S> <C> <C>
Net loss............................................... $ (8,687) $ (6,650)
Foreign currency translation adjustment................ (1,529) 2,054
----------- -----------
Comprehensive loss..................................... $ (10,216) $ (4,596)
=========== ===========
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</TABLE>
7
<PAGE>
(5) Revenue Recognition - Revenues from system and software licenses are
recognized at the time of shipment, except for those that include rights to
future software products or have significant other delivery requirements.
Product revenues from term or installment sales agreements which include
either perpetual or term licenses are principally with the Company's
top-rated credit customers and are recognized upon shipment while any
maintenance revenues included in these arrangements are deferred and
recognized ratably over the contract term. Revenues from subscription-type
term license agreements, which include software, rights to future software
products, and services, are deferred and recognized over the term of the
contract. Training and consulting contract revenues are recognized using
the percentage of completion method or as contract milestones are achieved.
(6) Segment Reporting - The Company operates principally in the EDA industry.
The Company markets its products primarily to customers in the
communications, computer, semiconductor, consumer electronics, aerospace,
and transportation industries. The Company sells and licenses its products
through its direct sales force in North and South America (Americas),
Europe, Japan and Pacific Rim, and through distributors where a direct
sales presence is not warranted. The Company's reportable segments are
based on geographic area.
All intercompany revenues and expenses are eliminated in computing revenues
and operating income (loss). The corporate component of operating income
(loss) represents research and development, corporate marketing and
selling, corporate general and administration, special, and merger and
acquisitions related charges. Corporate capital expenditures and
depreciation and amortization are generated from assets allotted to
research and development, corporate marketing and selling, and corporate
general and administration. Reportable segment information is as follows:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1999 1998 1999 1998
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Americas...................... $ 60,849 $ 68,007 $ 119,325 $ 122,687
Europe........................ 35,876 34,421 70,823 67,182
Japan......................... 16,083 12,810 40,328 29,228
Pacific Rim................... 6,699 3,879 11,604 8,028
---------- ---------- ---------- ----------
Total.............................. $ 119,507 $ 119,117 $ 242,080 $ 227,125
========== ========== ========== ==========
Operating income (loss)
Americas...................... $ 31,067 $ 28,366 $ 61,017 $ 49,113
Europe........................ 15,803 12,509 30,169 23,597
Japan......................... 6,570 3,318 18,583 9,679
Pacific Rim................... 4,042 1,513 6,696 3,564
Corporate..................... (52,201) (44,585) (119,094) (91,266)
---------- ----------- ---------- ----------
Total.............................. $ 5,281 $ 1,121 $ (2,629) $ (5,313)
========== =========== ========== ==========
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</TABLE>
8
<PAGE>
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
(All numerical references 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,
1999 totaled $66,670 and $139,410, respectively, representing an increase of
$2,816 or 4 percent and $17,350 or 14 percent from the same periods of 1998.
Compared to the respective prior periods, software product revenues were flat in
the second quarter of 1999 and increased during the first six months of 1999.
Accelerated verification systems revenues increased in the second quarter and
the first six months of 1999. The increase in software product revenues in the
first half of 1999 is attributable to continued growth of the Company's newer
product offerings as well as growth in some older products in the first quarter
of the year. The older product revenue gains were partly attributable to
customers seeking to have their design environments Year 2000 compliant. The
decline in growth of software product revenues in the comparable second quarters
is attributable to a consolidation of the Company's third party sales channel
and an increased percent of subscription type contract bookings where revenue is
not all recognized immediately. The purpose of the sales channel restructuring
was to increase efficiencies and better leverage marketing programs. The adverse
effects of this change on sales are expected to continue in the short term. The
increase in accelerated verification system sales is primarily due to continued
market acceptance of a next generation product offering that became available in
the second quarter of 1998. Accelerated verification systems products are not
available in U.S. markets. See "Part II - Item 1. Legal Proceedings" for further
discussion. The effects of a strengthening of the Japanese Yen versus the U.S.
dollar had a slightly favorable impact on revenues. See "Geographic Revenues
Information" for further discussion.
System and software gross margins were 90 percent for the second quarter and
first six months of 1999, respectively, compared to 87 and 88 percent for the
same periods a year ago. Gross margins were favorably impacted in 1999 by higher
year to date software sales, lower workstation hardware sales and improved gross
margins on accelerated verification systems sales. Purchased technology
amortization to system and software cost of goods sold was $334 and $653 for the
second quarter and first six months of 1999, respectively, compared to $739 and
$1,615 for the same periods of 1998, respectively. The decrease in purchased
technology amortization was primarily attributable to fewer technology
acquisitions in the last two years.
Service and Support
Service and support revenues for the three months and six months ended June 30,
1999 totaled $52,837 and $102,670, respectively, representing a decrease of
$2,426 or 4 percent and of $2,395 or 2 percent from the comparable periods of
1998. Service and support revenues consist of software support and professional
services, of which software support was approximately flat for the second
quarter and the first six months of 1999 compared to a year ago while
professional service revenues declined in the comparable periods. The decline of
professional service revenues is principally due to a continued shift toward
methodology engagements that enable customers to better utilize the Company's
products and away from custom design service engagements.
9
<PAGE>
Service and support gross margins were 58 and 57 percent for the second quarter
and first six months of 1999, compared to 55 and 53 percent for the comparable
periods a year ago. The increase in overall service and support gross margins is
attributable to improved professional service realization as a result of better
worldwide program management. Program management includes initial scoping,
subsequent pricing and final delivery of the contracted services.
Geographic Revenues Information
Domestic revenues from unaffiliated customers including service and support
revenues for the second quarter and first six months of 1999 were 51 and 49
percent of total revenues compared to 57 and 54 percent of total revenues for
comparable periods of 1998. Compared to the respective prior periods, European
revenues increased 4 and 5 percent in the second quarter and the first six
months of 1999 and Japanese revenues increased 26 and 38 percent in the second
quarter and the first six months of 1999. Japanese revenues were positively
impacted by exchange rate changes in the comparable periods, where the Yen
strengthened against the U.S. dollar by approximately 17 and 14 percent in the
second quarter and the first six months of 1999. Exclusive of currency effects,
higher revenue levels in Japan are primarily due to several large accelerated
verification transactions in the first half of 1999. 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 $27,687 and $29,323 or 23 and 25
percent of revenues for the second quarters of 1999 and 1998, respectively and
$56,556 and $57,728 or 23 and 25 percent of revenues for the first six months of
1999 and 1998, respectively. Marketing and selling expenses totaled $41,465 and
$40,301 or 35 and 34 percent of revenues for the second quarters of 1999 and
1998, respectively and $83,780 and $79,255 or 35 and 35 percent of revenues for
the first six months of 1999 and 1998, respectively. General and administration
expenses totaled $10,890 and $10,781 or 9 percent of revenues for the second
quarters of 1999 and 1998, respectively and $23,786 and $21,286 or 10 and 9
percent of revenues for the first six months of 1999 and 1998, respectively. The
decline in R&D expenses is primarily attributable to several business disposals
partially offset by increased investment in other technology areas. The increase
in year to date general and administration expenses is primarily attributable to
overlap and training costs associated with the transition of the European
distribution center to Ireland. These overlap costs were significantly reduced
in the second quarter of 1999.
SPECIAL CHARGES
During the first six months of 1999 the Company recorded special charges of
$21,831. The charges consisted of acquisition related costs attributable to the
purchase of the minority interest of a subsidiary, costs attributable to the
terminated tender offer for Quickturn Design Systems, Inc. (Quickturn) net of a
gain from the sale of acquired stock, two subsidiary divestitures and related
employee terminations. Substantially all of these costs were disbursed in the
first half of 1999. In January of 1999, the Company completed the purchase of
the remaining minority interest of its then 84% owned subsidiary, Exemplar
Logic, Inc. (Exemplar) for cash and stock options valued at $13,003. The cost of
the acquisition was allocated on the basis of the estimated fair value of assets
assumed. This allocation resulted in charges for in process R&D and compensation
and other related costs of $624 and $6,951, respectively. In addition,
capitalized goodwill and technology allocations were $4,452 and $976,
respectively. The goodwill and technology will be amortized to R&D over five
years and system and software product cost of goods sold over three years,
respectively.
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 half of
1998.
10
<PAGE>
OTHER INCOME (EXPENSE)
Other income (expense), net totaled $(5,687) and $(8,508) for the second quarter
and the first six months of 1999 compared to $(90) and $(3,213) for the same
periods of 1998. Other income (expense) was negatively impacted by legal costs
associated with the ongoing patent litigation with Quickturn, which became a
subsidiary of Cadence Design Systems, Inc. in the second quarter of 1999. These
costs totaled $6,850 and $10,883 in the second quarter and the first six months
of 1999, respectively compared to $1,161 and $5,854 for comparable periods of
1998. The year to year increase is attributable to a legal settlement of $3,000
for the Portland, Oregon SimExpress trial and other related costs during the
year. Included in the first quarter of 1998 were license fees for certain
intellectual property licensed from Aptix Corporation and expenses attributable
to a patent infringement lawsuit filed jointly by a subsidiary of the Company
and Aptix against Quickturn. Other legal proceedings are pending or are in
progress related to this matter. See "Part II - Item 1. Legal Proceedings" for
further discussion. Interest income from investments was $1,804 and $3,627 for
the second quarter and the first six months of 1999, compared to $1,767 and
$3,711 for comparable periods of 1998. During the second quarter and the first
six months of 1999, interest expense amounted to $216 and $456, respectively
compared to $193 and $289 for the comparable periods in 1998.
PROVISION (BENEFIT) FOR INCOME TAXES
The benefit for income taxes amounted to $2,450 for the six months ended June
30, 1999, as compared to a benefit of $1,876 for the same period in 1998. The
tax benefit in all periods is the result of the mix of profits earned by the
Company and its subsidiaries in tax jurisdictions with a broad range of income
tax rates.
Because the Company's income tax position combines the effects of available tax
benefits in certain countries where the Company does business, benefits from
available net operating loss carryforwards and tax expense for subsidiaries with
pre-tax income, the Company's income tax position and resultant effective tax
rate is uncertain for the remaining two quarters of 1999 and beyond.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS
Approximately half of the Company's revenues are generated outside of the United
States. For 1999 and 1998, approximately half of European and all of Japanese
revenues were subject to exchange rate fluctuations as they were booked in local
currencies. The effects of these fluctuations were substantially offset by local
currency cost of revenues and operating expenses, which resulted in an
immaterial net effect on the Company's results of operations.
The "accumulated other comprehensive income - foreign currency translation
adjustment," as reported in the stockholders' equity section of the Consolidated
Balance Sheets, decreased to $12,647 at June 30, 1999, from $14,176 at the end
of 1998. This reflects the decrease in the value of net assets denominated in
foreign currencies since year-end 1998 as a result of a stronger dollar as of
June 30, 1999.
11
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH AND INVESTMENTS
Total cash and short-term investments at June 30, 1999 were $116,956 compared to
$137,585 at the end of 1998. Cash provided by operations was $8,959 for the
first six months of 1999 compared to $11,660 during the same period of 1998.
During the first half of 1999 and 1998, cash used by operations was negatively
impacted by the net loss from operations including payments related to special
charges taken in 1999 and 1998. Cash used by investing activities, excluding
short-term investments, was $5,186 and $15,051 in the first half of 1999 and
1998, respectively. Investing activities in the first quarter of 1999 included a
cash payment made for a purchase of the minority interest in Exemplar of $7,572
and capital expenditures offset by cash received from the sale of Quickturn
stock of $8,191. Investing activities in the first half of 1998 included a cash
payment of $4,000 for a controlling interest in the Company's Korean distributor
and capital expenditures. Cash provided (used) by financing activities was
$(24,234) for the first six months of 1999 compared to $5,402 during the same
period of 1998. The use of cash for financing activities in 1999 included the
pay-down of a short-term borrowing of $24,000 and the repurchase of 528 shares
of common stock for $5,998.
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable decreased to $117,100 at June 30, 1999 from $125,844
at year-end 1998. Average days sales outstanding in accounts receivable
increased from 78 days at the end of 1998 to 88 days at the end of the second
quarter of 1999. This increase in average trade receivables days sales
outstanding is principally attributable to several large term contract sales
where the Company provided its customers extended payment terms. The decrease in
the trade accounts receivable balance is primarily attributable to the sale of
some short-term accounts receivable to a financing institution on a non-recourse
basis.
TERM RECEIVABLES, LONG-TERM
Term receivables, long-term increased to $45,453 at the end of the second
quarter of 1999 compared to $36,430 at December 31, 1998. The increase is
primarily due to an increase in demand for multi-year, multi-element term
license and perpetual license installment sales agreements principally from the
Company's top-rated credit customers. Balances under term agreements that are
due within one year are included in trade accounts receivable and balances that
are due in more than one year are included in term receivables, long-term. The
Company uses term agreements as a standard business practice and has a history
of successfully collecting under the original payment terms without making
concessions on payments, products or services.
12
<PAGE>
CAPITAL RESOURCES
Total capital expenditures decreased to $7,825 through June 30, 1999, compared
to $11,051 for the same period of 1998. Expenditures in the first half of 1999
and 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.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
The statements contained in this report that are not statements of historical
fact, including without limitation, statements containing the words "believes,"
"expects," and words of similar import, constitute 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 industry. The
Company's success is dependent upon its ability to develop and market products
and selling models that are innovative, cost-competitive and 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.
The Company's business is largely dependent upon the success and growth of the
electronics industry. The outlook for the electronics industry for 1999 is
uncertain due in part to adverse economic conditions in Asia and to the
uncertainty of growth in other regions. As a result, some companies in the
electronics industry may elect to cut costs through employee layoffs and
curtailing the number of electronic design projects which could reduce demand
for design automation capital including the Company's products and services. In
addition, there have been a number of mergers in the electronics industry, which
could result in decreased or delayed capital spending patterns. The above
business challenges for the electronics and related industries may have a
material adverse effect on the Company's financial condition and results of
operations.
As a result of the acquisition of Meta Systems and its accelerated verification
products, the Company has entered the hardware development and assembly
business. Risk factors 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
and related obsolescence issues, developing new processes to deliver customer
support of the hardware and placing new demands on the sales force. In addition,
the Company is engaged in litigation with Quickturn in which Quickturn has
asserted that the Company and Meta are infringing Quickturn patents. See "Part
II-Item 1. Legal Proceedings" for further discussion. The Company has been
prohibited from using, selling or marketing its SimExpress emulation products in
the United States and Germany. While the Company settled one SimExpress court
case in the second quarter of 1999, other legal proceedings and litigation
continue. These actions may result in the Company being unable to sell its
emulation products in other jurisdictions worldwide and may negatively affect
demand for accelerated verification products for the Company and all vendors
worldwide until the outcome is determined. This litigation could result in lower
sales of accelerated verification products, increase the risk of inventory
obsolescence and have a materially adverse effect on the Company's results of
operations.
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 few weeks 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.
13
<PAGE>
The Company uses term or installment sales agreements as a standard business
practice and has a history of successfully collecting under the original payment
terms without making concessions on payments, products or services. These
multi-year, multi-element term license and perpetual license term agreements are
from the Company's top-rated credit customers and average between one and three
years in length. These agreements may increase the element of risk associated
with collectibility from customers that can arise for a variety of reasons
including ability to pay, product satisfaction or disagreements and disputes. If
collectibility for any of these multi-million dollar agreements becomes a
problem the Company's results of operations could be adversely affected.
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.
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'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 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,
to meet various debt obligations used to finance acquisitions and to effectively
manage the business for long-term growth. There can be no assurance that these
challenges will be effectively met.
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.
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.
14
<PAGE>
YEAR 2000
The Company is aware of the potential inability of computer programs to
adequately process date information after December 31, 1999 (Year 2000). 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. The effect of the Year 2000 issue with
regard to the Company's product offerings is not expected to have any material
adverse effect on its financial condition and results of operations.
In addition to computers and related systems, the operations of the Company's
office and facilities equipment, such as fax machines, photocopiers, telephone
switched security systems, elevators and other common devices may be affected by
the Year 2000 problem. The Company is currently assessing the potential effect
of, and costs of remedying the Year 2000 problem on this equipment. The Company
estimates that its total remaining cost to complete any required modifications,
upgrades or replacements of these internal systems should total approximately
$700 for the rest of 1999. Identifiable expenditures through the second quarter
of 1999 have totaled approximately $3,600.
In addition, the Company has developed and is implementing a program to review
the Year 2000 compliance status of computer software programs licensed from
third parties and used in its internal business processes to obtain appropriate
assurances of Year 2000 compliance from manufacturers of these products. The
Company believes that it will be able to complete its Year 2000 compliance
review and make any necessary modifications prior to the end of 1999. 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 financial condition and
results of operations, is not expected to be material. However, the compliance
of systems acquired from third parties is dependent on factors outside the
Company's control. If key systems, or a significant number of systems fail as a
result of Year 2000 problems, the Company could incur substantial expense and
experience a disruption of business operations, which would potentially have a
material adverse effect on the Company's financial condition and results of
operations.
Furthermore, the Company is making an assessment as to whether any of its
customers, suppliers or service providers will be affected by the Year 2000
issue. Failure of the Company's customers, suppliers or service providers to
comply with Year 2000 could have a material adverse impact on the Company's
financial condition and results of operations. The purchasing patterns of
customers and potential customers may be affected by Year 2000 issues as
companies may be required to devote significant resources to correct or patch
their current software systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase the Company's software products
that could have a materially adverse effect on the Company's financial condition
and results of operations. There can be no assurance that Year 2000 related
operating problems or material expenses will not occur with the Company's
computer systems or in connection with the interface to the Company's major
vendors or suppliers.
The Company is currently developing contingency plans to be implemented as part
of its efforts to identify and correct Year 2000 problems affecting its internal
systems. The Company expects to complete its contingency plans by the end of the
third quarter of 1999. Depending on the systems affected, these plans could
include, (a) accelerated replacement of affected equipment and software; (b)
short to medium term use of back up equipment and software; (c) increased work
hours for the Company personnel or use of contract personnel to provide manual
workarounds for information systems; and (d) other similar approaches.
15
<PAGE>
Item 3. Quantitative And Qualitative Disclosures About Market Risk
(All numerical references in thousands, except for rates and
percentages)
INTEREST RATE RISK
The Company's exposure to market risk for changes in interest rates relate
primarily to its investment portfolio. The Company does not use derivative
financial instruments for speculative or trading purposes. The Company places
its investments in instruments that meet high credit quality standards, as
specified in the Company's investment policy. The policy also limits the amount
of credit exposure to any one issuer and type of instrument. The Company does
not expect any material loss with respect to its investment portfolio.
The table below presents the carrying value and related weighted-average
interest rates for the Company's investment portfolio. The carrying value
approximates fair value at June 30, 1999. In accordance with the Company's
investment policy all investments mature in twelve months or less. A nominal
amount of non-interest bearing instruments has been included in the table below:
<TABLE>
<CAPTION>
Carrying Average
Principal (notional) amounts in U.S. dollars Amount Interest Rate
- --------------------------------------------------------------------------------
<S> <C> <C>
Cash equivalents - fixed rate.......................$ 113,573 4.65%
Short-term investments - fixed rate................. 3,383 5.11%
---------- -----
Total interest bearing instruments..................$ 116,956 4.67%
========== =====
- --------------------------------------------------------------------------------
</TABLE>
FOREIGN CURRENCY RISK
The Company enters into forward foreign exchange contracts as a hedge against
foreign currency sales commitments and intercompany balances. To hedge its
foreign currency against highly anticipated sales transactions, the Company also
purchases foreign exchange options which permit but do not require foreign
currency exchanges at a future date with another party at a contracted exchange
price. Remeasurement gains and losses on forward and option contracts are
deferred and recognized when the sale occurs. All subsequent remeasurement gains
and losses are recognized as they occur to offset remeasurement gains and losses
recognized on the related foreign currency accounts receivable balances. These
contracts generally have maturities which do not exceed twelve months. At June
30, 1999, the difference between the recorded value and the fair value of the
Company's foreign exchange position related to these contracts was approximately
zero. The fair value of these contracts was calculated based on dealer quotes.
The Company does not anticipate non-performance by the counter-parties to these
contracts. Looking forward, the Company does not expect any material adverse
effect on its consolidated financial position, results of operations, or cash
flows resulting from the use of these instruments. There can be no assurance
that these strategies will be effective or that transaction losses can be
minimized or forecasted accurately.
16
<PAGE>
The following table provides information about the Company's foreign exchange
forward contracts at June 30, 1999. Due to the short-term nature of these
contracts, the contract rate approximates the weighted-average contractual
foreign currency exchange rate and the amount in U.S. dollars approximates the
fair value of the contract at June 30, 1999. These forward contracts mature in
approximately thirty days. The following table presents short-term forward
contracts to sell and buy foreign currencies in U.S. dollars related to customer
receivables and intercompany balances:
<TABLE>
<CAPTION>
Short-term forward contracts Amount Contract Rate
- -----------------------------------------------------------------------------
<S> <C> <C>
French francs................................ $ 13,403 $ 6.34
British pound sterling....................... 6,125 1.58
Japanese yen................................. 4,565 119.18
Euro......................................... 4,445 1.03
Other........................................ 7,144 -
- -----------------------------------------------------------------------------
</TABLE>
The unrealized gain (loss) on the outstanding forward contracts at June 30,
1999, was not material to the Company's consolidated financial statements. The
realized gain (loss) on these contracts as they matured was not material to the
Company's consolidated financial position, results of operations, or cash flows
for the periods presented.
17
<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. This action related to the SimExpress products of Meta
Systems SRL (Meta), a French company acquired by the Company in 1996. Quickturn
filed a counterclaim against the Company alleging infringement of six Quickturn
patents, including the three patents subject to the declaratory judgment action.
The counterclaim sought a permanent injunction prohibiting sales of the
Company's SimExpress products in the U.S., compensatory and punitive damages and
attorneys' fees. In June 1999, the Company and Quickturn settled this
litigation. The Company agreed that five Quickturn patents are valid and
enforceable, and were infringed by the Company's sale in the U.S. of its
SimExpress product from 1995-1997. Mentor Graphics also paid Cadence Design
Systems, Quickturn's parent company, $3 million in damages for infringement,
with each side to bear its own fees and costs. The court directed that the
Company's payment and its consent to the validity and infringement of the
Quickturn patents may not be used as evidence or for any other purpose in
litigation outside the U.S., and that the settlement does not address in any way
the issue of whether the Company's Celaro product infringes any patent issued in
the U.S. or other countries.
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 December 1997, the ITC issued a Cease and Desist Order
prohibiting the Company from importing certain hardware emulation products or
components and from providing repair or maintenance services to its existing
U.S. customers. That order took effect in 1998. In October 1997, Quickturn filed
an action against the Company's German subsidiary in a German District Court
alleging infringement by SimExpress of a European patent. The German court ruled
in April 1999 that the Company's German subsidiary's sales of SimExpress
violated a European patent owned by Quickturn and awarded unspecified damages.
The Company's German subsidiary no longer offers the SimExpress product in
Germany. Although the Company is appealing the ruling and contesting the
validity of the Quickturn patent, the Company can give no assurance as to the
outcome of such proceedings.
In October 1998, Quickturn filed an action against Meta and the Company in
France alleging infringement by SimExpress and Celaro of a European patent.
There have been no rulings by the French court regarding the merits of this case
to date.
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
Francisco, California. The complaint, which is based on a patent licensed to the
Company and Meta and which Meta has a 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 in U.S. District Court is
expected to occur the first quarter of 2000.
In July 1999, the Company filed suit in U.S. District Court for the District of
Delaware against Quickturn alleging infringement of two Mentor Graphics owned
patents by Quickturn's Mercury product. The Company is seeking a permanent
injunction prohibiting sales of Quickturn's Mercury products in the U.S., along
with damages and attorney's fees.
In addition to the above litigation, from time to time the Company is involved
in various disputes and litigation matters that arise from the ordinary course
of business. These include disputes and lawsuits relating to intellectual
property rights, licensing, contracts, and employee relations matters. The
Company believes that final resolution of such disputes and lawsuits will not
have a material adverse effect on the Company's financial position or results of
operations.
18
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
The 1999 Annual Meeting of Shareholders of the Company was held pursuant to
notice at 5:00 p.m. Pacific time on May 11, 1999 at the Company's offices in
Wilsonville, Oregon. There were present at the meeting, in person or represented
by proxy, the holders of 63,219,065 shares of the outstanding common stock,
which represented approximately 96% 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 matters voted on at the meeting and the votes cast are as follows:
Issue One: 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 97% 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 61,164,444 2,054,621
Marsha B. Congdon 61,163,344 2,055,721
James R. Fiebiger 61,164,444 2,054,621
David A. Hodges 61,164,444 2,054,621
Walden C. Rhines 61,158,206 2,060,859
Fontaine K. Richardson 61,164,444 2,054,621
Issue Two: Amendment of the Company's 1982 Stock Option Plan. The shareholders
approved an amendment to the Company's 1982 Stock Option Plan by the affirmative
vote of the holders of approximately 70% of those shares represented at the
meeting. The amendment was approved with 44,337,124 shares voted for approval,
18,144,571 shares voted against, and 321,211 shares abstaining.
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
19
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