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 March 31, 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 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 April 30,
1999: 66,318,125
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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 March 31, 1999 and 1998
Consolidated Balance Sheets as of March 31, 1999 4
and December 31, 1998
Consolidated Statements of Cash Flows for the 5
three months ended March 31, 1999 and 1998
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 8-13
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 14-15
PART II OTHER INFORMATION
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Item 1. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 17
SIGNATURES 17
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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 March 31, 1999 1998
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In thousands, except per share data
<S> <C> <C>
Revenues:
System and software.................................................... $ 72,740 $ 58,206
Service and support.................................................... 49,833 49,802
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Total revenues.................................................... 122,573 108,008
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Cost of revenues:
System and software.................................................... 7,446 6,256
Service and support.................................................... 22,382 24,547
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Total cost of revenues............................................ 29,828 30,803
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Gross margin...................................................... 92,745 77,205
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Operating expenses:
Research and development............................................... 28,869 28,405
Marketing and selling.................................................. 42,315 38,954
General and administration............................................. 12,896 10,505
Special charges........................................................ 16,575 5,775
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Total operating expenses.......................................... 100,655 83,639
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Operating loss.............................................................. (7,910) (6,434)
Other expense, net..................................................... (2,821) (3,123)
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Loss before income taxes.......................................... (10,731) (9,557)
Income tax benefit..................................................... (2,361) (2,103)
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Net loss.......................................................... $ (8,370) $ (7,454)
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Net loss per share:
Basic............................................................. $ (.13) $ (.12)
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Diluted........................................................... $ (.13) $ (.12)
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Weighted average number of shares outstanding:
Basic............................................................. 66,213 64,582
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Diluted........................................................... 66,213 64,582
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</TABLE>
3
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Balance Sheets
As of As of
March 31, 1999 December 31, 1998
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In thousands (Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................................. $ 94,297 $ 118,512
Short-term investments................................................ 1,688 19,073
Trade accounts receivable, net........................................ 124,013 125,844
Other receivables..................................................... 7,172 7,575
Prepaid expenses and other............................................ 17,317 23,503
Deferred income taxes................................................. 10,813 10,937
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Total current assets.............................................. 255,300 305,444
Property, plant and equipment, net......................................... 92,009 95,214
Term receivables, long-term................................................ 50,266 36,430
Other assets, net.......................................................... 27,763 27,035
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Total assets...................................................... $ 425,338 $ 464,123
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Liabilities and Stockholders' Equity
Current liabilities:
Short-term borrowings ................................................ $ - $ 24,000
Accounts payable...................................................... 6,233 10,101
Income taxes payable.................................................. 17,694 20,408
Accrued payroll and related liabilities............................... 24,659 41,958
Accrued liabilities................................................... 39,374 33,295
Deferred revenue...................................................... 46,390 36,484
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Total current liabilities......................................... 134,350 166,246
Other long-term deferrals.................................................. 1,608 1,425
Commitments and contingencies.............................................. - -
Minority interest.......................................................... 1,154 1,170
Stockholders' Equity:
Common stock.......................................................... 305,845 303,352
Accumulated deficit................................................... (30,617) (22,246)
Accumulated other comprehensive income - foreign currency
translation adjustment............................................ 12,998 14,176
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Total stockholders' equity............................................ 288,226 295,282
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Total liabilities and stockholders' equity........................ $ 425,338 $ 464,123
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</TABLE>
4
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<TABLE>
<CAPTION>
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(Unaudited)
Three months ended March 31, 1999 1998
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In thousands
<S> <C> <C>
Operating Cash Flows:
Net loss................................................................... $ (8,370) $ (7,454)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization of
property, plant and equipment..................................... 6,180 6,818
Deferred taxes........................................................ (203) 19
Amortization of other assets.......................................... 971 1,018
Write-down of assets.................................................. 18,134 1,630
Business disposals.................................................... 746 2,160
Gain on sale of investments........................................... (3,669) -
Changes in operating assets and liabilities:
Trade accounts receivable............................................. 1,276 5,546
Prepaid expenses and other............................................ 1,827 (6,287)
Term receivables, long-term .......................................... (14,654) (372)
Accounts payable...................................................... (3,623) (1,211)
Accrued liabilities................................................... (17,549) (13,370)
Other liabilities and deferrals....................................... 7,630 6,511
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Net cash used by operating activities...................................... (11,304) (4,992)
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Investing Cash Flows:
Net maturities of short-term investments.............................. 17,386 40,455
Purchases of property, plant and equipment, net ...................... (3,571) (6,371)
Purchases of equity interests......................................... (7,572) (4,000)
Proceeds from sale of investments..................................... 8,191 -
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Net cash provided by investing activities.................................. 14,434 30,084
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Financing Cash Flows:
Proceeds from issuance of common stock................................ 3,259 2,678
Repayment of short-term borrowings.................................... (24,000) (135)
Repayment of long-term debt........................................... - (26)
Repurchase of common stock............................................ (5,998) -
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Net cash provided (used) by financing activities........................... (26,739) 2,517
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Effect of exchange rate changes on
cash and cash equivalents ............................................ (606) (360)
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Net change in cash and cash equivalents.................................... (24,215) 27,249
Cash and cash equivalents at beginning of period........................... 118,512 84,402
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Cash and cash equivalents at end of period................................. $ 94,297 $ 111,651
============ ============
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</TABLE>
5
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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 three months of 1999 the Company
recorded special charges of $16,575. 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, a subsidiary divestiture and related employee terminations.
Substantially all of these costs were disbursed in the first quarter 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 to capitalized goodwill and technology of $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 three months of 1998 the Company recorded special charges
of $5,775. The charges consisted of two subsidiary closures, related
employee terminations, and the recognition of impairment in value of
certain assets. Substantially all of these costs were disbursed in the
first quarter of 1998.
(3) Supplemental Disclosures of Cash Flow Information - The following provides
additional information concerning cash flow activities:
<TABLE>
<CAPTION>
Three months ended March 31, 1999 1998
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<S> <C> <C>
Interest paid................................................ $ 219 $ 96
Income taxes paid, net of refunds............................ $ 195 $ 672
Issuance of stock options for purchase of
minority interest of subsidiary........................... $ 5,232 $ -
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</TABLE>
(4) Comprehensive Loss - The following provides a summary of comprehensive
loss:
<TABLE>
<CAPTION>
Three months ended March 31, 1999 1998
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<S> <C> <C>
Net loss..................................................... $ (8,370) $ (7,454)
Foreign currency translation adjustment...................... (1,178) 270
----------- -----------
Comprehensive loss........................................... $ (9,548) $ (7,184)
=========== ===========
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</TABLE>
6
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(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 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 ratably over the term of the subscription
period. 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 exclusively 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 March 31, 1999 1998
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<S> <C> <C>
Revenues
Americas................................................. $ 58,476 $ 54,680
Europe................................................... 34,947 32,761
Japan.................................................... 24,245 16,418
Pac Rim.................................................. 4,905 4,149
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Total........................................................ $ 122,573 $ 108,008
=========== ===========
Operating income (loss)
Americas................................................. $ 30,181 $ 29,562
Europe................................................... 13,627 11,127
Japan.................................................... 12,013 6,361
Pac Rim.................................................. 2,652 2,051
Corporate................................................ (66,383) (55,535)
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Total........................................................ $ (7,910) $ (6,434)
=========== ===========
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</TABLE>
7
<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 quarter ended March 31, 1999 totaled
$72,740 representing an increase of $14,534 or 25 percent from the first quarter
of 1998. Software product and accelerated verification system revenues increased
significantly for the comparable periods. The increase in software product
revenues is attributable to continued growth of the Company's newer product
offerings as well as growth in older products year over year. The older product
revenue gains are partly attributable to customers seeking to have their design
environments Year 2000 compliant. The increase in accelerated verification
system sales is primarily due to 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 due to a 1997
court ruling. See "Part II - Item 1. Legal Proceedings" for further discussion.
System and software gross margins were 90 and 89 percent for the quarters ended
March 31, 1999 and 1998, respectively. Gross margins were favorably impacted in
1999 by higher sales volume and lower amortization of purchased technology
partially off-set by an increase in lower margin accelerated verification
systems sales. Purchased technology amortization to system and software cost of
goods sold was $402 and $876 for the quarters ended March 31, 1999 and 1998,
respectively. The decrease in amortization of purchased technology is
attributable to the lower level of unamortized purchased technology in 1999.
Service and Support
Service and support revenues for the first quarter of 1999 totaled $49,833
compared to $49,802 for the same period of 1998. Service and support revenues
consist of software support and professional services, both of which were
approximately flat compared to the first quarter of 1998. The leveling off of
professional service revenues is principally due to a more narrowly focused
effort toward engagements that enable customers to better utilize the Company's
products and away from custom design service engagements.
Service and support gross margins were 55 and 51 percent for the quarters ended
March 31, 1999 and 1998, respectively. 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
Americas revenues including service and support revenues, increased by 7%
compared to the first quarter of 1998. Revenues outside of the Americas
represented 52% and 49% of total revenues in for the first quarters of 1999 and
1998, respectively. European revenues increased by approximately 7% from the
first quarter of 1998 to 1999. Japanese revenues increased by approximately 48%
from the first quarter of 1998 to 1999. The effects of exchange rate differences
from the Japanese Yen to the U.S. dollar positively impacted revenues by
approximately 11%. Exclusive of currency effects, higher revenue levels in Japan
are primarily due to two large accelerated verification transactions in the
first quarter of 1999. Since the Company generates approximately half of its
revenues outside of the U.S. and expects this to continue in the future, revenue
results should continue to be impacted by the effects of future foreign currency
fluctuations.
8
<PAGE>
OPERATING EXPENSES
Research and development expenses totaled $28,869 and $28,405 or 24 and 26
percent of revenues for the first quarters of 1999 and 1998, respectively.
Marketing and selling expenses totaled $42,315 and $38,954 or 35 and 36 percent
of revenues for the first quarters of 1999 and 1998, respectively. General and
administration expenses totaled $12,896 and $10,505 or 11 and 10 percent of
revenues for the first quarters of 1999 and 1998, respectively. The increase in
general and administration expenses is primarily attributable to overlap and
training costs associated with the transition of the European distribution
center to Ireland.
SPECIAL CHARGES
During the first three months of 1999 the Company recorded special charges of
$16,575. 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, a subsidiary divestiture and related
employee terminations. Substantially all of these costs were disbursed in the
first quarter 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 to
capitalized goodwill and technology of $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 three months of 1998 the Company recorded special charges of
$5,775. The charges consisted of two subsidiary closures, related employee
terminations, and the recognition of impairment in value of certain assets.
Substantially all of these costs were disbursed in the first quarter of 1998.
OTHER INCOME (EXPENSE)
Other income (expense), net totaled $(2,821) for the first quarter of 1999
compared to $(3,123) for the same period of 1998. Other income (expense) was
negatively impacted by legal costs associated with the ongoing patent litigation
with Quickturn which totaled $3,992 and $4,693 in the first quarters of 1999 and
1998, respectively. 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. See "Part II - Item 1. Legal
Proceedings" for further discussion. Interest income from investments was $1,823
for the first quarter of 1999, compared to $1,944 for the first quarter of 1998.
During the first quarter of 1999, interest expense amounted to $240, up from $96
for the comparable period in 1998.
PROVISION (BENEFIT) FOR INCOME TAXES
The benefit for income taxes amounted to $2,361 for the quarter ended March 31,
1999, as compared to a benefit of $2,103 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 three quarters of 1999 and beyond.
9
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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 $12,998 at March 31, 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 in the
first quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH AND INVESTMENTS
Total cash and short-term investments at March 31, 1999 were $95,985 compared to
$137,585 at the end of 1998. Cash used by operations was $11,304 for the first
three months of 1999 compared to cash used by operations of $4,992 during the
same period of 1998. During the first quarters 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 the first quarters of 1999 and
1998. Cash used by investing activities, excluding short-term investments, was
$2,952 and $10,371 in the first quarter 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 quarter 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 $(26,739)
for the first three months of 1999 compared to $2,517 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 $124,013 at March 31, 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 91 days at the end of the first
quarter of 1999. This increase in average trade receivables days sales
outstanding is principally attributable to a few large contract sales where the
Company provided its customers extended payment terms.
TERM RECEIVABLES, LONG-TERM
Term receivables, long-term increased to $50,266 at the end of the first 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 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.
10
<PAGE>
CAPITAL RESOURCES
Total capital expenditures decreased to $3,571 through March 31, 1999, compared
to $6,371 for the same period of 1998. Expenditures in the first quarter 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
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 potential
slowing of growth in other regions. As a result, many companies in the
electronics industry have announced employee layoffs and will likely curtail the
number of electronic design projects and the level of demand for design
automation capital which could result in decreased spending for 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. This litigation 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 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 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
11
<PAGE>
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.
A significant percent of the Company's sales to European customers is U.S.
dollar based. However, the Company is affected by the emergence of the new
European Monetary Unit and is currently implementing and testing system changes
to support transactions in this currency. Provided the Company's European
Monetary Unit project is completed on a timely basis, the expense of the
project, and its related effect on the Company's earnings, is not expected to be
material.
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.
12
<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 remediating the Year 2000 problem on this equipment. The
Company estimates that its total cost of completing any required modifications,
upgrades or replacements of these internal systems should total approximately
$1,500 for the rest of 1999. Identifiable expenditures through the first quarter
of 1999 have totaled approximately $2,800.
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.
13
<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 relates
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 March 31, 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................................. $ 94,297 4.78%
Short-term investments - fixed rate........................... 1,688 7.00%
------------ ------------
Total interest bearing instruments............................ $ 95,985 4.82%
============ ============
- -------------------------------------------------------------------------------------------------
</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 March
31, 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.
14
<PAGE>
The following table provides information about the Company's foreign exchange
forward contracts at March 31, 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 March 31, 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>
Euro.......................................................... $ 23,404 $ 1.15
Japanese yen.................................................. 11,676 118.24
British pound sterling........................................ 2,734 1.63
Other......................................................... 3,733 -
- --------------------------------------------------------------------------------------------------
</TABLE>
The unrealized gain (loss) on the outstanding forward contracts at March 31,
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.
15
<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. 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 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 has violated a European patent owned by Quickturn and awarded
unspecified damages. The Company has been prohibited from offering or selling
certain of its hardware emulation products 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 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 its existing U.S. customers. That order took
effect in 1998. A trial in the U.S. District Court action is scheduled in June
1999, 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 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 date in the U.S. District Court has been set for the first
quarter of 2000.
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 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.
16
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
(All numerical references in thousands, except for percentages)
A Special Meeting of Shareholders of the Company was held pursuant to notice at
5:00 p.m. Pacific time on March 10, 1999 at the Company's offices in
Wilsonville, Oregon. There were present at the meeting, in person or represented
by proxy, the holders of 60,886 shares of the outstanding common stock, which
represented approximately 92% 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
Special Meeting was called for the purpose of voting on amendments to the
Company's 1989 Employee Stock Purchase Plan. The amendments were approved with
52,674 shares voted for approval, 8,040 shares voted against, and 172 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
17
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<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 94,297
<SECURITIES> 1,688
<RECEIVABLES> 124,013
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 255,300
<PP&E> 92,009
<DEPRECIATION> 0
<TOTAL-ASSETS> 425,338
<CURRENT-LIABILITIES> 134,350
<BONDS> 0
0
0
<COMMON> 305,845
<OTHER-SE> (17,619)
<TOTAL-LIABILITY-AND-EQUITY> 425,338
<SALES> 122,573
<TOTAL-REVENUES> 122,573
<CGS> 29,828
<TOTAL-COSTS> 29,828
<OTHER-EXPENSES> 100,655
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 240
<INCOME-PRETAX> (10,731)
<INCOME-TAX> (2,361)
<INCOME-CONTINUING> (8,370)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,370)
<EPS-PRIMARY> (.13)
<EPS-DILUTED> (.13)
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