<PAGE>
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, 2000. 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 August 7,
2000: 64,171,951
<PAGE>
MENTOR GRAPHICS CORPORATION
Index to Form 10-Q
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE NUMBER
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<S> <C>
Item 1. Financial Statements
Consolidated Statements of Operations for the three 3
months ended June 30, 2000 and 1999
Consolidated Statements of Operations for the six 4
months ended June 30, 2000 and 1999
Consolidated Balance Sheets as of June 30, 2000 5
and December 31, 1999
Consolidated Statements of Cash Flows for the 6
six months ended June 30, 2000 and 1999
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 10-16
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 16-17
PART II OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings 18-19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 19
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</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 2000 1999
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IN THOUSANDS, EXCEPT PER SHARE DATA
<S> <C> <C>
REVENUES:
System and software $ 78,015 $ 66,670
Service and support 60,037 52,837
------------ ------------
Total revenues 138,052 119,507
------------ ------------
COST OF REVENUES:
System and software 7,518 6,968
Service and support 21,879 21,960
------------ ------------
Total cost of revenues 29,397 28,928
------------ ------------
Gross margin 108,655 90,579
------------ ------------
OPERATING EXPENSES:
Research and development 31,159 27,687
Marketing and selling 48,961 41,465
General and administration 12,182 10,890
Special charges 6,521 5,256
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Total operating expenses 98,823 85,298
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OPERATING INCOME 9,832 5,281
Other income (expense), net (2,144) (5,687)
------------ ------------
Income (loss) before income taxes 7,688 (406)
Income tax expense (benefit) 1,691 (89)
------------ ------------
Net income (loss) $ 5,997 $ (317)
============ ============
Net income (loss) per share:
Basic $ .09 $ .00
============ ============
Diluted $ .09 $ .00
============ ============
Weighted average number of shares outstanding:
Basic 63,400 66,355
============ ============
Diluted 66,254 66,355
============ ============
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</TABLE>
3
<PAGE>
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 2000 1999
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IN THOUSANDS, EXCEPT PER SHARE DATA
<S> <C> <C>
REVENUES:
System and software $ 150,654 $ 139,410
Service and support 115,532 102,670
------------ ------------
Total revenues 266,186 242,080
------------ ------------
COST OF REVENUES:
System and software 12,847 14,414
Service and support 43,323 44,342
------------ ------------
Total cost of revenues 56,170 58,756
------------ ------------
Gross margin 210,016 183,324
------------ ------------
OPERATING EXPENSES:
Research and development 61,168 56,556
Marketing and selling 93,734 83,780
General and administration 25,112 23,786
Special charges 6,521 21,831
------------ ------------
Total operating expenses 186,535 185,953
------------ ------------
OPERATING INCOME (LOSS) 23,481 (2,629)
Other income (expense), net (2,412) (8,508)
------------ ------------
Income (loss) before income taxes 21,069 (11,137)
Income tax expense (benefit) 4,635 (2,450)
------------ ------------
Net income (loss) $ 16,434 $ (8,687)
============ ============
Net income (loss) per share:
Basic $ .26 $ (.13)
============ ============
Diluted $ .25 $ (.13)
============ ============
Weighted average number of shares outstanding:
Basic 63,876 66,225
============ ============
Diluted 66,648 66,225
============ ============
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</TABLE>
4
<PAGE>
Mentor Graphics Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, 2000 DECEMBER 31, 1999
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IN THOUSANDS (Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 83,019 $ 95,637
Short-term investments 37,704 37,550
Trade accounts receivable, net 136,839 125,417
Other receivables 4,955 6,440
Prepaid expenses and other 17,806 14,921
Deferred income taxes 10,897 10,954
------------ ------------
Total current assets 291,220 290,919
PROPERTY, PLANT AND EQUIPMENT, NET 79,427 83,970
TERM RECEIVABLES, LONG-TERM 29,362 31,695
OTHER ASSETS, NET 44,610 42,755
------------ ------------
Total assets $ 444,619 $ 449,339
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,533 $ 9,979
Income taxes payable 24,329 22,599
Accrued payroll and related liabilities 34,747 41,628
Accrued liabilities 34,143 37,085
Deferred revenue 61,706 46,425
------------ ------------
Total current liabilities 162,458 157,716
OTHER LONG-TERM DEFERRALS 1,216 1,221
MINORITY INTEREST 1,857 1,622
STOCKHOLDERS' EQUITY:
Common stock 265,552 289,478
Accumulated deficit (3,928) (20,362)
Accumulated other comprehensive income - foreign
currency translation adjustment 17,464 19,664
------------ ------------
Total stockholders' equity 279,088 288,780
------------ ------------
Total liabilities and stockholders' equity $ 444,619 $ 449,339
============ ============
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</TABLE>
5
<PAGE>
Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 2000 1999
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IN THOUSANDS
<S> <C> <C>
OPERATING CASH FLOWS:
Net income (loss) $ 16,434 $ (8,687)
Adjustments to reconcile net income (loss) to net
cash used by operating activities:
Depreciation and amortization of
property, plant and equipment 9,857 11,540
Deferred taxes 156 244
Amortization of other assets 2,739 1,695
Write-down of assets 4,504 18,134
Business disposals -- 4,497
Gain on sale of property, plant, and equipment, net (3,118) --
Gain on sale of investments -- (3,669)
Changes in operating assets and liabilities, net of
assets acquired:
Trade accounts receivable (12,535) 6,230
Prepaid expenses and other (861) 5,871
Term receivables, long-term 2,003 (9,351)
Accounts payable (2,568) (3,227)
Accrued liabilities (10,844) (18,683)
Other liabilities and deferrals 17,082 4,365
------------ ------------
Net cash provided by operating activities 22,849 8,959
------------ ------------
INVESTING CASH FLOWS:
Net maturities (purchases) of short-term
investments (154) 15,690
Purchases of property, plant and equipment, net (6,755) (7,825)
Purchases of businesses and equity interests (8,458) (7,572)
Proceeds from sale of property, plant, and equipment 4,725 2,020
Proceeds from sale of investments -- 8,191
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Net cash provided (used) by investing activities (10,642) 10,504
------------ ------------
FINANCING CASH FLOWS:
Proceeds from issuance of common stock 17,608 5,764
Repayment of short-term borrowings -- (24,000)
Repurchase of common stock (41,534) (5,998)
------------ ------------
Net cash used by financing activities (23,926) (24,234)
------------ ------------
Effect of exchange rate changes on cash and
cash equivalents
(899) (168)
------------ ------------
Net change in cash and cash equivalents (12,618) (4,939)
Cash and cash equivalents at beginning of period 95,637 118,512
------------ ------------
Cash and cash equivalents at end of period $ 83,019 $ 113,573
============ ============
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</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE>
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 1999 to conform with the 2000 presentation.
(2) SPECIAL CHARGES - During the first six months of 2000 the Company
recorded special charges of $6,521. The charges consisted of costs
attributable to two acquisitions accounted for as purchases and
impairment in value of certain goodwill and purchased technology. In
addition, the Company incurred certain costs for employee terminations,
including terminations resulting from the acquisition of Escalade Corp.
Substantially all of the costs associated with these charges were
expended during the quarter and the remainder should be expended in the
second half of 2000.
In May 2000, the Company acquired Descon Informationssysteme GMBH, a
provider of applications that focus on the component, library and
design management needs of electronic manufacturing enterprises. The
total purchase price including cash, transaction costs and net assets
assumed was $5,212 and the acquisition was accounted for as a purchase.
The cost of the acquisition was allocated on the basis of the estimated
fair value of assets and liabilities assumed. This allocation resulted
in a charge for in-process research and development of $2,220.
Capitalized goodwill and technology allocations were $252 and $2,740,
respectively. The goodwill and technology is being amortized to R&D and
system and software product cost of goods sold over five years,
respectively. The separate results of operations were not material
compared to the Company's overall results of operations, and
accordingly pro-forma financial statements of the combined entities
have been omitted.
In May 2000, the Company acquired Escalade Corp., a provider of
Hardware Description Language (HDL) graphical design tools for
application specific integrated circuits (ASICs) and field programmable
gate arrays (FPGAs). The total purchase price including cash,
transaction costs and net assets assumed was $2,673 and the acquisition
was accounted for as a purchase. The cost of the acquisition was
allocated on the basis of the estimated fair value of assets assumed.
This allocation resulted in a charge for in-process research and
development of $940. In addition, capitalized goodwill and technology
allocations were $903 and $830, respectively. The goodwill and
technology is being amortized to R&D and system and software product
cost of goods sold over three years, respectively.
The following Mentor Graphics and Escalade Corp. pro forma information
assumes the acquisition occurred as of the beginning of each period
presented. The pro forma results are not necessarily indicative of what
actually would have occurred had the acquisition been in effect for the
periods presented. In addition, they are not intended to be a
projection of future results that may be achieved from the combined
operations.
<TABLE>
<CAPTION>
Six months ended June 30, 2000 1999
--------------------------------------------------------- -------------------- ---------------------
<S> <C> <C>
Revenue $ 267,395 $ 243,490
Net income (loss) $ 14,585 $ (12,824)
Basic net income (loss) per share $ 0.23 $ (0.19)
Diluted net income (loss) per share $ 0.22 $ (0.19)
--------------------------------------------------------- -------------------- ---------------------
</TABLE>
7
<PAGE>
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 is being amortized to R&D over five years and system and
software product cost of goods sold over three years, respectively.
(3) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - The following
provides additional information concerning cash flow activities:
<TABLE>
<CAPTION>
Six months ended June 30, 2000 1999
----------------------------------------------------------- -------------------- ---------------------
<S> <C> <C>
Interest paid $ 586 $ 412
Income taxes paid, net of refunds $ 2,453 $ 1,201
Issuance of stock options for purchase of
minority interest of subsidiary $ - $ 5,232
----------------------------------------------------------- -------------------- ---------------------
</TABLE>
(4) COMPREHENSIVE INCOME (LOSS) - The following provides a summary of
comprehensive income (loss):
<TABLE>
<CAPTION>
Six months ended June 30, 2000 1999
----------------------------------------------------------- -------------------- ---------------------
<S> <C> <C>
Net income (loss) $ 16,434 $ (8,687)
Foreign currency translation adjustment (2,200) (1,529)
------------------ ------------------
Comprehensive income (loss) $ 14,234 $ (10,216)
================= ==================
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</TABLE>
(5) REVENUE RECOGNITION - The Company has adopted the provisions of
Statement of Position (SOP) 97-2, "Software Revenue Recognition" and
SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions", which amends SOP 97-2 and supercedes
SOP 98-4. Under SOP 97-2, license revenues are recognized when
persuasive evidence of an arrangement exists, delivery of the product
has occurred, no significant company obligations remain, the fee is
fixed or determinable and collectibility is probable. 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 typically 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.
8
<PAGE>
SOP 98-9 amends certain paragraphs of SOP 97-2 to require recognition
of revenue using the "residual method" in circumstances outlined in the
SOP. Under the residual method revenue is recognized as follows: (1)
the total fair value of undelivered elements, as indicated by vendor
specific objective evidence (VSOE), is deferred and subsequently
recognized in accordance with the relevant sections of SOP 97-2 and (2)
the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related
to the delivered elements. SOP 98-9 is effective for the Company's
fiscal year 2000. The Company has applied the residual method to
multi-element transactions when VSOE was not present for all delivered
elements. Application of the residual method did not have a material
impact on the Company's consolidated financial statements.
(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 June 30, Six months ended June 30,
------------------------------------------------------------------------------------------
2000 1999 2000 1999
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<S> <C> <C> <C> <C>
REVENUES
Americas ..................... $ 62,428 $ 60,849 $ 124,334 $ 119,325
Europe ....................... 42,738 35,876 82,519 70,823
Japan ........................ 25,029 16,083 45,195 40,328
Pacific Rim .................. 7,857 6,699 14,138 11,604
------------ ------------ ------------ ------------
Total ............................. $ 138,052 $ 119,507 $ 266,186 $ 242,080
============ ============ ============ ============
OPERATING INCOME (LOSS)
Americas ..................... $ 32,584 $ 31,067 $ 65,755 $ 61,017
Europe ....................... 18,888 15,803 36,878 30,169
Japan ........................ 13,387 6,570 24,564 18,583
Pacific Rim .................. 5,041 4,042 8,970 6,696
Corporate .................... (60,068) (52,201) (112,686) (119,094)
------------ ------------ ------------ ------------
Total ............................. $ 9,832 $ 5,281 $ 23,481 $ (2,629)
============ ============ ============ ============
</TABLE>
9
<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,
2000 totaled $78,015 and $150,654, respectively, representing an increase of
$11,345 or 17% and $11,244 or 8% from the comparable periods of 1999. The
increases were attributable to both software product and accelerated
verification revenues. The growth in software product revenues was primarily
attributable to growth in the Company's newer product offerings and the
acquisition of VeriBest, Inc. (Veribest) in the fourth quarter of 1999. In
addition, the strengthening of the Japanese yen versus the U.S. dollar had a
favorable impact on revenues. See "Geographic Revenues Information" for further
discussion. The increase in accelerated verification system revenue was
primarily due to continued market acceptance and demand in Europe and Japan.
Accelerated verification systems products are not available in U.S. markets. See
"Part II - Item 1. Legal Proceedings" for further discussion.
System and software gross margins were 90% and 91% for the second quarter and
first six months of 2000, respectively, compared to 90% for the same periods a
year ago. Amortization of purchased technology to system and software cost of
goods sold was $380 and $1,259 for the second quarter and first six months of
2000, respectively, compared to $334 and $653 for the comparable periods in
1999. The increase in amortization of purchased technology is attributable to
the acquisition of VeriBest.
SERVICE AND SUPPORT
Service and support revenues for the three months and six months ended June 30,
2000 totaled $60,037 and $115,532, respectively, representing an increase of
$7,200 or 14% and $12,862 or 13% from the comparable periods of 1999. Service
and support revenues consist of software support and professional services, both
of which increased compared to 1999. The increase in software support revenue
was attributable to the acquisition of VeriBest, continued success of software
product offerings and larger installed base of customers. The increase in
professional service revenue was attributable to better utilization of global
resources.
Service and support gross margins were 64% and 63% for the second quarter and
first six months of 2000, compared to 58% and 57% for the comparable periods in
1999. The increase in overall service and support gross margins is due to higher
revenues and improved professional service utilization.
10
<PAGE>
GEOGRAPHIC REVENUES INFORMATION
Americas revenues including service and support revenues, increased 3% from the
second quarter of 1999 to the second quarter of 2000 and increased 4% from first
half of 1999 to the first half of 2000. Revenues outside of the Americas for the
second quarter and first six months of 2000 were 55% and 53% of total revenues
compared to 49% and 51% for comparable periods of 1999. Compared to the
respective prior periods, European revenues increased 19% and 17% in the second
quarter and the first six months of 2000 and Japanese revenues increased 56% and
12% in the second quarter and first six months of 2000. Exchange rate changes in
Europe resulted in negative impact to revenue of approximately 7% for both the
second quarter and the first six months of 2000. Exclusive of currency effects,
higher revenue levels in Europe were primarily due to continued strength in all
areas of the business. Japanese revenues were positively impacted by exchange
rate changes in the comparable periods, where the Japanese yen strengthened
against the U.S. dollar by approximately 18% and 11% in the second quarter and
the first six months of 2000. Exclusive of currency effects, higher revenue
levels in Japan were primarily due to growth in sales of accelerated
verification products. 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.
OPERATING EXPENSES
Research and development expenses totaled $31,159 and $27,687 or 23% of revenues
for the second quarters of 2000 and 1999, respectively and $61,168 and $56,556
or 23% of revenues for the first six months of 2000 and 1999, respectively.
Marketing and selling expenses totaled $48,961 and $41,465 or 35% of revenues
for the second quarters of 2000 and 1999, respectively and $93,734 and $83,780
or 35% of revenues for the first six months of 2000 and 1999, respectively.
General and administration expenses totaled $12,182 and $10,890 or 9% of
revenues for the second quarters of 2000 and 1999, respectively and $25,112 and
$23,786 or 9% and 10% for the first six months of 2000 and 1999, respectively.
The increase in absolute dollars is primarily attributable to the VeriBest
acquisition, increased product sales and annual and competitive salary
adjustments.
SPECIAL CHARGES
During the first six months of 2000 the Company recorded special charges of
$6,521. The charges consisted of costs attributable to two acquisitions
accounted for as purchases and impairment in value of certain goodwill and
purchased technology. In addition, the Company incurred certain costs for
employee terminations, including terminations resulting from the acquisition of
Escalade Corp. Substantially all of the costs associated with these charges were
expended during the quarter and the remainder should be expended in the second
half of 2000.
In May 2000, the Company acquired Descon Informationssysteme GMBH, a provider of
applications that focus on the component, library and design management needs of
electronic manufacturing enterprises. The total purchase price including cash,
transaction costs and net assets assumed was $5,212 and the acquisition was
accounted for as a purchase. The cost of the acquisition was allocated on the
basis of the estimated fair value of assets and liabilities assumed. This
allocation resulted in a charge for in-process research and development of
$2,220. Capitalized goodwill and technology allocations were $252 and $2,740,
respectively. The goodwill and technology is being amortized to R&D and system
and software product cost of goods sold over five years, respectively.
In May 2000, the Company acquired Escalade Corp., a provider of Hardware
Description Language (HDL) graphical design tools for application specific
integrated circuits (ASICs) and field programmable gate arrays (FPGAs). The
total purchase price including cash, transaction costs and net assets assumed
was $2,673 and the acquisition was accounted for as a purchase. The cost of the
acquisition was allocated on the basis of the estimated fair value of assets
assumed. This allocation resulted in a charge for in-process research and
development of $940. In addition, capitalized goodwill and technology
allocations were $903 and $830, respectively. The goodwill and technology is
being amortized to R&D and system and software product cost of goods sold over
three years, respectively.
11
<PAGE>
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 is being amortized to R&D over five
years and system and software product cost of goods sold over three years,
respectively.
OTHER EXPENSE, NET
Other expense, net totaled $2,144 and $2,412 for the second quarter and first
six months of 2000 compared to $5,687 and $8,508 for the same periods of 1999.
The period to period decrease is attributable in part to a gain on the sale of a
parcel of land adjacent to the Company's headquarters of $3,118 during 2000. In
addition, other expense was positively impacted by lower legal costs associated
with the ongoing patent litigation with Quickturn which totaled $2,986 and
$6,289 in the second quarter and first six months of 2000, respectively compared
to $6,850 and $10,883 for comparable periods of 1999. See "Part II - Item 1.
Legal Proceedings" for further discussion. The decrease is also attributable to
a 1999 legal settlement of $3,000 for the Portland, Oregon SimExpress trial.
Interest income from investments was $2,057 and $4,150 for the second quarter
and the first six months of 2000, compared to $1,804 and $3,627 for comparable
periods of 1999. Interest expense was $404 and $925 for the second quarter and
first six months of 2000, compared to $216 and $456 for comparable periods in
1999.
PROVISION (BENEFIT) FOR INCOME TAXES
The provision for income taxes amounted to $4,635 for the six months ended June
30, 2000, as compared to a benefit of $2,450 for the same period in 1999. The
tax expense (benefit) 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 for each year 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 2000 and beyond.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS
Approximately half of the Company's revenues are generated outside of the United
States. For 2000 and 1999, 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 $17,464 at June 30, 2000, from $19,664 at the end
of 1999. This reflects the decrease in the value of net assets denominated in
foreign currencies since year-end 1999 as a result of a stronger U.S. dollar as
of June 30, 2000.
12
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
CASH AND INVESTMENTS
Total cash and short-term investments at June 30, 2000 were $120,723 compared to
$133,187 at the end of 1999. Cash provided by operations was $22,849 for the
first six months of 2000 compared to $8,959 during the same period of 1999.
During the first half of 2000 operating cash was positively impacted by net
income from operations of $16,434 while for 1999, it was negatively impacted by
the net loss from operations of $8,687. Cash used by investing activities,
excluding short-term investments, was $10,488 and $5,186 in the first half of
2000 and 1999, respectively. Investing activities in the first half of 2000
included capital expenditures and purchase of Descon and Escalade for $8,458
offset by sale of land adjacent to the Company's Wilsonville headquarters to a
third party for $4,725. Investing activities in the first half of 1999 included
purchase of the minority interest in Exemplar for $7,572 and capital
expenditures offset by sale of Quickturn stock for $8,191. Cash used by
financing activities was $23,926 for the first half of 2000 compared to $24,234
during the same period of 1999. Cash and short-term investments were positively
impacted by the proceeds from issuance of common stock upon exercise of stock
options and employee stock plan purchases in the amount of $17,608 and $5,764 in
2000 and 1999, respectively. Cash used for financing activities in 2000 included
a repurchase of 2,500 shares of common stock for $41,534. The financing use of
cash in 1999 included the pay-down of a short-term borrowing of $24,000 and a
repurchase of 528 shares of common stock for $5,998.
TRADE ACCOUNTS RECEIVABLE
Trade accounts receivable increased to $136,839 at June 30, 2000 from $125,417
at year-end 1999. Excluding the current portion of term receivables of $55,888
and $54,375, average days sales outstanding were 53 days and 41 days at June 30,
2000 and December 31, 1999, respectively. Average days sales outstanding in
total accounts receivable increased from 73 days at the end of 1999 to 89 days
at the end of the second quarter of 2000. The increase in average trade
receivable days sales outstanding was due to the mix of revenue volume by
geography and less extended term contract sales in the second quarter of 2000
compared to the fourth quarter of 1999. Current quarter revenue mix was more
heavily weighted towards foreign geographies where payment terms are typically
longer. In the quarters where term contract revenue is recorded only about
one-third, or twelve months, of the receivable is reflected in current accounts
receivable. In the following quarters, the same amount is reflected in current
accounts receivable without the corresponding revenue. In addition, the Company
sold short-term accounts receivable of $19,404 and $23,011 to a financing
institution on a non-recourse basis in the second quarter of 2000 and the fourth
quarter of 1999, respectively.
PREPAID EXPENSES AND OTHER
Prepaid expenses and other increased $2,885 from December 31, 1999 to June 30,
2000. This increase was primarily due to higher accelerated verification systems
inventory, which is expected to ship in the third quarter of 2000. In addition,
prepaid income taxes and benefits costs increased from year-end 1999.
TERM RECEIVABLES, LONG-TERM
Term receivables, long-term decreased to $29,362 at June 30, 2000 compared to
$31,695 at December 31, 1999. 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.
13
<PAGE>
ACCRUED PAYROLL AND RELATED LIABILITIES
Accrued payroll and related liabilities decreased $6,881 from December 31, 1999
to June 30, 2000. This decrease was primarily due to payments of 1999's annual
and fourth quarter incentive compensation.
CAPITAL RESOURCES
Total capital expenditures decreased to $6,755 through June 30, 2000, compared
to $7,825 for the same period of 1999. Expenditures in the first quarter of 2000
and 1999 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133 establishes methods
of accounting for derivative financial instruments and hedging activities
related to those instruments as well as other hedging activities. In June 1999,
the FASB issued Statement No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES--DEFERRAL OF THE EFFECTIVE DATE OF FASB STATEMENT NO. 133.
Statement No. 137 defers the effective date of Statement No. 133 for one year.
Statement No. 133 is now effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000. The Company is currently evaluating the adoption
of SFAS Nos. 133 and 137 and its potential impact on its financial condition or
results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of the Staff's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. In June 2000, SAB 101B was issued which
defers the implementation date of SAB 101 until October 1, 2000. The Company is
currently evaluating the adoption of SAB 101 and its potential impact on its
financial condition or results of operations.
In March 2000, the Financial Accounting Standards Board, or FASB, issued
Interpretation No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK
COMPENSATION - AN INTERPRETATION OF APB OPINION NO. 25, (FIN 44). FIN 44 applies
prospectively to new awards, exchanges of awards in a business combination,
modifications to outstanding awards, and changes in grantee status that occur on
or after July 1, 2000, except for the provisions related to repricings and the
definition of an employee, which apply to awards issued after December 15, 1998.
The provisions related to modifications to fixed stock options awards to add a
reload feature are effective for awards modified after January 12, 2000. The
Company does not expect that this statement will have a significant impact on
our financial condition or results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
Certain 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 electronic design
automation (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. Additionally, new pricing and selling models in
the industry,
14
<PAGE>
including the use of fixed term licenses and subscription transactions versus
traditional perpetual licenses further complicate the Company's ability to
effectively price and package large multi-element contracts that are
competitive and profitable.
The Company's business is largely dependent upon the success and growth of the
electronics industry. From time to time the electronics industry cuts costs
through employee layoffs and reductions in the number of electronic design
projects which could reduce demand for the Company's products and services. In
addition, there have been a number of mergers in the electronics industry
worldwide, 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 is in 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, a subsidiary of Cadence Design Systems, Inc., 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 first generation
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 could
adversely effect the Company's ability to sell its accelerated verification
products in other jurisdictions worldwide and may negatively affect demand
for accelerated verification products for the Company 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.
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.
15
<PAGE>
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.
New or revised accounting standards, interpretation of standards and rules are
issued from time to time. Although they are not expected to have a material
impact on the reported financial results, they could have such an effect.
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.
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 June 30, 2000. In accordance with the Company's
investment policy all investments mature in twelve months or less.
<TABLE>
<CAPTION>
Carrying Average
Principal (notional) amounts in U.S. dollars Amount Interest Rate
-----------------------------------------------------------------------------------------------
<S> <C> <C>
Cash equivalents - fixed rate $ 26,472 6.53%
Short-term investments - fixed rate 37,704 6.52%
------------ ------------
Total interest bearing instruments $ 64,176 6.52%
============ ============
-----------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
FOREIGN CURRENCY RISK
The Company enters into foreign exchange options for highly anticipated sales
transactions between its foreign subsidiaries. These instruments provide the
Company the right to sell foreign currencies to third parties at future dates
with fixed exchange rates. The premium on such instruments is immaterial and is
amortized over the life of the contracts to other income (expense). The Company
currently has foreign currency options outstanding to sell Japanese yen over the
next 6 months with contract values totaling approximately $15,645 at average
contract exchange rates of approximately JPY 108.66. At June 30, 2000 the
difference between the recorded value and the fair value of the Company's
foreign exchange position related to these option contracts was approximately
zero.
The Company entered into a forward contract to stabilize the currency effects on
a portion of the Company's net investment in its Japanese subsidiary. This
contract to sell 2.65 billion Japanese yen will guarantee the Company $25,214 at
the contract's expiration. Any differences between the contracted currency rate
and the currency rate at each balance sheet date will impact the foreign
currency translation adjustment component of the stockholders' equity section of
the consolidated balance sheet. The result is a partial offset of the effect of
Japanese currency changes on stockholders' equity during the contract term. This
forward contract should not impact current or future consolidated statements of
operations. At June 30, 2000, the difference between the recorded value and the
fair value of the Company's foreign exchange position related to this contract
was approximately zero.
The Company also enters into forward foreign exchange contracts as a hedge
against foreign currency sales commitments and intercompany balances.
Remeasurement gains and losses on forward 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, 2000,
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 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.
The following table provides information about the Company's foreign exchange
forward contracts at June 30, 2000. 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, 2000. 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>
Japanese yen $ 9,759 $ 106.58
French franc 4,116 6.90
Euro 4,760 1.05
Swedish krona 4,446 8.82
Swiss franc 1,281 1.64
Italian lira 1,005 2,036.04
Other 2,151 -
------------------------------------------------------------------------------------------------------------------
</TABLE>
The unrealized gain (loss) on the outstanding forward contracts at June 30,
2000, 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 importation 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, the Company can give no
assurance as to the outcome of such proceeding.
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, based on a patent licensed to the Company
and Meta and which Meta obtained a right to enforce, sought damages for
infringement as a result of Quickturn's manufacture and sale of certain
emulation equipment. Meta was joined in the suit by Aptix Corporation of San
Jose, California. In June 2000, the court granted a motion brought by Quickturn
to dismiss the case on the ground that Aptix's CEO Dr. Amr Mohsen falsified and
destroyed evidence during the litigation. Due to Dr. Mohsen's misconduct, the
court found the Aptix patent to be unenforceable by anyone, including Meta. The
court specifically made no findings that either Meta or the Company engaged in
any misconduct. The court ordered Aptix to pay Quickturn all of its attorneys'
fees and expenses. No sanctions were awarded against Meta or the Company. Meta
has appealed the court's decision.
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 patents
by Quickturn's Mercury product ("Mercury lawsuit"). That lawsuit was transferred
to the Northern District of California. The Company's suit has been amended to
allege that Quickturn's Mercury and Mercury Plus products infringe five patents
held by the Company. The Company is seeking a permanent injunction prohibiting
sales of Quickturn's Mercury and Mercury Plus products in the U.S., along with
damages and attorney's fees.
18
<PAGE>
In March 2000, the Company filed a misappropriation of trade secret case in U.S.
District Court in San Jose. This case alleges that Quickturn misappropriated
Meta trade secrets during Quickturn's evaluation of Meta's technology in
connection with a possible acquisition of Meta in 1994 and 1995. This case has
been consolidated with the Mercury lawsuit for purposes of discovery and
scheduling.
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 relation matters.
Item 6. Exhibits and Reports on Form 8-K.
On May 12, 2000, the Company filed a Current Report on Form 8-K to report under
Item 2 the acquisition of Escalade Corp., a Delaware corporation ("Escalade"),
through a merger of Escalade with a wholly owned subsidiary of the Company.
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.
<TABLE>
<S> <C>
Dated: August 11, 2000. MENTOR GRAPHICS CORPORATION
(Registrant)
/s/ Gregory K. Hinckley
-----------------------
Gregory K. Hinckley
Executive Vice President and
Chief Operating Officer /Chief Financial Officer
</TABLE>
