<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 March 31, 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 May 1, 2000:
63,219,013
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MENTOR GRAPHICS CORPORATION
Index to Form 10-Q
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page Number
-----------
<S> <C>
Item 1. Financial Statements
Consolidated Statements of Operations for the three 3
months ended March 31, 2000 and 1999
Consolidated Balance Sheets as of March 31, 2000 4
and December 31, 1999
Consolidated Statements of Cash Flows for the 5
three months ended March 31, 2000 and 1999
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 13-14
PART II OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 16
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Mentor Graphics Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 2000 1999
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IN THOUSANDS, EXCEPT PER SHARE DATA
<S> <C> <C>
REVENUES:
System and software $ 72,639 $ 72,740
Service and support 55,495 49,833
----------------- -----------------
Total revenues 128,134 122,573
----------------- -----------------
COST OF REVENUES:
System and software 5,329 7,446
Service and support 21,444 22,382
----------------- -----------------
Total cost of revenues 26,773 29,828
----------------- -----------------
Gross margin 101,361 92,745
----------------- -----------------
OPERATING EXPENSES:
Research and development 30,009 28,869
Marketing and selling 44,773 42,315
General and administration 12,930 12,896
Special charges - 16,575
----------------- -----------------
Total operating expenses 87,712 100,655
----------------- -----------------
OPERATING INCOME (LOSS) 13,649 (7,910)
Other expense, net (268) (2,821)
------------------ ------------------
Income (loss) before income taxes 13,381 (10,731)
Income tax expense (benefit) 2,944 (2,361)
----------------- ------------------
Net income (loss) $ 10,437 $ (8,370)
================= ==================
Net income (loss) per share:
Basic $ .16 $ (.13)
================= ==================
Diluted $ .16 $ (.13)
================= ==================
Weighted average number of shares outstanding:
Basic 64,124 66,213
================= =================
Diluted 66,781 66,213
================= =================
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</TABLE>
3
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Mentor Graphics Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 31, 2000 DECEMBER 31, 1999
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IN THOUSANDS (Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 74,542 $ 95,637
Short-term investments 25,597 37,550
Trade accounts receivable, net 126,693 125,417
Other receivables 5,799 6,440
Prepaid expenses and other 20,570 14,921
Deferred income taxes 10,889 10,954
----------------- -----------------
Total current assets 264,090 290,919
PROPERTY, PLANT AND EQUIPMENT, NET 79,573 83,970
TERM RECEIVABLES, LONG-TERM 29,616 31,695
OTHER ASSETS, NET 40,577 42,755
----------------- -----------------
Total assets $ 413,856 $ 449,339
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable 7,071 9,979
Income taxes payable 23,354 22,599
Accrued payroll and related liabilities 27,602 41,628
Accrued liabilities 32,392 37,085
Deferred revenue 57,272 46,425
----------------- -----------------
Total current liabilities 147,691 157,716
OTHER LONG-TERM DEFERRALS 1,165 1,221
COMMITMENTS AND CONTINGENCIES - -
MINORITY INTEREST 1,696 1,622
STOCKHOLDERS' EQUITY:
Common stock 256,659 289,478
Accumulated deficit (9,925) (20,362)
Accumulated other comprehensive income - foreign currency
translation adjustment 16,570 19,664
----------------- -----------------
Total stockholders' equity 263,304 288,780
----------------- -----------------
Total liabilities and stockholders' equity $ 413,856 $ 449,339
================= =================
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</TABLE>
4
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Mentor Graphics Corporation
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 2000 1999
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IN THOUSANDS
<S> <C> <C>
OPERATING CASH FLOWS:
Net income (loss) $ 10,437 $ (8,370)
Adjustments to reconcile net income (loss) to net cash used by operating
activities:
Depreciation and amortization of
property, plant and equipment 4,845 6,180
Deferred taxes 101 (203)
Amortization of other assets 1,673 971
Write-down of assets - 18,134
Business disposals - 746
Gain on sale of property, plant, and equipment, net (3,118) -
Gain on sale of investments - (3,669)
Changes in operating assets and liabilities:
Trade accounts receivable (3,581) 1,276
Prepaid expenses and other (5,534) 1,827
Term receivables, long-term 1,518 (14,654)
Accounts payable (2,813) (3,623)
Accrued liabilities (17,945) (17,549)
Other liabilities and deferrals 12,466 7,630
----------------- -----------------
Net cash used by operating activities (1,951) (11,304)
------------------ ------------------
INVESTING CASH FLOWS:
Net maturities of short-term investments 11,953 17,386
Purchases of property, plant and equipment, net (2,309) (3,571)
Purchases of equity interests - (7,572)
Proceeds from sale of property, plant, and equipment 4,725 -
Proceeds from sale of investments - 8,191
----------------- -----------------
Net cash provided by investing activities 14,369 14,434
----------------- -----------------
FINANCING CASH FLOWS:
Proceeds from issuance of common stock 8,715 3,259
Repayment of short-term borrowings - (24,000)
Repurchase of common stock (41,534) (5,998)
------------------ ------------------
Net cash used by financing activities (32,819) (26,739)
------------------ ------------------
Effect of exchange rate changes on
cash and cash equivalents (694) (606)
------------------ ------------------
Net change in cash and cash equivalents (21,095) (24,215)
Cash and cash equivalents at beginning of period 95,637 118,512
----------------- -----------------
Cash and cash equivalents at end of period $ 74,542 $ 94,297
================= =================
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</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
5
<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 three months of 1999 the Company
recorded special charges of $16,575 compared to zero in the same period
of 2000. 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 research and development (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.
(3) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - The following
provides additional information concerning cash flow activities:
<TABLE>
<CAPTION>
Three months ended March 31, 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest paid $ 237 $ 219
Income taxes paid, net of refunds $ 2,019 $ 195
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>
Three months ended March 31, 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net income (loss) $ 10,437 $ (8,370)
Foreign currency translation adjustment (3,094) (1,178)
------------------ ------------------
Comprehensive income (loss) $ 7,343 $ (9,548)
================= ==================
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</TABLE>
6
<PAGE>
(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.
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 March 31, 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REVENUES
Americas $ 61,906 $ 58,476
Europe 39,781 34,947
Japan 20,166 24,245
Pac Rim 6,281 4,905
----------------- -----------------
Total $ 128,134 $ 122,573
================= =================
OPERATING INCOME (LOSS)
Americas $ 33,171 $ 30,181
Europe 17,990 13,627
Japan 11,177 12,013
Pac Rim 3,929 2,652
Corporate (52,618) (66,383)
------------------ ------------------
Total $ 13,649 $ (7,910)
================= ==================
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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, 2000 totaled
$72,639, which was approximately flat compared to the first quarter of 1999.
Software product revenues increased while accelerated verification revenue
declined for the 2000 period. The decrease in accelerated verification system
sales was partly due to timing of delivery as defined by the Company's
customers. 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 93% and 90% for the quarters ended March
31, 2000 and 1999, respectively. Gross margins were favorably impacted in 2000
by a slight increase in mix of higher margin software sales and improved
margins on accelerated verification sales partly offset by increased technology
amortization. Purchased technology amortization to system and software cost of
goods sold was $878 and $402 for the quarters ended March 31, 2000 and 1999,
respectively. The increase in amortization of purchased technology is
attributable to the acquisition of VeriBest, Inc. (VeriBest) in the fourth
quarter of 1999.
SERVICE AND SUPPORT
Service and support revenues for the first quarter of 2000 totaled $55,495
compared to $49,833 for the same period of 1999. Service and support revenues
consist of software support and professional services, both of which increased
compared to the first quarter of 1999. The increase in software support revenue
was attributable to earlier renewal of annual support contracts, the
acquisition of VeriBest, and the increase in prior period software product
sales, which increased the installed base of customers.
Service and support gross margins were 61% and 55% for the quarters ended March
31, 2000 and 1999, 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 6%
compared to the first quarter of 1999. Revenues outside of the Americas
represented 52% of total revenues in for the first quarters of 2000 and 1999.
European revenues increased by approximately 14% from the first quarter of
1999. Japanese revenues decreased by approximately 17% from the first quarter
of 1999. The effects of exchange rate differences from the Japanese Yen to the
U.S. dollar positively impacted revenues by approximately 7%. Exclusive of
currency effects, lower revenue levels in Japan are partly due to two large
accelerated verification transactions in the first quarter of 1999 which were
not matched in the same period this year. 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 $30,009 and $28,869 or 23% and 24% of
revenues for the first quarters of 2000 and 1999, respectively. Marketing and
selling expenses totaled $44,773 and $42,315 or 35% of revenues for the first
quarters of 2000 and 1999. General and administration expenses totaled $12,930
and $12,896 or 10% and 11% of revenues for the first quarters of 2000 and 1999,
respectively. The increase in expense in absolute dollars is primarily
attributable to the VeriBest acquisition.
SPECIAL CHARGES
During the first three months of 1999 the Company recorded special charges of
$16,575 compared to zero in the same period of 2000. The charges in 1999
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.
OTHER EXPENSE, NET
Other expense, net totaled $268 for the first quarter of 2000 compared to $2,821
for the same period of 1999. Other income (expense) was negatively impacted by
legal costs associated with the ongoing patent litigation with Quickturn which
totaled $3,303 and $3,992 in the first quarters of 2000 and 1999, respectively.
See "Part II - Item 1. Legal Proceedings" for further discussion. Other income
was positively impacted by a gain on the sale of a parcel of land adjacent to
the Company's headquarters of $3,118. Interest income from investments was
$2,093 for the first quarter of 2000, compared to $1,823 for the first quarter
of 1999. During the first quarter of 2000, interest expense amounted to $521, up
from $240 for the comparable period in 1999.
PROVISION (BENEFIT) FOR INCOME TAXES
The provision for income taxes amounted to $2,944 for the quarter ended March
31, 2000, as compared to a benefit of $2,361 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.
9
<PAGE>
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 $16,570 at March 31, 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 dollar in the
first quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND INVESTMENTS
Total cash and short-term investments at March 31, 2000 were $100,139 compared
to $133,187 at the end of 1999. Cash used by operations was $1,951 for the first
three months of 2000 compared to cash used by operations of $11,304 during the
same period of 1999. During the first quarter of 2000 operating cash was
positively impacted by net income from operations of $10,437 while for 1999, it
was negatively impacted by the net loss from operations of $8,370. Cash provided
(used) by investing activities, excluding short-term investments, was $2,416 and
$(2,952) in the first quarter of 2000 and 1999, respectively. Investing
activities in the first quarter of 2000 included cash received for the sale of
land adjacent to the Company's Wilsonville headquarters to a third party for
$4,725. 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. Cash used by financing activities was $32,819 for the first three months
of 2000 compared to $26,739 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 $8,715 and $3,259 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 $126,693 at March 31, 2000 from $125,417
at year-end 1999. Excluding the current portion of term receivables of $61,319
and $54,375, average days sales outstanding were 46 days and 41 days at March
31, 2000 and December 31, 1999, respectively. Average days sales outstanding in
total accounts receivable decreased from 91 days at the end of 1999 to 89 days
at the end of the first quarter of 2000. The Company sold short-term accounts
receivable of $23,166 and $25,886 to a financing institution on a non-recourse
basis in the first quarter of 2000 and the fourth quarter of 1999, respectively.
PREPAID EXPENSES AND OTHER
Prepaid expenses and other increased $5,649 from December 31, 1999 to March
31, 2000. This increase was primarily due higher accelerated verification
systems inventory, which is expected to ship in the second quarter of 2000.
Prepaid income taxes and benefits costs also increased during the quarter.
10
<PAGE>
TERM RECEIVABLES, LONG-TERM
Term receivables, long-term decreased to $29,616 at the end of the first quarter
of 1999 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.
ACCRUED PAYROLL AND RELATED LIABILITIES
The decrease in accrued payroll and related liabilities is related to payments
of 1999's annual and fourth quarter incentive compensation.
CAPITAL RESOURCES
Total capital expenditures decreased to $2,309 through March 31, 2000, compared
to $3,571 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 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. We do
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, 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.
11
<PAGE>
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 in which Quickturn has asserted that the
Company and Meta are infringing Quickturn patents. See "Part II-Item 1. Legal
Proceedings" for further discussion. The Company has been prohibited from using,
selling or marketing its SimExpress emulation products in the United States and
Germany. While the Company settled one SimExpress court case in the second
quarter of 1999, other legal proceedings and litigation continue. These actions
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.
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
12
<PAGE>
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.
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, 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 $ 47,679 4.88%
Short-term investments - fixed rate 25,597 5.16%
----------------- -------------
Total interest bearing instruments $ 73,276 4.97%
================= =============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
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 9 months with contract values totaling approximately $22,087 at
average contract
13
<PAGE>
exchange rates of approximately JPY 108.66. At March 31, 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 Yen 2.65 billion will guarantee the Company $25,130 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 March 31, 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 March 31, 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 March 31, 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 March 31, 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 $ 32,924 $ 105.48
French franc 31,391 6.34
Euro 5,817 1.02
Swedish krona 4,562 8.65
British pound sterling 3,292 1.57
Other 2,685 -
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The unrealized gain (loss) on the outstanding forward contracts at March 31,
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.
14
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During 1995, the Company filed suit in U.S. Federal District Court in Portland,
Oregon, against Quickturn Design Systems, Inc. (Quickturn) for a declaratory
judgment of non-infringement, invalidity and unenforceability of three of
Quickturn's patents. This action related to the SimExpress products of Meta
Systems SRL (Meta), a French company acquired by the Company in 1996. Quickturn
filed a counterclaim against the Company alleging infringement of six Quickturn
patents, including the three patents subject to the declaratory judgment action.
The counterclaim sought a permanent injunction prohibiting sales of the
Company's SimExpress products in the U.S., compensatory and punitive damages and
attorneys' fees. In June 1999, the Company and Quickturn settled this
litigation. The Company agreed that five Quickturn patents are valid and
enforceable, and were infringed by the Company's sale in the U.S. of its
SimExpress product from 1995-1997. Mentor Graphics also paid Cadence Design
Systems, Quickturn's parent company, $3 million in damages for infringement,
with each side to bear its own fees and costs. The court directed that the
Company's payment and its consent to the validity and infringement of the
Quickturn patents may not be used as evidence or for any other purpose in
litigation outside the U.S., and that the settlement does not address in any way
the issue of whether the Company's Celaro product infringes any patent issued in
the U.S. or other countries.
Quickturn filed an administrative complaint with the U.S. International Trade
Commission (ITC) in 1996 seeking to prohibit the distribution of SimExpress
products in the U.S. In December 1997, the ITC issued a Cease and Desist Order
prohibiting the Company from importing certain hardware emulation products or
components and from providing repair or maintenance services to its existing
U.S. customers. That order took effect in 1998. In October 1997, Quickturn filed
an action against the Company's German subsidiary in a German District Court
alleging infringement by SimExpress of a European patent. The German court ruled
in April 1999 that the Company's German subsidiary's sales of SimExpress
violated a European patent owned by Quickturn and awarded unspecified damages.
The Company's German subsidiary no longer offers the SimExpress product in
Germany. Although the Company is appealing the ruling and contesting the
validity of the Quickturn patent, the Company can give no assurance as to the
outcome of such proceedings.
In October 1998, Quickturn filed an action against Meta and the Company in
France alleging infringement by SimExpress and Celaro of a European patent.
There have been no rulings by the French court regarding the merits of this case
to date.
In February 1998, Meta filed a patent infringement action against Quickturn in
the U.S. District Court for the Northern District of California in San
Francisco, California. The complaint, which is based on a patent licensed to the
Company and Meta and which Meta has a right to enforce, seeks damages for
infringement as a result of Quickturn's manufacture and sale of certain
emulation equipment. Meta, which has been joined in the suit by Aptix
Corporation of San Jose, California, will ultimately seek an injunction
prohibiting further infringement by Quickturn. A trial in U.S. District Court is
expected to occur in October 2000.
In July 1999, the Company filed suit in U.S. District Court for the District of
Delaware against Quickturn alleging infringement of two Mentor Graphics owned
patents by Quickturn's Mercury product ("Mercury lawsuit"). That lawsuit has
been transferred to the Northern District of California. The Company is seeking
a permanent injunction prohibiting sales of Quickturn's Mercury products in the
U.S., along with damages and attorney's fees.
In March 2000, the Company filed a misappropriation of trade secret case in
U.S. District Court in San Jose. The 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. 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.
15
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
On January 14, 2000, the Company filed a Current Report on Form 8-K/A Amendment
No. 1 to amend its previously filed Form 8-K relating to the acquisition on
October 31, 1999 of substantially all of the assets of VeriBest, Inc., a
subsidiary of Intergraph Corporation. The amendment includes under Item 7 the
consolidated financial statements of VeriBest as of and for the periods ended
September 30, 1999 and December 31, 1998, and pro forma financial information as
of September 30, 1999 and for the periods ended September 30, 1999 and December
31, 1998.
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.
Dated: May 13, 2000. MENTOR GRAPHICS CORPORATION
(Registrant)
/s/ Gregory K. Hinckley
---------------------------
Gregory K. Hinckley
Executive Vice President and
Chief Operating Officer/Chief Financial Officer
16
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<S> <C>
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<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-END> MAR-31-2000
<CASH> 75,542
<SECURITIES> 25,597
<RECEIVABLES> 126,693
<ALLOWANCES> 0
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<CURRENT-ASSETS> 264,090
<PP&E> 79,573
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<COMMON> 256,659
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<SALES> 128,134
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