<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to _____________
Commission File Number : 0-22738
QUICKTURN DESIGN SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0159619
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
55 W. Trimble Road, San Jose, California 95131
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (408) 914-6000
NO CHANGE
---------------------------------------------------------
(Former name or former address, 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 [ ]
As of July 31, 1998 there were 17,922,518 shares of the registrant's common
stock outstanding.
This quarterly report on Form 10-Q contains 23 pages, of which this is page 1.
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUICKTURN DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -----------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue
Product revenue $ 14,859 $ 18,962 $ 29,741 $ 34,489
Maintenance and service revenue 9,088 7,476 17,771 13,351
--------- --------- --------- ---------
Total revenue 23,947 26,438 47,512 47,840
Cost of revenue
Cost of product revenue 10,575 7,492 15,666 12,773
Cost of maintenance and service revenue 2,981 900 5,994 2,453
--------- --------- --------- ---------
Total cost of revenue 13,556 8,392 21,660 15,226
--------- --------- --------- ---------
Gross profit 10,391 18,046 25,852 32,614
Operating expenses
Research and development 6,479 5,884 12,464 11,671
Sales and marketing 9,833 8,787 19,104 17,321
General and administrative 3,699 2,849 6,656 5,357
Merger related charges --- --- --- 1,200
--------- --------- --------- ---------
Total operating expenses 20,011 17,520 38,224 35,549
--------- --------- --------- ---------
Operating income (loss) (9,620) 526 (12,372) (2,935)
Other income, net 789 518 1,487 910
--------- --------- --------- ---------
Net income (loss) before provision for
(benefit from) income taxes (8,831) 1,044 (10,885) (2,025)
Provision for (benefit from) income taxes (3,826) 324 (4,463) (627)
--------- --------- --------- ---------
Net income (loss) $ (5,005) $ 720 $ (6,422) $ (1,398)
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic and diluted net income (loss) per share $ (0.28) $ 0.04 $ (0.36) $ (0.08)
--------- --------- --------- ---------
--------- --------- --------- ---------
Number of shares used in basic earnings
per share calculation 17,804 16,839 17,754 16,701
--------- --------- --------- ---------
--------- --------- --------- ---------
Number of shares used in diluted earnings
per share calculation 17,804 18,025 17,754 16,701
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-2-
<PAGE>
QUICKTURN DESIGN SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) $ (5,005) $ 720 $ (6,422) $ (1,398)
Other comprehensive income (loss)
Foreign currency translation adjustment (239) 487 (503) (75)
-------- -------- -------- --------
Unrealized gain (loss) on securities
Unrealized holding gain (loss)
arising during period (9) 131 (16) (7)
Less: reclassification adjustment
for gain included in net loss --- --- (9) ---
-------- -------- -------- --------
Net unrealized gain (loss) on securities (9) 131 (25) (7)
-------- -------- -------- --------
Total other comprehensive income (loss) (248) 618 (528) (82)
-------- -------- -------- --------
Comprehensive income (loss) $ (5,253) $ 1,338 $ (6,950) $ (1,480)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
<PAGE>
QUICKTURN DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
June 30, December 31,
1998 1997
---------- ---------
<S> <C> <C>
ASSETS (unaudited)
Current assets
Cash and cash equivalents $ 18,034 $ 14,589
Marketable securities 18,995 18,219
Accounts receivable, net of allowance for doubtful
accounts of $1,840 in 1998 and 1997 16,203 31,709
Inventories 5,008 10,899
Prepaid expenses and other current assets 4,134 4,324
Deferred income taxes 8,697 8,697
---------- ---------
Total current assets 71,071 88,437
Marketable securities 21,568 20,326
Fixed assets, net 14,034 11,118
Deferred income taxes 8,029 8,029
Other assets 1,344 1,282
---------- ---------
Total assets $ 116,046 $ 129,192
---------- ---------
---------- ---------
LIABILITIES
Current liabilities
Short term debt $ 715 $ 1,095
Accounts payable 3,672 6,231
Accrued liabilities 15,584 20,351
Deferred revenue 10,191 9,617
---------- ---------
Total current liabilities 30,162 37,294
---------- ---------
Total liabilities 30,162 37,294
---------- ---------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value:
Authorized: 40,000,000 shares;
Issued and outstanding: 17,903,336 shares in 1998;
17,606,006 shares in 1997 18 18
Additional paid-in capital 92,525 91,122
Deferred compensation (419) (573)
Retained earnings (4,526) 1,896
Accumulated other comprehensive loss (1,093) (565)
Treasury stock at cost
(85,000 shares in 1998; none in 1997) (621) ---
---------- ---------
Total stockholders' equity 85,884 91,898
---------- ---------
Total liabilities and stockholders' equity $ 116,046 $ 129,192
---------- ---------
---------- ---------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
-4-
<PAGE>
QUICKTURN DESIGN SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------------
1998 1997
---------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (6,422) $ (1,398)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 3,345 3,436
Amortization of deferred compensation 71 97
Gain on sale of marketable securities (9) ---
Changes in current assets and liabilities
Accounts receivable 15,506 1,332
Inventories 5,891 (4,593)
Prepaid expenses and other current assets 190 589
Accounts payable and accrued liabilities (7,326) (1,591)
Deferred revenue 574 241
---------- ---------
Net cash provided by (used in) operating activities 11,820 (1,887)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of fixed assets (6,161) (2,066)
Sale of marketable securities 12,029 8,055
Purchase of marketable securities (14,063) (13,480)
Purchase of Arkos --- (5,000)
Increase (decrease) in other assets (162) 1,157
---------- ---------
Net cash used in investing activities (8,357) (11,334)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of debt (380) (1,062)
Proceeds from stock issuances 1,486 1,593
Repurchase of treasury shares (621) ---
---------- ---------
Net cash provided by financing activities 485 531
---------- ---------
Effect of exchange rates on cash and cash equivalents (503) (76)
Net increase (decrease) in cash and cash equivalents 3,445 (12,766)
Cash and cash equivalents at beginning of year 14,589 25,790
---------- ---------
Cash and cash equivalents at end of period $ 18,034 $ 13,024
---------- ---------
---------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 32 $ 172
Income taxes $ 566 $ 2,384
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized holding losses on marketable securities $ 16 $ 7
Accrued costs related to Arkos purchase $ --- $ 2,000
Common stock and warrants issued in Arkos purchase $ --- $ 9,500
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
-5-
<PAGE>
QUICKTURN DESIGN SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements are unaudited (except for the
balance sheet information as of December 31, 1997, which is derived from the
Company's audited financial statements) and reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion
of management, necessary for a fair presentation of the financial position
and operating results for the interim periods. The condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, together with Management's Discussion
and Analysis of Financial Condition and Results of Operations contained in
the Company's 1997 Annual Report to Stockholders. The results of operations
for the six months ended June 30, 1998 are not necessarily indicative of the
results for the entire fiscal year ending December 31, 1998, or any future
interim period.
2. INVENTORIES
Inventories comprise:
<TABLE>
<CAPTION>
June 30, December 31,
(IN THOUSANDS) 1998 1997
- --------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Raw materials $ 4,043 $ 6,780
Work in process 965 4,119
-------- ---------
$ 5,008 $ 10,899
-------- ---------
-------- ---------
</TABLE>
In the second quarter of 1998, the Company incurred an inventory
obsolescence charge of $5.7 million in connection with the introduction of
its Mercury-TM- Design Verification System.
3. RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to the current
year presentation.
4. RECENT ACCOUNTING PRONOUNCEMENT
In October 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position 97-2, "Software Revenue Recognition" ("SOP 97-2"). This
statement delineates the accounting for software product and maintenance
revenues. It supersedes Statement of Position 91-1, "Software Revenue
Recognition," and is effective for transactions entered into in fiscal
years beginning after December 15, 1997. The Company has evaluated the
-6-
<PAGE>
requirements of SOP 97-2, as amended by Statement of Position 98-4,
"Deferral of the Effective Date of Provisions of SOP 97-2, Software
Revenue Recognition," and believes its current revenue recognition policy
is in compliance with the terms of the pronouncements.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133 requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheets and measure those
instruments at fair value. This statement becomes effective for the
Company for fiscal years beginning after December 15, 1999. The Company
is evaluating the requirements of SFAS 133 and the effects, if any, on the
Company's current reporting and disclosures.
5. STOCK REPURCHASE PROGRAM
In April 1998, the Board of Directors authorized the repurchase of shares of
the Company's common stock, at management's discretion, for total
expenditures of up to $10 million. Shares repurchased under this program are
expected to be used for issuance upon exercise of employee stock options
previously granted or to be granted in the future under the Company's
employee stock plans, thereby reducing the potential dilution that might
otherwise result from such exercises. The Company's repurchases of shares of
common stock are recorded as "Treasury stock at cost" and result in a
reduction of "Stockholders' Equity." As of June 30, 1998, 85,000 shares of
common stock at an average per share cost of $7.312 had been repurchased
under this Stock Repurchase Program.
6. STOCK OPTION REPRICING
In June 1998, the Company offered employees the right to cancel certain
outstanding stock options at original exercise prices and receive new
options with a new exercise price. The new exercise price is $7.438 per
share, based on the closing price of the common stock on the last trading
day prior to the date individual employees accepted the repricing offer.
Options to purchase a total of 1,546,503 shares at original exercise prices
ranging from $7.813 to $19.000 per share were cancelled and new options to
purchase an equivalent number of shares were issued in June 1998. Vesting
under the new options commences on the original vesting dates, and occurs
over a new vesting period of five years. Furthermore, the Company amended
its stock option plans to require stockholders' approval of future
repricings of stock options.
-7-
<PAGE>
7. EARNINGS PER SHARE
Basic and diluted earnings per share were calculated as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30,
----------------------------------------------------------------------------------
1998 1997
(UNAUDITED) ------------------------------------------ --------------------------------------
(AMOUNTS IN THOUSANDS Net Per-share Net Per-share
EXCEPT PER-SHARE DATA) Loss Shares Amount Income Shares Amount
- --------------------------------------------------------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $ (5,005) $ 720
BASIC EPS
Income (loss) available to ---------- --------
common stockholders (5,005) 17,804 (0.28) 720 16,839 0.04
EFFECT OF DILUTIVE SECURITIES
Stock options --- 1,186
DILUTED EPS
Income (loss) available to ---------- ------- -------- -------
common stockholders $ (5,005) 17,804 $ (0.28) $ 720 18,025 $0.04
---------- ------- -------- -------- ------- ------
---------- ------- -------- -------- ------- ------
<CAPTION>
Six Months Ended June 30,
----------------------------------------------------------------------------------
1998 1997
(UNAUDITED) ------------------------------------------ --------------------------------------
(AMOUNTS IN THOUSANDS Net Per-share Net Per-share
EXCEPT PER-SHARE DATA) Loss Shares Amount Loss Shares Amount
- --------------------------------------------------------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net loss $ (6,422) $ (1,398)
BASIC AND DILUTED EPS
Loss available to ---------- ---------
common stockholders $ (6,422) 17,754 $ (0.36) $ (1,398) 16,701 $ (0.08)
---------- ------- --------- --------- ------- ---------
---------- ------- --------- --------- ------- ---------
</TABLE>
At June 30, 1998 and 1997, options to purchase 3,699,274 and 3,230,751 shares
of common stock, respectively, and, warrants for 1,200,000 shares of common
stock, were outstanding but not included in the calculation of diluted
earnings per share because their inclusion would have been anti-dilutive.
-8-
<PAGE>
8. COMPREHENSIVE INCOME
Effective in the first quarter of 1998, the Company has adopted Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income"
("SFAS 130"). Comprehensive income generally represents all changes in
stockholders' equity except those resulting from investments or
contributions by stockholders. The Company has reclassified earlier
financial statements for comparative purposes. The adoption of this
standard did not have a material impact on the Company's results of
operations.
There were no tax effects allocated to the components of other comprehensive
loss for the six months ended June 30, 1998 and 1997.
Changes in accumulated other comprehensive loss balances are as follows:
<TABLE>
<CAPTION>
Foreign Net Unrealized Accumulated
Currency Gain (Loss) on Other
(UNAUDITED) Translation Marketable Comprehensive
(IN THOUSANDS) Adjustments Securities Loss
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
For the Six Months Ended June 30, 1998:
Balance, December 31, 1997 $ (653) $ 88 $ (565)
Current-period change (503) (25) (528)
---------- ------ --------
Balance, June 30, 1998 $ (1,156) $ 63 $(1,093)
---------- ------ --------
---------- ------ --------
</TABLE>
-9-
<PAGE>
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
TOTAL REVENUE
The Company's 1998 second quarter revenue of $23.9 million represented a 9%
decrease compared to the second quarter revenue of the prior year. Revenue
for the first six months of 1998 of $47.5 million decreased 1% compared to
the first six months of the prior year. The decrease in revenue was
attributable primarily to continued lower sales in the Asia-Pacific region,
particularly in Japan, somewhat offset by increased North American and
European sales. See "---Risk Factors: International Sales", "---Risk
Factors: Potential Fluctuations in Quarterly Results", "---Risk Factors:
Customer Concentration", "---Risk Factors: New Product Transition", "---Risk
Factors: Software Revenue Recognition" and "---Risk Factors: Dependence Upon
Certain Suppliers."
Product revenue for the second quarter of the current year decreased by 22%
from the second quarter of 1997. For the first six months of the current
year, product revenue decreased by 14% from the first six months of the prior
year. The decrease in product revenue was due primarily to the weakness in
the Asia-Pacific market, as discussed above.
Maintenance and service revenue for the second quarter of the current year
increased by 22% over the second quarter of 1997. For the first six months
of the current year, maintenance and service revenue increased by 33% over
the first six months of the prior year. The increase in maintenance and
service revenue was attributable primarily to a larger number of maintenance
contracts on customers' installed systems and to increased sales of the
Company's custom engineering services.
International revenue accounted for approximately 21% and 41% of total
revenue in the second quarters of the current and prior years, respectively.
For the first six months of the current and prior years, international
revenue was approximately 27% and 33% of total revenue, respectively. The
decrease in international revenue as a percentage of total revenue was due
primarily to the decreased volume of sales in the Asia-Pacific region,
slightly offset by an increased volume of sales in Europe. Revenue in the
Asia-Pacific region for the 1998 second quarter decreased by 78% from 1997
second quarter and decreased
-10-
<PAGE>
by 52% in the first six months of 1998 from the first six months of 1997.
See "---Risk Factors: International Sales."
GROSS MARGINS
Gross margins in the second quarter and the first six months of 1998 were 43%
and 54%, respectively, which included an inventory obsolescence charge of
$5.7 million in the second quarter of 1998. The inventory obsolescence charge
resulted from the introduction of the Company's Mercury Design Verification
System. Gross margins excluding the inventory obsolescence charge in the
second quarter and the first six months of 1998 were 67% and 66%,
respectively, as compared to 68% in both the second quarter and the first six
months of 1997. The decrease in gross margins, excluding the inventory
obsolescence charge, was attributable primarily to decreased maintenance and
service gross margins due to increased field support requirements to service
new and existing contracts. See "---Risk Factors: Gross Margins."
RESEARCH AND DEVELOPMENT
Research and development expenses increased by 10% in the second quarter of
1998 compared to the second quarter of the previous year. This increase was
primarily attributable to increased staffing and prototype and equipment
costs necessary to enhance current products and to develop the next
generation emulation and cycle-based simulation products. As a percentage of
total revenue, research and development expenses were approximately 27% and
22% for the second quarters of the current and previous years, respectively.
For the first six months in the current and prior fiscal years, research and
development expenses were 26% and 24% of total revenue, respectively. The
Company expects to continue to invest a significant amount of its resources
in research and development.
SALES AND MARKETING
Sales and marketing expenses increased 12% in the second quarter of 1998
compared to the second quarter of the previous year. This increase was
largely due to headcount increases to support both domestic and foreign
markets, and new product marketing efforts in the second quarter of 1998. As
a percentage of total revenue, sales and marketing expenses were
approximately 41% and 33% in the second quarters of the current and prior
years, respectively. For the first six months in the current and prior
years, sales and marketing expenses were 40% and 36% of total revenue,
respectively. The Company expects that sales and marketing expenses will
continue to increase in absolute dollar amounts as the Company expands its
sales and marketing efforts.
-11-
<PAGE>
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by 30% in the second quarter of
1998 compared to the second quarter of the previous year. This increase was
due largely to increased legal costs related to a patent infringement lawsuit
filed by the Company in January 1996, and various other legal proceedings.
See "---Part II., Item 1. Legal Proceedings." As a percentage of total
revenue, general and administrative expenses were approximately 15% and 11%
for the second quarters of the current and prior years, respectively.
For the first six months in the current and prior years, general and
administrative expenses were 14% and 11% of total revenue, respectively. The
Company expects general and administrative expenses to increase in 1998 due
primarily to continued legal costs.
MERGER RELATED CHARGES
In connection with its merger with SpeedSim, Inc. (the "SpeedSim Merger"),
the Company recorded one-time charges of $1.2 million in the first quarter of
1997 that included fees for investment banking, legal and accounting services
and other costs of consolidating.
OTHER INCOME, NET
Other income, net increased by $271,000 in the second quarter and by $577,000
in the first six months of 1998 compared to the second quarter and first six
months of 1997, respectively. The increases were due primarily to reduced
interest expenses related to the decreased level of debt associated with
maturing equipment leases, and increased interest income due to higher
average balances of cash and marketable securities.
PROVISION FOR (BENEFIT FROM) INCOME TAXES
The tax benefits of 43% and 41% for the second quarter and first six months
of 1998, respectively, are in excess of the federal statutory rate of 35%
primarily because of federal and state general business credits and interest
income on investments in tax-exempt obligations. The tax expense of 31% for
both the second quarter and first six months of 1997 is less than the
statutory federal rate of 35% primarily because of federal and state general
business credits, interest income on investments in tax-exempt obligations
and benefit from foreign sales corporation.
NET INCOME (LOSS) AND QUARTERLY RESULTS
Net loss in the second quarter of 1998 was $5.0 million, which included the
inventory obsolescence charge of $5.7 million offset by the related income
tax benefit of $2.5 million. Net loss in the second quarter of 1998
excluding the inventory obsolescence charge and its related income tax
benefit was $1.8
-12-
<PAGE>
million, compared to net income of $720,000 in the second quarter of
1997. This decrease in net income excluding the inventory obsolescence charge
was due primarily to a decrease in revenue and an increase in operating
expenses. See "Gross Margins" above.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $3.4 million from December 31, 1997 to
June 30, 1998. Net cash provided by operations was $11.8 million, due
primarily to decreased accounts receivable of $15.5 million, decreased
inventories of $5.9 million and depreciation and amortization of $3.3
million, partially offset by a net loss of $6.4 million and decreased
accounts payable and accrued liabilities of $7.3 million. Net cash used in
investing activities was $8.3 million, due primarily to purchases of
marketable securities of $14.1 million and cash paid for the acquisition of
fixed assets of $6.2 million, partially offset by sales of marketable
securities of $12.0 million. Net cash provided by financing activities was
$485,000, due primarily to proceeds from stock issuances of $1.5 million,
partially offset by the repurchase of treasury shares of $621,000.
The Company believes that its cash and cash equivalents, together with its
existing credit facility and the cash flows expected to be generated by
operations, will be sufficient to meet its anticipated cash needs for working
capital, capital expenditures and marketing expansion through at least the
next 12 months. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's liquidity requirements, the Company may
sell additional equity or debt securities or obtain additional credit
facilities.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997 AND IN THE DOCUMENTS INCORPORATED BY
REFERENCE THEREIN, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED
IN EVALUATING THE COMPANY AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY
HAVE A SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT IMPACT ON THE COMPANY'S
BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS.
Many of the Company's customers order on an as-needed basis and often delay
delivery of firm purchase orders until the commencement dates of such
customers' development projects are determined. Moreover, a significant
portion of the Company's revenue in each quarter generally results from
shipments in the last few weeks of the quarter; therefore, a delay in the
shipment of a few orders can have a significant impact upon total revenue and
results of operations in a given quarter.
-13-
<PAGE>
CUSTOMER CONCENTRATION
A relatively limited number of customers have historically accounted for a
substantial portion of the Company's revenue. These customers represent
early adopters of emulation technology, typically for the design of complex
integrated circuits. In particular, the Company's top ten customers
represented 56% and 53% of total revenue in the second quarters of 1998 and
1997, respectively. In the first six months of 1998 and 1997, the top ten
customers accounted for 52% and 43% of total revenue, respectively. The
Company expects that sales of its products to a relatively limited number of
customers will continue to account for a high percentage of revenue for the
foreseeable future. The loss of a major customer or any reduction in orders
by such a customer could have an adverse effect on the Company's financial
condition or results of operations. The Company believes that in the future
its results of operations in a quarterly period could be impacted by the
timing of customer development projects and related purchase orders for the
Company's emulation systems, new product announcements and releases by the
Company, and economic conditions generally and in the electronics industry
specifically.
NEW PRODUCT TRANSITION
In June 1998, the Company announced its new Mercury Design Verification
System, which is designed to replace certain of the Company's existing
emulation product offerings. There can be no assurance that this
announcement will not cause customers to defer purchases of the Company's
existing emulation products, or that the transition to the new Mercury System
will not be disrupted due to slow market acceptance or due to disruptions in
manufacturing or component availability, all of which could materially
adversely affect the Company's results of operations.
SOFTWARE REVENUE RECOGNITION
In October 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), which is effective for
transactions entered into in fiscal years beginning after December 15, 1997.
SOP 97-2 was amended by Statement of Position 98-4, "Deferral of the
Effective Date of Provisions of SOP 97-2, Software Revenue Recognition."
Because of the uncertainties related to the outcome of these pronouncements,
the impact on the future financial results of the Company is not currently
determinable.
-14-
<PAGE>
INTERNATIONAL SALES
As a significant portion of the Company's total revenue and net income are
derived from international operations, fluctuations of the U.S. dollar
against foreign currencies and the seasonality of Asia-Pacific, European, and
other international markets could impact the Company's results of operations
and financial condition in a particular quarter.
Revenue from most international customers is denominated in U.S. dollars.
However, receivables from certain other international customers are
denominated in local currencies. Such receivables are hedged, where
practicable, by forward exchange contracts to minimize the impact of foreign
exchange rate movements on the Company's operating results. There have been
no material gains or losses associated with the Company's hedging program.
However, there can be no assurance that fluctuations in the currency exchange
rates in the future will not have a material adverse impact on the
receivables derived from foreign currency denominated sales and thus the
Company's operating results and financial condition. See Note 2 of the Notes
to Consolidated Financial Statements in the Company's 1997 Annual Report to
Stockholders.
The Company plans to continue to expand its international sales and
distribution channels. However, there can be no assurance that the Company's
products will achieve widespread commercial acceptance in international
markets in the future. The Company is uncertain whether the recent weakness
experienced in the Asia-Pacific markets will continue in the foreseeable
future due to extreme currency devaluation and liquidity problems in this
region. Additionally, Electronic Design Automation ("EDA") spending budgets
of major Japanese electronics firms may be decreased; consequently, sales of
the Company's design verification products in Japan may continue to be down
in the foreseeable future. The Company's future international sales may be
subject to additional risks associated with international operations,
including currency exchange fluctuations, tariff regulations and requirements
for export, which licenses may on occasion be delayed or difficult to obtain.
DEPENDENCE UPON CERTAIN SUPPLIERS
Certain key components and board assemblies used in the Company's emulation
products are presently available from sole or limited sources. The inability
to develop alternate sources for these sole or limited sources or to obtain
sufficient quantities of these components or board assemblies could result in
delays or reductions in product shipments which could adversely affect the
Company's results of operations. In particular, the Company currently relies
on Xilinx, Inc. ("Xilinx") for its supply of field programmable gate arrays
("FPGAs") and on General Dynamics ("GD") for its computer board assemblies.
If for any reason
-15-
<PAGE>
there were to be a reduction or interruption of FPGA supply or board
assemblies to the Company, the Company's results of operations would be
materially adversely affected. Although the Company believes that it can
eventually obtain FPGAs and board assemblies from alternate sources in the
event of a reduction or interruption of FPGA supply or board assemblies from
Xilinx or GD, a significant amount of time and resources would be required to
redesign the Company's emulation systems and software to accommodate an
alternate FPGA supplier or board assembler. In such event, the Company's
results of operations could be materially adversely affected. The Company
currently mitigates this risk by maintaining inventory of these components in
excess of its near-term forecasted requirements. However, there can be no
assurance that these measures will be adequate to alleviate any future supply
problems.
GROSS MARGINS
There can be no assurance that the Company will be able to sustain its recent
gross margins. Furthermore, to the extent that the Company's cost reduction
goals are achieved, any resulting cost savings that are passed on to the
Company's customers may also have an adverse effect on gross margins.
COMPETITION
The EDA industry is highly competitive and rapidly changing. The Company
faces significant competition for emulation-based system-level verification
and cycle-based simulation, in addition to competition from traditional
design verification methodologies which rely on the approach of building and
then testing complete system prototypes. Because of the growing demand for a
design verification methodology which reduces the number of costly design
iterations and improves product quality, the Company expects competition in
the market for system-level verification and cycle-based simulation to
increase as other companies attempt to introduce emulation and cycle-based
simulation products and product enhancements, and as major new EDA
technologies may emerge. Moreover, the Company competes with companies that
have significantly greater financial, technical and marketing resources,
greater name recognition and larger installed bases than the Company. In
addition, many of these competitors have established relationships with
current and potential customers of the Company. Increased competition could
result in price reductions, reduced margins and loss of market share, all of
which could materially adversely affect the Company. The Company believes
that the principal competitive factors in the EDA market are quality of
results, the mission-critical nature of the technology, technical support,
product performance, reputation, price and support of industry standards. The
Company believes that it currently competes favorably with respect to these
factors. However, there can be no assurance that the Company will be able to
compete
-16-
<PAGE>
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, operating results and financial condition.
In addition, competitors may resort to litigation as a means of competition.
Such litigation may result in substantial costs to the Company and
significant diversion of management time. In 1995, Mentor Graphics
Corporation ("Mentor") filed suit against the Company for declaratory
judgment of noninfringement, invalidity and unenforceability of several of
the Company's patents. Several actions between the Company and Mentor were
consolidated in the U.S. District Court for the District of Oregon, where six
of the Company's patents are now involved in the disputes. The Company has
filed counterclaims against Mentor and Mentor's French subsidiary, Meta
Systems ("Meta"), for infringement and threatened infringement of those six
patents. Mentor has also filed claims against the Company for defamation and
tortious interference. In January 1996, the Company filed a complaint with
the International Trade Commission, seeking to stop unfair importation of
hardware logic emulation systems and components manufactured by Meta on the
grounds that such systems infringe the Company's patents. The Company is
also involved in litigation with Mentor's subsidiary in Germany and with
Aptix Corporation and Meta in the U.S. District Court, the Northern District
of California. See "---Part II., Item 1. Legal Proceedings." Although patent
and intellectual property disputes in the EDA industry are often settled
through licensing, cross-licensing or similar arrangements, costs associated
with such litigation and arrangements may be substantial.
IMPACT OF THE YEAR 2000 ISSUE
Many existing computer systems, applications and other control devices use
computer programs that recognize only two digits rather than four digits to
define an applicable year. Therefore, any of the Company's computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000 (the "Year 2000 Issue"). This could result in
a system failure or miscalculations causing disruptions of the Company's
operations or in the ability of the Company's customers to effectively
utilize the Company's design verification products.
Based on recent assessments, the Company has determined that it will be
required to modify or replace portions of its software so that its computer
systems and design verification products will properly utilize dates beyond
December 31, 1999. The Company presently believes that with modifications to
existing software or conversion to new software, the Year 2000 Issue can be
-17-
<PAGE>
mitigated. However, if such modifications and/or conversions are not made,
the Year 2000 Issue could have a material impact on the operations of the
Company.
The Company has initiated formal communications with its significant
suppliers to determine the extent to which the Company is vulnerable to those
third parties' failure to remedy their own Year 2000 Issue. However, there
can be no assurance that the systems of other companies on which the
Company's systems rely will be converted in a timely fashion, or that a
failure to convert by another company, or a conversion that is incompatible
with the Company's systems, would not have a material adverse effect on the
Company.
The Company will utilize both internal and external resources to reprogram or
replace, and test software for Year 2000 Issue modifications. The costs and
timing of the project to complete the Year 2000 Issue modifications are based
on management's best estimates. Management currently estimates the total
costs of the Year 2000 Issue project at $500,000. There can be no assurance
that these estimates will be achieved and actual results could differ
materially from these estimates. Specific factors that might cause such
material difference include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and correct all
relevant computer code, and similar uncertainties.
OTHER RISK FACTORS
Other factors which could adversely affect the Company's quarterly operating
results in the future include efficiencies as they relate to managing
inventories and fixed assets, the timing of expenditures in anticipation of
increased sales, customer product delivery requirements and shortages of
components or labor.
Due to the factors above, the Company's future earnings and stock price may
be subject to significant volatility, particularly on a quarterly basis. Any
shortfall in total revenue or earnings from levels expected by securities
analysts has had and could in the future have an immediate and significant
adverse effect on the trading price of the Company's common stock.
Additionally, the Company may not learn of such shortfalls until late in a
fiscal quarter, which could result in an even more immediate and adverse
effect on the trading price of the Company's common stock.
ITEM 3 IS NOT APPLICABLE AND HAS BEEN OMITTED.
-18-
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In January 1996, the Company filed a complaint with the International Trade
Commission (the "ITC") in Washington, DC, seeking to stop unfair importation
of logic emulation systems manufactured by Meta Systems ("Meta"), a French
subsidiary of Mentor Graphics Corporation ("Mentor"). In the complaint, the
Company alleges that Mentor's hardware logic emulation systems infringe the
Company's patents. The Company sought and received in August 1996, temporary
relief from the ITC in the form of Temporary Exclusion and Temporary Cease
and Desist Orders. The Federal Circuit Court of Appeals affirmed the ITC's
issuance of temporary relief in August 1997. In December 1997, the ITC
issued: (1) a Permanent Limited Exclusion Order which permanently prohibits
the importation of hardware logic emulation system, subassemblies or
components manufactured by Mentor and/or Meta, and (2) a Permanent Cease and
Desist Order permanently prohibiting Mentor from, among other things,
selling, offering for sale or advertising the same hardware logic emulation
devices. The ITC's two orders remain in effect until April 28, 2009, the
latest expiration date of the Company's patents involved in the investigation.
The Company is also engaged in a Federal District Court case with Mentor and
Meta involving six of the Company's patents. Mentor and Meta are seeking a
declaratory judgment of noninfringement, invalidity and unenforceability of
the patents in dispute, and the Company has filed counteractions against
Mentor and Meta for infringement and threatened infringement of the six
patents. Mentor has also claimed in this Federal District Court case that
press releases issued by the Company were defamatory and interfered with
Mentor's prospective economic relations. In June 1997, Quickturn filed a
motion for preliminary injunction, asking the District Court to prohibit
Mentor from manufacturing, assembling, marketing, loaning or otherwise
distributing emulation products and components in the United States, which
products and components infringe certain claims in Quickturn's U.S. Patent
No. 5,036,473. On August 1, 1997, the U.S. District Court in Oregon granted
Quickturn's motion for a preliminary injunction against Mentor's domestic
emulation activities. The Federal Circuit Court of Appeals affirmed the
Oregon District Court's decision on August 5, 1998. The Oregon action is
presently set for trial in December 1998.
In August 1997, a preliminary injunction sought by Mentor's German
subsidiary, Mentor Graphics (Deutschland) GmbH, was issued by a regional
court in Munich, enjoining agents of the Company from making certain
statements
-19-
<PAGE>
concerning U.S. litigation matters between the Company and Mentor. In May
1998, the Munich District Court set aside the preliminary injunction based on
the failure of Mentor's German subsidiary to advance its case within the
six-month statutory limitation.
In October 1997, the Company filed a complaint alleging infringement of the
German part of the Company's European Patent No. 0 437 491 B1 against Mentor
Graphics (Deutschland) GmbH, in the District Court of Dusseldorf. The main
court hearing for this matter is set for March 1999.
In November 1996, Aptix Corporation ("Aptix") filed a suit against the
Company, in the U.S. District Court, the Northern District of California,
alleging various violations of the antitrust laws and unfair competition.
The discovery phase of this case was recently completed.
The Company has mounted vigorous defenses against Mentor's defamation and
tortious interference claims and the antitrust and unfair competition claims
by Aptix, and recently argued six summary judgment motions against the Aptix
claims before the court. The outcome of these actions cannot be predicted
with certainty.
In February 1998, Aptix and Meta filed a lawsuit against the Company, in the
U.S. District Court, the Northern District of California, alleging
infringement of a U.S. patent owned by Aptix and licensed to Meta. The
Company is mounting a vigorous defense against this claim. The outcome of
this action cannot be predicted with certainty.
The Company is engaged in certain other legal and administrative proceedings
incidental to its normal business activities. While it is not possible to
determine the ultimate outcome of these actions at this time, management
believes that any liabilities resulting from such proceedings, or claims
which are pending or known to be threatened, will not have a material adverse
effect on the Company's consolidated financial position or results of
operations.
-20-
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders held on April 17, 1998,
the following members were elected to the Board of Directors:
<TABLE>
<CAPTION>
Votes Votes
For Withheld
-------------------------
<S> <C> <C>
Richard C. Alberding 14,619,283 562,549
Glen M. Antle 14,997,346 184,486
Michael R. D'Amour 14,997,428 184,404
Dr. Yen-Son (Paul) Huang 14,997,428 184,404
Dr. David K. Lam 14,999,083 182,749
Keith R. Lobo 14,976,420 205,412
</TABLE>
The following proposal was approved at the Company's Annual Meeting:
<TABLE>
<CAPTION>
Votes
Votes Votes Abstained/
For Against Not Voted
-----------------------------------
<S> <C> <C> <C>
Ratification of appointment of
PricewaterhouseCoopers LLP as
independent accountants. 15,131,430 36,042 14,360
</TABLE>
ITEM 5. OTHER INFORMATION
On August 12, 1998 the Company announced, in response to Mentor Graphics
Corporation's unsolicited tender offer for all outstanding shares of the
Company, that the Company's board of directors will study the offer and make
its recommendation to shareholders in due course. In the meantime, the
Company urges all its shareholders to take no action with respect to the
Mentor Graphics offer and any related activities until the Company's board of
directors has made its recommendation. The press release announcing the
response of the Board of Directors of the Company is attached hereto as
Exhibit 99.1.
-21-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27: Financial Data Schedule
Exhibit 99.1 Press Release of Quickturn Design Systems, Inc. dated August
12, 1998.
(b) REPORT ON FORM 8-K
No reports on Form 8-K were filed in the quarter ended June 30, 1998.
ITEMS 2 AND 3 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
-22-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QUICKTURN DESIGN SYSTEMS, Inc.
----------------------------------
(Registrant)
Date: August 13, 1998 By: /s/ RAYMOND K. OSTBY
---------------------- -----------------------
Raymond K. Ostby,
Vice President, Finance and
Administration,
Chief Financial Officer and
Secretary
(Principal Accounting Officer
and Duly Authorized Officer)
-23-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET, CONSOLIDATED STATEMENT OF OPERATIONS AND
CONSOLIDATED STATEMENT OF CASH FLOWS INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE
PERIOD ENDED JUNE 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 18,034
<SECURITIES> 18,995
<RECEIVABLES> 18,043
<ALLOWANCES> 1,840
<INVENTORY> 5,008
<CURRENT-ASSETS> 71,071
<PP&E> 36,056
<DEPRECIATION> 22,022
<TOTAL-ASSETS> 116,046
<CURRENT-LIABILITIES> 30,162
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 85,866
<TOTAL-LIABILITY-AND-EQUITY> 116,046
<SALES> 47,512
<TOTAL-REVENUES> 47,512
<CGS> 21,660
<TOTAL-COSTS> 21,660
<OTHER-EXPENSES> 38,224
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 66
<INCOME-PRETAX> (10,885)
<INCOME-TAX> (4,463)
<INCOME-CONTINUING> (6,422)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,422)
<EPS-PRIMARY> (0.36)
<EPS-DILUTED> (0.36)
</TABLE>
<PAGE>
EXHIBIT 99.1
Quickturn Board to Review Mentor Graphics'
Unsolicited Tender Offer
Advises Shareholders to Take No Action at Present Time
SAN JOSE, Calif.--(BUSINESS WIRE)--August 12, 1998--Quickturn Design Systems,
Inc. (NASDAQ: QKTN - news) announced today, in response to Mentor Graphics
Corporation's (NASDAQ: MENT - news) unsolicited tender offer for all
outstanding shares of Quickturn, that the Company's board of directors will
study the offer and make its recommendation to shareholders in due course. In
the meantime, Quickturn urges all its shareholders to take no action with
respect to the Mentor Graphics offer and any related activities until
Quickturn's board of directors has made its recommendation.
Quickturn Design Systems, Inc. is the leading provider of verification
products and time-to-market engineering (TtME(TM)) services for the design of
complex ICs and electronic systems. The company's products are used worldwide
by developers of high-performance computing, multimedia, graphics and
communications systems. Quickturn is headquartered at 55 W. Trimble Road, San
Jose, CA 95131-1013; Telephone: 408/914-6000. For more information, visit the
Quickturn Web site at www.quickturn.com or send e-mail to [email protected].
Contact:
Quickturn Design Systems, Inc.
Raymond K. Ostby
Vice President Finance & Administration, CFO
(408) 914-6633
or
Abernathy MacGregor Frank
Jim MacGregor/Matt Sherman
(212) 371-5999
