-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WKyAXHUYJGHanh2VBy7sXoD1PY68vfhdfxu1Cd1qFjKTyxcqJlw0SPjliub/1Uq0 4E2K8P0Rkt+xNEnDFlX6PQ== 0000701811-96-000007.txt : 19961118 0000701811-96-000007.hdr.sgml : 19961118 ACCESSION NUMBER: 0000701811-96-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MENTOR GRAPHICS CORP CENTRAL INDEX KEY: 0000701811 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 930786033 STATE OF INCORPORATION: OR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-13442 FILM NUMBER: 96662588 BUSINESS ADDRESS: STREET 1: 8005 SW BOECKMAN RD CITY: WILSONVILLE STATE: OR ZIP: 97070 BUSINESS PHONE: 5036857000 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended September 30, 1996. Commission File No. 0-13442 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 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 October 31, 1996: 64,494,404 MENTOR GRAPHICS CORPORATION Index to Form 10Q PART I FINANCIAL INFORMATION Page Number Item 1. Financial Statements Consolidated Statements of Operations for the three 3 months ended September 30, 1996 and 1995 Consolidated Statements of Operations for the nine 4 months ended September 30, 1996 and 1995 Consolidated Balance Sheets as of September 30, 1996 5 and December 31, 1995 Consolidated Statements of Cash Flows for the 6 nine months ended September 30, 1996 and 1995 Notes to Consolidated Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 11-20 PART II OTHER INFORMATION Item 1. Legal Proceedings 20 Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 21 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Mentor Graphics Corporation Consolidated Statements of Operations (In thousands, except net income per share) (Unaudited) Three Months Ended September 30, 1996 1995 Revenues: System and software $ 47,849 $ 55,918 Service and support 52,944 51,504 Total revenues 100,793 107,422 Cost of revenues: System and software 8,878 8,938 Service and support 22,981 20,867 Total cost of revenues 31,859 29,805 Gross margin 68,934 77,617 Operating expenses: Research and development 21,364 21,926 Marketing and selling 34,935 33,116 General and administration 9,869 9,093 Merger and acquisition related charges 2,830 -- Total operating expenses 68,998 64,135 Operating income (loss) (64) 13,482 Other income, net 938 991 Income before income taxes 874 14,473 Provision for income taxes 800 2,094 Net income $ 74 $ 12,379 Net income per common and common equivalent share $ -- $ .19 Weighted average number of common and common equivalent shares outstanding 65,002 65,596 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Statements of Operations (In thousands, except net income per share) (Unaudited) Nine Months Ended September 30, 1996 1995 Revenues: System and software $ 174,876 $ 165,270 Service and support 152,249 147,154 Total revenues 327,125 312,424 Cost of revenues System and software 30,103 27,159 Service and support 68,706 60,178 Total cost of revenues 98,809 87,337 Gross margin 228,316 225,087 Operating expenses: Research and development (R&D) 66,593 63,983 Marketing and selling 105,406 100,983 General and administration 29,850 28,033 Restructure costs -- (2,040) Merger and acquisition related charges 19,663 800 Total operating expenses 221,512 191,759 Operating income 6,804 33,328 Other income, net 2,577 4,605 Income before income taxes 9,381 37,933 Provision for income taxes 3,010 5,956 Net income $ 6,371 $ 31,977 Net income per common and common equivalent share $ .10 $ .49 Weighted average number of common and common equivalent shares outstanding 65,301 64,844 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Balance Sheets (In thousands) (Unaudited) As of As of September 30, 1996 December 31, 1995 ASSETS Current assets: Cash and cash equivalents $ 163,499 $ 186,676 Short-term investments 34,456 25,320 Trade accounts receivable, net 98,677 96,962 Other receivables 6,526 3,464 Prepaid expenses and other 19,053 15,161 Total current assets 322,211 327,583 Property, plant and equipment, net 100,828 99,605 Cash and investments, long-term 30,000 30,000 Other assets 45,923 38,184 Total $ 498,962 $ 495,372 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ 7,926 $ 9,358 Accounts payable 12,548 9,589 Income taxes payable 14,322 14,542 Accrued and other liabilities 45,710 53,020 Deferred revenue 31,693 27,583 Total current liabilities 112,199 114,092 Long-term debt 52,027 52,942 Other long-term deferrals 1,385 2,112 Total liabilities 165,611 169,146 Stockholders' equity: Common stock 296,206 294,917 Retained earnings 24,986 17,715 Foreign currency translation adjustment 12,159 13,594 Total stockholders' equity 333,351 326,226 Total $ 498,962 $ 495,372 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Statements of Cash Flows (In thousands) (Unaudited) Nine Months Ended September 30, 1996 1995 Operating Cash Flows: Net income $ 6,371 $ 31,977 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization of property, plant & equipment 16,164 18,723 Deferred taxes (53) (2,172) Amortization of other assets 7,701 7,490 Charge for in-process R&D 14,553 400 Restructure costs -- (2,040) Changes in operating assets and liabilities: Trade accounts receivable, net (1,816) 6,948 Prepaid expenses and other assets (3,983) 967 Accounts payable 549 (4,127) Accrued liabilities (10,633) (2,519) Other liabilities and deferrals 1,782 2,819 Net cash provided by operating activities 30,635 58,466 Investing Cash Flows: Purchases of short-term investments, net (7,878) (20,766) Purchases of property and equipment (16,772) (15,694) Capitalization of software development costs (4,328) (5,595) Purchase of businesses (21,646) (4,151) Net cash used by investing activities (50,624) (46,206) Financing Cash Flows: Proceeds from issuance of common stock 8,339 15,384 Repurchase of common stock (8,875) (2,250) Increase (decrease) in short-term borrowings (1,397) 406 Repayment of long-term debt (915) (1,148) Net cash provided (used) by financing activities (2,848) 12,392 Effect of exchange rate changes on cash and cash equivalents (340) 159 Net change in cash and cash equivalents (23,177) 24,811 Cash and cash equivalents at beginning of period 186,676 143,662 Cash and cash equivalents at end of period $ 163,499 $ 168,473 See accompanying notes to unaudited consolidated financial statements MENTOR GRAPHICS CORPORATION Notes to Consolidated Financial Statements (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 United States 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 1995 to conform with the 1996 presentation. (2) Business Acquisitions - On January 31, 1996, the Company issued 6,223 shares of its common stock for all outstanding common stock of Microtec Research, Inc. (Microtec). In addition, the Company reserved 688 shares of its common stock for previously outstanding options to purchase Microtec common stock. These options vest and become exercisable under the terms of the respective, original Microtec stock option agreements. The Company accounted for this transaction as a pooling of interests and accordingly, the Company's consolidated financial statements have been restated to include the results of Microtec for all periods presented. Microtec is primarily engaged in developing and marketing embedded operating systems and products to optimize the development and operation of embedded systems across hardware/software boundaries. Microtec's integrated software product solutions enable embedded systems developers to increase productivity, thereby decreasing costs of product development and reducing time-to-market for new products. On April 1, 1996, the Company completed the acquisition of dQdt, Inc. (dQdt). dQdt is primarily engaged in developing and marketing digital signal processing intellectual property products. The total purchase price including merger related costs and the re-issuance of 138 shares of Company treasury stock (with a market value of $1,825) was $2,303. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in-process R&D of $1,323 and technology capitalization of $980. The charge for in-process R&D was a result of allocating a portion of the acquisition cost to dQdt's in-process product development that had not reached technological feasibility. On June 3, 1996, the Company completed the acquisition of Seto Software GmbH (Seto). Seto is primarily engaged in developing and marketing personal computer-based layout tools used in the printed circuit board design process. The total purchase price including merger related costs was $3,495. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in- process R&D of $1,747, goodwill capitalization of $225 and technology capitalization of $1,523. The charge for in-process R&D was a result of allocating a portion of the acquisition cost to Seto's in-process product development that had not reached technological feasibility. On May 31, 1996, the Company completed the acquisition of Meta Systems, Inc. (Meta). Meta is primarily engaged in developing and marketing logic emulation products. The total purchase price including merger related costs was $13,741. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in-process R&D of $9,353, goodwill capitalization of $3,297 and technology capitalization of $1,091. The charge for in-process R&D was a result of allocating a portion of the acquisition cost to Meta's in-process product development that had not reached technological feasibility. On August 30, 1996, the Company issued 2,133 shares of its common stock for all outstanding common stock of Interconnectix, Inc. (Interconnectix). In addition, the Company reserved 112 shares of its common stock for previously outstanding options to purchase Interconnectix common stock. These options vest and become exercisable under the terms of the respective, original Interconnectix stock option agreements. The Company accounted for this transaction as a pooling of interests and accordingly, the Company's consolidated financial statements have been restated to include the results of Interconnectix for all periods presented. Interconnectix is primarily engaged in developing and marketing interconnect synthesis software for the design of high-speed, high-performance digital systems. On September 17, 1996, the Company completed the acquisition of Royal Digital Centers, Inc. (Royal Digital). Royal Digital is primarily engaged in developing and marketing technology that integrates printed circuit board computer-aided design tools with computer-aided manufacturing systems. The total purchase price including merger related costs was $4,680. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in-process R&D of $2,130 and technology capitalization of $2,550. The charge for in-process R&D was a result of allocating a portion of the acquisition cost to Royal Digital's in-process product development that had not reached technological feasibility. The capitalized technology costs for dQdt, Seto, Meta and Royal Digital will be amortized over a three year period to system and software cost of revenues. The goodwill costs for Seto and Meta will be amortized over a three year period to R&D expense. Financial results for dQdt, Seto, Meta and Royal Digital subsequent to the acquisition date have been included in the consolidated statements of operations and cash flows. The separate operational results of dQdt, Seto, Meta and Royal Digital were not material compared to the Company's overall results of operations, and accordingly pro-forma financial statements which include these entities have been omitted. (3) Capitalization of Software Development Costs - During the first nine months of 1996 and 1995, respectively $4,328 and $5,595 of new product development costs were capitalized and included in other assets on the consolidated balance sheets. Amortization of previously capitalized software development costs amounted to $4,604 and $4,161 for the nine months ended September 30, 1996 and 1995, respectively, and is included in system and software cost of revenues on the consolidated statements of operations. (4) Supplemental Disclosures of Cash Flow Information - The following provides additional information concerning cash flow and non-cash investing activities: Nine Months Ended September 30, 1996 1995 Interest paid $ 1,623 $ 1,712 Income taxes paid, net of refunds $ 1,309 $ 6,109 Issuance of common stock for purchase of business $ 1,825 $ -- (5) Commitments and contingencies - The Company is involved in various administrative matters and litigation. Management believes that the ultimate outcome resulting from known matters will not have a material adverse impact on the Company's consolidated financial position or results of operations. During 1995, the Company filed suit in United States (U.S.) Federal District Court against Quickturn Design Systems, Inc. (competitor) for declarative judgment on non-infringement, invalidity and unenforceability of three of the competitor's patents in anticipation of acquiring Meta. In January 1996, the competitor filed an administrative complaint with the International Trade Commission (ITC),a federal administrative agency, seeking to hinder the distribution of the Meta technology in the United States. Early in the third quarter of 1996, the ITC issued a temporary ruling allowing the importation of this technology to the U.S., but requiring posting of a bond for each sale. The required amount of the bond for each sale and the likelihood of the Company losing the posted amounts is uncertain at this time. There has been no final decision on the Company's declaratory judgment claims and the Company has applied for U.S. patent protection of certain aspects of this technology. While the outcome of this matter is uncertain at this time, management believes it will prevail. (Dean to help update) (6) Net Income per Common and Common Equivalent Share - Net income per common and common equivalent share was calculated on the basis of the weighted average number of common shares outstanding plus dilutive common stock equivalents related to stock options outstanding. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition (All numerical references are in thousands, except for percentages) RESULTS OF OPERATIONS BUSINESS ACQUISITIONS In January 1996, the Company completed the acquisition of Microtec Research, Inc. (Microtec), pursuant to a merger accounted for as a pooling of interests. Accordingly, the results of Microtec are included in the Company's consolidated financial statements for all periods presented. A total of 6,223 shares of the Company's common stock were issued in the transaction. Merger expenses of $4,410 were incurred associated with the elimination of duplicate facilities, severance costs related to the termination of certain employees, the write-off of certain property and equipment and legal and accounting fees associated with administration of the merger activities. In August 1996, the Company completed the acquisition of Interconnectix, Inc. (Interconnectix), pursuant to a merger accounted for as a pooling of interests. Accordingly, the results of Interconnectix are included in the Company's consolidated financial statements for all periods presented. A total of 2,133 shares of the Company's common stock were issued in the transaction. Merger expenses of $700 were incurred associated primarily with severance costs and legal and accounting fees associated with administration of the merger activities. The Company acquired dQdt Inc. (dQdt), Meta Systems, Inc. (Meta), Seto Software GmbH (Seto), and Royal Digital Centers, Inc. (Royal Digital) in April 1996, May 1996, June 1996 and September 1996, respectively. These acquisitions were accounted for as purchases and accordingly, their results of operations are included in the Company's results of operations from the date of acquisition. The cost of each acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. These allocations resulted in a charge for in- process research and development of $14,553, goodwill capitalization of $3,522 and technology capitalization of $6,144. REVENUES AND GROSS MARGINS System and Software System and software revenues for the quarter ended September 30, 1996 totaled $47,849, representing a decrease of $8,069 or 14% from the third quarter of 1995. Revenues declined in all regions due partially to slowdowns in spending by telecommunications and semiconductor customers. In addition, the decline in sales of more mature products in the third quarter of 1996 was higher than expected and sales of the Company's newer products did not fully offset this decline. The rate of increase in sales of new products has been adversely affected in part by turnover Microtec sales personnel and the ability of the distribution channel to assimilate the volume of new products. Japanese sales were negatively affected by a strengthening of the U.S. dollar as compared to the yen. See geographic revenue information below for further details of the effects of foreign currencies on revenue. System and software revenues during the first nine months of 1996 improved by $9,606 or 6% compared to the same period last year. Software product revenue accounted for approximately 80% of the increase while the decline in workstation hardware product revenue was more than offset by emulation hardware revenue resulting from the acquisition of Meta. System and software revenues were higher in the first nine months of 1996 due primarily to the Company's newer product offerings. In the last year, the Company has added new hardware/software co-verification, library and data management products and products that operate on the Windows 95 and Windows NT operating systems. The Company has also added many new products through business combinations during the past two years. In addition, the Company's more mature product offerings grew in the first half of 1996 while the volume increases of newer product offerings were higher. System and software gross margins for the third quarter of 1996 decreased to 81% compared to 84% for the same period of 1995. For the first nine months of 1996, system and software gross margins were 83% compared to 84% for the same period in 1995. The quarter to quarter decline in system and software gross margins is primarily attributable to lower revenue volumes in the third quarter of 1996 versus the same period a year ago, higher costs for third party royalties and higher costs for amortization of previously capitalized software development and capitalized purchased technology. System and software gross margin levels are dependent on such factors as third party software content for which royalties are paid, lower margin hardware revenue levels, and amortization of previously capitalized software development costs and purchased technology costs. Amortization of previously capitalized software development costs to system and software cost of revenues was $1,464 and $4,604 for the third quarter and first nine months of 1996, respectively, compared to $1,385 and $4,161 for the same periods a year ago. Purchased technology amortization to system and software cost of goods sold was $804 and $2,160 for the third quarter and first nine months of 1996, respectively, compared to $555 and $1,803 for the same periods a year ago. Due to the acquisition of Royal Digital previously discussed, amortization of purchased technology is expected to increase by approximately $500 per quarter. Sales of emulation systems, which are the result of the Company's acquisition of Meta, are expected to have a negative impact on system and software product gross margins over time. Meta products include hardware which does not yield gross margins as high as software product sales. The impact of emulation systems sales on system and software cost of revenues and gross margins was offset by the decline in workstation hardware revenues during the first nine months of 1996 compared to the same period last year. Service and Support Service and support revenues for the third quarter of 1996 were $52,944, representing an increase of 3% from the comparable quarter of 1995. For the first nine months of 1996, service and support revenues totaled $152,249, representing an increase of 3% from the same period of 1995. Growth in software support revenue is attributable to growth in the Company's installed customer base, and continued success of the Company's software support programs. Professional and other service revenues for the third quarter of 1996 were approximately $12,500, a decrease of 4% from the comparable quarter of 1995. For the first nine months of 1996, professional and other service revenues were approximately $37,300 compared to $38,800 for the same period in 1995. The year to year decline in professional and other service revenue is attributable to a process of realigning the core consulting business to better support the Company's integrated systems design strategy. This required an internal focus of resources which caused lower billable hours for revenue generating services. In the third quarter of 1996, the core consulting practice revenue levels improved. Offsetting this improvement was lower custom design professional service revenue which is attributable in part to the same market conditions discussed above under system and software revenues. Service and support gross margins were 57% and 59% for the quarters ended September 30, 1996 and 1995, and 55% and 59% for the first nine months of 1996 and 1995, respectively. Service and support gross margins were favorably impacted by higher software support revenue volume and unfavorably impacted by professional service margins. Professional service gross margins were approximately break-even for the third quarter of 1996 and year to date as the revenue levels were not in line with the cost structure of the business. The Company's primary focus will be on improvement of the revenue level through more efficient utilization of consultants to improve gross margins in the coming quarters. Geographic Revenue Information Domestic revenue from unaffiliated customers including service and support revenue decreased by 4% as compared to the third quarter of 1995. International revenues from unaffiliated customers including service and support revenue represented 46% and 48% of total revenue for the third quarters of 1996 and 1995, respectively. European and Japanese revenues decreased approximately 10% and 8%, respectively in the third quarter of 1996 compared to the same period in 1995. European revenues decreased approximately 2% and Japanese revenues increased approximately 3% for the first nine months of 1996 compared to the same period a year ago. For the third quarter of 1996 compared to the same period a year ago, a stable U.S. dollar did not materially impact European revenues, but a stronger U.S. dollar negatively impacted Japanese revenues by approximately 11%. For the first nine months of 1996 compared to the same period of 1995, a stronger U.S. dollar negatively impacted revenues by approximately 2% and 16% in Europe and Japan, respectively. Exclusive of such currency trends, year to date 1996 Japanese revenue was favorably impacted by improving economic conditions and more product offerings as previously discussed. Since the Company generates approximately half of its revenues outside of the United States and expects this to continue in the future, revenue results should continue to be impacted by the effects of future foreign currency fluctuations. OPERATING EXPENSES The following summarizes R&D expenses: Three Months Ended Nine Months Ended September 30, September 30, 1996 1995 1996 1995 Gross R&D $ 23,208 $ 24,080 $ 70,921 $ 69,578 Capitalized R&D (1,844) (2,154) (4,328) (5,595) Net R&D $ 21,364 $ 21,926 $ 66,593 $ 63,983 Gross R&D expense was 23% and 22% of revenue for the third quarter of 1996 and 1995, respectively and 22% of revenue for the nine months of 1996 and 1995. The increase in R&D as a percent of revenue is primarily the result of lower revenue levels during the comparable periods. Higher gross R&D expenses for the first nine months of 1996 are attributable to relocation of some of the Company's engineering team and accelerating depreciation of file-server equipment used by the Company's engineers. During the first quarter of 1996, the Company accelerated depreciation on the remaining book value of its Wilsonville file-server environment which resulted in a charge to R&D of approximately $500. The Company also consolidated certain engineering activities from New Jersey to Wilsonville to improve productivity of certain development activities and reduce future operating costs of such activities. Capitalization of software development costs was lower in the first nine months of 1996 compared to the same period of the prior year due to timing and content of product development activities. In the first quarter of 1996, the Company's product development efforts were focused on improvement of existing functionality versus new product enhancements. Significant product enhancement projects began to reach capitalization milestones in the second and third quarters of 1996, resulting in higher capitalized software development costs. Marketing and selling expense totaled $34,935 and $33,116 or 35% and 31% of revenue for the third quarter of 1996 and 1995, respectively. Marketing and selling expense totaled $105,406 and $100,983 or 32% of revenue for the nine months of 1996 and 1995. The quarter to quarter increase in marketing and selling as a percent of revenue is the result of lower revenue levels during the comparable periods, cost increases as a result of the purchases of dQdt, Meta and Seto and an increased number of new product offerings during the quarter. A stronger U.S. dollar during the third quarter of 1996 compared to the same period a year ago reduced expenses by approximately 4% and 20% in Europe and Japan, respectively. For the first nine months of 1996 compared to the same period of 1995, a stronger U.S. dollar reduced expenses by approximately 3% and 17% in Europe and Japan, respectively. General and administrative expense totaled $9,869 and $9,093 or 10% and 9% of revenue for the third quarter of 1996 and 1995, respectively. General and administrative expense totaled $29,850 and $28,033 or 9% of revenue for the nine months of 1996 and 1995. The increase in general and administrative costs as compared to revenue quarter to quarter is a result of a decline in revenues during the comparable periods. On an absolute dollar basis, the increase in general and administrative costs is attributable to business purchases previously discussed. MERGER RELATED CHARGES During the third quarter of 1996, the Company incurred merger related charges of $2,830 as a result of the write-off of in-process R&D associated with the purchase of Royal Digital of $2,130 and merger related charges relating to the acquisition of Interconnectix of $700. The charge for in-process R&D is a result of allocating a portion of the acquisition cost to Royal Digital's in-process product development that had not reached technological feasibility. During the second quarter of 1996, the Company incurred merger related charges of $12,423 as a result of the write-off of in-process R&D associated with the purchases of dQdt, Seto and Meta. During the first quarter of 1996, the Company incurred merger related charges of $4,410 as a result of the merger with Microtec. The second quarter 1995 merger related costs of $800 are the result of the acquisitions of Axiom Datorer Skandinavien AB and Exemplar Logic, Inc. OTHER INCOME (EXPENSE) During the third quarter and the first nine months of 1996, other income was $938 and $2,577, compared to other income of $991 and $4,605 for the same periods of 1995, respectively. Included in other income are external legal counsel costs associated with the Quickturn Design Systems, Inc. litigation (See Note 5 of Notes to Consolidated Financial Statements), totaling approximately $500 and $3,100 for the third quarter and first nine months of 1996 compared to zero for the comparable periods of the prior year. Interest income from investments was $2,454 and $7,161 for the third quarter and first nine months of 1996, respectively, compared to $2,019 and $6,112 for the same periods of 1995. The increase in interest income is primarily attributable to higher average interest rates paid on cash, cash equivalents and short term investments outstanding during the comparable quarters. During the third quarter and first nine months of 1996, interest expense amounted to $609 and $1,740, respectively, down from $683 and $1,828 for the comparable periods in 1995. The decrease in interest expense is due to lower average debt outstanding offset by higher average interest rates for the comparable periods. PROVISION FOR INCOME TAXES The provision for income taxes amounted to $800 for the quarter ended September 30, 1996, as compared to $2,094 for the same period in 1995. For the first nine months of 1996, the provision for income taxes was $3,010 compared to $5,956 for the same period a year ago. The acquisitions of dQdt, Meta, Seto and Royal Digital resulted in one-time non-tax deductible charges of $14,553 which increased the Company's anticipated effective tax rate for the year. The third quarter 1996 tax accrual also includes a catch-up adjustment to align the year to date effective rate with the current estimated year-end effective rate. The Company can incur pre-tax losses in tax-free jurisdictions while experiencing pre-tax gains in taxable jurisdictions which should negatively impact the overall effective tax rate. 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 carry forwards, and tax expense for subsidiaries with pre-tax income. As such, the Company's income tax position and resultant effective tax rate is uncertain for the remainder of 1996. EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS The Company experienced a net loss from foreign currency transactions of $22 and $509 during the third quarter and first nine months of 1996, respectively, compared to a net loss of $335 and $181 during the same periods a year ago. These amounts are comprised of realized gains and losses on cash transactions involving various foreign currencies, and unrealized gains and losses related to foreign currency receivables and payables resulting from exchange rate fluctuations between the various currencies in which the Company operates. Foreign currency gains and losses are included as a component of other income. The "foreign currency translation adjustment", as reported in the equity section of the consolidated balance sheet at September 30, 1996, decreased to $12,159 from $13,594 at the end of 1995. This reflects the decrease in the value of net assets denominated in foreign currencies against the U.S. dollar since year-end 1995. During the balance sheet period from December 31, 1995 to September 30, 1996, the U.S. dollar strengthened approximately 4% against the European currencies and 8% against the Japanese yen. For the nine months of 1996 compared to the same period of 1995, a stronger U.S. dollar negatively impacted revenues by approximately 2% and 16% in Europe and Japan, respectively. In addition, for the nine months of 1996 compared to the same period of 1995, a stronger U.S. dollar reduced expenses by approximately 3% and 17% in Europe and Japan, respectively. Generally, a strengthening of the U.S. dollar makes the Company's products more expensive in foreign markets, which has a negative impact on the Company's revenues over time. In addition, a strengthening U.S. dollar results in lower reported revenues and operating expenses due to translation of local currency activity to U.S. dollars for consolidated financial reporting. The Company generally realizes approximately half of its revenue outside the United States and expects this to continue in the future. As such, the Company's business and operating results may be impacted by the effects of future foreign currency fluctuations. LIQUIDITY AND CAPITAL RESOURCES CASH AND INVESTMENTS Total cash and short-term investments at September 30, 1996 were $197,955 compared to $211,996 at the end of 1995. Cash provided by operations was $30,635 for the first nine months of 1996 compared to $58,466 during the same period of 1995. Cash provided by operations was negatively impacted by net income of $6,371 for the first nine months of 1996 compared to $31,977 for the same period of 1995. In addition, trade receivables increased by $1,816 and accrued and other liabilities decreased by $10,633 offset by increased accounts payable of $549. Cash and short-term investments at September 30, 1996 were negatively impacted by new business investments of $21,646, decreased short-term borrowings of $1,397, investment in property, plant and equipment of $16,772, repurchase of common stock of $8,875, offset by proceeds from the issuance of common stock of $8,339. TRADE ACCOUNTS RECEIVABLE Trade accounts receivable increased to $98,677 at September 30, 1996 from $96,962 at year-end 1995. This increase was attributable to an increase in late quarter shipments in the third quarter of 1996 compared to the fourth quarter of 1995. As a result, a lower percent of shipments made during the third quarter of 1996 were converted into cash collections before the period ended. OTHER ASSETS Other assets increased to $45,923 at September 30, 1996 from $38,184 at year-end 1995. This increase was partially attributable to purchased technology of $6,144 and goodwill capitalization of $3,522 relating to the purchases of dQdt, Seto, Meta and Royal Digital offset by other purchased technology and goodwill amortization of $7,701. Net capitalized software development costs decreased by $276 as capitalization and amortization were $4,328 and $4,604, respectively, during the first nine months of 1996. CAPITAL RESOURCES Total capital expenditures increased to $16,772 through September 30, 1996, compared to $15,694 for the same period of 1995. The increase in capital expenditures is primarily a result of costs associated with a new global information system. These expenditures will continue as the year progresses. The Company anticipates that current cash balances, anticipated cash flows from operating activities, and existing credit facilities will be sufficient to meet its working capital needs for at least the next twelve months. FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION The statements contained in this report that are not statements of historical fact are forward looking statements that involve a number of risks and uncertainties. Moreover, from time to time the Company may issue other forward looking statements. The following discussion highlights factors that could cause actual results to differ materially from the forward looking statements. The forward looking statements should be considered in light of these factors. The Company competes in the highly competitive and dynamic EDA (electronic design automation) industry. The Company's success is dependent upon its ability to develop and market products that are innovative, cost-competitive and that meet customers' expectations, and to deliver those products to its customers in a timely manner. 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. A material amount of the Company's software product revenue is usually the result of current quarter order performance and the Company books the majority of its orders in the last month of each quarter. In addition, the Company's revenue often includes multi-million dollar contracts. The timing of the completion of these contracts and the terms of delivery of software, hardware and other services can have a material impact on revenue recognition for a given quarter. The combination of these factors impairs and delays the Company's ability to identify shortfalls or overages from quarterly revenue targets. The Company generally realizes approximately half of its revenue outside the United States and expects this to continue in the future. As such, the Company's business and operating results can be impacted by the effects of foreign currency fluctuations. In order 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 is currently reorganizing its professional services business to better support its integrated systems design strategy. This required an internal focus of resources which caused lower billable hours for revenue generating services in the first nine months of 1996. In addition, business reorganizations can increase personnel management complexities including retention and hiring of key technical and management positions. While the Company will look to improve the utilization of its consultants, there can be no assurance that the challenges of the reorganization will be effectively met. The Company's operating expenses are generally committed in advance of revenue and are based to some degree on future revenue expectations. Operating expenses are incurred in order 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 an integral 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 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, and to effectively manage the business for long-term growth. While the Company is aware of and is addressing such issues, there can be no assurance that these challenges will be effectively met. As a result of the acquisition of Meta, the Company has entered the hardware development and assembly business which results in several new issues that the Company must effectively manage. Some of the issues include its ability to procure hardware components on a timely basis, ability to assemble and ship systems on a timely basis with appropriate quality control, new distribution and shipment processes, inventory management issues and new demands on the sales force. The Company is currently involved in the replacement of its financial information systems, based primarily on software from SAP. The implementation phase of new information systems can cause significant disruptions to the Company's work efficiency. There can be no assurance that the project will be completed within budgeted time or dollar parameters. The Company has been successful at recruiting and retaining necessary personnel to research and develop 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. 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. PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is involved in various administrative matters and litigation. Management believes that the ultimate outcome resulting from known matters will not have a material adverse impact on the Company's consolidated financial position or results of operations. During 1995, the Company filed suit in United States (U.S.) Federal District Court against Quickturn Design Systems, Inc. (competitor) seeking a declarative judgment on non-infringement, invalidity and unenforceability of three of the competitor's patents in anticipation of acquiring Meta. In January 1996, the competitor filed an administrative complaint with the International Trade Commission (ITC), a federal administrative agency, seeking to hinder the distribution of the Meta technology in the United States. Early in the third quarter of 1996, the ITC issued a temporary ruling allowing the importation of this technology to the U.S., but requiring posting of a bond for each sale. The required amount of the bond for each sale and the likelihood of the Company losing the posted amounts is uncertain at this time. There has been no final decision on the Company's declaratory judgment claims and the Company has applied for U.S. patent protection of certain aspects of this technology. While the outcome of this matter is uncertain at this time, management believes it will prevail. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: None. (b) No reports on Form 8-K were filed by the registrant during the quarter ended September 30, 1996. 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, on November 13, 1996. MENTOR GRAPHICS CORPORATION (Registrant) R. Douglas Norby R. Douglas Norby Senior Vice President, and Chief Financial Officer Richard Trebing Richard Trebing Corporate Controller, and Chief Accounting Officer EX-27 2
5 9-MOS DEC-31-1996 SEP-30-1996 163,499 34,456 98,677 0 5,201 322,211 236,332 (135,504) 498,962 112,199 0 296,206 0 0 37,145 498,962 327,125 327,125 98,809 221,512 (4,317) 0 1,740 9,381 3,010 6,371 0 0 0 6,371 .10 .10
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