-----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, GyjmfZyVY0BhgtULqxHqOukEKI3pGqhrtHDilqjOIsfHmcD+1rtQPBwznMPD+K/e xOooOOZt6Ehq3Toba9SUbg== 0000893877-96-000061.txt : 19960328 0000893877-96-000061.hdr.sgml : 19960328 ACCESSION NUMBER: 0000893877-96-000061 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960327 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-13442 FILM NUMBER: 96539060 BUSINESS ADDRESS: STREET 1: 8005 SW BOECKMAN RD CITY: WILSONVILLE STATE: OR ZIP: 97070 BUSINESS PHONE: 5036857000 10-K 1 FORM 10-K Form 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1995 Commission file number 0 - 13442 MENTOR GRAPHICS CORPORATION (Exact name of registrant as specified in its charter) Oregon 93-0786033 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 8005 SW Boeckman Road 97070-7777 Wilsonville, Oregon (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code (503) 685-7000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value 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 twelve 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 ---- ----- The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $867,360,450 on March 1, 1996, based upon the last price of the Common Stock on that date reported in the NASDAQ National Market System. On March 1, 1996 there were 60,867,400 shares of the Registrant's Common Stock outstanding. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K. [ ] DOCUMENTS INCORPORATED BY REFERENCE Document Part of Form 10-K into -------- which incorporated ---------------------- Portions of 1995 Annual Report to Parts I, II and IV Shareholders Portions of the 1996 Proxy Statement Part III 2 PART I Item 1. Business General Mentor Graphics is a leading supplier of electronic design automation ("EDA") systems -- advanced computer software used to automate the design, analysis and testing of electronic systems. Mentor Graphics is also a leader in providing services which augment its product offering and provide overall EDA solutions to its customers. Mentor Graphics markets its products primarily to large companies in the semiconductor, aerospace, computer, telecommunications, automotive and consumer electronics industries. Customers use Mentor Graphics' software in the design of such diverse products as supercomputers, automotive electronics, missile guidance systems, signal processors and personal computers. Mentor Graphics sells and licenses its products primarily through its direct sales force in North America, Europe and Asia, and through distributors in territories where the volume of business does not warrant a direct sales presence. Mentor Graphics was incorporated in Oregon in 1981 and its common stock is traded in the NASDAQ National Market System under the symbol MENT. Mentor Graphics' executive offices are located at 8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777. The telephone number at that address is (503) 685-7000. Products Mentor Graphics designs, manufactures, markets and supports EDA software for systems which may either be or contain integrated circuits ("ICs"), application specific integrated circuits ("ASICs"), field programmable gate arrays ("FPGAs"), printed circuit boards ("PCBs") and multichip modules ("MCMs"). Current EDA processes must manage the speed, density and reliability tradeoffs necessary to allow customers to quickly create and test high performance IC and electronic system designs and, as a result, shorten product time-to-market. Mentor Graphics' software products enable engineers to design, analyze, place and route, and test electronic systems and subsystems prior to creating hardware prototypes. Mentor Graphics provides a full suite of software tools covering the entire EDA design flow, as well as high-performance software tools that can be used in other EDA vendor design environments. Mentor Graphics believes that its products help customers reduce development time while producing high quality, innovative hardware products. Mentor Graphics markets and supports worldwide over 150 software products for i) IC design flow, ii) ASIC/FPGA design flow, and iii) MCM/PCB design flow. Mentor Graphics' IC design flow products allow customers to create designs for ICs. "ICs" are high performance circuits with customized logic layers which generally allow for denser designs, increased functionality and better optimization than ASICs. IC design flow products allow designers to specify an IC design and check the design for errors, "layout" the electrical components of the design in a way that balances IC performance and the size of the IC used, and finally, create output which is used to direct the manufacturing and testing of the IC. Mentor Graphics products within the IC design flow include IC design and layout tools such as MS Analyzer, Cell Builder, GDT, IC Station, MicroRoute, AutoLogic II, QuickHDL, FastScan, and FlexTest, as well as power management and analog and analog/mixed signal design solutions. Mentor Graphics is able to connect its ASIC/FPGA and MCM/PCB design products with its IC design products to create a continuum of automation from the system level to the IC level. Mentor Graphics' ASIC/FPGA design products allow customers to create designs for ASICs and FPGAs. "ASICs" are special integrated circuits with standard logic layers which are customized by interconnect layers. The standard logic layers allow ASICs to be designed faster and manufactured at a lower cost for small unit volumes than traditional ICs. "FPGAs", as the name suggests, are circuits that can be programmed to include different functionality at the point of 3 manufacturing or during system startup. ASIC/FPGA design products allow designers to simulate designs to ensure that they possess the required performance and functionality, to test the design for errors, and to create output which will allow the design to be manufactured and tested. Mentor Graphics' products within the system design flow include BSDArchitect, DFTAdvisor, FastScan, FlexTest, QuickVHDL, System Design Station, System Architect, DSP Station, Top-Down Design Solver, AutoLogic II, FPGA Station and Idea Station. MCM/PCB design flow tools allow customers to determine the functionality of a MCM/PCB. "MCMs" may be thought of as several ICs or ASICs mounted together in a single package. "PCBs", a common way of packaging electronic circuits, are epoxy type "boards" upon which ICs, ASICs and discrete components such as resistors and capacitors are mounted. MCM/PCB design flow tools allow designers to select from a library of parts to be included in the MCM/PCB, to simulate and test the performance of the MCM/PCB, to test for manufacturability, thermal analysis and signal integrity, and to output data which will allow the MCM/PCB to be manufactured. Products within the MCM and PCB design flows include Board Station, MCM Station, Hybrid Station, AutoTherm MCM, AutoFlow, Logical Cable, Physical Test Manager: SITE, Manufacturing Advisor and EngineerView. Mentor Graphics believes that as computers, telecommunications, and consumer devices converge into portable and hand-held products, systems-on-silicon -- entire computer systems, both hardware and software, on a single IC or ASIC -- will become a major product paradigm and will soon account for a substantial number of design starts. As a result, increasingly complex EDA technology will be required to design hardware/software systems. Designs will be smaller and more densely packed with components. In May 1995, Mentor Graphics announced its Systems-on-Silicon Initiative (SoS Initiative), a company-wide program created to meet the growing challenge of designing systems on a single IC or ASIC. The SoS Initiative targets the challenge of creating entire systems on silicon, including design reuse, design creation and simulation at very high levels of abstraction, fully integrated design processes that support multiple design styles and technologies, hardware/software co-design, power management, and timing analysis. Under the SoS Initiative program, the research and development groups of Mentor Graphics are expected to contribute specific technology and expertise to meet the SoS Initiative's long-term goal of fully tested EDA design processes that support the entire design cycle for systems-on-silicon. These new technologies are also expected to impact Mentor Graphics' products targeted at IC, ASIC, FPGA, MCM and PCB designs. With the closing of its acquisition of Microtec Research, Inc. in January 1996, Mentor Graphics has broadened its EDA product offering to include software development tools, real-time operating systems and software connectivity products. These newly acquired products facilitate the development and operation of embedded software required by microprocessor-based products. Platforms Mentor Graphics' software products run primarily on UNIX workstations in a broad range of price and performance levels, including workstations manufactured by Hewlett-Packard Company, Sun Microsystems, Inc., Digital Equipment Corporation, and International Business Machines Corporation (IBM). These computer manufacturers have a substantial installed base of workstations, and make frequent introductions of new products. A limited number of Mentor Graphics' software products also support personal computers running Microsoft Windows 95 and Windows NT operating systems. Mentor Graphics anticipates that it will introduce additional products which will run under Microsoft Windows 95 and Windows NT operating systems during 1996 and 1997. 4 Marketing and Sales Mentor Graphics' marketing strategy emphasizes customer support, professional consulting services, a strong direct sales force and large corporate account penetration in the semiconductor, aerospace, computer, telecommunications, automotive and consumer electronics industries. Customers use Mentor Graphics' products in the design of such diverse products as supercomputers, automotive electronics, missile guidance systems, signal processors, personal computers, gallium arsenside circuits, microprocessors, telecommunication switching systems and wireless communication products. Mentor Graphics sells and licenses its products primarily through its direct sales force in North America, Asia and Europe. Mentor Graphics also licenses its products through distributors in territories where the volume of business is not sufficient to warrant a direct sales presence. During the years ending December 31, 1995 and 1994, sales outside of North America accounted for 48 and 46 percent, respectively, of total sales. Additional information relating to foreign and domestic operations is contained in Note 14 of Notes to Consolidated Financial Statements on page 35 of the 1995 Annual Report to Shareholders and is incorporated by this reference. Fluctuating exchange rates and other factors beyond Mentor Graphics' control, such as tariff and trade policies, domestic and foreign tax and economic policies and the relative stability of international economic and monetary conditions are expected to continue to affect the level and profitability of sales outside the United States. Mentor Graphics also licenses products through its newly created subsidiary, Antares Corporation ("Antares"). Antares was established to focus on high quality, lower cost tools for the UNIX and Microsoft Windows market. It does not use the Mentor Graphics sales force, but relies instead on telesales and value added resellers. Mentor Graphics' recently acquired Model Technology and Exemplar Logic subsidiaries have been combined to form Antares. Antares is currently wholly owned by Mentor Graphics, but over time, Mentor Graphics plans to issue approximately 10% of Antares' stock to Antares employees through an equity incentive program. Mentor Graphics' OpenDoor program coordinates and supports the integration of third party EDA software tools, both commercial products and tools developed by customers for their own internal use, into Mentor Graphics' design environment. Under this program, Mentor Graphics enables OpenDoor participant companies to develop interfaces from their products to Mentor Graphics products. OpenDoor participants select from a range of integration technologies to achieve an optional degree of integration for their products. There are now approximately 140 OpenDoor participants. No material portion of Mentor Graphics' business is dependent on a single customer. Mentor Graphics has traditionally experienced some seasonal fluctuations in receipts of orders, which are typically stronger in the second and fourth quarters of the year. As is typical of many other companies in the electronics industry, Mentor Graphics generally ships its products to customers within 10 to 90 days after receipt of an order, and a substantial portion of quarterly shipments tend to be made in the last month of each quarter. Mentor Graphics' backlog of firm orders was approximately $53.9 million on December 31, 1995 as compared to $46.5 million on December 31, 1994. This backlog includes products not shipped and unfulfilled professional services and training. The Company does not track backlog for support services. Support services are typically delivered under annual contracts which are accounted for on a prorata basis over the twelve month term of each contract. Substantially all of the December 31, 1995 backlog of orders is expected to ship during 1996. Mentor Graphics sells and licenses its products and some third party products pursuant to purchase and license agreements. Mentor Graphics schedules deliveries only after receipt of purchase orders under these agreements. 5 Manufacturing Operations Mentor Graphics' manufacturing operations primarily consist of reproduction of Mentor Graphics' software and documentation. In North America, manufacturing is substantially outsourced, with distribution to Western Hemisphere customers occurring from major west coast sites. Software and documentation distribution centers in The Netherlands, Japan and Singapore serve their respective regions. Mentor Graphics uses a manufacturing resource planning system to control its inventories and logistic processes. Product Development The EDA market is competitive and characterized by rapid technological change. During the years ended December 31, 1995, 1994 and 1993, Mentor Graphics expensed approximately $72,692,000, $67,792,000 and $75,304,000 respectively, and capitalized approximately $7,241,000, $5,156,000 and $3,609,000, respectively, related to product development. Mentor Graphics also seeks to expand existing product offerings and pursue new lines of business through acquisitions. Acquisitions accommodate Mentor Graphics' focused strategic requirements including filling gaps in existing products or technologies, eliminating dependencies on third parties and providing Mentor Graphics with an avenue into new lines of business. Suppliers Mentor Graphics seeks to provide its customers with software that addresses the entire electronic system design process. Supplier products fill gaps in Mentor Graphics' existing product lines and allow it to offer products which are needed by customers but which are not core to Mentor Graphics' business. Supplier agreements are also used by Mentor Graphics to explore possible new lines of business. Although Mentor Graphics has supplier agreements with several large customers who do not wish to develop a specific internal technology into a commercial product, Mentor Graphics' suppliers are typically small niche companies which do not have adequate distribution channels for their products. Mentor Graphics maintains three different types of supplier relationships: (i) a simple remarketing relationship where the supplier's product is added to Mentor Graphics' price list and drop shipped to the customer directly from the supplier; (ii) a partial integration relationship where the supplier's object code is packaged and shipped with other Mentor Graphics' products to the customer; and (iii) a fully integrated relationship where Mentor Graphics modifies or enhances the supplier's product before packaging and delivering it to the customer. Supplier agreements are typically three year agreements with royalty payments based on a percentage of product revenue. They generally require an escrow of the supplier's source code. Customer support for supplier products is usually provided by Mentor Graphics with the supplier providing backup support and research and development in the event of a problem with the product itself. Customer Support and Professional Services Mentor Graphics has a worldwide organization to meet its customers' needs for software support. Mentor Graphics offers support contracts providing software updates and support. Most of Mentor Graphics' customers have entered into software support contracts. Mentor Graphics provides technical support for its products through a direct telephone support line and an on-line electronic communications system. Mentor Graphics believes that delivery of professional services is a rapidly expanding segment of the EDA market. Mentor Graphics' Professional Services Division was established in 1987. This division's mission is to team with customers' design groups to increase productivity and reduce 6 costs by assisting customers with methodology and process changes, tool refinements, design implementation and integration services. The Professional Services Division has a worldwide team of EDA professionals available for on-site customer consultation providing software and services for design data management and electronic parts data creation, design services for ASICs, ICs, MCMs and EDA network and design environment management and software integration. Competition The EDA industry is competitive and has been characterized by rapid technological advances in application software, operating systems and hardware. Mentor Graphics' principal competitors are Cadence Design Systems, Inc., Synopsys, Inc., Viewlogic Systems, Inc., COMPASS Design Automation, Inc., Zuken-Redac, Intergraph Corporation and numerous small companies. Some of Mentor Graphics' competitors may have greater financial and marketing resources than Mentor Graphics. However, Mentor Graphics believes the main competitive factors in the EDA industry are breadth and quality of application software, product integration, ability to respond to technological change, quality of a company's sales force, price, size of the installed base, level of customer support and professional services. Mentor Graphics believes that it generally competes favorably in these areas. Mentor Graphics can give no assurance, however, that it will have financial resources, marketing, distribution and service capability, depth of key personnel or technological knowledge to compete successfully in the EDA market. Employees Mentor Graphics and its subsidiaries employed 2,039 persons full time as of December 31, 1995. Mentor Graphics' success will depend in part on its ability to attract and retain employees who are in great demand. Mentor Graphics continues to enjoy good employee relations. No Mentor Graphics employees are represented by a collective bargaining unit. Patents and Licenses Mentor Graphics owns eleven United States patents and nine foreign patents covering portions of its technology. Mentor Graphics is currently seeking to patent more of the inventive technology which Mentor Graphics believes gives it a competitive advantage. Mentor Graphics presently has patent applications pending and intends to file additional patent applications in the future. While Mentor Graphics believes the pending applications relate to patentable devices, there can be no assurance that any patent will be issued or that any patent can be successfully defended. Although Mentor Graphics believes that patents are less significant to the success of its business than technical competence, management ability, marketing capability and customer support, Mentor Graphics believes that software patents are becoming increasingly important in the software industry. Mentor Graphics regards its application software as proprietary and attempts to protect it with copyrights, trade secret laws, and internal non-disclosure safeguards, as well as patents, when appropriate, as noted above. Mentor Graphics typically incorporates restrictions on disclosure, usage and transferability into its agreements with customers and other third parties. Item 2. Properties Mentor Graphics' Wilsonville, Oregon facilities are located in six owned buildings on about 90 acres and take up approximately 387,500 square feet. All corporate functions, as well as a majority of research and development and domestic activities, operate from this site. 7 Mentor Graphics leases additional space in San Jose, California, and in various locations throughout the United States and in other countries, primarily for sales and customer service operations. Mentor Graphics believes that it will be able to renew or replace its existing leases as they expire and that its current facilities will be adequate through at least 1996. Item 3. Legal Proceedings There are no material legal proceedings pending against the Company. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the security holders of the Company during the fourth quarter of the fiscal year ended December 31, 1995. Executive Officers of Registrant The following are the executive officers of the Company:
Name Position Age Has Served As An Officer of Company Since Walden C. Rhines President, Chief Executive Officer 49 1993 and Director James W. Martin Executive Vice President 64 1996 R. Douglas Norby Senior Vice President and Chief 60 1993 Financial Officer Frank S. Delia Vice President, Human Resources and 49 1983 the Workplace Dean Freed Vice President, General Counsel and 37 1995 Secretary Richard Trebing Corporate Controller and Chief 36 1996 Accounting Officer Dennis Weldon Treasurer 47 1996
The executive officers are elected by the Board of Directors of the Company at its annual meeting. Officers hold their positions until they resign, are terminated or their successors are elected. There are no arrangements or understandings between the officers or any other person pursuant to which officers were elected and none of the officers are related. Dr. Rhines has served as Director, President and Chief Executive Officer of Mentor Graphics since October 1993. From 1972 to 1993, Dr. Rhines was employed by Texas Instruments Incorporated where he held a variety of technical and management positions and was most recently Executive Vice President of Texas Instruments Semiconductor Group. Dr. Rhines is currently a director of Cirrus Logic, Inc., and Triquint Semiconductor, Inc., both semiconductor manufacturers. 8 Mr. Martin has served as Executive Vice President of Mentor Graphics since January 1996. From February 1994 to 1996, Mr. Martin served as Special Assistant to the President of Mentor Graphics. From 1962 to 1992, he was employed by Texas Instruments Incorporated where he held a variety of management positions and most recently served as Corporate Vice President and Executive Vice President of the Information Systems Group. Mr. Norby has served as Senior Vice President and Chief Financial Officer of Mentor Graphics since July 1993. From 1992 to 1993, he served as President and Chief Executive Officer of Pharmetrix Corporation. From 1985 to 1992 he was employed by Lucasfilm, Ltd. where he last held the position of President and Chief Operating Officer. Mr. Delia has served as Vice President, Human Resources and the Workplace since July 1995. From 1990 to July 1995, Mr. Delia served as Vice President, Chief Administrative Officer, General Counsel and Secretary of Mentor Graphics. Mr. Freed has served as Vice President, General Counsel and Secretary of Mentor Graphics since July 1995. Mr. Freed served as Deputy General Counsel and Assistant Secretary of Mentor Graphics from April 1994 to July 1995, and was Associate General Counsel and Assistant Secretary from 1990 to April 1994. He has been employed by Mentor Graphics since January 1989. Mr. Trebing has served as Corporate Controller and Chief Accounting Officer since February 1996. Mr. Trebing served as Financial Planning and Reporting Manager from January 1995 to February 1996 and as a Divisional Controller from January 1994 to January 1995. From February 1992 to January 1994, Mr. Trebing served as a Finance Manager and from October 1989 to February 1992, as a Planning and Analysis Manager. Mr. Trebing has been employed by Mentor Graphics since October 1989. Mr. Weldon has served as Treasurer since February 1996. Mr. Weldon served as Director of Corporate Business Development from July 1994 to February 1996 and was a Director of Finance from January 1991 to July 1994. He has been employed by Mentor Graphics since July 1988. PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The Company does not intend to pay dividends in the foreseeable future. Additional information required by this item is included under "Quarterly Financial Information" on page 37 and under the shareholder information included on page 39 of the Company's 1995 Annual Report to Shareholders. Item 6. Selected Financial Data The information required by this item is included under "Selected Consolidated Financial Data" on page 13 of the Company's 1995 Annual Report to Shareholders. 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by this item is included under "Management's Discussion and Analysis of Results of Operations and Financial Condition" on pages 14-21 of the Company's 1995 Annual Report to Shareholders. Item 8. Financial Statements and Supplementary Data The financial statements are included in the Company's 1995 Annual Report to Shareholders on pages 22-36 and are indexed here under Item 14(a)(1). The supplementary data required by this item is included under "Quarterly Financial Information" on page 37 of the Company's 1995 Annual Report to Shareholders. See also the financial statement schedule appearing here as indexed under Item 14(a)(2). Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of Registrant The information required by this item concerning the Company's Directors is included under "Election of Directors" in the Company's 1996 Proxy Statement and is incorporated herein by reference. The information concerning the Company's Executive Officers is included herein on page 7 under the caption "Executive Officers of the Registrant." The information required by Item 405 of Regulation S-K is included under "Compliance with Section 16(a) of the Exchange Act" in the Company's 1996 Proxy Statement and is incorporated herein by reference. Item 11. Executive Compensation The information required by this item is included under "Compensation of Directors," and "Information Regarding Executive Officer Compensation" in the Company's 1996 Proxy Statement and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is included under "Election of Directors" and "Information Regarding Beneficial Ownership of Principal Shareholders and Management" in the Company's 1996 Proxy Statement and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information required by this item is not applicable to the Company. 10 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The documents listed are included on pages indicated in the Company's 1995 Annual Report to Shareholders: Page ---- (1) Financial Statements Consolidated Statements of Operations 22 Consolidated Balance Sheets 23 Consolidated Statements of Cash Flows 24 Consolidated Statements of Stockholders' Equity 25 Notes to Consolidated Financial Statements 26-36 Independent Auditors' Report 38 (2) Financial Statement Schedules The documents and schedule listed below are filed as part of this report on the pages indicated: Schedule Page -------- ---- II Valuation and Qualifying Accounts 13-14 Independent Auditors' Report on Financial Statement Schedule 15 All other financial statement schedules have been omitted since they are not required, not applicable or the information is included in the consolidated financial statements or notes. (3) Exhibits 3. A. 1987 Restated Articles of Incorporation. Incorporated by reference to Exhibit 4A to the Company's Registration Statement on Form S-3 (Registration No. 33-23024). B. Bylaws of the Company. Incorporated by reference to Exhibit 4B to the Company's Registration Statement on Form S-3 (Registration No. 33-56759). 10. *A. 1982 Stock Option Plan. Incorporated by reference to Exhibit 10.A to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (1994 10-K). *B. Nonqualified Stock Option Plan. Incorporated by reference to Exhibit 10.C to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (1989 10-K). *C. 1986 Stock Plan. Incorporated by reference to Exhibit 10.D to the Company's 1989 10-K. *D. 1987 Non-Employee Directors' Stock Option Plan. Incorporated by reference to Exhibit 10.D to the Company's 1994 10-K. *E. Form of Indemnity Agreement entered into between the Registrant and each of its 11 officers and directors. Incorporated by reference to Exhibit B to the Company's 1987 Proxy Statement. F. Lease dated November 20, 1991, for 999 Ridder Park Drive and 1051 Ridder Park Drive, San Jose, California. Incorporated by reference to Exhibit 10.M to the Company's Form SE dated March 25, 1992. G. Amended and Restated Loan Agreement between Mentor Graphics Corporation and First Interstate Bank of Oregon, N.A. dated December 31, 1992 as amended. Incorporated by reference to Exhibit 10.J to the Company's Form SE dated March 25, 1993. *H. Special Incentive Bonus Plan. 13. Portions of the 1995 Annual Report to Shareholders that are incorporated herein by reference. 21. List of Subsidiaries of the Company. 23. Consent of Accountants. -------------------------------- * Management contract or compensatory plan or arrangement (b) During the last quarter of 1995, Mentor Graphics reported on the signing of the Agreement and Plan of Merger among Mentor Graphics, M Acquisition Sub, Inc., and Microtec Research, Inc. on Form 8-K under Item 5, Other Events. The date of the event reported was October 9, 1995. No financial statements were filed. 12 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 March 27, 1996. MENTOR GRAPHICS CORPORATION By WALDEN C. RHINES ---------------------------------- Walden C. Rhines President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant on March 27, 1996 in the capacities indicated. Signature Title (1) Principal Executive Officer: WALDEN C. RHINES ------------------------------ President, Chief Executive Officer Walden C. Rhines and Director (2) Principal Financial Officer: R. DOUGLAS NORBY ------------------------------ Senior Vice President and Chief R. Douglas Norby Financial Officer (3) Principal Accounting Officer: JAMES J. LUTTENBACHER -------------------------------- Chief Accounting Officer for 1995 James J. Luttenbacher (4) Directors: JON A.SHIRLEY ------------------------------ Chairman of the Board Jon A. Shirley MARSHA B. CONGDON ------------------------------ Director Marsha B. Congdon JAMES R. FIEBIGER ------------------------------ Director James R. Fiebiger DAVID A. HODGES ------------------------------ Director David A. Hodges FONTAINE K. RICHARDSON ------------------------------ Director Fontaine K. Richardson 13 SCHEDULE II MENTOR GRAPHICS CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (In Thousands)
Additions Charged to Beginning Cost & Ending Description Balance Expenses Deductions Balance ----------- ------- -------- ---------- ------- Year ended December 31, 1993: Allowance for deferred tax assets $ 0 $58,495(1) $ 0 $58,495 Allowance for doubtful accounts $ 4,376 $ 508 $ 956(2) $ 3,928 Allowance for obsolete inventory $12,436 $ 1,924 $ 6,346(3) $ 8,014 Accrued restructure costs $12,270 $26,200 $10,096(4) $28,374 Year ended December 31, 1994: Allowance for deferred tax assets $58,495 $ 0 $12,282(1) $46,213 Allowance for doubtful accounts $ 3,928 $ 629 $ 1,559(2) $ 2,998 Allowance for obsolete inventory $ 8,014 $ 0 $ 7,155(3) $ 859 Accrued restructure costs $28,374 $ 4,000 $20,477(4) $11,897 Year ended December 31, 1995: Allowance for deferred tax assets $46,213 $ 2,933 $ 4,859(1) $44,287 Allowance for doubtful accounts $ 2,998 $ 308 $ 535(2) $ 2,771 Allowance for obsolete inventory $ 859 $ 26 $ 496(3) $ 389 Accrued restructure costs $11,897 $ 0 $ 8,146(4) $ 3,751 - --------------------------- (1) Addition in 1993 represents adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" on January 1, 1993 and increases to the valuation allowance during the year. As such, the Company established a valuation allowance for certain deferred tax assets, including net operating loss and tax credit carryforwards. Statement No. 109 requires that such a valuation allowance be recorded when it is more likely than not that some portion of the deferred tax assets will not be realized. The deduction in 1994 primarily represents the realization of net operating loss carryforwards for the year. The valuation allowance as of December 31, 1994 was $46,213, of which $1,974 was related to deferred tax assets of the Company's Japanese subsidiary. Based on operating income levels before tax for the Company's Japanese subsidiary in 1995, it was determined that it was more likely than not that the Japanese subsidiary's deferred tax assets would be realized. As such, the tax provision for 1995 was adjusted for the reversal of the valuation allowance for the Japanese deferred tax assets. (2) Deductions primarily represent accounts written off during the period. (3) Deductions represent inventory scrapped during each period and reclassification of demonstration equipment from inventory to property plant and equipment in 1994. 14 (4) Deductions primarily represent payments made to carry out restructure plans and reversals of accrued restructure charges due to changes in estimates of $2,040, $10,045 and $1,400 for the years ended December 31, 1995, 1994 and 1993, respectively.
15 Independent Auditors' Report - ---------------------------- The Board of Directors and Stockholders Mentor Graphics Corporation: Under date of January 29, 1996, we reported on the consolidated balance sheets of Mentor Graphics Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 1995, which are included in the 1995 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1995. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in note 1 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities", in 1994 and SFAS No. 109, "Accounting for Income Taxes", in 1993. KPMG PEAT MARWICK LLP January 29, 1996 EX-10.H 2 SPECIAL INCENTIVE BONUS PLAN MENTOR GRAPHICS CORPORATION SPECIAL INCENTIVE BONUS PLAN January 1, 1995 Mentor Graphics Corporation an Oregon Corporation 8005 SW Boeckman Road Wilsonville, OR 97070-7777 Mentor Mentor recognizes that its continuing success measured in terms of growth of its revenue and profit depends critically on the initiative and performance of its key executives and technologists. Mentor believes that by rewarding its key executives and technologists for enhancing those corporate goals, their performance will be motivated to Mentor's benefit. Mentor therefore adopts this Special Incentive Bonus Plan. 1. Effective Date The Plan is effective January 1, 1995. 2. Eligibility 2.01 Positions eligible to participate in the Plan shall be selected by Mentor's Chief Executive Officer (CEO) from Mentor's Operating Committee members and key technologist positions selected by the CEO. 2.02 Employees in the eligible positions shall participate in bonuses as provided in the Plan. 2.03 Participants shall be notified in writing of their participation in the Plan. 3. Annual Plan 3.01 The years 1995, 1996 and 1997 shall be Plan Years. 3.02 For each Plan Year, Mentor's Board of Directors shall establish an annual plan which shall include planned goals for Mentor's total revenues and net income. 2 4. Bonus 4.01 Each Plan Year that Mentor's actual net income (ANI) equals or exceeds planned net income (PNI), there shall be a bonus for each participant equal to 1/2 of 1 percent of base pay for every full percent (if any) by which actual total revenues exceed planned total revenues, plus 1 percent of base pay for every full percent (if any) by which ANI exceeds PNI. 4.02 The term "total revenues" shall be as reported in Mentor's published annual reports to shareholders. The term "net income" shall be as reported in Mentor's published annual reports to shareholders, as adjusted from time to time by the Compensation Committee of Mentor's Board of Directors for accounting items attributable to performance in a different fiscal period (such as the reversal in the current period of items accrued in a prior period) or that are otherwise determined by the Compensation Committee to reflect matters considered by the Committee not to be attributable to the initiative or performance desired of participants for the plan year in question. The Compensation Committee's exercise of discretion in this regard shall be final and binding on all affected persons. 4.03 The term "base pay" shall mean the midpoint of the pay range for the participant's pay grade under Mentor's compensation programs as in effect on the April 30 of the Plan Year to which it relates. Where a change occurs, the amount shall be understood to be the amount determined as of the last day of the Plan Year. 4.04 If a participant occupies a participating position for less than a full Plan Year, the bonus shall be based on prorated base pay for the period of service in the Plan Year. 4.05 If more than one participant occupies a participating position in a Plan Year, there shall be separate bonuses based on the prorated base pay of each. 4.06 Bonuses are payable and subject to forfeiture as provided in 5. 5. Payment and Forfeiture of Bonuses 5.01 Subject to 5.02 and 5.03, bonuses shall be payable to participants as follows: (a) Twenty five percent of any bonus for 1995 shall be payable in the first quarter of 1996 and the balance deferred until the first quarter of 1998. (b) Fifty percent of any bonus for 1996 shall be payable in the first quarter of 1997 and the balance deferred until the first quarter of 1998. (c) The entire amount of any bonus for 1997 shall be payable in the first quarter of 1998. 3 5.02 Bonuses shall be subject to forfeiture as follows: (a) If a participant is not an employee of Mentor or an affiliate on the last day of a Plan Year, the participant shall forfeit the entire amount of any bonus for that Plan Year. (b) If a participant is not an employee of Mentor or an affiliate on December 31, 1997, the participant shall forfeit the entire amount of any deferred bonuses. (c) Forfeiture shall not apply if termination of a participant's employment with Mentor resulted from the participant's death or retirement or disability under the Mentor Graphics Individual Deferred Tax and Savings Plan. 5.03 Payment of a bonus shall occur as follows: (a) Subject to (b), payment of a bonus shall occur as soon as practicable after the beginning of the quarter in which it is payable. (b) Prior to paying any bonus payable under (a), Mentor shall determine, using reasonable projections and estimates of amounts not yet paid where necessary, whether the payment, when taken together with an employee's other applicable employee remuneration, would result in the employee's receiving nondeductible remuneration for a taxable year under Internal Revenue Code sec. 162(m). If it would, payment of the bonus will be deferred and carried forward to succeeding taxable years to the extent necessary to allow deductibility. 6. Nontransferability No interest of any participant may be assigned, transferred, seized by legal process or subjected to the claims of creditors in any way. 7. Administration 7.01 The Plan shall be administered by the CEO, who may delegate any administrative duties to one or more agents and who may retain advisors, consultants or counsel, who may be advisors, consultants or counsel to Mentor. 7.02 The Administrator shall have general responsibility to interpret and administer the Plan. Any decision by the Administrator shall be final and bind all parties. The Administrator shall be responsible for communicating with participants. 4 8. Claims 8.01 Any person claiming a benefit or requesting an interpretation, information or a ruling under the Plan shall present the request in writing to the Administrator, who shall respond in writing as soon as practicable. 8.02 If a claim or request is denied, the written notice of denial shall state: (a) The reasons for the denial, with specific reference to the plan provisions on which the denial is based; (b) A description of any additional material or information required and an explanation of why it is necessary; (c) An explanation of the Plan's claim review procedure. 8.03 Any person whose claim or request is denied or who has not received a response within 30 days may request review by notice in writing to the Administrator. The original decision shall be reviewed by the Administrator who may, but shall not be required to, grant the claimant a hearing. On review, whether or not there is a hearing, the claimant may have representation, examine pertinent documents and submit issues and comments in writing. 8.04 The decision on review shall ordinarily be made within 60 days. If an extension of time is required for a hearing or other special circumstances the claimant shall be notified and the time limit shall be 120 days. The decision shall be in writing and shall state the reasons and the relevant plan provisions. All decisions on review shall be final and bind all parties concerned. 9. Not a Contract of Employment Nothing in this Plan shall confer on any participant, or be construed to confer on any participant, the right to continued employment or an acquired right to any compensation under the Plan. The Plan shall not prevent the termination of any participant's employment at any time for any reason. 5 10. Amendment and Termination Mentor's Board of Directors may amend or terminate this Plan at any time. Adopted: May 4, 1995 Mentor MENTOR GRAPHICS CORPORATION By DEAN FREED ----------------------------------- Its Vice Presdient and General Counsel Executed as of June 1, 1995 EX-13 3 EXHIBIT 13 SELECTED CONSOLIDATED FINANCIAL DATA
Year ended December 31, 1995 1994 1993 1992 1991 In thousands, except per share data and percentages ----------- ----------- ----------- ----------- ----------- Statement of Operations Data Total revenues $ 384,461 $ 346,204 $ 338,983 $ 347,114 $ 395,866 Research and development $ 72,692 $ 67,792 $ 75,304 $ 70,295 $ 75,278 Operating income (loss) $ 51,592 $ 28,880 $ (29,340) $ (40,732) $ (60,501) Net income (loss) $ 49,859 $ 27,767 $ (32,060) $ (50,861) $ (61,613) Gross margin percent 71.2% 71.2% 65.7% 55.9% 49.5% Operating income (loss) as a percent of total revenues 13.4% 8.3% (8.7%) (11.7%) (15.3)% Per Share Data Net income (loss) per common and common equivalent share $ .88 $ .51 $ (.66) $ (1.13) $ (1.43) Cash dividends per common share outstanding $ -- $ -- $ .18 $ .24 $ .24 Weighted average number of common and common equivalent shares outstanding 56,381 54,367 48,657 45,142 43,153 Balance Sheet Data As of December 31, 1995 1994 1993 1992 1991 ----------- ----------- ----------- ----------- ----------- Cash and short-term investments $ 201,004 $ 138,169 $ 109,881 $ 108,783 $ 144,022 Cash and investments, long-term $ 30,000 $ 30,000 $ 30,000 $ 30,000 $ -- Working capital $ 200,714 $ 137,245 $ 96,384 $ 108,892 $ 169,875 Property, plant and equipment, net $ 94,556 $ 98,020 $ 105,231 $ 109,580 $ 114,213 Total assets $ 461,622 $ 395,358 $ 355,145 $ 378,565 $ 445,661 Short-term borrowings $ 9,108 $ 8,488 $ 6,364 $ 5,548 $ 4,511 Long-term debt and other deferrals $ 53,472 $ 55,650 $ 56,270 $ 58,064 $ 53,462 Stockholders' equity $ 305,521 $ 239,527 $ 195,939 $ 221,406 $ 267,667
13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION All numerical references in thousands, except percentages NATURE OF OPERATIONS Mentor Graphics Corporation (the Company) is a supplier of electronic design automation (EDA) systems - advanced computer software used to automate the design, analysis and testing of electronic systems and components. Established in 1981, the Company is a leader in worldwide EDA sales and markets its products and services primarily to customers in the computer, telecommunications, consumer electronics, semiconductor, aerospace and automotive industries. The Company sells and licenses its products primarily through its direct sales force in North America, Europe and Asia, and through distributors in territories where the volume of business does not warrant a direct sales presence. In addition to its corporate offices in Wilsonville, Oregon, the Company has sales, support, software development and professional services offices worldwide. RECENT MERGERS AND ACQUISITIONS Acquisitions of complementary businesses are an integral part of the Company's overall business strategy. Acquisitions accommodate the Company's focused strategic requirements by filling gaps in existing products or technologies, eliminating dependencies on third parties and providing the Company with an avenue into new lines of business and new distribution channels. The Company will continue to evaluate make versus buy alternatives, which should result in additional business combinations in 1996. There can be no assurance that products, technologies and businesses of acquired companies, or the technical and sales personnel of such companies, will be effectively assimilated with those of the Company. On January 31, 1996 the Company completed the acquisition of Microtec Research, Inc. (Microtec), pursuant to a merger accounted for as a pooling of interests. A total of 6,223 shares of the Company's common stock were issued in the transaction. Since the acquisition was not consummated as of December 31, 1995, the results of Microtec are not included in the Company's consolidated financial statements. The Company acquired Axiom Datorer Scandinavian AB (Axiom), 3Soft Corporation (3Soft), and Zeelan Technology, Inc. (Zeelan) in May 1995, December 1995, and December 1995, 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 charges for in-process research and development (R&D) of $1,430, goodwill capitalization of $528 and technology capitalization of $892. In October 1995, the Company acquired Precedence Incorporated (Precedence), pursuant to a merger accounted for as a pooling of interests. Accordingly, the results of Precedence are included in the Company's consolidated financial statements for all periods presented. A total of 735 shares of the Company's common stock were issued in the transaction. Merger expenses of $210 were for services rendered to facilitate completion of the merger agreement. In May 1995, the Company acquired Exemplar Logic, Inc. (Exemplar), pursuant to a merger accounted for as a pooling of interests. Accordingly, the results of Exemplar are included in the Company's consolidated financial statements for all periods presented. A total of 1,512 shares of the Company's common stock were issued in the transaction. Merger expenses of $400 were for services rendered to facilitate completion of the merger agreement and for severance costs. In September 1994, the Company completed the acquisition of Anacad Electrical Engineering Software GmbH (Anacad). The acquisition was accounted for as a purchase and accordingly, the results of operations are included in the Company's results of operations from the date of acquisition. 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 $8,265, goodwill capitalization of $2,897 and technology capitalization of $4,735. In December 1994, the Company acquired Model Technology Incorporated (MTI), pursuant to a merger accounted for as a pooling of interests. The results of MTI are included in the Company's consolidated financial statements for 1994 and 1995. The Company's 1993 financial statements were not restated due to the relative materiality of MTI's separate financial statements. A total of 2,443 shares of the Company's common stock were issued in the transaction. Merger costs of $1,000 were paid by MTI for consulting services rendered to facilitate negotiation of the various components of the merger agreement. Also, cash distributions of $2,346 were paid in 1994 by MTI to its shareholders in the normal course of S-Corporation business prior to the date of acquisition. 14 RESULTS OF OPERATIONS Revenues and Gross Margins
Year ended December 31, 1995 Change 1994 Change 1993 ---------- ------ ----------- ------ ----------- System and software revenue $ 195,231 2% $ 190,530 (2)% $ 193,707 System and software gross margins $ 162,726 4% $ 156,758 10% $ 142,352 Percentage of revenue 83.4% 82.3% 73.5% Service and support revenue $ 189,230 22% $ 155,674 7% $ 145,276 Service and support gross margins $ 110,890 23% $ 89,901 12% $ 80,179 Percentage of revenue 58.6% 57.8% 55.2% Total revenues $ 384,461 11% $ 346,204 2% $ 338,983 Total gross margins $ 273,616 11% $ 246,659 11% $ 222,531 Percentage of revenues 71.2% 71.2% 65.7%
System and Software System and software revenue is derived from software products owned by the Company, software products owned by third parties for which the Company pays royalties, and some limited reselling of workstation hardware. System and software revenue increased 2% from 1994 to 1995 and declined 2% from 1993 to 1994. The primary factors contributing to the growth in 1995 are increased software product offerings as a result of internal development and acquisitions over the last several years and favorable effects of foreign currency exchange rate fluctuations as discussed under geographic revenue information. This increase was offset by a decline in older product offerings and lower workstation hardware revenue for each of the years presented. The software component of system and software revenue increased by 5% from 1994 to 1995 and 8% from 1993 to 1994. The Company has increased its product offerings in 1995 and 1994 through development of new tools and through acquisition of other businesses. After the transition of customers to the Company's Version 8 generation of software products was substantially completed in 1993, internal development resources were able to focus more on enhancement of current products and development of new products such as AutoLogic II, Design For Test and IC Verification. Acquisitions previously discussed have further increased the Company's product offerings. The workstation hardware component of system and software revenue declined as a percent of total system and software revenue to 6% in 1995 from 8% and 17% in 1994 and 1993, respectively, as a result of the Company's planned exit from the workstation hardware resale business. This decline was a primary factor in lower revenue levels in 1994 versus 1993. While almost all of the Company's customers now meet their workstation hardware needs by working directly with workstation hardware vendors, the Company continues to meet the demands of some of its customers who prefer to purchase complete systems from one supplier. System and software gross margin levels are affected by such factors as third party software content for which royalties are paid, lower margin workstation hardware revenue levels, and amortization of previously capitalized software development costs and purchased technology costs. The Company's dependence on third party software has been reduced as a result of recent acquisitions where third party royalty contracts previously existed. Anacad, Exemplar, MTI and Precedence represent business combinations where third party agreements were in place. The Company continues to have third party contracts that contribute varying levels of revenues and costs of revenues quarter to quarter. Future trends of [Graphic chart: Revenues System & Software Service & Support (Hardware Included) (Hardware Included) (dollar figures are in millions) (dollar figures are in millions) 1993 1994 1995 1993 1994 1995 ---- ---- ---- ---- ---- ---- $194 $191 $195 $145 $156 $189] 15 third party revenue content are difficult to predict since they are dependent on such variables as new third party agreements, potential acquisitions of third parties where existing agreements are in place, and varying levels of customer demand for third party product offerings. System and software gross margins improved in 1995 and 1994 compared to 1993 primarily as a result of increased software product versus workstation hardware sales each year. Software product gross margins are much higher than workstation hardware gross margins. The effect is more pronounced comparing 1993 to 1994 as workstation hardware revenue as a percent of total system and software revenue decreased from approximately 17% to 8%, respectively. The impact of workstation hardware versus software product mix-shift on gross margin results was less significant in 1995. The impact of this mix-shift is expected to remain insignificant in 1996 and beyond. Amortization of previously capitalized software development costs to system and software cost of revenue was $5,075, $6,220, and $7,449 for 1995, 1994, and 1993, respectively. The decline in amortization is attributable to several capitalized projects becoming fully amortized over the last two years. Amortization of such costs is expected to increase slightly in 1996 as the Company's capitalization level has grown in 1995 and to a lesser extent in 1994 as more resources have been directed to the development of new products and enhancement of existing products versus fixing software defects and assisting customers in their transition to the Company's Version 8 software. In addition, amortization of purchased technology costs to system and software cost of revenue was $2,418, $760 and $565 for 1995, 1994 and 1993, respectively. The increase in 1995 is primarily attributable to the purchase of Anacad in September 1994. Capitalized software development costs and purchased technology costs are amortized over a three year period to system and software cost of revenue. Service and Support Service and support revenue consists of revenue from annual software support maintenance contracts, hardware support, and professional services, which includes consulting services, training services, and custom design services. Service and support revenue increased 22% from 1994 to 1995 and increased 7% from 1993 to 1994. Factors contributing to the growth in 1994 and 1995 include higher software maintenance contract revenue, higher professional service revenue and favorable effects of foreign currency exchange rate fluctuations as discussed under geographic revenue information, offset by the elimination of workstation hardware maintenance contract revenue. Workstation hardware maintenance revenue totaled approximately $500, $2,100 and $7,100 in 1995, 1994 and 1993, respectively. This decline is a result of the Company's planned exit from the workstation hardware business previously discussed. Software maintenance revenue increased by 18% from 1994 to 1995 and 12% from 1993 to 1994. The increases are primarily a result of higher installed customer base of the Company's products, favorable effects of currency fluctuations discussed below and a continued effort to obtain customer renewals of maintenance contracts. The Company is currently studying the potential effects of unbundling maintenance services in response to customer requests. This change, if made, will allow customers to choose varying levels of phone support and software update support. This change could result in lower revenue levels as some customers could choose less than full support from available options. Since growth in software support is dependent on continued success of the software product offerings, increases in the Company's installed customer base, and the impact of acquisitions, future software support revenue levels are difficult to predict. Professional service revenue totaled $51,000, $36,900 and $34,000 in 1995, 1994 and 1993, respectively, resulting in increases of 38% from 1994 to 1995 and 9% from 1993 to 1994. Overall, professional service revenue is expected to continue to grow. In particular, integrated circuit technology center (ICTC) custom design services are experiencing increased demand. Over the past year, the Company has added resources to the ICTC business in response to the increased demand resulting in higher revenue levels as more design contracts are completed. In addition, the Company continues to experience increased demand for consulting and training services. Service and support gross margins improved in 1995 and 1994 as a result of higher software mainte- [Graphic chart: Gross Margins System & Software Service & Support (Hardware Included) (Hardware Included) 1993 1994 1995 1993 1994 1995 ---- ---- ---- ---- ---- ---- 73.5% 82.3% 83.4% 55.2% 57.8% 58.6%] 16 nance revenue volume and were unfavorably impacted by professional service volume. Consistent with EDA consulting and training business models, gross margins generated by the Company's professional service activities have been and are expected to continue to be lower than software support. Professional service gross margins improved in 1995 but remain substantially lower than software support. Future service and support gross margins are expected to be lower as growth in the professional service business is expected to be higher than growth in software support. Geographic Revenue Information Domestic revenues from unaffiliated customers including service and support revenue increased by 7% from 1994 to 1995 and 3% from 1993 to 1994. The North American sales force executed a reorganization in the first quarter of 1994 which resulted in a temporary reduction in productivity. The result of the reorganization was to streamline operations by reducing two layers of management and better align the sales team to meet customer demand. The second half of 1994 and beyond were favorably impacted by these changes as productivity in the region has improved. International revenues from unaffiliated customers including service and support revenue represented 48%, 46% and 47% of total revenues in 1995, 1994 and 1993, respectively. European revenues increased by 20% from 1994 to 1995 and decreased by 2% from 1993 to 1994. Japanese revenues increased by 9% from 1994 to 1995 and 8% from 1993 to 1994. A weakened U.S. dollar in 1995 favorably impacted revenues by approximately 8% and 7% in Europe and Japan, respectively. Exclusive of such currency trends, 1995 European revenues were favorably impacted by improving economic conditions while Japan's results continued to reflect economic weakness. In 1994, the U.S. dollar weakened by approximately 2% and 7% in Europe and Japan, respectively, which positively impacted year to year revenue trends. Exclusive of such currency trends, 1994 international revenues were approximately flat compared to prior year primarily due to weak economic conditions. 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
Year ended December 31, 1995 Change 1994 Change 1993 ---------- ------ ----------- ------ ----------- Gross research and development $ 79,933 10% $ 72,948 (8)% $ 78,913 Percentage of total revenues 20.8% 21.1% 23.3% Capitalized software development $ 7,241 40% $ 5,156 43% $ 3,609 Percentage of total revenues 1.9% 1.5% 1.1% Net research and development $ 72,692 7% $ 67,792 (10)% $ 75,304 Percentage of total revenues 18.9% 19.6% 22.2% Marketing, general, and administration $ 149,332 2% $ 146,767 (3)% $ 151,767 Percentage of total revenues 38.8% 42.4% 44.8% Restructure costs $ (2,040) --- $ (6,045) --- $ 24,800 Percentage of total revenues (.5)% (1.8)% 7.3%
Research And Development As a percent of revenue, gross R&D costs were 21%, 21% and 23% in 1995, 1994 and 1993, respectively. In 1995, gross R&D costs increased due to the purchases of Anacad and Axiom which resulted in a year to year increase of approximately $4,000. In addition, other acquisitions including MTI, Exemplar and Precedence, which were reflected in 1995 and 1994 results, experienced higher R&D investment in 1995. In 1994, R&D expenditures decreased due a lower head count plan that was achieved through attrition and layoffs. The Company closed an Integrated Circuit Division R&D site during the first quarter of 1994, consolidating activities with other pre-existing locations. Additional cost saving actions were taken in other R&D divisions of the Company during the year. During 1995 the Company capitalized software development costs of $7,241, compared to $5,156 and $3,609 for 1994 and 1993, respectively. Capitalization increased in 1995 as more resources were directed toward development of new products and enhancement of existing products. The Company will continue to evaluate make-or-buy alternatives in 1996 which should result in more acquisitions. Overall, management's goal is to maintain the ratio of R&D expense as a percent of revenue consistent with 1995 levels. 17 Achievement of this goal is not guaranteed due to the uncertainty of revenue. Marketing, General, and Administration In 1995, the increase in marketing, general and administrative (MG&A) expenses is principally attributable to merger and acquisition activity discussed above, offset by lower base business head count. As a percent of revenue, MG&A expenses were 39%, 42% and 45% in 1995, 1994 and 1993, respectively. In 1995, MG&A expense increased due to the purchases of Anacad and Axiom which resulted in a year to year increase of approximately $3,700. This increase was partially offset by continued cost reduction activity which focused on the administrative structure of the Company's base business in 1995. In 1994, MG&A expenses declined as actions associated with the December 1993 restructuring were executed during the year. The North American sales force executed a reorganization during the first quarter of 1994 which resulted in lower head count and reduced layers of management to better align the sales team with their respective territories. In addition, actions were executed at several international locations to streamline the organizations to improve the ratio of selling and administrative expense compared to regional revenue levels. Overall, the goal of management is to maintain the ratio of MG&A expense as a percent of revenue consistent with 1995 levels. Achievement of this goal is not guaranteed due to the uncertainty of revenue. Restructure Costs Implementation of the Company's restructuring plan, which was approved by management in December of 1993 and modified in 1994, continued during 1995. During the second quarter of 1995, the Company recorded a $2,040 restructure adjustment. The adjustment was primarily associated with the 1993 charge and was mainly the result of reduced estimates for severance costs associated with replacement and globalization of the Company's information systems. Information system implementation delays culminated when a key project plan milestone was missed during the second quarter, resulting in lower estimated costs for write-offs of old equipment due to prolonged in-service periods. In addition, certain actions associated with a product discontinuance plan were not taken when management determined that the technology could be used by the Company's consulting organization and sold as a custom integrated service rather than as a commercial design tool. During 1994, the Company recorded a gross restructuring credit of $10,045 offset by an accrual of $4,000. The credit was primarily associated with the 1993 and to a lesser extent the 1992 restructure charge and was the result of reduced estimates for severance costs due to greater than anticipated employee attrition among the product development and field selling organizations and lower costs of executing the plan. In the third quarter of 1994 the Company lowered its estimate of the cost of the 1993 plan by $5,600 mainly as a result of lower than anticipated costs associated with completion of the first phase of the Company's Japanese subsidiary re-alignment. Estimated costs of executing the plan were lowered by an additional $4,445 in the fourth quarter of 1994 due to several changes in circumstances. In the third and fourth quarters of 1994, the Company exceeded its goal for reducing operating expenses, exclusive of recent acquisitions. In addition, senior management changes subsequent to the initial 1993 charge resulted in re-evaluating and revising certain planned actions, such as the relocation of European headquarters and the out-sourcing of European order fulfillment. These elements of the plan were revised because lower head count through attrition and efficiencies through centralization made them financially less attractive. In the fourth quarter of 1994, an additional restructure accrual of $4,000 was established primarily to reduce a recently acquired subsidiary's engineering staff and management team and to further streamline the Company's core product development activities, including elimination of certain product offerings and reductions in engineering staff. In December 1993, the Company recorded a gross restructuring charge of $26,200 offset by a net credit adjustment of $1,400. The restructuring plan was aimed at lowering operating expenses by reducing staffing levels in product development and field sales organizations and streamlining business support operations with a new organization structure. Planned product development actions included down-sizing all divisions and closing two satellite locations. Field sales organization actions included eliminating several under performing locations, reducing management layers in all regions and centralizing administrative activities. Organization streamlining actions included globalizing the Company's information systems, out-sourcing European order fulfillment activities, centralizing European administrative activities and divisionalizing product development activities. The net restructure credit was associated with the 1992 charge and was the result of lower than estimated costs for settlements with customers for product discontinuance and lower than estimated costs for relocation of displaced employees offset by higher than expected severance costs in Europe. Costs remaining to be incurred in executing the restructuring plans consist primarily of direct costs associated with severance of employees, product discontinuance activities, and facility closure activities. Remaining severance and relocation accruals are for continued changes in 18 product development and field sales organizations. Senior management changes in both organizations were finalized in the second half of 1995 which should accelerate implementation of the final stages of the restructuring plan. In addition, costs associated with globalization of the Company's information systems remain accrued until the new system is implemented in 1996. Approximately $6,100 of the December 1994 restructuring accrual of $11,897 resulted in cash outflows in 1995. The remaining accrual of approximately $3,751 is expected to be disbursed in the first half of 1996. Merger and Acquisition Related Charges In 1995 the Company incurred merger related charges of $2,040. The purchases of Axiom, 3Soft and Zeelan resulted in charges for in-process R&D of $400, $850, and $180, respectively. These charges were a result of allocating a portion of the acquisition costs to in-process product development that had not reached technological feasibility. The acquisitions of Precedence and Exemplar were accounted for as pooling of interests which resulted in merger expenses of $400 and $210, respectively. These costs were for services rendered to facilitate completion of the merger agreements and severance costs to eliminate redundant management positions. In 1994 the Company incurred acquisition related charges of $9,265. The purchase of Anacad resulted in a charge for in-process R&D of $8,265. This charge was a result of allocating a portion of the acquisition cost to in-process product development that had not reached technological feasibility. In addition, merger expenses of $1,000 were paid by MTI for consulting services rendered to facilitate negotiation of the various components of the merger agreement. As a result of the merger with Microtec, the Company expects to incur a merger charge totaling between $3,000 and $4,000 in the first quarter of 1996. The costs associated with this charge are primarily related to elimination of redundant management positions and facilities locations. The expected cash outflow of this charge should occur primarily in 1996. Other Income (Expense) Year ended December 31, 1995 1994 1993 --------- --------- -------- Other income (expense), net $ 5,735 $ 2,428 $ (253) Other income (expense) has improved significantly over the last three years due to increased interest income and lower interest expense. Interest income was $8,534, $4,956, and $4,342 in 1995, 1994 and 1993, respectively. The improvement in interest income is attributable to higher average cash balances due to earnings in 1995 and 1994. Interest expense was $2,444, $2,730, and $4,404 in 1995, 1994 and 1993, respectively. In 1995 and 1994, compared to 1993, average debt outstanding was lower due to improved cash flow from operating activities and continued management of the Company's long term committed revolving credit facility. Provision For Income Taxes The provision for income taxes was $7,468, $3,541 and $2,467 in 1995, 1994 and 1993, respectively. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The cumulative effect of the change in the method for accounting for income taxes was not material to the Company's financial statements, and was therefore not disclosed separately in the consolidated statement of operations for the year ended December 31, 1993. The Company has established a valuation allowance for certain current deferred tax assets and net operating loss and tax credit carry forwards. The valuation allowance as of December 31, 1994 was $46,213, of which $1,974 was related to deferred tax assets of the Company's Japanese subsidiary. The allowance was established when it was more likely than not that some portion of the deferred tax asset would not be realized. Based on operating income levels before tax for the Company's Japanese subsidiary, it was determined that it was more likely than not that the Japanese subsidiary's deferred tax assets would be realized. As such, the tax provision for 1995 was adjusted for the reversal of the valuation allowance for the Japanese deferred tax assets. This reversal resulted in a lower effective tax rate for 1995. 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 carrybacks, and tax expense for subsidiaries with pre-tax income. Effects of Foreign Currency Fluctuations The Company experienced a net loss from foreign currency transactions of $620 in 1995 and net gains of $177 and $247 in 1994 and 1993, respectively. These amounts are 19 composed 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 and expense. The "foreign currency translation adjustment," as reported in the stockholders' equity section of the consolidated balance sheets, increased to $13,597 at December 31, 1995, from $12,675 at the end of 1994. This reflects the increase in the value of net assets denominated in foreign currencies since year-end 1994 as a result of a weaker U.S. dollar at the close of 1995. During 1995, the Company entered into a three year forward contract to stabilize the currency effects on a portion of the Company's net investment in its Japanese subsidiary. The contract to sell Yen 2.2 billion will guarantee the Company $25,400 at the contract's expiration. Any differences between the contracted currency rate and the currency rate at each balance sheet date will impact the foreign currency translation adjustment component of the stockholders' equity section of the consolidated balance sheet. The result is a partial offset of the effect of Japanese currency changes on stockholders' equity during the contract term. This forward contract should not impact current or future consolidated statements of operations. During 1995, the U.S. dollar weakened approximately 7% against the Japanese yen and 8% against European currencies in which the Company does business, primarily the Deutsche mark, British pound, and French franc. Since the majority of the Company's revenues are booked in the last month of each quarter a higher weight is given to the exchange rates of those months when analyzing currency fluctuations for revenue comparison purposes. A weaker U.S. dollar results in the Company's products being more affordable in foreign markets, which generally results in favorable economics for the Company. The weakening of the dollar relative to the foreign currencies also has a positive impact on revenues as local currency revenues translate into more U.S. dollars. However, this translation also results in higher reported expenses in U.S. dollar terms. During 1994, the U.S. dollar weakened approximately 7% and 2% against the Japanese yen and European currencies, respectively. The Company generates approximately half of its revenues outside of 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 future foreign currency fluctuations. LIQUIDITY AND CAPITAL RESOURCES
Year Ended December 31, 1995 1994 --------- ----------- Current Assets $ 303,343 $ 237,426 Cash and short term investments $ 201,004 $ 138,169 Cash and investments, long-term $ 30,000 $ 30,000 Cash provided by operations $ 83,187 $ 50,397 Cash used for investment activities, excluding short-term investments $ (32,981) $ (31,233) Cash provided by financing activities $ 13,617 $ 6,455
Cash and Investments Total cash and investments increased $62,835 during 1995. Cash provided by operations was $83,187, an increase of $32,790 from 1994. Positively impacting cash provided by operations in 1995 was net income of $49,859. This source of cash was offset by an increase in trade accounts receivable and decreased accrued liabilities associated with the restructuring accrual discussed previously. In 1994, cash was positively impacted by the net profit earned of $27,767 for the year. This source of cash was offset by an increase in trade accounts receivables and a decrease in accrued liabilities associated with the 1993 year-end restructuring. Cash and short-term investments were positively impacted by the proceeds from issuance of common stock upon exercise of stock options and employee stock plan purchases in the amount of $16,223 and $10,205 in 1995 and 1994, respectively. This increase was offset by investment in property, plant and equipment of $19,843 in 1995 and $14,327 in 1994. The purchase of Anacad late in 1994 resulted in cash payments totaling $10,050 in 1994 and $1,950 in 1995. Also, cash distributions of $2,346 were paid in 1994 by MTI to its shareholders in the normal course of S-Corporation business prior to the date of acquisition. Trade Accounts Receivable The trade accounts receivable balance increased $2,887 from December 31, 1994. The increase is primarily attributable to a growth in revenues offset by more evenly distributed shipments in 1995. The Company was able to 20 improve cash collections and reduce days sales outstanding in 1995 as a result of a more evenly distributed shipment pattern versus late quarter shipments. The Company continues to realize a majority of revenues in the last month of each quarter due to the timing of orders but has noted improvement in 1995. Future trade receivable trends are difficult to predict due to this relationship. Other Assets Other assets increased to $33,723 at December 31, 1995 from $29,912 at December 31, 1994. Net capitalized software development costs increased by $2,166 as capitalization and amortization were $7,241 and $5,075, respectively, in 1995. Also, capitalized purchased technology decreased by $440 in 1995 due to amortization which was partially offset by acquisitions. The purchase of Axiom, 3Soft and Zeelan in 1995 resulted in goodwill capitalization of $528 and technology capitalization of $892. The Company owns common stock and common stock warrants of two independent public companies with an original carrying cost of $1,200 and $0, and a market value of $4,150 and $1,812, as of December 31, 1995 and 1994, respectively. The securities have been classified as available for sale, which requires the difference between original carrying cost and market value to be recognized. In 1994, capitalization and amortization of software development costs were $5,156 and $6,220, respectively. The 1994 acquisition of Anacad resulted in goodwill capitalization of $2,897 and technology capitalization of $4,735. Goodwill costs are being amortized over a three year period to R&D expense and technology costs are being amortized over a three year period to system and software cost of revenue. Long-Term Debt Long-term debt decreased $975 from December 31, 1994. The Company had borrowings outstanding of $53,320 and $54,160 under its $55,000 committed revolving credit facility as of December 31, 1995 and 1994, respectively. Due to required annual commitment reductions, the Company reduced credit facility borrowings by $840 in July 1995. In addition, $840 of the credit facility borrowings are classified as current and included in short-term borrowings on the consolidated balance sheets as of December 31, 1995 and 1994. Dividends In October 1993, the Board of Directors voted to discontinue paying a quarterly dividend to shareholders. The Company intends to reinvest future earnings in opportunities for growth. Dividends were not paid during 1995 or 1994. Capital Resources Total capital expenditures increased to $25,740 for 1995, compared to $26,077 and $23,145 for 1994 and 1993, respectively. The purchases of Axiom, 3Soft and Zeelan in 1995 resulted in cash payments of $1,707. The Company also acquired a number of technologies, primarily software source code totaling $1,040 in 1995. The purchase of Anacad late in 1994 resulted in cash payments totaling $10,050 in 1994 and $1,950 in 1995. In addition, the Company purchased technologies totaling $1,700 during 1994. The Company will continue to evaluate make-or-buy alternatives which should result in additional capital expenditures in 1996. Expenditures for property and equipment were $19,843 and $14,327 in 1995 and 1994, respectively. In 1995, investment in the Company's new global information system resulted in expenditures of approximately $4,800 compared to approximately $2,500 in 1994. Future capital expenditure plans include maintaining a state of the art environment for research and development and sales demonstration equipment and implementing the new global information system. As a result of the merger with Microtec, the Company expects to incur a merger charge totaling between $3,000 and $4,000 in the first quarter of 1996. The costs associated with this charge are primarily related to elimination of redundant management positions and facilities locations. The expected cash outflow of this charge should primarily occur in 1996. 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. [Graphic chart: Cash & Investments Combined Short & Long-Term Debt (dollar figures are in millions) (dollar figures are in millions) 1993 1994 1995 1993 1994 1995 ---- ---- ---- ---- ---- ---- $140 $168 $231 $ 61 $ 62 $ 62] 21 CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31, 1995 1994 1993 In thousands, except per share data ----------- ----------- ----------- Revenues: System and software $ 195,231 $ 190,530 $ 193,707 Service and support 189,230 155,674 145,276 Total revenues 384,461 346,204 338,983 Cost of revenues: System and software 32,505 33,772 51,355 Service and support 78,340 65,773 65,097 Total cost of revenues 110,845 99,545 116,452 Gross margin 273,616 246,659 222,531 Operating expenses: Research and development (note 6) 72,692 67,792 75,304 Marketing, general, and administration 149,332 146,767 151,767 Restructure costs (note 2) (2,040) (6,045) 24,800 Merger and acquisition related charges (note 3) 2,040 9,265 --- Total operating expenses 222,024 217,779 251,871 Operating income (loss) 51,592 28,880 (29,340) Other income (expense), net (note 12) 5,735 2,428 (253) Income (loss) before income taxes 57,327 31,308 (29,593) Provision for income taxes (note 4) 7,468 3,541 2,467 Net income (loss) $ 49,859 $ 27,767 $ (32,060) Net income (loss) per common and common equivalent share $ .88 $ .51 $ (.66) Weighted average number of common and common equivalent shares outstanding 56,381 54,367 48,657 See accompanying notes to consolidated financial statements.
22 CONSOLIDATED BALANCE SHEETS
As of December 31, 1995 1994 In thousands ----------- ----------- Assets Current assets: Cash and cash equivalents $ 176,500 $ 130,989 Short-term investments 24,504 7,180 Trade accounts receivable, net of allowance for doubtful accounts of $2,771 in 1995 and $2,998 in 1994 85,994 83,107 Other receivables 3,421 4,853 Inventory 660 856 Prepaid expenses and other 12,264 10,441 Total current assets 303,343 237,426 Property, plant and equipment, net (notes 5 and 8) 94,556 98,020 Cash and investments, long-term (note 8) 30,000 30,000 Other assets (note 6) 33,723 29,912 Total assets $ 461,622 $ 395,358 Liabilities and Stockholders' Equity Current liabilities: Short-term borrowings (notes 7 and 8) $ 9,108 $ 8,488 Accounts payable 7,347 11,747 Income taxes payable (note 4) 14,439 12,793 Accrued payroll and related liabilities 25,286 19,765 Accrued restructure costs (note 2) 3,751 11,897 Accrued and other liabilities 19,802 17,399 Deferred revenue 22,896 18,092 Total current liabilities 102,629 100,181 Long-term debt (note 8) 52,700 53,675 Other long-term deferrals 772 1,975 Total liabilities 156,101 155,831 Stockholders' equity: (notes 9 and 10) Common stock, no par value, authorized 100,000 shares; 55,557 and 53,597 issued and outstanding for 1995 and 1994, respectively 268,807 254,731 Incentive stock, no par value, authorized 1,200 shares; none issued -- -- Retained earnings (accumulated deficit) 23,117 (27,879) Foreign currency translation adjustment 13,597 12,675 Total stockholders' equity 305,521 239,527 Commitments and contingencies (note 11) Total liabilities and stockholders' equity $ 461,622 $ 395,358 See accompanying notes to consolidated financial statements.
23 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 1995 1994 1993 In thousands ----------- ----------- ----------- Operating Cash Flows: Net income (loss) $ 49,859 $ 27,767 $ (32,060) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property, plant and equipment 23,836 24,687 27,600 Deferred taxes (1,338) (290) (259) Amortization of other assets 9,061 7,428 8,217 Amortization of nonqualified stock options 103 114 1,418 Write-down of assets - in-process R&D 1,430 8,265 -- Write-down of assets - other -- -- 812 Changes in operating assets and liabilities: Trade accounts receivable (1,663) (4,921) 2,788 Inventory 207 46 7,771 Prepaid expenses and other assets 170 (1,782) 6,623 Accounts payable (4,610) (1,596) (5,845) Accrued liabilities 2,435 (11,345) 16,634 Other liabilities and deferrals 3,697 2,024 (8,410) Net cash provided by operating activities 83,187 50,397 25,289 Investing Cash Flows: Net maturities (purchases) of short-term investments (17,092) 6,430 23,161 Purchases of property, plant and equipment (19,843) (14,327) (23,145) Capitalization of software development costs (7,241) (5,156) (3,609) Purchase of businesses (4,857) (10,050) -- Purchase of technologies (1,040) (1,700) -- Net cash used by investing activities (50,073) (24,803) (3,593) Financing Cash Flows: Proceeds from issuance of common stock 16,223 10,205 11,179 Proceeds (repayment) of short-term borrowings 619 (367) (89) Repayment of long-term debt (975) (1,936) (937) Cash distribution (note 3) -- (2,346) -- Adjustment for pooling of interests (note 3) -- 899 -- Dividends paid to stockholders -- -- (8,291) Repurchase of common stock (2,250) -- -- Net cash provided by financing activities 13,617 6,455 1,862 Effect of exchange rate changes on cash and cash equivalents (1,220) 2,669 388 Net change in cash and cash equivalents 45,511 34,718 23,946 Cash and cash equivalents at beginning of period 130,989 96,271 72,325 Cash and cash equivalents at end of period $ 176,500 $ 130,989 $ 96,271 See accompanying notes to consolidated financial statements.
24 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Foreign Total Retained Currency Stock- Common Stock Earnings Translation holders' In thousands, except per share data Shares Amount (Deficit) Adjustment Equity ------ ----------- ----------- ----------- ----------- Balance at December 31, 1992, as previously reported 45,597 $ 231,354 $ (15,415) $ 5,467 $ 221,406 Adjustment for acquisition of businesses (note 3) 2,247 460 (245) -- 215 Balance at December 31, 1992, as restated 47,844 231,814 (15,660) 5,467 221,621 Stock issued under stock option and stock purchase plans 1,641 10,672 -- -- 10,672 Stock issued for acquisition of business (note 3) 421 507 -- -- 507 Compensation related to nonqualified stock options granted (note 10) -- 1,418 -- -- 1,418 Foreign currency translation adjustment -- -- -- 2,072 2,072 Net loss -- -- (32,060) -- (32,060) Cash dividends ($.18 per common share outstanding) -- -- (8,291) -- (8,291) Balance at December 31, 1993 49,906 244,411 (56,011) 7,539 195,939 Stock issued under stock option and stock purchase plans 1,248 10,205 -- -- 10,205 Stock issued for acquisition of business (note 3) 2,443 1 899 -- 900 Compensation related to nonqualified stock options granted (note 10) -- 114 -- -- 114 Foreign currency translation adjustment -- -- -- 5,136 5,136 Change in value of investments available for sale -- -- 1,812 -- 1,812 Net income -- -- 27,767 -- 27,767 Cash distribution -- -- (2,346) -- (2,346) Balance at December 31, 1994 53,597 254,731 (27,879) 12,675 239,527 Stock issued under stock option and stock purchase plans 2,070 16,223 -- -- 16,223 Compensation related to nonqualified stock options granted (note 10) -- 103 -- -- 103 Repurchase of common stock (note 1) (110) (2,250) -- (2,250) Foreign currency translation adjustment -- -- -- 922 922 Change in value of investments available for sale -- -- 1,137 -- 1,137 Net income -- -- 49,859 -- 49,859 Balance at December 31, 1995 55,557 $ 268,807 $ 23,117 $ 13,597 $ 305,521 See accompanying notes to consolidated financial statements.
25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All numerical references in thousands, except percentages and per share data 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Mentor Graphics Corporation (the Company) is a supplier of electronic design automation (EDA) systems - advanced computer software used to automate the design, analysis and testing of electronic systems and components. System and software revenues comprise more than half of the Company's revenues and are derived primarily from software products owned by the Company and by third parties for which royalties are paid by the Company. Service and support revenues consist of revenue from annual software support maintenance contracts, hardware support, and professional services, which includes consulting services, training services, and custom design services. Established in 1981, the Company is a leader in worldwide EDA sales and markets its products primarily to customers in the aerospace, computer, consumer electronics, semiconductor, automotive and telecommunications industries. The Company sells and licenses its products primarily through its direct sales force in North America, Europe and Asia, and through distributors in territories where the volume of business does not warrant a direct sales presence. In addition to its corporate offices in Wilsonville, Oregon, the Company has sales, support, software development and professional services offices worldwide. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the financial statements of the Company and its wholly owned and majority-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. FOREIGN CURRENCY TRANSLATION Local currencies are the functional currencies for the Company's foreign subsidiaries except for the Netherlands and Singapore where the U.S. dollar is used as the functional currency. Assets and liabilities of foreign operations are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates. Gains and losses from foreign currency translation are included as a separate component of stockholders' equity. Foreign currency transaction gains and losses are included as a component of other income and expense (note 12). FINANCIAL INSTRUMENTS The Company enters into forward foreign exchange contracts as a hedge against foreign currency sales commitments. To hedge its foreign currency against highly anticipated sales transactions, the Company also purchases foreign exchange options which permit but do not require foreign currency exchanges at a future date with another party at a contracted exchange price. Remeasurement gains and losses on forward and option contracts are deferred and recognized when the sale occurs. All subsequent remeasurement gains and losses are recognized as they occur to offset remeasurement gains and losses recognized on the related foreign currency accounts receivable balances. At December 31, 1995 and 1994 the Company had forward contracts and options outstanding of $38,069 and $25,825, respectively, to primarily sell various foreign currencies. These contracts generally have maturities which do not exceed twelve months. At December 31, 1995 and 1994, the recorded value and the fair value of the Company's foreign exchange position related to these contracts was approximately zero. The fair value of these contracts was calculated based on dealer quotes. The Company does not anticipate non-performance by the counterparties to these contracts. During 1995, the Company entered into a three year forward contract to stabilize the currency effects on a portion of the Company's net investment in its Japanese subsidiary. The contract to sell Yen 2.2 billion will guarantee the Company $25,400 at the contract's expiration. Any differences between the contracted currency rate and the currency rate at each balance sheet date will impact the foreign currency translation adjustment component of the stockholders' equity section of the consolidated balance sheets. The result is a partial offset of the effect of Japanese currency changes on stockholders' equity during the contract term. This forward contract should not impact current or future consolidated statements of operations. At December 31, 1995 the difference between the recorded value and the fair value of the Company's foreign exchange position related to this contract was approximately zero. The fair value of this contract was calculated based on dealer quotes. The Company does not anticipate non-performance by the counterparty to this contract. The fair market value of the Company's long-term debt 26 approximates its carrying value as the interest rates on borrowings are floating rate based. The Company has entered into an interest rate swap agreement to manage exposure to interest rate fluctuations. The differential to be paid or received is accrued and is recognized over the life of the agreement as an adjustment to interest expense. The Company would incur a cost of approximately $2,689 to terminate its interest rate swap agreement as of December 31, 1995. This cost is based on dealer quotes taking into consideration current interest rates and the current creditworthiness of the counterparties (note 8). The Company places its cash equivalents and short-term investments with major banks and financial institutions. The Company's investment policy limits its credit exposure to any one financial institution. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base, and their dispersion across different businesses and geographic areas. The carrying amounts of cash equivalents, short-term investments, trade receivables, accounts payable, and short term borrowings approximate fair value because of the short-term nature of these instruments. In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Statement No. 115 requires reporting of investments as either held to maturity, available for sale or trading. The Company owns common stock and common stock warrants of two independent public companies with an original carrying cost of $1,200 and $0, and a market value of $4,150 and $1,812, as of December 31, 1995 and 1994, respectively. Under Statement No., 115, the securities have been classified as available for sale, which requires the difference between original carrying cost and market value to be recognized. This difference is included on the consolidated balance sheets in other assets (see note 6) and as an increase(reduction) of the same amount in retained earnings (accumulated deficit). No other investments owned by the Company are materially impacted by provisions of this Statement as the underlying carrying values approximate market. CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS The Company classifies highly liquid investments purchased with an original maturity of three months or less as cash equivalents. As of December 31, 1995 and 1994, the Company held $41,716 and $50,990, respectively of short term securities under agreements to resell on January 1, 1996 and 1995, respectively. Due to the short-term nature of these investments, the Company did not take possession of the securities which were instead held in the Company's account at Smith Barney, Inc. The Company does not believe it is exposed to any significant credit risk or market risk on cash and cash equivalent balances. Short-term investments consist of certificates of deposit, commercial paper and other highly liquid investments with original maturities in excess of three months. These investments mature primarily in less than one year. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is stated at cost and consists of land and land improvements, buildings and building equipment, computer equipment and furniture, leasehold improvements, and service spare parts (note 5). Expenditures for additions to property, plant and equipment are capitalized. The cost of repairs and maintenance is expensed as incurred. Depreciation of buildings and building equipment, and land improvements, is computed on a straight-line basis over lives of forty and twenty years, respectively. Depreciation of computer equipment and furniture is computed principally on a straight-line basis over the estimated useful lives of the assets, generally three to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the lease or estimated useful lives of the improvements. Service spare parts are amortized on a straight-line basis over their estimated useful lives, generally four years. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Statement No. 121 provides specific guidance regarding when impairment of Long-Lived assets such as plant, equipment and certain intangibles including goodwill and capitalized technology should be recognized and how impairment losses of such assets should be measured. Statement No. 121 is effective for fiscal years beginning after December 15, 1995. The Company is preparing to adopt Statement No. 121 in 1996 and expects the impact on its consolidated statements of operations will not be material. INCOME TAXES Effective January 1, 1993, the Company adopted Statement No. 109, "Accounting for Income Taxes." Statement No. 109 requires a change from the deferred method under APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts and tax balances of existing assets and liabilities. 27 Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The cumulative effect of that change in the method for accounting for income taxes was not material to the Company's financial statements, and is therefore not disclosed separately in the consolidated statement of operations for the year ended December 31, 1993. REVENUE RECOGNITION Revenues from system sales and software licenses are recognized at the time of shipment. Contract service revenues are billed in advance and recorded as deferred revenue. Service revenues are then recognized ratably over the contractual period as the services are performed. Training and consulting revenues are recognized as the related services are performed. Custom design and software porting revenues are recognized using the percentage of completion method or as contract milestones are achieved. SOFTWARE DEVELOPMENT COSTS The Company accounts for software development costs in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." The Company capitalizes certain costs incurred in the production of computer software once technological feasibility of the product to be marketed has been established. Capitalization of these costs ceases when the product is considered available for general release to customers. Costs incurred prior to technological feasibility, including amounts attributable to in-process research and development in business acquisitions, are expensed as incurred. Amortization of capitalized software development costs is calculated as the greater of the ratio that the current product revenues bear to estimated future revenues or the straight-line method over the expected product life cycle of approximately three years. Amortization is included in system and software cost of revenues in the consolidated statements of operations. STOCKHOLDERS' EQUITY In August 1995, the Company's Board of Directors approved a plan to repurchase, from time to time over the next eighteen months on the open market, up to $50,000 in market value of the Company's common shares. During the third quarter of 1995, the Company repurchased 110 shares on the open market with a market value of $2,250. All 110 shares repurchased during the third quarter of 1995 were subsequently reissued through the Company's stock option plan exercises prior to consummation of the October, 1995 acquisition of Precedence Incorporated (Precedence) described in Note 3. In October 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-Based Compensation." Statement No. 123 permits a company to choose either a new fair value based method of accounting for its stock-based compensation arrangements or to comply with the current APB Opinion 25 intrinsic value based method adding pro forma disclosures of net income and earnings per share computed as if the fair value based method had been applied in the financial statements. Statement No. 123 is effective for fiscal years beginning after December 15, 1995. The Company will adopt Statement No. 123 in 1996 using pro forma disclosures of net income and earnings per share. The impact of stock options on the Company's pro forma disclosures of net income and earnings per share calculation is not known as the Company has not yet implemented the provisions of this Statement. NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE For 1995 and 1994, 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. For 1993, net loss per common and common equivalent share was calculated using only the weighted average of common shares outstanding. Common stock equivalents related to stock options are anti-dilutive in a net loss situation and, therefore, were not included in 1993. USE OF ESTIMATES Generally accepted accounting principles require management to make estimates and assumptions that affect the reported amount of assets, liabilities and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. RECLASSIFICATIONS Certain reclassifications have been made in the accompanying consolidated financial statements for 1993 and 1994 to conform with the 1995 presentation. 28 2. RESTRUCTURING Following is a summary of the major elements of the restructure charges:
Year ended December 31, 1995 1994 1993 Additions to restructure charges: ----------- -------- -------- Employee severance $ -- $ 2,430 $ 15,850 Employee relocation -- -- 3,550 Asset write-offs and product discontinuance costs -- 1,570 2,300 Facilities closure and consolidation -- -- 4,300 Other -- -- 200 Total additions -- 4,000 26,200 Adjustment of restructure charges: Employee severance (1,540) (3,324) 1,280 Employee relocation -- (2,600) (450) Asset write-offs and product discontinuance costs (500) (2,060) (1,935) Facilities closure and consolidation -- (2,061) (295) Net adjustments (2,040) (10,045) (1,400) Net restructure charges $ (2,040) $ (6,045) $ 24,800
Implementation of the Company's restructuring plan, which was approved by management in December of 1993 and modified in 1994, continued during 1995. During the second quarter of 1995, the Company recorded a $2,040 restructure adjustment. The adjustment was primarily associated with the 1993 charge and was mainly the result of reduced estimates for severance costs associated with replacement and globalization of the Company's information systems. Information system implementation delays culminated when a key project plan milestone was missed during the second quarter, resulting in lower estimated costs for write-offs of old equipment due to prolonged in-service periods. In addition, certain actions associated with a product discontinuance plan were not taken when management determined that the technology could be used by the Company's consulting organization and sold as a custom integrated service rather than as a commercial design tool. During 1994, the Company recorded a gross restructuring credit of $10,045 offset by an accrual of $4,000. The credit was primarily associated with the 1993 and to a lesser extent the 1992 restructure charges and was the result of reduced estimates for severance costs due to greater than anticipated employee attrition among the product development and field selling organizations and lower costs of executing the plan. In the third quarter of 1994 the Company lowered its estimate of the cost of the 1993 plan by $5,600 mainly as a result of lower than anticipated costs associated with completion of the first phase of the Company's Japanese subsidiary re-alignment. Estimated costs of executing the plan were lowered by an additional $4,445 in the fourth quarter of 1994 due to several changes in circumstances. In the third and fourth quarters of 1994, the Company exceeded its goal for reducing operating expenses, exclusive of recent acquisitions. In addition, senior management changes subsequent to the initial 1993 charge resulted in re-evaluating and revising certain planned actions, such as the relocation of European headquarters and the out-sourcing of European order fulfillment. These elements of the plan were revised because lower head count through attrition and efficiencies through centralization made them financially less attractive. In the fourth quarter of 1994, an additional restructure accrual of $4,000 was established primarily to reduce a recently acquired subsidiary's engineering staff and management team and to further streamline the Company's core product development activities, including elimination of certain product offerings and reductions in engineering staff. In December 1993, the Company recorded a gross restructuring charge of $26,200 offset by a net credit adjustment of $1,400. The restructuring plan was aimed at lowering operating expenses by reducing staffing levels in product development and field sales organizations and streamlining business support operations with a new organization structure. Planned product development actions included down-sizing all divisions and closing two satellite locations. Field sales organization actions included eliminating several under performing locations, reducing management layers in all regions and centralizing administrative activities. Organization streamlining actions included globalizing the Company's information systems, out-sourcing European order fulfillment activities, centralizing European administrative activities and divisionalizing product development activities. The net restructure credit was associated with the 1992 charge and was the result of lower than estimated costs for settlements with customers for product discontinuance and lower than estimated costs for relocation of displaced employees offset by higher than expected severance costs in Europe. Costs remaining to be incurred in executing the restructuring plan consist primarily of direct costs associated with severance of employees, product discontinuance activities, and facility closure activities. Remaining severance and relocation accruals are for continued changes in product development and field sales organizations. Senior management changes in both organizations were finalized in the second half of 1995 which should accelerate imple- 29 mentation of the final stages of the restructuring plan. In addition, costs associated with globalization of the Company's information systems remain accrued until the new system is implemented in 1996. Approximately $6,100 of the December 1994 restructuring accrual of $11,897 resulted in cash outflows in 1995. The remaining accrual of approximately $3,751 is expected to be disbursed in the first half of 1996. 3. BUSINESS ACQUISITIONS The Company acquired Axiom Datorer Scandinavian AB (Axiom), 3Soft Corporation (3Soft), and Zeelan Technology, Inc. (Zeelan) in May 1995, December 1995, and December 1995, 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. Axiom and Zeelan are primarily engaged in developing, marketing and supporting software library tools used to model electronic components for the printed circuit board and the application specific integrated circuit markets of the EDA industry. 3Soft is primarily engaged in developing, marketing and supporting a library of pre-designed and tested standard logic functions or blocks which are process technology independent, and available at the Register Transfer Level for both VHDL and Verilog HDL markets of the EDA industry. In connection with these acquisitions, the Company recorded one-time charges to operations for the write-off of each enterprises' in-process product development that had not reached technological feasibility. The cost of each acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. These allocations resulted in charges for in-process R&D of $1,430, goodwill capitalization of $528 and technology capitalization of $892. The separate operational results of these acquisitions were not material compared to the Company's overall results of operations, and accordingly pro-forma financial statements of the combined entities have been omitted. In May 1995, the Company issued 1,512 shares of its common stock for all outstanding common stock of Exemplar Logic, Inc. (Exemplar). Exemplar develops, markets and supports a family of software tools for high level design automation for the application specific integrated circuit and field programmable gate array markets. The Company accounted for this transaction as a pooling of interests and accordingly, the results of Exemplar are included in the Company's consolidated financial statements for all periods presented. Merger expenses of $400 were for services rendered to facilitate completion of the merger agreement and severance costs. In October 1995, the Company issued 735 shares of its common stock for all outstanding common stock of Precedence Incorporated (Precedence). Precedence is primarily engaged in developing, marketing and supporting simulation backplane technology and co-simulation solutions for the electronic design automation industry. The Company accounted for this transaction as a pooling of interests and accordingly, the results of Precedence are included in the Company's consolidated financial statements for all periods presented. Merger expenses of $210 were for services rendered to facilitate completion of the merger agreement. In September 1994, the Company completed the acquisition of Anacad Electrical Engineering Software GmbH (Anacad). The acquisition was accounted for as a purchase and accordingly, the results of operations are included in the Company's results of operations from the date of acquisition. Anacad is primarily engaged in developing, marketing and supporting analog and mixed signal simulation and optimization software for the integrated circuit and printed circuit board markets of the EDA industry. The total purchase price of $12,000 was financed with cash of $10,050 and the issuance of a short-term obligation classified under accrued liabilities totaling $1,950, which was fully paid by December 31, 1995. In connection with this acquisition, the Company recorded a one-time charge to operations for the write-off Anacad's in-process product development that had not reached technological feasibility. 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 $8,265, goodwill capitalization of $2,897 and technology capitalization of $4,735. The separate operational results of Anacad were not material compared to the Company's overall results of operations, and accordingly pro-forma financial statements of the combined entities have been omitted. In December 1994, the Company issued 2,443 shares of its common stock for all outstanding common stock of Model Technology Incorporated (MTI). MTI is a developer of VHDL and Verilog simulation point tools using direct compile technology to design and test components and boards. The Company accounted for this transaction as a pooling of interests and accordingly, the results of MTI are included in the Company's consolidated financial statements for 1994 and 1995. The Company's 1993 financial statements were not restated due to the relative materiality of MTI's separate financial statements. Merger costs of $1,000 were paid by MTI for consulting services rendered to facilitate negotiation of the various components of the merger agreement. Also, cash distributions of $2,346 were paid in 1994 by MTI to its shareholders in the normal course of S-Corporation business prior to the date of acquisition. In December 1993, the Company issued 421 shares of its common stock for all outstanding common and pre- 30 ferred stock of CheckLogic Systems, Inc. (CheckLogic). CheckLogic is a developer of automatic test pattern generation point tools used to test designs of application specific integrated circuits. The Company accounted for this transaction as a pooling of interests and accordingly, the results of CheckLogic are included in the Company's consolidated financial statements for all periods presented. 4. INCOME TAXES
Domestic and foreign pre-tax income (loss) is as follows: Year ended December 31, 1995 1994 1993 ----------- ------------- ------------- Domestic $ 24,827 $ 6,675 $ (23,626) Foreign 32,500 24,633 (5,967) Total $ 57,327 $ 31,308 $ (29,593)
The provision for income taxes is as follows: Year ended December 31, 1995 1994 1993 Current: ----------- ------------- ------------ Federal $ 1,024 $ (269) $ 43 State 206 63 (162) Foreign 7,576 4,037 2,041 8,806 3,831 1,922 Deferred: Federal 251 (347) 655 Foreign (1,589) 57 (110) (1,338) (290) 545 Total $ 7,468 $ 3,541 $ 2,467
The effective tax rate differs from the federal tax rate as follows: Year ended December 31, 1995 1994 1993 ------ ----- ----- Federal tax rate 35.0% 35.0% (35.0)% State taxes, net 5.0 3.5 (2.3) Foreign tax rate differential (4.8) 9.2 8.0 Income and losses of foreign subsidiaries 7.2 6.4 0.6 Foreign tax credits (7.6) -- -- Non-taxable income of acquired corporations 0.4 (2.9) -- Change in valuation allowance (10.2) (39.2) 29.6 Adjustment to beginning valuation allowance (12.6) -- 2.5 Other, net 0.6 (0.7) 4.9 Effective tax rate 13.0% 11.3% 8.3%
The significant components of deferred income tax expense are as follows: Year ended December 31, 1995 1994 1993 ------ ----- ----- Net changes in deferred tax assets and liabilities $ 588 $ 11,992 $ (8,205) Increase(decrease) in beginning-of-year balance of the valuation allowance for deferred tax assets $ (1,926) $ (12,282) $ 8,750 Total $ (1,338) $ (290) $ 545
The tax effects of temporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities were as follows:
As of December 31, 1995 1994 ------------- ------------ Deferred tax assets: Property and equipment, principally due to differences in depreciation and capitalized interest $ 1,957 $ 2,032 Inventories, principally due to adjustments to lower of cost or market 207 494 Accounts receivable, principally due to allowance for doubtful accounts 343 836 Compensated absences and other compensation, principally due to accrual for financial reporting purposes 4,624 3,730 Restructure costs, principally due to accrual for financial reporting purposes 878 4,480 Net operating loss carryforwards 20,833 23,567 Tax credit carryforwards 16,445 11,153 Purchased technology 848 85 Other, net 2,644 2,123 Total gross deferred tax assets 48,779 48,500 Less valuation allowance (44,287) (46,213) Net deferred tax assets 4,492 2,287 Deferred tax liabilities: Capitalization of software development costs for financial reporting purposes (4,075) (3,208) Net deferred tax asset (liability) $ 417 $ (921)
31 The Company has established a valuation allowance for certain deferred tax assets, including those for net operating loss and tax credit carryforwards. Statement No. 109 requires that such a valuation allowance be recorded when it is more likely than not that some portion of the deferred tax assets will not be realized. The portion of the valuation allowance for deferred tax assets for which subsequently recognized tax benefits will be applied directly to contributed capital is $15,582 as of December 31, 1995. This amount was primarily attributable to differences between financial and tax reporting of employee stock option transactions. During 1995, the valuation allowance decrease included a benefit from net operating loss carryforwards of $2,885. As of December 31, 1995, the Company, for income tax purposes, has net operating loss carryforwards of approximately $49,834, research and experimentation credits carryforwards of $11,722 and a foreign tax credit carryforward of $4,723. If not used by the Company to reduce income taxes payable in future periods, net operating loss carryforwards will expire between 1997 through 2009, research and experimentation credit carryforwards between 1998 through 2010 and the foreign tax credit carryforward in the year 2000. The Company has not provided for Federal income taxes on approximately $96,727 of undistributed earnings of foreign subsidiaries at December 31, 1995, since these earnings have been invested indefinitely in subsidiary operations. Upon repatriation, some of these earnings would generate foreign tax credits which will reduce the Federal tax liability associated with any future foreign dividend. The Company has settled its Federal income tax obligations through 1991. The Company believes the provisions for income taxes for years since 1991 are adequate. 5. PROPERTY, PLANT AND EQUIPMENT A summary of property, plant and equipment follows:
As of December 31, 1995 1994 ----------- ----------- Computer equipment and furniture $ 141,140 $ 140,807 Buildings and building equipment 53,420 53,365 Land and improvements 14,641 14,641 Leasehold improvements 10,556 9,577 Service spare parts 207 188 219,964 218,578 Less accumulated depreciation and amortization (125,408) (120,558) Property, plant and equipment, net $ 94,556 $ 98,020
On January 20, 1993, the Company entered into an agreement to lease a portion of its headquarters site in Wilsonville, Oregon. Under terms of the five-year agreement, approximately 150 square feet of space was made available to a third party on a firm take-down schedule. The agreement results in rental payments of $2,168 over the remaining term of the lease. 6. OTHER ASSETS
A summary of other assets follows: As of December 31, 1995 1994 ----------- ------------ Software development costs, net $ 10,187 $ 8,021 Long-term deposits 5,987 6,220 Purchased technology, net 4,695 5,135 Goodwill 2,566 2,655 Investment in real estate 2,935 2,935 Investments available for sale 4,150 1,812 Long-term receivables 2,003 2,316 Other 1,200 818 Total $ 33,723 $ 29,912
The company capitalized software development costs amounting to $7,241, $5,156, and $3,609 in 1995, 1994, and 1993, respectively. Related amortization expense of $5,075, $6,220, and $7,449 was recorded for the years ended December 31, 1995, 1994, and 1993, respectively. The purchase of Axiom, 3Soft and Zeelan in 1995 resulted in goodwill capitalization of $528 and technology capitalization of $892. The 1994 Anacad acquisition resulted in goodwill capitalization of $2,897 and technology capitalization of $4,735. Other purchased technology of $1,040 and $1,700 was acquired in 1995 and 1994, respectively. Total purchased technology amortization expense of $2,418, $760, and $565 was recorded for the years ended December 31, 1995, 1994, and 1993, respectively. Goodwill costs are being amortized over a three year period to R&D expense and technology costs are being amortized over a three year period to system and software cost of revenues. 32 7. SHORT-TERM BORROWINGS Short-term borrowings represent drawings by subsidiaries under multi-currency unsecured credit agreements and the current portion of long-term debt. Interest rates are generally based on the applicable country's prime lending rate depending on the currency borrowed. The weighted average interest rate on short term borrowings during 1995 and 1994 was approximately 6%. The Company has available lines of credit of approximately $30,191 as of December 31, 1995. Certain agreements require compensatory balances which the Company has met. 8. LONG-TERM DEBT Long-term debt is comprised of the following:
As of December 31, 1995 1994 ----------- ----------- Revolving term credit facility $ 53,320 $ 54,160 Other 220 355 53,540 54,515 Less current portion (840) (840) Total $ 52,700 $ 53,675
At December 31, 1995 and 1994, the Company had a committed credit facility with First Interstate Bank of Oregon, N.A. which remains in effect until July 2000 at a commitment level of $55,000. The agreement requires commitment reductions of $840 annually which began in July 1994, therefore the debt was reduced by $840 in 1995 and 1994. Also, $840 of the debt is classified as current in short-term borrowings on the consolidated balance sheets as of December 31, 1995 and 1994. Interest on borrowings under the credit facility are floating rate based. Borrowings are collateralized by cash and investments of $30,000 and a trust deed on the Company's headquarters site in Wilsonville, Oregon of $25,000. At December 31, 1995 and 1994, the Company had an interest rate swap agreement with First Interstate Bank of Oregon, N.A. which effectively converts floating rates on $17,500 of borrowings to a fixed rate of 9.55% until expiration of the agreement in January 2000. The average floating interest rate as of December 31, 1995 was approximately 6%. While the Company may be exposed to credit risk in the event of nonperformance by the counterparty to the interest rate swap agreement, the risk of incurring losses due to nonperformance by the counterparty is considered remote. 9. INCENTIVE STOCK PLAN The Board of Directors has the authority to issue incentive stock in one or more series and to determine the relative rights and preferences of the incentive stock. The incentive stock is convertible into common stock upon attainment of specified objectives or upon the occurrence of certain events to be determined by the Board of Directors. 10. EMPLOYEE STOCK AND SAVINGS PLANS The Company has three common stock option plans which provide for the granting of incentive and nonqualified stock options to key employees, officers, and non-employee directors of the Company and its subsidiaries. The three stock option plans are administered by the Compensation Committee of the Board of Directors, and permit accelerated vesting of outstanding options upon the occurrence of certain changes in control of the Company. The Company also has a stock plan which provides for the sale of common stock to key employees of the Company and its subsidiaries. Shares can be awarded under the plan at no purchase price as a stock bonus and the stock plan also provides for the granting of nonqualified stock options. Options under all four plans generally become exercisable over a four to five-year period from the date of grant or from the commencement of employment at prices generally not less than the fair market value at the date of grant. The excess of the fair market value of the shares at the date of grant over the option price, if any, is charged to operations ratably over the vesting period. At December 31, 1995, options for 2,409 shares were exercisable, 22,310 shares were reserved for issuance and 2,914 shares were available for future grant. Stock options outstanding and transactions involving the stock option plans are summarized as follows:
Shares Price Per Share -------- --------------------- Balance at December 31, 1993 5,887 $ .07 - 19.76 Granted 983 9.63 - 14.31 Exercised (780) .07 - 13.00 Canceled (343) 6.00 - 14.63 Balance at December 31, 1994 5,747 .07 - 19.76 Granted 1,265 .71 - 21.13 Exercised (1,523) .07 - 15.41 Canceled (411) .07 - 19.76 Balance at December 31, 1995 5,078 $ .07 - 21.13
33 In May 1989, the shareholders adopted the 1989 Employee Stock Purchase Plan and reserved 1,400 shares for issuance. The shareholders have subsequently amended the plan to reserve an additional 4,000 shares for issuance. Under the plan, each eligible employee may purchase up to six hundred shares of stock per quarter at prices no less than 85% of its fair market value determined at certain specified dates. Employees purchased 382 and 527 shares under the plans in 1995 and 1994, respectively. At December 31, 1995, 2,415 shares remain available for future purchase under the plan. The plan will expire upon either issuance of all shares reserved for issuance or at the discretion of the Board of Directors. There are no plans to terminate the plan at this time. The Company has an employee savings plan (the Savings Plan) that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, participating U.S. employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. The Company currently matches 50% of eligible employee's contributions, up to a maximum of 6% of the employee's earnings. Employer matching contributions vest over 5 years, 20% for each year of service completed. The Company's matching contributions to the Savings Plan were $2,220, $1,997, and $1,896 in 1995, 1994, and 1993, respectively. 11. COMMITMENTS The Company leases a majority of its field office facilities under noncancellable operating leases. In addition, the Company leases certain equipment used in its research and development activities. This equipment is generally leased on a month-to-month basis after meeting a six-month lease minimum. The Company rents its Japanese facilities under a two year cancellable lease with a six month notice of cancellation. The total commitment under this cancellable lease, which expires in December 1996, is $3,022, of which the first six months payments of $1,511 are included in the schedule below. Future minimum lease payments under noncancellable operating leases are approximately as follows:
Operating Annual periods ending Lease December 31, Payments ------------ 1996 $ 9,448 1997 6,581 1998 6,105 1999 4,523 2000 3,459 Later years 9,715 Total $ 39,831
Rent expense under operating leases was approximately $14,006, $14,025, and $17,063 for the years ended December 31, 1995, 1994, and 1993, respectively. 12. OTHER INCOME (EXPENSE)
Other income (expense) is comprised of the following: Year ended December 31, 1995 1994 1993 -------- --------- -------- Interest income $ 8,534 $ 4,956 $ 4,342 Interest expense (2,444) (2,730) (4,404) Foreign exchange gain (loss) (620) 177 247 Other, net 265 25 (438) Total $ 5,735 $ 2,428 $ (253)
13. SUPPLEMENTAL CASH FLOW INFORMATION The following provides additional information concerning supplemental disclosures of cash flow activities:
Year ended December 31, 1995 1994 1993 Cash paid for: ----------- ----------- ------- Interest expense $ 2,221 $ 2,201 $ 4,042 Income taxes $ 6,868 $ 2,840 $ 2,403
The Company owns common stock and common stock warrants of two independent public companies with an original carrying cost of $1,200 and $0 and a market value of $4,150 and $1,812 as of December 31, 1995 and 1994, respectively. This difference resulted in a non-cash increase on the consolidated balance sheets in other assets and as a increase(reduction) of the same amount in retained earnings(accumulated deficit) as of December 31, 1995 and 1994. 34 14. INDUSTRY AND GEOGRAPHIC INFORMATION The Company is a supplier of EDA systems - advanced computer software used to automate the design, analysis and testing of electronic systems and components. System and software revenues comprise more than half of the Company's revenues and are derived primarily from software products owned by the Company and by third parties for which royalties are paid by the Company. Service and support revenues consist of revenue from annual software support maintenance contracts, hardware support, and professional services, which includes consulting services, training services, and custom design services. Established in 1981, the Company is a leader in worldwide EDA sales and markets its products primarily to customers in the aerospace, computer, consumer electronics, semiconductor, automotive and telecommunications industries. The Company sells and licenses its products primarily through its direct sales force in North America, Europe and Asia, and through distributors in territories where the volume of business does not warrant a direct sales presence. In addition to its corporate offices in Wilsonville, Oregon, the Company has sales, support, software development and professional services offices worldwide. Intercompany transfers are accounted for at amounts generally above cost. Corporate expenses are general expenses included in the United States and are not allocated to the operations of each geographic area. For the purposes of determining operating income, corporate administration expenses, corporate marketing expenses and research and development costs are included in the region where the expenses were actually incurred, resulting in such expenses being allocated primarily to the United States. Corporate assets of cash and investments and the Company's headquarter facilities in Wilsonville, Oregon are included in the United States. Geographic information for 1995, 1994 and 1993 is set forth in the table below.
Geographic Information U.S. Europe Japan Other Int'l Eliminations Consolidated ----------- ----------- ---------- ----------- ------------ ------------ 1995 Revenues from unaffiliated customers $ 198,346 $ 103,749 $ 59,620 $ 22,746 $ -- $ 384,461 Intercompany transfers -- -- -- 18,524 (18,524) -- Total revenues $ 198,346 $ 103,749 $ 59,620 $ 41,270 $ (18,524) $ 384,461 Operating income (loss) $ (9,543) $ 26,496 $ 26,330 $ 8,309 $ -- $ 51,592 Identifiable assets $ 280,738 $ 103,761 $ 48,357 $ 28,766 $ -- $ 461,622 1994 Revenues from unaffiliated customers $ 185,448 $ 86,532 $ 54,887 $ 19,337 $ -- $ 346,204 Intercompany transfers -- -- -- 13,618 (13,618) -- Total revenues $ 185,448 $ 86,532 $ 54,887 $ 32,955 $ (13,618) $ 346,204 Operating income (loss) $ (31,284) $ 29,925 $ 23,143 $ 7,096 $ -- $ 28,880 Identifiable assets $ 245,135 $ 87,514 $ 43,053 $ 19,656 $ -- $ 395,358 1993 Revenues from unaffiliated customers $ 179,393 $ 88,323 $ 50,667 $ 20,600 $ -- $ 338,983 Intercompany transfers -- -- -- 16,110 (16,110) -- Total revenues $ 179,393 $ 88,323 $ 50,667 $ 36,710 $ (16,110) $ 338,983 Operating income (loss) $ (68,784) $ 19,669 $ 14,839 $ 4,936 $ -- $ (29,340) Identifiable assets $ 212,547 $ 89,892 $ 35,545 $ 17,161 $ -- $ 355,145
35 15. SUBSEQUENT EVENT On January 31, 1996 the Company completed a merger agreement with Microtec Research, Inc. (Microtec). Under terms of the Agreement the Company issued 6,223 shares of its common stock for all outstanding common stock of Microtec. In addition, the Company has 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 transaction was accounted for as a pooling of interests. 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. Microtec's product offerings are complementary to the Company's current broad line of EDA tools and systems. Since the acquisition was not consummated as of December 31, 1995, the results of Microtec are not included in the Company's Consolidated Financial Statements. The following is a summary of certain information concerning unaudited pro forma consolidated financial information for the Company and Microtec for the years ended December 31,
1995 1994 ---------- --------- Total revenues $ 430,523 $ 389,930 Operating income $ 54,737 $ 34,114 Net income $ 52,562 $ 33,421 Net income per share $ 0.84 $ 0.56 Shares used in per share calculations 62,847 60,073
The unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the merger had been consummated at the beginning of the periods presented, nor is it necessarily indicative of future operating results or financial position. 36
QUARTERLY FINANCIAL INFORMATION - UNAUDITED Quarter ended March 31 June 30 September 30 December 31 in thousands, except per share data ---------- ----------- ------------ ----------- 1995 Total revenues $ 86,346 $ 94,453 $ 95,880 $ 107,782 Gross margin $ 59,606 $ 66,016 $ 68,091 $ 79,903 Operating income $ 7,015 $ 11,462 $ 13,789 $ 19,326 Net income $ 6,476 $ 11,957 $ 12,792 $ 18,634 Net income per common and common equivalent share $ .12 $ .21 $ .23 $ .33 1994 Total revenues $ 84,883 $ 82,423 $ 82,485 $ 96,413 Gross margin $ 60,643 $ 59,183 $ 58,034 $ 68,799 Operating income $ 5,094 $ 5,571 $ 4,858 $ 13,357 Net income $ 4,669 $ 4,908 $ 5,125 $ 13,065 Net income per common and common equivalent share $ .09 $ .09 $ .09 $ .24 Common stock market price: Quarter ended March 31 June 30 September 30 December 31 1995 ---------- --------- ------------ ----------- High $ 16 3/8 $ 18 1/2 $ 21 3/8 $ 22 7/8 Low $ 12 3/8 $ 14 7/8 $ 16 1/8 $ 16 1/8 1994 High $ 17 1/4 $ 16 1/8 $ 11 5/8 $ 15 5/8 Low $ 11 1/4 $ 10 $ 9 3/8 $ 10 5/8
The table above sets forth for the quarters indicated the high and low sales prices for the common stock as reported on the NASDAQ National Market System. As of December 31, 1995, the Company had 1,308 stockholders of record. 37 REPORTS OF MANAGEMENT AND INDEPENDENT AUDITORS REPORT OF MANAGEMENT Management of Mentor Graphics Corporation is responsible for the preparation of the accompanying consolidated financial statements. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and necessarily include some amounts which represent the best estimates and judgments of management. The consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent auditors, whose report is included on this page. The Audit Committee of the Board of Directors is comprised of three directors who are not officers or employees of Mentor Graphics Corporation or its subsidiaries. These directors meet with management and the independent auditors in connection with their review of matters relating to the Company's annual financial statements, the Company's system of internal accounting controls, and the services of the independent auditors. The Committee meets with the independent auditors, without management present, to discuss appropriate matters. The Committee reports its findings to the Board of Directors and also recommends the selection and engagement of independent auditors. R. DOUGLAS NORBY R. Douglas Norby Senior Vice President and Chief Financial Officer WALDEN RHINES Walden Rhines President and Chief Executive Officer INDEPENDENT AUDITORS' REPORT To the Stockholders and Board of Directors Mentor Graphics Corporation: We have audited the accompanying consolidated balance sheets of Mentor Graphics Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mentor Graphics Corporation and subsidiaries as of December 31, 1995, and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" in 1994 and SFAS No. 109, "Accounting for Income Taxes" in 1993. KPMG PEAT MARWICK LLP Portland, Oregon January 29, 1996 38 SHAREHOLDERS' INFORMATION DIRECTORS Jon A. Shirley Chairman of the Board of Directors Private Investor Walden C. Rhines President and Chief Executive Officer Mentor Graphics Corporation Marsha B. Congdon Vice President, Policy and Strategy US West, Inc. James R. Fiebiger Chairman of the Board and Managing Director Thunderbird Technologies, Inc. David A. Hodges Dean of College of Engineering The University of California at Berkeley Fontaine K. Richardson General Partner Eastech Management Company, Inc. CORPORATE OFFICE Mentor Graphics Corporation 8005 S.W. Boeckman Road Wilsonville, Oregon 97070-7777 (503) 685-7000 EXECUTIVE OFFICERS Walden C. Rhines President and Chief Executive Officer Mentor Graphics Corporation James W. Martin Executive Vice President R. Douglas Norby Senior Vice President and Chief Financial Officer Frank S. Delia Vice President Human Resources Dean Freed Vice President General Counsel and Secretary Richard Trebing Corporate Controller and Chief Accounting Officer Dennis Weldon Treasurer COUNSEL Stoel Rives LLP Attorneys-at-Law 900 SW Fifth Avenue, Suite 2300 Portland, Oregon 97204 INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS KPMG Peat Marwick LLP 1211 S.W. Fifth Avenue Suite 2000 Portland, Oregon 97204 TRANSFER AGENT AND REGISTRAR American Stock, Transfer & Trust Co. 40 Wall Street New York, New York 10005 212-936-5100 ANNUAL MEETING The Annual Meeting of shareholders will be held at 5:00 p.m., Pacific Time, on May 2, 1996 at: Mentor Graphics Corporation 8005 S.W. Boeckman Road Wilsonville, Oregon 97070-7777 INVESTOR RELATIONS For additional information on the Company, or to obtain a copy of Mentor Graphics' Annual Report on Form 10-K filed with the Securities and Exchange Commission, contact: Investor Relations Manager Mentor Graphics Corporation 8005 S.W. Boeckman Road Wilsonville, Oregon 97070-7777 For financial and company information, call 1-800-546-4628 or, visit Mentor Graphics on the World Wide Web: http://www.mentorg.com. STOCK TRADING Mentor Graphics Corporation's common stock is traded publicly in the NASDAQ National Market System under the symbol MENT. Windows 95 and Windows NT are registered trademarks of Microsoft Corporation. Design and text by Karakas, VanSickle, Ouellette Advertising and Public Relations. Photography by Damian Conrad Photography. Printed by Graphic Arts Center. 39 EX-21 4 LIST OF SUBSIDIARIES EXHIBIT 21 List of Subsidiaries of the Company - ----------------------------------- The following is a list of Mentor Graphics Corporation operating subsidiaries. Mentor Graphics has no parent companies. Subsidiary Percent owned Mentor Graphics (Canada) Limited 100% Mentor Graphics (Finland) OY 100% Mentor Graphics (France) SARL 100% Mentor Graphics (Deutschland) GmbH 100% Mentor Graphics Japan Co. Ltd. 100% Mentor Graphics (Netherlands) B.V. 100% Mentor Graphics (Singapore) PTE.LTD. 100% Mentor Graphics (Scandinavia) AB 100% Mentor Graphics (Schweiz) AG 100% Mentor Electronic Design SA [Spain] 100% Mentor Graphics (Taiwan) Co. Ltd. 100% Mentor Graphics (UK) Ltd. 100% Mentor Graphics (Denmark) 100% Mentor Graphics (Israel) Ltd. 100% European Development Center, N.V. 74% Anacad Computer Systems GmbH 100% Antares Corporation 100% Model Technology Incorporated 100% Exemplar Logic, Inc. 100% CoSoft Ltd. 100% 3Soft Corporation 100% Precedence Incorporated 100% Microtec Research, Inc. 100% Axiom Datorer Skandinavien, AB 100% EX-23 5 CONSENT OF ACCOUNTANTS EXHIBIT 23 Consent of Accountants - ---------------------- The Board of Directors and Shareholders Mentor Graphics Corporation: We consent to incorporation by reference in the registration statements on Form S-8 (Nos. 33-11291, 33-18259, 2-90577, 33-30036, 2-99251, 33-30774, 33- 57147, 33-57149, 33-57151, and 33-64717) and on Form S-3 (Nos. 33-52419, 33-56759, 33-60129, and 333-277) of Mentor Graphics Corporation and subsidiaries of our reports dated January 29, 1996, relating to the consolidated balance sheets of Mentor Graphics Corporation and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and stockholders' equity and related schedule for each of the years in the three-year period ended December 31, 1995, which reports appear or are incorporated by reference in the December 31, 1995 annual report on Form 10-K of Mentor Graphics Corporation and subsidiaries. Our reports refer to a change in the method of accounting for certain investments in debt and equity securities and income taxes. KPMG PEAT MARWICK LLP Portland, Oregon March 25, 1996 EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 YEAR YEAR DEC-31-1994 DEC-31-1995 DEC-31-1994 DEC-31-1995 130,989 176,500 7,180 24,504 83,107 85,994 2,998 2,771 856 660 237,426 303,343 98,020 94,556 24,687 23,836 395,358 461,622 100,181 102,629 0 0 0 0 0 0 254,731 268,807 (15,204) 36,714 395,358 461,622 346,204 384,461 346,204 384,461 99,545 110,845 99,545 110,845 217,779 222,024 629 308 2,730 2,444 31,308 57,327 3,541 7,468 27,767 49,859 0 0 0 0 0 0 27,767 49,859 .51 .88 .51 .88
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