-----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, RcFz28+S25VAZ8XMSguzjqRuAEH62as6MXCbohCnfWl4NaP61vyP5GPaLbbOqWtm LaNj2el6rAMYN7MILcl4iQ== 0000893877-99-000715.txt : 19991117 0000893877-99-000715.hdr.sgml : 19991117 ACCESSION NUMBER: 0000893877-99-000715 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MENTOR GRAPHICS CORP CENTRAL INDEX KEY: 0000701811 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 930786033 STATE OF INCORPORATION: OR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-13442 FILM NUMBER: 99753576 BUSINESS ADDRESS: STREET 1: 8005 SW BOECKMAN RD CITY: WILSONVILLE STATE: OR ZIP: 97070-7777 BUSINESS PHONE: 5036857000 10-Q 1 QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q - -------------------------------------------------------------------------------- Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended September 30, 1999. Commission File No. 0-13442 - -------------------------------------------------------------------------------- MENTOR GRAPHICS CORPORATION (Exact name of registrant as specified in its charter) Oregon 93-0786033 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777 (Address including zip code of principal executive offices) Registrant's telephone number, including area code: (503) 685-7000 - -------------------------------------------------------------------------------- NO CHANGE Former name, and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Number of shares of common stock, no par value, outstanding as of October 29, 1999: 64,199,815 MENTOR GRAPHICS CORPORATION Index to Form 10-Q PART I FINANCIAL INFORMATION Page Number Item 1. Financial Statements Consolidated Statements of Operations for the three 3 months ended September 30, 1999 and 1998 Consolidated Statements of Operations for the nine 4 months ended September 30, 1999 and 1998 Consolidated Balance Sheets as of September 30, 1999 5 and December 31, 1998 Consolidated Statements of Cash Flows for the 6 nine months ended September 30, 1999 and 1998 Notes to Consolidated Financial Statements 7-8 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 9-15 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16-17 PART II OTHER INFORMATION Item 1. Legal Proceedings 18 SIGNATURES 19 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements
Mentor Graphics Corporation Consolidated Statements of Operations (Unaudited) Three months ended September 30, 1999 1998 - ------------------------------------------------------------------------------------------------------------- In thousands, except per share data Revenues: System and software.................................................... $ 59,211 $ 64,338 Service and support.................................................... 54,870 53,595 ------------ ----------- Total revenues..................................................... 114,081 117,933 ------------ ----------- Cost of revenues: System and software.................................................... 6,517 6,083 Service and support.................................................... 21,406 23,245 ------------ ----------- Total cost of revenues............................................. 27,923 29,328 ------------ ----------- Gross margin....................................................... 86,158 88,605 ------------ ----------- Operating expenses: Research and development............................................... 29,828 28,907 Marketing and selling.................................................. 37,486 38,003 General and administration............................................. 10,711 11,516 ------------ ----------- Total operating expenses........................................... 78,025 78,426 ------------ ----------- Operating income ........................................................... 8,133 10,179 Other expense, net..................................................... (612) (303) ------------ ----------- Income before income taxes......................................... 7,521 9,876 Income tax expense..................................................... 1,655 2,173 ------------ ----------- Net income......................................................... $ 5,866 $ 7,703 ============ =========== Net income per share: Basic.............................................................. $ .09 $ .12 ============ =========== Diluted............................................................ $ .09 $ .12 ============ =========== Weighted average number of shares outstanding: Basic.............................................................. 65,841 65,380 ============ =========== Diluted............................................................ 66,309 65,629 ============ =========== - -------------------------------------------------------------------------------------------------------------
3
Mentor Graphics Corporation Consolidated Statements of Operations (Unaudited) Nine months ended September 30, 1999 1998 - ------------------------------------------------------------------------------------------------------------- In thousands, except per share data Revenues: System and software.................................................... $ 198,621 $ 186,398 Service and support.................................................... 157,540 158,660 ------------ ----------- Total revenues..................................................... 356,161 345,058 ------------ ----------- Cost of revenues: System and software.................................................... 20,931 20,473 Service and support.................................................... 65,748 72,717 ------------ ----------- Total cost of revenues............................................. 86,679 93,190 ------------ ----------- Gross margin....................................................... 269,482 251,868 ------------ ----------- Operating expenses: Research and development............................................... 86,384 86,635 Marketing and selling.................................................. 121,266 117,258 General and administration............................................. 34,497 32,802 Special charges........................................................ 21,831 10,307 ------------ ----------- Total operating expenses........................................... 263,978 247,002 ------------ ----------- Operating income............................................................ 5,504 4,866 Other expense, net..................................................... (9,120) (3,516) ------------ ----------- Income (loss) before income taxes.................................. (3,616) 1,350 Income tax expense (benefit)........................................... (795) 297 ------------ ----------- Net income (loss)............................................. $ (2,821) $ 1,053 ============ =========== Net income (loss) per share: Basic.............................................................. $ (.04) $ .02 ============ =========== Diluted............................................................ $ (.04) $ .02 ============ =========== Weighted average number of shares outstanding: Basic.............................................................. 66,042 64,996 ============ =========== Diluted............................................................ 66,042 65,432 ============ =========== - -------------------------------------------------------------------------------------------------------------
4
Mentor Graphics Corporation Consolidated Balance Sheets As of As of Sept. 30, 1999 Dec. 31, 1998 - ------------------------------------------------------------------------------------------------------------- In thousands (Unaudited) Assets Current assets: Cash and cash equivalents............................................. $ 108,657 $ 118,512 Short-term investments................................................ 2,000 19,073 Trade accounts receivable, net........................................ 121,655 125,844 Other receivables..................................................... 6,823 7,575 Prepaid expenses and other............................................ 15,755 23,503 Deferred income taxes................................................. 11,083 10,937 ------------ ----------- Total current assets.............................................. 265,973 305,444 Property, plant and equipment, net......................................... 84,858 95,214 Term receivables, long-term................................................ 30,750 36,430 Other assets, net.......................................................... 26,868 27,035 ------------ ----------- Total assets...................................................... $ 408,449 $ 464,123 ============ =========== Liabilities and Stockholders' Equity Current liabilities: Short-term borrowings ................................................ $ - $ 24,000 Accounts payable...................................................... 7,978 10,101 Income taxes payable.................................................. 17,573 20,408 Accrued payroll and related liabilities............................... 26,771 41,958 Accrued liabilities................................................... 28,837 33,295 Deferred revenue...................................................... 46,754 36,484 ------------ ----------- Total current liabilities......................................... 127,913 166,246 Other long-term deferrals.................................................. 1,245 1,425 Commitments and contingencies.............................................. - - Minority interest.......................................................... 1,209 1,170 Stockholders' Equity: Common stock.......................................................... 285,927 303,352 Accumulated deficit................................................... (25,067) (22,246) Accumulated other comprehensive income - foreign currency translation adjustment......................... 17,222 14,176 ------------ ----------- Total stockholders' equity............................................ 278,082 295,282 ------------ ----------- Total liabilities and stockholders' equity........................ $ 408,449 $ 464,123 ============ =========== - -------------------------------------------------------------------------------------------------------------
5
Mentor Graphics Corporation Consolidated Statements of Cash Flows (Unaudited) Nine months ended September 30, 1999 1998 - ------------------------------------------------------------------------------------------------------------- In thousands Operating Cash Flows: Net income (loss).......................................................... $ (2,821) $ 1,053 Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation and amortization of property, plant and equipment..................................... 16,844 20,252 Deferred taxes........................................................ (415) 195 Amortization of other assets.......................................... 2,817 2,789 Write-down of assets.................................................. 18,134 3,131 Business disposals.................................................... 4,497 2,628 Gain on sale of investments........................................... (3,669) - Changes in operating assets and liabilities: Trade accounts receivable............................................. 5,502 (9,731) Prepaid expenses and other............................................ 2,726 (11,671) Term receivables, long-term .......................................... 6,454 - Accounts payable...................................................... (2,226) (2,091) Accrued liabilities................................................... (26,920) (9,500) Other liabilities and deferrals....................................... 6,582 8,871 ------------ ----------- Net cash provided by operating activities................................. 27,505 5,926 ------------ ----------- Investing Cash Flows: Net maturities of short-term investments............................. 17,073 50,857 Purchases of property, plant and equipment, net ..................... (11,709) (16,322) Purchases of equity interests........................................ (7,572) (8,522) Proceeds from sale of property, plant and equipment.................. 3,009 - Proceeds from sale of investments.................................... 8,191 - ------------ ----------- Net cash provided by investing activities................................. 8,992 26,013 ------------ ----------- Financing Cash Flows: Proceeds from issuance of common stock............................... 9,891 8,113 Repayment of short-term borrowings................................... (24,000) - Repurchase of common stock........................................... (32,548) - ------------ ----------- Net cash provided (used) by financing activities.......................... (46,657) 8,113 ------------ ----------- Effect of exchange rate changes on cash and cash equivalents ........................................... 305 (448) ------------ ----------- Net change in cash and cash equivalents................................... (9,855) 39,604 Cash and cash equivalents at beginning of period.......................... 118,512 84,402 ------------ ----------- Cash and cash equivalents at end of period................................ $ 108,657 $ 124,006 ============ =========== - -------------------------------------------------------------------------------------------------------------
6 MENTOR GRAPHICS CORPORATION Notes to Consolidated Financial Statements (In thousands, except per share data) (Unaudited) (1) General - The accompanying financial statements have been prepared in conformity with generally accepted accounting principles. However, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary for a fair presentation of the results of the interim periods presented. Certain reclassifications have been made in the accompanying financial statements for 1998 to conform with the 1999 presentation. (2) Special Charges - During the first nine months of 1999 the Company recorded special charges of $21,831. The charges consisted of acquisition related costs attributable to the purchase of the minority interest of a subsidiary, costs attributable to the terminated tender offer for Quickturn Design Systems, Inc. (Quickturn) net of a gain from the sale of acquired stock, two subsidiary divestitures and related employee terminations. Substantially all of these costs were disbursed in the first half of 1999. In January of 1999, the Company completed the purchase of the remaining minority interest of its then 84% owned subsidiary, Exemplar Logic, Inc. (Exemplar) for cash and stock options valued at $13,003. The cost of the acquisition was allocated on the basis of the estimated fair value of assets assumed. This allocation resulted in charges for in process R&D and compensation and other related costs of $624 and $6,951, respectively. In addition, capitalized goodwill and technology allocations were $4,452 and $976, respectively. The goodwill and technology will be amortized to R&D over five years and system and software product cost of goods sold over three years, respectively. During the first nine months of 1998 the Company recorded special charges of $10,307. The charges consisted of three subsidiary divestitures, related employee terminations, and the recognition of impairment in value of certain assets. Substantially all of these costs were disbursed in the first half of 1998. (3) Supplemental Disclosures of Cash Flow Information - The following provides additional information concerning cash flow activities:
Nine months ended September 30, 1999 1998 ------------------------------------------------------------------------------------------------ Interest paid................................................... $ 650 $ 412 Income taxes paid, net of refunds............................... $ 718 $ 2,422 Issuance of stock options for purchase of minority interest of subsidiary............................... $ 5,232 $ - ------------------------------------------------------------------------------------------------
(4) Comprehensive Income - The following provides a summary of comprehensive income:
Nine months ended September 30, 1999 1998 ------------------------------------------------------------------------------------------------ Net income (loss)............................................... $ (2,821) $ 1,053 Foreign currency translation adjustment......................... 3,046 1,285 ----------- ----------- Comprehensive income............................................ $ 225 $ 2,338 =========== =========== ------------------------------------------------------------------------------------------------
7 (5) Revenue Recognition - Revenues from system and software licenses are recognized at the time of shipment, except for those that include rights to future software products or have significant other delivery requirements. Product revenues from term or installment sales agreements which include either perpetual or term licenses are principally with the Company's top-rated credit customers and are recognized upon shipment while any maintenance revenues included in these arrangements are deferred and recognized ratably over the contract term. Revenues from subscription-type term license agreements, which include software, rights to future software products, and services, are deferred and recognized over the term of the contract. Training and consulting contract revenues are recognized using the percentage of completion method or as contract milestones are achieved. (6) Segment Reporting - The Company operates principally in the EDA industry. The Company markets its products primarily to customers in the communications, computer, semiconductor, consumer electronics, aerospace, and transportation industries. The Company sells and licenses its products through its direct sales force in North and South America (Americas), Europe, Japan and Pacific Rim, and through distributors where a direct sales presence is not warranted. The Company's reportable segments are based on geographic area. All intercompany revenues and expenses are eliminated in computing revenues and operating income (loss). The corporate component of operating income (loss) represents research and development, corporate marketing and selling, corporate general and administration, special, and merger and acquisitions related charges. Corporate capital expenditures and depreciation and amortization are generated from assets allotted to research and development, corporate marketing and selling, and corporate general and administration. Reportable segment information is as follows:
Three months ended Sept. 30, Nine months ended Sept. 30, ----------------------------------------------------------- 1999 1998 1999 1998 -------------------------------------------------------------------------------------------------- Revenues Americas.......................... $ 51,060 $ 63,146 $ 170,385 $ 185,833 Europe............................ 36,563 36,199 107,386 103,381 Japan............................. 19,772 14,765 60,100 43,993 Pacific Rim....................... 6,686 3,823 18,290 11,851 ---------- ---------- ---------- ---------- Total................................ $ 114,081 $ 117,933 $ 356,161 $ 345,058 ========== ========== ========== ========== Operating income (loss) Americas.......................... $ 26,207 $ 32,173 $ 87,224 $ 91,811 Europe............................ 18,280 17,651 48,449 44,827 Japan............................. 10,872 6,978 29,455 20,822 Pacific Rim....................... 4,074 1,365 10,770 5,347 Corporate......................... (51,300) (47,988) (170,394) (157,941) ---------- ---------- ---------- ---------- Total................................ $ 8,133 $ 10,179 $ 5,504 $ 4,866 ========== ========== ========== ========== --------------------------------------------------------------------------------------------------
(7) Subsequent Event - On October 31, 1999, the Company purchased certain assets and liabilities of VeriBest, Inc. for $9,130 in cash and a warrant to purchase 500 shares of Mentor Graphics common stock at $15 per share, exercisable from October 31, 2001 until October 31, 2002. The business combination will be accounted for as a purchase and will include acquisition related costs and the cost of net liabilities. These costs will be allocated on the basis of estimated fair value of assets and liabilities assumed and will likely include a charge for in-process R&D for development that had not yet reached technological feasibility. The purchase price allocation including amount of capitalized goodwill and technology and in process R&D charge has yet to be determined. 8 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition (All numerical references in thousands, except for percentages) RESULTS OF OPERATIONS - --------------------- REVENUES AND GROSS MARGINS System and Software System and software revenues for the three months and nine months ended September 30, 1999 totaled $59,211 and $198,621, respectively, representing a decrease of $5,127 or 8 percent and an increase of $12,223 or 7 percent from the same periods of 1998. Compared to the respective prior periods, software product revenues were down in the third quarter of 1999 and increased during the first nine months of 1999. Accelerated verification systems revenues increased in the third quarter and the first nine months of 1999. The increase in software product revenues in the first nine months of 1999 is attributable to continued growth of the Company's newer product offerings as well as growth in some older products in the first quarter of the year. The older product revenue gains were attributable in part to customers seeking to have their design environments Year 2000 compliant. The decline in growth of software product revenues in the comparable third quarters is attributable in part to lower Field Programmable Gate Array(FPGA) sales due to a consolidation of the Company's third party sales channel and a late third quarter 1999 enhancement release of its FPGA simulation product offering. Three separate third party sales networks, which sold separate FPGA point tools, were combined in the first quarter of 1999 in order to increase efficiencies and better leverage marketing programs. The adverse effects of this change on sales may continue in the short term. The increase in accelerated verification system sales is primarily due to continued market acceptance of a next generation product offering that became available in the second quarter of 1998. Accelerated verification systems products are not available in U.S. markets. See "Part II - Item 1. Legal Proceedings" for further discussion. The effects of a strengthening of the Japanese Yen versus the U.S. dollar had a favorable impact on revenues. See "Geographic Revenues Information" for further discussion. System and software gross margins were 89 percent for the third quarter and 90 percent for the first nine months of 1999, respectively, compared to 91 and 89 percent for the same periods a year ago. Gross margins were favorably impacted in 1999 by higher year to date software sales, lower workstation hardware sales and improved gross margins on accelerated verification systems sales. Purchased technology amortization to system and software cost of goods sold was $332 and $985 for the third quarter and first nine months of 1999, respectively, compared to $310 and $1,925 for the same periods of 1998, respectively. The year to date decline in amortization levels is due to fewer technology acquisitions in recent years. Service and Support Service and support revenues for the three months and nine months ended September 30, 1999 totaled $54,870 and $157,540, respectively, representing an increase of $1,275 or 2 percent and a decrease of $1,120 or 1 percent from the comparable periods of 1998. Service and support revenues consist of software support and professional services, of which software support was approximately flat for the third quarter and the first nine months of 1999 compared to a year ago. Professional service revenues increased in the third quarter of 1999 compared to a year ago and declined slightly in the comparable nine month periods. The overall year to date decline of professional service revenues is principally due to a reduction in custom design service engagements as the Company continues to shift toward methodology engagements that enable customers to better utilize the Company's products. The increase in professional service revenues in the third quarter is attributable in part to increased demand for such services. 9 Service and support gross margins were 61 and 58 percent for the third quarter and first nine months of 1999, compared to 57 and 54 percent for the comparable periods a year ago. The increase in overall service and support gross margins is attributable to improved professional service realization as a result of better worldwide program management and a focus on more profitable design methodology engagements. Program management includes initial scoping, subsequent pricing and final delivery of the contracted services. Geographic Revenues Information Domestic revenues from unaffiliated customers including service and support revenues for the third quarter and first nine months of 1999 were 45 and 48 percent of total revenues compared to 54 percent of total revenues for comparable periods of 1998. Compared to the respective prior periods, European revenues increased 1 and 4 percent in the third quarter and the first nine months of 1999 and Japanese revenues increased 34 and 37 percent in the third quarter and the first nine months of 1999. Japanese revenues were positively impacted by exchange rate changes in the comparable periods, where the Yen strengthened against the U.S. dollar by approximately 21 and 13 percent in the third quarter and the first nine months of 1999. Exclusive of currency effects, higher revenue levels in Japan are primarily due to several large accelerated verification transactions in the first nine months of 1999. Since the Company generates approximately half of its revenues outside of the United States, revenue results should continue to be impacted by the effects of future foreign currency fluctuations. OPERATING EXPENSES Research and development expenses totaled $29,828 and $28,907 or 26 and 25 percent of revenues for the third quarters of 1999 and 1998, respectively, and $86,384 and $86,635 or 24 and 25 percent of revenues for the first nine months of 1999 and 1998, respectively. Marketing and selling expenses totaled $37,486 and $38,003 or 33 and 32 percent of revenues for the third quarters of 1999 and 1998, respectively, and $121,266 and $117,258 or 34 percent of revenues for the first nine months of 1999 and 1998, respectively. General and administration expenses totaled $10,711 and $11,516 or 9 and 10 percent of revenues for the third quarters of 1999 and 1998, respectively and $34,497 and $32,802 or 10 percent of revenues for the first nine months of 1999 and 1998, respectively. The increase in year to date general and administration expenses is primarily attributable to overlap and training costs associated with the transition of the European distribution center to Ireland. These overlap costs were significantly reduced by the second quarter of 1999. SPECIAL CHARGES During the first nine months of 1999 the Company recorded special charges of $21,831. The charges consisted of acquisition related costs attributable to the purchase of the minority interest of a subsidiary, costs attributable to the terminated tender offer for Quickturn Design Systems, Inc. (Quickturn) net of a gain from the sale of acquired stock, two subsidiary divestitures and related employee terminations. Substantially all of these costs were disbursed in the first half of 1999. In January of 1999, the Company completed the purchase of the remaining minority interest of its then 84% owned subsidiary, Exemplar Logic, Inc. (Exemplar) for cash and stock options valued at $13,003. The cost of the acquisition was allocated on the basis of the estimated fair value of assets assumed. This allocation resulted in charges for in process R&D and compensation and other related costs of $624 and $6,951, respectively. In addition, capitalized goodwill and technology allocations were $4,452 and $976, respectively. The goodwill and technology will be amortized to R&D over five years and system and software product cost of goods sold over three years, respectively. During the first nine months of 1998 the Company recorded special charges of $10,307. The charges consisted of three subsidiary divestitures, related employee terminations, and the recognition of impairment in value of certain assets. Substantially all of these costs were disbursed in the first half of 1998. 10 OTHER INCOME (EXPENSE) Other expense, net totaled $612 and $9,120 for the third quarter and the first nine months of 1999 compared to $303 and $3,516 for the same periods of 1998. Other income (expense) was negatively impacted by legal costs associated with the ongoing patent litigation with Quickturn, which became a subsidiary of Cadence Design Systems, Inc. in the second quarter of 1999. These costs totaled $1,773 and $12,656 in the third quarter and the first nine months of 1999, respectively compared to $1,230 and $7,084 for comparable periods of 1998. The year to year increase is attributable to a legal settlement of $3,000 for the Portland, Oregon SimExpress trial and other trial related costs during the first half of the year. Included in the first quarter of 1998 were license fees for certain intellectual property licensed from Aptix Corporation and expenses attributable to a patent infringement lawsuit filed jointly by a subsidiary of the Company and Aptix against Quickturn. Other legal proceedings are pending or are in progress related to this matter. See "Part II - Item 1. Legal Proceedings" for further discussion. Interest income from investments was $1,606 and $5,233 for the third quarter and the first nine months of 1999, compared to $1,813 and $5,525 for comparable periods of 1998. During the third quarter and the first nine months of 1999, interest expense amounted to $235 and $691, respectively compared to $262 and $551 for the comparable periods in 1998. PROVISION (BENEFIT) FOR INCOME TAXES The expense (benefit) for income taxes amounted to $(795) for the nine months ended September 30, 1999, as compared to $297 for the same period in 1998. The tax expense (benefit) in all periods is the result of the mix of profits earned by the Company and its subsidiaries in tax jurisdictions with a broad range of income tax rates. Because the Company's income tax position combines the effects of available tax benefits in certain countries where the Company does business, benefits from available net operating loss carry-forwards and tax expense for subsidiaries with pre-tax income, the Company's income tax position and resultant effective tax rate is uncertain for the remainder of 1999 and beyond. EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS Approximately half of the Company's revenues are generated outside of the United States. For 1999 and 1998, approximately half of European and all of Japanese revenues were subject to exchange rate fluctuations as they were booked in local currencies. The effects of these fluctuations were substantially offset by local currency cost of revenues and operating expenses, which resulted in an immaterial net effect on the Company's results of operations. The "accumulated other comprehensive income - foreign currency translation adjustment," as reported in the stockholders' equity section of the Consolidated Balance Sheets, increased to $17,222 at September 30, 1999, from $14,176 at the end of 1998. This reflects the increase in the value of net assets denominated in foreign currencies since year-end 1998 as a result of a stronger dollar as of September 30, 1999. 11 LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- CASH AND INVESTMENTS Total cash and short-term investments at September 30, 1999 were $110,657 compared to $137,585 at the end of 1998. Cash provided by operations was $27,505 for the first nine months of 1999 compared to $5,926 during the same period of 1998. During the first nine months of 1999, cash provided by operations was negatively impacted by payments related to special charges taken in 1999. During the same period of 1998 operating cash flow was positively impacted by income from operations and partially offset by special charge payments. Cash used by investing activities, excluding short-term investments, was $8,081 and $24,844 in the first nine months of 1999 and 1998, respectively. Investing activities in the first nine months of 1999 included a cash payment made for a purchase of the minority interest in Exemplar of $7,572 and capital expenditures offset by cash received from the sale of Quickturn stock of $8,191. Investing activities in the first nine months of 1998 included cash payments to acquire Quickturn stock of $4,522, a cash payment of $4,000 for a controlling interest in the Company's Korean distributor and capital expenditures. Cash provided (used) by financing activities was $(46,657) for the first nine months of 1999 compared to $8,113 during the same period of 1998. The use of cash for financing activities in 1999 included the pay-down of a short-term borrowing of $24,000 and the repurchase of 3,528 shares of common stock for $32,548. TRADE ACCOUNTS RECEIVABLE Trade accounts receivable decreased to $121,665 at September 30, 1999 from $125,844 at year-end 1998. Excluding the current portion of term receivables of $38,886 and $35,247, average days sales outstanding were 65 days and 56 days at September 30, 1999 and December 31, 1998, respectively. Average days sales outstanding in total accounts receivable increased from 78 days at the end of 1998 to 96 days at the end of the third quarter of 1999. This increase in average trade receivables days sales outstanding is principally attributable to term contract sales where the Company provided its customers extended payment terms. The decrease in the trade accounts receivable balance is primarily attributable to the sale of some short-term accounts receivable to a financing institution on a non-recourse basis. TERM RECEIVABLES, LONG-TERM Term receivables, long-term decreased to $30,750 at the end of the third quarter of 1999 compared to $36,430 at December 31, 1998. The balances are attributable to demand for multi-year, multi-element term license and perpetual license installment sales agreements principally from the Company's top-rated credit customers. Balances under term agreements that are due within one year are included in trade accounts receivable and balances that are due in more than one year are included in term receivables, long-term. The Company uses term agreements as a standard business practice and has a history of successfully collecting under the original payment terms without making concessions on payments, products or services. The decrease is primarily attributable to seasonally fewer agreements of this nature in the third quarter of 1999 versus fourth quarter of 1998. CAPITAL RESOURCES Total capital expenditures decreased to $11,709 through September 30, 1999, compared to $16,322 for the same period of 1998. Expenditures in the first nine months of 1999 and 1998 did not include any individually significant projects. The Company anticipates that current cash balances, anticipated cash flows from operating activities, and existing credit facilities will be sufficient to meet its working capital needs for at least the next twelve months. 12 FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION The statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words "believes," "expects," and words of similar import, constitute forward-looking statements that involve a number of risks and uncertainties. Moreover, from time to time the Company may issue other forward-looking statements. The following discussion highlights factors that could cause actual results to differ materially from the forward-looking statements. The forward-looking statements should be considered in light of these factors. The Company competes in the highly competitive and dynamic EDA industry. The Company's success is dependent upon its ability to develop and market products and selling models that are innovative, cost-competitive and meet customer expectations. Competition in the EDA industry is intense, which can create adverse effects including, but not limited to, price reductions, lower product margins, loss of market share and additional working capital requirements. Additionally, new pricing and selling models in the industry, including the use of fixed term licenses and subscription transactions versus traditional perpetual licenses further complicate the Company's ability to effectively price and package large multi-element contracts that are competitive and profitable. The Company's business is largely dependent upon the success and growth of the electronics industry. From time to time the electronics industry cuts costs through employee layoffs and reductions in the number of electronic design projects which could reduce demand for the Company's products and services. In addition, there have been a number of mergers in the electronics industry worldwide, which could result in decreased or delayed capital spending patterns. The above business challenges for the electronics and related industries may have a material adverse effect on the Company's financial condition and results of operations. As a result of the acquisition of Meta Systems and its accelerated verification products, the Company is in the hardware development and assembly business. Risk factors include procuring hardware components on a timely basis, assembling and shipping systems on a timely basis with appropriate quality control, developing new distribution and shipment processes, managing inventory and related obsolescence issues, developing new processes to deliver customer support of the hardware and placing new demands on the sales force. In addition, the Company is engaged in litigation with Quickturn in which Quickturn has asserted that the Company and Meta are infringing Quickturn patents. See "Part II-Item 1. Legal Proceedings" for further discussion. The Company has been prohibited from using, selling or marketing its SimExpress emulation products in the United States and Germany. While the Company settled one SimExpress court case in the second quarter of 1999, other legal proceedings and litigation continue. These actions may result in the Company being unable to sell its accelerated verification products in other jurisdictions worldwide and may negatively affect demand for accelerated verification products for the Company and all vendors worldwide until the outcome is determined. This litigation could result in lower sales of accelerated verification products, increase the risk of inventory obsolescence and have a materially adverse effect on the Company's results of operations. A material amount of the Company's software product revenue is usually the result of current quarter order performance of which the majority is usually booked in the last few weeks of each quarter. In addition, the Company's revenue often includes multi-million dollar contracts. The timing of the completion of these contracts and the terms of delivery of software, hardware and other services can have a material impact on revenue recognition for a given quarter. The combination of these factors impairs and delays the Company's ability to identify shortfalls or overages from quarterly revenue targets. The Company uses term or installment sales agreements as a standard business practice and has a history of successfully collecting under the original payment terms without making concessions on payments, products or services. These multi-year, multi-element term license and perpetual license term agreements are from the Company's top-rated credit customers and average between one and three years in length. These agreements may increase the element of risk associated with collectibility from customers that can arise for a variety of reasons including ability to pay, product satisfaction or disagreements and disputes. If collectibility for any of these multi-million dollar agreements becomes a problem the Company's results of operations could be adversely affected. 13 The Company generally realizes approximately half of its revenues outside the U.S. and expects this to continue in the future. As such, the effects of foreign currency fluctuations can impact the Company's business and operating results. To hedge the impact of foreign currency fluctuations, the Company enters into foreign currency forward contracts. However, significant changes in exchange rates may have a material adverse impact on the Company's results of operations. International operations subject the Company to other risks including, but not limited to, changes in regional or worldwide economic or political conditions, government trade restrictions, limitations on repatriation of earnings, licensing and intellectual property rights protection. The Company's operating expenses are generally committed in advance of revenue and are based to a large degree on future revenue expectations. Operating expenses are incurred to generate and sustain higher future revenue levels. If the revenue does not materialize as expected, the Company's results of operations can be adversely impacted. Acquisitions of complementary businesses are a part of the Company's overall business strategy. There are several risks associated with this strategy including integration of sales channels, training and education of the sales force for new product offerings, integration of product development efforts, retention of key employees, integration of systems of internal controls, and integration of information systems. All of these factors can impair the Company's ability to forecast, to meet quarterly revenue and earnings targets, to meet various debt obligations used to finance acquisitions and to effectively manage the business for long-term growth. There can be no assurance that these challenges will be effectively met. The Company has been able to recruit and retain necessary personnel to research and develop, market, sell and service products that satisfy customers' needs. There can be no assurance that the Company can continue to recruit and retain such personnel. Generally accepted accounting principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingencies at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. The Company is involved in various administrative matters and litigation. There can be no assurance that various litigation and administrative matters will not have a material adverse impact on the Company's consolidated financial position or results of operations. See "Part II-Item 1. Legal Proceedings" for further discussion. Due to the factors above, as well as other market factors outside the Company's control, the Company's future earnings and stock price may be subject to significant volatility. Past financial performance should not be considered a reliable indication of future performance. The investment community should use caution in using historical trends to estimate future results or trends. In addition, if future results vary significantly from expectations of analysts, the Company's stock price could be adversely impacted. 14 YEAR 2000 The Company is aware of the potential inability of computer programs to adequately process date information after December 31, 1999 (Year 2000). The Company has conducted a review of its products, information technology and facilities computer systems to identify all software that could be affected by the Year 2000 issue and has developed or is developing implementation plans to address this issue. The Company has announced that its current release of software products is Year 2000 compliant. The effect of the Year 2000 issue with regard to the Company's product offerings is not expected to have any material adverse effect on its financial condition and results of operations. In addition to computers and related systems, the operations of the Company's office and facilities equipment, such as fax machines, photocopiers, telephone switched security systems, elevators and other common devices may be affected by the Year 2000 problem. The Company estimates that its total remaining cost to complete any required modifications, upgrades or replacements of these internal systems should total approximately $400 for the rest of 1999. Identifiable expenditures through the third quarter of 1999 have totaled approximately $4,100. In addition, the Company has developed and implemented a program to review the Year 2000 compliance status of computer software programs licensed from third parties and used in its internal business processes to obtain appropriate assurances of Year 2000 compliance from manufacturers of these products. The Company's Year 2000 compliance review and necessary modifications are substantially complete. The effect on the Company's financial condition and results of operations from these projects is not expected to be material. However, the compliance of systems acquired from third parties is dependent on factors outside the Company's control. If key systems, or a significant number of systems fail as a result of Year 2000 problems, the Company could incur substantial expense and experience a disruption of business operations, which would potentially have a material adverse effect on the Company's financial condition and results of operations. Furthermore, the Company has made an assessment as to whether any of its suppliers and service providers will be affected by the Year 2000 issue. Failure of the Company's suppliers or service providers to comply with Year 2000 could have a material adverse impact on the Company's financial condition and results of operations. The purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies may be required to devote significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase the Company's software products that could have a materially adverse effect on the Company's financial condition and results of operations. There can be no assurance that Year 2000 related operating problems or material expenses will not occur with the Company's computer systems or in connection with the interface to the Company's major vendors or suppliers. The Company acquired certain assets and liabilities of VeriBest, Inc. on October 31, 1999 and has launched a project to review VeriBest's Year 2000 readiness. The project will include a review of VeriBest's business systems and other pertinent systems in an attempt to identify and correct any issues related to the Year 2000 effect. While the Company does not expect any significant unresolved issues, there can be no assurances that all issues will be identified or remedied in a timely and effective manner. The Company has developed contingency plans as part of its efforts to identify and correct Year 2000 problems affecting its internal systems. Depending on the systems affected, these plans include, (a) accelerated replacement of affected equipment and software; (b) short to medium term use of back up equipment and software; (c) increased work hours for the Company personnel or use of contract personnel to provide manual workarounds for information systems; and (d) other similar approaches. 15 Item 3. Quantitative And Qualitative Disclosures About Market Risk (All numerical references in thousands, except for rates and percentages) INTEREST RATE RISK The Company's exposure to market risk for changes in interest rates relate primarily to its investment portfolio. The Company does not use derivative financial instruments for speculative or trading purposes. The Company places its investments in instruments that meet high credit quality standards, as specified in the Company's investment policy. The policy also limits the amount of credit exposure to any one issuer and type of instrument. The Company does not expect any material loss with respect to its investment portfolio. The table below presents the carrying value and related weighted-average interest rates for the Company's investment portfolio. The carrying value approximates fair value at September 30, 1999. In accordance with the Company's investment policy all investments mature in twelve months or less. A nominal amount of non-interest bearing instruments has been included in the table below:
Carrying Average Principal (notional) amounts in U.S. dollars Amount Interest Rate - ------------------------------------------------------------------------------------------------ Cash equivalents - fixed rate................................... $ 108,657 4.05% Short-term investments - fixed rate............................. 2,000 5.21% ------------ ------------- Total interest bearing instruments.............................. $ 110,657 4.07% ============ ============= - ------------------------------------------------------------------------------------------------
FOREIGN CURRENCY RISK The Company enters into foreign exchange options for highly anticipated sales transactions between its foreign subsidiaries. These instruments provide the Company the option to sell foreign currencies to third parties at future dates with fixed exchange rates. The premium on such instruments is immaterial and is amortized over the life of the contracts to other income (expense). The Company currently has foreign currency options outstanding to sell Japanese Yen over the next 15 months with contract values totaling approximately $34,000 at average contract exchange rates of approximately JPY 120.77. At September 30, 1999, the difference between the recorded value and the fair value of the Company's foreign exchange position related to these option contracts was approximately zero. The Company also enters into forward foreign exchange contracts as a hedge against foreign currency sales commitments and intercompany balances. 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. These contracts generally have maturity dates which do not exceed twelve months. At September 30, 1999, the difference between the recorded value and the fair value of the Company's foreign exchange position related to these forward 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 counter-parties to these contracts. Looking forward, the Company does not expect any material adverse effect on its consolidated financial position, results of operations, or cash flows resulting from the use of these instruments. There can be no assurance that these strategies will be effective or that transaction losses can be minimized or forecasted accurately. 16 The following table provides information about the Company's foreign exchange forward contracts at September 30, 1999. Due to the short-term nature of these contracts, the contract rate approximates the weighted-average contractual foreign currency exchange rate and the amount in U.S. dollars approximates the fair value of the contract at September 30, 1999. These forward contracts mature in approximately thirty days. The following table presents short-term forward contracts to sell and buy foreign currencies in U.S. dollars related to customer receivables and intercompany balances:
Short-term forward contracts Amount Contract Rate - ----------------------------------------------------------------------------------------------- Euro............................................................... $ 15,698 1.06 British Pound Sterling............................................. 10,566 1.65 Other.............................................................. 4,175 - - -----------------------------------------------------------------------------------------------
The unrealized gain (loss) on the outstanding forward contracts at September 30, 1999, was not material to the Company's consolidated financial statements. The realized gain (loss) on these contracts as they matured was not material to the Company's consolidated financial position, results of operations, or cash flows for the periods presented. 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings During 1995, the Company filed suit in U.S. Federal District Court in Portland, Oregon, against Quickturn Design Systems, Inc. (Quickturn) for a declaratory judgment of non-infringement, invalidity and unenforceability of three of Quickturn's patents. This action related to the SimExpress products of Meta Systems SRL (Meta), a French company acquired by the Company in 1996. Quickturn filed a counterclaim against the Company alleging infringement of six Quickturn patents, including the three patents subject to the declaratory judgment action. The counterclaim sought a permanent injunction prohibiting sales of the Company's SimExpress products in the U.S., compensatory and punitive damages and attorneys' fees. In June 1999, the Company and Quickturn settled this litigation. The Company agreed that five Quickturn patents are valid and enforceable, and were infringed by the Company's sale in the U.S. of its SimExpress product from 1995-1997. Mentor Graphics also paid Cadence Design Systems, Quickturn's parent company, $3 million in damages for infringement, with each side to bear its own fees and costs. The court directed that the Company's payment and its consent to the validity and infringement of the Quickturn patents may not be used as evidence or for any other purpose in litigation outside the U.S., and that the settlement does not address in any way the issue of whether the Company's Celaro product infringes any patent issued in the U.S. or other countries. Quickturn filed an administrative complaint with the U.S. International Trade Commission (ITC) in 1996 seeking to prohibit the distribution of SimExpress products in the U.S. In December 1997, the ITC issued a Cease and Desist Order prohibiting the Company from importing certain hardware emulation products or components and from providing repair or maintenance services to its existing U.S. customers. That order took effect in 1998. In October 1997, Quickturn filed an action against the Company's German subsidiary in a German District Court alleging infringement by SimExpress of a European patent. The German court ruled in April 1999 that the Company's German subsidiary's sales of SimExpress violated a European patent owned by Quickturn and awarded unspecified damages. The Company's German subsidiary no longer offers the SimExpress product in Germany. Although the Company is appealing the ruling and contesting the validity of the Quickturn patent, the Company can give no assurance as to the outcome of such proceedings. In October 1998, Quickturn filed an action against Meta and the Company in France alleging infringement by SimExpress and Celaro of a European patent. There have been no rulings by the French court regarding the merits of this case to date. In February 1998, Meta filed a patent infringement action against Quickturn in the U.S. District Court for the Northern District of California in San Francisco, California. The complaint, which is based on a patent licensed to the Company and Meta and which Meta has a right to enforce, seeks damages for infringement as a result of Quickturn's manufacture and sale of certain emulation equipment. Meta, which has been joined in the suit by Aptix Corporation of San Jose, California, will ultimately seek an injunction prohibiting further infringement by Quickturn. A trial in U.S. District Court is expected to occur in October of 2000. In July 1999, the Company filed suit in U.S. District Court for the District of Delaware against Quickturn alleging infringement of two Mentor Graphics owned patents by Quickturn's Mercury product. The Company is seeking a permanent injunction prohibiting sales of Quickturn's Mercury products in the U.S., along with damages and attorney's fees. In addition to the above litigation, from time to time the Company is involved in various disputes and litigation matters that arise from the ordinary course of business. These include disputes and lawsuits relating to intellectual property rights, licensing, contracts, and employee relations matters. The Company believes that final resolution of such disputes and lawsuits will not have a material adverse effect on the Company's financial position or results of operations. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MENTOR GRAPHICS CORPORATION (Registrant) GREGORY K. HINCKLEY ----------------------------------------- Gregory K. Hinckley Executive Vice President and Chief Operating Officer/Chief Financial Officer 19 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS DEC-31-1999 SEP-30-1999 108,657 2,000 121,655 0 0 265,973 84,858 0 408,449 127,913 0 0 0 285,927 (7,845) 408,449 356,161 356,161 86,679 86,679 263,978 0 691 (3,616) (795) (2,821) 0 0 0 (2,821) (.04) (.04)
-----END PRIVACY-ENHANCED MESSAGE-----