UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to _____________
Commission File Number : 0-22738
QUICKTURN DESIGN SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0159619
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
55 W. Trimble Road, San Jose, California 95131
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (408) 914-6000
NO CHANGE
------------------------------------------------------------
(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES [X] NO [ ]
As of April 30, 1999 there were 18,416,484 shares of registrant's common
stock outstanding.
This quarterly report on Form 10-Q contains 25 pages, of which this is
page 1.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUICKTURN DESIGN SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
March 31,
--------------------------------
1999 1998
-------------- --------------
(RESTATED)
Revenue
Product revenue $ 21,262 $ 14,882
Maintenance and service revenue 8,695 8,683
-------------- --------------
Total revenue 29,957 23,565
Cost of revenue
Cost of product revenue 5,565 5,091
Cost of maintenance and service revenue 2,966 3,013
-------------- --------------
Total cost of revenue 8,531 8,104
-------------- --------------
Gross profit 21,426 15,461
Operating expenses
Research and development 5,667 5,985
Sales and marketing 9,895 9,271
General and administrative 4,776 2,957
Amortization of goodwill 257 257
-------------- --------------
Total operating expenses 20,595 18,470
-------------- --------------
Operating income (loss) 831 (3,009)
Interest and other, net 739 698
-------------- --------------
Net income (loss) before provision for
(benefit from) income taxes 1,570 (2,311)
Provision for (benefit from) income taxes 486 (717)
-------------- --------------
Net income (loss) $ 1,084 $ (1,594)
-------------- --------------
-------------- --------------
Basic net income (loss) per share $ 0.06 $ (0.09)
-------------- --------------
-------------- --------------
Number of shares used in basic per share calculation 18,078 17,704
-------------- --------------
-------------- --------------
Diluted net income (loss) per share $ 0.05 $ (0.09)
-------------- --------------
-------------- --------------
Number of shares used in diluted per share calculation 20,030 17,704
-------------- --------------
-------------- --------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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QUICKTURN DESIGN SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
Three Months Ended
March 31,
-------------------------------
1999 1998
-------------- -------------
(RESTATED)
Net income (loss) $ 1,084 $ (1,594)
Other comprehensive loss
Foreign currency translation adjustment (112) (264)
-------------- -------------
Unrealized loss on securities
Unrealized holding loss arising during period (49) (7)
Less: realized gain included in net income (loss) (3) (9)
-------------- -------------
Net unrealized loss on securities (52) (16)
-------------- -------------
Total other comprehensive loss (164) (280)
-------------- -------------
Comprehensive income (loss) $ 920 $ (1,874)
-------------- -------------
-------------- -------------
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
QUICKTURN DESIGN SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS EXCEPT SHARE DATA)
March 31, December 31,
1999 1998
--------------- ---------------
(UNAUDITED)
ASSETS
Current assets
Cash and cash equivalents $ 34,883 $ 26,552
Marketable securities 9,172 13,717
Accounts receivable, net of allowance for doubtful
accounts of $1,840 in 1999 and 1998 26,284 27,905
Inventories 8,111 9,904
Prepaid expenses and other current assets 1,994 1,851
Deferred income taxes 6,875 6,875
--------------- ---------------
Total current assets 87,319 86,804
Marketable securities 17,452 19,969
Fixed assets, net 10,738 11,533
Deferred income taxes 11,475 11,475
Goodwill 3,341 3,599
Other assets 1,105 1,248
--------------- ---------------
Total assets $ 131,430 $ 134,628
--------------- ---------------
--------------- ---------------
LIABILITIES
Current liabilities
Accounts payable $ 6,115 $ 12,130
Accrued liabilities 16,767 21,282
Deferred revenue 15,441 10,861
--------------- ---------------
Total current liabilities 38,323 44,273
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value: Authorized: 40,000,000
shares; Issued and outstanding: 18,393,966 shares in
in 1999; 18,111,105 shares in 1998 18 18
Additional paid-in capital 96,246 94,446
Deferred compensation (314) (346)
Retained deficit (1,510) (2,594)
Accumulated other comprehensive income 128 292
Treasury stock at cost
(195,000 shares in both 1999 and 1998) (1,461) (1,461)
--------------- ---------------
Total stockholders' equity 93,107 90,355
--------------- ---------------
Total liabilities and stockholders' equity $ 131,430 $ 134,628
--------------- ---------------
--------------- ---------------
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
QUICKTURN DESIGN SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
Three Months Ended
March 31,
-------------- --------------
1999 1998
-------------- --------------
(RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,084 $ (1,594)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 2,000 1,938
Amortization of deferred compensation 32 27
Gain on sale of marketable securities (3) (9)
Write down of inventories 489 1,259
Changes in current assets and liabilities
Accounts receivable 1,621 13,802
Inventories 1,304 (1,604)
Prepaid expenses and other current assets (143) (212)
Accounts payable and accrued liabilities (10,530) (7,920)
Deferred revenue 4,580 3,711
-------------- --------------
Net cash provided by operating activities 434 9,398
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of fixed assets (898) (3,944)
Sale of marketable securities 7,013 5,469
Purchase of marketable securities -- (8,820)
Increase (decrease) in other assets 94 (19)
-------------- --------------
Net cash provided by (used in) investing activities 6,209 (7,314)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of short term debt -- (244)
Proceeds from stock issuances 1,800 1,272
-------------- --------------
Net cash provided by financing activities 1,800 1,028
-------------- --------------
Effect of exchange rates on cash and cash equivalents (112) (264)
Net increase in cash and cash equivalents 8,331 2,848
Cash and cash equivalents at beginning of period 26,552 14,589
-------------- --------------
Cash and cash equivalents at end of period $ 34,883 $ 17,437
-------------- --------------
-------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for
Interest $ 1 $ 17
Income taxes $ 331 $ 376
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized holding loss on marketable securities $ (49) $ (7)
The accompanying notes are an integral part of these consolidated financial
statements.
-5-
QUICKTURN DESIGN SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements are unaudited (except for
the balance sheet information as of December 31, 1998, which is derived
from Quickturn's audited financial statements) and reflect all
adjustments (consisting only of normal recurring adjustments) which are,
in the opinion of management, necessary for a fair presentation of the
financial position and operating results for the interim periods. The
condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto, together
with Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in Quickturn's 1998 Annual Report on Form
10-K/A. The results of operations for the three months ended March 31,
1999 are not necessarily indicative of the results for the entire fiscal
year ending December 31, 1999, or any future interim period.
2. INVENTORIES
Inventories comprise:
March 31, December 31,
(IN THOUSANDS) 1999 1998
------------------------------------------------------------------------------
(UNAUDITED)
Raw materials $ 7,479 $ 8,799
Work in process 632 1,105
----------------- -----------------
$ 8,111 $ 9,904
----------------- -----------------
----------------- -----------------
3. RESTATEMENT
In June 1997, pursuant to an asset purchase agreement among Quickturn
Design Systems, Inc. ("Quickturn"), Synopsys, Inc. ("Synopsys") and Arkos
Design, Inc. ("Arkos"), Quickturn purchased from Synopsys certain assets
relating to Synopsys's emulation business, including all the outstanding
capital stock of Arkos (the "Arkos Acquisition").
Quickturn restated its accounting for the Arkos Acquisition as of
December 31, 1997 and the year then ended, along with the first three
quarters of 1998, to reflect a change in the allocation of the purchase
price. This restatement included the recognition of $5.1 million of
goodwill in the third quarter of 1997, and the goodwill is being
amortized over a five-year period. As a result of the restatement, there
was an additional charge for the amortization of goodwill of $257,000 and
a related income tax benefit of $80,000, or a decrease in net income of
$0.01 per share in the first quarter of 1998.
-6-
4. EARNINGS PER SHARE
Basic and diluted earnings per share were calculated as follows:
Three Months Ended March 31,
-------------------------------------------------------------------------------------
1999 1998
------------------------------------------- ----------------------------------------
(UNAUDITED) (RESTATED)
(AMOUNTS IN THOUSANDS NET PER-SHARE NET PER-SHARE
EXCEPT PER-SHARE DATA) INCOME SHARES AMOUNT LOSS SHARES AMOUNT
------------------------------------------------------------------------------- ----------------------------------------
Net income (loss) $ 1,084 $ (1,594)
--------------- ------------
BASIC EPS
Income (loss) available to
common stockholders 1,084 18,078 $ 0.06 (1,594) 17,704 $ (0.09)
Effect of dilutive securities
Stock options and warrants 1,952 --
DILUTED EPS
Income (loss) available to
common stockholders $ 1,084 20,030 $ 0.05 $ (1,594) 17,704 $ (0.09)
--------------- -------- --------------- ------------- -------- ------------
--------------- -------- --------------- ------------- -------- ------------
During the periods ended March 31, 1999 and 1998, options to purchase
32,920 and 3,149,482 shares of common stock, respectively, and warrants
for 200,000 and 1,200,000 shares of common stock, respectively, were
outstanding but not included in the calculation of diluted earnings per
share because their inclusion would have been anti-dilutive.
-7-
5. COMPREHENSIVE INCOME
Effective in the first quarter of 1998, Quickturn has adopted Statement
of Financial Accounting Standard No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). Comprehensive income generally represents all
changes in stockholders' equity except those resulting from contributions
by or disbursements to stockholders. The adoption of this standard did
not have a material impact on Quickturn's results of operations.
Changes in accumulated other comprehensive loss balances are as follows:
Foreign Net Unrealized Accumulated
Currency Gain (Loss) on Other
(UNAUDITED) Translation Marketable Comprehensive
(IN THOUSANDS) Adjustments Securities Income (Loss)
----------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 167 $ 125 $ 292
Current-period change (112) (52) (164)
--------------- --------------- ---------------
Balance, March 31, 1999 $ 55 $ 73 $ 128
--------------- --------------- ---------------
--------------- --------------- ---------------
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
TOTAL REVENUE
For the first quarter of 1999, Quickturn's total revenue was $30.0 million,
which represented an increase of $6.4 million, or 27% as compared to the
first quarter of 1998. The total revenue increase in the first quarter of
1999 over the first quarter of 1998 was attributable to an increase in
product sales of $6.4 million or 43% over the first quarter of 1998, as
further discussed below. See "---Risk Factors: QUICKTURN'S QUARTERLY RESULTS
OF OPERATIONS CAN FLUCTUATE SUBSTANTIALLY", "---Risk Factors: QUICKTURN
RELIES ON A FEW CUSTOMERS FOR MUCH OF ITS REVENUE", "---Risk Factors:
INTRODUCTION OF NEW PRODUCT MAY CAUSE CUSTOMERS TO DEFER PURCHASES", "---Risk
Factors: QUICKTURN IS EXPOSED TO CURRENCY EXCHANGE RATE FLUCTUATIONS, AND MAY
CONTINUE TO BE AFFECTED BY FOREIGN ECONOMIC CONDITIONS" and "---Risk Factors:
QUICKTURN'S INABILITY TO DEAL EFFECTIVELY WITH THE CONVERSION OF THE EURO MAY
NEGATIVELY IMPACT ITS MARKETING AND STRATEGIES."
Product revenue for the first quarter of 1999 as compared to the first
quarter of 1998 increased by $6.2 million or 72% in the U.S. market,
increased by $1.6 million or 48% in the European market, decreased by $2.0
million or 96% in the Japanese market, and increased by $655,000 or 74% in
the other regions. The increase in product sales in all geographic regions,
except Japan, was primarily due to the growing market acceptance of
Quickturn's Mercury Design Verification System-TM- ("Mercury") and CoBALT-TM-
Plus systems introduced during 1998, and also to customers' favorable
response to Quickturn's pending merger with Cadence Design Systems, Inc. The
decrease in product sales in Japan was primarily due to continuing economic
slowdown in the Asia-Pacific market.
Maintenance and service revenue for the first quarter of 1999 increased by
$12,000 over the first quarter of 1998. The flat growth of maintenance and
service revenue is primarily due to the effect of increased shipments of new
Mercury systems in the last quarter of 1998, which were still under terms of
free warranty during the first quarter of 1999.
International revenue accounted for approximately 32% and 36% of total
revenue in the first quarters of 1999 and 1998, respectively. The decrease in
international revenue as a percentage of total revenue was largely
attributable to a decrease of $2.0 million in product sales in Japan,
partially offset by increased product sales in both Europe and other regions,
as discussed in the product revenue section
-9-
above. See "---Risk Factors: QUICKTURN IS EXPOSED TO CURRENCY EXCHANGE RATE
FLUCTUATIONS, AND MAY CONTINUE TO BE AFFECTED BY FOREIGN ECONOMIC CONDITIONS"
and "---Risk Factors: QUICKTURN'S INABILITY TO DEAL EFFECTIVELY WITH THE
CONVERSION OF THE EURO MAY NEGATIVELY IMPACT ITS MARKETING AND STRATEGIES."
GROSS MARGINS
Gross margins were 72% and 66% in the first quarters of 1999 and 1998,
respectively. Product gross margins were 74% and 66% in the first quarters of
1999 and 1998, respectively. Maintenance and service gross margins were 66%
and 65% in the first quarters of 1999 and 1998, respectively. The increase in
product gross margins was primarily due to lower cost of sales of the new
Mercury product compared to the old System Realizer-TM- product, and to a larger
product revenue base over which to spread fixed costs. The slight increase in
maintenance and service gross margins was primarily due to a slight decrease
in material cost of sales and related costs over the prior year quarter. See
"---Risk Factors: QUICKTURN MAY NOT BE ABLE TO SUSTAIN OR INCREASE ITS GROSS
MARGINS" and "---Risk Factors: QUICKTURN OBTAINS KEY COMPONENTS FROM A
LIMITED NUMBER OF SUPPLIERS."
RESEARCH AND DEVELOPMENT
Research and development expenses decreased by $318,000, or 5% in the first
quarter of 1999 compared to the first quarter of 1998. This decrease was
primarily attributable to reduced Mercury prototype expenses in the first
quarter of 1999 compared to such expenses incurred in the first quarter of
1998. As a percentage of total revenue, research and development expenses
were approximately 19% and 25% for the first quarters of 1999 and 1998,
respectively. Quickturn expects to continue to invest a significant amount of
its resources in research and development.
SALES AND MARKETING
Sales and marketing expenses increased by $624,000, or 7% in the first
quarter of 1999 compared to the first quarter of 1998. This increase was
largely attributable to increased sales commissions as a result of increased
revenue in the first quarter of 1999 compared to the first quarter of 1998.
As a percentage of total revenue, sales and marketing expenses were
approximately 33% and 39% in the first quarters of 1999 and 1998,
respectively. Quickturn expects that sales and marketing expenses will
continue to increase in dollar amounts as Quickturn expands its sales and
marketing efforts.
-10-
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by $1.8 million, or 62% in the
first quarter of 1999 compared to the first quarter of 1998. This increase
was largely due to increased legal costs related to ongoing patent
infringement and other legal proceedings. See "---Part II., Item 1. Legal
Proceedings." As a percentage of total revenue, general and administrative
expenses were approximately 16% and 13% for the first quarters of 1999 and
1998, respectively. Quickturn expects general and administrative expenses to
increase in 1999 due primarily to continued legal costs.
AMORTIZATION OF GOODWILL
In June 1997, pursuant to an asset purchase agreement among Quickturn,
Synopsys, Inc. ("Synopsys") and Arkos Design, Inc. ("Arkos"), Quickturn
purchased from Synopsys certain assets relating to Synopsys's emulation
business, including all the outstanding capital stock of Arkos (the "Arkos
Acquisition").
Quickturn restated its accounting for the Arkos Acquisition as of December
31, 1997 and the year then ended, along with the first three quarters of
1998, to reflect a change in the allocation of the purchase price. This
restatement included the recognition of $5.1 million of goodwill in the third
quarter of 1997, and the goodwill is being amortized over a five-year period.
As a result of the restatement, there was an additional charge of $257,000
for amortization of the goodwill in each of the first quarters of 1999 and
1998. See Note 3 of the "Notes to Condensed Consolidated Financial
Statements."
OTHER INCOME, NET
Other income, net increased by $41,000 or 6% in the first quarter of 1999
compared to the first quarter of 1998. The increase was primarily due to
reduced interest expenses related to the reduction of equipment lease debt in
the first quarter of 1999 compared to the first quarter of 1998.
INCOME TAXES
The effective tax rates of 31% for both the first quarters of 1999 and 1998,
respectively, were lower than the statutory federal rate of 35% primarily
because of federal and state general business credits, interest income on
investments in tax-exempt obligations and benefit from a foreign sales
corporation.
NET INCOME (LOSS) AND QUARTERLY RESULTS
Net income in the first quarter of 1999 was $1.1 million, compared to net
loss of ($1.6) million in the first quarter of 1998. The increase in net
income was
-11-
primarily attributable to increased revenue partially offset by increased
operating expenses and increased income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $8.3 million from December 31, 1998 to
March 31, 1999. Net cash provided by operations was $434,000, primarily due
to $1.1 million in net income and $2.0 million depreciation and amortization,
an increase of $4.6 million in deferred revenue, a decrease of $1.6 million
in accounts receivable and a decrease of $1.3 million in inventories,
partially offset by a decrease of $10.5 million in accounts payable and
accrued liabilities. Net cash provided by investing activities was $6.2
million, primarily due to sales of marketable securities of $7.0 million,
partially offset by cash paid for the acquisition of fixed assets of
$898,000. Net cash provided by financing activities was $1.8 million related
to proceeds from stock issuances.
Quickturn believes that its cash and cash equivalents, together with its
existing credit facility and the cash flows expected to be generated by
operations, will be sufficient to meet its anticipated cash needs for working
capital, capital expenditures and marketing expansion through at least the
next 12 months.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN QUICKTURN'S ANNUAL REPORT ON FORM 10-K/A
FOR THE YEAR ENDED DECEMBER 31, 1998 AND IN THE DOCUMENTS INCORPORATED BY
REFERENCE THEREIN, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED
IN EVALUATING QUICKTURN AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE
A SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT IMPACT ON QUICKTURN'S
BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION.
QUICKTURN'S QUARTERLY RESULTS OF OPERATIONS CAN FLUCTUATE SUBSTANTIALLY.
Many of Quickturn's customers order on an as-needed basis and often delay
delivery of firm purchase orders until the commencement dates of such
customers' development projects are determined. Moreover, a significant
portion of Quickturn's revenue in each quarter generally results from
shipments in the last few weeks of the quarter; therefore, a delay in the
shipment of a few orders can have a significant impact upon total revenue and
results of operations in a given quarter. Quickturn believes that in the
future its results of operations in a quarterly period could be impacted by
the timing of customer development projects and related purchase orders for
Quickturn's emulation systems, new product announcements and releases by
Quickturn, and economic conditions generally and in the electronics industry
specifically.
QUICKTURN RELIES ON A FEW CUSTOMERS FOR MUCH OF ITS REVENUE.
-12-
A relatively limited number of customers have historically accounted for a
substantial portion of Quickturn's revenue. These customers represent early
adopters of emulation technology, typically for the design of complex
integrated circuits. In particular, Quickturn's top ten customers represented
75% and 69% of total revenue in the first quarters of 1999 and 1998,
respectively. Quickturn expects that sales of its products to a relatively
limited number of customers will continue to account for a high percentage of
revenue for the foreseeable future. The loss of a major customer or any
reduction in orders by such a customer could have an adverse effect on
Quickturn's financial condition or results of operations.
INTRODUCTION OF NEW PRODUCT MAY CAUSE CUSTOMERS TO DEFER PURCHASES.
In June 1998, Quickturn announced a new hardware-based emulation product,
Mercury, which is designed to replace its System Realizer emulation product.
This announcement could cause customers to defer purchasing the current
generation product. The transition to the new Mercury system may also be
disrupted by slow industry acceptance or interruptions in manufacturing or
component availability.
QUICKTURN IS EXPOSED TO CURRENCY EXCHANGE RATE FLUCTUATIONS, AND MAY CONTINUE TO
BE AFFECTED BY FOREIGN ECONOMIC CONDITIONS.
As a significant portion of Quickturn's total revenue and net income are
derived from international operations, fluctuations of the U.S. dollar
against foreign currencies and the seasonality of Asia-Pacific, European, and
other international markets could impact Quickturn's results of operations
and financial condition in a particular quarter.
Revenue from most international customers is denominated in U.S. dollars.
However, receivables from certain other international customers are
denominated in local currencies. Such receivables are hedged, where
practicable, by forward exchange contracts to minimize the impact of foreign
exchange rate movements on Quickturn's operating results. There have been no
material gains or losses associated with Quickturn's hedging program.
However, there can be no assurance that fluctuations in the currency exchange
rates in the future will not have a material adverse impact on the
receivables derived from foreign currency denominated sales and thus
Quickturn's operating results and financial condition.
Quickturn plans to continue to expand its international sales and
distribution channels. However, there can be no assurance that Quickturn's
products will achieve widespread commercial acceptance in international
markets in the future. Quickturn is uncertain whether the recent weakness
experienced in the Asia-Pacific markets will continue in the foreseeable
future due to extreme
-13-
currency devaluation and liquidity problems in this region. Additionally,
Electronic Design Automation ("EDA") spending budgets of major Japanese
electronics firms may be decreased; consequently, sales of Quickturn's design
verification products in Japan may be flat or down. Quickturn's future
international sales may be subject to additional risks associated with
international operations, including currency exchange fluctuations, tariff
regulations and requirements for export, which licenses may on occasion be
delayed or difficult to obtain.
QUICKTURN'S INABILITY TO DEAL EFFECTIVELY WITH THE CONVERSION OF THE EURO MAY
NEGATIVELY IMPACT ITS MARKETING AND STRATEGIES.
On January 1, 1999, 11 member countries of the European Union adopted the
euro as their common legal currency and established fixed conversion rates
between their sovereign currencies and the Euro. Electronic transactions can
be made in either the sovereign currencies or the euro until January 1, 2002,
after which the euro must be used exclusively for all transactions. Quickturn
believes that its internal systems and financial institution vendors are
capable of handling the euro conversion and is in the process of examining
current marketing and pricing policies and strategies that may be affected by
conversion to the euro. The cost of this effort is not expected to materially
hurt Quickturn's results of operations or financial condition. However,
Quickturn cannot be assured that all issues related to the euro conversion
have been identified and that any additional issues would not materially hurt
Quickturn's results of operations or financial condition. For example, the
conversion to the euro may have competitive implications on Quickturn's
pricing and marketing strategies and Quickturn may be at risk to the extent
its principal European customers are unable to deal effectively with the
impact of the euro conversion. Quickturn has not yet completed its evaluation
of the impact of the euro conversion on its functional currency designations.
QUICKTURN OBTAINS KEY COMPONENTS FROM A LIMITED NUMBER OF SUPPLIERS.
Quickturn depends on several suppliers for certain key components and board
assemblies used in its hardware-based emulation products. Quickturn's
inability to develop alternative sources or to obtain sufficient quantities
of these components or board assemblies could result in delays or reductions
in product shipments. In particular, Quickturn currently relies on Xilinx,
Inc. for the supply of key integrated circuits and on IBM for the hardware
components for both Quickturn's CoBALT and Mercury products. With regard to
Mercury, IBM recently replaced Quickturn's previous supplier and is currently
providing the assembly services for several Mercury components on an
order-by-order basis. Quickturn is negotiating with IBM to establish an
overall contract, but these negotiations may not be successfully completed,
thereby causing disruptions in
-14-
the supply of IBM's products or services. If there were a reduction or
interruption, Quickturn's results of operations would be seriously harmed.
Even if Quickturn could eventually obtain these components from alternative
sources, a significant amount of time and resources would be required to
redesign Quickturn's products to accommodate the alternative supplier.
QUICKTURN MAY NOT BE ABLE TO SUSTAIN OR INCREASE ITS GROSS MARGINS.
There can be no assurance that Quickturn will be able to sustain its recent
gross margins. Furthermore, to the extent that Quickturn's cost reduction
goals are achieved, any resulting cost savings that are passed on to
Quickturn's customers may also have an adverse effect on gross margins.
QUICKTURN'S INDUSTRY IS HIGHLY COMPETITIVE.
The EDA industry is highly competitive and rapidly changing. Quickturn faces
significant competition for emulation-based system-level verification and
cycle-based simulation, in addition to competition from traditional design
verification methodologies which rely on the approach of building and then
testing complete system prototypes. Because of the growing demand for a
design verification methodology which reduces the number of costly design
iterations and improves product quality, Quickturn expects competition in the
market for system-level verification and cycle-based simulation to increase
as other companies attempt to introduce emulation and cycle-based simulation
products and product enhancements, and as major new EDA technologies may
emerge. Moreover, Quickturn competes with companies that have significantly
greater financial, technical and marketing resources, greater name
recognition and larger installed bases than Quickturn. In addition, many of
these competitors have established relationships with current and potential
customers of Quickturn. Increased competition could result in price
reductions, reduced margins and loss of market share, all of which could
materially adversely affect Quickturn. Quickturn believes that the principal
competitive factors in the EDA market are quality of results, the
mission-critical nature of the technology, technical support, product
performance, reputation, price and support of industry standards. Quickturn
believes that it currently competes favorably with respect to these factors.
However, there can be no assurance that Quickturn will be able to compete
successfully against current and future competitors or that competitive
pressures faced by Quickturn will not materially adversely affect its
business, operating results and financial condition.
In addition, competitors may resort to litigation as a means of competition.
Such litigation may result in substantial costs to Quickturn, injunctive
relief preventing Quickturn from engaging in activities critical to its
business and significant diversion of management time. In 1995, Mentor
Graphics
-15-
Corporation ("Mentor") filed suit against Quickturn for declaratory judgment
of non-infringement, invalidity and unenforceability of several of
Quickturn's patents. Several actions between Quickturn and Mentor and
Mentor's French subsidiary, Meta Systems ("Meta"), ensued, and those cases
were consolidated in the U.S. District Court for the District of Oregon,
where five of Quickturn's patents are now involved in the disputes. Quickturn
has pending actions against Mentor and Meta for infringement of the five
patents at issue, and Mentor and Meta are seeking a declaratory judgment of
non-infringement and unenforceability of the five patents in dispute, and of
invalidity of two of those patents. Quickturn is also involved in litigation
with Mentor's German subsidiary; with Mentor's French and Dutch subsidiaries,
with Meta and with a French company named M2000 in France; and with Aptix
Corporation, Meta and Mentor in the U.S. District Court, the Northern
District of California. See "---Part I., Item 1. Legal Proceedings." Although
patent and intellectual property disputes in the EDA industry are often
settled through licensing, cross-licensing or similar arrangements, costs
associated with such litigation and arrangements may be substantial, and no
assurance can be given that any licensing or other arrangements would be
available on economically feasible terms, or at all.
"YEAR 2000" COMPUTER PROBLEMS COULD INTERRUPT QUICKTURN'S BUSINESS OPERATIONS.
Many existing computer systems, applications and other control devices use
computer programs that recognize only two digits rather than four to define
an applicable year. Therefore, any computer systems or other equipment with
embedded date-sensitive technology may recognize a date using "00" as the
year 1900 rather than the year 2000 (the "year 2000 issue"). In addition to
affecting the functionality of Quickturn's own software products and internal
systems, the year 2000 issue could result in system failure or
miscalculations causing disruptions in the operations of business and
government entities which could affect operations in any area of Quickturn,
including supply chain, manufacturing, distribution and financial.
Quickturn initiated a year 2000 compliance project in the fall of 1997. The
scope of this project includes addressing the year 2000 issue in six key
areas: (1) Quickturn's proprietary design verification products, (2)
internal-use computer systems for conducting business operations and product
development, (3) internal embedded systems or "infrastructure", (4)
third-party suppliers of products and services, (5) customers, and (6)
marketing joint ventures and other partnerships. The project consists of
addressing each of these six areas in four phases, which are: (1) planning,
(2) investigation, (3) remediation, and (4) testing.
During the first quarter of 1999, Quickturn substantially completed the final
item in the planning phase, which is a comprehensive contingency plan that is
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intended to mitigate possible disruptions that may occur due to material year
2000-related failures in any of the six key areas described above. The
contingency plan is further discussed below.
To date, Quickturn has also substantially completed the investigation phase
in all six areas of concern. The investigation included specifically
identifying information technology ("IT") and non-IT computer and embedded
systems, including Quickturn verification products and third party systems
used in Quickturn products and in business operations. During this phase,
Quickturn completed formal communications with its significant suppliers to
determine the extent to which Quickturn is vulnerable to those third parties'
failure to remedy their own year 2000 issue. Computer equipment and
embedded-systems vendors, business service providers and other third-party
vendors on whom Quickturn relies to carry out normal business operations
generally have indicated substantial remediation, or documented plans to
remediate, the year 2000 issue. Some have given written certification of
internal and product compliance. Substantially all critical inventory
suppliers have indicated product compliance. There can be no assurance,
however, that the systems of third party service providers on which
Quickturn's business operations rely will be converted in a timely fashion,
or that a failure to convert by a third party, or a conversion that is
incompatible with Quickturn's systems, will not have a material adverse
effect on Quickturn.
To date, Quickturn has also substantially completed the remediation phase
with respect to internal-use IT systems and embedded non-IT systems and to
its own currently supported proprietary software products. All critical
business and development computer systems have been updated with year 2000
compliant versions of software and are now in the testing phase to assure
that the software performs as indicated by the vendors. A number of critical
systems were successfully tested during the first quarter of 1999. Testing of
the Company's main business software, which has been upgraded to a year 2000
compliant version, is expected to be substantially completed by June 1999.
Material failure by any one of these business systems is not expected, based
on vendor certification and the results of testing to date. However, if such
failure were to occur, it could result in business interruption that, at
worst, might affect Quickturn's ability to ship products to its customers,
thus affecting the Company's results of operations in that quarter. Year 2000
remediation efforts are not expected to materially impact or delay
Quickturn's other IT projects or new product introductions.
Remediation, testing and qualification of year 2000 compliant software upgrades
have been substantially completed for the Quickturn's System Realizer and
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Mercury products. Mercury product upgrades that are year 2000 compliant have
been released. Installation of the Mercury upgrades by Quickturn field
personnel will begin in May 1999. System Realizer upgrades will be released
during the second quarter of 1999. Testing and qualification of the CoBALT
product are expected to be completed by mid-1999. Some customers' Quickturn
systems will receive year 2000 product updates during the second quarter of
1999, with all customer systems expected to be made compliant before the end
of 1999. Based on remediation and testing results achieved to date, it is
expected that the year 2000 compliant versions of Quickturn's software
products will be fully functional and will not result in any year
2000-related failures. However, if such failures were to occur, although the
date field in Quickturn's emulation and simulation software is not critical
to the performance of the software, some customers could experience
interruptions in their design process. Quickturn is diligently pursuing its
remediation efforts to mitigate the possibility of such occurrences.
Quickturn has completed a comprehensive contingency plan in the event of
either its own product failure or the failure of any critical third party
provider of goods or services. The plan provides guidelines to be followed in
case of year 2000 interruptions in Quickturn product performance, inventory
supply, business services or other areas. The plan includes preventative
measures, such as assuring that maintenance agreements are maintained with
source vendors on all systems and software used by Quickturn, so that, in
case of year 2000 failure, service and access to corrective bug fixes will be
available without delay. In general, third party vendors have indicated
virtually complete product compliance and substantially complete internal
compliance, so, although Quickturn has identified alternate vendors for some
critical items, it does not expect failures in this area to be material.
Quickturn has determined that it is not practicable to identify or arrange
for secondary backup services for such critical functions as electricity,
telephone, banking and government services on which Quickturn must rely.
Therefore, Quickturn continues to seek information on the status of each of
these service providers. Quickturn's plan provides for alternate service
sites for customer support and sales activity in case of electricity or
telephone failure at its main headquarters in San Jose. These alternate sites
include its plant in Chelmsford, Massachusetts or may include a site owned by
Cadence.
Quickturn's contingency plan for handling its proprietary software and
hardware product compliance consists principally of making available
appropriate engineering personnel to address customer problems that may
occur. As Quickturn's software products have been and will continue to be
fully tested for year 2000 readiness, the Company expects such issues, if
any, to be
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immaterial and to be handled in the normal course of business by existing R&D
engineering and field engineering staff.
Management's estimates of the expected costs to complete the Year 2000
project are based on the cumulative results of year 2000 remediation efforts
and investigations to date. Computer products purchased and used by Quickturn
are substantially new or relatively new computer equipment that is certified
year 2000 compliant by the manufacturer. The main software platforms used in
research and development and most other operations of Quickturn are the
latest versions of Sun Solaris and Windows NT, both of which have been
represented by their manufacturers as year 2000 compliant. Quickturn's key
internal business system, Computer Associates' Manman product, which runs on
an HP3000 minicomputer, has been updated to a year 2000 compliant version and
is currently being retested at Quickturn to assure full functionality in the
year 2000. Substantially all software updates, if required, have been
supplied to Quickturn free of charge under existing maintenance agreements.
In addition, Quickturn's own product year 2000 compliance will be achieved as
part of regular product upgrades, one of which was released in the first
quarter and the others to be completed during the second quarter of 1999.
Therefore, research and development costs, as well as the costs of
distribution and installation, for this release are considered normal and in
the course of ordinary business. Quickturn's SpeedSim simulation software has
no compliance issues. None of the inventory components currently used in
Quickturn's emulation products are date sensitive. There has been no
inventory obsolescence identified with the year 2000 issue and none is
expected to occur. However, some older System Realizers that are currently in
use either by customers or internally use older disk drives that are not year
2000 compliant. A handful of active systems also require replacement of a
non-compliant VME board. The affected systems have been identified and all
non-compliant drives and boards are scheduled to be replaced by the end of
1999.
Based on the above facts, management's estimate of $520,000 total cost for
the year 2000 project consists principally of the costs associated with
travel by field engineers and technicians to customer sites to assist in the
installation of upgrades before December 31, 1999 ($200,000); the cost to
replace disk drives in older System Realizer product and other miscellaneous
materials ($120,000); the cost of estimated incremental engineering time and
other related resources to assure timely integration of year 2000 code in the
latest version of Quest software ($125,000); and estimated miscellaneous,
non-critical, internal IT hardware systems replacements and upgrades
($75,000). Estimated costs incurred to date related to the year 2000 issue
modifications are $220,000, all of which have been
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expensed in the period incurred. Estimated costs do not include the costs
associated with contingency plans, which are not expected to be material.
There can be no assurance, however, that these cost estimates will be
achieved and actual results could differ materially from these estimates.
Specific factors that might cause such material difference include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer code, the failure of
third parties which are material to Quickturn's operations to mitigate their
own year 2000 issue, and similar uncertainties. However, Quickturn is
vigilantly pursuing the year 2000 issue, and believes that, once all phases
of the project have been completed and contingency plans have been explored
and put in place, Quickturn will be able to significantly reduce the impact
of any disruptions that may occur.
OTHER RISK FACTORS
Other factors which could adversely affect Quickturn's quarterly operating
results in the future include efficiencies as they relate to managing
inventories and fixed assets, the timing of expenditures in anticipation of
increased sales, customer product delivery requirements and shortages of
components or labor.
Due to the factors above, Quickturn's future earnings and stock price may be
subject to significant volatility, particularly on a quarterly basis. Any
shortfall in total revenue or earnings from levels expected by securities
analysts has had and could in the future have an immediate and significant
adverse effect on the trading price of Quickturn's common stock.
Additionally, Quickturn may not learn of such shortfalls until late in a
fiscal quarter, which could result in an even more immediate and adverse
effect on the trading price of Quickturn's common stock.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In January 1996, Quickturn filed a complaint with the International Trade
Commission (the "ITC") in Washington, DC, seeking to stop unfair importation
of logic emulation systems manufactured by Meta. In the complaint, Quickturn
alleges that Mentor's hardware logic emulation systems infringe Quickturn's
patents. In December 1997, the ITC issued: (1) a Permanent Limited Exclusion
Order which permanently prohibits the importation of infringing hardware
logic emulation systems, subassemblies or components manufactured by Mentor
and/or Meta, and (2) a Permanent Cease and Desist Order permanently
prohibiting Mentor from, among other things, selling, offering for sale or
advertising the same hardware logic emulation devices. The ITC's two orders
remain in effect until April 28, 2009, the latest expiration date of
Quickturn's patents involved in the investigation.
Quickturn is also engaged in a Federal District Court case with Mentor and
Meta involving five of Quickturn's patents. Quickturn has pending actions
against Mentor and Meta for infringement of the five patents, and Mentor and
Meta are seeking a declaratory judgment of non-infringement and
unenforceability of the five patents in dispute, and of invalidity of two of
those patents. In June 1997, Quickturn filed a motion for preliminary
injunction, asking the District Court to prohibit Mentor from manufacturing,
assembling, marketing, loaning or otherwise distributing emulation products
and components in the United States, which products and components infringe
certain claims in Quickturn's U.S. Patent No. 5,036,473. On August 1, 1997,
the U.S. District Court in Oregon granted Quickturn's motion for a
preliminary injunction against Mentor's domestic emulation activities. The
Federal Circuit Court of Appeals affirmed the Oregon District Court's
decision on August 5, 1998. A bench trial was conducted on April 6-8, 1999
with respect to Mentor's allegations of patent unenforceability. Post-trial
submissions for the bench trial will be completed by May 6, 1999, and the
court is expected to issue its decision and findings shortly thereafter. A
jury trial on the remaining liability and damages issues has been set for
June 1999.
In November 1996, Aptix Corporation ("Aptix") filed a suit against Quickturn,
in the U.S. District Court, the Northern District of California, San Jose
Division, alleging various violations of the antitrust laws and unfair
competition. Aptix sought preliminary damages of $5 million, an order
dedicating to the public all patents acquired by Quickturn, and an injunction
prohibiting Quickturn from acquiring further patents in the field of hardware
emulation and from enforcing its patents against competitors. The District
Court granted a summary judgment motion in favor of Quickturn and dismissed
the case. Aptix requested the Court
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to reconsider its decision and dismissal, but the Court denied Aptix's
request. Aptix has appealed the dismissal to the Ninth Circuit Court of
Appeals.
In October 1997, Quickturn filed a complaint in the German District Court of
Dusseldorf against Mentor's German subsidiary, Mentor Graphics (Deutschland)
GmbH, alleging infringement of the German part of Quickturn's European Patent
No. 0 437 491 B1. After two preliminary hearings in which procedural matters
were discussed, the parties have submitted their briefs to the court. The
Main Court Hearing for this action was held on March 16, 1999. On April 29,
1999, the German District Court in Dusseldorf issued a summary of its
decision ordering that Mentor Graphics (Deutschland) GmbH refrain from
offering or marketing in Germany emulation systems which infringe Quickturn's
German patent. The court also awarded Quickturn damages based on Mentor
GmbH's sales and offers for sale, since January 13, 1996, of products that
infringe Quickturn's German patent.
On March 19, 1999, Quickturn's patent counsel in Germany received official
service of a Nullification Complaint, filed by Mentor Graphics (Deutschland)
GmbH, in the German Federal Patent Court located in Munich. The Nullification
Complaint seeks to have certain claims of Quickturn's European Patent EP 0
437 491 declared void with respect to the sovereign territory of the Federal
Republic of Germany. Quickturn filed its initial response to Mentor's
Nullification action on April 12, 1999, notifying the court of Quickturn's
opposition to the complaint. In that initial response, Quickturn also
requested the court to dismiss Mentor's action - as a matter of law - for
violating the doctrine of loyalty and good faith because the patent rights
which Mentor Graphics (Deutschland) GmbH now seeks to have nullified were
sold to Quickturn by that company's parent, Mentor Graphics Corporation (USA).
In February 1998, Aptix and Meta filed a lawsuit against Quickturn, in the
U.S. District Court, the Northern District of California, alleging
infringement of a U.S. patent owned by Aptix and licensed to Meta. Quickturn
named Mentor as a party to this suit and filed a counter claim requesting the
Court to declare the Aptix patent to be unenforceable based on inequitable
conduct during the prosecution of the patent. Quickturn also filed a counter
claim against Aptix, Meta and Mentor for abuse of process, based on Aptix,
Meta and Mentor's submission of falsified evidence relating to the date of
invention of the technology described in the Aptix patent. Quickturn is
seeking $10 million in damages from Mentor, Meta and Aptix for their abuse of
process. The case is set for trial in January 2000.
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In October 1998, Quickturn filed a complaint in the District Court of Paris,
France, against Mentor Graphics (France) SARL, Mentor Graphics (Netherlands)
BV, Meta Systems (France), and M2000 (France) S.A. for infringement of the
French part of Quickturn's European Patent No. 0 437 491 B1. Certain
procedural and administrative issues concerning evidentiary matters have been
briefed and argued before one of the judges assigned to this case who is
responsible for administrative matters. The court's ruling on these issues is
pending, and no schedule has yet been set for determining the final
disposition of this case.
Quickturn has mounted vigorous defenses against Aptix and Meta's patent
infringement claim. The outcome of these actions cannot be predicted with
certainty.
On August 12, 1998, a subsidiary of Mentor Graphics Corporation initiated an
unsolicited tender offer to purchase all outstanding shares of Quickturn's
common stock. Even though the Tender Offer was subsequently withdrawn on
January 8, 1999, Quickturn is still engaged in legal proceedings in
connection with the unsolicited tender offer. The outcome of these lawsuits
cannot be predicted with certainty.
Quickturn is engaged in certain other legal and administrative proceedings
incidental to its normal business activities. While it is not possible to
determine the ultimate outcome of these actions at this time, management
believes that any liabilities resulting from such proceedings, or claims
which are pending or known to be threatened, will not have a material adverse
effect on Quickturn's consolidated financial position or results of
operations.
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ITEMS 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27: Financial Data Schedule
(b) REPORTS ON FORM 8-K
1. A Current Report on Form 8-K was filed with the SEC by
Quickturn on December 16, 1998, to report that Quickturn
signed a merger agreement with Cadence Design Systems, Inc.
("Cadence"). Under the merger agreement, Cadence will acquire
Quickturn in a transaction that is anticipated to be accounted
for as a pooling of interests and will qualify as a tax-free
reorganization. The merger is subject to approval by various
governmental agencies and Quickturn stockholders.
2. A Current Report on Form 8-K/A was filed with the SEC by
Quickturn on December 22, 1998, for the sole purpose of
correcting a typographical error to Quickturn's merger
agreement with Cadence.
3. A Current Report on Form 8-K/A was filed with the SEC by
Quickturn on January 6, 1999, to report that Quickturn and
Cadence amended their merger agreement to reflect an increase
in value of the shares of common stock of Cadence to be
received in connection with the merger by holders of common
stock of Quickturn to $15.00 per share of Quickturn common
stock.
4. A Current Report on Form 8-K/A was filed with the SEC by
Quickturn on January 6, 1999, for the sole purpose of
re-filing Exhibit 2.1 of the Amendment to Form 8-K dated
January 6, 1999. Amendment No. 2 to the Agreement and Plan of
Merger is replacing the Stock Option Agreement erroneously
filed as Exhibit 2.1.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Quickturn Design Systems, Inc.
----------------------------------
(Registrant)
Date: May 11, 1999 By: /s/ RAYMOND K. OSTBY
-------------------- ----------------------------------
Raymond K. Ostby,
Vice President, Finance and
Administration,
Chief Financial Officer and
Secretary
(Principal Accounting Officer
and Duly Authorized Officer)
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