ITEM 1. BUSINESS
GENERAL
Analogy, Inc. (the "Company" or "Analogy") develops, markets and supports high-performance software and model libraries for the top-down design and behavioral simulation of mixed-signal and mixed-technology systems. The Company's Saber simulator supports top-down design of mixed-signal, mixed-technology systems using the Company's proprietary analog hardware description language, MAST. The Saber simulator and its accompanying MAST models are used in the design of electronic, mechanical, hydraulic and optical components and systems. This multi-functional simulator provides manufacturers of products incorporating mixed-signal, mixed-technology systems with productivity increases similar to those Integrated Circuit ("IC") designers experienced through the adoption of digital simulators. The Saber simulator is used in many industries for products as diverse as deep sub-micron ICs, video recorders, hydraulic presses, engine controls in automobiles, anti-lock brake systems and avionics systems.
The Company was founded in 1985 and is incorporated under the laws of the State of Oregon. Its executive offices are located at 9205 SW Gemini Drive, Beaverton, Oregon, 97008.
PRODUCTS
The Company's primary software products are licensed to customers. The Company's model libraries are provided on an annual subscription basis, under which the customer receives periodic updates as new models are generated. Support is provided based on annual or other periodic contracts. A minimum, single-user configuration would include Saber, SaberScope and either SaberSketch or a Frameway Integration product. List price of such a minimum configuration for a single user, plus a one-year subscription to the Company's model libraries, would start at approximately $38,000. Options can increase the single user price to over $80,000. Minimum configuration multi-user systems start at $85,000 for three users.
SABER SIMULATOR. The Saber simulator is the core simulation engine for the Company's product line. It solves the system of equations described in the MAST models. This information provides the user with the ability to obtain performance data on circuit or system operation in many areas. Saber runs independently from the model library. It allows performance modeling from steady state operating levels to operation over time, under stress, over frequency, and in a wide variety of analytical modes. MAST is the Company's Hardware Description Language ("HDL"), and it was the first behavioral modeling HDL capable of handling both analog and digital components. MAST enables the modeling of any physical device or technology that can be represented in mathematical terms. Using MAST, complex mixed-signal, mixed-technology systems can be modeled and analyzed in a top-down or bottom-up manner, enabling an iterative design process. The models can be simple in content, as with those used in a "proof of concept" high-level design, or highly detailed, as would be required for new deep sub-micron devices developed in the IC industry.
CO-SIMULATION INTERFACES. The Company's co-simulation interface products provide linkages to digital simulators widely used in the IC design market, such as Cadence Design Systems, Inc.'s Verilog-XL, Mentor Graphics Corporation's QuickSim II and Quick HDL, Model Technology's ModelSim VHDL and ModelSim Plus, and Synopsys, Inc.'s Speedwave and VCS. The co-simulation interfaces allow customers requiring mixed-signal, mixed-technology simulation to use models previously developed for one of these digital simulators.
TEMPLATE MODEL LIBRARIES. The Company's template models are mathematical descriptions of device behavior with built-in flexibility that allows designers to characterize specific components. Such templates describe the behavior of devices, such as transistors, hydraulic pumps, valves, motors or fiber optic cable. Each new template model broadens the applicability of Saber.
COMPONENT MODEL LIBRARIES. The Company's component models are specific mathematical descriptions of device behavior. Component models represent the catalog of parts available to the simulator user, and include such things as specific diodes, transistors, opamps, regulators, analog-to-digital converters, pulse width modulators, motors, lamps, fuses and many non-electrical components such as fiber optic devices. The Company has a constantly growing set of component models, with over 8,000 parts in its component libraries.
To further strengthen the Company's modeling position, in November 1996 the Company acquired Symmetry Design Systems, Inc. ("Symmetry") of Los Altos, California. Through the acquisition of Symmetry's model library ("SymLib") which includes over 12,000 specific devices, the Company now offers the most comprehensive model library in the industry. In addition to this expanded model library, the acquisition of Symmetry enables the Company to offer Symmetry's MODPEX design tool which allows design engineers to create their own models. Both MODPEX and SymLib are now sold through the Company's worldwide sales force.
The Company's internal model development team has developed and refined techniques and special hardware and software that the Company uses to characterize and to build component models which account for behavioral changes caused by variations in temperature, frequency, power and by statistical variation in manufacturing.
SABERDESIGNER ENVIRONMENT. SaberDesigner is a comprehensive graphical design environment that provides a Windows-style integrated tool set and user interface for design entry, simulation and analysis. The SaberDesigner tool set consists of four basic elements: SaberGuide, a graphical user interface to access and operate the simulator; SaberScope, a graphical post-processing and waveform display program for analyzing and viewing simulation results; SaberBook, the on-line documentation package for Saber that allows guided access to relevant user information on-line and SaberSketch, a schematic entry and drawing package. SaberGuide and SaberBook are included with Saber. These tools are tightly integrated to enhance user convenience and the speed of the design process. SaberDesigner is a tool set intended to provide the power and capabilities of Saber simulation to the average or infrequent user. SaberDesigner is now available on both the UNIX and Windows NT platforms.
INSPECS ANALYSIS PACKAGE. The InSpecs Analysis Package ("InSpecs") is a set of tools that helps design engineers analyze the results of their simulations. Using this package, designers can identify and choose the best combination of component values, tolerances and ratings to optimize products, reduce costs and increase yields. This tool set uses stress and sensitivity analyses to identify the critical parts in the design, comprehensive measurements to acquire and distill data to assess performance and statistical "Monte Carlo" analysis to provide insight into the performance variations caused by component and parameter tolerances experienced in manufacturing.
FRAMEWAY INTEGRATIONS. The Company's Frameway Integrations provide interfaces to the design frameworks provided by Mentor Graphics Corporation, Cadence Design Systems, Inc. and Synopsys, Inc. By using an Analogy Frameway Integrations product, users of these other Electronic Design Automation ("EDA") frameworks can obtain the benefits and capabilities of the Company's products while using their standard design process and the accustomed look and feel of their host EDA framework. These Frameway Integrations also give users of the Company's simulation products the advantage of being able to move models, designs and simulation data between different EDA vendor environments. If one division or customer is using Mentor Graphics Corporation's tools and another division or customer is using Cadence Design Systems, Inc.'s tools, they can both use Saber and, through the Frameway Integrations, share models or designs across environments. This interoperability is not otherwise easily accomplished and enables the Company's products to provide a bridge between competing frameworks.
EXPRESS PRODUCTS. In 1998, the Company introduced PowerExpress NT ("PowerExpress"), which is a customized version of the SaberDesigner environment including Saber, targeted at power conversion applications. The PowerExpress product line packaging differs from the Company's standard products in that it is a completely bundled package that is sold on a version-based license instead of a perpetual-based license.
Customers must pay an upgrade fee of approximately 40% of list price to purchase new versions of the package. Additionally, the PowerExpress products are supported with models via ModelExpress, an internet-based vehicle for selling and licensing individual models from the Company's libraries. A minimal PowerExpress package sells for approximately $20,000. Individual models are licensed for prices ranging from $50 to $500. Special versions of InSpecs are available, but no co-simulation options or Frameway integrations are available for PowerExpress. Options can increase the single user price to over $35,000.
TESTIFY. Also in 1998, the Company delivered Testify, a software package which uses Saber to automatically evaluate the behavior of circuits under fault conditions. Testify is primarily focused at Test Program Set development by the military. Testify can help test engineers improve the testability of designs, which may reduce test development costs and improve Test Program Set quality. Testify also has applications in other systems environments such as automotive and industrial control.
CUSTOMER SERVICE. The Company provides services in training, on-site engineering and consulting and contract model development. The Company maintains six world-wide training centers: in Beaverton, Oregon; Ann Arbor, Michigan; Frederick, Maryland; Swindon, England; Paris, France and Munich, Germany. A seventh center is provided through the Company's distributor in Tokyo, Japan. Classes are taught regularly at these facilities on the use of the simulation products and on modeling in the MAST language. The Company also provides specialized component characterization services to its customers. For large class sizes, the Company will provide training at the customer's location. Company-trained applications engineers help develop customer-proprietary models and templates, and the Company maintains a staff of highly trained and experienced applications engineers to consult on specialized design and modeling applications in fields such as electrical, mechanical, ASIC and ICs, power supplies and control systems.
SALES AND MARKETING
The Company markets its products worldwide through a staff that, as of March 31, 1998, consisted of 75 Company-employed field sales and support personnel. The Company manages its worldwide sales operations from its Beaverton, Oregon headquarters. The Company markets its products in North America and Europe through a direct sales and support organization. U.S. sales offices are located in these metropolitan areas: Chicago, Dallas, Detroit, Huntsville (Alabama), Los Angeles, Rochester (New York), San Francisco, and Washington, D.C. as well as at the Company's headquarters in Beaverton, Oregon. In Europe the Company maintains, through wholly-owned subsidiaries, sales and support offices near Paris, London, Munich and Stockholm. The Company also maintains a direct sales office in Singapore and sells through distributors in Japan and Korea.
The Company also has a university program for purposes of increasing the number of engineers trained in the use of the Saber simulator, MAST modeling language and development of behavioral models. The Company has made its software available to more than 109 universities worldwide, many of which are conducting research in such areas as power device modeling, mixed-technology simulation and design and failure mode analysis. The results of this research are then made available to the industrial community, which enables Saber to be more readily used by these customers.
CUSTOMER SUPPORT AND SERVICE
The Company maintains and supports products through its own operations, those of its subsidiaries and through its distributors. The Company offers a technical support hotline to customers and distributors. Support engineers answer the technical support calls and generally provide same-day responses to questions that cannot be resolved during the initial call. Support, service and revenues under U.S. government grants and contracts accounted for 44.6%, 39.5% and 28.4% of the Company's total revenue for the fiscal years 1998, 1997 and 1996, respectively.
RESEARCH AND DEVELOPMENT
The Company focuses its research and development efforts in the areas of simulator development, model development techniques and product accessibility. Research and development expenditures for fiscal years 1998, 1997 and 1996 were $6.3 million, $5.4 million and $4.5 million, respectively.
In modeling, the Company continues to expand its model libraries through internal model development and research and development contracts. The Company believes that continued enhancement of the depth, breadth and quality of its model libraries will be critical to achieving and maintaining technological and market leadership. To further its research and development efforts in modeling techniques and model development consistent with its strategic objectives, the Company pursues funded research and development from governmental entities and corporations and has also entered into model development contracts with selected customers, including governmental entities.
The Company is continuing to extend the applicability and accessibility of its products by providing user interfaces that incorporate the vocabulary and mathematical and display conventions of engineers working in a variety of technologies. The Company continues to focus resources on maintaining its framework integration and co-simulation tools, as the products to which these tools are linked are updated.
No assurance can be given that current research and development efforts, including those described above, will be successful, or will result in the introduction of new or enhanced products on any particular timetable, or at all. In the face of technological change, a failure to introduce new or enhanced products or a failure to introduce them in a timely manner could have a material adverse impact on the Company's business, financial condition and results of operations.
COMPETITION
In the design of ICs, the Company faces competition from many vendors of simulation tools. However, most available simulators are digital or SPICE-based (Simulation Program with Integrated Circuit Emphasis) and are highly specialized to ICs and are therefore not applicable to broader mixed-signal, mixed-technology systems. In the broader systems markets, the Company does not believe that it currently experiences significant competition. However, the design environments of virtually all of the Company's major customers are based on one or another of the major EDA vendors' design frameworks. This pattern drives the need for and usefulness of the Company's Frameway Integration products that permit data interchange between Saber and the products of other vendors. Such other vendors typically have programs to encourage other companies to integrate with the vendors' products and the Company participates in these programs for frameworks it views as strategically important. Many of these large EDA vendors have a significant operating history and significantly greater financial, technical, and marketing resources, greater name recognition, larger installed customer bases and longer relationships with many of the Company's key existing and target customers than does the Company. In addition, most have introduced simulation products (including some analog and mixed-signal behavioral modeling simulation products) to serve the IC designer particularly. In the past year there has been significant progress in the development of analog and mixed-signal HDL standards based on the existing VHDL and Verilog standards. The Company is heavily involved in the definition of these standards and expects to offer products which support these standards. The Company also expects competitors, including major EDA companies, to introduce analog and/or mixed-signal simulation products based on one or more of these standards within the next 12 months. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not have a material adverse effect on its business, results of operations and financial condition.
PROPRIETARY RIGHTS
The Company relies primarily on trade secret and ongoing development efforts to protect its technology and augments those strategies with patents, copyrights and trademarks where the Company believes it is useful to do so. The Company has obtained six U.S. and two Canadian patents on various aspects of its products, including
parameter extraction techniques, Calaveras synchronization techniques for mixed mode simulation, waveform calculator and behavioral modeling. Other patent applications are pending or in process. The Company's policy has been to enter into confidentiality agreements with all employees and signed license agreements that include nondisclosure provisions with all distributors and customers. The Company limits access to and distribution of its software, applicable documentation and other proprietary information. The Company's software is protected as an unpublished copyrighted work and is shipped with a software security lock that limits software access to authorized users. Additionally, access to the software source code is only provided for interface products and selected models and only to major customers pursuant to license agreements that include nondisclosure provisions. The Company holds a worldwide, perpetual, fully paid-up license to use the Saber trademark from its owner, American Airlines, Inc. The Company has United States registrations for the following trademarks: Analogy, Analogy HDL, Calaveras Algorithm, Frameway, Hypermodel and MAST. The Company has European and Japanese registrations for certain of these and other trademarks. The Company asserts other common law trademarks and has a number of registrations pending.
Despite the activities described above, no assurance can be given that the steps taken by the Company will provide adequate protection of its technology or that competitors will not be able to develop similar or functionally equivalent technology. Additionally, copyright and trade secret protection may be limited in certain foreign countries. The Company believes, however, that because of the rapid pace of technological change in the EDA industry, the legal intellectual property protection for its products is a less significant factor in the Company's success than the knowledge, creative abilities and effectiveness of its engineering and marketing staff and the timeliness and quality of its support services. Although the Company does not believe that its products infringe the proprietary rights of others and has not received any claims of infringement of the proprietary rights of others, in the future the Company may receive notice of claims of infringement of other parties' proprietary rights and there can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims against third parties, such as customers) will not be asserted against the Company or that any such assertions will not have a material adverse effect on the Company's business, financial condition or results of operations.
EMPLOYEES
At March 31, 1998, the Company had 218 employees, including 101 in marketing and sales, 87 in research, development and engineering and 30 in systems, administration and finance. The Company believes its future success will depend on its continued ability to attract and retain highly qualified technical, management and sales and marketing personnel. The Company's employees are not subject to a collective bargaining agreement and the Company believes that its employee relations are good. SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS - SUBSEQUENT EVENT."
ITEM 2.
ITEM 2. PROPERTIES
The Company's executive offices, as well as its principal engineering and marketing operations, are located in leased facilities consisting of a total of approximately 51,000 square feet in Beaverton, Oregon. The leases expire December 31, 1999 through August 31, 2001. The Company also leases office space for eight U.S. field sales offices located in these metropolitan areas: Chicago, Dallas, Detroit, Huntsville (Alabama), Los Angeles, Rochester (New York), San Francisco, and Washington, D.C. Lease commitments for these facilities vary; some are month to month, and the remainder have terms of 12 to 36 months. In addition, the Company has leased office space near London, Munich, Paris and Stockholm, and maintains an office in Singapore.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this Report, there were no material legal proceedings to which the Company or its subsidiaries is a party or to which any of their properties are subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during the quarter ended March 31, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is quoted on the Nasdaq National Market System under the symbol "ANLG." The Company's common stock commenced trading on March 22, 1996. The high and low sales prices as reported on the Nasdaq National Market System for fiscal years 1998 and 1997 were as follows.
There were approximately 109 shareholders of record and 1,849 beneficial shareholders at June 1, 1998. The Company has never declared or paid dividends on its common stock. The Company intends to retain earnings from operations for use in the operation and expansion of its business and does not anticipate paying cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The Company's Selected Consolidated Financial Data appears on page of this Report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL The Company develops, markets and supports high-performance software and model libraries for the top-down design and behavioral simulation of mixed-signal and mixed-technology systems. The Company's core simulator product, Saber, was introduced in 1987. In addition to Saber, Analogy offers schematic capture and analysis tools and framework integration products providing interfaces to the design environments of major electronic design automation companies. The Company's fiscal year ends on March 31.
The Company's product license revenue consists of license fees for its software products and template and component model library subscription fees. Service and other revenue consists of software maintenance fees, training, consulting and both commercial and governmental contract model development and research and development contracts. The Company's software products are shipped only after the Company has an executed software license agreement with a customer. Revenue from software licenses is recognized upon shipment to the customer. Revenue from sales to resellers is generally recognized upon shipment to the reseller. In the case of certain long-term contracts, revenue is recognized on a subscription basis over the life of the contract. Revenue from library subscription fees is typically billed annually and the related revenue is recognized ratably over the life of the contract, usually twelve months. Maintenance is normally billed in advance and recognized ratably over the life of the contract, which is usually twelve months. Training, consulting and certain other services revenue is recognized as the services or portions thereof have been provided. Revenue from contract model development is recognized upon shipment of the underlying models, or upon acceptance criteria as agreed to with the customer.
The Company received a modeling contract from the U.S. Air Force in fiscal year 1997. The Company also received a contract from the Defense Advanced Research Projects Agency ("DARPA") in fiscal year 1997 and a multi-year grant from the National Institute of Standards and Technology ("NIST") in fiscal year 1996 which provide funding to the Company for research and development. The DARPA contract contains cost sharing provisions. The final models under the U.S. Air Force contract were delivered in the fourth quarter of fiscal year 1998, therefore, the Company does not expect significant revenues beyond fiscal year 1998 from this source. In addition, revenues from the NIST grant and the DARPA contract decreased significantly in the fourth quarter of fiscal year 1998 and are expected to be minimal in the first quarter of fiscal year 1999 and beyond. There can be no assurance that revenues from the U.S. Air Force, DARPA or NIST will replaced.
The Company has focused substantial efforts on its international business operations, particularly in Europe. The Company's international operations accounted for 42.5%, 41.0% and 43.5% of the Company's total revenue for fiscal years 1998, 1997 and 1996, respectively. The majority of the Company's international operations are conducted through the Company's wholly-owned subsidiaries in Europe. SEE NOTE 9 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
FORWARD LOOKING STATEMENTS
This report, including the following discussion and analysis of financial condition and results of operations, contains certain statements, trend analysis and other information that constitute "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which may involve risks and uncertainties. Such forward looking statements include, but are not limited to, statements including the words "anticipate," "believe," "estimate," "expect," "plan," "intend" and other similar expressions. These forward looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements, including, without limitation, increased adoption of behavioral modeling design methodologies for mixed-signal and mixed-technology systems design, the Company's ongoing ability to introduce new products and expand its markets, seasonal fluctuations in the Company's order pattern including the timing of significant orders, competitive initiatives, the Company's inability to predict the timing of sell-through orders to resellers, the Company's lack of control over the sell-through, the lengthy sales cycle, the significant percentage of orders that are not received by the company until near the end of the
quarter, unanticipated costs related to the Year 2000 issue, and other risks listed from time to time in the Company's Securities and Exchange Commission reports or otherwise disclosed by the Company.
Results of operations for the periods discussed below should not be considered indicative of the results to be expected in any future period, and fluctuations in operating results may also result in fluctuations in the market price of the Company's common stock. Like most high technology companies, the Company faces certain business risks that could have adverse effects on the Company's results of operations, including those discussed below, and those discussed elsewhere in this Report.
The Company's quarterly operating results have in the past and may in the future vary significantly depending on factors such as the receipt and timing of significant orders, increased competition, the timing of new product announcements, changes in pricing policies by the Company or its competitors, lengthy sales cycles, lack of market acceptance or delays in the introduction of new or enhanced versions of the Company's products, seasonal factors, the mix of direct and indirect sales and general economic conditions, and the potential effect of the Asian financial crisis. In particular, the Company's quarterly operating results have in the past fluctuated as a result of the large percentage of orders that are not received by the Company until near the end of the quarter. The Company's expense levels are based, in part, on its expectations as to future revenue. If revenue levels are below expectations, results of operations may be disproportionately affected because only a small portion of the Company's expenses varies with its revenue. As a result, the Company may not learn of, or be able to confirm, revenue or earnings shortfalls until late in the quarter or following the end of the quarter. Seasonal factors, particularly decreases in revenues in European markets in the second fiscal quarter resulting from European holidays in July and August, and cyclical economic patterns in the aerospace, defense, automotive or other end-user industries also contribute to quarter-to-quarter fluctuations. Any shortfall in revenue or earnings from expected levels or other failure to meet expectations of the financial markets regarding results of operations could have an immediate and significant adverse effect on the trading price of the Company's Common Stock in any given period.
The Company has historically derived a significant portion of its revenue from the aerospace and defense industries, which have been characterized by significant technological changes, high cyclicality and the potential for significant downturns in business activity resulting from changes in economic conditions or governmental resources and spending policies. The Company also has historically derived a significant portion of its revenue from the automotive industry. The automotive industry is characterized by high cyclicality, technological change, fluctuations in manufacturing capacity, labor issues, and pricing and gross margin pressures. This industry has from time to time experienced significant economic downturns characterized by decreased product demand, production over-capacity, price erosion, work slowdowns and layoffs. No assurance can be given that the industries served by the Company will experience economic growth, will not experience a downturn or that any downturn will not be severe, or that such conditions would not have a material adverse effect on the Company's business, financial condition and results of operations.
The Company's operating results have depended, and will continue to depend, upon designers of mixed-signal and mixed-technology systems adopting methods of design analysis and simulation which use behavioral modeling techniques. The design analysis and simulation industry is characterized by rapid technological change, frequent new product introductions and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. The Company's future success will depend upon its ability to enhance its current products and to develop or acquire new products that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of its customers.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected items of the Company's consolidated statements of operations as a percentage of total revenue:
FISCAL YEARS 1998 AND 1997
REVENUE
Total revenue increased 7.6% to $25.8 million in fiscal year 1998 from $24.0 million in fiscal year 1997. No one customer accounted for 10% or more of total revenue in fiscal year 1998 or 1997.
Product license revenue decreased 1.5% to $14.3 million in fiscal year 1998 from $14.5 million in fiscal year 1997.
Service and other revenue increased 21.7% to $11.5 million in fiscal year 1998 from $9.5 million in fiscal year 1997. The change was due primarily to increased demand for the Company's maintenance and other services, growth in the Company's installed base, greater revenues from the U.S. Air Force under a $2.0 million modeling contract awarded during the first quarter of fiscal year 1997 and greater revenues from DARPA under a $1.3 million contract awarded in September 1996. The final models under the U.S. Air Force contract were delivered in the fourth quarter of fiscal year 1998, therefore, the Company does not expect significant revenues beyond fiscal year 1998 from these sources. In addition, revenues from the NIST grant and the DARPA contract declined significantly in the fourth quarter of fiscal year 1998 and are expected to be minimal in the first quarter
of fiscal year 1999 and beyond, as these awards near expiration. There can be no assurance that revenues from the U.S. Air Force, DARPA or NIST will replaced. Revenues recognized under these contracts were as follows (dollars in thousands):
In addition to revenues received under the NIST grant, and under the contracts with the U.S. Air Force and DARPA, the Company received other revenues from the U.S. government or its subcontractors during fiscal years 1998 and 1997. Total revenues from U.S. government-related sources, including the previously mentioned specific awards, accounted for approximately 10.9% and 18.1% of total revenues during fiscal year 1998 and 1997, respectively. The cancellation or reduction of projects being undertaken by the U.S. government requiring products or services provided by the Company, or the Company's failure to obtain awards of such projects, could have an adverse effect on the Company's business, financial condition and results of operations.
International revenue was $11.0 million (42.5% of total revenue) in fiscal year 1998 compared to $9.8 million (41.0% of total revenue) in fiscal year 1997. International revenue increased as a percentage of total revenue primarily as a result of decreased sales in the United States in fiscal year 1998. The Company sells its products and services through its wholly-owned subsidiaries in Europe and through distributors in Asia. The Company is monitoring the Asian financial situation and the potential impact on its customers.
COST OF REVENUE
Total cost of revenue increased 19.6% to $4.6 million in fiscal year 1998 from $3.9 million in fiscal year 1997.
Cost of product license revenue consists primarily of documentation expense, media manufacturing costs, supplies, shipping expense and the amortization of component and template model library costs and royalty payments. The Company does not capitalize development costs for software products since the time between the establishment of a working model of the software product and its commercialization is typically of a short duration. Cost of product license revenue increased to 12.4% of product license revenue in fiscal year 1998 from 11.4% in fiscal year 1997, due primarily to increased amortization of model library costs and royalty payments. In addition, costs such as documentation expense and supplies are expensed as incurred, which may not necessarily relate to the number of product licenses shipped during the period.
Cost of service and other revenue consists primarily of maintenance and customer support expenses (including product enhancements and improvements, bug fixes, telephone support, installation assistance and on-site support), certain contract model development costs associated with the U.S. Air Force and DARPA contracts and the NIST grant, and the direct cost of providing services such as training and consulting. The costs associated with service and other revenue as a percentage of total revenue are typically higher than the costs of product license revenue. Cost of service and other revenue increased to 24.6% of service and other revenue in fiscal year 1998 from 23.3% of service and other revenue in fiscal year 1997. The increase was primarily attributable to increased costs associated with performance under the NIST, U.S. Air Force and DARPA contracts in fiscal year 1998. In addition, maintenance revenue earned in fiscal year 1998 increased compared to maintenance revenue earned in fiscal 1997. The NIST grant and the U.S. Air Force contract were nearing completion during the fourth quarter of fiscal year 1998, accordingly costs of services related to these contracts are not expected to be incurred beyond the first quarter of fiscal year 1999. Costs related to revenue under the DARPA contract are also expected to decrease significantly over the next two fiscal quarters, as the contract expires in October 1998.
RESEARCH AND DEVELOPMENT
Research and development expense includes all costs associated with development of new products and technology research. The costs classified in this category primarily include such items as salaries, fringe benefits, depreciation of capital equipment and an allocation of facilities and systems support costs used in research and development. Research and development expenses increased 15.6% to $6.3 million in fiscal year 1998 from $5.4 million in fiscal year 1997, and increased as a percentage of total revenue to 24.3% in fiscal year 1998 from 22.6% in fiscal year 1997. The increase was primarily attributable to increases in research and development personnel and increased salaries.
SALES AND MARKETING
Sales and marketing expense consists primarily of salaries, commissions and travel expenses for sales and marketing personnel, and advertising and public relations expenses. Sales and marketing expense increased 15.3% to $14.6 million in fiscal year 1998 from $12.6 million in fiscal year 1997, and increased as a percentage of total revenue to 56.4% in fiscal year 1998 from 52.7% in fiscal year 1997. The increases primarily resulted from increases in personnel, sales commissions, salaries, travel, the establishment of a new telemarketing function early in fiscal 1998, and costs associated with the Company's corporate image marketing campaign, which began in the fourth quarter of fiscal year 1998.
GENERAL AND ADMINISTRATIVE
General and administrative expense includes costs associated with the Company's executive staff, legal, accounting, corporate systems, facilities and human resources departments. General and administrative expenses increased 9.5% to $3.0 million in fiscal year 1998 from $2.7 million in fiscal year 1997, and increased as a percentage of total of revenue to 11.6% in fiscal year 1998 from 11.4% in fiscal 1997. The increases primarily resulted from increased depreciation expense related to the investment in application software and equipment associated with updating corporate information systems in fiscal year 1997, increased salaries expense and the effects of a full year of increased general and administrative expenses of Symmetry Design Systems, Inc., which was acquired during fiscal year 1997.
OTHER EXPENSE, NET
Other income (expense), net primarily consists of interest income on cash, cash equivalents and marketable securities offset by interest expense associated with capital leases and the effects of foreign currency transaction gains and losses. Other expense, net was $86,000 and $11,000 in fiscal year 1998 and 1997, respectively. The change was primarily attributable to reduced interest income resulting from a lower level of cash, cash equivalents and marketable securities held during the periods, offset by foreign currency transaction gains and losses.
INCOME TAX EXPENSE
The Company provided for foreign income and withholding taxes of $275,000 and $341,000 in fiscal years 1998 and 1997, respectively. The Company's effective tax rate is sensitive to shifts in income and losses among the various countries in which the Company does business, since in some countries the Company is in a tax paying position while in other countries the Company has operating loss carryforwards available to offset taxable income.
At March 31, 1998, the Company had federal net operating loss carryforwards of approximately $7.2 million which expire at various dates beginning in 2009 and ending in 2013, if not utilized. Utilization of $950,000 of federal net operating losses is subject to annual limitations due to a change in the Company's fiscal year in 1994. For financial reporting purposes the Company has established a valuation allowance against its deferred tax assets because of the uncertainty relating to the realization of such asset values. SEE NOTE 6 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
FISCAL YEARS 1997 AND 1996
REVENUE
Total revenue increased 10.2% to $24.0 million in fiscal year 1997 from $21.7 million in fiscal year 1996.
Product license revenue decreased 6.8% to $14.5 million in fiscal year 1997 from $15.6 million in fiscal year 1996. The decrease was primarily attributable to a decrease in sales to the automotive industry in the U.S. Sales to Electronic Data Systems Corp. ("EDS"), which serves as a distributor to certain automotive industry users, accounted for approximately 13.6% of total revenue in fiscal year 1996. Sales to EDS were not significant in fiscal year 1997. Reduced capital spending by General Motors has resulted in reductions in orders from EDS.
Service and other revenue increased 53.2% to $9.5 million in fiscal year 1997 from $6.2 million in fiscal year 1996. The increase was due primarily to increased demand for the Company's maintenance and other services, growth in the Company's installed base, revenues from NIST under a $2.0 million grant awarded in fiscal year 1996, revenues from the U.S. Air Force under a $2.0 million modeling contract awarded during the first quarter of fiscal year 1997, and revenues from DARPA under a $1.3 million contract awarded in September 1996. In fiscal year 1997, the Company recognized revenues of $768,000, $630,000 and $348,000, related to the NIST grant, the U.S. Air Force contract and the DARPA contract, respectively.
In addition to revenues received under the NIST grant, and under the contracts with the U.S. Air Force and DARPA, the Company received other revenues from the U.S. government or its subcontractors during fiscal years 1997 and 1996. Total revenues from U.S. government-related sources, including the previously mentioned specific awards, accounted for approximately 18.1% of total revenues in fiscal year 1997, and approximately 9.7% of total revenues in fiscal year 1996. The cancellation or reduction of projects being undertaken by the U.S. government requiring products or services provided by the Company, or the Company's failure to obtain awards of such projects, could have a material adverse effect on the Company's business, financial condition and results of operations.
COST OF REVENUE
Total cost of revenue increased 59.3% to $3.9 million in fiscal year 1997 from $2.4 million in fiscal year 1996.
Cost of product license revenue increased to 11.4% of product license revenue in fiscal year 1997 from 9.2% in fiscal year 1996, due primarily to increased amortization of model library costs and royalty payments.
Cost of service and other revenue increased to 23.3% of service and other revenue in fiscal year 1997 from 16.1% of service and other revenue in fiscal year 1996. The increases were due primarily to the Company's increased installed product base, costs associated with performance under the grant received from NIST and the costs associated with performance under the U.S. Air Force and DARPA contracts.
RESEARCH AND DEVELOPMENT
Research and development expenses increased 19.8% to $5.4 million in fiscal year 1997 from $4.5 million in fiscal year 1996. The increase primarily resulted from the increase in the number of research and development personnel throughout fiscal year 1997 and ongoing facilities and systems support expenses to accommodate the increased personnel. As a percentage of total revenue, research and development costs increased to 22.6% in fiscal year 1997 from 20.8% in fiscal year 1996, due to the above.
SALES AND MARKETING
Sales and marketing expense increased 17.9% to $12.6 million in fiscal year 1997 from $10.7 million in fiscal year 1996. The increase primarily resulted from increases in personnel and salaries and related benefits, travel and training. Additionally, marketing expenditures increased due to the launch of SaberDesigner NT, and the
development and implementation of focused marketing plans. As a percentage of total revenue, sales and marketing expenses increased to 52.7% in fiscal year 1997 from 49.3% in fiscal year 1996, due primarily to the above and to the Company falling short of its sales goals in the U.S. automotive sector.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 15.0% to $2.7 million in fiscal year 1997 from $2.4 million in fiscal year 1996. The increase was primarily attributable to significant investment in application software and equipment related to updating corporate information systems, increased costs of being a public company, including those related to external reporting requirements and legal and accounting costs, and increased administrative costs relating to the acquisition of Symmetry in November 1996. As a percentage of total revenue, general and administrative expenses increased slightly to 11.4% in fiscal year 1997 from 10.9% in fiscal 1996.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of Symmetry in November 1996, the Company acquired the ongoing research and development activities of Symmetry resulting in a one-time pre-tax charge of $1.9 million related to the write off of certain in-process research and development costs. The value assigned to the in-process research and development represents those research and development efforts in process at the acquisition date for which technological feasibility had not yet been established and which had no alternative future uses. Accounting principles require that such costs be charged to expense as incurred. The Company currently believes that these research and development efforts will result in commercially viable products over the next one to three years. SEE NOTE 2 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
OTHER EXPENSE, NET
Other expense, net was $11,000 and $523,000 in fiscal year 1997 and 1996, respectively. The reduction in other expense, net resulted primarily from decreased interest expense due to payments reducing the Company's short-term accounts receivable financing arrangement and subordinated debt, as a result of the Company's initial public offering in March 1996.
PROVISION FOR INCOME TAXES
The Company recorded income tax expense of $341,000 and $370,000, respectively in fiscal year 1997 and 1996. These amounts consist primarily of foreign tax expense. For financial reporting purposes the Company has established a valuation allowance against its deferred tax assets because of the uncertainty relating to the realization of such asset values. SEE NOTE 6 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception with private equity investments, cash from operations, subordinated debt, bank loans, capital equipment leases, accounts receivable financing and in March 1996, with an initial public offering of common stock which resulted in net proceeds to the Company of approximately $9.4 million.
Net cash provided by operating activities was $8.2 million in fiscal year 1998, primarily resulting from a decrease in accounts receivable and an increase in unearned revenue, offset by a net loss for the period, adjusted for depreciation and amortization. The decrease in accounts receivable was primarily attributable to the sale of approximately $4.0 million of accounts receivable to a financial institution in the fourth quarter of fiscal year 1998. SEE NOTE 1 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. The increase in unearned revenue was attributable to growth in the Company's maintenance base and the receipt of a $1.3 million contract in the fourth quarter of fiscal year 1998 which was recorded as unearned revenue and will be recognized as revenue ratably over the term of the contract.
Net cash used in investing activities was $1.9 million in the fiscal year 1998, which primarily included expenditures associated with the investment in the Company's component and template model libraries and capital expenditures for the upgrade of corporate information systems, offset by maturities of investments in marketable securities.
Net cash provided by financing activities was $174,000 in fiscal year 1998, which included proceeds from the exercise of stock options, offset by principal payments on capital lease obligations.
The Company has an operating line of credit with a bank which allows the Company to receive advances of up to $5.0 million based on eligible accounts receivable and is secured by accounts receivable, furniture, fixtures and equipment and general intangibles. Interest is payable monthly at the bank's prime rate plus 0.5%. The line of credit facility requires the Company to maintain certain financial and other covenants and matures on March 5, 1999. The Company was in compliance with or had obtained waivers of all covenants at March 31, 1998. No amounts were outstanding under this facility at March 31, 1998 and the Company is currently in the process of renegotiating the credit line.
The Company has a lease line of credit, which allows for the lease of up to $1,000,000 of computers and related equipment, under which approximately $466,000 was outstanding at March 31, 1998. Amounts borrowed under the lease line of credit are to be repaid over 36 months. The lease line of credit expires on March 31, 1999. In April 1997, in connection with the negotiation of the lease line of credit the Company issued warrants to purchase 10,000 shares of its common stock at $7.50 per share which expire on June 23, 2001.
The Company believes its existing cash and cash equivalents, combined with amounts available under its operating line of credit and lease line of credit, and cash flows expected to be generated by operations, will be sufficient to meet its anticipated cash needs for working capital and capital expenditures for the next 12 months.
YEAR 2000 ISSUE
The Company has made an assessment of the effect of the Year 2000 issue on its systems, equipment and software products. Based on this assessment, the Company believes that its software applications, operational programs and its software products will properly recognize calendar dates beginning in the Year 2000, and accordingly does not currently expect to incur material costs in connection with the Year 2000 issue, as it affects the Company's systems, equipment and software products. The Company also may be exposed to risks from computer systems of parties with which the Company transacts business. In response to this, the Company is taking steps, including contacting its major suppliers, to determine the extent to which the Company may be vulnerable to those parties' failure to remedy their own Year 2000 issues and to ascertain what actions, if any, need be taken by the Company in response to such risks. There can be no assurance the failure of the Company's software or that of the parties with which the Company transacts business will not have a material adverse effect on the Company's business, financial condition or results of operations.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes requirements for disclosure of comprehensive income. The objective of SFAS 130 is to report all changes in equity that result from transactions and economic events other than transactions with owners. Comprehensive income is the total of net income and all other non-owner changes in equity. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of earlier financial statements for comparative purposes is required. The Company has not quantified the effect of adoption of SFAS 130.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information"("SFAS No. 131") which requires public companies to report certain information about their operating segments in a complete set of financial statements to shareholders. It also requires reporting
of certain enterprise-wide information about the Company's products and services, its activities in different geographic areas and its reliance on major customers. The basis for determining the Company's operating segments is the manner in which management operates the business. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not expect implementation to have a significant impact on its consolidated financial statements.
In October 1997, the AICPA issued Statement of Position 97-2 , "Software Revenue Recognition,"("SOP 97-2"), which is effective for software transactions entered into beginning January 1, 1998. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The revenue allocated to software products generally is recognized upon delivery of the products. The revenue allocated to post-contract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements generally is recognized as the services are performed. The Company does not expect SOP 97-2 to have a significant impact on its consolidated financial statements.
SUBSEQUENT EVENT
On June 5, 1998, the Company announced that it is taking steps to reduce expenses to bring them in line with current sales levels. As a result, the Company eliminated approximately 15% of its workforce during the first two months of fiscal year 1999. A restructuring charge associated with the employment reductions and associated costs, when determined, is expected to be included in the Company's results of operations for the first quarter of fiscal year 1999.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is included under QUARTERLY CONSOLIDATED FINANCIAL DATA on page of this Report, and as listed below:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is included under the captions ELECTION OF DIRECTORS and MANAGEMENT in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders and is incorporated herein by reference. The information required by Item 405 of Regulation S-K is included under the caption SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the caption EXECUTIVE COMPENSATION in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption STOCK OWNED BY MANAGEMENT AND PRINCIPAL SHAREHOLDERS in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the caption CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS:
The information required by this item is included beginning on page of this Report, and as listed in Part II, Item 8 of this Report.
(a) (2) FINANCIAL STATEMENT SCHEDULES:
Schedules not listed under this item have been omitted because the information required to be set forth therein is not applicable.
(a) (3) EXHIBITS INCLUDED HEREIN:
* Denotes management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K:
A Report on Form 8-K, containing the Company's earnings release for the quarter and nine months ended December 31, 1997, under Item 5, was filed on January 27, 1998. No other Reports on Form 8-K were filed during the quarter ended March 31, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 22nd day of June 1998.
ANALOGY, INC.
By /s/ GARY P. ARNOLD ------------------ Gary P. Arnold Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated, on the 22nd day of June 1998.
Signature Title - --------- -----
/s/ GARY P. ARNOLD Chairman of the Board, President - ---------------------- and Chief Executive Officer Gary P. Arnold (Principal Executive Officer)
/s/TERRENCE A. RIXFORD Vice President, Finance and Administration - ---------------------- (Principal Financial Officer) Terrence A. Rixford
- ---------------------- Director Robert L. Cattoi
- ---------------------- Director John H. Faehndrich
/s/ NEIL E. GOLDSCHMIDT Director - ---------------------- Neil E. Goldschmidt
/s/ FRANK ROEHR Director - ---------------------- Frank Roehr
Director - ---------------------- Charles Sporck
/s/ DR. MARTIN VLACH Vice President, Chief Scientist - ---------------------- and Director Dr. Martin Vlach
ANALOGY, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ANALOGY, INC. AND SUBSIDIARIES QUARTERLY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) In April 1998, the Company determined that revenue from products sold to a reseller previously recognized in the first and second quarters of fiscal 1998 of $774,000 and $400,000, respectively, should more appropriately be recognized as revenue at the time the product is sold to the ultimate end user rather than to recognize the revenue when it is sold to the reseller. Accordingly, the results of operations for the first and second quarters of fiscal year 1998 have been restated.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders Analogy, Inc.:
We have audited the accompanying consolidated balance sheets of Analogy, Inc. and subsidiaries as of March 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended March 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Analogy, Inc. and subsidiaries as of March 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1998, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Portland, Oregon May 11, 1998
ANALOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ANALOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
ANALOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ANALOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ANALOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1998, 1997 AND 1996
(1) NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Analogy, Inc. and subsidiaries (the Company) develops, markets and supports high-performance software and model libraries for the top-down design and behavioral simulation of mixed-signal and mixed-technology systems.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of the Company and its wholly-owned subsidiaries, Analogy UK Ltd., Analogy GmbH, Analogy France SARL, Analogy AB (Sweden) and Symmetry Design Systems, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
FOREIGN CURRENCY TRANSLATION
The local currency is the functional currency in the Company's foreign subsidiaries. Assets and liabilities of the foreign subsidiaries are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates during the year. Foreign currency translation adjustments are included as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included as a component of other income and expense.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially expose the Company to concentration of credit risk consist primarily of accounts receivable. At March 31, 1998 and 1997, European customers accounted for approximately 50% and 31%, respectively, of accounts receivable. To reduce credit risk, the Company performs ongoing credit evaluations of its customers' financial condition. The Company does not generally require collateral.
The Company historically has derived a significant portion of its revenue from the automotive, aerospace and defense industries. Total revenues from U.S. government-related sources accounted for approximately 10.9%, 18.1% and 9.7% of total revenues during fiscal years 1998, 1997 and 1996, respectively.
CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash and cash equivalents consist of cash and temporary overnight investments. The Company accounts for marketable securities as "available for sale" in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" as the Company intends to utilize these investments for liquidity or operational purposes. Accordingly, these securities were carried at market value, which was not materially different from cost at March 31, 1997. These securities matured in fiscal year 1998.
ACCOUNTS RECEIVABLE
In March 1998, the Company sold approximately $4.0 million of accounts receivable on a non-recourse basis. The carrying amount approximated the fair value and as a result no gain or loss was recognized on the sale.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are stated at cost. Furniture and equipment under capital leases are stated at the lower of the present value of minimum lease payments at the beginning of the lease term or fair value of the leased assets at the inception of the lease.
Depreciation on furniture, fixtures and equipment is calculated on the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Furniture and equipment held under capital leases and leasehold improvements are amortized on the straight-line method over the shorter of the related lease term or estimated useful life of the leased assets.
RESEARCH AND DEVELOPMENT
Expenditures for research and development are expensed as incurred. The Company does not capitalize software development costs after technological feasibility has been established since the time period between product release and establishment of technological feasibility is short.
During fiscal year 1997, the Company entered into a cost-sharing agreement with DARPA for research and development covering a three year period, pursuant to which the Company is obligated to provide matching direct and indirect support costs up to $1.3 million and to deliver progress reports over the same period. Reimbursed costs under this agreement were $774,000 and $348,000 in fiscal years 1998 and 1997, respectively. During fiscal year 1996, the Company was awarded a research grant from NIST which covers a three year period, pursuant to which the Company is obligated to provide matching indirect cost of support up to $400,000 and to deliver progress reports over the same period. Reimbursed costs under this grant were $765,000, $768,000 and $373,000, in fiscal years 1998, 1997 and 1996, respectively.
LIBRARY COSTS
Development costs associated with creating the library of component and template models are capitalized and amortized on a straight-line basis over the estimated product life of five years, or on the ratio of current revenues to total projected product revenues, whichever is greater.
The Company recognized amortization expense of approximately $1,184,000, $975,000, and $841,000 related to its capitalized library costs in fiscal years 1998, 1997 and 1996, respectively.
REVENUE RECOGNITION
Software and license fee revenues are recognized at the time of shipment. In the case of certain long-term contracts, revenue is recognized on a subscription basis over the life of the contract. Revenue from sales to resellers is generally recognized upon shipment to the reseller. Software maintenance and library subscription agreements are billed in advance and recorded as unearned revenue. Unearned maintenance and library subscription revenues are recognized ratably over the contractual period. Contract modeling and nonrecurring engineering project revenues are recognized on the completed contract method, or upon acceptance criteria as agreed to with the customer. Revenues from training and other services are billed separately and recognized as the services are provided. Revenue related to original equipment manufacturer (OEM) contracts is recognized upon receipt of the OEM sales information. Product licenses include a limited initial term of product maintenance, the costs of which are insignificant.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
COMPUTATION OF NET (LOSS) INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128). This Statement supersedes APB Opinion No. 15 and specifies the computation, presentation and disclosure requirements for earnings per share for entities with publicly held common stock or potential common stock. The Company adopted the provisions of SFAS 128 during fiscal year 1998. As it relates to the Company, the principal differences between the provisions of SFAS 128 and previous authoritative pronouncements are the exclusion of potential common shares in the determination of basic earnings per share and the market price at which potential common shares are calculated in the determination of diluted earnings per share.
Basic earnings per common share is computed using the weighted average number of shares of common stock outstanding for the period. Diluted earnings per common share is computed using the weighted average number of shares of common stock and potential common shares related to stock options and warrants outstanding during the period.
The following is a reconciliation of the denominators of the basic and diluted computations of net (loss) income per share. There are no reconciling items for the numerators, which consist of net (loss) income for all periods presented.
The dilutive effect of stock options outstanding for the purchase of approximately 1.5 million and 1.3 million shares for fiscal years 1998 and 1997, respectively, and warrants outstanding for the purchase of 340,000 and 400,000 shares for fiscal year 1998 and 1997, respectively were not included in loss per share calculations, because to do so would have been anti-dilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short-term nature of these instruments. The fair value of marketable securities is estimated using quoted market rates for specific securities held and approximates carrying value.
Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument when available. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," ("SFAS 121"), the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when estimated future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. The Company has not identified any such impairment losses.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130), which establishes requirements for disclosure of comprehensive income. The objective of SFAS 130 is to report all changes in equity that result from transactions and economic events other than transactions with owners. Comprehensive income is the total of net income and all other non-owner changes in equity. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of earlier financial statements for comparative purposes is required. The Company has not quantified the effect of adoption of SFAS 130.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information". SFAS No. 131 requires public companies to report certain information about their operating segments in a complete set of financial statements to shareholders. It also requires reporting of certain enterprise-wide information about the Company's products and services, its activities in different geographic areas and its reliance on major customers. The basis for determining the Company's operating segments is the manner in which management operates the business. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The Company does not expect implementation to have a significant impact on its consolidated financial statements.
In October 1997, the AICPA issued Statement of Position 97-2 , "Software Revenue Recognition,"("SOP 97-2"), which is effective for software transactions entered into beginning January 1, 1998. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The revenue allocated to software products generally is recognized upon delivery of the products. The revenue allocated to post-contract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements generally is recognized as the services are performed. The Company does not expect SOP 97-2 to have a significant impact on its consolidated financial statements.
(2) ACQUISITION
In November 1996, the Company acquired Symmetry Design Systems, Inc., ("Symmetry") a leading independent developer of analog and mixed-signal modeling tools and model libraries. The Company accounted for the acquisition using the purchase method and valued the transaction at approximately $2.9 million. The excess of the acquisition cost over the fair value of the net assets acquired is being amortized over three years using the straight-line method. The accompanying financial statements include the results of operations of Symmetry from the date of the acquisition.
In connection with the acquisition, the Company acquired the ongoing research and development activities of Symmetry resulting in a one-time pre-tax charge of $1.9 million, in fiscal year 1997, related to the write off of certain in-process research and development costs. The value assigned to the in-process research and development represents those research and development efforts in process at the acquisition date for which technological feasibility had not yet been established and which had no alternative future uses. Accounting principles require that such costs be charged to expense as incurred.
In connection with the acquisition and in consideration for non-compete agreements entered into with certain key employees of Symmetry, the Company issued warrants to purchase 400,000 shares of the Company's common stock at $4.125 per share. The warrants are exercisable at the rate of 100,000 shares as of the end of each six-month period from the date of acquisition and expire upon termination of employment. At March 31, 1998, warrants to purchase 330,000 shares of common stock were outstanding and warrants to purchase 130,000 shares of common stock were exercisable.
(3) FURNITURE, FIXTURES AND EQUIPMENT, NET
Furniture, fixtures and equipment, net consists of the following (in thousands):
(4) LEASES
The Company has entered into various capital leases for certain furniture and equipment that expire at various dates during the next three years. Several capital leases require that the Company remit security deposits as collateral for the lease. Security deposits are generally released by the leasing company at the rate of one-half at twelve months and one-half at twenty-four months from the date of lease inception. In April 1997, in connection with the negotiation of a lease line of credit the Company issued warrants to purchase 10,000 shares of its common stock at $7.50 per share which were immediately exercisable and expire on June 23, 2001.
Furniture, fixtures and equipment, net include the following capital lease amounts (in thousands):
The Company also leases its office facilities and certain office equipment under non-cancelable operating lease agreements.
Future minimum lease payments under these leases are as follows (in thousands):
Rent expense under operating leases in fiscal years 1998, 1997 and 1996 was approximately $1,248,000, $1,429,000 and $1,266,000, respectively.
(5) STOCK-BASED COMPENSATION PLANS
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan (the "ESPP") which allows employees of the Company to purchase shares of the Company's common stock through accumulated payroll deductions. Participating employees may elect to contribute up to 10% of their eligible compensation during each pay period to the ESPP. The ESPP provides for two semi-annual offering periods beginning February 1 and August 1 of each year. Participant funds are accumulated during the offering period and used to automatically purchase shares of the Company's common stock at 85% of the lower of the fair market value of such stock at the beginning of the offering period or the fair market value at the purchase date. The Company has reserved 300,000 shares of common stock for issuance under the ESPP and had issued 139,913 shares as of March 31, 1998.
STOCK OPTION PLANS
The Company has a 1986 Stock Option Plan under which 625,000 shares of common stock are reserved for issuance, and a 1993 Stock Incentive Plan, as amended (the "1993 Plan") under which 1,627,911 shares of common stock are reserved for issuance. In January 1998, the Board of Directors of the Company reserved an additional 450,000 shares of common stock for issuance under the 1993 Plan, subject to approval by the shareholders of the Company at its 1998 Annual Meeting. The 1993 Plan expires in 2003 unless terminated sooner by the Company or options have been granted and exercised on all shares available under the plan.
The Board of Directors may grant either incentive stock options with an exercise price of not less than the fair market value of the common stock at the date of grant or non-qualified stock options with an exercise price of not less than 85% of the fair market value of the common stock at the date of grant. The Board of Directors shall determine the period of each option and the time or times at which options may be exercised and any restrictions on the transfer of stock issued upon exercise of any options. The options generally vest over a period of four years and are exercisable over a period of ten years.
The table below summarizes the Company's stock option activity:
At March 31, 1998, stock options to purchase approximately 758,281 shares of common stock were exercisable.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 ("SFAS 123")
SFAS 123 defines a fair value based method of accounting for employee stock options and similar equity instruments. As permitted under SFAS 123, the Company has elected to account for its stock-based compensation plans using APB 25. The Company has computed, for pro forma disclosure purposes, the value of options granted during fiscal year 1998 and 1997 using the Black-Scholes pricing model and the value of options granted during fiscal year 1996 using the minimum value pricing model.
The following weighted average assumptions were used in the computations:
The total value of options and warrants granted during fiscal years 1998, 1997 and 1996 was $1,076,000, $4,929,000 and $294,000, respectively, which would be amortized on a straight-line basis over the vesting period of the options or warrants (typically four years). The weighted average fair value of options and warrants granted during fiscal years 1998, 1997 and 1996 was $4.17, $4.41 per share and $0.90 per share, respectively. The Company issued 106,536 and 33,377 shares under its Company's Employee Stock Purchase Plan during fiscal years 1998 and 1997. The related weighted average purchase price and weighted average fair value of shares issued were $3.88 and $2.00, respectively for fiscal year 1998; and $4.30 and $1.15, respectively for fiscal year 1997.
If the Company had accounted for its stock-based compensation plans in accordance with SFAS 123, the Company's net (loss) income and net (loss) income per share would have approximated the pro forma amounts show below:
The effect of applying SFAS 123 in this pro forma disclosure is not indicative of future results. SFAS 123 does not apply to awards prior to April 1, 1995. Additional awards are anticipated in future years.
The following table summarizes the information about stock options and warrants outstanding at March 31, 1998:
(6) INCOME TAXES
Income (loss) before income taxes was as follows (in thousands):
Income tax expense consists of the following (in thousands):
The actual income tax expense differs from the expected tax expense (computed by applying the U.S. federal corporate income tax rate of 34% to net income (loss) before income taxes) as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands):
The valuation allowance for deferred tax assets as of March 31, 1998 was approximately $2.8 million. The net change in the total valuation allowance in fiscal years 1998, 1997 and 1996 was an increase (decrease) of approximately $1,258,000, $323,000 and $(237,000), respectively.
At March 31, 1998, the Company had net operating loss carryforwards for federal and state income tax purposes which can be used to offset future income subject to taxes. In addition, there are unused research and experimentation and foreign tax credits which can be offset against future federal income taxes after the loss carryforwards. Such loss carryforwards and tax credits are summarized below (in thousands):
In addition, the Company has foreign income tax net operating losses of approximately $172,000, which expire in various years. Due to the change in the Company's fiscal year end, federal and state net operating losses of approximately $950,000 are to be deducted ratably over the six year period from March 31, 1995 to March 31, 2000.
(7) PROFIT SHARING PLAN
The Company has a profit sharing plan covering substantially all employees. The plan has 401(k) provisions whereby employees contribute to the plan through payroll deductions. The Company may elect to make discretionary contributions to the plan which are approved by the Board of Directors. The Company's contributions for fiscal years 1998 and 1997 were $202,000 and $163,000, respectively. The Company did not make discretionary contributions for fiscal year 1996.
(8) OPERATING LINE OF CREDIT
The Company has an operating line of credit with a bank which allows the Company to receive advances of up to $5.0 million based on eligible accounts receivable and is secured by accounts receivable, furniture, fixtures and equipment and general intangibles. Interest is payable monthly at the bank's prime rate plus 0.5%. The line of credit facility requires the Company to maintain certain financial and other covenants and matures on March 5, 1999. The Company was in compliance with or had obtained waivers of all covenants at March 31, 1998. No amounts were outstanding under this facility at March 31, 1998 and the Company is currently in the process of renegotiating the credit line.
(9) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates primarily in one business segment, comprising the electronic design automation industry. The Company's geographic revenues and operating (loss) income are summarized as follows (in thousands):
No one customer accounted for more than 10% of total revenues for fiscal year 1998 or 1997. Revenue from one customer accounted for 13.6% of total revenue for fiscal year 1996.