10-Q 1 f69286e10-q.txt QUARTERLY REPORT FOR PERIOD ENDED 12/30/2000 1 ================================================================================ 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 quarter ended December 30, 2000 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 0-18623 --------------------------------- IKOS SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 77-0100318 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 79 GREAT OAKS BLVD., SAN JOSE, CA 95119 (Address of principal executive offices) (zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 284-0400 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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. ~~COMMON STOCK $.01 PAR VALUE 8,844,000 (Title of Class) (Outstanding as of December 30, 2000)~~

================================================================================ 2 IKOS SYSTEMS, INC. FORM 10-Q QUARTER ENDED DECEMBER 30, 2000 INDEX Part I: Financial Information Item 1: Financial Statements

3 PART I FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS IKOS SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per-share amounts)

See notes to consolidated financial statements. 3 4 IKOS SYSTEMS INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) (Unaudited)

See notes to consolidated financial statements. 4 5 IKOS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Increase (decrease) in cash and cash equivalents in thousands (in thousands)

See notes to consolidated financial statements. 5 6 IKOS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements at December 30, 2000 and for the three months ended December 30, 2000 and January 1, 2000, have been prepared in conformity with generally accepted accounting principles, consistent with those applied in, and should be read in conjunction with, the audited consolidated financial statements for the year ended September 30, 2000 included in the Form 10-K as filed with the Securities and Exchange Commission on December 21, 2000. The unaudited interim financial information reflects all normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of results for the interim periods presented. The results for the three months ended December 30, 2000 are not necessarily indicative of results expected for the full year. 2. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market and consisted of (in thousands):

3. NET INCOME PER SHARE The computation of basic net income per share for the periods presented is derived from the information on the face of the income statement, and there are no reconciling items in either the numerator or denominator. Additionally, there are no reconciling items in the numerator used to compute dilutive net income per share. The incremental common shares attributable to outstanding options for the three month periods ended December 30, 2000 and January 1, 2000 are 1,219,000 and 1,102,000 and are included in the total shares used in the denominator of the diluted net income per share calculation. 6 7 IKOS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 4. COMPREHENSIVE INCOME Comprehensive income for the three month periods ending December 30, 2000 and January 1, 2000 are as follows (in thousands):

5. RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements". IKOS is required to implement SAB101 no later than the quarter ending September 29, 2001. The Company is currently evaluating the impact of SAB 101 and is uncertain as to what impact, if any, SAB 101 will have on its revenues and results of operations. The impact of SAB 101, if any, will be reported as a change in accounting principle in accordance with FASB Statement No. 3. This may result in a significant cumulative effect change in accounting adjustment that would be reflected in the Company's results of operations for the fiscal year ended September 29, 2001. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires the Company to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow, or foreign currency hedges, and establishes accounting standards for reporting changes in the fair value of the derivative instruments. Upon adoption, the Company was required to adjust hedging instruments to fair value in the balance sheet and recognize the offsetting gains or losses as adjustments to be reported in net income or other comprehensive income, as appropriate. The Company adopted SFAS No. 133 as of October 1, 2000. The adoption of SFAS No. 133 had no effect on the Company's results of operations or financial position. 7 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT The statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations that are forward looking involve numerous risks and uncertainties and are based on current expectations. Actual results may differ materially from those projected. Such risks and uncertainties may be more fully described in other reports and information filed by the Company with the Securities and Exchange Commission. Certain of these risks and uncertainties are discussed under the caption "Factors That May Affect Future Results of Operations." NET REVENUES Net revenues for the three month period ending December 30, 2000 were $21,009,000, representing a 36% increase over the same period of the prior year. The period to period change was primarily reflective of an 83% increase in emulation product sales. Simulation product sales were up approximately 5% from the prior year and maintenance revenues increased by approximately 6%. Emulation revenues continue to increase as the Company continues to gain market share and realize increased demand for its emulation product offerings. Simulation revenues continued to remain stronger than anticipated showing a slight increase both over same period of the prior year and on a quarter-to-quarter basis. However, the Company continues to expect a decline in the simulation revenues as the transition to emulation continues. For the three month period ending December 30, 2000, maintenance revenues have increased primarily due to the Company's increasing installed base of emulation customers. However, certain simulation customers are declining to renew their maintenance on their simulation, partially offsetting the increase in the emulation installed base. The Company expects future maintenance revenues to be impacted as the transition to emulation continues. International revenues for the quarter totaled $5,963,000 or approximately 28% of total revenues. International revenues for the quarter decreased 22% when compared to the first quarter of the prior year. The decrease in revenues is due primarily a reduction of revenues in Japan. The Company believes the shortfall is a result of the Company's increased emphasis on emulation and the difficulties involved in penetrating the Japan market with a new product. GROSS PROFIT MARGINS Gross profit margins for the three month period ended December 30, 2000 were 79% versus 76% during the same period a year ago. The increase was primarily related to higher volume of business resulting in more fixed costs being absorbed and the sale of products with higher margins. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses for the three month period ending December 30, 2000 were approximately $4,508,000 or 21% of net revenues. This represented an increase of 38% over the first quarter of fiscal 2000. Research and development expenses increased primarily as a result of increased salaries and prototype costs. As the Company continues to research verification tool methodologies and introduce new products, research and development costs are expected to increase in absolute dollars over the remainder of the year. 8 9 SALES AND MARKETING EXPENSES Sales and marketing expenses for the three month period ending December 30, 2000 were approximately $7,278,000 or 35% of net revenues. This represented an increase of 23% over the same three month period in fiscal 2000. The increase over the prior year quarter is primarily related to increased salaries, commissions, consulting expenses and trade show expenses. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative costs for the three month period ending December 30, 2000 were $1,584,000 or 8% of net revenues. For the three month period ending December 30, 2000, the general and administrative expenses were higher than the same period in fiscal 2000 as a result of increased salaries and related expenses. General and administrative costs are expected to remain flat to down as a percentage of revenues over the remainder of fiscal 2000. INCOME TAXES The Company's effective tax rate on the consolidated pretax income was approximately 25%for the three month periods ending December 30, 2000 and January 1, 2000. The Company's effective tax rate for both periods differs from the federal statutory rate primarily due to benefits associated with its net operating loss carryforward. OTHER The Company has experienced minimal gains or losses on foreign currency translation. With the exception the Company's Japan operations, substantially all of its international sales to date have been billed and collected in U.S. dollars. The Company pays the expenses of its international operations in local currencies and to date the Company has not engaged in hedging transactions with respect to such obligations. The Company's sales in Japan are billed and collected in the Japanese local currency. As such, the Company periodically enters into foreign exchange contracts to minimize foreign exchange risk relating to the Japanese subsidiary's sales that are denominated in yen. A forward exchange contract obligates the Company to exchange predetermined amounts of a specified foreign currency at a specified exchange rate on a specified date or to make an equivalent US dollar payment equal to the value of such exchange. These contracts are accounted for as hedges of identifiable receivables denominated in Japanese yen. Realized gains or losses are recognized upon maturity of the contracts and offset the underlying asset or liability. Through December 30, 2000, the impact of such hedging arrangements have been immaterial to the Company operations. FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS Potential Fluctuations in Quarterly Results. The Company's quarterly operating results have in the past and may in the future vary significantly depending on factors including the timing of customer development projects and purchase orders, new product announcements and releases by the Company and other companies, gain or loss of significant customers, price discounting of the Company's products, the timing of expenditures, customer product delivery requirements, availability and cost of components or labor and economic conditions generally and in the electronics industry specifically. Any unfavorable change in these or other factors could have a material adverse effect on the Company's operating results for a particular quarter. Many of the Company's customers order on an as-needed basis and often delay issuance of firm purchase orders until their project commencement dates are determined. Quarterly revenue and operating results will therefore depend on the volume and timing of orders received during the quarter, which are difficult to forecast accurately. Moreover, a significant portion of the Company's 9 10 revenue may result from shipments during the last few weeks of the quarter from orders generally received in the last month of the quarter. Any concentration of sales at the end of the quarter may limit the Company's ability to plan or adjust operating expenses and production and inventory levels. Therefore, if anticipated shipments in any quarter do not occur or are delayed, expenditure levels could be disproportionately high as a percentage of revenue, and the Company's operating results for that quarter would be adversely affected. In addition, sales of individual systems with high average sales prices can constitute a significant percentage of the Company's quarterly revenue. Operating results in any period should not be considered indicative of the results to be expected for any future period, and there can be no assurance that the Company's net revenues will increase or that the Company will remain profitable in any future period. Sales Trends. Over the past several years the marketplace for the Company's products has evolved substantially. The Company has seen a significant reduction in sales of its simulation products as revenues have declined from approximately $37,044,000 in fiscal 1997 to approximately $21,719,000 in fiscal 2000. While the decrease is due in part to the evolution of the market, the primary cause of the decrease is the result of the Company's focus on its new emerging product line of emulation solutions. The Company has seen its revenues from its emulation products increase from approximately $6,000,000 in fiscal 1997 to over $32,933,000 in fiscal 2000. There can be no assurance that the Company will be able to maintain these past trends. These trends will be dependent upon the Company introducing new products and methodologies. Furthermore, increased overall sales will also depend on an increasing number of complex ICs designed for electronic systems, integration of the Company's products with other tools for IC design, the ability of the Company's products to shorten overall customer design cycles and increased industry acceptance of the Company verifications solutions. Because the market for hardware-assisted verification products is evolving, it is difficult to predict with any assurance whether the markets for such solutions will continue to expand. There can be no assurances that such market will expand, or even if such market expands, that the Company's products will achieve and maintain the market acceptance required to maintain revenue growth and profitability in the future. New Product Development. To obtain the expected revenue growth, the Company needs to continue to invest in new product development. The Company has focused most of its development resources on its emulation products. The Company's initial emulation product was commercially released in the first quarter of fiscal 1997. The Company encountered several product design issues with its second-generation emulation product, and in addition, the EDA marketplace for emulation products continued to evolve, impacting the original design. During 1998, the Company addressed its product design issues by completely redesigning the emulation product and released its third-generation product during fiscal 1999. This third-generation emulation product provides the customer of up to approximately five million-gates of emulation capacity. While the Company has seen favorable results with its latest release, there can be no assurance that the product will adequately meet the requirements of the marketplace. There continues to be further development of the emulation product as well as other verification products, and as the Company continues to develop such products which are based on the new technology, there can be no assurance that the enhanced products or other developed products resulting from this development will provide the necessary solutions to customer design verification needs, be of acceptable quality or achieve further market acceptance. The success of the Company in developing, introducing, selling and supporting verification products will depend on a variety of factors, including but not limited to, the timely and successful enhancement of current products, completion of product design and development of future products, the timely and efficient implementation of manufacturing processes, effective sales, marketing and customer service. Furthermore, the absence of performance problems or other difficulties that may require design modifications and related expenses will contribute to overall success otherwise such issues may hinder or damage market acceptance of the products. While the Company's verification 10 11 systems are designed to provide cost and ease of use advantages intended to broaden the market for hardware-assisted verification, there can be no assurance that its products will be able to achieve such goals. Moreover, there can be no assurance that the market for such verification solutions will broaden beyond the current set of users. The Company currently maintains a research and development facility in India. Through the acquisition of this facility the Company has developed certain technology, which has resulted in new products. The research and development facility has positively impacted the Company's ability to meet its product development deadlines. However, the Company has significant development risk with respect to the continued incorporation of the acquired technology into future products. Such effort will result in increased spending on research and development as the Company attempts to continue to meet its goals and deadlines. There can be no assurance that such goals or deadlines will be achieved in a timely manner. Furthermore, should such goals and deadlines for the introduction of new products be attained, there can be no assurance that the resulting new products will adequately meet the requirements of the marketplace. Competition. The EDA industry is highly competitive and rapidly changing. The Company's products are specifically targeted at the emerging portion of the industry relating to complex designs that the Company believes benefit from its verification products. The Company currently competes with traditional software verification methodologies, including product offerings sold by Cadence, Synopsys and Mentor Graphics. The Company's main competition for the sale of emulation systems is Quickturn/Cadence and Mentor Graphics. The Company expects competition in the market for verification tools to increase as other companies attempt to introduce new products and product enhancements. Moreover, the Company competes, and expects that it will continue to compete, with established EDA companies. A number of these companies have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and larger installed customer bases than the Company. In addition, many of these competitors and potential competitors have established relationships with current and potential customers of the Company and offer a broader and more comprehensive product line. Increased competition could result in price reductions, reduced margins and loss of market share, all of which could materially adversely affect the Company. In addition, current competitors or other entities may develop other products that have significant advantages over the Company's products. 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 materially adversely affect its operating results. New Products and Technological Change. The EDA industry is characterized by extremely rapid technological change in both hardware and software development, frequent new product introductions, evolving industry standards and changing customer requirements. 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 series of simulation and emulation systems and to design, develop and support its future simulation and emulation products on a timely basis. These efforts require a high level of expenditures for research and development by the Company to address the increasingly sophisticated needs of the customers. There can be no assurance that the Company will be successful in developing and marketing product enhancements or new products that respond to technological change or evolving industry standards or changing customer requirements, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products, or that its new products and product enhancements will adequately meet the requirements of the marketplace, will be of acceptable quality or will achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce products in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results and 11 12 financial condition will be materially and adversely affected. Moreover, from time to time, the Company may announce new products or technologies that have the potential to replace the Company's existing product offerings. There can be no assurance that the announcement of new product offerings will not cause customers to defer purchases of existing Company products, which could adversely affect the Company's results of operations for any particular quarter. Dependence on Electronics Industry. The Company is dependent upon the electronics industry and, in particular, new system and IC design projects. The electronics industry is characterized by rapid technological change, short product life cycles, fluctuations in manufacturing capacity and pricing and margin pressures, all of which cause it to be volatile. As a result, the electronics industry has historically experienced sudden and unexpected downturns, at which time the number of new system and IC design projects decrease. Because most of the Company's sales occur upon the commencement of new projects for system and IC products, the Company is dependent upon the rate of commencement of new system and IC design projects. Accordingly, negative factors affecting the electronics industry could have a material adverse effect on the Company's results of operations. Dependence Upon Certain Suppliers. Certain key components used in the Company's products are presently available from sole or limited sources. The inability to develop alternative sources for these sole or limited source components or to obtain sufficient quantities of these components could result in delays or reductions in product shipments which could adversely affect the Company's operating results. The Company's systems use proprietary ASICs and FPGAs that are currently manufactured solely by American Microsystems, Inc. ("AMI") and Xilinx, Inc. ("Xilinx"), respectively. The Company generally purchases these components, including semiconductor memories used in the Company's verification hardware, pursuant to purchase orders placed from time to time in the ordinary course of business and has no supply arrangements with any of its source suppliers that require the suppliers to provide components in guaranteed quantities or at set prices. Moreover, the manufacture of these components can be extremely complex, and the Company's reliance on the suppliers of these components exposes the Company to production difficulties and quality variations that may be experienced by these suppliers. Therefore, the Company's reliance on its sole and limited source suppliers involves several risks, including a potential inability to obtain an adequate supply of required components, reduced control over pricing and timely delivery and quality of acceptable components. While the timeliness and quality of deliveries to date from such suppliers have been acceptable, there can be no assurance that problems will not occur in the future. Any prolonged inability to obtain components or subassemblies in sufficient quantities or quality or on favorable pricing or delivery terms, or any other circumstances that would require the Company to seek alternative sources of supply, could have a material adverse effect on the Company's operating results and could damage the Company's relationships with its customers. Customer Concentration. A relatively limited number of customers have historically accounted for a substantial portion of the Company's net revenues. During fiscal 2000, 1999 and 1998, sales to the Company's top ten customers accounted for approximately 66%, 60% and 45%, respectively, of the Company's net revenues. The Company expects that sales of its products to a limited number of customers will continue to account for a high percentage of net revenues for the foreseeable future. The loss of a major customer or any reduction in orders by such customers, including reductions due to market or competitive conditions in the electronics or EDA industries, would have an adverse effect on the Company's results of operations. Moreover, the Company's ability to increase its sales will depend in part upon its ability to obtain orders from new customers, as well as the financial condition and success of its existing customers and the general economy. There can be no assurance that such increases will occur. 12 13 Euro Conversion. On January 1, 1999, certain member countries of the European Union established fixed conversion rates between their existing currencies and the Euro. The transition period for the introduction of the Euro ends June 30, 2002. Issues facing the Company as a result of the introduction of the Euro include converting information technology systems, reassessing currency risk, renegotiating vendor contracts, and processing tax and accounting records. We are addressing these issues and do not currently expect the Euro to have a material effect on our financial conditions or results of operations. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operations, including increases in accounts receivable, inventory and capital equipment acquisitions, primarily through private and public sales of equity securities and a loan secured by capital equipment. The Company's cash, cash equivalents and short-term investments increased to $21,809,000 at December 30, 2000 from $19,803,000 at September 30, 2000. The increase was a result of $5,276,000 of cash provided by operating activities offset by $1,721,000 of cash used in investing activities (excluding short-term investment activities) and $1,549,000 of cash used in financing activities. Operating Activities - The Company's operating activities provided cash of $5,276,000 during the first three months of fiscal 2000. The cash provided by operations was primarily due to net income adjusted for depreciation, amortization and accrued rent, decreases in accounts receivables and prepaid expenses, combined with an increase in accounts payable. These increases in cash provided by operations were offset by increases in inventories and other assets combined with decreases in accrued payroll expenses, accrued commissions, income taxes payable, other accrued expenses and deferred revenues. Investing Activities - Net cash used in investing activities for the first three months of 2000 was $7,503,000. The use of cash was primarily related to the purchases of short-term investments of $7,781,000 and the acquisition of capital equipment of $1,721,000) offset by the maturities of short-term investment in the amount of $1,999,000. Financing Activities -- Net cash used in financing activities for the three months ended December 30, 2000, was $1,549,000 and was primarily related to the repayment of the outstanding line of credit in the amount of $1,809,000 offset by the net sales of stock under stock option and purchase plans during the three months. The Company's primary unused sources of funds at December 30, 2000 consisted of $8,256,000 of cash and cash equivalents, in addition to $13,553,000 of short-term investments. The Company continues to carry a $3,000,000 working capital line and a $1,200,000 capital equipment line. Of this total the Company has approximately $2,700,000 available under the Company's lines as the remainder serves as collateral under two letter of credit arrangements the Company has outstanding relating to its facilities. The Company believes that its current cash, cash equivalents, short-term investments and its available credit facility, together with cash and cash equivalents generated from operations will be sufficient to finance its operations for at least the next twelve months. Should the Company require other financing arrangements, there can be no assurance that such financing will be available, if at all, on terms favorable or acceptable to the Company. 13 14 PART II. OTHER INFORMATION ITEMS 1-5 Not applicable ITEM 6 Exhibits and Reports on Form 8-K (a) INDEX TO EXHIBITS INDEX TO EXHIBITS

14 15

15 16

(b) REPORTS ON FORM 8-K NONE 16 17 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. IKOS SYSTEMS, INC. Registrant Date: February 9, 2001 /s/ Joseph W. Rockom ----------------------------------------- (JOSEPH W. ROCKOM CFO) Principal Financial Officer, Duly Authorized Officer 17

IKOS SYSTEMS INC 10-Q