UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q - -------------------------------------------------------------------------------- X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 1999 or - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _________ to ________ - -------------------------------------------------------------------------------- Commission file number: 000-20923 SUMMIT DESIGN, INC. (Exact name of registrant as specified in its charter) DELAWARE 93-1137888 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 9305 S. W. GEMINI DRIVE, BEAVERTON, OREGON 97008 (Address of principal executive office) Registrant's Telephone number, including area code: (503) 643-9281 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- As of August 12, 1999, the Registrant had outstanding 15,694,520 shares of Common Stock. SUMMIT DESIGN, INC. INDEX PART I FINANCIAL INFORMATION Item 1 Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of June 30, 1999 (unaudited) and December 31, 1998. 3 Condensed Consolidated Statements of Operations for the three months ended June 30, 1999 and 1998 and for the six months ended June 30, 1999 and 1998 (unaudited). 4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 1998 (unaudited). 5 Notes to Condensed Consolidated Financial Statements. 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 3 Quantitative and Qualitative Disclosures about Market Risk 28 PART II OTHER INFORMATION Item 4 Submissions of matters to a vote of security holders 29 Item 6 Exhibits and Reports on Form 8-K 29 Items 1, 2, 3 and 5 Not Applicable 29 Signature 30 Exhibit Index 31 -2- SUMMIT DESIGN, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) June 30, 1999 December 31, 1998 ----------------------- ---------------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents.................... $ 24,028 $27,693 Accounts receivable, net..................... 8,533 8,852 Prepaid expenses and other................... 585 862 Deferred income taxes........................ 792 792 ----------------------- ---------------------- Total current assets....................... 33,938 38,199 Furniture and equipment, net.................... 3,834 4,113 Intangibles, net................................ 2,366 2,870 Goodwill, net................................... 1,521 2,742 Deposits and other assets....................... 3,013 2,286 ----------------------- ---------------------- Total assets............................ $44,672 $50,210 ----------------------- ---------------------- ----------------------- ---------------------- LIABILITIES Current liabilities: Long-term debt, current portion.............. $ 92 $ 54 Capital lease obligation, current portion.... 20 43 Accounts payable............................. 982 2,520 Accrued liabilities.......................... 4,873 5,687 Deferred revenue............................. 5,546 5,640 ----------------------- ---------------------- Total current liabilities.................. 11,513 13,944 Long-term debt, less current portion............ - 156 Deferred revenue, less current portion.......... 117 146 Deferred income tax............................. 489 489 ----------------------- ---------------------- Total liabilities.......................... 12,119 14,735 ----------------------- ---------------------- Commitments and contingencies STOCKHOLDERS' EQUITY Common stock, $.01 par value. Authorized 30,000 shares; issued and outstanding 15,694 shares at June 30, 1999 and 15,457 shares at December 31, 1998. ............................. 156 155 Additional paid-in capital...................... 44,354 44,039 Accumulated deficit............................. (11,957) (8,719) ----------------------- ---------------------- Total stockholders' equity................. 32,553 35,475 ----------------------- ---------------------- Total liabilities and stockholders' equity $44,672 $50,210 ----------------------- ---------------------- ----------------------- ---------------------- The accompanying notes are an integral part of the condensed consolidated financial statements -3- SUMMIT DESIGN, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------ 1999 1998 1999 1998 ------- ------- ------- ------- Revenue: Product licenses................................. $ 4,549 $ 8,574 $ 8,605 $16,775 Maintenance and services......................... 2,633 2,347 5,393 4,411 Other............................................ - 91 - 183 ------- ------- ------- ------- Total revenue.................................. 7,182 11,012 13,998 21,369 Cost of revenue: Product licenses................................. 127 118 258 311 Maintenance and services......................... 348 279 606 504 Amortization of purchased technologies........... 166 166 331 331 ------- ------- ------- ------- Total cost of revenue.......................... 641 563 1,195 1,146 ------- ------- ------- ------- Gross profit................................ 6,541 10,449 12,803 20,223 Operating expenses: Research and development......................... 2,491 2,978 5,167 5,907 Sales and marketing.............................. 3,179 3,258 6,087 6,306 General and administrative....................... 1,373 1,080 2,540 2,142 Amortization of goodwill and other intangibles... 697 697 1,395 1,395 Non-recurring charges............................ - 227 1,340 227 ------- ------- ------- ------- Total operating expenses....................... 7,740 8,240 16,529 15,977 Income (loss) from operations....................... (1,199) 2,209 (3,726) 4,246 Other income, net................................... 195 204 488 492 ------- ------- ------- ------- Income (loss) before income taxes................... (1,004) 2,413 (3,238) 4,738 Income tax provision................................ - 958 - 1,881 ------- ------- ------- ------- Net income (loss)................................... $(1,004) $ 1,455 $(3,238) $ 2,857 ------- ------- ------- ------- ------- ------- ------- ------- Earnings (loss) per share: Basic.......................................... $ (0.06) $ 0.10 $ (0.21) $ 0.19 ------- ------- ------- ------- ------- ------- ------- ------- Diluted........................................ $ (0.06) $ 0.09 $ (0.21) $ 0.18 ------- ------- ------- ------- ------- ------- ------- ------- Number of shares used in computing earnings (loss) per share: Basic.......................................... 15,621 15,058 15,666 14,984 Diluted........................................ 15,621 16,285 15,666 16,240 The accompanying notes are an integral part of the condensed consolidated financial statements -4- SUMMIT DESIGN, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Six Months Ended June 30, ----------------------- 1999 1998 ------- ------- Cash flows from operating activities: Net income (loss)..................................... $(3,238) $ 2,857 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization.................... 2,545 2,262 Amortization of future contingent share liability - 1,100 Loss on asset disposition........................ 34 - Deferred taxes................................... - (81) Equity in losses of and transactions with unconsolidated joint venture.................. 120 350 Changes in assets and liabilities: Accounts receivable......................... 320 (541) Prepaid expenses and other.................. 276 216 Other, net.................................. (198) 131 Accounts payable............................ (1,539) 97 Accrued liabilities......................... (814) 1,066 Deferred revenue............................ (123) (37) ------- ------- Net cash provided by (used in) operating activities (2,617) 7,420 ------- ------- Cash flows from investing activities: Additions to furniture and equipment.................. (586) (1,045) Proceeds from sale of assets.......................... 11 - Notes receivable from related parties, net............ (650) (325) Loan to a joint venture............................... - (750) ------- ------- Net cash used in investing activities............... (1,225) (2,120) ------- ------- Cash flows from financing activities: Issuance of common stock, net of issuance costs....... 317 1,046 Tax benefit of option exercises....................... - 825 Payments to acquire treasury stock.................... - (2,329) Principal payments of debt obligations................ (117) (21) Principal payments of capital lease obligations....... (23) (26) ------- ------- Net cash provided by (used in) financing activities. 177 (505) ------- ------- Increase (decrease) in cash and cash equivalents.... (3,665) 4,795 Cash and cash equivalents, beginning of period............. 27,693 19,973 ------- ------- ------- ------- Cash and cash equivalents, end of period................... $24,028 $24,768 ------- ------- ------- ------- Supplemental disclosure of cash flow information: Cash paid during the period for: Interest......................................... $ 2 $ 3 Income taxes..................................... 1,167 667 Supplemental disclosure of non-cash financing activities: Retirement of treasury stock.......................... 11,555 The accompanying notes are an integral part of the condensed consolidated financial statements -5- SUMMIT DESIGN, INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared by Summit Design, Inc. ("Summit" or "the Company") in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company, and its results of operations and cash flows. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the years ended December 31, 1998, 1997 and 1996 included in the Company's Form 10-K filed for December 31, 1998. The results of operations for the six months ended June 30, 1999 are not necessarily indicative of the results that may be expected for the year ended December 31, 1999 or any other future interim period, and the Company makes no representations related thereto. 2. BALANCE SHEET COMPONENTS (IN THOUSANDS) June 30, 1999 December 31, 1998 ---------------------- ---------------------- (Unaudited) Accounts receivable: Trade receivables............................... $ 9,000 $ 9,363 Less allowance for doubtful accounts............ (467) (511) ---------------------- ---------------------- $ 8,533 $ 8,852 ---------------------- ---------------------- ---------------------- ---------------------- Furniture and equipment: Office furniture equipment ..................... $ 571 $ 1,201 Computer equipment.............................. 5,639 5,138 Leasehold improvements.......................... 596 491 ---------------------- ---------------------- 6,806 6,830 Less: accumulated depreciation and amortization.... (2,972) (2,717) ---------------------- ---------------------- $ 3,834 $ 4,113 ---------------------- ---------------------- ---------------------- ---------------------- Accrued liabilities: Payroll and related benefits.................... $ 2,322 $ 3,051 Severance....................................... 1,273 - Sales and marketing............................. 445 332 Accounting and legal............................ 218 310 Federal and state income taxes payable.......... 352 1,549 Sales taxes payable............................. 45 160 Other ......................................... 218 285 ---------------------- ---------------------- Total accrued liabilities..................... $ 4,873 $ 5,687 ---------------------- ---------------------- ---------------------- ---------------------- -6- SUMMIT DESIGN, INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 3. RECONCILIATION OF EARNINGS PER SHARE On January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." In accordance with SFAS No. 128, basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of common stock issuable upon exercise of stock options using the treasury stock method. The following provides a reconciliation of the numerators and denominators of the basic and diluted per share computations: Three Months Ended Six Months Ended June 30, June 30, --------------------------- -------------------------- 1999 1998 1999 1998 ------------ --------- ---------- --------- Numerator: Net income (loss) $ (1,004) $ 1,455 $ (3,238) $ 2,857 ------------ --------- ---------- --------- ------------ --------- ---------- --------- Denominator: Denominator for basic earnings (loss) per share weighted average shares 15,621 15,058 15,666 14,984 Effect of dilutive securities: Employee stock options - 1,227 - 1,256 ------------ --------- ---------- --------- Denominator for diluted earnings (loss) per share 15,621 16,285 15,666 16,240 ------------ --------- ---------- --------- ------------ --------- ---------- --------- Net income (loss) per share - basic $ (0.06) $ 0.10 $ (0.21) $ 0.19 ------------ --------- ---------- --------- ------------ --------- ---------- --------- Net income (loss) per share - diluted $ (0.06) $ 0.09 $ (0.21) $ 0.18 ------------ --------- ---------- --------- ------------ --------- ---------- --------- 4. BUSINESS SEGMENTS, EXPORTS AND MAJOR CUSTOMERS: The Company operates in a single industry segment comprising the electronic design automation industry. Net revenue by geographic region (in thousands) and as a percentage of total revenue for each region outside North America is as follows: For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------------- ------------------------ 1999 1998 1999 1998 ------ ------ ------ ------ Europe.................................... $1,664 $1,701 $2,922 $2,859 Japan..................................... 1,715 3,994 2,721 1,678 Other Asia Pacific........................ 100 654 201 501 As a Percentage of Total Revenue: Europe.................................... 23.2% 15.4% 20.9% 13.4% Japan..................................... 23.9 36.3 19.4 7.9 Other Asia Pacific........................ 1.4 5.9 1.4 2.3 Sales through one distributor accounted for 23.5%, 17.7%, 24.3%, and 19.3% of the Company's total revenue for the three months ended June 30, 1999 and 1998, and for the six months ended June 30, 1999 and 1998, respectively. Sales to Credence Systems Corporation ("CSC") accounted for 23.2% and 27.0% of the Company's total revenue for the three and six months ended June 31, 1998. Such revenue included $2.9 million of Visual Testbench license sales made pursuant to an OEM agreement with CSC. As of December 31, 1998, CSC had fully satisfied its obligation to purchase Visual Testbench Licenses pursuant to the OEM agreement and the Company does not expect to receive any additional revenue from sales of Visual Testbench licenses. The Company did not receive any revenue from CSC for the six months ended June 30, 1999. Revenue generated pursuant to another OEM agreement accounted for 10.7%, 7.5%, 12.6%, and 7.2% of the Company's total revenue for the three months ended June 30, 1999 and 1998 and for the six months ended June 30, 1999 and 1998, respectively. Foreign operations of Summit Design (EDA) Ltd. accounted for less than 10% of total revenue of the Company for the three and six months ended June 30, 1999. Identifiable assets of the Company's Israeli subsidiary were less than 10% of total assets at December 31, 1998. -7- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IMPORTANT NOTE ABOUT FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and similar expressions identify such forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. Factors which could cause actual results to differ materially include those set forth in the following discussion, and, in particular, the risks discussed below under the subheading "Additional Risk Factors that Could Affect Operating Results and Market Price of Stock." Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements. OVERVIEW Summit Design, Inc. ( the "Company") was founded in December 1993 to act as the holding company for Test Systems Strategies, Inc. ("TSSI") and SEE Technologies, (now Summit Design (EDA) Ltd.) (collectively, the "Reorganization"). TSSI was founded in 1979 to develop and market integrated circuit ("IC" or "chip") manufacturing test products. In January 1993, TSSI retained a new Chief Executive Officer and began to restructure its senior management team. Thereafter, the Company broadened its strategy from focusing primarily on manufacturing test products to include providing HLDA design creation and verification tools and integrating these with its core technology. As part of its strategy, in early 1994, TSSI acquired SEE Technologies, an Israeli company that, through its predecessor, began operations in 1983 and had operated primarily as a research and development and consulting company focused on the electronic design automation ("EDA") market. As a result of the Reorganization, TSSI and SEE Technologies became wholly-owned subsidiaries of the Company in the first quarter of 1994. Prior to the Reorganization, the Company's TDS product and related maintenance revenue accounted for all of the Company's revenue. After the Reorganization and through June 30, 1997, the Company's revenue was predominantly derived from two product lines, Visual HDL, which includes Visual HDL for VHDL and Visual HDL for Verilog, and TDS. As a result of the July 1997 sale of the TDS product line, Design to Test products are no longer a source of revenue for the Company. With the acquisition of TriQuest Design Automation, Inc. ("TriQuest") in February 1997, Simulation Technologies Corp ("SimTech"), in September 1997, and ProSoft OY ("ProSoft") in June 1998, the Company has also derived revenue from verification products which include hardware-software co-verification, code coverage, and HDL debugging products as well as analysis, verification and RTL optimization tools. Revenue consists primarily of fees for licenses of the Company's software products, maintenance and customer training. Product license revenue is derived from the sale of software licenses to distributors and end-users. Revenue from the sale of software licenses is recognized upon shipment of the product if remaining vendor obligations are insignificant and collection of the resulting receivable is probable, otherwise revenue from such software products is deferred until such time as vendor obligations are met. Maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically 12 months. Revenue from customer training is recognized when the service is performed. Revenue earned on software arrangements involving multiple elements is allocated to each element based on vendor-specific objective evidence (VSOE) of the fair value of the various elements within the arrangement. The Company sells its products through a direct sales force in North America and selected European countries and through distributors in the Company's other international markets. Revenue from product sales through distributors is recognized net of the associated distributor discounts. Fees received for granting distribution rights are deferred and recognized ratably over the term of the distribution agreement. -8- Although the Company has not adopted a formal return policy, the Company generally reimburses customers in full for returned products. Estimated sales returns are recorded when the related revenue is recognized. The Company's products perform a variety of functions, certain of which are, and in the future may be, offered as separate products or discrete point solutions by the Company's existing and future competitors. For example, certain companies currently offer design entry products without simulators. There can be no assurance that such competition will not cause the Company to offer point solutions instead of, or in addition to, the Company's current software products. Such point solutions would be priced lower than the Company's current product offerings and could cause the Company's average selling prices to decrease. Accordingly, based on these and other factors, the Company expects that average selling prices for its products may continue to fluctuate in the future. The Company entered into a joint venture with Anam, effective April 1, 1996, pursuant to which the joint venture corporation (Summit Asia, Ltd. ("Summit Asia")) acquired exclusive rights to sell, distribute and support all of the Company's products in the Asia-Pacific regions, excluding Japan. Prior to that date, Anam was an independent distributor of the Company's products in Korea. In April 1998, the joint venture corporation, Summit Asia, which is headquartered in Korea, was renamed Asia Design Corporation ("ADC"). In May 1998, the Company exchanged a portion of its ownership in ADC for ownership in another company located in Hong Kong, Summit Design Asia, Ltd. ("SDA"). SDA also acquired an equity investment in ADC. In June 1998, the Company and Anam each loaned SDA $750,000, which is guaranteed by ADC. SDA acquired from ADC the exclusive rights to sell, distribute and support the Company's products in Asia Pacific region, excluding Japan. SDA granted distribution rights to the Company's products to ADC for the Asia Pacific region, excluding Japan. In December 1998, SDA cancelled ADC's distribution rights in all areas except Korea and granted non-exclusive distribution rights to Semiconductor Technologies Australia ("STA") for the Asia Pacific region, excluding Japan and Korea. For the six months ended June 30, 1999 and 1998, sales through SDA accounted for 1.4% and 3.1% of the Company's revenue, respectively. The Company accounts for its ownership interest in SDA and ADC on the equity method of accounting and, as a result, the Company's share of the earnings and losses of SDA and ADC are recognized as income or losses in the Company's income statement in "Other income, net." The Company does not expect SDA or ADC to recognize a profit for the foreseeable future and thus does not expect to recognize income from its investment in SDA or ADC for the foreseeable future, if at all. There can be no assurance that the restructuring will result in SDA or ADC becoming profitable or that revenue attributable to sales in the Asia Pacific region, excluding Japan, would increase. Approximately 48.4%, 37.8%, 47.7%, and 35.1% of the Company's total revenue for the three months ended June 30, 1999 and 1998, and for the six months ended June 30, 1999 and 1998, respectively, were attributable to sales made outside the United States, which includes the Asia Pacific region and Europe. Approximately, 25.3%, 22.4%, 26.8% and 21.7% of the Company's revenue for the three months ended June 30, 1999 and 1998, and for the six months ended June 30, 1999 and 1998, respectively, were attributable to sales made in the Asia Pacific region. Approximately 23.2%, 15.4%, 20.9%, and 13.4% of the Company's revenue for the three months ended June 30, 1999 and 1998, and for the six months ended June 30, 1999 and 1998, respectively, were attributable to sales made in Europe. The increase in the percentage of revenue from sales made outside the United States in 1999 is primarily the result of a decrease in domestic sales made to Credence Systems Corporation ("CSC") in 1998 pursuant to an OEM agreement. As of December 31, 1998, CSC had satisfied its obligations under the OEM agreement and the Company will not receive any additional revenue pursuant to the OEM agreement. The Company expects that international revenue will continue to represent a significant portion of its total revenue. The Company's international revenue is currently denominated in U.S. dollars. As a result, increases in the value of the U.S. dollar relative to foreign currencies could make the Company's products more expensive and, therefore, potentially less competitive in those markets. The Company pays the expenses of its international operations in local -9- currencies and does not engage in hedging transactions with respect to such obligations. International sales and operations are subject to numerous risks, including tariff regulations and other trade barriers, requirements for licenses, particularly with respect to the export of certain technologies, collectability of accounts receivable, changes in regulatory requirements, difficulties in staffing and managing foreign operations and extended payment terms. There can be no assurance that such factors will not have a material adverse effect on the Company's future international sales and operations and, consequently, on the Company's business, financial condition, results of operations or cash flows. In addition, financial markets and economies in the Asia Pacific region have been experiencing adverse economic conditions. Demand for and sales of the Company's products in the Asia Pacific region have continued to decrease and there can be no assurance that such adverse economic conditions will not worsen. In June 1999, the Company lowered Seiko's specified quotas due to the adverse economic conditions in the Asia Pacific Region. As a result, Summit expects sales through Seiko to decrease for at least the current and following two quarters and revenue attributable to sales in the Asia Pacific region to decrease.(1) On February 28, 1997, the Company completed its acquisition of TriQuest. TriQuest develops HDL analysis, optimization, and verification tools for the design of high performance, deep submicron integrated circuits. The transaction has been accounted for as a "pooling of interest" in accordance with generally accepted accounting principles. Effective July 1, 1997, the Company sold substantially all of the assets used in its business of developing and marketing its Test Development Series "TDS" Products (the "Asset Sale") to CSC. As of July 1, 1997, TDS products ceased to be a source of such revenues. CSC assumed the Company's obligations under TDS maintenance contracts entered into prior to the closing and the Company has not recognized deferred revenue associated with such contracts since June 30, 1997. The Company maintained exclusive rights to its Visual Testbench technology and CSC agreed to purchase a minimum of $16 million of Visual Testbench licenses over a thirty-month period beginning July 1997, subject to specified quarterly maximums and certain additional conditions, and $2 million of maintenance over an eighteen month period beginning July 1997. In December 1998, the Company and CSC agreed to amend the agreement and as of December 31, 1998, CSC had satisfied its obligation to purchase $16 million of Visual Testbench licenses. CSC also obtained shared ownership of the Visual Testbench source code in December 1998 and has the right to sell Visual Testbench licenses based on the source code received from the Company. On September 9, 1997, the Company acquired SimTech, a company that develops and distributes hardware-software co-verification, code coverage and HDL debugging software. The aggregate consideration for the acquisition was 1,256,800 shares of the Company's common stock, 723,200 options to purchase the Company's common stock and $3.9 million in cash. The transaction was accounted for using the purchase method of accounting. Accordingly, SimTech's results of operations for the period from September 9, 1997 are included in the consolidated statements of operations. The purchase price was allocated to the net assets acquired based on their estimated fair market values at the date of acquisition. After discussion with the staff of the Securities and Exchange Commission (the "Staff") the Company restated the consolidated financial statements as of and for the quarters ended September 30, 1997, March 31, 1998, June 30, 1998 and September 30, 1998 and as of December 31, 1997 and for the year ended December 31, 1997 to reflect a change in the original accounting treatment to the September 1997 acquisition of SimTech. In connection with the acquisition of SimTech, the Company repurchased 939,000 shares of common stock in a private transaction at an average price of $12.30 per share for $11.6 million in September 1997. - ------------------- (1) This paragraph contains forward-looking statements reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Investors are strongly encouraged to review the section entitled "Additional Risk Factors That Could Affect Operating Results and Market Price of Stock" commencing on page 19 for a discussion of factors that could affect future performance. -10- On December 23, 1997, the Company announced that the Board of Directors had authorized the repurchase of up to 750,000 shares of the Company's Common Stock. From January 1, 1998 to May 12, 1998, the Company repurchased 162,500 shares of its common stock at a cost of $2.3 million. The Company subsequently issued these shares through the exercise of stock options during the three months ended June 30, 1998. On June 29, 1998, the Company cancelled this stock repurchase plan. On June 30, 1998, the Company completed its acquisition of ProSoft. ProSoft develops software tools used to verify embedded systems software prior to the availability of a hardware prototype. The aggregate consideration for the acquisition (including shares of common stock reserved for issuance upon exercise of ProSoft options, which were exchanged for options of the Company) was 248,334 shares of common stock. The transaction has been accounted for as a pooling of interests in accordance with generally accepted accounting principles. In compliance with such principles, the Company's financial statements have been restated to include the accounts of ProSoft as if the acquisition had occurred at the beginning of the first period presented. In September 1998, the Company announced its proposed acquisition of OrCAD, Inc. In February 1999, the Company announced that its planned acquisition of OrCAD, Inc. had been terminated. During the quarter ended December 31, 1998, the Company incurred approximately $1.0 million in costs related to the terminated acquisition. -11- RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain financial data as a percentage of revenue. Three Months Ended Six Months Ended June 30, June 30 ------------------------ ------------------------ 1999 1998 1999 1998 ---------- ---------- ---------- ---------- Revenue: Product licenses.......................... 63.3 % 77.9 % 61.5 % 78.5 % Maintenance and services.................. 36.7 21.3 38.5 20.6 Other..................................... - 0.8 - 0.9 ----- ----- ----- ----- Total revenue........................ 100.0 100.0 100.0 100.0 Cost of revenue: Product licenses.......................... 1.8 1.1 1.8 1.5 Amortization of purchased technologies.... 4.8 2.5 4.3 2.4 Maintenance and services.................. 2.3 1.5 2.4 1.5 ----- ----- ----- ----- Total cost of revenue................ 8.9 5.1 8.5 5.4 Gross profit......................... 91.1 94.9 91.5 94.6 Operating expenses: Research and development.................. 34.7 27.0 36.9 27.6 Sales and marketing....................... 44.3 29.6 43.5 29.5 General and administrative ............... 19.1 9.8 18.1 10.0 Amortization of goodwill and other intangibles............................ 9.7 6.3 10.0 6.5 Non-recurring charges (a)................. - 2.1 9.6 1.1 ----- ----- ----- ----- Total operating expenses............. 107.8 74.8 118.1 74.7 ----- ----- ----- ----- Income (loss) from operations.................. (16.7) 20.1 (26.6) 19.9 Other income (expense), net.................... 2.7 1.9 3.5 2.3 ----- ----- ----- ----- Income (loss) before income taxes.............. (14.0) 22 (23.1) 22.2 Income (loss) tax provision.................... - 8.7 0.0 8.8 ----- ----- ----- ----- ----- ----- ----- ----- Net income (14.0)% 13.3 % (23.1)% 13.4 % ----- ----- ----- ----- ----- ----- ----- ----- (a) Non-recurring charges of $1.3 million for the six months ended June 30, 1999 relate to severance obligations to certain management personnel, which will be paid in future periods. Non-recurring charges of $227,000 for the three and six months ended June 30, 1998 relate to the acquisition of ProSoft. TOTAL REVENUE Total revenue decreased by 34.8% from $11 million for the three months ended June 30, 1998 to $7.2 million for the three months ended June 30, 1999. Sales through one distributor accounted for 23.5%, 17.7%, 24.3%, and 19.3% of the Company's total revenue for the three months ended June 30, 1999 and 1998, and for the six months ended June 30, 1999 and 1998, respectively. Sales to CSC accounted for 23.2% and 27.0% of the Company's total revenue for the three and six months ended June 31, 1998. Such revenue included $2.9 million of Visual Testbench license sales made pursuant to an OEM agreement with CSC. As of December 31, 1998, CSC had fully satisfied its obligation to purchase Visual Testbench Licenses pursuant to the OEM agreement and the Company does not expect to receive any additional revenue from sales of Visual Testbench. The Company did not receive any revenue from CSC for the six months ended June 30, 1999. Revenue generated pursuant to another OEM agreement accounted for 10.7%, 7.5%, 12.6%, and 7.2% of the Company's total revenue for the three months ended June 30, 1999 and 1998 and for the six months ended June 30, 1999 and 1998, respectively. -12- REVENUE PRODUCT LICENSES REVENUE The Company's product licenses revenue is derived from license fees from the Company's HLDA products. Product licenses revenue decreased by 46.9% from $8.6 million for the three months ended June 30, 1998 to $4.5 million for the three months ended June 30, 1999. Product licenses revenue decreased by 48.7% from $16.8 million for the six months ended June 30, 1998 to $8.6 million for the six months ended June 30, 1999. The decrease in product licenses revenue was primarily attributable to the Company ceasing to receive revenue from CSC pursuant to the OEM Agreement. The decrease was also attributable to decreased sales as a result of the Company hiring fewer sales and marketing personnel than planned in the fourth quarter of 1998 and the first two quarters of 1999 and attrition in the existing sales force during the first two quarters of 1999. MAINTENANCE AND SERVICES REVENUE The Company's maintenance and services revenue is derived from maintenance contracts related to the Company's HLDA products and training classes offered to purchasers of the Company's software products. Maintenance and services revenue increased 12.2% from $2.3 million for the three months ended June 30, 1998 to $2.6 million for the three months ended June 30, 1999. Maintenance and services revenue increased 22.3% from $4.4 million for the six months ended June 30, 1998 to $5.4 million for the six months ended June 30, 1999. This increase is primarily attributable to maintenance contract renewals by the installed base of HLDA customers, and to a lesser extent from non-recurring engineering services provided to one customer, which is not expected to reoccur. OTHER REVENUE Other revenue consists of revenue from one-time technology sales and fees received for granting distribution rights. Other revenue decreased 100% from $91,000 for the three months ended June 30, 1998 to $0 for the three months ended June 30, 1999. Other revenue decreased 100% from $183,000 for the six months ended June 30, 1998 to $0 for the six months ended June 30, 1999. Although the Company renewed a significant distribution agreement the renewal did not include additional fees. As a result, the distribution rights fees paid at the inception of the agreement and amortized into revenue at $91,000 each quarter over the agreement period were no longer a source of other revenue as of December 31, 1998. COST OF REVENUE COST OF PRODUCT LICENSES REVENUE Cost of product licenses revenue includes product packaging, software documentation, labor and other costs associated with handling, packaging and shipping product and other production related costs. The cost of product licenses revenue increased 7.6% from $118,000 for the three months ended June 30, 1998 to $127,000 for the three months ended June 30, 1999. The cost of product licenses revenue decreased 17.0% from $311,000 for the six months ended June 30, 1998 to $258,000 for the six months ended June 30, 1999. As a percentage of product licenses revenue, the cost of product licenses revenue increased from 1.4% of product license revenue for the three months ended June 30, 1998 to 2.8% of product license revenue for the three months ended June 30, 1999. As a percentage of product licenses revenue, the cost of product licenses revenue increased from 1.9% of product license revenue for the six months ended June 30, 1998 to 3.0% of product license revenue for the six months ended June 30, 1999. This increase as a percentage of product license revenue was primarily due to fixed costs spread over decreased product license revenue. -13- COST OF MAINTENANCE AND SERVICES REVENUE Cost of maintenance and services revenue, which consists primarily of personnel costs for customer support and training classes offered to purchasers of the Company's products, increased 24.7% from $279,000 for the three months ended June 30, 1998 to $348,000 for the three months ended June 30, 1999. Cost of maintenance and services revenue increased 20.2% from $504,000 for the six months ended June 30, 1998 to $606,000 for the six months ended June 30, 1999. As a percentage of maintenance and services revenue, the cost of maintenance and services revenue increased from 11.9% for the three months ended June 30, 1998 to 13.2% for the three months ended June 30, 1999. As a percentage of maintenance and services revenue, the cost of maintenance and services revenue decreased from 11.4% for the six months ended June 30, 1998 to 11.2% for the six months ended June 30, 1999. The increase in the cost of maintenance and services revenue as a percentage of revenue, and in actual dollars, for the three months ended June 30, 1999 over the same period in 1998 was due primarily to additional costs incurred in the three months ended June 30, 1999 related to the distribution of a major upgrade to customers with maintenance contracts. The decrease in the cost of maintenance and services revenue as a percent of revenue for the six months ended June 30, 1999 over the same period in 1998 was primarily the result of increased maintenance and services revenue in 1999. AMORTIZATION OF PURCHASED TECHNOLOGIES The Company recorded $2.4 million of purchased technologies (intangibles) as part of the SimTech acquisition which are being amortized to cost of revenue on a straight-line basis over periods ranging from two to five years beginning September 9, 1997. The Company expensed approximately $166,000 for the three months ended June 30, 1999 and 1998. The Company expensed approximately $331,000 for the six months ended June 30, 1999 and 1998, respectively. OPERATING EXPENSES RESEARCH AND DEVELOPMENT Research and development expenses consist of the engineering and operations support costs of developing new products and enhancements to existing products and performing quality assurance activities. Research and development expenses decreased 16.4% from $3.0 million for the three months ended June 30, 1998 to $2.5 million for the three months ended June 30, 1999. Research and development expenses decreased 12.5% from $5.9 million for the six months ended June 30, 1998 to $5.1 million for the six months ended June 30, 1999. Research and development expenses for the three and six months ended June 30, 1998 included $550,000 and $1,100,000, respectively, of compensation expense recorded in connection with the Company's acquisition of SimTech in September 1997. The Company recorded a total of $4.4 million of compensation expense for shares issued as part of the acquisition which were contingent upon continued employment and were being expensed as the employment obligation lapsed. This expense was being recorded on a straight-line basis over the two year employment obligation period. However, in December 1998, the employment agreements to which this contingent compensation related were amended to eliminate the continued employment obligation and at that time, the remaining unrecorded compensation was expensed. Excluding the $550,000 compensation expense recorded in the three months ended June 30, 1998, research and development expense increased 2% from $2.4 million for the three months ended June 30, 1998 to $2.5 million for the same period in 1999. Excluding the $1,100,000 compensation expense recorded in the six months ended June 30, 1998, research and development expense increased 7.5% from $4.8 million for the six months ended June 30, 1998 to $5.2 million for the same period in 1999. -14- As a percentage of total revenue, research and development expenses increased from 27.0% and 27.6% for the three and six months ended June 31, 1998, respectively, to 34.7% and 36.9% for the three and six months ended June 30, 1999, respectively. The increase in research and development expenses as a percent of revenue is the result of a decrease in total revenues for the three and six months ended June 30, 1999. The Company continues to believe that significant investment in research and development is required to remain competitive in its markets, and the Company therefore anticipates that research and development expense will increase in absolute dollars in future periods, but may vary as a percent of revenue. (1) SALES AND MARKETING Sales and marketing expenses, consisting primarily of salaries, commissions and promotional costs, decreased 2.4% from $3.3 million for the three months ended June 30, 1998 to $3.2 million for the three months ended June 30, 1999. Sales and marketing expenses decreased 3.5% from $6.3 million for the six months ended June 30, 1998 to $6.1 million for the six months ended June 30, 1999. This decrease was primarily attributable to the Company hiring fewer sales and marketing personnel than planned in the fourth quarter of 1998 and the first two quarters of 1999 and attrition in the existing sales force during the first quarter of 1999. As a percentage of total revenue, sales and marketing expenses increased from 29.6% for the three months ended June 30, 1998 to 44.3% for the three months ended June 30, 1999. As a percentage of total revenue, sales and marketing expenses increased from 29.5% for the six months ended June 30, 1998 to 43.5% for the six months ended June 30, 1999. The increase as a percentage of total revenue was primarily attributable to the decrease in total revenue for 1999. In the future, the Company expects sales and marketing expenses to continue to increase in absolute dollars, in part due to the hiring of additional sales and marketing personnel.(2) GENERAL AND ADMINISTRATIVE General and administrative expenses consist primarily of the corporate, finance, human resource, information services, administrative, and legal and accounting expenses of the Company. General and administrative expenses increased 27.1% from $1.1 million for the three months ended June 30, 1998, to $1.4 million for the three months ended June 30, 1999. General and administrative expenses increased 18.6% from $2.1 million for the six months ended June 30, 1998, to $2.5 million for the six months ended June 30, 1999. As a percentage of total revenue, general and administrative expenses increased from 9.8% for the three months ended June 30, 1998 to 19.1% for the three months ended June 30, 1999. As a percentage of total revenue, general and administrative expenses increased from 10.0% for the six months ended June 30, 1998 to 18.1% for the six months ended June 30, 1999. The increase in general and administrative expenses as a percentage of total revenue and in actual dollars was primarily attributable to the addition of four positions and the cost of the CEO search. AMORTIZATION OF INTANGIBLES AND GOODWILL The Company recorded $4.1 million in intangibles (excluding $2.4 million of purchased technologies) and $3.8 million of goodwill as part of the SimTech acquisition which are being amortized to expense on a straight-line basis over periods ranging from two to five years beginning September 9, 1997. The Company expensed $697,000 for the three months ended June 30, 1999 and 1998, respectively. The Company expensed approximately $1.4 million for the six months ended June 30, 1999 and 1998, respectively. - --------------- (2) This sentence is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Investors are strongly encouraged to review the section entitled "Additional Risk Factors That Could Affect Operating Results and Market Price of Stock" commencing on page 19 for a discussion of factors that could affect future performance. -15- NON-RECURRING CHARGES During the six months ended June 30, 1999, the Company recorded $1.3 million in non-recurring charges related to severance obligations for certain management personnel. For the three months ended June 30, 1998 the Company incurred one-time charges of $227,000 related to the acquisition of ProSoft. INTEREST EXPENSE Interest expense remained constant at $1,000 for the three months ended June 30, 1999 and 1998. Interest expense also remained constant at $2,000 for the six months ended June 30, 1999 and 1998. The Company incurred no interest expense associated with the Company's bank line of credit for the three and six months ended June 30, 1999 and 1998. OTHER INCOME, NET Other income consists of interest income associated with available cash balances, gains or losses from the sale of property and equipment, the Company's pro rata share of the earnings and losses of SDA and ADC and foreign exchange rate differences resulting from paying operating expenses of foreign operations in the local currency. Other income was approximately $195,000, $204,000, $488,000, and $492,000 for the three months ended June 30, 1999 and 1998 and for the six months ended June 30, 1999 and 1998, respectively. INCOME TAX PROVISION The income tax provision decreased from $958,000 for the three months ended June 30, 1998 to $0 for the three months ended June 30, 1999. The income tax provision decreased from $1.9 million for the six months ended June 30, 1998 to $0 for the six months ended June 30, 1999. The 1998 income tax provision reflects the Company's estimated consolidated tax rate for federal, state and foreign taxes of approximately 40% of taxable income. The Company's estimated effective rate for the year ending December 31, 1999 is 0%, as the Company does not expect to generate either taxable income or net operating losses in 1999. EFFECTIVE CORPORATE TAX RATES Prior to 1996, the Company had experienced losses for income tax purposes in the United States. As of December 31, 1998, the Company has recognized the benefit of its U.S. net operating loss carryforwards and tax credit carryforwards in their financial statements. The Company's Israeli operations are performed entirely by Summit Design (EDA) Ltd., which is a separate taxable Israeli entity. The Company's existing Israeli production facility has been granted ""Approved Enterprise" status under the Israeli Investment Law, which entitles the Company to reductions in the tax rate normally applicable to Israeli companies with respect to the income generated by its "Approved Enterprise" programs. In particular, the tax holiday covers the seven year period beginning the first year in which Summit Design (EDA) Ltd. generates taxable income from its "Approved Enterprise" (after using any available NOLs), provided that such benefits will terminate in 2006 regardless of whether the seven year period has expired. The tax holiday provides that, during such seven year periods, a portion of the Company's taxable income from its Israeli operations will be taxed at favorable tax rates. The Company has recently applied for "Approved Enterprise" status with respect to a new project and intends to apply in the future with respect to additional projects. There can be no assurance that the Company will be granted any approvals and therefore there can be no assurance the Company will continue to have favorable tax status in Israel. Management of the Company intends to permanently reinvest earnings of the Israeli subsidiary outside the U.S. If such earnings were remitted to the U.S., additional U.S. federal and foreign taxes may be due. -16- The Company had foreign income tax net operating losses of approximately $5.6 million at December 31, 1998. These foreign losses were generated in Israel over several years and have not yet received final assessment from the Israeli government. Consequently, management is uncertain as to the availability of a substantial portion of such foreign loss carryforwards. The Company is also subject to risk that United States and foreign tax laws and rates may change in a future period or periods, and that any such changes may materially adversely affect the Company's tax rate. As a result of the factors described above and other related factors, there can be no assurance that the Company will maintain a favorable tax rate in future periods. Any increase in the Company's effective tax rate, or variations in the effective tax rate from period to period, could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows. LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations primarily through a public offering in 1996, the private placement of capital stock, as well as capital equipment leases, borrowings under its bank line of credit, Israeli research and development grants and cash generated from operations. As of June 30, 1999, the Company had approximately $24.0 million in cash and cash equivalents. Additionally, the Company had a $1.0 million bank line of credit, which expired on April 30, 1999. At April 30, 1999, the Company had no borrowings outstanding under this line of credit and subsequently did not renew the line. As of June 30, 1999, the Company has loaned $2.5 million to an independent software company pursuant to a secured loan agreement entered into during July 1997. Borrowings under the agreement bear interest at prime plus 2%. As of June 30, 1999, the Company had working capital of approximately $22.4 million. For the six months ended June 30, 1999, net cash used in operating activities was approximately $2.6 million. For the six months ended June 30, 1998, net cash generated by operating activities was approximately $7.4 million. Cash used in operations for the six months ended June 30, 1999 resulted primarily from a net loss offset by depreciation, amortization, and a decrease in accrued liabilities. Net cash used in investing activities was approximately $1.2 million and $2.1 million for the six months ended June 30, 1999 and 1998, respectively. Net cash used in investing activities was related to the acquisition of furniture and equipment and a loan to an independent software company for the six months ended June 30, 1999 and 1998. Net cash used in investing activities also included loans to a joint venture for the six months ended June 30, 1998. Net cash generated by financing activities was approximately $177,000 for the six months ended June 30, 1999. Net cash used by financing activities was approximately $505,000 for the six months ended June 30, 1998. For the six months ended June 30, 1999, financing activity cash was primarily generated by proceeds from the issuance of common stock through stock options plans, offset by payments of debt obligations and capital leases. For the six months ended June 30, 1998 the use of cash was primarily from repurchasing 162,500 shares of the Company's common stock, less proceeds from the issuance of common stock and a tax benefit from option exercises. The Company presently believes that its current cash and cash equivalents will satisfy the Company's anticipated working capital and other cash requirements for at least the next 12 months.(2) - ---------------- (2) This sentence is a forward-looking statement reflecting current expectations. There can be no assurance that the Company's actual future performance will meet the Company's current expectations. Investors are strongly encouraged to review the section entitled "Additional Risk Factors That Could Affect Operating Results and Market Price of Stock" commencing on page 19 for a discussion of factors that could affect future performance. -17- YEAR 2000 The Year 2000 issue results from computer programs written using two, rather than four, digits to define the applicable year. These computer programs may recognize a date using "00" as the year 1900 instead of 2000 and cause system failures or miscalculations, material disruptions of business operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business operations. If the Company, its significant customers, suppliers, service providers and other related third parties fail to take the necessary steps to correct or replace these problematic computer programs, the Year 2000 issue could have a material adverse effect on the Company. The Company cannot, however, quantify the impact at this time. The Company has begun upgrading or replacing the software packages underlying its financial, production, communication, desktop and other systems, as appropriate, to address the Year 2000 issue. It has also performed an in-depth analysis of all of its products and is in the process of modifying those products that are not Year 2000 compliant. Moreover, the Company is contacting all major external third parties that provide products and services to the Company to assess their readiness for the Year 2000. Management believes it has completed the review and assessment phase of affected systems within the Company and those which are external to the Company. This assessment indicated that most of the Company's significant internal information systems could be affected by the Year 2000 issue, and that the Company could be negatively impacted by non-compliance of related third parties. In addition, this assessment concluded that certain of the Company's products were also at risk. The Company has begun the remediation phase of the Company's internal information technology systems and has set October 1999 as the target for Year 2000 compliance of all of the Company's internal information technology systems. The Company's internal information technology systems include the Company's finance systems and those systems used in the research and development of the Company's products. The Company's products are subject to periodic upgrades. These upgrades are typically released to end-users once a year. The Company intends to modify its products, as required, in order to make such products Year 2000 compliant by September 1999. The Company is currently in the process of creating contingency plans for its internal information technology systems and products. These contingency plans are expected to be in place by October 31, 1999. In the event the Company's information technology systems and/or products are not Year 2000 compliant by October 31, 1999, the Company will decide at that time whether to implement the necessary contingency plan(s). The Company has queried its important suppliers and service providers and is presently obtaining assurances and verification from those selected third parties that they are or will be Year 2000 complaint. The inability of those parties to complete their Year 2000 resolution process could materially impact the Company. The effects of non-compliance by third parties where no system interface exists is not determinable. The Company will determine whether a contingency plan is necessary in relation to third parties with whom the Company has material relationships once the assessment of these third parties' Year 2000 compliance is complete. It is anticipated that third party assessment will be complete by August 31, 1999. Concurrent with performing the above steps, the Company will make certain investments in systems, applications and products to address Year 2000 issues. The Company has not tracked internal resources dedicated to the resolution of the Year 2000 issue and, therefore, is unable to quantify internal costs -18- incurred to date that are associated with the Year 2000 issue. The Company has, however, hired external consultants to resolve internal information system issues related to the resolution of the Year 2000 issue. Identifiable expenditures for these consultants were approximately $250,000 through December 31, 1998. Expenditures to resolve Year 2000 issues are not expected to be material and are expected to be funded through cash generated from operations. The Company's plans to complete the Year 2000 modifications are based upon management's best estimates, which were derived utilizing numerous assumptions of future events including continued availability of certain resources, and other factors. However, there can be no assurance that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material differences included the availability and cost of personnel trained in this area, and the ability to locate and correct all relevant computer codes. ADDITIONAL RISK FACTORS THAT COULD AFFECT OPERATING RESULTS AND MARKET PRICE OF STOCK FLUCTUATIONS IN QUARTERLY OPERATING RESULTS FACTORS WHICH MAY CAUSE THE COMPANY'S OPERATING RESULTS TO FLUCTUATE. The Company's quarterly operating results and cash flows have fluctuated in the past and have fluctuated significantly in certain quarters. Such fluctuations resulted from several factors including the size and timing of orders, the incurrence of a large one-time charge as a result of an acquisition, seasonal factors, the rate of acceptance of new products, product, customer and channel mix, and lengthy sales cycles. These fluctuations are likely to continue in future periods as a result of the factors discussed above and potentially due to corporate acquisitions and consolidations and the integration of acquired entities and the incurrence of any large one-time charges as a result of any acquisitions, the timing of new product announcements and introductions by the Company and its competitors, the rescheduling or cancellation of customer orders, the Company's ability to continue to develop and introduce new products and product enhancements on a timely basis, the level of competition, purchasing and payment patterns, pricing policies of the Company and its competitors, product quality issues, currency fluctuations and general economic conditions. REVENUE DIFFICULT TO FORECAST. The Company's revenue is difficult to forecast for several reasons. The Company operates with little product backlog because its products are typically shipped shortly after orders are received. Consequently, license backlog at the beginning of any quarter has in the past represented only a small portion of that quarter's expected revenue. As a result, license fee revenue in any quarter is difficult to forecast because it is substantially dependent on orders booked and shipped in that quarter. Moreover, the Company generally recognizes a substantial portion of its revenue in the last month of the quarter, frequently in the latter part of the month. Any significant deferral of purchases of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations in any particular quarter, and, to the extent that significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected. Quarterly license fee revenue is also difficult to forecast because the Company's sales cycle is typically six to nine months and varies substantially from customer to customer. In addition, a portion of the Company's sales are made through indirect channels and can be harder to predict. SHORTFALLS IN REVENUE COULD ADVERSELY IMPACT QUARTERLY OPERATING RESULTS. The Company establishes its expenditure levels for product development, sales and marketing and other operating activities based primarily on its expectations as to future revenue. Because a high percentage of the Company's expenses are relatively fixed in the near term, if revenue in any quarter is below expectations, expenditure levels could be disproportionately high as a percentage of revenue and the Company's operating results would be materially adversely affected. -19- OPERATING RESULTS LIKELY TO FLUCTUATE. Based upon the factors described above, the Company believes that its quarterly revenue, expenses and operating results are likely to vary significantly from quarter to quarter, that period-to-period comparisons of its operating results are not necessarily meaningful and that, as a result, such comparisons should not be relied upon as indications of the Company's future performance. Additionally, as of December 31, 1998, CSC had satisfied its obligation to purchase a minimum number of Visual Testbench licenses pursuant to an OEM agreement entered into in July 1997, and the Company does not expect to receive any additional revenue from sales of Visual Testbench to CSC. The Company will need to replace this revenue and the failure of the Company to replace this revenue would have a material adverse affect on the Company's operating results. In addition, the Company operates with high gross margins and as such, a downturn in revenue has had a significant impact on income from operations and net income. Due to the foregoing or other factors, the Company's results of operations were below investors' and market makers' expectations for the quarter ended June 30, 1999 and are likely to be below investors' and market makers' expectations in other quarters, which could have a severe adverse effect on the market price of the Company's Common Stock. DEPENDENCE ON HLDA PRODUCTS The Company's future success depends primarily upon the broad market acceptance of the Company's existing and future HLDA products. The Company commercially shipped its first HLDA product, Visual HDL for VHDL, in the first quarter of 1994. For the years ended December 31, 1998, 1997 and 1996, revenue from HLDA products and related maintenance contracts represented 100%, 88.8%, and 63.9%, respectively, of the Company's total revenue. As a result, factors adversely affecting sales of these products, including increased competition, inability to successfully introduce enhanced or improved versions of these products, product quality issues and technological change, could have a material adverse effect on the Company's business, financial condition and results of operations. UNCERTAINTY OF BROAD MARKET ACCEPTANCE OF HLDA PRODUCTS The Company's HLDA products incorporate certain unique design methodologies and thus represent a departure from industry standards for design creation and verification. The Company believes that broad market acceptance of its HLDA products will depend on several factors, including the ability to significantly enhance design productivity, ease of use, interoperability with existing EDA tools, price and the customer's assessment of the Company's financial resources and its technical, managerial, service and support expertise. The Company also depends on its distributors to assist the Company in gaining market acceptance of its products. There can be no assurance that sufficient priority will be given by the Company's distributors to marketing the Company's products or whether such distributors will continue to offer the Company's products. There can be no assurance that the Company's HLDA products will achieve broad market acceptance. A decline in the demand for, or the failure to achieve broad market acceptance of, the Company's HLDA products will have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. Although demand for HLDA products has increased in recent years, the market for HLDA products is still emerging and there can be no assurance that it will continue to grow or that, even if the market does grow, businesses will continue to purchase the Company's HLDA products. If the market for HLDA products fails to grow or grows more slowly than the Company currently anticipates, the Company's business, financial condition, results of operations or cash flows would be materially adversely affected. Traditionally, EDA customers have been risk averse in accepting new design methodologies. Because many of the Company's tools embody new design methodologies, this risk aversion on the part of potential customers presents an ongoing marketing and sales challenge to the Company and makes the introduction and acceptance of new products unpredictable. -20- COMPETITION The EDA industry is highly competitive and the Company expects competition to increase as other EDA companies introduce HLDA products. In the HLDA market, the Company principally competes with Mentor Graphics and a number of smaller firms. Indirectly, the Company also competes with other firms that offer alternatives to HLDA and could potentially offer more directly competitive products in the future. Certain of these companies have significantly greater financial, technical and marketing resources and larger installed customer bases than the Company. Some of the Company's current and future competitors offer a more complete range of EDA products and may distribute products that directly compete with the Company's HLDA products by bundling such products with their core product line. In addition, the Company's products perform a variety of functions, certain of which are, and in the future may be, offered as separate products or discrete point solutions by the Company's existing and future competitors. For example, certain companies currently offer design entry products without simulators. There can be no assurance that such competition will not cause the Company to offer point solutions instead of, or in addition to, the Company's current software products. Such point solutions would be priced lower than the Company's current product offerings and could cause the Company's average selling prices to decrease, which could have a material adverse effect on the Company's business, financial condition, results of operations, or cash flows. The Company competes on the basis of certain factors including product capabilities, product performance, price, support of industry standards, ease of use, first to market and customer technical support and service. The Company believes that they compete favorably overall with respect to these factors. However, in particular cases, the Company's competitors may offer HLDA products with functionality which is sought by the Company's prospective customers and which differs from that offered by the Company. In addition, certain competitors may achieve a marketing advantage by establishing formal alliances with other EDA vendors. Further, the EDA industry in general has experienced significant consolidation in recent years, and the acquisition of one of the Company's competitors by a larger, more established EDA vendor could create a more significant competitor. 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, financial condition, results of operations, or cash flows. There can be no assurance that the Company's current and future competitors will not be able to develop products comparable or superior to those developed by the Company or to adapt more quickly than the Company to new technologies, evolving industry trends or customer requirements. Increased competition could result in price reductions, reduced margins and loss of market share, all of which could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. DEPENDENCE ON ELECTRONICS INDUSTRY MARKET Because the electronics industry is characterized by rapid technological change, short product life cycles, fluctuations in manufacturing capacity and pricing and margin pressures, certain segments, including the computer, semiconductor, semiconductor test equipment and telecommunications industries, have experienced sudden and unexpected economic downturns. During these periods, capital spending is commonly curtailed and the number of design projects often decreases. Because the Company's sales are dependent upon capital spending trends and new design projects, negative factors affecting the electronics industry could have a material adverse effect on the Company's business, financial condition, results of operations, or cash flows. A number of electronics companies, including customers of the Company, have recently experienced a slowdown in their businesses. The Company's future operating results may reflect substantial fluctuations from period to period as a consequence of such industry patterns, general economic conditions affecting the timing of orders from customers and other factors. -21- DEPENDENCE ON THIRD PARTIES FOR PRODUCT INTEROPERABILITY Because the Company's products must interoperate with EDA products of other companies, particularly simulation and synthesis products, the Company must have timely access to third party software to perform development and testing of its products. Although the Company has established relationships with a variety of EDA vendors to gain early access to new product information, these relationships may be terminated by either party with limited notice. In addition, such relationships are with companies that are current or potential future competitors of the Company, including Synopsys, Mentor Graphics and Cadence. If any of these relationships were terminated and the Company was unable to obtain, in a timely manner, information regarding modifications of third party products necessary for modifying its software products to interoperate with these third party products, the Company could experience a significant increase in development costs, the development process would take longer, product introductions would be delayed and the Company's business, financial condition, results of operations or cash flows could be materially adversely affected. NEW PRODUCTS AND TECHNOLOGICAL CHANGE; EVOLVING INDUSTRY STANDARDS The EDA industry is characterized by extremely 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. In addition, customers in the EDA industry require software products that allow them to reduce time to market, differentiate their products, improve their engineering productivity and reduce their design errors. The Company's future success will depend upon its ability to enhance its current products, develop and introduce new products that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of its 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 emerging industry standards, 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 will adequately meet the requirements of the marketplace and 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, industry standards or other customer requirements, particularly if such product releases have been pre-announced, the Company's business, financial condition, results of operations or cash flows will be materially adversely affected. RISKS OF SOFTWARE DEFECTS Software products as complex as those offered by the Company may contain errors that may be detected at any point in the products' life cycles. The Company has in the past discovered software errors in certain of its products and has experienced delays in shipment of products during the period required to correct these errors. There can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found, resulting in loss of, or delay in, market acceptance and sales, diversion of development resources, injury to the Company's reputation or increased service and warranty costs, any of which could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. DEPENDENCE ON DISTRIBUTORS The Company relies on distributors for licensing and support of its products outside of North America. Approximately 41.9%, 24.9%, 23.1%, 28.7% and 45.6% of the Company's revenue for the six months ended June 30, 1999 and 1998 and for the years ended December 31, 1998, 1997 and 1996, respectively, were attributable to sales made through distributors. Effective April 1, 1996, the Company entered into a joint venture with Anam pursuant to which the joint venture corporation, Summit Asia, acquired exclusive rights -22- to sell, distribute and support all of the Company's products in the Asia Pacific region, excluding Japan. In April 1998, the joint venture corporation, Summit Asia, which is headquartered in Korea, was renamed Asia Design Corporation ("ADC"). In May 1998, the Company exchanged a portion of its ownership in ADC for ownership in another company located in Hong Kong, renamed Summit Design Asia, Ltd. ("SDA"). SDA also acquired an equity investment in ADC. In June 1998, the Company and Anam each loaned SDA $750,000, which is guaranteed by ADC. SDA acquired from ADC the exclusive rights to sell, distribute and support the Company's products in the Asia Pacific region, excluding Japan. SDA granted distribution rights to the Company's products to ADC for the Asia Pacific region, excluding Japan. In December 1998, SDA cancelled ADC's distribution rights in all areas except Korea and granted non-exclusive distribution rights to Semiconductor Technologies Australia ("STA") for the Asia Pacific region excluding Japan and Korea. There can be no assurance that this restructuring will result in SDA or ADC becoming profitable or that revenue attributable to sales in the Asia Pacific region, excluding Japan, would increase. In addition, in the first quarter of 1996, the Company entered into a three-year, exclusive distribution agreement for its HLDA products in Japan with Seiko. The agreement is renewable for successive five-year terms by mutual agreement of the Company and Seiko and is terminable by either party for breach. The agreement was renewed for an additional five-year term, which began in February 1999. In the event Seiko fails to meet specified quotas for two or more quarterly periods, exclusivity can be terminated by the Company, subject to Seiko's right to pay a specified fee to maintain exclusivity. Sales through Seiko accounted for 24.3%, 19.3%, 17.8%, 14.5%, and 15.1%, of the Company's total revenue for the six months ended June 30, 1999 and 1998 and for the years ended December 31, 1998, 1997, and 1996, respectively. In June 1999, the Company lowered Seiko's specified quotas due to the adverse economic conditions in the Asia Pacific Region. As a result, Summit expects sales through Seiko to decrease for at least the current and following two quarters and revenue attributable to sales in the Asia Pacific region to decrease. The Company also has independent distributors in Europe and is dependent on the continued viability and financial stability of its distributors. Since the Company's products are used by skilled design engineers, distributors must possess sufficient technical, marketing and sales resources and must devote these resources to a lengthy sales cycle, customer training and product service and support. Only a limited number of distributors possess these resources. In addition, Seiko, SDA and ADC, as well as the Company's other distributors may offer products of several different companies, including competitors of the Company. There can be no assurance that the Company's current distributors will continue to market or service and support the Company's products effectively, that any distributor will continue to sell the Company's products or that the distributors will not devote greater resources to products of other companies. The loss of, or a significant reduction in, revenue from the Company's distributors could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. INTERNATIONAL SALES AND OPERATIONS Approximately 47.7%, 35.1%, 35.8%, 33.2%, and 49.8% of the Company's revenue for the six months ended June 30, 1999 and 1998 and for the years ended December 31, 1998, 1997 and 1996, respectively, were attributable to sales made outside the United States, which includes the Asia Pacific region and Europe. Approximately, 26.8%, 21.7%, 21.9%, 22.3%, and 34.3% of the Company's revenue for the six months ended June 30, 1999 and 1998 and for the years ended December 31, 1998, 1997 and 1996, respectively, were attributable to sales made in the Asia Pacific region and approximately 20.9%, 13.4%, 13.9%, 11.4% and 15.5% of the Company's revenue for the six months ended June 30, 1999 and 1998 and for the years ended December 31, 1998, 1997 and 1996, respectively, were attributable to sales made in Europe. The Company expects that international revenue will continue to represent a significant portion of its total revenue. The Company's international revenue is currently denominated in U.S. dollars. As a result, increases in the value of the U.S. dollar relative to foreign currencies could make the Company's products more expensive and, therefore, potentially less competitive in those markets. The Company pays the expenses of its international operations in local currencies and does not engage in hedging transactions with respect to such obligations. International sales and operations are subject to numerous risks, including tariff regulations and other trade barriers, requirements for licenses, particularly with respect to the export of -23- certain technologies, collectability of accounts receivable, changes in regulatory requirements, difficulties in staffing and managing foreign operations and extended payment terms. There can be no assurance that such factors will not have a material adverse effect on the Company's future international sales and operations and, consequently, on the Company's business, financial condition, results of operations or cash flows. In addition, financial markets and economies in the Asia Pacific region have been experiencing adverse economic conditions. Demand for and sales of the Company's products in the Asia Pacific region have continued to decrease and there can be no assurance that such adverse economic conditions will not worsen or that demand for and sales of the Company's products in such region will not further decrease. In order to successfully expand international sales, the Company may need to establish additional foreign operations, hire additional personnel and recruit additional international distributors. This will require significant management attention and financial resources and could adversely affect the Company's operating margins. In addition, to the extent that the Company is unable to effect these additions in a timely manner, the Company's growth, if any, in international sales will be limited. There can be no assurance that the Company will be able to maintain or increase international sales of the Company's products, and failure to do so could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. MANAGEMENT OF GROWTH AND ACQUISITIONS The Company's ability to achieve significant growth will require it to implement and continually expand its operational and financial systems, recruit additional employees and train and manage current and future employees. The Company expects any such growth will place a significant strain on its operational resources and systems. Failure to effectively manage any such growth would have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. The Company has consummated a series of acquisitions including the acquisition of TriQuest in February 1997, SimTech in September 1997, and ProSoft in June 1998 and regularly evaluates acquisition opportunities. Future acquisitions by the Company, if any, could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, amortization expenses related to goodwill and other intangible assets, and large one-time charges which could materially adversely affect the Company's results of operations. Product and technology acquisitions entail numerous risks, including difficulties in the assimilation of acquired operations, technologies and products, diversion of management's attention to other business concerns, risks of entering markets in which the Company has no or limited prior experience and potential loss of key employees of acquired companies. The Company's management has had limited experience in assimilating acquired organizations and products into the Company's operations. No assurance can be given as to the ability of the Company to integrate successfully any operations, personnel or products that have been acquired or that might be acquired in the future, and the failure of the Company to do so could have a material adverse effect on the Company's results of operations. OPERATIONS IN ISRAEL RISKS ASSOCIATED WITH OPERATING IN ISRAEL. The Company's research and development operations related to its Visual HDL products are located in Israel and may be affected by economic, political and military conditions in that country. Accordingly, the Company's business, financial condition and results of operations could be materially adversely affected if hostilities involving Israel should occur. This risk is heightened due to the restrictions on the Company's ability to manufacture or transfer outside of Israel any technology developed under research and development grants from the government of Israel as described in "--Israeli Research, Development and Marketing Grants." In addition, while all of the Company's sales are denominated in U.S. dollars, a portion of the Company's annual costs and expenses in Israel are paid in Israeli currency. These costs and expenses were approximately $5.2, $4.7 and $4.3 million in 1998, 1997 and 1996, respectively. Payment in Israeli currency subjects the Company to foreign currency fluctuations -24- and to economic pressures resulting from Israel's generally high rate of inflation, which has been approximately 9%, 7% and 11% during 1998, 1997, and 1996, respectively. The Company's primary expense, which is paid in Israeli currency, is employee salaries for research and development activities. As a result, an increase in the value of Israeli currency in comparison to the U.S. dollar could increase the cost of research and development expenses and general and administrative expenses. There can be no assurance that currency fluctuations, changes in the rate of inflation in Israel or any of the other aforementioned factors will not have a material adverse effect on the Company's business, financial condition, results of operations, or cash flows. In addition, coordination with and management of the Israeli operations requires the Company to address differences in culture, regulations and time zones. Failure to successfully address these differences could be disruptive to the Company's operations. RISKS ASSOCIATED WITH "APPROVED ENTERPRISE" STATUS. The Company's Israeli production facility has been granted the status of an "Approved Enterprise" under the Israeli Investment Law for the Encouragement of Capital Investments, 1959 (the "Investment Law"). Taxable income of a company derived from an "Approved Enterprise" is eligible for certain tax benefits, including significant income tax rate reductions for up to seven years following the first year in which the "Approved Enterprise" has Israeli taxable income (after using any available net operating losses). The period of benefits cannot extend beyond 12 years from the year of commencement of operations or 14 years from the year in which approval was granted, whichever is earlier. The tax benefits derived from a certificate of approval for an "Approved Enterprise" relate only to taxable income attributable to such "Approved Enterprise" and are conditioned upon fulfillment of the conditions stipulated by the Investment Law, the regulations promulgated thereunder and the criteria set forth in the certificate of approval. In the event of a failure by the Company to comply with these conditions, the tax benefits could be canceled, in whole or in part, and the Company would be required to refund the amount of the canceled benefits, adjusted for inflation and interest. No "Approved Enterprise" tax benefits had been realized by the Company from its Israeli operations as of December 31, 1995 since the Israeli operations were still incurring losses at that time. During 1996, the Company realized income of $1.4 million from its Israeli operations and "Approved Enterprise" tax benefits of $53,000. During 1997, the Company realized income of $2.7 million from its Israeli operations and "Approved Enterprise" tax benefits of $702,000. During 1998, the Company realized income of $4.3 million from its Israeli operations and "Approved Enterprise" tax benefits of $1.9 million. The Company has recently applied for "Approved Enterprise" status with respect to a new project and intends to apply in the future with respect to additional projects. However, there can be no assurance that the Company's Israeli production facility will continue to operate or qualify as an "Approved Enterprise" or that the benefits under the "Approved Enterprise" regulations will continue, or be applicable, in the future. Management of the Company intends to permanently reinvest earnings of the Israeli Subsidiary outside the U.S. If such earnings were remitted to the U.S., additional U.S. federal and foreign taxes may be due. The loss of, or any material decrease in, these income tax benefits could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. DEPENDENCE ON KEY PERSONNEL The Company's success will continue to depend in large part on its key technical and management personnel and its ability to attract and retain highly-skilled technical, sales and marketing and management personnel. The Company has entered into employment agreements with certain of its executive officers; however, such agreements do not guarantee the services of these employees and do not contain non-competition provisions. The Company recently entered into a new employment agreement with C. Albert Koob, the Company's Chief Financial Officer. Mr. Koob's employment agreement provides that he is entitled to certain guaranteed severance payments and has been provided an incentive to remain with the Company through December 31, 1999 or such earlier date that a permanent Chief Executive Officer or Chief Financial Officer has begun working at the Company. -25- However, there can be no assurance that Mr. Koob will continue his employment until such date. Mr. Gerhard, the Company's former Chief Executive Officer resigned from his positions with the Company as of June 30, 1999. William V. Botts, a director of the Company, is currently serving as the Company's Interim Chief Executive Officer while the Company seeks a permanent Chief Executive Officer. The Company's failure to timely hire suitable replacements for Mr. Gerhard or Mr. Koob could have a material adverse effect on the Company. Competition for personnel in the software industry in general, and the EDA industry in particular, is intense, and the Company has at times in the past experienced difficulty in recruiting qualified personnel. There can be no assurance that the Company will retain its key personnel or that it will be successful in attracting and retaining other qualified technical, sales and marketing and management personnel in the future. The loss of any key employees or the inability to attract and retain additional qualified personnel may have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. Additions of new personnel and departures of existing personnel, particularly in key positions, can be disruptive and can result in departures of additional personnel, which could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. NEED TO EXPAND SALES AND MARKETING ORGANIZATIONS The Company's success will depend on its ability to build and expand its sales and marketing organizations. The Company hired fewer sales and marketing personnel than planned in the fourth quarter of 1998 and the first two quarters of 1999 and experienced attrition in the existing sales force during the first quarter of 1999. As a result of the lack of sales people, the Company's revenues for the fourth quarter of 1998 and first two quarters of 1999 were lower than expected. In February 1999, the Company's Senior Vice President of Worldwide Marketing and Sales resigned. The Company is seeking a Vice President of Sales and a Vice President of Marketing. The Company's future success will depend in part on its ability to hire and retain qualified sales and marketing personnel and the ability of these new persons to rapidly and effectively transition into their new positions. Competition for qualified sales and marketing personnel is intense, and the Company may not be able to hire and retain the number of sales and marketing personnel needed which would have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. ISRAELI RESEARCH, DEVELOPMENT AND MARKETING GRANTS The Company's Israeli subsidiary obtained research and development grants from the Chief Scientist in the Israeli Ministry of Industry and Trade of approximately $232,000 and $608,000 in 1993 and 1995, respectively. As of December 31, 1997, all amounts have been repaid. The terms of the grants prohibit the manufacture of products developed under these grants outside of Israel and the transfer of the technology developed pursuant to these grants to any person, without the prior written consent of the Chief Scientist. The Company's Visual HDL for VHDL products have been developed under grants from the Chief Scientist and thus are subject to these restrictions. If the Company is unable to obtain the consent of the government of Israel, the Company would be unable to take advantage of potential economic benefits such as lower taxes, lower labor and other manufacturing costs and advanced research and development facilities that may be available if such technology and manufacturing operations could be transferred to locations outside of Israel. In addition, the Company would be unable to minimize risks particular to operations in Israel, such as hostilities involving Israel. Although the Company is eligible to apply for additional grants from the Chief Scientist, it has no present plans to do so. The Company received a Marketing Fund Grant from the Israeli Ministry of Industry and Trade for an aggregate of $423,000. The grant must be repaid at the rate of 3% of the increase in exports over the 1993 export level of all Israeli products, until repaid. As of June 30, 1999, approximately $92,000 was outstanding under the grant. LIMITATIONS ON PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS NO ASSURANCE THAT EFFORTS TO PROTECT PROPRIETARY TECHNOLOGY WILL SUCCEED. The Company's success depends in part upon its proprietary technology. The Company relies on a combination of copyright, trademark and trade secret laws, confidentiality procedures, licensing arrangements and technical means to establish and -26- protect its proprietary rights. As part of its confidentiality procedures, the Company generally enters into non-disclosure agreements with its employees, distributors and corporate partners, and limits access to, and distribution of, its software, documentation and other proprietary information. In addition, the Company's products are protected by hardware locks and software encryption techniques designed to deter unauthorized use and copying. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization, or to develop similar technology independently. The Company provides products to end-users primarily under "shrink-wrap" license agreements included within the packaged software In addition, the Company delivers certain of its verification products electronically under an electronic version of a "shrink-wrap" license agreement. These agreements are not negotiated with or signed by the licensee, and thus may not be enforceable in certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights as fully as do the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights in the United States or abroad will be adequate or that competitors will not independently develop similar technology. RISKS OF INFRINGEMENT CLAIMS. The Company could be increasingly subject to infringement claims as the number of products and competitors in the Company's industry segment grows, the functionality of products in its industry segment overlaps and an increasing number of software patents are granted by the United States Patent and Trademark Office. There can be no assurance that a third party will not claim such infringement by the Company with respect to current or future products. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product delays or require the Company to enter into royalty or licensing agreements. Such royalty or license agreements, if required, may not be available on terms acceptable to the Company or at all. Failure to protect its proprietary rights or claims of infringement could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. POSSIBLE VOLATILITY OF STOCK PRICE The stock markets have experienced price and volume fluctuations that have particularly affected technology companies, resulting in changes in the market prices of the stocks of many companies which may not have been directly related to the operating performance of those companies. Such broad market fluctuations may adversely affect the market price of the Common Stock. In addition, factors such as announcements of technological innovations or new products by the Company or its competitors, market conditions in the computer software or hardware industries and quarterly fluctuations in the Company's operating results may have a significant adverse effect on the market price of the Company's Common Stock. YEAR 2000 The Company is currently reviewing its products, internal systems and infrastructure in order to identify and modify those products and systems that are not Year 2000 compliant. The Company expects any required modification to be made on a timely basis and does not believe that the cost of any such modification will have a material adverse effect on the Company's operating results. There can be no assurance, however, that there will not be a delay in, or increased costs associated with, implementation of any such modifications and inability to implement such modifications could have an adverse effect on the Company's future operating results. -27- ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risk from interest rate changes, foreign currency fluctuations, and changes in the market values of its investments. INTEREST RATE RISK. The Company invests its excess cash in debt instruments of the U.S. Government and its agencies, and in high-quality corporate issuers and, by policy, limits the amount of credit exposure to any one issue. The Company attempts to protect and preserve its invested funds by limiting default, market and reinvestment risk. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future investment income may fall short of expectations due to changes in interest rates and the Company may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. FOREIGN CURRENCY RISK. The Company pays the expenses of its international operations in local currencies. The Company's international operations are subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, the Company's future results could be materially adversely impacted by changes in these or other factors. The Company is also exposed to foreign exchange rate fluctuations as they relate to operating expenses as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations on the Company in 1999 was not material. INVESTMENT RISK. The Company has made equity investments in ADC and SDA and has provided loans to ADC and a privately-held, independent software company for business and strategic purposes. These investments are included in other long-term assets and are accounted for under the equity method when ownership is greater than 20% and the Company does not exert control. For these investments in privately-held companies, the Company's policy is to regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the carrying values. The Company identifies and records impairment losses on long-lived assets when events and circumstances indicate that such assets might be impaired. -28- PART II Item 1. Legal Proceedings Not applicable Item 2. Changes in Securities Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders The following matters were submitted to the stockholders at the Company's Annual Meeting of Stockholders held on May 26, 1999. Each of these matters was approved by a majority of the shares present at the meeting. 1. The election of two Class II director to serve for a term of three years: VOTES FOR VOTES WITHHELD CLASS II DIRECTORS --------- -------------- William V. Botts 10,717,760 693,221 Barbara M. Karmel 10,717,560 693,421 2. The amendment of the Company's 1994 Stock Plan to increase the number of shares reserved for issuance thereunder by 625,000 shares: VOTES FOR VOTES AGAINST VOTES WITHHELD --------- ------------- -------------- 7,773,819 3,599,506 37,656 3. The amendment of the Company's 1996 Employee Stock Purchase Plan to increase the number of shares reserved for issuance thereunder by 150,000 shares: VOTES FOR VOTES AGAINST VOTES WITHHELD --------- ------------- -------------- 11,108,697 242,720 59,564 4. The ratification of the appointment of PricewaterhouseCoopers LLP as the independent accountants for the Company for the fiscal year ending December 31, 1999: VOTES FOR VOTES AGAINST VOTES WITHHELD --------- ------------- -------------- 11,356,271 41,531 13,179 Item 5. Other Information Not applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.6 Employment Agreement between between the Registrant and C. Albert Koob dated as of July 30, 1999. 10.7 Employment agreement between the Registrant and Richard Davenport dated __, 1999. 10.9 Employment agreement between the Registrant and Eric Benayoun dated February 25, 1999. 10.10 Employment agreement between the Registrant and Moshe Guy dated February 25, 1999. 27.1 Financial Data Schedule (b) Reports on Form 8-K On June 11, 1999, the Company filed a Current Report on Form 8-K dated June 11, 1999 in connection with the resignation of Larry Gerhard, Chairman and Chief Executive Officer. -29- 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. SUMMIT DESIGN, INC. By: /s/ C. Albert Koob ------------------------------------ C. Albert Koob Vice President - Finance, Chief Financial Officer and Secretary Principal Financial and Accounting Officer and Duly Authorized Officer) Date: August 13, 1999 -30- EXHIBIT INDEX EXHIBIT 10.6 Employment agreement between the Registrant and C. Albert Koob dated July 30, 1999. EXHIBIT 10.7 Employment agreement between the Registrant and Richard Davenport dated February 25, 1999. EXHIBIT 10.9 Employment agreement between the Registrant and Eric Benhayoun dated February 25, 1999. EXHIBIT 10.10 Employment agreement between the Registrant and Moshe Guy dated February 25, 1999. EXHIBIT 27.1 Financial Data Schedule -31-