-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Aa8hLKQLot6C2nxZdEaTfmd1xDJbj6Cu9TND+WhlEJoxe+o1YnmGQnbbFr30XT5o Z6GYKqKHJNW+STZuFahEAA== 0001047469-99-009980.txt : 19990317 0001047469-99-009980.hdr.sgml : 19990317 ACCESSION NUMBER: 0001047469-99-009980 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUMMIT DESIGN INC CENTRAL INDEX KEY: 0000925072 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 931137888 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-20923 FILM NUMBER: 99566502 BUSINESS ADDRESS: STREET 1: 9305 S W GEMINI DRIVE CITY: BEAVERTON STATE: OR ZIP: 97008 BUSINESS PHONE: 5036439281 MAIL ADDRESS: STREET 1: 9305 S W GEMINI DRIVE CITY: BEVERTON STATE: OR ZIP: 97008 10-Q/A 1 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (AMENDMENT NO. 1) X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 1998 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 (I.R.S. Employer Identification Number) of 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 November 11, 1998, the Registrant had outstanding 15,393,609 shares of Common Stock. SUMMIT DESIGN, INC. INDEX PART I FINANCIAL INFORMATION Item 1 Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of September 30, 1998 (unaudited) and December 31, 1997. 3 Condensed Consolidated Statements of Operations for the three month periods ended September 30, 1998 and 1997 and for the nine month periods ended September 30, 1998 and 1997 (unaudited). 4 Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 1998 and 1997 (unaudited). 5 Notes to Condensed Consolidated Financial Statements. 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II OTHER INFORMATION Item 1 Not Applicable Item 2 Not Applicable Item 3 Not Applicable Item 4 Not Applicable Item 5 Not Applicable Item 6 Exhibits and Reports on Form 8-K 28 Signature 29 Exhibit Index 30
Restatement of Financial Statements and Changes to Certain Information The Registrant previously announced that it would revise the accounting treatment of its September 1997 acquisition of Simulation Technologies Corp. in response to comments received from the Securities and Exchange Commission. Accordingly, this Quarterly Report on Form 10-Q/A is being filed as Amendment No. 1 to the Registrant's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 16, 1998 for the purpose of restating financial information and related disclosures for the three and nine month periods ended September 30, 1998. See Note 1 to the Condensed Consolidated Financial Statements. -2- SUMMIT DESIGN, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
September 30, 1998 December 31, 1997 ------------------ ----------------- (Restated) (Restated) (Unaudited) ASSETS Current assets: Cash and cash equivalents.................... $ 24,662 $ 19,973 Accounts receivable, net..................... 7,654 5,131 Prepaid expenses and other................... 789 540 Deferred income taxes........................ 1,268 1,209 --------- --------- Total current assets....................... 34,373 26,853 Furniture and equipment, net.................... 3,659 2,698 Intangibles, net................................ 3,545 5,571 Goodwill, net................................... 2,930 3,493 Notes receivable................................ 1,750 565 Deposits and other assets....................... 392 490 --------- --------- Total assets............................ $ 46,649 $ 39,670 --------- --------- --------- --------- LIABILITIES Current liabilities: Long-term debt, current portion.............. 81 $ 134 Capital lease obligation, current portion.... 46 49 Accounts payable............................. 1,746 1,211 Accrued liabilities.......................... 6,486 5,182 Deferred revenue............................. 4,872 5,674 --------- --------- Total current liabilities.................. 13,231 12,250 Long-term debt, less current portion............ 156 194 Capital lease obligations, less current portion. 8 43 Deferred revenue, less current portion.......... 161 - Deferred taxes.................................. 965 987 --------- --------- Total liabilities.......................... 14,521 13,474 --------- --------- Commitments and contingencies STOCKHOLDERS' EQUITY Preferred stock, $.01 par value. Authorized 5,000 shares; no shares issued and outstanding - - Common stock, $.01 par value. Authorized 30,000 shares; issued and outstanding 15,330 shares at September 30, 1998 and 15,841 shares at December 31, 1997. .......................... 153 159 Additional paid-in capital...................... 41,177 51,412 Treasury stock , at cost, 939 shares at December 31, 1997............................... - (11,555) Accumulated deficit............................. (9,202) (13,820) --------- --------- Total stockholders' equity................. 32,128 26,196 --------- --------- Total liabilities and stockholders' equity ................................. $ 46,649 $ 39,670 --------- --------- --------- ---------
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 Nine Months Ended September 30, September 30, --------------------- --------------------- 1998 1997 1998 1997 ----- ---- ---- ---- (Restated) (Restated) (Restated) (Restated) Revenue: Product licenses................................. $ 8,705 $ 6,444 $ 25,480 $ 16,951 Maintenance and services......................... 2,518 1,374 6,929 4,300 Other............................................ 91 91 274 358 -------- --------- -------- --------- Total revenue.................................. 11,314 7,909 32,683 21,609 Cost of revenue: Product licenses................................. 179 165 490 514 Maintenance and services......................... 269 171 773 423 Amortization of purchased technologies........... 165 54 496 54 -------- --------- -------- --------- Total cost of revenue.......................... 613 390 1,759 991 -------- --------- -------- --------- Gross profit................................ 10,701 7,519 30,924 20,618 Operating expenses: Research and development......................... 3,021 1,817 8,928 4,944 Sales and marketing.............................. 3,235 2,705 9,541 7,820 General and administrative....................... 1,122 954 3,491 3,015 Amortization of intangibles and goodwill......... 698 244 2,093 244 In-process technology............................ -- 11,689 -- 11,689 -------- --------- -------- --------- Total operating expenses....................... 8,076 17,409 24,053 27,712 Income(loss) from operations........................ 2,625 (9,890) 6,871 (7,094) Other income, net................................... 298 346 790 786 Gain on sale of product line........................ -- 5,569 -- 5,569 -------- --------- -------- --------- Income(loss) before income taxes.................... 2,923 (3,975) 7,661 (739) Income tax provision................................ 1,162 533 3,043 713 -------- --------- -------- --------- Net income(loss) .................................. $ 1,761 $ (4,508) $ 4,618 $ (1,452) -------- --------- -------- --------- -------- --------- -------- --------- Earnings(loss) per share: Basic ....................................... $ 0.12 $ (0.31) $ 0.31 $ (0.10) -------- --------- -------- --------- -------- --------- -------- --------- Diluted ...................................... $ 0.11 $ (0.31) $ 0.28 $ (0.10) -------- --------- -------- --------- -------- --------- -------- --------- Number of shares used in computing Earnings(loss) per share: Basic ....................................... 15,245 14,456 15,072 14,245 Diluted ....................................... 16,100 14,456 16,208 14,245
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)
Nine Months Ended September 30, -------------------------- 1998 1997 ------------- ---------- (Restated) (Restated) Cash flows from operating activities: Net income(loss)..................................... $ 4,618 $ (1,452) Adjustments to reconcile net income to net cash Provided by operating activities: Depreciation and amortization................... 3,439 905 Amortization of future contingent share liability.................................... 1,650 183 Loss on asset disposition....................... - (1) Deferred taxes.................................. (81) (126) Gain on sale of TDS product line................ - (5,569) Write-off of in-process technology.............. - 11,689 Equity in losses and elimination of intercompany profits of unconsolidated joint venture...... 420 - Changes in assets and liabilities: Accounts receivable........................ (2,523) 858 Prepaid expenses and other................. (249) (27) Accounts payable........................... 536 436 Accrued liabilities........................ 1,303 1,226 Deferred revenue........................... (641) 1,294 Other, net................................. 98 (75) -------- ------- Net cash provided by operating activities............ 8,570 9,341 -------- ------- Cash flows from investing activities: Additions to furniture and equipment................. (1,811) (1,266) Acquisitions, net of cash received................... - (3,816) Proceeds from sale of product line, net.............. - 4,643 Proceeds from sale of assets......................... - 8 Loan to joint venture................................ (750) - Notes receivable, net.................. (855) (490) -------- ------- Net cash used in investing activities............. (3,416) (921) -------- ------- Cash flows from financing activities: Issuance of common stock, net of issuance costs...... 1,118 700 Tax benefit of option exercises...................... 875 - Payments to acquire treasury stock................... (2,329) (11,555) Principal payments of debt obligations............... (91) (81) Principal payments of capital lease obligations...... (38) (61) -------- ------- Net cash used in financing activities............. (465) (10,997) -------- ------- Increase(decrease) in cash and cash equivalents... 4,689 (2,577) Cash and cash equivalents, beginning of period............ 19,973 19,801 -------- ------- Cash and cash equivalents, end of period.................. $ 24,662 $17,224 -------- ------- -------- ------- Supplemental disclosure of cash flow information: Cash paid during the period for: Interest........................................ $ 3 $ 10 Income taxes.................................... 2,063 104 Supplemental disclosure of non-cash financing activities: Retirement of treasury stock......................... 11,555 - Acquisition, net of cash acquired: Net current assets other than cash acquired.......... - (1,603) Furniture and equipment.............................. - 377 In-process technology................................ - 11,689 Purchased technology, intangibles and goodwill....... - 10,225 Stock issued......................................... - (15,550) Cash used, net of cash acquired...................... - (3,816)
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 AND RESTATEMENT 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, 1997 (as restated), 1996 and 1995 included in the Company's Form 10-K/A filed for December 31, 1997. After discussion with the staff of the Securities and Exchange Commission (the "staff") the condensed consolidated financial statements as of September 30, 1998 and 1997 and for the three and nine months ended September 30, 1998 and 1997 have been restated to reflect a change in the original accounting treatment related to the September 1997 acquisition of Simulation Technologies Corp. ("SimTech") The Company allocated amounts to IPR&D and intangible assets in the third quarter of 1997 in a manner consistent with widely recognized appraisal practices and in consultation with their independent accountants PricewaterhouseCoopers LLP at the date of the acquisition of SimTech. Subsequent to the acquisition, the SEC staff expressed views that took issue with certain appraisal practices generally employed in determining the fair value of the IPR&D that was the basis for measurement of the Company's IPR&D charge. The charge of $19.9 million, originally reported, was based upon the work of an independent valuation firm that utilized methodologies the SEC has since announced it does not consider appropriate. As a result of computing IPR&D using the SEC preferred methodology, the Company, in consultation with their independent accountants, has revised the amount originally allocated to IPR&D. In addition, Summit adjusted the discount on common shares paid to SimTech shareholders from 28% to 10% and allocated $4.4 million of the purchase price, associated with certain shares, to contingent compensation. The Company has reduced the amount originally allocated to IPR&D from $19.9 million to $11.7 million and increased the amounts allocated to purchased technology, identifiable intangibles, deferred tax liability, and goodwill from $1.0 million to $2.4 million, $1.0 million to $4.1 million, $0 to $1.3 million and $0 to $3.8 million, respectively. These amounts are being amortized on a straight line basis over periods ranging from two to five years. The $4.4 million allocated to compensation will be recorded as expense as the employment obligation lapses. The restatement does not affect previously reported net cash flows for the periods. The effect of this reallocation on previously reported condensed consolidated financial statements as of and for the three and nine months ended September 30, 1998 and 1997 is as follows (in thousands except per share amounts, unaudited).
- ---------------------------------------- ---------------------------------- - ---------------------------------- Three Months Ended Nine Months Ended September 30, 1998 September 30, 1998 - ---------------------------------------- ---------------------------------- - ---------------------------------- Statements of Operations: As Reported Restated As Reported Restated - ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- Cost of revenues $ 532 $ 613 $ 1,521 $ 1,759 Gross margin 10,782 10,701 31,162 30,924 Operating expenses 6,866 8,076 20,420 24,053 Income (loss) from operations 3,916 2,625 10,742 6,871 Net income (loss) 3,033 1,761 8,332 4,618 Net income (loss) per share Basic $0.20 $0.12 $0.55 $0.31 Diluted $0.19 $0.11 $0.51 $0.28
- ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- Three Months Ended Nine Months Ended September 30, 1997 September 30, 1997 - ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- Statements of Operations: As Reported Restated As Reported Restated - ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- Cost of revenues $ 355 $ 390 $ 956 $ 991 Gross margin 7,554 7,519 20,653 20,618 Operating expenses excluding in process technology 5,301 5,720 15,604 16,023 In process technology 19,937 11,689 19,937 11,689 Income (loss) from operations (11,769) (3,975) (14,888) (7,094) Net income (loss) (12,409) (4,508) (9,353) (1,452) Net income (loss) per share Basic $(0.86) $(0.31) $(0.66) $(0.10) Diluted $(0.86) $(0.31) $(0.66) $(0.10)
September 30, 1998 December 31, 1997 - ---------------------------------------- ---------------------------------- - ---------------------------------- Balance Sheets: As Reported Restated As Reported Restated - ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- - ---------------------------------------- ----------------- -- ------------- - ----------------- -- ------------- Noncurrent assets $ 7,609 $ 12,276 $ 5,908 $ 12,817 Total assets 41,982 46,649 32,761 39,670 Deferred tax liability 0 965 0 987 Accumulated deficit (11,794) (9,202) (20,126) (13,820) Total shareholders' equity 28,270 32,128 20,275 26,196
The results of operations for the nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998 or any other future interim period, and the Company makes no representations related thereto. 2. ACQUISITION OF PROSOFT OY On June 30, 1998, the Company acquired ProSoft Oy ("ProSoft"), a Company located in Finland. 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 was 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. The effect of the combination did not have a material impact on the net sales and net income of the combined entity. 3. SOFTWARE REVENUE RECOGNITION During the first quarter of 1998, the Company adopted Statements of Position (SOP) 97-2, "Software Revenue Recognition" and 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2, "Software Revenue Recognition." The provisions of SOP's 97-2 and 98-4 have been applied to transactions entered into beginning January 1, 1998. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on vendor-specific objective evidence (VSOE) of the fair value of the various elements in a multiple element arrangement. Revenue from the sale of software licenses is recognized at the later of the time of shipment or satisfaction of all acceptance terms. The revenue allocated to maintenance is recognized ratably over the term of the maintenance agreement and revenue allocated to services is recognized as the services are performed. SOP 98-4 defers for one year, the application of several paragraphs and examples in SOP 97-2 that limit the definition of vendor specific objective evidence (VSOE) of the fair value of various elements in a multiple element arrangement. The Company analyzed the elements included in its multiple element arrangements and determined that the Company has sufficient evidence to allocate revenue to the license and maintenance components of its product licenses. The adoption of SOP's 97-2 and 98-4 did not have a significant effect on revenue recognized for the three and nine month periods ending September 30, 1998. -6- SUMMIT DESIGN, INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 4. BALANCE SHEET COMPONENTS (IN THOUSANDS)
September 30, 1998 December 31, 1997 ------------------ ----------------- (Unaudited) Accounts receivable: Trade receivables............................... $ 8,079 $ 5,723 Less allowance for doubtful accounts............ (425) (592) ------------------ ----------------- $ 7,654 $ 5,131 ------------------ ----------------- ------------------ ----------------- Furniture and equipment: Office furniture equipment ..................... $ 941 $ 596 Computer equipment.............................. 4,999 3,679 Leasehold improvements.......................... 197 66 ------------------ ----------------- 6,137 4,341 Less: accumulated depreciation and amortization.... (2,478) (1,643) ------------------ ----------------- $ 3,659 $ 2,698 ------------------ ----------------- ------------------ ----------------- Accrued expenses: Payroll and related benefits.................... $ 3,565 $ 2,887 Sales and marketing............................. 1,236 435 Accounting and legal............................ 238 260 Federal and state income taxes payable.......... 928 819 Sales taxes payable............................. 86 114 Other ......................................... 433 667 ------------------ ----------------- Total accrued expenses........................ $ 6,486 $ 5,182 ------------------ ----------------- ------------------ -----------------
-7- SUMMIT DESIGN, INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 5. RECONCILIATION OF EARNINGS PER SHARE 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 Nine months ended September 30, September 30, -------------------------- --------------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Numerator: Net income (loss) $ 1,761 $ (4,508) $ 4,618 $ (1,452) -------- --------- --------- --------- -------- --------- --------- --------- Denominator: Denominator for basic earnings per share weighted average shares 15,245 14,456 15,072 14,245 Effect of dilutive securities: Employee stock options 855 - 1,136 - -------- --------- --------- --------- Denominator for diluted earnings per share 16,100 14,465 16,208 14,425 -------- --------- --------- --------- -------- --------- --------- --------- Net income per share - basic $ 0.12 $ (0.31) $ 0.31 $ (0.10) -------- --------- --------- --------- -------- --------- --------- --------- Net income per share - diluted $ 0.11 $ (0.31) $ 0.28 $ (0.10) -------- --------- --------- --------- -------- --------- --------- ---------
Options to purchase 923,000 and 869,000 shares of common stock at various prices were outstanding during the three and nine months periods ended September 30, 1997, respectively, but were not included in the computation of diluted EPS because their effect on EPS for the three and nine months ended September 30, 1997, respectively, would have been antidilutive. 6. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either as asset or liability measured at its fair value. SFAS No. 133 also requires that changes in the derivative instrument's fair value be recognized currently in results of operations unless specific hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999, The Company does not expect SFAS No. 133 to have a material impact on its consolidated financial statements. 7. SUBSEQUENT EVENT On September 20, 1998, the Company entered into a definitive agreement to acquire OrCAD, Inc. ("OrCAD") a publicly traded software company headquartered in Beaverton, Oregon. Pursuant to the agreement, each outstanding share will be exchanged for 1.05 shares of Summit Common Stock upon the closing of the transaction. In addition, the Company will assume all options outstanding under OrCAD's stock option plans. The merger, which is intended to be to accounted for as a pooling of interests, is subject to the approval of OrCad's and the Company's stockholders and standard closing conditions. On February 1, 1999, the proposed acquisition was terminated. -8- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IMPORTANT NOTE ABOUT FORWARD LOOKING STATEMENTS The following discussion contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Predictions of future events are inherently uncertain. Actual events could differ materially from those predicted in the forward looking statements as a result of the risks set forth in the following discussion, and, in the particular, the risks discussed below under the subheading "Additional Risk Factors that Could Affect Operating Results and Market Price of Stock." OVERVIEW Summit previously announced it would revise the accounting treatment of its September 1997 acquisition of SimTech in response to comments received from the Securities and Exchange Commission. The following discussion includes all changes that have been made related to the restatement. Summit 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 high level design automation ("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") and HLDA market. As a result of the Reorganization, TSSI and SEE Technologies became wholly-owned subsidiaries of Summit in the first quarter of 1994. The Company's ongoing implementation of its strategy has involved significant expenditures. Following the Reorganization, the Company significantly increased its research and development expenditures to support the continued development of HLDA and Design to Test products. To promote its products, the Company added sales and marketing staff, increasing its sales and marketing expenditures by 187% from 1993 to 1997, and has restructured its key distributor relationships. This concurrent effort to develop products and promote market awareness and acceptance of its products in a new and evolving market contributed to the Company's annual losses through 1995. The Company introduced its first HLDA Plus product, Visual HDL for VHDL 1.0, in the first quarter of 1994. This product lacked compiled simulation and operated only on a PC platform. In the third quarter of 1994, with the release of version 2.5, Summit expanded the simulation capability of Visual HDL for VHDL and introduced its UNIX-based version of this product. Prior to the Reorganization, the Company's Test Development Series ("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 the 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 of 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 Register Transfer Language ("RTL") optimization tools. Summit generated net losses in 1993, 1994 and 1995, as a result of investing heavily in research and development as well as developing a direct sales channel for new products. In 1996, this investment generated increased revenues, which resulted in net income. For the nine months ended September 30, 1998, Summit has continued to increase revenues and operating margins and, as a result, has generated net income for the period. Summit operates with high gross margins and, as such, a downturn in revenue could have a significant impact on income from operations and net income. Revenue consists primarily of fees for licenses of the Company's software products, maintenance and customer training. 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 vendor obligations 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 -9- 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 when sales to a third party or end user are completed. Fees received for granting distribution rights are deferred and recognized ratably over the term of the distribution agreement. 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 Design Asia, Ltd. ("Summit Asia")) acquired exclusive rights to sell, distribute and support all of Summit's products in the Asia-Pacific region, 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 the Asia-Pacific region, excluding Japan. SDA granted distribution rights to the Company's products to ADC for the Asia Pacific region, excluding Japan. For the three months ended September 30, 1998 and 1997, sales through SDA and ADC combined accounted for 0.6% and 1.2% of the Company's revenue, respectively. For the nine months ended September 30, 1998 and 1997, sales through SDA and ADC combined accounted for 2.2% and 2.9% 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 pro rata 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 (expense), 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, will increase. Approximately 39%, 26%, 36% and 38% of the Company's total revenue for the three months ended September 30, 1998 and 1997, and for the nine months ended September 30, 1998 and 1997, respectively, were attributable to sales made outside the United States, which includes the Asia Pacific region and Europe. Approximately 27%, 18%, 23% and 26% of the Company's revenue for the three months ended September 30, 1998 and 1997, and for the nine months ended September 30, 1998 and 1997, respectively, were attributable to sales made in the Asia Pacific region and approximately 12%, 8%, 13% and 12% of the Company's revenue for the three months ended September 30, 1998 and 1997, and for the nine months ended September 30, 1998 and 1997, respectively were attributable to sales made in Europe. The decline in the percentage of revenue from sales made outside the United States in 1998 is primarily the result of (1) domestic sales to one customer, (2) the loss of Design to Test product sales in the last half of 1997 as a result of the sale of the product line, which had a strong international market, and (3) the addition of revenue from products acquired in the SimTech acquisition which had a principally domestic market. 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 -10- with respect to the export of certain technologies, collectibility of accounts receivable, changes in regulatory requirements, difficulties in staffing and managing foreign operations and extended payment terms. In addition, financial markets and economies in the Asia Pacific region have been experiencing adverse economic conditions. While such diverse economic conditions have not materially adversely affected Summit's sales in the Asia Pacific region to date, there can be no assurance that the current economic conditions will not worsen or that demand for Summit's products in such region will not flatten or decrease in the future.(1) On February 28, 1997, Summit 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 interests" 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 Credence Systems Corporation ("CSC"). The increase in the Company's product licenses revenue during the last twelve months has been primarily due to increased revenue associated with the Company's HLDA Plus products. Substantially all of the Company's Design to Test product license revenue and related maintenance and services revenue for the three and nine months ended September 30, 1997 were attributable to the TDS products. 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 after June 30, 1997. The Company maintained exclusive rights to its Visual Testbench technology and CSC agreed to purchase a minimum of $16,000,000 of Visual Testbench licenses over a thirty-month period beginning July 1997, subject to specified quarterly maximums and certain additional conditions, and $2,000,000 of maintenance over an eighteen month period beginning July 1997. As of September 30, 1998, the Company has sold $13.6 million of Visual Testbench licenses pursuant to this agreement. At the completion of the thirty month period, under certain conditions, CSC may obtain shared ownership to Visual Testbench for sales into the ATE marketplace. 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 Summit common stock, 723,200 options to purchase Summit common stock and $3,875,000 in cash. The transaction was accounted for using the purchase method of accounting. Accordingly, the 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 condensed consolidated financial statements as of September 30, 1998 and 1997 and for the three and nine months ended September 30, 1998 and 1997 have been restated to reflect a change in the original accounting treatment related to the September 1997 acquisition of SimTech. The Company allocated amounts to IPR&D and intangible assets in the third quarter of 1997 in a manner consistent with widely recognized appraisal practices and in consultation with their independent accountants PricewaterhouseCoopers LLP at the date of the acquisition of SimTech. Subsequent to the acquisition, the SEC staff expressed views that took issue with certain appraisal practices generally employed in determining the fair value of the IPR&D that was the basis for measurement of the Company's IPR&D charge. The charge of $19.9 million, originally reported, was based upon the work of an independent valuation firm that utilized methodologies the SEC has since announced it does not consider appropriate. As a result of computing IPR&D using the SEC preferred methodology, the Company, in consultation with their independent accountants, has revised the amount originally allocated to IPR&D from $19.9 million to $11.7 million. In addition, Summit adjusted the discount on common shares paid to SimTech shareholders from 28% to 10% and allocated $4.4 million of the purchase price, associated with certain shares, to contingent compensation. The Company has reduced the amount originally allocated to IPR&D and increased the amounts allocated to purchased technology, identifiable intangibles, deferred tax liability, and goodwill from $1.0 million to $2.4 million, $1.0 million to $4.1 million, $0 to $1.3 million and $0 to $3.8 million, respectively. These amounts are being amortized on a straight line basis over periods ranging from two to five years. The $4.4 million allocated to compensation will be recorded as expense as the employment obligation lapses. This restatement does not affect previously reported net cash flows for the periods. In connection with the acquisition of SimTech, the Company repurchased 939,000 shares of common stock in private transaction at an average price of $12.30 per share for $11,555,000 in September 1997. 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 reissued 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. - -------- (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. -11- 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. -12- RESULTS OF OPERATIONS The following table sets forth for the periods indicated, certain financial data as a percentage of revenue.
Three Months Ended Nine Months Ended September 30, September 30 ------------------------ ------------------------ 1998 1997 1998 1997 ---------- ---------- ---------- ---------- (Restated) (Restated) (Restated) (Restated) Revenue: Product licenses.......................... 76.9% 81.5% 78.0% 78.4% Maintenance and services.................. 22.3 17.4 21.2 19.9 Other .................................. 0.8 1.1 0.8 1.7 ----- ----- ----- ----- Total revenue........................ 100.0 100.0 100.0 100.0 Cost of revenue: Product licenses.......................... 1.6 2.0 1.5 2.4 Maintenance and services.................. 2.3 2.2 2.4 2.0 Amortization of purchased technologies.... 1.5 0.7 1.5 0.2 ----- ----- ----- ----- Total cost of revenue................ 5.4 4.9 5.4 4.6 ----- ----- ----- ----- Gross profit......................... 94.6 95.1 94.6 95.4 Operating expenses: Research and development.................. 26.7 23.0 27.3 22.8 Sales and marketing....................... 28.6 34.2 29.2 36.2 General and administrative (a)(b)........ 9.9 12.1 10.7 14.0 Amortization of intangibles and goodwill.. 6.2 3.1 6.4 1.1 In-process technology..................... - 147.7 - 54.1 ----- ----- ----- ----- Total operating expenses............. 71.4 220.1 73.6 128.2 ----- ----- ----- ----- Income(loss) from operations................... 23.2 (125.0) 21.0 (32.8) Other income, net.............................. 2.6 4.4 2.4 3.6 Gain on sale of TDS product line............... - 70.4 - 25.8 ----- ----- ----- ----- Income(loss) before income taxes............... 25.8 (50.2) 23.4 (3.4) Income tax provision........................... 10.2 6.8 9.3 3.3 ----- ----- ----- ----- Net income(loss) .............................. 15.6% (57.0)% 14.1% (6.7)% ----- ----- ----- ----- ----- ----- ----- -----
(a) General and administrative expenses for the nine months ended September 30, 1997 include a one-time charge of $379,000 (1.7% of revenue) for costs relating to the acquisition of TriQuest. (b) General and administrative expenses for the nine months ended September 30, 1998 include a one-time charge of $227,000 (0.7% of revenue), relating to the acquisition of ProSoft. TOTAL REVENUE Total revenue increased by 43.1% from $7.9 million for the three months ended September 30, 1997 to $11.3 million for the three months ended September 30, 1998 and total revenue increase by 51.2% from $21.6 million for the nine months ended September 30, 1997 to $32.7 million for the nine months ended September 30, 1998. Sales through one distributor accounted for 13.2% and 12.2% of the Company's total revenue for the three months ended September 30, 1998 and 1997, respectively. Sales through the same distributor accounted for 14.0% and 12.8% of the Company's total revenue for the nine months ended September 30, 1998 and 1997, respectively. Sales to CSC accounted for 22.1% and 25.2% of the Company's total revenue for the three and nine month periods ended September 30, 1998, respectively. Such revenue included $2.5 million and $8.2 million of Visual Testbench license sales made pursuant to the Company's contract with CSC for the three and nine months ended September 30, 1998, respectively. See "Overview." Sales to CSC accounted for 41.1% of total revenue for the three months ended September 30, 1997 and 24.9% of the total revenue for the nine months ended September 30, 1997. -13- REVENUE PRODUCT LICENSES REVENUE The Company's product licenses revenue is derived from license fees from the Company's HLDA Plus products and additionally from Design to Test products through June 30, 1997. Product licenses revenue increased 35.1% from $6.4 million for the three months ended September 30, 1997 to $8.7 million for the three months ended September 30, 1998 and increased 50.3% from $17.0 million for the nine months ended September 30, 1997 to $25.5 million for the nine months ended September 30, 1998. Due to the sale of the TDS product line in July of 1997, revenue from HLDA Plus products accounted for 100% of product licenses revenue for the three and nine months ended September 30, 1998. During the three months ended September 30, 1997, HLDA Plus revenues also accounted for 100% of product license revenue. During the nine months ended September 30, 1997, HLDA Plus and Design to Test revenues accounted for 87.9% and 12.1% of product and license revenue, respectively. HLDA Plus product license revenue increased 71.0% from $14.9 million for the nine months ended September 30, 1997 to $25.5 million for the nine months ended September 30, 1998. The increase was primarily attributable to sales of Visual Testbench and Visual to CSC, and, to a lesser extent, sales of the VirSim and VeriCov products that were not shipping in the comparable period in 1997, and growth in the installed base of HLDA Plus customers. Sales to the single customer are expected to continue over the next five quarters pursuant to contractual arrangements with the customer. (2) MAINTENANCE AND SERVICES REVENUE The Company's maintenance and services revenue is derived from maintenance contracts related to the Company's HLDA products, consulting services, and training classes offered to purchasers of the Company's software products. Maintenance and services revenue increased 83.3% from $1.4 million for the three months ended September 30, 1997 to $2.5 million for the three months ended September 30, 1998, and increased 61.1% from $4.3 million for the nine months ended September 30, 1997 to $6.9 million for the nine months ended September 30, 1998. The increase is primarily attributable to maintenance contracts for Verification products acquired in the SimTech acquisition, a maintenance contract with one customer, and an increase in the installed base of HLDA Plus customers over the previous comparable period. Additionally, such revenue for the nine months ended September 30, 1997 included $1.4 million Design to Test maintenance revenue for which there was no comparable revenue for the nine months ended September 30, 1998, due to the sale of the TDS product line as of July 1, 1997. OTHER REVENUE Other revenue consists of fees received for granting distribution rights. Other revenue remained constant at $91,000 for the three months ended September 30, 1998 and 1997 and decreased 23.5% from $358,000 for the nine months ended September 30, 1997 to $274,000 for the nine months ended September 30, 1998. In May 1997, a distribution agreement expired; and, as a result, the distribution rights fees paid at the inception of the agreement and amortized into revenue at $50,000 each quarter over the agreement period are no longer a source of other revenue. No material costs were associated with other revenue for the three and nine months ended September 30, 1998 and 1997. - ----- (2) This statement 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. -14- 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 plus the amortization of purchased technology acquired in the SimTech purchase. The cost of product licenses revenue increased 8.5% from $165,000 for the three months ended September 30, 1997 to $179,000 for the three months ended September 30, 1998, and decreased 4.7% from $514,000 for the nine months ended September 30, 1997 to $490,000 for the nine months ended September 30, 1998. As a percentage of product licenses revenue, the cost of product licenses revenue decreased from 2.6% of product licenses revenue for the three months ended September 30, 1997 to 2.1% of product licenses revenue for the three months ended September 30, 1998, and decreased from 3.0% of product licenses revenue for the nine months ended September 30, 1997 to 1.9% of product licenses revenue for the nine months ended September 30, 1998. The fluctuation in the cost of product license revenue as a percent of product license revenue is primarily the result of incremental changes in fixed costs leveraged across increased product license revenue. COST OF MAINTENANCE AND SERVICES REVENUE Cost of maintenance and services revenue, which consists primarily of personnel costs for customer support consulting and training classes offered to purchasers of the Company's products, increased 57.3% from $171,000 for the three months ended September 30, 1997 to $269,000 for the three months ended September 30, 1998, and increased 82.7% from $423,000 for the nine months ended September 30, 1997 to $773,000 for the nine months ended September 30, 1998. As a percentage of maintenance and services revenue, the cost of maintenance and services revenue decreased from 12.4% for the three months ended September 30, 1997 to 10.7% for the three months ended September 30, 1998 and increased from 9.8% for the nine months ended September 30, 1997 to 11.2% for the nine months ended September 30, 1998. The decrease as a percentage of maintenance and services revenue for the three months ended September 30, 1998, is due to fixed costs being leveraged over increased revenue. The increase as a percentage of maintenance and services revenue for the nine months ended September 30, 1998 is due to the Company operating at below forecasted staffing levels during the first half of 1997. 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 $165,000 and $496,000 for the three and nine months ended September 30, 1998 and $54,000 for the three and nine months ended September 30, 1997. 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 increased 66.3% from $1.8 million for the three months ended September 30, 1997 to $3.0 million for the three months ended September 30, 1998 and increased 80.6% from $4.9 million for the nine months ended September 30, 1997 to $8.9 million for the nine months ended September 30, 1998. A significant amount of the increase was attributable to compensation expense in the amount of $550,000 and $1.7 million for the three and nine months ended September 30, 1998 and $183,000 for the three and nine months ended September 30, 1997, recorded in connection with the Company's acquisition of SimTech in September 1997. The Company is recording $4.4 million of compensation expense for shares issued as part of the acquisition which are contingent upon continued employment and are expensed as the employment obligation lapses. Additionally the Company's research and development staff increased to 95 at September 30, 1998. This increase is primarily attributable to the addition of engineers through the acquisition of SimTech in September of 1997 and the hiring of additional engineers, less a decrease of engineers due to the sale of the TDS product line in July of 1997. As a percentage of total revenue, research and development expenses increased from 23.0% for the three months ended September 30, 1997 to 26.7% for the three months ended September 30, 1998, and increased from 22.9% for the nine months ended September 30, 1997 to 27.3% for the nine months ended September 30, 1998. A significant amount of the increase is related to the Company recording on a straight-line basis, $4.4 million of compensation for shares issued as part of the SimTech acquisition which are contingent upon continued employment for two years from the acquisition date. 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 -15- research and development expense will increase in absolute dollars in future periods, but may vary as a percent of revenue.(2) SALES AND MARKETING Sales and marketing expenses, consisting primarily of salaries, commissions and promotional costs, increased 19.6% from $2.7 million for the three months ended September 30, 1997 to $3.2 million for the three months ended September 30, 1998 and increased 22.0% from $7.8 million for the nine months ended September 30, 1997 to $9.5 million for the nine months ended September 30, 1998. The increase over 1997 was attributable to expenses related to the marketing of new products acquired with the purchase of SimTech and additional commissions directly related to the increase in gross sales over the comparable period in 1997. As a percentage of total revenue, sales and marketing expenses decreased from 34.2% for the three months ended September 30, 1997 to 28.6% for the three months ended September 30, 1998, and decreased from 36.2% for the nine months ended September 30, 1997 to 29.2% for the nine months ended September 30, 1998. The decrease as a percentage of revenue was primarily attributable to the increase in total revenue for 1998. In the future, the Company expects sales and marketing expenses to continue to increase in absolute dollars.(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 17.6% from $954,000 for the three months ended September 30, 1997, to $1.1 million for the three months ended September 30, 1998, and increased 15.8% from $3.0 million for the nine months ended September 30, 1997, which includes $379,000 one-time charge for costs associated with the acquisition of TriQuest, to $3.5 million for the nine months ended September 30, 1998, which includes a $227,000 one-time charge for costs associated with the acquisition of ProSoft. Excluding one-time charges, expenses increased by $628,000 (23.8%) for the nine months ended September 30, 1998, as compared to the same period in the prior year. As a percentage of total revenue, excluding the one time charges, general and administrative expenses decreased from 12.1% for the three months ended September 30, 1997 to 9.9% for the three months ended September 30, 1998, and decreased from 12.2% for the nine months ended September 30, 1997 to 10.0% for the nine months ended September 30, 1998. The decrease as a percentage of total revenue was attributable to the increase in total revenue in 1998. The Company expects general and administrative expenses to increase in absolute dollars to support future sales and operations.(2) AMORTIZATION OF INTANGIBLES AND GOODWILL The Company recorded $4.1 million in intangibles (excluding $2.4 million of developed 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 $698,000 and $2.1 million for the three and nine months ended September 30, 1998 and $244,000 for the three and nine months ended September 30, 1997. ACQUIRED IN-PROCESS TECHNOLOGY For the three months ended September 30, 1997, $11.7 million of the purchase price for the acquisition of Simulation Technologies, Corp. ($25.4 million) was allocated to in-process technology and accordingly, was expensed as of the acquisition date (September 9, 1997). The amount allocated to the in-process technology represented the technology that had not yet reached technological feasibility and had no alternative future use. The value assigned to purchased in-process technology was related primarily to two research projects for which technological feasibility had not been established, V-CPU ($8.1 million) and HDL Score ($3.1 million). The value was determined by estimating the net cash flows from the sale of products resulting from the completion of such projects, and discounting the net cash flows back to their present value. The Company then estimated the stage of completion of the products at the date of the acquisition based on the code that had been completed at the date of acquisition as compared to total estimated code at completion. The percentages derived from such calculation were then applied to the net present value of future cash flows to determine the in-process technology charge. The nature of the efforts to develop the purchased in-process technology into commercially viable products principally related to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the product can be produced to meet its design specification including function, features and technical performance requirements. The originally estimated costs to be incurred to develop the purchased in-process technology into commercially viable products was approximately $1.8 million. The estimated resulting net cash flows from such products were based on Summit management's estimates of revenues, cost of sales, research and development costs, selling, general and administrative costs, and income taxes from such projects. The estimated revenues include average compounded annual revenue growth rates for the V-CPU and HDL Score products of 155% to 88% during 1998 to 2000, declining slightly in 2001 and declining thereafter as other new products are expected to enter the market. These projections are based on Summit management's estimates of market size and growth (which are supported by independent market data), expected trends in technology and the nature and expected timing of new product introductions by Summit.(2) Estimated cost of sales of 5% is consistent with Summit's current cost of sales and future expectations for cost of sales. Sales, marketing and general administrative costs are expected to be higher than the Company's average costs in the introduction phase and then stabilize upon introduction at levels that are expected to be consistent with the Company's expected overall costs in these areas in future periods. Research and development costs are expected to be higher than the Company's average costs in the introduction and early phases of product sales and then decline below the Company's average costs as sales of the products begin to decline. This research and development cost pattern is consistent with the Company's historical experience through product life cycles. Income taxes were estimates at 30% which are consistent with the Company's anticipated tax rate for the foreseeable future. (1) Summit released the commercial version the V-CPU hardware/software co-verification product in the first quarter of 1998, consistent with expectations at the time of the acquisition. A market requirement for extensive embedded system component interfaces called bus functional models ("BFM") and instruction set simulators ("ISS") was underestimated in the introduction schedule and has caused delays in initial sales of the product. Summit introduced the HDL Score product in the second quarter of 1998 approximately four months later than originally anticipated due to delays in completing the control logic support functionality that was essential for product introduction to take place. For 1998, the Company estimates that revenues from the sales of the products acquired in connection with the SimTech acquisition will fall short of forecast by 10%. (2) The Company's forecast of revenues for 1999 reflects that the shortfall of revenues in 1998 related to HDL Score will be realized in 1999 and that V-CPU will have revenues that are approximately 50% of those originally estimated due to the delays in availability of BFM's and ISS's. (2) Although these delays affected the timing of the realization of revenue from these products as originally estimated by Summit, Summit believes the aggregate revenue streams originally anticipated from these products will be realized and that there has been no material change in expected return on investment related to these products. (2) However, there can be no assurance that Summit will realize revenue for V-CPU and HDL Score in the amounts estimated, and actual revenue realized from either or both of these products may be significantly lower than expected. (1) - ----- (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. (2) This statement 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. -16- 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 $346,000 for the three months ended September 30, 1997 and $298,000 for the three months ended September 30, 1998 and $786,000 for the nine months ended September 30, 1997 and $790,000 for the nine months ended September 30, 1998. The decrease in other income for the three months ended September 30, 1998 was primarily due to declining interest rates on the Company's cash holdings and a charge for the Company's share of the losses of the Asian joint venture. GAIN ON SALE OF TDS PRODUCT LINE On July 11, 1997 the Company sold substantially all of the assets used in its business of developing and marketing its Test Development Series "TDS" Products to Credence Systems Corporation ("CSC") for $5 million. CSC assumed certain liabilities, including the Company's obligations under TDS maintenance contracts entered into prior to the closing. The Company has recorded a gain on the sale of $5,569,000 for the three and nine months ended September 30, 1997. INCOME TAX PROVISION The income tax provision increased from $533,000 for the three months ended September 30, 1997 to $1.2 million for the three months ended September 30, 1998 and from $713,000 for the nine months ended September 30, 1997 to $3.0 million for the nine months ended September 30, 1998. The provision for the three and nine months ended September 30, 1997 reflects an effective rate of 5.6% of taxable income and is comprised of federal alternative minimum tax and Israeli income taxes. In 1997, the Company utilized net operating loss carryforwards to offset a considerable portion of U.S. federal and state taxable income. The 1998 income tax provision reflects the Company's expected annualized consolidated tax rate for federal, state and foreign taxes of approximately 40% of taxable income. The difference between the Company's expected effective rate and the statutory rate for the year ending December 31, 1998 is primarily due to an increased effective tax rate on U.S. income arising from non-deductible amortization of goodwill and non-deductible compensation expense associated with shares issued in connection with the acquisition of SimTech offset by reduced tax rates on the Company's income generated from operations in Israel. VARIABILITY OF OPERATING RESULTS The Company has experienced significant quarterly fluctuations in operating results and cash flows and it is likely that these fluctuations will continue in future periods. These fluctuations have been, and may in the future be, caused by a number of factors, including the rate of acceptance of new products, corporate acquisitions and consolidations, product quality issues, product, customer and channel mix, the size and timing of orders, lengthy sales cycles, the timing of new product announcements and introductions by the Company and its competitors, seasonal factors, 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. The Company has generally recognized a substantial portion of its revenue in the last month of each quarter, with this revenue concentrated 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. The Company's revenue is difficult to forecast for several reasons. The market for certain of the Company's software products is evolving. The Company's sales cycle is typically six to nine months and varies substantially from customer to customer. In addition, a significant portion of the Company's sales are made through indirect channels and can be harder to predict. 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. As a result, -17- if revenue in any quarter falls below expectations, expenditure levels could be disproportionately high as a percentage of revenue, and the Company's operating results for that quarter would be adversely affected. Based upon the factors described above, the Company believes that its quarterly revenue, expenses and operating results are likely to vary significantly in the future, that period-to-period comparisons of its results of operations are not necessarily meaningful and that, as a result, such comparisons should not be relied upon as indications of the Company's future performance. Moreover, although the Company's revenue has increased in recent periods, there can be no assurance that the Company's revenue will grow in future periods or that the Company will remain profitable on a quarterly or annual basis. Due to the foregoing or other factors, it is likely that the Company's results of operations may be below investors' and market analysts' expectations in some future quarters, which could have a severe adverse effect on the market price of the Company's Common Stock. EFFECTIVE CORPORATE TAX RATES Prior to 1996, the Company had experienced losses for income tax purposes in the United States. The Company is now profitable in the United States and expects to pay income taxes at or near the statutory tax rate on its U.S. taxable earnings. The Company expects its effective tax rate on U.S. earnings to be in excess of the statutory rate for the foreseeable future due to non- deductible charges for goodwill and certain compensation charges associated with stock issued to certain shareholders in connection with the SimTech acquisition. As of December 31, 1997, the Company had recognized the benefit of its U.S. net operating loss carryforwards and tax credit carryforwards in its 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, 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 Summit from its Israeli operations as of December 31, 1995 since the Israeli operations were still incurring losses at that time. During 1996, Summit realized income of $1.4 million from its Israeli operations and "Approved Enterprise" tax benefits of $53,000. During 1997, Summit realized income of $2.7 million from its Israeli operations and "Approved Enterprise" tax benefits of $702,000. 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 Company has foreign income tax net operating losses of approximately $5.6 million at December 31, 1997. 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 September 30, 1998, the Company had approximately $24.7 million in cash and cash equivalents and a $1.0 million bank line of credit with a major financial institution ("the Bank"). The line of credit expires on April 30, 1999. Borrowings thereunder accrue interest at specified percentages above the prime lending rate based on the Company's ratio of debt to tangible net worth. Advances under the line of credit are limited to a specified percentage of eligible accounts -18- receivable (as defined in the line of credit). Borrowings under the line of credit are collateralized by the Company's accounts receivable, inventory and general intangible assets, including its intellectual property rights. As of September 30, 1998 the Company had no borrowings outstanding under this line of credit. The Company is obligated to lend up to $2.5 million to an independent software development company pursuant to a secured loan agreement entered into during July 1997. Borrowings under the agreement bear interest at prime plus 2%. As of September 30, 1998, the Company had working capital of approximately $21.1 million. Net cash generated by operating activities was approximately $8.6 million and $9.3 million for the nine months ended September 30, 1998 and 1997, respectively. Cash generated by operating activities resulted primarily from profitable operations, and an increase in accrued liabilities partially offset by an increase in accounts receivable for the nine months ended September 30, 1998 and primarily from profitable operations plus an increase in accounts payable, accrued liabilities, deferred revenue and a decrease in accounts receivable for the nine months ended September 30, 1997. Net cash used in investing activities was approximately $3.4 million and $921,000 for the nine months ended September 30, 1998 and 1997, respectively. Net cash used in investing activities was related to the acquisition of furniture and equipment and loans to an unconsolidated joint venture and the software development company pursuant to the July 1997 loan agreement for the nine months ended September 30, 1998 and was primarily due to the acquisition of SimTech in September 1997 and the purchase of furniture and equipment less the cash provided from the sale of the TDS product line for the nine months ended September 30, 1997. Net cash used by financing activities was approximately $465,000 and $11.0 million for the nine months ended September 30, 1998 and 1997. For the nine months ended September 30, 1998 the use of cash was primarily from the repurchase of common stock, less the issuance of common stock and a tax benefit from option exercises. For the nine months ended September 30, 1997, the cash used in financing activities was primarily due to the purchase of treasury stock less the issuance of common stock. The Company presently believes that its current cash and cash equivalents, together with funds expected to be generated from operations, will satisfy the Company's anticipated working capital, debt service and other cash requirements for at least the next 12 months.(2) ADDITIONAL RISK FACTORS THAT COULD AFFECT OPERATING RESULTS AND MARKET PRICE OF STOCK FLUCTUATIONS IN QUARTERLY RESULTS Summit has experienced significant quarterly fluctuations in operating results and cash flows and it is likely that these fluctuations will continue in future periods. These fluctuations have been, and may in the future be, caused by a number of factors, including the rate of acceptance of new products, 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, product quality, product, customer and channel mix, the size and timing of orders, lengthy sales cycles, the timing of new product announcements and introductions by the Company and its competitors, seasonal factors, 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. Summit generated net losses in 1993, 1994 and 1995, as a result of investing heavily in research and development as well as developing a direct sales channel for new products. The net loss in 1997 was a result of a $11.7 million charge for in-process technology related to the acquisition of Simulation Technologies Corp. ("SimTech"). For the nine months ended September 30, 1998, Summit has continued to increase revenues and operating margins and, as a result, has generated net income for the period. Summit operates with high gross margins, and as such, a downturn in revenue could have a significant impact on income from operations and net income, and could potentially generate a net loss. - ------------- (2) This statement 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 this page for a discussion of factors that could affect future performance. -19- The Company has generally recognized a substantial portion of its revenue in the last month of each quarter, with this revenue concentrated 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, results of operations or cash flows in any particular quarter, and to the extent that significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected. The Company's revenue is difficult to forecast for several reasons. The market for certain of the Company's software products is evolving. The Company's sales cycle is typically six to nine months and varies substantially from customer to customer. The Company operates with little product backlog because its products are typically shipped shortly after orders are received. In addition, a significant portion of the Company's sales are made through indirect channels and can be harder to predict. 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. As a result, if revenue in any quarter falls below expectations, expenditure levels could be disproportionately high as a percentage of revenue, and the Company's operating results for that quarter would be adversely affected. Based upon the factors described above, the Company believes that its quarterly revenue, expenses and operating results are likely to vary significantly in the future, that period-to-period comparisons of its results of operations are not necessarily meaningful and that, as a result, such comparisons should not be relied upon as indications of the Company's future performance. Moreover, although the Company's revenue has increased in recent periods, there can be no assurance that the Company's revenue will grow in future periods or that the Company will remain profitable on a quarterly or annual basis. Due to the foregoing or other factors, it is likely that the Company's results of operations may be below investors' and market analysts' expectations in some future quarters, which could have a severe adverse effect on the market price of the Company's Common Stock. PRODUCT CONCENTRATION; UNCERTAINTY OF MARKET ACCEPTANCE OF HLDA Prior to July 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. Effective July 1, 1997, as a result of the Asset Sale, TDS products ceased to be a source of revenue. With the acquisition of TriQuest in February 1997, SimTech in September 1997, and ProSoft in June 1998, the Company also derives 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. The Company believes that HLDA Plus products will continue to account for substantially all of its revenue in the future. 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. The Company's future success depends primarily upon the market acceptance of its existing and future HLDA Plus products. The Company commercially shipped its first HLDA Plus product, Visual HDL for VHDL, in the first quarter of 1994. For the nine months ended September 30, 1998 and 1997 and the years ended December 31, 1997, 1996 and 1995, respectively, revenue from HLDA Plus products and related maintenance contracts represented 100%, 83.7%, 76.5%, 63.5%, and 43.6%, respectively, of the Company's total revenue. 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. -20- 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 Summit'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. The Company's Visual Testbench product, introduced in the fourth quarter of 1995, provides a new methodology and requires a change in the traditional design flow for creating IC test programs. The Company anticipates a lengthy period of test marketing for the Visual Testbench product. Accordingly, the Company cannot predict the extent, to which it will realize revenue from Visual Testbench in excess of the revenue expected to be received pursuant to an OEM agreement entered into in July 1997. As part of this agreement, CSC must purchase a minimum of $16.0 million of Visual Testbench licenses over a thirty month period beginning in July 1997. As of September 30, 1998 the Company had sold $13.6 million of Visual Testbench licenses pursuant to this agreement. The Company will need to replace this revenue when the $16.0 million purchase obligation is satisfied and the failure of the Company to replace this revenue would have a material adverse affect on the Company's operating results. 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 it competes 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. -21- 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. 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. 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. -22- DEPENDENCE ON DISTRIBUTORS The Company relies on distributors for licensing and support of its products outside of North America. Approximately 18%, 34%, 29%, 46% and 42% of the Company's revenue for the nine months ended September 30, 1998 and 1997and the years ended December 31, 1997, 1996 and 1995, 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 to sell, distribute and support all of the Company's products in the Asia-Pacific region, excluding Japan. Prior to that date, Anam was an independent distributor of the Company's products. 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 has 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. There can be no assurance that this restructuring will result in Summit Asia or ADC becoming profitable or that revenue attributable to sales in the Asia Pacific region, excluding Japan, would increase. During the first quarter of 1997, the Company entered into a distribution agreement with ATE pursuant to which ATE was granted exclusive rights to sell, distribute and support Summit's Visual Testbench products within Japan until March 1999, subject to the Company's ability to terminate the relationship if ATE fails to meet quarterly sales objectives. The agreement may also be terminated by either party for breach. 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. In the event Seiko fails to meet specified quotas for two or more quarterly periods, exclusivity can be terminated by Summit, subject to Seiko's right to pay a specified fee to maintain exclusivity. 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. Sales through Seiko accounted for 13%, 12%, 14% and 13% of the Company's total revenue for the three months ended September 30, 1998 and 1997 and for the nine months ended September 30, 1998 and 1997. For the nine months ended September 30, 1998 and the year ended December 31, 1997, all sales of the Company's products in the Asia-Pacific region were through Seiko, SDA, ADC and ATE. There can be no assurance the relationships with Seiko, SDA, ADC and ATE will be effective in maintaining or increasing sales relative to the levels experienced prior to such relationships. 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, ADC and ATE, 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 36%, 38%, 34%, 50% and 52% of the Company's revenue for the nine months ended September 30, 1998 and 1997 and the years ended December 31, 1997, 1996 and 1995, respectively, were attributable to sales made outside the United States, which includes the Asia Pacific region and Europe. Approximately 27%, 18%, 23% and 26% of the Company's revenue for the three month ended September 30, 1998 and 1997, and for the nine months ended September 30, 1998 and 1997, respectively, were attributable to sales made in the Asia Pacific region and approximately 12%, 8%, 13% and 12% of the Company's revenue for the three months ended September 30, 1998 and 1997, and for the nine months ended September 30, 1998 and 1997, 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 -23- 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, collectibility 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 conditions. While such adverse economic conditions have not materially affected Summit's sales in the Asia Pacific region to date, there can be no assurance that such adverse economic conditions will not worsen or that demand for Summit's products in such region will not flatten or decrease in the future. 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 Summit'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. Summit 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 Summit's business, financial condition, results of operations or cash flows. Summit has consummated a series of acquisitions since 1997, including the acquisition of TriQuest in February 1997, SimTech in September 1997, and ProSoft in June 1998. As a result of these acquisitions, Summit's operating expenses have increased and are expected to continue to increase. There can be no assurance that the integration of TriQuest's, SimTech's, or ProSoft's business can be successfully completed in a timely fashion, or at all, or that the revenues from TriQuest, SimTech, and ProSoft will be sufficient to support the costs associated with the acquired businesses, without adversely affecting Summit's operating margins. Any failure to successfully complete the integration in a timely fashion or to generate sufficient revenues from the acquired business could have a material adverse effect on Summit's business, financial condition, results of operations or cash flows. In addition, Summit regularly evaluates acquisition opportunities. Future acquisitions by Summit 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 concern, risks of entering markets in which Summit has no or limited prior experience and potential loss of key employees of acquired companies. Summit's management has had limited experience in assimilating acquired organizations and products into Summit's operations. No assurance can be given as to the ability of Summit to integrate successfully any operations, personnel or products that have been acquired or that might be acquired in the future, and the failure of Summit to do so could have a material adverse effect on Summit's results of operations. OPERATIONS IN ISRAEL The Company's research and development operations related to its HLDA 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 -24- 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 $4.7, $4.3 and $4.3 million in 1997, 1996 and 1995, respectively. Payment in Israeli currency subjects the Company to foreign currency fluctuations and to economic pressures resulting from Israel's generally high rate of inflation, which has been approximately 7%, 11% and 8% during 1997, 1996, and 1995, 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. 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 Summit from its Israeli operations as of December 31, 1995 since the Israeli operations were still incurring losses at that time. During 1996, Summit realized income of $1.4 million from its Israeli operations and "Approved Enterprise" tax benefits of $53,000. During 1997, Summit realized income of $2.7 million from its Israeli operations and "Approved Enterprise" tax benefits of $702,000. 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 future success depends in large part on the continued service of its key technical and management personnel and its ability to continue 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. 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. The Company has obtained a $1 million "key person" life insurance policy on its President/Chief Executive Officer. 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. ISRAELI RESEARCH, DEVELOPMENT AND MARKETING GRANTS Summit's Israeli subsidiary obtained research and development grants from the Office of the Chief Scientist (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 had been repaid. The terms of the -25- 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 September 30, 1998, approximately $187,000 was outstanding under the grant. LIMITATIONS ON PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS 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 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 its HLDA Plus 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. 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. -26- 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 causing 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 Summit, 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 Summit. Summit cannot, however, quantify the impact at this time. Summit has begun upgrading or replacing the software packages underlying its financial, production, communication, desktop and other systems, as appropriate, to address the Year 2000 issues. It has also performed an in-depth analysis of all of its products and begun to modify those that are not Year 2000 compliant. Moreover, Summit has begun to contact all major external third parties that provide products and services to Summit to assess their readiness for the Year 2000. Management believes it has completed the review and assessment phase of affected systems within Summit and those which are external to Summit. This assessment indicated that most of Summit's significant internal information systems could be affected by the Year 2000 issue, and that Summit could be negatively impacted by non-compliance of related third parties. In addition, this assessment concluded that certain of Summit's products were also at risk. Summit has begun the remediation phase of Summit's internal information technology systems and has set July 1999 as the target for Year 2000 compliance of all of Summit's internal information technology systems. Summit's internal information technology systems include Summit's finance systems and those systems used in the research and development of Summit's products. Summit's products are subject to periodic upgrades. These upgrades are typically released to end-users once a year. Summit intends to modify its products, as required, in order to make such products Year 2000 compliant by July 1999. Summit 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 July 31, 1999. In the event Summit's information technology systems and/or products are not Year 2000 compliant by July 31, 1999, Summit will decide at that time whether to implement the necessary contingency plan(s). Summit 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 compliant. The inability of those parties to complete their Year 2000 resolution process could materially impact Summit. The effects of non-compliance by third parties where no system interface exists is not determinable. Summit will determine whether a contingency plan is necessary in relation to third parties with whom Summit 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 July 31, 1999. Subsequent to performing the above steps, Summit will make certain investments in systems, applications and products to address Year 2000 issues. Summit has not tracked internal resources dedicated to the resolution of the Year 2000 issue and, therefore, is unable to quantify internal costs incurred to date that are associated with the Year 2000 issue. Summit has, however, hired external consultants to resolve internal information system issues related to the resolution of the Year 2000 issue. Identifiable expenditures for these investments were approximately $170,000 through June 30,1998. These expenditures are not expected to be material in the future. Investments to address the Year 2000 issue have been, and are expected to be, funded through cash generated from operations. Summit'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 include the availability and cost of personnel trained in this area, and the ability to locate and correct all relevant computer codes. -27- 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 Not applicable Item 5. Other Information Not applicable Item 6 Exhibits and Reports on Form 8-K (a) Exhibits 27.1 Financial Data Schedule (b) Reports on Form 8-K On September 30, 1998, the Company filed a report on Form 8-K dated September 20, 1998 in conjunction with the execution of a definitive Agreement to acquire OrCAD. -28- 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: March 15, 1999 -29- EXHIBIT INDEX EXHIBIT 27.1 Financial Data Schedule -30- EX-27.1 2 EX-27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RESPECTIVE BALANCE SHEETS AS OF SEPTEMBER 30, 1998 AND THE RELATED STATEMENTS OF INCOME AND CASH FLOWS FOR THE RESPECTIVE PERIOD THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 24,662 0 8,079 425 0 34,373 6,137 2,478 46,649 13,231 0 0 0 153 31,975 46,649 0 32,683 0 1,759 24,053 36 3 7,661 3,043 4,618 0 0 0 4,618 0.31 0.28
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