UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q 	 Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended June 30, 1996.			Commission File No. 0-13442 	 MENTOR GRAPHICS CORPORATION (Exact name of registrant as specified in its charter) Oregon 	93-0786033 (State or other jurisdiction of 	(IRS Employer Identification No.) incorporation or organization) 8005 S.W. Boeckman Road, Wilsonville, Oregon 97070-7777 (Address including zip code of principal executive offices) Registrant's telephone number, including area code: (503) 685-7000 	 NO CHANGE Former name, and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Number of shares of common stock, no par value, outstanding as of July 31, 1996: 62,024,302 MENTOR GRAPHICS CORPORATION Index to Form 10Q PART I FINANCIAL INFORMATION 	Page Number Item 1. Financial Statements 	Consolidated Statements of Operations for the three 	3 		months ended June 30, 1996 and 1995 	Consolidated Statements of Operations for the six 	4 		months ended June 30, 1996 and 1995 	Consolidated Balance Sheets as of June 30, 1996 	5 		and December 31, 1995 	Consolidated Statements of Cash Flows for the 	6 		six months ended June 30, 1996 and 1995 	Notes to Consolidated Financial Statements 	7-9 Item 2. Management's Discussion and Analysis of 			Results of Operations and Financial Condition 	10-18 PART II OTHER INFORMATION Item 1. Legal Proceedings 	19 Item 4. Submission of Matters to a Vote of Security Holders 	19 Item 6. Exhibits and Reports on Form 8-K	20 SIGNATURES	 	20 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Mentor Graphics Corporation Consolidated Statements of Operations (In thousands, except net income per share) (Unaudited) 	 Three Months Ended 	 June 30, 		 1996	 1995	 Revenues: 	System and software 	$	65,286	 $	55,653 	Service and support		 51,072	 	49,955 		Total revenues		 116,358		 105,608 Cost of revenues: 	System and software		 10,453	 	8,865 	Service and support	 	22,423	 	20,355 		Total cost of revenues		 32,876		 29,220 		Gross margin		 83,482	 	76,388 Operating expenses: 	Research and development 	 	21,089	 	21,137 	Marketing and selling		 35,152		 35,464 	General and administration		 9,814		 8,977 	Restructure costs 		 --	 	(2,040) 	Merger and acquisition related charges 		12,423	 	800 		Total operating expenses		 78,478		 64,338 Operating income 		 5,004		 12,050 	Other income (expense), net 	 	(156)	 	2,179 		Income before income taxes		 4,848	 	14,229 	Provision for income taxes	 	1,370		 1,628 		Net income 	 $	3,478	 $	12,601 Net income per common and 	common equivalent share 	$ 	.05	 $	 .20 Weighted average number of common and 	common equivalent shares outstanding 		63,267 		62,732 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Statements of Operations (In thousands, except net income per share) (Unaudited) 	 Six Months Ended 	 June 30, 		 1996	 1995	 Revenues: 	System and software 	$	126,233	 $	108,634 	Service and support		 98,507	 	95,343 		Total revenues		 224,740	 	203,977 Cost of revenues 	System and software		 21,011		 18,191 	Service and support		 44,424		 38,831 		Total cost of revenues		 65,435		 57,022 		Gross margin	 	159,305	 	146,955 Operating expenses: 	Research and development (R&D) 		44,380	 	41,270 	Marketing and selling		 69,735	 	67,100 	General and administration		 19,529		 18,693 	Restructure costs	 	--		 (2,040) 	Merger and acquisition related charges		 16,833	 	800 		Total operating expenses		 150,477 		125,823 Operating income 		 8,828 		21,132 	Other income, net 		1,633	 	3,544 		Income before income taxes		 10,461	 	24,676 	Provision for income taxes	 	2,210	 	3,862 		Net income 	$ 	8,251	 $	20,814 Net income per common and 	common equivalent share 	$ 	.13	 $	 .34 Weighted average number of common and 	common equivalent shares outstanding 		63,057 		62,212 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Balance Sheets (In thousands) 	 		As of 	As of 			 June 30, 1996 	December 31, 1995 			 (Unaudited)	 ASSETS Current assets: 	Cash and cash equivalents	 $	170,004	 $	185,825 	Short-term investments	 	22,309		 24,504 	Trade accounts receivable, net		 118,187		 95,946 	Other receivables	 	5,465		 3,421 	Prepaid expenses and other		 14,789	 	15,155 		Total current assets		 330,754		 324,851 Property, plant and equipment, net		 100,502	 	99,363 Cash and investments, long-term		 30,000		 30,000 Other assets		 43,729		 38,160 		Total	 $	504,985	 $	492,374 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: 	Short-term borrowings	 $	 7,289	 $	 9,108 	Accounts payable		 14,543	 	9,484 	Income taxes payable		 15,652		 14,542 	Accrued and other liabilities	 	50,131		 52,856 	Deferred revenue		 33,238	 	27,371 		Total current liabilities	 	120,853		 113,361 Long-term debt		 52,476	 	52,700 Other long-term deferrals		 1,648	 	2,102 		Total liabilities	 	174,977	 	168,163 Stockholders' equity: 	Common stock		 285,646	 	285,809 	Retained earnings		 33,159	 	24,808 	Foreign currency translation adjustment		 11,203	 	13,594 		Total stockholders' equity		 330,008		 324,211 		Total	 $	504,985	 $492,374 See accompanying notes to unaudited consolidated financial statements. Mentor Graphics Corporation Consolidated Statements of Cash Flows (In thousands) (Unaudited) 	Six Months Ended 	 June 30, 	 	1996	 1995	 Operating Cash Flows: Net income 	 $	8,251	 $	20,814 Adjustments to reconcile net income to net cash provided (used) by operating activities: 	Depreciation and amortization of property, plant & equipment 		 11,228		 11,151 	Deferred taxes		 (86)	 	(41) 	Amortization of other assets		 4,771		 5,136 	Charge for in process R&D		 12,423	 	400 	Restructure costs	 	--	 	(2,040) Changes in operating assets and liabilities: 	Trade accounts receivable		 (22,684)	 	8,638 	Prepaid expenses and other assets		 741		 617 	Accounts payable	 	2,684		 (5,135) 	Accrued liabilities		 (4,889)	 	(4,577)	 	Other liabilities and deferrals		 5,294		 1,654 Net cash provided by operating activities	 	17,733		 36,617 Investing Cash Flows: 	Maturities (purchases) of short-term investments		 3,463	 	(22,434) 	Purchases of property and equipment 		 (12,188)	 	(9,450) 	Capitalization of software development costs		 (2,484)	 	(3,441) 	Purchase of businesses 		(17,540) 		(3,261) Net cash used by investing activities		 (28,749)		 (38,586) Financing Cash Flows: 	Proceeds from issuance of common stock 		4,964	 	11,281 	Repurchase of common stock		 (6,952)		 -- 	Decrease in short-term borrowings	 	(1,762)		 (1,098) 	Repayment of long-term debt		 (224)		 (43) Net cash provided (used) by financing activities	 	(3,974)		 10,140 Effect of exchange rate changes on cash and cash equivalents	 	(831)	 	4,474 Net change in cash and cash equivalents		 (15,821) 		12,645 Cash and cash equivalents at beginning of period	 	185,825		 143,254 Cash and cash equivalents at end of period	 $	170,004	 $	155,899 See accompanying notes to unaudited consolidated financial statements MENTOR GRAPHICS CORPORATION Notes to Consolidated Financial Statements (Unaudited) (1)	General - The accompanying financial statements have been prepared in conformity with generally accepted accounting principles. However, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary for a fair presentation of the results of the interim periods presented. Certain reclassifications have been made in the accompanying financial statements for 1995 to conform with the 1996 presentation. (2)	Business Acquisitions - On January 31, 1996, the Company issued 6,223 shares of its common stock for all outstanding common stock of Microtec Research, Inc. (Microtec). In addition, the Company reserved 688 shares of its common stock for previously outstanding options to purchase Microtec common stock. These options vest and become exercisable under the terms of the respective, original Microtec stock option agreements. The Company accounted for this transaction as a pooling of interests and accordingly, the Company's consolidated financial statements have been restated to include the results of Microtec for all periods presented. Microtec is primarily engaged in developing and marketing embedded operating systems and products to optimize the development and operation of embedded systems across hardware/software boundaries. Microtec's integrated software product solutions enable embedded systems developers to increase productivity, thereby decreasing costs of product development and reducing time-to-market for new products. On April 1, 1996, the Company completed the acquisition of dQdt, Inc. (dQdt). dQdt is primarily engaged in developing and marketing digital signal processing intellectual property products. The total purchase price including merger related costs and the re-issuance of 127 shares of Company treasury stock (with a market value of $1,825) was $2,303. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in-process R&D of $1,323 and technology capitalization of $980. The charge for in-process R&D was a result of allocating a portion of the acquisition cost to dQdt's in-process product development that had not reached technological feasibility. 	 On June 3, 1996, the Company completed the acquisition of Seto Software GmbH (Seto). Seto is primarily engaged in developing and marketing personal computer-based layout tools used in the printed circuit board design process. The total purchase price including merger related costs was $3,495. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in- process R&D of $1,747, goodwill capitalization of $225 and technology capitalization of $1,523. The charge for in- process R&D was a result of allocating a portion of the acquisition cost to Seto's in-process product development that had not reached technological feasibility. On May 31, 1996, the Company completed the acquisition of Meta Systems, Inc. (Meta). Meta is primarily engaged in developing and marketing logic emulation products. The total purchase price including merger related costs was $13,741. The cost of the acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. This allocation resulted in a charge for in- process R&D of $9,353, goodwill capitalization of $3,297 and technology capitalization of $1,091. The charge for in- process R&D was a result of allocating a portion of the acquisition cost to Meta's in-process product development that had not reached technological feasibility. The technology costs for dQdt, Seto and Meta will be amortized over a three year period to system and software cost of revenues. The goodwill costs for Seto and Meta will be amortized over a three year period to R&D expense. Financial results subsequent to the acquisition date have been included in the consolidated statements of operations and cash flows. The separate operational results of dQdt, Seto and Meta were not material compared to the Company's overall results of operations, and accordingly pro-forma financial statements which include these entities have been omitted. 	 (3)	Capitalization of Software Development Costs - During the first six months of 1996 and 1995, respectively $2,484 and $3,441 of new product development costs were capitalized and included in other assets on the consolidated balance sheets. Amortization of previously capitalized software development costs amounted to $3,140 and $2,776 for the six months ended June 30, 1996 and 1995, respectively, and is included in system and software cost of revenues on the consolidated statements of operations. (4)	Supplemental Disclosures of Cash Flow Information - The following provides additional information concerning cash flow and non-cash investing activities: 			Six Months Ended 		 	June 30, 			 	1996		 	1995	 	 		Interest paid 	$ 	977	 $ 	1,113 		Income taxes paid, net of refunds	 $	 472	 $	 4,250 		Issuance of common stock for 		 purchase of business	 $	 1,825	 $ 	-- (5)	Commitments and contingencies - The Company is involved in various administrative matters and litigation. Management believes that the ultimate outcome resulting from known matters will not have a material adverse impact on the Company's consolidated financial position or results of operations. During 1995, the Company filed suit in United States (U.S.) Federal District Court against Quickturn Design Systems, Inc. (competitor) for declarative judgment on non- infringement, invalidity and unenforceability of three of the competitor's patents in anticipation of acquiring Meta. In January 1996, the competitor filed a complaint with the International Trade Commission (ITC) seeking to hinder the distribution of the Meta technology in the United States. Early in the third quarter of 1996, the ITC issued a temporary ruling allowing the importation of this technology to the U.S., but requiring posting of a bond for each sale. The required amount of the bond for each sale and the likelihood of the Company losing the posted amounts is uncertain at this time. There has been no final decision on the Company's declaratory judgment claims and the Company has applied for U.S. patent protection of certain aspects of this technology. While the outcome of this matter is uncertain at this time, management believes it will prevail. (6)	Net Income per Common and Common Equivalent Share - Net income per common and common equivalent share was calculated on the basis of the weighted average number of common shares outstanding plus dilutive common stock equivalents related to stock options outstanding. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition (All numerical references are in thousands, except for percentages) RESULTS OF OPERATIONS BUSINESS ACQUISITIONS In January 1996, the Company completed the acquisition of Microtec Research, Inc. (Microtec), pursuant to a merger accounted for as a pooling of interests. Accordingly, the results of Microtec are included in the Company's consolidated financial statements for all periods presented. A total of 6,223 shares of the Company's common stock were issued in the transaction. Merger expenses of $4,410 were incurred associated with the elimination of duplicate facilities, severance costs related to the termination of certain employees, the write-off of certain property and equipment and legal and accounting fees associated with administration of the merger activities. The Company acquired dQdt Inc. (dQdt), Seto Software GmbH (Seto), and Meta Systems, Inc. (Meta) in April 1996, May 1996 and May 1996, respectively. These acquisitions were accounted for as purchases and accordingly, their results of operations are included in the Company's results of operations from the date of acquisition. The cost of each acquisition was allocated on the basis of estimated fair value of the assets and liabilities assumed. These allocations resulted in a charge for in-process research and development of $12,423, goodwill capitalization of $3,522 and technology capitalization of $3,594. REVENUES AND GROSS MARGINS System and Software System and software revenues for the quarter ended June 30, 1996, totaled $65,286, representing an increase of $9,633 or 17% from the second quarter of 1995. For the first six months of 1996, system and software revenues increased $17,599 or 16% from the same period a year ago. System and software gross margins for the second quarter of 1996 remained consistent at 84% compared to the same period of 1995. For the first six months of 1996 and 1995, system and software gross margins were 83%. System and software revenues during the first half of 1996 improved by 16% compared to the same period last year. Software product revenue accounted for approximately 91% of the increase while the decline in workstation hardware product revenue was more than offset by emulation hardware revenue resulting from the acquisition of Meta. System and software revenues were higher in the first half of 1996 due to strong demand for the Company's newer product offerings. In the last year, the Company has added new library and data management products and products that operate on the Windows 95 and Windows NT operating systems. In addition, the Company's more mature product offerings continued to perform well with a level of decline lower than the volume increases of newer product offerings. System and software gross margin levels are dependent on such factors as third party software content for which royalties are paid, lower margin hardware revenue levels, and amortization of previously capitalized software development costs and purchased technology costs. Amortization of previously capitalized software development costs to system and software cost of revenues was $1,433 and $3,140 for the second quarter and first six months of 1996, respectively, compared to $1,540 and $2,776 for the same periods a year ago. Purchased technology amortization to system and software cost of goods sold was $1,481 and $1,109 for the six months ended June 30, 1996 and 1995, respectively. Due to the acquisitions previously discussed, amortization of purchased technology is expected to increase by approximately $300 per quarter. Sales of emulation systems, which are the result of the Company's acquisition of Meta, are expected to have a negative impact on system and software product gross margins over time. Meta products include hardware which does not yield gross margins as high as software product sales. Service and Support Service and support revenues for the second quarter of 1996 were $51,072, representing an increase of 2% from the comparable quarter of 1995. For the first six months of 1996, service and support revenues totaled $98,507, representing an increase of 3% from the same period of 1995. Growth in software support revenue is attributable to growth in the Company's installed customer base, and continued success of the Company's software support programs. Professional and other service revenues for the second quarter of 1996 were approximately $12,200, a decrease of 10% from the comparable quarter of 1995. For the first six months of 1996, professional and other service revenues were $24,200 compared to $25,600 for the same period in 1995. The decline in professional and other service revenue is attributable to a process of realigning the business to better support the Company's integrated systems design strategy. This required an internal focus of resources which caused lower billable hours for revenue generating services. Professional service productivity is expected to improve over the second half of 1996. Service and support gross margins were 56% and 59% for the quarters ended June 30, 1996 and 1995, and 55% and 59% for the first six months of 1996 and 1995, respectively. Service and support gross margins were favorably impacted by higher software support revenue volume and unfavorably impacted by professional service margins. Professional service gross margins were approximately break-even as the revenue levels were not in line with the cost structure of the business. The Company's primary focus will be on improvement of the revenue level through more efficient utilization of consultants to improve gross margins in the coming quarters. Geographic Revenue Information Domestic revenue from unaffiliated customers including service and support revenue increased by 18% as compared to the second quarter of 1995. Improvement of domestic revenue is partially the result of higher first quarter backlog in 1996 versus the same period of 1995. International revenues from unaffiliated customers including service and support revenue represented 44% and 48% of total revenue for the second quarters of 1996 and 1995, respectively. European and Japanese revenues were approximately flat from the second quarter of 1995 to 1996. European and Japanese revenue increased approximately 1% and 7%, respectively for the first half of 1996 compared to the same period a year ago. For the second quarter of 1996 compared to the same period a year ago, a stronger U.S. dollar negatively impacted revenues by approximately 4% and 28% in Europe and Japan, respectively. For the first half of 1996 compared to the same period of 1995, a stronger U.S. dollar negatively impacted revenues by approximately 2% and 18% in Europe and Japan, respectively. Exclusive of such currency trends, 1996 Japanese revenue was favorably impacted by improving economic conditions and more product offerings as previously discussed. Since the Company generates approximately half of its revenues outside of the United States and expects this to continue in the future, revenue results should continue to be impacted by the effects of future foreign currency fluctuations. OPERATING EXPENSES The following summarizes R&D expenses: 	Three Months Ended 	Six Months Ended 		 June 30,		 	June 30,	 		 	1996	 1995	 1996 	1995 	Gross R&D	 $	23,100	 $	22,364	 $	46,864	 $	44,711 	Capitalized R&D		 (2,011)		 (1,227)	 	(2,484)	 	(3,441) 		Net R&D	 $	21,089	 $	21,137	 $	44,380	 $	41,270 Gross R&D expense was 19% and 21% of revenue for the second quarter of 1996 and 1995, respectively and 21% and 22% of revenue for the six months of 1996 and 1995, respectively. The decline in R&D as a percent of revenue is primarily the result of strong revenue growth and controlled expense outlays during the comparable periods. Higher gross R&D expenses are attributable to relocation of some of the Company's engineering team and accelerating depreciation of file-server equipment used by the Company's engineers. During the first quarter of 1996, the Company accelerated depreciation on the remaining book value of its Wilsonville file-server environment which resulted in a charge to R&D of approximately $500. Through an evaluation of the file- server environment, the Company determined that changes in technology had rendered the existing equipment obsolete. The Company is also consolidating certain engineering activities from New Jersey to Wilsonville to improve productivity of certain development activities and reduce future operating costs of such activities. The costs of this transition are substantially complete. Capitalization of software development costs was substantially lower in the first half of 1996 compared to the same period of the prior year due to timing and content of product development activities. In the first quarter of 1996, the Company's product development efforts were focused on improvement of existing functionality versus new product enhancements. Significant product enhancement projects began to reach capitalization milestones in the second quarter of 1996, resulting in higher capitalized software development costs. On an absolute dollar basis, R&D costs are expected to increase as the purchases of Meta and Seto are combined for a full quarter versus only the last month of the second quarter of 1996. Marketing and selling expense totaled $35,152 and $35,464 or 30% and 34% of revenue for the second quarter of 1996 and 1995, respectively. Marketing and selling expense totaled $69,735 and $67,100 or 31% and 33% of revenue for the six months of 1996 and 1995, respectively. The decline in marketing and selling costs is related to the integration of the Anacad sales force into the existing sales channel. In addition, a stronger U.S. dollar during the second quarter of 1996 compared to the same period a year ago, positively impacted expenses by approximately 5% and 25% in Europe and Japan, respectively. For the first half of 1996 compared to the same period of 1995, a stronger U.S. dollar positively impacted expenses by approximately 1% and 15% in Europe and Japan, respectively. This is somewhat offset by higher commissions paid to sales representatives. On an absolute dollar basis, marketing and selling costs are expected to increase as the purchases of Meta and Seto are combined for a full quarter versus only the last month of the second quarter of 1996. General and administrative expense totaled $9,814 and $8,977 or 8% and 9% of revenue for the second quarter of 1996 and 1995, respectively. General and administrative expense totaled $19,529 and $18,693 or 9% and 9% of revenue for the six months of 1996 and 1995, respectively. The decline in general and administrative costs as compared to revenue quarter to quarter is a result of strong revenue growth during the comparable periods. MERGER RELATED CHARGES During the second quarter of 1996, the Company incurred merger related charges of $12,423 as a result of the write-off of in- process R&D associated with the purchases of dQdt, Seto and Meta. The charges for in-process R&D are a result of allocating a portion of the acquisition cost to each acquired Company's in- process product development that had not reached technological feasibility. During the first quarter of 1996, the Company incurred merger related charges of $4,410 as a result of the merger with Microtec. The costs associated with this charge include elimination of duplicate facilities, severance costs related to the termination of certain employees, the write-off of certain property and equipment and legal and accounting fees associated with administration of the merger activities. The cash outflow of this charge is expected to occur primarily in 1996. The second quarter 1995 merger related costs of $800 are the result of the acquisitions of Axiom Datorer Skandinavien AB and Exemplar Logic, Inc.. OTHER INCOME (EXPENSE) During the second quarter and the first six months of 1996, other expense was $156 and other income was $1,633, compared to other income of $2,179 and $3,544 for the same periods of 1995, respectively. Included in other income (expense) are external legal counsel costs associated with the Quickturn Design Systems, Inc. litigation as previously discussed, totaling $2,200 and $2,600 for the second quarter and first half of 1996 compared to zero for the comparable periods of prior year. Costs related to this litigation are expected to decline to approximately $500 to $1,000 and continue for at least the next several quarters. Interest income from investments was $2,315 and $4,679 for the second quarter and first six months of 1996, respectively, compared to $2,339 and $4,011 for the same periods of 1995. The decrease in interest income is primarily attributable to lower average cash, cash equivalents and short term investments outstanding during the comparable quarters. During the second quarter and first six months of 1996, interest expense amounted to $545 and $1,109, respectively, down from $469 and $1,134 for the comparable periods in 1995. The decrease in interest expense is due to lower average debt outstanding offset by higher average interest rates for the comparable periods. PROVISION FOR INCOME TAXES The provision for income taxes amounted to $1,370 for the quarter ended June 30, 1996, as compared to $1,628 for the same period in 1995. For the first six months of 1996, the provision for income taxes was $2,210 compared to $3,862 for the same period a year ago. The acquisitions of dQdt, Meta and Seto resulted in one-time non-deductible charges of $12,423 which increased the Company's anticipated effective tax rate for the year. The second quarter 1996 tax accrual also includes a catch up adjustment to align the year to date effective rate with the current estimated year-end effective rate. The Company's income tax position for each year combines the effects of available tax benefits in certain countries where the Company does business, benefits from available net operating loss carry forwards, and tax expense for subsidiaries with pre-tax income. As such, the Company's income tax position and resultant effective tax rate is uncertain for the remainder of 1996. EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS The Company experienced a net loss from foreign currency transactions of $138 and $487 during the second quarter and first six months of 1996, respectively, compared to a net gain of $58 and $153 during the same periods a year ago. These amounts are comprised of realized gains and losses on cash transactions involving various foreign currencies, and unrealized gains and losses related to foreign currency receivables and payables resulting from exchange rate fluctuations between the various currencies in which the Company operates. Foreign currency gains and losses are included as a component of other income. The "foreign currency translation adjustment", as reported in the equity section of the consolidated balance sheet at June 30, 1996, decreased to $11,203 from $13,594 at the end of 1995. This reflects the decrease in the value of net assets denominated in foreign currencies against the U.S. dollar since year-end 1995. During the balance sheet period from December 31, 1995 to June 30, 1996, the U.S. dollar strengthened approximately 6% against the Japanese yen and 4% against the European currencies. For the first half of 1996 compared to the same period of 1995, a stronger U.S. dollar negatively impacted revenues by approximately 2% and 18% in Europe and Japan, respectively. In addition, for the first half of 1996 compared to the same period of 1995, a stronger U.S. dollar positively impacted expenses by approximately 1% and 15% in Europe and Japan, respectively. Generally, a strengthening of the U.S. dollar makes the Company's products more expensive in foreign markets, which has a negative impact on the Company's revenues over time. In addition, a strengthening U.S. dollar results in lower reported revenues and operating expenses due to translation of local currency activity to U.S. dollars for consolidated financial reporting. The Company generally realizes approximately half of its revenue outside the United States and expects this to continue in the future. As such, the Company's business and operating results may be impacted by the effects of future foreign currency fluctuations. LIQUIDITY AND CAPITAL RESOURCES CASH AND INVESTMENTS Total cash and short-term investments at June 30, 1996 were $192,313 compared to $210,329 at the end of 1995. Cash provided by operations was $17,733 for the first six months of 1996 compared to $36,617 during the same period of 1995. Cash provided by operations was negatively impacted by net income of $8,251 for the first six months of 1996 compared to $20,814 for the same period of 1995. In addition, trade receivables increased by $22,684 offset by increased accounts payable of $2,684. Cash and short-term investments at June 30, 1996 were negatively impacted by new business investments of $17,540, decreased short-term borrowings of $1,762, investment in property, plant and equipment of $12,188, repurchase of common stock of $6,952, offset by proceeds from the issuance of common stock of $4,964. TRADE ACCOUNTS RECEIVABLE Trade accounts receivable increased to $118,187 at June 30, 1996 from $95,946 at year-end 1995. This increase was attributable to an increase in late quarter shipments in the second quarter of 1996 compared to the fourth quarter of 1995. As a result, a lower percent of shipments made during the second quarter of 1996 were converted into cash collections before the period ended. OTHER ASSETS Other assets increased to $43,729 at June 30, 1996 from $38,160 at year-end 1995. This increase was primarily attributable to purchased technology of $3,594 and goodwill capitalization of $3,522 relating to the purchases of dQdt, Seto and Meta offset by other purchased technology and goodwill amortization of $2,100. Net capitalized software development costs decreased by $656 as capitalization and amortization were $2,484 and $3,140, respectively, during the first six months of 1996. CAPITAL RESOURCES Total capital expenditures increased to $12,188 through June 30, 1996, compared to $9,450 for the same period of 1995. The increase in capital expenditures is primarily a result of costs associated with a new global information system. These expenditures will continue as the year progresses. The Company anticipates that current cash balances, anticipated cash flows from operating activities, and existing credit facilities will be sufficient to meet its working capital needs for at least the next twelve months. FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION The statements contained in this report that are not statements of historical fact are forward looking statements that involve a number of risks and uncertainties. Moreover, from time to time the Company may issue other forward looking statements. The following discussion highlights factors that could cause actual results to differ materially from the forward looking statements. The forward looking statements should be considered in light of these factors. The Company competes in the highly competitive and dynamic EDA (electronic design automation) industry. The Company's success is dependent upon its ability to develop and market products that are innovative, cost-competitive and that meet customers' expectations, and to deliver those products to its customers in a timely manner. Competition in the EDA industry is high, which can create adverse effects including, but not limited to, price reductions, lower product margins, loss of market share and additional working capital requirements. A material amount of the Company's software product revenue is usually the result of current quarter order performance and the Company books the majority of its orders in the last month of each quarter. In addition, the Company's revenue often includes multi- million dollar contracts. The timing of the completion of these contracts and the terms of delivery of software, hardware and other services can have a material impact on revenue recognition for a given quarter. The combination of these factors impairs and delays the Company's ability to identify shortfalls or overages from quarterly revenue targets. The Company generally realizes approximately half of its revenue outside the United States and expects this to continue in the future. As such, the Company's business and operating results can be impacted by the effects of foreign currency fluctuations. In order to hedge the impact of foreign currency fluctuations, the Company enters into foreign currency forward contracts. However, significant changes in exchange rates may have a material adverse impact on the Company's results of operations. International operations subject the Company to other risks including, but not limited to, changes in regional or worldwide economic or political conditions, government trade restrictions, limitations on repatriation of earnings, licensing and intellectual property rights protection. The Company is currently reorganizing its professional services business to better support its integrated systems design strategy. This required an internal focus of resources which caused lower billable hours for revenue generating services in the first half of 1996. In addition, business reorganizations can increase personnel management complexities including retention and hiring of key technical and management positions. While the Company will look to improve the utilization of its consultants, there can be no assurance that the challenges of the reorganization will be effectively met. The Company's operating expenses are generally committed in advance of revenue and are based to some degree on future revenue expectations. Operating expenses are incurred in order to generate and sustain higher future revenue levels. If the revenue does not materialize as expected, the Company's results of operations can be adversely impacted. Acquisitions of complementary businesses are an integral part of the Company's overall business strategy. There are several risks associated with this strategy including integration of sales channels, training and education of sales force for new product offerings, integration of product development efforts, retention of key employees, integration of systems of internal controls, and integration of information systems. All of these factors can impair the Company's ability to forecast, to meet quarterly revenue and earnings targets, and to effectively manage the business for long-term growth. While the Company is aware of and is addressing such issues, there can be no assurance that these challenges will be effectively met. As a result of the acquisition of Meta, the Company has entered the hardware development and assembly business which results in several new issues that the Company must effectively manage. Some of the issues include its ability to procure hardware components on a timely basis, ability to assemble and ship systems on a timely basis with appropriate quality control, new distribution and shipment processes, inventory management issues and new demands on the sales force. The Company is currently involved in the replacement of its financial information systems, based primarily on software from SAP. The implementation phase of new information systems can cause significant disruptions to the Company's work efficiency. There can be no assurance that the project will be completed within budgeted time or dollar parameters. The Company has been successful at recruiting and retaining necessary personnel to research and develop products that satisfy customers needs. There can be no assurance that the Company can continue to recruit and retain such personnel. Due to the factors above, as well as other market factors outside the Company's control, the Company's future earnings and stock price may be subject to significant volatility. Past financial performance should not be considered a reliable indication of future performance. The investment community should use caution in using historical trends to estimate future results or trends. In addition, if future results vary significantly from expectations of analysts, the Company's stock price could be adversely impacted. Generally accepted accounting principles require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingencies at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is involved in various administrative matters and litigation. Management believes that the ultimate outcome resulting from known matters will not have a material adverse impact on the Company's consolidated financial position or results of operations. During 1995, the Company filed suit in United States (U.S.) Federal District Court against Quickturn Design Systems, Inc. (competitor) for declarative judgment on non-infringement, invalidity and unenforceability of three of the competitor's patents in anticipation of acquiring Meta. In January 1996, the competitor filed a complaint with the International Trade Commission (ITC) seeking to hinder the distribution of the Meta technology in the United States. Early in the third quarter of 1996, the ITC issued a temporary ruling allowing the importation of this technology to the U.S., but requiring posting of a bond for each sale. The required amount of the bond for each sale and the likelihood of the Company losing the posted amounts is uncertain at this time. There has been no final decision on the Company's declaratory judgment claims and the Company has applied for U.S. patent protection of certain aspects of this technology. While the outcome of this matter is uncertain at this time, management believes it will prevail. Item 4.	Submission of Matters to a Vote of Security Holders. The 1996 Annual Meeting of Shareholders of the Company was held pursuant to notice at 5:00 p.m. Pacific time on May 2, 1996 at the Company's offices in Wilsonville, Oregon. There were present at the meeting, in person or represented by proxy, the holders of 53,026,816 shares of the outstanding common stock, which represented approximately 84% of the outstanding shares. Voting information set forth below was provided by American Stock Transfer & Trust Company, the Company's Transfer Agent for its common stock, as Inspector of Election. The matters voted on at the meeting and the votes cast are as follows: Issue One-Election of Nominees for Directors. The nominees for directors listed below and presented to the meeting were elected directors of the Company upon each receiving the affirmative vote of the holders of approximately 99% of those shares represented at the meeting, to serve until the next annual meeting of the shareholders and until their successors shall have been elected and qualified. 	FOR	 WITHHOLD Jon A. Shirley	 52,893,354	 133,462 Marsha B. Congdon	 52,892,504	 134,312 James R. Fiebiger	 52,894,254	 132,562 David A. Hodges	 52,892,604	 134,212 Walden C. Rhines	 52,895,154	 131,662 Fontaine K. Richardson	 52,894,304	 132,512 Item 6.	Exhibits and Reports on Form 8-K. (a)	Exhibits: None. (b)	During the second quarter of 1996, the Company filed a current report on Form 8-K/A Amendment No. 1 dated April 24, 1996 related to the merger with Microtec. Under Item 7 of the Form 8-K, the Company filed Supplemental Consolidated Financial Statements as of December 31, 1995 and 1994 and for the three years ended December 31, 1995, as restated to give retroactive effect to the merger which has been accounted for as a pooling of interests. 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, on August 13, 1996. MENTOR GRAPHICS CORPORATION 	(Registrant) 							R. Douglas Norby		 							R. Douglas Norby 							Senior Vice President,and 							Chief Financial Officer 							Richard Trebing 		 							Richard Trebing 							Corporate Controller,and 							Chief Accounting Officer