MENTOR GRAPHICS CORP, S-4/A, 1995-12-27

MENTOR GRAPHICS CORP
S-4/A, 1995-12-27
COMPUTER INTEGRATED SYSTEMS DESIGN

Previous: AIM SUMMIT FUND INC, N-30B-2, 1995-12-27

Next: DAILY TAX FREE INCOME FUND INC, N-30D, 1995-12-27

<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 27, 1995

REGISTRATION NO. 33-63733
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

AMENDMENT NO. 2

FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------

MENTOR GRAPHICS CORPORATION
(EXACT NAME OF REGISTRANTS AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
OREGON 7373 93-0786033
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>

8005 S.W. BOECKMAN ROAD
WILSONVILLE, OREGON 97070-7777
TELEPHONE: (503) 685-7000
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------

WALDEN C. RHINES
PRESIDENT AND CHIEF EXECUTIVE OFFICER
MENTOR GRAPHICS CORPORATION
8005 S.W. BOECKMAN ROAD
WILSONVILLE, OREGON 97070-7777
TELEPHONE: (503) 685-7000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------

COPIES TO:

<TABLE>
<S> <C> <C>
JOSHUA L. GREEN DEAN FREED TIMOTHY TOMLINSON
STANLEY F. PIERSON VICE PRESIDENT, GENERAL COUNSEL RICHARD JUDKINS
DEANN K. WRIGHT AND SECRETARY TOMLINSON ZISKO MOROSOLI & MASER
VENTURE LAW GROUP MENTOR GRAPHICS CORPORATION 200 PAGE MILL ROAD
A PROFESSIONAL CORPORATION 8005 S.W. BOECKMAN ROAD SECOND FLOOR
2800 SAND HILL ROAD WILSONVILLE, OREGON 97070-7777 PALO ALTO, CALIFORNIA 94306
MENLO PARK, CALIFORNIA 94025
</TABLE>

------------------------

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:

As promptly as practicable after this Registration Statement becomes
effective and the effective time of the proposed
merger of a subsidiary of the Registrant with and into Microtec Research, Inc.,
as described in the Agreement and Plan of Merger, dated as of October 9, 1995,
amended November 6, 1995, attached as Annex A to the Prospectus/Proxy Statement
forming a part of this Registration Statement.

If the securities being registered on this Form are being offered in
connection with the formation of a holding Company and there is compliance with
General Instruction G, check the following box. / /
------------------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2

MENTOR GRAPHICS CORPORATION
------------------------

CROSS-REFERENCE SHEET SHOWING LOCATION IN PROSPECTUS
OF INFORMATION REQUIRED BY ITEMS OF FORM S-4

<TABLE>
<CAPTION>
FORM S-4 REGISTRATION STATEMENT ITEM AND HEADING LOCATION IN PROSPECTUS
- ------------------------------------------------- ------------------------------------------
<C> <S> <C>
(Information about the Transaction)
1. Forepart of the Registration Statement and
Outside Front Cover Page of Prospectus.... Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages
of Prospectus............................. Inside Front and Outside Back Cover Pages
3. Risk Factors, Ratio of Earnings to Fixed
Charges and Other Information............. Summary; Selected Historical and Pro Forma
Financial Data; Comparative Stock Price
Data and Dividend History; Risk Factors;
The Special Meeting; The Merger; The
Merger Agreement; Mentor Graphics
Management's Discussion and Analysis of
Financial Condition and Results of
Operations; Information Concerning Mentor
Graphics; Information Concerning Microtec
4. Terms of the Transaction.................. Summary; The Merger; The Merger Agreement;
Description of Mentor Graphics Capital
Stock; Comparison of Rights of Holders of
Mentor Graphics Common Stock and Microtec
Common Stock
5. Pro Forma Financial Information........... Pro Forma Combined Condensed Financial
Statements; Management's Discussion and
Analysis of Pro Forma Financial Results
6. Material Contacts with the Company Being
Acquired.................................. The Merger
7. Additional Information Required for
Reoffering by Persons and Parties Deemed
to be Underwriters........................ *
</TABLE>

<TABLE>
<C> <S> <C>
8. Interests of Named Experts and Counsel.... Experts; Legal Matters
9. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................... *
(Information about the Registrant)
10. Information with Respect to S-3
Registrants............................... *
11. Incorporation of Certain Information by
Reference................................. *
12. Information with Respect to S-2 or S-3
Registrants............................... *
13. Incorporation of Certain Information by
Reference................................. *
</TABLE>
<PAGE> 3

<TABLE>
<CAPTION>
FORM S-4 REGISTRATION STATEMENT ITEM AND HEADING LOCATION IN PROSPECTUS
- ------------------------------------------------- ------------------------------------------
<C> <S> <C>
14. Information with Respect to Registrants
Other Than S-2 or S-3 Registrants......... Summary; Risk Factors; The Special
Meeting; The Merger; The Merger Agreement;
Mentor Graphics Management's Discussion
and Analysis of Financial Condition and
Results of Operations; Information
Concerning Mentor Graphics; Description of
Mentor Graphics Capital Stock; Comparison
of Rights of Holders of Mentor Graphics
Common Stock and Microtec Common Stock;
Index to Financial Statements
(Information about the Company being Acquired)
15. Information with Respect to S-3
Companies................................. *
16. Information with Respect to S-2 or S-3
Companies................................. *
17. Information with Respect to Companies
Other Than S-2 or S-3 Companies........... Summary; Risk Factors; The Special
Meeting; The Merger; The Merger Agreement;
Microtec Management's Discussion and
Analysis of Financial Condition and
Results of Operations; Information
Concerning Microtec; Comparison of Rights
of Holders of Mentor Graphics Common Stock
and Microtec Common Stock; Index to
Financial Statements
(Voting and Management Information)
18. Information if Proxies, Consents or
Authorizations are to be Solicited........ Summary; The Special Meeting: The Merger;
Information Concerning Mentor Graphics;
Information Concerning Microtec
19. Information if Proxies, Consents or
Authorizations are not to be Solicited or
in an Exchange Offer...................... *
</TABLE>

- ---------------

* Not Applicable.
<PAGE> 4

[LOGO]

MICROTEC RESEARCH, INC.
2350 MISSION COLLEGE BOULEVARD
SANTA CLARA, CALIFORNIA 95054

Dear Stockholder:

You are cordially invited to attend a special meeting of the stockholders
of Microtec Research, Inc. ("Microtec") to be held at 8:00 a.m. local time, on
January , 1996, at Microtec's executive offices, 2350 Mission College
Boulevard, Santa Clara, California (the "Special Meeting").

At the Special Meeting, you will be asked to consider and vote on a
proposal to approve and adopt the Agreement and Plan of Merger (the "Merger
Agreement"), dated as of October 9, 1995, as amended November 6, 1995, by and
among Mentor Graphics Corporation ("Mentor Graphics"), M Acquisition Sub, Inc.,
a wholly owned subsidiary of Mentor Graphics ("Merger Sub"), and Microtec, and
to approve the merger (the "Merger") of Merger Sub with and into Microtec
pursuant to the Merger Agreement. As a result of the Merger, Microtec will
become a wholly owned subsidiary of Mentor Graphics and each share of common
stock of Microtec will be converted into and exchanged for 0.6930693 shares of
Mentor Graphics Common Stock.

MICROTEC'S BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE MERGER AGREEMENT
AND HAS DETERMINED THAT THE MERGER IS IN THE BEST INTERESTS OF MICROTEC AND ITS
STOCKHOLDERS. AFTER CAREFUL CONSIDERATION, THE BOARD OF DIRECTORS UNANIMOUSLY
RECOMMENDS A VOTE FOR THE APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND
APPROVAL OF THE MERGER.

Details of the proposed Merger and other important information concerning
Mentor Graphics and Microtec are more fully described in the accompanying Proxy
Statement/Prospectus. Please give this material your careful attention.

Whether or not you plan to attend the Special Meeting, please complete,
sign and date the accompanying proxy card and return it in the enclosed prepaid
envelope. You may revoke your proxy in the manner described in the accompanying
Proxy Statement/Prospectus at any time before it has been voted at the Special
Meeting. If you attend the Special Meeting, you may vote in person even if you
have previously returned your proxy card. Your prompt cooperation will be
greatly appreciated.

Sincerely,

Jerry Kirk
Chairman of the Board of Directors,
President and Chief Executive Officer

Santa Clara, California

January , 1996

WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, YOU ARE URGED TO SIGN AND
PROMPTLY MAIL THE ENCLOSED PROXY IN THE RETURN ENVELOPE SO THAT YOUR STOCK MAY
BE REPRESENTED AT THE MEETING.
<PAGE> 5

MICROTEC RESEARCH, INC.
2350 MISSION COLLEGE BOULEVARD
SANTA CLARA, CALIFORNIA 95054
------------------------

NOTICE OF SPECIAL MEETING OF STOCKHOLDERS

TO BE HELD JANUARY , 1996

TO: THE STOCKHOLDERS OF MICROTEC RESEARCH, INC.

NOTICE IS HEREBY GIVEN that a special meeting of the stockholders of
Microtec Research, Inc., a Delaware corporation ("Microtec"), will be held at
8:00 a.m. local time, on January , 1996, at Microtec's executive offices, 2350
Mission College Boulevard, Santa Clara, California (the "Special Meeting"), to
consider and vote upon the following proposals:

1. To approve and adopt the Agreement and Plan of Merger (the "Merger
Agreement"), dated as of October 9, 1995, as amended November 6, 1995, by
and among Mentor Graphics Corporation ("Mentor Graphics"), M Acquisition
Sub, Inc., a wholly owned subsidiary of Mentor Graphics ("Merger Sub"), and
Microtec and to approve the merger (the "Merger") of Merger Sub with and
into Microtec pursuant to the Merger Agreement. As a result of the Merger,
Microtec will become a wholly owned subsidiary of Mentor Graphics and each
share of Common Stock of Microtec will be converted into and exchanged for
0.6930693 shares of Mentor Graphics Common Stock. A copy of the Merger
Agreement is attached as Annex A to the Proxy Statement and Prospectus (the
"Proxy Statement/Prospectus") accompanying this Notice.

2. To transact such other business as may properly come before the
Special Meeting or any postponements or adjournments thereof.

The Board of Directors has fixed the close of business on December 29, 1995
as the record date for the determination of the holders of Microtec Common Stock
entitled to notice of, and to vote at, the Special Meeting. Accordingly, only
stockholders of record at the close of business on such date are entitled to
notice of and to vote at the Special Meeting and any adjournment or postponement
thereof. The affirmative vote of a majority of the outstanding shares of
Microtec Common Stock entitled to vote thereon is necessary for approval and
adoption of the Merger Agreement and approval of the Merger.

You may revoke your proxy in the manner described in the accompanying Proxy
Statement/Prospectus at any time before it has been voted at the Special
Meeting. Any stockholder attending the Special Meeting may vote in person even
if he or she has returned a proxy.

By Order of the Board of Directors

Santa Clara, California Kenneth E. Lonchar
January , 1996 Vice President, Finance and
Administration
and Chief Financial Officer

WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, YOU ARE REQUESTED TO SIGN,
DATE AND MAIL PROMPTLY THE ENCLOSED PROXY WHICH IS BEING SOLICITED ON BEHALF OF
THE MICROTEC BOARD OF DIRECTORS. A RETURN ENVELOPE WHICH REQUIRES NO POSTAGE IF
MAILED IN THE UNITED STATES IS ENCLOSED FOR THAT PURPOSE.
<PAGE> 6

MICROTEC RESEARCH, INC.

PROXY STATEMENT
------------------------

MENTOR GRAPHICS CORPORATION

PROSPECTUS

This Proxy Statement/Prospectus (the "Proxy Statement/Prospectus") is being
furnished to the holders of common stock, par value $.001 per share (the
"Microtec Common Stock"), of Microtec Research, Inc., a Delaware corporation
("Microtec"), in connection with the solicitation of proxies by the Microtec
Board of Directors for use at the Special Meeting of Stockholders of Microtec to
be held on January , 1996 at 8:00 a.m., and at any and all adjournments or
postponements thereof (the "Special Meeting").

This Proxy Statement/Prospectus relates to the proposed merger (the
"Merger") of M Acquisition Sub, Inc. ("Merger Sub") with and into Microtec,
pursuant to which Microtec will become a wholly owned subsidiary of Mentor
Graphics Corporation ("Mentor Graphics") pursuant to an Agreement and Plan of
Merger dated as of October 9, 1995, as amended November 6, 1995, between Mentor
Graphics, Merger Sub and Microtec (the "Merger Agreement"). In the Merger, each
outstanding share of Microtec Common Stock will be converted into and represent
the right to receive 0.6930693 of a share of Mentor Graphics Common Stock. Cash
will be paid in lieu of any fractional share of Mentor Graphics Common Stock.

This Proxy Statement/Prospectus also constitutes the Prospectus of Mentor
Graphics with respect to up to 6,445,545 shares of Common Stock to be issued in
connection with the Merger. Mentor Graphics Common Stock is traded on the Nasdaq
National Market ("Nasdaq") under the symbol "MENT." On December 4, 1995, the
closing sale price for Mentor Graphics Common Stock as reported on Nasdaq was
$19.50 per share.

This Proxy Statement/Prospectus and the accompanying form of proxy are
first being mailed to the Stockholders of Microtec on or about January , 1996.

------------------------

SEE "RISK FACTORS" BEGINNING ON PAGE FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY MICROTEC STOCKHOLDERS.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OR THIS PROXY STATEMENT/PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

------------------------

THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS JANUARY , 1996.

<PAGE> 7

------------------------

No person has been authorized to give any information or to make any
representations not contained or incorporated in this Proxy Statement/Prospectus
in connection with the matters referred to herein and, if given or made, such
information or representations must not be relied upon as having been so
authorized by Microtec or by Mentor Graphics. This Proxy Statement/Prospectus
does not constitute an offer of any securities other than the registered
securities to which it relates or an offer to any person in any jurisdiction
where such offer would be unlawful. The delivery of this Proxy
Statement/Prospectus shall not, under any circumstances, create any implication
that the information herein is correct as of any time subsequent to date hereof.

------------------------

TRADEMARKS

Mentor Graphics(R), the Mentor Graphics logo, Board Station(R), GDT(R),
Hybrid Station(R), Idea Station(R), IC Station(R), MCM Station(R) and
QuickVHDL(R) are registered trademarks of Mentor Graphics Corporation.
AutoFlow(TM), AutoLogic II(TM), AutoTherm MCM(TM), BSDArchitect(TM), Cell
Builder(TM), DFTAdvisor(TM), DSP Station(TM), EngineerView(TM), FPGA
Station(TM), FastScan(TM), FlexTest(TM), Logical Cable(TM), MS Analyzer(TM),
Manufacturing Advisor(TM), MicroRoute(TM), Physical Cable(TM), Physical Test
Manager: SITE(TM), SOS Initiative(TM), System Design Station(TM), System
Architect(TM) and Top-Down Design Solver(TM) are trademarks of Mentor Graphics
Corporation.

Microtec(R), the Microtec logo, Spectra(R), VRTX(R), VRTX32(R), XRAY(R),
and XRAY MasterWorks(R) are registered trademarks of Microtec Research, Inc.
VRTXmc(TM) and VRTXsa(TM) are trademarks of Microtec Research, Inc.
<PAGE> 8

TABLE OF CONTENTS FOR
PROXY STATEMENT/PROSPECTUS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION................................................................. 2
SUMMARY............................................................................... 3
The Companies.................................................................... 3
Date and Place of the Special Meeting............................................ 4
Purpose of the Special Meeting; The Merger....................................... 4
Stockholders Entitled to Vote; Voting Agreement.................................. 4
Vote Required.................................................................... 4
Appraisal Rights................................................................. 5
Recommendation; Fairness Opinion................................................. 5
Reasons for the Merger........................................................... 5
Operations Following the Merger.................................................. 5
Interests of Certain Persons in the Merger....................................... 5
Effective Time of the Merger..................................................... 6
Conditions to the Merger......................................................... 6
Termination...................................................................... 6
Surrender of Certificates........................................................ 6
Accounting Treatment............................................................. 6
Certain Federal Income Tax Consequences.......................................... 6
Regulatory Matters............................................................... 7
SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA...................................... 8
COMPARATIVE STOCK PRICE DATA AND DIVIDEND HISTORY..................................... 11
RISK FACTORS.......................................................................... 12
THE SPECIAL MEETING................................................................... 14
General.......................................................................... 14
Matters to be Considered at the Special Meeting.................................. 14
Record Date; Voting at the Special Meeting; Vote Required........................ 14
Proxies.......................................................................... 14
THE MERGER............................................................................ 16
Description...................................................................... 16
Background of the Merger......................................................... 16
Reasons for the Merger; Recommendation of the Microtec Board of Directors........ 18
Operations Following the Merger.................................................. 19
Fairness Opinion................................................................. 20
Certain Federal Income Tax Consequences.......................................... 24
Accounting Treatment............................................................. 25
Interests of Certain Persons in the Merger....................................... 26
Regulatory Matters............................................................... 26
Appraisal Rights................................................................. 26
THE MERGER AGREEMENT.................................................................. 27
Effective Time of the Merger..................................................... 27
Conversion of Shares............................................................. 27
Treatment of Microtec Stock Options and Employee Stock Purchase Plan............. 27
Resale of Mentor Graphics Common Stock by Microtec Affiliates.................... 28
Business of Microtec Pending the Merger.......................................... 29
Solicitation of Alternative Transactions......................................... 30
Corporate Structure and Related Matters After the Merger......................... 30
Certain Covenants................................................................ 31
</TABLE>

i
<PAGE> 9

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Conditions to the Merger......................................................... 32
Termination; Amendment........................................................... 32
Fees and Expenses................................................................ 33
Confidentiality Agreement........................................................ 33
PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS..................................... 34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA FINANCIAL RESULTS................... 38
MENTOR GRAPHICS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................................... 40
INFORMATION CONCERNING MENTOR GRAPHICS................................................ 52
Business......................................................................... 52
Competition...................................................................... 55
Employees........................................................................ 56
Properties....................................................................... 56
Legal Proceedings................................................................ 56
Management....................................................................... 57
Information Regarding Beneficial Ownership of Principal Mentor Graphics
Stockholders and Management.................................................... 59
Certain Transactions............................................................. 60
Information Regarding Executive Officer Compensation............................. 61
MICROTEC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.......................................................................... 64
INFORMATION CONCERNING MICROTEC ...................................................... 73
Business......................................................................... 73
Employees........................................................................ 80
Properties....................................................................... 80
Legal Proceedings................................................................ 80
Management....................................................................... 81
Information Regarding Beneficial Ownership of Principal Microtec
Stockholders and Management.................................................... 83
Certain Transactions............................................................. 84
Information Regarding Executive Officer Compensation............................. 85
DESCRIPTION OF MENTOR GRAPHICS CAPITAL STOCK.......................................... 88
COMPARISON OF RIGHTS OF HOLDERS OF MENTOR GRAPHICS COMMON STOCK AND MICROTEC COMMON
STOCK............................................................................... 89
Amendment of Certificate or Articles of Incorporation; Amendment of Bylaws....... 89
Dividends and Other Distributions................................................ 89
Special Meeting of Stockholders.................................................. 90
Provisions Relating to Directors................................................. 90
Certain Anti-Takeover Provisions................................................. 91
Dissenters' Rights............................................................... 92
Limitation on Director Liability................................................. 92
EXPERTS............................................................................... 93
LEGAL MATTERS......................................................................... 93
OTHER MATTERS......................................................................... 93
INDEX TO FINANCIAL STATEMENTS......................................................... F-1
</TABLE>

ANNEX A: Agreement and Plan of Merger
ANNEX B: Opinion of Lehman Brothers

ii
<PAGE> 10

AVAILABLE INFORMATION

Mentor Graphics and Microtec are each subject to the informational
requirements of the Securities Exchange Act of 1934 (the "Exchange Act") and, in
accordance therewith, file reports, proxy statements and other information with
the Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information can be inspected and copied at the public
reference room of the Commission at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the public reference facilities in the New York
Regional Office, 7 World Trade Center, New York, New York 10048, and the Chicago
Regional Office, 500 West Madison Street, Chicago, Illinois 60661. Copies of
such material can be obtained at prescribed rates by writing to the Securities
and Exchange Commission, Public Reference Section, Washington, D.C. 20549. In
addition, material filed by Mentor Graphics and Microtec can be inspected at the
offices of the National Association of Securities Dealers, Inc., Reports
Section, 1935 K Street, N.W., Washington, D.C. 20006.

Mentor Graphics has filed with the Commission a Registration Statement on
Form S-4 (together with any amendments or supplements thereto, the "Registration
Statement") under the Securities Act of 1933, as amended (the "Securities Act"),
with respect to the securities to be issued pursuant to the Merger Agreement.
This Proxy Statement/Prospectus does not contain all the information set forth
in the Registration Statement. Such additional information may be obtained from
the Commission's principal office in Washington, D.C. Statements contained in
this Proxy Statement/Prospectus as to the contents of any contract or other
document referred to herein are not necessarily complete, and in each instance
reference is made to the copy of such contract or other documents filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference.

2
<PAGE> 11

SUMMARY

The following is a summary of certain information contained elsewhere in
this Proxy Statement/Prospectus and is qualified in its entirety by reference to
the full text of this Proxy Statement/Prospectus and the exhibits hereto.
Stockholders are urged to read this Proxy Statement/Prospectus, and the
accompanying exhibits in their entirety. See "Risk Factors" for certain
information that should be considered by the stockholders of Microtec.

THE COMPANIES

Mentor Graphics Corporation

Mentor Graphics is a leading supplier of electronic design automation
("EDA") systems -- advanced computer software used to automate the design,
analysis and testing of electronic systems and components. Mentor Graphics
markets its products primarily to large companies in the aerospace, computer,
consumer electronics, semiconductor and telecommunications industries. Mentor
Graphics' software products enable engineers and designers to design, analyze,
place and route, and test custom integrated circuits, application specific
integrated circuits, field programmable gate arrays, printed circuit boards,
multichip modules and other electronic systems and subsystems prior to creating
actual hardware prototypes. Customers use Mentor Graphics' software in the
design of such diverse products as supercomputers, automotive electronics,
missile guidance systems, signal processors and personal computers. Mentor
Graphics sells and licenses its products primarily through its direct sales
force in North America, Europe and Asia, and through distributors in territories
where the volume of business does not warrant a direct sales presence.

Mentor Graphics was incorporated in Oregon in 1981. Mentor Graphics'
executive offices are located at 8005 S.W. Boeckman Road, Wilsonville, Oregon
97070-7777. Its telephone number at that address is (503) 685-7000.

Microtec Research, Inc.

Microtec is a provider of software products for the development and
operation of embedded systems, including software development tools, real-time
operating systems and software connectivity products. Microtec's integrated
software solutions enable embedded systems developers to increase productivity,
thereby decreasing costs of product development and reducing time-to-market for
new products. Microtec has one of the largest installed customer bases in the
embedded systems software development market, with over 40,000 licensed users of
its software development tools and over 4,000 licensed users of its VRTX
real-time operating systems.

Microtec has a broad, integrated product line, including its C and
object-oriented C++ software development tools, VRTX real-time operating systems
and Spectra host-target connectivity products. Microtec has designed its
products to have an open architecture and to have common features and interfaces
across a range of microprocessors and host computers.

Microtec was incorporated in California in 1979 and reincorporated in
Delaware in December 1994. Microtec's executive offices are located at 2350
Mission College Boulevard, Santa Clara, California 95054. Its telephone number
at that address is (408) 980-1300.

M Acquisition Sub, Inc.

Merger Sub is a Delaware corporation recently organized by Mentor Graphics
for the purpose of effecting the acquisition of Microtec. It has no material
assets and has not engaged in any activities except in connection with the
proposed acquisition. Its executive offices are located at 8005 S.W. Boeckman
Road, Wilsonville, Oregon 97070-7777. Its telephone number at that address is
(503) 685-7000.

3
<PAGE> 12

DATE AND PLACE OF THE SPECIAL MEETING

The Special Meeting of the stockholders of Microtec (the "Special Meeting")
will be held on January , 1996 at 8:00 a.m., local time, at the executive
offices of Microtec located at 2350 Mission College Boulevard, Santa Clara,
California.

PURPOSE OF THE SPECIAL MEETING; THE MERGER

At the Special Meeting, the stockholders of Microtec will consider and vote
upon the proposals (i) to approve and adopt the Merger Agreement and to approve
the Merger and (ii) to transact such other business as may properly come before
the Special Meeting or any adjournments or postponements thereof. See "The
Special Meeting -- Matters to be Considered at the Special Meeting."

As a result of the Merger, each outstanding share of Microtec Common Stock
will be converted into the right to receive 0.6930693 (the "Exchange Ratio")
shares of Mentor Graphics Common Stock. Upon consummation of the Merger, each
then-outstanding option to purchase Microtec Common Stock under each of
Microtec's 1985 Amended and Restated Option Plan and 1994 Stock Option Plan (a
"Microtec Option") will be assumed by Mentor Graphics and will automatically be
converted into an option to purchase that number of shares of Mentor Graphics
Common Stock equal to the product of the number of shares of Microtec Common
Stock such option was exercisable for at the time of the Merger multiplied by
the Exchange Ratio at an exercise price equal to the quotient of the per share
exercise price of the Microtec Option at the time of the Merger divided by the
Exchange Ratio. From or after the date 30 days prior to the Effective Time, each
outstanding option to purchase Microtec Common Stock under Microtec's 1994
Outside Directors' Option Plan shall become fully exercisable and all such
options outstanding at the Effective Time shall automatically terminate. Subject
to the consummation of the Merger, on the last trading day prior to the
Effective Time, Microtec will apply the funds then credited under Microtec's
1994 Employee Stock Purchase Plan to each participant's payroll withholding
account to the purchase of whole shares of Microtec Common Stock. See "The
Merger Agreement -- Conversion of Shares; Treatment of Microtec Stock Options
and Employee Stock Purchase Plan."

STOCKHOLDERS ENTITLED TO VOTE; VOTING AGREEMENT

The close of business on December 29, 1995 is the record date for
determination of holders of Microtec Common Stock entitled to vote at the
Special Meeting. At that date, shares of Microtec Common Stock were
outstanding, held by approximately holders of record. As of such date,
directors and executive officers of Microtec and their affiliates may be deemed
to be beneficial owners of approximately [61.5%] of the outstanding shares of
Microtec Common Stock. See "The Special Meeting -- Record Date; Voting at the
Special Meeting; Vote Required."

The directors and executive officers of Microtec have indicated that they
intend to vote the shares of Microtec Common Stock held by them for approval and
adoption of the Merger Agreement and approval of the Merger. Jerry Kirk,
Chairman of the Board, President and Chief Executive Officer of Microtec, has
entered into a voting agreement with Mentor Graphics pursuant to which he has
agreed to vote his 4,248,334 shares of Microtec Common Stock (approximately
[48%] of the outstanding Microtec Common Stock) in favor of the Merger Agreement
and the Merger. Mr. Kirk has also given Mentor Graphics an irrevocable proxy to
vote these shares in favor of the Merger Agreement and the Merger. See "The
Special Meeting -- Record Date; Voting at the Special Meeting; Vote Required."

VOTE REQUIRED

Approval of the Merger Agreement and the Merger will require the
affirmative vote of the holders of a majority of the outstanding shares of
Microtec Common Stock entitled to vote thereon. Any other matters being
submitted for consideration by the Microtec stockholders will require the
affirmative vote of the holders of a majority of the shares of Microtec Common
Stock present (in person or by proxy) at the Special Meeting and entitled to
vote thereon. See "The Special Meeting -- Record Date; Voting at the Special
Meeting; Vote Required; Proxies."

4
<PAGE> 13

APPRAISAL RIGHTS

Under the Delaware General Corporation Law, the holders of Microtec Common
Stock are not entitled to appraisal rights in connection with the Merger.

RECOMMENDATION; FAIRNESS OPINION

The Board of Directors of Microtec (the "Microtec Board") has approved the
Merger Agreement and recommends that holders of Microtec Common Stock vote FOR
the approval and adoption of the Merger Agreement and approval of the Merger.

Lehman Brothers Inc. ("Lehman Brothers") has delivered to the Microtec
Board its written opinion dated as of October 9, 1995 to the effect that, based
upon and subject to the various considerations set forth in such opinion, as of
the date of such opinion, the Exchange Ratio is fair from a financial point of
view to the stockholders of Microtec.

A copy of the opinion of Lehman Brothers, which sets forth the assumptions
made, matters considered and scope of their review, is attached to this Proxy
Statement/Prospectus as Annex B, and should be read in its entirety. See "The
Merger -- Fairness Opinion," which also contains a discussion of the fee to be
paid to Lehman Brothers.

REASONS FOR THE MERGER

The Boards of Directors of Mentor Graphics and Microtec considered a number
of potential joint benefits resulting from the Merger, including expanded market
opportunities for both companys' products resulting from access to broader sales
and distribution channels and enhanced ability to exploit growth opportunities
in the embedded software systems market resulting from the combination of Mentor
Graphic's financial and technical resources with Microtec's products. The
Microtec Board believes that the Merger will provide the Microtec stockholders
with the opportunity to receive, on a tax-free basis, Mentor Graphics Common
Stock that will enable them to participate in opportunities for growth in the
combined company after the Merger.

Each Board of Directors has recognized that the potential benefits of the
Merger may not be realized. Risks associated with the Merger include the need to
integrate the operations, facilities and personnel, particularly engineering and
sales personnel, of the two companies and the dilution that may result from the
issuance of shares of Mentor Graphics Common Stock in the Merger. See "Risk
Factors."

For a discussion of the factors considered by the Board of Directors of
Microtec in reaching its decision to recommend the Merger, see "The
Merger -- Reasons for the Merger; Recommendation of the Microtec Board of
Directors."

OPERATIONS FOLLOWING THE MERGER

Microtec will become a wholly-owned subsidiary of Mentor Graphics at the
Effective Time of the Merger. Mentor Graphics intends that Microtec will be
operated as an independent business within Mentor Graphics' Hardware/Software
Design Division. None of the officers or directors of Microtec are expected to
serve as officers or directors of Mentor Graphics following the Merger (although
certain of Microtec's officers are expected to continue to serve as officers of
Microtec following the Merger). See "The Merger -- Operations Following the
Merger."

INTERESTS OF CERTAIN PERSONS IN THE MERGER

None of the officers or directors of Microtec will receive any
consideration other than as a securityholder in connection with the Merger,
except as described below with respect to (i) certain consulting and employment
agreements, (ii) options outstanding under the Directors Option Plan and (iii)
certain indemnification obligations which will survive the Merger. See "The
Merger -- Interests of Certain Persons in the Merger."

5
<PAGE> 14

EFFECTIVE TIME OF THE MERGER

As promptly as practicable after the satisfaction or waiver of the
conditions set forth in the Merger Agreement, the parties thereto will file a
certificate of merger with the Secretary of State of the State of Delaware. The
Merger will become effective upon such filing (the "Effective Time"). It is
anticipated that, assuming all conditions are met, the Merger will occur on or
before January 31, 1996.

CONDITIONS TO THE MERGER

Consummation of the Merger is subject to the satisfaction of a number of
conditions, including but not limited to (i) the adoption and approval of the
Merger Agreement by the requisite vote of the stockholders of Microtec; (ii) the
authorization for listing on the Nasdaq National Market of the shares of Mentor
Graphics Common Stock to be issued in connection with the Merger; (iii) the
absence of any restrictive court orders or any other legal restraints or
prohibitions, and of any pending governmental proceedings, preventing or making
illegal the consummation of the Merger; (iv) the continuing accuracy of the
representations and warranties made in the Merger Agreement on and as of the
Effective Time (except those limited by their terms to a different date) and (v)
the receipt by Mentor Graphics and Microtec of certain opinions regarding tax
and accounting matters. See "The Merger Agreement -- Conditions to the Merger."

TERMINATION

Under certain circumstances either Mentor Graphics or Microtec may be
required to pay a termination fee if the Merger Agreement is terminated. See
"The Merger Agreement -- Termination; Amendment" and "-- Fees and Expenses."

SURRENDER OF CERTIFICATES

If the Merger becomes effective, Mentor Graphics will cause American Stock
Transfer & Trust Company ("Exchange Agent") to mail a letter of transmittal (the
"Letter of Transmittal") with instructions to all holders of record of Microtec
Common Stock as of the Effective Time for use in surrendering their stock
certificates in exchange for certificates representing Mentor Graphics Common
Stock and a cash payment in lieu of fractional shares. Certificates should not
be surrendered until the Letter of Transmittal is received.

ACCOUNTING TREATMENT

The Merger is expected to be accounted for as a pooling of interests. Upon
execution of the Merger Agreement, Mentor Graphics received an opinion from KPMG
Peat Marwick LLP, independent auditors, to the effect that, based upon certain
material facts and certain representations and warranties described in such
opinion, such accounting treatment is appropriate. In addition, Microtec
received an opinion from Deloitte & Touche LLP, independent auditors, to the
effect that, based upon certain material facts and certain representations and
warranties described in such opinion, Microtec was not precluded from using the
pooling of interests method of accounting in a merger transaction. See "The
Merger -- Accounting Treatment."

CERTAIN FEDERAL INCOME TAX CONSEQUENCES

The Merger will qualify as a tax-free reorganization under Section 368(a)
of the Internal Revenue Code of 1986, as amended (the "Code"). Accordingly,
holders of Microtec Common Stock will not recognize gain or loss for federal
income tax purposes by reason of the conversion of Microtec Common Stock to
Mentor Graphics Common Stock, except for cash received in lieu of fractional
shares. See "The Merger -- Certain Federal Income Tax Consequences."

The Merger will not have any tax consequences to the stockholders of Mentor
Graphics.

6
<PAGE> 15

REGULATORY MATTERS

Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), and the rules promulgated thereunder by the United States
Federal Trade Commission (the "FTC"), the Merger may not be consummated until
notifications have been given and certain information has been furnished to the
FTC and the Antitrust Division of the United States Justice Department (the
"Antitrust Division"), and specified waiting period requirements have been
satisfied. The applicable waiting period under the HSR Act expired on November
26, 1995. See "The Merger -- Regulatory Matters."

7
<PAGE> 16

SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA

The following selected historical financial information of Mentor Graphics
and Microtec has been derived from their respective historical consolidated
financial statements, and should be read in conjunction with such consolidated
financial statements and the notes thereto, certain of which are included in
this Proxy Statement/Prospectus. The selected pro forma financial information of
Mentor Graphics and Microtec gives effect to the Merger and is derived from the
pro forma combined condensed financial statements and should be read in
conjunction with such pro forma statements and the notes thereto which are
included in this Proxy Statement/Prospectus. For pro forma purposes, Mentor
Graphics' financial statements for the three fiscal years ended December 31,
1994, 1993 and 1992, and for the nine months ended September 30, 1995 and 1994
have been combined with the financial statements of Microtec for the three
fiscal years ended March 31, 1995, 1994 and 1993 and for the nine months ended
September 30, 1995 and 1994. No dividends have been declared or paid on Microtec
Common Stock. The pro forma data does not reflect the issuance of additional
shares of Mentor Graphics Common Stock prior to consummation of the Merger.

The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the operating results or financial position
that would have occurred if the Merger had been consummated, nor is it
necessarily indicative of future operating results or financial position.

SELECTED HISTORICAL FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
(UNAUDITED) YEAR ENDED DECEMBER 31,
------------------- ----------------------------------------------------
1995 1994 1994 1993 1992 1991 1990
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Mentor Graphics Statement of Operations Data:
Net revenues................................... $274,821 $246,439 $348,294 $339,775 $350,766 $400,127 $435,185
Income (loss) from operations(1)............... 32,233 15,208 28,460 (29,392) (40,732) (60,501) 20,715
Net income (loss).............................. 31,305 14,530 27,537 (32,073) (50,861) (61,613) 23,625
Net income (loss) per share.................... $ 0.57 $ 0.28 $ 0.53 $ (0.69) $ (1.13) $ (1.43) $ 0.53
Cash dividends per share....................... .18 .24 .24 .22
Shares used in per share calculations.......... 55,323 51,966 52,120 46,410 45,142 43,153 44,833
Mentor Graphics Balance Sheet Data:
Working Capital................................ $181,989 $121,308 $138,779 $ 96,336 $108,392 $169,875 $208,223
Total Assets................................... 432,502 369,841 393,797 353,584 378,565 445,661 504,287
Long-term Debt................................. 52,589 54,096 53,625 54,321 55,709 50,554 50,167
Stockholders' Equity........................... 282,439 223,045 239,068 195,711 221,406 267,667 326,419
</TABLE>

- ---------------
(1) Includes restructuring costs of $(6,045), $24,800, $12,900 and $27,100 for
the years ended December 31, 1994, 1993, 1992 and 1991, respectively. Also
includes merger related charges of $9,265 for the year ended December 31,
1994.

<TABLE>
<CAPTION>
SIX MONTHS
ENDED SEPTEMBER30,
(UNAUDITED) YEAR ENDED MARCH 31,
------------------ ---------------------------------------------------
1995 1994 1995 1994 1993 1992 1991
------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Microtec Statement of Operations Data:
Net revenues................................... $22,732 $21,481 $45,212 $33,007 $22,626 $20,028 $15,553
Income (loss) from operations(1)............... 1,255 2,550 5,830 (13,999) 492 2,593 3,151
Net income (loss).............................. 1,168 1,808 4,350 (8,331) 156 2,086 2,551
Net income (loss) per share.................... $ 0.13 $ 0.22 $ 0.50 $ (1.21)
Shares used in per share calculations.......... 9,311 8,247 8,621 6,877
Microtec Balance Sheet Data:
Working Capital................................ $11,476 $ 5,238 $12,191 $ 4,519 $ 6,534 $ 7,168 $ 5,286
Total Assets................................... 34,168 25,640 36,769 25,161 16,827 14,448 11,250
Stockholders' Equity........................... 22,659 10,710 21,563 8,260 9,413 9,157 7,006
</TABLE>

- ---------------
(1) Includes acquired in process research and development and litigation related
costs of $18,282 in 1994 and $2,083 in 1993.

8
<PAGE> 17

SELECTED CONSOLIDATED FINANCIAL DATA -- PRO FORMA COMBINED (UNAUDITED)

Set forth below are unaudited selected consolidated financial data (pro
forma combined) of Mentor Graphics and Microtec which give effect to the Merger
under the pooling of interests method accounting. Such pro forma data assumes
the Merger had been effective at the beginning of the periods presented for the
statement of operations information and on September 30, 1995 and December 31,
1994, 1993 and 1992 for the balance sheet information. The pro forma information
is presented for illustrative purposes and is not necessarily indicative of
future operating results or financial position of combined companies. The
selected unaudited pro forma combined financial data should be read in
conjunction with the "Unaudited Pro Forma Condensed Combined Financial
Information," including the notes thereto.

SELECTED CONSOLIDATED FINANCIAL DATA -- PRO FORMA COMBINED (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, FOR THE YEAR ENDED DECEMBER
31,
------------------- ------------------------------
1995 1994 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:(1)(2)
Net Revenue................................. $309,681 $278,562 $393,506 $372,782 $373,392
Income (loss) before income taxes........... 39,822 21,585 37,502 (43,580) (47,845)
Net Income (loss)........................... 33,974 17,155 33,187 (45,904) (50,705)
Net Income (loss) per share................. $ 0.55 $ 0.30 $ 0.57 $ (0.90) $ (1.02)
Cash dividends per share.................... -- -- -- 0.17 0.22
Shares used in per share calculations....... 61,767 57,620 58,095 51,176 49,576
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, ----------------------------------
1995 1994 1993 1992
------------- -------- -------- --------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:(2)
Working Capital.............................. $ 192,965 $150,470 $ 97,155 $108,892
Total Assets................................. 462,470 426,366 373,245 378,565
Long-term Debt............................... 52,589 53,625 54,321 55,709
Stockholders' Equity......................... 300,898 256,431 198,471 221,406
</TABLE>

- ---------------
(1) All net income (loss) and per share data includes Mentor Graphics
restructuring costs of $(6,045), $24,800 and $12,900, for the years ended
December 31, 1994, 1993, & 1992, respectively, Mentor Graphics merger
related charges of $9,265 for the year ended December 31, 1994, and Microtec
acquired in process research and development and litigation related costs of
$18,282 and $2,083 for the years ended December 31, 1994 and 1993,
respectively.

(2) It is expected that following the Merger, Mentor Graphics will incur a
charge to operations, currently anticipated to be between $3,000 and $4,000,
in the quarter ending December 31, 1995 to reflect the combination of the
two companies. The charge includes elimination of duplicate facilities,
severance costs and the write-off of property and equipment. This charge is
not reflected in the pro forma data.

See Pro Forma Combined Condensed Financial Statements and accompanying
notes thereto.

9
<PAGE> 18

COMPARATIVE PER SHARE DATA

The following table sets forth certain historical per share data of Mentor
Graphics and Microtec and combined per share data on an unaudited pro forma
basis after giving effect to the Merger on a pooling of interests basis assuming
that 0.6930693 shares of Mentor Graphics Common Stock is issued in exchange for
each share of Microtec Common Stock in the Merger. This data should be read in
conjunction with the selected financial data, the pro forma combined condensed
financial statements and the separate historical financial statements of Mentor
Graphics and Microtec and notes thereto, included elsewhere in this Proxy
Statement/Prospectus. The unaudited pro forma combined financial data are not
necessarily indicative of the operating results that would have been achieved
had the transaction been in effect as of the beginning of the periods presented
and should not be construed as representative of future operations.

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
(UNAUDITED) YEAR ENDED DECEMBER 31,
------------------- ---------------------------
1995 1994 1994 1993 1992
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Historical Mentor Graphics:
Net income (loss).......................... $0.57 $0.28 $0.53 $(0.69) $(1.13)
Dividends.................................. 0.00 0.00 0.00 0.18 0.24
Book value................................. 5.18 4.66
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
(UNAUDITED) YEAR ENDED MARCH 31,
------------------- ---------------------------
1995 1994 1995 1994 1993
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Historical Microtec:
Net income (loss).......................... $0.29 $0.32 $0.50 $(1.21)
Dividends.................................. 0.00 0.00 0.00 0.00
Book value................................. 2.55 2.49
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
(UNAUDITED) (UNAUDITED)
------------------- ---------------------------
1995 1994 1994 1993 1992
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Pro Forma Combined Per Mentor Graphics Share:
Net income (loss).......................... $0.55 $0.30 $0.57 $(0.90) $(1.02)
Dividends.................................. 0.00 0.00 0.00 0.17 0.22
Book value................................. 4.96 4.47
Equivalent Pro Forma Combined Per Microtec
Share:
Net income (loss).......................... $0.38 $0.21 $0.40 $(0.62) $(0.71)
Dividends.................................. 0.00 0.00 0.00 0.12 0.15
Book value................................. 3.44 3.10
</TABLE>

- ---------------

On October 9, 1995, the last full trading day preceding the public
announcement by Mentor Graphics and Microtec of the execution of the Merger
Agreement, the closing price of Mentor Graphics Common Stock on Nasdaq was
$19.07, and the closing price of Microtec Common Stock on Nasdaq was $11.25. The
equivalent market price per share of Microtec Common Stock based on the Exchange
Ratio would have been $13.22.

See Pro Forma Combined Condensed Financial Statements and accompanying notes
thereto.

10
<PAGE> 19

COMPARATIVE STOCK PRICE DATA AND DIVIDEND HISTORY

The Mentor Graphics Common Stock and the Microtec Common Stock are quoted
on Nasdaq under the trading symbols "MENT" and "MTEC", respectively. The
following table sets forth, for the periods indicated, the quarterly high and
low sale prices per share of the Mentor Graphics Common Stock and the Microtec
Common Stock. The Microtec Common Stock began trading on Nasdaq on December 15,
1994.

<TABLE>
<CAPTION>
MENTOR
GRAPHICS MICROTEC
COMMON STOCK COMMON STOCK
-------------- --------------
HIGH LOW HIGH LOW
----- ----- ----- -----
<S> <C> <C> <C> <C>
1993
First Quarter............................................. $ 11 $7 7/8 -- --
Second Quarter............................................ 12 7 7/8 -- --
Third Quarter............................................. 11 1/2 8 3/8 -- --
Fourth Quarter............................................ 15 1/2 10 -- --
1994
First Quarter............................................. $17 1/4 $11 1/4 -- --
Second Quarter............................................ 16 1/8 10 -- --
Third Quarter............................................. 11 5/8 9 3/8 -- --
Fourth Quarter............................................ 15 5/8 10 5/8 $ 9 $ 8
1995
First Quarter............................................. $16 3/8 $12 3/8 $ 13 $8 1/4
Second Quarter............................................ 18 1/2 14 7/8 16 1/4 7 3/4
Third Quarter............................................. 21 3/8 16 1/8 12 1/4 7 3/4
Fourth Quarter (through December 1, 1995)................. 22 7/8 16 5/8 15 10 3/4
</TABLE>

The number of holders of record of Mentor Graphics Common Stock and
Microtec Common Stock on December 29, 1995 were approximately and ,
respectively.

No cash dividends have been previously paid on Microtec Common Stock. No
cash dividends have been paid on Mentor Graphics Common Stock since the third
quarter of 1993, and Mentor Graphics does not anticipate paying dividends in the
foreseeable future. Any future determination concerning the payment of cash
dividends will depend upon Mentor Graphics' results of operations, financial
condition, capital requirements and other factors deemed relevant by Mentor
Graphics' Board of Directors.

The following table sets forth the high, low and closing sale prices as
reported on Nasdaq of the Mentor Graphics Common Stock and the Microtec Common
Stock on Monday, October 9, 1995. The public announcement of the Merger
Agreement occurred prior to the opening of trading on Tuesday, October 10, 1995.

<TABLE>
<CAPTION>
MENTOR MICROTEC
GRAPHICS MICROTEC EQUIVALENT(1)
-------- -------- -------------
<S> <C> <C> <C>
High................................ $19.75 $11.75 $ 13.69
Low................................. 19.00 10.75 13.17
Closing............................. 19.07 11.25 13.22
</TABLE>

- ---------------
(1) The Microtec equivalent market value is computed by multiplying the high,
low and closing market price per share of Mentor Graphics Common Stock by
the Exchange Ratio.

The last reported sale prices for Mentor Graphics Common Stock and Microtec
Common Stock as reported on Nasdaq on December 22, 1995 were 17 3/4 and 12 1/2,
respectively.

11
<PAGE> 20

RISK FACTORS

The following risk factors should be considered by holders of Microtec
Common Stock in evaluating whether to approve the Merger Agreement and thereby
become holders of Mentor Graphics Common Stock. These factors should be
considered in conjunction with the other information included and incorporated
by reference in this Proxy Statement/Prospectus.

Competition. The EDA industry is highly competitive and has been
characterized by rapid technological advances in application software, operating
systems and hardware. Some of Mentor Graphics' competitors and potential
competitors may have greater name recognition, more extensive engineering,
manufacturing and marketing capabilities and greater financial, technological
and personnel resources than Mentor Graphics. There can be no assurance that
Mentor Graphics will have the financial resources, marketing, distribution and
service capability, depth of key personnel or technological knowledge to compete
successfully in the EDA market in the future. The primary competitors for Mentor
Graphics products are Cadence Design Systems, Inc., Synopsys, Inc., Viewlogic
Systems, Inc., COMPASS Design Automation, Inc., Zuken-Redac, Intergraph
Corporation and numerous small companies. The EDA industry has become
increasingly competitive and Mentor Graphics' results may be adversely affected
by the actions of existing or future competitors. Such actions may include the
development or acquisition of new technologies, the introduction of new
products, the assertion by third parties of patent or similar intellectual
property rights, and the reduction of prices by competitors to gain or retain
market share. Industry consolidation or alliances may also affect the
competitive environment. In particular, competitive pressures from existing or
new competitors who offer lower prices or introduce new products could result in
delayed or deferred purchasing decisions by potential customers and price
reductions, both of which would adversely affect Mentor Graphics' sales and
operating margins. See "Business -- Competition."

Key Personnel. The success of Mentor Graphics depends on its ability to
attract and retain qualified technical, managerial, sales and marketing
personnel. Competition for such personnel is intense in the software industry
and there can be no assurance that Mentor Graphics will be successful in
retaining its key technical, sales and marketing employees or that it can
attract, assimilate or retain other qualified technical, managerial, sales and
marketing personnel in the future. If Mentor Graphics is unable to hire the
necessary technical personnel, the development of new products could be
impaired. In addition, if Mentor Graphics is unable to retain qualified sales
personnel, sales of its products would be negatively affected.

Acquisition Strategy. Acquisitions of complementary businesses are an
integral part of Mentor Graphics' overall business strategy. In addition to the
Microtec acquisition, Mentor Graphics has recently consummated acquisitions of
several other companies, including Axiom Datorer Skandinavien, AB, Exemplar
Logic, Inc. and Precedence Incorporated. Mentor Graphics continually evaluates
potential acquisition and investment opportunities. There can be no assurance
that products, technologies and businesses of acquired companies, or the
technical and sales personnel of such companies, will be effectively assimilated
with those of Mentor Graphics. In addition, Mentor Graphics may incur
significant expenses to complete acquisitions and investments and to support the
acquired products, technologies or businesses. There can be no assurance that
any acquired products, technologies or businesses will contribute to Mentor
Graphics' revenues or earnings to any material extent. Furthermore, the
challenge of managing the integration of multiple companies simultaneously is
significant, and there can be no assurance that Mentor Graphics will be able to
manage such integration successfully.

Uncertainties Related to the Integration of Microtec's Business. The
successful combination of companies in the high technology industry may be more
difficult to accomplish than in other industries. There can be no assurance that
Mentor Graphics will be successful in developing additional products based on
Microtec's technology or engineering expertise, that Mentor Graphics will be
successful in integrating its own distribution channels with those of Microtec,
that Mentor Graphics will be successful in coordinating the activities of the
Microtec and Mentor Graphics sales force or in selling Microtec's products to
its own customer base, that the combined companies will retain their key
personnel or that Mentor Graphics will realize any of the other potential
benefits of the Merger.

Technological Change. The market for Mentor Graphics' products (including
the product lines of Microtec to be acquired in the Merger) is characterized by
rapidly changing technology, evolving industry

12
<PAGE> 21

standards, and frequent introductions of new products and product enhancements.
Mentor Graphics' success will depend upon its continued ability to enhance its
existing products, to introduce new products on a timely and cost-effective
basis to meet evolving customer requirements, to achieve market acceptance for
new product offerings, and to respond to emerging industry standards and other
technological changes. There can be no assurance that Mentor Graphics will be
successful in developing new products or enhancing its existing products or that
such new or enhanced products will receive market acceptance.

Product Protection and Intellectual Property. Mentor Graphics currently
relies upon a combination of patents, copyrights, trademarks and trade secret
laws to establish and protect its proprietary rights in its products. Mentor
Graphics maintains as proprietary the software and other portions of the
technology incorporated in its products. Mentor Graphics has been issued and has
applied for patents in the United States on various aspects of its products.
There can be no assurance that the steps taken by Mentor Graphics to protect its
proprietary rights will be adequate to prevent misappropriation of its
technology or that Mentor Graphics competitors will independently develop
technologies that are substantially equivalent or superior to Mentor Graphics'
technology. In addition, the laws of some foreign countries do not protect
Mentor Graphics' proprietary rights to the same extent as do the laws of the
United States. No assurance can be given that any patents currently held or
issued to Mentor Graphics in the future will not be challenged, invalidated or
circumvented or that the rights granted thereunder will provide competitive
advantages.

History of Losses; Repeated Restructuring Charges. Although Mentor
Graphics was profitable in 1994 and the first three quarters of 1995, in the
years ended December 31, 1993, 1992, and 1991, Mentor Graphics incurred net
losses of $32,073,000, $50,861,000, and $61,613,000, respectively, including
restructuring charges of $24,800,000, $12,900,000, and $27,100,000,
respectively. The 1993 restructuring charge related to a restructuring plan
approved in December 1993 aimed at reducing operating expenses by streamlining
and reorganizing Company operations. The 1992 and 1991 restructuring charges
related to restructuring plans aimed at improving Mentor Graphics' focus on its
core businesses of integrated circuit design and electronic systems design.
There can be no assurance as to Mentor Graphics' ability to avoid future
restructuring charges or to achieve sustained profitability.

Possible Volatility of Stock Price. The market price of Mentor Graphics'
Common Stock may be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, changes in earnings
estimates by analysts, announcements of technological innovations or new
products by Mentor Graphics or its competitors, general conditions in the
software and computer industries and other events or factors. In addition, the
stocks of many technology companies have experienced extreme price and volume
fluctuations which have often been unrelated to the companies' operating
performance. Such market fluctuations, as well as general economic, political
and market conditions, may adversely affect the market price of Mentor Graphics'
Common Stock. Because the market price of Mentor Graphics Common Stock is
subject to fluctuation, the market value of the shares of Mentor Graphics Common
Stock that Microtec stockholders will receive in the Merger may increase or
decrease prior to the Merger. Microtec stockholders are urged to obtain a
current market quotation for Mentor Graphics Common Stock.

13
<PAGE> 22

THE SPECIAL MEETING

GENERAL

This Proxy Statement/Prospectus is being furnished to holders of Microtec
Common Stock in connection with the solicitation of proxies by the Microtec
Board for use at the Special Meeting to be held at Microtec's executive offices,
2350 Mission College Boulevard, Santa Clara, California at 8:00 a.m., local
time, on January , 1996, or at any adjournments or postponements thereof, for
the purposes set forth herein and in the accompanying Notice of Special Meeting
of Stockholders of Microtec.

MATTERS TO BE CONSIDERED AT THE SPECIAL MEETING

At the Special Meeting, stockholders of record of Microtec as of the close
of business on December 29, 1995, will be asked to consider and vote upon
proposals (i) to approve and adopt the Merger Agreement and to approve the
Merger and (ii) to transact such other business as may properly come before the
Special Meeting or any postponements or adjournments thereof.

THE MICROTEC BOARD HAS DETERMINED THAT THE MERGER IS ADVISABLE AND IN THE
BEST INTERESTS OF MICROTEC AND ITS STOCKHOLDERS, HAS UNANIMOUSLY APPROVED THE
MERGER AGREEMENT AND THE MERGER, AND RECOMMENDS A VOTE BY THE STOCKHOLDERS OF
MICROTEC FOR APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND APPROVAL OF THE
MERGER.

RECORD DATE; VOTING AT THE SPECIAL MEETING; VOTE REQUIRED

The Microtec Board has fixed December 29, 1995 as the record date for the
determination of the stockholders of Microtec entitled to notice of and to vote
at the Special Meeting. Only holders of record of Microtec Common Stock on the
record date will be entitled to notice of and to vote at the Special Meeting. As
of December 29, 1995, there were shares of Microtec Common Stock
outstanding and entitled to vote, which were held by approximately holders of
record. Each record holder of Microtec Common Stock on the record date is
entitled to cast one vote per share, exercisable in person or by properly
executed proxy, on each matter properly submitted for the vote of the
stockholders of Microtec at the Special Meeting.

The presence, in person or by properly executed proxy, of the holders of a
majority of the outstanding shares of Microtec Common Stock entitled to vote at
the Special Meeting is necessary to constitute a quorum at the Special Meeting.
The approval of the Merger Agreement and the Merger will require the affirmative
vote of the holders of at least a majority of the outstanding shares of Microtec
Common Stock entitled to vote thereon. Abstentions and broker non-votes will not
be counted, but will have the practical effect of a vote against the Merger
Agreement and the Merger since they represent one less vote for approval.

As of December 29, 1995, directors, executive officers and affiliates of
Microtec may be deemed to be the beneficial owners of approximately [61.5%] of
the outstanding shares of Microtec Common Stock. Each of the directors and
executive officers of Microtec has indicated an intention to vote or direct the
vote of all shares of Microtec Common Stock over which he or she has voting
control in favor of the Merger Agreement and the Merger.

In addition, Jerry Kirk, the President, Chief Executive Officer and
Chairman of the Board of Microtec, has entered into a voting agreement with
Mentor Graphics pursuant to which he has agreed to vote his 4,248,334 shares of
Microtec Common Stock (approximately [48%] of the currently outstanding shares
of Microtec Common Stock) in favor of the Merger Agreement and the Merger. Mr.
Kirk has also given Mentor Graphics an irrevocable proxy to vote these shares in
favor of the Merger Agreement and the Merger.

PROXIES

This Proxy Statement/Prospectus is being furnished to holders of Microtec
Common Stock in connection with the solicitation of proxies by and on behalf of
the Microtec Board for use at the Special Meeting.

14
<PAGE> 23

All shares of Microtec Common Stock that are entitled to vote and are
represented at the Special Meeting by properly executed proxies received prior
to or at the Special Meeting and not duly and timely revoked, will be voted at
the Special Meeting in accordance with the instructions indicated on such
proxies. If no instructions are indicated, such proxies will be voted FOR
approval and adoption of the Merger Agreement and approval of the Merger.

If any other matters are properly presented for consideration at the
Special Meeting (or any adjournments or postponements thereof), including, among
other things, consideration of a motion to adjourn or postpone the Special
Meeting to another time and/or place (including, without limitation, for the
purpose of soliciting additional proxies), the persons named in the enclosed
forms of proxy and voting thereunder will have discretion to vote on such
matters in accordance with their best judgment, except that proxies voted
against the Merger will not be voted for any adjournment or postponement of the
Special Meeting.

Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before it is voted. Proxies may be revoked by (i) filing
with the Secretary of Microtec at or before the taking of the vote at the
Special Meeting, a written notice of revocation bearing a later date than the
proxy, (ii) duly executing a later dated proxy relating to the same shares and
delivering it to the Secretary of Microtec before taking the vote at the Special
Meeting or (iii) attending the Special Meeting and voting in person (although
attendance at the Special Meeting will not in and of itself constitute a
revocation of a proxy). Any written notice of revocation or subsequent proxy
should be sent so as to be delivered to Microtec, 2350 Mission College
Boulevard, Santa Clara, California 95054, Attention: Secretary, or
hand-delivered to the Secretary of Microtec at or before taking the vote at the
Special Meeting.

In addition to solicitation by use of the mails, proxies may be solicited
by directors, officers and employees of Microtec in person or by telephone,
telegram or other means of communication. Such directors, officers and employees
will not be additionally compensated, but may be reimbursed for reasonable
out-of-pocket expenses in connection with such solicitation. Arrangements will
also be made with custodians, nominees and fiduciaries for forwarding proxy
solicitation materials to beneficial owners of shares held of record by such
custodians, nominees and fiduciaries, and Microtec will reimburse such
custodians, nominees and fiduciaries for reasonable expenses incurred in
connection therewith.

STOCKHOLDERS SHOULD NOT SEND ANY STOCK CERTIFICATES
WITH THEIR PROXY CARDS

15
<PAGE> 24

THE MERGER
DESCRIPTION

Under the Merger Agreement, M Acquisition Sub, Inc. ("Merger Sub"), a
wholly owned subsidiary of Mentor Graphics formed for this purpose, will merge
with and into Microtec, which will continue as the surviving corporation. At the
effective time of the Merger, (i) each outstanding share of Microtec Common
Stock will be converted into the right to receive 0.6930693 (the "Exchange
Ratio") shares of Mentor Graphics Common Stock and (ii) each outstanding share
of common stock of Merger Sub will be converted into one share of common stock
of Microtec, as the surviving corporation. Microtec will become a wholly-owned
subsidiary of Mentor Graphics.

BACKGROUND OF THE MERGER

In April 1989, Mentor Graphics and Microtec entered into a Software
Development and License Agreement under which Microtec was to develop an
interactive interface between Mentor Graphics software and Microtec's XRAY
family of debugging software tools. In connection with an August 1991
restructuring of Mentor Graphics, all work on this project ceased.

During the second quarter of 1995, management of Mentor Graphics determined
that the company should pursue a strategy of hardware/software co-design, as a
result of which it began evaluating companies in the embedded software systems
market. In this connection, in early July of 1995, Chung Tung, Vice President
and General Manager of Mentor Graphics Hardware/Software Design Division,
contacted Jerry Kirk, President and Chief Executive Officer of Microtec to
discuss the possibility of working together on certain tools targeted at
hardware/software co-verification. Certain employees of Mentor Graphics and
Microtec subsequently met on July 18, 1995, to discuss the possibility of
cooperative development of selected design tools. At this meeting, the decision
was made to proceed with a technical evaluation of such a strategy, and
thereafter more detailed technical meetings took place between members of each
company.

On August 8, 1995, Mentor Graphics' President and Chief Executive Officer,
Walden C. Rhines, met with Mr. Kirk to discuss a possible relationship between
the two companies. Based on these discussions, it was determined that if a tight
integration of the companies' products was required to achieve the benefits of
the proposed development effort, then a more expansive collaboration, possibly
including a merger, might be considered. Dr. Rhines and Mr. Kirk agreed to
consider the possibility of a merger of the companies and to talk again. On
August 10, certain employees of Mentor Graphics met with Mr. Kirk and Kenneth E.
Lonchar, Microtec's Vice President and Chief Financial Officer, to learn more
about Microtec's business.

A further meeting was held on August 15, 1995, during which members of the
senior management of Mentor Graphics presented to senior management of Microtec
an overview of the process by which Mentor Graphics identifies, pursues and
integrates merger partners. At this meeting, representatives of Mentor Graphics
suggested a price range of $10.00 - $11.00 per share of Microtec Common Stock,
which was rejected by Microtec.

On September 6, 1995, the Board of Directors of Microtec discussed a
possible merger with Mentor Graphics and authorized management representatives
to meet with representatives of Mentor Graphics to further explore such a
possibility. In addition, on September 6 and 7, representatives of management of
each company met to discuss further a potential merger and to conduct
preliminary price discussions. The Mentor Graphics Board of Directors discussed
the proposed merger at a telephonic meeting on September 12, 1995. The Board
reviewed the due diligence conducted by Mentor Graphics to date and directed
management to proceed with preliminary acquisition discussions and to continue
its legal, technical and financial due diligence review of Microtec.

Discussions between the parties continued and on September 23,
representatives of Mentor Graphics and Microtec signed a summary of terms
expressing the parties' intent to proceed with negotiation and execution of a
definitive merger agreement. The summary provided that proceeding with the
proposed merger would be subject to a variety of conditions, including
financial, technical and legal due diligence review, accounting treatment of the
transaction as a pooling of interests, the approval of each company's Board of
Directors and

16
<PAGE> 25

the approval of Microtec's stockholders. The summary provided for the issuance
of Mentor Graphics Common Stock in exchange for Microtec Common Stock at a price
equivalent to $14.00 per share, to be based on the average closing price of
Mentor Graphics Common Stock over a specified ten-day trading period.

On September 25, 1995, Microtec engaged Lehman Brothers Inc. to render its
opinion with respect to the fairness to the Microtec stockholders, from a
financial point of view, of the consideration to be received in the proposed
Merger, including the proposed Exchange Ratio. Lehman Brothers had served as
managing underwriter for the initial public offering of Microtec's Common Stock
in December 1994. Also, in preparation for Microtec's next board meeting,
Microtec's management delivered to each member of the Microtec Board of
Directors certain due diligence materials regarding Mentor Graphics, including
Mentor Graphics' 1994 Annual Report, 1995 Proxy Statement, Form 10-K for the
year ended December 31, 1994, earnings release for the quarter ended June 30,
1995 and various analyst reports on Mentor Graphics. Additionally, between
September 25, 1995 and the Microtec Board meeting on October 6, 1995, members of
Microtec management and its counsel responded informally to various due
diligence questions raised from time to time by individual Microtec Board
members.

Mr. Kirk visited Mentor Graphics on September 28, 1995, to discuss merger
organizational issues and on September 30, 1995, representatives from each
company participated in a merger planning meeting at Mentor Graphics' San Jose
offices. The Board of Directors of Mentor Graphics participated in a telephonic
conference to discuss the proposed terms of the merger.

Mr. Lonchar and representatives of Lehman Brothers conducted further due
diligence at Mentor Graphics' headquarters on October 5, reviewing financial,
legal, tax, compatibility and other issues relating to the proposed Merger.

At a meeting held the evening of October 5, the Mentor Graphics Board
reviewed proposed merger terms and due diligence questions regarding Microtec.
At the conclusion of the meeting, the Mentor Graphics Board authorized Dr.
Rhines to enter into a binding agreement to acquire Microtec, following
satisfaction of certain due diligence and integration matters. At a meeting of
the Board of Directors of Microtec on October 6, 1995, Mr. Kirk and Mr. James F.
Ready, Microtec's Vice President, Chief Technical Officer, made a presentation
to the Board on the potential strategic benefits to Microtec of a merger with
Mentor Graphics. Mr. Lonchar made a due diligence presentation and
representatives of Lehman Brothers made a financial presentation. In addition,
Microtec's legal counsel advised the directors as to their fiduciary obligations
in considering the proposed merger. Thereafter, R. Douglas Norby, Senior Vice
President and Chief Financial Officer of Mentor Graphics, made a presentation on
the merger proposal from the point of view of Mentor Graphics. The Board
directed several questions to Mr. Norby and received responses. Representatives
of both companies held an all-day meeting at Mentor Graphics' headquarters on
October 8, 1995 to continue negotiations of the terms of the merger and to
discuss integration plans.

Prior to October 9, 1995, Microtec provided Mentor Graphics with the
following information with respect to Microtec's historic and projected
financial performance. In late August, Microtec provided Mentor Graphics copies
of the publicly available Lehman Brothers' and Volpe Welty & Co.'s then current
"street estimates" relating to Microtec's income statement data. At that time,
Microtec also provided Mentor Graphics with Microtec's internal projections of
its anticipated corporate tax rates for the fiscal years ended March 1996 and
1997 and certain historical quarterly revenue and cost of revenue by product
category data for the period April 1993 to June 1995. This information also
displayed quarterly projections of revenue and cost of revenue by product
category for the balance of fiscal years 1996 and 1997. These projections were
consistent with the Volpe Welty & Co. "street estimates" previously provided. In
early October (prior to October 9, 1995), Microtec provided a preliminary
September 30, 1995 balance sheet to Mentor Graphics as well as preliminary
internal quarterly income statement forecasts for fiscal years ended March 31,
1996 and 1997. Such forecasts represented preliminary estimates generated by
Microtec management and were based on numerous assumptions and draft business
operating plans neither approved nor reviewed by the Microtec Board.

On October 9, 1995, the parties conducted final negotiations relating to
the merger terms, and the Board of Directors of Microtec held a special meeting
to discuss the terms of the proposed Merger Agreement. At the meeting, Lehman
Brothers made a presentation and rendered its opinion as to the fairness, from a
financial

17
<PAGE> 26

point of view, of the consideration to be received by the Microtec stockholders.
After a lengthy discussion, the Microtec Board unanimously approved the terms of
the Merger Agreement. Later that evening, the Merger Agreement was executed.

REASONS FOR THE MERGER; RECOMMENDATION OF THE MICROTEC BOARD OF DIRECTORS

Mentor Graphics' Reasons for the Merger

The Mentor Graphics Board of Directors believes that the Merger is a key
step in Mentor Graphics' efforts to integrate hardware and software codesign for
its customers. By combining Mentor Graphics hardware design tools with
Microtec's integrated software development tools and family of real-time
operating system products, Mentor Graphics will seek to solve problems inherent
in the increasingly complex tasks of creating hardware designs and the software
systems "embedded" in that hardware. Mentor Graphics believes that the
complexity of electronic systems containing both hardware and software will
increase, presenting additional challenges for designers. The Mentor Graphics
Board believes that the Merger will be beneficial to Mentor Graphics because the
combination will expand the available market for Microtec's products by
leveraging Mentor Graphics' distribution channels and customer base. Mentor
Graphics' Board believes that there is significant growth opportunity in the
market for embedded systems, and the Merger will position Mentor Graphics to
participate in such growth by providing an opportunity for expanded distribution
of Microtec's products and, with Mentor Graphics' greater financial and
technical resources, provide a means for Mentor Graphics to develop and acquire
additional embedded software products. The Mentor Graphics Board of Directors
believes that over time this strategy will enhance the value of the combined
company to Stockholders of both Microtec and Mentor Graphics.

The Mentor Graphics Board also considered potentially negative factors in
its deliberations concerning the Merger, including but not limited to (i) the
risk that the potential benefits of the Merger might not be fully realized; (ii)
the dilution to Stockholders of Mentor Graphics that may result from issuance of
Mentor Graphics Common Stock in the Merger; (iii) the effect of the Merger on
Microtec's ability to continue to attract and retain key technical, sales and
other personnel; and (iv) additional risks described under "Risk Factors."

The Mentor Graphics Board considered, among other matters: (i) information
concerning each company's respective business, operations, prospects, financial
performance and condition, technology, management and competitive position; (ii)
the financial condition, results of operation and businesses of each company
before and after giving effect to the Merger; (iii) current financial market
conditions and historical market prices with respect to Mentor Graphics and
Microtec common stock; (iv) the consideration to be paid to stockholders of
Microtec in connection with the Merger; (v) the terms of the Merger Agreement;
(vi) the possibility of other alternatives with respect to pursuing Mentor
Graphics' strategic objective of entering the embedded systems market; (vii) the
impact of the Merger on Mentor Graphics' customers; and (viii) reports from
management, technical advisors, financial advisors and legal advisors as to the
results of their due diligence investigation of Microtec.

In view of the variety of factors considered in connection with the
evaluation of the Merger, the Mentor Graphics Board of Directors did not find it
practical to and did not quantify or otherwise assign relevant weights to
specific factors considered in reaching its determination.

Microtec's Reasons for the Merger

The Microtec Board has unanimously approved the Merger and determined that
the Merger is advisable and fair and in the best interests of Microtec and its
stockholders. The Microtec Board unanimously recommends to Microtec stockholders
that they vote FOR the approval of the Merger and the approval and adoption of
the Merger Agreement. The Microtec Board based its approval of the Merger and
its determination that the Exchange Ratio is fair to Microtec and its
stockholders upon a number of factors, including its views regarding the
following.

The Microtec Board believes that the Merger will be beneficial to Microtec
given the complementary nature of the two companies' product lines and the
opportunity for the potential realization of Microtec's

18
<PAGE> 27

strategic objective of developing and marketing innovative products to optimize
the design and development of embedded systems across hardware/software
boundaries by becoming an integrated hardware/software design tools supplier as
the result of the Merger. The Microtec Board believes that for the following
additional reasons the Merger will be beneficial to Microtec: (i) the
combination with Mentor Graphics will create a combined company with
significantly greater resources, more diversified product line and greater
financial and marketing capabilities than those of Microtec alone and may enable
the combined company to compete more effectively with competitors having greater
resources and broader product offerings than Microtec; (ii) the combination with
Mentor Graphics will provide an opportunity for expanded distribution of
Microtec's products, as Mentor Graphics has traditionally been stronger in sales
at the senior management level of customers and with hardware designers while
Microtec has been stronger with embedded software developers at operational
levels of management; (iii) the combination of Microtec and Mentor Graphics will
provide Microtec with additional financial and technological resources to meet
Microtec's commitment to an ongoing program of rapid technological innovation;
(iv) the consideration to be received by Microtec's stockholders in the Merger,
including the fact that the Exchange Ratio represented a premium of 24.0% over
the October 6, 1995 closing price of Microtec Common Stock; (v) the Merger will
provide Microtec stockholders with a security that has significantly larger
market float, greater liquidity and greater business diversification than
Microtec Common Stock; and (vi) the Microtec stockholders will have the
opportunity to receive, on a tax-free basis, Mentor Graphics Common Stock that
will enable them to participate in opportunities for growth in the combined
company after the Merger.

The Microtec Board also considered a variety of potentially negative
factors in its deliberations concerning the Merger, including, but not limited
to: (i) the risk that the potential benefits of the Merger might not be fully
realized; (ii) the possible restructuring of Microtec and a reduction in the
number of employees and consolidation of facilities; (iii) the possibility that
the Merger might not be consummated and the effect of public announcement of the
Merger on (a) Microtec's sales and operating results, (b) Microtec's ability to
attract and retain key management, marketing and technical personnel, and (c)
progress of certain development projects; and (iv) the other risks described
under "Risk Factors."

The Microtec Board also considered, among other matters: (i) information
concerning Microtec's and Mentor Graphics' respective business, prospects,
financial performance and condition, operations, technology, management and
competitive position; (ii) the financial condition, results of operations and
businesses of Microtec and Mentor Graphics before and after giving effect to the
Merger; (iii) current financial market conditions and historical market prices,
volatility and trading information with respect to Microtec and Mentor Graphics
Common Stock; (iv) the consideration to be received by Microtec stockholders in
the Merger and the relationship between market value of Mentor Graphics Common
Stock to be issued in exchange for Microtec Common Stock and Microtec's per
share reported earnings, earnings before interest and taxes and certain other
measures; (v) the belief that the terms of the Merger Agreement, including the
parties' representations, warranties and covenants, and the conditions to their
respective obligations are reasonable; (vi) Microtec's prospects as an
independent company; (vii) the potential for other third parties to enter into
strategic relationships with or to acquire Microtec; (viii) the ability of
Microtec, after receiving the advice of counsel that its fiduciary duties
require it to do so, to consider and negotiate other unsolicited, bona fide,
superior acquisition proposals and, in such event, to terminate the Merger
Agreement, subject to the payment of a fee to Mentor Graphics; (ix) the
financial presentations by Lehman Brothers, including Lehman Brothers' opinion
(which concluded that the consideration to be received by its stockholders was
fair from a financial point of view to Microtec and its stockholders); (x) the
impact of the Merger on Microtec's customers and employees; and (xi) reports
from management, financial advisors and legal advisors as the results of their
due diligence investigation of Mentor Graphics.

In view of the variety of factors considered in connection with its
evaluation of the Merger, the Microtec Board did not find it practicable to and
did not quantify or otherwise assign relative weights to the specific factors
considered in reaching its determination.

OPERATIONS FOLLOWING THE MERGER

Microtec will become a wholly-owned subsidiary of Mentor Graphics at the
Effective Time of the Merger. Mentor Graphics intends that Microtec will be
operated as an independent business within Mentor

19
<PAGE> 28

Graphics Hardware/Software Design (HSD) Division, with the Vice President and
General Manager of the HSD Division acting as President of Microtec. Microtec
will continue to develop and maintain its software separate from Mentor Graphics
research and development; however, Mentor Graphics and Microtec will collaborate
on certain co-simulation products. Initial joint products, targeted for release
in mid 1996, will consist of Mentor Graphics hardware design EDA tools and
Microtec software creation and debugging tools with some software links. The
products are intended to allow electronic system design teams to simplify and
speed up test and verification of hardware systems containing embedded software.

Microtec's marketing and sales will remain independent, although it is
anticipated that efforts between the two sales forces will be coordinated in
some respects, as Microtec and Mentor Graphics have mutual customers. None of
the officers or directors of Microtec are expected to serve as officers or
directors of Mentor Graphics following the Merger (although certain of
Microtec's officers are expected to continue to serve as officers of Microtec
following the Merger).

FAIRNESS OPINION

Microtec has engaged Lehman Brothers to render its opinion as to the
fairness, from a financial point of view, to Microtec's stockholders of the
Exchange Ratio to be offered to such stockholders in the Merger.

On October 6 and October 9, 1995 in connection with the evaluation of the
Merger Agreement by the Microtec Board of Directors, Lehman Brothers made
presentations to the Microtec Board with respect to the Merger and on October 9,
1995 rendered a written opinion dated October 9, 1995 that, as of the date of
such opinion, and subject to certain assumptions, factors and limitations set
forth in such written opinion as described below, the Exchange Ratio to be
offered to the stockholders of Microtec is fair, from a financial point of view,
to Microtec's stockholders.

The full text of the written opinion of Lehman Brothers dated October 9,
1995, which sets forth assumptions made, factors considered and limitations on
the review undertaken by Lehman Brothers, is set forth in Annex B to this Proxy
Statement/Prospectus. Microtec stockholders are urged to read such opinion
carefully in its entirety.

No limitations were imposed by Microtec on the scope of Lehman Brothers'
investigation or the procedures to be followed by Lehman Brothers in rendering
its opinion, except that Lehman Brothers was not authorized to solicit any
indications of interest from any third party with respect to the purchase of all
or a part of Microtec's business. Lehman Brothers was not requested to and did
not make any recommendation to the Microtec Board as to the form or amount of
consideration to be paid to Microtec stockholders in the Merger, which was
determined through arm's-length negotiations between Microtec and Mentor
Graphics. In arriving at its opinion, Lehman Brothers did not ascribe a specific
range of value to Microtec, but made its determination as to fairness, from a
financial point of view, to Microtec's stockholders of the Exchange Ratio on the
basis of the financial and comparative analyses summarized below. This opinion
has been requested by the Board of Directors of Microtec. Lehman Brothers'
opinion does not constitute a recommendation to any Microtec stockholder as to
how such stockholder should vote with respect to the Merger at the Microtec
Special Meeting. Lehman Brothers was not requested to opine as to, and its
opinion does not in any manner address, Microtec's underlying business decision
to proceed with or effect the Merger.

In arriving at its opinion, Lehman Brothers reviewed and analyzed: (1) the
Merger Agreement; (2) such publicly available information concerning Microtec
and Mentor Graphics that it believed to be relevant to its inquiry; (3)
financial and operating information with respect to the business, operations and
prospects of Microtec furnished to it by Microtec; (4) financial and operating
information with respect to the business, operations and prospects of Mentor
Graphics furnished to it by Mentor Graphics; (5) a trading history of the
Microtec Common Stock and a comparison of that trading history with those of
other companies which it deemed relevant; (6) a trading history of the Mentor
Graphics common Stock and a comparison of that trading history with those of
other companies which it deemed relevant; (7) a comparison of the historical
financial results and present financial condition of Microtec with those of
other companies which it deemed relevant; (8) a comparison of the historical
financial results and present financial condition of Mentor Graphics with those
of other companies which it deemed relevant; (9) a comparison of the financial
terms of the Merger with the financial terms of certain other recent
transactions which it deemed relevant; and

20
<PAGE> 29

(10) the potential pro forma earnings per share impact of the Merger on Mentor
Graphics' earnings. In addition, Lehman Brothers had discussions with the
management of Microtec and Mentor Graphics concerning their respective
businesses, operations, assets, financial conditions and prospects and undertook
such other studies, analyses and investigations as it deemed appropriate.

As indicated above, Lehman Brothers' analyses were based on a number of
factors, including trends based on historical results of the two companies,
financial data and guidance provided by Mentor Graphics and draft projections
provided by Microtec. Microtec's projections were contained in a draft business
plan for the remainder of fiscal 1996 which had not as yet been reviewed or
approved by the Microtec Board. This information was periodically reviewed,
updated and supplemented by Microtec in subsequent discussions with Lehman
Brothers' representatives.

In arriving at its opinion, Lehman Brothers assumed and relied upon the
accuracy and completeness of the financial and other information used by it
without assuming any responsibility for independent verification of such
information and further relied upon the assurances of the management of Microtec
that they were not aware of any facts that would make such information
inaccurate or misleading. With respect to the financial forecasts of Microtec
and Mentor Graphics, upon advice of Microtec, Lehman Brothers assumed that such
forecasts were reasonably prepared on a basis reflecting the best currently
available estimates and judgments of the managements of Microtec and Mentor
Graphics, as the case may be, as to the future financial performance of Microtec
and Mentor Graphics, respectively, and that Microtec and Mentor Graphics will
perform in accordance with such forecasts. In arriving at its opinion, Lehman
Brothers did not conduct a physical inspection of the properties and facilities
of Microtec or Mentor Graphics and did not make nor obtain any evaluations or
appraisals of the assets or liabilities of Microtec or Mentor Graphics. In
addition, Lehman Brothers was not authorized to solicit, and did not solicit,
any indications of interest from any third party with respect to the purchase of
all or a part of Microtec's business. Lehman Brothers' opinion was necessarily
based upon market, economic and other conditions as they existed on, and could
be evaluated as of, the date of its opinion.

In connection with preparing its presentations to the Microtec Board on
October 6 and October 9, 1994 and its written opinion on October 9, 1995, Lehman
Brothers performed a variety of financial and comparative analyses which are
summarized below. The preparation of a fairness opinion involves various
determinations as to the most appropriate and relevant methods of financial and
comparative analysis and application of those methods to the particular
circumstances, and therefore such an opinion is not readily susceptible to
summary description. Furthermore, in arriving at its fairness opinion, Lehman
Brothers did not attribute any particular weight to any analysis or factor
considered by it, but rather made qualitative judgments as to the significance
and relevance of each analysis and factor. Accordingly, Lehman Brothers believes
that its analyses must be considered as a whole and that considering any
portions of such analyses and factors, without considering all analyses and
factors, could create a misleading or incomplete view of the process underlying
the opinion. In its analyses, Lehman Brothers made numerous assumptions with
respect to industry performance, general business and economic conditions and
other matters, many of which are beyond the control of Microtec and Mentor
Graphics. Any estimates contained in these analyses are not necessarily
indicative of actual values or predictive of future results or values, which may
be significantly more or less favorable than as set forth therein. In addition,
analyses relating to the value of businesses do not purport to be appraisals or
to necessarily reflect the prices at which businesses actually may be sold.

Merger Premium and Exchange Ratio Analysis. Based on the average closing
price of Mentor Graphics common stock for the ten trading days ending two days
before the signing of a definitive agreement (i.e., $20.20 as of October 6,
1995), the Exchange Ratio values Microtec Common Stock at $13.95 per share,
which represented a premium of 24.0% over the October 6, 1995 closing price of
Microtec Common Stock and a 46.8% premium over the closing price 30 days prior
to October 9, 1995. At the 0.6930693 Exchange Ratio, Microtec stockholders would
own approximately 10.2% of Mentor Graphics on a pro forma fully diluted basis.

Analysis of Selected Publicly Traded Comparable Companies. Using publicly
available information and information provided by the managements of Microtec
and Mentor Graphics, Lehman Brothers compared selected financial data of
Microtec with similar data of selected publicly traded companies engaged in

21
<PAGE> 30

businesses considered by Lehman Brothers to be comparable to those of Microtec.
Specifically, Lehman Brothers considered Mentor Graphics, Integrated Systems,
Inc., RadiSys Corp. (based on the filing range), Rational Software Corp., Wind
River Systems, Inc., ArcSys, Inc., Cadence Design Systems, Inc., Integrated
Silicon Systems, Inc., Quickturn Design Systems, Inc., Synopsys, Inc., and
Viewlogic Systems, Inc. (the "Comparable Group"). Lehman Brothers calculated,
among other things, total equity value as a multiple of book value, last twelve
months ("LTM") EPS, estimated 1995 EPS and estimated 1996 EPS; estimated 1996
P/E ratio divided by estimated 5-year growth and total equity value plus net
debt as a multiple of LTM revenues and earnings before interest and taxes
("EBIT") for each of Microtec, Mentor Graphics and such comparable companies.
Estimated 1995 and 1996 EPS and 5-year growth estimates for the Comparable Group
except Microtec and Mentor Graphics was based on Institutional Brokers Estimate
Service ("IBES") median estimates and for Microtec and Mentor Graphics was based
on projections provided by the management of Microtec and financial data and
guidance provided by the management of Mentor Graphics. Lehman Brothers observed
that Microtec currently trades at a significant earnings multiple discount to
competing embedded systems software companies but at a multiple similar to other
technical software companies. Lehman Brothers believes this is caused by an
expectation of slower revenue and earnings growth for Microtec as compared to
other embedded systems software companies and lingering investor uncertainty
over Microtec's future performance due to its late market entry with a PowerPC
product, and also by the fact that the integration of the Ready Systems
Corporation acquisition has taken more management time than originally
estimated.

Analysis of Mentor Graphics' Current Stock Price. Lehman Brothers compared
Mentor Graphics' stock to a comparable group of electronic design automation
software companies including ArcSys Inc., Cadence Design Systems, Inc.,
Integrated Silicon Systems, Inc., Quickturn Design Systems, Inc., Synopsis, Inc.
and Viewlogic Systems, Inc. (the "EDA Group"). Lehman Brothers noted that Mentor
Graphics currently trades at a discount to the EDA Group based on multiples of
1995 and 1996 EPS.

Analysis of Selected Comparable Transactions. Using publicly available
information, Lehman Brothers compared selected financial data (including equity
value as a multiple of book value and LTM EPS and total equity value plus net
debt as a multiple of LTM revenues and EBIT) for Microtec, based on a $13.95
value of the Exchange Ratio, with similar data for selected transactions in the
embedded software industry. These transactions were announced between August,
1993 and August, 1995 and included the acquisition of Integrated Silicon Systems
Inc. by ArcSys Inc., the acquisition of OLAP Division of IRI Software by Oracle
Corp., the acquisition of Sabre Software Inc. by McAfee Associates Inc., the
Acquisition of Digitalk Inc. by ParcPlace Systems Inc., the acquisition of
Trinzic Corp. by Platinum Technology Inc., the acquisition of Altai Inc. by
Platinum Technology Inc., the acquisition of Sunrise Test Systems Inc. by
Viewlogic Systems Inc., the acquisition of KnowledgeWare Inc. by Sterling
Software Inc., the acquisition of PDA Engineering by MacNeal-Schwendler Corp.,
the acquisition of Chronologic Simulation by Viewlogic Systems, the acquisition
Logic Modeling Corp. by Synopsys Inc., the acquisition of Watcom Corp. by
Powersoft Corp., and the acquisition of Aries Technology, Inc. by
MacNeal-Schwendler Corp.

Lehman Brothers observed that, based on a $13.95 value, the Exchange Ratio
represented an LTM EPS multiple of 29.7x and an LTM revenue multiple of 2.43x.
This compared to the medians of comparable transactions of 40.6x for LTM EPS and
1.81x for LTM revenue. When viewed as a percentage premium to the market price
of Microtec's stock, the Exchange Ratio resulted in a 46.8% premium to the
market price 30 days prior to announcement and a 24.0% premium to the market one
day prior to announcement. This compared with median premiums of comparable
transactions of 36.0% for 30 days prior to announcement and 36.0% for one day
prior to announcement. However, because the reasons for, the circumstances
surrounding and the timing of each of the transactions analyzed were specific to
each transaction and because of the inherent differences between the business,
operations and prospects of Microtec, Mentor Graphics and the acquired companies
in such transactions, Lehman Brothers believed that an appropriate use of a
comparable transaction analysis in this instance also would involve qualitative
judgments concerning differences between the characteristics of the Merger and
these transactions which would affect the acquisition value of Microtec and the
acquired companies in such transactions.

22
<PAGE> 31

Contribution Analysis. Lehman Brothers analyzed the contribution of each
of Microtec and Mentor Graphics to revenues and operating income of the combined
entity for 1994 through 1997 based on the projections for Microtec and the
financial data and guidance of Mentor Graphics provided by the managements of
Microtec and Mentor Graphics. This analysis did not incorporate any cost savings
or synergies that may result with the Merger. Lehman Brothers was aware that
Microtec's forecasts had not as yet been reviewed or approved by Microtec Board
of Directors, although such information was periodically reviewed, updated and
supplemented by Microtec in subsequent discussions with Lehman Brothers'
representatives. Other than as described herein and the assumptions referenced
previously as to the accuracy, reasonableness and completeness of the Microtec
and Mentor Graphics financial information, the assumption that Microtec and
Mentor Graphics will perform in accordance with their respective financial
forecasts, and the general assumptions with respect to industry performance,
general business and economic conditions and other matters, Lehman Brothers made
no other material assumptions in connection with this analysis.

This analysis indicated that on a revenue basis Microtec and Mentor
Graphics would have contributed respectively, 11.2% and 88.8% in 1994, 11.1% and
88.9% in 1995 and an estimated 11.4% to 88.6% in 1996 and 12.3% to 87.7% in 1997
for the combined entity. This analysis indicated that on an operating income
basis Microtec and Mentor Graphics would have contributed respectively, 14.2%
and 85.8% in 1994, 6.9% and 93.1% in 1995, and an estimated 7.8% to 92.2% in
1996 and 8.4% to 91.6% in 1997 for the combined entity. Lehman Brothers compared
the approximately 10.2% pro forma ownership of Microtec stockholders and 89.8%
ownership of Mentor Graphics Stockholders of the combined entity with the
revenues and operating income contributions set forth above.

Discounted Cash Flow Analysis. Lehman Brothers calculated the present
value of the future streams of after-tax cash flows that Microtec could be
expected to produce over a five year period. The analysis utilized financial and
operating information relating to the business, operations and prospects of
Microtec provided by Microtec management and relied on certain assumptions with
respect to Microtec's future business and operations. After-tax cash flows were
calculated as the unlevered after-tax earnings plus amortization and
depreciation less net changes in non-cash working capital and capital
expenditures. Lehman Brothers calculated terminal values for Microtec in 2000 by
applying to projected EBIT a range of multiples of 15x to 27x. Lehman Brothers'
determination of the appropriate range of multiples was based on an assessment
of current trading multiples of the comparable companies and on Lehman Brothers'
general experience in valuations of companies. The cash flow streams and
terminal values were then discounted to present values using a range of discount
rates of 19% - 25%, which were chosen based on several assumptions regarding
factors such as inflation rate, interest rates, the inherent business risk in
Microtec's business as well as the embedded software industry as a whole, and
the cost of capital for Microtec. The discounted cash flow analysis indicated a
range of value of approximately $113.9-$157.6 million for Microtec which
compared to the implied total equity value for Microtec based on the Exchange
Ratio valued at $13.95 per share of $136.0 million.

Pro Forma Merger Analysis. Lehman Brothers analyzed the pro forma EPS
dilution effects of the Merger to Mentor Graphics for 1995 through 1997. This
analysis was based on the projections underlying the discounted cash flow
analysis for Microtec described above as well as estimates for Mentor Graphics
that were developed with guidance from Mentor Graphics' management. Lehman
Brothers calculated the EPS for the combined company for 1994, 1995, 1996 and
1997 which indicated that the Merger would be nominally dilutive to Mentor
Graphics' stand-alone EPS, as estimated by Mentor Graphics' management each such
year. The pro forma merger analysis excluded any potential cost savings and/or
synergies that might result from the Merger and a combination of the business of
Microtec and Mentor Graphics.

"Has/Gets" Valuation Analysis. Lehman Brothers analyzed the implied pro
forma benefits for Microtec stockholders on an EPS, revenue per share, book
value per share and cash per share basis. Lehman Brothers reviewed estimated pro
forma 1995, 1996 and 1997 EPS and estimated pro forma 1995 and 1996 revenue
merger-related benefits to Microtec stockholders and, assuming that current
multiples for Mentor Graphics remain applicable to the combined entity following
the Merger, calculated the implied per share increase to Microtec stockholders.
The resultant per share benefits attributable to Microtec stockholders ranged
from $1.47 per share, using 1995 estimated revenue per share, to $2.48 per
share, using pro forma 1997 estimated EPS.

23
<PAGE> 32

Lehman Brothers is an internationally recognized investment banking firm
and, as part of its investment banking activities, is regularly engaged in the
evaluation of businesses and their securities in connection with mergers and
acquisitions, negotiated underwriting, competitive bids, secondary distributions
of listed and unlisted securities, private placements, and valuations for
corporate and other purposes. The Microtec Board selected Lehman Brothers
because of its expertise, reputation and familiarity with Microtec and the
embedded software industry in general.

Pursuant to an engagement letter between Microtec and Lehman Brothers,
Microtec has agreed to pay Lehman Brothers a fee of $325,000 for rendering its
opinion. Microtec also has agreed to reimburse Lehman Brothers for reasonable
expenses incurred by Lehman Brothers and to indemnify Lehman Brothers for
certain liabilities that may arise out of the rendering of this opinion. Lehman
Brothers has performed various investment banking services for Microtec in the
past, including lead-managing Microtec's initial public offering in December
1994, and has received customary fees for such services. In the ordinary course
of its business, Lehman Brothers actively trades in the securities of Microtec
and Mentor Graphics for its own account and for the accounts of its customers
and, accordingly, may at any time hold a long or short position in such
securities.

Lehman Brothers has filed a written consent with the Commission relating to
the inclusion of its fairness opinion and the references to such opinion and to
such firm in the Registration Statement in which this Proxy Statement/Prospectus
is included. In giving such consent, Lehman Brothers neither admitted that it
comes within the category of persons whose consent is required under Section 7
of the Securities Act or the rules and regulations thereunder nor that they are
experts with respect to any part of such Registration Statement within the
meaning of the term "experts" as used in the Securities Act or the rules and
regulations thereunder.

CERTAIN FEDERAL INCOME TAX CONSEQUENCES

The following discussion summarizes federal income tax considerations of
the Merger that are generally applicable to holders of Microtec Common Stock and
reflects the opinions of tax counsel included in the Registration Statement of
which this Proxy Statement/Prospectus is a part. This discussion does not deal
with all federal income tax considerations that may be relevant to particular
Microtec stockholders in light of their particular circumstances, such as
stockholders who are dealers in securities, tax-exempt entities, foreign
persons, corporations who treat the Merger as producing gain for financial
statement purposes, or stockholders who acquired their shares upon exercise of
stock options or in other compensatory transactions. Furthermore, no foreign,
state or local tax considerations are addressed herein nor are federal tax
consequences other than income tax consequences addressed. ACCORDINGLY, ALL
MICROTEC STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF THE
MERGER.

As stated below, it is a condition to Mentor Graphics' and Microtec's
obligations to effect the Merger that each receives an opinion from its
respective legal counsel, Venture Law Group, A Professional Corporation, and
Tomlinson Zisko Morosoli & Maser, that the Merger will qualify as a
"reorganization" within the meaning of Section 368(a) of the Code. Subject to
the limitations and qualifications described herein, and assuming the Merger
does so qualify, then the following tax consequences will generally result:

(a) No gain or loss should be recognized by holders of Microtec Common
Stock upon their receipt in the Merger of Mentor Graphics Common Stock
(except to the extent of cash received in lieu of a fractional share
thereof) in exchange therefor;

(b) The aggregate tax basis of the Mentor Graphics Common Stock so
received in the Merger (including any fractional share not actually
received) should be the same as the aggregate tax basis of the Microtec
Common Stock surrendered in exchange therefor;

(c) The holding period of the Mentor Graphics Common Stock received in
the Merger should include the period for which the Microtec Common Stock
surrendered in exchange therefor was held, provided that the Microtec
Common Stock is held as a capital asset at the time of the Merger; and

24
<PAGE> 33

(d) A fractional share of Mentor Graphics Common Stock not actually
issued pursuant to the Merger but for which cash is received in lieu
thereof should be treated as if a fractional share of Mentor Graphics
Common Stock had been issued in the Merger and then redeemed by Mentor
Graphics. A Microtec stockholder receiving such cash should generally
recognize gain or loss upon such payment equal to the difference (if any)
between such stockholder's basis in the fractional share and the amount of
cash received. Such gain or loss should be a capital gain or loss if, at
the time of the Merger, the Microtec Common Stock is held as a capital
asset.

The parties will not request a ruling from the Internal Revenue Service
(the "IRS") regarding the consequences of the Merger. It is a condition to
Mentor Graphics' and Microtec's obligations to effect the Merger that they
receive opinions from their respective legal counsel, Venture Law Group and
Tomlinson Zisko Morosoli & Maser, respectively, to the effect that the Merger
will qualify as a "reorganization" within the meaning of Section 368(a) of the
Code. These opinions, which are collectively referred to herein as the "Tax
Opinions," neither bind the IRS nor preclude the IRS from adopting a contrary
position. In addition, the Tax Opinions will be subject to certain assumptions
and qualifications and will be based on the truth and accuracy of certain
representations and covenants made by Mentor Graphics, Microtec and certain
Microtec stockholders. Of particular importance will be an assumption that the
"continuity of interest" requirement for treatment of the Merger as a
"reorganization" will be satisfied and representations (described below)
relating to that requirement supporting such assumption.

To satisfy the continuity of interest requirement, Microtec stockholders
must not, pursuant to a plan or intent existing at or prior to the Merger,
dispose of or transfer so much of either (i) their Microtec Common Stock in
anticipation of the Merger or (ii) the Mentor Graphics Common Stock to be
received in the Merger (collectively "Planned Dispositions"), such that the
Microtec stockholders, as a group, would no longer have a significant equity
interest in the Microtec business conducted by Mentor Graphics after the Merger.
Each legal counsel rendering a Tax Opinion will receive, as a condition of
issuing such Tax Opinion, representations from Mentor Graphics and Microtec that
neither has knowledge of any such plan or intent and representations from
Microtec affiliates that they are not participating in and are not aware of any
such plan or intent.

Irrespective of the tax-free nature of the Merger, a Microtec stockholder
who receives shares of Mentor Graphics Common Stock will recognize gain to the
extent such shares are considered to be received in exchange for services or
property (other than solely Microtec Common Stock). All or a portion of such
gain may be taxable as ordinary income. Gain will also be recognized to the
extent a Microtec stockholder is treated as receiving (directly or indirectly)
consideration (other than Mentor Graphics Common Stock) in exchange for his or
her Microtec Common Stock or to the extent the Microtec Common Stock surrendered
in the Merger is not equal in value to the Mentor Graphics Common Stock received
in exchange therefor. The Tax Opinions and this discussion assume such equal
value.

A successful IRS challenge to the tax-free status of the Merger (as a
result of a failure of the "continuity of interest" requirement or otherwise)
would result in a recharacterization of the transaction by the IRS as a taxable
sale by all Microtec stockholders of their Microtec Common Stock to Mentor
Graphics in exchange for Mentor Graphics Common Stock (and any cash received in
lieu of fractional shares). In this event, a Microtec stockholder would
recognize gain or loss with respect to each share of Microtec Common Stock
exchanged in the Merger equal to the difference between the fair market value,
at the time of the Merger, of the Mentor Graphics Common Stock received in
exchange therefor (including any cash received in lieu of a fractional share)
and the stockholder's basis in the Microtec Common Stock so exchanged. A
stockholder's aggregate basis in the Mentor Graphics Common Stock so received
would equal its fair market value at the time of receipt, and the holding period
for such stock would not include the holding period for the Microtec Common
Stock exchanged therefor.

ACCOUNTING TREATMENT

The Merger is expected to be treated as a "pooling of interests" for
accounting purposes. This accounting method permits the recorded assets and
liabilities of both Mentor Graphics and Microtec to be carried forward to the
surviving corporation at their recorded historical amounts and no recognition of
goodwill in the combination is required of either company in the Merger.

25
<PAGE> 34

Upon execution of the Merger Agreement, Mentor Graphics received an opinion
from KPMG Peat Marwick LLP, independent auditors, to the effect that, based upon
certain material facts and certain representations and warranties described in
such opinion, the Merger will qualify for treatment as a pooling of interests.
In addition, Microtec received an opinion from Deloitte & Touche LLP,
independent auditors, to the effect that, based upon certain material facts and
certain representations and warranties described in such opinion, Microtec was
not precluded from using the pooling of interest method of accounting in a
merger transaction.

INTERESTS OF CERTAIN PERSONS IN THE MERGER

Mentor Graphics has entered into a consulting agreement with Mr. Kirk,
pursuant to which Mr. Kirk, through his wholly-owned corporation, will provide
ongoing services to Microtec on a full-time basis for a period of 6 months after
the Effective Time and on a part-time basis for a period of 18 months
thereafter. The consulting agreement contains non-compete and non-solicitation
provisions applicable for a period of three years following the Effective Time
of the Merger. Mr. Kirk will receive compensation of $22,500 per month under the
consulting agreement.

Microtec has entered into an employment agreement with Mr. Lonchar,
effective as of the Effective Time of the Merger, pursuant to which Mr. Lonchar
will provide ongoing services to Microtec on a full-time basis until June 30,
1996. The employment agreement contains non-compete and non-solicitation
provisions applicable for periods of one year and six months, respectively,
after the termination of the employment agreement. Mr. Lonchar will receive
compensation of $13,333 per month plus bonus compensation of up to $85,000 over
the term of the employment agreement.

Pursuant to the terms of the Directors Option Plan, outstanding options
issued thereunder will be subject to accelerated vesting on their exercisability
30 days prior to the Effective Time of the Merger. Each of two of the directors
of Microtec, Gregory Avis and Alan Herzig, hold an option under the Directors
Option Plan to purchase 5,000 shares of Microtec Common Stock. Based upon the
closing price of Mentor Graphics Common Stock on December 4, 1995 of $19.50, and
assuming the exercise of such outstanding options, the aggregate dollar value
(in Mentor Graphics Common Stock) of each such option is approximately $20,000.

In addition, indemnification provisions currently set forth in the
Certificate of Incorporation of Microtec shall survive for a period of six years
from the Effective Time with respect to individuals who at the Effective Time
were directors, officers, employees or agents of Microtec, unless such
modification is required by law. Mentor Graphics has agreed to maintain in
effect for a period of three years from the Effective Time policies of
directors' and officers' liability insurance comparable to those currently
maintained by Microtec, to the extent available on reasonable economic terms.

REGULATORY MATTERS

Under the HSR Act and the rules promulgated thereunder by the FTC, the
Merger may not be consummated until notifications have been given and certain
information has been furnished to the FTC and the Antitrust Division, and
specified waiting period requirements have been satisfied. Mentor Graphics and
Microtec each filed notification and report forms under the HSR Act with the FTC
and the Antitrust Division on October 27, 1995. On November 26, 1995, the
waiting period under the HSR Act expired. At any time before or after
consummation of the Merger, the FTC, the Antitrust Division, state attorneys
general or others could take action under the antitrust laws with respect to the
Merger, including seeking to enjoin the consummation of the Merger or seeking
divestiture of substantial assets of Mentor Graphics or Microtec.

APPRAISAL RIGHTS

Under the Delaware General Corporation Law, the holders of Microtec Common
Stock are not entitled to appraisal rights in connection with the Merger.

26
<PAGE> 35

THE MERGER AGREEMENT

The following paragraphs summarize, among other things, the material terms
of the Merger Agreement, which is attached hereto as Annex A and incorporated by
reference herein. Stockholders of Microtec are urged to read the Merger
Agreement in its entirety for a more complete description of the Merger.

EFFECTIVE TIME OF THE MERGER

CONVERSION OF SHARES

At the Effective Time, each outstanding share of Microtec Common Stock
(other than shares owned by Merger Sub, Mentor Graphics or any Subsidiary of
Mentor Graphics or Microtec) will be converted into the right to receive
0.6930693 (the "Exchange Ratio") shares of Mentor Graphics Common Stock. Merger
Sub will merge with and into Microtec, which will be the surviving corporation
and a wholly owned subsidiary of Mentor Graphics. Each share of Merger Sub
common stock issued and outstanding immediately prior to the Effective Time will
be converted into one share of common stock of the surviving corporation.
American Stock Transfer & Trust Company has been designated as exchange agent
("Exchange Agent") in the Merger.

As promptly as practicable after the Effective Time, Mentor Graphics will
cause Exchange Agent to mail to each stockholder of record of Microtec as of the
Effective Time transmittal materials for use in exchanging certificates of
Microtec Common Stock for certificates of Mentor Graphics Common Stock. The
transmittal materials will contain information and instructions with respect to
the surrender of Microtec Common Stock certificates in exchange for new
certificates representing Mentor Graphics Common Stock and cash in payment for
any fractional shares resulting from the exchange. Certificates should not be
surrendered until the Letter of Transmittal is received. Pending delivery to the
Exchange Agent of Microtec Common Stock certificates, any dividends on the
Mentor Graphics Common Stock to be issued as a result of the Merger that are
payable prior to the delivery of such certificates will be held by the Exchange
Agent. Such dividends will be paid, without interest, to the persons entitled
thereto upon delivery of such Microtec Common Stock certificates to the Exchange
Agent.

Fractional shares of Mentor Graphics Common Stock will not be issued in the
Merger. Instead, each stockholder of Microtec who would otherwise be entitled to
a fraction of a share will receive, in lieu thereof, an amount of cash (rounded
to the nearest whole cent) equal to the product of such fraction, multiplied by
$20.20.

TREATMENT OF MICROTEC STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN

1985 Amended and Restated Stock Option Plan (the "1985 Option Plan") and
1994 Stock Option Plan (the "1994 Option Plan"). At the Effective Time, each
outstanding option to purchase shares of Microtec Common Stock (a "Microtec
Option") under the 1985 Option Plan and the 1994 Option Plan, whether vested or
unvested, will be assumed by Mentor Graphics. Each Microtec Option assumed by
Mentor Graphics under the Merger Agreement will continue to have, and be subject
to, the same terms and conditions set forth in the 1985 Option Plan or the 1994
Option Plan, as applicable, (and in the agreement issued to the optionee for
each such Microtec Option) immediately prior to the Effective Time, except for
the number of shares of Mentor Graphics Common Stock to be purchased under such
option and the exercise price thereof. Each such option will be exercisable for
that number of whole shares of Mentor Graphics Common Stock equal to the product
of the number of shares of Microtec Common Stock that were purchasable under
such option multiplied by the Exchange Ratio, rounded down to the nearest whole
number of shares of Mentor Graphics Common Stock. The per share exercise price
for the shares of Mentor Graphics Common Stock issuable upon exercise of such
assumed option will be equal to the quotient determined by dividing the exercise
price per share of Microtec Common Stock at which such option was exercisable
immediately prior to the Effective Time by the Exchange Ratio, and rounding the
resulting exercise price up to the nearest whole cent.

27
<PAGE> 36

After the Effective Time, Mentor Graphics will issue to each holder of an
outstanding option a document evidencing the foregoing assumption of such option
by Mentor Graphics. It is the intention of Mentor Graphics and Microtec that the
options assumed by Mentor Graphics qualify following the Effective Time as
incentive stock options as defined in Section 422 of the Code to the extent the
options qualified as incentive stock options prior to the Effective Time. Mentor
Graphics will file a registration statement, or amend an existing registration
statement, to cover the shares of Mentor Graphics Common Stock issuable upon
exercise of the options assumed by Mentor Graphics.

1994 Outside Directors' Option Plan (the "Directors' Option Plan"). From
and after the date 30 days prior to the Effective Time, each outstanding option
to purchase shares of Microtec Common Stock under the Directors' Option Plan
shall become fully exercisable without regard to the vesting schedule of such
options. All options outstanding under the Directors Option Plan at the
Effective Time shall terminate and no such options shall be exercisable after
the Effective Time, be assumed by Mentor Graphics or be converted into the right
to purchase Mentor Graphics Common Stock.

1994 Employee Stock Purchase Plan (the "Microtec ESPP"). Subject to the
consummation of the Merger, on the last trading day prior to the Effective Time
(the "Final Company Purchase Date"), Microtec will apply the funds then credited
to each Microtec ESPP participant's payroll withholding account to the purchase
of whole shares of Microtec Common Stock. The cost to each participant in the
Purchase Plan for the shares of Microtec Common Stock thus purchased shall be
eighty-five percent (85%) of the lower of the closing sale price of Microtec
Common Stock on the Nasdaq National Market (i) the first day of the offering
period or (ii) the last trading day on or prior to the Final Company Purchase
Date. Shares of Microtec Common Stock purchased on the Final Company Purchase
Date will be converted in the same manner as described above in the "The Merger
Agreement -- Conversion of Shares."

RESALE OF MENTOR GRAPHICS COMMON STOCK BY MICROTEC AFFILIATES

Rule 145 promulgated under the Securities Act of 1933, as amended (the
"Securities Act"), regulates the disposition of securities of "affiliates" of
Microtec in connection with the Merger.

Microtec has delivered to Mentor Graphics a letter (the "Affiliate Letter")
identifying all persons who Microtec believes to be, at the time of the Microtec
Special Meeting, "affiliates" of Microtec for purposes of Rule 145 under the
Securities Act. Such Affiliate Letter may be further updated prior to the
Effective Time. Microtec has also agreed to use its best efforts to cause each
person (an "Affiliate") who is identified as an Affiliate in the Affiliate
Letter to deliver to Mentor Graphics, prior to the Effective Time, a written
agreement (an "Affiliate Agreement").

Under the Affiliate Agreement, such Affiliate will be advised that the
Affiliate may not sell, transfer or otherwise dispose of Mentor Graphics Common
Stock issued to the Affiliate in the Merger unless such sale, transfer or other
disposition (i) has been registered under the Securities Act, (ii) is made in
compliance with the requirements of Rule 145 under the Securities Act or (iii)
in the opinion of counsel reasonably acceptable to Mentor Graphics, is otherwise
exempt from registration under the Securities Act, Mentor Graphics is under no
obligation to register under the Securities Act the sale, transfer or other
disposition of Mentor Graphics Common Stock or to take any other action
necessary to make compliance with an exemption from such registration available.

Under the Affiliate Agreement, Mentor Graphics is entitled to issue
appropriate stock transfer instructions to the transfer agent for the shares of
Mentor Graphics Common Stock that are to be received by such Affiliate and to
place restrictive legends on the certificates evidencing Mentor Graphics Common
Stock. Unless the transfer by the Affiliate of its Mentor Graphics Common Stock
has been registered under the Securities Act or is a sale made in compliance
with the provisions of Rule 145 under the Securities Act. Mentor Graphics has
the right to insert restrictive legends on the certificates issued to any
transferee of the Affiliate.

The foregoing restrictions apply, with respect to Affiliates, to all
purported sales, transfers and other conveyances of Mentor Graphics Common Stock
received or to be received by such Affiliate pursuant to the

28
<PAGE> 37

Merger Agreement and to all purported reductions in the interest in or risks
relating to such Mentor Graphics Common Stock, whether or not such Affiliate
shall have exchanged following the Effective Time such Microtec Common Stock
certificates for Mentor Graphics Common Stock certificates.

The Affiliate Agreement also prohibits the Affiliate from any sale,
transfer or other disposition or any other reduction of the Affiliate's risk of
ownership of or investment in any securities of Mentor Graphics during the
30-day period before the Effective Time and until Mentor Graphics releases
publicly results including at least 30 days of its combined operations after the
Effective Time.

The Affiliate Agreement provides that, in order to satisfy the continuity
of interest requirement, Microtec stockholders must not, pursuant to a plan or
intent existing at or prior to the Merger, dispose of or transfer so much of
either (i) their Microtec Common Stock in anticipation of the Merger or (ii) the
Mentor Graphics Common Stock to be received in the Merger (collectively "Planned
Dispositions"), such that the Microtec stockholders, as a group, would no longer
have a significant equity interest in the Microtec business conducted by Mentor
Graphics after the Merger. See "The Merger -- Certain Federal Income Tax
Consequences."

BUSINESS OF MICROTEC PENDING THE MERGER

Pending the consummation of the Merger, and except as otherwise consented
to or approved in advance by Mentor Graphics in writing, Microtec has agreed
that Microtec and its subsidiaries will, among other things, operate their
business in accordance with their ordinary course of business and in a manner
consistent with past practices, and use reasonable commercial efforts to
preserve substantially intact their business organization, to keep available the
services of their present officers, employees and consultants and to preserve
their present relationships with customers and suppliers and other persons with
which they have significant business relations. In addition, Microtec and its
subsidiaries have agreed not to take any of the following actions without the
prior written consent of Mentor Graphics: (i) change or amend Microtec's
Certificate of Incorporation or Bylaws; (ii) issue, sell, pledge, dispose of or
encumber, or authorize the issuance, sale, pledge, disposition or encumbrance of
(a) any shares of capital stock of any class, or any options (except for options
granted consistent with past practices, to employees, other than officers, which
options represent the right to acquire no more than 75,000 shares of Microtec
Common Stock in the aggregate and no more than 7,500 shares of Microtec Common
Stock by any individual), warrants, convertible securities or other rights of
any kind to acquire any shares of capital stock, or any other ownership interest
of Microtec, its subsidiaries or affiliates (except for the issuance of shares
of Microtec Common Stock issuable upon the exercise of stock options outstanding
on the date of the Merger Agreement under the 1985 Option Plan, 1994 Option Plan
or the Director Option Plan or pursuant to rights to purchase such shares under
the Purchase Plan, or (b) any of their assets (except for sales of assets in the
ordinary course of business and in a manner consistent with past practices);
(iii) declare or pay any dividends or any other distribution with respect to
their common stock except for certain intracompany distributions; (iv) split,
combine or reclassify any of their capital stock or issue or authorize or
propose the issuance of any other securities in respect of, in lieu of, or in
substitution for shares of their capital stock; (v) amend the terms of,
repurchase, redeem or otherwise acquire any of their securities; (vi) sell,
transfer, license, sublicense or otherwise dispose of any Microtec Intellectual
Property (as defined in the Merger Agreement), or amend or modify any existing
agreements with respect to any Microtec Intellectual Property, other than those
entered into in the ordinary course of business and on terms consistent with
past practices of Microtec; (vii) (a) acquire (by merger, consolidation or
acquisition of stock or assets) any corporation, partnership or other business
organization or division thereof; (b) incur any indebtedness for borrowed money
or issue any debt securities or assume, guarantee (other than guarantees of bank
debt of Microtec's subsidiaries entered into in the ordinary course of business)
or endorse or otherwise become responsible for, the obligations of any person,
or make any loans or advances, except in the ordinary course of business
consistent with past practices; (c) enter into any contract or agreement other
than in the ordinary course of business; (d) authorize any capital expenditures
in excess of $80,000 for any particular item or which are, in the aggregate, in
excess of $350,000 for Microtec and its subsidiaries taken as a whole; (e) enter
into or amend any contract, agreement, commitment or arrangement with respect to
any of the matters set forth in this item (vii); (viii) increase the
compensation for their officers or employees, except for increases in salary or
wages of their employees who are not Microtec officers in accordance with past
practices, or grant

29
<PAGE> 38

any severance or termination pay or stock options (except for options granted
consistent with past practices, to employees, other than officers, which options
represent the right to acquire no more than 75,000 shares of Microtec Common
Stock in the aggregate and no more than 7,500 shares of Company Common Stock by
any individual) to, or enter into any employment or severance agreement with any
director, officer or other employees, or establish, adopt, enter into or amend
any collective bargaining, bonus, profit sharing, thrift, compensation, stock
option, restricted stock, pension, retirement, deferred compensation,
employment, termination, severance or other plan, agreement, trust, fund, policy
or arrangement for the benefit of any of their current or former directors,
officers or employees; (ix) take any action other than in the ordinary course of
business and in a manner consistent with past practices with respect to
accounting policies or procedures; (x) make any material tax election or settle
or compromise any material federal, state, local or foreign income tax liability
or agree to an extension of a statute of limitations; (xi) pay, discharge or
satisfy any claims, liabilities or obligations, other than the payment,
discharge or satisfaction in the ordinary course of business and consistent with
past practices of liabilities reflected or reserved against in the financial
statements of Microtec or incurred in the ordinary course of business and
consistent with past practice.

SOLICITATION OF ALTERNATIVE TRANSACTIONS

Microtec has agreed that it will not (a) solicit, initiate or knowingly
encourage or take any action knowingly to facilitate the submission of
inquiries, proposals or offers from any person relating to (i) any acquisition
or purchase of any of its material assets or any class of its equities
securities, (ii) any tender offer (including a self tender offer) or exchange
offer involving shares of its capital stock, (iii) any merger, consolidation,
business combination, sale of substantially all assets, recapitalization,
liquidation, dissolution, or similar transaction other than the transactions
contemplated by the Merger Agreement, or (iv) any other transaction the
consummation of which would or could reasonably be expected to impede, interfere
with, prevent or materially delay the Merger or which would or could reasonably
be expected to materially dilute the benefits to either party of the
transactions contemplated by the Merger Agreement (the transactions referred to
in clauses (i)-(iv) are collectively referred to herein as "Transaction
Proposals"), or (b) enter into or participate in any discussions or negotiations
regarding any Transaction Proposal, or furnish to any other person any
information with respect to its business, properties or assets or any
Transaction Proposal, or otherwise cooperate in any way with, or assist or
participate in, facilitate or encourage, any effort or attempt by any person to
make or seek any transaction Proposal; provided, however, that the foregoing
will not prohibit Microtec from (i) furnishing information pursuant to a
confidentiality agreement substantially similar to the confidentiality agreement
signed by the parties in connection with the discussions pertaining to the
Merger to a third party who has initiated contact with either party regarding a
bona fide unsolicited Transaction Proposal under specified circumstances (a
"Permitted Contact"), (ii) engaging in discussions or negotiations with a third
party who has initiated a Permitted Contact regarding a Transaction Proposal,
and/or (iii) following receipt of a Transaction Proposal, taking and disclosing
to its stockholders a position contemplated by Rule 14e-2(a) under the Exchange
Act, or otherwise making disclosure to its stockholders, but in each case
referred to in the foregoing clauses (i) through (iii) only to the extent that
the Board of Directors of Microtec concludes in good faith in the exercise of
its fiduciary duties, after consultation with its outside counsel and financial
advisor, that such actions are more likely than not to result in a bona fide
Transaction Proposal, the terms of which would be more favorable to its
stockholders than the Merger (a "Superior Proposal"). If Microtec receives a
Transaction Proposal, it will within one business day of its receipt of such
proposal inform Mentor Graphics of the terms and conditions of such proposal and
identity of the person making it.

CORPORATE STRUCTURE AND RELATED MATTERS AFTER THE MERGER

At the Effective Time, Merger Sub will be merged with and into Microtec,
which will be the surviving corporation and a wholly owned subsidiary of Mentor
Graphics. Each share of Merger Sub common stock issued and outstanding
immediately prior to the Effective Time will be converted into and exchanged for
one share of common stock of the surviving corporation. Each stock certificate
of Merger Sub evidencing ownership of any such shares shall continue to evidence
ownership of such shares of capital stock of the surviving corporation.

30
<PAGE> 39

Unless otherwise determined by Mentor Graphics prior to the Effective Time,
at the Effective Time the Certificate of Incorporation of Merger Sub, as in
effect immediately prior to the Effective Time, will be the Certificate of
Incorporation of the surviving corporation, except that Merger Sub will change
its legal name to "Microtec Research, Inc." until thereafter amended. The Bylaws
of Merger Sub, as in effect immediately prior to the Effective Time, will be the
Bylaws of the surviving corporation.

The directors of Merger Sub immediately prior to the Effective Time will be
the initial directors of the surviving corporation, and the officers of Microtec
immediately prior to the Effective Time will be the initial officers of the
surviving corporation, in each case until their respective successors are duly
elected or appointed and qualified.

After the Effective Time, all shares of Microtec Common Stock will cease to
be quoted on Nasdaq, and the surviving corporation will undertake to terminate
registration of Microtec Common Stock under the Exchange Act.

CERTAIN COVENANTS

Each of Mentor Graphics and Microtec will afford to the other party and its
representatives reasonable access to its properties, books, contracts,
commitments and records, and make available to the other party and its
representatives (i) a copy of each report, schedule, registration statement and
other document filed or received by it prior to the Effective Time pursuant to
the requirements of federal securities laws, and (ii) all other information
concerning its business, properties and personnel as said party and
representatives may reasonable request.

Mentor Graphics and Microtec will promptly prepare and file with the
Commission this Proxy Statement/Prospectus and Mentor Graphics will promptly
prepare and file with the Commission the Registration Statement. Each of Mentor
Graphics and Microtec will use all reasonable efforts to have the Registration
Statement declared effective under the Securities Act as promptly as practicable
after such filing, and Microtec will thereafter as promptly as practicable mail
the Proxy Statement/Prospectus to its stockholders. Mentor Graphics and Microtec
will use all reasonable efforts to obtain all necessary state securities law of
"Blue Sky" permits and approvals required to carry out the transactions
contemplated by the Merger Agreement.

Each of Mentor Graphics and Microtec will promptly prepare and file the
applicable notices (if any) required to be filed by it under the HSR Act and
comply promptly with any requests to it from the FTC or United States Department
of Justice for additional information.

Microtec will use its best efforts to cause each director, executive
officer and any other person who is an Affiliate to deliver to Mentor Graphics,
as soon as practicable, and prior to the date of the Special Meeting, an
Affiliate Agreement providing that such person will not sell, pledge, transfer
or otherwise dispose of any shares of Microtec Common Stock held by such
Affiliate and the shares of Mentor Graphics Common Stock to be received by such
Affiliate in the Merger: (i) in the case of shares of Mentor Graphics Common
Stock to be received by Affiliates of Microtec in the Merger, except in
compliance with the applicable provisions of the Securities Act and the rules
and regulations thereunder; and (ii) during the period commencing 30 days prior
to the Effective Time and ending at the time of the publication of financial
results covering at least 30 days of combined operations of Mentor Graphics and
Microtec.

Microtec will call a meeting of its stockholders to be held as soon as
practicable for the purpose of obtaining the stockholder approval required in
connection with the Merger Agreement, and will use its best efforts to cause
such meeting to occur on the same date. Subject to compliance with certain
provisions of the Merger Agreement and the directors' applicable fiduciary
duties, the Board of Directors of Microtec will recommend to its stockholders
that they vote to approve the Merger Agreement and the Merger.

Each of Mentor Graphics and Microtec will use its best efforts to take, or
cause to be taken, all actions necessary, proper or advisable (i) to comply with
all legal requirements which may be imposed on such party with respect to the
Merger and (ii) to consummate the transaction contemplated by the Merger
Agreement.

31
<PAGE> 40

CONDITIONS TO THE MERGER

Consummation of the Merger is subject to the satisfaction of various
conditions, including (i) the approval and adoption of the Merger Agreement and
the Merger by the requisite vote of the stockholders of Microtec; (ii) the
authorization for listing on the Nasdaq National Market of the shares of Mentor
Graphics Common Stock to be issued in connection with the Merger; (iii) the
expiration or termination of any waiting period and any extension thereof
applicable to the consummation of the Merger under the HSR Act (which waiting
period expired on November 26, 1995); (iv) the absence of any restrictive court
orders or any other legal restraints or prohibitions, and of any governmental
proceedings preventing the consummation of the Merger; (v) the receipt of an
officer certificate by each of Mentor Graphics and Microtec from the other
party's officers to the effect that certain representations and warranties made
by the respective party are true and correct in all material respects on and as
of the Effective Time; (vi) the receipt of an officer certificate by Mentor
Graphics and Microtec from the other party's officers to the effect that the
respective party has performed or complied in all material respects with all
agreements and covenants required by the Merger Agreement on or prior to the
Effective Time; (vii) the obtaining by Mentor Graphics and Microtec,
respectively, of all material consents, waivers, approvals, authorizations or
orders required to be obtained for the authorization, execution and delivery of
the Merger Agreement and the consummation of the transactions contemplated
thereby; (viii) the filing by Mentor Graphics and Microtec, respectively, of all
the documents required to be filed for the authorization, execution and delivery
of the Merger Agreement and the consummation of the transactions contemplated
thereby; (ix) the receipt by Mentor Graphics and Microtec, respectively, of
certain opinions regarding tax and accounting matters; and (x) the receipt by
Mentor Graphics of the Affiliate Agreements. Mentor Graphics' obligation to
consummate the Merger is conditioned on receipt of an opinion from Microtec's
independent auditors, to the effect that the Merger may be accounted for as a
pooling of interests (which opinion was received on October 9, 1995). Microtec's
obligation to consummate the Merger is conditioned on receipt of an opinion from
Lehman Brothers, Inc. dated as of the date of the Merger Agreement and
reaffirmed no earlier than two days prior to the mailing of this Proxy
Statement/Prospectus, in a form reasonably satisfactory to Microtec, to the
effect that the consideration to be received by the stockholders of Microtec
pursuant to the Merger Agreement is fair from a financial point of view to such
holders. Neither party intends to waive any of the conditions to the Merger.

TERMINATION; AMENDMENT

The Merger Agreement may be terminated and the Merger may be abandoned
prior to the Effective Time either before or after its approval by the
stockholders of Microtec, under the circumstances specified therein, including
(i) by mutual written agreement of Mentor Graphics and Microtec; (ii) by either
Mentor Graphics or Microtec, if the Merger shall not have been consummated by
January 31, 1996 and if the terminating party has not caused the failure of the
Merger to be consummated by its own willful failure to fulfill any of its
material obligations under the Merger Agreement; (iii) by either Mentor Graphics
or Microtec if a court or a governmental agency prohibits, by order, decree,
ruling or any other action, the transactions contemplated by the Merger
Agreement; (iv) by either Mentor Graphics or Microtec, if the stockholders of
Microtec fail to approve the Merger Agreement; (v) by either Mentor Graphics or
Microtec, in the event of a material breach by the other party of any
representation, warranty, covenant, term or provision of the Merger Agreement
which is not cured promptly after notice thereof; (vi) by Microtec if Microtec
receives a bona fide written Transaction Proposal from a third party and the
Board of Directors of Microtec determines in good faith that such Transaction
Proposal is a Superior Proposal and Microtec has provided Mentor Graphics with
at least five business days' written notice of such Transaction Proposal; and
(vii) by Mentor Graphics for any other reason upon payment of liquidated damages
as set forth below.

Microtec has agreed to pay Mentor Graphics a termination fee of $5,000,000
if the Merger Agreement is terminated because Microtec has accepted or
recommended to its stockholders a Superior Proposal. Mentor Graphics has agreed
to pay Microtec the sum of $10,000,000 as liquidated damages (i) if Microtec
terminates the Merger Agreement, as a result of a material breach by Mentor
Graphics of any representation, warranty, covenant, term or provision of the
Merger Agreement which is not cured promptly after notice thereof, or

32
<PAGE> 41

(ii) if Mentor Graphics terminates the Merger Agreement for any reason other
than those set forth in clauses (i)-(vi) of the foregoing paragraph.

The Merger Agreement may be amended by an agreement in writing among the
parties thereto at any time prior to the Effective Time; provided, however,
that, after approval of the Merger by the stockholders of Microtec, no amendment
may be made which would reduce the amount or change the type of consideration
into which each share of Microtec Common Stock will be converted upon
consummation of the Merger.

FEES AND EXPENSES

Except as set forth above (see "The Merger Agreement -- Termination;
Amendment"), all fees and expenses incurred in connection with the Merger
Agreement and the transactions contemplated thereby will be paid by the party
incurring such expenses, whether or not the Merger is consummated.

Mentor Graphics and Microtec will share equally all fees and expenses,
other than attorneys' fees, incurred in relation to the printing and filing of
the Proxy Statement/Prospectus, the Registration Statement and any amendments or
supplements thereto.

CONFIDENTIALITY AGREEMENT

Each party to the Merger Agreement has agreed to keep confidential,
pursuant to the Confidentiality Agreement dated August 10, 1995 (the
"Confidentiality Agreement") between Mentor Graphics and Microtec, information
provided to the other party pursuant to the Merger Agreement with respect to the
business, properties and personnel of the party furnishing such information. The
Confidentiality Agreement contains terms restricting the disclosure and use of
confidential information exchanged between the two parties in evaluating the
Merger and otherwise.

33
<PAGE> 42

PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

The following unaudited pro forma combined condensed financial statements
assume a business combination between Mentor Graphics and Microtec accounted for
on a pooling of interests basis. The pro forma combined condensed financial
statements are based on the respective historical financial statements and the
notes thereto, which are included elsewhere in the Proxy Statement/Prospectus.
The pro forma combined balance sheet combines Mentor Graphic's September 30,
1995 unaudited condensed consolidated balance sheet with Microtec's September
30, 1995 unaudited condensed consolidated balance sheet. The pro forma combined
condensed statements of operations combined Mentor Graphic's historical
condensed consolidated statements of operations for the three fiscal years ended
December 31, 1994 and the unaudited nine months ended September 30, 1995 and
1994 with the corresponding Microtec historical condensed consolidated
statements of operations for the three fiscal years ended March 31, 1995 and the
unaudited nine months ended September 30, 1995 and 1994, respectively. No cash
dividends were declared and paid on Microtec Common Stock.

The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the operating results or financial position
that would have occurred if the Merger had been consummated at the beginning of
the periods presented, nor is it necessarily indicative of future operating
results or financial position.

These pro forma combined condensed financial statements should be read in
conjunction with the historical consolidated financial statements and the
related notes thereto of Mentor Graphics and of Microtec, included elsewhere
herein. See "Index to Financial Statements."

34
<PAGE> 43

PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, DECEMBER 31,
--------------------- ----------------------------------
1995 1994 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net Revenue......................... $309,681 $278,562 $393,506 $372,782 $373,392
Costs & Expenses:
Cost of goods sold................ 87,457 76,421 112,722 125,350 156,653
Research & development............ 62,725 58,561 84,438 86,774 80,379
Selling, general &
administrative................. 125,419 121,920 158,836 164,846 163,050
Restructuring costs............... (2,040) (5,600) (6,045) 24,800 12,900
Merger-related charges............ 800 8,265 9,265 14,403 650
-------- -------- -------- -------- --------
Total costs & expenses.... 274,361 259,567 359,216 416,173 413,632
-------- -------- -------- -------- --------
Income (loss) from operations....... 35,320 18,995 34,290 (43,391) (40,240)
-------- -------- -------- -------- --------
Other income (expense), net......... 4,502 2,590 3,212 (189) (7,605)
-------- -------- -------- -------- --------
Income (loss) before income taxes... 39,822 21,585 37,502 (43,580) (47,845)
-------- -------- -------- -------- --------
Provision for income taxes (note
2)................................ 5,848 4,430 4,315 2,324 2,860
-------- -------- -------- -------- --------
Net income (loss)................... $ 33,974 $ 17,155 $ 33,187 $(45,904) $(50,705)
======== ======== ======== ======== ========
Net income (loss) per share......... $ 0.55 $ 0.30 $ 0.57 $ (0.90) $ (1.02)
======== ======== ======== ======== ========
Shares used in per share
calculations...................... 61,767 57,620 58,095 51,176 49,576
======== ======== ======== ======== ========
</TABLE>

* See accompanying Notes to Pro Forma Combined Condensed Financial Statements.

35
<PAGE> 44

PRO FORMA COMBINED CONDENSED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
MENTOR GRAPHICS MICROTEC COMBINED
--------------- ------------- -------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1995 1995 ADJUSTMENTS 1995
--------------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Assets
Current Assets:
Cash and cash equivalents........... $ 154,419 $11,345 $ 165,764
Short-term investments.............. 31,425 -- 31,425
Trade accounts receivable, net...... 79,527 7,647 87,174
Prepaid expense and other (note
2)............................... 13,253 2,476 (500) 15,229
-------- ------- ------- --------
Total Current Assets........ 278,624 21,468 (500) 299,592
Cash and investments, long-term....... 30,000 -- 30,000
Property plant and equipment, net..... 94,442 4,901 99,343
Other assets (note 2)................. 29,436 7,799 (3,700) 33,535
-------- ------- ------- --------
Total assets................ $ 432,502 $34,168 (4,200) $ 462,470
======== ======= ======= ========
Liabilities & Stockholder's equity
Current liabilities:
Short-term borrowings............... $ 8,815 $ 8,815
Accounts payable.................... 7,979 $ 1,584 9,563
Income taxes payable................ 13,329 337 13,666
Accrued and other liabilities....... 45,296 3,858 49,154
Deferred revenue.................... 21,216 4,213 25,429
-------- ------- ------- --------
Total current liabilities... 96,635 9,992 106,627
Long-term debt........................ 52,589 -- 52,589
Other long-term deferrals............. 839 1,517 2,356
-------- ------- ------- --------
Total Liabilities................ 150,063 11,509 161,572
Stockholders' equity
Common Stock........................ 266,525 16,940 283,465
Retained earnings (note 2).......... 2,346 5,688 (4,200) 3,834
Foreign currency translation
adjustment.......................... 13,568 31 13,599
-------- ------- ------- --------
Total stockholders'
equity.................... 282,439 22,659 (4,200) 300,898
======== ======= ======= ========
Total liabilities and stockholders'
equity.............................. $ 432,502 $34,168 (4,200) $ 462,470
======== ======= ======= ========
</TABLE>

* See accompanying Notes to Pro Forma Combined Condensed Financial Statements.

36
<PAGE> 45

NOTES TO PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

(1) The pro forma combined condensed financial statements reflect the issuance
of up to 6,168 shares of Mentor Graphics Common Stock for an aggregate of up
to 8,900 shares of Microtec Common Stock (based on shares of Common Stock
outstanding as of September 30, 1995) in connection with the Merger based on
an exchange ratio of .6930693 shares of Mentor Graphics Common Stock for
each share of Microtec Common Stock. The actual number of shares of Mentor
Graphics Common Stock to be issued will be determined at the Effective Time
of the Merger based on the Exchange Ratio and the number of shares of
Microtec Common Stock then outstanding.

There are no material differences between the accounting policies of Mentor
Graphics and Microtec.

(2) Mentor Graphics and Microtec account for income taxes under Financial
Accounting Standards Board's Statement No. 109, " Accounting for Income
Taxes." Statement No. 109 requires the use of the asset and liability method
of accounting for income taxes. Under the asset and liability method,
deferred income taxes are recognized for future tax consequences
attributable to temporary differences between the financial statement
carrying amounts and tax balances of existing assets and liabilities. Mentor
Graphics established a valuation allowance for certain deferred tax assets,
and net operating loss and tax credit carry forwards. Statement No. 109
requires that such a valuation allowance be recorded when it is more likely
than not that some portion of the deferred tax assets will not be realized.
Mentor Graphics deferred tax asset valuation allowance was $49,745 as of
January 1, 1993 which included a reserve against all domestic deferred tax
assets.

Microtec, on a stand alone basis, has not reserved for domestic deferred tax
assets. While this valuation position was reasonable for Microtec, when
combined with Mentor Graphics through pooling of interests, establishment of
a valuation reserve is necessary. On a combined basis, it is more likely
than not that the domestic deferred tax assets will not be realized for the
restated periods and beyond. As a result, an adjustment to reserve for
Microtec's deferred tax assets of $5,500 and $(1,300) was established for
the combined condensed financial information as of December 31, 1993 and
1994, respectively.

The following is a summary of consolidated adjustments for deferred tax
assets which reflect the merger, as if it was effected for all periods:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
-------------------
1994 1993
------ ------
<S> <C> <C>
Provision (benefit) for income taxes
Mentor Graphics.................................. 3,375 2,424
Microtec......................................... 2,240 (5,600)
------- -------
5,615 (3,176)
Adjustment....................................... (1,300) 5,500
------- -------
Adjusted......................................... 4,315 2,324
======= =======
</TABLE>

(3) Charges to operations by Mentor Graphics are expected to occur subsequent to
the Merger to reflect the combination of the two Companies. These charges
are estimated to be approximately $5,000 to $8,000 which include 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. Such charges and related activities are currently
being studied by Mentor Graphics and have not been finalized. These costs,
once established, will be charged to operations in the period in which the
Merger is consummated. This charge is not reflected in the Pro Forma
combined condensed financial information.

37
<PAGE> 46

MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA FINANCIAL RESULTS

(ALL NUMERICAL REFERENCES ARE IN THOUSANDS, EXCEPT FOR PERCENTAGES AND PER SHARE
DATA)

REVENUES AND GROSS MARGINS

All pro forma financial results are not necessarily indicative of the
results that would have occurred if Mentor Graphics and Microtec (referred to
herein collectively as the "Combined Company") were operating on a combined
basis during the reporting periods. The impact of the Merger on revenue and
gross margin performance of the Combined Company is not expected to be
significant. Some risks include the potential that Microtec revenue could be
negatively impacted for several quarters until distribution channel integration
issues have been resolved. Mentor Graphics' intent is to retain the Microtec
sales force and to coordinate in some respects the activities of the two sales
organizations.

The Companies are expecting to collaborate on certain co-simulation
products. The products are expected to allow customers to simplify and speed up
test and verification of hardware systems containing embedded software. These
products have yet to be designed and their resultant impact on future revenues
is uncertain at this time. Gross margins for Mentor Graphics and Microtec sales
have a recent history of approximately 70% and 85%, respectively. On a combined
basis, gross margins are expected to be closer to the Mentor Graphics level,
since Mentor Graphics' sales volume has been and is expected to continue to be
approximately 90% of the combined total. However, there are several factors that
impact gross margins, including revenue volume fluctuations, the amortization of
technology and capitalized software development costs, third party royalties,
and the cost of service and support personnel of each enterprise. Due to the
variety of factors impacting gross margins, future gross margin levels are
difficult to predict.

OPERATING EXPENSES AND RESULTS OF OPERATIONS

The impact of the Merger on operating expense performance is not expected
to be significant. Mentor Graphics does expect some limited reductions in
administrative staff. However, economies resulting from these reductions are not
expected to result in significant improvements to operating expenses of the
Combined Company. The Combined Company is expected to continue funding research
and development (R&D) activities at current percent of revenue levels to meet
current and future product delivery goals. Funding for joint product development
is not expected to increase expenses as a percent of revenues; however, since
revenue levels are difficult to predict, there can be no assurance that the
Combined Company will maintain a consistent percent of R&D investment per
revenue dollar.

Pro forma results of operations are expected to be slightly diluted due to
the issuance of approximately 6,000 shares of Common Stock in the Merger. As
reflected on the pro forma financial statements, the net income per share of
Mentor Graphics on a stand alone basis versus the Combined Company for the nine
months ended September 30, 1995 was 57 cents and 55 cents, respectively.
Microtec's contribution to net income of the Combined Company fluctuated from
approximately 15% to 8% for the nine months ended September 30, 1994 and 1995,
respectively. The combined effect of Microtec's improved earnings in 1994 and
the merger related charges in excess of $8,000 incurred by Mentor Graphics
during such period resulted in artificially increasing Microtec's, and
decreasing Mentor Graphics', contribution to combined operating income for such
period. In 1995, Microtec incurred higher than normal operating expenses in
connection with an anticipated PowerPC product launch. Such PowerPC products
have yet to be delivered to the market, resulting in lower revenue levels for
fiscal 1995 and further impacting Microtec's results of operations. Future
operating results of the Combined Company will be dependent on a variety of
factors, including successful delivery of new products, successful integration
of the sales, development and management teams of each company, and external
factors, such as the world economies.

LIQUIDITY AND CAPITAL RESOURCES

As a result of the Merger, Mentor Graphics expects to incur a merger charge
totaling between $3,000 and $4,000. The expected cash outflow associated with
this charge is expected to occur over the next twelve

38
<PAGE> 47

months. Exclusive of such merger-related charge, the Merger should not have a
negative impact on liquidity and capital resources since the transaction will
involve an exchange of common stock and not cash. In addition, each Company is
currently generating positive cash flows from operations. There can be no
assurances that positive operating cash flows will be sustained subsequent to
the Merger. As discussed above under "Operating Expenses and Results of
Operations," funding of R&D for current and future product development is not
expected to differ significantly from current spending levels. Mentor Graphics
anticipates that current cash balances, anticipated cash flows from operating
activities, and existing credit facilities should be sufficient to meet the
Combined Company's working capital needs for at least the next twelve months.

39
<PAGE> 48

MENTOR GRAPHICS MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(ALL NUMERICAL REFERENCES ARE IN THOUSANDS, EXCEPT FOR PERCENTAGES)

Years Ended December 31, 1994, 1993 and 1992

Revenue and Gross Margins.

<TABLE>
<CAPTION>
1994 CHANGE 1993 CHANGE 1992
-------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C>
System and software revenue.............. $187,117 (2)% $191,180 (10)% $212,397
System and software gross margins........ $150,360 8% $138,879 7% $130,404
Percentage of revenue.................. 80.4% 72.6% 61.4%
Service and support revenue.............. $161,177 8% $148,595 7% $138,369
Service and support gross margins........ $ 91,114 13% $ 80,704 20% $ 67,394
Percentage of revenue.................. 56.5% 54.3% 48.7%
Total revenue............................ $348,294 3% $339,775 (3)% $350,766
Total gross margins...................... $241,474 10% $219,583 11% $197,798
Percentage of revenue.................. 69.3% 64.6% 56.4%
</TABLE>

System and Software. System and software revenue is derived from software
products owned by Mentor Graphics, software products owned by third parties for
which royalties are paid by Mentor Graphics, and hardware products. System and
software revenue declined 2% from 1993 to 1994 and 10% from 1992 to 1993. The
primary factors contributing to the decline in system and software revenue
include a significant reduction in hardware revenue and a generally poor
world-wide economy in 1993. Offsetting these reductions, the software components
of 1993 and 1994 system and software revenue increased due to improved product
offerings, the completion of Version 8 and additional point tool products.

The hardware component of system and software revenue declined to 8% in
1994 from 17% and 34% in 1993 and 1992, respectively. During the last three
years Mentor Graphics has been executing a plan to exit the hardware business.
While almost all of Mentor Graphics' customers now meet their hardware needs by
working directly with hardware vendors, Mentor Graphics continues to meet the
demands of some customers who prefer to purchase complete systems from one
vendor. Hardware revenue will continue to decline, at a much slower rate,
becoming an insignificant element of revenue in the future.

Revenue for 1992, 1993, and to a much lesser extent 1994 were negatively
impacted by a poor world-wide economy. In 1994 Mentor Graphics experienced
improved activity in Europe while Japan continued to reflect weakness. During
1994 the software component of system and software revenue was up 24% for the
European region compared to the same period last year while North American and
Japan experienced modest 4% and 7% improvement for the same periods,
respectively. From December 31, 1993 to December 31, 1994, the U.S. dollar
weakened approximately 7% on a revenue-based weighted average against the
Japanese yen, resulting in higher U.S. dollar revenue from Japanese yen based
sales in 1994. Exclusive of currency exchange rate changes, the software
component of system and software revenue was flat year to year in Japan. The
North American sales force executed a reorganization during the first quarter of
1994 which resulted in a temporary reduction in productivity. The result of the
reorganization was to streamline operations by reducing two layers of management
and better aligning the sales team to meet customer demand. North America sales
were also impacted by the absence of large multi-year contracts which made a
significant contribution to revenue in 1993. 1994 systems and software revenue
was characterized by smaller sales contracts to a much broader customer base.

The software component of system and software revenue increased 8% from
1993 to 1994 and 14% from 1992 to 1993. The slower-than-anticipated conversion
of customers to Mentor Graphics' Version 8 software, which previously had slowed
sales of the new software tools, was substantially completed by the end of 1993.
During the first quarter of 1993 Mentor Graphics shipped Version 8.2 of its
software. This release included enhanced performance and reliability of the
Version 8 software and was a key factor in Mentor Graphics' ability to increase
the conversion of existing customers. Customers who transitioned or were in the
process of

40
<PAGE> 49

transitioning from Version 7 to Version 8 increased from 30% in 1992 to
approximately 80% in 1993. Customer conversion to Version 8 was no longer an
issue in 1994.

In 1994, Mentor Graphics merged with Anacad Electrical Engineering Software
GmbH (Anacad) and Model Technology Incorporated (MTI). The Anacad transaction
was accounted for as a purchase and was completed on September 30, 1994, while
the MTI transaction was accounted for as a pooling of interests and was
completed on November 30, 1994. The consolidated financial results of Anacad
were included in Mentor Graphics' consolidated statements of operations for the
fourth quarter of 1994 only. The financial results of MTI were included in
Mentor Graphics' consolidated statements of operations for all of 1994, while
Mentor Graphics' prior year financial statements were not restated due to the
relative immateriality of MTI's separate financial statements for 1993 and 1992.
The addition of Anacad and MTI revenue increased the software component of
system and software revenue by approximately 3% in 1994.

Overall growth in the EDA industry has been slower over the last several
years. To achieve additional revenue growth, EDA vendors must increase market
share by either developing or acquiring new technologies that provide additional
competitive solutions. The mergers with Anacad and MTI were a result of Mentor
Graphics' strategy to evaluate make-or-buy alternatives to achieve revenue
growth. Anacad's mixed signal simulation and optimization product offerings and
MTI's VHDL simulation product offerings are complementary to Mentor Graphics'
current product lines and will contribute to revenue growth in 1995. This growth
may be offset as some of Mentor Graphics' maturing products reach the late
stages of their product life cycles.

System and software gross margin improvement in 1994 and 1993 were
primarily a result of increased software versus hardware sales each year.
Software gross margins are much higher than hardware gross margins. The impact
of hardware-software mix-shift on gross margins will be less significant in 1995
as hardware revenue will decline at a much slower rate.

Amortization of previously capitalized software development costs to system
and software cost of good sold was $6,220, $7,449, and $5,875 for 1994, 1993,
and 1992, respectively.

Amortization of purchased technology increased in the fourth quarter of
1994 due to the acquisition of Anacad and other technologies during the third
quarter of 1994. Quarterly purchased technology amortization to system and
software cost of revenues for the next three years, exclusive of additional
acquisitions, is expected to increase by approximately $500. This increase will
be partially offset by reduced amortization of software development costs as
several capitalized projects became fully amortized in 1994. Technology
acquisitions are expected to continue in 1995 and may increase purchased
technology and related amortization, depending on the nature of the transaction.

Services and Support. Service and support revenue consists of software
support, which consists primarily of revenue from annual maintenance contracts,
hardware support, and professional services, which includes consulting services,
customer training and custom design services. Service and support revenue
increased 8% from 1993 to 1994 and 7% from 1992 to 1993. Rapid growth in
professional services combined with sustained growth in software support yielded
this result. These positive factors were offset by a reduction in hardware
support revenues as many customers contracted directly with primary providers of
hardware service. The reduction in hardware support revenue reflects Mentor
Graphics' planned shift to a software-only business model. Mentor Graphics also
recognized as a one-time benefit from an individual service contract in the
third quarter of 1993 increasing service and support revenue by $2,100.

The software support component of service and support revenue increased 12%
from 1993 to 1994 and 12% from 1993 to 1992. Significant Version 8 releases
during 1993 and 1994 were the main factors contributing to the success of Mentor
Graphics' software support program. These releases were a key to increasing both
installed customer base and the percent of established customers signing up for
the software support program. Growth in software support revenue is contingent
on continued development and acquisition of competitive software products. The
mergers with Anacad and MTI discussed above had minimal impact on 1994 service
and support revenue. Anacad and MTI are expected to contribute to software
maintenance and support revenue growth in 1995. This growth may be offset as
some of Mentor Graphics' current products reach the late stages of their product
life cycles.

41
<PAGE> 50

Mentor Graphics has focused resources in the past three years toward
development of the professional service business to meet customer needs for
comprehensive EDA solutions. The response to this service has been favorable
since many customers want consulting and other services, in addition to software
products, to optimize their design processes. Increased professional service
revenue is expected in 1995 as Mentor Graphics continues to respond to customer
demand.

The increase in service and support gross margins is primarily attributable
to the reduction of lower margin hardware support and higher volume to absorb
the fixed cost of overhead. In addition, 1993 gross margins were favorably
impacted by 100% margin associated with the individual service contract
discussed above. Consistent with consulting and training business models, gross
margins, generated by Mentor Graphics' professional service activities have
been, and are expected to continue to be, lower than software support. Lower
overall service and support gross margins are anticipated as growth in the
professional service business is expected to be higher than growth in software
maintenance and support.

Operating Expenses.

<TABLE>
<CAPTION>
1994 CHANGE 1993 CHANGE 1992
-------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C>
Research and development................. $ 72,484 (7)% $ 77,598 5% $ 73,947
Percentage of total revenues........ 20.8% 22.8% 21.1%
Marketing, general, and administration... $137,310 (6)% $146,577 (3)% $151,683
Percentage of total revenues........ 39.4% 43.1% 43.2%
Restructure costs........................ $ (6,045) -- $ 24,800 92% $ 12,900
Percentage of total revenues........ (1.7)% 7.3% 3.7%
</TABLE>

Research and Development. Gross research and development (R&D) costs were
$77,640, $81,207 and $80,067 for 1994, 1993 and 1992, respectively, representing
a 4% decrease from 1993 to 1994 and a 1% increase from 1992 to 1993. In 1994,
R&D expenditures decreased due to a lower headcount plan that was achieved
through attrition and layoffs. Mentor Graphics closed an Integrated Circuit
Division R&D site during the first quarter of 1994, consolidating activities
with other pre-existing locations. Additional cost saving actions were taken in
other R&D divisions of Mentor Graphics during the year.

Offsetting these cost savings were the acquisitions of Anacad and MTI.
Anacad and MTI increased R&D expense by approximately $1,100 each in 1994. In
1993, R&D expenditures remained flat while Mentor Graphics focused on
performance improvements of it's Version 8 software release. In the fourth
quarter of 1993, Mentor Graphics acquired CheckLogic Systems, Inc. resulting in
additional R&D expense of $630 for the year. Offsetting these expenses was a
reduction in headcount for the year due to attrition.

During 1994 Mentor Graphics capitalized software development costs of
$5,156, compared to $3,609 and $6,120 for 1993 and 1992, respectively.
Capitalization increased in 1994 as more resources were directed toward
development of new products and enhancement of existing products. The decline in
software development cost capitalization during 1993 relates to substantial
completion of development activities associated with Version 8, focus on
performance improvements and an effort toward transition of customers to the new
software.

Gross R&D costs are expected to increase from 1994 levels due to
acquisitions of Anacad and MTI, discussed above and additional research and
development investment in the coming year. In addition, Mentor Graphics will
continue to evaluate make-or-buy alternatives in 1995 which may result in more
acquisitions. Overall, the ratio of R&D expense as a percent of revenue may
increase in 1995 due to this additional investment activity.

Marketing, General, and Administration. Marketing, general and
administration (MG&A) expenses were $137,310, $146,577 and $151,683 for 1994,
1993 and 1992, respectively, representing a 6% decrease from 1993 to 1994 and a
3% decrease from 1992 to 1993. In 1994, MG&A expenses declined as actions
associated with the December 1993 restructuring were executed during the year.
The North American sales force executed a reorganization during the first
quarter of 1994 which resulted in lower headcount and reduced layers of
management to better align the sales teams with their respective territories. In
addition, actions were

42
<PAGE> 51

executed at several international locations to streamline the organizations to
improve the ratio of selling and administrative expense compared to regional
revenue levels.

Offsetting these cost savings were the acquisitions of Anacad and MTI,
which increased MG&A expense by approximately $1,100 and $1,300, respectively in
1994. The decline in 1993 represents headcount reductions by selective
replacement of voluntary attribution, partially offset by increased recruiting
costs associated with the successful hiring of several key management positions.

In 1995 MG&A expenses are expected to increase from 1994 levels due to
acquisitions of Anacad and MTI, discussed above. In addition, Mentor Graphics
will experience increased costs associated with the implementation of a new
global information system in the coming year. The system is expected to reduce
the costs associated with capturing and analyzing financial and non-financial
data in 1996. Overall, the goal of management is to improve the ratio of MG&A
expense as a percent of revenue as compared to 1994 levels. Achievement of this
goal is not guaranteed due to the uncertainty of revenues.

Restructuring Costs. During 1994, Mentor Graphics continued the execution
of the restructuring plan approved by its management in December 1993. This plan
was aimed at reducing operating expenses by streamlining and reorganizing
certain of its operations. In 1994, implementation of the restructuring plan
reduced expenses by an estimated $10,000. When all elements of the restructuring
plan have been fully implemented, Mentor Graphics expects future costs and
expenses to be reduced even further.

During 1994, Mentor Graphics recorded a gross restructure credit of
$10,045. This credit was the result of reduced estimates for the costs of
executing certain elements of the restructure plan, and cancellation of certain
actions, and was partially offset by an accrual of $4,000 associated with new
restructure activities approved by management during the year. The new
restructure costs accrued in 1994 were limited to severance and write-offs of
excess equipment and intangible software technology assets related to
discontinued product development activities. Reductions in the estimated costs
of the plan were realized primarily due to greater than anticipated employee
attrition, which allowed Mentor Graphics to achieve its cost reduction
objectives at a lower cost. In addition, the reduction in costs reflects lower
than anticipated severance package costs overseas. Approximately $10,000 of the
1993 restructure accrual resulted in cash expenditures in 1994. Approximately
$10,000 of the remaining $11,897 restructure accrual should result in cash
expenditure in 1995. Spending associated with certain facilities closures should
extend beyond 1995.

In 1993, restructure costs of $24,800 were recognized for the execution of
this plan. These costs consisted primarily of direct costs related to the
severance and relocation of employees, facilities closure, and write-offs of
excess equipment and intangible software technology assets related to
discontinued product development activities.

In August 1992, Mentor Graphics executed a restructuring plan aimed at
improving its focus on the core business of integrated circuit design and
electronic systems design. As part of the restructuring, Mentor Graphics
substantially reduced internal development on various software products and
consolidated certain field facilities to more economically support sales
efforts. Costs associated with the restructuring of $12,900 were recognized in
1992. Restructuring costs included direct costs related to the severance and
relocation of employees, consolidation of facilities, and write-offs of
intangible software technology assets related to discontinued product lines. The
result was to significantly reduce operating costs of administration,
distribution and sales.

Merger Related Charges. Merger related charges are the result of a
write-off of in-process R&D of $8,265 associated with the Anacad transaction and
consulting service costs of $1,000 associated with the MTI transaction. On
September 30, 1994, Mentor Graphics completed the acquisition of Anacad. The
acquisition was accounted for as a purchase. The cost of the acquisition has
been allocated on the basis of estimated fair value of the assets and
liabilities assumed. This allocation resulted in a one-time charge for
in-process R&D of $8,265, capitalization of goodwill of $2,897 and
capitalization of technology of $4,735. The charge for in-process R&D was a
result of allocating a portion of the acquisition costs to Anacad's in-process
product development that had not reached technological feasibility. On December
1, 1994, Mentor Graphics completed the merger with MTI. The transaction was
accounted for as a pooling of interests. Mentor

43
<PAGE> 52

Graphics' prior year financial statements were not restated due to relative
materiality of MTI's separate financial statements for 1993 and 1992. The merger
costs of $1,000 were paid by MTI for consulting services rendered to facilitate
negotiation of the various components of the merger agreement.

Other Income (Expense).

<TABLE>
<CAPTION>
1994 CHANGE 1993 CHANGE 1992
------ ------ ----- ------ -------
<S> <C> <C> <C> <C> <C>
Other income (expense), net........... $2,452 -- $(257) 97% $(7,539)
</TABLE>

Other income (expense) has increased significantly over the last three
years due to increased interest income in 1994, lower interest expense in 1994
and 1993, and one-time charges of $7,298 in 1992. Interest income was $4,953,
$4,338 and $5,284 in 1994, 1993 and 1992, respectively. The improvement in
interest income is attributable to higher interest rates and higher average cash
balances due to earnings in 1994. In 1993, compared to 1992, average interest
rates on investments were much lower, while average cash balances were flat,
resulting in lower interest income. Interest expense was $2,703, $4,404 and
$5,469 in 1994, 1993 and 1992, respectively. In 1994, average debt outstanding
was lower due to improved cashflow from operating activities and continued
management of Mentor Graphics' long term committed revolving credit facility.
Interest expense declined significantly in 1993 as a result of a reduction in
the notional amount of its interest rate swap agreement from $50,000 to $17,500
and lower average debt outstanding through management of Mentor Graphics' long
term committed revolving credit facility. The interest rate swap agreement
converts floating rates on $17,500 of borrowings to a fixed rate of 9.55%. The
reduction in notional amount resulted in moving $32,500 of borrowings to more
favorable floating rates.

Other expense for 1992 includes a charge of $6,150 related to termination
of a contractual relationship with a third-party software supplier. Mentor
Graphics paid $4,250 in the fourth quarter of 1992 and took a write-off of
$1,900 in balance sheet amounts related to the contract. In exchange, the
supplier relinquished all future claims against Mentor Graphics, including
cancellation of the obligation to pay royalties on sales of certain products
through September 30, 1994. Other expense in 1992 also includes write-downs for
certain non-operating assets to net realizable value, totaling $1,148.

Provision for Income Taxes. The provision for income taxes was $3,375,
$2,424 and $2,590 in 1994, 1993 and 1992, respectively. Mentor Graphics' income
tax position for each year combines the effects of available tax benefits in
certain countries where Mentor Graphics does business, benefits from available
net operating loss carrybacks, and tax expense for subsidiaries with pre-tax
income. As such Mentor Graphics' income tax position and resultant effective tax
rate is uncertain in 1995.

Effective January 1, 1993, Mentor Graphics adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." The cumulative
effect of the change in the method for accounting for income taxes was not
material to Mentor Graphics' financial statements, and is therefore not
disclosed separately in the Consolidated Statement of Operations for the year
ending December 31, 1993.

Effects of Foreign Currency Fluctuations. Mentor Graphics experienced net
gains from foreign currency transactions of $177, $247 and $297 in 1994, and
1993 and 1992, respectively. These amounts are composed of realized gains and
losses on cash transactions involving various foreign currencies, and unrealized
gains and losses related to foreign currency receivables and payable resulting
from exchange rate fluctuations between the various currencies in which Mentor
Graphics operates. Foreign currency gains and losses are included as a component
of other income and expense.

The "foreign currency translation adjustment," as reported in the
stockholders' equity section of the consolidated balance sheet, increased to
$12,674 at December 31, 1994, from $7,539 at the end of 1993. This reflects the
increase in the value of net assets denominated in foreign currencies since
year-end 1993 as a result of a weaker U.S. dollar at the close of 1994.

During 1994, the U.S. dollar weakened approximately 8% against the Japanese
yen and 2% against European currencies in which Mentor Graphics does business,
primarily the Deutsche mark, British pound, and French franc. The Japanese yen
strengthened steadily over 1994, while European currencies fluctuated minimally
during the same period. A weaker U.S. dollar results in Mentor Graphics'
products being more

44
<PAGE> 53

affordable in foreign markets, which generally results in favorable economics
for Mentor Graphics. The weakening of the dollar relative to the foreign
currencies also has a positive impact on revenues as local currency revenues
translate into more U.S. dollars. However, this translation also results in
higher reported expenses in U.S. dollars terms.

During 1993, the U.S. dollar was volatile against the European currencies,
strengthening during the first three months and last six months of the year. The
dollars weakened when compared to the yen during the first nine months of 1993
and rebounded slightly in the fourth quarter. Foreign currency fluctuations in
Europe and Japan resulted in a slightly weaker U.S. dollars overall during 1993.

Mentor Graphics generates approximately half of its revenues outside of the
United States and expects this to continue in the future. As such, Mentor
Graphics' business and operating results can be impacted by the effects of
future foreign currency fluctuations.

Liquidity and Capital Resources.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Current Assets............................................. $238,006 $198,088 $207,987
Cash and short-term investments............................ $137,856 $109,568 $108,783
Cash and investments, long-term............................ $ 30,000 $ 30,000 $ 30,000
Cash provided by operations................................ $ 50,397 $ 25,289 $ 13,610
Cash used for investment activities, excluding short-term
investments.............................................. $(31,233) $(26,754) $(29,559)
Cash provided (used) by financing activities............... $ 6,455 $ 1,862 $(18,354)
</TABLE>

Cash and Investments. Total cash and investments increased $28,288 during
1994. Cash provided by operations was $50,397, an increase of $25,108 from 1993.
Positively impacting cash provided by operations in 1994 was net income of
$27,537 coupled with the impact of the adjustment for in-process R&D associated
with the Anacad acquisition of $8,265. These sources of cash were offset by an
increase in trade accounts receivable and decreased accrued liabilities
associated with the restructuring accrual changes discussed previously. In 1993,
cash was negatively impacted by the net loss incurred of $32,073 for the year
and reductions in accounts payable. These uses of cash were offset by a
reduction in trade accounts receivable, continued transition out of the hardware
business resulting in lower inventory levels and increased accrued liabilities
associated with the year-end restructuring.

Cash and short-term investments were positively impacted by the proceeds
from issuance of common stock upon exercise of stock options and employee stock
plan purchases in the amount of $10,205 and $11,179 in 1994 and 1993,
respectively. This increase was offset by investment in property, plant and
equipment of $14,327 in 1994 and $22,790 in 1993. In addition, the purchase of
Anacad late in 1994 resulted in cash payments totaling $10,050. In 1993,
dividends paid to stockholders totaled $8,291. See dividends discussion below.
Also, cash distributions of $2,346 were paid in 1994 by MTI to its shareholders
in the normal course of S-Corporation business prior to Mentor Graphics'
November 30, 1994 acquisition.

Trade Accounts Receivable. The trade accounts receivable balance increased
$9,630 from the December 31, 1993 balance. The increase is primarily
attributable to a large customer contract receivable due in 1995 totaling
$8,000. In addition, Anacad and MTI acquisitions increased the trade receivable
balance by $2,531 year to year. Excluding the large customer contract and the
impact of acquisitions on trade receivables, Mentor Graphics was able to improve
cash collections and reduce days sales outstanding in 1994.

Inventory. Inventory levels at December 31, 1994 totaled $856, down $1,443
since December 31, 1993. The reduction in inventory reflects Mentor Graphics'
shift to a software-only business model resulting in the reclassification of
demonstration equipment to property, plant and equipment in 1994. In 1994,
demonstration equipment was not promoted for sale as it was in prior years.
Demonstration equipment included in inventory amounted to $1,835 at December 31,
1993. The remaining balance in inventory primarily consists of documentation and
CD ROM media for software updates. Inventory is expected to be at approximately

45
<PAGE> 54

current levels in 1995. For any remaining hardware requests from customers,
Mentor Graphics will use a drop ship approach, shipping directly from the
hardware vendor to the customer.

Other Assets. Other assets increased to $28,090 at December 31, 1994 from
$20,584 at year-end 1993. The 1994 acquisition of Anacad resulted in goodwill
capitalization of $2,897 and technology capitalization of $4,735. The goodwill
costs will be amortized over a three-year period to R&D expense. The technology
costs will be amortized over a three-year period to system and software cost of
revenues. Net capitalized software development costs decreased by $1,064 as
capitalization and amortization were $5,156 and $6,220, respectively, in 1994.
Also, capitalized purchased technology increased by $1,700 in 1994. In 1993,
capitalization and amortization of software development costs were $3,609 and
$7,449, respectively.

Long-term Debt. Long-term debt decreased $696 from December 31, 1993.
Mentor Graphics had borrowings outstanding of $54,160 and $55,000 under its
$55,000 committed revolving credit facility as of December 31, 1994 and 1993,
respectively. Due to required annual commitment reductions, Mentor Graphics
reduced credit facility borrowings by $840 in July 1994. In addition, $840 of
the credit facility borrowings are classified as current and included in
short-term borrowings on the consolidated balance sheets as of December 31, 1994
and 1993.

Dividends. In October 1993, the Board of Directors voted to discontinue
paying a quarterly dividend to Stockholders. Mentor Graphics intends to reinvest
future earnings in opportunities for growth. Dividends were paid during the
first three quarters of 1993 totaling $8,291.

Capital Resources. Total capital expenditures increased to $26,077 for
1994, compared to $23,145 and $23,439 for 1993 and 1992, respectively. The
purchase of Anacad late in 1994 resulted in cash payments totaling $10,050
during the year. In addition, Mentor Graphics purchased technologies totaling
$1,700 during 1994. Mentor Graphics will continue to evaluate make-or-buy
alternatives which should result in additional capital expenditures in 1995.

Expenditures for property and equipment were $14,327 and $22,790 in 1994
and 1993, respectively. In 1994 investment in computer equipment for development
engineers declined as significant investment in 1993 and 1992 completed Mentor
Graphics' transition to a UNIX-based operating system environment. Future
capital expenditure plans include maintaining a state of the art design
environment for research and development and sales demonstration equipment and
implementing a new global information system.

Mentor Graphics anticipates that current cash balances, anticipated
cashflows from operating activities, and existing credit facilities will be
sufficient to meet its working capital needs for at least the next twelve
months.

46
<PAGE> 55

Nine Months Ended September 30, 1995 and September 30, 1994

RESULTS OF OPERATIONS

System and Software Revenues and Gross Margins. System and software
revenues for the quarter ended September 30, 1995, totaled $47,290, representing
an increase of $5,616 or 13% from the third quarter of 1994. For the first nine
months of 1995, system and software revenues increased $1,687 or 1% from the
same period a year ago. Third quarter system and software gross margins
increased slightly to 83% in 1995 compared to 81% in the same period of 1994.
For the first nine months of 1995 and 1994, system and software gross margins
were 82%.

System and software revenues experienced only modest growth in the first
nine months of 1995 versus the same period of 1994 due to a one-time contract
which yielded approximately $11,000 in the first quarter of 1994. The
acquisitions of Anacad, Exemplar Logic, Inc. (Exemplar) and Axiom Datorer
Skandinavian AB (Axiom) contributed approximately $5,400 of system and software
revenues for the first nine months of 1995 compared to zero for the same period
a year ago. In addition, a general weakening of the U.S. dollar of approximately
3% to 4%, resulted in higher reported system and software revenues due to
translation of local currency activity to U.S. dollars for the first nine months
of 1995 versus 1994.

System and software product revenues are shifting from maturing product
offerings to new product offerings. The extent to which sales of new products
will off-set declining sales of older products will remain difficult to predict
for some time. In addition, revenue levels for newly acquired entities are
difficult to predict due to such variables as integration of engineering and
sales personnel.

Increasingly Mentor Graphics seeks to expand existing product offerings and
pursue new lines of business through acquisitions. Acquisitions accommodate
Mentor Graphics' strategic requirements including filing gaps in existing
products and technologies, eliminating dependencies on third parties and
creating avenues into new lines of business. During the fourth quarter of 1995
Mentor Graphics announced the acquisition of Precedence Incorporated
(Precedence) and entered into a merger agreement with Microtec which is pending
approval by the shareholders of Microtec and certain other conditions. Both
transactions are expected to be accounted for as a pooling of interests. The
impact of these acquisitions are not reflected in the accompanying financial
statements since the transactions were not consummated during the third quarter
of 1995.

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. Third party software royalty costs have
been favorably impacted by acquisitions of third parties where existing
agreements were in place. Mentor Graphics continues to have other third party
contracts that contribute varying levels of revenues and cost of revenues
quarter to quarter. Similar to Anacad, Exemplar and MTI, the fourth quarter 1995
Precedence acquisition represents a business combination where a third party
agreement was in place. Future trends of third party revenue content are
difficult to predict since they are dependent on such variables as new third
party agreements, potential acquisitions of third parties where existing
agreements are in place, and varying levels of customer demand for third party
product offerings.

Amortization of previously capitalized software development costs to system
and software cost of revenues was $1,181 and $3,653 for the third quarter and
first nine months of 1995, respectively, compared to $1,540 and $5,027 for the
same periods a year ago. In 1994, amortization reflected a higher level of
capitalized costs accumulated during development of Version 8 software products.
The amortization level declined in the first nine months of 1995 as several
capitalized projects became fully amortized during the prior year. Purchased
technology amortization to system and software cost of goods sold was $1,671 and
$214 for the nine months ended September 30, 1995 and 1994, respectively. The
increase in purchased technology amortization is due primarily to various
technology acquisitions in 1994, including the purchase of Anacad on September
30, 1994. Exclusive of additional acquisitions, amortization of capitalized
software development and purchased technology costs is expected to be
approximately flat for the next several quarters.

Service and Support Revenues and Gross Margins. Service and support
revenues for the third quarter of 1995 were $48,038, representing an increase of
$8,345 or 21% from the comparable quarter of 1994. For the

47
<PAGE> 56

first nine months of 1995, service and support revenues totaled $137,639,
representing an increase of 24% from the same period of 1994.

Growth in software support revenue is attributable to growth in Mentor
Graphics' installed customer base, acquisitions of Anacad and Exemplar, and
favorable effects of currency fluctuations. Mentor Graphics continues to
experience increases of installed customer base due to improved and expanded
software product offerings. In addition, a general weakening of the U.S. dollar
resulted in higher reported software support revenues due to translation of
local currency activity to U.S. dollars for the first nine months of 1995 versus
1994. Since growth in software support is dependent on continued success of the
software product offerings, increases in Mentor Graphics' installed customer
base, and the impact of acquisitions, future software support revenue levels are
difficult to predict.

Professional and other service revenues for the third quarter of 1995 were
approximately $12,200, an increase of 51% from the comparable quarter of 1994.
For the first nine months of 1995, professional and other service revenues
totaled approximately $37,100, an increase of 51% from the same period of 1994.
Overall professional service revenues are expected to continue to grow. In
particular, integrated circuit technology center (ICTC) custom design services
are experiencing increased demand. Over the past year, Mentor Graphics has added
resources to the ICTC business in response to the increased demand resulting in
higher revenue levels as more design contracts are completed.

Service and support gross margins were 59% and 58% for the quarters ended
September 30, 1995 and 1994, respectively and 58% and 56% for the first nine
months of 1995 and 1994, respectively. Service and support gross margins were
favorably impacted by higher software support revenue volume and unfavorably
impacted by professional service volume. Consistent with consulting and training
business models, gross margins generated by Mentor Graphics professional service
activities have been and are expected to continue to be lower than software
support. Professional service gross margins improved for the quarter and year to
date but remain substantially lower than software support. Future service and
support gross margins are expected to be lower as growth in the professional
service business is expected to be higher than growth in software support.

Operating Expenses

The following summarizes research and development (R&D) expenses:

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1995 1994 1995 1994
------- ------- ------- -------
<S> <C> <C> <C> <C>
Gross R&D................................. $20,570 $17,460 $58,433 $54,099
Capitalized R&D........................... (1,942) (991) (5,002) (4,064)
------- ------- ------- -------
Net R&D................................... $18,628 $16,469 $53,431 $50,035
======= ======= ======= =======
</TABLE>

Higher gross R&D expenses are attributable to merger and acquisition
activity and accelerating depreciation of file-server equipment used by Mentor
Graphics' engineers, off-set by lower base business head count. The acquisitions
of Anacad, Exemplar and Axiom resulted in additional R&D expenses of
approximately $4,400 in the first nine months of 1995, compared to zero in the
same period of 1994. Mentor Graphics accelerated depreciation on the remaining
book value of its Wilsonville file-server environment in the third quarter of
1995 which resulted in a one-time charge to R&D of $1,440. Through an evaluation
of the file-server environment, Mentor Graphics determined that changes in
technology had rendered the existing equipment obsolete. R&D expenses are
expected to increase as new business combinations are consummated in the fourth
quarter of 1995.

During the third quarter and the first nine months of 1995, marketing,
general and administration (MG&A) expenses were $35,118 and $107,755,
respectively, compared to $33,124 and $106,884 for the same periods of 1994,
respectively. The increase in MG&A expenses is principally attributable to
merger and acquisition activity discussed above, off-set by lower base business
head count. The acquisitions of Anacad,

48
<PAGE> 57

Exemplar and Axiom resulted in additional MG&A expenses of approximately $5,800
in the first nine months of 1995, compared to zero in the same period of 1994.
In 1994, Mentor Graphics streamlined its North American, European and Japanese
organizations to improve the ratio of selling and administrative expense
compared to regional revenue levels. This process was executed throughout 1994
resulting in lower expense levels as the year progressed. In addition, corporate
administrative costs have been reduced. MG&A expenses are expected to increase
in the fourth quarter of 1995 as new business combinations are consummated and
selling costs increase due to a seasonally strong quarter.

Merger Related Charges. Merger related charges are the result of a
write-off of in-process R&D of $400 associated with the Axiom transaction and
$400 in expenses primarily associated with the acquisition of Exemplar for
services rendered to facilitate completion of the merger agreement and severance
costs. On May 4, 1995, Mentor Graphics completed the acquisition of Axiom. The
total purchase price of Axiom was $480 in addition to Axiom's net deficit of
$413 for a total acquisition cost basis of $893. The acquisition was accounted
for as a purchase. The cost of the acquisition has been allocated on the basis
of estimated fair value of the assets and liabilities assumed. This allocation
resulted in a one-time charge for in-process R&D of $400, capitalization of
goodwill of $398 and capitalization of technology of $95. The charge for
in-process R&D was a result of allocating a portion of the acquisition cost to
Axiom's in-process product development that had not reached technological
feasibility. On May 31, 1995, Mentor Graphics completed the merger with
Exemplar. The transaction was accounted for as a pooling of interests. Mentor
Graphics' prior year financial statements were not restated due to relative
materiality of Exemplar's separate financial statements for 1994 and prior
years. It is expected that merger related charges associated with the
acquisitions of Precedence and Microtec should result in a fourth quarter charge
totaling between $3,000 and $4,000. 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.

Restructuring Costs. Implementation of Mentor Graphics' restructuring plan
which was approved by management in December 1993, and modified in 1994,
continued during 1995. Costs remaining to be incurred in executing the
restructuring plan consist primarily of direct costs associated with severance
and relocation of employees, facilities closures and write-offs of excess
equipment and intangible software technology assets related to discontinued
product development activities.

During the second quarter of 1995, several elements of the restructuring
plan were adjusted due to updated information. Costs associated with an
international reorganization were modified due to additional cost information
related to implementation activities associated with a new global information
system. In addition, certain actions associated with a product discontinuance
plan will not be taken as the technology will be used by Mentor Graphics'
consulting organization. As a result, the Company recorded a $2,040 credit
during the second quarter of 1995 reflecting these lower costs.

Approximately $8,000 of the December 31, 1994 restructuring accrual of
approximately $12,000 should result in cash outflows during 1995. For the first
nine months of 1995, restructure-related cash outflows were approximately
$3,400. For the fourth quarter of 1995, disbursements are anticipated to be near
$4,600. Other dispositions include the second quarter adjustment of $2,040 and
approximately $2,000 to be disbursed after 1995, primarily for facilities
closures.

Other Income (Expense). During the third quarter and the first nine months
of 1995, other income was $874 and $3,682, compared to other income of $1,214
and $2,122 for the same periods of 1994, respectively. Interest income from
investments was $1,975 and $5,983 for the third quarter and first nine months of
1995, respectively, compared to $1,369 and $3,452 for the same periods of 1994.
The increase in interest income is primarily attributable to higher average
cash, cash equivalents and short term investments outstanding during the
comparable quarters. During the third quarter and first nine months of 1995,
interest expense amounted to $679 and $1,785, respectively, up from $351 and
down from $1,855 for the comparable periods in 1994. In addition, Mentor
Graphics experienced a net loss from foreign currency transactions of $335 and
$181 during the third quarter and first nine months of 1995, respectively,
compared to a net gain of $194 and $141 during the same periods a year ago.

49
<PAGE> 58

Provision for Income Taxes. The provision for income taxes amounted to
$1,760 for the quarter ended September 30, 1995, as compared to $900 for the
same period in 1994. For the first nine months of 1995, the provision for income
taxes was $4,790 compared to $2,800 for the same period a year ago.

Effective January 1, 1993 Mentor Graphics adopted Statement No. 109,
"Accounting for Income Taxes." At that time a valuation allowance for certain
current deferred tax assets, and net operating loss and tax credit carryforwards
was established. The valuation allowance as of December 31, 1994 was $46,213, of
which $1,974 was related to deferred tax assets of Mentor Graphics' Japanese
subsidiary. The reserve was established when it was more likely than not that
some portion of the deferred tax asset would not be realized. Based on current
operating income levels before tax for Mentor Graphics' Japanese subsidiary, it
has been determined that it is now more likely than not that the Japanese
subsidiary's deferred tax assets will be realized. As such, the tax provision
for the third quarter and the last nine months of 1995 has been adjusted for the
reversal of the valuation allowance for the Japanese deferred tax assets. This
reversal, in addition to changes in operating income forecasts for certain tax
jurisdictions, results in a lower effective tax rate than was posted in the
first quarter of 1995. Mentor Graphics' income tax position for each year
combines the effects of available tax benefits in certain countries where Mentor
Graphics does business, benefits from available net operating loss carrybacks,
and tax expense for subsidiaries with pre-tax income. As such, Mentor Graphics'
income tax position and resultant effective tax rate is uncertain for the
remainder of 1995.

Effects of Foreign Currency Fluctuations. Mentor Graphics experienced a
net loss from foreign currency transactions of $335 and $181 during the third
quarter and first nine months of 1995, respectively, compared to a net gain of
$194 and $141 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 Mentor Graphics 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 September 30, 1995, increased to $13,568 from $12,674 at the
end of 1994. This reflects the increase in the value of net assets denominated
in foreign currencies against the U.S. dollar since year end 1994.

During the third quarter of 1995, Mentor Graphics entered into a three year
forward contract to stabilize the currency effects on a portion of Mentor
Graphics' net investment in its Japanese subsidiary. The contract to sell Yen
2.2 billion will guarantee Mentor Graphics $25,400 at the contract's expiration.
Any differences between the contracted currency rate and the currency rate at
each balance sheet date will impact the foreign currency translation adjustment
component of the stockholders' equity section of the Consolidated Balance Sheet.
The result is a partial off-set of the effect of Japanese currency changes on
stockholders' equity during the contract term. This forward contract should not
impact current or future Consolidated Statements of Operations.

During the period from December 31, 1994 to September 30, 1995, the U.S.
dollar weakened approximately 1% against the Japanese yen and 6% against the
European currencies. Generally, a weakening of the U.S. dollar makes Mentor
Graphics' products less expensive in foreign markets, which has a positive
impact on Mentor Graphics' revenues over time. In addition, a weakening U.S.
dollar results in higher reported revenues and operating expenses due to
translation of local currency activity to U.S. dollars for consolidated
financial reporting.

Mentor Graphics generally realizes approximately half of its revenue
outside the United States and expects this to continue in the future. As such,
Mentor Graphics' business and operating results may be impacted by the effects
of future foreign currency fluctuations.

Liquidity and Capital Resources

Cash and Cash Investments. Total cash and investments at September 30,
1995 were $185,844 compared to $137,856 at the end of 1994. Cash provided by
operations was $60,327 for the first nine months of 1995 compared to $33,852
during the same period of 1994. Cash provided by operations was positively
impacted by net income of $31,305 for the first nine months of 1995 compared to
$14,530 for the same period

50
<PAGE> 59

of 1994. In addition, strong collection efforts decreased trade receivables by
$5,838 offset by decreased accounts payable of $3,622 due primarily to lower
quarter-end purchasing activity versus higher year end activity due to the final
quarter attempt to match costs with fiscal year budgets. Cash and short-term
investments at September 30, 1995 were positively impacted by proceeds from the
issuance of common stock of $14,504, offset by repurchase of common stock of
$2,250, investment in property, plant and equipment of $14,957, and new business
investments of $3,820.

Trade Accounts Receivable. Trade accounts receivable decreased to $76,755
at September 30, 1995 form $82,285 at year end 1994. This decrease was
attributable to a more evenly distributed shipment pattern during the first nine
months of 1995 compared to the fourth quarter of 1994. As a result, a higher
percent of shipments made during the third quarter of 1995 were converted into
cash collections before the period ended.

Other Assets. Other assets increased to $29,436 at September 30, 1995 from
$28,090 at year-end 1994. Net capitalized software development costs increased
by $1,349 as capitalization and amortization were $5,002 and $3,653,
respectively, during the first nine months of 1995. This increase was also
attributable to the purchase of Axiom for $493 and $1,990 spent on investment in
other technology companies in which Mentor Graphics owns a minority interest.
This increase in other assets was offset by amortization of goodwill and
purchased technology of $2,760.

Capital Resources. Total capital expenditures increased to $14,957 through
September 30, 1995, compared to $8,425 for the same period of 1994. 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. As a result of the Merger with Microtec, Mentor Graphics expects to
incur a merger charge totaling between $3,000 and $4,000. The expected cash
outflow associated with this charge is expected to occur over the next twelve
months. Mentor Graphics 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.

51
<PAGE> 60

INFORMATION CONCERNING MENTOR GRAPHICS

BUSINESS

General

Mentor Graphics is a leading supplier of electronic design automation
("EDA") systems -- advanced computer software used to automate the design,
analysis and testing of electronic systems and components. Mentor Graphics
markets its products primarily to large companies in the aerospace, computer,
consumer electronics, semiconductor and telecommunications industries. Customers
use Mentor Graphics software in the design of such diverse products as
supercomputers, automotive electronics, missile guidance systems, signal
processors and personal computers. Mentor Graphics sells and licenses its
products primarily through its direct sales force in North America, Europe and
Asia, and through distributors in territories where the volume of business does
not warrant a direct sales presence. Mentor Graphics was incorporated in Oregon
in 1981. Mentor Graphics' executive officers are located at 8005 S.W. Boeckman
Road, Wilsonville, Oregon 97070-7777. Its telephone number at that address is
(503) 685-7000.

Platforms

Mentor Graphics' software products run primarily on UNIX workstations in a
broad range of price and performance levels, including workstations manufactured
by Hewlett-Packard Company, Sun Microsystems, Inc., Digital Equipment
Corporation, NEC Corporation and IBM. These computer manufacturers have a
substantial installed base of workstations, and make frequent introductions of
new products. A limited number of Mentor Graphics' software products also run on
personal computers.

Mentor Graphics has written virtually all of its software in the high level
languages C++, C, Pascal, or FORTRAN to facilitate its portability to other
platforms in the future, should availability of Mentor Graphics software on such
platforms prove desirable.

Products and Services

Products. Mentor Graphics designs, manufactures, markets and supports EDA
software for the integrated circuit ("IC") and electronic systems design
markets. Current EDA processes must manage the speed, density and reliability
tradeoffs necessary to allow customers to quickly create and test high
performance IC and electronic system designs and, as a result, to shorten
product time-to-market. Mentor Graphics' software products enable engineers and
designers to design, analyze, place and route, and test custom ICs, application
specific integrated circuits ("ASICs"), printed circuit boards ("PCBs"),
multichip modules ("MCMs") and other electronic systems and subsystems prior to
creating hardware prototypes. Mentor Graphics provides a full suite of software
tools covering the entire EDA design flow, as well as high-performance software
tools that can be used in other EDA vendor design environments. Mentor Graphics
believes that its products help customers reduce development times while
producing innovative hardware products of high quality. Mentor Graphics markets
and supports worldwide over 150 tools for design, capture, simulation, synthesis
analysis, verification, layout test and manufacturing tools.

Mentor Graphics' products include tools for system design flow, IC design
flow and MCM/PCB design flow. Mentor Graphics' system design products allow
customers to create designs for ASICs and Field Programmable Gate Arrays
("FPGA"). ASICs are special integrated circuits that can be designed much faster
than traditional ICs. FPGAs, as the name suggests, are circuits that can be
programmed to include different functionality at the point of manufacturing or
during system startup. System design products allow designers to simulate
designs to ensure that they possess the required performance and functionality,
to test the design for errors, and to create output which will allow the design
to be manufactured. Products within the system design flow include BSDArchitect,
DFTAdvisor, FastScan, FlexTest, QuickVHDL, System Design Station, System
Architect, DSP Station, Top-Down Design Solver, AutoLogic II, FPGA Station and
Idea Station.

52
<PAGE> 61

ICs are high performance circuits that are customized for each individual
design. The Company's IC design flow products allow designers to specify an IC
design to test the design for errors, "layout" the electrical components of the
design in a way that balances IC performance and the size of the IC used, and
finally, to create output which will allow the IC to be manufactured. Products
within the IC design flow include IC design and layout tools such as MS Analyzer
, Cell Builder, GDT, IC Station and MicroRoute, as well as all analog and
analog/mixed signal design solutions and power management.

MCM/PCB design flow tools allow customers to determine the functionality of
a MCM/PCB. PCBs are a common way of packaging electronic circuits in which
discrete components (for example, resistors and capacitors) and ICs are mounted
on an epoxy type "board." MCMs may be thought of as several ICs mounted together
on a single substrate. The tools allow designers to select from a library of
parts to be included in the PCB/MCM, to simulate and test the performance of the
MCM/PCB, to test for manufacturability, thermal analysis and signal integrity,
and to output data which will allow the MCM/PCB to be manufactured. Products
within the MCM and PCB design flows include Board Station, MCM Station, Hybrid
Station, AutoTherm MCM, AutoFlow, Logical Cable, Physical Cable, Physical Test
Manager: SITE, Manufacturing Advisor and EngineerView.

Mentor Graphics believes that as computers, telecommunications, and
consumer devices converge into portable and hand-held products, systems on
silicon will become a major product paradigm and will soon account for a
substantial number of design starts. As a result, EDA technology will be
required to design complex hardware/software systems. Designs will be
increasingly small and densely packed with components. In May 1995, Mentor
Graphics announced its Systems-on-Silicon ("SOS") Initiative, a company-wide
program created to meet the growing challenge of installing entire computer
systems, both hardware and software, on a single IC or ASIC. The SOS Initiative
of designing systems on a single IC targets the challenge of creating entire
systems on silicon, including design reuse, design creation and simulation at
very high levels of abstraction, fully integrated design processes that support
multiple design styles and technologies, hardware/software co-design, power
management, and timing analysis. Under the SOS Initiative program, each division
of Mentor Graphics is expected to contribute specific technology and expertise
to meet the Initiative's long-term goal of fully tested EDA design processes
that support the entire design cycle for systems on silicon. These new
technologies are also expected to impact Mentor Graphics' products targeted at
IC, ASIC, MCM and PCB designs.

Customer Support Services

Mentor Graphics has a worldwide organization to meet its customers' needs
for software support. Mentor Graphics offers support contracts providing
software updates and support. Most of Mentor Graphics' customers have entered
into software support contracts. Mentor Graphics provides technical support for
its products through a direct telephone support line and an on-line electronic
communications system.

Professional Services

Mentor Graphics believes that delivery of professional services is a
rapidly expanding segment of the EDA market. Mentor Graphics' Professional
Services Division (PSD) was established in 1987. This division's mission is to
team with customers' design groups to increase productivity and reduce costs by
assisting customers with methodology and process changes, tool refinements,
design implementation and integration services. The Professional Services
Division has a worldwide team of EDA professionals available for on-site
customer consultation providing software and services for design data management
and electronic parts data creation, co-design of ASICs, ICs, MCMs and EDA
network and design environment management and software integration.

Marketing and Sales

Mentor Graphics' marketing strategy emphasizes customer support,
professional consulting services, a strong direct sales force and large
corporate account penetration in the semiconductor, aerospace, computer,
telecommunications, automotive and consumer electronics industries. Customers
use Mentor Graphics' product in the design of such diverse products as
supercomputers, automotive electronics, missile guidance

53
<PAGE> 62

systems, signal processors, personal computers, gallium arsenside circuits,
microprocessors and telecommunication switching systems.

Mentor Graphics sells and licenses its products primarily through its
direct sales force in North America, Asia and Europe. Mentor Graphics also
licenses its products through distributors in territories where the volume of
business is not sufficient to warrant a direct sales presence. During the years
ending December 31, 1994 and 1993, sales outside of North America accounted for
45 and 46 percent, respectively, of total sales. Additional information relating
to foreign and domestic operations is contained in Note 14 of Mentor Graphics
Notes to Consolidated Financial Statements. Fluctuating exchange rates and other
factors beyond Mentor Graphics' control, such as tariff and trade policies,
domestic and foreign tax and economic policies and the relative stability of
international economic and monetary conditions should continue to affect the
level and profitability of sales outside the United States.

Mentor Graphics' also licenses products through its newly created
subsidiary, Antares Corporation ("Antares"). Antares was established to focus on
high quality, lower cost tools for the UNIX and personal computer market. It
will not use the Mentor Graphics sales force, but will rely instead on telesales
and value added resellers. Mentor Graphics' recently acquired Model Technology
and Exemplar Logic subsidiaries have been combined to form Antares. Antares is
currently wholly-owned by Mentor Graphics, but over time, Mentor Graphics plans
to issue approximately 20% of Antares' stock to Antares employees as a result of
equity incentive programs.

Mentor Graphics' OpenDoor program coordinates and supports the integration
of third party EDA products, both commercial and internally developed by
customers, into the Mentor Graphics' design environment. Under this program,
Mentor Graphics enables OpenDoor participant companies to develop interfaces
from their products to Mentor Graphics' products. OpenDoor participants can
select from a range of integration technologies to achieve an optional degree of
integration for their products. There are now approximately 130 OpenDoor
participants.

No material portion of Mentor Graphics' business is dependent on a single
customer. Mentor Graphics has traditionally experienced some seasonal
fluctuations in receipt of orders, which are typically stronger in the second
and fourth quarters of the year. As is typical of many other companies in the
electronics industry, Mentor Graphics generally ships its products to customers
within 10 to 90 days after receipt of an order, and a substantial portion of
quarterly shipments tend to be made in the last month of each quarter.

Mentor Graphics sells and licenses its products and some third-party
products pursuant to purchase and license agreements. Mentor Graphics schedules
deliveries only after receipt of purchase orders under these agreements.

Manufacturing Operations

Mentor Graphics' manufacturing operations primarily consist of reproduction
of Mentor Graphics' software and documentation. In North America, manufacturing
is outsourced. Software and documentation distribution centers in The
Netherlands, Japan and Singapore serve their respective regions. Mentor Graphics
uses a manufacturing resource planning system which integrates purchasing,
inventory control and accounting in all regions.

Product Development and Acquisitions

The EDA market is competitive and characterized by rapid technological
change. Although traditionally most of Mentor Graphics' new product offerings
were developed by Mentor Graphics itself, more and more research and development
is concentrated on enhancing existing product lines. During the years ended
December 31, 1994, 1993 and 1992, Mentor Graphics expensed approximately
$72,484,000, $77,598,000 and $73,947,000 respectively, and capitalized
approximately $5,156,000, $3,609,000 and $6,120,000, respectively, related to
product development. Increasingly Mentor Graphics seeks to expand existing
product offerings and pursue new lines of business through acquisitions.
Acquisitions accommodate Mentor Graphics' focused strategic requirements
including filling gaps in existing products or technologies, eliminating
dependencies on third parties and providing Mentor Graphics with an avenue into
new lines of business. During 1994, Mentor

54
<PAGE> 63

Graphics acquired Anacad and MTI, to date in 1995, Mentor Graphics has acquired
Axiom, Exemplar and Precedence.

Suppliers

Mentor Graphics seeks to provide its customers with software that addresses
the entire electronic design process. Supplier products fill in the gaps in the
existing product lines and allow Mentor Graphics to offer products which are
needed by customers but which are not core to Mentor Graphics' business.
Supplier agreements are also used by Mentor Graphics to explore possible new
lines of business. Although Mentor Graphics has supplier agreements with several
large customers who do not wish to develop a specific internal technology into a
commercial product, Mentor Graphics' suppliers are typically small niche
companies which do not have adequate distribution channels for their products.
Mentor Graphics maintains three different types of supplier relationships: (i) a
simple remarketing relationship where the product is added to the Mentor
Graphics' price list and drop shipped to the customer directly from the
supplier; (ii) a partial integration relationship where the supplier's object
code is packaged and shipped with other Mentor Graphics' products to the
customer; and (iii) a fully integrated relationship where Mentor Graphics
acquires the supplier's source code and makes some modifications to the product
before it is packaged and delivered to the customer.

Supplier agreements are typically three year agreements with royalty
payments based on a percentage of product revenue. They generally provide for
adequate quality assurance and require an escrow of the supplier's source code.
Customer support for supplier products is typically provided by Mentor Graphics
with the supplier providing backup support and research and development in the
event of a problem with the product itself. See "Product Development and
Acquisitions."

Patents and Licenses

Mentor Graphics owns eight United States patents and nine foreign patents
covering portions of its technology. Mentor Graphics is currently seeking to
patent more of the inventive technology which Mentor Graphics believes gives it
a competitive advantage. Mentor Graphics presently has patent applications
pending and intends to file additional patent applications in the future. While
Mentor Graphics believes the pending applications relate to patentable devices,
there can be no assurance that any patent will be issued or that any patent can
be successfully defended. Although Mentor Graphics believes that patents are
less significant to the success of its business than technical competence,
management ability, marketing capability and customer support, Mentor Graphics
believes that software patents are becoming increasingly important in the EDA
industry.

Mentor Graphics regards its application software as proprietary and
attempts to protect it with copyrights, trade secret laws, and internal
non-disclosure safeguards, as well as patents, when appropriate, as noted above.
Mentor Graphics typically incorporates restrictions on disclosure, usage and
transferability into its agreements with customers and other third parties.

COMPETITION

The EDA industry is competitive and has been characterized by rapid
technological advances in application software, operating systems and hardware.
Mentor Graphics' principal competitors are Cadence Design Systems Inc., Synopsys
Inc., Viewlogic Systems, Inc., COMPASS Design Automation, Inc., Zuken-Redac,
Intergraph Corporation and numerous small companies. Mentor Graphics believes
that other companies may also be developing EDA systems.

Some of Mentor Graphics' competitors and potential competitors may have
greater financial and marketing resources than Mentor Graphics. However, Mentor
Graphics believes the main competitive factors in the EDA industry are breadth
and quality of application software, product integration, ability to respond to
technological change, quality of a company's sales force, price, size of the
installed base, level of customer support and value added services. Mentor
Graphics believes that it generally competes favorably in these areas. Mentor
Graphics can give no assurance, however, that it will have financial resources,
marketing, distribution and service capability, depth of key personnel or
technological knowledge to compete successfully in the EDA market.

55
<PAGE> 64

EMPLOYEES

Mentor Graphics and its subsidiaries employed approximately 2,031 persons
full time as of November 1, 1995. Mentor Graphics' success will depend in part
on its ability to attract and retain employees who are in great demand. Mentor
Graphics continues to enjoy good employee relations. No Mentor Graphics
employees are represented by a collective bargaining unit.

PROPERTIES

Mentor Graphics' Wilsonville, Oregon facilities are located in six owned
buildings of approximately 420,000 total square feet located on about 90 acres.
All corporate functions, as well as a majority of research and development and
domestic activities, operate from this site.

Mentor Graphics leases additional space in San Jose, California, and in
various locations throughout the United States and in other countries, primarily
for sales and customers service operations. Mentor Graphics believes that it
will be able to renew or replace its existing leases as they expire and that its
current facilities will be adequate through at least 1996.

LEGAL PROCEEDINGS

There are no material legal proceedings pending against Mentor Graphics.

56
<PAGE> 65

MANAGEMENT

The directors and executive officers of Mentor Graphics, and their ages as
of November 1, 1995, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---------------------------------------- --- ------------------------------------------
<S> <C> <C>
Walden C. Rhines........................ 49 President, Chief Executive Officer and
Director
R. Douglas Norby........................ 60 Senior Vice President and Chief Financial
Officer
Frank S. Delia.......................... 49 Vice President and Chief Administrative
Officer
Dean Freed.............................. 37 Vice President, General Counsel and
Secretary
James J. Luttenbacher................... 40 Corporate Controller and Chief Accounting
Officer
Bob Van Leyen........................... 52 Treasurer
Jon A. Shirley(2)(3).................... 57 Chairman of the Board of Directors
Marsha B. Congdon(1)(2)(3).............. 48 Director
James R. Fiebiger(1)(3)................. 54 Director
Fontaine K. Richardson(2)(3)............ 54 Director
</TABLE>

- ---------------
(1) Member of the Audit Committee

(2) Member of the Compensation Committee

(3) Member of the Nominating Committee

Dr. Rhines has served as Director, President and Chief Executive Officer of
Mentor Graphics since November 1993. From 1972 to 1993, Dr. Rhines was employed
by Texas Instruments, Incorporated where he held a variety of technical and
management positions and was most recently Executive Vice President of Texas
Instruments Semiconductor Group. Dr. Rhines is currently a director of Cirrus
Logic, Inc., a manufacturer of semiconductors, and Triquint Semiconductor, Inc.,
a semiconductor manufacturer.

Mr. Norby has served as Senior Vice President and Chief Financial Officer
of Mentor Graphics since July 1993. From 1992 to 1993, he served as President
and Chief Executive Officer of Pharmetrix Corporation. From 1985 to 1992, he was
employed by Lucasfilm, Ltd. where he last held the position of President and
Chief Operating Officer.

Mr. Delia has served as Vice President and Chief Administrative Officer of
Mentor Graphics since July 1995. From 1990 to July 1995, Mr. Delia served as
Vice President, Chief Administrative Officer, General Counsel and Secretary of
Mentor Graphics.

Mr. Freed has served as Vice President, General Counsel and Secretary of
Mentor Graphics since July 1995. Mr. Freed served as Deputy General Counsel and
Assistant Secretary of Mentor Graphics from April 1994 to July 1995, and was
Associate General Counsel and Assistant Secretary from 1990 to April 1994. He
has been employed by Mentor Graphics since January 1989.

Mr. Luttenbacher has served as Corporate Controller and Chief Accounting
Officer since October 1993, having served as Corporate Controller from August
1992 until October 1993. From 1981 to 1992, Mr. Luttenbacher was employed by
Hewlett-Packard Company in a variety of accounting positions, the most recent of
which was Manager of the North American Financial Services Group.

Mr. Van Leyen has served as Treasurer of Mentor Graphics since May 1994. He
has been employed by Mentor Graphics since 1986 and, before becoming Treasurer,
was based in Paris, France and held the title of Finance Director, European
Operations.

Mr. Shirley has served as Chairman of the Board of Directors since 1994 and
as a director of Mentor Graphics since 1989. Mr. Shirley has been a private
investor since 1990. He served as President and Chief

57
<PAGE> 66

Operating Officer of Microsoft Corporation from 1983 to 1990 and continues to
serve as a director of Microsoft Corporation.

Ms. Congdon has served as a director of Mentor Graphics since 1991. Since
March 1994 she has served as Vice President, Policy and Strategy of US West
Inc., a provider of communication services. From December 1992 to March 1994,
Ms. Congdon was the Regional Vice President and Chief Executive Officer, Oregon
of US West Communications and from 1987 to December 1992 she was its Vice
President and Chief Executive Officer, Oregon. Ms. Congdon is currently a
director of US Bank of Oregon.

Mr. Fiebiger has served as a director of Mentor Graphics since 1994. Since
1993, Mr. Fiebiger has been Chairman of the Board and Managing Director of
Thunderbird Technologies, Inc., a technology licensing company. From 1988 to
1993, he served as President and Chief Operating Officer of VLSI Technology
Inc., a manufacturer of semiconductors. Mr. Fiebiger is currently a director of
Zycad Corporation, a manufacturer of electronic design automation tools.

Mr. Richardson has served as a director of Mentor Graphics since 1983.
Since 1983, Mr. Richardson has been a general partner of Eastech Management
Company, a venture capital firm. He is currently a director of Banyan Systems,
Inc., a manufacturer of computer network software products.

Officers are elected by and serve at the discretion of the Board of
Directors. There are no family relationships among any of the directors or
officers of Mentor Graphics.

58
<PAGE> 67

INFORMATION REGARDING BENEFICIAL OWNERSHIP OF PRINCIPAL
MENTOR GRAPHICS STOCKHOLDERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of Mentor Graphics' Common Stock as of November 15, 1995, by: (i) each
director; (ii) each of the Executive Officers named in the Summary Compensation
Table employed by Mentor Graphics in that capacity on November 15, 1995; (iii)
all officers and directors as a group; and (iv) each beneficial owner of more
than five percent (5%) of Mentor Graphics' Common Stock:

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED
PRIOR TO THE
MERGER(1) PERCENT
--------------------- AFTER
BENEFICIAL OWNERS NUMBER PERCENT THE MERGER(2)
- ---------------------------------------------------------- --------- ------- -------------
<S> <C> <C> <C>
Merrill Lynch & Co., Inc.(3).............................. 4,655,600 8.3% 7.5%
and various subsidiaries
World Financial Center, North Tower
New York, NY 10281-1323
State of Wisconsin Investment Board(4).................... 4,576,000 8.2% 7.4%
P.O. Box 7842
Madison, WI 53707
FMR Corp.(5).............................................. 3,667,700 6.6% 5.9%
82 Devonshire Street
Boston, MA 02109
Capital Research and Management Company,(6)............... 3,635,000 6.5% 5.9%
a registered investment adviser and an operating
subsidiary of
The Capital Group, Inc.
333 South Hope Street
Los Angeles, CA 90071
Crabbe-Huson Company(7)................................... 2,896,700 5.2% 4.7%
121 S.W. Morrison
Portland, OR 97204
Walden C. Rhines(8)....................................... 253,375 * *
R. Douglas Norby(9)....................................... 40,000 * *
James J. Luttenbacher(10)................................. 14,957 * *
Frank S. Delia(11)........................................ 32,528 * *
Jon A. Shirley(12)........................................ 109,342 * *
Marsha B. Congdon(13)..................................... 40,902 * *
James R. Fiebiger(14)..................................... 6,000 * *
Fontaine K. Richardson(15)................................ 94,800 * *
All directors and executive officers as a group (8
persons)(16)............................................ 591,904 1.1% *
</TABLE>

- ---------------
* Less than 1%

(1) Unless otherwise indicated in the footnotes to this table, the persons
named in this table have sole voting and investment power with respect to
the shares indicated as beneficially owned by them, subject to community
property laws where applicable. Share figures based on copies of reports
filed with the Securities and Exchange Commission (the "SEC"). Applicable
percentages are based on 55,453,650 shares outstanding on November 15,
1995, as adjusted as required by rules promulgated by the SEC.

(2) Applicable percentages are based on 61,899,195 shares outstanding on
November 15, 1995, as adjusted as required by rules promulgated by the SEC.

(3) Information provided as of February 10, 1995 in a Schedule 13G filed by the
stockholder.

(4) Information provided as of February 13, 1995 in a Schedule 13G filed by the
stockholder.

(5) Information provided as of February 13, 1995 in a Schedule 13G filed by the
stockholder.

59
<PAGE> 68

(6) Information provided as of February 8, 1995 in a Schedule 13G filed by the
stockholder.

(7) Information provided as of February 10, 1995 in a Schedule 13G filed by the
stockholder.

(8) Includes 53,375 shares held and 200,000 shares subject to options
exercisable within 60 days of November 15, 1995.

(9) Includes 20,000 shares held and 20,000 shares subject to options
exercisable within 60 days of November 15, 1995.

(10) Includes 4,832 shares held and 10,125 shares subject to options exercisable
within 60 days of November 15, 1995.

(11) Includes 1,328 shares held and 31,200 shares subject to options exercisable
within 60 days of November 15, 1995.

(12) Includes 5,000 shares held and 104,342 shares subject to options
exercisable within 60 days of November 15, 1995.

(13) Includes 1,253 shares held and 39,649 shares subject to options exercisable
within 60 days of November 15, 1995.

(14) Consists of 6,000 shares subject to options exercisable within 60 days of
November 15, 1995.

(15) Consists of 94,800 shares subject to options exercisable within 60 days of
November 15, 1995.

(16) Includes 85,788 shares held and 506,116 shares subject to options
exercisable within 60 days of November 15, 1995.

CERTAIN TRANSACTIONS

During 1992, Mentor Graphics had outstanding loans to four executive
officers: (a) $64,000 to David Y. Chen, a former officer, at 8.5% interest as a
bridge relocation loan; (b) $75,000 to Brian W. Maggs, a former officer, at 6%
interest for the purchase of real estate; and (c) $146,000 to Marvin S. Wolfson,
a former officer, at 10% interest for the purchase of real estate and Mentor
Graphics Common Stock. Mentor Graphics held a security interest in certain
assets securing such loans, all of which have been repaid in full. In 1992
Mentor Graphics executed a one year consulting agreement with Gerard H.
Langeler, a former director and officer, under which as payment for services,
Mentor Graphics extended for two years the exercise period on 113,000
unexercised stock options previously granted to Mr. Langeler.

Mentor Graphics executed a non-compete agreement with David C. Moffenbeier,
a former director and officer, on June 1, 1993, under which, until May 31, 1994,
Mentor Graphics agreed to pay Mr. Moffenbeier $255,000, and extended certain
health insurance benefits and allowed 80,100 previously granted stock options to
vest and be exercisable through May 31, 1994. In connection with the resignation
of Thomas H. Bruggere as an officer and employee of Mentor Graphics on February
11, 1994, Mentor Graphics entered into a consulting and non-compete agreement
with Mr. Bruggere pursuant to which Mr. Bruggere received a continuation of his
$400,000 annual salary through January 31, 1995, a one-year extension of health
insurance and, with respect to outstanding options for 277,700 shares of Common
Stock, an extension of vesting through October 7, 1995 and an extension of
exercisability through October 7, 1996.

During 1992, 1993 and 1994, Mentor Graphics had an outstanding secured loan
in the amount of $75,000 to Frank S. Delia at 10% interest for the purchase of
real estate. Mr. Delia has repaid the loan in full.

60
<PAGE> 69

INFORMATION REGARDING EXECUTIVE OFFICER COMPENSATION

Summary Compensation Table

The following summary compensation table shows compensation paid by Mentor
Graphics for the last three fiscal years to Mentor Graphics' Chief Executive
Officer and each of Mentor Graphics' four other most highly compensated
executive officers (Named Executive Officers).

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION SECURITIES ALL OTHER
NAME AND -------------------- UNDERLYING COMPENSATION
PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS/SARS(#) ($)(6)
- ------------------------------------------- ---- --------- -------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Walden C. Rhines........................... 1994 400,000 276,000 0 0
President and Chief Executive 1993 84,872 413,333 600,000 0
Officer(1) 1992 -- -- -- --
Waldo J. Richards.......................... 1994 247,458 150,000 15,000 4,620
Senior Vice President, Product 1993 199,449 37,000 100,000 734
Operations(2) 1992 -- -- -- --
R. Douglas Norby........................... 1994 235,000 160,000 0 4,620
Senior Vice President 1993 86,166 66,667 250,000 0
and Chief Financial Officer(3) 1992 -- -- -- --
James J. Luttenbacher...................... 1994 148,927 51,000 4,500 4,620
Chief Accounting Officer and 1993 142,648 14,000 0 4,497
Corporate Controller(4) 1992 -- -- -- --
Frank S. Delia............................. 1994 148,142 58,816 8,000 4,620
Vice President and Chief 1993 145,000 20,000 0 4,350
Administrative Officer 1992 145,000 0 64,200(5) 4,364
</TABLE>

- ---------------
(1) Dr. Rhines began employment with Mentor Graphics in October 1993.

(2) Mr. Richards began employment with Mentor Graphics in February 1993. He
resigned as an employee of Mentor Graphics in March 1995.

(3) Mr. Norby began employment with Mentor Graphics in July 1993.

(4) Mr. Luttenbacher began employment with Mentor Graphics in August 1992 and
became an executive officer in October 1993.

(5) On October 7, 1992, the Compensation Committee and the Board of Directors
approved a repricing of outstanding options under Mentor Graphics' employee
stock option plans. For purposes of the table above, repriced options are
considered to be option grants and, therefore, are included in the number of
options granted in 1992. If repriced options are not counted, an option
grant in 1992 was made to Mr. Delia for 10,000 shares.

(6) Amounts shown are Company contributions to the Individual Deferred Tax and
Savings Plan pursuant to which Mentor Graphics' U.S. employees may defer
compensation under Section 401(k) of the Internal Revenue Code. Mentor
Graphics contributes an amount equal to 50% of the first 6% of salary
contributed under the plan by an eligible employee.

61
<PAGE> 70

Option Grants in Fiscal Year

The following table shows for the fiscal year ended December 31, 1994,
certain information regarding options granted to, exercised by, and held at year
end by the Named Executive Officers.

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
---------------------------------------------------- ANNUAL RATES OF
# OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(2)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION --------------------
NAME GRANTED(1) FISCAL YEAR ($/SHARE) DATE 5%($) 10%($)
- ------------------------------ ---------- ------------ ----------- ---------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Walden C. Rhines.............. -- -- -- -- -- --
Waldo J. Richards............. 15,000 1.7 9.625 7/31/2004 90,797 230,097
R. Douglas Norby.............. -- -- -- -- -- --
James J. Luttenbacher......... 4,500 .5 9.625 7/31/2004 27,239 69,029
Frank S. Delia................ 8,000 .9 9.625 7/31/2004 48,425 122,718
</TABLE>

- ---------------
(1) Each option is fully exercisable four years after August 4, 1994, with 25%
becoming exercisable on each of the first four anniversaries after that
date. All options become fully exercisable upon a "change in control" of
Mentor Graphics as defined in the 1982 Stock Option Plan. Unless otherwise
determined by the Compensation Committee before the occurrence of the event,
a "change in control" generally includes the following events: the
acquisition by any person of 20% or more of Mentor Graphics' Common Stock,
the nomination (and subsequent election) of a majority of Mentor Graphics'
directors by persons other than the incumbent directors and the approval by
Mentor Graphics' shareholders of a merger, share exchange, sale of
substantially all of Mentor Graphics' assets or plan of liquidation.

(2) The 5% and 10% assumed rates of appreciation are required by the Securities
and Exchange Commission and do not represent Mentor Graphics' estimate or
projection of the future Common Stock price.

Aggregated Option Exercises in Last Fiscal Year-End Option Values

The following table provides information on option exercises for the last
fiscal year by the Named Executive Officers and the value of such officers'
unexercised options as of December 31, 1994.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT 12/31/94(#) AT 12/31/94($)
ACQUIRED ON VALUE ----------------------------- -----------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Walden C. Rhines...... 0 0 100,000 400,000 362,500 1,450,000
Waldo J. Richards..... 0 0 20,000 95,000 102,500 494,375
R. Douglas Norby...... 0 0 20,000(1) 230,000 127,500 1,466,250
James J.
Luttenbacher........ 0 0 6,000 13,500 50,250 100,688
Frank S. Delia........ 30,000 217,500 20,866 23,334 178,761 186,840
</TABLE>

- ---------------
(1) Includes 15,000 shares currently held by Mr. Norby as the result of
exercising an option to purchase these shares in February 1995.

Employment Agreements

In connection with the hiring of R. Douglas Norby in July 1993, Mentor
Graphics entered into an employment agreement with him for a two-year term.
Pursuant to this agreement, Mr. Norby was granted a ten-year option for 100,000
shares of Common Stock at the then current market price of $8.875 per share,
vesting 20% per year over the first five years of his employment. Also pursuant
to this agreement, he was granted a ten-year option for 150,000 shares of Common
Stock at $8.875 per share subject to both time and performance vesting.
One-third of the shares will vest after the third anniversary of the grant if
the average closing price of the Common Stock over any 30-day period after such
third anniversary exceeds $25. One-third of the shares will vest after the
fourth anniversary if such 30-day average closing price exceeds $30, and

62
<PAGE> 71

the remaining third will vest after the fifth anniversary if such 30-day average
closing price exceeds $40. All of the shares will vest if Mr. Norby is employed
by Mentor Graphics 9 1/2 years after the grant. The agreement also provides that
if Mentor Graphics terminates Mr. Norby's employment without cause during the
term of the agreement, Mentor Graphics will continue his salary and health
insurance for two years after such termination.

In connection with the hiring of Dr. Walden C. Rhines in October 1993,
Mentor Graphics agreed that if it terminated the employment of Dr. Rhines
without cause at any time prior to October 15, 1995, Mentor Graphics would pay
Dr. Rhines $600,000 in settlement of any and all claims he may have against
Mentor Graphics.

Directors

Directors who are not employees of Mentor Graphics are paid an annual fee
of $20,000 and are reimbursed for expenses incurred in attending Board and Board
Committee meetings. Any non-employee director who also serves as Chairman of the
Board is paid an additional fee of $10,000.

Mentor Graphics' 1987 Non-Employee Directors' Stock Option Plan (the "1987
Directors' Option Plan") provides that upon initial election to the Board of
Directors, each non-employee director will receive a one-time grant of an option
to purchase 30,000 shares of Mentor Graphics Common Stock. The 1987 Directors'
Option Plan also provides that on the date of each annual meeting of the
stockholders, each non-employee director who is re-elected to the Board is
automatically granted an option to purchase 10,000 shares of Mentor Graphics
Common Stock. Each such option becomes exercisable for 20% of the number of
shares covered by the option at the end of each of the first five years
following the grant.

Compensation Committee Interlocks and Insider Participation

At December 31, 1994, the members of the Compensation Committee consisted
of Mr. Richardson, Mr. Shirley and former director David R. Hathaway. As of
September 30, 1995, the members of the Compensation Committee consisted of Mr.
Richardson, Mr. Shirley and Ms. Congdon.

63
<PAGE> 72

MICROTEC MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview

Microtec develops, markets and supports software development tools,
real-time operating systems and software connectivity products for the embedded
systems market. Microtec provides a range of services, including customer
service and support contracts, training, consulting and contract development.
Microtec markets its products on a worldwide basis through a direct sales force,
distributors and resellers. Microtec provides sales, marketing and product
support for foreign customers through wholly-owned subsidiary companies in
Europe and Japan.

In the second half of fiscal 1994, Microtec acquired Ready Systems, a
leading developer of real-time operating systems software. The Ready Systems
acquisition was accounted for as a purchase and the operations of Ready Systems
have been included in the consolidated results of Microtec subsequent to
November 30, 1993. The real-time operating systems and connectivity products
acquired from Ready Systems are key to Microtec's strategy of providing
integrated solutions to embedded systems developers. Ready Systems' revenues had
declined rapidly prior to the acquisition as a result of its decision to
discontinue several product lines and a lack of financial resources. Since the
acquisition, the level of revenue generated by the Ready Systems products has
been relatively stable and Microtec has significantly decreased related
operating expenses. Microtec's future success will depend in part on its ability
to increase sales of products acquired in connection with the Ready Systems
acquisition. For the year ended March 31, 1995, 30% of Microtec's license
revenues were generated from licenses of real-time operating systems and
host/target connectivity products.

Microtec has undergone a period of rapid growth and expansion due in part
to its acquisition of Ready Systems, which has placed, and will continue to
place, a significant strain on its resources. Microtec has been and is faced
with the challenge of integrating and incorporating new operations, product
lines, technologies and personnel from Ready Systems. Microtec has in the past
encountered problems in connection with this integration including employee
turnover and product integration issues. Failure to fully integrate the Ready
Systems product line with Microtec's products could materially and adversely
affect Microtec's ability to effectively compete in the embedded software
development market. Microtec's success will depend in part on its ability to
manage growth successfully and to continue to assimilate such new operations,
products, technologies and personnel and to continue to improve its operational,
management and financial systems and controls. Since the Ready Systems merger,
Microtec has experienced greater than normal turnover of personnel. Microtec's
future success depends to a significant extent on its ability to attract and
retain sufficient numbers of highly-skilled personnel, particularly in its sales
and engineering areas. There can be no assurance that Microtec will be
successful in these efforts.

Microtec's revenue is comprised of license revenue, including development
and run-time licenses, and service revenue. Growth in license revenue has
historically been driven primarily by increasing market acceptance of Microtec's
products and the shift from distribution to direct sales and, to a lesser
extent, to the introduction of new products.

The growth in service revenue since fiscal 1993 has been driven primarily
by increased sales of service and support contracts on new orders and, to a
lesser extent, by increasing renewals of these contracts as Microtec's installed
base of development licenses has increased. The composition of Microtec's
service revenue changed significantly in fiscal 1993 as Microtec reduced its
focus on contract development. Microtec expects that revenues from development
contracts will remain relatively constant or decrease on an annual basis as
compared to levels experienced in recent years, but may vary significantly on a
quarterly basis.

Microtec's results of operations have been impacted over the periods
discussed below by a number of non recurring events. In fiscal 1993, Microtec
acquired Digitailor AB, its Swedish distributor and value-added reseller. In
connection with that acquisition, $0.7 million was attributed to in-process
research and development and was expensed. In fiscal 1994, in connection with
the Ready Systems acquisition, Microtec allocated $14.4 million of the purchase
price to in-process research and development which was expensed. In fiscal 1994
and 1993, Microtec incurred litigation related costs, including the cost of
settlement, of $3.9 million and $1.4 million, respectively, in connection with a
lawsuit alleging misappropriation by Microtec of trade secrets of Green Hills
Software, Inc. (the "Green Hills Litigation"). The Green Hills Litigation was
settled in June 1993.

64
<PAGE> 73

Results of Operations for the Three Years Ended March 31, 1995, 1994 and 1993

The following table sets forth certain Consolidated Statements of
Operations for the periods indicated and the percentage of net revenue
represented by certain line items.

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
--------------------------------------------------------
1995 1994 1993
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net revenue:
License............................... $36,015 80% $26,234 79% $18,175 80%
Services.............................. 9,197 20 6,773 21 4,451 20
------- --- ------- ---- ------- ---
Total......................... 45,212 100 33,007 100 22,626 100
------- --- ------- ---- ------- ---
Costs and expenses:
Cost of revenue....................... 5,902 13 5,158 16 3,685 16
Selling and marketing................. 17,726 39 10,276 31 7,092 31
Research and development.............. 11,954 27 9,176 28 6,432 28
Acquired research and development..... 14,403 43 650 3
General and administrative............ 3,800 8 4,114 12 2,842 13
Litigation and settlement costs....... 3,879 12 1,433 6
------- --- ------- ---- ------- ---
Total costs and expenses...... 39,382 87 47,006 142 22,134 98
------- --- ------- ---- ------- ---
Operating income (loss)................. 5,830 13 (13,999) (42) 492 2
Other income (expense), net............. 760 2 68 (66)
------- --- ------- ---- ------- ---
Income (loss) before taxes.............. 6,590 15 (13,931) (42) 426 2
Provision (credit) for taxes............ 2,240 5 (5,600) (17) 270 1
------- --- ------- ---- ------- ---
Net income (loss).................. $ 4,350 10% $(8,331) (25)% $ 156 1%
======= === ======= ==== ======= ===
Gross Margin:
License............................... 90% 87% 87%
Service............................... 76% 75% 70%
</TABLE>

Net Revenue

Microtec's overall revenue growth rate was 37%, 46%, and 13% in fiscal
1995, 1994 and 1993 respectively. Microtec's revenue results primarily from fees
for licenses of its software products, from run-time licenses and from customer
support, training and maintenance services. License revenues accounted for
approximately 80% in each fiscal year 1995, 1994 and 1993, with service revenue
accounting for the balance of net revenues for these periods. Substantially all
of the increases in license revenues were attributable to increases in the
volume of licenses sold.

License Revenue. License revenue increased 37%, 44% and 18% in fiscal
years 1995, 1994 and 1993, respectively. The fiscal year 1995 increase in
license revenue was primarily the result of revenue generated from a full year
of sales of Microtec's real-time operating systems and connectivity products
acquired in connection with the Ready Systems acquisition in the December 1993
quarter and from the continued growth in market acceptance of Microtec's
software development tools. Additionally, license revenue increased, to a lesser
extent, due to new products introduced in the December 1994 quarter and a
continuing shift from distribution to direct sales that resulted in higher
revenue per unit. License revenue increased at a higher rate in Asia than in the
United States or Europe due to increased direct sales in Asia and the
consolidation of the results of operations of Microtec's joint venture in the
fourth quarter of fiscal 1994. Microtec expects to generate an increasing
percentage of future license revenue through direct sales and anticipates that
license revenue generated through third parties will correspondingly decrease as
a percent of total license revenue. The increase in fiscal 1994 was primarily
attributable to revenue generated by licensing real-time operating systems
products obtained in connection with the Ready Systems acquisition, increased
market acceptance of Microtec's object-oriented C++ products and other software
development tools and, to a lesser extent, a shift from distribution to direct
sales resulting in higher average revenue per unit. The increase in fiscal 1993
was

65
<PAGE> 74

primarily attributable to Microtec's acquisition of its Swedish distributor and
value-added reseller, Digitailor AB, licenses for the newly released XRAY
Monitor product, the increased market acceptance of Microtec's first
object-oriented C++ products and, to a lesser extent, growth in overall unit
shipments.

Service Revenue. Service revenue increased 36%, and 52% in fiscal 1995 and
1994, respectively and decreased 2% in 1993. For both fiscal 1995 and 1994, the
increase was primarily due to increased sales of service and support contracts
on new orders and the renewal of service and support contracts on existing
licenses. The decrease in fiscal 1993 was primarily due to a significant
decrease in revenue from contract development as Microtec reduced its focus on
this activity, offset by a significant increase in revenue from service and
support contracts. The deferred service and contract revenue balance, totaling
approximately $5.3 million at March 31, 1995, related primarily to customer
prepayments under software maintenance agreements that will be recognized
ratably over the life of the agreements as revenue in fiscal 1996.

Total international net revenues were 56%, 56% and 51% of total net revenue
for fiscal 1995, 1994 and 1993 respectively. Microtec anticipates that
international sales will continue to account for a significant portion of net
sales in the foreseeable future. As a result, Microtec will be subject to
certain risks, including tariffs and other barriers, difficulties in staffing
and managing foreign subsidiary operations, difficulties in managing
distributors and resellers, adverse tax consequences and difficulty in accounts
receivable collection. Microtec is also subject to the risks associated with the
imposition of protective legislation and regulations relating to import or
export or otherwise resulting from trade or foreign policy. Microtec cannot
predict whether quotas, duties, taxes or other charges or restrictions will be
implemented by the United States or any other country upon the import or export
of Microtec's products in the future. There can be no assurance that any of
these factors or the adoption of restrictive policies will not have a material
adverse effect on Microtec's business, financial condition and results of
operations. In addition, Microtec denominates sales to and by foreign
subsidiaries in local currency. Microtec attempts to offset or "hedge" a portion
of its foreign currency transaction exposure through a combination of foreign
exchange contracts and short term borrowings denominated in such local currency.
To date, Microtec's results of operations have not been significantly affected
by currency fluctuations, however, there can be no assurance that Microtec's
future results of operations will not be adversely affected by such
fluctuations.

Cost of Revenue

Cost of License Revenue. Cost of license revenue includes both direct and
indirect cost for the production and duplication of media and manuals for
software products and consists principally of materials, packaging and freight,
amortization of capitalized software costs and royalties. In fiscal 1995 the
cost of license revenue dropped to 10% of license revenue from 13% of license
revenue in both fiscal 1994 and 1993. The decrease is attributable primarily to
an increased percentage of revenue generated from run-time royalties where the
cost of revenue is significantly lower than other software products and, to a
lesser extent, decreased product costs associated with software development
tools. Amortization of capitalized software development costs included in cost
of license revenue amounted to $0.7 million, $0.4 million and $0.3 million in
fiscal 1995, 1994 and 1993, respectively.

Cost of Service Revenue. Cost of service revenue includes customer
technical support and maintenance, engineering services consulting and training.
Gross margin on service revenue was 76%, 75% and 70% in fiscal 1995, 1994 and
1993, respectively. These increases were primarily the result of a greater
portion of service revenue attributable to higher margin service and support
contracts obtained as Microtec's maintenance base continued to grow, offset by
the cost of additional personnel to support real-time operating products.

Operating Expenses

Selling and Marketing. Selling and marketing expenses increased 72%, 45%
and 28% in fiscal 1995, 1994 and 1993, respectively. The increases were
primarily due to Microtec's continued expansion of its global sales and
marketing infrastructure including the addition of sales and marketing personnel
and opening additional sales offices and, to a lesser extent, an increase in
Microtec's direct sales force in connection with the Ready Systems acquisition.
The overall growth in sales personnel was primarily due to the greater

66
<PAGE> 75

emphasis that Microtec placed on direct sales. Selling and marketing expenses
increased as a percentage of revenues to 39% in fiscal 1995 from 31% in both
fiscal 1994 and fiscal 1993.

Research and Development. Research and development expenses increased 30%,
43% and 11% in fiscal 1995, 1994 and 1993, respectively. During fiscal 1995
research and development expenses decreased slightly as a percentage of revenue
to 27% of total revenue from the 28% level in both 1994 and 1993. Research and
development expenses increased in absolute dollars in both fiscal 1995 and
fiscal 1994 primarily as the result of a significant increase in engineering
personnel in connection with the Ready Systems acquisition and internal growth.
Microtec expects that it will be necessary to continue to make significant
investments in product development and engineering for the foreseeable future to
reduce its reliance on third-party providers of certain technologies. While a
significant majority of product development costs have been charged to expense
as incurred, Microtec capitalized software development costs of $0.7 million in
fiscal 1995 and $0.3 million in each of fiscal 1994 and 1993. Capitalized
software development costs represented 5%, 4% and 5% of research and development
expenses for fiscal 1995, 1994 and 1993, respectively.

Acquired Research and Development. In fiscal 1994, Microtec acquired all
of the outstanding stock of Ready Systems for preferred stock valued at $7.0
million, cash of $0.1 million and the assumption of all outstanding stock
options. The transaction was accounted for as a purchase. The excess of the
purchase price and liabilities of Ready Systems over tangible assets was $16.3
million of which $14.4 million was allocated to in-process research and
development and expensed, $1.6 million was allocated to capitalized software and
$0.3 million was allocated to goodwill. In fiscal 1993, Microtec purchased the
outstanding stock of Digitailor AB, a distributor and value-added reseller of
Microtec's products in Sweden, for $0.9 million in cash and common stock valued
at $0.2 million. The transaction was accounted for as a purchase. In connection
with this acquisition, costs in excess of the underlying net value were $0.9
million, of which $0.7 million was attributed to in-process research and
development and expensed during fiscal 1993.

General and Administrative. General and administrative expenses decreased
8% in fiscal 1995 and increased 45% and 27% in fiscal 1994 and 1993,
respectively. General and administrative expenses as a percentage of revenue
were 8%, 12% and 13% in fiscal 1995, 1994 and 1993, respectively. The decrease
in fiscal 1995 resulted primarily from increased revenue levels and from
increased efficiencies in Microtec's finance and administrative operations after
the consolidation with Ready Systems. The increase in absolute dollars in fiscal
1994 was primarily the result of expenses related to the Ready Systems
acquisition and profit-sharing and bonus payments.

Litigation and Settlement Costs. Microtec incurred litigation and
settlement costs related to the Green Hills Litigation of $3.9 million and $1.4
million in fiscal 1994 and 1993, respectively. The Green Hills Litigation was
settled in June 1993 and Microtec has no ongoing obligations with respect to the
products that were the subject of the lawsuit.

Income (Loss) from Operations. The loss from operations of $14.0 million
in fiscal 1994 was primarily due to acquired in-process research and development
of $14.4 million which was expensed and litigation and settlement costs of $3.9
million. Income from operations of $0.5 million in fiscal 1993 was adversely
affected by litigation and settlement costs of $1.4 million.

Other Income (Expense), Net. Other income (expense), net increased to $0.7
million in fiscal 1995 from $0.1 million in fiscal 1994 primarily due to foreign
exchange gains, increases in interest income earned on higher average cash
balances and, to a lesser extent reduced interest expense. Other income
(expense), net increased to $0.1 million in fiscal 1994 from a net expense of
$0.1 million in fiscal 1993. The fiscal 1993 net expense was due to the effect
of minority interests. By the end of fiscal 1993, Microtec had purchased all of
the minority interests of its foreign subsidiaries and, accordingly, fiscal 1994
did not include any similar charges. Interest income decreased in fiscal 1994
due to reduced cash balances as a result of the settlement of the Green Hills
Litigation. Interest expense increased in fiscal 1994 as a result of Microtec's
assumption of Ready Systems' debt.

Income Taxes. Microtec's effective consolidated tax rates were 34%, 40%
and 63% in fiscal 1995, 1994 and 1993, respectively. The overall decrease in the
effective tax rate for fiscal 1995 resulted from research tax

67
<PAGE> 76

credits. The fiscal 1994 tax credit reflects state taxes and research tax
credits. The fiscal 1993 tax rate, due to the low level of U.S. earnings in that
year, was significantly impacted by overseas losses which could not be offset
against U.S. taxable income, as well as research tax credits.

Quarterly Results of Operations

Microtec has experienced quarterly fluctuations in operating results and
such fluctuations may occur in the future. Microtec generally ships products
within a few days after an order is received and, as a result, typically has
little or no backlog. Quarterly revenues and operating results therefore depend
on the volume and timing of orders received during that quarter, which are
difficult to forecast and may vary from quarter to quarter based upon customer
buying decisions. In addition, since its acquisition of Ready Systems,
Microtec's sales cycle has been lengthening because the sales cycle for
real-time operating systems products is generally longer than the sales cycle
for software development tools products. The procurement process of Microtec's
customers typically ranges from a few weeks to several months or longer from
initial inquiry to order, making the timing of sales and license fees difficult
to predict. Moreover, as purchasing of development environments increasingly
becomes a more strategic decision made at higher management levels, there can be
no assurance that sales cycles for Microtec's products will not further
lengthen. Over the last several quarters, Microtec's quarterly revenues have
become increasingly concentrated in the last two or three weeks of each quarter
due primarily to Microtec's lengthening sales cycle and the increasing
percentage of sales made through its direct sales force. Operating results may
also fluctuate due to factors such as the demand for Microtec's products,
introduction of new products and product enhancements or upgrades by Microtec or
its competitors, changes in the proportion of revenues attributable to license
versus service revenue, timing of revenue recognition for development contracts,
buyouts of run-time licenses, changes in the level of operating expenses,
including increases in salaries related to employee review cycles, fluctuations
in foreign currency, competitive conditions in the industry, and unusual events
such as acquisitions or litigation. Because Microtec's staffing and other
operating expenses are based on anticipated revenue, variations in the receipt
of orders or delays in the shipment of products can cause significant variations
in operating results from quarter to quarter.

In view of the Ready Systems acquisition in the second half of fiscal 1994,
the growth in revenues and operating income experienced by Microtec in recent
quarters is not necessarily indicative of future results. In addition, Microtec
believes that period-to-period comparisons of its financial results should not
be relied upon as an indication of future performance. Microtec's operating
results reflect seasonal trends with quarterly license revenues typically lower
in the second fiscal quarter as compared to the first fiscal quarter due in
large part to the slow down in business activity in the European market during
those months.

The following tables set forth selected unaudited consolidated results of
operations data for each of the eight quarters ended March 31, 1995. This
information has been derived from unaudited consolidated financial statements of
Microtec that, in the opinion of management, reflect all recurring adjustments
necessary to fairly present this information when read in conjunction with
Microtec's Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus/Proxy Statement. The results of operations for any
quarter are not necessarily indicative of the results to be expected for any
future period.

<TABLE>
<CAPTION>
FISCAL 1995
QUARTER ENDED(1)
--------------------------------------------------------
JUNE
30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1994 1994 1994 1995
------- ------------- ------------ ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Total Net Revenue............................ $10,644 $10,837 $ 11,603 $12,128
Income from Operations....................... 1,213 1,337 1,447 1,833
Income before income taxes................... 1,340 1,590 1,623 2,037
Net income................................... $ 825 $ 983 $ 1,039 $ 1,503
Net income per share......................... $ 0.10 $ 0.12 $ 0.12 $ 0.16
Shares used in per share calculations(2)..... 8,159 8,263 8,503 9,272
</TABLE>

68
<PAGE> 77

<TABLE>
<CAPTION>
FISCAL 1994
QUARTER ENDED(1)
--------------------------------------------------------
JUNE
30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1993 1993 1993 1994
------- ------------- ------------ ---------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Total net revenue............................ $ 6,635 $ 6,551 $ 9,179 $10,642
Income (loss) from operations................ (3,350) 893 (12,779) 1,237
Income (loss) before income taxes............ (3,315) 882 (12,823) 1,325
Net income (loss)............................ (1,989) 529 (7,688) 817
Net income (loss) per share.................. $ (0.31) $ 0.08 $ (1.11) $ 0.10
Shares used in per share calculations(2)..... 6,492 6,967 6,905 8,006
</TABLE>

- ---------------
(1) Includes the consolidated results of operations of Ready Systems subsequent
to November 30, 1993.

(2) Net income (loss) per share is computed using the same method as described
in Note 1 of Notes to Consolidated Financial Statements.

Liquidity and Capital Resources

Microtec has funded its operations primarily through cash flow from
operations, sales of capital stock and long-term borrowings. At March 31, 1995,
Microtec had working capital of $12.2 million and cash and equivalents and
short-term investments of $13.7 million. Microtec currently has a revolving
line-of-credit agreement with a bank providing for borrowings up to $3.0 million
at the bank's prime rate (9% at March 31, 1995). The line-of-credit agreement
provides for loans to be collateralized by accounts receivable and equipment and
to be due on demand. At March 31, 1995, Microtec had no outstanding borrowings.

In 1995 Microtec generated cash flow from operations of $5.6 million,
resulting primarily from net income of $4.4 million. Microtec's operating
activities used cash of $0.5 million in fiscal 1994. The primary change in
fiscal 1994 was due to the $4.3 million settlement of the Green Hills
Litigation. Microtec's $8.3 million net loss during fiscal 1994 included a
noncash charge for purchased in-process research of $14.4 million related to the
acquisition of Ready Systems, which was offset by an increased deferred tax
asset of $5.4 million.

Microtec's investing activities used cash of $4.3 million in fiscal 1995,
$1.5 million in fiscal 1994 and $2.5 million in fiscal 1993. Investing
activities during those periods consisted primarily of capital expenditures of
$2.6 million, $0.8 million and $1.5 million, respectively, as well as $0.9
million for the acquisition of Digitailor AB in fiscal 1993.

In fiscal 1995 Microtec generated cash of $7.3 million from financing
activities, resulting primarily from its December 1994 initial public offering
pursuant to which it sold one million shares of common stock and received net
proceeds of $6.5 million. Microtec used cash from financing activities of $1.3
million in fiscal 1994. The primary use of cash from financing activities in
fiscal 1994 was the repayment of $1.4 million in bank debt assumed in the Ready
Systems acquisition.

A significant portion of the purchase price paid for Ready Systems was
attributable to products considered in-process. Microtec has incurred
significant research and development expenses related to these products and
Microtec believes that significant additional expenditures will be required to
prepare these products for commercial release, which it anticipates funding
through cash flows from operating activities.

Microtec believes that the cash flow generated from operations, existing
cash balances and available borrowings under Microtec's revolving line of
credit, will be sufficient to meet its cash requirements for at least the next
twelve (12) months.

Results of Operations for the Six Months Ended September 30, 1995 and 1994

The following table sets forth, for the periods indicated, the percentage
of total revenue represented by certain line items from Microtec's Condensed
Consolidated Statement of Operations for the Six Months

69
<PAGE> 78

Ended September 30, 1995 and 1994, respectively, and the percentage change from
the comparative period in each line item:

<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL REVENUE
--------------- PERIOD-TO-PERIOD
PERCENTAGE CHANGE
SIX MONTHS ---------------------
ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1995 1994 1995 COMPARED TO 1994
---- ---- ---------------------
<S> <C> <C> <C>
License revenue.......................................... 75 % 79 % 1%
Service revenue.......................................... 25 21 23
--- --- ---
Total revenue.......................................... 100 100 6
Cost of sales............................................ 15 15 9
--- --- ---
Gross margin........................................... 85 85 5
Operating expenses:
Selling and marketing.................................... 42 38 18
Research and development................................. 27 26 8
General and administrative............................... 10 9 17
--- --- ---
Total operating expenses............................... 79 73 14
Income from operations................................... 6 12 (51)
Interest and other income................................ 1 1 15
--- --- ---
Income before income taxes............................... 7 13 (42)
Provision for income taxes............................... 2 5 (53)
--- --- ---
Net income............................................... 5 % 8 % (35%)
--- --- ---------------
--- --- ---------------
</TABLE>

Net Revenue

License revenue. License revenue increased 1% from $16.9 million in the
first six months of fiscal 1995 to $17.1 million in the first six months of
fiscal 1996. The increase in overall license revenue was primarily the result of
revenue generated by sales of new products introduced in the last four quarters
and a continuing shift from distribution to direct sales resulting in higher
revenue per unit. This increase was partially offset by an absence of a PowerPC
product line, for which Microtec's key competitors currently offer products.
During the first six months of fiscal 1996, Microtec's operations have been
adversely affected by an absence of a PowerPC product line and Microtec believes
that its business and results of operations will continue to be adversely
affected until it is able to offer a competitive product that receives market
acceptance. Microtec expects to generate an increasing percentage of future
license revenue through direct sales and anticipates that license revenue
generated through third parties will correspondingly decrease as a percentage of
total license revenue. In particular, Integrated Systems, Inc. (ISI) sells
products that are competitive with the real-time operating systems products
Microtec acquired in connection with the Ready Systems acquisition. As a result
of the acquisition of competitive products, Microtec expects ISI to increasingly
offer alternative development tools products to its customers and, therefore,
expects that revenue from ISI will decrease in future periods.

Prior to Microtec's acquisition of Ready Systems in the second half of
fiscal 1994, the revenues of Ready Systems were declining. Since the
acquisition, the level of revenue generated by the real-time operating systems
and host/target connectivity products acquired in connection with the Ready
systems merger have been relatively stable. There can be no assurance that
Microtec will be successful in maintaining or increasing its sales of real-time
operating systems or host/target connectivity products and the failure to do so
could have a material adverse effect on Microtec's results of operations.

Service revenue. Service revenue increased 23% from $4.5 million in the
first six months of fiscal 1995 to $5.6 million in the first six months of
fiscal 1996. The increase was primarily due to increased sales of service and
support contracts on new orders and the renewal of service and support contracts
on existing licenses. Service revenue increased at a faster rate than license
revenue for the six months ended

70
<PAGE> 79

September 30, 1995 due to the large number of service and support contracts
being renewed for existing licenses and the increased sales of new service and
support agreements.

Domestic license and service revenue increased by 21% between the
comparative six month periods, while international license and service revenue
decreased by 4%. The international revenue decrease was primarily due to a large
non-recurring order from an Asian customer in fiscal 1995. The percentage of
Microtec's total domestic revenue increased to 46% of net revenue in the first
six months of fiscal 1996, compared to 40% in the first six months of fiscal
1995.

Gross Margin. Gross margin was 85% for both of the six month periods ended
September 30, 1995 and 1994. This reflects a product mix change that has license
revenue generating 75% of total revenue in the first six months of fiscal 1996
versus 79% of revenue in the first six months of fiscal 1995. For the first six
months of fiscal 1996, Microtec experienced higher gross margin on license
revenue primarily generated through run-time royalties where the cost of sales
is significantly lower than other products, offset by a lower gross margin on
service revenue.

Sales and Marketing. Sales and marketing expenses increased 18% from $8.2
million in the six months ended September 30, 1994 to $9.7 million in the six
months ended September 30, 1995. Sales and marketing expenses as a percent of
net revenue increased from 38% in the first six months of fiscal 1995 to 42% in
the first six months of fiscal 1996. This increase is due primarily to an
increase in Microtec's direct sales force and, to a lesser extent, Microtec's
continued expansion of its global sales and marketing infrastructure including
the addition of sales and marketing personnel and opening additional sales
offices. The growth in sales personnel was primarily due to the greater emphasis
that Microtec is now placing on direct sales.

Research and Development. Research and development expenses increased 8%
from $5.7 million in the six months ended September 30, 1994 to $6.1 million in
the six months ended September 30, 1995. This increase reflects the additional
costs associated with utilizing certain subcontractors and, to a lesser extent
the addition of engineering personnel. Research and development expenses as a
percent of net revenue increased from 27% for the six months ended September 30,
1994 to 28% for the six months ended September 30, 1995, primarily due to the
additional costs associated with utilizing certain subcontractors.

General and Administrative. General and administrative expenses increased
17% from $1.9 million in the six months ended September 30, 1994 to $2.2 million
in the six months ended September 30, 1995 primarily due to the nonrecurring
expenses related to the ISI Arbitration (see Note 4 to Microtec's Condensed
Consolidated Financial Statements for the six months ended September 30, 1995).
Microtec expects the absolute dollar amounts expensed in the general and
administrative area to increase in the future, and accordingly, these expenses
may fluctuate as a percent of revenue.

Other Income (Expense), Net. Other income (expense), net remained
relatively flat at $0.4 million for both the six months ended September 30, 1995
and 1994. This is primarily due to increases in interest income earned on higher
average cash balances partially offset by recognizing lesser amounts of foreign
currency transaction gains in the six months ended September 30, 1995.

Provision for Income Taxes. Tax expense for the six months ended September
30, 1995 reflects Microtec's expected annual tax rate of 31%, which decreased
slightly from the 38% rate for comparable period last year based on expected
changes in the mix of foreign and domestic income, which are taxed at differing
rates, and to a lesser extent the effect of research tax credits.

Potential Fluctuations in Quarterly Results. Microtec has experienced
quarterly fluctuations in operating results and such fluctuations may occur in
the future. In particular, during the first six months of fiscal 1996 Microtec's
operations were adversely affected by this absence of a PowerPC product line and
Microtec believes that its business and results of operations will continue to
be adversely affected until it is able to offer a competitive product that
receives market acceptance. Microtec generally ships products within a few days
after an order is received and, as a result, typically has little or no backlog.
Quarterly revenues and operating results therefore depend on the volume and
timing of orders received during that quarter, which are difficult to forecast
and may vary from quarter to quarter based upon customer buying decisions.
Microtec's sales cycle has been lengthening because the sales cycle for
real-time operating system products is generally longer than

71
<PAGE> 80

the sales cycle for software development tools products. The procurement process
of Microtec's customers typically ranges from a few weeks to several months or
longer from initial inquiry to order, making the timing of sales and license
fees difficult to predict. Moreover, as purchasing of development environments
increasingly becomes a more strategic decision made at higher management levels,
there can be no assurance that sales cycles for Microtec's products will not
further lengthen. Over the last several quarters, Microtec's quarterly revenues
have become increasingly concentrated in the last two or three weeks of each
quarter due primarily to lengthening sales cycle and the increasing percentage
of revenue generated through its direct sales force. Operating results may also
fluctuate due to factors such as the demand for Microtec's products,
introduction of new products and product enhancements or upgrades by Microtec or
its competitors, changes in the proportion of revenue attributable to license
versus service revenue, timing of recognition of revenue for development
contracts, buyouts of run-time licenses, changes in the level of operating
expenses, including increases in salaries related to employee review cycles,
fluctuations in foreign currency, competitive conditions in the industry, and
extraordinary events such as acquisitions or litigation. Because Microtec's
staffing and other operating expenses are based on anticipated revenue,
variations in the receipt of orders or delays in the shipment of products can
cause significant variations in operating results from quarter to quarter.

Liquidity and Capital Resources

Microtec has funded its operation through cash flow from operations. At
September 30, 1995, Microtec had $11.3 million of cash, cash equivalents and
short-term investments. This represents a decrease of $2.4 million from March
31, 1995. Microtec currently has a revolving line of credit with a bank
providing for borrowings up to $3.0 million at the bank's prime lending rate
(8.75% at September 30, 1995). The line of credit agreement provided for loans
to be collateralized by accounts receivable and equipment and to be due on
demand. At September 30, 1995, Microtec had no outstanding borrowings. During
the second fiscal quarter, Microtec announced that the Board of Directors
authorized Microtec to repurchase up to 150,000 shares of common stock for cash,
from time-to-time at market prices. During the quarter ended September 30, 1995,
Microtec repurchased a total of 23,400 shares of common stock.

Microtec's operating activities generated cash of $0.6 million in the six
months ended September 30, 1995, compared to cash generated from operations of
$1.9 million in the six months ended September 30, 1994. The decrease in cash
generated by operating activities was primarily due to lower net income and a
reduction of accounts payable and accrued liabilities, partially offset by the
changes in accounts receivable. Net cash used in investing activities totaled
$1.9 million in the first six months of fiscal 1996 compared to $2.0 million in
the first six months of fiscal 1995. The net cash used in investing activities
was due primarily to the purchase of an equity interest in an affiliate (see
Note 3 to Microtec's Condensed Consolidated Financial Statements) and capital
purchases, offset by a decrease in short-term investments and amounts refunded
for an office lease deposit. Financing activities provided cash of $0.5 in the
six months ended September 30, 1995. Cash generated by financing activities
include $0.7 million representing the proceeds from the exercise of common stock
options, partially offset by the repurchase of common stock for $0.2 million.

Microtec believes that its existing resources of liquidity, cash generated
from operating activities and available borrowings under Microtec's revolving
line of credit, will satisfy Microtec's cash requirements for at least the next
twelve (12) months.

72
<PAGE> 81

INFORMATION CONCERNING MICROTEC

BUSINESS

General

Microtec is a provider of software products used for the development and
operation of embedded systems. Microtec offers a broad, integrated line of
software products including software development tools, real-time operating
systems and host/target connectivity products. 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. Microtec markets and supports its products on a global basis
through its worldwide sales and service organization, distributors, OEMs and
VARs.

Microtec was incorporated in California on March 28, 1979 and
reincorporated in Delaware on December 1, 1994. Microtec's principal executive
offices are located at 2350 Mission College Boulevard, Santa Clara, California
95054 and its telephone number at that location is (408) 980-1300.

Industry Background

Embedded systems are hidden computers found in many common products such as
VCRs, telephones and fax machines. An embedded system is comprised of a
microprocessor and related software that are dedicated to a specialized task or
set of tasks embedded within a larger device. Many products require "real-time"
embedded systems that provide an immediate, predictable and reliable response to
unpredictable sequences of external events. For example, an embedded system that
controls an anti-lock braking system in an automobile needs to react to external
events such as pressure on the brake, speed of the automobile and road
conditions, all within a fraction of a second.

The availability and decreasing cost of more powerful microprocessors has
enabled the use of embedded systems in a wide range of applications in the
communications, medical instrumentation, transportation, computer, industrial
and consumer markets. These embedded systems are rapidly replacing existing
systems based on mechanical, analog or discrete digital implementations and are
enabling the development of many new applications. Embedded systems are used
today in telecommunications products such as cellular telephones, satellites and
call processing systems; datacommunications products such as modems, routers and
hubs; medical instrumentation systems such as implantable defibrillators and
diagnostic imaging machines; and consumer entertainment products such as video
game consoles and set-top boxes.

The development of applications software for embedded systems requires
software development tools and, for more complex embedded systems, a real-time
operating system. Software development tools, including compilers, debuggers and
simulators, are used by developers to create applications software that enable
the embedded system to perform its required functions. Developers use
workstations or personal computers as a platform (the "host") to create
applications code and then use connectivity software and debuggers to
interactively load, test and debug applications software on the embedded
microprocessor (the "target"). Real-time operating system software is used in
many embedded systems to provide system level functions such as task scheduling,
memory management and communication with input/output devices and other embedded
systems.

Embedded systems developers typically purchase software development tools
from third-party vendors and many use internally developed operating systems. In
recent years, however, embedded systems developers have increasingly begun to
replace internally developed real-time operating systems with third-party
solutions. The market for embedded software development tools and real-time
operating systems is highly fragmented with over 100 third-party vendors
offering software products for embedded systems software development. The
ongoing adoption of third-party real-time operating systems has segmented the
32-bit embedded systems software development market into three general
categories: (i) developers who develop applications without an operating system;
(ii) developers who continue to use internally developed operating systems; and
(iii) developers who have migrated to third party development solutions.

73
<PAGE> 82

In order to provide greater functionality, embedded systems are
increasingly based upon 32-bit microprocessors and have a significantly higher
software content than embedded systems based upon less powerful microprocessors.
The complexity and size of these new software applications requires a more
substantial engineering effort, necessitating more sophisticated development
tools and real-time operating systems. As the number of engineers working on a
development project increases, coordination of development efforts becomes more
critical to meet time-to-market and quality requirements. As a result, the cost
of software development has increased rapidly and software development has often
become the bottleneck in the overall embedded systems development process.

Demand for embedded systems software development tools and real-time
operating systems has been driven by the increasing proliferation of embedded
systems and the larger number of software engineers required to develop complex
applications. Companies developing embedded systems are focused on maximizing
productivity and minimizing costs while maintaining flexibility. Thus, embedded
systems developers are seeking to increase productivity by utilizing a suite of
software development tools that are fully integrated and allow software
development to occur concurrently with hardware development. To minimize
development and support costs, embedded systems developers seek solutions that
enable reuse of applications code and reduce the need for retraining. At the
same time, embedded systems developers want to maintain flexibility and thus are
seeking uniform suites of software development products for different host and
target systems and open solutions that allow them to preserve their existing
investments and choose among products from third-party vendors.

Demand for third-party real-time operating systems has also been driven by
growth in real-time embedded systems and by a migration of embedded systems
developers from internally developed solutions to third-party products. Embedded
systems developers are increasingly replacing internally developed real-time
operating systems primarily because development and maintenance is costly and
diverts engineering resources that could otherwise be focused on application
development. In addition, internally developed real-time operating systems are
often developed for a single project and typically are not easily portable to
other microprocessors or scalable for differing applications.

The make-versus-buy and product selection decisions for development tools
and real-time operating systems have typically been made on a project-by-project
basis, and companies frequently use different development tools and real-time
operating systems for each embedded software project often resulting in
incompatibility and increased training and support costs. As product development
costs and time-to-market pressures increase, enterprise-wide software
productivity is becoming a more strategic issue that is being closely evaluated
at senior management levels. Microtec believes that this trend towards higher
level purchasing decisions will result in more companies standardizing on
integrated, enterprise-wide solutions, which will drive a market consolidation
around a small number of vendors who are able to provide complete integrated
solutions and global sales, service and support.

Products and Services

Microtec provides integrated software development solutions including a
suite of application development tools optimized for embedded software
development, feature-rich, reliable real-time operating systems and advanced
host/target connectivity products that allow embedded software developers to
focus more resources on application software development. Microtec currently
offers software development tools, real-time operating systems and software
connectivity products for embedded systems based on a wide range of
industry-standard microprocessors. Microtec also offers a wide range of services
including technical support, consulting, training and contract development.

Products

Software Development Tools. Microtec offers a broad line of software
development tools including compilers, assemblers, linkers, simulators and the
XRAY Debugger. Microtec's XRAY MasterWorks product offers an integrated
development environment that provides interactive coordination of individual
tools through an easy-to-use common interface.

74
<PAGE> 83

Microtec offers industry-standard C compilers and, for most of its
supported microprocessors, object-oriented C++ compilers. Microtec's XRAY
Debugger is a widely-used product whose source code debugging capabilities are
designed to work in coordination with the features of Microtec's other software
development tools and real-time operating systems. Microtec also provides
host-based simulation products that simulate execution of an application by the
target microprocessor allowing engineers to develop software for hardware that
is unavailable or still unstable. These software development tools are
compatible with UNIX workstations offered by Sun Microsystems and
Hewlett-Packard and with IBM-compatible personal computers under DOS, although
not all products are available for all host computers. A Windows version of the
XRAY Debugger for Motorola 68xxx processors is available and Windows versions of
the XRAY Debugger are being implemented for other microprocessor families.

Connectivity Products. Spectra is Microtec's host/target software
connectivity product, portions of which reside on the host computer and the
target embedded system. Its client/server architecture enables engineers working
on multiple host systems to coordinate access to one or more embedded systems
concurrently. Spectra allows a team of engineers using multiple host-based
development tools to have access to one or more targets. The host-based
development tools can include both Microtec development tools and other
third-party development tools. Spectra is available for UNIX workstations
offered by Sun Microsystems and Hewlett-Packard and is under development for
Windows. Microtec offers KernelIntegrator to facilitate the connection of
Spectra to various other real-time operating systems. Microtec also offers
NetROM, a hardware assist product that facilitates network connectivity.

Real-Time Operating Systems. The VRTX family of compatible embedded
real-time operating systems includes VRTX32, a widely-deployed system that has
been certified in certain applications regulated by the FAA and FDA, such as
airplane flight control systems and blood serum analyzers; VRTXsa, an enhanced
feature-rich real-time operating system designed for more complex embedded
applications such as advanced telecommunication applications; and VRTXmc, a
recently announced microcontroller real-time operating system adapted to the
requirements of embedded systems with very limited hardware resources such as
cellular phones. These VRTX real-time operating systems serve as the foundation
for layered run-time packages offered by Microtec to support networking and
access to file systems by embedded applications.

Licensing. Microtec's software development products are typically licensed
on a per-user basis. Microtec's real-time operating systems and layered run-time
packages are also generally licensed for development on a per-user basis.
Run-time license fees are typically charged on a per-unit basis when the
customer's application is deployed. List prices for Microtec's software
development tools and real-time operating system development licenses generally
range from $1,500 to $16,000. Microtec derives a substantial portion of its
revenues from software products targeted at the Motorola 68xxx family of
microprocessors.

The market for Microtec's products is characterized by ongoing
technological developments, evolving industry standards and rapid changes in
customer requirements. Microtec's success depends upon its ability to offer its
products across a spectrum of microprocessor families used in the embedded
systems market, to continue to enhance its existing product lines, to develop
and introduce in a timely manner new products that take advantage of
technological advances, and to respond promptly to customer requirements. In
particular, Microtec has identified a number of extensions to its existing
product offerings as well as new products which it believes are important to its
continued success in the embedded systems market including additional software
development tools and connectivity products for the Microsoft Windows
("Windows") environment, real-time operating systems and connectivity products
for additional microprocessors, and networking enhancements to its real-time
operating systems products. Software development tools and real-time operating
systems designed for the Motorola 68xxx family of microprocessors accounted for
a substantial portion of Microtec's product revenue in fiscal 1995. As a result,
any shift in the embedded systems market towards other microprocessors before
Microtec develops its product line for such target microprocessors, or the
occurrence of any factor adversely affecting the demand for the Motorola 68xxx
microprocessors, could have a material adverse affect on Microtec's business and
results of operations. In particular, in the first and second quarters of fiscal
1996 Microtec experienced a more rapid than anticipated shift in the market
toward the PowerPC, for which Microtec does not currently provide products.
Microtec's resulting operations for the first and second quarters were adversely
affected by the absence of a PowerPC product line, and although Microtec

75
<PAGE> 84

has contracted with a third party developer to help provide PowerPC products in
the second half of fiscal 1996, there can be no assurance that Microtec will be
successful in developing and marketing such products on a timely basis or that
they will adequately address the needs of the marketplace. Microtec believes
that its business and results of operations will continue to be adversely
affected until it is able to offer a competitive PowerPC solution that receives
market acceptance. There can be no assurance that Microtec will be successful in
developing and marketing, on a timely basis, enhancements to its existing
products or new products, or that its new products will adequately address the
changing needs of the marketplace. Failure by Microtec in any of these areas
will materially and adversely affect Microtec's business and results of
operations.

Prior to Microtec's acquisition in the second half of fiscal 1994 of Ready
Systems Corporation, a developer of real-time operating systems software, the
revenues of Ready Systems were declining. Since the acquisition, the level of
revenue generated by the real-time operating systems and host/target
connectivity products acquired in connection with the Ready Systems acquisition
have been relatively stable. These products are key to Microtec's strategy of
providing integrated solutions for embedded systems developers and Microtec's
future success will depend on its ability to increase sales of its real-time
operating systems and host/ target connectivity products. There can be no
assurance that Microtec will be successful in maintaining or increasing its
sales of real-time operating systems or host/ target connectivity products and
the failure to do so could have a material adverse effect on Microtec's results
of operations.

Service and Support

Microtec provides a wide range of customer services including technical
support, training and consulting. A high level of customer service and support
is essential because many of Microtec's customers depend on Microtec's products
to support the development and operation of complex, mission-critical embedded
applications. Microtec's service and support contracts typically have one year
terms and include technical support, product upgrades and updates. Microtec's
technical support staff assists customers in the installation and use of
Microtec's products. Technical support outside of North America is provided by
Microtec's staff of support engineers located at six sites, four in Europe and
two in Asia/Pacific. Distributors and OEMs generally offer first-level customer
support to their end-user customers and rely on Microtec for additional support.

Microtec offers consulting services through an internal consulting group
and independent consultants trained in the use of Microtec's products. In
addition to support and consulting services, Microtec offers a comprehensive
training program to customers; publishes a periodic technical publication,
NewBits; and maintains a bulletin board and a network of user groups throughout
the world. Microtec also selectively engages in contract development activities
related to extensions of its product line.

Marketing, Sales and Distribution

Microtec distributes its products and provides services worldwide through
an international direct sales force, as well as VARs, OEMs and distributors. As
of November 1, 1995, Microtec had 63 sales employees worldwide including 28
sales employees located in seven direct sales offices throughout North America
and 35 sales employees located in wholly-owned subsidiaries in France, Germany,
Japan, Sweden and the United Kingdom. Microtec also has international
distribution agreements covering more than 13 countries in Europe, Asia and
South America as well as Australia. For fiscal 1995, 1994 and 1993,
international sales represented 56%, 56% and 52%, respectively, of Microtec's
revenues. Microtec expects that international sales will continue to account for
a significant portion of Microtec's revenues in the future.

Microtec has established non-exclusive cooperative marketing and
distribution relationships with industry leaders in the semiconductor, hardware
and software markets. These relationships provide Microtec with access to a
broader customer base and enable it to have its products offered as key
components of larger development solutions. Microtec believes that developing
and maintaining these relationships is important to Microtec's ability to
achieve broad market penetration and obtain key design wins.

Microtec works closely with a number of VARs and OEMs worldwide to help
customers meet their specific needs for software development tools, hardware
assist tools and real-time operating systems. However,

76
<PAGE> 85

as purchasing decisions are beginning to be made at higher levels of management,
Microtec has allocated more resources to its direct sales efforts. As a result,
Microtec expects that the percentage of its net revenues generated through these
reseller channels will decrease. Furthermore, Integrated Systems, Inc. ("ISI"),
a VAR of Microtec's software development tools, sells products which are
competitive with the real-time operating systems products that Microtec acquired
in connection with its acquisition of Ready Systems. As a result of the
acquisition of competitive real-time operating systems products, Microtec
expects ISI to increasingly offer alternative software development tools to its
customers and, as a result, expects revenue from ISI to decrease substantially
in future periods. There can be no assurance that Microtec's business and
results of operations will not be materially and adversely affected if such
decrease were to occur over a short time period and Microtec were unable to
replace the revenue currently generated by ISI with revenue from other
customers. ISI accounted for 5% of revenue for fiscal 1995. ISI was Microtec's
largest customer in fiscal 1994, accounting for over 7% of revenue.

The sales cycle for Microtec's products typically ranges from a few weeks
to several months or more from the initial identification of a qualified
potential customer to the installation of the software. The procurement process
of Microtec's customers typically ranges from a few weeks to several months or
longer from initial inquiry to order, making the timing of sales and license
fees difficult to predict, and Microtec's sales cycle has been lengthening
because the sales cycle for real-time operating systems products is generally
longer than the sales cycle for software development tools products. Moreover,
as purchasing of development environments increasingly becomes a more strategic
decision made at higher management levels, there can be no assurance that sales
cycles for Microtec's products will not further lengthen. Microtec's coordinated
sales organization includes telemarketing, telesales and field sales functions.
The field sales force focuses on selling to major accounts. Microtec's success
also depends in large part upon its ability to attract and retain highly-skilled
sales and marketing personnel and to provide them with timely specialized
training required to market, position and sell Microtec's technical software
products.

In support of the sales organization, the marketing department positions,
promotes and markets Microtec's products. Marketing personnel engage in a
variety of activities including public relations, direct marketing, trade shows,
advertising, seminars and newsletters. In addition, the marketing department
evaluates market requirements and customer needs, and performs market research.

Research and Development

Microtec has made substantial investments in research and development.
Microtec believes that its future will depend upon its ability to enhance its
existing products and develop and introduce new products that keep pace with
technological developments in the embedded systems marketplace and address the
increasingly sophisticated needs of its end-users. Microtec intends to expand
its existing product offerings and to introduce new products for the embedded
systems market. While Microtec expects that certain of its new products will be
developed internally, Microtec may, based on timing and cost considerations,
expand its product offerings through acquisitions or technology licensing.

Microtec has identified a number of extensions to its existing product
offerings which it believes are important to the further penetration of the
embedded systems market, including additional software development tools and
connectivity products for the Windows environment, real-time operating systems
designed for additional microprocessors and networking enhancements to its
real-time operating systems products. Microtec has also announced its commitment
to provide software development tools and real-time operating systems for the
Motorola PowerPC microprocessor. Part of Microtec's success in developing its
PowerPC product line will depend on third-party developers to provide it with
certain product enhancements. There can be no assurance that the development of
these products will be completed successfully or on time or that the products
will include features required to achieve market acceptance. Microtec has in the
past experienced delays in software development and there can be no assurance
that Microtec will not experience delays in connection with its current or
future product development activities. Prior delays have been the result of the
reallocation of engineering resources to other higher priority projects,
problems with independent contractors, changes in market requirements and
unanticipated difficulties in engineering. While Microtec believes it has
adequately resolved the causes of prior delays, there can be no assurance that
future delays in

77
<PAGE> 86

the introduction of new products will not be the result of similar problems. If
Microtec is unable to successfully develop and introduce its products in a
timely manner and achieve acceptance, Microtec's business and results of
operations could be materially and adversely affected.

Microtec has a separate quality assurance and quality control group.
Application specialists within this group, who generally have more than three
years' experience with Microtec's products, perform the testing and packaging of
new products. Microtec has a separate documentation group that is dedicated to
creating and updating the documentation for each product.

During fiscal 1995, 1994 and 1993 research and development expenses were
$11.9 million, $9.2 million and $6.4 million, respectively, excluding
capitalized software development costs. Microtec capitalized software
development costs of $0.7 million in fiscal 1995 and $0.3 million in each fiscal
year 1994 and 1993. Microtec anticipates that it will continue to commit
substantial resources to research and development in the future.

Competition

The embedded software development industry is highly competitive and is
characterized by rapidly advancing technology. Microtec's products compete with
software offered by other third parties, including software vendors and
microprocessor manufacturers, and software developed internally by embedded
system manufacturers. Third-party competition is comprised of over 100 vendors
of software development tools or real-time operating systems for embedded
systems including many privately-held companies and several publicly-held
companies. Many of the microprocessor manufacturers, including Intel Corp. and
Motorola, Inc., also sell products that directly compete with Microtec's
products. Microtec also faces competition from the Free Software Foundation,
which makes its GNU software development tools available without a license fee,
and from companies, such as Intel Corp., which commercialize GNU software. In
addition, as the industry continues to develop, Microtec expects that additional
competitors, including other large software vendors such as Microsoft, may seek
to expand their product offerings in the embedded software development market.
Many of Microtec's existing and potential competitors have substantially greater
financial, technical, marketing and sales resources than Microtec and there can
be no assurance that Microtec will be able to successfully compete against these
companies.

In addition to competition from other third-party vendors, Microtec
believes that it faces significant competition for real-time operating systems
from companies that internally develop and maintain real-time operating systems
rather than purchasing products from third-party software vendors such as
Microtec. Many of these organizations have substantial programming resources and
the ability to develop specific products for their needs. While Microtec
believes its products and services offer a number of advantages over internally
developed alternatives, many of these companies have significant investments in
their existing software and Microtec's future success will depend to a large
extent on its ability to persuade existing and potential customers to replace or
augment their internally developed real-time operating systems with Microtec's
products. There can be no assurance that Microtec can successfully accomplish
this objective.

Microtec believes its ability to effectively compete in the embedded
software development market depends on factors both within and outside its
control, including timing and success of new products developed by Microtec and
its competitors, product performance and price, distribution and customer
support, product reputation, customers' willingness to replace internally
developed software and customers' assessment of Microtec's financial resources
and its technical and service expertise. There can be no assurance that Microtec
will be able to compete successfully with respect to these and other factors. In
particular, competitive pressures, including pricing pressures and new product
introductions, from existing and new competitors could adversely affect
Microtec's business and results from operations. Microtec currently does not
provide software development tools and real-time operating systems for the
PowerPC microprocessor which has placed it at a competitive disadvantage since
its key competitors currently offer PowerPC products. In particular, in the
first and second quarters of fiscal 1996, Microtec's operations were adversely
affected by this absence of a PowerPC product line and Microtec believes that
its business and results of operations will continue to be adversely affected
until it is able to offer a competitive product that receives market acceptance.
Also, run-time licenses, which provide for per-unit royalty payments for each
embedded system that incorporates

78
<PAGE> 87

Microtec's real-time operating systems, may be subject to significant pricing
pressures, which could also have an adverse affect on Microtec's business and
results from operations.

Microtec believes that it competes effectively in the embedded software
market on the basis of product functionality and reliability, price/performance
characteristics, reputation, worldwide infrastructure, support services, sales
and marketing strength and financial stability. There can be no assurance that
Microtec will be able to compete successfully in the embedded software market or
that its profitability or financial performance will not be adversely affected
by increased competition. Further there can be no assurance that Microtec's
current competitors or other entities will not develop embedded software
products or other technologies offering significant advantages over Microtec's
technology, which could have a material adverse effect on Microtec's business
and financial results.

Proprietary Rights

Microtec's success is dependent upon its proprietary technology and
products. Microtec regards its software as proprietary and, to date, Microtec
has relied principally upon copyrights, trademarks, trade secrets and
contractual restrictions to protect its proprietary technology. Microtec
currently has no patents and has one U.S. patent application pending. Microtec
generally enters into confidentiality agreements with its employees and
confidentiality and license agreements with its distributors, customers and
potential customers, and limits access to and distribution of the source code to
its software and other proprietary information. Under some circumstances,
Microtec grants licenses that give limited access to the source code of
Microtec's products which increases the likelihood of misappropriation or misuse
of Microtec's technology. End-user licenses of Microtec's software are often in
the form of shrink-wrap license agreements. A shrink-wrap license agreement is a
printed license agreement included within packaged software that sets forth the
terms and conditions under which the purchaser can use the product, and binds
the purchaser to such terms and conditions upon opening and using the software
products. Shrink-wrap licenses typically are not signed by licensees and
therefore may be unenforceable under the laws of many jurisdictions. In
addition, the laws of some foreign countries do not protect Microtec's
proprietary rights to the same extent as do the laws of the United States.
Accordingly, despite precautions taken by Microtec, it may be possible for
unauthorized third parties to copy certain portions of Microtec's technology or
to obtain and use information that Microtec regards as proprietary. There can be
no assurance that the steps taken by Microtec will be adequate to prevent
misappropriation of its technology or to provide an adequate remedy in the event
of a breach by others.

Certain technology used in Microtec's products is licensed from third
parties. These licenses generally require Microtec to pay royalties and to
fulfill confidentiality obligations. In the future, it may be necessary or
desirable for Microtec to seek additional licenses to intellectual property
rights held by third parties. There can be no assurance that such licenses will
be available or, if such licenses are available, that the terms thereof will not
have a material adverse effect on Microtec's business, financial condition and
results of operations.

There has been substantial industry litigation regarding intellectual
property rights of technology companies. Although Microtec is not aware of any
infringement by its products of any patents or proprietary rights of others,
patent protection for software is still a developing area of law and increased
visibility of Microtec and its products could provoke claims of infringement
from third parties. Microtec has agreed to indemnify its customers for liability
incurred in connection with the infringement of a third party's intellectual
property rights including patents. Microtec has, in the past, been subject to
litigation related to alleged infringement by Microtec of third party rights,
which resulted not only in Microtec incurring significant legal fees and
settlement costs but also in a substantial diversion of management attention. In
the future, litigation may be necessary to enforce and protect trade secrets and
other intellectual property rights owned by Microtec. Microtec may also be
subject to litigation to defend Microtec against claimed infringement of the
rights of others or to determine the scope and validity of the proprietary
rights of others. Any such litigation could be costly and cause diversion of
management's attention, either of which could have a material adverse effect on
Microtec's results of operations and financial condition. Adverse determinations
in such litigation could result in the loss of Microtec's proprietary rights,
subject Microtec to significant liabilities, require Microtec to seek licenses
from third parties or prevent Microtec from manufacturing or selling its
products, any one of which could have a material adverse effect on Microtec's
business, financial condition and results of

79
<PAGE> 88

operations. Furthermore, there can be no assurance that any necessary licenses
will be available on reasonable terms, or at all.

Manufacturing and Backlog

Microtec prepares master software media, user manuals and packaging for
each product. Microtec's media duplication, as well as its product packaging, is
performed by Microtec at its facilities throughout the world, while printing of
user manuals and related materials is performed to Microtec's specifications by
outside sources in both the United States and, for those printed in Kanji, in
Japan. During peak demand, Microtec has used outside sources for media
duplication and product packaging to its specifications. To date, Microtec has
not experienced any material difficulties or delays in manufacture through an
interruption in its own production or the production of any of its suppliers.
Microtec grants duplication rights to certain of its OEMs. Because of the
generally short time between order and shipment, Microtec does not believe that
its backlog as of a particular point is indicative of future sales levels.

EMPLOYEES

As of November 1, 1995, Microtec employed 332 people, including 164 in
marketing, sales and support services, 128 in engineering and product
development and 40 in management, operation, finance and administration. Of
these employees, 248 are located in the United States and 84 are employed by
Microtec's subsidiaries in the United Kingdom, Germany, France, Sweden and
Japan. None of Microtec's employees is represented by a labor union or is the
subject of a collective bargaining agreement. Microtec has never experienced a
work stoppage and believes that its employee relations are good.

PROPERTIES

Microtec's executive offices are located in a single building in Santa
Clara, California, and consist of approximately 59,000 square feet under lease
agreements expiring through February 2003. This space is also used for research
and development, marketing and sales, operations and administration. The annual
base rental payment for this space is approximately $1.4 million. Microtec also
leases six other domestic sales and support offices in the United States and
international sales offices in the United Kingdom, Germany, France, Sweden and
Japan for an aggregate annual rental payment of approximately $0.8 million.
Microtec believes that its facilities are adequate for its present needs and
that additional space will be available as needed.

LEGAL PROCEEDINGS

In September 1994, Microtec initiated legal proceedings against ISI seeking
to recover amounts which Microtec believes are owed under Microtec's VAR
agreement with ISI (the "ISI Agreement"). In response, ISI indicated that it
believed that it had certain counterclaims against Microtec. In November 1994,
Microtec and ISI entered into a Partial Settlement, Arbitration and Release
Agreement (the "Arbitration Agreement") whereby the parties agreed to submit
certain claims of each party under the ISI Agreement to binding arbitration and
to release all other known and unknown claims. On March 31, 1995, the arbitrator
found in Microtec's favor on all significant elements of the Arbitration. The
final settlement award was determined in Microtec's first quarter of fiscal 1996
and the awarded amounts and additional costs related to the Arbitration were
reflected in Microtec's operating results for the quarter ended June 30, 1995.
The resulting impact on Microtec's liquidity and operating results for such
quarter was not material.

80
<PAGE> 89

MANAGEMENT

The directors and officers of Microtec, and their ages as of November 1,
1995, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ ---- ----------------------------------------------------
<S> <C> <C>
Jerry Kirk.................... 47 President, Chief Executive Officer and Chairman of
the Board
Daniel E. Jaskolski........... 50 Executive Vice President, Chief Operating Officer,
Secretary and Director
Kenneth E. Lonchar............ 37 Vice President, Finance and Administration and Chief
Financial Officer
James F. Ready................ 46 Vice President, Chief Technical Officer
Luke C. Dion.................. 40 Vice President, Engineering
Paul M. Getty................. 47 Vice President, Worldwide Sales
Gail E. Hamilton.............. 46 Vice President, Marketing
Andre C. Kobel................ 53 Vice President, Business Development
Ronald C. Workman............. 40 Vice President, Applied Customer Engineering
Services
Gregory M. Avis (1)(2)........ 37 Director
Alan C. Herzig (1)(2)......... 61 Director
John C. Savage (1)(2)......... 47 Director
</TABLE>

- ---------------
(1) Member of the Compensation Committee

(2) Member of the Audit Committee

Jerry Kirk, a founder of Microtec, has been Microtec's President, Chief
Executive Officer and Chairman of the Board since 1979. Before founding
Microtec, Mr. Kirk held engineering and engineering management positions in the
semiconductor industry and at Bell Telephone Laboratories. Mr. Kirk holds a B.S.
degree in Electrical Engineering from Kansas State University and an M.S. degree
in Electrical Engineering and Computer Science from the University of
California, Berkeley.

Daniel E. Jaskolski joined Microtec in April 1983 as General Manager and
was named Executive Vice President, Chief Operating Officer and a Director in
March 1984. From October 1970 until November 1982, Mr. Jaskolski held several
software development management positions with Medicus Systems Corporation, a
provider of information systems to health care institutions. Mr. Jaskolski holds
a B.A. degree in Mathematics from La Salle College and an M.B.A. from the
University of Pittsburgh.

Kenneth E. Lonchar joined Microtec in November 1988 as Director of Finance
and was promoted in August 1989 to Vice President, Finance and Administration
and Chief Financial Officer. Mr. Lonchar holds a B.B.A. degree in Accounting and
an M.B.A. degree from Idaho State University. Mr. Lonchar is a Certified Public
Accountant.

James F. Ready joined Microtec in December 1993 as Vice President, Chief
Technical Officer. Mr. Ready, a founder of Ready Systems, served as a Director
and its Vice President from 1981 to Microtec's acquisition of Ready Systems. Mr.
Ready holds a B.A. from the University of Illinois and an M.A. from the
University of California, Berkeley.

Luke C. Dion joined Microtec in January 1991 as Vice President,
Engineering. From July 1986 to December 1990, Mr. Dion was Software Operations
Manager at the Motorola Microcomputer Division (now called the Motorola Computer
Group). Mr. Dion received B.A. degrees in Mathematics and Computer Science from
the University of California, Berkeley.

Paul M. Getty joined Microtec in September 1992 as Vice President,
Worldwide Sales. From June 1992 until August 1992, he was self-employed as a
consultant to start-up businesses and as an advisor to Ampro Computers, a
computer systems company. He was previously Vice President of Worldwide Sales at
Ampro Computers from January 1991 to May 1992. From January 1989 until December
1990, Mr. Getty was

81
<PAGE> 90

employed as a sales executive with Digital Equipment Corporation, a manufacturer
of computer systems. Mr. Getty holds a B.S. degree in Chemistry from Wayne State
University and an M.B.A. from the University of Michigan.

Gail E. Hamilton joined Microtec in July 1992 as Vice President, Marketing.
Prior to joining Microtec, Ms. Hamilton was employed by Hewlett-Packard Company,
a computer manufacturer, most recently as Marketing Manager for the Networked
Systems Group from October 1991 to June 1992. From January 1988 to September
1991, she managed marketing for Hewlett-Packard's Software Engineering Systems
Division and its SoftBench product family. Ms. Hamilton holds a B.S. degree in
Electrical Engineering and Computer Science from the University of Colorado and
an M.S. degree in Electrical Engineering: Administration from Stanford
University.

Andre C. Kobel joined Microtec in December 1993 as Vice President, Business
Development from Ready Systems. In August 1987, Mr. Kobel joined Ready Systems
as Director of Asia Pacific Sales and was promoted in January 1992 to Vice
President of International Operations, which position he held until the merger
between Microtec and Ready Systems. Mr. Kobel holds a B.S. degree in Electrical
Engineering from the College of Technology in Berne, Switzerland.

Ronald C. Workman joined Microtec as Director, VAR/OEM Sales in December
1993 from Ready Systems and was promoted to Vice President of VAR/OEM Sales in
June 1994. In March 1995 Mr. Workman accepted the position of Vice President,
Applied Customer Engineering Services. From October 1991 to the time of the
merger between Microtec and Ready Systems, Mr. Workman was Vice President of
North American Sales for Ready Systems. Mr. Workman served as Vice President of
Marketing for Ready Systems from June 1989 to September 1991. He holds B.S.
degrees in Biology and Food Science from the California Polytechnic State
University.

Gregory M. Avis has served on the Board of Directors since December 1991.
Mr. Avis also serves as a director of Digital Link Corp., a manufacturer of
networking products; CMG Information Services, Inc., an information services
company; and several private companies. Since January 1987, Mr. Avis has been a
general partner of Summit Partners, a venture capital partnership.

Alan C. Herzig has served on the Board of Directors since July 1991. Mr.
Herzig has been an independent consultant since May 1994 and serves as a
director of two private corporations. From April 1987 until his retirement in
March 1994, he was President of Robert Fleming Pacific, Inc. and a member of the
Board of Directors of Robert Fleming, Inc.

John C. Savage has served on the Board of Directors since March 1994. Mr.
Savage was previously a director of Ready Systems from March 1992 to the time of
the merger between Microtec and Ready Systems. Since 1990, Mr. Savage has been
Managing Partner at Glenwood Capital partners, a venture buyout partnership.
From 1981 to 1990, he was a partner of Weiss, Peck & Greer, an investment
management firm, and a general partner of several venture capital partnerships
affiliated with Weiss, Peck & Greer. He is a director of FileNet Corporation, a
document image processing company; ELSXI Corporation, a diversified
conglomerate; Mattson Technology, a semiconductor equipment company; and several
private companies.

Officers are elected by and serve at the discretion of the Board of
Directors. There are no family relationships among any of the directors or
officers of Microtec.

82
<PAGE> 91

INFORMATION REGARDING BENEFICIAL OWNERSHIP OF PRINCIPAL
MICROTEC STOCKHOLDERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of Microtec's Common Stock as of November 15, 1995, by: (i) each
director; (ii) by each of the Executive Officers named in the Summary
Compensation Table employed by Microtec in that capacity on November 15, 1995;
(iii) by all officers and directors as a group; and (iv) each beneficial owner
of more than five percent (5%) of Microtec Common Stock.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED(1)
PRIOR TO THE MERGER
-------------------------
BENEFICIAL OWNERS NUMBER PERCENT
- --------------------------------------------------------------------- --------- -------
<S> <C> <C>
Jerry Kirk (2)....................................................... 4,248,334 47.62%
2350 Mission College Blvd.
Santa Clara, CA 95054
Mentor Graphics Corporation (3)...................................... 4,248,334 47.62%
8005 S.W. Boeckman Road
Wilsonville, OR 97070-7777
Daniel E. Jaskolski.................................................. 387,551 4.35%
Glenwood Capital Partners (4)........................................ 382,063 4.29%
John C. Savage
Entities affiliated with Summit Partners(5).......................... 307,931 3.45%
Gregory M. Avis
J.P. Morgan & Co., Inc. (6).......................................... 236,900 2.66%
J.P. Morgan Investment Management, Inc.
522 Fifth Avenue
New York, NY 10036
Kenneth E. Lonchar (7)............................................... 87,389 *
Luke C. Dion (8)..................................................... 30,000 *
Alan C. Herzig (9)................................................... 24,166 *
Paul M. Getty (10)................................................... 18,493 *
All officers and directors as a group................................ 5,561,676 61.51%
(12 persons) (11)
</TABLE>

- ---------------
* Less than 1%.

(1) Unless otherwise indicated in the footnotes to this table, the persons named
in this table have sole voting and investment power with respect to the
shares indicated as beneficially owned by them, subject to community
property laws where applicable. Applicable percentages are based on
8,913,148 shares outstanding on November 15, 1995, as adjusted as required
by rules promulgated by the SEC.

(2) Includes 8,334 shares subject to stock options exercisable within 60 days of
November 15, 1995.

(3) Includes 4,248,334 shares for which Jerry Kirk is the record holder and
8,334 shares subject to stock options held by Jerry Kirk exercisable within
60 days of November 15, 1995. Jerry Kirk has entered into a voting agreement
with Mentor Graphics pursuant to which he has agreed to vote all such shares
in favor of the Merger Agreement and the Merger. Mr. Kirk has also given
Mentor Graphics a proxy with respect to voting such shares in favor of the
Merger Agreement and the Merger. Mentor Graphics disclaims beneficial
ownership of such shares.

(4) Includes 382,063 shares held by Meriken Nominees Ltd. as Nominee for
Glenwood Capital Investment Partners. Mr. Savage, a director of Microtec, is
a general partner of Glenwood Capital Partners. Mr. Savage may be deemed to
share voting and investment powers with these entities but disclaims
beneficial ownership of such shares held by entities affiliated with
Glenwood Capital Partners except to the extent Mr. Savage has a pecuniary
interest.

(5) Includes 299,615 shares held by Summit Ventures II, L.P., 3,316 shares held
by Summit Investors II, L.P. and 5,000 shares subject to stock options held
directly by Mr. Avis exercisable within 60 days of November 15, 1995. Mr.
Avis, a director of Microtec, is a general partner of an affiliate of Summit
Ventures II, L.P. Mr. Avis may be deemed to share voting and investment
powers with these entities but

83
<PAGE> 92

disclaims beneficial ownership of such shares held by entities affiliated
with Summit Partners except to the extent Mr. Avis has a pecuniary interest.

(6) According to a Schedule 13G filed with the SEC, as of March 31, 1995, J.P.
Morgan Investment Management Inc. ("J.P. Morgan") beneficially owned 683,900
shares of Microtec's Common Stock. J.P. Morgan has since informed Microtec
that, as of November 15, 1995, it beneficially owned 236,900 shares of
Microtec's Common Stock. However, Microtec has not yet received a copy of an
amended Schedule 13G or 13D filed with the SEC concerning J.P. Morgan's
change in beneficial ownership.

(7) Includes 7,334 shares subject to stock options exercisable within 60 days of
November 15, 1995.

(8) Includes 20,000 shares subject to stock options exercisable within 60 days
of November 15, 1995.

(9) Includes 7,500 shares subject to stock options exercisable within 60 days of
November 15, 1995.

(10) Includes 12,501 shares subject to stock options exercisable within 60 days
of November 15, 1995.

(11) Includes 144,608 shares subject to stock options exercisable within 60 days
of November 15, 1995, and includes shares held by Meriken Nominees Ltd.,
Summit Ventures II, L.P., and Summit Investors II, L.P. See Notes 4 and 5
above.

CERTAIN TRANSACTIONS

On April 23, 1993, Microtec loaned Daniel E. Jaskolski $136,500 in
connection with an exercise of stock options. The loan matures on April 23, 1996
and accrues interest at the rate of 4.25% per annum. The loan is secured by
182,000 shares of Common Stock of Microtec.

On December 14, 1993, Microtec entered into an Agreement of Employment with
James F. Ready for his employment as Vice President, Chief Technical Officer.
The term of the agreement is for two years. The Agreement provides that if Mr.
Ready is terminated without cause or his position is eliminated, he will be
entitled to twelve months base salary and bonus. Mr. Ready was Vice President of
Ready Systems at the time of the Merger with Microtec.

On March 1, 1994, Glenwood Capital Partners and its affiliates and certain
other parties entered into a Put and Call Agreement with Microtec providing for
an option to purchase shares of Series B Preferred Stock for a per share price
of $3.214. Microtec also had the right to require the parties to purchase such
shares if the option was not exercised. On June 3, 1994, Glenwood Capital
Partners and its affiliates exercised such option and purchased shares of Series
B Preferred Stock, which converted into 41,485 shares of Common Stock. John C.
Savage, a Director of Microtec, is a general partner of Glenwood Capital
Partners.

On March 7, 1994, Microtec issued shares of Series B Preferred Stock, which
converted into 78,980 shares of Common Stock, to Robert Fleming Nominee Ltd.
pursuant to the December 14, 1993 Plan of Reorganization and Agreement of Merger
between Microtec and Ready Systems. Robert Fleming Nominee Ltd. is affiliated
with Robert Fleming Pacific Inc. ("Flemings"). Alan C. Herzig, a Director of
Microtec, was President of Flemings at the time of issuance.

84
<PAGE> 93

INFORMATION REGARDING EXECUTIVE OFFICER COMPENSATION

Summary Compensation Table

The following summary compensation table sets forth the compensation paid
or accrued by Microtec during the fiscal years ended March 31, 1995 and 1994 to
Microtec's Chief Executive Officer and each of Microtec's four other most highly
compensated executive officers (Named Executive Officers).

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL AWARDS
COMPENSATION SECURITIES OTHER ANNUAL
NAME AND PRINCIPAL POSITION ------------------ BONUS UNDERLYING COMPENSATION
DURING FISCAL 1995 YEAR SALARY($) ($)(1) OPTIONS(#) ($)(2)
- ------------------------------------------ ----- --------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Jerry Kirk................................ 1995 158,000 42,660 33,333 33,600(3)
President, Chief Executive Officer, 1994 170,000 21,237 -- 33,600(3)
and Chairman of the Board
Daniel E. Jaskolski....................... 1995 145,000 34,256 20,000 --
Executive Vice President, Chief 1994 136,000 22,284 -- --
Operating Officer, Secretary and
Director
Kenneth E. Lonchar........................ 1995 138,333 49,000 33,333 --
Vice President, Finance and 1994 120,000 21,780 -- --
Administration and Chief Financial
Officer
Paul M. Getty............................. 1995 157,489(4) 20,250 16,667 --
Vice President, Worldwide Sales 1994 143,118(5) 7,084 -- --
Luke C. Dion.............................. 1995 145,000 24,469 10,000 --
Vice President, Engineering 1994 138,000 5,496 -- --
</TABLE>

- ---------------
(1) Includes bonuses earned in respective fiscal year and paid the following
fiscal year pursuant to Microtec's Officers' compensation arrangements.

(2) Unless otherwise specified, the total amount of personal benefits paid to
executive officers during the fiscal year was less than the lesser of (i)
$50,000 and (ii) 10% of such executive officer's total reported salary and
bonus.

(3) Includes $27,600 for lease payments by Microtec for corporate use of a
nonprimary residence owned by Mr. Kirk and $6,000 for automobile allowance.

(4) Includes commission payments in the aggregate amount of $37,489.

(5) Includes commission payments in the aggregate amount of $23,118.

85
<PAGE> 94

Option Grants in Last Fiscal Year

The following table shows for the fiscal year ended March 31, 1995, certain
information regarding options granted to, exercised by, and held at year end by
the Named Executive Officers:

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS IN POTENTIAL
FISCAL 1995 REALIZABLE
---------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF
SECURITIES OPTIONS STOCK PRICE
UNDERLYING GRANTED TO EXERCISE APPRECIATION FOR
OPTIONS EMPLOYEES OR BASE OPTION TERM(1)
GRANTED IN FISCAL PRICE EXPIRATION -----------------
NAME (#) YEAR(2) ($/SH) DATE 5%($) 10%($)
- --------------------------------------- --------- ---------- -------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Jerry Kirk............................. 33,333 6.46% $ 2.81 4/04/99 $14,817 $43,226
Daniel E. Jaskolski.................... 20,000 3.88% $ 2.55 4/04/04 $32,074 $81,281
Kenneth E. Lonchar..................... 20,000 3.88% $ 2.55 4/04/04 $32,074 $81,281
13,333 2.58% $ 3.38 8/01/04 $28,341 $71,823
Paul M. Getty.......................... 16,667 3.23% $ 2.55 4/04/04 $26,729 $67,735
Luke C. Dion........................... 10,000 1.94% $ 2.55 4/04/04 $16,037 $40,640
</TABLE>

- ---------------
(1) The potential realizable value is based on the term of the option at the
time of the grant, either five or ten years. It is calculated by assuming
that the stock price on the date of grant appreciates at the indicated
annual rate, compounded annually for the entire term of the option, and that
the option is exercised and sold on the last day of its term for the
appreciated stock value. No gain to the optionee is possible unless the
stock price increases over the option term, which will benefit all
stockholders. These amounts represent certain assumed rates of appreciation
only in accordance with the rules of the SEC. Actual gains, if any, on stock
option exercises are dependent on the future performance of the Common
Stock, overall market conditions and the option holder's continued
employment throughout the vesting period. The amounts reflected in this
table may not necessarily be achieved.

(2) Based on 516,058 options granted to employees in fiscal 1995.

Aggregated Option Exercises in Last Fiscal Year-End Option Values

The following table provides information on option exercises for the last
fiscal year by the Named Executive Officers and the value of such officers'
unexercised options as of March 31, 1995.

<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
SHARES NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED OPTIONS AT 3/31/95 AT 3/31/95(1)
ON VALUE ------------------------------ ------------------------------
NAME EXERCISE REALIZED(2) EXERCISABLE(3) UNEXERCISABLE EXERCISABLE(3) UNEXERCISABLE
- -------------------------- -------- ----------- -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Jerry Kirk................ -- -- -- 33,333 -- $ 322,997
Daniel E. Jaskolski....... 83,333 $ 933,330 137,133 20,000 $1,572,463 $ 199,000
Kenneth E. Lonchar........ 26,666 $ 238,661 4,000 37,333 $ 41,000 $ 361,597
Paul M. Getty............. -- -- 4,167 25,000 $ 42,712 $ 251,250
Luke C. Dion.............. 10,000 $ 13,500 15,000 15,000 $ 164,250 $ 150,750
</TABLE>

- ---------------
(1) Based on the value of $12.50 per share which was the closing price of
Microtec's Common Stock on March 31, 1995. The value shown is for all
outstanding in-the-money options regardless of vesting restrictions.

(2) "Value Realized" represents the fair market value of the underlying
securities on the exercise date, minus the aggregate exercise price of each
option.

(3) Options were granted under Microtec's 1985 Stock Option Plan (the "1985
Option Plan") and 1994 Stock Option Plan (the "1994 Option Plan"). Under the
1985 Option Plan, options become exercisable in full not later than four
years after the date of grant and at a rate of at least 25% of the shares
subject to the option per year. Under the 1994 Option Plan, options vests
over a four year period at a rate of 25% per

86
<PAGE> 95

year of the optionee's continuous employment with Microtec. Under the 1985
Option Plan and 1994 Option Plan, the Board retains discretion to modify the
terms, including the price, of outstanding options.

Change of Control Arrangements

The 1985 Option Plan provides that in the event of a dissolution or
liquidation of Microtec, a sale of substantially all of its business and assets,
or a merger or consolidation in which Microtec is not the surviving corporation
in which, in any such case, no provision is made for the issuance of replacement
options for the options then outstanding under the 1985 Option Plan, each
optionee will have the right to exercise prior to such event the options granted
under the 1985 Option Plan as to all of the shares then subject to such options,
including any such shares as to which the options otherwise would not be
exercisable. Options not continued or substituted for in connection with any
such dissolution, liquidation, sale, merger or consolidation or exercised prior
to such event will terminate.

Compensation of Directors

Microtec's non-employee directors did not receive any compensation for
their services as members of the Board of Directors during the fiscal year ended
March 1, 1995, but were reimbursed for expenses incurred in attending each Board
and committee meeting. On August 1, 1994, Alan C. Herzig was granted a
nonqualified stock option under the 1985 Option Plan to purchase 10,000 shares
of Microtec Common Stock.

The Directors Option Plan provides that upon initial election to the Board
of Directors, each new nonemployee director will receive a one-time grant of an
option to purchase 15,000 shares of Microtec Common Stock (an "Initial Option").
The Directors Option Plan also provides that on the date of each annual meeting
of the stockholders, each nonemployee director who remains a member of the Board
(excluding any nonemployee director who received an Initial Option at such
annual meeting) will be granted automatically an option to purchase 5,000 shares
of Microtec Common Stock. In no event is any one nonemployee director entitled
to acquire more than 40,000 shares under the Directors Option Plan.

Compensation Committee Interlocks and Insider Participation

At March 31, 1995, the members of the Compensation Committee consisted of
Gregory M. Avis, Alan C. Herzig and John C. Savage.

Until October 1994, Jerry Kirk served as a member of the Compensation
Committee. Mr. Kirk is also the President, Chief Executive Officer and Chairman
of the Board of Microtec.

Alan C. Herzig served as a member of the Board's Compensation Committee
during the year ended March 31, 1995. Mr. Herzig is the former President of
Robert Fleming Pacific, Inc. ("Flemings"). On March 7, 1994, Microtec issued
shares of Series B Preferred Stock which converted into 78,980 shares of
Microtec's Common Stock to Robert Fleming Nominee Ltd. pursuant to the December
14, 1993 Plan of Reorganization and Agreement of Merger between Microtec and
Ready Systems. Robert Fleming Nominee Ltd. is affiliated with Flemings, which
served as Microtec's advisor for mergers and acquisitions and for the Ready
Systems merger.

87
<PAGE> 96

DESCRIPTION OF MENTOR GRAPHICS CAPITAL STOCK

The authorized capital stock of Mentor Graphics consists of 100,000,000
shares of Common Stock, no par value, and 1,200,000 shares of Incentive Stock,
no par value.

COMMON STOCK

As of September 30, 1995, there were 55,889,807 shares of Mentor Graphics
Common Stock outstanding held of record by approximately 1,269 stockholders.

Subject to preferences that may be applicable to any outstanding Incentive
Stock, holders of Mentor Graphics Common Stock are entitled to receive ratably
such dividends as may be declared by the Board of Directors out of funds legally
available therefor. Each holder of Mentor Graphics Common Stock is entitled to
one vote for each share held of record by him or her and may not cumulate votes
for the election of directors. In the event of a liquidation or dissolution,
voluntary or involuntary, of Mentor Graphics, holders of Mentor Graphics Common
Stock are entitled to share ratably in all assets remaining after payment of
liabilities and the liquidation preference of any outstanding Incentive Stock.
Holders of Mentor Graphics Common Stock have no preemptive rights and have no
rights to convert their Common Stock into any securities and there are no
redemption provisions with respect to such shares. All of the outstanding shares
of Mentor Graphics Common Stock are fully paid and non-assessable.

The transfer agent for Mentor Graphics Common Stock is American Stock
Transfer & Trust Company.

INCENTIVE STOCK

As of September 30, 1995, there were no shares of Mentor Graphics Incentive
Stock outstanding. The Mentor Graphics Incentive Stock may be issued from time
to time in one or more series. Mentor Graphics' Board of Directors has authority
to fix the designation, preferences, and rights of each such series and the
qualifications, limitations and restrictions thereon and to increase or decrease
the number of shares of such series (but not below the number of shares of such
series then outstanding), without any further vote or action by the
stockholders. The Incentive Stock has no voting rights except as required by
law.

88
<PAGE> 97

COMPARISON OF RIGHTS OF HOLDERS OF
MENTOR GRAPHICS COMMON STOCK AND MICROTEC COMMON STOCK

Mentor Graphics and Microtec are incorporated in Oregon and Delaware,
respectively. Stockholders of Microtec receiving Mentor Graphics Common Stock in
connection with the Merger, whose rights as stockholders are currently governed
by the Delaware General Corporation Law ("Delaware law"), Microtec's Certificate
of Incorporation (the "Microtec Certificate") and Microtec's Bylaws (the
"Microtec Bylaws") will, upon the Effective Time of the Merger, automatically
become stockholders of Mentor Graphics, and their rights will be governed by the
Oregon Business Corporation Act ("Oregon law"), Mentor Graphics' Articles of
Incorporation, as amended and restated (the "Mentor Graphics Articles") and
Mentor Graphics' Bylaws ("the Mentor Graphics Bylaws"). The following is a
summary of material similarities and differences between the rights of Mentor
Graphics stockholders under the Mentor Graphics Articles and Mentor Graphics
Bylaws and Oregon law on the one hand and Microtec stockholders under the
Microtec Certificate and Microtec Bylaws and Delaware law on the other hand.

AMENDMENT OF CERTIFICATE OR ARTICLES OF INCORPORATION; AMENDMENT OF BYLAWS

Both Oregon law and Delaware law generally provide that in order for an
amendment to a corporation's articles of incorporation to be adopted, the board
of directors of the corporation must adopt a resolution setting forth the
proposed amendment and direct that it be submitted to a vote at a meeting of
stockholders. Under Oregon law, an amendment to the articles of incorporation is
approved if a quorum exits and the votes cast favoring the amendment exceed the
votes cast opposing the action, unless the amendment would create dissenters'
rights, in which case a majority of the votes entitled to be cast is required
for approval. Supermajority voting requirements may be imposed and maintained by
the articles of incorporation.

Under Delaware law, in order for an amendment to a corporation's
certificate of incorporation to be adopted, the amendment must be approved by a
majority of the outstanding stock entitled to vote thereon and a majority of the
outstanding stock of each class entitled to vote thereon. Supermajority voting
requirements may be imposed and maintained by the articles of incorporation.

Under Oregon law, a corporation's board of directors may amend or repeal
the corporation's bylaws unless the corporation's articles of incorporation or
Oregon law reserves the power to amend the bylaws exclusively to the
stockholders in whole or in part, or the stockholders, in amending or repealing
a particular bylaw, provide expressly that the board of directors may not amend
or repeal that bylaw. The Mentor Graphics Bylaws grant the authority to the
board of directors to alter, amend or repeal, and adopt new bylaws, subject to
repeal or change by action of the stockholders.

Under Delaware law, an amendment to a corporation's bylaws requires the
approval of the stockholders, unless the certificate of incorporation confers
the power to amend or repeal the bylaws upon the board of directors. The
Microtec Bylaws permit the board of directors to adopt, amend or repeal the
Bylaws by approval of a majority of the total number of authorized directors.
The stockholders of Microtec are authorized to adopt, amend or repeal the
Microtec Bylaws. Any such adoption, amendment or repeal of the Bylaws requires
the affirmative vote of holders of at least 66 2/3% of the voting power of all
of the then outstanding shares of capital stock entitled to vote generally in
the election of directors, voting together as a single class.

DIVIDENDS AND OTHER DISTRIBUTIONS

Under Oregon law, the board of directors of a corporation may authorize and
the corporation may make distributions (including dividends) to stockholders
only if after giving effect to the distribution (i) the corporation would be
able to pay its debts as they become due in the usual course of business and
(ii) the corporation's total assets would at least equal the sum of the total
liabilities plus, unless the corporation's articles of incorporation permit
otherwise, the amount that would be needed if the corporation were to be
dissolved at the time of the distribution to satisfy the preferential rights
upon dissolution of stockholders whose preferential rights are superior to those
receiving the distribution.

89
<PAGE> 98

Delaware law permits a corporation to declare and pay dividends out of
surplus (defined as net assets minus capital) or, if there is no surplus, out of
net profits for the fiscal year in which the dividend is declared and/or for the
preceding year, as long as the amount of capital of the corporation following
the declaration and payment of the dividend is not less than the aggregate
amount of the capital represented by the issued and outstanding stock of all
classes having a preference upon the distribution of assets. In addition,
Delaware law generally provides that a corporation may redeem or repurchase its
shares only if such redemption or repurchase would not impair the capital of the
corporation.

Neither the Mentor Graphics Articles nor the Microtec Certificate contains
any restrictions on the payment of dividends or the repurchase of shares.

SPECIAL MEETING OF STOCKHOLDERS

Oregon law provides that a special meeting of stockholders may be called by
the board of directors or the holders of 10% or more of the votes entitled to be
cast on any issue proposed to be considered at the special meeting, or by such
persons as are specified in the articles of incorporation or bylaws. The Mentor
Graphics Bylaws contain provisions concerning special meetings consistent with
the provisions of Oregon law described above, authorizing the president, in
addition to the board of directors, to call a special meeting.

Under Delaware law, a special meeting of stockholders may be called by the
board of directors or by any other person authorized to do so in the certificate
of incorporation or the bylaws. The Microtec Bylaws contain provisions
concerning special meetings consistent with the provisions of Delaware law
described above, and also empower holders of not less than 10% of all of the
shares entitled to cast votes at such meeting to call a special meeting.

PROVISIONS RELATING TO DIRECTORS

Under both Oregon law and Delaware law a corporation must have a board of
directors consisting of at least one director. The Mentor Graphics Bylaws
provide that the Mentor Graphics Board shall consist of not less than 5 nor more
than 9 persons, the current number being set at 5, as may be amended from time
to time by the Board or stockholders. The Microtec Bylaws provide for a
classified board of directors, currently with Class I, Class II and Class III
directors. A classified board of directors is one in which a certain number, but
not all, of the directors are elected on a rotating basis each year. This method
of electing directors makes changes in the composition of the board of
directors, and thus a potential change in control of a corporation, a lengthier
and more difficult process. None of the Mentor Graphics Articles or Mentor
Graphics Bylaws or the Microtec Certificate or the Microtec Bylaws set forth
specific qualification requirements for directors.

Both Oregon law and Delaware law allow for cumulative voting in an election
of directors. Under cumulative voting, each share of stock normally having one
vote is entitled to a number of votes equal to the number of directors to be
elected. A stockholder may then cast all such votes for a single candidate or
may allocate them among as many candidates as the stockholder may desire.
Without cumulative voting, the holders of a majority of the shares voting in the
election of directors would have the power to elect all the directors to be
elected, and no person could be elected without the support of holders of a
majority of the shares. Neither the Mentor Graphics Articles nor the Microtec
Certificate provides for cumulative voting.

Under Oregon law, unless otherwise provided in the articles of
incorporation, every stockholder entitled to vote at the election of directors
has the right to vote, in person or by proxy. Delaware law requires that the
election of directors be by written ballot, unless otherwise provided in a
corporation's certificate of incorporation.

The Mentor Graphics Bylaws provide that vacancies in the Mentor Graphics
Board may be filled in accordance with Oregon law, which allows vacancies to be
filled by the stockholders or the directors then in office. The Microtec Bylaws
provide that vacancies may be filled by the stockholders or the directors then
in office.

Under Oregon law, a director may be removed with or without cause unless
the articles of incorporation provide that directors may be removed only for
cause. Mentor Graphics Articles do not provide that the

90
<PAGE> 99

directors may be removed only for cause. A director may be removed by the
stockholders only at a meeting called for the purpose of removing the director
and the meeting notice must state that the purpose, or one of the purposes of
the meeting, is removal of the director.

Delaware law provides that at a meeting of stockholders called expressly
for the purpose of removing directors, any director or the entire board of
directors may be removed, with or without cause, by a vote of the holders of a
majority of the shares then entitled to vote at an election of directors. The
Microtec Certificate provides that all or any number of directors may be removed
with or without cause.

CERTAIN ANTI-TAKEOVER PROVISIONS

Oregon law regulates the process by which a person may acquire control of
any Oregon-based corporation with 100 or more stockholders without the consent
and cooperation of the board of directors. This law would apply to persons
seeking to acquire control of Mentor Graphics. The law restricts the ability to
vote shares of stock acquired in a transaction that causes the acquiring person
to control at least one-fifth, one-third or one-half of the votes entitled to be
cast in the election of directors. Shares acquired in a control share
acquisition have no voting rights except as authorized by a vote of the
stockholders. Although a corporation may elect not to be governed by this law by
amendment to its articles of incorporation or bylaws, Mentor Graphics has not
made such an election. In addition, Oregon has enacted a business combination
statute that applies to Mentor Graphics and that is in all material respects
identical to Section 203 of the Delaware law as discussed below.

Delaware has enacted a business combination statute that is contained in
Section 203 of the Delaware law providing that any person who acquires 15% or
more of a corporation's voting stock (thereby becoming an "interested
stockholder") may not engage in certain "business combinations" with the target
corporation for a period of three years following the date the person became an
interested stockholder, unless (1) the board of directors of the corporation has
approved, prior to that acquisition date, either the business combination or the
transaction that resulted in the person becoming an interested stockholder, (2)
upon consummation of the transaction that resulted in the person becoming an
interested stockholder, that person owns at least 85% of the corporation's
voting stock outstanding at the time the transaction is commenced (excluding
shares owned by persons who are both directors and officers and shares owned by
employee stock plans in which participants do not have the right to determine
confidentially whether shares will be tendered in a tender or exchange offer),
or (3) the business combination is approved by the board of directors and
authorized by the affirmative vote (at an annual or special meeting and not by
written consent) of at least 66% of the outstanding voting stock not owned by
the interested stockholder.

For purposes of determining whether a person is the "owner" of 15% or more
of a corporation's voting stock for purposes of Section 203, ownership is
defined broadly to include the right, directly or indirectly, to acquire the
stock or to control the voting or disposition of the stock. A "business
combination" is also defined broadly to include (1) mergers and sales or other
dispositions of 10% or more of the assets of a corporation with or to an
interested stockholder, (2) certain transactions resulting in the issuance or
transfer to the interested stockholder of any stock of the corporation or its
subsidiaries, (3) certain transactions which would result in increasing the
proportionate share of the stock of a corporation or its subsidiaries owned by
the interested stockholder, and (4) receipt by the interested stockholder of the
benefit (except proportionately as a stockholder) of any loans, advances,
guarantees, pledges, or other financial benefits.

These restrictions placed on interested stockholders by Section 203 do not
apply under certain circumstances, including, but not limited to, the following:
(1) if the corporation's original certificate of incorporation contains a
provision expressly electing not to be governed by Section 203 or (2) if the
corporation, by action of its stockholders, adopts an amendment to its bylaws or
certificate of incorporation expressly electing not to be governed by Section
203, provided that such an amendment is approved by the affirmative vote of not
less than a majority of the outstanding shares entitled to vote and that such an
amendment will not be effective until 12 months after its adoption and will not
apply to any business combination with a person who became an interested
stockholder at or prior to such adoption.

91
<PAGE> 100

DISSENTERS' RIGHTS

Under Oregon law, a stockholder is entitled to dissent from, and obtain
payment of the fair value of the stockholder's shares in the event of, any of
the following corporate acts:

(i) consummation of a plan of merger to which the corporation is a
party if stockholder approval is required and the stockholder is entitled
to vote on the merger;

(ii) consummation of a plan of share exchange to which the corporation
is a party as the corporation whose shares will be acquired, if the
stockholder is entitled to vote on the plan;

(iii) consummation of a sale or exchange of all or substantially all
of the property of the corporation other than in the usual and regular
course of business if the stockholder is entitled to vote on the sale or
exchange, unless the sale is for cash pursuant to which all or
substantially all of the net proceeds will be distributed to stockholders
within one year.

(iv) an amendment of the articles of incorporation that materially and
adversely affects rights in respect of a dissenter's shares because it (A)
alters or abolishes a preemptive right of the holder of the shares to
acquire shares or other securities or (B) reduces the number of shares
owned by the stockholder to a fraction of a share if the fractional share
so created is to be acquired for cash under Oregon law; or

(v) any corporate action taken pursuant to a stockholder vote to the
extent the articles of incorporation, bylaws or a resolution of the board
of directors provides that voting or nonvoting stockholders are entitled to
dissent and obtain payment for their shares.

Unless the articles of incorporation provide otherwise, dissenters' rights
do not apply to the holders of shares of any class or series if the shares of
the class or series were registered on a national securities exchange or quoted
on the Nasdaq National Market on the record date for the meeting of stockholders
at which the corporate action giving rise to dissenters' rights is to be
approved.

Under Delaware law, appraisal rights are available only in connection with
certain mergers or consolidations, unless otherwise provided in the
corporation's certificate of incorporation. Even in the event of those mergers
or consolidations, unless the certificate of incorporation otherwise provides,
Delaware law does not provide appraisal rights (1) if the shares of the
corporation are listed on a national securities exchange or quoted on the Nasdaq
National Market or (2) held of record by more than 2,000 stockholders (as long
as in the merger the stockholders receive shares of the surviving corporation or
any other corporation the shares of which are listed on a national securities
exchange or held of record by more than 2,000 stockholders). In addition,
appraisal rights are not available if the corporation is the surviving
corporation and no vote of its stockholders is required for the merger.

LIMITATION ON DIRECTOR LIABILITY

Oregon law and Delaware law permit a corporation to include a provision in
its articles/certificate of incorporation to limit or eliminate the personal
liability of directors, subject to certain limitations. Mentor Graphics Articles
contain a provision that limits the liability of any director of Mentor Graphics
to Mentor Graphics or its stockholders for monetary damages for certain conduct
as a director not excluded from the provision by the Oregon law. The Microtec
Certificate contains a similar provision.

92
<PAGE> 101

EXPERTS

The consolidated financial statements of Mentor Graphics Corporation and
subsidiaries as of December 31, 1994 and 1993 and for each of the years in the
three year period ended December 31, 1994, have been included herein and in the
registration statement in reliance upon the report of KPMG Peat Marwick LLP,
independent auditors, included herein, and upon the authority of said firm as
experts in accounting and auditing. The reports of KPMG Peat Marwick LLP
covering the December 31, 1994 financial statements refer to a change in the
method of accounting for certain debt and equity securities and income taxes.

The consolidated financial statements of Microtec Research, Inc. at March
31, 1995 and 1994, and for each of the three years in the period ended March 31,
1995, included in this Proxy Statement/Prospectus, have been audited by Deloitte
& Touche LLP, independent auditors, as set forth in their report appearing
elsewhere herein, and are included in reliance upon the report of such firm
given upon their authority as experts in accounting and auditing.

LEGAL MATTERS

The validity of the Mentor Graphics Common Stock issuable pursuant to the
Merger and certain other legal matters relating thereto will be passed upon for
Mentor Graphics by Venture Law Group, A Professional Corporation, Menlo Park,
California. Tomlinson Zisko Morosoli & Maser, Palo Alto, California is acting as
counsel for Microtec in connection with certain legal matters relating to the
Merger and the transactions contemplated thereby.

OTHER MATTERS

The Microtec Board does not intend to bring any matters before the meeting
other than those specifically set forth in the notice of meeting and does not
know of any matters to be brought before the meeting by others. If any other
matters properly come before the meeting, it is the intention of the persons
named in the accompanying proxy to vote such proxy in accordance with the
judgment of the Microtec Board.

93
<PAGE> 102

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MENTOR GRAPHICS CORPORATION
Independent Auditors' Report........................................................ F-2
Consolidated Balance Sheets as of December 31, 1994 and 1993........................ F-3
Consolidated Statements of Operations for the years ended December 31, 1994, 1993
and 1992......................................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1994, 1993 and 1992.............................................................. F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993
and 1992......................................................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
Consolidated Balance Sheets as of September 30, 1995 (unaudited) and December 31,
1994............................................................................. F-21
Consolidated Statements of Operations for the nine months ended September 30, 1995
and 1994 (unaudited)............................................................. F-22
Consolidated Statements of Cash Flows for the nine months ended September 30, 1995
and 1994 (unaudited)............................................................. F-23
Notes to Unaudited Consolidated Financial Statements................................ F-24
MICROTEC RESEARCH, INC.
Independent Auditors' Report........................................................ F-27
Consolidated Balance Sheets as of March 31, 1995 and 1994........................... F-28
Consolidated Statements of Operations for the years ended March 31, 1995, 1994 and
1993............................................................................. F-29
Consolidated Statements of Stockholders' Equity for the years ended March 31, 1995,
1994 and 1993.................................................................... F-30
Consolidated Statements of Cash Flows for the years ended March 31, 1995, 1994 and
1993............................................................................. F-31
Notes to Consolidated Financial Statements.......................................... F-32
Condensed Consolidated Balance Sheets as of September 30, 1995 (unaudited) and March
31, 1995 (derived from audited information)...................................... F-41
Condensed Consolidated Statements of Operations for the six months ended September
30, 1995 and 1994 (unaudited).................................................... F-42
Condensed Consolidated Statements of Cash Flows for the six months ended September
30, 1995 and 1994 (unaudited).................................................... F-43
Notes to Condensed Consolidated Financial Statements................................ F-44
</TABLE>

F-1
<PAGE> 103

INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors
Mentor Graphics Corporation:

We have audited the accompanying consolidated balance sheets of Mentor
Graphics Corporation and subsidiaries as of December 31, 1994 and 1993, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1994.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mentor
Graphics Corporation and subsidiaries as of December 31, 1994, and 1993, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1994, in conformity with generally accepted
accounting principles.

As discussed in Notes 1 and 4, to the consolidated financial statements,
the Company adopted the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" in 1994 and SFAS No. 109,
"Accounting for Income Taxes" in 1993.

KPMG Peat Marwick LLP

Portland, Oregon
January 31, 1995

F-2
<PAGE> 104

MENTOR GRAPHICS CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------
1994 1993
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................ $130,676 $ 95,958
Short-term investments............................................... 7,180 13,610
Trade accounts receivable, net of allowance for doubtful accounts of
$2,847 in 1994 and $3,928 in 1993................................. 82,285 72,655
Other receivables.................................................... 4,853 4,167
Inventory............................................................ 856 2,299
Prepaid expenses and other........................................... 12,156 9,399
-------- --------
Total current assets......................................... 238,006 198,088
PROPERTY, PLANT AND EQUIPMENT, Net (notes 5 and 8)..................... 97,701 104,912
CASH AND INVESTMENTS, LONG-TERM (notes 8).............................. 30,000 30,000
OTHER ASSETS (note 6).................................................. 28,090 20,584
-------- --------
Total assets................................................. $393,797 $353,584
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings (notes 7 and 8)................................ $ 8,450 $ 6,364
Accounts payable..................................................... 11,570 10,637
Income taxes payable (note 4)........................................ 12,793 9,974
Accrued payroll and related liabilities.............................. 19,469 14,162
Accrued restructure costs............................................ 11,897 28,374
Accrued and other liabilities........................................ 17,399 14,603
Deferred revenue..................................................... 17,649 17,638
-------- --------
Total current liabilities.................................... 99,227 101,752
LONG-TERM DEBT (note 8)................................................ 53,625 54,321
OTHER LONG-TERM DEFERRALS.............................................. 1,877 1,800
-------- --------
Total liabilities............................................ 154,729 157,873
-------- --------
STOCKHOLDERS' EQUITY: (notes 9 and 10)
Common stock, no par value, authorized 100,000 shares; 51,350 and
47,659 issued and outstanding for 1994 and 1993, respectively..... 254,271 243,951
Incentive stock, no par value, authorized 1,200 shares; none
issued............................................................ -- --
Accumulated deficit.................................................. (27,877) (55,779)
Foreign currency translation adjustment.............................. 12,674 7,539
-------- --------
Total stockholders' equity................................... 239,068 195,711
-------- --------
COMMITMENTS AND CONTINGENCIES (note 11)
Total liabilities and stockholders' equity................... $393,797 $353,584
======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-3
<PAGE> 105

MENTOR GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
REVENUES:
System and software...................................... $187,117 $191,180 $212,397
Service and support...................................... 161,177 148,595 138,369
-------- -------- --------
Total revenues................................... 348,294 339,775 350,766
-------- -------- --------
COST OF REVENUES:
System and software...................................... 36,757 52,301 81,993
Service and support...................................... 70,063 67,891 70,975
-------- -------- --------
Total cost of revenues........................... 106,820 120,192 152,968
-------- -------- --------
Gross margin..................................... 241,474 219,583 197,798
-------- -------- --------
OPERATING EXPENSES:
Research and development (note 6)........................ 72,484 77,598 73,947
Marketing, general, and administration................... 137,310 146,577 151,683
Restructure costs (note 2)............................... (6,045) 24,800 12,900
Merger related charges (note 3).......................... 9,265 -- --
-------- -------- --------
Total operating expenses......................... 213,014 248,975 238,530
-------- -------- --------
OPERATING INCOME (LOSS).................................... 28,460 (29,392) (40,732)
Other income (expense), net (note 12).................... 2,452 (257) (7,539)
-------- -------- --------
Income (loss) before income taxes..................... 30,912 (29,649) (48,271)
-------- -------- --------
Provision for income taxes (note 4)...................... 3,375 2,424 2,590
-------- -------- --------
Net Income (loss)..................................... $ 27,537 $(32,073) $(50,861)
======== ======== ========
Net Income (loss) per common and
common equivalent share............................. $ .53 $ (.69) $ (1.13)
======== ======== ========
Weighted average number of common and common equivalent
shares outstanding.................................... 52,120 46,410 45,142
======== ======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE> 106

MENTOR GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
FOREIGN
COMMON RETAINED CURRENCY TOTAL
STOCK EARNINGS TRANSLATION STOCKHOLDER'S
SHARES AMOUNT (DEFICIT) ADJUSTMENT EQUITY
------ -------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1991............... 43,595 $215,043 $ 46,272 $ 6,352 $ 267,667
Stock issued under stock option and stock
purchase plans........................... 2,002 16,074 -- -- 16,074
Compensation related to nonqualified stock
options granted (note 10)................ -- 237 -- -- 237
Foreign currency translation adjustment.... -- -- -- (885) (885)
Net loss................................... -- -- (50,861) -- (50,861)
Cash dividends ($.24 per common share
outstanding)............................. -- -- (10,826) -- (10,826)
------ -------- -------- ------- --------
Balance at December 31, 1992............... 45,597 231,354 (15,415) 5,467 221,406
Stock issued under stock option and stock
purchase plans........................... 1,641 10,672 -- -- 10,672
Stock issued for acquisition of business
(note 3)................................. 421 507 -- -- 507
Compensation related to nonqualified stock
options granted (note 10)................ -- 1,418 -- -- 1,418
Foreign currency translation adjustment.... -- -- -- 2,072 2,072
Net loss................................... -- -- (32,073) -- (32,073)
Cash dividends ($.18 per common share
outstanding)............................. -- -- (8,291) -- (8,291)
------ -------- -------- ------- --------
Balance at December 31, 1993............... 47,659 243,951 (55,779) 7,539 195,711
Stock issued under stock option and stock
purchase plans........................... 1,248 10,205 -- -- 10,205
Stock issued for acquisition of business
(note 3)................................. 2,443 1 899 -- 900
Compensation related to nonqualified stock
options granted (note 10)................ -- 114 -- -- 114
Foreign currency translation adjustment.... -- -- -- 5,135 5,135
Change in value of trading securities...... -- -- 1,812 -- 1,812
Net Income................................. -- -- 27,537 -- 27,537
Cash distribution.......................... -- -- (2,346) -- (2,346)
------ -------- -------- ------- --------
Balance at December 31, 1994............... 51,350 $254,271 $(27,877) $12,674 $ 239,068
====== ======== ======== ======= ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE> 107

MENTOR GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
OPERATING CASH FLOWS:
Net Income (loss)............................................ $ 27,537 $(32,073) $(50,861)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization of property, plant and
equipment............................................... 24,687 27,600 25,750
Deferred taxes............................................ (290) (259) 2,512
Amortization of other assets.............................. 7,428 8,217 8,743
Amortization of nonqualified stock options................ 114 1,418 237
Write-down of assets -- in-process R&D.................... 8,265 -- --
Write-down of assets -- other............................. -- 812 6,088
Changes in operating assets and liabilities:
Trade accounts receivable................................. (4,921) 2,788 23,490
Inventory................................................. 46 7,771 13,934
Prepaid expenses and other assets......................... (1,782) 6,623 9,409
Accounts payable.......................................... (1,596) (5,845) (9,383)
Accrued liabilities....................................... (11,345) 16,634 (8,078)
Other liabilities and deferrals........................... 2,254 (8,397) (8,231)
-------- -------- --------
Net cash provided by operating activities............ 50,397 25,289 13,610
-------- -------- --------
INVESTING CASH FLOWS:
Net maturities of short-term investments.................. 6,430 23,161 28,831
Purchases of property, plant and equipment................ (14,327) (22,790) (18,784)
Capitalization of software development costs.............. (5,156) (3,609) (6,120)
Development of corporate facilities....................... -- (355) (4,655)
Purchase of business...................................... (10,050) -- --
Purchases of technology................................... (1,700) -- --
-------- -------- --------
Net cash used by investing activities................ (24,803) (3,593) (728)
-------- -------- --------
FINANCING CASH FLOWS:
Proceeds from issuance of common stock.................... 10,205 11,179 16,074
Proceeds (repayment) of short-term borrowings............. (367) (89) 1,222
Proceeds (repayment) of long-term debt.................... (1,936) (937) 5,176
Cash distribution......................................... (2,346) -- --
Adjustment for pooling of interests....................... 899 -- --
Dividends paid to stockholders............................ -- (8,291) (10,826)
Increase in cash and investments, long-term............... -- -- (30,000)
-------- -------- --------
Net cash provided (used) by financing activities..... 6,455 1,862 (18,354)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS... 2,669 388 (992)
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS........................ 34,718 23,946 (6,464)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............... 95,958 72,012 78,476
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD..................... $130,676 $ 95,958 $ 72,012
======== ======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-6
<PAGE> 108

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

All numerical references in thousands, except percentages and per share data

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the financial statements of
Mentor Graphics Corporation and its wholly owned and majority-owned subsidiaries
(the Company). All significant intercompany accounts and transactions are
eliminated in consolidation.

Foreign Currency Translation

Local currencies are the functional currencies for the Company's foreign
subsidiaries except for the Netherlands and Singapore where the U.S. dollar is
used as the functional currency. Assets and liabilities of foreign operations
are translated to U.S. dollars at current rates of exchange, and revenues and
expenses are translated using weighted average rates. Gains and losses from
foreign currency translation are included as a separate component of
stockholders' equity. Foreign currency transaction gains and losses are included
as a component of other income and expense (note 12).

Financial Instruments

The Company enters into forward foreign exchange contracts as a hedge
against foreign currency sales commitments. To hedge its foreign currency
against highly anticipated sales transactions, the Company also purchases
foreign exchange options which permit but do not require foreign currency
exchanges at a future date with another party at a contracted exchange price.
Remeasurement gains and losses on forward and option contracts are deferred and
recognized when the sale occurs. All subsequent remeasurement gains and losses
are recognized as they occur to offset remeasurement gains and losses recognized
on the related foreign currency accounts receivable balances. At December 31,
1994 and 1993 the Company had forward contracts and options outstanding of
$25,825 and $13,847, respectively, to primarily sell various foreign currencies.
These contracts generally have maturities which do not exceed twelve months. At
December 31, 1994, the recorded value and the fair value of the Company's
foreign exchange position related to these contracts was approximately zero. The
fair value of these contracts was calculated based on dealer quotes. The Company
does not anticipate non-performance by the counterparties to these contracts.

The fair market value of the Company's long-term debt approximates its
carrying value as the interest rates on borrowings are floating rate based. The
Company has entered into an interest rate swap agreement to manage exposure to
interest rate fluctuations. The differential to be paid or received is accrued
and is recognized over the life of the agreement as an adjustment to interest
expense. The Company would incur a cost of approximately $994 to terminate its
interest rate swap agreement as of December 31, 1994. This cost is based on
dealer quotes taking into consideration current interest rates and the current
creditworthiness of the counterparties (note 8).

The Company places its cash equivalents and short-term investments with
major banks and financial institutions. The investment policy limits the
Company's credit exposure to any one financial institution. Concentrations of
credit risk with respect to trade receivables are limited due to the large
number of customers comprising the Company's customer base, and their dispersion
across different businesses and geographic areas. The carrying amounts of cash
equivalents, short-term investments, trade receivables, accounts payable, and
short term borrowings approximate fair value because of the short-term nature of
these instruments.

In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Statement No. 115 requires reporting of investments
as either held to maturity, available for sale or trading. The Company owns
common stock and common stock warrants of an independent public company with an
original carrying cost of

F-7
<PAGE> 109

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$0 and a market value of $1,812 as of December 31, 1994. Under Statement No.
115, the securities have been classified as available for sale, which requires
the difference between original carrying cost and market value to be recognized.
This difference is included on the consolidated balance sheet in prepaid and
other assets and as a reduction of the same amount in accumulated deficit. No
other investments owned by the Company are materially impacted by provisions of
this Statement as the underlying carrying values approximate market.

Cash, Cash Equivalents, and Short-Term Investments

The Company classifies highly liquid investments purchased with an original
maturity of three months or less as cash equivalents. As of December 31, 1994
and 1993, the Company held $50,990 and $35,614, respectively of short term
securities under agreements to resell on January 1, 1994 and 1995, respectively.
Due to the short-term nature of these investments, the Company did not take
possession of the securities which were instead held in the Company's account at
Smith Barney Inc. The Company does not believe it is exposed to any significant
credit or market risk on cash and cash equivalent balances.

Short-term investments consist of certificates of deposit, commercial paper
and other highly liquid investments with original maturities in excess of three
months. These investments mature primarily in less than one year.

Property, Plant and Equipment

Property, plant and equipment is stated at cost and consists of land and
improvements, buildings and building equipment, computer equipment and
furniture, leasehold improvements, and service spare parts (note 5).
Expenditures for additions to property, plant and equipment are capitalized. The
cost of repairs and maintenance is expensed as incurred. Depreciation of
buildings and building equipment, and land improvements, is computed on a
straight-line basis over lives of forty and twenty years, respectively.
Depreciation of computer equipment and furniture is computed principally on a
straight-line basis over the estimated useful lives of the assets, generally
three to five years. Leasehold improvements are amortized on a straight-line
basis over the lesser of the term of the lease or estimated useful lives of the
improvements. Service spare parts are amortized on a straight-line basis over
their estimated useful lives, generally four years.

Income Taxes

Effective January 1, 1993, the Company adopted Statement No. 109,
"Accounting for Income Taxes." Statement No. 109 requires a change from the
deferred method under APB Opinion 11 to the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred
income taxes are recognized for the future tax consequences attributable to
temporary differences between the financial statement carrying amounts and tax
balances of existing assets and liabilities. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under Statement 109, the effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment date.
The cumulative effect of that change in the method for accounting for income
taxes was not material to the Company's financial statements, and is therefore
not disclosed separately in the Consolidated Statement of Operations for the
year ending December 31, 1993.

Pursuant to the deferred method under APB Opinion 11, which was applied in
1992 and prior years, deferred income taxes are recognized for income and
expense items that are reported in different years for financial reporting
purposes and income tax purposes using the tax rate applicable for the year of
calculation. Under the deferred method, deferred taxes are not adjusted for
subsequent changes in tax rates.

F-8
<PAGE> 110

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Revenue Recognition

Revenues from system sales and software licenses are recognized at the time
of shipment. Contract service revenues are billed in advance and recorded as
deferred revenue. Service revenues are then recognized ratably over the
contractual period as the services are performed. Training and consulting
revenues are recognized as the related services are performed. Custom design and
software porting revenues are recognized using the percentage of completion
method or as contract milestones are achieved.

Software Development Costs

The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." The Company
capitalizes certain costs incurred in the production of computer software once
technological feasibility of the product to be marketed has been established.
Capitalization of these costs ceases when the product is considered available
for general release to customers. Costs incurred prior to technological
feasibility, including amounts attributable to in-process research and
development in business acquisitions, are expensed as research and development
costs.

Amortization of capitalized software development costs is calculated as the
greater of the ratio that the current product revenues bear to estimated future
revenues or the straight-line method over the expected product life cycle of
approximately three years. Amortization is included in system and software cost
of revenues in the Consolidated Statements of Operations.

Net Income (Loss) per Common and Common Equivalent Share

For 1994, 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. For 1993
and 1992, net loss per common and common equivalent share was calculated using
only the weighted average of common shares outstanding. Common stock equivalents
related to stock options are anti-dilutive in a net loss situation and,
therefore, were not included in 1993 and 1992.

Reclassifications

Certain reclassifications have been made in the accompanying consolidated
financial statements for 1992 and 1993 to conform with the 1994 presentation.

2. RESTRUCTURING

During 1994, the Company recorded a gross restructure credit of $10,045.
This credit was the result of reduced estimates for the costs of executing
certain elements of the 1993 restructure plan, and cancellation of certain
actions, and was partially offset by an accrual of $4,000 associated with new
restructure activities approved by management during the year. The new
restructure costs in 1994 are limited to severance and write-offs of excess
equipment and intangible software technology related to discontinued product
development activities. Reductions in the estimated costs and cancellation of
certain actions were realized primarily due to greater than anticipated employee
attrition, which allowed the Company to achieve its cost reduction plan with
lower severence costs. In addition, the reduction in costs reflects lower than
anticipated severance costs overseas.

In December 1993, the Company recorded a charge of $24,800 associated with
a restructuring plan aimed at reducing operating expenses by streamlining and
reorganizing company operations. These costs consisted primarily of direct costs
related to the severance and relocation of employees facilities closure, and
write-offs of obsolete equipment and intangible software technology assets.

Restructuring costs of $12,900 were recognized in 1992. Restructuring costs
included direct costs related to the severance and relocation of employees,
consolidation of facilities, and write-offs of intangible software technology
assets related to discontinued product lines. The result was to significantly
reduce operating costs of administration, distribution, and sales.

F-9
<PAGE> 111

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Following is a summary of the major elements of the restructure charges:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
-------- ------- -------
<S> <C> <C> <C>
Employee severance and relocation.................... $ 2,430 $19,400 $ 5,700
Asset write-offs and product discontinuance costs.... 1,570 2,300 6,435
Facilities closure and consolidation................. -- 4,300 1,800
Reversal of accrued restructure costs................ (10,045) (1,400) (1,600)
Other................................................ -- 200 565
-------- ------- -------
Total...................................... $ (6,045) $24,800 $12,900
======== ======= =======
</TABLE>

3. BUSINESS AQUISITIONS

On September 30, 1994, the Company completed the acquisition of Anacad
Electrical Engineering Software GmbH (Anacad). Anacad is primarily engaged in
developing, marketing and supporting analog and mixed signal simulation and
optimization software for the integrated circuit and printed circuit board
markets of the electronic design automation (EDA) industry. Anacad's product
offerings are complementary to the Company's current broad line of EDA tools and
systems. The total purchase price of $12,000 was financed with cash of $10,050
and the issuance of a short-term obligation classified under accrued liabilities
totalling $1,950.

The acquisition was accounted for as a purchase, and therefore, the
consolidated balance sheet of Anacad has been included in the accompanying
Consolidated Balance sheets as of December 31, 1994. 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 $8,265,
goodwill capitalization of $2,897 and technology capitalization of $4,735. The
charge for in-process R&D was a result of allocating a portion of the
acquisition cost to Anacad's in-process product development that had not reached
technological feasibility. The goodwill costs will be amortized over a three
year period to R&D expense primarily to recognize the value of the development
work-force acquired. The technology costs will be amortized over a three year
period to system and software cost of revenues. Financial results subsequent to
the acquisition date have been included in the Consolidated Statements of
Operations and Cash Flows. The separate operational results of Anacad were not
material compared to the Company's overall results of operations, and
accordingly pro-forma financial statements of the combined entities have been
omitted.

On November 30, 1994, the Company issued 2,443 shares of its common stock
for all outstanding common stock of Model Technology Incorporated (MTI). MTI is
a developer of VHDL simulation point tools using direct compile technology to
design and test application specific integrated circuits. The Company accounted
for this transaction as a pooling of interests. The balance sheet of MTI is
included in the accompanying Consolidated Balance Sheets as of December 31, 1994
and MTI's results of operations are included in the accompanying Consolidated
Statement of Operations for all of 1994. The Company's prior year financial
statements were not restated due to the relative materiality of MTI's separate
financial statements for 1993 and 1992. Merger costs of $1,000 were paid by MTI
for consulting services rendered to facilitate negotiation of the various
components of the merger agreement. Also, cash distributions of $2,346 were paid
in 1994 by MTI to its shareholders in the normal course of S-Corporation
business prior to the Company's November 30, 1994 acquisition.

On December 1, 1993, the Company issued 421 shares of its common stock for
all outstanding common and preferred stock of CheckLogic Systems, Inc.
(CheckLogic). In addition, up to 35 common shares were reserved for issuance
with respect to CheckLogic employee stock options outstanding. CheckLogic is a
developer of automatic test pattern generation point tools used to test designs
of application specific integrated circuits. The Company accounted for this
transaction as a pooling of interests, and the financial results for the year
ended December 31, 1993 include the accounts of CheckLogic. The separate
financial results of

F-10
<PAGE> 112

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CheckLogic prior to the acquisition were not material, and accordingly the
consolidated financial statements for 1992 were not restated.

4. INCOME TAXES

Domestic and foreign pre-tax income (loss) is as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1993 1992
------- -------- --------
<S> <C> <C> <C>
Domestic............................................ $ 6,279 $(23,682) $(41,322)
Foreign............................................. 24,633 (5,967) (6,949)
------- -------- --------
Total..................................... $30,912 $(29,649) $(48,271)
======= ======== ========
</TABLE>

The provision (benefit) for income taxes is as follows:

<TABLE>
<CAPTION>
1994 1993 1992
------- -------- --------
<S> <C> <C> <C>
Current:
Federal........................................... $ (435) $ -- $ (1,141)
State............................................. 63 (162) 138
Foreign........................................... 4,033 2,041 1,081
------- -------- --------
3,661 1,879 78
Deferred:
Federal........................................... (347) 655 102
Foreign........................................... 57 (110) 2,410
------- -------- --------
(290) 545 2,512
------- -------- --------
Total..................................... $ 3,375 $ 2,424 $ 2,590
======= ======== ========
</TABLE>

The effective tax (benefit) rate differs from the Federal statutory rate as
follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1994 1993 1992
----- ----- -----
<S> <C> <C> <C>
Federal statutory tax (benefit) rate........................ 35% (35.0)% (34.0)%
State taxes, net of Federal tax benefits.................... 3.5 (2.3) 0.3
Foreign tax rate differential............................... 9.2 8.0 0.3
Losses from foreign subsidiaries............................ 6.4 0.6 7.7
Unrealized benefit of net operating loss carryforwards...... -- -- 26.9
Adjustment of deferred tax assets due to net operating
loss...................................................... -- -- 4.2
Adjustment of beginning of year balance of deferred tax
assets and liabilities for settlement of Federal income
tax obligations........................................... -- 2.5 --
Income of acquired S corporation not subject to income
tax....................................................... (2.9) -- 0
Change in valuation allowance for deferred tax assets....... (39.7) 29.5 0
Other, net.................................................. (0.6) 4.9 0
----- ----- -----
Effective tax rate.......................................... 10.9% 8.2% 5.4%
===== ===== =====
</TABLE>

F-11
<PAGE> 113

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The significant components of deferred income tax expense are as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1994 1993
-------- -------
<S> <C> <C>
Net changes in deferred tax assets and liabilities.............. $ 11,992 $(8,205)
Increase(decrease) in beginning-of-year balance of the valuation
allowance for deferred tax assets............................. (12,282) 8,750
-------- -------
Total................................................. $ (290) $ 545
======== =======
</TABLE>

For the year ended December 31, 1992, deferred income tax expense was
$2,512, resulting from timing differences in the recognition of income and
expense for income tax and financial reporting purposes.

The sources and tax effects of those timing differences are presented
below:

<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1992
------------
<S> <C>
Depreciation............................................................ $ 1,198
Inventory valuation adjustments......................................... 556
Accrued vacation and other compensation................................. 822
Other asset valuation adjustments....................................... 413
Capitalization of software development costs............................ (152)
Customer service accruals............................................... 901
Accrued restructure costs............................................... (292)
Adjustment of deferred tax assets due to net operating loss............. (1,296)
Other, net.............................................................. 362
-------
Total......................................................... $ 2,512
=======
</TABLE>

F-12
<PAGE> 114

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The tax effects of temporary differences and carryforwards which gave rise
to significant portions of deferred tax assets and liabilities were as follows:

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------
1994 1993
-------- --------
<S> <C> <C>
Deferred tax assets:
Property and equipment, principally due to differences in
depreciation and capitalized interest..................... $ 2,032 $ 810
Inventories, principally due to adjustments to lower of cost or
market....................................................... 494 3,358
Accounts receivable, principally due to allowance for doubtful
accounts..................................................... 836 1,241
Compensated absences and other compensation, principally due to
accrual for financial reporting purposes..................... 3,730 3,105
Restructure costs, principally due to accrual for financial
reporting purposes........................................... 4,480 9,642
Net operating loss carryforwards............................... 23,567 29,576
Tax credit carryforwards....................................... 11,153 11,523
Other, net..................................................... 2,208 1,663
-------- --------
Total gross deferred tax assets.............................. 48,500 60,918
-------- --------
Less valuation allowance..................................... (46,213) (58,495)
-------- --------
Net deferred tax assets...................................... 2,287 2,423
Deferred tax liabilities:
Capitalization of software development costs for financial
reporting purposes........................................ (3,208) (3,634)
-------- --------
Net deferred tax liability..................................... $ (921) $ (1,211)
======== ========
</TABLE>

The Company has established a valuation allowance for certain current
deferred tax assets, and net operating loss and tax credit carryforwards.
Statement 109 requires that such a valuation allowance be recorded when it is
more likely than not that some portion of the deferred tax assets will not be
realized. The portion of the valuation allowance for deferred tax assets for
which subsequently recognized tax benefits will be applied directly to
contributed capital is $10,650 as of December 31, 1994. This amount was
primarily attributable to differences between financial and tax reporting of
employee stock option transactions. During 1994, the valuation allowance
decreased by $12,282, of which $6,404 related to the realization of net
operating loss carry forwards. The valuation allowance as of January 1, 1993 was
$49,745. The net increase in the valuation allowance for the year ended December
31, 1993 was $8,750.

As of December 31, 1994, the Company has net operating loss carryforwards
for income tax purposes of approximately $53,726. Such carryforwards will expire
from 1998 to 2009 if not used by the Company to reduce income taxes payable in
future periods.

As of December 31, 1994 the Company has research and experimentation tax
credits available totaling approximately $11,153. These tax credits are
applicable against Federal tax liabilities from 1994 through 2008 subject to
various limitations under current tax law.

The Company has not provided for Federal income taxes on approximately
$85,291 of undistributed earnings of foreign subsidiaries at December 31, 1994,
since these earnings have been invested indefinitely in subsidiary operations.
Upon repatriation, some of these earnings would generate foreign tax credits
which will reduce the Federal tax liability associated with any future foreign
dividend.

The Company has settled its Federal income tax obligations through 1991.
The Company believes the provisions for income taxes for years since 1991 are
adequate.

F-13
<PAGE> 115

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. PROPERTY, PLANT AND EQUIPMENT

A summary of property, plant and equipment follows:

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
1994 1993
--------- --------
<S> <C> <C>
Computer equipment and furniture.............................. $ 135,723 $121,975
Buildings and building equipment.............................. 53,365 53,326
Land and improvements......................................... 14,641 14,641
Leasehold improvements........................................ 9,577 9,613
Service spare parts........................................... 4,953 3,857
--------- --------
218,259 203,412
Less accumulated depreciation and amortization................ (120,558) (98,500)
--------- --------
Property, plant and equipment, net............................ $ 97,701 $104,912
========= ========
</TABLE>

On January 20, 1993, the Company entered into an agreement to lease a
portion of its headquarters site in Wilsonville, Oregon. Under terms of the
five-year agreement, approximately 150 square feet of space was made available
to a third party on a firm take-down schedule. The agreement results in rental
payments of $3,252 over the remaining term of the lease.

6. OTHER ASSETS

A summary of other assets follows:

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1994 1993
------- -------
<S> <C> <C>
Software development costs, net.................................. $ 8,021 $ 9,085
Long-term deposits............................................... 6,220 5,613
Purchased technology, net........................................ 5,781 106
Goodwill......................................................... 2,655 --
Investment in real estate........................................ 2,935 2,935
Long-term receivables............................................ 2,316 2,453
Other............................................................ 162 392
------- -------
Total.................................................. $28,090 $20,584
======= =======
</TABLE>

The Company capitalized software development costs amounting to $5,156,
$3,609, and $6,120 in 1994, 1993, and 1992, respectively. Related amortization
expense of $6,220, $7,449, and $5,875 was recorded for the years ended December
31, 1994, 1993, and 1992, respectively.

Purchased technology is carried at cost and is amortized over the estimated
economic life of the technology, generally three years. Related amortization
expense of $760, $565, and $636 was recorded for the years ended December 31,
1994, 1993, and 1992, respectively. The 1994 Anacad acquisition resulted in
goodwill capitalization of $2,897 and technology capitalization of $4,735. In
addition, other purchased technology totalling $1,700 was acquired in 1994.

During 1993 and 1992, certain purchased technology and software development
costs were written off due to product discontinuance resulting from the December
1993 and August 1992 restructurings. These write-offs, combined with write-downs
of certain other software development, prepaid royalty, and purchased technology
costs to net realizable value, totaled $812 and $1,005 in 1993 and 1992,
respectively.

F-14
<PAGE> 116

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. SHORT-TERM BORROWINGS

Short-term borrowings represent drawings by subsidiaries under
multi-currency unsecured credit agreements and the current portion of long-term
debt. Interest rates are generally based on the applicable country's prime
lending rate depending on the currency borrowed. The Company has available lines
of credit of approximately $23,574 as of December 31, 1994. Certain agreements
require compensatory balances which the Company has met.

8. LONG-TERM DEBT

Long-term debt is comprised of the following:

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1994 1993
------- -------
<S> <C> <C>
Revolving term credit facility................................... $54,160 $55,000
Bank note........................................................ -- 2,681
Other............................................................ 305 161
------- -------
54,465 57,842
Less current portion............................................. (840) (3,521)
------- -------
Total.................................................. $53,625 $54,321
======= =======
</TABLE>

Effective December 31, 1992, the Company amended its committed credit
facility with First Interstate Bank of Oregon, N.A. Under terms of the
amendment, the revolving credit facility remains in effect until July 2000 and
the commitment level was established at $55,000. Interest on borrowings under
the credit facility remain floating rate based. Borrowings are collateralized by
cash and investments of $30,000 and a trust deed on the Company's headquarters
site in Wilsonville, Oregon of $25,000. The amendment requires commitment
reductions of $840 annually which began in July 1994, therefore the debt was
reduced by $840 in 1994. Also, $840 of the debt is classified as current in
short-term borrowings on the Consolidated Balance Sheets as of December 31, 1994
and 1993.

In conjunction with the loan amendment, the Company also modified its
interest rate swap agreement with First Interstate Bank of Oregon, N.A.,
reducing the notional amount from $50,000 to $17,500 without any negative
financial impact. The interest rate swap agreement effectively converts floating
rates on $17,500 of borrowings to a fixed rate of 9.55% until expiration of the
agreement in January 2000. The amendment allowed the Company to move $32,500 of
9.55% fixed rate borrowings to more favorable floating rates. The average
floating interest rate as of December 31, 1994 was approximately 5%. While the
Company may be exposed to credit risk in the event of nonperformance by the
counterparty to the interest rate swap agreement, the risk of incurring losses
due to nonperformance by the counterparty is considered remote.

During 1992, the Company's Japanese subsidiary borrowed 300 million Yen
($2,681 at December 31, 1993 exchange rates) from a local bank to finance its
local operations. The interest rate on these borrowings was floating rate based
with a cap of 5.95%. The effective rate on these borrowings during 1994 was
approximately 2%. The entire bank note was paid off on July 20, 1994.

9. INCENTIVE STOCK PLAN

The Board of Directors has the authority to issue incentive stock in one or
more series and to determine the relative rights and preferences of the
incentive stock (note 10). The incentive stock is convertible into common stock
upon attainment of specified objectives or upon the occurrence of certain events
to be determined by the Board of Directors.

F-15
<PAGE> 117

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. EMPLOYEE STOCK AND SAVINGS PLAN

The Company has five stock option plans. The three common stock option
plans provide for the granting of incentive and nonqualified stock options to
key employees, officers, and non-employee directors of the Company and its
subsidiaries.

The three stock option plans are administered by the Compensation Committee
of the Board of Directors, and permit accelerated vesting of outstanding options
upon the occurrence of certain changes in control of the Company.

The Company also has a stock plan which provides for the sale of common
stock to key employees of the Company and its subsidiaries. Shares can be
awarded under the plan at no purchase price as a stock bonus and the stock plan
also provides for the granting of nonqualified stock options.

In addition, the Company has an incentive stock option plan and has
reserved 600 shares of incentive stock for issuance. No options have been
granted under this plan.

Options under all five plans generally become exercisable over a four to
five-year period from the date of grant or from the commencement of employment
at prices generally not less than the fair market value at the date of grant.
The excess of the fair market value of the shares at the date of grant over the
option price, if any, is charged to operations ratably over the vesting period.
At December 31, 1994, options for 2,949 shares were exercisable, 19,810 shares
were reserved for issuance and 3,549 shares were available for future grant.
Stock options outstanding and transactions involving the stock option plans are
summarized as follows:

<TABLE>
<CAPTION>
SHARES PRICE PER SHARE
------ ---------------
<S> <C> <C>
Balance at December 31, 1992................................ 6,576 $ .21 - $19.76
Granted..................................................... 1,180 .07 - 12.63
Exercised................................................... (1,021) .21 - 13.00
Canceled.................................................... (848) 4.95 - 18.13
------
Balance at December 31, 1993................................ 5,887 .07 - 19.76
Granted..................................................... 983 9.63 - 14.31
Exercised................................................... (780) .07 - 13.00
Canceled.................................................... (343) 6.00 - 14.63
------
Balance at December 31, 1994................................ 5,747 $ .07 - 19.76
======
</TABLE>

In October 1992, the Board of Directors adopted a resolution to offer
employees holding incentive and nonqualified stock options for 5,840 shares the
opportunity to exchange their existing options for nonqualified stock options.
The exchange allowed employees to receive the same number of shares at $6.00 per
share, the then current market price. The new options vest ratably over between
two to five years, depending on the vesting status of exchanged options as of
January 2, 1993. The offer was made because the Board of Directors believes
lower-priced options provide a greater incentive to key employees and officers.
Option holders elected to exchange options covering 3,808 shares.

In May 1989, the shareholders adopted the 1989 Employee Stock Purchase Plan
and reserved 1,400 shares for issuance. In April 1992, the shareholders amended
the plan to reserve an additional 2,000 shares for issuance. Under the plan,
each eligible employee may purchase up to six hundred shares of stock per
quarter at prices no less than 85% of its fair market value determined at
certain specified dates. Employees purchased 527 and 605 shares under the plans
in 1994 and 1993, respectively. At December 31, 1994, 797 shares remain
available for future purchase under the plan. The plan will expire upon either
issuance of all shares reserved for issuance or at the discretion of the Board
of Directors. There are no plans to terminate the plan at this time.

F-16
<PAGE> 118

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company has an employee savings plan (the Savings Plan) that qualifies
as a deferred salary arrangement under Section 401(k) of the Internal Revenue
Code. Under the Savings Plan, participating U.S. employees may defer a portion
of their pretax earnings, up to the Internal Revenue Service annual contribution
limit. The Company currently matches 50% of eligible employee's contributions,
up to a maximum of 6% of the employee's earnings. Employer matching
contributions vest over 5 years, 20% for each year of service completed. The
Company's matching contributions to the Savings Plan were $1,997, $1,896, and
$1,989 in 1994, 1993, and 1992, respectively.

11. COMMITMENTS

The Company leases a majority of its field office facilities under
noncancellable operating leases. In addition, the Company leases certain
equipment used in its research and development activities. This equipment is
generally leased on a month-to-month basis after meeting a six-month lease
minimum.

The Company rents its Japanese facilities under a two year cancellable
lease with a six month notice of cancellation. The total commitment under this
cancellable lease, which expires in December 1996, is $6,256, of which the first
six month's payments in 1995 of $1,564 are included in the schedule below.
Future minimum lease payments under noncancellable operating leases are
approximately as follows:

<TABLE>
<CAPTION>
ANNUAL PERIODS OPERATING
ENDING LEASE
DECEMBER 31, PAYMENTS
------------------------------------------------------------------- ---------
<S> <C>
1995............................................................. $ 9,270
1996............................................................. 6,325
1997............................................................. 5,198
1998............................................................. 4,838
1999............................................................. 4,624
Later years........................................................ 15,698
Total.................................................... $45,953
</TABLE>

Rent expense under operating leases was approximately $13,722, $16,776, and
$16,156 for the years ending December 31, 1994, 1993, and 1992, respectively.

12. OTHER INCOME (EXPENSE)

Other income (expense) is comprised of the following:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1993 1992
------- ------- -------
<S> <C> <C> <C>
Interest income....................................... $ 4,953 $ 4,338 $ 5,284
Interest expense...................................... (2,703) (4,404) (5,469)
Foreign exchange gain................................. 177 247 297
Contract settlement................................... -- -- (6,150)
Write-off of non-operating items...................... -- -- (1,148)
Other, net............................................ 25 (438) (353)
------- ------- -------
Total....................................... $ 2,452 $ (257) $(7,539)
======= ======= =======
</TABLE>

F-17
<PAGE> 119

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. SUPPLEMENTAL CASH FLOW INFORMATION

The following provides additional information concerning supplemental
disclosures of cash flow activities:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1993 1992
------ ------ -------
<S> <C> <C> <C>
Cash paid (received) for:
Interest expense, net of capitalized interest......... $2,201 $4,042 $ 5,030
Income taxes............................................ $2,840 $2,403 $(2,662)
</TABLE>

The Company owns common stock and common stock warrants of an independent
public company with an original carrying cost of $0 and a market value of $1,812
as of December 31, 1994. This difference resulted in a non-cash increase on the
consolidated balance sheet in prepaid and other assets and as a reduction of the
same amount in accumulated deficit as of December 31, 1994.

14. INDUSTRY AND GEOGRAPHIC INFORMATION

The Company designs, manufactures, markets and supports electronic design
automation (EDA) software for the integrated circuit (IC) and systems design
markets. The Company provides a broad range of EDA tools developed either by the
Company or together with third parties to support the entire electronic design
process. The Company's software products enable engineers and designers to
design, analyze, place and route, and test custom ICs, application specific ICs
(ASICs), printed circuit boards, multichip modules and other electronic systems
and subsystems. The Company's Falcon Framework software provides a common
foundation for the Company's EDA software products. Falcon Framework software
also allows for the integration of third party software tools developed by other
commercial EDA vendors and by customers for their own internal use. The
Company's products help customers reduce development time while producing
innovative hardware products of high quality. In addition to software products,
the Company's Professional Services Division offers consulting, support and
training services to enhance customers' success in the design and manufacture of
hardware products.

Foreign operations consist of offices whose principal activities are the
sale, distribution, service, and research and development of the Company's
products. Foreign offices purchase the computer workstations on which the
Company's software operates principally from suppliers located in each
respective geographic area.

F-18
<PAGE> 120

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Intercompany transfers are accounted for at amounts generally above cost.
Corporate expenses are general expenses which are not allocated to the
operations of each geographic area. For the purposes of determining operating
income, research and development and certain marketing expenses are allocated
based on each region's percentage of total revenue contribution. Corporate
assets are comprised of capital assets used in research and development
activities, short-term investments, and cash and investments classified as long-
term in the consolidated balance sheets. Geographic information for 1994, 1993
and 1992 is set forth in the table below.

<TABLE>
<CAPTION>
GEOGRAPHIC INFORMATION USA EUROPE JAPAN OTHER INTL ELIMINATIONS CORPORATE CONSOLIDATED
- ------------------------ -------- -------- ------- ---------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1994
Revenues from
unaffiliated
customers............. $189,495 $ 88,593 $53,059 $ 17,818 $ (671) $ -- $348,294
Intercompany
transfers............. 2,103 1,728 -- 14,609 (18,440) -- --
-------- -------- ------- ------- --------- -------- --------
Total revenues.......... $191,598 $ 90,321 $53,059 $ 32,427 $ (19,111) $ -- $348,294
Operating income
(loss)................ $ 23,195 $ 6,885 $ 3,948 $ 5,102 $ 1,979 $ (12,649) $ 28,460
-------- -------- ------- ------- --------- -------- --------
Identifiable assets..... $197,124 $150,508 $44,900 $ 24,169 $ (112,701) $ 89,797 $393,797
======== ======== ======= ======= ========= ======== ========
1993
Revenues from
unaffiliated
customers............. $181,371 $ 87,178 $50,667 $ 20,559 $ -- $ -- $339,775
Intercompany
transfers............. 1,282 5,016 -- 20,948 (27,246) -- --
-------- -------- ------- ------- --------- -------- --------
Total revenues.......... $182,653 $ 92,194 $50,667 $ 41,507 $ (27,246) $ -- $339,775
Operating income
(loss)................ $ 1,354 $(14,564) $(2,402) $ 2,531 $ (2,939) $ (13,372) $(29,392)
-------- -------- ------- ------- --------- -------- --------
Identifiable assets..... $150,915 $124,956 $39,548 $ 26,322 $ (92,258) $ 104,101 $353,584
======== ======== ======= ======= ========= ======== ========
1992
Revenues from
unaffiliated
customers............. $178,732 $ 99,481 $53,626 $ 18,927 $ -- $ -- $350,766
Intercompany
transfers............. 1,611 11,849 -- 15,187 (28,647) -- --
-------- -------- ------- ------- --------- -------- --------
Total revenues.......... $180,343 $111,330 $53,626 $ 34,114 $ (28,647) $ -- $350,766
Operating income
(loss)................ $(19,035) $ (7,267) $(1,205) $ (176) $ (1,538) $ (11,511) $(40,732)
-------- -------- ------- ------- --------- -------- --------
Identifiable assets..... $162,654 $116,174 $33,522 $ 21,956 $ (60,471) $ 104,730 $378,565
======== ======== ======= ======= ========= ======== ========
</TABLE>

F-19
<PAGE> 121

MENTOR GRAPHICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

QUARTERLY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1994
Total revenues................................ $85,299 $82,668 $ 83,543 $ 96,784
Gross margin.................................. $59,234 $57,333 $ 57,526 $ 67,381
Operating income.............................. $ 4,989 $ 5,466 $ 4,753 $ 13,252
Net income.................................... $ 4,612 $ 4,851 $ 5,067 $ 13,007
Net income per common and common equivalent
share....................................... $ .09 $ .09 $ .10 $ .25
1993
Total revenues................................ $82,639 $88,416 $ 84,950 $ 83,770
Gross margin.................................. $52,371 $56,214 $ 56,378 $ 54,620
Operating income (loss)....................... $(3,317 ) $ 633 $ 1,888 $ (28,596)
Net income (loss)............................. $(4,298 ) $ 290 $ 1,490 $ (29,555)
Net income (loss) per common and common
equivalent share............................ $ (.09 ) $ .01 $ .03 $ (.63)
</TABLE>

COMMON STOCK MARKET PRICE:

The table above sets forth for the quarters indicated the high and low
sales prices for the common stock as reported on the NASDAQ National Market
System. As of December 31, 1994, the Company had 1,532 shareholders of record.

F-20
<PAGE> 122

MENTOR GRAPHICS CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
1994
AS OF ------------
SEPTEMBER 30,
1995
-------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................... $ 154,419 $130,676
Short-term investments............................................. 31,425 7,180
Trade accounts receivable, net..................................... 76,755 82,285
Other receivables.................................................. 2,772 4,853
Prepaid expenses and other......................................... 13,253 13,012
-------- --------
Total current assets....................................... 278,624 238,006
PROPERTY, PLANT AND EQUIPMENT, NET................................... 94,442 97,701
CASH AND INVESTMENTS, LONG-TERM...................................... 30,000 30,000
OTHER ASSETS......................................................... 29,436 28,090
-------- --------
Total assets............................................... $ 432,502 $393,797
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings.............................................. $ 8,815 $ 8,450
Accounts payable................................................... 7,979 11,570
Income taxes payable............................................... 13,329 12,793
Accrued and other liabilities...................................... 45,296 48,765
Deferred revenue................................................... 21,216 17,649
-------- --------
Total current liabilities.................................. 96,635 99,227
LONG-TERM DEBT....................................................... 52,589 53,625
OTHER LONG-TERM DEFERRALS............................................ 839 1,877
-------- --------
Total liabilities.......................................... 150,063 154,729
-------- --------
STOCKHOLDERS' EQUITY:
Common stock....................................................... 266,525 254,271
Accumulated deficit................................................ 2,346 (27,877)
Foreign currency translation adjustment............................ 13,568 12,674
-------- --------
Total stockholders' equity................................. 282,439 239,068
-------- --------
Total liabilities and stockholders' equity................. $ 432,502 $393,797
======== ========
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-21
<PAGE> 123

MENTOR GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------
1995 1994
-------- --------
<S> <C> <C>
REVENUES:
System and software.................................................. $137,182 $135,495
Service and support.................................................. 137,639 110,944
-------- --------
Total revenues............................................... 274,821 246,439
-------- --------
COST OF REVENUES:
System and software.................................................. 24,392 24,332
Service and support.................................................. 58,250 47,315
-------- --------
Total cost of revenues....................................... 82,642 71,647
-------- --------
Gross margin................................................. 192,179 174,792
-------- --------
EXPENSES:
Research and development............................................. 53,431 50,035
Marketing, general and administration................................ 107,755 106,884
Restructuring adjustment............................................. (2,040) (5,600)
Merger related charges............................................... 800 8,265
-------- --------
Total expenses............................................... 159,946 159,584
-------- --------
OPERATING INCOME....................................................... 32,233 15,208
Other income, net.................................................... 3,862 2,122
-------- --------
Income before income taxes........................................ 36,095 17,330
-------- --------
Provision for income taxes........................................... 4,790 2,800
-------- --------
Net income........................................................ $ 31,305 $ 14,530
======== ========
Net income per common and common equivalent share................. $ .57 $ .28
======== ========
Weighted average number of common and common equivalent shares
outstanding....................................................... 55,323 51,966
======== ========
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-22
<PAGE> 124

MENTOR GRAPHICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
-------------------
1995 1994
-------- --------
<S> <C> <C>
OPERATING CASH FLOWS:
Net Income............................................................. $ 31,305 $ 14,530
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of property, plant and equipment...... 18,723 18,674
Deferred taxes...................................................... (2,172) (54)
Amortization of other assets........................................ 6,413 5,390
Charge for in-process R&D........................................... 400 8,265
Restructuring adjustment............................................ (2,040) (5,600)
Changes in operating assets and liabilities:
Trade accounts receivable........................................... 5,838 2,061
Prepaid expenses and other assets................................... 2,226 (1,544)
Accounts payable.................................................... (3,622) (4,978)
Accrued liabilities................................................. (226) (5,790)
Other liabilities and deferrals..................................... 3,482 2,898
-------- --------
Net cash provided by operating activities...................... 60,327 33,852
-------- --------
INVESTING CASH FLOWS:
Maturities (purchases) of short-term investments.................... (24,170) 9,314
Purchases of property and equipment................................. (14,957) (8,425)
Capitalization of software development costs........................ (5,002) (4,064)
Purchase of businesses.............................................. (3,820) (9,345)
Purchase of technology.............................................. -- (1,770)
-------- --------
Net cash used by investing activities.......................... (47,949) (14,290)
-------- --------
FINANCING CASH FLOWS:
Proceeds from issuance of common stock.............................. 14,504 7,627
Repurchase of common stock.......................................... (2,250) --
Increase (decrease) in short-term borrowings........................ 339 (4,826)
Repayment of long-term debt......................................... (1,038) (2,982)
Adjustment for pooling of interests................................. (331) 899
Cash Distribution................................................... -- (1,848)
-------- --------
Net cash provided (used) by financing activities............... 11,224 (1,130)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS............. 141 2,969
-------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS.................................. 23,743 21,401
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD......................... 130,676 95,958
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............................... $154,419 $117,359
======== ========
</TABLE>

See accompanying notes to unaudited consolidated financial statements.

F-23
<PAGE> 125

MENTOR GRAPHICS CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 1994 to conform with the 1995 presentation.

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Statement No.
121 provides specific guidance regarding when impairment of Long-Lived assets
such as plant, equipment and certain intangibles including goodwill and
capitalized technology should be recognized and how impairment losses of such
assets should be measured. The Company is preparing to adopt Statement No. 121
in January 1996 and expects the impact on its Statements of Operations and
Financial Position will not be material.

2. ACQUISITIONS

On May 4, 1995, the Company completed the acquisition of Axiom Datorer
Skandinavien AB (Axiom), headquartered in Stockholm, Sweden. Axiom is primarily
engaged in developing, marketing and supporting software library tools used to
model electronic components primarily for the printed circuit board and to a
lesser extent the application specific integrated circuit markets of the
electronic design automation (EDA) industry. Axiom's product offerings are
complementary to the Company's current broad line of EDA tools and systems. The
total purchase price was $480 in addition to Axiom's net deficit of $413 for a
total acquisition cost basis of $893. The transaction was accounted for as a
purchase, and therefore, the Consolidated Balance Sheet of Axiom has been
included in the accompanying Consolidated Balance sheets as of June 30, 1995.
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 $400, goodwill capitalization of $398 and technology
capitalization of $95. The charge for in-process R&D was a result of allocating
a portion of the acquisition cost to Axiom's in-process product development that
had not reached technological feasibility. The goodwill costs will be amortized
over a three year period to R&D expense primarily to recognize the value of the
development work-force acquired. The technology costs will be amortized over a
three year period to system and software cost of revenues. Financial results
subsequent to the acquisition date have been included in the Consolidated
Statements of Operations and Cash Flows. The separate operational results of
Axiom were not material compared to the Company's overall results of operations,
and accordingly pro-forma financial statements of the combined entities have
been omitted.

On May 31, 1995, the Company issued 1,512 shares of its common stock for
all outstanding common stock of Exemplar Logic, Inc. (Exemplar) headquartered in
Alameda, California. Exemplar develops, markets and supports a family of
software tools for high-level-design-automation for the application specific
integrated circuit and field programmable gate array markets. Exemplar's product
offerings are complementary to the Company's line of EDA tools and systems. The
Company accounted for this transaction as a pooling of interests. The balance
sheet of Exemplar is included in the accompanying Consolidated Balance Sheet as
of September 30, 1995 and Exemplar's results of operations are included in the
accompanying Consolidated Statement of Operations for all of 1995. The Company's
prior year financial statements were not restated due to the relative
materiality of Exemplar's separate financial statements for 1994 and prior.
Merger expenses of $350 were for services rendered to facilitate completion of
the merger agreement and severance costs.

F-24
<PAGE> 126

MENTOR GRAPHICS CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. RESTRUCTURING

Implementation of the Company's restructuring plan which was approved by
management in December 1993, and modified in 1994, continued during 1995. Costs
remaining to be incurred in executing the restructuring plan consist primarily
of direct costs associated with severance and relocation of employees,
facilities closures and write-offs of excess equipment and intangible software
technology assets related to discontinued product development activities.

During the second quarter of 1995, several elements of the restructuring
plan were adjusted due to updated information. Costs associated with an
international reorganization were modified due to additional cost information
related to implementation activities associated with a new global information
system. In addition, certain actions associated with a product discontinuance
plan will not be taken as the technology will be used by the Company's
consulting organization. As a result, the Company recorded a $2,040 credit
during the second quarter of 1995 reflecting these lower costs.

4. CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS

During the first nine months of 1995 and 1994, $5,002 and $4,064 of new
product development costs were capitalized and included in other assets on the
Consolidated Balance Sheets, respectively. Amortization of previously
capitalized software development costs amounted to $3,653 and $5,027 for the
nine months ended September 30, 1995 and 1994, respectively, and is included in
system and software cost of revenues on the Consolidated Statements of
Operations.

5. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

The following provides additional information concerning cash flow
activities:

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1995 1994
------ ------
<S> <C> <C>
Interest paid.................................................... $1,671 $1,686
Income taxes paid, net of refunds................................ $5,951 $2,054
</TABLE>

6. STOCK REPURCHASE

In August, 1995 the Company's Board of Directors approved a plan to
repurchase, from time to time over the next eighteen months on the open market,
up to $50,000 in market value of the Company's common shares. During the third
quarter of 1995, the Company repurchased 110 shares on the open market with a
market value of $2,250. All 110 shares repurchased during the third quarter of
1995 were subsequently re-issued through the Company's stock option plan
exercises prior to consummation of the October 16, 1995 acquisition of
Precedence Incorporated (Precedence) described in Note 7.

7. SUBSEQUENT EVENTS

On October 16, 1995, the Company issued 735 shares of its common stock for
all outstanding common stock of Precedence headquartered in Santa Clara,
California. Precedence is primarily engaged in developing, marketing and
supporting simulation backplane technology and co-simulation solutions for the
electronic design automation industry. Precedence's product offerings are
complementary to the Company's current broad line of EDA tools and systems. the
Company accounted for this transaction as a pooling of interest. Since the
acquisition was consummated subsequent to September 30, 1995, the results of
Precedence are not included in the Consolidated Financial Statements. The
Company's prior year financial statements will not be restated due to the
relative materiality of Precedence's separate financial statements for 1994 and
prior. In addition, the separate operating results of Precedence are not
material compared to the Company's overall results of operations, and
accordingly, pro forma financial statements of the combined entities have been
omitted.

F-25
<PAGE> 127

MENTOR GRAPHICS CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On October 9, 1995, the Company entered into a merger agreement with
Microtec, headquartered in Santa Clara, California. Under terms of the
Agreement, which is subject to approval by the shareholders of Microtec and
certain other conditions, the Company will issue an estimated 6,500 shares of
its common stock for all outstanding common stock of Microtec. the Company
anticipates that the transaction will be completed prior to December 31, 1995.
When consummated, the merger will be accounted for as a pooling of interests.
Microtec is primarily engaged in developing and marketing 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. Microtec's product
offerings are complementary to the Company's current broad line of EDA tools and
systems. Since the acquisition has not been consummated, the results of Microtec
are not included in the Company's Consolidated Financial Statements.

The following is a summary of certain information concerning pro forma
consolidated financial information for the Company and Microtec for the interim
periods presented:

<TABLE>
<CAPTION>
THREE MONTHS ENDED
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1995 1994 1995 1994
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Total revenues................................... $106,737 $92,204 $309,681 $278,562
Operating income................................. 14,428 6,090 35,320 18,995
Net income....................................... $ 13,398 $ 6,050 $ 33,974 $ 17,155
Net income per share............................. $ 0.21 $ 0.10 $ 0.55 $ 0.30
Shares used in per share calculations............ 62,494 57,599 61,767 57,620
</TABLE>

The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the operating results or financial position
that would have occurred if the merger had been consummated at the beginning of
the periods presented, nor is it necessarily indicative of future operating
results or financial position.

F-26
<PAGE> 128

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
Microtec Research, Inc.:

We have audited the accompanying consolidated balance sheets of Microtec
Research, Inc. and subsidiaries as of March 31, 1995 and 1994, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended March 31, 1995. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Microtec Research, Inc. and
subsidiaries as of March 31, 1995 and 1994, and the results of their operations
and their cash flows for each of the three years in the period ended March 31,
1995 in conformity with generally accepted accounting principles.

Deloitte & Touche LLP
San Jose, California
April 28, 1995

F-27
<PAGE> 129

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
MARCH 31,
-------------------
1995 1994
------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents................................................... $12,748 $ 3,673
Short-term investments................................................. 987 --
Accounts receivable, less allowance for doubtful accounts of $591 and
$847................................................................ 9,409 7,673
Income taxes receivable................................................ 63 456
Deferred income taxes.................................................. 478 3,731
Prepaid expenses and other assets...................................... 1,829 1,337
------- -------
Total current assets........................................... 25,514 16,870
PROPERTY AND EQUIPMENT, Net.............................................. 4,180 3,151
OTHER ASSETS:
Software development costs, net........................................ 2,052 1,950
Deposits and other..................................................... 1,270 1,077
Deferred income taxes.................................................. 3,753 1,833
Goodwill, net.......................................................... -- 280
------- -------
TOTAL.................................................................... $36,769 $25,161
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable....................................................... $ 1,979 $ 1,575
Accrued compensation and related benefits.............................. 1,721 1,169
Other accrued expenses................................................. 3,805 2,959
Deferred service revenue............................................... 4,941 4,241
Deferred contract revenue.............................................. 308 1,968
Income taxes payable................................................... 569 439
------- -------
Total current liabilities...................................... 13,323 12,351
------- -------
DEFERRED RENT............................................................ 1,883 3,480
COMMITMENTS AND CONTINGENCIES (Notes 9 and 13)
REDEEMABLE CONVERTIBLE PREFERRED STOCK, $.001 par value; 960 shares
outstanding at March 31, 1994.......................................... -- 1,070
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $.001 par value; 2,000 shares authorized
at March 31, 1995; 2,084 shares outstanding at March 31, 1994....... -- 7,018
Common stock, $.001 par value; 20,000 shares authorized; 8,656 and
5,040 shares outstanding............................................ 16,742 911
Deferred stock compensation............................................ (150) --
Notes receivable for common stock...................................... (137) (186)
Accumulated translation adjustments.................................... 588 186
Retained earnings...................................................... 4,520 331
------- -------
Total stockholders' equity..................................... 21,563 8,260
------- -------
TOTAL.................................................................... $36,769 $25,161
======= =======
</TABLE>

See notes to consolidated financial statements.

F-28
<PAGE> 130

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
--------------------------------
1995 1994 1993
------- -------- -------
<S> <C> <C> <C>
NET REVENUE:
License.................................................... $36,015 $ 26,234 $18,175
Service.................................................... 9,197 6,773 4,451
------- -------- -------
Total net revenue.................................. 45,212 33,007 22,626
------- -------- -------
COST OF REVENUE:
License.................................................... 3,700 3,446 2,337
Service.................................................... 2,202 1,712 1,348
------- -------- -------
Total cost of revenue.............................. 5,902 5,158 3,685
------- -------- -------
GROSS PROFIT................................................. 39,310 27,849 18,941
------- -------- -------
COSTS AND EXPENSES:
Selling and marketing...................................... 17,726 10,276 7,092
Research and development................................... 11,954 9,176 6,432
In-process research acquired............................... -- 14,403 650
General and administrative................................. 3,800 4,114 2,842
Litigation and settlement costs............................ -- 3,879 1,433
------- -------- -------
Total operating expenses........................... 33,480 41,848 18,449
------- -------- -------
INCOME (LOSS) FROM OPERATIONS................................ 5,830 (13,999) 492
OTHER INCOME (EXPENSE):
Interest income............................................ 389 196 287
Interest expense........................................... (81) (128) (3)
Foreign currency transaction gain, net..................... 452 -- 13
Minority interest in consolidated subsidiaries............. -- -- (363)
------- -------- -------
Total other income (expense), net.................. 760 68 (66)
------- -------- -------
INCOME (LOSS) BEFORE INCOME TAXES............................ 6,590 (13,931) 426
PROVISION (BENEFIT) FOR INCOME TAXES......................... 2,240 (5,600) 270
------- -------- -------
NET INCOME (LOSS)............................................ $ 4,350 $ (8,331) $ 156
======= ======== =======
NET INCOME (LOSS) PER SHARE.................................. $ 0.50 $ (1.21)
======= ========
SHARES USED IN PER SHARE CALCULATION......................... 8,621 6,877
======= ========
</TABLE>

See notes to consolidated financial statements.

F-29
<PAGE> 131

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED MARCH 31, 1995, 1994 AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
NOTES
PREFERRED STOCK COMMON STOCK DEFERRED RECEIVABLE ACCUMULATED
------------------ ------------------ STOCK FOR COMMON TRANSLATION
SHARES AMOUNT SHARES AMOUNT COMPENSATION STOCK ADJUSTMENTS
------ ------- ------ ------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES, April 1, 1992........... -- $ -- 4,509 $ 293 $ -- $ (49) $ (52)
Common stock issued under option
plans............................ 167 145
Common stock issued in conjunction
with acquisitions................ 104 179
Tax benefit of employee stock
option transactions.............. 70
Accumulated translation
adjustment....................... (96)
Accretion of redeemable
convertible preferred stock......
Net income........................
------ ------ ----- ------- ---- ---- ----
BALANCES, March 31, 1993.......... -- -- 4,780 687 -- (49) (148)
Common stock issued under option
plans............................ 260 224 (137)
Issuance of Series B convertible
preferred stock, in connection
with acquisition of Ready
Systems, Inc..................... 2,084 7,018
Accumulated translation
adjustment....................... 334
Accretion of redeemable
convertible preferred stock......
Net loss..........................
------ ------ ----- ------- ---- ---- ----
BALANCES, March 31, 1994.......... 2,084 7,018 5,040 911 -- (186) 186
Sale of Series B convertible
preferred stock.................. 114 368
Common stock issued under option
plans............................ 351 425
Deferred stock compensation....... 274 (200)
Amortization of deferred stock
compensation..................... 50
Accretion of redeemable
convertible preferred stock......
Public offering of common stock,
net of issuance costs of
$1,485........................... 1,000 6,515
Conversion of Series A redeemable
convertible preferred stock...... 800 1,231
Conversion of Series B convertible
preferred stock.................. (2,198) (7,386 ) 1,465 7,386
Repayment of note receivable...... 49
Accumulated translation
adjustment....................... 402
Net income........................
------ ------ ----- ------- ---- ---- ----
BALANCES, March 31, 1995.......... -- $ -- 8,656 $16,742 $ (150) $ (137) $ 588
====== ====== ===== ======= ==== ==== ====

TOTAL
RETAINED STOCKHOLDERS'
EARNINGS EQUITY
-------- -------------
<S> <C<C> <C>
BALANCES, April 1, 1992........... $ 8,965 $ 9,157
Common stock issued under option
plans............................ 145
Common stock issued in conjunction
with acquisitions................ 179
Tax benefit of employee stock
option transactions.............. 70
Accumulated translation
adjustment....................... (96)
Accretion of redeemable
convertible preferred stock...... (198 ) (198)
Net income........................ 156 156
------ -------
BALANCES, March 31, 1993.......... 8,923 9,413
Common stock issued under option
plans............................ 87
Issuance of Series B convertible
preferred stock, in connection
with acquisition of Ready
Systems, Inc..................... 7,018
Accumulated translation
adjustment....................... 334
Accretion of redeemable
convertible preferred stock...... (261 ) (261)
Net loss.......................... (8,331 ) (8,331)
------ -------
BALANCES, March 31, 1994.......... 331 8,260
Sale of Series B convertible
preferred stock.................. 368
Common stock issued under option
plans............................ 425
Deferred stock compensation....... 74
Amortization of deferred stock
compensation..................... 50
Accretion of redeemable
convertible preferred stock...... (161 ) (161)
Public offering of common stock,
net of issuance costs of
$1,485........................... 6,515
Conversion of Series A redeemable
convertible preferred stock...... 1,231
Conversion of Series B convertible
preferred stock.................. --
Repayment of note receivable...... 49
Accumulated translation
adjustment....................... 402
Net income........................ 4,350 4,350
------ -------
BALANCES, March 31, 1995.......... $ 4,520 $21,563
====== =======
</TABLE>

See notes to consolidated financial statements.

F-30
<PAGE> 132

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 4,350 $(8,331) $ 156
Reconciliation to net cash provided by (used in) operating
activities:
Depreciation and amortization............................ 1,857 1,021 926
Amortization of software development costs............... 650 401 264
Amortization of deferred stock compensation.............. 49 -- --
In-process research acquired............................. -- 14,403 650
Deferred rent............................................ (1,597) (137) (75)
Deferred income taxes.................................... 1,333 (5,430) (313)
Effect of minority interest on consolidated
subsidiaries........................................... -- -- 364
Changes in operating assets and liabilities:
Accounts receivable.................................... (952) (572) (1,450)
Prepaid expenses and other assets...................... (353) (462) (190)
Accounts payable....................................... (247) (635) 760
Accrued liabilities.................................... 1,253 (2,678) 645
Deferred revenue....................................... (1,193) 2,147 1,030
Income taxes receivable/payable........................ 502 (267) (29)
------- ------- -------
Net cash provided by (used in) operating
activities........................................ 5,652 (540) 2,738
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short term investments.......................... (987) -- --
Proceeds from sale of short-term investments................ -- -- 123
Purchases of property and equipment......................... (2,606) (789) (1,475)
Sale of property............................................ -- -- 391
Capitalized software development costs...................... (752) (332) (300)
Decrease (increase) in deposits and other................... (42) 33 (150)
Decrease (increase) in notes receivable..................... 54 (13) (47)
Cash used in acquisitions, net of cash acquired............. -- (377) (1,016)
------- ------- -------
Net cash used in investing activities............... (4,333) (1,478) (2,474)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Public offering of common stock, net of issuance costs...... 6,515 -- --
Repayment of capital lease obligations...................... -- -- (15)
Repayments of long-term debt................................ -- (1,350) (223)
Exercise of employee stock options.......................... 425 87 145
Sale of Series B convertible preferred stock, net of
issuance costs........................................... 368 -- --
------- ------- -------
Net cash provided by (used in) financing
activities........................................ 7,308 (1,263) (93)
EFFECT OF EXCHANGE RATE CHANGES ON CASH....................... 448 228 (52)
------- ------- -------
NET INCREASE IN CASH AND EQUIVALENTS.......................... 9,075 (3,053) 119
CASH AND EQUIVALENTS, Beginning of year....................... 3,673 6,726 6,607
------- ------- -------
CASH AND EQUIVALENTS, End of year............................. $12,748 $ 3,673 $ 6,726
======= ======= =======
</TABLE>

See notes to consolidated financial statements.

F-31
<PAGE> 133

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED MARCH 31, 1995, 1994 AND 1993

1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION -- Microtec Research, Inc. (the Company) develops, markets and
supports software development tools, real-time operating systems and
connectivity products for the embedded systems market. The Company provides a
range of services, including customer service and support contracts, training,
consulting and contract development. The Company markets its products on a
worldwide basis through a direct sales force, distributors and resellers.

CONSOLIDATION -- The consolidated financial statements include the Company
and its wholly-owned subsidiaries. Intercompany accounts and transactions are
eliminated.

CASH AND EQUIVALENTS -- The Company considers all highly liquid debt
investments with a maturity date of three months or less when purchased to be
cash equivalents.

SHORT-TERM INVESTMENTS -- During fiscal 1995, the Company adopted Statement
of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." At March 31, 1995, the Company held
commercial paper totaling $987,000 with 180 day maturities. Such amounts have
been classified as short-term investments to be held to maturity and their
carrying value is amortized cost, which approximates market value. There was no
cumulative effect from the initial adoption of this standard.

PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets which range from three to 15 years. Leasehold
improvements are amortized over the shorter of the estimated life of the
improvements or the lease term.

REVENUE RECOGNITION -- Revenue from product sales is recognized upon
shipment. Royalties earned from original equipment manufacturers (OEM) relating
to licensing agreements, whereby the OEM licenses the Company's propriety
software for redistribution to the OEM's end-user customers, are recognized when
the OEM ships its products incorporating the Company's software.

Service maintenance and support revenue from contracts is recognized
ratably over the terms of the contracts. Revenue from contract programming
services is recognized using the percentage of completion method.

SOFTWARE DEVELOPMENT COSTS -- The Company capitalizes certain costs
incurred in the production of computer software once technological feasibility
of the product to be marketed has been established. Costs incurred prior to
technological feasibility, including amounts attributable to in-process research
and development in business acquisitions, are expensed as research and
development costs if there is no alternative future use. Capitalization of these
costs ceases when the product is considered available for general release to
customers.

INCOME TAXES -- The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, which requires an asset and
liability approach for financial accounting and reporting of income taxes.

CONCENTRATION OF CREDIT RISK -- Financial instruments which potentially
subject the Company to concentrations of credit risk consist primarily of cash
equivalents, short-term investments and trade accounts receivable. By policy,
the Company places its investments only with high credit quality financial
institutions and limits the amounts invested in any one institution or in any
type of instrument. Almost all of the

F-32
<PAGE> 134

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Company's trade accounts receivable are derived from sales to customers in the
telecommunications, medical, transportation, computer, industrial and consumer
markets. The Company performs ongoing credit evaluations of its customers'
financial condition and limits its exposure to losses from bad debts by limiting
the amount of credit extended whenever deemed necessary and generally does not
require collateral.

FOREIGN CURRENCY TRANSLATION -- The functional currency of each of the
Company's foreign subsidiaries is the local currency of that country. Assets and
liabilities of operations outside the United States are translated into U.S.
dollars using the current exchange rates and income statement items at the
average rate; the effects of foreign currency translation adjustments are
included as a component of stockholders' equity. Gains and losses from
transactions denominated in currencies other than the functional currency of the
Company or its foreign subsidiaries are included in the determination of net
income. The Company has entered into foreign currency exchange contracts from
time to time to hedge certain currency exposures. There were no open contracts
at March 31, 1994 or 1993. At March 31, 1995, the Company had forward sales
contracts denominated in yen totaling Y60,252,000 ($692,000 at March 31, 1995
exchange rates), to receive U.S. dollars totaling $612,000, with maturity dates
in May and June 1995, to hedge intercompany receivables.

PER SHARE DATA -- Per share data is computed based on the weighted average
number of common shares outstanding during the period including dilutive common
share equivalents. Common share equivalents represent outstanding stock options
when the exercise price is less than the average market price. In addition,
pursuant to rules of the Securities and Exchange Commission, all common shares
issued and stock options granted by the Company at a price less than its
December 1994 initial public offering price during the 12 months preceding the
offering date (using the treasury stock method until shares are issued) have
been included in the calculation of common and equivalent shares outstanding for
the periods prior to the initial public offering.

2. ACQUISITIONS

In December 1993, the Company entered into an agreement to acquire all of
the outstanding stock of Ready Systems Corporation (Ready), a developer of
real-time operating systems and software connectivity products, for 2,083,853
shares of Series B convertible preferred stock valued at $7,018,000, cash of
$76,000 and the assumption of Ready's common stock options. For accounting
purposes, the transaction has been treated as a purchase and the operations of
Ready have been included in the consolidated results of the Company since
December 1993. An additional 114,447 shares of Series B convertible preferred
stock were sold in June 1994 at $3.214 under the Ready Purchase Agreement.

The excess of the purchase price paid and the liabilities assumed of Ready
over the tangible assets (see Note 11) was $16,273,000, of which $14,403,000 was
allocated to in-process research and development (which was expensed),
$1,570,000 to capitalized software and $300,000 goodwill.

The following table presents unaudited pro forma results of operations of
the Company as if the Ready acquisition had occurred at the beginning of fiscal
1993 and excludes the nonrecurring charge and related tax effect for the
write-offs of Ready's in-process research and development (in thousands, except
per share data):

<TABLE>
<CAPTION>
YEARS ENDED MARCH
31,
-------------------
1994 1993
------- -------
<S> <C> <C>
Net revenue...................................................... $39,526 $36,135
Loss from operations............................................. (3,106) (2,840)
Net loss......................................................... (3,710) (3,305)
Pro forma net loss per share..................................... (.50) --
Shares used in pro forma share calculation....................... 7,464 --
</TABLE>

F-33
<PAGE> 135

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In December 1993, the Company purchased the minority interest in a joint
venture between Ready and a Japanese company for $48,000, which was equivalent
to the value of the net assets at the date of acquisition.

In September 1992, the Company purchased the outstanding common stock of
Digitailor AB, a distributor and value-added reseller of the Company's software
in Sweden, for $910,000 cash and 66,665 shares of the Company's common stock
valued at $150,000. This transaction was accounted for as a purchase;
accordingly, the operations of Digitailor AB have been included in the
consolidated results of the Company since the date of acquisition. In connection
with this acquisition, costs in excess of the underlying net assets acquired
were $925,000, of which $650,000 was attributed to in-process research, which
was expensed. The remaining goodwill was to be amortized over a period of three
years; as a result of the Ready acquisition described above, it was determined
that the remaining goodwill of $137,000 was impaired and written off in fiscal
1994.

In fiscal 1993, the Company purchased the minority interests in its
European subsidiaries for $214,000 and 37,332 shares of common stock valued at
$269,000. One of the former minority interest holders has the right to put
24,667 shares back to the Company for $9.75 per share in June and July of 1995.
The value ascribed to the put option has been included in accrued liabilities.

3. PROPERTY AND EQUIPMENT

Property and equipment at March 31 consist of the following (in thousands):

<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Computer equipment............................................... $ 7,206 $ 5,419
Furniture and fixtures........................................... 1,690 1,031
Automobiles...................................................... 233 225
Leasehold improvements........................................... 384 232
------- -------
9,513 6,907
Accumulated depreciation and amortization........................ (5,333) (3,756)
------- -------
$ 4,180 $ 3,151
======= =======
</TABLE>

4. OTHER ASSETS

Software development costs of $2,052,000 and $1,950,000 at March 31, 1995
and 1994, respectively, are presented net of accumulated amortization of
$903,000 and $580,000. Goodwill is presented net of accumulated amortization of
$20,000 at March 31, 1994; all remaining goodwill was reduced to zero based on
utilization of Ready NOL's in 1995.

5. FINANCING ARRANGEMENTS

The Company has a revolving line-of-credit agreement with a bank that is
due on demand. Under the terms of the agreement the Company can borrow up to
$3,000,000 with interest at the bank's prime rate (9% at March 31, 1995).
Borrowings under the line of credit are collateralized by accounts receivable
and equipment. The agreement requires the Company to maintain certain financial
covenants. There were no outstanding borrowings under the line of credit at
March 31, 1995 and 1994.

6. STOCKHOLDERS' EQUITY

In November 1994, the stockholders approved a reincorporation in Delaware
and the associated exchange of two shares of common stock of the successor
Delaware corporation for every three shares of the predecessor California
corporation. All shares and per share data have been adjusted to reflect the
reverse split.

F-34
<PAGE> 136

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On December 15, 1994, the Company completed its initial public offering of
1,000,000 shares of common stock. All outstanding shares of preferred stock were
converted to common stock at that time. The Company is authorized to issue up to
2,000,000 new shares of preferred stock.

STOCK OPTION PLANS

In October 1994, the Board of Directors adopted the 1994 Stock Option Plan
and reserved 1,000,000 shares of common stock for future grants. The terms of
the plan are similar to the 1985 Stock Option Plan and no future grants are
contemplated under the 1985 plan. Under both plans, the Company is authorized to
grant incentive stock options and nonqualified stock options to officers, key
employees and independent contractors. Incentive stock options are granted at
fair market value on the date of grant, and nonqualified stock options are
granted at a price not less than 85% of the fair market value on the date of
grant. Options are exercisable from time to time as set forth in the stock
option agreements (typically ratably over four years) and have a five- or
ten-year term.

In October 1994, the Board of Directors also adopted the 1994 Outside
Directors Stock Option Plan and reserved 250,000 shares of common stock for
future grants. Under this plan, nonstatutory stock options are automatically
granted to nonemployee directors of the Company. Under the plan each outside
director is initially granted an option to purchase 15,000 shares of common
stock at the fair market value as of the grant date; in addition, option grants
to purchase 5,000 additional shares are to be issued in each subsequent year up
to a maximum of 40,000 shares for each outside director.

Additional information with respect to the stock option plans is as
follows:

<TABLE>
<CAPTION>
SHARES OUTSTANDING OPTIONS TOTAL
AVAILABLE --------------------------- --------------
FOR FUTURE NUMBER
GRANT OF SHARES PRICE PER SHARE (IN THOUSANDS)
---------- --------- ---------------
<S> <C> <C> <C> <C>
Balances, April 1, 1992........................ 456 1,157 $ 0.75 - $ 1.88 $1,184
Exercised...................................... -- (167) 0.75 - 1.35 (145)
Granted........................................ (107) 107 2.03 - 2.25 236
Cancelled...................................... 44 (44) 0.90 - 2.25 (46)
----- ----- ------
Balances, March 31, 1993....................... 393 1,053 0.75 - 2.25 1,229
Authorized..................................... 667 -- --
Assumed in merger.............................. (51) 51 1.86 95
Exercised...................................... -- (260) 0.75 - 2.25 (224)
Granted........................................ (11) 11 2.25 24
Cancelled...................................... 5 (5) 0.90 - 2.25 (4)
----- ----- ------
Balances, March 31, 1994....................... 1,003 850 0.90 - 2.25 1,120
Close out of 1985 Plan......................... (608) --
Authorized under 1994 Plans.................... 1,250 -- --
Exercised...................................... -- (351) 0.90 - 2.25 (425)
Granted........................................ (526) 526 2.25 - 11.00 1,868
Cancelled...................................... 57 (57) 1.05 - 7.20 (127)
----- ----- ------
Balances, March 31, 1995....................... 1,176 968 $ 1.05 - $11.00 $2,436
===== ===== ======
</TABLE>

At March 31, 1995, options to purchase 463,000 shares of common stock were
exercisable.

F-35
<PAGE> 137

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEFERRED STOCK COMPENSATION

In connection with the grant of certain stock options to employees in the
year ended March 31, 1995, the Company recorded $274,000 for the difference
between the deemed fair value for accounting purposes and the option price as
determined by the Board at the date of grant. Of such amount, $74,000 related to
option grants to former Ready employees which had been previously accrued in
fiscal 1994; the remaining $200,000 is presented as a reduction of stockholders'
equity and is being amortized over the 48-month vesting period of the related
stock options.

7. INCOME TAXES

The income (loss) before income taxes for the years ended March 31 consists
of the following (in thousands):

<TABLE>
<CAPTION>
1995 1994 1993
------ -------- ----
<S> <C> <C> <C>
Domestic............................................... $5,411 $(15,499) $461
Foreign................................................ 1,179 1,568 (35)
------ --------- ----
$6,590 $(13,931) $426
====== ========= ====
</TABLE>

The provision (benefit) for income taxes for the years ended March 31
consists of the following (in thousands):

<TABLE>
<CAPTION>
1995 1994 1993
------ ------- -----
<S> <C> <C> <C>
Current income taxes (benefit):
Federal.............................................. $ 518 $ (456) $ 201
State................................................ 207 -- 64
Foreign.............................................. 182 286 318
------ ------- -----
907 (170) 583
Deferred income taxes (benefit):
Federal.............................................. 1,512 (4,930) (112)
State................................................ (227) (500) (20)
Foreign.............................................. 48 -- (181)
------ ------- -----
1,333 (5,430) (313)
------ ------- -----
$2,240 $(5,600) $ 270
====== ======= =====
</TABLE>

The provision (benefit) for income taxes is net of research tax credits of
$589,000 in 1995, none in 1994 and $343,000 in 1993.

Deferred income taxes which result from temporary differences in the
recognition of revenue and expense for tax and financial reporting purposes
consists of (in thousands):

<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -----
<S> <C> <C> <C>
Reserves and accruals................................. $ 478 $ 2,237 $ 463
Research credit carryforwards......................... 1,520 131 --
Acquired research and development..................... 2,342 4,089 --
Software development costs............................ (286) (735) (180)
Depreciation and amortization......................... 177 (158) (149)
Operating loss carryforward of foreign subsidiaries... 1,043 1,263 --
Valuation allowance................................... (1,043) (1,263) --
------- ------- -----
Net deferred tax asset................................ $ 4,231 $ 5,564 $ 134
======= ======= =====
</TABLE>

F-36
<PAGE> 138

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's foreign subsidiaries have net operating loss carryforwards of
approximately $2,500,000 which are available to offset future taxable income
through 1999. These fully reserved foreign net operating losses were incurred by
Ready and its subsidiaries prior to acquisition by the Company. Accordingly, the
tax benefit of realizing these net operating losses in the future will be used
to reduce long-term intangible assets acquired in the Ready transaction. Tax
benefits realized in excess of such intangible assets will reduce future tax
expense.

The effective tax rate differs from the statutory federal income tax rate
as follows:

<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Federal statutory rate........................................ 35% (35)% 34%
State income taxes, net of federal benefit.................... 5 (2) 7
Foreign income taxed at different rates....................... (1) (2) 25
Foreign losses without current benefit........................ -- -- 38
Effect of minority interest transactions...................... -- -- 27
Research income tax credits................................... (9) (3) (65)
Change in valuation allowance................................. 3 -- --
Other, net.................................................... 1 2 (3)
--
--- ---
Effective tax rate............................................ 34% (40)% 63%
== === ===
</TABLE>

8. EMPLOYEE BENEFIT PLANS

The Microtec Research, Inc. Profit-Sharing and Savings Plan covers
substantially all U.S. employees. The Plan permits voluntary salary reduction
contributions in accordance with Section 401(k) of the Internal Revenue Code as
well as voluntary contributions from the Company. The Company made no
contributions to the Plan for the years ended March 31, 1995, 1994 and 1993.

In October 1994, the Board of Directors adopted the 1994 Employee Stock
Purchase Plan. Under this plan, eligible employees may authorize payroll
deductions of up to 10% of their regular base salary to purchase shares at the
lower of 85% of the fair market value of the common stock on the date of
commencement of the offering or on the last day of the six-month purchase
period. At March 31, 1995, $199,000 had been contributed by employees that will
be used to purchase a minimum of 29,000 shares in fiscal 1996 at a price
determined under the terms of the Plan. At March 31, 1995, the Company had
400,000 shares of its common stock reserved for future issuance under the plan.

9. LEASES

The Company leases facilities and equipment under operating leases which
expire through 2003. Certain of the facilities leases require the Company to pay
a portion of property taxes, insurance and common area charges and contain rent
escalation clauses and renewal options. In connection with one of the leases,
the Company has been granted a free rent period. The consolidated statements of
income reflect rent expense on a straight-line basis over the terms of the
leases.

F-37
<PAGE> 139

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Following is a schedule of future minimum rental payments under
noncancelable operating lease agreements (in thousands):

<TABLE>
<CAPTION>
YEARS ENDING
MARCH 31,
-----------------------------------------------------------
<S> <C>
1996..................................................... $ 2,237
1997..................................................... 1,977
1998..................................................... 1,913
1999..................................................... 1,621
2000..................................................... 1,024
Thereafter through 2003.................................... 2,479
-------
$11,251
=======
</TABLE>

Rent expense for the years ended March 31, 1995, 1994 and 1993 was
$2,064,000, $1,721,000 and $1,211,000, respectively.

10. GEOGRAPHIC AREA INFORMATION

The Company and its subsidiaries market products in the United States and
in foreign countries. Geographic financial information is as follows (in
thousands):

<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-------------------------------
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Net sales to unaffiliated customers:
United States....................................... $23,818 $17,591 $12,483
Asia................................................ 8,285 5,805 3,253
Western Europe...................................... 13,109 9,611 6,890
------- ------- -------
$45,212 $33,007 $22,626
======= ======= =======
Transfers from the United States to foreign
subsidiaries (eliminated in consolidation).......... $ 9,236 $ 6,045 $ 4,034
======= ======= =======
Net income (loss):
United States....................................... $ 3,402 $(9,777) $ 483
Asia................................................ 55 689 (310)
Western Europe...................................... 893 757 (17)
------- ------- -------
$ 4,350 $(8,331) $ 156
======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
MARCH 31,
-------------------------------
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Identifiable assets:
United States....................................... $23,924 $14,964 $11,209
Asia................................................ 4,516 3,914 1,568
Western Europe...................................... 8,329 6,283 4,050
------- ------- -------
$36,769 $25,161 $16,827
======= ======= =======
</TABLE>

F-38
<PAGE> 140

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Unaffiliated sales by the U.S. operations include export revenues of the
following (in thousands):

<TABLE>
<CAPTION>
1995 1994 1993
------ ------ ------
<S> <C> <C> <C>
Asia........................................... $2,687 $1,603 $1,022
Western Europe................................. 1,446 1,577 485
------ ------ ------
$4,133 $3,180 $1,507
====== ====== ======
</TABLE>

During 1995, 1994 and 1993, no single customer accounted for more than 10%
of revenues.

11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

The following provides additional information concerning supplemental
disclosures of cash flow activities (in thousands):

<TABLE>
<CAPTION>
1995 1994 1993
---- -------- -------
<S> <C> <C> <C>
Cash paid during the year for:
Income taxes, net..................................... $557 $ 372 $ 577
Interest.............................................. 13 128 3
Noncash investing and financing activities:
Note receivable for issuance of common stock.......... -- 137 --
Tax benefit of employee stock option transactions..... -- -- 70
Effect of acquisitions:
Liabilities assumed................................... $ 12,759 $ 822
Cash paid, net of cash acquired....................... 377 1,016
Stock issued.......................................... 7,018 419
In-process technology and minority interests
acquired........................................... (14,403) (1,133)
-------- -------
Total assets acquired......................... $ 5,751 $ 1,124
======== =======
</TABLE>

12. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized quarterly financial data for fiscal 1995 and 1994 are as
follows:

<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
YEAR ENDED MARCH 31, 1995: QUARTER QUARTER QUARTER QUARTER
------------------------------------------- ------- ------- -------- -------
<S> <C> <C> <C> <C>
Net revenue................................ $10,644 $10,837 $ 11,603 $12,128
Cost of revenue............................ 1,700 1,497 1,362 1,343
Gross profit............................... 8,944 9,340 10,241 10,785
Income from operations..................... 1,213 1,337 1,447 1,833
Net income................................. 825 983 1,039 1,502
Income per share........................... $ 0.10 $ 0.12 $ 0.12 $ 0.16
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, 1994:
-------------------------------------------
<S> <C> <C> <C> <C>
Net revenue................................ $ 6,635 $ 6,551 $ 9,179 $10,642
Cost of revenue............................ 1,234 915 1,432 1,577
Gross profit............................... 5,401 5,636 7,747 9,065
Income (loss) from operations.............. (3,350) 893 (12,779) 1,237
Net income (loss).......................... (1,989) 529 (7,688) 817
Income (loss) per share.................... $ (0.31) $ 0.08 $ (1.11) $ 0.10
</TABLE>

F-39
<PAGE> 141

MICROTEC RESEARCH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. CONTINGENCIES

Litigation and settlement costs represent the cost of litigation with, and
settlement payment made to, Green Hills Software, Inc. regarding alleged
misappropriation of trade secrets by the Company. The Company has no ongoing
obligations with respect to the issues which were the subject of the litigation.

In September 1994, the Company initiated legal proceedings against a
distributor seeking to recover amounts which the Company believed were owed
under the distributor agreement. In November 1994, the Company and the
distributor entered into a Partial Settlement, Arbitration and Release Agreement
(the Arbitration Agreement) whereby the parties agreed to submit certain claims
of each party under the distributor agreement to binding arbitration and to
release all other known and unknown claims. On March 31, 1995 judgment was ruled
in the Company's favor on all significant elements of the Arbitration Agreement,
however the settlement award had not yet been determined. The financial results
for the year ended March 31, 1995 do not include any of the awarded gain.

* * * * *

F-40
<PAGE> 142

MICROTEC RESEARCH, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
UNAUDITED DERIVED FROM
SEPT. 30, AUDITED INFORMATION
1995 MARCH 31, 1995
------------- -------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $11,345 $12,748
Short-term investments...................................... -- 987
Accounts receivable, net.................................... 7,647 9,409
Deferred income taxes....................................... 525 478
Prepaids and other current assets........................... 1,951 1,892
------- -------
Total current assets................................ 21,468 25,514
Equipment and furniture, net................................ 4,901 4,180
Software development costs, net............................. 2,040 2,052
Deposits and other assets................................... 869 1,270
Deferred income taxes....................................... 3,546 3,753
Investment in affiliate..................................... 1,344 --
------- -------
Total Assets........................................ $34,168 $36,769
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 1,584 $ 1,979
Accrued liabilities and compensation........................ 3,858 5,526
Deferred revenue............................................ 4,213 5,249
Income taxes payable........................................ 337 569
------- -------
Total current liabilities........................... 9,992 13,323
Deferred rent............................................... 1,517 1,883
Stockholders' equity:
Common stock............................................. 17,202 16,742
Deferred stock compensation.............................. (125) (150)
Notes receivable for common stock........................ (137) (137)
Accumulated translation adjustments...................... 31 588
Retained earnings........................................ 5,688 4,520
------- -------
Total stockholders' equity.......................... 22,659 21,563
------- -------
Total liabilities and stockholders' equity.......... $34,168 $36,769
======= =======
</TABLE>

See notes to condensed consolidated financial statements.

F-41
<PAGE> 143

MICROTEC RESEARCH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
-------------------
1995 1994
------- -------
<S> <C> <C>
Net revenue:
License................................................................ $17,143 $16,935
Service................................................................ 5,589 4,546
------- -------
Total net revenue.............................................. 22,732 21,481
Costs and expenses:
Cost of revenue........................................................ 3,472 3,197
Selling and marketing.................................................. 9,662 8,154
Research and development............................................... 6,146 5,706
General and administrative............................................. 2,197 1,874
------- -------
Total costs and expenses....................................... 21,477 18,931
Income from operations.................................... 1,255 2,550
Interest income.......................................................... 340 150
Interest expense......................................................... (34) (15)
Foreign currency transaction gains....................................... 131 245
------- -------
Total other income (expense), net.............................. 437 380
Income before income taxes................................ 1,692 2,930
Provision for income taxes............................................... 524 1,122
------- -------
Net income............................................................... $ 1,168 $ 1,808
======= =======
Net income per share..................................................... $ 0.13 $ 0.22
======= =======
Shares used in per share calculations.................................... 9,311 8,247
======= =======
</TABLE>

See notes to condensed consolidated financial statements.

F-42
<PAGE> 144

MICROTEC RESEARCH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
--------------------
1995 1994
------- ------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................ $ 1,168 $1,808
Reconciliation to net cash provided by (used in) operating activities:
Depreciation and amortization...................................... 735 894
Amortization of software development costs......................... 409 210
Equity in net loss of affiliate.................................... 55 --
Amortization of deferred stock compensation........................ 25 25
Increase (decrease) in deferred rent............................... (378) (987)
Deferred income taxes.............................................. 159 970
Change in operating assets and liabilities:
Accounts receivable, net......................................... 1,762 (166)
Prepaid expenses and other current assets........................ (58) (35)
Accounts payable................................................. (394) 350
Accrued compensation and related benefits........................ (186) 191
Other accrued liabilities........................................ (1,470) 172
Deferred revenue................................................. (1,036) (1,456)
Income taxes receivable/payable.................................. (232) (89)
------- ------
Net cash provided by (used in) operating activities................... 559 1,887
Cash flows from investing activities:
Capital expenditures.................................................. (1,456) (1,335)
Capitalized software development costs................................ (397) (255)
Decrease (increase) in deposits....................................... 402 (420)
Decrease in short-term investments.................................... 987 --
Decrease (increase) in notes receivable............................... (2) --
(Purchase) of investment in affiliate................................. (1,399) --
------- ------
Net cash uses in investing activities................................. (1,865) (2,010)
Cash flows from financing activities:
Exercise of common stock options...................................... 683 194
Sales of convertible preferred stock.................................. -- 368
Repurchase of common stock............................................ (223) --
------- ------
Net cash provided by (used in) financing activities................... 460 562
Effect of foreign exchange rate changes on cash......................... (557) (97)
------- ------
Net increase in cash and cash equivalents............................. (1,403) 342
Cash and cash equivalents at beginning of period...................... 12,748 3,673
------- ------
Cash and cash equivalents at end of period............................ $11,345 $4,015
======= ======
Supplemental disclosures:
Cash paid during the period for:
Income taxes....................................................... $ 372 $ 240
Interest........................................................... $ 34 $ 15
</TABLE>

See notes to condensed consolidated financial statements.

F-43
<PAGE> 145

MICROTEC RESEARCH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)

1. GENERAL

Microtec Research, Inc. (the Company), a Delaware corporation, develops,
markets, sells and supports software development tools, real-time operating
systems and connectivity products for the embedded systems market.

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions for Form 10-Q and therefore do
not include all information and footnotes necessary for a complete presentation
of the results of operations, the financial position and cash flows, in
conformity with generally accepted accounting principles. The Company filed
audited financial statements that included all information and footnotes
necessary for such a presentation of the results of operation, the financial
position and cash flows for the three years ended March 31, 1995, in conjunction
with its Form 10-K for the fiscal year ended March 31, 1995. The condensed
balance sheet data as of March 31, 1995 included herein has been derived from
such audited financial statements.

In the opinion of management, the accompanying unaudited interim condensed
consolidated financial statements reflect all adjustments (consisting only of
normal recurring accruals) necessary to summarize fairly the financial position,
results of operations and cash flows for such periods. The results for the
interim period ended September 30, 1995 are not indicative of the results that
may be expected for any future period.

2. SOFTWARE DEVELOPMENT COSTS

The Company capitalizes certain costs incurred in the production of
computer software once technological feasibility of the product to be marketed
has been established. Costs incurred prior to technological feasibility,
including amounts attributable to in-process research and development in
business acquisitions, are expensed as research and development costs.
Capitalization of these costs ceases when the product is considered available
for general release to customers. Amounts capitalized for the six months ended
September 30, 1995 was $397,000, compared to $255,000 for the same period of the
previous year.

Amortization of capitalized software development costs is calculated as the
greater of the ratio that current product revenues bear to estimated future
revenues or the straight-line method over the expected product life cycle of
three to five years. Amortization for the six months ended September 30, 1995
was $409,000 compared to $210,000 for the six months ended September 30, 1994.

3. INVESTMENT IN AFFILIATE

In June 1995, the Company purchased a 20% equity interest in a privately
held software company for $1.4 million. The investment is carried at cost and
future results of the Company will reflect the effect of using the equity method
of accounting for this investment. The excess of the purchase price over the
proportionate recorded net book value of the company is being amortized over
five years.

4. LEGAL PROCEEDINGS:

In November 1994, the Company and Integrated Systems, Inc. (ISI) a Value
Added Reseller (VAR) of the Company's software development tools, began
arbitration proceedings (the Arbitration) whereby the Company sought to recover
amounts that the Company believed were owed under the Company's VAR agreement
with ISI. On March 31, 1995 judgment was ruled in the company's favor on all
significant elements of the Arbitration. The final settlement award was
determined in the Company's first fiscal quarter and the awarded amounts and
additional costs related to the Arbitration were reflected in the Company's
operating results for the quarter ended June 30, 1995. The resulting impact on
Microtec's liquidity and operating results for such quarter was not material.

F-44
<PAGE> 146

MICROTEC RESEARCH, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

5. SUBSEQUENT EVENT

On October 9, 1995, the Company entered into an Agreement and Plan of
Merger with Mentor Graphics Corporation (Mentor). The merger, which is subject
to approval of the Company's stockholders, will be a stock exchange whereby each
share of the Company's common stock will be exchanged for .6930693 shares of
Mentor common stock.

F-45
<PAGE> 147

ANNEX A

AGREEMENT AND PLAN OF MERGER

AMONG

MENTOR GRAPHICS CORPORATION

M ACQUISITION SUB, INC.

AND

MICROTEC RESEARCH, INC.

DATED AS OF OCTOBER 9, 1995
<PAGE> 148

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
ARTICLE I -- THE MERGER............................................................... 1
1.1 The Mergers.............................................................. 1
1.2 Effective Time........................................................... 1
1.3 Effect of the Merger..................................................... 1
1.4 Certificate of Incorporation; Bylaws..................................... 1
1.5 Directors and Officers................................................... 1
1.6 Effect on Capital Stock.................................................. 2
1.7 Surrender of Certificates................................................ 2
1.8 No Further Ownership Rights in Company Common Stock...................... 3
1.9 Lost, Stolen or Destroyed Certificates................................... 3
1.10 Tax and Accounting Consequences.......................................... 4
1.11 Taking of Necessary Action; Further Action............................... 4
ARTICLE II -- REPRESENTATIONS ANY WARRANTIES OF THE COMPANY........................... 4
2.1 Organization and Qualification; Subsidiaries............................. 4
2.2 Certificate of Incorporation and Bylaws.................................. 4
2.3 Capitalization........................................................... 5
2.4 Authority Relative to this Agreement..................................... 5
2.5 No Conflict; Required Filings and Consents............................... 5
2.6 Compliance, Permits...................................................... 6
2.7 SEC Filings; Financial Statements........................................ 6
2.8 Absence of Certain Changes or Events..................................... 7
2.9 No Undisclosed Liabilities............................................... 7
2.10 Absence of Litigation.................................................... 7
2.11 Employee Benefit Plans................................................... 7
2.12 Labor Matters............................................................ 8
2.13 Registration Statement; Proxy Statement/Prospectus....................... 9
2.14 Restrictions on Business Activities...................................... 9
2.15 Title to Property........................................................ 9
2.16 Taxes.................................................................... 10
2.17 Environmental Matters.................................................... 10
2.18 Brokers.................................................................. 11
2.19 Full Disclosure.......................................................... 11
2.20 Intellectual Property.................................................... 11
2.21 Pooling Matters.......................................................... 12
2.22 Insurance................................................................ 12
2.23 Opinion of Financial Advisor............................................. 12
2.24 The Company's Best Knowledge............................................. 12
</TABLE>

A-i
<PAGE> 149

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
ARTICLE III -- REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB................
13
3.1 Organization and Qualification; Subsidiaries............................. 13
3.2 Certificate of Incorporation and Bylaws.................................. 13
3.3 Capitalization........................................................... 13
3.4 Authority Relative to this Agreement..................................... 13
3.5 No Conflict; Required Filings and Consents............................... 14
3.6 Compliance............................................................... 14
3.7 SEC Filings; Financial Statements........................................ 14
3.8 Absence of Certain Changes or Events..................................... 15
3.9 Absence of Litigation.................................................... 15
3.10 Registration Statement; Proxy Statement/Prospectus....................... 15
3.11 Restrictions on Business Activities...................................... 15
3.12 Brokers.................................................................. 16
3.13 Full Disclosure.......................................................... 16
3.14 Pooling Matters.......................................................... 16
3.15 Intellectual Property.................................................... 16
ARTICLE IV -- CONDUCT OF BUSINESS PENDING THE MERGER.................................. 16
4.1 Conduct of Business by the Company Pending the Merger.................... 16
4.2 No Company Solicitation.................................................. 18
ARTICLE V -- ADDITIONAL AGREEMENTS.................................................... 18
5.1 Proxy Statement/Prospectus; Registration Statement....................... 18
5.2 Meeting of Company Stockholders.......................................... 19
5.3 Access to Information; Confidentiality................................... 19
5.4 Hart-Scott-Rodino Filings................................................ 19
5.5 Consents; Approvals...................................................... 19
5.6 Stock Options............................................................ 19
5.7 Company Employee Stock Purchase Plans.................................... 20
5.8 Agreements of Affiliates................................................. 20
5.9 Notification of Certain Matters.......................................... 20
5.10 Further Action........................................................... 20
5.11 Public Announcements..................................................... 21
5.12 Parent Stock............................................................. 21
5.13 Director and Officer Indemnification..................................... 21
ARTICLE VI -- CONDITIONS OF MERGER.................................................... 21
6.1 Conditions to Obligation of Each Party to Effect the Merger.............. 21
6.2 Additional Conditions to Obligations of Parent and Merger Sub............ 22
6.3 Additional Conditions to Obligation of the Company....................... 22
ARTICLE VII -- TERMINATION, AMENDMENT AND WAIVER...................................... 23
7.1 Termination.............................................................. 23
</TABLE>

A-ii
<PAGE> 150

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
7.2 Liquidated Damages....................................................... 24
7.3 Effect of Termination.................................................... 24
7.4 Fees and Expenses........................................................ 24
7.5 Amendment................................................................ 24
7.6 Waiver................................................................... 24
ARTICLE VIII -- GENERAL PROVISIONS.................................................... 25
8.1 Non-Survival of Representations, Warranties and Agreements............... 25
8.2 Notices.................................................................. 25
8.3 Certain Definitions...................................................... 25
8.4 Headings................................................................. 26
8.5 Severability............................................................. 26
8.6 Entire Agreement......................................................... 26
8.7 Assignment............................................................... 26
8.8 Parties in Interest...................................................... 26
8.9 Governing Law............................................................ 26
8.10 Counterparts............................................................. 26
EXHIBITS AND SCHEDULES
Exhibit A -- Form of Affiliates Letter
</TABLE>

A-iii
<PAGE> 151

AGREEMENT AND PLAN OF MERGER

THIS AGREEMENT AND PLAN OF MERGER (the "Agreement"), is made and entered
into as of October 9, 1995 among MENTOR GRAPHICS CORPORATION, an Oregon
corporation ("Parent"), M ACQUISITION SUB, INC., a Delaware corporation and a
wholly owned subsidiary of Parent ("Merger Sub"), and MICROTEC RESEARCH, INC., a
Delaware corporation (the "Company").

WHEREAS, the Boards of Directors of Parent, Merger Sub and the Company have
each determined that it is in the best interests of their respective
stockholders for Parent to acquire the Company upon the terms and subject to the
conditions set forth herein; and

WHEREAS, in furtherance of such acquisition, the Boards of Directors of
Parent, Merger Sub and the Company have each approved the merger (the "Merger")
of Merger Sub with and into the Company in accordance with the General
Corporation Law of' the State of Delaware ("Delaware Law") and upon the terms
and subject to the conditions set forth herein;

NOW, THEREFORE, in consideration of the foregoing and the mutual covenants
and agreements herein contained, and intending to be legally bound hereby,
Parent, Merger Sub and the Company hereby agree as follows:

ARTICLE I

THE MERGER

1.1 The Merger. At the Effective Time (as defined in Section 1.2) and
subject to and upon the terms and conditions of this Agreement and Delaware Law,
Merger Sub shall be merged with and into the Company, the separate corporate
existence of Merger Sub shall cease and the Company shall continue as the
surviving corporation. The Company as the surviving corporation after the Merger
is hereinafter sometimes referred to as the "Surviving Corporation."

1.2 Effective Time. As promptly as practicable after the satisfaction or
waiver of the conditions set forth in Article VI, the parties hereto shall cause
the Merger to be consummated by filing this Agreement or a Certificate of Merger
(the "Certificate of Merger") with the Secretary of State of the State of
Delaware, in such form as required by, and executed in accordance with the
relevant provisions of, Delaware Law (the time of such filing being the
"Effective Time").

1.3 Effect of the Merger. At the Effective Time, the effect of the Merger
shall be as provided in the applicable provisions of Delaware law. Without
limiting the generality of the foregoing, and subject thereto, at the Effective
Time all the property, rights, privileges, powers and franchises of the Company
and Merger Sub shall vest in the Surviving Corporation, and all debts,
liabilities and duties of the Company and Merger Sub shall become the debts,
liabilities and duties of the Surviving Corporation.

1.4 Certificate of Incorporation; Bylaws.

(a) Unless otherwise determined by Parent prior to the Effective Time,
at the Effective Time the Certificate of Incorporation of Merger Sub, as in
effect immediately prior to the Effective Time, shall be the Certificate of
Incorporation of the Surviving Corporation until thereafter amended as
provided by law and such Certificate of Incorporation; provided, however,
that Article I of the Certificate of Incorporation of the Surviving
Corporation shall be amended to read as follows: "The name of the
corporation is Microtec Research, Inc."

(b) The Bylaws of Merger Sub, as in effect immediately prior to the
Effective Time, shall be the Bylaws of the Surviving Corporation until
thereafter amended as provided by Delaware Law, the Certificate of
Incorporation of the Surviving Corporation and such Bylaws.

1.5 Directors and Officers. The directors of Merger Sub immediately prior
to the Effective Time shall be the initial directors of the Surviving
Corporation, each to hold office in accordance with the Certificate of
Incorporation and Bylaws of the Surviving Corporation, and the officers of the
Company immediately prior to

A-1
<PAGE> 152

the Effective Time shall be the initial officers of the Surviving Corporation,
in each case until their respective successors are duly elected or appointed and
qualified.

1.6 Effect on Capital Stock. At the Effective Time, by virtue of the
Merger and without any action on the part of Merger Sub, the Company or the
holders of any of the securities of Parent, Merger Sub or the Company:

(a) Conversion of Company Common Stock. Each share of common stock,
par value $.001 per share, of the Company (the "Company Common Stock)"
issued and outstanding immediately prior to the Effective Time (other than
any shares of Company Common Stock to be canceled pursuant to Section
l.6(b)) will be canceled and extinguished and be converted automatically
into the right to receive 0.6930693 shares (the "Exchange Ratio") of common
stock, no par value, of Parent (the "Parent Common Stock") in the manner
provided in Section 1.7.

(b) Cancellation of Treasury Stock and Parent-Owned Stock. Each share
of Company Common Stock held in the treasury of the Company and each share
of Company Common Stock owned by Merger Sub, Parent or any direct or
indirect wholly owned subsidiary of Parent or of the Company immediately
prior to the Effective Time shall be canceled and extinguished without any
conversion thereof.

(c) Stock Options and Stock Purchase Rights. At the Effective Time,
all options to purchase Company Common Stock then outstanding under the
Company's Amended and Restated 1985 Stock Option Plan (the "1985 Option
Plan") and the Company's 1994 Stock Option Plan (the "1994 Option Plan")
shall be assumed by Parent in accordance with Section 5.6(a) and all
options to purchase Company Common Stock then outstanding under the
Company's 1994 Outside Directors' Stock Option Plan (the "Directors Option
Plan") shall terminate in accordance with Section 5.6(d). Immediately prior
to the Effective Time, all outstanding rights to acquire shares of Company
Common Stock under the Company's 1994 Employee Stock Purchase Plan (the
"Company ESPP") shall be exercised for shares of Company Common Stock as
provided in Section 5.7.

(d) Capital Stock of Merger Sub. Each share of common stock, par
value $.001 per share, of Merger Sub issued and outstanding immediately
prior to the Effective Time shall be converted into and exchanged for one
validly issued, fully paid and nonassessable share of common stock, par
value $.001 per share, of the Surviving Corporation. Each stock certificate
of Merger Sub evidencing ownership of any such shares shall continue to
evidence ownership of such shares of capital stock of the Surviving
Corporation.

(e) Adjustments to Exchange Ratio. The Exchange Ratio shall be
adjusted to reflect fully the effect of any stock split, reverse split,
stock dividend (including any dividend or distribution of securities
convertible into Parent Common Stock or Company Common Stock),
reorganization, recapitalization or other like change with respect to
Parent Common Stock or Company Common Stock occurring after the date hereof
and prior to the Effective Time.

(f) Fractional Shares. No fraction of a share of Parent Common Stock
will be issued, but in lieu thereof each holder of shares of Company Common
Stock who would otherwise be entitled to a fraction of a share of Parent
Common Stock (after aggregating all fractional shares of Parent Common
Stock to be received by such holder) shall receive from Parent an amount of
cash (rounded to the nearest whole cent) equal to the product of such
fraction, multiplied by $20.20.

1.7 Surrender of Certificates.

(a) Exchange Agent. Prior to the Effective Time, Parent shall
designate a bank or trust company reasonably acceptable to the Company to
act as exchange agent (the "Exchange Agent") in the Merger.

(b) Parent to Provide Common Stock. As soon as reasonably practicable
after the Effective Time, Parent shall make available to the Exchange Agent
for exchange in accordance with this Article I, through such reasonable
procedures as Parent may adopt, certificates representing the shares of
Parent Common Stock issuable pursuant to Section 1.6 in exchange for
outstanding shares of Company Common Stock and, from time to time, cash for
payment in lieu of fractional shares.

A-2
<PAGE> 153

(c) Exchange Procedures. As soon as reasonably practicable after the
Effective Time, Parent shall cause Exchange Agent to mail to each holder of
record of a certificate or certificates (the "Certificates") which
immediately prior to the Effective Time represented outstanding shares of
Company Common Stock whose shares were converted into the right to receive
shares of Parent Common Stock pursuant to Section 1.6, (i) a letter of
transmittal (which shall specify that delivery shall be effected, and risk
of loss and title to the Certificates shall pass, only upon delivery of the
Certificates to the Exchange Agent and shall be in such form and have such
other provisions as Parent may reasonably specify) and (ii) instructions
for use in effecting the surrender of the Certificates in exchange for
certificates representing shares of Parent Common Stock. Upon surrender of
a Certificate for cancellation to the Exchange Agent, together with such
letter of transmittal, duly completed and validly executed in accordance
with the instructions thereto, the holder of such Certificate shall be
entitled to receive in exchange therefor a certificate representing the
number of whole shares of Parent Common Stock and payment in lieu of
fractional shares which such holder has the right to receive pursuant to
Section 1.6, and the Certificate so surrendered shall forthwith be
canceled. Until so surrendered, each outstanding certificate that, prior to
the Effective Time, represented shares of Company Common Stock will be
deemed from and after the Effective Time, for all corporate purposes, other
than the payment of dividends, to evidence the ownership of the number of
full shares of Parent Common Stock into which such shares of Company Common
Stock shall have been so converted and the right to receive an amount in
cash in lieu of the issuance of any fractional shares in accordance with
Section 1.6.

(d) Distributions With Respect to Unexchanged Shares. No dividends or
other distributions declared or made after the Effective Time with respect
to Parent Common Stock with a record date after the Effective Time will be
paid to the holder of any unsurrendered Certificate with respect to the
shares of Parent Common Stock represented thereby until the holder of
record of such Certificate shall surrender such Certificate. Subject to
applicable law, following surrender of any such Certificate, there shall be
paid to the record holder of the certificates representing whole shares of
Parent Common Stock issued in exchange therefor without interest, at the
time of such surrender, the amount of dividends or other distributions with
a record date after the Effective Time theretofore paid with respect to
such whole shares of Parent Common Stock.

(e) Transfers of Ownership. If any certificate for shares of Parent
Common Stock is to be issued in a name other than that in which the
certificate surrendered in exchange therefor is registered, it will be a
condition of the issuance thereof that the certificate so surrendered will
be properly endorsed and otherwise in proper form for transfer and that the
person requesting such exchange will have paid to Parent or any agent
designated by it any transfer or other taxes required by reason of the
issuance of a certificate for shares of Parent Common Stock in any name
other than that of the registered holder of the certificate surrendered, or
established to the satisfaction of Parent or any agent designated by it
that such tax has been paid or is not payable.

(f) No Liability. Notwithstanding anything to the contrary in this
Section 1.7, none of the Exchange Agent, Parent, the Surviving Corporation
or any party hereto shall be liable to a holder of Shares for any amount
properly paid to a public official pursuant to any applicable abandoned
property, escheat or similar law.

1.8 No Further Ownership Rights in Company Common Stock. All shares of
Parent Common Stock issued upon the surrender for exchange of shares of Company
Common Stock in accordance with the terms hereof (including any cash paid in
respect thereof) shall be deemed to have been issued in full satisfaction of all
rights pertaining to such shares of Company Common Stock, and there shall be no
further registration of transfers on the records of the Surviving Corporation of
shares of Company Common Stock which were outstanding immediately prior to the
Effective Time. If, after the Effective Time, Certificates are presented to the
Surviving Corporation for any reason, they shall be canceled and exchanged as
provided in this Article I.

1.9 Lost, Stolen or Destroyed Certificates. In the event any certificates
evidencing shares of Company Common Stock shall have been lost, stolen or
destroyed, the Exchange Agent shall issue in exchange for such lost, stolen or
destroyed certificates, upon the making of an affidavit of that fact by the
holder thereof, such

A-3
<PAGE> 154

shares of Parent Common Stock and cash for fractional shares, if any, as may be
required pursuant to Section 1.6; provided, however, that Parent may, in its
discretion and as a condition precedent to the issuance thereof, require the
owner of such lost, stolen or destroyed certificates to deliver a bond in such
sum as it may reasonably direct as indemnity against any claim that may be made
against Parent or the Exchange Agent with respect to the certificates alleged to
have been lost, stolen or destroyed.

1.10 Tax and Accounting Consequences. It is intended by the parties hereto
that the Merger shall constitute a reorganization within the meaning of Section
368 of the Internal Revenue Code of 1986, as amended, and qualify for accounting
treatment as a pooling of interests.

1.11 Taking of Necessary Action; Further Action. If, at any time after the
Effective Time, any such further action is necessary or desirable to carry out
the purposes of this Agreement and to vest the Surviving Corporation with full
right, title and possession to all assets, property, rights, privileges, powers
and franchises of the Company and Merger Sub, the officers and directors of the
Company and Merger Sub are fully authorized in the name of their respective
corporations or otherwise to take, and will take, all such lawful and necessary
action.

ARTICLE II

REPRESENTATIONS AND WARRANTIES OF THE COMPANY

The Company hereby represents and warrants to Parent and Merger Sub that,
except as set forth in the Disclosure Schedule previously delivered by the
Company to Parent (the "Company Disclosure Schedule"):

2.1 Organization and Qualification; Subsidiaries. Each of the Company and
each of its subsidiaries is a corporation duly organized, validly existing and
in good standing under the laws of the jurisdiction of its incorporation and has
the requisite corporate power and authority and is in possession of all
franchises, grants, authorizations, licenses, permits, easements, consents,
certificates, approvals and orders ("Approvals") necessary to own, lease and
operate the properties it purports to own, operate or lease and to carry on its
business as it is now being conducted, except where the failure to be so
organized, existing and in good standing or to have such power. authority and
Approvals would not, individually or in the aggregate, have a Material Adverse
Effect (as defined below). Each of the Company and each of its subsidiaries is
duly qualified or licensed as a foreign corporation to do business, and is in
good standing, in each jurisdiction where the character of its properties owned,
leased or operated by it or the nature of its activities makes such
qualification or licensing necessary, except for such failures to be so duly
qualified or licensed and in good standing that would not, either individually
or in the aggregate, have a Material Adverse Effect. When used in connection
with the Company or any of its subsidiaries, the term "Material Adverse Effect"
means any change or effect that is or is reasonably likely to be materially
adverse to the business, assets (including intangible assets), financial
condition, results of operations, or prospects of the Company and its
subsidiaries taken as a whole. The term "Material Adverse Effect" shall not
include adverse effects resulting from (i) changes attributable to conditions
affecting the embedded systems business generally (in the case of the Company),
(ii) changes in general economic conditions or (iii) changes attributable to the
announcement or pendency of the Merger. A true and complete list of all of the
Company's subsidiaries, together with the jurisdiction of incorporation of each
subsidiary, is set forth in Section 2.1 of the Company Disclosure Schedule.
Except as set forth in Section 2.1 of the Company Disclosure Schedule, the
Company does not directly or indirectly own any equity or similar interest in,
or any interest convertible into or exchangeable or exercisable for, any equity
or similar interest in, any corporation, partnership, joint venture or other
business association or entity.

2.2 Certificate of Incorporation and Bylaws. The Company has heretofore
furnished to Parent a complete and correct copy of its Certificate of
Incorporation and Bylaws, as amended to date. Such Certificate of Incorporation,
Bylaws and equivalent organizational documents of each of its subsidiaries are
in full force and effect. Neither the Company nor any of its subsidiaries is in
violation of any of the provisions of its Certificate of Incorporation or Bylaws
or equivalent organizational documents.

A-4
<PAGE> 155

2.3 Capitalization. The authorized capital stock of the Company consists
of 20,000,000 shares of Company Common Stock and 2,000,000 shares of Preferred
Stock, par value $.001 per share, of the Company (the "Company Preferred
Stock"). As of September 30, 1995, (i) 8,923,161 shares of Company Common Stock
were issued and outstanding, all of which are validly issued, fully paid and
nonassessable; (ii) 23,400 shares of Company Common Stock were held in the
treasury of the Company or by subsidiaries of the Company; (iii) 919,682 shares
of Company Common Stock were reserved for future issuance pursuant to
outstanding employee stock options granted under the Company's 1985 Option Plan
and the Company's 1994 Option Plan and 10,000 shares were reserved for issuance
pursuant to outstanding stock options granted under the Company's Director
Option Plan; and (iv) approximately 75,000 shares of Company Common Stock had
been subscribed for the purchase period ending December 31, 1995 pursuant to the
Company ESPP. Except as set forth in this Section 2.3 or in Section 2.3 of the
Company Disclosure Schedule, there are no options, warrants or other rights,
agreements, arrangements or commitments of any character relating to the issued
or unissued capital stock of the Company or any of its subsidiaries or
obligating the Company or any of its subsidiaries to issue or sell any shares of
capital stock of, or other equity interests in, the Company or any of its
subsidiaries. All shares of Company Common Stock subject to issuance as
aforesaid, upon issuance on the terms and conditions specified in the
instruments pursuant to which they are issuable, shall be duly authorized,
validly issued, fully paid and nonassessable. There are no obligations,
contingent or otherwise, of the Company or any of its subsidiaries to
repurchase, redeem or otherwise acquire any shares of Company Common Stock or
the capital stock of any subsidiary or to provide funds to or make any
investment (in the form of a loan, capital contribution or otherwise) in any
such subsidiary or any other entity other than guarantees of bank obligations of
subsidiaries entered into in the ordinary course of business. All of the
outstanding shares of capital stock (other than directors' qualifying shares) of
each of the Company's subsidiaries is duly authorized, validly issued, fully
paid and nonassessable and all such shares (other than directors' qualifying
shares) are owned by the Company or another subsidiary free and clear of all
security interests, liens, claims, pledges, agreements, limitations in the
Company's voting rights, charges or other encumbrances of any nature whatsoever.

2.4 Authority Relative to this Agreement. The Company has all necessary
corporate power and authority to execute and deliver this Agreement and to
perform its obligations hereunder and to consummate the transactions
contemplated hereby. The execution and delivery of this Agreement by the Company
and the consummation by the Company of the transactions contemplated hereby have
been duly and validly authorized by all necessary corporate action and no other
corporate proceedings on the part of the Company are necessary to authorize this
Agreement or to consummate the transactions so contemplated (other than, with
respect to the Merger, the approval and adoption of this Agreement by the
holders of a majority of the outstanding shares of Company Common Stock in
accordance with Delaware Law and the Company's Certificate of Incorporation and
Bylaws). This Agreement has been duly and validly executed and delivered by the
Company and, assuming the due authorization, execution and delivery by Parent
and Merger Sub, constitutes a legal, valid and binding obligation of the
Company.

2.5 No Conflict; Required Filings and Consents.

(a) Section 2.5(a) of the Company Disclosure Schedule includes a list
of all material agreements (the "Material Contracts") of the Company and
its subsidiaries, taken as a whole.

(b) Except as noted in Section 2.5(b) of the Company Disclosure
Schedule, the execution and delivery of this Agreement by the Company do
not, and the performance of this Agreement by the Company shall not, (i)
conflict with or violate the Certificate of Incorporation or Bylaws or
equivalent organizational documents of the Company or any of its
subsidiaries, (ii) conflict with or violate any law, rule, regulation,
order, judgment or decree applicable to the Company or any of its
subsidiaries or by which its or any of their respective properties is bound
or affected, or (iii) result in any breach of or constitute a default (or
an event that with notice or lapse of time or both would become a default),
or impair the Company's rights or alter the rights or obligations of any
third party under, or give to others any rights of termination, amendment,
acceleration or cancellation of, or result in the creation of a lien or
encumbrance on any of the material properties or assets of the Company or
any of its subsidiaries pursuant to, any material note, bond, mortgage,
indenture, contract, agreement, lease, license, permit, franchise or other
instrument or obligation to which the Company or any of its subsidiaries is
a party or by

A-5
<PAGE> 156

which the Company or any of its subsidiaries or its or any of their
respective properties is bound or affected, except for such events that may
result from a "change in control" or similar provision contained in the
Material Contracts ("Change in Control Provisions"), which Material
Contracts containing such a Change in Control Provision shall be
specifically designated in Schedule 2.5(b) of the Company Disclosure
Schedule, and except for any such breaches, defaults or other occurrences
that would not, individually or in the aggregate, have a Material Adverse
Effect.

(c) The execution and delivery of this Agreement by the Company do
not, and the performance of this Agreement by the Company shall not,
require any consent, approval, authorization or permit of, or filing with
or notification to, any governmental or regulatory authority, domestic or
foreign, except (i) for applicable requirements, if any, of the Securities
Act of 1933 (the "Securities Act"), the Securities Exchange Act of 1934
(the "Exchange Act"), state securities laws ("Blue Sky Laws"), the
pre-merger notification requirements of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"), and the filing and
recordation of appropriate merger or other documents as required by
Delaware Law and (ii) where the failure to obtain such consents, approvals,
authorizations or permits, or to make such filings or notifications, would
not prevent or delay consummation of the Merger, or otherwise prevent the
Company from performing its obligations under this Agreement, and would not
have a Material Adverse Effect.

2.6 Compliance, Permits.

(a) Neither the Company nor any of its subsidiaries is in conflict
with, or in default or violation of, (i) any law, rule, regulation, order,
judgment or decree applicable to the Company or any of its subsidiaries or
by which its or any of their respective properties is bound or affected, or
(ii) any note, bond, mortgage, indenture, contract, agreement, lease,
license, permit, franchise or other instrument or obligation to which the
Company or any of its subsidiaries is a party or by which the Company or
any of its subsidiaries or its or any of their respective properties is
bound or affected, except for any such conflicts, defaults or violations
which would not, individually or in the aggregate, have a Material Adverse
Effect.

(b) The Company and its subsidiaries hold all permits, licenses,
variances, exemptions, orders and approvals from governmental authorities
which are material to the operation of the business of the Company and its
subsidiaries taken as a whole (collectively, the "Company Permits"). The
Company and its subsidiaries are in compliance with the terms of the
Company Permits, except where the failure to so comply would not have a
Material Adverse Effect.

2.7 SEC Filings; Financial Statements.

(a) The Company has filed all forms, reports and documents required to
be filed with the Securities and Exchange Commission ("SEC") since December
15, 1994, and has made available to Parent complete and correct copies of
(i) its Annual Report on Form 10-K for the fiscal year ended March 31,
1995, (ii) its Quarterly Report on Form 10-Q for the period ended June 30,
1995, (iii) all proxy statements relating to the Company's meetings of
stockholders (whether annual or special) held since December 15, 1994, (iv)
all other reports or registration statements (other than Reports on Form
10-Q not referred to in clause (ii) above and Reports on Form SR) filed by
the Company with the SEC since December 15, 1994 and (vi) all amendments
and supplements to all such reports and registration statements filed by
the Company with the SEC (collectively, the "Company SEC Reports"). The
Company SEC Reports (i) were prepared in accordance with the requirements
of the Securities Act or the Exchange Act, as the case may be, and (ii) did
not at the time they were filed (or if amended or superseded by a filing
prior to the date of this Agreement, then on the date of such filing)
contain any untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading. None of the Company's subsidiaries is required to
file any forms, reports or other documents with the SEC.

A-6
<PAGE> 157

(b) Each of the consolidated financial statements (including, in each
case, any related notes thereto) contained in the Company SEC Reports was
prepared in accordance with generally accepted accounting principles
applied on a consistent basis throughout the periods involved (except as
may be indicated in the notes thereto) and each fairly presented the
consolidated financial position of the Company and its subsidiaries as at
the respective dates thereof and the consolidated results of its operations
and cash flows for the periods indicated, except that the unaudited interim
financial statements were or are subject to normal and recurring year-end
adjustments which were not or are not expected to be material in amount.

(c) The Company has heretofore furnished to Parent a complete and
correct copy of any amendments or modifications, which have not yet been
filed with the SEC but which are required to be filed, to agreements,
documents or other instruments which previously had been filed by the
Company with the SEC pursuant to the Securities Act or the Exchange Act.

2.8 Absence of Certain Changes or Events. Since June 30, 1995, the Company
and its subsidiaries have conducted their businesses only in the ordinary course
and in a manner consistent with past practice and, since such date, there has
not been (i) any change in the financial condition, results of operations or
business of the Company or any of its subsidiaries having a Material Adverse
Effect or, to the best knowledge of the Company, any development that could
reasonably be expected to have a Material Adverse Effect, other than as
reflected in the Company's results of operations for the quarter ended June 30,
1995, or as disclosed in Company SEC Reports, (ii) any damage, destruction or
loss (whether or not covered by insurance) with respect to any assets of the
Company or any of its subsidiaries having a Material Adverse Effect, (iii) any
change by the Company in its accounting methods, principles or practices, (iv)
any revaluation by the Company of any of its assets, including, without
limitation, writing down the value of capitalized software or inventory or
writing off notes or accounts receivable other than in the ordinary course of
business or (v) except as disclosed in the Company Disclosure Schedule, any
other action or event that would have required the consent of Parent pursuant to
Section 4.1 had such action or event occurred after the date of this Agreement.

2.9 No Undisclosed Liabilities. Neither the Company nor any of its
subsidiaries has any liabilities (absolute, accrued, contingent or otherwise)
which are, in the aggregate, material to the business, operations or financial
condition of the Company and its subsidiaries taken as a whole, except
liabilities (a) adequately provided for in the Company's balance sheet for the
fiscal year ended March 31,1995, (b) incurred in the ordinary course of business
and not required under GAAP to be reflected on such balance sheet, or (c)
incurred since March 31, 1995 in the ordinary course of business and consistent
with past practice, and liabilities incurred in connection with this Agreement.

2.10 Absence of Litigation. Except as set forth in Section 2.10 of the
Company Disclosure Schedule, there are no claims, actions, suits, proceedings or
investigations pending or, to the best knowledge of the Company, threatened
against the Company or any of its subsidiaries, or any properties or rights of
the Company or any of its subsidiaries before any court, arbitrator or
administrative, governmental or regulatory authority or body, domestic or
foreign, that, individually or in the aggregate, could have a Material Adverse
Effect.

2.11 Employee Benefit Plans.

(a) Section 2.11 of the Company Disclosure Schedule lists all employee
benefit plans (as defined in Section 3(3) of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA")) and all bonus, stock option,
stock purchase, incentive, deferred compensation, supplemental retirement,
severance and other similar fringe or employee benefit plans, programs or
arrangements, and any current or former employment or executive
compensation or severance agreements, written or otherwise, for the benefit
of, or relating to, any employee of the Company, any trade or business
(whether or not incorporated) which is a member or which is under common
control with the Company (an "ERISA Affiliate") within the meaning of
Section 414 of the Internal Revenue Code of 1986, as amended (the "Code"),
or any subsidiary of the Company (together, the "Employee Plans"), and a
copy of each such Employee Plan and all amendments, documents,
correspondence and filings related thereto, including but not limited to
any statements, filings, returns, reports or returned files with any
governmental agency with

A-7
<PAGE> 158

respect to the Employee Plans at any time within the three-year period
ending on the date hereof has been made available to Parent.

(b) (i) None of the Employee Plans promises or provides retiree
medical or other retiree welfare benefits to any person, except as required
by applicable law, including but not limited to the Consolidated Omnibus
Budget Reconciliation Act of 1985 ("COBRA"); (ii) there has been no
"prohibited transaction," as such term is defined in Section 406 of ERISA
and Section 4975 of the Code, with respect to any Employee Plan, which
could result in any material liability of the Company or any of its
subsidiaries; (iii) all Employee Plans are in compliance in all material
respects with the requirements prescribed by any and all statutes
(including ERISA and the Code), orders, or governmental rules and
regulations currently in effect with respect thereto (including all
applicable requirements for notification to participants or the Department
of Labor, Internal Revenue Service or Secretary of the Treasury), and the
Company and each of its subsidiaries have performed all material
obligations required to be performed by them under, are not in any material
respect in default under or violation of, and have no knowledge of any
default or violation by any other party to, any of the Employee Plans; (iv)
each Employee Plan intended to qualify under Section 401(a) of the Code and
each trust intended to qualify under Section 501(a) of the Code does so
qualify and a favorable determination letter with respect to each such
Employee Plan and trust has been received from the Internal Revenue Service
(the "IRS"), and nothing has occurred which may reasonably be expected to
cause the loss of such qualification or exemption; (v) all contributions,
premiums or other payments required to be made to any Employee Plan, the
terms of the Employee Plan or any collective bargaining agreement, have
been made on or before their due dates and a reasonable amount has been
accrued for contributions to each Employee Plan for the current plan years,
all accounts have been made in accordance with generally accepted
accounting principles consistently applied on a reasonable basis and no
further contributions will be due or will have accrued thereunder as of the
Closing Date; (vi) with respect to each Employee Plan, no "reportable
event" within the meaning of Section 4043 of ERISA (excluding any such
event for which the thirty (30) day notice requirement has been waived
under the regulations to Section 4043 of ERISA) nor any event described in
Section 4062, 4063 or 4041 of ERISA has occurred; (vii) no Employee Plan is
covered by, and neither the Company nor any subsidiary has incurred or
expects to incur any liability under, Title IV of ERISA or Section 412 of
the Code; (viii) with respect to each Employee Plan, no act or omission by
the Company and each of its subsidiaries constituting a violation of
Section 402, 403, 404, 405, 503, 510 or 511 of ERISA or giving rise to
liability under Section 502 of ERISA or under Sections 4972 or 4976 through
4980 of the Code has occurred; and (ix) to the best knowledge of the
Company and its subsidiaries, there are no pending, threatened or
anticipated claims (other than routine claims for benefits) by, on behalf
of or against any of the Employee Plans or any trusts related thereto.

(c) Section 2.11(c) of the Company Disclosure Schedule sets forth a
true and complete list of each current or former employee, officer or
director of the Company or any of its subsidiaries who holds any option to
purchase Company Common Stock as of the date hereof, together with the
number of shares of Company Common Stock subject to such option, the date
of grant of such option, the extent to which such option is vested, the
option price of such option, whether such option is intended to qualify as
an incentive stock option within the meaning of Section 422(b) of the Code
(an "ISO"), and the expiration date of such option. Section 2.11(c) of the
Company Disclosure Schedule also sets forth the total number of such ISOs
and such nonqualified options.

2.12 Labor Matters.

(a) Except as set forth in Section 2.12 of the Company Disclosure
Schedule, (i) there are no controversies pending or, to the knowledge of
the Company or any of its subsidiaries, threatened, between the Company or
any of its subsidiaries and any of their respective employees, which
controversies have or may have a Material Adverse Effect; (ii) neither the
Company nor any of its subsidiaries is a party to any collective bargaining
agreement or other labor union contract applicable to persons employed by
the Company or its subsidiaries nor does the Company or any of its
subsidiaries know of any activities or proceedings of any labor union to
organize any such employees; and (iii) neither the Company nor any of

A-8
<PAGE> 159

its subsidiaries has any knowledge of any strikes, slowdowns, work
stoppages, lockouts, or threats thereof, by or with respect to any
employees of the Company or any of its subsidiaries.

(b) The Company is in compliance in all material respects with all
currently applicable laws and regulations respecting employment,
discrimination in employment, terms and conditions of employment, wage and
hour laws and occupational safety and health and employment practices, and
is not engaged in any unfair labor practice. The Company has complied in
all material aspects with all applicable provisions of COBRA and has no
material obligations with respect to any former employees or qualifying
beneficiaries thereunder.

2.13 Registration Statement; Proxy Statement/Prospectus. The information
supplied by the Company for inclusion in the Registration Statement (as defined
in Section 3.10) shall not at the time the Registration Statement is declared
effective contain any untrue statement of a material fact or omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading. The information supplied by the Company for inclusion in
the proxy statement/prospectus to be sent to the stockholders of the Company in
connection with the meeting of the Company's stockholders to consider the Merger
(the "Company Stockholders' Meeting") (such proxy statement/prospectus as
amended or supplemented is referred to herein as the "Proxy Statement"), shall
not, on the date the Proxy Statement (or any amendment thereof or supplement
thereto) is first mailed to stockholders, at the time of the Company
Stockholders' Meeting and at the Effective Time, contain any statement which, at
such time and in light of the circumstances under which it shall be made, is
false or misleading with respect to any material fact, or shall omit to state
any material fact necessary in order to make the statements made therein, not
false or misleading; or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the solicitation of
proxies for the Company Stockholders' Meeting which has become false or
misleading. If at any time prior to the Effective Time any event relating to the
Company or any of its respective affiliates, officers or directors should be
discovered by the Company which should be set forth in an amendment to the
Registration Statement or a supplement to the Proxy Statement, the Company shall
promptly inform Parent and Merger Sub. Notwithstanding the foregoing, the
Company makes no representation or warranty with respect to any information
supplied by Parent or Merger Sub which is contained in any of the foregoing
documents. The Proxy Statement shall comply in all material respects as to form
and substance with the requirements of the Exchange Act and the rules and
regulations thereunder.

2.14 Restrictions on Business Activities. Except as set forth in Section
2.14 of the Company Disclosure Schedule, there is no material agreement,
judgment, injunction, order or decree binding upon the Company or any of its
subsidiaries which has had or could reasonably be expected to have the effect of
prohibiting or materially impairing any business practice of the Company or any
of its subsidiaries, any acquisition of property by the Company or any of its
subsidiaries or the conduct of business by the Company or any of its
subsidiaries as currently conducted or as proposed to be conducted by the
Company.

2.15 Title to Property. The Company owns no real property. Section 2.15 of
the Company Disclosure Statement sets forth a true and complete list of all real
property leased by the Company or any of its subsidiaries and the aggregate
monthly rental or other fee payable under such lease. Except as set forth in
Section 2.15 of the Company Disclosure Schedule, the Company and each of its
subsidiaries have good and marketable title to all of their properties and
assets, free and clear of all liens, charges and encumbrances, except liens for
taxes not yet due and payable as reflected in the Company's financial
statements, liens for current taxes not yet delinquent, liens imposed by law and
incurred in the ordinary course of business for obligations not yet due to
carriers, warehousemen, laborers, materialmen and the like, liens and respective
pledges or deposits under worker's compensation laws or similar legislation and
such liens or other imperfections of title, if any, as do not materially detract
from the value of or interfere with the present use of the property affected
thereby or which, individually or in the aggregate, would not have a Material
Adverse Effect; and all leases pursuant to which the Company or any of its
subsidiaries lease from others material amounts of real or personal property,
are in good standing, valid and effective in accordance with their respective
terms, and there is not, under any of such leases, any existing material default
or event of default on the part of the Company or its subsidiaries (or event
which with notice or lapse of time, or both, would

A-9
<PAGE> 160

constitute a material default and in respect of which the Company or such
subsidiary has not taken adequate steps to prevent such a default from
occurring) except where the lack of such good standing, validity and
effectiveness or the existence of such default or event of default would not
have a Material Adverse Effect. All the plants, structures and equipment of the
Company and its subsidiaries, except such as may be under construction, are in
good operating condition and repair, except where the failure of such plants,
structures and equipment to be in such good operating condition and repair would
not, individually or in the aggregate, have a Material Adverse Effect.

2.16 Taxes.

(a) The Company and its subsidiaries have filed all United States
federal income tax and all other material tax returns required to be filed
by them, and the Company and its subsidiaries have paid and discharged all
Taxes due in connection with or with respect to the filing of all Tax
Returns and have paid all other Taxes as are due, except such as are being
contested in good faith by appropriate proceedings (to the extent any such
proceedings are required) and with respect to which the Company is
maintaining reserves to the extent currently required in all material
respects adequate for their payment except to the extent the failure to do
so would not have a Material Adverse Effect. For purposes of this
agreement, "Tax" or "Taxes" shall mean taxes and governmental impositions
of any kind in the nature of (or similar to) taxes, payable to any federal,
state, local or foreign taxing authority, including (without limitation)
(i) income, franchise, profits, gross receipts, ad valorem, value added,
sales, use, service, real or personal property, capital stock, license,
payroll, withholding, employment, social security, workers' compensation,
unemployment compensation, utility, severance, production, excise, stamp,
occupation, premiums, windfall profits, transfer and gains taxes and (ii)
interest, penalties and additions to tax imposed with respect thereto; and
"Tax Returns" shall mean returns, reports, and information statements with
respect to Taxes required to be filed with the IRS or any other taxing
authority, domestic or foreign, including, without limitation,
consolidated, combined and unitary tax returns. Neither the IRS nor any
other taxing authority or agency is now asserting or, to the best of the
Company's knowledge, threatening to assert against the Company or any of
its subsidiaries any deficiency or claim for additional Taxes other than
additional Taxes with respect to which the Company is maintaining reserves
in all material respects adequate for their payment. Neither the Company
nor any of its subsidiaries has granted any waiver of any federal or
California statute of limitations with respect to, or any extension of a
period for the assessment of, any Tax. There are no liens for Taxes on any
of the Company's or its subsidiaries' assets, other than liens for Taxes
not yet due. The accruals and reserves for Taxes reflected in the March 31,
1995 Balance Sheet are in all material respects adequate to cover all Taxes
accruable through the date thereof in accordance with generally accepted
accounting principles, and no material tax liability has been incurred (or
prior to closing will be incurred) since the date thereof other than in the
ordinary course of business. Neither the Company nor any of its
subsidiaries is required to include in income either (i) any amount in
respect of any adjustment under Section 481 of the Code, or (ii) any
installment sale gain, where the inclusion in income would result in a tax
liability materially in excess of the reserves therefor. Neither the
Company nor any of its subsidiaries has made an election under Section
341(1) of the Code.

(b) Except as set forth in Section 2.16 of the Company Disclosure
Schedule, neither the Company nor any of its subsidiaries is a party to any
agreement, contract or arrangement that may result, separately or in the
aggregate, in the payment of any "excess parachute payment" within the
meaning of Section 280G of the Code, determined without regard to Section
280G(b)(4) of the Code.

2.17 Environmental Matters. Except as set forth in Section 2.17 of the
Company Disclosure Schedule, and except in all cases as, in the aggregate, have
not had and could not reasonably be expected to have a Material Adverse Effect,
the Company and each of its subsidiaries to the best of their respective
knowledge (i) have obtained all applicable permits, licenses and other
authorization which are required under federal, state or local laws relating to
pollution or protection of the environment, including laws relating to
emissions, discharges, releases or threatened releases of pollutants,
contaminants, or hazardous or toxic materials or wastes into ambient air,
surface water, ground water, or land or otherwise relating to the manufacture,
processing, distribution, use, treatment, storage, disposal, transport, or
handling of pollutants, contaminants or hazardous or toxic materials or wastes
by the Company or its subsidiaries (or their respective agents); (ii) are

A-10
<PAGE> 161

in compliance with all terms and conditions of such required permits, licenses
and authorization, and also are in compliance with all other limitations,
restrictions, conditions, standards, prohibitions, requirements, obligations,
schedules and timetables contained in such laws or contained in any regulation,
code, plan, order, decree, judgment, notice or demand letter issued, entered,
promulgated or approved thereunder; (iii) as of the date hereof, are not aware
of nor have received notice of any event, condition, circumstance, activity,
practice, incident, action or plan which is reasonably likely to interfere with
or prevent continued compliance or which would give rise to any common law or
statutory liability, or otherwise form the basis of any claim, action, suit or
proceeding, based on or resulting from the Company's or any of its subsidiary's
(or any of their respective agent's) manufacture, processing, distribution, use,
treatment, storage, disposal, transport, or handling, or the emission,
discharge, or release into the environment, of any pollutant, contaminant, or
hazardous or toxic material or waste; and (iv) have taken all actions necessary
under applicable requirements of Federal, state or local laws, rules or
regulations to register any products or materials required to be registered by
the Company or its subsidiaries (or any of their respective agents) thereunder.

2.18 Brokers. Except as set forth in Section 2.18 of the Company
Disclosure Schedule, no broker, finder or investment banker is entitled to any
brokerage, finder's or other fee or commission in connection with the
transactions contemplated by this Agreement based upon arrangements made by or
on behalf of the Company. The Company has heretofore furnished to Parent a
complete and correct copy of all agreements between the Company and any such
broker, finder or investment banker pursuant to which such firm would be
entitled to any payment relating to the transactions contemplated hereunder.

2.19 Full Disclosure. No statement contained in any certificate or
schedule furnished or to be furnished by the Company or its subsidiaries to
Parent or Merger Sub in, or pursuant to the provisions of, this Agreement taken
together with this Agreement, the exhibits, certificates and schedules delivered
hereunder and other documents expressly required to be delivered hereunder
contains or shall contain any untrue statement of a material fact or omits or
shall omit to state any material fact necessary, in the light of the
circumstances under which it was made, in order to make the statements herein or
therein not misleading.

2.20 Intellectual Property. The Company owns, or is licensed or otherwise
has sufficient rights to use rights to all patents, trademarks, trade names,
service marks, copyrights, and any applications therefor, schematics,
technology, know-how, microcode, computer software programs or applications and
tangible or intangible proprietary information or material that in any material
respect are used or proposed to be used in any material portion of the business
of the Company and its subsidiaries as currently conducted or as proposed to be
conducted within the twelve months following the date hereof (the "Company
Intellectual Property"). Section 2.20 of the Company Disclosure Schedule lists
all patents, trademarks, registered copyrights, trade names and service marks
which are included in the Company Intellectual Property and relate to products
currently offered for sale by the Company, and specifies the jurisdictions in
which each such Company Intellectual Property has been issued or registered or
in which an application for such issuance and registration has been filed,
including the respective registration or application numbers. Attached to the
Company Disclosure Schedule is a catalogue of the Company's software products;
the Company holds a registered or unregistered copyright to each such product.
Sections 2.5(a) and 2.20 of the Company Disclosure Schedule also list all
material licenses, sublicenses and other agreements, other than license
agreements with customers in the ordinary course of the Company's business, as
to which the Company or any of its subsidiaries is a party and pursuant to which
the Company or any of its subsidiaries or any other person is authorized to use
any Company Intellectual Property or other trade secret material to the Company
or any of its subsidiaries. Neither the Company nor any of its subsidiaries is
in material violation of, and the execution and delivery of this Agreement and
the performance by the Company of its obligations hereunder will not impair in
any material respect, the Company's rights or alter the rights or obligations of
any third party under or violate any material license, sublicense or agreement,
except for any Change in Control Provisions. Except as set forth in Section 2.20
of the Company Disclosure Schedule, the Company is not contractually obligated
to pay any compensation in excess of $100,000 per year in the aggregate to any
third party in respect of any Company Intellectual Property or the material
covered thereby or in connection with the services or products in respect of
which the Company Intellectual Property is being used or proposed to be used.
Except as set forth in Section 2.20 of the Company Disclosure Schedule, no
claims with respect to the Company Intellectual

A-11
<PAGE> 162

Property have been asserted or, to the knowledge of the Company, are threatened
by any person, nor does the Company or any subsidiary of the Company have
knowledge of any valid grounds for any bona fide claims (i) to the effect that
the manufacture, sale or use of any product, or any licensing of any Company
Intellectual Property, as now used or offered or proposed for sale, use or
licensing by the Company or any subsidiary of the Company, infringes on any
copyright, patent or trade secret, (ii) against the use by the Company or any
subsidiary of the Company of any Company Intellectual Property, or (iii)
challenging the ownership or validity of any of the Company Intellectual
Property and which, in the case of all three subclauses, would have a Material
Adverse Effect if determined adversely. To the Company's best knowledge, all
patents, registered trademarks and copyrights held by the Company are valid.
Except as set forth in Section 2.20 of the Company Disclosure Schedule, to the
Company's knowledge, there is no material unauthorized use, infringement or
misappropriation of any of the Company Intellectual Property by any third party,
including any employee or former employee of the Company or any of its
subsidiaries. Except as set forth in Section 2.20 of the Company Disclosure
Schedule, neither the Company nor any of its subsidiaries (i) has been sued or
charged in writing as a defendant in any claim, suit, action or proceeding which
involves a claim or infringement of trade secrets, any patents, trademarks,
service marks, or copyrights and which has not been finally terminated prior to
the date hereof or (ii) has knowledge of any infringement liability with respect
to, or infringement by, the Company or any of its subsidiaries of any trade
secret, patent, trademark, service mark or copyright of another. The Company
maintains a trade secret protection program pursuant to which its officers,
employees and consultants have been requested to sign a proprietary information
and inventions agreement substantially in the form delivered to Parent (which
agreement includes, among other things, confidentiality and assignment of
inventions provisions). Since December 15, 1994 and thereafter, each of the
Company's officers, employees and consultants with access to technical data of
the Company has signed such an agreement and each such agreement remains in full
force and effect. To the best knowledge of the Company, none of its current or
former officers, employees or consultants is in violation of such agreements.

2.21 Pooling Matters. Neither the Company nor any of its affiliates has,
to its knowledge and based upon consultation with its independent accountants,
taken or agreed to take any action that (without giving effect to any action
taken or agreed to be taken by Parent or any of its affiliates) would prevent
the ability of Parent to account for the business combination to be effected by
the Merger as a pooling of interests.

2.22 Insurance. Except as set forth in Section 2.22 of the Company
Disclosure Schedule, the Company Disclosure Schedule lists all material
insurance policies and fidelity bonds covering the assets, business, equipment,
properties, operations, employees, officers and directors of the Company and its
subsidiaries. There is no claim by the Company or any of its subsidiaries
pending under any of such policies or bonds as to which coverage has been
questioned, denied or disputed by the underwriters of such policies or bonds.
All premiums payable under all such policies and bonds have been paid and the
Company and its subsidiaries are otherwise in full compliance with the terms of
such policies and bonds (or other policies and bonds providing substantially
similar insurance coverage). Such policies of insurance and bonds are of the
type and in amounts customarily carried by persons conducting businesses similar
to those of the Company and its subsidiaries. The Company does not know of any
threatened termination of or material premium increase with respect to, any of
such policies.

2.23 Opinion of Financial Advisor. The Company has been advised by its
financial advisor, Lehman Brothers Inc., that in its opinion, as of the date
hereof, the terms of the Merger are fair to the stockholders of the Company from
a financial point of view.

2.24 The Company's Best Knowledge. The term "the Company's best knowledge"
or words of similar import shall mean the best knowledge of any of the Company's
Chief Executive Officer, Chief Operating Officer, or Chief Financial Officer.

A-12
<PAGE> 163

ARTICLE III

REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB

Parent and Merger Sub hereby, jointly and severally, represent and warrant
to the Company that, except as set forth in the Disclosure Schedule previously
delivered by Parent to the Company (the "Parent Disclosure Schedule"):

3.1 Organization and Qualification; Subsidiaries. Each of Parent and each
of its subsidiaries is a corporation duly organized, validly existing and in
good standing under the laws of the jurisdiction of its incorporation and has
the requisite corporate power and authority and is in possession of all
franchises, grants, authorizations, licenses, permits, easements, consents,
certificates, approvals and orders ("Approvals") necessary to own, lease and
operate the properties it purports to own, operate or lease and to carry on its
business as it is now being conducted, except where the failure to be so
organized, existing and in good standing or to have such power, authority and
Approvals would not, individually or in the aggregate, have a Material Adverse
Effect (as defined below). Each of Parent and each of its subsidiaries is duly
qualified or licensed as a foreign corporation to do business, and is in good
standing, in each jurisdiction where the character of its properties owned,
leased or operated by it or the nature of its activities makes such
qualification or licensing necessary, except for such failures to be so duly
qualified or licensed and in good standing that would not, either individually
or in the aggregate, have a Material Adverse Effect. When used in connection
with Parent or any of its subsidiaries, the term "Material Adverse Effect" means
any change or effect that is or is reasonably likely to be materially adverse to
the business, assets (including intangible assets), financial condition, results
of operations, or prospects of Parent and its subsidiaries taken as a whole.

3.2 Certificate of Incorporation and Bylaws. Parent has heretofore
furnished to the Company a complete and correct copy of the Certificate of
Incorporation and Bylaws, as amended to date, of each Parent and Merger Sub.
Such Certificate of Incorporation and Bylaws are in full force and effect.
Neither Parent nor any of its subsidiaries is in violation of any of the
provisions of its Certificate of Incorporation or Bylaws.

3.3 Capitalization.

(a) As of June 30, 1995, the authorized capital stock of Parent
consisted of (i) 100,000,000 shares of Parent Common Stock of which:
54,326,189 shares were issued and outstanding, no shares were held in
treasury, an aggregate of 5,497,162 shares were reserved for issuance
pursuant to outstanding options under Parent's 1982 Stock Option Plan,
Nonqualified Stock Option Plan, 1986 Stock Plan and 1987 Non-Employee
Directors' Stock Option Plans ("Parent Stock Plans") and 2,503,048 shares
remained available for issuance under Parent's 1989 Employee Stock Purchase
Plan and (ii) 1,200,000 shares of Incentive Stock were authorized and were
reserved for issuance, none of which was outstanding. No material change in
such capitalization has occurred between June 30, 1995 and the date hereof.
The authorized capital stock of Merger Sub consists of 1,000 shares of
common stock, par value $.001 per share, 100 shares of which are issued and
outstanding, as of the date hereof.

(b) The shares of Parent Common Stock to be issued pursuant to the
Merger will be duly authorized, validly issued, fully paid and
nonassessable and, subject to notice of issuance, shall be listed on the
Nasdaq National Market System.

3.4 Authority Relative to this Agreement. Each of Parent and Merger Sub
has all necessary corporate power and authority to execute and deliver this
Agreement and to perform its obligations hereunder and to consummate the
transactions contemplated hereby. The execution and delivery of this Agreement
by Parent and Merger Sub and the consummation by Parent and Merger Sub of the
transactions contemplated hereby have been duly and validly authorized by all
necessary corporate action on the part of Parent and Merger Sub and no other
corporate proceedings on the part of Parent or Merger Sub are necessary to
authorize this Agreement or to consummate the transactions so contemplated. This
Agreement has been duly and validly executed and delivered by Parent and Merger
Sub and, assuming the due authorization, execution and delivery by the Company,
constitutes a legal, valid and binding obligation of Parent and Merger Sub.

A-13
<PAGE> 164

3.5 No Conflict; Required Filings and Consents.

(a) The execution and delivery of this Agreement by Parent and Merger
Sub do not, and the performance of this Agreement by Parent and Merger Sub
shall not, (i) conflict with or violate the Certificate of Incorporation or
Bylaws of Parent or Merger Sub, (ii) conflict with or violate any law,
rule, regulation, order, judgment or decree applicable to Parent or Merger
Sub or by which Parent's properties are bound or affected, or (iii) result
in any breach of or constitute a default (or an event which with notice or
lapse of time or both would become a default) under, or impair Parent's
rights, or give to others any rights of termination, amendment,
acceleration or cancellation of, or result in the creation of a lien or
encumbrance on any of the properties or assets of Parent pursuant to, any
material note, bond, mortgage, indenture, contract, agreement, lease,
license, permit, franchise or other instrument or obligation to which
Parent is a party or by which Parent or its properties are bound or
affected, except for any such breaches, defaults or other occurrences that
would not, individually or in the aggregate, have a Material Adverse
Effect.

(b) The execution and delivery of this Agreement by Parent and Merger
Sub do not, and the performance of this Agreement by Parent and Merger Sub
shall not, require any consent, approval, authorization or permit of, or
filing with or notification to, any governmental or regulatory authority,
domestic or foreign, except (i) for applicable requirements, if any, of the
Securities Act, the Exchange Act, Blue Sky Laws, the pre-merger
notification requirements of the HSR Act and the rules and regulations
thereunder, and the filing and recordation of appropriate merger or other
documents as required by Delaware Law and (ii) where the failure to obtain
such consents, approvals, authorizations or permits, or to make such
filings or notifications, would not prevent or delay consummation of the
Merger, or otherwise prevent Parent or Merger Sub from performing their
respective obligations under this Agreement, and would not have Material
Adverse Effect.

3.6 Compliance.

(a) Neither Parent nor Merger Sub is in conflict with, or in default
or violation of, (i) any law, rule, regulation, order, judgment or decree
applicable to Parent or Merger Sub or by which its or any of their
respective properties is bound or affected, or (ii) any note, bond,
mortgage, indenture, contract, agreement, lease, license, permit, franchise
or other instrument or obligation to which Parent or Merger Sub, is a party
or by which Parent or Merger Sub or Parent's properties is bound or
affected, except for any such conflicts, defaults or violations which would
not, individually or in the aggregate, have a Material Adverse Effect.

(b) Parent and Merger Sub hold all permits, licenses, variances,
exemptions, orders and approvals from governmental authorities which are
material to the operation of the business of Parent and Merger Sub
(collectively, the "Parent Permits"). Parent and Merger Sub are in
compliance with the terms of the Parent Permits, except where the failure
to so comply would not have a Material Adverse Effect.

3.7 SEC Filings; Financial Statements.

(a) Parent has filed all forms, reports and documents required to be
filed with the SEC since June 30, 1992, and has heretofore delivered to the
Company, in the form filed with the SEC, (i) its Annual Reports on Form
10-K for the fiscal years ended December 31, 1992, 1993 and 1994, (ii) its
Quarterly Reports on Form 10-Q for the periods ended March 31 and June 30,
1995, (iii) all proxy statements relating to Parent's meetings of
stockholders (whether annual or special) held since June 30, 1992, (iv) all
other reports or registration statements (other than Reports on Form 10-Q
not referred to in clause (ii) above) filed by Parent with the SEC since
June 30, 1992 and (v) all amendments and supplements to all such reports
and registration statements filed by Parent with the SEC (collectively, the
"Parent SEC Reports"). The Parent SEC Reports (i) were prepared in
accordance with the requirements of the Securities Act or the Exchange Act,
as the case may be, and (ii) did not at the time they were filed (or if
amended or superseded by a filing prior to the date of this Agreement, then
on the date of such filing) contain any untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary
in order to make the statements therein, in the light of the circumstances
under which they were made, not misleading.

A-14
<PAGE> 165

(b) Each of the consolidated financial statements (including, in each
case, any related notes thereto) contained in the Parent SEC Reports has
been prepared in accordance with generally accepted accounting principles
applied on a consistent basis throughout the periods involved (except as
may be indicated in the notes thereto) and each fairly presents the
consolidated financial position of Parent and its subsidiaries as at the
respective dates thereof and the consolidated results of its operations and
cash flows for the periods indicated, except that the unaudited interim
financial statements were or are subject to normal and recurring year-end
adjustments which were not or are not expected to be material in amount.

3.8 Absence of Certain Changes or Events. Since June 30, 1995, Parent and
its subsidiaries have conducted their businesses only in the ordinary course and
in a manner consistent with past practice and, since such date, there has not
been (i) any change in the financial condition, results of operations or
business of Parent or any of its subsidiaries having a Material Adverse Effect
or, to the best knowledge of Parent, any development that could reasonably be
expected to have a Material Adverse Effect, other than as reflected in the
Company's results of operations for the quarter ended June 30, 1995, or as
disclosed in Company SEC Reports, (ii) any damage, destruction or loss (whether
or not covered by insurance) with respect to any assets of Parent or any of its
subsidiaries having a Material Adverse Effect, (iii) any change by Parent in its
accounting methods, principles or practices or (iv) any revaluation by Parent of
any of its assets, including, without limitation, writing down the value of
capitalized software or inventory or writing off notes or accounts receivable
other than in the ordinary course of business.

3.9 Absence of Litigation. Other than as disclosed in the Parent SEC
Reports, there are no claims, actions, suits, proceedings or investigations
pending or, to the best knowledge of Parent, threatened against Parent or any of
its subsidiaries, or any properties or rights of Parent or any of its
subsidiaries, before any court, arbitrator or administrative, governmental or
regulatory authority or body, domestic or foreign, that, individually or in the
aggregate, could have a Material Adverse Effect.

3.10 Registration Statement; Proxy Statement/Prospectus.

(a) Subject to the accuracy of the representations of the Company in
Section 2.13, the registration statement (the "Registration Statement")
pursuant to which the shares of Parent Common Stock to be issued in the
Merger will be registered with the SEC shall not, at the time the
Registration Statement (including any amendments or supplements thereto) is
declared effective by the SEC, contain any untrue statement of a material
fact or omit to state any material fact necessary in order to make the
statements included therein, in light of the circumstances under which they
were made, not misleading.

(b) The information supplied by Parent for inclusion in the Proxy
Statement shall not, on the date the Proxy Statement is first mailed to
stockholders, at the time of the Company Stockholders' Meeting and at the
Effective Time, contain any statement which, at such time and in light of
the circumstances under which it shall be made, is false or misleading with
respect to any material fact, or shall omit to state any material fact
necessary in order to make the statements therein not false or misleading.
If at any time prior to the Effective Time any event relating to Parent,
Merger Sub or any of their respective affiliates, officers or directors
should be discovered by Parent or Merger Sub which should be set forth in
an amendment to the Registration Statement or a supplement to the Proxy
Statement, Parent or Merger Sub will promptly inform the Company.
Notwithstanding the foregoing, Parent and Merger Sub make no representation
or warranty with respect to any information supplied by the Company which
is contained in any of the foregoing documents. The Registration Statement
and Proxy Statement shall comply in all material respects as to form and
substance with the requirements of the Securities Act, the Exchange Act and
the rules and regulations thereunder.

3.11 Restrictions on Business Activities. There is no material agreement,
judgment, injunction, order or decree binding upon Parent which has had or could
reasonably be expected to have the effect of prohibiting or materially impairing
any business practice of Parent, any acquisition of property by Parent or the
conduct of business by Parent as currently conducted or as proposed to be
conducted by Parent.

A-15
<PAGE> 166

3.12 Brokers. Except as set forth in Section 3.11 of the Parent Disclosure
Schedule, no broker, finder or investment banker is entitled to any brokerage,
finder's or other fee or commission in connection with the transactions
contemplated by this Agreement based upon arrangements made by or on behalf of
Parent or Merger Sub.

3.13 Full Disclosure. No statement contained in any certificate or
schedule furnished or to be furnished by Parent or Merger Sub to the Company in,
or pursuant to the provisions of, this Agreement contains or shall contain any
untrue statement of a material fact or omits or shall omit to state any material
fact necessary, in the light of the circumstances under which it was made, in
order to make the statements herein or therein not misleading.

3.14 Pooling Matters. Neither Parent nor any of its affiliates has, to its
knowledge and based upon consultation with its independent accountants, taken or
agreed to take any action that (without giving effect to any action taken or
agreed to be taken by the Company or any of its affiliates) would prevent the
ability of Parent to account for the business combination to be effected by the
Merger as a pooling of interests.

3.15 Intellectual Property. Except as disclosed in the Disclosure
Schedule, Parent owns or has valid rights to use all patents, patent rights,
trademarks, trademark rights, trade names, trade name rights, copyrights,
service marks, trade secrets, applications for trademarks and for service marks,
know-how and other proprietary rights and information used or held for use in
connection with the business of Parent as currently conducted, and to the
knowledge of Parent, there is no assertion or claim challenging the validity of
any of the foregoing which, individually or in the aggregate, could have a
Material Adverse Effect on Parent. Except as disclosed in the Disclosure
Schedule, to the knowledge of Parent, the conduct of the business of Parent as
currently conducted does not conflict in any way with any patent, patent right,
license, trademark, trademark right, trade name, trade name right, service mark
or copyright of any third party that, individually or in the aggregate, could
have a Material Adverse Effect on Parent. Except as disclose in the Disclosure
Schedule, to the knowledge of Parent, there are no infringements of any
proprietary rights owned by Parent which, individually or in the aggregate,
could have a Material Adverse Effect on Parent.

ARTICLE IV

CONDUCT OF BUSINESS PENDING THE MERGER

4.1 Conduct of Business by the Company Pending the Merger. The Company
covenants and agrees that, between the date of this Agreement and the Effective
Time, unless Parent shall otherwise agree in writing, the Company shall, and
shall cause the businesses of its subsidiaries to be conducted only in, and the
Company and its subsidiaries shall not take any action except in, the ordinary
course of business and in a manner consistent with past practice; and the
Company shall use all reasonable efforts to preserve substantially intact the
business organization of the Company and its subsidiaries, to keep available the
services of the present officers, employees and consultants of the Company and
its subsidiaries and to preserve the present relationships of the Company and
its subsidiaries with customers, suppliers and other persons with which the
Company or any of its subsidiaries has significant business relations. By way of
amplification and not limitation, except as contemplated by this Agreement,
neither the Company nor any of its subsidiaries shall, between the date of this
Agreement and the Effective Time, directly or indirectly do, or propose to do,
any of the following without the prior written consent of Parent:

(a) amend or otherwise change the Company's Certificate of
Incorporation or Bylaws or equivalent organizational documents;

(b) issue, sell, pledge, dispose of or encumber, or authorize the
issuance, sale, pledge, disposition or encumbrance of, (i) any shares of
capital stock of any class, or any options (except for options granted
consistent with past practices, to employees, other than officers hired on
or after September 6, 1995, which options represent the right to acquire no
more than 75,000 shares of Company Common Stock in the aggregate and no
more than 7,500 shares of Company Common Stock by any individual),
warrants, convertible securities or other rights of any kind to acquire any
shares of capital stock, or any other ownership interest of the Company,
any of its subsidiaries or affiliates (except for the issuance of shares

A-16
<PAGE> 167

of Company Common Stock issuable upon the exercise of stock options
outstanding on the date hereof under the Company's 1985 Option Plan, 1994
Option Plan or the Director Option Plan or pursuant to rights to purchase
such shares under the Company ESPP or (ii) any assets of the Company or any
of its subsidiaries (except for sales of assets in the ordinary course of
business and in a manner consistent with past practice);

(c) (i) declare, set aside or pay any dividend or other distribution
(whether in cash, stock or property or any combination thereof) in respect
of any of its capital stock, except that a wholly owned subsidiary of the
Company may declare and pay a dividend to its parent, (ii) split, combine
or reclassify any of its capital stock or issue or authorize or propose the
issuance of any other securities in respect of, in lieu of or in
substitution for shares of its capital stock or (iii) amend the terms of,
repurchase, redeem or otherwise acquire, or permit any subsidiary to
repurchase, redeem or otherwise acquire, any of its securities or any
securities of its subsidiaries, or propose to do any of the foregoing;

(d) sell, transfer, license, sublicense or otherwise dispose of any
Company Intellectual Property, or amend or modify any existing agreements
with respect to any Company Intellectual Property except in the ordinary
course of business;

(e) (i) acquire (by merger, consolidation, or acquisition of stock or
assets) any corporation, partnership or other business organization or
division thereof; (ii) incur any indebtedness for borrowed money or issue
any debt securities or assume, guarantee (other than guarantees of bank
debt of the Company's subsidiaries entered into in the ordinary course of
business) or endorse or otherwise as an accommodation become responsible
for, the obligations of any person, or make any loans or advances, except
in the ordinary course of business consistent with past practice; (iii)
enter into any contract or agreement other than in the ordinary course of
business; (iv) authorize any capital expenditures in excess of $80,000 for
any particular item or which are, in the aggregate, in excess of $350,000
for the Company and its subsidiaries taken as a whole; or (v) enter into or
amend any contract, agreement, commitment or arrangement with respect to
any of the matters set forth in this Section 4.1(e);

(f) increase the compensation payable or to become payable to its
officers or employees, except for increases in salary or wages of employees
of the Company or its subsidiaries who are not officers of the Company in
accordance with past practices, or grant any severance or termination pay
or stock options (except for options granted consistent with past
practices, to employees, other than officers, hired on or after September
6, 1995, which options represent the right to acquire no more than 75,000
shares of Company Common Stock in the aggregate and no more than 7,500
shares of Company Common Stock by any individual) to, or enter into any
employment or severance agreement with any director, officer or other
employee of the Company or any of its subsidiaries, or establish, adopt,
enter into or amend any collective bargaining, bonus, profit sharing,
thrift, compensation, stock option, restricted stock, pension, retirement,
deferred compensation, employment, termination, severance or other plan,
agreement, trust, fund, policy or arrangement for the benefit of any
current or former directors, officers or employees;

(g) take any action other than in the ordinary course of business and
in a manner consistent with past practice (none of which actions shall be
unreasonable or unusual) with respect to accounting policies or procedures
(including, without limitation, procedures with respect to revenue
recognition, payments of accounts payable and collection of accounts
receivable);

(h) make any material Tax election, settle or compromise any material
federal, state, local or foreign income Tax liability, adopt or change any
material for amounting material or agree to an extension of a statute of
limitations; or

(i) pay, discharge or satisfy any claims, liabilities or obligations
(absolute, accrued, asserted or unasserted, contingent or otherwise), other
than the payment, discharge or satisfaction in the ordinary course of
business and consistent with past practice of liabilities reflected or
reserved against in the financial statements of the Company or incurred in
the ordinary course of business and consistent with past practice.

A-17
<PAGE> 168

4.2 No Company Solicitation. The Company shall not, and shall not
authorize or permit any of its officers, directors, agents, representatives or
advisors to, (a) solicit, initiate or knowingly encourage or take any action
knowingly to facilitate the submission of inquiries, proposals or offers from
any person relating to (i) any acquisition or purchase of any material asset or
assets of the Company or any class of equity securities of the Company, (ii) any
tender offer (including a self tender offer) or exchange offer involving shares
of capital stock of the Company, (iii) any merger, consolidation, business
combination, sale of substantially all assets, recapitalization, liquidation,
dissolution or similar transaction involving the Company other than the
transactions contemplated by this Agreement or (iv) any other transaction the
consummation of which would or could reasonably be expected to impede, interfere
with, prevent or materially delay the Merger or which would or could reasonably
be expected to materially dilute the benefits to Parent of the transactions
contemplated hereby (the transactions referred to in clauses (i)-(iv) are
collectively referred to herein as "Company Transaction Proposals"), or (b)
enter into or participate in any discussions or negotiations regarding any
Company Transaction Proposal, or furnish to any other person any information
with respect to its business, properties or assets or any Company Transaction
Proposal, or otherwise cooperate in any way with, or assist or participate in,
facilitate or encourage, any effort or attempt by any person to make or seek any
Company Transaction Proposal; provided, however, that the foregoing shall not
prohibit the Company from (x) furnishing information pursuant to a
confidentiality agreement substantially similar to the Confidentiality Agreement
(as defined in Section 5.3(b) hereof) to a third party who has initiated contact
with the Company regarding a bona fide unsolicited Company Transaction Proposal
under circumstances not constituting a breach of the foregoing provisions of
this Section 4.2 (a "Permitted Company Contact"), (y) engaging in discussions or
negotiations with a third party who has initiated a Permitted Company Contact
regarding a Company Transaction Proposal, and/or (z) following receipt of a
Company Transaction Proposal, taking and disclosing to its stockholders a
position contemplated by Rule 14e-2(a) under the Exchange Act or otherwise make
disclosure to its stockholders, but in each case referred to in the foregoing
clauses (x) through (z) only to the extent that the Board of Directors of the
Company shall have concluded in good faith in the exercise of its fiduciary
duties, after consultation with its outside counsel and financial advisor, that
such actions are more likely than not to result in a bona fide Company
Transaction Proposal, the terms of which would be more favorable to the
Company's stockholders than the Merger (a "Superior Company Proposal"). If the
Company receives a Company Transaction Proposal, the Company shall within one
business day of its receipt of such proposal inform Parent of the terms and
conditions of such proposal and identity of the person making it. Immediately
from and after the date hereof, the Company will cease and cause to be
terminated any existing activities, discussions or negotiations with the parties
conducted heretofore with respect to any Company Transaction Proposal.

ARTICLE V

ADDITIONAL AGREEMENTS

5.1 Proxy Statement/Prospectus; Registration Statement.

(a) Each of the Company and Parent shall promptly prepare and file
with the SEC the Proxy Statement and Parent shall promptly prepare and file
with the SEC the Registration Statement on Form S-4, in which the Proxy
Statement will be included as a prospectus. Subject to Section 4.2, each of
Parent and the Company shall use all reasonable efforts to (i) have the
Registration Statement declared effective under the Securities Act a
promptly as practicable after such filing and (ii) cause the Proxy
Statement to be mailed to the stockholders of the Company at the earliest
practicable date. Parent shall also take any action required to be taken
under any applicable state securities laws in connection with the issuance
of the Parent Common Stock in the Merger and the Company shall furnish all
information concerning the Company and the holders of the Company Common
Stock as may be reasonably requested in connection with any such action.

(b) Parent and the Company shall make all necessary filings with
respect to the Merger under the Securities Act and the Exchange Act and the
rules and regulations thereunder, under applicable Blue Sky

A-18
<PAGE> 169

or similar securities laws, rules and regulations and shall use all
reasonable efforts to obtain required approvals and clearances with respect
thereto.

5.2 Meeting of Company Stockholders. The Company shall promptly after the
date hereof take all action necessary in accordance with Delaware Law and its
Certificate of Incorporation and Bylaws to convene the Company Stockholders'
Meeting. The Company shall consult with Parent and use all reasonable efforts to
hold the Company Stockholders' Meeting as soon as practicable and shall not
postpone or adjourn (other than for the absence of a quorum) the Company
Stockholders' Meeting. Subject to Sections 4.2 and 5.1(a), the Company shall use
its best efforts to solicit from stockholders of the Company proxies in favor of
the Merger and shall take all other action necessary or advisable to secure the
vote or consent of stockholders required by Delaware Law to effect the Merger.

5.3 Access to Information; Confidentiality.

(a) Upon reasonable notice and subject to restrictions contained in
confidentiality agreements to which the Company is subject (from which the
Company shall use reasonable efforts to be released) the Company shall (and
shall cause its subsidiaries to) afford to the officers, employees,
accountants, counsel and other representatives of Parent, reasonable
access, during the period prior to the Effective Time, to all its
properties, books, contracts, commitments and records, and during such
period, the Company shall (and shall cause its subsidiaries to) furnish
promptly to Parent all information concerning its business, properties and
personnel as Parent may reasonably request, and shall make available to
Parent such appropriate individuals for discussion of the Company's
business, properties and personnel as Parent may reasonably request.

(b) Parent shall keep such information confidential in accordance with
the terms of the Confidential Information Exchange Agreement, dated August
10, 1995 (the "Confidentiality Agreement"), between Parent and the Company.

5.4 Hart-Scott-Rodino Filings. Each of Parent, the Company and Jerry Kirk
shall promptly prepare and file the applicable notices required to be filed by
it under the HSR Act and comply promptly with any requests to it from the
Federal Trade Commission or United States Department of Justice for additional
information.

5.5 Consents; Approvals. The Company and Parent shall use all reasonable
efforts to obtain all consents, waivers, approvals, authorizations or orders
(including, without limitation, all United States and foreign governmental and
regulatory rulings and approvals), and the Company and Parent shall make all
filings (including, without limitation, all filings with United States and
foreign governmental or regulatory agencies) required in connection with the
authorization, execution and delivery of this Agreement by the Company and
Parent and the consummation by them of the transactions contemplated hereby. The
Company and Parent shall furnish all information required to be included in the
Proxy Statement and the Registration Statement, or for any application or other
filing to be made pursuant to the rules and regulations of any United States or
foreign governmental body in connection with the transactions contemplated by
this Agreement.

5.6 Stock Options.

(a) At the Effective Time, each outstanding option to purchase shares
of Company Common Stock (each a "Company Option") under the Company's 1985
Option Plan and 1994 Option Plan, as amended (the "Company Option Plans"),
whether vested or unvested, will be assumed by Parent. Each Company Option
so assumed by Parent under this Agreement shall continue to have, and be
subject to, the same terms and conditions set forth in the either of the
Company Option Plans, as applicable, (and in the agreement issued to the
optionee for each such Company Option) immediately prior to the Effective
Time, except that (i) such Company Option will be exercisable for that
number of whole shares of Parent Common Stock equal to the product of the
number of shares of Company Common Stock that were purchasable under such
Company Option immediately prior to the Effective Time multiplied by the
Exchange Ratio, rounded down to the nearest whole number of shares of
Parent Common Stock, and (ii) the per share exercise price for the shares
of Parent Common Stock issuable upon exercise of such assumed Company
Option will be equal to the quotient determined by dividing the exercise
price per

A-19
<PAGE> 170

share of Company Common Stock at which such Company Option was exercisable
immediately prior to the Effective Time by the Exchange Ratio, and rounding
the resulting exercise price up to the nearest whole cent.

(b) After the Effective Time, Parent will issue to each holder of an
outstanding Company Option a document evidencing the foregoing assumption
of such Company Option by Parent.

(c) It is the intention of the parties that the Company Options
assumed by Parent qualify following the Effective Time as incentive stock
options as defined in Section 422 of the Code to the extent the Company
Options qualified as incentive stock options immediately prior to the
Effective Time.

(d) In accordance with the terms of the Company's Directors Option
Plan, (i) from and after the date 30 days prior to the Effective Time, all
options outstanding under such plan shall become fully exercisable without
regard to the vesting schedule of such options and (ii) all options
outstanding thereunder at the Effective Time shall terminate and no such
options shall be exercisable after the Effective Time, be assumed by Parent
or be converted into the right to purchase Parent Common Stock.

(e) As promptly as practicable after the Effective Time, Parent shall
file a registration statement, or amend an existing registration statement,
in order to cover the shares of Parent Common Stock issuable upon the
exercise of the Company Options converted to Parent Options pursuant to
this Section 5.6 and shall use all reasonable efforts to cause the offer
and sale of such shares to be registered under the Securities Act, and to
maintain such registration in effect until the exercise or termination of
the Company Options. Parent shall also use all reasonable efforts to cause
such shares of Parent Common Stock to be listed on the Nasdaq National
Market System.

5.7 Company Employee Stock Purchase Plans.

(a) The Company shall take such actions as are necessary to cause the
Purchase Date (as such term is used in the Company ESPP) applicable to the
then current offering period (as such term is used in the Company ESPP) to
be the last trading day on which the Company Common Stock is traded on the
Nasdaq National Market immediately prior to the Effective Time (the "Final
Company Purchase Date"); provided, that such change in the Purchase Date
shall be conditioned upon the consummation of the Merger. On the Final
Company Purchase Date, the Company shall apply the funds credited as of
such date under the Company ESPP within each participant's payroll
withholdings account to the purchase of whole shares of Company Common
Stock in accordance with the terms of the Company ESPP.

(b) Parent hereby consents, pursuant to Section 4.1 hereof, to the
grant of rights to purchase shares of Company Common Stock pursuant to and
in accordance with the terms of the Company ESPP and consistent with the
Company's past practices, except as otherwise contemplated by this Section
5.7.

5.8 Agreements of Affiliates. The Company has delivered to Parent, prior
to the date of this Agreement, a letter (the "Affiliate Letter") identifying all
persons who are "affiliates" of the Company for purposes of Rule 145 under the
Securities Act. The Company shall use its best efforts to cause each person who
is identified as an "affiliate" in the Affiliate Letter, or who shall be an
"affiliate" at the time of the Company Stockholders' Meeting, to deliver to
Parent, prior to the Effective Time, a written agreement (an "Affiliate
Agreement") in the form attached hereto as Exhibit A.

5.9 Notification of Certain Matters. The Company shall give prompt notice
to Parent, and Parent shall give prompt notice to the Company, of (i) the
occurrence, or non-occurrence, of any event the occurrence, or non-occurrence,
of which would be likely to cause any representation or warranty contained in
this Agreement to be untrue or inaccurate and (ii) any failure of the Company,
Parent or Merger Sub, as the case may be, to comply with or satisfy any
covenant, condition or agreement to be complied with or satisfied by it
hereunder; provided, however, that the delivery of any notice pursuant to this
Section shall not limit or otherwise affect the remedies available hereunder to
the party receiving such notice.

5.10 Further Action. Upon the terms and subject to the conditions hereof,
each of the parties hereto shall use all reasonable efforts to take, or cause to
be taken, all actions and to do, or cause to be done, all other

A-20
<PAGE> 171

things necessary, proper or advisable to consummate and make effective as
promptly as practicable the transactions contemplated by this Agreement, to
obtain in a timely manner all necessary waivers, consents and approvals and to
effect all necessary registrations and filings, and to otherwise satisfy or
cause to be satisfied all conditions precedent to its obligations under this
Agreement.

5.11 Public Announcements. Parent and the Company shall consult with each
other before issuing any press release or otherwise making any public statements
with respect to the Merger or this Agreement and shall not issue any such press
release or make any such public statement prior to such consultation, except as
may be required by applicable laws or the rules and regulations of the Nasdaq
National Market.

5.12 Nasdaq Listing. Parent shall file an additional listing application
with Nasdaq to list the shares of Parent Common Stock to be issued in the Merger
and shall use its best efforts to cause such application to be approved prior to
the Effective Time.

5.13 Director and Officer Indemnification. Parent agrees that all rights
to indemnification and advancement of expenses existing in favor of the current
and former directors and officers of the Company (the "Indemnified Parties")
under the provisions existing on the date hereof the Certificate of
Incorporation, Bylaws and indemnification agreements of the Company shall
survive the Effective Date for a period of six years thereafter and Parent
agrees to indemnify and advance expenses to the Indemnified Parties to the full
extent as would be required or permitted by the Company under the provisions
existing on the date hereof of the Certificate of Incorporation, Bylaws and
indemnification agreements of the Company. Until the third anniversary of the
Effective Time, Parent shall cause the Surviving Corporation to maintain in
effect with respect to matters occurring prior to the Effective Time, to the
extent available on reasonable economic terms, the policies of directors' and
officers' liability insurance currently maintained by the Company; provided that
the Surviving Corporation may substitute therefor policies containing coverage,
terms and conditions which are comparable.

ARTICLE VI

CONDITIONS OF MERGER

6.1 Conditions to Obligation of Each Party to Effect the Merger. The
respective obligations of each party to effect the Merger shall be subject to
the satisfaction at or prior to the Effective Time of the following conditions:

(a) Effectiveness of the Registration Statement. The Registration
Statement shall have been declared effective. No stop order suspending the
effectiveness of the Registration Statement shall have been issued by the
SEC and no proceedings for that purpose and no similar proceeding in
respect of the Proxy Statement shall, on or prior to the Effective Time,
have been initiated or, to the knowledge of Parent or the Company,
threatened by the SEC;

(b) Shareholder Approval. This Agreement and the Merger shall have
been approved and adopted by the requisite vote of the stockholders of the
Company;

(c) Nasdaq Listing. The shares of Parent Common Stock issuable to the
Company's stockholders pursuant to this Agreement shall have been
authorized for listing on the Nasdaq National Market.

(d) HSR Act. Any waiting period (and any extension thereof)
applicable to the consummation of the Merger under the HSR Act shall have
expired or been terminated;

(e) No Injunctions or Restraints; Illegality. No temporary
restraining order, preliminary or permanent injunction or other order
issued by any court of competent jurisdiction or other legal restraint or
prohibition (an "Injunction") preventing the consummation of the Merger
shall be in effect, nor shall any proceeding brought by any administrative
agency or commission or other governmental authority or instrumentality,
domestic or foreign, seeking arty of the foregoing be pending. There shall
not be any action taken, or any statute, rule, regulation or order enacted,
entered, enforced or deemed applicable to the Merger, which makes the
consummation of the Merger illegal; and

A-21
<PAGE> 172

(f) Tax Opinion. Parent and the Company shall have received written
opinions of Venture Law Group and Tomlinson Zisko Morosoli & Maser, in form
and substance reasonably satisfactory to them, to the effect that the
Merger will constitute a reorganization within the meaning of Section 368
of the Code. In rendering such opinion, counsel may rely upon
representations of the parties hereto contained herein and in certificates
of officers of Parent, the Company and others.

6.2 Additional Conditions to Obligations of Parent and Merger Sub. The
obligations of Parent and Merger Sub to effect the Merger are also subject to
the following conditions:

(a) Representations and Warranties. The representations and
warranties of the Company contained in this Agreement shall be true and
correct in all material respects on and as of the Effective Time, except
for changes contemplated by this Agreement (together with the Company
Disclosure Schedule), except that the representation contained in Section
2.8(i) shall be correct only as of the date of this Agreement (and shall
remain true and correct as of such date), and except for those
representations and warranties which address matters only as of a
particular date (which shall remain true and correct as of such date), with
the same force and effect as if made on and as of the Effective Time,
except, in all such cases, for such breaches, inaccuracies or omission of
such representations and warranties as do not have a Material Adverse
Effect, and Parent and Merger Sub shall have received a certificate to such
effect signed by the President and Chief Financial Officer of the Company;

(b) Agreements and Covenants. The Company shall have performed or
complied in all material respects with all agreements and covenants
required by this Agreement to be performed or complied with by it on or
prior to the Effective Time, and Parent and Merger Sub shall have received
a certificate to such effect signed by the President and Chief Financial
Officer of the Company;

(c) Consents Obtained. All material consents, waivers, approvals,
authorizations or orders required to be obtained, and all filings required
to be made, by the Company for the authorization, execution and delivery of
this Agreement and the consummation by it of the transactions contemplated
hereby shall have been obtained and made by the Company;

(d) Employment/Non-Compete Agreements. Parent shall have entered into
consulting or employment agreements in a form reasonably satisfactory to
Parent (which agreements shall include a covenant not to compete with
Parent) with Jerry Kirk and Kenneth E. Lonchar;

(e) Affiliate Agreements. Parent shall have received from each person
who is identified in the Affiliate Letter as an "affiliate" of the Company,
an Affiliate Agreement substantially in the form attached hereto as Exhibit
A; and

(f) Opinion of Accountants. Provided that Parent has complied with
Section 5.12 hereof, Parent and the Company shall have received an opinion
of Deloitte & Touche LLP, independent auditors, to the effect that the
Merger qualifies for a pooling of interests accounting treatment if
consummated in accordance with this Agreement, which opinion shall be
delivered before or concurrent with the execution of this Agreement.

6.3 Additional Conditions to Obligation of the Company. The obligation of
the Company to effect the Merger is also subject to the following conditions:

(a) Representations and Warranties. The representations and
warranties of Parent and Merger Sub contained in this Agreement shall be
true and correct in all material respects on and as of the Effective Time,
except for changes contemplated by this Agreement (together with the Parent
Disclosure Schedule), and except for those representations and warranties
which address matters only as of a particular date (which shall remain true
and correct as of such date), with the same force and effect as if made on
and as of the Effective Time, except, in all such cases, for such breaches,
inaccuracies or omission of such representations and warranties as do not
have a Material Adverse Effect, and the Company shall have received a
certificate to such effect signed by the President and Treasurer of Parent;

(b) Agreements and Covenants. Parent and Merger Sub shall have
performed or complied in all material respects with all agreements and
covenants required by this Agreement to be performed or

A-22
<PAGE> 173

complied with by them on or prior to the Effective Time, and the Company
shall have received a certificate to such effect signed by the President
and Treasurer of Parent;

(c) Consents Obtained. All material consents, waivers, approvals,
authorizations or orders required to be obtained, and all filings required
to be made, by Parent and Merger Sub for the authorization, execution and
delivery of this Agreement and the consummation by them of the transactions
contemplated hereby shall have been obtained and made by Parent and Merger
Sub;

(d) Opinion of Investment Banker. Lehman Brothers Inc. shall have
delivered an opinion to the Board of Directors of the Company, dated the
date of this Agreement and reaffirmed no earlier than two days prior to the
mailing of the Proxy Statement, in form reasonably satisfactory to the
Company, to the effect that the consideration to be received by the
stockholders of the Company pursuant to this Agreement is fair from a
financial point of view to such holders.

ARTICLE VII

TERMINATION, AMENDMENT AND WAIVER

7.1 Termination. This Agreement may be terminated and the Merger
contemplated hereby may be abandoned at any time prior to the Effective Time,
notwithstanding approval thereof by the stockholders of the Company:

(a) by mutual written consent duly authorized by the Boards of
Directors of Parent and the Company; or

(b) by either Parent or the Company if the Merger shall not have been
consummated by January 31, 1996; provided that the right to terminate this
Agreement under this Section 7.1(b) shall not be available to any party
whose willful failure to fulfill any material obligation under this
Agreement has been the cause of, or resulted in, the failure of the
Effective Time to occur on or before such date; or

(c) by either Parent or the Company if a court of competent
jurisdiction or governmental, regulatory or administrative agency or
commission shall have issued an order, decree or ruling or taken any other
action, in each case having the effect of permanently restraining,
enjoining or otherwise prohibiting the Merger; or

(d) by Parent or the Company, if, at the Company Stockholders' Meeting
(including any adjournment or postponement thereof), the requisite vote of
the stockholders of the Company shall not have been obtained; or

(e) by the Company if prior to the consummation of the Merger, (i) the
Company receives a bona fide written Company Transaction Proposal from a
third party, (ii) the Board of Directors of the Company determines in good
faith pursuant to Section 4.2 that such Company Transaction Proposal is a
Superior Company Proposal and (iii) the Company has provided Parent with at
least five business days' written notice of such Company Transaction
Proposal, including a copy thereof, and of the determination of its Board
of Directors referred to in clause (ii) above; provided, however, that a
condition to the effectiveness of the termination of this Agreement and the
abandonment of the Merger pursuant to this subsection 7.1(e) is the payment
to Parent in same day funds of the sum of Five Million Dollars ($5,000,000)
(the "Termination Fee"); or

(f) by Parent, if neither Parent nor Merger Sub is in material breach
of its obligations under this Agreement, and if (A) there has been a breach
by the Company of any of its representations and warranties hereunder such
that Section 6.2(a) will not be satisfied or (B)there has been the willful
breach on the part of the Company of any of its covenants or agreements
contained in this Agreement such that Section 6.2(b) will not be satisfied,
and, in both case (A) and case (B), such breach has not been promptly cured
after notice to the Company; or

(g) by the Company, if it is not in material breach of its obligations
under this Agreement, and if (A)there has been a breach by Parent or Merger
Sub of any of their respective representations and

A-23
<PAGE> 174

warranties hereunder such that Section 6.3(a) will not be satisfied or (B)
there has been the willful breach on the part of Parent or Merger Sub of
any of their respective covenants or agreements contained in this Agreement
such that Section 6.3(b) will not be satisfied, and, in both case (A) and
case (B), such breach has not been promptly cured after notice to Parent
and Merger Sub.

(h) by Parent for any reason other than as provided in subsections
7.1(a), (b), (c), (d) or (f) upon payment by Parent to the Company, as
liquidated damages for breach of this Agreement, the amount of the
Termination Fee, in same day funds. The parties agree that such amount is a
reasonable sum considering all the circumstances existing on the date of
this Agreement, including the relationship of the sum to the range of harm
to the Company that reasonably could be anticipated and the anticipation
that proof of actual damages would be costly or inconvenient.

The power of termination provided for by this Section 7.1 may be exercised
for Parent or the Company only by their respective Boards of Directors and will
be effective only after written notice thereof, signed on behalf of the party
for which it is given by its Chairman of the Board, President or other duly
authorized officer, shall have been given to the other. If this Agreement is
terminated in accordance with this Section 7.1, the Merger shall be abandoned
without further action by Parent or the Company.

7.2 Liquidated Damages. In the event that the Company terminates this
Agreement as a result of Parent's continued breach of the Agreement pursuant to
Section 7.1(g) hereof, then Parent shall pay to the Company an amount equal to
the Termination Fee as liquidated damages. The parties agree that such amount is
a reasonable sum considering all the circumstances existing on the date of this
Agreement, including the relationship of the sum to the range of harm to the
Company that reasonably could be anticipated and the anticipation that proof of
actual damages would be costly or inconvenient.

7.3 Effect of Termination. In the event of the termination of this
Agreement pursuant to Section 7.1, this Agreement shall forthwith become void
and there shall be no liability on the part of any party hereto (i) except as
set forth in Section 7.1(e), Section 7.1(h), Section 7.2, Section 7.4 and
Section 8.1 hereof and (ii) except as set forth in clause (i) of this Section
7.3, notwithstanding anything to the contrary contained in this Agreement,
neither Parent nor the Company shall be relieved of or released from any
liabilities or damages arising out of any breach of any provision of this
Agreement.

7.4 Fees and Expenses. Except as set forth in Section 7.1(e), 7.1(h),
Section 7.2 and this Section 7.4, all fees and expenses incurred in connection
with this Agreement and the transactions contemplated hereby shall be paid by
the party incurring such expenses, whether or not the Merger is consummated;
provided, however, that Parent and the Company shall share equally all fees and
expenses, other than attorneys' fees, incurred in relation to the printing and
filing of the Proxy Statement (including any preliminary materials related
thereto) and the Registration Statement (including financial statements and
exhibits) and any amendments or supplements thereto.

7.5 Amendment. This Agreement may be amended by the parties hereto by
action taken by or on behalf of their respective Boards of Directors at any time
prior to the Effective Time; provided, however, that, after approval of the
Merger by the stockholders of the Company, no amendment may be made which would
reduce the amount or change the type of consideration into which each share of
Company Common Stock shall be converted upon consummation of the Merger. This
Agreement may not be amended except by an instrument in writing signed by the
parties hereto.

7.6 Waiver. At any time prior to the Effective Time, any party hereto may
(a) extend the time for the performance of any of the obligations or other acts
required hereunder, (b) waive any inaccuracies in the representations and
warranties contained herein or in any document delivered pursuant hereto and (c)
waive compliance with any of the agreements or conditions contained herein, in
the case of each of subsections (a), (b) and (c), by or of the other parties
hereto. Any such extension or waiver shall be valid if set forth in an
instrument in writing signed by the party or parties to be bound thereby.

A-24
<PAGE> 175

ARTICLE VIII

GENERAL PROVISIONS

8.1 Non-Survival of Representations, Warranties and Agreements. The
representations, warranties and agreements in this Agreement shall terminate at
the Effective Time or upon the termination of this Agreement pursuant to Section
7.1, as the case may be, except that the agreements set forth in Article I,
Section 5.5, Section 5.6 and Section 5.13, shall survive the Effective Time
indefinitely and those set forth in Section 5.3(b) and 7.2 shall survive
termination indefinitely.

8.2 Notices. All notices and other communications given or made pursuant
hereto shall be in writing and shall be deemed to have been duly given or made
as of the date delivered or mailed if delivered personally, by fax or mailed by
registered or certified mail (postage prepaid, return receipt requested) to the
parties at the following addresses (or at such other address for a party as
shall be specified by like changes of address shall be effective upon receipt):

(a) If to Parent or Merger Sub:

Mentor Graphics Corporation
8005 S.W. Boeckman Road
Wilsonville, OR 97070-7777
Facsimile Number: (503) 685-1485
Attention: Vice President and General Counsel

With a copy to:

Venture Law Group
2800 Sand Hill Road
Menlo Park, CA 94025
Facsimile Number: (415) 854-1121
Attention: Craig W. Johnson

(b) If to the Company:

Microtec Research, Inc.
2350 Mission College Boulevard
Santa Clara, CA 95054
Facsimile Number: (408) 982-8266
Attention: President

With a copy to:

Tomlinson Zisko Morosoli & Maser
200 Page Mill Road
Second Floor
Palo Alto, CA 94306
Facsimile Number: (415) 324-1808
Attention: Timothy Tomlinson

8.3 Certain Definitions. For purposes of this Agreement, the term:

(a) "affiliates" means a person that directly or indirectly, through
one or more intermediaries, controls, is controlled by, or is under common
control with, the first mentioned person;

(b) "beneficial owner" with respect to any shares of Company Common
Stock, means a person who shall be deemed to be the beneficial owner of
such shares (i) which such person or any of its affiliates or associates
beneficially owns, directly or indirectly, (ii) which such person or any of
its affiliates or associates (as such term is defined in Rule 12b-2 of the
Exchange Act) has, directly or indirectly, (A) the right to acquire
(whether such right is exercisable immediately or subject only to the
passage of time), pursuant to any agreement, arrangement or understanding
or upon the exercise of consideration

A-25
<PAGE> 176

rights, exchange rights, warrants or options. or otherwise, or (B) the
right to vote pursuant to any agreement, arrangement or understanding or
(iii) which are beneficially owned, directly or indirectly, by any other
persons with whom such person or any of its affiliates or person with whom
such person or any of its affiliates or associates has any agreement,
arrangement or understanding for the purpose of acquiring, holding, voting
or disposing of any shares;

(c) "business day" means any day other than a day on which banks in
Oregon or California are required or authorized to be closed;

(d) "control" (including the terms "controlled by" and "under common
control with") means the possession, directly or indirectly or as trustee
or executor, of the power to direct or cause the direction of the
management or policies of a person, whether through the ownership of stock,
as trustee or executor, by contract or credit arrangement or otherwise;

(e) "person" means an individual, corporation, partnership,
association, trust, unincorporated organization, other entity or group (as
defined in Section 13(d)(3) of the Exchange Act); and

(f) "subsidiary" or "subsidiaries" of the Company, the Surviving
Corporation, Parent or any other person means any corporation, partnership,
joint venture or other legal entity of which the Company, the Surviving
Corporation, Parent or such other person, as the case may be, (either alone
or through or together with any other subsidiary) owns, directly or
indirectly, more than 50% of the stock or other equity interests the
holders of which are generally entitled to vote for the election of the
board of directors or other governing body of such corporation or other
legal entity.

8.4 Headings. The headings continued in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.

8.5 Severability. If any term or other provision of this Agreement is
invalid, illegal or incapable of being enforced by any rule of law, or public
policy, all other conditions and provisions of this Agreement shall nevertheless
remain in full force and effect so long as the economic or legal substance of
the transactions contemplated hereby is not affected in any manner adverse to
any party. Upon such determination that any term or other provision is invalid,
illegal or incapable of being enforced, the parties hereto shall negotiate in
good faith to modify this Agreement so as to effect the original intent of the
parties as closely as possible in an acceptable manner to the end that
transactions contemplated hereby are fulfilled to the extent possible.

8.6 Entire Agreement. This Agreement, together with the Disclosure
Schedules, exhibits and schedules hereto, constitutes the entire agreement and
supersedes all prior agreements and undertakings (other than the Confidentiality
Agreement), both written and oral, among the parties, or any of them, with
respect to the subject matter hereof and, except as otherwise expressly provided
herein, are not intended to confer upon any other person any rights or remedies
hereunder.

8.7 Assignment. This Agreement shall not be assigned by operation of law
or otherwise, except that Merger Sub may assign all or any of its rights
hereunder to any wholly owned nonoperating subsidiary of Parent provided that no
such assignment shall relieve the assigning party of its obligations hereunder.

8.8 Parties in Interest. This Agreement shall be binding upon and inure
solely to the benefit of each party hereto, and nothing in this Agreement,
express or implied, is intended to or shall confer upon any other person any
right, benefit or remedy of any nature whatsoever under or by reason of this
Agreement.

8.9 Governing Law. This Agreement shall governed by, and construed in
accordance with, the laws of the State of Delaware.

8.10 Counterparts. This Agreement may be executed in one or more
counterparts, and by the different parties hereto in separate counterparts, each
of which when executed shall be deemed to be an original but all of which taken
together shall constitute one and the same agreement.

A-26
<PAGE> 177

IN WITNESS WHEREOF, Parent, Merger Sub and the Company have caused this
Agreement to be executed as of the date first written above by their respective
officers thereunto duly authorized.

MENTOR GRAPHICS CORPORATION

By: /s/ WALDEN C. RHINES

------------------------------------
Walden C. Rhines
President and Chief Executive
Officer

M ACQUISITION SUB, INC.

By: /s/ WALDEN C. RHINES

------------------------------------
Walden C. Rhines
President

MICROTEC RESEARCH, INC.

By: /s/ JERRY KIRK

------------------------------------
Jerry Kirk
Chairman of the Board, President and
Chief Executive Officer

A-27
<PAGE> 178

EXHIBIT A

AFFILIATE AGREEMENT
, 1995

Mentor Graphics Corporation
8005 S.W. Boeckman Road
Wilsonville, OR 97070-7777

Gentlemen:

Pursuant to the terms of the Agreement and Plan of Merger dated as of
October 9, 1995 (the "Merger Agreement"), among Mentor Graphics Corporation, an
Oregon corporation ("Parent"), M Acquisition Sub, Inc., a Delaware corporation
and wholly owned subsidiary of Parent ("Merger Sub"), and Microtec Research,
Inc., a Delaware corporation (the "Company"), Parent will acquire the Company
through the merger of Merger Sub with and into the Company (the "Merger").
Subject to the terms and conditions of the Merger Agreement, at the Effective
Time (as defined in the Merger Agreement), outstanding shares of the common
stock, par value $.001 per share, of the Company (the "Company Common Stock")
will be converted into the right to receive shares of the common stock, no par
value, of Parent (the "Parent Common Stock") on the basis described in the
Merger Agreement. The Merger is intended to qualify as a "reorganization" under
the provisions of Section 368(a) of the Internal Revenue Code of 1986, as
amended.

The undersigned has been advised that as of the date hereof it may be
deemed to be (but does not hereby admit to be) an "affiliate" of the Company, as
the term "affiliate" is (i) defined for purposes of paragraphs (c) and (d) of
Rule 145 of the Rules and Regulations (the "Rules and Regulations") of the
Securities and Exchange Commission (the "Commission") under the Securities Act
of 1933, as amended (the "Act"), and/or used in and for purposes of Accounting
Series Releases 130 and 135, as amended, of the Commission.

The undersigned understands that the representations, warranties and
covenants set forth herein will be relied upon by Parent, stockholders of
Parent, the Company, other stockholders of the Company and their respective
counsel and accounting firms.

The undersigned represents and warrants to and agrees with Parent that:

1. The undersigned has full power to execute and deliver this Affiliate
Agreement and to make the representations and warranties herein and to perform
its obligations hereunder.

2. The undersigned has carefully read this letter and the Merger Agreement
and discussed its requirements and other applicable limitations upon its ability
to sell, transfer or otherwise dispose of Parent Common Stock to the extent the
undersigned felt necessary, with its counsel or with counsel for the Company.

3. The undersigned shall not make any sale, transfer or other disposition
of Parent Common Stock in violation of the Act or the Rules and Regulations.

4. The undersigned has been advised that the issuance of shares of Parent
Common Stock to the undersigned in connection with the Merger has been or will
be registered with the Commission under the Act on a Registration Statement on
Form S-4. However, the undersigned has also been advised that, since, at the
time the Merger was submitted for a vote of the stockholders of the Company the
undersigned may be deemed to have been an affiliate of the Company and the
distribution by the undersigned of any Parent Common Stock has not been
registered under the Act, the undersigned may not sell, transfer or otherwise
dispose of Parent Common Stock issued to the undersigned in the Merger unless
(i) such sale, transfer or other disposition has been registered under the Act,
(ii) such sale, transfer or other disposition is made in conformity with the
requirements of Rule 145 promulgated by the Commission under the Act, or (iii)
in the opinion of counsel reasonably acceptable to Parent, such sale, transfer
or other disposition is otherwise exempt from registration under the Act.

5. Parent is under no obligation to register the sale, transfer or other
disposition of Parent Common Stock by the undersigned or on its behalf under the
Act or to take any other action necessary in order to make

A-28
<PAGE> 179

compliance with an exemption from such registration available. Parent agrees
that it shall make available adequate current public information as required by
Rule 144(c) promulgated by the Commission under the Act.

6. Stop transfer instructions will be given to Parent's transfer agents
with respect to the Parent Common Stock and that there will be placed on the
certificates for the Parent Common Stock issued to the undersigned, or any
substitutions therefor, a legend stating in substance:

"The shares represented by this certificate were issued in a transaction to
which Rule 145 promulgated under the Securities Act of 1933 applies. The shares
represented by this certificate may only be transferred in accordance with the
terms of an agreement dated October 9, 1995, between the registered holder
hereof and Parent, a copy of which agreement is on file at the principal offices
of Parent."

7. Unless the transfer by the undersigned of its Parent Common Stock has
been registered under the Act or is a sale made in conformity with the
provisions of Rule 145, Parent reserves the right to put the following legend on
the certificates issued any transferee of the undersigned:

"The shares represented by this certificate have not been registered under
the Securities Act of 1933 and were acquired from a person who received such
shares in a transaction to which Rule 145 promulgated under the Securities Act
of 1933 applies. The shares have been acquired by the holder not with a view to,
or for resale in connection with, any distribution thereof within the meaning of
the Securities Act of 1933 and may not be sold, pledged or otherwise transferred
except in accordance with an exemption from the registration requirements of the
Securities Act of 1933."

8. The legends set forth in paragraphs 6 and 7 above shall be removed by
delivery of substitute certificates without such legend if the undersigned shall
have delivered to Parent a copy of a letter from the staff of the Commission, or
an opinion of counsel in form and substance reasonably satisfactory to Parent,
to the effect that such legend is not required for purposes of the Act.

9. The undersigned is the beneficial owner of (has sole or shared voting or
investment power with respect to) all the shares of Company Common Stock,
options to purchase Company Common Stock indicated on the last page hereof (the
"Company Securities"). Except for the Company Securities, the undersigned does
not beneficially own any shares of Company Common Stock or any other equity
securities of the Company or any options, warrants or other rights to acquire
any equity securities of the Company.

10. Continuity of Interest. The undersigned has, and at all times from the
date hereof to the Effective Time will have, no present plan or intent to engage
in a sale, exchange, transfer, pledge, redemption, disposition or any other
transaction (including a distribution by a partnership to its partners or by a
corporation to its shareholders) that results in a reduction in the risk of
ownership (collectively, a "Sale") of more than 25% of the Parent Common Stock
to be acquired by the undersigned upon consummation of the Merger. The
undersigned is not aware of, nor participating in, any plan or intent on the
part of the Company shareholders (a "Plan") to engage in Sales of Parent Common
Stock to be issued in the Merger that will reduce the Company shareholders'
ownership of Parent Common Stock to a number of shares having an aggregate fair
market value, as of the Effective Time, of less than fifty percent (50%) of the
aggregate fair market value of all shares of outstanding Company Common Stock
immediately prior to the Merger. A Sale of Company Common Stock will be
considered to have occurred pursuant to a Plan if such Sale occurs in a
transaction that is in contemplation of, or related or pursuant to, the Merger
Agreement (a "Related Transaction"). In addition, shares of Company Common Stock
(i) exchanged for cash in lieu of fractional shares of Company Common Stock and
(ii) with respect to which a Sale occurred in a Related Transaction prior to or
after the Merger will be considered to have been shares of outstanding Company
Common Stock that were exchanged for Parent Common Stock in the Merger and then
disposed of pursuant to a Plan. If any of the undersigned's representations and
covenants in this paragraph 10 ceases to be true at any time prior to the
Effective Time, the undersigned will deliver to each of Company and Parent,
prior to the Effective Time, a written statement to that effect. Except as
indicated on the last page hereof, the undersigned Shareholder has not engaged
in a

A-29
<PAGE> 180

sale of any shares of Company Common Stock since July 1, 1995. The undersigned
Shareholder understands and acknowledges that Company, Parent and their
respective shareholders and stockholders, as well as legal counsel (in
connection with rendering an opinion that the Merger will qualify as a
"reorganization" described in Section 368(a) of the Code), are entitled to rely
on (i) the truth and accuracy of the undersigned Shareholder's representations
and covenants herein and (ii) the undersigned Shareholder's performance of the
obligations set forth herein.

11. Notwithstanding any other provision hereof to the contrary, during the
30-day period immediately preceding the Effective Time (as defined in the
Agreement), the undersigned has not or will not, and after the Effective Time
until such time as results covering at least 30 days of combined operations of
the Company and Parent have been published by Parent, in the form of a quarterly
earnings report, an effective registration statement filed with the Commission,
a report to the Commission on Form 10-K, 10-Q or 8-K, or any other public filing
or announcement which includes the combined results of operations, the
undersigned will not sell, transfer or otherwise dispose of, or offer or agree
to sell, transfer or otherwise dispose of, or in any other way reduce the risk
of the undersigned's risk of ownership of or investment in, any of the
following:

(a) any shares of Parent Common Stock which the undersigned may
acquire in connection with the Merger, or any securities which may be paid
as a dividend or otherwise distributed thereon or with respect thereto or
issued or delivered in exchange or substitution therefore (all such shares
and other securities being referred to herein, collectively, as "Restricted
Securities"), or any option, right or other interest with respect to any
Restricted Securities;

(b) any Company Securities; or

(c) any shares of Company Common Stock or other Company equity
securities which the undersigned purchases or otherwise acquires after the
execution of this Affiliate Agreement.

12. As promptly as practicable following the Merger, Parent shall publish
results covering at least 30 days of combined operations of the Company and
Parent in the form of a quarterly earnings report, an effective registration
statement filed with the Commission, a report to the Commission on Form 10-K,
10-Q or 8-K, or any other public filing or announcement which includes the
combined results of operations; provided, however, that Parent shall be under no
obligation to publish any such financial information other than with respect to
a fiscal quarter of Parent.

A-30
<PAGE> 181

NUMBER OF SHARES OF COMPANY COMMON STOCK
BENEFICIALLY OWNED BY THE UNDERSIGNED:
------------------------

NUMBER OF SHARES OF COMPANY COMMON STOCK SUBJECT TO
OPTIONS BENEFICIALLY OWNED BY THE UNDERSIGNED:
------------------------

SALES OF COMPANY COMMON STOCK BY THE UNDERSIGNED SINCE JULY 1, 1995 ____ :
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

Very truly yours,

--------------------------------------
(print name of stockholder above)

By:

------------------------------------

Title:

-----------------------------------
(if applicable)

Accepted this ____ day
of ______________ , 1995,
by:

MENTOR GRAPHICS CORPORATION

By:

--------------------------------------------------------

Name:

-------------------------------------------------------

Title:

--------------------------------------------------------

A-31
<PAGE> 182

AMENDMENT TO AGREEMENT AND PLAN OF MERGER

THIS AMENDMENT TO THE AGREEMENT AND PLAN OF MERGER (the "AMENDMENT") is
entered into as of November 6, 1995, by and among Microtec Research, Inc., a
Delaware corporation ("MRI"), Mentor Graphics Corporation, an Oregon corporation
("PARENT") and M Acquisition Sub, Inc., a Delaware corporation and a wholly
owned subsidiary of Parent ("MERGER SUB") to amend that certain Agreement and
Plan of Merger entered into as of October 9, 1995 by and among MRI, Parent and
Merger Sub (the "MERGER AGREEMENT"). Capitalized terms used in this Amendment
and not otherwise defined herein shall have the respective meanings assigned to
them in the Merger Agreement.

RECITALS

A. Pursuant to the Merger Agreement, Merger Sub will merge into and with
MRI and MRI will be the surviving corporation.

B. Pursuant to Article VII, Section 7.5, the Merger Agreement may be
amended by or on behalf of the respective Boards of Directors by a writing
signed by the parties to the Merger Agreement.

C. In accordance with Article VII, Section 7.2 of the Merger Agreement, in
the event that Parent is in continuing breach of certain obligations set forth
in the Merger Agreement, MRI has the option to terminate the Merger Agreement
upon Parent's failure to promptly cure such breach after notice of the breach
from MRI. Parent must pay to MRI an amount equal to the Termination Fee of Five
Million Dollars ($5,000,000) as liquidated damages for such breach and resulting
termination.

D. In connection with the Merger Agreement and pending Merger, the parties
desire to increase the amount payable pursuant to Article VII, Section 7.2 by
Parent to MRI as liquidated damages from an amount equal to the Termination Fee
of Five Million Dollars ($5,000,000) to Ten Million Dollars ($10,000,000), and
in consideration of the increase in liquidated damages, MRI will reasonably
cooperate in certain transition planning, including making its employees
reasonably available for consultations with Parent and making office space and
administrative support available on a reasonable basis for certain Parent
employees engaged in the transition effort.

AMENDMENT

NOW, THEREFORE, in reliance on the foregoing recitals and for valuable
consideration, the receipt and sufficiency of which are hereby acknowledged,
MRI, Parent and Merger Sub do hereby consent and agree as follows:

1. Article VII, Section 7.2 is amended to increase the liquidated damages
payable by Parent to MRI for certain continuing breaches of the Merger Agreement
from an amount equal to the Termination Fee to Ten Million Dollars
($10,000,000), which amount is a reasonable sum considering all the
circumstances existing on the date of this Amendment, including the relationship
of the sum to the range of harm to MRI that reasonably could be anticipated and
the anticipation that proof of actual damages would be costly or inconvenient.

2. MRI will reasonably cooperate in certain transition planning, including
making its employees reasonably available for consultations with Parent and
making office space and administrative support available on a reasonable basis
for certain Parent employees engaged in the transition effort.

3. Except as expressly amended herein, the terms and conditions of the
Merger Agreement shall remain in full force and effect.

A-32
<PAGE> 183

Microtec Research, Inc.
Amendment to Agreement and Plan of Merger
Page 2

4. This Amendment may be executed in any number of counterparts, each of
which shall be an original as against any party whose signature appears thereon
and all of which together shall constitute one and the same instrument.

IN WITNESS WHEREOF, MRI, Parent and Merger Sub have executed this Amendment
as of the date first hereinabove written.

MICROTEC RESEARCH, INC.

By: /s/ JERRY KIRK

------------------------------------
Jerry Kirk
Chairman of the Board, President
and Chief Executive Officer

MENTOR GRAPHICS CORPORATION

By: /s/ WALDEN C. RHINES

------------------------------------
Walden C. Rhines
President and Chief Executive
Officer

M ACQUISITION SUB, INC.

By: /s/ WALDEN C. RHINES

------------------------------------
Walden C. Rhines
President

A-33
<PAGE> 184

ANNEX B

OPINION OF LEHMAN BROTHERS, INC.

October 9, 1995

Board of Directors
Microtec Research, Inc.
2350 Mission College Boulevard
Santa Clara, CA 95054

Attention: Mr. Jerry Kirk
Chairman and Chief Executive Officer

Members of the Board:

We understand that Microtec Research, Inc. ("Microtec" or the "Company")
intends to merge with M Acquisition Sub, Inc. ("MAS"), a wholly-owned subsidiary
of Mentor Graphics Corporation ("Mentor"), whereby Microtec shall continue as
the surviving corporation and become a wholly-owned subsidiary of Mentor (the
"Proposed Merger"). In the Proposed Merger, each outstanding share of Microtec
stock will be exchanged for 0.69307 shares of Mentor common stock (the
"Conversion Ratio"). In addition, each outstanding option to purchase Microtec
common stock will be converted to an option to purchase shares of Mentor common
stock based upon the Conversion Ratio. The terms and conditions of the Proposed
Merger are set forth in more detail in the Agreement and Plan of Merger by and
among Microtec, MAS and Mentor dated as of October 9, 1995 (the "Merger
Agreement").

We have been requested by the Board of Directors of the Company to render
our opinion with respect to the fairness, from a financial point of view, to the
Company's stockholders of the Conversion Ratio to be offered to such
stockholders in the Proposed Merger. We have not been requested to opine as to,
and our opinion does not in any manner address, the Company's underlying
business decision to proceed with or effect the Proposed Transaction.

In arriving at our opinion, we reviewed and analyzed: (1) the Merger
Agreement, (2) such publicly available information concerning the Company and
Mentor which we believe to be relevant to our inquiry, (3) financial and
operating information with respect to the business, operations and prospects of
the Company furnished to us by the Company, (4) financial and operating
information with respect to the business, operations and prospects of Mentor
furnished to us by Mentor, (5) a trading history of the Company's common stock
and a comparison of that trading history with those of other companies which we
deemed relevant, (6) a trading history of Mentor's common stock and a comparison
of that trading history with those of other companies which we deemed relevant,
(7) a comparison of the historical financial results and present financial
condition of the Company with those of other companies which we deemed relevant,
(8) a comparison of the historical financial results and present financial
condition of Mentor with those of other companies which we deemed relevant, (9)
a comparison of the financial terms of the Proposed Merger with the financial
terms of certain other recent transactions which we deemed relevant, and (10)
the potential pro forma earnings per share impact of the Proposed Merger on
Mentor's earnings. In addition, we have had discussions with the managements of
the Company and Mentor concerning their respective businesses, operations,
assets, financial conditions and prospects, and undertook such other studies,
analyses and investigations as we deemed appropriate.

In arriving at our opinion, we have assumed and relied upon the accuracy
and completeness of the financial and other information used by us without
assuming any responsibility for independent verification of such information and
have further relied upon the assurances of management of the Company that they
are not aware of any facts that would make such information inaccurate or
misleading. With respect to the

B-1
<PAGE> 185

Microtec Research, Inc.
October 9, 1995
Page 2

financial forecasts of the Company and Mentor, upon advice of the Company we
have assumed that such forecasts have been reasonably prepared on a basis
reflecting the best currently available estimates and judgments of the
respective managements of the Company and Mentor as to the future financial
performance of the Company and Mentor, as the case may be, and that the Company
and Mentor will perform in accordance with such forecasts. In arriving at our
opinion, we have not conducted a physical inspection of the properties and
facilities of the Company or Mentor and have not made nor obtained any
evaluations or appraisals of the assets or liabilities of the Company or Mentor.
In addition, you have not authorized us to solicit, and we have not solicited,
any indications of interest from any third party with respect to the purchase of
all or a part of the Company's business. Our opinion is necessarily based upon
market, economic and other conditions as they exist on, and can be evaluated as
of, the date of this letter.

Based upon and subject to the foregoing, we are of the opinion as of the
date hereof that, from a financial point of view, the Conversion Ratio to be
offered to the stockholders of the Company in the Proposed Merger is fair to
such stockholders.

The Company has agreed to pay us a fee in connection with the delivery of
this opinion and to indemnify us for certain liabilities which may arise out of
the rendering of this opinion. We also have performed various investment banking
services for the Company in the past and have received customary fees for such
services. In the ordinary course of our business, we may actively trade in the
equity securities of the Company and Mentor for our own account and for the
accounts of our customers and, accordingly, may at any time hold a long or short
position in such securities.

This opinion is for the use and benefit of the Board of Directors of the
Company. This opinion is not intended to be and does not constitute a
recommendation to any stockholder of the Company as to how such stockholder
should vote with respect to the Proposed Merger.

Very truly yours,

LEHMAN BROTHERS

B-2
<PAGE> 186

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 20. INDEMNIFICATION OF OFFICERS AND DIRECTORS

The Restated Certificate of Incorporation of the Registrant provides that a
director of the Registrant, to the full extent permitted by the Oregon Business
Corporation Act shall not be liable to the Registrant or its stockholders for
monetary damages for breach of fiduciary duty as a director.

Article V of the Registrant's Bylaws provides for the indemnification of
officers, directors, employees and agents of the Registrant. The Bylaws provide
that the Registrant shall indemnify its directors, officers, employees and
agents against expenses, judgments, fines and amounts paid in settlement
actually and reasonably incurred by them in connection with any threatened,
pending, or completed action, suit or proceeding (other than an action by or in
the right of the corporation), if they acted in good faith and in a manner they
reasonably believe to be in or not opposed to the best interest of the
corporation, was not adjudged liable on the basis of receipt of an improper
personal benefit, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe the conduct was unlawful. In relation to a
proceeding by or in the right of the Registrant, a director, officer, employee
or agent shall be indemnified against expenses actually and reasonably incurred
in connection with the defense or settlement of such proceeding if the director,
officer, employee or agent acted in good faith and in a manner he or she
reasonably believed to be in or not opposed to the best interests of the
corporation, except that no indemnification shall be made in respect of any
claim, issue or matter as to which such person shall have been adjudged to be
liable to the corporation. The Bylaws also provide that expenses incurred by a
director or officer may be advanced by the Registrant upon receipt of a written
affirmation of such director or officer's good faith belief that he or she is
entitled to be indemnified by the corporation and an undertaking by or on behalf
of the director or officer to repay such amount to the extent it shall
ultimately be determined that he or she is not entitled to be indemnified by the
Registrant. The Registrant may also obtain insurance for the protection of its
directors and officers against any liability asserted against them in their
official capacities.

The rights of indemnification described above are not exclusive of any
other rights of indemnification to which the persons indemnified may be entitled
under any bylaw, agreement, vote of stockholders or directors, or otherwise.

The Registrant has also entered into Indemnity Agreements with all
directors and officers. While the Indemnity Agreements in large part incorporate
the indemnification provisions of the Oregon Business Corporation Act ("the
Act") as described above, they vary from the Act in several respects. The
Indemnity Agreements obligate the Registrant to provide the maximum
indemnification protection allowed under Oregon law, which is intended to
provide indemnification broader than that expressly authorized by the Act. The
most significant effect of the Indemnity Agreements is to add indemnification
for judgments and settlements of derivative lawsuits to the fullest extent
permitted by law as may be limited by public policy considerations applied by
the courts.

ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(A) EXHIBITS

The following exhibits are filed herewith or incorporated herein by
reference.

<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION FOOTNOTE
- ------ --------------------------------------------------------------------- --------
<C> <C> <S> <C>
2.1 -- Agreement and Plan of Merger, dated as of October 9, 1995 as amended
November 6, 1995, among the Registrant, M Acquisition Sub, Inc. and
Microtec Research, Inc. (included as Annex A to the Proxy
Statement/Prospectus included as part of this Registration
Statement).
*2.2 -- Form of Certificate of Merger between M Acquisition Sub, Inc. and
Microtec Research, Inc.
3.1 (1) -- Restated Articles of Incorporation of the Registrant, as amended.
3.2 (2) -- Bylaws of the Registrant.
*5.1 -- Opinion of Venture Law Group, A Professional Corporation, as to the
legality of the Registrant's Common Stock being registered hereby.
8.1 -- Form of tax opinion of Venture Law Group, A Professional Corporation,
together with Exhibits.
</TABLE>

II-1
<PAGE> 187

<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION FOOTNOTE
- ------ --------------------------------------------------------------------- --------
<C> <C> <S> <C>
</TABLE>

<TABLE>
<C> <C> <S> <C>
8.2 -- Form of tax opinion of Tomlinson Zisko Morosoli & Maser, together
with Exhibits.
10.1 (3) -- 1982 Stock Option Plan.
10.2 (4) -- Nonqualified Stock Option Plan.
10.3 (5) -- 1986 Stock Plan.
10.4 (6) -- 1987 Non-Employee Directors' Stock Option Plan.
10.5 (7) -- Stock Option Agreement under the 1986 Stock Plan dated October 15,
1993 between the Registrant and Walden C. Rhines.
10.6 (8) -- Employment Agreement dated July 7, 1993, as amended July 5, 1994,
between the Registrant and R. Douglas Norby.
10.7 (9) -- Form of Indemnity Agreement entered into between the Registrant and
each of its officers and directors.
10.8 (10) -- Lease dated November 20, 1991, for 999 Ridder Park Drive and 1051
Ridder Park Drive, San Jose, California.
10.9 (11) -- Amended and Restated Loan Agreement between the Registrant and First
Interstate Bank of Oregon, N.A. dated December 31, 1992, as amended.
21.1 (12) -- Subsidiaries of the Registrant.
*23.1 -- Consent of Venture Law Group, A Professional Corporation, with
respect to the legality of securities being registered (contained in
Exhibit 5.1).
23.2 -- Consent of Venture Law Group, A Professional Corporation, with
respect to certain tax matters (contained in Exhibit 8.1).
23.3 -- Consent of Tomlinson Zisko Morosoli & Maser, with respect to certain
tax matters (contained in Exhibit 8.2)...............................
23.4 -- Consent of KPMG Peat Marwick LLP, Independent Auditors, with respect
to financial statements of the Registrant.
23.5 -- Consent of Deloitte & Touche LLP, Independent Auditors, with respect
to financial statements of Microtec.
*23.6 -- Consent of Lehman Brothers with respect to its fairness opinion.
*24.1 -- Power of Attorney.
*99.1 -- Voting Agreement, dated as of October 9, 1995, among the Registrant,
Microtec and Jerry Kirk.
*99.2 -- Consultant Services Agreement, dated October 9, 1995, between the
Registrant and Jerry Kirk, together with the Agreement Re Stock
Option, dated October 9, 1995, between the Registrant and Jerry Kirk,
the Assignment and Assumption of Contract, dated November 6, 1995,
between Microsystem Services, Inc. and Jerry Kirk, and the Guaranty,
dated November 6, 1995, between the Registrant and Jerry Kirk,
relating to the Consultant Services Agreement.
*99.3 -- Form of Proxy Card.
</TABLE>

(B) FINANCIAL STATEMENT SCHEDULE

The following schedule is filed herewith.

<TABLE>
<C> <S> <C>
II. Valuation and Qualifying Accounts
</TABLE>

Other financial statement schedules have been omitted since they are either
not required, not applicable, or the required information is shown in the
Consolidated Financial Statements or notes thereto.
- ---------------
* Previously filed with the Commission.

(1) Incorporated by reference to Exhibit 4A to the Registrant's Registration
Statement on Form S-3 (Registration No. 33-23024).

(2) Incorporated by reference to Exhibit 4B to the Registrant's Registration
Statement on Form S-3 (Registration No. 33-56759).

(3) Incorporated by reference to Exhibit 10A to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1994 (the "1994 Form
10-K").

(4) Incorporated by reference to Exhibit 10B to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1989 (the "1989 Form
10-K").

(5) Incorporated by reference to Exhibit 10C to the Registrant's 1989 Form
10-K.

II-2
<PAGE> 188

(6) Incorporated by reference to Exhibit 10D to the Registrant's 1994 Form
10-K.

(7) Incorporated by reference to Exhibit 10E to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.

(8) Incorporated by reference to Exhibit 10F to the Registrant's 1994 Form
10-K.

(9) Incorporated by reference to Exhibit B to the Registrant's 1987 Proxy
Statement.

(10) Incorporated by reference to Exhibit 10M to the Registrant's Form SE dated
March 25, 1992.

(11) Incorporated by reference to Exhibit 10J to the Registrant's Form SE dated
March 25, 1993.

(12) Incorporated by reference to Exhibit 21 to the Registrant's 1994 Form 10-K.

ITEM 22. UNDERTAKINGS

A. The undersigned registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:

(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;

(ii) To reflect in the prospectus any facts or events arising after
the effective date of the Registration Statement (or most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the Registration Statement; and

(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the Registration Statement
or any material change to such information in the Registration
Statement.

(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.

(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.

B. The undersigned Registrant hereby undertakes as follows: that prior to
any public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this Registration Statement by any person or party
who is deemed to be an underwriter within the meaning of Rule 145(c), the issuer
undertakes that such reoffering prospectus will contain the information called
for by the applicable registration form with respect to reofferings by persons
who may be deemed underwriters, in addition to the information called for by the
other items of the applicable form.

The Registrant undertakes that every prospectus: (i) that is filed pursuant
to the immediately preceding paragraph, or (ii) that purports to meet the
requirements of Section 10(a)(3) of the Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the Registration Statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act of 1933, as amended, each such post-effective amendment
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

C. Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the

II-3
<PAGE> 189

event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer,
or controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.

D. The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Item 4, 10(b), 11, or 13 of this form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the Registration Statement through the
date of responding to the request.

E. The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.

II-4
<PAGE> 190

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, Mentor Graphics
Corporation has duly caused this Amendment No. 2 to the Registration Statement
No. 33-63733 to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Wilsonville, State of Oregon, on December 26, 1995.

MENTOR GRAPHICS CORPORATION

By: /s/ WALDEN C. RHINES

------------------------------------
Walden C. Rhines
President and Chief Executive
Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 2 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED:

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ----------------------------------- ----------------------------------- ------------------
<S> <C> <C>
/s/ WALDEN C. RHINES Director, President and December 26, 1995
- ----------------------------------- Chief Executive Officer
Walden C. Rhines (Principal Executive Officer)
* Senior Vice President and December 26, 1995
- ----------------------------------- Chief Financial Officer
R. Douglas Norby
* Corporate Controller and December 26, 1995
- ----------------------------------- Chief Accounting Officer
James J. Luttenbacher
* Chairman of the Board of Directors December 26, 1995
- -----------------------------------
Jon A. Shirley
* Director December 26, 1995
- -----------------------------------
Marsha B. Congdon
* Director December 26, 1995
- -----------------------------------
James R. Fiebiger
* Director December 26, 1995
- -----------------------------------
Fontaine K. Richardson
</TABLE>

*By: /s/ DEAN FREED

--------------------------
Dean Freed
Attorney-in-Fact

II-5
<PAGE> 191

SCHEDULE II

MENTOR GRAPHICS CORPORATION

VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONS
CHARGED TO
BEGINNING COST & ENDING
DESCRIPTION BALANCE EXPENSES DEDUCTION BALANCE
- ------------------------------------------------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Year ended December 31, 1992:
Allowance for deferred tax assets.............. $ 0 $ 0 $ 0 $ 0
Allowance for doubtful accounts................ $ 3,736 $ 1,282 $ 642(1) $ 4,376
Allowance for obsolete inventory............... $15,639 $ 2,665 $ 5,868(2) $12,436
Accrued restructure costs...................... $10,233 $ 14,500 $ 12,463(3) $12,270
Year ended December 31, 1993:
Allowance for deferred tax assets.............. $ 0 $ 58,495(4) $ 0 $58,495
Allowance for doubtful accounts................ $ 4,376 $ 508 $ 956(1) $ 3,928
Allowance for obsolete inventory............... $12,436 $ 1,924 $ 6,346(2) $ 8,014
Accrued restructure costs...................... $12,270 $ 26,200 $ 10,096(3) $28,374
Year ended December 31, 1994:
Allowance for deferred tax assets.............. $58,495 $ 0 $ 12,282(4) $46,213
Allowance for doubtful accounts................ $ 3,928 $ 478 $ 1,559(1) $ 2,847
Allowance for obsolete inventory............... $ 8,014 $ 0 $ 7,155(2) $ 859
Accrued restructure costs...................... $28,374 $ 4,000 $ 20,477(3) $11,897
</TABLE>

- ---------------
(1) Deductions primarily represent accounts written off during the period.

(2) Deductions represent inventory scrapped during each period and
reclassification of demonstration equipment from inventory to property plan
and equipment in 1994.

(3) Deductions primarily represent payments made to carry out restructure plans
and reversals of accrued restructure charges due to changes in estimates of
$10,045, $1,400 and $1,600 for the years ended December 31, 1994, 1993 and
1992, respectively.

(4) Addition represents adoption of Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" on January 1, 1993 and increases to
the valuation allowance during the year. As such, the Company established a
valuation allowance for certain deferred tax assets, including net operating
loss and tax credit carryforwards. Statement No. 109 requires that such a
valuation allowance be recorded when it is more likely than not that some
portion of the deferred tax assets will not be realized. The deduction in
1994 primarily represents the realization of net operating loss
carryforwards for the year.

S-1
<PAGE> 192

INDEX TO EXHIBITS

The Exhibit numbers in the following list correspond to the numbers
assigned to such exhibits in Item 601 of Regulation S-K.

<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION FOOTNOTE
- ------ ----------------------------------------------------------------------- --------
<C> <C> <S> <C>
2.1 -- Agreement and Plan of Merger, dated as of October 9, 1995 as amended
November 6, 1995, among the Registrant, M Acquisition Sub, Inc. and
Microtec Research, Inc. (included as Annex A to the Proxy
Statement/Prospectus included as part of this Registration
Statement).............................................................
*2.2 -- Form of Certificate of Merger between M Acquisition Sub, Inc. and
Microtec Research, Inc. ...............................................
</TABLE>

<TABLE>
<C> <C> <S> <C>
3.1(1) -- Restated Articles of Incorporation of the Registrant, as amended.......
3.2(2) -- Bylaws of the Registrant...............................................
*5.1 -- Opinion of Venture Law Group, A Professional Corporation, as to the
legality of the Registrant's Common Stock being registered hereby......
8.1 -- Form of tax opinion of Venture Law Group, A Professional Corporation,
together with Exhibits.................................................
8.2 -- Form of tax opinion of Tomlinson Zisko Morosoli & Maser, together with
Exhibits...............................................................
10.1(3) -- 1982 Stock Option Plan.................................................
10.2(4) -- Nonqualified Stock Option Plan.........................................
10.3(5) -- 1986 Stock Plan........................................................
10.4(6) -- 1987 Non-Employee Directors' Stock Option Plan.........................
10.5(7) -- Stock Option Agreement under the 1986 Stock Plan dated October 15, 1993
between the Registrant and Walden C. Rhines............................
10.6(8) -- Employment Agreement dated July 7, 1993, as amended July 5, 1994,
between the Registrant and R. Douglas Norby............................
10.7(9) -- Form of Indemnity Agreement entered into between the Registrant and
each of its officers and directors.....................................
10.8(10) -- Lease dated November 20, 1991, for 999 Ridder Park Drive and 1051
Ridder Park Drive, San Jose, California................................
10.9(11) -- Amended and Restated Loan Agreement between the Registrant and First
Interstate Bank of Oregon, N.A. dated December 31, 1992, as amended....
21.1(12) -- Subsidiaries of the Registrant.........................................
*23.1 -- Consent of Venture Law Group, A Professional Corporation, with respect
to the legality of securities being registered (contained in Exhibit
5.1)...................................................................
23.2 -- Consent of Venture Law Group, A Professional Corporation, with respect
to certain tax matters (contained in Exhibit 8.1)......................
23.3 -- Consent of Tomlinson Zisko Morosoli & Maser, with respect to certain
tax matters (contained in Exhibit 8.2).................................
23.4 -- Consent of KPMG Peat Marwick LLP, Independent Auditors, with respect to
financial statements of the Registrant.................................
23.5 -- Consent of Deloitte & Touche LLP, Independent Auditors, with respect to
financial statements of Microtec.......................................
*23.6 -- Consent of Lehman Brothers with respect to its fairness opinion........
*24.1 -- Power of Attorney......................................................
</TABLE>

<PAGE> 193

<TABLE>
<CAPTION>
EXHIBIT PAGE OR
NUMBER DESCRIPTION FOOTNOTE
- ------ ----------------------------------------------------------------------- --------
<C> <C> <S> <C>
*99.1 -- Voting Agreement, dated as of October 9, 1995, among the Registrant,
Microtec and Jerry Kirk................................................
*99.2 -- Consultant Services Agreement, dated October 9, 1995, between the
Registrant and Jerry Kirk, together with the Agreement Re Stock Option,
dated October 9, 1995, between the Registrant and Jerry Kirk, the
Assignment and Assumption of Contract, dated November 6, 1995, between
Microsystem Services, Inc. and Jerry Kirk, and the Guaranty, dated
November 6, 1995, between the Registrant and Jerry Kirk, relating to
the Consultant Services Agreement......................................
*99.3 -- Form of Proxy Card.....................................................
</TABLE>

- ---------------
* Previously filed with the Commission.

(1) Incorporated by reference to Exhibit 4A to the Registrant's Registration
Statement on Form S-3 (Registration No. 33-23024).

(2) Incorporated by reference to Exhibit 4B to the Registrant's Registration
Statement on Form S-3 (Registration No. 33-56759).

(3) Incorporated by reference to Exhibit 10A to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1994 (the "1994 Form
10-K").

(4) Incorporated by reference to Exhibit 10B to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1989 (the "1989 Form
10-K").

(5) Incorporated by reference to Exhibit 10C to the Registrant's 1989 Form
10-K.

<PAGE> 1
EXHIBIT 8.1
January ___, 1996

Mentor Graphics Corporation
8005 S.W. Boeckman Road
Wilsonville, Oregon 97070-7777

Re: Federal Income Tax Consequences of Merger

Ladies and Gentlemen:

This opinion is being delivered to you in accordance with the Agreement and Plan
of Merger dated as of October 9, 1995, amended as of November 6, 1995 (the
"Merger Agreement") among Mentor Graphics Corporation, an Oregon corporation
("Mentor Graphics") and M Acquisition Sub, Inc. ("Sub"), and Microtec Research,
Inc., a Delaware corporation ("Microtec"). Pursuant to the Agreement and the
exhibits, schedules and other documents related thereto (collectively, the
"Merger Agreements"), Sub will merge with and into Microtec, with Microtec
continuing as the surviving corporation (the "Merger").

Except as otherwise provided, capitalized terms referred to herein have the
meanings set forth in the Merger Agreements. All section references, unless
otherwise indicated, are to the Internal Revenue Code of 1986, as amended (the
"Code").

A. Factual Basis and Assumptions

We have acted as legal counsel to Microtec in connection with the Merger. As
such, and for the purpose of rendering this opinion, we have examined (or will
examine on or prior to the Closing of the Merger) and are relying (or will rely)
upon, without any independent investigation or review thereof, the truth and
accuracy at all relevant times of the statements, covenants, representations and
warranties made by the parties to the Merger in the following documents
(including all schedules and exhibits thereto):

<PAGE> 2

Mentor Graphics Corporation
January ___, 1996
Page 2

1. The Merger Agreement;

2. Representations made by certain shareholders of Microtec in the
Shareholder Continuity of Interest Certificate attached hereto as Exhibit A;

3. Representations made to us by Microtec and Mentor Graphics in a
letter attached hereto as Exhibit B ("Representation Letter");

4. The Proxy and Registration Statement of Microtec and Mentor
Graphics dated ______________________(the "Proxy Statement/Registration"): and

5. Such other instruments and documents related to the formation,
organization and operation of Mentor Graphics, Sub and Microtec, or to the
consummation of the Merger and the transactions contemplated thereby, as we have
deemed necessary or appropriate to review.

In connection with rendering this opinion, we have assumed or obtained
representations (and are relying thereon, without any independent investigation
or review thereof) that:

1. Original documents (including signatures) are authentic, documents
submitted to us as copies conform to the original documents, and there has been
(or will be by the Closing of the Merger) due execution and delivery of all
documents where due execution and delivery are prerequisites to effectiveness
thereof;

2. Any representation or statement referred to above made "to the knowledge
of" or otherwise similarly qualified is correct without such qualification. As
to all matters in which a person or entity making a representation referred to
above has represented that such person or entity either is not a party to, does
not have, or is not aware of, any plan, intention, understanding or agreement,
there is in fact no such plan, intention, understanding or agreement. In
addition, in the case of any representation of statement referred to above
relating to a person's or entity's intentions as of the Effective Time with
respect to conduct following the Merger, such person or entity will in fact act
in a manner consistent therewith.

3. The Merger will be consummated pursuant to the Merger Agreement and will
be effective under the laws of the State of Delaware, and each party to such
Merger Agreement will comply with its respective representations, warranties,
covenants and statements made therein;

<PAGE> 3

Mentor Graphics Corporation
January ___, 1996
Page 3

Stock to be issued to them in the Merger ("Parent Exchange Stock") that
would reduce the Microtec stockholders' ownership of Parent Exchange Stock to a
number of shares having a value, as of the Effective Time of the Merger, of less
than fifty percent (50%) of the value of all of the formerly outstanding capital
stock of Microtec as of the same date ("Outstanding Microtec Common Stock"). For
purposes of this representation, a Sale of Parent Exchange Stock shall be
considered to have occurred pursuant to a Plan: (i) to the extent cash is
received in lieu of a fractional share of Parent Exchange Stock, or (ii) if such
Sale occurs in a transaction that is in contemplation of or related to the
Merger (a "Related Transaction"). In addition, for purposes of this assumption
only, shares of Microtec Common Stock with respect to which a Sale occurs in any
Related Transaction shall be considered to have been shares of Outstanding
Microtec Common Stock that were then exchanged for Parent Exchange Stock in the
Merger and then disposed of pursuant to a Plan.

5. In accordance with the representations, warranties and covenants made in
the Merger Agreement and the Representation Letter, the assets transferred by
Sub to Microtec pursuant to the Merger represent at least ninety percent (90%)
of the fair market value of the net assets and at least seventy percent (70%) of
the fair market value of the gross assets held by Sub immediately prior to the
Merger. At least ninety percent (90%) of the fair market value of the net
assets, and at least seventy (70%) of the fair market value of the gross assets,
held by Microtec immediately prior to the Merger will continue to be held by
Microtec immediately after the Merger.

For purposes of the preceding sentences, the following assets will be
treated as property held by the Sub or Microtec immediately prior to the Merger
for the purpose of determining the percentage of net and gross assets of
Microtec and Sub held by Microtec immediately following the Merger: Assets used
by Microtec to (i) pay expenses incurred in connection with the Merger, (ii)
make any redemptions or distributions prior to the Merger and in contemplation
thereof or in pursuance of the Plan of Merger, and (iii) assets disposed of by
Microtec prior to or subsequent to the Merger and in contemplation thereof or
pursuant to the Plan of Merger (including any asset disposed of by Microtec
other than in the ordinary course of business pursuant to a plan or intent
existing prior to the Merger.

6. To the extent any expenses relating to the Merger (or the "plan of
reorganization" within the meaning of Treas. Reg. 1.368-l(e) with respect to
the Merger) are funded directly or indirectly by a party other than the
incurring party, such expenses will be within the guidelines established in Rev.
Rule. 73-54, 1973-1 C.B. 187.

<PAGE> 4

Mentor Graphics Corporation
January ___, 1996
Page 4

368(a)(1)(A) and (a)(2)(E) of the Code. In such event, the following United
States federal income tax consequences will result:

(a) No gain or loss should be recognized by the holders of Microtec Common
Stock upon their receipt in the merger of the Parent Exchange Stock (except to
the extent of cash received in lieu of a fractional share thereof) in exchange
therefor;

(b) The aggregate tax basis of the Parent Exchange Stock so received in the
Merger (including any fractional share not actually received) should be the same
as the aggregate tax basis of the Microtec Common Stock surrendered in exchange
therefor;

(c) The holding of the Parent Exchange Stock received in the Merger should
include the period for which the Microtec Common Stock surrendered in exchange
therefor was held, provided that the Microtec Common Stock is held as a capital
asset at the time of the Merger; and

(d) A fractional share of the Parent Exchange Stock not actually issued
pursuant to the Merger but for which cash is received in lieu thereof should be
treated as if a fractional share of Parent Exchange Stock had been issued in the
Merger and then redeemed by Mentor Graphics. A Microtec stockholder receiving
such cash should generally recognize gain or loss upon such payment equal to the
difference (if any) between such stockholder's basis in the fractional share and
the amount of cash received. Such gain or loss should be a capital gain or loss
if, at the time of the Merger, Microtec Common Stock is held as a capital asset.

In addition to the matters set forth above, this opinion is subject to the
following additional exceptions, limitations and qualifications:

1. This opinion represents and is based upon our best judgment regarding the
application of United States federal income tax laws arising under the Code,
existing judicial decisions, administrative regulations and published rulings
and procedures. Our opinion expressly does not address the application of any
tax laws other than United States federal income tax laws, including the tax
laws of any country other than the United States and the tax laws of any state
or local jurisdiction.

Furthermore, our opinion is not binding upon the IRS or the courts, and
there is no assurance that the IRS will not successfully assert a contrary
position. Furthermore, no assurance can be given that future legislative,
judicial or administrative changes, on either a prospective or retroactive
basis, would not adversely affect the accuracy of the conclusions stated herein.
We undertake no responsibility to advise you of any new developments in the
application or interpretation of the United States federal income tax laws.

<PAGE> 5

Mentor Graphics Corporation
January ___, 1996
Page 5

2. This opinion addresses only the classification of the Merger as a
reorganization under Section 368(a) of the Code. It does not address any other
federal, state, local or foreign tax consequences that may result from the
Merger or any other transaction (including any transaction undertaken in
connection with the Merger). In particular, except as expressly stated in the
preceding sentence, we express no opinion regarding:

(a) whether and the extent to which any Microtec shareholder who
has provided or will provide services to Microtec, Sub or Mentor Graphics will
have compensation income under any provision of the Code;

(b) the effects of such compensation income, including but not
limited to the effect upon the basis and holding period of the Mentor Graphics
stock received by any such stockholder in the Merger;

(c) the potential application of the "golden parachute" provisions
(Sections 280G, 3121 (v)(2) and 4999) of the Code, the alternative minimum tax
provisions (Sections 55, 56 and 57) of the Code or Sections 305 and 306 of the
Code, or the effect of the classification of Mentor Graphics, Sub or Microtec as
a collapsible corporation within the meaning of Section 341 of the Code; and the
regulations promulgated thereunder;

(d) any consequences to Mentor Graphics, Sub or Microtec as a
result of the Merger, including, but not limited to gain or loss, basis, holding
period, or the survival and/or availability after the Merger of any federal
income tax attributes, including any net operating loss carryover, after
application of any provision of the Code, as well as the regulations promulgated
thereunder; and

(e) the tax consequences of the Merger that may be relevant to
particular stockholders of Microtec such as dealers in securities, corporate
stockholders subject to the alternative minimum tax, foreign persons, holders of
warrant, and holders of shares acquired upon exercise of stock option or in
other compensatory transactions.

3. No opinion is expressed as to any transaction other than the Merger as
described in the Merger Agreement or to any transaction whatsoever, including
the Merger, if all the transactions described in the Merger Agreement are not
consummated in accordance with the terms of such Merger Agreement and without
waiver of breach of any material provision thereof or if all of the
representations, warranties, statements and assumptions upon which we relied are
not true and accurate at all relevant times. In the event any one of the
statements, representations, warranties or assumptions upon which we have relied
to issue this opinion is incorrect, our opinion might be adversely affected and
may not be relied upon.

<PAGE> 6

Mentor Graphics Corporation
January ___, 1996
Page 6

4. This opinion is intended solely for your benefit and the benefit of your
stockholders and may not be relied upon for any other purpose or by any other
person or entity, and may not be made available to any other person or entity
without prior written consent. We hereby consent to inclusion of this opinion in
the Proxy Statement/Registration and to the reference to our firm under the
caption "Certain Income Tax Consequences -- United States" in the Proxy
Statement/Registration.

Very truly yours,

VENTURE LAW GROUP
A Professional Corporation

<PAGE> 7
Exhibit A

CONTINUITY OF INTEREST CERTIFICATE

I am aware that pursuant to an Agreement and Plan of Merger dated as of
October 9, 1995, amended as of November 6, 1995 (the "Merger Agreement") made
and entered into by and among Mentor Graphics, Inc., a Delaware corporation
("Mentor Graphics"), M Sub Acquisition Corporation, a Delaware Corporation and a
wholly-owned subsidiary of Mentor Graphics, Inc. ("Sub"), and Microtec Research,
Inc., a Delaware corporation ("Microtec"), Sub will merge with and into Microtec
Research, Inc. (the "Merger") in a transaction in which shares of Microtec
Common Stock will be changed and converted into shares of Mentor Graphics
Common.

1. The undersigned represents as follows:

(a) The undersigned is currently the owner of that number of
shares of Microtec Common Stock set forth in Appendix A hereto (the "Shares")
and has held the Shares at all times since April 1, 1995, unless otherwise set
forth in Appendix A;

(b) The undersigned has no present plan or intent (a "Plan")
to engage in a sale, exchange, transfer distribution (including a distribution
by a partnership to its shareholders), redemption or reduction in any way of the
undersigned's risk of ownership by short sale or otherwise, or other
disposition, directly or indirectly (such actions being collectively referred to
herein as a "Sale") of any shares of the Mentor Graphics Common to be received
by the undersigned in the Merger ("Exchange Stock");

(c) The undersigned is not aware of, or participating in, any
plan or intent on the part of the shareholders of Microtec (a "Plan") to engage
in a Sale of the Exchange Stock to be received by such Microtec shareholders in
the Merger such that the aggregate fair market value, as of the Effective Date
of the Merger, of the shares of Exchange Stock subject to such Sales would
exceed fifty percent (50%) of the aggregate fair market value of all shares of
outstanding Microtec stock immediately prior to the Merger ("Outstanding
Microtec Capital Stock"). A Sale of Exchange Stock shall be considered to have
occurred pursuant to a Plan if, among other things, such Sale occurs in a
transaction that is in contemplation of, or related or pursuant to, the Merger
or the Merger Agreement (a "Related Transaction"). In addition, shares of
Microtec stock with respect to which a pre-Merger Sale occurs in a Related
Transaction shall be considered to be shares of Outstanding Microtec Capital
Stock that are exchanged for shares of Exchange Stock which are disposed of
pursuant to a Plan;

(d) The undersigned has not engaged in a Sale of any shares of
Microtec Common Stock (including the Shares) at any time since April 1, 1995,
unless otherwise set forth in Appendix A;

<PAGE> 8

(e) The representations contained herein shall be true and
correct at all times from the date hereof through the date the Merger occurs,
except to the extent the undersigned notified Microtec in writing in a manner
received by Microtec prior to the Merger; and

(f) The undersigned has consulted such legal and financial
counsel as the undersigned deemed appropriate in connection with the execution
of this Certificate.

2. The undersigned has no present plan or intent to engage in a
Sale of the Shares (other than in exchange for Exchange Stock in the Merger).

3. The undersigned does not intend to take a position on any
federal or state income tax return that is inconsistent with the treatment of
the Merger as a tax-free reorganization for federal or state income tax
purposes.

4. The undersigned understands that Mentor Graphics, Sub,
Microtec, their respective shareholders and counsel for Microtec and Mentor
Graphics (in connection with rendering its opinion that the Merger will
constitute a tax-free reorganization for federal income tax purposes) will be
relying on (i) the truth and accuracy of the representations contained herein,
and (ii) the undersigned's performance of the obligations set forth herein.

IN WITNESS WHEREOF, the undersigned has executed the foregoing
Certificate this ___th day of December, 1995.

_________________________

By: _________________________

Title: ________________________
<PAGE> 9

APPENDIX A

Name of Shareholder: ___________________________________________________________

Type of Entity*: _______________________________________________________________

*(individual, corporation, partnership, other - please specify)

Number of Shares Date of Such
Number of Shares Sold or Otherwise Number of Shares Disposition or
of Microtec Disposed of Since Acquired Since Acquisition (on or
Owned on 4/1/95 4/1/95 4/1/95 after (4/1/95)

<PAGE> 10
Exhibit B

REPRESENTATION LETTER
[Date]

TOMLINSON ZISKO MOROSOLI & MASER VENTURE LAW GROUP
200 Page Mill Road, Second Floor 2800 Sand Hill Road
Palo Alto, CA 94306 Menlo Park, CA 94025

RE: Merger Pursuant to Agreement and Plan of Merger ("Agreement of Merger")
dated as of October 9, 1995, amended as of November 6, 1995, among Mentor
Graphics Corporation ("Mentor Graphics"), M Acquisition Sub, Inc. ("Sub"), and
Microtec Research, Inc. ("Microtec").

Ladies and Gentlemen:

This letter is supplied to you in connection with your tax opinion pursuant to
Section 6.1(f) of the Agreement of Merger and related exhibits (collectively
referred to herein as the "Agreement"). All Section references, unless otherwise
indicated, are to the Internal Revenue Code of 1986, as amended (the "Code").
Capitalized terms not defined herein have the meanings set forth in the
Agreement.

A. REPRESENTATIONS OF MENTOR GRAPHICS AND SUB

Mentor Graphics and Sub hereby certify that the following facts are
true as of the date hereof (and will be true at all times up to and including
the Effective Time of the Merger):

1. Mentor Graphics and Sub have significant, bona fide, non-tax
business reasons for participating in the Merger.

2. Mentor Graphics has no plan or intention to redeem or
otherwise reacquire any of the Microtec Capital Stock to be issued in the
Merger.

3. Following the Merger, Mentor Graphics will cause Microtec to
continue to conduct the historic business of Microtec as a wholly-owned
subsidiary of Mentor Graphics, and Mentor Graphics will either continue such
business or cause Microtec to continue to use a significant portion of
Microtec's historic business assets in a business.

4. At all times prior to the Merger, Mentor Graphics has owned
all of the outstanding equity interests in Sub (including rights to acquire an
equity interest in Sub, if any). Accordingly, prior to the Merger, Mentor
Graphics will be in control of Sub within the meaning of Section 368(c) of the
Code. Mentor Graphics formed Sub solely for the purpose of effecting the Merger
and, at all times prior to the Effective Time of the Merger, Sub does not and
will not conduct any business or investment activities and has no liabilities
except possible liabilities for organizational expenses and expenses in
connection with the Merger.

5. Mentor Graphics has no plan or intention to transfer
ownership, sell, or otherwise dispose of any shares of Sub's stock (other than
in the Merger), to liquidate Sub, to merge Sub with and into another corporation
(other than Microtec), or to cause Sub to sell or otherwise dispose of any
portion of Sub's assets other than in the ordinary course of business or to
Microtec pursuant to the Merger.

<PAGE> 11
Tomlinson Zisko Morosoli & Maser
Page 2

6. After the Merger, Mentor Graphics will be in control of
Microtec within the meaning of Section 368(c) of the Code. Mentor Graphics has
no plan or intention to transfer ownership or otherwise dispose of any such
equity interest in Microtec, to liquidate Microtec, to merge Microtec with any
other corporation (including Mentor Graphics), or to cause Microtec (i)to issue
additional equity interests, or (ii) to sell or otherwise dispose of or transfer
any portion of Microtec's assets (including those acquired from Sub) other than
in the ordinary course of business or to make payments contemplated by the
Agreement.

7. No compensation paid pursuant to employment, consulting or
non-competition agreements arising in connection with the Merger, if any,
between Mentor Graphics or Sub (or any member of a controlled group within the
meaning of Section 1563 of the Code, determined without regard to Section
1563(b)(2) ("Controlled Group") in which Mentor Graphics is a member) and any
holder of Microtec Common Stock or any other interest in Microtec considered
equity for tax purposes or otherwise will be separate consideration for, or
allocable to, the exchange of shares of Mentor Graphics Common. None of the
shares of Mentor Graphics Common will be received in exchange for, or allocable
to, services or any covenant not to compete.

8. Neither Mentor Graphics nor Sub is an "investment company" as
defined in Section 368(a)(2)(F)(iii) and (iv) of the Code.

9. Neither Mentor Graphics nor Sub is under the jurisdiction of a
court in a Title 11 or similar case within the meaning of Section 368(a)(3)(A)
of the Code.

10. In connection with the Merger, no shareholder of Microtec is
acting as an agent or on behalf of Mentor Graphics or any member of a Controlled
Group in which Mentor Graphics is a member.

11. No stock of Sub will be issued in the Merger.

12. Neither Mentor Graphics, Sub, nor any member of a Controlled
Group within the meaning of Section 1563 of the Code in which Mentor Graphics is
a member owns or has owned within the preceding five years, directly or
indirectly, any Microtec Common Stock.

13. Sub will have no liabilities assumed by Microtec (other than
its expenses incurred in connection with this transaction), and will not
transfer to Microtec any assets subject to liabilities, in the transaction.

14. Mentor Graphics hereby confirms the truth and accuracy of each
of the representations made by it and by Sub in the Merger Agreement.

15. Mentor Graphics and Sub are authorized to make all the
representations made by them and set forth herein.

<PAGE> 12
Tomlinson Zisko Morosoli & Maser
Page 3

B. REPRESENTATIONS OF MICROTEC

Microtec hereby certifies that the following facts are true as of the
date hereof (and will be true at all times up to and including the Effective
Time of the Merger):

1. Microtec has significant, bona fide, non-tax business reasons
for participating in the Merger.

2. Other than in the ordinary course of its business or as
disclosed in the Agreement, Microtec has made no transfer of any of its assets
in contemplation of the Merger or during the period commencing with the active
conduct of negotiations with Mentor Graphics or Sub regarding the Merger and
ending immediately prior to the Effective Time of the Merger (the "Pre-Merger
Period"). For the purposes of this paragraph, a transfer of assets includes any
distribution of assets with respect to stock or in redemption of stock other
than the possible repurchase of unvested shares, if any, held by employees.

3. Except as disclosed in the Agreement of Merger, at the time of
the Merger, (i) Microtec shall have no outstanding warrants, options, or
convertible securities nor any other type of right outstanding pursuant to which
any person could acquire shares of Microtec Common Stock, and (ii) Microtec
shall have no outstanding equity interest other than shares of Microtec Common
Stock and rights to acquire Microtec Common Stock. No right to acquire Microtec
Capital Stock exists which, if exercised, would affect Mentor Graphics'
acquisition and retention of control of Microtec within the meaning of Section
368(c) of the Code.

4. The liabilities of Microtec have been incurred by Microtec in
the ordinary course of its business and are associated with the assets of
Microtec's business operations.

5. The fair market value of the assets of Microtec will, at the
Effective Time of the Merger, equal or exceed the sum of the aggregate
liabilities of Microtec, plus the amount of liabilities, if any, to which such
assets are subject.

6. Except as disclosed in the Agreement, no redemptions of or
distributions on Microtec Common Stock have occurred or will occur during the
Pre-Merger Period.

7. Employment, consulting or non-competition agreements arising
in connection with the Merger, if any, between Microtec (or any member of a
Controlled Group in which Microtec is also a member) and any holder of Microtec
Common Stock or any other interest in Microtec considered equity for tax
purposes, are for services actually rendered. No compensation paid pursuant to
such agreements or otherwise represents consideration for the exchange of shares
of Microtec Common Stock in the Merger None of the shares of Parent Common Stock
will be received in exchange for, or allocable to, services or any covenant not
to compete.

8. Microtec is not and will not be at the Effective Time of the
Merger an "investment company" as defined in Section 368(a)(2)(F)(iii) and (iv)
of the Code.

9. Microtec is not under the jurisdiction of a court in a Title
11 or similar case within the meaning of Section 368(a)(3)(A) of the Code.

<PAGE> 13
Tomlinson Zisko Morosoli & Maser
Page 4

10. Following the Merger, Microtec will not issue additional
equity interests that would result in Mentor Graphics losing control of Microtec
within the meaning of Section 368(c) of the Code.

11. In the Merger, shares of Microtec Common Stock representing
control of Microtec, as defined in Section 368(c) of the Code, will be exchanged
solely for voting stock of Mentor Graphics. For purposes of this representation,
shares of Microtec Common Stock exchanged for cash or other property originating
with Mentor Graphics will be treated as outstanding Microtec Common Stock on the
date of the Merger.

12. Microtec confirms the truth and accuracy of each of the
representations made by it in the Agreement.

13. Microtec is authorized to make all of the representations made
by it and set forth herein.

C. JOINT REPRESENTATIONS

Mentor Graphics, Sub, and Microtec hereby certify that the following
facts are true as of the date hereof (and will be true at all times up to and
including the Effective Time of the Merger):

1. The Merger is the result of arm's length negotiations between
the parties.

2. Except as to fractional shares which will be canceled in
exchange for cash, each share of Microtec Common Stock outstanding immediately
prior to the Merger will be converted into and exchanged for the number of
shares of Parent Common Stock as determined in accordance with the Agreement
(such shares of Parent Common and Stock shall be referred to hereinafter as
"Parent Exchange Stock".

3. The fair market value of the Parent Exchange Stock and other
consideration, if any, received by each Microtec shareholder will be
approximately equal to the fair market value of the shares of Microtec Stock
surrendered in exchange therefor. Microtec shareholders will receive no
consideration other than Parent Exchange Stock (except to the extent of cash
received in lieu of fractional shares of Parent Exchange Stock) in exchange for
their shares of Microtec Common Stock. The aggregate consideration received by
Microtec shareholders in exchange for their Microtec Common Stock will be
approximately equal to the fair market value of all shares of Outstanding
Microtec Common Stock (as defined below).

4. The payment of cash in lieu of fractional shares of Parent
Exchange Stock is made solely for the purpose of avoiding the expense and
inconvenience of issuing and transferring fractional shares and does not
represent separately bargained for consideration. The total cash consideration
that will be paid at the time of such conversion instead of issuing fractional
shares of Parent Exchange Stock will not exceed one percent (1%) of the total
consideration that will be paid to Microtec shareholders at the time they
exchange their shares of Microtec Common Stock for Parent Exchange Stock.

<PAGE> 14
Tomlinson Zisko Morosoli & Maser
Page 5

5. Pursuant to the Merger, Sub will merge with and into Microtec
and Microtec will acquire all of the assets and liabilities of Sub. The assets
transferred to Microtec pursuant to the Merger represents at least ninety
percent (90%) of the fair market value of the net assets and at least seventy
percent (70%) of the fair market value of the gross assets held by Sub
immediately prior to the Merger. In addition, at least ninety percent (90%) of
the fair market value of the net assets and at least seventy percent (70%) of
the fair market value of the gross assets held by Microtec immediately prior to
the Merger will continue to be held by Microtec immediately after the Merger.
For purposes of this representation, the following assets will be treated as
property held by Microtec or Sub, as the case may be, immediately prior to the
Merger (but not subsequent thereto) in determining the percentage of Microtec's
and Sub's net and gross assets held by Microtec immediately following the
Merger: (i) assets disposed of by Microtec or Sub (other than assets transferred
from Sub to P in the Merger) prior to or subsequent to the Merger and in
contemplation thereof or pursuant to the Agreement (including any asset disposed
of by Microtec other than in the ordinary course of business pursuant to a plan
or intent existing during the Pre-Merger Period); (ii) assets used by Microtec
or Sub to pay expenses incurred in connection with the Merger, if any; and (iii)
assets used to make any redemptions, distributions, or other payments in respect
of Microtec Common Stock or rights to acquire such stock (including payments
treated as such for tax purposes) that are made prior to the Merger and in
contemplation thereof (except for regular, normal dividends).

6. After due inquiry of certain officers, directors and
shareholders of Microtec, Mentor Graphics, Sub, and Microtec have no knowledge
of and believe there is no plan or intention on the part of Microtec
shareholders in the aggregate (a "Plan"), to engage in a sale, exchange,
transfer, reduction of risk of ownership by short sale or otherwise, or other
disposition of, directly or indirectly, (a "Sale") of shares of Parent Exchange
Stock to be issued to them in the Merger that would reduce the Microtec
shareholders' ownership of Parent Exchange Stock to a number of shares having a
value, as of the Effective Time of the Merger, of less than fifty percent (50%)
of the value of all of the formerly outstanding capital stock of Microtec as of
the same date ("Outstanding Microtec Common Stock"). For purposes of this
representation, a Sale of Parent Exchange Stock shall be considered to have
occurred pursuant to a Plan: (i) to the extent cash is received in lieu of a
fractional share of Parent Exchange Stock, or (ii) if such Sale occurs in a
transaction that is in contemplation of or related to the Merger (a "Related
Transaction"). In addition, for purposed of this representation only, shares
Microtec Common Stock with respect to which a Sale occurs in any Related
Transaction shall be considered to have been shares of Outstanding Microtec
Common Stock that were then exchanged for Parent Exchange Stock in the Merger
and then disposed of pursuant to a Plan. Moreover, shares of Microtec capital
stock and shares of Mentor Graphics Common held by Microtec shareholders and
otherwise sold, redeemed, or disposed of prior or subsequent to the Merger will
be considered in making this representation.

7. Except as disclosed in the Agreement, the shares of Parent
Exchange Stock issued pursuant to the Merger will not be subject to any
restriction whatsoever (other than any restrictions imposed under any applicable
securities laws or for pooling-of-interest requirements).

8. There is no intercorporate indebtedness existing between
Mentor Graphics and Microtec, or between Sub and Microtec that was issued,
acquired, or will be settled at a discount in the Merger or in a transaction
related to the Merger.

<PAGE> 15
Tomlinson Zisko Morosoli & Maser
Page 6

9. Mentor Graphics, Sub, Microtec, and shareholders of Microtec
shall each bear their respective expenses, if any, incurred in connection with
the Merger. To the extent any such expenses are not paid by the incurring a
party, such expenses are within the guidelines established in Rev. Rul. 73-54,
1973-1 C.B. 187. Neither Mentor Graphics, Sub, Microtec, nor any member of a
Controlled Group in which Mentor Graphics or Microtec is also a member is
directly or indirectly funding or guaranteeing the expenses of any Microtec
shareholder in connection with the Merger and all transactions and proceedings
relating thereto.

10. No shares of Sub have been or will be used as consideration or
issued to shareholders of Microtec in the Merger.

D. LIMITATIONS ON THE TAX OPINION

1. Mentor Graphics, Sub, and Microtec have read the opinion and
we each understand all the limitations and qualifications to which your opinion
are subject and the items upon which you have relied in rendering your opinion.

2. The undersigned recognize that your opinion will be base upon
the representations in this letter and that such opinion may not be relied upon
if, among other things, any representation is not accurate in all material
respects at all relevant times.

3. The undersigned recognize that your opinion will not address
any consequence of either the Merger or any action taken in connection therewith
except as expressly set forth therein.

Very truly yours,

MENTOR GRAPHICS CORPORATION

By:________________________________
Title:_____________________________

M ACQUISITION SUB, INC. MICROTEC RESEARCH, INC.

By:________________________________ By:__________________________
Title:_____________________________ Title:_______________________

<PAGE> 1
EXHIBIT 8.2
January __, 1996

Microtec Research, Inc.
2350 Mission College Blvd.
Santa Clara, California 95054

Re: Federal Income Tax Consequences of Merger

Ladies and Gentlemen:

A. Factual Basis and Assumptions

<PAGE> 2

Microtec Research, Inc.
January ___, 1996
Page 2

(including all schedules and exhibits thereto):

1. The Merger Agreement;

2. Representations made by certain shareholders of Microtec in the
Shareholder Continuity of Interest Certificate attached hereto as Exhibit A;

3. Representations made to us by Microtec and Mentor Graphics in a
letter attached hereto as Exhibit B ("Representation Letter");

4. The Proxy and Registration Statement of Microtec and Mentor
Graphics dated ______________________(the "Proxy Statement/Registration"): and

In connection with rendering this opinion, we have assumed or obtained
representations (and are relying thereon, without any independent investigation
or review thereof) that:

<PAGE> 3

Microtec Research, Inc.
January ___, 1996
Page 3

4. There is no plan or intention on the part of Microtec stockholders in the
aggregate (a "Plan"), to engage in a sale, exchange, transfer, reduction of risk
of ownership by short sale or otherwise, or other disposition of, directly or
indirectly, (a "Sale") of shares of Mentor Graphics Stock to be issued to them
in the Merger ("Parent Exchange Stock") that would reduce the Microtec
stockholders' ownership of Parent Exchange Stock to a number of shares having a
value, as of the Effective Time of the Merger, of less than fifty percent (50%)
of the value of all of the formerly outstanding capital stock of Microtec as of
the same date ("Outstanding Microtec Common Stock"). For purposes of this
representation, a Sale of Parent Exchange Stock shall be considered to have
occurred pursuant to a Plan: (i) to the extent cash is received in lieu of a
fractional share of Parent Exchange Stock, or (ii) if such Sale occurs in a
transaction that is in contemplation of or related to the Merger (a "Related
Transaction"). In addition, for purposes of this assumption only, shares of
Microtec Common Stock with respect to which a Sale occurs in any Related
Transaction shall be considered to have been shares of Outstanding Microtec
Common Stock that were then exchanged for Parent Exchange Stock in the Merger
and then disposed of pursuant to a Plan.

For purposes of the preceding sentences, the following assets will
be treated as property held by the Sub or Microtec immediately prior to the
Merger for the purpose of determining the percentage of net and gross assets of
Microtec and Sub held by Microtec immediately following the Merger: Assets used
by Microtec to (i) pay expenses incurred in connection with the Merger, (ii)
make any redemptions or distributions prior to the Merger and in contemplation
thereof or in pursuance of the Plan of Merger, and (iii) assets disposed of by
Microtec prior to or subsequent to the Merger and in contemplation thereof or
pursuant to the Plan of Merger (including any asset disposed of by Microtec
other than in the ordinary course of business pursuant to a plan or intent
existing prior to the Merger.

<PAGE> 4

Microtec Research, Inc.
January ___, 1996
Page 4

Based on our examination of the foregoing items, and subject to the assumptions,
exceptions, limitations and qualifications set forth herein, we are of the
opinion that, for United States federal income tax purposes, the Merger will
constitute a reorganization as defined in Section 368(a)(1)(A) and (a)(2)(E) of
the Code. In such event, the following United States federal income tax
consequences will result:

In addition to the matters set forth above, this opinion is subject to the
following additional exceptions, limitations and qualifications:

Furthermore, our opinion is not binding upon the IRS or the courts,
and there is no assurance that the IRS will not successfully assert a contrary
position. Furthermore, no assurance

<PAGE> 5

Microtec Research, Inc.
January ___, 1996
Page 5

can be given that future legislative, judicial or administrative changes, on
either a prospective or retroactive basis, would not adversely affect the
accuracy of the conclusions stated herein. We undertake no responsibility to
advise you of any new developments in the application or interpretation of the
United States federal income tax laws.

(b) the effects of such compensation income, including but not
limited to the effect upon the basis and holding period of the Mentor Graphics
stock received by any such stockholder in the Merger;

3. No opinion is expressed as to any transaction other than the
Merger as described in the Merger Agreement or to any transaction whatsoever,
including the Merger, if all the transactions

<PAGE> 6

Microtec Research, Inc.
January ___, 1996
Page 6

described in the Merger Agreement are not consummated in accordance with the
terms of such Merger Agreement and without waiver of breach of any material
provision thereof or if all of the representations, warranties, statements and
assumptions upon which we relied are not true and accurate at all relevant
times. In the event any one of the statements, representations, warranties or
assumptions upon which we have relied to issue this opinion is incorrect, our
opinion might be adversely affected and may not be relied upon.

Very truly yours,

Tomlinson Zisko Morosoli & Maser

<PAGE> 7
Exhibit A

CONTINUITY OF INTEREST CERTIFICATE

1. The undersigned represents as follows:

(d) The undersigned has not engaged in a Sale of any shares of
Microtec Common Stock (including the Shares) at any time since April 1, 1995,
unless otherwise set forth in Appendix A;

<PAGE> 8

(f) The undersigned has consulted such legal and financial
counsel as the undersigned deemed appropriate in connection with the execution
of this Certificate.

2. The undersigned has no present plan or intent to engage in a
Sale of the Shares (other than in exchange for Exchange Stock in the Merger).

IN WITNESS WHEREOF, the undersigned has executed the foregoing
Certificate this ___th day of December, 1995.

_________________________

By: _________________________

Title: ________________________
<PAGE> 9

APPENDIX A

Name of Shareholder: ___________________________________________________________

Type of Entity*: _______________________________________________________________

*(individual, corporation, partnership, other - please specify)

<PAGE> 10
Exhibit B

REPRESENTATION LETTER
[Date]

TOMLINSON ZISKO MOROSOLI & MASER VENTURE LAW GROUP
200 Page Mill Road, Second Floor 2800 Sand Hill Road
Palo Alto, CA 94306 Menlo Park, CA 94025

Ladies and Gentlemen:

A. REPRESENTATIONS OF MENTOR GRAPHICS AND SUB

Mentor Graphics and Sub hereby certify that the following facts are
true as of the date hereof (and will be true at all times up to and including
the Effective Time of the Merger):

1. Mentor Graphics and Sub have significant, bona fide, non-tax
business reasons for participating in the Merger.

2. Mentor Graphics has no plan or intention to redeem or
otherwise reacquire any of the Microtec Capital Stock to be issued in the
Merger.

<PAGE> 11
Tomlinson Zisko Morosoli & Maser
Page 2

8. Neither Mentor Graphics nor Sub is an "investment company" as
defined in Section 368(a)(2)(F)(iii) and (iv) of the Code.

9. Neither Mentor Graphics nor Sub is under the jurisdiction of a
court in a Title 11 or similar case within the meaning of Section 368(a)(3)(A)
of the Code.

10. In connection with the Merger, no shareholder of Microtec is
acting as an agent or on behalf of Mentor Graphics or any member of a Controlled
Group in which Mentor Graphics is a member.

11. No stock of Sub will be issued in the Merger.

14. Mentor Graphics hereby confirms the truth and accuracy of each
of the representations made by it and by Sub in the Merger Agreement.

15. Mentor Graphics and Sub are authorized to make all the
representations made by them and set forth herein.

<PAGE> 12
Tomlinson Zisko Morosoli & Maser
Page 3

B. REPRESENTATIONS OF MICROTEC

Microtec hereby certifies that the following facts are true as of the
date hereof (and will be true at all times up to and including the Effective
Time of the Merger):

1. Microtec has significant, bona fide, non-tax business reasons
for participating in the Merger.

4. The liabilities of Microtec have been incurred by Microtec in
the ordinary course of its business and are associated with the assets of
Microtec's business operations.

6. Except as disclosed in the Agreement, no redemptions of or
distributions on Microtec Common Stock have occurred or will occur during the
Pre-Merger Period.

8. Microtec is not and will not be at the Effective Time of the
Merger an "investment company" as defined in Section 368(a)(2)(F)(iii) and (iv)
of the Code.

9. Microtec is not under the jurisdiction of a court in a Title
11 or similar case within the meaning of Section 368(a)(3)(A) of the Code.

<PAGE> 13
Tomlinson Zisko Morosoli & Maser
Page 4

10. Following the Merger, Microtec will not issue additional
equity interests that would result in Mentor Graphics losing control of Microtec
within the meaning of Section 368(c) of the Code.

12. Microtec confirms the truth and accuracy of each of the
representations made by it in the Agreement.

13. Microtec is authorized to make all of the representations made
by it and set forth herein.

C. JOINT REPRESENTATIONS

Mentor Graphics, Sub, and Microtec hereby certify that the following
facts are true as of the date hereof (and will be true at all times up to and
including the Effective Time of the Merger):

1. The Merger is the result of arm's length negotiations between
the parties.

<PAGE> 14
Tomlinson Zisko Morosoli & Maser
Page 5

<PAGE> 15
Tomlinson Zisko Morosoli & Maser
Page 6

10. No shares of Sub have been or will be used as consideration or
issued to shareholders of Microtec in the Merger.

D. LIMITATIONS ON THE TAX OPINION

3. The undersigned recognize that your opinion will not address
any consequence of either the Merger or any action taken in connection therewith
except as expressly set forth therein.

Very truly yours,

MENTOR GRAPHICS CORPORATION

By:________________________________
Title:_____________________________

M ACQUISITION SUB, INC. MICROTEC RESEARCH, INC.

By:________________________________ By:__________________________
Title:_____________________________ Title:_______________________

<PAGE> 1

EXHIBIT 23.4

CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors
Mentor Graphics Corporation

The audits referred to in our report dated January 31, 1995, included the
related financial statement schedule as of December 31, 1994, and for each of
the years in the three-year period ended December 31, 1994, included in the
registration statement. This financial statement schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits. In our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

We consent to the use of our reports included herein and to the reference
to our firm under the headings, "Summary -- Accounting Treatment," "The
Merger -- Accounting Treatment," and "Experts" in the registration statement.
Our reports refer to a change in the method of accounting for certain debt and
equity securities and income taxes.

KPMG PEAT MARWICK LLP

Portland, Oregon

December 26, 1995

<PAGE> 1

EXHIBIT 23.5

CONSENT OF DELOITTE & TOUCHE LLP, INDEPENDENT AUDITORS

We consent to the use in this Amendment No. 2 to the Registration Statement
of Mentor Graphics Corporation on Form S-4 of our report dated April 28, 1995
relating to the consolidated financial statements of Microtec Research, Inc.
appearing in the Proxy Statement/Prospectus, which is a part of such
Registration Statement.

We also consent to the reference to us under the headings,
"Summary -- Accounting Treatment," "The Merger -- Accounting Treatment," and
"Experts" in such Proxy Statement/Prospectus.

DELOITTE & TOUCHE LLP

San Jose, California

December 26, 1995