-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Vh5CKuZch1DHX73kOpt85ZTDqxQqXmfGvt46Fxj9l0qrbtTFTUfah8aGp+mG1TKK dEJdrM7VjTLVJfGgnbZNIw== 0000912057-97-010967.txt : 19970401 0000912057-97-010967.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-010967 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUICKTURN DESIGN SYSTEMS INC CENTRAL INDEX KEY: 0000914252 STANDARD INDUSTRIAL CLASSIFICATION: INSTRUMENTS FOR MEAS & TESTING OF ELECTRICITY & ELEC SIGNALS [3825] IRS NUMBER: 770159619 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22738 FILM NUMBER: 97568575 BUSINESS ADDRESS: STREET 1: 440 CLYDE AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 4159673300 MAIL ADDRESS: STREET 1: 440 CLYDE AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ COMMISSION FILE NUMBER: 0-22738 QUICKTURN DESIGN SYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 77-0159619 - -------------------------------- ---------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 440 Clyde Avenue, Mountain View, California 94043 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (415) 967-3300 - ------------------------------------------------------------------------------ Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value per share ------------------------------------------------------------ (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by nonaffiliates of the Registrant, based upon the closing sale price of the Common Stock on February 28, 1997 on the Nasdaq National Market was approximately $225,056,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the Registrant's Common Stock as of February 28, 1997 was 16,571,067. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996 are incorporated by reference in Parts II and IV of this Form 10-K to the extent stated herein. Also, certain sections of the Registrant's definitive Proxy Statement for the 1997 Annual Meeting of Stockholders to be held on April 11, 1997 are incorporated by reference in Part III of this Form 10-K to the extent stated herein. PART I ITEM 1. BUSINESS. OVERVIEW Quickturn Design Systems, Inc. ("Quickturn" or the "Company") designs, manufactures, sells and supports system-level verification solutions for the design of integrated circuits ("ICs") and electronic systems. The Company's cycle-based simulation and emulation technologies are designed to improve design quality and to reduce time-to-market and prototype development costs compared to traditional verification methodologies. The cycle-based simulation products, which complement the Company's emulation products, can be used by customers to verify digital logic designs early in the design process, particularly when design changes occur several times per day. Later in the design process, when designs become more stabilized, customers use in-circuit emulation to test the entire system containing the design and to help identify system-level bugs, which typically are more difficult to find. The Company was incorporated in California in July 1987 and reincorporated in Delaware in December 1993. The Company's principal executive offices are located at 440 Clyde Avenue, Mountain View, California, 94043, and its telephone number is (415) 967-3300. The Company's homepage can be located on the Web at http://www.quickturn.com/. SPEEDSIM MERGER On February 7, 1997, the Company acquired SpeedSim, Inc. ("SpeedSim"), a provider of cycle-based simulation software for the verification of digital logic designs ("the SpeedSim Merger") for 2.8 million shares of Quickturn common stock. The acquisition was accounted for as a pooling of interests. The Company estimates that it will incur direct transaction costs of at least $1.2 million associated with the acquisition, which will be charged to operations during the quarter ending March 31, 1997. See Note 15 of the Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. TECHNOLOGY AND PRODUCTS CYCLE-BASED SIMULATION The IC design process begins when electronic design engineers create an initial description of an IC, typically using high level or register transfer level ("RTL") languages such as VHDL or Verilog. This description is then debugged using software simulation on standard desktop workstations. The simulation software creates a mock-up of the logic flow of an IC based on the RTL description, which is then fed test inputs to determine if the current design executes instructions as desired. Once an IC design is deemed reliable at the RTL level, the designer maps out a physical layout of the transistors and gates comprising the IC. This is often accomplished using synthesis software which transforms RTL designs into gate level architecture. Also at the gate level, the design must be tested for critical operating functionality. Such RTL and gate level tests are typically run on event-based simulation software, which runs at speeds substantially below the normal speed of a completed IC. The speed of most event-based simulation software is typically in the range of tens or hundreds of cycles per second, while most complex ICs are designed to run in the range of one million to hundreds of millions of cycles per second. Therefore, software simulation testing of a highly complex design with hundreds of thousands of gates using event-based simulation could take a substantial period of time. Since a design may need to undergo dozens of iterations, given the time-to-market urgency in the electronics industry, the delays associated with event-based simulation for complex IC designs can be unacceptable to IC designers. The Company's SpeedSim high performance simulation software uses cycle- based simulation ("CBS") technology, which is an alternative to traditional event-based simulation. CBS is specifically designed to overcome the verification speed limitations of event-based simulation, and may also help reduce IC design costs by reducing the need for expensive hardware simulation accelerators. The Company's SpeedSim cycle-based simulator employs a proprietary technology called Boolean Dataflow Engine ("BDE") to enhance verification performance. This performance enhancement is accomplished by having the cycle-based simulator examine results only at the end of every clock cycle, therefore eliminating unnecessary calculations. These unnecessary calculations are inherent in traditional event-based simulation, which is programmed to examine every active signal that propagates through every device during a clock cycle. Therefore, the Company's CBS approach may be ten to one hundred times faster than event-based simulation because CBS focuses only on the primary task at hand, which is functional verification of chip design logic. BDE further enhances performance by employing fewer logic states, typically two (1s and 0s), while full event-based-simulation supports from four to 28 logic states. Other enhancements related to BDE technology include: * Minimal Memory Usage: The SpeedSim product further enhances performance by utilizing less memory than event-based simulation. Using BDE, engineers can fit a one million gate design into a 10MB image. Without BDE, the same image may be typically five to 50 times larger. For very large chip designs, the reduced memory requirements would allow a design team to speed up verification by simulating a design running different tests on all of their desktop workstations in their network at once, instead of on one large server. * Simultaneous Test: This SpeedSim option allows for up to 32 different tests to be run simultaneously on one image of a design model using a single workstation, which can result in a five-fold to ten-fold gain in performance. * Symmetric MultiProcessing ("SMP"): This feature allows chip designers to take a single design and divide it into segments. Each segment is then simulated on different CPUs within the SMP box, thereby creating a much faster simulation across multiple CPUs compared to a simulation on a single CPU. * Fast Design Iterations: After a design bug is located and fixed, this feature provides for fast recompilation, typically within minutes for very large designs, instead of hours using event-based simulation. The platforms supported by the SpeedSim product include UNIX workstations on SUN, HP, DEC, IBM and Intel-compatible PCs running LINUX or Windows/NT. 2 EMULATION Quickturn's System Realizer (TM) emulation system and the new CoBALT (TM) (Concurrent Broadcast Array Logic Technology) emulation system are used by electronic design engineers to generate reprogrammable physical prototypes, or "virtual silicon" (TM) representations, of their electronic circuit designs. This enables designers to achieve concurrent verification of the entire target system, including system software and applications, and to perform iterative design changes prior to actual silicon fabrication. System Realizer offers a versatile solution for synchronous and asynchronous designs in the range of 150,000 to six million logic gates. CoBALT provides verification capabilities for ultracomplex, synchronous designs of up to 8 million logic gates. Both systems share the same software environment, allowing designers to select the optimum emulation solution for any design style. The emulation process begins by the Company's products automatically accepting logic designs created in the most widely used, commercially available electronic design automation ("EDA") systems, as well as those created in the proprietary design environments of selected large customers. These designs are then processed by the Company's proprietary software on a commercial workstation. Using information provided by engineers as well as built-in proprietary algorithms, the software partitions designs into different blocks of logic which are then automatically mapped into a virtual silicon implementation. The software also performs logic optimization to best utilize the available programmable resources in the emulation system. Once the designs are partitioned, the software defines the interconnection of the various blocks of logic and the specific routing through the programmable architecture of the emulation system. The designs are then downloaded from the commercial workstation to the emulation system, thereby creating a virtual silicon implementation of the designs. The virtual silicon is then cabled into the target system in which the fabricated silicon will ultimately reside. At this time, the target system can be run just as it would if a fabricated silicon were available. The target system is then tested by running embedded software, operating systems and application software. The verification of the target system will typically run at speeds in the millions of cycles per second range, several orders of magnitude faster than gate-level simulation, but typically slower than real operating speeds. The emulation system includes an integrated logic analyzer and software debugging tools which enable the engineer to observe the details of the design behavior at any location within a design. These observation points may be moved interactively under software control to any other location. When design problems are discovered, changes are made to the original design. These design changes are then implemented by the emulation software as changes to the virtual silicon. The impact of the changes can be determined quickly in the target system operating environment while the design can still be easily modified. Quickturn's products are based on the Company's patented technologies and proprietary software algorithms which have produced the following core technologies: * LOGIC COMPILATION INCLUDING PARTITIONING: the complex software that segments a large IC design into smaller units which are programmed into the field programmable gate arrays 3 ("FPGAs") and programmable memories that constitute the core reprogrammable components of Quickturn's emulation systems. * INTERCONNECT ARCHITECTURE: the patented system-level schema for connection of the reprogrammable components, which is implemented with Quickturn's proprietary interconnect ICs and placement and routing software. * LOGIC MAPPING: the software which optimizes the mapping of the design to be emulated into the basic cells of the FPGAs in the emulation system. * MEMORY ARCHITECTURE MAPPING: the software which optimizes the use of programmable memories in the emulation system to represent the memory architecture of the IC to be emulated. * INSTRUMENTATION: the fully integrated software and logic analyzer technology which allows users of Quickturn's emulation systems to observe the gate level behavior of the virtual silicon, allowing for the assessment of a design's correctness at this level. These core technologies maximize the cost effectiveness of the products by optimizing emulation system capacity and performance and minimizing both the user's time to emulation and the costs required to verify and debug designs. Substantially all of the Company's revenue has been derived from the sale of its verification products, and sales of such products are expected to continue to account for substantially all of the Company's revenue for the foreseeable future. To date, the Company's products have been sold to a limited number of customers. See "---Customers." Accordingly, broad market acceptance of verification products by existing and new customers is critical to the Company's future success. The adoption of the Company's verification products in the design verification process by IC and system designers, particularly those which have historically relied on other methodologies, generally requires the adoption of an entirely new method of design verification. While the Company believes that its verification products offer considerable advantages in the IC and system design process, there can be no assurance that market acceptance of those products will continue to grow. Moreover, there can be no assurance that emulation products will be adopted beyond the high-end emulation market, which is characterized by complex ICs of hundreds of thousands or, in some cases, millions of logic gates. The adoption of the Company's verification products for designing ICs and systems will also depend on the continued increase in complexity of ICs designed into electronic systems, integration of the Company's products with other tools for design and verification, importance of the time-to-market benefits of verification products and industry acceptance of the need to close the time gap between high level design and silicon production. Because the market for verification products is new and evolving, it is difficult to predict with any assurance whether the market for verification products will continue to expand. CUSTOMERS The Company markets its products to customers who design complex ICs and electronic systems. Early adopters represent the IC and system companies with the largest verification problems. As the technology has matured, a broader range of customers has begun to adopt the 4 technology, and now the Company's customers include computer, semiconductor, telecommunications, consumer electronics, networking and multimedia companies. The Company's customers are in industries characterized by rapid advances in technology, competitive pressures to develop and introduce new products in less time and the need for extensive system-level verification and debugging prior to design implementation. Microprocessors and microcontrollers with complexity levels of hundreds of thousands and even millions of gates are applications for which emulation is considered a critical technology because of the requirement to verify design compatibility with new and existing software. Typical new users of Quickturn's verification products are designing custom integrated circuits or ASICs with 30,000 to 100,000 or more logic gates. A relatively limited number of customers have historically accounted for a substantial portion of the Company's revenue. The Company expects that sales of its products to a limited number of customers will continue to account for a high percentage of revenue for the foreseeable future. The loss of a major customer or any reduction in orders by such customers, including reductions due to market or competitive conditions in the electronics or EDA industry, would have an adverse effect on the Company's financial condition and results of operations. Moreover, the Company's ability to increase its sales will depend in part upon its ability to obtain orders from new customers, as well as the financial condition and success of its customers and the general economy; there can be no assurance that such an increase will occur. CUSTOMER SERVICE AND SUPPORT The Company provides customers with technical support, training and design consulting services. The Company believes that a high level of customer service and support is critical to the adoption of the Company's verification technology by new users. During the early stages of a customer's first project, the Company works closely with the project team to ensure a smooth integration of its verification products into the design process. Quickturn maintains a rapid response program which is designed to meet customer support issues. For customers using the Company's verification products on mission-critical projects, the Company offers expert-user design consulting services through its Time-to-Market-Engineering Services ("TtME") to provide such expert assistance to customers. Additionally, substantially all of the Company's customers currently have maintenance agreements with the Company. The Company generally warrants its products to be free from defects and to substantially conform to material specifications for a period of 90 days. SALES AND MARKETING The Company markets its products and services primarily through its direct sales and service force. The Company employs a highly skilled sales force and application engineering team capable of serving the sophisticated needs of prospective customers' engineering and management staffs. The sales process is supported with a broad range of marketing programs which include trade shows, direct marketing, public relations and customer seminars. From time to time the Company may enter into joint marketing agreements with EDA companies and other technology partners to increase market acceptance of the Company's verification products. Sales of the Company's products depend, in significant part, upon the decision of a prospective customer to commence a project for the design and development of complex ICs and 5 systems. In view of the significant amount of time and commitment of capital involved in the design and development of complex ICs and systems, the Company may experience delays following initial qualification of the Company's verification products as a result of delays in commencement of the project by a customer. For this and other reasons, the Company's verification products typically have a lengthy sales cycle during which the Company may expend substantial funds and management effort. Lengthy sales cycles subject the Company to a number of significant risks, including inventory obsolescence and fluctuations in operating results, over which the Company has little or no control. The Company's quarterly operating results have in the past and may in the future vary significantly depending on factors such as the timing of customer development projects and related orders to purchase the Company's verification products, new product announcements and releases by the Company, and economic conditions generally and in the electronics industry specifically. Other factors which could adversely affect the Company's quarterly operating results in the future include the efficiencies achieved by the Company in managing inventories and fixed assets, the timing of expenditures in anticipation of increased sales, customer product delivery requirements and shortages of components or labor. Many of the Company's customers order on an as-needed basis and often delay delivery of firm purchase orders until their project commencement dates are determined, and as a result, backlog at the beginning of a quarter may not represent a significant percentage of the product sales anticipated in that quarter. Quarterly revenue and operating results will therefore depend on the volume and timing of orders received during the quarter, which are difficult to forecast. Moreover, a significant portion of the Company's revenue in each quarter generally results from shipments during the last few weeks of the quarter. The absence of significant backlog and the concentration of sales at the end of the quarter limit the Company's ability to plan operating expenses and production and inventory levels. In addition, sales of individual systems make up a significant percentage of the Company's quarterly revenue. Therefore, if anticipated shipments in any quarter do not occur or are delayed, expenditure levels could be disproportionately high as a percentage of revenue, and the Company's operating results for that quarter would be adversely affected. As of February 28, 1997, the Company's direct sales and service force consisted of 147 technical, administrative and management employees. The Company has 16 sales and support offices throughout the United States located in Arizona, Colorado, California (three locations), Florida, Georgia, Illinois, Massachusetts (two locations), Minnesota, New Jersey, North Carolina, Oregon and Texas (two locations). Internationally, the Company has six sales and support offices in London, Munich, Osaka, Paris, Stockholm and Yokohama. In Japan, the Company serves its customers through its direct sales and service offices in Yokohama and Osaka. Additionally in Japan, the Company has a hardware maintenance agreement with D Scan Service Co., Ltd. The Company utilizes manufacturer's representatives and other selected distributors in Israel, Japan, Korea, Singapore, Sweden, Taiwan and the U.K. International sales accounted for approximately 37%, 31% and 26% of the Company's revenue in 1996, 1995 and 1994, respectively. Revenue from most international customers is denominated in U.S. dollars. However, receivables from certain other international customers are denominated in local currencies. Such receivables are hedged, where practicable, by foreign exchange contracts to minimize the impact of foreign exchange rate movements on the Company's operating results. The Company plans to continue to expand its international sales and distribution channels. However, there can be no assurance that the Company's products 6 will achieve widespread commercial acceptance in international markets in the future. The Company's future international sales may be subject to additional risks associated with international operations, including currency exchange fluctuations, tariff regulations and requirements for export licenses, which licenses may on occasion be delayed or difficult to obtain. RESEARCH AND DEVELOPMENT The Company will continue to invest in research and development to allow continued innovation in key technology areas, to develop new products and improve existing products to support its current leadership position in the verification market. As of February 28, 1997, the Company's research and development group consisted of 127 full-time employees. Within the research and development organization there were 88 employees with advanced degrees, including 17 with PhD's. Among the technical staff, approximately 70% were involved in software development and the balance in hardware design. During 1996, 1995 and 1994, research and development expenses were $18.6 million, $14.9 million and $12.4 million, respectively. The Company anticipates that it will continue to commit substantial resources to research and development in the future. The EDA industry is characterized by extremely rapid technological change in both hardware and software development, frequent new product introductions and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. The Company's future success will depend upon its ability to enhance its current lines of verification products and to design, develop and support its next-generation verification products on a timely basis that keep pace with technological developments and emerging industry standards. Next-generation verification products must address increasingly sophisticated customer needs, all of which require a high level of expenditures for research and development by the Company. Although the Company is not currently aware of any material limitations on its ability to develop new products which are capable of verifying the next generation of ICs, there can be no assurance that the Company will be successful in developing and marketing product enhancements or new products that respond to technological change or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products, or that its new products and product enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce products in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results and financial condition will be materially and adversely affected. Moreover, from time to time, the Company may announce new products or technologies that have the potential to replace the Company's existing product offerings. There can be no assurance that the announcement of new product offerings will not cause customers to defer purchases of existing Company products, which could adversely affect the Company's results of operations. MANUFACTURING The Company's verification products are complex and are used by the Company's customers in critical development projects which demand a high level of quality and reliability. 7 The Company invests substantial resources to assure the quality and reliability of its verification products and is required to provide a high level of service to its customers in the event of a malfunction to minimize downtime. There can be no assurance that the Company will be able to meet customer requirements for quality and reliability in the future. The Company performs final assembly and test of its emulation products in its Mountain View, California facility. The Company utilizes subcontractors for all major subassembly manufacturing, including all individual printed circuit boards and custom integrated circuits. The Company has a testing and qualification program to ensure that all subassemblies meet the Company's specifications before going into final assembly and test. Certain key components used in the Company's emulation products are presently available from sole or limited sources. The inability to develop alternate sources for these sole or limited source components or to obtain sufficient quantities of these components could result in delays or reductions in product shipments which could adversely affect the Company's operating results. In particular, the Company currently relies on Xilinx Inc. ("Xilinx") for its supply of field programmable gate arrays ("FPGAs"). The Company does not have a long-term supply agreement with Xilinx. If for any reason there were to be a reduction or interruption of supply of these FPGAs to the Company, the Company's results of operations would be materially adversely affected. Although the Company believes that it can obtain FPGAs from alternate sources in the event of a reduction or interruption of supply from Xilinx, a significant amount of time would be required to redesign the Company's emulation systems and software to accommodate an alternate FPGA supplier. In such event, the Company's operating results could be materially adversely affected. The Company currently mitigates this risk by maintaining a supply of FPGAs in inventory in excess of its forecasted requirements; however, there can be no assurance that this measure will be adequate to alleviate any future supply problems. The Company's verification products also use a proprietary IC that is currently manufactured solely by National Semiconductor Corporation, circuit boards that are currently assembled by two outside contractors and subassemblies that are manufactured by several third-party vendors. The Company generally purchases these components pursuant to purchase orders placed from time to time in the ordinary course of business and has no guaranteed supply arrangements with any of these source suppliers. Moreover, the manufacture of these components is extremely complex, and the Company's reliance on the suppliers of these components exposes the Company to production difficulties and quality variations that may be experienced by these suppliers. Therefore, the Company's reliance on its sole and limited source suppliers involves several risks, including a potential inability to obtain an adequate supply of required components, reduced control over pricing, and timely delivery and quality of acceptable components. While the timeliness and quality of deliveries to date from such suppliers have been acceptable, there can be no assurance that problems will not occur in the future. Any prolonged inability to obtain adequate deliveries, or any other circumstances that would require the Company to seek alternative sources of supply, could have a material adverse effect on the Company's operating results and could damage the Company's relationships with its customers. Although the Company's customers often forecast projected requirements considerably in advance of the proposed shipment date, actual orders are typically not received until shortly before the desired shipment date. As a result, backlog at the beginning of a period may not represent a significant percentage of the product sales anticipated for that period. Accordingly, the Company does not consider backlog to be a significant measure of anticipated sales for any 8 future period. However, the Company partially relies on forecasts to determine inventory levels and manufacturing schedules. COMPETITION The EDA industry is highly competitive and rapidly changing. The Company's products are specifically targeted at the emerging portion of this industry relating to advanced verification technology, and to date substantially all of the Company's revenue has resulted from sales in this segment. The Company faces significant competition in advanced verification, in addition to competition from traditional design verification methodologies which rely on the approach of building and then testing complete system prototypes. The Company must continue to educate potential customers with respect to the benefits of emulation and cycle-based simulation in order for such customers to adopt the Company's advanced verification systems as a complement to standard simulation tools. Further, because of the requirement for a design verification methodology which reduces the number of costly design iterations and improves product quality, the Company expects competition in the market for advanced verification to increase as other companies attempt to introduce their products and product enhancements. Moreover, the Company competes with established EDA companies that have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and larger installed customer bases than the Company. In addition, many of these competitors have established relationships with current and potential customers of the Company. Increased competition could result in price reductions, reduced margins and loss of market share, all of which could materially adversely affect the Company. Further, the Company competes with the design engineers of its existing and potential customers, who sometimes develop customized prototyping solutions for their particular needs. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, operating results and financial condition. In addition, competitors may resort to litigation as a means of competition. Such litigation may result in substantial costs to the Company and significant diversion of management time. In 1995, Mentor Graphics Corporation ("Mentor") filed suit against the Company for declaratory judgment of noninfringement, invalidity and unenforceability of several of the Company's patents. Six of the Company's patents are now involved in the dispute, and the Company has filed counterclaims against Mentor and Mentor's French subsidiary, Meta Systems ("Meta"), for infringement and threatened infringement of those six patents. Furthermore, in January 1996, the Company filed a complaint with the International Trade Commission seeking to stop unfair importation of hardware logic emulation systems manufactured by Meta on the grounds that such systems infringe the Company's patents. There can be no assurance as to the outcome of these matters. See "---Item 3. Legal Proceedings." Although patent and intellectual property disputes in the EDA industry are often settled through licensing, cross-licensing or similar arrangements, costs associated with such litigation and arrangements may be substantial. 9 PROPRIETARY RIGHTS The Company's success and ability to compete is dependent in part upon its proprietary technology. While the Company relies on patent, trademark, trade secret and copyright law to protect its technology, the Company also believes that factors such as the technological and creative skills of its personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are essential to establishing and maintaining a technology leadership position. The Company currently holds 15 U.S. patents, of which one is co-owned, and has 18 patent applications on file at the U.S. Patent and Trademark Office. The Company's U.S. patents expire between 2008 and 2014. The Company also holds six corresponding foreign patents and 24 foreign patent applications pending. The six foreign patents expire in 2009, except for one patent that expires in 2105. However, there can be no assurance that any patent owned by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications, whether or not being currently challenged by applicable governmental patent examiners, will be issued with the scope of the claims sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology, or design around the patents owned by the Company. The source code for the Company's proprietary software is protected both as a trade secret and as an unpublished copyrighted work. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products or technology without authorization, or to develop similar technology independently. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. The Company generally enters into confidentiality or license agreements with its employees, distributors and customers, and limits access to and distribution of its software, documentation and other proprietary information. Nevertheless, there can be no assurance that the steps taken by the Company will prevent misappropriation of its technology. In addition, litigation has been necessary in the past to enforce the Company's patents and may be necessary in the future to enforce the Company's patents and other intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. See "---Competition" and "---Item 3, Legal Proceedings." Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. From time to time the Company has received, and may receive in the future, notice of claims of infringement of other parties' proprietary rights. Although the Company does not believe that its products infringe the proprietary rights of any third parties, there can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted against the Company or that any such assertions will not materially adversely affect the Company's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, the Company 10 could incur significant costs with respect to the defense thereof which could have a material adverse effect on the Company's business, financial condition or results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances, a license would be available under reasonable terms or at all. The Company also relies on certain software which it licenses from third parties, including software which is integrated with internally developed software and used in the Company's verification products to perform key functions. There can be no assurance that these third party software licenses will continue to be available to the Company on commercially reasonable terms. The loss of or inability to maintain any of these software licenses could result in delays or reductions in product shipments until equivalent software could be identified, licensed and integrated, which would adversely affect the Company's operating results. EMPLOYEES As of February 28, 1997, the Company had a total of 369 employees, of whom 330 were based in the United States and 39 were based overseas. Of the total, 164 were engaged in sales, marketing and related customer support services, 127 were in research and development, 54 were in manufacturing and 24 were in finance and administration. The Company's performance is substantially dependent on the performance of its executive officers, some of whom have worked together for only a short period of time. Furthermore, the loss of the services of any of its executive officers or other key employees could have a material adverse effect on the Company. The Company does not maintain key person life insurance policies on the lives of its key officers or key personnel, all of whom are important to the Company's future success. The Company's future success also depends on its continuing ability to attract and retain highly qualified technical and managerial personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be able to retain its key managerial and technical employees or that it will be able to attract, assimilate or retain other highly qualified technical and managerial personnel in the future. The inability of the Company to attract and retain the necessary technical personnel in the future could impair the development of new products and have a material adverse effect upon the Company's business, operating results and financial condition. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages and considers its relations with its employees to be good. ITEM 2. PROPERTIES. The Company's principal administrative, sales, marketing, manufacturing and research and development facility is located in five buildings totaling approximately 126,000 square feet in Mountain View, California that have leases expiring at various times from November 1998 through June 2002. The Company has fifteen other domestic sales and service offices throughout the United States. The Company also leases international sales and service offices in London, Munich, Osaka, Paris, Stockholm and Yokohama. The Company expects that it will be able to renew its leases on satisfactory terms. The Company believes that its existing facilities are adequate for its current needs and that additional space will be available as needed. However, the Company anticipates moving its headquarters in late 1997 to larger facilities located in San Jose, California. 11 ITEM 3. LEGAL PROCEEDINGS. In January 1995, the Company and certain of its officers and directors were named in a securities class action filed in the United States District Court for the Northern District of California. The complaint seeks unspecified damages and related fees and costs. In September 1995, the Court dismissed with prejudice all claims against several defendants, including the Company's outside directors. The Court also dismissed with prejudice many of the allegations and claims asserted against the Company and certain of its officers. While the Company believes that it has meritorious defenses to the claims remaining in the action, the Company has entered into a Stipulation of Settlement with plaintiffs in order to conserve legal expenses and management resources. The Company's contribution to the proposed $2.75 million settlement, net of insurance proceeds, is not material. The proposed settlement has been preliminarily approved by the Court but remains subject to the Court's final approval. There can be no assurance that the Company will in fact succeed in obtaining final Court approval of the proposed settlement with the plaintiffs. In the event the Court does not grant final approval of the settlement, the Company will continue to contest this action vigorously. While the outcome of the action in the absence of the proposed settlement cannot be predicted with certainty, management does not believe the outcome will have a material adverse impact on the Company's financial position or results of operations. Additionally, in January 1996, the Company filed a complaint with the International Trade Commission (the "ITC") in Washington, DC, seeking to stop unfair importation of logic emulation systems manufactured by Meta Systems, a subsidiary of Mentor. In the complaint, the Company alleges that Mentor's hardware logic emulation systems infringe the Company's patents. In July 1996, the ITC Administrative Law Judge issued an Initial Determination granting a Temporary Exclusion Order stopping the importation of Mentor's emulation systems into the U.S., absent the posting of a bond by Mentor. The ITC Initial Determination included a Cease and Desist Order against all sales activities of the Mentor emulation products into the U.S. In August 1996, the ITC ratified the judges's Initial Determination. The Company is continuing its legal efforts with the ITC to obtain a permanent Exclusion Order prohibiting the importation of Mentor's emulation products into the U.S. The Company also is engaged in a Federal District Court case with Mentor and Meta involving six of the Company's patents. Mentor and Meta are seeking a declaratory judgment of noninfringement, invalidity and unenforceability of the patents in dispute, and the Company has filed counteractions against Mentor and Meta for infringement and threatened infringement of the six patents. Mentor has also claimed in this Federal District Court case that press releases issued by the Company were defamatory and interfered with Mentor's business advantage. Additionally, Aptix Corporation recently filed a suit against the Company alleging various violations of the antitrust laws and unfair competition. The Company does not believe that these claims are meritorious and plans to mount a vigorous defense against them. The outcome of these actions cannot be predicted with certainty. The Company is engaged in certain other legal and administrative proceedings incidental to its normal business activities. While it is not possible to determine the ultimate outcome of these actions at this time, management believes that any liabilities resulting from such proceedings, or claims which are pending or known to be threatened, will not have a material adverse effect on the Company's consolidated financial position or results of operations. 12 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1996. EXECUTIVE OFFICERS AND VICE PRESIDENTS OF THE COMPANY The executive officers and vice presidents of the Company and their ages as of March 1, 1997, are as follows:
Name Age Position - ---- --- -------- Keith R. Lobo . . . . . . . . . . . . . 45 President, Chief Executive Officer and Director Raymond K. Ostby . . . . . . . . . . . . 49 Vice President, Finance and Administration, Chief Financial Officer and Secretary K. C. Chu. . . . . . . . . . . . . . . . 50 Vice President, Software Development Bernard A. Gilbert . . . . . . . . . . . 40 Vice President, Engineering Operations, Advanced Simulation Division Jeffrey K. Jordan . . . . . . . . . . . 52 Vice President, North American Sales Kevin L. Ladd. . . . . . . . . . . . . . 34 Vice President and Chief Technologist, Advanced Simulation Division Alexander M. Levi. . . . . . . . . . . . 39 Vice President, Asia-Pacific Sales Donald J. McInnis . . . . . . . . . . . 50 Senior Vice President, Advanced Simulation Division Harlen Ng. . . . . . . . . . . . . . . . 56 Vice President, Program Development Stephen P. Sample. . . . . . . . . . . . 45 Vice President, Advanced Development Dugald H. Stewart. . . . . . . . . . . . 44 Vice President, Manufacturing Christopher J. Tice. . . . . . . . . . . 37 Vice President, World-Wide Support Services Tung-sun Tung. . . . . . . . . . . . . . 48 Vice President, Research and Development Ming Yang Wang . . . . . . . . . . . . . 52 Vice President, Advanced Technology Solutions Naeem Zafar. . . . . . . . . . . . . . . 39 Vice President, Marketing
The Company's executive officers and vice presidents are appointed by, and serve at the discretion of the Board of Directors. Each executive officer and vice president is a full time employee of the Company. There is no family relationship among any executive officer, vice president or director of the Company. Keith R. Lobo joined the Company in November 1992 as President, Chief Executive Officer and as a Director. From March 1992 to October 1992, Mr. Lobo served as a consultant in the venture capital field and was a private investor. From March 1988 to February 1992, he served as Executive Vice President and Chief Operating Officer of Chips & Technologies, Inc., a semiconductor supplier of microcomputer components to the personal computer industry. From August 1981 to March 1988, he served in a variety of positions, most recently as Vice President of Advanced Products and General Manager of the RISC Microprocessor Group at LSI Logic Corporation, a supplier of ASICs. 13 Raymond K. Ostby joined the Company in September 1993 as Vice President, Finance and Administration, Chief Financial Officer and Secretary. From July 1991 to September 1993, he served as Vice President, Finance and Administration and Chief Financial Officer at Force Computers, Inc., a computer products company. From June 1985 to July 1991, he served as Vice President, Finance and Administration and Chief Financial Officer of Atmel Corporation, a manufacturer of semiconductor products. K.C. Chu joined the Company in June 1995 as Vice President, Entry Systems and HDL-ICE Development and has served as Vice President, Software Development since January 1996. From July 1992 to June 1995, he served as Director, Sunnyvale Research and Development Lab of Mitsubishi Electric Research Labs, Inc., a research and development facility, and from May 1990 to June 1992, he served as a Senior Manager, Research and Development at Mitsubishi Electronics America, Inc., a supplier of semiconductor products. Bernard A. Gilbert has served as Vice President, Engineering Operations of the Advanced Simulation Division of the Company from February, 1997. From March 1996 to February 1997 he was Vice President, Engineering Operations at SpeedSim, Inc., a provider of cycle-based simulation technology, and from March 1985 to March 1996, he served as Director of Core Technology Research and Development at ComputerVision Corp., a provider of CAD/CAM software services. Jeffrey K. Jordan has served as Vice President, North American Sales since October 1996. From May 1994 to October 1996 he was Eastern Area Sales Director and from April 1993 to May 1994 he served as Eastern Area Sales Manager. From August 1989 to April 1993, Mr. Jordan served as Regional Service Manager at Integrated Measurement Systems, a provider of test station hardware and software. Kevin L. Ladd has served as Vice President and Chief Technologist of the Advanced Simulation Division of the Company from February 1997. From June 1994 to February 1997 he served as Chairman and Vice President of Research and Development of SpeedSim, Inc. Mr. Ladd was a consulting engineer for ViewLogic Systems, Inc., a provider of software products used in IC design and simulation from August 1992 to December 1993. From May 1982 to August 1992 he served in a variety of positions most recently as Principal Engineer, at Digital Equipment Corporation, a manufacturer of computer systems and software. Alexander M. Levi has served as Vice President, Asia-Pacific Sales from November 1996. Previously, he was Director, Asia Sales from January 1995 to November 1996. Mr. Levi joined the Company in February 1991 and served as Account Manager until December 1994. Donald J. McInnis has served as Senior Vice President, Advanced Simulation Division of the Company from February, 1997. From June 1994 to February 1997, he served as President and Chief Executive Officer of SpeedSim, Inc. From May 1990 to February 1994, Mr. McInnis was Vice President and General Manager, Software Business Unit of ComputerVision Corporation, a provider of CAD/CAM software services. Harlen Ng has served as Vice President, Program Development since August 1995. From January 1995 to August 1995, he was Vice President of Systems Engineering Assurance, and from August 1991 to January 1995, he served as Director, Engineering Operations for PiE Design Systems ("Pie"), a provider of emulation systems for system-level verification. From November 14 1983 to July 1991, Mr. Ng served in a variety of positions at Cadence Design Systems, Inc., a provider of automation tools used in IC design, most recently as Director, Customer Support. Stephen P. Sample co-founded the Company and served as Director, Hardware Design from its inception in July 1987. In July 1993, he became Vice President, Hardware Design, and since August 1994 he has served as Vice President, Advanced Development. Dugald H. Stewart joined the Company in January 1989 as Director of Manufacturing, and has served as Vice President, Manufacturing since June 1993. From August 1979 to January 1989, he served as Director of Manufacturing at KLA Instruments, Inc., a semiconductor equipment manufacturer. Christopher J. Tice has served as Vice President, World-Wide Support Services since March 1995. Previously he was Director, World-Wide Support Services from June 1993 to March 1995. From November 1991 to June 1993, Mr. Tice served as Director, Support for PiE. From November 1985 to November 1991, he served as General Manager, Processor Business Group at Weitek, a provider of enhancement processors and controllers. Tung-sun Tung has served as Vice President, Research and Development from January 1996, and as Vice President , Emulation System Development from October 1994 to January 1996. From June 1993 to October 1994, he was Director, Hardware Design. From October 1991 to June 1993, he served as Director, Manufacturing at PiE. From April 1988 to October 1991, he was Director, Engineering at NetFRAME Systems, Inc., a designer and manufacturer of fault tolerant servers. Ming Yang Wang has served as Vice President, Advanced Technology Solutions from December 1996, and as Director, Solutions Development from July 1993 to December 1996. From April 1990 to July 1993, Mr. Wang was Program Manager at PiE. Naeem Zafar joined the Company in June 1988 and has served as Vice President, Marketing since September 1995. From March 1995 to September 1995, he was Vice President, Technology Strategy and Planning, from December 1994 to March 1995, he was Director, Advanced Products, and from June 1993 to December 1994, Mr. Zafar was Director, Marketing. From April 1992 to June 1993, he was Director, Product Marketing, from October 1990 to April 1992, he was Senior Product Marketing Manager, from April 1989 to October 1990, he was Technical Marketing Manager, and from June 1988 to April 1989, he was Senior Hardware Engineer. 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required by this item is incorporated by reference to the section entitled "Selected Consolidated Financial Data" on page 17 of the Company's 1996 Annual Report to Stockholders. ITEM 6. SELECTED FINANCIAL DATA. The information required by this item is incorporated by reference to the section entitled "Financial Highlights" on page 1 of the Company's 1996 Annual Report to Stockholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information required by this item is incorporated by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 18 through 22 of the Company's 1996 Annual Report to Stockholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by this item is incorporated by reference to the Consolidated Financial Statements, related notes thereto and Report of Independent Accountants on pages 23 through 37 of the Company's 1996 Annual Report to Stockholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. With the exception of the information incorporated by reference from the 1996 Annual Report to Stockholders in Parts II and IV of this Form 10-K, the Company's Annual Report to Stockholders is not to be deemed filed as part of this Report. 16 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY. The information required by this item concerning the Company's directors is incorporated by reference to the information set forth in the section entitled "Proposal No. 1: Election of Directors" in the Company's Proxy Statement for the 1997 Annual Meeting of Stockholders filed with the Commission on March 4, 1997 (the "1997 Proxy Statement"). The information required by this item concerning the executive officers of the Company is incorporated by reference to the information set forth in the section entitled "Executive Officers and Vice Presidents of the Company" at the end of Part I of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. The information required by this item regarding executive compensation is incorporated by reference to the information set forth in the section entitled "Executive Officer Compensation" in the Company's 1997 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth in the section entitled "Beneficial Security Ownership of Management and Certain Beneficial Owners" in the Company's 1997 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Not applicable. 17 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this Form 10-K. 1. FINANCIAL STATEMENTS. The following consolidated financial statements of the Company and the Report of Independent Accountants are incorporated by reference to pages 23 through 37 of the Company's 1996 Annual Report to Stockholders. Report of Coopers & Lybrand L.L.P., Independent Accountants Consolidated Balance Sheets as of December 31, 1996 and 1995 Consolidated Statements of Income for the Years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1995 and 1994 Notes to the Consolidated Financial Statements 2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedules of the Company for the years ended December 31, 1996, 1995 and 1994 are filed as part of this Form 10-K and should be read in conjunction with the Consolidated Financial Statements, and related notes thereto, of the Company. Schedule Title Page -------- ----- ---- Report of Independent Accountants on S-1 Financial Statement Schedule II Valuation and Qualifying Accounts S-2 Schedules other than those listed above have been omitted since they are either not required, not applicable, or the information is otherwise included. 3. EXHIBITS: The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Form 10-K. (b) REPORT ON FORM 8-K. No reports on Form 8-K were filed by the Company during the last quarter of the fiscal year ended December 31, 1996. 18 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on this 25th day of March 1997. QUICKTURN DESIGN SYSTEMS, INC. By: /s/ RAYMOND K. OSTBY ------------------------------------------- Raymond K. Ostby, Vice President, Finance and Administration, Chief Financial Officer and Secretary POWER OF ATTORNEY KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Keith R. Lobo and Raymond K. Ostby and each of them, jointly and severally, his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signatures Title Date - --------------------------- ------------------------------------- -------------- /s/ KEITH R. LOBO President and Chief Executive Officer March 25, 1997 - --------------------------- (Principal Executive Officer) Keith R. Lobo /s/ RAYMOND K. OSTBY Vice President, Finance and March 25, 1997 - --------------------------- Administration, Chief Financial Raymond K. Ostby Officer and Secretary (Principal Financial and Accounting Officer) /s/ GLEN M. ANTLE Chairman of the Board March 25, 1997 - --------------------------- Glen M. Antle /s/ RICHARD C. ALBERDING Director March 25, 1997 - --------------------------- Richard C. Alberding /s/ FRANK J. CAUFIELD Director March 25, 1997 - --------------------------- Frank J. Caufield /s/ MICHAEL R. D'AMOUR Director March 25, 1997 - --------------------------- Michael R. D'Amour /s/ YEN-SON (PAUL) HUANG Director March 25, 1997 - --------------------------- Yen-Son (Paul) Huang /s/ DR. DAVID K. LAM Director March 25, 1997 - --------------------------- Dr. David K. Lam
19 REPORT OF INDEPENDENT ACCOUNTANTS Our report on the consolidated financial statements of Quickturn Design Systems, Inc. has been incorporated by reference in this Form 10-K from page 37 of the 1996 Annual Report to Stockholders of Quickturn Design Systems, Inc. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 18 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material aspects, the information required to be included therein. /s/ COOPERS & LYBRAND L.L.P. San Jose, California January 16, 1997 S-1 SCHEDULE II - PURSUANT TO REGULATION S-X RULE 12-09 QUICKTURN DESIGN SYSTEMS, INC. Valuation and Qualifying Accounts (in thousands)
Deductions Balance Balance at Additions (Charges at Beginning (Charges to Against End Description of Period Expenses) Reserves) of Period - ----------------------------------------- ---------- ------------ ----------- --------- Year ended December 31, 1994 Allowance for doubtful accounts $ 730 $ 1,110 $ ---- $ 1,840 ------- -------- -------- -------- ------- -------- -------- -------- Year ended December 31, 1995 Allowance for doubtful accounts $ 1,840 $ ----- $ ---- $ 1,840 ------- -------- -------- -------- ------- -------- -------- -------- Year ended December 31, 1996 Allowance for doubtful accounts $ 1,840 $ ----- $ ---- $ 1,840 ------- -------- -------- -------- ------- -------- -------- --------
S-2 QUICKTURN DESIGN SYSTEMS, INC. ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED DECEMBER 31, 1996 INDEX TO EXHIBITS Exhibit Number Description - ------- ------------------------------------------------------------------------ 2.1 Agreement and Plan of Reorganization dated January 16, 1997 among the Company, SpeedSim, Inc. and QT Corporation. (4) 3.1 Certificate of Incorporation of Registrant, as amended. (1) 3.2 Bylaws of Registrant. (1) 4.1 Form of Registrant's Common Stock certificate. (1) 10.1 Form of Indemnification Agreement entered into by Registrant with each of its directors and executive officers. (1) (2) 10.2 1988 Stock Option Plan and related agreements. (1) (2) 10.3 Key Executive Stock Option Plan and related agreements. (1) (2) 10.4 1993 Employee Qualified Stock Purchase Plan and related agreements. (1) (2) 10.5 Software License Agreement dated December 18, 1987 between Xilinx, Inc. and Registrant. (1) 10.6 Leases dated March 17, 1993 between MV 440, Inc. and Registrant. (1) 10.7 Revolving Credit Loan Agreement dated November 30, 1995 between Comerica Bank-California and Registrant. (6) 10.8 Offer letter dated November 4, 1992 between Keith R. Lobo and Registrant, as amended. (1) (2) 10.9 1994 Outside Director Stock Option Plan. (3) 10.10 SpeedSim, Inc. 1995 Incentive and Nonqualified Stock Option Plan. (2) (5) 10.11 1996 Supplemental Stock Plan (2) (7) -i- Exhibit Number Description - ------- ------------------------------------------------------------------------ 11.1 Statement of computation of earnings per share. 13.1 Portions of 1996 Annual Report to Stockholders expressly incorporated by reference herein. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Coopers & Lybrand L.L.P., Independent Accountants. 24.1 Power of Attorney (see page 19). 27.1 Data Schedule (EDGAR) __________________________________ (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (Reg. No. 33-71022), which became effective on December 15, 1993. Except as noted, each exhibit listed in this index is incorporated by reference to the exhibit of the same number. (2) Indicates management compensatory plan, contract or arrangement. (3) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (Reg. No. 33-82452), which became effective on August 5, 1994. (4) Incorporated by reference from the Registrant's Current Report on Form 8-K filed February 21, 1997. (5) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (Reg. No. 333-21587), which became effective on February 11, 1997. (6) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. (7) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (Reg. No. 333-18407), which became effective on December 20, 1996. -ii- EX-11.1 2 EXHIBIT 11.1 Exhibit 11.1 QUICKTURN DESIGN SYSTEMS, INC. COMPUTATION OF EARNINGS PER SHARE (1) (in thousands, except per share amount)
Year Ended December 31, --------------------------------- 1996 1995 1994 --------- -------- -------- Weighted average shares outstanding: Common stock 13,872 13,359 12,816 Common stock equivalents 1,332 1,246 1,534 --------- -------- -------- Weighted average common shares and equivalents 15,204 14,605 14,350 --------- -------- -------- --------- -------- -------- Net income (loss) $ 12,639 $ 13,083 $ 4,601 --------- -------- -------- --------- -------- -------- Net income (loss) per share (2) $ 0.83 $ 0.90 $ 0.32 --------- -------- -------- --------- -------- --------
________________ (1) This schedule should be read with Notes 2 and 10 of the Notes to Consolidated Financial Statements. (2) There is no difference between primary and fully diluted net income (loss) per share. EX-13.1 3 EXHIBIT 13.1 EXHIBIT 13.1 1996 ANNUAL REPORT TO STOCKHOLDERS QUICKTURN DESIGN SYSTEMS, INC. FINANCIAL HIGHLIGHTS - ------------------------------------------------------------------------------ (AMOUNTS IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AND EMPLOYEE DATA)
For the Fiscal Year 1992 1993 1994 1995 1996 - ------------------- --------- --------- --------- --------- ---------- Total revenue $ 25,779 $ 54,865 $ 65,523 $ 81,800 $ 104,370 Net income (loss) (5,467) (5,356) 4,601 * 13,083 ** 12,639 Net income (loss) per share (1.07) (0.63) 0.32 * 0.90 ** 0.83 Total revenue by geographic area North America 21,858 40,872 48,594 56,107 65,716 Asia-Pacific 3,852 8,940 9,336 16,449 29,920 Europe 69 5,053 7,593 9,244 8,734 --------- --------- --------- --------- ---------- Total $ 25,779 $ 54,865 $ 65,523 $ 81,800 $ 104,370 --------- --------- --------- --------- ---------- --------- --------- --------- --------- ---------- At Year End - ----------- Working capital $ 11,632 $ 33,927 $ 34,998 $ 43,538 $ 47,205 Total assets $ 25,352 $ 56,199 $ 77,349 $ 92,784 $ 108,853 Long-term debt $ 938 $ 3,487 $ 3,819 $ 3,502 --- Stockholders' equity $ 15,368 $ 38,296 $ 49,895 $ 65,627 $ 81,786 Employees 122 177 244 272 333
* The 1995 results include a net year-to-date tax benefit of $3.7 million or $0.26 per share. ** The 1996 results include a net year-to-date tax benefit of $542,000 or $0.03 per share. TOTAL REVENUES STOCKHOLDERS' EQUITY WORKING CAPITAL EMPLOYEES (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) 1992 $ 25,779 1992 $ 15,368 1992 $ 11,632 1992 122 1993 $ 54,865 1993 $ 38,296 1993 $ 33,927 1993 177 1994 $ 65,523 1994 $ 49,895 1994 $ 34,998 1994 244 1995 $ 81,800 1995 $ 65,627 1995 $ 43,538 1995 272 1996 $104,370 1996 $ 81,786 1996 $ 47,205 1996 333 QUICKTURN DESIGN SYSTEMS, INC. SELECTED CONSOLIDATED FINANCIAL DATA (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) UNAUDITED
Quarter Ended -------------------------------------------------------------------- Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 1996 1996 1996 1996 1995 1995 1995 1995 --------- ------- ------- -------- -------- -------- ------- ------- Total revenue $28,786 $27,151 $25,339 $23,094 $23,000 $21,200 $19,600 $18,000 Cost of revenue 8,934 8,464 7,854 7,131 7,012 6,510 6,013 5,547 --------- ------- ------- -------- -------- -------- ------- ------- Gross profit 19,852 18,687 17,485 15,963 15,988 14,690 13,587 12,453 Operating expenses Research & development 5,226 4,837 4,408 4,077 4,152 3,872 3,576 3,264 Sales & marketing 8,069 7,987 7,627 7,011 7,004 6,512 6,141 5,782 General & administrative 1,751 1,655 1,604 1,466 1,216 1,232 1,169 1,064 --------- ------- ------- -------- -------- -------- ------- ------- Total operating expenses 15,046 14,479 13,639 12,554 12,372 11,616 10,886 10,110 Operating income 4,806 4,208 3,846 3,409 3,616 3,074 2,701 2,343 Interest and other, net 505 510 467 303 192 225 167 153 --------- ------- ------- -------- -------- -------- ------- ------- Net income before provision for (benefit from) income taxes 5,311 4,718 4,313 3,712 3,808 3,299 2,868 2,496 Provision for (benefit from) income taxes 1,216 1,555 1,421 1,223 (2,778) 825 717 624 --------- ------- ------- -------- -------- -------- ------- ------- Net income $4,095 $3,163 $2,892 $2,489 $6,586 $2,474 $2,151 $1,872 --------- ------- ------- -------- -------- -------- ------- ------- --------- ------- ------- -------- -------- -------- ------- ------- Net income per share $0.26 $0.21 $0.19 $0.17 $0.45 $0.17 $0.15 $0.13 --------- ------- ------- -------- -------- -------- ------- ------- --------- ------- ------- -------- -------- -------- ------- ------- Number of shares used in per share calculations 15,583 15,228 15,171 14,832 14,735 14,741 14,552 14,390 --------- ------- ------- -------- -------- -------- ------- ------- --------- ------- ------- -------- -------- -------- ------- ------- Market price range: High $21.63 $15.13 $16.50 $11.50 $11.13 $12.00 $10.38 $12.75 Low $11.75 $11.88 $11.13 $ 9.00 $ 9.00 $8.88 $ 7.88 $ 6.50 - ------------------------------------------------------------------------------------------------------ (AS A PERCENTAGE OF TOTAL REVENUE) Quarter Ended ----------------------------------------------------------------- Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 1996 1996 1996 1996 1995 1995 1995 1995 --------- ------- ------- -------- -------- -------- ------- ------- Total revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenue 31.0% 31.2% 31.0% 30.9% 30.5% 30.7% 30.7% 30.8% --------- ------- ------- -------- -------- -------- ------- ------- Gross profit 69.0% 68.8% 69.0% 69.1% 69.5% 69.3% 69.3% 69.2% Operating expenses Research & development 18.2% 17.8% 17.4% 17.7% 18.0% 18.3% 18.2% 18.2% Sales & marketing 28.0% 29.4% 30.1% 30.3% 30.5% 30.7% 31.3% 32.1% General & administrative 6.1% 6.1% 6.3% 6.3% 5.3% 5.8% 6.0% 5.9% --------- ------- ------- -------- -------- -------- ------- ------- Total operating expenses 52.3% 53.3% 53.8% 54.3% 53.8% 54.8% 55.5% 56.2% Operating income 16.7% 15.5% 15.2% 14.8% 15.7% 14.5% 13.8% 13.0% Interest and other, net 1.7% 1.9% 1.8% 1.3% 0.8% 1.1% 0.8% 0.9% --------- ------- ------- -------- -------- -------- ------- ------- Net income before provision for (benefit from) income taxes 18.4% 17.4% 17.0% 16.1% 16.5% 15.6% 14.6% 13.9% Provision for (benefit from) income taxes 4.2% 5.8% 5.6% 5.3% (12.1%) 3.9% 3.6% 3.5% --------- ------- ------- -------- -------- -------- ------- ------- Net income 14.2% 11.6% 11.4% 10.8% 28.6% 11.7% 11.0% 10.4% --------- ------- ------- -------- -------- -------- ------- ------- --------- ------- ------- -------- -------- -------- ------- -------
The Company's common stock is traded on the over-the-counter market on the Nasdaq National Market under the symbol "QKTN." As of December 31, 1996 there were approximately 209 stockholders of record and an estimated 6,000 additional stockholders who held stock in "street name." 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Quickturn Design Systems, Inc. (the "Company") designs, manufactures, sells and supports products that provide system-level verification solutions for the design of integrated circuits and electronic systems. The Company currently derives a substantial majority of its revenue from its System Realizer product and related maintenance and consulting services. Quickturn's products serve the needs of IC and systems design engineers in a variety of markets including computers, workstations and PCs, telecommunications, semiconductor, microprocesser and multimedia graphics. The Company began operations in 1987 and commenced shipments in 1989. In 1996, the Company introduced two new software products, Quest II and HDL-ICE 2.0 to enable customers to more quickly and easily compile their IC designs. On February 7, 1997, the Company acquired SpeedSim, Inc. ("SpeedSim"), a provider of cycle-based simulation software for the verification of digital logic designs (the "SpeedSim Merger") for 2.8 million shares of Quickturn common stock. The acquisition was accounted for as a pooling of interests. The Company estimates that it will incur direct transaction costs of at least $1.2 million associated with the acquisition, which will be charged to operations during the quarter ending March 31, 1997. See Note 15 of the Notes to Consolidated Financial Statements. RESULTS OF OPERATIONS The following table sets forth certain financial data from the Company's consolidated statements of operations as a percentage of revenue: Year Ended December 31, ----------------------------- 1996 1995 1994 ----------------------------- Total revenue 100.0% 100.0% 100.0% Cost of revenue 31.0% 30.7% 30.9% ----------------------------- Gross margin 69.0% 69.3% 69.1% Operating expenses Research and development 17.8% 18.2% 18.9% Sales and marketing 29.4% 31.1% 32.4% General and administrative 6.2% 5.7% 11.6% ----------------------------- Total operating expenses 53.4% 55.0% 62.9% Operating income 15.6% 14.3% 6.2% Interest and other, net 1.7% 0.9% 1.4% ----------------------------- Net income before provision for (benefit from) income taxes 17.3% 15.2% 7.6% Provision for (benefit from) income taxes 5.2% (0.8%) 0.6% ----------------------------- Net income 12.1% 16.0% 7.0% ----------------------------- ----------------------------- TOTAL REVENUE Total revenue increased by $22.6 million, or 28%, to $104.4 million in 1996 over 1995 compared with an increase of $16.3 million, or 25%, in 1995 over 1994. The total revenue growth in both 1996 and 1995 was primarily attributable to increased sales of greater emulation capacity. System Realizer product revenue accounted for 71% and 66% of total revenue in 1996 and 1995, respectively, while previous generation emulation products accounted for 65% of total revenue in 1994. Maintenance revenue for all products accounted for 16%, 14% and 13% of total revenue in 1996, 1995 and 1994, respectively. On a price per logic gate basis, both product costs and the average price for an emulation system with equivalent capacity decreased due to increased efficiency of reprogrammable system components and lower component costs. 18 Domestic revenue (North American sales) grew by 17%, 15% and 19%, while international revenue grew by 50%, 52% and 21% in 1996, 1995 and 1994, respectively. International sales accounted for approximately 37%, 31% and 26% of total revenue in 1996, 1995 and 1994, respectively. The increase in international sales was largely due to revenue growth in the Asia-Pacific markets, which increased by 82% to $29.9 million in 1996, and by 76% to $16.4 million in 1995. Revenue from most international customers is denominated in U.S. dollars. However, receivables from certain other international customers are denominated in local currencies. Such receivables are hedged, where practicable, by forward exchange contracts to minimize the impact of foreign exchange rate movements on the Company's operating results. See Note 2 of the Notes to Consolidated Financial Statements. There can be no assurance that fluctuations in the currency exchange rates in the future will not have a material adverse impact on the receivables derived from foreign currency denominated sales and thus the Company's operating results and financial condition. Many of the Company's customers order on an as-needed basis and often delay delivery of firm purchase orders until the commencement dates of such customers' development projects are determined. Moreover, a significant portion of the Company's total revenue in each quarter generally results from shipments in the last few weeks of the quarter; therefore, a delay in the shipment of a few orders can have a significant impact upon total revenue and results of operations in a given quarter. A relatively limited number of customers have historically accounted for a substantial portion of the Company's revenue. These customers represent early adopters of emulation technology, typically for the design of complex integrated circuits. In particular, the Company's top ten customers represented 51%, 48% and 46% of total revenue in 1996, 1995 and 1994, respectively. One customer, Fujitsu, comprised 13% of the Company's total revenue in 1996, and no customer individually comprised more than 10% of the Company's total revenue in 1995 and 1994. The Company expects that sales of its products to a relatively limited number of customers will continue to account for a high percentage of revenue for the foreseeable future. The loss of a major customer or any reduction in orders by such a customer could have an adverse effect on the Company's financial condition or results of operations. The Company believes that in the future its results of operations in a quarterly period could be impacted by the timing of customer development projects and related purchase orders for the Company's emulation systems, new product announcements and releases by the Company, and economic conditions generally and in the electronics industry specifically. The Company recognizes revenue from sales of its emulation products and services when all substantial conditions have been met, including shipment to the customer, fulfillment of acceptance terms, if any, and completion of all significant contractual terms. Maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically twelve months. Maintenance contracts are typically renewed annually. Warranty and similar costs related to post-contract customer support are accrued at the time of sale. GROSS MARGINS Cost of revenue includes materials, labor and overhead incurred in the manufacture of emulation systems as well as the cost of providing service and maintenance. Gross margins were approximately 69% of total revenue in each of the fiscal years 1996, 1995 and 1994. The Company was able to maintain its gross margins primarily due to a sufficiently large revenue base over which to spread fixed costs, and to continued manufacturing efficiencies, somewhat offset by a decreasing average price per logic gate. The Company expects competitive pressures to increase in its market from existing companies and new entrants, which among other things could accelerate the trend of such decreasing average price per logic gate. Accordingly, there can be no assurance that the Company will be able to sustain its recent gross margins. Furthermore, to the extent that the Company's cost reduction goals are achieved, any resulting cost savings that are passed on to the Company's customers may also have an adverse effect on gross margins. RESEARCH AND DEVELOPMENT Research and development expenses increased to $18.5 million in 1996 compared to $14.9 million in 1995 and $12.4 million in 1994. These increases were primarily attributable to increased staffing and equipment costs necessary to enhance current products and research and development activities for the next generation emulation products. Research and development expenses as a percentage of total revenue were approximately 18%, 18% and 19% in 1996, 1995 and 1994, respectively. The Company expects to continue to invest a significant amount of its resources in research and development. 19 SALES AND MARKETING Sales and marketing expenses were $30.7 million in 1996 compared to $25.4 million in 1995 and $21.2 million in 1994. Sales and marketing expenses increased in each period due to the expansion of the Company's marketing and sales organizations and higher sales commissions associated with increased revenue. As a percentage of total revenue, sales and marketing expenses were approximately 29%, 31% and 32% in 1996, 1995 and 1994, respectively. The Company expects that sales and marketing expenses will continue to increase in absolute dollar amounts as the Company expands its sales and marketing efforts. GENERAL AND ADMINISTRATIVE General and administrative expenses were $6.5 million in 1996 compared to $4.7 million in 1995 and $7.6 million in 1994. The increase in general and administrative expenses in 1996 was primarily attributable to increased legal costs related to a patent infringement lawsuit filed by the Company in January 1996. See Note 14 of the Notes to Consolidated Financial Statements. The Company expects general and administrative expenses to increase in 1997 due primarily to continued legal costs associated with the lawsuit. General and administrative expenses in 1994 included a $3.7 million write-off for bad debts, consisting of a one-time charge attributed to two customers that advised the Company in the quarter ended December 31, 1994 of their inability to meet financial obligations. See Note 2 of the Notes to Consolidated Financial Statements. General and administrative expenses represented approximately 6%, 6% and 12% of total revenue in 1996, 1995 and 1994, respectively. OTHER INCOME AND EXPENSE Interest income increased by $392,000 in 1996 over 1995 due primarily to a greater average balance of cash and cash equivalents and marketable securities. Interest expenses decreased $316,000 in 1996 over 1995 due to the payoff of lease lines used to purchase certain fixed assets and the reduction of other debt. PROVISION FOR INCOME TAXES The provision for federal, state and foreign income taxes was an expense of $5.4 million in 1996, a benefit of $612,000 in 1995 and an expense of $401,000 in 1994, representing effective tax rates of 30%, (4.9%) and 8%, respectively. The effective income tax rate in each year was impacted by a reduction in the Company's valuation allowance against deferred tax assets of $1.6 million, $6.8 million and $1.1 million for 1996, 1995 and 1994, respectively. The effective tax rate was also reduced by the tax benefit from the Company's foreign sales corporation in 1996 and 1995, and by utilization of federal and state tax credits in all years. At December 31, 1996, the Company had federal net operating loss carryforwards of $2.1 million and federal and state tax credit carryforwards of $300,000 and $50,000, respectively. A significant portion of the Company's net operating loss and tax credit carryforwards were acquired in a merger and are subject to an annual limitation of approximately $1.2 million. FACTORS AFFECTING OPERATING RESULTS COMPETITION The EDA industry is highly competitive and rapidly changing. The Company faces significant competition for emulation-based system-level verification, in addition to competition from traditional design verification methodologies which rely on the approach of building and then testing complete system prototypes. Because of customers' requirements for a design verification methodology which reduces the number of costly design iterations and improves product quality, the Company expects competition in the market for system-level verification to increase as other companies attempt to introduce emulation products and product enhancements. Moreover, the Company competes with companies that have significantly greater financial, technical and marketing resources, greater name recognition and larger installed bases than the Company. In addition, many of these competitors have established relationships with current and potential customers of the Company. Increased competition could result in price reductions, reduced margins and loss of market share, all of which could materially adversely affect the Company. The Company believes that the principal competitive factors in the EDA market are 20 quality of results, the mission-critical nature of the technology, technical support, product performance, reputation, price and support of industry standards. The Company believes that it currently competes favorably with respect to these factors. However, there can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, operating results and financial condition. In addition, competitors may resort to litigation as a means of competition. Such litigation may result in substantial costs to the Company and significant diversion of management time. In 1995, Mentor Graphics Corporation ("Mentor") filed suit against the Company for declaratory judgment of noninfringement, invalidity and unenforceability of several of the Company's patents. Six of the Company's patents are now involved in the disputes and the Company has filed counterclaims against Mentor and Mentor's French subsidiary, Meta Systems ("Meta"), for infringement and threatened infringement of those six patents. Furthermore, in January 1996, the Company filed a complaint with the International Trade Commission, seeking to stop unfair importation of hardware logic emulation systems manufactured by Meta on the grounds that such systems infringe the Company's patents. See Note 14 of the Notes to Consolidated Financial Statements. Although patent and intellectual property disputes in the EDA industry are often settled through licensing, cross-licensing or similar arrangements, costs associated with such litigation and arrangements may be substantial. RISKS ASSOCIATED WITH THE SPEEDSIM MERGER On February 7, 1997, the Company completed the SpeedSim Merger. There can be no assurance that the Company will not incur additional charges in subsequent quarters to reflect costs associated with the SpeedSim Merger or that management will be successful in its efforts to integrate the operations of the acquired company. Although the Company believes the SpeedSim Merger is in the best interest of the Company and its stockholders, there are significant risks associated with these transactions, including but not limited to: (i) difficulties in the integration of SpeedSim, (ii) difficulties in maintaining revenue levels during product transitions, (iii) difficulties or delays in achieving product and technology integration benefits, and (iv) increased competition from other software companies. Moreover, SpeedSim is a company in the early stages of development. As a result, the Company believes that the increases in operating expenses associated with the development and integration of these new technologies will, in the near term, greatly exceed any associated increases in revenue which will have an adverse impact on operating results. OTHER FACTORS Other factors which could adversely affect the Company's quarterly operating results in the future include efficiencies as they relate to managing inventories and fixed assets, the timing of expenditures in anticipation of increased sales, customer product delivery requirements and shortages of components or labor. Moreover, a significant portion of the Company's total revenue in each quarter generally results from shipments in the last few weeks of the quarter; therefore, a delay in the shipment of a few orders can have a significant impact upon total revenue and results of operations in a given quarter. Additionally, as a significant portion of the Company's revenue and net income may come from international operations, fluctuations of the U.S. dollar against foreign currencies and the seasonality of Asia-Pacific, European and other international markets could impact the Company's results of operations and financial condition in a particular quarter. Due to the factors above, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Any shortfall in total revenue or earnings from levels expected by securities analysts has had and could in the future have an immediate and significant adverse effect on the trading price of the Company's common stock. Additionally, the Company may not learn of such shortfalls until late in a fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's common stock. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1996, the Company had $52.4 million in cash, cash equivalents and marketable securities. Additionally, the Company had $9.8 million in unsecured revolving bank lines of credit. To date, no funds have been drawn from the bank lines of credit. The Company's credit agreements contain certain affirmative and restrictive covenants that are typical of such commercial lending arrangements. The agreements require, among other things, that the Company maintain a stipulated tangible net worth, meet certain financial ratios (quick asset to current liability and debt to tangible net worth), achieve annual profitability targets and maintain quarterly debt service. The agreements also prohibit, among other things, the Company from paying cash dividends. See Note 7 of the Notes to Consolidated Financial Statements. 21 Net cash provided by operating activities was $20.9 million in 1996, $10.9 million in 1995 and $2.7 million in 1994. The increase in cash provided by operating activities in 1996 as compared to 1995 was primarily attributable to an increase in deferred revenue and a significantly smaller increase in deferred income taxes offset by an increase in inventories. Additionally, the increase in cash provided by operations in 1995 as compared to 1994 was primarily attributable to greater net income from operations and a significantly smaller increase in accounts receivable and inventories in 1995 compared to the increase in accounts receivable and inventories in 1994, offset by a decrease in accounts payable and accrued liabilities in 1995 compared to an increase in accounts payable and accrued liabilities in 1994. Net cash used in investing activities was $13.4 million in 1996, as compared with $500,000 provided by investing activities in 1995, and $32.4 million used in investing activities in 1994. Net cash used in investing activities was related primarily to net purchases of marketable securities, and to acquisitions of property and equipment. The Company expects that investment levels and net cash used in investing activities will increase in future periods. Capital expenditures, including capital leases, were approximately $6.2 million, $7.7 million and $9.3 million in 1996, 1995 and 1994, respectively. These expenditures were primarily for the expansion of production capacity and the addition of research and development equipment. While the Company has no material capital commitments, the Company anticipates that its planned purchases of capital equipment in 1997 will require additional expenditures of approximately $11.0 million, a portion of which may be financed with cash and a portion of which may be financed through capital leases. The Company believes that its current cash and cash equivalents, together with its existing credit facility and the cash flows expected to be generated by operations, will be sufficient to meet its anticipated cash needs for working capital, capital expenditures and marketing expansion through at least 1997. Thereafter, if cash generated from operations is insufficient to satisfy the Company's liquidity requirements, the Company may sell additional equity or debt securities or obtain additional credit facilities. 22 QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) Year Ended December 31, ----------------------------- 1996 1995 1994 --------- ---------- -------- Revenue Product revenue $ 83,259 $ 67,679 $ 55,170 Maintenance and service revenue 21,111 14,121 10,353 --------- ---------- -------- Total revenue 104,370 81,800 65,523 Cost of revenue Cost of product revenue 25,833 20,752 17,049 Cost of maintenance and service revenue 6,550 4,330 3,199 --------- ---------- -------- Total cost of revenue 32,383 25,082 20,248 --------- ---------- -------- Gross profit 71,987 56,718 45,275 Operating expenses Research and development 18,548 14,864 12,414 Sales and marketing 30,694 25,439 21,195 General and administrative 6,476 4,681 7,612 --------- ---------- -------- Total operating expenses 55,718 44,984 41,221 Operating income 16,269 11,734 4,054 Interest income 2,126 1,734 1,368 Interest expense (420) (736) (437) Other, net 79 (261) 17 --------- ---------- -------- Net income before provision for (benefit from) income taxes 18,054 12,471 5,002 Provision for (benefit from) income taxes 5,415 (612) 401 --------- ---------- -------- Net income $ 12,639 $ 13,083 $ 4,601 --------- ---------- -------- --------- ---------- -------- Net income per share $ 0.83 $ 0.90 $ 0.32 --------- ---------- -------- --------- ---------- -------- Number of shares used in per share calculations 15,204 14,605 14,350 --------- ---------- -------- --------- ---------- -------- The accompanying notes are an integral part of these consolidated financial statements. 23 QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS EXCEPT SHARE DATA) December 31, ------------------ ASSETS 1996 1995 --------- -------- Current assets Cash and cash equivalents $ 23,911 $17,216 Marketable securities 10,314 14,181 Accounts receivable, net of allowance for doubtful accounts of $1,840 in 1996 and 1995 21,537 20,706 Inventories 10,141 7,805 Prepaid expenses and other current assets 2,770 1,895 Deferred income taxes 5,599 5,390 --------- -------- Total current assets 74,272 67,193 Marketable securities 18,198 9,110 Fixed assets, net 11,032 13,003 Deferred income taxes 2,939 2,639 Other assets 2,412 839 --------- -------- Total assets $108,853 $92,784 --------- -------- --------- -------- LIABILITIES Current liabilities Current portion of long term debt $ 3,502 $ 3,401 Accounts payable 873 869 Accrued liabilities 14,541 15,847 Deferred revenue 8,151 3,538 --------- -------- Total current liabilities 27,067 23,655 Long term debt -- 3,502 --------- -------- Total liabilities 27,067 27,157 --------- -------- Commitments and contingencies (Notes 9 and 14). STOCKHOLDERS' EQUITY Preferred stock, $.001 par value: Authorized: 2,000,000 shares; Issued and outstanding: no shares -- -- Common stock, $.001 par value: Authorized: 20,000,000 shares; Issued and outstanding: 14,122,558 shares in in 1996; 13,596,060 shares in 1995 14 14 Additional paid-in capital 75,119 71,507 Unrealized holding gain on marketable securities 10 102 Retained earnings (deficit) 6,643 (5,996) --------- -------- Total stockholders' equity 81,786 65,627 --------- -------- Total liabilities and stockholders' equity $108,853 $92,784 --------- -------- --------- -------- The accompanying notes are an integral part of these consolidated financial statements. 24 QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS EXCEPT SHARE DATA)
Unrealized Common Stock Additional Holding Gain (Loss) Retained ----------------------- Paid-in on Marketable Earnings Shares Amount Capital Securities (Deficit) Total ------------ -------- ----------- ------------------- ----------- -------- BALANCES, DECEMBER 31, 1993 12,118,020 $12 $61,964 -- $(23,680) $38,296 Issuance of common stock, less issuance costs 510,000 1 5,691 -- -- 5,692 Issuance of common stock, employee stock purchase plan 87,360 -- 598 -- -- 598 Exercise of stock options and warrants 386,687 -- 344 -- -- 344 Tax benefit from option exercises -- -- 700 -- -- 700 Unrealized holding loss on marketable securities -- -- -- $(336) -- (336) Net income -- -- -- -- 4,601 4,601 ------------ -------- ----------- ------------------- ----------- -------- BALANCES, DECEMBER 31, 1994 13,102,067 13 69,297 (336) (19,079) 49,895 Issuance of common stock, employee stock purchase plan 158,488 -- 1,091 -- -- 1,091 Exercise of stock options 335,505 1 574 -- -- 575 Tax benefit from option exercises -- -- 545 -- -- 545 Unrealized holding gain on marketable securities -- -- -- 438 -- 438 Net income -- -- -- -- 13,083 13,083 ------------ -------- ----------- ------------------- ----------- -------- BALANCES, DECEMBER 31, 1995 13,596,060 14 71,507 102 (5,996) 65,627 Issuance of common stock, employee stock purchase plan 198,117 -- 1,452 -- -- 1,452 Exercise of stock options 328,381 -- 1,161 -- -- 1,161 Tax benefit from option exercises -- -- 999 -- -- 999 Unrealized holding loss on marketable securities -- -- -- (92) -- (92) Net income -- -- -- -- 12,639 12,639 ------------ -------- ----------- ------------------- ----------- -------- BALANCES, DECEMBER 31, 1996 14,122,558 $14 $75,119 $ 10 $ 6,643 $81,786 ------------ -------- ----------- ------------------- ----------- -------- ------------ -------- ----------- ------------------- ----------- --------
The accompanying notes are an integral part of these consolidated financial statements. 25 QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
Year Ended December 31, ------------------------------ 1996 1995 1994 ----------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 12,639 $ 13,083 $ 4,601 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 8,455 7,880 5,016 Provision for doubtful accounts -- -- 1,110 Write down of inventories 719 244 130 Deferred income taxes (509) (6,814) (1,215) Changes in current assets and liabilities Accounts receivable (831) (781) (11,270) Inventories (3,055) (1,771) (4,472) Prepaid expenses and other current assets (875) (955) (189) Accounts payable and accrued liabilities (303) 8 8,915 Deferred revenue 4,613 (35) 65 ----------- -------- -------- Net cash provided by operating activities 20,853 10,859 2,691 ----------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisition of fixed assets (6,197) (4,747) (6,133) Sale of marketable securities 19,931 27,530 44,958 Purchase of marketable securities (25,244) (21,714) (69,993) Increase in other assets (1,860) (556) (1,269) ----------- -------- -------- Net cash provided by (used in) investing activities (13,370) 513 (32,437) ----------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from equipment financing -- 1,500 784 Payments of long term debt (3,401) (4,219) (2,697) Proceeds from stock issuances 2,613 1,666 6,634 ----------- -------- -------- Net cash provided by (used in) financing activities (788) (1,053) 4,721 ----------- -------- -------- Net increase (decrease) in cash and cash equivalents 6,695 10,319 (25,025) Cash and cash equivalents at beginning of period 17,216 6,897 31,922 ----------- -------- -------- Cash and cash equivalents at end of period $ 23,911 $ 17,216 $ 6,897 ----------- -------- -------- ----------- -------- -------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for: Interest $ 408 $ 827 $ 421 Income taxes $ 4,338 $ 776 $ 1,044 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITY Additions to fixed assets through capital lease obligations $ -- $ 2,994 $ 3,184 Unrealized holding loss (gain) on marketable securities $ 92 $ (438) $ 336 Tax benefit from stock option exercises $ 999 $ 545 $ 700
The accompanying notes are an integral part of these consolidated financial statements. 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1 BUSINESS OF THE COMPANY Quickturn Design Systems, Inc. (the "Company") designs, manufactures, sells and supports system-level verification solutions for the design of integrated circuits and electronic systems. The Company's development and manufacturing facilities are located in Mountain View, California. The Company's principal markets are in North America, Asia-Pacific and Europe. 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES FINANCIAL STATEMENT PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates. CERTAIN RISKS AND CONCENTRATIONS The Company's products are concentrated in the electronic design automation industry which is highly competitive and rapidly changing. Revenue is concentrated with a relatively limited number of customers, and supplies for certain components are concentrated among a few providers. The loss of a major customer or any reduction in orders by such a customer, the interruption of certain supplier relationships, significant technological changes in the industry or customer requirements, the infringement or expropriation of proprietary intellectual property rights or patents, or the emergence of a major direct competitor could affect operating results adversely. In addition, a significant portion of the Company's revenue is derived from international sales; therefore, fluctuations of the U.S. dollar against foreign currencies or local economic conditions could adversely affect operating results. All marketable securities are classified as available-for-sale and are carried at fair value. Unrealized gains and losses on marketable securities classified as available-for-sale, when material, are reported as a separate component of stockholders' equity. Realized gains and losses on sales of all such investments are reported in earnings and computed using the specific identification cost method. Financial instruments which potentially subject the Company to a concentration of credit risk principally consist of cash and cash equivalents, marketable securities and accounts receivable. The Company sells products to companies in the electronics industry in North America, Asia-Pacific and Europe. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition. The Company maintains reserves for potential credit losses on its trade accounts receivable which are uncollateralized. Historically, except for the quarter ended December 31, 1994, the Company has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area. In addition to the increase of reserves for doubtful accounts, the Company recorded a $3.7 million write-off of bad debts related to two customers in the quarter ended December 31, 1994. The Company maintains its excess cash balances in a variety of financial instruments such as money market securities in various financial institutions and securities backed by the United States government. The Company has not experienced any material losses in any of the instruments it has used for excess cash balances. The Company enters into foreign exchange forward contracts to hedge certain foreign currency denominated receivable balances against changes in foreign currency exchange rates. Gains and losses on the contracts are included together with the gains or losses from revaluation of the related receivables. These contracts require the Company to exchange foreign currencies for U.S. dollars and generally mature within six months. At December 31, 1996, the Company had forward exchange contracts outstanding with a notional value of $2,597,000 and an estimated fair value of $2,602,000. TRANSLATION OF FOREIGN CURRENCIES The Company's foreign consolidated subsidiaries are considered to be extensions of the U.S. operation and the functional currency of the subsidiaries is the U.S. dollar. Accordingly, foreign entities translate monetary assets and liabilities at year-end exchange rates while 27 nonmonetary items are translated at historical rates. Translation gains and losses related to these subsidiaries are included in income. Income and expense accounts are translated at the average rates in effect during the year, except for depreciation and cost of revenue which are translated at historical rates. REVENUE RECOGNITION The Company recognizes revenue from sales of its emulation products and services when all substantial conditions have been met, including shipment to the customer, fulfillment of acceptance terms, if any, and completion of all significant contractual terms. Maintenance revenue is deferred and recognized ratably over the term of the maintenance agreement, which is typically twelve months. Maintenance contracts are typically renewed annually. Warranty and similar costs related to post-contract customer support are accrued at the time of sale. RESEARCH AND DEVELOPMENT Research and development expenses are charged to operations as incurred. CASH EQUIVALENTS Investments and deposits with original maturities of three months or less at the date of purchase are considered to be cash equivalents. FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of the note payable and capital lease obligations approximates fair value. Estimated fair values for marketable securities (See Note 3) and forward exchange contracts (see Certain Risks and Concentrations, above) are based on quoted market prices for the same or similar instruments. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company's inventories include high technology parts and components that may be specialized in nature or subject to rapid technological obsolescence. While the Company has programs to minimize the required inventories on hand and considers technological obsolescence when estimating required reserves to reduce recorded amounts to market values, it is reasonably possible that such estimates could change in the near term. DEPRECIATION AND AMORTIZATION Fixed assets are stated at cost and are depreciated on a straight-line method over the estimated useful lives of the assets, typically one to five years. Leasehold improvements are amortized on a straight-line method over the shorter of the remaining lease term or the estimated useful life of the asset, typically three to five years. Amortization of equipment under capital leases is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful life of the related asset, typically three to five years. ACCRUED WARRANTY The Company provides an accrual for future warranty costs based on the historical relationship of revenue to warranty costs incurred. RECLASSIFICATION Certain amounts in the financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no impact on previously reported working capital, operating income or net income. INCOME TAXES The Company provides for income taxes under the liability method in accordance with Statement of Financial Accounting Standards No.109, (SFAS 109), "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, measured at the tax rates that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. NET INCOME PER SHARE Net income per share is calculated using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of common stock issuable upon exercise of stock options and warrants (using the treasury stock method). FISCAL YEAR-END Since 1995, for purposes of presentation, the Company has indicated that its fiscal year ends on December 31, although the Company operates on a 52-week or 53-week fiscal year, ending on the last Sunday in December. Both 1995 and 1996 were 52-week years. 28 3 MARKETABLE SECURITIES At December 31, 1996 and 1995, all marketable securities are classified as available-for-sale and are summarized as follows:
Marketable securities at December 31, 1996 - -------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Market Cost Unrealized Unrealized Net Unrealized Value Basis Gains Losses Gains(Losses) -------- -------- ---------- ---------- --------------- United States government debt securities $ 6,355 $ 6,364 $ 6 $ (15) $ (9) Municipal debt securities 17,815 17,800 39 (24) 15 Corporate debt securities 4,342 4,338 5 (1) 4 -------- -------- ---------- ---------- --------------- $ 28,512 $ 28,502 $ 50 $ (40) $ 10 -------- -------- ---------- ---------- --------------- -------- -------- ---------- ---------- --------------- Marketable securities at December 31, 1995 - -------------------------------------------------------------------------------------------------------------- (IN THOUSANDS) Market Cost Unrealized Unrealized Net Unrealized Value Basis Gains Losses Gains -------- -------- ---------- ---------- --------------- United States government debt securities $ 2,369 $ 2,345 $ 24 $ --- $ 24 Municipal debt securities 11,002 10,987 34 (19) 15 Corporate debt securities 9,920 9,857 74 (11) 63 -------- -------- ---------- ---------- --------------- $ 23,291 $ 23,189 $ 132 $ (30) $ 102 -------- -------- ---------- ---------- --------------- -------- -------- ---------- ---------- ---------------
At December 31, 1996, all marketable debt securities classified as current have scheduled maturities of less than one year. Marketable debt securities classified as noncurrent have scheduled maturities of one to three years. 4 INVENTORIES Inventories comprise: - ------------------------------------------------------------------------ (IN THOUSANDS) December 31, ----------------------------- 1996 1995 ----------------------------- Raw materials $ 8,431 $ 5,819 Work in process 1,710 1,986 --------- ---------- $ 10,141 $ 7,805 --------- ---------- --------- ---------- 5 FIXED ASSETS Fixed assets comprise: - ------------------------------------------------------------------------ (IN THOUSANDS) December 31, ----------------------------- 1996 1995 ----------------------------- Equipment $ 24,429 $ 20,843 Furniture, fixtures and leasehold improvements 3,598 2,725 Demonstration and rental equipment 4,829 3,241 --------- ---------- 32,856 26,809 Less accumulated depreciation and amortization (21,824) (13,806) --------- ---------- $ 11,032 $ 13,003 --------- ---------- --------- ---------- Depreciation and amortization expense amounted to $8,168,000, $6,989,000 and $4,493,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Fixed assets include equipment under capital leases as follows: - ------------------------------------------------------------------------ (IN THOUSANDS) December 31, ----------------------------- 1996 1995 ----------------------------- Cost $ 2,302 $ 5,102 Less accumulated amortization (1,313) (2,021) --------- --------- $ 989 $ 3,081 --------- --------- --------- --------- The equipment under capital leases is pledged as collateral for repayment of the related lease obligations. 29 6 ACCRUED LIABILITIES Accrued liabilities comprise: - ------------------------------------------------------------------------ (IN THOUSANDS) December 31, ----------------------------- 1996 1995 ----------------------------- Accrued payroll and related items $ 5,465 $ 5,643 Income taxes payable 6,298 5,702 Other accrued liabilities 2,778 4,502 --------- -------- $ 14,541 $ 15,847 --------- -------- --------- -------- 7 BANK BORROWING ARRANGEMENTS The Company has unsecured revolving lines of credit totaling $9,800,000 which provide for borrowings through June 1, 1997. Borrowings under these agreements bear interest at the banks' prime rate (8.25% at December 31, 1996). The agreements are subject to certain restrictive covenants which include achieving annual profitability, and meeting certain financial ratios and minimum tangible net worth requirements. The agreements also prohibit the payment of cash dividends. To date, no funds have been drawn against the lines of credit. 8 LONG TERM DEBT CAPITAL LEASE OBLIGATIONS The Company has leases totaling $2,302,000 at interest rates varying from 8.4% to 9.8%. The Company's lease obligations under the leases were collateralized by restricted deposits at December 31, 1996 and 1995 of $85,000 and $106,000, respectively, which are included in other assets. Minimum future lease payments for the year ending December 31, 1997, under all equipment lease arrangements, are $2,441,000, of which $139,000 represents interest. NOTE PAYABLE At December 31, 1996, the Company had an uncollateralized note payable of $1,200,000. The note had an original principal balance of $3,000,000 and bears interest at 4% per annum, payable quarterly. 9 COMMITMENTS The Company leases its operating facilities under noncancellable operating leases with terms greater than one year. At December 31, 1996, future minimum rent payments under these leases are as follows: Year ending December 31, - ------------------------------------------------------------------ (IN THOUSANDS) 1997 $ 2,614 1998 4,075 1999 3,840 2000 3,368 2001 3,157 Thereafter 8,310 --------- $ 25,364 --------- --------- Rent expense related to the facility and various equipment leases was $1,561,000, $1,337,000 and $1,118,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 10 STOCKHOLDERS' EQUITY STOCK OPTION PLANS As of December 31, 1996 the Company has reserved 3,723,713 common shares for issuance under various stock option plans. Except for the 1994 Outside Director Stock Option Plan, which provides for automatic grants to non-employee directors, the Board of Directors may, under these plans, issue incentive stock options to employees and nonstatutory stock options to employees or paid consultants of the Company at prices no less than fair market value for incentive and 85% of fair market value for nonstatutory stock options. The options are exercisable at times and in increments as specified by the Board of Directors. Options generally vest over four years and expire ten years from date of grant. Options are exercisable prior to vesting, however such unvested shares are subject to repurchase by the Company at their original cost. At December 31, 1996, there were 375 shares subject to repurchase. 30 EMPLOYEE STOCK PURCHASE PLAN The Company has reserved 450,000 shares of common stock for issuance under the Employee Stock Purchase Plan ("ESPP"). Shares are purchased through employees' payroll deductions at exercise prices equal to 85% of the lesser of the fair market value of the Company's common stock at either the first day of an offering period or the last day of such offering period. Shares issued under the ESPP in 1996, 1995 and 1994 were 198,117, 158,488 and 87,360 respectively. WARRANTS At December 31, 1996, warrants to purchase 474,059 shares of common stock were outstanding which may be exercised at prices ranging from $6.98 to $30.00 per share. The warrants expire over periods ranging from 1 to 5 years.
Information with respect to activity under these plans is set forth below: - ---------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) Outstanding Options ----------------------------------------------------------------------------- Shares Available Options Number Price Aggregate Weighted Avg for Grant Exercised of Shares Per Share Price Exercise Price ----------- --------- --------- ------------------ ---------- --------------- Balance, December 31, 1993 446,856 295,350 2,119,953 $ 0.26 - $ 12.00 $ 6,351 $ 3.00 Additional shares reserved 250,000 --- --- --- --- --- Options granted (1,161,900) --- 1,161,900 $ 6.13 - $ 14.75 9,372 $ 7.89 Options exercised --- 381,996 (381,996) $ 0.26 - $ 9.00 (344) $ 0.90 Options terminated 672,069 --- (672,069) $ 0.30 - $ 14.75 (6,737) $ 10.03 Options retired --- --- (33,600) $ 0.64 - $ 6.30 (123) $ 3.66 ----------- --------- --------- ---------- Balance, December 31, 1994 207,025 677,346 2,194,188 $ 0.26 - $ 13.25 8,519 $ 3.62 Additional shares reserved 1,000,000 --- --- --- --- --- Options granted (742,585) --- 742,585 $ 7.00 - $ 11.63 6,314 $ 8.76 Options exercised --- 336,401 (336,401) $ 0.26 - $ 10.38 (575) $ 1.73 Options terminated 314,217 --- (314,217) $ 0.30 - $ 11.63 (1,932) $ 6.15 Options repurchased 896 --- --- $ 0.30 - $ 0.50 --- $ 0.36 Options retired --- --- (13,497) $ 0.64 - $ 6.30 (38) $ 2.82 ----------- --------- --------- ---------- Balance, December 31, 1995 779,553 1,013,747 2,272,658 $ 0.30 - $ 13.25 12,288 $ 5.40 Additional shares reserved 1,000,000 --- --- --- --- --- Options granted (1,199,400) --- 1,199,400 $ 9.25 - $ 19.00 15,006 $ 12.53 Options exercised --- 328,381 (328,381) $ 0.30 - $ 11.63 (1,161) $ 3.54 Options terminated 355,891 --- (355,891) $ 0.50 - $ 13.25 (3,294) $ 9.51 Options retired --- --- (117) $ 0.64 - $ 0.64 --- $ 0.64 ----------- --------- --------- ---------- Balance, December 31, 1996 936,044 1,342,128 2,787,669 $ 0.30 - $ 19.00 $22,839 $ 8.19 ----------- --------- --------- ------------------ ---------- --------------- ----------- --------- --------- ------------------ ---------- ---------------
At December 31, 1996 and 1995, vested options to purchase 1,183,030 and 1,016,615 shares respectively were unexercised. In July 1994, the Board of Directors offered to all employees the opportunity to cancel outstanding stock options with exercise prices in excess of $6.13 per share (the fair market value of the common stock at that time) in exchange for options exercisable at $6.13 per share which were otherwise identical to the cancelled options except for a one-year extension of the original vesting term. Options to purchase 562,025 shares of common stock at original exercise prices ranging from $8.00 to $14.75 per share were exchanged and are included above as 1994 grants and terminations. 31 The following table summarizes information with respect to stock options outstanding at December 31, 1996:
Options Outstanding Options Exercisable -------------------------------------------------------- ------------------------------ Number Weighted Average Weighted Average Number Weighted Average Range of Outstanding Remaining Exercise Exercisable Exercise Exercise Prices at 12/31/96 Contractual Life (Years) Price at 12/31/96 Price - ------------------- ----------- ------------------------ ---------------- ----------- ---------------- $ 0.30 - $ 4.00 687,581 5.57 $ 1.58 687,543 $ 1.58 $ 6.00 - $ 9.00 645,320 7.44 $ 6.65 366,050 $ 6.57 $ 9.25 - $ 11.63 591,068 8.86 $10.37 113,604 $ 9.90 $ 12.13 - $ 19.00 863,700 9.70 $13.12 15,833 $13.27 ----------- ----------- $ 0.30 - $ 19.00 2,787,669 7.98 $ 8.19 1,183,030 $ 4.08 ----------- ----------- ----------- -----------
The following information concerning the Company's stock option and employee stock purchase plans is provided in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." The Company accounts for such plans in accordance with APB No. 25 and related interpretations. The fair value of each option grant has been estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1996 and 1995: Group A Group B ------------- ----------- Risk-free interest rates 6.30% 6.22% Expected life 5 years 4 years Volatility 0.70 0.70 Dividend yield --- --- The weighted average expected life was calculated based on the exercise behavior of each group. Group A represents officers and directors who are a smaller group holding a greater average number of options than other option holders and who tend to exercise later in the vesting period. Group B represents all other option holders, virtually all of whom are employees. This group tends to exercise earlier in the vesting period. The weighted average fair value of those options granted in 1996 and 1995 was $7.73 and $5.18, respectively. The Company has also estimated the fair value for the purchase rights issued under the Company's Employee Stock Purchase Plan, under the Black-Scholes valuation model using the following assumptions for 1996 and 1995: Risk-free interest rates 5.74% - 6.01% Expected life 1.25 years Volatility 0.70 Dividend yield --- The weighted average fair value of those purchase rights granted in 1996 and 1995 was $5.15 and $3.74, respectively. The following proforma income information has been prepared following the provisions of SFAS No. 123: - ------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) 1996 1995 ---------- ---------- Net income - proforma $ 10,953 $ 12,313 Net income per share - proforma $ 0.72 $ 0.84 The above proforma effects on income may not be representative of the effects on net income for future years as option grants typically vest over several years and additional options are generally granted each year. 32 11 INCOME TAXES Income before taxes and details of the income tax provision consist of the following: - ------------------------------------------------------------------------------- (IN THOUSANDS) Year Ended December 31, ----------------------------------- 1996 1995 1994 --------- -------- --------- Domestic income before taxes $17,058 $12,135 $ 4,731 Foreign income before taxes 996 336 271 --------- -------- --------- Income before taxes $18,054 $12,471 $ 5,002 --------- -------- --------- --------- -------- --------- Income tax provision: Federal: Current payable (net of benefit from utilization of net operating loss carryforwards of $1,292, $1,753 and $2,975 for 1996, 1995 and 1994, respectively) $ 4,749 $ 5,279 $ 1,251 Deferred (464) (5,579) (1,129) --------- -------- --------- 4,285 (300) (122) State: Current payable 600 749 160 Deferred (45) (1,235) (86) --------- -------- --------- 555 (486) (74) Foreign: Current payable 575 174 205 Deferred --- --- --- --------- -------- --------- 575 174 205 --------- -------- --------- Income tax provision (benefit) $ 5,415 $ (612) $ 401 --------- -------- --------- --------- -------- --------- The items accounting for the difference between income taxes computed at the federal statutory rate and the provision for income taxes are as follows: - ------------------------------------------------------------------------------- Year Ended December 31, ------------------------------- 1996 1995 1994 -------- -------- -------- Income tax at statutory rate 35.0% 35.0% 34.0% State income taxes, net of federal benefit 5.9% 5.9% 3.0% Change in valuation allowance (8.8%) (54.3%) (27.4%) Benefit of foreign sales corporation (3.3%) (0.4%) --- Nondeductible expenses 0.6% 2.0% 1.4% Foreign taxes 1.5% 3.9% 0.5% Research and development and business tax credits (3.8%) (1.9%) (6.1%) Other 2.9% 4.9% 2.6% -------- -------- -------- Effective tax rate 30.0% (4.9%) 8.0% -------- -------- -------- -------- -------- -------- The effective income tax rate in each year was impacted by a reduction in the Company's valuation allowance against deferred tax assets of $1.6 million, $6.8 million and $1.1 million for 1996, 1995 and 1994, respectively. 33 The components of the net deferred tax assets are: - ------------------------------------------------------------------------------- (IN THOUSANDS) December 31, ------------------------ 1996 1995 --------- --------- Accrued vacation and bonus $ 283 $ 499 Reserve for inventories 1,793 1,422 Depreciation expense 1,864 1,367 Deferred revenue 970 305 Other liabilities and reserves 2,393 3,741 State taxes, net of federal benefit 118 154 Net operating loss carryforward 767 1,710 Research and development and business credits 350 419 Valuation allowance --- (1,588) --------- --------- Net deferred tax asset $ 8,538 $ 8,029 --------- --------- --------- --------- No provision has been made for federal, state or foreign taxes that may result from future remittances of undistributed earnings of foreign subsidiaries ($649,000 at December 31, 1996) because it is expected that such earnings will be reinvested in these foreign operations. It is not practical to estimate the amount of taxes that might be payable on the eventual remittance of such earnings. The Company's income taxes currently payable for both federal and state purposes have been reduced by the tax benefit derived from the disqualifying dispositions of incentive stock options and the exercise of nonqualified stock options. The benefit, which totalled $999,000 in 1996 and $545,000 in 1995 was credited directly to additional paid-in capital. At December 31, 1996, the Company had approximately $2,100,000 of combined net operating losses and federal and state tax credit carryforwards of $300,000 and $50,000, respectively. The carryforwards expire in 2005 through 2010, if not utilized. A significant portion of the Company's net operating loss and tax credit carryforwards is subject to an annual limitation of approximately $1,200,000. 12 BUSINESS SEGMENTS AND MAJOR CUSTOMERS The Company operates in a single industry segment encompassing the development, manufacture, sales and support of system-level verification solutions for the design of integrated circuits and electronic systems. The Company's top ten customers represented 51%, 48% and 46% of total revenue for the years ended December 31, 1996, 1995 and 1994, respectively. In the year ended December 31, 1996, one customer, Fujitsu, comprised 13% of the Company's total revenue, and in the years ended December 31, 1995 and 1994, no customer individually comprised more than 10% of the Company's total revenue. The Company markets its products to customers in North America, Asia-Pacific and Europe and offers technical support, design consulting services, training, hardware maintenance and software upgrades to its customers. Products and services are marketed through a direct sales force in North America, Japan and Europe. The Company also maintains distributorship relationships in Israel, Korea, Singapore and Taiwan. Revenue information by geographic region is as follows: - ------------------------------------------------------------------------------- (IN THOUSANDS) Year Ended December 31, ---------------------------------------- 1996 1995 1994 --------- --------- --------- North America $ 65,716 $ 56,107 $ 48,594 Asia-Pacific 29,920 16,449 9,336 Europe 8,734 9,244 7,593 --------- --------- --------- $104,370 $ 81,800 $ 65,523 --------- --------- --------- --------- --------- --------- Identifiable assets of foreign operations are not significant. The net income for all periods presented are derived primarily from the Company's North American operations. 34 13 EMPLOYEE BENEFIT PLANS The Company maintains 401(k) savings plans to provide retirement benefits through tax deferred salary deductions for all its employees. The Company may make discretionary contributions as determined by the Board of Directors, which cannot exceed a percentage of the annual aggregate salaries of those employees eligible to participate. The Company has made total contributions to the plans of $394,000 for the year ended December 31, 1996, and none for the years ended December 31, 1995 and 1994. 14 CONTINGENCIES In January 1995, the Company and certain of its officers and directors were named in a securities class action filed in the United States District Court for the Northern District of California. The complaint seeks unspecified damages and related fees and costs. In September 1995, the Court dismissed with prejudice all claims against several defendants, including the Company's outside directors. The Court also dismissed with prejudice many of the allegations and claims asserted against the Company and certain of its officers. While the Company believes that it has meritorious defenses to the claims remaining in the action, the Company has entered into a Stipulation of Settlement with plaintiffs in order to conserve legal expenses and management resources. The Company's contribution to the proposed $2.75 million settlement, net of insurance proceeds, is not material. The proposed settlement has been preliminarily approved by the Court but remains subject to the Court's final approval. There can be no assurance that the Company will in fact succeed in obtaining final Court approval of the proposed settlement with the plaintiffs. In the event the Court does not grant final approval of the settlement, the Company will continue to contest this action vigorously. While the outcome of the action in the absence of the proposed settlement cannot be predicted with certainty, management does not believe the outcome will have a material adverse impact on the Company's financial position or results of operations. Additionally, in January 1996, the Company filed a complaint with the International Trade Commission (the "ITC") in Washington, DC, seeking to stop unfair importation of logic emulation systems manufactured by Meta Systems ("Meta") of France, a subsidiary of Mentor Graphics Corporation ("Mentor"). In the complaint, the Company alleges that Mentor's hardware logic emulation systems infringe the Company's patents. In July 1996, the ITC Administrative Law Judge issued an Initial Determination granting a Temporary Exclusion Order stopping the importation of Mentor Graphic's emulation products into the U.S., absent the posting of a bond by Mentor. The ITC Initial Determination included a Cease and Desist Order against all sales activities of the Mentor emulation products into the U.S. In August 1996, the ITC ratified the judge's Initial Determination. The Company is continuing its legal efforts with the ITC to obtain a Permanent Exclusion Order stopping the importation of Mentor's emulation products into the U.S. The Company also is engaged in a Federal District Court case involving six of the Company's patents. Mentor and Meta are seeking a declaratory judgment of noninfringement, invalidity and unenforceability of the patents in dispute, and the Company has filed counteractions against Mentor and Meta for infringement and threatened infringement of the six patents. Mentor has also claimed in this Federal District Court case that press releases issued by the Company were defamatory and interfered with Mentor's business advantage. Additionally, Aptix Corporation recently filed a suit against the Company alleging various violations of the antitrust laws and unfair competition. The Company does not believe these claims are meritorious and plans to mount a vigorous defense against them. The outcome of these actions cannot be predicted with certainty. The Company is engaged in certain other legal and administrative proceedings incidental to its normal business activities. While it is not possible to determine the ultimate outcome of these actions at this time, management believes that any liabilities resulting from such proceedings or claims which are pending or known to be threatened, will not have a material adverse effect on the Company's consolidated financial position or results of operations. 35 15 SUBSEQUENT EVENT On February 7, 1997, the Company acquired SpeedSim, Inc. ("SpeedSim"), a provider of cycle-based simulation software for the verification of digital logic designs (the "SpeedSim Merger"). The Company purchased all of the outstanding capital stock and assumed all of the outstanding stock options of SpeedSim, a privately held company, for an aggregate of approximately 2.8 million shares of Quickturn common stock. The Company estimates that it will incur direct transaction costs of at least $1.2 million associated with the acquisition, which will be charged to operations during the quarter ending March 31, 1997. The acquisition was accounted for as a pooling of interests, and accordingly, historical financial data in future reports of the Company will be restated to include SpeedSim data. The following unaudited pro forma data summarizes the combined results of operations of the Company and SpeedSim for the years presented except for 1994, which had an immaterial pro forma impact on results of operations and net income per share: Year Ended December 31, (unaudited pro forma) (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) ---------------------------- 1996 1995 -------- -------- Total revenue $109,578 $ 82,442 Net income $ 14,131 $ 12,478 Net income per common share: $ 0.79 $ 0.74 36 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders Quickturn Design Systems, Inc. Mountain View, California We have audited the accompanying consolidated balance sheets of Quickturn Design Systems, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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. 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 aspects, the consolidated financial position of Quickturn Design Systems, Inc. as of December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. San Jose, California January 16, 1997 37 EX-21.1 4 EXHIBIT 21.1 Exhibit 21.1 QUICKTURN DESIGN SYSTEMS, INC. SUBSIDIARIES OF THE REGISTRANT The following companies are subsidiaries of the Registrant: 1. Quickturn Design Systems GmbH 2. Quickturn Design Systems S.A.R.L. 3. Quickturn Design Systems Ltd. 4. Quickturn Design Systems K.K. 5. QDS Sweden AB 6. SpeedSim, Inc. (the Company's Advanced Simulation Division) EX-23.1 5 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statements (Form S-8, No. 33-72970, No. 33-82452, No. 33-93092, No. 333-18407 and No. 333-21587) pertaining to the 1988 Stock Option Plan, 1990 Stock Option Plan, 1993 Employee Qualified Stock Purchase Plan, 1992 Key Executive Stock Option Plan, 1994 Outside Director Stock Option Plan, 1996 Supplemental Stock Plan and SpeedSim, Inc. 1995 Incentive and Nonqualified Stock Option Plan, and in the Registration Statement (Form S3, No. 333-22907) of our report dated January 16, 1997, on our audits of the consolidated financial statements and financial statement schedule of Quickturn Design Systems, Inc. as of December 31, 1996 and 1995, and for the three years in the period ended December 31, 1996, which report is incorporated by reference in this Annual Report on Form 10-K. /s/ Coopers & Lybrand L.L.P. San Jose, California March 26, 1997 EX-27 6 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET, CONSOLIDATED STATEMENT OF OPERATIONS AND CONSOLIDATED STATEMENT OF CASH FLOWS INCLUDED IN THE COMPANY'S FORM 10-K FOR THE PERIOD ENDING DECEMBER 31, 1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 23,911 10,314 23,377 1,840 10,141 74,272 32,856 21,824 108,853 27,067 0 0 0 14 81,772 108,853 104,370 104,370 32,383 32,383 55,718 0 420 18,054 5,415 12,639 0 0 0 12,639 0.83 0.83
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