-----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, Btkt33wAcpIKiCifL48vRfh9+zHyrYOQdwkFRlEGUjTTEFyJ1+thFukqji3josYG Q2DgrvzFEmMzHIcf4i7Qdg== 0001047469-98-012229.txt : 19980331 0001047469-98-012229.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012229 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 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: SEC FILE NUMBER: 000-22738 FILM NUMBER: 98577380 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, 1997 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) 55 W. Trimble Road, San Jose, CA 95131 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (408) 914-6000 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. [ ] 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 27, 1998 on the Nasdaq National Market was approximately $171,682,000. 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 27, 1998 was 17,772,921. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1997 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 1998 Annual Meeting of Stockholders to be held on April 17, 1998 are incorporated by reference in Part III of this Form 10-K to the extent stated herein. THIS ANNUAL REPORT ON FORM 10-K AND THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE CONTAIN FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS ABOUT QUICKTURN'S INDUSTRY, MANAGEMENT'S BELIEFS, AND CERTAIN ASSUMPTIONS MADE BY QUICKTURN'S MANAGEMENT. WORDS SUCH AS "ANTICIPATES," "EXPECTS," "INTENDS," "PLANS," "BELIEVES," "SEEKS," "ESTIMATES," VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT; THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE THOSE SET FORTH HEREIN UNDER "RISK FACTORS" ON PAGES 11 THROUGH 18, AS WELL AS THOSE NOTED IN THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE. UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS SET FORTH IN OTHER REPORTS OR DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, PARTICULARLY THE QUARTERLY REPORTS ON FORM 10-Q AND ANY CURRENT REPORTS ON FORM 8-K. PART I ITEM 1. BUSINESS. OVERVIEW Quickturn Design Systems, Inc. (the "Company" or "Quickturn") designs, manufactures, sells and supports products that verify the design of integrated circuits ("ICs") and electronic systems. The Company derives substantially all of its revenue from its design verification products and related maintenance and consulting services. The Company's principal design verification products include System Realizer-TM- and CoBALT-TM- (Concurrent Broadcast Array Logic Technology) emulators, and SpeedSim-TM- cycle-based simulation software. Emulation systems are sold in modules of various system capacities measured in "logic gates," which are measurement units that describe the design elements created and verified by Quickturn's customers. As system capacity increases, the selling price of these systems increases correspondingly. Cycle-based simulation revenue is charged on a per-license basis. 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 -1- when design changes occur several times per day. Later, when designs become more stabilized, customers may use in-circuit emulation to test the entire system that contains the design and to help identify system-level bugs, which typically are more difficult to find at this stage in the design process. Quickturn's products serve the needs of IC and systems design engineers in a variety of markets including microprocessors, computers, workstations and PCs, telecommunications and networking, multimedia, and graphics. The Company was incorporated in California in July 1987 and reincorporated in Delaware in December 1993. In January 1997, the Company commenced shipment of its CoBALT emulation system which was co-developed with IBM. In February 1997, the Company merged with SpeedSim, Inc. ("SpeedSim"), a provider of cycle-based simulation software (the "SpeedSim Merger"). See Note 3 of the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders. In June 1997, the Company purchased from Synopsys, Inc. ("Synopsys") certain assets relating to Synopsys's emulation business of Arkos Design, Inc. (the "Arkos Acquisition"). See Note 3 of the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders. Also in June 1997, the Company extended its relationship with IBM to develop the next generation of custom processor-based emulation systems. In November 1997, Quickturn moved its corporate headquarters to San Jose, California. Late in 1997, the Company introduced release 5.1 of its Quest-TM- II emulation software, which is designed to enable customers to more quickly and easily compile their IC designs. The Company's principal executive offices are located at 55 W. Trimble Road, San Jose, California, 95131, and its telephone number is (408) 914-6000. The Company's homepage can be located on the Web at http://www.quickturn.com/. 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 which creates a software mock-up of the IC's logic flow based on the RTL description. Test inputs are then fed into the mock-up to determine if the current design performs as desired. -2- Once an IC design is deemed reliable at the RTL level, the designer maps out a physical layout of the transistors and gates. This is often accomplished using synthesis software which transforms RTL designs into gate level architecture. Once at the gate level, the design again must be tested for critical operating functionality. Both RTL and gate level tests are typically run on event-driven simulation software, which runs at speeds substantially below the normal speed of a completed IC. The speed of most event-driven 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 tens of millions 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-driven simulation could take a substantial period of time. Since a design may need to undergo dozens of iterations, given the time-to-market demands in the electronics industry, the delays associated with full event-driven 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-driven simulation. CBS is specifically designed to improve on the verification speed limitations of event-driven simulation, and it may also contribute to lower 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 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 to traditional event-driven simulation, which examines every active signal that propagates through every device during a clock cycle. Therefore, the Company believes that its CBS approach may be five to ten times faster than event-driven 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-driven-simulation addresses from four to nine logic states. Other enhancements related to BDE technology include: * Minimal Memory Usage: The SpeedSim product enhances performance by utilizing less memory than event-driven simulation. Using BDE, engineers can fit a one million gate design into a 10MB image. Without BDE, the computer memory requirements for the same image may be typically five to 50 times -3- larger. For very large chip designs, the reduced memory requirements made possible by BDE are further enhanced by allowing a design team to speed up verification by running different tests on all of their desktop workstations in their network at once, instead of on just 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 throughput. * Symmetric MultiProcessing ("SMP"): This feature allows chip designers to take a single design of one million gates or more and divide it into segments. Each segment is then simulated on different CPUs within the SMP box, thereby creating software simulation that is four to eight times faster across multiple CPUs compared to having to simulate 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 some event-driven simulation. The platforms supported by the SpeedSim product include UNIX workstations on SUN, HP, DEC, and IBM platforms and Intel-compatible PCs running LINUX or Windows/NT. EMULATION Quickturn's System Realizer emulation system and CoBALT 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 complex, synchronous designs of up to 8 million logic gates. Both systems share the same software environment, which allows designers to select the optimum emulation solution for any design style. The emulation process begins with the Company's emulation 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. -4- These designs are then processed by the Company's proprietary software on a commercial workstation. Using information provided by engineers as well as by built-in proprietary algorithms, the software is used to partition designs into different blocks of logic which are then automatically mapped into a virtual silicon implementation. The user's gate or RTL description is mapped into the programmable hardware of CoBALT or System Realizer. Optimization is done during the mapping process to best utilize the programmable hardware. Once the designs are partitioned, the software defines the interconnection and logic routing of the various blocks of logic. 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 where the fabricated silicon will ultimately reside. At this time, the target system can be run just as it would if 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. When design problems are discovered, changes are made and then transferred by the emulation software to the virtual silicon. The impact of the changes can be determined quickly in the target system while the design can still be easily modified. The Company's emulation products range in emulation capacities from 150,000 logic gates to 8 million logic gates and are priced at between $0.75 to $1.00 per logic gate. Quickturn's products are based on the Company's patented technologies and proprietary software algorithms that 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 ("FPGAs") for System Realizer or processor chips for CoBALT, and programmable memories that constitute the core reprogrammable components of Quickturn's emulation systems. -5- * INTERCONNECT ARCHITECTURE: in System Realizer, the patented system-level schema for connecting 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. See "---Risk Factors: Developing Market; Acceptance of the Company's Products." 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 design verification problems. As the technology has matured, a broader range of customers has adopted the technology. Today, the Company's customers include microprocessor, computer, workstation and PC, telecommunications and networking, multimedia, and graphics companies. The Company's customers are in industries characterized by rapid advances in technology, competitive pressures to quickly develop and introduce new products and the need for extensive system-level design verification and debugging prior to design implementation. Microprocessors and microcontrollers with complexity levels of hundreds of thousands and even millions of logic 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 design verification products are designers of custom ICs or -6- Application Specific Integrated Circuits ("ASICs") with 30,000 to 100,000 or more logic gates. See "---Risk Factors: Customer Concentration." 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 design verification technology by new users. During the early stages of a customer's first project, the Company works closely with the customer's project team to ensure a smooth integration of its design 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 design 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 an application engineering team capable of serving the sophisticated needs of prospective customers' engineering and management staffs. The sales process is supported by a broad range of marketing programs which includes 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 design verification products. See "---Risk Factors: Potential Fluctuations in Quarterly Results" and "---Risk Factors: Lengthy Sales Cycles." As of February 28, 1998, the Company's direct sales and service force consisted of 155 technical, administrative and management employees. The Company has 14 sales and support offices throughout the United States located in Arizona, California (Garden Grove, San Diego, San Jose), Colorado, Illinois, Massachusetts (Marlborough and North Chelmsford), Minnesota, New Jersey, North Carolina, Oregon and Texas (Austin and Dallas). Internationally, the -7- Company has six sales and support offices, one each in London, Munich, Osaka, Paris, Stockholm and Yokohama. The Company plans to lease a sales office in Tel Aviv by the second quarter of 1998. In Japan, the Company serves its customers through its direct sales and service offices in Osaka and Yokohama. 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, Korea, Singapore and Taiwan. International sales (sales outside of North America) accounted for approximately 34%, 36% and 31% of the Company's revenue in 1997, 1996 and 1995, respectively. See "---Risk Factors: International Sales." RESEARCH AND DEVELOPMENT To support its current leadership position in the design verification market, the Company presently invests and will continue to invest in continued innovation in the key technology areas of new products and existing products. As of February 28, 1998, the Company's research and development group consisted of 135 full-time employees. Within the research and development organization, approximately 74% was involved in software development, with the balance in hardware design. During 1997, 1996 and 1995, research and development expenses were $23.5 million, $19.7 million and $15.4 million, respectively. The Company anticipates that it will continue to commit substantial resources to research and development in the future. See "---Risk Factors: New Products and Technological Change." MANUFACTURING The Company performs final assembly and test of its emulation products in its San Jose, 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. 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, -8- 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 future period. However, the Company partially relies on forecasts to determine inventory levels and manufacturing schedules. See "---Risk Factors: Dependence Upon Certain Suppliers" and "---Risk Factors: Manufacturing." 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 for emulation-based system-level design verification and cycle-based simulation, and also competition from traditional design verification methodologies which rely on the approach of building and then testing complete system prototypes, as well as from potentially new tools such as formal verfication. The Company will continue to inform potential customers of the benefits of emulation and cycle-based simulation in order for such customers to adopt the Company's advanced design verification systems as a complement to standard simulation tools. See "---Risk Factors: Competition." 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. Several actions between the Company and Mentor were consolidated in the U.S. District Court for the District of Oregon, where six of the Company's patents are now involved in the disputes. The Company has filed counterclaims against Mentor and Mentor's French subsidiary, Meta Systems ("Meta"), for infringement and threatened infringement of those six patents. Mentor has also filed claims against the Company for defamation and tortious interference. In January 1996, the Company filed a complaint with the International Trade Commission, seeking to stop unfair importation of hardware logic emulation systems and components manufactured by Meta on the grounds that such systems infringe the Company's patents. In November 1996, Aptix Corporation filed a suit against the Company alleging antitrust violations and unfair competition. In August 1997, a preliminary injunction sought by Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, was issued by a -9- regional court in Munich, enjoining agents of the Company from making certain statements concerning the U.S. litigation matters between Mentor and the Company. In October 1997, the Company filed suit in Germany against Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, for infringement of the Company's German patent. See Note 16 of the Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Stockholders. 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. PROPRIETARY RIGHTS The Company's success and ability to compete depend 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 22 U.S. patents, of which one is co-owned, and has 24 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 five corresponding foreign patents and 43 foreign patent applications pending. The five foreign patents expire in 2009. See "---Risk Factors: Proprietary Rights." EMPLOYEES As of February 28, 1998, the Company had a total of 388 employees, of whom 350 were based in the United States and 38 were based overseas. Of the total, 173 were engaged in sales, marketing and related customer support services, 135 were in research and development, 55 were in manufacturing and 25 were in finance and administration. See "---Risk Factors: Dependence Upon Key Personnel." -10- RISK FACTORS IN ADDITION TO OTHER INFORMATION IN THIS ANNUAL REPORT ON FORM 10-K AND IN THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN, THE FOLLOWING RISK FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS BUSINESS BECAUSE SUCH FACTORS CURRENTLY HAVE A SIGNIFICANT IMPACT OR MAY HAVE A SIGNIFICANT IMPACT IN THE COMPANY'S BUSINESS, OPERATING RESULTS OR FINANCIAL CONDITION. DEVELOPING MARKET; ACCEPTANCE OF THE COMPANY'S PRODUCTS. Substantially all of the Company's revenue has been derived from the sale of its design verification products, and sales of such products are expected to continue to account for substantially all of the Company's revenue in the foreseeable future. To date, the Company's products have been sold to a limited number of customers. See "---Risk Factors: Customer Concentration." Accordingly, broad market acceptance of design verification products by existing and new customers is critical to the Company's future success. The adoption of the Company's design verification products in the design verification process by IC and system designers, particularly those which have historically relied on other methodologies, generally requires the designer to adopt an entirely new method of design verification. While the Company believes that its design 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 design verification products for designing ICs and systems will also depend on the continued increased 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 the Company's design verification products and industry acceptance of the need to close the gap between high level design and silicon production. Because the market for design verification products is new and evolving, it is difficult to predict with any assurance whether the market for design verification products will continue to expand. POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS. 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 design verification products, new product announcements and releases by the Company, and economic conditions generally and in the electronics industry specifically. Other factors which could -11- 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 product 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. 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. LENGTHY SALES CYCLES. 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 systems. In view of the significant amounts of both 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 design verification products as a result of delays in commencement of the project by a customer. For this and other reasons, the Company's design 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. CUSTOMER CONCENTRATION. A relatively limited number of customers has 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 ICs. 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 in the foreseeable future. The loss of a major customer or any reduction in orders by such a customer, including reductions due to market or competitive conditions in the electronics or EDA industry, could have an -12- 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. DEPENDENCE ON ELECTRONICS INDUSTRY. The Company is dependent upon the state of the electronics industry, and in particular on new system and IC design projects. The electronics industry is characterized by rapid technological change, short product life cycles, fluctuations in manufacturing capacity and pricing and margin pressures, which cause the industry to be volatile. As a result, the electronics industry has historically experienced sudden and unexpected downturns during which new system and IC design projects decrease. Because most of the Company's sales occur upon the commencement of new projects for system and IC products, the Company is dependent upon the rate of commencement of new system and IC design projects. Accordingly, negative factors affecting the electronics industry could have a material adverse effect on the Company's financial condition or results of operations. NEW PRODUCTS AND TECHNOLOGICAL CHANGE. The EDA industry is characterized by extremely rapid technological change in 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 design verification products on a timely basis that keep pace with technological developments and emerging industry standards. Next-generation design 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 successfully develop and market 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, -13- 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. COMPETITION. Because of the demand 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 design verification and cycle-based simulation to increase as other companies attempt to introduce emulation and cycle-based simulation products and product enhancements, and as major new EDA technologies may emerge. 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. The Company believes that the principal competitive factors in the EDA market are 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. INTERNATIONAL SALES. 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. The Company plans to continue to expand its international sales and distribution channels. However, there can be no assurance that the Company's products will achieve widespread commercial acceptance in international markets in the future. The Company is uncertain whether the recent weakness experienced in the Asia-Pacific markets will continue in the foreseeable future due to extreme -14- currency devaluation and liquidity problems in this region. Additionally, EDA spending budgets of major Japanese electronics firms may be decreased; consequently, sales of the Company's design verification products in Japan may be flat or down. 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, which licenses may on occasion be delayed or difficult to obtain. DEPENDENCE UPON CERTAIN SUPPLIERS. 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 design verification products also use a proprietary IC that is currently manufactured solely by National Semiconductor Corporation. The Company generally purchases this component pursuant to purchase orders placed from time to time in the ordinary course of business and has no guaranteed supply arrangements with this source supplier. Moreover, the manufacture of this component is extremely complex, and the Company's reliance on the supplier of this component exposes the Company to production difficulties and quality variations that may be experienced by this supplier. Therefore, the Company's reliance on this sole and limited source supplier 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 this supplier have been acceptable, there can be no assurance that problems will not occur in the future. Any prolonged inability to obtain adequate -15- 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. DEPENDENCE UPON KEY PERSONNEL. 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. MANUFACTURING. The Company's emulation systems are complex and are used by the Company's customers in critical development projects which demand a high level of quality and reliability. The Company invests substantial resources to ensure the quality and reliability of its emulation systems and is required to provide a high level of service to its customers to minimize downtime in the event of a malfunction. There can be no assurance that the Company will be able to meet customer requirements for quality and reliability in the future. PROPRIETARY RIGHTS. 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 -16- 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," "---Risk Factors: 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. 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. 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 upon 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 could incur significant costs with respect to the defense thereof, which costs 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 -17- loss of or inability to maintain any of these software licenses could result in delays or reductions in product shipments until equivalent software were identified, licensed and integrated, which would adversely affect the Company's operating results. VOLATILITY OF STOCK PRICE. The market for Quickturn's Common Stock is highly volatile, and could be subject to wide fluctuations in response to quarterly variations in operating and financial results, announcements of technological innovations or new products by Quickturn or its competitors, changes in prices of Quickturn's or its competitors' products and services, changes in product mix, changes in revenue and revenue growth rates for Quickturn as a whole or for individual geographic areas, product units, products or product categories, as well as other events or factors. Statements or changes in opinions, ratings, or earnings estimates made by brokerage firms or industry analysts relating to the market in which Quickturn does business or relating to Quickturn specifically have resulted, and could in the future result, in an immediate and adverse effect on the market price of Quickturn's Common Stock. Statements by financial or industry analysts regarding the extent of the dilution in Quickturn's net income per share resulting from the SpeedSim Merger and the extent to which such analysts expect potential business synergies to offset such dilution can be expected to contribute to volatility in the market price of Quickturn's Common Stock. In addition, the stock market has from time to time experienced extreme price and volume fluctuations which have particularly affected the market price for the securities of many high-technology companies and which often have been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of Quickturn's Common Stock. ANTI-TAKEOVER PROVISIONS. The Company has adopted a number of provisions that could have antitakeover effects. In January 1996, the Company's Board of Directors adopted a Preferred Shares Rights Agreement, commonly referred to as a "poison pill." In addition, the Company's Board of Directors has the authority to issue up to 2,000,000 shares of Preferred Stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of these shares without any further vote or action by the stockholders. Furthermore, Quickturn is subject to the provisions of Section 203 of the General Corporation Law of Delaware, which has the effect of restricting changes of control of a company. -18- ITEM 2. PROPERTIES. The Company's principal administrative, sales, marketing, manufacturing and research and development facility is located in two buildings totaling 145,815 square feet in San Jose, California, which are subject to a lease that expires in August 2004. The Company leases thirteen 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, and plans to lease a sales office in Tel Aviv by the second quarter of 1998. 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. ITEM 3. LEGAL PROCEEDINGS. 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"), a French 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, an ITC Administrative Law Judge issued an Initial Determination granting a Temporary Exclusion Order stopping the importation of Mentor's emulation systems into the United States, absent the posting of a bond by Mentor. The ITC Initial Determination included a Cease and Desist Order against all sales activities regarding unbonded Mentor emulation products imported into the United States. In August 1996, the ITC ratified the judge's Initial Determination. Mentor and Meta appealed the Temporary Exclusion Order to the Federal Circuit Court of Appeals, asking that the ITC's Interpretation of Quickturn's patent claims be overturned. On August 15, 1997, the Federal Circuit Court of Appeals affirmed the ITC's decision granting temporary relief to the Company and adopted the patent claim interpretation of the ITC as being correct and derived in accordance with the Federal Circuit's case law. Meanwhile, on August 1, 1997, the ITC Administrative Law Judge issued an Initial Determination that Mentor's SimExpress emulation systems and components, including software components, infringe five of the Company's patents. The Administrative Law Judge recommended that the ITC issue a Permanent Exclusion Order prohibiting the importation of SimExpress systems and components. The Administrative Law Judge further recommended that the ITC issue a Cease and Desist Order prohibiting Mentor from distributing any SimExpress software of non-U.S. origin in the United States. On October 2, 1997, the ITC ratified the Administrative Law -19- Judge's Initial Determination. On December 3, 1997, the ITC issued a Permanent Limited Exclusion Order permanently prohibiting the importation of hardware logic emulation systems, subassemblies or components (including software) manufactured by Mentor and/or Meta. At the same time, the ITC issued a Permanent Cease and Desist Order permanently prohibiting Mentor from, among other things, selling, offering for sale or advertising the same hardware logic emulation devices. The period in which President Clinton had to review the ITC's actions expired on February 2, 1998, and the two orders became final by operation of law. The Company is also 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 prospective economic relations. In June 1997, Quickturn filed a motion for preliminary injunction, asking the District Court to prohibit Mentor from manufacturing, assembling, marketing, loaning or otherwise distributing emulation products and components in the United States, which products and components infringe certain claims in Quickturn's U.S. Patent No. 5,036,473. On August 1, 1997, the U.S. District Court in Oregon granted Quickturn's motion for a preliminary injunction against Mentor's domestic emulation activities. The Oregon action is presently set for trial in August 1998. In August 1997, a preliminary injunction sought by Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, was issued by a regional court in Munich, enjoining agents of the Company from making certain statements concerning U.S. litigation matters between the Company and Mentor. The Company filed a motion with the regional court in Munich to dismiss this action based on the failure of Mentor's German subsidiary to advance its case within the 6-month statutory limitation. In October 1997, the Company filed a complaint alleging infringement of the German part of the Company's European Patent No. 0 437 491 B1 against Mentor Graphics (Deutschland) GmbH, in the District Court of Dusseldorf. The main court hearing for this matter is set for March 1999. In November 1996, Aptix Corporation ("Aptix") also filed a suit against the Company alleging various violations of the antitrust laws and unfair competition. The discovery phase of this case was recently completed. -20- The Company has mounted vigorous defenses against Mentor's defamation and tortious interference claims and the antitrust and unfair competition claims by Aptix. The outcome of these actions cannot be predicted with certainty. In February 1998, Aptix and Meta filed a lawsuit against the Company alleging infringement of a U.S. patent owned by Aptix and licensed to Meta. The Company is mounting vigorous defense against this claim. The outcome of this action 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. 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 1997. Executive Officers and Vice Presidents of the Company - ----------------------------------------------------- The executive officers and vice presidents of the Company, and their ages as of February 28, 1998, are as follows:
Name Age Position - ---- --- -------- Keith R. Lobo . . . . . . . . . . 46 President, Chief Executive Officer and Director Raymond K. Ostby . . . . . . . . 50 Vice President, Finance and Administration, Chief Financial Officer and Secretary Donald J. McInnis . . . . . . . . 51 Senior Vice President, Advanced Simulation Division Dr. K. C. Chu . . . . . . . . . . 51 Vice President, Software Development Bernard A. Gilbert . . . . . . . 41 Vice President, Engineering Operations, Advanced Simulation Division Jeffrey K. Jordan . . . . . . . . 53 Vice President, North American Sales Kevin L. Ladd . . . . . . . . . . 35 Vice President and Chief Technologist, Advanced Simulation Division
-21-
Harlen Ng. . . . . . . . . . . . 57 Vice President, Program Development Stephen P. Sample . . . . . . . . 46 Vice President, Advanced Development Dugald H. Stewart . . . . . . . . 45 Vice President, Manufacturing Christopher J. Tice . . . . . . . 38 Vice President, World-Wide Support Services Tung-sun Tung . . . . . . . . . . 49 Vice President, Research and Development Dr. Ming Yang Wang . . . . . . . 53 Vice President, Advanced Technology Solutions Naeem Zafar . . . . . . . . . . . 40 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. 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. 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. -22- Dr. 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 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 since 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 Eastern Regional Sales 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 since 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. 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 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. -23- 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 since 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. Dr. 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, Dr. 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. -24- 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 1997 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 2 of the Company's 1997 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 1997 Annual Report to Stockholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 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 1997 Annual Report to Stockholders, the Consolidated Financial Statements, the related notes thereto and Report of Independent Accountants on pages 23 through 38 of the Company's 1997 Annual Report to Stockholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOURE. Not applicable. With the exception of the information specifically incorporated by reference from the 1997 Annual Report to Stockholders in Parts II and IV of this Form 10-K, the Company's 1997 Annual Report to Stockholders is not to be deemed filed as part of this Report. -25- 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 1998 Annual Meeting of Stockholders filed with the Commission on March 10, 1998 (the "1998 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 1998 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 1998 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Not applicable. -26- 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 38 of the Company's 1997 Annual Report to Stockholders. Report of Coopers & Lybrand L.L.P., Independent Accountants Consolidated Balance Sheets as of December 31, 1997 and 1996 Consolidated Statements of Operations for the Years ended December 31, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996 and 1995 Notes to the Consolidated Financial Statements 2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule of the Company for the years ended December 31, 1997, 1996 and 1995 is 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 S-1 on Financial Statement Schedule II Valuation and Qualifying Accounts S-2 -27- 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, 1997. -28- 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 27th day of March 1998. QUICKTURN DESIGN SYSTEMS, INC. By: /s/ RAYMOND K. OSTBY --------------------------- Raymond K. Ostby, Vice President, Finance and Administration, Chief Financial Officer and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on March 27, 1998 on behalf of the Registrant and in the capacities indicated: Signatures Title ----------------------------- --------------------------------------- /s/ KEITH R. LOBO President and Chief Executive Officer ----------------------------- (Principal Executive Officer) Keith R. Lobo /s/ RAYMOND K. OSTBY Vice President, Finance and ----------------------------- Administration, Chief Financial Officer Raymond K. Ostby and Secretary (Principal Financial and Accounting Officer) /s/ GLEN M. ANTLE Chairman of the Board ----------------------------- Glen M. Antle /s/ RICHARD C. ALBERDING Director ----------------------------- Richard C. Alberding /s/ MICHAEL R. D'AMOUR Director ----------------------------- Michael R. D'Amour /s/ DR. YEN-SON (PAUL) HUANG Director ----------------------------- Dr. Yen-Son (Paul) Huang /s/ DR. DAVID K. LAM Director ----------------------------- Dr. David K. Lam 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 38 of the 1997 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 27 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 20, 1998 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, 1995 Allowance for doubtful accounts $ 1,840 $ ----- $ ----- $ 1,840 --------- --------- --------- --------- --------- --------- --------- --------- Year ended December 31, 1996 Allowance for doubtful accounts $ 1,840 $ ----- $ ----- $ 1,840 --------- --------- --------- --------- --------- --------- --------- --------- Year ended December 31, 1997 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, 1997 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 (which is incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated February 7, 1997). 3.1 Certificate of Incorporation of the Registrant, as amended (which is incorporated herein by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1, Registration No. 33-71022 ("Registrant's 1993 Form S-1")). 3.2 Certificate of Amendment of the Certificate of Incorporation of the Registrant, dated April 11, 1997. 3.3 Bylaws of the Registrant (which are incorporated herein by reference to Exhibit 3.2 to the Registrant's 1993 Form S-1). 4.1 Form of Registrant's Common Stock certificate (which is incorporated herein by reference to Exhibit 4.1 to the Registrant's 1993 Form S-1). 10.1 * Form of Indemnification Agreement entered into by Registrant with each of its directors and executive officers (which is incorporated herein by reference to Exhibit 10.1 to the Registrant's 1993 Form S-1). 10.2 * 1988 Stock Option Plan and related agreements (which is incorporated herein by reference to Exhibit 10.2 to the Registrant's 1993 Form S-1). 10.3 * Key Executive Stock Option Plan and related agreements (which is incorporated herein by reference to Exhibit 10.3 to the Registrant's 1993 Form S-1). 10.4 * 1993 Employee Qualified Stock Purchase Plan and related agreements (which is incorporated herein by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-8, Registration No. 333-25459 ("Registrant's 1997 Form S-8")). 10.5 Software License Agreement dated December 18, 1987 between Xilinx, Inc. and Registrant (which is incorporated herein by reference to Exhibit 10.8 to the Registrant's 1993 Form S-1). -i- QUICKTURN DESIGN SYSTEMS, INC. ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED DECEMBER 31, 1997 INDEX TO EXHIBITS ----------------- Exhibit Number Description - ------- --------------------------------------------------------------------- 10.6 Lease dated December 6, 1996 between San Jose Acquisition Co., L.L.C. and Registrant. 10.8 * Offer letter dated November 4, 1992 between Keith R. Lobo and Registrant, as amended (which is incorporated herein by reference to Exhibit 10.18 to Registrant's 1993 Form S-1). 10.9 * 1994 Outside Director Stock Option Plan (which is incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8, Registration No. 33-82452). 10.10 * SpeedSim, Inc. 1995 Incentive and Nonqualified Stock Option Plan (which is incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8, Registration No. 333-21587). 10.11 * 1996 Supplemental Stock Plan (which is incorporated herein by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8, Registration No. 333-18407). 10.12 * 1997 Stock Option Plan (which is incorporated herein by reference to Exhibit 4.1 to Registrant's Registration Statement on Form S-8, Registration No. 33-25459). 13.1 Portions of 1997 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. 27.1 Financial Data Schedule for fiscal year of 1997 (EDGAR). 27.2 Restated Financial Data Schedule for fiscal year of 1996 and quarters 1, 2, 3 of 1996 (EDGAR). 27.3 Restated Financial Data Schedule for fiscal year of 1995 (EDGAR). - ---------------------------- * Indicates management compensatory plan, contract or arrangement. -ii- EX-3.2 2 EXHIBIT 3.2 CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF INCORPORATION OF QUICKTURN DESIGN SYSTEMS, INC. Quickturn Design Systems, Inc., a corporation organized and existing under the laws of the State of Delaware (the "Corporation"), pursuant to the provisions of the General Corporation Law of the State of Delaware (the "DGCL"), DOES HEREBY CERTIFY as follows: FIRST: The Certificate of Incorporation of the Corporation is hereby amended by deleting the first paragraph of the Article numbered "Fourth" in its present form and substituting therefor a new first paragraph of the Article numbered "Fourth" in the following form: "This corporation is authorized to issue two classes of shares to be designated respectively Preferred Stock ("Preferred") and Common Stock ("Common"). The total number of shares of Preferred this corporation shall have authority to issue shall be 2,000,000, $.001 par value, and the total number of shares of Common which this corporation shall have the authority to issue shall be 40,000,000, $.001 par value." SECOND: The amendment to the Certificate of Incorporation of the Corporation set forth in this Certificate of Amendment has been duly adopted in accordance with the provisions of Section 242 of the DGCL by (a) the Board of Directors of the Corporation having duly adopted a resolution setting forth such amendment and declaring its advisability and submitting it to the stockholders of the Corporation for their approval, and (b) the stockholders of the Corporation having duly adopted such amendment by vote of the holders of a majority of the outstanding stock entitled to vote thereon at an annual meeting of stockholders called and held upon notice in accordance with Section 222 of the DGCL. IN WITNESS WHEREOF, the Corporation has caused its corporate seal to be hereunto affixed and this Certificate of Amendment to be signed by Keith R. Lobo, its President and Chief Executive Officer, and attested by Raymond K. Ostby, its Vice President, Finance and Administration, Chief Financial Officer and Secretary, this 11th day of April 1997. QUICKTURN DESIGN SYSTEMS, INC. By: /s/ Keith R. Lobo ----------------------- Keith R. Lobo President and Chief Executive Officer ATTEST: /s/ Raymond K. Ostby - ------------------------- Raymond K. Ostby Vice President, Finance and Administration, Chief Financial Officer and Secretary EX-10.6 3 EXHIBIT 10.6 Exhibit 10.6 LEASE DATED December 6, 1996 BY AND BETWEEN San Jose Acquisition Company As Landlord and Quickturn Design Systems, Inc. As Tenant AFFECTING PREMISES COMMONLY KNOWN AS 2610 Orchard Parkway and 55 W. Trimble Road San Jose, Ca 95131 - 1013 [12/15/95 MULTI TENANT NET INDUSTRIAL LEASE] TABLE OF CONTENTS
PAGE: ----- ARTICLE 1 - DEFINITIONS - ----------------------- 1.1 General 1 1.2 Additional Rent 1 1.3 Address for Notices 1 1.4 Agents 1 1.5 Agreed Interest Rate 1 1.6 Base Monthly Rate 1 1.7 Building 1 1.8 Commencement Date 1 1.9 Common Area 1 1.10 Common Operating Expense 1 1.11 Consumer Price Index 1 1.12 Effective Date 1 1.13 Event of Tenant's Default 1 1.14 Hazardous Materials 1 1.15 Insured and Uninsured Peril 1 1.16 Law 1 1.17 Lease 1 1.18 Lease Term 1 1.19 Lender 1 1.20 Permitted Use 2 1.21 Premises 2 1.22 Project 2 1.23 Private Restrictions 2 1.24 Real Property Taxes 2 1.25 Scheduled Commencement Date 2 1.26 Security Instrument 2 1.27 Summary 2 1.28 Tenant's Alterations 2 1.29 Tenant's Share 2 1.30 Trade Fixtures 2 ARTICLE 2 - DEMISE, CONSTRUCTION, AND ACCEPTANCE 2 - ------------------------------------------------ 2.1 Demise of Premises 2 2.2 Commencement Date 2 2.3 Construction of Improvements 2 2.4 Delivery and Acceptance of Possession 2 2.5 Early Occupancy 3 ARTICLE 3 - RENT 3 - ---------------- 3.1 Base Monthly Rent 3 3.2 Additional Rent 3 3.3 Payment of Rent 3 3.4 Late Charge and Interest on Rent in Default 3 3.5 Security Deposit 3 ARTICLE 4 - USE OF PREMISES 3 - --------------------------- 4.1 Limitation on Use 3 4.2 Compliance with Regulations 4 4.3 Outside Areas 4 4.4 Signs 4 4.5 Parking 4 4.6 Rules and Regulations 4
i TABLE OF CONTENTS (CONTINUED)
PAGE: ----- ARTICLE 5 - TRADE FIXTURES AND ALTERATIONS 4 - ------------------------------------------ 5.1 Trade Fixtures 4 5.2 Tenant's Alterations 4 5.3 Alterations Required by Law 5 5.4 Amortization of Certain Capital Improvements 5 5.5 Mechanic's Liens 5 5.6 Taxes on Tenant's Property 6 ARTICLE 6 - REPAIR AND MAINTENANCE 6 - ---------------------------------- 6.1 Tenant's Obligation to Maintain 6 6.2 Landlord's Obligation to Maintain 6 6.3 Control of Common Area 6 ARTICLE 7 - WASTE DISPOSAL AND UTILITIES 7 - ---------------------------------------- 7.1 Waste Disposal 7 7.2 Hazardous Materials 7 7.3 Utilities 8 7.4 Compliance with Governmental Regulations 8 ARTICLE 8 - COMMON OPERATING EXPENSES 8 - ------------------------------------- 8.1 Tenant's Obligation to Reimburse 8 8.2 Common Operating Expenses Defined 8 8.3 Real Property Taxes Defined 9 ARTICLE 9 - INSURANCE 9 - --------------------- 9.1 Tenant's Insurance 9 9.2 Landlord's Insurance 10 9.3 Tenant's Obligation to Reimburse 10 9.4 Release and Waiver of Subrogation 10 ARTICLE 10 - LIMITATION ON LANDLORD'S LIABILITY AND INDEMNITY 10 - ------------------------------------------------------------- 10.1 Limitation on Landlord's Liability 10 10.2 Limitation on Tenant's Recourse 11 10.3 Indemnification of Landlord 11 ARTICLE 11 - DAMAGE TO PREMISES 11 - ------------------------------- 11.1 Landlord's Duty to Restore 11 11.2 Landlord's Right to Terminate 11 11.3 Tenant's Right to Terminate 12 11.4 Abatement of Rent 12 ARTICLE 12 - CONDEMNATION 12 - ------------------------- 12.1 Landlord's Termination Right 12 12.2 Tenant's Termination Right 12 12.3 Restoration and Abatement of Rent 12 12.4 Temporary Taking 12 12.5 Division of Condemnation Award 12
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PAGE: ----- ARTICLE 13 - DEFAULT AND REMEDIES 13 - --------------------------------- 13.1 Events of Tenant's Default 13 13.2 Landlord's Remedies 13 13.3 Waiver 14 13.4 Limitation on Exercise of Rights 14 13.5 Waiver by Tenant of Certain Remedies 14 ARTICLE 14 - ASSIGNMENT AND SUBLETTING 14 - -------------------------------------- 14.1 Transfer by Tenant 14 14.2 Transfer by Landlord 16 ARTICLE 15 - GENERAL PROVISIONS 16 - ------------------------------- 15.1 Landlord's Right to Enter 16 15.2 Surrender of the Premises 17 15.3 Holding Over 17 15.4 Subordination 17 15.5 Mortgagee Protection and Attornment 17 15.6 Estoppel Certificates and Financial Statements 17 15.7 Reasonable Consent 18 15.8 Notices 18 15.9 Attorney's Fees 18 15.10 Corporate Authority 18 15.11 Miscellaneous 18 15.12 Termination by Exercise of Right 18 15.13 Brokerage Commissions 19 15.14 Force Majeure 19 15.15 Entire Agreement 19 EXHIBITS - -------- Exhibit A - Site plan of the Project containing a description of the Premises Exhibit B - Improvement Agreement Exhibit C - Approved Specifications Exhibit D - PUNCH LIST Exhibit E - Description of Private Restrictions Exhibit F - Sign Criteria Exhibit G - Form of Subordination Agreement Exhibit H - Hazardous Materials Questionnaire
iii SUMMARY OF BASIC LEASE TERMS SECTION TERMS (LEASE REFERENCE) A. LEASE REFERENCE DATE: December 6, 1996 (Introduction) B. LANDLORD: San Jose Acquisition Co., L.L.C., (Introduction) a Delaware limited liability company C. TENANT: Quickturn Design Systems, Inc., (Introduction) a Delaware corporation D. PREMISES: That area consisting of 145,815 square (Section 1.21) feet of gross leasable area the address of which is 2610 Orchard Parkway and 55 West Trimble Road, San Jose, CA within the as Shown on Exhibit A. Buildings and connector E. PROJECT: The land and improvements shown on (Section 1.22) Exhibit A consisting of three (3) buildings the aggregate gross leasable area of which is 206,448 square feet. F. BUILDINGS: The buildings in which the Premises are (Section 1.7) located known as 2610 Orchard Parkway and 55 W. Trimble Road, San Jose, Ca containing 145,815 square feet of gross leasable area. G. TENANT'S SHARE: 100% of the Premises; 100% of the (Section 1.29) Building; and 70.63% of the Project. H. TENANT'S ALLOCATED PARKING STALLS: 580 stalls. (Section 4.5) I. COMMENCEMENT DATE: August 3, 1997. Also see Paragraph 6 of (Section 1.26) the First Addendum To Lease: J. LEASE TERM: 84 calendar months (plus the partial (Section 1.18) month following the Commencement Date if such date is not the first day of a month). K BASE MONTHLY RENT: Months 1 - 12: $218,722.50 per month (Section 3.1) Months 13 - 24: $226,013.25 per month Months 25 - 36: $233,304.00 per month Months 37 - 48: $240,594.75 per month Months 49 - 60: $247,885.50 per month Months 61 - 72: $255,176.25 per month Months 73 - 84: $262,467.00 per Month L. PREPAID RENT: $218.722.50 (Section 3.3) M. SECURITY DEPOSIT: $262,467.00 (Section 3.5) N. PERMITTED USE: Office, marketing, research, (Section 4.1) development, test, assembly, storage and distribution of electronic components. 0. PERMIT TENANT'S ALTERATIONS LIMIT: $10,000.00 (Section 5.2) P. TENANT'S LIABILITY INSURANCE MINIMUM: $3,000,000.00 (Section 9.1) Q. Landlord's Address: Suite 300 (Section 1.3) 2290 North First Street San Jose, Ca 95131 R. Tenant's Address: 440 Clyde Avenue (Section 1.3) Mountain View, Ca 94043 S. Retained Real Estate Brokers: Wayne Mascia Associates (Section 15.13) T. Lease: This Lease includes the summary of the Basic Lease (Section 1.17) Terms, the Lease, and the following exhibits and addenda: First Addendum to Lease, EXHIBIT A (site plan of the Project containing description of the Premises), EXHIBIT B (Improvement Agreement), EXHIBIT C (Approved Specifications), EXHIBIT D (Punch List), EXHIBIT E description of Private restrictions), EXHIBIT F (sign criteria), EXHIBIT G (form of subordination agreement), EXHIBIT H (Hazardous Materials Questionnaire) LANDLORD: TENANT: SAN JOSE ACQUISITION CO., L.L.C. QUICKTURN DESIGN SYSTEMS, INC. A DELAWARE LIMITED LIABILITY COMPANY A DELAWARE CORPORATION BY: ARGO PARTNERSHIP, L.P., ITS GENERAL PARTNER BY: /s/ Ray Ostby RAY OSTBY BY: ARGO MANAGEMENT COMPANY, L.P. ITS GENERAL PARTNER TITLE: CHIEF FINANCIAL OFFICER BY: O'CONNER CAPITAL PARTNERS, L.P., DATE: 12/16/96 ITS GENERAL PARTNER BY: 0'CONNER CAPITAL INCORPORATED, ITS GENERAL PARTNER BY: /s/ K.J. Artingstall K.J. ARTINGSTALL VICE PRESIDENT BY: ARGO PARTNERSHIP II L.P., ITS MANAGER BY: ARGO II MANAGEMENT COMPANY, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL PARTNERS II, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL II INCORPORATED ITS GENERAL PARTNER BY: /s/ K.J. Artingstall K.J. ARTINGSTALL VICE PRESIDENT DATE: 12/18/96 LEASE This Lease is dated as of the lease reference date specified in SECTION A of the Summary and is made by and between the party identified as Landlord in SECTION B of the Summary and the party identified as Tenant in SECTION C of the Summary. ARTICLE 1 DEFINITIONS 1.1 GENERAL: Any initially capitalized term that is given a special meaning by this Article 1, the Summary, or by any other provision of this Lease (including the exhibits attached hereto) shall have such meaning when used in this Lease or any addendum or amendment hereto unless otherwise clearly indicated by the context. 1.2 ADDITIONAL RENT: The term "Additional Rent" is defined in Paragraph 3.2. 1.3 ADDRESS FOR NOTICES: The term "Address for Notices" shall mean the addresses set forth in SECTIONS Q and R of the Summary, provided, however, that after the Commencement Date, Tenant's Address for Notices shall be the address of the Premises. 1.4 AGENTS: The term "Agents" shall mean the following: (i) with respect to Landlord or Tenant, the agents, employees, contractors, and invitees of such party; and (ii) in addition with respect to Tenant, Tenant's subtenants and their respective agents, employees, contractors, and invitees. 1.5 AGREED INTEREST RATE: The term "Agreed Interest Rate" shall mean that interest rate determined as of the time it is to be applied that is equal to the lesser of (i) 5% in excess of the discount rate established by the Federal Reserve Bank of San Francisco as it may be adjusted from time to time, or (ii) the maximum interest rate permitted by Law. 1.6 BASE MONTHLY RENT: The term "Base Monthly Rent" shall mean the fixed monthly rent payable by Tenant pursuant to Paragraph 3.1 which is specified in Section K of the Summary. 1.7 BUILDING. The term "Building" shall mean the buildings in which the Premises are located which buildings are identified in SECTION F of the Summary, the gross leasable area of which is referred to herein as the "Building Gross Leasable Area." 1.8 COMMENCEMENT DATE: The term "Commencement Date" is the date the Lease Term commences, which term is defined in Paragraph 2.2. See Paragraph 2.2 of the Lease and Paragraph 6 of the First Addendum to Lease. 1.9 COMMON AREA: The term "Common Area" shall mean all areas and facilities within the Project that are not designated by Landlord for the exclusive use of Tenant or any other lessee or other occupant of the Project, including the parking areas, access and perimeter roads, pedestrian sidewalks, landscaped areas, trash enclosures, recreation areas and the like. 1.10 COMMON OPERATING EXPENSES: The term "Common Operating Expenses" is defined in Paragraph 8.2. 1.11 CONSUMER PRICE INDEX: The term "Consumer Price Index" shall refer to the Consumer Price Index, All Urban Consumers, subgroup "All items", for the San Francisco-Oakland-San Jose metropolitan area (base year 1982-84 equals 100), which is presently being published monthly by the United States Department of Labor, Bureau of Labor Statistics. However, if this Consumer Price Index is changed so that the base year is altered from that used as of the commencement of the initial term of this Lease, the Consumer Price Index shall be converted in accordance with the conversion factor published by the United States Department of Labor, Bureau of Labor Statistics to obtain the same results that would have been obtained had the base year not been changed. If no conversion factor is available, or if the Consumer Price Index is otherwise changed, revised or discontinued for any reason, there shall be substituted in lieu thereof and the term "Consumer Price Index" shall thereafter refer to the most nearly comparable official price index of the United States government in order to obtain substantially the same result as would have been obtained had the original Consumer Price Index not been discontinued, revised or changed, which alternative index shall be selected by Landlord and shall be subject to Tenant's written approval. 1.12 EFFECTIVE DATE: The term "Effective Date" shall mean the date the last signatory to this Lease whose execution is required to make it binding on the parties hereto shall have executed this Lease. 1.13 EVENT OF TENANT'S DEFAULT: The term "Event of Tenant's Default" is defined in Paragraph 13.1. 1.14 HAZARDOUS MATERIALS: The terms "Hazardous Materials" and "Hazardous Materials Laws" are defined in Paragraph 7.2E. 1.15 INSURED AND UNINSURED PERIL: The terms "Insured Peril" and "Uninsured Peril" are defined in Paragraph 11.2E. 1.16 LAW: The term "Law" shall mean any judicial decision, statute, constitution, ordinance, resolution, regulation, rule, administrative order, or other requirement of any municipal, county, state, federal or other government agency or authority having jurisdiction over the parties to this Lease or the Premises, or both, in effect either at the Effective Date or any time during the Lease Term. 1.17 LEASE: The term "Lease" shall mean the Summary and all elements of this Lease identified in SECTION T of the Summary, all of which are attached hereto and incorporated herein by this reference. 1.18 Lease Term: The term "Lease Term" shall mean the term of this Lease which shall commence on the Commencement Date and continue for the period specified in SECTION J of the Summary. 1.19 LENDER: The term "Lender" shall mean any beneficiary, mortgagee, secured party, lessor, or other holder of any Security Instrument. 1.20 PERMITTED USE: The term "Permitted Use" shall mean the use specified in SECTION N of the Summary. LEASE 1.21 PREMISES: The term "Premises" shall mean those Buildings and connector described in SECTION D of the Summary. 1.22 PROJECT: The term "Project" shall mean that real property and the improvements thereon which are specified in SECTION E of the Summary, the aggregate gross leasable area of which is referred to herein as the "Project Gross Leasable Area." 1.23 PRIVATE RESTRICTIONS: The term "Private Restrictions" shall mean all recorded covenants, conditions and restrictions, private agreements, reciprocal easement agreements, and any other recorded instruments affecting the use of the Premises which (i) exist as of the Effective Date, or (ii) are recorded after the Effective Date and are approved by Tenant. 1.24 REAL PROPERTY TAXES: The term "Real Property Taxes" is defined in Paragraph 8.3. 1.26 SECURITY INSTRUMENT: The term "Security Instrument" shall mean any underlying lease, mortgage or deed of trust which now or hereafter affects the Project, and any renewal, modification, consolidation, replacement or extension thereof. 1.27 SUMMARY: The term "Summary" shall mean the Summary of Basic Lease Terms executed by Landlord and Tenant that is part of this Lease. 1.28 TENANT'S ALTERATIONS: The term "Tenant's Alterations" shall mean all improvements, additions, alterations, and fixtures installed in the Premises by Tenant at its expense which are not Trade Fixtures. 1.29 TENANT'S SHARE: The term 'Tenant's Share" shall mean the percentage identified in SECTION G of the Summary. 1.30 TRADE FIXTURES: The term "Trade Fixtures" shall mean (i) Tenant's inventory, furniture, signs, and business equipment, and (ii) anything affixed to the Premises by Tenant at its expense for purposes of trade, manufacture, ornament or domestic use (except replacement of similar work or material originally installed by Landlord) which can be removed without material injury to the Premises unless such thing has, by the manner in which it is affixed, become an integral part of the Premises. ARTICLE 2 DEMISE, CONSTRUCTION, AND ACCEPTANCE 2.1 DEMISE OF PREMISES: Landlord hereby leases to Tenant, and Tenant leases from Landlord, for the Lease Term upon the terms and conditions of this Lease, the Premises for Tenant's own use in the conduct of Tenant's business together with (i) the non-exclusive right to use the number of Tenant Allocated Parking Stalls within the Common Area (subject to the limitations set forth in Paragraph 4.5), and (ii) the non-exclusive right to use the Common Area for ingress to and egress from the Premises. Landlord reserves the use of the exterior walls, the roof and the area beneath and above the Premises, together with the right to install, maintain, use, and replace ducts, wires, conduits and pipes leading through the Premises in locations which will not materially interfere with Tenant's use of the Premises. 2.2 COMMENCEMENT DATE: The Commencement Date shall be August 3, 1997. Also see paragraph 6 of the First Addendum to Lease. 2.3 CONSTRUCTION OF IMPROVEMENTS: Landlord shall construct certain improvements that shall constitute or become part of the Premises if required by, and then in accordance with, the terms of EXHIBIT B and EXHIBIT C. 2.4 DELIVERY AND ACCEPTANCE OF POSSESSION: If this Lease provides that Landlord must deliver possession of the Premises to Tenant on a certain date, then if Landlord is unable to deliver possession of the Premises to Tenant on or before such date for any reason whatsoever, this Lease shall not be void or voidable for a period of 180 days thereafter, and Landlord shall not be liable to Tenant for any loss or damage resulting there from. Tenant shall accept possession and enter into good faith occupancy of the entire Premises. Tenant acknowledges that it has had an opportunity to conduct, and has conducted, such inspections of the Premises as it deems necessary to evaluate its condition. Except as otherwise specifically provided herein, Tenant agrees to accept possession of the Premises in its then existing condition, "as-is", including all patent and latent defects. Tenant's taking possession of any part of the Premises shall be deemed to be an acceptance by Tenant of any work of improvement done by Landlord in such part as complete and in accordance with the terms of this Lease except for defects of which Tenant has given Landlord written notice prior to the time Tenant takes possession. At the time Landlord delivers possession of the Premises to Tenant, Landlord and Tenant shall together execute an Punch List Agreement in the form attached as 2 LEASE EXHIBIT D, appropriately completed. Landlord shall have no obligation to deliver possession, nor shall Tenant be entitled to take occupancy, of the Premises until such Punch List agreement has been executed, and Tenant's obligation to pay Base Monthly Rent and Additional Rent shall not be excused or delayed because of Tenant's failure to execute such Punch List agreement. 2.5 EARLY OCCUPANCY: If Tenant enters or permits its contractors to enter the Premises prior to the Commencement Date with the written permission of Landlord, it shall do so upon all of the terms of this Lease (including its obligations regarding indemnity and insurance) except those regarding the obligation to pay Base Monthly Rent, utilities, and Additional Rent which shall commence on the Commencement Date. ARTICLE 3 RENT 3.1 BASE MONTHLY RENT: Commencing on the Commencement Date and continuing throughout the Lease Term, Tenant shall pay to Landlord the Base Monthly Rent set forth in SECTION K of the Summary. 3.2 ADDITIONAL RENT: Commencing on the Commencement Date and continuing throughout the Lease Term, Tenant shall pay the following as additional rent (the "Additional Rent"): (i) any late charges or interest due Landlord pursuant to Paragraph 3.4; (ii) Tenant's Share of Common Operating Expenses as provided in Paragraph 8.1; (iii) Landlord's share of any Subrent received by Tenant upon certain assignments and sublettings as required by Paragraph 14.1; (iv) any legal fees and costs due Landlord pursuant to Paragraph 15.9; and (v) any other charges due Landlord pursuant to this Lease. 3.3 PAYMENT OF RENT. Concurrently with the execution of this Lease by both parties, Tenant shall pay to Landlord the amount set forth in SECTION L of the Summary as prepayment of rent for credit against the first installment(s) of Base Monthly Rent. All rent required to be paid in monthly installments shall be paid in advance on the first day of each calendar month during the Lease Term. If SECTION K of the Summary provides that the Base Monthly Rent is to be increased during the Lease Term and if the date of such increase does not fall on the first day of a calendar month, such increase shall become effective on the first day of the next calendar month. All rent shall be paid in lawful money of the United States, without any abatement, deduction or offset whatsoever (except specifically provided in Paragraph 11.4 and Paragraph 12.3), an without any prior demand therefor. Rent shall be paid to Landlord at its address set forth in SECTION P of the Summary, or at such other place as Landlord may designate from time to time. Tenant's obligation to pay Base Monthly Rent and Tenant's Share of Common Operating Expense shall be prorated at the commencement and termination of the Lease. 3.4 LATE CHARGE AND INTEREST ON RENT IN DEFAULT: If any Base Monthly Rent or Additional Rent is not received by Landlord from Tenant within three business days after Landlord has notified Tenant writing that payment of such rent has not been received by Landlord, then Tenant shall immediately pay to Landlord a late charge equal to 5% of such delinquent rent as liquidated damages for Tenant's failure to make timely payment. In no event shall this provision for a late charge be deemed to grant to Tenant a grace period or extension of time within which to pay any rent or prevent Landlord from exercising any right or remedy available to Landlord upon Tenant's failure to pay any rent due under this Lease in a timely fashion, including any right to terminate this Lease pursuant to Paragraph 13.2B. If any rent remains delinquent for a period in excess of 30 days then, in addition to such late charge, Tenant shall pay to Landlord interest on any rent that is not paid when due at the Agreed Interest Rate following the date such amount became due until paid. 3.5 SECURITY DEPOSIT: On the Effective Date, Tenant shall deposit with Landlord the amount set forth in Section M of the Summary as security for the performance by Tenant of its obligations under this Lease, and not as prepayment of rent (the "Security Deposit"). Landlord may from time to time apply such portion of the Security Deposit as is reasonably necessary for the following purposes: (i) to remedy any default by Tenant in the payment of rent; (ii) to repair damage to the Premises caused by Tenant; (iii) to clean the Premises upon termination of the Lease; and (iv) to remedy any other default of Tenant to the extent permitted by Law and, in this regard, Tenant hereby waives any restriction on the uses to which the Security Deposit may be put contained in California Civil Code Section 1950.7. In the event the Security Deposit or any portion thereof is so used, Tenant agrees to pay to Landlord promptly upon demand an amount in cash sufficient to restore the Security Deposit to the full original amount. Landlord shall not be deemed a trustee of the Security Deposit, may use the Security Deposit in business, and shall not be required to segregate it from its general accounts. Tenant shall not be entitled to any interest on the Security Deposit. If Landlord transfers the Premises during the Lease Term, Landlord shall pay the Security Deposit to any transferee of Landlord's interest in conformity with the provisions of California Civil Code Section 1950.7 and/or any successor statute, in which event the transferring Landlord will be released from all liability for the return of the Security Deposit. ARTICLE 4 USE OF PREMISES 4.1 LIMITATION ON USE: Tenant shall use the Premises solely for the Permitted Use specified in SECTION N of the Summary. Tenant shall not do anything in or about the Premises which will (i) cause structural injury to the Building, or (ii) cause damage to any part of the Building except to the extent reasonably necessary for the installation of Tenant's Trade Fixtures and Tenant's Alterations, and then only in a manner which has been first approved by Landlord in writing. Tenant shall not operate any equipment within the Premises which will (i) materially damage the Building or the Common Area, (ii) overload existing electrical systems or other mechanical equipment servicing the Building, (iii) impair the efficient operation of the sprinkler system or the heating, ventilating or air 3 LEASE conditioning ("HVAC") equipment within or servicing the Building, or (iv) damage, overload or corrode the sanitary sewer system. Tenant shall not attach, hang or suspend anything from the ceiling, roof, walls or columns of the Building or set any load on the floor in excess of the load limits for which such items are designed nor operate hard wheel forklifts within the Premises. Any dust, fumes, or waste products generated by Tenant's use of the Premises shall be contained and disposed so that they do not (i) create an unreasonable fire or health hazard, (ii) damage the Premises, or (iii) result in the violation of any Law. Except as approved by Landlord, Tenant shall not change the exterior of the Building or install any equipment or antennas on or make any penetrations of the exterior or roof of the Building. Tenant shall not commit any waste in or about the Premises, and Tenant shall keep the Premises in an neat, clean, attractive and orderly condition, free of a nuisances. If Landlord designates a standard window covering for use throughout the Building, Tenant shall use this standard window covering to cover all windows in the Premises. Tenant shall not conduct on any portion of the Premises or the Project any sale of any kind, including any public or private auction, fire sale, going-out-of-business sale, distress sale or other liquidation sale. 4.2 COMPLIANCE WITH REGULATIONS: Tenant shall not use the Premises in any material manner which violate any Laws or Private Restrictions which affect the Premises. Tenant shall abide by and promptly observe and comply with all Laws and Private Restrictions. Tenant shall not use the Premises in any manner which will cause a cancellation of any insurance policy covering Tenant's Alternations of any improvements installed by Landlord at its expense or which poses an unreasonable risk of damage or injury to the Premises. Tenant shall not sell, or permit to be kept, used, or sold in or about the Premises any article which may be prohibited by the standard form of fire insurance policy. Tenant shall comply with all reasonable requirements of any insurance company, insurance underwriter, or Board of Fire Underwriters which are necessary to maintain the insurance coverage carried by either Landlord or Tenant pursuant to this Lease. 4.3 OUTSIDE AREAS: No materials, supplies, tan or containers, equipment, finished products or semi finished products, raw materials, inoperable vehicle or articles of any nature shall be stored upon or permitted to remain outside of the Premises except in fully fenced and screened areas outside the Building which have been designed for such purpose and have been approved in writing by Landlord of such use by Tenant. 4.4 SIGNS: Tenant shall not place on any portion of the Premises any sign, placard, lettering in or on windows, banner, displays or other advertising or communicative material which is visible from the exterior of the Building without the prior written approval of Landlord. All such approved signs shall strictly conform to all Laws, Private Restriction, and Landlord's sign criteria attached as EXHIBIT F and shall be installed at the expense of Tenant. Tenant shall maintain such signs in good condition and repair. 4.5 PARKING: Tenant is allocated and shall have the non-exclusive right to use not more than the number of Tenant's Allocated Parking Stalls contained within the Project described in SECTION H of the Summary for its use and the use of Tenant's Agents, the location of which may be designated from time to time by Landlord. Tenant shall not at any time use more parking spaces than the number so allocated to Tenant or park its vehicles or the vehicles of others in any portion of the Project not designated by Landlord as a non-exclusive parking area. Tenant shall not have the exclusive right to use any specific parking space. If Landlord grants to any other tenant the exclusive right to use any particular parking space(s) (which shall not materially fringe upon Tenant's parking rights), Tenant shall not use such spaces. Landlord reserves the right, after having given Tenant reasonable notice, to have any vehicles owned by Tenant or Tenant's Agent utilizing parking spaces in excess of the parking spaces allowed for Tenant's use to be towed away at Tenant's cost. All trucks and delivery vehicles shall be (i) parked at the rear of the Building, (ii) loaded and unloaded in a manner which does not interfere with the businesses of other occupants of the Project, and (iii) permitted to remain on the Project only so long as is reasonably necessary to complete loading and unloading. In the event Landlord elects or is required by any Law to limit or control parking in the Project, whether by validation of parking tickets or any other method of assessment, Tenant agrees to participate in such validation or assessment program under such reasonable rules and regulations as are from time to time established by Landlord. 4.6 RULES AND REGULATIONS: Landlord may from time to time promulgate reasonable and nondiscriminatory rules and regulations applicable to all occupants of the Project for the care and orderly management of the Project and the safety of its tenants and invitees. Such rules and regulations shall be binding upon Tenant upon delivery of a copy thereof to Tenant, and Tenant agrees to abide by such rules and regulations. If there is a conflict between the rules and regulations and any of the provisions of this Lease, the provisions of this Lease shall prevail. Landlord shall not be responsible for the violation by any other tenant of the Project of any such rules and regulations. ARTICLE 5 TRADE FIXTURES AND ALTERATIONS 5.1 TRADE FIXTURE: Throughout the Lease Term, Tenant may provide and install any Trade Fixtures required in the conduct of its business in the Premises. All Trade Fixtures shall remain Tenant's property. 5.2 TENANT'S ALTERATIONS: Construction by Tenant of Tenant's Alterations shall be governed by the following: A. Tenant shall not construct any Tenant's Alterations or otherwise alter the Premises without Landlord's prior written approval. Tenant shall be entitled, without Landlord's prior approval, to make Tenant's Alterations (i) which do not affect the structural or exterior parts or water tight character of the Building, and (ii) the reasonably estimated cost of which, plus the original cost of any part of 4 LEASE the Premises removed or materially altered in connection with such Tenant's Alterations, together do not exceed the Permitted Tenant Alterations Limit specified in SECTION O of the Summary per work of improvement. In the event Landlord's approval for any Tenant's Alterations is required, Tenant shall not construct the Leasehold improvement until Landlord has approved in writing the plans and specifications therefor, and such Tenant's Alterations shall be constructed substantially in compliance with such approved plans and specifications by a licensed contractor first approved by Landlord. All Tenant's Alterations constructed by Tenant shall be constructed by a licensed contractor in accordance with all Law using new materials of good quality. B. Tenant shall not commence construction of any Tenant's Alterations until (i) all required governmental approvals and permits have been obtained, (ii) all requirements regarding insurance imposed by this Lease have been satisfied, (iii) Tenant has given Landlord at least five days' prior written notice of its intention to commence such construction, and (iv) if reasonably requested Landlord, Tenant has obtained contingent liable and broad form builders' risk insurance in a amount reasonably satisfactory to Landlord if there are any perils relating to the proposed construction not covered by insurance carried pursuant to Article 9. C. All Tenant's Alterations shall remain the property of Tenant during the Lease Term shall not be altered or removed from the Premises. At the expiration or sooner termination of the Lease Term, all Tenant's Alterations shall be surrendered to Landlord as part of the realty and shall then become Landlord's property, and Landlord shall have no obligation to reimburse Tenant for all or any portion of the value or cost thereof, provided, however, that if Landlord requires Tenant to remove any Tenant's Alterations, Tenant shall so remove such Tenant's Alterations prior to the expiration or sooner termination of the Lease Term. Notwithstanding the foregoing, Tenant shall not be obligated to remove any Tenant's Alteration with respect to which the following is true: (i) Tenant was required, or elected, to obtain the approval of Landlord to the installation of the Leasehold Improvement in question; (ii) at the time Tenant requested Landlord's approval, Tenant requested of Landlord in writing that Landlord inform Tenant of whether or not Landlord would require Tenant to remove such Leasehold Improvement at the expiration of the Lease Term; and (iii) at the time Landlord granted its approval, it did not inform Tenant that it would require Tenant to remove such Leasehold Improvement the expiration of the Lease Term. 5.3 ALTERATIONS REQUIRED BY LAW: Tenant shall make any alteration, addition or change of any sort to the Premises that is required by any Law because of (i) Tenant's particular use or change of use the Premises; (ii) Tenant's application for a permit or governmental approval; or (iii) Tenant construction or installation of any Tenant Alterations or Trade Fixtures. Any other alteration, addition, or change required by Law which is the responsibility of Tenant pursuant to foregoing shall be made by Landlord (subject to Landlord's right to reimbursement from Tenant specified in Paragraph 5.4). 5.4 AMORTIZATION OF CERTAIN CAPITAL IMPROVEMENTS: Tenant shall pay Additional Rent in the event Landlord reasonably elects or is required to make any of the following kinds of capital improvements to the Project and the cost thereof is not reimbursable as a Common Operating Expense: (i) capital improvements required to be constructed in order to comply with any Law (excluding any Hazardous Materials Law) not in effect or applicable to the Project as of the Effective Date; (ii) modification of existing or construction of additional capital improvements or building service equipment for the purpose of reducing the consumption of utility services or Common Operating Expenses of the Project (but not in excess of the savings realized as a consequence of the capital improvement); (iii) replacement of capital improvements or building service equipment existing as of the Effective Date when required because of normal wear and tear; and (iv) restoration of any part of the Project that has been damaged by any peril to the extent the cost thereof is not covered by insurance proceeds actually recovered by Landlord up to a maximum amount per occurrence of 10% of the then replacement cost of the Premises. The amount of Additional Rent Tenant is to pay with respect to each such capital improvement shall be determined as follows: A. All costs reasonably paid by Landlord to construct such improvements (including financing costs) shall be amortized over the useful life of such improvement (as reasonably determined by Landlord in accordance with generally accepted accounting principles) with interest on the unamortized balance at the then prevailing market rate Landlord would pay if it borrowed funds to construct such improvements from an institutional lender, and Landlord shall inform Tenant of the monthly amortization payment required to so amortize such costs, and shall also provide Tenant with the information upon which such determination is made. B. As Additional Rent, Tenant shall pay at the same time the Base Monthly Rent is due an amount equal to Tenant's Share of that portion of such monthly amortization payment fairly allocable to the Buildings (as reasonably determined by Landlord) for each month after such improvements are completed until the first to occur of (i) the expiration of the Lease Term (as it may be extended), or (ii) the end of the term over which such costs were amortized. 5.5 MECHANIC'S LIENS: Tenant shall keep the Project free from any liens and shall pay when due all bills arising out of any work performed, materials furnished, or obligations incurred by Tenant or Tenant's Agents relating to the Project. If any claim of lien is recorded (except those caused by Landlord or Landlord's Agents), Tenant shall bond against or discharge the same within 10 days after the same has been recorded against the Project. Should any lien be filed against the Project or any action be commenced affecting title to the Project, the party receiving notice of such lien or action shall immediately give the other party written notice thereof. 5.6 TAXES ON TENANT'S PROPERTY: Tenant shall 5 LEASE pay before delinquency any and all taxes, assessments, license fees and public charges levied, assessed or imposed against Tenant or Tenant's estate in this Lease or the property of Tenant situated within the Premises which become due during the Lease Term. If any tax or other charge is assessed by any governmental agency because of the execution of this Lease, such tax shall be paid by Tenant. On demand by Landlord, Tenant shall furnish Landlord with satisfactory evidence of these payments. ARTICLE 6 REPAIR AND MAINTENANCE 6.1 TENANT'S OBLIGATION TO MAINTAIN: Except as otherwise provided in the Addendum, Exhibit B, or Paragraph 6.2, Paragraph 11.1, and Paragraph 12.3, Tenant shall be responsible for the following during the Lease Term: A. Tenant shall clean and maintain in good order, condition, and repair and replace when necessary the Premises and every part thereof, through regular inspections and servicing, including, but not limited to: (i) all plumbing and sewage facilities (including all sinks, toilets, faucets and drains), and all ducts, pipes, vents or other parts of the HVAC or plumbing system; (ii) all fixtures, interior walls, floors, carpets and ceilings; (iii) all windows, doors, entrances, plate glass, showcases and skylights (including cleaning both interior and exterior surfaces); (iv) all electrical facilities and all equipment (including all lighting fixtures, lamps, bulbs, tubes, fans, vents, exhaust equipment and systems); and (v) any automatic fire extinguisher equipment in the Premises. B. With respect to utility facilities serving the Premises (including electrical wiring and conduits, gas lines, water pipes, and plumbing and sewage fixtures and pipes), Tenant shall be responsible for the maintenance and repair of any such facilities which serve only the Premises, including all such facilities that are within the walls or floor, or on the roof of the Premises, and any part of such facility that is not within the Premises, but only up to the point where such facilities join a main or other junction (e.g., sewer main or electrical transformer) from which such utility services are distributed to other parts of the Project as well as to the Premises. Tenant shall replace any damaged or broken glass in the Premises (including all interior and exterior doors and windows) with glass of the same kind, size and quality. Tenant shall repair any damage to the Premises (including exterior doors and windows) caused by vandalism or any unauthorized entry. C. Tenant shall (i) maintain, repair and replace when necessary all HVAC equipment which services only the Premises, and shall keep the same in good condition through regular inspection and servicing, and (maintain continuously throughout the Lease Term a service contract for the maintenance of all such HVAC equipment with a licensed HVAC repair and maintenance contractor approved by Landlord, which contract provides for the periodic inspection and servicing of the HVAC equipment at least once every 60 days during the Lease Term. Notwithstanding the foregoing, Landlord may elect at any time to assume responsibility for the maintenance, repair and replacement of such HVAC equipment which serves only the Premises. Tenant shall maintain continuously throughout the Lease Term a service contract for the washing of all exterior windows (both interior and exterior surfaces) in the Premises with a contractor approved by Landlord, which contract provides for the periodic washing of all such windows at least once every 60 days during the Lease Term. Tenant shall furnish Landlord with copies of all such service contracts, which shall provide that they may not be cancelled or changed without at least 30 days' prior written notice to Landlord. D. All repairs and replacements required of Tenant shall be promptly made with new materials of like kind and quality. If the work affects the structural parts of the Building or if the estimated cost of any item of repair or replacement is in excess of the Permitted Tenant's Alterations Limit, then Tenant shall first obtain Landlord's written approval of the scope of the work, plans therefor, materials to be used, and the contractor in accordance with Section 5.2. 6.2 LANDLORD'S OBLIGATION TO MAINTAIN: Landlord shall repair, maintain and operate the Common Area and repair and maintain the roof, exterior and structural parts of the building(s) located on the Project so that the same are kept in good order and repair. If there is central HVAC or other building service equipment and/or utility facilities serving portions of the Common Area and/or both the Premises and other parts of the Building, Landlord shall maintain and operate (and replace when necessary) such equipment. Landlord shall not be responsible for repairs required by an accident, fire or other peril or for damage caused to any part of the Project by any act or omission of Tenant or Tenant's Agents except as otherwise required by Article 11. Landlord may engage contractors of its choice to perform the obligations required of it by this Article, and the necessity of any expenditure to perform such obligations shall be at the sole discretion of Landlord. 6.3 CONTROL OF COMMON AREA: Landlord shall at all times have exclusive control of the Common Area. Landlord shall have the right, without the same constituting an actual or constructive eviction and without entitling Tenant to any abatement of rent, to: (i) close any part of the Common Area to whatever extent required in the opinion of Landlord's counsel to prevent a dedication thereof or the accrual of any prescriptive rights therein; (ii) temporarily close the Common Area to perform maintenance or for any other reason deemed sufficient by Landlord; (iii) change the shape, size, location and extent of the Common Area; (iv) eliminate from or add to the Project any land or improvement, including multi-deck parking structures; (v) make changes to the Common Area including, without limitation, changes in the location of driveways, entrances, passageways, doors and doorways, elevators, stairs, restrooms, exits, parking spaces, parking areas, sidewalks or the direction of the flow of traffic and the site of the Common Area; (vi) remove unauthorized persons from the Project; and/or (vii) change the name or address of the Building or Project. In exercising the foregoing rights, Landlord shall not materially infringe upon Tenant's parking rights except as otherwise required by Law. Tenant shall keep the Common Area clear of all obstructions created or permitted by Tenant. If in the opinion of Landlord unauthorized persons are using any of the Common 6 LEASE Area by reason of the presence of Tenant in the Building, Tenant, upon demand of Landlord, shall restrain such unauthorized use by appropriate proceedings. In exercising any such rights regarding the Common Area, (i) Landlord shall make a reasonable effort to minimize any disruption to Tenant's business, and (ii) Landlord shall not exercise its rights to control the Common Area in a manner that would materially interfere with Tenant's use of the Premises without first obtaining Tenant's written consent. Landlord shall have no obligation to provide guard services or other security measures for the benefit of the Project. Tenant assumes all responsibility for the protection of Tenant and Tenant's Agents from acts of third parties; provided, however, that nothing contained herein shall prevent Landlord, at its sole option, from providing security measures for the Project. ARTICLE 7 WASTE DISPOSAL AND UTILITIES 7.1 WASTE DISPOSAL: Tenant shall store its waste either inside the Premises or within outside trash enclosures that are fully fenced and screened in compliance with all Private Restrictions, and designed for such purpose. All entrances to such outside trash enclosures shall be kept closed, and waste shall be stored in such manner as not to be visible from the exterior of such outside enclosures. Tenant shall cause all of its waste to be regularly removed from the Premises at Tenant's sole cost. Tenant shall keep all fire corridors and mechanical equipment rooms in the Premises free and clear of all obstructions at all times. 7.2 HAZARDOUS MATERIALS: Landlord and Tenant agree as follows with respect to the existence or use of Hazardous Materials on the Project: A. Any handling, transportation, storage, treatment, disposal or use of Hazardous Materials by Tenant and Tenant's Agents after the Effective Date in or about the Project shall strictly comply with all applicable Hazardous Materials Laws. Tenant shall indemnify, defend upon demand with counsel reasonably acceptable to Landlord, and hold harmless Landlord from and against any liabilities, losses, claims, damages, lost profits, consequential damages, interest, penalties, fines, monetary sanctions, attorneys' fees, experts' fees, court costs, redemption costs, investigation costs, and other expenses which result from or arise in any manner whatsoever out of the use, storage, treatment, transportation, release, or disposal of Hazardous Materials on or about the Project by Tenant or Tenant's Agents after the Effective Date. B. If the presence of Hazardous Materials on the Project caused or permitted by Tenant or Tenant's Agents after the Effective Date results in contamination or deterioration of water or soil resulting in a level of contamination greater than the levels established as acceptable by any governmental agency having jurisdiction over such contamination, then Tenant shall promptly take any and all action necessary to investigate and remediate such contamination if required by Law or as a condition to the issuance or continuing effectiveness of any governmental approval which relates to the use of the Project or any part thereof. Tenant shall further be solely responsible for, and shall defend, indemnify and hold Landlord and its agents harmless from and against, all claims, costs and liabilities, including attorneys fees and costs, arising out of or in connection with any investigation and redemption required hereunder to return the Project to its condition existing prior to the appearance of such Hazardous Materials. C. Landlord and Tenant shall each give written notice to the other as soon as reasonably practicable of (i) any communication received from any governmental authority concerning Hazardous Materials which relates to the Project, and (ii) any contamination of the Project by Hazardous Materials which constitutes a violation of any Hazardous Materials Law. Tenant may use small quantities of household chemicals such as adhesives, lubricants, and cleaning fluids in order to conduct its business at the Premises and such other Hazardous Materials as are necessary for the operation of Tenant's business of which Landlord receives notice prior to such Hazardous Materials being brought onto the Premises and which Landlord consents in writing may be brought onto the Premises. At any time during the Lease Term, Tenant shall, within five days after written request therefor received from Landlord, disclose in writing all Hazardous Materials that are being used by Tenant on the Project, the nature of such use, and the manner of storage and disposal. D. Landlord may cause testing wells to be installed on the Project, and may cause the ground water to be tested to detect the presence of Hazardous Material by the use of such tests as are then customarily used for such purposes. If Tenant so requests, Landlord shall supply Tenant with copies of such test results. The cost of such tests and of the installation, maintenance, repair and replacement of such wells shall be paid by Tenant if such tests disclose the existence of facts which gives rise to liability of Tenant pursuant to its indemnity given in Paragraph 7.2A and/or Paragraph 7.2B. E. As used herein, the term "Hazardous Material," means any hazardous or toxic substance, material or waste which is or becomes regulated by any local governmental authority, the State of California or the United States Government. The term "Hazardous Material," includes, without limitation, petroleum products, asbestos, PCBs, and any material or substance which is (i) listed under Article 9 or defined as hazardous or extremely hazardous pursuant to Article 11 of Title 22 of the California Administrative Code, Division 4, Chapter 20, (ii) defined as a "hazardous waste" pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. 6901 et seq. (42 U.S.C. 6903), or (iii) defined as a "hazardous substance" pursuant to Section 101 of the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. 9601 et seq. (42 U.S.C. 9601). As used herein, the term "Hazardous Material Law" shall mean any statute, law, ordinance, or regulation of any governmental body or agency (including the U.S. Environmental Protection Agency, the California Regional Water Quality Control Board, and the California Department of Health Services) which regulates the use, storage, release or disposal of any Hazardous Material. 7 LEASE F. The obligations of Landlord and Tenant under this Paragraph 7.2 shall survive the expiration or earlier termination of the Lease Term. The rights and obligations of Landlord and Tenant with respect to issues relating to Hazardous Materials are exclusively established by this Paragraph 7.2 and Paragraph 22 of the First Addendum to Lease. In the event of any inconsistency between any other part of this Lease and this Paragraph 7.2, the terms of this Paragraph 7.2 shall control. 7.3 UTILITIES: Tenant shall promptly pay, as the same become due, all charges for water, gas, electricity, telephone, sewer service, waste pick-up and any other utilities, materials or services furnished directly to or used by Tenant on or about the Premises during the Lease Term, including, without limitation, (i) meter, use and/or connection fees, hook-up fees, or standby fee (excluding any connection fees or hook-up fees which relate to making the existing electrical, gas, and water service available to the Premises as of the Commencement Date), and (ii) penalties for discontinued or interrupted service. If any utility service is not separately metered to the Premises, then Tenant shall pay its pro rata share of the cost of such utility service with all others served by the service not separately metered. However, if Landlord determines that Tenant is using a disproportionate amount of any utility service not separately metered, then Landlord at its election may (i) periodically charge Tenant, as Additional Rent, a sum equal to Landlord's reasonable estimate of the cost of Tenant's excess use of such utility service, or (ii) install a separate meter (at Tenant's expense) to measure the utility service supplied to the Premises. 7.4 COMPLIANCE WITH GOVERNMENTAL REGULATIONS: Landlord and Tenant shall comply with all rules, regulations and requirements promulgated by national, state or local governmental agencies or utility suppliers concerning the use of utility services, including any rationing, limitation or other control. Except as expressly provided to the contrary in this Lease, Tenant shall not be entitled to terminate this Lease nor to any abatement in rent by reason of such compliance. ARTICLE 8 COMMON OPERATING EXPENSES 8.1 TENANT'S OBLIGATION TO REIMBURSE: As Additional Rent, Tenant shall pay Tenant's Share (specified in SECTION G of the Summary) of all Common Operating Expenses; provided, however, if the Project contains more than one building, then Tenant shall pay Tenant's Share of all Common Operating Expenses fairly allocable to the Buildings including (i) all Common Operating Expenses paid with respect to the maintenance, repair, replacement and use of the Building, and (ii) a proportionate share (based on the Building Gross Leasable Area as a percentage of the Project Gross Leasable Area) of all Common Operating Expenses which relate to the Project in general are not fairly allocable to any one building that is part of the Project. Tenant shall pay such share of the actual Common Operating Expenses incurred or paid by Landlord but not theretofore billed to Tenant within 10 days after receipt of a written bill therefor from Landlord, on such periodic basis as Landlord shall designate, but in no event more frequently than once a month. Alternatively, Landlord may from time to time require that Tenant pay Tenant's Share of Common Operating Expenses in advance in estimated monthly installments, in accordance with the following: (i) Landlord shall deliver to Tenant Landlord's reasonable estimate of the Common Operating expenses it anticipates will be paid or incurred for the Landlord's fiscal year in question; (ii) during such Landlord's fiscal year Tenant shall pay such share of the estimated Common Operating Expenses in advance in monthly installments as required by Landlord due with the installments of Base Monthly Rent; and (iii) within 90 days after the end of each Landlord's fiscal year, Landlord shall furnish to Tenant a statement in reasonable detail of the actual Common Operating Expenses paid or incurred by Landlord during the just ended Landlord's fiscal year and thereupon there shall be an adjustment between Landlord and Tenant, with payment to Landlord or credit by Landlord against the next installment of Base Monthly Rent, as the case may require, within 10 days after delivery Landlord to Tenant of said statement (or if the Lease has terminated by a cash payment delivered concurrently with the reconciliation), so that Landlord shall receive the entire amount of Tenant's Share of all Common Operating Expenses for such Landlord's fiscal year and no more. Tenant shall have the right at its expense, exercisable upon reasonable prior written notice to Landlord, to inspect at Landlord's office during normal business hours Landlord's books and records as they relate to Common Operating Expenses. Such inspection must be within 90 days of Tenant's receipt of Landlord's annual statement for the same, and shall be limited to verification of the charges contained in such statement. Tenant may not withhold payment of such bill pending completion of such inspection, but, if an error of more than 10% of the annual amount of Common Operating Expenses is made, Landlord shall pay the reasonable costs of the audit and make reimbursement of the overpayment within 30 days of Tenant's demand. 8.2 COMMON OPERATING EXPENSES DEFINED: The term "Common Operating Expenses" shall mean the following: A. All costs and expenses paid or incurred by Landlord in doing the following (including payments to independent contractors providing services related to the performance of the following): (i) maintaining, cleaning, repairing and resurfacing the roof (including repair of leaks) and the exterior surfaces (including painting) of all buildings located on the Project; (ii) maintenance of the liability, fire and property damage insurance covering the Project carried by Landlord pursuant to Paragraph 9.2 (including the prepayment of premiums for coverage of up to one year); (iii) maintaining, repairing, operating and replacing when necessary HVAC equipment, utility facilities and other building service equipment; (iv) providing utilities to the Common Area (including lighting, trash removal and water for landscaping irrigation); (v) complying with all applicable Laws and Private Restrictions; (vi) operating, maintaining, repairing, cleaning, painting, restriping and resurfacing the Common Area; (vii) replacement or installation of lighting fixtures, directional or other signs and signals, irrigation systems, trees, shrubs, ground cover and other plant materials, and all landscaping in the Common Area; and (viii) providing security; B. The following costs: (i) Real Property Taxes as defined in Paragraph 8.3; (ii) the amount of any "deductible" paid by Landlord with respect to damage caused by any Insured Peril; (iii) the cost to repair damage caused by an Uninsured Peril up to 8 LEASE a maximum amount in any 12 month period equal to 2% of the replacement cost of the buildings or other improvements damaged; and (iv) that portion of all compensation (including benefits and premiums for workers' compensation and other insurance) paid to or on behalf of employees of Landlord but only to the extent they are involved in the performance of the work described by Paragraph 8.2A that is fairly allocable to the Project; C. Fees for management services rendered by either Landlord or a third party manager engaged by Landlord (which may be a party affiliated with Landlord), except that the total amount charged for management services and included in Tenant Share of Common Operating Expenses shall not exceed the monthly rate of 5% of the Base Monthly Rent. D. All additional costs and expenses incurred by Landlord with respect to the operation, protection, maintenance, repair and replacement of the Project which would be considered a current expense (and not a capital expenditure) pursuant to generally accepted accounting principles; provided, however, that Common Operating Expenses shall not include any of the following: (i) payments on any loans or ground leases affecting the Project; (ii) depreciation of any buildings or any major systems of building service equipment within the Project; (iii) leasing commissions; (iv) the cost of tenant improvements installed for the exclusive use of other tenants of the Project; (v) any cost incurred in complying with Hazardous Materials Laws, which subject is governed exclusively by Paragraph 7.2 and (vi) reserves for expenditures beyond the calendar year in question. 8.3 REAL PROPERTY TAXES DEFINED: The term "Real Property Taxes" shall mean all taxes, assessments, levies, and other charges of any kind or nature whatsoever, general and special, foreseen and unforeseen (including all installments of principal and interest required to pay any existing or future general or special assessments for public improvements, services or benefits, and any increases resulting from reassessments resulting from a change in ownership, new construction, or any other cause), now or hereafter imposed by any governmental or quasi-governmental authority or special district having the direct or indirect power to tax or levy assessments, which are levied or assessed against, or with respect to the value, occupancy or use of a or any portion of the Project (as now constructed or as may at any time hereafter be constructed, altered, or otherwise changed) or Landlord's interest therein, the fixtures, equipment and other property of Landlord, real or personal, that are an integral part of and located on the Project, the gross receipts, income, or rentals from the Project, or the use of parking areas, public utilities, or energy within the Project, or Landlord's business of leasing the Project. If at any time during the Lease Term the method of taxation or assessment of the Project prevailing as of the Effective Date shall be altered so that in lieu of or in addition to any Real Property Tax described above there shall be levied, assessed or imposed (whether by reason of a change in the method of taxation or assessment, creation of a new tax or charge or any other cause) an alternate or additional tax or charge (i) on the value, use or occupancy of the Project or Landlord's interest therein, or (ii) on or measured by the gross receipts, income or rentals from the Project, on Landlord's business of leasing the Project, or computed in any manner with respect to the operation of the Project, then any such tax or charge, however designated, shall be included within the meaning of the term "Real Property Taxes" for purposes of this Lease. If any Real Property Tax is based upon property or rents unrelated to the Project, then only that part of such Real Property Tax that is fairly allocable to the Project shall be included within the meaning of the term "Real Property Taxes". Notwithstanding the foregoing, the term "Real Property Taxes" shall not include estate, inheritance, transfer, gift or franchise taxes of Landlord or the federal or state net income tax imposed on Landlord's income from all sources. ARTICLE 9 INSURANCE 9.1 TENANT'S INSURANCE: Tenant shall maintain insurance complying with all of the following: A. Tenant shall procure, pay for and keep in full force and effect the following: (1) Commercial general liability insurance, including property damage, against liability for personal injury, bodily injury, death and damage to property occurring in or about, or resulting from an occurrence in or about, the Premises with combined single limit coverage of not less than the amount of Tenant's Liability Insurance Minimum specified in SECTION P of the Summary, which insurance shall contain a "contractual liability" endorsement insuring Tenant's performance of Tenant's obligation to indemnify Landlord contained in Paragraph 10.3; (2) Fire and property damage insurance in so-called "all risk" form insuring Tenant's Trade Fixtures and Tenant's Alterations for at least 90% the value thereof; (3) Such other insurance that is either (i) required by any Lender, or (ii) reasonably required by Landlord and customarily carried by tenants of similar property in similar businesses. B. Where applicable and required by Landlord, each policy of insurance required to be carried by Tenant pursuant to this Paragraph 9.1: (i) shall name Landlord and such other parties in interest as Landlord reasonably designates as additional insured; (ii) shall be primary insurance which provides that the insurer shall be liable for the full amount of the loss up to and including the total amount of liability set forth in the declarations without the right of contribution from any other insurance coverage of Landlord; (iii) shall be in a form reasonably satisfactory to Landlord; (iv) shall be carried with companies reasonably acceptable to Landlord; (v) shall provide that such policy shall not be subject to cancellation, lapse or change except after at least 30 days prior written notice to Landlord so long as such provision of 30 days notice is reasonably obtainable, but in any event not less than 10 days prior written notice; (vi) shall not have a "deductible" in excess of such amount as is approved by Landlord; (vii) shall contain a cross liability endorsement; and (viii) shall contain a "severability" clause. If Tenant has in full force and effect a 9 LEASE blanket policy of liability insurance with the same coverage for the Premises as described above, as well as other coverage of other premises and properties of Tenant, or in which Tenant has some interest, such blanket insurance shall satisfy the requirements of this Paragraph 9.1. C. A copy of each paid-up policy evidencing the insurance required to be carried by Tenant pursuant to this Paragraph 9.1 (appropriately authenticated by the insurer) or a certificate of the insurer, certifying that such policy has been issued, providing the coverage required by this Paragraph 9.1, and containing the provisions specified herein, shall be delivered to Landlord prior to the time Tenant or any of its Agents enters the Premises and upon renewal of such policies, but not less than 5 days prior to the expiration of the term of such coverage. Landlord may, at any time, and from time to time, inspect and/or copy any and all insurance policies required to be procured by Tenant pursuant to this Paragraph 9.1. If any Lender reasonably determines at any time that the amount of coverage required for any policy of insurance Tenant is to obtain pursuant to this Paragraph 9.1 is not adequate, then Tenant shall increase such coverage for such insurance to such amount as such Lender reasonably deems adequate, not to exceed the level of coverage for such insurance commonly carried by comparable businesses similarly situated. 9.2 LANDLORD'S INSURANCE: Landlord shall have the following obligations and options regarding insurance: A. Landlord shall maintain a policy or policies of fire and property damage insurance in so-called "all risk" form insuring Landlord (and such others as Landlord may designate) against loss of rents for a period of not less than 12 months and from physical damage to the Project with coverage of not less than the full replacement cost thereof. Landlord may so insure the Project separately, or may insure the Project with other property owned by Landlord which Landlord elects to insure together under the same policy or policies. Such fire and property damage insurance (i) may be endorsed to cover loss caused by such additional perils against which Landlord may elect to insure, including earthquake and/or flood, and to provide such additional coverage as Landlord reasonably requires, and (ii) shall contain reasonable "deductibles" which, in the case of earthquake and flood insurance, may be up to 15% of the replacement value of the property insured or such higher amount as is then commercially reasonable. Landlord shall not be required to cause such insurance to cover any Trade Fixtures or Tenant's Alterations of Tenant. B. Landlord may maintain a policy or policies of commercial general liability insurance insuring Landlord (and such others as are designated by Landlord) against liability for personal injury, bodily injury, death and damage to property occurring or resulting from an occurrence in, on or about the Project, with combined single limit coverage in such amount as Landlord from time to time determines is reasonably necessary for its protection. 9.3 TENANT'S OBLIGATION TO REIMBURSE: If Landlord's insurance rates for the Building are increased at any time during the Lease Term as a result of the nature of Tenant's use of the Premises, Tenant shall reimburse Landlord for the full amount of such increase immediately upon receipt of a bill from Landlord therefor. 9.4 RELEASE AND WAIVER OF SUBROGATION: Notwithstanding anything to the contrary in this Lease, parties hereto release each other, and their respective Agents and employees, from any liability for injury to any person or damage to property that is caused by or results from any risk insured against under any valid and collectible insurance policy carried by either of the parties which contains a waiver of subrogation by the insurer and is in force at the time of such injury or damage or which is required by this Article 9 to be insured against (without regard to whether such insurance is actually in force); subject to the following limitations: (i) the foregoing provision shall not apply to the commercial general liability insurance described by subparagraphs Paragraph 9.1A and 9.2B; (iii) Paragraph) such release shall apply to liability resulting from any risk insured against or covered by self-insurance maintained or provided by Tenant to satisfy the requirements of Paragraph 9.1 to the extent permitted by this Lease; and (iii) Tenant shall not be released from any such liability to the extent any damages resulting from such injury or damage are not covered by the recovery obtained by Landlord from such insurance, but only if the insurance in question permits such partial release in connection with obtaining a waiver of subrogation from the insurer. This release shall be in effect only so long as the applicable insurance policy contains a clause to the effect that this release shall not affect the right of the insured to recover under such policy. Each party shall use reasonable efforts to cause each insurance policy obtained by it to provide that the insurer waives all right of recovery by way of subrogation against the other party and its Agents and employees in connection with any injury or damage covered by such policy. However, if any insurance policy cannot be obtained with such a waiver of subrogation, or if such waiver of subrogation is only available at additional cost and the party for whose benefit the waiver is to be obtained does not pay such additional cost, then the party obtaining such insurance shall notify the other party of that fact and thereupon shall be relieved of the obligation to obtain such waiver of subrogation rights from the insurer with respect to the particular insurance involved. ARTICLE 10 LIMITATION ON LANDLORD'S LIABILITY AND INDEMNITY 10.1 LIMITATION ON LANDLORD'S LIABILITY: Landlord shall not be liable to Tenant, nor shall Tenant be entitled to terminate this Lease or to any abatement of rent (except as expressly provided otherwise herein), for any injury to Tenant or Tenant's Agents, damage to the property of Tenant or Tenant's Agents, or loss to Tenant's business resulting from any cause, including without limitation any: (i) failure, interruption or installation of any HVAC or other utility system or service; (ii) failure to furnish or delay in furnishing any utilities or services when such failure or delay is caused by fire or other peril, the elements, labor disturbances of any character, or any other accidents or other conditions beyond the reasonable control of 10 LEASE Landlord; (iii) limitation, curtailment, rationing or restriction on the use of water or electricity, gas or any other form of energy or any services or utility serving the Project; (iv) vandalism or forcible entry by unauthorized persons or the criminal act of any person; or (v) penetration of water into or onto any portion of the Premises or the Building through roof leaks or otherwise. Notwithstanding the foregoing but subject to Paragraph 9.4 Paragraph shall be liable for any such injury, damage or loss which is proximately caused by Landlord's willful misconduct or active negligence of which Landlord has actual notice and a reasonable opportunity to cure but which it fails to so cure. 10.2 LIMITATION ON TENANT'S RECOURSE: If Landlord is a corporation, trust, partnership, joint venture, unincorporated association or other form of business entity: (i) the obligations of Landlord shall not constitute personal obligations of the officers, directors, trustees, partners, joint venturers, members, owners, stockholders, or other principals or representatives of such business entity; and (ii) Tenant shall not have recourse to the assets of such officers, directors, trustees, partners, joint venturers, members, owners, stockholders, principals or representatives except to the extent of their interest in the Project. Tenant shall have recourse only to the interest of Landlord in the Project for the satisfaction of the obligations of Landlord and shall not have recourse to any other assets of Landlord for the satisfaction of such obligations. 10.3 INDEMNIFICATION OF LANDLORD: Tenant shall hold harmless, indemnify and defend Landlord, and its employees, agents and contractors, with competent counsel reasonably satisfactory to Landlord (and Landlord agrees to accept counsel that any insurer requires be used), from all liability, penalties, losses, damages, costs, expenses, causes of action, claims and/or judgments arising by reason of any death, bodily injury, personal injury or property damage resulting from (i) any cause or causes whatsoever (other than the willful misconduct or active negligence of Landlord of which Landlord has had notice and a reasonable time to cure, but which Landlord has failed to cure) occurring in or about or resulting from an occurrence in or about the Premises during the Lease Term, (ii) the negligence or willful misconduct of Tenant or its agents, employees and contractors, wherever the same may occur, or (iii) an Event of Tenant's Default. The provisions of this Paragraph 10.3 shall survive the expiration or sooner termination of this Lease. ARTICLE 11 DAMAGE TO PREMISES 11.1 LANDLORD'S DUTY TO RESTORE: If the Premises are damaged by any peril after the Effective Date, Landlord shall restore the Premises unless the Lease is terminated by Landlord pursuant to Paragraph 11.2 or by Tenant pursuant to Paragraph 11.3. All insurance proceeds available from the fire and property damage insurance carried by Landlord pursuant to Paragraph 9.2 shall be paid to and become the property of Landlord. If this Lease is terminated pursuant to either Paragraph 11.2 or Paragraph 11.3, then all insurance proceeds available from insurance carried by Tenant which covers loss to property that is Landlord's property or would become Landlord's property on termination of this Lease shall be paid to and become the property of Landlord. If this Lease is not so terminated, then upon receipt of the insurance proceeds (if the loss is covered by insurance) and the issuance of all necessary governmental permits, Landlord shall commence and diligently prosecute to completion the restoration of the Premises, to the extent then allowed by Law, to substantially the same condition in which the Premises were immediately prior to such damage. Landlord's obligation to restore shall be limited to the Premises and interior improvements constructed by Landlord as they existed as of the Commencement Date, excluding any Tenant's Alterations, Trade Fixtures and/or personal property constructed or installed by Tenant in the Premises. Tenant shall forthwith replace or fully repair all Tenant's Alterations installed by Tenant and existing at the time of such damage or destruction, and all insurance proceeds received by Tenant from the insurance carried by it pursuant to Paragraph 9.1A(2) shall be used for such purpose. 11.2 LANDLORD'S RIGHT TO TERMINATE: Landlord shall have the right to terminate this Lease in the event any of the following occurs, which right may be exercised only by delivery to Tenant of a written notice of election to terminate within 30 days after the date of such damage: A. Either the Project or the Premises is damaged by an Insured Peril to such an extent that the estimated cost to restore exceeds 33% of the then actual replacement cost thereof; B. Either the Project or the Premises is damaged by an Uninsured Peril to such an extent that the estimated cost to restore exceeds 2% of the then actual replacement cost thereof, provided, however, that Landlord may not terminate this Lease pursuant to this Paragraph 11.2B if one or more tenants of the Project agree in writing to pay the amount by which the cost to restore the damage exceeds such amount and subsequently deposit such amount with Landlord within 30 days after Landlord has notified Tenant of its election to terminate this Lease, or provides other reasonable assurances reasonably acceptable to Landlord, of Tenant's ability to pay the excess amount as the work progresses. C. The Premises are damaged by any peril within 12 months of the last day of the Lease Term to such an extent that the estimated cost to restore equals or exceeds an amount equal to six times the Base Monthly Rent then due; provided, however, that Landlord may not terminate this Lease pursuant to this Paragraph 11.2C if Tenant, at the time of such damage, has a then valid express written option to extend the Lease Term and Tenant exercises such option to extend the Lease Term within 15 days following the date of notice to Tenant that the Lease will be terminated, unless Tenant exercises its option. D. Either the Project or the Premises is damaged by any peril and, because of the Laws then in force, (i) cannot be restored at reasonable cost to substantially the same condition in which it was prior to such damage, or (ii) cannot be used for the same use being made thereof before such damage if restored as required by this Article. E. As used herein, the following terms shall have the following meanings (i) the term "Insured Peril" shall mean a peril actually insured 11 LEASE against or which Landlord is required by this Lease to insure against which the insurance proceeds actually received by Landlord or which would be received by Landlord if it had caused the insurance required by this Lease, plus any sums Tenant is required by this Lease to contribute or which Tenant elects to contribute to the restoration are sufficient (except for any "deductible" amount specified by such insurance) to restore the Project under then existing building codes to substantially the condition existing immediately prior to the damage; and (a) the term "Uninsured Peril" shall mean any peril which is not an Insured Peril. Notwithstanding the foregoing, if the "deductible" for earthquake or flood insurance exceeds 2% of the replacement cost of the improvements insured, such peril shall be deemed an "Uninsured Peril". 11.3 TENANT'S RIGHT TO TERMINATE: If the Premises are damaged by any peril and Landlord does not elect to terminate this Lease or is not entitled to terminate this Lease pursuant to Paragraph 11.2, then as soon as reasonably practicable, Landlord shall furnish Tenant with the written opinion of Landlord's architect or construction consultant as to when the restoration work required of Landlord may be completed. Tenant shall have the right to terminate this Lease in the event any of the following occurs, which right may be exercised only by delivery to Landlord of a written notice of election to terminate within 10 days after Tenant receives from Landlord the estimate of the time needed to complete such restoration. A. The Premises are damaged by any peril and, in the reasonable opinion of Landlord's architect or construction consultant, the restoration of the Premises cannot be substantially completed within 270 days after the date of such damage; or B. The Premises are damaged by any peril within 12 months of the last day of the Lease Term and, in the reasonable opinion of Landlord's architect or construction consultant, the restoration of the Premises cannot be substantially completed within 90 days after the date of such damage and such damage renders unusable more than 30% of the Premises. C. The Premises are not actually restored within 90 days following the date for completion estimated by Landlord's architect. 11.4 ABATEMENT OF RENT: In the event of damage to the Premises which does not result in the termination of this Lease, the Base Monthly Rent and the Additional Rent shall be temporarily abated during the period following the destruction and during restoration in proportion to the degree to which Tenant's use of the Premises is impaired by such damage. Tenant shall not be entitled to any compensation or damages from Landlord for loss of Tenant's business or property or for any inconvenience or annoyance caused by such damage or restoration. Tenant hereby waives the provisions of California Civil Code Sections 1932(2) and 1933(4) and the provisions of any similar law hereinafter enacted. ARTICLE 12 CONDEMNATION 12.1 LANDLORD'S TERMINATION RIGHT: Landlord shall have the right to terminate this Lease if, as a result of a taking by means of the exercise of the power of eminent domain (including a voluntary sale or transfer by Landlord to a condemnor under threat of condemnation), (i) all or any part of the Premises is so taken, (ii) more than 10% of the Building Leasable Area is so taken, or (iii) more than 50% of the Common Area is so taken. Any such right to terminate by Landlord must be exercised within a reasonable period of time, to be effective as of the date possession is taken by the condemnor. 12.2 TENANT'S TERMINATION RIGHT: Tenant shall have the right to terminate this Lease if, as a result of any taking by means of the exercise of the power of eminent domain (including any voluntary sale or transfer by Landlord to any condemnor under threat of condemnation), (i) 10% or more of the Premises is so taken and that part of the Premises that remains cannot be restored within a reasonable period of time and thereby made reasonably suitable for the continued operation of the Tenant's business, or (ii) there is a taking affecting the Common Area and, as a result of such taking, Landlord cannot provide parking spaces within reasonable walking distance of the Premises equal in number to at least 80% of the number of spaces allocated to Tenant by Paragraph 2.1, whether by rearrangement of the remaining parking areas in the Common Area (including construction of multi-deck parking structures or restriping for compact cars where permitted by Law) or by alternative parking facilities on other land. Tenant must exercise such right within a reasonable period of time, to be effective on the date that possession of that portion of the Premises or Common Area that is condemned is taken by the condemnor. 12.3 RESTORATION AND ABATEMENT OF RENT: If any part of the Premises or the Common Area is taken by condemnation and this Lease is not terminated, then Landlord shall restore the remaining portion of the Premises and Common Area and interior improvements constructed by Landlord as they existed as of the Commencement Date, excluding any Tenant's Alterations, Trade Fixtures and/or personal property constructed or installed by Tenant. Thereafter, except in the case of a temporary taking, as of the date possession is taken the Base Monthly Rent shall be reduced in the same proportion that the floor area of that part of the Premises so taken (less any addition thereto by reason of any reconstruction) bears to the original floor area of the Premises. 12.4 TEMPORARY TAKING: If any portion of the Premises is temporarily taken for one year or less, this Lease shall remain in effect. If any portion of the Premises is temporarily taken by condemnation for a period which exceeds one year or which extends beyond the natural expiration of the Lease Term, and such taking materially and adversely affects Tenant's ability to use the Premises for the Permitted Use, then Tenant shall have the right to terminate this Lease, effective on the date possession is taken by the condemnor. 12.5 DIVISION OF CONDEMNATION AWARD: Any award made as a result of any condemnation of the Premises or the Common Area shall belong to and be paid to Landlord, and Tenant hereby assigns to Landlord all of its right, title and interest in any such award; provided, however, that Tenant shall be entitled to receive any condemnation award that is made directly to Tenant for the following so long as the award made to Landlord is not thereby reduced: (i) for the taking of Tenant's Property or Trade Fixtures belonging to Tenant, (ii) for the interruption of Tenant's business or its moving costs, (iii) for loss of Tenant's goodwill; or (iv) for 12 LEASE any temporary taking where this Lease is not terminated as a result of such taking. The rights of Landlord and Tenant regarding any condemnation shall be determined as provided in this Article, and each party hereby waives the provisions of California Code of Civil Procedure Section 1265.130 and the provisions of any similar law hereinafter enacted allowing either party to petition the Superior Court to terminate this Lease in the event of a partial taking of the Premises. ARTICLE 13 DEFAULT AND REMEDIES 13.1 EVENTS OF TENANT'S DEFAULT: Tenant shall be in default of its obligations under this Lease if any of the following events occurs (an "Event of Tenant's Default"): A. Tenant shall have failed to pay Base Monthly Rent or Additional Rent when due, and such failure is not cured within 3 days after delivery of written notice from Landlord specifying such failure to pay; or B. Tenant shall have failed to perform any term, covenant, or condition of this Lease except those requiring the payment of Base Monthly Rent or Additional Rent, and Tenant shall have failed to cure such breach within 30 days after written notice from Landlord specifying the nature of such breach where such breach could reasonably be cured within said 30 day period, or if such breach could not be reasonably cured within said 30 day period, Tenant shall have failed to commence such cure within said 30 day period and thereafter continue with due diligence to prosecute such cure to completion within such time period as is reasonably needed; or C. Tenant shall have sublet the Premises or assigned its interest in the Lease in violation of the provisions contained in Article 14; or D. Tenant shall have abandoned the Premises and failed to perform its obligation hereunder; or E. The occurrence of the following: (i) the making by Tenant of any general arrangements or assignments for the benefit of creditors; (ii) Tenant becomes a "debtor" as defined in 11 USC Section 101 or any successor statute thereto (unless, in the case of a petition filed against Tenant, the same is dismissed within 60 days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where possession is not restored to Tenant within 30 days; or (iv) the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where such seizure is not discharged within 30 days; provided, however, in the event that any provision of this Section 13.1E is contrary to any applicable Law, such provision shall be of no force or effect; or F. Tenant shall have failed to deliver documents required of it pursuant to Paragraph 15.4 or 15.6 within the time periods specified therein. 13.2 LANDLORD'S REMEDIES: If an Event of Tenant's Default occurs, Landlord shall have the following remedies, in addition to all other rights and remedies provided by any Law or otherwise provided in this Lease, to which Landlord may resort cumulatively or in the alternative: A. Landlord may keep this Lease in effect and enforce by an action at law or in equity all of its rights and remedies under this Lease, including (i) the right to recover the rent and other sums as they become due by appropriate legal action, (ii) the right to make payments required of Tenant or perform Tenant's obligations and be reimbursed by Tenant for the cost thereof with interest at the Agreed Interest Rate from the date the sum is paid by Landlord until Landlord is reimbursed by Tenant, and (iii) the remedies of injunctive relief and specific performance to compel Tenant to perform its obligations under this Lease. Notwithstanding anything contained in this Lease, in the event of a breach of an obligation by Tenant which results in a condition which poses an imminent danger to safety of persons or damage to property, an unsightly condition visible from the exterior of the Building, or a threat to insurance coverage, then if Tenant does not cure such breach within 3 days after delivery to it of written notice from Landlord identifying the breach, Landlord may cure the breach of Tenant and be reimbursed by Tenant for the cost thereof with interest at the Agreed Interest Rate from the date the sum is paid by Landlord until Landlord is reimbursed by Tenant. B. Landlord may enter the Premises and release them to third parties for Tenant's account for any period, whether shorter or longer than the remaining Lease Term. Tenant shall be liable immediately to Landlord for all costs Landlord incurs in releasing the Premises, including brokers' commissions, expenses of altering and preparing the Premises required by the releasing. Tenant shall pay to Landlord the rent and other sums due under this Lease on the date the rent is due, less the rent and other sums Landlord received from any releasing. No act by Landlord allowed by this subparagraph shall terminate this Lease unless Landlord notifies Tenant in writing that Landlord elects to terminate this Lease. Notwithstanding any releasing without termination, Landlord may later elect to terminate this Lease because of the default by Tenant. C. Landlord may terminate this Lease by giving Tenant written notice of termination, in which event this Lease shall terminate on the date set forth for termination in such notice. Any termination under this Paragraph 13.2C shall not relieve Tenant from its obligation to pay sums then due Landlord or from any claim against Tenant for damages or rent previously accrued or then accruing. In no event shall any one or more of the following actions by Landlord, in the absence of a written election by Landlord to terminate this Lease, constitute a termination of this Lease: (i) appointment of a receiver or keeper in order to protect Landlord's interest hereunder; (ii) consent to any subletting of the Premises or assignment of this Lease by Tenant, whether pursuant to the provisions hereof or otherwise; or (iii) any other action by Landlord or Landlord's Agents intended 13 LEASE to mitigate the adverse effects of any breach of this Lease by Tenant, including without limitation any action taken to maintain and preserve the Premises or any action taken to relet the Premises or any portions thereof to the extent such actions do not affect a termination of Tenant's right to possession of the Premises. D. In the event Tenant breaches this Lease and abandons the Premises, this Lease shall not terminate unless Landlord gives Tenant written notice of its election to so terminate this Lease. No act by or on behalf of Landlord intended to mitigate the adverse effect of such breach, including those described by Paragraph 13.C, shall constitute a termination of Tenant's right to possession unless Landlord gives Tenant written notice of termination. Should Landlord not terminate this Lease by giving Tenant written notice, Landlord may enforce all its rights and remedies under this Lease, including the right to recover the rent as it becomes due under the Lease as provided in California Civil Code Section 1951.4. E. In the event Landlord terminates this Lease, Landlord shall be entitled, at Landlord's election, to damages in an amount as set forth in California Civil Code Section 1951.2 as in effect on the Effective Date. For purposes of computing damages pursuant to California Civil Code Section 1951.2., (i) an interest rate equal to the Agreed Interest Rate shall be used where permitted, and (ii) the term "rent" includes Base Monthly Rent and Additional Rent. Such damages shall include: (1) The worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided, computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%); and (2) Any other amount necessary to compensate Landlord for all detriment proximately caused by Tenant's failure to perform Tenant's obligations under this Lease, or which in the ordinary course of things would be likely to result therefrom, including the following: (i) expenses for cleaning, repairing or restoring the Premises; (ii) expenses for altering, remodeling or otherwise improving the Premises for the purpose of reletting, including installation of leasehold improvements (whether such installation be funded by a reduction of rent, direct payment or allowance to a new tenant, or otherwise); (iii) broker's fees, advertising costs and other expenses of reletting the Premises; (i) costs of carrying the Premises, such as taxes, insurance premiums, utilities and security precautions; (v) expenses in retaking possession of the Premises; and (vi) attorneys' fees and court costs incurred by Landlord in retaking possession of the Premises and in releasing the Premises or otherwise incurred as a result of Tenant's default. F. Nothing in this 13.2 shall limit Landlord's right to indemnification from Tenant as provided in Paragraph 17.2 and Paragraph 10.3. Any notice given by Landlord in order to satisfy the requirements of Paragraph 13.1A or Paragraph 13.1B above shall also satisfy the notice requirements of California Code of Civil Procedure Section 1161 regarding unlawful detainer proceedings, if it is delivered in the form and by means described in said Code Sections. 13.3 WAIVER: One party's consent to or approval of any act by the other party requiring the first party's consent or approval shall not be deemed to waive or render unnecessary the list party consent to or approval of any subsequent similar act by the other party. The receipt by Landlord of any rent or payment with or without knowledge of the breach of any other provision hereof shall not be deemed a waiver of any such breach unless such waiver is in writing and signed by Landlord. No delay or omission in the exercise of any right or remedy accruing to either party upon any breach by the other party under this Lease shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by either party of any breach of any provision of this Lease shall not be deemed to be a waiver of any subsequent breach of the same or of any other provisions herein contained. 13.4 LIMITATION ON EXERCISE OF RIGHT: At any time that an Event of Tenant's Default has occurred and remains uncured, (i) it shall not be unreasonable for Landlord to deny or withhold any consent or approval requested of it by Tenant which Landlord would otherwise be obligated to give unless as a consequence of the transaction the Default will be cured, and (ii) Tenant may not exercise any option to extend, right to terminate this Lease, or other right granted to it by this Lease which would otherwise be available to it. 13.5 WAIVER BY TENANT OF CERTAIN REMEDIES. Tenant waives the provisions of Sections 1932(l), 1941 and 1942 of the California Civil Code and any similar or successor law regarding Tenant's right to terminate this Lease or to make repairs and deduct the expenses of such repairs from the rent due under this Lease. Tenant hereby waives any right of redemption or relief from forfeiture under the laws of the State of California, or under any other present or future law, including the provisions of Sections 1174 and 1179 of the California Code of Civil Procedure. ARTICLE 14 ASSIGNMENT AND SUBLETTING 14.1 TRANSFER BY TENANT: The following provisions shall apply to any assignment, subletting or other transfer by Tenant or any subtenant or assignee or other successor in interest of the original Tenant (collectively referred to in this Paragraph 14.1 as "Tenant"): A. Tenant shall not do any of the following (collectively referred to herein as a "Transfer"), whether voluntarily, involuntarily or by operation of law, without the prior written consent of Landlord, which consent shall not be unreasonably withheld or delayed: (i) sublet all or any part of the Premises or allow it to be sublet, occupied or used by any person or entity other than Tenant; (ii) assign its interest in this Lease; (iii) mortgage or encumber the Lease (or otherwise use the Lease as a security device) in any manner; or (iv) materially amend or modify an assignment, sublease or other transfer that has been previously approved by Landlord. Tenant shall reimburse Landlord for all reasonable 14 LEASE costs and attorney fees incurred by Landlord in connection with the evaluation, processing, and/or documentation of any requested Transfer, whether or not Landlord's consent is granted. Landlord's reasonable costs shall include the cost of any review or investigation performed by Landlord or consultant acting on Landlord's behalf of (i) Hazardous Materials (as defined in Section 7.2E of this Lease) used, stored, released, or disposed of by the potential Subtenant or Assignee, and/or (ii) violations of Hazardous Materials Law (as defined in Section 7.2E of this lease) by the Tenant or the proposed Subtenant or Assignee. Any Transfer so approved by Landlord shall not be effective until Tenant has delivered to Landlord an executed counterpart of the document evidencing the Transfer which (i) is in a form reasonably approved by Landlord, (ii) contains the same terms and conditions as stated in Tenant's notice given to Landlord pursuant to Paragraph 14.1B, and (iii) in the case of an assignment of the Lease, contains the agreement of the proposed transferee to assume all obligations of Tenant under this Lease arising after the effective date of such Transfer and to remain jointly and severally liable therefor with Tenant. Any attempted Transfer without any required Landlord's consent shall constitute an Event of Tenant's Default and shall be voidable at Landlord's option. Landlord's consent to any one Transfer shall not constitute a waiver of the provisions of this Paragraph 14.1 as to any subsequent Transfer or a consent to any subsequent Transfer. No Transfer, even with the consent of Landlord, shall relieve Tenant of its personal and primary obligation to pay the rent and to perform all of the other obligations to be performed by Tenant hereunder. The acceptance of rent by Landlord from any person shall not be deemed to be a waiver by Landlord of any provision of this Lease nor to be a consent to any Transfer. B. At least 15 days before a proposed Transfer is to become effective, Tenant shall give Landlord written notice of the proposed terms of such Transfer and request Landlord's approval, which notice shall include the following: (i) the name and legal composition of the proposed transferee; (ii) a current best available Financial statement of the transferee, best available financial statements of the transferee covering the preceding three years if the same exist, and (if available) an audited financial statement of the transferee for a period ending not more than one year prior to the proposed effective date of the Transfer, all of which statements are prepared in accordance with generally accepted accounting principles; (iii) the nature of the proposed transferee's business to be carried on in the Premises; (iv) all consideration to be given on account of the Transfer; (v) a current financial statement of Tenant; and (vi) an accurately filled out response to Landlord's standard Hazardous Materials Questionnaire in use by Landlord with other tenants at the time of the Transfer. Tenant shall provide to Landlord such other information as may be reasonably requested by Landlord within seven days after Landlord's receipt of such notice from Tenant. Landlord shall respond in writing to Tenant's request for Landlord's consent to a Transfer within the later of (i) 10 days of receipt of such request together with the required accompanying documentation, or (ii) seven days after Landlord's receipt of all information which Landlord reasonably requests within seven days after it receives Tenant's first notice regarding the Transfer in question. If Landlord fails to respond in writing within said period, Landlord will be deemed to have withheld consent to such Transfer. Tenant shall immediately notify Landlord of any material modification to the proposed terms of such Transfer. C. In the event that Tenant seeks to assign or sublease for the balance of the Lease Term, Landlord shall have the right to terminate this Lease or, in the case of a sublease of less than all of the Premises, terminate this Lease as to that part of the Premises proposed to be so sublet, either (i) on the condition that the proposed transferee immediately enter into a direct lease of the Premises with Landlord (or, in the case of a partial sublease, a lease for the portion proposed to be so sublet) on the same terms and conditions contained in Tenant's notice, or (ii) so that Landlord is thereafter free to lease the Premises (or, in the case of a partial sublease, the portion proposed to be so sublet) to whomever it pleases on whatever terms are acceptable to Landlord. In the event Landlord elects to so terminate this Lease, then (i) if such termination is conditioned upon the execution of a lease between Landlord and the proposed transferee, Tenant's obligations under this Lease shall not be terminated until such transferee executes a new lease with Landlord, enters into possession and commences the payment of rent, and (ii) if Landlord elects simply to terminate this Lease (or, in the case of a partial sublease, terminate this Lease as to the portion to be so sublet), the Lease shall so terminate in its entirety (or as to the space to be so sublet) fifteen (15) days after Landlord has notified Tenant in writing of such election. Upon such termination, Tenant shall be released from any further obligation under this Lease if it is terminated in its entirety, or shall be released from any further obligation under the Lease with respect to the space proposed to be sublet in the case of a proposed partial sublease. In the case of a partial termination of the Lease, the Base Monthly Rent and Tenant's Share shall be reduced to an amount which bears the same relationship to the original amount thereof as the area of that part of the Premises which remains subject to the Lease bears to the original area of the Premises. Landlord and Tenant shall execute a cancellation and release with respect to the Lease to effect such termination. Landlord shall not unreasonably withhold consent to a change in use in order to accommodate any Transfer which does not pose a health or safety risk to the Project and conforms to all applicable laws. D. If Landlord consents to a Transfer proposed by Tenant or if Landlord's consent is not required, Tenant may enter into such Transfer, and if Tenant does so, the following shall apply: (1) Tenant shall not be released of its liability for the performance of all of its obligations under the Lease. (2) If Tenant assigns its interest in this Lease, then Tenant shall pay to Landlord 50% of all Subrent (as defined in Paragraph 14.1D)(5)) received by Tenant over and above (i) the assignee's agreement to assume the obligations of Tenant under this Lease, and (ii) all Permitted Transfer Costs related to such assignment. In the case of assignment, the amount of Subrent owed to Landlord shall be paid to Landlord on the same basis, whether periodic or in lump sum, that such Subrent is paid to Tenant by the assignee. (3) If Tenant sublets any part of the Premises, then with respect to the space so 15 LEASE subleased, Tenant shall pay to Landlord 50% of the positive difference, if any, between (i) all Subrent paid by the subtenant to Tenant, after deduction of (ii) the sum of all base Monthly Rent and Additional Rent allocable to the space sublet and all Permitted Transfer Costs related to such sublease. Such amount shall be paid to Landlord on the same basis, whether periodic or in lump sum, that such Subrent is paid to Tenant by its subtenant. In calculating Landlord's share of any periodic payments, all Permitted Transfer Costs shall be first recovered by Tenant. (4) Tenant's obligations under this Paragraph 14.1D shall survive any Transfer, and Tenant's failure to perform its obligations hereunder shall be an Event of Tenant's Default. At the time Tenant makes any payment to Landlord required by this Paragraph 14.1D, Tenant shall deliver an itemized statement of the method by which the amount to which Landlord is entitled was calculated, certified by Tenant as true and correct. Landlord shall have the right at reasonable intervals to inspect Tenant's books and records relating to the payments due hereunder. Upon request therefor, Tenant shall deliver to Landlord copies of all bills, invoices or other documents upon which its calculations are based. Landlord may condition its approval of any Transfer requiring Landlord's consent upon obtaining a certification from both Tenant and the proposed transferee of all Subrent and other amounts that are to be paid to Tenant in connection with such Transfer. (5) As used in this Paragraph 14.1D, the term "Subrent" shall mean any consideration of any kind received, or to be received, by Tenant as a consideration for the Transfer, if such sums are related to Tenant's interest in this Lease or in the Premises. As used in this Paragraph 14.1D, the term "Permitted Transfer Costs" shall mean (i) all reasonable leasing commissions paid to third parties not affiliated with Tenant in order to obtain the Transfer in question, (ii) all reasonable attorneys' fees incurred by Tenant with respect to the Transfer in question, (iii) all other reasonable cost paid or incurred by Tenant to perform its obligations under the Transfer document/sublease reflected in the Subrent. E. If Tenant is a corporation, the following shall be deemed a voluntary assignment of Tenant" interest in this Lease: (i) any dissolution, merger, consolidation, or other reorganization of or affecting Tenant, whether or not Tenant is the surviving corporation; and (ii) if the capital stock of Tenant is not publicly traded, the sale or transfer to one person or entity (or to any group of related persons or entities) stock possessing more than 50% of the total combined voting power of all classes of Tenant's capital stock issued, outstanding and entitled to vote for the election of directors. If Tenant is a partnership, any withdrawal or substitution (whether voluntary, involuntary or by operation of law, and whether occurring at one time or over a period of time) of any partner owning 25% or more (cumulatively) of any interest in the capital or profits of the partnership, or the dissolution of the partnership, shall be deemed a voluntary assignment of Tenant's interest in this Lease. F. Notwithstanding anything contained in Paragraph 14.1, so long as Tenant otherwise complies with the provisions of Paragraph 14.1 Tenant may enter into any of the following transfers (a "Permitted Transfer") without Landlord's prior written consent, and Landlord shall not be entitled to terminate the Lease pursuant to Paragraph 14.1C or to receive any part of any Subrent resulting therefrom that would otherwise be due it pursuant to Paragraph 14.1D: (1) Tenant may sublease all or part of the Premises or assign its interest in this Lease to any corporation which controls, is controlled by, or is under common control with the original Tenant to this Lease by means of an ownership interest of more than 50%; (2) Tenant may assign its interest in the Lease to a corporation which results from a merger, consolidation or other reorganization in which Tenant is not the surviving corporation, so long as the surviving corporation has a net worth at the time of such assignment that is equal to or greater than the net worth of Tenant immediately prior to such transaction; and (3) Tenant may assign this Lease to a corporation which purchases or otherwise acquires all or substantially all of the stock of Tenant or substantially all of the assets of Tenant, so long as the Tenant after the transaction has a net worth at the time of such assignment that is equal to or greater than the net worth of Tenant immediately prior to such transaction. 14.2 TRANSFER BY LANDLORD: Landlord and its successors in interest shall have the right to transfer their interest in this Lease and the Project at any time and to any person or entity. In the event of any such transfer, the Landlord originally named herein (and, in the case of any subsequent transfer, the transferor) from the date of such transfer, shall be automatically relieved, without any further act by any person or entity, of all liability for the performance of the obligations of the Landlord hereunder which may accrue after the date of such transfer and which are assumed by Landlord's transferee. After the date of any such transfer, term "Landlord" as used herein shall mean the transferee of such interest in the Premises. ARTICLE 15 GENERAL PROVISIONS 15.1 LANDLORD'S RIGHT TO ENTER: Landlord and its agents may enter the Premises at any reasonable time after giving at least 24 hours' prior notice to Tenant (and immediately in the case of emergency) for the purpose of: (i) inspecting the same; (ii) posting notices of non-responsibility; (iii) supplying any service to be provided by Landlord to Tenant; (iv) showing the Premises to prospective purchasers, mortgagees or tenants; (v) making necessary alterations, additions or repairs; (vi) performing Tenant's obligations when Tenant has failed to do so after written notice from Landlord; (vii) placing upon the Premises ordinary "for lease" signs or "for sale" signs (clearly indicating the Project, not the business, is for sale) and (viii) responding to an emergency. Landlord shall have the right to use any and all means Landlord may deem necessary and proper to enter the Premises in an emergency. Any entry into the Premises obtained by Landlord in accordance with this Paragraph 15.1 shall not be a forcible or unlawful 16 entry into, or a detainer of, the Premises, or an eviction, actual or constructive, of Tenant from the Premises. 15.2 SURRENDER OF THE PREMISES: Upon the expiration or sooner termination of this Lease, Tenant shall vacate and surrender the Premises to Landlord in the same condition as existed at the Commencement Date, (unless Landlord has agreed, prior to the construction of such Tenant Alterations, that such will not be required to be removed at the termination of the Lease) except for (i) reasonable wear and tear, (ii) damage caused by any peril or condemnation, and (iii) contamination by Hazardous Material for which Tenant is not responsible pursuant to Paragraph 7.2A or Paragraph 7.2B. In this regard, normal wear and tear shall be construed to mean wear and tear caused to the Premises by the natural aging process which occurs in spite of prudent application of the best standards for maintenance, repair and janitorial practices, and does not include items of neglected or deferred maintenance required of Tenant by the Lease. In any event, Tenant shall cause the following to be done prior to the expiration or the sooner termination of this Lease: (i) all interior walls shall be cleaned; (ii) all tiled floors shall be cleaned and waxed; (iii) all carpets shall be cleaned and shampooed; (iv) all broken, marred, stained or nonconforming acoustical ceiling tiles shall be replaced; (v) all windows shall be washed; (vi) the HVAC system shall be serviced by a reputable and licensed service firm and left in good operating condition and repair as so certified by such firm; and (vii) the plumbing and electrical systems and lighting shall be placed in good order and repair (including replacement of any burned out, discolored or broken light bulbs, ballasts, or lenses). If Landlord so requests, Tenant shall, prior to the expiration or sooner termination of this Lease, (i) remove any Tenant's Alterations which Tenant is required to remove pursuant to Paragraph 15.2 and repair all damage caused by such removal, and (ii) return the Premises or any part thereof to its original configuration existing as of the time the Premises were delivered to Tenant (unless Landlord has agreed, prior to the construction of such Tenant Alterations, that such will not be required to be removed at the termination of the Lease). If the Premises are not so surrendered at the termination of this Lease, Tenant shall be liable to Landlord for all costs incurred by Landlord in returning the Premises to the required condition, plus interest on all costs incurred at the Agreed Interest Rate. Tenant shall indemnify Landlord against loss or liability resulting from delay by Tenant in so surrendering the Premises, including, without limitation, any claims made by any succeeding tenant or losses to Landlord due to lost opportunities to lease to succeeding tenants. 15.3 HOLDING OVER: This Lease shall terminate without further notice at the expiration of the Lease Term. Any holding over by Tenant after expiration of the Lease Term shall not constitute a renewal or extension of the Lease or give Tenant any rights in or to the Premises except as expressly provided in this Lease. Any holding over after such expiration with the written consent of Landlord shall be construed to be a tenancy from month to month on the same terms and conditions herein specified insofar as applicable except that Base Monthly Rent shall be increased to an amount equal to 150% of the Base Monthly Rent payable during the last full calendar month of the Lease Term. 15.4 SUBORDINATION: The following provisions shall govern the relationship of this Lease to any Security Instrument: A. The Lease is subject and subordinate to all Security Instruments existing as of the Effective Date. However, if any Lender so requires, this Lease shall become prior and superior to any such Security Instrument. Upon written request from Tenant, Landlord shall use all reasonable efforts to obtain a non-disturbance agreement from Landlord's Lender on the Lender's standard form. All costs, if any, in obtaining agreement shall be paid by Tenant. B. At Landlord's election, this Lease shall become subject and subordinate to any Security Instrument created after the Effective Date. Notwithstanding such subordination, Tenant's right to quiet possession of the Premises shall not be disturbed so long as Tenant is not in default and performs all of its obligations under this Lease, unless this Lease is otherwise terminated pursuant to its terms. C. Tenant shall upon request execute any document or instrument reasonably required by any Lender to make this Lease either prior or subordinate to a Security Instrument, which may include such other matters as the Lender customarily and reasonably requires in connection with such agreements, including provisions that the Lender not be liable for (i) the return of any security deposit unless the Lender receives it from Landlord, and (ii) any defaults on the part of Landlord occurring prior to the time the Lender takes possession of the Project in connection with the enforcement of its Security Instrument. Tenant's failure to execute any such document or instrument within 10 days after written demand therefor shall constitute an Event of Tenant's Default. Tenant approves as reasonable the form of subordination agreement attached to this Lease as EXHIBIT G. 15.5 MORTGAGE PROTECTION AND ATTORNMENT: In the event of any default on the part of the Landlord, Tenant will use reasonable efforts to give notice by registered mail to any Lender whose name has been provided to Tenant and shall offer such Lender a reasonable opportunity to cure the default, including time to obtain possession of the Premises by power of sale or judicial foreclosure or other appropriate legal proceedings, if such should prove necessary to effect a cure. Tenant shall attorn to any purchaser of the Premises at any foreclosure sale or private sale conducted pursuant to any Security Instrument encumbering the Premises, or to any grantee or transferee designated in any deed given in lieu of foreclosure. 15.6 ESTOPPEL CERTIFICATES AND FINANCIAL STATEMENTS: At all times during the Lease Term, each party agrees, following any request by the other party, promptly to execute and deliver to the requesting party within 15 days following delivery of such request an estoppel certificate: (i) certifying that this Lease is unmodified and in full force and effect or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect, (ii) stating the date to which the rent and other charges are paid in advance, if any, (iii) acknowledging that there are not, to the certifying party's knowledge, any uncured defaults on the part of any party hereunder or, if there are uncured defaults, specifying the nature of such defaults, and (iv) certifying such other information about the Lease as may be reasonably required by the requesting party. A failure to 17 LEASE deliver an estoppel certificate within 15 days after delivery of a request therefor shall be a conclusive admission that, as of the date of the request for such statement: (i) this Lease is unmodified except as may be represented by the requesting party in said request and is in full force and effect, (ii) there are no uncured defaults in the requesting party's performance, and (iii) no rent has been paid more than 30 days in advance of its due date hereunder. At any time during the Lease Term Tenant shall, upon 15 days' prior written notice from Landlord, provide Tenant's most recent financial statement and financial statements covering the 24 month period prior to the date of such most recent financial statement to any existing Lender or to any potential Lender or buyer of the Premises. Such statements shall be prepared in accordance with generally accepted accounting principles and, if such is the normal practice of Tenant, shall be audited by an independent certified public accountant. 15.7 REASONABLE CONSENT: Whenever any party's approval or consent is required by this Lease before an action may be taken by the other party, such approval or consent shall not be unreasonably withheld or delayed. 15.8 NOTICES. Any notice required or desired to be given regarding this Lease shall be in writing and may be given by personal delivery, by facsimile telecopy, by courier service or by mail. A notice shall be deemed to have been given (i) on the third business day after mailing if such notice was deposited in the United States mail, certified or registered, postage prepaid, addressed to the party to be served at its Address for Notices specified in SECTION Q or SECTION R of the Summary (as applicable), (ii) when delivered if given by personal delivery, and (iii) in all other cases when actually received at the party's Address for Notices. Either party may change its address by giving notice of the same in accordance with this Paragraph 15.8, provided, however, that any address to which notices may be sent must be a California address. Notwithstanding the foregoing, no notice of default may be delivered by fax. 15.9 ATTORNEYS' FEES: In the event either Landlord or Tenant shall bring any action or legal proceeding for an alleged breach of any provision of this Lease, to recover rent, to terminate this Lease or otherwise to enforce, protect or establish any term or covenant of this Lease, the prevailing party shall be entitled to recover as a part of such action or proceeding, or in a separate action brought for that purpose, reasonable attorneys' fees, court costs, and experts' fees as may be fixed by the court. 15.10 CORPORATE AUTHORITY: If Tenant is a corporation (or partnership), each individual executing this Lease on behalf of Tenant represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of such corporation in accordance with the by-laws of such corporation (or partnership in accordance with the partnership agreement of such partnership) and that this Lease is binding upon such corporation (or partnership) in accordance with its terms. Each of the persons executing this Lease on behalf of a corporation does hereby covenant and warrant that the party of whom it is executing this Lease is a duly authorized and existing corporation, that it is qualified to do business in California, and that the corporation has full right and authority to enter into this Lease. 15.11 MISCELLANEOUS: Should any provision of this Lease prove to be invalid or illegal, such invalidity or illegality shall in no way affect, impair or invalidate any other provision hereof, and such remaining provisions shall remain in full force and effect. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. The captions used in this Lease are for convenience only and shall not be considered in the construction or interpretation of any provision hereof. Any executed copy of this Lease shall be deemed an original for all purposes. This Lease shall, subject to the provisions regarding assignment, apply to and bind the respective heirs, successors, executors, administrators and assigns of Landlord and Tenant. "Party" shall mean Landlord or Tenant, as the context implies. If Tenant consists of more than one person or entity, then all members of Tenant shall be jointly and severally liable hereunder. This Lease shall be construed and enforced in accordance with the laws of the State of California. The language in all parts of this Lease shall in all cases be construed as a whole according to its fair meaning, and not strictly for or against either Landlord or Tenant. When the context of this Lease requires, the neuter gender includes the masculine, the feminine, a partnership or corporation or joint venture, and the singular includes the plural. The terms "shall", "will" and "agree" are mandatory. The term "may" is permissive. When a party is required to do something by this Lease, it shall do so at its sole cost and expense without right of reimbursement from the other party unless a provision of this Lease expressly requires reimbursement. Landlord and Tenant agree that (i) the gross leasable area of the Premises includes any atriums, depressed loading docks, covered entrances or egresses, and covered loading areas, (ii) each has had an opportunity to determine to its satisfaction the actual area of the Project and the Premises, (iii) all measurements of area contained in this Lease are conclusively agreed to be correct and binding upon the parties, even if a subsequent measurement of any one of these areas determines that it is more or less than the amount of area reflected in this Lease, and (iv) any such subsequent determination that the area is more or less than shown in this Lease shall not result in a change in any of the computations of rent, improvement allowances, or other matters described in this Lease where area is a factor. Where a party hereto is obligated not to perform any act, such party is also obligated to restrain any others within its control from performing said act, including the Agents of such party. Landlord shall not become or be deemed a partner or a joint venturer with Tenant by reason of the provisions of this Lease. 15.12 TERMINATION BY EXERCISE OF RIGHT: If this Lease is terminated pursuant to its terms by the proper exercise of a right to terminate specifically granted to Landlord or Tenant by this Lease, then this Lease shall terminate on a date thereafter selected by Tenant, which date shall not be more than 180 days after the date the right to terminate is properly exercised (unless another date is specified in that part of the Lease creating the right, in which event the date so specified for termination shall prevail), the rent and all other charges due hereunder shall be prorated as of the date of termination, and neither Landlord nor Tenant shall have any further rights or obligations under this Lease except for those that have accrued 18 LEASE prior to the date of termination or those obligations which this Lease specifically provides are to survive termination. This Paragraph 15.12 does not apply to a termination of this Lease by Landlord as a result of an Event of Tenant's Default. 15.13 BROKERAGE COMMISSIONS: Each party hereto (i) represents and warrants to the other that it has not had any dealings with any real estate brokers, leasing agents or salesmen, or incurred any obligations for the payment of real estate brokerage commissions or finder's fees which would be earned or due and payable by reason of the execution of this Lease, other than to the Retained Real Estate Brokers described in SECTION S of the Summary, and (ii) agrees to indemnify, defend, and hold harmless the other party from any claim for any such commission or fees which result from the actions of the indemnifying party. Landlord shall be responsible for the payment of any commission owed to the Retained Real Estate Brokers if there is a separate written commission agreement between Landlord and the Retained Real Estate Brokers for the payment of a commission as a result of the execution of this Lease. 15.14 FORCE MAJEURE: Any prevention, delay or stoppage due to strikes, lock-outs, inclement weather, labor disputes, inability to obtain labor, materials, fuels or reasonable substitutes therefor, governmental restrictions, regulations, controls, action or inaction, civil commotion, fire or other acts of God, and other causes beyond the reasonable control of the party obligated to perform (except financial inability) shall excuse the performance, for a period equal to the period of any said prevention, delay or stoppage, of any obligation hereunder except the obligation of Tenant or Landlord to pay rent or any other sums due hereunder. 15.15 ENTIRE AGREEMENT: This Lease constitutes the entire agreement between the parties, and there are no binding agreements or representations between the parties except as expressed herein. Tenant acknowledges that neither Landlord nor Landlord's Agents has made any legally binding representation or warranty as to any matter except those expressly set forth herein, including any warranty as to (i) whether the Premises may be used for Tenant's intended use under existing Law, (ii) the suitability of the Premises or the Project for the conduct of Tenant's business, or (iii) the condition of any improvements. There are no oral agreements between Landlord and Tenant affecting this Lease, and this Lease supercedes and cancels any and all previous negotiations, arrangements, brochures, agreements and understandings, if any, between Landlord and Tenant or displayed by Landlord to Tenant with respect to the subject matter of this Lease. This instrument shall not be legally binding until it is executed by both Landlord and Tenant. No subsequent change or addition to this Lease shall be binding unless in writing and signed by Landlord and Tenant. IN WITNESS WHEREOF, Landlord and Tenants have executed this Lease with the intent to be legally bound thereby, to be effective as of the Effective Date. LANDLORD: SAN JOSE ACQUISITION CO., L.L.C. A DELAWARE LIMITED LIABILITY COMPANY BY: ARGO PARTNERSHIP L.P. ITS GENERAL PARTNER BY: ARGO MANAGEMENT COMPANY, L.P. ITS GENERAL PARTNER BY: 0'CONNER CAPITAL PARTNERS, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL INCORPORATED ITS GENERAL PARTNER BY: /s/ K.J. Artingstall K.J. ARTINGSTALL VICE PRESIDENT BY: ARGO PARTNERSHIP II, L.P., ITS MANAGER BY: ARGO II MANAGEMENT COMPANY, L.P. ITS GENERAL PARTNER BY: O'CONNER CAPITAL PARTNERS II L.P., ITS GENERAL PARTNER BY: 0'CONNER CAPITAL II INCORPORATED ITS GENERAL PARTNER BY: /s/ K.J. Artingstall K.J. ARTINGSTALL VICE PRESIDENT DATE: 12-18-96 TENANT: QUICKTURN DESIGN SYSTEMS, INC. A DELAWARE CORPORATION BY: /s/ Ray Ostby RAY OSTBY TITLE: CHIEF FINANCIAL OFFICER DATE: 12/16/96 FIRST ADDENDUM TO LEASE THIS FIRST ADDENDUM is dated for reference purposes as December 6, 1996, and is made a part of that Lease Agreement (the "Lease") dated December 6, 1996, by and between SAN JOSE ACQUISITION CO., L.L.C., a Delaware limited liability company ("Landlord") and QUICKTURN DESIGN SYSTEMS, INC., a Delaware corporation ("Tenant") affecting certain real property commonly known as 2610 Orchard Parkway and 55 W. Trimble Road, San Jose, California , with reference to the following facts: 1. TENANT IMPROVEMENT ALLOWANCES: A. The term "First Level Tenant Improvement Allowance" shall mean the maximum amount Landlord is required to spend toward the payment of Interior Improvement Costs for all Interior Improvements constructed in the Premises, which amount is $729,075.00 (i.e., $5.00 per square foot for Tenant's Gross Leasable Area within the entire Premises). B. A second level Tenant Improvement Allowance ("Second Level Tenant Improvement Allowance") of $291,630 (i.e., $2.00 per square foot for Tenant's Gross Leasable Area within the entire Premises) shall be made available for an increase in the Base Monthly Rent as provided for in paragraph 2 of this Addendum To Lease. C. The First Level Tenant Improvement Allowance plus the Second Level Tenant Improvement Allowance shall be termed the "Total Tenant Improvement Allowance" consisting of $1,020,705.00 (i.e., $7.00 per square foot for Tenant's Gross Leasable Area within the entire Premise). D. Landlord shall not be obligated to provide future use of any Tenant Improvement Allowance not spent within ninety (90) days after the Commencement Date, subject to delays caused by Landlord, its employees, its contractors, or Agents. 2. ADJUSTMENTS TO THE BASE MONTHLY RENT: The Base Monthly Rent as provided for in Article 3 of the Lease shall be adjusted as follows: A. For every increment of $145,815 (i.e., $0.0166 per square foot of Gross Leasable Area), or proportion thereof of the Second Level Tenant Improvement Allowance that Tenant elects to spend for the payment of the Interior Improvement Costs as defined in Exhibit B, "Interior Improvement Agreement", the Base Monthly Rent shall increase $0.0166 per square foot per month. As an example, if $218,722.50 of Second Level Tenant Improvement Allowance is spent, the Base Monthly Rent shall increase $3,630.79 per month. B. No credit in the Base Monthly Rent shall be made if a portion of the Tenant Improvement Allowance is not spent. 3. CALCULATION OF FINAL PREPAID RENT AND SECURITY DEPOSIT: Notwithstanding the provisions of Section L and M of the Summary to this Lease, upon execution of Exhibit D ("Punch List Agreement"), Tenant shall increase: (i) the Prepaid Rent to an amount equal to the first month's Base Monthly Rent; and, (ii) the Security Deposit to an amount equal to the last month's Base Monthly Rent, as those amounts are finally calculated as provided for in Paragraph 2 of this First Addendum to Lease. 4. TENANT'S RIGHT OF FIRST NEGOTIATION FOR ADDITIONAL SPACE: A. GRANT AND RIGHT OF FIRST NEGOTIATION: Landlord hereby grants to Tenant a Right of First Negotiation regarding the leasing of the "First Negotiation Space", which consists of the portion of the Building which is identified and described on Exhibit "A" as the First Negotiation Space, being approximately 60,633 square feet of rentable space commonly known as 2630 Orchard Parkway, San Jose, California on the terms contained in this Paragraph. B. NEGOTIATION NOTICE: If Landlord proposes to lease all or part of the First Negotiation Space at any time after the Effective Date of this Lease and before the expiration or earlier termination of this Right of First Negotiation, Landlord shall notify Tenant in writing (the "Negotiation Notice") of the following basic business terms upon which Landlord would be willing to lease the First Negotiation Space; (i) the portion of the First Negotiation Landlord propose to lease (the "Offered Space"), (ii) the term of the proposed lease; (iii) the Page Two tenant improvements Landlord is willing to construct or that it will require be constructed and the contribution Landlord is willing to make to pay for such tenant improvements; (iv) the rent for the terms of the lease or formula to be used to determine such rent, and (v) any other material business terms Landlord elects to specify. C. NEGOTIATION PERIOD: Tenant shall have fifteen (15) days (the "Negotiation Period") from the Negotiation Notice within which to accept the terms specified in the Negotiation Notice or to conduct negotiations with Landlord regarding Tenant's leasing of the Offered Space, whether on the terms set forth in Landlord's notice or otherwise. D. DUTIES DURING NEGOTIATION PERIOD: During the Negotiation Period, Landlord and Tenant will negotiate in good faith in an attempt to agree on a lease of the Offered Space. Neither Landlord nor Tenant shall be bound to agree to or accept any terms and conditions for such lease except those which each party, in its sole discretion, wishes to agree to. "Good Faith" in such negotiations does not require either party to make concessions to the other party's position, but only requires that each party give the other party a reasonable opportunity, within the Negotiation Period, to present and discuss the party's proposals. Landlord is not bound to agree to any or all of the terms set forth in the Negotiation Notice if Tenant does not accept such terms without change and Landlord determines during negotiations that one or more of said terms is not in landlord's best interest. E. LANDLORD'S RIGHT TO LEASE ABSENT AGREEMENT: If Tenant does not accept the terms set forth in the Negotiation Notice and Landlord and Tenant do not reach agreement in writing on other terms for Tenant to lease the Offered Space within the Negotiation Period, Landlord thereafter shall have the right to offer the Offered Space to any third party, on such terms and conditions as Landlord may elect which are not more favorable to Tenant than those contained in Landlord's notice, provided such transaction is consummated within 180 days following the end of the Negotiation Period and in such case Landlord shall not thereafter, have any duty to further offer the Offered Space to Tenant. F. TERMINATION: The right granted to Tenant in this Paragraph is personal to Tenant, and may not be assigned by Tenant to any third party, either alone on in conjunction with an assignment of this Lease or a sublease of all or any part of the Premises. The rights granted to Tenant under this paragraph shall terminate upon the earliest of the following to occur: (i) the expiration or earlier termination of the Lease; (ii) any assignment by Tenant of its interest in this Lease; (iii) any subletting by Tenant of substantially all of the Premises for substantially all of the remainder of the Lease Term, (iv) the termination of this right by default as set forth in Subparagraph G below, or (v) as to any Offered Space, when the Negotiation Period ends without Tenant and Landlord reaching a written agreement for Tenant to lease the Offered Space. G. TERMINATION BY DEFAULT: The rights of Tenant under this Paragraph shall not be effective at any time when Tenant is in default under this Lease beyond any applicable cure period provided in this Lease. If Tenant, with the agreement of landlord, shall nevertheless cure such default, then the rights provided hereunder shall be reinstated, but any transaction to lease any or all of the First Negotiation Space entered into by Landlord during such period of default shall be valid and Tenant shall have no further Right of First Negotiation as to any such space leased by Landlord while Tenant is in default under this Subparagraph. H. NO RIGHT TO NEGOTIATION FOR RENEWAL OR EXTENSION SPACE: The right granted to Tenant by this Paragraph shall not arise on account of or in connection with the renewal or extension of the term of any then existing lease affecting all or any portion of the First Negotiation Space as with the existing tenant thereunder or its permitted assignee. 5. WARRANTY OF EXISTING CONDITION: Landlord shall provide the Premises to Tenant with all electrical, plumbing, HVAC, elevator, fire safety system, and roof systems in good working condition as of the Commencement Date. 6. COMMENCEMENT DATE: Landlord represents to Tenant, and Tenant acknowledges, that (i) Landlord's existing lease with Altera Corporation ("Altera") for the Premises expires on July 4, 1997, (ii) that Altera has a "hold-over" right to remain in the Premises for up to three (3) months after the July 4, 1997 date, and (iii) Altera must exercise its "hold-over" right and state the length Page Three of the hold-over period no later than February 1, 1997. Therefore, the Commencement Date of August 3, 1997 of this Lease shall be delayed for up to three (3) months beyond August 3, 1997 (i) only if Landlord provides written notice to Tenant that Altera has exercised its "hold-over" right, and (ii) the Commencement Date of this Lease shall be delayed a period equal to Landlord's written notice to Tenant stating the period of time of Altera's hold-over, which notice shall be delivered to Tenant no later than February 15, 1997. If Altera does not deliver possession of the Premises to Landlord on or before the date Altera is required to surrender, whether such date is July 4, 1997, or an extended date set by a hold-over notice, then the Commencement Date shall be delayed one day for every day beyond such required surrender date, during which Altera continues in possession of the Premises. Although the Commencement Date shall not be affected by the date of Substantial Completion of Interior Improvements under Exhibit "B" hereto, Landlord agrees that it will keep Tenant advised on negotiations for the construction contract with the Prime Contractor, that it will provide in such contract for penalties for delay in completion of construction by the Prime Contractor, and that Tenant will have the right to approve the Prime Construction Contract, approval not be unreasonably withheld or delayed, solely with regard to the timeline schedule for construction, the penalties which are to be charged to the Prime Contractor in the event of delay, and construction warranties. 7. PARKING. Notwithstanding anything to the contrary in the Lease without change Tenant as part of its Allocated Parking Stalls shall have the exclusive use of not more than fifteen (15) reserved parking spaces, at the immediate entrance to both Buildings constituting the Premises. Landlord shall in no event oversubscribe parking or grant any exclusive parking within the parking area designated for Tenant's exclusive use. 8. RULES AND REGULATION: Notwithstanding anything to the contrary in the Lease, Tenant shall not be required to comply with any new rule or regulation enacted solely by Landlord, unless the same applies nondiscriminatory to all occupants of the Project and does not unreasonably interfere with Tenant's use of the Premises, the Common Area, or Tenant's parking rights. 9. ALTERATIONS, ADDITIONS AND IMPROVEMENTS: Notwithstanding anything to the contrary in the Lease Form: A. LANDLORD'S CONSENT: If Landlord's consent is required for a Tenant's Alteration or any repair pursuant to Section 6.1.D of the Lease form, Landlord's approval shall not be unreasonably withheld or delayed. B. TENANT'S PROPERTY: All Tenant Trade Fixtures, and any other personal property installed in the Premises at Tenant's expense ("Tenant's Property") shall at all times remain Tenant's property and Tenant shall be entitled to all depreciation, amortization and other tax benefits with respect to all Tenant Alterations and Tenant's Property installed in the Premises at Tenant's expense. Tenant may remove Tenant's Property from the Premises at any time, provided Tenant repairs all damage caused by such removal. C. INSURANCE: Tenant shall have no obligation to insure any property in the Premises other than Tenant's Property and Tenant Alterations from fire or any other casualty, and Tenant shall be entitled to all insurance proceeds and condemnation awards and settlements payable with respect to Tenant's Property. 10. COMMON OPERATING EXPENSES: Notwithstanding anything to the contrary in the Lease, in no event shall Common Operating Expenses include nor shall Tenant have any other obligation to perform or to pay directly, or to reimburse Landlord for, all or any portion of the following repairs, maintenance, improvements, replacements, premiums, claims, losses, liabilities, fees, charges, costs and expenses (collectively, "Costs"): A. CAPITAL IMPROVEMENTS: Costs for capital improvements, except to the except to the extent provided in Section 5.4, and as a result of operations due to the performance of Sections 6.1 and 8.2 of the Lease. B. REIMBURSABLE EXPENSES: Costs for which Landlord has a right of reimbursement from others. Page Four C. REAL ESTATE TAXES: Real Property Taxes (i) on land and improvements not reserved for Tenant's exclusive or nonexclusive use, (ii) on improvements reserved for the exclusive use of other occupants of the Project, (iii) for Hazardous Materials remediation or removal (except to the extent provided otherwise in Section 7.2), any interest on taxes or penalties resulting from Landlord's failure to pay Real Property Taxes, and (iv) in any tax year the amount of any assessment payable in installments in excess of the installment payable for such tax year. D. LEASING COSTS: Fees, commissions, attorneys' fees, costs or other disbursements incurred in connection with the negotiation of this Lease or any negotiations or disputes with any other occupant of the Project, and costs arising from the violation by Landlord or any occupant of the Project (other than Tenant) of the terms and conditions of any lease or other agreement. E. MANAGEMENT: Wages, salaries, compensation, and labor burden for any employee of Landlord (except as provided in subpart 8.2B.(iv) of the Lease Form and any management fee in excess of the amount described in Section 8.2.C of the Lease Form. I. DUPLICATION: Costs and expenses for which Tenant reimburses Landlord directly or which Tenant pays directly to a third person. J. STRUCTURAL: Costs for maintenance, repair or replacement to or of the structural elements of the Buildings. 11. REAL PROPERTY TAXES: Any and all rebates on account of Real Property Taxes paid or reimbursed to Landlord by Tenant covering any period of the Lease Term under the provisions of this Lease shall belong to Tenant, and Landlord will, on the request of Tenant, execute any receipts, assignments, or other acquaintances that may be necessary in order to secure the recovery of the rebates, and will pay over to Tenant any rebates that may be received by Landlord. Tenant shall have the right to contest any Real Property Tax payable by Tenant hereunder, provided that during any such contest, (i) Tenant shall take any such action required to protect the Project from a tax lien resulting from such contest, (ii) Tenant shall promptly pay any Real Property Tax payable as a consequence of such contest, and (iii) Tenant may not withhold payment of any Real Property Tax pending completion of such contest. 12. ASSIGNMENT AND SUBLETTING: For the purpose of this Lease, the sale of Tenant's capital stock, through any public exchange, shall not be deemed an assignment, subletting, or any other transfer of the Lease or the Premises. 13. REASONABLE EXPENDITURES: Notwithstanding anything to the contrary in the Lease, any expenditure by a party permitted or required under the Lease, for which such party is entitled to demand and does demand reimbursement from the other party, shall be limited to the fair market value of the goods and services involved, shall be reasonably incurred, and shall be substantiated by documentary evidence available for inspection and review by the other party or its representative during normal business hours. 14. LANDLORD'S ENTRY OF PREMISES: Notwithstanding anything to the contrary in the Lease any entry by Landlord and Landlord's Agents shall not impair Tenant's operations more than reasonably necessary. During any such entry, Landlord and Landlord's Agents shall at all times be accompanied by Tenant and shall conform to Tenant's reasonable security requirements. 15. LANDLORD'S AUTHORITY TO EXECUTE: Landlord warrants and represents to Tenant that Landlord has the full right, power and authority to enter into this Lease and has obtained all necessary consents and approvals from its partners, officers, board of directors or other members required under the documents governing is affairs in order to consummate the Lease contemplated hereby. The persons executing this Lease on behalf of Landlord have the full right, power and authority so to do and affirm the foregoing warranty on behalf of Landlord and on their own behalf. 16. OPTION TO EXTEND LEASE TERM: Landlord hereby grants to Tenant one option to extend the Lease Term for a five (5) year term on the following terms and conditions: Page Five A. Tenant must give Landlord notice in writing of its exercise of the option in question no earlier than one hundred eight (180) days and no later than one hundred twenty (120) days before the date the Lease Term would end but for said exercise. B. Tenant may not extend the Lease Term pursuant to any option granted by this paragraph if Tenant is materially in default beyond any applicable cure period as of the date of exercise of the option in question or as of the date this Lease would have been terminated but for said exercise. C. All terms and conditions of this Lease shall apply during the option period, except that the Base Monthly Rent for the option period shall be determined as provided in Paragraph D. D. The Base Monthly Rent for the Option Period shall be the greater of (i) one hundred percent (100%) of the Base Monthly Rent due the last month of the previous Lease Term, or (ii) one-hundred percent (100%) of the then fair market monthly rent determined as of the commencement of the option period in question based upon like buildings with like improvements in the San Jose area within the boundaries of Highways 237,101 and 880. If the parties are unable to agree upon the fair market monthly rent for the Premises for the option period in question at least seventy-five (75) days prior to the commencement of the option period in question, then the fair market monthly rent shall be determined by appraisal conducted pursuant to subparagraph E. E. In the event it becomes necessary to determine by appraisal the fair market rent of the Premises for the purpose of establishing the Base Monthly Rent during the Option Period, then such fair market monthly rent shall be determined by three (3) real estate appraisers, all of whom shall be members of the American Institute of Real Estate Appraisers with not less than five (5) years experience appraising real property (other than residential or agricultural property) located in Santa Clara County, California, in accordance with the following procedures: (1) The party demanding an appraisal (the "Notifying Party") shall notify the other party (the "Non-Notifying Party") thereof by delivering a written demand for appraisal, which demand, to be effective, must give the name, address, and qualifications of an appraiser selected by the Notifying Party. Within ten (10) days of receipt of said demand, the Non-Notifying Party shall select its appraiser and notify the Notifying Party, in writing, of the name, address, and qualifications of an appraiser selected by it. Failure by the Non-Notifying Party to select a qualified appraiser within said ten (10) day period shall be deemed a waiver of its right to select a second appraiser on its own behalf and the Notifying Party shall select a second appraiser on behalf of the Non-Notifying Party within five (5) days after the expiration of said ten (10) day period. Within ten (10) days from the date the second appraiser shall have been appointed, the two (2) appraisers so selected shall appoint a third appraiser. If the two appraisers fail to select a third qualified appraiser, the third appraiser shall be selected by the American Arbitrations Association or if it shall refuse to perform this function, then at the request of either Landlord or Tenant, such third appraiser shall be promptly appointed by the then Presiding Judge of the Superior Court of the State of California for the County of Santa Clara. (2) The three (3) appraisers so selected shall meet in San Jose, California, not later than twenty (20) days following the selection of the third appraiser. At said meeting the appraisers so selected shall attempt to determine the fair market monthly rent of the Premises for the option period in question (including the timing and amount of periodic increases). (3) If the appraisers so selected are unable to complete their determinations in one meeting, they may continue to consult at such times as they deem necessary for a fifteen (15) day period from the date of the first meeting, in an attempt to have at least two (2) of them agree. If, at the initial meeting or at any time during said fifteen (15) day period, two (2) or more of the appraisers so selected agree on the fair market rent of the Leased Premises, such agreement shall be determinative and binding on the parties hereto, and the agreeing appraisers shall, in simple letter form executed by the agreeing appraisers, forthwith notify both Landlord and Tenant of the amount set by such agreement. Page Six (4) If two (2) or more appraisers do not so agree within said fifteen (15) day period, then each appraiser shall, within five (5) days after the expiration of said fifteen (15) day period, submit his independent appraisal in simple letter form to Landlord and Tenant stating his determination of the fair market rent of the Premises for the option period in question. The parties shall then determine the fair market rent for the Premises by determining the average of the fair market rent set by each of the appraisers. However, if the lowest appraisal is less than eighty-five percent (85%) of the middle appraisal then such lowest appraisal shall be disregarded and/or if the highest appraisal is greater than one hundred fifteen percent (115%) of the middle appraisal then such highest appraisal shall be disregarded. If the fair market rent set by any appraisal is so disregarded, then the average shall be determined by computing the average set by the other appraisals that have not been disregarded. (5) Nothing contained herein shall prevent Landlord and Tenant from jointly selecting a single appraiser to determine the fair market rent of the Premises, in which event the determination of such appraisal shall be conclusively deemed the fair market rent of the Premises. (6) Each party shall bear the fees and expenses of the appraiser selected by or for it, and the fees and expenses of the third appraiser (or the joint appraiser if one joint appraiser is used) shall be borne fifty percent (50%) by Landlord and fifty percent (50%) by Tenant. 17. AMORTIZATION OF LARGE EXPENSES: Any expenses of repair or replacement of a single item which are the responsibility of Landlord under the Lease, which Landlord has the right to pass through to Tenant as Common Operating Expenses or other form of Additional Rent, and which exceed, on any single item, the sum of $50,000.00, shall be amortized over a time period to be selected in Landlord's sole discretion, to be exercised in good faith, and shall be charged to Tenant as Common Operating Expenses on such an amortized basis. 18. EXTERIOR PLATE GLASS: Notwithstanding anything to the contrary in the Lease, Landlord shall be solely responsible to pay any necessary and reasonable expenses of replacement of any exterior plate glass which breaks as a direct result of a structural defect in the Building. 19. FAILURE TO INSURE: If a loss is not covered by insurance due to a party's failure to obtain such insurance in breach of said party's obligations under this Lease, then the party which should have been insured shall have the benefit of the above release notwithstanding the lack of insurance, but solely to the extent that said party would have been released had the party with the duty to insure performed that duty. 20. DAMAGE TO PREMISES: If, because of damage to the Premises, Landlord has the right to terminate the Lease (a) under Paragraph 11.2A of this Lease, or (b) under Paragraph II. 2D (I) of this Lease solely on the ground that the cost of restoration are not reasonable within the meaning of said Paragraph 11.2D(I); then in either case Tenant shall have the option to avoid such termination and have the Lease continue if Tenant fulfills the conditions set forth in this Paragraph. The option shall be exercised by written notice to Landlord that Tenant will pay for all of the costs and expenses of said restoration to the extent that same are not covered and paid by insurance. Such notice must be given within ten (10) days after Landlord has given Tenant notice of termination under such Paragraphs, and if such notice is not given within the specified time, such option shall be of no further force or effect. If Tenant exercised such an option, then Landlord shall give Tenant written notice of Landlord's estimate of (a) the costs and expenses of restoration, and (b) the Landlord's anticipated insurance proceeds, if any. Within thirty (30) days of Tenant's receipt of this notice, Tenant shall deposit with Landlord the amount of the difference stated in Landlord's written estimate between Landlord's insurance proceeds and the costs and expenses of restoration. If Tenant does not deposit such funds within the specified time, then Landlord's notice of termination shall be deemed valid as originally given, and Tenant's exercise of the option granted in this Paragraph shall be null and void. When the Premises have been rebuilt, Landlord shall account to Tenant for the actual costs and expenses of rebuilding and the actual insurance proceeds. Within thirty (30) days of Landlord's accounting, Tenant shall pay to Landlord any further sum necessary to fully reimburse Landlord for the difference between its actually recovered insurance proceeds and its actual costs of construction, or Landlord shall reimburse the Tenant for any amount paid by Tenant in excess of the difference between Landlord's actually recovered insurance proceeds and its actual costs of construction, as the case may be Page Seven 21. QUIET POSSESSION: Tenant's right to quiet possession of the Premises shall not be disturbed so long as Tenant is not in default and performs all of its obligations under this Lease, unless this Lease is otherwise terminated pursuant to its terms. 22. HAZARDOUS MATERIALS: No expenses of investigating, responding to, or removing Hazardous Materials from the Property shall be recoverable by Landlord from Tenant, as a Common Operating Expense or otherwise, if Tenant shows by clear and convincing evidence that (a) the expenses were incurred as a result of contamination caused solely by one of the other tenants of the Property; or (b) the expenses were incurred because of contamination of the Property which took place before the earlier of Tenant's first date of occupancy of the Premises or the Commencement Date. In the event of contamination of the Property with Hazardous Materials which is not caused by Tenant or its Agents, but as to which Tenant is not exculpated under (a) and (b) above, Tenant shall be liable for all of the expenses for any contamination, release, or spill which takes place within the Premises, but Tenant shall be liable only for Tenant's Share of such expenses for such contamination which takes place outside the Premises. LANDLORD: TENANT: SAN JOSE ACQUISITION CO., L.L.C. QUICKTURN DESIGN SYSTEMS, INC. A DELAWARE LIMITED LIABILITY COMPANY A DELAWARE CORPORATION BY: ARGO PARTNERSHIP, L.P., ITS GENERAL PARTNER BY: /s/ Ray Ostby RAY OSTBY BY: ARGO MANAGEMENT COMPANY, L.P. ITS GENERAL PARTNER TITLE: CHIEF FINANCIAL OFFICER BY: O'CONNER CAPITAL PARTNERS, L.P., ITS GENERAL PARTNER DATE: 12/16/96 BY: 0'CONNER CAPITAL INCORPORATED, ITS GENERAL PARTNER BY: /s/ K. J. Artingstall K. J. ARTINGSTALL VICE PRESIDENT BY: ARGO PARTNERSHIP II, L.P., ITS MANAGER BY: ARGO II MANAGEMENT COMPANY, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL PARTNERS II, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL II INCORPORATED ITS GENERAL PARTNER BY: /s/ K. J. Artingstall K. J. ARTINGSTALL VICE PRESIDENT DATE: 12/18/96 SITE PLAN EXHIBIT A [Graphical representation of site plan of leased premises located at 2610 Orchard Parkway and 55 W. Trimble Road, San Jose, CA 95131-1013.] EXHIBIT B INTERIOR IMPROVEMENT AGREEMENT THIS IMPROVEMENT AGREEMENT is made part of that Lease dated December 6, 1996, (the "Lease") by and between SAN JOSE ACQUISITION CO., L.L.C., ("Landlord"), and QUICKTURN DESIGN SYSTEMS, INC. ("Tenant"). Landlord and Tenant agree that the following terms are part of the Lease: 1. PURPOSE OF IMPROVEMENT AGREEMENT: The purpose of this Improvement Agreement is to set forth the rights and obligations of Landlord and Tenant with respect to the construction of Interior Improvements within the Premises prior to the Commencement Date. 2. DEFINITIONS: As used in this Interior Improvement Agreement, the following terms shall have the following meanings, and terms which are not defined below, but which are defined in the Lease and which are used in this Interior Improvement Agreement, shall have the meanings ascribed to them by the Lease: A. APPROVED SPECIFICATIONS: The term "Approved Specifications" shall mean those specifications for the Interior Improvements to be constructed by Landlord which are described by Exhibit "C" to the Lease. B. ARCHITECT: Design and Engineering Systems. C. INTERIOR IMPROVEMENTS: The term "Interior Improvements" shall mean all interior improvements to be constructed by Landlord in accordance with the Approved Specifications (e.g., HVAC equipment and distribution, transformer and power distribution, partitions, floor, wall, and window covering, lighting fixtures), whether within or outside the exterior Premise walls. D. INTERIOR IMPROVEMENT COSTS: The term "Interior Improvement Costs" shall mean the following: (i) the total amount due pursuant to the general construction contract entered into by Landlord to construct the Interior Improvements; (ii) the cost of all governmental approvals required as a condition to the construction of the Interior Improvements (including all construction taxes imposed by the City of San Jose) in connection with the issuance of a building permit for the Interior Improvements; (iii) all utility connection or use fees; (iv) fees of Architect or engineers for services rendered in connection with the design and construction of the Interior Improvements; and (v) the cost of payment and performance bonds obtained by Landlord or Prime Contractor to assure completion of the Interior Improvement. Notwithstanding the foregoing, in no event shall Interior Improvement Costs include, and Landlord shall be solely responsible to pay: (1) costs for which Landlord actually recovers from a third party (e.g., insurers, warrantors, tortfeasors), (2) cost for any work not shown on the Final Interior Improvement Plans as the same may be modified by Change Orders approved in writing by Tenant, or (3) construction management fees on that portion of the Interior Improvement Costs paid out of any portion of the Total Tenant Improvement Allowance. However, Landlord may charge a construction management fee, not to exceed 3%, on any Tenant contribution to the payment of Interior Improvement Costs. The parties acknowledge that the City of San Jose imposes certain taxes as a condition to the issuance of building permits in certain circumstances, including the "Building and Structure Construction Tax" imposed by Chapter 4.46 of the City of San Jose Municipal Code (the "BSC Tax") and the "Commercial-Residential-Mobile Home Park Building Tax" imposed by Chapter 4.47 of the City of San Jose Municipal Code (the "CRM Tax"). The parties further acknowledge that the rate for these two taxes is higher for a structure designed or intended to be used for "industrial purposes". However, the parties acknowledge and agree that (i) an additional BSC Tax will be due upon the issuance of a building permit for all Interior Improvements if the City of San Jose determines that the Interior Improvements are intended for "industrial purposes" or (ii) a BSC Tax and a CRM Tax based on the value of the Interior Improvements, plus an additional BSC Tax and a CRM Tax based on the value of the shell, will be due if the City of San Jose determines that the Building is intended for "commercial purposes", and (iii) any of such taxes that must be paid in order to obtain building permits for the Interior Improvements shall be "Interior Improvement Costs". E. SUBSTANTIAL COMPLETION AND SUBSTANTIALLY COMPLETE: The terms "Substantial Completion" and "Substantially Complete" shall each mean the date when all the EXHIBIT B Page Two following have occurred with respect to the Interior Improvements in question: (i) the construction of the Interior Improvements in question has been substantially completed in accordance with the requirements of this Lease, except for Punchlist items which do not unreasonably interfere with Tenant's use of the Premises for Tenant's intended purpose; (ii) the Architect responsible for preparing the plans shall have executed a certificate or statement representing that the Interior Improvements in question have been substantially completed in accordance with the plans and specifications therefor; and (iii) the Building Department of the City of San Jose or any other approvals required by applicable Law has completed its final inspection of such improvements and has "signed off' the building inspection card approving such work as complete. 3. SCHEDULE OF PERFORMANCE: Set forth in this paragraph is a schedule of certain critical dates relating to Landlord's and Tenant's respective obligations regarding the construction of the Interior Improvements (the "Schedule of Performance"). Landlord and Tenant shall each be obligated to use reasonable efforts to perform their respective obligations within the time periods set forth in the Schedule of Performance and elsewhere in this Interior Improvement Agreement. The Schedule of Performance is as follows: Action Responsible Items Due Date Party ---------- -------- ------------ A. Delivery to March 1, 1997 Tenant Landlord of Tenant's Interior Requirements B. Delivery to Within ten (10) business days Landlord Tenant of after delivery to Landlord of Preliminary conceptual plans for the Interior Interior Improvements. Improvement Plans C. Approval by Within five (5) business Tenant Tenant of days after Tenant receives Preliminary Preliminary Interior Plans. Interior Plans D. Delivery to Within fifteen (15) business Landlord Tenant of days after approval of the. Final Preliminary Interior Plans Interior Plans E. Approval by Within two (2) business days after Tenant Tenant of Tenant receives Final Interior Plans Final Interior Plans F. Commence- Within five (5) days after Landlord ment of issuance of all necessary construction governmental approvals of Interior Improvement Page Three G. Substantial Within sixty (60) days after Landlord Completion issuance of building permit for of Interior the Interior Improvements, subject Improvements to any delay for specialized improvements or long lead items. 4. CONSTRUCTION OF INTERIOR IMPROVEMENTS: Landlord shall construct the Interior Improvements in accordance with the following: A. DEVELOPMENT AND APPROVAL OF PRELIMINARY INTERIOR PLANS: On or before the due date specified in the Schedule of Performance, Tenant shall deliver to Landlord a proposed floor plan identifying its requirements for the Interior Improvements that is consistent with the Approved Specifications ("Tenant's Interior Requirements"). On or before the due date specified in the Schedule of Performance, Landlord shall and deliver to Tenant for its review and approval preliminary plans for the Interior Improvements which are consistent with and conform to Tenant's Interior Requirements and the Approved Specifications (the "Preliminary Interior Plans"). On or before the due date specified in the Schedule of Performance, Tenant shall either approve such plans or notify Landlord in writing of its specific objections to the Preliminary Interior Plans. If Tenant so objects, Landlord shall revise the Preliminary Interior Plans to address such objections in a manner consistent with the parameters for the Interior Improvements set forth in this Improvement Agreement and the Approved Specifications and shall resubmit such revised Preliminary Interior Plans as soon as reasonably practicable to Tenant for its approval. When such revised Preliminary Interior Plans are resubmitted to Tenant, it shall either approve such plans or notify Landlord of any further objections in writing within two (2) business days after receipt thereof. If Tenant has further objections to the revised Preliminary Interior Plans, the parties shall meet and confer to develop Preliminary Interior Plans that are acceptable to both Landlord and Tenant within five (5) business days after Tenant has notified Landlord of its second set of objections. In the event Tenant and Landlord do not resolve all of Tenant's objections within such five (5) business day period, Landlord and Tenant shall immediately cause Landlord's Architect to meet and confer with Tenant's architect or construction consultant, who shall apply the standards set forth in this Improvement Agreement to resolve Tenant's objections and incorporate such resolution into the Preliminary Interior Plans, which process Landlord and Tenant shall cause to be completed within five (5) business days after the conclusion of the five (5) business day period referred to in the immediately preceding sentence. B. DEVELOPMENT AND APPROVAL OF FINAL INTERIOR PLANS: Once the Preliminary Interior Plans have been approved by Landlord and Tenant (including all changes made to resolve Tenant's objections approved by Landlord's Architect and Tenant's representative or construction consultant pursuant to subparagraph 4A), Landlord shall complete and submit to Tenant for its approval final working drawings for the Interior Improvements by the due date specified in the Schedule of Performance. Tenant shall approve the final plans for the Interior Improvements or notify Landlord in writing of its specific objections by the due date specified in the Schedule of Performance. If Tenant so objects, the parties shall confer and reach agreement upon final working drawings for the Interior Improvements within five (5) business days after Tenant has notified Landlord of its objections. In the event Tenant and Landlord do not resolve all of Tenant's objections within such five (5) business day period, Landlord and Tenant shall immediately cause the Architect to meet and confer with Tenant's representative or construction consultant, who shall apply the standards set forth in the Improvement Agreement to resolve Tenant's objections and incorporate such resolution into the Final Interior Plans, which process Landlord and Tenant shall cause to be completed within five (5) business days after the conclusion of the five (5) business day period referred to in the immediately preceding sentence. The final working drawings so approved by Landlord and Tenant (including all changes made to resolve Tenant's objections approved by the Architect and Tenant's representative or construction consultant) are referred to herein as the "Final Interior Plans". C. STANDARD FOR CONSENT: Landlord's and Tenant's approval of the Tenant Interior Requirements, the Preliminary Interior Plans, the Final Interior Plans, the Final Improvement Cost Budget, and any modifications thereto or to the Schedule of Performance shall not be unreasonably withheld or delayed, provided, however, that: Page Four 1. Landlord may withhold its approval in its sole discretion to any work, which adversely affects the building structure, roof or building service equipment, is visible from the exterior of the premises and is not aesthetically in keeping with the Project, and 2. Tenant may withhold is approval in its sole discretion to any work, which causes the Final Improvement Cost Budget to exceed the Total Landlord's Allowance by more than $50,000.00, delays the expected Substantial Completion Date more than 60 days, or modifies the Interior Improvements within the demising wall of the Premises. Any disapproval by Landlord or Tenant shall be accompanied by a written statement of the disapproved item, the reasons for disapproval, and the specific changes required to make the item acceptable. If a party's written notice of disapproval is not delivered in accordance with the time limits and standards set forth in this Agreement, such disapproval shall be deemed not given. D. BUILDING PERMIT: As soon as the Final Interior Plans have been approved by Landlord and Tenant, Landlord shall apply for a building permit for the Interior Improvements, and shall diligently prosecute to completion such approval process. E. CONSTRUCTION CONTRACT: Landlord and Tenant shall cooperate to cause the Interior Improvements to be constructed by a general contractor who is engaged by Landlord in accordance with the procedures set forth in subparagraph 4D(1) hereof. (1) The job of constructing the Interior Improvements shall be offered for "competitive bid", on a fixed price basis, to three (3) general contractors selected by Landlord and approved by Tenant. The construction contract in form reasonably acceptable to Tenant shall be awarded to the bidder submitting the lowest bid for the job. Landlord shall submit to Tenant a list of general contractors acceptable to Landlord to whom the job may be bid, and Tenant shall notify Landlord within three (3) business days after receipt of such list of its objection to any proposed contractor. Tenant's failure to object within such period of time shall be deemed to be its approval of all bidders on the list so submitted by Landlord. If the lowest bid resulting from such competitive bidding process indicates that the Interior Improvement Costs will exceed $1,020,705.00 Dollars ($7.00 per gross leasable square foot of the Premises), Landlord shall promptly notify Tenant, in writing, to that effect, and Tenant shall have the right to propose modifications to the Final Interior Plans within five (5) business days after Tenant's receipt of Landlord's notice, subject to Landlord's approval of such changes, for the purpose of reducing the Interior Improvement Costs. Such revision of the final Interior Plans shall be completed as expeditiously as possible; provided, however, that (i) the job shall nonetheless be awarded to the low bidder whose price shall be adjusted based upon the changes requested by Tenant and approved by Landlord made to the Final Interior Plans; and (ii) if Tenant should choose to exercise its right to modify the final Interior Plans for the purpose of reducing the Interior Improvement costs, any delay resulting from the failure by Tenant to timely exercise its right to do so shall be a delay caused by Tenant for purposes of paragraph 7 hereof. (2) Landlord and Tenant shall use their best efforts to approve the general contractor and all subcontractors all major material suppliers and the form of contract for such parties so that the construction contract may be executed as soon as possible. F. COMMENCEMENT OF INTERIOR IMPROVEMENTS: On or before the due date specified in the Schedule of Performance, Landlord shall commence construction for the Interior Improvements and shall diligently prosecute such construction to completion, using all reasonable efforts to achieve Substantial Completion of the Interior Improvements by the due date specified in the Schedule of Performance. 5. PAYMENT OF INTERIOR IMPROVEMENT COSTS: Landlord and Tenant shall have the following obligations with respect to the payment of Interior Improvement Costs: A. Landlord shall be obligated to pay an amount equal to the Tenant Improvement Allowance (including the First Level Tenant Improvement Allowance and so much of the Second Level Tenant Improvement Allowance as Tenant shall elect to utilize) as provided for in Paragraph 1 of the First Addendum To Lease for the Payment of Interior Improvement costs. If the total of Interior Improvement Costs exceeds the amount of Landlord's required Page Five contribution, Tenant shall be obligated to pay the entire amount of such excess either in cash or, if the Second Level Tenant Improvement Allowance has not been depleted, from such portion of the Second Level Tenant Improvement Allowance as Tenant shall elect to utilize. In the event that Tenant elects to utilize all or a portion of the Second Level Tenant Improvement Allowance for these purposes, then the Base Monthly Rent shall be increased as provided for in Paragraph 2 of the First Addendum to Lease. In no event shall Landlord be obligated to pay for Interior Improvement Costs in excess of the allowances provided for in Paragraph 1 of the First Addendum To Lease. If Tenant becomes obligated to contribute toward paying Interior Improvement Costs pursuant to this subparagraph 5A, then Landlord shall estimate the amount of such excess prior to commencing construction of the Interior Improvements and Tenant shall pay to Landlord a proportionate share of each progress payment due to the general contractor which bears the same relationship to the total amount of the progress payment in question as the amount Tenant is obligated to contribute to the payment of Interior Improvement Costs bears to the total estimated Interior Improvement Costs approved by Tenant at the time the final Improvement Plans are approved. Tenant shall pay Tenant's share of any progress payment to Landlord within five (5) business days after receipt of a statement therefor from landlord. At the time the final accounting is rendered by Landlord pursuant to subparagraph 5C hereof, there shall be an adjustment between Landlord and Tenant such that each shall only be required to contribute to the payment of Interior Improvement Costs in accordance with the obligations set forth in this subparagraph 5A, which adjustment shall be made within five (5) days after Landlord notifies Tenant of the required adjustment. If Tenant is required to make a payment to Landlord, Tenant shall make such payment even if Tenant elects to audit the statement submitted by Landlord pursuant to subparagraph 5C. In the event Tenant's audit discloses that an overpayment or underpayment was made by Tenant, there shall be an adjustment between Landlord and Tenant as soon as reasonably practicable such that each shall only be required to contribute to the payment of costs in accordance with the obligations set forth in this subparagraph 5A. B. If Tenant fails to pay any amount when due pursuant to this paragraph 5, then (i) Landlord may (but without the obligation to do so) advance such funds on Tenant's behalf, and Tenant shall be obligated to reimburse Landlord for the amount of funds so advanced on its behalf, and (ii) Tenant shall be liable for the payment of a late charge and interest in the same manner as if Tenant had failed to pay Base Monthly Rent when due as described in paragraph 3.4 of the Lease. Any amounts paid to Landlord by Tenant pursuant to this subparagraph shall be held by Landlord as Tenant's agent, for disbursal to the general contractor in payment for work costing in excess of Landlord's required contribution. C. When the Interior Improvements are Substantially Completed, Landlord shall submit to Tenant a final and detailed accounting of all Interior Improvement Costs paid by Landlord, certified as true and correct by Landlord's financial officers. Tenant shall have the right to audit the books, records, and supporting documents of Landlord to the extent necessary to determine the accuracy of such accounting during normal business hours after giving Landlord at least two (2) days prior written notice. Tenant shall bear the cost of such audit, unless such audit discloses that Landlord has overstated the total of such costs by more than two percent (2%) of the actual amount of such costs, in which event Landlord shall pay the cost of Tenant's audit. Any such audit must be conducted, if at all, within ninety (90) days after Landlord delivers such accounting to Tenant. 6. CHANGES TO APPROVED PLANS: Once the Final Interior Plans have been approved by Landlord and Tenant, neither shall have the right to order extra work or change orders with respect to the construction of the Interior Improvements without the prior written consent of the other which consent shall be given or withheld in accordance with Section 4.C above. All extra work or change orders requested by either Landlord or Tenant shall be made in writing, shall specify any added or reduced cost and/or construction time resulting therefrom, and shall become effective and a part of the Final Interior Plans once approved in writing by both parties. If a change order requested by Tenant results in an increase in the cost of constructing the Interior Improvements, Tenant shall pay the amount of such increase caused by the change order requested by Tenant at the time the change order is approved by both Landlord and Tenant if and to the extent such change order causes the Interior Improvement Costs to exceed Landlord's required contribution thereto described in subparagraph 5A. If a change order results in an Page Six increase in the amount of construction time needed by Landlord to complete the Interior Improvements, paragraph 7 hereof may apply. 7. DELIVERY OF POSSESSION AND PUNCH LIST AGREEMENT: As soon as the Interior Improvements are Substantially Completed, Landlord and Tenant shall together walk through the Premises and inspect all Interior Improvements so completed, using reasonable efforts to discover all uncompleted or defective construction in the Interior Improvements. After such inspection has been completed, each party shall sign an punch list agreement in the form attached to the Lease as EXHIBIT "D", which shall include a list of all "punch list" items which the parties agree are to be corrected by Landlord. As soon as such inspection has been completed and such agreement executed, Landlord shall use reasonable efforts to complete and/or repair such "punch list" items within thirty (30) days after executing the punch list agreement. Tenant's taking possession of any part of the Premises shall be deemed to be an acceptance by Tenant of Landlord's work of improvement in such part as complete and in accordance with the terms of the Lease except for the punch list items noted and latent defects that could not reasonable have been discovered by Tenant during its inspection of the Interior Improvements prior to completion of the punch list agreement. Notwithstanding anything contained herein, Tenant's obligation to pay the Base Monthly Rent and Additional Rent shall commence as provided in the Lease, regardless of whether Tenant completes such inspection or executes such punch list agreement. 8. STANDARD OF CONSTRUCTION AND WARRANTY: Landlord hereby warrants that the Interior Improvements shall be constructed in accordance with the Final Interior Plans (as modified by change orders approved by Landlord and Tenant), all Private Restrictions and all Laws, in a good and workmanlike manner, and all materials and equipment furnished shall conform to such final plans and shall be new and otherwise of good quality. The foregoing warranty shall be subject to, and limited by, the following: A. Once Landlord is notified in writing of any breach of the above-described warranty, Landlord shall promptly commence the cure of such breach and complete such cure with diligence at Landlord's sole cost and expense. B. Landlord's liability pursuant to such warranty shall be limited to the cost of correcting the defect or other matter in question. In no event shall Landlord be liable to Tenant for any damages or liability incurred by Tenant as a result of such defect or other matter, including without limitation damages resulting from any loss of business by Tenant or other consequential damages, provided Landlord promptly commences and diligently completes the cure of the breach of warranty after the delivery of written notice of the need for cure to Landlord. C. Notwithstanding anything contained herein, Landlord shall not be liable for any defect in design, construction, or equipment furnished which is discovered and of which Landlord receives written notice from Tenant after the first (1st) anniversary of the recordation of a notice of completion for the work of improvement affected by the defect. D. With respect to defects for which Landlord is not responsible pursuant to this Lease or with respect to repairs for which Landlord is responsible hereunder, but which Landlord fails to complete within thirty (30) days (or such longer time as is reasonably required to complete the repair) following delivery to Landlord of notice of the need for repairs, Tenant shall have the benefit of any construction or equipment warranties existing in favor of Landlord that would assist Tenant in correcting such defect and in discharging its obligations regarding the repair and maintenance of the Premises. Upon request by Tenant, Landlord shall inform Tenant of all written construction and equipment warranties existing in favor of Landlord which affect the Interior Improvements. Landlord shall cooperate with Tenant in enforcing such warranties and in bringing any suit that may be necessary to enforce liability with regard to any defect for which Landlord is not responsible pursuant to this paragraph so long as Tenant pays all costs reasonably incurred by Landlord in so acting. E. Landlord makes no other express or implied warranty with respect to the design, construction or operation of the Interior Improvements except as set that forth in this Lease. Page Seven F. EFFECT OF ACCEPTANCE OF INTERIOR IMPROVEMENTS: Notwithstanding anything to the contrary in the Lease or this Improvement Agreement, Tenant's acceptance of the Interior Improvements shall not waive the foregoing warranty. 9. EFFECT OF AGREEMENT: In the event of any inconsistency between this Improvement Agreement and the Lease, the terms of this Improvement Agreement shall prevail. LANDLORD: TENANT: SAN JOSE ACQUISITION CO., L.L.C. QUICKTURN DESIGN SYSTEMS, INC. A DELAWARE LIMITED LIABILITY COMPANY A DELAWARE CORPORATION BY: ARGO PARTNERSHIP, L.P., ITS GENERAL PARTNER BY: /s/ Ray Ostby RAY OSTBY BY: ARGO MANAGEMENT COMPANY, L.P. ITS GENERAL PARTNER TITLE: CHIEF FINANCIAL OFFICER BY: O'CONNER CAPITAL PARTNERS, L.P., ITS GENERAL PARTNER DATE: 12/16/96 BY: O'CONNER CAPITAL INCORPORATED, ITS GENERAL PARTNER BY: /s/ K. J. Artingstall K. J. ARTINGSTALL VICE PRESIDENT BY: ARGO PARTNERSHIP II, L.P., ITS MANAGER BY: ARGO II MANAGEMENT COMPANY, L.P., ITS GENERAL PARTNER BY: 0'CONNER CAPITAL PARTNERS II, L.P., ITS GENERAL PARTNER BY: O'CONNER CAPITAL II INCORPORATED ITS GENERAL PARTNER BY: /s/ K. J. Artingstall K. J. ARTINGSTALL VICE PRESIDENT DATE: 12/18/96 EXHIBIT "C" APPROVED SPECIFICATIONS (To be attached at a later date) Multi-Tenant Net Industrial EXHIBIT C PUNCH LIST Tenant: Page: Of Address: Job No.: Contractor: Walk-thru Date: Time: Room Description Compl. App. No./Name of Work Item Date By Orchard: Date: Tenant Date: Contractor: Date: Completion Approved: Date: EXHIBIT D SANTA CLARA COUNTY TITLE CO. 636 NO. FIRST ST. SAN JOSE CA 95112 DECLARATION OF COVENANTS, CONDITIONS AND RESTRICTIONS OF THE ORCHARD TECHNOLOGY PARK THIS DECLARATION is made on June 12 1978, by NEW ENGLAND MUTUAL LIFE INSURANCE COMPANY, a Massachusetts corporation (hereinafter called "Declarant") as owner of that certain real property situated in the City of San Jose, County of Santa Clara, State of California described in Exhibit "A" hereto which exhibit is by this reference incorporated herein as if fully set forth herein. ARTICLE 1 DEFINITIONS 1.1 Unless the context otherwise specifies or requires, the terms defined in this Article shall, for all purposes of this Declaration, have the meanings herein specified. 1.2 ARCHITECT: The term "Architect" shall mean a person holding a certificate to practice architecture in the State of California under authority of the Business and Professions Code of the State of California. 1.3 DECLARATION: The term "Declaration" shall mean this Declaration of Covenants, Conditions and Restrictions. 1.4 DEED OF TRUST: The term "Deed of Trust" or "Trust Deed" shall mean a mortgage as well as a deed of trust. 1.5 APPROVING AGENT: The term "Approving Agent" shall mean, in the following order or precedence: A. NEW ENGLAND MUTUAL LIFE INSURANCE COMPANY, a Massachusetts corporation whose present address is 501 Boylston Street, Boston, Massachusetts, (hereinafter referred to as "New England"), shall be the Approving Agent until New England shall have resigned as Approving Agent by executing a written resignation and causing an original of same to be recorded, and by giving written notice of such resignation to each Owner of record, as shown on the most recent county assessor's roll, of real property then subject to this Declaration; provided, New England may delegate its duties and rights as Approving Agent to a third party (the "Appointed Approving Agent") selected by New England, in New England's sole discretion, including without limitation Orchard Properties, a California corporation ("Orchard") by executing a written assignment, which shall have been accepted in writing by such Appointed Approving Agent, and causing an original of such assignment to be recorded and by giving written notice of such Assignment to each Owner of record as shown an the most recent county assessor's roll, of real property then subject to this Declaration, in which event such Appointed Approving Account shall be the Approving Agent until the first to occur of (1) such Appointed Approving Agent shall have resigned as Approving Agent by executing a written resignation EXHIBIT E and causing an original of same to be recorded and by giving written notice of such resignation to each owner of record, as shown on the most recent county assessor's roll, of real property then subject to this Declaration or (ii) Now England shall have removed such Appointed Approving Agent by delivering a "Notice of Removal" to the Appointed Approving Agent and causing an original of same to be recorded and by giving written notice of such removal to each owner of record, as shown on the most recent county assessor's roll, of real property then subject to this Declaration; provided, that in the event of such a resignation or removal of an Appointed Approving Agent, New England shall once again become Approving Agent with the right and power to appoint another Appointed Approving Agent, an herein a set forth. B. If at any time during which Now England shall serve as Approving Agent, or shall re-acquire the right to so serve pursuant to subparagraph A above, any corporation, association or trust controlled by New England or with which New England has been merged or consolidated or by which New England has been acquired, is certified of record by New England (hereinafter referred to as "New England's Successor") then New England's Successor shall be the Approving Agent provided it has been granted of record by New England the exclusive right to act as Approving Agent pursuant to this Declaration, in which event New England's Successor shall be the Approving Agent until New England's successor shall have resigned an Approving Agent by executing a written resignation and causing an original of same to be recorded, and by giving written notice of such resignation to each Owner of record, as shown on the most recent county assessor's roll, of real property then subject to this Declaration; and thereafter, C. Any association (whether or not incorporated) organized by the owners of sixty six and two-thirds percent (66-2/3%) of the land area (exclusive of portions dedicated to a public agency or authority for a public use) then subject to this Declaration for the purpose of acting as and assuming the functions of an Approving Agent, in which membership is available to all Owners and decisions are made on the basis of majority vote with one vote assigned for each square foot of land owned by each Owner, but only if the Owners organizing such association within not less than six (6) months from the date that New England or New England's Successor, as the case may be shall have ceased to be the Approving Agent, shall have (i) organized such association and (ii) executed and recorded a statement in the form of an amendment to this Declaration as described in Paragraph 8.2 Setting forth that such organization has been formed for the purpose of acting as Approving Agent pursuant to this Declaration and (iii) shall have, given written notice to -2- all owners of record of real property then subject to this Declaration that such association has been formed; and D. If New England, Orchard or New England's Successor, as the case may be, shall cease to be the Approving Agent and no organization is formed pursuant to Paragraph 1.5B satisfying all the conditions precedent contained therein within the specified time period, there shall be no Approving Agent for the remainder of the life of this Declaration. 1.6 STRUCTURES: The term "structure(s)" shall include all structures, buildings, outbuildings, sheds, fences and screening walls over three (3) feet in height, barriers or retaining walls. 1.7 MORTGAGEE: The term "Mortgagee" shall mean a beneficiary under or a holder of a Deed of Trust as well as a mortgagee under a mortgage, 1.8 THE ORCHARD TECHNOLOGY PARK: The term "The Orchard Technology Park" shall mean all of the real property described in Exhibit "A" hereto. 1.9 RESTRICTIONS: The term "Restrictions" shall mean the Covenants, Conditions and Restrictions set forth in this Declaration, as it may from time to time be amended, or supplemented. 1.10 OWNER: The term "Owner" shall mean and refer to any person owning a fee estate in the land, or any portion thereof, contained within the Orchard Technology Park, but excluding either (a) any person who holds such interest as security for the payment of an obligation or (b) any person holding a leasehold estate. 1.11 RECORD, RECORDED: the terms "record" or "recorded" shall mean, with respect to any document, the recordation of said document in the office of the County Recorder of the County of Santa Clara, State of California. 1.12 SIGN: The term "sign" shall mean any structures device or contrivance, electric or non-electric, and all parts thereof which are erected or used for advertising purposes upon or within which any poster, bill, bulletin, printing, lettering, painting, device or other advertising of any kind whatsoever is used, placed, posted or otherwise fastened or affixed to ground or structures. 1.13 STREETS: The term "street(s)" shall mean any publicly dedicated street highway, or other publicly dedicated thoroughfare within or adjacent to the Orchard Technology Park and shown on any recorded subdivision or parcel map, or record of survey, whether designated thereon as a publicly dedicated street, boulevard, place, drive, road, terrace, way, lane, circle or court, 1.14 VISIBLE FROM NEIGHBORING PROPERTY: The term "visible from neighboring property" shall mean, with respect to any given object, that such object is or would be visible -3- to a person six (6) feet tall having 20/20 vision and standing on any part of such neighboring property at an elevation no greater than the elevation of the base of the object being viewed. 1.15 PERSON: The term "person" shall mean an individual, group of individuals, corporation, partnership, trust, unincorporated business association or such other legal entity as the context in which such term is used may imply. 1.16 LOT: The term "lot" shall mean any parcel of land contained within the Orchard Technology Park as divided or subdivided on subdivision or parcel map(s) recorded in the official records of the Recorder of Santa Clara County, California, as they from time to time become currents. 1.17 FRONT: The term "front" shall mean, with respect to any structure, any wall facing a street. ARTICLE 2 PROPERTY SUBJECT TO THE ORCHARD TECHNOLOGY PARK RESTRICTIONS 2.1 GENERAL DECLARATION CREATING THE MUTUAL RESTRICTIONS: Declarant hereby declares that all of the real property located in the County of Santa Clara, State of California as described in Exhibit "A", which exhibit is attached hereto and incorporated herein by this reference, (sometimes hereinafter called the "Orchard Technology Park") is and shall be, conveyed, hypothecated, encumbered, leased, occupied, built upon or otherwise used, improved or transferred, in whole or in part, subject to the Restrictions and that all of said Restrictions, and all the covenants, conditions and agreements herein contained are declared and agreed to be in furtherance of a general plan for the subdivision, improvement and sale of said real property and are established for the purpose of enhancing and perfecting the value, desirability, and attractiveness of said real property and every part thereof. Declarant further declares that (a) that the Restrictions and each of the covenants, conditions and agreements herein contained are made for the direct, mutual and reciprocal benefit of each and every lot contained within the orchard Technology Park and that such Restrictions are and shall be mutual equitable servitudes burdening each lot for the benefit of all other lots within the Orchard Technology Park and (b) the Restrictions and each of the covenants, conditions and agreements herein contained shall be "covenants running with the land" burdening each lot within the Orchard Technology Park for the benefit of all other lots within the Orchard Technology Park, the burdens of which shall be binding upon each Owner, lessee, licensee, occupant or user of each lot within the Orchard Technology Park, his successors and assigns, for the benefit of each owner of all other lots within the Orchard Technology Park, his successors and assigns. -4- ARTICLE 3 --------- APPROVAL OF PLANS FOR STRUCTURES 3.1 APPROVAL REQUIRED: So long as there is a then serving Approving Agent, no structure shall be erected, placed, constructed, substantially remodeled, rebuilt or reconstructed on any land subject to this Declaration until the following procedures have been fully complied with and the Approving Agent has approved in writing the Preliminary Plans (as defined below) and the Final Plans (as defined below): A. The owner, or lessee, licensee, or other occupant of the lot to be improved or his authorized agent (the "Applicant") shall deliver to the Approving Agent preliminary plans and specifications (the "Preliminary Plans") in such form and containing such information an may be required by the Approving Agent for the following: (1) A site development plan showing the location of all proposed driveways, parking areas, walkways, landscaped areas, storage and refuse areas, and building area; (2) A landscaping plan for the particular lot; (3) A sign and lighting plan; (4) A building elevation plan showing dimensions, materials and exterior color schemes; (5) A grading plan. Such Preliminary Plans shall be submitted in writing in duplicate over the authorized signature of the Applicant. B. At such time as the Approving Agent shall have approved in writing the Preliminary Plans and prior to the submission of said Final Plans to the City of San Jose the Applicant shall submit to the Approving Agent complete and detailed final plans, specifications and working drawing (the "Final Plans") with regard to the proposed improvements, which Final Plans will be in such form as may then be required by the City of San Jose for review by said City and shall contain such additional information as may be required by the Approving Agent; provided, such Final Plans need not include detailing with regard to interior improvements such an interior partitioning walls. C. No such prior approval of any Preliminary Plans or Final Plans shall be required if there is no then serving Approving Agent to so approve such plans. Changes in approved Preliminary Plans or approved Final Plans which materially affect landscaping, signing, building size, placement or external appearance must be similarly submitted to and approved by the Approving Agent. 3.2 ADDITIONAL APPROVAL REQUIRED: So long as there is a then serving Approving Agent, no exterior surface of any structure or improvement existing on any lot subject to this -5- Declaration shall be painted, texturized or otherwise changed, no alterations, additions or changes of any type whatsoever shall be made to any landscaping placed on any lot subject to this Declaration, and no additions or alterations to any paved area on any lot subject to this Declaration shall be made until plans for such painting, alterations, additions or changes, including samples of colors, materials, landscaping plans, and/or plans and specifications with regard to paving, as the case may require, together with such other information as shall be required by the Approving Agent, shall have been submitted to the Approving Agent and the Approving Agent shall have approved in writing such requested change. 3.3 BASIS FOR APPROVAL: The Approving Agent shall have the right to disapprove any plans and specifications submitted hereunder for any reason (provided that such approval shall not be unreasonably withheld), including but not limited to any of the following: A. Failure to comply with any of the Restrictions; B. Failure to include information in such plans and specifications as may have been reasonably requested by the Approving Agent; C. Objection to the exterior design of the proposed structures or the appearance of materials to be used in the construction of any proposed structure which are found by the Approving Agent to be incompatible with existing structures in the Orchard Technology Park; D. Objections based upon the inadequacy of the number of onsite parking spaces considering (1) the contemplated use or future possible use of the structures proposed and (2) the availability of additional parking offsite. E. Objection to the location of any proposed structure upon any lot as it relates to other lots within the Orchard Technology Park; F. Objection to the grading plan for any lot; G. Objection to the color scheme, finish, proportions, style or architecture, height, bulk or appropriateness of any structure as they relate to other structures within the Orchard Technology Park; H. Objection to the landscaping materials an they relate to other landscaping materials then used or contemplated for use within the Orchard Technology Park; I. Any other matter which, in the judgment of the Approving Agent. would render the proposed structure or structures or use inharmonious with the general plan for improvement of Orchard Technology Park or with structures or landscaping then located upon or proposed to be located upon other lots or other properties within Orchard Technology Park. 3.4 APPROVAL: Upon approval by the Approving Agent of any plans and specifications submitted hereunder, a copy of -6- such plans and specifications as approved shall be deposited for permanent record with the Approving Agent, and a copy of ouch plans and specifications bearing such approval, in writing, shall be returned to the applicant submitting the same. 3.5 RESULT OF INACTION: if the Approving Agent fails either to approve or disapprove either the Preliminary Plans or the Final Plans within thirty (30) days after such Preliminary Plans or Final Plans, as the case may be, have been submitted to it, it shall be conclusively presumed that the Approving Agent has approved said Preliminary or Final Plans; provided, however, that if within said thirty (30) day period, the Approving Agent gives written notice of the fact that more time is required for the review of such plans, there shall be no presumption that the same are approved until the expiration of a reasonable period of time as set forth in said notice not to exceed thirty(30) days. Such presumption shall not apply if the review fee required by Paragraph 3.9 was not paid at the time the plans were first submitted to the Approving Agent. 3.6 PROCEEDING WITH WORK: Upon receipt of approval from the Approving Agent pursuant to this Article, the Owner or lessee to whom the same is given shall as soon as practicable satisfy all conditions thereof and diligently proceed with the commencement and completion of all approved construction, refinishing, alterations and excavations. In all cases work shall be commenced within one (1) year from the date of such approval. If Applicant fails to commence construction of the structures within one (1) year from date of such approval, then the approval given pursuant to this Article shall be deemed revoked unless the Approving Agent upon request made prior to the expiration of said one (1) year period extends in writing the time for commencing work. In all cases work shall be completed in accordance with the Preliminary Plans and the Final Plans within two years from date of issuance of the first (or only) building permit with regard to such work. 3.7 LIMITATION ON APPROVING AGENT: In no event shall the Approving Agent disapprove any plans and specifications solely by reason of the Applicant's proposed use of the lot if such use is specifically permitted pursuant to Section 5.1. 3.8 LIABILITY: Neither the Declarant nor the Approving Agent shall be liable for any damage, loss or prejudice suffered or claimed on account of: A. The approval or disapproval of any plans, drawings and specifications, whether or not defective; B. The construction or performance of any work, whether or not done pursuant to approved plans, drawings and specifications; or -7- C. The development of any property within Orchard Technology Park. 3.9 REVIEW FEE: An architectural review fee shall be paid to the Approving Agent as follows: A. At such time as Preliminary Plans pertaining to erection, placement, construction, remodeling or reconstruction of structures within the Orchard Technology are submitted for approval based on the following schedule: (1) When the plans submitted are prepared by an architect, the architectural review fee shall be Two Hundred Fifty Dollars ($250.00); (2) In all other cases the architectural review fee shall be Four Hundred Dollars ($400.00). B. At such time as documents required to be submitted pursuant to paragraph 3.2 above are submitted for approval, the architectural review fee shall be the sum of Fifty Dollars ($50.00). 3.10 CERTIFICATE OF COMPLIANCE: So long as there is an Approving Agent, such Approving Agent shall within twenty one (21) days following written request therefor by an Owner, execute and deliver to such requesting Owner a "Certificate of Compliance" stating that the lot specified by such Owner in said request for Certificate of Compliance is in compliance with Article 3 of these Restrictions, or, if such lot shall not be in compliance with Article 3 of these Restrictions, stating the nature of such noncompliance and the specific paragraph of this Article 3 with which said lot does not comply. ARTICLE 4 --------- LIMITATIONS ON IMPROVEMENTS 4.1 UTILITY LINES: All onsite utility transmission lines shall be placed underground. 4.2 COVERAGE: No more than thirty-five percent (35%) of the square foot area of any lot shall be occupied by structures. 4.3 MINIMUM SETBACK LINES: No structures, and no part thereof, shall be placed closer than forty (40) feet from a property line fronting any street ("frontage setback area"); provided, however, no structure shall be placed closer than twenty (20) feet from any property line not fronting on any street ("interior setback area"). 4.4 PARKING AREAS: No parking spaces shall be located within, and no parking shall be permitted within, a frontage setback area adjacent to any street, except that parking shall be permitted within said setback area if such parking is screened from view from the street by a screen wall, shrubbery or berms extending at least forty-two (42) inches above the high point of the finished adjacent pavement in said parking area. in no case shall such parking area be closer than twenty five (25) feet from a property line -8- fronting on any street or closer than ten (10) feet from any property line not fronting on any street. 4.5 STORAGE AND LOADING AREAS: No loading dock, truck loading, storage area or other such facility shall be located in the front of any building or structure or within any frontage setback area or between a front of any building or structure and the street which said front faces. ARTICLE 5 --------- RESTRICTIONS ON OPERATION AND USE 5.1 PERMITTED USES: Subject to compliance with these Restrictions, the following uses shall be permitted in the Orchard Technology Park. A. Manufacture (including storage of raw materials and finished products therefrom) of the following: (1) Pharmaceutical and cosmetic products; (2) Optical, electronic, timing and measuring instruments for use in research, development, business and professional facilities; and (3) Industrial, communication, transportation and utility equipment; B. Wholesaling, warehousing and distribution establishments and public utility facility (excluding storing and warehousing of acids, chemicals, cement, plaster, petroleum products or explosive material); C. Research, experimental and engineering laboratories; D. Catalog sales and mail order establishments; E. Establishments for the repair, cleaning and servicing of commercial or industrial equipment or products; F. Construction firms but only such construction firms whose activities are carried on entirely within an enclosed building and which have no construction yard on said lot; G. So long as there is an Approving Agent, any commercial use not specifically prohibited by Paragraph 5.3 which is first approved in writing by the Approving Agent; H. So long as there is an Approving Agents any industrial or manufacturing use not specifically prohibited by Paragraph 5.3 which is first approved in writing by the Approving Agent; I. If there is no Approving Agent, any industrial manufacturing or commercial use permitted by the then existing zoning or other applicable land use regulations as promulgated by requisite governmental authorities, except those uses specifically prohibited by Paragraph 5.3. 5.2 CONDUCT OF PERMITTED USES: All permitted uses shall be performed or carried out entirely within a building that is so designed and constructed, Certain activities which cannot be carried on within a building may be permitted, but only (a) so long as there is then serving an Approving -9- Agent, if the Approving Agent specifically consents to use and the location for such activity, in writing, or (b) if there is no then serving Approving Agent, if allowed under then existing zoning or other applicable land use regulations except for uses which are specifically prohibited pursuant to Paragraph 5.31; provided, however, that in either of the foregoing situations such use shall be permitted only if (i) such activity is screened so as not to be visible from neighboring property and streets and (ii) all lighting required for such use is shielded from adjacent streets. 5.3 PROHIBITED USES: The following operations and uses shall not be permitted on any property subject to these Restrictions: A. Residential of any type; B. Trailer courts, mobile home parks or recreation vehicle campgrounds; C. Junk yards or recycling facilities; D. Drilling for and/or the removal of oil, gas or other hydrocarbon substances (except that this provision shall not be deemed to prohibit the entry of the property below a depth of five hundred (500) foot for such purposes); E. Commercial excavation except in the course of approved construction; F. Distillation of bones; G. Dumping, disposal, incineration or reduction of garbage, sewage, offal, dead animals or refuse; H. Fat rendering; I. Stockyard or slaughter of animals; J. Cemeteries; K. Refining of petroleum or of its products; L. Smelting of iron, tin, zinc, or other ores; M. Jail or honor farms; N. Labor or migrant worker camps; O. Truck, bus terminals; P. Petroleum storage yards. Q. Auto wrecking, auto repair or auto painting establishment. 5.4 EMISSIONS: No use shall be permitted to exist or operate any lot which: A. Emits dust, sweepings, dirt, cinders, fumes, odors, radiation, gases, vapors or discharged liquid or solid wastes or other harmful matter into the atmosphere or any stream, river or other body of water which may adversely affect (i) the health or safety of persons within the area or (ii) the use of property within the Orchard Technology Park or (iii) vegetation within the Orchard Technology Park, nor shall waste or any substance or materials of any kind be discharged into any public sewer serving the Orchard Technology Park or any part thereof, in violation of any regulations of any public body having jurisdiction. -10- B. Produces intense glare or heat unless such use is performed only within an enclosed or screened area and then only in such manner that the glare or heat emitted will not be discernible from any exterior lot line. C. Creates a sound pressure level in violation of any regulation of any public body having jurisdiction. D. Allows the visible emissions of smoke (outside any building) other than the exhausts emitted by motor vehicles or other transportation facilities in violation of any regulation of any public body having jurisdiction. This requirement shall also be applicable to the disposal of trash and waste materials. E. Creates a ground vibration that is perceptible, without instruments, at any point along any of the exterior lot lines. 5.5 SIGNS: The Approving Agent may, from time to time, enact sign criteria setting forth such requirements for signs to be erected within the Orchard Technology Park as the Approving Agent may doom desirable, which sign criteria shall become effective upon recordation thereof in the official records of Santa Clara County. All signs erected by any owner on a lot within the Orchard Technology Park subsequent to the recordation of said sign criteria shall be in conformance with the criteria set forth therein. Except as specifically otherwise allowed in any then existing sign criteria, no sign shall be installed or erected or placed on any lot other than those signs identifying the name, business and products of the person or firm occupying the lot and those offering the lots for sale or lessee. 5.6 LANDSCAPING CRITERIA: The Approving Agent may, from time to time, enact landscaping criteria setting forth such requirements for landscaping to be placed an or in lots located within the Orchard Technology Park as the Approving Agent may doom desirable including, without limitations, amount of area to be plated in sod lawns or other plantings, type of plantings, placement of irrigation systems, requirements for trees and raised planter boxes, which landscape criteria shall become effective upon recordation thereof in the official records of Santa Clara County. All landscaping placed by any owner on a lot within the Orchard Technology Park subsequent to the recordation of said landscape criteria shall be in conformance with the criteria met forth therein. 5.7 STORAGE AND REFUSE COLLECTION AREAS: A. No materials, supplies or equipment, including company owned or operated trucks or motor vehicles, shall be stored in any area an a lot except inside a closed building, or behind a visual barrier screening such areas so that they are not visible from the neighboring properties or streets. No storage areas shall be maintained between a street and the front of the structure nearest such street. -11- B. All outdoor refuse collection areas shall be visually screened so as not to be visible from streets and neighboring property. No refuse collection areas shall he maintained between a street and the front of the structure nearest such street. 5.8 CONDITION OF PROPERTY: The Owner of each lot shall at all times keep and properly maintain the promises structures, improvements, landscaping, paving and appurtenances situate thereon in a safe, clean, sightly and wholesome condition and in a good state of repair and shall comply in all respects with all governmental, health, fire and police requirements and regulations, and shall cause to be regularly removed at its own expense any rubbish of any character whatsoever which may accumulate on such lot, and in particular and without limitation: A. All areas of each lot not used for structures, walkways, paved driveways, parking or storage areas shall be at all times maintained by a professional landscape engineer or gardener in a fully and well kept landscaped condition utilizing ground cover and/or shrub and tree materials. Undeveloped areas proposed for future expansion shall be maintained in a weed-free condition. An automatic underground landscape irrigation system shall be provided by the Owner of each lot which is sufficient to properly irrigate all landscaped areas within such lot. B. Parking areas shall be paved so an to provide all-weather surfaces. Each parking space shall be designated by lines painted on the paved surfaces and shall be adequate in area, and all parking areas shall provide, in addition to parking spaces, adequate driveways and space for the pavement of vehicles. 5.9 EXCAVATION: No excavation shall be made on, and no sand, gravel, soil, or other material shall be removed from, any lot, except in connection with the construction of structures. Upon completion of much construction exposed openings shall be backfilled to grade, and disturbed ground shall be graded level and paved or landscaped in conformity with the requirements of this Declaration. ARTICLE 6 --------- VARIANCES 6.1 VARIANCE BY APPROVING AGENT: So long as there shall be Approving Agent then serving, it shall have the exclusive right to grant variances from requirements set forth in Article 4 or waive entirely the restrictions set forth in said Article 4 with respect to any given lot, as the Approving Agent, in its sole discretion, shall determine is necessary for the successful development of the Orchard Technology Park. 6.2 GRANTING OF VARIANCE: Any variance granted hereunder shall be effective upon, and only upon, the recordation of a Notice of Variance executed by the Approving Agents. -12- ARTICLE 7 --------- ENFORCEMENT 7.1 REMEDY: So long as there in an Approving Agent, it shall have e exclusive right to enforce the provisions hereof, but without liability for failure so to do. In the event that the Approving Agent shall fail to take action respecting the breach or violation of any of the provisions of this Declaration within thirty (30) days from the written demand by any Owner within the Orchard Technology Park to take such action or if such breach or violation of this Declaration shall occur at such time as there in no Approving Agent, then any Owner of a lot within the Orchard Technology Park shall have the right to enforce the provisions contained in this Declaration. 7.2 RIGHT TO ENTER: So long as New England shall be serving as the Approving Agent, New England, and only New England, in addition to any other remedy available, may, with respect to a violation or breach of the covenants to maintain a set forth in Paragraph 5.8, and only with respect to a breach violation of the covenants to maintain at contained in paragraph 5.8, enter upon the lot on which such violation or breach shall then be occurring and take whatever action it may deem necessary to effect compliance with the provisions of said Paragraph 5.8, including without limitation making of such repairs or the performance of such required maintenance necessary to conform to the requirements imposed by these Restrictions at the expense of the Owner of said lot, provided that Orchard shall have first given to the Owner of such lot at least sixty (60) days prior written notice of its intention to do so and then, only if said Owner of such lot shall have failed to correct said violation or breach within said sixty (60) day period if such violation or breach was curable within sixty (60) days, or if not curable within sixty (60) days then only if such Owner shall have failed to commence and then be diligently seeking to so cure such violation or breach in the event that New England shall, after having complied with the above notice requirements, enter such lot and remedy such breach or violation, the Owner of such lot shall be responsible to reimburse New England forthwith upon demand for all costs and expenses incurred in connection therewith ("Non-Compliance Expenses") in accordance with the provisions of this Section. Each Owner of any lot within the Orchard Technology Park by acceptance of a deed or other conveyance whether or not it hall be so expressed in any such deed or other conveyance, is and shall be deemed to covenant and agree to pay to New England an assessment for any Non-Compliance Expenses incurred by New England in connection with such Owner's lot, A. New England shall maintain accurate books and records reflecting any Non-Compliance Expenses, and shall -13- provide each Owner of an affected lot a statement with respect thereto. Each affected Owner shall pay Non-Compliance Expenses incurred applicable to such Owner's lot within ten (10) days of receipt of a statement. If such statement is deposited in the United States mail duly certified or registered with postage prepaid and addressed to the Owner affected thereby at his lot, the same shall be deemed received by such Owner on the fifth (5th) business day after such deposit. B. Any Non-Compliance Expenses assessments, together with such interest thereon and costs of collection thereof as provided hereinbelow, shall be a charge on the lot and shall be a continuing lien upon the lot against which such assessments are made. The lien shall become effective upon recordation of a notice of claim of lien as provided herein. Such assessment, together with such interest and costs, shall also be the personal obligation of the person who is the Owner of such lot at the time when the assessment, or any portion thereof, fell due but in no events shall the person who is the owner of such lot be personally obligated for a sum in excess of One Thousand Dollars ($1,000.00) for any given violation (but without limiting the amount that may become upon such lot for any given violation or the aggregate the personal obligation for successive violations). Any personal obligation created hereunder shall not pass to such Owners successors in title unless it is expressly assumed by them but any lien created hereunder shall remain a charge against the lot except as to "bona fide purchasers or encumbrancers for value", without notice of same. No Owner may waive or otherwise escape personal liability for the personal assessment provided herein by non-use or abandonment of his lot. C. If any Non-Compliance Expenses assessment or any portion thereof is not paid within ten (10) days after the date due it shall bear interest from the date of delinquency at the then legal rate, and, in addition to all other legal and equitable rights or remedies, New England may, at its option, bring an action at law against the Owner who is personally obligated to pay the same, or upon compliance with the notice provisions set forth hereinbelow, to foreclose the lien against the affected lot, and there shall be added to the amount of such assessment or any portion thereof, the interest thereon, all costs and expenses, including reasonable attorneys fees, incurred by New England and in collecting the delinquent assessment. In lieu of judicially foreclosing the lien, New England, at its option, may foreclose such lien by proceeding under a power of sale as provided hereinbelow, such a power of sale being given to New England as to each and every lot for the purpose of collecting assessments. -14- D. No action shall be brought to foreclose the lien, or to proceed under the power of sale, less than thirty (30) days after the date that a notice of claim of lien, executed by New England, is recorded, stating the amount claimed (which may include interest and cost of collection, including reasonable attorneys' fees), a good and sufficient legal description of the lot being assessed, the name of the record Owner or reputed Owner thereof, and the name and address of New England as claimant. A copy of said notice of claim shall be deposited in the United States mail, certified or registered, with postage prepaid, to the Owner of said lot. E. Any such sale provided for above shall be conducted in accordance with Sections 2924, 2924(b), and 2924(c) of the Civil Code of the State of California, applicable to the exercise of powers of sale in mortgages and deeds of trust, or in any other manner permitted or provided by law, New England shall have the power to bid on the lot at the foreclosure sale, and to acquire and hold, mortgage and convey the same. F. Upon the timely curing of any default for which a notice of claim of lien was recorded by New England, New England is hereby authorized to file or record, as the case may be, an appropriate release of such notice, upon payment by the defaulting Owner of a fee to be determined by New England but not to exceed Twenty-five Dollars ($25.00), to cover the costs of preparing and filing or recording such release together with the payment of such other costs, interest or fees as shall have been incurred. G. The assessment lien and the rights to foreclosure and sale thereunder shall be in addition to and not in substitution for all other rights and remedies which New England may have hereunder, at law or in equity. 7.3 RESULT OF VIOLATION: The result of every action or omission whereby the provisions of this Declaration are violated in whole or in part is hereby declared to be and to constitute a nuisance, and every remedy allowed by law or equity shall be available to any Owner of any lot within the Orchard Technology Park. 7.4 ATTORNEY'S FEES: In any legal or equitable proceeding for the enforcement or the provisions of this Declaration, whether it be an action for damages, declaratory relief or injunctive relief, the losing party or parties shall pay the attorneys' fees of the prevailing party or parties, in such reasonable amount as may be fixed by the court in such proceedings, or in a separate action brought for that purpose. The prevailing party shall be entitled to said attorneys' fees, even though said proceeding is settled prior to judgments. -15- 7.5 REMEDIES CUMULATIVE: All remedies provided herein, or at law or in equity shall be cumulative and not exclusive. 7.6 WAIVER: Failure by the Approving Agent to enforce the provisions of this Declaration shall in no event be deemed a waiver of the right to do so thereafter, nor of the right to enforce any other covenants or restrictions herein, nor of the rights of other owners of the property within the Orchard Technology Park to enforce same. 7.7 ORCHARD: For Purposes of this Article 7 the term "New England" shall include New England, New England's Successor as defined in Paragraph 1.5A and Orchard. ARTICLE 8 --------- DURATION, MODIFICATION AND REPEAL 8.1 DURATION OF RESTRICTIONS: These Restrictions shall continue and remain in full force and effect at all times with respect to all property, and each part thereof, now or hereafter made subject to these Restrictions (subject, however, to the right to amend and repeal an provided for herein) until January 1, 2009. 8.2 TERMINATION AND MODIFICATIONS: This Declaration or any provision thereof, or any covenant, condition or restriction contained herein, may be terminated, extended, modified or amended, as to the whole of the Orchard Technology Park upon the written consent of the owners of sixty-six and two-thirds percent (66-2/3%) of the total square footage of the land area contained within the Orchard Technology Park (exclusive of dedicated public streets); provided, however, that so long as New England, New England's successor or Orchard (as defined in paragraph 1.5A) is the Approving Agent, no such termination, extension or modification or amendment shall be effective without the written approval of New England, New England's successor or Orchard as the case may be. No such termination, extension, modification or amendment shall be effective until a proper instrument in writing describing such termination, extension, modification or amendment has been executed by the requisite number of Owners and by New England, New England's successor or Orchard, if so required, and recorded. ARTICLE 9 --------- MISCELLANEOUS PROVISIONS 9.1 CONSTRUCTIVE NOTICE AND ACCEPTANCE: Every person who now or hereafter owns, occupies or acquires any right, title or interest in or to any portion of the property made subject to these Restrictions is and shall be conclusively deemed to have consented and agreed to every covenant, condition and restriction contained herein whether or not any reference to this Declaration in contained in the instrument by which such person acquired an interest in said property. -16- 9.2 WAIVER OF LIABILITY: Neither the Declarant nor the Approving Agent shall be liable to any Owner, lessee, licensee, or occupant of land subject to this Declaration by reason of any mistake in judgment, negligence, nonfeasance, action or inaction or for the enforcement or failure to enforce any provision of this Declaration. Every Owner, lessee, licensee or occupant of any of said property by acquiring his interest therein agrees that he will not bring any action or suit against New England (or New England's Successor or Orchard, as the case may be) or any other Approving Agent to recover any such damages from or to seek equitable relief against the Declarant by reason of same. 9.3 RIGHTS OF MORTGAGEE: No breach of the Restrictions and other provisions contained herein, or any enforcement thereof, shall defeat or render invalid the lion of any mortgage or deed of trust now or hereafter executed upon land subject to these Restrictions; provided, however, that if any portion of said property is sold under a foreclosure of any mortgage or under the provisions of any deed of trust, any purchaser at such sale and his successors and assigns shall hold any and all property so purchased subject to all of the Restrictions and other provisions of this Declaration. Any notice of claim of lien recorded pursuant to paragraph 7.2 hereof shall take its priority vis-a-vis other encumbrances as of the date of its recordation. 9.4 PARAGRAPH HEADINGS: Paragraph headings, where used herein, are inserted for convenience only and are not intended to be a part of this Declaration or in any way to define, limit or describe the scope and intent of the particular paragraphs to which they refer. 9.5 EFFECT OF INVALIDATION: If any provision of this Declarations is held to be invalid by any Court, the invalidity of such provision shall not effect the validity of the remaining provisions hereof. 9.6 ASSIGNMENT AND DELEGATION: New England (or an Appointed Approving Agent or New England's Successor as defined in paragraphs 1.5A and 1.5B respectively) shall have no right to assign its rights granted hereunder as Approving Agent nor to delegate its duties imposed hereunder as Approving Agent except as set forth in Article I of this Declaration. IN WITNESS WHEREOF, the undersigned have executed this Declaration the day and year first above written. NEW ENGLAND MUTUAL LIFE INSURANCE COMPANY a Massachusetts corporation By /s/ Joseph W. O'Connor Its second Vice President ATTEST: /s/ John R. Hicinbothem Its Assistant Secretary #571 5/5/78 -17- New England COMMONWEALTH OF MASSACHUSETTS ) ) ss: COUNTY OF SUFFOLK ) On this 26th day of May, 1978, before me, Daniel J. Kelliher, Jr., the undersigned, a Notary Public in and for said County of Suffolk and the Commonwealth of Massachusetts, personally appeared Joseph W. O'Connor and John R. Hicinbothem known to me to be the Second Vice President and the Assistant Secretary, respectively, of NEW ENGLAND MUTUAL LIFE INSURANCE COMPANY, a Massachusetts corporation, the corporation that executed the within instrument and known to me to be the persons who executed the within instrument on behalf of the corporation therein named and acknowledged to me that they executed the within instrument on behalf of said corporation and that such corporation executed the same pursuant to a rule if its board of directors or its by-laws. WITNESS my hand official seal. NOTARY PUBLIC, COMMONWEALTH OF MASSACHUSETTS DANIEL J. KELLIHER, Notary Public My Commission Expires: June 29, 1981 EXHIBIT "A" LEGAL DESCRIPTION: All that certain real property situate in the City of San Jose, County of Santa Clara, State of California, described as follows: A. Parcel 2 as shown on a Parcel Map recorded March 29, 1978 in Book 415, Page 48 of Maps, Official Records of Santa Clara County, California. B. Parcels 1, 2, 3, 4 and 5, as shown on a Parcel Map recorded June 21, 1978 in Book 421, Pages 6 and 7 of Maps, Official Records of Santa Clara County, California. WHEN RECORDED RETURN TO: WILSON, SONSINI, GOODRICH & ROSATI Two Palo Alto Square, Suite 900 Palo Alto, CA 94306 Attn: Real Estate Department FIRST AMENDMENT TO FIRST SIGN CRITERIA OF DECLARATION OF COVENANTS, CONDITIONS, AND RESTRICTIONS OF THE ORCHARD TECHNOLOGY PARK This First Amendment to First Sign Criteria is made to be effective this 13th day of August, 1985, by ORCHARD PROPERTIES, a California corporation ("Approving Agent"). R E C I T A L S: WHEREAS, New England Mutual Life Insurance Company, a Massachusetts corporation, as Declarant, as then owner of all that real property located in the City of San Jose, County of Santa Clara, California described in EXHIBIT A hereto (the "Orchard Technology Park") has executed, effective as of June 12, 1978, that certain Declaration of Covenants, Conditions and Restrictions of the Orchard Technology Park (the "CC&Rs") and caused same to be recorded on June 23, 1978 in the official records of Santa Clara County in Book D762 at pages 474 through 492; and WHEREAS, the CC&Rs provide, among other things, that from time to time the "Approving Agent" as defined in paragraph 1.5 of the CC&Rs may enact sign criteria to affect all property located in the Orchard Technology Park, which "First Sign Criteria of Declaration VIID-5 EXHIBIT F of Covenants, Conditions and Restrictions of the Orchard Technology Park" (the "First Sign Criteria") is dated October 25, 1978 and recorded November 17, 1978 in Book E104, Page 74 of the Official Records of Santa Clara County; and WHEREAS, Orchard Properties is the Approving Agent under the CC&Rs and desires to enact this First Amendment to First Sign Criteria in order (i) to assist lot owners in preparation of their graphic design and (ii) to set forth minimum requirements for signs to be placed on or in lots located within the Orchard Technology Park, with the understanding that the First Sign Criteria are minimum requirements only and that so long as there exists an Approving Agent, as defined in the CC&Rs, then prior to installation or replacement of any sign upon any lot(s) in the Orchard Technology Park, the then serving Approving Agent must approve a sign plan related thereto, as more specifically provided in the CC&Rs. NOW, THEREFORE, the Approving Agent herein enacts this First Amendment to First Sign Criteria, as follows: 1. MINIMUM CRITERIA FOR SIGNS: Article 2 of the First Sign Criteria, entitled "Minimum Criteria for Signs", is hereby deleted in its entirety and replaced by the following: "2.1 LOCATION: Any sign permitted to be placed upon a lot within the Orchard Technology Park shall be located in the frontage setback area of such lot, and only in such frontage setback area; provided, no part of any such sign shall be less than ten (10) feet -2- from the public street right of way line adjacent to such frontage setback area. In determining the location of such sign within said frontage setback area, the location of the meandering sidewalk and landscaping contained within said frontage setback are shall be considered. No signs shall be permitted to be placed upon any structure located on a lot located within the Orchard Technology Park, except in the event multiple users occupy such lot in which event the location of each such user in said structure may be designated by means of a master sign plan which has been previously approved by the then serving Approving Agent. "2.2 NUMBER OF SIGNS: The number of signs permitted shall depend upon the number of buildings, the number of street frontages and the number of users of the Property, as follows: 1. One (1) User One (1) sign face not to exceed One (1) Building forty (40) square feet per side. One (1) Street Frontage 2. One (1) User One (1) sign face not to exceed One (1) Building forty (40) square feet per side More than one (1) Street or one (1) sign face per street Frontage frontage not to exceed twenty (20) square feet per side. 3. One (1) User One (1) sign face not to exceed More than one (1) Building forty (40) square feet per side per More than one (1) Street street frontage or one (1) sign per Frontage building not to exceed twenty (20) square feet per side. 4. One (1) User One (1) sign face not to exceed More than one (1) Building forty (40) square feet per side or One (1) Street Frontage one (1) sign face per building not to exceed twenty (20) square feet per side. 5. More than one (1) User One (1) sign face not to exceed One (1) Building forty (40) square feet per side One (1) Street Frontage with spaces of equal sizes for -3- multiple identification or one (1) sign face per tenant not to exceed twenty (20) square feet per side. 6. More than one (1) User One (1) sign face per street One (1) Building frontage not to exceed forty More than one (1) (40) square feet per side with Street Frontage spaces of equal size for multiple identification or one (1) sign face per tenant per street front- age not to exceed twenty (20) square feet per side. "2.3 DIMENSIONS OF PERMITTED SIGNS: No sign permitted hereunder shall have a total area in excess of forty (40) square feet per side nor shall any single dimension in any such sign exceed twelve (12) feet, No portion of any such sign shall extend more than six (6) feet above the ground level as measured perpendicular from the high point of any such sign. "2.4 MECHANICAL DEVICES: A. All portions of any sign installed within the Orchard Technology Park shall be stationary and no sign, and no portion thereof, shall revolve, rotate, move, or create the illusion of revolvement, rotation or movement. B. No sign shall be internally illuminated nor shall there be any exterior spotlighting or other illumination on any sign installed in the Orchard Technology Park. "2.5 CONTENTS OF SIGN: Any sign located on any lot located within the Orchard Technology Park shall contain the business name of the entity occupying said lot and no other name, lettering, logo, trademark or copy shall be permitted on any such sign. Copy shall be permitted only upon two sides of any sign permitted hereunder. -4- In the event more than one business shall occupy any lot within the Orchard Technology Park, then the location of such multiple occupants shall be designated by means of a master sign plan approved by the then serving Approving Agent. "2.6 SIGN MATERIAL: Each sign placed upon a lot located within the Orchard Technology Park shall be constructed of materials which will: A. Complement and harmonize with the materials used in any structure located on such lot and with structures located an adjacent lots; and B. Resist the impact of weather elements. "2.7 TEMPORARY SIGNS: The foregoing notwithstanding, during the period from commencement of construction of a structure on any lot contained within Orchard Technology Park until completion of such structure, New England Mutual Life Insurance Company will provide at its sole cost and expense one standard project identification sign (of a design substantially as described in Exhibit B hereto) of sufficient size to describe the proposed occupant of the structure under construction, the architect of such structure, the contractor, the developer, and the lender (or any portion of the above named as selected by the owner). The owner of such lot shall pay at its own cost and expense for all the graphic work and copy to place the above described information upon the sign either (i) by installing his own copy, subject to previous approval by the then serving Approving Agent, or (ii) by request to Declarant that Declarant prepare and install such sign copy, in which event such owner shall -5- promptly, upon request therefor by Declarant, reimburse Declarant for all costs and expenses incurred for such preparation and installation, The copy, size, dimensions and location of such project identification sign shall be subject to prior approval by the Approving Agent in its sole discretion. No other signs of any type shall be permitted on any lot located within the Orchard Technology Park during construction of a structure on any such lot." 2. CONTINUED EFFECTIVENESS: Except as expressly amended by this instrument, the First Sign Criteria remains in full force and effect. IN WITNESS WHEREOF, the undersigned has executed this Amendment the day and year first above written. ORCHARD PROPERTIES, a California corporation By /s/ Signature Illegible Its President By /s/ Craig Duncan Its Secretary -6- VIID-10 [Section containing graphical representation of permitted number, types, dimensions and positions of signs on property located in the Orchard Technology Park.] SPECIFICATIONS FOR ADDRESS NUMBERS ON BUILDINGS ----------------------------------------------- 1. Height: 8" 2. Color: Contrasting to background of building and matching accent trim on building. 3. Location: Viewable from the street upper corner of building 4. Example: IBM building at the corner of Brokaw Road and Zanker Road 5. Composition: Metal 6. Paint: Primer plus two coats of finish paint 7. Approval: By Orchard Properties in writing previous to installation. May desire approval from San Jose Fire Department, Station #5 on North Tenth Street, telephone 277-4365 11/1984 VIIA-8 [Section containing graphical representation of size, style and content of a standard "unauthorized parking" sign.] ORCHARD PROPERTIES VISITOR PARKING SPACE DESIGNATION Signs designating visitor parking spaces are allowed in parking areas of single user buildings only, and conform to the following criteria: 1. A maximum of 3 inches high and consisting of only the word "Visitor". 2. Painted with a flat white exterior paint. 3. Applied to either the curb or bumpers of the approved designated spaces. 4. Painted by the tenant at tenant's expense but with the prior written approval of Orchard Properties. 5. Repainted a minimum of every three years. 6. Upon request from Orchard Properties, removed at the termination of the lease. No other designated parking signs are acceptable. 11/1984 VIIA-14 EXHIBIT "G" ----------- SUBORDINATION, NON-DISTURBANCE AND ATTORNMENT AGREEMENT THIS AGREEMENT is entered into as of the _________ day of ______ , ______, by and between _____________, a__________________(the "Beneficiary"), ____________________, __________________(the "Tenant") and ______________, a _______________(the "Landlord"). WITNESSETH A. Tenant has entered into a certain lease dated __________, ______, (the "Lease") with Landlord covering certain space (the "Premises") located in and upon the real property described in Schedule 1 attached hereto (the "Property"); B. Beneficiary is the holder of a mortgage loan (the "Loan") to Landlord in the amount of_____________ Dollars ($___________________) which is secured by a_______________________________(the "Deed of Trust") covering the Property; C. The parties hereto desire expressly to confirm the subordination of the Lease to the lien of the Deed of Trust, it being a requirement by Beneficiary that the lien and charge of the Deed of Trust be unconditionally and at all times prior and superior to the leasehold interests and estates created by the Lease; and D. Tenant has requested that Beneficiary agree not to disturb Tenant's possessory rights in the Premises in the event Beneficiary should foreclose the Deed of Trust, provided that Tenant is now in default under the Lease and provided that Tenant attorns to Beneficiary or the purchaser at any foreclosure or Trustee's sale of the Property. NOW, THEREFORE, in consideration of the mutual covenants contained herein and of other good and valuable consideration the receipt and sufficiency of which is hereby acknowledged, the parties hereby agree as follows: 1. Notwithstanding anything to the contrary set forth in the Lease, the Lease and the leasehold estate created thereby and all of Tenant's rights thereunder shall be and shall at all times remain subject, subordinate to the Deed of Trust and the lien thereof and all rights of Beneficiary thereunder and to any and all renewals, modifications, consolidations, replacements and extensions thereof. 2. Tenant hereby declares, agrees and acknowledges that: A. Beneficiary would not have agreed to recognize the Lease without this Agreement; and B. Beneficiary, in making disbursements pursuant to the agreements evidencing and securing the Loan, is under no obligation or duty to oversee or direct the application of the proceeds of such disbursements and such proceeds may be used by Landlord for purposes other than improvement of the Premises. 3. In the event of foreclosure of the Deed of Trust, or upon a sale of the Property pursuant to the Trustee's power of sale contained therein, or upon a transfer of the Property by deed in lieu of foreclosure, then so long as Tenant is not in default under any of the terms, covenants, or conditions of the Lease, the Lease shall continue in full force and effect as a direct lose between the succeeding owner of the Property and Tenant, upon and subject to all of the terms, covenants and conditions of the Lease for the balance of the term of the Lease. Tenant hereby agrees to attorn to and accept any such successor owner as landlord under the Lease, and to be bound by and perform all of the obligations imposed by the Lease, and Beneficiary or any such successor owner of the Property will not disturb the possession of Tenant, and will be bound by all of the obligations imposed by the Lease upon the landlord thereunder: provided, however, that the Beneficiary, or any purchaser at a trustee's or sheriff's sale or any successor owner of the Property shall not be: A. liable for any act or omission of a prior landlord (including Landlord); or B. subject to any offsets or defenses which the Tenant might have against any prior landlord (including Landlord); or EXHIBIT G C. bound by any rent or additional rent which the Tenant might have paid in advance to any prior landlord (including Landlord) for a period in excess of one month; or D. bound by any agreement or modification of the Lease made without the written consent of the Beneficiary; or E. liable or responsible for or with respect to the retention, application and/or return to Tenant of any security deposit paid to any prior lessor (including Landlord), whether or not still held by such prior lessor, unless and until Beneficiary or such other purchaser has actually received for its own account as lessor the full amount of such security deposit; or F. bound by or liable under any representations, warranties, covenants or indemnities made to Tenant by any prior landlord (including Landlord) regarding Hazardous Materials (as defined in the Lease); or G. obligated to construct the building in which the Premises are located or any improvements for Tenant's use. 4. Upon the written request of Beneficiary at the time of a foreclosure, Trustee's sale or deed in lieu thereof or at any time thereafter, the parties agree to execute a lease of the Premises upon the same terms and conditions as the Lease between Landlord and Tenant, which lease shall cover any unexpired term of the Lease existing prior to such foreclosure, Trustee's sale or conveyance in lieu of foreclosure. 5. Tenant agrees to give to Beneficiary, by registered mail, a copy of any notice or statement served upon Landlord. Tenant agrees not to exercise any rights of termination available by virtue of a default unless (i) Landlord shall have failed to cure such default, and (ii) following expiration of the applicable period under the Lease for cure by Landlord of such default, Tenant shall have furnished to Beneficiary notice of Landlord's failure to cure such default and afforded Beneficiary an additional thirty (30) days following receipt of such notice within which to cure such default or if such default cannot be cured within that time, then such additional time as may be necessary if within such thirty (30) days Beneficiary has commenced and is diligently pursuing the remedies necessary to cure such default (including, but not limited to, commencement of foreclosure proceedings if necessary to effect such cure), in which event such right, if any, as Tenant might otherwise have to terminate the Lease shall not be exercised while such remedies are being so diligently pursued. 6. Landlord, as landlord under the Lease and trustor under the Deed of Trust, agrees for itself and its heirs, successors and assigns, that: (i) this Agreement does not constitute a waiver by Beneficiary of any of its rights under the Deed of Trust, or in any way release Landlord from its obligation to comply with the terms, provisions, conditions, covenants, agreements and clauses of the Deed of Trust; and (ii) the provisions of the Deed of Trust remain in full force and effect and must be complied with by Landlord, if Beneficiary so requires. 7. Tenant acknowledges that it has notice that the Lease and the rent and all other sums due thereunder have been assigned or are to be assigned to Beneficiary as security for the Loan secured by the Deed of Trust. In the event that Beneficiary notifies Tenant of a default under the Deed of Trust and demands that Tenant pay its rent and all other sums due under the Lease to Beneficiary, Tenant agrees that it will honor such demand and pay its rent and all other sums due under the Lease directly to the Beneficiary or as otherwise required pursuant to such notice. 8. All notices hereunder shall be deemed to have been duly given if mailed by United States registered or certified mail, with return receipt requested, postage prepaid, to Beneficiary at the following address (or at such other address as shall be given in writing by Beneficiary to the Tenant) and shall be deemed complete upon any such mailing: ___________________________ ___________________________ ___________________________ ___________________________ Attention: ________________ with a copy to: ____________________ ____________________ ____________________ ____________________ 9. This Agreement supersedes any inconsistent provisions of the Lease. -2- 10. This Agreement shall inure to the benefit of the parties hereto, their successors and permitted assigns; provided however, that in the event of the assignment or transfer of the interest of Beneficiary, all obligations and liabilities of Beneficiary under this Agreement shall terminate, and thereupon all such obligations and liabilities shall be the responsibility of the party to whom Beneficiary's interest is assigned or transferred. 11. Tenant agrees that this Agreement satisfies any condition or requirement in the Lease relating to the granting of a non-disturbance agreement. 12. This Agreement shall be governed by and construed in accordance with the laws of the State of California. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first set forth above. "Beneficiary": "Landlord": ________________________ ________________________ ________________________, a a_______________________ By:__________________ By:____________________ Printed Printed Name:_______________ Name:___________________ Title:______________ Title:__________________ "Tenant": _______________________, a _____________________ By:____________________ Printed Name:___________________ Title:__________________ -3- ACKNOWLEDGMENT -------------- THE UNDERSIGNED HEREBY ACKNOWLEDGES THAT IT (Mark One): X Does not use any hazardous materials other than minor amounts of - ----- reproduction and janitorial chemicals consistent with routine office uses. (NO NEED TO FILL OUT THE ATTACHED HAZARDOUS MATERIALS QUESTIONNAIRE.) Does not use hazardous materials in a manner or in a quantity - ----- requiring the preparation of a hazardous material management plan or any other documents under California Health and Safety Code Section 25503.5. (PLEASE FILL OUT THE ATTACHED HAZARDOUS MATERIALS QUESTIONNAIRE.) Uses only those chemicals identified in the attached - ----- questionnaire in accordance with the provisions of the attached hazardous materials management plan, which has been approved by the Fire Department of the City of _______________ and is in full force and effect. (PLEASE FILL OUT THE ATTACHED HAZARDOUS MATERIALS QUESTIONNAIRE AND ATTACH COPY OF YOUR HAZARDOUS MATERIALS MANAGEMENT PLAN.) THE UNDERSIGNED FURTHER ACKNOWLEDGES THAT IT HAS COMPLIED IN ALL RESPECTS TO THE PROVISIONS OF LOCAL, STATE AND FEDERAL LAW AND THE HAZARDOUS MATERIALS MANAGEMENT PLAN ATTACHED HERETO IN CONNECTION WITH ITS STORAGE, USE AND DISPOSAL OF HAZARDOUS MATERIALS AND THAT IT HAS DISPOSED OF HAZARDOUS MATERIALS ONLY BY (1) DISCHARGE TO APPROPRIATELY TREATED WASTE TO A PUBLICLY OWNED TREATMENT WORK IN ACCORDANCE WITH A VALID AND ENFORCEABLE WASTE DISCHARGE PERMIT AND (2) DELIVERY OF HAZARDOUS WASTES TO A PROPERLY LICENSED WASTE DISPOSAL AGENT. IN WITNESS WHEREOF, the undersigned, an authorized officer of the aforementioned company has executed this acknowledgment as of the date written below. Quickturn Design Systems, Inc. (Company Name) a Delaware Corporation By: /s/ R.K. Ostby R.K. Ostby Vice President (Print Name and title) EXHIBIT H EX-13.1 4 EXHIBIT 13.1 p 2. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. FINANCIAL HIGHLIGHTS
(amounts in thousands of dollars except per share and employee data) 1993 1994 1995(1) 1996(1) 1997 - --------------------------------------------------------------------------------------------------------------- FOR THE FISCAL YEAR Total revenue $ 54,865 $ 65,523 $ 82,442 $ 109,578 $ 110,404 Net income (loss) $ (5,356) $ 4,601 $ 12,478(2) $ 14,131(3) $ (5,346)(4) Diluted net income (loss) per share $ (0.96)(5) $ 0.32 $ 0.74(2) $ 0.79(3) $ (0.31)(4) Total revenue by geographic area North America $ 40,872 $ 48,594 $ 56,702 $ 70,658 $ 73,186 Asia-Pacific 8,940 9,336 16,496 30,138 26,025 Europe 5,053 7,593 9,244 8,782 11,193 ----------------------------------------------------------- Total $ 54,865 $ 65,523 $ 82,442 $ 109,578 $ 110,404 ----------------------------------------------------------- ----------------------------------------------------------- AT YEAR END Working capital $ 33,927 $ 34,998 $ 44,381 $ 49,243 $ 51,143 Total assets $ 56,199 $ 77,349 $ 94,240 $ 111,977 $ 129,192 Long-term debt $ 3,487 $ 3,819 $ 3,701 $ -- $ -- Stockholders' equity $ 38,296 $ 49,895 $ 66,337 $ 84,045 $ 91,898 Employees 177 244 285 363 382
(1) The 1995 and 1996 results have been restated to reflect the February 1997 merger of the Company with SpeedSim-TM-, Inc. which was accounted for as a pooling of interests. (2) The 1995 results include a net year-to-date tax benefit of $3.7 million or $0.22 per share. (3) The 1996 results include a net year-to-date tax benefit of $891,000 or $0.05 per share. (4) The 1997 results include one-time acquisition and merger related charges of $19.2 million or ($0.61) per share, net of tax. (5) Diluted net loss per share has been calculated in accordance with application of Statement of Financial Accounting Standards No. 128, which resulted in a restatement of diluted net loss per share for the fiscal year 1993. TOTAL REVENUE (in thousands) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1993 $54,865 1994 $65,523 1995 $82,442 1996 $109,578 1997 $110,404
STOCKHOLDERS' EQUITY (in thousands) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1993 $38,296 1994 $49,895 1995 $66,337 1996 $84,045 1997 $91,898
WORKING CAPITAL (in thousands) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1993 $33,927 1994 $34,998 1995 $44,381 1996 $49,243 1997 $51,143
EMPLOYEES EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1993 177 1994 244 1995 285 1996 363 1997 382
Financial Review p 17. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. SELECTED CONSOLIDATED FINANCIAL DATA (unaudited)
Quarter Ended --------------------------------------------------------------------------------------------------- (amounts in thousands except Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 per share data) 1997 1997 1997 1997 1996 1996 1996 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue $ 32,500 $ 30,064 $ 26,438 $ 21,402 $ 30,664 $ 28,787 $ 26,259 $ 23,868 Cost of revenue 8,841 8,813 8,392 6,834 9,124 8,482 7,913 7,144 --------------------------------------------------------------------------------------------------- Gross profit 23,659 21,251 18,046 14,568 21,540 20,305 18,346 16,724 Operating expenses Research and development 5,944 5,884 5,884 5,787 5,600 5,158 4,681 4,267 Sales and marketing 10,065 9,389 8,787 8,534 8,511 8,318 7,966 7,187 General and administrative 3,094 3,034 2,849 2,508 2,146 1,790 1,755 1,563 Acquisition and merger related charges -- 18,031 -- 1,200 -- -- -- -- --------------------------------------------------------------------------------------------------- Total operating expenses 19,103 36,338 17,520 18,029 16,257 15,266 14,402 13,017 --------------------------------------------------------------------------------------------------- Operating income (loss) 4,556 (15,087) 526 (3,461) 5,283 5,039 3,944 3,707 Interest and other, net 629 636 518 392 547 533 487 312 --------------------------------------------------------------------------------------------------- Net income (loss) before provision for (benefit from) income taxes 5,185 (14,451) 1,044 (3,069) 5,830 5,572 4,431 4,019 Provision for (benefit from) income taxes 1,607 (6,925) 324 (951) 1,305 1,700 1,441 1,275 --------------------------------------------------------------------------------------------------- Net income (loss) $ 3,578 $ (7,526) $ 720 $ (2,118) $ 4,525 $ 3,872 $ 2,990 $ 2,744 --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Diluted net income (loss) per share $ 0.19 $ (0.43) $ 0.04 $ (0.13) $ 0.25 $ 0.22 $ 0.17 $ 0.16 --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Number of shares used in diluted per share calculation 18,971 17,462 18,025 16,562 18,378 17,967 17,857 17,445 --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Market price range High $ 16.31 $ 16.63 $ 15.88 $ 21.00 $ 21.63 $ 15.13 $ 16.50 $ 11.50 Low $ 10.69 $ 12.13 $ 6.69 $ 15.00 $ 11.75 $ 11.88 $ 11.13 $ 9.00
Quarter Ended --------------------------------------------------------------------------------------------------- (as a percentage of Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 total revenue) 1997 1997 1997 1997 1996 1996 1996 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of revenue 27.2% 29.3% 31.7% 31.9% 29.8% 29.5% 30.1% 29.9% --------------------------------------------------------------------------------------------------- Gross profit 72.8% 70.7% 68.3% 68.1% 70.2% 70.5% 69.9% 70.1% Operating expenses Research and development 18.3% 19.6% 22.3% 27.0% 18.2% 17.9% 17.8% 17.9% Sales and marketing 31.0% 31.2% 33.2% 39.9% 27.8% 28.9% 30.4% 30.1% General and administrative 9.5% 10.1% 10.8% 11.7% 7.0% 6.2% 6.7% 6.6% Acquisition and merger related charges -- 60.0% -- 5.6% -- -- -- -- --------------------------------------------------------------------------------------------------- Total operating expenses 58.8% 120.9% 66.3% 84.2% 53.0% 53.0% 54.9% 54.6% --------------------------------------------------------------------------------------------------- Operating income (loss) 14.0% (50.2%) 2.0% (16.1%) 17.2% 17.5% 15.0% 15.5% Interest and other, net 2.0% 2.1% 1.9% 1.8% 1.8% 1.9% 1.9% 1.3% --------------------------------------------------------------------------------------------------- Net income (loss) before provision for (benefit from) income taxes 16.0% (48.1%) 3.9% (14.3%) 19.0% 19.4% 16.9% 16.8% Provision for (benefit from) income taxes 5.0% (23.1%) 1.2% (4.4%) 4.2% 5.9% 5.5% 5.3% --------------------------------------------------------------------------------------------------- Net income (loss) 11.0% (25.0%) 2.7% (9.9%) 14.8% 13.5% 11.4% 11.5% --------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------
The 1996 quarterly results have been restated to reflect the February 1997 merger of the Company with SpeedSim, Inc. which was accounted for as a pooling of interests. The Company's common stock is traded on the Nasdaq National Market under the symbol "QKTN." As of December 31, 1997, there were approximately 207 stockholders of record and an estimated 6,500 additional stockholders who held stock in "street name." p 18. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Quickturn Design Systems, Inc. (the "Company" or "Quickturn") designs, manufactures, sells and supports products that verify the designs of complex integrated circuits ("ICs") and electronic systems. The Company derives substantially all of its revenue from its design verification products and related maintenance and consulting services. The principal design verification products include System Realizer and CoBALT emulators and SpeedSim cycle-based simulators. Emulation systems are sold in modules of various capacities measured in "logic gates," a unit describing the design elements created and verified by Quickturn's customers. As system capacity increases, the selling price of these systems increases correspondingly. Simulation revenue is charged on a per-license basis. Quickturn's products serve the needs of IC and systems design engineers in a variety of markets including microprocessors, computers, workstations and PCs, telecommunications and networking, multimedia and graphics. The Company began operations in 1987 and commenced product shipments in 1989. In January 1997, the Company commenced shipments of its CoBALT emulation system which resulted from the Company's technology relationship with IBM. In February 1997, the Company merged with SpeedSim, Inc. ("SpeedSim"), a provider of cycle-based simulation software (the "SpeedSim Merger"). See Note 3 of the Notes to Consolidated Financial Statements. In June 1997, the Company purchased from Synopsys, Inc. ("Synopsys") certain assets relating to Synopsys's emulation business of Arkos Design, Inc. (the "Arkos Acquisition"). See Note 3 of the Notes to Consolidated Financial Statements. Also in June 1997, the Company extended its relationship with IBM to develop the next generation of custom processor-based emulation systems. In November 1997, Quickturn moved its corporate headquarters to San Jose, California. Late in 1997, the Company introduced release 5.1 of its Quest II software, designed to enable customers to more quickly and easily compile their IC designs. RESULTS OF OPERATIONS The following table sets forth certain financial data from the Company's consolidated statements of operations as a percentage of total revenue:
Year Ended December 31, --------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------- Total revenue 100.0% 100.0% 100.0% Cost of revenue 29.8% 29.8% 30.5% -------------------------- Gross margin 70.2% 70.2% 69.5% Operating expenses Research and development 21.3% 18.0% 18.7% Sales and marketing 33.3% 29.2% 31.3% General and administrative 10.4% 6.6% 6.1% Acquisition and merger related charges 17.4% -- -- -------------------------- Total operating expenses 82.4% 53.8% 56.1% -------------------------- Operating income (loss) (12.2%) 16.4% 13.4% Interest and other, net 2.0% 1.7% 1.0% -------------------------- Net income (loss) before provision for (benefit from) income taxes (10.2%) 18.1% 14.4% Provision for (benefit from) income taxes (5.4%) 5.2% (0.7%) -------------------------- Net income (loss) (4.8%) 12.9% 15.1% -------------------------- --------------------------
TOTAL REVENUE The Company derives its total revenue from the sales of its products, maintenance and services. Product revenue consists primarily of sales of its System Realizer and CoBALT emulation systems, and cycle-based simulation software. Maintenance and service revenue consists of fees for maintenance and support services, training and consulting. Total revenue increased by $826,000, or 1%, to $110.4 million in 1997 over 1996 compared with an increase of $27.1 million, or 33%, in 1996 over 1995. The relatively flat growth in total revenue in 1997 was attributable to an increase in maintenance and service revenue due to a larger installed customer base, partially offset by a decrease in product revenue. The decrease in product revenue in 1997 was due to lower product volume somewhat offset by a higher mix of emulation systems containing more emulation modules. The total revenue growth in 1996 and 1995 was primarily attributable to an increase of product revenue due to a higher mix of emulation systems containing more emulation modules. Product revenue accounted for 73%, 80% and 83% of total revenue in 1997, 1996 and 1995, respectively, while maintenance and service revenue accounted for 27%, 20% and 17% of total revenue in 1997, 1996 and 1995, 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 repro- grammable system components and lower component costs. Domestic revenue (North American sales) grew by 4%, 25% and 17% in 1997, 1996 and 1995, respectively, while international revenue decreased by 4% in 1997, and increased by 51% and 52% in 1996 and 1995, respectively. See Note 14 of the Notes to Consolidated Financial Statements. International revenue (sales outside of North America) accounted for approximately 34%, 36% and 31% of total revenue in 1997, 1996 and 1995, respectively. The decrease in international revenue in 1997 in dollar amounts was largely due to lower revenue in the Asia-Pacific markets, excluding Japan, which decreased by 64% to $2.9 million, somewhat offset by higher revenue in Europe which increased 27% to $11.2 million. The Company is uncertain whether the softness in the Asia-Pacific markets, excluding Japan, will continue in the foreseeable future due to extreme currency devaluation and liquidity problems in this region. The increase in international revenue in 1996 and 1995 was largely due to revenue growth in the Asia-Pacific markets which increased by 83% to $30.1 million in 1996 and by 77% to $16.5 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 p 19. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. exchange rate movements on the Company's operating results. There have been no material gains or losses associated with the Company's hedging program. However, 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. See Note 2 of the Notes to Consolidated Financial Statements. 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 43%, 52% and 48% of total revenue in 1997, 1996 and 1995, respectively. One customer, Fujitsu, comprised 12% of the Company's total revenue in 1996, and no customer individually comprised more than 10% of the Company's total revenue in 1997 and 1995. The Company expects that sales of its products to a relatively limited number of customers will continue to account for a high percentage of total 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 design verification 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 and cycle-based simulation software as well as the cost of providing service and maintenance. Total gross margins, which consist of product, and maintenance and service gross margins, were 70% in each of the three years 1997, 1996 and 1995. Product gross margins were 70% in each of the three years 1997, 1996 and 1995. Maintenance and service gross margins were 70% in 1997 and 69% in 1996 and 1995. 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. The Company expects competitive pressures to increase in its market from existing companies and new entrants, which among other things could result in a decreasing average sales price. 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 were $23.5 million, $19.7 million and $15.4 million in 1997, 1996 and 1995, respectively. The increases in research and development expenses were primarily attributable to increased staffing and equipment costs necessary to enhance current products and carry out research and development activities for the next generation emulation and cycle-based simulation products. Research and development expenses as a percentage of total revenue were approximately 21%, 18% and 19% in 1997, 1996 and 1995, respectively. The Company expects to continue to invest a significant amount of its resources in research and development. SALES AND MARKETING Sales and marketing expenses were $36.8 million, $32.0 million and $25.8 million in 1997, 1996 and 1995, respectively. Sales and marketing expenses increased in each period due to the expansion of the Company's sales and marketing organizations. As a percentage of total revenue, sales and marketing expenses were approximately 33%, 29% and 31% in 1997, 1996 and 1995, respectively. The Company expects that sales and marketing expenses will continue to increase in dollar amounts as the Company expands its sales and marketing efforts. GENERAL AND ADMINISTRATIVE General and administrative expenses were $11.5 million, $7.3 million and $5.0 million in 1997, 1996 and 1995, respectively. The increases in general and administrative expenses in 1997 and 1996 were primarily attributable to increased legal costs related to a patent infringement p 20. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. lawsuit filed by the Company in January 1996. See Note 16 of the Notes to Consolidated Financial Statements. The Company expects general and administrative expenses to increase in 1998 due primarily to continued legal costs. General and administrative expenses represented approximately 10%, 7% and 6% of total revenue in 1997, 1996 and 1995, respectively. ACQUISITION AND MERGER RELATED CHARGES In connection with the SpeedSim Merger, the Company recorded a one-time charge of $1.2 million in the first quarter of 1997 that included fees for investment banking, legal and accounting services and other costs of consolidating. In connection with the Arkos Acquisition, the Company incurred charges of $18.0 million in the third quarter of 1997 representing the portion of the purchase price expensed. The balance of the purchase price will be amortized over three to five years. The Company acquired certain in-process technology which was expensed in accordance with Interpretation 4 to Statement of Financial Accounting Standard No. 2, "Accounting for Research and Development Costs." Such in-process technology was valued, along with other acquired net assets, in accordance with valuation techniques commonly used in the technology industry. See Note 3 of the Notes to Consolidated Financial Statements. INTEREST INCOME AND EXPENSE Interest income was $2.4 million, $2.2 million and $1.8 million in 1997, 1996 and 1995, respectively. The increases in interest income in 1997 and 1996 were due primarily to a greater average balance of cash and cash equivalents and marketable securities. Interest expense was $272,000, $429,000 and $750,000 in 1997, 1996 and 1995, respectively. The decreases in interest expense in 1997 and 1996 were due primarily 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 a benefit of $5.9 million in 1997, an expense of $5.7 million in 1996 and a benefit of $612,000 in 1995, representing effective tax provision (benefit) rates of approximately (53%), 29% and (5%), respectively. The effective income tax rate was impacted by a reduction in the Company's valuation allowance against deferred tax assets of none, $1.9 million and $6.8 million for 1997, 1996 and 1995, respectively. The effective tax rate was also reduced by the tax benefit from the Company's foreign sales corporation, and by utilization of federal and state tax credits in all years presented. At December 31, 1997, the Company had federal net operating loss carryforwards of $5.7 million and federal and state tax credit carryforwards of $1.3 million and $1.1 million, respectively. A 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 Electronic Design Automation ("EDA") industry is highly competitive and rapidly changing. The Company faces significant competition for emulation-based system-level verification and cycle-based simulation, in addition to competition from traditional design verification methodologies which rely on the approach of building and then testing complete system prototypes. Because of the growing demand 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 and cycle-based simulation to increase as other companies attempt to introduce emulation and cycle-based simulation products and product enhancements, and as major new EDA technologies may emerge. 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 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 a suit against the Company for declaratory judgment of noninfringement, invalidity and unenforceability of several of the Company's patents. Several actions between these parties were consolidated in the U.S. District Court for the District of Oregon, where six of the Company's patents are now involved in the disputes. The Company has filed counterclaims against Mentor and Mentor's French subsidiary, Meta Systems ("Meta"), for p 21. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. infringement and threatened infringement of those six patents. Mentor has also filed claims against the Company for defamation and tortious interference. In January 1996, the Company filed a complaint with the International Trade Commission, seeking to stop unfair importation of hardware logic emulation systems and components manufactured by Meta on the grounds that such systems infringe the Company's patents. In November 1996, Aptix Corporation filed a suit against the Company alleging antitrust violations and unfair competition. In August 1997, a preliminary injunction sought by Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, was issued by a regional court in Munich, enjoining agents of the Company from making certain statements concerning U.S. litigation matters between Mentor and the Company. In October 1997, the Company filed suit in Germany against Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, for infringement of the Company's German patent. See Note 16 of the Notes to Consolidated Financial Statements. Although patent, intellectual property and related antitrust 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. IMPACT OF THE YEAR 2000 ISSUE Many existing computer systems, applications and other control devices use computer programs that recognize only two digits rather than four digits to define an applicable year. Therefore, any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000 (the "Year 2000 Issue"). This could result in a system failure or miscalculations causing disruptions of the Company's operations or in the ability of the Company's customers to effectively utilize the Company's design verification products. Based on recent assessments, the Company has determined that it will be required to modify or replace portions of its software so that its computer systems and design verification products will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software or conversion to new software, the Year 2000 Issue can be mitigated. However, if such modifications and/or conversions are not made, the Year 2000 Issue could have a material impact on the operations of the Company. The Company has initiated formal communications with its significant suppliers to determine the extent to which the Company is vulnerable to those third parties' failure to remedy their own Year 2000 Issue. However, there can be no assurance that the systems of other companies on which the Company's systems rely upon will be converted in a timely fashion, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company will utilize both internal and external resources to reprogram or replace, and test software for Year 2000 Issue modifications. The costs and timing of the project on which the Company plans to complete the Year 2000 Issue modifications are based on management's best estimates. Management has determined that the costs of the Year 2000 Issue project will not be material to the Company's results of operations, liquidity and capital resources. There can be no assurance that these estimates will be achieved and actual results could differ materially from those plans. Specific factors that might cause such material difference include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. 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 revenue, 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, since a significant portion of the Company's revenue and net income is derived 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. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement establishes requirements for disclosure of comprehensive income and becomes effective for the Company for fiscal years beginning after December 15, 1997, with reclassification of earlier financial statements for comparative p 22. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. purposes. Comprehensive income generally represents all changes in stockholders' equity except those resulting from investments or contributions by stockholders. The Company is evaluating alternative formats for presenting this information, but does not expect this pronouncement to materially impact the Company's results of operations. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supercedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." The new standard becomes effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company had $53.1 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 excluding the one-time write-off of the Arkos Acquisition and maintain quarterly debt service. The agreements also prohibit, among other things, the Company from paying cash dividends. See Note 8 of the Notes to Consolidated Financial Statements. Net cash provided by operating activities was $9.2 million, $22.4 million and $10.2 million in 1997, 1996 and 1995, respectively. The decrease in cash provided by operating activities in 1997 as compared to 1996 was primarily attributable to a decrease in net income and increase in accounts receivable, partially offset by the write-off of the Arkos Acquisition. Additionally, the increase in cash provided by operations in 1996 as compared to 1995 was primarily attributable to a significantly smaller decrease in deferred income taxes and an increase in deferred revenue. Net cash used in investing activities was $20.6 million, $13.3 million and $171,000 in 1997, 1996 and 1995, respectively. Net cash used in investing activities was related primarily to net purchases of marketable securities, and to acquisitions of property and equipment. The increase in cash used in investing activities in 1997 as compared to 1996 was primarily attributable to the Arkos Acquisition, while the increase in 1996 against 1995 was primarily due to an increase in net purchases of marketable securities. 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 $7.5 million, $6.4 million and $7.8 million in 1997, 1996 and 1995, 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 1998 will require additional expenditures of approximately $9.0 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 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 1998. 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. p 23. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, -------------------------------------- (amounts in thousands except per share data) 1997 1996 1995 - ------------------------------------------------------------------------------------------ Revenue Product revenue $ 80,850 $ 88,090 $ 68,321 Maintenance and service revenue 29,554 21,488 14,121 -------------------------------------- Total revenue 110,404 109,578 82,442 Cost of revenue Cost of product revenue 23,984 26,050 20,776 Cost of maintenance and service revenue 8,896 6,613 4,330 -------------------------------------- Total cost of revenue 32,880 32,663 25,106 -------------------------------------- Gross profit 77,524 76,915 57,336 Operating expenses Research and development 23,499 19,706 15,436 Sales and marketing 36,775 31,982 25,809 General and administrative 11,485 7,254 5,006 Acquisition and merger related charges 19,231 -- -- -------------------------------------- Total operating expenses 90,990 58,942 46,251 -------------------------------------- Operating income (loss) (13,466) 17,973 11,085 Interest income 2,370 2,229 1,792 Interest expense (272) (429) (750) Other income (expense), net 77 79 (261) -------------------------------------- Net income (loss) before provision for (benefit from) income taxes (11,291) 19,852 11,866 Provision for (benefit from) income taxes (5,945) 5,721 (612) -------------------------------------- Net income (loss) $ (5,346) $ 14,131 $ 12,478 -------------------------------------- -------------------------------------- Basic net income (loss) per share $ (0.31) $ 0.87 $ 0.81 -------------------------------------- -------------------------------------- Number of shares used in basic per share calculation 17,110 16,323 15,497 -------------------------------------- -------------------------------------- Diluted net income (loss) per share $ (0.31) $ 0.79 $ 0.74 -------------------------------------- -------------------------------------- Number of shares used in diluted per share calculation 17,110 17,912 16,806 -------------------------------------- --------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. p 24. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS
December 31, ------------------------- (amounts in thousands except share data) 1997 1996 - ---------------------------------------------------------------------------- Assets Current assets Cash and cash equivalents $ 14,589 $ 25,790 Marketable securities 18,219 10,614 Accounts receivable, net of allowance for doubtful accounts of $1,840 in 1997 and 1996 31,709 21,768 Inventories 10,899 10,141 Prepaid expenses and other current assets 4,324 2,991 Deferred income taxes 8,697 5,871 ------------------------ Total current assets 88,437 77,175 Marketable securities 20,326 18,198 Fixed assets, net 11,118 11,243 Deferred income taxes 8,029 2,939 Other assets 1,282 2,422 ------------------------ Total assets $ 129,192 $ 111,977 ------------------------ ------------------------ Liabilities Current liabilities Short term debt $ 1,095 $ 3,502 Accounts payable 6,231 894 Accrued liabilities 20,351 14,586 Deferred revenue 9,617 8,950 ------------------------ Total current liabilities 37,294 27,932 ------------------------ Total liabilities 37,294 27,932 ------------------------ Commitments and contingencies (Notes 10 and 16). Stockholders' Equity Preferred stock, $.001 par value: Authorized: 2,000,000 shares; Issued and outstanding: no shares -- -- Common stock, $.001 par value: Authorized: 40,000,000 shares; Issued and outstanding: 17,606,006 shares in 1997; 16,526,904 shares in 1996 18 17 Additional paid-in capital 91,122 77,545 Cumulative translation adjustment (653) -- Unrealized holding gains on marketable securities 88 10 Retained earnings 1,896 7,242 Deferred compensation (573) (769) ------------------------ Total stockholders' equity 91,898 84,045 ------------------------ Total liabilities and stockholders' equity $ 129,192 $ 111,977 ------------------------ ------------------------
The accompanying notes are an integral part of these consolidated financial statements. p 25. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional Cumulative ------------------ Paid-in Translation (amounts in thousands except share data) Shares Amount Capital Adjustment - -------------------------------------------------------------------------------------- Balance, Dec 31, 1994 13,102,067 $ 13 $ 69,297 $ -- Issuance of common stock 2,399,039 2 1,601 -- Issuance of common stock, employee stock purchase plan 158,488 -- 1,091 -- Exercise of stock options 335,505 1 574 -- Tax benefit from option exercises -- -- 545 -- Unrealized holding gains on marketable securities -- -- -- -- Net income -- -- -- -- --------------------------------------------- Balance, Dec 31, 1995 15,995,099 16 73,108 -- Issuance of common stock, employee stock purchase plan 198,117 -- 1,452 -- Exercise of stock options 333,688 1 1,161 -- Tax benefit from option exercises -- -- 999 -- SpeedSim issuance of stock options in lieu of compensation -- -- 825 -- Unrealized holding losses on marketable securities -- -- -- -- Amortization of deferred compensation -- -- -- -- Net income -- -- -- -- --------------------------------------------- Balance, Dec 31, 1996 16,526,904 17 77,545 -- Issuance of common stock, employee stock purchase plan 176,733 -- 1,812 -- Exercise of stock options and warrants 402,369 -- 1,406 -- Tax benefit from option exercises -- -- 860 -- Issuance of common stock for Arkos Acquisition 500,000 1 6,499 -- Issuance of warrants for Arkos Acquisition -- -- 3,000 -- Unrealized holding gains on marketable securities -- -- -- -- Cumulative translation adjustment -- -- -- (653) Amortization of deferred compensation -- -- -- -- Net loss -- -- -- -- --------------------------------------------- Balance, Dec 31, 1997 17,606,006 $ 18 $ 91,122 $ (653) --------------------------------------------- ---------------------------------------------
Unrealized Holding Gains (Losses) on Retained Marketable Earnings Deferred Securities (Deficit) Compensation Total ----------------------------------------------- Balance, Dec 31, 1994 $ (336) $(19,367) $ -- $ 49,607 Issuance of common stock -- -- -- 1,603 Issuance of common stock, employee stock purchase plan -- -- -- 1,091 Exercise of stock options -- -- -- 575 Tax benefit from option exercises -- -- -- 545 Unrealized holding gains on marketable securities 438 -- -- 438 Net income -- 12,478 -- 12,478 ----------------------------------------------- Balance, Dec 31, 1995 102 (6,889) -- 66,337 Issuance of common stock, employee stock purchase plan -- -- -- 1,452 Exercise of stock options -- -- -- 1,162 Tax benefit from option exercises -- -- -- 999 SpeedSim issuance of stock options in lieu of compensation -- -- (825) -- Unrealized holding losses on marketable securities (92) -- -- (92) Amortization of deferred compensation -- -- 56 56 Net income -- 14,131 -- 14,131 ----------------------------------------------- Balance, Dec 31, 1996 10 7,242 (769) 84,045 Issuance of common stock, employee stock purchase plan -- -- -- 1,812 Exercise of stock options and warrants -- -- -- 1,406 Tax benefit from option exercises -- -- -- 860 Issuance of common stock for Arkos Acquisition -- -- -- 6,500 Issuance of warrants for Arkos Acquisition -- -- -- 3,000 Unrealized holding gains on marketable securities 78 -- -- 78 Cumulative translation adjustment -- -- -- (653) Amortization of deferred compensation -- -- 196 196 Net loss -- (5,346) -- (5,346) ----------------------------------------------- Balance, Dec 31, 1997 $ 88 $ 1,896 $ (573) $ 91,898 ----------------------------------------------- -----------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. p 26. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ----------------------------------- (amounts in thousands) 1997 1996 1995 - ----------------------------------------------------------------------------------------------- Cash flows from operating activities Net income (loss) $ (5,346) $ 14,131 $ 12,478 Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization 7,820 8,524 7,902 Amortization of deferred compensation 196 56 -- Write-off of Arkos Acquisition 18,031 -- -- Write-down of inventories 1,551 719 244 Deferred income taxes (7,378) (782) (6,814) Changes in current assets and liabilities Accounts receivable (9,941) (710) (1,133) Inventories (6,481) (3,055) (1,771) Prepaid expenses and other current assets (1,871) (1,094) (1,243) Accounts payable and accrued liabilities 11,962 (285) 56 Deferred revenue 667 4,912 464 ----------------------------------- Net cash provided by operating activities 9,210 22,416 10,183 ----------------------------------- Cash flows from investing activities Acquisition of fixed assets (7,529) (6,413) (4,833) Sale of marketable securities 16,173 20,527 28,926 Purchase of marketable securities (25,828) (25,544) (23,706) Purchase of Arkos (5,000) -- -- Increase (decrease) in other assets 1,615 (1,868) (558) ----------------------------------- Net cash used in investing activities (20,569) (13,298) (171) ----------------------------------- Cash flows from financing activities Proceeds from equipment financing -- -- 1,500 Payments of debts (2,407) (3,600) (4,020) Proceeds from stock issuances 3,218 2,614 3,269 ----------------------------------- Net cash provided by (used in) financing activities 811 (986) 749 ----------------------------------- Effect of exchange rates on cash and cash equivalents (653) -- -- ----------------------------------- Net increase (decrease) in cash and cash equivalents (11,201) 8,132 10,761 Cash and cash equivalents at beginning of year 25,790 17,658 6,897 ----------------------------------- Cash and cash equivalents at end of year $ 14,589 $ 25,790 $ 17,658 ----------------------------------- ----------------------------------- Supplemental disclosure of cash flow information Cash paid during the period for: Interest $ 278 $ 417 $ 828 Income taxes $ 3,187 $ 5,112 $ 776 Supplemental disclosure of noncash investing and financing activities Additions to fixed assets through capital lease obligations $ -- $ -- $ 2,994 Unrealized holding gains (losses) on marketable securities $ 78 $ (92) $ 438 Tax benefit from stock option exercises $ 860 $ 999 $ 545 Assets acquired in Arkos Acquisition $ 641 $ -- $ -- Common stock and warrants issued in Arkos Acquisition $ 9,500 $ -- $ --
The accompanying notes are an integral part of these consolidated financial statements. p 27. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS OF THE COMPANY Quickturn Design Systems, Inc. (the "Company" or "Quickturn") designs, manufactures, sells and supports emulation and cycle-based simulation system-level verification solutions for the design of integrated circuits and electronic systems. The Company's development and manufacturing facilities are located in San Jose, California, and additional development facilities are located in North Chelmsford, Massachusetts. 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 ("EDA") 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. The Company has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area. 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 U.S. government. The Company has not experienced any material losses in any of the instruments it has used for excess cash balances. The Company uses forward exchange contracts to hedge certain assets denominated in foreign currencies. For these instruments, risk reduction is assessed on a transaction basis and the instruments are designated and deemed effective as a hedge and are highly inversely correlated to the hedged item as required by generally accepted accounting principles. Gains and losses on these hedges are included in the carrying amounts of the assets and are ultimately recognized in income as part of those carrying amounts. If a hedging instrument ceases to qualify as a hedge, any subsequent gains and losses are recognized currently in income. The Company does not use any derivatives for trading or speculative purposes. If a derivative ceases to qualify for hedge accounting, it is accounted for on a mark to market basis. p 28. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. TRANSLATION OF FOREIGN CURRENCIES Effective in 1997, the Company's foreign subsidiary in Japan is considered an independent operation having the local currency as its functional currency. Accordingly, its net assets are translated at year-end exchange rates, while its income and expense accounts are translated at average rates in effect during the year. Adjustments resulting from these translations are reflected in the Stockholders' Equity section titled "Cumulative translation adjustment." Prior to 1997, all of the Company's foreign subsidiaries, including Japan, were considered to be extensions of the U.S. operation having the U.S. dollar as their functional currency. The Company's foreign subsidiaries whose functional currency is the U.S. dollar translate monetary assets and liabilities at year-end exchange rates while non-monetary items are translated at historical rates. Income and expense accounts are translated at average rates, except for depreciation and cost of revenue which are translated at historical rates. Translation gains and losses related to these subsidiaries are included in income. REVENUE RECOGNITION The Company recognizes revenue from sales of its design verification 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 values of the note payable and capital lease obligations approximate fair value. Estimated fair values for marketable securities (See Note 4) 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 generally based on a straight-line method over the estimated useful lives of the assets, generally one to three years. Leasehold improvements are amortized based 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 years. ACCRUED WARRANTY The Company provides an accrual for future warranty costs based on the historical relationship of revenue to warranty costs incurred. INCOME TAXES The Company provides for income taxes under the liability method in accordance with Statement of Financial Accounting Standards No.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 (LOSS) PER SHARE Effective in 1997, the Company adopted Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." All prior-period earnings per share data presented have been restated to comply with SFAS 128. The adoption of this standard did not have a material impact on the Company's earnings per share. p 29. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. Basic net income (loss) per share is calculated using the weighted average number of common shares outstanding for the period. Diluted net income (loss) 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 Effective in 1997, the Company changed its fiscal year to December 31 from a 52-week or 53-week year, ending on the last Sunday in December. The change had no significant impact on the current period results of operations. For purposes of presentation, the Company has indicated that its fiscal year ended on December 31 for 1995 and 1996, although it operated on a 52-week or 53-week fiscal year for those years. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement establishes requirements for disclosure of comprehensive income and becomes effective for the Company for fiscal years beginning after December 15, 1997, with reclassification of earlier financial statements for comparative purposes. Comprehensive income generally represents all changes in stockholders' equity except those resulting from investments or contributions by stockholders. The Company is evaluating alternative formats for presenting this information, but does not expect this pronouncement to materially impact the Company's results of operations. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supercedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." The new standard becomes effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. 3. BUSINESS COMBINATIONS In February 1997, the Company merged with 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 merger was accounted for as a pooling of interests. The Company incurred direct transaction costs of $1.2 million associated with the merger, which were charged to operations during the quarter ended March 31, 1997. All financial information herein has been restated to include the results of operations of SpeedSim. Revenue and net income (loss) of the separate companies during the periods preceding the SpeedSim Merger are presented below.
Year ended December 31, ------------------------ (in thousands) 1996 1995 - ----------------------------------------------------------------- Revenue The Company $ 104,370 $ 81,800 SpeedSim 5,208 642 --------- -------- Combined $ 109,578 $ 82,442 --------- -------- --------- -------- Net income (loss) The Company $ 12,639 $ 13,083 SpeedSim 1,492 (605) --------- -------- Combined $ 14,131 $ 12,478 --------- -------- --------- --------
In June 1997, pursuant to an asset purchase agreement among the Company, Synopsys, Inc. ("Synopsys") and Arkos Design, Inc. ("Arkos"), the Company purchased from Synopsys certain assets relating to Synopsys's emulation business, including all the outstanding capital stock of Arkos (the "Arkos Acquisition"). The consideration paid by the Company was valued at $14.5 million and consisted of $5.0 million cash, 500,000 shares of Quickturn common stock and warrants to purchase 1.0 million shares of Quickturn common stock. The exercise price of the warrants is $13.34 per share. The acquisition was accounted for as a purchase. The Company recognized charges of $18.0 million in the third quarter of 1997, which consisted of a $2.8 million write-off of the portion of the purchase price which was allocated to in-process research and development and marketing rights, and $15.2 million for the accrual of certain liabilities incurred in connection with the acquisition and other costs related to the acquisition. The balance of the purchase price, consisting of intellectual property of $541,000 and fixed assets of $100,000, is being amortized over three to five years. p 30. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. 4. MARKETABLE SECURITIES At December 31, 1997 and 1996, all marketable securities are classified as available-for-sale and are summarized as follows: Marketable securities at December 31, 1997
Net Unrealized Market Cost Unrealized Unrealized Gains (in thousands) Value Basis Gains Losses (Losses) - ---------------------------------------------------------------------------------------------------------- U.S. government debt securities $ 14,562 $ 14,549 $ 21 $ (8) $ 13 Municipal debt securities 22,424 22,348 78 (2) 76 Corporate debt securities 1,559 1,560 2 (3) (1) ---------------------------------------------------------------- $ 38,545 $ 38,457 $ 101 $(13) $ 88 ---------------------------------------------------------------- ----------------------------------------------------------------
Marketable securities at December 31, 1996
Net Unrealized Market Cost Unrealized Unrealized Gains (in thousands) Value Basis Gains Losses (Losses) - ---------------------------------------------------------------------------------------------------------- U.S. government debt securities $ 6,655 $ 6,664 $ 6 $ (15) $ (9) Municipal debt securities 17,815 17,800 39 (24) 15 Corporate debt securities 4,342 4,338 5 (1) 4 ---------------------------------------------------------------- $ 28,812 $ 28,802 $ 50 $ (40) $ 10 ---------------------------------------------------------------- ----------------------------------------------------------------
At December 31, 1997 and 1996, all marketable debt securities classified as current had scheduled maturities of less than one year. Marketable debt securities classified as noncurrent had scheduled maturities of one to three years. 5. INVENTORIES Inventories comprise:
December 31, --------------------- (in thousands) 1997 1996 - ----------------------------------------------------- Raw materials $ 6,780 $ 8,431 Work in process 4,119 1,710 --------------------- $ 10,899 $ 10,141 --------------------- ---------------------
6. FIXED ASSETS Fixed assets comprise:
December 31, ------------------ (in thousands) 1997 1996 - ------------------------------------------------------------ Equipment $ 23,070 $ 24,731 Furniture, fixtures and leasehold improvements 6,072 3,598 Demonstration and rental equipment 1,698 4,829 -------------------- 30,840 33,158 Less accumulated depreciation and amortization (19,722) (21,915) -------------------- $ 11,118 $ 11,243 -------------------- --------------------
Depreciation and amortization expense amounted to $7,754,000, $8,238,000 and $7,008,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Fixed assets include equipment under capital leases as follows:
December 31, ------------------ (in thousands) 1997 1996 - ------------------------------------------------------------ Cost $ 495 $ 2,302 Less accumulated amortization (389) (1,313) --------------------- $ 106 $ 989 --------------------- ---------------------
The equipment under capital leases is pledged as collateral for repayment of the related lease obligations. 7. ACCRUED LIABILITIES Accrued liabilities comprise:
December 31, ------------------ (in thousands) 1997 1996 - ------------------------------------------------------------ Accrued payroll and related items $ 7,218 $ 5,466 Income taxes payable 5,789 6,298 Other accrued liabilities 7,344 2,822 -------------------- $20,351 $ 14,586 -------------------- --------------------
p 31. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. 8. BANK BORROWING ARRANGEMENTS The Company has unsecured revolving lines of credit totaling $9.8 million which provide for borrowings through June 1, 1998. Borrowings under these agreements bear interest at the banks' prime rate (8.5% at December 31, 1997). The agreements are subject to certain restrictive covenants which include achieving annual profitability, excluding the one-time write-off of the Arkos Acquisition, and meeting certain financial ratios and minimum tangible net worth requirements. The Company is currently in compliance with the agreement. The agreements also prohibit the payment of cash dividends. To date, no funds have been drawn against the lines of credit. 9. SHORT TERM DEBT Capital Lease Obligations The Company has equipment leases totaling $495,000 at interest rates varying from 8.7% to 9.4%. Certain lease obligations were collateralized by restricted deposits at December 31, 1997 and 1996 of $73,000 and $85,000, respectively, which are included in other assets. Minimum future lease payments for the year ending December 31, 1997, under all equipment lease arrangements, are $510,000, of which $15,000 represents interest. Note Payable At December 31, 1997, the Company had an uncollateralized note payable of $600,000. The note had an original principal balance of $3.0 million and bears interest at 4% per annum, payable quarterly. 10. COMMITMENTS The Company leases its operating facilities under noncancellable operating leases with terms greater than one year. At December 31, 1997, future minimum rent payments under these leases are as follows:
(in thousands) Year ending December 31, - ------------------------------------------------------------ 1998 $ 4,806 1999 4,853 2000 3,924 2001 3,345 2002 3,436 Thereafter 5,262 -------- $ 25,626 -------- --------
Rent expense related to the facilities and various equipment leases was $2,704,000, $1,615,000 and $1,359,000 for the years ended December 31, 1997, 1996 and 1995, respectively. 11. STOCKHOLDERS' EQUITY Stock Option Plans As of December 31, 1997, the Company had reserved 4,743,060 shares of common stock 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, 1997, there were no shares subject to repurchase. In accordance with Accounting Principles Board Opinion No.25 ("APB 25"), the Company recognized $825,000 of deferred compensation which is amortized over the vesting period of the options. The amortization expense for the years ended December 31, 1997, 1996 and 1995 was $196,000, $56,000 and none, respectively. Employee Stock Purchase Plan As of December 31, 1997, the Company had reserved 579,302 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 1997, 1996 and 1995 were 176,733, 198,117 and 158,488, respectively. Warrants At December 31, 1997, warrants to purchase 1.2 million shares of common stock (of which 700,000 were exercisable) were outstanding which may be exercised at prices ranging from $13.34 to $30.00 per share. The warrants expire over periods ranging from 2 to 3 years. p 32. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. Information with respect to activity under these stock option plans is set forth below:
Outstanding Options Shares ---------------------------------------------------------- (amounts in thousands, Available Options Number Price Aggregate Weighted Avg. except share data) for Grant Exercised of Shares Per Share Price Exercise Price - ----------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994 207,025 677,346 2,194,188 $ 0.26 - $ 13.25 $ 8,519 $ 3.62 Additional shares reserved 1,428,164 -- -- -- -- -- Options granted (926,078) -- 926,078 $ 0.19 - $ 11.63 6,357 $ 6.86 Options exercised -- 336,401 (336,401) $ 0.26 - $ 10.38 (575) $ 1.71 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 1,024,224 1,013,747 2,456,151 $ 0.19 - $ 13.25 12,331 $ 5.02 Additional shares reserved 1,000,000 -- -- -- -- -- Options granted (1,436,110) -- 1,436,110 $ 0.19 - $ 19.00 15,206 $10.59 Options exercised -- 333,688 (333,688) $ 0.30 - $ 11.63 (1,166) $ 3.49 Options terminated 363,852 -- (363,852) $ 0.50 - $ 13.25 (3,302) $ 9.08 Options retired -- -- (117) $ 0.64 - $ 0.64 -- $ 0.64 -------------------------------------- -------- Balance, December 31, 1996 951,966 1,347,435 3,194,604 $ 0.19 - $ 19.00 23,069 $ 7.22 Additional shares reserved 1,000,000 -- -- -- -- -- Options granted (751,097) -- 751,097 $ 2.83 - $ 18.63 8,617 $11.47 Options exercised -- 389,156 (389,156) $ 0.19 - $ 13.50 (1,406) $ 3.61 Options terminated 267,791 -- (267,791) $ 6.13 - $ 19.00 (3,330) $12.44 Options retired -- -- (14,354) $ 0.19 - $ 6.30 (33) $ 2.30 -------------------------------------- -------- Balance, December 31, 1997 1,468,660 1,736,591 3,274,400 $ 0.19 - $ 19.00 $ 26,917 $ 8.22 -------------------------------------- -------- -------------------------------------- --------
At December 31, 1997 and 1996, vested options to purchase 1,657,860 and 1,251,457 shares, respectively, were unexercised. The following table summarizes information with respect to stock options outstanding at December 31, 1997:
Options Outstanding Options Exercisable ------------------------------------------------------- ----------------------------- Number Weighted Average Weighted Average Number Weighted Average Range of Outstanding Remaining Exercise Exercisable Exercise Exercise Prices at 12/31/97 Contractual Life (Years) Price at 12/31/97 Price - ------------------------------------------------------------------------------------------------------------- $ 0.19 - $ 0.95 373,101 6.24 $ 0.49 322,696 $ 0.44 $ 1.42 - $ 6.13 825,675 5.68 $ 3.80 713,679 $ 3.77 $ 6.30 - $ 10.50 761,884 8.06 $ 8.45 318,484 $ 8.60 $ 11.50 - $ 13.13 741,065 8.67 $ 12.01 232,891 $ 11.97 $ 13.38 - $ 19.00 572,675 9.30 $ 14.41 70,110 $ 15.19 --------- --------- $ 0.19 - $ 19.00 3,274,400 7.61 $ 8.22 1,657,860 $ 5.68 --------- --------- --------- ---------
p 33. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. The Company accounts for its stock option and employee stock purchase plans in accordance with APB 25 and related interpretations. The following information concerning such plans is provided in accordance with Statement of Financial Accounting Standards No.123 ("SFAS 123"), "Accounting for Stock-Based Compensation." 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 1997:
Group A Group B - ----------------------------------------------------- Risk-free interest rates 6.16% 6.16% Expected life 5 years 4 years Volatility 0.80 0.80 Dividend yield -- --
Similarly, the following weighted average assumptions were 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 values of those options granted in 1997, 1996 and 1995 were $7.24, $8.43 and $5.84, respectively. The Company has also estimated the fair value of the purchase rights issued under the Company's Employee Stock Purchase Plan, using the Black-Scholes valuation model with the following weighted average assumptions for all years reported: Risk-free interest rates 5.84% Expected life 1.25 years Volatility 0.72 Dividend yield --
The weighted average fair values of those purchase rights granted in 1997, 1996 and 1995 were $6.14, $5.15 and $3.74, respectively. The following pro forma income information has been prepared in accordance with the provisions of SFAS 123:
(amounts in thousands except per share data) 1997 1996 1995 - --------------------------------------------------------------------------- Net income (loss) - pro forma $ (7,516) $ 12,430 $ 11,701 Basic net income (loss) per share - pro forma $ (0.44) $ 0.76 $ 0.76 Diluted net income (loss) per share - pro forma $ (0.44) $ 0.69 $ 0.70
The above pro forma effects on net income (loss) 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. p 34. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. 12. INCOME TAXES Income before taxes and details of the income tax provision consist of the following:
Year Ended December 31, ---------------------------------- (in thousands) 1997 1996 1995 - ---------------------------------------------------------------------- Domestic income (loss) before taxes $ (11,813) $ 18,856 $ 11,530 Foreign income before taxes 522 996 336 ---------------------------------- Income (loss) before taxes $ (11,291) $ 19,852 $ 11,866 ---------------------------------- ---------------------------------- Income tax provision (benefit) Federal Current payable (net of benefit from utilization of net operating loss carryforwards of $1,292 and $2,068 for 1996 and 1995, respectively) $ 703 $ 5,235 $ 5,279 Deferred (6,155) (678) (5,579) ---------------------------------- (5,452) 4,557 (300) State Current payable 365 692 749 Deferred (1,223) (103) (1,235) ---------------------------------- (858) 589 (486) Foreign Current payable 365 575 174 Deferred -- -- -- ---------------------------------- 365 575 174 ---------------------------------- Income tax provision (benefit) $ (5,945) $ 5,721 $ (612) ---------------------------------- ----------------------------------
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, ---------------------------------- (in thousands) 1997 1996 1995 - ---------------------------------------------------------------------- Income tax at statutory rate (35.0%) 35.0% 35.0% State income taxes, net of federal benefit (10.8%) 5.5% 6.2% Change in valuation allowance -- (9.5%) (55.0%) Benefit of foreign sales corporation (2.4%) (3.0%) (0.4%) Nondeductible expenses -- 0.5% 2.1% Foreign taxes 0.7% 1.4% 4.1% Research and development and business tax credits (7.6%) (3.7%) (2.0%) Other 2.4% 2.6% 4.9% ---------------------------------- Effective tax provision (benefit) rate (52.7%) 28.8% (5.1%) ---------------------------------- ----------------------------------
The effective income tax provision (benefit) rate in 1997, 1996 and 1995 was impacted by a reduction in the Company's valuation allowance against deferred tax assets of none, $1.9 million and $6.8 million, respectively. The components of the net deferred tax assets are:
December 31, --------------------- (in thousands) 1997 1996 - ---------------------------------------------------------------------- Accrued vacation and bonus $ 391 $ 283 Reserve for inventories 4,386 1,793 Depreciation expense 1,806 1,864 Deferred revenue 1,129 970 Other liabilities and reserves 4,312 2,666 State taxes, net of federal benefit -- 118 Net operating loss carryforwards 2,049 767 Research and development and business credits 2,653 350 ----------------------- Net deferred tax assets $ 16,726 $ 8,811 ----------------------- -----------------------
No provision has been made for federal, state or foreign taxes that may result from future remittances of undistributed earnings of foreign subsidiaries ($806,000 at December 31, 1997) 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 totaled $860,000 in 1997 and $999,000 in 1996 was credited directly to additional paid-in capital. At December 31, 1997, the Company had approximately $5.7 million of federal net operating loss carryforwards and federal and state tax credit carryforwards of $1.3 million and $1.1 million, respectively. The carryforwards expire in 2005 through 2011, if not utilized. A portion of the Company's net operating loss and tax credit carryforwards is subject to an annual limitation of approximately $1.2 million. p 35. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. 13. EARNINGS PER SHARE Basic and diluted earnings per share were calculated as follows:
Year Ended December 31, ----------------------------------------------------------------------------------------- 1997 1996 1995 ---------------------------- ---------------------------- ---------------------------- (amounts in thousands except Per share Net Per share Net Per share per share amounts) Net Loss Shares Amount Income Shares Amount Income Shares Amount - ------------------------------------------------------------- ---------------------------- ---------------------------- Net Income (loss) ($5,346) $14,131 $12,478 BASIC EPS Net Income (loss) available to common stockholders ($5,346) 17,110 ($0.31) $14,131 16,323 $0.87 $12,478 15,497 $0.81 ------ ----- ----- ------ ----- ----- EFFECT OF DILUTIVE SECURITIES Options -- -- -- 1,554 -- 1,303 Warrants -- -- -- 35 -- 6 ---------------- ---------------- --------------- -- -- -- 1,589 -- 1,309 DILUTED EPS Income (loss) available to common stockholders plus assumed conversions ($5,346) 17,110 ($0.31) $14,131 17,912 $0.79 $12,478 16,806 $0.74 -------------------------- --------------------------- --------------------------- -------------------------- --------------------------- ---------------------------
Options to purchase 1,547,522 shares and warrants for 50,802 shares were outstanding during 1997 but were not included in the computation of diluted EPS because their inclusion would have an anti-dilutive effect on the net loss per share. During 1997, 1996 and 1995, options to purchase 174,118, 73,281 and 142,731 shares, respectively, at weighted average exercise prices of $17.25, $14.64 and $11.31 per share, respectively, were outstanding, but were not included in the computation of diluted EPS because the exercise price of the options was greater than the average market price of the common shares. During 1997 and 1996, warrants for 200,000 shares at a weighted average exercise price of $30.00 per share, and during 1995, warrants for 450,000 shares at a weighted average exercise price of $20.00 per share were outstanding but were not included in the computation of diluted EPS because the exercise price of the warrants was greater than the average market price of the common shares. At the end of 1997, anti-dilutive options for 174,118 shares and anti-dilutive warrants for 200,000 shares were still outstanding. p 36. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. 14. BUSINESS SEGMENTS AND MAJOR CUSTOMERS The Company operates in a single industry segment encompassing the development, manufacture, sale and support of system-level verification solutions for the design of integrated circuits and electronic systems. The Company's top ten customers represented 43%, 52% and 48% of total revenue for the years ended December 31, 1997, 1996 and 1995, respectively. In the year ended December 31, 1996, one customer, Fujitsu, comprised 12% of the Company's total revenue, and in the years ended December 31, 1997 and 1995, no customer individually constituted 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:
Year Ended December 31, --------------------------------- (in thousands) 1997 1996 1995 - ----------------------------------------------------------------- North America $ 73,186 $ 70,658 $ 56,702 Asia-Pacific 26,025 30,138 16,496 Europe 11,193 8,782 9,244 ---------------------------------- $ 110,404 $ 109,578 $ 82,442 ---------------------------------- ----------------------------------
North America sales include sales to U.S. customers of $71.1 million, $69.4 million and $55.1 million in 1997, 1996 and 1995, respectively. Identifiable assets of foreign operations are not significant. The net income (loss) for all periods presented are derived primarily from the Company's North American operations. 15. 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 made total contributions to the plans of $497,000 and $394,000 for the years ended December 31, 1997 and 1996, respectively, and none for the year ended December 31, 1995. 16. CONTINGENCIES 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 French subsidiary of Mentor. In the complaint, the Company alleges that Mentor's hardware logic emulation systems infringe the Company's patents. In July 1996, an ITC Administrative Law Judge issued an Initial Determination granting a Temporary Exclusion Order stopping the importation of Mentor's emulation systems into the United States, absent the posting of a bond by Mentor. The ITC Initial Determination included a Cease and Desist Order against all sales activities regarding unbonded Mentor emulation products imported into the United States. In August 1996, the ITC ratified the judge's Initial Determination. Mentor and Meta appealed the Temporary Exclusion Order to the Federal Circuit Court of Appeals, asking that the ITC's Interpretation of Quickturn's patent claims be overturned. On August 15, 1997, the Federal Circuit Court of Appeals affirmed the ITC's decision granting temporary relief to the Company and adopted the patent claim interpretation of the ITC as being correct and derived in accordance with the Federal Circuit's case law. Meanwhile, on August 1, 1997, the ITC Administrative Law Judge issued an Initial Determination that Mentor's SimExpress emulation systems and components, including software components, infringe five of the Company's patents. The Administrative Law Judge recommended that the ITC issue a Permanent Exclusion Order prohibiting the importation of infringing SimExpress systems and components. The Administrative Law Judge further p 37. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. recommended that the ITC issue a Cease and Desist Order prohibiting Mentor from distributing any SimExpress software of non-U.S. origin in the United States. On October 2, 1997, the ITC ratified the Administrative Law Judge's Initial Determination. On December 3, 1997, the ITC issued a Permanent Limited Exclusion Order permanently prohibiting the importation of hardware logic emulation systems, subassemblies or components (including software) manufactured by Mentor and/or Meta. At the same time, the ITC issued a Permanent Cease and Desist Order permanently prohibiting Mentor from, among other things, selling, offering for sale or advertising the same hardware logic emulation devices. The period in which President Clinton had to review the ITC's actions expired on February 2, 1998 and the two orders became final by operation of law. 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 prospective economic relations. In June 1997, Quickturn filed a motion for preliminary injunction, asking the District Court to prohibit Mentor from manufacturing, assembling, marketing, loaning or otherwise distributing emulation products and components in the United States, which products and components infringe certain claims in Quickturn's U.S. Patent No. 5,036,473. On August 1, 1997, the U.S. District Court in Oregon granted Quickturn's motion for a preliminary injunction against Mentor's domestic emulation activities. In August 1997, a preliminary injunction sought by Mentor's German subsidiary, Mentor Graphics (Deutschland) GmbH, was issued by a regional court in Munich, enjoining agents of the Company from making certain statements concerning U.S. litigation matters between the Company and Mentor. On October 17, 1997, the Company filed a complaint alleging infringement of the German part of the Company's European Patent No. 0 437 491 B1 against Mentor Graphics (Deutschland) GmbH, in the District Court of Dusseldorf. A preliminary hearing in this case is set for mid-February. Aptix Corporation ("Aptix") also filed a suit against the Company alleging various violations of the antitrust laws and unfair competition. The discovery phase of this case was recently completed. The Company has mounted vigorous defenses against Mentor's defamation and tortious interference claims and the antitrust and unfair competition claims by Aptix. 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. p 38. 1997 annual report QUICKTURN DESIGN SYSTEMS, INC. REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders Quickturn Design Systems, Inc. San Jose, California We have audited the accompanying consolidated balance sheets of Quickturn Design Systems, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. San Jose, California January 20, 1998 EX-21.1 5 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) 7. Quickturn Design Systems Israel Ltd. EX-23.1 6 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. 333-21587, No. 333-18407 and No. 33-25459) pertaining to the 1988 Stock Option Plan, 1990 Stock Option Plan, 1992 Key Executive Stock Option Plan, 1993 Employee Qualified Stock Purchase Plan, 1994 Outside Director Stock Option Plan, SpeedSim, Inc. 1995 Incentive and Nonqualified Stock Option Plan, 1996 Supplemental Stock Plan and 1997 Stock Option Plan, and in the Registration Statement (Form S-3, No. 333-22907) of our reports, dated January 20, 1998, on our audits of the consolidated financial statements and financial statement schedule of Quickturn Design Systems, Inc. as of December 31, 1997 and 1996, and for the three years in the period ended December 31, 1997, which reports are incorporated by reference or included in this Annual Report on Form 10-K. /s/ Coopers & Lybrand L.L.P. San Jose, California March 27, 1998 EX-27.1 7 EXHIBIT 27.1
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, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 14,589 18,219 33,549 1,840 10,899 88,437 30,840 19,722 129,192 37,294 0 0 0 18 91,880 129,192 110,404 110,404 32,880 32,880 90,990 0 272 (11,291) (5,945) (5,346) 0 0 0 (5,346) (0.31) (0.31)
EX-27.2 8 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S FORM 10-K AND FORMS 10-Q FOR FISCAL YEAR 1996. THE FIGURES HEREIN REFLECT THE FEBRUARY 1997 MERGER OF THE COMPANY WITH SPEEDSIM, INC. WHICH WAS ACCOUNTED FOR AS A POOLING OF INTERESTS. 1,000 YEAR 3-MOS 6-MOS 9-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996 25,790 21,339 24,078 29,425 10,614 15,927 15,109 13,678 23,608 17,825 23,221 21,352 1,840 1,840 1,867 1,840 10,141 9,284 10,055 10,059 77,175 70,033 78,551 80,241 33,158 28,331 30,698 31,433 21,915 15,424 17,469 19,419 111,977 97,115 106,398 107,773 27,932 24,162 30,352 27,932 0 0 0 0 0 0 0 0 0 0 0 0 17 16 16 16 84,028 69,799 73,414 78,388 111,977 97,115 106,398 107,773 109,578 23,868 50,127 78,914 109,578 23,868 50,127 78,914 32,663 7,144 15,057 23,539 32,663 7,144 15,057 23,539 58,942 13,017 27,419 42,685 0 0 0 0 429 132 240 354 19,852 4,019 8,450 14,022 5,721 1,275 2,716 4,416 14,131 2,744 5,734 9,606 0 0 0 0 0 0 0 0 0 0 0 0 14,131 2,744 5,734 9,606 0.87 0.17 0.35 0.59 0.79 0.16 0.32 0.54
EX-27.3 9 EXHIBIT 27.3
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S FORM 10-K FOR FISCAL YEAR 1995. THE FIGURES HEREIN REFLECT THE FEBRUARY 1997 MERGER OF THE COMPANY WITH SPEEDSIM, INC. WHICH WAS ACCOUNTED FOR AS A POOLING OF INTERESTS. 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 17,658 14,777 22,898 1,840 7,805 68,583 26,895 13,828 94,240 24,202 0 0 0 16 66,321 94,240 82,442 82,442 25,106 25,106 46,251 0 750 11,866 (612) 12,478 0 0 0 12,478 0.81 0.74
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