-----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, BEUT9KNimzRS/IBglrQ0HB25h+1RARq6qr0wphuyFUk00NlkjonXwwmF7APTBhIH eLDs9pF6hdualtxIwQZWpA== 0000950109-00-000283.txt : 20000204 0000950109-00-000283.hdr.sgml : 20000204 ACCESSION NUMBER: 0000950109-00-000283 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 20000203 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APPLIED SCIENCE FICTION INC CENTRAL INDEX KEY: 0001010116 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 742765186 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-96077 FILM NUMBER: 522560 BUSINESS ADDRESS: STREET 1: 8920 BUSINESS PARK DRIVE CITY: AUSTIN STATE: TX ZIP: 78759 BUSINESS PHONE: 5126516200 MAIL ADDRESS: STREET 1: 8920 BUSINESS PARK DRIVE CITY: AUSTIN STATE: TX ZIP: 78759 S-1 1 FORM S-1 As filed with the Securities and Exchange Commission on February 3, 2000 Registration No. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- APPLIED SCIENCE FICTION, INC. (Exact name of registrant as specified in its charter) Delaware 3861 74-2765186 (State or other jurisdiction of incorporation or organization) (Primary Standard Industrial Classification Code Number) (I.R.S. Employer Identification Number) Applied Science Fiction, Inc. 8920 Business Park Drive Austin, Texas 78759 Telephone: (512) 651-6200 Facsimile: (512) 651-6205 (Address, including zip code, and telephone number, including area code, of the registrant's principal executive offices) --------------- Mark R. Urdahl Chairman of the Board, President and Chief Executive Officer Applied Science Fiction, Inc. 8920 Business Park Drive Austin, Texas 78759 (512) 651-6200 Facsimile: (512) 651-6205 (Name, address, including zip code, and telephone number, including area code, of agent for service) --------------- Copies to: Carmelo M. Gordian, P.C. Julia Cowles S. Michael Dunn, P.C. Davis Polk & Wardwell Terry Fokas 450 Lexington Avenue Brobeck, Phleger & Harrison LLP New York, New York 10017 301 Congress Avenue, Suite 1200 (212) 450-4000 Austin, Texas 78701 Facsimile (212) 450-4800 (512) 477-5495 Facsimile (512) 477-5813 Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box. [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] --------------- CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Proposed Maximum Title of Each Class of Aggregate Offering Amount of Securities to be Registered Price (1) Registration Fee - -------------------------------------------------------------------------------- Common Stock, $0.001 par value...... $57,500,000 $15,180 - --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o). The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and we are not soliciting offers to buy these + +securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ PROSPECTUS (Subject to Completion) Issued February 3, 2000 Shares APPLIED SCIENCE FICTION, INC. [LOGO] COMMON STOCK ----------- Applied Science Fiction, Inc. is offering shares of its common stock. This is our initial public offering and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $ and $ per share. ----------- An application will be made to qualify our common stock for quotation on the Nasdaq National Market under the symbol "ASFX." ----------- Investing in our common stock involves risks. See "Risk Factors" beginning on page 8. ----------- PRICE $ A SHARE -----------
Price Underwriting Proceeds to to Discounts and Applied Public Commissions Science Fiction ------ ------------- --------------- Per Share.................................. $ $ $ Total...................................... $ $ $
Applied Science Fiction has granted the underwriters the right to purchase up to an additional shares to cover over-allotments. The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers on , 2000. ----------- MORGAN STANLEY DEAN WITTER CREDIT SUISSE FIRST BOSTON SALOMON SMITH BARNEY PRUDENTIAL VOLPE TECHNOLOGY a unit of Prudential Securities , 2000 [To be filed by amendment] TABLE OF CONTENTS
Page ---- Prospectus Summary.................. 4 Risk Factors........................ 8 Special Note Regarding Forward- Looking Statements................. 16 Use of Proceeds..................... 17 Dividend Policy..................... 17 Capitalization...................... 18 Dilution............................ 19 Selected Consolidated Financial Data............................... 20 Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 21
Page ---- Business............................ 28 Management.......................... 42 Related Party Transactions.......... 52 Principal Stockholders.............. 53 Description of Capital Stock........ 55 Shares Eligible for Future Sale..... 58 Underwriters........................ 60 Legal Matters....................... 62 Experts............................. 62 Where You Can Find Additional Information About Applied Science Fiction............................ 62 Index to Consolidated Financial Statements......................... F-1
---------------- You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock, only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. In this prospectus, the terms "ASF," "we," "us" and "our" refer to Applied Science Fiction, Inc. and our consolidated subsidiaries. Until , 2000, all dealers that buy, sell or trade shares, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. 3 PROSPECTUS SUMMARY You should read the following summary together with the more detailed information regarding our company and the common stock being sold in this offering, especially the risks of investing in our common stock discussed under the caption "Risk Factors" and our consolidated financial statements and related notes appearing elsewhere in this prospectus. APPLIED SCIENCE FICTION We innovate, develop, license and sell proprietary imaging technologies that optimize, enhance and enable the digitization of photographic images for traditional photo processing applications as well as for desktop, professional and Internet publishing applications. Our two principal technologies are: . Digital Film Processing, or DFP, which permits the direct digitization of exposed but undeveloped 35mm and Advanced Photosystem, or APS, film; and . ICE/3/ (pronounced "ICE cubed") technologies, which are embedded in scanners and have the power to eliminate surface defects, restore faded color values and enhance the granular clarity of scanned color photographic images. We have developed a product prototype of our DFP subsystem, which includes a highly specialized digital image capture engine that we expect will be incorporated within DFP systems which we expect will be introduced by our original equipment manufacturer customers. When commercially introduced, DFP systems will process exposed but undeveloped standard 35mm and APS film directly into a digital form without a wet chemical development process, and will thus serve as a substitute means for processing such film. We believe that DFP systems will offer a number of advantages over traditional film processing systems, including: . end-user convenience and flexibility in processing traditional film into digital form; . fewer over- and under-exposures in processed images; . enabling our customers to compete more effectively in the market for image output, including Internet storage, archiving, transmission and printing of digital images; . no use or discharge of hazardous chemicals in the film-development process; . no need for plumbing or specialized handling of hazardous chemicals, enabling DFP systems to be deployed at diverse locations; and . scalability of use, including the possible introduction of multiple DFP engine central processing units and PC-compatible versions for small office/home office use. ICE/3/ consists of the following three technologies that improve and enhance the digitized quality of existing color photographs, slides and negatives, which we refer to simply as "photographic images": . Digital Image Correction and Enhancement, or Digital ICE, which eliminates scratches, dust, fingerprints and other surface defects in scanned color photographic images; . Digital Reconstruction of Color, or Digital ROC, which corrects color fading in aging photographic images and restores the color values in a digitized image to their original condition; and . Digital Grain Equalization and Management, or Digital GEM, which minimizes the distracting visual pattern seen in photographic images caused by excess silver grains in the original developed image. Our objectives are to establish DFP subsystems as a premier means for processing exposed but undeveloped 35mm and APS film and to establish ICE/3/ technologies as premier technologies for enhancing the digitization of existing color images. To achieve these objectives, we plan to: . leverage our current relationships with global market leaders, such as Gretag, Hewlett-Packard, Kodak, Konica, Minolta, Nikon and Noritsu, and expand our customer base; 4 . continue to enhance our technology position through research and development and the patenting of our core technologies; . expand end-user awareness of our company and its technologies through brand identity; . diversify sources of recurring revenue, including ICE/3/ royalties and sales of the developing agent consumable that will be used in DFP subsystems; and . pursue strategic alliances in the evolving imaging industry. We expect that a significant portion of our future growth will depend on the success of our DFP technology and products. We are in the process of further developing our DFP technology for commercial application. We have, to date, recognized contract revenues relating to the development of our DFP technology, but we do not expect to derive revenue from sales of DFP subsystems and related products prior to the second half of 2001. We have generated most of our revenue to date from our Digital ICE technology. As of December 31, 1999, we had an accumulated deficit of $24.6 million, including net losses of approximately $15.9 million in 1999, and we expect to continue to incur significant losses for the foreseeable future. Our ability to reduce these losses will depend in large part on our ability to generate significant additional revenues. Our technologies are largely unproven and we may not achieve profitability. ---------------- Unless otherwise indicated, all information in this prospectus gives effect to the conversion of all outstanding shares of our preferred stock into shares of common stock effective upon the closing of the offering and assumes no exercise of the underwriters' over-allotment option. Our principal executive offices are located at 8920 Business Park Drive, Austin, Texas 78759. Our telephone number is (512) 651-6200. ---------------- 5 THE OFFERING Common stock offered......................... shares Common stock to be outstanding after this offering.................................... shares Use of proceeds.............................. We intend to use the net proceeds for research and development, sales and marketing activities, purchases of capital equipment and leasehold improvements and general corporate purposes. Proposed Nasdaq National Market symbol....... ASFX
The above information is based on shares outstanding as of December 31, 1999. It excludes (1) 270,439 shares of common stock issuable upon exercise of options outstanding as of December 31, 1999 with a weighted average exercise price of $.83 per share, (2) 484,607 additional shares of common stock reserved under our option plan as of December 31, 1999 and (3) 1,258,332 shares of common stock, on an as-converted basis, that are subject to outstanding warrants as of December 31, 1999 with a weighted average exercise price of $.68 per share. 6 SUMMARY CONSOLIDATED FINANCIAL DATA The following table summarizes our financial data. For a more detailed explanation of our financial condition and operating results, you should read "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes to those statements included in this prospectus. Unaudited pro forma basic and diluted net loss per share have been calculated assuming the conversion of all outstanding shares of our preferred stock into common stock as if the shares had converted immediately upon their issuance.
Year Ended December 31, -------------------------- 1997 1998 1999 ------- ------- -------- (in thousands, except per share data) Consolidated Statements of Operations Data: Revenues........................................... $ 628 $ 502 $ 3,973 Loss from operations............................... (1,130) (7,538) (16,284) Net loss........................................... (990) (7,510) (15,898) Basic and diluted net loss per share............... $ (.18) $ (1.01) $ (1.70) Shares used in computing basic and diluted net loss per share......................................... 5,361 7,424 9,353 Pro forma basic and diluted net loss per share..... $ (.88) Shares used in computing pro forma basic and diluted net loss per share.................................... 18,119
The following table contains a summary of our balance sheet: . on an actual basis at December 31, 1999; . on a pro forma basis at December 31, 1999 to reflect the conversion of all outstanding shares of our preferred stock into an aggregate of 8,766,033 shares of common stock; and . on a pro forma as adjusted basis at December 31, 1999 to reflect our sale of shares of common stock in this offering at an assumed initial public offering price of $ per share and the application of the net proceeds received from this offering.
At December 31, 1999 ------------------------ Pro As Actual Forma Adjusted ------- ------- -------- (in thousands) Consolidated Balance Sheet Data: Cash, cash equivalents and short- and long-term investments.......................................... $18,735 $18,735 $ Working capital....................................... 7,434 7,434 Total assets.......................................... 23,656 23,656 Notes payable to bank, less current portion........... 6,436 6,436 6,436 Total stockholders' equity (deficit).................. $11,730 $11,730 $
7 RISK FACTORS You should carefully consider the risks described below before making an investment decision. You should also refer to the other information in this prospectus, including our consolidated financial statements and the related notes thereto. The risks and uncertainties described below are those that we currently believe may materially affect our company. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. Additional risks and uncertainties that we are unaware of or that we currently deem immaterial also may become important factors that affect our company. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. This prospectus also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including the risks faced by us described below and elsewhere in this prospectus. Risks Related to Our Business Our business is at an early stage of development and our technologies may not prove to be commercially viable We are at an early stage of development and our success depends largely on the efforts of OEMs to effectively implement our technologies and achieve significant sales of products which incorporate our technologies. We cannot be certain that our technologies will be incorporated into products that achieve broad commercial acceptance. All of our revenues during 1998 and approximately half of our revenues during 1999 were derived from our Digital ICE technology. We do not expect to earn royalty revenues from our Digital ROC and Digital GEM technologies prior to the fourth quarter of 2000. Our DFP technology is still in the commercialization phase and we do not expect to earn any revenues from sales of DFP subsystems and related products prior to the second half of 2001. However, we may not generate any revenues from the sales or licensing of DFP products or technologies by these dates, or at all. We do not have, and do not anticipate having, agreements which bind OEMs to commercialize our DFP technology and it is possible that our customers may fail or cease their efforts to commercialize our DFP technology Our business model depends on the successful commercialization of our DFP technology and products that use DFP technology. We have completed the design phase and have begun the development phase with one OEM customer and are in the design phase with two other OEM customers. However, we have not entered into, and do not anticipate entering into, agreements that would affimatively obligate the OEMs to develop and/or commercialize our DFP technology. Our current arrangements with the OEMs: . do not require the OEMs to develop and commercialize our DFP technology; . do not require the OEMs to license our DFP technology or to purchase the DFP consumable; . do not specify launch schedules for products incorporating our DFP technology; . do not require the OEMs to create interest in or establish a market for products incorporating our DFP technology; . do not set a minimum price at which products incorporating our DFP technology will be sold; and . may be terminated by the OEMs without significant penalty. We cannot assure you that our OEM customers will complete the development and commercialization of our DFP technology. We expect that any such agreements, if entered into, would not create any affirmative obligation requiring OEMs to complete the development and/or commercialization of DFP. If OEMs do not commercialize DFP, we may not earn contract revenues from DFP implementations or achieve sales of DFP products in accordance with our expected timetable, or at all. 8 We have recognized limited revenues, have incurred significant net losses and may never achieve profitability We have a limited operating history upon which you may evaluate our company and prospects. We have recognized limited revenues, have incurred significant net losses and may never achieve profitability. We incurred net losses of $7.5 million in 1998 and $15.9 million in 1999. As of December 31, 1999, we had an accumulated deficit of $24.6 million. We expect to incur significant operating expenses over the next several years in connection with the continued development and expansion of our business. As a result, we expect to continue to incur significant losses and negative cash flow for the foreseeable future. With increased expenses, we will need to generate significant revenues in order to achieve profitability. We may never achieve profitability, and even if we do, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. We depend on a limited number of OEM customers for the vast majority of our revenues, and the loss of, or a significant reduction in, contract fees or royalties from any OEM customer could significantly reduce our revenues A significant percentage of our revenues are derived from contract fees and royalties that are received from a small number of OEM customers. For example, in 1999, Hewlett-Packard and Nikon accounted for 68% of our total revenues, including 89% of our DFP contract fees and 91% of our Digital ICE royalties, respectively. During 1998, Nikon accounted for 74% of our total revenues, including 100% of our Digital ICE royalties. Furthermore, the particular customers which account for significant portions of our revenues have varied from period to period, and a major customer in one period may not produce significant additional revenue in a subsequent period. The loss of one or more of our largest customers, unfavorable renegotiation of existing agreements with our customers or our inability to successfully develop relationships with additional key customers could cause our revenues to decline significantly. We are dependent upon the film-based photography market, and if this method of capturing images is replaced by digital camera photography or by another technology, our business will suffer Our technologies are designed to digitize, enhance and develop images captured on traditional photographic film. Our business success is dependent upon the continued dominance of film-based photography as a means of capturing images. Broad use of digital cameras as a means of capturing images, or the development of other technologies which replace film, would have a material adverse affect on the demand for our technologies or for products that incorporate our technologies. Although the dominant method of capturing images today is film-based photography, digital cameras are gaining increasing acceptance. It is possible that digital camera photography could replace film- based photography as the primary means of capturing images, particularly if digital camera technology improves. In addition, our business would be materially and adversely affected in the event of a significant slowdown in the markets for image scanners or other image capture hardware, or for proprietary imaging technology used to digitize or enhance and develop film- based images. We are dependent on our OEM customers' efforts to generate sufficient interest in our technologies and to create end-user demand for the commercial application of our technologies Our current and future revenues depend upon the achievement of meaningful sales of products utilizing our licensed technologies. In particular, we will be dependent on our OEM customers' efforts to establish a market for DFP systems. Our OEM customers will have significant influence on the commercialization of our DFP technology, including control over feature definition, launch schedules, marketing, sales and pricing of DFP systems. Although we actively participate in the implementation of our licensed technologies, we cannot assure you that our OEM customers will be able to effectively implement our technologies or that our OEM customers will be able to achieve significant sales of products incorporating our technologies. The failure of our OEM customers to achieve significant sales of products which incorporate our technologies would significantly reduce our revenues, which, in turn, could adversely affect our business. 9 We depend on a non-exclusive license from IBM which, if terminated or renewed on less favorable terms, could cause us to incur substantial expenses in developing new technologies We are dependent on technology that we license from International Business Machines Corporation. IBM has granted us a non-exclusive license which expires in October 2000 to use several of its patents for the development of our proprietary DFP and ICE/3/ technologies. In addition, our ICE/3/ customers must also enter into third-party license agreements directly with IBM in order to incorporate our technologies into their products or be cross-licensed with IBM for those patents. IBM retains the right to license these patents to other companies, including larger and better capitalized companies which may compete with us in the development of similar imaging technologies. If IBM elects to terminate or fails to renew our license on similar terms, or fails to grant the necessary licenses to our customers, we will be required to develop alternative technologies which could require payment of substantial fees to third parties for development costs and prove to be time-consuming and expensive. The features or functionality offered by our technologies may also be compromised, which could limit the ability of our customers to sell products that incorporate our technologies. Competition within our markets may reduce demand for our technologies and reduce our market share The markets for digital image editing software and photofinishing equipment and services are intensely competitive. Certain sectors within these markets are characterized by rapid technological change and increasing competition in both domestic and foreign markets, as well as by constant demand for, and the introduction of, new products and product enhancements. Our technologies compete directly or indirectly with: . products and technologies offered by many large companies, including many of our customers, such as Nikon, Noritsu and Kodak, and other companies, such as Canon, Polaroid and Xerox; . products and technologies which may be offered in the future, including technologies under evaluation by our current and prospective customers; . digital cameras, which as a result of technological advances, may produce images of a quality approaching that attained with 35mm or APS film; . digital minilabs and other services which develop and scan traditional film and provide end users with the ability to receive prints, negatives and digitized images at the same time; and . traditional wet chemistry film processing equipment and commercially- available scanners. In the future, if products incorporating our DFP technologies are widely adopted, use of such products may reduce or eliminate the need to scan photographs into a digital format, which would result in reduced demand for our ICE/3/ technologies. Many of our potential competitors, including our current and prospective customers, have longer operating histories and significantly greater financial, technical, sales and marketing resources, as well as greater name recognition, larger customer bases and more established product distribution channels, than we do. As a result, these competitors may be able to respond more effectively to new or emerging technologies and changes in customer requirements, withstand significant price decreases or devote greater resources to the development, promotion, sale and support of their products and technologies than we can. In addition, our present or future competitors, including our OEM customers, may be able to develop products or technologies comparable or superior to those offered by us. We may be unable to continue to compete effectively in our markets, and future competition may materially and adversely affect our business. See "Business--Competition." 10 We will be dependent upon third-party manufacturers to build our DFP subsystems and if we or our contract manufacturers do not manage the procurement, supply and order fulfillment process effectively, our business will suffer We will contract with third-party manufacturers to build our DFP subsystems. We have never entered into arrangements with contract manufacturers to assemble DFP subsystems and, therefore, we have no experience in this area. If our contract manufacturers cannot secure the materials and components necessary for the manufacture of our DFP subsystems or if we cannot effectively manage this process, we could suffer delays in providing, or we may not be able to provide, DFP subsystems to our customers. Any material disruption in the procurement, supply and order fulfillment process would materially and adversely affect our ability to supply our customers with DFP subsystems on a timely basis, or at all, which in turn, would adversely affect our revenues and harm our business reputation. We recently have experienced rapid growth and our failure to effectively manage this expansion could impede our future growth Our revenues increased 691% to $4.0 million in 1999 from $502,000 in 1998, and our total number of employees increased to 136 at December 31, 1999 from 54 at December 31, 1998. We anticipate hiring new employees in 2000 and beyond. Our growth has resulted, and will continue to result, in new and increased responsibilities for our management. We cannot assure you that our existing or future management controls, internal systems or procedures will be adequate to support our future operations. Our ability to manage any future growth of our business will require us to improve our financial and management controls, reporting systems and procedures on a timely basis, to implement new systems as necessary and to expand, train and manage our workforce effectively. If we are unable to effectively manage our future growth, our business will be harmed. Our quarterly and annual revenues and operating results may fluctuate significantly, which may result in volatility in our stock price Many of our revenue components fluctuate on a quarterly and annual basis and are difficult to predict although our expenses are largely fixed. Therefore, it is difficult for us to accurately forecast our future revenues or operating losses on a quarterly or annual basis. Contract fee revenues, which are comprised primarily of development fees, represented 79% of our revenues in 1999 and will continue to represent a significant portion of our revenues through at least 2001. The amount of development fees that we will earn in a particular period are difficult to predict. Our revenues vary from period to period depending on: . the timing of our achievement of milestones as specified under our agreements; . our customers' licensed product development and launch schedules; . our customers' sales volumes of products incorporating our licensed technologies and the royalty rates applicable to those sales; and . restructurings, reorganizations or mergers and consolidations involving our customers. Because contract and licensing revenues are difficult to accurately predict, it will be difficult for us to forecast our revenues and operating results. We depend on our key personnel to manage our business effectively and if we are unable to retain our current personnel or hire additional personnel, our business could be harmed Our future success will depend on the continued employment of our key senior management, technical and sales and marketing personnel, many of whom would be difficult to replace. In particular, we believe that our future success is highly dependent on Mark Urdahl, our Chairman, President and Chief Executive Officer, and Albert Edgar, our Chief Scientist. Our success is also dependent upon our ability to attract, motivate and retain other highly qualified personnel, particularly personnel with imaging industry or intellectual property 11 knowledge and experience. The loss of any existing key personnel or our inability to attract, motivate and retain additional qualified personnel could have a material adverse effect on our business. We may not be able to protect our intellectual property, which would adversely affect our ability to compete We are dependent upon our proprietary information and technology. We rely primarily on a combination of patent, copyright, trademark and trade secret laws and license agreements to establish and protect our intellectual property. We require our employees, third-party consultants and contractors to enter into agreements which limit the use of, access to and distribution of our proprietary information. We cannot assure you that our precautions will be adequate to prevent misappropriation or infringement of our intellectual property. The laws of some foreign countries may not protect our proprietary information and technology rights as fully as the laws of the United States. Despite the steps taken by us to protect our proprietary rights, it may be possible for unauthorized third parties to copy aspects of our technologies, reverse engineer the products which may be derived from our technologies or otherwise obtain and use information or technology that we regard as proprietary. Several of our license agreements allow our licensees to access the source code versions of our software upon the occurrence of specified events, such as the insolvency or bankruptcy of our company. Although our license agreements with these customers attempt to prevent misuse of the source code, the possession of our source code by third parties increases the ease and likelihood of potential misappropriation of our intellectual property. We may need to engage in litigation in order to enforce our intellectual property rights in the future, which could result in substantial costs and diversion of management and other resources. Failure to protect our intellectual property rights in a meaningful manner could have a material and adverse effect on our business. Claims may be brought against us that our technologies infringe the intellectual property rights of others, which may require us to incur costs in defending ourselves and our customers against such allegations Although we do not believe that our technologies infringe the proprietary rights of others, it is possible that infringement or invalidity claims could be asserted or prosecuted against us in the future. Any such assertions or prosecutions could have a material adverse effect on our business. There is a substantial risk of litigation regarding intellectual property rights in our industry. Any claims, with or without merit, could: . be time-consuming, costly to defend and harm our reputation; . divert management's attention and resources; . cause delays in the delivery of products that incorporate our technologies; . require the payment of monetary damages, which may be tripled if the infringement is found to be willful; . result in an injunction, which would prohibit us from offering licenses to a particular technology; . require us to enter into royalty or licensing agreements which may not be available on acceptable terms; or . require us to pay damages to or indemnify our customers under our contracts with them. Our technologies are complex and may contain undetected software or hardware errors which could lead to an increase in our costs or a reduction in our revenues All of our technologies and products in development include a significant software component. Complex software such as ours frequently contains errors or defects, especially when first introduced or when new versions or enhancements are released. If our software contains undetected defects or errors, we could experience: . delayed or lost revenues; 12 . termination or renegotiation of license agreements and difficulties in obtaining new agreements; . expenses associated with warranty service costs or unexpected reprogramming costs; . claims for substantial damages; . negative publicity regarding us and our technologies, which could adversely affect our ability to attract new customers; and . diversion of time and resources of our management and development team. A significant portion of our revenues are generated from international customers, which subjects us to additional business risks During 1999, revenues from customers with principal offices in foreign countries constituted approximately 48% of our revenues. We expect that revenues derived from international customers will continue to represent a significant portion of our revenues in the future. All of our revenues from our licensing agreement with Nikon are denominated in Japanese yen and, as a result, are subject to exchange rate fluctuations. To date, we have not used derivative instruments to hedge against foreign currency exchange rate risks. International operations and demand from our international customers are subject to a variety of risks, including: . increases in tariffs, duties, price controls or similar restrictions; . restrictions on the import or export of our technologies or on products incorporating our technologies; . trade barriers; . changes in regulatory requirements; . longer payment cycles and difficulties in collecting accounts receivables; . export license requirements; . foreign government regulation; . political and economic instability; . fluctuations in foreign currency exchange rates; . lower protection for intellectual property rights; and . changes in diplomatic and trade relationships. In addition, the laws of certain countries require significant withholding taxes on payments for intellectual property. We may not be able to offset these withholding taxes fully against our United States tax obligations. We are subject to the further risk that tax authorities in those countries may recharacterize engineering fee revenues as license fees, which could result in increased tax liabilities and penalties. Industry standards affecting our business evolve rapidly, and if we cannot develop products that are compatible with these evolving standards, our business will suffer The markets for our technologies and products are characterized by rapidly changing technology, evolving industry standards and short product life cycles. Our success will depend to a substantial degree upon our ability to develop and market new technologies, products and enhancements to our existing technologies that meet evolving customer requirements and emerging industry standards. The development of new imaging technologies is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. In order to succeed we will need to: . identify, develop, market and support new technologies and products successfully; . develop new technologies and products that gain market acceptance; and . respond effectively to technological changes, emerging industry standards and product announcements by our competitors. 13 Our failure to address these factors could have a material adverse effect on our business. Our principal stockholders will continue to have significant influence over our company after this offering on matters submitted to a stockholder vote Upon completion of this offering, our officers and directors and their affiliates will continue to own a significant percentage of our common stock. Consequently, these stockholders, acting together, will be able to exert significant influence over the outcome of all matters submitted for stockholder vote, including the election of our board of directors and the approval of significant corporate transactions. Risks Related to This Offering Our stock price may be volatile because our shares have not been publicly traded before this offering, and you may not be able to resell your shares at or above our initial public offering price Prior to this offering, you could not buy or sell our common stock publicly. The initial public offering price for our common stock will be determined through negotiations between the underwriters and us. The initial public offering price may vary from the market price of our common stock after the offering. If you purchase shares of our common stock, you may not be able to resell your shares at or above the initial public offering price. The market price of our common stock may fluctuate significantly in response to numerous factors, some of which are beyond our control, including the following: . actual or anticipated fluctuations in our quarterly or annual operating results; . changes in financial estimates or investment recommendations by securities analysts or our failure to perform in line with analysts' estimates; . changes in consumer use of film-based photography products; . announcements by us or our competitors of significant contracts, technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments; . the loss of one or more key OEM customers or the reduction in sales of products incorporating our technologies; . additions or departures of key personnel; . the potential for future sales of our common stock; and . fluctuations in stock market prices and the volume of traded shares generally, and particularly fluctuations in the stock prices of technology companies. We are at risk of securities class action litigation due to our expected stock price volatility In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their securities. Due to the potential volatility of our stock price, we may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management's attention and resources, and, therefore, could adversely affect our operating results and financial condition. We will need to raise additional capital that may not be available We expect that the net proceeds from this offering, together with our existing cash balances and availability under our credit facilities, will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. After that, we may need to raise additional funds and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. If we need additional capital and cannot raise it on acceptable terms, we may not be able to: . develop new technologies and products or enhancements to our technologies and products; 14 . hire, train and retain employees; and . respond to competitive pressures or unanticipated requirements. Provisions in our charter documents, Delaware law and customer agreements could prevent, delay or impede a change in our control and may reduce the market price of our common stock Provisions in our certificate of incorporation and bylaws could have the effect of discouraging, delaying or preventing a merger or acquisition that stockholders may consider favorable. We also are subject to the anti-takeover laws under the Delaware General Corporation Law which may discourage, delay or prevent a third party from acquiring or merging with us. In addition, certain of our customer agreements permit our customers to terminate their obligations to us in the event we are acquired by a competitor of such customer. These provisions of Delaware law and of our charter, bylaws and customer agreements may depress the market price of our common stock as they may make it more difficult for a third party to acquire control of our company or for stockholders to change management. Our management may apply the proceeds of this offering to uses that our stockholders may not agree with and in ways that do not increase our profits or market value Our management will have considerable discretion in the application of the net proceeds received by us from this offering, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. Our net proceeds may be used for purposes that do not increase our profitability or our market value. Pending their application, proceeds of this offering may be placed in investments that do not produce income or that lose value. For a more complete description of how we plan to use the proceeds of this offering, please see "Use of Proceeds." There may be sales of a substantial amount of our common stock after this offering that could cause our stock price to fall Our current stockholders hold a substantial number of shares, which they will be able to sell in the public market in the near future. All of the shares sold in this offering will be freely tradable, with the remaining 21,926,324 shares outstanding (based on the number of shares outstanding as of December 31, 1999) being "restricted securities" as defined in Rule 144 of the Securities Act of 1933. All of these restricted shares will be freely tradable, subject in some cases to volume and other limitations imposed upon restricted securities that have been held less than two years, under Rule 144, beginning 180 days after the effective date of this offering upon the termination of lock-up agreements with the underwriters. The underwriters may waive or terminate these agreements at their discretion, which could enable these shares to be available for sale prior to the expiration of such 180-day period. Sales of a substantial number of shares of our common stock after this offering, or the perception that a substantial amount of shares will be sold, could cause our stock price to fall. In addition, the sale of these shares could impair our ability to raise capital through the sale of additional stock. You will experience immediate and substantial dilution in the book value of your shares The initial public offering price is expected to be substantially higher than the book value per share of our outstanding common stock immediately after this offering. Accordingly, if you purchase our common stock in this offering, you will incur immediate and substantial dilution of approximately $ in the book value per share of our common stock from the price you pay for our common stock based on an assumed initial public offering price of $ per share. For information regarding the dilution that you will experience, please see "Dilution." 15 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may," "will," "should," "expect," "intend," "plan," "anticipate," "believe," "estimate," "continue," "potential" and "future." You should read statements that contain these words carefully because they discuss our future expectations, make projections of our future results of operations or financial condition or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able to accurately predict or control. The factors listed in the sections captioned "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," as well as any cautionary language in this prospectus, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Before you invest in our common stock, you should be aware that the occurrence of the events described in the "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" sections and elsewhere in this prospectus could have a material adverse effect on our business and may result in the loss of a portion or all of your investment in our common stock. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform them to actual results. 16 USE OF PROCEEDS Assuming an initial public offering price of $ per share, we will receive approximately $ million from the sale of shares of our common stock, net of estimated offering expenses and underwriting discounts and commissions payable by us. If the underwriters exercise their over-allotment option in full, we will receive an additional $ million in net proceeds. The principal purposes of this offering are to increase our equity capital, create a public market for our common stock, facilitate future access by us to the public equity markets and provide us with increased visibility in our markets. We intend to use the net proceeds of this offering for research and development, sales and marketing activities, the purchase of capital equipment and leasehold improvements, and general corporate purposes. In addition, we may use a portion of the net proceeds to acquire businesses, products or technologies that are complementary to our current or future business and technologies. We have no current plans, agreements or commitments and are not currently engaged in any negotiations with respect to any acquisition transaction, although we have from time to time engaged in acquisition discussions with other parties. Our management will have significant flexibility in applying the net proceeds of this offering. Pending such uses, we will invest the net proceeds of this offering in high quality, investment grade, interest-bearing securities. DIVIDEND POLICY We have never declared or paid any dividends on our capital stock, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently expect to retain future earnings, if any, to fund the operation and expansion of our business. In addition, our existing indebtedness restricts, and indebtedness we may incur in the future may prohibit or effectively restrict, the payment of cash dividends. 17 CAPITALIZATION The following table sets forth our capitalization at December 31, 1999: . on an actual basis; . on a pro forma basis to reflect the conversion of all outstanding shares of our outstanding preferred stock into an aggregate of 8,766,033 shares of our common stock upon completion of this offering; and . on a pro forma as adjusted basis to reflect the estimated net proceeds from the sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, and the application of the net proceeds as described under "Use of Proceeds." You should read the following table in conjunction with our financial statements and the notes to those statements included elsewhere in this prospectus.
At December 31, 1999 -------------------------- Pro Pro Forma As Actual Forma Adjusted ------- ------- -------- (in thousands, except share data) Current portion of notes payable to bank............ $ 1,402 $ 1,402 $ 1,402 ------- ------- ------- Notes payable to bank, less current portion......... $ 6,436 $ 6,436 $ 6,436 Stockholders' equity (deficit): Convertible preferred stock, $.001 par value, 25,000,000 shares authorized, 5,653,162 shares designated, 5,635,189 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted......................................... 6 -- Common stock, $.001 par value, 100,000,000 shares authorized, 13,160,291 shares issued and outstanding, actual; shares authorized, 21,926,324 issued and outstanding, pro forma; shares authorized, shares issued and outstanding, pro forma as adjusted.... 13 22 Additional paid-in capital.......................... 48,750 48,747 Deferred stock-based compensation................... (6,713) (6,713) (6,713) Notes receivable from stockholders.................. (5,675) (5,675) (5,675) Accumulated other comprehensive loss................ (42) (42) (42) Accumulated deficit................................. (24,609) (24,609) (24,609) ------- ------- ------- Total stockholders' equity...................... 11,730 11,730 ------- ------- ------- Total capitalization.......................... $18,166 $18,166 $ ======= ======= =======
- -------- The share information set forth above at December 31, 1999 excludes: . 1,258,332 shares of common stock, on an as-converted basis, that are subject to outstanding warrants with a weighted average exercise price of $.68 per share; . 270,439 shares of common stock that are subject to outstanding options under our stock option/stock issuance plan with a weighted average exercise price of $.83 per share; and . 484,607 additional shares of common stock that are reserved for issuance under our stock option plan. 18 DILUTION Our pro forma net tangible book value at December 31, 1999, after giving effect to the conversion of all outstanding shares of our convertible preferred stock into shares of common stock upon completion of this offering, was approximately $11.7 million, or $.53 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities, divided by the pro forma number of shares of common stock outstanding at December 31, 1999. Dilution in pro forma net tangible book value per share represents the difference between the amount per share paid by purchasers in this offering and the pro forma net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to our sale of shares of common stock in this offering at an assumed initial public offering price of $ per share, and after deducting estimated underwriting discounts and commissions and offering expenses payable by us, our pro forma net tangible book value at December 31, 1999 would have been $ million, or $ per share. This amount represents an immediate increase in pro forma net tangible book value to our existing stockholders of $ per share and an immediate and substantial dilution to new investors of $ per share. The following table illustrates this per share dilution: Assumed initial public offering price per share..................... $ Pro forma net tangible book value per share at December 31, 1999.. $.53 Increase in pro forma net tangible book value per share attributable to new investors.................................... ---- Pro forma net tangible book value per share after this offering..... ----- Dilution per share to new investors................................. =====
If the underwriters exercise their over-allotment option in full, our adjusted pro forma net tangible book value at December 31, 1999 would have been $ million, or $ per share, representing an immediate increase in pro forma net tangible book value to our existing stockholders of $ per share and an immediate dilution to new investors of $ per share. The following table summarizes, at December 31, 1999, on a pro forma basis to reflect the conversion of all of our outstanding convertible preferred stock into common stock, the differences between the number of shares of common stock purchased from us, the aggregate cash consideration paid to us and the average price per share paid by our existing stockholders and by new investors purchasing shares of common stock in this offering. The calculation below is based on an assumed initial public offering price of $ per share, before deducting underwriting discounts and commissions and offering expenses payable by us:
Average Shares Purchased Total Consideration Price ------------------ ------------------- per Number Percent Amount Percent Share ---------- ------- ----------- ------- ------- Existing stockholders............ 21,926,324 % $43,087,000 % $1.97 New investors.................... ---------- ----- ----------- ----- Total.......................... 100.0% 100.0% ========== ===== =========== =====
The foregoing table assumes no exercise of the underwriter's over-allotment option or shares underlying outstanding options and warrants. At December 31, 1999, there were options outstanding to purchase a total of 270,439 shares of our common stock with a weighted average exercise price of $.83 per share and warrants outstanding to purchase a total of 1,258,332 shares of common stock, on an as-converted basis, with a weighted average exercise price of $.68 per share. To the extent that any of these options or warrants are exercised, there will be further dilution to new investors. See "Capitalization." 19 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data with respect to the period from June 15, 1995 (inception) to December 31, 1995, and each of the years in the four-year period ended December 31, 1999, have been derived from our consolidated financial statements. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the consolidated financial statements and the related notes thereto included at the end of this prospectus and the other financial information included elsewhere in this prospectus. The selected statements of operations data for the period from June 15, 1995 (inception) to December 31, 1995 and for the year ended December 31, 1996 and the balance sheet data as of December 31, 1995 and 1996 have been derived from unaudited financial statements not included herein. The balance sheet data at December 31, 1997 have been derived from audited financial statements not included in this prospectus. The consolidated statements of operations data for the years ended December 31, 1997, 1998 and 1999 and the consolidated balance sheet data at December 31, 1998 and 1999 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. See Note 2 of the notes to our consolidated financial statements for a detailed explanation of the determination of shares used in computing basic and diluted, and pro forma basic and diluted, net loss per share.
Period from June 15, 1995 (Inception) to Year Ended December 31, December 31, ---------------------------------- 1995 1996 1997 1998 1999 ------------ ----- ------- -------- -------- (in thousands, except per share data) Consolidated Statements of Operations Data: Revenues: Contract revenues........... $ -- $ 160 $ 628 $ 214 $ 3,152 Royalty revenues............ -- -- -- 288 821 ------ ----- ------- -------- -------- Total revenues............ -- 160 628 502 3,973 Costs and expenses: Cost of contract revenues... -- 19 43 250 2,147 Research and development.... -- 139 717 4,218 9,050 Selling, general and administrative............. 9 209 998 3,572 7,629 Amortization of stock-based compensation............... -- -- -- -- 1,431 ------ ----- ------- -------- -------- Total operating expenses.. 9 367 1,758 8,040 20,257 ------ ----- ------- -------- -------- Loss from operations.......... $ (9) $(207) $(1,130) $ (7,538) $(16,284) Interest and other income, net.......................... -- 4 202 28 457 ------ ----- ------- -------- -------- Net loss before foreign withholding taxes............ $ (9) $(203) $ (928) $ (7,510) $(15,827) Foreign withholding taxes..... -- -- 62 -- 71 ------ ----- ------- -------- -------- Net loss...................... $ (9) $(203) $ (990) $ (7,510) $(15,898) ====== ===== ======= ======== ======== Basic and diluted net loss per share........................ $ (.01) $(.07) $ (.18) $ (1.01) $ (1.70) Shares used in computing basic and diluted net loss per share........................ 1,349 2,970 5,361 7,424 9,353 Pro forma basic and diluted net loss per share........... $ (.88) Shares used in computing pro forma basic and diluted net loss per share............... 18,119 Year Ended December 31, ----------------------------------------------- 1995 1996 1997 1998 1999 ------------ ----- ------- -------- -------- (in thousands) Consolidated Balance Sheet Data: Cash, cash equivalents, short and long-term investments.... $89 $ 76 $5,199 $ 633 $18,735 Working capital (deficit)..... 82 81 4,349 (957) 7,434 Total assets.................. 89 205 5,532 2,228 23,656 Notes payable to bank, less current portion.............. -- -- -- 3,028 6,436 Total stockholders' equity (deficit).................... $(8) $(10) $4,552 $(2,958) $11,730
20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and related notes thereto included at the end of this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Risk Factors" and elsewhere in this prospectus. Overview Applied Science Fiction innovates, develops, licenses and sells proprietary imaging technologies that optimize, enhance and enable the digitization of photographic images for traditional photo processing applications, as well as for desktop, professional and Internet publishing applications. Our two principal technologies are digital film processing, or DFP, and ICE/3/ technologies, which consist of our Digital ICE, Digital ROC and Digital GEM technologies. DFP technology permits the direct digitization of exposed but undeveloped 35 mm and advanced photo system, or APS, film. ICE/3/ technologies are embedded in scanners and eliminate surface defects, restore faded color values and enhance the granular clarity of scanned photographic images. We were incorporated in June 1995 and have devoted our efforts principally to raising capital, conducting research and development activities and establishing markets for our technologies. Revenues Currently, our revenues are comprised of contract and royalty revenues. Contract revenues are generally earned by us when we meet specified milestones set forth in our agreements with OEMs to develop, adapt and customize our technologies for use in OEM products. Royalty revenues generally relate to licensing fees paid to us by OEMs for use of our ICE/3/ technologies in their products. We recognize royalty fees as revenues under ICE/3/ license agreements upon our receipt of a report from our licensees that they have shipped products that incorporate our technology. We do not receive these reports from the licensee until the quarter after the licensee has shipped the product that incorporates our technology, resulting in a one quarter delay between shipment and recognition of revenues from those sales. The amount of contract revenues that we earn typically varies from period to period depending on factors such as the timing of our achievement of contract- specific development milestones and our customers' licensed product development and launch schedules. Royalty revenues also may vary from period to period based on our customers' sales volumes of products incorporating our licensed technologies. Because many of our revenue components fluctuate due to factors beyond our control and our expenses are largely fixed, our revenues and operating results may vary significantly from period to period. We record cash receipts from customers and billed amounts due from customers in excess of recognized revenue as deferred revenues. The timing and amount of cash receipts from customers can vary significantly depending on specific contractual terms and can therefore have a significant impact on the amount of deferred revenue we record in any given period. DFP Technology We are currently developing our first generation DFP subsystem. During 1999, we developed a functional product prototype of a DFP subsystem under a design review agreement with Hewlett-Packard. We are currently in negotiations with three OEMs to design, develop and manufacture through third party contract manufacturers, a specified "class" of DFP subsystem and related developing agent consumable. Each "class" of DFP subsystem is defined primarily by film- processing speed. We expect the design and development effort for the first specified class of DFP subsystems to take approximately 18 to 24 months. 21 In 1999, we derived 48% of our revenues from DFP contract fees. We believe that a substantial portion of our revenues through at least 2001 will be from contract fees under DFP development agreements that we expect to enter into with our OEM customers. We anticipate generating revenues from the design, development and sales of our DFP subsystems and associated licenses, and from sales of the proprietary developing agent consumable that we are developing for use in DFP subsystems. Pursuant to agreements that we expect to enter into with our OEM customers, we expect to (1) manufacture, through a contract manufacturer, and distribute DFP subsystems and a developing agent consumable to our OEM customers and (2) invoice the sales price for DFP subsystems and developing agent consumable upon shipment to OEM customers. We do not expect to recognize revenues related to sales of our DFP subsystems and the developing agent consumable until the second half of 2001. ICE/3/ Technologies We derive contract fees under ICE/3/ development agreements from the adaptation and customization of our technologies for use with OEM scanner products. ICE/3/ adaptation and customization efforts for an OEM customer generally take from three to 12 months to complete, with the period varying depending on the technology and services provided and the particular requirements of the customer. Through December 31, 1999, substantially all of our ICE/3/ contract fees have been generated under Digital ICE development agreements. We believe that a substantial portion of our revenues through at least 2000 will be from contract fees related to ICE/3/ development agreements. We have derived all of our royalty fees through December 31, 1999 from the licensing of our Digital ICE technology to Kodak and Nikon. Presently, Nikon and Minolta are shipping film scanners and Kodak is shipping a kiosk with an embedded film scanner that incorporates our Digital ICE technology. With respect to film scanners, royalty rates for the licensing of our Digital ICE technology range from 2% to 7% of the manufacturers' price for the scanner. Noritsu has licensed Digital ICE for use in digital minilabs. Under our agreement with Noritsu, we will receive a set dollar amount per unit for each digital minilab sold. Digital ICE royalty rates applicable to future products that may incorporate this technology may vary considerably from our current range. We do not expect that we will recognize royalty revenues related to our Digital ROC and Digital GEM technologies prior to the fourth quarter of 2000. We expect to establish royalty rates pertaining to the licensing of Digital ROC and Digital GEM technologies in a manner similar to those established for our Digital ICE technology. Costs and Expenses Since our inception, we have incurred substantial costs to develop our technology and products, to recruit and train personnel for our engineering, sales and marketing and professional services departments, and to establish an administrative organization. As a result, we have incurred net losses in each fiscal quarter since inception and, as of December 31, 1999, had an accumulated deficit of $24.6 million. We anticipate that our operating expenses will increase substantially in future quarters as we increase sales and marketing operations, fund greater levels of research and development, improve operational and financial systems and increase expenses associated with protecting our intellectual property. Accordingly, we expect to incur additional losses for the foreseeable future. In addition, our limited operating history makes it difficult for us to predict future operating results and, accordingly, there can be no assurance that we will achieve or sustain revenue growth or profitability. We had 136 full-time employees at December 31, 1999, compared to 54 employees at December 31, 1998. This rapid growth places a significant demand on our management and operational resources. In order to manage growth effectively, we must implement and improve our operational systems, procedures and controls on a timely basis. In addition, we expect that future expansion will continue to challenge our management's ability to hire, train, motivate, and manage our employees. Competition is intense for highly qualified technical, sales and marketing and management personnel. If our total revenue does not increase relative to our operating expenses, if our management systems do not expand to meet increasing demands, if we fail to attract, assimilate and retain qualified personnel, or if our management otherwise fails to manage our expansion effectively, there would be a material adverse effect on our business, financial condition and operating results would be adversely affected. 22 Results of Operations The following discussion should be read in connection with the audited financial statements and the related notes included elsewhere in this prospectus. Years Ended December 31, 1997, 1998 and 1999 Revenues Total revenues increased 691% from $502,000 in 1998 to $4.0 million in 1999. This increase was attributable to an increase in our customer base for both DFP and ICE/3/ technologies. Nikon accounted for approximately 64%, 74% and 25% of our revenues in 1997, 1998 and 1999, respectively; Kodak accounted for approximately 35% and 16% of our revenues in 1997 and 1998, respectively; and Hewlett-Packard accounted for approximately 43% of our revenues in 1999. Contract revenues. Contract revenues increased from $214,000 in 1998 to $3.2 million in 1999 primarily due to fees earned and recognized under our first DFP design review agreement and an increase in the fees earned and recognized under ICE/3/ agreements. Contract revenues decreased 66% from $628,000 in 1997 to $214,000 in 1998, due to the amount and timing of revenue recognized upon our achievement of contract specific development milestones. Royalty revenues. We began recognizing royalty revenue under a license agreement for our Digital ICE technology in the third quarter of 1998 and, as a result, royalty revenues increased by 185% from $288,000 in 1998 to $821,000 in 1999. We did not recognize any royalty revenues during 1997. Costs and Expenses Cost of contract revenues and research and development. Cost of contract revenues consists of costs incurred to fulfill our obligations under design review or development agreements with our OEM customers. Research and development expense combined with cost of contract revenues comprise our total engineering costs. In a given period, the allocation of engineering costs between cost of contract revenues and research and development expense is a function of the timing and extent of the adaptation, customization and development of our technologies to licensees' products and specifications and does not necessarily correspond to the recognition of revenues under the related contracts. Cost of contract revenues increased by 481% from $43,000 in 1997 to $250,000 in 1998, and by 759% to $2.1 million in 1999. These increases were due to increases in personnel and other costs associated with greater obligations under design review and development arrangements with our OEM customers. We expect cost of contract revenues to increase in the future due to the expansion of our obligations under future design review and development arrangements that we expect to enter into with our OEM customers. Research and development expense consists primarily of personnel costs to support the general development of our technologies. Research and development expense increased by 488% from $717,000 in 1997 to $4.2 million in 1998, and by 115% to $9.1 million in 1999. These increases were primarily due to increases in internal engineering personnel. We believe that continued investment in research and development is critical to attaining our strategic objectives and, as a result, we expect research and development expense to increase significantly in future periods. To date, all software development costs have been expensed in the period incurred. Selling, general and administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for sales and marketing personnel and salaries and related costs of our executive, accounting, finance, legal and administrative personnel. Selling, general and administrative expenses increased by 258% from $1.0 million in 1997 to $3.6 million in 1998, and by 114% to $7.6 million in 1999. These increases were primarily due to a significant increase in personnel and an increase in legal expense related to the protection of our intellectual property. We believe these expenses will continue to increase in 23 future periods as we expect to continue to expand our sales and marketing efforts, add personnel to our general and administrative departments to support our expanding operations, incur additional costs related to the growth of our business and assume the responsibilities of a public company. Amortization of deferred stock compensation. In 1999, we recorded total deferred stock-based compensation of $8.1 million in connection with stock options granted during 1999. We are amortizing this amount primarily over the vesting periods, generally four years, of the applicable options, resulting in amortization expense of $1.4 million in 1999. These amounts primarily represent the difference between the exercise price of certain stock option grants made in 1999 and the deemed fair value of our common stock at the time of such grants. Interest and other income, net. Interest and other income, net consists primarily of interest income and expense. Interest and other income, net increased from $28,000 in 1998 to $457,000 in 1999. This increase was primarily due to interest income earned on higher average cash and investment balances, partially offset by interest expense on a higher average debt balance. Interest and other income, net decreased by 86% from $202,000 in 1997 to $28,000 in 1998, primarily due to interest expense on a higher average debt balance and interest income earned on a lower average cash balance in 1998 when compared to 1997. Additionally, other income in 1997 included a $90,000 cancellation payment from a former OEM customer. Foreign Withholding Taxes. Foreign withholding taxes paid in 1997 and 1999 relate to withholdings on royalties from a customer located in a foreign country. 24 Selected Quarterly Financial Results The following table presents selected unaudited quarterly operating results for each of the eight quarters in the period ended December 31, 1999. This data has been derived from unaudited consolidated financial statements that have been prepared on the same basis as the annual audited consolidated financial statements and, in our opinion, include all recurring adjustments necessary for a fair presentation of such information. We believe this unaudited consolidated financial information accurately reflects our operating results during these periods and should be read in conjunction with the audited consolidated financial statements and the notes thereto appearing elsewhere in the prospectus. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period. The amount of contract revenues that we earn vary from period to period depending on factors such as the timing of our achievement of contract-specific development milestones and our customers' licensed product development and launch schedules. Royalty revenues also may vary from period to period based on our customers' sales volumes of products incorporating our licensed technologies. Because many of our revenue components fluctuate due to factors beyond our control and our expenses are largely fixed, our revenues and operating results have varied significantly from period to period and we expect that they will continue to do so in future periods.
Three Months Ended ------------------------------------------------------------------------------ March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31, 1998 1998 1998 1998 1999 1999 1999 1999 --------- -------- --------- -------- --------- -------- --------- -------- (in thousands) Consolidated Statements of Operations Data: Revenues: Contract revenues...... $ -- $ 20 $ 84 $ 110 $ 598 $ 409 $ 773 $ 1,372 Royalty revenues....... -- -- 109 179 198 228 203 192 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues.......... -- 20 193 289 796 637 976 1,564 Costs and Expenses: Cost of contract revenues.............. 54 61 66 69 71 472 786 818 Research and development........... 947 1,059 1,072 1,140 1,609 2,142 2,682 2,617 Selling, general and administrative........ 534 804 1,104 1,130 1,033 1,763 2,120 2,713 Amortization of stock- based compensation.......... -- -- -- -- 45 159 323 904 ------- ------- ------- ------- ------- ------- ------- ------- 1,535 1,924 2,242 2,339 2,758 4,536 5,911 7,052 ------- ------- ------- ------- ------- ------- ------- ------- Loss from operations.... (1,535) (1,904) (2,049) (2,050) (1,962) (3,899) (4,935) (5,488) Interest and other income (expense), net.. 48 38 10 (68) (20) 178 169 130 ------- ------- ------- ------- ------- ------- ------- ------- Net loss before withholding taxes...... (1,487) (1,866) (2,039) (2,118) (1,982) (3,721) (4,766) (5,358) Foreign withholding taxes.................. -- -- -- -- -- 35 15 21 ------- ------- ------- ------- ------- ------- ------- ------- Net loss................ $(1,487) $(1,866) $(2,039) $(2,118) $(1,982) $(3,756) $(4,781) $(5,379) ======= ======= ======= ======= ======= ======= ======= =======
Liquidity and Capital Resources We have accessed two separate equipment lines of credit with Silicon Valley Bank to finance purchases of capital equipment. At December 31, 1999, borrowings under these facilities bore interest at a weighted average annual rate of 8.90%. Borrowings under these facilities are collateralized by all of our tangible assets except those resulting from specified Digital ICE license agreements discussed below. We are obligated to make monthly payments of principal and interest through March and December 2001 under these respective lines of credit. Under the second line of credit, any prepayment of principal or interest is subject to a prepayment penalty. At December 31, 1999, we were in compliance with the only financial covenant under the second line of credit and $939,000 was available for future borrowings. This second facility expires on March 31, 2000 and any future borrowings will bear a fixed interest rate equal to the then 18 month U.S. treasury bill rate plus 325 basis points. No further borrowings are available under our first line of credit. Our principal sources of liquidity at December 31, 1999 consisted of $18.7 million of cash and cash equivalents, highly liquid short- and long-term investments and availability under the foregoing equipment line of credit. 25 We have issued to Silicon Valley Bank a $2.5 million and a $3.5 million royalty-backed annuity note pursuant to a note purchase agreement. The two notes are secured by future royalty receipts under specified Digital ICE license agreements. At December 31, 1999, these notes bore interest at an annual rate of 9.25%. According to the terms of the notes, the interest rate was decreased during 1999 when two additional products incorporating our technologies began shipping and will be decreased further when a fourth licensed product begins shipping. Payments we receive under a specified Digital ICE license agreement are first applied against the interest obligation, with any remaining amounts then applied against the outstanding principal. Any principal amount still outstanding beginning in October 2004 will be payable in equal quarterly installments over the succeeding four years. We may prepay the notes at any time without penalty. In the event the specified Digital ICE license agreements are terminated on or before October 2008, Silicon Valley Bank may demand, at its option, that principal amounts then outstanding be paid in equal quarterly installments over the four years following such termination. In such case, the remaining principal amount of the notes would bear interest at an annual rate equal to the then issuable four-year U.S. treasury notes rate plus 650 basis points. In addition, Silicon Valley Bank would be entitled to exercise warrants to purchase shares of our common stock with a value of $300,000 subject to upward incremental adjustments to a maximum of $1.2 million if the outstanding amount is not repaid within 36 months from the date the specified license agreements were terminated. For the year ended December 31, 1999, cash used in operating activities was $12.3 million compared to $6.8 million in 1998 and $18,000 in 1997. The increases in net cash used in operating activities were primarily due to increased losses from operations. For the year ended December 31, 1999, cash provided by financing activities was $33.6 million compared to $3.5 million in 1998 and $5.3 million in 1997. We have funded our operations to date primarily through sales of preferred stock, resulting in aggregate net proceeds to us of $34.5 million, and to a lesser extent, bank debt and contract fees and royalties. For the year ended December 31, 1999, cash used in investing activities was $15.8 million compared to $1.2 million in 1998 and $172,000 in 1997. The increases in cash used in investing activities were primarily due to net purchases of short- and long-term investments in 1999 and increases in purchases of computer equipment, software development tools and leasehold improvements, all of which were required to support our business expansion. We anticipate capital expenditures through 2000 of approximately $9.0 million primarily for purchases of additional computer equipment, software development tools and leasehold improvements. We believe the net proceeds we receive from this offering, together with our existing cash balances and the availability under our credit facilities, will be sufficient to meet our capital requirements over the next 12 months. However, we could be required, or could elect, to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support technology and product development efforts and expansion of our sales and marketing activities. Although we are currently not a party to any agreement or letter of intent with respect to a potential acquisition, we may enter into acquisitions in the future which also could require us to seek equity or debt financing. We cannot assure you that additional equity or debt financing, if required, will be available to us on acceptable terms, or at all. Year 2000 Computer Functions Prior to January 1, 2000, there was a great deal of concern regarding the ability of computers to adequately distinguish 21st century dates from 20th century dates due to the two-digit date fields used by many systems. Most reports to date, however, are that computer systems are functioning normally and the compliance and remediation work accomplished leading up to 2000 was effective to prevent any problems. Computer experts have warned that there may still be residual consequences of the change in centuries and any such difficulties could result in a decrease in sales of our products, an increase in allocation of resources to address 26 Year 2000 problems of our customers, or an increase in litigation costs relating to losses suffered by our customers due to such Year 2000 problems. Effect of Recent Accounting Changes In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments. The statement requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value, and that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. We do not have any derivative instruments as of December 31, 1999. We believe that the adoption of SFAS No. 133 will not have a material effect on our consolidated financial statements. In March 1999, the Financial Accounting Standards Board issued an exposure draft entitled "Accounting for Certain Transactions involving Stock Compensation," which is a proposed interpretation of APB Opinion No. 25. However, the exposure draft has not been finalized. Once finalized and issued, the current accounting practices for transactions involving stock compensation may need to change and such changes could affect our future operating results. Qualitative and Quantitative Disclosure about Market Risk Interest Rate Risk Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in cash equivalents and short-term instruments. In addition, we are exposed to interest rate risks through our credit facilities, where we borrow at prevailing short- term variable rates. We do not hedge against our interest rate exposure, and we do not use derivative financial instruments for trading or speculative trading purposes. Due to the nature of our cash equivalents and investments, we have concluded that there is no material market risk exposure to changes in interest rates. Foreign Exchange Risk Royalty revenues under our Digital ICE agreement with Nikon are denominated in Japanese yen. As a result, 19% of our revenues in 1999 were denominated in Japanese yen. We believe that our exposure to changes in foreign exchange rates is minimal, and therefore, we do not hedge against such exposure. We intend to enter into U.S. dollar-denominated contracts in the future. 27 BUSINESS We innovate, develop, license and sell proprietary imaging technologies that optimize, enhance and enable the digitization of photographic images for traditional photo processing applications as well as for desktop, professional and Internet publishing applications. Our two principal technologies are: . Digital Film Processing, or DFP, which permits the direct digitization of exposed but undeveloped 35mm and Advanced Photosystem, or APS, film; and . ICE/3/ (pronounced "ICE cubed") technologies, which are embedded in scanners, and have the power to eliminate surface defects, restore faded color values and enhance the granular clarity of scanned color photographic images. We have developed a product prototype of our DFP subsystem that includes a highly specialized digital image capture engine that will be incorporated within DFP systems which we expect will be introduced by our OEM customers. When commercially introduced, DFP systems will provide an alternative to processing exposed but undeveloped standard 35mm and APS film directly into a digital form without a wet chemical development process. We believe that DFP systems will offer a number of advantages over traditional film processing systems, including: . end-user convenience and flexibility in processing traditional film into a digital form; . fewer over- and under-exposures in processed images; . enabling our customers to compete more effectively in the market for image output, including Internet storage, archiving, transmission and printing of digital images; . no use or discharge of hazardous chemicals in the film-development process; . no need for plumbing or specialized handling of hazardous chemicals, enabling DFP systems to be deployed at diverse locations; and . scalability of use, including the possible introduction of multiple DFP engine central processing units and PC-compatible versions for small office/home office use. For these reasons, we believe that DFP has the potential to revolutionize the imaging industry. Furthermore, unlike digital camera technology, DFP will not require end users to purchase additional camera equipment, as traditional film- based cameras can be used to achieve direct-to-digital capabilities. The implementation of our technologies for use by our customers generally occurs in three distinct phases: design, development and production. First, in the design phase, we coordinate with the OEM customer to design the product specifications; next, in the development phase, we develop or assist in the development of a product prototype; and third, in the production phase, either the OEM customer or a third-party manufacturer produces the resultant products. For DFP subsystems, we have completed the design phase and have begun the development phase with one OEM customer and are in the design phase with two other OEM customers. We intend to license and sell these subsystems, together with our proprietary developing agent consumable that will be used in the DFP process. We anticipate that our customers will integrate our DFP subsystems initially with either conventional wet chemistry photoprinting or dry digital photoprinting capabilities. When introduced into the market, DFP systems may also be integrated with an e-commerce platform that will allow consumers to drop off rolls of exposed but unprocessed film at a DFP processing location and then receive their images in digitized form via an e-mail or posted at a Web site. We expect that the market for DFP systems and the related developing agent consumable will include traditional photofinishing equipment and service providers, as well as new market entrants. We also believe that DFP will contribute to the emergence of new markets for photofinishing services such as desktop photofinishing and Internet photo-serving applications. 28 ICE/3/ consists of the following three distinct technologies that improve and enhance the digitized quality of existing color photographs, slides and negatives: . Digital Image Correction and Enhancement, or Digital ICE, which eliminates scratches, dust, fingerprints and other surface defects in scanned color photographic images; . Digital Reconstruction of Color, or Digital ROC, which corrects color fading in aging photographic images and restores the color values in a digitized image to their original condition; and . Digital Grain Equalization and Management, or Digital GEM, which minimizes the distracting visual pattern seen in photographic images caused by excess silver grains in the original developed image. ICE/3/ technologies may be licensed individually or in combinations of two or all three. We first made Digital ROC and Digital GEM available for licensing in the fourth quarter of 1999. To date, we have entered into agreements to license our Digital ICE technology to OEMs in the image scanning and photofinishing equipment industries, including Gretag, Kodak, Minolta, Nikon and Noritsu, all of whom are in various phases of design, development or production. Industry Background Snapshot of the Photographic Imaging Industry Since the invention of the camera, our personal histories, and that of the world, have been largely captured on film. Images pervade our daily life, from recording personal experiences to facilitating commercial transactions. Photofinishing News estimates that there are at least 650 billion photographic images currently in storage worldwide. This publication also estimates that annual sales within the photographic industry, which includes sales of cameras and film, were approximately $85 billion in 1998. A joint report of Photofinishing News and Lyra Research estimated that 84 billion images, or 95%, of images captured in 1998, were taken by conventional film-based cameras, with other media, including digital cameras, accounting for the balance. According to the same report, an estimated 89 billion, or 79%, of images captured in 2002 will be taken by conventional film-based cameras. The widespread availability of single-use cameras, which, according to the same report, is expected to increase in unit sales from 276 million in 1998 to 378 million in 2002, will continue to be an important contributor to the annual growth in image creation. In the past, most rolls of exposed but undeveloped film were dropped off at a collection point where the film was forwarded to central photofinishing labs that operate high capacity film-processing equipment. In more recent years, on- site photofinishing systems, or minilabs, have been installed at consumer- convenient locations to provide on-site photoprocessing services with a much faster turnaround time than is possible with centralized off-site facilities. The greater convenience and more rapid film-processing offered by minilabs have eroded the dominance of the central lab facilities in film-development services. According to Photofinishing News, the central labs' share of total film-roll volume in the United States declined to approximately 55% in 1998. However, because traditional film-processing services involve a wet chemistry process that, in turn, requires plumbing, the handling and discharge of hazardous substances such as emulsions and fixes, and specialized operator training, photofinishing equipment cannot be readily installed at widespread locations, which has limited the proliferation of minilabs. Advent of Image Digitization In recent years, advances in computer processing capability, improvements in computer storage systems and the availability of less expensive personal computers, printers and scanners, combined with the broad adoption of networked communications and Internet-based entertainment and electronic commerce, have created strong demand for photographic images to be digitized so that they may be accessed, stored and transmitted through digital communications. Generally, there are two methods for digitizing an image: (1) the scanning of a photograph, slide or negative image previously captured by a conventional camera or (2) the original capture of the image with a digital camera. Consumer acceptance of digital cameras has been slow due to relatively poor image quality, high price points and the lack of an established infrastructure. Improvements in the pricing and image quality of digital cameras to approach the capabilities of 35mm and APS film cameras 29 will require significant advances in technology, including improved storage and optics technologies. Due to these limitations, we believe scanners will remain a primary means for image digitization for the foreseeable future. Shipments of scanners have grown dramatically in recent years, with International Data Corporation projecting that annual unit shipments will increase from 13.9 million in 1998 to 39.1 million in 2003. This unit growth largely will be driven by flatbed and handheld scanners that are relatively inexpensive and easy to use, making them widely accessible for small office, educational and personal use, as well as more traditional commercial applications. The quality of scanner technology, as well as the quality of the original photographic image, significantly affect the quality of the final digitized image. This creates an enormous opportunity for technology capable of both improving the quality of digitized images and making access to digitization more efficient for participants in the industry and more convenient for the end user. Evolving Competitive Dynamics within the Imaging Industry Providers of photofinishing services have strongly influenced the duplication, enhancement and output options for images captured by consumers. With the advent of digitization, once an image is digitized, the duplication, enhancement, distribution and storage of that image ceases to be influenced by the providers of photofinishing services. For example, a digitized image can be stored on a personal computer, on a CD-rom or at a Web site; it can be transferred over a network or the Internet; and it can be cropped, modified and printed at home, at a commercial copy shop or by an online service provider. Thus, opportunities have emerged to provide post-processing imaging equipment, software and services in markets that previously were dominated by photofinishing equipment vendors and service providers. For the consumer, image digitization offers a greater selection of output products and services. Instead of receiving only negatives and copies of photographs printed on photographic paper, image digitization enables consumers to have images delivered by email, saved on a photodisk, posted on a Web site or printed from a PC on photo-quality paper. With the changes in output options, new markets are being created for paper, photo-quality dry printers, inkjet supplies and related products, as well as Web pages, Internet advertising and photo-archival services. As a result, digital imaging has provided opportunities for companies across diverse industries, including manufacturers of storage devices, toner and inkjet suppliers and e-commerce businesses. Manufacturers of color copiers, such as Canon, Ricoh and Xerox, have introduced high-capacity photo-quality digital printing into retail copy/print locations using networked color copiers. Traditional photo companies, such as Kodak, Fuji and their respective retailers, as well as a large number of new imaging companies, such as Camera.com, e-Memories.com, ImageBank, MyFamily.com, Photopoint.com, Seattle Filmworks, ShutterFly.com and Zing.com, have introduced Internet-based photo networks that allow online access and archiving of consumer images. According to the joint report of Photofinishing News and Lyra Research, revenues from digital online photofinishing services, such as archiving, printing and delivery, uploading and scanning, are expected to grow from approximately $10 million in 1998 to approximately $3.3 billion in 2002. The ongoing mass digitization has begun to drive the convergence of companies within traditionally distinct industries, such as the computer, printing, scanning, Internet and photography industries. These companies are beginning to compete for a share of the rapidly growing markets within an expanding imaging industry with suppliers increasingly vying to control the sale of associated follow-on services and consumables and to generate online advertising and e-commerce revenues. Current Approaches are Limited in Responding to the Demand for Digitized Images The two accepted approaches to digitization, digital cameras and image scanning, currently do not fully address the growing demand for digitized images. Most professional and amateur photographers are familiar with the capabilities of conventional film-based cameras and are knowledgeable about where to purchase cameras and film and where to have pictures processed, reproduced and enhanced. A similar infrastructure has not yet developed for digital camera photography. This lack of infrastructure, combined with the reluctance of consumers to replace their film-based cameras with digital cameras, has resulted in the vast majority of end users continuing to rely on traditional film-based photography as their primary means for capturing images. In addition, growth in the popularity and availability of inexpensive one-time use cameras has established a new standard for convenience that has impacted consumers' buying behavior. 30 The advent of digitization has allowed for new entrants in the image output market and has increased competition within that market. However, the input market, which essentially consists of traditional film processing, continues to be strongly influenced by photofinishing equipment manufacturers. The best opportunity to provide consumers with a convenient means to digitize their images is at the same time that their traditional film is processed. To address this opportunity and in order to continue to exert influence over the image input and output markets, a number of companies within the photofinishing equipment and services industries, such as Fuji, Gretag, Kodak, Konica and Noritsu, have modified their minilab products to incorporate an on-board film scanner that digitizes photographic images immediately following the traditional wet chemistry development process. These minilabs with on-board scanners are referred to as "digital minilabs" and are expected to rapidly gain market acceptance as a primary means for digitizing images. Infotrends estimates that annual sales of digital minilabs will increase from approximately 3,000 units in 2000 to over 23,000 units in 2002. Scanning processes, including the digital minilab scanning process, however, are susceptible to a number of deficiencies. Most scanners are able to produce an image that is comparable, but not superior to, the original image. Therefore, dust, scratches, color fading and grain buildup on the original image are passed on to the digitized image. In order to attain better quality images, the original image must be thoroughly cleaned prior to scanning and then touched up once in digitized form with commercially-available software. This process is labor intensive. Moreover, because digital minilabs are dependent on the traditional wet chemistry film development process which requires a plumbing system, specialized operator training and a relatively large physical space to operate, digital minilabs generally cannot be installed at businesses that are unable or unwilling to meet these requirements. These limitations have impeded the expansion of film processing capabilities to a wider range of markets such as quick print and color copier service venues, small office/home office markets and markets within less industrialized nations. THE APPLIED SCIENCE FICTION SOLUTION We innovate, develop, license and sell proprietary imaging technologies that optimize, enhance and accelerate the digitization of photographic images for traditional photo-processing applications, as well as for desktop, professional and Internet publishing applications. In order to address the limitations of both digital cameras and traditional film processing, we have developed DFP technology which processes exposed but undeveloped 35mm and APS film directly into digital form. When DFP becomes commercially available, it will enable direct and rapid digitization of photographic images as a supplement to, or replacement for, conventional wet chemistry film processing. In addition, we have introduced to market our ICE/3/ technologies, which eliminate surface defects, restore faded color values and enhance the granular clarity of scanned images. Our ICE/3/ technologies empower users to automate the restoration of original film-based images in digital form with high quality and accuracy. These technologies are important for users who continue to develop their images through traditional photofinishing services or who seek to improve or enhance the digital quality of previously developed images. Our technologies offer the imaging industry and its consumers the following benefits: Convenience and Flexibility. Our technologies are intended to support the development of products that meet existing imaging market demands, as well as create new market opportunities. DFP has been designed to be compatible with 35mm and APS film standards. When DFP becomes commercially available, photographers will be able to use their film-based cameras to capture images and then process the exposed but undeveloped film on DFP systems, which may be located at traditional photo labs, DFP retail outlets or kiosks or through Internet photo-delivery services, depending on our OEMs' marketing strategy. Furthermore, as DFP systems will not require plumbing systems and should be smaller and less expensive to operate than traditional film-processing equipment, these systems will be easier to deploy and operate than traditional wet chemistry systems. We believe these features will make DFP services an attractive business for a variety of retailers, including those who do not offer photoprocessing services today, including malls, convenience stores, vending locations and hotels. In addition, because of its dry development and direct-to-digital capabilities, DFP will provide consumers with a more convenient solution for processing digital images. The digitized images can 31 then be archived, accessed and transmitted over the Internet. For existing photographic images, our ICE/3/ technologies automate the enhancement of these images during the scanning process, thus making image restoration simple, convenient and cost-effective. Enable Broad Capabilities for Film Processing. When commercially available, DFP systems will create new opportunities for film processing services across a number of markets. We believe that DFP will be an attractive product extension for manufacturers of digital minilabs that will enable them to sell equipment to businesses and consumers that are not within the scope of their current minilab markets. DFP systems also will enable OEMs to market and sell to businesses from a wide variety of industries, including photo labs, photocopy businesses and other retailers, as well as large commercial users of photographic images, such as advertising agencies, real estate agencies, insurance companies and catalog and e-commerce retailers. Our OEM customers could choose to deploy DFP systems to expand their film-processing capabilities in potential high growth markets, such as in Africa, Asia and Latin America. In addition, with further technological advances in computer processing and storage capabilities and in our DFP technology, as well as economies of scale from volume production, we believe that DFP units eventually may become cost effective for broad consumer use as a computer peripheral, thereby facilitating home-based film processing. We believe that our DFP systems will also allow OEMs or their customers to compete more effectively in the market for image output, such as Internet storage, archiving, transmission and printing. Image Quality and Consistency. We believe that DFP has the potential to process film with a smaller percentage of under- and over-exposures than can be produced by conventional photoprocessing equipment due to the ability to establish the development settings on a pixel-by-pixel basis. Furthermore, our ICE/3/ technologies improve the quality and consistency of images that are scanned for digital use. In contrast to traditional photoprocessing and photo- enhancement services, both DFP and ICE/3/ will be able to achieve image quality without special operator training and expertise. Cost Effectiveness. Our technologies offer the imaging industry cost- effective solutions to pursue attractive market opportunities. Because DFP systems will not require plumbing, will require less space to operate and will not use or discharge hazardous chemicals, we expect DFP systems to be less expensive to operate than traditional film-processing equipment. Our ICE/3/ technologies can significantly improve the quality of existing photographic images in an automated process that occurs during the scanning of the image. As a result, image restoration and enhancement can be conducted without labor- intensive cleaning and post-scanning touch-ups. Strategy Our objectives are to establish DFP subsystems as a premier means for processing exposed but undeveloped 35mm and APS film and to establish ICE/3/ technologies as premier technologies for enhancing the digitization of existing color images. Our strategy is based on the following key elements: Leverage Our Current Relationships with Global Market Leaders and Expand Customer Base. We have established important customer relationships with Gretag, Hewlett-Packard, Kodak, Konica, Minolta, Nikon and Noritsu. We believe that if our current technologies are successfully adopted by these OEMs, we will be able to expand these relationships to cover additional technologies that will allow them to bring innovative products to market before their competitors. In addition, we expect that successes by our first OEM customers will generate additional demand for our technologies from other companies that will seek to remain competitive. We will continue to work closely with OEMs to identify opportunities where we can enhance their market position through the development and introduction of innovative technologies. Continue to Enhance Our Technology Position. We intend to continue to capitalize on advanced technologies and developments in the digital imaging industry and introduce new technologies through our OEM customer base. In addition, we intend to maintain and enhance our position as an industry innovator in image digitization technologies by continuing to invest significant resources in research and development. Our research and development efforts resulted in the filing of 83 patent applications as of December 31, 1999. We intend to continue to patent our core technologies and to license our technologies under terms that provide us with additional intellectual property protection, including the ownership of derivative and enhancement 32 products and, where appropriate, covenants not to compete. We plan to recruit and hire additional personnel for our research and development organization, as well as continue to expand our in-house patent protection and technology licensing team. Expand End-User Awareness of Our Company and its Technologies through Brand Identity. We believe that continuing to establish and enhance the brand identity of our company and our digitization technologies is highly beneficial for creating awareness and generating demand from end users for products that incorporate our technologies. To this end, our licensing arrangements generally require our customers to place our logo on their products, packaging and software user interfaces. We also will continue to actively participate in industry trade shows independently and in conjunction with our customers, including trade shows which are oriented toward our OEM customers' customers in order to stimulate end-user demand for products that incorporate our technologies. We intend to begin establishing a brand name for our DFP technology prior to the first commercial launch of a DFP system. By expanding our co-branding efforts with our OEM customers and by generating end-user awareness of ASF technologies, we believe that our technologies and products will be perceived by end users as differentiated features and capabilities that justify price premiums for the OEM products that incorporate them. Diversify Sources of Recurring Revenue. We intend to continue to implement and expand OEM licensing arrangements for our ICE/3/ technologies that will assure us a strong and diversified foundation of recurring royalty revenue. Furthermore, besides selling and licensing DFP subsystems, we intend to supply the developing agent consumable used in these subsystems. The licensing and sale of our proprietary DFP developing agent consumable will generate recurring revenues that will increase as DFP systems are broadly deployed by retailers and accepted by the public. Pursue Strategic Opportunities in the Evolving Imaging Industry. We anticipate that ongoing competitive convergence within the imaging industry, which we expect will be more pronounced with the introduction of DFP systems, will continue to present us with numerous opportunities to establish strategic relationships with current and new market participants. After the commercial launch of DFP, we will actively explore strategic relationships with manufacturers of digital minilabs and companies in other industries that are being affected by the demand for digital images, including storage solution providers, online photo-server companies and personal computer OEMs. We also will continue to evaluate and seek to establish strategic alliances with other developers of imaging technologies as a means to expand the scope of the technologies that we offer to our customers. ASF Technologies and Products Digital Film Processing DFP is a proprietary technology that processes exposed but undeveloped color and black-and-white 35mm and APS film directly into a digital format. We have completed the development of a product prototype DFP image capture engine and are in negotiations with OEMs to incorporate this engine into their products. This highly specialized DFP image capture engine will be integrated with a computer system and our proprietary ASF digital image processing software to form a DFP subsystem. Other than our DFP technology, the remaining components of the DFP subsystem will consist largely of commercially available products and technologies such as PCs and electro-optical and high capacity storage components. We expect to outsource the manufacture of DFP subsystems and the related developing agent consumable to one or more third-party contract manufacturers. In order to prepare for the commercial launch of the first DFP system, we are customizing and adapting our technology to meet the specifications of our OEM customers, increasing the film development speed and improving the quality of the resulting digital images. Our current development schedule with our OEMs contemplates the commercial introduction of a DFP system in the second half of 2001. When commercially introduced, DFP technology will enable our OEM customers to integrate either conventional wet chemistry photoprinting or dry digital photoprinting, Internet access and other devices with our DFP subsystems to create a comprehensive DFP system which they can market and sell, along with the related developing agent consumable, to end users in traditional retail and wholesale photoprocessing markets, as well as possible new markets for photoprocessing that will be enabled by DFP, such as Internet and desktop photoprocessing and 33 image serving applications. In addition, we believe the advent of DFP systems may develop further the adoption of photoprocessing in potential high growth markets, such as in Africa, Asia and Latin America, where photofinishing equipment- and services-to-population ratios are low relative to the United States, Japan and Europe. In a DFP system, a roll of exposed but undeveloped 35mm or APS film is placed into a feeder. As the film is fed through the image capture engine, a proprietary non-toxic developing agent is applied to the film with no resultant by-product. The DFP system then makes a digital record of the image. Once this image data is captured, settings are established on a pixel-by-pixel basis in software for each element of the image, with each element developed to its optimal exposure level. The data for the final digitized image then can be routed to one or more destinations, including the Internet, a file server, inkjet color printers, removable disk media or a digital video disk (DVD) where the developed image is stored or printed. The developed digital images may be managed online using commercially available file servers with archival and retrieval software or with HTML tags on Web server software. Because DFP processes the film directly to a digital format, film negatives are not generated as a direct result of the process, although it is possible to produce traditional negatives by outputting the digital record to a film recorder. However, we expect most customers will receive selected printed copies of their images, a CD-rom or an e-mail of their photographs, or have them posted directly to a password protected Web site. We believe consumers will prefer to have their pictures developed with a DFP system for several reasons. For instance, due to the ability to automatically establish the settings on a pixel-by-pixel basis during the development process, we believe that pictures can be developed with a lower percentage of over-and under-exposures. In addition, DFP systems could be configured with a quick-feed batch print output system, enabling the end user to review composites of the entire roll of developed film, select the photos and quantities they want, and have prints and images outputted in digital form much more rapidly than is possible with traditional photoprocessing systems. When commercially introduced, DFP will be an environmentally-friendly alternative to the conventional wet chemistry film processing system, a feature which we believe consumers will value. DFP does not use any effluent chemicals or generate hazardous waste, thereby eliminating the need for color stabilizers, bleach, fix and other environmental contaminants that are used in wet chemistry film processing. Finally, DFP may facilitate broader and more convenient distribution of photoprocessing systems, including at kiosks and a variety of other retail and office locations. ICE/3/ ICE/3/ consists of three technologies: Digital Image Correction and Enhancement, or Digital ICE, Digital Reconstruction of Color, or Digital ROC, and Digital Grain Equalization and Management, or Digital GEM. We offer non- exclusive, worldwide licenses for ICE/3/ technologies individually, in combinations of two or as an entire suite of all three. Digital ROC and Digital GEM became available for licensing in the fourth quarter of 1999; however, we do not expect any royalty revenues from Digital ROC or Digital GEM until the second half of 2000. We believe that scanners which are enabled with our ICE/3/ technologies can reduce up to 90% of the most common touch-ups that are traditionally performed by desktop publishing applications following the scanning of a photographic image. The resulting improvement in the quality of the digitized image can be significant. Digital ICE. When installed in a scanner, Digital ICE eliminates dust, scratches, fingerprints and many other surface defects from scanned color photographs, slides and negatives. Digital ICE technology performs this feature by identifying a "defect channel," in addition to the standard red, green and blue channels that all scanners capture in order to build color images. A Digital ICE-enabled scanner sends the defect channel along with the red, green and blue channels to a host PC where the defects are accurately identified and automatically removed from the resultant digitized image. Implementing Digital ICE technology involves modifications to both a scanner's hardware and software. A scanner manufacturer will first modify its basic scanner hardware to be Digital ICE-capable by implementing a proprietary ASF design specification so that the scanner is able to generate and transmit a high quality defect channel. We customize our Digital ICE software specifically to each OEM's scanner in order to optimize 34 performance and quality. We also coordinate closely with our OEM licensees to develop easy to use interface software. In addition, a trademarked "Digital ICE" logo is applied to the OEM's product. Digital ROC. Digital ROC is a software application that automatically and consistently rebuilds the lost color values in faded photographic images in order to produce color corrected digitized images. This application is an attractive feature for scanners, color copiers, photocopy print stations and other digital input/output systems where true color correction has value to the end user. As with Digital ICE, software vendors currently offer products that enable color enhancement and touch-up, but these applications require significant manual intervention and often blur or distort the image in the colorizing process. In contrast, Digital ROC operates by identifying clues from the original film image to extrapolate the original color for reconstruction in the digital image. Digital ROC can be implemented as a fully-automated, one- touch feature that performs relatively basic image color reconstruction or can be adjusted to allow for the control of all aspects of image correction, with definable profiles for different input devices, output devices and customer preferences. Digital GEM. Digital GEM is designed to correct the "graininess" in processed film images and thereby enhance the visual impact of photographic images in their digitized form. Film grain refers to the distracting visual pattern often seen in photographs that is caused by the uneven distribution of silver grains in the original photographic image. These grains are by-products of the light sensitive emulsion used to develop exposed film. Our Digital GEM technology analyzes a film's unique grain pattern, extracts the data related to image quality, color and sharpness and then applies a proprietary algorithm to remove excess grain from the scanned record of the image. Target Markets and Customers Digital Film Processing We have identified the following three major target markets for our DFP technologies: manufacturers of photofinishing equipment, manufacturers of photo kiosks and manufacturers of dry output equipment, such as inkjet printers and photocopiers. We have identified companies within each of these markets that may serve as "first movers" in the development and commercial introduction of complete DFP systems. Photofinishing Equipment Manufacturers. This market consists of a relatively small number of companies that manufacture photofinishing equipment for central labs and minilabs, including digital minilabs. Because digital minilabs currently serve as a primary means for digitizing newly developed film images for use in online photo networks and managed archive systems, photofinishing equipment manufacturers may extend their digitization capabilities and expand their market share through the introduction of DFP systems. DFP systems will enable these manufacturers to sell equipment to their existing customer base, such as central photofinishing labs that may offer high-volume DFP photoprocessing services with a rapid turnaround time in conjunction with more convenient film drop off locations. Furthermore, by offering DFP systems, photofinishing equipment manufacturers will be able to shift more photofinishing services to on-site locations within their current large customer base, including discount and mass merchandisers, drug stores and supermarkets. Additionally, DFP provides them with the opportunity to expand into previously untapped distribution channels, such as copy centers, convenience stores and businesses in potential high growth markets, such as in Africa, Asia and Latin America. Assuming that technological advances continue to be made in computer processing and storage capabilities and by us in our DFP development efforts, and assuming that we achieve the economies of scale that we expect from volume production, we believe that these manufacturers will have the opportunity to sell DFP systems into a broader class of customers, such as small offices and eventually home users. Photo Kiosk Manufacturers. Because of its dry development characteristics, DFP will offer manufacturers of photo kiosks greater ability to expand their market share within the photofinishing services industry. We believe that DFP photo kiosks will be introduced in both self-serve and operator-attended installations in such locations as malls, convenience stores, vending locations and hotels. Self-serve kiosks likely would be configured with a PC interface to the Internet or a help-line telephone that will enable the end user to receive 35 trained assistance in the use of the DFP system. Kiosks could also allow a variety of convenience options such as rapid turnaround photoprocessing or direct delivery of photos to an email or Web site address, without the need to return to the kiosk to pick up the images in an output form. Dry Output Equipment Manufacturers. This target market consists largely of companies that offer products that benefit from the demand for digital images, such as manufacturers of scanners, photocopiers, inkjet printers and personal computers. When introduced, DFP systems will allow businesses and consumers to store and retrieve photo quality images on their desktop PCs. Photo quality printers introduced by Canon, Epson and Hewlett-Packard, among others, enable end users to produce thick, glossy prints which are virtually indistinguishable from standard 35mm and APS film-based prints available from photo labs today. Image editing software from Adobe, Live Picture and MGI would further enable users to produce calendars, postcards, digital photo albums and image-oriented Web pages with near professional quality. We believe that DFP systems, when integrated with the Internet and desktop PCs, will leverage the enormous investment in technology and market development that is occurring in the PC imaging industry today. ICE/3/ We have licensed our Digital ICE technology, and expect to license our Digital ROC and Digital GEM technologies, to scanner and photofinishing equipment OEMs for incorporation into their products. We use market research information in order to customize our base technologies for specific segments of the market and to assist OEM customers in defining their end-user offerings. In licensing these technologies, we segment the scanner market into two key markets: Film scanners. A film scanner is used to scan and digitize images on slides and negatives, but not photographic prints. Film scanners are incorporated into digital minilabs and also are widely used by graphic artists, service bureaus and pre-press professionals for desktop publishing. We believe that any incremental amount paid by an end user for a film scanner with one or more ICE/3/ technologies is more than offset by the costs saved in not having to manually or otherwise touch-up and restore damaged images in their digital form. A film scanner is typically priced at the retail level between $350 and $9,000. According to International Data Corporation, film scanner sales were approximately $160 million in 1998 and are expected to grow to approximately $200 million by 2003. Minolta and Nikon, manufacturers of film scanners, have licensed our Digital ICE technology for inclusion in several of their products. Our Digital ROC and Digital GEM technologies are in the process of being incorporated into film scanners and digital minilabs with products incorporating these technologies scheduled for commercial release in the fourth quarter of 2000. Flatbed scanners. Flatbed scanners are used to scan and digitize photographic prints and are growing in popularity as a PC accessory for small office and home use. Flatbed scanners with Digital ICE and Digital ROC features will provide an easy and efficient means to digitize and restore damaged images. Most flatbed scanners are priced at less than $1,000, with many models in the fastest growing segment priced at less than $100. According to International Data Corporation, sales of flatbed scanners were approximately $2.6 billion in 1998 and are expected to grow to approximately $5.4 billion by 2003. As a result of the benefits to the owner of a flatbed scanner that is enabled with one or more of our ICE/3/ technologies, a significant opportunity may exist to license these technologies to flatbed scanner manufacturers. Our Digital ICE and Digital ROC technologies are in the process of being incorporated into flatbed scanners under development agreements with OEMs, but to date, OEMs of flatbed scanners have not shipped any resultant licensed product. We do not expect Digital GEM to be incorporated into flatbed scanners in the foreseeable future. Licensing and Implementation of Our Technologies The implementation of our technologies for use by our OEM customers generally occurs in three distinct phases: design, development and production. First, in the design phase, we coordinate with the customer to design the product specifications; next, in the development phase, we develop or assist in the development of a product prototype; and third, in the production phase, either the OEM customer or a third-party manufacturer 36 produces the resultant products. During the design and development phases, we generally adapt and customize our technologies to our OEM customers' products and specifications, as well as provide the manufacturer with software customization services to support its product implementation. As part of our arrangements with our licensees, we offer the following services: design review, prototype design engineering and product development assistance. The typical license agreement package consists of: (1) a license to use our proprietary know-how and design specifications; (2) a patent license for all ASF patents related to the applicable technologies; (3) a copyright license for customized ASF software; and (4) a trademark license to use our trademarks on the OEM's products. Prior to undertaking a DFP design review, we require the prospective customer to enter into a nondisclosure agreement that requires the customer to maintain the confidentiality of our proprietary information. Our nondisclosure agreements typically include a covenant on the part of the customer not to compete with us with respect to DFP technology and may include an assignment of intellectual property rights from the customer. During the design and development phases, we expect to be paid contract fees as milestones specified in the contracts are achieved. The amount of contract fees varies according to the level of services provided and the particular customization and adaptation required by the OEM customer. During these phases, we expect to develop DFP subsystems to the customer's specifications and assist the customer with the integration of our DFP subsystems into its products. During the production phase, we expect to outsource the manufacture and distribution of DFP subsystems and the related DFP developing agent consumable. Our current schedule contemplates the commercial introduction of a DFP system in late 2001, and we expect to recognize revenues related to license and sales of our DFP subsystems and developing agent consumable at that time. Although we have entered into agreements with three OEMs whereby we have produced preliminary design specifications for DFP subsystems, we do not have any agreements which bind OEMs to commercialize our DFP technology. We expect that, as a general practice, agreements we enter into will not create any affirmative obligation requiring OEMs to complete the development and/or commercialization of DFP. Implementation and support of our ICE/3/ technologies follow a somewhat similar process as DFP but are focused on adaptation of our technology with the OEMs existing or planned scanner products. With respect to ICE/3/ technologies, the design review phase entails an evaluation of the prospective licensee's scanner or other imaging product to ensure that it can accommodate the licensed ICE/3/ technology, and if so, the extent of the adaptation and customization effort that will be required. We then proceed to the two other phases: the development phase and the production phase. During the development phase, we provide instruction and guidance to the customer to modify its product's hardware to accommodate the licensed ICE/3/ technology. Once the customer is satisfied with a prototype, the production phase ensues. During the production phase, we provide additional guidance and instruction to the customer to produce scanners or other imaging products that incorporate the licensed ICE/3/ technologies. Additional or ongoing technical support may also be obtained for an additional fee. The customer can terminate the relationship at any time after the commencement of the development phase. 37 Customers, Sales and Marketing We sell and license our technologies to manufacturers of photofinishing equipment, scanners, dry printers and other companies within the imaging industry. Our current customers, the technologies subject to their arrangements with us, and the respective phases of implementation with respect to those technologies are depicted in the following table.
OEM Technologies Phase of Implementation --- ------------ ----------------------- Eastman-Kodak Digital ICE Production phase for Kodak's PictureMaker kiosk; and in the development phase for Kodak's digital minilab system Noritsu Digital ICE Development DFP Design Nikon Digital ICE Production phase for Nikon's LS-2000 scanner; and in the development phase for an additional Nikon product Digital ROC Development Minolta Digital ICE Production phase for Minolta's Dimage Scan Speed; and in design phase for an additional Minolta product Digital ROC/Digital GEM Development Konica Digital GEM Design Gretag DFP Design Hewlett-Packard DFP Development
We cannot assure you that any of these OEMs will deliver products incorporating these technologies to market. Moreover, it is possible that these OEMs will withdraw their products from the market after they have begun delivery of such products. Please see "Risk Factors--We do not have, and do not anticipate having, agreements which bind OEMs to commercialize our DFP technology and it is possible that our customers may fail or cease their efforts to commercialize our DFP technology." Customers that accounted for 10% or more of our total revenues in 1999 were Hewlett-Packard and Nikon, and in 1998 were Nikon and Kodak. A significant portion of our revenues through December 31, 1999 were derived from development and license agreements for our Digital ICE technology. However, we expect that, as our customers undertake additional DFP development projects and we sell licenses for our Digital ROC and Digital GEM technologies, we will become less dependent on Digital ICE for generating revenues. To date, we have sold licenses to our technologies through direct sales conducted from our corporate headquarters and our Japanese subsidiary. At December 31, 1999, our direct sales force consisted of nine personnel. Our sales force contacts prospective customers in order to build awareness of our technologies and their capabilities. Once a lead is established, senior personnel, including our executive officers, will often engage in discussions with their counterparts at the prospective customer. The sales cycle for the licensing of our ICE/3/ technologies has ranged from six to 14 months, but is expected to be significantly longer for our DFP technology due to the relative size and complexity of DFP development and licensing projects. We believe the technology awareness that we create with our customers through our initial licensing engagement will enable us to license additional technologies to them on a successive basis. Our Digital ICE licensees, for example, also may become licensees of Digital ROC, Digital GEM and DFP. 38 Through our participation in industry trade shows and conferences, such as PhotoKina in Europe and the Photo Marketing Association trade show in the U.S., our Web site and an advertising campaign that we commenced in the first quarter of 2000, we intend to build broad awareness of our company and our technologies. Industry trade shows and conferences provide us with the opportunity to educate prospective customers of the potential value of our DFP and ICE/3/ technologies, thereby stimulating demand for them. Our marketing efforts are focused not only on leading companies within the imaging industry, but the customers of those companies as well. By marketing to our customer's customers, we intend to cultivate end-user demand for our technologies that will translate into increased demand from the OEMs that sell to those end users. Competition The markets for image editing software and film-development products are intensely competitive and are characterized by rapid technological change, increasing foreign and domestic competition and constant demand for new products and product enhancements. Our technologies and the products that incorporate our technologies compete directly or indirectly with products offered by many large companies. Our technologies and the products that incorporate our technologies may also compete in the future with products offering similar functionality that may be introduced by our current customers, including Hewlett-Packard, Kodak and Nikon as well as by other companies such as Canon, Polaroid and Xerox. All of our customers, and most of our other potential competitors, have longer operating histories and significantly greater financial, technical, sales, marketing and other resources than us. In addition, many of our potential competitors also have greater name recognition and larger customer bases. As a result, our competitors may be able to respond more effectively to new or emerging technologies and changes in customer requirements or preferences, withstand significant price decreases or devote greater resources to the development, promotion, sale and support of their products than us. Our future competitors may also be able to develop products or technologies comparable or superior to those we offer and may be able to adapt more quickly than us to new technologies or evolving customer requirements. We believe that the principal competitive factors in our market include the following: . ease of integration of software and other technology with OEM hardware and software systems; . technology and product performance and reliability; . price; . service; . convenience and ease of use by end users; . timeliness of new product introductions and enhancements of current products; . the extent to which an infrastructure exists for competing products and technologies; . customer service and support capabilities; and . effective strategic alliances and partnering arrangements. Although we believe that we are competitive with respect to most of these factors, there can be no assurance that we will compete successfully in our markets in the future. Digital Film Processing DFP subsystems, when incorporated into commercial DFP systems, will compete with conventional digital imaging input technologies, such as digital cameras, and conventional wet chemistry photo imaging processes with scanners, including digital minilabs. Digital camera technologies are rapidly advancing and there can be no assurance that they will not replace film-based photography in the future as the prevailing means for capturing images. New services, such as those offered by Seattle Filmworks and Kodak/America Online, have 39 also been introduced that offer traditional film processing and scanning, and then provide end users with the ability to receive prints and negatives of the digitized images, as well as storage and Internet delivery of the images. In the retail processing market, DFP systems installed in kiosks and at other retail sites will compete with digital minilabs, copy machines, PC equipment and software, mid-range film and photo scanners, and other types of office or digital imaging equipment. In the PC photography market, future desktop DFP systems will compete with digital cameras, conventional film and photo scanners, as well as service businesses such as one-hour photo labs, all of which offer alternative methods of either digitizing photo images or delivering photographs to consumers. ICE/3/ Our ICE/3/ technologies compete, or are expected to compete, with certain features of image editing software such as Adobe's Photoshop, as well as image reconstruction software specifically designed to correct defects in an image. While defects in digitized images can be corrected with image editing software, the process typically is slow, often inaccurate and limited to those defects that are readily discernible to the human eye. Although there are software solutions available in the market to assist in the removal of defects in an image, we believe that these software-only solutions are inferior to our ICE/3/ technologies because of the relative complexity involved in their use and their relative expense (both in time and dollars) as compared to our technologies. However, to the extent that DFP systems are successfully introduced to market, we anticipate that we will experience a decline in revenues from ICE/3/ licenses to manufacturers of digital minilabs, as DFP systems will compete directly with digital minilabs. Research and Development Our long-term growth and success depends, in significant part, on our ability to develop high quality technologies on a timely basis that have commercial appeal for OEMs and end-users in the imaging industry. We intend to focus our research and development activities on enhancing our existing technologies and developing new technologies and products that incorporate innovative ideas, designs and features to expand or improve the performance of our customers' products. Our objective with respect to research and development activities is to aggressively expand the scope of our patents and to create new markets where we may develop additional patents that define a market that we have established. To this end, we had filed 83 patent applications as of December 31, 1999, including 68 patent applications in 1999 alone. We cannot assure you that any patents will be issued from these applications, other than the single issued patent we have received and the two patent applications that have been allowed. At December 31, 1999, our research and development organization consisted of 90 employees, and 10 independent consultants who were retained on a full-time or part-time basis to assist in specific research and development projects. Intellectual Property Rights We rely on domestic, foreign, and international laws and treaties to establish and protect our proprietary rights in our technologies and products. In particular, we rely on a combination of patent, trademark, copyright, trade secret and contract law, as well as other technical measures to protect our proprietary technologies and products. Our principal intellectual property strategy is to patent the ideas and inventions that embody our technologies. One aspect of our intellectual property strategy is to maximize the time our technologies are protected by patents. To that end, we have filed provisional patent applications with the United States Patent and Trademark Office which effectively protects our technologies for 21 years from the filing date. Another aspect of our intellectual property strategy is to protect our technologies internationally. The majority of our patent applications are also filed as Patent Cooperation Treaty, or PCT, applications. The PCT applications give us the opportunity to file for patent protection in 69 countries around the world. We have filed a number of patent applications on inventions that pertain to our ICE/3/ and DFP technologies. In addition, we have filed patent applications on inventions which go beyond the scope of our 40 current licensed technologies and may represent future market opportunities. At December 31, 1999, we had filed 83 patent applications with the U.S. Patent and Trademark Office. To date, we have received one issued patent and allowance of two other patents applications from the U.S. Patent and Trademark Office with respect to these applications. We expect the allowed applications to issue as patents in the near future. Although we have filed numerous patent applications covering our technologies and products, no assurance can be given that any pending patent applications will result in the issuance of patents. We rely to some extent on trade secret protection to protect our technologies, and we regularly enter into confidentiality agreements with our customers. However, there can be no assurance that third parties will not independently develop the same or similar technology, obtain unauthorized access to our proprietary technologies, or misuse technologies that we have granted access to our customers. In addition, we cannot guarantee that our technologies and products will not infringe the patents or rights of any third party. We also rely on trademarks to establish consumer recognition and loyalty. We have filed a total of 111 trademark applications on 14 separate marks. The marks on which we have filed trademark applications include "ASF," "Applied Science Fiction," "Digital ICE," "Digital ICE/2/," "Digital ICE/3/," "Digital ROC," "Digital GEM," "Digital Negative" and "Virtual Negative". We have received notices of allowance on five of the marks for which we have submitted trademark applications, and we expect an additional 16 applications to be approved in the near future. No assurance can be given, however, that any pending trademark application will result in the registration of the trademark. In addition, we cannot guarantee that a third party does not already own rights in or to our pending trademarks, which may prevent us from obtaining trademark protection. Our ICE/3/ and DFP technologies utilize patented inventions that we presently license from IBM. Our intellectual property strategy with respect to the licensed IBM patents is to augment these patents with our own patents. In exchange for the use of the IBM patents, our customers are generally required to enter into a separate license agreement with IBM. Royalties from this agreement are payable directly to IBM by our customers. This payment is in addition to the royalties paid to us by our customers for the use of our technologies and products. Our license agreement with IBM expires on October 31, 2000. We believe that this license agreement will be renewed on substantially the same terms in accordance with IBM's open-licensing policy pursuant to which licenses of IBM intellectual property generally are renewed as a matter of course, unless there is a material breach of our agreement with IBM. Employees As of December 31, 1999, we had 134 full-time employees in our offices in Austin, Texas and two full-time employees in our offices in Tokyo, Japan. Of these employees, 90 were engaged in research and development, 26 were employed in sales and marketing and 20 were employed in finance and administration. None of our employees is represented by a labor union or is subject to a collective bargaining agreement. We believe that our relationship with our employees is good. Facilities Our executive offices and principal operations are currently located in a leased facility in Austin, Texas that provides us with up to approximately 54,000 square feet of office and lab space, of which approximately 1,500 square feet is subleased to third parties. As these subleases terminate, we will take down the additional space to support our growth. In November 1999, we entered into a letter of intent with a commercial real estate developer to lease 100,000 square feet of build-to-suit office and lab space in Austin, Texas, with a proposed lease term commencing in the first quarter of 2001. This letter of intent also contemplates an option to lease an additional 335,000 square feet of build-to-suit space as the need arises, subject to the terms and conditions of the definitive agreements that will be entered into by the parties. We also lease approximately 1,000 square feet in Tokyo, Japan to support sales, marketing and development for customers in Asia. We believe that our lease arrangements for our facilities are adequate to meet our needs for the foreseeable future. Legal Proceedings We are currently not a party to any material legal proceedings. 41 MANAGEMENT Directors and Executive Officers Set forth below is certain information concerning our directors and executive officers.
Name Age Position - ---- --- -------- Mark R. Urdahl.......... 39 President, Chief Executive Officer and Chairman of the Board Dr. Albert Edgar........ 50 Chief Scientist and Director Robert E. Sleet, Jr..... 53 Executive Vice President and Chief Financial Officer, Secretary and Treasurer Jerome W. Johnson....... 50 Executive Vice President Sales, Marketing and Licensing Operations Daniel J. Sullivan...... 52 Executive Vice President, Intellectual Property, Strategy and Administration S. Dana Seccombe........ 51 Executive Vice President, Research and Development John Asa(2)............. 62 Director Harvey B. Cash.......... 61 Director Carmelo M. Gordian...... 41 Director Richard H. Kimball(1)... 43 Director Peter M. Palermo(1)(2).. 58 Director
- -------- (1) Member of our Compensation Committee (2) Member of our Audit Committee Executive Officers and Directors Mark R. Urdahl is a founder of our company and has served as our President and Chief Executive Officer since June 1995. Mr. Urdahl also serves as our Chairman of the Board. Prior to joining our company, Mr. Urdahl was Program Manager of Open Ventures at IBM, where he focused on software investments and alliances, including the Fibre Channel System Initiative, a joint effort of IBM, Sun Microsytems and Hewlett-Packard. From August 1983 through June 1995, Mr. Urdahl held management and marketing positions at IBM where he focused on advanced software, imaging and network communications technologies as well as Internet strategies. Mr. Urdahl holds a B.S. in Economics from the University of California at Santa Barbara. Dr. Albert Edgar is a founder of our company and has served as our Chief Scientist since June 1995. Dr. Edgar also serves as one of our directors. From June 1978 to June 1995, Dr. Edgar was employed by IBM where he engaged in various scientific and engineering projects. Dr. Edgar holds B.S. degrees in Electrical Engineering and Physics from Northwestern University and Ph.D.s in Electrical Engineering and Computer Science from the University of Oklahoma. Robert E. Sleet, Jr. is our Secretary and Treasurer and has served as our Executive Vice President and Chief Financial Officer since October 1999. From January 1999 to June 1999, Mr. Sleet was Chief Financial Officer at Real Time Data, Inc., a vending services holding company. Mr. Sleet served as Vice President and Treasurer at Sprint PCS, a global telecommunications services company, from April 1996 to November 1998. From April 1985 to April 1996, Mr. Sleet served as Vice President and Treasurer at Global Marine Inc., an offshore drilling contractor and services company. Mr. Sleet holds a B.A. in Economics and Finance from the University of North Carolina at Charlotte. Jerome W. Johnson has served as our Executive Vice President Sales, Marketing and Licensing Operations since June 1999. From 1993 to May 1999, Mr. Johnson was Vice President and General Manager of the U.S. and Canadian Consumer Imaging Division of Kodak. Mr. Johnson holds a B.S. in Business from the University of North Dakota and an M.B.A. from Syracuse University. Daniel J. Sullivan has served as our Executive Vice President, Intellectual Property, Strategy and Administration since December 1999. From August 1974 to November 1999, Mr. Sullivan was employed by 42 IBM where he served in various positions, including, most recently, as its Vice President, Asia Pacific Technical Operations. Mr. Sullivan holds a B.A. in Liberal Arts from Hanover College and an M.S. in Systems Management from the University of Southern California. S. Dana Seccombe has served as our Executive Vice President, Research and Development since December 1999. From April 1968 to November 1999, Mr. Seccombe was Vice President and General Manager of Hewlett-Packard's Inkjet Supplies Business Unit. From August 1972 through March 1988, Mr. Seccombe held various other positions at Hewlett-Packard, including Group Research and Development Manager, General Manager--Information Hardware Operation and Research and Development Manager. Mr. Seccombe holds a B.S. and an M.S. in Electrical Engineering from the Massachusetts Institute of Technology. John Asa has served as a director since January 2000. Mr. Asa has served as the Executive Vice President and General Manager of Japan Camera, Inc. since November 1990. Mr. Asa was the Executive Vice President and General Manager of ASA Corporation, Ltd., a wholesale distributor of photographic products, from March 1963 to October 1990. Harvey B. Cash has served as a director since January 1999. Mr. Cash has served as a partner of various venture capital organizations affiliated with InterWest Partners, a venture capital firm, since 1985. Mr. Cash serves on the board of directors of the following public companies: AMX Corporation, a manufacturer of remote control systems; Aurora Electronics, Inc., a distributor of recycled integrated circuit boards and computer components; Ciena Corporation, a manufacturer of systems for long distance fiberoptic networks; i2 Technologies, Inc., a software company; Liberte Investors, Inc., an investment company; and ProNet, Inc., a manufacturer of paging devices. In addition, Mr. Cash is a director of several privately held companies. Mr. Cash holds a B.S. in Electrical Engineering from Texas A&M University and an M.B.A. from Western Michigan University. Carmelo M. Gordian has served as a director since January 2000. Since October 1994, Mr. Gordian has served as a partner of Brobeck, Phleger & Harrison LLP, a law firm, either directly or through Carmelo M. Gordian, P.C., a professional corporation of which Mr. Gordian is the sole director and shareholder. Mr. Gordian also serves as Chairman of that firm's Business and Technology Group. Mr. Gordian holds a B.A. in Economics from Harvard College and a J.D. from Harvard Law School. Richard H. Kimball has served as a director since April 1999. Mr. Kimball is a General Partner of Technology Crossover Ventures, which he co-founded in June 1995. From September 1984 to December 1994, Mr. Kimball was a Managing Director at Montgomery Securities. Mr. Kimball is on the Board of Directors at Copper Mountain, Inc. and several private companies and is an outside advisor to Intel and its Intel 64 Fund. Mr. Kimball holds an A.B. from Dartmouth College and an M.B.A. from the University of Chicago. Peter Palermo has served as a director since November 1999. Mr. Palermo has been President and Chief Executive Officer of The Strategic Triangle, Inc., an international management consulting firm, since 1994. From July 1963 to December 1993, Mr. Palermo has served in a variety of positions at Kodak, including, most recently, as its Corporate Vice President, Director of Marketing and Senior Vice President of Imaging. Mr. Palermo holds a B.A. in Psychology and English from Bowling Green State University and an M.B.A. from the University of Rochester. Classified Board of Directors We currently have authorized seven directors. At the first annual meeting of stockholders following the closing of this offering, our board of directors will be divided into three classes, as nearly equal in size as is practicable, to serve staggered three-year terms as follows: . Class I, whose terms will expire at the annual meeting of stockholders to be held in 2000; . Class II, whose term will expire at the annual meeting of stockholders to be held in 2001; and . Class III, whose term will expire at the annual meeting of stockholders to be held in 2002. 43 The directors for each class will be elected for three-year terms at the annual meeting of stockholders in the year in which their term expires. Each director's term is subject to the election and qualification of his successor, or his earlier death, resignation or removal. Committees of the Board of Directors Our board of directors established an audit committee in May 1998. The members of the audit committee are Messrs. Asa and Palermo. The audit committee reports to the board of directors with regard to the selection of our independent auditors, the scope and records of our annual audits, fees to be paid to the auditors, the performance of our independent auditors, compliance with our accounting and financial policies and management's procedures and policies relative to the adequacy of our internal accounting controls. Our board of directors established a compensation committee in April 1999. The members of the compensation committee are Messrs. Kimball and Palermo. The compensation committee reviews and makes recommendations to the board of directors regarding our compensation policies and all forms of compensation to be provided to our directors, executive officers and certain other employees. In addition, the compensation committee reviews bonus and stock compensation arrangements for all of our other employees. The compensation committee also administers our stock option and stock purchase plans. Compensation Committee Interlocks and Insider Participation Prior to establishing the compensation committee, our board of directors as a whole performed the functions delegated to the compensation committee. No member of our board of directors or the compensation committee serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee. No interlocking relationships exist between our board of directors or compensation committee and the board of directors or compensation committee of any other company, nor have any such interlocking relationships existed in the past. Director Compensation We typically do not pay our directors for their services as directors other than to grant them stock options to purchase our common stock. However, we may, by resolution of our board of directors, reimburse directors for expenses incurred in connection with their attendance at board and committee meetings. On November 12, 1999, we granted Peter M. Palermo an option to purchase 55,000 shares of common stock at a price of $3.50 per share. Limitation of Liability and Indemnification Matters Our certificate of incorporation limits the liability of our directors to our company or our stockholders for breaches of the directors' fiduciary duties to the fullest extent permitted by Delaware law. In addition, our certificate of incorporation and bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Delaware law. Prior to consummation of this offering, we also intend to obtain directors' and officers' liability insurance and will have entered into indemnification agreements with all of our directors and executive officers. Employment Contracts The officers generally serve at the discretion of our board of directors. However, we have entered into employment contracts with Jerome W. Johnson, Daniel J. Sullivan, S. Dana Seccombe and Robert E. Sleet, Jr. Mr. Johnson If, prior to our entering into a written agreement resulting in a "change in our control," we terminate Mr. Johnson's employment without "cause," or he terminates his employment for "good reason," all as defined in 44 his employment agreement, then he shall receive from us: (1) 50% of his annual base salary paid in one lump-sum immediately following his termination; (2) 100% of his annual base salary and target bonus which will be paid out in installments over the 12 month period following his termination; (3) six months of continued health benefits, including coverage for his dependents; (4) six months of accelerated vesting of unvested shares immediately following his termination; and (5) an additional 12 months of continued vesting of his unvested shares over the 12 months following his termination. In addition, if, within 18 months of our entering into a written agreement resulting in a "change in our control," we terminate Mr. Johnson's employment without "cause," or he terminates his employment for "good reason," all as defined in his employment agreement, then he shall receive from us: (1) 200% of his annual base salary and target bonus paid in one lump-sum immediately following his termination; (2) six months of continued health benefits, including coverage for his dependents; and (3) 100% accelerated vesting of his unvested shares immediately following his termination. In addition, if Mr. Johnson terminates his employment for any reason during a 30-day period commencing 12 months after a written agreement resulting in a "change in our control," as defined in his employment agreement, then he shall receive 50% accelerated vesting of his then unvested shares immediately following such termination. If any of the foregoing benefits provided to Mr. Johnson constitute "parachute payments," as defined under Section 280G of the Internal Revenue Code, then we will pay any resultant excise and income taxes up to a maximum of $100,000. If Mr. Johnson dies or becomes permanently and totally disabled while employed by us, then he or his estate will receive from us immediately upon his death or disability: (1) 100% of his annual base salary and target bonus paid in one lump-sum; (2) 12 months of continued health benefits for him or his dependents, as the case may be; and (3) 12 months of accelerated vesting of his unvested shares. Mr. Seccombe If, prior to our entering into a written agreement resulting in a "change in our control," we terminate Mr. Seccombe's employment without "cause," as defined in his employment agreement, then he shall receive from us: (1) 50% of his annual base salary plus 50% of his target bonus paid in one lump-sum immediately following his termination; (2) 100% of his annual base salary and a dollar amount equal to 1/12 of his target bonus paid over the 18 months following his termination; (3) six months of continued health benefits, including coverage for his dependents; (4) continued vesting of unvested shares as if his employment was not terminated until all those options shares are fully vested; and (5) an extension of the exercisability of his options following such termination for a period of 48 months. If, within 18 months of our entering into a written agreement resulting in a "change in our control," we terminate Mr. Seccombe's employment without "cause," as defined in his employment agreement, then he shall receive from us: (1) 200% of his annual base salary and target bonus paid in one lump-sum immediately following his termination; (2) six months of continued health benefits, including coverage for his dependents; (3) continued vesting of unvested shares as if his employment had not been terminated until all shares are fully vested; and (4) an extension of the exercisability of his options following such termination for a period of 48 months. Upon the expiration of the 18 month period, Mr. Seccombe's rights upon termination shall be governed by the same provisions that apply to termination prior to our entering into a written agreement resulting in a "change in our control" as set forth above. In addition, if Mr. Seccombe terminates his employment for any and all reasons during a 30-day period commencing 12 months after a written agreement resulting in a "change in our control," as defined as defined in his employment agreement, then for purposes of vesting he shall receive from us an additional 24 months of service (and the shares reflecting the additional 24 months of service shall immediately vest). If Mr. Seccombe dies or becomes permanently and totally disabled while employed by us, then he or his estate shall receive from us immediately upon his death or disability: (1) 100% of his annual base salary and target bonus paid in one lump-sum; (2) 24 months of continued health benefits for him or his dependents, as the case may be; and (3) 24 months accelerated vesting of his unvested shares. 45 Mr. Sleet If, prior to our entering into a written agreement resulting in a "change in our control," we terminate Mr. Sleet's employment without "cause," as defined in his employment agreement, then he shall receive from us immediately following his termination: (1) 100% of his annual base salary paid in one lump- sum; and (2) accelerated vesting of his unvested shares as if he were employed through his next employment anniversary date. If within 18 months of our entering into a written agreement resulting in a "change in our control," we "involuntarily terminate" Mr. Sleet's employment, as defined in his employment agreement, then he shall receive from us immediately following his termination: (1) 100% of his annual base salary paid in one lump-sum; and (2) 100% accelerated vesting of his unvested shares. Mr. Sullivan If, prior to our entering into a written agreement resulting in a "change in our control," we terminate Mr. Sullivan's employment without "cause," as defined in his employment agreement, then he shall receive from us immediately following his termination: (1) 100% of his base salary paid in one lump-sum; and (2) accelerated vesting of his unvested shares as if he were employed through his next anniversary. If, within 18 months of our entering into a written agreement resulting in a "change in our control," we "involuntarily terminate" Mr. Sullivan's employment, as defined in his employment agreement, then he shall receive from us immediately following his termination: (1) 100% of his annual base salary paid in one lump-sum; and (2) 100% accelerated vesting of his unvested shares. Executive Compensation The following table provides the total compensation paid to our Chief Executive Officer and the only other executive officer of our company whose compensation (salary and bonus) was in excess of $100,000 for services rendered in all capacities to us for the year ended December 31, 1999. Summary Compensation Table
Long-Term Annual Compensation Compensation --------------------------------- ------------ Securities Salary Bonus All Other Underlying Name and Principal Position ($) ($) Compensations($) Options - -------------------------------- -------- ------- ---------------- ------------ Mark Urdahl..................... $205,000 $70,539 $ -- 35,484 President and Chief Executive Officer Albert Edgar ................... 190,000 67,203 -- 16,129 Chief Scientist Jerome W. Johnson............... 127,885 50,000 30,700 (1) 216,500 Executive Vice President Sales, Marketing and Licensing Operations
- -------- (1) Consists of relocation expenses paid by us. Option Grants in Last Fiscal Year The following table provides information concerning individual grants of stock options made during the year ended December 31, 1999 to each of our executive officers. We have never granted any stock appreciation rights. The exercise prices represent our board of director's estimate of the fair market value of our common stock on the grant date. In establishing these prices, our board considered many factors, including our financial condition and operating results, development milestones, recent transactions and the market for comparable stocks. The amounts shown as potential realizable value represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. These amounts represent certain assumed rates 46 of appreciation in the value of our common stock. The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission and do not represent our estimate or projection of the future price of our common stock. The potential realizable value is calculated based on the ten year term of the option at its time of grant. It is calculated based on the assumption that the assumed initial public offering price of $ per share appreciates at the indicated annual rate compounded annually for the entire term of the option and that the option is exercised and sold on the last day of its term for the appreciated stock price. Actual gains, if any on stock option exercises depend on the future performance of our common stock. There can be no assurance that the amounts reflected in the table will be achieved. We granted these options under our 1995 Stock Option/Stock Issuance Plan. Each option has a maximum term of ten years, subject to earlier termination if the optionee's services are terminated. These options are immediately exercisable, but we have the right to repurchase, at the exercise price, any shares that have not vested at the time the optionee terminates employment with us. The percentage of total options granted to our employees in the last fiscal year is based on options to purchase an aggregate of 2,148,721 shares of stock granted during 1999.
Potential Realizable Value of Assumed Annual Rates of Stock Price Option Grants During Year Ended Appreciation December 31, 1999 Individual Grants for Option Term ------------------------------------------------------ --------------------- Percent of Number of Total Exercise Securities Options Granted Price Underlying Options to Employees per Expiration Name Granted (1)(#) in Fiscal 1999 Share($) Date 5% 10% - ---- ------------------ --------------- -------- ---------- ---------- ---------- Mark Urdahl............. 35,484 1.7% $1.55 08/11/09 $ $ Albert Edgar............ 16,129 0.8 1.55 08/11/09 Jerome W. Johnson....... 216,500 10.0 1.55 06/16/09
- -------- (1) All options were granted at fair market value, as determined by our board of directors on the date of grant. All options granted to our executive officers in 1999 were exercised shortly after the date of grant. As of December 31, 1999, all shares exercised by our executive officers were subject to repurchase. Fiscal Year-End Option Values The following table sets forth information concerning option exercises and option holdings for the year ended December 31, 1999 with respect to each of our executive officers named in the Summary Compensation table. We have never granted any stock appreciation rights.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values ----------------------------------------------------------------------------- Value Number of Securities Realized Underlying Unexercised Value of Unexercised Number (Market Price Options at In-the-Money Options at of Shares at Exercise December 31, 1999 December 31, 1999 Acquired on less Exercise ------------------------- ------------------------- Name Exercise Price) Exercisable Unexercisable Exercisable Unexercisable - ---- ----------- ------------- ----------- ------------- ----------- ------------- Mark Urdahl............. 35,484 -- -- -- -- Albert Edgar............ 16,129 -- -- -- -- Jerome W. Johnson....... 216,500 -- -- -- --
47 Benefit Plans 2000 Stock Incentive Plan The 2000 Stock Incentive Plan is intended to serve as the successor equity incentive program to our 1995 Stock Option/Stock Issuance. The 2000 Stock Incentive Plan became effective upon its adoption by the board of directors on January 24, 2000; and it will be approved by the stockholders prior to the date of this offering. We have reserved 5,000,000 shares of our common stock for issuance under the 2000 Stock Incentive Plan. This share reserve consists of the shares available for issuance under the predecessor plan on the effective date of this offering plus an additional increase of 4,244,954 shares. The share reserve will automatically be increased on the first trading day of January each calendar year, beginning in January 2001, by a number of shares equal to 3% of the total number of shares of common stock outstanding on the last trading day of the immediately preceding calendar year, but no such annual increase will exceed 1,500,000 shares. However, in no event may any one participant in the 2000 Stock Incentive Plan receive option grants or direct stock issuances for more than 500,000 shares in the aggregate per calendar year. Outstanding options under the predecessor plan will be incorporated into the 2000 Stock Incentive Plan on the date of this offering, and no further option grants will be made under that plan. The incorporated options will continue to be governed by their existing terms, unless our compensation committee extends one or more features of the 2000 Stock Incentive Plan to those options. However, except as otherwise noted below, the outstanding options under the predecessor plan contain substantially the same terms and conditions summarized below for the discretionary option grant program under the 2000 Stock Incentive Plan. The 2000 Stock Incentive Plan has five separate programs: . the discretionary option grant program under which eligible individuals in our employ or service (including officers, non-employee board members and consultants) may be granted options to purchase shares of our common stock, . the stock issuance program under which such individuals may be issued shares of common stock directly, through the purchase of such shares or as a bonus tied to the performance of services, . the salary investment option grant program under which executive officers and other highly compensated employees may elect to apply a portion of their base salary to the acquisition of special below-market stock option grants, . the automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee board members and . the director fee option grant program under which non-employee members of our board of directors may elect to apply a portion of their retainer fee to the acquisition of special below-market stock option grants. The discretionary option grant and stock issuance programs will be administered by our compensation committee. This committee will determine which eligible individuals are to receive option grants or stock issuances, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the exercise or purchase price for each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The committee will also select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years. Neither the compensation committee nor the board will exercise any administrative discretion with respect to option grants made under the salary investment option grant program or under the automatic option grant or director fee option grant program for the non-employee board members. 48 The exercise price for the options will be determined by the compensation committee and may be paid in cash or in shares of our common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. In addition, the compensation committee may allow a participant to pay the option exercise price or direct issue price (and any associated withholding taxes incurred in connection with the acquisition of shares) with a full-recourse, interest-bearing promissory note. In the event that the company is acquired, whether by merger, asset sale or board-approved sale by the stockholders of more than 50% of our voting stock, each outstanding option under the discretionary option grant program which is not assumed by the successor corporation or otherwise continued will automatically accelerate in full, and all unvested shares under the discretionary option grant and stock issuance programs will immediately vest, except to the extent the company's repurchase rights with respect to those shares are to be assigned to the successor corporation or otherwise continued in effect. The compensation committee may grant options and issue shares under those programs which will accelerate (1) in the acquisition even if the options are assumed or if the optionee's service is subsequently terminated or (2) in connection with a hostile change in control (effected through a successful tender offer for more than 50% of our outstanding voting stock or by proxy contest for the election of board members) or upon a subsequent termination of the individual's service. In the event of an acquisition (by merger or asset sale), options currently outstanding under the 1995 Stock Option/Stock Issuance Plan will accelerate unless assumed by the successor corporation; all assumed options will accelerate upon the optionee's involuntary termination (including a forced resignation) within 18 months following the acquisition. Such options are not by their terms subject to acceleration upon any other change in control or hostile takeover. Stock appreciation rights may be issued under the discretionary option grant program which will provide the holders with the election to surrender their outstanding options for an appreciation distribution from our company equal to the fair market value of the vested shares subject to the surrendered option less the aggregate exercise price payable for such shares. Such appreciation distribution may be made in cash or in shares of our common stock. There are currently no outstanding stock appreciation rights under the predecessor plan. The compensation committee has the authority to cancel outstanding options under the discretionary option grant program (including options incorporated from predecessor plans) in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of the common stock on the new grant date. In the event the compensation committee elects to activate the salary investment option grant program for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $50,000. In return, the individual will automatically be granted, on the first trading day in the calendar year for which the salary reduction is to be in effect, a non- statutory option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of our common stock on the grant date. The option exercise price will be equal to one-third of the fair market value of the option shares on the grant date. As a result, the fair market value of the option shares on the grant date less the exercise price payable for those shares will be equal to the salary reduction amount. The option will become exercisable in a series of 12 equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting in the event of an acquisition or change in control of the company. Under the automatic option grant program, each individual who first joins the board after the effective date of this offering as a non-employee board member will automatically be granted an option to purchase 15,000 shares of our common stock at the time of his or her commencement of board service. Each automatic grant will have an exercise price equal to the fair market value per share of our common stock on the grant date and will have a maximum term of 10 years, subject to earlier termination following the optionee's cessation of 49 board service. Each option will be immediately exercisable, subject to the company's right to repurchase any unvested shares, at the original exercise price, at the time of the board member's cessation of service. The options will vest, and the company's repurchase right will lapse, in a series of four equal successive annual installments upon the optionee's completion of each year of service over the four-year period measured from the grant date. However, each outstanding option will immediately vest upon an acquisition or change in control or the death or disability of the optionee while serving as a member of the board of directors. If the director fee option grant program is put into effect in the future, then each non-employee board member may elect to apply all or a portion of any cash retainer fee for the year to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the non-employee board member would otherwise be paid the cash retainer fee in the absence of his or her election. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of our common stock on the grant date. As a result, the fair market value of the option shares on the grant date less the exercise price payable for those shares will be equal to the portion of the retainer fee applied to that option. The option will become exercisable in a series of twelve equal monthly installments over the calendar year for which the election is in effect. However, the option will become immediately exercisable for all the option shares upon the death or disability of the optionee while serving as a board member. Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, director fee option grant and salary investment option grant programs and may be granted to one or more officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to the company upon the successful completion of a hostile tender offer for more than 50% of our outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from the company in an amount per surrendered option share equal to the highest price per share of common stock paid in connection with the tender offer less the exercise price payable for such share. The board may amend or modify the 2000 Stock Incentive Plan at any time, subject to any required stockholder approval. The 2000 Stock Incentive Plan will terminate no later than January 23, 2010. Employee Stock Purchase Plan The Employee Stock Purchase Plan was adopted by the board on January 24, 2000 and will be approved by the stockholders prior to the date of this offering. The plan will become effective immediately upon the execution of the underwriting agreement for this offering. The plan is designed to allow eligible employees of our company and its participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions. A total of 500,000 shares of our common stock will initially be issued under the plan. The share reserve will increase on the first trading day of each calendar year beginning with the 2001 calendar year by 1% of the total number of shares of common stock outstanding on the last day of the immediately preceding year, but no such annual increase will exceed 250,000 shares. The plan will have a series of successive offering periods, each with a maximum duration of 24 months. However, the initial offering period will begin on the day the underwriting agreement is executed in connection with this offering and will end on the last business day in April 2002. The next offering period will begin on the first business day in May 2002, and subsequent offering periods will be set by our compensation committee. Individuals who are eligible employees on the start date of any offering period may enter the plan on that start date or on any subsequent semi-annual entry date (generally May 1 or November 1 each year). Individuals who become eligible employees after the start date of the offering period may join the plan on any subsequent semi-annual entry date within that period. 50 A participant may contribute up to 15% of his or her cash earnings through payroll deductions and the accumulated payroll deductions will be applied to the purchase of shares on the participant's behalf on each semi-annual purchase date (the last business day in April and October each year). The purchase price per share will be 85% of the lower of the fair market value of our common stock on the participant's entry date into the offering period or the fair market value on the semi-annual purchase date. The first purchase date will occur on the last business day in October 2000. In no event, however, may any participant purchase more than 1,000 shares. Should the fair market value of our common stock on any semi-annual purchase date be less than the fair market value on the first day of the offering period, then the current offering period will automatically end and a new offering period will begin, based on the lower fair market value. The board may at any time amend or modify the plan. The plan will terminate no later than the last business day in April 2010. 51 RELATED PARTY TRANSACTIONS The following is a description of transactions during the last three years to which we have been a party, in which the amount involved in the transaction exceeded $60,000 and in which any director, executive officer or holder of more than 5% of our capital stock had or will have a direct or indirect material interest other than compensation arrangements that are otherwise required to be described under "Management." Private Placement Of Equity During the past three years, we have issued shares of our convertible preferred stock as follows: . In August 1999, we issued 10,233 warrants exercisable into share of Series D preferred stock to Silicon Valley Bank for $7.74 share. . In March 1999, we sold 4,069,767 shares of Series D preferred stock in a private placement at a purchase price of $7.74 per share; . In July and September 1997, we sold an aggregate of 1,471,500 shares of Series C preferred stock in a private placement at a purchase price of $3.70 per share and issued warrants to purchase 1,224,879 shares of common stock for $.62 per share. Our officers, directors and 5% stockholders participated in the foregoing transactions as follows:
Number of Number of Aggregate Number of Shares of Number of Warrants to Shares Common Stock Issuable Upon Shares Purchase Shares of Series Exercise of Warrants and Name of Purchaser of Series C of Common D Conversion of Preferred Stock - ----------------- ----------- --------------- --------- ----------------------------- Mark R. Urdahl.......... -- -- -- 2,448 Dr. Albert Edgar........ -- -- -- 14,601 Harvey B. Cash.......... 13,513 11,247 -- 51,786 CenterPoint Venture Partners............... 594,595 494,946 258,398 2,537,129 InterWest Funds......... 405,406 337,464 258,398 1,812,080 Sevin Rosen Funds....... 374,325 311,589 516,796 1,951,360 Technology Crossover Venture Funds.......... -- -- 1,453,489 1,453,489
Registration Rights. We granted registration rights to the investors in our preferred stock which require us to register or include their shares in a registered offering of our securities. Please see "Description of Capital Stock--Registration Rights" for a description of these rights. 52 PRINCIPAL STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of our common stock at December 31, 1999 and as adjusted to reflect the sale of shares offered hereby, by (1) each person who is known by us to own beneficially more than 5% of our common stock, (2) each of our directors, (3) each of our executive officers named in the Summary Compensation table on page 46 and (4) all executive officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting and investment power with respect to the securities. Except as indicated by footnote, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. The number of shares of common stock used to calculate the percentage ownership of each listed person includes the shares of common stock underlying options or warrants held by such persons that are exercisable within 60 days of this offering. The percentage of beneficial ownership before the offering is based on 21,926,324 shares of common stock outstanding at December 31, 1999, consisting of 13,160,291 shares of common stock outstanding, and 8,766,033 shares issuable upon the conversion of the preferred stock.
Percentage of Common Stock Beneficially Owned Shares ----------------- Beneficially Before After Beneficial Owners Owned Offering Offering - -------------------------------------------- ------------ -------- -------- Executive Officers and Directors Mark R. Urdahl.............................. 2,553,930 11.6% Dr. Albert Edgar............................ 2,546,728 11.6 Jerome W. Johnson........................... 216,500 * John Asa.................................... Harvey B. Cash.............................. 51,786 * Carmelo Gordian............................. Richard H. Kimball.......................... -- -- Peter M. Palermo............................ 55,000 * All directors and executive officers as a group (11 persons)......................... 6,061,344 27.6 CenterPoint Venture Partners................ 2,537,129 11.6 InterWest Funds............................. 1,812,080 8.3 Sevin Rosen Funds........................... 1,951,360 8.9 Technology Crossover Venture Funds.......... 1,453,489 6.6
- -------- *Less than 1%. Named Officers and Directors. Additional information regarding beneficial ownership of shares held by our executive officers and directors is contained below. Except as indicated below, the address for each executive officer and director is c/o Applied Science Fiction, Inc., 8920 Business Park Drive, Austin, Texas 78759. Mark R. Urdahl. Includes 2,488 shares issuable upon exercise of a currently exercisable warrant and 35,484 shares of common stock which are currently unvested and subject to our right to repurchase them if Mr. Urdahl's services are terminated prior to vesting. Dr. Albert Edgar. Includes 1,224 shares issuable upon exercise of a currently exercisable warrant and 16,129 shares of common stock which are currently unvested and subject to our right to repurchase them if Mr. Edgar's services are terminated prior to vesting. 53 Jerome W. Johnson. Includes 216,500 shares of common stock which are currently unvested and subject to our right to repurchase them if Mr. Johnson's services are terminated prior to vesting. Harvey B. Cash. Includes 11,247 shares issuable upon exercise of a currently exercisable warrant. Peter M. Palermo. Includes 55,000 shares of common stock which are currently unvested and subject to our right to repurchase them if Mr. Palermo's services are terminated prior to vesting. All directors and officers as a group. Includes 195,000, 185,000 and 257,400 shares of common stock owned by Messrs. Sleet, Sullivan and Seccombe. These shares are currently unvested and subject to our right to repurchase them if the respective individual's service is terminated prior to vesting. Other 5% Stockholders. Additional information regarding the beneficial owners of 5% or more of our stock is as follows: CenterPoint Venture Partners. CenterPoint Venture Partners, L.P.'s address is Two Galleria Tower, 13455 Noel Road, Suite 1670, Dallas, Texas 75240. Funds affiliated with InterWest Ventures. Includes (a) 1,758,241 common stock equivalent shares held by InterWest Partners VI, L.P. and (b) 53,839 shares held by InterWest Investors VI, L.P. The address of the investment funds associated with InterWest Ventures is 3000 Sand Hill Road, Building 3, Suite 255, Menlo Park, California 94025. Funds affiliated with Sevin Rosen. Includes (a) 1,315,886 shares held by Sevin Rosen Fund V, L.P.; (b) 56,258 shares held by Sevin Rosen V Affiliates Fund L.P.; (c) 191,619 shares held by Sevin Rosen Management Company; (d) 359,302 shares held by Sevin Rosen Fund VI, L.P.; and (e) 28,295 shares Sevin Rosen VI Affiliates Fund, L.P. The address of the investment funds associated with Sevin Rosen is Two Galleria Tower, 13455 Noel Road, Suite 1670, Dallas, Texas 75240. Funds affiliated with Technology Crossover Ventures. Includes (a) 10,544 shares held by TCV III (GP); (b) 50,132 shares held by TCV III, L.P.; (c) 1,332,462 shares held by TCV III (Q) L.P.; and (d) 60,341 shares held by TCV III Strategic Partners, L.P. The address of the investment funds associated with Technology Crossover Ventures is 56 Main Street, Milburn, New Jersey 07041. 54 DESCRIPTION OF CAPITAL STOCK General Upon completion of this offering, our authorized capital stock will consist of shares of common stock, $0.001 par value, and shares of undesignated preferred stock, $0.001 par value. The following description of our capital stock is subject to and qualified in its entirety by our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus forms a part, and by the provisions of applicable Delaware law. Common Stock At December 31, 1999, there were 21,926,324 shares of common stock outstanding after giving pro forma effect to the conversion of all outstanding shares of preferred stock into common stock upon the closing of this offering. These shares were held of record by approximately 200 stockholders. The holders of our common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, the holders of common stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by our board of directors out of funds legally available for that purpose. In the event of a liquidation, dissolution or winding up, the holders of our common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The holders of our common stock do not have preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. Preferred Stock Our board of directors has the authority, without action by our stockholders, to designate and issue preferred stock in one or more series with certain rights, preferences and privileges which may be greater than the rights of the common stock. It is not possible to accurately describe the actual effect of the issuance of any shares of preferred stock upon the rights of holders of common stock until our board of directors determines the specific rights of the holders of such preferred stock. However, the effects might include, among other things: . restricting dividends on our common stock; . diluting the voting power of our common stock; . impairing the liquidation rights of our common stock; or . delaying or preventing a change in control of Applied Science Fiction without further action by the stockholders. Upon the closing of this offering, no shares of preferred stock will be outstanding. At the present, we have no plans to issue any shares of preferred stock. Warrants At December 31, 1999 there were warrants outstanding to purchase 7,740 shares of Series B preferred stock and 10,233 shares of Series D preferred stock. Upon completion of this offering, these warrants will become exercisable for 33,453 shares of common stock. In addition, there were warrants outstanding to purchase 1,224,879 shares of common stock. Also, under the terms of a warrant issued to Silicon Valley Bank, Silicon Valley Bank may become entitled to purchase up to $1.2 million of our common stock in certain circumstances. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 55 Registration Rights According to the terms of an investors' rights agreement, beginning 180 days after the closing of this offering, some of our stockholders, who hold in the aggregate shares of common stock, may require us to file a registration statement under the Securities Act of 1933, as amended, with respect to the resale of their shares. To demand such registration, investors holding an aggregate of at least shares must request that the registration statement register at least shares. We are not required to effect more than two demand registrations in any 12 month period. Additionally, the holders of shares of common stock will have piggyback registration rights with respect to the registration of shares of common stock under the Securities Act. If we propose to register any shares of common stock under the Securities Act, the holders of shares having piggyback registration rights are entitled to receive notice of that registration and are entitled to include their shares in the registration. At any time after we become eligible to file a registration statement on Form S-3, holders of demand registration rights may require us to file registration statements on Form S-3 under the Securities Act with respect to their shares of common stock. We are not required to effect more than two such registrations on Form S-3 in any 12 month period. These registration rights are subject to conditions and limitations, including the right of the underwriters of an offering to limit the number of shares of common stock to be included in the registration. We are generally required to bear all of the expenses of all registrations under the investors' rights agreement, except underwriting discounts and selling commissions. The investors' rights agreement also contains our commitment to indemnify the holders of registration rights and certain other people for certain losses they may incur in connection with registrations under the agreement. Registration of any of the shares of common stock held by security holders with registration rights would result in those shares becoming freely tradeable without restriction under the Securities Act. Anti-Takeover Provisions Certain provisions of Delaware law, our certificate of incorporation and our bylaws could make the following transactions more difficult: . the acquisition of Applied Science Fiction by means of a tender offer; . the acquisition of Applied Science Fiction by means of a proxy contest or otherwise; or . the removal of our incumbent officers and directors. These provisions, summarized below, are intended to discourage certain types of coercive takeover practices and inadequate takeover bids. They are designed to encourage persons seeking to acquire control of Applied Science Fiction to first negotiate with our board of directors. We believe that the benefits of our increased ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure Applied Science Fiction outweigh the disadvantages of discouraging such proposals as negotiation of such proposals could result in an improvement of their terms. Delaware Anti-Takeover Law. We are subject to Section 203 of the General Corporation Law of the State of Delaware, an anti-takeover law. In general, Section 203 prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years following the date the person became an interested stockholder, unless the "business combination" or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. Generally, an "interested stockholder" is a person who, together with affiliates and associates, owns or within three years prior to the determination of interested stockholder status, did own, 15% or more of a corporation's voting stock. The existence of this provision may have an anti- takeover effect with 56 respect to transactions not approved in advance by our board of directors, including, but not limited to, discouraging attempts that might result in a premium over the market price of shares of common stock held by our stockholders. Election and Removal of Directors. Our board of directors is divided into three classes. The directors in each class will serve for a three-year term upon being elected by our stockholders. See "Management--Executive Officers and Directors." This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of Applied Science Fiction because it generally makes it more difficult for stockholders to replace a majority of the directors. Stockholders Meetings. Under our bylaws, only our board of directors, Chairman of the Board and President may call special meetings of stockholders. Requirements for Advance Notification of Stockholder Nominations and Proposals. Our bylaws establish advance notice procedures with respect to stockholder proposals and stockholder nominations of candidates for election as directors. Elimination of Stockholder Action by Written Consent. Our certificate of incorporation eliminates the right of stockholders to act by written consent. Elimination of Cumulative Voting. Our certificate of incorporation and bylaws do not provide for cumulative voting in the election of our directors. Undesignated Preferred Stock. The authorization of undesignated preferred stock allows our board of directors to issue preferred stock with voting and other rights or preferences that could impede the success of any attempt to change control of Applied Science Fiction. These and other provisions may have the effect of deterring hostile takeovers or delaying changes in our officers and directors. Supermajority Vote Provisions. The Delaware General Corporate Law provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation's certificate of incorporation or bylaws, unless a corporation's certificate of incorporation or bylaws, as the case may be, requires a greater percentage. Our certificate of incorporation imposes supermajority vote requirements in connection with the amendment of certain provisions of our certificate of incorporation, including the provisions relating to the classified board of directors and action by written consent of stockholders. Indemnification. We indemnify our directors and officers to the fullest extent permitted by Delaware law. We have entered into indemnity agreements with all of our directors and officers and have purchased directors' and officers' liability insurance. In addition, our charter limits the personal liability of our board members for breaches by the directors of their fiduciary duties where permitted under Delaware law. Transfer Agent and Registrar The Transfer Agent and Registrar for the common stock is . 57 SHARES ELIGIBLE FOR FUTURE SALE If our stockholders sell substantial amounts of our common stock in the public market following this offering, the prevailing market price of our common stock could decline. Furthermore, because we do not expect any shares will be available for sale for 180 days after this offering as a result of certain contractual and legal restrictions on resale described below, sales of substantial amounts of our common stock in the public market after these restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon the closing of this offering, we will have outstanding an aggregate of shares of our common stock, based upon the number of shares outstanding at , 2000, and assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options. Of these shares, all shares sold in this offering will be freely tradeable without restriction or further registration under the Securities Act unless they are purchased by our "affiliates," as that term is defined in Rule 144 under the Securities Act. The remaining shares will be eligible for sale in the public market as follows:
Number of Shares Date ---------------- ---- After the date of this prospectus, freely tradeable shares sold in this offering and shares saleable under Rule 144(k) that are not subject to the 180-day lock-up. After 180 days from the date of this prospectus, the 180-day lock-up is released and these shares are saleable under Rule 144 (subject, in some cases, to volume limitations), Rule 144(k) or Rule 701. After 180 days from the date of this prospectus, restricted securities that are held for less than one year and are not yet saleable under Rule 144. However, of these shares will become eligible for sale on the public markets within 10 days after the expiration of the lock-up.
The remaining shares of common stock held by existing stockholders are "restricted securities" as defined in Rule 144. Our existing stockholders may sell restricted securities in the public market only if the shares are registered or if the shares qualify for an exemption from registration under Rule 144 or 701 under the Securities Act, which are summarized below. Lock-up Agreements. All of our directors and officers and substantially all of our stockholders and option holders are expected to sign lock-up agreements under which they agreed not to transfer or dispose of, directly or indirectly, any shares of our common stock or any securities convertible into or exercisable or exchangeable for shares of our common stock for 180 days after the date of this prospectus. Transfers or dispositions can be made sooner with the prior written consent of Morgan Stanley & Co. Incorporated. Rule 144. In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year, including the holding period of certain prior owners other than affiliates, is entitled to sell within any three-month period a number of shares that does not exceed the greater of (a) 1% of the number of shares of our common stock then outstanding, which will equal approximately shares immediately after the offering, or (b) the average weekly trading volume of our common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to that sale. Sales under Rule 144 are also 58 subject to certain manner-of-sale provisions, notice requirements and the availability of current public information about us. Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one of our affiliates at any time during the three months preceding a sale and who has beneficially owned shares for at least two years, including the holding period of certain prior owners other than affiliates, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless otherwise restricted, Rule 144(k) shares may be sold immediately upon the closing of this offering. Rule 701. In general, under Rule 701 of the Securities Act as currently in effect, each of our directors, officers, employees, consultants or advisors who purchased shares from us before the date of this prospectus in connection with a compensatory stock plan or other written compensatory agreement is eligible to resell such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with certain restrictions, including the holding period, contained in Rule 144. Registration Rights. After this offering, the holders of at least shares of our common stock will be entitled to certain rights with respect to the registration of those shares under the Securities Act. See "Description of Capital Stock Registration Rights." After such registration, these shares of our common stock become freely tradeable without restriction under the Securities Act. These sales could cause the market price of our common stock to decline. Stock Plans. After this offering, we intend to file a Form S-8 registration statement under the Securities Act covering 5,500,000 shares of common stock issued or reserved for issuance under our 2000 Stock Incentive Plan and our 2000 Employee Stock Purchase Plan. We expect this registration statement to become effective as soon as practicable after the effective date of this offering. As of December 31, 1999, options to purchase 270,439 shares of our common stock were issued and outstanding. All of these shares will be eligible for sale in the public market from time to time, subject to vesting provisions, Rule 144 volume limitations applicable to our affiliates and the expiration of lock-up agreements. 59 UNDERWRITERS Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the underwriters named below have severally agreed to purchase, and Applied Science Fiction has agreed to sell to them, severally, the number of shares indicated below:
Name Number of Shares - ---- ---------------- Morgan Stanley & Co. Incorporated.............................. Credit Suisse First Boston Corporation......................... Salomon Smith Barney, Inc...................................... Prudential Securities Incorporated............................. ---------- Total........................................................ ==========
The underwriters are offering the shares of common stock subject to their acceptance of the shares from Applied Science Fiction and subject to prior sale. The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered by this prospectus are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriters are obligated to take and pay for all of the shares of common stock offered by this prospectus if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters' over- allotment option described below. The underwriters initially propose to offer part of the shares of common stock directly to the public at the public offering price listed on the cover page of this prospectus and part to certain dealers at as price that represents a concession not in excess of $ a share under the public offering price. Any underwriter may allow, and such dealers may reallow, a concession not in excess of $ a share to other underwriters or to certain dealers. After the initial offering of the shares of common stock, the offering price and other selling terms may from time to time be varied by the representatives of the underwriters. Applied Science Fiction has granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of additional shares of common stock at the public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The underwriters may exercise this option solely for the purpose of covering overallotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. To the extent the option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase about the same percentage of the additional shares of common stock as the number listed next to the underwriter's name in the preceding table bears to the total number of shares of common stock listed next to the names of all underwriters in the preceding table. If the underwriters' option is exercised in full, the total price to the public would be $ , the total underwriters' discounts and commissions would be $ and total proceeds to Applied Science Fiction would be $ . The underwriters have informed Applied Science Fiction that they do not intend sales to discretionary accounts to exceed five percent of the total number of shares of common stock offered by them. We expect to file an application to qualify our common stock for quotation on the NASDAQ National Market under the symbol "ASFX." Each of Applied Science Fiction, each of our directors and officers and substantially all of our stockholders have agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the underwriters, they will not, during the period ending 180 days after the date of this prospectus: . offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of directly or indirectly, any shares of common stock or any securities convertible into to exercisable or exchangeable for common stock; or 60 . enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock. whether any transaction described above is to be settled by delivery of common stock or such other securities, in cash or otherwise. The restrictions in this paragraph do not apply to: . the sale of shares to the underwriters; or . the issuance by Applied Science Fiction of shares of common stock upon the exercise of an option or a warrant or the conversion of a security outstanding on the date of this prospectus of which the underwriters have been advised in writing. In order to facilitate the offering of the common stock, the underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock. Specifically, the underwriters may over-allot in connection with the offering, creating a short position in the common stock for their own account. In addition, to cover over-allotments or to stabilize the price of the common stock, the underwriters may bid for, and purchase, shares of common stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an underwriter or a dealer for distributing the common stock in the offering, if the syndicate repurchases previously distributed common stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the common stock above independent market levels. The underwriters are not required to engage in these activities, and may end any of these activities at any time. From time to time, Morgan Stanley & Co. Incorporated has provided, and continues to provide, investment banking services to Applied Science Fiction. Applied Science Fiction and the underwriters have agreed to indemnify each other against certain liabilities, including liability under the Securities Act. At our request, the underwriters have reserved for sale, at the initial offering price, up to shares offered hereby for the directors, officers, employees, business associates, stockholders and related persons of Applied Science Fiction. Of this amount, up to shares, representing up to five percent of the shares of our common stock sold by us in the offering, will be offered to the holders of our Series C and Series D preferred stock pursuant to an agreement made with them prior to the filing of this registration statement. The shares of common stock available for sale to the general public will be reduced to the extent such persons purchase such reserved shares. Any reserved shares which are not so purchased will be offered by the underwriters to the general public on the same basis as the other shares offered hereby. Pricing of the Offering Prior to this offering, there has been no public market for the common stock. The initial public offering price will be determined by negotiations between Applied Science Fiction and the underwriters. Among the factors to be considered in determining the initial public offering price will be the future prospects of Applied Science Fiction and its industry in general, sales, earnings and certain other financial operating information of Applied Science Fiction in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and certain financial and operating information of companies engaged in activities similar to those of Applied Science Fiction. The anticipated initial public offering price range set forth on the cover page of this preliminary prospectus is subject to change as a result of market conditions and other factors. 61 LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for us by Brobeck, Phleger & Harrison LLP, Austin, Texas and for the underwriters by Davis Polk & Wardwell, New York, New York. Mr. Gordian, a partner at Brobeck, Phleger & Harrison LLP, was recently appointed as one of our directors. EXPERTS Ernst & Young LLP, independent auditors, have audited our consolidated financial statements at December 31, 1998 and 1999, and for each of the three years in the period ending December 31, 1999, as set forth in their report. We have included our consolidated financial statements in the prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP's report, given their authority as experts in accounting and auditing. WHERE YOU CAN FIND ADDITIONAL INFORMATION ABOUT APPLIED SCIENCE FICTION We have filed with the Securities and Exchange Commission a registration statement on Form S-1 under the Securities Act with respect to the common stock offered in this offering. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules to the registration statement. For further information about us and the common stock offered in this offering, we refer you to the registration statement and to the attached exhibits and schedules. Complete exhibits have been filed with our registration statements on Form S-1. You may inspect our registration statement and the attached exhibits and schedules without charge at the public reference facilities maintained by the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information about the public reference rooms. You may obtain copies of all or any part of our registration statement from the Securities and Exchange Commission upon payment of prescribed fees. Our filings with the Securities and Exchange Commission, including the registration statement, are also available without charge at the Securities and Exchange Commission's Web site http://www.sec.gov. Upon completion of this offering, Applied Science Fiction will become subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934 and, accordingly, will file periodic reports, proxy statements and other information with the Securities and Exchange Commission. Such periodic reports, proxy statements and other information will be available for inspection and copying at the Securities and Exchange Commission's public reference rooms, and the Web site of the Securities and Exchange Commission referred to above. 62 APPLIED SCIENCE FICTION, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Auditors............................................ F-2 Consolidated Balance Sheets as of December 31, 1998 and 1999.............. F-3 Consolidated Statements of Operations for the Years Ended December 31, 1997, 1998 and 1999...................................................... F-4 Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended December 31, 1997, 1998 and 1999................................... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999...................................................... F-6 Notes to Consolidated Financial Statements................................ F-7
F-1 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders Applied Science Fiction, Inc. We have audited the accompanying consolidated balance sheets of Applied Science Fiction, Inc. as of December 31, 1998 and 1999 and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the three years in the period ended December 31, 1999. 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied Science Fiction, Inc. at December 31, 1998 and 1999, and the results of its operations and its cash flows for the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Austin, Texas January 21, 2000 F-2 APPLIED SCIENCE FICTION, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
Pro Forma Stockholders' December 31, Equity ----------------- December 31, 1998 1999 1999 ------- -------- ------------- (Unaudited) ASSETS ------ Current assets: Cash and cash equivalents................... $ 633 $ 6,092 Short-term investments...................... -- 4,906 Accounts receivable, net of allowance of $0 in 1998 and $20 in 1999.................... 170 1,372 Prepaid expenses and other current assets... 60 268 ------- -------- Total current assets...................... 863 12,638 Property and equipment: Computer equipment and software............. 770 2,815 Lab equipment............................... 441 1,263 Furniture and fixtures...................... 248 476 ------- -------- 1,459 4,554 Accumulated depreciation.................... (407) (1,675) ------- -------- Net property and equipment.................... 1,052 2,879 Long-term investments......................... -- 7,737 Other long-term assets........................ 313 402 ------- -------- Total assets.............................. $ 2,228 $ 23,656 ======= ======== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) - ---------------------------------------------- Current liabilities: Accounts payable and accrued liabilities.... $ 696 $ 1,735 Accrued compensation........................ 524 1,917 Deferred revenues........................... 177 150 Current portion of notes payable to bank.... 423 1,402 ------- -------- Total current liabilities................. 1,820 5,204 Accrued rent.................................. 338 286 Notes payable to bank, less current portion... 3,028 6,436 Stockholders' equity (deficit): Convertible Preferred Stock; $.001 par value; 25,000,000 shares authorized; 1,573,917 and 5,653,162 shares designated; 1,564,606 and 5,635,189 shares issued and outstanding; liquidation preference of $5,616 and $37,118 at December 31, 1998 and 1999, respectively; and none issued and outstanding pro forma...................... 2 6 $ -- Common Stock: $.001 par value; 100,000,000 shares authorized; and 11,185,431, 13,160,291 and 21,926,324 shares issued and outstanding at December 31, 1998, 1999, and pro forma, respectively.................... 11 13 22 Additional paid-in capital.................. 5,972 48,750 48,747 Deferred stock-based compensation........... -- (6,713) (6,713) Notes receivable from stockholders.......... (232) (5,675) (5,675) Accumulated other comprehensive loss........ -- (42) (42) Accumulated deficit......................... (8,711) (24,609) (24,609) ------- -------- -------- Total stockholders' equity (deficit)...... (2,958) 11,730 $ 11,730 ------- -------- ======== Total liabilities and stockholders' equity (deficit)................................ $ 2,228 $ 23,656 ======= ========
See accompanying notes. F-3 APPLIED SCIENCE FICTION, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Year ended December 31, -------------------------- 1997 1998 1999 ------- ------- -------- Revenues: Contract revenues................................ $ 628 $ 214 $ 3,152 Royalty revenues................................. -- 288 821 ------- ------- -------- Total revenues................................. 628 502 3,973 Costs and expenses: Cost of contract revenues........................ 43 250 2,147 Research and development......................... 717 4,218 9,050 Selling, general and administrative.............. 998 3,572 7,629 Amortization of stock-based compensation......... -- -- 1,431 ------- ------- -------- 1,758 8,040 20,257 ------- ------- -------- Loss from operations............................... (1,130) (7,538) (16,284) Interest income.................................... 116 167 1,092 Interest expense................................... (4) (122) (627) Other income (expense), net........................ 90 (17) (8) ------- ------- -------- Net loss before foreign withholding taxes.......... (928) (7,510) (15,827) Foreign withholding taxes.......................... 62 -- 71 ------- ------- -------- Net loss........................................... $ (990) $(7,510) $(15,898) ======= ======= ======== Basic and diluted net loss per share............... $ (0.18) $ (1.01) $ (1.70) ======= ======= ======== Shares used in computing basic and diluted net loss per share......................................... 5,361 7,424 9,353 ======= ======= ======== Pro forma basic and diluted net loss per share..... $ (0.88) ======== Shares used in computing pro forma basic and diluted net loss per share........................ 18,119 ========
See accompanying notes. F-4 APPLIED SCIENCE FICTION, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands, except share amounts)
Convertible Preferred Stock Common Stock Notes Accumulated ----------------- ----------------- Additional Deferred Receivable Other $ $ Paid-In Stock-Based from Comprehensive Accumulated Shares Amount Shares Amount Capital Compensation Stockholders Income (Loss) Deficit --------- ------ ---------- ------ ---------- ------------ ------------ ------------- ----------- Balance at December 31, 1996............. 201,906 $ 1 8,722,500 $ 9 $ 347 $ -- $ (3) $-- $ (211) Cancellation of Series A Preferred Stock. (108,800) -- -- -- -- -- -- -- -- Issuance of Series C Preferred Stock, net of offering costs of $131... 1,471,500 1 -- -- 5,312 -- -- -- -- Issuance of Common Stock to certain founders for services rendered........ -- -- 696,000 1 85 -- -- -- -- Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... -- -- 439,581 -- 56 -- (56) -- -- Net loss........ (990) Comprehensive loss............ -- -- -- -- -- -- -- -- -- --------- --- ---------- --- ------- ------- ------- ---- -------- Balance at December 31, 1997............. 1,564,606 2 9,858,081 10 5,800 -- (59) -- (1,201) Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... -- -- 1,327,350 1 172 -- (173) -- -- Net loss........ (7,510) Comprehensive loss............ -- -- -- -- -- -- -- -- -- --------- --- ---------- --- ------- ------- ------- ---- -------- Balance at December 31, 1998............. 1,564,606 2 11,185,431 11 5,972 -- (232) -- (8,711) Issuance of Series B Preferred Stock upon exercise of warrants........ 816 -- -- -- 2 -- -- -- -- Issuance of Series D Preferred Stock, net of offering costs of $2,331. 4,069,767 4 -- -- 29,165 -- -- -- -- Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... -- -- 1,974,860 2 5,442 -- (5,443) -- -- Issuance of warrants to purchase preferred stock. -- -- -- -- 25 -- -- -- -- Stock-based compensation.... -- -- -- -- 8,144 (8,144) -- -- -- Amortization of deferred stock- based compensation.... -- -- -- -- -- 1,431 -- -- -- Net loss........ -- (15,898) Foreign currency adjustment...... 3 -- Unrealized loss on available- for-sale securities...... -- -- -- -- -- -- -- (45) -- Comprehensive loss............ -- -- -- -- -- -- -- -- -- --------- --- ---------- --- ------- ------- ------- ---- -------- Balance at December 31, 1999............. 5,635,189 $ 6 13,160,291 $13 $48,750 $(6,713) $(5,675) $(42) $(24,609) ========= === ========== === ======= ======= ======= ==== ======== Total Stockholders' Equity (Deficit) ------------- Balance at December 31, 1996............. $ 143 Cancellation of Series A Preferred Stock. -- Issuance of Series C Preferred Stock, net of offering costs of $131... 5,313 Issuance of Common Stock to certain founders for services rendered........ 86 Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... -- Net loss........ (990) ------------- Comprehensive loss............ (990) ------------- Balance at December 31, 1997............. 4,552 Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... -- Net loss........ (7,510) ------------- Comprehensive loss............ (7,510) ------------- Balance at December 31, 1998............. (2,958) Issuance of Series B Preferred Stock upon exercise of warrants........ 2 Issuance of Series D Preferred Stock, net of offering costs of $2,331. 29,169 Issuance of Common Stock under Stock Option/Stock Issuance Plan, net of cancellations... 1 Issuance of warrants to purchase preferred stock. 25 Stock-based compensation.... -- Amortization of deferred stock- based compensation.... 1,431 Net loss........ (15,898) Foreign currency adjustment...... 3 Unrealized loss on available- for-sale securities...... (45) ------------- Comprehensive loss............ (15,940) ------------- Balance at December 31, 1999............. $ 11,730 =============
See accompanying notes. F-5 APPLIED SCIENCE FICTION, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Year Ended December 31, ------------------------- 1997 1998 1999 ------ ------- -------- Operating activities Net loss............................................ $ (990) $(7,510) $(15,898) Non-cash adjustments to net loss: Depreciation expense.............................. 31 383 1,268 Compensation expense related to issuance of common stock............................................ 86 -- -- Amortization of warrant........................... -- -- 5 Amortization of stock-based compensation.......... -- -- 1,431 Changes in assets and liabilities: Accounts receivable............................. (33) (70) (1,202) Prepaids and other assets....................... (30) (342) (277) Accounts payable and accrued liabilities........ 50 921 987 Accrued compensation............................ 199 326 1,393 Deferred revenues............................... 669 (493) (27) ------ ------- -------- Cash used in operating activities................... (18) (6,785) (12,320) Investing activities Purchases of short- and long-term investments....... -- -- (18,188) Sales and maturities of short- and long-term investments........................................ -- -- 5,500 Purchases of property and equipment, net of retirements........................................ (172) (1,232) (3,095) ------ ------- -------- Cash used in investing activities................... (172) (1,232) (15,783) Financing activities Proceeds from issuance of notes payable to bank..... -- 3,451 5,530 Payments on notes payable to bank................... -- -- (1,143) Proceeds from issuance of preferred stock, net of offering costs..................................... 5,313 -- 29,169 Proceeds from exercise of preferred stock warrants.. -- -- 2 Proceeds from notes receivable from stockholders.... -- -- 1 ------ ------- -------- Cash provided by financing activities............... 5,313 3,451 33,559 Effect of exchange rate changes on cash and cash equivalents........................................ -- -- 3 ------ ------- -------- Net increase (decrease) in cash..................... 5,123 (4,566) 5,459 Cash and cash equivalents at beginning of year...... 76 5,199 633 ------ ------- -------- Cash and cash equivalents at end of year............ $5,199 $ 633 $ 6,092 ====== ======= ======== Supplemental disclosure of cash flow information Foreign taxes paid.................................. $ 62 $ -- $ 71 ====== ======= ======== Interest paid....................................... $ 4 $ 122 $ 627 ====== ======= ======== Non-cash transaction Issuance of Common Stock under Stock Option/Stock Issuance plan and paid through the issuance of full-recourse notes by stockholders, net of cancellations...................................... $ 56 $ 173 $ 5,444 ====== ======= ======== Issuance of warrants to purchase preferred stock.... $ -- $ -- $ 25 ====== ======= ========
See accompanying notes. F-6 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization Applied Science Fiction, Inc. (the Company, or ASF) is a leading innovator, developer and licensor of proprietary imaging technologies that optimize, enhance and enable the digitization of photographic images for traditional photoprocessing applications, as well as desktop, professional and Internet publishing applications. The Company, a Delaware corporation, was incorporated on June 15, 1995. 2. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Applied Science Fiction Japan Co., Ltd. All intercompany transactions and balances have been eliminated in consolidation. Unaudited Pro Forma Information Upon the closing of the initial public offering, each of the outstanding shares of Series D convertible preferred stock will convert into one share of common stock and each of the outstanding shares of Series C and Series B convertible preferred stock will convert into three shares of common stock. The pro forma stockholders' equity presents the Company's stockholders' equity as if this had occurred at December 31, 1999. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist of highly liquid cash equivalents, short- and long-term investments and trade receivables. The Company's cash equivalents, short- and long-term investments are placed with high credit quality financial institutions and issuers. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. The Company provides for an allowance for doubtful accounts receivable based upon the expected collectibility of such receivables. The following table summarizes the changes in the allowance for doubtful accounts receivable (in thousands): Balance at December 31, 1998........................................ $ -- Additions charged to costs and expenses............................. 20 Write-off of uncollectible accounts................................. -- ---- Balance at December 31, 1999........................................ $ 20 ====
There was no activity in the allowance for doubtful accounts receivable, nor any related balance, in 1997 or 1998. F-7 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following is a detail of customers that accounted for greater than 10% of gross revenue in the respective fiscal years:
1997 1998 1999 ---- ---- ---- Customer A................................................ 64% 74% 25% Customer B................................................ 35% 16% -- Customer C................................................ -- -- 43%
Cash, Cash Equivalents and Long- and Short-Term Investments The Company's cash equivalents, short- and long-term investments consist of highly liquid debt instruments--all of which are high-grade corporate securities--and are held by three U.S. banks. The Company considers all debt instruments with an original maturity at date of purchase of (i) three months or less to be cash equivalents; (ii) between three and twelve months to be short-term investments; and (iii) twelve months or more to be long-term investments. The Company's debt instruments have been classified as available-for-sale and are stated at market value with unrealized gains and losses reported as a component of "accumulated other comprehensive loss" within stockholders' equity. Realized gains and losses and declines in value judged to be other than temporary are included in "interest income" and have not been material to date. The amortized cost and estimated fair value of debt securities at December 31, 1999, by contractual maturity, is shown below (in thousands). Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Gross Gross Estimated Unrealized Unrealized Fair Cost Gains Losses Value ------- ---------- ---------- --------- (In thousands) Due in one year or less.......... $ 4,701 $ 1 $-- $ 4,702 Due after one year through five years........................... 7,987 -- (46) 7,941 ------- --- ---- ------- $12,688 $ 1 $(46) $12,643 ======= === ==== =======
Fair values were determined using quoted market prices. Fair Value of Financial Instruments The Company's financial instruments consist principally of cash and cash equivalents, short-and long-term investments, receivables, accounts payable, and borrowings. The Company believes all of the financial instruments' recorded values approximate current market values. Property and Equipment Property and equipment are carried at cost less accumulated depreciation. Depreciation of property and equipment is computed using the straight-line method over the estimated useful life of the assets (generally two to five years). Computer Software to be Sold, Leased or Otherwise Marketed The Company capitalizes eligible computer software costs upon achievement of technological feasibility subject to net realizable value considerations. The Company has defined technological feasibility as the completion of a working model. The Company has not capitalized any software development costs as such costs have been insignificant. F-8 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Revenue Recognition Since inception and through December 31, 1999, the Company's revenues have been derived from contract fees associated with its DFP (Digital Film Processing), Digital ICE (Image Correction and Enhancement), and Digital ROC (Reconstruction of Colors) technologies and royalties associated with its Digital ICE technology. Contract fees generally refer to fees paid by original equipment manufacturers (OEMs) for developing, adapting and customizing the Company's technologies for use in OEM products. The Company generally recognizes contract fees as revenues based upon the achievement of certain milestones in accordance with the terms of the related arrangements. Cost of contract revenues have been determined based on the portion of engineering costs that the Company has incurred to fulfill its obligations under the related arrangements. Royalties under Digital ICE license agreements are recognized as revenues when shipments by the licensee of products that incorporate the Digital ICE technology are reported to the Company. Such reports are generally received by the Company in the quarter following shipment by the licensee of such products resulting in a one quarter delay between shipment and recognition of revenues from those sales. The amount of prepaid royalties and contract fees received by the Company in excess of recognized revenues are recorded as deferred revenues, as appropriate, until earned. Advertising Advertising costs are expensed as incurred. Advertising expenses in the years ended December 31, 1997, 1998, and 1999 were not material. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. This statement prescribes the use of the liability method whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Stock-Based Compensation Stock-based compensation is recognized using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock, amortized over the vesting period. Any stock options granted to non-employee consultants are valued at the fair market value of the equity investment in accordance with EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. The resultant deferred stock-based compensation is amortized over the vesting period, or the expected life, of the applicable options, as appropriate. Information regarding the Company's pro forma disclosure of stock-based compensation pursuant to SFAS No. 123, Accounting for Stock-Based Compensation, may be found under the heading "Stockholders' Equity" in these Notes to Consolidated Financial Statements (see Note 7). Net Loss Per Share Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period (excluding shares subject to repurchase). Diluted net loss per common share was the same as basic net loss per common share for all periods presented since the effect of any potentially dilutive securities is excluded as they are anti-dilutive because of the Company's net losses. F-9 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Pro forma basic and diluted net loss per share is computed by dividing net loss by the sum of the weighted average number of common shares outstanding for the period (excluding shares subject to repurchase) and the weighted average number of common shares resulting from the assumed conversion of outstanding shares of convertible preferred stock. The calculation of historical and pro forma basic and diluted net loss per share is as follows (in thousands, except per share amounts):
Year ended December 31, ------------------------- 1997 1998 1999 ------ ------- -------- Historical: Net loss.......................................... $ (990) $(7,510) $(15,898) ====== ======= ======== Weighted-average shares of common stock outstanding. 9,042 10,706 11,663 Less: Weighted-average shares that may be repurchased........................................ (3,681) (3,282) (2,310) ------ ------- -------- Weighted-average shares of common stock outstanding used in computing basic and diluted net loss per share.............................................. 5,361 7,424 9,353 ====== ======= ======== Basic and diluted net loss per share................ $(0.18) $ (1.01) $ (1.70) ====== ======= ======== Pro forma: Net loss.......................................... $(15,898) ======== Weighted-average shares used in computing basic and diluted net loss per share (from above)...... 9,353 Adjustment to reflect the effect of the assumed conversion of preferred stock from the date of issuance......................................... 8,766 -------- Weighted-average shares used in computing pro forma basic and diluted net loss per share....... 18,119 ======== Pro forma basic and diluted net loss per share.... $ (0.88) ========
If the Company had reported net income, the calculation of historical and pro forma diluted earnings per share would have included approximately 3,681,000, 3,282,000 and 2,310,000 weighted average shares subject to repurchase, and approximately 472,000, 657,000 and 697,000 common equivalent shares related to outstanding stock options and warrants not included above (determined using the treasury stock method), for the years ended December 31, 1997, 1998 and 1999, respectively. Comprehensive Income (Loss) In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income, which requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from nonowner sources. The Company adopted this statement in 1998 and has presented its total comprehensive loss in the statements of stockholders' equity (deficit). There was no accumulated other comprehensive gain or loss during 1997 and 1998. Accumulated other comprehensive loss is comprised of unrealized losses on available-for-sale securities and foreign currency adjustments during 1999. Segment Information Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The adoption of SFAS No. 131 did not have a significant effect on the disclosure of segment information as the Company continues to consider its business activities as a single F-10 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) segment. Revenues from customers with principal offices in Japan were approximately $401,000, $402,000 and $1,901,000 for the years ending December 31, 1997, 1998, and 1999. Substantially all of the long-lived assets as of December 31, 1998 and 1999 are located in the United States. Reclassifications Certain prior year amounts have been reclassified to conform to current year presentation. Recently Issued Accounting Standards In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, which is effective for fiscal years beginning after June 15, 2000. This statement requires companies to record derivatives on the balance sheet as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for the Company's year ending December 31, 2001. Management believes that this statement will not have a material impact on the Company's financial position or results of operations. In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB No. 101), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The application of SAB No. 101 did not have a material impact on the financial statements of the Company. In March 1999, the FASB issued an exposure draft entitled "Accounting for Certain Transactions involving Stock Compensation," which is a proposed interpretation of APB Opinion No. 25. However, the exposure draft has not been finalized. Once finalized and issued, the current accounting practices for transactions involving stock compensation may need to change and such changes could affect the Company's future operating results. 3. Notes Payable to Bank Royalty Backed Annuity Notes In October 1998 and January 1999, the Company issued to a bank (the Bank) a $2.5 million and a $3.5 million royalty backed annuity note, respectively, pursuant to a note purchase agreement. The two annuity notes are secured by future royalty receipts under specified Digital ICE license agreements. At December 31, 1999, these notes bore interest at an annual rate of 9.25%. According to the terms of the notes, the interest rate was decreased during 1999 when two additional products incorporating the Company's technologies began shipping and will be decreased further when a fourth licensed product begins shipping. Payments received by the Company under a specified Digital ICE license agreement are first applied against the interest obligation, with any remaining amounts then applied against the outstanding principal. Any principal amount still outstanding beginning in October 2004 will be payable in equal quarterly installments over the succeeding four years. The Company may repay the annuity notes at any time without penalty. In the event the specified Digital ICE license agreements are terminated on or before October 2008, the Bank may, at its option, demand that principal amounts then outstanding be paid in equal quarterly installments over the four years following such termination. In such case, the remaining principal amount of the annuity notes would bear interest at an annual rate equal to the then issuable four-year U.S. Treasury Bills plus 650 basis points. In addition, the Company would be obligated to issue to the Bank warrants to purchase shares of the Company's common stock with a value of $300,000 subject to upward incremental adjustments to a maximum of $1.2 million if the outstanding principal amount is not repaid within 36 months from the date the specified license agreements were terminated. F-11 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Equipment Lines of Credit During 1998 and 1999, the Company borrowed under two separate equipment lines of credit with the Bank to finance most of its purchases of capital equipment. At December 31, 1999, borrowings under these facilities bore interest at a weighted average rate of 8.90% and are collateralized by all of the Company's tangible assets except those resulting from specified Digital ICE license agreements discussed above. The Company is obligated to make equal monthly payments of principal plus interest through March and December 2001 under these respective lines of credit. Under the second line of credit, any prepayment of principal or interest is subject to a prepayment penalty. At December 31, 1999, $939,000 was available for future borrowings under the second line of credit. This second facility expires on March 31, 2000 and any future borrowings will bear a fixed interest rate equal to the then eighteen month U.S. treasury bill rate plus 325 basis points. No further borrowings are available under the first line of credit. Notes payable to bank consisted of the following at December 31, 1999 (in thousands): Royalty backed annuity notes...................................... $5,544 Borrowings under equipment lines of credit........................ 2,294 ------ Total notes payable to bank..................................... 7,838 Less: current portion............................................. (1,402) ------ $6,436 ======
The expected future principal payments on notes payable to bank as of December 31, 1999 are presented below. The expected future principal payments related to the royalty backed annuity notes are determined based upon the most current forecast of royalty receipts under the specified Digital ICE license agreement in excess of the expected interest obligation at an interest rate of 9.25% (in thousands): 2000............................................................... $1,402 2001............................................................... 892 2002 .............................................................. -- 2003 .............................................................. -- Thereafter......................................................... 5,544 ------ Total principal.................................................... $7,838 ======
4. Leases The Company leases certain office space and equipment under various noncancelable operating leases. Rent expense under all operating leases was $55,393, $606,156, and $707,351 for the years ended December 31, 1997, 1998 and 1999, respectively. Rent expense for the years ended December 31, 1998 and 1999 was offset by $230,259 and $334,946, respectively, in payments received by the Company pursuant to sublease agreements with several companies to rent office space not then occupied by the Company. Future minimum payments under these sublease agreements are not material. Under the terms of the Company's lease agreement for its corporate headquarters, the monthly payments increase at certain dates during the five-year term. At December 31, 1999, future minimum lease payments under noncancelable leases are as follows (in thousands): 2000............................................................... $ 759 2001............................................................... 777 2002............................................................... 839 2003............................................................... 292 ------ Total.............................................................. $2,667 ======
F-12 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 5. Income Taxes As of December 31, 1999, the Company had federal net operating loss carryforwards of approximately $20,431,000, a research and development credit carryforward of approximately $573,000 and a foreign tax credit carryforward of approximately $133,000. The net operating loss carryforward and research and development credit carryforward will begin to expire in 2012 if not utilized. The foreign tax credit carryforward will begin to expire in 2003 if not utilized. The Tax Reform Act of 1986 imposes substantial restrictions on the utilization of net operating losses and tax credits in the event of an "ownership change" of a corporation. The Company's utilization of the net operating losses may be subject to a substantial annual limitation due to an "ownership change" resulting from the sales of private equity securities. The annual limitation may result in the expiration of net operating losses and tax credits before utilization. Significant components of the provision for income taxes attributable to continuing operations are as follows:
1998 1999 ------- ------- Current: Federal................................................. $ -- $ -- State................................................... -- -- Foreign................................................. -- 71,000 ------- ------- Total current........................................... -- 71,000 ------- ------- Deferred: Federal................................................. -- -- State................................................... -- -- Foreign................................................. -- -- ------- ------- Total deferred.......................................... -- -- ------- ------- $ -- $71,000 ======= =======
The foreign taxes relate to withholdings on royalties from a customer located in a foreign country. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes as of December 31, 1999 are as follows:
1998 1999 ---------- ---------- Deferred tax liabilities Prepaid expenses............................... $ -- $ (14,000) ---------- ---------- -- (14,000) Deferred tax assets: Depreciable assets............................. 106,000 210,000 Accrued liabilities............................ 209,000 662,000 Net operating loss and tax credit carryforwards................................. 3,112,000 8,265,000 Deferred revenue............................... 30,000 18,000 Bad debt....................................... -- 7,000 ---------- ---------- 3,457,000 9,162,000 ---------- ---------- Net deferred tax asset........................... 3,457,000 9,148,000 Valuation allowance for net deferred tax assets.. (3,457,000) (9,148,000) ---------- ---------- Net deferred taxes............................... $ -- $ -- ========== ==========
F-13 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company has established a valuation allowance equal to the net deferred tax asset due to uncertainties regarding the realization of deferred tax assets based on the Company's lack of earnings history. The valuation allowance increased by approximately $5,692,000 during the year ended December 31, 1999. The Company's recorded provision for income taxes differs from the expected tax expense amount computed by applying the statutory federal income tax rate of 34% to income before income taxes as a result of the following:
1998 1999 ----------- ----------- Computed at statutory rate..................... $(2,553,000) $(5,381,000) State taxes, net of federal benefit............ (225,000) (427,000) Permanent items................................ 9,000 545,000 Effect of foreign operations................... -- 71,000 Tax credits.................................... (115,000) (465,000) Other.......................................... -- 36,000 Change in valuation allowance.................. 2,884,000 5,692,000 ----------- ----------- $ -- $ 71,000 =========== ===========
6. Employee Benefit Plan The Company sponsors a defined contribution plan in accordance with Section 401(k) of the Internal Revenue Code. The Plan is available to all full-time employees of the Company on the first day of the quarter following employment. The Plan is funded through employee contributions. The Company's only expenses relating to the Plan are administrative costs, which are not significant. 7. Stockholders' Equity The following is a summary of convertible preferred stock issued by the Company at December 31, 1999, except where noted (in thousands, except share amounts):
Shares Issued and Outstanding ----------------------------- Number of December 31 Aggregate Shares ----------------------------- Liquidation Designated 1997 1998 1999 Preference ---------- --------- --------- --------- ----------- Series B............ 101,662 93,106 93,106 93,922 $ 173 Series C............ 1,471,500 1,471,500 1,471,500 1,471,500 5,445 Series D............ 4,080,000 -- -- 4,069,767 31,500 --------- --------- --------- --------- ------- 5,653,162 1,564,606 1,564,606 5,635,189 $37,118 ========= ========= ========= ========= =======
Series A Convertible Preferred Stock In July 1997, all outstanding Series A Preferred Stock and warrants to purchase Series A Preferred Stock were returned to the Company and immediately canceled for no consideration. The Series A Preferred stockholder also paid the Company a $90,000 fee to cancel a development agreement that had been entered into with the Company. The cancellation fee has been classified as other income in the accompanying Statement of Operations. Series A Preferred Stock is no longer authorized for issuance. Series B, C and D Convertible Preferred Stock Non-cumulative dividends are paid to the Series B, C and D Preferred stockholders only if declared by the Board of Directors at the rate of up to $0.18, $0.37 and $0.77 per share, respectively. Dividends may not be paid to the common stockholders unless approved by at least two-thirds of the voting power (as determined on an as-converted basis) of all then outstanding shares of Series B, C and D Preferred Stock, each voting as a distinct and separate class. F-14 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In the event of any liquidation, dissolution or winding up of the Company, the Series B, C and D Preferred stockholders are entitled to receive a distribution of $1.84, $3.70 and $7.74 per share, respectively, before any distribution may be made to the Common stockholders. The distribution rate per share may be adjusted as defined in the related agreement. The Series B, C and D Preferred Stock may be converted into Common Stock at the option of each Series B, C and D Preferred stockholder at any time. All of the Series B Preferred Stock will automatically convert to Common Stock in the event of any qualified public offering, as defined in the related agreement. All of the Series C Preferred Stock will automatically convert to Common Stock (i) in the event of a qualified public offering, as defined in the related agreement, in which the aggregate proceeds of such an offering exceeds $20,000,000 (Qualified Offering), or (ii) upon written consent of the holders of at least two-thirds of the shares of Series C Preferred Stock then outstanding. All of the Series D Preferred Stock will automatically convert to Common Stock (i) in the event of a Qualified Offering prior to or after March 30, 2000 in which the initial price per share of Common Stock sold to the public is at least $10.06 or $13.16, respectively, (in each case the minimum price per share may be adjusted as defined in the related agreement), or (ii) upon written consent of the holders of at least a majority of the shares of Series D Preferred Stock then outstanding. The conversion rates are presently three shares of Common Stock for each share of Series B and C Preferred Stock and one share of Common Stock for each share of Series D Preferred Stock, subject to certain anti-dilution adjustments. The Series B Preferred Stock is non-voting. The Series C and D Preferred stockholders are entitled to one vote for each share of Common Stock into which such Preferred Stock could then be converted. The Series D stockholders are entitled to participate in the Company's initial public offering. The Company is obligated to require the underwriters to reserve five percent of the shares offered pursuant to such offering in the form of a directed share program. The Company is obligated to require the underwriters to grant the Series D stockholders a priority to purchase that number of shares equal to the lesser of (i) 100% of the shares reserved in the directed share program or (ii) the number of shares obtained by dividing $3,000,000 by the initial price to the public. Such shares will be offered to the Series D stockholders at the initial price to the public. In December 1999, the Board of Directors authorized that all holders of Series D Preferred Stock of record as of December 16, 1999 be granted a dividend of not more than 469,406 shares of common stock in the event the Company does not complete an initial public offering prior to December 31, 2000 or at an implied market capitalization greater than $800 million. Stock Purchase Warrants In connection with the issuance of the Series B Preferred Stock, the Company issued warrants to the Series B Preferred stockholders to purchase 8,556 shares of Series B Preferred Stock at $1.84 per share, of which options to purchase 7,740 shares remained outstanding at December 31, 1999. These warrants are exercisable by the warrant holders at any time prior to January 2001, and automatically convert to warrants to purchase 23,220 shares of Common Stock, subject to adjustment, and upon certain events as defined above. No amount was allocated to the value of these warrants as such amounts were not significant. In connection with the issuance of the Series C Preferred Stock, the Company issued warrants to the Series C Preferred stockholders to purchase 1,224,879 shares of Common Stock at $0.62 per share. The warrants are exercisable by the warrant holders for a period of fifteen years from the date of an exercise event. An exercise event is defined in the agreement as a qualified public offering, a sale of substantially all of the Company's assets, or a merger or acquisition in which the Company is not the surviving corporation or in F-15 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) which the stockholders of the Company immediately prior to the transaction hold less than half of the voting stock of the surviving entity. No amount was allocated to the value of these warrants as such amounts were not significant. In connection with the second equipment line of credit, the Company issued warrants to the Bank to purchase 10,233 shares of Series D Preferred Stock at $7.74 per share. These warrants are exercisable through August 2006 and automatically convert to warrants to purchase 10,233 shares of Common Stock, subject to adjustment, and upon certain events as defined above. The warrants were recorded at their fair market value of approximately $25,000 and are being amortized over the term of the equipment line of credit. Common Stock The Company had 13,160,291 shares of common stock outstanding as of December 31, 1999. Of these shares, 2,943,307 shares were unvested and are subject to rights of repurchase that lapse according to a time-based vesting schedule. Common stock reserved at December 31, 1999 consists of the following: For conversion of convertible preferred stock................. 8,766,033 For exercise of warrants to purchase common stock............. 1,258,332 For issuance under the Company's 1995 Stock Option/Stock Issuance Plan................................................ 755,046 ---------- Total....................................................... 10,779,411 ==========
Stock Split On March 26, 1999, the Company effected a three-for-one stock split. All references to common stock share and per share amounts including options to purchase common stock have been retroactively restated to reflect the stock split as if such split had taken place at the inception of the Company. Stock Option/Stock Issuance Plan The Company has established the 1995 Stock Option/Stock Issuance Plan ( the Plan), providing for two separate equity programs: (i) the option grant program providing for the granting of both incentive and non-statutory stock options, as defined by the Internal Revenue Code, and (ii) the stock issuance program providing for the issuance of common stock directly, either through the immediate purchase of such shares or for services rendered to the Company. The Plan provides for a maximum number of common shares to be optioned/issued of 10,819,337 after an increase of 469,406 approved by the Company's Board of Directors in December 1999. Accordingly, the Company has reserved a sufficient number of shares of common stock to permit exercise of options or issuance of common shares in accordance with the terms of the Plan. Under the Plan, incentive stock options may be granted only to Company employees (including officers and directors who are also employees) and shall be issued at an exercise price not less than 100% of the fair market value of the Company's common stock at the grant date, as determined by the Company's Board of Directors or by a committee of the Board of Directors appointed to administer the Plan, except for incentive stock option grants to a stockholder that owns greater than 10% of the Company's outstanding stock in which case the exercise price per share is not less than 110% of the fair market value of the Company's common stock at date of grant. Non-Statutory stock options may be granted to Company employees, members of the board, and consultants at the exercise price determined by the F-16 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Board of Directors or a committee appointed by the Board of Directors to administer the Plan. Options granted under the Plan are exercisable no later than ten years from the date of grant except for incentive stock options granted to an optionee that owns more than 10% of the voting stock at the date of grant in which case the option term shall be five years from the date of grant or shorter based on the terms enumerated in the related option agreement. At the time of the grant, the Company's Board of Directors or committee appointed by the board to administer the Plan determines the exercise price and vesting schedules. Generally, 25% of each option vests one year from the vesting commencement date, as defined in the option agreement after the grant and the remaining amount vests ratably over the remaining three years of the vesting period. The Plan allows for options to be immediately exercisable, subject to the Company's right of repurchase for unvested shares at the original exercise price and for vested shares at the then current fair value as determined by the Board of Directors. The stock issuance program under the Plan allows eligible persons to purchase shares of common stock at an amount that may be less than, equal to or greater than the fair market value of the common shares on the issuance date. Such shares may be fully vested when issued or may vest over time as the recipient provides services or as specified performance objectives are attained as determined by the Board of Directors or a committee appointed by the board to administer the Plan. The Company retains the right to repurchase unvested shares issued in conjunction with the stock issuance program upon voluntary or involuntary termination of service, at an amount equal to the original price paid by the purchaser and for vested shares at the then current fair value as determined by the Board of Directors. A summary of activity of stock options granted to employees, and to certain non-employees, for the years ended December 31, 1997, 1998, and 1999 is noted below.
Weighted- Range of Average Exercise Exercise Shares Prices Price ---------- ---------- --------- Outstanding, December 31, 1996........... -- $ -- $ -- Options granted........................ 1,171,200 0.12 0.12 Options exercised...................... (462,081) 0.12 0.12 Options forfeited...................... (60,000) 0.12 0.12 ---------- ---------- ----- Outstanding, December 31, 1997........... 649,119 0.12 0.12 Options granted........................ 985,650 0.12-0.25 0.14 Options exercised...................... (1,405,350) 0.12-0.25 0.13 Options forfeited...................... (9,000) 0.12 0.12 ---------- ---------- ----- Outstanding, December 31, 1998........... 220,419 0.12-0.25 0.14 Options granted........................ 2,148,721 0.25-3.50 2.64 Options exercised...................... (2,073,201) 0.25-3.50 2.63 Options forfeited...................... (25,500) 0.25-1.55 1.09 ---------- ---------- ----- Outstanding, December 31, 1999........... 270,439 $0.12-3.50 $0.83 ========== ========== =====
At December 31, 1999, 755,046 shares of Common Stock were reserved for future issuance and 484,607 options were available for future grants. F-17 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes information concerning currently outstanding and exercisable options at December 31, 1999:
Options Outstanding Options Exercisable ------------------------------------- ----------------------- Weighted Average Weighted Weighted Remaining Average Number Average Exercise Number Contractual Exercise Exercisable Exercise Prices Outstanding Life Price and Vested Price -------- ----------- ----------- -------- ----------- -------- $ 0.12 172,419 8.01 $0.12 89,487 $0.12 $ 0.25 30,000 8.88 $0.25 8,750 $0.25 $ 1.55 17,580 9.30 $1.55 -- $ -- $ 2.15 5,100 9.63 $2.15 -- $ -- $ 3.50 45,340 9.88 $3.50 12,000 $3.50 ------- ----- ------- ----- Total 270,439 $0.83 110,237 $0.50 ======= ===== ======= =====
The Company recorded deferred stock-based compensation of $7,956,000 in connection with stock options granted to employees for 1,890,262 shares of common stock during 1999. This amount represents the difference between the deemed fair value of the Company's common stock underlying these options and their exercise price at the date of grant. The deferred stock-based compensation is amortized over the vesting periods of the applicable options, resulting in amortization of $1,416,000 for the year ended December 31, 1999. The Company also recorded deferred stock-based compensation of $188,000 in connection with stock options granted to nonemployee consultants for 20,000 shares of common stock during 1999. This amount represents the fair market value of the stock options at December 31, 1999. The deferred stock-based compensation is amortized over the expected life of the applicable options, resulting in amortization of $15,000 for the year ended December 31, 1999. Pro Forma Disclosures FAS 123 requires that the Company present pro forma information regarding net income as if the Company had accounted for the stock options under the fair value method of that Statement. The fair value of the options was estimated at the date of grant using a minimum value pricing model with the following weighted-average assumptions:
Year-ended December 31, 1999 ------------ Risk-free interest rate...................................... 6.0% Dividend yield............................................... 0% Weighted-average expected life of the options................ 2 years
The weighted-average fair value of options granted during fiscal 1997, 1998, and 1999 was $0.03, $0.03, and $0.55, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is expensed over the options' vesting periods. The Company's pro forma information for the years ended December 31, 1997, 1998 and 1999 follows (in thousands, except per share amounts):
1997 1998 1999 ------ ------- -------- Pro forma stock-based compensation expense.... $ (2) $ (12) $ (103) Pro forma net loss............................ $ (992) $(7,522) $(16,001) Pro forma basic and diluted loss per share.... $(0.19) $ (1.01) $ (1.71)
F-18 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Option valuation models incorporate highly subjective assumptions. Because changes in the subjective assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single measure of the fair value of the Company's employee stock options. Because the determination of fair value of all employee stock options granted after such time as the Company becomes a public entity will include an expected volatility factor and because, for pro forma disclosure purposes, the estimated fair value of the Company's employee stock options is treated as if amortized to expense over the options' expected life, the effects of applying SFAS No. 123 for pro forma disclosures are not necessarily indicative of future amounts. Notes Receivable from Stockholders During 1997, 1998, and 1999, the Company made full-recourse loans to employees of $56,000, $173,000 and $5,444,000, respectively, in connection with the employees' purchase of shares through exercises of options. These full- recourse notes are secured by the shares of stock, are generally interest bearing at a weighted average interest rate of 5.68% at December 31, 1999, have terms of five years, and must be repaid upon the sale of the underlying shares of stock. 8. Litigation The Company is involved in various legal matters which have arisen in the normal course of business. While the ultimate results of these matters cannot be predicted with certainty, management does not expect them to have a material adverse effect on the financial position of the Company. 9. Subsequent Events 2000 Employee Stock Purchase Plan In January 2000, the Company's Board of Directors approved the adoption of the Company's 2000 Employee Stock Purchase Plan (the Purchase Plan). A total of 500,000 shares of common stock have been reserved for issuance under the Purchase Plan. The share reserve will automatically increase each calendar year beginning in 2001 by an amount equal to 1% of the total number of outstanding shares of our common stock on the last day of December in the prior calendar year. The Purchase Plan permits eligible employees to purchase shares of common stock through payroll deductions at 85% of the fair market value of the common stock, as defined in the Purchase Plan. 2000 Stock Incentive Plan In January 2000, the Board of Directors approved the Company's 2000 Stock Incentive Plan (the 2000 Plan). A total of 5,000,000 shares of common stock have been reserved for issuance under the 2000 Plan. This share reserve includes the number of shares carried over from the 1995 Stock Option/Stock Issuance Plan. The share reserve will automatically increase each calendar year beginning in 2001 by an amount equal to 3% of the total number of shares of our common stock outstanding on the last day of December in the prior calendar year, but in no event will the annual increase exceed 1,500,000. The 2000 Plan provides for: (i) discretionary option grant program under which eligible persons may be granted options to purchase shares of common stock; (ii) a salary investment option grant program under which eligible employees may elect to have a portion of their base salary invested each year in special options; (iii) a stock issuance program under which eligible persons may be issued shares of common stock directly, either through the immediate purchase of such shares or as a bonus; (iv) an automatic option grant program under which eligible non-employee board members will automatically receive options at periodic intervals to purchase shares of common stock; and (v) a director fee option grant program under which non-employee board members may elect to have all or part of their annual retainer fee applied to a special option grant. F-19 APPLIED SCIENCE FICTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Amendment to Certificate of Incorporation (Unaudited) In January 2000, the Company's Board of Directors authorized management to file a registration statement with the Securities and Exchange Commission to permit the Company to sell shares of its common stock to the public. In connection with this authorization, the Board of Directors authorized the amendment of the Company's Certificate of Incorporation and changed the aggregate number of shares of preferred stock and common stock authorized to be issued to 25,000,000 and 100,000,000, respectively. All share information included in the accompanying consolidated financial statements have been retroactively adjusted to reflect the increase in the number of authorized shares. F-20 [INSIDE BACK COVER ART] PART II INFORMATION NOT REQUIRED IN PROSPECTUS All capitalized terms used and not defined in Part II of this registration statement shall have the meaning assigned to them in the prospectus which forms a part of this registration statement. Item 13. Other Expenses of Issuance and Distribution. The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by Applied Science Fiction in connection with the sale of common stock being registered. All amounts are estimates except the SEC registration fee and the NASD filing fees. SEC registration fee............................................. $15,180 NASD filing fee.................................................. 6,250 Nasdaq National Market listing fee............................... * Printing and engraving expenses.................................. * Legal fees and expenses.......................................... * Accounting fees and expenses..................................... * Blue sky fees and expenses....................................... * Transfer agent fees.............................................. * Miscellaneous.................................................... * ------- Total.......................................................... $ * =======
- -------- *To be provided by amendment. Item 14. Indemnification of Directors and Officers. Subsection (a) of Section 145 of the General Corporation Law of the State of Delaware empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgements, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonably cause to believe the person's conduct was unlawful. Subsection (b) of Section 145 of the General Corporation Law of the State of Delaware empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person acted in any of the capacities set forth above, against expenses (including attorneys' fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification may be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. II-1 Section 145 further provides: that to the extent a director or officer of a corporation has been successful on the merits or otherwise in the defense of any such action, suit or proceeding referred to in subsections (a) and (b) of Section 145, or in the defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith; that the indemnification provided for by Section 145 shall not be deemed exclusive of any other rights to which the indemnified party may be entitled; that indemnification provided by Section 145 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of such person's heirs, executors and administrators; and that the corporation shall have the power to purchase and maintain insurance on behalf of a director or officer of the corporation against any liability asserted against such person and incurred by him in any such capacity, or arising out of such person's status as such, whether or not the corporation would have the power to indemnify such person against such liabilities under Section 145. Section 102(b)(7) of the General Corporation Law of the State of Delaware provides that a certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders. (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of the State of Delaware, or (iv) for any transaction from which the director derived an improper personal benefit. Article VI of our Fifth Amended and Restated Certificate of Incorporation provides that, to the fullest extent permitted by the General Corporation Law of the State of Delaware as the same exists, or as it may hereafter be amended, no director of the registrant shall be personally liable to the registrant or its stockholders for monetary damages for breach of fiduciary duty as a director. Article XI of our Bylaws further provides that the registrant shall, to the maximum extent and in the manner permitted by Section 145 of the General Corporation Law of the State of Delaware as that Section may be amended and supplemented from time to time, indemnify each of its directors and officers against expenses (including attorneys' fees), judgments, fines, amounts paid in settlements, and for other matters referred to or covered by that Section by reason of the fact that such person is or was a director or officer of the registrant and is or was serving at the request of the registrant as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise. The registrant has entered into indemnification agreements with each of its directors and executive officers that provide for indemnification and expense advancement to the fullest extent permitted under the General Corporation Law of the State of Delaware. The registrant maintains officers' and directors' liability insurance. Reference is made to Section of the Underwriting Agreement filed as Exhibit 1.1 hereto, indemnifying officers and directors of the registrant against certain liabilities. Item 15. Recent Sales of Unregistered Securities. Since January 31, 1997, Registrant has issued securities to a limited number of entities as described below. 1. In July and September 1997, Registrant issued 1,471,500 shares of Series C preferred stock to accredited investors for $3.70 per share, for an aggregate purchase price of $5,444,550. Registrant also issued warrants to accredited investors to purchase up to 1,224,879 shares of common stock at an exercise price of $0.62 per share. These securities were issued pursuant to Rule 506 of Regulation D of the Securities Act. II-2 2. In March 1999, Registrant issued 4,069,767 shares of Series D preferred stock to accredited investors for $7.74 per share, for an aggregate purchase price of $31,499,996.58. These securities were issued pursuant to Rule 506 of Regulation D of the Securities Act. 3. In August 1999, Registrant issued warrants to Silicon Valley Bank to purchase up to 10,233 shares of Series D preferred stock at an exercise price of $7.74 per share. These securities were issued pursuant to Rule 506 of Regulation D of the Securities Act. 4. Through December 31, 1999, Registrant had issued and sold 10,263,132 shares of its common stock to directors, employees and consultants upon the exercise of options granted at a weighted average exercise price of $.64. These shares were issued pursuant to Rule 701 promulgated under the Securities Act. 5. Through December 31, 1999, Registrant had issued options to purchase 10,628,071 shares of common stock, of which 10,263,132 have been exercised, 270,439 remain outstanding and 94,500 have been forfeited and returned to our option plan for future grant. These options were issued pursuant to Rule 701 promulgated under the Securities Act. Item 16. Exhibits and Financial Statement Schedules. (a) Exhibits: 1.1* Form of Underwriting Agreement. 3.1 Amended and Restated Certificate of Incorporation of the Registrant to be in effect immediately following the offering made under this Registration Statement. 3.2 Amended and Restated Bylaws of the Registrant to be in effect immediately following the closing of the offering made under this Registration Statement. 4.1* Specimen Common Stock Certificate (standard form, not filed). 5.1* Opinion of Brobeck, Phleger & Harrison LLP. 10.1 Form of Indemnification Agreement between the Registrant and each of its directors and officers. 10.2* 2000 Stock Incentive Plan and form of agreements thereunder. 10.3* 2000 Employee Stock Purchase Plan and form of agreements thereunder. 10.4 Amended and Restated Investors' Rights Agreement dated September 26, 1997, by and among the Registrant and the investors named therein. 10.5 Registrant Office Lease dated March 19, 1998 by and between RGK Rentals, Ltd. and Applied Science Fiction, Inc. 10.6+ IBM License Agreements. 23.1 Consent of Ernst & Young LLP. 23.2* Consent of Brobeck, Phleger & Harrison LLP (see Exhibit 5.1). 24.1 Power of Attorney (included on signature page). 27.1 Financial Data Schedule.
- -------- *To be filed by amendment +Filed herewith under a confidential treatment request, redacted portions have been provided to the Commission. II-3 (b) Financial Statement Schedules. Not included because the information required to be set forth therein is not applicable or is shown in registrant's Consolidated Financial Statements or the related Notes. Item 17. Undertakings. The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the General Corporation Law of the State of Delaware, the Certificate of Incorporation or the Bylaws of the registrant, the Underwriting Agreement, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered hereunder, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Austin, State of Texas, on this 2nd day of February, 2000. Applied Science Fiction, Inc. /s/ Mark R. Urdahl By:__________________________________ Mark R. Urdahl President, Chief Executive Officer and Chairman of the Board POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Mark R. Urdahl and Robert E. Sleet, Jr. and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, and to sign any registration statement for the same offering covered by this registration statement that is to be effective upon filing pursuant to Rule 462(b) promulgated under the Securities Act of 1933, and all post-effective amendments thereto, and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in- fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statement has been signed by the following persons in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Mark R. Urdahl President, Chief Executive February 2, 2000 ____________________________________ Officer and Chariman of the Mark R. Urdahl Board (principal executive officer) /s/ Robert E. Sleet, Jr. Executive Vice President and February 2, 2000 ____________________________________ Chief Financial Officer Robert E. Sleet, Jr. (principal accounting officer) /s/ Dr. Albert Edgar Director February 2, 2000 ____________________________________ Dr. Albert Edgar Director February 2, 2000 ____________________________________ John Asa Director February 2, 2000 ____________________________________ Harvey B. Cash /s/ Richard H. Kimball Director February 2, 2000 ____________________________________ Richard H. Kimball Director February 2, 2000 ____________________________________ Peter M. Palermo /s/ Carmelo M. Gordian Director February 2, 2000 ____________________________________ Carmelo M. Gordian
II-5 INDEX TO EXHIBITS
Exhibit Number Description ------- ----------- 1.1* Form of Underwriting Agreement. 3.1 Amended and Restated Certificate of Incorporation of the Registrant to be in effect immediately following the offering made under this Registration Statement. 3.2 Amended and Restated Bylaws of the Registrant to be in effect immediately following the closing of the offering made under this Registration Statement. 4.1* Specimen Common Stock Certificate (standard form, not filed). 5.1* Opinion of Brobeck, Phleger & Harrison LLP. 10.1 Form of Indemnification Agreement between the Registrant and each of its directors and officers. 10.2* 2000 Stock Incentive Plan and form of agreements thereunder. 10.3* 2000 Employee Stock Purchase Plan and form of agreements thereunder. 10.4 Amended and Restated Investors' Rights Agreement dated September 26, 1997, by and among the Registrant and the investors named therein. 10.5 Registrant Office Lease dated March 19, 1998 by and between RGK Rentals, Ltd. and Applied Science Fiction, Inc. 10.6+ IBM License Agreements. 23.1 Consent of Ernst & Young LLP. 23.2* Consent of Brobeck, Phleger & Harrison LLP (see Exhibit 5.1). 24.1 Power of Attorney (included on signature page). 27.1 Financial Data Schedule.
- -------- *To be filed by amendment +Filed herewith under a confidential treatment request, redacted portions have been provided to the Commission. EX-3.1 2 CERTIFICATE OF INCORPORATION Exhibit 3.1 FIFTH AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF APPLIED SCIENCE FICTION, INC. ARTICLE I The name of this Corporation is Applied Science Fiction, Inc. (the "Corporation"). ----------- ARTICLE II The address of the registered office of the Corporation in the State of Delaware is The Corporation Trust Center, 1209 Orange Street, City of Wilmington, County of New Castle, Delaware, and the name of the registered agent of the corporation in the State of Delaware at such address is The Corporation Trust Company. ARTICLE III The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware. ARTICLE IV 4.1 Prior to a Qualified IPO (as defined in Section 4(b) of Article V below), the Corporation's capital stock shall be comprised as set forth in this Section 4.1 and Article V as follows: A. Classes of Stock. The Corporation is authorized to issue two classes ---------------- of capital stock to be designated, respectively, "Common Stock" and "Preferred Stock." The total number of shares of capital stock authorized to be issued is Fifty Million (50,000,000) shares. Thirty-Five Million (35,000,000) shares shall be Common Stock, par value $0.001 per share, and Fifteen Million (15,000,000) shares shall be Preferred Stock, par value $0.001 per share. Concurrently with the filing of this Fourth Restated Certificate of Incorporation of the Corporation with the Secretary of State of the State of Delaware, each share of Common Stock of the Corporation issued and outstanding on the date of such filing shall be divided into three (3) shares of Common Stock of the Corporation authorized hereunder, without any further action on the part of the Corporation or the holder thereof. B. Rights, Preferences and Restrictions of Preferred Stock. The ------------------------------------------------------- Preferred Stock authorized under this Fourth Restated Certificate of Incorporation of the Corporation (this "Restated Certificate") may be issued from time to time in one or more series. The first series shall consist of 101,662 shares and is designated "Series B Preferred Stock." The second series shall consist of 1,471,500 shares and is designated "Series C Preferred Stock." The third series shall consist of 4,080,000 shares and is designated "Series D Preferred Stock." Shares of the Corporation's authorized but undesignated Preferred Stock may be issued from time to time in one or more series. The Board of Directors of the Corporation is hereby authorized, subject to the provisions of Section 5 of Article V hereof, by filing a certificate pursuant to the Delaware General Corporation Law, to fix or alter from time to time the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations and restrictions thereof, including without limitation, the dividend rights, dividend rate, conversion rights, voting rights, rights and terms of redemption (including sinking fund provisions), redemption price or prices, and the liquidation preferences of any wholly unissued series of Preferred Stock, and to establish from time to time the number of shares constituting any such series and the designation thereof, or any of them (a "Preferred Stock Designation"); and to increase or decrease the number of shares of any series (including without limitation the series designated in Article V hereof to the extent provided by Article V hereof) subsequent to the issuance of shares of that series, but not below the number of shares of such series then outstanding. In case the number of shares of any series shall be decreased in accordance with the foregoing sentence or be converted pursuant to the Preferred Stock Designation or Section 4 of Article V hereunder, the shares constituting such decrease or so converted shall resume the status of authorized but unissued and undesignated Preferred Stock. If at any time subsequent to the issuance of shares of a particular series, there are no shares of such series remaining outstanding, such series thereupon shall constitute a wholly unissued series and may be altered (including without limitation the elimination of such series) to the full extent as hereinabove provided, except as otherwise provided herein. The foregoing authority of the Corporation's Board of Directors expressly includes the authority to designate, in accordance with Section 5 of Article V hereof, series of Preferred Stock with designations, powers, preferences, rights, qualifications, limitations and restrictions senior to, junior to, or on parity with, the designations, powers, preferences, rights, qualifications, limitations and restrictions of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock defined and designated below. C. Common Stock. ------------ 1. Dividend Rights. Subject to the provisions of Section 1 of Article --------------- V, the holders of the Common Stock shall be entitled to receive, when and as declared by the Board of Directors of the Corporation, out of any funds of the Corporation legally available therefor, such dividends as may be declared from time to time by the Board of Directors of the Corporation. 2. Liquidation Rights. Upon the liquidation, dissolution or winding ------------------ up of the Corporation, the assets of the Corporation shall be distributed as provided in Section 2 of Article V hereof. 3. Redemption. The Common Stock is not redeemable. ---------- 4. Voting Rights. The holder of each share of Common Stock shall have ------------- the right to one vote, and shall be entitled to notice of any stockholders' meeting in accordance with the Bylaws of the Corporation, and shall be entitled to vote upon such matters and in such manner as may be provided by law. 2 4.2 Effective immediately (as defined in Section 4(b) of Article V below), the Corporation's capital stock shall be comprised as follows: A. Authorized Shares. The aggregate number of shares that the Corporation ----------------- shall have authority to issue is 125,000,000, (a) 100,000,000 shares of which shall be Common Stock, par value $0.001 per share, and (b) 25,000,000 of which shall be Preferred Stock, par value $0.001 per share. B. Common Stock. Each share of Common Stock shall have one vote on each ------------ matter submitted to a vote of the stockholders of the Corporation. Subject to the provisions of applicable law and the rights of the holders of the outstanding shares of Preferred Stock, if any, the holders of the Common Stock shall be entitled to receive, when and as declared by the Board of Directors of the Corporation, out of the assets of the Corporation legally available therefor, dividends or other distributions, whether payable in cash, property or securities of the Corporation. The holders of shares of Common Stock shall be entitled to receive, in proportion to the number of shares of Common Stock held, the net assets of the Corporation upon dissolution after any preferential amounts required to be paid or distributed to holders of outstanding shares of Preferred Stock, if any, are so paid or distributed. C. Preferred Stock. --------------- 1. Series. The Preferred Stock may be issued from time to time by the ------ Board of Directors as shares of one or more series. The description of shares of each additional series of Preferred Stock, including any designations, preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends, qualifications and terms and conditions of redemption shall be as set forth in resolutions adopted by the Board of Directors. 2. Rights and Preferences. The Board of Directors is expressly ---------------------- authorized, at any time, by adopting resolutions providing for the issuance of, or providing for a change in the number of any particular series of Preferred Stock and, if and to the extent from time to time required by law, by filing certificates of amendment or designation which are effective without stockholder action, to increase or decrease the number of shares included in each series of Preferred Stock, but not below the number of shares then issued, and to set in any one or more respects the designations, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications, or terms and conditions of redemption relating to the shares of each such series. The authority of the Board of Directors with respect to each series of Preferred Stock shall include, but not be limited to, setting or changing the following: (a) the dividend rate, if any, on shares of such series, the times of payment and the date from which dividends shall be accumulated, if dividends are to be cumulative; (b) whether the shares of such series shall be redeemable and, if so, the redemption price and the terms and conditions of such redemption; (c) the obligation, if any, of the Corporation to redeem shares of such series pursuant to a sinking fund; 3 (d) whether shares of such series shall be convertible into, or exchangeable for, shares of stock of any other class of classes and, if so, the terms and conditions of such conversion or exchange, including the price or prices or the rate or rates of conversion or exchange and the terms of adjustment, if any; (e) whether the shares of such series shall have voting rights, in addition to the voting rights provided by law, and, if so, the extent of such voting rights; (f) the rights of the shares of such series in the event of voluntary or involuntary liquidation, dissolution or winding-up of the Corporation; and (g) any other relative rights, powers, preferences, qualifications, limitations or restrictions thereof relating to such series. ARTICLE V The respective rights, preferences, privileges and restrictions granted to and imposed on the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock of the Corporation are as set forth below in this Article V. 1. Dividend Provisions. ------------------- (a) The holders of shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall be entitled to receive dividends, out of any assets legally available therefor, prior and in preference to any declaration or payment of any dividend (payable other than in Common Stock or other securities and rights convertible into or entitling the holder thereof to receive, directly or indirectly, additional shares of Common Stock of the Corporation) on the Common Stock of the Corporation, in such amounts and at such times as the Board of Directors of the Corporation deems advisable with respect to the Series B Preferred Stock (provided, however, in no event shall such amount exceed $0.18 per share) and at the rate of $0.37 and $0.774 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) per annum, with respect to the Series C Preferred Stock and the Series D Preferred Stock, respectively, payable quarterly when, as and if declared by the Board of Directors. Declared dividends with respect to each share of Series B Preferred Stock, each share of Series C Preferred Stock and each share of Series D Preferred Stock which are payable shall, upon conversion of such share to Common Stock, be paid in shares of Common Stock (valued at the fair market value on the date of payment as determined in the manner provided in subsection 2(b)(ii) of this Article V). Dividends on the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall not be cumulative. (b) So long as any shares of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock are issued and outstanding, the Corporation shall not declare and distribute any cash dividends among the holders of Common Stock, nor shall the Corporation purchase, redeem or acquire any shares of Common Stock or pay funds into or set aside or make available a sinking fund for the purchase, redemption or acquisition of shares of Common Stock, unless, in each case, such declaration, distribution, purchase, redemption or acquisition is approved by the holders of at least two thirds (2/3rds) of the voting power (as determined on an as-converted basis) of all then outstanding shares of Series B Preferred Stock, 4 Series C Preferred Stock and Series D Preferred Stock, each voting as a distinct and separate class; provided, however, that the foregoing restriction shall not -------- ------- apply to the repurchase of shares of Common Stock held by employees, officers, directors, consultants or other persons performing services for the Corporation or any wholly-owned subsidiary of the Corporation (including, but not by way of limitation, distributors and sales representatives) pursuant to restrictive stock purchase agreements under which the Corporation has the option to repurchase such shares at cost (or other fixed price intended to be representative of the cost of such shares of Common Stock) upon the occurrence of certain events such as the termination of employment. (c) Any dividend or distribution which is declared by the Corporation and payable with assets of the Corporation other than cash shall be valued in accordance with the provisions of subsection 2(b)(ii) of this Article V. 2. Liquidation Preference. ---------------------- (a) In the event of any liquidation, dissolution or winding up of the Corporation, either voluntary or involuntary, the holders of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of the Corporation to the holders of Common Stock by reason of their ownership thereof, an amount per share equal to the sum of (i) $1.8382353 for each outstanding share of Series B Preferred Stock (the "Original Series B Issue Price"), $3.70 for each outstanding share of Series C Preferred Stock (the "Original Series C Issue Price") and $7.74 for each outstanding share of Series D Preferred Stock (the "Original Series D Issue Price") (in each case, as adjusted for any stock dividends, combinations or splits with respect to such shares) held by such holder and (ii) an amount equal to all declared but unpaid, dividends on such shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, as the case may be, held by such holder. The Original Series B Issue Price, Original Series C Issue Price and Original Series D Issue Price are sometimes referred to herein collectively as the "Original Issue Price". If upon the occurrence of such event, the assets and funds thus distributed among the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall be insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the entire assets and funds of the Corporation legally available for distribution shall be distributed ratably among the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock in proportion to the preferential amount each such holder is otherwise entitled to receive pursuant to this subsection (a). (b) After the distribution described in subsection (a) above has been paid and in addition to any amounts so paid, the remaining assets of the Corporation available for distribution to stockholders shall be distributed among the holders of Common Stock pro rata based on the number of shares of Common Stock held by each of them. (i) For purposes of this Section 2, a liquidation, dissolution or winding up of the Corporation shall be deemed to be occasioned by, or to include, (A) the acquisition of the Corporation by another entity by means of any transaction or series of related transactions (including, without limitation, any reorganization, merger or consolidation) that results in the transfer of 50% or more of the outstanding voting power of the Corporation or (B) a sale of all or substantially all of the assets of the Corporation; unless, ------ in either event, such sale or 5 other transaction or related transactions is determined not to be a liquidation, dissolution or winding up of the Corporation by (x) the holders of a majority of the Series B Preferred Stock and Series C Preferred Stock, voting together as a single class and on an as-converted basis, and (y) the holders of a majority of the Series D Preferred Stock, voting as a single and separate class. (ii) In any of such events, if the consideration received by the Corporation is other than cash, its value will be deemed its fair market value. Any securities to be delivered to the holders of Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock or Common Stock, as the case may be, shall be valued as follows: (A) If traded on a securities exchange or through the Nasdaq National Market, the value shall be deemed to be the average of the closing prices of the securities on such exchange over the thirty (30) day period ending three (3) days prior to the closing; (B) If actively traded over-the-counter, the value shall be deemed to be the average of the closing bid or sale prices (whichever is applicable) over the thirty (30) day period ending three (3) days prior to the closing; and (C) If there is no active public market, the value shall be the fair market value thereof, as mutually determined by the Corporation and the holders of at least two thirds (2/3rds) of the voting power (as determined on an as-converted basis) of all then outstanding shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock. (iii) In the event the requirements of this Section 2 are not complied with, the Corporation shall forthwith either: (A) cause such closing to be postponed until such time as the requirements of this Section 2 have been complied with; or (B) cancel such transaction, in which event the respective rights, preferences and privileges of the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall revert to and be the same as such rights, preferences and privileges existing immediately prior to the date of the first notice referred to in subsection 2(b)(iv) hereof. (iv) The Corporation shall give each holder of record of Series B Preferred Stock, each holder of record of Series C Preferred Stock and each holder of record of Series D Preferred Stock written notice of such impending transaction not later than twenty (20) days prior to the stockholders' meeting called to approve such transaction, or twenty (20) days prior to the closing of such transaction, whichever is earlier, and shall also notify such holders in writing of the final approval of such transaction. The first of such notices shall describe the material terms and conditions of the impending transaction and the provisions of this Section 2, and the Corporation shall thereafter give such holders prompt notice of any material changes. The transaction shall in no event take place sooner than twenty (20) days after the Corporation has given the first notice provided for herein or sooner than ten (10) days after the Corporation 6 has given notice of any material changes provided for herein; provided, however, -------- ------- that such periods may be shortened upon the Corporation's receipt of written consent of the holders of at least two thirds (2/3rds) of the outstanding shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, each voting separately and not as a single class, entitled to such notice rights or similar notice rights. 3. Redemption. None of the Series B Preferred Stock, Series C Preferred ---------- Stock or Series D Preferred Stock is redeemable. 4. Conversion. The holders of the Series B Preferred Stock, Series C ---------- Preferred Stock and Series D Preferred Stock shall have the following respective conversion rights (the "Conversion Rights"): (a) Right to Convert. Each share of Series B Preferred Stock shall be ---------------- convertible, at the option of the holder thereof, at any time after the date of issuance of such share, at the office of the Corporation or any transfer agent for such stock, into such number of fully paid and nonassessable shares of Common Stock as is determined, with respect to each share of Series B Preferred Stock, by dividing the Original Series B Issue Price plus all declared but unpaid dividends on the Series B Preferred Stock by the Series B Conversion Price, determined as hereinafter provided, in effect on the date the certificate is surrendered for conversion (the result of such division is hereinafter referred to as the "Series B Conversion Rate"). The initial Series B Conversion Price per share for the Series B Preferred Stock shall be $1.8382353; provided, -------- however, that such Series B Conversion Price shall be subject to adjustment as - ------- set forth in subsections 4(d), 4(e) and 4(f). Each share of Series C Preferred Stock shall be convertible, at the option of the holder thereof, at any time after the date of issuance of such share, at the office of the Corporation or any transfer agent for such stock, into such number of fully paid and nonassessable shares of Common Stock as is determined, with respect to each share of Series C Preferred Stock, by dividing the Original Series C Issue Price plus all declared but unpaid dividends on the Series C Preferred Stock by the Series C Conversion Price, determined as hereinafter provided, in effect on the date the certificate is surrendered for conversion (the result of such division is hereinafter referred to as the "Series C Conversion Rate"). The initial Series C Conversion Price per share for the Series C Preferred Stock shall be $3.70; provided, however, that such Series C Conversion price shall be subject -------- ------- to adjustment as set forth in subsections 4(d), 4(e), 4(f) and 4(g). Each share of Series D Preferred Stock shall be convertible, at the option of the holder thereof, at any time after the date of issuance of such share, at the office of the Corporation or any transfer agent for such stock, into such number of fully paid and nonassessable shares of Common Stock as is determined, with respect to each share of Series D Preferred Stock, by dividing the Original Series D Issue Price plus all declared but unpaid dividends on the Series D Preferred Stock, by the Series D Conversion Price in effect on the date the certificate is surrendered for conversion (the result of such division is hereinafter referred to as the "Series D Conversion Rate"). The initial Series D Conversion Price per share for the Series D Preferred Stock shall be $7.74; provided, however, that -------- ------- such Series D Conversion Price shall be subject to adjustment as set forth in subsections 4(d), 4(e), 4(f) and 4(g). (b) Mandatory Conversion. Each share of Series B Preferred Stock shall -------------------- automatically be converted into shares of Common Stock at the then effective Series B 7 Conversion Rate immediately upon the closing with an underwriter or underwriters of the sale of Common Stock pursuant to an underwritten offer of securities under the Securities Act of 1933, as amended (the "Securities Act"). Each share of Series C Preferred Stock shall automatically be converted into shares of Common Stock at the then effective Series C Conversion Rate immediately upon the earlier of (i) the date specified by vote or written consent of the holders of at least two-thirds (2/3) of the shares of Series C Preferred Stock then outstanding or (ii) the closing of the Corporation's sale of its Common Stock in a firm commitment underwritten public offering pursuant to a registration statement under the Securities Act in which the aggregate proceeds to the Corporation and any selling stockholders participating therein is at least $20 million (a "Qualified IPO"). Each share of Series D Preferred Stock shall automatically be converted into shares of Common Stock at the then effective Series D Conversion Rate immediately upon the earlier of (i) the date specified by vote or written consent of the holders of at least a majority of the shares of Series D Preferred Stock then outstanding or (ii) the closing of a Qualified IPO wherein the initial price at which shares of Common Stock are sold to the public is at least (x) $10.06 if the Qualified IPO occurs within twelve (12) months of the first issuance of shares of Series D Preferred Stock or (y) $13.16 if the Qualified IPO occurs more than twelve (12) months following the first issuance of shares of the Series D Preferred Stock (in each case as such minimum per share price is adjusted to reflect stock dividends, stock splits, combinations, recapitalizations or the like after the date of the filing of this Restated Certificate with the Secretary of State of the State of Delaware). (c) Mechanics of Conversion. Prior to the conversion of any shares of ----------------------- Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock, as the case may be, into shares of Common Stock (other than pursuant to a mandatory conversion under subsection 4(b)), such holder shall surrender the certificate or certificates thereof, duly endorsed, at the office of the Corporation or of any transfer agent for such stock, and shall give written notice by mail, postage prepaid, to the Corporation at such office that such holder elects to convert the same and shall state therein the name or names in which the holder wishes the certificate or certificates for shares of Common Stock to be issued. The Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock, or to the nominee or nominees of such holder, as the case may be, a certificate or certificates for the number of shares of Common Stock to which the holder shall be entitled as aforesaid and a check payable to the holder in the amount of any cash amounts payable as the result of a conversion into fractional shares of Common Stock pursuant to subsection 4(m) hereunder and any declared but unpaid dividends on such fractional shares of the converted Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock to which the holder may be entitled. Except for a conversion in connection with an underwritten offering of securities under the Securities Act pursuant to subsection 4(b) hereof, such conversion shall be deemed to have been made immediately prior to the close of business on the date of surrender of the shares of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock to be converted, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock on such date. In the case of a conversion pursuant to subsection 4(b) hereof in connection with an underwritten offering of securities under the Securities Act, the conversion shall be conditioned upon the closing with the underwriter or underwriters of the sale of securities pursuant to such offering, and such conversion shall then be deemed to occur immediately prior to the closing of such sale 8 of securities. In the event of a conversion pursuant to subsection 4(b) hereof, the outstanding shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall be converted automatically without any further action by the holders of such shares and whether or not the certificates representing such shares are surrendered to the Corporation or its transfer agent; and provided further that the Corporation shall not be obligated to issue certificates evidencing the shares of Common Stock issuable upon such automatic conversion unless and until the certificates evidencing such shares of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock, as the case may be, are either delivered to the Corporation or its transfer agent as provided above, or the holder notifies the Corporation or its transfer agent that such certificates have been lost, stolen or destroyed and executes an agreement satisfactory to the Corporation to indemnify the Corporation from any loss incurred by it in connection with such certificates. (d) Adjustment for Subdivisions. Combinations or Consolidations of --------------------------- --------------------------------- Common Stock and Stock Dividend. In the event that, after the date that the - ------------------------------- Series C Preferred Stock was first issued and prior to the date on which shares of Series D Preferred Stock were first issued, the outstanding shares of Common Stock shall be subdivided (by stock split or otherwise) into a greater number of shares of Common Stock, or a dividend or distribution of Common Stock payable to all holders of Common Stock shall be made (or a record date for such dividend declared), each of the Series B Conversion Price and Series C Conversion Price then in effect shall, concurrently with the effectiveness (or record date) of such subdivision or dividend, be proportionately decreased. In the event that, after the date on which the Series D Preferred Stock was first issued, the outstanding shares of Common Stock shall be subdivided (by stock split or otherwise) into a greater number of shares of Common Stock, or a dividend or distribution of Common Stock payable to all holders of Common Stock shall be made (or a record date for such dividend declared), each of the Series B Conversion Price, Series C Conversion Price and Series D Conversion Price then in effect shall, concurrently with the effectiveness (or record date) of such subdivision or dividend, be proportionately decreased. In the event that, after the date on which shares of the Series D Preferred Stock were first issued, the outstanding shares of Common Stock shall be combined or consolidated, by reclassification or otherwise, into a lesser number of shares of Common Stock, each of the Series B Conversion Price, Series C Conversion Price and Series D Conversion Price then in effect shall, concurrently with the effectiveness of such combination or consolidation, be proportionately increased. In each case, the proportionate decrease or increase, respectively, of the Series B Conversion Price, Series C Conversion Price and/or Series D Conversion Price shall be equal to the number of shares of Common Stock outstanding immediately prior to the event giving rise to the adjustment divided by the number of shares of Common Stock outstanding immediately after such event. (e) Adjustments for Other Distributions. In the event the Corporation at ----------------------------------- any time or from time to time after the date on which shares of Series D Preferred Stock were first issued makes, or fixes a record date for the determination of holders of Common Stock entitled to receive, any distribution payable in securities of the Corporation other than Common Stock or otherwise, then in each such event, provision shall be made so that the holders of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall receive upon conversion thereof, in addition to the number of shares of Common Stock receivable thereupon, the amount of securities of the Corporation or portion of any other distribution which they would have received had their Series B Preferred Stock, Series C Preferred Stock and Series D 9 Preferred Stock, as the case may be, been converted into Common Stock on the date of such event and had they thereafter, during the period from the date of such event to and including the date of conversion, retained such securities receivable by them as aforesaid during such period, subject to all other adjustments called for during such period under this Section 4 of Article V with respect to the rights of the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock. (f) Adjustments for Reorganization, Reclassification, Exchange and -------------------------------------------------------------- Substitution. If the Common Stock issuable upon conversion of the Series B - ------------ Preferred Stock, Series C Preferred Stock and Series D Preferred Stock shall be changed into the same or a different number of shares of any other class or classes of stock or other securities or property, whether by reorganization (unless such reorganization is deemed a liquidation under subsection 2(b)(i) of this Article V), reclassification or otherwise (other than a subdivision or combination of shares provided for above), each of the Series B Conversion Price, Series C Conversion Price and Series D Conversion Price then in effect shall, concurrently with the effectiveness of such reorganization or reclassification, be proportionately adjusted such that the Series B Preferred Stock, Series C Preferred Stock and Series D Convertible Stock, respectively, shall be convertible into, in lieu of the number of shares of Common Stock which the holders would otherwise have been entitled to receive, a number of shares of such other class or classes of stock or other securities or property equivalent to the number of shares of Common Stock that would have been subject to receipt by the holders upon conversion of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, as the case may be, immediately before such event; and, in any such case, appropriate adjustment (as determined by the Board of Directors of the Corporation) shall be made in the application of the provisions herein set forth with respect to the rights and interest thereafter of the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, to the end that the provisions set forth herein (including provisions with respect to changes in and other adjustments of the Series B Conversion Price, Series C Conversion Price and Series D Conversion Price) shall thereafter be applicable, as nearly as reasonably may be, in relation to any shares of stock or other property thereafter deliverable upon the conversion of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, as the case may be. (g) Adjustments to Series C Conversion Price and Series D Conversion ---------------------------------------------------------------- Price for Certain Diluting Issues. - --------------------------------- (i) Special Definitions. For purposes of this subsection 4(g), the ------------------- following definitions apply: (A) "Options" shall mean rights, options, or warrants to subscribe for, purchase or otherwise acquire either Common Stock or Convertible Securities (defined below). (B) "Original Issue Date" shall mean the date on which a share of Series D Preferred Stock was first issued by the Corporation. (C) "Convertible Securities" shall mean any evidences of indebtedness, shares (other than Common Stock, Series B Preferred Stock, Series C Preferred 10 Stock and Series D Preferred Stock) or other securities convertible into or exchangeable for Common Stock. (D) "Additional Shares of Common Stock" shall mean, all shares of Common Stock issued (or, pursuant to subsection 4(g)(iii), deemed to be issued) by the Corporation after the Original Issue Date, other than shares of Common Stock issued or issuable: (w) to employees or directors of, or consultants to, the Corporation under stock option, stock bonus or stock purchase plans or agreements or similar plans or agreements approved by the Board of Directors or an authorized committee thereof; provided, however, that this subsection -------- ----- 4(g)(i)(D)(w) shall only apply to 3,000,000 shares (notwithstanding anything herein to the contrary, including without limitation in Section 4(g)(ii), such amount including both Options outstanding on the Original Issue Date and Options reserved for issuance under the Company's stock option plan on the Original Issue Date) (as adjusted for any stock dividends, combinations or splits and net of any repurchases of shares or cancellations or expirations of options) issued (or deemed to be issued) to such employees, directors or consultants; (x) as a dividend or distribution on Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock; (y) for which adjustment of the Series B Conversion Price, Series C Conversion Price and Series D Conversion Price is made pursuant to subsections 4(d), 4(e) or 4(f); or (z) upon issuance of warrants or options to subscribe for, purchase or otherwise acquire Common Stock or convertible Securities issued to financial institutions or other lenders, lessors or guarantors in connection with current or potential borrowings, indebtedness or leases of real or personal property by the Corporation, so long as the principal purpose of such issuance is not equity financing and so long as such issuance is approved by the Board of Directors of the Corporation. (ii) No Adjustment of Conversion Price. Any provision herein to --------------------------------- the contrary notwithstanding, no adjustment in the Series C Conversion Price shall be made in respect of the issuance of Additional Shares of Common Stock unless the consideration per share (determined pursuant to subsection 4(g)(v) hereof) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the Series C Conversion Price in effect on the date of, and immediately prior to, such issue. Any provision herein to the contrary notwithstanding, no adjustment in the Series D Conversion Price shall be made in respect of the issuance of Additional Shares of Common Stock unless the consideration per share (determined pursuant to subsection 4(g)(v) hereof) for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the Series D Conversion Price in effect on the date of, and immediately prior to, such issue. 11 (iii) Deemed Issue of Additional Shares of Common Stock. In the ------------------------------------------------- event the Corporation at any time or from time to time after the Original Issue Date shall issue any Options or Convertible Securities or shall fix a record date for the determination of holders of any class of securities then entitled to receive any such Options or Convertible Securities, then the maximum number of shares (as set forth in the instrument relating thereto without regard to any provisions contained therein designed to protect against dilution) of Common Stock issuable upon the exercise of such Options or, in the case of Convertible Securities and Options therefor, the exercise and conversion or exchange of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities, shall be deemed to be Additional Shares of Common Stock (unless excluded from the definition thereof pursuant to subsection 4(g)(i)(D)) issued as of the time of such issue or, in case such a record date shall have been fixed, as of the close of business on such record date, provided that in any such case in which Additional Shares of Common Stock are deemed to be issued: (A) no further adjustments in the Series C Conversion Price or the Series D Conversion Price, as the case may be, shall be made upon the subsequent issue of Convertible Securities or shares of Common Stock upon the exercise of such Options or conversion or exchange of such Convertible Securities; (B) if such Options or Convertible Securities by their terms provide, with the passage of time or otherwise, for any increase or decrease in the consideration payable to the Corporation, or decrease or increase in the number of shares of Common Stock issuable, upon the exercise, conversion or exchange thereof, the Series C Conversion Price and the Series D Conversion Price, as the case may be, computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon any such increase or decrease becoming effective, be recomputed to reflect such increase or decrease insofar as it affects such Options or the rights of conversion or exchange under such Convertible Securities (provided, however, that no such adjustment of the Series -------- ------- C Conversion Price or Series D Conversion Price shall affect Common Stock previously issued upon conversion of the Series C Preferred Stock or the Series D Preferred Stock, as the case may be); (C) upon the expiration of any such Options or any rights of conversion or exchange under such Convertible Securities which shall not have been exercised, the Series C Conversion Price and the Series D Conversion Price, as the case may be, computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon such expiration, be recomputed as if: (x) in the case of Convertible Securities or Options for Common Stock, the only Additional Shares of Common Stock issued were the shares of Common Stock, if any, actually issued upon the exercise of such Options or the conversion or exchange of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of all such Options, whether or not exercised, plus the consideration actually received by the Corporation upon such exercise, or for the issue of all such Convertible Securities which 12 were actually converted or exchanged, plus the additional consideration, if any, actually received by the Corporation upon such conversion or exchange, and (y) in the case of Options for Convertible Securities, only the Convertible Securities, if any, actually issued upon the exercise thereof were issued at the time of issue of such Options, and the consideration received by the Corporation for the Additional Shares of Common Stock deemed to have been then issued was the consideration actually received by the Corporation for the issue of all such Options, whether or not exercised, plus the consideration deemed to have been received by the Corporation (determined pursuant to subsection 4(g)(v) hereof) upon the issue of the Convertible Securities with respect to which such Options were actually exercised; (D) no readjustment pursuant to subsection 4(g)(iii)(B) or (C) above shall have the effect of increasing the Series C Conversion Price or the Series D Conversion Price to an amount which exceeds the lower of (x) the Series C Conversion Price or the Series D Conversion Price, as the case may be, on the original adjustment date, or (b) the Series C Conversion Price or the Series D Conversion Price, as the case may be, that would have resulted from any issuance or issuances of Additional Shares of Common Stock between the original adjustment date and such readjustment date; (E) in the case of any Options or Convertible Securities which expire by their terms not more than 30 days after the date of issue thereof, no adjustment of the Series C Conversion Price or Series D Conversion Price shall be made until the expiration or exercise of all such Options, whereupon such adjustment shall be made in the same manner provided in subsection 4(g)(iii)(C) above; and (F) in the case of any Options or Convertible Securities with respect to which the maximum number of shares of Common Stock issuable upon exercise or conversion or exchange thereof is not determinable, no adjustment to the Series C Conversion Price or the Series D Conversion Price shall be made until such number becomes determinable. (iv) Adjustment of Conversion Price Upon Issuance of Additional ---------------------------------------------------------- Shares of Common Stock. In the event the Corporation, at any time after the - ---------------------- Original Issue Date, shall issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to subsection 4(g)(iii)) without consideration or for a consideration per share less than the Series C Conversion Price or the Series D Conversion Price, as the case may be, in effect on the date of, and immediately prior to, such issue, then and in such event, the Series C Conversion Price or the Series D Conversion Price, as the case may be, shall be reduced, concurrently with such issue, to a price (calculated in accordance with subsection 4(g)(vi)(b)) determined by multiplying the Series C Conversion Price or the Series D Conversion Price, as the case may be, by a fraction, (x) the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of shares of Common Stock which the aggregate consideration received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at the Series C Conversion Price or the Series D Conversion Price, as the case may be, in effect immediately prior to such issuance, and (y) the denominator of which shall be the number of shares of 13 Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued. For the purpose of the above calculation, the number of shares of Common Stock outstanding immediately prior to such issue shall be calculated on a fully-diluted basis, as if all shares of Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and all Convertible Securities had been fully converted into shares of Common Stock immediately prior to such issuance and any outstanding warrants, options or other rights for the purchase of shares of stock or convertible securities had been fully exercised immediately prior to such issuance (and the resulting securities fully converted into shares of Common Stock, if so convertible) as of such date, but not including in such calculation any additional shares of Common Stock issuable with respect to shares of Series C Preferred Stock, Series D Preferred Stock and Convertible Securities, or outstanding options, warrants or other rights for the purchase of shares of stock or convertible securities, solely as a result of the adjustment of the Series C Conversion Price or Series D Conversion Price (or other conversion ratios) resulting from the issuance of Additional Shares of Common Stock causing such adjustment. (v) Determination of Consideration. For purposes of this subsection ------------------------------ 4(g), the consideration received by the Corporation for the issue of any Additional Shares of Common Stock shall be computed as follows: (A) Cash and Property. Such consideration shall: ----------------- (x) insofar as it consists of cash, be computed at the aggregate amount of cash received by the Corporation excluding amounts paid or payable for accrued interest or accrued dividends; (y) insofar as it consists of property other than cash, be computed at the fair value thereof at the time of such issue, as determined in good faith by the Board of Directors; and (z) in the event Additional Shares of Common Stock are issued together with other shares or securities or other assets of the Corporation for consideration which covers both, be the proportion of such consideration so received, computed as provided in clauses (x) and (y) above, as determined in good faith by the Board of Directors. (B) Options and Convertible Securities. The consideration per ---------------------------------- share received by the Corporation for Additional Shares of Common Stock deemed to have been issued pursuant to subsection 4(g) relating to Options and Convertible Securities shall be equal to the quotient determined by dividing: (x) the total amount, if any, received or receivable by the Corporation as consideration for the issue of such Options or Convertible Securities, plus the minimum aggregate amount of additional consideration (as set forth in the instruments relating thereto, without regard to any provision contained therein designed to protect against dilution) payable to the Corporation upon the exercise of such Options or the conversion or exchange of such Convertible Securities, or in the 14 case of Options for Convertible Securities, the exercise of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities, by (y) the maximum number of shares of Common Stock (as set forth in the instruments relating thereto, without regard to any provision contained therein designed to protect against the dilution) issuable upon the exercise of such Options or conversion or exchange of such Convertible Securities, or in the case of Options for Convertible Securities, the exercise of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities. (vi) Miscellaneous. ------------- (A) All calculations under this subsection 4(g) shall be made to the nearest cent or to the nearest one hundredth (1/100) of a share, as the case may be. (B) No adjustment in the Series C Conversion Price or the Series D Conversion Price need be made if such adjustment would result in a change in such Series C Conversion Price or Series D Conversion Price, as the case may be, of less than $0.01. Any adjustment of less than $0.01 which is not made shall be carried forward and shall be made at the time of and together with any subsequent adjustment made prior to three (3) years from the date of the event giving rise to the adjustment being carried forward which, on a cumulative basis, amounts to an adjustment of $0.01 or more in such Series C Conversion Price or Series D Conversion Price, as the case may be, or shall be made at the end of three (3) years from the date of the event giving rise to the adjustment being carried forward. (h) No Impairment. The Corporation will not, by amendment of this ------------- Restated Certificate or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issuance or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Corporation, but will at all times in good faith assist in the carrying out of all the provisions of this Section 4 of this Article V and in the taking of all such action as may be necessary or appropriate in order to protect the respective conversion rights of the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock against impairment. (i) Certificates as to Adjustments. Upon the occurrence of each ------------------------------ adjustment or readjustment of the Series B Conversion Price, Series C Conversion Price or Series D Conversion Price pursuant to this Section 4, the Corporation, at its expense, shall promptly compute such adjustment or readjustment in accordance with the terms hereof and prepare and furnish to each holder of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. The Corporation shall, upon the written request at any time of any holder of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock, furnish or cause to be furnished to such holder a like certificate setting forth (i) such applicable adjustments and readjustments, (ii) the applicable Series B Conversion Price, Series C Conversion Price and Series D Conversion Price at the time in effect, and (iii) the number of shares of Common Stock and the amount, if any, of other 15 property which at the time would be received upon the conversion of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock. Any certificate sent to the holders of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock pursuant to this subsection 4(i) shall be certified by the President or Chief Financial Officer of the Corporation. (j) Notices of Record Date. In the event that this Corporation shall ---------------------- propose at any time: (i) to declare any dividend or distribution upon its Common Stock, whether in cash, property, stock or other securities, whether or not a regular cash dividend and whether or not out of earnings or earned surplus; (ii) to offer for subscription pro rata to the holders of any class or series of its stock any additional shares of stock of any class or series or other rights; or (iii) to effect any reclassification or recapitalization of its Common Stock outstanding involving a change in the Common Stock; then, in connection with each such event, the Corporation shall send to the holders of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock: (A) at least twenty (20) days prior written notice of the date on which a record shall be taken for such dividend, distribution or subscription rights (and specifying the date on which holders of Common Stock shall be entitled thereto and the approximate amount and character of such dividend, distribution or right) or for determining rights to vote in respect of the matters referred to in (i) and (ii) above; and (B) in the case of the matters referred to in (iii) above, at least twenty (20) days prior written notice of the date when the same shall take place (and specifying the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon the occurrence of such event and the approximate amount and character of such dividend, distribution or right). (k) Issue Taxes. The Corporation shall pay any and all issue and ----------- other taxes that may be payable in respect of any issue or delivery of shares of Common Stock on conversion of shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock pursuant hereto; provided, however, -------- ------- that the Corporation shall not be obligated to pay any transfer taxes or income taxes payable by the stockholder and resulting from any transfer requested by any holder in connection with any such conversion. (l) Reservation of Stock Issuable Upon Conversion. There is hereby --------------------------------------------- reserved out of the presently authorized but unissued shares of Common Stock 304,986, 4,414,500 shares and 4,080,000 shares for the sole purpose of issuance pursuant to conversions of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, respectively, as provided herein. The Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock, solely for the purpose of effecting the conversion of the shares of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, such number of its shares of Common Stock as shall from time to time be 16 sufficient to effect the conversion of all outstanding shares of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock; and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, in addition to such other remedies as shall be available to the holders of such Preferred Stock, the Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose. (m) Fractional Shares. No fractional share shall be issued upon the ----------------- conversion of any share or shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock. Whether or not fractional shares are issuable upon such conversion shall be determined on the basis of the total number of shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock that the holder is at the time converting into Common Stock and the number of shares of Common Stock issuable upon such aggregate conversion. If the conversion would result in the issuance of a fraction of a share of Common Stock, the Corporation shall, in lieu of issuing any fractional share, pay the holder otherwise entitled to such fraction a sum in cash equal to the fair market value of such fraction on the date of conversion (as determined in good faith by the Board of Directors of the Corporation). (n) Notices. Any notice required by the provisions of this Section 4 ------- to be given to the holders of shares of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock shall be deemed given if delivered personally or three days after being deposited in the United States mail, first class postage prepaid, and addressed to each holder of record at his address appearing on the books of the Corporation. 5. Restrictions and Limitations. ----------------------------- (a) Actions Requiring Approval of Holders of Series B Preferred ----------------------------------------------------------- Stock. In addition to any other rights provided by law, so long as any Series B - ----- Preferred Stock shall be outstanding, the Corporation shall not, without the vote or written consent by the holders of at least a majority of the then outstanding shares of the Series B Preferred Stock: (i) Purchase, redeem or otherwise acquire (or pay into or set aside for a sinking fund for such purpose), any of the Common Stock or any other series of preferred stock of the Corporation (other than by conversion); provided, however, that this restriction shall not apply to the repurchase of - -------- ------- shares of Common Stock from employees, officers, directors, consultants or other persons performing services for the Corporation or any subsidiary of the Corporation, in accordance with written plans or agreements; or (ii) Increase or decrease (other than by conversion) the total number of authorized shares of Series B Preferred Stock of the Corporation; or (iii) Authorize or issue, or obligate itself to issue, any other equity security senior to the Series B Preferred Stock as to liquidation preferences without contemporaneously amending the liquidation preference of the Series B Preferred Stock such that it is pari passu to such equity security, or create any obligation or security convertible into or 17 exchangeable for, or having any option rights to purchase, any such equity security which is senior to the Series B Preferred Stock with respect to liquidation preferences without contemporaneously amending the liquidation preference of the Series B Preferred Stock such that it is pari passu to such equity security. (b) Actions Requiring Approval of Holders of Each of the Series C ------------------------------------------------------------- Preferred Stock and Series D Preferred Stock. In addition to any other rights - -------------------------------------------- provided by law, so long as any Series C Preferred Stock or Series D Preferred Stock shall be outstanding, the Corporation shall not, without the vote or written consent by the holders of at least a majority of the then outstanding shares of the Series C Preferred Stock and Series D Preferred Stock, respectively, each voting or acting, as the case may be, as a single and separate class: (i) Amend this Restated Certificate or the Corporation's Bylaws, or waive any provision thereof, if such amendment or waiver would adversely affect the powers, privileges, preferences or rights of the outstanding shares of such series of the Preferred Stock provided for herein; or (ii) Authorize or issue, or obligate itself to issue, any other equity security senior to such series of the Preferred Stock as to liquidation preferences, voting rights, redemption, conversion or dividends, or create any obligation or security convertible into, or exercisable or exchangeable for, any such equity security which is senior to such series of the Preferred Stock with respect to liquidation preferences, voting rights, redemption, conversion or dividends; or (iii) Effect any sale, lease, assignment, transfer or other conveyance of all or substantially all of the assets of the Corporation, or any acquisition of the Corporation by another entity by means of any transaction or series of related transactions (including, without limitation, any reorganization, merger or consolidation) that results in the transfer of 50% or more of the outstanding voting power of the Corporation, other than any such sale, lease, assignment, transfer, conveyance, acquisition, reorganization, merger or consolidation in which holders of such series of the Preferred Stock receive consideration, as a result of their ownership thereof, with a fair market value (as determined in accordance with Section 2(b)(ii)) at least equal to two (2) times the Original Issue Price of such series of the Preferred Stock (as such Original Issue Price may be adjusted for any stock splits, reverse stock splits or stock dividends, and the like); or (iv) Purchase, redeem or otherwise acquire (or pay into or set aside for a sinking fund for such purpose), any of the Common Stock or any other series of Preferred Stock of the Corporation (other than by conversion); provided, however, that this restriction shall not apply to the repurchase of - -------- ------- shares of Common Stock at cost from employees, officers, directors, consultants or other persons performing services for the Corporation or any subsidiary of the Corporation, in accordance with written plans or agreements, except for any such repurchase as would adversely affect the rights of a holder of Series C Preferred Stock or Series D Preferred Stock under Section 1202 of the Internal Revenue Code of 1986, as amended; or 18 (v) Increase or decrease (other than by conversion) the total number of authorized shares of such series of the Preferred Stock of the Corporation; or (vi) Amend this Section 5(b). (c) Actions Requiring Approval of Holders of Two-Thirds of the ---------------------------------------------------------- Series C Preferred Stock and Series D Preferred Stock. In addition to any other - ----------------------------------------------------- rights provided by law, so long as any Series C Preferred Stock or Series D Preferred Stock shall be outstanding, the Corporation shall not, without the vote or written consent by the holders of at least two-thirds (2/3) of the then outstanding shares of the Series C Preferred Stock and Series D Preferred Stock (as determined on an as-converted basis), voting or acting, as the case may be, together as a single, and not as a separate, class: (i) Authorize or issue, or obligate itself to issue, any other equity security senior to such series of the Preferred Stock as to liquidation preferences, voting rights, redemption, conversion or dividends, or create any obligation or security convertible into, or exercisable or exchangeable for, any such equity security which is senior to such series of the Preferred Stock with respect to liquidation preferences, voting rights, redemption, conversion or dividends; or (ii) Increase or decrease (other than by conversion) the total number of authorized shares of the Series C Preferred Stock or Series D Preferred Stock; or (iii) Declare or pay dividends on any shares of Common Stock (other than dividends payable solely in shares of Common Stock); or (iv) Purchase, redeem or otherwise acquire (or pay into or set aside for a sinking fund for such purpose), any of the Common Stock or any other series of Preferred Stock of the Corporation (other than by conversion); provided, however, that this restriction shall not apply to the repurchase of - -------- ------- shares of Common Stock at cost from employees, officers, directors, consultants or other persons performing services for the Corporation or any subsidiary of the Corporation, in accordance with written plans or agreements, except for any such repurchase as would adversely affect the rights of a holder of Series C Preferred Stock or Series D Preferred Stock under Section 1202 of the Internal Revenue Code of 1986, as amended; or (v) Own, or permit any subsidiary company to own, any stock or other securities of any subsidiary company or other corporation, partnership or entity unless it is wholly-owned by the Corporation; or (vi) Increase or decrease the number of authorized members of the Board of Directors from the authorized number of nine (9) directors; or (vii) Increase the total number of shares reserved for issuance under the Corporation's employee stock option, stock incentive or other compensation plans or arrangements to more than 3,000,000 shares of Common Stock; or (viii) Amend this Section 5(c). 19 6. Voting Rights. ------------- (a) Each holder of shares of the Series C Preferred Stock or Series D Preferred Stock shall be entitled to the number of votes equal to the whole number of shares of Common Stock into which such holder's shares of Series C Preferred Stock and/or Series D Preferred Stock could be converted immediately prior to the close of business on the record date fixed for such meeting or, if no record date is established, at the date such vote is taken, or on the date any such written consent is executed by such holder, and shall have voting rights and powers equal to the voting rights and powers of the Common Stock (except as otherwise expressly provided herein or as required by law, voting together with the Common Stock as a single class) and shall be entitled to notice of any stockholders' meeting in accordance with the Bylaws of the Corporation. Fractional votes shall not, however, be permitted and any fractional voting rights resulting from the above formula (after aggregating all shares into which shares of Series C Preferred Stock and Series D Preferred Stock held by each holder could be converted) shall be rounded to the nearest whole number (with one-half being rounded upward). (b) Until the closing of the Corporation's initial sale of securities pursuant to an underwritten public offering registered under the Securities Act, other than a registration relating solely to a transaction under Rule 145 under the Securities Act (or any successor thereto) or to an employee benefit plan of the Corporation, (i) the holders of Series C Preferred Stock, voting together as a single class, shall be entitled to elect three (3) members of the Board of Directors, (ii) the holders of Series D Preferred Stock, voting together as a single class, shall be entitled to elect one (1) member of the Board of Directors and (iii) the holders of the Common Stock, voting together as a single class, shall be entitled to elect the remaining members of the Board of Directors; provided, however, that one such director to be elected by the -------- ------- holders of the Common Stock shall be nominated upon the advice and consent of the Board of Directors. Promptly following the closing of the Corporation's initial public offering of securities, the Board of Directors shall promptly call a special meeting of the stockholders at which all directors will be elected by the holders of Common Stock, and the terms of office of all persons who are then directors of the Corporation shall terminate immediately upon, the election of their successors. (c) In the case of any vacancy in the office of a director occurring among the directors elected by the holders of the Series C Preferred Stock, Series D Preferred Stock or Common Stock pursuant to subsection 6(b) of this Article V, the remaining director or directors so elected by the holders of the Series C Preferred Stock or Common Stock (as the case may be) may, by affirmative vote of a majority of such remaining directors (or the remaining director so elected if there is but one, or if there is no such director remaining (as would be the case in the event of a vacancy in the director seat to be filled by the Series D Preferred Stock), by the affirmative vote of the holders of a majority of the shares of that class) elect a successor or successors to hold the office for the unexpired term of the director or directors whose place or places shall be vacant. Any director who shall have been elected by the holders of the Series C Preferred Stock, Series D Preferred Stock or Common Stock or any director so elected as provided in the preceding sentence hereof, may be removed during the aforesaid term of office, whether with or without cause, only in accordance with the provisions of the Delaware General Corporation Law and by the affirmative vote of the holders of a majority of the Series C Preferred Stock, Series D Preferred Stock or Common Stock, as the case may be. 20 (d) Except as specified in subsection 5(a) hereof, prior to conversion of the Series B Preferred Stock, the holders of Series B Preferred Stock shall not be entitled to vote on any matters pertaining to the governance or management of the Corporation and shall not be entitled to notice of any stockholders' meeting. 7. Status of Converted or Redeemed Stock. In the event any shares of ------------------------------------- Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock shall be converted pursuant to Section 4 above, or in the event any shares of Series B Preferred Stock, Series C Preferred Stock or Series D Preferred Stock shall be redeemed pursuant to Section 3 above, the shares so converted or redeemed shall be cancelled and shall not be issuable by the Corporation. The Restated Certificate shall be amended at such time or times as the Corporation deems it reasonably practicable to effect the corresponding reduction in the Corporation's authorized capital stock. ARTICLE VI A Director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived any improper personal benefit. If the Delaware General Corporation Law is amended after approval by the stockholders of this Article VI to authorize corporate action further eliminating or limiting the personal liability of directors then the liability of a Director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law as so amended. ARTICLE VII The management of the business and the conduct of the affairs of the Corporation shall be vested in its Board of Directors. The numbers of directors which shall constitute the whole Board of Directors of the Corporation shall be fixed by, or in the manner provided in, the Bylaws of the Corporation. ARTICLE VIII Meetings of stockholders may be held within or without the State of Delaware, as the Bylaws may provide. The books of the Corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in the Bylaws of the Corporation. ARTICLE IX Election of directors at an annual or special meeting of stockholders need not be by written ballot unless the Bylaws of the Corporation shall so provide. 21 ARTICLE X A. At each annual meeting of stockholders, directors of the Corporation shall be elected to hold office until the expiration of the term for which they are elected, and until their successors have been duly elected and qualified. At the first annual meeting of stockholders following the closing of the initial public offering (the "First Public Company Annual Meeting") of the Corporation's ----------------------------------- capital stock pursuant to an effective registration statement filed under the Securities Act of 1933, as amended (the "Initial Public Offering"), the ----------------------- directors of the Corporation shall be divided into three classes as nearly equal in size as is practicable, hereby designated as Class I, Class II and Class III. The term of office of the initial Class I directors shall expire at the next succeeding annual meeting of stockholders, the term of office of the initial Class II directors shall expire at the second succeeding annual meeting of stockholders and the term of office of the initial Class III directors shall expire at the third succeeding annual meeting of stockholders. For the purposes hereof, the initial Class I, Class II and Class III directors shall be those directors designated and elected at the First Public Company Annual Meeting. At each annual meeting after the First Public Company Annual Meeting, directors to replace those of a Class whose terms expire at such annual meeting shall be elected to hold office until the third succeeding annual meeting and until their respective successors shall have been duly elected and qualified. If the number of directors is hereafter changed, any newly created directorships or decrease in directorships shall be so apportioned among the classes as to make all classes as nearly equal in number as is practicable. B. Vacancies occurring on the Board of Directors for any reason may be filled by vote of a majority of the remaining members of the Board of Directors, although less than a quorum, at a meeting of the Board of Directors. A person so elected by the Board of Directors to fill a vacancy shall hold office until the next succeeding annual meeting of stockholders of the Corporation and until his or her successor shall have been duly elected and qualified. ARTICLE XI In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to make, alter, amend or repeal the Bylaws of the Corporation. ARTICLE XII Effective upon the closing of the Initial Public Offering, stockholders of the Corporation may not take action be written consent in lieu of a meeting but must take any actions at a duly called annual or special meeting. ARTICLE XIII Notwithstanding any other provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any affirmative vote of the holders of the capital stock required by law of this Certificate of Incorporation, the affirmative vote of the holders of at least two-thirds (2/3) of the combined 22 voting power of all of the then-outstanding shares of the Corporation entitled to vote shall be required to alter, amend or repeal Articles X, XII or XIII, or any provisions thereof. ARTICLE XIV The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred on stockholders herein are granted subject to this reservation. 23 EX-3.2 3 BYLAWS EXHIBIT 3.2 AMENDED AND RESTATED BYLAWS OF APPLIED SCIENCE FICTION, INC., a Delaware corporation
TABLE OF CONTENTS Page ---- ARTICLE I. Offices...................................................................1 Section 1.1 Registered Office..................................................1 Section 1.2 Other Offices......................................................1 ARTICLE II. Corporate Seal...........................................................1 ARTICLE III. Stockholders' Meetings..................................................1 Section 3.1 Place of Meetings.................................................1 Section 3.2 Annual Meeting....................................................2 Section 3.3 Special Meetings..................................................4 Section 3.4 Notice of Meetings................................................4 Section 3.5 Quorum............................................................4 Section 3.6 Adjournment and Notice of Adjourned Meetings......................5 Section 3.7 Voting Rights.....................................................5 Section 3.8 Joint Owners of Stock.............................................5 Section 3.9 List of Stockholders..............................................5 Section 3.10 No Action Without Meeting.........................................6 Section 3.11 Organization......................................................6 ARTICLE IV. Directors................................................................7 Section 4.1 Number and Term of Office; Classification.........................7 Section 4.2 Powers............................................................7 Section 4.3 Vacancies.........................................................7 Section 4.4 Resignation.......................................................8 Section 4.5 Removal...........................................................8 Section 4.6 Meetings..........................................................8 Section 4.7 Quorum and Voting.................................................9 Section 4.8 Action Without Meeting............................................9 Section 4.9 Fees and Compensation.............................................9 Section 4.10 Committees.......................................................10 ARTICLE V. Officers.................................................................11 Section 5.1 Officers Designated..............................................11 Section 5.2 Tenure and Duties of Officers....................................11 Section 5.3 Delegation of Authority..........................................14 Section 5.4 Resignations.....................................................14 Section 5.5 Removal..........................................................14 ARTICLE VI. Execution of Corporate Instruments and Voting of Securities Owned by the Corporation.....................................................................14 Section 6.1 Execution of Corporate Instruments...............................14 Section 6.2 Voting of Securities Owned by the Corporation....................15
ii ARTICLE VII. Shares of Stock........................................................15 Section 7.1 Form and Execution of Certificates...............................15 Section 7.2 Lost Certificates................................................16 Section 7.3 Transfers........................................................16 Section 7.4 Fixing Record Dates..............................................16 Section 7.5 Registered Stockholders..........................................17 ARTICLE VIII. Other Securities of the Corporation...................................17 Section 8.1 Execution of Other Securities....................................17 ARTICLE IX. Dividends...............................................................18 Section 9.1 Declaration of Dividends.........................................18 Section 9.2 Dividend Reserve.................................................18 ARTICLE X. Fiscal Year..............................................................18 ARTICLE XI. Indemnification of Directors, Officers, Employees and Other Agents......18 Section 11.1 Directors and Executive Officers.................................18 Section 11.2 Other Officers, Employees and Other Agents.......................19 Section 11.3 Good Faith.......................................................19 Section 11.5 Enforcement......................................................20 Section 11.6 Non-Exclusivity of Rights........................................20 Section 11.7 Survival of Rights...............................................20 Section 11.8 Insurance........................................................20 Section 11.9 Amendments.......................................................21 Section 11.10 Savings Clause...................................................21 Section 11.11 Certain Definitions..............................................21 ARTICLE XII. Notices................................................................22 Section 12.1 Notice to Stockholders...........................................22 Section 12.2 Notice to Directors..............................................22 Section 12.3 Address Unknown..................................................22 Section 12.4 Affidavit of Mailing.............................................22 Section 12.5 Time Notices Deemed Given........................................22 Section 12.6 Failure to Receive Notice........................................22 Section 12.7 Notice to Person with Whom Communication Is Unlawful.............22 Section 12.8 Notice to Person with Undeliverable Address......................23 ARTICLE XIII. Amendments............................................................23 Section 13.1 Amendments.......................................................23 Section 13.2 Application of Bylaws............................................23 ARTICLE XIV. Loans to Officers......................................................24
iii BYLAWS OF APPLIED SCIENCE FICTION, INC., a Delaware corporation - -------------------------------------------------------------------------------- ARTICLE I. OFFICES ------- Section 1.1 Registered Office. The registered office of the corporation ----------------- shall be the registered office named in the certificate of incorporation of the corporation, or such other office as may be designated from time to time by the Board of Directors in the manner provided by law. Section 1.2 Other Offices. The corporation may have offices at such other ------------- places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the corporation may require. The books of the corporation may be kept (subject to any provision contained in the Delaware General Corporation Law) outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in these Bylaws. ARTICLE II. CORPORATE SEAL -------------- The corporate seal shall consist of a die bearing the name of the corporation. Said seal may be used by causing it, or a facsimile thereof, to be impressed, affixed or reproduced. ARTICLE III. STOCKHOLDERS' MEETINGS ---------------------- Section 3.1 Place of Meetings. Meetings of the stockholders of the ----------------- corporation shall be held at such place, either within or without the State of Delaware, as may be designated from time to time by the Board of Directors, or, if not so designated, then at the principal executive offices of the corporation. Section 3.2 Annual Meeting. -------------- (a) The annual meeting of the stockholders of the corporation, for the purpose of election of Directors and for such other business as may lawfully come before it, shall be held on such date and at such time as may be designated from time to time by the Board of Directors. (b) At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be: (A) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors; (B) otherwise properly brought before the meeting by or at the direction of the Board of Directors; or (C) otherwise properly brought before the meeting by a stockholder. For business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the corporation. To be timely, a stockholder's notice must be delivered to or mailed and received by the Secretary of the corporation not later than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the date of the proxy statement delivered to stockholders in connection with the preceding year's annual meeting; provided, however, that if either (i) the date of the annual meeting is advanced more than thirty (30) days or delayed (other than as a result of adjournment) more than sixty (60) days from such an anniversary date or (ii) no proxy statement was delivered to stockholders in connection with the preceding year's annual meeting, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the ninetieth (90th) day prior to such annual meeting and not later than the close of business on the later of the sixtieth (60th) day prior to such annual meeting or the close of business on the tenth (10th) day following the day on which public announcement of the date of such meeting is first made by the corporation. To be in proper form, a stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting: (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting; (ii) a representation that the stockholder is a holder of record of stock of the corporation entitled to vote at such meeting and, if applicable, intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice or introduce the business specified in the notice; (iii) the name and address, as they appear on the corporation's books, of the stockholder proposing such business; (iv) the class and number of shares of the corporation which are beneficially owned by the stockholder; (v) any material interest of the stockholder in such business; and (vi) any other information that is required to be provided by the stockholder pursuant to Regulation 14A under the Securities Exchange Act of 2 1934, as amended (the "Exchange Act"), in such stockholder's capacity as a proponent of a stockholder proposal. The chairman of the meeting shall determine whether any business proposed to be transacted by the stockholders has been properly brought before the meeting and, if any proposed business has not been properly brought before the meeting, the chairman shall declare that such proposed business shall not be presented for stockholder action at the meeting. For purposes of this Section 3.2, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Sections 13, 14 or 15(d) of the Exchange Act. Notwithstanding any provision in this Section 3.2 to the contrary, requests for inclusion of proposals in the corporation's proxy statement made pursuant to Rule 14a-8 under the Exchange Act shall be deemed to have been delivered in a timely manner if delivered in accordance with such Rule. Notwithstanding compliance with the requirements of this Section 3.2, the chairman presiding at any meeting of the stockholders may, in his sole discretion, refuse to allow a stockholder or stockholder representative to present any proposal which the corporation would not be required to include in a proxy statement under any rule promulgated by the Securities and Exchange Commission. (c) Only persons who are nominated in accordance with the procedures set forth in this paragraph shall be eligible for election as Directors. Nominations of persons for election to the Board of Directors of the corporation may be made at a meeting of stockholders by or at the direction of the Board of Directors or by any stockholder of the corporation entitled to vote in the election of Directors at the meeting who complies with the notice procedures set forth in this paragraph. Such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of the corporation in accordance with the provisions of paragraph (b) of this Section 3.2. Such stockholder's notice shall set forth (i) as to each person, if any, whom the stockholder proposes to nominate for election or re-election as a Director: (A) the name, age, business address and residence address of such person; (B) the principal occupation or employment of such person; (C) the class and number of shares of the corporation which are beneficially owned by such person; (D) a description of all arrangements or understandings between the stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nominations are to be made by the stockholder; and (E) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of Directors, or is otherwise required in each case pursuant to Regulation 14A under the 1934 Act (including without limitation such person's written consent to being named in the proxy statement, if any, as a nominee and to serving as a Director if elected); and (ii) as to such stockholder giving notice, the information required to be provided pursuant to paragraph (b) of this Section 3.2. At the request of the Board of Directors, any person nominated by a stockholder for election as a Director shall furnish to the Secretary of the corporation that information required to be set forth in the stockholder's notice of nomination which pertains to the nominee. No person shall be eligible for election as a Director of the corporation unless nominated in accordance with the procedures set forth in this paragraph. The chairman of the meeting shall, if the facts warrant, determine and declare at the meeting that a nomination was not made in accordance with the procedures prescribed by these Bylaws, and if the chairman should so determine, the chairman shall so declare at the meeting, and the defective nomination shall be disregarded. 3 Section 3.3 Special Meetings. ---------------- (a) Special meetings of the stockholders of the corporation may only be called, for any purpose or purposes, by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized Directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board of Directors for adoption). (b) No business may be transacted at such special meeting otherwise than specified in the resolution calling for the meeting. The Board of Directors shall determine the time and place of such special meeting, which shall be held not less than thirty-five (35) nor more than one hundred twenty (120) days after the date of the receipt of the request other than any actions effected prior to an Initial Public Offering (as defined below). Upon determination of the time and place of the meeting, notice shall be given to the stockholders entitled to vote, in accordance with the provisions of Section 3.4 of these Bylaws. If the notice is not given within sixty (60) days after the receipt of the request, the person or persons requesting the meeting may set the time and place of the meeting and give the notice. Nothing contained in this paragraph (b) shall be construed as limiting, fixing or affecting the time when a meeting of stockholders may be held. Section 3.4 Notice of Meetings. Except as otherwise provided by law or the ------------------ certificate of incorporation of the corporation, as the same may be amended or restated from time to time and including any certificates of designation thereunder (hereinafter, the "Certificate of Incorporation"), and for actions effected prior to an Initial Public Offering (for which no notice need be given) written notice of each meeting of stockholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at such meeting, such notice to specify the place, date, time and purpose or purposes of the meeting. Notice of any meeting of stockholders may be waived in writing, signed by the person entitled to notice thereof, either before or after such meeting, and will be waived by any stockholder by his attendance thereat in person or by proxy, except when the stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Any stockholder so waiving notice of such meeting shall be bound by the proceedings of any such meeting in all respects as if due notice thereof had been given. Section 3.5 Quorum. At all meetings of stockholders, except where otherwise ------ provided by statute or by the Certificate of Incorporation, or by these Bylaws, the presence, in person or by duly authorized proxy, of the holders of a majority of the outstanding shares of stock entitled to vote shall constitute a quorum for the transaction of business. In the absence of a quorum, any meeting of stockholders may be adjourned, from time to time, either by the chairman of the meeting or by vote of the holders of a majority of the shares represented thereat, but no other business shall be transacted at such meeting. The stockholders present at a duly called or convened meeting, at which a quorum is present, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. Except as otherwise provided by law, the Certificate of Incorporation or these Bylaws, all actions taken by the holders of a majority of the votes cast, excluding abstentions, at any meeting at which a quorum is present shall be valid and binding upon the corporation; provided, 4 however, that Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of Directors. Where a separate vote by a class or classes is required, a majority of the outstanding shares of such class or classes, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter and the affirmative vote of the majority (plurality, in the case of the election of Directors) of shares of such class or classes present in person or represented by proxy at the meeting shall be the act of such class. Section 3.6 Adjournment and Notice of Adjourned Meetings. Any meeting of -------------------------------------------- stockholders, whether annual or special, may be adjourned from time to time either by the chairman of the meeting or by the vote of a majority of the shares casting votes, excluding abstentions. When a meeting is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than thirty (30) days or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. Section 3.7 Voting Rights. For the purpose of determining those ------------- stockholders entitled to vote at any meeting of the stockholders, except as otherwise provided by law, only persons in whose names shares stand on the stock records of the corporation on the record date, as provided in Section 7.5 of these Bylaws, shall be entitled to vote at any meeting of stockholders. Every person entitled to vote or execute consents shall have the right to do so either in person or by an agent or agents authorized by a written proxy executed by such person or his duly authorized agent, which proxy shall be filed with the Secretary at or before the meeting at which it is to be used. An agent so appointed need not be a stockholder. No proxy shall be voted after three (3) years from its date of creation unless the proxy provides for a longer period. Elections of Directors need not be by written ballot, unless otherwise provided in the Certificate of Incorporation. Section 3.8 Joint Owners of Stock. If shares or other securities having --------------------- voting power stand of record in the names of two (2) or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, tenants by the entirety, or otherwise, or if two (2) or more persons have the same fiduciary relationship respecting the same shares, unless the Secretary is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein it is so provided, their acts with respect to voting shall have the following effect: (a) if only one (1) votes, his act binds all; (b) if more than one (1) votes, the act of the majority so voting binds all; or (c) if more than one (1) votes, but the vote is evenly split on any particular matter, each faction may vote the securities in question proportionally, or may apply to the Delaware Court of Chancery for relief as provided in the Delaware General Corporation Law, Section 217(b). If the instrument filed with the Secretary shows that any such tenancy is held in unequal interests, a majority or even-split for the purpose of clause (c) shall be a majority or even-split in interest. Section 3.9 List of Stockholders. The Secretary shall prepare and make, at -------------------- least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to 5 vote at said meeting, arranged in alphabetical order, showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not specified, at the place where the meeting is to be held. The list shall be produced and kept at the time and place of meeting during the whole time thereof and may be inspected by any stockholder who is present. Section 3.10 No Action Without Meeting. Effective upon the closing of the ------------------------- corporation's initial public offering of its capital stock pursuant to an effective registration statement filed under the Securities Act of 1933, as amended (the "Initial Public Offering"), the stockholders of the corporation may not take action by written consent without a meeting and must take any actions at a duly called annual or special meeting. Section 3.11 Organization. ------------ (a) At every meeting of stockholders, unless another officer of the corporation has been appointed by the Board of Directors, the Chairman of the Board of Directors, or, if a Chairman has not been appointed, is absent, or designates the next senior officer present to so act, the President, or, if the President is absent, the most senior Vice President present, or, in the absence of any such officer, a chairman of the meeting chosen by a majority in interest of the stockholders entitled to vote, present in person or by proxy, shall act as chairman. The Secretary, or, in his absence, an Assistant Secretary directed to do so by the President, shall act as secretary of the meeting. (b) The Board of Directors of the corporation shall be entitled to make such rules or regulations for the conduct of meetings of stockholders as it shall deem necessary, appropriate or convenient. Subject to such rules and regulations of the Board of Directors, if any, the chairman of the meeting shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such chairman, are necessary, appropriate or convenient for the proper conduct of the meeting, including, without limitation, establishing an agenda or order of business for the meeting, rules and procedures for maintaining order at the meeting and the safety of those present, limitations on participation in such meeting to stockholders of record of the corporation and their duly authorized and constituted proxies and such other persons as the chairman shall permit, restrictions on entry to the meeting after the time fixed for the commencement thereof, limitations on the time allotted to questions or comments by participants and regulation of the opening and closing of the polls for balloting on matters which are to be voted on by ballot. Unless and to the extent determined by the Board of Directors or the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with rules of parliamentary procedure. 6 ARTICLE IV. DIRECTORS --------- Section 4.1 Number and Term of Office; Classification. ----------------------------------------- (a) The number of directors which shall constitute the whole Board of Directors shall be determined from time to time by the Board of Directors (provided that no decrease in the number of directors which would have the effect of shortening the term of an incumbent director may be made by the Board of Directors), provided that the number of directors shall be not less than one (1). At each annual meeting of stockholders, Directors of the corporation shall be elected to hold office until the expiration of the term for which they are elected, and until their successors have been duly elected and qualified or until such Director's earlier death, resignation or due removal; except that if any such election shall not be so held, such election shall take place at a stockholders' meeting called and held in accordance with the Delaware General Corporation Law. Directors need not be stockholders unless so required by the Certificate of Incorporation. If, for any reason, the Directors shall not have been elected at an annual meeting, they may be elected as soon thereafter as convenient at a special meeting of the stockholders called for that purpose in the manner provided in these Bylaws. (b) At the first annual meeting of stockholders following the closing of the Initial Public Offering (the "First Public Company Annual Meeting"), the Directors of the corporation shall be divided into three classes as nearly equal in size as is practicable, hereby designated Class I, Class II and Class III. The initial Class I, Class II and Class III directors shall be those directors designated and elected at the First Public Company Annual Meeting. The term of office of the initial Class I directors shall expire at the next succeeding annual meeting of stockholders, the term of office of the initial Class II directors shall expire at the second succeeding annual meeting of stockholders, and the term of office of the initial Class III directors shall expire at the third succeeding annual meeting of stockholders. At each annual meeting of stockholders following the First Public Company Annual Meeting, Directors to replace those of the Class whose terms expire at such annual meeting shall be elected to hold office until the third succeeding annual meeting and until their respective successors shall have been duly elected and qualified. If the number of directors is hereafter changed, any newly created directorships or decrease in directorships shall be so apportioned among the classes as to make all classes as nearly equal in number as is practicable. Section 4.2 Powers. The powers of the corporation shall be exercised, its ------ business conducted and its property controlled by the Board of Directors, except as may be otherwise provided by statute or by the Certificate of Incorporation. Section 4.3 Vacancies. Vacancies occurring on the Board of Directors may be --------- filled by vote of a majority of the remaining members of the Board of Directors, although less than a quorum. Each Director so elected shall hold office for the unexpired portion of the term of the Director or newly created directorship whose place shall be vacant and until his or her successor shall have been duly elected and qualified or until such Director's earlier death, resignation or due removal. A vacancy in the Board of Directors shall be deemed to exist under this Section 4.3 in the case of (i) the death, removal or resignation of any Director; (ii) an 7 increase in the authorized number of Directors pursuant to Section 4.1(a) above; or (iii) if the stockholders fail at any meeting of stockholders at which Directors are to be elected (including any meeting referred to in Section 4.6 below) to elect the number of Directors then constituting the whole Board of Directors. Section 4.4 Resignation. Any Director may resign at any time by delivering ----------- his or her written resignation to the Secretary, such resignation to specify whether it will be effective at a particular time, upon receipt by the Secretary or at the pleasure of the Board of Directors. If no such specification is made, it shall be deemed effective at the pleasure of the Board of Directors. When one or more Directors shall resign from the Board of Directors, effective at a future date, a majority of the Directors then in office, including those who have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each Director so chosen shall hold office for the unexpired portion of the term of the Director whose place shall be vacated and until his successor shall have been duly elected and qualified. Section 4.5 Removal. At a special meeting of stockholders called for such ------- purpose and in the manner provided herein, subject to any limitations imposed by law or the Certificate of Incorporation, the Board of Directors, or any individual Director, may only be removed from office for cause, and a new Director or Directors shall be elected by a vote of stockholders holding a majority of the outstanding shares entitled to vote at an election of Directors. Section 4.6 Meetings. -------- (a) Annual Meetings. Unless the Board shall determine otherwise, the --------------- annual meeting of the Board of Directors shall be held immediately before or after the annual meeting of stockholders and at the place where such meeting is held. No notice of an annual meeting of the Board of Directors shall be necessary and such meeting shall be held for the purpose of electing officers and transacting such other business as may lawfully come before it. (b) Regular Meetings. Except as hereinafter otherwise provided, ---------------- regular meetings of the Board of Directors shall be held in the principal executive offices of the corporation. Unless otherwise restricted by the Certificate of Incorporation, regular meetings of the Board of Directors may also be held at any place within or without the State of Delaware which has been designated by resolution of the Board of Directors or the written consent of all directors. (c) Special Meetings. Unless otherwise restricted by the Certificate ---------------- of Incorporation, and subject to the notice requirements contained herein, special meetings of the Board of Directors may be held at any time and place within or without the State of Delaware whenever called by the Chairman of the Board, the President or any two of the Directors. (d) Telephone Meetings. Any member of the Board of Directors, or of ------------------ any committee thereof, may participate in a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear 8 each other, and participation in a meeting by such means shall constitute presence in person at such meeting. (e) Notice of Meetings. Written notice of the time and place of all ------------------ special meetings of the Board of Directors shall be given at least one (1) day before the date of the meeting. Such notice need not state the purpose or purposes of such meeting, except as may otherwise be required by law or provided for in the Certificate of Incorporation or these Bylaws. Notice of any meeting may be waived in writing at any time before or after the meeting and will be deemed waived by any Director by attendance thereat, except when the Director attends the meeting solely for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. (f) Waiver of Notice. The transaction of all business at any meeting ---------------- of the Board of Directors, or any committee thereof, however called or noticed, or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present and if, either before or after meeting, each of the Directors not present shall sign a written waiver of notice, or a consent to holding such meeting, or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Section 4.7 Quorum and Voting. ----------------- (a) Unless the Certificate of Incorporation requires a greater number and except with respect to indemnification questions arising under Article XI hereof, for which a quorum shall be one-third of the exact number of Directors fixed from time to time in accordance with Section 4.1 hereof, but not less than one (1), a quorum of the Board of Directors shall consist of a majority of the exact number of directors fixed from time to time in accordance with Section 4.1 of these Bylaws, but not less than one (1); provided, however, at any meeting whether a quorum be present or otherwise, a majority of the Directors present may adjourn from time to time until the time fixed for the next regular meeting of the Board of Directors, without notice other than by announcement at the meeting. (b) At each meeting of the Board of Directors at which a quorum is present, all questions and business shall be determined by a vote of the majority of the Directors present, unless a different vote is required by law, the Certificate of Incorporation or these Bylaws. Section 4.8 Action Without Meeting. Unless otherwise restricted by the ---------------------- Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the Board of Directors or committee, as the case may be, consent thereto in writing, and such writing or writings are filed with the minutes of proceedings of the Board of Directors or committee. Section 4.9 Fees and Compensation. Directors shall be entitled to such --------------------- compensation for their services as may be approved by the Board of Directors, including, if so approved, by resolution of the Board of Directors, a fixed sum and expenses of attendance, if any, for attendance at each regular or special meeting of the Board of Directors and at any 9 meeting of a committee of the Board of Directors. Nothing herein contained shall be construed to preclude any Director from serving the corporation in any other capacity as an officer, agent, employee, or otherwise and receiving compensation therefor. Section 4.10 Committees. ---------- (a) Executive Committee. The Board of Directors may by resolution ------------------- passed by a majority of the whole Board of Directors appoint an Executive Committee to consist of one (1) or more members of the Board of Directors. The Executive Committee, to the extent permitted by law and specifically granted by the Board of Directors, shall have, and may exercise when the Board of Directors is not in session, all powers of the Board of Directors in the management of the business and affairs of the corporation except such committee shall not have the power or authority to amend the Certificate of Incorporation, to adopt an agreement of merger or consolidation, to recommend to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, to recommend to the stockholders of the corporation a dissolution of the corporation or a revocation of a dissolution, or to amend these Bylaws. (b) Other Committees. The Board of Directors may, by resolution passed ---------------- by a majority of the whole Board of Directors, from time to time appoint such other committees as may be permitted by law. Such other committees appointed by the Board of Directors shall consist of one (1) or more members of the Board of Directors and shall have such powers and perform such duties as may be prescribed by the resolution or resolutions creating such committees, but in no event shall such committee have the powers denied to the Executive Committee in these Bylaws. (c) Term. Each member of a committee of the Board of Directors shall ---- serve a term on the committee coexistent with such member's term on the Board of Directors. The Board of Directors, subject to the provisions of paragraphs (a) and (b) of this Section 4.10 may at any time increase or decrease the number of members of a committee or terminate the existence of a committee. The membership of a committee member shall terminate on the date of his or her death or voluntary resignation from the committee or from the Board of Directors. The Board of Directors may at any time for any reason remove any individual committee member and the Board of Directors may fill any committee vacancy created by death, resignation, removal or increase in the number of members of the committee. The Board of Directors may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee, and, in addition, in the absence or disqualification of any member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. (d) Meetings. Unless the Board of Directors shall otherwise provide, -------- regular meetings of the Executive Committee or any other committee appointed pursuant to this Section 4.10 shall be held at such times and places as are determined by the Board of Directors, or by any such committee, and when notice thereof has been given to each member of such committee, no further notice of such regular meetings need be given thereafter. Special meetings 10 of any such committee may be held at any place which has been determined from time to time by such committee, and may be called by any Director who is a member of such committee, upon written notice to the members of such committee of the time and place of such special meeting given in the manner provided for the giving of written notice to members of the Board of Directors of the time and place of special meetings of the Board of Directors. Notice of any special meeting of any committee may be waived in writing at any time before or after the meeting and will be waived by any Director by attendance thereat, except when the Director attends such special meeting solely for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. A majority of the authorized number of members of any such committee shall constitute a quorum for the transaction of business, and the act of a majority of those present at any meeting at which a quorum is present shall be the act of such committee. (e) Organization. The Chairman of the Board shall preside at every ------------ meeting of the Board of Directors, if present. In the case of any meeting, if there is no Chairman of the Board or if the Chairman is not present, the Vice Chairman (if there be one) shall preside, or if there be no Vice Chairman or if the Vice Chairman is not present, a chairman chosen by a majority of the Directors present shall act as chairman of such meeting. The Secretary of the corporation or, in the absence of the Secretary, any person appointed by the Chairman shall act as secretary of the meeting. ARTICLE V. OFFICERS -------- Section 5.1 Officers Designated. The officers of the corporation shall ------------------- include a President and a Secretary, and, if and when designated by the Board of Directors, Chairman of the Board of Directors, one or more executive and non-executive Vice Presidents (any one or more of which executive Vice Presidents may be designated as Executive Vice President or Senior Vice President or a similar title), and a Treasurer. The Board of Directors also may, at its discretion, create additional officers and assign such duties to those offices as it may deem appropriate from time to time, which offices may include a Vice Chairman of the Board of Directors, a Chief Executive Officer, a Chief Operating Officer, a Chief Financial Officer, one or more Assistant Secretaries and Assistant Treasurers, and one or more other officers which may be created at the discretion of the Board of Directors. Any one person may hold any number of offices of the corporation at any one time unless specifically prohibited therefrom by law. The salaries and other compensation of the officers of the corporation shall be fixed by or in the manner designated by the Board of Directors. Section 5.2 Tenure and Duties of Officers. ----------------------------- (a) General. All officers shall hold office at the pleasure of the ------- Board of Directors and until their successors shall have been duly elected and qualified, unless sooner removed. Any officer elected or appointed by the Board of Directors may be removed at any time by the Board of Directors. If the office of any officer becomes vacant for any reason, the 11 vacancy may be filled by the Board of Directors. Except for the Chairman of the Board and the Vice Chairman of the Board, no officer need be a director. (b) Duties of Chairman of the Board of Directors. The Chairman of the -------------------------------------------- Board of Directors, when present, shall preside at all meetings of the Board of Directors and, unless the Chairman has designated the next senior officer to so preside, at all meetings of the stockholders. The Chairman of the Board of Directors shall perform other duties commonly incident to such office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time. (c) Powers and Duties of the Vice Chairman of the Board. The Board of ---------------------------------------------------- Directors may but is not required to assign areas of responsibility to a Vice Chairman of the Board, and, in such event, and subject to the overall direction of the Chairman of the Board and the Board of Directors, the Vice Chairman of the Board shall be responsible for supervising the management of the affairs of the corporation and its subsidiaries within the area or areas assigned and shall monitor and review on behalf of the Board of Directors all functions within such corresponding area or areas of the corporation and each such subsidiary of the corporation. In the absence of the President, or in the event of the President's inability or refusal to act, the Vice Chairman of the Board shall perform the duties of the President, and when so acting shall have all the powers of and be subject to all the restrictions upon the President. Further, the Vice Chairman of the Board shall have such other powers and duties as designated in accordance with these Bylaws and as from time to time may be assigned to the Vice Chairman of the Board by the Board of Directors or the Chairman of the Board. (d) Duties of President. Unless the Board of Directors otherwise ------------------- determines (including by election of Chief Executive Officer) and subject to the provisions of paragraph (e) below, the President shall be the chief executive and chief operating officer of the corporation. Unless the Board of Directors otherwise determines, he shall, in the absence of the Chairman of the Board or Vice Chairman of the Board or if there be no Chairman of the Board or Vice Chairman of the Board, preside at all meetings of the stockholders and (should he be a director) of the Board of Directors. The President shall have such other powers and duties as designated in accordance with these Bylaws and as from time to time may be assigned to him by the Board of Directors. (e) Duties of the Chief Executive and Chief Operating Officers. ---------------------------------------------------------- Subject to the control of the Board of Directors, the chief executive officer shall have general executive charge, management and control, of the properties, business and operations of the corporation with all such powers as may be reasonably incident to such responsibilities; and subject to the control of the chief executive officer, the chief operating officer shall have general operating charge, management and control, of the properties, business and operations of the corporation with all such powers as may be reasonably incident to such responsibilities. (f) Duties of Vice Presidents. Vice Presidents, by virtue of their ------------------------- appointment as such, shall not necessarily be deemed to be executive officers of the corporation, such status as an executive officer only being conferred if and to the extent such Vice President is placed in charge of a principal business unit, division or function (e.g., sales, administration or finance) or performs a policy-making function for the corporation (within the meaning of Section 16 of the 12 1934 Act and the rules and regulations promulgated thereunder). Each executive Vice President shall at all times possess, and upon the authority of the President or the chief executive officer any non-executive Vice President shall from time to time possess, power to sign all certificates, contracts and other instruments of the corporation, except as otherwise limited pursuant to Article VI hereof or by the Chairman of the Board, the President, chief executive officer or the Vice Chairman of the Board. The Vice Presidents shall perform other duties commonly incident to their office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. (g) Duties of Secretary. The Secretary shall keep the minutes of all ------------------- meetings of the Board of Directors, committees of the Board of Directors and the stockholders, in books provided for that purpose; shall attend to the giving and serving of all notices; may in the name of the corporation affix the seal of the corporation to all contracts and attest the affixation of the seal of the corporation thereto; may sign with the other appointed officers all certificates for shares of capital stock of the corporation; and shall have charge of the certificate books, transfer books and stock ledgers, and such other books and papers as the Board of Directors may direct, all of which shall at all reasonable times be open to inspection of any director upon application at the office of the corporation during business hours. The Secretary shall perform all other duties given in these Bylaws and other duties commonly incident to such office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time. The chief executive officer may direct any Assistant Secretary to assume and perform the duties of the Secretary in the absence or disability of the Secretary, and each Assistant Secretary shall perform other duties commonly incident to such office and shall also perform such other duties and have such other powers as the Board of Directors or the chief executive officer, shall designate from time to time. (h) Assistant Secretaries. Each Assistant Secretary shall have the --------------------- usual powers and duties pertaining to such offices, together with such other powers and duties as designated in these Bylaws and as from time to time may be assigned to an Assistant Secretary by the Board of Directors, the Chairman of the Board, the President, the Vice Chairman of the Board, or the Secretary. The Assistant Secretaries shall exercise the powers of the Secretary during that officer's absence or inability or refusal to act. (i) Duties of Treasurer. ------------------- (i) The Treasurer shall keep or cause to be kept the books of account of the corporation in a thorough and proper manner and shall render statements of the financial affairs of the corporation in such form and as often as required by the Board of Directors, the Chairman of the Board, the Vice Chairman of the Board, chief executive officer, if one be designated, the Chief Financial Officer. The Treasurer, subject to the order of the Board of Directors, shall have the custody of all funds and securities of the corporation. The Treasurer shall perform other duties commonly incident to such office and shall also perform such other duties and have such other powers as the Board of Directors, the Chairman of the Board, the Vice Chairman of the Board or the President shall designate from time to time. 13 (ii) In absence of a designated Chief Financial Officer, unless otherwise determined by the Board of Directors or chief executive officer, the Treasurer shall serve as the chief financial officer subject to control of the chief executive officer. (iii) The Chief Financial Officer, if any be designated, may, but need not serve as the Treasurer. (j) Assistant Treasurers. Each Assistant Treasurer shall have the -------------------- usual powers and duties pertaining to such office, together with such other powers and duties as designated in these Bylaws and as from time to time may be assigned to each Assistant Treasurer by the Board of Directors, the Chairman of the Board, the President, the Vice Chairman of the Board, or the Treasurer. The Assistant Treasurers shall exercise the powers of the Treasurer during that officer's absence or inability or refusal to act. Section 5.3 Delegation of Authority. For any reason that the Board of ----------------------- Directors may deem sufficient, the Board of Directors may, except where otherwise provided by statute, delegate the powers or duties of any officer to any other person, and may authorize any officer to delegate specified duties of such office to any other person. Any such delegation or authorization by the Board shall be effected from time to time by resolution of the Board of Directors. Section 5.4 Resignations. Any officer may resign at any time by giving ------------ written notice to the Board of Directors or to the President or to the Secretary. Any such resignation shall be effective when received by the person or persons to whom such notice is given, unless a later time is specified therein, in which event the resignation shall become effective at such later time. Unless otherwise specified in such notice, the acceptance of any such resignation shall not be necessary to make it effective. Any resignation shall be without prejudice to the rights, if any, of the corporation under any contract with the resigning officer. Section 5.5 Removal. Any officer may be removed from office at any time, ------- either with or without cause, by the vote or written consent of a majority of the Directors in office at the time, or by any committee or superior officers upon whom such power of removal may have been conferred by the Board of Directors. ARTICLE VI. EXECUTION OF CORPORATE INSTRUMENTS AND VOTING --------------------------------------------- OF SECURITIES OWNED BY THE CORPORATION -------------------------------------- Section 6.1 Execution of Corporate Instruments. The Board of Directors may, ---------------------------------- in its discretion, determine the method and designate the signatory officer or officers, or other person or persons, to execute on behalf of the corporation any corporate instrument or document, or to sign on behalf of the corporation the corporate name without limitation, or to enter into contracts on behalf of the corporation, except where otherwise provided by law or these Bylaws, and such execution or signature shall be binding upon the corporation. 14 Unless otherwise specifically determined by the Board of Directors or otherwise required by law, promissory notes, deeds of trust, mortgages and other evidences of indebtedness of the corporation, and other corporate instruments or documents requiring the corporate seal, and certificates of shares of stock owned by the corporation, shall be executed, signed or endorsed by the Chairman of the Board of Directors, the President, Chief Executive Officer or any executive Vice President and if any be designated, Chief Financial Officer, Treasurer, Assistant Secretary or Assistant Treasurer, and upon the authority conferred by the Board of Directors, President or Chief Executive Officer, any non-executive Vice President, and by the Secretary. All other instruments and documents requiring the corporate signature, but not requiring the corporate seal, may be executed as aforesaid or in such other manner as may be directed by the Board of Directors. All checks and drafts drawn on banks or other depositaries on funds to the credit of the corporation or in special accounts of the corporation shall be signed by such person or persons as the Board of Directors shall authorize so to do. Unless authorized or ratified by the Board of Directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. Section 6.2 Voting of Securities Owned by the Corporation. All stock and --------------------------------------------- other securities of other corporations owned or held by the corporation for itself, or for other parties in any capacity, shall be voted, and all proxies with respect thereto shall be executed, by the person authorized so to do by resolution of the Board of Directors, or, in the absence of such authorization, by the Chairman or Vice Chairman of the Board of Directors, Chief Executive Officer, the President, or any executive Vice President. ARTICLE VII. SHARES OF STOCK --------------- Section 7.1 Form and Execution of Certificates. Certificates for the shares ---------------------------------- of stock of the corporation shall be in such form as is consistent with the Certificate of Incorporation and applicable law. Every holder of stock in the corporation shall be entitled to have a certificate signed by or in the name of the corporation by the Chairman or Vice Chairman of the Board of Directors, the Chief Executive Officer, the President or any executive Vice President and by the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer, certifying the number of shares and the class or series owned by him in the corporation. Where such certificate is countersigned by a transfer agent other than the corporation or its employee, or by a registrar other than the corporation or its employee, any other signature on the certificate may be a facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may 15 be issued with the same effect as if he were such officer, transfer agent, or registrar at the date of issue. Section 7.2 Lost Certificates. A new certificate or certificates shall be ----------------- issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen, or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen, or destroyed. The corporation may require, as a condition precedent to the issuance of a new certificate or certificates, the owner of such lost, stolen, or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require or to give the corporation a surety bond in such form and amount as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed. Section 7.3 Transfers. --------- (a) Transfers of record of shares of stock of the corporation shall be made only on its books by the holders thereof, in person or by attorney duly authorized and upon the surrender of a properly endorsed certificate or certificates for a like number of shares. Upon surrender to the corporation or a transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. The Board of Directors shall have the power and authority to make all such other rules and regulations as they may deem expedient concerning the issue, transfer and registration or the replacement of certificates for shares of capital stock of the corporation. (b) The corporation shall have power to enter into and perform any agreement with any number of stockholders of any one or more classes of stock of the corporation to restrict the transfer of shares of stock of the corporation of any one or more classes owned by such stockholders in any manner not prohibited by the Delaware General Corporation Law. Section 7.4 FIXING RECORD DATES. (a) In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall not be more than sixty (60) nor less than ten (10) days before the date of such meeting. If no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. 16 (b) In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights or the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than sixty (60) days prior to such action. If no record date is fixed by the Board of Directors, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. Section 7.5 Registered Stockholders. The corporation shall be entitled to ----------------------- recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. ARTICLE VIII. OTHER SECURITIES OF THE CORPORATION ----------------------------------- Section 8.1 Execution of Other Securities. All bonds, debentures and other ----------------------------- corporate ecurities of the corporation, other than stock certificates (covered in Section 7.1), may be signed by the Chairman or Vice Chairman of the Board of Directors, the Chief Executive Officer, the President or any executive Vice President, or such other person as may be authorized by the Board of Directors, and the corporate seal impressed thereon or a facsimile of such seal imprinted thereon and attested by the signature of the Secretary or an Assistant Secretary, or the Treasurer or an Assistant Treasurer; provided, however, that where any such bond, debenture or other corporate security shall be authenticated by the manual signature of a trustee under an indenture pursuant to which such bond, debenture or other corporate security shall be issued, the signatures of the persons signing and attesting the corporate seal on such bond, debenture or other corporate security may be the imprinted facsimile of the signatures of such persons. Interest coupons appertaining to any such bond, debenture or other corporate security, authenticated by a trustee as aforesaid, shall be signed by the Treasurer or an Assistant Treasurer of the corporation or such other person as may be authorized by the Board of Directors, or bear imprinted thereon the facsimile signature of such person. In case any officer who shall have signed or attested any bond, debenture or other corporate security, or whose facsimile signature shall appear thereon or on any such interest coupon, shall have ceased to be such officer before any bond, debenture or other corporate security so signed or attested shall have been delivered, such bond, debenture or other corporate security nevertheless may be adopted by the corporation and issued and delivered as though the person who signed the same or whose facsimile signature shall have been used thereon had not ceased to be such officer of the corporation. 17 ARTICLE IX. DIVIDENDS --------- Section 9.1 Declaration of Dividends. Dividends upon the capital stock of ------------------------ the corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors pursuant to law at any regular or special meeting. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation. Section 9.2 Dividend Reserve. Before payment of any dividend, there may be ---------------- set aside out of any funds of the corporation available for dividends such sum or sums as the Board of Directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the corporation, or for such other purpose as the Board of Directors shall think conducive to the interests of the corporation, and the Board of Directors may modify or abolish any such reserve in the manner in which it was created. ARTICLE X. FISCAL YEAR ----------- The fiscal year of the corporation shall end as of December 31st, unless otherwise fixed by resolution of the Board of Directors. ARTICLE XI. INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER ----------------------------------------------------------- AGENTS ------ Section 11.1 Directors and Executive Officers. The corporation shall -------------------------------- indemnify its Directors and executive officers to the fullest extent not prohibited by the Delaware General Corporation Law; provided, however, that the -------- ------- corporation may limit the extent of such indemnification by individual contracts with its Directors and executive officers; and, provided, further, that the -------- ------- corporation shall not be required to indemnify any Director or executive officer in connection with any proceeding (or part thereof) initiated by such person or any proceeding by such person against the corporation or its Directors, officers, employees or other agents unless (i) such indemnification is expressly required to be made by law, (ii) the proceeding was authorized by the Board of Directors of the corporation, or (iii) such indemnification is provided by the corporation, in its sole discretion, pursuant to the powers vested in the corporation under the Delaware General Corporation Law. 18 Section 11.2 Other Officers, Employees and Other Agents. The corporation ------------------------------------------ shall have power to indemnify its other officers, employees and other agents as set forth in the Delaware General Corporation Law. Section 11.3 Good Faith. ---------- (a) For purposes of any determination under this Article XI, a Director or executive officer shall be deemed to have acted in good faith and in a manner such officer reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, to have had no reasonable cause to believe that such officer's conduct was unlawful, if such officer's action is based on information, opinions, reports and statements, including financial statements and other financial data, in each case prepared or presented by: (i) one or more officers or employees of the corporation whom the Director or executive officer believed to be reliable and competent in the matters presented; (ii) counsel, independent accountants or other persons as to matters which the Director or executive officer believed to be within such person's professional competence; and (iii) with respect to a Director, a committee of the Board upon which such Director does not serve, as to matters within such committee's designated authority, which committee the Director believes to merit confidence; so long as, in each case, the Director or executive officer acts without knowledge that would cause such reliance to be unwarranted. (b) The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal proceeding, that such person had reasonable cause to believe that his conduct was unlawful. (c) The provisions of this Section 11.3 shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth by the Delaware General Corporation Law. Section 11.4 Expenses. The corporation shall advance, prior to the final -------- disposition of any proceeding, promptly following request therefor, all expenses incurred by any Director or executive officer in connection with such proceeding upon receipt of an undertaking by or on behalf of such person to repay said amounts if it should be determined ultimately that such person is not entitled to be indemnified under this Article XI or otherwise. Notwithstanding the foregoing, unless otherwise determined pursuant to Section 11.5 of this Article XI, no advance shall be made by the corporation if a determination is reasonably and 19 promptly made (i) by the Board of Directors by a majority vote of a quorum consisting of Directors who were not parties to the proceeding, or (ii) if such quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, that the facts known to the decision-making party at the time such determination is made demonstrate clearly and convincingly that such person acted in bad faith or in a manner that such person did not believe to be in or not opposed to the best interests of the corporation. Section 11.5 Enforcement. Without the necessity of entering into an express ----------- contract, all rights to indemnification and advances to Directors and executive officers under this Article XI shall be deemed to be contractual rights and be effective to the same extent and as if provided for in a contract between the corporation and the Director or executive officer. Any right to indemnification or advances granted by this Article XI to a Director or executive officer shall be enforceable by or on behalf of the person holding such right in any court of competent jurisdiction if (i) the claim for indemnification or advances is denied, in whole or in part, or (ii) no disposition of such claim is made within ninety (90) days of request therefor. The claimant in such enforcement action, if successful in whole or in part, also shall be entitled to be paid the expense of prosecuting his claim. The corporation shall be entitled to raise as a defense to any such action that the claimant has not met the standards of conduct that make it permissible under the Delaware General Corporation Law for the corporation to indemnify the claimant for the amount claimed. Neither the failure of the corporation (including its Board of Directors, independent legal counsel or its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because such person has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the corporation (including its Board of Directors, independent legal counsel or its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that claimant has not met the applicable standard of conduct. Section 11.6 Non-Exclusivity of Rights. The rights conferred on any person ------------------------- by this Article XI shall not be exclusive of any other right which such person may have or hereafter acquire under any statute, provision of the Certificate of Incorporation, Bylaws, agreement, vote of stockholders or disinterested Directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. The corporation is specifically authorized to enter into individual contracts with any or all of its Directors, officers, employees or agents respecting indemnification and advances, to the fullest extent not prohibited by the Delaware General Corporation Law. Section 11.7 Survival of Rights. The rights conferred on any person by this ------------------ Article XI shall continue as to a person who has ceased to be a Director, officer, employee or other agent and shall inure to the benefit of the heirs, executors and administrators of such a person. Section 11.8 Insurance. To the fullest extent permitted by the Delaware --------- General Corporation Law, the corporation, upon approval by the Board of Directors, may purchase insurance on behalf of any person required or permitted to be indemnified pursuant to this Article XI. 20 Section 11.9 Amendments. Any repeal or modification of this Article XI ---------- shall only be prospective and shall not affect the rights under this Article XI in effect at the time of the alleged occurrence of any action or omission to act that is the cause of any proceeding against any agent of the corporation. Section 11.10 Savings Clause. If this Article XI or any portion hereof -------------- shall be invalidated on any ground by any court of competent jurisdiction, then the corporation shall nevertheless indemnify each Director and executive officer to the full extent not prohibited by any applicable portion of this Article XI that shall not have been invalidated, or by any other applicable law. Section 11.11 Certain Definitions. For the purposes of this Article XI, the ------------------- following definitions shall apply: (a) The term "proceeding" shall be broadly construed and shall include, without limitation, the investigation, preparation, prosecution, defense, settlement, arbitration and appeal of, and the giving of testimony in, any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative. (b) The term "expenses" shall be broadly construed and shall include, without limitation, court costs, attorneys' fees, witness fees, fines, amounts paid in settlement or judgment and any other costs and expenses of any nature or kind incurred in connection with any proceeding. (c) The term the "corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article XI with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. (d) References to a "director," "officer," "employee," or "agent" of the corporation shall include without limitation, situations where such person is serving at the request of the corporation as a director, officer, employee, trustee or agent of another corporation, partnership, joint venture, trust or other enterprise. (e) References to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the corporation" shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an 21 employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the corporation" as referred to in this Article XI. ARTICLE XII. NOTICES ------- Section 12.1 Notice to Stockholders. Unless the Certificate of ---------------------- Incorporation requires otherwise, whenever, under any provisions of these Bylaws, notice is required to be given to any stockholder, it shall be given in writing, timely and duly deposited in the United States mail, postage prepaid, and addressed to such stockholder's last known post office address as shown by the stock record of the corporation or its transfer agent. Section 12.2 Notice to Directors. Any notice required to be given to any ------------------- Director may be given by the method stated in Section 12.1, or by facsimile, telex or telegram, except that such notice other than one which is delivered personally shall be sent to such address as such Director shall have filed in writing with the Secretary, or, in the absence of such filing, to the last known post office address of such Director. It shall not be necessary that the same method of giving notice be employed in respect of all Directors, but one permissible method may be employed in respect of any one or more, and any other permissible method or methods may be employed in respect of any other or others. Section 12.3 Address Unknown. If no address of a stockholder or Director be --------------- known, notice may be sent to the principal executive officer of the corporation. Section 12.4 Affidavit of Mailing. An affidavit of mailing, executed by a -------------------- duly authorized and competent employee of the corporation or its transfer agent appointed with respect to the class of stock affected, specifying the name and address or the names and addresses of the stockholder or stockholders, or Director or Directors, to whom any such notice or notices was or were given, and the time and method of giving the same, shall be conclusive evidence of the statements therein contained. Section 12.5 Time Notices Deemed Given. All notices given by mail, as above ------------------------- provided, shall be deemed to have been given as at the time of mailing, and all notices given by facsimile, telex or telegram shall be deemed to have been given as of the sending time recorded at the time of transmission. Section 12.6 Failure to Receive Notice. The period or limitation of time ------------------------- within which any stockholder may exercise any option or right, or enjoy any privilege or benefit, or be required to act, or within which any Director may exercise any power or right, or enjoy any privilege, pursuant to any notice sent such person in the manner above provided, shall not be affected or extended in any manner by the failure of such stockholder or such Director to receive such notice. Section 12.7 Notice to Person with Whom Communication Is Unlawful. Whenever ---------------------------------------------------- notice is required to be given, under any provision of law or of the Certificate of 22 Incorporation or Bylaws of the corporation, to any person with whom communication is unlawful, the giving of such notice to such person shall not be required and there shall be no duty to apply to any governmental authority or agency for a license or permit to give such notice to such person. Any action or meeting which shall be taken or held without notice to any such person with whom communication is unlawful shall have the same force and effect as if such notice had been duly given. In the event that the action taken by the corporation is such as to require the filing of a certificate under any provision of the Delaware General Corporation Law, the certificate shall state, if such is the fact and if notice is required, that notice was given to all persons entitled to receive notice except such persons with whom communication is unlawful. Section 12.8 Notice to Person with Undeliverable Address. Whenever notice ------------------------------------------- is required to be given, under any provision of law or the Certificate of Incorporation or Bylaws of the corporation, to any stockholder to whom (i) notice of two consecutive annual meetings, and all notices of meetings to such person during the period between such two consecutive annual meetings, or (ii) all, and at least two, payments (if sent by first class mail) of dividends or interest on securities during a twelve-month period, have been mailed addressed to such person at such person's address as shown on the records of the corporation and have been returned undeliverable, the giving of such notice to such person shall not be required. Any action or meeting which shall be taken or held without notice to such person shall have the same force and effect as if such notice had been duly given. If any such person shall deliver to the corporation a written notice setting forth such person's then current address, the requirement that notice be given to such person shall be reinstated. In the event that the action taken by the corporation is such as to require the filing of a certificate under any provision of the Delaware General Corporation Law, the certificate need not state that notice was not given to persons to whom notice was not required to be given pursuant to this paragraph. ARTICLE XIII. AMENDMENTS ---------- Section 13.1 Amendments. Except as otherwise provided in the Certificate of ---------- Incorporation, these Bylaws may be altered, amended or repealed, or new Bylaws may be adopted, by the holders of a majority of the outstanding voting shares or by the Board of Directors, when such power is conferred upon the Board of Directors by the Certificate of Incorporation, at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if notice of such alteration, amendment, repeal or adoption of new Bylaws be contained in the notice of such special meeting. If the power to adopt, amend or repeal Bylaws is conferred upon the Board of Directors by the Certificate of Incorporation, it shall not divest or limit the power of the stockholders to adopt, amend or repeal Bylaws. Section 13.2 Application of Bylaws. In the event that any provisions of --------------------- these Bylaws is or may be in conflict with any law of the United States, of the state of incorporation of the corporation or of any other governmental body or power having jurisdiction over this corporation, or over the subject matter to which such provision of these Bylaws applies, or may apply, such provision of these Bylaws shall be inoperative to the extent only that the operation 23 thereof unavoidably conflicts with such law, and shall in all other respects be in full force and effect. ARTICLE XIV. LOANS TO OFFICERS ----------------- The corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the corporation or of its subsidiaries, including any officer or employee who is a Director of the corporation or its subsidiaries, whenever, in the judgment of the Board of Directors, such loan, guarantee or assistance may reasonably be expected to benefit the corporation. The loan, guarantee or other assistance may be with or without interest and may be unsecured, or secured in such manner as the Board of Directors shall approve, including, without limitation, a pledge of shares of stock of the corporation. Nothing in this Bylaw shall be deemed to deny, limit or restrict the powers of guaranty or warranty of the corporation at common law or under statute. 24 EX-10.1 4 FORM OF INDEMNIFICATION EXHIBIT 10.1 INDEMNITY AGREEMENT This Indemnity Agreement (this "Agreement") is made and entered --------- into this _____ day of January 2000, between Applied Science Fiction, Inc., a Delaware corporation (the "Company"), and ________________________ ------- ("Indemnitee"). ---------- INTRODUCTION: A. Indemnitee, as a member of the Company's Board of Directors and/or an officer of the Company, performs valuable services for the Company. B. The Company and Indemnitee recognize the continued difficulty in obtaining liability insurance for corporate directors, officers, employees, controlling persons, agents and fiduciaries, the significant increases in the cost of such insurance and the general reductions in the coverage of such insurance. C. The Company and Indemnitee further recognize the substantial increase in corporate litigation in general, subjecting directors, officers, employees, controlling persons, agents and fiduciaries to expensive litigation risks at the same time as the availability and coverage of liability insurance has been severely limited. D. The stockholders of the Company have adopted Bylaws (the "Bylaws") providing for the indemnification of the officers, directors, agents and employees of the Company to the maximum extent authorized by Section 145 of the Delaware General Corporation Law, as amended ("DGCL"). ---- E. Indemnitee does not regard the current protection available for the Company's directors, officers, employees, controlling persons, agents and fiduciaries as adequate under the present circumstances, and Indemnitee and other directors, officers, employees, controlling persons, agents and fiduciaries of the Company may not be willing to serve or continue to serve in such capacities without additional protection. F. The Bylaws and the DGCL, by their non-exclusive nature, permit contracts between the Company and its directors, officers, employees, controlling persons, agents or fiduciaries with respect to indemnification of such directors. G. The Company (a) desires to attract and retain the involvement of highly qualified individuals, such as Indemnitee, to serve the Company and, in part, in order to induce Indemnitee to be involved with the Company and (b) wishes to provide for the indemnification and advancing of expenses to Indemnitee to the maximum extent permitted by law. H. In view of the considerations set forth above, the Company desires that Indemnitee be indemnified by the Company as set forth herein. AGREEMENT: Now, Therefore, in consideration of Indemnitee's service to the Company, the parties hereto agree as follows: 1. Indemnity of Indemnitee. The Company hereby agrees to ----------------------- indemnify Indemnitee to the fullest extent permitted by law, even if such indemnification is not specifically authorized by the other provisions of this Agreement, the Company's Certificate of Incorporation (the "Certificate"), the ----------- Company's Bylaws or by statute. In the event of any change after the date of this Agreement in any applicable law, statute or rule which expands the right of a Delaware corporation to indemnify a member of its Board of Directors or an officer, employee, controlling person, agent or fiduciary, it is the intent of the parties hereto that Indemnitee shall enjoy by this Agreement the greater benefits afforded by such change. In the event of any change in any applicable law, statute or rule which narrows the right of a Delaware corporation to indemnify a member of its Board of Directors or an officer, employee, agent or fiduciary, such change, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder except as set forth in Section 9(a) hereof. 2. Additional Indemnity. The Company hereby agrees to hold -------------------- harmless and indemnify the Indemnitee: against any and all expenses incurred by Indemnitee, as set forth in Section 3(a) below; and otherwise to the fullest extent not prohibited by the Certificate, the Bylaws or the DGCL. 3. Indemnification Rights. ---------------------- Indemnification of Expenses. The Company shall indemnify and --------------------------- hold harmless Indemnitee, together with Indemnitee's partners, affiliates, employees, agents and spouse and each person who controls any of them or who may be liable within the meaning of Section 15 of the Securities Act of 1933, as amended (the "Securities Act"), or Section 20 of the Securities Exchange Act of -------------- 1934, as amended (the "Exchange Act"), to the fullest extent permitted by law if ------------ Indemnitee was or is or becomes a party to or witness or other participant in, or is threatened to be made a party to or witness or other participant in, any threatened, pending or completed action, suit, proceeding or alternative dispute resolution mechanism, or any hearing, inquiry or investigation that Indemnitee and the Company believe might lead to the institution of any such action, suit, proceeding or alternative dispute resolution mechanism, whether civil, criminal, administrative, investigative or other (hereinafter a "Claim") against (i) any ----- and all expenses (including attorneys' fees) and all other costs, expenses and obligations incurred in connection with investigating, defending, being a witness in or participating in (including on appeal), or preparing to defend, be a witness in or participate in, a Claim, (ii) judgments, fines, penalties and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) of a Claim and (iii) any federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payments under this 2 Agreement (collectively, hereinafter "Expenses"), including all interest, -------- assessments and other charges paid or payable in connection with or in respect of such Expenses, incurred by Indemnitee by reason of (or arising in part out of) any event or occurrence related to the fact that Indemnitee is or was a director, officer, employee, controlling person, agent or fiduciary of the Company or any subsidiary of the Company, or is or was serving at the request of the Company as a director, officer, employee, controlling person, agent or fiduciary of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action or inaction on the part of Indemnitee while serving in such capacity including, without limitation, any and all losses, claims, damages, expenses and liabilities, joint or several (including any investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of, any action, suit, proceeding or any claim asserted) under the Securities Act, the Exchange Act or other federal or state statutory law or regulation, at common law or otherwise, which relate directly or indirectly to the registration, purchase, sale or ownership of any securities of the Company or to any fiduciary obligation owed with respect thereto (hereinafter an "Indemnification Event"). The Company shall make such payment of --------------------- Expenses as soon as practicable but in any event no later than 25 days after written demand by Indemnitee therefor is presented to the Company. Reviewing Party. Notwithstanding the foregoing, (i) the --------------- obligations of the Company under Section 2 shall be subject to the condition that the Reviewing Party (as described in Section 11(e) hereof) shall not have determined (in a written opinion, in any case in which the Independent Legal Counsel as defined in Section 11(d) hereof is involved) that Indemnitee would not be permitted to be indemnified under applicable law and (ii) and Indemnitee acknowledges and agrees that the obligation of the Company to make an advance payment of Expenses to Indemnitee pursuant to Section 4(a) (an "Expense ------- Advance") shall be subject to the condition that, if, when and to the extent - ------- that the Reviewing Party determines that Indemnitee would not be permitted to be so indemnified under applicable law, the Company shall be entitled to be reimbursed by Indemnitee (who hereby agrees to reimburse the Company) for all such amounts theretofore paid; provided, however, that if Indemnitee has commenced or thereafter commences legal proceedings in a court of competent jurisdiction to secure a determination that Indemnitee should be indemnified under applicable law, any determination made by the Reviewing Party that Indemnitee would not be permitted to be indemnified under applicable law shall not be binding and Indemnitee shall not be required to reimburse the Company for any Expense Advance until a final judicial determination is made with respect thereto (as to which all rights of appeal therefrom have been exhausted or lapsed). Indemnitee's obligation to reimburse the Company for any Expense Advance shall be unsecured and no interest shall be charged thereon. If there has not been a Change in Control (as defined in Section 11(c) hereof), the Reviewing Party shall be selected by the Board of Directors, and if there has been such a Change in Control (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control), the Reviewing Party shall be the Independent Legal Counsel referred to in Section 3(e) hereof. If there has been no determination by the Reviewing Party or if the Reviewing Party determines that Indemnitee substantively would not be permitted to be indemnified in whole or in part under applicable law, Indemnitee shall 3 have the right to commence litigation seeking an initial determination by the court or challenging any such determination by the Reviewing Party or any aspect thereof, including the legal or factual bases therefor, and the Company hereby consents to service of process and to appear in any such proceeding. Any determination by the Reviewing Party otherwise shall be conclusive and binding on the Company and Indemnitee. Contribution. If the indemnification provided for in Section ------------ 3(a) above for any reason is held by a court of competent jurisdiction to be unavailable to an Indemnitee in respect of any losses, claims, damages, expenses or liabilities referred to therein, then the Company, in lieu of indemnifying Indemnitee thereunder, shall contribute to the amount paid or payable by Indemnitee as a result of such losses, claims, damages, expenses or liabilities (i) in such proportion as is appropriate to reflect the relative benefits received by the Company and Indemnitee or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company and Indemnitee in connection with the action or inaction which resulted in such losses, claims, damages, expenses or liabilities, as well as any other relevant equitable considerations. In connection with the registration of the Company's securities, the relative benefits received by the Company and Indemnitee shall be deemed to be in the same respective proportions that the net proceeds from the offering (before deducting expenses) received by the Company and the Indemnitee, in each case as set forth in the table on the cover page of the applicable prospectus, bear to the aggregate public offering price of the securities so offered. The relative fault of the Company and Indemnitee shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or Indemnitee and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and Indemnitee agree that it would not be just and equitable if contribution pursuant to this Section 3(c) were determined by pro rata or per capita allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. In connection with the registration of the Company's securities, in no event shall an Indemnitee be required to contribute any amount under this Section 3(c) in excess of the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified against equal to the proportion of the total securities sold under such registration statement which is being sold by Indemnitee or (ii) the proceeds received by Indemnitee from its sale of securities under such registration statement. No person found guilty of fraudulent misrepresentation (within the meaning of Section 10(f) of the Securities Act) shall be entitled to contribution from any person who was not found guilty of such fraudulent misrepresentation. Survival Regardless of Investigation. The indemnification and ------------------------------------ contribution provided for herein will remain in full force and effect regardless of any investigation made by or on behalf of Indemnitee or any officer, director, employee, agent or controlling person of Indemnitee. 4 Change in Control. After the date hereof, the Company agrees ----------------- that if there is a Change in Control of the Company (other than a Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to such Change in Control) then, with respect to all matters thereafter arising concerning the rights of Indemnitee to payments of Expenses under this Agreement or any other agreement or under the Company's Certificate or Bylaws as now or hereafter in effect, Independent Legal Counsel (as defined in Section 11(d) hereof) shall be selected by Indemnitee and approved by the Company (which approval shall not be unreasonably withheld). Such counsel, among other things, shall render its written opinion to the Company and Indemnitee as to whether and to what extent Indemnitee would be permitted to be indemnified under applicable law. The Company agrees to abide by such opinion and to pay the reasonable fees of the Independent Legal Counsel referred to above and to fully indemnify such counsel against any and all reasonable expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement or its engagement pursuant hereto. Mandatory Payment of Expenses. Notwithstanding any other ----------------------------- provision of this Agreement, to the extent that Indemnitee has been successful on the merits or otherwise, including, without limitation, the dismissal of an action without prejudice, in the defense of any action, suit, proceeding, inquiry or investigation referred to in Section 3(a) hereof or in the defense of any claim, issue or matter therein, Indemnitee shall be indemnified against all Expenses incurred by Indemnitee in connection herewith. 4. Expenses; Indemnification Procedure. ----------------------------------- Advancement of Expenses. The Company shall advance all Expenses ----------------------------------- incurred by Indemnitee. The advances to be made hereunder shall be paid by the Company to Indemnitee as soon as practicable but in any event no later than ten (10) business days after written demand by Indemnitee therefor to the Company. Notice/Cooperation by Indemnitee. Indemnitee shall give the -------------------------------- Company notice in writing in accordance with Section 15 of this Agreement as soon as practicable of any Claim made against Indemnitee for which indemnification will or could be sought under this Agreement. No Presumptions; Burden of Proof. For purposes of this -------------------------------- Agreement, the termination of any Claim by judgment, order, settlement (whether with or without court approval) or conviction, or upon a plea of nolo contendere, or its equivalent, shall not create a presumption that Indemnitee did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. In addition, neither the failure of the Reviewing Party to have made a determination as to whether Indemnitee has met any particular standard of conduct or had any particular belief, nor an actual determination by the Reviewing Party that Indemnitee has not met such standard of conduct or did not have such belief, prior to the commencement of legal proceedings by Indemnitee to secure a judicial determination that Indemnitee should be indemnified under applicable law, shall be a defense to Indemnitee's claim or create a presumption that Indemnitee has not met any particular 5 standard of conduct or did not have any particular belief. In connection with any determination by the Reviewing Party or otherwise as to whether Indemnitee is entitled to be indemnified hereunder, the burden of proof shall be on the Company to establish that Indemnitee is not so entitled. Notice to Insurers. If, at the time of the receipt by the ------------------ Company of a notice of a Claim pursuant to Section 4(b) hereof, the Company has liability insurance in effect which may cover such Claim, the Company shall give prompt notice of the commencement of such Claim to the insurers in accordance with the procedures set forth in each of the Company's policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of Indemnitee, all amounts payable as a result of such action, suit, proceeding, inquiry or investigation in accordance with the terms of such policies. (a) Selection of Counsel. In the event the Company shall be -------------------- obligated hereunder to pay the Expenses of any Claim, the Company shall be entitled to assume the defense of such Claim, with counsel approved by the Indemnitee (which approval shall not be unreasonably withheld) upon the delivery to Indemnitee of written notice of its election to do so. After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to Indemnitee under this Agreement for any fees of counsel subsequently incurred by Indemnitee with respect to the same Claim; provided that (i) Indemnitee shall have the right to employ Indemnitee's counsel in any such Claim at Indemnitee's expense and (ii) if (A) the employment of counsel by Indemnitee has been previously authorized by the Company, (B) Indemnitee shall have reasonably concluded that there is a conflict of interest between the Company and Indemnitee in the conduct of any such defense or (C) the Company shall not continue to retain such counsel to defend such Claim, then the fees and expenses of Indemnitee's counsel shall be at the expense of the Company. 5. Nonexclusivity. The indemnification provided by this -------------- Agreement shall be in addition to any rights to which Indemnitee may be entitled under the Company's Certificate of Incorporation, its Bylaws, any agreement, any vote of stockholders or disinterested directors, the DGCL, or otherwise. The indemnification provided under this Agreement shall continue as to Indemnitee for any action Indemnitee took or did not take while serving in an indemnified capacity even though Indemnitee may have ceased to serve in such capacity. 6. No Duplication of Payments. The Company shall not be liable -------------------------- under this Agreement to make any payment in connection with any Claim made against any Indemnitee to the extent Indemnitee has otherwise actually received payment (under any insurance policy, Certificate of Incorporation, Bylaw or otherwise) of the amounts otherwise indemnifiable hereunder. 7. Partial Indemnification. If any Indemnitee is entitled under ----------------------- any provision of this Agreement to indemnification by the Company for any portion of Expenses incurred in connection with any Claim, but not, however, for all of the total amount thereof, the Company shall nevertheless indemnify Indemnitee for the portion of such Expenses to which Indemnitee is entitled. 6 8. Mutual Acknowledgement. The Company and Indemnitee ---------------------- acknowledge that in certain instances, Federal law or applicable public policy may prohibit the Company from indemnifying its directors, officers, employees, controlling persons, agents or fiduciaries under this Agreement or otherwise. Each Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's rights under public policy to indemnify Indemnitee. 9. Exceptions. Any other provision herein to the contrary ---------- notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement: Claims Initiated by Indemnitee. To indemnify or advance expenses ------------------------------ to any Indemnitee with respect to Claims initiated or brought voluntarily by Indemnitee and not by way of defense, except (i) with respect to actions or proceedings to establish or enforce a right to indemnify under this Agreement or any other agreement or insurance policy or under the Company's Certificate of Incorporation or Bylaws now or hereafter in effect relating to Claims for Indemnifiable Events, (ii) in specific cases if the Board of Directors has approved the initiation or bringing of such Claim or (iii) as otherwise required under Section 145 of the DGCL, regardless of whether Indemnitee ultimately is determined to be entitled to such indemnification, advance expense payment or insurance recovery, as the case may be; Claims Under Section 16(b). To indemnify Indemnitee for expenses -------------------------- and the payment of profits arising from the purchase and sale by Indemnitee of securities in violation of Section 16(b) of the Exchange Act or any similar successor statute; or Claims Excluded Under Section 145 of the Delaware General --------------------------------------------------------- Corporation Law. To indemnify Indemnitee if (i) Indemnitee did not act in good - --------------- faith or in a manner reasonably believed by such Indemnitee to be in or not opposed to the best interests of the Company, (ii) with respect to any criminal action or proceeding, Indemnitee had reasonable cause to believe Indemnitee's conduct was unlawful or (iii) Indemnitee shall have been adjudged to be liable to the Company unless and only to the extent the court in which such action was brought shall permit indemnification as provided in Section 145(b) of the DGCL. 10. Period of Limitations. No legal action shall be brought and --------------------- no cause of action shall be asserted by or in the right of the Company against any Indemnitee, any Indemnitee's estate, spouse, heirs, executors or personal or legal representatives after the expiration of five years from the date of accrual of such cause of action, and any claim or cause of action of the Company shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such five-year period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action, such shorter period shall govern. 7 11. Construction of Certain Phrases. ------------------------------- For purposes of this Agreement, references to the "Company" ------- shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, employees, agents or fiduciaries, so that if Indemnitee is or was a director, officer, employee, agent, control person or fiduciary of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee, control person, agent or fiduciary of another corporation, partnership, joint venture, employee benefit plan, trust or other enterprise, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving corporation as Indemnitee would have with respect to such constituent corporation if its separate existence had continued. For purposes of this Agreement, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on any Indemnitee with respect to an employee benefit plan; and references to "serving at the request of the Company" shall include any service as a director, officer, employee, agent or fiduciary of the Company which imposes duties on, or involves services by, such director, officer, employee, agent or fiduciary with respect to an employee benefit plan, its participants or its beneficiaries; and if any Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in the interests of the participants and beneficiaries of an employee benefit plan, Indemnitee shall be deemed to have acted in a manner "not opposed to the best interests of the Company" as referred to in this Agreement. For purposes of this Agreement a "Change in Control" shall be ----------------- deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d)(3) and 14(d)(2) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, (A) who is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 10% or more of the combined voting power of the Company's then outstanding Voting Securities, increases his or her beneficial ownership of such securities by 5% or more over the percentage so owned by such person or (B) becomes the "beneficial owner" (as defined in Rule ---------------- 13d-3 under said Exchange Act), directly or indirectly, of securities of the Company representing more than 20% of the total voting power represented by the Company's then outstanding Voting Securities, (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation other than a merger or 8 consolidation which would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 80% of the total voting power represented by the Voting Securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of (in one transaction or a series of transactions) all or substantially all of the Company's assets. For purposes of this Agreement, "Independent Legal Counsel" ------------------------- shall mean an attorney or firm of attorneys, selected in accordance with the provisions of Section 3(d) hereof, who shall not have otherwise performed services for the Company or any Indemnitee within the last three years (other than with respect to matters concerning the right of any Indemnitee under this Agreement, or of other indemnitees under similar indemnity agreements). For purposes of this Agreement, a "Reviewing Party" shall mean --------------- any appropriate person or body consisting of a member or members of the Company's Board of Directors or any other person or body appointed by the Board of Directors who is not a party to the particular Claim for which Indemnitee are seeking indemnification, or Independent Legal Counsel. For purposes of this Agreement, "Voting Securities" shall mean ----------------- any securities of the Company that vote generally in the election of directors. 12. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall constitute an original. 13. Binding Effect; Successors and Assigns. This Agreement shall -------------------------------------- be binding upon and inure to the benefit of and be enforceable by the parties hereto and their respective successors, assigns, including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business and/or assets of the Company, spouses, heirs, and personal and legal representatives. The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all, substantially all, or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. This Agreement shall continue in effect with respect to Claims relating to Indemnifiable Events regardless of whether any Indemnitee continues to serve as a director, officer, employee, agent, controlling person or fiduciary of the Company or of any other enterprise, including subsidiaries of the Company, at the Company's request. 14. Attorneys' Fees. In the event that any action is instituted --------------- by an Indemnitee under this Agreement or under any liability insurance policies maintained by the Company to enforce or interpret any of the terms hereof or thereof, any Indemnitee shall be entitled to be paid all Expenses incurred by Indemnitee with respect to such action if Indemnitee 9 is ultimately successful in such action, and shall be entitled to the advancement of Expenses with respect to such action, unless, as a part of such action, a court of competent jurisdiction over such action determines that the material assertions made by Indemnitee as a basis for such action were not made in good faith or were frivolous. In the event of an action instituted by or in the name of the Company under this Agreement to enforce or interpret any of the terms of this Agreement, Indemnitee shall be entitled to be paid all Expenses incurred by Indemnitee in defense of such action (including costs and expenses incurred with respect to Indemnitee counterclaims and cross-claims made in such action), and shall be entitled to the advancement of Expenses with respect to such action, unless, as a part of such action, a court having jurisdiction over such action determines that the Indemnitee's material defenses to such action were made in bad faith or were frivolous. 15. Notice. All notices and other communications required or ------ permitted hereunder shall be in writing, shall be effective when given, and shall in any event be deemed to be given (a) five (5) calendar days after deposit with the U.S. Postal Service or other applicable postal service, if delivered by first class mail, postage prepaid, (b) upon delivery, if delivered by hand, (c) one (1) business day after the business day of deposit with Federal Express or similar overnight courier, freight prepaid, or (d) one day after the business day of delivery by facsimile transmission, if deliverable by facsimile transmission, with copy by first class mail, postage prepaid, and shall be addressed if to Indemnitee, at Indemnitee's address as set forth beneath Indemnitee's signature to this Agreement and if to the Company at the address of its principal corporate offices (attention: Chief Executive Officer) or at such other address as such party may designate by ten calendar days' advance written notice to the other party hereto. 16. Consent to Jurisdiction. The Company and Indemnitee each ----------------------- hereby irrevocably consent to the jurisdiction of the courts of the State of Texas for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be commenced, prosecuted and continued only in the state or federal courts of the State of Texas, which shall be the exclusive and only proper forum for adjudicating such a claim. 17. Severability. The provisions of this Agreement shall be ------------ severable in the event that any of the provisions hereof (including any provision within a single section, paragraph or sentence) are held by a court of competent jurisdiction to be invalid, void or otherwise unenforceable, and the remaining provisions shall remain enforceable to the fullest extent permitted by law. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitations, each portion of this Agreement containing any provision held to be invalid, void or otherwise unenforceable, that is not itself invalid, void or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable. 18. Choice of Law. This Agreement shall be governed by and its ------------- provisions construed and enforced in accordance with the laws of the State of Texas, as applied to contracts between Texas residents, entered into and to be performed entirely within the State of Texas, without regard to the conflict of laws principles thereof. 10 19. Subrogation. In the event of payment under this Agreement, ----------- the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights. 20. Amendment and Termination. No amendment, modification, ------------------------- termination or cancellation of this Agreement shall be effective unless it is in writing signed by all parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. 21. Integration and Entire Agreement. This Agreement sets forth -------------------------------- the entire understanding between the parties hereto and supersedes and merges all previous written and oral negotiations, commitments, understandings and agreements relating to the subject matter hereof between the parties hereto. 22. No Construction as Employment Agreement. Nothing contained --------------------------------------- in this Agreement shall be construed as giving the Indemnitee any right to be retained in the employ of the Company or any of its subsidiaries. 23. Corporate Authority. The Board of Directors of the Company ------------------- has approved the terms of this Agreement. [Signature Page Follows] 11 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on and as of the day and year first above written. COMPANY: ------- APPLIED SCIENCE FICTION, INC. --------------------------------- Mark R. Urdahl President INDEMNITEE: ---------- --------------------------------- Printed Name: Address: -------------------------- -------------------------- -------------------------- EX-10.4 5 AMENDED AND RESTATED RIGHTS AGREEMENT EXHIBIT 10.4 APPLIED SCIENCE FICTION, INC. ----------------------------- AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT ------------------------------------------------ THIS AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT (the "Agreement") is made as of the 29th day of March, 1999, by and among Applied Science Fiction, Inc., a Delaware corporation (the "Company"), the holders of the Company's Series C Preferred Stock and Series D Preferred Stock listed on Exhibit A hereto --------- (each an "Investor") and the stockholders of the Company identified on Exhibit B --------- hereto (each a "Key Employee Stockholder"). R E C I T A L S: --------------- WHEREAS, certain of the Investors hold shares of the Company's Series C Preferred Stock (the "Series C Preferred Stock"), and possess registration rights, information rights and other rights pursuant to an Investors' Rights Agreement dated as of July 29, 1997, among the Company, such Investors and the Key Employee Stockholders (the "Original Agreement"); WHEREAS, the Company, Investors holding in excess of sixty percent (60%) of the outstanding shares of Series C Preferred Stock and the undersigned Key Employee Stockholders who hold in excess of a majority of the Key Employee Shares (as hereinafter defined) desire to amend and restate the Original Agreement pursuant to Section 3.3 thereof and to accept the rights created pursuant hereto in lieu of the rights granted to them under the Original Agreement; WHEREAS, the Company and certain of the Investors have entered into the Series D Purchase Agreement (as defined below) of even date herewith pursuant to which the Company has agreed to sell, and such Investors have agreed to purchase, shares of the Series D Preferred Stock of the Company (the "Series D Preferred Stock"); WHEREAS, the respective obligations of the parties to consummate the transactions contemplated by the Series D Purchase Agreement are conditioned upon the execution and delivery of this Agreement; and WHEREAS, in order to induce the Company to enter into the Series D Purchase Agreement and to induce those Investors that have entered into the Series D Purchase Agreement to invest funds in the Company pursuant to their purchase of Series D Preferred Stock, each of the Investors, the Key Employee Stockholders and the Company hereby agree that this Agreement shall govern the rights of the Investors to cause the Company to register shares of Common Stock issuable to the Investors and certain other matters as set forth herein. NOW THEREFORE, in consideration of the mutual promises and covenants set forth herein, the Investors who are parties to the Original Agreement hereby amend and restate the Original Agreement in its entirety and the parties hereto agree as follows: SECTION 1 --------- Restrictions on Transferability of Securities; Registration Rights ------------------------------------------------------------------ 1.1 Certain Definitions. As used in this Agreement, the following ------------------- terms shall have the meanings set forth below: (a) "Closing" shall mean the date of the initial sale of shares of the Series D Preferred Stock under the Series D Purchase Agreement. (b) "Commission" shall mean the United States Securities and Exchange Commission or any other federal agency at the time administering the Securities Act. (c) "Common Stock" shall mean the Company's Common Stock, par value $0.001 per share. (d) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar successor federal statute and the rules and regulations thereunder, all as the same shall be in effect from time to time. (e) "Holder" shall mean any Investor who holds Registrable Securities and any holder of Registrable Securities to whom the registration rights conferred by this Agreement have been transferred in compliance with Section 1.11 hereof. (f) "Initiating Holders" shall mean any Holder or Holders who, in the aggregate, hold not less than twenty five percent (25%) of the outstanding Registrable Securities. (g) "Investors" shall mean persons who purchased Shares pursuant to the Series C Purchase Agreement or the Series D Purchase Agreement, and their respective affiliates, constituent members and partners. (h) "Investor Warrants" shall mean those warrants to purchase up to 1,224,879 shares of Common Stock issued to certain of the Investors pursuant to the Series C Purchase Agreement. (i) "Key Employee Shares" shall mean (i) 8,796,000 shares of Common Stock or options to acquire Common Stock (as presently constituted and subject to adjustment for subsequent stock splits, reverse splits and the like) held by the Key Employee Stockholders on the date hereof, (ii) shares of Common Stock issued or issuable pursuant to the conversion of 19,143 shares of Series B Preferred Stock, including shares of Series B Preferred Stock issuable upon the exercise of warrants to purchase Series B Preferred Stock, held by the Key Employee Stockholders on the date hereof and (iii) any Common Stock issued as a dividend or other distribution with respect to or in exchange for or in replacement of the shares referenced in (i) or (ii) above, provided, however, that Key Employee -------- ------- Shares shall not include any securities which have previously been registered or which have been sold to the public pursuant to a registration statement or Rule 144 or which have otherwise been sold or transferred by the Key Employee Stockholders. 2 (j) "Other Stockholders" shall mean persons other than Holders and Key Employee Stockholders who, by virtue of agreements with the Company, are entitled to include their securities in certain registrations hereunder. (k) "Preferred Stock" shall mean the Series B Preferred Stock, the Series C Preferred Stock and the Series D Preferred Stock. (l) "Qualified IPO" shall mean the first underwritten public offering of equity securities by the Company registered under the Securities Act. (m) The terms "register," "registered" and registration" shall refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act and applicable rules and regulations thereunder, and the declaration or ordering of the effectiveness of such registration statement. (n) "Registrable Securities" shall mean (1) shares of Common Stock issued or issuable pursuant to the conversion of the Shares and Investor Warrants and (2) any Common Stock issued as (or issuable upon the conversion or exercise of any warrant, right or other security that is issued as) a dividend or other distribution with respect to or in exchange for or in replacement of the shares referenced in (1) above; provided, however, that Registrable Securities shall -------- ------- not include any shares of Common Stock which have previously been registered or which have been sold to the public either pursuant to a registration statement or Rule 144 or which have been sold or transferred in a private transaction in which the transferees rights under this Agreement are not assigned. (o) "Registration Expenses" shall mean all expenses incurred by the Company in effecting any registration pursuant to this Agreement, including, without limitation, all registration, qualification, and filing fees, printing expenses, escrow fees, fees and disbursements of counsel for the Company, blue sky fees and expenses, fees and disbursements of a single counsel for the Holders and/or Key Employee Stockholders and expenses of any regular or special audits incident to or required by any such registration, but shall not include Selling Expenses (but excluding the compensation of regular employees of the Company, which shall be paid in any event by the Company). (p) "Rule 144" shall mean Rule 144 as promulgated by the Commission under the Securities Act, as such Rule may be amended from time to time, or any similar successor rule that may be promulgated by the Commission. (q) "Rule 145" shall mean Rule 145 as promulgated by the Commission under the Securities Act, as such Rule may be amended from time to time, or any similar successor rule that may be promulgated by the Commission. (r) "Securities Act" shall mean the Securities Act of 1933, as amended, or any similar successor federal statute and the rules and regulations thereunder, all as the same shall be in effect from time to time. (s) "Selling Expenses" shall mean all underwriting discounts and selling commissions applicable to the sale of Registrable Securities. 3 (t) "Series B Preferred Stock" shall mean the Company's Series B Preferred Stock, par value $.001 per share. (u) "Series B Warrants" shall mean those certain warrants to purchase up to 8,556 shares of Series B Preferred Stock which the Company has issued to holders of Series B Preferred Stock. (v) "Series C Purchase Agreement" shall mean the Stock Purchase Agreement dated as of July 29, 1997, between the Company and the purchasers of the Series C Preferred Stock named therein. (w) "Series D Purchase Agreement" shall mean the Stock Purchase Agreement dated as of March 29, 1999, between the Company and the purchasers of the Series D Preferred Stock named therein. (x) "Shares" shall mean the Company's Series C Preferred Stock, par value $.001 per share, and Series D Preferred Stock, par value $.001 per share. 1.2 Requested Registration. ---------------------- (a) Request for Registration. If the Company shall receive from the ------------------------ Initiating Holders at any time not earlier than one hundred eighty (180) days after the closing of the Company's Qualified IPO, a written request that the Company effect a registration with respect to at least twenty five percent (25%) of the Registrable Securities (or a lesser percentage if the aggregate public offering price of the Registrable Securities subject to such request will exceed $7,500,000), then the Company will: (i) promptly give written notice of the proposed registration to all other Holders; and (ii) promptly use its best efforts to effect such registration (including, without limitation, filing post-effective amendments, appropriate qualifications under applicable blue sky or other state securities laws and appropriate compliance with the Securities Act) and to take all such actions as would permit or facilitate the sale and distribution of all or such portion of such Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any Holder or Holders joining in such request as are specified in a written request received by the Company within twenty (20) days after such written notice from the Company is mailed or delivered. The Company shall not be obligated to effect, or to take any action to effect, any such registration pursuant to this Section 1.2: (A) In any particular jurisdiction in which the Company would be required to execute a general consent to service of process in effecting such registration, qualification, or compliance, unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act; 4 (B) After the Company has initiated one such registration pursuant to this Section 1.2(a) (counting for these purposes only registrations which have been declared or ordered effective and pursuant to which securities have been sold and registrations which have been withdrawn by the Holders as to which the Holders have not elected to bear the Registration Expenses pursuant to Section 1.4 hereof and would, absent such election, have been required to bear such expenses); provided, that if in -------- the registration effected pursuant to this Section 1.2(a), less than sixty- seven percent (67%) of all Registrable Securities outstanding at the time of the delivery of the Company's notice under Section 1.2(a)(i) were sold in such registration and at least one hundred eighty (180) days have elapsed since the effective date of such first registration, then such first registration shall not be counted against the single registration which the Initiating Holders may request under this Section 1.2(a); provided, further, that if at the time the Holders elect to withdraw a -------- ------- request for registration, the Holders have learned of a material adverse change in the condition, business or prospects of the Company from that known to the Holders at the time of their request for registration and have withdrawn the request with reasonable promptness following disclosure by the Company of such material adverse change, then the Holders shall retain their rights to request registration and shall not be required to pay the costs of the withdrawn registration. (C) During the period beginning sixty (60) days prior to the date of the filing of a registration statement by the Company pursuant to a Company-initiated registration and ending one hundred eighty (180) days after the effective date of such registration statement; provided, that the -------- Company is actively employing in good faith all reasonable efforts to cause such registration statement to become effective; or (D) If the Initiating Holders propose to dispose of shares of Registrable Securities which may be immediately registered on Form S-3 pursuant to a request made under Section 1.5 hereof. (b) Filing of Registration Statement. Subject to the foregoing clauses (A) -------------------------------- through (D), the Company shall file a registration statement covering the Registrable Securities so requested to be registered as soon as practicable after receipt of the request or requests of the Initiating Holders; provided, however, that if (i) in the good faith judgment of the Board of - -------- ------- Directors of the Company, such registration would be seriously detrimental to the Company and the Board of Directors of the Company concludes, as a result, that it is necessary to defer the filing of such registration statement at such time, and (ii) the Company shall furnish to such Holders a certificate signed by the President of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company for such registration statement to be filed in the near future and that it is, therefore, necessary to defer the filing of such registration statement, then the Company shall have the right to defer such filing for the period during which such disclosure would be seriously detrimental, provided that (except as -------- provided in clause (C) above) the Company may not defer the filing for a period of more than ninety (90) days after receipt of the request of the Initiating Holders, and, provided further, that -------- ------- 5 the Company shall not defer its obligation in this manner more than once in any twelve (12) month period. The registration statement filed pursuant to the request of the Initiating Holders may, subject to the provisions of Sections 1.2(b) and 1.13 hereof, include other securities of the Company, with respect to which registration rights have been granted, and may include securities of the Company being sold for the account of the Company. (c) Underwriting. The right of any Holder to registration pursuant to ------------ Section 1.2 shall be conditioned upon such Holder's participation in any such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Registrable Securities held by the Holders participating in such registration and such Holder with respect to such participation and inclusion) to the extent provided herein. A Holder may elect to include in such underwriting all or a part of the Registrable Securities he holds. (d) Procedures. If the Company shall request inclusion in any registration ---------- pursuant to Section 1.2 of securities being sold for its own account, or if other persons shall request inclusion in any registration pursuant to Section 1.2, the Initiating Holders shall on behalf of all Holders, offer to include such securities in the underwriting and may condition such offer on their acceptance of the further applicable provisions of this Section 1 (including Section 1.12). The Company shall (together with all Holders and other persons proposing to distribute their securities through such underwriting) enter into an underwriting agreement in customary form with the representative of the underwriter or underwriters selected for such underwriting by a majority in interest of the Initiating Holders, which underwriters are reasonably acceptable to the Company. Notwithstanding any other provision of this Section 1.2, if the representative of the underwriters advises the Initiating Holders in writing that marketing factors require a limitation on the number of shares to be underwritten, the number of shares to be included in the underwriting or registration shall be allocated as set forth in Section 1.13 hereof. If a person who has requested inclusion in such registration as provided above does not agree to the terms of any such underwriting, such person shall be excluded therefrom by written notice from the Company, the underwriter or the Initiating Holders. The securities so excluded shall also be withdrawn from registration. Any Registrable Securities or other securities excluded shall also be withdrawn from such registration. If shares are so withdrawn from the registration and if the number of shares to be included in such registration was previously reduced as a result of marketing factors pursuant to this Section 1.2(d), then the Company shall offer to all Holders who have retained rights to include securities in the registration the right to include additional securities in the registration in an aggregate amount equal to the number of shares so withdrawn, with such shares to be allocated among such Holders requesting additional inclusions in accordance with Section 1.13. 1.3 Company Registration. -------------------- (a) Piggy-back Rights. If the Company shall determine to register any of ----------------- its securities either for its own account or the account of a security holder or holders exercising their respective registration rights (other than pursuant to Section 1.2 or 1.5 hereof), other than a registration relating solely to employee benefit plans, or a registration relating solely to a Rule 6 145 transaction, or a registration on any registration form that does not permit secondary sales, the Company will: (i) promptly give to each Holder and Key Employee Stockholder written notice thereof; and (ii) use its best efforts to include in such registration (and any related qualification under blue sky laws or other compliance), except as set forth in Section 1.3(b) below, and in any underwriting involved therein, all the Registrable Securities or Key Employee Shares, as the case may be, specified in a written request or requests made by any Holder or Key Employee Stockholders, respectively, and received by the Company within ten (10) business days after the written notice from the Company described in clause (i) above is mailed or delivered by the Company. Such written request may specify all or a part of a Holder's Registrable Securities or all or any part of a Key Employee Stockholder's Key Employee Shares, as the case may be. (b) Underwriting. If the registration of which the Company gives notice is ------------ for a registered public offering involving an underwriting, the Company shall so advise the Holders and Key Employee Stockholders as a part of the written notice given pursuant to Section 1.3(a)(i). In such event, the right of any Holder and of any Key Employee Stockholder to registration pursuant to this Section 1.3 shall be conditioned upon such persons participation in such underwriting and the inclusion of such Holder's Registrable Securities or such Key Employee Stockholder's Key Employee Shares (as applicable) in the underwriting to the extent provided herein. All Holders and Key Employee Stockholders proposing to distribute their securities through such underwriting shall (together with the Company and the other holders of securities of the Company with registration rights to participate therein distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the representative of the underwriter or underwriters selected by the Company. Notwithstanding any other provision of this Section 1.3, if the representative of the underwriters advises the Company in writing that marketing factors require a limitation on the number of shares to be underwritten, the representative may (subject to the limitations set forth below) exclude all Registrable Securities and Key Employee Shares from, or limit the number of Registrable Securities and Key Employee Shares to be included in, the registration and underwriting. If the registration is the Qualified IPO, the Company may limit, to the extent so advised by the underwriters, the amount of securities (including Registrable Securities and Key Employee Shares) to be included in the registration by the Company's stockholders (including the Holders and Key Employee Stockholders), or may exclude, to the extent so advised by the underwriters, such underwritten securities entirely from such registration. If such registration is the second or any subsequent registered offering of the Company's securities to the general public initiated by the Company or at the request of any other holder, the Company may limit, to the extent so advised by the underwriters, the amount of securities (including Registrable Securities and Key Employee Shares) to be included in the registration by the Company's stockholders (including the Holders and Key Employee Stockholders); provided, however, that the Company shall permit the -------- ------- Holders to include at least thirty percent (30%) of the total securities to be offered in such registration. The Company shall so advise all holders of securities requesting registration and, subject to the proviso in the immediately preceding 7 sentence, the number of shares of securities that are entitled to be included in the registration and underwriting shall be allocated first to the Company for securities being sold for its own account and thereafter as set forth in Section 1.13. If any person does not agree to the terms of any such underwriting, such person shall be excluded therefrom by written notice from the Company or the underwriter. Any Registrable Securities, Key Employee Shares or other securities excluded or withdrawn from such underwriting shall be withdrawn from such registration. If shares are so withdrawn from the registration and if the number of shares of Registrable Securities and Key Employee Shares to be included in such registration was previously reduced as a result of marketing factors, the Company shall then offer to all persons who have retained the right to include securities in the registration the right to include additional securities in the registration in an aggregate amount equal to the number of shares so withdrawn, with such shares to be allocated among the persons requesting additional inclusion in accordance with Section 1.13 hereof. 1.4 Expenses of Registration. All Registration Expenses incurred in ------------------------ connection with any registration, qualification or compliance pursuant to Section 1.2 hereof, and the reasonable fees of one counsel for all of the selling stockholders, shall be borne by the Company; provided, however, that if -------- ------- the Holders bear the Registration Expenses for any registration proceeding begun pursuant to Section 1.2 and subsequently withdrawn by the Holders registering shares therein, such registration proceeding shall not be counted as a requested registration pursuant to Section 1.2 hereof, except in the event that such withdrawal is based upon material adverse information relating to the Company that is different from the information known or available (upon request from the Company or otherwise) to the Holders requesting registration at the time of their request for registration under Section 1.2, in which event such registration shall not be treated as a counted registration for purposes of Section 1.2 hereof, even though the Holders do not bear the Registration Expenses for such registration. All Registration Expenses incurred in connection with any registration, qualification or compliance with respect to Registrable Securities or Key Employee Shares pursuant to Sections 1.3 or 1.5 hereof, and the reasonable fees of one counsel for all of the selling stockholders, shall be paid by the Company. Selling Expenses relating to securities registered under any section hereof shall be borne by the holders of such securities pro rata on the basis of the number of shares of securities so registered on their behalf. 1.5 Registration on Form S-3. ------------------------ (a) After its initial public offering, the Company shall use its best efforts to qualify for registration on Form S-3 or any comparable or successor form or forms. After the Company has qualified for the use of Form S-3, in addition to the rights contained in the foregoing provisions of this Section 1, the Holders shall have the right to request up to an aggregate of four registrations, but no more than two in any twelve (12) month period, each on Form S-3 (such requests shall be in writing and shall state the number of shares of Registrable Securities to be disposed of and the intended methods of disposition of such shares by such Holder or Holders), provided, however, that -------- ------- the Company shall not be obligated to effect any such registration (i) if the Holders, together with the holders of any other securities of the Company entitled to inclusion in such registration, propose to sell Registrable Securities and such other securities (if any) on Form S-3 at an aggregate price to the public of less than $1,000,000, (ii) in the event that 8 the Company shall furnish the certification described in paragraph 1.2(b)(ii) (but subject to the limitations set forth therein) or (iii) if it is to be effected more than five (5) years after the Company's initial public offering. (b) If a request complying with the requirements of section 1.5(a) hereof is delivered to the Company, the provisions of Sections 1.2(a)(i) and (ii) and Section 1.2(b) hereof shall apply to such registration. If the registration is for an underwritten offering, the provisions of Sections 1.2(c) and 1.2(d) hereof shall apply to such registration. 1.6 Registration Procedures. In the case of each registration effected by ----------------------- the Company pursuant to Section 1, the Company will keep each Holder and, if applicable, Key Employee Stockholder, advised in writing as to the initiation of each registration and as to the completion thereof. At its expense, the Company will use its best efforts to: (a) Keep such registration effective for a period of one hundred eighty (180) days or until the Holder or Holders (and, if applicable, Key Employee Stockholder(s)) have completed the distribution described in the registration statement relating thereto, whichever first occurs; provided, -------- however, that (i) such one hundred eighty (180) day period shall be extended for - ------- a period of time equal to the period the Holder or Key Employee Stockholder refrain from selling any securities included in such registration at the request of an underwriter of Common Stock (or other securities) of the Company; and (ii) in the case of any registration of Registrable Securities on Form S-3 which are intended to be offered on a continuous or delayed basis, such one hundred eighty (180) day period shall be extended, if necessary, to keep the registration statement effective until all such Registrable Securities are sold, provided that Rule 415, or any successor rule under the Securities Act, permits an offering on a continuous or delayed basis, and provided further that applicable rules under the Securities Act governing the obligation to file a post-effective amendment permit, in lieu of filing a post-effective amendment that (A) includes any prospectus required by section 10(a)(3) of the Securities Act or (B) reflects facts or events representing a material or fundamental change in the information set forth in the registration statement, the incorporation by reference of information required to be included in (A) and (B) above to be contained in periodic reports filed pursuant to section 13 or 15(d) of the Exchange Act in the registration statement; (b) Prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement and permit counsel for the Holders participating in such registration to review all such amendments and supplements and such prospectus prior to the filing thereof with the Commission; (c) Furnish such number of prospectuses in conformity with the requirements of the Securities Act and other documents incident thereto, including any amendment of or supplement to the prospectus, as a Holder (and, if applicable, Key Employee Stockholder) from time to time may reasonably request; (d) Use its best efforts to register or qualify such Registrable Securities under the securities or blue sky laws of such jurisdictions as any Holder participating in such registration 9 reasonably requests and do any and all other acts and things which may be reasonably necessary or advisable to enable such Holder to consummate the disposition in such jurisdictions of Registrable Securities owned by such Holder; provided, that the Company will not be required to (i) qualify generally -------- to do business in any jurisdiction where it would not otherwise be required to qualify but for this paragraph (d), (ii) subject itself to taxation in any such jurisdiction or (iii) consent to general service of process in any such jurisdiction; (e) Notify each seller of Registrable Securities or Key Employee Shares covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading or incomplete in the light of the circumstances then existing, and at the request of any such seller, prepare and furnish to such seller a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such shares, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading or incomplete in the light of the circumstances then existing (and, pending receipt of such supplemental or amended prospectus or of a written notice from the Company that the use of the applicable prospectus may be resumed, each seller shall forthwith discontinue disposition of such Registrable Securities or Key Employee Shares covered by such registration); provided, however, that the -------- ------- period set forth in (a) above shall be extended for a number of days equal to the number of days that the Holder was unable to sell Registrable Securities under the registration statement; (f) Cause all such Registrable Securities (and, if applicable, Key Employee Shares) registered pursuant hereunder to be listed on each securities exchange on which similar securities issued by the Company are then listed; (g) Provide a transfer agent and registrar for all Registrable Securities (and, if applicable, Key Employee Shares) registered pursuant to such registration statement and a CUSIP number for all such Registrable Securities and Key Employee Shares, in each case not later than the effective date of such registration; and (h) In connection with any underwritten offering pursuant to a registration statement filed pursuant to Section 1.2 and 1.5 hereof, the Company will enter into an underwriting agreement reasonably necessary to effect the offer and sale of Common Stock, provided such underwriting agreement contains customary underwriting provisions and provided further that if the underwriter so requests the underwriting agreement will contain customary contribution provisions. 1.7 Indemnification. --------------- (a) The Company will indemnify and hold harmless each Holder and Key Employee Stockholder, each of its officers, directors and partners, legal counsel, and accountants and each person controlling such Holder or Key Employee Stockholder within the meaning of Section 15 of the Securities Act, with respect to which registration, qualification, or compliance has been 10 effected pursuant to this Section 1, and each underwriter, if any, and each person who controls within the meaning of Section 15 of the Securities Act any underwriter, against all expenses, claims, losses, damages, and liabilities (or actions, proceedings, or settlements in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any prospectus, offering circular, or other document (including any related registration statement, notification, or the like) incident to any such registration, qualification, or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation or alleged violation by the Company of the Securities Act, the Exchange Act, any state securities laws or any rule or regulation promulgated under the Securities Act, the Exchange Act or any state securities laws applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, qualification, or compliance, and will reimburse each such Holder and Key Employee Stockholder, each of its officers, directors, partners, legal counsel, and accountants and each person controlling such Holder or Key Employee Stockholder, each such underwriter, and each person who controls any such underwriter, for any legal and any other expenses reasonably incurred in connection with investigating and defending or settling any such claim, loss, damage, liability, or action, provided, that the Company will not be liable in -------- any such case to the extent that any such claim, loss, damage, liability, or expense arises out of or is based on any untrue statement or omission based upon written information furnished to the Company by such Holder, Key Employee Stockholder or underwriter and stated in writing to be specifically for use therein. It is agreed that the indemnity agreement contained in this Section 1.7(a) shall not apply to amounts paid in settlement of any such loss, claim damage, liability, or action if such settlement is effected without the consent of the Company (which consent has not been unreasonably withheld). (b) Each Holder and Key Employee Stockholder will, if Registrable Securities held by it or him are included in the securities as to which such registration, qualification, or compliance is being effected, indemnify the Company, each of its directors, officers, partners, legal counsel, and accountants and each underwriter, if any, of the Company's securities covered by such a registration statement, each person who controls the Company or such underwriter within the meaning of Section 15 of the Securities Act, each other such Holder, Key Employee Stockholder and Other Stockholder, and each of their officers, directors, and partners, and each person controlling such Holder or Other Stockholder, against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company and such Holders, Key Employee Stockholders, Other Stockholders, directors, officers, partners, legal counsel, and accountants, persons, underwriters, or control persons for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability, or action, in each case to the extent, but only to the extent that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular, or other document in reliance upon and in conformity with written information furnished to the Company by such Holder or Key Employee Stockholder and stated to be specifically for use therein; provided, however, that the obligations of -------- ------- such Holder or Key Employee Stockholder hereunder shall not apply to amounts paid in settlement of any such claims, losses, damages, or liabilities (or actions 11 in respect thereof) if such settlement is effected without consent of such Holder or Key Employee Stockholder, as the case may be (which consent shall not be unreasonably withheld). Notwithstanding the foregoing, in no event shall any indemnity under this subsection (b) exceed the net proceeds from the offering received by such Holder or Key Employee Stockholder, as the case may be. (c) Each party entitled to indemnification under this Section 1.7 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of such claim or any litigation resulting therefrom; provided, that counsel for the Indemnifying -------- Party, who shall conduct the defense of such claim or any litigation resulting therefrom, shall be approved by the Indemnified Party (whose approval shall not unreasonably be withheld), and the Indemnified Party (together with all other Indemnified Parties that may be represented without conflict by one counsel) may participate in such defense at such party's expense; provided, however, that the -------- ------- Indemnifying Party shall pay the fees and expenses of additional counsel if more than one counsel is required to be retained by other Indemnified Parties due to actual or potential conflicts for one counsel to represent all of the Indemnified Parties; and provided, further, that the failure of any Indemnified -------- ------- Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Section 1 to the extent such failure is not prejudicial. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement that does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. Each Indemnified Party shall furnish such information regarding itself or the claim in question as an Indemnifying Party may reasonably request in writing and as shall be reasonably required in connection with defense of such claim and litigation resulting therefrom. (d) If the indemnification provided for in this Section 1.7 is held by a court of competent jurisdiction to be unavailable to an Indemnified Party with respect to any loss, liability, claim, damage, or expense referred to therein, then the Indemnifying Party, in lieu of indemnifying such Indemnified Party hereunder, shall contribute to the amount paid or payable by such Indemnified Party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party on the one hand and of the Indemnified Party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the Indemnifying Party and of the Indemnified Party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the Indemnifying Party or by the Indemnified Party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into, in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall control. 12 1.8 Information by Holder. Each Holder of Registrable Securities and --------------------- each Key Employee Stockholder shall furnish to the Company such information regarding such person or entity and the distribution proposed by such person or entity as the Company may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification, or compliance referred to in this Section 1. 1.9 Limitations on Registration of Issues of Securities. From and after --------------------------------------------------- the date of this Agreement, the Company shall not, without the prior written consent of two thirds (2/3rds) in interest of the Holders, enter into any agreement with any holder or prospective holder of any securities of the Company giving such holder or prospective holder any rights to initiate a registration of securities of the Company. Notwithstanding the foregoing, from and after the date of this Agreement, the Company may enter into any agreement with any holder or prospective holder of any securities of the Company giving such holder or prospective holder rights to initiate a registration of securities of the Company the terms of which are pari passu with the registration rights granted to the Holders in Section 1.2 hereof only upon the written consent of two thirds (2/3rds) in interest of the Holders; provided, however, that without the prior -------- ------- written consent of a majority in interest of the Holders, in no registration may the amount of Registrable Securities to be included in such registration by the Holder be limited due to marketing factors, pursuant to Sections 1.2(d) or 1.3(b) of this Agreement, unless the securities held by such third-party holder or holders are excluded from such registration altogether. 1.10 Rule 144 Reporting. With a view to making available the benefits of ------------------ certain rules and regulations of the Commission that may permit the sale of Registrable Securities that are "restricted securities" within the meaning of the Securities Act ("Restricted Securities") to the public without registration, the Company agrees to use its best efforts to: (a) Make and keep public information regarding the Company available as those terms are understood and defined in Rule 144 under the Securities Act, at all times from and after ninety (90) days following the effective date of the first registration statement under the Securities Act filed by the Company for an offering of its securities to the general public; (b) File with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act at any time after it has become subject to such reporting requirements; and (c) So long as a Holder owns any Restricted Securities, furnish to the Holder forthwith upon written request a written statement by the Company as to its compliance with the reporting requirements of Rule 144 (at any time from and after ninety (90) days following the effective date of the first registration statement filed by the Company for an offering of its securities to the general public), and of the Securities Act and the Exchange Act (at any time after it has become subject to such reporting requirements), a written statement that the Company is eligible to use Form S-3, a copy of the most recent annual or quarterly report of the Company, and such other reports and documents so filed as a Holder may reasonably request in availing itself of any rule or regulation of the Commission allowing a Holder to sell any such securities without registration. 13 1.11 Transfer or Assignment of Registration Rights. The rights to cause --------------------------------------------- the Company to register securities granted to a Holder by the Company under this Section 1 may be transferred or assigned along with all related obligations (including, without limitation, those set forth in Section 1.12) by a Holder only (a) to a transferee or assignee of not less than 300,000 shares (aggregating all shares of Registrable Securities held by affiliates of such Holder) of Registrable Securities (as presently constituted and subject to subsequent adjustments for stock splits, stock dividends, reverse stock splits, and the like) or, if less, all shares of Registrable Securities held by such Holder, (b) to an affiliate, constituent partner, limited partner, shareholder or retired partner of such Holder in connection with a transfer or assignment of such Holder's Registrable Securities or (c) to a person who is a Holder immediately prior to such transfer or assignment; provided, in all such cases, -------- that the Company is given written notice at the time of or within a reasonable time after such transfer or assignment, stating the name and address of the transferee or assignee and identifying the securities with respect to which such registration rights are being transferred or assigned; and provided further, -------- ------- that the transferee or assignee of such rights assumes the obligations of such Holder under this Section 1. The right of Key Employee Stockholders to cause the Company to register securities granted to such Key Employee Stockholder under this Section 1 may not be transferred or assigned. 1.12 "Market Stand-Off" Agreement. If requested by the Company or an --------------------------- underwriter of Common Stock (or other securities) of the Company, no Holder or Key Employee Stockholder shall sell or otherwise transfer or dispose of any Registrable Securities or Key Employee Shares and any other shares of capital stock acquired prior to the date of the Company's Qualified IPO held by such Holder or Key Employee Stockholder, respectively (other than those included in the registration) during a period not to exceed one hundred eighty (180) days following the effective date of the Company's Qualified IPO; provided, that (i) -------- each officer, director and holder of at least one percent (1%) of the Company's securities entitled to vote generally in the election of directors (calculated assuming full conversion of all voting securities which are convertible into Common Stock), enter into similar agreements and (ii) if the Company or any representative of the underwriters of the Qualified IPO shall provide, in its discretion, a waiver or termination of the "market stand-off" restrictions for the benefit of any of the Company's shareholders (the "Waiver Recipient"), then the "market stand-off" restriction imposed hereunder shall immediately cease to be applicable to all Holders and Key Employee Stockholders on a pro rata basis according to the number of shares subject to the waiver or termination held by the Waiver Recipient bears to the total number of shares held by all Holders and Key Employee Stockholders. The obligations described in this Section 1.12 shall apply only to the Qualified IPO. The Company may impose stop-transfer instructions with respect to the shares (or securities) subject to the foregoing restriction until the end of such one hundred eighty (180) day period. 1.13 Allocation of Registration Opportunities. In any circumstance ---------------------------------------- in which all of the Registrable Securities, Key Employee Shares and shares of Common Stock of the Company (including shares of Common Stock issued or issuable upon conversion of shares of any currently unissued series of Preferred Stock of the Company) with registration rights held by Other Stockholders (the "Other Shares") requested to be included in a registration on behalf of the Holders, Key Employee Stockholders or Other Stockholders cannot be so included as a result of limitations of the aggregate number of shares of Registrable Securities, Key Employee Shares and Other Shares that may be so included, the number of shares of Registrable Securities, Key Employee Shares 14 and Other Shares that may be so included shall be allocated as follows: (a) if the registration is initiated by Holders, then Holders requesting inclusion of Registrable Securities shall be entitled to include shares first on a pro rata basis among them, with any additional shares that may be included allocated pro rata among the Key Employee Stockholders and Other Stockholders; (b) if the registration is initiated by the Company, then the shares available for sale by the Holders, Key Employee Stockholders and Other Stockholders requesting inclusion of shares in such registration shall be allocated among the Holders and the Other Stockholders pro rata on the basis of the number of shares of Registrable Securities, Key Employee Shares and Other Shares that would be held by such Holders, Key Employee Stockholders and Other Stockholders, assuming conversion, with any additional shares that may be included allocated pro rata among the Key Employee Stockholders, subject to Section 1.3(b) hereof; (c) if the registration is initiated by Other Stockholders, then the shares available for sale by the Holders, Key Employee Stockholders and Other Stockholders requesting inclusion of shares in such registration shall be allocated first among the Holders and the Other Stockholders pro rata on the basis of the number of shares of Registrable Securities and Other Shares that would be held by such Holders and Other Stockholders, assuming conversion, with any additional shares that may be included allocated pro rata among the Key Employee Stockholders; or (d) if the registration is initiated by Key Employee Stockholder (should they, after the date hereof, receive rights to initiate a registration), then the shares available for sale by the Holders, Key Employee Stockholders and Other Stockholders requesting inclusion of shares in such registration shall be allocated first among the Holders and the Key Employee Stockholders pro rata on the basis of the number of shares of Registrable Securities and Key Employee Shares that would be held by such Holders and Key Employee Stockholders, assuming conversion, with any additional shares that may be included allocated pro rata among the Other Stockholders; provided, however, so that any such allocation shall not operate to reduce the - -------- ------- aggregate number of Registrable Securities, Key Employee Shares and Other Shares to be included in such registration, if any Holder, Key Employee Stockholder or Other Stockholder does not request inclusion of the maximum number of shares of Registrable Securities, Key Employee Shares and Other Shares allocated to it pursuant to the above-described procedure, the remaining portion of its allocation shall be reallocated among those requesting Holders, Key Employee Stockholders and Other Stockholders whose allocations did not satisfy their requests in accordance with the allocation provisions set forth above, and this procedure shall be repeated until all of the shares of Registrable Securities, Key Employee Shares and Other Shares which may be included in the registration on behalf of the Holders, Key Employee Stockholders and Other Stockholders have been so allocated. Notwithstanding the foregoing, the Company shall not limit the number of Registrable Securities or Key Employee Shares to be included in a registration pursuant to this Agreement in order to include shares held by stockholders with no registration rights, and with respect to registrations under Sections 1.2 or 1.5 hereof, shall not limit the number of Registrable 15 Securities included in such registration in order to include therein any Key Employee Shares, Other Shares or securities registered for the Company's own account. 1.14 Delay of Registration. No Holder shall have any right to take any --------------------- action to restrain, enjoin, or otherwise delay any registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Section 1. 1.15 Termination of Registration Rights. The right to request registration ---------------------------------- or inclusion in any registration pursuant to Section 1.2, 1.3 or 1.5 (and the right of any Key Employee Stockholder to request inclusion in any registration pursuant to Section 1.3) shall terminate five (5) years after the closing of a Qualified IPO in which all shares of Preferred Stock convert into Common Stock or earlier, with respect to any Holder or Key Employee Stockholder, at such time as such Holder or Key Employee Stockholder shall be able to sell all of such Holder's Registrable Securities or such Key Employee Stockholder's Key Employee Shares, as the case may be, under Rule 144 during any three (3) month period. SECTION 2 --------- Covenants of the Company ------------------------ The Company hereby covenants and agrees, so long as any Holder owns any Registrable Securities and subject to the other terms and conditions provided herein, as follows: 2.1 Financial Information. The Company will furnish the following reports --------------------- to each Holder owning at least 150,000 shares of Registrable Securities (for purposes of calculating the ownership of any Holder under this Section 2, Registrable Securities owned by any entity that is, within the meaning of the Securities Act, controlling, controlled by or under common control with such Holder shall be aggregated with Registrable Securities owned by such Holder), as presently constituted and subject to subsequent adjustment for stock splits, stock dividends, reverse stock splits and the like (each, a "Significant Holder"): (a) As soon as practicable after the end of each fiscal year (beginning with the fiscal year ending December 31, 1999) of the Company, and in any event within ninety (90) days thereafter, an audited consolidated balance sheet of the Company and its subsidiaries, if any, as at the end of such fiscal year, and audited consolidated statements of income and cash flows of the Company and its subsidiaries, if any, for such year, prepared in accordance with generally accepted accounting principles consistently applied, all in reasonable detail and prepared by accountants of nationally recognized standing; (b) At least thirty (30) days prior to the end of each fiscal year of the Company, an annual operating budget and updated business plan of the Company; and (c) As soon as practicable after the end of the first, second, and third quarterly accounting periods in each fiscal year of the Company, and in any event within forty-five (45) days thereafter, an unaudited consolidated balance sheet of the Company and its subsidiaries, if any, as of the end of each such quarterly period, and unaudited consolidated statements of income and cash flows of the Company and its subsidiaries for such period and for the current fiscal year to date, prepared in accordance with generally accepted accounting principles 16 consistently applied, subject to changes resulting from normal year-end audit adjustments, all in reasonable detail and certified by the principal financial or accounting officer of the Company, except that such financial statements need not contain the notes required by generally accepted accounting principles. 2.2 Inspection. The Company shall permit each Investor that holds at ---------- least 150,000 shares of Registrable Securities, at such Investor's expense and upon forty-eight hours prior notice, to visit and inspect the Company's properties, to examine its books of account and records and to discuss the Company's affairs, finances and accounts with its officers, all at such reasonable times as may be requested by the Investor; provided, however, that the Company shall not be obligated pursuant to this Section 2.2 to provide access to any information that it reasonably considers to be a trade secret or similar confidential information. 2.3 Right of First Offer. The Company hereby grants to each Investor the -------------------- right of first offer to purchase a pro rata share of New Securities (as defined in this Section 2.3) which the Company may, from time to time, propose to sell and issue. An Investor's pro rata share, for purposes of this right of first offer, is the ratio of (i) the sum of (x) the number of shares of Common Stock owned by such Investor immediately prior to the issuance of New Securities, assuming full conversion of the Shares, and (y) the shares issuable upon exercise of the Investor Warrants owned by such Investor, to (ii) the sum of the total number of shares of Common Stock outstanding immediately prior to the issuance of New Securities, assuming full conversion of the Shares and exercise of all outstanding rights, options and warrants to acquire Common Stock of the Company, and the 2,211,900 shares currently reserved for issuance under options that may be granted in the future under the Company's director-approved stock option/stock issuance plan. Each Investor shall have a right of over-allotment such that if any Investor, or any other securities holder of the Company with rights of first offer to purchase New Securities, fails to exercise its right hereunder or under any other agreement with the Company to purchase its pro rata share of New Securities, the other Investors may purchase the non-purchasing Investor's or other securities holder's portion on a pro rata basis within five (5) days from the date of notice of such failure to exercise provided by the Company such non-purchasing Investor or other securities holder fails to exercise its right to purchase its pro rata share of New Securities. This right of first offer shall be subject to the following provisions: (a) "New Securities" shall mean any capital stock (including Common Stock and/or Preferred Stock) of the Company whether now authorized or not, and rights, options or warrants to purchase such capital stock, and securities of any type whatsoever that are, or may become, convertible into capital stock; provided, that the term "New Securities" does not include (i) securities - -------- purchased under the Series D Purchase Agreement; (ii) securities issued or issuable upon the conversion or exercise of currently outstanding options, warrants, rights or other convertible or exercisable securities (including, without limitation, upon conversion or exercise of the Shares, the Series B Preferred Stock, the Series B Warrants and the Investor Warrants); (iii) securities issued pursuant to any acquisition by the Company of another business entity or business segment of any such entity by merger, purchase of assets or otherwise, or pursuant to any other business combination, or in connection with any joint venture or other corporate partnering transaction, in each such case, so long as such issuance has been approved by the Board of Directors of the Company; (iv) any warrants issued pursuant to contractual obligations of the Company existing on the date of this Agreement; (v) any borrowings or guarantees 17 thereof, direct or indirect, from financial institutions or other persons by the Company, whether or not presently authorized, including any type of loan or payment evidenced by any type of debt instrument; (vi) any warrants, options or similar rights issued to financial institutions, other lenders or guarantors in connection with borrowings or commitments or agreements therefor, whether or not involving present borrowings, or to a lessor, guarantor or other person in connection with obtaining lease financing, provided that such issuance is approved by the Company's Board of Directors and does not have equity financing as its principal purpose; (vii) up to 2,211,900 shares of Common Stock issuable after the date of this Agreement to employees, consultants, officers or directors of the Company pursuant to any stock option, stock purchase or stock bonus plan, agreement or arrangement for the primary purpose of soliciting or retaining such persons' services; (viii) securities issued to vendors or customers or to other persons in similar commercial situations with the Company if such issuance is approved by the Board of Directors and is for other than primarily equity financing purposes; (ix) Common Stock issued in a Qualified IPO in which all Preferred Stock converts into Common Stock; and (x) securities issued in connection with any stock split, stock dividend or recapitalization of the Company. (b) In the event the Company proposes to undertake an issuance of New Securities, it shall give each Investor written notice of its intention, describing the type of New Securities, and their price and the general terms upon which the Company proposes to issue the same. Each Investor shall have twenty (20) days after any such notice is mailed or delivered to agree to purchase such Investor's pro rata share of such New Securities for the price and upon the terms specified in the notice by giving written notice to the Company and stating therein the quantity of New Securities to be purchased. (c) In the event the Investors fail to exercise fully the right of first offer within such twenty (20) day period and after the expiration of the five (5) day period for the exercise of the over-allotment provisions of this Section 2.2, the Company shall have ninety (90) days thereafter to sell or enter into an agreement (pursuant to which the sale of New Securities covered thereby shall be closed, if at all, within ninety (90) days from the date of such agreement) to sell the New Securities respecting which the Investors' right of first offer option set forth in this Section 2.2 was not exercised, at a price and upon terms no more favorable to the purchasers thereof than specified in the Company's notice to the Investors pursuant to Section 2.2(b). In the event the Company has not sold within such ninety (90) day period or entered into an agreement to sell the New Securities in accordance with the foregoing within ninety (90) days from the date of such agreement, the Company shall not thereafter issue or sell any New Securities, without first again offering such securities to the Investors in the manner provided in Section 2.2(b) above. (d) The right of first offer granted under this Agreement shall expire upon, and shall not be applicable to, the first sale of Common Stock of the Company to the public effected pursuant to a registration statement filed with, and declared effective by, the Commission under the Securities Act in which all classes of Preferred Stock are converted into shares of the Company's Common Stock. (e) The right of first offer set forth in this Section 2.2 may not be assigned or transferred, except that such right shall be assignable by each Investor to any affiliate of such Investor (within the meaning of the Securities Act) or to any constituent partner, limited partner, shareholder or retired partners of such Investor; provided, however, that no such assignment or -------- ------- 18 transfer shall be permitted except in connection with the sale or transfer of at least 150,000 Shares (as presently constituted and subject to subsequent adjustments for stock splits, stock dividends, reverse stock splits, and the like) (or, if less, all of the Shares held by such Investor), to the proposed assignee or transferee of such right, provided that the Company is given written notice at the time of or within a reasonable time after such transfer or assignment, stating the name and address of the transferee or assignee and identifying the Shares with respect to which such right of first offer is being transferred or assigned and provided, further, that the proposed assignee or transferee is an "accredited investor" (as defined in Regulation D under the Securities Act) and provides the Company, upon request, with written certification of its qualifications as a permitted assignee under this Section 2.2(e). (f) In the event that Investors holding, in the aggregate, at least two thirds (2/3rds) of the Shares shall waive their rights under this Section 2.2, such waiver shall be binding upon all Investors; provided, however, that if -------- ------- an Investor is an "investment company" within the meaning of the Investment Company Act of 1940, as amended, such waiver shall only be effective as to such Investor if executed by it. 2.4 Board of Directors. Until the time of effectiveness of a Qualified ------------------ IPO in which all shares of Preferred Stock convert into Common Stock, the parties agree to take all appropriate actions such that the Company shall fix and maintain a Board of Directors of no more than nine persons. The makeup of the Board of Directors immediately following the Closing under the Series D Purchase Agreement shall be Mark Urdahl, Sada Cumber, Albert Edgar, Laura Kilcrease (such person being referred to as the "Interim Director"), Terrence Rock, Charles Phipps, Harvey B. Cash, Richard Kimball (as the designee of the holders of the Series D Preferred Stock) and Mike Wilkes. All holders of Series D Preferred Stock hereby agree that entities affiliated with Technology Crossover Ventures ("TCV") shall be entitled to designate one person to serve as a member of the Board of Directors and agree to vote their Shares in favor of the election of such person (and for any successor or replacement) so long as TCV and its affiliates continue to own at least seventy five percent (75%) of the shares of Series D Preferred Stock purchased by TCV and its affiliates under the Series D Purchase Agreement. All holders of Series C Preferred Stock hereby agree that CenterPoint Venture Partners ("CenterPoint") shall be entitled to designate two persons, and InterWest Partners ("InterWest") shall be entitled to designate one person, to serve as members of the Board of Directors and agree to vote their Shares in favor of the election of such persons (and for any successors or replacements) so long as CenterPoint or InterWest, respectively, and their respective affiliates continue to own at least a majority of the shares of Series C Preferred Stock purchased by CenterPoint and InterWest and their respective affiliates under the Series C Purchase Agreement. The parties agree to work cooperatively to identify a replacement director of recognized standing in the Company's industry as soon as practicable after the date hereto and the Key Employee Stockholders agree to use their respective best efforts to cause such replacement director to be elected to the Board of Directors in replacement of the Interim Director, as soon as practicable thereafter. Such replacement director shall serve on the Board of Directors in accordance with the Fourth Restated Certificate of Incorporation and Bylaws. Each Director shall be entitled to reimbursement of reasonable expenses incurred by him or her in connection with attending meetings of the Board of Directors. 19 2.5 Qualified Small Business Stock. In the event that the Company ------------------------------ proposes to act or engage in a transaction that would be reasonably expected to result in the termination or impairment of the Company's capital stock status as "qualified small business stock" as set forth in Section 1202(c) of the Internal Revenue Code of 1986, as amended (the "Code"), the Company shall notify the Investors and consult in good faith to devise a mutually agreeable and reasonable alternative transaction structure that would preserve such status. In addition, the Company shall submit to the Investors and to the Internal Revenue Service any reports that may re required under Section 1202(d)(1)(c) of the Code and any related Treasury Regulations. In addition, within twenty (20) days after any Investor has delivered to the Company a written request therefor, the Company shall deliver to such Investor a written statement informing the Investor whether such Investor's interest in the Company constitutes "qualified small business stock" as defined in Section 1202 (c) of the Code; provided, --------- however, that an Investor shall only be entitled to make one such request in any - ------- twelve (12) month period at the expense of the Company and any expenses directly related to fulfilling any additional request within such twelve (12) month period shall be borne by the Investor making such request with the estimated amount of such expenses (based on such expenses incurred to fulfill prior requests) being payable in advance to the Company by the Investor. The Company's obligation to furnish a written statement pursuant to this Section 2.5 shall continue notwithstanding the fact that a class of the Company's stock may be traded on an established securities market. 2.6 Termination of Covenants. The covenants set forth in this Section 2 ------------------------ (except for Section 2.5) shall terminate and be of no further force and effect after the time of effectiveness of the registration statement for the Company's Qualified IPO in which all shares of Preferred Stock will convert into Common Stock upon the consummation thereof. SECTION 3 --------- Miscellaneous ------------- 3.1 Governing law. This Agreement shall be governed in all respects by ------------- the laws of the State of Delaware, as if entered into by and between Delaware residents exclusively for performance entirely within Delaware. 3.2 Successors and Assigns. Except as otherwise expressly provided herein, ---------------------- the provisions hereof shall inure to the benefit of and be binding upon, the successors, assigns, heirs, executors and administrators of the parties hereto. 3.3 Entire Agreement Amendment: Waiver. This Agreement (including the Exhibits hereto) constitutes the full and entire understanding and agreement between the parties with regard to the subject matter hereof and supersedes all prior agreements, including, but not limited to, the Original Agreement which is hereby terminated and of no further force or effect. Neither this Agreement nor any term hereof may be amended, waived, discharged or terminated, except by a written instrument signed by the Company, the holders of at least two thirds (2/3rds) of the Series C Preferred Stock and the holders of at least two thirds (2/3rds) of the Series D Preferred Stock (and, in the case of an amendment, waiver, discharge or termination of the rights of Key Employee Stockholders adverse in a manner different from the affect on the Holders under Section 1.3 hereof, at least a majority of the Key Employee Shares) and any such amendment, 20 waiver, discharge or termination shall be binding on all the Holders and Key Employee Stockholders, but in no event shall the obligation of any Holder or Key Employee Stockholder hereunder be materially increased, except upon the written consent of such Holder or Key Employee Stockholder, and in no event shall any amendment or waiver be effective as to an Investor that is an "investment company" within the meaning of the Investment Company Act of 1940, as amended, unless consented to in writing by such Investor. 3.4 Notices, etc. All notices and other communications required or ------------ permitted hereunder shall be in writing and shall be sent by registered United States mail, postage prepaid, or delivered personally by hand or nationally recognized courier addressed (a) if to a Holder or Key Employee Stockholder, as indicated on the list of Holders and Key Employee Stockholders attached hereto as Exhibits A and B or at such other address as such Holder, Key Employee Stockholder or permitted assignee shall have furnished to the Company in writing, or (b) if to the Company, at 8920 Business Park Drive, Austin, Texas 78759, Attention: President, or at such other address as the Company shall have furnished to each holder in writing. All such notices and other written communications shall be effective (i) if mailed, five (5) days after mailing and (ii) if delivered, upon delivery. 3.5 Delays or Omissions. No delay or omission to exercise any right, ------------------- power or remedy accruing to any Holder or Key Employee Stockholder, upon any breach or default of the Company under this Agreement shall impair any such right, power or remedy of such Holder or Key Employee Stockholder nor shall it be construed to be a waiver of any such breach or default, or an acquiescence therein, or of or in any similar breach or default thereafter occurring, nor shall any waiver of any single breach or default be deemed a waiver of any other breach or default therefore or thereafter occurring. All remedies, either under this Agreement or by law or otherwise afforded to any Holder or Key Employee Stockholder, shall be cumulative and not alternative. 3.6 Rights; Separability. Unless otherwise expressly provided herein, a -------------------- Holder's or Key Employee Stockholder's rights hereunder are several rights, not rights jointly held with any of the other Holders or Key Employee Stockholders. In case any provision of the Agreement shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. 3.7 Information Confidential. Each Holder and Key Employee Stockholder ------------------------ acknowledges that the information received by such holder pursuant hereto may be confidential and for its use only, and it will not use such confidential information in violation of the Exchange Act or reproduce, disclose or disseminate such information to any other person (other than to the general partners of a Holder, or the affiliates of such general partners, limited partners, or to the directors, employees or agents of a Holder having a need to know the contents of such information, and its attorneys, or to the extent required by any law, or any rule or regulation of a government agency or any order or mandate of any court or similar judicial body), except in connection with the exercise of rights under this Agreement, unless the Company has made such information available to the public generally or such Holder or Key Employee Stockholder is required to disclose such information by a governmental body. 21 3.8 Titles and Subtitles. The titles of the paragraphs and -------------------- subparagraphs of this Agreement are for convenience of reference only and are not to be considered in construing this Agreement. 3.9 Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which shall be an Original, but all of which together shall constitute one instrument. 3.10 Condition Precedent to Agreement. This Agreement shall not bind or -------------------------------- grant rights to any Key Employee Stockholder who does not execute this Agreement. In any such event all references to such person who is not bound hereby shall be deleted herefrom, and such person shall not be considered a Key Employee Stockholder for purposes of this Agreement but this Agreement shall otherwise remain in effect. 22 IN WITNESS WHEREOF, the parties hereto have executed this Amended and Restated Investors Rights Agreement effective as of the day and year first above written. Applied Science Fiction, inc. By: ------------------------------ Mark Urdahl, President and Chief Executive Officer 23 HOLDERS: -------- TCV III (GP) By: Technology Crossover Management III, L.L.C., its General Partner By: ---------------------------------- Robert C. Bensky, Chief Financial Officer TCV III, L.P. By: Technology Crossover Management III, L.L.C., its General Partner By: ---------------------------------- Robert C. Bensky, Chief Financial Officer TCV III (Q), L.P. By: Technology Crossover Management III, L.L.C., its General Partner By: ---------------------------------- Robert C. Bensky, Chief Financial Officer TCV III Strategic Partners, L.P. By: Technology Crossover Management III, L.L.C., its General Partner By: ---------------------------------- Robert C. Bensky, Chief Financial Officer [Signature page to amended and Restated Investors' Rights Agreement] AMERINDO INVESTMENT ADVISORS By: By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- SELIGMAN COMMUNICATIONS AND INFORMATION FUND, INC. By: J. & W. Seligman & Co. Incorporated, its investment adviser By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- BEAGLE LIMITED By: By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- ASF LLC By: ---------------------------------- Anthony B. Davis, General Partner [Signature page to Amended and Restated Investors' Rights Agreement] HAMBRECHT & QUIST CALIFORNIA By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- HAMBRECHT & QUIST EMPLOYEE VENTURE FUND, L.P. II By: H & Q Venture Management, L.L.C., its General Partner By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- ACCESS TECHNOLOGY PARTNERS, L.P. By: Access Technology Management, L.L.C., its General Partner By: H & Q Venture Management, L.L.C., its Managing Member By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- ACCESS TECHNOLOGY PARTNERS BROKERS FUND, L.P. II By: H & Q Venture Management, L.L.C., its General Partner By: ---------------------------------- Name: --------------------------------- Title: -------------------------------- [Signature page to Amended and Restated Investors' Rights Agreement] VF FAMILY PARTNERSHIP By: ----------------------------------- Gary D. Vollen, Partnership Manager SCULLEY BROTHERS, LLC By: ---------------------------------- Arthur Sculley, General Partner GROSVENOR SELECT LP By: Grosvenor Select Partners LLC, its General Partner By: ----------------------------------- Doug Dunnan, [Title] [Signature page to Amended and Restated Investors' Rights Agreement] INTERWEST PARTNERS VI, L.P. By: InterWest Management Partners VI, L.L.C., its General Partner By: ------------------------------------ Stephen Holmes, Managing Director INTERWEST INVESTORS VI, L.P. By: InterWest Management Partners VI, L.L.C., its General Partner By: ------------------------------------- Stephen Holmes, Managing Director [Signature page to Amended and Restated Investors' Rights Agreement] SEVIN ROSEN FUND V, L.P. By: SRB Associates V L.P., its General Partner By: -------------------------------------- John V. Jaggers, General Partner SEVIN ROSEN V AFFILIATES FUND L.P. By: SRB Associates V L.P., its General Partner By: ----------------------------------------- John V. Jaggers, General Partner SEVIN ROSEN FUND VI L.P. By: SRB Associates VI L.P., its General Partner By: ----------------------------------------- John V. Jaggers, General Partner SEVIN ROSEN VI AFFILIATES FUND L.P. By: SRB Associates VI L.P., its General Partner By: ----------------------------------------- John V. Jaggers, General Partner [Signature page to Amended and Restated Investors' Rights Agreement] TIMARK L.P. By: ----------------------------------------- Frank J. Marshall General Partner KNCL ASSOCIATES LIMITED By: ----------------------------------------- Kent Fuka, General Partner CROWN GROWTH PARTNERS, LP By: Crown Partners LLC, its General Partner By: ----------------------------------------- David F. Bellet, General Partner PARSON FINANCE LIMITED By: Crown Advisors International Ltd, its Investment Manager By: ----------------------------------------- David F. Bellet, Chairman [Signature page to Amended and Restated Investors' Rights Agreement] INDIVIDUAL HOLDERS: ----------------------------------------- Thomas Aschenbrenner ----------------------------------------- Joseph Arsenio ----------------------------------------- Harvey B. Cash ----------------------------------------- Neil Cohen ----------------------------------------- James Davidson ----------------------------------------- Dietrich R. Erdmann ----------------------------------------- Ken Hao ----------------------------------------- Eugene Lowenthal ----------------------------------------- Regis McKenna ----------------------------------------- Benjamin Rosen ----------------------------------------- L.J. Sevin ----------------------------------------- Steven J. Wallach [Signature page to Amended and Restated Investors' Rights Agreement] KEY EMPLOYEE STOCKHOLDERS: ----------------------------------------- Mark Urdahl ----------------------------------------- Sada Cumber ----------------------------------------- Albert Edgar ----------------------------------------- Mark Bishop ----------------------------------------- Sheppard Parker ----------------------------------------- Mike Wilkes ----------------------------------------- Steven Penn [Signature page to Amended and Restated Investors' Rights Agreement] TRITON VENTURE PARTNERS, L.P. By: Triton Venture Management, LLC, its General Partner By: ----------------------------------------- Laura J. Kilcrease, Manager [Signature page to Amended and Restated Investors' Rights Agreement] GREENOVER GROUP L.P. By: Greenover Managers, L.L.C., its General Partner By: ----------------------------------------- Kelley Williams, Jr., General Partner [Signature page to Amended and Restated Investors' Rights Agreement] CENTERPOINT VENTURE PARTNERS L.P. By: Paluck Associates, L.P., its General Partner By: ----------------------------------------- Robert J. Paluck, General Partner [Signature page to Amended and Restated Investors' Rights Agreement] EXHIBIT A --------- SCHEDULE OF INVESTORS ---------------------
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - --------------------------------------------------- ------------------ ------------------ TCV III (GP) -- 10,554 c/o Technology Crossover Management III, L.L.C. Attn: Robert C. Bensky 56 Main Street Milburn, New Jersey 07041 and CC: Mike Linnert 575 High Street, Suite 400 Palo Alto, California 94301 TCV III, L.P. -- 50,132 c/o Technology Crossover Management III, L.L.C. Attn: Robert C. Bensky 56 Main Street Milburn, New Jersey 07041 and CC: Mike Linnert 575 High Street, Suite 400 Palo Alto, California 94301 TCV III (Q), L.P. -- 1,332,462 c/o Technology Crossover Management III, L.L.C. Attn: Robert C. Bensky 56 Main Street Milburn, New Jersey 07041 and CC: Mike Linnert 575 High Street, Suite 400 Palo Alto, California 94301
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - --------------------------------------------------- ------------------ ------------------ TCV III Strategic Partners, L.P. -- 60,341 c/o Technology Crossover Management III, L.L.C. Attn: Robert C. Bensky 56 Main Street Milburn, New Jersey 07041 and CC: Mike Linnert 575 High Street, Suite 400 Palo Alto, California 94301 ATGF II -- 205,174 Attn: Marc Weiss 399 Park Avenue 18th Floor New York, New York 10022 Litton Master Trust -- 179,923 Attn: Marc Weiss 399 Park Avenue 18th Floor New York, New York 10022 Marc Weiss -- 2,499 399 Park Avenue 18th Floor New York, New York 10022 J.W. Seligman -- 387,595 Attn: Paul Goucher 100 Park Avenue New York, New York 10017 Beagle Limited -- 193,798 Attn: Victor Cunningham 1 West 67th Street Suite 101 New York, New York 10023 Triton Venture Partners, L.P. -- 183,075 Attn: Laura Kilcrease 1301 W. 25th Street Suite 300 Austin, Texas 78705
A-2
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - --------------------------------------------------- ------------------ ------------------ ASF LLC -- 96,899 Attn: Joe Tate 2119 E. 30th Place Tulsa, Oklahoma 74114 Hambrecht & Quist California -- 6,298 Attn: Michael Beblo One Bush Street San Francisco, California 94104 Hambrecht & Quist Employee Venture Fund, L.P. II -- 2,422 Attn: Michael Beblo One Bush Street San Francisco, California 94104 Access Technology Partners, L.P. -- 51,034 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104 Access Technology Partners Brokers Fund, L.P. -- 565 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104 VF Family Partnership -- 689 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104 Kenneth Hao -- 689 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104 Joseph Arsenio -- 689 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104
A-3
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - --------------------------------------------------- ------------------ ------------------ James Davidson -- 2,218 c/o Hambrecht & Quist Attn: Michael Beblo One Bush Street San Francisco, California 94104 Sculley Brothers -- 64,599 Attn: Arthur Sculley 90 Park Avenue 32nd Floor New York, New York 10016 Neil Cohen -- 32,300 10501 Rhode Island Avenue Beltsville, Maryland 20705 Greenover Group L.P. -- 32,300 Attn: Kelley Williams, Jr. 4418 Hickory Ridge Jackson, Mississippi 39211 Grosvenor Select Partners LLC -- 32,300 Attn: Bruce Dunnan 1717 Pennsylvania Avenue, N.W. Suite 225 Washington, D.C. 20006 CenterPoint Venture Partners, L.P. 594,595 258,398 Attn: Robert J. Paluck Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 InterWest Partners VI, L.P. 393,407 250,543 Attn: Stephen Holmes Building 3, Suite 255 3000 Sand Hill Road Menlo Park, California 94025 InterWest Investors VI, L.P. 11,999 7,855 Building 3, Suite 255 3000 Sand Hill Road Menlo Park, California 94025
A-4
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - --------------------------------------------------- ------------------ ------------------ Sevin Rosen Fund V L.P. 311,208 123,902 Attn: John Jaggers Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 Sevin Rosen V Affiliates Fund L.P. 13,297 5,297 Attn: John Jaggers Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 Sevin Rosen Fund VI L.P. -- 359,302 Attn: John Jaggers Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 Sevin Rosen VI Affiliates Fund L.P. -- 28,295 Attn: John Jaggers Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 L.J. Sevin 25,000 32,300 Two Galleria Tower 13455 Noel Road, Suite 1670 Dallas, Texas 75240 Benjamin Rosen 25,000 0 One Central Park West Apartment 43A New York, New York 10023 Thomas H. Aschenbrenner 19,065 18,605 6016 Oakcrest Dallas, Texas 75248 Steven J. Wallach 2,703 3,230 7314 Wester Way Dallas, Texas 75248 Eugene Lowenthal 5,406 4,522 9600 Crumley Ranch Road Austin, Texas 78736
A-5
Shares of Series C Shares of Series D Name and Address Preferred Stock Preferred Stock - ------------------------------------------------ ------------------ ------------------ David Bellet 13,513 0 The Lincoln Building Suite # 3405 60 East 42nd Street New York, NY 10165 Crown Growth Partners, LP -- 11,628 Attn: David Bellet The Lincoln Building Suite # 3405 60 East 42nd Street New York, NY 10165 Parson Finance Limited -- 7,752 Attn: David Bellet The Lincoln Building Suite # 3405 60 East 42nd Street New York, NY 10165 Harvey B. Cash 13,513 0 c/o CenterPoint Venture Partners, L.P. 13455 Noel Road, Suite 1670 Dallas, Texas 75240 Dietrich R. Erdman 13,507 13,175 c/o CenterPoint Venture Partners, L.P. 13455 Noel Road, Suite 1670 Dallas, Texas 75240 KNCL Associates Limited 2,441 0 Kent Fuka, General Partner 10904 Low Bridge Lane Austin, Texas 78750 Regis McKenna 13,513 13,178 c/o The McKenna Group 1755 Embarcadero Road Palo Alto, California 94303 TIMARK, L.P. 13,513 3,230 Frank J. Marshall, General Partner 20100 Hill Ave. Saratoga, California 95070 1,471,500 4,069,767 ========= =========
A-6 EXHIBIT B --------- LIST OF KEY EMPLOYEE STOCKHOLDERS ---------------------------------
Shares of and Shares of and Warrants to Options to Acquire Purchase Series B Name and Address Common Stock Preferred Stock ---------------- ------------ --------------- Mark Urdahl 2,515,998 9,734 c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321 Sada Cumber 1,616,001 -- c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321 Dr. Albert Edgar 2,515,998 4,867 c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321 Mark Bishop 716,001 4,542 c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321 Sheppard Parker 716,001 -- c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321 Mike Wilkes 716,001 -- c/o Applied Science Fiction, Inc. 8920 Business Park Drive Austin, TX 78759-5321
B-1 EX-10.5 6 OFFICE LEASE AGREEMENT EXHIBIT 10.5 BALCONES NORTH OFFICE BUILDING OFFICE LEASE AGREEMENT LEASE AGREEMENT BY AND BETWEEN RGK RENTALS, LTD., AS LESSOR AND APPLIED SCIENCE FICTION, INC AS LESSEE March 19, 1998 LEASE AGREEMENT STATE OF TEXAS ) ) ) KNOW ALL MEN BY THESE PRESENTS: COUNTY OF TRAVIS ) 1. PARTIES. This Lease Agreement (the "Lease") is made and entered into by and between RGK RENTALS, LTD., a Texas limited partnership (hereinafter referred to as the "Lessor") and APPLIED SCIENCE FICTION, INC., a Delaware corporation (hereinafter referred to as "Lessee"). 2. LEASED PREMISES. In return for the consideration, covenants and agreements hereinafter set forth to be paid, observed and/or performed by Lessee, Lessor hereby demises and lets unto Lessee, and Lessee does hereby lease from Lessor, that certain real property and improvements including an approximately 53,984 rentable square foot building (the "Building") together with the related parking, driveways and landscaped areas, locally known as 8920 Business Park Drive in Austin, Travis County, Texas, legally described as Lot 1, Block A, North Crossing Subdivision, Section I-B, City of Austin, recorded at Volume 80, Page 286 of the Plat Records of Travis County, Texas (all of which is hereinafter collectively referred to as the "Leased Premises") indicated on the Site Plan attached hereto as Exhibit A. 3. TERM, RENEWAL AND CANCELLATION. The term of this Lease shall commence on April 1, 1998, ("Commencement Date") and shall end on March 31, 2003 (the "Term"). Lessee shall have two (2) two-year renewal options at then market rates. Market rates shall be governed by Exhibit D attached hereto. In the event Lessee desires to exercise such option to renew this Lease, Lessee shall give Lessor 180 days prior written notice of such exercise. After the first thirty- six (36) months of this Lease, Lessee shall have the right to cancel the Lease by giving Lessor one-hundred and eighty (180) days written notice and by paying Lessor Two Hundred and Fifty Thousand Dollars ($250,000) plus the then unamortized portion of the cost of Lessor's Allowance for Improvements (as defined in paragraph 22 herein) and brokerage fees. Any sublease agreements, pursuant to paragraph 18 below, shall contain appropriate cancellation provisions, reflecting Lessee's right to terminate this Lease contained in this Paragraph 3. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 1 4. COMMENCEMENT OF LESSEE'S POSSESSION. On March 20, 1998, Lessee has possession of the Leased Premises subject to all the terms of this Lease, with the exception of the payment of rent which will commence on April 1, 1998, as more fully described below. 5. RENTAL PAYMENTS. (a) Commencing on the Commencement Date and continuing throughout the Term, Lessee hereby agrees to pay the Base Rental as described in paragraph 6, plus Forecast Additional Rental and Additional Rental as descfibed in paragraph 7. The Base Rental and Forecast Additional Rental shall be due and payable in equal installments on the first day of each calendar month during the Term and any renewals or extensions thereof, and Lessee hereby agrees to make such payments monthly in advance to Lessor at Lessor's address as provided herein (or such other address as may be designated by Lessor from time to time). (b) If the Term commences or terminates on other than the first day of a calendar month or terminates on other than the last day of a calendar month, then the installments of Base Rental and Forecast Additional Rental for such month or months shall be prorated and the installment or installments so prorated shall be paid in advance. The payment for such prorated month shall be calculated by multiplying the monthly installment by a fraction, the numerator of which shall be the number of days of the Term occurring during said commencement or termination month, as the case may be, and the denominator of which shall be the total number of days occurring in said commencement or termination month. Also, if the Term commences or terminates on other than the first day of a calendar year, Additional Rent shall be prorated for such commencement or termination year, as the case may be, by multiplying each by a fraction, the numerator of which shall be the number of days of the Term during the commencement or termination year, as the case may be, and the denominator of which shall be 365. (c) Lessee shall pay all rent and other sums of money as they shall become due and payable to Lessor under this Lease at the time and in the manner provided herein, without demand, set-off or counterclaims. At Lessor's option, Lessee shall pay (i) five percent (5%) of the monthly rent (including Base Rental, Forecast Additional Rental and all other sums owed by Lessee to Lessor under the provisions this Lease), if same are not fully paid within ten (10) days of the due date as specified herein, or (ii) $25.00 per day from due date (if not paid within ten (10) days of due date) until all sums due, including late charges, are paid in full. The parties hereby agree that such charges represent a fair and reasonable estimate of expenses Lessor /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 2 would incur by reason of Lessee's late payments. Acceptance of such late charge by Lessor shall neither constitute a waiver of Lessee's default nor, in the event of Lessee's default, shall it prevent Lessor from exercising any rights or remedies specified herein or otherwise. 6. BASE RENTAL. (Beginning on April 1, 1998, Lessee shall pay to Lessor a monthly rental (the "Base Rental") as follows: April 1, 1998 until September 30, 1998 $20,625.00 per month October 1, 1998 until December 31, 1998 $35,291.67 per month January 1, 1999 until March 31, 1999 $49,485.33 per month April 1, 1999 until March 31, 2000 $58,482.67 per month April 1, 2000 until March 31, 2002 $62,981.33 per month April 1, 2002 until March 31, 2003 $71,978.67 per month 7. ADDITIONAL RENTAL. (a) Beginning on the Commencement Date and continuing thereafter for each calendar year during the Term, Lessor shall present to Lessee, prior to the beginning of said period, a statement of Forecast Additional Rental. Lessee shall pay Forecast Additional Rental in equal monthly installments in advance. "Forecast Additional Rental" shall mean Lessor's reasonable estimate of Additional Rental. Lessee shall be liable also for any Additional Rental. (b) The term "Additional Rental" shall mean Lessor's Actual Operating Expenses (defined below in paragraph 8) for the Leased Premises incurred during each calendar year. (c) By April 1 of each year during the Term, or as soon as possible thereafter, Lessor shall provide Lessee a statement showing the Actual Operating Expenses for the twelve-month period then ended, and a statement prepared by Lessor comparing Forecast Additional Rental with Additional Rental. In the event that Forecast Additional Rental exceeds Additional Rental for said calendar year, Lessor shall pay Lessee (in the form of a credit against rentals next due) an amount equal to such excess. In the event that the Additional Rental exceeds Forecast Additional Rental for said calendar year, Lessee shall pay Lessor, within thirty (30) days of receipt of the statement, an amount equal to such difference. The calculation described in this paragraph 6(c) shall be made as soon as possible after the termination of the Lease, and all provisions of this Lease relating to said calculation shall survive the termination of this Lease. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 3 8. LESSOR'S ACTUAL OPERATING EXPENSES. Lessor shall pay all of Lessor's "Actual Operating Expenses," which term shall include solely the following: (a) Ad valorem taxes for the Leased Premises. (b) Casualty insurance on the Leased Premises to be carried by Lessor as described in paragraph 12 below. 9. LESSEE'S OPERATING EXPENSES. Lessee is responsible for paying when due Lessee's Operating Expenses for the Leased Premises. The term "Lessee's Operating Expenses" shall mean the aggregate all of operating and maintenance expenses incurred by Lessor or Lessee in connection with the Leased Premises, other than Lessor's Actual Operating Expenses, and shall include without limitation the following: (a) The cost of all wages, salaries and any ancillary expenses of all employees actually engaged in operation and maintenance of the Leased Premises, including taxes, insurance and benefits relating thereto. (b) The cost of all supplies and material used in operation and maintenance of the Leased Premises. (c) The cost of all utilities, including but not limited to electric, gas, water, heating, lighting, air conditioning and ventilation of the Building. (d) The cost of all maintenance, service and operating agreements for the Leased Premises and related equipment, including but not limited to security service, window cleaning, elevator maintenance and janitorial service. (e) The gross cost of liability insurance applicable to the Leased Premises and Lessor's personal property used in connection therewith; excluding however cost of casualty insurance on the Building included in Lessor's Actual Operating Expenses. (f) The cost of all taxes and assessments and governmental charges whether federal, state, county or municipal, whether they be by taxing district or authorities presently taxing the Leased Premises or by others, subsequently created or otherwise, and any other taxes and assessments attributable to the Leased Premises or its operator and maintenance or its operation, /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 4 excluding only Lessor's federal and state taxes on income, franchise tax and inheritance tax. Lessee will be responsible for all ad valorem taxes on its personal property and on the Leased Premises not covered by Lessor's Actual Operating Expenses as described above. If any such taxes, assessments or charges are paid by Lessor, Lessee will reimburse Lessor therefor, upon Lessor's demand accompanied by a supporting statement setting forth Lessor's reasonable calculation of the amount of such taxes chargeable to the Leased Premises. (g) The cost of repairs, replacements and maintenance on or of the Leased Premises (excluding repairs to the structure, foundation and the exterior walls of the Building or replacement of the roof membrane). Lessee's obligation to maintain, repair and make replacements to the Leased Premises shall cover, but not be limited to, pest control (including termites), roof repairs, trash removal and the maintenance, repair and replacement of all window glass, HVAC, electrical, plumbing, fire and security and other mechanical systems. (h) The cost of expenditures, capital or otherwise, made for the specific purpose of installing equipment, devices or materials intended to reduce operating expenses of the Building if required by law or regulation of a governmental authority. (i) The cost of landscaping and any other costs necessary to maintain the Leased Premises in a first class condition. 10. SECURITY DEPOSIT. Upon the execution of this Lease, Lessee shall pay Lessor a security deposit in the amount of Three Hundred Thousand Dollars ($300,000) as security for Lessee's full performance of all the provisions of this Lease. If Lessee fails to pay rent or otherwise defaults with respect to any provision of this Lease, Lessor may use, apply or retain all or any portion of the security deposit for the payment of Base Rent, Additional Rent, or any other charge in default, or for the payment of any other sum to which Lessor may become obligated by reason of Lessee's default, or to compensate Lessor for any loss or damage which Lessor may suffer thereby. If Lessor so uses or applies all or any portion of the security deposit, Lessee must within five days after written demand, deposit cash with Lessor in any amount sufficient to restore the security deposit to the original amount and Lessee's failure to do so is a material breach of this Lease. The security deposit shall be placed in an interest bearing account or other instruments chosen by Lessee in Lessor's name at a bank chosen by Lessee. If Lessee performs all of Lessee's obligations hereunder, the security deposit, or as much thereof as has not been applied by Lessor shall be returned to Lessee with accrued interest. At the end of the /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 5 twenty-fourth month of this lease, so long as Lessee has paid all Base Rental and Additional Rental amounts on or before the due date each month, Lessor will refund $75,000 of Lessee's security deposit. At the end of the thirty-sixth month of this lease, so long as Lessee has paid all Base Rental and Additional Rental amounts on before the due date each month, Lessor will refund $50,000 of Lessee's security deposit plus one-half of the accrued interest on Lessee's security deposit. At the end of the forty-eighth month of this lease, so long as Lessee has paid all Base Rental and Additional Rental amounts on or before the due date each month, Lessor will refund $50,000 of Lessee's security deposit plus one-half of the accrued interest over the last twelve months. Lessee will request in writing any refunds of its security deposit. Lessee's security deposit shall never drop below $150,000. 11. LESSEE'S DUTIES. (a) Use of Leased Premises. The Leased Premises are to be used and occupied by the Lessee solely for the purpose of general office, engineering labs and computer rooms and for no other purpose without the prior written consent of Lessor, which consent shall not be unreasonably withheld. Lessee agrees not to commit or suffer to be committed on the Leased Premises any nuisance or other act or thing against public policy or which violates any law or governmental regulation or which is disreputable or which may disturb the quiet enjoyment of any sublease of the Building. Lessee will not use, occupy, or permit the use or occupancy of the Leased Premises for any unlawful, disreputable, immoral, or hazardous purpose, or maintain or permit the maintenance of any public or private nuisance, or keep any substance or carry on or permit any operation which might emit offensive odors into other portions of the Building or permit anything to be done which would increase the fire insurance rate of the Building or contents or which could lead to the cancellation of the fire insurance coverage. (b) Condition of the Leased Premises. Lessee shall not damage the Leased Premises and will maintain the Leased Premises in a clean, attractive condition and in good repair, ordinary wear and tear excepted. Upon termination of this Lease, Lessee will surrender and deliver up the Leased Premises in good order and repair and in the same condition as upon the Commencement Date of this Lease, ordinary wear and tear excepted. (c) Compliance with Laws. Lessee will comply with all applicable federal, state, municipal and other laws, ordinances, rules, and regulations applicable to the Leased Premises and to the business conducted therein by Lessee, including without limitation the American's /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 6 with Disabilities Act (collectively, "Applicable Laws"). Within fourteen (14) days of receipt, Lessee shall forward to Lessor copies of any notices received from any governmental authority regarding noncompliance with any Applicable Laws. Lessor represents and warrants to Lessee, that to the best of Lessor's knowledge, that at the commencement of the Lease, the Leased Premises are in compliance with all applicable laws. (d) Liens. Lessee shall allow no liens to be filed against the Leased Premises, or any part thereof, and shall promptly cause the release any liens that are filed against the Leased Premises, or any part thereof (e) Alterations, Addition and Improvements. Lessee covenants and agrees not to permit the Leased Premises to be used for any purpose other than that stated in paragraph 10(a) hereof, or make or allow to be made any alterations or physical additions in or to the Leased Premises, or place on the Leased Premises any signs visible from outside the Leased Premises, or place any safes or vaults (whether movable or not) upon or in the Leased Premises, without first obtaining the written consent of Lessor. All plans and drawings pertaining to buildout or remodeling of the Building exterior, corridors or core, shall first be submitted to Lessor for review and reasonable determination of Lessor's approval or disapproval. Remodeling and buildout of the general office and lab areas are excluded from Lessor review. Within 7 days of any and all remodeling, Lessee will provide Lessor an electronic file and blue line drawing of changes to the as-built of the Building. Any and all such alterations, physical additions, or improvements made to the Leased Premises shall at once become the property of Lessor and shall be surrendered to Lessor upon the termination of this Lease, whether by lapse of time or otherwise; however, this clause shall not apply to movable equipment or furniture owned by Lessee, provided no damage is caused to the Leased Premises by the removal thereof If not in default at the termination of this Lease, Lessee may remove all such fixtures, equipment, decoration, furniture or other such items installed by Lessee. Any damage occasioned and caused by the installation or removal of such fixtures and equipment shall be repaired at Lessee's expense. Upon written request by Lessor, Lessee shall remove all such furniture and equipment and repair the damage caused by the removal of same. In the event Lessee does not remove such fixtures, equipment and other installed items, Lessor shall have the right to remove the same and to repair any damage caused by such removal, and Lessee shall be obligated to pay the cost of such removal and repair. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 7 (f) Rules and Regulations. Lessee shall comply with the Rules and Regulations of the Building provided in Exhibit B attached hereto and made a part hereof. Lessor reserves the right from time to time, after consultation with Lessee and upon written notice to Lessee, to make such changes, additions or amendments to the Rules and Regulations as it may deem necessary or advisable. Lessor shall have no liability to Lessee for any failure of any sublessees or lessees of the Building to comply with such Rules and Regulations. (g) Operation. Lessee shall not place, install, or operate on the Leased Premises or in any part of the Building any engine, refrigerating, heating or air conditioning apparatus, stove, or machinery, or conduct mechanical operations, or place or use in or about the Leased Premises any inflammable, explosive, hazardous, or odorous solvents or materials without the prior written consent of Lessor. No portion of the Leased Premises shall at any time be used for cooking, residential quarters; provided, however, that Lessee may place refrigerators and microwave ovens in the Building. (h) Repair and Maintenance. Lessee shall, at its own cost, repair/replace any damage or injury done to the Leased Premises or any part thereof caused by Lessee or Lessee's agents, contractors, employees, invitees, or visitors. If Lessee fails promptly to make such repairs/replacements to the Leased Premises, Lessor may make such repairs/replacement, and Lessee shall repay the cost of such repairs/replacement plus ten percent (10%) thereof to Lessor on demand. (i) Telephone System. (i) As part of this Lease, Lessor hereby leases to Lessee, the existing telephone system "as is where is", including without limitation all cabling, telephone switch, telephone instruments, voice mail system, network cabling in the Building (collectively called the "Telephone System") as more particularly described on Exhibit C attached hereto for all purposes. Lessee may, at its own cost, add upgrades to the Telephone System at any time during the Term. Any such upgrades shall become the property of Lessor and shall remain with the Telephone System after departure of Lessee from the Leased Premises. (ii) Lessee shall maintain and pay for telephone service provided by a third party approved by Lessor. Any existing unexpired service agreements at the commencement or /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 8 termination of this Lease shall be paid in full by Lessee or shall be paid by Lessor and reimbursed to Lessor by Lessee. (iii) Lessee must not sell, mortgage or part with possession or control, or attempt to sell, mortgage or part with possession or control of the Telephone System, except as provided in paragraph 18 hereof. (iv) Lessee may not pledge, encumber, create a security interest in, or permit any lien to become effective on all or any portion of the Telephone System. On the occurrence of any of these events, Lessee will be in default. Lessee must promptly notify Lessor of any such liens, charges, or other encumbrances of which Lessee has knowledge. Lessee must promptly pay or satisfy any obligation from which any such lien or encumbrance arises. Lessee must deliver to Lessor appropriate satisfactions, waivers, or evidence of payment of any such lien or encumbrance. (v) On the expiration of the Term, or on any earlier termination of this Lease, Lessee must return the Telephone System to Lessor in good repair, condition and working order, normal wear and tear excepted. In addition, Lessee will provide Lessor a complete and updated inventory of the Telephone System. (j) Signage. Lessee shall be allowed exterior signage on the Building subject to Lessor and City of Austin design approval. (k) Lessor Access. Lessor shall have the right to enter upon and inspect the Leased Premises following reasonable notice to Lessee in accordance with paragraph 21(b). 12. QUIET ENJOYMENT. So long as Lessee is not in default under the terms and provisions of this Lease, Lessee shall peaceably hold and enjoy the Leased Premises during the said term. 13. INSURANCE; INDEMNITY. (a) Lessee's Insurance. Lessee shall, at Lessee's expense, obtain and keep in force during the term of this Lease: /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 9 (i) Comprehensive general liability insurance with broad form general liability endorsement, in an amount of not less than $1,000,000 per occurrence of bodily injury and property damage combined, or in a greater amount as reasonably determined by Lessor, and shall insure Lessee with Lessor as an additional insured against liability arising out of the use, occupancy or maintenance of the Leased Premises. Compliance with the above requirement shall not, however, limit the liability of Lessee hereunder. (ii) Worker's compensation coverage as required by law, together with employer's liability coverage, with a limit of not less than $500,000. (iii) Fire and extended coverage insurance, with vandalism and malicious mischief, in an amount sufficient to cover not less than 100% of the full replacement cost, as the same may exist from time to time, of all Lessee's personal property, fixtures, equipment, and tenant improvements. (b) Insurance Policies. Lessee shall deliver to Lessor copies of liability insurance policies required under (a) above, or certificates evidencing the existence and amounts of such insurance, within seven (7) days after the Commencement Date. No such policy shall be cancelable or subject to reduction of coverage or other modification except after thirty (30) days prior written notice to Lessor. Lessee shall, at least thirty (30) days prior to the expiration of such policies, furnish Lessor with evidence of renewals thereof. (c) No Representation of Adequate Coverage. Lessor makes no representation that the limits or forms of coverage of insurance specified in this Paragraph 13 are adequate to cover Lessee's property or obligations under this Lease. (d) Hazard Insurance. During the Lease term, Lessor shall maintain policies of insurance covering loss of or damage to the Leased Premises in an amount equal to 100% of the replacement value of the Building. Such policies shall provide protection against all perils included within the classification of fire, extended coverage, vandalism, malicious mischief, special extended perils (all risk), and Inflation Guard endorsement, and any other perils (except flood and earthquake, unless required by any lender holding a security interest in the Leased Premises) which Lessor deems necessary. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 10 (e) INDEMNITY. LESSEE SHALL INDEMNIFY AND HOLD HARMLESS LESSOR AND LESSOR'S DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, GUESTS, INVITEES, AND LENDERS FROM AND AGAINST ALL LOSSES, CLAIMS, COSTS, DAMAGE, LIABILITY OR EXPENSES, INCLUDING BUT NOT LIMITED TO REASONABLE ATTORNEYS' FEES, ARISING OUT OF ANY AND ALL INJURIES TO OR DEATH OF ANY PERSON OR DAMAGE TO ANY PROPERTY ARISING OUT OF ANY OCCURRENCE ON OR IN THE PREMISES, INCLUDING THAT CAUSED BY THE NEGLIGENCE OF LESSOR, BUT NOT TO THE EXTENT CAUSED BY THE INTENTIONAL ACT OR GROSS NEGLIGENCE OF LESSOR, OR ARISING FROM ANY BREACH OR DEFAULT IN THE PERFORMANCE OF ANY OF LESSEE'S OBLIGATIONS UNDER THIS LEASE, OR ARISING FROM ANY ACT OR OMISSION OF LESSEE OR LESSEE'S DIRECTORS, OFFICERS, CONTRACTORS, CUSTOMERS, INVITEES, EMPLOYEES. IF ANY ACTION OR PROCEEDING IS BROUGHT AGAINST LESSOR BY REASON OF ANY SUCH MATTER, LESSEE UPON NOTICE FROM LESSOR SHALL DEFEND THE SAME AT LESSEE'S EXPENSE BY COUNSEL REASONABLY SATISFACTORY TO LESSOR AND LESSOR SHALL COOPERATE WITH LESSEE IN SUCH DEFENSE. LESSOR NEED NOT HAVE FIRST PAID ANY SUCH CLAIM IN ORDER TO BE SO INDEMNIFIED. LESSEE, AS A MATERIAL PART OF THE CONSIDERATION TO LESSOR, HEREBY ASSUMES ALL RISK OF DAMAGE TO PROPERTY OF LESSEE OR INJURY TO PERSONS, IN, UPON OR ABOUT THE LEASED PREMISES ARISING FROM ANY CAUSE AND LESSEE HEREBY WAIVES ALL CLAIMS IN RESPECT THEREOF AGAINST LESSOR, EXCEPT TO THE EXTENT CAUSED BY THE INTENTIONAL ACT OR GROSS NEGLIGENCE OF LESSOR. (f) Exemption of Lessor from Liability. Lessee hereby agrees that except to the extent caused by the intentional act or gross negligence of Lessor, Lessor shall not be liable to Lessee's business or any loss of income therefrom or for loss of or damage to the goods, wares, merchandise or other property of Lessee, Lessee's employees, invitees, customers, or any other person in or about the Leased Premises, nor shall Lessor be liable for injury to the person of Lessee, Lessee's employees, agents or contractors, regardless of whether such damage or injury is caused by or results from theft, fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, sprinklers, wires, appliances, plumbing, air-conditioning or lighting fixtures, or from any other cause, including the negligence of Lessor, regardless of whether said damage or injury results from conditions arising upon the Leased /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 11 Premises, or of the equipment, fixtures or appurtenances applicable thereto, and regardless of whether the cause of such damage or injury or the means of repairing the same is inaccessible. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant, occupant or user of the Leased Premises, nor from the failure of Lessor to enforce the provisions of any lease of any other sublessee of the Leased Premises. (g) Waiver of Subrogation. Anything in this Lease to the contrary notwithstanding, as and to the extent permitted by applicable insurance policies, Lessor and Lessee each hereby waive any and all rights of recovery, claim, action, or cause of action, against the other, its agents, officers, or employees, for any loss or damage that may occur to the Leased Premises, or any improvements thereto, or the Building, or any improvements thereto, or any personal property of such party therein, by reason of fire, the elements, or any other cause to the extent but only to the extent the foregoing are insured against under the terms of standard fire and extended coverage insurance policies, regardless of cause or origin, including negligence of the other party hereto, its agents, officers, or employees, and covenants that no insurer shall hold any right of subrogation against such other party. (h) Fire or Other Casualty. The parties hereto mutually agree that if any time during the Term the Leased Premises or any portion of the Building are partially (more than 20% of replacement cost) or totally destroyed by fire or other casualty covered by the fire and extended coverage insurance, the Lessor may, at its option, upon written notice to Lessee, delivered within sixty (60) days after such occurrence, elect either (i) to promptly repair and restore the Leased Premises and the Building, as soon as it is reasonably practicable, to substantially the same conditions in which the Leased Premises and the Building were before such damage, or (ii) to terminate the Lease with such termination to be effective on the date of such fire or other casualty; provided, however in the event Lessee has occupied and conducted business on the Leased Premises during the interim between the fire or other casualty and the delivery of the written notice, the termination will be effective on the date Lessee last occupied and conducted business on the Leased Premises. In the event the Leased Premises are completely destroyed or so damaged by fire or other casualty covered by the fire and extended coverage insurance to be carried by Lessor under the terms hereof that it cannot reasonably be used by Lessee for the purposes herein provided and this Lease is not terminated as above provided, then there shall be a total /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 12 abatement of rent until the Leased Premises are made usable. In the event the Leased Premises are substantially destroyed or damaged by fire or other hazard so that the Leased Premises can be only partially used by Lessee for the purposes herein provided, then there shall be a partial abatement in the rent corresponding to the time and extent to which the Leased Premises cannot be used by Lessee. If the Leased Premises shall be damaged by fire or other casualty resulting from the fault or negligence of Lessee, or the agents employees, licensees, or invitees of Lessee, then, to the extent not covered by insurance, such damage shall be repaired by and at the expense of Lessee, under the direction and supervision of Lessor, and rent shall continue without abatement. (i) Condemnation and Loss or Damage. If the Leased Premises or any part thereof shall be taken or condemned for any public purpose to such an extent as to render the remainder of the Leased Premises, in the opinion of Lessor and Lessee, not reasonably suitable for Lessee's occupancy, this Lease shall, at the option of either party, forthwith cease and terminate. All proceeds from any taking or condemnation of the Leased Premises shall belong to and be paid to Lessor. In addition, Lessor shall not be liable or responsible to Lessee for any loss or damage to any property or persons occasioned by theft, fire, act of God, public enemy, injunction, riot, strike, insurrection, war, court order, requisition or order of governmental body or authority, force majeure or any other cause beyond the control of Lessor, or for any damage or inconvenience which may arise through repair or alteration of any part of the Building, or failure to make repairs, except to the extent caused by the intentional act or gross negligence of Lessor. 14. DEFAULT BY LESSEE. The occurrence of any one or more of the following events shall constitute a default and breach of the Lease by Lessee. (a) The vacating or abandonment of the Leased Premises by Lessee. Such vacating or abandonment shall be deemed to have occurred upon the absence of the Lessee from the Leased Premises for ten (10) consecutive days while Lessee is in default in the payment of any sum to be paid by Lessee hereunder, during the term of the Lease or any renewals or extensions thereof. (b) The failure by Lessee to make any payment of Monthly Rental, Additional Rental or Forecast Additional Rental or any other payment required to be made by Lessee hereunder as /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 13 and when due, provided such failure shall continue for a period of ten (10) business days after written notice thereof by Lessor to Lessee. (c) The failure by Lessee to observe or perform any of the covenants, conditions or provisions of this Lease to be observed or performed by the Lessee, other than described in Paragraph 13(a) and (b) above, where such failure shall continue for a period of thirty (30) days after written notice thereof by Lessor to Lessee; provided, however, that if the nature of Lessee's default is such that more than thirty (30) days are reasonably required for its cure, then Lessee shall not be deemed to be in default if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (d) The making by Lessee, or any guarantor of Lessee's obligations under this Lease, of any general assignment or general arrangement for the benefit of creditors; or the filing by or against Lessee, or any guarantor of Lessee's obligations under this Lease, of a petition to have Lessee, or any guarantor of Lessee's obligations under this Lease, adjudged a bankrupt, or a petition for reorganization or arrangement under any laws relating to bankruptcy (unless, in the case of a petition filed against Lessee, or any guarantor of Lessee's obligations under this Lease, the same is dismissed within thirty (30) days); or the appointment of a trustee or a receiver to take possession of substantially all of Lessee's assets located at the Leased Premises or of interests in this Lease, where possession is not restored to Lessee within thirty (30) days; or the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Leased Premises or of Lessee's interest in this Lease, where such seizure is not discharged in thirty (30) days. 15. REMEDIES IN DEFAULT BY LESSEE. Except as otherwise required herein, in the event of any such default or breach by Lessee, from time to time, in its sole discretion, and without notice and without limiting Lessor in the exercise of any other right or remedy which Lessor may be entitled to exercise at law or in equity, Lessor may elect to: (a) Terminate this Lease, after ten (10) business days written notice to Lessee, and forthwith repossess the Leased Premises and be entitled to recover as damages a sum of money equal to the total of (1) the cost of recovering the Leased Premises; (2) all unpaid Base Rental, Additional Rental and Forecast Additional Rental earned at the time of termination, plus interest thereon at the maximum lawful rate; (3) an amount equal to the difference between (i) the total rental (Base Rental, Additional Rental and Forecast Additional Rental computed as stated in this /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 14 Lease) for the remaining portion of the Term; and (ii) the then present value of the fair rental value of the Leased Premises for such period (the parties hereto agreeing that the fair rental value of the Leased Premises shall be the sum of all rentals to be paid during such period discounted at the rate of ten percent (10%) per annum); (4) the cost of repairs or of alteration of the Leased Premises that are the Lessee's responsibility under this Lease; (5) that portion of any leasing commission paid by Lessor applicable to the unexpired term of Lease; and (6) any other sum of money and damages owed by Lessee to Lessor. (b) Terminate, after five (5) days written notice to Lessee, Lessee's right of possession (but not the Lease) and repossess the Leased Premises by forcible entry or otherwise, without demand or notice of any kind to Lessee and without terminating this Lease, in which event Lessor may, but shall be under no obligation to do so, re-let the same for the account of Lessee for such rent and upon such terms as shall be satisfactory to Lessor. For the purpose of such re- letting, Lessor is authorized to make any repairs, changes, alterations, or additions in or to Leased Premises that may be desirable, necessary or convenient, and, if the same are re-let and a sufficient sum shall not be realized from such re-letting after paying the unpaid Rental, Additional Rental or Forecast Additional Rental due hereunder earned but unpaid at the time of re- letting, plus interest thereon at a maximum lawful rate, the cost of recovering possession, and all of the costs and expenses of such repairs, changes, alterations, and additions and the expenses of such re-letting and of the collection of the rent accruing therefrom to satisfy all rent provided for in this Lease to be paid, the Lessee shall satisfy and pay any such deficiency upon demand therefor from time to time. If Lessor is unable to re-let the Lease Premises, then Lessee shall pay to Lessor as damages a sum equal to the amount of all rentals specified in this Lease for the term thereof. Lessee agrees that Lessor may file suit to recover any sums falling due under the terms of this paragraph from time to time, and that no delivery or recovery of any portion due Lessor hereunder shall be any defense to any subsequent action brought for any amount not previously reduced to judgment in favor of Lessor, nor shall such re- letting be construed as an election on the part of the Lessor to terminate this Lease unless a written notice of such intention be given to Lessee by Lessor. Notwithstanding any such re-letting without termination, Lessor may at any time thereafter elect to terminate this lease for any previous breach. (c) In the event of abandonment as defined in paragraph 14(a) above, of the Leased Premises by Lessee, Lessor may enter the premises to make inspections, to show prospective tenants and to remove and store any property of Lessee in the Leased Premises, without /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 15 terminating this Lease or limiting any other remedy of Lessor under this Lease. In addition to any other rights of Lessor, Lessor may dispose of the stored property if Lessee does not claim such property within sixty (60) days after the property is stored. Lessor shall deliver by certified mail to Lessee at Lessee's last known address a notice stating that Lessor may dispose of Lessee's property if Lessee does not claim the property within sixty (60) days after the date the property is stored. Lessee's rights in and to such stored property and Lessor's obligations as herein set forth with regard to such stored property are subject to and subordinated to the landlord's lien in and to all personal property of Lessee on the Leased Premises as set forth in paragraph 15(g). Notwithstanding anything herein to the contrary, upon an abandonment of the Leased Premises by Lessee, Lessor shall be under no obligation to re-enter the Leased Premises, store any property or take any other action. In any such event, Lessor may continue this Lease and recover the full amount of the rent to be paid hereunder as it comes due. (d) Pursuit of any remedy by Lessor, whether hereunder or otherwise, shall never be deemed an election of remedies. Lessee further agrees that failure by Lessor to use diligence in enforcing its rights against Lessee, or in requiring performance by Lessee of any of its obligations hereunder or in preserving the liability of Lessee hereunder, shall not impair, reduce or in any manner affect Lessor's rights or remedies hereunder, or Lessee's liability or obligations hereunder. (e) Exercise by Lessor of any one or more remedies hereunder granted or otherwise available shall not be deemed to be an acceptance of surrender of the Leased Premises by Lessee, whether by agreement or by operation of law, it being understood that such surrender can be effected only by the written agreement of Lessor and Lessee. No removal or other exercise of dominion by Lessor over the property of Lessee or others on the Leased Premises shall be deemed unauthorized or constitute a conversion, Lessee hereby consenting, after any event of default, to the aforesaid exercise of dominion over Lessee's property within the Leased Premises. All claims for damages, except to the property of Lessee or others on the Leased Premises, by reason of such re-entry and/or repossession are hereby waived, as are all claims for damages by reason of any distress warrant, forcible entry and detainer proceedings, sequestration proceedings or other legal process. Lessee agrees that any re-entry by Lessor may be pursuant to judgment contained in forcible entry and detainer proceedings or other legal proceedings or without the necessity for any legal proceedings if such re-entry may be accomplished without force, as Lessor may elect, and Lessor shall not be liable in trespass or otherwise. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 16 (f) If Lessee should fail to make any payment or cure any default hereunder within the time herein permitted, Lessor, without being under any obligation to do so and without thereby waiving such default, may make such payment and/or remedy such other default for the account of Lessee (and enter the Leased Premises for such purpose), and thereupon Lessee shall be obligated to, and hereby agrees, to pay Lessor, upon demand, all reasonable costs, expenses and disbursements (including reasonable attorneys' fees) incurred by Lessor in taking such remedial action. (g) In the event that Lessor shall have taken possession of the Leased Premises pursuant to the authority herein granted, then Lessor shall have the right to keep in place and use all of the furniture, fixtures, equipment, and other personal property at the Leased Premises, including that which is owned by or leased to Lessee, at all times prior to any foreclosure thereon by Lessor or repossession thereof by any Lessor thereof or third party having a lien thereon. Lessor shall also have the right to remove from the Leased Premises (without notice to Lessee and without the necessity of obtaining a distress warrant, writ of sequestration or other legal process) all or any portion of such furniture, fixtures, equipment and other property located thereon and place same in storage at any place within Travis County; and in such event, Lessee shall be liable to Lessor for costs incurred by Lessor in connection with such removal and storage. Lessor shall also have the right to relinquish possession of all or any portion of such furniture, fixtures, equipment and other property to any person ("Claimant") claiming to be entitled to possession thereof who presents to Lessor a copy of any instrument represented to Lessor by Claimant to have been executed by Lessee granting Claimant the right under the circumstances to take possession of such furniture, fixtures, equipment or other property, without the necessity on the part of Lessor to inquire into the authenticity of said instrument and without the necessity of Lessor making any investigation or inquiry as to the validity of the factual or legal basis upon which Claimant purports to act. 16. HOLDING OVER. In the event of holding over by Lessee after expiration or termination of this Lease without the written consent of Lessor, Lessee shall pay monthly as liquidated damages a sum equal to one and one-half (1 1/2) times the amount of the monthly Base Rental, Forecast Additional Rental and Additional Rental paid, or to be paid, by Lessee to Lessor for the last month of the Term for the entire holdover period. No holding over by Lessee after the Term of the lease shall operate to extend the Lease. In the event of any unauthorized holding over, Lessee shall indemnify Lessor against all claims for damages by any other Lessee to whom /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 17 Lessor may have leased all or any part of the Leased Premises covered hereby effective upon the termination of this Lease. Any holding over with the consent of Lessor in writing shall thereafter constitute this Lease a lease from month to month. 17. NON-WAIVER. Failure of Lessor to declare any default immediately upon occurrence thereof, or delay in taking any action in connection therewith, shall not waive such default, but Lessor shall have the right to declare any such default at any time and take such action as might be lawful or authorized hereunder, either at law or in equity. 18. DEFAULT BY LESSOR. Except as may otherwise be provided herein, Lessor shall not be in default unless Lessor fails to perform obligations required of Lessor within a reasonable time, but in no event later than thirty (30) days after written notice by Lessee to Lessor and to the holder of any first mortgage or deed of trust covering the Leased Premises whose name and address shall have been furnished previously to Lessee in writing, specifying wherein Lessor has failed to perform such obligations; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are required for performance, then Lessor shall not be in default if Lessor commences performance within such thirty (30) day period and thereafter diligently prosecutes the same to completion. Except as may otherwise be provided herein, Lessee shall not have the right to terminate this Lease, it being agreed that Lessee's remedies shall be limited to actual damages, without any award for incidental or consequential damages. 19. ASSIGNMENT AND SUBLETTING. (a) Lessee may assign the Leased Premises or any part thereof or sublease, mortgage, pledge, or hypothecate its leasehold interest only with the prior express written permission of Lessor. Such permission shall not be unreasonably withheld or delayed. Any attempt to do any of the foregoing without the prior express written permission of Lessor, shall be void and of no effect. Lessee must furnish to Lessor the name and terms of any proposed assignment or sublease of each proposed assignee or sublessee. (b) Any assignment or sublease of the leasehold, whether or not consent is required under the terms of this Lease, and consent to any assignment or sublease by Lessor, shall not operate to release Lessee of any obligation hereunder and Lessee shall remain liable for the performance of all of the covenants, duties, and obligations hereunder including without limitation /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 18 the obligation to pay all rent and other sums herein provided to be paid, and Lessor shall be entitled to enforce the provisions of this instrument against the Lessee and/or against any assignee or sublessee, or either of them, at the election of Lessor. (c) Lessee shall give Lessor written notice of the consummation of any assignment or sublease consented to by Lessor, shall furnish to Lessor copies of all assignments, transfers, subleases, and other documents executed in connection with such assignment or sublease, and shall notify Lessor in writing of the date the assignee or sublessee takes possession of the Leased Premises or a portion thereof. (d) Lessee shall require of any sublessee a security deposit equal to at least one month's rent with Lessor to be held pursuant to the terms of paragraph 9 above. 20. SUBORDINATION. This Lease and Lessee's rights hereunder are and will remain subordinate to any ground lease, mortgage, deed of trust or any other hypothecation for security now or hereafter placed upon the Leased Premises, and to all increases, renewals, modifications, consolidations, replacements, and extension thereof (collectively referred to as the "Mortgage"). If the holder of a Mortgage becomes the owner of the Leased Premises by reason of foreclosure or acceptance of a deed in lieu of foreclosure, at such holder's election Lessee will be bound to such holder or its successor-in-interest under all terms and conditions of this Lease, and Lessee will be deemed to have attorned to and recognized such holder or successor as Lessor's successor-in-interest for the remainder of the Lease term or any extension thereof. In such event, the holder of such Mortgage will agree that, so long as Lessee is not then in default hereunder, such holder will recognize this Lease and will not disturb Lessee in its possession of the Leased Premises for any reason other than one which would entitle the Lessor to terminate this Lease under its terms. The foregoing is self-operative and no further instrument of subordination and/or attornment will be necessary unless required by Lessor or the holder of a Mortgage, in which case Lessee will, within ten (10) days after written request, execute and deliver without charge any documents reasonably required by Lessor or such holder in order to confirm the subordination and attornment set forth above. Should the holder of a Mortgage request that this Lease and Lessee's rights hereunder be made superior, rather than subordinate, to the Mortgage, then Lessee will, within ten (10) days after written request, execute and deliver without charge such agreement as may be reasonably required by such holder in order to effectuate and evidence such superiority of the Lease to the Mortgage. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 19 21. MISCELLANEOUS. (a) Attorney's Fees. In case it should be necessary or proper for Lessor or Lessee to bring any action under this Lease, then the prevailing party in any such action shall be entitled to reasonable attorneys' fees, expenses and court costs from the non-prevailing party. (b) Lessor's Entry/Inspections. With 4 hours notice, Lessor's agents and representatives shall have the right to enter the Leased Premises at any reasonable time during business hours (or at any time in case of emergency) (i) to inspect the Premises, (ii) to make such repairs as may be required or permitted pursuant to this Lease, and/or (iii) during the last 180 day period prior to expiration of this Lease or following notice from Lessee of Lessee's intent to cancel this Lease pursuant to paragraph 3 above, for showing the Leased Premises to any prospective tenant. In addition, Lessor shall have the right to erect a suitable sign on the Leased Premises stating the Leased Premises are available for lease. Lessee will provide Lessor with all keys necessary to enter the Leased Premises in case of an emergency. (c) No Partnership or Agency. Lessor does not in any way or for any purpose become a partner of Lessee in the conduct of its business or otherwise, or a joint venturer with Lessee. Lessee shall not be deemed an agent of Lessor for any purpose. (d) Accord and Satisfaction. No payment by Lessee or receipt by Lessor of a lesser amount than the monthly consideration or other payments herein stipulated shall be deemed to be other than an account of the earliest stipulated monthly consideration or other payments then due, or shall any check or writing accompanying any check or payment as monthly consideration or other payment provided for herein be deemed an accord or satisfaction; and Lessor may accept such check or payment without prejudice to Lessor's right to recover the balance of such monthly consideration or other payments or to pursue other remedies provided in this Lease or by law. (e) Acceptance of Leased Premises and Building by Lessee. In consideration of the Allowance granted by Lessor to Lessee under paragraph 22 hereof, the taking of possession of the Leased Premises by Lessee shall be conclusive evidence as against Lessee (1) that Lessee accepts the Leased Premises in "AS IS" condition and as suitable for the purpose for which same is leased; (2) that it accepts the Building and the land and each and every part and appurtenance thereof as being in a good and satisfactory condition; and (3) that Lessee waives any defects in the Leased Premises and its appurtenances. Lessor shall not be liable, except in the /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 20 event of negligence if and to the extent such liability is indemnified by insurance, and in the event of the intentional act or gross negligence notwithstanding whether such claim is indemnified by insurance, to Lessee or any of its agents, employees, and servants for any injury or damage to person or property due to the condition or design of or any defect in the Building or its mechanical systems and equipment which may exist or occur. Lessor shall be liable for simple negligence only to the extent Lessor is indemnified by insurance. In addition to a visual inspection of the Leased Premises, Lessor warrants and conveys to Lessee that the Leased Premises are in good working order at lease commencement including but not limited to: the roof membrane, HVAC, Telephone System and security system. (f) Laws Governing. The laws of the State of Texas shall govern the interpretation and validity of, and other matters pertaining to, this lease. (g) Notice. Any notice which may or shall be given under the terms of this Lease shall, unless otherwise provided herein, be in writing and shall be either delivered by hand or sent by United States Registered or Certified Mail, postage prepaid, to the address below. Such addresses may be changed from time to time by either party by giving written notice as provided above. Notice shall be deemed given when delivered (if delivered by Hand) or when postmarked (if sent by mail). LESSOR: RGK RENTALS, LTD. 1301 West 25th Street, Suite 300 Austin, Texas 78705 Attention: David McNeil LESSEE: APPLIED SCIENCE FICTION, INC. 8920 Business Park Drive Austin, Texas 78759 Attention: Mark Urdahl LESSEE: FACILITIES SERVICES, INC. P.O. Box 830849 Richardson, Texas 75083 Attention: Jimmie Mayhew /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 21 (h) Severability. If any clause or provision of this Lease is illegal, invalid, or unenforceable, under present or future laws effective during the term hereof, then it is the intention of the parties hereto that the remainder of this lease shall not be affected thereby, and it is also the intention of both parties that in lieu of each clause or provision that is illegal, invalid, or unenforceable, there be added as a party of this Lease a clause or provision as similar to in terms to such illegal, invalid, or unenforceable clause or provision as is enforceable. (i) Entire Agreement and Binding Effect. This Lease Agreement, including exhibits A, B, C and D all of which are hereby incorporated herein by reference, constitute the entire agreement between Lessor and Lessee; no prior written or prior contemporaneous oral promises or representations shall be binding. Paragraph captions herein are for convenience only, and neither limit nor amplify the provisions of this Lease. The provisions of this Lease shall be binding upon and insure to the benefit of the heirs, executors, administrator, successors, and assigns of the parties, but this provision shall in no way alter the restriction herein in connection with assignment and subletting by Lessee. (j) Assignment by Lessor. Lessor shall have the right to transfer and assign, in whole or in part, all of its rights and obligations hereunder and in the Building and the Leased Premises referred to herein. (k) Alterations. This Lease may not be altered, changed, or amended, except by an instrument in writing signed by both parties herein. (l) Gender. When required for clarity, the masculine gender shall also include the feminine and neuter. 22. REFURBISHMENT ALLOWANCE. Lessor grants to Lessee a refurbishment allowance of $269,920.00 (the "Allowance") to be used by Lessee for improvements to and renovation of the Leased Premises (the "Improvements"). Upon submission of invoices and releases by Lessee, Lessor shall promptly reimburse Lessee for actual costs incurred in construction of the Improvements. Lessee is solely responsible for the cost of any Improvements in excess of the Allowance. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 22 23. Brokerage. Lessor agrees to pay to KAM Properties, Inc. and the Don Cox Company of Austin, Texas, for services performed in procurring and negotiating this agreement, as set out in the Commission Agreement executed February 20, 1998. EXECUTED this 20th day of March, 1998 LESSOR: RKG RENTALS, LTD. By: KMS Ventures, Inc., Partner By: /s/ Gregory A. Kozmetsky ------------------------------- Gregory A. Kozmetsky, President LESSEE: APPLIED SCIENCE FICTION, INC. By: /s/ Mark Urdahl ------------------------------ Mark Urdahl, President and C.E.O. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 23 EXHIBIT A LEASED PREMISES BALCONES NORTH OFFICE BUILDING [FLOOR PLAN APPEARS HERE] /s/ /s/ - ------------------ --------------------- Lessor Lessee A-1 EXHIBIT B RULES AND REGULATIONS 1. No signs of any kind or nature, symbol, or identifying mark shall be put on the Building, elevators, staircases, entrances, parking areas or upon the doors or walls, whether plate glass or otherwise of the Leased Premises nor within the Leased Premises so as to be visible from the public areas or exterior of the Building, without prior written approval of Lessor. All signs or lettering shall conform in all respects to the sign and/or lettering criteria established by Lessor. 2. Lessee shall not make or permit any loud or improper noises in the building or otherwise interfere in any way with other Lessees. 3. Lessor will not be responsible for any lost or stolen personal property or equipment from the Leased Premises or public areas, regardless of whether such loss occurs when the area is locked against entry or not. 4. Lessee, or the employees, agents, servants, visitors, or licensees of Lessee shall not, at any time or place, leave or discard rubbish, paper, articles, or objects of any kind whatsoever outside the doors of the Leased Premises or in the corridors or passageways of the Building. No animals or vehicles of any description shall be brought into or kept in or about the building. 5. None of the entries, passages, doors, hallways, or stairways in the building shall be blocked or obstructed. 6. Lessor shall have the right to determine and prescribe the weight and proper position of any unusually heavy equipment, including computers, safes, large files, etc., that are to be placed in the building, and only those which in the exclusive judgment of the Lessor will not do damage to the floors, structure, and/or elevators may be moved into the Building. Any damage caused by installing, moving, or removing such aforementioned articles in the Building shall be paid by Lessee. 7. All Christmas and other decorations must be constructed of flame retardant materials. 8. All doors leading from public corridors to the Leased Premises are to be kept closed when not in use. 9. Canvassing, soliciting, or peddling in the Building is prohibited and Lessee shall cooperate to prevent the same. 10. Lessee shall give immediate notice to Lessor in case of accidents in the Leased Premises or in the Building or of defects therein or in any fixtures or equipment, or of any known emergency in the Building. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 1 EXHIBIT C TELEPHONE SYSTEM A complete inventory of the Telephone System will be delivered to Lessee at Lessee's possession of the Leased Premises /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 1 EXHIBIT D FAIR MARKET RENTAL RATE If Lessee elects to renew this Lease, Base Rental and Forecasted Additional Rental for each renewal term shall be an amount equal to one hundred percent (100%) of the Fair Market Rental Rate of the Leased Premises in relation to market conditions at the time of the extension. The Fair Market Rental Rate of the Leased Premises shall be determined as follows: After timely receipt by Lessor of Lessee's notice of exercise of option to renew the Lease, Lessor and Lessee shall have a period of thirty (30) days in which to agree on the Fair Market Rental Rate as the Base Rental for the Leased Premises. If Lessor and Lessee agree on the Fair Market Rental Rate for the Leased Premises, then they shall immediately execute a new lease. In the event that Lessor and Lessee are unable to agree as to the Fair Market Rental Rate of the Leased Premises under a renewal of the Lease within thirty (30) days after such notice of intent to renew was given by Lessee, Lessor and Lessee shall each promptly appoint an appraiser, and the two appraisers so appointed shall select a third, or if they cannot agree upon a third appraiser, either party may petition a court of competent jurisdiction for the appointment of a third appraiser; provided, however, that each appraiser must be an "MAI" appraiser with at least five (5) years experience in appraising real property in Travis County, Texas. Each party shall be responsible for the compensation, if any, of the third appraiser. Such appraisers shall each make a separate appraisal of the Fair Market Rental Rate of the Leased Premises under a renewal of the Lease and shall deliver copies of their appraisals to Lessor and Lessee, and the average of the three appraisals shall be the figure designated as the Fair Market Rental Rate for the purposes of this renewal option. Lessor and Lessee shall, separately and collectively and in good faith, take any necessary steps to insure that all three appraisals are completed within thirty (30) days after the appointment of the first appraiser to be appointed. If Lessee wishes to renew the Lease at the Fair Market Rental Rate determined by such appraisal, Lessee shall, within ten (10) days after the last appraisal has been delivered to it, give notice in writing to Lessor of Lessee's agreement to renew the Lease at a rental rate equal to the average of the three appraisals, which rental rate shall be specified in such notice. Failure by Lessee to timely give such notice of agreement shall terminate the right of Lessee to renew the Lease. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 1 11. Lessee shall not use the Leased Premises or permit the Leased Premises to be used for photographic multilith, or multigraph reproductions, except in connection with its own business without Lessor consent and Lessor will not unreasonably withhold consent. 12. Any damages (excepting normal wear and tear) caused to carpet in the Leased Premises shall be repaired or replaced at the expense of Lessee. 13. Lessee, or the employees, agents, servants, visitors, or licensees of Lessee, shall abide by the Rules and Regulations established from time to time for the parking area. 14. Lessee shall not allow to pass into any sewer, drain, or toilet serving the Leased Premises or located in the Building any oil, grease, or any other deleterious effluent or substance which may cause an obstruction in or damage to such sewer, drain, or toilet. 15. All areas within the Building are designated as "no smoking areas". 16. Lessor reserves the right, after consultation with Lessee, to rescind any of these Rules and Regulations of the Building, and to make such other and further Rules and Regulations of the Building as in its judgment shall from time to time be needful for the safety, protection, care and cleanliness of the Building, the Leased Premises, and the operation thereof, the preservation of good order therein, and the protection and comfort of the other Lessees in the Building and their agents, employees, and invitees. Changes in these Rules and Regulations, when made and written notice thereof is given to Lessee, shall be binding upon Lessee in like manner as if originally herein prescribed. Provided, however, such changes shall not operate so as to change the provisions of the lease agreement between lessor and lessee and as long as changes do not effect normal operations of business that are in place at the time on a day-to-day basis. /s/ /s/ - ---------------------------------- ------------------------------------- Lessor Lessee 2 EX-10.6 7 IBM LICENSE AGREEMENT CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 EXHIBIT 10.6 103095 AGREEMENT with an effective date of October 31, 1995 between INTERNATIONAL BUSINESS MACHINES CORPORATION, a New York corporation (hereinafter called IBM), and APPLIED SCIENCE FICTION, a Delaware corporation (hereinafter called LICENSEE). IBM has the right to license others under certain patents. LICENSEE desires to acquire a nonexclusive license under those patents. In consideration of the premises and mutual covenants herein contained, IBM and LICENSEE agree as follows: Section 1. Definitions 1.1 "Information Handling System" shall mean any instrumentality or aggregate of instrumentalities primarily designed to compute, classify, process, transmit, receive, retrieve, originate, switch, store, display, manifest, measure, detect, record, reproduce, handle or utilize any form of information, intelligence or data for business, scientific, control or other purposes. 1.2 "IHS Product" shall mean: 1.2.1 an Information Handling System; or 1 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 1.2.2 any instrumentality or aggregate of instrumentalities (including, without limitation, any component, subassembly or program) designed for incorporation into an Information Handling System. An apparatus primarily designed for use in the fabrication (including testing) of an IHS Product shall not be considered an IHS Product even if it otherwise meets the above definition. 1.3 "Type Number" shall mean the combination of numbers, letters or words utilized by LICENSEE to identify each type or model of Licensed Product. 1.4 "Licensed Patents" shall mean the patents listed in Exhibit 1 to this Agreement, any patents issuing on the applications listed in Exhibit 1, any patents of other countries corresponding to the listed patents and applications, and any reissues, divisions, continuations, or extensions of the foregoing patents and applications. 1.5 "Licensed Products" shall mean IHS Products which capture, create, process, handle, transmit, store, or output images. 1.6 "Patented Portion" shall mean that portion of a Licensed Product which embodies or uses all of the elements or steps recited in one claim of one Licensed Patent or which is 2 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 manufactured by the use of all of the steps recited in one claim of one Licensed Patent or which is capable of being used to practice the method recited in one claim of one Licensed Patent. A Licensed Product which embodies or uses all of the elements or steps recited in more than one claim of one Licensed Patent or in the claims of more than one Licensed Patent shall have more than one Patented Portion. 1.7 "Subsidiary" shall mean a corporation, company or other entity: 1.7.1 more than fifty percent (50%) of whose outstanding shares or securities (representing the right to vote for the election of directors or other managing authority) are, now or hereafter, owned or controlled, directly or indirectly, by a party hereto, but such corporation, company or other entity shall be deemed to be a Subsidiary only so long as such ownership or control exists; or 1.7.2 which does not have outstanding shares or securities, as may be the case in a partnership, joint venture or unincorporated association, but more than fifty percent (50%) of whose ownership interest representing the right to make the decisions for such corporation, company or other entity is now or hereafter, owned or controlled, directly or indirectly, by a party hereto, but such corporation, company or other entity shall be 3 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 deemed to be a Subsidiary only so long as such ownership or control exists. 1.8 "LICENSEE's Selling Price" for each Licensed Product sold by LICENSEE to other than its affiliate shall mean the bona fide selling price, after prompt payment discounts and quantity discounts actually allowed, at which LICENSEE sold said Licensed Product. If said selling price includes the following items, they may be deducted only if separately invoiced to LICENSEE's customer: packing, transportation and insurance charges; import, export, excise, sales and value added taxes; and customs duties. "LICENSEE's Selling Price" for each Licensed Product sold by LICENSEE to one of its affiliates shall be equal to the average of the LICENSEE's Selling Prices for all Licensed Products identical to said Licensed Product which were sold to other than LICENSEE's affiliates in the relevant semiannual accounting period. Section 2. License 2.1 IBM grants to LICENSEE a nonexclusive license under the Licensed Patents: 2.1.1 to make, use, import, and lease, sell and otherwise transfer Licensed Products; and 2.1.2 to use any apparatus in the manufacture of Licensed Products and practice any method or process in the manufacture or use of Licensed Products. 4 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 The license granted in this Section 2.1 for any particular Licensed Product shall be only under claims of Licensed Patents which claims define a Patented Portion for said particular Licensed Product and which are claims of Licensed Patents of the countries of manufacture, use, importation, or lease, sale or other transfer by LICENSEE. A particular Licensed Product is licensed under a Licensed Patent when and only when: 2.1.3 such Licensed Patent defines a Patented Portion of such Licensed Product; 2.1.4 such Licensed Patent was identified in a report, as specified in Section 5.5, as covering such Licensed Product; and 2.1.5 the royalty attributable to such Licensed Product was either timely paid as required by Section 5.4 or a late payment was made and accepted by IBM pursuant to Section 5.2. 2.2 No license, immunity or other right is granted by IBM either directly or by implication, estoppel, or otherwise: 2.2.1 other than under the Licensed Patents; 2.2.2 to have Licensed Products made by a third party for LICENSEE; 2.2.3 with respect to any Licensed Product which does not fully include a Patented Portion; 5 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 2.2.4 with respect to any item other than a Licensed Product notwithstanding that such other item may incorporate one or more Licensed Products; or 2.2.5 to parties acquiring any item from LICENSEE for the combination of such acquired item with any other item, including other items provided by LICENSEE, or for the use of any such combination even if such acquired item has no substantial use other than as part of such combination. Section 3. Extension of License to Subsidiaries 3.1 The license granted herein by IBM is also granted to LICENSEE's Subsidiaries, provided that: 3.1.1 each Subsidiary so licensed shall be bound by the terms and conditions of this Agreement as if it were named herein in the place of LICENSEE; and 3.1.2 LICENSEE shall pay and account to IBM for royalties hereunder in respect of the exercise by any Subsidiary of any license granted to it hereunder. Any license granted to a Subsidiary shall terminate on the date such Subsidiary ceases to be a Subsidiary. Section 4. Royalty and Other Payment 4.1 LICENSEE shall pay, as hereinafter provided, royalties to IBM in respect of each Licensed Product having one or more Patented Portions by virtue of one or more Licensed Patents of 6 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 the countries of manufacture, use, or lease, sale, or other transfer. 4.2 Subject to Sections 4.3, 4.5 and 4.6, for each Licensed Product which includes one or more Patented Portions and which is manufactured, used, or leased, sold or otherwise transferred in any country by or for LICENSEE, LICENSEE shall pay a royalty at a rate computed at the following percentages of LICENSEE's Selling Price of such Licensed Product: Number of Licensed Patents Percentage of Licensee's Defining Patented Portions Selling Price -------------------------- ------------------------ 1 [*] 2 [*] 3 [*] 4 [*] 5 or more [*] For the purposes of this Section 4.2, a Licensed Patent and its corresponding patents shall be deemed to be one Licensed Patent. 4.3 In computing royalties on a Licensed Product, LICENSEE may exclude from the number of Licensed Patents used to compute royalties under Section 4.2, any Licensed Patent that defines one or more Patented Portions which are fully included in an item that is part of the Licensed Product and which was purchased by Licensee directly or indirectly from a third party who was authorized by IBM to sell such item. If, however, a Licensed 7 - ----------- [*] Indicates that material has been omitted and confidential treatment requested therefor. All such material has been filed separately with the Commission pursuant to Rule 406. CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 Patent also defines another Patented Portion not fully included in such purchased item, that particular Licensed Patent must be counted in the number of Licensed Patents used to compute the percentage of LICENSEE's Selling Price of the Licensed Product in accordance with Section 4.2. 4.4 If LICENSEE purchases from a third party portions of a Licensed Product and combines such portions with each other and/or with other portions such that the combination is itself a Licensed Product which includes a Patented Portion not fully included in any individual purchased portion, then royalty shall be due for the combination in accordance with this Section 4, notwithstanding the fact that said third party is authorized by IBM to sell said purchased portions. 4.5 No royalties shall be paid by LICENSEE for Licensed Products which LICENSEE manufactures for a third party where: 4.5.1 the third party is licensed by IBM to have such Licensed Product manufactured for it; and 4.5.2 LICENSEE received prior authorization from such third party under such party's license from IBM for such manufacture. 4.6 For royalties accruing through December 31, 1995, if a Licensed Product is covered by more than four (4) Licensed Patents, LICENSEE may, at his election, pay a royalty of four 8 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 percent (4%) of the LICENSEE's Selling Price of said Licensed Product. On January 1, 1996, this Section 4.6 and the reference to it contained in Section 4.2 shall be deemed to have been automatically deleted from this Agreement. 4.7 LICENSEE shall bear and pay all taxes (including, without limitation, sales and value added taxes) imposed by the national government (including any political subdivision thereof) of any country in which LICENSEE is doing business, as the result of the existence of this Agreement or the exercise of rights hereunder. Section 5. Accruals, Records, Reports and Other Information 5.1 Royalties shall accrue when a Licensed Product, with respect to which royalty payments are required by this Agreement, is first sold or otherwise transferred (including, except as otherwise agreed in writing by IBM, sold or otherwise transferred to IBM or any of its Subsidiaries), or first used or leased in each country of use or lease, by or for LICENSEE, or when a newly issued or acquired Licensed Patent covers any portion of a Licensed Product in use or on lease by or for LICENSEE on which portion the royalties provided for in Section 4.1 have not previously accrued. 5.2 IBM may accept a late payment provided such payment includes all overdue royalties or other payment plus an interest penalty. The interest penalty on any overdue royalty or other payment 9 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 shall be calculated commencing on the date such royalty or other payment became due, using an annual rate which is the greater of ten percent (10%) or one percentage point higher than the prime interest rate as quoted by the head office of Citibank N.A., New York, at the close of banking on such date, or on the first business day thereafter if such date falls on a non-business day. If such interest rate exceeds the maximum legal rate in the jurisdiction where a claim therefor is being asserted, the interest rate shall be reduced to such maximum legal rate. 5.3 LICENSEE shall pay all royalties and other payments due hereunder in United States dollars. All royalties for an accounting period computed in other currencies shall be converted into United States dollars at the exchange rate for bank transfers from such currency to United States dollars as quoted by the head office of Citibank N.A., New York, at the close of banking on the last day of such accounting period (or the first business day thereafter if such last day shall be a non-business day). 5.4 LICENSEE's accounting period shall be semiannual and shall end on the last day of each June and December during the term of this Agreement. Within sixty (60) days after the end of each such period LICENSEE shall furnish to IBM a written report containing the information specified in Section 5.5 and shall pay 10 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 to IBM all unpaid royalties accrued hereunder to the end of each such period. 5.5 LICENSEE's written report shall be certified by an officer of LICENSEE and shall contain the following information: 5.5.1 for each Type Number of each Licensed Product upon which royalty has accrued, the Type Number, a description of said Licensed Product, the quantity sold or otherwise transferred during the accounting period, and the total LICENSEE Selling Price for such quantity; 5.5.2 each country in which the Licensed Products identified pursuant to Section 5.5.1 were manufactured or leased, sold or otherwise transferred; 5.5.3 each Licensed Patent covering each such Licensed Product upon which LICENSEE is paying royalties. However, if LICENSEE pays royalties for the use of five (5) or more Licensed Patents for a particular Licensed Product pursuant to Section 4, LICENSEE shall have no obligation to identify the Licensed Patents for that Licensed Product; 5.5.4 the amount of royalties due for each Licensed Product; 5.5.5 the aggregate amount of all royalties due; 5.5.6 on IBM's request, the name and address of any third party providing items as described in Section 4.3; 5.5.7 for each Type Number of Licensed Product which LICENSEE has delivered during such accounting period to a third 11 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 party and which is exempt from royalty under Section 4.5, the quantity delivered, a description of such Licensed Product, and the name of such third party; and 5.5.8 in the event that any of Sections 5.5.1 through 5.5.7 do not apply to an accounting period, LICENSEE shall so state as to each such Section. In the event no royalties are due, LICENSEE'S report shall so state. 5.6 For the purpose of determining obligations under IBM patents, LICENSEE shall, within thirty (30) days of a written request by IBM: 5.6.1 provide to or make available for inspection by IBM or its designee a copy of any materials (including, but not limited to, brochures and service, use and other technical manuals) relevant to any product identified by IBM; 5.6.2 sell, license or otherwise transfer and deliver to IBM any product at any time offered for sale or license or otherwise marketed or transferred by LICENSEE or, at IBM's option, make such product available to IBM for inspection on LICENSEE'S premises. Such sale, license or transfer shall occur under LICENSEE'S generally available terms and conditions, subject to the time requirement specified in this Section 5.6; and 12 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 5.6.3 provide to IBM or its designee access to those manufacturing processes used by LICENSEE in the manufacture of LICENSEE's products. 5.7 LICENSEE shall keep records in accordance with generally accepted accounting principles and in sufficient detail to permit the determination of products subject to this Agreement, the royalties due IBM, and the accuracy of the information on LICENSEE's written reports. Such records shall include, but not be limited to, detailed records supporting the information provided under Section 5.5. Such records shall be kept for six (6) years following the due date for the report relating to the reporting period to which such records pertain. Upon IBM's written request for an audit, LICENSEE shall permit auditors designated by IBM, together with such legal and technical support as IBM deems necessary, to examine, during ordinary business hours, records, materials, and manufacturing processes of LICENSEE for the purpose of determining royalties due IBM. Such audit shall be restricted to an audit of those records, materials, and manufacturing processes related to Licensed Products or Licensed Patents. Such records and materials shall 13 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 be deemed to include general financial information to provide a cross-check for the amount of royalties reported. Such general financial information shall include, but not be limited to, records on the total revenue for the period covered by the audit with documentation supporting the fact that the part of LICENSEE's total revenue which exceeds the reported total of LICENSEE's Selling Price for Licensed Product was derived from activities other than the sale, lease or other transfer of Licensed Products. LICENSEE shall provide its full cooperation in such audit. Such cooperation shall include, but not be limited to, providing sufficient time for such examination and convenient access to relevant personnel and records. Each party shall pay the costs that it incurs in the course of the audit. However, in the event that the audit establishes underpayment greater than or equal to the lesser of: five percent (5%) of the royalties which should have been paid for the accounting periods being audited or the cost of the audit, then LICENSEE shall reimburse IBM for the costs IBM incurred in conducting such audit. However, such costs shall not include salaries paid to IBM employees associated with such audit and such reimbursement shall not exceed the amount of underpayment. 14 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 5.8 In the event an audit under the provisions of Section 5.7 identifies an underpayment of royalties by LICENSEE, LICENSEE shall pay an amount equal to the sum of such underpayment, any interest due under the provisions of Section 5.2, and any reimbursement to IBM for the costs IBM incurred in conducting such audit as specified by Section 5.7, within sixty (60) days of IBM's written request. Such amounts shall be subject to interest under the provisions of Section 5.2. Section 6. Term of Agreement; Termination 6.1 The term of this Agreement shall be from the effective date of this Agreement until five (5) years after said date. 6.2 LICENSEE may terminate the license granted herein, in whole or as to any specified Licensed Patent by giving notice in writing to IBM, provided, however, that termination of the license as to any specified Licensed Patent shall include termination of the license as to all Licensed Patents in other countries which correspond to such specified License Patent. Such termination shall be effective on the date such notice is mailed unless the notice specifies a later date. Any such termination shall be irrevocable. 6.3 IBM shall have the right to terminate this Agreement, or LICENSEE's license granted hereunder, if LICENSEE: 6.3.1 fails, at any time: 15 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 6.3.1.1 to make a report which meets the requirements of Section 5.5; 6.3.1.2 to pay any accrued royalties; 6.3.1.3 to make any other payment required herein; 6.3.1.4 to permit an audit pursuant to Section 5.7; or 6.3.1.5 to comply with the provisions of Section 5.6; and 6.3.2 does not cure such failure (including the payment of any interest due pursuant to Section 5.2) within sixty (60) days after written notice from IBM to LICENSEE specifying the nature of such failure. IBM's termination of this Agreement or of LICENSEE's license shall be given by written notice to LICENSEE by mail or by facsimile transmission, effective on the date of mailing or transmission. 6.4 IBM shall notify LICENSEE in the event IBM identifies an underpayment of accrued royalties. IBM shall provide to LICENSEE the basis on which it has identified such underpayment. If LICENSEE cannot show that the basis used is substantially incorrect, IBM may, in its sole discretion, terminate LICENSEE's license. In such event, IBM shall institute an audit. If such audit shows that the LICENSEE's payments of royalties are substantially correct for the period being audited, LICENSEE's license shall be reinstated effective as of the date of its termination. 16 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 6.5 In the event this Agreement or the license granted hereunder, in whole or as to any specified patent or claim, shall be terminated pursuant to this Section 6, the corresponding licenses granted to Subsidiaries of LICENSEE pursuant to Section 3 shall likewise terminate, but no notices need be given by IBM to such Subsidiaries. 6.6 In the event that more than fifty percent (50%) of LICENSEE's outstanding shares or securities (representing the right to vote for the election of directors or other managing authority) are now, or hereafter become, owned or controlled, directly or indirectly, by a third party, LICENSEE's license shall terminate unless IBM agrees otherwise in a signed writing. 6.7 No termination pursuant to this Section 6, Section 3.1 or Section 12.9 shall relieve LICENSEE of any obligation or liability accrued hereunder prior to such termination, or rescind or give rise to any right to rescind anything done by LICENSEE or any payments made or other consideration given to IBM hereunder prior to the time such termination becomes effective. Such termination shall not affect in any manner any rights of IBM arising under this Agreement prior to such termination, even though the exercise of such rights occurs after such termination. Section 7. Options for Other Licenses 17 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 7.1 LICENSEE grants to IBM the right to obtain, at any time, and from time to time, during the term of this Agreement, a license upon terms and conditions, including royalty rates, no less favorable than those granted to LICENSEE herein or in any amendment hereto. Said right shall be with respect to any IHS Product and any patent, including utility models and including design patents for type fonts and registrations for type fonts (but not including any other design patents or registrations), issued prior to the termination of this Agreement, which patent covers an invention applicable to IHS Products or any method or process involved in the manufacture or use of such IHS Product and under which patent, or the application therefor, LICENSEE or any of its Subsidiaries has the right, at any time during the term of this Agreement, to grant licenses to third parties (other than Subsidiaries). Said right of IBM shall be exercisable with respect to any such patents whether or not issued and whether or not the applications therefor exist at the time such right is exercised. If IBM exercises said right, IBM shall pay to LICENSEE the sum of five thousand United States dollars ($5,000) if such license is for a single patent of one country and its corresponding patents, or twenty-five thousand United States dollars ($25,000) if such license is for two or more patents, which sum shall be creditable against royalties payable by IBM under the provisions of said license agreement. The date of said license agreement shall be the date on which IBM requests such license. 18 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 Section 8. Warranty 8.1 IBM represents and warrants that it has the full right and power to grant the license set forth in Section 2, and that there are no outstanding agreements, assignments, or encumbrances inconsistent with the provisions of said license or with any other provisions of this Agreement. IBM makes no other representations or warranties, express or implied, nor does IBM assume any liability, in respect of any infringement of patents or other rights of third parties due to LICENSEE's operation under the license herein granted. 8.2 IBM does not warrant nor does it represent that LICENSEE will not require a license under other patents (owned by IBM or by third parties) to make, use, import, or lease, sell or otherwise transfer Licensed Products. Section 9. Means of Payments and Communications 9.1 Payment shall be made by electronic funds transfer. Any notice or other communication required or permitted to be made or given to either party hereto pursuant to this Agreement shall be sent to such party by facsimile or by registered airmail (except that registered or certified mail may be used where delivery is in the same country as mailing), postage prepaid, addressed to it at its address set forth below, or to such other address as it shall designate by written notice given to the other party. Payments shall be deemed to be made on the date of electronic 19 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 funds transfer. Notices or other communications shall be deemed to have been given or provided on the date of sending. The addresses are as follows: 9.1.1 For electronic funds transfers of payments: IBM Director of Licensing The Bank of New York 48 Wall Street New York, New York 10286 United States of America Credit Account No. 890-0209-674 ABA No. 0210-0001-8 9.1.2 For mailing to IBM: Director of Licensing International Business Machines Corporation 500 Columbus Avenue Thornwood, New York 10594 United States of America 9.1.3 For facsimile transmission to IBM: (914) 742-6737 9.1.4 For mailing to LICENSEE: Controller Applied Science Fiction 2700 West Anderson Lane, Suite 901 Austin, TX 78757 9.1.5 For facsimile transmission to ASF: (512) 450-0397 Section 10. Trade Secrets, Know-How and Copyrights 10.1 No license or other right is granted herein to either party, directly or by implication, estoppel or otherwise, with respect to any trade secrets or know- how, and no such license or other 20 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 right shall arise from the consummation of this Agreement or from any acts, statements or dealings leading to such consummation. Except as specifically provided herein, neither party is required hereunder to furnish or disclose to the other any technical or other information. 10.2 No license or other right is granted herein to either party, directly or by implication, estoppel or otherwise to or under copyrights, or mask work or similar rights. Section 11. Assignments 11.1 IBM shall neither assign nor grant any right under any of its Licensed Patents, and LICENSEE shall neither assign nor grant any right under any of its patents which are subject to IBM's rights pursuant to Section 7, unless such assignment or grant is made subject to the terms and conditions of this Agreement. LICENSEE shall neither sublicense nor assign any of its rights or privileges hereunder without the prior written consent of IBM. Any attempted sublicense, assignment, or grant in derogation of the foregoing shall be void. Section 12. Miscellaneous 12.1 Nothing contained in this Agreement shall be construed as conferring on either party any license or other right to copy the exterior design of the products of the other party. 21 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 12.2 Nothing contained in this Agreement shall be construed as conferring any right to use in advertising, publicity, or other promotional activities any name, trade name, trademark or other designation of either party hereto (including any contraction, abbreviation or simulation of any of the foregoing). Each party hereto agrees not to use or refer to this Agreement or any provision thereof in any promotional activity associated with products licensed hereunder, without the express written approval of the other party. 12.3 Nothing contained in this Agreement shall be construed as limiting the rights which the parties have outside the scope of the license granted hereunder, or restricting the right of either party or any of its Subsidiaries to make, have made, use, or lease, sell or otherwise dispose of any particular product or products not herein licensed. 12.4 Neither party nor any of its Subsidiaries shall be required hereunder to file any patent application, or to secure any patent or patent rights, or to maintain any patent in force, or to provide copies of patent applications to the other party or its Subsidiaries, or to disclose any inventions described or claimed in such patent applications. 12.5 IBM shall not have any obligation hereunder to institute any action or suit against third parties for infringement of any 22 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 patent applications or Licensed Patents or to defend any action or suit brought by a third party which challenges or concerns the validity of any patent applications or Licensed Patents. In addition, LICENSEE shall not have any right to institute any action or suit against third parties for infringement of any patent applications or Licensed Patents. 12.6 In the event IBM prevails in any claim, proceeding or suit against LICENSEE based upon this Agreement, including, but not limited to, actions for the recovery of royalties due, LICENSEE shall pay all of IBM's associated costs and attorneys' fees. 12.7 This Agreement shall not be binding upon the parties nor shall it obligate either of the parties until it has been signed hereinbelow by or on behalf of each party, in which event it shall be effective as of the date of this Agreement first above written. No amendment or modification hereof shall be valid or binding upon the parties unless made in writing and signed as aforesaid. This Agreement and its Exhibit I embody the entire understanding of the parties with respect to the Licensed Patents hereof and merges all prior discussions between them, and neither of the parties shall be bound by any conditions, definitions, warranties, understandings or representations with respect to the subject matter hereof other than as expressly provided herein. 23 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 12.8 The headings of the several Sections are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. 12.9 If any Section of this Agreement is found by competent authority to be invalid, illegal or unenforceable in any respect for any reason, the validity, legality and enforceability of any such Section in every other respect and the remainder of this Agreement shall continue in effect so long as the Agreement still expresses the intent of the parties. If the intent of the parties cannot be preserved, this Agreement shall be either renegotiated or terminated. 12.10 This Agreement shall be construed, and the legal relations between the parties hereto shall be determined, in accordance with the law of the State of New York, United States of America. 24 CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly signed as of the date first above written. INTERNATIONAL BUSINESS MACHINES CORPORATION Witness: By /s/ M. C. Phelps, Jr. ----------------------------- /s/ D. J. Sullivan M. C. Phelps, Jr. - ------------------------- Vice President APPLIED SCIENCE FICTION By /s/ Mark Urdahl ----------------------------- Mark Urdahl President Witness: /s/ ????????????????? - ------------------------- CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 EXHIBIT I ---------- Licensed Patents 1. Issued US Patents Patent Number Issue Date - ------------- ---------- [*] [*] 2. Filed US Patent Applications Serial Number Date Filed Title - ------------- ---------- ----- [*] [*] [*] - ----------- [*] Indicates that material has been omitted and confidential treatment requested therefor. All such material has been filed separately with the Commission pursuant to Rule 406. CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 EXHIBIT 1 (CONT'D) Serial Number Date Filed Title - ------------- ---------- ----- [*] [*] [*] - ----------- [*] Indicates that material has been omitted and confidential treatment requested therefor. All such material has been filed separately with the Commission pursuant to Rule 406. CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 021997 AMENDMENT No. I dated January 1, 1997 between INTERNATIONAL BUSINESS MACHINES CORPORATION a New York corporation (hereinafter "IBM") and APPLIED SCIENCE FICTION a Delaware corporation (hereinafter "ASF"). IBM and ASF entered into a patent license agreement "Agreement" effective October 31, 1995 in which IBM granted ASF certain rights under Licensed Patents as defined in Agreement. ASF now desires, and IBM wishes to grant, the right to ASF to have Licensed Products made by others: In consideration of the premises and the mutual covenants herein contained, IBM and LICENSEE agree as follows: Delete section 2.1 and replace with new section 2.1 as follows: Section 2. License 2.1 IBM grants to LICENSEE a nonexclusive license under the Licensed Patents: 2.1.1 to make, use, import, and lease, sell and otherwise transfer Licensed Products; and 2.1.2 to use any apparatus in the manufacture of Licensed Products and practice and method or process in the manufacture or use of Licensed Products. 2.1.3 to have Licensed Products made by another manufacturer for the use and/or lease, sale or other transfer by LICENSEE provided: (a) the specifications for Licensed Products were created by LICENSEE (either solely or jointly with one or more third parties); and further provided that the license to have made products granted in this Section 2.1.3 (b) shall only be under claims of the Licensed Patents, the infringement of which would be necessitated by compliance with such specifications; (c) shall not be under claims for a method or process unless such method or process is based upon technology created by LICENSEE (either solely or jointly with one or more third parties); and (d) shall not apply to any products in the form manufactured or marketed by said other manufacturer prior to LICENSEE's furnishing of said specifications. Unless LICENSEE informs IBM to the contrary, LICENSEE shall be deemed to have authorized said other manufacturer to make Licensed Products under the license granted to LICENSEE in this section 2.1.3 when the conditions specified herein 2.1.3 are fulfilled. In response to a written request identifying a product and a manufacturer, LICENSEE shall in a timely manner inform IBM of the quantity of such product, if any, manufactured by such manufacturer pursuant to the license granted in this Section 2.1.3. CONFIDENTIAL TREATMENT REQUESTED UNDER 17 C.F.R. Sections 200.80(b) (4), 200.83 AND 230.496 The license granted in this Section 2.1 for any particular Licensed Product shall be only under claims of Licensed Patents which claims define a Patented Portion for said particular Licensed Product and which are claims of Licensed Patents of the countries of manufacture, use, importation, or lease, sale or other transfer by LICENSEE. A particular Licensed Product is licensed under a Licensed Patent when and only when: 2.1.4 such Licensed Patent defines a Patented Portion of such Licensed Product; 2.1.5 such Licensed Patent was identified in a report, as specified in Section 5.5, as covering such Licensed Product; and 2.1.6 the royalty attributable to such Licensed Product was either timely paid as required by Section 5.4 or a late payment was made and accepted by IBM pursuant to Section 5.2. Add new Section 6.8 as follows: 6.8 Each party agrees to promptly enter into good faith negotiations for a new license on terms and conditions no less favorable then the terms and conditions of this Agreement, upon written request received no more than six months prior to the expiration of this Agreement. Delete Sections 9.1.4 and 9.1.5 and replace with new sections 9.1.4 and 9.1.5, respectively, as follows: 9.1.4 For mailing to LICENSEE: Intellectual Property Counsel Applied Science Fiction 3925 West Braker Lane, Suite 500 Austin, TX 78759 9.1.5 For facsimile transmission to ASF: (512) 305-0811 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly signed as of the date first above written. Agreed to: Agreed to: International Business Machines Corporation By: /s/ Mark Urdahl By: /s/ M. C. Phelps, Jr. -------------------------- ------------------------- Name: Mark Urdahl M. C. Phelps, Jr. Title: President & CEO Vice President Witness: Ava C. Ward Witness: Linda Condels ---------------------- -------------------- 2 EX-23.1 8 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated January 21, 2000, in this Registration Statement (Form S-1) and related Prospectus of Applied Science Fiction, Inc. for the registration of its common stock. /s/ Ernst & Young LLP Austin, Texas February 1, 2000 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 6,092 12,643 1,392 20 0 12,638 4,554 1,675 23,656 5,204 0 0 6 13 11,711 23,656 3,973 3,973 2,147 2,147 18,110 0 627 (15,827) 71 (15,898) 0 0 0 (15,898) (1.70) (1.70)
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