-----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, ToCH7a3K4Q2pz6bgT8IYS59XZ1+q5D7iNRf252eCxOlXKUr/GXb48oBmnAguRWek e7CI7J0lGhHwdVFS18TVpA== 0000912057-00-015316.txt : 20000510 0000912057-00-015316.hdr.sgml : 20000510 ACCESSION NUMBER: 0000912057-00-015316 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 DATE AS OF CHANGE: 20000509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCRIPPS FINANCIAL CORP CENTRAL INDEX KEY: 0001086370 STANDARD INDUSTRIAL CLASSIFICATION: 6035 IRS NUMBER: 000000000 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26081 FILM NUMBER: 589631 BUSINESS ADDRESS: STREET 1: 7817 IVANHOE AVENUE CITY: LAJOLLA STATE: CA ZIP: 92037 BUSINESS PHONE: 6194562265 MAIL ADDRESS: STREET 1: C/O GRAY GARY STREET 2: 4365 EXECUTIVE DRIVE - SUITE 1600 CITY: SAN DIEGO STATE: CA ZIP: 92121 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended DECEMBER 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . -------- ---------- Commission file number 0-26081 SCRIPPS FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) CALIFORNIA 33-0855985 ---------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 5787 Chesapeake Court, San Diego, CALIFORNIA 92123 -------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (858) 456-2265 Securities to be registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which To be so Registered Each Class is to be Registered ------------------- ------------------------------ NONE NOT APPLICABLE Securities to be registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of class) Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-X contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K. [ ] As of March 23, 2000, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $ 48,250,000. Shares of Common Stock held by each officer and director and each person owning more than five percent of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of the affiliate status is not necessarily a conclusive determination for other purposes The number of shares of Common Stock of the registrant outstanding as of February 29, 2000, was 6,913,139. 2 The following report contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate," "project" and "continue" or similar words. You should read statements that contain these words carefully because they: (1) discuss our future expectations; (2) contain projections of our future results of operations or of our financial condition; or (3) state other "forward-looking" information. We believe it is important to communicate our expectations; however, there may be events in the future that we are not able to predict accurately or over which we have no control. Our actual results may differ materially from the expectations we describe in forward-looking statements. Factors that could cause actual results to differ materially from those we describe include, but are not limited to, local economic conditions in Southern California and particularly in San Diego, the ability to manage growth of Scripps Financial Corporation ("SFC") and Scripps Bank ("Scripps"), business conditions and interest rate fluctuation, competition, a decline in real estate prices, new product development, federal and state regulation. Forward-looking statements below should be read in light of these factors. PART I ITEM 1. BUSINESS GENERAL SCRIPPS FINANCIAL CORPORATION. SFC is a California corporation, which was formed in the spring of 1999 as a federally regulated bank holding company. SFC acquired the stock of Scripps on June 30, 1999 in a transaction in which all of the shareholders of Scripps became shareholders of SFC. At this time Scripps became a wholly owned subsidiary of SFC. The transaction was accounted for by SFC at historical cost in a manner comparable to a pooling-of-interests. As a result of this accounting treatment, periods presented in the financial statements of SFC from before its incorporation include data for Scripps. Prior to the merger SFC had no operations and held no assets other than the stock in the subsidiary used to effect the merger. In the merger each shareholder of Scripps received a number of shares of SFC equal to the number of shares such shareholder held in Scripps immediately prior to the merger. They therefore received the same percentage interest in SFC as they held in Scripps immediately prior to the merger. Currently, SFC holds all of the stock of Scripps. Information regarding Scripps is set forth below to provide a better understanding of the primary asset of SFC, which is its ownership of Scripps. SCRIPPS BANK. Scripps, a California banking corporation, is a federally insured bank with its headquarters in Kearny Mesa and main office in La Jolla and additional full-service offices in downtown San Diego, El Cajon, Escondido, Kearny Mesa, Encinitas, Point Loma and Chula Vista. Scripps commenced operations on January 16, 1984. Scripps is licensed and regulated by the California Department of Financial Institutions ("DFI"), and its deposits are insured up to the maximum legal limits by the FDIC. OPERATIONS OF SFC Management of SFC includes two officers. SFC has six directors. SFC is committed to enhancing shareholder value by building a solid future for its customers, employees and the communities it serves. It was formed as a holding company for Scripps to provide regulatory flexibility, because bank holding companies have certain business opportunities not available to state-regulated banks. BANKING SERVICES Scripps targets businesses, professionals and individuals interested in personalized relationship-oriented financial services in its geographical markets of San Diego County currently comprising La Jolla, downtown San Diego, El Cajon, Escondido, Kearny Mesa, Encinitas, Point Loma and Chula Vista. The bank offers a broad range of banking products and services including but not limited to: - Business loans and lines of credit - includes secured and unsecured loans to finance working capital, inventory and accounts receivable, and term loans for the purchase of equipment. 3 - Consumer loans and lines of credit - includes equity lines of credit, home improvement loans, car loans and loans for investment purposes. - Real estate construction loans - includes construction loans for single family dwellings and small to medium size commercial and multi-family buildings. - Real estate mortgage loans - includes intermediate and long term mortgage loans for commercial and residential property. - Corporate lending - specializes in loans to larger companies and in mortgage financing. - SBA guaranteed lending - Scripps is designated as a Preferred lender by the Small Business Administration (SBA) and offers commercial and real estate SBA loans. - Equipment leasing - Residential lending brokerage services - specializes in brokerage services for single family residences, condos and two to four unit dwellings. - International department services - provides collection services, letters of credit and foreign exchange services. - Cash management services for businesses - provides collection services, letters of credit and foreign exchange services. - Credit and debit cards through affiliated institutions - Customized depository services, including demand, savings, money market, money fund, certificates of deposit, US Savings Bonds and individual retirement accounts - On-line home banking with bill pay service - individuals have access to their account information through their PC, along with the bill payment option. - Automated teller machines - Scripps has ATMs at each branch and belongs to several networks that allow customers to obtain cash throughout the world. - 24 hour telephone banking - the "Any Time Line" provides access to account balance and transaction information and allows funds transfer. - Customer courier services - business customers have the option of courier services to bring deposits to Scripps. - Safe deposit boxes - Property management banking is specifically designed to meet the unique banking needs of property management companies and individual Homeowners Association by offering a variety of services to include Remittance Processing and specialized Depository and Loan services. Scripps holds no patents, registered trademarks, licenses (other than licenses obtained from regulatory agencies), franchises or concessions. Scripps has not spent material amounts on research and development of new products or services or improvements to existing products or services. LENDING SERVICES 4 COMMERCIAL Loans in this category include loans to small and middle market businesses, individuals and professionals located primarily in Scripps' market areas. Scripps provides secured and unsecured loans and lines of credit for the operation and expansion needs of businesses, including working capital lines of credit inventory and accounts receivable financing and equipment financing. Scripps typically looks to the cash flow generated by a borrower as the principal source of repayment. Scripps may also take personal property and/or a first or second deed of trust on real estate as an additional form of collateral. This category of loans represents our most risky loans. While the majority of these loans are collateralized by business assets, in a troubled debt situation, which can arise from a variety of factors, the risk of significantly diminished collateral value is high. To mitigate such risks, management has established a process to segment the portfolio by industry type in order to evaluate concentration risk. Also, in 1999 Scripps started a credit department to provide consistent credit analysis, central review of loan covenants and collateral tracking. REAL ESTATE Scripps makes intermediate and long-term real estate loans to homeowners and other borrowers who have a defined repayment source. These loans generally carry terms of three to thirty years with amortization schedules of up to 30 years. This category also includes interim construction loans for single family dwellings, and small or medium size commercial and multi-family buildings and lots to be developed. Scripps also makes longer-term real estate loans on commercial properties in conjunction with the SBA guaranteed lending program. The SBA guarantees second trust deed secured debentures, which are junior liens to Scripps' loans, to enable business owners to acquire commercial facilities for their businesses. CONSUMER Consumer loans are primarily automobile secured loans, home improvement loans, and equity lines of credit, generally secured by second trust deeds on personal residences, loans secured by various personal property and unsecured lines of credit. Fixed rate consumer loans, which comprise approximately 33% of the consumer portfolio, are generally made as amortizing loans over terms in excess of one year. The variable rate portion of consumer loans are primarily equity lines of credit secured by lien positions on real property or unsecured revolving credit facilities to qualified individuals. This category is more risky than real estate loans, due in large part to industry-wide excessive availability of credit, an overall increase in the consumers' appetite for debt, and the relative ease by which consumers can discharge their obligations through bankruptcy. LEASES A major portion of Scripps' lease assets is comprised of leases for electronic equipment, such as computers and data processing equipment. The remaining balance of the lease portfolio includes leases on a variety of other equipment. CREDIT REVIEW All loans are rated by an objective risk rating system, which is applied on a regular basis. Any exceptions to underwriting standards are tracked in order to identify trends. The credit review process was outsourced in early 1999. This provides management and the Board of Directors with reports from an unbiased third party on the status of loans. The bank maintains a Special Asset Department, which actively monitors classified loans - those loans that have deteriorated to the degree that there is a potential for loss. The objective of this department is to identify the classified loans as soon as possible, to protect or enhance the Bank's position, and ultimately to return the loan to non-classified status or recognize it as a loss. TRUST SERVICES AND INVESTMENT MANAGEMENT SERVICES The Scripps Trust Department is committed to providing San Diego County with high quality personalized trust and investment management services. The Trust Department offers a full range of personal trust services to individuals, including the administration of: 5 - living trusts - testamentary trusts - custodial agencies - investment agencies - executorships - conservatorships All standard employee benefit trust services are available, including trust administration and asset management. The Trust Department also assists individuals who wish to establish an IRA rollover for qualified retirement plan distributions. The Trust Department strives to attain a personalized approach to trust services by custom tailoring products and services to meet the customer's needs. The Trust Department utilizes an independent registered investment advisor to provide investment advice to the Trust Investment Committee in an attempt to provide individualized asset management programs for each trust account. The Trust Department also offers "no load" mutual funds for some accounts to achieve proper diversification of assets. Scripps has offered the ability to buy and sell stocks, bonds, and mutual funds through the Scripps Trust Department since June 1999. These products are not FDIC insured. COMMITMENTS AND CONTINGENT LIABILITIES In the course of normal business, SFC enters into various types of transactions that include commitments to extend credit that are not reflected on its statements of financial condition. SCF's exposure to loss under commitments to extend credit is represented by the total amount of these commitments. See "Notes to Consolidated financial statements." COMPETITION The banking business in California generally, and in the San Diego market area specifically, is highly competitive with numerous competitors both making loans and accepting deposits. The trust and investment management services business in SFCs' market area is also highly competitive, with six major banks and various credit unions and savings and loans serving the area. SFC competes for loans, deposits and trust services with other commercial banks, savings and loan associations, finance companies, money market funds, credit unions, brokerage firms and other financial institutions, including a number of institutions that have significantly greater financial resources than SFC. SFC also competes for business with unregulated lenders. There has been increased competition for deposit and loan business over the past several years as a result of deregulation, and with the advent of interstate banking, bank holding companies headquartered outside of California may also enter the California market in greater numbers and provide further competition for SFC. Many of the major commercial banks operating in SFC's market area offer some services which SFC does not offer directly but can provide through a correspondent bank or through a strategic alliance with a financial service provider. Additionally, banks with larger capitalization have larger lending limits and are thereby better able to serve the higher dollar needs of larger customers. SFC intends to compete with such banks through customer service orientation, active involvement of its board of directors, management and employees in community affairs, and commitment to the community. With nine branches, Scripps is the largest locally owned and managed bank in San Diego County. Scripps holds 2.65% of the deposit market share countywide. 6 The regulatory climate became more favorable to large competitors in the 1990s. On September 29, 1994, President Clinton signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking Act"). The Interstate Banking Act has various provisions designed to facilitate the acquisition of banks and branching across state borders. It allows the FRB to approve a bank holding company's application to acquire control or substantial assets of a bank located outside the bank holding company's home state, regardless of whether the acquisition would be prohibited by state law. In addition, the Interstate Banking Act now permits a bank in one state to merge with another bank in a different state. On October 2, 1995, the California legislature adopted the Caldera, Weggeland, and Killea California Interstate Banking and Branching Act of 1995 (the "California Act"). The California Act expressly permits an out-of-state bank to acquire an entire California bank by acquiring an entity through a merger or purchase. Merely adding a branch or directly acquiring a branch in California continues to be prohibited to out-of-state banks. Out-of-state banks are permitted to affiliate with California institutions and may establish facilities in California (such as loan production offices) under conditions set forth in the California Act. APPLICABLE REGULATIONS Bank holding companies and financial institutions are extensively regulated under federal and state law. As a result, the growth and earnings of SFC can be affected by the regulations and policies of governmental regulatory authorities in addition to management decisions and general economic conditions. Several of the more significant regulations which apply to SFC and Scripps are discussed below. When information in this report describes statutory or regulatory provisions, it is qualified in its entirety to the statutes or regulations. SFC is subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the "Exchange Act"). As a result, SFC files annual, quarterly and other current reports with the SEC and is subject to securities regulations including rules regarding proxies. Directors, executive officers and principal shareholders of more than 10% of SFC's common stock are also subject to periodic reporting requirements. Both SFC and Scripps are subject to the Internal Revenue Service and state taxing authorities. SFC is a bank holding company under the Bank Holding Company Act of 1956, as amended, so is required to file reports with the Federal Reserve Board. Prior to March 13, 2000, a bank holding company generally was prohibited from acquiring the beneficial ownership or control of more than 5% of the voting shares or substantially all of the assets of any company, including a bank, without the FRB's prior approval. Also, prior to March 13, 2000, a bank holding company generally was limited to engaging in banking and activities that the FRB had determined to be closely related to banking. Under the Gramm-Leach-Bliley Act of 1999, beginning March 13, 2000 eligible bank holding companies may elect to become financial holding companies, and thereafter affiliate with securities firms and insurance companies and engage other activities that are financial in nature. A bank holding company is eligible to become a financial holding company if each of its subsidiary banks and savings associations is well capitalized, is well managed, and has a Community Reinvestment Act rating of satisfactory or better. SFC has not yet determined whether it will elect to become a financial holding company. Even if SFC were to elect to become a financial holding company, it would continue to be required to comply with other bank holding company regulations promulgated by the FRB. 7 The FRB has by regulation determined certain activities in which holding companies including SFC may or may not conduct business. As a holding company SFC is currently prohibited from such activities as real estate brokerage and syndication; real estate development; property management; underwriting of life insurance not related to credit transactions; and, with certain exceptions, securities underwriting and equity funding. As a California state-chartered bank, Scripps is subject to primary supervision, periodic examination and regulation by the California Department of Financial Institutions and the FDIC. If, as a result of an examination of a bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the bank's operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to FDIC. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate a bank's deposit insurance, which for a California state-charted bank would result in a revocation of the bank's charter. The DFI has many of the same remedial powers. Scripps is insured by the FDIC, which currently insures deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a semi-annual statutory premium and is subject to the rules and regulations of the FDIC. Although Scripps is not a member of the Federal Reserve System, it is subject to certain regulations of the FRB. CAPITAL ADEQUACY GUIDELINES The FRB and the FDIC have issued guidelines to implement risk-based capital requirements. The guidelines are intended to establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and takes off-balance sheet items into account in assessing capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Under these guidelines, assets and credit equivalent amounts of off-balance sheet items, such as letters of credit and outstanding loan commitments, are assigned to one of several risk categories, which range from 0% for risk-free assets, such as cash and certain United States government securities, to 100% for relatively high-risk assets, such as loans and investments in fixed assets, premises and other real estate owned. The aggregate dollar amount of each category is then multiplied by the risk-weight associated with that category. The resulting weighted values from each of the risk categories are then added together to determine the total risk-weighted assets. The guidelines require a minimum ratio of qualifying total capital to risk-weighted assets of eight percent, of which at least four percent must consist of Tier 1 capital. Higher risk-based ratios are required for an insured depository institution to be considered well capitalized under the prompt corrective action provisions of the FDIC Improvement Act. See "Federal Deposit Insurance Corporation Improvement Act of 1991." 8 A banking organization's qualifying total capital consists of two components: Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier 1 capital consists primarily of common stock, related surplus and retained earnings, qualifying noncumulative perpetual preferred stock (plus, for bank holding companies, qualifying percentage of cumulative perpetual preferred stock in an amount up to 25% of Tier 1 capital) and minority interest in the equity accounts of consolidated subsidiaries. Intangibles, such as goodwill, are generally deducted from Tier 1 capital; however, purchased mortgage servicing rights and purchased credit card relationships may be included, subject to certain limitations. At least 50% of banking organization's total regulatory capital must consist of Tier 1 capital. Tier 2 capital may consist of (i) the allowance for possible loan and lease losses in an amount up to 1.25% of risk-weighted assets; (ii) cumulative perpetual preferred stock and long-term preferred stock (which for bank holding companies must have an original maturity of 20 years or more) and related surplus; (iii) hybrid capital instruments with characteristics of both debt and equity), perpetual debt and mandatory convertible debt securities; and (iv) eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus, in an amount up to 50% of Tier 1 capital. The inclusion of the foregoing elements of Tier 2 capital are subject to certain requirements and limitations of the Federal banking agencies. The FRB and the FDIC also have adopted a minimum leverage ratio of Tier 1 capital to average total assets of three percent for institutions which have been determined to be in the highest of five categories used by regulators to rate financial institutions. This leverage ratio is only a minimum. All other institutions are required to maintain leverage ratios of at least 100 to 200 basis points above the three percent minimum. Furthermore, higher leverage ratios are required for an insured depository institution to be considered well capitalized or adequately capitalized under the prompt corrective action provisions of the FDIC Improvement Act. As of December 31, 1999, SFC's Tier 1 risk-based capital and total risk-based capital ratios were 10.18% and 11.35%, respectively. The risk-based capital standards of the federal banking agencies take into account concentrations of credit (relatively large proportions of loans involving one borrower, industry, location, collateral or loan type) and the risks of "non-traditional" activities (those that have not customarily been part of the banking business). These regulations require institutions with high or inordinate levels of risk to operate with higher minimum capital standards, and authorize the regulators to review an institution's management of such risks in assessing an institution's capital adequacy. The federal banking agencies have also revised the risk-based capital regulations to include exposure to interest rate risk as a factor that the regulators will consider in evaluating a bank's capital adequacy. Interest rate risk is the exposure of a bank's current and future earnings and equity capital arising from adverse movements in interest rates. While interest risk is inherent to a bank's role as financial intermediary, it introduces volatility to bank earnings and to the economic value of the bank. The FRB also requires the maintenance of a leverage capital ratio designed to supplement the risk-based capital guidelines. Banks and Bank Holding Companies that have received the 9 highest regulatory ratings must maintain Tier 1 leverage capital ratio of at least 3.0%. All other institutions are required to maintain a leverage ratio of at least 100 to 200 basis points above the 3.0% minimum, for a minimum of 4.0% to 5.0%. Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans, and federal regulators may, however, set higher capital requirements when a bank's particular circumstances warrant. As of December 31, 1999 SFC's and Scripps' Tier 1 leverage capital ratios were 7.5% and 7.4%, respectively, exceeding regulatory minimums. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Capital Resources." FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 In December 1991, the FDIC Improvement Act was enacted into law. This legislation substantially revises the bank regulatory and funding provisions of the Federal Deposit Insurance Act and makes revisions to several other federal banking statutes. Set forth below is a brief discussion of certain portions of this law and implementing regulations that have been adopted by the FRB, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the FDIC (collectively, the "Federal banking agencies"). - - - IMPROVED EXAMINATIONS. All insured depository institutions must undergo a full-scope, on-site examination by their primary Federal banking agency at least once every 12 months. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate Federal banking agency against each institution or affiliate as it deems necessary or appropriate. - - - STANDARDS FOR SAFETY AND SOUNDNESS. Pursuant to the FDIC Improvement Act, the Federal banking agencies have issued safety and soundness standards and guidelines on matters such as loan underwriting and documentation, asset quality and growth, earnings, internal controls, information and audit systems, interest rate risk exposure and compensation and other employee benefits. The Federal banking agencies have also issued final regulations prescribing uniform guidelines for real estate lending, which require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit secured by real estate. The policies must address loan portfolio management, underwriting standards and loan to value limits that do not exceed the supervisory limits prescribed by the regulations. - - - PROMPT CORRECTIVE REGULATORY ACTION. The FDIC Improvement Act requires each Federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions that fall below one or more prescribed minimum capital ratios. The purpose of this law is to resolve the problems of insured depository institutions at the least possible long-term cost to the appropriate deposit insurance fund. The law requires each Federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized (significantly exceeding the required minimum capital requirements), adequately capitalized (meeting the required capital requirements), undercapitalized (failing to meet one or more of the capital requirements), significantly 10 undercapitalized (significantly below one or more capital requirements) and critically undercapitalized (failing to meet all capital requirements). In September, 1992, the Federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of the FDIC Improvement Act. Under the regulations, an insured depository institution will be deemed to be: - "Well capitalized" if it (i) has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of six percent or greater and a leverage ratio of five percent or greater and (ii) is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; - "Adequately capitalized" if it has a total risk-based capital ratio of eight percent or greater, a Tier 1 risk based capital ratio of four percent or greater and a leverage ratio of four percent or greater (or a leverage ratio of three percent or greater if the institution is rated composite 1 under the applicable regulatory rating system in its most recent report of examination); - "Undercapitalized" if it has a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio that is less than four percent or a leverage ratio that is less than four percent; and - "Significantly undercapitalized" if it has a total risk-based capital ratio that is less than six percent, a Tier 1 risk-based capital ratio that is less than three percent or a leverage ratio that is less than three percent; and - "Critically capitalized" if it has a ratio of tangible equity to total assets that is equal to or less than two percent. An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized or undercapitalized may be reclassified to the next lower capital category if the appropriate Federal banking agency, after notice and opportunity for hearing, (i) determines that the institution is in an unsafe or unsound condition or (ii) deems the institution to be engaging in an unsafe or unsound practice and not to have corrected the deficiency. At each successive lower capital category, an insured depository institution is subject to more restrictions and federal banking agencies are given less flexibility in deciding how to deal with such institution. The law prohibits insured depository institutions from paying management fees to any controlling persons or; with certain limited exceptions, making capital distributions, including dividends, if after such transaction the institution would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate Federal banking agency, subject to asset growth restrictions, and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate Federal banking agency 45 days after becoming undercapitalized. The appropriate Federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (i) specifies the steps the institution will take to become adequately capitalized, (ii) is based on realistic assumptions and (iii) is likely to succeed in restoring the depository 11 institution's capital. In addition, each company controlling an undercapitalized depository institution must guarantee that the institution will comply with the capital plan until the depository institution has been adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to five percent of the depository institution's total assets at the time the institution became undercapitalized and (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institutions as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate Federal banking agency may impose on any undercapitalized depository institution any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt corrective action provisions. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce the total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator. OTHER REQUIREMENTS OF THE FDIC IMPROVEMENT ACT The FDIC Improvement Act also, among other things, (i) limits the percentage of interest paid on brokered deposits and limits the unrestricted use of such deposits to only those institutions that are well capitalized; (ii) requires the FDIC to charge insurance premiums based on the risk profile of each institution; (iii) eliminates "pass-through" deposit insurance for certain employee benefit accounts unless the depository institution is well capitalized or, under certain circumstances, adequately capitalized; (iv) prohibits insured state-chartered banks from engaging as principal in any type of activity that is not permissible for a national bank unless the FDIC permits such activity and the bank meets all of its regulatory capital requirements; (v) directs the appropriate Federal banking agency to determine the amount of readily marketable purchased mortgage servicing rights that may be included in calculating such institution's tangible, core and risk-based capital; and (vi) provides that, subject to certain limitations, any Federal savings association may acquire or be acquired by any insured depository institution. The FDIC has also issued final regulations which prohibit, subject to certain specified exceptions, insured state-chartered banks from engaging as principal in any activity not permitted of a national bank, without FDIC approval. The regulations also provide that, subject to certain specified exceptions, subsidiaries of insured state-charted banks may not engage as principal in any activity that is not permitted of a subsidiary of a national bank, without FDIC approval. The impact of the FDIC Improvement Act on Scripps is uncertain. Certain provisions may affect the way in which Scripps conducts its business, and other provisions, such as those relating to the establishment of the risk-based premium system and the limitations on pass-through insurance may affect its results of operations. Furthermore, the actual and potential restrictions and sanctions that apply to or may be imposed on undercapitalized institutions under the prompt corrective action and other provisions of the FDIC Improvement Act may significantly affect the 12 operations and liquidity of Scripps, the value of SFC Common Stock and its ability to raise funds in the financial markets. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The Community Reinvestment Act ("CRA") requires banks, as well as other lenders, to identify the communities served by the bank's offices and to identify the types of credit the bank is prepared to extend within such communities. The CRA also requires the FDIC to assess the performance of a bank in meeting the credit needs of its community and to take such assessment into consideration in reviewing applications for mergers, acquisitions, and other transactions. An unsatisfactory CRA rating may be the basis for denying such an application. Scripps is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and CRA activities. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the Federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. In 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in lending. The policy statement describes the three methods that Federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. In connection with its assessment of CRA performance, the FDIC assigns a rating of "outstanding," "satisfactory," "needs to improve," or "substantial noncompliance." The FDIC conducts examinations of a bank's CRA performance, among other matters, approximately every two years. Based on a CRA and consumer compliance examination conducted during November 1999, Scripps was rated "satisfactory." There can be no assurance that Scripps will retain this rating. FEDERAL RESERVE SYSTEM The FRB requires banks to maintain noninterest-earning reserves against certain of their transactional accounts (primarily deposit accounts that may be accessed by writing checks) and non-personal time deposits. As a creditor and a financial institution, Scripps is subject to certain regulations promulgated by the FRB, including, without limitation, Regulation B (Equal Credit Opportunity Act), Regulation D (Reserves), Regulation E (Electronic Funds Transfers Act), Regulation F (inter bank liabilities), Regulation Z (Truth in Lending Act), Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth in Savings Act). As creditors on loans secured by real property and as owners of real property, financial institutions, including Scripps, may be subject to potential liability under various statutes and regulations applicable to property owners, generally including statutes and regulations relating to the environmental condition of the property. 13 Other state and federal statutes and regulations apply to many aspects of the operations of SFC and Scripps, including requirements to maintain reserves against deposits and meet capital requirements, and regulation of interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends and locations of branch offices. From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies. The likelihood of any major changes and the impact such changes might have on SFC and Scripps are impossible to predict. EMPLOYEES 14 As of December 31, 1999, Scripps had a full time equivalent staff of 275 persons on a full-time and part-time basis. SFC had no employees. ITEM 2. PROPERTIES. SFC and Scripps together have 14 locations, nine of which are branch offices of Scripps. Another location, in Carmel Valley, will open in Fall 2000. In February 2000 SFC relocated its SFC and Scripps corporate headquarters to 5787 Chesapeake Court, San Diego, California, 92123, from Ivanhoe Avenue in La Jolla. Scripps' main office branch is located at 7733 Girard, La Jolla, California, 92037. Scripps has sub-leased major portions of the former corporate headquarters in La Jolla and offsets rent expense with the income from the sub-leases. Scripps plans on sub-leasing the second floor of the Carmel Valley property, while retaining the first floor for a branch. The following table sets forth-certain information regarding SFC and Scripps property, net of accumulated depreciation, at December 31, 1999: 15
SQUARE DATE NET BOOK VALUE OF FEET LOCATION OPENED PREMISES & EQUIPMENT ------ -------- ------ -------------------- 7,000 South Bay Regional Office 1984 $ 196,000 20,200 Corporate Headquarters (former), La Jolla 1984 357,000 -- Trust Department, La Jolla 1990 175,000 5,500 East County Regional Office, El Cajon 1992 195,000 5,400 San Diego Regional Office, Downtown San Diego 1993 184,000 5,600 North County Coastal Regional Office, Escondido 1994 142,000 9,300 Service Center 1995 1,638,000 6,700 Chula Vista Center City Office 1995 331,000 5,200 Kearny Mesa Regional and Corporate Lending 1997 448,000 4,800 Encinitas Regional Office 1997 572,000 4,100 Point Loma Regional Office 1997 227,000 6,900 Girard Office, La Jolla main office 1999 1,478,000 1,300 Rancho Bernardo Center 1999 69,000 23,000 Corporate Headquarters (current), San Diego 2000 0 29,000 Carmel Valley Office To Open 0 Fall 2000 TOTAL $6,012,000
The SFC and Scripps facilities are held under lease agreements that expire at various times from 2001 through 2026. The lease agreements have option periods to extend their terms at rates equivalent to the then market rates. Annual minimum lease commitments for SFC and Scripps together approximate $2.1 million on average through the year 2004. ITEM 3. LEGAL PROCEEDINGS. No litigation against SFC is known by its board of directors to be pending or threatened. Scripps is at times subject to pending and threatened legal actions that arise out of the normal course of business. Management, after reviewing all actions and proceedings pending against SFC and Scripps, considers that the ultimate disposition of pending or threatened litigation will not have a material effect on the financial condition or results of operations of SFC. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. PART II ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. SFC COMMON STOCK PRICE RANGE AND DIVIDEND POLICY In October 1999 SFC listed its common stock on the American Stock Exchange (AMEX). Between this listing and July 1, 1999, SFC Common Stock was traded on the over-the-counter bulletin board. Before July 1, 1999, Scripps common stock was listed on the over-the-counter bulletin board. Scripps is the sole subsidiary of SFC. As a state-chartered bank, the ability of Scripps to pay dividends or make distributions to SFC is subject to restrictions set forth in the California Financial Code. The California Financial Code provides that neither a bank nor any majority-owned subsidiary of a bank may make a distribution to its shareholders in an amount which exceeds the lesser of (i) the bank's retained earnings, or (ii) the bank's net income for its last three fiscal years, less the amount of any distributions made by the bank or by any majority-owned subsidiary of the bank to the shareholders of the bank during such period. However, a bank or a majority-owned subsidiary of a bank may, with the prior approval of the Commissioner of the DFI, make a distribution to the shareholders of the bank in an amount not exceeding the greatest of (i) the bank's retained earnings, (ii) the bank's 16 net income for its last fiscal year, or (iii) the bank's net income for its current fiscal year. In the event that the Commissioner of the DFI determines that the stockholders' equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe or unsound, the Commissioner may order the bank to refrain from making a proposed distribution. As of December 31, 1999 Scripps had approximately $11.6 million legally available for the payment of dividends. SFC paid semi-annual cash dividends to its shareholders for a total of $.12 per share and $.16 per share in 1999 and 1998, respectively. In 1999 the first payment was declared by Scripps and the second payment by SFC. SFC will depend on dividends from its subsidiaries for operating funds and to provide dividends to its shareholders. Payment of future dividends by SFC will be subject to the discretion of the SFC Board of Directors and will depend upon available revenue, its financial condition, its capital requirements, its need for funds, applicable governmental policies and regulations and such other matters, as the Board deems appropriate. At present, SFC desires to continue paying cash dividends on a periodic basis comparable to the historical levels paid by Scripps, which has been semi-annual payments ranging from 13% to 18% of net income. However, the ability of SFC to make such payments and the rate at which such payments may be made is not assured and will depend on the factors discussed above. The price information contained in the following table sets forth the high and low closing prices per share of SFC or Scripps Common Stock as reported by the composite closing price table published by the Bloomberg Financial Markets Service. The high and low bid prices of SFC and Scripps Common Stock do not include retail markups, markdowns or commissions and may not represent actual transactions.
HIGH LOW ------- ------- 1998 First Quarter 21.38 17.38 Second Quarter 20.50 17.00 Third Quarter 20.38 16.63 Fourth Quarter 17.50 15.25 1999 First Quarter 17.25 14.75 Second Quarter 15.50 14.00 Third Quarter* 16.00 13.63 Fourth Quarter* 16.38 13.50
*SFC common stock On March 22, 2000, the last sales price of the SFC Common Stock, according to the composite closing price table published by the Bloomberg Financial Markets Service was $12.125 per share. There were approximately 449 holders of Common Stock of SFC as of March 22, 2000. SALES OF UNREGISTERED SECURITIES. No unregistered securities have been issued by SFC since its formation. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA OF SFC (Dollar amounts in thousands, except per share data) The selected consolidated financial data presented below as of and for the years ended December 31, 1999, 1998, 1997, 1996 and 1995 have been derived from the consolidated financial statements of SFC audited by PricewaterhouseCoopers, LLP. In the opinion of SFC management, the unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments necessary for a fair presentation of the financial position and the results of operations for these periods, the most recent three years of which are included in this filing. The data below should be read in conjunction with the audited consolidated financial statements and notes there to, and with management's discussion and analysis included in this report. 17
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------------------------- 1999 1998 1997 1996 1995 ---------- ---------- ---------- ---------- ---------- INCOME STATEMENT DATA: Net interest income $ 32,839 $ 28,396 $ 23,218 $ 18,099 $ 15,958 Provision for loan losses (7,230) (1,805) (1,452) (922) (1,263) Noninterest income 5,624 6,095 5,390 4,230 3,554 Noninterest expense (24,014) (22,823) (20,168) (15,746) (13,792) Provision for income taxes (2,790) (3,995) (2,758) (2,259) (1,835) ---------- ---------- ---------- ---------- ---------- Net income $ 4,429 $ 5,868 $ 4,230 $ 3,402 $ 2,622 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- PER COMMON SHARE DATA: (1) Net income (basic) $ 0.64 $ 0.87 $ 0.63 $ 0.56 $ 0.52 Net income (diluted) 0.63 0.84 0.61 0.55 0.52 Cash dividends declared 0.12 0.16 0.34 0.31 0.36 Period-end book value 6.56 6.44 5.66 5.12 4.11 SHARES OUTSTANDING: Weighted average common shares outstanding (basic) 6,879,000 6,754,000 6,726,000 6,026,000 5,064,000 Weighted average common shares outstanding (diluted) 6,991,000 6,974,000 6,987,000 6,213,000 5,090,000 Common shares outstanding at period end 6,909,000 6,797,000 6,708,000 6,772,000 5,570,000 AVERAGE FINANCIAL CONDITION DATA: (2)(3) Investment securities (4) $ 151,467 $ 127,003 $ 99,318 $ 86,899 $ 55,319 Loans 365,105 307,061 243,895 183,176 161,083 Assets 588,058 508,871 404,605 324,825 263,732 Deposits 537,820 463,829 364,927 293,795 240,661 Shareholders' equity 46,005 41,095 36,117 28,542 20,930 ASSET QUALITY RATIOS: (2) Net charge-offs to average loans 1.80% 0.22% 0.27% 0.36% 0.56% Nonperforming loans to total Loans (5) (10) 1.09% 0.40% 0.35% 0.62% 2.09% Nonperforming assets to total Assets (10) 0.68% 0.23% 0.31% 0.50% 1.20% Allowance for loan losses to total Loans (10) 1.36% 1.40% 1.28% 1.32% 1.58% Allowance for loan losses to Nonperforming loans (10) 125.25% 352.07% 368.29% 213.31% 75.56% PERFORMANCE RATIOS: (2) Return on average assets 0.75% 1.15% 1.05% 1.05% 0.99% Return on average equity 9.63% 14.28% 11.71% 11.92% 12.53% Equity to assets 7.82% 8.08% 8.93% 8.79% 7.94% Dividend payout 18.64% 18.57% 53.99% 54.65% 69.80% Net interest margin (6) 6.03% 6.02% 6.31% 6.16% 6.67% Efficiency ratio (7) 62.35% 66.12% 70.36% 70.32% 70.49% REGULATORY CAPITAL RATIOS: (8) (10) Leverage ratio (9) 7.54% 7.63% 8.30% 9.63% 7.83% Tier 1 risk-based capital 10.18% 10.19% 11.10% 13.93% 16.21% Total risk-based capital 11.35% 11.32% 12.20% 15.08% 17.24%
(1) Per share data have been retroactively adjusted to reflect a 10% stock dividend in 1996, a 10% stock dividend in 1997 and a two for one split in 1997 for all periods presented. (2) Amounts have not been derived from SFC's consolidated financial statements but were compiled separately by management. (3) Average balance sheet data has been derived from quarterly balances for 1995, otherwise from year-to-date daily balances. (4) Amounts are derived from average balances based upon market value. 18 (5) Nonperforming loans represent nonaccrual loans and loans still accruing interest and contractually past due 90 days or more. (6) Net interest income divided by average interest-earning assets. (7) Efficiency ratio is defined as the ratio of noninterest expenses, less cost related to real estate owned, to the sum of net interest income and noninterest income exclusive of securities gains/(losses). (8) Computed in accordance with 1992 Federal guidelines, which were initially effective January 1, 1990. (9) Leverage ratio is defined as the ratio of Tier 1 capital to average assets for the most recent quarter. (10) Data is as of period end. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL SFC, with $632 million in total assets at December 31, 1999, derives substantially all of its revenues and income by providing a full range of commercial banking, consumer banking and trust services primarily to small and middle market businesses and individuals in San Diego County, California. The revenues of SFC are derived principally from interest earned on loans and investment securities, from trust and residential lending service fees, and from other loan and deposit account-related fees and service charges. The operations of SFC are influenced significantly by general economic conditions and by policies of its primary regulators, FRB, and for Scripps DFI and FDIC. Return on average equity ("ROE") is determined by dividing annual net income by average shareholders' equity and indicates the effectiveness of an institution in generating net income from the capital invested by its shareholders. For the year ended December 31, 1999, SFCs' ROE was 10% compared to 14% for 1998 and 12% for 1997. Return on average assets ("ROA") measures net income in relation to total average assets and generally indicates an institution's ability to use its assets profitably. For the year ended December 31, 1999, SFCs' ROA was 0.8% compared to 1.2% for 1998 and 1.1% for 1997. ROE for 1999 decreased by 0.4% from 1998 primarily as a result of the need to replenish the reserve for loan losses due to net charge-offs of $6.6 million. $6.4 million of the charge-offs were from two loans and are considered by management to be non-recurring in nature. In 1998 PCB merged with and into Scripps, resulting in two new offices for Scripps. Management believes the continued growth of market share in existing and new markets, enhanced internal efficiency, the continued resolution of its nonperforming assets, and a general economic recovery of Southern California will have a positive effect upon future operations, although there can be no assurance these developments will occur. There are many factors that could adversely affect the future operations of SFC, including any decline in the San Diego County economy at a time when SFC is incurring costs of expansion. INSTITUTIONAL GROWTH Scripps began to experience significant growth in 1995 as the local economy improved and following the failure or merger of several larger San Diego headquartered financial institutions. The decision was made to increase the bank's capital and to take advantage of the opportunity to increase market share. Prior to 1996, the bank had established offices in La Jolla, El Cajon, downtown San Diego and Escondido. In 1996, the bank obtained an additional $9.5 million through the sale of Scripps Common Stock and received regulatory approval to open three new offices in Kearny Mesa, Encinitas and Point Loma. Those offices were opened during 1997, and all have experienced satisfactory growth in loans and deposits. In 1998 Scripps expanded into Chula Vista and the South Bay area of San Diego County, adding two offices, through its merger with PCB. SFC's long term plan includes establishing a total of eleven to thirteen Scripps offices strategically located throughout San Diego County. Through the merger of PCB and Scripps, the resulting institution has nine branches serving much of San Diego County. Although there can be no assurances that it will prove to be correct, SFC's management believes that significant growth and market opportunity will occur in the near future in the South Bay area, and that it is therefore very important for the bank to be represented in that area. It is anticipated that in the future, one or two additional offices may be opened in North County, and possibly one additional office in East County. Growth has and will enable SFC to expand its deposit gathering and loan delivery systems geographically within San Diego County. Increases in average interest-earning assets and average interest-bearing liabilities contributed to increases in total interest income interest expense and net interest income. Expansion has 19 also contributed to the gathering of additional noninterest-bearing deposits, which effectively lowers SFC's internal cost of funds and increases net interest income. Growth has also caused, and can be expected to continue to cause, increases in noninterest expense. SFC's growth during the period from 1994 through the end of 1999 facilitated increases in earnings per share. In 1999 income per share decreased due to loan charge-offs as noted above. As SFC's growth continues and as noninterest expense continues to rise, income per share may decline. SFC believes that even if additional investment in growth comes at the cost of lower income per share for several quarters, SFC's profitability will be enhanced over the long term, although there can be no assurance that this will in fact be the case. ANNUAL COMPARISON The following discussion is intended to provide information to facilitate the understanding and assessment of significant changes and trends related to the results of operations and the financial condition of SFC. This discussion and analysis should be read in conjunction with SFC's audited consolidated financial statements, including notes thereto, located elsewhere in this report. NET EARNINGS Net earnings were $4 million ($.64 per share basic; $.63 per share diluted) for the year ended December 31, 1999, compared with $6 million ($.87 per share basic; $.84 per share diluted) for 1998, a decrease of $2 million or 25%. Net earnings for 1998 reflect an increase of $2 million or 39% over net earnings of $4 million ($.63 per share basic; $.61 per share diluted) for the year ended December 31, 1997. SFC's decrease in earnings between 1999 and 1998 resulted primarily from the charge-offs noted above. The charge-offs were partially offset by earnings from an increase in average interest-earning assets, primarily in loans and investment securities. SFC's improved performance between 1998 and 1997 was primarily due to an increase in average interest-earning assets, primarily in loans and investment securities. The higher levels of net interest income in 1998 and 1997 were partially offset by the costs and additional salary expense associated with the Scripps-PCB merger in 1998. NET INTEREST INCOME Net interest income, which constitutes one of the principal sources of income for SFC, represents the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. The net yield on total interest-earning assets, also referred to as interest rate margin or net interest margin, represents net interest income divided by average interest-earning assets. SFC's principal interest-earning assets are loans, investment securities and Federal funds sold, while its principal interest-bearing liabilities are interest-bearing demand accounts, savings deposits and time deposits. Net interest income was $33 million for fiscal 1999, an increase of $5 million or 16% compared with net interest income of $28 million for 1998, which represented an increase of $5 million or 22% compared to net interest income of $23 million for 1997. Comparing 1999 to 1998, SFC's average interest-earning assets increased to $545 million in 1999 from $472 million in 1998, representing an increase of 15% which resulted from increases in all interest-earning asset categories but primarily in loans (19%) and investments (19%). Average interest-bearing deposits increased to $372 million in 1999 from $328 million in 1998, representing an increase of 14%, while average noninterest-bearing demand deposits also increased $30 million or 22%. The net interest margin of 6.03% for 1999 reflects an increase of 1 basis point from that of 1998. This increase in net interest margin resulted primarily from average interest-earning asset growth out pacing average interest-bearing deposits, and the effective interest rate paid on deposits was significantly lower than 1998. This increase was partially offset by both the decrease in the prime rate from an average of 8.3% in 1998 to 8.0% in 1999 (since a majority of Scripps' loans are tied to the prime rate, a decrease in the rate immediately affects net interest income) and continued competitive pressure in pricing loans. Comparing 1998 to 1997, SFC's average interest-earning assets increased to $472 million in 1998 from $368 million in 1997, representing an increase of 29% which resulted from increases in all interest-earning asset categories. Average interest-bearing deposits increased to $328 million in 1998 from $258 million in 1997, representing an increase of 27%, while average noninterest-bearing demand deposits also increased $29 million or 27%. The net interest margin of 6.02% for 1998 reflects a decrease of 29 basis points from that of 1997. 20 This decrease in net interest margin resulted primarily from both the decrease in the prime rate from an average of 8.4% in 1997 to 8.3% in 1998, and competitive loan pricing. SFC's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities, referred to as a "rate change." The following table sets forth the categories of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the periods indicated. The table also sets forth the average rate earned on all interest-earning assets, the average rate paid on all interest-bearing liabilities, and the net yields earned by SFC for the same periods. 21
AVERAGE BALANCES AND INTEREST RATES (Dollars in thousands) YEARS ENDED DECEMBER 31, ----------------------------- ----------------------------- ---------------------------- 1999 1998 1997 ----------------------------- ----------------------------- ---------------------------- INTEREST INTEREST INTEREST AVERAGE INCOME/ AVERAGE AVERAGE INCOME/ AVERAGE AVERAGE INCOME/ AVERAGE BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE -------- -------- ------- -------- -------- ------- ------- -------- ------- Interest-earning assets: Loans, net (1) $365,105 $36,230 9.92% $307,061 $32,151 10.47% $243,895 $26,214 10.75% Investment securities 153,651 8,732 5.68% 132,740 7,830 5.90% 104,335 6,372 6.11% Federal funds 25,945 1,309 5.05% 31,982 1,730 5.41% 19,851 1,085 5.47% -------- ------- -------- ------- -------- ------- Total interest-earning assets 544,701 46,271 8.49% 471,783 41,711 8.84% 368,081 33,671 9.15% Other assets 43,357 37,088 36,524 -------- -------- -------- Total assets $588,058 $508,871 $404,605 -------- -------- -------- -------- -------- -------- Interest-bearing liabilities: Deposits: Interest-bearing demand deposits $251,443 $ 8,434 3.35% $219,223 $ 8,387 3.83% $164,110 $ 6,155 3.75% Savings deposits 26,525 622 2.34% 24,596 623 2.53% 22,768 594 2.61% Time deposits 94,163 4,331 4.60% 84,056 4,305 5.12% 70,936 3,705 5.22% -------- ------- -------- ------- -------- ------- Total interest-bearing deposits 372,131 13,387 3.60% 327,875 13,315 4.06% 257,814 10,454 4.05% Other borrowed money 382 45 11.78% 0 0 0.00% 0 0 0.00% Noninterest-bearing liabilities: Noninterest-bearing deposits 165,689 135,954 107,113 Other liabilities 3,840 3,947 3,449 Stockholders' equity 46,016 41,095 36,229 -------- -------- -------- Total liabilities and Stockholders' equity $588,058 $508,871 $404,605 -------- -------- -------- -------- -------- -------- Net interest income $32,839 $28,396 $23,217 ------- ------- ------- ------- ------- ------- Net interest spread (2) 4.90% 4.78% 5.09% Net interest margin (3) 6.03% 6.02% 6.31%
- - --------------------- (1) Nonaccrual loans are included in the average balances used in this table. (2) Net interest spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities. (3) Net interest margin is net interest income divided by average interest-earning assets. The following table illustrates the changes in Scripps' net interest income due to changes in volume (change in volume multiplied by initial rate) and changes in interest rate (change in rate multiplied by initial volume) for the periods indicated. Changes attributable to the combined effect of volume and interest rate have been allocated proportionately to the changes in volume and the changes in interest rate. 22
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME (Dollars in thousands) 1999 1998 COMPARED WITH COMPARED WITH 1998 1997 -------------------------------------- ------------------------------------- INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO VOLUME RATE CHANGES VOLUME RATE CHANGES -------- -------- ------- -------- -------- ------- Interest income on: Loans, net (1) $ 5,638 $ (1,559) $ 4,079 $ 6,595 $ (658) $ 5,937 Investment securities 1,175 (272) 903 1,667 (209) 1,458 Federal funds (310) (111) (421) 656 (11) 645 -------- -------- ------- -------- -------- ------- Total interest income 6,503 (1,942) 4,561 8,918 (878) 8,040 -------- -------- ------- -------- -------- ------- Interest paid on: Interest-bearing demand Deposits 291 (244) 47 2,106 126 2,232 Savings deposits (19) 18 (1) 46 (17) 29 Time deposits 171 (145) 26 670 (70) 600 -------- -------- ------- -------- -------- ------- Total deposit interest expense 443 (371) 72 2,822 39 2,861 Other borrowed money 45 0 45 0 0 0 -------- -------- ------- -------- -------- ------- Total interest expense 488 (371) 117 2,822 39 2,861 -------- -------- ------- -------- -------- ------- Net interest income $ 6,015 $ (1,571) $ 4,444 $ 6,096 $ (917) $ 5,179 -------- -------- ------- -------- -------- ------- -------- -------- ------- -------- -------- -------
(1) Nonaccrual loans are included in the average balances used in calculating this table. PROVISION FOR LOAN LOSSES Provisions for loan losses are charged to earnings to bring the total reserve for loan losses to a level deemed appropriate by management based upon such factors as historical loss experience, the volume and type of lending conducted by Scripps, the amounts of classified and nonperforming assets, regulatory policies and examination results, concentrations, general economic and business conditions, credit quality trends, and other factors related to the collectability of loans in Scripps' portfolio. The provision for loan losses was $7.2 million for 1999, an increase of $5.4 million or 301% compared to the provision for loan losses of $1.8 million for 1998, which in turn represented an increase of $0.3 million or 24% compared to the provision for loan losses of $1.5 million for 1997. The increase in the provision for 1999 reflects the following: Scripps charged-off two large loans in 1999 totalling $6.4 million, average loans increased 19% over the prior year and non-accrual loans increased 128% for the same period. Factors influencing the 1998 provision include the 26% increase in average loans over the prior year and the increase of 39% in non-accrual loans for the same period. NONINTEREST INCOME Noninterest income was $6 million for the year ended December 31, 1999, unchanged compared with noninterest income of $6 million for 1998, which represented an increase of $1 million or 13% compared with noninterest income of $5 million for 1997. In 1999 trust income increased by 18%, but was offset by a decrease in service charge and other income. The primary reasons for the increase in noninterest income over the years presented are growth in trust assets under administration of 20% to $804 million over the two year period ended December 31, 23 1999 and growth in deposits of 38% to $582 million over the two year period ended December 31, 1999. There continues to be high levels of competition in the deposit services and trust services arena. The following table sets forth the various categories of noninterest income.
NONINTEREST INCOME DATA (Dollars in thousands) YEARS ENDED DECEMBER 31, ----------------------------------------------- 1999 % CHANGE 1998 % CHANGE 1997 ------ ---------- ------ -------- ------ Customer service charges $1,955 -14% $2,269 24% $1,833 Trust fees 2,528 18% 2,140 15% 1,862 Gain on sale of securities 0 0% 0 -100% 44 Other non-interest income 284 -27% 387 45% 222 Other fees 857 -34% 1,299 -9% 1,429 ------ ---------- ------ -------- ------ Total $5,624 -8% $6,095 13% $5,390 ------ ------ ------ ------ ------ ------
NONINTEREST EXPENSE Noninterest expense was $24 million for 1999, an increase of $1 million or 5% compared with noninterest expense of $23 million for 1998, and an increase of $3 million or 13% compared with noninterest expense of $20 million for 1997. Personnel expense was $13.5 million for 1999, an increase of $1.5 million or 12% compared with personnel expense of $12 million for 1998, and an increase of $1 million or 10% compared with personnel expense of $11 million for 1997. Occupancy expense was $2.7 million for 1999, an increase of $0.2 million or 6% compared with occupancy expense of $2.5 million for 1998, and an increase of $0.4 million or 15% compared with occupancy expense of $2.1 million for 1997. The aggregate increases over the three-year period principally reflect the additional costs associated with opening new locations as part of SFC's long-term growth strategy. In 1998, noninterest expense included expenses associated with the Scripps-PCB merger. Data processing expense was $0.2 million for 1999, a decrease of $0.6 million or 72% compared with data processing expense of $0.8 million for 1998, an increase of $0.2 million or 23% compared with data processing expense of $0.6 million for 1997. The decrease in data processing expense resulted principally from the in house servicing of the acquired PCB offices along with enhanced technical functionality from equipment acquired in 1998. The increase over the prior two-year period resulted principally from the increase in volumes processed due to loan and deposit growth, offset in part by enhanced technical functionality from equipment acquired in 1996. The following table sets forth the amount of each of the various categories of noninterest expense for the periods indicated.
NONINTEREST EXPENSE DATA (Dollars in thousands) YEARS ENDED DECEMBER 31, ----------------------------------------------- 1999 % CHANGE 1998 % CHANGE 1997 ------- ---------- ------- -------- ------- Salaries and employee benefits $13,460 12% $12,023 10% $10,884 Occupancy and equipment 2,689 6% 2,528 15% 2,190 Data processing 210 -72% 756 23% 615 Depreciation and amortization 1,483 24% 1,200 4% 1,156 Other real estate owned 31 63% 19 -51% 39 Professional services 1,463 -29% 2,052 39% 1,472 Other general and administrative 4,678 10% 4,245 11% 3,812 ------- ---------- ------- -------- ------- Total $24,014 5% $22,823 13% $20,168 ------- ------- ------- ------- ------- -------
24 INCOME TAXES The provision for income taxes was $3 million, $4 million and $3 million for the years ended December 31, 1999, 1998 and 1997, respectively. Effective tax rates, the percentage of earnings set aside for federal and state income taxes were 39%, 41% and 39% for the years ended December 31, 1999, 1998 and 1997, respectively. The decrease in effective rate reflects higher levels of tax exempt income in 1999, as compared to 1998, while 1998 experienced a rise in the effective rate due to lower levels of tax-exempt income over 1997. LOANS AND ASSET QUALITY Net loans (gross loans less unearned income and reserve for loan losses) were $392 million at December 31, 1999, an increase of $56 million or 17% from loans of $336 million at December 31, 1998. This increase followed loan growth of $56 million or 20% from loans of $280 million at December 31, 1997. This increase was preceded by an increase of $68 million or 32% from loans of $212 million at the end of 1996. The rate of loan growth for these periods increased due to an overall improvement in the Southern California economy as well as Scripps' positive reputation in the community to provide quality service and products. Management expects loan growth to be moderate in 2000 assuming that the economy will remain strong, but that the overall competition for loans will be a factor to contend with. If the economy weakens or competition increases, loan growth may be less than expected. Scripps' lending activities are guided by the basic lending policy established by its Board of Directors. The Scripps Board of Directors has established loan approval limits for the officers of Scripps. Under regulations governing California state-chartered banks, Scripps may lend up to 15% of its total capital on an unsecured basis and 25% of its total capital on a secured basis to any one borrower, up to a limit of 25% of total capital for all direct and indirect loans to any one borrower. Additionally, loan concentrations are defined as amounts loaned to a number of borrowers engaged in similar activities or resident in the same geographic region, which would cause them to be similarly affected by economic or other conditions. Scripps, on a regular and periodic basis, evaluates these concentrations for the purposes of making corrections in its lending practices in consideration of economic conditions, industry trends and a variety of other factors. As a result of SFC's market focus, Scripps has a concentration of its customers and assets in San Diego County. The following table sets forth the composition of Scripps' loan portfolio by type of loan on the dates indicated in terms of amount and as a percentage of the total loan portfolio.
LOAN PORTFOLIO ANALYSIS (Dollars in thousands) DECEMBER 31, --------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 % of % of % of % of % of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans -------- -------- -------- -------- -------- -------- -------- -------- -------- --------- Loans and leases: Commercial and other $154,290 39% $156,236 46% $134,960 48% $105,229 49% $ 82,097 50% Real estate construction(1) 57,975 14% 37,932 11% 29,510 11% 14,396 7% 5,335 3% Real estate mortgage(1) 120,256 31% 93,681 28% 74,516 26% 57,049 26% 43,402 27% Consumer (2) 58,076 15% 48,375 14% 42,390 15% 35,718 17% 28,177 18% Lease financing 7,852 2% 6,199 2% 3,212 1% 3,608 2% 5,172 3% Less: Unearned income and fees 1,073 1% 1,648 1% 941 1% 901 1% 1,112 1% -------- -------- -------- -------- -------- --------- Total $397,376 100% $340,775 100% $283,647 100% $215,099 100% $163,071 100% -------- -------- -------- -------- -------- --------- -------- -------- -------- -------- -------- ---------
25 - - ----------------------------- (1) The calculation of real estate loans for financial statement purposes differs from the calculation of loans secured by real estate as reported in Scripps' regulatory call reports. At December 31, 1999, for instance, total loans secured by real estate as reported in Scripps' call report were 225 million or 57%. (2) Represents installment loans to individuals. The following table sets forth the selected loan maturity data of Scripps' loan portfolio. Maturities are presented on a contractual basis.
SELECTED LOAN PORTFOLIO MATURITY (Dollars in thousands) DECEMBER 31, 1999 Maturing ---------------------------------------------- After One Within But Within More Than One Year Five Years Five Years Total -------- ---------- ---------- -------- Commercial and other loans $ 82,529 $ 58,727 $ 13,034 $154,290 Real estate construction loans 49,486 6,944 1,544 57,974 Real estate mortgage loans 23,565 55,979 40,713 120,257 -------- ---------- ---------- -------- Total $155,580 $121,650 $ 55,292 $332,522 -------- ---------- ---------- -------- -------- ---------- ---------- --------
Sensitivity of loans due after one year to changes in interest rates: Fixed rate loans $ 68,792 $ 35,966 $104,758 Variable rate loans 52,858 19,326 72,184 ---------- ---------- -------- Total $121,650 $ 55,292 $176,942 ---------- ---------- -------- ---------- ---------- --------
LOAN CONCENTRATIONS Scripps tracks loan concentrations by standard industry codes (SIC). The table set forth below estimates concentrations of 10 percent or more of total loans as of December 31, 1999. (Dollars in thousands)
SIC Percent Amount - - --- ------- ------------ Manufacturing 13% $ 51,798 Finance, insurance, and real estate 20% 79,690 Services 19% 75,705 Managers and administrators 14% 55,783 --- -------- Total 66% $262,976 All real estate related loans 34% $135,473
Much of the San Diego economy is based on real estate development and investment. As noted above, real estate related borrowers make up approximately 34% of Scripps' loan portfolio, therefore the portfolio is vulnerable to stress in this sector. The Bank has several tools in place to mitigate exposure in the real estate sector, such as conservative underwriting practices, monitoring of sales price trends, centralized monitoring of loans based on accounts or contracts receivable or work in process, and a concerted focus on the underlying strength of the borrower. 26 NONPERFORMING ASSETS Generally, Scripps' policy is to discontinue accrual of interest on loans, which are delinquent for 90 days, or more unless management determines that a loan is adequately collateralized or other circumstances justify treating a loan as fully collectable. When a loan is placed on nonaccrual status, income is not recognized until payment has actually been received and future payments of principal and interest appear certain. Interest income, which has been accrued up to the point a loan is placed on nonaccrual status, is reversed if management determines that the collectability of the accrued interest is doubtful. Real estate acquired by Scripps as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned. Such real estate is reclassified to real estate owned at the lower of cost or fair value less estimated selling costs, and any estimated loss upon reclassification is charged to allowance for losses at that time. Further increases to the allowance for losses on real estate owned are recorded as charges to noninterest expense at the time such costs are incurred or management believes additional deterioration in value has occurred. Management regularly reviews and monitors the loan portfolio to identify borrowers experiencing financial difficulties. Management believes that as of December 31, 1999, all problem loans to date had been identified and included in the nonaccrual or 90 days past due totals reflected below. Management, as part of the responsibilities of Credit Administration and Regulatory Risk Management, is particularly focused upon the objective of reducing its nonperforming and classified assets. In fact, management noted an increase in nonperforming loans in 1999 and is closely monitoring the adequacy of the loan loss reserve in light of this increase. There can be no assurance that management will achieve the objective of reducing nonperforming and classified assets. The following table sets forth certain information with respect to Scripps' nonaccrual loans, accruing loans for which payments of principal and interest are contractually past due 90 days or more, and real estate owned for the periods indicated.
NONPERFORMING ASSETS (Dollars in thousands) DECEMBER 31, ---------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- Nonaccrual loans $ 2,759 $ 1,211 $ 872 $ 661 $ 2,015 Accruing loans past due 90 days or more 1,562 143 112 669 1,393 -------- -------- -------- -------- -------- Total nonperforming loans 4,321 1,354 984 1,330 3,408 Real estate owned 0 0 428 488 48 -------- -------- -------- -------- -------- Total nonperforming assets $ 4,321 $ 1,354 $ 1,412 $ 1,818 $ 3,456 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total nonperforming assets to total assets .68% .23% .31% .50% 1.20%
Reductions in real estate owned over the years presented have resulted principally from Scripps' efforts to dispose of, and keep to a minimum, holdings of such non-earning assets. The bank's level of restructured loans was $1,351,000, $549,000, $643,000, $651,000 and $2,252,000 at December 31, 1999, 1998, 1997, 1996 and 1995 respectively, for which it had established reserves for potential losses of $150,000, $97,000, $153,000, $164,000 and $475,000. Scripps has a Special Assets Department with the primary responsibilities of regular internal loan quality reviews and the monitoring and disposition of nonperforming and classified assets. However, there can be no assurance that reductions in the balance and percent of nonperforming assets will occur in the future. 27 RESERVE FOR LOAN LOSSES In originating loans, Scripps recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for such loan. Management maintains a reserve for loan losses at a level considered adequate to absorb known and inherent risks in the loan portfolio. Management's evaluation of the adequacy of the reserve is ongoing and comprehensive. The following table set forth the breakdown of the allocation of the reserve for loan losses by category of loan on the dates indicated. The allocation of the reserve to each category is not necessarily indicative of future losses and does not restrict the use of the reserve to absorb losses in any other category. 28
ALLOCATION OF THE RESERVE FOR LOAN LOSSES (Dollars in thousands) FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 % of % of % of % of % of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- --------- Loans and leases: Commercial and other $3,993,480 39% $3,798,916 46% $2,988,051 48% $1,773,785 49% $1,483,867 50% Real Estate construction 280,470 14% 0 11% 0 11% 0 7% 0 3% Real Estate mortgage 612,866 31% 568,653 28% 397,337 26% 349,433 26% 396,376 27% Consumer 485,338 15% 345,431 14% 156,222 15% 621,824 17% 694,757 18% Lease financing 39,846 2% 54,000 2% 82,390 1% 91,958 2% 0 3% ---------- ---------- ---------- ---------- ---------- Total allowance for Loan losses $5,412,000 100% $4,767,000 100% $3,624,000 100% $2,837,000 100% $2,575,000 100% ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Management has and will continue to actively monitor Scripps' asset quality, to charge off loans against the reserve for loan losses when appropriate and to provide for specific losses when necessary. Although management believes it uses the best information available to make determinations with respect to the reserve for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations. There can be no assurance that economic conditions that may adversely affect SFC's market area or other circumstances will not result in increased loan losses in Scripps' loan portfolio. The following table sets forth an analysis of Scripps' reserve for loan losses for the periods indicated. 29
RESERVE FOR LOAN LOSSES DATA (Dollars in thousands) DECEMBER 31, -------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- Beginning balance of reserve for loan losses $ 4,767 $ 3,624 $ 2,837 $ 2,575 $ 2,208 --------- --------- --------- --------- --------- Loans charged off: Real estate construction 0 0 0 0 45 Real estate mortgage 90 88 0 169 288 Commercial and other 6,605 394 664 619 515 Consumer 74 241 123 116 99 Lease financing 0 12 2 25 3 --------- --------- --------- --------- --------- Total loans charged off 6,769 735 789 929 950 --------- --------- --------- --------- --------- Recovery of loans previously charged off: Real estate mortgage 28 1 1 63 7 Commercial and other 132 30 114 190 8 Consumer 16 13 9 8 39 Lease financing 9 29 0 8 0 --------- --------- --------- --------- --------- Total recoveries 185 73 124 269 54 --------- --------- --------- --------- --------- Net loans charged off 6,585 662 665 660 896 Provision for loan losses 7,230 1,805 1,452 922 1,263 --------- --------- --------- --------- --------- Ending balance of reserve for loan losses $ 5,412 $ 4,767 $ 3,624 $ 2,837 $ 2,575 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Average net loans outstanding during the period $365,105 $307,061 $243,895 $183,176 $161,083 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Total net loans outstanding at period-end $397,376 $340,775 $283,647 $215,099 $163,071 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Net loans charged off to average net loans 1.80% .22% .27% .36% .56% Reserve for loan losses as a percentage of nonperforming loans 125.25% 352.07% 368.29% 213.31% 75.56% Reserve for loan losses as a percentage of total net loans outstanding at period-end 1.36% 1.40% 1.28% 1.32% 1.58%
INVESTMENT ACTIVITIES Scripps' investment portfolio is used primarily for liquidity purposes and secondarily for investment income. Investment securities classified as available for sale ("AFS") are stated at their current market value with stockholders' equity being adjusted for the after-tax unrecognized gain (loss) on said securities. Investment securities classified as held to maturity ("HTM") are stated at cost, decreased by amortization of premium and increased by accretion of discount, over the period to maturity of the related securities. During 1999 and 1998, Scripps classified its entire investment portfolio as available for sale. Management attempts to maintain investment 30 securities in its portfolio that offer a stable total return profile over a wide range of interest rate environments, as well as securities with varied maturities (a "laddered" portfolio) so that, under normal conditions, there should be no need to sell securities prior to maturity dates, thereby minimizing the impact of interest rate fluctuations on net interest income. However, there can be no assurance that Scripps' investment securities will continue to reflect a stable total return profile over time or that SFC would not sell any investment securities during a rising interest rate environment and recognize a loss. Scripps' current investment policy enables management to invest primarily in United States Treasury and Government Agency obligations, United States Government-sponsored agency securities, mortgage-backed securities, collateralized mortgage obligations and obligations of states and political subdivisions with a maximum aggregate portfolio duration not to exceed four years. Scripps uses an investment advisor to provide added expertise with respect to managing the portfolio. Scripps retains control of all investment decisions. Equity Securities are comprised of mutual fund shares in a variable rate government bond fund, which was acquired through the merger with PCB. The following table sets forth an analysis of Scripps' investment portfolio as of the dates indicated.
INVESTMENT PORTFOLIO COMPOSITION (Dollars in thousands) DECEMBER 31, ----------------------------- 1999 1998 1997 ---------- ----------- ----------- AVAILABLE FOR SALE: U.S. Treasury and U.S. Government Corporation & Agency Securities $70,074 $59,907 $36,517 Mortgage-backed securities: U.S. Government Agency 32,406 38,260 13,530 U.S. Government-Sponsored Agency Securities 3,157 4,970 4,684 Collateralized Mortgage Obligations 36,686 38,507 39,792 States and political subdivisions 19,652 18,128 17,903 Equity Securities 1,308 1,335 1,360 ---------- ----------- ----------- Total available for sale 163,283 161,107 113,786 HELD TO MATURITY: U.S. Treasury and U.S. Government Corporation & Agency Securities 0 0 3,798 Mortgage-backed securities: U.S. Government Agency 0 0 102 U.S. Government-Sponsored Agency Securities 0 0 45 Collateralized Mortgage Obligations 0 0 970 Total held to maturity 0 0 4,915 ---------- ----------- ----------- Total investment securities $163,283 $161,107 $118,701 ---------- ----------- ----------- ---------- ----------- -----------
31 The following table sets forth the maturity distribution and weighted average yield of the investment portfolio as of December 31, 1999.
INVESTMENT PORTFOLIO MATURITY DISTRIBUTION AND YIELDS (Dollars in thousands) ---------------------------------------------------------------------------------- DUE FROM ONE DUE FROM MORTGAGE- YEAR FIVE YEARS BACKED AND DUE IN ONE THROUGH FIVE THROUGH TEN DUE AFTER SBA LOAN YEAR OR LESS YEARS YEARS TEN YEARS POOLS TOTAL ------------ ------------ ----------- --------- ---------- ----- Available for Sale: U.S. Treasury and U.S. Government Corporation & Agency securities $4,995 $57,424 $1,460 $ 0 $6,195 $70,074 Weighted average Yield 6.03% 6.16% 6.91% 6.01% 6.15% Mortgage-backed securities: U.S. Government Agency 32,406 32,406 Weighted average yield 6.93% 6.93% U.S. Government-sponsored Agency Securities 3,157 3,157 Weighted average yield 7.83% 7.83% Collateralized Mortgage Obligations 36,686 36,686 Weighted average yield 6.00% 6.00% States and political subdivisions 372 10,399 8,881 19,652 Weighted average yield (1) 5.36% 5.05% 5.48% 5.25% Equity Securities 1,308 1,308 Weighted average yield 4.46% 4.46% ------------ ------------ ----------- --------- ---------- ----- Percentage of total 3% 36% 7% 5% 49% 100%
- - ------------------------------- (1) The calculation of this yield is not on a tax equivalent basis. DEPOSIT ACTIVITIES Scripps attracts deposits through the offering of a broad variety of deposit instruments for both the consumer and business customer including checking accounts, money market accounts, negotiable orders of withdrawal ("NOW") accounts, savings accounts, term certificates of deposit (including "jumbo" certificates in denominations of $100,000 or more), and retirement savings plans. Scripps' average balance of total deposits was approximately $538 million for the year ended December 31, 1999, an increase of $74 million or 16% compared with the average balance of total deposits for 1998. Scripps' average balance of total deposits was approximately $464 million for the year ended December 31, 1998, an increase of $99 million or 27% compared with the average balance of total deposits of approximately $365 million for 1997. The following table sets forth the average balances and weighted average rates for Scripps' categories of deposits for the periods indicated. 32
AVERAGE DEPOSITS (Dollars in thousands) DECEMBER 31, ------------------------------------------------------------------------------------------------ 1999 1998 1997 ------------------------------ ------------------------------- --------------------------------- AVERAGE % OF TOTAL AVERAGE % OF TOTAL AVERAGE % OF TOTAL BALANCE DEPOSITS BALANCE DEPOSITS BALANCE DEPOSTIS -------------- --------------- --------------- --------------- --------------- ----------------- Noninterest bearing demand deposits $ 165,689 30% $ 135,954 29% $107,113 29% Interest-bearing demand deposits (Money Market and NOW accounts) 251,443 47% 219,223 47% 164,110 45% Weighted average rate 3.35% 3.83% 3.75% Savings deposits 26,525 5% 24,596 5% 22,768 5% Weighted average rate 2.34% 2.53% 2.61% Time deposits 94,163 18% 84,056 18% 70,936 15% Weighted average rate 4.60% 5.12% 5.22%
The following table sets forth the amount of Scripps' certificates of deposit of $100,000 or more by time remaining until maturity.
TIME DEPOSITS OF $100,000 OR MORE (Dollars in thousands) DECEMBER 31, 1999 ------------------------------------ BALANCE % OF TOTAL -------- ---------- Three months or less $ 44,941 64% Over three months through six months 12,906 19% Over six months through twelve months 10,949 16% Over twelve months 955 1% -------- ---------- Total $ 69,751 100% -------- --------
LIQUIDITY The objective of liquidity management is to maintain a balance between sources and uses of funds in such a way that the cash requirements of customers for loans and deposit withdrawals are met in the most economical manner. Management monitors its liquidity position continuously in relation to trends of loans and deposits for short term as well as long term requirements. Liquid resources are monitored on a daily basis to assure maximum availability. Management also manages its liquidity requirements by maintaining an adequate level of readily marketable assets (primarily Federal funds and investment securities available for sale) and access to short term funding sources. Currently, Scripps also has a line of credit of $22 million from non-affiliated financial institutions that enable it to borrow Federal funds on an unsecured basis. Scripps also has a secured discount window borrowing facility with the Federal Reserve Bank of $82 million and a secured borrowing facility with the Federal Home Loan Bank of approximately $23 million. At December 31, 1999, Scripps had no amounts outstanding in connection with any of its borrowing facilities. Management uses several tools and processes to monitor liquid resources: semi-monthly liquidity projection reports, liquidity and volatile deposit dependency ratios, deposit product trends, weekly deposit rate management, and daily large balance fluctuation reports, among others. Management uses a Bank liquidity ratio, defined as the sum of unpledged marketable securities, Federal funds sold, and cash and balances due from banks divided by total deposits, as a measurement tool indicating the volume of liquid resources. This ratio will increase or decrease in response to general economic conditions, loan demand, the phases of the interest rate cycle, and deposit growth/contraction, among other things, and was approximately 37%, 42% and 39% at December 31, 1999, 1998 and 1997, respectively. The decrease in the liquidity ratio from 1998 to 1999 actually reflects a more cost-effective level of liquidity that is well within Scripps' policy guidelines. There can be no assurance that Scripps liquidity will continue to be maintained at a level comparable to that in 1999. Additionally, Scripps closely monitors its loan-to-deposit ratio. This ratio (calculated as gross loans divided by total deposits) was 68%, 64% and 68% at December 31, 1999, 1998 and 1997, respectively. Management anticipated the ratio increase in 1999 with the expanding local economy. This ratio decreased between 1998 and 1997, primarily as a result of deposit growth outpacing loan growth. There can be no assurances that the economy will continue to expand or that loans will outpace deposit growth. 33 Scripps' ratio of core deposits (defined as customers' deposits less time certificates of deposit of $100,000 or more) to total deposits was 88% at December 31, 1999, compared to 89% at December 31, 1998, compared with 87% at December 31, 1997. While total time deposits as a percent of total deposits has been 18%, 17% and 20% for December 31, 1999, 1998 and 1997, respectively, the percent of time deposits greater than $100,000 has increased, thereby decreasing the core deposit ratio. A significant portion of Scripps' core deposits is concentrated in the Scripps Money Fund, a higher interest-bearing demand deposit product that comprised $192 million or 33% of total deposits at December 31, 1999. The Money Fund balance at December 31, 1999 represented a decrease of $3 million or 2% from the balance of $195 million or 37% of deposits at December 31, 1998. Comparing 1998 and 1997, the Money Fund increased $78 million or 67% from the balance of $117 million or 33% of deposits at year end 1997. Another significant portion of Scripps' core deposits is non-interest-bearing demand deposits. These deposits increased to $166 million or 31% of deposits at December 31, 1999, from $136 million or 29% at December 31, 1998. Comparing 1998 and 1997, non-interest-bearing demand deposits increased $29 million or 29% from the balance of $107 million or 32% of deposits at year end 1997. Management attempts to actively monitor its liquidity position and deposit composition; however, there can be no assurance that Scripps' overall liquidity position and deposit base will continue to be satisfactory in the future. CAPITAL RESOURCES Total stockholders' equity was $45 million at December 31, 1999, an increase of $1 million or 4% compared with stockholders' equity of $44 million as of December 31, 1998. This increase is attributable primarily to earnings of $4 million for 1999 and new share issuances of $0.6 million, partially offset by the increase in unrealized holding loss on available for sale securities and dividends declared of $0.8 million. Total stockholders' equity of $44 million at December 31, 1998, reflects an increase of $6 million or 15% compared with stockholders' equity of $38 million as of December 31, 1997. This increase is primarily the result of the earnings of $6 million for 1998, partially offset by dividends declared of approximately $0.8 million. Management seeks to maintain capital adequate to support anticipated asset growth and credit risks and to ensure that SFC is within established regulatory guidelines and industry standards. The 1992 risk-based capital guidelines adopted by the FRB and FDIC require SFC to maintain certain minimum ratios of capital to risk-weighted assets. In addition, the FRB and FDIC have adopted a leverage ratio that requires a minimum ratio of Tier 1 capital to total assets. Higher minimum requirements for an institution may be established if, for example, a bank has previously received special attention or has a higher susceptibility to interest rate risk. These risk-based capital guidelines require state banks to have a ratio of Tier 1 capital to total risk-weighted assets of four percent and a ratio of total capital to total risk-weighted assets of eight percent. As depicted in the following table, the capital ratios of SFC have continuously exceeded the federal minimum regulatory requirements for a well-capitalized institution. The following table sets forth the actual capital ratios of SFC as of the dates indicated.
CAPITAL RATIOS DECEMBER 31, ---------------------------- WELL MINIMUM CAPITALIZED CAPITAL CAPITAL RATIOS(1): 1999 1998 1997 RATIOS RATIOS ----------- --------- ---------- ------------ ----------- Leverage (2) 7.54% 7.63% 8.30% 5.0% 4.0% Tier 1 risk-based 10.18% 10.19% 11.10% 6.0% 4.0% Total risk-based 11.35% 11.32% 12.20% 10.0% 8.0%
- - ---------------------------------------- (1) Computed in accordance with 1992 Federal guidelines, which were initially effective January 1, 1990. (2) Leverage ratio is defined as the ratio of Tier 1 capital to the most recent quarterly average assets. IMPACT OF INFLATION, CHANGING PRICES AND MONETARY POLICIES 34 The consolidated financial statements and related consolidated financial data concerning SFC presented in this filing have been prepared in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation in accordance with generally accepted accounting principles. The primary effect of inflation on the operations of SFC is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of SFC, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the FRB. The FRB implements national monetary policy such as seeking to curb inflation and combat recession by its open market operations in United States government securities, control of the discount rate applicable to borrowing by banks and the establishment of reserve requirements against bank deposits. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits, and affect the interest rates charged on loans and paid on deposits. The nature, timing and impact of any future changes in federal monetary and fiscal policies on SFC and its results of operations are not predictable. In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. For SFC, this new standard is effective in 2000 and is not to be applied retroactively to financial statements of prior periods. The impact of this Statement, if any, is yet to be determined. 35 OUR PERFORMANCE DEPENDS ON THE SOUTHERN CALIFORNIA ECONOMY All of SFC's operations are in Southern California, principally San Diego County. As a result of this geographic concentration, our growth and operations are significantly influenced by local economic conditions. There can be no assurance that general economic conditions and the local business environment will continue to be favorable. During California's economic downturn of the early 1990's, many actual and prospective customers of SFC experienced reductions in their net worth, cash flow and the value of their real estate. FLUCTUATIONS IN INTEREST RATES AFFECT OUR FINANCIAL PERFORMANCE Changes in interest rates will affect the value of Scripps' investment securities portfolio, all of which is designated as available for sale, and which at December 31, 1999 represented 25.8% of total assets. Generally, an increase in interest rates would result in a decline in the value of fixed rate investment securities available for sale, which would result in a corresponding adjustment, net of tax effects, in shareholders' equity. Therefore, Scripps' shareholders' equity and regulatory capital levels could be adversely affected by an increase in interest rates, due to a reduction in the value of investment securities available for sale. An increase in interest rates would also generally cause a decline in the market value of Scripps' fixed rate loan portfolio, which at December 31, 1999 represented approximately 22% % of total assets. Approximately 41% of assets at December 31, 1999 were comprised of variable rate loans tied to Prime or similar indices. A decline in interest rates will generally have the immediate effect of reducing interest income associated with such loans. Declines in interest rates will also typically result in accelerated loan prepayments, which can impact our net interest income and profitability. FLUCTUATIONS IN INTEREST RATES CAN REDUCE DEMAND FOR OUR SERVICES AND LOANS The operations of SFC and Scripps are significantly influenced by general economic conditions and by the related monetary and fiscal policies of the Federal government. The nature, timing and impact of any future changes in federal monetary and fiscal policies on Scripps and its results of operations are not predictable. Deposit flows and the cost of funds are influenced by interest rates of competing investments and general market rates of interest. Lending activities are affected by the demand for loans which, in turn, is affected by the interest rates at which such financing may be offered and by other factors affecting the availability of funds. Increases in the level of interest rates may reduce the demand for loans and therefore the amount of loans originated by Scripps and, thus, the amount of loan and commitment fees. Moreover, decreases in interest rates relative to the rate of return on other investment vehicles may result in disintermediation, which is the flow of funds away from depository institutions into direct investments, such as corporate securities and other investment vehicles which, because of the absence of Federal deposit insurance, generally pay higher rates of return than deposits in depository institutions. COMPETITION MAY AFFECT OUR MARKET SHARE The banking business in California generally, and in Scripps' market area specifically, is highly competitive with respect to both loans and deposits. The trust and investment management services business in Scripps' market area is also highly competitive. Scripps competes for loans, deposits and trust services with other commercial banks, savings and loan associations, finance companies, money market funds, credit unions, brokerage firms and other financial institutions, 36 including a number of institutions that have significantly greater financial resources than Scripps. Scripps also competes for business with institutions in unregulated industries. Deregulation has increased competition for deposit and loan business over the past several years. After interstate banking became lawful in the 1990's, bank holding companies headquartered outside of California entered the California market, providing further competition for Scripps. Many of the major commercial banks operating in Scripps' market area offer certain services which Scripps does not offer directly but can provide through a correspondent bank or through other financial services providers. Banks with larger capitalization also have larger lending limits and are thereby better able to serve the higher dollar needs of larger customers. There are no assurances that the strategies of Scripps for responding to this competition will succeed. AN ADVERSE REAL ESTATE MARKET COULD AFFECT OUR LOAN PORTFOLIO On December 31, 1999, Scripps had approximately $178.2 million in loans secured in whole or in part by real property, including interim construction loans, short, intermediate, and long term commercial and residential real estate loans, home improvement loans, and equity lines of credit. This reflects approximately 45% of Scripps' total loan portfolio at that date. A sharp and significant decline in real estate prices would potentially have a material adverse affect on Scripps' lending activities and on the quality of Scripps' real estate loan portfolio. WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION SFC and Scripps are subject to extensive state and federal supervision, regulation and legislation. We cannot predict the precise impact of recent legislation, nor the probable course or impact of future legislation or regulatory actions affecting the financial services industry. WE NEED TO IMPLEMENT GROWTH SUCCESSFULLY SFC and Scripps plan to expand its regional office network over time throughout San Diego County. The overall success of this strategy will largely depend on SFC's and Scripps' ability to manage its credit, interest rate and fiduciary risks, control costs, and attract and retain high quality personnel with business followings and skills sufficient for SFC and Scripps to operate profitably in new markets, while continuing to provide relationship-oriented banking services and competitive financial products. There are no assurances that existing and prospective customers will be responsive to, or have the need for, the services offered by SFC and Scripps in new markets. In addition, we may not receive the approvals required by the Federal Reserve Board ("FRB"), California Department of Financial Institutions ("DFI") and Federal Deposit Insurance Corporation ("FDIC") in order to grow into new markets. Expansion activity will likely require the expenditure of substantial sums to lease or purchase real property and equipment and to hire high quality, experienced and regionally-oriented new personnel. Our expansion may not generate the returns our management anticipates. Our ability to implement our growth strategy may depend on our retention of existing management. OUR STOCK MAY NOT BE LIQUID SFC Common Stock was listed on the American Stock Exchange in October 1999. Accordingly, there has been a very limited trading market for SFC Common Stock. Any swing in the price of our stock may be magnified into a material reduction in price because relatively few buyers may be available to purchase our stock. No assurance can be given that an active public market will exist in the future. 37 THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE The market price of SFC common stock has been volatile, reflecting loan write-offs, quarterly variations in our operating results, changes in market interest in local banks and financial stocks in general, and economic and financial conditions. WE MAY NOT PAY DIVIDENDS The California Financial Code restricts the payment of dividends by bank holding companies and banks. While SFC has paid cash and stock dividends in the past on its Common Stock, there can be no assurance that it will continue to do so or will be legally permitted to do so in the future. Any payment of dividends by SFC will depend on receipt of dividends from Scripps. Generally, California state banks such as Scripps may not declare or pay a dividend without the prior written approval of the California Commissioner, if the total of all dividends declared by such bank in any calendar year would exceed the total of its net profits, as defined, for that year combined with its retained net profits, as defined, for the preceding two years. The payment of dividends by Scripps is also affected by various regulatory requirements and policies, such as the requirement to maintain capital at or above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The FDIC has issued policy statements which provide that insured banks should generally only pay dividends out of current operating earnings. If Scripps is unable to pay dividends or if the Scripps board of directors determines to reduce its payment of dividends to SFC, SFC in turn may be unable to make or may reduce dividend payments to its shareholders. OUR CHARTER DOCUMENTS MAY DETER ACQUISITIONS The organizational documents of SFC contain certain provisions designed to encourage takeover bidders to engage in arm's-length negotiations with SFC before attempting a takeover. However, these provisions may make the SFC Common Stock less attractive to potential acquirers and may serve as a deterrent to acquisitions of SFC Common Stock, thus potentially preventing shareholders from realizing a return on their investment in an acquisition. The Board of Directors of SFC is authorized, without further shareholder approval, to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions granted or imposed upon any unissued shares of preferred stock and to fix the number of shares constituting any series and the designations of such shares. The issuance of preferred stock may have the effect of delaying or preventing a change in control of SFC. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to the holders of SFC Common Stock or could adversely effect the rights and powers, including voting rights, of the holders of SFC Common Stock. In certain circumstances, such issuance could have the effect of decreasing the market price of the Common Stock. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK SFC's balance sheet consists of interest-earning assets, primarily loans and investment securities, which are principally funded by interest-bearing liabilities, primarily deposits. These financial instruments have varying levels of sensitivity to changes in market interest rates resulting in market risk. In evaluating the exposure of SFC to market risk, management relies on gap analysis and rate shock analysis. Gap analysis provides information on the timing and repricing differences between rate sensitive assets and rate sensitive liabilities. Rate shock analysis provides management with estimates of the impact of immediate changes in interest rates both in terms of the change in net interest income and the change in fair market value of these instruments. There are certain shortcomings inherent in these methods and the following table that must be considered in evaluating market risk. Although certain assets may have similar maturities or periods to reprice, they may react in different degrees to changes in interest rates or they may precede or lag behind changes in market interest rates. In addition, certain interest rate sensitive assets may have contractual limitations to changes in interest rates. SFC considers these various factors and their anticipated effects in managing the company's exposure to interest rate risk. Management seeks to maintain a reasonably balanced interest rate risk position over one year to protect its financial condition and net interest margin from market fluctuations in interest rates. Overall management strategies to reduce SFC's interest rate risk consist of: (i) maintaining a majority of its loan assets and deposit liabilities on an adjustable rate basis, (ii) limiting the volume of its loans with terms-to-maturity in excess of five years and (iii) maintaining a portion of its investment securities with varied terms to maturity. Additionally, Scripps maintains a Management Asset/Liability Committee and a Directors Asset/Liability Committee, both of which review on a regular and periodic basis such matters as earnings, asset quality, asset and liability mix, liquidity and funding sources, investment resources, capital, interest rate risk, and economic events and trends, among other matters. Both Committees review bank compliance with a set of Board-approved directives with which Scripps should comply to meet its asset and liability management objectives. The following table presents additional information about SFC's financial instruments that are sensitive to changes in interest rates. Cash flows in this presentation are grouped by maturity dates rather than repricing dates. Consideration is given to prepayment assumptions for mortgage-backed securities (MBS), including collateralized mortgage obligations (CMOs). The cash flows from mortgage-backed securities are influenced by prepayments, which are dependent on a number of factors, including the current interest rate and the interest rate on the security, the availability of refinancing of the underlying mortgages at attractive terms, as well as geographic specific factors 38 which affect the sales and price levels of residential property. SFC's management uses average prepayment speeds provided by Wall Street dealers to calculate principal repayments and estimated maturity dates for these securities. The cash flows for other securities are based on the actual maturity dates of the instruments, except for equity securities. Equity securities, for which there is no contractual maturity, consist of a variable rate government fund, which is included in the second column (after one year but within two years). Fair values for investment securities are based on quoted market prices or dealer quotes. Loans are distinguished by variable or fixed rates. Because variable rate loans are repricable immediately as market rates change, the fair value is assumed to be equal to the carrying value. The fair value of fixed rate loans is estimated using a discounted cash flow calculation. Non-maturing deposits consist of interest-bearing demand, savings, and money market accounts and have no maturity dates. Cash flow amortizations for these deposits are included in the first column (within one year). The fair value of non-maturing deposits is estimated to be the carrying value, which is the amount payable on demand. Time deposits are grouped according to contractual maturity dates. The fair value of time deposits is estimated using a discounted cash flow calculation. Average interest rates represent the weighted average yield in each category. 39
INTEREST-SENSITIVE FINANCIAL INSTRUMENTS (Dollars in thousands) EXPECTED MATURITY DATE AS OF DECEMBER 31, 1999 ----------------------------------------------------------------------------------------------------- AFTER 2 AFTER 1 YEARS BUT AFTER 3 AFTER 4 YEAR BUT WITHIN YEARS BUT YEARS BUT WITHIN ONE WITHIN TWO THREE WITHIN FOUR WITHIN FIVE YEAR YEARS YEARS YEARS YEARS THEREAFTER TOTAL FAIR VALUE ----------- ---------- --------- ----------- ---------- ------------ ------- ------------ Financial Assets: Loans: Variable rate $143,776 $24,608 $10,757 $28,332 $15,341 $32,934 $255,748 $255,748 Average interest rate 9.73% 9.88% 9.90% 9.48% 9.90% 10.35% 9.81% Fixed rate 13,645 22,224 17,695 33,686 12,067 42,311 141,628 140,760 Average interest rate 8.54% 8.42% 9.05% 8.89% 8.68% 8.37% 8.63% Investment securities: CMOs 5,767 4,358 3,767 5,867 4,275 13,285 37,319 33,280 Average interest rate 6.04% 6.36% 6.04% 6.03% 6.03% 5.96% 6.01% MBS 13,707 10,455 5,824 4,537 926 947 36,396 34,783 Average interest rate 7.03% 7.02% 6.96% 6.91% 6.88% 6.67% 6.99% SBAs 153 2,737 3,334 6,224 6,299 Average interest rate 9.73% 6.13% 6.20% 6.26% U.S. Treasury and Agency 8,511 25,256 24,348 6,953 65,068 47,667 Average interest rate 6.18% 6.20% 6.27% 5.50% 6.15% States and political subdivisions 38 1,959 9,793 8,144 19,934 18,641 Average interest rate 8.10% 5.46% 5.30% 5.13% 5.25% Equity 1,461 1,461 1,308 Average interest rate 4.46% 4.46% Federal Home Loan Bank Stock 1,793 1,793 1,793 Average interest rate 5.49% 5.49% Interest bearing due from banks 789 789 789 Average interest rate 5.90% 5.90% Federal funds sold 29,670 29,670 29,670 Average interest rate 5.14% 5.14% Financial Liabilities: Interest bearing deposits: Non-maturing Deposits 293,914 293,914 293,914 Average interest rate 3.64% 3.64% Time deposits 101,876 2,473 80 27 104,456 104,427 Average interest rate 4.79% 4.86% 4.57% 5.25% 4.79% Capitalized lease obligation 767 767 767 Average interest rate 9.87% 9.87% Guarantee of loan to ESOP Trust 38 6 44 44 Average interest rate 7.75% 7.75% 7.75%
40 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Scripps Financial Corporation The information contained in the accompanying consolidated statements of financial condition and the related consolidated statements of income, of changes in stockholders' equity and of cash flows have been prepared by management. Management has the primary responsibility for ascertaining that these financial consolidated statements present fairly the financial position and the results of operations and cash flows of Scripps Financial Corporation as of and for the years ended December 31, 1999 and 1998. These financial statements were prepared in accordance with generally accepted accounting principles and necessarily include amounts that are based on best estimates and judgments with appropriate consideration given to materiality. Management has made these estimates and judgments based on extensive experience and a substantive understanding of the underlying events and transactions. In fulfilling its responsibility for the reliability and integrity of financial information, management has established and maintains accounting procedures and related internal control systems. Management believes that these systems and controls provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with management's authorizations and properly recorded to permit the preparation of reliable financial statements in conformity with generally accepted accounting principles, and that material errors or irregularities are either prevented or detected within a timely period by employees in the normal course of performing their assigned duties. Scripps Financial Corporation's independent accountants review and test the established internal control systems to the extent necessary to express an opinion on the accompanying consolidated financial statements. 41 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF SCRIPPS FINANCIAL CORPORATION - - -------------------------------------------------------------------------------- In our opinion, the accompanying consolidated statements of financial condition and the related consolidated statements of income, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Scripps Financial Corporation and its subsidiary at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. 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 of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP San Diego, California February 4, 2000 42 SCRIPPS FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - - ------------------------------------------------------------------
December 31, -------------------------- 1999 1998 -------------------------- ASSETS Cash and amounts due from banks $25,046,000 $24,330,000 Federal funds sold 29,670,000 42,790,000 -------------------------- Cash and cash equivalents 54,716,000 67,120,000 Interest bearing due from banks 789,000 4,352,000 Investment securities 163,283,000 161,107,000 Investment in Federal Home Loan Bank stock 1,793,000 1,210,000 Loans and leases, net 391,964,000 336,008,000 Premises and equipment, net 6,012,000 4,441,000 Other assets and accrued interest receivable 13,388,000 8,392,000 -------------------------- $631,945,000 $582,630,000 ========================== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand, non-interest bearing $184,015,000 $152,697,000 Money market, NOW and savings accounts 293,914,000 290,113,000 Time certificates: Under $100,000 34,705,000 31,861,000 $100,000 or greater 69,751,000 56,303,000 -------------------------- Total deposits 582,385,000 530,974,000 Guarantee of loan to ESOP Trust 44,000 76,000 Capitalized lease obligation 767,000 0 Other liabilities and accrued interest expense 3,452,000 7,825,000 -------------------------- Total liabilities 586,648,000 538,875,000 Commitments and contingencies (Notes 10 and 11) Stockholders' equity: Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 6,909,000 shares (1998 6,797,000 shares) 34,702,000 34,092,000 Retained earnings 12,497,000 8,896,000 Guarantee of loan to ESOP Trust (44,000) (76,000) Accumulated other comprehensive (loss) income, net (1,858,000) 843,000 -------------------------- Total stockholders' equity 45,297,000 43,755,000 -------------------------- $631,945,000 $582,630,000 ==========================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 43 SCRIPPS FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME - - ------------------------------------------------------------------
Year Ended December 31, ------------------------------------- 1999 1998 1997 ------------------------------------- Interest income: Loans and leases, including fees earned $36,230,000 $32,151,000 $26,215,000 Investment securities: Taxable 7,566,000 6,500,000 5,401,000 Exempt from federal income tax 955,000 920,000 651,000 Dividends from Federal Home Loan Bank stock 84,000 66,000 16,000 Federal funds sold 1,309,000 1,730,000 1,085,000 Balances due from Banks 127,000 344,000 304,000 ------------------------------------- Total interest income 46,271,000 41,711,000 33,672,000 Interest expense on deposits (13,387,000) (13,315,000)(10,454,000) Interest expense on other borrowed money (45,000) 0 0 ------------------------------------- Total interest expense (13,432,000) (13,315,000)(10,454,000) Net interest income 32,839,000 28,396,000 23,218,000 Provision for loan losses (7,230,000) (1,805,000) (1,452,000) ------------------------------------- Net interest income after provision for loan losses 25,609,000 26,591,000 21,766,000 Non-interest income 5,624,000 6,095,000 5,390,000 Non-interest expense (24,014,000) (22,823,000)(20,168,000) ------------------------------------- Income before provision for income taxes 7,219,000 9,863,000 6,988,000 Provision for income taxes (2,790,000) (3,995,000) (2,758,000) ------------------------------------- Net income $4,429,000 $5,868,000 $4,230,000 ===================================== Basic net income per share $0.64 $0.87 $0.63 ===================================== Diluted net income per share $0.63 $0.84 $0.61 ===================================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 44 SCRIPPS FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - - --------------------------------------------------------------------------------------------------------------------- Accumulated Common Stock Guarantee Other Total ------------------------- Retained of Loan to Comprehensive Stockholders' Shares Amount Earnings ESOP Trust (Loss) Income Equity --------------------------------------------------------------------------------- Balance at December 31, 1996 4,031,000 $27,352,000 $7,415,000 $(143,000) $ 64,000 $34,688,000 Comprehensive income: Net income 4,230,000 4,230,000 Unrealized holding gain on available for sale Securities, net of tax of $463,000 694,000 694,000 --------------------------------------------------------------------------------- Total comprehensive income 4,924,000 --------------------------------------------------------------------------------- Net principal decrease of loan to ESOP Trust 36,000 36,000 Stock options exercised 52,000 346,000 346,000 Cash dividends declared (917,000) (917,000) Stock dividend declared (10%) 223,000 5,516,000 (5,516,000) 0 Stock dividend declared (2.3%) 85,000 668,000 (668,000) 0 Repurchase and retirement of common stock (149,000) (380,000) (740,000) (1,120,000) Stock split (2 for 1, in the form of a 100% stock dividend) 2,466,000 0 --------------------------------------------------------------------------------- Balance at December 31, 1997 6,708,000 $33,502,000 $3,804,000 $(107,000) $ 758,000 $37,957,000 --------------------------------------------------------------------------------- Comprehensive income: Net income 5,868,000 5,868,000 Unrealized holding gain on available for sale securities, net of tax of $70,000 85,000 85,000 --------------------------------------------------------------------------------- Total comprehensive income 5,953,000 --------------------------------------------------------------------------------- Net principal decrease of loan to ESOP Trust 31,000 31,000 Stock options exercised 74,000 280,000 280,000 Cash dividends declared (776,000) (776,000) Stock issued for services 12,000 250,000 250,000 Stock issued for dividends reinvested 3,000 60,000 60,000 --------------------------------------------------------------------------------- Balance at December 31, 1998 6,797,000 $34,092,000 $8,896,000 $ (76,000) $ 843,000 $43,755,000 --------------------------------------------------------------------------------- Comprehensive income: Net income 4,429,000 4,429,000 Unrealized holding loss on available for sale securities (2,701,000) (2,701,000) --------------------------------------------------------------------------------- Total comprehensive income 1,728,000 --------------------------------------------------------------------------------- Net principal decrease of loan to ESOP Trust 32,000 32,000 Stock options exercised 110,000 574,000 574,000 Cash dividends declared (828,000) (828,000) Stock issued for dividends reinvested 2,000 36,000 36,000 --------------------------------------------------------------------------------- Balance at December 31, 1999 6,909,000 $34,702,000 $12,497,000 ($44,000) ($1,858,000) $45,297,000 =================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 45 SCRIPPS FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS - - ------------------------------------------------------------------
Year Ended December 31, ------------------------------------- 1999 1998 1997 ------------------------------------- Cash flows from operating activities: Net income $4,429,000 $5,868,000 $4,230,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,483,000 1,200,000 1,156,000 Provision for loan losses 7,230,000 1,805,000 1,411,000 Amortization of discounts, premiums and loan fees (245,000) (808,000) (805,000) Loss (gain) on sale of real estate owned 2,000 (10,000) (26,000) Stock issued for services 0 250,000 0 Decrease (increase) in other assets and accrued interest receivable (3,384,000) (837,000) (946,000) Increase (decrease) in other liabilities and accrued interest expense (3,612,000) 4,459,000 559,000 ------------------------------------- Net cash provided by operating activities 5,903,000 11,927,000 5,579,000 ------------------------------------- Cash flows from investing activities: Proceeds from maturities and principal payments received from investment securities 109,286,000 106,782,000 17,009,000 Proceeds from sale of investment securities 0 0 29,421,000 Proceeds from sale of furniture, fixtures & equipment 8,000 169,000 10,000 Proceeds from sale of real estate owned 250,000 438,000 487,000 Maturities/(purchases) of investment certificate of deposit 3,563,000 1,385,000 (89,000) Purchases of investment securities (117,235,000)(149,266,000)(72,159,000) Net funding of loans (62,274,000) (56,957,000)(69,024,000) Purchases of premises and equipment, net (3,104,000) (1,820,000) (2,765,000) ------------------------------------- Net cash used in investing activities (69,506,000) (99,269,000)(97,110,000) ------------------------------------- Cash flows from financing activities: Net increase in demand deposits, NOW accounts and savings accounts 35,119,000 104,824,000 72,609,000 Net increase (decrease) in certificates of deposit 16,292,000 5,473,000 20,980,000 Net proceeds from issuance of common stock 610,000 340,000 346,000 Repurchase and retirement of common stock 0 0 (1,120,000) Dividends paid (822,000) (674,000) (833,000) ------------------------------------- Net cash provided by financing activities 51,199,000 109,963,000 91,982,000 ------------------------------------- Net increase (decrease) in cash and cash equivalents (12,404,000) 22,621,000 451,000 Cash and cash equivalents at beginning of year 67,120,000 44,499,000 44,048,000 ------------------------------------- Cash and cash equivalents at end of year $54,716,000 $67,120,000 $44,499,000 =====================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 46 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Scripps Financial Corporation, a California corporation ("SFC"), was formed on May 14, 1999 as a federally regulated bank holding company. Its wholly-owned subsidiary Scripps Bank ("the Bank") is a California State Banking Corporation organized in 1983, whose primary business is commercial banking. At December 31, 1999, the Bank is the only business activity of SFC. The accounting and reporting policies of SFC are in accordance with generally accepted accounting principles and conform to practices within the banking industry. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A summary of the significant accounting policies used in the preparation of these consolidated financial statements follows. BASIS OF PRESENTATION AND BUSINESS COMBINATION The accompanying consolidated financial statements include the accounts of both SFC and the Bank. All inter-company transactions and balances have been eliminated. The merger in August 1998 with Pacific Commerce Bank, as described in Note 13, was accounted for as a pooling-of-interests. Under this method of accounting, the assets, liabilities and shareholders' equity of Pacific Commerce Bank were carried forward at their historical amounts and its results of operations were combined with the Bank's results of operations, retroactively for all periods. No adjustments to conform accounting methods of the merged company to the Bank were required. Certain amounts have been reclassified with regard to presentation of the financial information of the merged banks. INVESTMENT SECURITIES The Bank has classified its entire securities portfolio as available-for-sale at December 31, 1999 and 1998. Available-for-sale securities are recorded at estimated market value with the unrealized cumulative gain or loss being reflected in accumulated other comprehensive income as a component of stockholders' equity. The held-to-maturity securities acquired through the merger with Pacific Commerce Bank were transferred to the available-for-sale account at the merger date, resulting in a decrease in unrealized gain of $19,000, net of tax of $13,000. The amortized cost of these securities at the date of the merger was $3,860,000. Gains and losses realized upon sale of securities are determined using the specific identification method. LOANS AND LEASES Loans are reported at their outstanding principal amount, net of unearned discounts and fees. Unearned discounts and interest on loans and other interest earning assets are accrued monthly as earned. The accrual of interest on loans is discontinued when, in management's judgment, the interest will not be paid in accordance with contractual terms of the loan agreement. Loan origination fees, net of direct costs, are amortized to interest income as an adjustment of yield over the term of the loan. The Bank considers a loan to be impaired when, based on current information and events, it is probable that the Bank may not collect amounts due according to the original contractual terms of, and as scheduled in, the original loan agreement. The Bank measures impaired loans by using one of the following methods: (i) the present value of expected cash flows discounted at the loan's effective interest rate; (ii) the observable value of the loan's market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Cash receipts for impaired loans placed on non-accrual status are first applied to reduce principal. Direct financing lease agreements are recorded at the aggregate of lease payments receivable and the estimated residual values, net of unearned income. Lease income is recognized to yield a level rate of return on the net investment in leases outstanding. 47 OTHER REAL ESTATE OWNED Real estate acquired in satisfaction of loan obligations is recorded at the lower of the loan balance at the date of acquisition, the present value of expected cash flows or the fair value less expected selling costs. Subsequent operating expenses or income, reductions in estimated value, and gains or losses upon sale are charged to earnings as incurred. RESERVE FOR LOAN LOSSES The Bank maintains a reserve for estimated loan losses at a level considered adequate by the Bank to provide for known and inherent risks in the loan and lease portfolio. The reserve is increased by provisions charged to expense and reduced by charge-offs, net of recoveries. Management's evaluation of the adequacy of the reserve includes periodic review and assessment of the overall risk in the loan and lease portfolio, prior loan and lease loss experience, and prevailing and anticipated economic conditions. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets (3 to 25 years). Leasehold improvements are capitalized and amortized over the term of the lease or the estimated useful life of the improvement, whichever is shorter. Maintenance and repair costs are expensed as incurred, while renewals and betterments are capitalized. Capital leases are included in premises and equipment at cost, less accumulated depreciation. INCOME TAXES Income taxes are provided using the liability method of accounting. Under this method, a deferred tax asset and/or liability is computed for both the expected future impact of differences between the financial statement and tax basis of assets and liabilities and for the expected future tax benefit to be derived from tax loss and tax credit carry forwards. This method also requires the establishment of a valuation allowance, if necessary, to reflect the likelihood of realization of deferred tax assets. The effect of tax rate changes are reflected in income in the period such changes are enacted. EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP") The guaranteed borrowing by SFC's ESOP Trust is reflected in the accompanying consolidated financial statements as both a liability and a reduction of stockholders' equity. The debt service requirements of the plan are funded by contributions from SFC. Such contributions are included in non-interest expense for the period in which the contributions are made. DIVIDEND REINVESTMENT PLAN SFC has a Dividend Reinvestment Plan ("the Plan"), which allows shareholders to automatically reinvest all or a portion of cash dividends paid on their shares of Common Stock in newly issued shares without payment of any brokerage commissions or service charges. The Plan is currently suspended until such time as the necessary SEC registration filing is made. EARNINGS PER SHARE ("EPS") Basic EPS represents net income divided by the weighted average common shares outstanding during the period excluding any potential dilutive effects. The weighted average number of shares used for the computation of basic EPS was 6,879,000, 6,754,000 and 6,726,000 shares in 1999, 1998 and 1997, respectively. Diluted EPS gives effect to all potential issuances of common stock that would have caused basic EPS to be lower as if the issuance had already occurred. Accordingly, diluted EPS reflects an increase in the weighted average shares outstanding of 112,000, 220,000 and 261,000 for 1999, 1998 and 1997 respectively, due to the assumed exercise of stock options. 48 STATEMENT OF CASH FLOWS For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and Federal funds sold. Total interest paid on deposits in 1999, 1998 and 1997 aggregated approximately $14,377,000, $13,991,000 and $10,778,000, respectively. Income taxes paid in 1999, 1998 and 1997 total approximately $4,250,000, $4,294,000 and $3,280,000, respectively. Dividends declared, not yet paid in 1999, 1998 and 1997 were $415,000, $408,000 and $300,000, respectively. TRUST DEPARTMENT In accordance with the usual practice of financial institutions, the assets and liabilities of individual trusts, agencies, and fiduciary funds are not included in the accompanying consolidated financial statements. Trust assets under management total approximately $804,400,000 and $867,312,000 at December 31, 1999 and 1998, respectively. NOTE 2 - INVESTMENT SECURITIES The components of investment securities, which management has classified entirely as available-for-sale are as follows:
DECEMBER 31, 1999 ------------------------------------------------------------------------- GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------------------------------------------------------------------- US Treasury and US Government Corporation & Agency securities $ 71,292,000 $ 16,000 $ (1,234,000) $ 70,074,000 Mortgage-backed securities: US Government Agency 33,231,000 106,000 (931,000) 32,406,000 US Government-sponsored Agency securities 3,165,000 8,000 (16,000) 3,157,000 Collateralized mortgage obligations 37,319,000 6,000 (639,000) 36,686,000 States and political subdivisions 19,934,000 51,000 (333,000) 19,652,000 Equity securities 1,461,000 0 (153,000) 1,308,000 ---------------- ---------------- -------------- -------------- $ 166,402,000 $ 187,000 $ (3,306,000) $ 163,283,000 ---------------- ---------------- -------------- -------------- ---------------- ---------------- -------------- --------------
The collateralized mortgage obligations owned by the Bank at December 31, 1999 are issued or guaranteed by a US Government Agency ("GNMA") or US Government-sponsored Agencies ("FNMA" and "FHLMC") or are collateralized by mortgage-backed securities issued or guaranteed by the same agencies. These securities have weighted average lives estimated at less than five years, although actual terms to maturity may differ due to the variability of principal repayments. Equity securities are comprised of mutual fund shares in a variable-rate government bond fund.
DECEMBER 31, 1998 ------------------------------------------------------------------------- GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ------------------------------------------------------------------------- US Treasury and US Government Corporation & Agency securities $ 59,655,000 $ 323,000 $ (71,000) $ 59,907,000 Mortgage-backed securities: US Government Agency 38,009,000 314,000 (63,000) 38,260,000 US Government-sponsored 49 Agency securities 4,922,000 64,000 (16,000) 4,970,000 Collateralized mortgage obligations 38,418,000 171,000 (82,000) 38,507,000 States and political subdivisions 17,236,000 892,000 18,128,000 Equity securities 1,461,000 (126,000) 1,335,000 ---------------- ---------------- -------------- -------------- $ 159,701,000 $ 1,764,000 $ (358,000) $ 161,107,000 ---------------- ---------------- -------------- -------------- ---------------- ---------------- -------------- --------------
The maturity distribution of available-for-sale investment securities at December 31, 1999 is as follows:
AMORTIZED ESTIMATED COST MARKET VALUE -------------------------------- Due in one year or less $ 5,000,000 $ 4,995,000 Due from one year through five years 58,951,000 57,796,000 Due from five years through ten years 12,004,000 11,860,000 Due after ten years 9,048,000 8,880,000 Mortgage-backed and guaranteed Small Business Administration loan-backed securities 79,938,000 78,444,000 Equity securities 1,461,000 1,308,0000 -------------- -------------- $ 166,402,000 $ 163,283,000 -------------- -------------- -------------- --------------
The maturities of mortgage-backed securities, collateralized mortgage obligations, and Small Business Administration (a US Government Agency) loan-backed securities will differ from contractually-stated maturities because the mortgages or loans underlying the securities amortize regularly and may also prepay without penalty; in addition, equity securities have no stated maturity date. Accordingly, these securities are listed separately in the above maturity distribution. Securities with a fair value of $114,676,000 and $14,867,000 at December 31, 1999 and 1998, respectively, were pledged to secure certain deposits and other borrowings as required or permitted by law. Realized net gains from the sale of securities during 1999, 1998 and 1997 were $0, $0 and $44,000, respectively. The increase in pledged securities between 1998 and 1999 was the result of the Bank's decision to establish Y2K liquidity lines, none of which were drawn on. NOTE 3 - LOANS AND LEASES, AND RESERVE FOR LOAN LOSSES Loans and leases comprise the following:
DECEMBER 31, ---------------------------------- 1999 1998 ---------------------------------- LOANS AND LEASES: Commercial $ 154,290,000 $ 156,236,000 Real estate construction 57,975,000 37,932,000 Real estate mortgage 120,256,000 93,681,000 Consumer 58,076,000 48,375,000 Lease financing 7,852,000 6,199,000 --------------- --------------- 398,449,000 342,423,000 LESS: Unearned income and fees 1,073,000 1,648,000 Reserve for loan losses 5,412,000 4,767,000 --------------- --------------- Total $ 391,964,000 $ 336,008,000 --------------- --------------- --------------- ---------------
50 At December 31, 1999, minimum lease payments to be received on direct financing leases for each of the succeeding years ending December 31 are estimated as follows: $3,469,000 in 2000, $2,570,000 in 2001, $1,577,000 in 2002, $946,000 in 2003 and $375,000 in 2004. The Bank has made loans to various directors and officers of the Bank or SFC. The loans, which were made in accordance with the Bank's general lending policies, totaled $119,000 and $1,363,000 at December 31, 1999 and 1998, respectively. During 1999, new loans (including drawdowns on revolving lines of credit and advances) aggregated $0 and repayments aggregated $1,244,000. Loans placed on non-accrual status totaled $2,759,000 and $1,211,000 at December 31, 1999 and 1998, respectively. The Bank's investment in impaired loans was $1,351,000 and $549,000 at December 31, 1999 and 1998, respectively, for which it had established reserves for estimated losses of $150,000 and $97,000. The average recorded investment in impaired loans during 1999 and 1998 was $1,354,000 and $552,000, respectively. Interest income on impaired loans of $116,000, $40,000 and $41,000 was recognized for cash payments received in 1999, 1998 and 1997, respectively. Activity in the reserve for loan losses follows:
YEAR ENDED DECEMBER 31 ------------------------------------------------------- 1999 1998 1997 ------------------------------------------------------- Balance at beginning of year $ 4,767,000 $ 3,624,000 $ 2,837,000 Provision charged to expense 7,230,000 1,805,000 1,452,000 Loans charged off (6,769,000) (735,000) (789,000) Recoveries 184,000 73,000 124,000 ---------------- --------------- --------------- Balance at end of year $ 5,412,000 $ 4,767,000 $ 3,624,000 ---------------- --------------- --------------- ---------------- --------------- ---------------
NOTE 4 - PREMISES AND EQUIPMENT Premises and equipment consist of:
DECEMBER 31, ---------------------------------- 1999 1998 ---------------------------------- Furniture, fixtures and equipment $ 8,634,000 $ 7,047,000 Leasehold improvements 3,505,000 3,083,000 Premises 777,000 89,000 --------------- --------------- 12,916,000 10,219,000 Less: Accumulated depreciation and amortization 6,976,000 5,778,000 --------------- --------------- Premises and equipment, net $ 6,012,000 $ 4,441,000 --------------- --------------- --------------- ---------------
Included in premises at December 31, 1999 is a branch office leased under a capital lease in the amount of $760,000. Future minimum lease payments at December 31, 1999 are as follows: 2000 $ 167,000 2001 171,000 2002 180,000 2003 180,000 51 2004 192,000 Thereafter 5,973,000 --------------- Total minimum capital lease payments $ 6,863,000 --------------- ---------------
The Bank leases its facilities under non-cancelable operating leases that expire at various times beginning in the years 2001 through 2026. The Bank leases one of its offices from a partnership in which a director of the Bank is the general partner under a lease expiring on September 24, 2006. In the opinion of management, the terms of the lease are comparable to the terms of other leases that could be obtained if the Bank leased similar space from an unrelated party. The lease agreements have option periods to extend at rates equivalent to the then market rates. The future minimum rental commitments at December 31, 1999 are as follows: 2000 $ 1,820,000 2001 2,442,000 2002 2,393,000 2003 2,292,000 2004 1,763,000 Thereafter 10,944,000 --------------- Total minimum lease payments $ 21,654,000 --------------- ---------------
The total rental expense was $1,424,000, $1,350,000 and $1,102,000 for the years ended December 31, 1999, 1998 and 1997, respectively. NOTE 5 - NON-INTEREST INCOME AND EXPENSE Non-interest income consists of:
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1999 1998 1997 ------------------------------------------------------ Customer service charges $ 1,955,000 $ 2,269,000 $ 1,833,000 Trust income 2,528,000 2,140,000 1,862,000 Other fees 857,000 1,299,000 1,429,000 Other non-interest income 284,000 387,000 266,000 --------------- --------------- --------------- $ 5,624,000 $ 6,095,000 $ 5,390,000 --------------- --------------- --------------- --------------- --------------- --------------- Non-interest expense consists of: Salaries and employee benefits $ 13,460,000 $ 12,023,000 $ 10,884,000 Occupancy & equipment 2,689,000 2,528,000 2,190,000 Depreciation and amortization 1,483,000 1,200,000 1,156,000 Data processing 210,000 756,000 615,000 Professional services 1,463,000 2,052,000 1,472,000 Other general and administrative 4,709,000 4,264,000 3,851,000 --------------- --------------- ---------------- $ 24,014,000 $ 22,823,000 $ 20,168,000 --------------- --------------- ---------------- --------------- --------------- ----------------
NOTE 6 - INCOME TAXES The provision for income taxes includes the following components: 52
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1999 1998 1997 ------------------------------------------------------- CURRENT: Federal $ 2,225,000 $ 3,460,000 $ 2,210,000 State 764,000 1,157,000 892,000 --------------- --------------- ---------------- 2,989,000 4,617,000 3,102,000 DEFERRED: Federal (206,000) (574,000) (245,000) State 7,000 (48,000) (99,000) --------------- --------------- ---------------- (199,000) (622,000) (344,000) --------------- --------------- ---------------- $ 2,790,000 $ 3,995,000 $ 2,758,000 --------------- --------------- ---------------- --------------- --------------- ----------------
Deferred tax assets and liabilities represent the expected future income tax impact of the differences between tax basis and financial statement basis of assets and liabilities. The components of net deferred tax assets were as follows:
DECEMBER 31, ----------------------------------- 1999 1998 ----------------------------------- Loan loss provision $ 1,661,000 $ 1,273,000 Deferred loan fees 437,000 332,000 Leases (555,000) (236,000) Deferred compensation 564,000 460,000 Fixed assets 549,000 335,000 Unrealized gain on AFS securities 1,259,000 (599,000) Other (282,000) 217,000 --------------- ---------------- $ 3,633,000 $ 1,782,000 --------------- ---------------- --------------- ----------------
Based on SFC's earnings history and projections, management considers the net deferred tax asset to be realizable. Accordingly, no valuation allowance has been established. The reconciliation between the statutory Federal income tax rate and the effective rate follows:
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1999 1998 1997 ------------------------------------------------------- Federal statutory rate 34% 34% 34% Tax exempt income (5) (8) (4) State tax, net of Federal tax effect 7 11 8 Other 2 4 1 --------------- -------------- ---------------- Effective tax rate 39% 41% 39% --------------- -------------- ---------------- --------------- -------------- ----------------
53 NOTE 7 - EMPLOYEE BENEFIT PLANS SFC has a 401(k) plan covering substantially all employees who meet certain age and service requirements. The Board of Directors determines employer contributions based on net income. During 1999, 1998 and 1997 SFC contributed to the plan $306,000, $240,000 and $226,000, respectively. The Scripps Bank Board of Directors changed the plan to a matching contribution, effective January 1999. In 1999, SFC contributed an amount equal to 50% of the employee's contribution, up to 12% of the employee's salary. Beginning January 1, 2000 the SFC contribution was reduced to 50% of the employee's contribution, up to 6% of the employee's salary. In 1996, the ESOP obtained a loan to purchase shares of common stock, which are held by a third party lender as security for the loan. The loan is guaranteed by the Bank as to payment of principal and interest. The outstanding loan balances at December 31, 1999 and 1998 were $44,000 and $76,000, respectively. SFC's contributions to the ESOP during 1999, 1998 and 1997 were approximately $40,000, $80,000 and $75,000 respectively. At December 31, 1999, approximately 103,200 shares owned by the ESOP are allocated to the ESOP participants, and approximately 6,400 shares currently owned by the ESOP are held as collateral for the ESOP loan. SFC has a stock purchase plan in which all employees and directors may participate. SFC contributes an amount equal to 25% of the participants' contributions; these contributions are then used to purchase common stock of SFC. During 1999, 1998 and 1997, SFC contributed $59,000, $60,000 and $46,000, respectively, to the plan. The plan held approximately 134,000 and 122,300 shares of common stock at December 31, 1999 and 1998, respectively. The Bank has adopted supplemental retirement plans to provide additional retirement benefits for its president. The present value of the estimated future obligation is being accrued and funded over the vesting period. NOTE 8 - STOCK OPTIONS EMPLOYEE STOCK OPTION PLANS SFC has granted incentive stock options and non-qualified stock options to certain officers, employees and directors to purchase common stock. The purpose of these Plans is to advance the interest of SFC and its shareholders by providing officers, directors and key employees with an incentive to serve and to continue service with SFC. SFC currently has options outstanding under three option plans, the 1998 Outside Director Plan ("1998 Plan"), the 1995 Stock Option Plan ("1995 Plan"), and the 1992 Stock Option Plan ("1992 Plan"). The stock options under these plans vest at various rates up to five years and expire over a period of up to ten years. No compensation cost has been recognized for its employee stock option grants, which are fixed in nature, as the options have been granted at a price equal to the market value of SFC's common stock at the date of grant. Had compensation cost for SFC's stock based compensation plans been determined based on the estimated fair value at the grant date rather than market value during the year ended December 31, 1999, SFC's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1999 1998 1997 ------------------------------------------------------- NET INCOME: As reported $ 4,429,000 $ 5,868,000 $ 4,230,000 Pro forma $ 4,265,000 $ 5,697,000 $ 4,143,000 BASIC EARNINGS PER SHARE: As reported $.64 $.87 $.63 Pro forma $.62 $.84 $.62 DILUTED EARNINGS PER SHARE: As reported $.63 $.84 $.61 Pro forma $.61 $.82 $.59
54 The fair value of each option grant has been estimated on the date of grant using the following assumptions: for 1999: an expected option life of three and eight years, a constant dividend yield of 1%, a risk-free interest rate of 6.62% and 6.79%, and a volatility factor of 31%; for 1998: an expected option life of three and eight years, a constant dividend yield of 1%, a risk-free interest rate of 4.60% and 4.80%, and a volatility factor of 34%; for 1997: an expected option life of eight years, a constant dividend yield of 1%, a risk-free interest rate of 5.60%, and a volatility factor of 27%. Employee transactions are summarized as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------- 1999 1998 1997 ----------------------------------------------------------------------- NUMBER WEIGHTED NUMBER WEIGHTED NUMBER WEIGHTED OF AVERAGE OF AVERAGE OF AVERAGE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------- -------- -------- --------- -------- --------- EMPLOYEE STOCK OPTIONS Options outstanding at beginning of year 388,847 $9.51 417,095 $7.31 421,904 $4.67 Granted 44,500 14.75 55,000 18.34 92,194 16.51 Exercised 111,278 4.07 74,438 3.95 94,825 3.63 Forfeited 26,668 14.72 8,810 7.00 2,178 5.70 ------- -------- -------- Options outstanding at end of year 295,401 11.88 388,847 9.51 417,095 7.31 ------- -------- ------- ------- -------- ------- Options exercisable at end of year 158,487 9.26 204,045 5.48 199,885 4.09 Weighted average fair value per share of options granted during the year $5.97 $7.37 $6.88
The following table summarizes information about stock options outstanding at December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------------- -------------------------------- WEIGHTED- AVERAGE WEIGHTED- RANGE OF REMAINING AVERAGE WEIGHTED- EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER OF AVERAGE PRICES OUTSTANDING LIFE PRICE OPTIONS PRICE ---------------------------------------------------------- -------------------------------- $3 to $9 146,801 4.8 yrs. $ 5.97 114,047 $ 5.35 $10 to $20 148,600 7.5 yrs. $ 17.71 44,440 $ 19.29
Approximately 260,500 shares of common stock were available for future grant under the Plan at December 31, 1999. NOTE 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with disclosure requirements, management has estimated the fair value of SFC's financial instruments. In cases where quoted market prices are not available, fair value estimates are based on the present value of expected future cash flows, or other valuation techniques, all of which are significantly affected by the assumptions used therein. Accordingly, most fair value estimates cannot be substantiated by comparison to independent market quotes and could not be realized from offering for sale SFC's entire holdings of a particular financial instrument at one time. Furthermore, management does not intend to dispose of significant portions of all of its financial instruments and, thus, any aggregate unrealized gain or loss should not be interpreted as a forecast of future earnings and cash flows. 55 Certain financial instruments such as equity investments in consolidated subsidiaries, obligations for pension and other postretirement benefits and deferred compensation arrangements, among others, are generally excluded from fair value disclosure requirements. In addition, the fair value estimates do not attempt to include the value of anticipated future business, such as trust and core deposit relationships, and the value of assets and liabilities that are not considered financial instruments such as deferred tax assets, intangibles, and premises and equipment. The fair values of financial instruments are derived using numerous subjective assumptions and may not be necessarily indicative of the net realizable or liquidation value of these instruments. These fair value estimates involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. The fair values are also influenced by the estimation methods, including discount rates and cash flow assumptions, chosen from acceptable alternatives. Comparisons of fair value information among companies are limited by variability in estimations and judgments. The following methods and assumptions were used to estimate the fair value of each material class of financial instruments at a specific point in time: CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD The carrying amount of these financial instruments reasonably approximates fair value. INVESTMENT SECURITIES The fair value of investment securities is based upon independently quoted market prices. LOANS AND LEASES The fair value of loans and leases is based upon the aggregate estimated fair values of each product type, giving effect to credit quality and time to maturity. The fair value of fixed rate loans and leases is estimated by discounting expected future cash flows, based upon rates offered as of the reporting date for similar loans and leases. The carrying amount of variable rate loans reasonably approximates fair value. DEPOSITS The fair value of demand, money market, NOW and savings deposits is the amount payable on demand at the reporting date. The carrying amount for variable rate time deposit accounts reasonably approximates fair value. The fair value of fixed rate time deposits is estimated using a discounted cash flow calculation. The discount rate on such deposits is based upon rates offered as of the reporting date for deposits with similar remaining maturities. GUARANTEE OF LOAN TO ESOP TRUST The carrying amount of this financial instrument reasonably approximates fair value. COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT The fair value of commitments to extend credit and letters of credit is estimated to be the cost to terminate or otherwise settle such obligations with counterparties. The fair value of such items at the reporting date is not considered to be material in relation to the consolidated financial statements taken as a whole (Note 11). The carrying amount and fair value of SFC's financial instruments are as follows:
DECEMBER 31, 1999 DECEMBER 31, 1998 ------------------------------- ------------------------------ CARRY FAIR CARRY FAIR AMOUNT VALUE AMOUNT VALUE ------------- ------------ ------------ ------------ FINANCIAL ASSETS: Cash and due from banks $ 25,046,000 $ 25,046,000 $ 24,330,000 $ 24,330,000 Federal funds sold 29,670,000 29,670,000 42,790,000 42,790,000 Investment securities, available-for-sale 165,076,000 165,076,000 162,317,000 162,317,000 Loans and leases, net 391,964,000 391,096,000 336,008,000 337,588,000 FINANCIAL LIABILITIES: Deposits 582,385,000 582,356,000 530,974,000 531,120,000 Guarantee of loan to ESOP trust 44,000 44,000 76,000 76,000
56 NOTE 10 - FINANCIAL INSTITUTION RISK In the normal course of its business, SFC encounters two significant types of risk: economic and regulatory. Economic risk is comprised of three components - interest rate risk, credit risk, and market risk. SFC is subject to interest rate risk to the degree that its interest-bearing liabilities mature and reprice at different speeds, or on a different basis, than its interest-bearing assets. Credit risk is the risk of default on the Bank's loan portfolio that results from the borrower's inability or unwillingness to make contractually required payments. Market risk results from changes in the value of assets and liabilities which may impact, favorably or unfavorably, the realizability of those assets and liabilities. Additionally, SFC is subject to regulations of various governmental agencies. These regulations can and do change significantly from period to period. SFC also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions resulting from the regulators' judgments based on information available to them at the time of their examination. The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the counter party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and other income-producing commercial properties. The Bank's lending activities are concentrated in San Diego County, California. The Bank's commercial loan portfolio is diverse as to the industries represented. The real estate portion of the loan portfolio includes credits to many different borrowers for a variety of projects and for residential real estate. NOTE 11 - COMMITMENTS AND CONTINGENT LIABILITIES Undisbursed loan commitments amount to approximately $193,604,000 and $157,757,000 at December 31, 1999 and 1998, respectively. Standby letters of credit total approximately $1,927,000 and $4,447,000 at December 31, 1999 and 1998, respectively. International letters of credit total approximately $1,362,000 and $477,000 at December 31, 1999 and 1998, respectively. SFC is at times subject to pending and threatened legal actions that arise out of the normal course of business. Management has reviewed these matters with legal counsel and, in the opinion of management, the ultimate disposition of all pending or threatened litigation will not have a material effect on the financial condition or results of operations of SFC. The Bank has a line of credit available to purchase federal funds from a non-affiliated financial institution at the prevailing market rate. The line is subject to the availability of funds at the lending institution. The Bank also has borrowing lines with Federal Reserve Bank "FRB" and Federal Home Loan Bank "FHLB". Borrowing at FRB would be at the discount rate as set by FRB. Borrowing at FHLB would be at the prevailing rate offered by FHLB. No amounts were outstanding on any line at December 31, 1999 and 1998. 57 NOTE 12 - REGULATORY CAPITAL REQUIREMENTS Risk-based capital guidelines issued by bank regulatory authorities incorporate into the determination of capital adequacy an institution's asset risk profile and off-balance sheet exposures, such as unused loan commitments and standby letters of credit. The guidelines for an adequately capitalized institution require a total capital to risk-weighted assets ratio of at least 8.0% and a tier 1 capital to risk-weighted assets ratio of at least 4.0%. The risk-based capital rules have been further supplemented by a leverage ratio, defined as tier 1 capital divided by average total assets of the most recent quarter. A minimum leverage ratio of 4.0% is required for most banking institutions. As of December 31, 1999, the most recent notification from the appropriate regulatory agency categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. Management is not aware of any conditions or events subsequent to December 31, 1999, which would have caused a change in the Bank's category. The following table summarizes SFC and the Bank's regulatory capital ratios:
ACTUAL DECEMBER 31, WELL --------------------------------- CAPITALIZED REGULATORY 1999 1998 THRESHOLD MINIMUM --------------------------------- SFC Total risk-based capital ratio 11.4% 11.3% 10.0% 8.0% Tier 1 risk-based capital ratio 10.2% 10.2% 6.0% 4.0% Leverage ratio 7.5% 7.6% 5.0% 4.0% BANK Total risk-based capital ratio 11.2% 11.3% 10.0% 8.0% Tier 1 risk-based capital ratio 10.1% 10.2% 6.0% 4.0% Leverage ratio 7.4% 7.6% 5.0% 4.0%
NOTE 13 - MERGER On August 31, 1998, Pacific Commerce Bank was merged with and into Scripps Bank. Pursuant to the Agreement and Plan of Merger, dated April 22, 1998, each share of Pacific Commerce Bank was exchanged for 2.1789 shares of Scripps Bank common stock, resulting in approximately 1.8 million shares being issued. At the date of merger, Pacific Commerce Bank had total assets of $72.3 million, including $43.5 in loans and $22.3 million in investment securities, and $65.0 million in liabilities, including $64.2 million in deposits. The merger was accounted for as a pooling-of-interests and, accordingly, financial results for 1998 and prior periods include the combined financial results of both entities. Merger costs totaling $821,000 were recorded during 1998 in connection with the Pacific Commerce Bank transaction. Such costs related primarily to professional, legal and other support activities. NOTE 14 - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY The following tables present condensed financial information for 1999, the year in which SFC was formed. Condensed Parent Only Statement of Financial Condition - - ------------------------------------------------------ 58
December 31, 1999 ------------ ASSETS Cash and cash equivalents $120,000 Investment in subsidiary 44,794,000 Other assets and accrued interest receivable 812,000 ------------ $45,726,000 ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities and accrued interest expense $429,000 ------------ Total liabilities 429,000 ------------ Stockholders' equity: Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 6,909,000 shares 34,702,000 Retained earnings 12,497,000 Guarantee of loan to ESOP Trust (44,000) Accumulated other comprehensive income, net (1,858,000) ------------ Total stockholders' equity 45,297,000 ------------ $45,726,000 ------------ ------------
Condensed Parent Only Statement of Income - - -----------------------------------------
Year Ended December 31, 1999 ------------ Non-interest income $0 Non-interest expense (223,000) ------------ Income before provision for income taxes (223,000) Provision for income taxes 64,000 ------------ 59 Income before undistributed income of subsidiary (159,000) Equity in undistributed income of subsidiary 4,588,000 ------------ Net income $4,429,000 ------------ ------------ Basic net income per share $0.64 ------------ ------------ Diluted net income per share $0.63 ------------ ------------
Condensed Parent Only Statement of Cash Flows - - ---------------------------------------------
Year Ended December 31, 1999 ------------ Cash flows from operating activities: Net income $4,429,000 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income from subsidiary (4,588,000) Increase in other assets and accrued interest receivable (812,000) Increase in other liabilities and accrued interest expense 423,000 ------------ Net cash used by operating activities (548,000) ------------ Cash flows from investing activities: Net cash provided by subsidiary 880,000 ------------ Net cash provided by investing activities 880,000 ------------ 60 Cash flows from financing activities: Net proceeds from issuance of common stock 610,000 Dividends paid (822,000) ------------ Net cash used by financing activities (212,000) ------------ Net Increase in cash and cash equivalents 120,000 Cash and cash equivalents at beginning of year 0 ------------ Cash and cash equivalents at end of year $120,000 ------------ ------------
NOTE 15 - SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
1999 Quarters Ended ---------------------------------------------------- December 31 September 30 June 30 March 31 ---------------------------------------------------- Interest income $12,416,000 $11,757,000 $11,119,000 $10,979,000 Interest expense (3,812,000) (3,296,000) (3,011,000) (3,313,000) ---------------------------------------------------- Net interest income 8,604,000 8,461,000 8,108,000 7,666,000 Provision for loan losses (4,320,000) (750,000) (1,275,000) (885,000) ---------------------------------------------------- Net interest income after provision for loan losses 4,284,000 7,711,000 6,833,000 6,781,000 Non-interest income 1,407,000 1,417,000 1,404,000 1,396,000 Non-interest expense (5,964,000) (6,552,000) (5,854,000) (5,644,000) ---------------------------------------------------- Income before provision for income taxes (273,000) 2,576,000 2,383,000 2,533,000 Provision for income taxes 192,000 (1,030,000) (952,000) (1,000,000) ---------------------------------------------------- Net income ($81,000) $1,546,000 $1,431,000 $1,533,000 ---------------------------------------------------- ---------------------------------------------------- 61 Basic net income per share ($0.01) $0.22 $0.21 $0.22 ---------------------------------------------------- ---------------------------------------------------- Diluted net income per share ($0.02) $0.22 $0.21 $0.22 ---------------------------------------------------- ----------------------------------------------------
1998 Quarters Ended ---------------------------------------------------- December 31 September 30 June 30 March 31 ---------------------------------------------------- Interest income $11,130,000 $10,897,000 $10,185,000 $9,499,000 Interest expense (3,548,000) (3,531,000) (3,190,000) (3,046,000) ---------------------------------------------------- Net interest income 7,582,000 7,366,000 6,995,000 6,453,000 Provision for loan losses (360,000) (520,000) (465,000) (460,000) ---------------------------------------------------- Net interest income after provision for loan losses 7,222,000 6,846,000 6,530,000 5,993,000 Non-interest income 1,320,000 1,494,000 1,613,000 1,668,000 Non-interest expense (5,902,000) (5,861,000) (5,636,000) (5,424,000) ---------------------------------------------------- Income before provision for income taxes 2,640,000 2,479,000 2,507,000 2,237,000 Provision for income taxes (1,107,000) (1,006,000) (1,002,000) (880,000) ---------------------------------------------------- Net income $1,533,000 $1,473,000 $1,505,000 $1,357,000 ---------------------------------------------------- ---------------------------------------------------- Basic net income per share $0.23 $0.22 $0.22 $0.20 ---------------------------------------------------- ---------------------------------------------------- Diluted net income per share $0.21 $0.21 $0.22 $0.20 ---------------------------------------------------- ----------------------------------------------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
NAME AND ADDRESS OF BENEFICIAL OWNERS AGE POSITION(S) - - --------------------------------------- --- ----------- Ronald J. Carlson...................... 65 President, Chief Executive Officer and Director of SFC M. Catherine Wright.................... 49 Secretary and Chief Financial Officer of SFC Christopher C. Calkins................. 54 Director Christopher S. McKellar................ 50 Director William E. Nelson...................... 73 Chairman of the Board Alfred B. Salganick, M.D............... 62 Director William T. Stephens.................... 61 Director
62 CHRISTOPHER C. CALKINS is a director of SFC, Vice Chairman of the Board of Scripps, President of Carltas Management, Manager of Carltas Company, a real estate holding company, and general counsel of the Paul Ecke Ranch, a floricultural production company. He has been a director of Scripps since 1984. He is a Director of the Thomas C. Ackerman Foundation and President of the Charles H. and Anna S. Stern Foundation. Mr. Calkins is a former partner of the law firm of Gray Cary Ames & Frye (now Gray Cary Ware & Freidenrich). RONALD J. CARLSON is President and a director of SFC. He assumed the position of President and Chief Operating Officer of Scripps Bank (in organization) on July 1, 1983, and was named President and Chief Executive Officer of Scripps Bank on December 20, 1984. Prior to joining Scripps, Mr. Carlson served as President and Chief Executive Officer of the Bank of Rancho Bernardo from 1981 to 1983, and President and Chief Operating Officer and Executive Vice President of La Jolla Bank & Trust Company from 1973 to 1980. Prior to his employment with La Jolla Bank & Trust Company, he was employed by California First Bank (now Union Bank of California) for 10 years in various assignments including Manager of the Main Office and Regional Vice President. Mr. Carlson has a B.S. degree from the University of Colorado. He is a Regent of California Lutheran University, Chairman of the Board of Directors of the Greater San Diego Division of the American Heart Association, Advisory Director of the Salvation Army, and a Trustee of the San Diego Maritime Museum. CHRISTOPHER S. MCKELLAR was a director of Scripps from 1984 until the 1999 annual meeting of Scripps and is a director of SFC. He is Chief Executive Officer of California Traditions, Inc. Mr. McKellar has been involved in more than $1 billion of commercial, industrial and residential development in Southern California and Utah. Mr. McKellar serves as Chairman of the Board of the Medical Biology Institute. Formerly, he served on the boards of the Scripps Memorial Hospital Foundation, Chancellor's Advisory Board of University of California, San Diego, and the Mayor's Housing Committee. WILLIAM E. NELSON has been Chairman of the Board of Scripps since 1984 and is Chairman of the Board of SFC. He is an attorney and real estate developer. He served as President and Chief Executive Officer of Scripps Institution of Medicine and Science from 1993 to 1996. He has been the prime developer of several commercial buildings in Southern California. He has also authored books and articles on real estate finance and served as a Lecturer on finance at the University of Southern California. He currently is a Regent's Lecturer on Economics and Ethics of Health Care at University of California, San Diego. He is currently President and a Director of the San Diego Blood Bank, a Director of the San Diego Dialogue, which he also founded, and is involved with other community activities such as the San Diego Opera. ALFRED B. SALGANICK, M.D. is on the board of SFC. He retired from his practice as a family practice physician in 1997. He received his pre-medical education in New York and completed medical school in Chicago. Dr. Salganick served in the U.S. Navy from 1965 through 1967 and then practiced medicine in Chula Vista, California from 1967 through 1997. He was a founder and Chairman of the Board of Pacific Commerce Bank ("PCB") in Chula Vista, which merged with Scripps in 1998. Immediately after the PCB merger, Dr. Salganick joined the Scripps Board. Dr. Salganick has been a member of the New York Stock Exchange since 1978. WILLIAM T. STEPHENS is a director of SFC, director of Scripps since 1996 and President of Kennebec Financial Corporation, a company providing trustee and investment services to private trusts. Mr. Stephens has been in banking for over 35 years and served on the board of directors of San Diego Trust and Saving Bank until its sale in 1994. He currently is a Director of the J.W. Sefton Foundation and serves on the Board of Directors of the San Diego County Tax Payers Association and is an active member of the San Diego Downtown Rotary Club. He has served as an officer and director for many local philanthropic organizations including having served as President and a Director of the local American Cancer Society. Mr. Stephens is a Staff Commodore of the San Diego Yacht Club and a member of the De Anza Country Club. M. CATHERINE WRIGHT assumed the position of Senior Vice President/Chief Financial Officer/Finance & Administration Division Manager of Scripps in December 1997 and is Secretary and Chief Financial Officer of SFC. Ms. Wright has over 25 years of banking experience which include serving as Senior Vice President/Cashier at First National Bank, Vice President/Cashier at Bank of Commerce and in various capacities in the areas of lending and operations at Bank of America. She has a B.S. in Accountancy from National University, San Diego and is a 63 graduate of Pacific Coast Banking School at the University of Washington and the ABA National School of Bank Investments and Financial Management. Ms. Wright is a member of Financial Women International. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. To the knowledge of SFC, no director, officer or beneficial owner of greater than 10% of the common stock of SFC during fiscal 1999 failed to file on a timely basis reports required by Section 16(a) of the Securities and Exchange Act of 1934, as amended. ITEM 11. EXECUTIVE COMPENSATION. The following table summarizes the compensation paid to or earned by the named executive officers--the SFC President and Chief Executive Officer, and the Secretary and Chief Financial Officer--the only two officers of SFC during the fiscal year ended December 31, 1999: SUMMARY COMPENSATION TABLE
1999 ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS ---------------------------- ---------------------------------------------------- SECURITIES OTHER NAME AND PRINCIPAL POSITION SALARY BONUS UNDERLYING OPTIONS COMPENSATION (1) - - --------------------------------------- ------------ -------------- -------------------- -------------------------------- Ronald J. Carlson, President and Chief $230,000 $22,304 - $219,489 (2) Executive Officer M. Catherine Wright, Secretary and 87,550 9,044 - 11,831 Chief Financial Officer
- - ---------------------------------- (1) Includes taxable auto allowance or lease value, club dues, term life insurance in excess of $50,000, and the bank's contribution to the Stock Purchase Plan, the Stock Ownership Plan and the 401(k) Plan. (2) Includes accruals toward supplemental retirement plans. There were no grants of options to purchase SFC Common Stock made during the fiscal year ended December 31, 1999 to the named executive officers. The following table provides the specified information concerning option exercises during fiscal year 1999 and the exercisable and unexercisable options held by the named executive officers. OPTION EXERCISES AND FISCAL YEAR END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE- UNDERLYING UNEXERCISED MONEY OPTIONS AT OPTIONS AT DECEMBER 31, 1999 (3) DECEMBER 31, 1999 (2) ---------------------------------- -------------------------------------- SHARES ACQUIRED ON VALUE NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - - -------------------- ---------------- -------------- --------------- ------------------ ---------------- --------------------- Ronald J. Carlson 6,050 $64,731 9,840 11,210 $36,348 $9,087 M. Catherine Wright 0 $0 1,200 4,800 $0 $0
- - --------------------------- (1) Difference between fair market value of shares acquired and cost of shares pursuant to exercise of option. (2) Based on the closing sale price of SFC Common Stock as of December 31, 1999 as reported by Bloomberg Financial Markets Service ($13.50). (3) The number of unexercised stock options has been restated to reflect the effect of all prior stock dividends and a two for one stock split declared in November 1997. 64 DIRECTORS' COMPENSATION SFC and Scripps pay fees to all non-management directors for their attendance at board meetings and committee meetings, including $750 for attendance at board meetings and $200 for attendance at all committee meetings. Because of the additional time commitment, the Chairman of SFC and Scripps receives $1,500 per month for attendance at board meetings. No director has received reimbursement for travel expenses incurred in traveling to meetings. In 1999, as a group, SFC and Scripps non-management directors received compensation totaling $219,350 for services in their capacity as directors. This amount does not include approximately $34,100 contributed on their behalf by SFC and Scripps to the Restated Stock Purchase Plan. Under the 1992 Stock Option Plan, there were outstanding stock options for the purchase of 7,260 shares of common stock with a weighted average exercise price of $4.96. There are no shares available for grant in the 1992 Plan. In addition, under the 1998 Outside Directors Stock Option Plan, each non-employee director was granted an option to purchase 1,000 shares of Common Stock of SFC after the last annual meeting and will receive an option to purchase additional 1,000 shares upon re-election. As of December 31, 1999 there were outstanding stock options for the purchase of 30,000 shares of Common Stock with a weighted average exercise price of $17.47. As of that date, there were 70,000 shares available for grant. SEVERANCE AND CHANGE OF CONTROL ARRANGEMENTS SUPPLEMENTAL RETIREMENT PLAN Scripps has entered into a Supplemental Retirement Plan (the "Retirement Plan") with Mr. Carlson. Under the Retirement Plan, if Mr. Carlson remains in the employment of Scripps until he attains age 67, he will be entitled to a monthly annuity payment in the base amount of $4,167. The amount of the monthly payment will adjust annually by a three- percent increase as a cost-of-living adjustment. If Mr. Carlson terminates employment with Scripps prior to age 67, he may elect early commencement of a reduced monthly payment, as determined actuarially. However, if Mr. Carlson terminates employment prior to age 67 due to total disability, he will be entitled to the full amount of the monthly annuity payment beginning on the first day of the month following such termination of service. If Mr. Carlson dies and is survived by Barbara Ann Carlson, then she will be entitled for life to monthly payments equivalent to those Mr. Carlson would have received if he were alive. Scripps has established a grantor trust to which it may make contributions to help satisfy its obligations under the Retirement Plan. All assets held in the trust are subject to the claims of general creditors of Scripps. PRESIDENT'S UNFUNDED DEFERRED COMPENSATION AGREEMENTS Scripps has entered into two Unfunded Deferred Compensation Agreements (the "Deferred Compensation Agreements") with Mr. Carlson. Under one Deferred Compensation Agreement, an annual benefit of $20,000 per year is to be paid to Mr. Carlson following the latter of the dates at which he attains age 65 or the date he separates from service with Scripps. Payments are to be made each year beginning with the year in which Mr. Carlson attains age 66. The amount of this payment is adjusted on each annual anniversary date to take into effect any cost of living increases from the date in which he attains the age of 65. If Mr. Carlson dies, is impaired by a disability, or otherwise separates from service prior to attaining age 65, then he or Barbara Ann Carlson if he is deceased, receives a reduced annual benefit. Under the other Deferred Compensation Agreement, an annual benefit of $25,000 per year, increased by 3% as a cost of living adjustment, is to be paid to Mr. Carlson commencing upon his retirement if he remains in the employment of Scripps until the earlier of October 1, 2002 or total and permanent disability. If Scripps terminates Mr. Carlson's employment prior to October 1, 2002 for reasons other than cause, he is entitled to receive the retirement benefit. If Mr. Carlson's employment is terminated by Scripps for cause at any time, no payments will be made under this Deferred Compensation Agreement. This Deferred Compensation Agreement includes death benefits payable to Deirdre Carlson. The obligations of Scripps under the Deferred Compensation Agreements are unfunded. Scripps accrues a liability for its obligations each year, but does not set aside a separate fund to be held in trust for Mr. Carlson's benefit. 65 LONG TERM INCENTIVE COMPENSATION PLAN The Bank has entered into a Long Term Incentive Compensation Plan with Mr. Carlson. The Plan allows for awards based on the bank's attainment of certain performance related goals. The goals will be measured as of December 31, 2001. If the goals are met or exceeded, awards would be payable to Mr. Carlson as of October 1, 2002. The maximum amount payable would be 140 percent of Mr. Carlson's salary as of October 1, 2002. Mr. Carlson will have the option to receive his award in the form of cash, SFC stock, or deferred payments up to five years. EMPLOYMENT AGREEMENTS Scripps has entered into employment agreements ("Employment Agreements") with Mr. Ronald Carlson and Ms. M. Catherine Wright, which provide for base annual salaries that adjust annually. As of December 31, 1999, the base salaries of such employees were $230,000 and $87,550, respectively. In addition, the Employment Agreements provide for an automobile use allowance. The respective terms of the Employment Agreements expire October 2002 and June 2001. SCRIPPS FINANCIAL CORPORATION 1992 AND 1995 STOCK OPTION PLANS The purpose of the SFC Stock Option Plans is to attract, retain and reward persons providing services to SFC and certain affiliated entities and to motivate such persons to contribute to the growth and profits of SFC. Options may be granted to directors and full-time salaried employees, including officers and directors who are also employees. As of December 31, 1999, there were outstanding stock options for the purchase of 221,249 shares of Common Stock under the Stock Option Plan originally adopted in 1995 (the "1995 Plan") with a weighted average exercise price of $12.44 per share. As of that date, there were 190,542 shares of Common Stock available for grant under the 1995 Plan. As of December 31, 1999, there were outstanding stock options for the purchase of 44,152 shares of SFC Common Stock under the Stock Option Plan originally adopted in 1992 (the "1992 Plan"), with weighted average exercise price of $5.32 per share. No shares of Common Stock remain available for grant under the 1992 Plan. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The members of the Compensation and Nominations Committee review and recommend to the full Scripps board of directors the salaries and other terms of employment of executive officers of Scripps. The Scripps Compensation and Nominations Committee, comprised of Scripps directors F. Seth Brown, Christopher C. Calkins, Ronald J. Carlson, Martin C. Dickinson, James A. McKellar, William F. Miller, Jr., Gail K. Naughton, and William E. Nelson held seven meetings in 1999. Except for Mr. Carlson, none of these individuals was at any time during 1999 an officer or employee of Scripps. Martin Dickinson was formerly a senior vice president of Scripps but retired in 1996. The Compensation and Nomination Committee considers and sets, by recommendation to the full board, the individuals to be nominated for election to the board as well as the compensation, titles, and other aspects of the powers and names of individuals acting as, or being considered for, executive officers. Further, the Committee considers and sets, by similar recommendation, the general levels of compensation for all employees by class, not individually, and it reviews and sets by recommendation, any and all bonus, incentive plans, or other special awards and payments. In its consideration of individual executive officers, weight is given to the recommendations of the Chief Executive Officer; however, supporting data such as industry comparisons and individual performance outcomes are also reviewed. With respect to the CEO, his performance standards are established and agreed to in writing at the start of each year. The Chairman of the Board (who is not an officer or employee) reviews with the CEO the objective achievements as compared to those agreed upon standards each quarter. This review is documented as a signed report kept in the appropriate file. The CEO's compensation is discussed and decided by the board when he is not present. The degree of difficulty of the agreed performance standards, the actual accomplishments, any special achievements, and the local industry 66 trends rae all issues bearing on the ultimate compensation. Since the CEO's age at the commencement of his employment was significantly different than the ages of other executive officers, it was clear that the standard retirement program would seriously disadvantage him. Therefore, with the concurrence of the full board (except the CEO who was not present) special supplementary retirement programs were designed by a consultant and adopted by the board. With respect to all compensation and benefits, the performance of SFC, objectively measured by Return on Equity, Return on Assets and other criteria approved by the Board, is a primary factor; however, subjective factors such as "shopping reports," customer comments and growth also have weight. SHAREHOLDER TOTAL RETURN PERFORMANCE GRAPH Set forth below is a line graph comparing the cumulative total return to shareholders on the SFC's Common Stock with the cumulative total return on the American Stock Exchange Composite Index (Amex) and the S & P Banks Index for the five year period ending December 31, 1999. Since SFC was established in 1999, the data presented prior to 1999 represents the return for Scripps Bank Common Stock. (1) [GRAPHIC]
- - ---------------------------------------------------------------------------------------------------------- 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98 12/31/99 - - ---------------------------------------------------------------------------------------------------------- SFC $100 $125.10 $179.10 $431.70 $ 351.90 $ 281.90 - - ---------------------------------------------------------------------------------------------------------- Amex $100 $126.42 $134.50 $163.13 $ 165.96 $ 214.40 - - ---------------------------------------------------------------------------------------------------------- S & P Banks $100 $158.40 $223.00 $321.00 $ 342.00 $ 298.60 - - ----------------------------------------------------------------------------------------------------------
(1) Assumes that $100 was invested in SFC's Common Stock on December 31, 1994, and that all dividends were reinvested. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns. 67 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information, as of February 29, 2000, with respect to the beneficial ownership of SFC Common Stock by (i) all persons known by SFC to be the beneficial owners of more than five percent of the outstanding SFC Common Stock, (ii) each director of SFC, and (iii) each executive officer of SFC named in the Summary Compensation Table.
SHARES THAT MAY BE ACQUIRED WITHIN 60 DAYS NAME AND ADDRESS OF PERCENTAGE OF OF FEBRUARY BENEFICIAL OWNERS (1) SHARES OWNED CLASS (2) 29, 2000 - - --------------------------------------------------------------------- ------------ ------------- -------------- Ronald J. Carlson (3) 31,200 * 9,840 M. Catherine Wright (3) 1,852 * 1,200 Christopher C. Calkins (3) 57,535 * 1,000 Christopher S. McKellar (3)(4)(5) 286,650 4.15% 1,000 William E. Nelson (3)(6) 578,068 8.36% 1,000 Alfred B. Salganick, M.D. (3) 492,384 7.12% 1,000 William T. Stephens (3) 16,822 * 1,000 Thomas W. Sefton Trust (7) 710,208 10.27% 0 Executive Officers and Directors as a group (7 persons) 2,174,719 31.38% 16,040
*Less than 1% - - ----------------------------- (1) Except as indicated in the footnotes to this table, (a) the address of the persons named in this table is 5787 Chesapeake Court, San Diego, California 92123 and (b) the persons named in the table have sole voting and investment power with respect to all shares of SFC Common Stock shown as beneficially owned by them, subject to community property laws, where applicable. (2) Calculated on the basis of 6,913,139 shares of Scripps Common Stock outstanding. Shares of Scripps Common Stock underlying options exercisable within 60 days of February 29, 2000 are deemed to be outstanding for purposes of calculating the beneficial ownership of securities of the holders of such options. (3) Includes shares beneficially owned as a participant in SFC Restated Stock Purchase Plan for employees, officers and directors of SFC and Scripps. (4) Christopher S. McKellar is the son of James A. McKellar, who is on the Scripps Bank board of directors. (5) Includes 5,240 shares held in trust for which Christopher S. McKellar is trustee, 56,332 shares held as custodian for the benefit of his children, and 57,474 shares held as a general partner and 114,460 shares held in the name of Axiom Inc. (6) Includes 140,788 shares owned by Nelson Management, Inc., of which Mr. Nelson is President and 399,491 shares held in trust for which Mr. Nelson is co-trustee. (7) The address of the Thomas W. Sefton Trust is 2550 Fifth Avenue, Suite 808, San Diego, California 92103-6624. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Scripps from time to time has outstanding extensions of credit to individual officers, directors, principal security holders or their associates. Extensions of credit to such persons were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectability or present other unfavorable features. The aggregate extensions of credit by Scripps to directors, executive officers, principal shareholders, employees and their associates as of December 31, 1999 totaled approximately $333,194. SFC has entered into indemnification agreements in a form originally approved by its shareholders with each director and various executive officers containing provisions which may require it, among other things, to indemnify its officers and directors against liabilities that m may arise by reasons of their status or service as officers or directors and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. Scripps and SFC intend to execute these agreements with their future directors and executive officers. 68 Richard B. Huntington, a director of Scripps, and his wife own shares of a corporation that is the general partner of the lessor of Scripps' Point Loma branch. Together, Mr. Huntington and his wife own one-third of the real estate partnership. The ten-year lease of Scripps for this office space began in 1997. Scripps paid for tenant improvements, which are amortized over the lease term, and monthly rent, which increases by 4% annually; 2000 rental and premises and equipment expenses are expected to be approximately $162,000. In 1997 Sefton Capital Management began providing advisory services for the securities portfolio of Scripps. This agreement was approved by the Scripps Board of Directors. In 1998 an independent committee of the Scripps board of directors approved the Scripps trust department entering into a contract with Sefton Capital Management for the management of trust investment vehicles for which investment was not otherwise designated. The fees for these services were based upon the bank's understanding of the market rate for such services. In 1999, aggregate fees paid to Sefton Capital Management were approximately $217,000. In the first quarter of 1999, the Trust Department reviewed the services it could obtain elsewhere; it terminated the agreement with Sefton Capital Management effective May 1999. Harley K. Sefton, a director of Scripps, is an officer, principal and shareholder of Sefton Capital Management. In November 1999 Sefton Capital Management merged into another company, at which time the investment portfolio advisory service was moved to Chandler Asset Management in San Diego. The husband of Susan Whiteley, the Senior Vice President/Services and Support Division Manager of Scripps, is the Chief Operating Officer of Advanced Network, Inc. ANI provides Scripps with information technology consulting, automated teller machine processing and servicing and merchant deposit processing services. The fee arrangements with ANI were based in part on competitive bids and were approved by the board of directors of Scripps. Scripps paid ANI an aggregate of approximately $373,000 in 1999. When PCB merged with and into Scripps in 1998, Dr. Salganick, the former Chairman of PCB, became a director of Scripps and began to receive compensation and stock options at the same level as the other outside directors of Scripps. Pursuant to the terms of the merger agreement, each of the directors of PCB who was party to an ongoing deferred compensation agreement elected, effective as of the effective date of the PCB merger, to have all deferred compensation drawn and paid within ten years of the "normal retirement date" or "expiration date." 69 PART IV ITEM 14. FINANCIAL STATEMENTS AND EXHIBITS. (a) Documents Filed as Part of this Report EXHIBITS EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - - ------- ----------------------------------------------------------------- 3.1 * Articles of Incorporation of SFC. 3.2 * By-laws of SFC. 4.1 * Specimen Common Stock Certificate of SFC. 10.1 * Form of Indemnification Agreement for directors and executive officers 10.2 * 1995 Stock Option Plan, and forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement thereunder 10.3 * 1992 Stock Option Plan, and forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement thereunder 10.4 * 1998 Outside Directors Stock Option Plan 10.5 * Agreement and Plan of Merger between Scripps and PCB 10.6 * Form of Employment Agreement for executive officers 10.7 * Employment Agreement dated October 1, 1995, between Thomas D. Michelli and Pacific Commerce Bank, as amended 10.8 * Lease, dated September 1, 1983, between Scripps and Oklahoma City Investment Group, as amended 10.9 * Lease, dated April 25, 1995, between Scripps and Kearny Villa Center East 10.10 * Sublease, dated March 1, 1999, between Scripps and Wells Fargo Bank, N.A. 10.11 * Supplemental Retirement Plan between Scripps and Ronald J. Carlson 10.12 * 1992 Unfunded Deferred Compensation Agreement between Scripps and Ronald J. Carlson 10.13 * 1999 Unfunded Deferred Compensation Agreement between Scripps and Ronald J. Carlson 10.14 Lease, dated October 21, 1999, between Scripps and Prentiss Properties Acquisition Partners, L.P. 10.15 Lease, dated September 23, 1999, between Scripps and Balboa Investors 1 Ltd. 10.16 Long-Term Incentive Compensation Plan between Scripps and Ronald J. Carlson 21.1* List of SFC Subsidiaries. 23.1 Consent of PricewaterhouseCoopers, LLP 27.1 Financial Data Schedule. - - ---------------------- * Incorporated by reference herein from the SFC Registration Statement on Form 10 (Registration No. 0-26081) filed with the SEC on May 14, 1999, as subsequently amended. (b) SFC did not file any reports on Form 8-K during the quarter ended December 31, 1999. (c) See (a) above for all exhibits filed herewith and the exhibit index. (d) There are no financial statements or schedules which were excluded from Item 8 which are required to be reported herein. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. SCRIPPS FINANCIAL CORPORATION March 30, 2000 /s/ Ronald J. Carlson - - ---------------- ------------------------------------- Date Name: Ronald J. Carlson, President, Chief Executive Officer and Director 70 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated. /s/ Ronald J. Carlson March 30, 2000 - - ------------------------------------- ---------------- Ronald J. Carlson, President, Chief Executive Officer and Date Director /s/ Christopher C. Calkins March 30, 2000 - - ------------------------------------- ---------------- Christopher C. Calkins, Director Date /s/ Christopher S. McKellar March 30, 2000 - - ------------------------------------- ---------------- Christopher S. McKellar, Director Date /s/ William E. Nelson March 30, 2000 - - ------------------------------------- ---------------- William E. Nelson, Director Date /s/ M. Catherine Wright March 30, 2000 - - ------------------------------------- ---------------- M. Catherine Wright, Chief Financial Officer (Principal Date Accounting Officer) 71 EX-10.14 2 EXHIBIT 10.14 LEASE AGREEMENT THIS LEASE AGREEMENT (this "LEASE") is made and entered into by and between PRENTISS PROPERTIES ACQUISITION PARTNERS, L.P., a Delaware limited partnership ("LANDLORD"), and SCRIPPS BANK, a California banking corporation ("TENANT"), upon all the terms set forth in this Lease and in all Exhibits and Riders hereto, to each and all of which terms Landlord and Tenant hereby mutually agree. ARTICLE I BASIC LEASE INFORMATION AND CERTAIN DEFINITIONS 1.1. Each reference in this Lease to information and definitions contained in the Basic Lease Information and Certain Definitions and each use of the terms capitalized and defined in this Section 1.1 shall be deemed to refer to, and shall have the respective meaning set forth in, this Section 1.1. A. Premises: That certain space identified by diagonal lines or shaded area on the floor plans attached hereto as Exhibit "A", consisting of a portion of the first (1st) floor and the entire second (2nd) floor of the Building. B. Building: The building to be constructed and to be located at 11988 El Camino Real, San Diego, California 92130. C. Land: Those certain parcels of land underlying the Project. D. Parking Facility: The parking areas to be located on the Land. E. Project: The Land and all improvements to be constructed thereon, including the Building, the Parking Facility, and all Common Areas, all as conceptually shown on EXHIBIT "B" attached hereto. F. Commencement Date: The date defined in Section 3.1 hereof. G. Usable Area of Premises: 25,845 square feet. H. Term: Ten (10) years, unless this Lease is sooner terminated as provided herein, beginning on the Commencement Date. I. Net Rentable Area of the 29,349 square feet of Net Rentable Area Premises: consisting of (i) approximately 9,235 square feet of Net Rentable Area on the first (1st) floor of the Building, and (ii) approximately 20,114 square feet of Net Rentable Area on the second (2nd) floor of the Building. J. Net Rentable Area of the 163,635 square feet of Net Rentable Area. Building: K. Tenant's Share: 17.94%, representing a fraction, the numerator of which is the Net Rentable Area of the Premises and the denominator of which is the Net Rentable Area of the Building, subject to future adjustment pursuant to the provisions of Section 5.4 hereof L. Rent: The Base Rent and the Additional Rent. M. Base Rent: The Base Rent shall be as shown in this Section 1.1(M) below. Base Rent includes Base Year Operating Costs.
Monthly Base Rent per Square Month of Lease Monthly Base Foot of Net Term Rent Rentable Area ---- ---- ------------- 1-12 $77,774.85 $2.65 13-24 $79,242.30 $2.70 25-36 $80,709.75 $2.75 37-48 $82,177.20 $2.80 49-60 $83,644.65 $2.85 61-72 $85,112.10 $2.90 73-84 $86,579.55 $2.95 85-96 $88,047.00 $3.00 97-108 $89,514.45 $3.05 109-120 $90,981.90 $3.10
N. Additional Rent The Additional Rent shall be all other sums due and payable by Tenant under the Lease, including, but not limited to, Tenant's Share of Operating Costs. 0. Base Year Operating The grossed up (to 95% occupancy) Operating Costs: Costs for the calendar year 2001. P. Parking Permits: Tenant shall be entitled to take, at no charge during the initial Term, one hundred three (103) Parking Permits consisting of (i) seventy-eight (78) unassigned parking spaces to be used in common with others in the Parking Facility and (ii) twenty-five (25) reserved parking spaces in, subject to Article 6, the Parking Facility. Q. Tenant's Permitted Uses: Tenant may use the Premises for general office use and for no other purpose whatsoever, except that the portion of the Premises located on the ground floor may be used for retail banking purposes. R. Security Deposit: None. S. Broker(s): Business Real Estate Brokerage Company representing Landlord and CB Richard Ellis representing Tenant. T. Landlord's Address for Prentiss Properties Acquisition Partners, Notice: L.P. 3890 West Northwest Highway, Suite 400 Dallas, Texas 75220 Attention: Thomas F. August With a copy to: Prentiss Properties Acquisition Partners, L.P. 970 West 190th Street, Suite 550 Torrance, California 90502 Attention: Chris Hipps U. Landlord's Address for Prentiss Properties Acquisition Partners, Payment: L.P. P. 0. Box 100435 Pasadena, California 91189-0435 V. Tenant's Address for Scripps Bank Notice: P.0 Box 8996 La Jolla, California 92038 Attention: Linda Ahlswede-Cox W. Guarantor(s): None. X. Extension Option(s): See Section 3.6 hereof. Y. Allowance for Leasehold See EXHIBIT "C". Improvements: -2- ARTICLE 2 PREMISES AND QUIET ENJOYMENT 2.1. Landlord hereby leases the Premises to Tenant, and Tenant hereby rents and hires the Premises from Landlord, for the Term. During the Term, Tenant shall have the right to use, in common with others and in accordance with the Rules and Regulations, the Common Areas. 2.2. Provided that Tenant fully and timely performs all the terms of this Lease on Tenant's part to be performed, including payment by Tenant of all Rent, Tenant shall have, hold and enjoy the Premises during the Term without hindrance or disturbance from or by Landlord; subject, however, to all of the terms, conditions and provisions of any and all ground leases, deeds to secure debt, mortgages, restrictive covenants, easements, and other encumbrances now or hereafter affecting the Premises or the Project (collectively, the "ENCUMBRANCES"). Landlord shall, on or before the Commencement Date, endeavor to provide Tenant with notice of any such Encumbrances hereafter affecting the Premises or the Project that may, in Landlord's good faith opinion, adversely affect Tenant's rights and obligations hereunder. ARTICLE 3 TERM; COMMENCEMENT DATE DELIVERY AND ACCEPTANCE OF PREMISES 3.1. The Commencement Date shall be the earlier of (a) the date the Premises are deemed Available for Occupancy pursuant to Section 3.2 hereof or (b) the date Tenant, or anyone claiming by, through or under Tenant, occupies all or any portion of the Premises for the purpose of the conduct of Tenant's (or such other person's) business therein; provided, however, that until the Premises are deemed Available for Occupancy (pursuant to Section 3.2 hereof) the Base Rent payable by Tenant for the Premises after the occurrence of the Commencement Date pursuant to Section 3.1(b) above shall be prorated based on the ratio of the total Net Rentable Area in the Premises and the Net Rentable Area in the Premises actually occupied by Tenant (or anyone claiming by, through or under Tenant) for the purpose of the conduct of Tenant's (or such other person's) business therein. 3.2. A. The Premises shall be deemed Available for Occupancy as soon as the following conditions have been met: (a) the Leasehold Improvements (as defined in EXHIBIT "C" to the Lease) have been substantially completed as determined by Landlord's architect or space planner; (b) either a certificate of occupancy (temporary or final) or other certificate permitting the lawful occupancy of the Premises has been issued for the Premises, or such portion of the Premises, as the case may be, by the appropriate governmental authority; and (c) at least three (3) Business Days' notice of the anticipated occurrence of the conditions in clauses (a) and (b) above has been given to Tenant. B. Notwithstanding anything to the contrary contained herein, if there is a delay in the Availability for Occupancy of the Premises due to Tenant Delay (as defined in EXHIBIT "C" to the Lease), then the Premises shall be deemed Available for Occupancy on the date on which the Premises would have been available for occupancy but for such Tenant Delay, even though a certificate of occupancy or other certificate permitting the lawful occupancy of the Premises has not been issued or the Leasehold Improvements have not been commenced or completed. C. In the event that the Premises is not Available for Occupancy by January 1, 2001 ("COMPLETION OUTSIDE DATE"), as such Completion Outside Date may be extended by the number of days of Tenant Delays and by the number of days of "Force Majeure Delays" (as defined below), then the sole remedy of Tenant shall be the right to deliver a notice to Landlord (the "TERMINATION NOTICE") electing to terminate this Lease effective upon receipt of the Termination Notice by Landlord (the "TERMINATION EFFECTIVE DATE"). Except as provided hereinbelow, the Termination Notice must be delivered by Tenant to Landlord, if at all, not earlier than the Completion Outside Date and not later than five (5) business days after the Completion Outside Date. If Tenant delivers the Termination Notice to Landlord, then Landlord shall have the right to suspend the Termination Effective Date for a period ending thirty (30) days after the original Termination Effective Date. In order to suspend the Termination Effective Date, Landlord must deliver to Tenant, within five (5) business days after receipt of the Termination Notice, a certificate of the general contractor certifying that it is such contractor's best good faith judgment that the Premises will be Available for Occupancy within thirty (30) days after the original Termination Effective Date. If the Premises is Available for Occupancy within said thirty (30) day suspension period, then the Termination Notice shall be of no further force and effect; if, however, the Premises is not Available for Occupancy within said thirty (30) day suspension period, then this Lease shall terminate as of the date of expiration of such thirty (30) day period. If prior to the Completion Outside Date Landlord determines that the Premises will not be Available for Occupancy by the Completion Outside Date, Landlord shall have the right to deliver a written notice to Tenant stating Landlord's opinion as to the date by which the Premises will be Available for Occupancy and Tenant shall be required, within five (5) business days after receipt of such notice, to either deliver the Termination Notice (which will mean that this Lease shall thereupon terminate and shall be of no further force and effect) or agree to extend the Completion Outside Date to that date which is set by Landlord. Failure of Tenant to so respond in writing within said five (5) business day period shall be deemed to constitute Tenant's agreement to extend the Completion Outside Date to that date which is set by Landlord. If the Completion Outside Date is so extended, Landlord's right to request Tenant to elect to either terminate or further extend the Completion Outside Date shall remain and shall continue to remain, with each of the notice periods and response periods set forth above, until the Premises is Available for Occupancy or until this Lease is terminated. For purposes of this Section 3.2.C, "FORCE MAJEURE DELAYS" shall mean and refer to a period of delay or delays encountered by Landlord affecting Landlord's completion of the Building and/or the Project and/or the work of construction of the Leasehold Improvements -3- because of delays due to excess time in obtaining governmental permits or approvals for a lot split/lot line adjustment of the Land and/or pertaining to grading permits and/or building permits beyond the time period normally required to obtain such permits or approvals for similar work, similarly improved, in the Carmel Valley area of San Diego County; fire, earthquake or other acts of God; acts of the public enemy; riot; insurrection; governmental regulations of the sales of materials or supplies or the transportation thereof; strikes or boycotts; shortages of material or labor or any other cause beyond the reasonable control of Landlord. 3.3. The Net Rentable Area of the Premises and the Building are as stated in Sections 1.1I and J, respectively. By written instrument substantially in the form of EXHIBIT "D" attached hereto, Landlord shall notify Tenant of the Commencement Date, the Net Rentable Area of the Premises and all other matters stated therein. The Commencement Notice shall be conclusive and binding on Tenant as to all matters set forth therein, unless within ten (10) days following delivery of such Commencement Notice, Tenant contests any of the matters contained therein by notifying Landlord in writing of Tenant's objections. The foregoing notwithstanding, Landlord's failure to deliver any Commencement Notice to Tenant shall not affect Landlord's determination of the Commencement Date. 3.4. Except as otherwise provided in Paragraph 10 of EXHIBIT "C", Tenant may not enter or occupy the Premises prior to the Commencement Date without Landlord's express written consent and any entry by Tenant shall be subject to all of the terms of this Lease; provided however, that no such early entry shall change the Commencement Date or the date on which the Term expires (the "EXPIRATION DATE"). 3.5. Occupancy of the Premises or any portion thereof by Tenant or anyone claiming through or under Tenant for the conduct of Tenant's or such other person's business therein shall be conclusive evidence that Tenant and all parties claiming through or under Tenant (a) have accepted the Premises or such portion as suitable for the purposes for which the Premises are leased hereunder, (b) have accepted the Common Areas as being in a good and satisfactory condition, and (c) have waived any defects in the Premises and the Project; provided however, that, if any Leasehold Improvements have been constructed and installed to prepare the Premises for Tenant's occupancy, Tenant's acceptance of the Premises, and waiver of any defect therein, shall occur upon Landlord's substantial completion of the Leasehold Improvements in accordance with the terms of EXHIBIT "C" hereof, subject only to Landlord's completion of items on Landlord's punchlist (in accordance with Section 9 of EXHIBIT "C") and latent defects of which Tenant has given Landlord notice within forty five (45) days following the date on which Landlord first makes the Premises available to Tenant for any occupancy or any work in the Premises to be undertaken by Tenant. 3.6. A. Subject to the terms of this Section 3.6 and Section 3.7, Landlord hereby grants to Tenant an option (the "EXTENSION OPTION") to extend the Term of this Lease with respect to the entire Premises for one (1) additional period of five (5) years (the "OPTION TERM"), on the same terms, covenants and conditions as provided for in this Lease during the initial Lease Term, except that the rent payable by Tenant during such Option Term (including all economic terms such as, without limitation, monthly Base Rent, a new Base Year for Operating Costs, parking charges, etc.), shall be equal to the "fair market rental rate" for the Premises for the Option Term as defined and determined in accordance with the provisions of this Section 3.6 below; provided, however, that under no circumstances shall the "fair market rental rate" be less than the Base Rent rate paid by Tenant at the end of the original Lease Term. B. The Extension Option must be exercised, if at all, by written notice ("EXTENSION NOTICE") delivered by Tenant to Landlord no earlier than the date which is twelve (12) months, and no later than the date which is six (6) months, prior to the expiration of the then current Term of this Lease. C. The term "FAIR MARKET RENTAL RATE" as used herein shall mean the annual amount per rentable square foot, projected during the relevant period, that a willing, comparable, non-equity tenant (excluding sublease and assignment transactions) would pay, and a willing, comparable landlord of a comparable quality building located in the Comparison Area would accept, at arm's length (what Landlord is accepting in current transactions for the Building may be considered), for space unencumbered by any other tenant's expansion right and comparable in size, quality and floor height as the Premises taking into account the value of the existing improvements in the Premises to Tenant, as compared with the value of the existing improvements in such comparable space, with such value to be based on the age, quality and layout of the existing improvements in the Premises (and the extent to which the same could be utilized by Tenant with consideration given to the fact that the improvements existing in the Premises are specifically suitable to Tenant) and taking into account items that lessors customarily consider in renewal transactions including, but not limited to, rental rates, office space availability, tenant size, operating expenses and allowance, parking charges, and any other amounts then being charged by Landlord or the lessors of such similar office buildings. D. Landlord's determination of fair market rental rate shall be delivered to Tenant in writing not later than thirty (30) days following Landlord's receipt of Tenant's Extension Notice. Tenant will have thirty (30) days ("TENANT'S REVIEW PERIOD") after receipt of Landlord's notice of the fair market rental rate within which to accept such fair market rental rate or to object thereto in writing. Tenant's failure to accept the fair market rental rate submitted by Landlord in writing within Tenant's Review Period will conclusively be deemed Tenant's disapproval thereof. If Tenant objects to (or is deemed to have disapproved) the fair market rental rate submitted by Landlord within Tenant's Review Period, then Landlord and Tenant will attempt in good faith to agree upon such fair market rental rate using their best good faith efforts. If Landlord and Tenant fail to reach agreement on such fair market rental rate within fifteen (15) days following the expiration of Tenant's Review Period (the "OUTSIDE AGREEMENT DATE"), then Tenant may, within five (5) business days following the Outside Agreement Date, demand by written notice to Landlord that each party's determination be submitted to appraisal in accordance with the provisions below of this Section 3.6. Tenant's failure to timely demand appraisal will constitute Tenant's rescission of its Extension Notice and the Extension Option will be void and of no further force or effect. -4- E. (1) Landlord and Tenant shall each appoint one independent, unaffiliated appraiser who shall by profession be a real estate broker who has been active over the five (5) year period ending on the date of such appointment in the leasing of comparable office space in the Comparison Area. Each such appraiser will be appointed within thirty (30) days after the Outside Agreement Date. (2) The two (2) appraisers so appointed will within fifteen (15) days of the date of the appointment of the last appointed appraiser agree upon and appoint a third appraiser who shall be qualified under the same criteria set forth herein above for qualification of the initial two (2) appraisers. (3) The determination of the appraisers shall be limited solely to the issue of whether Landlord's or Tenant's last proposed (as of the Outside Agreement Date) new fair market rental rate for the Premises is the closest to the actual new fair market rental rate for the Premises as determined by the appraisers, taking into account the requirements of Paragraph C and this Paragraph E regarding same. (4) The three (3) appraisers shall within thirty (30) days of the appointment of the third appraiser reach a decision as to whether the parties shall use Landlord's or Tenant's submitted new fair market rental rate (i.e., the appraisers may only select Landlord's or Tenant's submission and may not select a compromise position), and shall notify Landlord and Tenant thereof. (5) The decision of the majority of the three (3) appraisers shall be binding upon Landlord and Tenant. The cost of each party's appraiser shall be the responsibility of the party selecting such appraiser, and the cost of the third appraiser (or arbitration, if necessary) shall be shared equally by Landlord and Tenant. (6) If either Landlord or Tenant fails to appoint an appraiser within the time period in Paragraph E(1) herein above, the appraiser appointed by one of them shall reach a decision, notify Landlord and Tenant thereof and such appraiser's decision shall be binding upon Landlord and Tenant. (7) If the two (2) appraisers fail to agree upon and appoint a third appraiser, both appraisers shall be dismissed and the matter to be decided shall be forthwith submitted to arbitration under the provisions of the American Arbitration Association (but subject to the requirements of Paragraph C and this Paragraph E). (8) In the event that the new Monthly Base Rent is not established prior to end of the initial Term of the Lease, the monthly Base Rent immediately payable at the commencement of such Option Term shall be the monthly Base Rent payable in the immediately preceding month. Notwithstanding the above, once the fair market rental is determined in accordance with this section, the parties shall settle any underpayment or overpayment on the next monthly Base Rent payment date falling not less than thirty (30) days after such determination. 3.7. A. As used in this Section, the word "OPTION" means the Extension Option pursuant to Section 3.6 herein. B. The Option is personal to the original Tenant executing this Lease ("ORIGINAL TENANT") or any successor by merger or acquisition of all or substantially all of Tenant's assets (the "PERMITTED TRANSFEREE") and may be exercised only by the original Tenant executing this Lease or a Permitted Transferee while occupying the entire Premises and may not be exercised or be assigned, voluntarily or involuntarily, by any person or entity other than the original Tenant executing this Lease or a Permitted Transferee. The Option is not assignable separate and apart from this Lease, nor may the Option be separated from this Lease in any manner, either by reservation or otherwise. C. Tenant shall have no right to exercise the Option, notwithstanding any provision of the grant of Option to the contrary, and Tenant's exercise of the Option may, at Landlord's option, be nullified by Landlord and deemed of no further force or effect, if Tenant shall be in default under the terms of this Lease after the expiration of applicable cure periods as of Tenant's exercise of the Option or at any time after the exercise of such Option and prior to the commencement of the Option event. ARTICLE 4 RENT 4.1. Tenant shall pay to Landlord, without notice, demand, offset or deduction, in lawful money of the United States of America, at Landlord's Address for Payment specified in Section 1.1.U above, or at such other place as Landlord shall designate in writing from time to time: (a) the Base Rent in equal monthly installments, in advance, on the first day of each calendar month during the Term, and (b) the Additional Rent, at the respective times required hereunder. The first monthly installment of Base Rent shall be paid in advance on the date of Tenant's execution of this Lease and applied to the first installment of Base Rent coming due under this Lease. Payment of Rent shall begin on the Commencement Date; provided, however, that, if either the Commencement Date or the Expiration Date falls on a date other than the first day of a calendar month, the Rent due for such fractional month shall be prorated on a per diem basis between Landlord and Tenant so as to charge Tenant only for the portion of such fractional month falling within the Term. 4.2. All past due installments of Rent not paid within five (5) days after notice that such amount is due shall be subject to a late charge of five percent (5%) of the amount of the late payment and shall further bear interest until paid at a rate per annum (the "INTEREST RATE") equal to the greater of fifteen percent (15%) or four percent (4%) -5- above the prime rate of interest from time to time publicly announced by Bank of America, a national banking association, or any successor thereof; provided, however, that, if at the time such interest is sought to be imposed the rate of interest exceeds the maximum rate permitted under federal law or under the laws of the State of California, the rate of interest on such past due installments of Rent shall be the maximum rate of interest then permitted by applicable law. ARTICLE 5 OPERATING COSTS 5.1. Tenant shall pay to Landlord, as Additional Rent, for each year or fractional year during the Term, an amount ("TENANT'S OPERATING COSTS PAYMENT") equal to Tenant's Share of Operating Costs, for such year in excess of Tenant's Share of Base Year Operating Costs, such amount to be calculated and paid as follows: A. Beginning on January 1st of the year following the year in which the Commencement Date occurs, and on the first day of January of each year during the Term thereafter, or as soon thereafter as is practicable, Landlord shall furnish Tenant with a statement ("LANDLORD'S OPERATING COSTS ESTIMATE") setting forth Landlord's reasonable estimate of grossed up Operating Costs for the forthcoming year and Tenant's Operating Costs Payment for such year. On the first day of each calendar month during such year, Tenant shall pay to Landlord one-twelfth (1/12th) of Tenant's Operating Costs Payment as estimated on Landlord's Operating Costs Estimate. If for any reason Landlord has not provided Tenant with Landlord's Operating Costs Estimate on the first day of January of any year during the Term, then (a) until the first day of the calendar month following the month in which Tenant is given Landlord's Operating Costs Estimate, Tenant shall continue to pay to Landlord on the first day of each calendar month the sum, if any, payable by Tenant under this Section 5.1 for the month of December of the preceding year, and (b) promptly after Landlords' Operating Costs Estimate is furnished to Tenant, Landlord shall give notice to Tenant stating whether the installments of Tenant's Operating Costs Payments previously made for such year were greater or less than the installments of Tenant's Operating Costs Payments to be made for such year, and (i) if there shall be a deficiency, Tenant shall pay the amount thereof to Landlord within twenty (20) days after the delivery of Landlord's Operating Costs Estimate, or (ii) if there shall have been an overpayment, Landlord shall apply such overpayment as a credit against the next accruing monthly installment(s) of Tenant's Operating Costs Payment due from Tenant until fully credited to Tenant (or pay such amount to Tenant if this Lease has expired or terminated), and (iii) on the first day of the calendar month following the month in which Landlord's Operating Costs Estimate is given to Tenant and on the first day of each calendar month throughout the remainder of such year, Tenant shall pay to Landlord an amount equal to one-twelfth (1/12th) of Tenant's Operating Costs Payment. B. On the first day of March of each year during the Term (beginning on the first day of March of the second year following the year in which the Commencement Date occurs), or as soon thereafter as is practicable, Landlord shall furnish Tenant with a statement of the grossed up Operating Costs for the preceding year. Within thirty (30) days after Landlord's giving of such statement, Tenant shall make a lump sum payment to Landlord in the amount, if any, by which Tenants' Operating Costs Payment for such preceding year as shown on such Landlord's statement, exceeds the aggregate of the monthly installments of Tenant's Operating Costs Payments paid during such preceding year. If Tenant's Operating Costs Payment, as shown on such Landlord's statement, is less than the aggregate of the monthly installments of Tenant's Operating Costs Payment actually paid by Tenant during such preceding year, then Landlord shall apply such amount to the next accruing monthly installment(s) of Tenant's Operating Costs Payment due from Tenant until fully credited to Tenant. C. If the Term ends on a date other than the last day of December, the actual Operating Costs for the year in which the Expiration Date occurs shall be prorated so that Tenant shall pay that portion of Tenant's Operating Costs Payment for such year represented by a fraction, the numerator of which shall be the number of days during such fractional year falling within the Term, and the denominator of which is 365 (or 366, in the case of a leap year). The provisions of this Section 5.1 shall survive the Expiration Date or any sooner termination provided for in this Lease. 5.2. A. For purposes of this Lease, the term "OPERATING COSTS" shall mean any and all expenses, costs and disbursements of every kind which Landlord pays, incurs or becomes obligated to pay in connection with the operation, management, repair and maintenance of all portions of the Project and which are allocated by Landlord to the Building (as opposed to the adjacent building(s)) on a reasonable and consistent basis. All Operating Costs shall be determined according to consistently applied accounting principles. Operating Costs include, without limitation, the following: (a) Wages, salaries, benefits and fees of all personnel or entities to the extent engaged in the operation, repair, maintenance, management, or safekeeping of the Project, including taxes, insurance, and benefits relating thereto and the costs of all supplies and materials used in the operation, repair, maintenance and security of the Project; (b) Cost of performance by Landlord's personnel of, or of all service agreements for, maintenance, janitorial services, access control, alarm service, window cleaning, elevator maintenance and landscaping for the Project. Such cost shall include the rental of personal property used by Landlord's personnel in the maintenance and repair of the Project; (c) Cost of utilities for the Project, including water, sewer, power, electricity for common areas, gas, fuel, lighting and all air-conditioning, heating and ventilating costs; (d) Cost of all insurance, including casualty and liability insurance applicable to the Project and to Landlord's equipment, fixtures and personal property used in connection therewith, business interruption or rent insurance against such perils as are commonly insured against by prudent landlords, such other insurance as may be required by any lessor or mortgagee of Landlord, and such other insurance which Landlord considers reasonably necessary in the operation of the Project, together with all appraisal and consultants' fees in connection with such insurance; (e) All Taxes. For purposes hereof, the term "TAXES" shall mean, all taxes, assessments, and other governmental charges, applicable to or assessed against the Project or any portion thereof, or applicable to or assessed against Landlord's personal property used in connection therewith, whether federal, state, county, or municipal and whether assessed by taxing districts or authorities presently taxing the Project or the operation thereof or by other taxing authorities subsequently created, or otherwise, and any other taxes and assessments attributable to -6- or assessed against all or any part of the Project or its operation; including any reasonable expenses, including fees and disbursements of attorneys, tax consultants, arbitrators, appraisers, experts and other witnesses, incurred by Landlord in contesting any taxes or the assessed valuation of all or any part of the Project. If at any time during the Term there shall be levied, assessed, or imposed on Landlord or all or any part of the Project by any governmental entity any general or special ad valorem or other charge or tax directly upon rents received under leases, or if any fee, tax, assessment, or other charge is imposed which is measured by or based, in whole or in part, upon such rents, or if any charge or tax is made based directly or indirectly upon the transactions represented by leases or the occupancy or use of the Project or any portion thereof, such taxes, fees, assessments of other charges shall be deemed to be Taxes; provided, however, that any (i) franchise, corporation, income or net profits tax, unless substituted for real estate taxes or imposed as additional charges in connection with the ownership of the Project, which may be assessed against Landlord or the Project or both, (ii) transfer taxes assessed against Landlord or the Project or both, (iii) penalties or interest on any late payments of Landlord, and (iv) personal property taxes of Tenant or other tenants in the Project, shall be excluded from Taxes. If any or all of the Taxes paid hereunder are by law permitted to be paid in installments, notwithstanding how Landlord pays the same, then, for purposes of calculating Operating Costs, such Taxes shall be deemed to have been divided and paid in the maximum number of installments permitted by law, and there shall be included in Operating Costs for each year only such installments as are required by law to be paid within such year, together with interest thereon and on future such installments as provided by law; (f) Legal and accounting costs incurred by Landlord or paid by Landlord to third parties (exclusive of legal fees with respect to disputes with individual tenants, negotiations of tenant leases, or with respect to the ownership rather than the operation of the Project), appraisal fees, consulting fees, all other professional fees and disbursements and all association dues; (g) Cost of non-capitalized repairs and general maintenance for the Project (excluding repairs and general maintenance paid by proceeds of insurance or by Tenant, other tenants of the Project or other third parties); (h) Amortization of the cost of improvements or equipment which are capital in nature and which (1) are for the purpose of reducing Operating Costs for the Project, up to the amount reasonably anticipated to be saved as a result of the installation thereof, as reasonably estimated by Landlord, or (2) are required by any governmental authority, or (3) replace any Building equipment needed to operate the Project at the same quality levels as prior to the replacement. All such costs, including interest thereon, shall be amortized on a straight-line basis over the useful life of the capital investment items, as reasonably determined by Landlord, but in no event beyond the reasonable useful life of the Project as a first class office project; (i) the Project management office rent or rental value; (j) a management fee comparable to that being charged by institutional landlords of comparable projects in the Comparison Area, but not to be less than four percent (4%) or more than five percent (5%) of revenues from the Building (whether or not Landlord engages a manager for the Project or manages the Project with Landlord's personnel) and all items reimbursable to the Project manager, if any, pursuant to any management contract for the Project; and (k) amounts payable to any associations created under any instruments of record affecting the Building or the Land, as amended from time to time. B. "Operating Costs" shall not include (a) costs for any capital repairs, replacements or improvements, except as provided above; (b) expenses for which Landlord is reimbursed or indemnified (either by an insurer, condemnor, tenant, warrantor or otherwise), to the extent of funds received by Landlord; (c) expenses incurred in leasing or procuring tenants (including lease commissions, advertising expenses and expenses of renovating space for tenants); (d) payments for rented equipment, the cost of which would constitute a capital expenditure not permitted pursuant to the foregoing if the equipment were purchased; (e) interest or amortization payments on any mortgages; (f) net basic rents under ground leases; (g) costs representing an amount paid to an affiliate of Landlord which is in excess of the amount which would have been paid in the absence of such relationship; (h) costs specially billed to and paid by specific tenants; (i) damage and repairs to the extent actually reimbursed to Landlord under any insurance policy carried by Landlord in connection with the Building, Common Areas or Parking Facilities; j) Landlord's general overhead expenses not related to the Building, Common Areas or Parking Facility; (k) costs (including permit, license and inspection fees) incurred in renovating or otherwise improving, decorating, painting or altering space for other tenants or other occupants of the vacant space within the Building; (l) costs incurred due to a violation by Landlord or any other tenant in the Building of the terms and conditions of any lease; (m) rentals and other related expenses for leasing HVAC systems, elevators, or other items (except when needed in connection with normal repairs and maintenance of the Building or the Project) which if purchased, rather than rented, would constitute a capital improvement not included in Operating Costs pursuant to this Lease; (n) depreciation, amortization and interest payments, except as specifically included in Operating Costs pursuant to the terms of this Lease and except on materials, tools, supplies and vendor-type equipment purchased by Landlord to enable Landlord to supply services Landlord might otherwise contract for with a third party, where such depreciation, amortization and interest payments would otherwise have been included in the charge for such third party's services, all as determined in accordance with generally accepted accounting principles, consistently applied, and when depreciation or amortization is permitted or required, the item shall be amortized over its reasonably anticipated useful life; or (o) interest and tax penalties incurred as a result of Landlord's negligence, inability or unwillingness to make payments or file returns when due. There shall be no duplication of costs or reimbursements. Operating Costs attributable to the Common Areas or Parking Facilities in general will be equitably prorated among all of the buildings in the Project and Tenant shall be responsible for Tenant's Share of those costs attributable to the Building. In the event of any dispute as to the amount of Tenant's Share of Operating Costs, Tenant or a nationally recognized accounting firm selected by Tenant and reasonably satisfactory to Landlord (billing hourly and not on a contingency fee basis) will have the right, by prior written notice ("AUDIT NOTICE") given within sixty (60) days ("AUDIT PERIOD") following receipt of Landlord's annual reconciliation ("ACTUAL STATEMENT") and at reasonable times during normal business hours, to audit Landlord's accounting records with respect to Operating Costs relative to the year to which such Actual Statement relates at the offices of Landlord's property manager. In no event will Landlord or its property manager be required to (i) photocopy any accounting records or other items or contracts, (ii) create any ledgers or schedules not already in existence, (iii) incur any costs or costs relative to such inspection, or (iv) perform any other tasks other than making available such accounting records as aforesaid. Neither Tenant nor its auditor may leave the offices of Landlord's property manager with copies of any materials supplied by Landlord. Tenant must pay Tenant's Share of Operating Costs when due pursuant to the terms of this Lease and may not withhold payment of Operating Costs or any other rent pending results of the audit or during a dispute regarding Operating Costs. The audit must be completed within thirty (30) days of the date of Tenant's Audit Notice and the results of such audit shall be delivered to Landlord within forty-five (45) days of the date of Tenant's Audit Notice. -7- If Tenant does not comply with any of the aforementioned time frames, then such Actual Statement will be conclusively binding on Tenant. If such audit or review correctly reveals that Landlord has overcharged Tenant, then within thirty (30) days after the results of such audit are made available to Landlord, Landlord agrees to reimburse Tenant the amount of such overcharge. If the audit reveals that Tenant was undercharged, then within thirty (30) days after the results of the audit are made available to Tenant, Tenant agrees to reimburse Landlord the amount of such undercharge. In all cases, Tenant agrees to pay the cost of such audit. Tenant agrees to keep the results of the audit confidential and will cause its agents, employees and contractors to keep such results confidential. To that end, Landlord may require Tenant and its auditor to execute a confidentiality agreement provided by Landlord. C. For purposes of this Section 5.2.C, the term "CONTROLLABLE OPERATING COSTS" shall mean all Operating Costs (as defined above) except those Operating Costs described in subsections 5.2(A)(c), 5.2(A)(d) and 5.2(A)(e) above. Notwithstanding anything to the contrary contained herein and solely for purposes of calculating Tenant's Operating Costs Payment, the aggregate Controllable Operating Costs for any year after the Base Year shall not increase more than seven percent (7%) over the maximum permitted Controllable Operating Costs for the immediately preceding year (regardless of the actual Controllable Operating Costs incurred for such preceding calendar year); provided, however, if the actual Controllable Operating Costs for any calendar year are greater than the maximum amount permitted to be charged to Tenant hereunder, the difference shall be added to Controllable Operating Costs for succeeding calendar years until such excess(es) is/are exhausted. The maximum permitted Controllable Operating Costs for the Base Year shall be the actual amounts of permitted Controllable Operating Costs for the Base Year. 5.3. If the Building is not fully completed (in accordance with the base building plans for the Building), occupied (meaning ninety-five percent (95%) of the Net Rentable Area of the Building) and/or assessed (for purposes of Taxes) during any full or fractional year of the Term (including the Base Year), the actual Operating Costs (including Taxes) shall be adjusted for such year to an amount which Landlord estimates would have been incurred in Landlord's reasonable judgment had the Building been ninety-five percent (95%) completed, occupied and fully assessed. 5.4. If during the Term any change occurs in either the number of square feet of the Net Rentable Area of the Premises or of the Net Rentable Area of the Building, Tenant's Share of Operating Costs shall be adjusted, effective as of the date of any such change. Landlord shall promptly notify Tenant in writing of such change and the reason therefor. Any changes made pursuant to this Section 5.4 shall not alter the computation of Operating Costs as provided in this Article 5, but, on and after the date of any such change, Tenant's Operating Costs Payment pursuant to Section 5.1A shall be computed upon Tenant's Share thereof, as adjusted. If such estimated payments of Tenant's Share are so adjusted during a year, a reconciliation payment for Tenant's Share of Operating Costs pursuant to this Article 5 for the calendar year in which such change occurs shall be computed pursuant to the method set forth in Section 5.1B, such computation to take into account the daily weighted average of Tenant's Share of Operating Costs during such year. ARTICLE 6 PARKING Subject to the terms hereof, Landlord hereby grants to Tenant a license to use in common with other tenants and with the public the Parking Facility and shall issue Parking Permits for such use. Each such Parking Permit shall entitle Tenant to one (1) unassigned parking space in the Parking Facility. Each reserved Parking Permit shall entitle Tenant to one (1) reserved, covered parking space in the Parking Facility in a location to be designated by Landlord from time to time in Landlord's reasonable discretion. Notwithstanding anything above to the contrary, Landlord shall have the right, in its sole and absolute discretion, to provide up to ten (10) of such reserved Parking Permits in the uncovered parking lot depicted on EXHIBIT "B". Any costs incurred by Landlord to designate Tenant's reserved parking spaces as reserved for Tenant shall be paid by Tenant, as additional rent, within ten (10) days after Tenant's receipt of an invoice therefor. All such parking shall be free of charge throughout the initial Lease Term. Thereafter, the charge for all parking shall be at the prevailing rates as determined by Landlord. The number of parking permits to be issued to Tenant is set forth in Section 1.1P. Landlord shall not be obligated to provide Tenant with any additional Parking Permits. If Tenant fails to observe the Rules and Regulations with respect to the Parking Facility, then Landlord, at its option, shall have the right to treat such failure as a default under this Lease and to terminate Tenant's Parking Permits, without legal process, and to remove Tenant's vehicles and those of its employees, licensees or invitees and all of Tenant's personal property from the Parking Facility. If all or any portion of the Parking Facility shall be damaged or rendered unusable by fire or other casualty or any taking pursuant to eminent domain proceeding (or deed in lieu thereof), and as a result thereof Landlord or the garage operator is unable to make available to Tenant the parking provided for herein, then the number of cars which Tenant shall be entitled to park hereunder shall be proportionately reduced so that the number of cars which Tenant may park in the Parking Facility after the casualty or condemnation in question shall bear the same ratio to the total number of cars which can be parked in the Parking Facility at such time as the number of cars Tenant had the right to park in the Parking Facility prior to such casualty condemnation bore to the aggregate number of cars which could be parked therein at that time. ARTICLE 7 UTILITIES AND SERVICES 7.1 A. During the Term, Landlord shall furnish Tenant with the following services: (a) hot and cold water in Building Standard bathrooms and chilled water in Building Standard drinking fountains; (b) heating, ventilating or air-conditioning, as appropriate, during Business Hours (as defined in Article 26) at such temperatures -8- and in such amounts as customarily and seasonally provided to tenants occupying comparable space in first-class office buildings in the San Diego Corporate Center/Del Mar Heights office submarket area ("COMPARISON AREA"); (c) electrical wiring and facilities and power for normal general office use to accommodate a maximum capacity of seven and one-half (7.5) watts limited to a maximum demand consumption of three and one-quarter (3.25) watts per square foot of Usable Area in the Premises available at the bus riser during all hours; (d) electric lighting for the Common Areas of the Project; (e) passenger elevator service, in common with others, for access to and from the Premises twenty-four (24) hours per day, seven (7) day per week; provided, however, that Landlord shall have the right to limit the number of (but not cease to operate all) elevators to be operated after Business Hours and on Saturdays, Sundays and Holidays; (f) janitorial cleaning services; (g) facilities for Tenant's loading, unloading, delivery and pick-up activities, including access thereto during Business Hours, subject to the Rules and Regulations, the type of facilities, and other limitations of such loading facilities; and (h) replacement, as necessary, of all Building Standard lamps and ballasts in Building Standard light fixtures within the Premises. All services referred to in this Section 7.1A shall be provided by Landlord and paid for by Tenant as part of Tenant's Operating Costs Payment. B. If Tenant requires electricity, air-conditioning, heating or other services, including cleaning services, routinely supplied by Landlord for hours or days in addition to the hours and days specified in Section 7.1A, Landlord shall make commercially reasonable efforts to provide such additional service after reasonable prior written request therefor from Tenant, and Tenant shall reimburse Landlord for the amount Landlord reasonably determines to be its total actual cost of providing such additional service as further described below. Landlord shall have no obligation to provide any additional service to Tenant at any time Tenant is in default under this Lease unless Tenant pays to Landlord, in advance, the actual cost of such additional service. If Tenant uses electricity, water or heat or air-conditioning in the Premises during hours or days in addition to the hours and days specified in Section 7.1A or otherwise in excess of that required to be supplied by Landlord pursuant to Section 7.1.A above, or if Tenant's consumption of electricity in the Premises shall exceed three and one-quarter (3.25) watts of lights and receptacle demand electrical load per square foot of Usable Area of the Premises, Tenant shall pay to Landlord, upon billing, all actual costs incurred by Landlord in connection with the provision of such excess consumption, the actual cost of the installation, operation, and maintenance of equipment which is installed in order to supply and measure such excess consumption, the actual cost of the increased wear and tear on existing or future equipment in the Building caused by such excess consumption and depreciation of any such equipment. If any machinery or equipment which generates abnormal heat or otherwise creates unusual demands on the air-conditioning or heating system serving the Premises is used in the Premises and if Tenant has not, within five (5) days after demand from Landlord, taken such steps, at Tenant's expense, as shall be necessary to cease such adverse affect on the air-conditioning or heating system, Landlord shall have the right to install supplemental air- conditioning or heating units in the Premises, and the full cost of such supplemental units (including the cost of acquisition, installation, operation, use and maintenance thereof) shall be paid by Tenant to Landlord in advance or on demand. C. At no time shall use of electricity in the Premises exceed the capacity of existing feeders and risers to or wiring in the Premises. Any risers or wiring to meet Tenant's excess electrical requirements shall, upon Tenant's written request, be installed by Landlord, at Tenant's sole cost, if, in Landlord's reasonable judgment, the same are necessary and shall not (i) cause permanent damage or injury to the Project, the Building or the Premises, (ii) cause or create a dangerous or hazardous condition, (iii) entail excessive or unreasonable alterations, repairs or expenses, or (iv) interfere with or disturb other tenants or occupants of the Building. 7.2. Landlord's obligation to furnish the utility services specified herein shall be subject to the rules and regulations of the supplier of such electricity or other utility services and the rules and regulations of any municipal or other governmental authority regulating the business of providing electricity and other utility services. Landlord shall have the right, at Landlord's option, upon not less than thirty (30) days' prior written notice to Tenant (provided such prior notice will be less if either the discontinuance of such service is required by applicable law or Landlord receives shorter notice from the utility company providing electricity or other utility service), to discontinue utility services to the Premises and arrange for a direct connection thereof through a public utility supplying such service. If Landlord gives such notice of discontinuance, Landlord shall make all necessary arrangements with the public utility supplying such utility service directly to the Building to furnish such utility service to the Premises, and, unless prohibited by law or regulations of such public utility, Landlord shall not discontinue such utility service to the Premises until such public utility is ready to supply service to the Premises. Tenant shall, however, be responsible for contracting promptly and directly with such public utility supplying such service and for paying all deposits for, and all costs relating to, such service. 7.3. No failure to furnish, or any stoppage of, the services referred to in this Article 7 resulting from in any cause shall make Landlord liable in any respect for damages to any person, property or business, or be construed as an eviction of Tenant, or entitle Tenant to any abatement of Rent or other relief from any of Tenant's obligations under this Lease. Should any malfunction of any systems or facilities occur within the Project or should maintenance or alterations of such systems or facilities become necessary, Landlord shall repair the same promptly and with reasonable diligence, and Tenant, except as otherwise expressly provided below, shall have no claim for rebate, abatement of Rent, or damages because of malfunctions or any such interruptions in service. Tenant hereby waives the provisions of California Civil Code Section 1932(1) or any other applicable existing or future law, ordinance or governmental regulation permitting the termination of this Lease due to an interruption, failure or inability to provide any services. 7.4. Tenant may, at its sole cost and expense, install its own security system ("TENANT'S SECURITY SYSTEM") in the Premises; provided, however, that Tenant shall coordinate the installation and operation of Tenant's Security System with Landlord to assure that Tenant's Security System is, in Landlord's reasonable discretion, compatible with Landlord's security system and the Building systems and equipment and to the extent that Tenant's Security System is not compatible with Landlord's security system and the Building systems and equipment, Tenant shall not be entitled to install or operate it. Tenant shall be solely responsible, at Tenant's sole cost and expense, for the monitoring, operation and removal (upon the expiration or earlier termination of this Lease) of Tenant's Security -9- System. Tenant acknowledges and agrees that Tenant's obligations to indemnify, defend and hold Landlord harmless as provided in Article 17 of this Lease shall apply to Tenant's use and operation of Tenant's Security System and that the installation of Tenant's Security System shall be subject to the terms and conditions of Article 10 of this Lease. Landlord and Tenant acknowledge and agree that nothing contained in this Section 7.4 shall be construed to limit the rights of Landlord under Article 20 of this Lease. In connection with Tenant's installation of Tenant's Security System, Tenant shall provide to Landlord, commencing with the installation of Tenant's Security System in the Premises, the telephone number(s) of an authorized representative of Tenant to whom Landlord shall give reasonable prior notice (as determined by Landlord, given the circumstances, emergency or otherwise) in the event Landlord must enter the Premises pursuant to Article 20 hereof, but in no event shall Landlord, following Landlord's provision of such reasonable notice to Tenant's authorized representative, be obligated to delay Landlord's entry into the Premises or to monitor or otherwise operate Tenant's Security System while inside the Premises. ARTICLE 8 ASSIGNMENT AND SUBLETTING 8.1. Neither Tenant nor its legal representatives or successors in interest shall, by operation of law or otherwise, assign, mortgage, pledge, encumber or otherwise transfer this Lease or any part hereof, or the interest of Tenant under this Lease, or in any sublease or the rent thereunder. The Premises or any part thereof shall not be sublet, occupied or used for any purpose by anyone other than Tenant, without Tenant's obtaining in each instance the prior written consent of Landlord in the manner hereinafter provided. As indicated in, and subject to, Section 8.4 below, Landlord's consent shall not be unreasonably withheld. Tenant shall not modify, extend, or amend a sublease previously consented to by Landlord without obtaining Landlord's prior written consent thereto. 8.2. An assignment of this Lease shall be deemed to have occurred (a) if, in a single transaction or in a series of transactions, a more than fifty percent (50%) interest in Tenant, any guarantor of this Lease, or any subtenant (whether stock, partnership, interest or otherwise) is transferred, diluted, reduced, or otherwise affected with the result that the present holder or owners of Tenant, such guarantor, or such subtenant have less than a Fifty percent (50%) interest in Tenant, such guarantor or such subtenant, or (b) if Tenant's obligations under this Lease are taken over or assumed in consideration of Tenant leasing space in another office building. The transfer of the outstanding capital stock of any corporate Tenant, guarantor or subtenant through the "OVER-THE-COUNTER" market or any recognized national securities exchange shall not be included in the calculation of such 50% interest in clause (a) above. 8.3. Notwithstanding anything to the contrary in Section 8.1, Tenant shall have the right, upon notice to Landlord, to (a) sublet or license all or part of the Premises to any related corporation or other entity which controls Tenant, is controlled by Tenant or is under common-control with Tenant; or (b) assign this Lease to a successor corporation into which or with which Tenant is merged or consolidated or which acquired substantially all of Tenant's assets and property; provided that (i) such successor corporation assumes all of the obligations and liabilities of Tenant and shall have assets, capitalization and net worth at least sufficient to perform the obligations of Tenant under this Lease, accounting for the obligations assumed by such successor in such transaction, (ii) Tenant shall provide in its notice to Landlord the information required in Section 8.4, and (iii) such assignment or sublease is not a subterfuge by Tenant to avoid its obligations under this Lease. An assignee of Tenant's entire interest in this Lease may be referred to herein as a "PERMITTED ASSIGNEE". No such transaction shall operate to release Tenant from any liability under this Lease. For the purpose hereof "CONTROL" shall mean ownership of not less than fifty percent (50%) of all the voting stock or legal and equitable interest in such corporation or entity. 8.4. If Tenant should desire to assign this Lease or sublet the Premises (or any part thereof), Tenant shall give Landlord written notice no later than the time required for notice under Section 8.3 in the case of an assignment or subletting, or thirty (30) days in advance of the proposed effective date of any other proposed assignment or sublease, specifying (a) the name, current address, and business of the proposed assignee or sublessee, (b) the amount and location of the space within the Premises proposed to be so subleased, (c) the proposed effective date and duration of the assignment or subletting, and (d) the proposed rent or consideration to be paid to Tenant by such assignee or sublessee. Tenant shall promptly supply Landlord with financial statements and other information as Landlord may request to evaluate the proposed assignment or sublease. For assignments and sublettings other than those permitted by Section 8.3, Landlord shall have fifteen (15) days following receipt of such notice and other information requested by Landlord within which to notify Tenant in writing that Landlord elects: (i) to terminate this Lease as to the space so affected as of the proposed effective date set forth in Tenant's notice, in which event Tenant shall be relieved of all further obligations hereunder as to such space, except for obligations under Articles 17, 19 and 22 and all other provisions of this Lease which expressly survive the termination hereof; or (ii) to permit Tenant to assign or sublet such space; provided, however, that, if the rent rate agreed upon between Tenant and its proposed subtenant is greater than the rent rate that Tenant must pay Landlord hereunder for that portion of the Premises, or if any consideration shall be promised to or received by Tenant in connection with such proposed assignment or sublease (in addition to rent), then 50% of such excess rent and other consideration shall be considered Additional Rent owed by Tenant to Landlord (less brokerage commissions, attorneys' fees and other disbursements reasonably incurred by Tenant for such assignment and subletting if acceptable evidence of such disbursements is delivered to Landlord), and shall be paid by Tenant to Landlord, in the case of excess rent, in the same manner that Tenant pays Base Rent and, in the case of any other consideration, within ten (10) Business Days after receipt thereof by Tenant; or (iii) to refuse, in Landlord's reasonable discretion, to consent to Tenant's assignment or subleasing of such space and to continue this Lease in full force and effect as to the entire Premises. Landlord cannot unreasonably withhold its consent, but the parties agree that Landlord shall be deemed reasonable in its refusal to consent to an assignment or subletting for the following reasons (without limiting any other reasons): the proposed assignee or subtenant is not financially creditworthy, is a governmental authority or agency, an organization or person enjoying sovereign or diplomatic immunity, a medical or dental practice or a user that will attract a volume, frequency or type of visitor or employee to the Building which is not consistent with the standards -10- of a high quality office building or that will impose an excessive demand on or use of the facilities or services of the Building. It shall also be reasonable for Landlord to refuse to consent to any assignment or subletting if (x) Tenant is then in default under this Lease, or (y) such assignment of subletting would cause a default under another lease in the Building or under any ground lease, deed of trust, mortgage, restrictive covenant, easement or other encumbrance affecting the Project. If Landlord should fail to notify Tenant in writing of such election within the aforesaid fifteen (15) day period, Landlord shall be deemed to have elected option (iii) above. Tenant agrees to reimburse Landlord for reasonable legal fees not to exceed One Thousand Dollars ($1,000.00), and any other reasonable costs incurred by Landlord in connection with any proposed assignment or subletting and such payment shall not be deducted from the Additional Rent owed to Landlord pursuant to subsection (ii) above. Tenant shall deliver to Landlord copies of all documents executed in connection with any permitted assignment or subletting, which documents shall be in form and substance reasonably satisfactory to Landlord. No acceptance by Landlord of any Rent or any other sum of money from any assignee, sublessee or other category of transferee shall be deemed to constitute Landlord's consent to any assignment, sublease, or transfer. 8.5. Any attempted assignment or sublease by Tenant in violation of the terms and provisions of this Article 8 shall be void and shall constitute a material breach of this Lease. In no event, shall any assignment, subletting or transfer, whether or not with Landlord's consent, relieve Tenant of its primary liability under this Lease for the entire Term, and Tenant shall in no way be released from the full and complete performance of all the terms hereof. If Landlord takes possession of the Premises before the expiration of the Term of this Lease, Landlord shall have the right, at its option, to terminate all subleases, or to take over any sublease of the Premises or any portion thereof and such subtenant shall attorn to Landlord, as its landlord, under all the terms and obligations of such sublease occurring from and after such date, but excluding previous acts, omissions, negligence, or defaults of Tenant. 8.6. The term "Landlord," as used in this Lease, so far as covenants or obligations on the part of Landlord are concerned, shall be limited to mean and include only the owner or owners, at the time in question, of the fee title to, or a lessee's interest in a ground lease of, the Land or the Building. In the event of any transfer, assignment or other conveyance or transfers of any such title or interest, Landlord herein named (and in case of any subsequent transfers or conveyances, the then grantor) shall be automatically freed and relieved from and after the date of such transfer, assignment or conveyance of all liability as respects the performance of any covenants or obligations on the part of Landlord contained in this Lease thereafter to be performed and, without further agreement, the transferee of such title or interest shall be deemed to have assumed and agreed to observe and perform any and all obligations of Landlord hereunder, during its ownership of the Project. Landlord may transfer its interest in the Project without the consent of Tenant. ARTICLE 9 REPAIRS 9.1. Landlord agrees to repair and maintain the structural portions of the Building and the plumbing, heating, ventilating, air conditioning and electrical systems installed or furnished by Landlord, unless such maintenance and repairs are (i) attributable to items installed in the Premises by Tenant or which are above standard interior improvements (such as, for example, custom lighting, special HVAC and/or electrical panels or systems, kitchen or restroom facilities and appliances constructed or installed within the Premises) or (ii) caused by the negligence or willful misconduct or gross negligence of Tenant or its agents, contractors, invitees and licensees, in which case Tenant will pay to Landlord, as additional rent, the cost of such maintenance and repair plus a fee equal to fifteen percent (15%) of the actual costs to cover overhead and a fee for Landlord's agent or manager. Amounts payable by Tenant pursuant to this Section 9.1 shall be payable on demand after receipt of an invoice therefor from Landlord. Landlord has no obligation and has made no promise to maintain, alter, remodel, improve, repair, decorate, or paint the Premises, the Building or the Project or any part thereof, except as specifically set forth in this Lease. In no event shall Landlord have any obligation to maintain, repair or replace any furniture, furnishings, fixtures or personal property of Tenant. Tenant hereby waives the provisions of California Civil Code Sections 1932(1), 1941 and 1942 and or any similar law, statute or ordinance now or hereafter in effect. 9.2. Tenant shall keep the Premises (including the Leasehold Improvements) in good order and in a safe, neat and clean condition, and, when and if needed, at Tenant's sole cost and expense, shall make all repairs to the Premises and every part thereof. In the event Tenant fails to promptly commence and diligently pursue the performance of such maintenance or the making of such repairs or replacements, then Landlord, at its option, may perform such maintenance or make such repairs and Tenant shall reimburse Landlord, on demand after Tenant receives an invoice therefor, the cost thereof plus a fee equal to fifteen percent (15%) of the actual costs to cover overhead and a fee for Landlord's agent or manager. 9.3. All repairs made by Tenant pursuant to Section 9.2 shall be performed in a good and workmanlike manner by contractors or other repair personnel selected by Tenant from an approved list of contractors and repair personnel maintained by Landlord in the Project's management office; provided, however, that neither Tenant nor its contractors or repair personnel shall be permitted to do any work affecting the Central Systems (as such term is defined in EXHIBIT "C" hereof). In no event shall such work be done for Landlord's account or in a manner which allows any liens to be filed in violation of Article 11. To the extent any repairs involve the making of alterations to the Premises, Tenant shall comply with the provisions of Article 10. 9.4. Subject to the other provisions of this Lease imposing obligations regarding repair upon Tenant, Landlord shall repair all machinery and equipment necessary to provide the services of Landlord described in Article 7 (provided that Tenant shall pay the costs of any repair to such systems or any part thereof damaged by Tenant and Tenant's employees, customers, clients, agents, licensees and invitees) and for repair of all portions of the Project which do not comprise a part of the Premises and are not leased to others. -11- ARTICLE 10 ALTERATIONS 10.1. Tenant shall not at any time during the Term make any alterations to the Premises without first obtaining Landlord's written consent thereto, which consent Landlord shall not unreasonably withhold or delay; provided, however, that Landlord shall not be deemed unreasonable by refusing to consent to any alterations which are visible from the exterior of the Building or the Project, which will or are likely to cause any weakening of any part of the structure of the Premises, the Building or the Project or which will or are likely to cause damage or disruption to the Central Systems or which are prohibited by any underlying ground lease or mortgage. Notwithstanding the foregoing, Landlord's prior approval will not be required for any alterations to the interior of the Premises which are not visible from the exterior of the Premises which are either cosmetic in nature (such as floor or wall coverings) or are nonstructural in nature and do not affect any Central Systems and cost less than Ten Thousand Dollars ($10,000.00) in the aggregate, provided Landlord receives prior notice thereof and the other conditions set forth in this Article 10 are satisfied. Should Tenant desire to make any alterations to the Premises, Tenant shall submit all plans and specifications for such proposed alterations to Landlord for Landlord's review before Tenant allows any such work to commence, and Landlord shall promptly approve or disapprove such plans and specifications for any of the reasons set forth in this Section 10.1 or for any other reason reasonably deemed sufficient by Landlord. Tenant shall select and use only contractors, subcontractors or other repair personnel from those listed on Landlord's approved list maintained by Landlord in the Project management office. Upon Tenant's receipt of written approval from Landlord, and upon Tenant's payment to Landlord of a reasonable fee prescribed by Landlord for the work of Landlord and Landlord's employees and representatives in reviewing and approving such plans and specifications, Tenant shall have the right to proceed with the construction of all approved alterations, but only so long as such alterations are in strict compliance with the plans and specifications so approved by Landlord and with the provisions of this Article 10. All alterations shall be made at Tenant's sole cost and expense, by contractors retained by Tenant pursuant to this Section 10.1 above; however, if Tenant requests, and Landlord agrees, that Landlord shall retain the contractors, Tenant shall pay to Landlord a fee of fifteen percent (15%) of the actual costs of such work to cover Landlord's overhead and a fee for Landlord's agent or manager in supervising and coordinating such work. In no event, however, shall anyone other than Landlord or Landlord's employees or representatives perform work to be done which affects the Central Systems. 10.2. All construction, alterations and repair work done by or for Tenant shall (a) be performed in such a manner as to maintain harmonious labor relations; (b) not adversely affect the safety of the Project, the Building or the Premises or the systems thereof and not affect the Central Systems; (c) comply with all building, safety, fire, plumbing, electrical, and other codes and governmental and insurance requirements; (d) not result in any usage in excess of Building Standard of water, electricity, gas, or other utilities or of heating, ventilating or air-conditioning (either during or after such work) unless prior written arrangements satisfactory to Landlord are made with respect thereto; (e) be completed promptly and in a good and workmanlike manner and in compliance with all rules and regulations promulgated by Landlord; and (f) not disturb Landlord or other tenants in the Building. After completion of any alterations to the Premises, Tenant will deliver to Landlord a copy of "as built" plans and specifications depicting and describing such alterations. 10.3. All Leasehold Improvements, alterations and other physical additions made to or installed by or for Tenant in the Premises shall be and remain Landlord's property (except for Tenant's furniture, personal property and movable trade fixtures) and shall not be removed without Landlord's written consent; provided, however, Landlord may, by notice to Tenant given concurrently with Landlord's approval of any alterations or physical additions made to the Premises after the Commencement Date, elect to require Tenant to remove same upon the expiration or earlier termination of the Term of this Lease. Tenant agrees to remove, at its sole cost and expense, all of Tenant's furniture, personal property and movable trade fixtures, and, if directed to or permitted to do so by Landlord in writing, all, or any part of, the alterations and other physical additions made by Tenant to the Premises, on or before the Expiration Date or any earlier date of termination of this Lease. Tenant shall repair, or promptly reimburse Landlord for the cost of repairing, all damage done to the Premises or the building by such removal. Any alterations or physical additions made by Tenant which Landlord does not direct or permit Tenant to remove at any time during or at the end of the Term shall become the property of Landlord at the end of the Term without any payment to Tenant. Landlord reserves the right to require Tenant to remove any alterations or physical additions made by Tenant to which Landlord did not expressly consent. If Tenant fails to remove any of Tenant's furniture, personal property or movable trade fixtures by the Expiration Date or any sooner date of termination of the Lease or, if Tenant fails to remove any alterations and other physical additions made by Tenant to the Premises which Landlord has in writing directed Tenant to remove, Landlord shall have the right, on the fifth (5th) day after Landlord's delivery of written notice to Tenant to deem such property abandoned by Tenant and to remove, store, sell, discard or otherwise deal with or dispose of such abandoned property in a commercially reasonable manner. Tenant shall be liable for all costs of such disposition of Tenant's abandoned property, and Landlord shall have no liability to Tenant in any respect regarding such property of Tenant. The provisions of this Section 10.3 shall survive the expiration or any earlier termination of this Lease. ARTICLE 11 LIENS Tenant shall keep the Project, the Building and the Premises and Landlord's interest therein free from any liens arising from any work performed, materials furnished, or obligations incurred by, or on behalf of Tenant (other than by Landlord pursuant to Exhibit "C"). Notice is hereby given that neither Landlord nor any mortgagee or lessor of Landlord shall be liable for any labor or materials furnished to Tenant except as furnished to Tenant by Landlord pursuant to Exhibit "C". If any lien is filed for such work or materials, such lien shall encumber only Tenant's interest in leasehold improvements on the Premises. Within ten (10) days after Tenant learns of the filing of any -12- such lien, Tenant shall notify Landlord of such lien and shall either discharge and cancel such lien of record or post a bond sufficient under the laws of the State of California to cover the amount of the lien claim plus any penalties, interest, attorneys' fees, court costs, and other legal expenses in connection with such lien. If Tenant fails to so discharge or bond such lien within ten (10) calendar days after written demand from Landlord, Landlord shall have the right, at Landlord's option, to pay the full amount of such lien without inquiry into the validity thereof, and Landlord shall be promptly reimbursed by Tenant, as Additional Rent, for all amounts so paid by Landlord, including expenses, interest, and attorneys' fees. ARTICLE 12 USE AND COMPLIANCE WITH LAWS 12.1 The Premises shall be used only for the uses specifically set forth in Section 1.1Q and for no other purposes whatsoever. Tenant shall use and maintain the Premises in a clean, careful, safe, lawful and proper manner and shall not allow within the Premises, any offensive noise, odor, conduct or private or public nuisance or permit Tenant's employees, agents, licensees or invitees to create a public or private nuisance or act in a disorderly manner within the Building or in the Project. Any statement as to the particular nature of the business to be conducted by Tenant in the Premises and uses to be made thereof by Tenant as set forth in Section 1.1Q hereof shall not constitute a representation or warranty by Landlord that such business or uses are lawful or permissible under any certificate of occupancy for the Premises or the Building or are otherwise permitted by law. Landlord does, however, represent that any certificate of occupancy issued with respect to the Premises shall allow use for executive and administrative offices. 12.2. Tenant shall, at Tenant's sole expense, (a) comply with all laws, orders, ordinances, and regulations of federal, state, county, and municipal authorities having jurisdiction over the Premises, (b) comply with any directive, order or citation made pursuant to law by any public officer requiring abatement of any nuisance or which imposes upon Landlord or Tenant any duty or obligation arising from Tenant's occupancy or use of the Premises or from conditions which have been created by or at the request or insistence of Tenant, or required by reason of a breach of any of Tenant's obligations hereunder or by or through other fault of Tenant, (c) comply with all insurance requirements applicable to the Premises and (d) indemnify and hold Landlord harmless from any loss, cost, claim or expense which Landlord incurs or suffers by reason of Tenant's failure to comply with its obligations under clauses (a), (b) or (c) above. If Tenant receives notice of any such directive, order citation or of any violation of any law, order, ordinance, regulation or any insurance requirement, Tenant shall promptly notify Landlord in writing of such alleged violation and furnish Landlord with a copy of such notice. 12.3. Because Tenant is preparing the Construction Drawings for the Leasehold Improvements, Tenant shall be solely responsible for causing, at Tenant's sole cost and expense, the Premises (including the Leasehold Improvements therein) to comply with the Americans With Disabilities Act of 1990, as subsequently amended (the "ADA"), and all similar federal, state and local laws, rules and regulations and subsequent amendments thereof; provided, however, that Landlord shall be responsible for causing the other portions of the Building (excluding the Premises) to comply with the requirements of the ADA and other applicable laws in effect as of the date of this Lease including such laws pertaining to the presence of Hazardous Materials and seismic requirements. Further, Operating Costs shall not include any cost (if any) incurred by Landlord in connection with upgrading the Building or the Premises to comply with the requirements of the ADA and other applicable laws that are in effect as of the date of this Lease, including penalties or damages incurred due to such noncompliance; provided, however that to the extent such costs are incurred as a result of Tenant's specific use of the Premises, or as a result of any alterations to the Premises made by or on behalf of Tenant, in which case such costs will be the sole responsibility of Tenant. Landlord shall use commercially reasonable efforts to remedy any problems which may arise with systems and equipment serving the Building as a result of the transition from calendar year 1999 to calendar year 2000 and the expense of such efforts shall be excluded from Operating Costs. Upon written request from Tenant, Landlord shall provide Tenant with documentation reasonably evidencing Landlord's compliance with the requirements of this Section 12.3. ARTICLE 13 DEFAULT AND REMEDIES 13.1. The occurrence of any one or more of the following events shall constitute an "EVENT OF DEFAULT" of Tenant under this Lease: (a) if Tenant fails to pay any Rent hereunder as and when such Rent becomes due and such failure shall continue for more than five (5) days after Landlord gives Tenant notice of past due Rent; (b) if the Premises are abandoned or if Tenant fails to take possession of the Premises on the Commencement Date or promptly thereafter; (c) if Tenant permits to be done anything which creates a lien upon the Premises and fails to discharge or bond such lien or post such security with Landlord as is required by Article 11; (d) if Tenant violates the provisions of Article 8 by attempting to make an unpermitted assignment or sublease; (e) if Tenant fails to maintain in force all policies of insurance required by this Lease and such failure shall continue for more than ten (10) days after Landlord gives Tenant notice of such failure; or (f) if Tenant fails to perform or observe any other terms of this Lease and such failure shall continue for more than thirty (30) days after Landlord gives Tenant notice of such failure, or, if such failure cannot be corrected within such thirty (30) day period, if Tenant does not commence to correct such default within said thirty (30) day period and thereafter diligently prosecute the correction of same to completion within a reasonable time and in any event prior to the time a failure to complete such correction could cause Landlord to be subject to prosecution for violation of any law, rule, ordinance or regulation or causes, or could cause, a default under any mortgage, underlying lease, tenant leases or other agreements applicable to the Project. The provisions of any notice given pursuant to the foregoing will be in lieu of, and not in addition to, any notice required under applicable law (including, without limitation, California Code of Civil Procedure Section 1161 regarding unlawful detainer actions and any successor statute or similar law) -13- 13.2. If an Event of Default occurs, Landlord shall have the right at any time to give a written termination notice to Tenant and, on the date specified in such notice, Tenant's right to possession shall terminate and this Lease shall terminate. Upon such termination, Landlord shall have the right to recover from Tenant: A. The worth at the time of award of all unpaid Base Rent and Additional Rent which had been earned at the time of termination; B. The worth at the time of award of the amount by which all unpaid Base Rent and Additional Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; C. The worth at the time of award of the amount by which all unpaid Base Rent and Additional Rent for the balance of the term of this Lease after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; and D. All other amounts necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform all of Tenant's obligations under this Lease or which in the ordinary course of things would be likely to result therefrom. The "worth at the time of award" of the amounts referred to in clauses (a) and (b) above shall be computed by allowing interest at the Interest Rate. The "worth at the time of award" of the amount referred to in clause (c) above shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). Notwithstanding the occurrence of an Event of Default, pursuant to California Civil Code Section 1951.4, or any successor statute thereof, Landlord may continue this Lease in effect after Tenant's breach and abandonment and recover all rent as it becomes due, if Tenant has the right to sublet or assign, subject only to reasonable restrictions. Acts of maintenance or preservation or efforts to relet the Premises or the appointment of a receiver upon initiative of Landlord to protect Landlord's interest under this Lease shall not constitute a termination of Tenant's right to possession unless written notice of termination is given by Landlord to Tenant. The remedies provided for in this Lease are in addition to all other remedies available to Landlord at law or in equity by statute or otherwise. 13.3. No agreement to accept a surrender of the Premises and no act or omission by Landlord or Landlord's agents during the Term shall constitute an acceptance or surrender of the Premises unless made in writing and signed by Landlord. No re-entry or taking possession of the Premises by Landlord shall constitute an election by Landlord to terminate this Lease unless a written notice of such intention is given to Tenant. 13.4. No provision of this Lease shall be deemed to have been waived by Landlord unless such waiver is in writing and signed by Landlord. Landlord's acceptance of Rent following an Event of Default hereunder shall not be construed as a waiver of such Event of Default. No custom or practice which may arise between the parties in connection with the terms of this Lease shall be construed to waive or lessen Landlord's right to insist upon strict performance of the terms of this Lease, without a written notice thereof to Tenant from Landlord. 13.5. The rights granted to Landlord in this Article 13 shall be cumulative of every other right or remedy provided in this Lease or which Landlord may otherwise have at law or in equity or by statute, and the exercise of one or more rights or remedies shall not prejudice or impair the concurrent or subsequent exercise of other rights or remedies or constitute a forfeiture or waiver of Rent or damages accruing to Landlord by reason of any Event of Default under this Lease. Tenant agrees to pay to Landlord all costs and expenses incurred by Landlord in the enforcement of this Lease, including all attorneys' fees incurred in connection with the collection of any sums due hereunder or the enforcement of any right or remedy of Landlord. 13.6. Landlord will not be in default in the performance of any obligation required to be performed by Landlord under this Lease unless Landlord fails to perform such obligation within thirty (30) days after the receipt of written notice from Tenant specifying in detail Landlord's failure to perform; provided however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for performance, then Landlord will not be deemed in default if it commences such performance within such thirty (30) day period and thereafter diligently pursues the same to completion. Upon any default by Landlord, Tenant may exercise any of its rights provided at law or in equity, subject to the limitations on liability set forth in Section 25.5 of this Lease; provided, however: (a) Tenant shall have no right to offset or abate Rent in the event of any default by Landlord under this Lease, except to the extent offset rights are specifically provided to Tenant in this Lease; (b) Tenant shall have no right to terminate this Lease; (c) Tenant's rights and remedies hereunder shall be limited to the extent (i) Tenant has expressly waived in this Lease any of such rights or remedies and/or (ii) this Lease otherwise expressly limits Tenant's rights or remedies; and (d) in no event shall Landlord be liable for consequential damages or loss of business profits. ARTICLE 14 INSURANCE 14.1. A. Tenant, at its sole expense, shall obtain and keep in force during the Term the following insurance: (a) "SPECIAL FORM" insurance insuring all property located in the Premises, including furniture, equipment, fittings, installations, fixtures, supplies and any other personal property, leasehold improvements and alterations, including the Leasehold Improvements ("TENANT'S PROPERTY"), in an amount equal to ninety percent (90%) of the full replacement value, it being understood that no lack or inadequacy of insurance by Tenant shall in any event make Landlord subject to any claim by virtue of any theft of or loss or damage to any uninsured or inadequately insured property; (b) Extra Expense insurance in an amount that will reimburse Tenant for direct or indirect loss of earnings attributable to all perils insured against under Section 14.1(a) or attributable to the prevention of access to the Premises by civil authority; (c) Commercial general public liability insurance including -14- personal injury, bodily injury, broad form property damage, operations hazard, owner's protective coverage, contractual liability, with a cross liability clause and a severability of interests clause to cover Tenant's indemnities set forth herein, and products and completed operations liability, in limits not less than Two Million Dollars ($2,000,000) inclusive per occurrence or such higher limits as Landlord may reasonably require from time to time during the Term; (d) Worker's Compensation and Employer's Liability insurance, in form and amount as required by applicable law for Worker's Compensation, and One Million Dollars ($1,000,000) per occurrence for Employer's Liability; and (e) any other form or forms of insurance or any changes or endorsements to the insurance required herein as Landlord, or any mortgagee or lessor of Landlord may reasonably require, from time to time, in form or in amount, and for insurance risks against which a prudent tenant would protect itself, but only to the extent coverage for such risks and amounts are available in the insurance market at commercially acceptable rates. B. Tenant shall have the right to include the insurance required by Section 14.1A under Tenant's policies of "BLANKET INSURANCE," provided that no other loss which may also be insured by such blanket insurance shall affect the insurance coverages required hereby and further provided that Tenant delivers to Landlord a certificate specifically stating that such coverages apply to Landlord, the Premises and the Project. All policies of insurance required by Section 14.1A(c) shall name Landlord as additional insured and shall also name all mortgagees and lessors of Landlord, of which Tenant has been notified, additional insureds, all as their respective interest may appear. All such policies or certificates shall be issued by insurers reasonably acceptable to Landlord and in form satisfactory to Landlord. Tenant shall deliver to Landlord certificates with certificates of policies, together with satisfactory evidence of payment of premiums for such policies, by the Commencement Date and, with respect to renewals of such policies, not later than thirty (30) days prior to the end of the expiring term of coverage. All policies of insurance shall be endorsed to be primary and noncontributory to any insurance which may be carried by Landlord. All such policies shall contain an agreement by the insurers that the insurers shall notify Landlord and any mortgagee or lessor of Landlord in writing, by certified mail, return receipt requested, not less than thirty (30) days before any material change, cancellation, including cancellation for nonpayment of premium, or other termination thereof or change therein and shall (with respect to the insurance required by clauses (a) and (b) of Section 14.1A) include a clause or endorsement denying the insurer any rights or subrogation against Landlord. 14.2. Landlord shall insure the Building and the Project (but excluding the Leasehold Improvements) against damage with property insurance and shall carry commercial general public liability insurance, all in such amounts and with such deductible as Landlord reasonably deems appropriate. As provided hereinabove, Landlord shall not be required to carry insurance of any kind on Tenant's Property, and Tenant hereby agrees that Tenant shall have no right to receive any proceeds from any insurance policies carried by Landlord. 14.3. Tenant shall not knowingly conduct or permit to be conducted in the Premises any activity, or place any equipment in or about the Premises or the Building, which will invalidate the insurance coverage in effect or increase the rate of insurance on the Premises or the Building, and Tenant shall comply with all requirements and regulations of Landlord's insurers which are provided in writing to Tenant. If any invalidation of coverage or increase in the rate of fire insurance or other insurance occurs or is threatened by any insurance company due to any act or omission by Tenant, or its agents, employees, representatives, or contractors, such statement or threat shall be conclusive evidence that the increase in such rate is due to such act of Tenant or the contents or equipment in or about the Premises, and, as a result thereof, Tenant shall be liable for such increase and shall be considered Additional Rent payable with the next monthly installment of Base Rent due under this Lease. In no event shall Tenant introduce or permit to be kept on the Premises or brought into the Building any dangerous, noxious, radioactive or explosive substance. 14.4. Landlord and Tenant each hereby waive any right of subrogation and right of recovery or cause of action for injury or loss to the extent that such injury or loss is covered by fire, extended coverage, "Special Form" or similar policies covering real property or personal property (or which would have been covered if Tenant or Landlord, as the case may be, was carrying the insurance required by this Lease). Said waivers shall be in addition to, and not in limitation or derogation of, any other waiver or release contained in this Lease. Insurance policies shall be properly endorsed, if necessary, to prevent the invalidation of said policies by reason of such waivers. ARTICLE 15 DAMAGE BY FIRE OR OTHER CAUSE 15.1. If the Building or any portion thereof (exclusive of the Premises) is damaged or destroyed by any casualty to the extent that, in Landlord's reasonable judgment, (a) repair of such damage or destruction would not be economically feasible, or (b) the damage or destruction to the Building cannot be repaired within two hundred seventy (270) days after the date Landlord learns of the necessity for repairs as a result of such damage or destruction, or if the proceeds from insurance remaining after any required payment to any mortgagee or lessor of Landlord are insufficient to repair such damage or destruction, Landlord shall have the right, at Landlord's option, to terminate this Lease (provided Landlord terminates the leases, where Landlord has the right to do so, of all of the other tenants of the Building similarly affected) by giving Tenant notice of such termination, within sixty (60) days after the date Landlord learns of the necessity for repairs as a result of such damage or destruction. 15.2. If the Premises or any portion thereof is damaged or destroyed by any casualty, and if, in Landlord's reasonable opinion, the Premises cannot be rebuilt or made fit for Tenant's purposes within two hundred seventy (270) days after the date Landlord learns of the necessity for repairs as a result of such damage or destruction, or if the proceeds from the insurance Landlord is required to maintain pursuant to Article 14 hereof (or the amount of proceeds which would have been available if Landlord was carrying such insurance) are insufficient to repair such damage or destruction, then either Landlord or Tenant shall have the right, at the option of either party, to terminate this Lease by giving the other written notice, within sixty (60) days after Landlord learns of the necessity for repairs as a result of such damage or destruction. -15- 15.3. In the event of partial destruction or damage to the Building or the Premises which is not subject to Section 15.1 or 15.2, but which renders the Premises partially but not wholly untenantable or renders the Premises wholly untenantable for a short enough period of time that this Lease is not otherwise terminated in accordance with the terms of this Article 15, this Lease shall not terminate and Rent shall be abated in proportion to the area of the Premises which cannot be used or occupied by Tenant as a result of such casualty. Landlord shall in such event, within a reasonable time after the date of such destruction or damage, subject to force majeure (as defined in Section 25.6) or to Tenant Delay and to the extent and availability of insurance proceeds, restore the Premises to as near the same condition as existed prior to such partial damage or destruction. If Landlord fails to proceed with reasonable diligence to rebuild the Premises, or if the Premises are not repaired or rebuilt within two hundred seventy (270) days after Landlord learns of the necessity for repairs as a result of such damage or destruction, for a reason other than force majeure or Tenant Delays, then Tenant may, at Tenant's sole option, elect to terminate this Lease upon thirty (30) days written notice to Landlord, unless Landlord cures the failure within such thirty (30) day period of time, in which case Tenant's termination notice shall be of no effect. In no event shall Rent abate (except to the extent Landlord recovers insurance therefor) nor shall any termination by Tenant occur if damage to or destruction of the Premises is the result of the negligence or willful act of Tenant, or Tenant's agents, employees, representatives, contractors, successors, assigns, licensees or invitees. 15.4. If any material portion of the Premises is destroyed by fire or other causes at any time during the last year of the Term, such that the Premises or a material portion thereof cannot be occupied for in excess of thirty (30) days as a result thereof, then either Landlord or Tenant shall have the right, at the option of either party, to terminate this Lease by giving written notice to the other within fifteen (15) days after the date of such destruction. 15.5. Landlord shall have no liability to Tenant for inconvenience, loss of business, or annoyance arising from any repair of any portion of the Premises or the Building. Tenant hereby waives California Civil Code Sections 1932(2) and 1933(4), providing for termination of hiring upon destruction of the thing hired and Sections 1941 and 1942, providing for repairs to and of the Premises. 15.6. In the event of termination of this Lease pursuant to Sections 15.1, 15.2, 15.3 or 15.4, all Rent shall be apportioned and paid to the date on which possession is relinquished or the date of such damage, whichever last occurs, and Tenant shall immediately vacate the Premises according to such notice of termination; provided, however, that those provisions of this Lease which are designated to cover matters of termination and the period thereafter shall survive the termination hereof. 15.7. In the event of any damage or destruction of all or any part of the Premises, Tenant shall: (a) immediately notify Landlord thereof, and (b) within thirty (30) days of such damage or destruction, deliver to Landlord all insurance proceeds received by Tenant with respect to the Leasehold Improvements and Tenant's alterations and improvements to the Premises (excluding proceeds for Tenant's furniture and other personal property), whether or not this Lease is terminated as permitted in this Article 15, and Tenant hereby assigns to Landlord all rights to receive such insurance proceeds. If Tenant fails to receive insurance proceeds covering the full replacement cost of such Leasehold Improvements and Tenant's alterations and improvements to the Premises which are damaged, Tenant shall be deemed to have self-insured the replacement cost of such Leasehold Improvements and Tenant's alterations and improvements, and upon any damage or destruction thereto, Tenant shall immediately pay to Landlord the full replacement cost of such items, less any insurance proceeds actually received by Landlord from Landlord's or Tenant's insurance with respect to such items. ARTICLE 16 CONDEMNATION 16.1. In the event the whole or substantially the whole of the Building or the Premises are taken or condemned by eminent domain or by any conveyance in lieu thereof (such taking, condemnation or conveyance in lieu thereof being hereinafter referred to as "CONDEMNATION"), this Lease shall terminate on the earlier of the date the condemning authority takes possession or the date title vests in the condemning authority. 16.2. In the event any portion of the Building shall be taken by condemnation (whether or not such taking includes any portion of the Premises), which taking, in Landlord's judgment, is such that the Building cannot be restored in an economically feasible manner for use substantially as originally designed, then Landlord shall have the right, at Landlord's option, to terminate this Lease (provided Landlord also terminates the leases of the other tenants of the Building similarly situated), effective as of the date specified by Landlord (at least sixty (60) days in the future) in a written notice of termination from Landlord to Tenant. 16.3. In the event any portion of the Parking Facility shall be taken by condemnation, which taking in Landlord's judgment is such that the Parking Facility cannot be restored in an economically feasible manner for use substantially as originally designed, including in such consideration the possible use of additional Parking Facility in the vicinity of the Building, then Landlord shall have the right, at Landlord's option, to terminate this Lease (provided Landlord also terminates the leases, where Landlord has the right to do so, of the other tenants of the Building similarly affected), effective as of the date specified by Landlord (at least sixty (60) days in the future) in a written notice of termination from Landlord to Tenant. 16.4. In the event that a portion, but less than substantially the whole, of the Premises shall be taken by condemnation, then this Lease shall be terminated as of the date of such condemnation as to the portion of the Premises so taken, and unless Landlord exercises its option to terminate this Lease pursuant to Section 16.2 or Tenant exercises its option to terminate this Lease pursuant to this Section 16.4 below, this Lease shall remain in full force and effect as to the remainder of the Premises. If any part of the Premises shall be taken by condemnation and such partial condemnation renders the Premises unusable for the business of Tenant, as reasonably determined by Tenant, or in the event a substantial portion of the Building or the Parking Facility is taken by condemnation -16- rendering the Premises unusable for the business of Tenant, as reasonably determined by Tenant, then in either such event Tenant may elect to terminate this Lease as of the date specified by Tenant in a written notice of termination from Tenant to Landlord, which date shall not be later than sixty (60) days following the date of the taking. If such condemnation is not sufficiently extensive to render the Premises unusable for the business of Tenant as reasonably determined by Tenant, and Landlord has not elected to terminate this Lease in accordance with the provisions of Section 16.2, 16.3 or this Section 16.4, then Landlord shall promptly restore the Premises to a condition comparable to its condition immediately prior to such condemnation (excluding Tenant's alterations, furniture, fixtures and equipment), less the portion thereof lost in such condemnation, and this Lease shall continue in full force and effect, except that after the date of any such taking of the Premises, the Rent shall be equitably apportioned from and after such date. 16.5. In the event of termination of this Lease pursuant to the provisions of Section 16.1, 16.2, or 16.3, the Rent shall be apportioned as of such date of termination; provided, however, that those provisions of this Lease which are designated to cover matters of termination and the period thereafter shall survive the termination hereof. 16.6. All compensation awarded or paid upon a condemnation of any portion of the Project shall belong to and be the property of Landlord without participation by Tenant. Nothing herein shall be construed, however, to preclude Tenant from prosecuting any claim directly against the condemning authority for loss of business, loss of good will, moving expenses, damage to, and cost of removal of, trade fixtures, furniture and other personal property belonging to Tenant. 16.7. If any portion of the Project other than the Building or the Parking Facility is taken by condemnation, or if the temporary use or occupancy of all or any part of the Premises shall be taken by condemnation during the Term, this Lease shall be and remain unaffected by such condemnation, and Tenant shall continue to pay in full the Rent payable hereunder. In the event of any such temporary taking for use or occupancy of all or any part of the Premises, Tenant shall be entitled to appear, claim, prove and receive the portion of the award for such taking that represents compensation for use or occupancy of the Premises during the Term and Landlord shall be entitled to appear, claim, prove and receive the portion of the award that represents the cost of restoration of the Premises and the use or occupancy of the Premises after the end of the Term hereof. In the event of any such condemnation of any portion of the Project other than the Building, Landlord shall be entitled to appear, claim, prove and receive all of that award. In the event of any permanent taking of the Premises, Tenant will have the right to recover from the condemning authority (but not from Landlord) any compensation as may be separately awarded or recoverable by Tenant for the taking of Tenant's furniture, fixtures, equipment and other personal property within the Premises, for Tenant relocation expenses, and for any loss of good will or other damage to Tenant's business by reason of such taking, but Tenant will not be entitled to any so-called bonus or excess value of this Lease, which will be the sole property of Landlord. 16.8. Landlord and Tenant each hereby waive the provisions of California Code of Civil Procedure Section 1265.130 and any other applicable existing or future law, ordinance or governmental regulation providing for, or allowing either party to petition the courts of the state in which the Project is located for, a termination of this lease upon a partial taking of the Premises and/or the Building. ARTICLE 17 INDEMNIFICATION 17.1. Tenant shall, and hereby agrees to, indemnify and hold Landlord harmless from any damage to any property or injury to, or death of, any person arising from (a) the use or occupancy of the Premises, or (b) the negligent or intentionally wrongful use or occupancy of the Common Areas by Tenant, its agents, employees, representatives, contractors, successors, assigns, licensees, or invitees, except to the extent such damage or injury is caused by the negligence or willful misconduct of Landlord, its agents, employees, representatives, or contractors (in which case Landlord shall be responsible to the extent such damage or injury is not covered by insurance required to be carried by Tenant under this Lease or actually carried by Tenant). Landlord shall not be liable for any damage or injury caused by other tenants or persons in the Building or by occupants of adjacent property thereto, or by the public, or caused by construction (except to the extent caused by the negligence or willful misconduct of Landlord (in which case Landlord shall be responsible to the extent such damage or injury is not covered by insurance required to be carried by Tenant under this Lease or actually carried by Tenant)) or by any private, public or quasipublic work. Tenant's foregoing indemnity shall include attorneys' fees, investigation costs, and all other reasonable costs and expenses incurred by Landlord in any connection therewith. The provisions of this Article 17 shall survive the expiration or termination of this Lease with respect to any damage, injury, or death occurring before such expiration or termination. If Landlord is made a party to any litigation commenced by or against Tenant or relating to this Lease or to the Premises, and provided that in any such litigation Landlord is not finally adjudicated to be solely at fault, then Tenant shall pay all costs and expenses, including attorneys' fees and court costs, incurred by or imposed upon Landlord because of any such litigation, and the amount of all such costs and expenses, including attorneys' fees and court costs, shall be a demand obligation owing by Tenant to Landlord. 17.2. Landlord shall, and hereby agrees to, indemnify and hold Tenant harmless from any damages in connection with loss of life, bodily or personal injury or property damage arising from any occurrence in the Common Areas to the extent not the result of the negligence or willful misconduct of Tenant. If Tenant is made a party to any litigation commenced by or against Landlord or relating to this Lease or to the Premises, and provided that in any such litigation Tenant is not finally adjudicated to be solely at fault, then Landlord shall pay all costs and expenses, including attorneys' fees and court costs, incurred by or imposed upon Tenant because of any such litigation, and the amount of all such costs and expenses, including attorneys' fees and court costs, shall be a demand obligation owing by Landlord to Tenant. -17- ARTICLE 18 SUBORDINATION AND ESTOPPEL CERTIFICATES 18.1. This Lease and all rights of Tenant hereunder are subject and subordinate to all underlying leases now or hereafter in existence, and to any supplements, amendments, modifications, and extensions of such leases heretofore or hereafter made and to any deeds to secure debt, mortgages, or other security instruments which now or hereafter cover all or any portion of the Project or any interest of Landlord therein, and to any advances made on the security thereof, and to any increases, renewals, modifications, consolidations, replacements, and extensions of any of such mortgages. This provision is declared by Landlord and Tenant to be self-operative and no further instrument shall be required to effect such subordination of this Lease. Upon demand, however, Tenant shall execute, acknowledge, and deliver to Landlord any further instruments and certificates evidencing such subordination as Landlord, and any mortgagee or lessor of Landlord shall reasonably require, and if Tenant fails to so execute, acknowledge and deliver such instruments within ten (10) days after Landlord's request, Tenant shall be in default of this Lease. Tenant shall not unreasonably withhold, delay, or defer its written consent reasonable modifications in this Lease which are a condition of any construction, interim or permanent financing for the Project or any reciprocal easement agreement with facilities in the vicinity of the Building, provided that such modifications do not increase the obligations of Tenant hereunder or materially and adversely affect Tenant's use and enjoyment of the Premises. This Lease is further subject and subordinate to: (a) all applicable ordinances of any government authority having jurisdiction over the Project, relating to easements, franchises, and other interests or rights upon, across, or appurtenant to the Project; and (b) all utility easements and agreements, now or hereafter created for the benefit of the Project. Notwithstanding anything above to the contrary, Landlord agrees to provide Tenant with commercially reasonable non-disturbance agreement(s) in favor of Tenant from any ground lessors, mortgage holders and deed of trust beneficiaries of Landlord acquiring an interest in the Building or the underlying land after the date of this Lease until the expiration of the Term of this Lease in consideration of, and as an express condition precedent to, any subordination of this Lease provided for hereunder. 18.2. Notwithstanding the generality of the foregoing provisions of Section 18.1, any mortgagee or lessor of Landlord shall have the right at any time to subordinate any such mortgage or underlying lease to this Lease, or to any of the provisions hereof, on such terms and subject to such conditions as such mortgagee or lessor of Landlord may consider appropriate in its discretion. At any time, before or after the institution of any proceedings for the foreclosure of any such mortgage, or the sale of the Building under any such mortgage, or the termination of any underlying lease, Tenant shall, upon request of such mortgagee or any person or entities succeeding to the interest of such mortgagee or the purchaser at any foreclosure sale ("SUCCESSOR LANDLORD"), automatically become the Tenant (or if the Premises has been validly subleased, the subtenant) of the Successor Landlord, without change in the terms or other provisions of this Lease (or, in the case of a permitted sublease, without change in this Lease or in the instrument setting forth the terms of such sublease); provided, however, that the Successor Landlord shall not be (i) bound by any payment made by Tenant of Rent or Additional Rent for more than one (1) month in advance, except for (i) a Security Deposit previously paid to Landlord (and then only if such Security Deposit has been deposited with and is under the control of the Successor Landlord and/or (ii) overpayment of installments of Tenant's Operating Costs Payments (based on Landlord' Operating Costs Estimate) in excess of actual Operating Costs for such period payable by Tenant), (ii) bound by any termination, modification, amendment or surrender of the Lease done without the Successor Landlord's consent, (iii) liable for any damages or subject to any offset or defense by Tenant to the payment of Rent by reason of any act or omission of any prior landlord (including Landlord), or (iv) personally or corporately liable, in any event, beyond the limitations on liability set forth in Section 25.5 of this Lease. This agreement of Tenant to attorn to a Successor Landlord shall survive any such foreclosure sale, trustee's sale conveyance in lieu thereof or termination of any underlying lease. Tenant shall upon demand at any time, before or after any such foreclosure or termination execute, acknowledge, and deliver to the Successor Landlord any written instruments and certificates evidencing such attornment as such Successor Landlord may reasonably require; provided, however, that Landlord shall use its reasonable efforts to require that such agreement provide that upon such attornment, as long as Tenant is not in default hereunder, Tenant's possession of the Premises under this Lease shall not be disturbed. 18.3. Tenant shall, from time to time, within ten (10) business days after request from Landlord, or from any mortgagee or lessor of Landlord, execute, acknowledge and deliver in recordable form a certificate certifying, to the extent true, that this Lease is in full force and effect and unmodified (or, if there have been modifications, that the same is in full force and effect as modified and stating the modifications); that the Term has commenced and the full amount of the Rent then accruing hereunder; the dates to which the Rent has been paid; that Tenant has accepted possession of the Premises and that any improvements required by the terms of this Lease to be made by Landlord have been completed to the satisfaction of Tenant; the amount, if any, that Tenant has paid to Landlord as a Security Deposit; that no Rent under this Lease has been paid more than thirty (30) days in advance of its due date; that the address for notices to be sent to Tenant is as set forth in this Lease (or has been changed by notice duly given and is as set forth in the certificate); that Tenant, as of the date of such certificate, has no charge, lien, or claim of offset under this Lease or otherwise against Rent or other charges due or to become due hereunder; that, to the knowledge of Tenant, Landlord is not then in default under this Lease; and such other matters as may be requested by Landlord or any mortgagee or lessor of Landlord. Any such certificate may be relied upon by Landlord, any Successor Landlord, or any mortgagee or lessor of Landlord. 18.4. Landlord shall use its good faith efforts to deliver to Tenant, within ninety (90) days after Tenant's written request, a Subordination, Non-Disturbance and Attornment Agreement substantially in the form of EXHIBIT "E" attached hereto and made a part hereof (or such other form as may be required by any ground lessor, mortgage holder or deed of trust beneficiary of Landlord's interest in the Project) ("NON-DISTURBANCE AGREEMENT"), which Non-Disturbance Agreement Tenant shall execute and deliver to Landlord within five (5) days after Tenant's receipt thereof. Within ninety (90) days after Landlord's receipt of the Non-Disturbance Agreement (executed by Tenant), Landlord shall use its good faith efforts to cause the Non-Disturbance Agreement to be executed by any ground lessors, mortgage holders and deed of trust beneficiaries in existence as of the date hereof. -18- ARTICLE 19 SURRENDER OF THE PREMISES Upon the Expiration Date or earlier termination of this Lease, Tenant, at Tenant's sole cost and expense, shall peacefully vacate and surrender the Premises to Landlord in good order, broom clean and in the same condition as at the beginning of the Term or as the Premises may thereafter have been improved by Landlord or Tenant (subject to Section 10.3 hereof), reasonable use and wear thereof and repairs which are Landlord's obligations under Articles 9, 15 and 16 only excepted, and Tenant shall remove all of Tenant's Property and turn over all keys for the Premises to Landlord. No provision of this Lease shall impose upon Landlord any obligation to care for or preserve any of Tenant's Property left upon the Premises, and Tenant hereby waives and releases Landlord from any claim or liability in connection with the removal of such property from the Premises and the storage thereof and specifically waives the provisions of California Civil Code Section 1542 with respect to such release. Should Tenant continue to hold the Premises after the expiration or earlier termination of this Lease, such holding over, unless otherwise agreed to by Landlord in writing, shall constitute and be construed as a tenancy at sufferance at monthly installments of Rent equal to one hundred fifty percent (150%) of the monthly portion of Rent in effect as of the date of expiration or earlier termination, and subject to all of the other terms, charges and expenses set forth herein except any right to renew this Lease or to expand the Premises or any right to additional services. Tenant shall also be liable to Landlord for all damage which Landlord suffers because of any holding over by Tenant, and Tenant shall indemnify Landlord against all claims made by any other tenant or prospective tenant against Landlord resulting from delay by Landlord in delivering possession of the Premises to such other tenant or prospective tenant. The provisions of this Article 19 shall survive the expiration or earlier termination of this Lease. ARTICLE 20 LANDLORD'S RIGHT TO INSPECT Landlord shall retain duplicate keys to all doors of the Premises. Tenant shall provide Landlord with new keys should Tenant receive Landlord's consent to change the locks. Landlord shall have the right to enter the Premises to provide janitorial service as required under this Lease and other times at reasonable hours following reasonable prior notice (or, in the event of an emergency, at any hour) (a) to exhibit the same to present to prospective mortgagees, lessors or purchasers during the Term and to prospective tenants during the last year of the Term, (b) to inspect the Premises, (c) to confirm that Tenant is complying with all of Tenant's covenants and obligations under this Lease, (d) to make repairs required of Landlord under the terms of this Lease, (e) to make repairs to areas adjoining the Premises, and (f) to repair and service utility lines or other components of the Building; provided, however, Landlord shall use reasonable efforts to minimize interference with Tenant's business. ARTICLE 21 SECURITY DEPOSIT Tenant's Security Deposit (if any) shall be held by Landlord, without liability for interest except to the extent required by law, as security for the performance of Tenant's obligations under this Lease. Unless required by applicable law, Landlord shall not be required to keep the Security Deposit segregated from other funds of Landlord. Tenant shall not assign or in a any way encumber the Security Deposit. Upon the occurrence of any Event of Default by Tenant, Landlord shall have the right, without prejudice to any other remedy, to use the Security Deposit, or portions thereof, to the extent necessary to pay any arrearages in Rent, and any other damage, injury or expense. Following any such application of all or any portion of the Security Deposit, Tenant shall pay to Landlord, on demand, the amount so applied in order to restore the Security Deposit to its original amount. If Tenant is not in default at the termination of this Lease, any remaining balance of the Security Deposit shall be returned to Tenant, provided that Tenant surrenders the Premises without damage pursuant to Article 19 hereof. If Landlord transfers its interest in the Premises during the Term, Landlord shall assign the Security Deposit to the transferee, and thereafter Landlord shall have no further liability to Tenant for the Security Deposit. ARTICLE 22 BROKERAGE Tenant and Landlord each represent and warrant to the other that it has not entered into any agreement with, or otherwise had any dealings with, any broker or agent in connection with the negotiation or execution of this Lease which could form the basis of any claim by any such broker or agent for a brokerage fee or commission, finder's fee, or any other compensation of any kind or nature in connection herewith, other than with Brokers listed in Section 1.1.S (who shall be paid by Landlord in accordance with Landlord's separate agreement(s) with the Brokers) and each party shall, and hereby agrees to, indemnify and hold the other harmless from all costs (including court costs, investigation costs, and attorneys' fees), expenses, or liability for commissions or other compensation claimed by any broker or agent with respect to this Lease which arise out of any agreement or dealings, or alleged agreement or dealings, between the indemnifying party and any such agent or broker, other than with Brokers. This provision shall survive the expiration or earlier termination of this Lease. -19- ARTICLE 23 OBSERVANCE OF RULES AND REGULATIONS Tenant and Tenant's servants, employees, agents, visitors, and licensees shall observe faithfully and comply strictly with all Rules and Regulations (herein so called) attached to this Lease as Rider No. 1, as such Rules and Regulations may be changed from time to time. Landlord shall at all times have the right to make reasonable changes in and additions to such Rules and Regulations; provided Landlord gives Tenant prior notice of such changes and provided that such new rules and regulations or changes in existing rules and regulations do not conflict with this Lease, and do not materially interfere with the lawful conduct of Tenant's business in the Premises. Any failure by Landlord to enforce any of the Rules and Regulations now or hereafter in effect, either against Tenant or any other tenant in the Building, shall not constitute a waiver of any such Rules and Regulations. Landlord shall not be liable to Tenant for the failure or refusal by any other tenant, guest, invitee, visitor, or occupant of the Building to comply with any of the Rules and Regulations. Landlord shall enforce the Rules and Regulations in a nondiscriminatory manner. ARTICLE 24 NOTICES All notices, consents, demands, requests, documents, or other communications (other than payment of Rent) required or permitted hereunder (collectively, "NOTICES") shall be deemed given, whether actually received or not, when dispatched for hand delivery or delivery by air express courier (with signed receipts) to the other party, or on the second Business Day after deposit in the United States mail, postage prepaid, certified, return receipt requested, except for notice of change of address which shall be deemed given only upon actual receipt. The addresses of the parties for notices are set forth in Article 1, or any such other addresses subsequently specified by each party in notices given pursuant to this Article 24. ARTICLE 25 MISCELLANEOUS 25.1. PROFESSIONAL FEES. In any action or proceeding brought by either party against the other under this Lease, the prevailing party shall be entitled to recover from the other party its professional fees for attorneys, appraisers and accountants, its investigation costs, and any other legal expenses and court costs incurred by the prevailing party in such action or proceeding. 25.2. REIMBURSEMENTS. Wherever the Lease requires Tenant to reimburse Landlord for the cost of any item, such costs will be the reasonable and customary charge periodically established by Landlord for such item. Landlord shall keep in its manager's office a schedule of such charges (which Landlord may periodically change) for Tenant's examination. The schedule of charges may include, at the discretion of Landlord, a reasonable allocation of overhead, administrative, and related costs and a reasonable fee for Landlord's agent or manager who performs such services or arranges for performance of such services. All such charges shall be payable upon demand as Additional Rent. 25.3. SEVERABILITY. Every agreement contained in this Lease is, and shall be construed as, a separate and independent agreement. If any term of this Lease or the application thereof to any person or circumstances shall be invalid or unenforceable, the remaining agreements contained in this Lease shall not be affected. 25.4. NON-MERGER. There shall be no merger of this Lease with any ground leasehold interest or the fee estate in the Project or any part thereof by reason of the fact that the same person may acquire or hold, directly or indirectly, this Lease or any interest in this Lease as well as any ground leasehold interest or fee estate in the Project or any interest in such fee estate. 25.5. LANDLORD'S LIABILITY. Anything contained in this Lease to the contrary notwithstanding, Tenant agrees that Tenant shall look solely to the estate and property of Landlord in the Project for the collection of any judgment or other judicial process requiring the payment of money by Landlord for any default or breach by Landlord under this Lease, subject, however, to the prior rights of any mortgagee or lessor of the Project. No other assets of Landlord or any members, partners, shareholders, or other principals of Landlord shall be subject to levy, execution or other judicial process for the satisfaction of Tenant's claim. 25.6. FORCE MAJEURE. Whenever the period of time is herein prescribed for action to be taken by Landlord or Tenant, Landlord or Tenant shall not be liable or responsible for, and there shall be excluded from the computation for any such period of time, any delays due to force majeure, which term shall include strikes, riots, acts of God, shortages of labor or materials, war, governmental approvals, laws, regulations, or restrictions, or any other cause of any kind whatsoever which is beyond the reasonable control of Landlord or Tenant. Force Majeure shall not excuse or delay Tenant's obligation to pay Rent or any other amount due under this Lease. 25.7. HEADINGS. The article headings contained in this Lease are for convenience only and shall not enlarge or limit the scope or meaning of the various and several articles hereof. Words in the singular number shall be held to include the plural, unless the context otherwise requires. All agreements and covenants herein contained shall be binding upon the respective heirs, personal representatives, and successors and assigns of the parties thereto. -20- 25.8. SUCCESSORS AND ASSIGNS. All agreements and covenants herein contained shall be binding upon the respective heirs, personal representatives, successors and assigns or the parties hereto. If there be more than one Tenant, the obligations hereunder imposed upon Tenant shall be joint and several. If there is a guarantor of Tenant's obligations hereunder, Tenant's obligations shall be joint and several obligations of Tenant and such guarantor, and Landlord need not first proceed against Tenant hereunder before proceeding against such guarantor, and any such guarantor shall not be released from its guarantee for any reason, including any amendment of this Lease, any forbearance by Landlord or waiver of any of Landlord's rights, the failure to give Tenant or such guarantor any notices, or the release of any party liable for the payment or performance of Tenant's obligations hereunder. Notwithstanding the foregoing, nothing contained in this Section 25.8 shall be deemed to override Article 8. 25.9. LANDLORD'S REPRESENTATIONS. Neither Landlord nor Landlord's agents or brokers have made any representations or promises with respect to the Premises, the Building, the Parking Facility, the Land, or any other portions of the Project except as herein expressly set forth and all reliance with respect to any representations or promises is based solely on those contained herein. No rights, easements, or licenses are acquired by Tenant under this Lease by implication or otherwise except as, and unless, expressly set forth in this Lease. 25.10. ENTIRE AGREEMENTS; AMENDMENTS. This Lease and the Exhibits and Riders attached hereto set forth the entire agreement between the parties and cancel all prior negotiations, arrangements, brochures, agreements, and understandings, if any, between Landlord and Tenant regarding the subject matter of this Lease. No amendment or modification of this Lease shall be binding or valid unless expressed in writing executed by both parties hereto. 25.11. TENANT'S AUTHORITY. If Tenant signs as a corporation, execution hereof shall constitute a representation and warranty by Tenant that Tenant is a duly organized and existing corporation, that Tenant has been and is qualified to do business in the State of California and in good standing with the State of California, that the corporation has full right and authority to enter into this Lease, and that all persons signing on behalf of the corporation were authorized to do so by appropriate corporate action. If Tenant signs as a limited liability company, partnership, trust, or other legal entity, execution hereof shall constitute a representation and warranty by Tenant that Tenant has complied with all applicable laws, rules, and governmental regulations relative to Tenant's right to do business in the State of California, that such entity has the full right and authority to enter into this Lease, and that all persons signing on behalf of Tenant were authorized to do so by any and all necessary or appropriate company, partnership, trust, or other actions. 25.12. GOVERNING LAW. This Lease shall be governed by and construed under the laws of the State of California. Should any provision of this Lease require judicial interpretation, Landlord and Tenant hereby agree and stipulate that the court interpreting or considering same shall not apply the presumption that the terms hereof shall be more strictly construed against a party by reason of any rule or conclusion that a document should be construed more strictly against the party who itself or through its agents prepared the same, it being agreed that all parties hereto have participated in the preparation of this Lease and that each party had full opportunity to consult legal counsel of its choice before the execution of this Lease. 25.13. TENANT'S USE OF NAME OF THE BUILDING. Tenant shall not, without the prior written consent of Landlord, use the name of the Building for any purpose other than as the address of the business to be conducted by Tenant in the Premises, and Tenant shall not do or permit the doing of anything in connection with Tenant's business or advertising (including brokers' flyers promoting sublease space) which in the reasonable judgment of Landlord may reflect unfavorably on Landlord or the Building or confuse or mislead the public as to any apparent connection or relationship between Tenant and Landlord, the Building, or the Land. 25.14. VIEW AND LIGHTS. Any elimination or shutting off of light, air, or view by any structure which may be erected on lands adjacent to the Building shall in no way affect this Lease and Landlord shall have no liability to Tenant with respect thereto. 25.15. CHANGES TO PROJECT BY LANDLORD. Landlord shall have the unrestricted right to make changes to all portions of the Project in Landlord's reasonable discretion for the purpose of improving access or security to the Project or the flow of pedestrian and vehicular traffic therein. Landlord shall have the right at any time, without the same constituting an actual or constructive eviction and without incurring any liability to Tenant therefor, to change the arrangement or location of entrances or passageways, doors and doorways, corridors, elevators, stairs. bathrooms, or any other Common Areas so long as reasonable access to the Premises remains available. Landlord shall also have the right to (a) rearrange, change, expand or contract portions of the Project constituting Common Areas, (b) to use Common Areas while engaged in making improvements, repairs or alterations to the Project, or any portion thereof, and (c) to do and perform such other acts and make such other changes in to or with respect to the Project, or any portion thereof, as Landlord may, in the exercise of sound business judgment, deem to be appropriate. Without liability to Tenant, Landlord shall be entitled to change the name or address of the Building or the Project. A name change shall not require any prior notice to Tenant; provided, however, Landlord will provide Tenant with reasonable advance notice if Landlord voluntarily changes the address of the Building. Landlord shall have the right to close, from time to time, the Common Areas and other portions of the Project for such temporary periods as Landlord deems legally sufficient to evidence Landlord's ownership and control thereof and to prevent any claim of adverse possession by, or any implied or actual dedication to, the public or any party other than Landlord. 25.16. TIME OF ESSENCE. Time is of the essence of this Lease. 25.17. LANDLORD'S ACCEPTANCE OF LEASE. The submission of this Lease to Tenant shall not be construed as an offer and Tenant shall not have any rights with respect thereto unless said Lease is consented to by mortgagee, and any lessor of Landlord, to the extent such consent is required, and Landlord executes a copy of this Lease and delivers the same to Tenant. -21- 25.18. PERFORMANCE BY TENANT. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant, at Tenant's sole cost and expense, and without any abatement of Rent. If Tenant shall fail to pay any Rent, other than Base Rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder, and such failure shall continue for longer than the period of cure, if any, permitted in Section 13.1, Landlord may, at its option, without waiving or releasing Tenant from obligations of Tenant, make any such payment or perform any such other act on behalf of Tenant. All sums so paid by Landlord and all necessary incidental costs, together with interest thereon at the Interest Rate, from the date of such payment by Landlord, shall be payable to Landlord on demand. Tenant covenants to pay any such sums, and Landlord shall have (in addition to any other right or remedy of Landlord) the same rights and remedies in the event of the non-payment thereof by Tenant as in the case of default by Tenant in the payment of Rent. 25.19. FINANCIAL STATEMENTS. At any time during the term of this Lease, Tenant shall, upon ten (10) days prior written notice from Landlord, provide Landlord with the most recent existing financial statement and existing financial statements of the two (2) years prior to the most recent financial statement year. Such statements shall be prepared in accordance with generally accepted accounting principles and, if such is the normal practice of Tenant, shall be audited by an independent certified public accountant. 25.20. AUTOMATED TELLER MACHINE AND DEPOSITORY. Landlord and Tenant hereby agree that Tenant shall be entitled, during the Lease Term (and any Option Term, if applicable) at its sole cost and expense and subject to the terms and conditions of this Section 25.20, to install, maintain and operate (i) one (1) automated teller machine ("ATM"), together with related equipment, accessories, and identifying signage (collectively, the "ATM EQUIPMENT") and (ii) one (1) after-hours depository ("DEPOSITORY"), all at the location in the Premises shown on Exhibit "A-1." Tenant's installation of the ATM, the ATM Equipment and the Depository shall comply with all the terms and conditions of the Work Letter Agreement attached hereto as Exhibit "C" and otherwise in compliance with Article 10 and for purposes of this Lease, the ATM, the ATM Equipment and the Depository shall be considered part of the Leasehold Improvements. In connection with Tenant's installation, maintenance and operation of the ATM, the ATM Equipment and the Depository, Tenant shall, at its sole cost and expense (i) obtain all necessary federal, state, and local permits, licenses, and approvals; (ii) comply with all laws applicable to the installation, use and operation of the ATM, the ATM Equipment and the Depository, including, without limitation any provisions of the ADA; (iii) maintain the ATM, the ATM Equipment and the Depository, and the area in the vicinity thereof in clean and working condition and service the ATM and fill the ATM with cash and supplies (such services shall be performed before or after the normal business hours of the Project, except as deemed reasonably necessary by Tenant) and except for such periodic servicing and maintenance, Tenant shall operate the ATM continuously during reasonably operating hours as determined by Tenant from time to time; (iv) provide all security measures that are customary for similar facilities in comparable buildings in the vicinity of the Project including, without limitation, mirrors, surveillance cameras, door locks, adequate lighting, card entry systems, and warning signage and Tenant shall review such security measures at least annually and revise same to reflect then customary security measures; (v) pay all real, personal property, or other taxes or fees assessed or imposed on the ATM, the ATM Equipment and the Depository; (vi) remove, upon the expiration or earlier termination of the Lease (or at Landlord's option, upon the transfer or assignment of the Original Tenant's interest in this Lease), the ATM, the ATM Equipment and the Depository, including any ATM Signage (as that term is defined below) and repair any damage to the Project caused by such removal; and (vii) arrange with, and pay directly to, the applicable public or private utilities, as the case may be, for furnishing, installing, and maintaining of all telecommunications lines, services, and equipment as may be required by Tenant for the operation of the ATM, the ATM Equipment and the Depository and, in connection therewith, Tenant shall not modify or disturb any telecommunications lines, services and/or equipment in the Project without Landlord's prior written consent. Further, subject to Landlord's prior approval (which approval shall not be unreasonably withheld to the extent that such signage is required by applicable law), Tenant shall be permitted, at Tenant's sole cost and expense, to install signage and any other advertising material or displays at the ATM ("ATM SIGNAGE"), which ATM Signage shall identify Tenant and/or any automated teller network operated by Tenant and/or any shared automatic teller networks with which the ATM is affiliated. Tenant shall be responsible, at its sole cost and expense, for obtaining any permits or governmental approval required for the ATM Signage and for the maintenance and repair of the ATM Signage. Landlord reserves the right (but Landlord shall have no obligation) to engage a security consultant to determine whether any additional or different security measures are necessary at the Project as a result of Tenant's installation of the ATM, the ATM Equipment and the Depository and Tenant shall pay as additional rent, within ten (10) days after Landlord's invoice, all costs and expenses incurred by Landlord in connection therewith and Tenant shall, at Tenant's sole cost and expense, promptly implement such recommendations of such security consultant; provided, however, that if Landlord engages said security consultant, such engagement shall be for the sole benefit of Landlord and Tenant shall not rely thereon. Landlord may restrict the hours of operation of the ATM or require Tenant to temporarily discontinue services in connection with Landlord's maintenance and repair of the Project or any portion thereof, or if necessary in Landlord's reasonable judgment, for the security of the Project or its occupants or contents, and any such action by Landlord shall not be deemed a constructive eviction of Tenant or a disturbance of Tenant's use of the Premises or the Project and without Landlord incurring any liability to Tenant whatsoever. Landlord shall have no responsibility whatsoever for the ATM, the ATM Equipment and the Depository and shall not be liable for any damage or disruption to same however caused, including without limitation, due to a disruption in electrical or telecommunication service. Landlord makes no representations as to the suitability of the Project for an ATM or the Depository, whether or not the ATM and/or the Depository may be installed in the Project under applicable zoning ordinances or other laws, or as to the safety or security of the Project. The ATM and the Depository and surrounding area with respect thereto shall be deemed to constitute a portion of the Premises for purposes of Articles 14 and 17 above. 25.21. QUIET ENJOYMENT. Landlord covenants and agrees with Tenant that upon Tenant paying the rent required under this Lease and paying all other charges and performing all of the covenants and provisions on Tenant's part to be observed and performed under this Lease, Tenant may peaceably and quietly have, hold and enjoy the Premises in accordance with this Lease without hindrance or molestation by Landlord or its employees or agents. -22- 25.22. SIGNAGE. A. INTERIOR SIGNAGE. (1) FULL FLOORS. Subject to Landlord's prior written approval, in its sole discretion, and provided all signs are in keeping with the quality, design and style of the Building and Project, Tenant, for any portion of the Premises which comprises an entire floor of the Building, at its sole cost and expense, may install identification signage anywhere in such full floor portion of the Premises including in the elevator lobby of such full floor portion of the Premises, provided that such signs must not be visible from the exterior of the Building. Tenant shall be responsible, at Tenant's sole cost and expense, for maintenance and repair of any such signs. In addition, Tenant shall cause such signs to be removed from the Premises and shall repair all damage to the Premises and the Building resulting from such removal, at Tenant's sole cost and expense, prior to the expiration or earlier termination of this Lease. (2) MULTI-TENANT FLOORS. If other tenants occupy space on the floor on which the Premises is located, Tenant's identifying signage shall be provided by Landlord, at Tenant's cost, and such signage shall be comparable to that used by Landlord for other similar floors in the Building and shall comply with Landlord's Building standard signage program. (3) DIRECTORY. Tenant, at Tenant's sole cost and expense, shall be entitled to have Tenant's name, as well as the names of Tenant's employees, listed on a directory sign in the main lobby of the Building, up to a maximum of two (2) directory strips. B. TENANT'S EXTERIOR SIGNAGE. (1) TOP OF THE BUILDING SIGNAGE. Subject to the terms hereof, the Original Tenant shall have the exclusive right to install, at Original Tenant's sole cost and expense, signage identifying the Original Tenant on the top of the exterior wall of the Building in the two (2) locations generally depicted on Exhibit "F," attached hereto and incorporated herein by this reference. The signage to which Tenant is entitled pursuant to the immediately preceding sentence may be referred to herein as Tenant's "BUILDING TOP SIGNAGE." The graphics, materials, color, design, lettering, lighting, size, specifications, manner of affixing and exact location of the Building Top Signage shall be subject to Landlord's sole and absolute (but good faith) discretion. In addition, the Building Top Signage shall be subject to Tenant's receipt of all required governmental permits and approvals and shall be subject to all applicable governmental laws and ordinances, and any covenants, conditions and restrictions affecting the Project; provided, however, if Tenant does not receive the necessary governmental permits and approvals for the Building Top Signage, Landlord's and Tenant's rights and obligations under the remaining provisions of this Lease shall, except as otherwise provided in below, be unaffected. The cost of installation of the Building Top Signage, as well as all costs of design and construction of such signage and all other costs associated with such signage including, without limitation, permits and maintenance and repair, shall be the sole responsibility of Tenant. (2) EYEBROW SIGN. The Original Tenant shall have the right to install, at Original Tenant's sole cost and expense, one (1) "eyebrow" sign (the "EYEBROW SIGN") identifying the Original Tenant on the exterior of the Building in the location generally depicted on Exhibit "F". The graphics, materials, color, design, lettering, lighting, size, specifications, manner of affixing and exact location of the Eyebrow Sign shall be subject to Landlord's sole and absolute (but good faith) discretion. In addition, the Eyebrow Sign shall be subject to Tenant's receipt of all required governmental permits and approvals and shall be subject to all applicable governmental laws and ordinances, and any covenants, conditions and restrictions affecting the Project; provided, however, if Tenant does not receive the necessary governmental permits and approvals for the Eyebrow Sign, Landlord's and Tenant's rights and obligations under the remaining provisions of this Lease shall, except as otherwise provided in below, be unaffected. The cost of installation of the Eyebrow Sign, as well as all costs of design and construction of such signage and all other costs associated with such signage including, without limitation, permits and maintenance and repair, shall be the sole responsibility of Tenant. Notwithstanding anything above to the contrary, Landlord and Tenant acknowledge and agree that, without limiting the generality of the foregoing, Tenant's right to install such Eyebrow Sign is subject to Tenant's installation of a separate primary entrance to the Premises (other than through the lobby of the Building). As such, Tenant acknowledges and agrees that such entry shall be included, if at all, in connection with the construction of the Leasehold Improvements (and such entry shall be set forth in Tenant's Design Development Drawings (and in the Final Plans) and shall, therefore, be subject to Landlord's approval as to location and other specifications and criteria. Tenant further acknowledges and agrees that the hard costs of the construction of such entry (including, but not limited to, door(s) and hardware) shall, notwithstanding anything in this Lease to the contrary, be shared by Landlord and Tenant on an equal basis; provided, however, in no event shall Tenant be obligated to expend more than Five Thousand Dollars ($5,000.00) in connection with the hard construction costs associated with such entry access. (3) SIGNAGE TERMINATION. The Building Top Signage and the Eyebrow Sign are collectively referred to herein as the "EXTERIOR SIGNAGE." The rights to the Exterior Signage are personal to the Original Tenant and shall exist only as long as the Original Tenant actually occupies the entire Premises. Upon the expiration or sooner termination of this Lease, or if at any time after the Commencement Date, Tenant fails to occupy the entire Premises (each, a "SIGNAGE TERMINATION EVENT"), then Tenant's Exterior Signage rights shall forever terminate and Tenant shall, at Tenant's sole cost and expense, cause the Exterior Signage to be removed from the Building and to repair any damage (including any discoloration) to the Building resulting from such removal. If Tenant fails to remove its Exterior Signage from the Building and to repair any damage to the Building resulting from such removal within thirty (30) days following a Signage Termination Event, then Landlord may perform such work, and all costs and expenses incurred by Landlord in so performing shall be reimbursed by Tenant to Landlord within thirty (30) days after Tenant's receipt of Landlord's invoice therefor. The immediately preceding sentence shall survive the expiration or earlier termination of this Lease. Notwithstanding anything to the contrary contained in this Section 22.22.B, Landlord shall have the right, in its sole discretion (and without the necessity of -23- obtaining Tenant's consent or providing prior notice to Tenant), to grant to any other tenant(s) of the Building "eyebrow" signage or other signage rights in the Project which other tenant(s') signage may be more prominent than Tenant's Exterior Signage. (4) CONDITIONAL RENT ABATEMENT. Notwithstanding anything above to the contrary, Landlord acknowledges and agrees that in the event Tenant, after utilizing Tenant's best efforts (including appearing before the applicable governmental bodies and instituting court action (if necessary)), fails to obtain the necessary governmental permits and approvals for Tenant's Building Top Signage and/or Eyebrow Sign (to the extent a separate entryway to the Premises in compliance with all laws, permits and approvals has been constructed ) within six (6) months from the Commencement Date (the "TRIGGER DATE") then, after such Trigger Date, the applicable monthly Base Rent per square foot of Net Rentable Area set forth in Section 1.1.M of this Lease shall be deemed reduced by five cents ($0.05) (the "SPECIAL RENT ABATEMENT"); provided, however, that (i) Tenant shall only be entitled to the Special Rent Abatement to the extent that, and only for so long as, the applicable governmental authorities disallow any form of Tenant's Building Top Signage and/or (subject to the terms hereof) Eyebrow Signage and (ii) Tenant shall not, in any event, be entitled to any such Special Rent Abatement for the period of time prior to the Trigger Date (i.e., the first six (6) months of the Term). C. PROHIBITED SIGNAGE AND OTHER ITEMS. Any signs, notices, logos, pictures, names or advertisements which are visible from the exterior of the Premises and that have not been separately approved by Landlord may be removed without notice by Landlord at the sole expense of Tenant. Except as expressly set forth herein, Tenant may not install any signs on the exterior of the Project. Any signs, window coverings, or blinds (even if the same are located behind the Landlord-approved window coverings for the Building), or other items visible from the exterior of the Premises or Building, shall be subject to the prior written approval of Landlord, in its sole discretion. 25.23. WAIVER OF JURY TRIAL. Each party hereby waives any right to a trial by jury in any action seeking specific performance of any provision of this Lease, for damages for any breach under this Lease, or otherwise for enforcement of any right or remedy hereunder. 25.24. LEASING RESTRICTIONS. So long as the Original Tenant (i) is not in default under this Lease and (ii) is occupying all of the Net Rentable Area in the Premises as a licensed banking company or banking corporation in the business of accepting money deposits from the general public, Landlord will not, without Tenant's prior written consent (which consent shall not be unreasonably withheld, conditional or delayed), lease any space in the ground floor of the Building to any tenant whose primary stated use in its lease is a licensed banking company or banking corporation, savings and loan, bank thrift or credit union but only to the extent that any such tenant entity's business involves accepting money deposits from the general public; provided, however, that such restriction is only for the benefit of the Original Tenant and not any other person or entity. If the circumstances descried in items (i) or (ii) do not apply, the leasing restriction in the immediately preceding sentence shall thereafter be null and void. 25.25. SECURED AREAS. Notwithstanding anything to the contrary contained herein, Tenant shall be entitled, during the Lease Term to designate a reasonable portion (or portions) of the Premises as a "SECURED AREA" and to install door locks or other access control systems as necessary to secure such Secured Area(s), provided that Tenant gives Landlord prior written notice of Tenant's designation of such Secured Area(s) and that such Secured Area(s) shall be used by Tenant solely for the purposes permitted under this Lease. Tenant hereby agrees and acknowledges that Landlord shall have no obligation to perform janitorial services in such Secured Area(s) unless Tenant provides Landlord a written request for same and provides Landlord with access to such Secured Area(s) (by providing Landlord a key or other device, by scheduling Landlord's entry with an escort or otherwise) and, in the event that Tenant does not provide Landlord with a key or other device to gain access to such Secured Area(s), Landlord shall have the right to use reasonable force to gain access to such Secured Area(s) in the case of emergency and Landlord shall have no liability whatsoever to Tenant in connection therewith. Landlord and Tenant hereby agree and acknowledge that, except as provided in the immediately preceding sentence, Landlord shall enter such Secured Area(s) only upon one (1) business days' prior notice to Tenant and only after providing Tenant with the opportunity to have a representative of Tenant present as an escort. Landlord and Tenant hereby agree to use commercially reasonable efforts to schedule any such entries into the Secured Area(s) by Landlord at times that are mutually convenient to both Landlord and Tenant, taking into consideration the nature of Tenant's operations in the Premises. Tenant agrees that Tenant shall be responsible, at its sole cost and expense, for complying with all applicable laws regarding such Secured Area(s) and that such Secured Area(s) are subject to the indemnification provisions of Article 17 above. ARTICLE 26 OTHER DEFINITIONS When used in this Lease, the terms set forth hereinbelow shall have the following meanings: (a) "BUSINESS DAYS" shall mean Monday through Friday (except for Holidays); "BUSINESS HOURS" shall mean 7:30 a.m. to 6:00 p.m. on Monday through Friday and 9:00 a.m. to 1:00 p.m. on Saturdays (except for Holidays); and "HOLIDAYS" shall mean those holidays designated by Landlord, which holidays shall be consistent with those holidays designated by landlords of other first-class office buildings in the Comparison Area. (b) "COMMON AREAS" shall mean those certain areas and facilities of the Building and the Parking Facility and those certain improvements to the Land which are from time to time provided by Landlord for the use of tenants of the Building and their employees, clients, customers, licensees and invitees or for use by the public, which facilities and improvements include any health facility (if any) in the Project, any and all corridors, elevator foyers, vending areas, bathrooms, electrical and telephone rooms, mechanical rooms, janitorial areas and other similar facilities of the Building and of the Parking Facility and any and all grounds, parks, landscaped areas, outside -24- sitting areas, sidewalks, walkways, tunnels, pedestrianways, skybridges, and generally all other improvements located on the Land, or which connect the Land to other buildings. (c) The words "DAY" or "DAYS" shall refer to calendar days, except where "Business Days" are specified. (d) The words "HEREIN", "HEREOF", "HEREBY", "HEREUNDER" and words of similar import shall be construed to refer to this Lease as a whole and not to any particular Article or Section thereof unless expressly so stated. (e) The words "INCLUDE" and "INCLUDING" shall be construed as if followed by the phrase "without being limited to." (f) "NET RENTABLE AREA" and "USABLE AREA" shall mean "Net Rentable Area" and "Usable Area" (as applicable) determined in accordance with the Standard Method For Measuring Floor Area in Office Buildings ANSI/BOMA Z65.1-1996 ("BOMA STANDARD"); provided, however, that for all purposes under this Lease the calculation of the Usable Area shall in no event include the area comprising the elevator lobbies, telephone rooms, electrical rooms, mechanical rooms, freight vestibule areas or restrooms. Landlord shall have the right, within ninety (90) days after the Commencement Date, to verify the Net Rentable Area and/or Usable Area of the Premises in accordance with the BOMA Standard (as modified pursuant to the immediately preceding sentence). Tenant shall have the right, at its sole cost and expense, within sixty (60) days after the Commencement Date, to have a qualified architect or space planner reasonably approved by Landlord verify the Net Rentable Area and/or Usable Area of the Premises and the Building in accordance with the BOMA Standard (as modified pursuant to the immediately preceding sentence); provided, however, that such determination shall be subject to the reasonable review and approval of Landlord and its designated consultants, surveyors, or engineers. If, as a result of such verification (and approval by Landlord), it is determined that the Net Rentable Area and/or Usable Area of the Premises are different than the amounts set forth in Section 1.1 above, all corresponding amounts set forth this Lease (including, without limitation, Tenant's Share, the amount of monthly Base Rent, the amount of the Security Deposit and the Allowance) shall be retroactively adjusted and appropriate payments, if applicable, shall be made by Landlord to Tenant or Tenant to Landlord (as applicable) within ten (10) days after such determination and approval by Landlord. Both parties agree to execute a commercially reasonable instrument in order to document such revised amounts. From time to time throughout the Term of this Lease, Landlord shall have the right, at its sole cost and expense, to verify the Net Rentable Area and/or Usable Area of the Premises, the Building and the Project in accordance with the BOMA Standard and this subparagraph (f) (pertaining to adjustment of certain Lease provisions and appropriate payments (if applicable)). (g) Reference to Landlord as having "NO LIABILITY TO TENANT" or being "WITHOUT LIABILITY TO TENANT" or words of like import shall mean that Tenant is not entitled to terminate this Lease, or to claim actual or constructive eviction, partial or total, or to receive any abatement or diminution of rent, or to be relieved in any manner of any of Tenant's other obligations hereunder, or to be compensated for loss or injury suffered or to enforce any other right or kind of liability whatsoever against Landlord under or with respect to this Lease or with respect to Tenant's use or occupancy of the Premises. (h) A "REPAIR" shall be deemed to include such rebuilding, replacement and restoration as may be necessary to achieve and maintain good working order and condition. (i) The "TERMINATION OF THIS LEASE" and words of like import includes the expiration of the Term or the cancellation of this Lease pursuant to any of the provisions of this Lease or to law. Upon the termination of this Lease, the Term shall end at 11:59 p.m. (local time for the Building) on the date of termination as if such date were the Expiration Date, and neither party shall have any further obligation or liability to the other after such termination except (i) as shall be expressly provided for in this Lease and (ii) for such obligations as by their nature or under the circumstances can only be, or by the provisions of this Lease, may be, performed after such termination and, in any event, unless expressly otherwise provided in this Lease, any liability for a payment (which shall be apportioned as of the date of such termination) which shall have accrued to or with respect to any period ending at the time of termination shall survive the termination of this Lease. (j) The "TERMS OF THIS LEASE" shall be deemed to include all terms, covenants, conditions, provisions, obligations, limitations, restrictions, reservations and agreements contained in this Lease. (k) "TENANT" shall be deemed to include Tenant's successors and assigns (to the extent permitted by Landlord) and any and all occupants of the Premises permitted by Landlord and claiming by, through or under Tenant. ARTICLE 27 RIGHT OF FIRST NEGOTIATION 27.1. IN GENERAL. Subject to the terms hereof, Landlord hereby grants to Tenant a right of first negotiation with respect to space on the ground floor of the Building (the "FIRST NEGOTIATION SPACE"). Notwithstanding the foregoing, such first negotiation right shall be subordinate and secondary to all rights of expansion, first refusal, first offer or similar rights granted to Brandes Investment Partners, L.P., an existing tenant of the Project (the rights described above to be known as "SUPERIOR RIGHTS"). Tenant's right of first negotiation shall be on the terms and conditions set forth in this Article 27. 27.2. PROCEDURE FOR NEGOTIATION. Landlord shall notify Tenant (the "FIRST NEGOTIATION NOTICE") from time to time when Landlord receives a proposal for all or any portion of the First Negotiation Space which Landlord -25- would seriously consider (and where no holder of a Superior Right desires to lease such space). The First Negotiation Notice shall describe the space so offered to Tenant and shall set forth Landlord's proposed economic terms and conditions applicable to Tenant's lease of such space (collectively, the "ECONOMIC TERMS"). 27.3. PROCEDURE FOR ACCEPTANCE. If Tenant wishes to exercise Tenant's right of first negotiation with respect to the space described in the First Negotiation Notice, then within three (3) business days after delivery of the First Negotiation Notice to Tenant ("ELECTION DATE"), Tenant shall deliver notice to Landlord of Tenant's exercise its right of first negotiation with respect to the entire space described in the First Negotiation Notice based on the Economic Terms contained therein. If Tenant does not exercise its right of first negotiation within such three (3) business day period or if Tenant exercises its right of first negotiation but objects to any of the Economic Terms then, in any event, Landlord shall be free to lease the space described in the First Negotiation Notice to any person or entity within twelve (12) months after the Election Date upon any terms Landlord desires and Tenant's right of first negotiation shall terminate as to the First Negotiation Space described in the First Negotiation Notice. Notwithstanding anything to the contrary contained herein, Tenant must elect to exercise its right of first negotiation, if at all, with respect to all of the space offered by Landlord to Tenant at any particular time, and Tenant may not elect to lease only a portion thereof. 27.4. CONDITION OF FIRST NEGOTIATION SPACE. Subject to the Economic Terms, Tenant shall lease the First Negotiation Space in its "then as-is" condition as of the date of Landlord's delivery of the First Negotiation Space to Tenant. Tenant may construct improvements in the First Negotiation Space in accordance with Article 10 of the Lease. 27.5. LEASE OF FIRST NEGOTIATION SPACE. If Tenant timely exercises Tenant's right to lease the First Negotiation Space as set forth herein, Landlord and Tenant shall, within five (5) business days after the Election Date, execute an amendment adding such First Negotiation Space to this Lease upon the same non-economic terms and conditions as applicable to the initial Premises, and the economic terms and conditions as provided in this Article 27. Tenant shall commence payment of rent for the First Negotiation Space and the Lease Term of the First Negotiation Space shall commence on the date Landlord makes such First Negotiation Space available to Tenant. The Lease Term for the First Negotiation Space shall expire co-terminously with Tenant's lease of the initial Premises; provided, however, that notwithstanding anything above to the contrary, Tenant acknowledges and agrees that in no event shall Landlord be obligated to provide Tenant with a First Negotiation Notice during the last thirty-six (36) months of the Lease Term and, accordingly, Tenant will not have a right to lease any First Negotiation Space for a term of less than thirty-six (36) months. 27.6. NO DEFAULTS. The rights contained in this Article 27 shall be personal to the Original Tenant and any Permitted Assignee of the Original Tenant's entire interest in this Lease and may only be exercised by the Original Tenant (and such Permitted Assignee) if the Original Tenant occupies the entire Premises as of the date of the First Negotiation Notice. Tenant shall not have the right to lease First Negotiation Space as provided in this Article 27 if, as of the date of the First Negotiation Notice, or, at Landlord's option, as of the scheduled date of delivery of such First Negotiation Space to Tenant, Tenant is in default under this Lease or Tenant has previously been in default under this Lease more than once. IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the date set forth on the cover page hereof. TENANT: LANDLORD: SCRIPPS BANK, PRENTISS PROPERTIES ACQUISITION a California banking corporation PARTNERS, L.P., a Delaware limited partnership By: Prentiss Properties I, Inc. By: /s/ Ronald J. Carlson Its: General Partner ----------------------------- Name: Ronald J. Carlson ------------------------ Title: President & CEO ----------------------- By: /s/ Christopher M. Hipps ---------------------------- Name: Christopher M. Hipps ----------------------- Title: Senior Vice President ----------------------- By: /s/ M. Catherine Wright ----------------------------- Name: M. Catherine Wright ------------------------ By: /s/ J. Kevan Dilbeck Title: Sr. Vice President/CFO --------------------------- ----------------------- Name: J. Kevan Dilbeck ---------------------- Title: Senior Vice President ---------------------- -26- EXHIBIT "C" WORK LETTER AGREEMENT [ALLOWANCE] This WORK LETTER AGREEMENT ("AGREEMENT") supplements the Office Lease (the "LEASE") dated October 21, 1999, executed concurrently herewith, by and between PRENTISS PROPERTIES ACQUISITION PARTNERS, L.P., a Delaware limited partnership ("LANDLORD"), and SCRIPPS BANK, a California banking corporation ("TENANT"), covering certain premises described in the Lease (the "PREMISES"). All terms not defined herein shall have the same meaning as set forth in the Lease. 1. CONSTRUCTION OF BUILDING. At Landlord's sole cost, Landlord shall construct, through its contractor, the Parking Facility and the Building shell, including the following as part of the Building shell: (a) concrete floor; (b) unfinished ceilings on tenant space; (c) finished core area, including elevators, toilet rooms, electrical rooms, telephone rooms, janitorial closets, exit stairs and mechanical shaft; (d) dry wall (taped and finished, not painted) around surfaces of core walls; (e) primary heating, ventilating and air conditioning service to the edge of the Building core (not including branch distribution, controls and heat pumps); (f) primary sprinkler stem, main distribution loops, primary loop piping and distribution piping on an open-plan, unoccupied basis; and (g) life safety systems as required by code for the Building shell. The elevators and the items described in clauses (e), (f) and (g) above are referred to in the Lease as the "CENTRAL SYSTEMS." 2. CONSTRUCTION PLANS FOR PREMISES. All plans and drawings required by this Paragraph shall be prepared in accordance with the schedule provided in Paragraph 7 below. 2.1. Tenant shall retain J.A. Lindberg Interiors (the "SPACE PLANNER") to prepare, for Landlord's approval, preliminary space plans sufficient to convey the architectural design of the Premises, including preliminary partition layout and reflective ceiling plans ("TENANT'S DESIGN DEVELOPMENT DRAWINGS"). Tenant's Design Development Drawings shall be furnished to Landlord on or before the due date specified in Section 7(ii) of this Agreement. If Landlord shall disapprove of any portion of Tenant's Design Development Drawings, Landlord shall advise Tenant of such revisions, and reasons therefor, as are reasonably required by Landlord for the purpose of obtaining approval. Tenant shall then submit to Landlord for Landlord's approval, a redesign of Tenant's Design Development Drawings, incorporating the revisions requested by Landlord and such modifications thereof as are suggested by Tenant, said modifications to be subsequently approved by Landlord prior to Tenant's submission of Final Plans. 2.2. Based on Tenant's Design Development Drawings which have been approved by Landlord, Tenant shall retain Smith Consulting Architects ("ARCHITECT") and cause Architect to prepare complete architectural plans, drawings and specifications and complete engineered mechanical, structural and electrical working drawings for the Premises showing the subdivision, layout, finish and decoration work (including carpeting and other floor coverings) desired by Tenant (collectively, "FINAL PLANS"; the work shown thereon being called the "LEASEHOLD IMPROVEMENTS") and in such form and such detail as may be reasonably required by Landlord; provided, however, that Tenant shall be required to use the architectural firm of Syska & Hennessy for those portions of the Final Plans pertaining to the electrical, mechanical and plumbing systems. The Final Plans shall: (i) comply with all applicable laws and ordinances, and the rules and regulations of all governmental authorities having jurisdiction; (ii) comply with all applicable insurance regulations; (iii) include locations and complete dimensions; and (iv) be compatible with the Building shell, with the design, construction and equipment of the Building and with the standards set forth in Schedule I to this EXHIBIT "C" (the "BUILDING STANDARDS"), it being agreed that Tenant shall not deviate from the Building Standards without the prior written approval of Landlord. Tenant's Final Plans shall be furnished to Landlord on or before the due date specified in Section 7(vi) of this Agreement for the approval of Landlord. The approval/disapproval process for the Final Plans shall be as provided in Subparagraph 2.1 above for approval by Landlord of Tenant's Design Development Drawings and in accordance with Paragraph 7 hereof (and Landlord shall have approval rights over the same as provided in Subparagraph 2.1 above). 2.3. If the Final Plans or any amendment thereof or supplement thereto shall, due to the original design of the Premises as depicted in Tenant's Design Development Drawings, require changes in the Building shell, the increased cost of the Building shell work caused by such changes shall be charged against the Allowance or shall be promptly paid by Tenant if the Allowance has been expended. 2.4. Tenant's Design Development Drawings and the Final Plans are sometimes referred to herein as the "CONSTRUCTION DRAWINGS." Tenant and Tenant's Architect shall verify, in the field, the dimensions and conditions as shown on the relevant portions of the Base Building Plans, and Tenant and Tenant's Architect shall be solely responsible for the same, and Landlord shall have no responsibility in connection therewith. Landlord's review of the Construction Drawings as set forth in this Agreement, shall be for its sole purpose and shall not imply Landlord's review of the same, or obligate Landlord to review the same, for quality, design, code compliance or other like matters. Accordingly, notwithstanding that any Construction Drawings are reviewed by Landlord or its space planner, architect, engineers and consultants, and notwithstanding any advice or assistance which may be rendered to Tenant by Landlord or Landlord's space planner, architect, engineers, and consultants, Landlord shall have no liability whatsoever in connection therewith and shall not be responsible for any omissions or errors contained in the Construction Drawings. EXHIBIT "C" -1- 2.5. On or before the due date specified in Paragraph 7(xii), Tenant shall deliver to Landlord all applicable building permits necessary to allow Landlord's contractor to commence and fully complete the construction of the Leasehold Improvements (collectively, the "PERMITS") and, in connection therewith, Tenant shall coordinate with Landlord in order to allow Landlord, at Landlord's option, to take part in all phases of the permitting process, and shall supply Landlord, as soon as possible, with all plan check numbers and dates of submittal. Notwithstanding the foregoing, Tenant hereby agrees that neither Landlord nor Landlord's consultants shall be responsible for obtaining any building permit for the Premises and that the obtaining of the same shall be Tenants responsibility; provided, however, that Landlord shall, in any event, cooperate with Tenant in executing permit applications and performing other ministerial acts reasonably necessary to enable Tenant to obtain any such permit. 3. ALLOWANCE FOR WORK. 3.1. Tenant shall receive from Landlord an allowance (the "ALLOWANCE") of Thirty-Five Dollars ($35.00) per square foot of Usable Area of the Premises, i.e., Nine Hundred Four Thousand Five Hundred Seventy-Five Dollars ($904,575.00), which Allowance shall be used solely for the design, engineering and permitting fees, materials procurement, construction management fees, and installation of the Leasehold Improvements and other aspects of the Work Cost as hereinafter defined. All items of the Leasehold Improvements, whether or not the cost thereof is covered by the Allowance, shall become the property of Landlord upon expiration or earlier termination of the Lease and shall remain on the Premises at all times during the Term of this Lease. Tenant shall be entitled to no payment, credit or rent reduction for any part of the Allowance not used by Tenant. Tenant shall have the option, exercisable by written notice to Landlord within ten (10) days after Tenant's submittal to Landlord of Tenant's Design Development Drawings, to increase the amount of the Allowance by up to Five Dollars ($5.00) per square foot of Usable Area of the Premises (the "INCREASED ALLOWANCE AMOUNT"); provided, however, that notwithstanding anything in this Exhibit "C" to the contrary, such Increased Allowance Amount may only be used by Tenant for the design and construction of Leasehold Improvements pertaining to the ground floor portion of the Premises. If Tenant exercises such option, the monthly Base Rent payable by Tenant throughout the ten (10) year Lease Term shall be increased by an amount sufficient to fully amortize such Increased Allowance Amount throughout said ten (10) year period based upon equal monthly payments of principal and interest, with interest imputed on the outstanding principal balance at the rate of ten and one-half percent (10.5%) per annum. By way of illustration only, a Five Dollar ($5.00) per square foot of Useable Area Increased Allowance Amount will result in an increase, on a per rentable square foot basis, in the Base Rent of $0.0675 per square foot of Rentable Area of the Premises per month (or $0.81 per square foot of Rentable Area of the Premises per year). 3.2. Prior to the commencement of any Leasehold Improvements, Landlord shall submit to Tenant a preliminary written statement of Work Cost (as hereinafter defined) of all Leasehold Improvements, which preliminary written statement shall be based on the Tenant's Final Plans. Thereupon Tenant shall either approve the estimate or disapprove specific items and submit to Landlord revisions of Final Plans to reflect the deletion of and/or substitution for such disapproved items. Submission and approval of the preliminary Work Cost statement shall proceed in accordance with the schedule provided in Paragraph 7 below. Upon Tenant's approval of said statement, such approved statement to be hereinafter known as the "WORK COST STATEMENT," Landlord shall have the right to purchase materials and to commence the construction of the items included in said Work Cost Statement pursuant to Paragraph 4 hereof. If the Work Cost Statement exceeds the Allowance, Tenant shall be liable for and shall pay to Landlord within five (5) business days after invoice therefor, the estimated excess costs for the Leasehold Improvements. If the Work Cost exceeds the amount reflected on the Work Cost Statement due to changes requested by Tenant or any governmental entity, Tenant agrees to pay to Landlord such excess (except to the extent the Allowance is still available) within five (5) business days after invoice therefor (less any sums previously paid by Tenant for such excess pursuant to the Work Cost Statement). In no event will the Allowance be used to pay for Tenant's furniture, artifacts, equipment, telephone systems or any other item of personal property which is not affixed to the Premises. 3.3. Until Tenant approves the Work Cost Statement and pays any excess costs to Landlord as contemplated in Subparagraph 3.2 above, Landlord shall be under no obligation to perform the installation of the items of the Leasehold Improvements. 4. CONSTRUCTION. Following Tenant's approval of the Work Cost Statement described in Subparagraph 3.2 and upon Tenant's payment of any amounts as contemplated in Subparagraph 3.2 above, and at such time when, in Landlord's discretion, the Building has reached the stage of construction where it is appropriate to commence construction, a contractor or contractors selected by Landlord shall commence and diligently proceed with the construction of all of the Leasehold Improvements. Landlord shall cause such contractor to submit to bidding, all trades except for that portion of the Leasehold Improvements involving mechanical, electrical and sprinkler work, which mechanical, electrical and sprinkler work shall, in any event, be performed by landlord's subcontractors for the Project. Landlord shall have the right to review the bids and to perform a reconciliation in order to adjust inconsistent or incorrect assumptions so that a like-kind comparison can be made and low bidder(s) determined. Landlord shall select the lowest bidder who can meet Landlord's construction schedule. Promptly upon the commencement of the Leasehold Improvements, Landlord shall furnish Tenant with a schedule setting forth the projected completion dates therefor and showing the deadlines for any actions required to be taken by Tenant during such construction, and Landlord may from time to time during the prosecution of the Leasehold Improvements modify or amend such schedule due to delays encountered by Landlord. Landlord shall make a reasonable effort to meet such schedule (as the same may be modified or amended). 5. WORK COST. "WORK COST" means: (i) all design and engineering fees incurred by Tenant or Landlord in connection with the preparation of the preliminary space plans and Final Plans; (ii) governmental agency plan check, permit and other fees; (iii) sales and use taxes; (iv) Title 24 fees; (v) testing and inspecting costs; (vi) the actual costs and EXHIBIT "C" -2- charges for material and labor, contractor's profit and general overhead incurred by Landlord in having the Leasehold Improvements constructed; (vii) all other costs to be expended by Landlord in the construction of the Leasehold Improvements, including those costs incurred by Landlord for construction of elements of the Leasehold Improvements in the Premises, which construction was performed by Landlord prior to the execution of this Lease by Landlord and Tenant (i.e., during or after the construction of the Building shell) and which construction is for the benefit of tenants and is customarily performed by Landlord prior to the execution of leases for such space in the Building for reasons of economics [examples of such construction would include wall construction, column enclosures and painting outside of the core of the Building, ceiling hanger wires and window treatment; and (viii) an administration fee for Landlord of 5% of the total Work Cost specified in (i) through (vii) above. 6. ELEVATOR. Landlord shall, consistent with its obligations to other tenants then in occupancy in the Building, make an elevator available to Tenant in connection with initial decorating, furnishing and moving into the Premises. 7. SCHEDULE. Preparation and approval of all plans and drawings and the Work Cost Statement shall proceed as indicated below and each action shall be completed on or before the date herein specified:
Due Date in Calendar Days Action Responsibility Following Date of Lease ------ -------------- ----------------------- (i) Delivery to Tenant's architect of Building Landlord (Delivered September 23, background drawings 1999) (ii) Delivery to Landlord of Tenant's Design Tenant January 3, 2000 Development Drawings (iii) Delivery to Tenant of written notice approving Landlord January 10, 2000 or disapproving Tenant's Design Development Drawings (iv) Delivery to Landlord, if necessary, of redesign of Tenant January 31, 2000 Tenant's Design Development Drawings (v) Delivery to Tenant of written notice of final Landlord February 7, 2000 approval of Tenant's Design Development Drawings (vi) Delivery to Landlord of Final Plans. Tenant March 20, 2000 (vii) Delivery to Tenant of written notice approving Landlord March 27, 2000 or disapproving Final Plans (viii) Delivery to Landlord, if necessary, of redesign of Tenant April 3, 2000 Final Plans (ix) Delivery to Tenant of written notice of final Landlord April 10, 2000 approval of Final Plans (x) Delivery to Tenant of Work Cost estimate Landlord April 124, 2000 (xi) Delivery to Landlord of written notice of final Tenant May 1, 2000 approval of Work Cost Statement (xii) Delivery to Landlord of Building Permits Tenant May 8, 2000
8. DELAYS. Except as otherwise set forth in Section 3.1 of the Lease, the Term of the Lease shall not commence until Landlord has substantially completed all work to be performed by Landlord in this Work Letter Agreement as provided in Section 3.1 of the Lease; provided, however, that if Landlord shall be delayed in substantially completing said work as a result of any of the following (collectively, "TENANT DELAYS"): (i) Tenant's failure to complete any action item on or before the due date which is the responsibility of Tenant, or (ii) Tenant's changes to the Final Plans after the final approval date in Subparagraph 7(ix) above, or (iii) Tenant's request for materials, finishes, or installations other than Building Standard work, or EXHIBIT "C" -3- (iv) Any delay of Tenant in making payment to Landlord for Tenant's share of Work Cost, then as soon as reasonably possible following the Commencement Date, Landlord shall provide to Tenant a reasonably particularized statement of the net number of Tenant Delays, and Tenant shall pay to Landlord, as Additional Rent under this Lease, the product of the per diem Base Rent times the number of days of such net Tenant Delays, such payment to be made within thirty (30) days of receipt of the invoice from Landlord together with said particularized statement. 9. PUNCH-LIST ITEMS. Within five (5) days of Substantial Completion, Tenant shall provide to Landlord a detailed punch-list of unfinished items of the Leasehold Improvements. Upon receipt of the punch-list, Landlord shall, at Landlord's sole cost and expense, proceed diligently to remedy such items; provided, however, that Tenant shall be responsible, at Tenant's sole cost and expense, for the remediation of any items on the punch-list caused by Tenant's acts or omissions. 10. EARLY ENTRY. Provided that Tenant and its agents will not, in Landlord's sole discretion, interfere with the Contractor's work in the Building and the Premises and subject to the terms hereof, Landlord shall allow Tenant access to the Premises prior to the date of Substantial Completion of the Leasehold Improvements for the purpose of Tenant installing equipment or trade fixtures (including Tenant's data and telephone equipment, transmission cables and lines, and interior permanent and non-permanent improvements) in the Premises only. Tenant shall hold Landlord harmless from and indemnify, protect and defend Landlord against any loss or damage to the Building or Premises and against injury to any persons caused by Tenant's actions pursuant to this Paragraph 10. TENANT: LANDLORD: SCRIPPS BANK, PRENTISS PROPERTIES ACQUISITION a California banking corporation PARTNERS, L.P., a Delaware limited partnership By: Prentiss Properties I, Inc. By: /s/ Ronald J. Carlson Its: General Partner ----------------------------- Name: Ronald J. Carlson ------------------------ Title: President & CEO ----------------------- By: /s/ Christopher M. Hipps ---------------------------- Name: Christopher M. Hipps ----------------------- Title: Senior Vice President ----------------------- By: /s/ M. Catherine Wright ----------------------------- Name: M. Catherine Wright ------------------------ Title: Sr. Vice President/CEO ----------------------- By: /s/ J. Kevan Dilbeck --------------------------- Name: J. Kevan Dilbeck ---------------------- Title: Senior Vice President ---------------------- EXHIBIT "C" -4- EX-10.15 3 EXHIBIT 10.15 BUSINESS PROPERTY LEASE AGREEMENT INDUSTRIAL THIS LEASE is made and entered into Thursday, September 23. 1999. For and in consideration of the rental and of the covenants and agreements hereinafter set forth to be kept and performed by the Tenant, Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises herein described for the term, at the rental and subject to and upon all of the terms, covenants and agreements hereinafter set forth. SECTION I PARTIES: TERM: POSSESSION: PREMISES. 1.01 PARTIES: Landlord and Tenant are as follows: Landlord: BALBOA INVESTORS 1 LTD Tenant SCRIPPS BANK c/o Balboa Development Corp. 7817 Ivanhoe Avenue PO Box 9037 La Jolla, CA 92037 Le Jolla, CA 92038-9037 State Of Incorporation; CALIFORNIA State Of Incorporation: CALIFORNIA Tax Identification No.: 95-3761297 Tax Identification No.: 95-3875333 1.01 FINANCIAL INFORMATION: Tenant agrees to provide financial statements as may be required by Landlord or Landlord's lender or mortgagee, at the request of Landlord. Such requests shall be limited to no more than once per calendar year during the term of this lease or extension thereof. All such financial statements shall be received by Landlord in confidence. 1.02 TERM: Except as otherwise provided in this Lease, the Commencement Date is the TWENTYTHIRD day of SEPTEMBER, 1999 and the Expiration Date is the THIRTYFIRST day of DECEMBER, 2009. 1.02-1 POSSESSION OF PREMISES: Landlord shall deliver possession of the Premises to Tenant upon execution of the lease document and delivery of certificates of insurance indicating that Tenant's Insurance obligations are in full force and effect. 1.02-2 ACCEPTANCE OF PREMISES: Tenant accepts the building, premises and related parking "as is", and agrees that they have completed their due diligence with regard to existing conditions. 1.02-3 RENEWAL OPTION: If this Lease then remains in full force and effect, Tenant shall have the option to extend the term of this Lease for TWO (2) additional FIVE (5) year terms upon all the terms and conditions set forth in this Lease; except that the monthly basic rent to be paid by Tenant to Landlord for the extended term shall be the greater of the then current market rate for comparable space in the buildings market area or that computed by adding to the minimum monthly basic rent set forth in Section II paragraph 2.01-1 of this Lease a sum obtained by multiplying said minimum monthly basic rent by a factor equal to the percentage increase in the Consumer Price Index (All Urban Consumers), as defined in Section II paragraph 2.02 of this Lease, last published prior to the commencement of the original term of this Lease and the Consumer Price Index (All Urban Consumers) last published immediately preceding the commencement of the extended term. In no event shall the monthly basic rent for the extended term be less than the monthly basic rent (as adjusted) which is in effect at the time of the expiration of the initial Lease term. Tenant shall have no further renewal options. This option to renew must be exercised by written notice to Landlord one-hundred eighty (180) days prior to the expiration of the initial term or any subsequent terms, and once exercised is irrevocable. Any brokerage or agency services utilized by Tenant in connection with the exercise of this option shall be at Tenants expense. 1.03 PREMISES: Landlord leases to Tenant and Tenant leases from Landlord the Premises designated as all of the Office Building and the adjacent parking which is located at 5787 CHESAPEAKE COURT in the City of San Diego and the State of California. The Premises do NOT include, and expressly exclude, that vacant land lying to the north of the existing parking structure and adjoining Kearny Villa Road. Landlord reserves the right to perform a lot split severing the vacant lot so described from the balance of the existing lot. Tenant agrees to cooperate with reasonable requests in connection with any such lot split. 1:03-1 DESCRIPTION: The Premises contain approximately TWENTY THREE THOUSAND (23,000) square feet, which represents ONE HUNDRED percent (100%) of the total rentable area of the Building, in which the Premises are located. This percentage will be used for purposes of proration of expenses or other allocations required by the lease agreement, and may be changed from time to time by Landlord, to reflect any change in the total rentable area of the Building, The property and Premises am further described in Exhibit A attached. 1.03-2 IMPROVEMENT: The obligations of Landlord and Tenant to perform the work and supply material and labor to prepare the Premises for occupancy are set forth in detail in Exhibit B. Landlord and Tenant shall expand all funds and do all acts required of them and shall have the work performed promptly and diligently. SECTION II RENT: ADJUSTMENTS TO RENT: SECURITY DEPOSIT: LANDLORD'S LIEN: 2.01 RENT: WHEN DUE: WHERE PAID: All moneys payable by Tenant to Landlord under this Lease shall be deemed to be rent and shall be payable and recoverable as rent in the manner herein provided and Landlord shall have all rights against Tenant for default in any such payment. Rent shall be paid to Landlord in advance, on the first day of each calendar month, during the entire term of this Lease, without deduction or offset, in legal tender of the jurisdiction in which the Building is located at the address of Landlord as set forth, or to such other person or entity or to such other address as Landlord may designate in writing. Tenant's obligation to pay all rent due under this Lease shall survive the expiration or earlier termination of this Lease. Should this Lease commence on a day other than the first day of the month or terminate on a day other than the last day of the month, the rent for such partial month shall be prorated based on a three hundred sixty-five (365) day year. 2.01-1 BASIC RENT: Tenant agrees to pay a base rent of SIXTEEN THOUSAND ONE HUNDRED dollars ($16,100.00) per month (as such amount may be modified from time to time in accordance with provisions of Section II of this Lease) to Landlord. 2.01-2 DELIVERY OF RENT: All payments by Tenant to Landlord under this Lease shall be deemed made only at such time as Landlord receives good funds in hand. Tenant bears the risk of any delay in delivery of payments to Landlord, whether by US Postal Service or independent courier. The date of posting or delivery to an Independent courier service shall not be determinative of timely payment and Tenant alone bears the risk of dependence on methods of Page: 4 of 16 Initials: TENANT LA LANDLORD FH --- --- delivery. In the event any payment by Tenant to Landlord is made in the form of a check which is dishonored for any reason upon presentation for payment, such payment shall be deemed to have not been made and Landlord may require that all subsequent payments by Tenant be made in the form of a cashier's check or other guaranteed funds. Rent may be paid by direct wire transfer to Landlord's benefit in a bank and account that may be designated from time to time by Landlord and obligations shall be deemed paid by such deposit. 2.01-3 LATE PAYMENT CHARGE: Tenant hereby acknowledges that late payment by Tenant to Landlord of rent and other sums due here under will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any mortgage or trust deed covering the Premises. Accordingly, if any installment of rent or any other sum due from Tenant shall not be received by Landlord or Landlord's designee within ten (10) days after such amount shall be due, Tenant shall pay to Landlord a late payment charge equal to the greater of, six percent (6%) of the amount of each item or occurrence, or ONE HUNDRED dollars ($100.00). The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's default with respect to such overdue amount nor prevent Landlord from exercising any of the other rights and remedies granted here under. ACKNOWLEDGMENT OF THE ABOVE NEGOTIATED AGREEMENT: TENANT LA LANDLORD FH -- -- 2.01-4 INTEREST ON PAST DUE OBLIGATIONS: Except as expressly herein provided any amount due to Landlord and not paid when due shall bear interest at the maximum legal rate, or if no legal rate, at the rate of one percent (1%) per month from the date due until paid. Payment of such interest shall not excuse or cure any default by Tenant under this Lease. 2-01-5 PREPAID: In the event this Lease terminates before the expiration date, there shall be no refunds of prepaid rents. 2.02 ADJUSTMENT TO RENT (FIXED INCREASE): The monthly basic rent plus prior fixed increases to be paid Landlord by Tenant shall be adjusted effective January First of each calendar year of the lease term, beginning January First 2001, by an amount equal to FIVE HUNDRED AND SIXTY THREE AND FIFTY ONE HUNDREDTHS dollars ($563.50). During any renewal period of this lease, the annual adjustment shall be equal to FOUR percent (4%) of the base rent determined at the commencement of the option period. 2.03 ADJUSTMENT TO RENT (UTILITIES): Tenant shall contract for and pay directly the cost of all utilities supplied to or used in the Premises at the rate prevailing for Tenant's class of use as established by the company providing utilities to Premises. Landlord shall not be liable for any failure or interruption of any utility service being furnished to the Premises, and no such failure or interruption shall entitle Tenant to terminate this Lease, or seek compensation from Landlord or his agent. 2.04 ADJUSTMENT TO RENT (REAL PROPERTY TAXES); Landlord shall pay all real property taxes and Tenant shall reimburse Landlord for such taxes within 10 days of invoice from Landlord. Tenant shall NOT be responsible for increases to property taxes to the extent they result from reassessment due to the sale of the property. 2.05 ADJUSTMENT TO RENT (RENTAL TAX): Tenant shall pay an excise, transaction, sales, business or privilege tax (except income tax) attributed to or measured by rental which is now or subsequently imposed upon Landlord by any government or unit thereof. 2.06 ADJUSTMENT TO RENT (OPERATING COST): Tenant shall pay all "Operating Costs", necessary or appropriate for the efficient operation, maintenance and repair of the Building, the interiors thereof, the land upon which it is situated, and any parking or other facilities provided by Landlord for tenant. Tenant shall pay the cost of all alterations or improvements required to be made to the Building by reason of the laws and/or requirements of any insurer, mortgagee, trust deed beneficiary, or governmental agency. SECTION III USE: RESTRICTIONS ON USE: BUILDING REGULATIONS: QUIET ENJOYMENT: PARKING: 3.01 USE: Premises shall be used by Tenant for banking and general office space and for no other purpose. Tenant shall, at Tenant's expense, comply with all laws, rules, regulations, requirements, and ordinances existing or hereafter enacted or imposed by any governmental authority having jurisdiction over the Building, Premises, Landlord or Tenant applicable to Tenant and Tenant's use of the Building and Premises. Tenant acknowledges that neither Landlord nor any agent, employee or representative of Landlord has made any representation or warranty with respect to the suitability of the Building or Premises for the conduct of Tenant's business or any other purpose, or the compliance of Tenant's intended use with local zoning or other governmental regulation. 3.02 RESTRICTIONS ON USE: Tenant shall not: 3.02-1 INSURANCE INCREASE: Do or permit to be done anything which will invalidate or increase the cost of insurance coverage on the Building and the Premises. 3.02-2 ILLEGAL USE: IMPROPER USE: Tenant shall not use the Premises or permit anything to be done in or about the Premises which will in any way conflict with any law, statute, zoning restriction, ordinance or governmental rule or regulation or requirements or duly constituted public authorities now in force or which may hereafter be enacted or promulgated. 3.02-3 NUISANCE: Cause, maintain or permit any nuisance or objectionable uses in or about the Premises. 3.02-4 WASTE: Commit or permit any waste to be committed in the Premises. 3.02-5 SERVICE OVERLOAD: Install in the Premises or bring into the Building any fixtures, equipment, furniture, materials or other objects which will overload, damage of obstruct any utility lines or heating or air conditioning equipment or systems providing services to the Building or Premises. 3.02-6 FLOOR LOADING: Install in the Premises or bring into the Building any fixtures, equipment, furniture, materials or other objects which will overload the floors in the Premises or in any way affect the structural capacity or design of the Premises or the Building. Tenant shall bear the expense of any professional services required to determine the suitability of any specific item or installation. Tenant is expressly authorized to increase the structural capacity of the building floor loads as it deems necessary for its use. Such modifications shall be considered "alterations", and are subject to the conditions set forth in Section V Paragraph 5.04. 3.02-7 HAZARDOUS MATERIALS: Tenant shall not, without the prior written consent of Landlord, store, inventory or use materials, chemicals or compounds which have been determined by any Municipal, State, or Federal agency or regulation to be toxic or otherwise injurious to any person or persons who might be exposed to these materials as a result of their storage, inventory or use, Tenant agrees that they will bear the cost and comply with all prudent or regulatory requirements, obtain any required permits, pay any and all taxes or charges associated with the disposal of any toxic materials or waste, and bear the cost of any required modifications to the Premises, should Landlord elect at its sole discretion to allow such storage or use on or about the Premises. As a condition of consent, tenant shall at tenant's expense provide landlord with a phase 1 environmental audit reports, at intervals of twelve (12) months during the remaining term of this Lease or any extension thereof, from an independent firm, acceptable to Landlord, licensed or qualified to perform toxic or hazardous material investigations. The initial report is to be provided at time of initial request. All reports shall be at least a complete Phase 1 or higher as may be necessitated by the nature of the use or storage and shall include the completion of any recommended further investigation. If, within ten (10) days following notice by Landlord, Page: 5 of 16 Initials: TENANT LA LANDLORD FH --- --- Tenant fails or refuses to supply the required reports, Landlord may, at its option, cause all required reports to be prepared. Tenant shall promptly pay Landlord all costs incurred plus an administrative fee of twenty percent (20%) of such costs. 3.03 BUILDING REGULATIONS: Tenant shall obey all rules and regulations of the Building as imposed by Landlord and set forth in Exhibit C and incorporated as a part of this Lease. The rules and regulations are in addition to, and shall not be construed to modify or amend this Lease in any way. Landlord shall have the right to make changes or additions to such rules and regulations provided such changes or additions, except those affecting the safety and operation of the Building or Premises, do not unreasonably affect Tenant's use of the Premises. 3.04 QUIET ENJOYMENT: Landlord represents and covenants that it has the authority to enter into this Lease, and that Tenant, upon payment of the rentals and performance of the covenants and Tenant's part to be performed, shall and may peaceably and quietly occupy the Premises during the term of this Lease and any renewal or extension thereof. Landlord agrees to make reasonable efforts to protect Tenant from interference or disturbance by other tenants or third persons; however, Landlord shall not be liable for any such interference or disturbance, nor shall Tenant be released from any of the obligations of this lease because of such interference or disturbance. SECTION IV ASSIGNMENT: SUBLET: RECAPTURE OF PREMISES: MORTGAGE BY LANDLORD: SUBORDINATION: ATTORNMENT: ESTOPPEL CERTIFICATE: NOTICE TO MORTGAGE: SALE BY LANDLORD: 4.01 ASSIGNMENT: SUBLET: Tenant shall not assign this Lease or any part thereof or sublet all or any part of the Premises without prior written consent of Landlord, which shall not be unreasonably withheld. If Tenant desires to assign or sublet all or a portion of the Premises, Tenant shall first advise Landlord in writing of the name, proposed use of Premises and such financial information as Landlord may reasonably require applicable to the proposed assignee or subtenant. Tenant shall also accompany such request for consent with a copy of the proposed assignment or sublease and any other agreements to be entered into concurrently with such assignment or sublease. Tenant at Tenant's expense shall provide Landlord with an environmental audit report from an independent firm, acceptable to Landlord, licensed or qualified to perform toxic or hazardous material investigations. The presence of Toxic or Hazardous materials, with or without Landlord's consent, shall be cause to deny assignment or sublet. It shall not be unreasonable for Landlord to withhold consent if the reputation, financial responsibility or business of proposed assignee or subtenant is unacceptable to Landlord or if the intended use by the proposed assignee or subtenant is not comparable to the use of the Premises authorized Tenant by the provisions of this Lease or if the proposed assignee or subtenant is a present or former tenant of the Building. Any assignment or subletting consented to by Landlord shall be evidenced in writing in a form acceptable to Landlord. This Lease shall not be assignable by operation of law. Any transfer of this Lease by merger, consolidation, liquidation or change in ownership of or power to vote the majority of outstanding stock of Tenant or, if Tenant is a partnership, any withdrawal, replacement or substitution of any partner or partners, either general or limited, shall constitute an assignment, whether the result of a single or series of transactions. Any assignment or subletting shall not diminish the liability of the Tenant. Consent by Landlord shall not relieve the Tenant from obtaining written consent to any subsequent assignment or subletting. Tenant agrees to pay Landlord the sum of Five Hundred dollars ($500.00) to defray expenses associated with reviewing and processing of any application for assignment or subletting of the premises, whether or not such consent is ultimately granted. Further, Tenant agrees to pay any out-of-pocket costs incurred by Landlord in connection with such review and processing including, but not limited to, fees incurred for consulting with attorneys, accountants, or other professionals. Prior to delivery of the Premises to any Sub-Tenant or assignee, Tenant shall comply with those requirements contained in paragraph 9.01 hereof, with specific regard to the physical condition of the Premises. Such action does not relieve Tenant of those responsibilities, or any other responsibilities, at the subsequent termination of this Lease. 4.02 CORPORATE TRANSFER: If Tenant is a corporation, Tenant may, so long as the use of Premises as herein provided is not changed, assign or sublet all or a part of the Premises, to Tenant's parent corporation or a wholly-owned subsidiary of Tenant or tenant's parent without Landlord's prior approval, provided, however, that in such event, Tenant shall promptly notify Landlord in writing of such assignment or subletting. Such notification shall be in a form acceptable to Landlord, executed by Tenant and Tenant's assignee or subtenant and shall provide that Tenant and Tenant's assignee or subtenant are jointly and severally liable under this Lease. Such an assignment or sublet shall not effect or change the rental rate at the time of the action and no processing fee (Paragraph 4.01) shall be charged. 4.03 MARKET RENTAL RATE: Landlord and Tenant acknowledge that in the course of negotiating this lease they have discussed and negotiated Landlord's right to receive market rental rate even if this results in an increase in rent, at such time as Tenant either assigns or subleases the Premises. Accordingly, Landlord and Tenant agree that the rental rate charged here under shall be adjusted to market rental rate, given the terms and conditions of the Lease at the time of such assignment or sublease, including, but not limited to, remaining term, configuration of the premises, and existing use. Landlord and Tenant shall attempt to negotiate such market rent. In the event Landlord and Tenant are unable to agree, market rental shall be determined by appraisal. Landlord and Tenant shall attempt to select a single appraiser who shall determine market rent. In the event Landlord and Tenant are unable to agree upon a single appraiser, each party shall pick one appraiser and the two so chosen shall pick a third, who shall determine market rent for the proposed sublease or assignment. Landlord shall receive such market rental commencing on the effective date of such sublease or assignment. In no event, however, shall the rental to be paid to Landlord be less than the rent currently payable pursuant to the terms of the lease agreement absent the assignment or sublease. Tenant hereby agrees to bear the cost of any appraisal required in order to determine market rental pursuant to this paragraph. All other terms of this Lease including cost of living adjustments and Tenant paid expenses shall remain in full force and effect. ACKNOWLEDGMENT OF THE ABOVE NEGOTIATED AGREEMENT: TENANT LA LANDLORD FH -- -- 4.04 MORTGAGE BY LANDLORD: Landlord shall have the right to transfer, assign, mortgage or convey in whole or in part the Building, land upon which it is situated, and any and all of its rights under this Lease, and nothing herein shall be construed as a restriction upon Landlord's so doing. 4.05 SUBORDINATION: This Lease is and shall be subject and subordinate in all respects to any and all mortgages and deeds of trust now or hereafter placed on the Building or the land upon which it is situated, and to all renewals, modifications, consolidations, replacements and extensions thereof. Any mortgagee or beneficiary may elect to give the rights and interest of Tenant priority over the lien of its mortgage or deed of trust. In the event of such election and upon the mortgagee or beneficiary notifying Tenant of such election, the rights and interests of Tenant under this Lease shall be deemed superior to or have priority over the lien of said mortgage or deed of trust, whether this Lease is dated prior to or subsequent to the date of such mortgage or deed of trust. In such event, Tenant shall within ten (10) days after written demand, execute and deliver whatever instruments may be required by said mortgagee or beneficiary and if Tenant fails to do so, Tenant hereby irrevocably appoints Landlord an attorney-in-fact of Tenant, in Tenant's name to execute such instruments required by said mortgagee or beneficiary. 4.06 ATTORNMENT: Not withstanding any subordination of this Lease to mortgagees and Deeds of Trust as stated in 4.05 above, this Lease and Tenant's rights and obligations herein provided shall survive any foreclosures, institution offsets or other proceedings or any termination of Landlord's interest hereunder. Tenant shall promptly, upon request, execute appropriate Attornment Agreements, prospectively with any Lender, or upon any Termination of Landlord's interests. 4.07 ESTOPPEL CERTIFICATE: Tenant shall any time and from time to time upon not less than ten (10) days prior notice from Landlord or Landlord's mortgagee, execute, acknowledge and deliver a written statement certifying that this Lease is in full force and effect subject only to such modifications as may be set out; and, Tenant is in possession of the Premises and is paying rent as provided in his Lease; and, the date to which rent is paid in advance; and, there are not, to the signatory's knowledge any uncured defaults on the part of the Landlord, or specifying such defaults if any are claimed. Any such statement may be relied upon by any prospective transferee or encumbrancer of all or any portion of the Building or land upon which it is situated, or any assignee of any such persons. If Tenant fails to timely deliver such statement, Tenant shall be deemed to have acknowledged that this Lease is in full force and effect, without modification except as may be represented by Landlord and that there are no uncured defaults in Landlord's performance. 4.08 LIABILITY OF LANDLORD: SALE BY LANDLORD: The liability of Landlord under this Lease is limited to Landlord's interest in the Building and land upon which it is situated, and any judgment against Landlord will be enforceable solely against Landlord's interest in said Building and land. In the event Landlord transfers its interest in the Building, Landlord shall thereby be released from any further obligation here under, and Tenant agrees to look solely to the successor in interest of the Landlord for the Page: 6 of 16 Initials: TENANT LA LANDLORD FH --- --- performance of such obligations. Landlord shall transfer Tenant's security deposit, if any, to such assignee or transferee and Tenant shall look solely to such assignee or transferee for the return, if any, of all or any part of such deposit to which Tenant may be entitled. SECTION V MAINTENANCE AND REPAIRS: RIGHT OF ENTRY: ALTERATIONS: LIENS: SIGNS: 5.01 MAINTENANCE AND REPAIRS BY TENANT: By occupying the Premises, Tenant shall be deemed to accept the same and acknowledge that they comply fully with Landlord's covenants and obligations as provided in this Lease, subject to completion of any items which it is Landlord's responsibility to furnish and which have been listed by Landlord and Tenant upon inspection of the Premises. During the term of this Lease, Tenant shall maintain exterior walls and roof, the Premises, including all electrical, mechanical and plumbing in as good condition as when Tenant took possession, ordinary wear and tear and repairs which are specifically Landlord's responsibility as provided for in this Lease excepted, and shall repair all damage or injury to the Building or to fixtures, appurtenances and equipment of the Building caused by Tenant's installation or removal of its property or resulting from any acts or conduct of Tenant, its employees, contractors, agents, licensees or invitees. Ordinary wear and tear shall consist only of that wear and/or deterioration which is uniform throughout the Premises and which has not been caused directly by abuse, failure to maintain, alteration or the accumulation of soil, dirt or foreign substances. Abuse of walls, ceilings, floors or floor coverings as a result of concentrated traffic or abrasion shall not be considered ordinary wear and tear. Tenant shall be responsible for the effectiveness of periodic janitorial or maintenance services whether or not these services are supplied by Tenant or Landlord. Tenant's obligations to maintain the Premises in good condition and repair is part of the consideration for Landlord's leasing the Premises to Tenant. All maintenance and repairs made by Tenant shall be performed only by licensed contractors first approved in writing by Landlord. Tenant shall require its contractor to comply with Landlord's requirements regarding all work to be performed. 5.01-1 LANDLORD'S RIGHT TO MAINTAIN OR REPAIR: If, within ten (10) days following notice by Landlord, Tenant fails or refuses to do any maintenance or to repair or replace any damage to the Premises or Building caused by Tenant, its agents, employees or invitees. Landlord may, at its option, cause all required maintenance, repairs or replacements to be made. Tenant shall promptly pay Landlord all costs incurred plus an administrative fee of twenty percent (20%) of such costs. 5.02 LANDLORD'S RIGHT OF ENTRY: Landlord, its agents and employees, shall have the right to enter the Premises at any time to inspect the Premises upon reasonable notice and with an employee or agent of Tenant, to exhibit the Premises to prospective purchasers, lenders or tenants; to determine if Tenant is complying with all terms and provisions of this Lease; to supply any service to be provided by Landlord to Tenant as required in this Lease; to post notices of responsibility and to make repairs required of Landlord here under or repairs to any adjoining space or utility services or make repairs, alterations or improvements to any other portion of the Building, provided however that all such repairs, alterations and improvements shall be done promptly in a manner so as to minimize interference with Tenant's use of the Premises, it being understood however that Landlord shall not be required to have such work performed outside of normal business hours. Tenant hereby waives any claim for damages for any injury or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises or any other loss occasioned by such entry. Any entry to the Premises by Landlord, its agents or employees, shall not under reasonable circumstances be considered to be a forcible or unlawful entry of the Premises or an eviction, actual or constructive, of Tenant from the Premises or any portion thereof. 5.03 MAINTENANCE BY LANDLORD: Landlord shall be responsible for the repair of structural components of the building and foundation. ALL other repairs and maintenance shall be performed and paid for by Tenant. 5.04 ALTERATIONS BY TENANT: Tenant shall make no alterations, additions or improvements to the Premises without prior written consent of Landlord. Such consent shall not be unreasonably withheld in the case of alterations, improvements or additions to the interior of the Premises if such alterations, additions or improvements are normal for the permitted use of the Premises, do not adversely affect the utility of the Premises for future Tenants, do not alter the exterior of the Building and are not of a structural nature. Tenant shall conduct its work in such a manner as to maintain harmonious labor relations and shall not interfere with the operation of the Building or other tenants situated therein. Prior to commencing its work, Tenant shall submit to Landlord copies of all necessary permits. All alterations, additions or improvements, whether temporary or permanent, made in or upon the Premises, either by Landlord or Tenant, shall be Landlord's property and shall remain in the Premises upon expiration or termination of this lease without compensation to Tenant. If, however, Landlord shall, no later than thirty (30) days prior to expiration or termination of this Lease, request, in writing, Tenant shall immediately remove any and all alterations, additions and improvements made or installed by Tenant in the Premises and will repair any damage caused by such removal and Tenant failing to remove and repair as requested by Landlord, Landlord may effect such removal and repairs at Tenant's expense, including rent at the then current rate until the Premises have been restored and are available for occupancy. Landlord may require restoration of the Premises at the end of the Lease term or extensions thereof as a condition of consent. Landlord shall not be responsible for ADA compliance requirements at the premises, including the Building, parking lot, access or otherwise. Tenant shall have this responsibility. 5.05 ALTERATIONS BY LANDLORD: Landlord may make any repairs, alterations or improvements which Landlord deems necessary or advisable for the preservation or safety of the Building or the Premises. 5.06 LIENS: Except with respect to activities for which Landlord is responsible, Tenant shall pay as due all claims for work done on and for services rendered or material furnished to the Premises and shall keep the Premises, Building and land upon which the Building is located free from any liens. If Tenant fails to pay any such claims or to discharge any lien, Landlord may do so and Tenant shall pay Landlord the amount so expended upon demand. Such action by Landlord shall not constitute a waiver of any right or remedy which Landlord may have on account of Tenant's default. Tenant may withhold payment of any claim in connection with a good-faith dispute over the obligation to pay, so long as Landlord's property interests are not jeopardized. If a lien is filed as a result of non-payment, Tenant shall, within ten (10) days after knowledge of the filing, secure the discharge of the lien or deposit with Landlord cash or sufficient corporate surety bond or other security acceptable to Landlord in an amount sufficient to discharge the lien plus any costs, attorneys' fees, and other charges that could accrue as a result of a foreclosure or sale under the lien. 5.07 SIGNS: Tenant may erect or install any sign, lettering, placard, picture, name, notice or advertising media which are allowed by cognizant CC&R's codes or regulations on any part of the outside or inside of the Building or Premises without Landlord's prior consent. Tenant also agrees to maintain any signs installed by Tenant or at Tenant's direction or expense, in good condition and repair at all times, to remove such sign or media at the expiration or termination of this Lease and to repair all damage caused by such installation or removal. Landlord reserves the right to allocate special or Building identification signage to one or more major Tenants of the Building. SECTION VI INSURANCE: INDEMNITY: SUBROGATION: 6.01 INSURANCE BY LANDLORD: Landlord shall maintain insurance for those perils and in amounts which would be considered prudent for similar type income property situated in the general area of the Building or which is required by any mortgagee or creditor of Landlord. The named insured on all policies of insurance maintained by Landlord shall be the Landlord, and if required, any mortgagee or creditor of Landlord. Cost of insurance maintained by Landlord shall be paid by Tenant and Tenant shall reimburse Landlord within 10 days of invoice from Landlord. 6.02 INSURANCE BY TENANT: Tenant shall maintain at all times during the term of this Lease, at Tenant's expense: 6.02-1 LIABILITY AND PROPERTY DAMAGE: Comprehensive public liability and property damage insurance providing protection against all perils, including fire, extended coverage, vandalism, malicious mischief, break-in, sprinkler leakage, flood and overage water and special extended (all risk) coverage on an occurrence basis with respect to Tenant's business and occupancy of the Premises for any one occurrence or claim of not less than TWO MILLION dollars ($2,000,000.00) or such greater amount as Landlord may reasonably require in writing from time to time. Such insurance shall contain a provision including coverage for all liabilities assumed by Tenant under this Lease. Page: 7 of 16 Initials: TENANT LA LANDLORD FH --- --- 6.02-2 WORKMAN'S COMPENSATION: Workman's Compensation insurance for all Tenant's employees working in the Premises in an amount sufficient to comply with applicable laws or regulations. 6.02-3 BUSINESS INTERRUPTION INSURANCE: Tenant at its cost shall maintain business interruption insurance insuring that the minimum monthly rent will be paid to the Landlord for a period of one (1) year if the leased premises are destroyed or rendered inaccesable by a risk insured against by a policy of standard fire and extended coverage insurance, with vandalism and malicious mischief endorsements, or flood and overage waters insurance. 6.02-4 OTHER COVERAGE: Insurance against such other perils and in such amounts as Landlord may from time to time reasonably require in writing. Such request shall be made on the basis that the insurance coverage requested is customary at the time for prudent tenants. 6.02-5 POLICY FORM: All policies of insurance maintained by Tenant shall be in a form acceptable to Landlord; issued by an insurer acceptable to Landlord and licensed to do business in the state in which the Building is situated; if requested, name Landlord and any managing agent and other designee as additional insured; and require at least thirty (30) days written notice to Landlord of termination or material alteration and waive, to the extent available, any right of subrogation against Landlord. Tenant shall, upon the Commencement Date of this Lease and thereafter within thirty (30) days prior to the expiration of each such policy, promptly deliver to Landlord certified copies of such policies and evidence satisfactory to Landlord that all premiums have been paid and policies are in effect. Landlord and it's agents shall be named as additional insureds of Tenant's policy. 6.02-6 FAILURE TO MAINTAIN: If Tenant fails to secure or maintain any insurance coverage required by Landlord or should insurance secured not be approved by Landlord and such failure or approval not be corrected within twenty-four (24) hours after written notice from Landlord, Landlord may, in Landlord's sole discretion, purchase such insurance coverage required at Tenant's expense. Tenant shall reimburse Landlord on demand for any moneys expended, including reasonable administrative and out of pocket expense. 6.03 INDEMNITY: Tenant shall indemnify and hold harmless Landlord from all loss, claim, demand, damage, liability or expense, including attorneys' fees, for any injury or damage occasioned by use of the Premises, the failure or interruption of any utility service, flooding, discharge of sprinklers, heating and air conditioning equipment, fire, tornado, windstorm, hail, water, snow, frost, excessive heat or cold, falling plaster, broken glass, sewage, gas, odors, noise, or the bursting or leakage of pipes or plumbing fixtures upon or in the Building or adjacent premises, including consequential damages specifically including business interruption and loss of profits caused by anything other than the misconduct or failure to perform lease obligations, by Landlord or Landlord's agents. Tenant waives and releases all claims against Landlord, its employees or agents for any injury or damage, either proximate or remote, caused by any repairs, alterations, defects or injuries, in or to the Building or the Premises, whether by reason of negligence or default of Landlord, its agents or employees or by visitors, patrons, licensees or tenants of the Building or Premises and any and all claims for injury or death to persons or injury or loss to property occasioned by any act, omission or negligence of Tenant, its agents, employees or invitees, or occasioned from want of repair of Premises or furniture, fixtures or equipment located therein, occurring in any way upon the Premises or the Building. All property in the Building or Premises belonging to Tenant, its agents, employees or invitees shall be there at the risk of Tenant. Tenant agrees to indemnify Landlord against claims for damage to, theft, misappropriation or loss of said property. 6.04 WAIVER OF SUBROGATION: Regardless of fault or negligence, Landlord and Tenant hereby waive any claim arising in favor of one against the other, or anyone claiming through either, by way of subrogation or otherwise, for any loss of or damage to any property of either which loss or damage is recovered under said policies. Said waiver shall be in addition to any other waiver or release contained in this Lease with regard to loss or damage to property of either. Landlord and Tenant shall request its insurers to consent to such waiver and agree to waive all rights or subrogation against the other party. In the event that any policy of insurance is in place relative to this lease which would be voided by virtue of this paragraph, then in that event this paragraph shall have no force or effect with respect to such policy. SECTION VII DAMAGE AND DESTRUCTION: 7.01 DAMAGE REPAIR: In the event the Building or the Premises shall be destroyed or rendered untenantable, either in whole or in major part, by fire or other casualty, Landlord may, at its option, restore the Building or Premises to as near their previous condition as is reasonably possible, and in the meantime, unless the damage was caused by acts, omissions or negligence of Tenant, its agents, employees, contractors or invitees, the rent shall be abated in the same proportion as the untenantable portion of the Premises bears to the whole thereof; but unless Landlord, within sixty (60) days after the happening of any such casualty, shall notify Tenant of its election to restore, this Lease shall not continue and Landlord shall not commence the necessary restoration. Such restoration by Landlord shall not include replacement of furniture, equipment or other items that are not part of the Building or any improvements to the Premises in excess of those in place as of the commencement date of this Lease. Tenant agrees to pay Landlord the amount of any deductible relating to insurance coverage within ten (10) days of such casualty. Restoration of the Premises required beyond Landlord's obligation shall be performed by Tenant at no cost to Landlord. If Landlord shall elect to notify Tenant that Landlord shall not restore, this Lease shall terminate as of the date of the occurrence and Tenant shall promptly vacate the Premises. Upon vacating, any prepaid rent from date of vacating shall be refunded to Tenant. 7.02 DAMAGE CAUSED BY VANDALISM OR BREAK-IN: In the event of damage to the Premises resulting from vandalism, malicious mischief, break-in or causes outside the control of Tenant, then Tenant shall be responsible for such repairs utilizing insurance proceeds as described herein or at Tenant's own expense. Tenant shall be responsible for repairs to the extent of any deductible. In the event of damage to the building apart from the Premises resulting from vandalism, malicious mischief, break-in or causes outside the control of Tenant, the Landlord shall repair such damages which shall constitute additional operating costs within the meaning of Section II paragraph 2.06 of this agreement. Damage to doors permitting access to the Premises or windows of the Premises caused by vandalism, malicious mischief or break-in shall be repaired by Landlord at Tenant's expense. 7.03 DAMAGE CAUSED BY TENANT: In the event of damage to the Premises or the Building by fire or other causes resulting from fault or negligence of Tenant, its agents, employees, contractors or invitees, such damage shall be promptly reported to Landlord and shall be repaired at the expense of Tenant under direction and supervision of Landlord. There shall be no abatement of rent during the period of repair. 7.04 DELAY BEYOND LANDLORD'S CONTROL: No penalty shall accrue to Landlord for delay in commencing or completing repairs caused by adjustment of insurance claims, governmental requirements or any cause beyond Landlord's reasonable control. 7.05 BUSINESS INTERRUPTION: No damages, compensation or claim shall be payable by Landlord for inconvenience, loss of business or annoyance arising from any repair or restoration of any portion of the Premises or of the Building. Landlord shall use its best efforts to effect such repairs promptly and in such manner as not unreasonably to interfere with Tenant's occupancy. 7.06 TENANT IMPROVEMENTS: Landlord will not carry insurance of any kind on any improvements, additions or alterations made and paid for by Tenant or Tenant's furniture or furnishings or on any fixtures, equipment, improvements or appurtenances of Tenant under this Lease and Landlord (except as provided by law by reason of its negligence) shall not be obligated to repair any damage thereto or replace the same. Landlord shall, if electing to repair, make repairs or restoration only of those portions of the Premises which were originally provided at Landlord's expense, and the repair and restoration of items not provided at Landlord's expense shall be the obligation of Tenant. 7.07 DESTRUCTION DURING LAST YEAR OF TERM: In case the Building shall be substantially destroyed by fire or other causes at any time during the last year of the term of this Lease, either Landlord or Tenant may terminate this Lease upon written notice to the other party hereto given within ten (10) days of the date of such destruction. Page: 8 of 16 Initials: TENANT LA LANDLORD FH --- --- 7.08 MUTUAL RELEASE: Upon any termination of this Lease as a result of damage or destruction of the Building or Premises as provided herein, the parties shall be released thereby without further obligation to the other from the date possession of the Premises is surrendered to Landlord except for rent and any other moneys or obligations which have accrued and are then unpaid or unfulfilled. 7.09 UNINSURED CASUALTY: In the event the Premises shall be damaged to any extent by any casualty, act or occurrence not covered by Landlord's insurance, Landlord may repair the damage, in which event this Lease shall continue, or, at Landlord's sole option, Landlord may elect not to repair the damage and to terminate this Lease in which event Landlord shall upon electing to terminate, notify Tenant in writing within sixty (60) days following the date such damage occurred, of Landlord's election to terminate 7.10 WAIVER OF STATUTORY RIGHTS: Tenant waives any statutory rights of termination that may arise by reason of any partial or total destruction of Premises repaired by Landlord as provided in this Lease. 7.11 REQUIREMENTS OF MORTGAGEE: Provided that the insurance proceeds recovered from any casualty to the building are sufficient to permit rebuilding, such proceeds shall be applied to that purpose. If reconstruction is feasible, but the proceeds are insufficient to complete reconstruction, the Landlord shall nevertheless reconstruct provided that Tenant funds the difference between the insurance proceeds and the cost to reconstruct. In the event that such proceeds are insufficient for such purpose and any beneficiary, creditor or mortgagee under a deed of trust, security agreement or mortgage should require that the insurance proceeds payable upon damage to or destruction of the Building or Premises by fire or other casualty be used to retire or apply on the debt secured by such deed of trust, security agreement or mortgage, or in the event any lessor under any underlying ground lease should require that such proceeds be paid to such lessor, Landlord shall, in such event, have no obligation to repair or rebuild such damage and at Landlord's election, this Lease shall terminate upon Landlord's furnishing Tenant written notice of Landlord's election to terminate. SECTION VIII CONDEMNATION: 8.01 CONDEMNATION; AWARD; TERMINATION: If the Building or Premises shall be taken or condemned for any public purpose, or for any reason whatsoever, to such an extent as to render either or both untenantable, either Landlord or Tenant shall have the option to terminate this Lease effective as of the date of taking or condemnation. If the taking or condemnation does not render the Building and the Premises untenantable, this Lease shall continue in effect and Landlord shall promptly restore the portion not taken to the extent possible to the condition existing prior to the taking. In such event, however, Landlord shall not be required to expend an amount in excess of the proceeds received by Landlord from the condemning authority. If, as a result of such restoration, the area of the Premises is reduced, the rental shall be reduced proportionately. All proceeds from any taking or condemnation shall be paid to Landlord. In the event the Premises are taken in Eminent Domain by a public agency, the parties shall share in the award as their interests may be determined by the court in accordance with California law. A voluntary sale or conveyance in lieu of but under the threat of condemnation shall be considered a taking or condemnation for public purpose. 8.02 CONDEMNATION FOR A LIMITED PERIOD: If all or any portion of the Premises shall be taken for a limited period, this Lease shall not terminate, there shall be no abatement of rent or additional rent payable here under and Tenant shall be entitled to receive the entire award (whether paid as damages, rent or otherwise) unless the period of occupancy by the condemning body extends beyond the expiration of this Lease. In such event Landlord shall be entitled to such part of the award as shall be properly allocable to the cost of restoration of the Premises to the condition in which they were prior to the taking, and the balance of such award shall be apportioned between Landlord and Tenant as of the date of such expiration. If the termination of such occupancy by the condemning body is prior to the expiration of this Lease, Tenant shall, after application for and diligent pursuit of an award for the purpose of restoring the Premises, to the extent such award has been made, restore the Premises to the condition in which they were prior to the taking. SECTION IX SURRENDER OF PREMISES: 9.01 SURRENDER AT TERMINATION: At the expiration or termination of this Lease, Tenant shall peaceably vacate and deliver the Premises and all alterations and additions thereto in good order, repair and condition, ordinary wear and tear as defined in paragraph 5.01 herein excepted, restoring the Premises wherever necessary and leaving them clean and neat. Tenant shall remove all personal property prior to the expiration of this Lease, including any signs, notices and displays placed by Tenant, and Tenant shall perform any necessary restoration of the Premises occasioned by such removal. Tenant shall also remove those improvements, alterations and additions made by Tenant or by Landlord on behalf of Tenant which Landlord required Tenant to remove when Landlord provided Tenant with its consent to the installation of such improvements, alterations and additions, unless Landlord, prior to the expiration or termination of this Lease, elects in writing not to require such removal. Tenant shall repair any damage caused by such removal and shall restore the Premises and leave them clean. If Tenant is not required by Landlord to remove such improvements, alterations or additions to the Premises upon the expiration or termination of this Lease, such improvements, alterations and additions to the Premises, as well as any of Tenant's personal property left on the Premises by Tenant shall become the property of Landlord and shall remain and be surrendered with the premises. Tenant waives all claims against Landlord for any damage to Tenant resulting from Landlord's retention or disposition of any such improvements, alterations, additions or Tenant's personal property. Tenant shall be liable to Landlord for Landlord's costs for storing, removing and disposing of any improvements, alterations, additions or Tenant's personal property, together with the then current rental value of the premises during the time required to perform any such clean up or restoration. 9.02 ENVIRONMENTAL AUDIT AT TERMINATION: At the expiration or termination of this Lease, Tenant shall provide Landlord an environmental audit, survey or investigation to determine the presence or residue of toxic or hazardous materials, if Tenant at any time during the term of this Lease has, with or without Landlord's consent, inventoried, stored or used toxic or hazardous materials on or about the Premises. This includes the legal or illegal use of these materials by Tenant or any of its employees, agents or invitees. This report shall be at least a complete Phase 1 or higher as may be necessitated by the nature of the prior use or storage and shall include the completion of any recommended further investigation. The cost of this report or any clean-up or restoration as might be recommended or required by such investigation or governmental agency shall be borne solely by Tenant. These costs are to include all costs related to the removal of any material or waste and the restoration of any parts of the Premises required by compliance with any clean-up or removal recommended or required, including all taxes or licenses, and any legal or professional expenses which may be necessary to insure completion and compliance. Should clean-up or restoration commence or continue beyond the term of this Lease, such a period shall be considered a holding over without Landlord's consent and rent shall continue to be due and payable in accordance with Section 12, Paragraph 12.02 of this Lease. If, within ten (10) days following notice by Landlord, Tenant fails or refuses to supply the required reports, Landlord may, at its option, cause all required reports to be prepared. Tenant shall promptly pay Landlord all costs incurred plus an administrative fee of twenty percent (20%) of such costs. 9.03 SURVIVAL OF TENANT'S OBLIGATION: Tenant's obligation to observe or perform the provisions of this Section shall survive the expiration or other termination of this Lease. SECTION X ARBITRATION: 10.01 APPOINTMENT OF ARBITRATORS: If any dispute arises under this Lease as to a matter which this Lease provides should be arbitrated, or as to any other question involving apportionment, valuation or rental, either party may request arbitration and appoint as arbitrator one attorney or property manager or real estate appraiser, whichever is most appropriate, having experience with respect to the matter in dispute. The other party shall select an arbitrator with qualifications similar to those of the first selected, and the two arbitrators shall within thirty (30) days select a third with similar qualifications. If the selection of the second or third arbitrator is not made within thirty (30) days after selection of the prior arbitrator then either party may apply to the presiding judge of the Superior Court of California to select the required arbitrator. If agreed to by both Landlord and Tenant, in writing, a single arbitrator may act in lieu of the three arbitrator panel described above. 10.02 SUBMISSION: At any time within ten (10) days after appointment of the third arbitrator, either party may submit the dispute for settlement by the arbitrators. Page: 9 of 16 Initials: TENANT LA LANDLORD FH --- --- 10.03 INVESTIGATION: DISCOVERY: HEARING: DECISION: The arbitrators to whom a dispute is submitted shall conduct such investigations and hearings as shall be reasonably necessary, and the written decision of the majority shall be submitted to both parties within thirty (30) days after the referral unless the arbitrators determine that further time is reasonably required to make a proper investigation of the relevant facts. In addition to the powers conferred by law or this agreement, a majority of the arbitrators shall have the power to compel oral or documentary evidence from either party or any other person or firm at the request of either party for discovery purposes. The arbitration shall take place in San Diego, California. 10.04 EFFECT OF ARBITRATORS' DECISION: The parties shall be bound by the decision of a majority of the arbitrators, including any decision as to whether or not the question was subject to arbitration. 10.05 COSTS: Each party shall pay the fees and expenses of the one of the two original arbitrators appointed by such party, or in whose stead as above provided, such arbitrator was appointed, and the fees and expenses of the third arbitrator, if any, shall be borne equally by both parties. SECTION XI DEFAULT: EVENTS: REMEDIES: 11.01 EVENTS OF DEFAULT: The occurrence of any one of the following events shall constitute a default of this Lease by Tenant: 11.01-1 FAILURE TO PAY RENT: Failure of Tenant to make any payment of rent or other required payment, when due. 11.01-2 FAILURE TO TAKE POSSESSION: Failure by Tenant to take possession of the Premises within ten (10) days following commencement of this Lease. 11.01-3 ABANDONMENT: Vacating or abandonment of all or a substantial portion of the Premises. 11.01-4 FAILURE TO COMPLY WITH LEASE PROVISIONS: Failure of Tenant to comply with any provision of this Lease, other than payment of rent, and such failure shall continue for thirty (30) days after mailing of written notice by Landlord to Tenant specifying the nature of non-compliance by Tenant with reasonable particularity provided, however, that if the nature of Tenant's default is such that more than thirty (30) days are reasonably required for its cure, Tenant shall not be in default if Tenant immediately commences or has commenced such cure and thereafter diligently proceeds to cure such default within ten (10) days. 11.01-5 CREDITORS ASSIGNMENT: The making of an assignment or general arrangement for the benefit of creditors by Tenant or any guarantor of Tenant's obligations under the Lease. 11.01-6 BANKRUPTCY: The filing by Tenant or any guarantor of Tenant's obligations under this Lease of a petition under any section or chapter of the present Federal Bankruptcy Act (or foreign equivalent) or amendment thereto or under any similar law or statute of the United States (or foreign country) or any state (or province) thereof, or the failure of the dismissal, within thirty (30) days after the filing of an involuntary petition of bankruptcy or insolvency against Tenant or guarantor of Tenant's obligations. 11.01-7 RECEIVERSHIP: The appointment of a receiver or trustee for all or substantially all the assets of Tenant or any guarantor of Tenant's obligations under this Lease and such receivership shall not have been terminated or stayed within the time permitted by law. 11.01-8 SEIZURE OF TENANTS ASSETS: The attachment, execution or other judicial seizure of substantially all of Tenant's assets located in the Premises or of Tenant's interest in this Lease where such seizure is not discharged within thirty (30) days. 11.02 REMEDIES IN EVENT OF DEFAULT: Upon the occurrence of any event of default, Landlord shall have the option to do any one or more of the following without any notice or demand: 11.02-1 TERMINATION OF LEASE: Terminate this Lease, in which event Tenant shall immediately surrender the Premises to Landlord. If Tenant shall fail to do so, Landlord may without notice and prejudice to any other remedy available, enter and take possession of the Premises and remove Tenant or anyone occupying the Premises and its effects without being liable to prosecution or any claim for damages. Tenant agrees to indemnify Landlord for all loss and damage suffered by Landlord because of such termination whether through inability to re-let the Premises or otherwise, including any loss of rent for the remainder of the term of this Lease. If Landlord elects to terminate this Lease, Tenant's liability to Landlord for damages shall survive such termination. 11.02-2 ACCELERATION OF RENT: Declare the entire amount of all rent past due as well as which would have become due and payable during the remainder of the term of this Lease to be due and payable immediately, in which event Tenant agrees to pay the same to Landlord immediately. Such payment shall constitute payment of past due rent and payment in advance of the rent stipulated for the remainder of the lease term. Acceptance by Landlord of the payment of such rent shall not constitute a waiver of any then existing default occurring thereafter. Landlord shall specifically be entitled to recover those damages provided for in California Civil Code 1951.2 including but not limited to the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the tenant proves could have reasonably avoided. 11.02-3 RE-LETTING OF PREMISES: Enter upon and take possession of the Premises as agent of Tenant without terminating this Lease and without being liable to prosecution or any claim for damages. Landlord may re-let the Premises and in that connection may make any suitable alterations or refurbish the Premises, or both, or change the character or use of the Premises, but Landlord shall not be required to re-let for any use or purpose other than that specified in this Lease or which Landlord may reasonably consider injurious to the Premises, or to any tenant which Landlord may consider objectionable. Landlord may re-let all or any portion of the Premises, alone or in conjunction with other portions of the Building, for a term longer or shorter than the term of this Lease, at a rental rate greater or less than the then current rental rate provided in this Lease, and upon such other terms (including the granting of concessions) as Landlord solely determines to be acceptable. If Landlord elects to reenter and re-let all or any portion of the Premises, Landlord shall be entitled to recover, as damages, immediately, without waiting until the due date of any future rent, or until the date fixed for expiration of this Lease, the total of all rent owing and unpaid as of the date of the default; the costs of reentry and re-letting include without limitation the cost of any clean-up, refurbishing, removal of Tenant's property and fixtures; and other expense occasioned by Tenant's failure to quit the Premises and to leave them in the required condition; any remodeling costs; attorneys' fees; court costs; brokers' commissions; advertising costs and the difference between the rent and all of Tenant's other obligations under this Lease and the actual rent received by Landlord from the Premises for the period commencing with the date of the default and continuing through the date designated as the expiration date of this Lease. No such reentry or taking possession of the Premises shall be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention be given to Tenant. Landlord, however, shall have no duty to re-let the Premises and Landlord's failure to do so shall not release Tenant's liability for rent or damages. If Landlord elects to enter and re-let the Premises the Landlord may at any time thereafter elect to terminate this Lease for Tenant's default. If Landlord takes possession of the Premises, Landlord shall have the right to rent any other available space in the Building before re-letting or attempting to re-let the Premises. 11.02-4 LANDLORD'S RIGHT TO PERFORM: Landlord may do whatever Tenant is obligated to do by the provisions of this Lease and may enter the Premises without being liable to prosecution or claim for damages in order to accomplish this purpose. Tenant agrees to reimburse Landlord immediately upon demand for any expenses which Landlord may incur in complying with the terms of this Lease on behalf of Tenant. Tenant agrees that Landlord shall not be liable for any damages to Tenant from such action, whether caused by negligence of Landlord or otherwise. Page: 10 of 16 Initials: TENANT LA LANDLORD FH --- --- 11.02-5 RIGHT TO SUE MORE THAN ONCE: Landlord may sue periodically to recover damages during the period corresponding to the remainder of the term of this Lease, and no action for damages shall bar a later action for damages subsequently accruing. 11.02-6 REMEDIES CUMULATIVE: The remedies as set forth and available to Landlord because of the default of Tenant, shall be in addition to and shall not exclude any other remedy available to Landlord under this Lease or applicable law. 11.03 WAIVER OF REDEMPTION RIGHTS: Tenant, for itself, and on behalf of any and all persons claiming through or under it, including creditors of all kinds, does hereby waive and surrender all right and privilege which they or any of them might have under or by reason of any present or future law, to redeem the Premises or to have a continuance of this Lease for its remaining term after having been dispossessed or ejected from the Premises by process of law or under the terms of this Lease or after the termination of this Lease as herein provided. 11.04 LIMITATION OF LANDLORD'S LIABILITY: Each of the following covenants and agreements shall be applicable to any covenant or agreement either expressly contained in this Lease or imposed by statute or at common law. 11.04-1 LANDLORD DEFAULT: If Landlord is in default of this Lease, and as a consequence, Tenant recovers a money judgment against Landlord, the judgment shall be satisfied only out of the proceeds of sale received on execution of the judgment and levy against the right, title, and interest of Landlord in the premises which the leased premises are a part, and out of rent or other income from such real property receivable by Landlord or out of the consideration received by Landlord from the sale or other disposition of all or any part of Landlord's right title, and interest in the premises of which the leased premises are a part. 11.04-2 PERSONAL LIABILITY: Landlord shall not be personally liable for any deficiency and it Landlord or its successor is a partnership it shall not be personally liable and no partner of Landlord shall be sued or named as a party in any suit or action or service of process be made against any partner of the partnership. No partner of Landlord shall be required to answer or otherwise plead to any service of process and no judgment will be taken or writ of execution levied against any partner of Landlord. SECTION XII GENERAL PROVISIONS: 12.01 WAIVER: No provision of this Lease shall be deemed to have been waived by Landlord unless such waiver is in writing signed by Landlord. Landlord's waiver of a breach of any term or condition of this Lease shall not prevent a subsequent act, which would have originally constituted a breach, from having the effect of any original breach. Landlord's receipt of rent with knowledge of a breach by Tenant of any term or condition of this Lease shall not prevent a subsequent act, which would have originally constituted a breach, from having the effect of any original breach. Landlord's receipt of rent with knowledge of a breach by Tenant of any term or condition of this Lease shall not be deemed a waiver of such breach. Landlord's failure to enforce against Tenant or any other tenant of the Building any of the rules or regulations made by Landlord shall not be deemed a waiver of such rules or regulations. No act or thing done by Landlord, its agents or employees during this lease term shall be deemed an acceptance of a surrender of the Premises and no agreement to accept a surrender of the Premises shall be valid unless in writing signed by Landlord. The delivery of keys to any of Landlord's agents or employees shall not operate as a termination of this Lease or a surrender of the Premises. No payment by Tenant, or receipt by Landlord, of a lesser amount than the rent due shall be deemed to be other than on account of the earliest stipulated rent, nor shall any endorsement or statement on any check or any letter accompanying a payment as rent be deemed an accord and satisfaction and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such rent or pursue any other remedy available to Landlord. 12.02 HOLDING OVER: If Tenant shall, with the written consent of Landlord, continue to occupy all or any portion of the Premises following the expiration or sooner termination of this Lease, such occupancy shall be deemed a month-to-month tenancy which may be terminated by either Landlord or Tenant in accordance with then applicable law. During such tenancy, Tenant agrees to pay Landlord monthly the then building scheduled rental rate or the rental due for the month preceding the expiration or termination, whichever amount is greater and Tenant further agrees to be bound by all other applicable terms and provisions of this Lease. Consent shall be at Landlord's sole discretion. If Landlord shall not give written consent to continue occupancy of the Premises by Tenant, Tenant shall, until possession of the Premises has been surrendered to Landlord, pay to Landlord monthly rent equal to two (2) times the then building scheduled rental rate for the Premises. For any period of holding over the applicable monthly rate shall be due for each month of occupancy, or part thereof, without proration. 12.03 REMOVAL OF PROPERTY: Upon termination or sooner termination of this Lease, all of Tenant's trade fixtures, personal property and improvements remaining in the Premises or the Building shall be deemed conclusively to have been abandoned by Tenant and may be appropriated, sold, destroyed or otherwise disposed of by Landlord without notice or obligation to compensate Tenant or to account therefor, and Tenant shall pay to Landlord on written demand all costs incurred by Landlord in connection therewith. 12.04 NOTICES: All notices under this Lease shall be in writing and delivered in person or sent by prepaid registered or certified mail to Landlord at the same place to which rent payments are made, and to the Tenant at the Premises, or such addresses as hereafter may be designated by either party in writing. Notices mailed shall be deemed given on the date of mailing. 12.05 CONSENT NOT UNREASONABLY WITHHELD: Unless otherwise specifically provided, whenever consent or approval of Landlord or Tenant is required under the terms of this Lease, such consent or approval shall not be unreasonably withheld or delayed. Tenant's sole remedy if Landlord unreasonably withholds or delays consent or approval shall be an action for specific performance and Landlord shall not be liable for damages. If either party withholds any consent or approval, such party shall on written request deliver to the other party a written statement giving the reasons therefor. 12.06 ATTORNEYS' FEES: If Tenant or Landlord shall bring any action for any relief against the other, declaratory or otherwise, arising out of this Lease, including any suit by Landlord for the recovery of rent or possession of the Premises, the losing party shall pay the successful party a reasonable sum for attorneys' fees and costs which shall be deemed to have accrued on the commencement of such action and shall be paid whether or not such action is prosecuted to judgment. Such attorneys' fees and costs shall be payable with respect to any suit, action at law or arbitration, whether binding, non-binding, judicially directed, or conducted pursuant to stipulation of the parties. 12.07 TIME OF THE ESSENCE: In all instances where Tenant is required by the terms and provisions of this Lease to pay any sum or to do any act at a particular indicated time or within an indicated period, it is understood and agreed that time is of the essence. 12.08 WAIVER OF JURY TRIAL: In event suit or action is commenced by either Landlord or Tenant against the other in connection with any controversy arising out of this Lease, Landlord and Tenant each hereby waive their right to a jury trial. 12-09 DESIGNATED PARTIES: Landlord may act in any matter provided for herein by its property manager or any other person who shall from time to time be designated by Landlord by notice to Tenant. Tenant may designate in writing a person to act on its behalf in any matter provided for herein and may, by written notice, change such designation. In the absence of such designation, the person or persons executing this Lease for Tenant shall be deemed to be authorized to act on behalf of Tenant in any matter provided for herein. 12.10 SUCCESSORS: All covenants, agreements, terms and conditions contained in this Lease shall apply to and be binding upon Landlord and Tenant and their respective heirs, executors, administrators, successors and assignees. Page: 11 of 16 Initials: TENANT LA LANDLORD FH --- --- 12.11 JOINT AND SEVERAL LIABILITY: If there is more than one Tenant, the obligations here under imposed upon Tenant shall be joint and several. 12.12 MERGER: The voluntary or other surrender of this Lease by Tenant or the cancellation of this Lease by mutual agreement of Landlord and Tenant shall not work a merger, and shall at Landlord's option terminate all or any subleases or sub-tenancies. Landlord's option shall be exercised by notice to Tenant and all known tenants under any sublease or sub-tenancies. 12.13 RELATIONSHIP OF PARTIES: Nothing contained in this Lease shall create any relationship between the Landlord and Tenant other than that of Landlord and Tenant, and it is acknowledged and agreed that Landlord does not in any way or for any purpose become a partner of Tenant in the conduct of Tenant's business, or a joint venture or a member of a joint or common enterprise with Tenant. 12.14 ENTIRE AGREEMENT: CAPTIONS: Tenant acknowledges and agrees that it has not relied upon any statement, representation, agreement or warranty except such as may be expressly set forth in this Lease and it is agreed by Landlord and Tenant that no amendment or modification of this Lease shall be valid or binding unless in writing executed by Landlord and Tenant. No provision of this Lease shall be altered, waived, amended or extended except in writing executed by Landlord and Tenant. The paragraph headings contained in this Lease are for convenience only and shall in no way enlarge or limit the scope or meaning of the provisions of this Lease. 12.15 SEVERABILITY: If any clause or provision of this Lease is held to be illegal, invalid or unenforceable under present or future law effective during the term of this Lease, the remainder of this Lease shall not be affected thereby. In lieu of such clause or provision held to be illegal, invalid or unenforceable there shall be added, as a part of this Lease, a clause or provision as similar in terms as possible which shall be legal, valid and enforceable. 12.16 GENDER: Words of any gender used in this Lease shall be held and construed to include any other gender, and words in the singular number shall be held to include the plural, unless the context otherwise requires. 12.17 BROKERAGE COMMISSIONS: Landlord has engaged the services of IPC Commercial Real Estate. Tenant has retained Capital Growth Properties as its broker. Landlord's sole obligation with respect to brokerage commissions shall be as is set forth in Landlord's agreement with IPC Commercial Real Estate. Any commissions payable to Capital Growth Properties shall be paid either by IPC Commercial Real Estate pursuant to agreement with Capital Growth Properties, or by Tenant. 12.18 CORPORATE OR PARTNERSHIP AUTHORITY: If Tenant is a corporation, Tenant shall, upon request from Landlord, furnish Landlord with a certified copy of resolutions of the board of directors of Tenant authorizing this Lease and granting the person or persons who executed this Lease the authority to execute it. If Tenant is a general or limited partnership and less than all the general partners of Tenant have executed this Lease, Tenant shall, upon request of Landlord, furnish Landlord with an agreement executed by all partners authorizing this Lease and granting the person or persons who executed this Lease the authority to execute it. 12.19 GOVERNING LAW: This Lease shall be governed by, construed and enforced in accordance with the laws of the State of California USA. 12.20 FORCE MAJEURE: Landlord shall not be required to perform any term, condition or covenant in this Lease so long as such performance is delayed or prevented by acts of God, strikes, lockouts, material or labor restrictions by any governmental authority, civil riot, floods, and any other cause not reasonably within the control of Landlord and which by the exercise of due diligence Landlord is unable, wholly or in part, to prevent or overcome. 12.21 RECORDATION: Tenant shall not record this Lease without the prior written consent of Landlord. Either party shall, upon request of the other party, execute and acknowledge a "short form" memorandum of this Lease for recording purposes, the cost of preparation and recording the memorandum to be borne by the party requesting execution of the memorandum. IN WITNESS WHEREOF, the Landlord and Tenant have executed this Lease. Landlord: /s/ F.E. Hollow Tenant: /s/ Linda Ahlswede-Cox ------------------- ------------------------ F.E. Hollow - President Linda Ahlswede-Cox - Senior Vice President BALBOA DEVELOPMENT CORP - SCRIPPS BANK GENERAL PARTNER BALBOA INVESTORS 1 LTD Date: 9/23/99 Date: 9/23/99 --------------------- --------------------- Page: 12 of 16 Initials: TENANT LA LANDLORD FH --- --- EX-10.16 4 EXHIBIT 10.16 SCRIPPS BANK AMENDED AND RESTATED LONG-TERM INCENTIVE COMPENSATION PLAN FOR PRESIDENT & CHIEF EXECUTIVE OFFICER BACKGROUND Ronald J. Carlson currently has the following compensation arrangement with Scripps Bank: A. Based on his 11/97 employment agreement, as amended and restated as of March __, 2000, Ronald J. Carlson currently has: - An annual base salary of $230,000 and is eligible to receive annual salary increases. - Receives both the standard employee benefit package (E.G., 401(k), ESOP, health benefits) and additional executive perquisites (E.G., car allowance). B. Has an amended and restated supplemental retirement plan which will provide to him a $50,000 annuity (paid monthly) commencing upon his planned retirement on October 1, 2002. C. Has an additional $25,000 amended and restated supplemental retirement agreement with spousal survivor benefit. D. Has an amended and restated unfunded deferred compensation agreement that provides him an annual $20,000 benefit which can be adjusted from time to time. This arrangement was approved August 1992. E. Is eligible for the annual Stakeholders Bonus. In 1998, he received $22,304. F. Has received additional discretionary awards, the last one in the amount of $9,000 for fiscal year 1998. G. Receives periodic grants of stock options. OBJECTIVES A. Scripps Bank desires to amend and restate the long-term compensation plan for Ronald J. Carlson dated as of October 20, 1999 as set forth in this Amended and Restated Long Term Compensation Plan (the "Amended Plan"). The Amended Plan is intended to focus his attention on achieving the strategic plan that the Bank developed and approved this year. B. The Amended Plan is independent of any other pay or incentives currently available to Ronald J. Carlson. C. The Amended Plan should be a performance based plan whereby Ronald J. Carlson's performance at the expected date of his retirement (October 2002), can be measured on both a quantitative and qualitative basis by the Board of Directors. D. Ronald J. Carlson would not be eligible for any award under the Amended Plan unless he achieves minimum targets as set forth herein. E. The earliest Ronald J. Carlson can receive any awards under the Amended Plan would be upon his retirement from the Bank. F. The Amended Plan should have a deferral provision, so that Ronald J. Carlson could elect either a lump sum payment of any earned awards or stretch out the receipt of such payment over a number of years. AMENDED PLAN DESIGN A. ELIGIBILITY: This Amended Plan is solely designed for Mr. Ronald J. Carlson in his capacity as President and Chief Executive Officer of Scripps Bank. Ronald J. Carlson will be eligible for the incentive compensation awards detailed in this Amended Plan as long as: 1. Ronald J. Carlson is employed as the President and Chief Executive Officer of Scripps Bank through October 1, 2002 and meets all conditions stated in his Amended Employment Agreement. 2. Ronald J. Carlson achieves the minimum performance requirements as described in this Amended Plan. 3. Ronald J. Carlson has made all elections as required under this Amended Plan. B. AMENDED PLAN PERIOD: This Amended Plan is effective with the approval of the Scripps Bank Board of Directors and will remain in place through October 1, 2002. The Amended Plan period may be modified should Scripps Bank and Ronald J. Carlson agree to modify the Term of the Amended Employment Agreement, as defined therein. C. PERFORMANCE GOALS: 1. Performance goals will be based upon the July 1999 Scripps Bank Strategic Plan adopted by the Scripps Bank Board of Directors. 2. Under this Amended Plan, there will be FOUR GOALS which will be evaluated by the Board of Directors at the end of the Amended Plan period to determine if Ronald J. Carlson is eligible for any incentive compensation awards. 2 3. The four goals are: GOAL #1: To obtain a return on ending equity of 16.0% by the end of 2001. GOAL #2: To grow assets to $800,000,000 by the end of 2001. GOAL #3: Meet or exceed quality trigger from Stakeholders Plan model - net loan losses and classified loans as a percentage of Plan loans. GOAL #4: To achieve five non-financial "Big Picture Goals" as stated on Page 2 of the Strategic Plan. In summary, these are: (a) To be viewed as the premier relationship bank in San Diego County. (b) To hire and retain the highest level of financial service professionals. (c) To attract and retain profitable customer relationships. (d) To assure that the Bank electronic banking services are enhanced to be superior to other community banks of similar size and potential. (e) To have established a plan for orderly management successors. D. MEASUREMENT DOCUMENTATION: GOAL #1: A report from the Chief Financial Officer of Scripps Bank and the Bank's independent auditor. GOAL #2: A report from the Chief Financial Office of Scripps Bank and the Bank's independent auditor. GOAL #3: A detailed report from the President and Chief Executive Officer describing the accomplishments made to achieving the four Big Picture Goals. The report should reference the specific strategies to be accomplished in the Strategic Plan. GOAL #4: A detailed report from the Chairman of the Board taking up each factor and providing an objective appraisal for review by the Board. E. COMPENSATION: 1. The basis for determining Ronald J. Carlson's incentive compensation award will be: (a) Ronald J. Carlson's annual base salary as of 10/1/2002. 3 (b) How well Ronald J. Carlson has achieved each of the three goals. (c) An award amount calculated from a percentage of Ronald J. Carlson's annual base salary. 2. The award schedule described below is predicated on Ronald J. Carlson earning 100% of his final base salary for achieving 100% of all three goals. Note that more emphasis is placed upon achieving the first two goals (which are measured quantifiably) than Goal #3 (a qualitative and more subjective measurement). 3. The award schedule is as follows: PERCENT OF GOAL ACHIEVED 90% 100% 110+%
GOAL PERCENT OF BASE SALARY AWARDED ---- #1 20% 40% 60% #2 20% 40% 60% #3 0% 20% 20%
4. In the above schedule, Goal #3 is measured as either a pass/fail, as determined by the Board of Directors after reviewing the documentation indicated. 5. The schedule extends to 110% with a specific award, however, it shall remain within the discretion of the Board upon retirement to increase the award for performance found to be superior. 6. In the example below, upon his retirement date on October 1, 2002, let us assume that: (a) Ronald J. Carlson's annual salary is $250,000 (b) Ronald J. Carlson's performance to each of the three goals was: GOAL #1: 105% of goal achieved. GOAL #2: 115% of goal achieved. GOAL #3: Met the goal. 4 (c) Calculation of Ronald J. Carlson's award: GOAL #1: $250,000 x 40% = $100,000 GOAL #2: $250,000 x 60% = $150,000 GOAL #3: $250,000 x 25% = $ 50,000 TOTAL AWARD: = $300,000 F. METHOD OF PAYMENT: 1. Ronald J. Carlson should be provided the opportunity to elect payment of his award among the following options: (a) A cash award upon his retirement date on October 1, 2002. This would be a lump sum payment subject to taxation similar to any other bonus payment. (b) An award of Scripps Bank Stock equivalent to the cash award. This, too, would be subject to applicable tax rules at the time of issuance. (c) An election to defer payments (via a non-qualified deferred compensation arrangement) for a period of up to five years. Bank can elect to purchase an annuity to fulfill this method of payment. This will require that Ronald J. Carlson make an election in the year prior to his retirement as to whether he wishes to defer and, if so, in what manner. For example, the Amended Plan could be structured so that his options are: 1. No deferral resulting in a lump sum payment and applicable taxation. 2. Deferral for up to five years, at which time he would receive his award and applicable taxes would then be taken. 3. Equal payout installments over X years (not to exceed five). If Ronald J. Carlson elects either #2 or #3, the Bank could apply an interest rate to the undistributed funds. (d) If the Bank adopts the deferral provision, a formal plan document adhering to current legal requirements should be prepared as an additional to the incentive compensation plan. G. MISCELLANEOUS PROVISIONS: 1. This Amended Plan can be modified, amended, rescinded, or terminated at any time at the sole and absolute discretion of the Board of Directors. There are no 5 representations, inducements, promises or agreements, oral or otherwise, that are made by anyone acting on behalf of the Bank, which are not embodied herein, and that no agreement, statement or promise not contained or referenced in this Amended Plan shall be valid or binding. 2. If any legal action, including an action for declaratory relief, is brought to enforce or interpret the provisions of this Amended Plan, the prevailing party shall be entitled to recover reasonable attorneys' fees and costs from the other party. These fees, which may be set by the court in the same action or in a separate action brought for that purpose, are in addition to any relief to which the prevailing party may be entitled. This provision applies to the entire Amended Plan. 3. In the event of a transfer or sale of the assets of Scripps Bank or a merger or consolidation of Scripps Bank into or with any other corporation or entity, each of the Performance Goals set forth in Section C of this Amended Plan shall be deemed met at the 100% level as of the date of any such transfer or sale of assets, merger or consolidation; therefore entitling Ronald J. Carlson to receive no later than October 1, 2002, the compensation award set forth in Section E of this Amended Plan. By: By: ------------------------------- --------------------------- William E. Nelson Ronald J. Carlson Chairman of the Board President and Chief Executive Officer Date: Date: ------------------------------- -------------------------- 6 EX-23.1 5 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-87745) of Scripps Financial Corporation of our report dated February 4, 2000 which is included in this Annual Report on Form 10-K. PricewaterhouseCoopers LLP San Diego, California March 29, 2000 EX-27 6 EXHIBIT 27
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF SFC AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 25,046 789 29,670 0 165,076 0 0 397,376 5,412 631,945 582,385 44 3,452 767 0 0 34,702 10,595 631,945 36,230 8,605 1,436 46,271 13,387 13,432 32,839 7,230 0 24,014 7,219 4,429 0 0 4,429 .64 .63 6.03 2,759 1,562 1,351 530 4,767 6,769 184 5,412 5,412 0 0
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