-----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, PyEk9afLJsW3iTZ9Kda1vOOGYvxcnTf13l5sGPQr35Lzc4LmvT4OnLNQgxqG8AY6 oYnj/VoMiOowx0pRZ4+Ulg== 0000950148-96-001291.txt : 19960626 0000950148-96-001291.hdr.sgml : 19960626 ACCESSION NUMBER: 0000950148-96-001291 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19960331 FILED AS OF DATE: 19960625 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHAD THERAPEUTICS INC CENTRAL INDEX KEY: 0000713492 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 953792700 STATE OF INCORPORATION: CA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12214 FILM NUMBER: 96584910 BUSINESS ADDRESS: STREET 1: 9445 DE SOTO AVE CITY: CHATSWORTH STATE: CA ZIP: 91311 BUSINESS PHONE: 8188820883 MAIL ADDRESS: STREET 1: 9445 DE SOTO AVE CITY: CHATSWORTH STATE: CA ZIP: 91311 10-K 1 FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 F O R M 10 - K [x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the fiscal year ended March 31, 1996 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) For the transition period from __________ to __________ Commission file number 0-11363 Chad Therapeutics, Inc. (Exact name of registrant as specified in its charter) California 95-3792700 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
9445 De Soto Avenue, Chatsworth, CA 91311 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 882-0883 Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Shares, $.01 par value (Title of class) Indicate by check mark whether the Registrant (1) has 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 reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x_ No __ Indicate by check mark if disclosures of delinquent filers pursuant to Item 405 of Regulation SK (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] 2 The aggregate market value of the voting shares held by non-affiliates of the Registrant on June 17, 1996 (based on the average over-the-counter bid and asked prices of such stock on such date) was $172,175,000. Indicate the number of shares outstanding of each of the registrant's classes of common stock as of June 17, 1996: Common Shares 9,632,185
Portions of the Registrant's definitive Proxy Statement for its September 10, 1996, Shareholders' meeting ("Proxy Statement") (which Proxy Statement has not been filed as of the date hereof) are incorporated into Part III as set forth herein. Portions of the Registrant's Annual Report to Shareholders for the year ended March 31, 1996 ("Annual Report") are incorporated into Part II as set forth herein and only such portions of the Annual Report as are specifically incorporated by reference are thereby made a part of this Annual Report on Form 10-K. 2 3 PART I Item 1. Business Chad Therapeutics, Inc. ("CHAD" or the "Company") was organized in August, 1982, to develop, produce and market respiratory care devices designed to improve the efficiency of oxygen delivery systems for both home and hospital treatment of patients who require supplemental oxygen. The Company introduced its first respiratory care device in the market in June, 1983, and has introduced additional respiratory care devices in subsequent years. Pulmonary Disease and Oxygen Therapy The Company was organized to pursue the development and marketing of devices which improve the efficiency of systems used to administer oxygen to patients requiring supplemental oxygen. These are primarily patients suffering from chronic obstructive pulmonary diseases. Chronic obstructive pulmonary diseases (COPD) are progressive, debilitating conditions that affect millions of Americans, severely limiting their activities and shortening their lives. Such conditions, which include chronic bronchitis, emphysema and severe asthma, decrease the capacity of the lungs to oxygenate the blood. To make up for this deficiency, it is common medical practice to administer supplemental oxygen, usually on a 24 hours per day basis in an amount sufficient to increase blood oxygenation to near normal levels. A report issued in September, 1981, by the National Heart, Lung and Blood Institute of the National Institutes of Health (NIH) stated that chronic obstructive pulmonary diseases were the fastest rising cause of death in the United States, accounting for approximately 2.5% of all deaths and costing more than $15 billion a year in health care and lost time and wages. The NIH Report estimated that in 1981 there were approximately 9 million people in the United States suffering from chronic bronchitis and emphysema. More recently, the Epidemiology and Statistics Unit of the American Lung Association reported that in 1989 there were 14.6 million Americans suffering from COPD. This report also notes that the death rate from COPD has increased by 28.5 percent in the decade from 1979 to 1989. Some authorities estimate that as many as 20 million Americans who are now affected by COPD will eventually require supplemental oxygen. Although precise data are not available, various individual and institutional sources and reports estimate that there are more than 1 million home care patients receiving supplementary 3 4 administration of oxygen. Total dealer revenues for home oxygen therapy were estimated at $1.5 billion for 1993. Medicare, which accounts for about 60% of home oxygen dealers' revenues, expected to spend almost $1 billion in 1993 for home oxygen as compared to $826 million in 1992 according to officials of the Health Care Financing Administration. Market revenues for home oxygen have grown consistently at 8-10% per year for the past five years. This is due to the increasing number of COPD patients as well as the move to home care and out of hospitals. Overall hospital discharge rates relative to COPD declined 67% over the period 1983 - 1989. Chronic obstructive pulmonary diseases are also prevalent in other countries, particularly in some European nations where the incidence is higher than in the United States. The potential international market for home oxygen is expected to grow to 150% of the U.S. market before the end of the decade. The primary oxygen supply for home patients is provided from cylinders containing compressed gaseous oxygen (5-10% of users), reservoirs containing liquid oxygen (20-25%) or by means of concentrators which concentrate oxygen from the ambient air (65-75%). Standard oxygen delivery systems are characteristically inefficient, permitting over 67% of the oxygen supply delivered to the patient to be wasted, primarily because the oxygen is administered steadily to the patient, even while he is exhaling. Since the normal breathing cycle consists of an exhalation period which is approximately twice as long as the inhalation period, at least two-thirds of the oxygen from this continuous flow system is wasted. Furthermore, it is generally accepted that the oxygen breathed in during the first one-third of the inhalation period provides most of the oxygenation benefit to the patient. In June, 1989, the home oxygen market changed. A new procedure for payment by Medicare for home oxygen services became effective. This new procedure provides a prospective flat fee monthly payment based solely on the patient's prescribed oxygen requirement and disregards modality, the type of system in use. Prior to that time, dealers were reimbursed on the basis of total oxygen delivered by the dealer and reimbursement also varied based on the modality used and other variables. The prior procedure tended to encourage waste and inefficiency. Consequently, with the incentive to operate efficiently, inexpensive concentrators have grown in popularity because of low cost and less frequent servicing requirements. At the same time interest heightened in oxygen conserving devices which can extend the life of oxygen supplies and reduce service calls by dealers. There is also a separate fixed allowance from Medicare for patients who need to be mobile and therefore require portable oxygen systems. 4 5 Mobility has increased in importance as the treatment of pulmonary patients has moved away from hospitals and into home care. Also, leading authorities now state that maintenance and improvement of the patient's quality of life should be the major objective in the treatment of COPD. Maintaining quality of life and compliance with prescribed exercise programs require that the patient be as mobile as possible and thus increase the demand for portable oxygen equipment. CHAD's Products Recognizing the need for more efficient oxygen delivery systems, the Company has pursued, since its inception, the development and marketing of devices which are designed to conserve oxygen. The benefits of such improvements include substantial cost savings and increased mobility for ambulatory patients who require portable oxygen supplies. These devices extend the life of oxygen supplies, make possible more compact and longer lasting portable systems and thereby improve the quality of life for home oxygen patients. OXYMIZER and OXYMIZER Pendant Oxygen-Conserving Devices. In June, 1983, the Company began marketing its first product, the OXYMIZER disposable oxygen-conserving device, a unique, patented, disposable device developed to provide up to 4 to 1 savings of oxygen when used with any oxygen supply source. The OXYMIZER device contains a collapsible reservoir which captures incoming oxygen delivered during expiration and prevents its waste. The oxygen captured in this reservoir is then inhaled by the patient during the first instant of his next inspiration. The OXYMIZER device thus both conserves oxygen and provides the patient with an extra rich supply of oxygen at the beginning of the inhalation period when it can be most effectively utilized. Extensive clinical testing and trials over the past ten years have repeatedly demonstrated that patients using the OXYMIZER device are able to achieve equivalent blood oxygenation levels while using significantly less oxygen. There have been more than 32 clinical evaluations from institutions worldwide, that have confirmed the efficacy and oxygen savings realized by patients who use the OXYMIZER devices. The greater efficiency provided by the OXYMIZER devices over standard oxygen delivery systems also permits home health care patients to achieve greater mobility by enabling them to use smaller portable cylinders or by obtaining two to four times the life from standard sized portable cylinders. 5 6 For home oxygen dealers the disposable OXYMIZER devices afford the cost advantages of oxygen conservation without capital investment in expensive equipment. In hospitals the OXYMIZER devices are reported to be frequently used for maintenance of certain patients requiring higher flow levels of oxygen without having to resort to uncomfortable oxygen masks. The Company is pursuing a marketing strategy which emphasizes the cost savings, efficiencies and level of patient comfort associated with the use of the OXYMIZER devices. See "Marketing" and "Competition". The OXYMIZER Pendant device is similar to the OXYMIZER device, except that its reservoir is located in a "pendant" which hangs over the patient's chest rather than under the nose. The OXYMIZER Pendant has a more traditional appearance than the OXYMIZER. The Company began marketing the OXYMIZER Pendant in August, 1984, and to date sales have approximated those achieved by the OXYMIZER device. Total sales of these two devices now account for approximately 3% of the Company's sales. OXYMATIC Electronic Oxygen Conservers. The Company began marketing the OXYMATIC conserver in March, 1986. This product is a small electronic device, designed for use with portable oxygen systems. The OXYMATIC Model 201 conserver electronically senses the optimal moment in the breathing cycle for delivery of oxygen and at that moment, releases a very brief pulse of oxygen to the patient. The OXYMATIC conserver concentrates the administration of oxygen during the first one-third of the inhalation phase, when oxygen is most efficiently utilized. Through its optimal efficiency the OXYMATIC electronic conserver makes possible oxygen savings ratios of from 4 to 1 up to 12 to 1 depending on the user's breathing rate. In clinical experience the average saving has been shown to be 7 to 1 - about twice the efficiency of any known competitive product. There have been at least twelve controlled clinical trials and studies of patient groups using the OXYMATIC conserver, all of which have confirmed its efficacy and efficiency. In May, 1995, the Company introduced the new OXYMATIC Model 301 which replaces the Model 201. This new model incorporates improved electronics, providing a longer battery life and other improvements which make it more user friendly. In June, 1993, the Company introduced a different version of the OXYMATIC conserver, the OXYMATIC - 2400. This model incorporates substantial improvements and additional features, such as an alarm system, which are designed to allow it to be used 24 hours a day with both primary and portable oxygen sources. The OXYMATIC - 2400 conserver affords the same oxygen savings ratios as the original OXYMATIC conserver. 6 7 The OXYMATIC conservers now account for approximately 41% of the Company's sales, with 9% of these sales relating to sales of the OXYMATIC - 2400. These amounts do not include OXYMATIC devices sold as part of OXYLITE systems. OXYLITE Complete Portable Oxygen System. The Company also markets eight OXYLITE complete portable oxygen systems, each of which is available with either the OXYMATIC Model 301 conserver or the OXYMATIC - 2400 conserver. These systems combine the OXYMATIC electronic oxygen conserver with small, lightweight oxygen cylinders and lightweight pressure regulators in an attractive carrying pouch. The OXYMATIC conserver extends the time the contents of the cylinders will last by an average of seven times. They provide ambulatory patients with greater mobility and less weight. These systems offer a superior alternative to commonly used liquid oxygen systems for mobile patients and are more cost effective for homecare dealers to supply. OXYLITE system and cylinder sales now account for approximately 48% of the Company's total sales, of which 46% represents the sales value of OXYMATIC conservers. OXYFILL Refilling Systems. In March, 1996, the Company began marketing the OXYFILL oxygen cylinder refilling systems which were designed to reduce the home oxygen dealers costs of providing ambulatory oxygen to patients using the Company's OXYLITE portable oxygen systems. These refilling systems allow the home care dealer to refill cylinders at his base facility or in the patient's driveway and thereby reduce purchases and inventory of oxygen cylinders, reduce refill costs and gain more control over their oxygen business. To date, there have been limited sales of the OXYFILL refilling systems. OXYCOIL Coiled Oxygen Tubing. In January, 1986, the Company began marketing the OXYCOIL coiled oxygen tubing, a device which replaces the standard supply tubing for the OXYMIZER devices, the OXYMATIC conserver or conventional nasal cannulas. The OXYCOIL tubing is a convenience and safety device which can be used with any oxygen system to help keep the supply tubing out of the patients' way, thus minimizing the tripping and tangling problems associated with standard supply tubing. OXYCOIL tubing sales now account for approximately 1% of the Company's total sales. The technology for each of the devices described above belongs to the inventors thereof. The Company has acquired exclusive licenses to manufacture and market the OXYMIZER device, the OXYMIZER Pendant device, the OXYMATIC conservers and the OXYCOIL tubing. See "Licensing and Related Agreements". 7 8 Other Products. The Company also offers a variety of ancillary products which support the principal oxygen conserving products. These include oxygen cylinders of various sizes and compositions, regulators, cannulas and connecting tubing and assorted carrying pouches, which account for less than 9% of total sales. Products Under Development It is the Company's objective to continuously improve and add to its oxygen conserving and related products. In April, 1996, the Company entered into an exclusive development contract with an outside vendor to develop unique oxygen therapy products. If the project is successful, the Company intends to begin marketing the first product late in fiscal 1998. No assurance can be given that any products developed pursuant to this contract will be successfully marketed or that the Company will ever derive any revenues or earnings from the sale of such product. Research and Development For the year ended March 31, 1996, the Company expended approximately $113,000 on research and development and has expended approximately $1,053,000 since its inception in August, 1982. The Company operates in an industry which is subject to rapid technological change, and its ability to compete successfully depends upon, among other things, its ability to stay abreast or ahead of new technological developments. Accordingly, the Company expects to expend increasing amounts for the development or acquisition of new products or the improvement of existing products. In the next fiscal year the Company will expend $400,000 on the project discussed above in addition to other amounts on smaller projects. The Company conducts research and development in the electronics area internally and also utilizes the services of outside firms and consultants for its research and development activities. Licensing and Related Agreements The Company has entered into license agreements (the "Inventors License Agreements") with Brian L. Tiep, M.D., Robert E. Phillips and Ben A. Otsap, the inventors of the OXYMIZER device (the "Inventors"), with respect to that device and each of the additional oxygen conserving devices developed by them. At the present time, the Company has licensed the OXYMIZER device, the OXYMIZER Pendant device and the OXYMATIC conserver, thereby acquiring exclusive rights to manufacture and market such products. Pursuant to the Inventors License Agreements, the Inventors grant to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use and sell such device. The Inventors License Agreements provide that the Company pay royalties 8 9 to the Inventors on the net proceeds of sales of the device covered by the agreement at the rate of 6% on amounts up to $10 million and 3% on amounts of $10 million or more. The Inventors License Agreements also provide that the Company pay minimum advance royalties for each license year in the amount of $10,000 for each year. The advance payments are to be applied toward royalties payable for the corresponding license year, and any amounts paid by the Company under one agreement (except those on the OXYMIZER device), in excess of the minimum, may be applied by the Company against the minimum payable under any other such agreement. The Company is obligated to prosecute and defend, at its own expense, any infringement suits related to manufacture or sale of each device covered by any such agreement. Each Inventors License Agreement continues until the expiration of the last to expire of any patent covering the related device or, if no patent issues, for 17 years. The Inventors may terminate the Inventors License Agreements at an earlier date if the Company is in arrears for 60 days on any royalty payment or if the Company defaults in performing any other term of the agreement and fails to cure such default within 60 days. Manufacturing and Sources of Supply The Company tests and packages its products in its own facility. Some of its other manufacturing processes are conducted by other firms and the Company expects to continue using outside firms for certain manufacturing processes for the foreseeable future. All outside manufacturing is conducted under the supervision and control of the Company and with tooling provided by the Company. Pursuant to an oral agreement, the Company purchases semi- finished units of the OXYMIZER and OXYMIZER Pendant devices from a supplier in Southern California. Final assembly and packaging are completed at the Company's facilities. The Company does not contemplate entering into a formal written agreement for these units. This arrangement is terminable at will by either party. The Company believes that other injection molding facilities would be available in the event of a termination of this arrangement. Pursuant to a written agreement, the Company purchases the OXYMATIC 2400 conserver from a supplier in Southern California. This arrangement is terminable with notice by either party. The Company believes that other electronic assembly facilities would be available in the event of a termination of the agreement. Production of the OXYMATIC Model 301 is being handled internally with only a portion of electronic assembly being subcontracted outside the Company. The Company is currently 9 10 subcontracting with two electronic assembly facilities and believes that other facilities would be available in the event of an interruption of supply from the existing facilities. Pursuant to oral agreements, the Company purchases components for its OXYLITE systems (other than the OXYMATIC conserver) from several suppliers. These arrangements are terminable at will and the Company believes other suppliers would be available in the event of termination of these arrangements. The Company is not aware of any shortages of materials necessary for the manufacture of its products. The Company provides customers the right to return merchandise for credit but does not provide extended payment terms. Marketing The Company's products are designed to reduce the cost of health care while maintaining or enhancing the therapeutic benefits to the patient, and improving the user's quality of life. The Company's marketing efforts have focused primarily on providing home oxygen suppliers with products that they can utilize to increase their revenues and profits. Homecare dealers have significantly increased their revenues by using the Company's OXYLITE complete portable oxygen systems or by locally assembling small portable systems incorporating the Company's OXYMATIC conserver as a vehicle to increase their revenues by attracting new and additional patients to their business. These lightweight, long-lasting portable systems have both high professional and patient acceptance which allows the supplier promoting these products to attract new and additional customers. Medical professionals, who frequently refer patients to specific home oxygen suppliers, find that these systems assist patients in more easily complying with prescribed exercise programs and help them to achieve the therapeutic benefits of maintaining a lifestyle as normal as possible. Patients, most of whom are free to select their oxygen supplier, are receptive to changing suppliers in order to obtain equipment that will allow them to travel and maintain their quality of life. Approximately 80% of all home oxygen patients are covered by Medicare. Since June 1989, home oxygen suppliers have been reimbursed by Medicare on a fixed monthly fee basis. The monthly reimbursement amount does not vary, as in the past, with either the type of oxygen delivery equipment provided or the amount of oxygen supplied. Since monthly per patient revenues are fixed, home oxygen suppliers can only increase their per patient profitability by reducing costs. The Company's oxygen conserving products allow these suppliers to decrease their costs while providing their patients with improved therapeutic benefits and quality of life. 10 11 While the home respiratory care dealer remains the primary focus of the Company's marketing efforts, this focus was augmented recently by a major effort to increase professional awareness. Promotional programs were initiated which targeted respiratory care physicians, nurses and therapists. A Medical Advisory Committee was formed composed of nine physicians who are among the world's leading respiratory authorities. The Company markets its products directly to home oxygen suppliers throughout the U.S. The Company currently has a Marketing Director, a Director of Professional and Government Relations, a Promotion Manager, a marketing assistant, a National Sales Manager and six in-house customer service representatives who are in regular and frequent telephone sales contact with customers and potential customers. In the past, the Company extensively tested the use of manufacturer representatives. It has subsequently found that dealers, professionals, and users can be provided better service via direct contact with the in-house customer service representatives. The Company also utilizes extensive direct mail, trade show attendance, and trade advertising to promote the benefits of the products to home care dealers. Additionally, the Company actively seeks to increase professional awareness of its products through professional advertising and participation in professional meetings. Home oxygen therapy markets outside the United States are, in most cases, at a much earlier stage of development. In many countries, these patients are cared for in domiciliary settings. As the trend develops to move patients into home care, opportunities for the Company's products should increase. Sales of the OXYMATIC conserver in Europe, Canada and Japan have become an important part of the Company's business. Based on industry market research projections, the Company expects the market potential to increase to 150% of the U.S. potential within the current decade. The Company has entered into exclusive distributorship agreements in Germany, Canada, Japan, and Australia. The Company's distributor in Germany covers the entire European Community. The Company also has non-exclusive distributors in many other countries. Sales outside of the United States will subject the Company to certain risks, including those involving political and economic factors, interruption of shipments of products, currency fluctuations and devaluations and governmental restrictions and regulations. Customers, Backlog and Orders The Company presently has an active list of approximately 4,100 dealer and hospital customers. Based upon information developed from various lists the Company believes that there are 11 12 approximately 5,000 to 6,000 oxygen dealers and 3,000 general hospitals in the United States which are potential customers or customer sources for the Company. Accordingly, the Company believes it is unlikely that it will be dependent upon a limited number of domestic customers. Financial Information Relating to Foreign and Domestic Operations and Export Sales
1996 1995 1994 ------ ------ ------ Sales (thousands): United States $17,832 12,651 8,073 Europe 961 718 747 Other 1,566 1,149 650 ------ ------ ----- Total $20,359 14,518 9,470 ======= ====== ===== Gross profit: United States $10,630 6,717 4,334 Europe 436 340 351 Other 773 545 324 ------ ----- ----- Total $11,879 7,602 5,009 ======= ===== =====
All identifiable assets are located in the United States. The Company does not presently have, and does not intend in the future to have, any backlog of orders for any of its products. The Company presently has and intends to maintain a large enough inventory to ship all of its products immediately upon receipt of orders. The Company believes that such an inventory is necessary to meet the requirements of its customers. Competition The Company is not aware of any firm which markets an oxygen conserving device directly competitive with the OXYMIZER devices. The Company is aware of several demand valve, electronically controlled devices currently being marketed. Of these devices, those that are the principal competitors of the OXYMATIC conserver are targeted primarily to a specific segment of the market - - liquid oxygen usage. The Company does not know the levels of sales achieved by the companies marketing these systems. Two companies, Nellcor/Puritan Bennett and Sunrise/De Vilbiss, market smaller (5.5 lbs.) portable liquid oxygen systems incorporating simple oxygen conserving devices which double the useful life of these systems. Although these units allow longer ambulation and/or reduce the weight of portable liquid oxygen, they are heavier than the smallest OXYLITE system and provide less ambulatory time due to the greater efficiency of the OXYMATIC conserver, which provides at least double the oxygen savings of 12 13 other conservers. Also both units are more expensive than OXYLITE systems and still require the supplier to make frequent and costly oxygen deliveries. The Company does not know the levels of sales achieved by the companies marketing these systems. There are several other types of portable oxygen systems which compete with the Company's OXYLITE systems but do not utilize oxygen conserving devices. Aluminum and steel oxygen cylinders with continuous flow are utilized by some oxygen suppliers as portable systems. Although they do provide users with some portability, their size and bulk limits their use by patients who need or want to be truly ambulatory. The most commonly used of these cylinders is approximately three feet high, weighs over 20 lbs., and provides an average patient with less than 5 hours of oxygen. The OXYMATIC conserver, which provides an average oxygen savings of 7 to 1, allows the use of smaller, lighter cylinders and thus provide greater mobility. Until the availability of OXYLITE systems and the previously cited changes in Medicare oxygen reimbursement, liquid oxygen was the modality of choice for truly mobile users. Portable liquid oxygen systems which weigh 8 to 10 lbs., provide an average patient with 6 to 8 hours of oxygen, compared to the smallest OXYLITE system which weighs 4.5 lbs. and provides an average patient with 10.5 hours of oxygen. These systems are more costly than OXYLITE systems and require frequent and expensive (usually weekly) deliveries of bulk liquid oxygen to the patient's home. Although many oxygen suppliers continue to use and re-use existing inventories of liquid oxygen equipment to service ambulatory patients, purchases of new liquid oxygen equipment by home care dealers is decreasing. Patents and Trademarks The Company regards the products that it develops or licenses and its manufacturing processes as proprietary and relies on a combination of patents, trademarks, trade secret laws and confidentiality agreements to protect its rights in its products. A U.S. patent has been issued covering the original OXYMIZER device, the OXYMIZER Pendant device and the OXYMATIC conserver. A number of foreign patent applications pertaining to the Company's activities have also been issued. The Company pursues a policy of obtaining patents for appropriate inventions related to products marketed or manufactured by the Company. The Company considers the patentability of products developed for it to be significant to the success of the Company. To the extent that the products to be marketed by the Company do not receive patent protection, competitors may be able to manufacture and market substantially similar products. Such competition could have an adverse impact upon the Company's business. 13 14 There can be no assurance that patents, domestic or foreign, will be obtained with respect to the Company's products, or that, if issued, they will provide substantial protection or be of commercial benefit to the Company. In addition, the patent laws of foreign countries may differ from those of the United States as to the patentability of the Company's products and processes and, accordingly, the degree of protection afforded by foreign patents may be more or less than in the United States. In the United States, although a patent has a statutory presumption of validity, the issuance of a patent is not conclusive as to such validity or as to the enforceable scope of its claims therein. The validity and enforceability of a patent can be attacked by litigation after its issuance by the U.S. Patent and Trademark Office. If the outcome of such litigation is adverse to the owner of the patent in that the patent is held to be invalid, other parties may then use the invention covered by the patent. Accordingly, there can be no assurance that patents with respect to the Company's products, if issued, will afford protection against competitors with similar products, nor can there be any assurance that the patents will not be infringed upon or designed around by others. The Company has obtained U.S. registration for the trademarks "OXYMIZER", "OXYMATIC", "CHAD" and "OXYCOIL" and has filed an application for the trademark "OXYFILL". A series of foreign applications to register the trademark "OXYMIZER" in a number of countries of commercial interest to the Company have been filed. Governmental Regulation The commercialization of the OXYMIZER and OXYMATIC devices is subject to the Federal Food, Drug and Cosmetic Act (the "Food and Drug Act") and to regulations issued thereunder. The Company anticipates that commercialization of other devices which it intends to market will also be subject to the Food and Drug Act. The Food and Drug Act is administered by the FDA, which has authority to regulate the marketing, manufacturing, labeling, packaging and distribution of products subject to the Food and Drug Act. In addition, there are requirements under other federal laws and under state, local and foreign statutes which may apply to the manufacture and marketing of the Company's products. The Medical Device Amendments of 1976 to the Food and Drug Act (the "Amendments") and the Safe Medical Device Act of 1990 significantly extended the authority of the FDA to regulate the commercialization of medical devices. The Amendments established three classifications of medical devices: Class I, Class II and Class III. With respect to all three classes, the general provisions of the Food and Drug Act prohibit adulteration and misbranding. A medical device may be adulterated if the device is or could be adversely affected by its methods of manufacture, storage or 14 15 packaging. A medical device may be misbranded if its labeling is false or misleading or if its labeling does not contain specific information required by law applicable to such type of device. In addition, failure to register a medical device covered under the Food and Drug Act with the FDA will render it misbranded under the Food and Drug Act. All manufacturers of medical devices must register with the FDA and, with their initial registration, list all medical devices produced by them. This listing must be updated annually. In addition, prior to commercial distribution of additional devices, the manufacturer must file with the FDA and receive approval prior to the commencement of such commercial distribution, a notice setting forth certain information about the device, including the classification into which the manufacturer believes it falls. Class I devices are subject only to the general controls concerning adulteration, misbranding, good manufacturing practices, record keeping and reporting requirements. Class II devices must, in addition, comply with performance standards as promulgated by the FDA. The Company has registered with the Bureau of Medical Devices of the FDA as a Medical Device Establishment and with the Department of Health Services of the State of California as a Medical Device Manufacturer. In addition, the Company has developed procedures to comply with FDA standards concerning good manufacturing practices, record keeping and reporting. The Company has filed notification submissions pursuant to Section 510(k) of the Food and Drug Act of its intent to market the OXYMIZER, the OXYMIZER Pendant, the OXYMIZER Flow Restrictor, the OXYMATIC conserver and the OXYCOIL; it has been granted permission by the FDA to market the OXYMIZER and the OXYMIZER Pendant as Class I devices. Permission has been granted to market the OXYMATIC and the OXYCOIL as Class II devices. Employees As of June 17, 1996, CHAD had 70 full-time and no part-time employees. Forty-four of the Company's employees are engaged in manufacturing and the remainder are engaged in marketing, sales, administration and management. None of the Company's employees are represented by unions; the Company believes its employee relations are satisfactory. The Company will employ additional personnel in all phases of its activities as required by the growth in its activities. The number of additional personnel will be dependent on sales levels of individual products. 15 16 Item 2. Properties. The Company's principal offices and manufacturing facilities are situated in premises located in Chatsworth, California and consist of 16,714 square feet, at a monthly rental fee of $16,246 pursuant to a lease expiring in January, 1997. The Company has entered into a lease for new facilities which commences in July, 1996. The new facilities, also located in Chatsworth, California, consist of 55,500 square feet at a monthly rental rate of $24,500 and management feels this larger facility should adequately handle the Company's needs for the foreseeable future. The Company does not own any real property and does not anticipate acquiring any in the foreseeable future. Item 3. Legal Proceedings. The Company may become involved in legal proceedings in the ordinary course of business. The Company maintains product liability insurance in an amount deemed customary in the industry for protection of the Company against potential product liability claims. There are no pending legal proceedings which, in the opinion of management, would have a material adverse effect on the Company's financial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Stockholder Matters. The information required herein is hereby incorporated by reference to the information contained under the caption "Corporate Data" in the Company's Annual Report. Item 6. Selected Financial Data. The information required herein is hereby incorporated by reference to the information contained under the caption "Selected Financial Data" in the Company's Annual Report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required herein is hereby incorporated by reference to the information contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report. 16 17 Item 8. Financial Statements and Supplementary Data. The information required herein is hereby incorporated by reference to the Financial Statements and the Notes thereto contained in the Company's Annual Report. Item 9. Disagreements on Accounting and Financial Disclosure. None. PART III Item 10. Directors and Executive Officers of the Registrant. The information required herein is hereby incorporated by reference to the information appearing under the captions "Election of Directors" and "Executive Officers" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 11. Executive Compensation. The information required herein is hereby incorporated by reference to the information appearing under the caption "Compensation of Directors and Executive Officers" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required herein is hereby incorporated by reference to the information appearing under the caption "Voting Securities and Principal Holders Thereof" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 13. Certain Relationships and Related Transactions. None. 17 18 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) (1) Financial Statements. Included in Part II of this Report: Independent Auditors' Report Balance Sheets -- March 31, 1996 and 1995 Statements of Operations -- Years ended March 31, 1996, 1995 and 1994. Statements of Shareholders' Equity -- Years ended March 31, 1996, 1995 and 1994. Statements of Cash Flows -- Years ended March 31, 1996, 1995 and 1994. Notes to Financial Statements. (a) (2) Financial Statement Schedules. None. (3) Exhibits. 3.1 Articles of Incorporation of the Registrant, as amended***** 3.2 Bylaws of the Registrant, as amended* 10.3 OXYMIZER License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap* 10.5 Pulser System License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap. (The Pulser System is now called the OXYMATIC.)* 10.7 OXYMIZER Pendant License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap*
18 19 10.20 OXYCOIL tubing License Agreement with Mary Smart (licensed under the name Respi-Coil).*** 10.22 Lease on real property at 9445 DeSoto Avenue, Chatsworth, California**** 10.23 Summary plan description for Chad Therapeutics, Inc. Employee Savings and Retirement Plan**** 10.24 1994 Stock Option Plan 13.1 Annual Report to Shareholders for the year ended March 31, 1996. 28.1 Letter from the FDA authorizing the Company to market the OXYMIZER oxygen conserving device as a Class 1 device.* 28.2 Letter from the FDA authorizing the Company to market the OXYMIZER Pendant oxygen conserving device as a Class 1 device.** 28.5 Letter from the FDA authorizing the Company to market the OXYMATIC electronic oxygen conserver as a Class 2 device.*** 28.6 Letter from the FDA authorizing the Company to market the OXYCOIL coiled oxygen tubing as a Class 2 device.***
(b) Reports on Form 8-K - None filed. (c) Index to Exhibits. (d) Financial Statement Schedules - None - --------------- * Previously filed as an Exhibit to the Registrants' Registration Statement on Form S-18, File No. 2-83926. ** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1984. *** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1986. **** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1993. ***** Previously filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1994. 19 20 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on the 25th day of June, 1996. CHAD THERAPEUTICS, INC. By /S/Charles R. Adams --------------------------------------- Charles R. Adams, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date /S/Charles R. Adams Chief Executive June 25, 1996 - ----------------------- Officer and Director Charles R. Adams (Principal Executive Officer) /S/Francis R. Fleming President, Chief June 25, 1996 - ----------------------- Operating Officer and Francis R. Fleming Director /S/Earl L. Yager Senior Vice President, June 25, 1996 - ----------------------- Chief Financial Earl L. Yager Officer and Secretary and Director (Principal Financial and Accounting Officer) /S/David L. Cutter Director June 25, 1996 - ----------------------- David L. Cutter /S/John C. Boyd Director June 25, 1996 - ----------------------- John C. Boyd /S/Norman Cooper Director June 25, 1996 - ----------------------- Norman Cooper /S/Philip Wolfstein Director June 25, 1996 - ----------------------- Philip Wolfstein
20 21 Exhibit Index
Exhibit Index Sequentially Exhibit No. Document Numbered Page - ----------- ------------- ------------- 13.1 Annual Report to Shareholders for the year ended March 31, 1996 10.25 Lease on real property at 21622 Plummer Street, Chatsworth, California
21 EX-10.25 2 EXHIBIT 10.25 1 Exhibit 10.25 STANDARD INDUSTRIAL LEASE AGREEMENT between TCEP II PROPERTIES JOINT VENTURE, a Texas joint venture as Landlord and CHAD THERAPEUTICS, INC., a California corporation as Tenant Premises Location: 21622 Plummer Street Chatsworth, California 91311 2 STANDARD INDUSTRIAL LEASE AGREEMENT THIS STANDARD INDUSTRIAL LEASE AGREEMENT (this "Lease"), dated this 12th day of April, 1996, is made and entered into by and between TCEP II PROPERTIES JOINT VENTURE, a Texas joint venture, hereinafter referred to as "Landlord", and CHAD THERAPEUTICS, INC., a California corporation, hereinafter referred to as "Tenant". BASIC LEASE PROVISIONS 1. Area of Premises: Approximately 54,361 rentable square feet. (Paragraph 1.1) 2. Building Address: 21622 Plummer Street Chatsworth, California 91311 (Paragraph 1.1) 3. Commencement Date: The earlier of (a) Tenant's commencement of business operations from the Premises, or (b) July 1, 1996. 4. Term: Eighty-four (84) months. (Paragraph 1.2) 5. The amount of the First Month's Rent is as follows: (Paragraph 2. 1) (a) Base Rent (See Paragraph 2.2 for adjustments thereto) $24,500.00 (b) Taxes $2,989.86 (c) Insurance $1,630.83 (d) Operating Expenses $3,261.66 First Month's Rent Total $32,382.35
6. Security Deposit: $24,500.00. (Paragraph 2.3) 7. Tenant's Proportionate Share: The Premises comprise forty-one and 60/the percent (41.60%) of the Building (such percentage shall be Tenant's Proportionate Share). (Paragraph 2.4) 8. Use of Premises: Light manufacturing, assembly, warehousing and distribution of medical care products, all subject to compliance with all laws, codes, rules and regulations (Paragraph 3.1) 9. Parking: 150 automobiles, 75 of which may be on a reserved basis in accordance with the terms of Paragraph 3.3. (Paragraph 3.3) 10. Liability insurance amount: $3,000,000.00. (Paragraph 12.3.1) 11. Tenant's Address For Notices: 9445 De Soto Avenue Chatsworth, California 91311 (Paragraph 22.21) 12. Landlord's Address For Payments and Notices: 5801 S. Eastern Avenue, Suite 100 Los Angeles, California 90040 (Paragraph 22.21) -1- 3 13. Brokers: The Seeley Company (Robert Valencia) and Trammell Crow So. Cal, Inc. (Paragraph 22.24) 14. Exhibits: "A" Site Plan of Project "B" Work Letter and Construction Agreement "C" Additional Provisions The paragraphs of the Lease identified above in parentheses are those provisions where references to particular items from the Basic Lease Provisions appear, and such items are incorporated into the Lease as part thereof. In the event of any conflict between any Basic Lease Provision and the Lease, the former shall control. -2- 4 1. PREMISES AND TERM. 1.1 LEASE OF PREMISES. Landlord leases to Tenant, and Tenant hires from Landlord, certain premises (the "Premises") consisting of the rentable area shown in Item 1 of the Basic Lease Provisions within a building (the "Building") described in Item 2 of the Basic Lease Provisions. The location of the Building and Premises are shown on the site plan attached hereto as "Exhibit A" and incorporated herein. The "Project" shall refer to the land shown on the site plan (the "Land") together with such additions and deletions to the Land as Landlord may from time to time designate, plus all buildings and improvements located thereon. 1.2 TERM. The term of this Lease shall commence on the "Commencement Date" specified in or established pursuant to Item 3 of the Basic Lease Provisions, and except as otherwise provided herein, shall continue in full force and effect through the number of months provided in Item 4 of the Basic Lease Provisions (the "Term"), provided, however, that if the Commencement Date is a date other than the first day of a calendar month, the Term shall consist of the remainder of the calendar month including and following the Commencement Date, plus said number of full calendar months. 1.3 CONDITION OF PREMISES. Tenant acknowledges that it has inspected and accepts the Premises in their present condition as suitable for the purpose for which the Premises are leased. Notwithstanding the preceding sentence, Landlord shall make the following repairs, alterations or improvements prior to delivery of possession of the Premises to Tenant: (a) repair and/or replace the existing mezzanine floor within the Premises as reasonably necessary to be functional and comply with law; and (b) provide an electrical meter and switch of 480 volts, 3 phase, 4 wire, with at least 600 amps service to the Premises ("Initial Electrical Service") (collectively, "Landlord's Work"). The taking of possession by Tenant shall be conclusive to establish that the Premises are in good and satisfactory condition when possession is taken, except that Landlord hereby agrees to use all commercially reasonable efforts to replace the Initial Electrical Service with an electrical meter and switch of 480 volts, 3 phase, 4 wire, with at least 1000 amps service to the Premises ("Modified Electrical Service") on or before the later of (i) Tenant's commencement of business operations from the Premises, or (ii) July 1, 1996 (the "Modified Electrical Service Outside Date"). If Landlord is unable to provide the Modified Electrical Service to the Premises on or before the Modified Electrical Service Outside Date, and such failure is not due in whole or in part to any act or omission of Tenant or Tenant's Parties, then for each day of delay in Landlord's delivery of the Modified Electrical Service beyond the Modified Electrical Service Outside Date, Tenant shall accrue one (1) day of Rent credit. Landlord shall coordinate with Tenant's contractor and/or architect in connection with the installation of the Modified Electrical Service. Tenant further acknowledges that no representations or promises were made by Landlord or any agent of Landlord to repair, alter, remodel or improve the Premises, except as expressly set forth in this Lease. Notwithstanding the foregoing, Landlord represents and warrants that the exterior roof covering the Premises is in good condition and repair (except to the extent any defects in the roof exist as a result of any act or omission of Tenant or Tenant's Parties [defined below], in which event Tenant shall be solely responsible for the repair thereof); provided, however, if Tenant does hot deliver written notice to Landlord of any defects with respect to the condition of the roof before the end of the twenty-fourth (24th) month of the Term, Tenant shall be deemed to have inspected and accepted the condition of the roof in its present condition as suitable for the purpose for which the Premises are leased and the correction of any subsequently discovered defects shall be the obligation of Tenant (except as -3- 5 expressly provided to the contrary in Paragraph 5.1 below). If a breach of the foregoing warranty exists and Tenant timely (i.e., within 24 months) delivers written notice to Landlord of the same setting forth in reasonable detail a description of such breach, Landlord shall, as Tenant's sole and exclusive remedy, rectify the same at Landlord's sole expense. The Commencement Date shall be the date provided in Item 3 of the Basic Lease Provisions. If this Lease is executed before the Premises become vacant or otherwise available or if any present tenant or occupant of the Premises holds over, and Landlord cannot acquire possession of the Premises in time to deliver them by the Commencement Date, or if any required repairs, alterations or improvements are not substantially completed by Landlord prior to the Commencement Date, this Lease shall not be void or voidable, and Landlord shall not be deemed to be in default hereunder, nor shall Landlord be liable for any loss or damage directly or indirectly arising out of or resulting from such holdover. Tenant agrees to accept possession of the Premises at such time as Landlord is able to tender the same, which date shall thenceforth be deemed the Commencement Date. After the Commencement Date, Tenant shall, upon demand, execute and deliver to Landlord a letter of acceptance of delivery of the Premises specifying the Commencement Date. Notwithstanding the foregoing, (a) if Landlord is unable to deliver possession of the Premises to Tenant with Landlord's Work substantially completed on or before April 15, 1996 (the "Initial Target Delivery Date"), and such failure is not due in whole or in part to any Force Majeure Event (as defined below) or any act or omission of Tenant or Tenant's Parties, then the Commencement Date shall be delayed by one (1) day for each day of delay beyond the Initial Target Delivery Date that Landlord has failed to deliver possession of the Premises to Tenant with Landlord's Work, substantially completed, and (b) if Landlord is unable to deliver possession of the Premises to Tenant with Landlord's Work substantially completed on or before May 15, 1996 (the "Initial Outside Date"), and such failure is not due in whole or in part to any Force Majeure Event or any act or omission of Tenant or Tenant's Parties, then Tenant shall have the right to terminate this Lease by delivering thirty (30) days advance written notice to Landlord within ten (10) days following the Initial Outside Date; provided, however, if Landlord delivers possession of the Premises to Tenant with Landlord's Work substantially completed on or before the expiration of the thirty (30) day period following Tenant's delivery of termination notice, Tenant's termination notice shall be null and void and this Lease shall remain in full force and effect. If Tenant fails to timely deliver any such termination notice within said ten (10) days following the Initial Outside Date, Tenant shall have no further right of termination with respect to the Initial Outside Date and this Lease shall continue in full force and effect. The Initial Target Delivery Date and the Initial Outside Date shall be extended for each day of delay resulting from any Force Majeure Event or any act or omission of Tenant or Tenant's Parties. Notwithstanding the occurrence of any Force Majeure Event, if Landlord fails to deliver possession of the Premises to Tenant with Landlord's Work substantially completed on or before June 15, 1996 ("Ultimate Outside Date"), and such failure is not due in whole or in part to any act or omissions of Tenant or Tenant's Parties (each such day of delay to result in one (1) day of delay of the Ultimate Outside Date), then Tenant shall have the right to terminate this Lease upon ten (10) days advance written notice to Landlord within five (5) days following the Ultimate Outside Date; provided, however, if Landlord delivers the Premises with Landlord's Work substantially completed on or before the expiration of the ten (10) day period following Tenant's delivery of the termination notice, Tenant's termination notice shall be null and void and this Lease shall remain in full force and effect. If Tenant fails to timely deliver any such termination notice within said ten (10) days following the Ultimate Outside Date, Tenant shall have no further right of termination under this Paragraph 1.3. The term "Force Majeure Event" shall mean -4- 6 fire, earthquake, or other acts of God, strikes, boycotts, war, riot, insurrection, embargoes, shortages of equipment, labor or materials, delays in issuance of governmental permits or approvals, weather delays or any other cause beyond the reasonable control of Landlord. 1.4 EARLY ENTRY INTO PREMISES. Tenant may enter into the Premises upon receipt of Landlord's consent, solely for the purpose of installing the Tenant Improvements (as defined in Exhibit "B") and furniture, special flooring or carpeting, trade fixtures, telephones, computers, photocopy equipment, and other business equipment. Such early entry will not advance the Commencement Date so long as Tenant does not commence business operations from any part of the Premises. All of the provisions of this Lease shall apply to Tenant during any early entry, including the indemnity in Paragraph 12.1, but excluding the obligation to pay Rent unless and until Tenant has commenced business operations in the Premises, whereupon Rent shall commence. Landlord may revoke its permission for Tenant's early entry if Tenant's activities or workers unreasonably interfere with the completion of Landlord's Work. If Tenant is granted early entry, Landlord shall not be responsible for any loss, including theft, damage or destruction to any work or material installed or stored by Tenant at the Premises or for any injury to Tenant or its agents, employees, contractors, subcontractors, subtenants, assigns or invitees (collectively, "Tenant's Parties"). Landlord shall have the right to post appropriate notices of non-responsibility and to require Tenant to provide Landlord with evidence that Tenant has fulfilled its obligation to provide insurance pursuant to paragraphs 7(c) and 12.3 of this Lease. 2. RENT AND SECURITY DEPOSIT. 2.1 RENT. Rent (as defined below) shall accrue hereunder from the Commencement Date. The amounts per month provided in Item 5(a) of the Basic Lease Provisions, as adjusted pursuant to Paragraph 2.2 ("Base Rent"), plus the "Additional Rent" (as defined in Paragraph 2.5 below) shall collectively constitute the "Rent". The first full calendar month's Base Rent shall be due and payable upon execution of this Lease in the total amount shown in Item 5(a) of the Basic Lease Provisions. A like monthly installment, subject to the adjustments described herein, shall be due and payable without demand on or before the first day of each calendar month succeeding the Commencement Date during the Term, except that Rent for any fractional calendar month at the commencement or end of the Term shall be prorated on a daily basis. 2.2 ADJUSTMENT OF BASE RENT. Base Rent shall be increased on the first day of the thirteenth (13th), twenty-fifth (25th), thirty- seventh (37th), forty-ninth (49th), sixty-first (61st) and seventy-third (73rd) months as follows:
Month of Term Base Rent 13-24 $25,480.00 per month 25-36 $26,499.20 per month 37-48 $27,559.17 per month 49-60 $28,661.53 per month 61-72 $29,808.00 per month 73-84 $31,000.32 per month
2.3 SECURITY DEPOSIT. Tenant shall deposit with Landlord upon execution of this Lease the sum provided in Item 6 of the Basic Lease Provisions ("Security Deposit"), which sum shall be held by Landlord in its general fund, without obligation for interest, as security for the performance of Tenant's covenants and obligations under this Lease, it being expressly understood and agreed that the Security Deposit is not an advance rental deposit or a measure of Landlord's damages in case of Tenant's default. Upon the occurrence of any event of default by Tenant, -5- 7 Landlord may, without prejudice to any other remedy provided herein or provided by law, use the Security Deposit to the extent necessary to make good any arrears of Rent or other payments due Landlord hereunder, all of which shall be deemed to be Rent, and any other damage, injury, expense or liability caused by such event of default; and Tenant shall pay to Landlord on demand the amount so applied in order to restore the Security Deposit to its original amount. Any remaining balance of the Security Deposit shall be returned by Landlord to Tenant within fourteen (14) days after termination of this Lease, provided all of Tenant's obligations under this Lease have been fulfilled. 2.4 TENANT'S PROPORTIONATE SHARE. "Tenant's Proportionate Share", as used in this Lease, shall mean that portion of the cost of the applicable item that is obtained by multiplying such cost of the applicable item by a fraction, the numerator of which is the rentable square footage of the Premises and the denominator of which is the rentable square footage of the Building, which fraction is set forth as a percentage figure in Item 7 of the Basic Lease Provisions. 2.5 ADDITIONAL RENT. 2.5.1 DEFINITION. In addition to the Base Rent set forth in Paragraph 2.1, Tenant agrees to pay Tenant's Proportionate Share of (a) "Taxes" as defined in and payable by Landlord pursuant to Paragraph 4.1 below, (b) Landlord's costs of providing insurance on the Project pursuant to Paragraph 12.2 below, and (c) "Operating Expenses" as defined in and incurred pursuant to Paragraph 5.1 below (collectively, "Additional Rent"). Notwithstanding the foregoing, Tenant's Proportionate Share of "Controllable Operating Expenses" (defined below) shall not increase by more than eight percent (8% per year ("Controllable Operating Expense Cap"), provided such Controllable Operating Expense Cap shall be cumulative and compounded annually. "Controllable Operating Expenses" shall mean all Operating Expenses other than (i) Taxes, (ii) insurance expenses, (iii) utility expenses, and (iv) labor cost increases resulting from unionized labor or prevailing wage agreements (each of which items shall not be subject to the Controllable Operating Expense Cap). 2.5.2 MONTHLY PAYMENTS AND ANNUAL RECONCILIATION. On the first day of each month of the Term, Tenant shall pay Landlord a sum equal to 1/12 of the estimated amount of Additional Rent for that particular year based on Landlord's reasonable estimate thereof, to be delivered to Tenant on or about April of each year during the Term. The monthly payments are subject to increase or decrease as determined by Landlord to reflect revised estimates of such costs. Tenant shall pay within ten (10) days following demand therefor by Landlord any increases in estimated Additional Rent upon receipt of any initial or revised estimate retroactive to January of that calendar year. The payments made by Tenant shall be reconciled annually (Landlord to use commercially reasonable efforts to deliver such reconciliation statement on or about May 1 of each year). If Tenant's total payments of Additional Rent are less than the actual Additional Rent due under Paragraph 2.5.1, Tenant shall pay the difference within ten (10) days following demand therefor by Landlord; if the total payments of Additional Rent made by Tenant are more than the actual Additional Rent due under Paragraph 2.5.1, Landlord shall retain such excess and credit it to Tenant's next accruing Additional Rent payments, except at the end of the Term, when any excess will be refunded. Any failure or delay by Landlord in delivering any estimate, demand or reconciliation shall not affect the rights and obligations of the parties hereunder. 2.5.3 TENANT'S AUDIT RIGHTS. Provided that Tenant is not then in default beyond any applicable cure period of its obligations to pay Rent, or any other payments required to be made by it under this Lease and provided further that Tenant -6- 8 shall have the right, once each calendar year, to reasonably review supporting data for any portion of an actual statement of annual Operating Expenses delivered by Landlord (the "Actual Statement") (provided, however, Tenant may not have an audit right to all documentation relating to Building operations an this would far-exceed the relevant information necessary to properly document a pass-through billing statement, but real estate tax statements, and information an utilities, repairs, maintenance and insurance will be available), in accordance with the following procedure: (i) Tenant shall, within thirty (30) days after any Actual Statement is delivered, deliver a written notice to Landlord specifying the portions of the Actual Statement that are claimed to be incorrect, and Tenant shall simultaneously pay to Landlord all amounts due from Tenant to Landlord as specified in the Actual Statement. In no event shall Tenant be entitled co withhold, deduct, or offset any monetary obligation of Tenant to Landlord under the Lease (including without limitation, Tenant's obligation to make all payments of Rent and all payments of Tenant's Operating Expenses) pending the completion of and regardless of the results of any review of records under this Paragraph. The right of Tenant under this Paragraph may only be exercised once for any Actual Statement, and if Tenant fails to meet any of the above conditions as a prerequisite to the exercise of such right, the right of Tenant under this Paragraph for a particular Actual Statement shall be deemed waived. (ii) Tenant acknowledges that Landlord maintains its records for the project at Landlord's main office and Tenant and Landlord agree that any review of records under this Paragraph shall be conducted by Tenant's internal accountants or an independent firm of certified public accountants selected by Tenant and subject to the reasonable approval of Landlord. Tenant acknowledges and agrees that any records reviewed under this Paragraph constitute confidential information of Landlord, which shall not be disclosed to anyone other than the accountants performing the review, the principals of Tenant who receive the results of the review, and Tenant's accounting employees. The disclosure of such information to any other person, whether or not caused by the conduct of Tenant, shall constitute a material breach of this Lease. Tenant shall pay for the costs of its audit, unless it is conclusively determined in accordance with Section 2.5.3(iii) that Landlord has overstated Operating expenses on the Actual Statement by five percent (5%) or more, in which case Landlord shall pay for Tenant's reasonable out-of-pocket costs incurred in conducting such audit. (iii) Any errors disclosed by the review shall be promptly corrected by Landlord, provided, however, that if Landlord disagrees with any such claimed errors, Landlord shall have the right to cause another review to be made by an independent firm of certified public accountants of national standing. In the event of a disagreement between the two accounting firms (or between Tenant's internal accountants and Landlord's accounting firm, as the case may be), the review that discloses the least amount of deviation from the Actual Statement shall be deemed to be correct. In the event that the results of the review of records (taking into account, if applicable, the results of any additional review caused by Landlord) reveal that Tenant has overpaid obligations for a preceding period, the amount of such overpayment shall be credited against Tenant's subsequent installment obligations to pay the estimated Operating Expense. In the event that such results show that Tenant has underpaid its obligations for a preceding period, the amount of such underpayment shall be paid by Tenant to Landlord with the next succeeding installment obligation of estimated Operating Expense. 2.6 PAYMENT. Tenant shall pay Landlord all amounts due from Tenant to Landlord hereunder, whether for Rent or otherwise,' in lawful money of the United States, at the place designated for the delivery of notices to Landlord pursuant to Paragraph 22.21, without any deduction or offset whatsoever, except as expressly set forth in this Lease to the contrary. 2.7 LATE CHARGES. Tenant acknowledges that late payment by Tenant of any sum owed to Landlord under this Lease will cause Landlord to incur costs not contemplated by this Lease, the exact -7- 9 amounts of which are extremely difficult and impracticable to fix. Such costs include, without limitation, processing and accounting charges, time spent addressing the issue with Tenant, and late charges that may be imposed on Landlord by the terms of any obligation or note secured by any encumbrance covering the Premises. Therefore, if any installment of rent or other payment due from Tenant is not received by Landlord within five (5) days from when due, Tenant shall pay to Landlord an additional sum equal to five percent (5%) of the overdue rent or other payment as a late charge. Late charges shall be deemed Additional Rent. The parties agree that this late charge represents a fair and reasonable estimate of the administrative and other costs that Landlord will incur by reason of a late payment by Tenant. Acceptance of any late payment charge shall not constitute a waiver of Tenant's default with respect to the overdue payment, nor prevent Landlord from exercising any of the other rights and remedies available to Landlord under this Lease, at law or in equity, including, but not limited to, the interest charge imposed pursuant to Paragraph 22.2. 2.8 BASE RENT CREDIT. Provided that Tenant is not in default under any of the terms, covenants or conditions of this Lease, Tenant shall be credited with the payment of one-half (1/2) of the Base Rent due and payable under this Lease for the first (1st) through the tenth (10th) months of the Term, as and when the same becomes due (i.e., the credit shall be in the amount of $12,250.00 per month for each of the first ten (10) months of the Term). No such Base Rent credit shall reduce or limit any Additional Rent or other sum due and payable by Tenant under this Lease. Tenant understands and agrees that the foregoing Base Rent credit is conditioned upon Tenant's not having wrongfully terminated this Lease or Landlord not having. terminated this Lease by reason of Tenant's default hereunder (each such termination, a "Trigger Event"). Accordingly, upon the occurrence of any Trigger Event during any portion of the Base Rent credit period, the foregoing Base Rent credit shall be null and void, and all of the Base Rent which, in the absence of such Base Rent credit, would have been payable during such period up to the date of the Trigger Event shall become immediately due and payable by Tenant, and Tenant shall pay Base Rent during the remainder of such Base Rent credit period as such Base Rent would have become due and payable in the absence of such Base Rent credit provision. 3. USE. 3.1 USE OF PREMISES. Subject to any additional uses or limitations on use contained in Item 8 of the Basic Lease Provisions, the Premises shall be used only for the purpose of receiving, storing, shipping and selling (other than retail) products, materials and merchandise made and/or distributed by Tenant and for such other lawful purposes as may be directly incidental thereto, and for no other use or purpose. Tenant acknowledges that Landlord has not made any representations or warranties with respect to the suitability of the Premises for Tenant's uses. Tenant and Tenant's Parties shall at all times comply with all rules and regulations regarding the Premises, the Building and/or the Project as Landlord may establish from time to time. Landlord shall not be responsible for nor liable to Tenant for any violation and/or enforcement of such rules and regulations by any other tenant of the Project. Tenant shall be responsible for and shall at its own cost and expense obtain any and all licenses and permits necessary for any such use. Tenant shall comply with all governmental laws, ordinances and regulations applicable to the use of the Premises, including, without limitation, the Americans with Disabilities Act of 1990 triggered subsequent to the Commencement Date as a result of Tenant's alterations or use of the Premises. Without limiting the generality of the foregoing, and subject to Paragraph 7 below, Tenant shall at its own cost and expense install and construct all physical improvements to or -8- 10 needed to serve the Premises (but not the exterior of the Building unless triggered by Tenant's alterations or particular use of the Premises) (i) required by any federal, state or local building code or other law or regulation enacted or becoming effective after the Commencement Date, including, but not limited to, special plumbing, railings, ramps and other improvements for use by the handicapped, or (ii) made necessary by the nature of Tenant's use of the Premises; provided, however, that Landlord shall have the option to install and construct such improvements, in which case the cost thereof shall be equitably allocated by Landlord in its reasonable discretion among the benefitted premises, and Tenant, upon demand, shall pay to Landlord, as Additional Rent, such portion of the cost thereof as may be allocated equitably, in Landlord's reasonable discretion, to the Premises. Tenant shall not place a load upon the floor of the Premises which exceeds the load per square foot which such floor was designed to carry and which is allowed by law. Tenant shall promptly comply with all governmental orders and directives for the correction, prevention and abatement of nuisances in or upon, or connected with, the Premises, all at Tenant's sole expense. Tenant shall not permit any objectionable or unpleasant odors, smoke, dust, gas, noise or vibrations to emanate from the Premises, nor take any other action which would constitute a nuisance or would disturb or endanger any other tenants of the Project or unreasonably interfere with their use of their respective premises. Landlord shall be responsible for the exterior of the Building's compliance with the Americans with Disabilities Act of 1990 unless any such compliance requirements are triggered by Tenant's alterations or particular use of the Premises, in which event Tenant shall be responsible for all such compliance. Tenant shall not permit the Premises to be used for any purpose or in any manner (including without limitation any method of storage) which would render the insurance thereon void or the insurance risk more hazardous or cause the state insurance authority to disallow any sprinkler credits. If any increase in the fire and extended coverage insurance premiums paid by Landlord or other tenants for the Project is caused by Tenant's use and occupancy of the Premises, or if Tenant vacates the Premises and causes any increase in such premiums, then Tenant shall pay as additional Rent the amount of such increase to Landlord, and, upon demand by Landlord, correct at Tenant's expense the cause of such disallowance, increased cost, penalty or surcharge to the satisfaction of the particular insurance provider or authority, as applicable. 3.2 HAZARDOUS MATERIALS. Except for the incidental use of certain products for routine cleaning and maintenance of floors, bathrooms, windows, kitchens, and administrative offices on the Premises or Project, and certain oxygen cylinders and adhesives which shall be stored in compliance with all Environmental Laws, which products have been disclosed by Tenant to Landlord in the Environmental Questionnaire (as defined below), Tenant hereby represents, warrants and covenants that Tenant will not produce, use, store or generate any "Hazardous Materials" (as defined below) on, under or about the Premises and/or Project. Tenant has fully and accurately completed Landlord's Pre-Leasing Environmental Exposure Questionnaire ("Environmental Questionnaire"), which is incorporated herein by reference. Tenant shall not cause or permit any Hazardous Material to be brought upon, placed, stored, manufactured, generated, blended, handled, recycled, disposed of, used or released on, in, under or about the Premises and/or Project by Tenant or Tenant's Parties. Tenant shall keep, operate and maintain the Premises in full compliance with all federal, state and local environmental, health and/or safety laws, ordinances, rules, regulations, codes, orders, directives, guidelines, permits or permit conditions currently existing and as amended, enacted, issued or adopted in the future which are applicable to the Premises (collectively, "Environmental Laws"). -9- 11 Landlord shall have the right (but not the obligation) to enter upon the Premises and cure any noncompliance by Tenant with the terms of this Paragraph 3.2 or any Environmental Laws or any release, discharge, spill, improper use, storage, handling or disposal of Hazardous Materials on, under, from, or about the Premises or Project, regardless of the quantity of any such release, discharge, spill, improper use, storage, handling or disposal of Hazardous Materials on or about the Premises or Project, the full cost of which shall be deemed to be Rent and shall be due and payable by Tenant to Landlord immediately upon demand. If Landlord elects to enter upon the Premises and cure any such non-compliance or release, discharge, spill, improper use, storage, handling or disposal of Hazardous Materials on, under, from, or about the Premises or Project, Tenant shall not be entitled to participate in Landlord's activities on the Premises. If any information provided to Landlord by Tenant in the Environmental Questionnaire, or otherwise relating to information concerning Hazardous Materials is false, incomplete, or misleading in any material respect, the same shall be deemed an event of default by Tenant under this Lease. Without limiting in any way Tenant's obligations under any other provision of this Lease, Tenant and its successors and assigns shall indemnify, protect, defend and hold Landlord, its partners, officers, directors, shareholders, employees, agents, lenders, contractors and each of their respective successors and assigns (collectively, the "Indemnified Parties,") harmless from any and all claims, judgments, damages, penalties, enforcement actions, taxes, fines, remedial actions, liabilities, losses, costs and expenses (including, without limitation, reasonable attorneys' fees, litigation, arbitration and administrative proceeding costs, expert and consultant fees and laboratory costs) including, without limitation, damages arising out of the diminution in the value of the Premises or Project or any portion thereof, damages for the loss of the Premises or Project, damages arising from any adverse impact on the marketing of space in the Premises or Project, and sums paid in settlement of claims, which arise during or after the Term in whole or in part as a result of the presence or suspected presence of any Hazardous Materials, in, on, under, from or about the Premises or the Project and/or other adjacent properties due to Tenant's or Tenant's Parties' activities, or failures to act (including, without limitation, Tenant's failure to report any spill or release to the appropriate regulatory agencies), on or about the Premises or Project. For purposes of this Lease, the term "Hazardous Material" means any chemical, substance, material, controlled substance, object, waste or any combination thereof, which is or may be hazardous to human health, safety or to the environment due to its radioactivity, ignitability, corrosiveness, reactivity, explosiveness, toxicity, carcinogenicity, infectiousness or other harmful or potentially harmful properties or effects, including, without limitation, petroleum and petroleum products, benzene, toluene, ethyl benzene, xylenes, waste oil, asbestos, radon, polychlorinated biphenyls (PCBs), degreasers, solvents, and any and all of those chemicals, substances, materials, controlled substances, objects, wastes or combinations thereof which are now or may become in the future listed, defined or regulated in any manner as "hazardous substances", "hazardous wastes", "toxic substances", "solid wastes," or bearing similar or analogous definitions pursuant to any and all Environmental Laws. Notwithstanding anything to the contrary contained in this Lease, Tenant shall not be responsible, in any manner whatsoever, for any violation of Environmental Laws regarding Hazardous Materials located in, on or about the Premises (i) that was not caused or permitted, directly or indirectly, by the acts or omissions of Tenant or any of Tenant's Parties, (ii) that -10- 12 existed in, on or under the Premises prior to Tenant's occupying of the Premises unless caused or exacerbated by any acts or omissions of Tenant or any of Tenant's Parties, (iii) that was caused by Landlord, or its agents, contractors or employees, or (iv) that was caused by third parties unaffiliated with Tenant or any of Tenant's Parties or which migrated onto the Premises from neighboring properties owned and occupied by parties unaffiliated with Tenant or any of Tenant's Parties. 3.3 USE OF COMMON AREAS. Tenant and Tenant's Parties shall have the non-exclusive right, in common with the other parties occupying the Project, to use the grounds, sidewalks, parking areas, driveways and alleys of the Project, subject to such reasonable rules and regulations as Landlord may from time to time prescribe. Tenant and Tenant's Parties may park only up to the maximum number of automobiles shown in Item 9 of the Basic Lease Provisions near the Premises during normal business hours on a non-exclusive basis; provided, however, Tenant shall have the right to park up to seventy-five (75) of such vehicles on an exclusive basis, but only in the area identified on Exhibit "A" as "Tenant's Reserved Parking Area". If any other tenants of the Building are unreasonably encroaching on Tenant's parking rights hereunder, Tenant shall deliver written notice of the same to Landlord, and if Landlord cannot reasonably present further encroachment by the adjacent tenant, Landlord shall reserve up to all 150 parking spaces of Tenant (or such lesser number as is necessary to provide Tenant with use of 150 parking spaces). outside storage, including without limitation, trucks and other vehicles, is prohibited without Landlord's prior written consent, which may be withheld in Landlord's sole and absolute discretion. Tenant shall not succeed to any of Landlord's easement rights over and relating to the Project, nor shall Tenant obtain any rights to common areas, as designated by Landlord, other than those rights specifically granted to Tenant in this Lease. Landlord shall have the sole right of control over the use, maintenance, configuration, repair and improvement of the common area. Landlord may make such changes to the use or configuration of, or improvements comprising, the common area as Landlord may elect without liability to Tenant (including the right to add or eliminate buildings from the Project), subject only to Tenant's vehicular parking rights shown in Item 9 of the Basic Lease Provisions. 4. TAXES. 4.1 PAYMENT OF REAL PROPERTY TAXES. Landlord agrees to pay, before they become delinquent, all real property taxes; current installments of any general or special assessments; license fees, commercial rental taxes, in lieu taxes, levies, charges, penalties or similar impositions imposed by any authority having the direct power to tax, and are paid or incurred by Landlord, including but not limited to, the following: (a) any tax on or measured by Rent received by Landlord from the Project or as against Landlord's business of leasing any of the Project; (b) any assessment, tax, fee, levy or charge imposed by governmental agencies for such services as fire protection, street, sidewalk and road maintenance, transportation, refuse removal and for other governmental services formerly provided without charge to property owners or occupants; (c) assessments due to deed restrictions and/or owner associations; and (d) costs of determining, filing, contesting and appealing any such tax, assessment or charge, including accountants', attorneys' and consultants' fees, but excluding any income, inheritance, estate or corporate franchise taxes of Landlord (collectively, "Taxes"). Taxes shall also include any assessment, tax, fee, levy or charge in substitution, partially or totally, of any assessment, tax, fee, levy or charge previously included within the definition of Taxes. It is hereby acknowledged by Tenant and Landlord that Proposition 13 was adopted by the voters of California in June 1978 and that assessments, taxes, fees, levies -11- 13 and charges may be imposed by governmental agencies for such services as fire protection, street, sidewalk and road maintenance, transportation, refuse removal and other governmental services formerly provided without charge to property owners or occupants. It is the intention of Tenant and Landlord that all such new and increased assessments, taxes, fees, levies and charges, and all similar assessments, taxes, fees, levies and charges be included within the definition of Taxes for purposes of this Lease, and all property tax refunds received by Landlord which relate to periods for which Tenant previously paid Tenant's Proportionate Share of Taxes based on the amount of Taxes without taking into account the refund shall be applied to reduce Tenant's next coming due payment of Taxes. 4.2 LIABILITY FOR ALL PERSONAL PROPERTY TAXES. Tenant shall be liable for all taxes levied or assessed against personal property, furniture, fixtures, above-standard Tenant Improvements and alterations, additions or improvements placed by or for Tenant in the Premises. If any such taxes for which Tenant is liable are levied or assessed against Landlord or Landlord's property and if Landlord elects to pay the same or if the assessed value of Landlord's property is increased by inclusion of personal property, furniture, fixtures, above-standard Tenant Improvements or alterations, additions or improvements placed by or for Tenant in the Premises, and Landlord elects to pay the Taxes based on such increase, Tenant shall pay to Landlord, within ten (10) days of written demand therefor, that portion of the Taxes. 5. LANDLORD'S MAINTENANCE AND REPAIR. 5.1 LANDLORD'S MAINTENANCE. Subject to Tenant's obligation to reimburse Landlord for all costs and expenses incurred by Landlord, Landlord shall maintain and repair the exterior portions of the roof, and the foundation and the structural soundness of the exterior walls of the Building and utility facilities stubbed to the Premises in good condition, reasonable wear and tear excepted. The term "walls" as used herein shall not include windows, glass or plate glass, doors, special store fronts or office entries, unless otherwise specified by Landlord in writing. Landlord shall also maintain, repair and repaint the exterior walls, overhead doors, canopies, entries, handrails, gutters and other exposed parts of the Building as deemed necessary by Landlord to maintain safety and aesthetic standards, and Landlord shall maintain, repair, and operate the common areas of the Project, including but not limited to, mowing grass and general landscaping, maintenance of parking areas, driveways and alleys, parking lot sweeping, paving and restriping, exterior lighting, painting, pest control and window washing. The cost of all of the foregoing, including the cost of all supplies, uniforms, equipment, tools and materials, together with utility costs not otherwise charged directly to Tenant or other tenants, all wages and benefits of employees and independent contractors engaged in the operation, maintenance and repair of the Project, all expenses for security and safety services and equipment, any license, permit and inspection fees required in connection with the operation, maintenance or repair of the Project (but not related to improvements to tenant space), management, consulting, legal and accounting fees of independent contractors engaged by Landlord (but not related to the negotiation or enforcement of leases), other costs and expenses actually incurred by Landlord in connection with the ownership, operation, leasing and management of the Project, and other usual costs and expenses which are typically paid by other landlords to provide on-site operation of industrial, warehouse and service center projects, are collectively referred to herein as "Operating Expenses" and are subject to reimbursement by Tenant in accordance with Paragraph 2.5.1 above. To the extent that an Operating Expense consists of a maintenance or repair (including renovation and refurbishment) expense that is not properly fully deductible as an expense in the year incurred in accordance with generally accepted accounting principles, such expense shall be -12- 14 amortized over its useful life. Any amounts which are amortized shall result in equal payments being included in operating Expenses for the year of expenditure and succeeding years during the amortization period. 5.2 PROCEDURE AND LIABILITY. Tenant shall immediately give Landlord written notice of any defect or the teed for repair of the items for which Landlord is responsible, after which Landlord shall have reasonable opportunity to repair the same or cure such defect. Landlord's liability with respect to any defects, repairs or maintenance for which Landlord is responsible under any of the provisions of this Lease shall be limited to the cost of such repairs or maintenance or the curing of such defect. If Tenant or Tenant's Parties caused any damage necessitating such repair, then Tenant shall pay the cost thereof, upon demand. Tenant hereby waives the benefit of California Civil Code Sections 1941 and 1942, and any other statute providing a right to make repairs and deduct the cost thereof from the Rent. Tenant waives any right to terminate this Lease or offset or abate Rent by reason of any failure of Landlord to make repairs to the Premises. 6. TENANT'S MAINTENANCE AND REPAIR. 6.1 TENANT'S MAINTENANCE. Tenant shall, at its own cost and expense, keep and maintain all parts of the Premises (except those listed as Landlord's responsibility in Paragraph 5.1 above) in good and sanitary condition, ordinary wear and tear excepted, promptly making all necessary repairs and replacements, including but not limited to, windows, glass and plate glass, doors, any special store front or office entry, interior walls and finish work, floors and floor covering, heating and air conditioning systems, dock boards, truck doors, dock bumpers, plumbing work and fixtures, termite and pest extermination, and regular removal of trash and debris. If Tenant shall fail to make any repair for which Tenant is responsible within ten (10) days following notice from Landlord requiring the same, Landlord and its agents and contractors shall have the right, but not the obligation, to enter upon the Premises and perform such repairs, the full cost of which shall be deemed to be Rent and shall be due and payable by Tenant to Landlord immediately within ten (10) days following Landlord's written demand therefor; provided, however, that if such disrepair is not susceptible to cure within such ten (10) day period, Landlord shall not be permitted to perform the same at Tenant's expense so long as Tenant has commenced such repair within such ten (10) day period and thereafter diligently prosecutes the same to completion. In the case of emergency, Landlord, its agents and contractors may enter upon the Premises to perform such repairs without the necessity of prior notice to Tenant. Repairs shall be made in accordance with all applicable laws, including without limitation, the Americans with Disabilities Act of 1990. The cost of maintenance and repair of any common party wall (any wall, divider, partition or any other structure separating the Premises from any adjacent premises occupied by other tenants) shall be shared equally by Tenant and the tenant(s) occupying such adjacent premises. Tenant shall not damage any party wall or disturb the integrity and support provided by any party wall and shall, at its sole cost and expense, promptly repair any damage or injury to any party wall caused by Tenant or Tenant's Parties. 6.2 MAINTENANCE/SERVICE CONTRACTS. Tenant shall, at its own cost and expense, enter into a regularly scheduled preventive maintenance/service contract with a maintenance contractor for servicing all hot water, heating and air conditioning systems and equipment within the Premises. The maintenance contractor and the contract must be approved in writing by Landlord in advance. The service contract shall include all services recommended by the equipment manufacturer within the operation/maintenance manual and shall become effective (and a copy thereof delivered to Landlord) within thirty (30) days following the date Tenant takes possession of the Premises. -13- 15 7. ALTERATIONS. Tenant shall make no alterations, additions or improvements to the Premises (including, without limitation, roof and wall penetrations) or any part thereof without obtaining the prior written consent of Landlord in each instance. Such consent may be granted or withheld in Landlord's reasonable discretion (except if such alterations are of a structural nature or affect the exterior of the Building, in which event Landlord may withhold its consent in its sole and absolute discretion); provided, however, Tenant may make non-mechanical, non-electrical, non-structural alterations to the Premises without the prior written consent of Landlord (but nevertheless requiring advance written notice to Landlord) provided that the cost of such alterations does not exceed $25,000.00 in any one instance or $100,000.00 in the aggregate over the Term; provided further that such alterations do not affect the exterior of the Premises or the Building. Landlord may impose as a condition to such consent such requirements as Landlord may deem necessary, in its reasonable discretion, including, without limitation that: (a) Landlord be furnished with working drawings before work commences; (b) Landlord approve the contractor by whom the work is to be performed; and (c) adequate course of construction and general liability insurance be in place and Landlord be named as an additional insured under the contractor's liability and property insurance policies. All such alterations, additions or improvements must be performed in a good and workmanlike manner in compliance with all laws, rules and regulations, including, without limitation, the Americans with Disabilities Act of 1990, and diligently prosecuted to completion. Tenant shall deliver to Landlord upon commencement of such work, a copy of the building permit with respect thereto, and a certificate of occupancy, if applicable, immediately upon completion of the work. All such work shall be performed so as not to obstruct the access to the premises of any other tenant in the Building or Project. Should Tenant make any alterations without Landlord's prior written consent, or without satisfaction of any of the conditions established by Landlord in conjunction with granting such consent, Landlord shall have the right, in addition to and without limitation of any right or remedy Landlord may have under this Lease, at law or in equity, to require Tenant to remove all or some of the alterations, additions or improvements at Tenant's sole cost and restore the Premises to the same condition as existed prior to undertaking the alterations, or if Tenant shall fail to do so, Landlord may cause such removal or restoration to be performed at Tenant's expense and the cost thereof shall be Additional Rent to be paid by Tenant within ten (10) days following written demand therefor. Subject to the terms of Paragraph 16, Landlord shall have the right to require Tenant, at Tenant's expense, to remove any and all alterations, additions or improvements and to restore the Premises to its prior condition upon the expiration or sooner termination of this Lease. Tenant shall notify Landlord in writing at least ten (10) days prior to the commencement of any such work in or about the Premises, and Landlord shall have the right at any time and from time to time to post and maintain notices of nonresponsibility in or about the Premises. 8. LIENS. Tenant shall have no authority, express or implied, to create or place any lien or encumbrance of any kind or nature whatsoever upon, or in any manner to bind, the interest of Landlord or Tenant in the Premises or to charge the Rent payable hereunder for any claim in favor of any person dealing with Tenant, including those who may furnish materials or perform labor for any construction or repairs. Tenant shall pay or cause to be paid all sums legally due and payable by it on account of any labor performed or materials furnished in connection with any work performed by Tenant on the Premises. Tenant shall discharge of record by payment, bonding or otherwise any lien filed against the Premises on account of any labor performed or materials -14- 16 furnished in connection with any work performed by Tenant on the Premises immediately upon the filing of any claim of lien. Tenant shall indemnify, defend and hold Landlord harmless from any and all liability, loss, cost or expense based on or arising out of asserted claims or liens against the leasehold estate or against the right, title and interest of Landlord in the Project or this Lease arising from the act or agreement of Tenant. Tenant agrees to give Landlord immediate written notice of the placing of any lien or encumbrance against the Premises. Landlord shall have the right, at Landlord's option, of paying and discharging the same or any portion thereof without inquiry as to the validity thereof, and any amounts so paid, including expenses and applicable late charge, shall be Additional Rent immediately due and payable by Tenant upon rendition of a bill therefor; provided, however, with respect to any liens which appear of record and for which Landlord receives written notice during the first ninety (90) days of the Term only, Landlord must provide at least twenty (20) days prior written notice to Tenant before paying and discharging any such lien at Tenant's expense. 9. SIGNS. 9.1 SIGNAGE. Subject to compliance with all laws, rules, regulations, ordinances and CC&Rs, Tenant shall have the nonexclusive right to install a sign of its name on the Building, the exact size, location and appearance of which shall be subject to Landlord's approval. Any and all costs in connection with the fabrication, installation, maintenance and removal of such sign shall be borne by Tenant at its sole cost and expense. Tenant's signage rights contained herein are personal to CHAD Therapeutics, Inc. and may not be assigned under any circumstances, whether voluntarily or involuntarily, except with Landlord's prior written consent, which consent shall not be unreasonably withheld. 9.2 CRITERIA FOR CHANGES. Tenant shall not, without Landlord's prior written consent, which may be withheld in Landlord's sole and absolute discretion: (a) make any changes to or paint the exterior of the Building; (b) install any exterior lights, decorations or paintings; or (c) erect or install any signs, window or door lettering, placards, decorations or advertising media of any type which can be viewed from the exterior of the Premises. All signs, decorations, advertising media, blinds, draperies and other window treatment or bars or other security installations visible from outside the Premises shall be subject to the prior written approval of Landlord as to construction, method of attachment, size, shape, height, design, lighting, color and general appearance. All signs shall be in compliance with all applicable laws and regulations and all covenants, conditions and restrictions relating to the Premises. All signs shall be kept in good condition and in proper operating order at all times. 10. UTILITIES. Tenant shall pay for all separately metered water, gas, heat, light, telephone, sewer and sprinkler charges and for other utilities and services used on or from the Premises, together with any taxes, penalties, surcharges or the like pertaining thereto and any maintenance charges for utilities, and shall furnish all electric light bulbs and tubes. If any utilities serving the Premises are not separately metered, Tenant shall pay to Landlord its proportionate share of the cost thereof as reasonably determined by Landlord. Landlord shall in no event be liable for any damages directly or indirectly resulting from or arising out of the interruption or failure of utility services on the Premises. Tenant shall have no right to terminate this Lease nor shall Tenant be entitled to any abatement in Rent as a result of any such interruption or failure of utility services. No such interruption or failure of utility services shall be deemed to constitute a constructive eviction of Tenant. Notwithstanding the foregoing, if any of the utilities are interrupted and not -15- 17 available ("Interruption") for more than five (5) consecutive business days, then beginning on the sixth (6th) consecutive business day of Interruption through the last day of such Interruption, Tenant shall be entitled to an abatement of Rent, and the Term shall be extended the same number of days, but only if (i) the Interruption is not caused by a casualty covered by Paragraph 11 of this Lease or by an act or omission of Tenant or Tenant's Parties, (ii) Tenant is materially prevented by the Interruption from using and does not use the Premises or any portion thereof, and (iii) Tenant has provided Landlord with written notice of the same. 11. FIRE AND CASUALTY DAMAGE. 11.1 NOTICE OF DESTRUCTION. If the Premises are damaged or destroyed by fire, earthquake or other casualty, Tenant shall give immediate written notice thereof to Landlord. 11.2 LOSS COVERED BY INSURANCE. If at any time prior to the expiration or termination of this Lease, the Premises or the Project are wholly or partially damaged or destroyed, the loss to Landlord from which is fully covered (except for any applicable deductibles) by proceeds of insurance maintained or required to be maintained by Landlord or for Landlord's benefit, which damage renders the Premises totally or partially inaccessible or unusable by Tenant in the ordinary conduct of Tenant's business, then: (a) If all repairs to the Premises or Project can, in Landlord's judgment, be completed within two hundred (200) days following the date of notice to Landlord of such damage or destruction without the payment of overtime or other premiums, and if such damage or destruction is not the result of the negligence or willful misconduct or omission of Tenant or Tenant's Parties (as contemplated in Paragraph 11.4), Landlord shall notify Tenant of the same within sixty (60) days following the date of notice to Landlord of such damage or destruction, and Landlord shall, at Landlord's expense (other than the deductible) (provided Landlord can obtain all necessary governmental permits and approvals therefor at reasonable cost and on reasonable conditions), repair the same, and this Lease shall remain in full force and effect and a proportionate reduction of Rent shall be allowed Tenant for such portion of the Premises as shall be rendered inaccessible or unusable to Tenant during the period of time that such portion is unusable or inaccessible. There shall be no proportionate reduction of Rent by reason of any portion of the Premises being unusable or inaccessible for a period equal to five (5) consecutive business days or less. (b) If such damage or destruction is not the result of the negligence or willful misconduct or omission of Tenant or Tenant's Parties, and if all such repairs cannot, in Landlord's judgment, be completed within two hundred (200) days following the date of notice to Landlord of such damage or destruction without the payment of overtime or other premiums, Landlord shall notify Tenant of the same within sixty (60) days following the date of notice to Landlord of such damage or destruction, in which event either party may, at its sole and absolute option, by written notice to the other given within twenty (20) days following the date of Landlord's notice to Tenant stating that all such repairs cannot in Landlord's judgment, be completed within said two hundred (200) days, terminate this Lease as of the date of the occurrence of such damage or destruction; provided, however, if neither party elects to terminate this Lease within said twenty (20) day period, then this Lease shall remain in full force and effect, but the Rent shall be proportionately reduced as provided in Paragraph 11.2(a). Notwithstanding anything to the contrary contained in this Paragraph 11, Tenant shall pay to Landlord, within ten (10) days following Landlord's demand therefor, the amount of the -16- 18 deductible under Landlord's insurance policy (Tenant's Proportionate Share of which shall not exceed (i) $25,000.00 per occurrence for casualties covered under Landlord's all risk property insurance, and (ii) $100,000.00 per occurrence under Landlord's earthquake coverage, if any). If the damage involves portions of the Project other than the Premises, Tenant shall pay only a portion of the deductible based on the ratio of the cost of repairing the damage in the Premises to the total cost of repairing all of the damage in the Project. 11.3 LOSS NOT COVERED BY INSURANCE. If, at any time prior to the expiration or termination of this Lease, the Premises or the Project are totally or partially damaged or destroyed from a risk, the loss to Landlord from which is not fully covered (except for any applicable deductibles) by insurance maintained or required to be maintained by Landlord or for Landlord's benefit, which damage renders the Premises inaccessible or unusable to Tenant in the ordinary course of its business, and if such damage or destruction is not the result of the negligence or willful misconduct or omission of Tenant or Tenant's Parties, Landlord may, at its option, upon written notice to Tenant within thirty (30) days after notice to Landlord of the occurrence of such damage or destruction, elect to repair or restore such damage or destruction, or Landlord may elect to terminate this Lease. If Landlord elects to repair or restore such damage or destruction, this Lease shall continue in full force and effect, but the Rent shall be proportionately reduced as provided in Paragraph 11.2(a). If Landlord elects to terminate this Lease, such termination shall be effective as of the date of the occurrence of such damage or destruction. Notwithstanding anything to the contrary contained in this Paragraph 11.3, if all such repairs cannot, in Landlord's judgment, be completed within two hundred (200) days following the date of notice to Landlord of such damage or destruction without the payment of overtime or other premiums, Landlord shall notify Tenant of the same within sixty (60) days following the date of notice to Landlord of such damage or destruction, in which event either party may, at its sole and absolute option, by written notice to the other given within twenty (20) days following the date of Landlord's notice to Tenant stating that all such repairs cannot, in Landlord's judgment, be completed within said two hundred (200) days, terminate this Lease as of the date of occurrence of such damage or destruction; provided, however, if neither party elects to terminate this Lease within said twenty (20) day period, then this Lease shall remain in full force and effect but the Rent shall be proportionately reduced as provided in Paragraph 11.2(a). 11.4 LOSS CAUSED BY TENANT OR TENANT'S PARTIES. If the Premises or the Project are wholly or partially damaged or destroyed as a result of the negligence or willful misconduct or omission of Tenant or Tenant's Parties, Tenant shall forthwith diligently undertake to repair or restore all such damage or destruction at Tenant's sole cost and expense, or Landlord may at its option undertake such repair or restoration at Tenant's sole cost and expense; provided, however, that Tenant shall be relieved of its repair and payment obligations pursuant to this Paragraph 11.4 to the extent such damage is covered by insurance carried or required to be carried by Landlord hereunder, although Tenant shall in all such events pay to Landlord the full amount of the deductible under Landlord's insurance policy and any amounts not insured. This Lease shall continue in full force and effect without any abatement or reduction in Rent or other payments owed by Tenant. 11.5 DESTRUCTION NEAR END OF TERM. Notwithstanding the foregoing, if the Premises or the Project are wholly or partially damaged or destroyed (such that the same cannot, in Landlord's judgment, be repaired or restored within sixty (60) days) within the final nine (9) months of the Term, either party may, at its option, elect to terminate this Lease upon written notice given -17- 19 to the other within thirty (30) days following such damage or destruction.. 11.6 DESTRUCTION OF IMPROVEMENTS AND PERSONAL PROPERTY. In the event of any damage to or destruction of the Premises or the Project, under no circumstances shall Landlord be required to repair, replace or compensate Tenant, Tenant's Parties or any other person for the personal property, trade fixtures, machinery, equipment or furniture of Tenant or any of Tenant's Parties, or any alterations, additions or improvements installed in the Premises by Tenant, and Tenant shall promptly repair and replace all such personal property and improvements at Tenant's sole cost and expense. 11.7 EXCLUSIVE REMEDY. The provisions of this Paragraph 11 shall constitute Tenant's sole and exclusive remedy in the event of damage or destruction to the Premises or the Project, and Tenant waives and releases all statutory rights and remedies in favor of Tenant in the event of damage or destruction, including without limitation those available under California Civil Code Sections 1932 and 1933(4). No damages, compensation or claim shall be payable by Landlord for any inconvenience, any interruption or cessation of Tenant's business, or any annoyance, arising from any damage or destruction of all or any portion of the Premises or the Project. 11.8 LENDER DISCRETION. Notwithstanding anything herein to the contrary, in the event the holder of any indebtedness secured by a mortgage or deed of trust covering the Premises requires that the insurance proceeds from insurance held by Landlord be applied to such indebtedness, then Landlord shall have the right to deliver written notice to Tenant terminating. this Lease. 12. INDEMNITY AND INSURANCE. 12.1 INDEMNITY. Tenant shall indemnify, protect, defend and hold the Indemnified Parties harmless from any and all claims, judgments, damages, liabilities, losses, sums paid in settlement of claims, costs and expenses (including, but not limited to, reasonable attorneys, fees and litigation costs), obligations, liens and causes of action, whether threatened or actual, direct or indirect (collectively, "Claims"), which arise in any way, directly or indirectly, resulting from or in connection with, in whole or in part, Tenant's or Tenant's Parties' activities in, on or about the Premises or Project, including, without limitation, Tenant's breach or default of any obligation of Tenant to be performed under the terms of this Lease, the conduct of Tenant's business, the nonobservance or nonperformance of any law, ordinance or regulation or the negligence or misconduct of Tenant or Tenant's Parties, except injury to persons or damage to property the sole cause of which is the negligence or willful misconduct of Landlord, or the wrongful failure of Landlord to repair any part of the Project which Landlord is obligated to repair and maintain hereunder within a reasonable time after the receipt of written notice from Tenant of needed repairs. Landlord shall not be liable to Tenant for any damages arising from any act, omission or neglect of any other tenant in the Project. 12.2 LANDLORD'S INSURANCE. Landlord shall maintain (i) fire insurance and extended all risk insurance covering the Building in an amount not less than 100% of the replacement cost thereof, and (ii) such other types (and in amounts) of insurance as Landlord deems necessary or desirable in its sole discretion, which may include, without limitation, liability, property damage and/or loss of rental income coverage. Such insurance shall be for the sole benefit of Landlord and under its sole control. The premiums for any such insurance shall be an Operating Expense. 12.3 TENANT'S INSURANCE OBLIGATIONS. Tenant agrees that at all times from and after the date Tenant is given access to -18- 20 the Premises for any reason, Tenant shall carry and maintain, at its sole cost and expense, the following types, amounts and forms of insurance: 12.3.1 GENERAL LIABILITY INSURANCE. A broad form comprehensive general liability or commercial general liability policy covering property damage, personal injury, advertising injury and bodily injury, and including blanket contractual liability coverage for obligations under this Lease, covering the Project in an amount of not less than the amount per occurrence specified in Item 10 of the Basic Lease Provisions. Such policy shall be in the occurrence form with a per location general aggregate. Each policy shall name Landlord and any management agent from time to time designated by Landlord and any lender of Landlord as additional insureds, and shall provide that any coverage to additional insureds shall be primary; when any policy issued to Landlord provides duplicate coverage or is similar in coverage, Landlord's policy will be excess over Tenant's policies. No deductibles in excess of Five Thousand Dollars ($5,000) per occurrence shall be permitted. Tenant shall pay any deductibles. 12.3.2 PROPERTY INSURANCE. A policy or policies, including the Boiler and Machinery Perils and the Special Causes of Loss form of coverage ("All Risks"), including vandalism and malicious mischief, theft, sprinkler leakage (including earthquake sprinkler leakage) and water damage coverage in an amount equal to the full replacement value, new without deduction for depreciation, on an agreed amount basis (no co-insurance requirement), of all trade fixtures, furniture and equipment in the Premises, and all alterations, additions and improvements to the Premises installed by or for Tenant or provided to Tenant. Such insurance shall also include business interruption and extra expense coverage for Tenant's operations and debris removal coverage for removal of property of Tenant and Tenant's Parties which may be damaged within the Premises. Such coverage shall name the Landlord as an additional insured and/or loss payee as its interest may appear. No deductibles in excess of Five Thousand Dollars ($5,000) shall be permitted. Tenant shall pay any deductibles. 12.3.3 WORKERS' COMPENSATION INSURANCE. Workers' compensation insurance, including employers, liability coverage, shall comply with applicable California law. Such insurance shall include a waiver of subrogation in favor of Landlord, if available. 12.4 EVIDENCE OF COVERAGE. All of the policies required to be obtained by Tenant pursuant to Paragraph 12.3 shall be with companies and in form satisfactory to Landlord. Each insurance company providing coverage shall have a current Best's Rating of "A-XII" or better. Upon notice from Landlord, Tenant shall add any mortgagee of the Building and any management agent designated by Landlord as an additional insured or loss payee, as applicable. Tenant shall provide Landlord with certificates and copies of endorsements (and upon request, policies) of insurance acceptable to Landlord issued by each of the insurance companies issuing any of the policies required pursuant to the provisions of Paragraph 12.3, and said certificates and endorsements shall provide that the insurance issued thereunder shall not be altered, cancelled or non-renewed until after thirty (30) days, written notice to Landlord. "Claims made" policies shall not be permitted. Each policy shall permit the waiver in Section 12.5 below. Evidence of insurance coverage shall be furnished to Landlord prior to Tenant's possession of the Premises and thereafter not fewer than fifteen (15) days prior to the expiration date of any required policy. Tenant may satisfy its insurance obligations hereunder by carrying such insurance under a so-called blanket policy or policies of insurance which are acceptable to Landlord. If Tenant fails to obtain any insurance required hereby or provide evidence thereof to Landlord, Landlord may, but shall not be obligated to, and Tenant hereby appoints -19- 21 Landlord as its agent to, procure such insurance and bill the cost of the-insurance plus a twenty percent (20%) handling charge to Tenant. Tenant shall pay such costs to Landlord as Additional Rent with the next monthly payment of Rent. 12.5 WAIVERS OF SUBROGATION. Landlord waives any and all rights of recovery against Tenant for or arising out of damage to, or destruction of the Building or the Premises to the extent that Landlord's insurance policies then in force or the policies required to be carried by Landlord under the terms of this Lease, whichever is broader, insure against such damage-or destruction and permit such waiver. Tenant waives any and all rights of recovery against Landlord for or arising out of damage to or destruction of any property of Tenant to the extent that Tenant's insurance policies then in force or the policies required by this Lease, whichever is broader, insure against such damage or destruction. 13. LANDLORD'S RIGHT OF ACCESS. Tenant shall permit Landlord and its employees and agents, at all reasonable times upon reasonable notice and at any time (without any requirement of notice) in case of emergency, in such manner as to cause as little disturbance to Tenant as reasonably practicable (a) to enter into and upon the Premises to inspect them, to protect the Landlord's interest therein, or to post notices of non-responsibility, (b) to take all necessary materials and equipment into the Premises, and perform necessary work therein, and (c) to perform periodic environmental audits, inspections, investigations, testing and sampling of the Premises and/or the Project, and to review and copy any documents, materials, data, inventories, financial data, notices or correspondence to or from private parties or governmental authorities in connection therewith. No such work shall cause or permit any rebate of Rent to Tenant for any loss of occupancy or quiet enjoyment of the Premises, or damage, injury or inconvenience thereby occasioned, or constitute constructive eviction. Landlord may at any time place on or about the Building any ordinary "for sale" and "for lease" signs. Tenant shall also permit Landlord and its employees and agents, upon request, to enter the Premises or any part thereof, at reasonable times during normal business hours, to show the Premises to any fee owners, lessors of superior leases, holders of encumbrances on the interest of Landlord under the Lease, or prospective purchasers, mortgagees or lessees of the Project or Building as an entirety. During the period of six (6) months prior to the expiration date of this Lease, Landlord may exhibit the Premises to prospective tenants. 14. ASSIGNMENT AND SUBLETTING. 14.1 LANDLORD'S CONSENT. Tenant shall not assign all or any portion of its interest in this Lease, whether voluntarily, by operation of law or otherwise, and shall not sublet all or any portion of the Premises, including, but not limited to, sharing them, permitting another party to occupy them or granting concessions or licenses to another party, except with the prior written consent of Landlord, which Landlord may withhold for any reasonable condition, including, but not limited to: (a) Tenant is in default of this Lease; (b) the assignee or subtenant is unwilling to assume in writing all of Tenant's obligations hereunder; (c) the assignee or subtenant has a financial condition which is reasonably unsatisfactory to Landlord or Landlord's mortgagee; (d) the Premises will be used for different purposes than those set forth in Paragraph 3 or for a use requiring or generating increased or different Hazardous Materials; (e) the proposed assignee or subtenant or its business is subject to compliance with additional requirements of the law (including related resolutions) commonly known as the Americans with Disabilities Act of 1990 beyond those requirements applicable to Tenant; (f) Tenant proposes to assign less than all of its interest in this Lease or to sublet the Premises in units -20- 22 that are unusually small for the Project; and (g) the assignee or subtenant requires extensive alterations to the Premises. 14.2 FEES. Tenant shall pay Landlord's reasonable attorneys' fees incurred in evaluating any proposed assignment or sublease and documenting Landlord's consent. 14.3 PROCEDURE. Whenever Tenant has obtained an offer to assign any interest in this Lease or to sublease all or any portion of the Premises, Tenant shall provide to Landlord the name and address of said proposed assignee or sublessee, the base rent and all other compensation to be paid to Tenant, the proposed use by the proposed assignee or sublessee, the proposed effective date of the assignment or subletting, and any other business terms which are material to the offer and/or which differ from the provisions of this Lease ("Notice of Offer"). Tenant shall also provide to Landlord the nature of business, financial statement and business experience resume for the immediately preceding five (5) years of the proposed assignee or sublessee and such other information concerning such proposed assignee or sublessee as Landlord may require. The foregoing information shall be in writing and shall be received by Landlord no less than forty-five (45) days prior to the effective date of the proposed assignment or sublease. Within thirty (30) days following its receipt of a Notice of Offer for the proposed assignment or subletting, Landlord shall be entitled to terminate this Lease as to all of the Premises (unless Tenant proposes a sublease of a portion of the Premises, in which event Landlord may terminate this Lease as to such portion) by written notice to Tenant ("Termination Notice"), and such termination shall be effective as of the proposed effective date of the proposed assignment or sublease. If Landlord does not elect to terminate this Lease, Landlord shall either notify Tenant that Landlord consents to the proposed assignment or subletting or withholds its consent for reasons to be specified in the notice. If Landlord does not provide a Termination Notice or a notice withholding its consent to Tenant within thirty (30) days following its receipt of a Notice of Offer, Landlord shall be deemed to have consented to the proposed assignment or subletting. 14.4 BONUS RENT. If any interest in this Lease is assigned or all or any portion of the Premises is subleased, Landlord shall receive all of the "bonus rent" to be realized from such assignment or subletting. The bonus rent shall mean any lump sum payment or other value received by Tenant, plus any base rent, percentage rent or periodic compensation received by Tenant from or for the benefit of an assignee or sublessee in excess of (a) all amounts owed for Rent and other charges pursuant to this Lease, and (b) all reasonable commissions and fees paid to any real estate broker or finder who is unaffiliated with Tenant in connection with the assignment or subletting. If a portion of the Premises is subleased, the amount in clause (a) shall be prorated based on the portion of the Premises, rentable area to be subleased. The bonus rent shall be paid on the first (1st) day of each calendar month next following tenant's receipt of each payment from its assignee or sublessee, after reduction for all amounts described in clauses (a) and (b) above, amortized over the full term of the assignment or sublease. 14.5 CONTINUING TENANT OBLIGATIONS. No subleasing or assignment shall relieve Tenant from liability for payment of all forms of Rent and other charges herein provided or from Tenant's obligations to keep and be bound by the terms, conditions and covenants of this Lease. 14.6 WAIVER, DEFAULT AND CONSENT. The acceptance of Rent from any other person shall not be deemed to be a waiver of any of the provisions of this Lease or a consent to the assignment or subletting of the Premises. Any assignment or sublease without the Landlord's prior written consent shall be voidable, at -21- 23 Landlord's election, and shall constitute a noncurable event of default under this Lease. Consent to any assignment or subletting shall not be deemed a consent to any future assignment or subletting. 14.7 RESTRUCTURING OF BUSINESS ORGANIZATIONS. Any transfer of corporate shares or partnership interests of Tenant, so as to result in a change in the present voting control of Tenant by the person or persons owning a majority of said corporate shares or partnership interests on the date of this Lease (except for trading on an exchange), shall constitute an assignment and shall be subject to the provisions of this Paragraph 14. Notwithstanding the foregoing, an assignment of this Lease by operation of law as a result of a merger or consolidation of Tenant, or an assignment of this Lease in conjunction with (i) the sale of all or substantially all of Tenant's assets, or (ii) a public offering of the stock of Tenant, shall not constitute an assignment of this Lease under this Paragraph 14, provided that, and only so long as, the surviving tenant or assignee has a net worth greater than or equal to that of Tenant as of the date hereof. Notwithstanding the foregoing, an assignment of this Lease to an entity ("Affiliate Entity") which owns, or is owned by, Tenant, shall not constitute an assignment of this Lease under this paragraph 14, provided that (a) such entity owns more than fifty percent (50%) of the outstanding shares of all classes of voting stock of Tenant, or Tenant owns more than fifty percent (50%) of all ownership and controlling interests of such assignee, and (b) in either such case, the assignee has a net worth greater than or equal to that of Tenant as of the date hereof. 14.8 ASSIGNMENT OF SUBLEASE RENT. Tenant immediately and irrevocably assigns to Landlord, as security for Tenant's obligations under this Lease, all rents from any subletting of all or any part of the Premises, and Landlord, as assignee and as attorney-in-fact for Tenant for purposes hereof, or a receiver for Tenant appointed on Landlord's application, may collect such rents and apply same toward Tenant's obligations under this Lease, except that, until the occurrence of an event of default by Tenant, Tenant shall have the right and license to collect such rents. 14.9 ASSIGNMENT IN BANKRUPTCY. If this Lease is assigned to any person or entity pursuant to the provisions of the United States Bankruptcy Code, 11 U.S.C. Section 101 et seq., or such similar laws or amendments thereto which may be enacted from time to time (the "Bankruptcy Code"), any and all monies or other considerations payable or otherwise to be delivered in connection with such assignment shall be paid or delivered to Landlord, shall be and remain the exclusive property of Landlord and shall not constitute property of Tenant or of the estate of Tenant within the meaning of the Bankruptcy Code. Any and all monies or other considerations constituting Landlord's property under the preceding sentence not paid or delivered to Landlord shall be held in trust for the benefit of Landlord and be promptly paid or delivered to Landlord. 14.10 ASSUMPTION OF OBLIGATIONS. Any person or entity to which this Lease is assigned pursuant to the provisions of the Bankruptcy Code shall be deemed, without further act or deed, to have assumed all of the obligations arising under this Lease on and after the date of such assignment. Any such assignee shall upon demand execute and deliver to Landlord an instrument confirming such assumption. 15. CONDEMNATION. 15.1 TOTAL TAKING. If the whole or any substantial part of the Premises or the Project shall be taken or damaged because of the exercise of the power of eminent domain, whether by condemnation proceedings or otherwise, including acts or omissions constituting inverse condemnation, or any transfer of -22- 24 the Premises or Project or portion thereof in avoidance of the exercise of the power of eminent domain (collectively, a "Taking"), and the Taking would prevent or materially interfere with the use of the Premises for the purpose for which they are being used, this Lease shall terminate effective when the physical Taking of the Premises shall occur. 15.2 PARTIAL TAKING. If part of the Premises shall be subject to a Taking and this Lease is not terminated as provided in the Paragraph 15.1 above, this Lease shall not terminate but the Rent payable hereunder during the unexpired portion of this Lease shall be reduced in proportion to the area of the Premises rendered unusable by Tenant. 15.3 CONDEMNATION AWARD. The entire award or compensation for any Taking of the Project and/or the Premises, or any part thereof, or for diminution in value, shall be the property of Landlord, and Tenant hereby assigns its interest in any such award to Landlord; provided, however, Landlord shall have no interest in any separate award made to Tenant for loss of business, for relocation purposes, or for the taking of Tenant's fixtures and improvements. 15.4 EXCLUSIVE REMEDY. This Paragraph 15 shall be Tenant's sole and exclusive remedy in the event of any Taking. Tenant hereby waives the benefits of California Code of Civil Procedure Section 1265.130 or any other statute granting Tenant specific rights in the event of a Taking which are contrary to the provisions of this Paragraph 15. 16. SURRENDER AND HOLDING OVER. 16.1 SURRENDER. Upon the expiration or sooner termination of this Lease, Tenant shall surrender the Premises in as good condition as when received, reasonable wear and tear excepted, broom clean and free of trash and rubbish, and free from all tenancies or occupancies by any person. Tenant shall remove all trade fixtures, furniture, equipment and other personal property installed in the Premises prior to the expiration or earlier termination of this Lease. Unless otherwise provided in Paragraph 7 or waived by Landlord in writing prior to the expiration or earlier termination of this Lease, Tenant shall remove at its sole cost all alterations, additions and improvements (other than the Tenant Improvements, as set forth in the plans delivered by Tenant and received by Landlord prior to the date of this Lease) made by Tenant to the Premises; provided, however, Landlord shall, upon Tenant's written request therefor, notify Tenant in writing at the time of Landlord's written consent (if applicable) whether Landlord will require the removal of such alterations. Alterations, additions and improvements remaining on the Premises at the expiration or earlier termination of this Lease shall become the property of Landlord. Tenant shall, at its own cost, completely repair any and all damage to the Premises and the Building resulting from or caused by such removal. The provisions of Paragraph 7 shall apply to such removal and repair work. 16.2 HOLDING OVER. If Landlord agrees in writing that Tenant may hold over after the expiration or earlier termination of this Lease, unless the parties hereto otherwise agree in writing as to the terms of such holding over, the holdover tenancy shall be subject to termination by Landlord or Tenant at.. any time upon not less than thirty (30) days, prior written notice. If Tenant holds over without the consent of Landlord, the same shall be a tenancy at will terminable at any time, and Tenant shall be liable to Landlord for, and Tenant shall indemnify, protect, defend and hold Landlord harmless from and against, any damages, liabilities, losses, costs, expenses or claims suffered or caused by such holdover, including damages and costs related to any successor tenant of the Premises to whom Landlord could not deliver possession of the Premises when promised. All of the other terms and provisions of this Lease -23- 25 shall be applicable during any holdover period, with or without consent, except that Tenant shall pay to Landlord from time to time upon demand, as Rent for the period of any holdover, an amount equal to one hundred fifty percent (150%) of the then applicable Base Rent plus all Additional Rent in effect on the termination date, computed on a daily basis for each day of the holdover period. No holding over by Tenant, whether with or without consent of Landlord, shall operate to extend this Lease. The preceding provisions of this Paragraph 16.2 shall not be construed as Landlord's consent to any holding over by Tenant. 16.3 ENTRY AT END OF TERM. If during the last month of the Term, Tenant shall have removed substantially all of Tenant's property and personnel from the Premises, Landlord may enter the Premises and repair, alter and redecorate the same, without abatement of Rent and without liability to Tenant, and such acts shall have no effect on this Lease. Tenant shall give written notice to Landlord at least thirty (30) days prior to vacating the Premises and shall arrange to meet with Landlord for a joint inspection of the Premises prior to vacating. In the event of Tenant's failure to give such notice or arrange such joint inspection, Landlord's inspection at or after Tenant's vacation of the Premises shall be conclusively deemed correct for purposes of determining Tenant's responsibility for repairs and restoration. 17. QUIET ENJOYMENT. Landlord represents and warrants that it has full rights and authority to enter into this Lease and that Tenant, upon paying the Rent and performing its other covenants and agreements herein set forth, shall peaceably and quietly have, hold and enjoy the Premises for the Term without hindrance or molestation from Landlord, subject to the terms and provisions of this Lease, any ground lease, any mortgage or deed of trust now or hereafter encumbering the Premises or the Project, and all matters of record. 18. EVENTS OF DEFAULT. The following events shall be deemed to be events of default by Tenant under this Lease: 18.1 FAILURE TO PAY RENT. Tenant shall fail to pay any installment of the Rent herein reserved within five (5) days following written notice that Rent is due, or any other payment or reimbursement to Landlord required herein within five (5) days following written notice that Rent is due. 18.2 INSOLVENCY. Tenant or any guarantor of Tenant's obligations hereunder shall generally not pay its debts as they become due or shall admit in writing the inability to pay its debts or shall make a general assignment for the benefit of creditors. 18.3 APPOINTMENT OF RECEIVER. A receiver or trustee (or similar official) shall be appointed for all or substantially all of the assets of Tenant. 18.4 BANKRUPTCY. The filing of any voluntary petition by Tenant under the Bankruptcy Code, or the filing of an involuntary petition by Tenant's creditors, which involuntary petition remains undischarged for a period of forty-five (45) days. 18.5 ATTACHMENT. The attachment, execution or other judicial seizure or non-judicial seizure of all or substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease or the Premises, if such attachment or other seizure remains undismissed or undischarged for a period of ten (10) business days after the levy thereof. 18.6 INTENTIONALLY OMITTED. -24- 26 18.7 CERTIFICATES. Tenant shall fail to deliver to Landlord any subordination agreement within the time limit prescribed iii Paragraph 21 below, or a Certificate of occupancy, all financial statements or an estoppel certificate within the time limits prescribed in Paragraph 22.7 below. 18.8 FAILURE TO DISCHARGE LIENS. Tenant shall fail to discharge any lien placed upon the Premises in violation of Paragraph 8 hereof. 18.9 FALSE FINANCIAL STATEMENT. Landlord discovers that any financial statement given to Landlord by Tenant, any assignee, subtenant or successor in interest of Tenant, or any guarantor of Tenant's obligations hereunder, or any of them, was materially false when given to Landlord. 18.10 FAILURE TO COMPLY WITH LEASE TERMS. Tenant shall fail to comply with any other term, provision or covenant of this Lease, and shall not cure such failure within twenty (20) days after written notice thereof to Tenant; provided, however, if the nature of the obligation is such that it cannot be cured within twenty (20) days, Tenant shall not be in default so long as it commences performance of such cure with all diligence (and in no event later than 20 days) and thereafter diligently prosecutes the same to completion. 19. LANDLORD'S REMEDIES. Upon the occurrence of any event of default, Landlord may, at its option without further notice or demand and in addition to any other rights and remedies hereunder or at law or in equity, do any or all of the following: 19.1 TERMINATION. Terminate Tenant's right to possession of the Premises by any lawful means upon at least 3 days' written notice (which notice may be satisfied by any notice which may be given by Landlord pursuant to Paragraph 18, if applicable), in which case Tenant shall immediately surrender possession of the Premises to Landlord and, in addition to any rights and remedies Landlord may have at law or in equity, Landlord shall have the following rights: (a) To re-enter the Premises then or at any time thereafter and remove all persons and property and possess the Premises, without prejudice to any other remedies Landlord may have by reason of Tenant's default or of such termination, and Tenant shall have no further claim hereunder. (b) To recover all damages incurred by Landlord by reason of the default, including without limitation (i) the worth at the time of the award of the payments owed by Tenant to Landlord under this Lease that were earned but unpaid at the time of termination; (ii) the worth at the time of the award of the amount by which the payments owed by Tenant to Landlord under the Lease that would have been earned after the date of termination until the time of the award exceeds the amount of the loss of payments owed by Tenant to Landlord under this Lease for the same period that Tenant proves could have been reasonably avoided; (iii) the worth at the time of the award of the amount by which the payments owed by Tenant to Landlord for the balance of the Term after the time. of the award exceeds the amount of the loss of payments owed by Tenant for the same period that Tenant proves could have been reasonably avoided; (iv) all costs incurred by Landlord in retaking possession of the Premises and restoring them to good order and condition; (v) all costs, including without limitation brokerage commissions, advertising costs and restoration and remodeling costs, incurred by -25- 27 Landlord in reletting the Premises; plus (vi) any other amount, including without limitation reasonable attorneys' fees and audit expenses, necessary to compensate Landlord for all detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom. "The worth at the time of the award," as used in clauses (i) and (ii) of this paragraph, is to be determined by computing interest as to each unpaid payment owed by Tenant to Landlord under the Lease, at the highest interest rate permitted by law. "The worth at the time of the award," as referred to in clause (iii) of this paragraph, is to be determined by discounting such amount, as of the time of award, at the discount rate of the San Francisco Federal Reserve Bank, plus 1%. (c) To remove, at Tenant's sole risk, any and all personal property in the Premises and place such in a public or private warehouse or elsewhere at the sole cost and expense and in the name of Tenant. Any such warehouser shall have all of the rights and remedies provided by law against Tenant as owner of such property. If Tenant shall not pay the cost of such storage within thirty (30) days following Landlord's demand, Landlord may, subject to the provisions of applicable law, sell any or all such property at a public or private sale in such manner and at such times and places as Landlord deems proper, without notice to or demand upon Tenant. Tenant waives all claims for damages caused by Landlord's removal, storage or sale of the property and shall indemnify and hold Landlord free and harmless from and against any and all loss, cost and damage, including without limitation court costs and attorneys' fees. Tenant hereby irrevocably appoints Landlord as Tenant's attorney-in-fact, coupled with an interest, with all rights and powers necessary to effectuate the provisions of this subparagraph. 19.2 CONTINUATION OF LEASE. Maintain Tenant's right to possession, in which case this Lease shall continue in effect whether or not Tenant shall have abandoned the Premises. In such event, Landlord may enforce all of Landlord's rights and remedies under this Lease, including the right to recover rent as it becomes due hereunder, and, at Landlord's election, to re-enter and relet the Premises on such terms and conditions as Landlord deems appropriate. Without limiting the generality of the foregoing, Landlord shall have the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has right to sublet or assign, subject only to reasonable limitations). If Landlord relets the Premises or any portion thereof, any rent collected shall be applied against amounts due from Tenant. Landlord may execute any lease made pursuant hereto in its own name, and Tenant shall have no right to collect any such rent or other proceeds. Landlord's reentry and/or reletting of the Premises, or any other acts, shall not be deemed an acceptance of surrender of the Premises or Tenant's interest therein, a termination of this Lease or a waiver or release of Tenant's obligations hereunder. Landlord shall have the same rights with respect to Tenant's improvements and personal property as under Paragraph 19.1 above, even though such re-entry and/or reletting do not constitute acceptance of surrender of the Premises or termination of this Lease. 19.3 APPOINTMENT OF RECEIVER. Cause a receiver to be appointed in any action against Tenant and to cause such receiver to take possession of the Premises and to collect the rents or bonus rent derived therefrom. The foregoing shall not constitute -26- 28 an election by Landlord to terminate this Lease unless specific notice of such intent is given. 19.4 LATE CHARGE. Subject to the terms of Paragraph 2.7, charge late charges. 19.5 INTEREST. Subject to the terms of Paragraph 22.2, charge interest on any amount not paid when due. Interest shall accrue from the date funds are first due or, if the payment is for funds expended by Landlord on Tenant's behalf, from the date Landlord expends such funds. 19.6 ATTORNEYS' FEES. Collect, upon demand, all reasonable attorneys' fees and expenses incurred by Landlord in enforcing its rights and remedies hereunder. 19.7 INJUNCTION. To restrain by injunction or other equitable means any breach or anticipated breach of this Lease. 20. TENANT'S REMEDIES. 20.1 LANDLORD'S DEFAULT. Landlord shall not be in default under this Lease unless Landlord fails to perform obligations required of Landlord within sixty (60) days after written notice is delivered by Tenant to Landlord and to the holder of any mortgages or deeds of trust (collectively, "Lender") covering the Premises whose name and address shall have theretofore been furnished to Tenant in writing, specifying the obligation which Landlord has failed to perform; provided, however, that if the nature of Landlord's obligation is such that more than sixty (60) days are required for performance, then Landlord shall not be in default if Landlord or Lender commences performance within such sixty (60) day period and thereafter diligently prosecutes the same to completion. All obligations of Landlord hereunder shall be construed as covenants, not conditions. 20.2 TENANT'S REMEDIES. In the event of any default, breach or violation of Tenant's rights under this Lease by Landlord, Tenant's exclusive remedies shall be an action for specific performance or action for actual damages. Tenant hereby waives the benefit of any laws granting it the right to perform Landlord's obligation, a lien upon the property of Landlord and/or upon Rent due Landlord, or the right to terminate this Lease or withhold Rent on account of any Landlord default. Notwithstanding the foregoing, if Landlord fails to make any repair required of Landlord under this Lease within the time period specified in Paragraph 20.1 above, then five (5) business days following Landlord's receipt of a new written notice from Tenant stating that such failure remains uncured (and provided such cure has not then been performed), Tenant may cause such repairs (other than work affecting the structural integrity of the Building) to be made, and Landlord shall reimburse Tenant for the reasonable cost thereof within thirty (30) days of Landlord's receipt of paid invoices for such repairs. 20.3 NON-RECOURSE. Notwithstanding anything to the contrary in this Lease, any judgment obtained by Tenant or any of Tenant's Parties against Landlord or any Indemnified Parties shall be satisfied only out of Landlord's interest in the Building and the legal parcel of land on which it sits. Neither Landlord nor any Indemnified Parties shall have any personal liability for any matter in connection with this Lease or its obligations as Landlord of the Premises, except as provided above. Tenant shall not institute, seek or enforce any personal or deficiency judgment against Landlord or any Indemnified Parties, and none of their property shall be available to satisfy any judgment hereunder, except as provided in this Paragraph 20.3. 20.4 SALE OF PREMISES. In the event of any sale or transfer of the Premises (and provided that any security deposit held by the seller, transferor or assignor (collectively, -27- 29 "Seller") is delivered or credited to the purchaser, transferee or assignee (collectively, "Purchaser"), the Seller shall be and hereby is entirely freed and relieved of all agreements, covenants and obligations of Landlord thereafter to be performed and it shall be deemed and construed without further agreement between the parties or their successors in interest or between the Seller and the Purchaser on any such sale, transfer or assignment that such Purchaser has assumed and agreed to carry out any and all agreements, covenants and obligations of Landlord hereunder. 21. MORTGAGES. Tenant accepts this Lease subject and subordinate to any ground lease, mortgage and/or deed of trust now or at any time hereafter constituting a lien or encumbrance upon the Premises; provided, however, with respect to future mortgages, such subordination is conditioned upon Tenant receiving a nondisturbance agreement (on such mortgagee's then standard form). Notwithstanding any such subordination, Tenant's right to quiet possession of the Premises shall not be disturbed if Tenant is not in default and so long as Tenant shall pay the Rent and observe and perform all of its obligations hereunder, unless this Lease is otherwise terminated pursuant to its terms. If any ground lessor, mortgagee or beneficiary under a deed of trust elects to have Tenant's interest in this Lease superior to any such instrument, then by notice to Tenant from such ground lessor, mortgagee or beneficiary, this Lease shall be deemed superior to such ground lease or lien, whether this Lease was executed before or after said ground lease, mortgage or deed of trust. Tenant shall at any time hereafter on demand execute any instruments, releases or other documents which may be required by any ground lessor or mortgagee for the purpose of attornment or subjecting and subordinating this Lease to any ground lease or the lien of any such mortgage; provided, however, the foregoing obligation of Tenant to execute a subordination agreement is conditioned upon such subordination agreement also containing a nondisturbance provision. Tenant's failure to execute each instrument, release or document within ten (10) days after written demand shall constitute an event of default by Tenant hereunder without further notice to Tenant, or at Landlord's option Landlord shall execute such instrument, release or document on behalf of Tenant as Tenant's attorney-in-fact. Tenant does hereby make, constitute and irrevocably appoint Landlord as Tenant's attorney-in-fact, coupled with an interest, and in Tenant's name, place and stead, to execute such documents in accordance with this Paragraph 21. Landlord hereby agrees to use all commercially reasonable efforts to provide Tenant, within forty-five (45) days following the mutual execution and delivery of this Lease (the "SNDA Outside Date"), with a subordination, nondisturbance and attornment agreement ("SNDA") from the current beneficiary of the deed of trust encumbering the Building, provided that Landlord's sole obligation shall be to provide the SNDA on such current beneficiary's then current standard form. If Landlord is unable to deliver the SNDA to Tenant on or before the SNDA Outside Date, and such failure is not due in whole or in part to any act or omission of Tenant or Tenant's Parties, then for each day of delay in Landlord's delivery to Tenant of the SNDA beyond the SNDA Outside Date which actually causes a delay in the construction of the Tenant Improvements, the Commencement Date shall be delayed by one (1) day. 22. GENERAL PROVISIONS. 22.1 SINGULAR AND PLURAL. 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. 22.2 INTEREST ON PAST-DUE OBLIGATIONS. Except as expressly herein provided to the contrary, any amount due to Landlord not paid within five (5) days from when due shall bear -28- 30 interest at the maximum rate then allowable by law from the date due. Payment of such interest shall not excuse or cure any default by Tenant under this Lease, provided, however, that interest shall not be payable on late charges incurred by Tenant. 22.3 TIME OF ESSENCE. Time is of the essence. 22.4 BINDING EFFECT. The terms, provisions and covenants and conditions contained in this Lease shall apply to, inure to the benefit of, and be binding upon, the parties hereto and upon their respective heirs, legal representatives, successors and permitted assigns, except as otherwise herein expressly provided. 22.5 CHOICE OF LAW. This Lease shall be governed by the laws of the State of California applicable to contracts made and to be performed in such state. 22.6 CAPTIONS. The captions inserted in this Lease are for convenience only and in no way define, limit or otherwise describe the scope or intent of this Lease, or any provision hereof, or in any way affect the interpretation of this Lease. 22.7 CERTIFICATES. Tenant agrees from time to time within ten (10) days after request of Landlord, to deliver to Landlord, or Landlord's designee, a Certificate of Occupancy for work performed by Tenant or Tenant's Parties in the Premises, annual financial statements for each of the previous three (3) fiscal years of Tenant, and an estoppel certificate stating that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect), the date to which Rent has been paid, the unexpired Term of this Lease and such other matters pertaining to this Lease as may be requested by Landlord or Landlord's designee. Any such certificate may be conclusively relied upon by Landlord or Landlord's designee. At Landlord's option, Tenant's failure to timely deliver such certificate shall be an event of default by Tenant, without further notice to Tenant, or it shall be conclusive upon Tenant that this Lease is in full force and effect, without modification except as may be represented by Landlord, that there are no uncured defaults in Landlord's performance, and that not more than one (1) month's rent has been paid in advance. 22.8 AMENDMENTS. This Lease may not be altered, changed or amended except by an instrument in writing signed and dated by both parties hereto. Tenant agrees to make such reasonable modifications to this Lease as may be required by any lender in connection with the obtaining of financing or refinancing of the Project or any portion thereof. 22.9 ENTIRE AGREEMENT. This Lease constitutes the entire understanding and agreement of Landlord and Tenant with respect to the subject matter of this Lease, and contains all of the covenants and agreements of Landlord and Tenant with respect thereto, and supersedes all prior agreements or understandings. Landlord and Tenant each acknowledge that no representations, inducements, promises or agreements, oral or written, have been made by Landlord or Tenant, or anyone acting on behalf of Landlord or Tenant, which are not contained herein, and any prior agreements, promises, negotiations, or representations not expressly set forth in this Lease are of no force or effect. 22.10 WAIVERS. The waiver by Landlord of any term, covenant, agreement or condition herein contained shall not be deemed to be a waiver of any subsequent breach of the same or any other term, covenant, agreement or condition herein contained, nor shall any custom or practice which may arise between the parties in the administration of this Lease be construed to waive or lessen the right of Landlord to insist upon the performance by Tenant in strict accordance with all of the provisions of this Lease. The subsequent acceptance of Rent hereunder by Landlord -29- 31 shall not be deemed to be a waiver of any preceding breach by Tenant of any provisions, covenant, agreement or condition of this Lease, other than the failure of Tenant to pay the particular Rent so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such Rent. 22.11 ATTORNEYS' FEES. If either Landlord or Tenant commences or engages in, or threatens to commence or engage in, an action by or against the other party arising out of or in connection with this Lease or the Premises, including but not limited to any action for recovery of Rent due and unpaid, to recover possession or for damages for breach of this Lease, the prevailing party shall be entitled to have and recover from the losing party reasonable attorneys' fees and other costs incurred in connection with the action, preparation for such action, any appeals relating thereto and enforcing any judgments rendered in connection therewith. If Landlord becomes involved in any action, threatened or actual, by or against anyone not a party to this Lease, but arising by reason of or related to any act or omission of Tenant or Tenant's Parties, Tenant agrees to pay Landlord's reasonable attorneys, fees and other costs incurred in connection with the action, preparation for such action, any appeals relating thereto and enforcing any judgments rendered in connection therewith. 22.12 MERGER. The voluntary or other surrender of this Lease by Tenant or a mutual cancellation hereof shall not constitute a merger. Such event shall, at the option of Landlord, either terminate all or any existing subtenancies or operate as an assignment to Landlord of any or all of such subtenancies. 22.13 SURVIVAL OF OBLIGATIONS. Paragraphs 2, 3.2, 4.2, 5.2, 8, 12.1, 12.5, 15.3, 16, 19, 20 and 22 and all obligations of Tenant hereunder not fully performed as of the expiration or earlier termination of the Term shall survive the expiration or earlier termination of the Term, including without limitation, all payment obligations with respect to Rent and all obligations concerning the condition of the Premises. Upon the expiration or earlier termination of the Term, and prior to Tenant vacating the Premises, Tenant shall pay to Landlord any amount reasonably estimated by Landlord (i) as necessary to perform Tenant's duties under paragraphs 6.1 and 16.1 and put the Premises, including without limitation, all heating and air conditioning systems and equipment therein, in good condition and repair, and (ii) as sufficient to meet Tenant's obligation hereunder for prorated Additional Rent for the year in which the Lease expires or terminates. All such amounts shall be used and held by Landlord for payment of such obligations, with Tenant being liable for any additional costs therefor upon demand by Landlord, or with any excess to be returned to Tenant after all such obligations have been determined and satisfied as the case may be. Any Security Deposit held by Landlord shall be credited against the amounts payable by Tenant under this Paragraph 22.13. 22.14 SEVERABILITY. If any clause or provision of this Lease is illegal, invalid or unenforceable under present or future laws effective during the Term, the remainder of this Lease shall not be affected thereby, and in lieu of each clause or provision of this Lease that is illegal, invalid or unenforceable, there shall be added as a part of this Lease a clause or provision as similar in terms to such illegal, invalid or unenforceable clause or provision as may be possible and be legal, valid and enforceable. 22.15 SECURITY MEASURES. Tenant hereby acknowledges that the Rent payable to Landlord hereunder does not include the cost of guard service or other security measures, and that Landlord shall have no obligation whatsoever to provide same. Tenant assumes all responsibility for the protection of Tenant, Tenants' Parties and their property from acts of third parties. -30- 32 22.16 EASEMENTS. Landlord reserves to itself the right, from time to time, to grant such easements, rights and dedications that Landlord deems necessary or desirable, and to cause the recordation of parcel maps, easement agreements and covenants, conditions and restrictions, so long as such easements, rights, dedications, maps and covenants, conditions and restrictions do not unreasonably interfere with the permitted use of the Premises by Tenant. Tenant shall sign any of the aforementioned documents upon request of Landlord and failure to do so shall constitute a material breach of this Lease. 22.17 MULTIPLE PARTIES. If more than one person or entity is named as Tenant herein, the obligations of Tenant hereunder shall be the joint and several responsibility of all persons or entities so named. 22.18 CONFLICT. Any conflict between the printed provisions of this Lease and any typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 22.19 NO THIRD PARTY BENEFICIARIES. This Lease is not intended by either party to confer any benefit on any third party, including without limitations any broker, finder, or brokerage firm. 22.20 EFFECTIVE DATE/NONBINDING OFFER. Submission of this Lease for examination or signature by Tenant does not constitute an offer or option for lease, and it is not effective as a lease or otherwise until executed and delivered by both Landlord and Tenant. 22.21 NOTICES. Each provision of this Lease or of any applicable governmental laws, ordinances, regulations and other requirements with reference to the sending, mailing or delivery of any notice or the making of any payment by one party to the other shall be deemed to be complied with when and if the following steps are taken: (a) All Rent and other Payments required to be made hereunder shall be payable to the applicable party hereto as follows: to Landlord at the address set forth in Item 12 of the Basic Lease Provisions, and to Tenant at the Premises, or at such other addresses as the parties may have hereafter specified by written notice. All obligations to pay Rent and/or any other amounts under the terms of this Lease shall not be deemed satisfied until such Rent and other amounts have been actually received by the respective party. (b) Wherever any notice is required or permitted hereunder, such notice shall be in writing. Any notice or document required or permitted to be delivered hereunder shall be deemed to be delivered (i) upon personal delivery; (ii) seventy-two (72) hours after deposit thereof in the United States mail, postage prepaid, certified or registered mail, return receipt requested; (iii) upon confirmation of delivery by Federal Express or other reputable overnight delivery service; or (iv) upon written confirmation of delivery by telegraph, telecopy or other electronic written transmission device; correctly addressed to the parties hereto as follows: if to Tenant before the Commencement Date, then at the address specified in Item 11 of the Basic Lease Provisions; if to Tenant after the Commencement Date, then at the Premises; and if to Landlord, then at the address specified in Item 12 of the Basic Lease Provisions; or at such other address (but no more than one (1) address at a time, except as provided in Paragraph 20.1) as the recipient may theretofore have specified by written notice. 22.22 WATER, OIL AND MINERAL RIGHTS. Landlord reserves all right, title or interest in water, oil, gas or other hydrocarbons, other mineral rights and air and development rights, together with the sole and exclusive right of Landlord to -31- 33 sell, lease, assign or otherwise transfer the same, but without any right of Landlord or any such transferee to enter upon the Premises during the Term except as otherwise provided herein. 22.23 CONFIDENTIALITY. Tenant agrees to keep the Lease and its terms, covenants, obligations and conditions strictly confidential and not to disclose such matters to any other landlord, tenant, prospective tenant, or broker; provided, however, Tenant may provide a copy of this Lease to its attorneys, accountants and bankers, and to a non-party solely in conjunction with Tenant's reasonable and good faith effort to secure an assignee or sublessee for the Premises. 22.24 BROKER'S FEES. Tenant represents and warrants that it has dealt with no broker, agent or other person in connection with this transaction and that no broker, agent or other person brought about this transaction, other than the brokerage firm specified in Item 13 of the Basic Lease Provisions, if any, and Tenant shall indemnify, defend, protect and hold Landlord harmless from and against any claims, losses, liabilities, demands, costs, expenses or causes of action by any other broker, agent or other person claiming a commission or other form of compensation by virtue of having dealt with Tenant with regard to this leasing transaction. 22.25 REMEDIES CUMULATIVE. All rights, privileges and remedies of the parties are cumulative and not alternative or exclusive to the extent permitted by law, except as otherwise provided herein. 22.26 RETURN OF CHECK. If Tenant's check, given to Landlord in payment of any sum, is returned by the bank for nonpayment, Tenant shall pay to Landlord immediately on demand, as Additional Rent, all expenses incurred by Landlord as a result thereof. 22.27 NO RECORDATION OF LEASE. Neither this Lease nor any memorandum hereof may be recorded. 22.28 AUTHORITY. If Tenant is a corporation or partnership, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease. Tenant shall, within thirty (30) days following execution of this Lease, deliver to Landlord evidence of such authority satisfactory to Landlord. 22.29 INTERPRETATION. This Lease shall be construed fairly according to its terms without regard to which party, or which party's attorneys, prepared its form. 22.30 LANDLORD'S APPROVALS. Except where the provisions of this Lease expressly provide that Landlord's consent or approval must be reasonably given, all consents or approvals of Landlord sought or required pursuant to the terms of this Lease may be given or withheld in Landlord's sole and absolute discretion. -32- 34 22.31 ADDITIONAL PROVISIONS. Those additional provisions set forth in Exhibit "C", if any, are hereby incorporated by this reference as if fully set forth herein. LANDLORD: TCEP II PROPERTIES JOINT VENTURE, a Texas joint venture By: TCEP II Properties/First Plaza Limited Partnership, a Texas limited partnership, Co-Venturer By: TCV/TCEP II Properties Limited Partnership, a Texas limited partnership, General Partner By: Trammell Crow Ventures #3, Ltd., a Texas limited partnership, General Partner By: Trammell Crow Ventures Management Company, Inc., a Texas corporation, General Partner By: /s/ JEFFREY C. CHAVEZ Name: JEFFREY C. CHAVEZ Title: VICE PRESIDENT By: Trammell Crow Equity Partners II, Ltd., a Texas limited partnership Co-Venturer By: Trammell Crow Ventures #2, Ltd., a Texas limited partnership, General Partner By: Trammell Crow Ventures #3, Ltd., a Texas limited partnership, General Partner By: Trammell Crow Ventures Management Company, Inc., a Texas corporation, General Partner By: /s/ JEFFREY C. CHAVEZ Name: JEFFREY C. CHAVEZ Title: VICE PRESIDENT TENANT: CHAD THERAPEUTICS, INC., a California corporation By: /s/ CHARLES R. ADAMS Name: CHARLES R. ADAMS Title: CHMN./C.E.O. By: /s/ EARL L. YAGER Name: EARL L. YAGER Title: CFO -33- 35 EXHIBIT "A" CHAD THERAPEUTICS TOTAL PARKING SPACES (150) of which are DESIGNATED PARKING SPACES (75 SPACES) --------------------------------- CHATSWORTH, CA [REPRESENTATION OF PARKING AREA] /x/ = reserved spaces 36 EXHIBIT "B" WORK LETTER AND CONSTRUCTION AGREEMENT (Tenant to Construct Improvements) 1. TENANT'S IMPROVEMENTS. Except as set forth in the Lease to the contrary, Tenant accepts the Premises and existing improvements therein in their "as is" condition. Tenant shall, at its sole cost and expense, furnish and install within the Premises those improvements (the "Tenant Improvements") shown on the plans and specifications finally approved by Landlord and Tenant, pursuant to Paragraph 2 below, in compliance with all applicable codes and regulations. All Tenant Improvements shall be constructed pursuant to this Work Letter and shall be performed by Tenant's general contractor utilizing those subcontractors approved by Landlord in accordance with this Work Letter. 2. PLANS AND SPECIFICATIONS FOR IMPROVEMENTS. 2.1 Tenant shall retain a licensed architect of its choice, subject to Landlord's reasonable approval, to prepare the plans and specifications described hereinafter for the Tenant Improvements. The plans and specifications shall be subject to Landlord's approval, which approval shall not be unreasonably withheld or delayed. 2.2 Promptly following the date of execution of the Lease by Tenant, Tenant shall cause its architect to furnish to Landlord for Landlord's approval space plans sufficient to convey the architectural design of the Premises, including, without limitation, the location of doors, partitions, electrical and telephone outlets, plumbing fixtures, heavy floor loads and other special requirements (collectively, the "Space Plan"). If required by Landlord, Tenant's architect shall consult with Landlord's engineer in preparing the Space Plan and incorporate such engineer's requirements into the Space Plan. The fees of such engineer shall be a Cost of Tenant Improvements (as hereafter defined). If Landlord fails to disapprove the Space Plan within the ten (10) day period following its receipt of the Space Plan, the Space Plan shall be deemed approved. If Landlord shall disapprove of any portion of the Space Plan within such ten (10) day period, Landlord shall advise Tenant of the reasons therefor and shall notify Tenant of the revisions to the Space Plan that are reasonably required by Landlord for the purpose of obtaining approval. Tenant shall thereafter promptly submit to Landlord, for Landlord's approval, a redesign of the Space Plan, incorporating the revisions required by Landlord. If the redesign of the Space Plan is not approved by Landlord within ten (10) days following Landlord's receipt of same, then at Landlord's election, this Lease may be terminated. 2.3 Tenant shall cause its architect to prepare from Tenant's approved Space Plan, complete architectural plans, drawings and specifications promptly after Landlord approves the Space Plan. Such complete plans, drawings and specifications are referred to herein as the "Plans". Tenant's Plans shall (i) be compatible with the Building shell and with the design, construction and equipment of the Building; (ii) comply with all applicable laws and ordinances, and the rules and regulations of all governmental authorities having jurisdiction; (iii) comply with all applicable insurance regulations, and (iv) be consistent with the Space Plan. Tenant shall submit the Plans for the approval of Landlord in the same manner as provided in Subparagraph 2.2 above for approval by Landlord of Tenant's Space Plan. 2.4 Tenant shall cause its architect to provide documentation for all changes to the Plans at the time each change is authorized for construction, pursuant to the -1- 37 requirements of paragraph 6. At the conclusion of construction, Tenant shall cause its architect to update Tenant's plans and specifications as necessary to reflect all changes to the Plans during the course of construction and to issue a set of sepias to the contractor for its review and mark up. Tenant shall cause its architect to review and certify the contractor's marked up plans and provide to Landlord's designated construction representative a "record set" of as-built sepias within thirty (30) days following completion of the Tenant Improvements. Landlord shall have no liability to Tenant or to any other person for errors or omissions in the Plans, Landlord's review being for Landlord's own purposes. Tenant shall rely solely on the advice and experience of Tenant's architect in assuring the accuracy and sufficiency of the Plans for Tenant's purposes. 3. NON-STANDARD TENANT IMPROVEMENTS. 3.1 Subject to obtaining Landlord's prior written consent, which consent shall not be unreasonably withheld or delayed, Tenant may install non-standard floor covering and wall finishes. Such non-standard floor covering and wall finish deviations shall not be of a lesser quality than the improvements delivered to Tenant as of the Commencement Date. 3.2 Landlord shall not be required to approve any non-standard finishes that: (1) do not conform to applicable government regulations or are disapproved by any governmental agency; or (2) are, in Landlord's reasonable opinion, of a nature or quality that are inconsistent with the objectives of Landlord. 4. BUILDING SHELL CHANGES. If the Plans or any amendment thereof or supplement thereto shall require changes in the Building shell, the cost of the Building shell work caused by such Plans, amendment or supplement, shall be charged against Tenant. The preceding sentence shall not be construed as requiring that Landlord must approve any Plans which specify changes in the Building shell. If Building shell work is permitted by Landlord, the cost thereof shall include all architectural and/or engineering fees and expenses in connection therewith, as well as compensation to Landlord for the costs of any delays which arise from such changes. Landlord shall, at its sole cost and expense, repair any defects in the initial construction of the Building shell, and comply with any requirements imposed by any governmental agency pertaining to the Building shell, unless such requirements arise out of laws, codes or ordinances enacted or effective after the Commencement Date, or out of the Tenant Improvements to the Premises or Tenant's use of the Premises. 5. TENANT IMPROVEMENT APPROVAL AND COST. 5.1 Promptly upon completion of the Plans, Tenant shall submit the Plans to Tenant's general contractor to bid the project to subcontractors to determine the cost of construction of the Tenant Improvements. Tenant shall obtain Landlord's prior approval of Tenant's general contractor and the form of contract to be used, such approval not to be unreasonably withheld or delayed. The general contractor and all subcontractors shall be appropriately licensed. The subcontractors shall be chosen from a list provided by Tenant and approved by Landlord. 5.2 Tenant shall be solely responsible for any and all costs incurred in connection with or otherwise arising out of the Tenant Improvements and Tenant shall indemnify, defend, protect and hold Landlord and the Indemnified Parties (as defined in the Lease) harmless from and against any Claims (as defined in the Lease) suffered by Landlord (or any of the Indemnified Parties) which arise in any way out of the construction of the Tenant Improvements including, without limitation, any mechanics liens resulting from Tenant's failure to timely pay the same. -2- 38 5.3 Subject to the terms of Paragraph 16.1 of the Lease, all of the Tenant improvements 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. 6. TENANT CHANGES. Tenant may request a change, addition or alteration in the Tenant Improvements as shown by the Plans after Landlord's final approval of such Plans (a "Change Order") by delivery of a written request to Landlord, for its approval. Tenant's architect shall complete all working drawings necessary to show the change, addition or alteration, and a change Order in form satisfactory to Landlord. Following its approval of the Change Order and any delays in construction occasioned by the Change Order, Landlord shall deliver to Tenant its written approval of the Change Order and authorization to proceed with the work as shown by the Change Order. Landlord may decline any proposed Change Order if the change is inconsistent with the provisions of any of paragraphs 1 through 5 above. 7. CONSTRUCTION OF TENANT IMPROVEMENTS. 7.1 Upon approval by Landlord of the Plans and Tenant's general contractor, Tenant shall cause its general contractor to proceed to secure a building permit and commence construction. 7.2 Subject to the terms of Paragraph 1.3 of the Lease, the Commencement Date shall not be later than July 1, 1996, irrespective of the date Tenant has substantially completed the Tenant Improvements. 7.3 The construction of Tenant Improvements by Tenant and Tenant's general contractor shall comply with all of the following: (i) Tenant shall reimburse Landlord for all costs directly or indirectly related to the Tenant Improvements, including, without limitation: costs of site services, facilities and utilities (such as trash removal, electrical service, etc.); costs of remedying deficient or faulty work or inadequate clean-up done by Tenant or its contractor(s). (ii) All Tenant improvements shall be installed in coordination with Landlord or its designated agents. (iii) Subject to the terms of Paragraph 8 of the Lease, Tenant will promptly pay all contractors, subcontractors and materialmen with respect to the Tenant Improvements and will obtain unconditional lien releases as reasonably required by Landlord within thirty (30) days following Tenant's commencement of business operations from the Premises. 7.4 Tenant shall assure that Tenant's general contractor secures the insurance specified herein, and maintains the same until substantial completion and final acceptance of the work. Certificates of insurance affording evidence of same shall be obtained from Tenant's general contractor by Tenant and delivered to Landlord prior to the commencement of any work by Tenant's general contractor. The required insurance coverage is as follows: (i) Worker's compensation and employer's liability insurance affording 30 days' written notice of cancellation to Landlord. The employer's liability minimum limits required are as follows: Bodily Injury by Accident - $100,000 each accident Bodily Injury by Disease - $500,000 policy limit Bodily Injury by Disease - $100,000 each employee -3- 39 (ii) General liability insurance in the amount of $2,000,000 for each occurrence for bodily injury and/or property damage combined, written on an occurrence basis and including: (a) Premises and operations coverage with X, C and U exclusions deleted, if any. (b) Owner's and contractor's protective coverage. (c) Products and completed operations coverage. (d) Blanket contractual coverage. (e) Personal injury coverage. (f) Broad form property damage coverage, including completed operations. (g) An endorsement naming Landlord as additional insured. (h) An endorsement affording 30 days' prior written notice to Landlord in the event of cancellation or nonrenewal. (i) An endorsement providing that such insurance as is afforded under such policy is primary insurance as respects Landlord, and that any other insurance maintained by Landlord is excess and noncontributing with the insurance required hereunder. (j) An endorsement which states that the general aggregate limit applies separately to each project away from the premises owned by or rented to Tenant's general contractor. No endorsement limiting or excluding a required coverage shall be permitted. No deductible in excess of $5,000 per occurrence shall be permitted. Tenant's general contractor shall be responsible for payment of any deductible. Claims-made coverage shall not be acceptable. (iii) Business auto liability insurance written in the amount of $2,000,000 for each occurrence for bodily injury and/or property damage liability combined, including: (a) Owned autos; (b) Hired autos; (c) Non-owned autos; and (d) An endorsement affording 30 days, prior written notice to Landlord in the event of cancellation or nonrenewal. A certificate and endorsements affording evidence of the coverage required under paragraphs (i) through (iii) must be delivered to Landlord before Tenant's general contractor performs any work at or prepares or delivers materials to the construction site. Tenant shall require its general contractor to cause its subcontractors to provide insurance where Tenant's general contractor would be required to carry insurance under this insurance section and to be responsible for obtaining (and providing to Landlord on request) the appropriate certificates or other evidence of insurance; provided, however, each subcontractor need not carry in excess of One Million Dollars ($1,000,000.00) liability insurance. The requirements for the foregoing insurance shall not derogate from the provisions for -4- 40 indemnification of Landlord by Tenant under this Lease. All insurance, except workers' compensation, maintained by Tenant's general contractor and its subcontractors, shall preclude subrogation claims by the insurer against anyone insured thereunder. Tenant's general contractor shall maintain all of the foregoing insurance coverage in force until the work under this Work Letter and Construction Agreement is fully completed and accepted except as to products and completed operations liability coverage with amendments specified in 7.4(i) above, which shall be maintained in force until such time as an action on account of any matter covered by such insurance is barred by any applicable statute of limitations. This insurance obligation shall survive the expiration or termination of this Lease. If Tenant fails to secure and maintain the required insurance from Tenant's general contractor, Landlord shall have the right (but without any obligation to do so) to secure same in the name and for the account of Tenant's general contractor, in which event Tenant shall pay the cost thereof, together with a twenty percent (20%) servicing fee, as Additional Rent and shall furnish upon demand all information that may be required in connection therewith. 8. MISCELLANEOUS. 8.1 Landlord may impose such rules and regulations regarding the construction of the Tenant Improvements and the conduct of Tenant's general contractor and subcontractors as Landlord may reasonably elect from time to time. If Landlord or its agents discover any work which is either not in substantial conformity with the Plans or not in compliance with any laws or regulations, Landlord may without liability to Tenant require Tenant to stop the work and replace all defective or non-conforming work. 8.2 Any default of Tenant in this Work Letter and Construction Agreement shall constitute a default of Tenant under the Lease, and Landlord's remedies shall be as set forth therein. All provisions of the Lease are fully incorporated in this Exhibit "B" as though set forth herein at length. 8.3 Tenant shall designate one (1) construction representative authorized to act for Tenant upon whom Landlord can rely, and who shall consult with Landlord and Landlord's contractors, employees and agents in connection with the construction of the Tenant Improvements. 8.4 Tenant shall indemnify, defend, protect and hold the Indemnified Parties harmless from all Claims (as defined in the Lease) which arise in any way, directly or indirectly, from or in connection with the design or construction of the Tenant Improvements, including without limitation arising from the work of Tenant's architect, engineer, general contractor, subcontractors, suppliers, laborers, employees or agents. 8.5 Tenant hereby agrees to cause its general contractor to construct a demising wall ("Demising Wall") dividing the Premises from the remaining space within the Building, such Demising Wall to be in accordance with plans and specifications approved by Landlord. In consideration of Tenant's construction of the Demising Wall as described above, Landlord agrees to reimburse Tenant, within thirty (30) days following Landlord's receipt of paid invoices therefor, for all costs incurred by Tenant in connection with the construction of the Demising Wall, but only to the extent such costs exceed $3,223.00, and provided further that in no event shall Landlord's reimbursement obligation hereunder exceed the sum of $9,669.00. -5- 41 EXHIBIT "C" ADDITIONAL LEASE PROVISIONS A. Option to Extend Term. Landlord grants to Tenant one (1) option to extend the Term of this Lease for a sixty (60) month period (the "Option") commencing upon the expiration of the initial Term (or upon the expiration of the preceding Option if any), upon each of the following conditions and terms: 1. Tenant shall give to Landlord, and Landlord shall actually receive, on a date which is at least six (6) months and not more than twelve (12) months prior to the then scheduled expiration date of the Term, a written notice of Tenant's exercise of such Option (the "Option Notice"), time being of the essence. If the Option Notice is not timely so given and received, such Option shall automatically expire. 2. Tenant shall have no right to exercise an Option, notwithstanding any provision hereof to the contrary, (a) during the time commencing from the date Landlord gives to Tenant a notice of default pursuant to Paragraph 18.10 of this Lease and continuing until the noncompliance alleged in said notice of default is cured, or (b) during the period of time commencing on the day after a monetary obligation to Landlord is due from Tenant and unpaid (without any necessity for notice thereof to Tenant) and continuing until the obligation is paid, or (c) if Landlord has given to Tenant three or more notices of default under Paragraph 18.10 of this Lease, whether or not the defaults are cured, or Tenant has been late on three or more occasions in the payment of a monetary obligation to Landlord (without any necessity for notice thereof to Tenant), during the 12 month period of time immediately prior to the time that Tenant attempts to exercise the Option, or (d) if Tenant has committed any noncurable breach, or is otherwise in default of any of the terms, covenants or conditions of this Lease. 3. The period of time within which the Option may be exercised shall not be extended or enlarged by reason of Tenant's inability to exercise an Option because of the provisions of Paragraph A.2 above. 4. All Option rights of Tenant under this Paragraph A. shall terminate and be of no further force or effect, notwithstanding Tenant's due and timely exercise of the Option, if, after such exercise and during the initial Term of this Lease (as and if previously extended), (a) Tenant fails to pay to Landlord a monetary obligation of Tenant for a period of ten (10) days after such obligation becomes due (without any necessity of Landlord to give notice thereof to Tenant), or (b) Tenant fails to commence to cure a default specified in Paragraph 18.10 of this Lease within ten (10) days after the date that Landlord gives notice to Tenant of such default and/or Tenant fails thereafter to diligently prosecute said cure to completion within thirty (30) days after the date of such notice, or (c) Landlord gives to Tenant one (1) or more notices of default under Paragraph 18.10 of this Lease, or Tenant is late on one (1) or more occasions in the payment of a monetary obligation to Landlord (without any necessity of notice thereof to Tenant), whether or not the defaults are cured, or (d) Tenant has committed any incurable breach, or is otherwise in default of any of the terms, covenants and conditions of this Lease. 5. The Option granted to Tenant in this Lease is personal to the original Tenant and may be exercised only by the original Tenant while occupying the Premises who does so without the intent of thereafter assigning this Lease or subletting the Premises or any portion thereof, and may not be exercised or be assigned, voluntarily or involuntarily, by or to any person or entity other than Tenant. The Option herein granted to Tenant is not assignable separate and apart from this Lease, nor may the -1- 42 Option be separated from this Lease in any manner, either by reservation or otherwise. 6. All of the terms and conditions of this Lease except where specifically modified by this Paragraph A shall apply during the extended Term (the "Option Period"). Tenant hereby acknowledges and agrees that Paragraph 2.8 of the Lease (Base Rent Credit) does not apply with respect to the Option Period, and Tenant shall accept the Premises in its "as-is", "where-is" condition without any representations or warranties whatsoever from Landlord during the Option period. 7. The monthly Base Rent payable during the Option period shall be as follows:
Month of Option Period Base Rent ------------- --------- 1-12 $32,240.33 per month 13-24 $33,529.94 per month 25-36 $34,871.14 per month 37-48 $36,265.99 per month 49-60 $37,716.63 per month
-2- EX-13.1 3 EXHIBIT 13.1 1 Exhibit 13.1 NET EARNINGS PER SHARE [GRAPH] SHAREHOLDERS' EQUITY [GRAPH] TOTAL ASSETS [GRAPH] SELECTED FINANCIAL DATA
YEARS ENDED MARCH 31, ----------------------------------------------------------------- 1996 1995 1994 1993 1992 ----------- ----------- --------- --------- --------- Net Sales $20,359,000 14,518,000 9,470,000 5,805,000 3,232,000 Interest Income 97,000 50,000 28,000 8,000 7,000 Net Earnings 4,310,000 2,606,000 2,053,000 1,237,000 573,000 Earnings Per Common Share .43 .26 .21 .13 .06 Net Working Capital 9,219,000 5,172,000 4,176,000 1,943,000 701,000 Total Assets 10,778,000 6,371,000 5,075,000 2,635,000 1,197,000 Shareholders' Equity 9,775,000 5,574,000 4,507,000 2,180,000 779,000
No cash dividends have been declared or paid during the periods presented. CHAD THERAPEUTICS, INC. 3 2 BALANCE SHEETS - --------------------------------------------------------------------------------
March 31, ------------------------- ASSETS 1996 1995 ----------- ----------- Current Assets: Cash $ 1,809,000 1,219,000 Marketable securities 1,029,000 416,000 Accounts receivable, less allowance for doubtful accounts of $92,000 and $52,000 in 1996 and 1995 2,872,000 2,126,000 Inventories (Note 2) 4,011,000 1,845,000 Income taxes refundable (Note 3) - 84,000 Prepaid expenses 145,000 125,000 Deferred income taxes (Note 3) 356,000 154,000 ----------- ----------- Total current assets 10,222,000 5,969,000 ----------- ----------- Property and equipment, at cost: Office equipment and furniture 478,000 257,000 Machinery and equipment 192,000 145,000 Tooling 303,000 303,000 Leasehold improvements 101,000 101,000 ----------- ----------- 1,074,000 806,000 Less accumulated depreciation and amortization 574,000 460,000 ----------- ----------- Net property and equipment 500,000 346,000 ----------- ----------- Other assets, net 56,000 56,000 ----------- ----------- $10,778,000 6,371,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995 ----------- ----------- Current liabilities: Accounts payable $399,000 514,000 Accrued expenses 424,000 283,000 income taxes payable (Note 3) 180,000 - ----------- ----------- Total current liabilities 1,003,000 797,000 ----------- ----------- Commitments (Note 6) Shareholders' equity (Note 4): Common shares Authorized 40,000,000 shares; 9,623,000 and 9,620,000 shares issued and outstanding 6,791,000 6,832,000 Retained earnings (accumulated deficit) 3,052,000 (1,258,000) ----------- ----------- 9,843,000 5,574,000 Less treasury shares at cost, 5,000 shares at March 31, 1 996 (68,000) - ----------- ----------- Net shareholders' equity 9,775,000 5,574,000 ----------- ----------- $10,778,000 6,371,000 =========== ===========
See accompanying notes to financial statements. 14 CHAD THERAPEUTICS, INC. 3 STATEMENTS OF EARNINGS - --------------------------------------------------------------------------------
Years Ended March 31, --------------------------------------------- 1996 1995 1994 ----------- ---------- --------- Net sales $20,359,000 14,518,000 9,470,000 Cost of sales 8,480,000 6,916,000 4,461,000 ----------- ---------- --------- Gross profit 11,879,000 7,602,000 5,009,000 Costs and expenses: Selling, general and administrative 4,791,000 3,777,000 2,645,000 Research and development 113,000 70,000 11,000 ----------- ---------- --------- Total costs and expenses 4,904,000 3,847,000 2,656,000 ----------- ---------- --------- Operating income 6,975,000 3,755,000 2,353,000 Interest income 97,000 50,000 28,000 ----------- ---------- --------- Earnings before income taxes 7,072,000 3,805,000 2,381,000 Income taxes (Note 3) 2,762,000 1,199,000 328,000 ----------- ---------- --------- Net earnings $ 4,310,000 2,606,000 2,053,000 =========== ========== ========= Net earnings per share $ .43 .26 .21 =========== ========== ========= Weighted average number of common shares and common share equivalents 9,922,000 9,873,000 9,990,000 =========== ========== =========
See accompanying notes to financial statements. CHAD THERAPEUTICS, INC. 15 4 STATEMENTS OF SHAREHOLDERS" EQUITY - ------------------------------------------------------------------------------- For the years ended March 31, 1996, 1995 and 1994
RETAINED COMMON SHARES (NOTE 4) EARNINGS ----------------------------- (ACCUMULATED SHARES AMOUNT DEFICIT) TREASURY SHARES --------- ----------- ------------ --------------- Balance at March 31, 1993 8,924,000 $ 5,021,000 $(2,841,000) $ - 3% Stock Dividend 267,000 552,000 (552,000) - Common Shares Repurchased At Cost - - - (70,000) Common Shares Issued For Purchases Under Employee Benefit Plan (Note 4) - 46,000 - 42,000 Exercise of Stock Options 247,000 98,000 - - Tax Benefit From Exercise of Non-Qualified Stock Options (Note 4) - 158,000 - - Net Earnings - - 2,053,000 - --------- ----------- ----------- --------- Balance at March 31, 1994 9,438,000 5,875,000 (1,340,000) (28,000) Common Shares Issued For Purchases Under Employee Benefit Plan (Note 4) - 44,000 - 28,000 Common Shares Repurchased and Retired (307,000) (1,675,000) - - 5% Stock Dividend 459,000 2,524,000 (2,524,000) - Exercise of Stock Options 30,000 23,000 - - Tax Benefit From Exercise of Non-Qualified Stock Options (Note 4) - 41,000 - - Net Earnings - - 2,606,000 - --------- ----------- ----------- --------- Balance at March 31, 1995 9,620,000 6,832,000 (1,258,000) - Common Shares Repurchased and Retired (71,000) (392,000) - - Common Shares Repurchased At Cost - - - (228,000) Common Shares Issued For Purchases Under Employee Benefit Plan (Note 4) - - - 160,000 Exercise of Stock Options 74,000 187,000 - - Tax Benefit From Exercise of Non-Qualified Stock Options (Note 4) - 164,000 - - Net Earnings - - 4,310,000 - --------- ----------- ----------- --------- Balance at March 31, 1996 9,623,000 $ 6,791,000 $ 3,052,000 $ (68,000) ========= =========== =========== =========
See accompanying notes to financial statements. 16 CHAD THERAPEUTICS, INC. 5 STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH YEARS ENDED March 31, ------------------------------------------ 1996 1995 1994 ----------- ---------- ---------- Cash flows from operating activities: Net earnings $ 4,310,000 2,606,000 2,053,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 114,000 88,000 67,000 Changes in assets and liabilities: Decrease (increase) in accounts receivable (746,000) (696,000) (435,000) Decrease (increase) in inventories (2,166,000) (685,000) (754,000) Decrease (increase) in income taxes refundable 84,000 (27,000) (57,000) Decrease (increase) in prepaid expenses (20,000) (59,000) 17,000 Decrease (increase) in deferred income taxes (202,000) (154,000) -- Decrease (increase) in other assets -- (21,000) (5,000) Increase (decrease) in accounts payable (115,000) 230,000 135,000 Increase (decrease) in accrued expenses 141,000 5,000 47,000 Increase (decrease) in income taxes payable 344,000 35,000 89,000 ----------- ---------- ---------- Net cash provided by operating activities 1,744,000 1,322,000 1,157,000 ----------- ---------- ---------- Cash flows from investing activities: Increase in marketable securities (613,000) (416,000) -- Capital expenditures (268,000) (138,000) (156,000) ----------- ---------- ---------- Net cash (used in) investing activities (881,000) (554,000) (156,000) ----------- ---------- ---------- Cash flows from financing activities: Exercise of stock options 187,000 23,000 98,000 Common shares purchased (620,000) (1,675,000) (70,000) Common shares issued 160,000 72,000 88,000 ----------- ---------- ---------- Net cash provided by (used in) financing activities (273,000) (1,580,000) 116,000 ----------- ---------- ---------- Net increase (decrease) in cash 590,000 (812,000) 1,117,000 Cash beginning of year 1,219,000 2,031,000 914,000 ----------- ---------- ---------- Cash end of year $ 1,809,000 1,219,000 2,031,000 =========== ========== ========== Supplemental disclosure of cash flow information: Cash paid during the year for: Income taxes $ 2,535,000 1,342,000 296,000 =========== ========== ========== Supplemental schedule of noncash investing and financing activities: Tax benefit from exercise of nonqualified stock options $ 164,000 41,000 158,000 =========== ========== ==========
See accompanying notes to financial statements. CHAD THERAPEUTICS, INC. 17 6 NOTES TO FINANCIAL STATEMENTS MARCH 31, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Chad Therapeutics, Inc. (the Company) is in the business of developing, producing and marketing respiratory care devices designed to improve the efficiency of oxygen delivery systems for home health care and hospital treatment of patients suffering from pulmonary diseases. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of financial instruments approximate fair value as of March 31, 1996. The carrying amounts related to cash, accounts receivable, other current assets, accounts payable and accrued expenses approximate fair value due to the relatively short maturity of such instruments. INVENTORIES Inventories are valued at lower of cost (first-in, first-out) or market. DEPRECIATION Depreciation of property and equipment is provided using straight-line methods based on the estimated useful lives of the related assets as follows: Office Equipment and Furniture 5-10 Years Machinery and Equipment 5-10 Years Tooling 3-7 Years
Amortization of leasehold improvements is over the life of the related lease. USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment of merchandise. NET EARNINGS PER COMMON SHARE The net earnings per common share is based upon the weighted average number of shares and common stock equivalents outstanding during the period. All of the share, per share and weighted average number of shares have been retroactively adjusted for a two-for-one stock split distributed on October 15, 1993, to all shareholders of record on October 1, 1993 and a three-for-two stock split distributed on October 16, 1995, to all shareholders of record on October 2, 1995. In addition, the weighted average number of shares has been adjusted for a 3% stock dividend paid on April 14, 1993, to all shareholders of record on March 31, 1993, which resulted in the issuance of 178,406 new shares and a 5% stock dividend paid on October 21, 1994, to shareholders of record on October 7, 1994, which resulted in the issuance of 306,017 new shares. RESEARCH AND DEVELOPMENT COSTS The Company charges all research and development costs to expense when incurred. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are 18 CHAD THERAPEUTICS, INC. 7 recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enacted date. MAJOR CUSTOMER The Company had export sales to one Western European distributor which accounted for approximately 5%, 5% and 7% of net sales during the years ended March 31, 1996, 1995 and 1994, respectively. MARKETABLE SECURITIES The Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities," on April 1, 1994. SFAS 115 requires investments to be classified in one of three categories: held-to-maturity securities, available-for-sale securities, and trading securities. The Company classifies its investments, comprised principally of highly liquid debt instruments with maturities greater than 90 days, as available-for-sale securities. Available-for-sale securities are reported at fair values, which approximates cost. RECLASSIFICATIONS Certain reclassifications have been made to the prior year's balances to conform to the 1996 presentation. NEWLY ISSUED ACCOUNTING STANDARDS In March, 1995, Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of," was issued. This statement provides guidelines for recognition of impairment losses related to long-term assets and is effective for fiscal years beginning after December 15, 1995. Company management does not believe that the adoption of this new standard will have a material effect on the Company's financial statements. In October, 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement No. 123"), was issued. This statement encourages, but does not require, a fair value based method of accounting for employee stock options and will be effective for fiscal years beginning after December 15, 1995. While the Company is still evaluating Statement No. 123, it currently expects to elect to continue to measure compensation costs under APB Opinion No. 25, "Accounting for Stock Issued to Employees" and to comply with the pro forma disclosure requirements of Statement No. 123. If the Company makes this election, Statement No. 123 will have no effect on the Company's financial statements. (2) INVENTORIES At March 31, 1996 and 1995, inventories consisted of the following:
1996 1995 Finished goods $ 787,000 555,000 Work in process 1,532,000 572,000 Raw materials and supplies 1,692,000 718,000 ---------- --------- $4,011,000 1,845,000 ========== =========
CHAD THERAPEUTICS, INC. 19 8 (3) INCOME TAXES The provision for income taxes for fiscal 1996, 1995 and 1994 consists of the following:
1996 1995 1994 ---------- --------- ------- Current: Federal $2,288,000 967,000 115,000 State 676,000 345,000 163,000 ---------- --------- ------- 2,964,000 1,312,000 278,000 Deferred: Federal (181,000) (122,000) 44,000 State (21,000) 9,000 6,000 ---------- --------- ------- (202,000) (113,000) 50,000 ---------- --------- ------- Total $2,762,000 1,199,000 328,000 ========== ========= =======
A reconciliation of the difference between the Company's provision for income taxes and the statutory income tax for the years ended March 31, 1996, 1995 and 1994, respectively, is as follows:
1996 1995 1994 ---------- --------- -------- Statutory tax expense $2,404,000 1,294,000 810,000 Benefit of net carryforward position -- (243,000) (641,000) State income tax 432,000 234,000 108,000 Warranty and other (74,000) (86,000) 51,000 ---------- --------- -------- $2,762,000 1,199,000 328,000 ========== ========= ========
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at March 31, 1996 and 1995 are presented below:
1996 1995 -------- ------- State income taxes 222,000 117,000 Other 134,000 37,000 Total gross deferred tax assets 356,000 154,000 -------- ------- Less valuation allowance -- -- -------- ------- Net deferred tax assets $356,000 154,000 ======== =======
(4) SHAREHOLDERS' EQUITY In 1995 and 1994 the Company purchased its own stock for purposes of funding contributions to the Company's 401(k) plan. Periodically as common shares are sold to the plan, the difference between the cost and fair market value at the date of transfer is credited to shareholders' equity ($44,000 in 1995). The Company has an incentive stock option plan (the Plan) for key employees as defined under Section 422(A) of the Internal Revenue Code. The Plan as amended, provides that 1,465,000 common shares be reserved for issuance under the Plan, which expires on September 10, 2004. In addition, the Plan provides that nonqualified options can be granted to directors and independent contractors of the Company. Transactions involving the stock option plan are summarized as follows: 20 CHAD THERAPEUTICS, INC. 9
OPTION OPTION PRICE SHARES AMOUNT PER SHARE -------- ---------- ------------ Incentive Options: ------------------ Outstanding - March 31, 1993 229,000 $231,000 .077-1.888 Granted 8,000 34,000 4.286 Exercised (115,000) (19,000) .077- .193 -------- ---------- ------------ Outstanding - March 31, 1994 122,000 246,000 1.734-4.286 Granted 386,000 2,308,000 5.238-6.167 Exercised (11,000) (18,000) 1.734 -------- ---------- ------------ Outstanding - March 31, 1995 497,000 6,000 1.734- 6.167 Granted 130,000 1,520,000 5.833-13.875 Exercised (37,000) (89,000) 1.888-5.238 -------- ---------- ------------ Outstanding - March 31, 1996 590,000 $3,967,000 1.734-13.875 ======== ========== ============ Exercisable - March 31, 1996 162,000 $ 681,000 1.734-6.167 ======== ========== ============ Nonqualified Options: --------------------- Outstanding - March 31, 1993 209,000 $ 146,000 .077-1.888 Granted 82,000 383,000 4.047 Exercised (132,000) (79,000) .077-1.888 -------- ---------- ------------ Outstanding - March 31, 1994 159,000 450,000 .193-4.047 Granted 15,000 81,000 5.333 Exercised (19,000) (5,000) .193 -------- ---------- ------------ Outstanding - March 31, 1995 155,000 526,000 .193-5.333 Granted 60,000 775,000 12.917 Exercised (37,000) (98,000) .193-4.048 -------- ---------- ------------ Outstanding - March 31, 1996 178,000 $1,203,000 1.888-12.917 ======== ========== ============ Exercisable - March 31, 1996 85,000 $ 279,000 1.888-5.333 ======== ========== ============
Incentive and nonqualified options were granted at prices not less than 100% of fair market value at dates of grant. Options under the plan become exercisable on the anniversary of the grant date on a prorata basis over a defined period and expire 10 years after the date of grant. To the extent the Company derived a tax benefit from options exercised by employees, such benefit is credited to Common Stock when realized on the Company's income tax returns. (5) EMPLOYEE BENEFIT PLAN In December, 1992, the Company adopted a defined contribution profit sharing plan, including features under Section 401(k) of the Internal Revenue Code. The purpose of the plan is to provide an incentive for employees to make regular savings for their retirement. Company contributions to the profit sharing plan are discretionary and are determined by the Board of Directors. The Company has accrued and paid $71,000, $48,000, and $41,000 of the plan contributions during 1996, 1995 and 1994, respectively. (6) COMMITMENTS The Company is currently leasing its administrative and plant facilities and certain office equipment under noncancellable operating leases which expire through June, 2003. The Company's minimum annual rental commitments under these leases are as follows: 1997 $125,000 1998 305,000 1999 325,000 2000 328,000 2001 341,000 Thereafter 816,000 ---------- TOTAL: $2,240,000 ==========
Rent expense amounted to $239,000, $192,000, and $171,000 for the years ended March 31, 1996, 1995 and 1994, respectively. (7) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table presents summarized unaudited quarterly financial data for 1996 and 1995:
GROSS NET NET EARNINGS REVENUE PROFIT EARNINGS PER SHARE ----------- ----------- ---------- ------------ 1996 ---- First Quarter $ 5,283,000 $2,930,000 $ 955,000 $0.10 Second Quarter 5,264,000 3,079,000 1,021,000 0.10 Third Quarter 4,641,000 2,637,000 940,000 0.09 Fourth Quarter 5,171,000 3,233,000 1,394,000 0.14 ----------- ----------- ---------- ----- Year $20,359,000 $11,879,000 $4,310,000 $0.43 =========== =========== ========== ===== 1995 ---- First Quarter $3,465,000 $1,809,000 $ 566,000 $0.05 Second Quarter 3,583,000 1,893,000 606,000 0.06 Third Quarter 3,667,000 1,946,000 649,000 0.07 Fourth Quarter 3,803,000 1,954,000 785,000 0.08 ----------- ----------- ---------- ----- Year $14,518,000 $7,602,000 $2,606,000 $0.26 =========== =========== ========== =====
CHAD THERAPEUTICS, INC. 21 10 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders Chad Therapeutics, Inc. We have audited the accompanying balance sheets of Chad Therapeutics, Inc. as of March 31, 1996 and 1995 and the related statements of earnings, shareholders' equity and cash flows the three years ended March 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Chad Therapeutics, Inc. as of March 31, 1996 and 1995 and the results of its operations and its cash flows for the three years ended March 31, 1996, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Los Angeles, California May 22, 1996 22 CHAD THERAPEUTICS, INC. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Sales for the years ended March 31, 1996 and 1995, increased $5,841,000 and $5,048,000 or 40.2% and 53.3%, respectively, over the prior year's periods. There were no price increases during the periods presented. The increase in sales relates primarily to increases in domestic sales of OXYMATIC conservers and OXYLITE complete portable oxygen systems which are benefiting from the current marketing environment for home oxygen therapy discussed below. Sales to foreign distributors represented 12.4% and 12.9% of total sales for the years ended March 31, 1996 and 1995, respectively, as these sales increased at a slightly slower rate than domestic sales. Currently, management expects a smaller increase in sales to foreign distributors during the upcoming fiscal year and while these sales should continue to increase on an annual basis, quarter to quarter sales will fluctuate depending on the timing of shipments. In addition, all foreign sales are transacted in dollars, thus quarter to quarter unit sales could be affected by foreign currency fluctuations. In June, 1989, a new procedure for payment by Medicare for home oxygen services became effective which provides a prospective flat fee monthly payment based solely on the patient's prescribed oxygen requirement. Previously dealers were reimbursed on the basis of total oxygen delivered and a rental charge which varied based on the type of system being used and other factors. The prior procedure tended to encourage waste and inefficiency. Consequently, with the incentive now to operate efficiently, inexpensive concentrators have grown in popularity because of low cost and less frequent servicing requirements. At the same time, interest heightened in oxygen conserving devices which can extend the life of oxygen supplies and reduce service calls by dealers. Management believes the new reimbursement procedures have heightened interest in the cost savings and increased mobility afforded by oxygen conserving devices such as the Company's products. In addition, other changes in the health care delivery system including the increase in the acceptance and utilization of managed care - have stimulated a significant consolidation among home oxygen dealers. As major national and regional home medical equipment chains attempt to secure managed care contracts and improve their market position, they have expanded their distribution networks through the acquisition of independent dealers in strategic areas. The Company's products, which allow homecare dealers to provide cost efficient home oxygen therapy, are well suited for use in a managed care environment and as a tool for dealers to increase revenues and profits. To ensure continued awareness of the benefits of the Company's products by chain headquarters personnel, a proactive marketing and communications program has been initiated with all of the major national chains. Management believes that the consolidation activity being experienced in the home oxygen business is temporary and should have no adverse effects on the Company's growth. Cost of sales as a percent of net sales decreased from 47.6% to 41.7% and increased from 47.1% to 47.6%, respectively, for the years ended March 31, 1996 and 1995, as compared to the prior year's periods. The current year has been benefitted from decreased production costs associated with bringing certain manufacturing operations in house. The increase in cost of sales percentage in the prior year resulted from the start up costs associated with this process. Management believes the cost per unit should remain at or near current levels in future periods as efficiencies of in house manufacturing have mostly been realized. Selling, general and administrative expenditures decreased as a percentage of net sales for the years ended March 31, 1996 and 1995, from 26.0% to 23.5% and from 27.9% to 26.0%, respectively, as compared to the prior year's periods, as the rate of growth in sales exceeded the increased costs associated with such growth. Research and development expenses increased by $43,000 and $59,000 for the years ended March 31, 1996 and 1995, respectively, as compared to the prior year's periods. Currently, management expects research and development expenditures to increase by approximately $500,000 in the upcoming fiscal year on projects to enhance and expand the Company's product line. At March 31, 1995, the Company had fully utilized its net operating loss carryforwards for Federal income tax purposes and other tax credit carryforwards. Future years will therefore be fully taxed and management estimates that the combined Federal and California income tax rates will be approximately 40%, as compared to 39.1% in 1996 and 31.5% in 1995. CHAD THERAPEUTICS, INC. 23 12 FINANCIAL CONDITION At March 31, 1996, the Company had cash and marketable securities totaling $2,838,000 or 26% of total assets, as compared to $1,635,000 (26%) at March 31, 1995. On June 30, 1994, the Company announced that the Board of Directors had authorized stock repurchases of its common shares in privately negotiated transactions for a minimum of 10,000 shares. In fiscal 1996, under this plan the Company has used $392,000 in cash to purchase 71,000 common shares at $5.50 per share, which shares have been retired. In addition, in the current period the Company purchased approximately 18,000 shares of its own stock at a cost of $228,000 for purposes of funding contributions to the Company's 401(k) plan. Net working capital increased from $5,172,000 at March 31, 1995, to $9,219,000 at March 31, 1996, in spite of the amounts utilized in the aforementioned stock purchases. Accounts receivable increased $746,000 during the period ended March 31, 1996, which related to increase in the sales activity. Future increases or decreases in accounts receivable will generally coincide with sales volume fluctuations and the timing of shipments to foreign customers. During the same period, inventories increased $2,166,000. The Company attempts to maintain sufficient inventories to meet its customer needs as orders are received. Thus, future inventory and related accounts payable levels will be impacted by the ability of the Company to maintain its safety stock levels. If safety stock levels drop below target amounts then inventories in subsequent periods will increase more rapidly as inventory balances are replenished. While historically the Company had relied upon the proceeds derived from the sale of securities to finance its operations, management believes funds derived from operations should be adequate to meet the Company's present cash requirements. The Company expects capital expenditures during the next twelve months to be approximately $1,200,000, primarily related to the costs associated with moving to new facilities in 1997. Also, the Company may make additional stock repurchases pursuant to the Board of Directors authorization. The Company does not provide post employment retirement benefits. NEWLY ISSUED ACCOUNTING STANDARDS In March, 1995, Statement of Financial Accounting Standards N. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of," was issued. This statement provides guidelines for recognition of impairment losses related to long-term assets and is effective for fiscal years beginning after December 15, 1995. Company management does not believe that the adoption of this new standard will have a material effect on the Company's financial statements. In October 1995, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement No. 123"), was issued. This statement encourages, but does not require, a fair value based method of accounting for employee stock options and will be effective for fiscal years beginning after December 15, 1995. While the Company is still evaluating Statement No. 123, it currently expects to elect to continue to measure compensation costs under APB Opinion No. 25, "Accounting for Stock Issued to Employees" and to comply with the pro forma disclosure requirements of Statement No. 123. If the Company makes this election, Statement 123 will have no impact on the Company's consolidated financial statements. OUTLOOK: ISSUES & RISKS From time to time, the Company may make forward-looking statements regarding its anticipated future performance or prospects. All such forward-looking statements are subject to certain inherent risks and uncertainties. Among the factors that could cause actual results to differ materially are the following: Dependence Upon A Single Product Line Although the Company currently markets a number of products, these products comprise a single product line for patients requiring supplementary oxygen. The Company's future performance is thus dependent upon developments affecting this segment of the health care market and the Company's ability to remain competitive within this market sector. Rapid Technological Change The health care industry is characterized by rapid technological 24 CHAD THERAPEUTICS, INC. 13 change. The Company's products may become obsolete as a result of new developments. The Company's ability to remain competitive will depend to a large extent upon its ability to anticipate and stay abreast of new technological developments related to oxygen therapy, The Company has limited internal research and development capabilities. Historically, the Company has contracted with outside parties to develop new products. Some of the Company's competitors have substantially greater funds and facilities to pursue research and development of new products and technologies for oxygen therapy. Potential Changes in Administration of Health Care A number of bills proposing to regulate, control or alter the method of financing health care costs have been discussed and certain of such bills have been introduced in Congress and various state legislatures. There are wide variations among these bills and proposals. Because of the uncertain state of the health care proposals, it is not possible at this time to predict the effect on the business of the Company if any of these proposals is enacted. Federal law has altered the payment rates available to providers of Medicare services in various ways during the last several years. Congress has passed legislation which would reduce Medicare spending. Some of the savings are to come from increases in premiums to cover part of the Medicare program cost. It cannot be predicted, however, what prospective payment system rates or rule changes will be made to determine how rates will be affected. There can be no assurance that a change in Medicare reimbursement rates will not have an adverse effect on the Company's business. Patents and Trademarks The Company pursues a policy of obtaining patents for appropriate inventions related to products marketed or manufactured by the Company. The Company considers the patentability of its products to be significant to the success of the Company. To the extent that the products to be marketed by the Company do not receive patent protection, competitors may be able to manufacture and market substantially similar products. Such competition could have an adverse impact upon the Company's business Products Liability The nature of the Company's business subjects it to potential claims asserting that the Company is liable for damages for product liability claims. Although the Company maintains products liability insurance in an amount which it believes to be customary in the industry, there is no assurance that this insurance will be sufficient to cover the costs of defense or judgments which might be entered against the Company. The type and frequency of these claims could have an impact on the Company's results of operations and financial position. Availability of Third Party Component Products The Company tests and packages its products in its own facility. Some of its other manufacturing processes are conducted by other firms and the Company expects to continue using outside firms for certain manufacturing processes for the foreseeable future. The Company's agreements with its suppliers are terminable at will or by notice. The Company believes that other suppliers would be available in the event of termination of these arrangements. No assurance can be given, however, that the Company will not suffer a material disruption in the supply of its products. Accounting Standards Accounting standards promulgated by the Financial Accounting Standards Board change periodically. Changes in such standards may have an impact on the Company's future reported earnings and financial position. Additional Risk Factors Additional risk factors may be listed from time to time in the reports filed by the Company with the Securities and Exchange Commission. CHAD THERAPEUTICS, INC. 25 14 OFFICERS CHARLES R. ADAMS Chief Executive Officer FRANCIS R. FLEMING President and Chief Operating Officer EARL L. YAGER Senior Vice President, Chief Financial Officer and Secretary OSCAR J. SANCHEZ Vice President, Manufacturing LOUIE GORYOKA Vice President, Quality Assurance and Regulatory Affairs DIRECTORS CHARLES R. ADAMS Chairman and Chief Executive Officer Chad Therapeutics, Inc. FRANCIS R. FLEMING President Chad Therapeutics, Inc. EARL L. YAGER Senior Vice President Chad Therapeutics, Inc. DAVID L. CUTTER Retired Chairman Of The Board Cutter Laboratories, Inc. NORMAN COOPER Retired Chairman Kallir, Philips, Ross, Inc. JOHN C. BOYD Retired PHILIP T. WOLFSTEIN President Wolfstein International, Inc. CORPORATE DATA CORPORATE HEADQUARTERS 9445 De Soto Avenue Chatsworth, CA 91311 (818) 882-0883 LEGAL COUNSEL Graham & James LLP AUDITORS KPMG Peat Marwick LLP Los Angeles, California TRANSFER AGENT AND REGISTRAR American Stock Transfer Company 40 Wall Street New York, NY 10005 COMMON STOCK PRICE RANGE The Company's Common Shares were traded on NASDAQ from its initial public offering on July 20, 1983 through February 10, 1987, under the NASDAQ symbol 3CTHU. From February 10, 1987 to August 3, 1993, the Company's Common Shares were not part of the automated quotations system. Beginning August 3, 1993, the Company's common shares were traded on the American Stock Exchange Emerging Company Marketplace and on June 6, 1994, the Company's shares moved to the primary list of the American Stock Exchange with the symbol CTU. The following table sets forth, for the periods indicated, the range of high and low closing bid prices of the Company's Common Shares, as furnished by the National Quotation Bureau, incorporated and high and low closing prices as furnished by the American Stock Exchange. Prices have been adjusted to reflect a 2 for I split distributed October 15, 1993, and a 3 for 2 split distributed on October 16, 1995.
QUARTER ENDED HIGH LOW - June 30, 1994 6 4-1/8 September 30, 1994 6 5-1/16 December 31, 1994 5-1/2 4-1/2 March 31, 1995 6-5/8 4-5/8 June 30, 1995 11-1/8 5-7/16 September 30, 1995 15 9-1/2 December 31, 1995 16 11-3/8 March 31, 1996 15-1/8 11
Prices prior to August 3, 1993, represent quotations between dealers without adjustment for retail markups, markdown or commissions and may not represent actual transactions. As of June 17, 1996, there were approximately 318 shareholders of record of the Company's common stock. No cash dividends have been paid on the common stock. SEC FORM 10-K A copy of the Company's annual report to the Securities and Exchange Commission on Form 10-K is available without charge upon written request to: Senior Vice President Chad Therapeutics, Inc. 9445 De Soto Avenue Chatsworth, CA 91311 26 CHAD THERAPEUTICS, INC. EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 US DOLLARS 12-MOS MAR-31-1996 APR-01-1995 MAR-31-1996 1,000 1,808 1,029 2,872 0 4,011 10,222 1,074 574 10,778 1,003 0 0 0 6,791 2,984 10,778 20,359 0 8,480 4,904 0 0 0 7,072 2,762 0 0 0 0 4,310 .43 0
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