-----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, BM72na5Nrm606L0V4lOuS1d0wh4SrJnjjcx5OgopsHTnZKy34S31ApZGKEFUdu6l xEac47fUDnPg7VBKaIfIkw== 0000719625-95-000023.txt : 19951228 0000719625-95-000023.hdr.sgml : 19951228 ACCESSION NUMBER: 0000719625-95-000023 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19950930 FILED AS OF DATE: 19951227 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILC TECHNOLOGY INC CENTRAL INDEX KEY: 0000719625 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 941655721 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-11360 FILM NUMBER: 95604497 BUSINESS ADDRESS: STREET 1: 399 JAVA DR CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4087457900 MAIL ADDRESS: STREET 1: 399 JAVA DRIVE CITY: SUNNYVALE STATE: CA ZIP: 94089 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended SEPTEMBER 30, 1995 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 0-11360 ILC TECHNOLOGY, INC. (Exact name of registrant as specified in its charter) CALIFORNIA 94-1655721 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 399 Java Drive, Suunyvale, California 94089 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (408) 745-7900 --------------------------- Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered None Securities registered pursuant to Section 12(g) of the Act: Common Stock (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 disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of the Common Stock on December 18, 1995, was approximately $40,347,244. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of outstanding shares of the registrant's Common Stock on December 18, 1995 was 4,691,416. Parts of the following documents are incorporated by reference into Part III of this Annual Report and Form 10-K: (1) Proxy Statement for registrant's 1995 Annual Meeting of Shareholders. TABLE OF CONTENTS ITEM DESCRIPTION PAGE PART 1 1 Business 1 -7 2 Properties 7 3 Legal Proceedings 7 4 Submission of Matters to a Vote of Security Holders 7 PART II 5 Market for the Registrant's Common Equity and Related Stockholder Matters 8 6 Selected Financial Data 9 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 9 - 13 8 Financial Statements and Supplementary Data 14 - 32 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 33 PART III 10 Directors and Executive Officers of the Registrant 33 11 Executive Compensation 33 12 Security Ownership of Certain Beneficial Owners and Management 33 13 Certain Relationships and Related Transactions 33 PART IV 14 Exhibits, Financial Statement Schedule, and Reports on Form 8-K 34 Signatures 35 PART I ITEM 1. BUSINESS GENERAL ILC Technology, Inc. ("ILC" or the "Company") designs, develops, and manufactures high intensity lamps and lighting products for medical, industrial, communication, aerospace, scientific, entertainment, and military industries. ILC Technology, Inc. was incorporated under the laws of the State of California on September 15, 1967. Its principal manufacturing and executive facilities are located at 399 Java Drive, Sunnyvale, California 94089. The Company's telephone number is (408) 745-7900. BUSINESS STRATEGY The Company uses a market focused business strategy. ILC targets selected high growth markets which most closely match the Company's technological expertise and manufacturing strengths. With a strong emphasis on research and development, ILC achieves and maintains a leadership position in these market segments through advanced technology, engineering design capability and attentive customer support. PRODUCTS - FLASHLAMPS The flashlamp line of products was ILC's founding product line. The Company makes pulsed and direct current arc lamps that are designed to satisfy a wide variety of laser and industrial applications requiring rigorous, high-performance standards. The primary source of sales, of which approximately 80% are for the replacement market, derives from industrial uses such as materials aging (solar simulation), and laser cutting, drilling, scribing and marking. Ancillary sales are generated by the medical field where lasers are utilized in cataract surgery and other exacting procedures. Production is highly labor-intensive and requires a lengthy training period to achieve a quality product. The laser market, while somewhat predictable and a steady source of revenue for the Company, is not expected to grow dramatically. ILC anticipates that the market for flashlamps in low-energy laser pumping applications will erode as alternative technologies such as laser diode pumps become increasingly cost-effective. However, in high-powered laser applications, flashlamps remain more efficient at less than 50% of the total life cycle cost of laser diodes. Therefore, ILC continues to investigate high growth arc lamp markets outside of the laser industry. Some of these include UV sterilization and curing, machine vision and spectrofluoroscopy. In August 1991, ILC purchased Q-Arc Ltd., an arc lamp manufacturing company based in Cambridge, England. In the third quarter of fiscal 1994, ILC invested $2.7 million to expand Q-Arc's manufacturing capacity and using the new facility as a base, ILC has begun to broaden its sales effort for all product lines in key sales locations throughout Europe. PRODUCTS - CERMAX(R) AND EQUIPMENT The Company provides short arc xenon lamps that are optically pre-aligned, encased in a very safe ceramic body bonded to a metallized sapphire window, and are capable of transmitting the full spectrum from infrared to ultra-violet wavelengths. In addition, the Company also manufactures fully- encased and open frame power supplies, lamp holders and other accessories to support the Cermax(R) product line. Products also include complete fiber-optic lightsources that are private labelled for manufacturers of medical equipment. Currently, the primary market is in fiber optic illumination for medical procedures such as endoscopy. 1 PRODUCTS - CERMAX(R) AND EQUIPMENT (CONTINUED) The market for Cermax(R) lightsources and related equipment used in endoscopy is composed of two segments - a high-intensity or critical segment and a low-intensity or non-critical segment. Critical endoscopy applications require high-intensity Cermax(R) lightsources with specialized power supplies due to the small size of the fiberoptic lightguide. Furthermore, as these applications often use video displays, high-intensity lightsources are required for good color rendition. The low-intensity market is dominated by manufacturers of halogen lightsources. Ancillary industrial uses for Cermax(R) lightsources include illuminating areas that are difficult to inspect such as nuclear reactors or jet engines. Emerging uses include lamps for analytical instruments and video projection. The Company has also targeted new non-medical lightsource markets which include spot UV curing lightsources and Flash-Cermax(R) machine vision systems. For several years, ILC has conducted research and development activities focused on utilizing Cermax(R), with its brightness characteristics, as a light source for the projection of computer and television video images. Using the Cermax(R) light source and a new display technology which is based on Texas Instruments' Digital Micromirror Device ("DMD"), Rank Brimar Limited, a division of The Rank Organization Plc, demonstrated a bright, large screen, digital video projector which promises exceptional image quality. The video projection market, for both computer and television applications, is expected to expand as new digital projection technology enables bright, large-screen display of video in a fully lit setting with exceptional image quality. Companies such as Texas Instruments and Rank Brimar have developed this technology for applications in leisure, entertainment and business. Digital projectors are expected to gain acceptance in entertainment venues, corporate environments, conference centers, concerts, advertising and promotional events, training and education and data display. The factors that may adversely affect the Company's Cermax(R) business include the expected entry of competitors into the market. The Company's primary patent on the Cermax(R) lightsource expired in 1991 and the Company expects competition from established and emerging companies. Increased competition could result in price reductions, which in turn could generate lower net sales on stable unit volume. Increased competition could also result in fewer customer orders, reduced gross margins and loss of market share. PRODUCTS - SHORT ARC LAMPS MERCURY XENON SHORT ARC LAMPS ("STEPPER LAMPS") In fiscal 1995, the Company began commercial shipment of a new product, the mercury xenon short arc lamp ("stepper lamp"), which is used to expose patterns during the fabrication of semiconductor wafers. ILC is currently shipping a complete line of 1,000 watt stepper lamps, expects to begin shipping a 2,000 watt stepper lamp by the end of the first quarter of fiscal 1996 and plans to complete the full family of stepper lamps with power ratings from 1,000 to 2,500 watts. Each lamp, fully utilized, lasts for approximately 1-2 months. Accordingly, the Company expects that the product will generate a high repeat business. The market for stepper lamps is currently dominated by a Japanese competitor of the Company. ILC has invested heavily in ensuring the quality of its stepper lamps since end users perceive substantial risk in switching suppliers. In addition, ILC's stepper lamp does not require the end user to modify any of its maintenance procedures. The Company has worked over the last three years with major U.S. end users of stepper equipment, including IBM, Intel, Texas Instruments, Motorola and Hewlett-Packard to ensure that ILC's stepper lamps become qualified at each of its customers' plants. ILC's 1,000 watt stepper lamp has also recently been qualified by Sony and Hitachi in Japan. 2 PRODUCTS - SHORT ARC LAMPS (CONTINUED) MERCURY XENON SHORT ARC LAMPS ("STEPPER LAMPS") The Company's stepper lamps are engineered to be of equivalent quality and performance and completely interchangeable with lamps provided by other qualified suppliers. ILC has established relationships with sales representatives in Japan, Taiwan and Korea and plans to sell stepper lamps through distributors to reach a broader manufacturing market in Asia. To accommodate an increased volume of stepper lamps, ILC purchased a 20,000 square foot office and manufacturing facility in nearby Santa Clara, California in October 1994. The failure of the Company's stepper lamp to achieve market acceptance would have a material adverse effect on the Company's results of operations. MERCURY CAPILLARY LAMPS Mercury capillary lamps are manufactured using technology and processes that are similar to those developed for stepper lamps. The applications for capillary lamps range from the photolithography of grid patterns on color TV screens to printed circuit boards for computers. The total market for capillary lamps is about $20 million with about 15% annual growth rate. PRODUCTS - ADVANCED LIGHTING The Company develops metal halide technologies for a broad range of commercial and military applications. Advanced Lighting products include: o DTI-The Company began new product development activities in fiscal 1994 to commercialize its aerospace and military metal halide technology. The Company has developed DTI, a series of integral low-power metal halide lamps (less than 500 watts) for commercial projection, stage and medical applications. o DAYMAX(R) LAMPS-Daymax(R) lamps simulate stable daylight conditions. Originally developed for use in the space program, these products are now widely used throughout the entertainment business. Applications include: indoor and outdoor lighting for motion picture and television productions, high speed and special effects lighting, concert, disco and stadium lighting, theatrical lighting and lighting for projection systems. Daymax(R) lamps are also used for solar simulation in certain manufacturing processes. o AEROSPACE PRODUCTS-ILC offers standard, modified, and customer systems covering the visible, infrared, and ultraviolet spectrum to meet each space lighting requirement. The Company's lighting systems are key elements of NASA's Space Transportation System. These systems are installed in the Space Shuttle interior and exterior, on the Manned Maneuvering Unit, on Spacelab and in several experiments carried aboard the shuttle orbiters. Other ILC systems are being designed for use on International Space Station Alpha, in future shuttle experiments and payload packages and space robotic vehicles. ILC is the only domestic manufacturer of space lighting qualified to serve NASA and other government agencies in Japan and Europe. ILC aerospace lighting systems feature efficiency, reliability, ruggedness, light weight and full space qualification. New systems aimed to meet unique requirements can often be developed from ILC's large selection of space-qualified designs and components, substantially reducing development costs and lead times. o MILITARY PRODUCTS-These products include infrared lamps used by the military on tanks and aircraft to deflect offensive heat seeking missiles. 3 PRODUCTS - CONVERTER POWER ILC acquired Converter Power, Inc. (CPI) in January 1993. CPI is a leading producer of high efficiency, small form factor lamp power sources built to fit compactly into a variety of systems. The Company designs and manufactures a full family of UL and TUV-approved power supplies which can be incorporated into original equipment manufacturer (OEM) equipment. In addition, CPI maintains a business relationship with a particular OEM to design custom power supplies for equipment which services the ion implant sector of the semiconductor manufacturing industry as well as several medical markets. CPI also provides power supplies which have been specifically engineered for ILC's Cermax(R) and metal halide lamps. This effort has enabled CPI to design power sources which will eventually be sold into the video projection market. PRODUCTS - PRECISION LAMP Precision Lamp, Inc. (PLI), purchased in June 1992, distributes over 1,500 types of miniature to microminiature industrial incandescent lamps, and manufactures the world's only surface-mount lamp small enough to be automatically inserted onto a printed circuit board. These lamps can be used in pagers, watches, camera lenses and many other customized miniature lighting circumstances. Production of the surface-mount lamp and backlight panel are semi-automated. The Company has invested in a liquid crystal display (LCD) backlight panel incorporating the technology of the surface-mount lamp. It is an innovative product in that it distributes light uniformly across a panel whereas direct backlighting or light emitting diodes can result in burn spots or uneven scattering of light. Furthermore, management believes the newly introduced backlight panel is an easier and less expensive component to use than electro-luminescent panels which require drive circuitry. This panel is the first backlight available for small displays. The LCD backlight panel is used in pagers, phones, two-way radios, games, toys, calculators and cameras. ILC received its first order at the end of fiscal 1993 for the backlight panel from an OEM making TV remote controls. Due to the wide range of consumer-driven applications, this product should enable ILC to broaden its customer base. Currently, Precision Lamp is working with major LCD fabricators in Japan, Korea, Taiwan, Singapore and Europe, all of whom are extremely interested in utilizing this component in their products. The failure of the backlight panel to achieve market acceptance would have a material adverse effect on the Company's results of operations. MARKETING AND SALES ILC sells its products through a direct sales force to OEMs and sells to end users through sales representatives and distributors. In situations where the Company is entering an existing market, such as the stepper lamp market, ILC works directly with end users in qualifying the lamps utilizing indirect distribution channels. In addition, ILC maintains a team of ten people to provide sales and customer service support to its customer base and network of foreign and domestic distributors. A European sales office located at the facilities of Q-Arc in Cambridge, England, sells and markets the complete line of lamp and equipment products and provides local support for European customers. With the formation of a joint venture in Japan, ILC has broadened its sales reach to Asia and established a local presence for its Asian customers. Sales activities of the Company' subsidiaries, Q-Arc, CPI and PLI, operate independently with overall coordination handled by ILC corporate in Sunnyvale. 4 MARKETING AND SALES (CONTINUED) For fiscal 1995, approximately 34.8% of the Company's net sales represented international sales, primarily in the Pacific Rim and Europe. Information regarding the Company's export sales and major customers is incorporated herein by reference to Note 3 of Notes to Consolidated Financial Statements. BACKLOG As of September 30, 1995, ILC's backlog of unfilled orders was approximately $33,767,000 as compared to approximately $27,730,000 at October 1, 1994. The Company includes in its backlog only orders which have been released by the customer for shipment within the next 12 months. Due to the possibility of customer changes in delivery schedules or cancellations of orders, backlog as of any particular date may not be representative of actual sales for any succeeding period. MANUFACTURING ILC's lamp groups have built substantial expertise in the fields of sealing technology (ceramic-to- metal, quartz-to-metal, vacuum sealing), materials research, plasma physics, electrical engineering, optoelectronics, and electrode technology. With PLI, ILC obtained unique semi-automated manufacturing capabilities required for high-volume, low-cost manufacturing. With CPI, ILC obtained the essential power supply expertise necessary for providing OEMs with integrated solutions. The manufacturing of most of the Company's lamp and power supply products is labor and capital intensive, and accordingly, the labor force is highly skilled and experienced with specialty equipment. The combination of ILC's technical and manufacturing expertise enables ILC to dominate its selected market niches for specialty lighting. ILC designs, develops, and manufactures a majority of its products in two facilities totalling 97,000 square feet. These adjoining buildings include lamp development laboratories, separate manufacturing facilities for xenon and krypton arc lamps, Cermax(R) lamps, Daymax(R) metal halide lamps, mercury short arc ("stepper") lamps, mercury capillary lamps, Cermax(R) equipment and Aerospace products. The Company also purchased, in October 1994, a facility in Santa Clara, California totalling approximately 20,000 square feet to accommodate stepper lamp manufacturing. The need for more production capacity for the subsidiaries of ILC prompted expansion of existing manufacturing facilities. Q-Arc Ltd purchased a new facility of approximately 36,000 square feet in June 1994 and occupied the new facility in early fiscal 1995. Q-Arc currently occupies approximately 25,000 of the 36,000 square feet and is seeking a tenant to occupy the balance of the space. The 10,000 square foot facility which Q-Arc previously occupied was sublet to a third party. Converter Power, in late fiscal 1995, signed a lease for a 32,000 square foot facility to satisfy the growing production requirements of laser power supplies. CPI had previously occupied a 15,000 square foot facility and is currently seeking a tenant to sublet the property which has one year left on the lease. Precision Lamp occupies a 24,000 square foot facility in Cotati, California for the automated manufacture of surface mounted miniature incandescent lamps and LCD backlight panels. Precision Lamp moved into this facility in fiscal 1993. PLI received ISO9001 certification in fiscal 1994 and Q-Arc received ISO9002 certification in fiscal 1995. ILC Sunnyvale has been recommended for ISO9001 certification and management excepts CPI to be certified by late 1996. ISO9001 certification ensures customers that ILC has a quality system that will result in continuous product quality improvement. It is a recognition of a commitment to quality throughout all sections of the organization. 5 PATENTS AND TRADEMARKS The Company holds approximately 42 patents related to the key features of several of its products and several applications are pending. While these patents tend to enhance the Company's competitive position, management believes that the Company's success depends primarily upon its proprietary technological, engineering, production and marketing skills and the high quality of its products. The names of two of the Company's products, Cermax(R) and Daymax(R) are registered as trademarks in the United States Patent and Trademark Office and in many other countries in which the Company's products are sold. The Company's patents expire at various dates between 1996 and 2012. There can be no assurance that any patents held by the Company will not be challenged and invalidated, that patents will issue from any of the Company's pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in all countries where the Company's products can be sold to provide meaningful protection or any commercial advantage to the Company. Competitors of the Company also may be able to design around the Company's patents. COMPETITION ILC competes on the basis of product performance, applications engineering, customer service, reputation and price. The Company competes in many markets in which technology develops and improves rapidly, stimulating ILC to enhance the capability of its products and technologies. Competitors consist of both large and small companies located in the United States, Japan and Europe. They include EG&G Inc., Osram, Philips, Ushio, ORC Japan, Koto, Wolfram and GE. In many market sequents, the competition has established the bench mark for product acceptance at a very high level, causing ILC to continuously improve all phases of its processes for customer satisfaction. The Company believes that by exploiting segmented market areas in which ILC has technological, manufacturing and marketing strengths, ILC can compete effectively. At the same time, by focusing its product development and acquisition activities in these areas, the Company can defend its strengths and maintain its leadership in selected markets. ENGINEERING AND RESEARCH ILC's engineering, research, and development efforts consist of three main activities. The first area of activity is extensive application engineering in response to customer requirements. These activities result in customer specific products and modifications to existing products to satisfy the needs of the customers. The second area is that of joint engineering and development work made in connection with customer production contracts. The third area includes those projects funded by the Company to develop new products and technologies. In 1995, the Company spent $4,497,000 for Company funded research and development efforts. This is compared to $3,998,000 and $2,767,000 spent in fiscal years 1994 and 1993, respectively. The Company's engineering and research personnel are engineers and scientists, all of whom have technical degrees. In fiscal 1995, a Corporate Technology Business Unit was formed to provide ILC Sunnyvale with a focused research capability. This core competency will be directed and managed to service generic challenges. This newly formed group will also act as a focus of business opportunities that do not naturally fall within the strategic plans of an existing product line. Initially, this group will direct its efforts toward answering some basic questions regarding electrodes, envelopes and material related processes. 6 EMPLOYEES As of September 30, 1995, the Company had 584 full-time employees, comprised of 53 in research and engineering, 21 in marketing and sales, 466 in manufacturing and 44 in general and administrative positions. ILC believes that its future success depends upon its continued ability to recruit and maintain highly skilled employees in all disciplines. Although competition for qualified personnel is strong, ILC has been successful in attracting and retaining skilled employees. None of the Company's employees is represented by a labor union. The Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company owns and leases an aggregate of approximately 153,000 and 56,000 square feet, respectively, of office and manufacturing space in six separate buildings in Sunnyvale, Santa Clara and Cotati, California; Beverly, Massachusetts; and Cambridge, England. In Sunnyvale, the Company owns 97,000 square feet in two adjacent buildings. These buildings were constructed by the Company in 1977 and 1979, sold in 1982 and leased back from the new owners, and re-purchased from the landlord in August 1993. The Company leases to one tenant approximately 5,000 square feet of its space in Sunnyvale under a lease which expires in March 1996. In early October 1994, the Company purchased 20,000 square feet of office and manufacturing space in Santa Clara, California. In June 1994, the Company purchased 36,000 square feet of office and manufacturing space in Cambridge, England. Q-Arc currently occupies approximately 25,000 square feet and is currently seeking a tenant to lease the balance of the space. Q-Arc previously leased a 10,000 square foot facility, which has been sublet to a third party. Precision Lamp moved into a new facility in July 1993. The lease for the 24,000 square feet of office and manufacturing space, located in Cotati, California, expires in 2003. Finally, Converter Power, in late fiscal 1995, entered into a lease to occupy approximately 32,000 square feet of office and manufacturing space in Beverly, Massachusetts. This lease expires in September 2000. Converter Power will begin to move into the new facility in the first quarter of fiscal 1996. CPI previously occupied a 15,000 square foot facility in Ipswich, Massachusetts, under a lease that expires in December 1996. The Company is currently seeking a tenant to sublet the property. For a discussion of the Company's lease commitments, see Note 8 of the Notes to Consolidated Financial Statements appearing elsewhere herein. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the security holders during the fourth quarter of fiscal 1995. 7 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ILC's common stock is traded in the Nasdaq National Market (symbol ILCT). The high and low closing sales prices for the common stock on the Nasdaq National Market, are set forth below for the quarters as indicated: FISCAL 1995 HIGH LOW 1st Quarter 10 3/8 7 1/2 2nd Quarter 10 3/4 8 3rd Quarter 11 1/8 8 3/4 4th Quarter 11 1/4 9 FISCAL 1994 HIGH LOW 1st Quarter 11 3/4 10 2nd Quarter 11 1/2 8 1/2 3rd Quarter 9 6 5/8 4th Quarter 9 5/8 7 1/4 There were approximately 2,000 institutional and individual stockholders as of December 18, 1995. The closing sales price of the common stock on December 18, 1995 as reported by Nasdaq was $9.38. The Company intends to retain earnings for use in its business and does not expect to pay cash dividends in the foreseeable future. The Company's credit agreement with Union Bank provides that the Company shall not declare or pay any dividend or other distribution on its Common Stock (other than a stock dividend) or purchase or redeem any Common Stock, without the bank's prior written consent. 8 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data of the Company should be read in conjunction with the Consolidated Financial Statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. FISCAL YEAR ENDED (in thousands except per share data
1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Net sales $58,429 $52,022 $51,997 $40,885 $40,208 Net income $ 4,538 $ 191 $ 4,759 $ 4,950 $ 4,524 Net income per share $ .95 $ .04 $ .96 $ 1.00 $ .98 Weighted average shares outstanding 4,765 4,825 4,980 4,956 4,595 Working capital $11,066 $ 9,428 $11,786 $10,263 $ 9,358 Total assets $47,185 $41,997 $40,440 $29,107 $20,854 Total long-term debt $ 6,592 $ 6,421 $ 5,805 $ 2,193 $ 332 Total stockholders' equity $28,802 $23,624 $24,565 $19,578 $14,345
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL During fiscal 1995, 1994 and 1993, the Company derived approximately 34%, 44% and 45%, respectively, of its net sales from the medical market. During fiscal 1995, 1994 and 1993, the Company's sales in the industrial market accounted for 40%, 44% and 38%, respectively, of net sales. In each of the fiscal years 1995, 1994 and 1993, the Company's sales in the aerospace market accounted for 7% of net sales. Products sold in the medical market are incorporated into products sold into the health-care and health-care related industries. These industries have recently been subject to significant fluctuations in demand which in turn have affected the demand for components used in these products. The Company expects sales to the medical market to continue to decrease as a percentage of net sales for the foreseeable future. Aerospace sales have remained relatively constant over the last two fiscal years. Due to the continuing slowdown in military and defense spending, the Company does not expect aerospace sales to grow significantly from fiscal 1995 and 1994 levels. To compensate for this slowdown, the Company began new product development activities in fiscal 1995 and 1994 for commercial applications for metal halide lamps used for projection and information display. FISCAL 1995 COMPARED TO FISCAL 1994 Net sales for fiscal 1995 were $58,429,000, an increase of 12.3% over fiscal 1994 net sales of $52,022,000. The $6,407,000 increase was primarily attributable to a $4 million sales increase at Converter Power and a $1 million 9 FISCAL 1995 COMPARED TO FISCAL 1994 (CONTINUED) sales increase at both Precision Lamp and Q-Arc. Although total net sales at ILC Technology remained unchanged between the two fiscal years, Cermax and related equipment sales decreased approximately $2.4 million, due to a softness in the medical market as discussed above. Flash and Quartz lamp sales increased $1 million and Advanced Lighting sales increased $1.4 million. In the second quarter of fiscal 1994, Precision Lamp experienced a significant shortfall in orders from a major customer. Due to this slowdown, sales to this customer are expected to be significantly lower than previously anticipated. (See Note 11 of Notes to Consolidated Financial Statements). During fiscal 1995, sales to this major customer were slightly above the fiscal 1994 sales level. The $1 million Precision Lamp revenue increase discussed above was primarily the result of new product sales. Cost of sales as a percentage of net sales was 67.1% for fiscal 1995 compared to 67.8% for fiscal 1994. The fiscal 1994 percentage was negatively impacted due to the write off of approximately $500,000 of excess Precision Lamp inventory relating to the slowdown in the release of shippable product from a major customer as discussed above. The ratio of the inventory reserve to year end inventory in fiscal years 1995, 1994 and 1993 was 18.0%, 20.9% and 17.5%, respectively. The fiscal year 1994 ratio excludes the above mentioned $500,000 reserve addition. Research and development expenses, 7.7% of net sales in both fiscal 1995 and 1994, increased $499,000 between the two fiscal years. The majority of the increase was concentrated in the Quartz stepper lamp product. Marketing expenses, 5.1% of net sales in fiscal 1995 compared to 4.4% of net sales in fiscal 1994, increased $705,000. The increase between the two fiscal years was primarily due to the addition of personnel, more travel and trade show attendance and additional commission expense on an increased sales volume. As a percentage of sales, general and administrative expenses were 8.7% in fiscal 1995 and 10.0% in fiscal 1994. The $139,000 decrease was due to the accrual in the second quarter of fiscal 1994 for early exit incentives for various long time ILC employees ($500,000) and the write off of a note receivable, doubtful of collection ($250,000). This decrease was partially offset by expenses incurred by Q-Arc in its move to a larger manufacturing facility and by personnel additions and other expenses at Converter Power, totalling approximately $600,000, in fiscal 1995. Amortization of intangibles of $290,000 in fiscal 1995 represents the amortization of covenants-not-to-compete arising from the acquisitions of Precision Lamp in 1992 and Q-Arc in 1991. The amortization of intangibles of $3,765,000 in fiscal 1994 includes a $3,400,000 write down of intangibles generated from the acquisition of Precision Lamp. As discussed below, Precision Lamp experienced a significant shortfall in orders from a major customer in the second quarter of fiscal 1994. In assessing the recoverability of the unamortized goodwill and covenant-not-to-compete generated from the acquisition, management determined that an impairment occurred and recorded a $3.4 million charge. Interest income was $313,000 in fiscal 1995, which amount included approximately $235,000 of interest income from an income tax refund in the third quarter of fiscal 1995. Interest income in fiscal 1994 was $200,000. Interest expense, $696,000 in fiscal 1995 as compared to $339,000 in fiscal 1994, increased $357,000 between the two fiscal years. The increase was due to additional borrowings on the Company's line of credit and equipment purchases. 10 FISCAL 1995 COMPARED TO FISCAL 1994 (CONTINUED) The Company reported income from operations before provision for income taxes of $5,978,000 in fiscal 1995 compared to $1,343,000 in fiscal 1994. The fiscal 1995 provision for income taxes, exclusive of an income tax refund of $238,000 in the third quarter of fiscal 1995, was 28% of pretax income before provision for income taxes. This compares with a fiscal 1994 provision for income taxes of approximately 31% of pretax income before provision for income taxes, which provision is exclusive of the effect related to the non-deductible portion of the write down of intangibles discussed above. The Company believes that inflation and changing prices had no significant impact on sales or costs during fiscal 1995 and 1994. FISCAL 1994 COMPARED TO FISCAL 1993 Net sales remained relatively constant at $52,022,000 and $51,997,000 in fiscal 1994 and 1993, respectively. Although the total net sales were unchanged, Cermax(R) and related equipment sales decreased approximately $2 million, Flash and Quartz lamp sales increased approximately $1 million and Converter Power sales increased approximately $3 million between the two fiscal years. Additionally, in the second quarter of fiscal 1994, Precision Lamp experienced a significant shortfall in orders from a major customer. This slowdown resulted in lower sales of approximately $2 million in fiscal 1994 as compared to fiscal 1993. Sales to this customer are now expected to be significantly lower than previously anticipated. (See Note 11 of Notes to Consolidated Financial Statements.) Cost of sales as a percentage of net sales was 67.8% for fiscal 1994 compared to 67.0% for fiscal 1993. The percentage increase was primarily due to the write off of approximately $500,000 related to excess Precision Lamp inventory caused by a slowdown in the release of shippable product from a major customer discussed above. The ratio of the inventory reserve to year end inventory in fiscal 1994, 1993 and 1992 was 20.9%, 17.5% and 22.8%, respectively. The fiscal 1994 ratio excludes the above mentioned $500,000 reserve addition. Spending in the area of research and development, 7.7% of net sales in fiscal 1994, compared to 5.3% of net sales in fiscal 1993, increased $1,231,000 between the two fiscal years. The increase occurred in Cermax(R) for the development of lamps for video projection, in Quartz lamps for the development of the stepper lamp and in Advanced Lighting for the design and development of lamps used for entertainment applications. Also contributing to the increase was spending at Precision Lamp for the development of panels to light the entire rear of a liquid crystal display and spending at Converter Power for the design of new power supplies. Marketing expenses were $2,271,000, or 4.4% of net sales in fiscal 1994 compared to $2,642,000, or 5.1% of net sales in fiscal 1993. The $371,000 decrease between the two fiscal years was due primarily to less travel and trade show attendance coupled with less commission expense associated with lower sales at Precision Lamp caused by the slowdown in the release of shippable product from a major Precision Lamp customer. General and administrative expenses, as a percentage of net sales, were 10.0% in fiscal 1994 compared to 7.6% in fiscal 1993. The $1,282,000 increase between the two periods was due to a combination of the accrual for early exit incentives for various long-time ILC employees, the write off of a note receivable, doubtful of collection, which arose from the United Detector Technology divestiture in 1990 and increases to general and administrative expenses at Converter Power and Q- Arc. This increase was partially offset by the suspension of contributions to the ILC profit sharing plan for the first six months of fiscal 1994. 11 FISCAL 1994 COMPARED TO FISCAL 1993 (CONTINUED) Amortization of intangibles of $3,765,000 in fiscal 1994 includes a $3,400,000 write down of intangibles generated from the acquisition of Precision Lamp in June 1992. As discussed above, Precision Lamp experienced a significant shortfall in orders from a major customer in the second quarter of fiscal 1994. In assessing the recoverability of the unamortized goodwill and covenant-not-to- compete generated from the acquisition, management determined that an impairment occurred in that quarter. Total sales and earnings of Precision Lamp for the period March 1994 to March 2002 as projected at the time of the intangible impairment calculation were approximately 50% and 70% lower than sales and earnings estimates, respectively, at the time of the Precision Lamp acquisition. These projections represent management's best estimate for future results for that subsidiary. Precision Lamp is actively seeking to solicit other customers and alter its products to meet their specifications for the surface mounted miniature incandescent lamp. However, because of the major customer's dominance of its market, and because other manufacturers are numerous and small volume, the Company believes that Precision Lamp will be unable to secure new customers to make up for the significant shortfall in orders. Accordingly, a $3.4 million charge was recorded to write down the intangibles to net realizable value. The writedown was determined based on the currently projected un-discounted cash flows of Precision Lamp from March 1994 to March 2002, which projected aggregate cash flows of approximately $900,000 over that period which was based on projected net income which averaged 9% higher than the net income projection for fiscal 1994 (with no loss years included in the projection), compared with the carrying value of the Company's investment in Precision Lamp, including goodwill, at the date of the writedown. At October 1, 1994, there were net assets associated with the Precision Lamp acquisition of approximately $2,270,000, or approximately 5% of total assets, for which recoverability is primarily dependent upon sales to the major customer discussed above. The amortization of intangibles of $757,000 in fiscal 1993 represents the amortization of covenants-not-to- compete plus the amortization of goodwill both arising from the acquisitions of Precision Lamp in 1992 and Q-Arc in 1991. Although interest income remained constant between fiscal 1994 and fiscal 1993, interest expense increased by approximately $261,000 during the same period due to the term loan obtained to purchase the Company's two operating facilities in Sunnyvale, California in August 1993 and the manufacturing facility in Cambridge, England in June 1994. The Company reported income before provision for income taxes of $1,343,000 in fiscal 1994 compared to $7,111,000 in fiscal 1993. The provision for income taxes, exclusive of the effect related to the non-deductible portion of the write down of intangibles discussed above, was approximately 31.0% of pretax income before provision for income taxes in fiscal 1994 compared to 33.1% in fiscal 1993. The Company believes that inflation and changing prices had no significant impact on sales or costs during fiscal 1994 and 1993. LIQUIDITY AND FINANCIAL POSITION Cash and cash equivalents decreased to $1,509,000 in fiscal 1995 from $2,462,000 in fiscal 1994. Cash provided from operations amounted to $3,449,000 in fiscal 1995, a decrease of $3,226,000 from $6,675,000 in fiscal 1994. This decrease occurred primarily due to an increase in accounts receivable of $2,767,000 and an increase in inventories of $2,304,000. During fiscal 1995, the Company used cash of $1,745,000 to purchase land and a new manufacturing facility in Santa Clara, California and made capital equipment acquisitions of $3,419,000. In fiscal 1995, the Company increased its net borrowings under its line of credit by $2,000,000, increased its net borrowings under 12 LIQUIDITY AND FINANCIAL POSITION (CONTINUED) an equipment line by $670,000 and paid down a term loan by $1,578,000. In fiscal 1994, the Company used cash of $2,701,000 to purchase a new office and manufacturing facility in Cambridge, England, deposited $1,300,000 for the purchase of land and a manufacturing facility in Santa Clara, California and paid $312,000 for land in Cotati, California. Capital equipment acquisitions in fiscal 1994 amounted to $2,634,000. In fiscal 1994, the Company increased its net borrowings under a term loan for real estate acquisitions by $800,000 and increased the net borrowings under an equipment line by $591,000. In addition, in fiscal 1994, the Company also repurchased, on the open market, 204,000 shares of its common stock for $1,556,000. In fiscal 1993, the Company used cash of $7,600,000 to purchase its manufacturing facilities and corporate offices in Sunnyvale, California. Also in fiscal 1993, the Company used cash of $1,467,000 for capital equipment acquisitions and borrowed $5,000,000 under a term loan to finance the purchase of the above mentioned facilities in Sunnyvale, California. The Company has working capital of $11,066,000 and a current ratio of 1.94 to 1.0 at September 30, 1995. This compares with working capital of $9,428,000 and a current ratio of 1.79 to 1.0 at October 1, 1994. As of September 30, 1995, the Company has $2,000,000 unused on a $4,000,000 bank line of credit with interest at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995). The Company also has available approximately $690,000 remaining on a $1,500,000 equipment credit facility at the above interest rate. This credit facility can be increased to accomodate the capital equipment needs of the Company. In fiscal 1996, ILC anticipates making capital expenditures of approximately $3 million. These financial resources, together with anticipated additional resources to be provided from operations, are expected to be adequate to meet the Company's working capital needs, capital equipment requirements and debt service obligations at least through fiscal 1996. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." The Company is not required to adopt the provisions of this statement until its fiscal year 1996. The provisions of this statement must be made on a prospective basis. The Company plans to adopt the disclosure provisions of this statement in 1996, and theefore the effect on its financial position and results of operations, upon adoption, will not be significant. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed Of." The Company will adopt the provision of this statement in fiscal 1996 and believes the effect on its financial position and result of operations, upon adoption, will not be significant. 13 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS PAGE Consolidated Balance Sheets - September 30, 1995 and October 1, 1994 15 - 16 Consolidated Statements of Operations for the Three Fiscal Years Ended September 30, 1995 17 Consolidated Statements of Stockholders' Equity for the Three Fiscal Years Ended September 30, 1995 18 Consolidated Statements of Cash Flows for the Three Fiscal Years Ended September 30, 1995 19 - 20 Notes to Consolidated Financial Statements 21 - 30 Form 10-K Schedule 31 Report of Independent Public Accountants 32 14 ILC TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1995 AND OCTOBER 1, 1994
ASSETS 1995 1994 ---- ---- Current assets: Cash and cash equivalents $ 1,508,971 $ 2,461,549 Marketable securities - 998,129 Accounts receivable, less allowance for for doubtful accounts of $409,950 and $332,803, respectively 9,834,704 6,956,981 Receivable from long-term contracts 610,122 824,007 Inventories 9,289,207 7,192,197 Deferred tax asset 1,454,000 2,405,000 Prepaid expenses 159,180 542,801 ----------- ----------- Total current assets 22,856,184 21,380,664 ---------- ---------- Property and equipment, net 22,441,755 17,688,277 Deposit on land and building purchase - 1,300,000 Covenants-not-to-compete, net of accumulated amortization and writedown of $2,435,354 and $2,145,473, respectively 1,116,811 1,406,692 Other assets 770,186 221,789 ------------ ------------- $47,184,936 $41,997,422 =========== =========== The accompanying notes are an integral part of these financial statements. 15 ILC TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1995 AND OCTOBER 1, 1994 LIABILITIES AND STOCKHOLDERS' EQUITY 1995 1994 ---- ---- Current liabilities: Accounts payable ...................... $ 4,080,000 $ 3,921,112 Accrued payroll and related items ..... 1,753,303 1,765,605 Other accrued liabilities ............. 1,112,326 1,144,184 Current portion of non-compete obligation . 520,000 520,000 Current portion of long-term debt ..... 2,455,500 2,196,494 Accrued income taxes payable .......... 1,869,494 2,405,000 ----------- ----------- Total current liabilities ......... 11,790,623 11,952,395 ----------- ----------- Long-term liabilities, net of current portion: Long-term debt ...................... 5,898,040 5,096,494 Non-compete obligation ............. 390,000 910,000 Other accruals ..................... 304,074 414,844 ----------- ----------- Total long-term liabilities ...... 6,592,114 6,421,338 ----------- ----------- Commitments and contingencies (Note 7) Stockholders' equity: Common stock, no par value; 10,000,000 shares authorized; 4,683,174 shares and 4,522,951 shares outstanding, respectively ..... 6,132,914 5,492,338 Retained earnings .................... 22,669,285 18,131,351 ----------- ----------- Total stockholders' equity ........ 28,802,199 23,623,689 ----------- ----------- $47,184,936 $41,997,422 =========== =========== The accompanying notes are an integral part of these financial statements. 16 ILC TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1995 1995 1994 1993 ----------- ------------ ------------ Net sales .................... $58,429,214 $ 52,022,328 $ 51,996,509 Costs and expenses: Cost of sales ............... 39,226,370 35,287,928 34,818,944 Research and development .... 4,497,013 3,998,136 2,767,448 Sales and marketing ......... 2,976,326 2,271,099 2,641,810 General and administrative .. 5,079,500 5,218,701 3,936,940 Amortization and writedown of intangibles ............. 289,881 3,764,678 756,712 ----------- ------------ ------------ 52,069,090 50,540,542 44,921,854 ----------- ------------ ------------ Income from operations ........ 6,360,124 1,481,786 7,074,655 ----------- ------------ ------------ Other (income) expense: Interest, net ............... 382,190 139,173 (113,598) Rental operations, net ...... - - 77,582 ---------- ----------- ------------ 382,190 139,173 (36,016) ---------- ----------- ------------ Income before provision for income taxes ............. 5,977,934 1,342,613 7,110,671 Provision for income taxes .... 1,440,000 1,152,000 2,352,000 ----------- ------------ ------------ Net income .................... $ 4,537,934 $ 190,613 $ 4,758,671 =========== ============ ============ Net income per share .......... $ 0.95 $ 0.04 $ 0.96 =========== ============ ============ Weighted average shares outstanding used to compute net income per share ......... 4,764,989 4,825,009 4,979,529 =========== ============ ============ The accompanying notes are an integral part of these financial statements. 17 ILC TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1995 Common Common Stock Retained Shares Amount Earnings Total Balance at October 3, 1992 ....4,574,695 $6,396,232 $13,182,067 $19,578,299 Net income ................. - - 4,758,671 4,758,671 Issuance of common stock under stock purchase plan .. 14,281 134,283 - 134,283 Exercise of stock options ... 30,500 93,313 - 93,313 -------- ------- --------- ---------- Balance at October 2, 1993 ....4,619,476 6,623,828 17,940,738 24,564,566 Net income .................. - - 190,613 190,613 Issuance of common stock under stock purchase plan ...................... 25,475 196,590 - 196,590 Exercise of stock options ... 82,000 227,420 - 227,420 Repurchase of common stock .. (204,000) (1,555,500) - (1,555,500) --------- ----------- -------- ----------- Balance at October 1, 1994 ....4,522,951 5,492,338 18,131,351 23,623,689 Net income .................. - - 4,537,934 4,537,934 Issuance of common stock under stock purchase plan .. 37,973 266,575 - 266,575 Exercise of stock options .... 132,250 450,751 - 450,751 Repurchase of common stock ... (10,000) (76,750) - (76,750) --------- -------- ---------- ------------ Balance at September 30, 1995 .4,683,174 $6,132,914 $22,669,285 $28,802,199 ========== ========== =========== =========== The accompanying notes are an integral part of these financial statements. 18 ILC TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1995 1995 1994 1993 ---- ----- ----- Cash flows from operating activities: Net Income ........................ $ 4,537,934 $ 190,613 $4,758,671 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ... 1,684,122 1,115,236 1,033,104 Provision for doubtful accounts and note....................... 103,251 383,902 (98,769) Provision for inventory obsolescence ................... 206,859 1,772,346 (22,125) Net loss on property and equipment sold or retired....... 26,367 3,839 68,687 Amortization and write down of non-compete agreements ...... 289,881 1,442,309 491,428 Amortization and write down of goodwill..................... - 2,321,248 265,284 Changes in assets and liabilities: Decrease in marketable securities ................... 998,129 438,078 475,704 (Increase) decrease in accounts receivable........... (2,767,089) 226,209 (1,150,930) Increase in inventories ....... (2,303,869) (1,639,654) (148,901) Decrease in deferred tax asset ........................ 951,000 - - (Increase) decrease in prepaid expenses.............. 383,621 (220,922) (198,491) (Increase) decrease in other assets ................. (98,397) 182,694 133,572 Increase (decrease) in accounts payable.............. 158,888 (86,511) 263,444 Increase (decrease) in accrued liabilities........... (722,015) 545,369 (49,438) ----------- ---------- ---------- Total adjustments ......... (1,089,252) 6,484,143 1,062,569 ----------- --------- --------- Net cash provided by operating activities....... 3,448,682 6,674,756 5,821,240 ----------- ----------- ----------- Cash flows from investing activities: Purchase of land and real estate ...(3,045,412) (3,012,844) (7,600,000) (Increase) decrease in deposit on land and building purchase...... 1,300,000 (1,300,000) - Investment in joint venture ........ (450,000) - - Capital expenditures ...............(3,418,555) (2,634,348) (1,466,924) ----------- ------------ ------------ Net cash used in investing activities....... (5,613,967) (6,947,192) (9,066,924) ----------- ----------- ----------- The accompanying notes are an integral part of these financial statements. 19 ILC TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1995 (CONTINUED) 1995 1994 1993 ---- ---- ---- Cash flows from financing activities: Principal borrowings under line of credit................ $8,450,000 $ - $ - Principal repayments under line of credit............... (6,450,000) - - New borrowings under equipment line .............. 1,720,089 1,090,702 717,336 Principal repayments under equipment line............... (1,049,958) (499,225) (453,940) Principal borrowings under term loan ................... - 1,333,333 5,000,000 Principal repayments under term loan ................... (1,578,000) (533,333) - Payments under non-compete agreement ................... (520,000) (520,000) (520,000) Proceeds from issuance of common stock ................ 717,326 424,010 227,596 Repurchase of common stock ... (76,750) (1,555,500) - ----------- ----------- ----------- Net cash provided by (used in) financing activities................. 1,212,707 (260,013) 4,970,992 ----------- ---------- ----------- Net increase (decrease) in cash and cash equivalents................ (952,578) (532,449) 1,725,308 Cash and cash equivalents at beginning of year.............. 2,461,549 2,993,998 1,268,690 ----------- ----------- ----------- Cash and cash equivalents at end of year ................... $1,508,971 $2,461,549 $2,993,998 ========== ========== ========== Supplemental disclosures of cash flow information: 1995 1994 1993 ---- ---- ---- Cash paid during the year for: Interest expense ........... $695,541 $338,751 $77,925 Income taxes ............... 909,000 2,500,539 2,213,100 Supplemental disclosures of noncash investing and financing activities: A capital lease obligation of $174,268 was incurred in fiscal 1994 when the Company entered into a capital lease for new computer equipment. The accompanying notes are an integral part of these financial statements. 20
ILC TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1995 1. THE COMPANY ILC Technology, Inc. (the "Company") was incorporated on September 15, 1967. The Company designs, develops and manufactures high intensity lamps and lighting products for medical, industrial, communication, aerospace, scientific, entertainment and military industries. The Company develops and manufactures the majority of its products at its headquarter facilities in California and the remainder at its subsidiary facilities in Massachusetts, the United Kingdom and another location in California. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The financial statements include the accounts of ILC Technology, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. The Company's fiscal year end is the Saturday closest to September 30. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS For the purpose of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less at the time of issue to be cash equivalents. MARKETABLE SECURITIES Effective October 3, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting For Certain Investments in Debt and Equity Securities". The adoption of this statement did not materially impact the Company's results from operations or financial position. Marketable securities at October 1, 1994 were being accounted for as trading securities and were therefore valued at fair market value in the accompanying balance sheet. The change in the net unrealized holding loss, which was included in fiscal 1994 income, was approximately $80,000 during fiscal 1994. During fiscal 1995, all marketable securities were liquidated. 21 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market, and include material, labor and manufacturing overhead. Inventories at September 30, 1995 and October 1, 1994, net of inventory reserves of $2,042,813 and $2,533,233, respectively, consisted of: 1995 1994 ---- ---- Raw materials .................... $4,846,508 $ 3,393,249 Work-in-process................... 2,609,006 2,556,006 Finished goods ................... 1,833,693 1,242,942 ---------- ----------- Total inventories................. $9,289,207 $ 7,192,197 ========== =========== DEVELOPMENTAL AND MANUFACTURING CONTRACTS The Company contracts with the U.S. Government and other customers for the development and manufacturing of various products under both cost-plus-fixed-fee and fixed-price contracts. Revenues are recognized under these contracts using the percentage of completion method, whereby revenues are reported in the proportion that costs incurred bear to the total estimated costs for each contract. Periodic reviews of estimated total costs during the performance of such contracts may result in revisions of contract estimates in subsequent periods. Any loss contracts are reserved at the time such losses are determined. Revenues from these contracts were less than 10% of net revenues during 1995, 1994 and 1993. DEPRECIATION AND AMORTIZATION Depreciation and amortization on property and equipment are provided on a straight-line basis over estimated useful lives of 3 to 31.5 years, except for leasehold improvements which are amortized over the terms of the leases. NET INCOME PER SHARE Net income per share is computed based on the weighted average number of common shares and common equivalent shares (using the treasury stock method and when such equivalents have a dilutive effect) outstanding during the period. Fully diluted net income per share is not significantly different from net income per share as reported. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." The Company is not required to adopt the provisions of this statement until its fiscal year 1996. The provisions of this statement must be made on a prospective basis. The Company plans to adopt the disclosure provisions of this statement in 1996, and theefore the effect on its financial position and results of operations, upon adoption, will not be significant. 22 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INTANGIBLE ASSETS The Company has certain intangible assets as a result of its acquisition of two subsidiaries (see Note 10). Subsequent to these acquisitions, the Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful lives of these intangibles may warrant revision or that the remaining balances of intangibles may not be recoverable. When factors indicate that intangibles should be evaluated for possible impairment, the Company uses an estimate of the related subsidiary's undiscounted cash flow over the remaining life of the intangibles in measuring whether the intangibles are recoverable. Covenants-not-to-compete are amortized over the period of the covenant. INVESTMENT IN JOINT VENTURE In February 1995, the Company invested $450,000 in a lamp manufacturer located in Japan. The Company's investment represents a 49% ownership interest in the equity of the investee, consequently the Company accounts for its investment using the equity method of accounting. The Company's investment is included in Other Assets in the accompanying consolidated balance sheets and its proportionate interest in the income of the investee of $89,000 in fiscal 1995 is included in the accompanying consolidated statements of operations. FORWARD EXCHANGE CONTRACTS The Company enters into forward exchange contracts to reduce its exposure to currency exchange risk for purchases from one Japanese vendor. The effect of this practice is to minimize the impact of foreign exchange rate movements on the Company's operating results. The Company's hedging activities do not subject the Company to exchange rate risk, as gains and losses on these contracts offset losses and gains on the liabilities being hedged. At September 30, 1995, the Company had forward exchange contracts maturing from October 1995 to December 1995 to purchase 22,200,000 Japanese yen ($224,000). 3. REVENUES The Company recognizes revenue on all product sales upon shipment of the product. The Company accrues for estimated warranty obligations at the time of the sale of the related product based upon its past history of claims experience and costs to discharge its obligations. The Company operates in a single industry segment, the designing, developing, manufacturing and marketing of high performance light source products. Revenues are geographically summarized as follows (in thousands): 1995 1994 1993 ----------- ------------ ------------ United States ................... $ 38,080 $ 31,627 $ 29,994 Europe .......................... 6,062 4,435 5,188 Asia ............................ 14,239 15,794 16,447 Other international ............. 48 166 368 ----------- ------------ ------------ Total revenues ...... $ 58,429 $ 52,022 $ 51,997 =========== ============ ============ 23 3. REVENUES (CONTINUED) Customers comprising more than 10% of net sales are as follows: 1995 1994 1993 ----------- ------------ ------------ Customer A ............... 10.3% 17.6% 19% Customer B ............... 12.1% 12.8% 17% Customer C ............... 10.3% * * *less than 10% of net sales The Company provides credit in the form of trade accounts receivable to its customers. The Company does not generally require collateral to support customer receivables. The Company performs ongoing credit evaluations of its customers and maintains allowances which management believes are adequate for potential credit losses. Approximately 34% of the Company's sales in fiscal 1995 were to customers in the health-care industry. This industry has experienced significant fluctuations in demand and the Company expects sales to the medical market to decrease as a percentage of net sales in the forseeable future. Customer C, referred to above, is in the semi-conducto industry. This industry also can be subject to significant fluctuations in demand. 4. PROPERTY AND EQUIPMENT Property and equipment at September 30, 1995 and October 1, 1994 consisted of: Property and equipment, at cost: Machinery and equipment ................ $15,706,092 $11,856,023 Land and buildings ..................... 14,810,768 11,229,341 Furniture and fixtures ................. 670,145 463,910 Equipment under capital lease .......... 174,268 174,268 Leasehold improvements ................. 244,166 209,830 Construction-in-progress ............... 684,693 1,939,963 ----------- ----------- 32,290,132 25,873,335 Less accumulated depreciation and amortization ........................... (9,848,377) (8,185,058) ----------- ----------- Property and equipment, net ............... $22,441,755 $17,688,277 =========== =========== 5. BANK BORROWINGS The Company has a $4 million line of credit available with a bank which expires in January 1997. Borrowings under this line are at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995) and are limited to 75% of eligible accounts receivable. Under the covenants of the loan agreement, unless written approval from the bank is obtained, the Company is restricted from entering into certain transactions and is required to maintain certain specified financial covenants and profitability. As of September 30, 1995, the Company was in compliance with all bank requirements. The average balance outstanding (based on month-end balances) under the line of credit in 1995 was $1,550,000. The maximum borrowings were $2,450,000 at an average interest rate of 7.8% for 1995. There were no borrowings under the line of credit in fiscal 1994, nor were there any amounts outstanding as of October 1, 1994. As of September 30, 1995, $2 million was available for future borrowings under this line of credit. 24 5. BANK BORROWINGS (CONTINUED) In addition, in connection with the purchase of its Sunnyvale manufacturing facilities, the Company entered into a term note with a bank for $5,000,000 in 1993, which was subsequently increased to $6,333,333 in 1994. The note matures in August, 1998. The term loan requires monthly principal payments equal to one-forty-eighth of the principal amount plus interest at 2% above the LIBOR rate (London Interbank Offer Rate) (7.8% at September 30, 1995). The term loan is a reducing revolving credit facility which allows for principal pre-payments and the flexibility for re-borrowing up to the maximum amount that would be outstanding under the term loan given normal amortization to the date of re-borrowing. The Company also has available a $1.5 million equipment line of credit for 100% of the purchase cost of new equipment, which expires in January 1996. Borrowings under this line bear interest at 2% above the LIBOR rate (7.8% at September 30, 1995), with principal balances amortized over a 2 year period. At September 30, 1995, the Company had approximately $690,000 available for future borrowings under this line of credit. As of September 30, 1995 and October 1, 1994, borrowings outstanding under its credit facilities consisted of: 1995 1994 ----------- ----------- Term note ............................. $ 4,222,000 $ 5,800,000 Line of credit ........................ 2,000,000 - Equipment line of credit .............. 2,011,000 1,340,869 Other capital lease ................... 120,540 152,119 ----------- ----------- 8,353,540 7,292,988 Less: current portion ................. (2,455,500) (2,196,494) ----------- ----------- Long-term debt ........................ $ 5,898,040 $ 5,096,494 =========== =========== Aggregate maturities for long-term debt during the next five years are approximately: 1996 - $2,455,500, 1997 - $2,455,500, 1998 - $1,450,000, 1999 none and 2000 - none. All of the above credit facilities are secured by all of the property of the Company. 6. INCOME TAXES Effective October 3, 1993, the Company adopted the provisions of SFAS No. 109, "Accounting for Income Taxes", on a prospective basis. SFAS No. 109 requires an asset and liability approach to accounting for income taxes. The adoption of SFAS No. 109 did not have a material effect on the Company's consolidated financial statements. Income before provision for income taxes consists of the following for fiscal 1995, 1994 and 1993: 1995 1994 1993 ---- ---- ---- U.S. $5,456,897 $ 971,283 $6,906,493 Foreign 521,037 371,330 204,178 ---------- ---------- ---------- $5,977,934 $1,342,613 $7,110,671 ========== ========== ========== 25 6. INCOME TAXES (CONTINUED) The components of the provision for income taxes are as follows: 1995 1994 1993 ----------- ------------ ------------ Federal - Current $833,000 $2,373,000 $1,575,000 Deferred 554,000 (1,361,000) - -------- ---------- ---------- 1,387,000 1,012,000 1,575,000 State - Current 199,000 493,000 777,000 Deferred 92,000 (353,000) - --------- --------- --------- 291,000 140,000 777,000 Federal refund received (238,000) - - --------- --------- --------- Total provision for income taxes $1,440,000 $1,152,000 $2,352,000 ========== ========== ========== The major components of the deferred tax accounts as computed under SFAS No. 109, are as follows: 1995 1994 ---- ---- Inventory reserve $838,000 $754,000 Bad debt reserve 271,000 258,000 Warranty reserve 105,000 228,000 Accruals not currently deductible for tax purposes 448,000 1,078,000 Amortization of covenant-not-to-compete 278,000 538,000 Excess of tax over book depreciation (801,000) (710,000) Other 315,000 259,000 -------- ---------- $1,454,000 $2,405,000 ========== ========== The provisions for income taxes differ from the amounts which would result by applying the applicable statutory Federal income tax rate to income before taxes as follows: 1995 1994 1993 ---- ---- ---- Computed expected provision $2,092,000 $470,000 $2,418,000 State tax 359,000 81,000 436,000 Amortization and writedown of goodwill - 812,000 90,000 FSC commission (211,000) (259,000) (254,000) General business credits (200,000) (72,000) (33,000) Refund received (238,000) - - Other (362,000) 120,000 (305,000) -------- ------- ------- $1,440,000 $1,152,000 $2,352,000 ========== ========== ========== 26 7. EMPLOYEE RETIREMENT PLAN On January 1, 1984, the Company adopted a thrift incentive savings plan (the "Plan"). The Plan is qualified under section 401(k) of the Internal Revenue Code and is available to all full-time employees with one or more years of employment with the Company. Under the terms of the Plan, participating employees must contribute at least 2% of their salary to the Plan, and the Company contributes (as a matching contribution) 100% of this amount. Employees may also contribute an additional amount up to 13% of their salary to the Plan, with no further contributions by the Company. The Company's contributions vest at a rate of 20% per year, commencing on the first anniversary of employment. Total employer matching contributions under the Plan were $212,000, $163,000, and $145,000 for the fiscal years 1995, 1994 and 1993, respectively. 8. COMMITMENTS AND CONTINGENCIES In October 1994, Q-Arc Ltd. purchased a new office and manufacturing facility in Cambridge, England. Prior to this, Q-Arc had leased its manufacturing facility under an operating lease agreement, which lease agreement has been assumed by another company. In August 1993, the Company purchased two buildings, which were its two principal operating facilities in Sunnyvale, California, from the landlord for $7,600,000. The Company has leased a small portion of the Sunnyvale facility under a lease which expires in 1996. At September 30, 1995, the future minimum rental payments under all building leases for fiscal 1996 through 2000 are approximately $380,000, $423,000, $424,000, $444,000 and $444,000, respectively, and $660,000 thereafter. The amounts total $2,775,000. For fiscal years 1995, 1994 and 1993, rental expense was approximately $277,000, $318,000 and $934,000 respectively. 9. STOCK OPTION AND PURCHASE PLANS In 1993, the Company adopted the 1992 Stock Option Plan and reserved 200,000 shares for issuance. The 1992 Option Plan replaced the 1983 Option Plan which expired in June 1993. Although options granted under the 1983 Stock Option Plan before such expiration will remain outstanding in accordance with their terms, no further options will be granted under the 1983 Stock Option Plan after June 1993. The exercise price per share for stock options cannot be less than the fair market value on the date of grant. Options granted are for a ten-year term and generally vest ratably over a period of four years commencing one year after the date of grant. In November 1993, the Company's 1992 Stock Option Plan was amended to provide for the automatic grant of a nonstatutory stock option to purchase shares of Common Stock to each outside Director. Subsequent grants will occur annually during the Company's third fiscal quarter. During fiscal 1995, each outside Director was granted an automatic option to purchase a total of 5,000 shares of the Company's Common Stock. A summary of the option transactions is as follows: 27 9. STOCK OPTION AND PURCHASE PLANS (CONTINUED) Options Outstanding ------------------- Options Number Available of Price per for Grant Shares Share --------- ------ --------- Balance at October 3, 1992 11,624 698,500 $2.13-11.50 1992 Option Plan new shares approved 200,000 - - Options assumed in Converter Power Acquisition - 26,027 $1.09 Granted (57,500) 57,500 $9.00-11.50 Canceled 5,500 (5,500) $8.75-11.50 Exercised - (30,500) $ 2.13 -3.75 ------- ------- ------------ Balance at October 2, 1993 159,624 746,027 $1.09-11.50 Granted (74,000) 74,000 $7.38-11.00 Canceled 18,000 (18,000) $3.75-11.50 Exercised - (82,000) $ 1.09 -8.75 ------- ------ ------------ Balance at October 1, 1994 103,624 720,027 $1.09-11.50 Granted (28,000) 28,000 $9.50 Canceled 34,000 (34,000) $8.75-11.50 Exercised - (132,250) $ 2.13 -8.75 ------ ------- ------------ Balance at September 30, 1995 109,624 581,777 $1.09 -11.50 ======= ======= ============ Options exercisable at September 30, 1995 439,715 $1.09 -11.50 ======= ============ In February 1985, the Company adopted an employee stock purchase plan. Under the plan, the Company has reserved 200,000 shares of common stock for issuance to participating employees who have met certain eligibility requirements. In 1994, the Board of Directors and shareholders approved an amendment to the employee stock purchase plan to increase the number of shares reserved for issuance from 200,000 to 300,000 shares. The number of shares available for purchase by each participant is based upon annual base earnings and at a purchase price equal to 85% of the fair market value at the beginning or the end of the quarter of purchase, whichever is lower. During fiscal 1995, 1994 and 1993, a total of 37,973, 25,475 and 14,281 shares of common stock respectively, were purchased by the Company employees under the plan. As of September 30, 1995, 95,797 shares were available for future purchase. If all options outstanding at September 30, 1995 were exercised, the total proceeds to the Company wuld be approximately $4 million (unaudited). 28 10. OTHER INCOME/EXPENSE Other (income) expense consists of the following: 1995 1994 1993 ---- ---- ---- Interest income ................. $(313,351) $(199,578) $(191,941) Interest expense ................ 695,541 338,751 78,343 Rental and sublease income ...... - - (60,995) Net rental expense on sublet property ....................... - - 138,577 --------- --------- ------- $ 382,190 $ 139,173 $(36,016) ========= ========= ========= 11. ACQUISITIONS In August 1991, the Company acquired all the outstanding stock of Q-Arc Ltd. of Cambridge, England for $1,400,000 in cash and the assumption of certain liabilities. Q-Arc is a manufacturer of specialty lamps for laser and non- laser applications. This transaction was accounted for as a purchase and accordingly, all assets were revalued to their respective fair values. The acquisition price was equal to the fair value of net assets acquired. Net assets included a covenant-not-to-compete of approximately $951,000. The covenant is being amortized over an eight year period. At September 30, 1995, the unamortized balance of the Q-Arc covenant-not-to-compete is approximately $476,000. On June 30, 1992, the Company acquired all of the outstanding stock of Precision Lamp, Inc. located in Cotati, California. Precision Lamp designs, manufactures and distributes miniature incandescent lamps for various applications. The Company paid approximately $2,000,000 in cash for all of the outstanding shares, agreed to pay off approximately $1,100,000 of bank debt and assumed all liabilities ($1,321,000) of Precision Lamp. The Company also agreed to pay at least $2,600,000 to the primary selling shareholder as consideration for a covenant-not-to-compete among the primary selling shareholder, Precision Lamp and ILC. These payments will be made in equal installments through 1997. This transaction was accounted for as a purchase and accordingly, all assets were revalued to their respective fair values. This purchase price allocation resulted in goodwill of approximately $2,650,000 which is being amortized over a ten year period. The $2,600,000 covenant- not-to-compete is being amortized over a seven year period. In the second quarter of fiscal 1994, management determined that an impairment occurred in the recoverability of the unamortized goodwill and covenant-not-to-compete due to a significant shortfall in orders from a major Precision Lamp customer. Accordingly, a $3.4 million charge was recorded to write off the intangibles to net realizable value. The writedown was determined based on the currently projected undiscounted cash flows of Precision Lamp from March 1994 to March 2004, which projected aggregate cash flows of approximately $900,000 (unaudited) over that period and was based on projected net income which averaged 9% higher than the net income projection for fiscal 1994 (with no loss years included in the projection), compared with the carrying value of the Company's investment in Precision Lamp, including goodwill, at the date of the writedown. These projections represented management's best estimate for future results for that subsidiary. At September 30, 1995, the unamortized balance of the Precision Lamp covenant-not-to-compete is approximately $641,000. 29 12. RIGHTS AGREEMENT On September 19, 1989, the Company's Board of Directors declared a dividend of one common share purchase right for each outstanding share of common stock, no par value, of the Company. The dividend was payable on October 2, 1989 to the shareholders of record on that date. Each Right entitles the registered holder to purchase from the Company one share of common stock of the Company at a price of $30.00 per common share. The rights will not be exercisable until a party either acquires beneficial ownership of 20% of the Company's common stock or makes a tender offer for at least 30% of its common stock. In the event the rights become exercisable and thereafter a person or group acquires 30% or more of the Company's stock, a 20% shareholder ("Acquiring Person") engages in any specified self-dealing transaction, or, as a result of a recapitalization or reorganization, an Acquiring Person's shareholdings are increased by more than 3%, each right will entitle the holder to purchase from the Company, for the exercise price, common stock having a market value of twice the exercise price of the right. In the event the rights become exercisable and thereafter the Company is acquired in a merger or other business combination, each right will enable the holder to purchase from the surviving corporation, for the exercise price, common stock having a market value of twice the exercise price of the right. At the Company's option, the rights are redeemable in their entirety, prior to becoming exercisable, at $.01 per right. The rights are subject to adjustment to prevent dilution and expire September 29, 1999. 13. REPURCHASE OF COMMON STOCK In March 1994, the Board of Directors authorized the purchase of up to 1,000,000 shares of the Company's common shares outstanding through March 1995. During 1995 and 1994, the Company repurchased 10,000 and 204,000 shares of common stock for an aggregate amount of $76,750 and $1,555,500, respectively. Purchases were made on the open market. 30 SCHEDULE VIII ILC TECHNOLOGY, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR FISCAL YEARS 1995, 1994 AND 1993 Balance Charged at (Credited) Addition Deductions Balance Beginning to Cost and from and at end of Of Period Expenses Acquisition Write Off Period --------- ----------- ----------- ---------- -------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year ended October 2, 1993 $341,355 $(98,769) $ 7,258 $ 30,716 $219,128 Year ended $219,128 $383,902 $ - $270,227 $332,803 October 1, 1994 Year ended September 30, 1995 $332,803 $103,251 $ - $ 26,104 $409,950 RESERVE FOR INVENTORY OBSOLESCENCE: Year ended October 2, 1993 $1,990,256 $ (22,125) $ - $414,672 $1,553,459 Year ended October 1, 1994 $1,553,459 $1,772,346 $ - $792,572 $2,533,233 Year ended September 30, 1995 $2,533,233 $ 206,859 $ - $697,279 $2,042,813 31 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To ILC Technology, Inc. We have audited the accompanying consolidated balance sheets of ILC Technology, Inc. (a California Corporation) and subsidiaries as of September 30, 1995 and October 1, 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1995. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 consolidated financial position of ILC Technology, Inc. and subsidiaries as of September 30, 1995 and October 1, 1994 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1995 in conformity with generally accepted accounting principles. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule presented on page 31 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP San Jose, California November 3, 1995 32 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III Certain information required by Part III is omitted from this Report in that registrant will file a definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") for its Annual Meeting of Shareholders to be held February 14, 1996, not later than 120 days after the end of the fiscal year covered by this Report, and the information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information regarding directors required by this item appearing in the Company's 1995 Proxy Statement under the caption "Election of Directors-Nominees" is incorporated herein by reference. The information regarding executive officers of the Company required by this item appearing in the Company's 1995 Proxy Statement under the caption "Election of Directors- Other Officers" is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item appearing in the Company's 1995 Proxy Statement under the captions "Election of Directors-Director Compensation" and "Executive Compensation" is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item appearing in the Company's 1995 Proxy Statement under the caption "Election of Directors-Nominees" is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item appearing in the Company's 1995 Proxy Statement under the captions "Election of Directors-Director Compensation" and "Executive Compensation" is incorporated herein by reference. 33 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. FINANCIAL STATEMENTS The Consolidated Financial Statements, notes thereto, and Report of Independent Public Accountants thereon are included in Part II, Item 8 of this report. Page in 2. FINANCIAL STATEMENT SCHEDULE Form 10-K Schedule VIII Valuation and Qualifying Accounts and Reserves 31 All other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Consolidated Financial Statements or notes thereto. 3. EXHIBITS The exhibits listed in the Index to Exhibits following the signature page are filed as part of this Report. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the last quarter of fiscal 1995. . 34 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. ILC TECHNOLOGY, INC. By: /S/ HENRY C. BAUMGARTNER Henry C. Baumgartner President and Chief Executive Officer Dated: December 22, 1995 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. SIGNATURES TITLE DATE Chairman of the Board December , 1995 - ------------------------------- (Wirt D. Walker, III) (Director) /S/ HENRY C. BAUMGARTNER President and Chief December 22, 1995 - ------------------------------- (Henry C. Baumgartner) Executive Officer (Principal Executive Officer and Director) /S/ RONALD E. FREDIANELLI Chief Financial Officer December 22, 1995 - ------------------------------- Ronald E. Fredianelli) and Secretary (Principal Financial and Accounting Officer) (Richard D. Capra) Director December , 1995 /S/ HARRISON H. AUGUR Director December 22, 1995 - ------------------------------- (Harrison H. Augur) /S/ ARTHUR L. SCHAWLOW Director December 22, 1995 - ------------------------------- (Arthur L. Schawlow) 35 INDEX TO EXHIBITS Exhibit NUMBER DESCRIPTION 3.1 (A) Restated Articles of Incorporation of ILC Technology, Inc. as filed in the Office of the California Secretary of State on March 8, 1991. 3.2 (A) Amended and restated Bylaws as of February 8, 1989. 4.1 (C) Certificate evidencing shares of Common Stock without par value, ILC Technology, Inc. 10.1 (F) ILC Technology, Inc. 1983 Employee Incentive and Nonstatutory Stock Option Plan, as amended, together with related form of Stock Option Agreement. 10.2 (B) Rights Agreement between ILC Technology, Inc. and Security Pacific National Bank dated as of September 29, 1989. 10.3 (D) Employment Agreement between ILC Technology, Inc. and Richard E. DuNah dated July 1, 1992.* 10.4 (F) ILC Technology, Inc. 1992 Stock Option Plan, as amended, and related form of Option Agreement.* 10.5 (D) Form of Officer and Director Indemnification Agreement* 10.6 Credit Agreement dated March 2, 1995, by and between Union Bank and ILC Technology, Inc. 10.7 (F) Purchase and Sale Agreement dated August 19, 1993, by and between Cambridge Investors I Limited Partnership and ILC Technology, Inc. 10.8 (F) Standard Industrial/Commercial Single-Tenant Lease between ILC Technology, Inc. (720 Portal Street, Cotati, California) and John Gary Taylor, dated December 29, 1992. 10.9 (E) Agreement and Plan of Reorganization among ILC Technology, Inc., ILC Acquisitions, Inc., Converter Power, Inc. and the shareholders of Converter Power, Inc., dated January 29, 1993. 10.10 (E) Employment Agreement between ILC Technology, Inc. and William F. O'Brien dated January 29, 1993.* 10.11 (E) Employment Agreement between ILC Technology, Inc. and Dean A. Mac Farland dated January 29, 1993.* 10.12 (G) Purchase and Sale Agreement dated June 24, 1994, by and between UCB Bank PLC and Q-Arc, Limited relating to property on the south side of Saxon Way, Bar Hill, Cambridge, England. 10.13 (G) Asset Purchase Agreement dated September 16, 1994, by and between ILC Technology, Inc. and UVP, Inc. INDEX TO EXHIBITS (CONTINUED) 10.14 Lease Agreement between Converter Power, Inc. (150 Sohier Road, Beverly, Massachusetts) and Communications & Power Industries, Inc., dated September 15, 1995 21.1 (G) Subsidiaries of Registrant 23.1 Consent of Arthur Andersen LLP 27.1 Financial Data Schedule 99.1 Proxy Statement for the Company's 1995 Annual Meeting of Shareholders (to be deemed filed only to the extent required by General Instructions H to Form 10-K) - ------------------------------------------------------------------------------- (A) Incorporated by reference from the Exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended September 28, 1991. (B) Incorporated by reference from the Exhibits to Registrant's Current Report on Form 8-K dated September 19, 1989. (C) Incorporated by reference from the Exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988. (D) Incorporated by reference from the Exhibits to Registrants' Annual Report on Form 10-K for the fiscal year ended October 3, 1992. (E) Incorporated by reference from the Exhibits to Registrants' Registration Statement on Form S-3, as amended (File No. 33-59904), effective May 19, 1993. (F) Incorporated by reference from the Exhibits to Registrants Annual Report on Form 10-K for the fiscal year ended October 2, 1993. (G) Incorporated by reference from the Exhibits to Registrants' Registration Statement on Form 10-K for the year ended October 1, 1994. * Management Contract or Compenstory Plan or arrangement. EX-10.6 2 LOAN AGREEMENT EXHIBIT 10.6 LOAN AGREEMENT THIS LOAN AGREEMENT ("Agreement") is made and entered into as of March 2, 1995 by and between ILC Technology, Inc., ("Borrower") and UNION BANK, a California banking corporation ("Bank"). SECTION 1. THE LOAN 1.1.1 THE REVOLVING LOAN. Bank will loan to Borrower an amount not to exceed Four Million Dollars ($4,000,000) outstanding in the aggregate at any one time (the "Revolving Loan"). Borrower may borrow, repay and reborrow all or part of the Revolving Loan in accordance with the terms of the Revolving Note. All borrowings of the Revolving Loan must be made before January 31, 1997 at which time all unpaid principal and interest of the Revolving Loan shall be due and payable. The Revolving Loan shall be evidenced by a promissory note (the "Revolving Note") on the standard form used by Bank for commercial loans. Bank shall enter each amount borrowed and repaid in Bank's records and such entries shall be deemed to be the amount of the Revolving Loan outstanding. Omission of Bank to make any such entries shall not discharge Borrower of its obligation to repay in full with interest all amounts borrowed. 1.1.2 REVOLVING EQUIPMENT LOAN. Subject to the terms and conditions hereof, between the date of the Agreement and January 31, 1996 (the "Revolving Equipment Loan Termination Date"), so long as no Default or Potential Default has occurred and is continuing, Bank shall extend to Borrower such loan ("Revolving Equipment Loan") as Borrower may request from time to time in an aggregate unpaid principal amount not exceeding at any one time One Million Five Hundred Thousand Dollars ($1,500,000) (the "Revolving Equipment Credit Commitment"). Within the limits of time and amount set forth in this Section 1.1.2, Borrower may borrow, repay and reborrow all or part of the Revolving Equipment Loan. Borrower authorized Bank to make Revolving Equipment Loan based upon telephonic notice or upon such other instructions as Bank received from anyone purporting to be an authorized representative of the Borrower, received within the time prior to the Banking Day of the proposed Revolving Equipment Loan as set forth in the Revolving Note, or, if not therein set forth, then by 10:00 a.m. of the Banking Day of the proposed Revolving Equipment Loan. Such notice shall be given to any of Bank's commercial banking officers at Bank's Commercial Portfolio Administration Department ("Bank's Lending Office") and shall be irrevocable. 1.1.3 OTHER LOANS. Bank has extended and will continue to extend, subject to the terms of this Agreement and the terms of the respective Note, certain additional facilities each evidenced by a Note described as follows: A. Obligation #0000000002 dated 2/24/93 in the original principal amount of $900,000 with a present unpaid principal balance of $270,000. B. Obligation #002700003 dated 6/21/94 in the original principal amount of $6,333,333 with a present unpaid principal balance of $5,145,000. -1- C. Obligation #0000000003 dated 6/21/94 in the original principal amount of $360,000 with a present unpaid principal balance of $240,000. D. Obligation #0001000001 dated 1/5/95 in the original principal amount of $1,464,000 with a present unpaid principal balance of $1,403,000. 1.2 TERMINOLOGY. As used herein the word "Loan" shall mean, collectively, all the credit facilities described above. As used herein the word "Note" shall mean, collectively, all the promissory notes described above. As used herein, the words "Loan Documents" shall mean all documents executed in connection with this Agreement. 1.3 BORROWING BASE. Notwithstanding any other provisions of this Agreement, Bank shall not be obligated to advance funds under the Revolving Loan, if at any time the aggregate of Borrower's obligations to Bank thereunder shall exceed the sum of seventy-five percent (75%) of Borrower's Eligible Accounts. If at any time Borrower's obligations to Bank under the above facilities exceed the sum so permitted, Borrower shall immediately repay to Bank such excess. 1.3.1 ELIGIBLE ACCOUNTS. The term "Accounts" means all presently existing and hereafter arising accounts receivable, contract rights, chattel paper, and all other forms of obligations owing to Borrower, payable in United States Dollars, arising out of the sale or lease of goods, or the rendition of services by Borrower, whether or not earned by performance, and any and all credit insurance, guaranties and other security therefor, as well as all merchandise returned to or reclaimed by Borrower and Borrower's books and records relating to any of the foregoing. The term "Eligible Accounts" means those Accounts, net of finance charges, which are due and payable within Ninety (90) days, or less, from the date of the invoice, have been validly assigned to Bank and strictly comply with all of Borrower's warranties and representations to Bank, but Eligible Accounts shall not include the following: (a) Any Account with respect to which the account debtor is an officer, shareholder, director, employee or agent of Borrower; (b) Any Account with respect to which the account debtor is a subsidiary of, related to, or affiliated or has common officers or directors with Borrower; (c) Any Account relating to goods placed on consignment, guaranteed sale or other terms by reason of which the payment by the account debtor may be conditional; -2- (d) Any Account with respect to which the account debtor is not a resident of the United States or Canada; (e) Any Account with respect to which the account debtor is the United States or any department, agency or instrumentality of the United States; (f) Any Account with respect to which Borrower is or may become liable to the account debtor for goods sold or services rendered by the account debtor to Borrower; (g) Any Account with respect to which there is asserted a defense, counterclaim, discount or setoff, whether well-founded or otherwise, except for those discounts, allowances and returns arising in the ordinary course of Borrower's business; (h) Any Account with respect to which the account debtor becomes insolvent, fails to pay its debts as they mature or goes out of business or is owed by an account debtor which has become the subject of a proceeding under any provision of the Untied States Bankruptcy Code, as amended, or under any other bankruptcy or insolvency law, including, but not limited to, assignments for the benefit of creditors, formal or informal moratoriums, compositions or extensions with all or substantially all of its creditors; (i) Any Account owed by any account debtor with respect to which twenty-five percent (25%) or more of the aggregate dollar amount of its Accounts are not paid within ninety (90) days from the due date of the invoice; (j) That portion of the Accounts owed by any single account debtor which exceeds twenty percent (20%) of all of the Accounts; and 1.4 PURPOSE OF LOAN. The proceeds of the Revolving Loan shall be used for general working capital purposes and the proceeds of the Revolving Equipment Loan shall be used only for Borrower's Capital Equipment Requirements. 1.5 INTEREST. (A) Interest on the usage of the Revolving Loan shall be payable monthly to January 31, 1997 at which time the principal shall be due and payable. Interest on this loan shall be payable at Bank's Reference Rate or at the Borrower's option a fixed rate of libor plus 200 basis points. Twenty four hour notice shall be given if the fixed rate option is taken. (B) Interest on the usage of the Revolving Equipment Loan shall be payable monthly to January 31, 1996 at which time the principal amount then outstanding will equally amortize over a 24 month period. Interest on this loan shall be payable at Bank's Reference Rate or at the Borrower's option a fixed rate of libor plus 200 basis points. Twenty four hour notice shall be given if the fixed rate option is taken. -3- 1.6 BALANCES. Borrower shall maintain its major depository accounts with Bank until the Note and all sums payable pursuant to this Agreement have been paid in full. 1.7 DISBURSEMENT. Upon execution hereof, Bank shall disburse the proceeds of the Loan as provided in Bank's standard form Authorization executed by Borrower. 1.8 SECURITY. Prior to any disbursement of the Loan, Borrower, ILC Technology, Inc. and Guarantors, Converter Power, Inc. and Precision Lamp, Inc., shall have executed a security agreement, on Bank's standard form, and a financing statement, suitable for filing in the office of the Secretary of State of the State of California and any other state designated by Bank, granting to Bank a first priority security interest in such of Borrower's property as is described in said security agreement. Exceptions to Bank's first priority, if any, are permitted only as otherwise provided in this Agreement. 1.9 CONTROLLING DOCUMENT. In the event of any inconsistency between the terms of this Agreement and any Note or any of the other Loan Documents, the terms of such Note or other Loan Documents will prevail over the terms of this Agreement. SECTION 2. CONDITIONS PRECEDENT Bank shall not be obligated to disburse all or any portion of the proceeds of the Loan unless at or prior to the time for the making of such disbursement, the following conditions have been fulfilled to Bank's satisfaction. 2.1 COMPLIANCE. Borrower shall have performed and complied with all terms and condition required by this Agreement to be performed or complied with by it prior to or at the date of the making of such disbursement and shall have executed and delivered to Bank the Note and other documents deemed necessary by Bank. 2.2 GUARANTIES. Converter Power, Inc., Precision Lamp, Inc. and Q-ARC Limited ("Guarantors") shall have executed and delivered to Bank their respective continuing guaranties in form and amount satisfactory to Bank. Borrower shall cause each Guarantor to submit to Bank not later than Ninety (90) days after the end of each fiscal year such Guarantor's financial statement in form satisfactory to Bank. 2.3 BORROWING RESOLUTION. Borrower shall have provided Bank with certified copies of resolutions duly adopted by the Board of Directors of Borrower, authorizing this Agreement and the Loan Documents. Such resolutions shall also designate the persons who are authorized to act on Borrower's behalf in connection with this Agreement and to do the things required of Borrower pursuant to this Agreement. 2.4 CONTINUING COMPLIANCE. At the time any disbursement is to be made, there shall not exist any event, condition or act which constitutes an event of default under Section 6 hereof or any event, condition or act which with notice, lapse of time or both would constitute such event of default; nor shall there be any such event, condition, or act immediately after the disbursement were it to be made. -4- SECTION 3. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that: 3.1 BUSINESS ACTIVITY. The principal business of Borrower is Manufacturer of Light Source Products. 3.2 AFFILIATES AND SUBSIDIARIES. Borrower's affiliates and subsidiaries (those entities in which Borrower has either a controlling interest or at least 25% ownership interest) and their addresses, and the names of Borrower's principal shareholders, are as provided on a schedule delivered to Bank on or before the date of this Agreement. 3.3 AUTHORITY TO BORROW. The execution, delivery and performance of this Agreement, the Note and all other agreements and instruments required by Bank in connection with the Loan are not in contravention of any of the terms of any indenture, agreement or undertaking to which Borrower is a party or by which it or any of its property is bound or affected. 3.4 FINANCIAL STATEMENTS. The financial statements of Borrower, including both a balance sheet at October 1, 1994, together with supporting schedules, and an income statement for the Twelve (12) months ended October 1, 1994, have heretofore been furnished to Bank, and are true and complete and fairly represent the financial condition of Borrower during the period covered thereby. Since October 1, 1994, there has been no material adverse change in the financial condition or operations of Borrower. 3.5 TITLE. Except for assets which may have been disposed of in the ordinary course of business, Borrower has good and marketable title to all of the property reflected in its financial statements delivered to Bank and to all property acquired by Borrower since the date of said financial statements, free and clear of all liens, encumbrances, security interests and adverse claims except those specifically referred to in said financial statements. 3.6 LITIGATION. There is no litigation or proceeding pending or threatened against Borrower or any of its property which is reasonably likely to affect the financial condition, property or business of Borrower in a materially adverse manner or result in liability in excess of Borrower's insurance coverage. 3.7 DEFAULT. Borrower is not now in default in the payment of any of its material obligations, and there exists no event, condition or act which constitutes an event of default under Section 6 hereof and no condition, event or act which with notice or lapse of time, or both, would constitute an event of default. -5- 3.8 COMPLIANCE WITH LAWS. Borrower is not in violation with respect to any applicable laws, rules, ordinances or regulations which materially affect the operations or financial condition of Borrower. 3.9 CONTINUING REPRESENTATIONS. These representations shall be considered to have been made again at and as of the date of each disbursement of the Loan and shall be true and correct as of such date or dates. SECTION 4. AFFIRMATIVE COVENANTS Until the Note and all sums payable pursuant to this Agreement or any other of the Loan Documents have been paid in full, unless Bank waives compliance in writing, Borrower agrees that: 4.1 USE OF PROCEEDS. Borrower will use the proceeds of the Loan only as provided in subsection 1.4 above. 4.2 PAYMENT OF OBLIGATIONS. Borrower will pay and discharge promptly all taxes, assessments and other governmental charges and claims levied or imposed upon it or its property, or any part thereof, provided, however, that Borrower shall have the right in good faith to contest any such taxes, assessments, charges or claims and, pending the outcome of such contest, to delay or refuse payment thereof provided that adequately funded reserves are established by it to pay and discharge any such taxes, assessments, charges and claims. 4.3 MAINTENANCE OF EXISTENCE. Borrower will maintain and preserve its existence and assets and all rights, franchises, licenses and other authority necessary for the conduct of its business and will maintain and preserve its property, equipment and facilities in good order, condition and repair. Bank may, at reasonable times, visit and inspect any of the properties of Borrower. 4.4 RECORDS. Borrower will keep and maintain full and accurate accounts and records of its operations according to generally accepted accounting principles and will permit Bank to have access thereto, to make examination and photocopies thereof, and to make audits during regular business hours. Costs for such audits shall be paid by Borrower. 4.5 INFORMATION FURNISHED. Borrower will furnish to Bank: (a) Within Forty-Five (45) days after the close of each fiscal quarter, except for the final quarter of each fiscal year, its unaudited balance sheet as of the close of such fiscal quarter, its unaudited income and expense statement with supportive schedules and statement of retained earnings for that fiscal quarter, prepared in accordance with generally accepted accounting principles: (b) Within Ninety (90) days after the close of each fiscal year, a copy of its statement of financial condition including at least its balance -6- sheet as of the close of such fiscal year, its income and expense statement and retained earnings statement for such fiscal year, examined and prepared on an audited basis by independent certified public accountants selected by Borrower and reasonably satisfactory to Bank, in accordance with generally accepted accounting principles applied on a basis consistent with that of the previous year; (c) As soon as available, but in any event within Ninety (90) days after the close of each fiscal year of Borrower, projections for the next succeeding fiscal year of corresponding cash flow statement by Borrower and acceptable to Bank; d) Such other financialstatements and information as Bank may reasonably request from time to time; e) In connection with each financial statement provided hereunder, a statement executed by Chief Financial Officer of Borrower, certifying that no default has occurred and no event exists which with notice or the lapse of time, or both, would result in a default hereunder; (f) In connection with each fiscal year-end statement required hereunder, any management letter of Borrower's certified public accountants; (g) Within Forty-Five (45) days after each fiscal quarter, a certification of compliance with all covenants under this Agreement, executed by Borrower's chief financial officer or other duly authorized officer of Borrower, in form acceptable to Bank; (h) Prompt written notice to Bank of all events of default under any of the terms or provisions of this Agreement or of any other agreement, contract, document or instrument entered, or to be entered into with Bank; and of any litigation which, if decided adversely to Borrower, would have a material adverse effect on Borrower's financial condition; and of any other matter which has resulted in, or is likely to result in, a material adverse change in its financial condition or operations; and (i) Prior written notice to Bank of any changes in Borrower's officers and other senior management; Borrower's name; and location of Borrower's assets, principal place of business or chief executive office; and (j) Within Forty-Five (45) days after each fiscal quarter, a copy of Borrower's accounts receivable aging. (k) Within Thirty (30) days after each calendar month end a copy of Borrower's certificate of compliance with borrowing base described above, executed by Borrower's Chief Financial Officer or other duly authorized officer of Borrower, in form acceptable to Bank, which certificate shall accurately report Borrower's account receivable and eligible accounts. 4.6 CURRENT RATIO. Borrower will at all times maintain a ratio of current assets to current liabilities of at least 1.50 : 1.0, as such terms are defined by generally accepted accounting principles. -7- 4.7 TANGIBLE NET WORTH. Maintain a Tangible Net Worth of not less than Twenty Two Million Five Hundred Thousand ($22,500,000) plus 75% of quarterly net profits after taxes (calculated without giving effect to net losses and inclusive of extraordinary gains) beginning with the quarter to end March 31, 1995 plus the proceeds of all sales by Borrower of its stock. "Tangible Net Worth" means the difference between (a) the gross book value of the assets of Borrower, and (b) the sum of (i) the amount of all intangibles such as goodwill, patents, trademarks, organization expenses, treasury stock, unamortized debt discount and expense and deferred charges, (ii) the amount of reserves established by Borrower for anticipated losses and expenses, and (iii) the amount of all liabilities and indebtedness of Borrower, including accrued but deferred income taxes. 4.8 DEBT TO TANGIBLE NET WORTH. Borrower will at all times maintain a ratio of total liabilities to tangible net worth of not greater than 1:0 : 1.0. "Tangible Net Worth" shall mean net worth decreased by patents, licenses, trademarks, trade names, goodwill and other similar intangible assets, organizational expenses, security deposits, prepaid costs and expenses and monies due from affiliates (including officers, shareholders and directors). 4.9 PROFITABILITY. Borrower will maintain a net profit, after provision for income taxes, of any positive amount for any two consecutive fiscal quarters, as reported at the end of each such fiscal quarter, and maintain a net profit, after provision for income taxes for its fiscal year end. 4.10 CASH FLOW COVERAGE. Maintain for each Measurement Period, Cash Flow Coverage of not less than One Hundred Seventy Five Percent (175%), as measured at the end of each fiscal quarter (each such date being a "Measurement date"). "Measurement Period" means the immediately preceding twelve month period ending on a given Measurement Date. "Cash Flow Coverage" is a fraction stated as percentage and computed as the quotient of (i) Borrower's net profit after taxes for a given Measurement Period, exclusive of nonrecurring income and increased by depreciation and amortization and other non-cash expenditures (taken in accordance with GAAP) divided by (ii) the aggregate amount of all principal, interest (and also including amounts coming due in respect of leases) payable by Borrower in such Measurement Period. 4.11 INVESTMENT IN YUMEX CORPORATION. Borrower's total investment in Yumex Corporation as reflected on Borrower's balance sheet, is not to exceed Seven Hundred Fifty Thousand Dollars ($750,000). 4.12 INSURANCE. Borrower will keep all of its insurable property, real, personal or mixed, insured by companies and in amounts approved by Bank against fire and such other risks, and in such amounts, as is customarily obtained by companies conducting similar business with respect to like properties. Borrower will furnish to Bank statements of its insurance coverage, will promptly furnish other or additional insurance deemed necessary by and upon request of Bank to the extent that such insurance may be available and hereby assigns to Bank, as security for Borrower's obligations to Bank, the proceeds of any such insurance. Prior to any disbursement of the Loan, Bank will be named loss payee on all policies insuring collateral. Borrower will maintain adequate worker's -8- compensation insurance and adequate insurance against liability for damage to persons or property. All policies shall require at least ten (10 days' written notice to Bank before any policy may be altered or cancelled. 4.13 ADDITIONAL REQUIREMENTS. Borrower will promptly, upon demand by Bank, take such further action and execute all such additional documents and instruments in connection with this Agreement as Bank in its reasonable discretion deems necessary, and promptly supply Bank with such other information concerning its affairs as Bank may request from time to time. 4.14 LITIGATION AND ATTORNEYS' FEES. Borrower will pay promptly to Bank upon demand, reasonable attorneys' fees (including but not limited to the reasonable estimate of the allocated costs and expenses of in-house legal counsel and legal staff) and all costs and other expenses paid or incurred by Bank in collecting, modifying or compromising the Loan or in enforcing or exercising its rights or remedies created by, connected with or provided for in this Agreement or any of the Loan Documents, whether or not an arbitration, judicial action or other proceeding is commenced. If such proceeding is commenced, only the prevailing party shall be entitled to attorneys' fees and court costs. 4.15 BANK EXPENSES. Borrower will pay or reimburse Bank for all costs, expenses and fees incurred by Bank in preparing and documenting this Agreement and the Loan, and all amendment and modifications thereof, including but not limited to all filing and recording fees, costs of appraisals, insurance and attorneys' fees, including the reasonable estimate of the allocated costs and expenses of in-house legal counsel and legal staff. 4.16 REPORTS UNDER PENSION PLANS. Borrower will furnish to Bank, as soon as possible and in any event within 15 days after Borrower knows or has reason to know that any event or condition with respect to any defined benefit pension plans of Borrower described in Section 3 above has occurred, a statement of an authorized officer of Borrower describing such event or condition and the action, if any, which Borrower proposes to take with respect thereto. SECTION 5. NEGATIVE COVENANTS Until the Note and all other sums payable pursuant to this Agreement or any other of the Loan Documents have been paid in full, unless Bank waives compliance in writing, Borrower agrees that: 5.1 ENCUMBRANCES AND LIENS. Except for those already disclosed on its fiscal year end 10/1/94 financial statement, Borrower will not create, assume or suffer to exist any mortgage, pledge, security interest, encumbrance, or lien (other than for taxes not delinquent and for taxes and other items being contested in good faith) on property of any kind, whether real, personal or mixed, now owned or hereafter acquired, or upon the income or profits thereof, except to Bank and except for minor encumbrances and easements on real property which do not affect its market value, and except for existing liens on Borrower's personal property and future purchase money security interests encumbering only the personal property purchased. -9- 5.2 BORROWINGS. Borrower will not sell, discount or otherwise transfer any account receivable or any note, draft or other evidence of indebtedness, except to Bank or except to a financial institution at face value for deposit or collection purposes only and without any fee other than fees normally charged by the financial institution for deposit or collection services. Borrower will not borrow any money, become contingently liable to borrow money, nor enter any agreement to directly or indirectly obtain borrowed money, except pursuant to agreements made with Bank. 5.3 SALE OF ASSETS, LIQUIDATION OR MERGER. Borrower will neither liquidate nor dissolve nor enter into any consolidation, merger, partnership or other combinations, nor convey, nor sell, nor lease all or the greater part of its assets or business, nor purchase or lease all or the greater part of the assets or business of another, without prior written consent from Bank. 5.4 LOANS, ADVANCES AND GUARANTIES. Borrower will not, except in the ordinary course of business as currently conducted, make any loans or advances, become a guarantor or surety, pledge its credit or properties in any manner or extend credit. 5.5 INVESTMENTS. Borrower will not purchase the debt or equity of another person or entity except for savings accounts and certificates of deposit of Bank, direct U.S. Government obligations and commercial paper issued by corporations with the top ratings of Moody's or Standard & Poor's, provided all such permitted investments shall mature within one year of purchase. 5.6 PAYMENT OF DIVIDENDS. Borrower will not declare or pay any dividends, other than a dividend payable in its own common Stock, or authorize or make any other distribution with respect to any of its stock now or hereafter outstanding. 5.7 RETIREMENT OF STOCK. Borrower will not acquire or retire any share of its capital stock for value. SECTION 6. EVENTS OF DEFAULT The occurrence of any of the following events ("Events of Default") shall terminate any obligation on the part of Bank to make or continue the Loan and automatically, unless otherwise provided under the Note, shall make all sums of interest and principal and any other amounts owing under the Loan immediately due and payable, without notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor, or any other notices or demands: 6.1 Borrower shall default in the due and punctual payment of the principal of or the interest on the Note or any of the other Loan Documents; or 6.2 Any default shall occur under the Note; or 6.2 Any default shall occur under the Note; or -10- 6.3 Borrower shall default in the due performance or observance of any covenant or condition of the Loan Documents; 6.4 Any guaranty or subordination agreementrequired hereunder is breached or becomes ineffective, or any Guarantor or subordinating creditor dies, disavows or attempts to revoke or terminate such guaranty or subordination agreement; or 6.5 There is a change in ownership or control of ten percent (10%) or more of the issued and outstanding stock of Borrower or any Guarantor. SECTION 7. MISCELLANEOUS PROVISIONS 7.1 ADDITIONAL REMEDIES. The rights, power and remedies given to Bank hereunder shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Bank by law against Borrower or any other person, including but not limited to Bank's rights of setoff or banker's lien. 7.2 NONWAIVER. Any forebearance or failure or delay by Bank in exercising any right, power or remedy hereunder shall not be deemed a waiver thereof and any single or partial exercise of any right, power or remedy shall not preclude the further exercise thereof. No waiver shall be effective unless it is in writing and signed by an officer of Bank. 7.3 INUREMENT. The benefits of this Agreement shall inure to the successor and assigns of Bank and the permitted successors and assignees of Borrower, and any assignment of Borrower without Bank's consent shall be null and void. 7.4 APPLICABLE LAW. This Agreement and all other agreements and instruments required by Bank in connection therewith shall be governed by and construed according to the laws of the State of California. 7.5 SEVERABILITY. Should any one or more provisions of this Agreement be determined to be illegal or unenforceable, all other provisions nevertheless shall be effective. 7.6 INTEGRATION CLAUSE. Except for documents and instruments specifically referenced herein, this Agreement constitutes the entire agreement between Bank and Borrower regarding the Loan and all prior communications verbal or written between Borrower and Bank shall be of no further effect or evidentiary value. 7.7 CONSTRUCTION. The section and subsection headings herein are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 7.8 AMENDMENTS. This Agreement may be amended only in writing signed by all parties hereto. -11- 7.9 COUNTERPARTS. Borrower and Bank may execute one or more counterparts to this Agreement, each of which shall be deemed an original. SECTION 8. SERVICE OF NOTICES 8.1 Any notices or other communications provided for or allowed hereunder shall be effective only when given by one of the following methods and addressed to the respective party at its address given with the signatures at the end of this Agreement and shall be considered to have been validly given: (a) upon delivery, if delivered personally; (b) upon receipt, if mailed, first class postage prepaid, with the United States Postal Service; (c) on the next business day, if sent by overnight courier service of recognized standing; and (d) upon telephoned confirmation of receipt, if telecopied. 8.2 The addresses to which notices or demands are to be given may be changed from time to time by notice delivered as provided above. (THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK) -12- THIS AGREEMENT is executed on behalf of the parties by duly authorized officers as of the date first above written. UNION BANK By: Title: By: Title: Address: Attention: Telecopier: Telephone: BORROWER: ILC TECHNOLOGY, INC. GUARANTORS: Converter Power, Inc. By: By: Title: Title: Q-ARC Limited By: By: Title: Title Precision Lamp, Inc. Address: By: Title: Attention: Telecopier: Telephone: -13- EX-10.14 3 LEASE EXHIBIT 10.14 LEASE SECTION 1 SECTION 1.1. REFERENCE INFORMATION. Reference in this Lease to any of the following shall have the meaning set forth below: Date of this lease: 1 October 1995 Premises: Approximately 31,917 square feet of floor space identified as the Premises Part A and Part B on the plan attached hereto as Exhibit B of Building Number 7 (the "Building") on the lot (the "Site") situated at 150 Sohier Road, Beverly, Massachusetts, together with the unassigned parking spaces (located in the parking area adjoining the Building) as shown on the plan attached hereto as Exhibit A. Landlord: Communications & Power Industries, Inc., a Delaware corporation Address of Landlord: 150 Sohier Road, Beverly, Massachusetts 01915 Tenant: Converter Power Inc., a Massachusetts corporation Address of Tenant: 148 Sohier Road, Beverly, Massachusetts 01915 Commencement Date: Part A, 1 October 1995; Part B, January 1, 1996 Expiration Date: 30 September 2000 Premises Square Footage: Part A - 5,760 square feet; and Part B - 26,157 square feet for a total of approximately 31,917 square feet. Building Square Footage: Approximately 39,576 square feet. Annual Fixed Rent Rate During Initial Term: Part A (5,760 square feet): _________ 1, 1995 to December 31, 1995: $3,120/mo. Part A and B (31,917 square feet): January 1, 1996 to August 31, 1998: $17,288.38/mo. September 1, 1998 to August 31, 2000: $18,136.13/mo. -1- Permitted Uses: Office, light manufacturing and storage Security Deposit: None Broker: Hunneman Commercial Company, Boston, MA; Mr. Greg Klemmer. SECTION 1.2. EXHIBITS. The following Exhibits are attached to and incorporated in this Lease: Exhibit A: Site Plan Exhibit B: Plan of Premises (Part A & B) Exhibit C: List of Hazardous Substances Used By Tenant Exhibit D: List of Environmental Reports SECTION 2 PREMISES AND TERM SECTION 2.1. PREMISES. Landlord hereby leases and demises the Premises to Tenant and Tenant hereby leases the Premises from Landlord, subject to any and all existing encumbrances and subject to the terms and provisions of this Lease. Landlord is the owner in fee simple of the Premises, the Building, and the Site. Tenant shall have the right of full and unrestricted ingress to and egress from the Premises. Notwithstanding the foregoing, it is understood and agreed that (a) certain property of Landlord may remain on the Premises after the Commencement Date, but shall be removed by Landlord, at it's sole cost and expense on or before January 1, 1996 and (b) as of the date hereof, there is no interior wall separating the Premises from the remaining portion of the Building not included in the Premises. It is also understood that another tenant, Multilevel Metals, Inc., or any successor occupant thereto, with reasonable notification to Converter Power, Inc., shall have the right of full and unrestricted ingress to and egress from the loading dock through the Leased Premises of Converter Power, Inc. to access Multilevel Metal, Inc.'s (or such successor's) Leased Premises as approved and directed by Converter Power, Inc. SECTION 2.2. TERM. TO HAVE AND TO HOLD for an initial term (the "Initial Term") beginning on the Commencement Date and ending on the Expiration Date, unless sooner terminated as hereinafter provided. The initial Term shall be subject to the extensions provided for in Section 2.3. The Initial Term and the Extended Term (as hereinafter defined), if Tenant exercises its right to extend this Lease in accordance with the terms of Section 2.3, shall be collectively referred to herein as the "Term". SECTION 2.3. EXTENSION. If no Event of Default (as hereinafter defined) shall have occurred and be continuing (either on the date that Tenant exercises its right to extend the Term of this Lease or on the date that the Extended Term is to commence), Tenant is hereby granted the right to extend the Term of this Lease beyond the Initial Term for one additional 5-year period (the "Extended Term"), exercisable upon not less than twelve (12) months prior written notice -2- to Landlord. During the Extended Term, all of the terms and conditions of this Lease shall continue in force and effect. The annual fixed rent rate during the extension term shall be the fair rental value of the premises on September 1, 2000 but not less than the rent paid during the extension term shall be the fair rental value of the premises on September 1, 2000 but not less than the rent paid during the last year of the original term. The parties shall first attempt to agree on fair rental value. In the event that the parties shall fail to agree on fair rental value by January 1, 2000 respectively, the matter shall be submitted to arbitration under the rule of the American Arbitration Association. Each party shall chose as an arbitrator a licensed real estate broker whose principal business is the leasing of commercial real estate in the greater Beverly Area, and the two arbitrators shall choose a third arbitrator with similar qualifications. The decision of two arbitrators shall be binding on the parties. The arbitrators shall attempt to reach a decision before the commencement of the extended term. In the event that they have not reached a decision by that time, the tenant shall pay the same rent as in the last year of the previous term and pay any additional rent due within ten days of the arbitrator's decision. SECTION 3 CONDITION OF PREMISES SECTION 3.1. Condition of Premises. Tenant agrees to accept the Premises in its present "AS IS" condition. Landlord shall have no obligation to perform any work or construction. If Tenant shall desire to perform any work or construction, the same shall be done only in accordance with this Lease. Landlord represents that the Premises has a Certificate of Occupancy to permit its use for manufacturing, warehousing, and offices. SECTION 4 FIXED RENT SECTION 4.1. THE FIXED RENT. Tenant shall pay rent (the "Fixed Rent") to Landlord at the Address of Landlord or at such other place or to such other person or entity as Landlord may by notice to Tenant from time to time direct, at the Annual Fixed Rent Rate set forth in Section 1, in equal installments equal to 1/12th of the Annual Fixed Rent Rate in advance on the first day of each calendar month included in the Term, and for any portion of a calendar month at the beginning or end of the Term, at that rate payable in advance for such portion. SECTION 4.2. ADDITIONAL RENT. Tenant's Proportionate Share of Additional Rent includes Utilities which is 14.6% for Premises Part A, and 66.1% for Premises Part B (or a total of 80.7% for the entire Premises (As "Utilities" are hereinafter defined in Section 7.1), shall be payable by Tenant within thirty (30) days after a reasonably detailed statement of actual expenses is presented to Tenant by Landlord. At Landlord's option, however, an amount may be estimated by Landlord from time to time of Tenant's proportionate share of Additional Rent and the same shall be payable monthly, during each 12-month period of the lease term, in advance, on the first day of each calendar month included in the Term, and for any portion of a calendar month at the beginning or the end of the Term, at the rate payable in advance for such portion. Landlord shall deliver to Tenant within sixty (60) days after the expiration of -3- each calendar year a reasonably detailed statement showing Tenant's Share of Actual Additional Rent incurred during the preceding year. If Tenant's payments under this Section 4.2 during said preceding year exceed Tenant's Proportionate Share as indicated on said statement, Tenant shall be credited the amount of such over-payment against Tenant's Proportionate Share of Additional Rent next becoming due. If Tenant's payment under this Section 4.2 during said preceding year are less than Tenant's Proportionate Share as indicated on said statement, Tenant shall pay to Landlord the amount of the deficiency within thirty (30) days after the delivery by Landlord to Tenant of said statement. Tenant shall have the opportunity upon written request to Landlord to review the books and records of Landlord relating to the charges reflected in such statement and may, within 60 days after the delivery of such statement, contest any such statement if Tenant reasonably believes that it is inaccurate. No such review or contest shall affect the obligations of Landlord and Tenant to make credits and payments on the basis of such statements as aforesaid, but upon resolution of any contest, a readjustment of any such credit or payment shall promptly be made. SECTION 5 REAL ESTATE AND OTHER TAXES SECTION 5.1. REAL ESTATE TAXES. Landlord, at its sole cost, shall pay all real property taxes and general and special assessments levied or assessed against the Site during the Term, excluding any increases in such taxes resulting from (i) improvements to the Premises made by or for Tenant, or (ii) any increase in such taxes assessed against the tax lot of which the Building is a part above the taxes assessed for fiscal year 1995, plus 2-1/2%. Any increase in taxes against the tax lot of which the Building is a part shall be allocated proportionally to the Premises based upon square footage of occupied buildings on such tax lot. Tenant shall reimburse Landlord upon demand as Additional Rent the amount of such increases in taxes and assessments. SECTION 5.2. PERSONAL PROPERTY TAXES. Tenant shall pay before delinquency all taxes, assessments, licenses, fees and other charges (Taxes) that are levied or assessed against Tenant's personal property installed or located in or on the Premises which become payable during the Term. Upon Landlord's demand, Tenant shall furnish Landlord with satisfactory evidence of these payments. If any Taxes on Tenant's personal property are levied against Landlord or Landlord's property, or if the assessed value of Landlord's property is increased by the inclusion of a value placed on Tenant's personal property, Tenant, on demand, shall immediately reimburse Landlord the sum of the Taxes levied against Landlord on account of Tenant's personal property, or the proportion of the Taxes resulting from the inclusion of Tenant's personal property in Landlord's assessment. Landlord shall have the right to pay such Taxes without incurring any liability to Tenant and without necessity of contesting their validity, but will assign all rights Landlord may have to contest these Taxes to Tenant upon Tenant's written demand therefor. -4- SECTION 6 INSURANCE SECTION 6.1.TENANT'S INSURANCE. Tenant shall at all times during the Term of the Lease maintain, at its sole cost, a standard policy of fire and extended coverage insurance in an amount customary in reasonable business practice covering Tenant's trade fixtures, furnishings, equipment and all other items of personal property of Tenant as well as any minor improvements or Improvements constructed for or by Tenant and all property for which Tenant is responsible. Tenant shall also maintain during the Term of this Lease, comprehensive general public liability insurance covering its use, occupancy and maintenance of the Premises and all areas appurtenant thereto. Such coverage, at the commencement of the Term, shall have a minimum single limit of liability of at least Two Million Dollars ($2,000,000) per person and Two Million Dollars ($2,000,000) per occurrence and, from time to time during the Term, shall be for such higher limits as are reasonably required by Landlord. Such insurance shall be written to apply to all bodily injury, property damage and other covered loss during the Term of the Lease. Further, Tenant shall maintain Worker's Compensation insurance and all other legally required insurance coverage in at least the minimum amount mandated by statute. All of Tenant's insurance policies shall provide primary coverage for the matters covered thereby and Landlord's insurance shall have no obligation to contribute. Tenant's policies for comprehensive general liability shall name Landlord as an additional insured party. SECTION 6.2. LANDLORD'S INSURANCE. Landlord, at its sole cost, shall obtain and keep in force during the Term of this Lease a standard policy of fire and extended coverage insurance on the Site on which the Premises are located and in an amount customary with Landlord's business practice. Landlord shall also maintain a standard policy of public liability insurance insuring against liability arising out of Landlord's ownership of the Premises, the Site and all areas appurtenant thereto in an amount of not less than Two Million Dollars ($2,000,000) per occurrence. SECTION 6.3. WAIVER OF SUBROGATION. Landlord shall cause each insurance policy carried by Landlord insuring the Premises against loss by fire and causes covered by standard extended coverage, and Tenant shall cause each insurance policy carried by Tenant and insuring the Premises and its fixtures and contents against loss by fire and causes covered by standard extended coverage, to be written in a manner so as to provide that the insurance company waives all right of recovery by way of subrogation against Landlord or Tenant in connection with any loss or damage covered by any such policies. Neither party shall be liable to the other for any loss or damage caused by fire or any of the risks enumerated in standard extended coverage insurance. Tenant and Landlord shall, upon obtaining the policies of insurance required hereunder, give notice to the insurance carrier or carriers that the foregoing mutual Waiver of Subrogation is contained in this Lease. This waiver of right of recovery applies also to loss or damage within Landlord's or Tenant's respective deductible or self-insured retentions. SECTION 6.4. INSURANCE POLICIES. Insurance required of Tenant hereunder shall be provided by companies licensed to do business in the state of -5- Massachusetts, satisfactory to Landlord and having A.M. Best's rating of not less than A. Prior to the commencement of this Lease, Tenant shall deliver to Landlord copies of policies of insurance required under this Lease or certificates evidencing the existence and amounts of such insurance. No such policy shall be cancelable or subject to reduction of coverage or other modification except after thirty (30) days prior written notice to Landlord. Tenant shall, at least thirty (30) days prior to the expiration or cancellation of any or all such policies, furnish Landlord with renewals or binders thereof or replacement policies; if Tenant fails to do so, Landlord may obtain such insurance and charge the cost thereof and interest thereon to Tenant, which amount shall be payable by Tenant upon demand. Tenant shall not do or permit to be done anything on or about the Premises which shall invalidate any of the insurance policies required to be carried hereunder or make any such insurance unobtainable. SECTION 7 UTILITIES; MAINTENANCE EXPENSES; FIRE ALARMS AND SPRINKLER SYSTEMS SECTION 7.1. UTILITIES. Landlord shall provide electrical, water and gas services and reasonable amounts of compressed air to the Premises (the "Utilities"), the cost of which shall be paid for by Tenant pursuant to Section 4.2. Landlord shall not be liable for any interruption or failure in the supply of any such utilities to the Premises. SECTION 7.2. MAINTENANCE EXPENSES. To the extent repairs or maintenance covered by Section 9 are required due to Tenant's negligence or willful misconduct, Landlord shall effect such repairs or maintenance at Tenant's sole expense. SECTION 7.3. FIRE ALARMS AND SPRINKLER SYSTEMS. Landlord shall maintain the fire alarms and sprinkler systems for the Premises and fire extinguishers that presently are located in Premises. SECTION 8 HAZARDOUS SUBSTANCES SECTION 8.1. USE OF HAZARDOUS SUBSTANCES. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, chemical, material or waste whose presence, nature, quantity and/or intensity of existence, use, manufacture, disposal, transportation, spill, release or effect, either by itself or in combination with other materials expected to be on the Premises, is: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority and/or (iii) a basis for liability to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substance shall include, but not be limited to, hydrocarbons, petroleum, gasoline, crude oil or any products, by-products or fractions thereof. Tenant shall not engage in any activity in, on or about the Premises (or permit any of its agents or employees to engage in any activity in, on or about the Premise) which constitutes the generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of a Hazardous Substance except in strict compliance with Applicable Law (as hereinafter defined), and provided, such generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of Hazardous Substance does not expose the Premises, the Building, the -6- Site and/or neighboring properties to any risk of contamination or damage, or expose Landlord or any Lender (as hereinafter defined) to any liability therefor. Notwithstanding anything to the contrary contained herein, in no event shall Tenant, its agents, employees, contractors, social guests, or business invitees (a) generate, possess, manufacture, store, use, transport, handle, treat, release, deposit and/or dispose of any Hazardous Substance other than the Hazardous Substances identified on Exhibit C attached hereto, which may not exceed the specific volume or quantities identified therein, without the prior written consent of Landlord, which consent may by withheld in Landlord's sole and absolute discretion and/or (b) introduce, in any manner, any Hazardous Substances in or through the plumbing and/or sewer systems servicing any portion of the Site. Without limiting the foregoing, Tenant shall introduce only domestic sewage into the plumbing and sewer systems in compliance with Applicable Laws, including the rules and regulations of the South Essex Sewer District. In addition, with respect to the presence, generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substance in, on, under or about the Premises as may be allowed hereunder, Tenant shall give Landlord such additional assurances as Landlord, in its subjective, good faith discretion, deems necessary to protect itself, the public, the Premises, the Building, the Site and the environment against damage, contamination or injury and/or liability therefrom or therefor, including, but not limited to, the installation (and removal on or before the expiration or earlier termination of this Lease) of reasonably necessary protective modifications to the Premises (such as concrete encasements or other containments), provided that no such protective modifications applicable to the use of the items listed on Exhibit C may be required in excess of measures necessary to comply with Applicable Law. Tenant shall be solely responsible for providing any notice of the presence, generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substance to persons occupying or entering the Premises, the Building and/or the Site and to neighboring properties. Upon the expiration or earlier termination of this Lease, Tenant shall, at its sole cost and expense, upon Landlord's request and in compliance with all Applicable Laws: (i) remove, remediate, abate, and/or dispose of any Hazardous Substance stored or otherwise located in, on, under or about the Premises, the Building and/or the Site (including, without limitation, general decontamination of workspaces and duct-work) by Tenant, its agents, employees, contractors, social guests, or business invitees; (ii) remove, remediate, abate, dispose of and/or replace any soil (and compact the same as then required by law or by Landlord) contaminated by Tenant, its agents, employees, contractors, social guests, or business invitees; and (iii) remediate, remove, abate and/or dispose of any surface water, or ground water contaminated by Tenant, its agents, employees, contractors, social guests, or business invitees; such that the Premises, the Building and the Site are free from any Hazardous Substances which were generated, possessed, manufactured, stored, used, transported, handled, treated, released, deposited and/or disposed of by Tenant, its agents, employees, contractors, social guests, or business invitees. SECTION 8.2. DUTY TO INFORM LANDLORD. If Tenant knows, or has reasonable cause to believe, that a Hazardous Substance, or a condition involving or resulting from same, has come to be located in, on, under or about the Premises, other than as previously consented to by Landlord, Tenant shall immediately give -7- oral notice of such fact to Landlord, followed as soon as possible by written notice to Landlord. Such oral and written notice shall be made for any release or discharge of any quantity of Hazardous Material at the site that (i) is likely to come in contact with soil or groundwater or (ii) is more than one pound by weight or (iii) cannot be cleaned up within 15 minutes. Such notice shall include a complete description of the type and quantity of Hazardous Material released or discharged, the location of the release or discharge and the regulatory agencies notified. Tenant shall also immediately give Landlord a copy of any statement, report, notice, registration, application, permit, business plan, license, claim, action or proceeding given to, or received from, any governmental authority or private party, or persons entering or occupying the Premises, concerning the presence, spill, release, discharge of, or exposure to, any Hazardous Substance or contamination in, on, or about the Premises. Tenant acknowledges that it, and not Landlord, is in charge of the Premises for purposes of all reporting requirements under any Applicable Law. SECTION 8.3. INDEMNIFICATION. Tenant shall indemnify, protect, defend and hold Landlord its agents, employees, partners, co-managing directors, lenders, the Premises, the Building and the Site harmless from and against any and all loss of rents and/or damages, liabilities, judgments, costs, claims, liens, expenses, penalties, permits and attorneys' and consultants' fees arising out of or involving the presence, generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substance in, on, under or from the Premises on or after the Commencement Date and continuing during the Term and any extension thereof due to the activities of Tenant, its agents, employees, contractors, social guests or business invitees on or about the Site. Tenant's obligations under this Section 8 shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Tenant, its agents, employees, contractors, social guests, or business invitees, and the cost of investigation (including, without limitation, consultants' and attorneys' reasonable fees and testing), removal, remediation, restoration and/or abatement thereof, or of any contamination therein involved and any costs and fees related to the generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substances by Tenant, its agents, employees, contractors, social guests, or business invitees, and shall survive the expiration or earlier termination of this Lease. No termination, cancellation or release agreement entered into by Landlord and Tenant shall release Tenant from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Landlord in writing at the time of such agreement. Landlord shall indemnify, protect, defend and hold Tenant, its agents, and employees, harmless from and against any and all claims by third parties against Tenant for loss of rents and/or damages, liabilities, judgments, costs, claims, liens, expenses, penalties, permits and attorneys' and consultants' fees arising out of or involving the presence, generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substance in, on, under or from the Site before the Commencement Date or due to the activities of Landlord, its agents, employees, contractors, social guests, or business invitees on or about the Site. Landlord's obligations under this Section 8 shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Landlord or the prior tenants of the Site, and the cost of Tenant's investigation (including consultant's and attorney's reasonable fees and -8- testing), removal, remediation, restoration and/or abatement thereof, or of any contamination therein involved and any costs and fees related to the generation, possession, manufacture, storage, use, transportation, handling, treatment, release, deposit and/or disposal of any Hazardous Substances by Landlord, its agents, employees, contractors, social guests, or business invitees, and shall survive the expiration or earlier termination of this Lease. SECTION 8.4. HAZARDOUS SUBSTANCE HANDLING. Tenant shall, at its own expense, procure, maintain in effect and comply with all conditions of any and all permits, licenses and other governmental and regulatory approvals required for Tenant's use of the Premises. Subject to Tenant's compliance with the provisions of this Section 8, Tenant shall cause any and all Hazardous Substance used, stored, released, generated, manufactured or produced on the Premises to be removed, transported and disposed of solely by duly licensed haulers to duly licensed facilities for final disposal of such Hazardous Substance. In no event shall Tenant dispose of any Hazardous Substance on, in, under or about the Premises. Upon the expiration or earlier termination of this Lease, Tenant shall cause all Hazardous Substance to be removed from the Premises and transported for use, storage or disposal in accordance and compliance with all Applicable Law. Tenant shall not take any remedial action in response to the presence of any Hazardous Substance in or about the Premises, nor enter into any settlement agreement, consent decree or other agreement in respect to any complaint or claim relating to any Hazardous Substance in any way connected with the Premises, without first notifying Landlord of Tenant's intention to do so and affording Landlord ample opportunity to appear, intervene and otherwise appropriately assert and protect Landlord's and Landlord's predecessor's, Varian Associates, Inc. ("Varian") interests in the contemplated action; however, notwithstanding anything to the contrary contained herein, Tenant shall immediately take any action as necessary to respond to any spills or releases of Hazardous Substances and shall immediately inform Landlord of the details of all such events and such actions taken. SECTION 8.5. WAIVER AND RELEASE. Tenant acknowledges that Landlord has made available to Tenant the environment reports regarding the Site listed on Exhibit D attached hereto and that no environmental testing has been performed on the Premises or the Building, so that Landlord and Tenant have no knowledge whether any Hazardous Substances are present in, on, under or about the Premises or in, under or about the Building (except to the extent that any Hazardous Substances are utilized by Landlord in connection with the operation of its business in the Building or the presence of any Hazardous Substances is disclosed in the environmental reports listed on Exhibit D). Subject to the provisions of section 8.3, Tenant hereby waives, releases and discharges Landlord and Varian, and each of Landlord's and Varian's officers, directors, shareholders, partners, employees, agents, representatives, attorneys, successors and assigns from any and all environmental suits, causes of action, legal or administrative proceedings, liabilities, claims, damages, losses, costs and expenses of whatever kind, or unknown, including any action under the Comprehensive Environmental Reponse, Compensation and Liability Act (42 U.S.C. Section 9601 et seq.), as amended ("CERCLA") and the provisions of the Massachusetts Hazardous Waste Management Act, M.G.L. c. 21 C and the Massachusetts Oil and Hazardous Material Release Prevention and Response Act, M.G.L. c. 21E, as amended, which Tenant has or may have, based upon the presence, discharge, treatment, recycling, use, migration, storage, generation, release, or transportation to or -9- from the Premises of any Hazardous Substance or the environmental condition of the Premises (including without limitation all facilities, improvements, structures and equipment thereon and soil and groundwater thereunder) on and after the Commencement Date. SECTION 8.6. ENVIRONMENTAL REMEDIATION. Tenant acknowledges that Landlord has informed Tenant that Landlord and Varian are in the process of conducting investigations of the Hazardous Substances located on the Site (collectively, the "Investigations") and that Landlord and Varian shall complete such remediation of the Site as Landlord and Varian deem appropriate based upon the results of such investigations (the "Remediation"). Notwithstanding anything to the contrary contained herein, Landlord and Varian reserve the right to conduct and complete the Investigations and Remediation on the Site, including, without limitation, in, under and about the Premises, and, to that end, Landlord and its agents, consultants and employees including Varian employees, agents and consultants shall have the right to enter upon the Premises to undertake the Investigations and Remediation, and Tenant's use and access to the Premises, the Building, the parking areas and the Site may be limited by the activities conducted by Landlord and Varian and Landlord's and Varian's agents, consultants and employees in connection with the Investigations and Remediation; provided, however that Landlord and Varian shall use reasonable efforts to minimize any limitation of and/or disruption to Tenant's use and access to the Premises, the Building, the parking areas and the Site as a result of the Investigations and Remediation on the Site. Without limiting the foregoing, Landlord reserves the right to re-assign parking spaces to Tenant; provided, however, that in no event shall less than one hundred thirty (130) parking spaces be assigned to Tenant at any time during the Term. SECTION 8.7. COOPERATION WITH VARIAN. Tenant shall cooperate with Varian and Landlord in the conduct of Investigations and Remediation, shall not unreasonably interfere with Varian's activities and shall cooperate with Varian's efforts to accomplish the Investigations and Remediations in a cost effective and reasonable manner. Tenant shall provide Landlord with reasonable written notice of any construction at or alterations to the site which may adversely affect such Investigations and Remediation. Provided Tenant complies with this Section 8.7, if the exercise of rights under Section 8.6 deprives Tenant of the use of a material portion of the Premises for more than 5 days after notice to Landlord, Tenant shall be entitled to an equitable abatement of rent until such use is restored. SECTION 8.8. COOPERATION WITH AGENCIES. Tenant shall cooperate with governmental agencies to the extent reasonably necessary for Varian to perform the Investigations and Remediation. SECTION 8.9. PERFORMANCE OF TESTING. Tenant shall provide reasonable advance written notice to Landlord, which notice shall not be less than fifteen (15) working days (unless a shorter period is necessitated by legal or regulatory requirements, in which case notice shall be provided as much in advance as is reasonably practical), before performing or causing to be performed any Hazardous Material testing of the soils, groundwater or surface waters at or near the site, including installation of soil borings or monitoring -10- wells or testing of soils, groundwater or surface waters. Tenant shall promptly furnish Landlord with a copy of all test results. SECTION 8.10. OSHA ASBESTOS NOTIFICATION. Pursuant to 29 CFR ss. 1910.1001, Landlord hereby notifies Tenant that Landlord has good cause to believe that asbestos containing materials or materials presumed to contain asbestos, as those terms are defined in the OSHA regulations identified above, are located in the Premises. The materials containing or presumed to contain asbestos are located in vinyl asbestos tiles and in roofing materials. SECTION 9 LANDLORD'S COVENANTS SECTION 9.1. BUILDING MAINTENANCE. Subject to 7.2, Sections 8, 10 and 11, Landlord shall maintain and repair the exterior walls (exclusive of the interior surfaces of the exterior walls, all of which Tenant shall maintain and repair), doors, windows, roof, foundation, structural supports of the Building and, the Building's and Premises' heating and ventilation. Landlord shall have no obligation to make any such repairs until a reasonable time after Landlord's receipt of written notice from Tenant specifying the need for such repairs. Notwithstanding the foregoing, any emergency repairs shall be done as quickly as practicable. SECTION 9.2. COMMON AREA MAINTENANCE. Subject to Sections 7.2, 8, 10 and 11, Landlord shall maintain and repair the common areas of the Building, if any, and the common areas on the Site, including all sidewalks, access driveways, parking lot area, exterior light standards and fences. Landlord shall clean and provide snowplowing and landscaping for the same. Landlord shall have no obligation to make any such repairs until a reasonable time after Landlord's receipt of written notice from Tenant specifying the fees for such repairs. Tenant has the right to install vending machines with prior written consent of Landlord which approval shall not be unreasonably withheld or delayed. Section 9.3. Cafeteria Service. Landlord shall make available food service at Landlord's main Cafeteria on the Site which may be purchased by Tenant's employees and visitors. Tenant may install vending machines in the Premises using Landlord's vending machine supplier. SECTION 10 TENANT'S COVENANTS SECTION 10.1. USE. Tenant shall use the Premises only for the Permitted Uses and shall from to time procure all licenses and permits necessary therefor at Tenant's sole expense. In no event may Tenant's use of the Premises, the parking area or any of the common areas of the Building or Site interfere with the use of the Site by Landlord and/or other occupants of the Site. SECTION 10.2. TRASH AND JANITORIAL SERVICE. Tenant shall keep in a safe, secure and sanitary condition all trash and rubbish temporarily stored at the Premises (which shall be stored at a location on the Site to be mutually agreed upon by Tenant and Landlord) and shall arrange for and be responsible for all of the costs of a trash and rubbish removal and janitorial service in connection with Tenant's use of the Premises. -11- SECTION 10.3. TENANT'S COMPLIANCE WITH LAW. Tenant, shall, at Tenant's sole cost and expense, fully, diligently and in a timely manner, comply with all "Applicable Law," which term is used in this Lease to include all laws, rules, regulations, ordinances, orders, directives, covenants, easements and restrictions of record, permits, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Landlord's engineers and/or consultants, relating in any manner to the Premises (including but not limited to matters pertaining to (i) industrial hygiene, (ii) environmental conditions on, in, under or about the Premises, including soil and ground water conditions, and (iii) the presence, use, generation, manufacture, production, installation, maintenance, removal, disposal, transportation, storage, spill or release of any Hazardous Substance or storage tank), now in effect or which may hereafter come into effect, and whether or not reflecting a change in Applicable Law or policy from any previously existing Applicable Law or policy Tenant shall, within five (5) days after receipt of Landlord's written request, provide Landlord with copies of all documents and information, including, but not limited to, permits, registrations, manifests, applications, reports and certificates, evidencing Tenant's compliance with any Applicable Law specified by Landlord, and shall immediately upon receipt, notify Landlord in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving failure by Tenant or the Premises to comply with any Applicable Law. SECTION 10.4. INSPECTION; COMPLIANCE. Landlord, Varian and/or any Lender shall have the right to enter the Premises at any time, provided that prior notice is given except in the case of an emergency, for the purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with this Lease and all Applicable Law, and to employ experts and/or consultants in connection therewith and/or to advise Landlord with respect to Tenant's activities, including but not limited to the installation, operation, use, monitoring, maintenance, or removal of any Hazardous Substance on, under or from the Premises. The costs and expenses of any such inspections shall by paid by the party requesting same, unless an Event of Default, violation of Applicable Law, or a contamination, caused or materially contributed to by Tenant is found to exist or be imminent in Landlord's subjective, good faith judgment, or unless the inspection is requested or ordered by a governmental authority as the result of any such existing or imminent violation or contamination. In any such case, Tenant shall upon request reimburse Landlord and/or the applicable Lender, as the case may be, for the costs and expenses of such inspections. SECTION 10.5. BUILDING CONTAMINANTS. Without limiting the provisions of Section 8, to prevent the generation, growth, or deposit of any mold, mildew, bacillus, virus, pollen or other micro-organism (collectively, "Biologicals") and the deposit, release or circulation of any indoor Contaminants, including emissions from paint, carpet and drapery treatments, cleaning, maintenance and construction materials and supplies, pesticides, pressed wood products, insulation, and other materials and products (collectively with Biologicals, "Contaminants"), that could adversely affect the health, safety or welfare of any tenant, employee, or other occupant of the Building or their invitees (each, an "Occupant"), Tenant shall, at Tenant's sole cost and expense, at all times during the Term (i) operate the Premises in such a manner to prevent or minimize the accumulation of stagnant water and moisture in planters, kitchen appliances and vessels, carpeting, insulation, water coolers and any other locations where stagnant water and moisture could accumulate and (ii) otherwise operate the Premises to prevent the generation, growth, deposit, release or circulation of any Contaminants. If any -12- governmental entity or any Occupant alleges that health, safety or welfare has or could be adversely affected by any such Contaminants, Tenant shall notify Landlord in writing within twenty-four (24) hours of the time the allegation is made. Landlord may then elect to engage the services of an industrial hygiene testing laboratory (or alternatively or concurrently require Tenant to do the same) to determine whether the cause of any alleged adverse health effect is or could be attributable to any Contaminants present within the Premises. Tenant shall be responsible for all such testing costs and for any consequential damages and costs (including, without limitation, any third-party claims, loss of rental, remediation, removal and/or abatement costs, and increase in insurance premiums) resulting from Tenant's failure to comply in whole or in part with the terms of this Section 10.5. SECTION 10.6. TENANT'S WORK. Tenant shall not make any installations, alterations, additions or improvements (collectively, the "Improvements") in or to the Premises costing in the aggregate more than Ten Thousand Dollars ($10,000) and/or requiring a building permit, including, without limitation, any apertures in the walls, partitions, ceilings or floors, without on each occasion obtaining the prior written consent of Landlord, which consent shall not be unreasonably withheld. Any such work so approved by Landlord shall be performed only in accordance with plans and specifications therefor approved by Landlord. Plans and specifications pertaining to any proposed Improvements must be submitted to Landlord for approval, along with the name of the contractor to perform such work, at least thirty (30) days prior to the commencement of construction of the Improvements. Tenant shall procure at Tenant's sole expense all necessary permits and licenses before undertaking any work on the Premises and shall perform all such work in a good and workmanlike manner employing materials of good quality and so as to conform with all applicable zoning, building, fire, health and other codes, regulations, ordinances and laws and with all applicable insurance requirements. If reasonably requested by Landlord, Tenant shall furnish to Landlord prior to the commencement of any such work a bond or other security acceptable to Landlord assuring that any work to be performed by, or on behalf of, Tenant, will be completed in accordance with the approved plans and specifications. Tenant shall keep the Premises at all times free of liens for labor and materials. If any such lien is filed, Landlord may, but shall not be required to, take such action as Landlord in its sole discretion deems necessary to remove all such liens, Tenant shall pay to Landlord upon demand the amounts expended by Landlord in causing such removal, together with interest thereon at the Delinquency Rate (as hereinafter defined) from and including the date of Landlord's expenditure until the date Landlord is reimbursed by Tenant. In connection with the construction of all Improvements, Tenant shall engage a contractor (licensed to conduct business in the Commonwealth of Massachusetts) who shall obtain and maintain general liability insurance and property damage insurance and workers' compensation insurance in amounts not less than required of Tenant under Section 6 and such policies (excluding the workers' compensation insurance) shall name Landlord as an additional insured and will be issued by insurance companies licensed to do business in the Commonwealth of Massachusetts, satisfactory to Landlord and having an A.M. Best's rating of not less than A. Certificates of insurance relative to such policies shall be delivered to Landlord prior to the commencement of construction of any Improvements. -13- Tenant shall save Landlord harmless and indemnified from all injuries, losses, costs (including, without limitation), claims and damages to any person or property occasioned by or growing out of such work. Landlord may inspect the work of Tenant at reasonable times and give notice of observed defects. SECTION 10.7. INDEMNITY. Tenant shall defend, with counsel approved by Landlord, all actions against Landlord, any partner, trustee, stockholder, officer, director, employee or beneficiary of Landlord, holders of mortgages now or hereafter secured by the Building and/or the Site (collectively, "Lenders") and any other party having an interest in the Premises, the Building and/or the Site (collectively, "Indemnified Parties") with respect to, and shall pay, protect, indemnify and save harmless, to the extent permitted by law, all Indemnified Parties from and against, any and all liabilities, losses, damages, costs, expenses (including reasonable attorneys' fees and expenses), causes of action, suits, claims, demands or judgments of any nature arising from (a) injury to or death of any person, or damage to or loss of property, occurring in the Premises or connected with the use, condition or occupancy of any thereof unless caused by the negligence of Landlord or its servants or agents, or by another Tenant, or its servants or agents, (b) violation of this Lease by Tenant, or (c) any act, fault, omission, or other misconduct of Tenant or its agents, contractors, licensees, sublicenssees or invitees. SECTION 10.8. LANDLORD'S RIGHT TO ENTER. Without limiting any provision of Section 10.4, Tenant shall permit Landlord and its agents to enter into the Premises at reasonable times and upon reasonable notice to examine the Premises, make such repairs and replacements as Landlord may be required to make under the terms of this Lease or may elect, without however, any obligation to do so, and show the Premises to prospective purchasers and Lenders, and, during the last year of the Term, to show the Premises to prospective tenants and to keep affixed in suitable places notices of availability of the Premises. SECTION 10.9. PERSONAL PROPERTY AT TENANT'S RISK. All furnishings, fixtures, equipment, effects and property of every kind of Tenant and of all persons claiming by, through or under Tenant which may be on the Premises, shall be at the sole risk and hazard of Tenant and if the whole or any part thereof shall be destroyed or damage by fire, water or otherwise, or by the leakage or bursting of water pipes, steam pipes, or other pipes, by theft or from any other cause, no part of said loss or damage shall be charged to or to be borne by Landlord, except that Landlord shall in no event be indemnified or held harmless or exonerated from any liability to Tenant for any injury, loss, damage or liability not covered by Tenant's insurance to the extent prohibited by law. Tenant shall insure Tenant's personal property. SECTION 10.10. PAYMENT OF LANDLORD'S COST OF ENFORCEMENT. Tenant shall pay, on demand, Landlord's expenses, including reasonable attorneys' fees and expenses, incurred in enforcing any obligation of Tenant under this Lease (including, without limitation, enforcing any indemnification agreement set forth herein) or in curing any default of Tenant under this Lease as provided in Section 12.4. SECTION 10.11. YIELD UP. At the expiration of the Term or earlier termination of this Lease, Tenant shall surrender all keys to the Premises, remove all of its trade fixtures and personal property in the Premises, remove such installations and improvements made by Tenant as Landlord -14- may request and all Tenant's signs wherever located, repair all damage caused by such removal and yield up the Premises (including all installations and improvements made by Tenant except for trade fixtures and such installations or improvements made by Tenant as Landlord shall request Tenant to remove) broom-clean and in the same good order and repair in which Tenant is obliged to keep and maintain the Premises under this Lease. Any property not so removed shall be deemed abandoned and may be removed and disposed of by Landlord in such manner as Landlord shall determine and Tenant shall pay Landlord the entire cost and expense incurred by it in effecting such removal and disposition and in making any incidental repairs and replacements to the Premises and for use and occupancy during the period after the expiration of the Term and prior to Tenant's performance of its obligations under this Section 10.11. SECTION 10.12. ESTOPPEL CERTIFICATE. Upon not less than five (5) business days' prior notice by Landlord, Tenant shall execute, acknowledge and deliver to Landlord a statement in writing certifying that this Lease is unmodified and in full force and effect and that, except as stated therein, Tenant has no knowledge of any defenses, offsets or counterclaims against its obligations to pay the Fixed Rent and Additional Rent and any other charges and to perform its other covenants under this Lease (or, if there have been any modifications that the Lease is in full force and effect as modified and stating the modifications and, if there are any defenses, offsets or counterclaims, setting them forth in reasonable detail), the dates to which the Fixed Rent and Additional Rent and other charges have been paid and a statement that, to the best of Tenant's knowledge, that Landlord is not in default hereunder (or if Tenant claims Landlord is in default, the nature of such default, in reasonable detail). Any such statement delivered pursuant to this Section 10.12 may be relied upon by any prospective purchaser or mortgagee of the Building and/or the Site. SECTION 10.13. LANDLORD'S EXPENSES RE CONSENTS. Tenant shall reimburse Landlord promptly on demand for all out-of-pocket expenses reasonably incurred by Landlord in connection with all requests by Tenant for consent or approval hereunder. Out of pocket expenses shall not include any legal fees incurred by Landlord. SECTION 10.14. RULES AND REGULATIONS. Tenant shall comply with such reasonable Rules and Regulations as may be adopted from time to time by Landlord to provide for the beneficial operation of the Site and Building. SECTION 10.15. HOLDING OVER. Tenant shall vacate the Premises immediately upon the expiration or sooner termination of this Lease. If Tenant retains possession of the Premises or any part thereof after the termination of the term without Landlord's express consent, Tenant shall pay Landlord Fixed Rent for the time Tenant thus remains in possession in an amount equal to the greater of (i) the then current Annual Fixed Rent Rate specified in Section 1 multiplied by 1.25 or (ii) one hundred twenty-five percent (125%) of the then current market rate for similar space in the same general geographic area as the Premises, and, in addition thereto, shall pay Landlord for all damages, consequential as well as direct, sustained by reason of Tenant's retention of possession. The provisions of this Section 10.15 do not exclude Landlord's rights of re-entry or any other right hereunder, including without limitation, the right to remove Tenant through summary proceedings for holding over beyond the expiration of the Term. -15- SECTION 10.16. ASSIGNMENT AND SUBLETTING. Tenant shall not assign, transfer, mortgage or pledge this Lease or grant a security interest in Tenant's rights hereunder or sublease (which term shall be deemed to include the granting of concessions and licenses and the like) all or any part of the Premises or suffer or permit this Lease or the leasehold estate hereby created or any other rights arising under this Lease to be assigned, transferred or encumbered, in whole or in part, whether voluntarily, involuntarily or by operation of law, or permit the occupancy of the Premises by anyone other than Tenant. Any attempted assignment, transfer, mortgage, pledge, grant of security interest, sublease or other encumbrance, except with prior written approval thereof from Landlord which approval shall not be unreasonably withheld or delayed, shall be void. No assignment, transfer, mortgage, grant of security interest, sublease or other encumbrance, whether or not approved, and no indulgence granted by Landlord to any assignee or sublessee, shall in any way impair the continuing primary liability (which after an assignment shall be joint and several with the assignee) of Tenant hereunder, and no approval in a particular instance shall be deemed to be a waiver of the obligation to obtain Landlord's approval in any other case. Landlord shall not be deemed to have unreasonably withheld its consent to a proposed assignment or subletting if (a) the financial strength, net worth and creditworthiness of the proposed assignee or sublessee are not at least equal to that of the existing Tenant both at the time of the proposed assignment or subletting and at the date hereof; (b) the business reputation of the proposed assignee or sublessee is not in accordance with generally accepted commercial standards or is not at least equal to that of the existing Tenant, both at the time of the proposed assignment and at the date hereof; (c) the gross revenues reasonably anticipated to be received from the conduct of business on the Premises by the proposed assignee or sublessee are not at least equal to that of the existing Tenant both at the time of the proposed assignment or subletting and as of the date hereof; (d) the use of the Premises by the proposed assignee or subtenant will violate or create any potential violation of Applicable Law; and (e) the use of the Premises will violate any other agreements affecting the Premises, the Building, the Site or Landlord. In connection with any proposed assignment or subletting, Tenant shall provide to landlord such financial and other information relating to the proposed assignee or sublessee as Landlord may reasonably request. If for any assignment or sublease Tenant shall receive rent or other consideration, either initially or over the term of the assignment or sublease, in excess of the rent called for hereunder (or in the case of the sublease of part, in excess of such rent allocable to the part) after appropriate adjustments to assure that all other payments called for hereunder are taken into account, Tenant shall pay to Landlord, as Additional Rent, ninety percent (90%) of such excess of such payment of rent or other consideration received by Tenant, promptly after its receipt. For the purposes of this Section 10.16, the term "assign" shall be deemed to include any one or more sales, pledges or other transfers of (i) any of capital stock of any class of Tenant, (ii) ten percent (10%) or more of the capital assets or income interest in Converter Power Inc. Notwithstanding anything contained herein to the contrary, Landlord's consent to any assignment or sublease shall be conditioned upon the consent thereto from any and all Lenders. -16- Notwithstanding the foregoing, Landlord's consent shall not be required (i) for a sublease or assignment to any entity controlled by, controlling or under common control with Tenant, or (ii) for an assignment to any entity which is a successor to Tenant by virtue of the acquisition of all or substantially all of the assets or voting shares of Tenant, provided that in all cases under clauses (i) and (ii) above no assignment or subletting shall affect the continuing primary liability of Tenant (which following assignment shall be joint and several with the assignee), and provided further that Tenant's right of assignment under clause (ii) above shall be conditioned upon Landlord's written acknowledgment, which it shall not unreasonably withhold, that it has received from Tenant, at least 15 days prior to any proposed assignment pursuant to clause (ii), evidence satisfactory to Landlord that the net worth of the successor is and will be immediately after such assignment equal to or greater than the net worth of Tenant as of the date of such notice. SECTION 10.17. OVERLOADING AND NUISANCE. Tenant shall not injure, overload, deface or otherwise harm the Premises, commit any nuisance, permit the emission of any objectionable noise, vibration or odor, make, allow or suffer any waste or make any use of the Premises which is improper, offensive or contrary to any law or ordinance or which will invalidate any of Landlord's insurance. SECTION 10.18. SIGNS. Tenant shall not place or permit to be placed any sign on the Premises, the Building or the Site without the prior written approval of Landlord, which approval shall include approval of the style, size and design of the sign, but shall not be unreasonably withheld. Notwithstanding the foregoing, Tenant may only place signs in the locations designated on Exhibit A. All such signs shall comply with any and all applicable laws, regulations and restrictions and shall be the sole cost and responsibility of Tenant. Landlord may require their removal at Tenant's sole cost and expense upon the expiration or earlier termination of this Lease. Tenant shall not place or permit to be placed any other notices or advertisements on the Premises, the Building or the Site. SECTION 10.19. MAINTENANCE. Except as otherwise provided in Sections 9 and 11, Tenant shall keep and maintain the Premises and all glass in windows in good order, repair and condition, reasonable wear and tear and damage by fire or other insured casualty only excepted. SECTION 11 CASUALTY OR TAKING SECTION 11.1. TERMINATION. In the event that greater than twenty-five percent (25%) of the Premises shall be taken by any public authority or for any public use or destroyed by the action of any public authority (a "Taking") then this Lease may be terminated by either Landlord or Tenant effective on the effective date of the Taking. In the event that the Premises shall be destroyed or damaged by fire or casualty (a "Casualty"), Tenant shall immediately give notice thereof to Landlord and within thirty (30) days of receipt of such notice, Landlord shall determine whether it will require in excess of one hundred eighty (180) days from the date of the Casualty to restore the Premises. If Landlord determines it will require in excess of one hundred eighty (180) days from the date of the casualty to restore the Premises, this Lease may be terminated by - -17- either Landlord or Tenant by notice to the other within forty-five (45) days after the casualty. In the case of a Taking such election, which may be made notwithstanding the fact that Landlord's entire interest may have been divested, shall be made by the giving of notice by Landlord or Tenant to the other within thirty (30) days after Landlord or Tenant, as the case may be, shall receive notice of the Taking. SECTION 11.2. RESTORATION. In the event of a Taking or a Casualty, if neither Landlord nor Tenant exercises the election to terminate provided in Section 11.1, this Lease shall continue in force and a just proportion of the Fixed Rent and other charges hereunder, according to the nature and extent of the damages sustained by the Premises shall be abated until the Premises, or what may remain thereof, shall be put by Landlord in proper condition for use subject to zoning and building laws or ordinances then in existence, which, unless Landlord or Tenant has exercised its option to terminate pursuant to Section 11.1, Landlord covenants to do with reasonable diligence at Landlord's expense. Landlord's obligations with respect to restoration shall not require Landlord to expend more than the net proceeds of insurance recovered or damages awarded for such Casualty or Taking and made available for restoration by Landlord's mortgagees. "Net proceeds of insurance recovered or damages awarded" refers to the gross amount of such insurance or damages less the reasonable expenses of Landlord in connection with the collection of the same, including without limitation, fees and expenses for legal and appraisal services. SECTION 11.3. AWARD. Irrespective of the form in which recovery may be had by law, all rights to damages or compensation from a Taking shall belong to Landlord in all cases. Tenant hereby grants to Landlord all of Tenant's rights to such damages and compensation and covenants to deliver such further assignments thereof as Landlord may from time to time request and Tenant agrees to reasonably cooperate with Landlord in pursuing such claims. Notwithstanding the foregoing, Tenant may pursue any claim(s) to which it may be entitled against a taking authority for reimbursement of relocation expenses, personal property and trade fixtures. SECTION 12 DEFAULT SECTION 12.1. EVENTS OF DEFAULT. If any one or more of the following events (individually, an "Event of Default") shall occur: (a) if Tenant shall default in the performance of any of its obligations to pay the Fixed Rent, Additional Rent or any other sum payable hereunder and if such default shall continue for ten (10) days after notice to Tenant; (b) if Tenant shall fail to observe or perform any other term, covenant, condition or warranty of this Lease, other than as specified in subsections (c) through (g) below, and such failure is not cured by Tenant within a period of thirty (30) days after receipt by Tenant of notice thereof from Landlord, unless such failure cannot with due -18- diligence be cured within a period of thirty (30) days, in which case such failure shall not be deemed to continue if Tenant proceeds promptly and with due diligence to cure the failure and diligently completes the curing thereof within a period of one hundred twenty (120) days after such notice; or (c) if any assignment for the benefit of creditors shall be made by Tenant; (d) if Tenant's leasehold interest shall be taken on execution or other process of law in any action against Tenant; (e) if a lien or other involuntary encumbrance is filed against Tenant's leasehold interest, and is not discharged, bonded off, or otherwise secured against to the sole satisfaction of Landlord within ninety (90) days thereafter; (f) if a petition is filed by Tenant seeking appointment of a receiver of Tenant (or of the whole or substantially all of its property), or for liquidation, or for reorganization or an arrangement or any other relief under any provision of the federal bankruptcy laws or any other applicable law or statute of the United States of America or any state thereof as then in force and effect; or (g) if an involuntary petition seeking the relief described in Section 12.1 (f) is filed against Tenant and such involuntary petition is not dismissed within ninety (90) days thereafter, then, and in any of such cases, Landlord and the agents and servants of Landlord lawfully may, in addition to and not in derogation of any remedies for any preceding breach of covenant, immediately or at any time thereafter and without demand or notice and with or without process of law (forcibly, if necessary) enter into and upon the Premises or any part thereof in the name of the whole, or mail a notice of termination addressed to Tenant, and repossess the same as of Landlord's former estate and expel Tenant and those claiming through or under Tenant and remove its and their effect without being deemed guilty of any manner of trespass and without prejudice to any remedies which might otherwise be used for arrears of rent or prior breach of covenant, and upon such entry or mailing as aforesaid this Lease shall terminate, Tenant hereby waiving all statutory rights (including, without limitation, rights of redemption, if any) to the extent such rights may be lawfully waived. Landlord, without notice to Tenant, may store Tenant's effects, and those of any person claiming through or under Tenant at the expense and risk of Tenant, and, if Landlord so elects, may sell such effects at public auction or private sale and apply the net proceeds to the payment of all sums due to Landlord from Tenant, if any, and pay over the balance, if any, to Tenant. SECTION 12.2. Remedies. In the event that this Lease is terminated under any of the provisions contained in Section 12.1, Tenant shall pay forthwith to Landlord, as compensation, the excess of the total rent reserved for the residue of the Term over the fair market rental value of the Premises for the residue of the term, such excess to be discounted to present value at the then current Federal Reserve Bank discount rate. In calculating the rent reserved there shall be included, in addition to the Fixed Rent and Additional Rent, the value of all other considerations agreed to be paid or performed by Tenant during the residue. As additional and cumulative obligations after any such termination, Tenant shall also pay punctually to Landlord all the -19- sums and shall perform all the obligations which Tenant covenants in this Lease to pay and to perform in the same manner and to the same extent and at the same time as if this Lease had not been terminated. In calculating the amounts to be paid by Tenant pursuant to the preceding sentence, Tenant shall be credited with any amount paid to Landlord pursuant to the first sentence of this Section 12.2 and also with the net proceeds of any rent obtained by Landlord by reletting the Premises, after deducting all Landlord's reasonable expenses in connection with such reletting, including, without limitation, all repossession costs, brokerage commissions, fees for legal services and expenses of preparing the Premises for such reletting, it being agreed by Tenant that Landlord may (i) relet the Premises or any part or parts thereof for a term or terms which may at Landlord's option be equal to or less than or exceed the period which would otherwise have constituted the balance of the term hereof and may grant such concessions and free rent as Landlord in its reasonable judgment considers advisable or necessary to relet the same and (ii) make such alterations, repairs and decorations in the Premises as Landlord in its reasonable judgment considers advisable or necessary to relet the same, and no action of Landlord in accordance with the foregoing or failure to relet or to collect rent under reletting shall operate or be construed to release or reduce Tenant's liability as aforesaid. SECTION 12.3. REMEDIES CUMULATIVE. Except as otherwise expressly provided herein, any and all rights and remedies which Landlord may have under this Lease and at law and equity shall be cumulative and shall not be deemed inconsistent with each other, and any two or more of all such rights and remedies may be exercised at the same time to the greatest extent permitted by law. SECTION 12.4. LANDLORD'S RIGHT TO CURE DEFAULTS. At any time following ten (10) days' prior notice to Tenant (except in cases of emergency when no notice shall be required), Landlord may (but shall not be obligated to) cure any default by Tenant under this Lease, and whenever Landlord so elects, all costs and expenses incurred by Landlord, including reasonable attorneys' fees, in curing a default shall be paid by Tenant to Landlord as Additional Rent on demand, together with interest thereon at the rate provided in Section 12.7 from the date of payment by Landlord to the date of payment by Tenant. SECTION 12.5. EFFECT OF WAIVERS OF DEFAULT. Any consent or permission by Landlord to any act or omission which otherwise would be a breach of any covenant or condition herein, or any waiver by Landlord of the breach of any covenant or condition herein, shall not in any way be held or construed (unless expressly so declared) to operate so as to impair the continuing obligation of any covenant or condition herein, or otherwise operate to permit the same or similar acts or omissions except as to the specific instance. The failure of Landlord to seek redress for violation of, or to insist upon the strict performance of, any covenant or condition of this Lease shall not be deemed a waiver of such violation nor prevent a subsequent act, which would have originally constituted a violation, from having all the force and effect of an original violation. The receipt by Landlord of rent with knowledge of the breach of any covenant of this Lease shall not be deemed to have been a waiver of such breach by Landlord or of any of Landlord's remedies on account thereof, including its right of termination for such default. SECTION 12.6. NO ACCORD AND SATISFACTION. No acceptance by Landlord of a lesser sum than the Fixed Rent, Additional Rent or any other charge then due -20- shall be deemed to be other than on account of the earliest installment of such rent or charge due, unless Landlord elects by notice to Tenant to credit such sum against the most recent installment due. An endorsement or statement on any check or any letter accompanying any check or payment as rent or other charge shall not be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such installment or pursue any other remedy under this Lease or otherwise. SECTION 12.7. INTEREST ON OVERDUE SUMS. If Tenant fails to pay Fixed Rent, Additional Rent or any other sum payable by Tenant to Landlord by the due date thereof (i.e., the due date disregarding any requirement of notice from Landlord or any period of grace allowed to Tenant), the amount so unpaid shall bear interest, at a variable rate per annum (the "Delinquency Rate") equal to the greater of (i) four percent (4%) in excess of the base rate (prime rate) of The First National Bank of Boston from time to time in effect or (ii) the maximum interest rate permissible under applicable law, commencing with the due date and continuing through the day on which payment of such delinquent payment with interest thereon is paid. SECTION 13 MORTGAGES SECTION 13.1. RIGHTS OF MORTGAGE HOLDERS. No Fixed Rent, Additional Rent or any other charge shall be paid more than ten (10) days prior to the due date thereof and payments made in violation of this provision shall (except to the extent that such payments are actually received by a mortgagee in possession or in the process of foreclosing its mortgage) be a nullity as against such mortgagee and Tenant shall be liable for the amount of such payments to such mortgagee. In the event of any act or omission by Landlord which would give Tenant the right to terminate this Lease or to claim a partial or total eviction, Tenant shall not exercise any such right (a) until it shall have given notice, in the manner provided in Section 14.1, of such act or omission to any Lender whose name and address shall have been furnished to Tenant in writing, at the last address so furnished, and (b) until a reasonable period of time for remedying such act or omission shall have elapsed following the giving of such notice, provided that following the giving of such notice, Landlord or such Lender shall, with reasonable diligence have commenced and continued to remedy such act or omission or to cause the same to be rendered. In the event any proceedings are brought for the foreclosure of, or in the event of exercise of the power of sale under, any mortgage now or hereafter encumbering the Premises, Tenant shall attorn to the purchaser upon such foreclosure or sale or upon any grant of a deed in lieu of foreclosure and recognize such purchaser as Landlord under this Lease. SECTION 13.2. SUPERIORITY OF LEASE; OPTION TO SUBORDINATE. Unless Landlord exercises the option set forth below in this Section 13.2, this Lease shall be superior to and shall not be subordinate to any mortgage on the Premises. Landlord shall have the option to subordinate this Lease to any mortgage of the Premises provided that the holder of record thereof enters into an agreement with Tenant, in such holder's customary form, by the terms of which such holder will agree to (a) recognize the rights of Tenant under this Lease, (b) perform Landlord's obligations hereunder arising after the date of such -21- holder's acquisition of title and (c) accept Tenant as tenant of the Premises under the terms and conditions of this Lease in the event of acquisition of title by such holder through foreclosure proceedings or otherwise and Tenant will agree to recognize the holder of such mortgage as Landlord in such event, which agreement shall be made expressly to bind and inure to the benefit of the successors and assigns of Tenant and of the holder and upon anyone purchasing the Premises at any foreclosure sale. Tenant agrees to execute and deliver any appropriate instruments necessary to carry out the agreements contained in this Section 13.2. SECTION 14 MISCELLANEOUS PROVISIONS SECTION 14.1. NOTICES FROM ONE PARTY TO THE OTHER. For the purposes of this Lease, all notices, demands, requests, or refusal to accept delivery which may be or are required to be given under this Lease shall be in writing and shall be given by personal delivery, or by certified mail, return receipt requested, postage prepaid, or by Federal Express or similar nationally recognized overnight courier, charges prepaid, and addressed to Landlord at Communications & Power Industries, Inc., Attention: Facilities Manager, 150 Sohier Road, Beverly, Massachusetts 01915, and addressed to Tenant at Converter Power Inc., Attention: Wendy Ventura, 148 Sohier Road, Beverly, Massachusetts 01915. The addresses of the parties may be changed from time to time by notice given in the manner set forth in this Section 14.1. Each notice, request, demand, advice or designation given under this Lease shall be deemed properly given upon actual receipt by the party to whom the same is addressed. Any notice shall be deemed duly given when delivered or tendered for delivery at such address. SECTION 14.2. QUIET ENJOYMENT. Landlord agrees that upon Tenant's paying the Fixed Rent, Additional Rent and all other sums due hereunder and performing and observing the terms, covenants, conditions and provisions on its part to be performed and observed, Tenant shall and may peaceably and quietly have, hold and enjoy the Premises during the term without any manner of hindrance or molestation from Landlord or anyone claiming under Landlord, subject, however, to the terms of this Lease. SECTION 14.3. LEASE NOT TO BE RECORDED; NOTICE OF LEASE. Tenant agrees that it will not record this Lease. If the Term of this Lease, including options and/or extensions, exceeds seven years, Landlord and Tenant agree that, on the request of either, they will enter and record a notice of lease in form reasonably acceptable to Landlord. SECTION 14.4.. BIND AND INURE; LIMITATION OF LANDLORD'S LIABILITY. The obligations of this Lease shall run with the land, and this Lease shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. No owner of the Premises shall be liable under this Lease except for breaches of Landlord's obligations occurring while such party is the owner of the Premises. The obligations of Landlord shall be binding upon the assets of Landlord which comprise the Building but not upon other assets of Landlord. No individual partner, trustee, stockholder, officer, director, employee or beneficiary of Landlord shall be personally liable under this Lease and Tenant shall look solely to Landlord's interest in the Premises in pursuit -22- of its remedies upon an event of default hereunder, and the general assets of Landlord and its partners, trustees, stockholders, officers, employees or beneficiaries of Landlord shall not be subject to levy, execution or other enforcement procedure for the satisfaction of the remedies of Tenant. Landlord shall not have any liability to Tenant for any incidental or consequential damages arising out of or related to the services provided under this Lease, including, but not limited to, the loss of use, revenue or profit arising from any delay or failure of Landlord's performance hereunder or for any defects or problems related thereto. Landlord's sole liability shall be to refund an equitable portion of the Fixed Rent paid by Tenant for such service or services which are the subject of claim or dispute. SECTION 14.5. ACTS OF GOD. Excepting only the obligation of Tenant to pay any monetary amount due hereunder, in any case where either party hereto is required to do any act, delays caused by or resulting from acts of God, war, civil commotion, fire, flood or other casualty, labor difficulties, shortages of labor, materials or equipment, government regulations, unusually severe weather, or other causes beyond such party's reasonable control (other than financial inability) shall not be counted in determining the time during which work shall be completed, whether such time be designated by a fixed date, a fixed time or a "reasonable time", and such time shall be deemed to be extended by the period of such delay. SECTION 14.6. LANDLORD'S DEFAULT. Landlord shall not be deemed to be in default in the performance of any of its obligations hereunder unless it shall fail to perform such obligations and unless within thirty (30) days after notice from Tenant to Landlord specifying such default Landlord has not commenced diligently to correct the default so specified or has not thereafter diligently pursued such correction to completion. Tenant shall have no right, for any default by Landlord, to offset or counterclaim against any rent due hereunder. SECTION 14.7. BROKERAGE. Landlord is responsible for paying one commission to "Broker", and Landlord agrees to pay such commission. Tenant warrants and represents to Landlord that it has had no dealings with any broker or agent in connection with this Lease except "Broker", and covenants to defend with counsel approved by Landlord, hold harmless and indemnify Landlord from and against any and all cost, expense or liability for any compensation, commissions and charges claimed by any broker or agent with whom it has dealt and the costs incurred by Landlord in connection with the enforcement of this indemnification agreement. Landlord warrants and represents to Tenant that it has had no dealings with any broker or agent in connection with this Lease except "Broker", and covenants to defend with counsel approved by Tenant, hold harmless and indemnify Tenant from and against any and all cost, expense or liability for any compensation, commissions and charges claimed by any broker or agent with whom it has dealt and the costs incurred by Tenant in connection with the enforcement of this indemnification agreement. The aforesaid indemnification agreement shall survive the expiration or earlier termination of this Lease. SECTION 14.8. MISCELLANEOUS. This Lease shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts. This Lease constitutes the entire agreement between the parties with respect to the subject matter hereof and supersede all prior and contemporaneous agreements, representations, warranties, and understandings of the parties, written and oral, which pertain to said subject matter. No supplement, modification or amendment of this Lease shall be binding unless executed in writing by authorized representatives of the parties hereto. -23- SECTION 14.9. CORPORATE AUTHORITY. Each individual executing this Lease on behalf of its respective corporation represents and warrants that such corporation is validly formed, duly authorized and existing, qualified to do business in the state of Massachusetts, has the full right and legal authority to enter into this Lease, and that such individual is duly authorized to execute and deliver this Lease in accordance with such corporation's bylaws and/or a Board of Directors resolution, and that this Lease is binding upon the parties in accordance with all the terms and conditions therein. SECTION 14.10. HEADINGS, EXHIBITS. The subject headings of the Sections of this Lease are included for purposes of convenience of reference only, and shall not effect the construction or interpretation of this Lease. All Exhibits referred to herein are a part of this Lease. SECTION 14.11. SEVERABILITY. If any one or more of the provisions, or a portion of any such provision, of this Lease shall be deemed to be contrary to law, invalid, illegal or unenforceable in any respect by any governmental agency or court of law having competent jurisdiction over the subject matter and the parties hereto, the remaining provisions shall be severable and enforceable in accordance with their terms. It is the express intent of the parties that in the event that any term, provision or portion of this Lease is deemed contrary to law, invalid, illegal or unenforceable, the parties shall make whatever reasonable adjustments in their arrangements, if any are required, as may be mutually fair in light of their original intent as reflected in this Lease. SECTION 14.12. TIME OF ESSENCE. Time is of the essence in regard to all obligations provided for in the Lease. Section 14.13. Grants and Easements. During the Term, Landlord reserves to itself the right, from time to time, to grant any easements, rights, restrictions and dedications (collectively, Grants), as it may deem necessary or as may be required by law and to cause the recording of any instruments evidencing such Grants, provided that such Grants do not unreasonably interfere with the use of the Premises by Tenant. Tenant agrees to fully cooperate in relocating any such Grants which will not unreasonably interfere with Tenant's use of the Premises. Tenant shall sign any agreements with respect to such Grants as may be reasonably requested by Landlord and Tenant's failure to do so shall constitute a material breach of this Lease. SECTION 14.14. COUNTERPARTS. This Lease may be executed in counterparts, each of which shall be valid and binding original, but all of which together shall constitute one and the same instrument. The signature page and acknowledgment of any counterpart may be removed therefrom and attached to any other counterpart to evidence execution thereof by all of the parties hereto without affecting the validity thereof. -24- WITNESS the execution hereof under seal as of the day and year first above written. Tenant: CONVERTER POWER INC., a Massachusetts corporation By --------------------------------- Name: Title: Landlord: COMMUNICATIONS & POWER INDUSTRIES, INC., a Delaware corporation By: -------------------------------- Name: Title: -25- EX-23.1 4 CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated November 3, 1995, included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statements, File Numbers 2-90841, 2-95899, 33-6917, 33-27001, 33-50404 and 33-89470. ARTHUR ANDERSEN LLP San Jose, California December 22, 1995 EX-27 5 FDS --
5 ILC Technology Inc., Financial Data Sheet 0000719625 ILC Technology, Inc. 1,000 12-MOS SEP-30-1995 OCT-01-1994 SEP-30-1995 1,509 0 10,855 410 9,289 1,613 32,290 9,848 47,085 11,791 0 6,133 0 0 22,669 47,185 58,429 58,429 39,226 39,226 12,843 0 382 5,978 1,152 4,538 0 0 0 4,538 .95 .95
EX-99.1 6 ILC TECHNOLOGY INC. NOTICE AND PROXY STATEMENT EXHIBIT 99.1 ILC TECHNOLOGY, INC. ------------------ NOTICE OF ANNUAL MEETING OF SHAREHOLDERS FEBRUARY 14, 1996 ------------------------ The 1995 Annual Meeting of the Shareholders of ILC Technology, Inc., a California corporation (the "Company"), will be held on Wednesday, February 14, 1996, at 2:00 p.m. local time at the principal office of the Company at 399 Java Drive, Sunnyvale, California, for the following purposes: 1. To elect a Board of five Directors. 2. To approve an amendment to the 1992 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder and to set the maximum number of shares subject to options granted to any participant in any fiscal year. 3. To ratify the appointment of Arthur Andersen LLP as independent public accountants of the Company for fiscal 1996. 4. To transact such other business as may properly come before the meeting or any adjournment or postponement thereof. These items of business are more fully described in the Proxy Statement accompanying this Notice. Only shareholders of record at the close of business on December 18, 1995 are entitled to notice of and to vote at the meeting. A majority of the Company's outstanding shares must be represented at the meeting (in person or by proxy) to transact business. To assure proper representation at the meeting, please mark, sign, and date the enclosed proxy and mail it promptly in the enclosed self-addressed envelope. Your proxy will not be used if you revoke it either before or at the meeting. Ronald E. Fredianelli SECRETARY Dated: January 2, 1996 IF YOU ARE UNABLE TO BE PERSONALLY PRESENT, PLEASE SIGN AND DATE THE ENCLOSED PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE. YOUR VOTE IS IMPORTANT. ILC TECHNOLOGY, INC. ------------------ PROXY STATEMENT ------------------------ INFORMATION CONCERNING SOLICITATION AND VOTING The enclosed proxy is solicited on behalf of the Board of Directors of ILC Technology, Inc. (the "Company") for use at the Annual Meeting of Shareholders (the "Meeting") to be held Wednesday, February 14, 1996 at 2:00 p.m. local time, or at any adjournment or postponement thereof. The Meeting will be held at the principal offices of the Company, which are located at 399 Java Drive, Sunnyvale, California 94089. The Company's telephone number is (408) 745-7900. These proxy solicitation materials were mailed to shareholders on or about January 2, 1996. Shareholders of record at the close of business on December 18, 1995 are entitled to notice of, and to vote at, the Meeting. On December 18, 1995, 4,691,416 shares of the Company's Common Stock were issued and outstanding. A majority of the shares issued and outstanding as of December 18, 1995 must be present in person or represented by proxy at the Meeting for the transaction of business. Nominees for election of directors are elected by plurality vote of all votes cast at the Meeting. Approval of the amendment to the 1992 Stock Option Plan and ratification of Arthur Andersen LLP as the independent public accountants require the affirmative vote of a majority of the shares present at the Meeting in person or by proxy and entitled to vote. Abstentions have the effect of a negative vote, but broker non-votes do not affect the calculation. For the election of directors, shareholders may exercise cumulative voting rights which enable them to cast as many votes as there are directors to be elected, multiplied by the number of shares held by each shareholder. All such votes may be cast for one candidate or may be distributed as desired among two or more candidates. However, no shareholder shall be entitled to cumulate votes unless the candidate's name has been placed in nomination before the voting and the shareholder has given notice at the Meeting before the voting of the shareholder's intention to cumulate votes. If one shareholder gives such notice, all shareholders may cumulate their votes and the proxy holders may vote all proxies on a cumulative voting basis. On all other matters, each share has one vote. Any person may revoke a proxy at any time before its use by delivering to the Company a written revocation or a duly executed proxy bearing a later date or by attending the Meeting and voting in person. The cost of this solicitation will be borne by the Company. These costs represent amounts normally expended for a solicitation for an election of directors. The Company may reimburse brokerage firms and 1 other persons representing beneficial owners of shares for their expenses in forwarding solicitation material to such beneficial owners. Proxies may also be solicited by certain of the Company's directors, officers and regular employees, without additional compensation, personally, by telephone or otherwise. DEADLINE FOR RECEIPT OF SHAREHOLDER PROPOSALS FOR 1996 ANNUAL MEETING Proposals of shareholders that are intended to be presented by such shareholders at the Company's 1996 meeting of shareholders must be received by the Company no later than September 4, 1996. ELECTION OF DIRECTORS NOMINEES A board of five directors is to be elected at the Meeting. There will be one vacancy on the Board. Unless marked to the contrary, all properly signed and returned proxies will be voted for the election of management's five nominees named below, all of whom are directors of the Company. If any nominee is unable or declines to serve as a director at the time of the Meeting, the proxies will be voted for any nominee designated by the present Board of Directors to fill the vacancy. The Company is not aware of any nominee who will be unable or will decline to serve as a director. The proxy holders reserve the right to cumulate votes for the election of directors in such a manner as will assure the election of as many of the nominees listed below as possible, and, in such event, the specific nominees to be voted for will be determined by the proxy holders. The term of office of each person elected as a director will continue until the next meeting of shareholders or until a successor has been elected and qualified. The names of the nominees and certain information about them are set forth below.
SHARES OF COMMON STOCK BENEFICIALLY OWNED AS OF DECEMBER 18, 1995 (1) DIRECTOR ------------------ NAME, PRINCIPAL OCCUPATION AND DIRECTORSHIPS AGE SINCE NUMBER PERCENT - --------------------------------------------------------------------------- --- -------- ------- ------- Henry C. Baumgartner 63 1967 209,988(2) 4.4% President and Chief Executive Officer of the Company since April 1990; Chief Financial Officer and Chairman of the Board of the Company from November 1986 to April 1990; Secretary of the Company from December 1986 to June 1987; Chief Executive Officer of the Company from November 1986 to February 1987; Retired from June 1985 to November 1986; Vice President of the Company from 1974 to June 1985; Chief Financial Officer and Secretary of the Company from 1967 to June 1985.
2
SHARES OF COMMON STOCK BENEFICIALLY OWNED AS OF DECEMBER 18, 1995 (1) DIRECTOR ------------------ NAME, PRINCIPAL OCCUPATION AND DIRECTORSHIPS AGE SINCE NUMBER PERCENT - --------------------------------------------------------------------------- --- -------- ------- ------- Arthur L. Schawlow 74 1984 18,250(3) * Retired in 1991; Professor of Physics at Stanford University from 1961 to 1991; Director of the Company from 1969 to 1971 and since 1984; Nobel Prize in 1981 for contributions to the development of laser spectroscopy. Wirt D. Walker, III 49 1988 178,750(4) 3.8% Chairman of the Board of the Company since April 1990 and Director since 1988; Managing Director of KuwAm Corporation since 1982; Chairman of Commander Aircraft Company; Chairman of Advanced Laser Graphics, Inc.; Chairman of Securacom, Incorporated. Harrison H. Augur 54 1989 38,250(5) * General Partner of Capital Asset Management since June 1987; Executive Vice President and Director of Worms & Co., Inc. from April 1981 to August 1991. Richard D. Capra 63 1995 -- -- President and Chief Executive Officer of AeroM since December 1994; President and Chief Operating Officer of Crescent Electric Supply Company from January 1993 to December 1994; Management Consultant from 1991 to 1993; President and Chief Executive Officer of Philip Lighting Company, U.S. from 1987 to 1991; Director of Venture Lighting Intl. EXECUTIVE OFFICERS Ronald E. Fredianelli 46 63,341(6) 1.3% Chief Financial Officer and Secretary Felix J. Schuda 47 88,957(7) 1.9% Vice President Lynn J. Reiter (8) 46 31,174 * Vice President All Officers and Directors as a Group (7 persons)(9) 628,710 12.7%
- ------------------------ * Less than 1% 3 (1) The persons named in the table have sole voting and investment power with respect to all shares of Common Stock beneficially owned by them, subject to applicable community property laws and the information contained in the footnotes to the table. (2) Includes 111,250 shares subject to outstanding options that are exercisable on or before February 16, 1996. (3) Includes 11,250 shares subject to outstanding options that are exercisable on or before February 16, 1996. (4) Includes 6,250 shares subject to outstanding options that are exercisable on or before February 16, 1996. Includes 100,000 shares owned by Special Situation Investment Holdings, a limited partnership in which Mr. Walker holds an interest and 50,000 shares owned by KuwAm Corporation, of which Mr. Walker is the Managing Director. Mr. Walker disclaims beneficial ownership of all such shares. Also includes 7,500 shares owned by persons whose accounts are managed by Mr. Walker, as to which Mr. Walker disclaims beneficial ownership. (5) Includes 26,250 shares subject to outstanding options that are exercisable on or before February 16, 1996. (6) Includes 47,500 shares subject to outstanding options that are exercisable on or before February 16, 1996. (7) Includes 38,500 shares subject to outstanding options that are exercisable on or before February 16, 1996. (8) Mr. Reiter resigned his position with the Company effective September 30, 1995. (9) Includes 241,000 shares subject to outstanding options held by the executive officers and four directors that are exercisable on or before February 16, 1996. DIRECTOR COMPENSATION Members of the Board who are not also officers or employees of the Company ("Outside Directors") are paid an annual fee of $10,000 for services as director. Such fees are paid quarterly and prorated when a director does not serve for a full year. Directors receive no additional compensation for committee participation or attendance at committee meetings. During fiscal 1995, each Outside Director was granted automatic options to purchase a total of 5,000 shares of the Company's Common Stock at an exercise price of $9.50 per share. No Outside Directors exercised options during fiscal 1995. As of September 30, 1995, options to purchase 75,000 shares were outstanding to four Outside Directors, at the weighted average exercise price per share indicated: Mr. Augur -- 35,000 shares at $6.32 per share; Mr. Capra -- 5,000 shares at $9.50 per share; Dr. Schawlow -- 20,000 shares at $8.19 per share; and Mr. Walker -- 15,000 shares at $9.75 per share. 4 BOARD MEETINGS AND COMMITTEES The Board of Directors held a total of four meetings during the fiscal year ended September 30, 1995. The Board has two committees: the Audit Committee and the Compensation and Stock Option Committee. The Audit Committee, comprised of Directors Augur, Walker, Schawlow and Capra, recommends engagement of the Company's independent public accountants and is primarily responsible for approving the services performed by the Company's independent public accountants and for reviewing and evaluating the Company's accounting practices and its systems of internal accounting controls. The Audit Committee held two meetings during fiscal 1995. Each quarter the Chairman of the Audit Committee meets with the Company's independent public accountants. The Compensation and Stock Option Committee, comprised of Directors Augur, Walker, Schawlow and Capra, recommends the amount and nature of compensation to be paid to the Company's Chief Executive Officer and reviews and approves the compensation plan for other corporate officers. It also reviews the performance of the Company's key employees who are eligible for the Company's Stock Option Plan and determines the number of shares, if any, to be granted each employee under such plan and the terms of such grants. The Compensation and Stock Option Committee held two meetings during fiscal 1995. No director attended fewer than 75% of all meetings of the Board of Directors held during fiscal 1995 or of all meetings of any committee upon which such director served during fiscal 1995. OTHER OFFICERS Felix J. Schuda, age 47, was elected a Vice President of the Company in 1981. He has been employed by the Company in various engineering and engineering management positions since June 1976. Ronald E. Fredianelli, age 46, was elected Chief Financial Officer of the Company in April 1990 and Secretary in 1987. Except for the period from November 1985 to August 1986 and until he was elected Chief Financial Officer in 1990, Mr. Fredianelli was the Controller of the Company since August 1979. From November 1985 to August 1986, he was Controller of Synergy Computer Graphics. 5 EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table shows certain information concerning the compensation of each of the Company's executive officers for services rendered in all capacities to the Company for the fiscal years ended 1995, 1994 and 1993. There were no options grants to executive officers and no restricted stock awards or LTIP payouts during any of the years covered.
ANNUAL COMPENSATION ------------------------------------- ALL OTHER NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY (1) BONUS (2) COMPENSATION (3) - --------------------------------------------- ------------- ----------- --------- ----------------- Henry C. Baumgartner 1995 $ 175,000 $ 26,392 $ 3,021 Chief Executive Officer 1994 144,462 26,417 2,889 1993 112,615 37,734 2,252 Ronald E. Fredianelli 1995 113,423 19,074 2,262 Chief Financial Officer and Secretary 1994 101,192 20,913 2,024 1993 89,154 29,913 1,783 Felix J. Schuda 1995 105,000 15,893 2,100 Vice President 1994 97,292 20,253 1,946 1993 86,339 28,945 1,727 Lynn J. Reiter 1995 105,000 15,890 2,100 Vice President 1994 96,761 20,033 1,935 1993 85,400 28,623 1,708
- ------------------------ (1) No compensation is paid to officers of the Company for services rendered as directors. (2) Includes cash bonuses paid during the year and cash bonuses accrued for services rendered during the year. (3) Company matching contributions under the Company's Thrift Incentive Savings Plan. 6 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table shows the number of shares of Common Stock acquired by the executive officers upon the exercise of stock options during fiscal 1995, the net value realized at exercise, the number of shares of Common Stock represented by outstanding stock options held by each executive officer as of September 30, 1995 and the value of such options based on the closing price of the Company's Common Stock on September 30, 1995, which was $11.25.
VALUE OF NUMBER OF UNEXERCISED UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT FY - END (#)(1) FY - END ($)(2) ---------------- ------------------- SHARES ACQUIRED VALUE REALIZED EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE (#) ($)(3) UNEXERCISABLE UNEXERCISABLE - --------------------------- --------------- ------------------- ---------------- ------------------- Henry C. Baumgartner -- -- 111,250/3,750 $ 859,625/$9,375 Ronald E. Fredianelli -- -- 47,500/2,500 $ 345,000/$6,250 Felix J. Schuda 3,000 $ 22,895 38,500/2,500 $ 259,875/$6,250 Lynn J. Reiter (4) 41,500 $ 261,688 -- --
- ------------------------ (1) Represents the total number of shares subject to stock options held by each executive officer. These options were granted on various dates during fiscal years 1986 through 1992 and are exercisable on various dates beginning in 1987 and expiring in 2002. (2) Represents the difference between the exercise price and $11.25, which is the September 30, 1995 closing price. Stock option exercise prices range from $2.13 to $8.75. (3) Aggregate market value of the shares covered by the option at the date of exercise, less the aggregate exercise price. (4) Mr. Reiter resigned his position with the Company effective September 30, 1995 BOARD COMPENSATION AND STOCK OPTION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Compensation and Stock Option Committee of the Board of Directors (the "Committee") is composed of Harrison H. Augur, Chairman, Arthur L. Schawlow, Wirt D. Walker and Richard D. Capra. All are independent outside directors. The Committee is charged with the responsibility for reviewing the performance and approving the compensation of key executives and for establishing general compensation policies and standards for reviewing management performance. The Committee also reviews both corporate and key executive performance in light of established criteria and goals and approves individual key executive compensation. 7 COMPENSATION PHILOSOPHY The executive compensation philosophy of the Company is to provide competitive levels of compensation that advance the Company's annual and long-term performance objectives, reward corporate performance, and assist the Company in attracting, retaining and motivating highly qualified executives. The framework for the Committee's executive compensation programs is to establish base salaries which are competitive and to incentivize excellent performance by providing executives with the opportunity to earn additional remuneration linked to the Company's profitability. The incentive plan goals are designed to improve the effectiveness and enhance the efficiency of Company operations, to provide savings for customers and to create value for shareholders. It is also the Company's policy to encourage share ownership by executive officers and Outside Directors through the grant of stock options. COMPONENTS OF COMPENSATION The compensation package of the Company's executive officers consists of base annual salary, bonus opportunities and stock option grants. At executive levels, base salaries are reviewed but not necessarily increased annually. Base salaries are fixed at levels slightly below competitive amounts paid to individuals with comparable qualifications, experience and responsibilities engaged in similar businesses as the Company. The Company develops its executive compensation data from a nationally recognized survey for high technology companies of similar size, industry and location. Mr. Fredianelli's base salary of $110,000 was increased to $120,000 in May 1995. No other executive officer of the Company received a salary increase in fiscal 1995. Incentive compensation is closely tied to the Company's success in achieving financial performance goals. Each year the Committee approves a management bonus program based upon performance objectives for executive officers and other key employees. Under the program, a participant may receive in any year a portion of a management bonus pool, which pool is based on a percentage of yearly pre-tax profits with no ceiling. The participant's share is based on his or her base wage as a percent of the total salaries of all participants during the management bonus period. The participant's distribution is then calculated in accordance with a bonus point scaling system tied to financial performance goals. In addition, all employees share in another bonus program based solely on a percentage of pre-tax profits, again with no ceiling, and distributed based on a percentage of base salary. The Company uses stock options both to reward past performance and to motivate future performance, especially long-term performance. The Committee believes that through the use of stock options, executive interests are directly tied to enhancing shareholder value. Stock options are granted at fair market value as of the date of grant, and have a term of ten years. The options vest 25% per year, beginning on the first anniversary date of the grant. The stock options provide value to the recipients only when the market price of the Company's Common Stock increases above the option grant price and only as the shares vest and become exercisable. 8 The Committee did not approve any stock option grants for any of the executive officers during fiscal year 1995. MR. BAUMGARTNER'S 1995 COMPENSATION The Committee makes decisions regarding the compensation of the Chief Executive Officer using the same philosophy set forth above. The Committee's approach in setting Mr. Baumgartner's base compensation, as with that of the Company's other executives, is to be competitive with other companies within the industry, taking into consideration company size, operating conditions and compensation philosophy and performance. Mr. Baumgartner's base salary in fiscal 1995 was the same as his base salary in fiscal 1994. Mr. Baumgartner's fiscal 1995 incentive compensation was earned under the same bonus plans and performance criteria that were described previously in this report. He received no stock option grants during fiscal 1995. COMPENSATION AND STOCK OPTION COMMITTEE Harrison H. Augur, Chairman Arthur L. Schawlow Wirt D. Walker, III Richard D. Capra 9 PERFORMANCE GRAPH The Securities and Exchange Commission requires that the Company include in this Proxy Statement a line-graph presentation comparing cumulative, five-year shareholder returns on an indexed basis with (i) a broad equity market index and (ii) either an industry index or peer group. The following graph compares the percentage change in the cumulative total shareholder return on the Company's Common Stock against the cumulative total return of the Standard & Poors 500 Index and the NASDAQ SIC Group 364 (Electric Lighting and Wiring Equipment) for a period of five years. "Total return," for the purpose of this graph, assumes reinvestment of all dividends, if any. The stock price performance shown on the graph is not necessarily indicative of future price performance. COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN* AMONG ILC TECHNOLOGY, INC., THE S & P 500 INDEX AND NASDAQ SIC GROUP 364 EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
ILC TECHNOLOGY, INC. NASDAQ SIC GROUP 364 S & P 500 9-90 100 100 100 9-91 303 154 131 9-92 254 178 146 9-93 254 214 165 9-94 195 248 171 9-95 243 306 221
* $100 invested on 09/30/90 in stock or index, including reinvestment of dividends. Fiscal year ending September 30. 10 AMENDMENT OF THE 1992 STOCK OPTION PLAN In November 1995, the Board of Directors adopted a resolution, subject to shareholder approval, approving an amendment to the Company's 1992 Stock Option Plan (the "Plan") to increase the number of shares of Common Stock issuable thereunder by 200,000 shares to 400,000 shares and to set the maximum number of shares subject to options granted to any participant under the Plan in any fiscal year at 100,000 shares of Common Stock. Before giving effect to the proposed amendment to increase the number of shares reserved for issuance under the Plan, 874 shares of Common Stock were available for issuance under the Plan. The purpose of the amendment to limit the maximum number of shares subject to options granted to any one individual in any fiscal year is to conform the Plan to requirements of recent tax legislation to ensure the deductibility of the compensation element of options granted under the Plan. Approval of the amendment to the Plan requires the affirmative vote of a majority of the shares present at the Meeting in person or by proxy and entitled to vote. The Board of Directors recommends that shareholders vote for the amendment to the Plan. The essential features of the Plan are summarized below. The purpose of the Plan is to advance the interests of the Company by giving the Company's employees and Outside Directors incentive through ownership of the Company's Common Stock to continue in the service of the Company and thereby to help the Company compete effectively with other enterprises for the services of qualified individuals. Options granted under the Plan may be either "incentive stock options" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or nonstatutory stock options. ADMINISTRATION The Plan is administered by the Compensation and Stock Option Committee of the Board of Directors (the "Committee"). In addition to having general supervisory and interpretive authority over the Plan, the Committee determines, upon the recommendation of management and subject to the terms and limits of the Plan, the employees, if any, to whom options will be granted, the time at which options are granted, the number of shares subject to each option and the terms and conditions of exercise of options. ELIGIBILITY All employees (including officers and directors who are also employees) of the Company and its subsidiaries are eligible to receive incentive stock options under the Plan. Nonstatutory stock options may be granted under the Plan to employees and directors of the Company. Participants are selected by the Committee upon the recommendation of management. Nonstatutory stock options are also granted under the Plan to all Outside Directors pursuant to the automatic grant program. As of September 30, 1995, 588 persons were eligible to receive options under the Plan, of which three were executive officers of the Company, 581 were non-executive officer employees and four were Outside Directors. 11 Under the terms of the Plan, the aggregate fair market value (determined at the date of the option grant) of the stock with respect to which incentive stock options are exercisable for the first time by any employee during any calendar year may not exceed $100,000. Under the terms of the Plan, as amended, no participant will be able to receive options to purchase more than a total of 100,000 shares of Common Stock under the Plan in any fiscal year. The Plan provides for an automatic grant program for Outside Directors, whereby each year, each Outside Director is automatically granted a new ten-year nonstatutory stock option to purchase 5,000 shares of Common Stock, which is exercisable in cumulative annual increments of 25% beginning on the first anniversary of the date of grant. See "Plan Benefits." TERMS OF OPTIONS Each option granted under the Plan must be evidenced by an option agreement between the Company and the optionee and has a term of up to 10 years, unless sooner terminated in accordance with the Plan or the option agreement. Options granted pursuant to the Plan need not be identical, but each option is subject to the following terms and conditions: (a) EXERCISE OF OPTION. Options are exercisable by the optionee in such periodic increments and/or at such milestones as the Committee, in its sole discretion, shall determine on an individual basis with respect to each optionee. Options are generally exercisable in cumulative increments of 25% per year beginning on the first anniversary of the date of grant. In no event shall an officer or director of the Company exercise any option during the six-month period immediately following the grant of such option. An option is exercised by giving written notice of exercise to the Company, specifying the number of full shares of Common Stock to be purchased, and tendering payment of the purchase price and any applicable taxes to the Company. Payment for shares issued upon exercise of an option may consist of cash, check or delivery of a properly executed exercise notice together with irrevocable instructions to a broker to promptly deliver to the Company the amount of sale or loan proceeds required to pay the exercise price. (b) EXERCISE PRICE. The exercise price is determined by the Committee, provided that in no instance shall such price be less than the fair market value of the Common Stock on the date the option is granted. The Plan defines "fair market value" as the closing sales price of the Common Stock of the Company as reported by the Nasdaq National Market on the last market trading day before the date of grant. The closing sales price of the Company's Common Stock on the Nasdaq National Market on December 18, 1995 was $9.375 per share. Incentive stock options granted to shareholders owning more than 10% of the combined voting power of all the stock of the Company are subject to the additional restrictions that the exercise price be no less than 110% of the fair market value on the date of grant and that options expire no later than 5 years from the date of grant. 12 (c) TERMINATION OF EMPLOYMENT. Incentive stock options granted under the Plan terminate 30 days after the optionee ceases to be employed by the Company unless (i) the termination of employment is due to permanent and total disability, in which case the option may be exercised at any time within 12 months after termination to the extent the option was exercisable on the date of termination; (ii) the optionee dies while employed by the Company, in which case the option may be exercised at any time within 12 months after death to the extent the option was exercisable on the date of death; or (iii) the option by its terms specifically provides otherwise. Subject to special rules for incentive stock options, the Committee may, in its discretion, extend the period of exercisability of an option after an optionee's termination of employment, but in no event shall any option be exercisable after the expiration date set forth in the option agreement. (d) EXPIRATION OF OPTIONS. No option is exercisable by any person after the expiration of 10 years from the date the option was granted. (e) NONTRANSFERABILITY OF OPTION. Options granted under the Plan are transferable only by will or the laws of descent and distribution and are exercisable during the optionee's lifetime only by the optionee or the optionee's guardian or legal representative. (f) OTHER PROVISIONS. The option agreement may contain such other terms, provisions and conditions not inconsistent with the Plan as the Committee may deem necessary or appropriate. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION The Plan provides for adjustments to be made in the shares subject to option to give effect to changes in the capital structure of the Company resulting from recapitalizations, stock splits, stock dividends, combinations of shares, mergers or reorganizations. Depending upon the circumstances, the particular adjustments may require a change in the number, kind and class of securities covered by the option and a change in the exercise price or prices thereof to give effect to the purpose and intent of the Plan. The Plan and all options terminate in the event of the dissolution or liquidation of the Company. CORPORATE TRANSACTIONS. A Corporate Transaction is defined in the Plan generally as a merger or asset sale in which the Company does not survive, or any reorganization that results in the transfer of beneficial ownership of 50% or more of the Company's voting stock outstanding. Immediately before the effective date of a Corporate Transaction, each option outstanding under the Plan will automatically become exercisable in full unless the option is either to be assumed by the successor corporation or a parent thereof or replaced by a reasonably comparable option to purchase shares of the successor corporation or parent thereof, in connection with the Corporate Transaction. Upon the consummation of any Corporate Transaction, all outstanding options will terminate, to the extent not previously exercised by the optionees or assumed by the successor corporation or its parent company. CHANGE IN CONTROL. Change in control is defined in the Plan generally as a tender or exchange offer that is not recommended by the Company's Board of Directors for 25% or more of the Company's voting 13 stock by a person or related group of persons other than the Company or an affiliate of the Company, or a contested election for the Board of Directors that results in a change in a majority of the Board. Effective 15 days following the effective date of a Change in Control, each option outstanding under the Plan will automatically become exercisable in full and will remain fully exercisable until the expiration or sooner termination of the option term specified in the option agreement. Acceleration of the exercisability of options in the event of a Corporate Transaction or a Change in Control may have the effect of depressing the market price of the Company's Common Stock and denying shareholders a control premium that might otherwise be paid for their shares in such a transaction and may have the effect of discouraging a proposal for merger, a takeover attempt or other efforts to gain control of the Company. ADJUSTMENT TO OPTION RIGHTS Subject to the general limitations of the Plan, the Committee may adjust the exercise price, term or any other provision of an option (other than automatic options granted to Outside Directors) by cancelling and regranting the option or by amending or substituting the option. Options that have been so adjusted may have higher or lower exercise prices, have longer or shorter terms, or be subject to different rights and restrictions than prior options. The Committee may also adjust the number of options granted to an optionee by cancelling outstanding options or granting additional options. Except for adjustments necessary to ensure compliance with any applicable state or federal law, no such adjustment may impair an optionee's rights under any option agreement without the consent of the optionee. AMENDMENT AND TERMINATION OF THE PLAN The Board may amend the Plan from time to time or may suspend or terminate the Plan. In addition, to the extent necessary to comply with applicable laws or regulations, the Company shall obtain shareholder approval of any amendment to the Plan in such a manner as required. However, no such action by the Board or shareholders may alter or impair any option previously granted under the Plan without the consent of the optionee. The Plan terminates by its terms when all shares available for issuance under the Plan have been issued or in November 2002, whichever is earlier, subject to earlier termination by the Board of Directors. Notwithstanding such termination, options granted under the Plan will remain outstanding in accordance with their terms. PLAN BENEFITS Automatic options are granted to the Outside Directors at the meeting of the Committee held during the Company's third fiscal quarter. Under the Plan, each Outside Director, currently Messrs. Auger, Capra, Schawlow and Walker, will receive an automatic grant of options to purchase 5,000 share of Common Stock each calendar year. 14 FEDERAL INCOME TAX INFORMATION The following summary is intended only as a general guide as to the federal income tax consequences under current law with respect to participation in the Plan and does not describe all possible federal and other tax consequences of such participation. Furthermore, the tax consequences of options are complex and subject to change, and a taxpayer's situation may be such that some variation of the described rules applies. The summary does not address other taxes that may affect an optionee such as state and local income taxes, federal and state estate, inheritance and gift taxes and foreign taxes. Optionees should consult with their own tax advisors before the exercise of any option and before the disposition of any shares acquired upon the exercise of an option. INCENTIVE STOCK OPTIONS. If an option is treated as an incentive stock option ("ISO"), the optionee does not recognize taxable income upon its grant or incur tax on its exercise (unless the optionee is subject to the alternative minimum tax described below). If the optionee holds the stock acquired upon exercise of an ISO ("ISO Shares") for more than one year after the date the option was exercised and for more than two years after the date the option was granted, the optionee generally will realize long-term capital gain or loss (rather than ordinary income or loss) upon disposition of the ISO Shares. This gain or loss will be equal to the difference between the amount realized upon such disposition and the amount paid for the ISO Shares. If the optionee disposes of ISO Shares before the expiration of either required holding period (a "disqualifying disposition"), then gain realized upon such disqualifying disposition, up to the difference between the fair market value of the ISO Shares on the date of exercise (or, if less, the amount realized on a sale of such ISO Shares) and the option exercise price, will be treated as ordinary income. Any additional gain will be long-term or short-term capital gain, depending upon the length of time the optionee held the ISO Shares. The Company will be entitled to a deduction in connection with the disposition of ISO Shares only to the extent that the optionee recognizes ordinary income on a disqualifying disposition of the ISO Shares. ALTERNATIVE MINIMUM TAX. The difference between the exercise price and fair market value of the ISO Shares on the date of exercise of an ISO is an adjustment to income for purposes of the alternative minimum tax ("AMT"). The AMT (imposed to the extent it exceeds the taxpayer's regular tax) is 26% of an individual taxpayer's alternative minimum taxable income (28% in the case of alternative minimum taxable income in excess of $175,000). Alternative minimum taxable income is determined by adjusting regular taxable income for certain items, increasing that income by certain tax preference items and reducing this amount by the applicable exemption amount ($45,000 in the case of a joint return, subject to reduction in certain circumstances). If a disqualifying disposition of the ISO Shares occurs in the same calendar year as exercise of the ISO, there is no AMT adjustment with respect to those ISO Shares. Also, upon a sale of ISO Shares that is not a disqualifying disposition, alternative minimum taxable income is reduced in the year of sale by the excess of the fair market value of the ISO Shares at exercise over the amount paid for the ISO Shares. 15 NONSTATUTORY STOCK OPTIONS. An optionee does not recognize any taxable income at the time a nonstatutory stock option ("NSO") is granted. However, upon exercise of an NSO, the optionee must include in income as compensation an amount equal to the difference between the fair market value of the shares on the date of exercise and the amount paid for that stock upon exercise of the NSO. The included amount must be treated as ordinary income by the optionee and will be subject to income tax withholding by the Company. Upon resale of the shares by the optionee, any subsequent appreciation or depreciation in the value of the shares will be treated as capital gain or loss. The Company will be entitled to a deduction in connection with the exercise of an NSO by a domestic optionee to the extent that the optionee recognizes ordinary income and the Company withholds tax. In addition, for taxable years beginning after 1993, deductions taken by the Company for compensation paid to certain employees generally will be limited to $1 million per employee. This limitation is subject to a number of exceptions, and will not apply to the compensation element of stock options to the extent that such amounts are deemed to be paid in connection with the attainment by the employee of performance goals, if certain other requirements are met. RATIFICATION OF APPOINTMENT OF AUDITORS The Board of Directors has selected Arthur Andersen LLP, independent public accountants, to serve as the auditors for the Company for fiscal 1996. At the Meeting, the shareholders will be asked to ratify such appointment. Representatives of Arthur Andersen LLP are expected to attend the Meeting and will be given the opportunity to make a statement and to answer appropriate questions. OTHER MATTERS The Company knows of no other matters to be submitted to the Meeting. However, if any other matters properly come before the Meeting or any adjournment or postponement thereof, it is the intention of the proxy holders to vote the shares they represent as the Board of Directors may recommend. By Order of the Board of Directors Ronald E. Fredianelli, SECRETARY Dated: January 2, 1996 Sunnyvale, California 16 -----END PRIVACY-ENHANCED MESSAGE-----