-----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, D0/LEOxZtlpFTPbxPUFA56oRV0Gt59BF9X4mDZrsmEv5p2BhXD1+1ry+z6AsbJa4 6fgGL/z81flhmk3NptSXkA== 0000950148-96-001038.txt : 19960529 0000950148-96-001038.hdr.sgml : 19960529 ACCESSION NUMBER: 0000950148-96-001038 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19960229 FILED AS OF DATE: 19960528 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DENSE PAC MICROSYSTEMS INC CENTRAL INDEX KEY: 0000784770 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330033759 STATE OF INCORPORATION: CA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-14843 FILM NUMBER: 96573042 BUSINESS ADDRESS: STREET 1: 7321 LINCOLN WAY CITY: GARDEN GROVE STATE: CA ZIP: 92641 BUSINESS PHONE: 7148980007 MAIL ADDRESS: STREET 2: 7321 LINCOLN WAY CITY: GARDEN GROVE STATE: CA ZIP: 92641 10KSB 1 FORM 10-KSB PERIOD ENDING 2-29-96 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) /X/ Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 [Fee required] For the fiscal year ended February 29, 1996, / / Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 [No fee required] For the transition period from _________ to _________. Commission file number: 0-14843 DENSE-PAC MICROSYSTEMS, INC. (Name of Small Business Issuer in its Charter) CALIFORNIA 33-0033759 (State or other jurisdiction of (I.R.S. Employer incorporation of organization) Identification No.) 7321 LINCOLN WAY GARDEN GROVE, CALIFORNIA 92641 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (714) 898-0007 Securities registered pursuant to Section 12(g) of the Act: Common Stock Check whether the Issuer (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period as 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 --- --- Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB [ ] The Issuer's revenues for its most recent fiscal year were $18,006,000. The aggregate market value of the Issuer's Common Stock, no par value, held by non-affiliates of the Issuer on May 2, 1996 (based on the average bid and asked price per share on that date as reported on NASDAQ), was $77,917,120. Issuer's Common Stock outstanding at May 2, 1996: 16,846,181 shares. Documents Incorporated By Reference Portions of the Proxy Statement for the 1996 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report. 2 PART I ITEM 1: BUSINESS For a discussion of certain factors which may affect the Company's business, see "Cautionary Statements" beginning at page 13 of this Report. General Dense-Pac Microsystems, Inc. ("Dense-Pac" or the "Company") designs, develops, manufactures and markets a broad line of standard and custom monolithic memories and memory/logic modules and subsystems. The Company's products are used in a variety of military, industrial and commercial applications where high memory density, high performance and high reliability are required. Typical product applications are in the areas of communications, medical instrumentation, missiles, avionics and space satellites. The Company's products are designed to improve performance and reliability at the system level by reducing space, weight and power requirements. The Company procures silicon from a variety of semiconductor foundries and incorporates the silicon die into high density products utilizing the latest process technology and the Company's advanced package designs. The Company's products range from monolithic semiconductors to the patented, high density, three-dimensional "Dense-Stack" product line. The majority of the Company's products are memory related. A memory module is a miniaturized memory subsystem which can consist of up to 64 memory devices plus support chips in a component only a few times larger than a conventionally packaged integrated circuit. The Company's proprietary packaging technology enables memory systems to be designed with up to 10 or more times the amount of memory in a given area as can be accomplished with conventional packaging techniques. For example, a memory system which would require 20 square inches of printed circuit board using conventional packaging techniques, can be packaged by the Company in a memory module less than two square inches in size. The module approach to memory packaging allows the elimination of most of the printed circuit boards as well as their mating connectors, resulting in smaller, lighter and less expensive digital systems. Also, since the electrical signals have less distance to travel, operating speeds are enhanced. The Company also offers programmable logic products that offer similar space savings to its customers. High density packaging is used in numerous applications within the electronics industry. Improved performance and reliability in increasingly smaller packages has been a continuous trend in 2 3 electronics. During the past 20 years, advances have been made in reducing size and increasing performance at the integrated circuit level (LSI, VLSI, etc.). However, high pin count, complex semiconductors with adequate test methods have reached levels that are both difficult and costly to achieve. The Company's packaging technologies address the market's need to both reduce the size and improve the performance of memory products. In addition to improving performance, packaging technology allows the use of more available, less expensive, lower density chips to achieve the same performance levels of newer, more expensive high density chips. For example, one of the Company's products is a 64 Meg DRAM emulator which uses four 16 Meg DRAMS to provide the same memory as a single 64 Meg DRAM chip. Packaging technology can thereby reduce the cost of certain products by allowing customers to use a module consisting of multiple low cost, volume produced memory chips (e.g., 16 Meg DRAMs) instead of a single expensive state-of-the-art semiconductor chip (e.g., 64 Meg DRAM). Dense-Pac is also able to offer customers leading edge memory products by packaging the highest memory chips available. For example, the SuperSIMM module provides a gigabit of memory by stacking 16 Meg DRAM chips, a level of memory which no single chip can currently provide. Because of the rapid technological advances in the semiconductor industry, however, the Company's products are subject to obsolescence or price erosion as new chips with the same or greater density as the Company modules are continuously introduced. This results in the Company's products having relatively short life cycles and the need to continually develop new products which incorporate the latest semiconductor technologies. 3-D Stacking Products In September 1990 the Company was awarded a patent on a new packaging technology which allows use of the "Z" axis (the third dimension) to further increase density over what was available in the market. In three-dimensional packaging, individual memory chips are stacked one on the other, and vertically interconnected. The Company's "stacking" products are to computers what skyscrapers are to real estate, enabling more efficient use of a given space by dramatically expanding memory capacity and speed on less circuit board space. For example, this stacking technology permits the Company to package 32 megabytes of memory in a three-dimensional package measuring just 1.4" x 2.0" x .8". This technique, which increases memory board density by a factor of 20 over conventional packaging techniques, has particular advantages in applications where high memory capacity and space are critical, such as portable computers and communications devices. 3 4 The Company commenced shipments of its first generation "Dense- Stack" products in fiscal year 1991. The first generation stacking products are manufactured on ceramic substrates to withstand extreme temperature and vibration ranges and adverse environmental conditions. These products are used primarily in military, aerospace and high industrial applications such as satellites and deep well drill bits. The products are available in multiple speed ranges of SRAM, flash and DRAM. In fiscal year 1995 the Company developed a second generation stacking product for commercial applications where space, savings and high memory density are critical, such as cellular telephones, portable and palm-top computers, interactive communications, and medical instruments. This technology represents a four times improvement in density and a 75% reduction in manufacturing costs compared to the first generation products. The second generation products can be utilized directly in emerging multi-chip MCM module applications or encapsulated in plastic for use on conventional printed circuit boards. The Company has not been able to market the second generation product because the sole supplier ceased production of the SRAM die that was designed into the product. The Company believes that the second generation technology remains valid and it may redesign this product to incorporate new die technology when market conditions are appropriate. During fiscal year 1996 the Company introduced a third generation of commercial stacking products based on its three-dimensional packaging technology. One of these new products is the SuperSIMM, a super memory board which quadruples the memory available with a standard SIMM (single inline memory module). The SuperSIMM is constructed of 16 stacks of four standard 16 MEG DRAM chips, mounted on an industry standard 72 pin substrate. The SuperSIMM provides a gigabit of memory when plugged into the same size slot of a high-end workstation used by a SIMM. The highest density SIMM modules currently provide 256 megabit of memory. The SuperSIMM module is about the size of a 1/2-inch thick business card. The SuperSIMM is targeted at high-end workstations, network servers, solid state disk and data markets, and memory intensive software applications such as video on demand, computer automated design, multimedia and special effects. High-end workstations produced by Sun, IBM, Hewlett Packard, Digital and Silicon Graphics have multiple slots for SIMM modules which would also accommodate the Dense-Pac SuperSIMM module. The third generation stacking products can also combine various types of chips such as SRAMs, DRAMs, flash memory and microprocessors to improve performance and versatility. 4 5 Standard Products The Company offers a standard product line of ceramic and plastic memory modules with a variety of capabilities to meet market requirements. The Company's standard memory modules incorporate static random access memories (SRAMs), erasable programmable read-only memories (EPROMs) electrically erasable programmable read-only memories (EEPROM's), including newly developed flash technology, and dynamic random access memories (DRAM). Due to the various configurations and applications of the Company's products, prices range from less than $100 for single 256k bit modules to several thousand dollars for high-end military specification 1 megabyte (l024k x 8) modules. Custom Design Capabilities Many of the Company's customers require product packaging which meets specialized density, size and performance standards. Accordingly, an important aspect of the Company's business is its ability to custom design and manufacture modules to meet a customer's specifications. In most cases, the Company retains ownership of the custom designs for prototype products and therefore is able to offer such designs to other customers as standard products. Thus, the Company's custom design capabilities also provide it with an ongoing source of new standard products. Patents and Technology Rights The Company's first generation, three-dimensional stacking technology is the subject of a United States patent which expires in 2007. In 1993, the Company was awarded a U.S. patent on certain aspects of its second generation three-dimensional technology which expires in 2010. There can be no assurance that these patents will afford the Company's products any competitive advantage, that they will not be challenged or circumvented by third parties, or that patents issued to others will not adversely affect the development or commercialization of the Company's products. The semiconductor packaging industry is characterized by rapid technological change and is highly competitive with respect to timely product innovation. Memory products typically have a product life of only three to five years. The Company's success depends on its ability to develop new products or product enhancements to keep up with technological advances and to meet customer needs. In order to obtain large orders for the Dense-Stack products from OEMs, the Company may be required to provide manufacturing licenses to third parties as second sources to ensure that the 5 6 customer's requirements are met. Such second sources could then compete directly with the Company for customers. Marketing and Customers The Company markets its products to military, aerospace and commercial customers that require high reliability, high density and high performance. The Company's military/aerospace customers use the Company's products in high performance weapons, avionics and communications systems. Commercial markets are in the areas of computers, communications, multimedia and medical instruments. Compared to the military/aerospace business, the commercial business is characterized by more competition, a higher risk of inventory obsolescence and lower margins. The commercial market is also characterized by more rapid product innovation in response to new technologies. As a result, commercial products have approximately a two to four-year life, whereas military/aerospace products have a four to eight-year or longer life. In addition, the Company is required to carry significant levels of inventory before orders are received in order to meet the short delivery requirements of commercial customers. The Company markets its products throughout the world directly through its own sales staff and through independent sales representatives. Sales representatives obtain orders on an agency basis and shipment is made directly to the customer by the Company. The sales representatives receive a commission on sales of the Company's products within their territories. In fiscal years 1996 and 1995, approximately 23% and 27%, respectively, of the Company's sales were export sales, primarily to Western Europe. Foreign sales are in U.S. dollars. Manufacturing and Supplies The principal components of a memory module are semiconductor memory chips and the ceramic or plastic substrates on which they are mounted. The Company purchases unpackaged chips from various semiconductor vendors, depending on the customer's requirements. The semiconductor chips must be packed in ceramic leadless chip carriers (LCCs) so that they can be soldered onto the substrate surface. The Company has the unpackaged chips packaged in LCCs by various assembly houses. The Company then performs final product assembly by mounting the LCCs on the substrate. The substrate performs the same function as a miniaturized printed circuit board by providing interconnection between the LCCs and the memory module's contact pins. Dense-Pac electronically tests its products at various stages in the assembly process to meet military or other customer 6 7 specifications and performs high temperature burn-in on military, avionics and industrial grade products. Ceramic substrate products are hermetically sealed, resulting in a product which can withstand extreme temperature ranges and exposure to adverse environmental conditions such as moisture and corrosives. Ceramic products are typically used in military and aerospace applications. Plastic substrate products, because they use plastic-molded parts, are lower cost, have a shorter life span and are used in benign environments. Plastic products are typically used in commercial applications such as robotics, medical instrumentation, test equipment, portable computers and cellular phones. The Company purchases raw materials and components from several key material suppliers, but does not have any supply agreements. Although alternative suppliers are available, a significant unplanned event at a major supplier or assembly house could have a short-term adverse impact on the Company's operations. The market for memory devices is characterized by periodic shortages which can adversely impact the Company's costs and/or ability to timely ship products. Defense-Related Subcontracts A portion of the Company's sales are derived from defense-related subcontracts. As a result, the Company is subject to business risks resulting from federal budgeting constraints, changes in governmental appropriations and changes in national defense policies and priorities, and termination, reduction or modification of contracts for the convenience of the government. Many of the programs in which the Company participates as a subcontractor may extend for several years, but since the Government funds contracts on a year-to-year basis, the Company's business is dependent on annual appropriations and funding of new and existing contracts. Competition The Company does not generally compete with chip manufacturers who focus on the lowest cost consumer markets to keep volumes high. Instead, the Company focuses on niche markets where the customer's requirements allow the Company to utilize its unique engineering and packaging skills to maintain a high value added content. Dense-Pac's direct competition includes specialty memory module assembly companies such as Electronic Designs, Inc. and Integrated Circuits, Inc. Semiconductor firms such as Integrated Device Technology, Inc., Mitsubishi Corp., Fujitsu Ltd. and Harris Semiconductor also compete in the memory module marketplace. Such companies, however, are not typically direct competition to the 7 8 specialty assembly houses such as the Company due to their large production run requirements (attributable to extensive automation) and the fact that they use only their own semiconductors. Dense-Pac, on the other hand, manufactures memory modules which incorporate whichever semiconductor components are best suited to meet the customer's requirements. According to industry sources, there are more than 30 companies worldwide developing or marketing three dimensional packaged products, including IBM, Irvine Sensors, Texas Instruments, Thompson CSF, Mitsubishi, Motorola, Staktek, Cubic Memory, and Stac Electronics Inc. The principal competitive factors in the memory module market include product reliability, product performance characteristics, the ability to meet the customer's product needs and delivery requirements, and price. Dense-Pac believes it competes favorably with respect to all of these factors. The Company's commercial business is characterized by more intense competition, with the most important factors being price and the ability to meet short development and delivery schedules. Many of Dense-Pac's competitors have greater financial, technical and personnel resources than the Company. Employees At May 2, 1996, the Company had 93 full-time employees, of which 11 were engaged in engineering, 55 in manufacturing, production and testing, 7 in quality assurance, 9 in marketing/sales and 11 in management and administration. None of the Company's employees is represented by a labor union and the Company considers its employee relations to be good. ITEM 2: PROPERTIES The Company's executive offices and manufacturing facilities consist of 21,350 square feet in an industrial park in Garden Grove, California. The lease expires January 31, 2001 and provides for an effective monthly rent of $10,900. The Company believes that its facilities are adequate to meet its foreseeable needs. ITEM 3: LEGAL PROCEEDINGS In December 1993, the Company was named as a co-defendant along with an employee in a suit filed in the Superior Court of the State of California, County of Orange. The plaintiff claimed damages resulting from an alleged altercation between the plaintiff and a Company employee. The suit was settled in March 1996 for a nominal sum which was paid by the Company's insurance carrier. 8 9 ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of fiscal year 1996. PART II ITEM 5: MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock commenced trading on the Nasdaq National Stock Market on March 14, 1996, under the symbol "DPAC." It previously traded on the Nasdaq Small Cap Market. The following table sets forth the high and low closing bid prices of the Common Stock on the Nasdaq Small Cap Market for the periods indicated as reported by Nasdaq. Quotations on the Nasdaq Small Cap Market are inter-dealer prices without retail mark-up, mark-down or commissions, and may not represent actual transactions.
High Low ---- --- Fiscal Year 1995: Quarter Ended May 31, 1994 $2-5/8 $1-1/2 August 31, 1994 2-1/2 1-5/32 November 30, 1994 3-3/16 2-1/16 February 28, 1995 2-5/8 1-15/16 Fiscal Year 1996: Quarter Ended May 31, 1995 2-7/16 1-3/4 August 31, 1995 4-11/16 1-15/16 November 30, 1995 7-7/16 4-3/8 February 29, 1996 6-11/16 5-3/8
As of May 2, 1996, the Company had 325 shareholders of record, and over 1,000 beneficial shareholders, based on information provided by the Company's transfer agent. The Company has not paid any dividends and it does not expect to pay any dividends in the foreseeable future. There are currently no contractual or other restrictions affecting the Company's ability to pay dividends. 9 10 ITEM 6: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The Company's sources of liquidity during fiscal year 1996 were cash flow from operations and $1.9 million cash proceeds from the exercise of warrants in October 1995. The Company experienced negative cash flow from operations for the entire fiscal year of $576,907 due to a $1,673,060 increase in accounts receivable and a $803,901 increase in inventories which resulted from the growth in sales. Cash used for investing activities consisted of approximately $662,000 of capitalized engineering labor and approximately $620,000 for the purchase of engineering and test equipment, computers, machinery and tooling. The Company has no material commitments for capital expenditures in fiscal year 1997. At February 29, 1996, the Company had a $1.8 million loan payable to a major shareholder with interest at 5% per annum, and a $100,000 loan payable to a director with interest at 8% per annum, with interest payable quarterly on both loans and the principal on both loans due in October 1999. These loans are secured by all of the Company's assets, although the major shareholder has agreed to subordinate its security interest in accounts receivable in order to permit the Company to obtain conventional bank financing for accounts receivable. These loans preclude the Company from incurring additional debt without the consent of the lenders except for purchase money indebtedness incurred for the purchase or lease of equipment and machinery. The Company also has a loan from a Belgian bank due November 2000 which provides for semi-annual principal payments of $70,533. The interest rate is two points over the LIBOR rate in effect at the time of each principal payment and interest is payable semi-annually. At February 29, 1996, the outstanding principal amount was $705,530. Principal and interest payments on this loan totalled $218,000 in fiscal 1996. The Company's working capital at February 29, 1996 was $11,125,604. In fiscal year 1997 the Company expects to see growth in its existing product lines, in particular the first generation products. The Company also believes that the new third generation commercial stacking products will contribute to sales in the second half of the fiscal year, although the anticipated sales prices of these new products have been negatively affected by the recent decrease in DRAM prices. The sources of liquidity to support growth in fiscal year 1997 (principally to finance increased inventories and accounts receivable) are the $4.3 million net proceeds obtained from the sale of 900,000 shares of Common Stock in February 1996 and cash flow from operations. The Company is 10 11 also seeking a bank line of credit of $2 to $3 million. The Company believes that it has the financial resources to meet its business requirements for the foreseeable future. Results of Operations Fiscal 1996 Compared to Fiscal 1995. Fiscal year 1996 net sales of $18,006,091 increased by $6,511,382 (57%) over fiscal year 1995 sales of $11,494,709. These results reflected an increase in the first generation stack modules of over $4,000,000 compared to the prior year due to increased market penetration of these ceramic stackable chip products as well as new technology and improved density in such product. The first generation products represented approximately 35% of net sales in fiscal year 1996 compared to 33% of net sales in fiscal year 1995. Additional sales also resulted from continued strong demand for the 512kx8 standard commercial product, which represented approximately 34% of net sales in fiscal year 1996, compared to approximately 30% in fiscal year 1995. Sales of this product increased by $2,800,000 due to opportunities generated through new distribution arrangements and the availability of stock on had to support quick turn business. Due to technology advances, the Company expects to experience a significant decline in sales of 512kx8 standard products in fiscal year 1997. While the Company has developed a replacement product which incorporates the advanced technology, the market acceptance of such new product cannot be predicted. Foreign sales increased approximately $1,000,000 as the Company was successful in obtaining several new representatives to sell the Company's products into new foreign markets. Foreign sales represented 23% of net sales in fiscal year 1996 compared to 27% of net sales in fiscal year 1995. Costs of sales for fiscal year 1996 was $12,935,789 (72% of sales), an increase of $3,828,035 (42%) over fiscal year 1995 cost of sales of $9,107,754 (79% of sales). Approximately $1,000,000 of cost of sales in fiscal year 1995 related to preproduction costs associated with the second generation technology. Without such expenses, cost of sales as a percentage of sales for fiscal year 1995 would have been approximately 71%. Despite the increased sales in fiscal year 1996, cost of sales as a percentage of sales in fiscal year 1996 compared to fiscal year 1995 (excluding the effect of the second generation pre-production costs) did not decrease due to lower margins attributable to commercial products and approximately $80,000 of additional compensation resulting from the Company's variable compensation plan. See Note 13 of the Financial Statements for a description of this plan. Selling, general and administrative expenses increased by $380,744 (16%) from $2,398,057 in fiscal year 1995 to $2,778,801 in fiscal year 1996. The increase was due to payments under the variable compensation plan of approximately $169,000 during fiscal 11 12 year 1996 compared to no such payments in the prior fiscal year. In addition, bonuses under the Management Bonus Plan of approximately $186,500 were accrued for fiscal year 1996 compared to $19,706 in fiscal year 1995. See Note 13 of the Financial Statements for a description of the bonus plan. Due to the greater rate of growth of net sales, selling, general and administrative expenses decreased as a percentage of net sales from 21% of net sales in fiscal year 1995 to 15% of net sales in fiscal year 1996. Research and development expense remained essentially unchanged in fiscal year 1996 as compared to fiscal year 1995. Net interest expense increased by $28,188 (14%) from $196,167 in fiscal year 1995 to $224,355 in fiscal year 1996 because a related party note was outstanding for the entire fiscal year rather than a partial year in fiscal year 1995 and the Company entered into an additional lease relating to new equipment in fiscal year 1996. In the fourth quarter of fiscal year 1996 the Company recognized a $150,000 deferred tax benefit as a result of the availability of operating tax loss carryforwards and the expected utilization of those carryforwards. In the prior fiscal year, the Company reversed $300,000 of a deferred tax benefit which had been recorded in fiscal year 1994. Fiscal 1995 Compared to Fiscal 1994. Fiscal year 1995 net sales of $11,494,709 increased by $290,012 (3%) over fiscal year 1994 sales of $11,204,697. This increase reflected a slight growth in sales of the Company's first generation product line from the previous year, principally in the European market. The first generation product line represented approximately 33% of the Company's sales in fiscal year 1995 compared to 25% of sales in fiscal year 1994. Foreign sales increased from 18% of sales in fiscal year 1994 to 27% of sales in fiscal year 1995. The Company also continued to experience strong demand for 512K x 8 standard memory products, which represented approximately 30% of sales, and the Company increased its customer base over the prior year. Cost of sales for fiscal year 1995 was $9,107,754 (79% of sales), an increase of $1,547,997 (20%) over fiscal year 1994 cost of sales of $7,559,756 (67% of sales). Approximately $1,000,000 of the increase in cost of sales was due to preproduction costs associated with the second generation product line, facilities and related overhead, which did not generate significant revenue during the fiscal year. The balance of the increase in cost of sales was due to increased material costs due to a change in product mix and higher manufacturing costs. Other costs in fiscal year 1995 consisted of a one-time charge of $1,668,638 recorded in the fourth quarter in connection with the 12 13 discontinuation of certain product lines. The Company decided to discontinue low volume, older technology product lines in order to concentrate on the higher density memory products demanded by the market. The charge included a write-down of capitalized engineering costs ($830,040), a write-off of inventories ($772,661) and a write-off of certain other costs ($65,937). The write-down of capitalized engineering costs was in part due to a change in the estimate of the useful life of such costs from five years to three years. Selling, general and administrative expense remained essentially unchanged in fiscal year 1995 compared to fiscal year 1994. Research and development expense increase by $176,214 (43%) from $406,779 in fiscal year 1994 to $582,993 in fiscal year 1995. This increase was due to the Company's efforts to finish the second generation product development while at the same time concentrating on developing new products for the future. Two individuals, whose sole responsibility is to conduct research and development for new products, were hired during fiscal year 1995. Net interest expense increased by $89,916 (85%) from $106,251 in fiscal year 1994 to $196,167 in fiscal year 1995, due to an increase in borrowings, primarily to finance new equipment. In the fourth quarter of fiscal year 1995 the Company established a valuation allowance of $300,000 for a deferred tax benefit recorded in fiscal year 1994 due to the uncertainty of the recoverability of the deferred tax benefit. CAUTIONARY STATEMENTS Statements in this Report which are not historical facts, including statements about the Company's business strategy and expectations about new and existing products and technologies or market characteristics and conditions, are forward-looking statements that involve risks and uncertainties. These include, but are not limited to, the factors described below which could cause actual results to differ from those contemplated by the forward-looking statements. Product Development and Technological Change The semiconductor and memory module industries are characterized by rapid technological change and are highly competitive with respect to timely product innovation. The Company's memory products are subject to obsolescence or price erosion because semiconductor manufacturers are continuously introducing chips with the same or greater memory density as the Company's modules. As a result, memory products typically have a product life of only three to five years. 13 14 The Company's future success depends on its ability to develop new products and product enhancements to keep up with technological advances and to meet customer needs. Any failure by the Company to anticipate or respond adequately to technological developments and customer requirements, or any significant delays in product development or introduction, could have a material adverse effect on the Company's financial condition and results of operations. For example, pre-production delays associated with the second generation Dense-Stack product line caused the Company to lose its source of acceptable SRAM die because the supplier discontinued production of the die that the second generation product had been designed for. The Company believes that the second generation technology remains valid and it may redesign this product to incorporate new die technology when market conditions are appropriate. There can be no assurance that the Company will be successful in its product development or marketing efforts, or that the Company will have adequate financial or technical resources for future product development and promotion. Uncertainty of Market Acceptance or Profitability of New Products The introduction of the SuperSIMM product or other new products which the Company may introduce in the future will require the expenditure of funds for research and development, tooling, manufacturing processes, inventory and marketing. In order to achieve high volume production of the SuperSIMM product, the Company will have to make substantial investments in inventory and increase production rates. The Company has limited marketing capabilities and resources and is dependent upon internal sales and marketing personnel and a network of independent sales representatives for the marketing and sale of its products. There can be no assurance that the SuperSIMM product or future new products will achieve market acceptance, result in increased revenues, or be profitable. Such products could also be subject to technological obsolescence or price erosion resulting from competition or other factors. Parts Shortages and Dependence on Suppliers The semiconductor industry is characterized by periodic shortages of parts which have in the past and may in the future negatively affect the Company's operations. The Company is dependent on a limited number of suppliers for semiconductor devices used in its products, but it has no long-term supply contracts with any of them. For example, the Company was not able to market its second generation Dense-Stack product when it lost its source of SRAM die. Due to the cyclical nature of the semiconductor industry and competitive conditions, there can be no assurance that the Company will not experience difficulties in meeting its supply requirements in the future. Any inability to 14 15 obtain adequate deliveries of parts, either due to the loss of a supplier or industry-wide shortages, could delay shipments of the Company's products, increase its cost of goods sold and have a material adverse effect on its business, financial condition and results of operations. Dependence on Defense-Related Business The Company has historically derived a substantial portion of its revenues from defense-related contracts. As a result, the Company's business has been impacted by reductions in the federal defense budget and will continue to be subject to risks affecting the defense industry, including changes in governmental appropriations and changes in national defense policies and priorities. The Company has sought to reduce its dependence on defense-related business by developing products with commercial applications, although such products generally have lower margins than defense-related products. Patent Rights The Company's ability to compete effectively is dependent on its proprietary know-how, technology and patent rights. The Company holds U.S. patents on certain aspects of its 3-D stacking technology and has applied for additional patents. There can be no assurance that the Company's patent applications will be approved, that any issued patents will afford the Company's products any competitive advantage or will not be challenged or circumvented by third parties, or that patents issued to others will not adversely affect the development or commercialization of the Company's products. Management of Growth The Company intends to use the net proceeds of approximately $4.3 million from a private offering of Common Stock completed in February 1996 to finance expected growth. Successful expansion of the Company's operations will depend on, among other things, the ability to obtain new customers, to attract and retain skilled management and other personnel, to secure adequate sources of supply on commercially reasonable terms and to successfully manage growth. To manage growth effectively, the Company will have to continue to implement and improve its operational, financial and management information systems, procedures and controls. As the Company expands, it may from time to time experience constraints that will adversely effect its ability to satisfy customer demand in a timely fashion. Failure to manage growth effectively could adversely effect the Company's financial condition and results of operations. 15 16 Competition Numerous memory companies are in the process of developing three-dimensional products, including IBM, Irvine Sensors, Texas Instruments, Mitsubishi, Motorola, Staktek, Cubic Memory and Thompson CSF in France. Many of such companies have substantially greater financial, manufacturing and marketing capabilities than the Company. The Company could also experience competition from established and emerging computer memory companies. There can be no assurance that the Company's products will be competitive with existing or future products, or that the Company will be able to establish or maintain a profitable price structure for its products. Manufacturing Licenses In order to obtain large orders for the its commercial products from OEMs, the Company may be required to provide royalty-free manufacturing licenses to third parties as second sources to ensure that the customer's requirements are met. Such second sources could then compete directly with the Company for customers. As a result, the Company could become dependent on the efforts and abilities of its licensees, if any, to manufacture and market its products. ITEM 7: FINANCIAL STATEMENTS The Company's Financial Statements are included in this report commencing at page F-1. ITEM 8: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 16 17 PART III ITEM 9: DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The required information is incorporated herein by reference to the sections entitled "Election of Directors", "Executive Officers" and "Ownership of Common Stock - Section 16 Reports" in the Company's Proxy Statement for the 1996 Annual Meeting of Shareholders. ITEM 10: EXECUTIVE COMPENSATION The required information is incorporated herein by reference to the sections entitled "Executive Compensation" and "Election of Directors - Directors' Compensation" in the Company's Proxy Statement for the 1996 Annual Meeting of Shareholders. ITEM 11: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The required information is incorporated herein by reference to the section entitled "Ownership of Common Stock" in the Company's Proxy Statement for the 1996 Annual Meeting of Shareholders. ITEM 12: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The required information is incorporated herein by reference to the section entitled "Certain Transactions" in the Company's Proxy Statement for the 1996 Annual Meeting of Shareholders. 17 18 PART IV ITEM 13: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Articles of Incorporation, as amended (1) 3.2 By-laws, as amended (1) 10.1 Letter dated December 4, 1990 from Kreidietbank regarding $1,270,000 loan (2) 10.2 Lease for Premises at 7321 Lincoln Way, Garden Grove, California, dated June 19, 1995. * 10.3 1996 Stock Option Plan * 10.4 1985 Stock Option Plan, as amended (3) * 10.5 Management Bonus Plan For Fiscal Year 1996 - See Note 13 of the Financial Statements * 10.6 Form of Indemnification Agreement with officers and directors (3) 10.7 Loan Agreement and Security Agreement dated October 12, 1994 between the Company and Euroventures Benelux II B.V. and Trude C. Taylor (4) 10.8 Form of Warrant Agreement dated November 14, 1994, between the Company and each of Euroventures Benelux II B.V. and Trude C. Taylor (5) 10.9 Warrant Agreement and Addendum to Loan Agreement effective as of October 23, 1995, between the Company and Euroventures Benelux II B.V. (6) * 10.10 Management Bonus Plan for fiscal year 1997 23.1 Independent Auditors' Consent 27.1 Financial Data Schedule _________________ * Management contracts, compensation plans and arrangements. (1) Incorporated by reference to Registrant's Current Report on Form 8-K, Date of Event July 11, 1988. 18 19 (2) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1990. (3) Incorporated by reference to Registrant's Annual Report on Form 10-KSB for the year ended February 28, 1994. (4) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1994. (5) Incorporated by reference to the Registrant's Registration Statement on Form S-3 (No. 33-87704) filed on December 22, 1994. (6) Incorporated by reference to Registrant's Form 8-K, Date of Event October 23, 1995. (b) Reports on Form 8-K A Current Report on Form 8-K, Date of Event: February 8, 1996, filed on February 29, 1996, reported a completed private placement of securities under Item 5, Other Events. 19 20 SIGNATURES In accordance with 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. DENSE-PAC MICROSYSTEMS, INC. Date: May 28, 1996 By: /S/ James G. Turner ------------------- James G. Turner Chief Executive Officer In accordance with 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. /S/ James G. Turner Chairman of the Board, May 28, 1996 - ------------------------- Chief Executive Officer James G. Turner and President (Principal Executive Officer) /S/ William M. Stowell Vice President-Finance, May 28, 1996 - ------------------------- Chief Financial Officer William M. Stowell and Secretary (Principal Financial and Accounting Officer) /S/ Roger Claes Director May 28, 1996 - ------------------------- Roger Claes /S/ Robert Southwick Director May 28, 1996 - ------------------------- Robert Southwick /S/ Trude C. Taylor Director May 28, 1996 - ------------------------- Trude C. Taylor 20 21 [DELOITTE & TOUCHE LLP LETTERHEAD] INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Dense-Pac Microsystems, Inc.: We have audited the accompanying balance sheets of Dense-Pac Microsystems, Inc. (the Company) as of February 29, 1996 and February 28, 1995, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended February 29, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Dense-Pac Microsystems, Inc. as of February 29, 1996 and February 28, 1995, and the results of its operations and its cash flows for each of the three years in the period ended February 29, 1996, in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP - ------------------------- Costa Mesa, California May 3, 1996 F-1 22 DENSE-PAC MICROSYSTEMS, INC. BALANCE SHEETS AS OF FEBRUARY 29, 1996 AND FEBRUARY 28, 1995 - --------------------------------------------------------------------------------
1996 1995 ASSETS CURRENT ASSETS: Cash $ 4,579,840 $ 356,787 Accounts receivable, net of allowance for doubtful accounts of $40,000 in 1996 and 1995 3,574,822 1,901,762 Inventories (Notes 1 and 2) 5,151,106 4,347,205 Deferred income taxes (Note 10) 150,000 Prepaid expenses and other current assets 287,075 122,223 ----------- ---------- Total current assets 13,742,843 6,727,977 PROPERTY, net (Notes 1, 3 and 5) 3,448,860 2,512,641 TECHNOLOGY AND MARKETING RIGHTS, net (Note 1) 409,048 481,840 OTHER ASSETS 67,262 67,262 ----------- ---------- $17,668,013 $9,789,720 =========== ==========
See accompanying notes to financial statements. F-2 23 DENSE-PAC MICROSYSTEMS, INC. BALANCE SHEETS AS OF FEBRUARY 29, 1996 AND FEBRUARY 28, 1995 (CONTINUED) - --------------------------------------------------------------------------------
1996 1995 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt (Note 5) $ 413,851 $ 375,553 Accounts payable 1,568,907 1,170,997 Deferred revenue (Note 7) 717,023 Accrued compensation 572,499 296,288 Other accrued liabilities 61,982 36,667 ----------- ----------- Total current liabilities 2,617,239 2,596,528 NOTES PAYABLE DUE TO RELATED PARTIES (Note 6) 1,900,000 2,000,000 LONG-TERM DEBT (Note 5) 699,134 993,201 COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDERS' EQUITY (Notes 6, 9 and 11): Common stock, no par value; authorized, 20,000,000 shares; issued and outstanding, 16,748,231 and 14,625,531 shares in 1996 and 1995, respectively 15,795,004 9,241,036 Accumulated deficit (3,343,364) (5,041,045) ----------- ----------- Net stockholders' equity 12,451,640 4,199,991 ----------- ----------- $17,668,013 $ 9,789,720 =========== ===========
See accompanying notes to financial statements. F-3 24 DENSE-PAC MICROSYSTEMS, INC. STATEMENTS OF OPERATIONS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 - --------------------------------------------------------------------------------
1996 1995 1994 NET SALES (Notes 7 and 12) $18,006,091 $11,494,709 $11,204,697 COST OF SALES (Note 1) 12,935,789 9,107,754 7,559,756 ----------- ----------- ----------- GROSS PROFIT 5,070,302 2,386,955 3,644,941 COSTS AND EXPENSES (Notes 1, 8 and 13): Selling, general and administrative 2,778,801 2,398,057 2,392,928 Research and development 518,665 582,993 406,779 Other costs 1,668,638 ----------- ----------- ----------- Total costs and expenses 3,297,466 4,649,688 2,799,707 ----------- ----------- ----------- INCOME (LOSS) FROM OPERATIONS 1,772,836 (2,262,733) 845,234 INTEREST EXPENSE, net (Notes 5 and 6) (224,355) (196,167) (106,251) ----------- ----------- ----------- INCOME (LOSS) BEFORE INCOME TAX (BENEFIT) PROVISION 1,548,481 (2,458,900) 738,983 INCOME TAX (BENEFIT) PROVISION (Note 10) (149,200) 280,606 (278,200) ----------- ----------- ----------- NET INCOME (LOSS) $ 1,697,681 $(2,739,506) $ 1,017,183 =========== =========== =========== NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE (Note 1) $ 0.11 $ (0.19) $ 0.07 =========== =========== =========== WEIGHTED AVERAGE SHARES OUTSTANDING 15,729,864 14,605,802 14,588,398 =========== =========== ===========
See accompanying notes to financial statements. F-4 25 DENSE-PAC MICROSYSTEMS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 - --------------------------------------------------------------------------------
COMMON STOCK TOTAL -------------------------- ACCUMULATED STOCKHOLDERS' SHARES AMOUNT DEFICIT EQUITY BALANCE, March 1, 1993 10,413,213 $ 5,766,985 $(3,318,722) $ 2,448,263 Sale of common stock (Note 9) 3,300,000 2,840,352 2,840,352 Conversion of convertible debt to common stock (Note 6) 560,093 504,083 504,083 Exercise of warrants to purchase common stock (Note 9) 152,850 9,500 9,500 Issuance of common stock upon exercise of stock options (Note 11) 155,125 80,258 80,258 Net income 1,017,183 1,017,183 ---------- ----------- ----------- ----------- BALANCE, February 28, 1994 14,581,281 9,201,178 (2,301,539) 6,899,639 Exercise of warrants to purchase common stock (Note 9) 4,000 4,000 4,000 Issuance of common stock upon exercise of stock options (Note 11) 40,250 35,858 35,858 Net loss (2,739,506) (2,739,506) ---------- ----------- ----------- ----------- BALANCE, February 28, 1995 14,625,531 9,241,036 (5,041,045) 4,199,991 Sale of common stock, net (Note 9) 900,000 4,297,200 4,297,200 Exercise of warrants to purchase common stock, net (Notes 6 and 9) 1,056,700 2,024,913 2,024,913 Issuance of common stock upon exercise of stock options (Note 11) 166,600 231,855 231,855 Net income 1,697,681 1,697,681 ---------- ----------- ----------- ----------- BALANCE, February 29, 1996 16,748,831 $15,795,004 $(3,343,364) $12,451,640 ========== =========== =========== ===========
See accompanying notes to financial statements. F-5 26 DENSE-PAC MICROSYSTEMS, INC. STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 - --------------------------------------------------------------------------------
1996 1995 1994 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 1,697,681 $(2,739,506) $ 1,017,183 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 534,812 988,653 607,018 Change in deferred income taxes (150,000) 300,000 (300,000) Write-off of property 535,810 Foreign currency transaction gain 432 Changes in operating assets and liabilities: Accounts receivable (1,673,060) 242,950 (1,205,880) Inventories (803,901) (288,778) (2,256,883) Prepaid expenses and other current assets (164,852) 94,546 (156,560) Accounts payable 397,910 (146,146) 346,898 Income taxes payable (21,000) 21,000 Deferred revenue (717,023) 717,023 Accrued compensation 276,211 (53,668) 195,923 Other accrued liabilities 25,315 22,989 (77,653) ----------- ----------- ----------- Net cash used in operating activities (576,907) (337,127) (1,808,522) CASH FLOWS FROM INVESTING ACTIVITIES - Property additions (1,282,738) (781,833) (1,250,626) CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayment) proceeds of short-term bank borrowings (683,149) 183,948 Proceeds from issuance of convertible note due to related party 300,000 (Repayment) proceeds from note payable due to related parties (100,000) 2,000,000 411,481 Principal payments on long-term debt (371,270) (319,590) (485,436) Net proceeds from issuance of common stock 6,553,968 39,858 2,930,110 Decrease in deferred private placement costs 32,410 ----------- ----------- ----------- Net cash provided by financing activities 6,082,698 1,037,119 3,372,513 =========== =========== ===========
See accompanying notes to financial statements. F-6 27 DENSE-PAC MICROSYSTEMS, INC. STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - --------------------------------------------------------------------------------
1996 1995 1994 NET INCREASE (DECREASE) IN CASH $4,223,053 $(81,841) $313,365 CASH, beginning of year 356,787 438,628 125,263 ---------- -------- -------- CASH, end of year $4,579,840 $356,787 $438,628 ========== ======== ======== SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid $ 255,631 $187,817 $142,765 ========== ======== ======== Income taxes paid $ 800 $ 800 $ 800 ========== ======== ======== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of property for note payable $ 115,501 $206,655 $ -- ========== ======== ======== Acquisition of property under capital leases $ -- $ 89,484 $ -- ========== ======== ======== Conversion of convertible debt to common stock $ -- $ -- $504,083 ========== ======== ========
See accompanying notes to financial statements. F-7 28 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations - Dense-Pac Microsystems, Inc. (the Company) is engaged in the design, development, manufacture and marketing of a full line of high-density, miniaturized memory surface mount components and subsystems for a variety of commercial, industrial and military applications. The Company's revenues are generated primarily from manufacturers of electronic components, as well as from subcontracts where the primary contractor is the United States government. The Company grants credit to customers included in the military, aerospace and a variety of commercial industries. Fair Value of Financial Instruments - The Company's balance sheet includes the following financial instruments: cash, accounts receivable, accounts payable, accrued liabilities and debt. The Company considers the carrying value of cash, accounts receivable, accounts payable and accrued liabilities in the financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. The Company believes the carrying value of its long-term debt approximates its fair value or the interest rate approximates a rate the Company could obtain under similar terms at the balance sheet date. Based on borrowing rates currently available to the Company for loans with similar terms, the fair value of notes payable to related parties at February 29, 1996 is approximately $1,605,000. Inventories - Inventories (Note 2) are stated at the lower of first-in, first-out cost or market. The Company regularly monitors inventory for excess or obsolete items and makes any necessary adjustments when such adjustments are needed. Property - Property is stated at cost less accumulated depreciation and amortization (Note 3). Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, generally ranging from three to twelve years. Leasehold improvements are amortized on a straight-line basis over the shorter of the useful lives of the improvements or the term of the related lease. Direct costs associated with the development of software and test boards used for internal product testing are capitalized and amortized on a straight-line basis over three years. Technology and Marketing Rights - Technology and marketing rights are amortized using the straight-line method over 12 years. The net carrying amount of technology and marketing rights was considered recoverable at February 29, 1996 based on the net present value of future cash flows expected to be realized from continued sales of the Company's products into European markets. Accumulated amortization was $465,385 and $392,593 at February 29, 1996 and February 28, 1995, respectively. Revenue Recognition - Revenues are recognized upon shipment of the related products. The Company records an accrual for estimated returns at the time of product shipment based on historical experience. Income Taxes - Income taxes are recorded in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. F - 8 29 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- Net Income (Loss) Per Common and Common Equivalent Share - Net income (loss) per common and common equivalent share is computed by dividing net income (loss), adjusted for preferred dividend requirements (if applicable), by the weighted average number of common and common equivalent shares (if applicable) outstanding during the years. Common equivalent shares relate to stock options and warrants (Notes 9 and 11). In fiscal 1995, common equivalent shares were antidilutive and were not included. Fiscal Year 1995 Fourth Quarter Write-off - On March 13, 1995, the Board of Directors approved a write-off and write-down of certain assets associated with certain product lines. During the fourth quarter of fiscal 1995, the costs associated with the product lines totaled $1,669,000 consisting primarily of the write-down of fixed assets and inventories associated with those product lines. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles necessarily 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 revenue and expenses during the reporting periods. Actual results could differ from these estimates. Significant Concentrations - The Company is dependent on a limited number of suppliers for semiconductor devices used in its products but has no long-term supply contracts with any of them. Due to the cyclical nature of the semiconductor industry and competitive conditions, there can be no assurance that the Company will not experience difficulties in meeting its supply requirements in the future. Any inability to obtain adequate deliveries of parts, either due to the loss of a supplier or industry-wide shortages, could delay shipments of the Company's products, increase its cost of goods sold and have a material adverse effect on its business, financial condition and results of operations. The Company has historically derived a substantial portion of its revenues from defense-related contracts. As a result, the Company's business has been impacted by reductions in the federal defense budget and will continue to be subject to risks affecting the defense industry, including changes in governmental appropriations and changes in national defense policies and priorities. The Company has sought to reduce its dependence on defense-related business by developing products with commercial applications, although such products generally have lower margins than defense-related products. F - 9 30 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (Continued) - -------------------------------------------------------------------------------- 2. INVENTORIES Inventories consist of the following:
1996 1995 Raw materials $1,338,472 $1,235,939 Work-in-process 2,650,086 2,613,057 Finished goods 1,162,548 498,209 ---------- ---------- Total inventories $5,151,106 $4,347,205 ========== ==========
3. PROPERTY Property consists of the following:
1996 1995 Machinery and equipment $ 4,700,253 $ 3,595,075 Furniture and fixtures 143,074 75,589 Leasehold improvements 156,406 80,945 Computer software and equipment financed under capital leases 89,484 89,484 ----------- ----------- 5,089,217 3,841,093 Less accumulated depreciation and amortization (1,640,357) (1,328,452) ----------- ----------- Property, net $ 3,448,860 $ 2,512,641 =========== ===========
4. SHORT-TERM BANK BORROWINGS During the year ended February 28, 1995, the Company had a $1,250,000 line of credit with a commercial bank. In October 1994, the line of credit was repaid with proceeds received from a $2,000,000 loan agreement with related parties (Note 6). The Company is currently negotiating a new bank line of credit agreement with a commercial bank. F - 10 31 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (Continued) - -------------------------------------------------------------------------------- 5. LONG-TERM DEBT Long-term debt consists of the following:
1996 1995 Note payable to bank, collateralized by substantially all of the Company's assets, payable in 20 semi-annual principal payments - four of $35,288 and 16 of $70,553, plus interest commencing in July 1991, interest rate determined as LIBOR rate on payment dates, plus 2% $ 705,530 $ 846,636 Notes payable to finance company, collateralized by fixed assets, bearing interest at rates ranging from 8.88% to 9.65%, payable in monthly installments of principal and interest, maturing at various dates through January 1999 380,792 455,840 Obligations under capital leases, bearing interest at rates ranging from 9.44% to 14.59%, maturing at various dates through February 1997 26,663 66,278 ----------- ----------- 1,112,985 1,368,754 Less current portion of other long-term debt (413,851) (375,553) ----------- ----------- $ 699,134 $ 993,201 =========== ===========
Long-term debt at February 29, 1996 matures as follows:
Year ending: 1997 $ 413,851 1998 237,835 1999 179,087 2000 141,106 2001 141,106 ---------- $1,112,985 ==========
Interest expense related to long-term debt was $243,029, $114,264 and $89,042 for the fiscal years 1996, 1995 and 1994, respectively. F - 11 32 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (Continued) - -------------------------------------------------------------------------------- 6. RELATED PARTY BORROWINGS On January 20, 1993, the Company entered into a loan agreement with a related party whereby the Company could borrow up to $325,000, with interest of 8% per annum, due on December 31, 1993. The Company borrowed $200,000 against such agreement in January 1993 and $125,000 in March 1993. In connection with the Company's private placement in 1993 (Note 9), the $325,000 loan, plus accrued interest, was converted into 365,095 shares of the Company's common stock. The Company also entered into another loan agreement with a related party and borrowed $175,000 in March 1993 which was converted, plus accrued interest, into 194,998 shares of the Company's common stock in March 1993. On October 12, 1994, the Company entered into a loan agreement with related parties whereby the Company could borrow up to $2,000,000, with interest at 8% per annum, due on October 12, 1999. The Company borrowed $1,200,000 against such agreement in October 1994 and $800,000 in November 1994. Interest expense related to the agreement was $137,468 and $54,371 for the years ended February 29, 1996 and February 28, 1995, respectively. In November 1994, in conjunction with the loan agreement, the Company issued five-year warrants to purchase 1,000,000 shares of the Company's common stock at $2.00 per share. In October 1995, all the warrants were exercised and the Company issued 1,000,000 shares of common stock. In conjunction with the exercise of the warrants, the Company amended the terms of one of the loan agreements. Under the terms of the amended loan agreement, $1,800,000 of the principal amount accrues interest at 5% per annum with principal and interest due on October 12, 1999. In connection with the amended loan agreement, the Company issued four-year warrants to purchase 375,000 shares of the Company's common stock at a price to be determined on the occurrence of certain future events. Effective April 1, 1996, the warrant price was established at $7.00 per share. Under the terms of the warrant agreement, if at any time after April 1, 1996 the Company sells any common stock, other than pursuant to employee benefit plans or warrants outstanding as of April 1, 1996, at a price which is less than $7.00 per share, the exercise price of the warrants is subject to adjustment. At February 29, 1996, all the warrants were outstanding and exercisable. 7. DEFERRED REVENUE During fiscal 1995, the Company entered into an agreement to manufacture certain components to be delivered on various dates through 1995 for an aggregate purchase price of approximately $1,700,000. In connection with this agreement, as of February 28, 1995, the Company has been paid $875,000, of which $662,350 was included in the accompanying balance sheet as of February 28, 1995 as deferred revenue. The Company recognized the remaining revenue relating to this agreement when the related components were shipped during the year ended February 29, 1996. F - 12 33 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (Continued) - -------------------------------------------------------------------------------- 8. COMMITMENTS AND CONTINGENCIES The Company leases its office and manufacturing facility under an operating lease arrangement which expires on January 31, 2001. The facility lease requires additional payments for property taxes, insurance and maintenance costs. The following table summarizes the future minimum payments under the Company's operating leases at February 29, 1996: 1997 $ 131,479 1998 136,260 1999 141,041 2000 145,822 2001 145,822 Thereafter 8,963 --------- Total future minimum lease payments $ 709,387 =========
Rent expense relating to the operating lease was approximately $138,000, $174,000 and $148,000 for fiscal 1996, 1995 and 1994, respectively. The Company, in the normal course of business, is subject to various legal matters. However, management believes that none of these matters will have an adverse effect on the Company's financial statements. 9. STOCKHOLDERS' EQUITY In March 1993, the Company raised $2,840,352, net of offering costs, from the sale of 3.3 million shares of common stock at $1.00 per share. In connection with the offering, the Company also issued warrants to purchase 313,180 shares of the Company's common stock at $1.00 per share at any time up to five years from the date of the offering. The warrant holder also has the option to exercise such warrants at no cost and receive fewer shares based on a formula as defined in the warrant agreement. During fiscal years 1996, 1995 and 1994, 56,700, 4,000 and 252,480 warrants were exercised and the Company issued 56,700, 4,000 and 152,880 shares of common stock, respectively. Warrants outstanding and exercisable at February 28, 1995 and 1994 were 56,700 and 60,700, respectively. None of the warrants issued in connection with the March 1993 offering were outstanding at February 29, 1996. In February 1996, the Company raised $4,297,200, net of offering costs, from the sale of 900,000 shares of common stock at $5.00 per share to private investors. F - 13 34 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- In January 1995, the Company issued warrants to purchase 12,000 shares of the Company's common stock at $2.25 per share, as additional compensation for services rendered. Under the terms of the warrant agreement, the warrants become exercisable in four installments of 3,000 warrants each in six-month intervals commencing July 1, 1995, provided that the vendor's services are still being utilized by the Company. Each installment is exercisable for a period of 32 months. In March 1996, the Company issued additional warrants to purchase 15,000 shares of the Company's common stock at $7.00 per share to the same vendor as additional compensation for services rendered. Under the terms of the warrant agreement, the warrants become exercisable in four installments of 3,750 warrants each in one-year intervals commencing March 18, 1997 provided that the services are still being utilized by the Company. Each installment is exercisable until March 2001. 10. INCOME TAXES Effective March 1, 1993, the Company adopted Statement of Financing Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities to reflect the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequence of differences between financial reporting bases and tax bases of the Company's assets and liabilities results in a deferred tax asset, SFAS 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. No cumulative effect on the Company's financial statements was recorded as a result of adopting this new statement. The income tax (benefit) provision consists of the following:
1996 1995 1994 Current: Federal $ -- $(14,000) $ 11,000 State 800 (5,394) 10,800 Deferred (150,000) 300,000 (300,000) --------- -------- --------- Total $(149,200) $280,606 $(278,200) ========= ======== =========
F-14 35 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- The Company's net deferred income taxes consist of the following:
1996 1995 Deferred tax assets: Inventories $ 223,384 $ 428,433 Other reserves 45,484 41,108 State taxes 272 272 Net operating loss carryforwards, general business credit carryforwards and AMT credit carryforwards 1,762,054 1,883,980 ----------- ----------- Total gross deferred assets 2,031,194 2,353,793 Deferred tax liability - Depreciation and amortization (527,440) (203,185) ----------- ----------- 1,503,754 2,150,608 Valuation allowance (1,353,754) (2,150,608) ----------- ----------- Net deferred income taxes $ 150,000 $ -- =========== ===========
A reconciliation of the Company's effective tax rate compared to the statutory federal tax rate is as follows:
1996 1995 1994 Statutory rate 35% (35)% 35% State income taxes, net of federal benefit 1 Utilization of net operating loss carryforwards (32) Limitation on utilization of operating loss 34 Change in valuation allowance (45) 10 (41) Other 1 (1) --- --- --- (10)% 10% (38)% === === ===
As of February 29, 1996, the Company had net operating loss carryforwards of $4,466,000 for regular income tax and $4,557,000 for alternative minimum tax available to offset future federal taxable income (a portion of the net operating losses are subject to annual limitations of approximately $270,600), expiring at various dates through 2010. As of February 29, 1996, the Company had available tax credit carryforwards of approximately $164,000 to offset future federal income taxes, which expire at various dates through 2006. F-15 36 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- 11. EMPLOYEE STOCK OPTION PLAN At February 29, 1996, options to purchase 1,355,050 shares of the Company's common stock were outstanding under the Company's 1985 stock option plan, of which options to purchase 502,000 shares were exercisable. Options issued under this plan are granted at fair market value and generally vest at a rate of 25% per year and expire within ten years from the date of grant or upon 90 days after termination of employment. In January 1996, the Company's Board of Directors adopted the 1996 Stock Option Plan, which is subject to approval by the Company's stockholders at the annual meeting. Under the terms of the plan, options to purchase 2,000,000 shares of the Company's common stock will be available for issuance to employees, officers, directors and consultants. A summary of activity for the 1985 stock option plan is as follows:
NUMBER OF EXERCISE SHARES PRICE RANGE Outstanding at March 1, 1993 686,500 $0.24 - $1.56 Granted 718,000 1.88 - 3.03 Exercised (155,125) 0.24 - 1.44 Canceled (66,125) 0.28 - 3.03 --------- Outstanding at February 28, 1994 1,183,250 0.24 - 3.03 Granted 278,750 1.20 - 2.00 Exercised (40,250) 0.24 - 1.44 Canceled (299,750) 0.56 - 3.03 --------- Outstanding at February 28, 1995 1,122,000 0.24 - 2.88 Granted 431,000 1.72 - 5.69 Exercised (166,600) 0.24 - 2.88 Canceled (31,350) 1.44 - 2.34 --------- Outstanding at February 29, 1996 1,355,050 $0.24 - $5.69 =========
Recently Issued Accounting Standard - In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which requires adoption of the disclosure provisions for fiscal years beginning after December 15, 1995 and adoptions of the recognition and measurement provisions for non-employee transactions no later than December 15, 1995. The new standard defines a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. F-16 37 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- Pursuant to the new standard, companies are encouraged, but not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, but would be required to disclose in a note to the financial statements pro forma net income, and if presented, net income per share as if the company had applied the new method of accounting. The accounting requirements of the new method are effective for all employee awards granted after the beginning of the fiscal year of adoption. Adoption of the new standard will have no effect on the Company's cash flows. The Company has determined that it will not change to the fair value method and will continue to use Accounting Principles Board Opinion No. 25 for measurement and recognition of employee stock-based transactions. 12. CONCENTRATION OF CREDIT RISK AND GEOGRAPHIC INFORMATION For fiscal 1996, one customer accounted for approximately 10% of net sales. The Company had export sales (primarily to Western European customers) accounting for approximately 23%, 27% and 18% of net sales for fiscal 1996, 1995 and 1994, respectively. 13. BENEFIT AND COMPENSATION PLANS During fiscal 1991, the Company instituted a variable compensation plan. Under the plan, all employees with a base salary of $30,000 or greater receive reduced salary during each quarter that the Company's income before taxes represents less than 2% of beginning stockholders' equity. In each quarter in which income before taxes exceeds 2% of beginning stockholders' equity, the Company is required to pay additional salary up to a maximum of 100% of each employee's base salary. In accordance with the terms of the plan, the Company recorded additional salary in fiscal 1996 of $361,147. Amounts withheld or paid in fiscal 1995 and 1994 were immaterial. The Management Bonus Plan provides for a bonus of up to 50% of base salary based on three performance criteria. The bonus is an amount equal to the sum of (i) 2% of base salary for every $1.5 million of fiscal year bookings that exceeded the prior fiscal year bookings (maximum 15% of base salary), (ii) 2% of base salary for every $1.2 million of fiscal year shipments that exceeded the prior year fiscal year shipments (maximum 15% of base salary), and (iii) 2% of base salary for every $250,000 of fiscal year profits. The Company paid $206,236, $19,706 and $96,445 under this plan for fiscal 1996, 1995 and 1994, respectively. F-17 38 DENSE-PAC MICROSYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED FEBRUARY 29, 1996 (CONTINUED) - -------------------------------------------------------------------------------- The Company has a contributory 401(k) plan for all eligible employees. The Company matches up to 50% of an employee's contribution to the 401(k) plan, up to 4% of the employee's eligible salary, subject to certain limitations. The Company contributed $46,400, $34,600 and $23,400 to the 401(k) plan during fiscal 1996, 1995 and 1994, respectively. The Company has an employee profit-sharing plan in which all employees except officers participate. The amount of the profit sharing is determined by the Board of Directors on a quarterly basis. The Company paid $17,000 in profit sharing during fiscal 1994. No profit sharing was recorded in fiscal 1996 or 1995. F-18 39 EXHIBIT INDEX 3.1 Articles of Incorporation, as amended (1) 3.2 By-laws, as amended (1) 10.1 Letter dated December 4, 1990 from Kreidietbank regarding $1,270,000 loan (2) 10.2 Lease for Premises at 7321 Lincoln Way, Garden Grove, California, dated June 19, 1995. * 10.3 1996 Stock Option Plan * 10.4 1985 Stock Option Plan, as amended (3) * 10.5 Management Bonus Plan For Fiscal Year 1996 - See Note 13 of the Financial Statements * 10.6 Form of Indemnification Agreement with officers and directors (3) 10.7 Loan Agreement and Security Agreement dated October 12, 1994 between the Company and Euroventures Benelux II B.V. and Trude C. Taylor (4) 10.8 Form of Warrant Agreement dated November 14, 1994, between the Company and each of Euroventures Benelux II B.V. and Trude C. Taylor (5) 10.9 Warrant Agreement and Addendum to Loan Agreement effective as of October 23, 1995, between the Company and Euroventures Benelux II B.V. (6) * 10.10 Management Bonus Plan for fiscal year 1997 23.1 Independent Auditors' Consent 27.1 Financial Data Schedule - ----------------------- * Management contracts, compensation plans and arrangements. (1) Incorporated by reference to Registrant's Current Report on Form 8-K, Date of Event July 11, 1988. (2) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1990. (3) Incorporated by reference to Registrant's Annual Report on Form 10-KSB for the year ended February 28, 1994. (4) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1994. (5) Incorporated by reference to the Registrant's Registration Statement on Form S-3 (No. 33-87704) filed on December 22, 1994. (6) Incorporated by reference to Registrant's Form 8-K, Date of Event October 23, 1995. EX-10.2 2 LEASE AGREEMENT -- BASIC LEASE INFORMATION 1 EXHIBIT 10.2 LEASE AGREEMENT (Net) BASIC LEASE INFORMATION LEASE DATE: June 19, 1995 LESSOR: Principal Mutual Life Insurance Company LESSOR'S ADDRESS: P.O. Box 19693, 30 Executive Park, Suite 100 Irvine, California 92713-9693 LESSEE: Dense-Pac Microsystems, Inc., A California Corporation LESSEE'S ADDRESS: 7321 Lincoln Way Garden Grove, CA 92641 PREMISES: Approximately 21,346 square feet as shown on Exhibit A PREMISES ADDRESS: 7321 Lincoln Way Garden Grove, CA 92641 BUILDING: 37,060 square feet PARK: 122,626 square feet TERM: September 1, 1995 ("Commencement Date"), through January 31, 2001 ("Expiration Date") BASE RENT (PARAGRAPH 3): Ten Thousand Five Hundred Fifty-Eight and 13/100 Dollars ($10,558.13) per month ADJUSTMENTS TO BASE RENT: Months 1 - 4 $ 0.00 (Rent Waiver Period) Months 5 - 12 $10,558.13 per month Months 13 - 36 $11,354.97 per month Months 37 - 65 $12,151.81 per month
SECURITY DEPOSIT (PARAGRAPH 4.A): $14,360.00 CLEANING DEPOSIT (PARAGRAPH 4.B): None LESSEE'S SHARE OF OPERATING EXPENSES (PARAGRAPH 6.A): 57.60 % of the Building LESSEE'S SHARE OF TAX EXPENSES (PARAGRAPH 6.B): 57.60 % of the Building LESSEE'S SHARE OF COMMON AREA UTILITY COSTS (PARAGRAPH 7): 57.60 % of the Building
PERMITTED USES: General and administrative offices, warehouse and lab areas relating to the research and development, manufacture, assembly and shipment of Lessee's products. GENERAL LIABILITY INSURANCE Bodily injury limit of not less than AMOUNT (PARAGRAPH 12): $1,000,000 per occurrence; Property damage limit of not less than $1,000,000 per occurrence; Combined single limit of not less than $1,000,000. UNRESERVED PARKING SPACES: Eighty-Six (86) nonexclusive and undesignated spaces BROKER (PARAGRAPH 38): None. EXHIBITS: Exhibit A - Premises, Building, Lot and/or Park Exhibit B - Tenant Improvements Exhibit C - Rules and Regulations Exhibit D - CC&Rs Exhibit E - Sign Criteria Exhibit F - Hazardous Materials Disclosure Certificate Exhibit G - Change of Commencement Date -- Example only. ADDENDA: Addendum I: Option to Extend the Lease Term. Addendum II: Early Possession Agreement 1 2 LEASE AGREEMENT DATE: This Lease is made and entered into as of the Lease Date defined on Page 1. The Basic Lease information set forth on Page 1 and this Lease are and shall be construed as a single instrument. 1. PREMISES: Lessor hereby leases the Premises to Lessee upon the terms and conditions contained herein. Lessor hereby grants to Lessee a revocable license for the right to use, on a non-exclusive basis, parking areas and ancillary facilities located within the Common Area of the Park, subject to the terms of this Lease. 2. ADJUSTMENT OF COMMENCEMENT DATE; CONDITION OF THE PREMISES: If Lessor cannot deliver possession of the Premises on the Commencement Date, Lessor shall not be subject to any liability nor shall the validity of the Lease be affected; provided the Lease term and the obligation to pay Rent shall commence on the date possession is tendered and the termination date shall be extended by a period of time equal to the period computed from the Commencement Date to the date possession is tendered by Lessor to Lessee. In the event the commencement date of this Lease is other than the Commencement Date provided on Page 1, Lessor and Lessee shall execute a written amendment to this Lease, substantially in the form of Exhibit G hereto, wherein the parties shall specify the actual commencement date, termination date and the date on which Lessee is to commence paying Rent. In the event that Lessor permits Lessee to occupy the Premises prior to the Commencement Date, such occupancy shall be at Lessee's sole risk and subject to all the provisions of this Lease, including, but not limited to, the requirement to pay Rent and the Security Deposit, and to obtain the insurance required pursuant to this Lease and to deliver insurance certificates as required herein. In addition to the foregoing, Lessor shall have the right to impose such reasonable additional conditions on Lessee's early entry as Lessor shall deem appropriate. By taking possession of the Premises, Lessee shall be deemed to have accepted the Premises in a good, clean and (except for the Tenant Improvements and Repairs to Premises delineated in Exhibit "B" of this Lease) completed condition and state of repair and, so far as Lessee knows as of the date of this Lease, in compliance with all applicable laws, codes, regulations, administrative orders and ordinances, and subject to all matters of record. Lessee hereby acknowledges and agrees that neither Lessor nor Lessor's agents or representatives has made any representations or warranties as to the suitability, safety or fitness of the Premises for the conduct of Lessee's business, Lessee's intended use of the Premises or for any other purpose, and that neither Lessor nor Lessor's agents or representatives has agreed to undertake any alterations or construct any Tenant Improvements to the Premises except as expressly provided in this Lease and the Exhibits to the Lease. 3. RENT: On the date that Lessee executes this Lease, Lessee shall deliver to Lessor the original executed Lease, the Base Rent (which shall be applied against the Rent payable for the first month Lessee is required to pay Base Rent), the Security Deposit, the Cleaning Deposit, and all insurance certificates evidencing the insurance required to be obtained by Lessee under Paragraph 12 of this Lease. Lessee agrees to pay Lessor, without prior notice or demand, or abatement, offset, deduction or claim, the Base Rent described on Page 1, payable in advance at Lessor's address shown on Page 1 on the first day of each month throughout the term of the Lease. In addition to the Base Rent set forth on Page 1, Lessee shall pay Lessor in advance and on the first (1st) day of each month throughout the term of this Lease (including any extensions of such term), as additional rent Lessee's share, as set forth on Page 1, of Operating Expenses, Tax Expenses, Common Area Utility Costs, administrative expenses and Utility Expenses, as specified in Paragraphs 6.A., 6.B., 6.C. and 7 of this Lease, respectively. Additionally, Lessee shall pay to Lessor as additional rent hereunder, immediately on Lessor's demand therefor, any and all costs and expenses incurred by Lessor to enforce the provisions of this Lease, including, but not limited to, costs associated with any proposed assignment or subletting of all or any portion of the Premises by Lessee, costs associated with the delivery of notices, delivery and recordation of notice(s) of default, attorneys' fees, expert fees, court costs and filing fees (collectively, the "Enforcement Expenses"). The term "Rent" whenever used herein refers to the aggregate of all these amounts. If Lessor permits Lessee to occupy the Premises without requiring Lessee to pay rental payments for a period of time, the waiver of the requirement to pay rental payments shall only apply to waiver of the Base Rent and Lessee shall otherwise perform all other obligations of Lessee hereunder, including, but not limited to paying to Lessor any and all amounts considered additional rent, such as Lessee's share of Operating Expenses, Tax Expenses, Common Area Utility Costs, Utility Expenses, and administrative expenses. If, at any time, Lessee is in default of or otherwise breaches any term, condition or provision of this Lease, any such waiver by Lessor of Lessee's requirement to pay rental payments shall be null and void and Lessee shall immediately pay to Lessor all rental payments waived by Lessor. The Rent for any fractional part of a calendar month at the commencement or termination of the Lease term shall be a prorated amount of the 2 3 Rent for a full calendar month based upon a thirty (30) day month. The prorated Rent shall be paid on the Commencement Date and the first day of the calendar month in which the date of termination occurs, as the case may be. 4. SECURITY DEPOSIT AND CLEANING DEPOSIT: A. SECURITY DEPOSIT: Upon Lessee's execution of this Lease, Lessee shall deliver to Lessor, as a Security Deposit for the performance by Lessee of its obligations under this Lease, the amount described on Page 1. If Lessee is in default, Lessor may, but without obligation to do so, use the Security Deposit, or any portion thereof, to cure the default or to compensate Lessor for all damages sustained by Lessor resulting from Lessee's default, including, but not limited to the Enforcement Expenses. Lessee shall, immediately on demand, pay to Lessor a sum equal to the portion of the Security Deposit so applied or used so as to replenish the amount of the Security Deposit held up to the amount initially deposited with Lessor. Concurrently with any increase in the Base Rent, Lessee shall deliver to Lessor an amount equal to such increase, which amount shall be added to the Security Deposit being held by Lessor and be deemed a part of such Security Deposit thereafter. At anytime after Lessee has defaulted hereunder, Lessor may require an increase in the amount of the Security Deposit required hereunder for the then balance of the Lease term and Lessee shall, immediately on demand, pay to Lessor additional sums in the amount of such increase. As soon as practicable after the termination of this Lease, Lessor shall return the Security Deposit to Lessee, less such amounts as are reasonably necessary, as determined solely by Lessor, to remedy Lessee's default(s) hereunder or to otherwise restore the Premises to a clean and safe condition, reasonable wear and tear excepted. If the cost to restore the Premises exceeds the amount of the Security Deposit, Lessee shall promptly deliver to Lessor any and all of such excess sums as determined solely by Lessor. Lessor shall not be required to keep the Security Deposit separate from other funds, and, unless otherwise required by law, Lessee shall not be entitled to interest on the Security Deposit. In no event or circumstance shall Lessee have the right to any use of the Security Deposit and, specifically, Lessee may not use the Security Deposit as a credit or to otherwise offset any payments required hereunder, including, but not limited to, Rent or any portion thereof. B. [INTENTIONALLY OMITTED] 5. CONDITION OF PREMISES: Lessee hereby accepts the Premises in its current "as is" condition unless otherwise specified in Exhibit B, attached hereto and incorporated herein by this reference. If so specified in Exhibit B hereto, Lessor or Lessee, as the case may be, shall install the improvements ("Tenant Improvements") on the Premises as described and in accordance with the terms, conditions, criteria and provisions set forth in Exhibit B, attached and incorporated herein by this reference. Lessee acknowledges that neither Lessor nor any of Lessor's agents, representatives or employees has made any representations as to the suitability or fitness of the Premises for the conduct of Lessee's business or for any other purpose, and that neither Lessor nor any of Lessor's agents, representatives or employees has agreed to undertake any alterations or construct any Tenant Improvements to the Premises except as expressly provided in this Lease and in Exhibit B to this Lease. 3 4 6. EXPENSES: A. OPERATING EXPENSES: In addition to the Base Rent set forth in Paragraph 3, Lessee shall pay its share, which is defined on Page 1, of all Operating Expenses as additional rent. The term "Operating Expenses" as used herein shall mean the total amounts paid or payable by Lessor in connection with the ownership, maintenance, repair and operation of the Premises, the Building and the Lot, and where applicable, of the Park referred to on Page 1. For those Operating Expenses covered by subparagraphs 6.A. (i), (iv) and (viii) that are deemed by Lessor, pursuant to generally accepted accounting principles, to be capital costs, the Operating Expenses for a given year shall be equal to Lessee's share of the yearly pro rata cost of that expenditure, based upon its useful life. (By way of example, if the useful life of a capital item is five years, the Operating Expenses for a given year will be Lessee's share of 20% of the cost.) Removal or other abatement of asbestos or asbestos-containing materials from the Premises, Building, Park or Common Area shall also not be considered an Operating Expense, provided, however, that if the asbestos or asbestos-containing materials are (or were) installed by or on behalf of Lessee, Lessee may have independent obligations regarding them in Paragraphs 10 and 29. The amount of Lessee's share of Operating Expenses shall be reviewed from time to time by Lessor and shall be subject to modification by Lessor as reasonably determined by Lessor. These Operating Expenses may include, but are not limited to: (i) Lessor's cost of non-structural repairs to and maintenance of the roof and exterior walls of the Building. Notwithstanding the foregoing sentence, in no event shall the cost of a complete or substantially complete roof replacement be deemed an Operating Expense; (ii) Lessor's cost of maintaining the outside paved area, landscaping and other common areas for the Park. The term "Common Area" shall mean all areas and facilities within the Park exclusive of the Premises and the other portions of the Park leased exclusively to other tenants. The Common Area includes, but is not limited to, interior lobbies, mezzanines, parking areas, access and perimeter roads, sidewalks, landscaped areas and similar areas and facilities; (iii) Lessor's annual cost of insurance insuring against fire and extended coverage (including, if Lessor elects, "all risk" coverage) and all other insurance, including, but not limited to, earthquake, flood and/or surface water endorsements for the Building, the Lot and the Park (including the Common Area), and rental value insurance against loss of Rent in an amount equal to the amount of Rent for a period of at least six (6) months commencing on the date of loss; (iv) Lessor's cost of modifications to the Building, the Common Area and/or the Park occasioned by any rules, laws or regulations effective subsequent to the commencement of the Lease; (v) Lessor's cost of modifications to the Building, the Common Area and/or the Park occasioned by any rules, laws or regulations arising from Lessee's use of the Premises regardless of when such rules, laws or regulations became effective; (vi) If Lessor elects to so procure, Lessor's cost of preventative maintenance, repair and replacement contracts including, but not limited to, contracts for elevator systems and heating, ventilation and air conditioning systems, and trash or refuse collection; (vii) Lessor's cost of security and fire protection services for the Park, if in Lessor's sole discretion such services are provided; (viii) Lessor's establishment of reasonable reserves for replacements and/or repairs of Common Area improvements, equipment and supplies; (ix) Intentionally omitted (x) Lessor's cost of supplies, equipment, rental equipment and other similar items used in the operation and/or maintenance of the Park. B. TAX EXPENSES: In addition to the Base Rent set forth in Paragraph 3, Lessee shall pay its share, which is defined on Page 1, of all real property taxes applicable to the land and improvements included within the Lot on which the Premises are situated and one hundred percent (100%) of all personal property taxes now or hereafter assessed or levied against the Premises or Lessee's personal property maintained on the Premises. The amount of Lessee's share of Tax Expenses shall be reviewed from time to time by Lessor and shall be subject to modification by Lessor as reasonably determined by Lessor. Lessee shall also pay any increase in real property taxes attributable, in Lessor's sole discretion, to any and all alterations, Tenant Improvements or other improvements of any kind whatsoever placed in, on or about the Premises for the benefit of, at the request of, or by Lessee. The term "Tax Expenses" includes, but is not limited to, any form of tax and assessment (general, special, ordinary or extraordinary), 4 5 ordinary or extraordinary), commercial rental tax, payments under any improvement bond or bonds, license, rental tax, transaction tax, levy, or penalty imposed by authority having the direct or indirect power of tax (including any city, county, state or federal government, or any school, agricultural, lighting, drainage or other improvement district thereof) as against any legal or equitable interest of Lessor in the Premises, Lot or Park, as against Lessor's right to rent or other income therefrom, or as against Lessor's business of leasing the Premises or the occupancy of Lessee or any other tax, fee, or excise, however described (excluding inheritance or estate taxes), including any value added tax, or any tax imposed in substitution, partially or totally, of any tax previously included within the definition of real property taxes, or any additional tax the nature of which was previously included within the definition of real property tax. C. PAYMENT OF EXPENSES AND ADMINISTRATIVE EXPENSES: Lessor shall reasonably estimate Lessee's share of the Operating Expenses and Tax Expenses for the calendar year in which the Lease commences. Commencing on the Commencement Date, one-twelfth (1/12th) of this estimated amount shall be paid by Lessee to Lessor, as additional rent, on the first (1st) day of each month and throughout the remaining months of such calendar year. Thereafter, Lessor may estimate such expenses as of the beginning of each calendar year and Lessee shall pay one-twelfth (1/12th) of such estimated amount as additional rent hereunder on the first day of each month during such calendar year and for each ensuing calendar year throughout the term of this Lease (including any extensions of the term). Not later than March 31 of each of the following calendar years, or as soon thereafter as reasonably possible, including the calendar year after the calendar year in which this Lease terminates or the term expires, Lessor shall furnish Lessee with a true and correct accounting of actual Operating Expenses and Tax Expenses upon Lessee's request. Within thirty (30) days of Lessor's delivery of such accounting, Lessee shall pay to Lessor the amount of any underpayment. Lessor shall credit the amount of any overpayment by Lessee toward the next estimated monthly installment(s) falling due, or where the term of the Lease has expired, refund the amount of overpayment to Lessee within thirty (30) days of Lessor's delivery of accounting. Lessee, at its sole cost and expense through any certified public accountant designated by it, shall have the right to examine and/or audit the books and records evidencing such costs and expenses for the previous one (1) calendar year, during Lessor's reasonable business hours and not more frequently than once during any calendar year. Lessee's obligations to pay its share of Operating Expenses and Tax Expenses shall survive the expiration or earlier termination of this Lease. If the term of the Lease expires prior to the annual reconciliation of expenses, Lessor shall have the right to reasonably estimate Lessee's share of such expenses, and if Lessor determines that an underpayment is due, Lessee hereby agrees that Lessor shall be entitled to deduct such underpayment from Lessee's Security Deposit, which shall be deemed payment to the extent of said deductions. If Lessor reasonably determines that an overpayment has been made by Lessee, Lessor shall refund said overpayment together with the return of Lessee's Security Deposit. Notwithstanding the foregoing, failure of Lessor to accurately estimate Lessee's share of such expenses shall not constitute a waiver of Lessor's right to collect any of Lessee's underpayment at anytime. Notwithstanding anything contained in this Paragraph 6.C to the contrary, to the extent that Lessor fails to bring suit against Lessee within the time limits codified in Code of Civil Procedure Section 337, et seq. for payment of Operating Expenses or Tax Expenses, nothing in the Paragraph 6.C shall be deemed a waiver on the part of Lessee of any defense based upon an applicable statute of limitations. In addition to the Base Rent set forth in Paragraph 3 hereof, Lessee shall pay Lessor, without prior notice or demand, on the first (1st) day of each month throughout the term of this Lease (including any extensions of such term), as compensation to Lessor for accounting and management services rendered on behalf of the Park, an amount equal to ten percent (10%) of the aggregate of Lessee's share of (i) the total Operating Expenses and Tax Expenses as described in Paragraphs 6.A. and 6.B. above, respectively, and (ii) all Common Area Utility Costs for the Park as described in Paragraph 7. Lessee's obligations to pay its share of such administrative expenses shall survive the expiration or earlier termination of this Lease. 7. UTILITIES: Lessee shall pay the cost of all water, sewer use and connection fees, gas, heat, electricity, refuse pickup, janitorial service, telephone and other utilities billed or metered separately to the Premises and/or Lessee. Lessee shall also pay its share of any assessments or charges for utility or similar purposes included within any tax bill for the Lot on which the Premises are situated. For any such utility fees or use charges that are not billed or metered separately to Lessee, Lessee shall pay to Lessor, as additional rent, without prior notice or demand, on the first (1st) day of each month throughout the term of this Lease the amount which is attributable to Lessee's use of the Premises as reasonably estimated and determined by Lessor based upon factors such as size of the Premises and intensity of use of such utilities by Lessee such that Lessee shall pay the portion of such charges reasonably consistent with Lessee's use of such utilities ("Utility Expenses"). Subject to Paragraph 10 of this Lease, Lessee may, at any time and at Lessee's sole option and discretion, cause any of the utilities at the Premises, not currently separately 5 6 metered, to be separately metered at Lessee's sole cost and expenses; if Lessee elects to do so, Lessor will not include any utility charges for the utility (ies) Lessee elects to have separately metered in the Utility Expenses assessed against Lessee. If Lessee disputes any such estimate or determination, then Lessee shall either pay the estimated amount or cause the Premises to be separately metered at Lessee's sole expense. In addition, Lessee shall pay Lessor its share, which is described on Page 1, as additional rent, of any Common Area utility costs, fees, charges or expenses ("Common Area Utility Costs") within fifteen (15) days after receiving a bill from Lessor. The amount of Lessee's share of Common Area Utility Costs shall be reviewed from time to time by Lessor and shall be subject to modification by Lessor as reasonably determined by Lessor. Lessee acknowledges that the Premises may become subject to the rationing of utility services or restrictions on utility use as required by a public utility company, governmental agency or other similar entity having jurisdiction thereof. Notwithstanding any such rationing or restrictions on use of any such utility services, Lessee acknowledges and agrees that its tenancy and occupancy hereunder shall be subject to such rationing restrictions as may be imposed upon Lessor, Lessee, the Premises, the Building or the Park, and Lessee shall in no event be excused or relieved from any covenant or obligation to be kept or performed by Lessee by reason of any such rationing or restrictions. Lessee further agrees to pay and discharge, prior to delinquency, any amount, tax, charge, surcharge, assessment or imposition levied, assessed or imposed upon the Premises, or Lessee's use and occupancy thereof, or as a result directly or indirectly of any such rationing or restrictions. 8. LATE CHARGES: Lessee acknowledges that late payment (the tenth day of each month or anytime thereafter) by Lessee to Lessor of Base Rent, Lessee's share of Operating Expenses, Tax Expenses, Common Area Utility Costs, Utility Expenses or other sums due hereunder, will cause Lessor to incur costs not contemplated by this Lease, the exact amount of such costs being extremely difficult and impracticable to fix. Such costs include, without limitation, processing and accounting charges, and late charges that may be imposed on Lessor by the terms of any note secured by any encumbrance against the Premises, and late charges and penalties due to the late payment of real property taxes on the Premises. Therefore, if any installment of Rent or any other sum due from Lessee is not received by Lessor when due, Lessee shall promptly pay to Lessor all of the following, as applicable: (a) an additional sum equal to ten percent (10%) of such delinquent amount for the time period such payments are delinquent as a late charge for every month or portion thereof that such sums remain unpaid, (b) the amount of fifty dollars ($50) relating to checks for which there are not sufficient funds. The parties agree that this late charge and the other charges referenced above represent a fair and reasonable estimate of the costs that Lessor will incur by reason of late payment by Lessee. Acceptance of any late charge or other charges shall not constitute a waiver by Lessor of Lessee's default with respect to the delinquent amount, nor prevent Lessor from exercising any of the other rights and remedies available to Lessor for any other breach of Lessee under this Lease. If a late charge or other charge becomes payable for any three (3) installments of Rent within any twelve (12) month period, then Lessor, at Lessor's sole option, can require the rent to be paid monthly in advance by cashier's check or by electronic funds transfer. 9. USE OF PREMISES: The Premises are to be used solely for the uses stated generally on Page 1 and for no other uses or purposes without Lessor's prior written consent which consent Lessor will not unreasonably withhold. The use of the Premises by Lessee and its agents, invitees and employees shall be subject to, and at all times in compliance with, (a) any and all applicable laws, ordinances, statutes, orders and regulations as same exist from time to time (collectively, the "Laws"), and (b) any and all declarations of covenants, conditions and restrictions ("CC&Rs") and any supplement thereto which has been or hereafter is recorded in any official or public records with respect to the Premises, the Building, the Lot and/or the Park, or any portion thereof. Lessee shall not use the Premises or permit anything to be done in or about the Premises nor keep or bring anything therein which will in any way conflict with any of the requirements of the Board of Fire Underwriters or similar body now or hereafter constituted or in any way increase the existing rate of or affect any policy of fire or other insurance upon the Building or any of its contents, or cause a cancellation of any insurance policy. Lessee shall not do or permit anything to be done in or about the Premises which will in any way obstruct or interfere with the rights of Lessor, other tenants or occupants of the Building, other buildings in the Park, or other persons or businesses in the Park, or injure or annoy other tenants or use or allow the Premises to be used for any improper, immoral, unlawful or objectionable purpose, as determined by Lessor, in its sole discretion, for the benefit, quiet enjoyment and use by Lessor and all other tenants or occupants of the Building or other buildings in the Park; nor shall Lessee cause, maintain or permit any private or public nuisance in, on or about the Premises, Building, Park and/or the Common Area, including, but not limited to, any offensive odors, fumes or vibrations. Lessee shall not damage or deface or otherwise commit or suffer to be committed any waste in, upon or about the Premises. Lessee shall not store, nor permit any other person or entity to store, any property, equipment, materials, supplies, personal property or any other items or goods outside of the Premises. Lessee shall not permit any animals, including, but not limited to, any household pets, to be brought or kept in or about the Premises. 6 7 Lessee shall place no loads upon the floors, walls, or ceilings in excess of the maximum designed load permitted by the applicable Uniform Building Code or which may damage the Building or outside Park; nor place any harmful liquids in the drainage systems; nor dump or store waste materials, refuse or other such materials, or allow such to remain outside the Building area, except in refuse dumpsters or in any enclosed trash areas provided. Lessee shall honor the terms of all recorded CC&Rs relating to the Premises, the Building, the Lot and/or the Park. Lessee shall honor the rules and regulations set forth in Exhibit C, attached to and made a part of this Lease, and any other reasonable rules and regulations of Lessor now or hereafter enacted relating to parking and the operation of the Building and the Park. 10. ALTERATIONS AND ADDITIONS: Subject to Paragraph 37, Lessee shall not install any signs, fixtures, improvements, nor make or permit any other alterations or additions to the Premises without the prior written consent of Lessor, which consent Lessor will not unreasonably withhold, provided that Lessor's prior written consent shall not be required for alterations and additions that are less than $1,000 per event, up to an aggregate of $10,000 throughout the Term of the Lease, inclusive of the Option to Extend. For any such alteration or addition, expressly permitted by Lessor or otherwise permitted by this Paragraph 10, Lessee shall deliver at least twenty (20) days prior notice to Lessor, from the date Lessee intends to commence construction, sufficient to enable Lessor to post a Notice of Non-Responsibility. In all events, Lessee shall obtain all permits or other governmental approvals prior to commencing any of such work and deliver a copy of same to Lessor. All alterations and additions shall be installed by a licensed contractor approved by Lessor, which approval Lessor will not unreasonably withhold, at Lessee's sole expense in compliance with all applicable Laws, CC&Rs, and Lessor's rules and regulations. Lessee shall be responsible, at its sole cost and expense, for removal or other abatement of asbestos or asbestos- containing materials installed by or on behalf of Lessee, where such removal or abatement is either required by law or otherwise prudent in the course of Lessee's performance of any alterations and additions pursuant to this Paragraph 10. This provision relating to asbestos and asbestos-containing materials shall in no way be deemed in lieu of any requirements of Lessee pursuant to Paragraph 29. Lessee shall keep the Premises and the property on which the Premises are situated free from any liens arising out of any work performed, materials furnished or obligations incurred by or on behalf of Lessee. As a condition to Lessor's consent to the installation of any fixtures or improvements, Lessor may require Lessee to post and obtain a completion and indemnity bond for up to one hundred twenty-five percent (125%) of the cost of the work. Upon termination of this Lease, Lessee shall remove all signs, fixtures, furniture and furnishings and if requested by Lessor, remove any improvements made by Lessee and repair any damage caused by the installation or removal of such signs, fixtures, furniture, furnishings and improvements and leave the Premises in as good condition as they were in at the time of the commencement of this Lease, excepting for reasonable wear and tear. Reasonable wear and tear shall not include any damage or deterioration that would have been prevented by proper maintenance by Lessee or Lessee otherwise performing all of its obligations under this Lease. 11. REPAIRS AND MAINTENANCE: Lessee shall, at Lessee's sole cost and expense, keep and maintain the non-structural portion of the Premises described in this Paragraph below and the adjacent Park in good, clean and safe condition and repair to the reasonable satisfaction of Lessor including, but not limited to, repairing any damage caused by Lessee or its employees, representatives, agents, invitees, licensees or contractors. Without limiting the generality of the foregoing, Lessee shall be solely responsible for maintaining, repairing and replacing all interior plumbing and mechanical systems, heating, ventilation and air conditioning systems, interior electrical wiring and equipment, interior lighting, all interior glass, interior window casements, partitions, tenant signage, interior doors and door closers, fixtures, equipment, interior painting, and interior walls and floors of the Premises. Lessee's obligation to keep, maintain, preserve and repair the Premises and the adjacent Park shall specifically extend to the cleanup and removal of any and all Hazardous Materials (hereafter defined) occurring in, on or about the Premises, pursuant to Paragraph 29. Subject to the provisions of Paragraphs 6 and 9 of this Lease and except for repairs rendered necessary by the active or passive negligent acts or omissions of Lessee, its agents, customers, employees and invitees, Lessor agrees, at Lessor's expense, subject to reimbursement pursuant to Paragraph 6 above, to keep in good repair the plumbing and mechanical systems exterior to the Premises, roof membranes, signage (exclusive of tenant signage), exterior electrical wiring and equipment, exterior lighting, all exterior glass, exterior doors and entrances, exterior window casements, exterior doors and door closers, exterior painting, and underground utility and sewer pipes outside the exterior walls of the Building. Lessor reserves the right, but without the obligation, to procure and maintain the heating, ventilation and air conditioning systems maintenance contract and if Lessor so elects, Lessee will reimburse Lessor for the cost thereof in accordance with the provisions of Paragraph 6 above. Except for repairs rendered necessary by the active or passive negligent acts or omissions of Lessee, its agents, customers, employees and invitees, Lessor agrees, at Lessor's sole cost and expense, 7 8 to keep in good repair the structural portions of the floors, foundations and exterior walls (exclusive of glass and exterior doors), and the structural portions of the roof (excluding the roof membrane) of the Building. Except for normal maintenance and repair of the items outlined above, Lessee shall have no right of access to or right to install any device on the roof of the Building nor make any penetrations of the roof of the Building without the express prior written consent of Lessor which consent Lessor will not unreasonably withhold. If Lessee refuses or neglects to repair and maintain the Premises and the adjacent Park properly as required herein and to the reasonable satisfaction of Lessor, Lessor may, but without obligation to do so, at anytime make such repairs and/or maintenance without Lessor having any liability to Lessee for any loss or damage that may accrue to Lessee's merchandise, fixtures or other property, or to Lessee's business by reason thereof. In the event Lessor makes such repairs and/or maintenance, upon completion thereof Lessee shall pay to Lessor, as additional rent, the Lessor's costs for making such repairs and/or maintenance, plus ten percent (10%) for overhead, upon presentation of a bill therefor, plus any Enforcement Expenses. The obligations of Lessee hereunder shall survive the expiration of the term of this Lease or the earlier termination thereof. Lessee hereby waives any right to repair at the expense of Lessor under any applicable Laws now or hereafter in effect respecting the Premises. 12. INSURANCE: Lessee shall maintain in full force and effect at all times during the term of this Lease, at Lessee's sole cost and expense, for the protection of Lessee and Lessor, as their interests may appear, policies of insurance issued by a carrier or carriers acceptable to Lessor and its lender(s) which afford the following coverages: (i) worker's compensation: statutory limits; (ii) employer's liability: as required by law with a minimum of $1,000,000; (iii) comprehensive general liability insurance (occurrence form) including blanket contractual liability, broad form property damage, premises, personal injury, completed operations, products liability, personal and advertising coverage, and fire damage with a combined single limit of not less than (the amount set forth on Page 1) per occurrence, and (the amount set forth on Page 1) per occurrence per location if Lessee has multiple locations, with deletion of (a) the exclusion for operations within fifty (50) feet of a railroad track (railroad protective liability), if applicable, and (b) the exclusion for explosion, collapse or underground hazard, if applicable, and if necessary, Lessee shall provide for restoration of the aggregate limit; (iv) comprehensive automobile liability insurance: a combined single limit of not less than $1,000,000 per occurrence and insuring Lessee against liability for claims arising out of the ownership, maintenance, or use of any owned, hired or non-owned automobiles; and (v) "all risk" property insurance including boiler and machinery comprehensive form, if applicable, covering damage to or loss of any personal property, fixtures and equipment, including, without limitation, electronic data processing equipment, of Lessee (and coverage for the full replacement cost thereof including business interruption of Lessee), together with, if the property of Lessee's invitees is to be kept in the Premises, warehouser's legal liability or bailee customers insurance for the full replacement cost of the property belonging to invitees and located in the Premises. Insurance required to be maintained by Lessee shall be written by companies licensed to do business in the State of California and having a "General Policyholders Rating" of at least A (or such higher rating as may be required by a lender having a lien on the Premises) as set forth in the most current issue of "Best's Insurance Guide." Lessee shall deliver to Lessor certificates of insurance for all insurance required to be maintained by Lessee hereunder at the time of execution of this Lease by Lessee. Lessee shall, at least thirty (30) days prior to expiration of each policy, furnish Lessor with certificates of renewal or "binders" thereof. Each certificate shall expressly provide that such policies shall not be cancelable or otherwise subject to modification except after thirty (30) days prior written notice to the parties named as additional insureds as required in this Lease (except for cancellation for nonpayment of premium, in which event cancellation shall not take effect until at least ten (10) days' notice has been given to Lessor). If Lessee fails to maintain any insurance required in this Lease, Lessee shall be liable for all losses and costs resulting from such failure. Lessor, any property management company of Lessor for the Premises, any lender(s) of Lessor having a lien against the Premises, the Building, the Lot or the Park, and any joint venture partners of Lessor shall be named as additional insureds under all of the policies required in Paragraph 12.(iii) above. Additionally, such policies shall provide for severability of interest. All insurance to be maintained by Lessee shall, except for workers' compensation and employer's liability insurance, be primary, without right of contribution from insurance maintained by Lessor. Any umbrella liability policy or excess liability policy (which shall be in "following form") shall provide that if the underlying aggregate is exhausted, the excess coverage will drop down as primary insurance. The limits of insurance maintained by Lessee shall not limit Lessee's liability under this Lease. 13. LIMITATION OF LIABILITY AND INDEMNITY: Except for damage (or any portion of any damage) resulting from or contributed by the sole active gross negligence or willful misconduct of Lessor or its 8 9 employees or authorized representatives, Lessee agrees to protect, defend (with counsel acceptable to Lessor) and hold Lessor and Lessor's lender(s), partners, employees, representatives, legal representatives, successors and assigns (collectively, the "Indemnitees") harmless and indemnify the Indemnitees from and against any portion of any liabilities, damages, claims, losses, judgments, charges and expenses (including reasonable attorneys' fees, costs of court and expenses necessary in the prosecution or defense of any litigation including the enforcement of this provision) arising from or in any way related to, directly or indirectly, Lessee's use of the Premises and/or the Park, or the conduct of Lessee's business, or from any activity, work or thing done, permitted or suffered by Lessee in or about the Premises, or in any way connected with the Premises or with the improvements or personal property therein, including, but not limited to, any liability for injury to person or property of Lessee, its agents or employees or third party persons. Lessee agrees that the obligations of Lessee herein shall survive the expiration or earlier termination of this Lease. Except for damage (or any portion of any damage) resulting from or contributed by the sole active gross negligence or willful misconduct of Lessor or its employees or representatives, Lessor shall not be liable to Lessee for any portion of any loss or damage to Lessee or Lessee's property, for any injury to or loss of Lessee's business or for any damage or injury to any person from any cause whatsoever, including, but not limited to, any acts, errors or omissions by or on behalf of any other tenants or occupants of the Building and/or the Park. Lessee shall not, in any event or circumstance, be permitted to offset or otherwise credit against any payments of Rent required herein for matters for which Lessor may be liable hereunder. Lessor and its authorized representatives shall not be liable for any interference with light or air, or for any latent defect in the Premises or the Building. 14. ASSIGNMENT AND SUBLEASING: A. PROHIBITION: Lessee shall not assign, mortgage, hypothecate, encumber, grant any license or concession, pledge or otherwise transfer this Lease (collectively, "assignment"), in whole or in part, whether voluntarily or involuntarily or by operation of law, nor sublet or permit occupancy by any person other than Lessee of all or any portion of the Premises without first obtaining the prior written consent of Lessor, which shall not be unreasonably withheld. If Lessee seeks to sublet or assign all or any portion of the Premises, Lessee shall deliver to Lessor at least thirty (30) days prior to the proposed commencement of the sublease or assignment (the "Proposed Effective Date") the following: (i) the name of the proposed assignee or sublessee; (ii) such information as to such assignee's or sublessee's financial responsibility and standing as Lessor may reasonably require; and (iii) a copy of the proposed sublease or assignment agreement and all agreements collateral thereto, which instrument shall include a provision whereby the assignee or sublessee assumes all of Lessee's obligations hereunder and agrees to be bound by the terms hereof. As additional rent hereunder, Lessee shall pay to Lessor a fee in in an amount not to exceed One Thousand Five Hundred Dollars ($1,500) plus Lessee shall reimburse Lessor for actual legal and other expenses incurred by Lessor in connection with any request by Lessee for Lessor's consent to assignment or subletting. In the event the sublease (1) by itself or taken together with prior sublease(s) covers or totals, as the case may be, more than twenty-five percent (25%) of the rentable square feet of the Premises or (2) is for a term which by itself or taken together with prior or other subleases is greater than fifty percent (50%) of the period remaining in the term of this Lease as of the time of the Proposed Effective Date, then Lessor shall have the right, to be exercised by giving written notice to Lessee, to recapture the space described in the sublease. If such recapture notice is given, it shall serve to terminate this Lease with respect to the proposed sublease space, or, if the proposed sublease space covers all the Premises, it shall serve to terminate the entire term of this Lease, in either case as of the Proposed Effective Date. However, no termination of this Lease with respect to part or all of the Premises shall become effective without the prior written consent, where necessary, of the holder of each deed of trust encumbering the Premises or any part thereof. If this Lease is terminated pursuant to the foregoing with respect to less than the entire Premises, the Rent shall be adjusted on the basis of the proportion of square feet retained by Lessee to the square feet originally demised and this Lease as so amended shall continue thereafter in full force and effect. Each permitted assignee or sublessee shall assume and be deemed to assume this Lease and shall be and remain liable jointly and severally with Lessee for payment of Rent and for the due performance of, and compliance with all the terms, covenants, conditions and agreements herein contained on Lessee's part to be performed or complied with, for the term of this Lease. No assignment or subletting shall affect the continuing primary liability of Lessee (which, following assignment, shall be joint and several with the assignee), and Lessee shall not be released from performing any of the terms, covenants and conditions of this Lease. For purposes hereof, in the event Lessee is a corporation, partnership, joint venture, trust or other entity other than a natural person, any change in the direct or indirect ownership of Lessee (whether pursuant to one or more transfers) which results in a change of more than fifty percent (50%) in the direct or indirect ownership of Lessee shall be deemed to be an assignment within the meaning of this Paragraph 14 and shall be subject to all the provisions hereof. Any and all options, first rights of refusal, tenant improvement allowances and other similar rights granted to Lessee in this Lease, if any, shall not be assignable by Lessee unless expressly authorized in writing by Lessor. 9 10 B. EXCESS SUBLEASE RENTAL OR ASSIGNMENT CONSIDERATION: In the event of any sublease or assignment of all or any portion of the Premises where the rent or other consideration provided for in the sublease or assignment either initially or over the term of the sublease or assignment exceeds the Rent or pro rata portion of the Rent, as the case may be, for such space reserved in the Lease, Lessee shall pay the Lessor monthly, as additional rent, at the same time as the monthly installments of Rent are payable hereunder, fifty percent (50%) of the excess of each such payment of rent or other consideration in excess of the Rent called for hereunder. C. WAIVER: Notwithstanding, and in the event of, any assignment or sublease of the entire Premises, or any indulgences, waivers or extensions of time granted by Lessor to any assignee or sublessee, or failure by Lessor to take action against any assignee or sublessee, Lessee waives notice of any default of any assignee or sublessee and agrees that Lessor may, at its option, proceed against Lessee without having taken action against or joined such assignee or sublessee, except that Lessee shall have the benefit of any indulgences, waivers and extensions of time granted to any such assignee or sublessee. 15. WAIVER OF SUBROGATION: Lessee and/or Lessor waive any right to recover against the other party for claims for damages to Lessee's or Lessor's property, including, but not limited to, personal property, fixtures and equipment, covered by insurance. This provision is intended to waive fully, and for the benefit of Lessor and Lessee, any rights and/or claims which might give rise to a right of subrogation in favor of any insurance carrier. The coverage obtained by Lessee or Lessor pursuant to this Lease shall include, without limitation, a waiver of subrogation endorsement attached to the certificate of insurance. 16. AD VALOREM TAXES: Prior to delinquency, Lessee shall pay all taxes and assessments levied upon trade fixtures, alterations, additions, improvements, inventories and personal property located and/or installed on or in the Premises by, or on behalf of, Lessee; and if requested in writing by Lessor, Lessee shall promptly deliver to Lessor copies of receipts for payment of all such taxes and assessments within thirty (30) days of Lessor's written request. To the extent any such taxes are not separately assessed or billed to Lessee, Lessee shall pay the amount thereof as reasonably invoiced by Lessor. 17. SUBORDINATION: Without the necessity of any additional document being executed by Lessee for the purpose of effecting a subordination, and at the election of Lessor or any bona fide mortgagee or deed of trust beneficiary with a lien on all or any portion of the Premises or any ground lessor with respect to the land of which the Premises are a part, this Lease shall be subject and subordinate at all times to: (i) all ground leases or underlying leases which may now exist or hereafter be executed affecting the Building or the land upon which the Building is situated or both, and (ii) the lien of any mortgage or deed of trust which may now exist or hereafter be executed in any amount for which the Building, the Lot, ground leases or underlying leases, or Lessor's interest or estate in any of said items is specified as security. Notwithstanding the foregoing, Lessor or any such ground lessor, mortgagee, or any beneficiary shall have the right to subordinate or cause to be subordinated any such ground leases or underlying leases or any such liens to this Lease. If any ground lease or underlying lease terminates for any reason or any mortgage or deed of trust is foreclosed or a conveyance in lieu of foreclosure is made for any reason, Lessee shall, notwithstanding any subordination and upon the request of such successor to Lessor, attorn to and become the Lessee of the successor in interest to Lessor, provided such successor in interest will not disturb Lessee's use, occupancy or quiet enjoyment of the Premises so long as Lessee is not in default of the terms and provisions of this Lease. The successor in interest to Lessor following foreclosure, sale or deed in lieu thereof shall not be (a) liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership; (b) subject to any offsets or defenses which Lessee might have against any prior lessor; (c) bound by prepayment of more than one (1) month's Rent; or (d) liable to Lessee for any Security Deposit not actually received by such successor in interest. Subsections (a) and (b) of the previous sentence are not intended to exonerate a successor to Lessor if the prior Lessor's acts or omissions constituted a breach of the Lease or of any duty owed to Lessee under the Lease by prior Lessor and continues uncured by the successor to Lessor after its acquisition of ownership. Lessee covenants and agrees to execute (and acknowledge if required by Lessor, any lender or ground lessor) and deliver, within fifteen (15) calendar days of a demand or request by Lessor and in the form reasonably requested by Lessor, ground lessor, mortgagee or beneficiary, any additional documents evidencing the priority or subordination of this Lease with respect to any such ground leases or underlying leases or the lien of any such mortgage or deed of trust. Lessee's failure to timely execute and deliver such additional documents shall, at Lessor's option, constitute a material default hereunder. 10 11 18. RIGHT OF ENTRY: Lessee grants Lessor or its agents the right to enter the Premises at all reasonable times for purposes of inspection, exhibition, posting of notices, repair or alteration. At Lessor's option, Lessor shall at all times have and retain a key with which to unlock all the doors in, upon and about the Premises, excluding Lessee's vaults and safes. It is further agreed that Lessor shall have the right to use any and all means Lessor deems necessary to enter the Premises in an emergency. Lessor shall also have the right to place "for rent" signs, within 180 days prior to the expiration of this Lease or any exercised option period(s) thereof, and/or "for sale" signs on the outside of the Premises at any time. Lessee hereby waives any claim from damages or for any injury or inconvenience to or interference with Lessee's business, or any other loss occasioned thereby except for any claim (or any portion of any claim) for any of the foregoing arising out of, or contributed to by, the sole gross active negligent acts or willful misconduct of Lessor or its employees or its authorized representatives. 19. ESTOPPEL CERTIFICATE: Lessee shall execute (and acknowledge if required by any lender or ground lessor) and deliver to Lessor, within fifteen (15) calendar days after Lessor provides such to Lessee, a statement in writing certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification), the date to which the Rent and other charges are paid in advance, if any, acknowledging that there are not, to Lessee's knowledge, any uncured defaults on the part of Lessor hereunder or specifying such defaults as are claimed, and such other matters as Lessor may reasonably require. Any such statement may be conclusively relied upon by Lessor and any prospective purchaser or encumbrancer of the Premises. Lessee's failure to deliver such statement within such time shall be conclusive upon the Lessee that (a) this Lease is in full force and effect, without modification except as may be represented by Lessor; (b) there are no uncured defaults in Lessor's performance; and (c) not more than one month's Rent has been paid in advance. Failure by Lessee to so deliver such certified estoppel certificate shall be a default of the provisions of this Lease. 20. LESSEE'S DEFAULT: The occurrence of any one or more of the following events shall, at Lessor's option, constitute a default and breach of this Lease by Lessee: (i) The abandonment of the Premises by Lessee for a period of ten (10) consecutive days, and Lessee waives any right to notice Lessee may have under applicable law; (ii) The failure by Lessee to make any payment of Rent or any other payment required hereunder on the date said payment is due; (iii) The failure by Lessee to observe, perform or comply with any of the conditions, covenants or provisions of this Lease (except default in the payment of Rent); provided, if such default is susceptible of cure and Lessee has promptly commenced the cure of such default and is diligently prosecuting such cure to completion, then the same must remain uncured for a period, unless otherwise noted herein, of thirty (30) days after written notice. The failure by Lessee to observe, perform or comply with any of the conditions, covenants, or provisions of this Lease (except default in the payment of Rent) and such failure continues for a period of fifteen (15) days after written notice from Lessor; provided, however, that if the nature of Lessee's obligation is such that more than fifteen (15) days is reasonably necessary for its performance, then Lessee shall not be in breach or default of this Lease if performance of such obligation is commenced within fifteen (15) days of written notice from Lessor and thereafter diligently pursued to completion by Lessee; (iv) The making of a general assignment by Lessee for the benefit of creditors, the filing of a voluntary petition by Lessee or the filing of an involuntary petition by any of Lessee's creditors seeking the rehabilitation, liquidation, or reorganization of Lessee under any law relating to bankruptcy, insolvency or other relief of debtors and, in the case of an involuntary action, the failure to remove or discharge the same within sixty (60) days of such filing, the appointment of a receiver or other custodian to take possession of substantially all of Lessee's assets or this leasehold, Lessee's insolvency or inability to pay Lessee's debts or failure generally to pay Lessee's debts when due, any court entering a decree or order directing the winding up or liquidation of Lessee or of substantially all of Lessee's assets, Lessee taking any action toward the dissolution or winding up of Lessee's affairs, the cessation or suspension of Lessee's use of the Premises, or the attachment, execution or other judicial seizure of substantially all of Lessee's assets or this leasehold; (v) Lessee's use or storage of Hazardous Materials on the Premises other than as permitted by the provisions of Paragraph 29 below; (vi) The making of any material misrepresentation or omission by Lessee in any materials delivered by or on behalf of Lessee to Lessor pursuant to this Lease; or (vii) Intentionally Omitted 11 12 21. REMEDIES FOR LESSEE'S DEFAULT: In the event of Lessee's default or breach of the Lease, Lessor may terminate Lessee's right to possession of the Premises by any lawful means in which case upon delivery of written notice by Lessor this Lease shall terminate on the date specified by Lessor in such notice and Lessee shall immediately surrender possession of the Premises to Lessor. In addition, the Lessor shall have the immediate right of re-entry whether or not this Lease is terminated, and if this right of re-entry is exercised following abandonment of the Premises by Lessee, Lessor may consider any personal property belonging to Lessee and left on the Premises to also have been abandoned. No re-entry or taking possession of the Premises by Lessor pursuant to this Paragraph 21 shall be construed as an election to terminate this Lease unless a written notice of such intention is given to Lessee. If Lessor relets the Premises or any portion thereof, (i) Lessee shall be liable immediately to Lessor for all costs Lessor incurs in reletting the Premises or any part thereof, including, without limitation, broker's commissions, expenses of cleaning, redecorating, and further improving the Premises and other similar costs, and (ii) the rent received by Lessor from such reletting shall be applied to the payment of, first, any indebtedness from Lessee to Lessor other than Base Rent, Operating Expenses, Tax Expenses, Common Area Utility Costs, and Utility Expenses; second, all costs including maintenance, incurred by Lessor in reletting; and, third, Base Rent, Operating Expenses, Tax Expenses, Common Area Utility Costs, and Utility Expenses due under this Lease. After deducting the payments referred to above, any sum remaining from the rental Lessor receives from reletting shall be held by Lessor and applied in payment of future Rent as Rent becomes due under this Lease. In no event shall Lessee be entitled to any excess rent received by Lessor. Reletting may be for a period shorter or longer than the remaining term of this Lease. No act by Lessor other than giving written notice to Lessee shall terminate this Lease. Acts of maintenance, efforts to relet the Premises or the appointment of a receiver on Lessor's initiative to protect Lessor's interest under this Lease shall not constitute a termination of Lessee's right to possession. So long as this Lease is not terminated, Lessor shall have the right to remedy any default of Lessee, to maintain or improve the Premises, to cause a receiver to be appointed to administer the Premises and new or existing subleases and to add to the Rent payable hereunder all of Lessor's reasonable costs in so doing, with interest at the maximum rate permitted by law from the date of such expenditure. If Lessee breaches this Lease and abandons the property before the end of the term, or if Lessee's right to possession is terminated by Lessor because of a breach or default of the Lease, then in either such case, Lessor may recover from Lessee all damages suffered by Lessor as a result of Lessee's failure to perform its obligations hereunder, including, but not limited to, the cost of any tenant improvements, and all costs Lessor incurs in reletting the Premises or any part thereof, including without limitation, brokerage or leasing commissions, expenses of cleaning, redecorating, and further improving the Premises and like costs, and the worth at the time of the award (computed in accordance with Paragraph (3) of Subdivision (a) of Section 1951.2 of the California Civil Code) of the amount by which the Rent then unpaid hereunder for the balance of the Lease term exceeds the amount of such loss of Rent for the same period which Lessee proves could be reasonably avoided by Lessor and in such case, Lessor prior to the award, may relet the Premises for the purpose of mitigating damages suffered by Lessor because of Lessee's failure to perform its obligations hereunder; provided, however, that even though Lessee has abandoned the Premises following such breach, this Lease shall nevertheless continue in full force and effect for as long as Lessor does not terminate Lessee's right of possession, and until such termination, Lessor shall have the remedy described in Section 1951.4 of the California Civil Code (Lessor may continue this Lease in effect after Lessee's breach and abandonment and recover Rent as it becomes due, if Lessee has the right to sublet or assign, subject only to reasonable limitations) and may enforce all its rights and remedies under this Lease, including the right to recover the Rent from Lessee as it becomes due hereunder. The "worth at the time of the award" within the meaning of SubParagraphs (a)(1) and (a)(2) of Section 1951.2 of the California Civil Code shall be computed by allowing interest at the rate of ten percent (10%) per annum. Lessee waives redemption or relief from forfeiture under California Code of Civil Procedure Sections 1174 and 1179, or under any other present or future law, in the event Lessee is evicted or Lessor takes possession of the Premises by reason of any default of Lessee hereunder. The foregoing rights and remedies of Lessor are not exclusive; they are cumulative in addition to any rights and remedies now or hereafter existing at law, in equity by statute or otherwise, or to any equitable remedies Lessor may have, and to any remedies Lessor may have under bankruptcy laws or laws affecting creditor's rights generally. In addition to all remedies set forth above, if Lessee defaults or otherwise breaches this Lease, any and all Base Rent waived by Lessor under Paragraph 3 above shall be immediately due and payable to Lessor and all options granted to Lessee hereunder shall automatically terminate, unless otherwise expressly agreed to in writing by Lessor. The waiver by Lessor of any default or breach of any provision of this Lease shall not be deemed or construed a waiver of any other breach or default by Lessee hereunder or of any subsequent breach or default of this Lease, except for the default specified in the waiver. 12 13 22. HOLDING OVER: If Lessee holds possession of the Premises after the expiration of the term of this Lease with Lessor's consent, Lessee shall become a tenant from month-to-month upon the terms and provisions of this Lease, provided the monthly Base Rent during such hold over period shall be 150% of the Base Rent due on the last month of the Lease term, payable in advance on or before the first day of each month. Such month-to-month tenancy shall not constitute a renewal or extension for any further term. All options, if any, granted under the terms of this Lease shall be deemed automatically terminated and be of no force or effect during said month-to-month tenancy. Lessee shall continue in possession until such tenancy shall be terminated by either Lessor or Lessee giving written notice of termination to the other party at least thirty (30) days prior to the effective date of termination. This Paragraph shall not be construed as Lessor's permission for Lessee to hold over. Acceptance of Base Rent by Lessor following expiration or termination of this Lease shall not constitute a renewal of this Lease. 23. LESSOR'S DEFAULT: Lessor shall not be deemed in breach or default of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor hereunder. For purposes of this provision, a reasonable time shall in no event be more than thirty (30) days after receipt by Lessor of written notice specifying the nature of the obligation Lessor has not performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days, after receipt of written notice, is reasonably necessary for its performance, then Lessor shall not be in breach or default of this Lease if performance of such obligation is commenced within such thirty (30) day period and thereafter diligently pursued to completion. 24. PARKING: Lessee shall have a license to use the number of undesignated and nonexclusive parking spaces set forth on Page 1. Lessor shall exercise reasonable efforts to insure that such spaces are available to Lessee for its use, but Lessor shall not be required to enforce Lessee's right to use the same. 25. SALE OF PREMISES: In the event of any sale of the Premises by Lessor, Lessor shall be and is hereby entirely released from any and all of its obligations to perform or further perform under this Lease and from all liability hereunder as of the date of such sale; and the purchaser, at such sale or any subsequent sale of the Premises shall be deemed, without any further agreement between the parties or their successors in interest or between the parties and any such purchaser, to have assumed and agreed to carry out any and all of the covenants and obligations of the Lessor under this Lease. Lessee agrees to attorn to such new owner provided such new owner does not disturb Lessee's use, occupancy or quiet enjoyment of the Premises so long as Lessee is not in default of any of the provisions of this Lease. 26. WAIVER: No delay or omission in the exercise of any right or remedy of Lessor on any default by Lessee shall impair such a right or remedy or be construed as a waiver. The subsequent acceptance of Rent by Lessor after breach by Lessee of any covenant or term of this Lease shall not be deemed a waiver of such breach, other than a waiver of timely payment for the particular Rent payment (or portion thereof) involved, and shall not prevent Lessor from maintaining an unlawful detainer or other action based on such breach. No payment by Lessee or receipt by Lessor of a lesser amount than the monthly Rent and other sums due hereunder shall be deemed to be other than on account of the earliest Rent or other sums due, nor shall any endorsement or statement on any check or accompanying any check or payment be deemed an accord and satisfaction; and Lessor may accept such check or payment without prejudice to Lessor's right to recover the balance of such Rent or other sum or pursue any other remedy provided in this Lease. 27. CASUALTY DAMAGE: If the Premises or any part thereof shall be damaged by fire or other casualty, Lessee shall give prompt written notice thereof to Lessor. In case the Building shall be so damaged by fire or other casualty that substantial alteration or reconstruction of the Building shall, in Lessor's sole opinion, be required (whether or not the Premises shall have been damaged by such fire or other casualty), Lessor may, at its option, terminate this Lease by notifying Lessee in writing of such termination within sixty (60) days after the date of such damage, in which event the Rent shall be abated as of the date of such damage. If Lessor does not elect to terminate this Lease and provided insurance proceeds and any contributions from Lessee, if necessary, are available to fully repair the damage, Lessor shall within ninety (90) days after the date of such damage commence to repair and restore the Building and shall proceed with reasonable diligence to restore the Building (except that Lessor shall not be responsible for delays outside its control) to substantially the same condition in which it was immediately prior to the happening of the casualty; provided, Lessor shall not be required to rebuild, repair, or replace any part of Lessee's furniture, furnishings or fixtures and equipment removable by Lessee or any improvements, alterations or 13 14 additions installed by or for the benefit of Lessee under the provisions of this Lease. Lessor shall not in any event be required to spend for such work an amount in excess of the insurance proceeds and any contributions from Lessee, if necessary, actually received by Lessor as a result of the fire or other casualty. Lessor shall not be liable for any inconvenience or annoyance to Lessee, injury to the business of Lessee, loss of use of any part of the Premises by the Lessee or loss of Lessee's personal property resulting in any way from such damage or the repair thereof, except that, subject to the provisions of the next sentence, Lessor shall allow Lessee a fair diminution of Rent during the time and to the extent the Premises are unfit for occupancy. If the Premises or any other portion of the Building be damaged by fire or other casualty resulting from the fault or active or passive negligence or omissions of Lessee or any of Lessee's agents, employees, or invitees, the Rent shall not be diminished during the repair of such damage and Lessee shall be liable to Lessor for the reasonable cost and expense of the repair and restoration of the Building caused thereby to the extent such cost and expense is not covered by insurance proceeds. In the event the holder of any indebtedness secured by the Premises requires that the insurance proceeds be applied to such indebtedness, then Lessor shall have the right to terminate this Lease by delivering written notice of termination to Lessee within forty-five (45) days after the date of notice to Lessee of any such event, whereupon all rights and obligations shall cease and terminate hereunder. Except as otherwise provided in this Paragraph 27, Lessee hereby waives the provisions of Sections 1932(2.), 1933(4.), 1941 and 1942 of the California Civil Code. 28. CONDEMNATION: If twenty-five percent (25%) or more of the Premises is condemned by eminent domain, inversely condemned or sold in lieu of condemnation for any public or quasi-public use or purpose ("Condemned"), then Lessee or Lessor may terminate this Lease as of the date when physical possession of the Premises is taken and title vests in such condemning authority, and Rent shall be adjusted to the date of termination. Lessee shall not because of such condemnation assert any claim against Lessor or the condemning authority for any compensation because of such condemnation, and Lessor shall be entitled to receive the entire amount of any award without deduction for any estate of interest or interest of Lessee. If a substantial portion of the Premises, Building or the Lot is so Condemned, Lessor at its option which option Lessor will reasonably exercise, may terminate this Lease. If Lessor does not elect to terminate this Lease, Lessor shall, if necessary, promptly proceed to restore the Premises or the Building to substantially its same condition prior to such partial condemnation, allowing for the reasonable effects of such partial condemnation, and a proportionate allowance shall be made to Lessee, as solely determined by Lessor, for the Rent corresponding to the time during which, and to the part of the Premises of which, Lessee is deprived on account of such partial condemnation and restoration. Lessor shall not be required to spend funds for restoration in excess of the amount received by Lessor as compensation awarded. 29. ENVIRONMENTAL MATTERS/HAZARDOUS MATERIALS: Concurrently with executing this Lease, and within thirty (30) days of each anniversary of the Commencement Date during the term of this Lease, Lessee shall execute, and deliver to Lessor, the Hazardous Materials Disclosure Certificate in substantially the form attached as Exhibit F, and any other reasonably necessary documents as requested by Lessor. Subject to the remaining provisions of this Paragraph, Lessee shall be entitled to use and store only those Hazardous Materials (defined below), that are necessary for Lessee's business and to the extent disclosed in the Hazardous Materials Disclosure Certificate, provided that such usage and storage is in full compliance with any and all local, state and federal environmental, health and/or safety-related laws, statutes, orders, standards, courts' decisions, ordinances, rules and regulations (as interpreted by judicial and administrative decisions), decrees, directives, guidelines, permits or permit conditions, currently existing and as amended, enacted, issued or adopted in the future which are or become applicable to Lessee or the Premises (collectively, the "Environmental Laws"). Lessor shall have the right at all times during the term of this Lease to (i) inspect the Premises, (ii) conduct tests and investigations to determine whether Lessee is in compliance with the provisions of this Paragraph so long as the Lessor uses its best efforts not to unreasonably interfere with Lessee's business operations, and (iii) request lists of all Hazardous Materials used, stored or located on, under or about the Premises; the cost of all such inspections, tests and investigations to be borne by Lessee, if Lessor reasonably believes they are necessary. Lessee shall give to Lessor immediate verbal and follow-up written notice of any spills, releases or discharges of Hazardous Materials on, under or about the Premises, or in any Common Areas or parking lots (if not considered part of the Premises). Lessee covenants to promptly investigate, 14 15 clean up and otherwise remediate any spill, release or discharge of Hazardous Materials caused by the acts (active or passive) or omissions of Lessee, or its agents, employees, representatives, invitees, licensees, subtenants, customers or contractors at Lessee's sole cost and expense; such investigation, clean up and remediation to be performed after Lessee has obtained Lessor's written consent, which shall not be unreasonably withheld; provided, however, that Lessee shall be entitled to respond immediately to an emergency without first obtaining Lessor's written consent. If Lessee fails to so promptly investigate, clean up or otherwise remediate, Lessor may, but without obligation to do so, take any and all steps necessary to rectify the same and Lessee shall promptly reimburse Lessor, upon demand, for all costs and expenses to Lessor of performing investigation and remediation work. Lessee shall indemnify, defend (with counsel acceptable to Lessor) and hold Lessor and Lessor's lenders, partners, property management company (if other than Lessor), directors, officers, employees, representatives, contractors and shareholders and each of their respective successors and assigns harmless from and against any and all claims, judgments, damages, penalties, fines, liabilities, losses, suits, administrative proceedings and costs (including, but not limited to, attorneys' and consultant fees and court costs) arising at any time during or after the term of this Lease in connection with or related to the use, presence, transportation, storage, disposal, spill, release or discharge of Hazardous Materials on, in or about the Premises as a result (directly or indirectly) of the acts (active or passive) or omissions of Lessee, its agents, employees, representatives, invitees, licensees, subtenants, customers or contractors. Lessee shall not be entitled to install any tanks under, on or about the Premises for the storage of Hazardous Materials without the express written consent of Lessor, which may be given or withheld in Lessor's sole discretion. Neither the written consent of Lessor to the presence of Hazardous Materials on, under or about the Premises nor the strict compliance by Lessee with all Environmental Laws shall excuse Lessee from its obligation of indemnification pursuant hereto. As used herein, the term Hazardous Materials shall mean (i) any hazardous or toxic wastes, materials or substances, and other pollutants or contaminants, which are or become regulated by any Environmental Laws; (ii) petroleum and petroleum by products; (iii) asbestos; (iv) polychlorinated biphenyls; and (v) radioactive materials. The provisions of this Paragraph shall survive the termination of this Lease. If it is determined by Lessor that Lessee, its use of the Premises, Building and/or Park, or the condition of the Premises, Building and/or Park is not in compliance with all Environmental Laws at the expiration or termination of this Lease, then at Lessor's sole option, Lessor may require Lessee to hold over possession of the Premises until Lessee can surrender the Premises to Lessor in compliance with all Environmental Laws. Any such holdover by Lessee will be with Lessor's consent, will not be terminable by Lessee in any event or circumstance and will otherwise be subject to the provisions of Paragraph 22 of this Lease. 30. FINANCIAL STATEMENTS: Lessee, for the reliance of Lessor, any lender holding or anticipated to acquire a lien upon the Premises, the Building or the Park or any portion thereof, or any prospective purchaser of the Building or the Park or any portion thereof, within thirty (30) days after Lessor's request therefor, but not more often than once annually so long as Lessee is not in default of this Lease, shall deliver to Lessor the then current audited financial statements of Lessee (including interim periods following the end of the last fiscal year for which annual statements are available) which statements shall be prepared or compiled by a certified public accountant and shall present fairly the financial condition of Lessee at such dates and the result of its operations and changes in its financial positions for the periods ended on such dates. If an audited financial statement has not been prepared, Lessee shall provide Lessor with an unaudited financial statement and/or such other information, the type and form of which are acceptable to Lessor in Lessor's reasonable discretion, which reflects the financial condition of Lessee. 31. GENERAL PROVISIONS: (i) TIME. Time is of the essence in this Lease and with respect to each and all of its provisions in which performance is a factor. (ii) SUCCESSORS AND ASSIGNS. The covenants and conditions herein contained, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of the parties hereto. (iii) RECORDATION. Lessee shall not record this Lease or a short form memorandum hereof without the prior written consent of the Lessor. (iv) LESSOR'S PERSONAL LIABILITY. The liability of Lessor (which, for purposes of this Lease, shall include Lessor and the owner of the Building if other than Lessor) to Lessee for any default by Lessor under the terms of this Lease shall be limited to the actual interest of Lessor and its present or future partners in the Premises or the Building and Lessee agrees to look solely to the Premises for satisfaction of any liability and shall not look to other assets of Lessor nor seek any recourse against the assets of the individual partners, directors, officers, shareholders, agents or employees of Lessor; it being intended that Lessor and the individual partners, directors, officers, shareholders, agents or employees of Lessor shall not be personally liable in any manner whatsoever for any judgment or deficiency. The liability of Lessor under this Lease is limited to its actual period of ownership of title to the Building, and Lessor shall be automatically released from further performance under this Lease and from all further liabilities and expenses hereunder upon transfer of Lessor's interest in the Premises or the Building. Lessee agrees to attorn to any entity purchasing or otherwise acquiring the Premises. 15 16 (v) SEPARABILITY. Any provisions of this Lease which shall prove to be invalid, void or illegal shall in no way affect, impair or invalidate any other provisions hereof and such other provision shall remain in full force and effect. (vi) CHOICE OF LAW. This Lease shall be governed by the laws of the State of California. (vii) ATTORNEYS' FEES. In the event any legal action is brought to enforce or interpret the provisions of this Lease, the prevailing party therein shall be entitled to recover all costs and expenses including reasonable attorneys' fees. (viii) ENTIRE AGREEMENT. This Lease supersedes any prior agreements, representations, negotiations or correspondence between the parties, and contains the entire agreement of the parties on matters covered. No other agreement, statement or promise made by any party that is not in writing and signed by all parties to this Lease shall be binding. (ix) WARRANTY OF AUTHORITY. Each person executing this agreement on behalf of a party represents and warrants that (1) such person is duly and validly authorized to do so on behalf of the entity it purports to so bind, and (2) if such party is a partnership, corporation or trustee, that such partnership, corporation or trustee has full right and authority to enter into this Lease and perform all of its obligations hereunder. (x) NOTICES. All notices and demands required or permitted to be sent to Lessor or Lessee shall be in writing and shall be sent by United States mail, certified and postage prepaid, or by personal delivery or by overnight courier, addressed to Lessor at 30 Executive Park, Suite 100, Irvine, California 92714, or to Lessee at the Premises, or to such other place as such party may designate in a notice to the other party given as provided herein. Notice shall be deemed given upon the earlier of actual receipt or the third day following deposit in the United States mail. (xi) JOINT AND SEVERAL. If Lessee consists of more than one person or entity, the obligations of all such persons or entities shall be joint and several. (xii) COVENANTS AND CONDITIONS. Each provision to be performed by Lessee hereunder shall be deemed to be both a covenant and a condition. (xiii) Intentionally Omitted (xiv) Intentionally Omitted 32. SIGNS: All signs and graphics of every kind visible in or from public view or corridors or the exterior of the Premises shall be subject to Lessor's prior written approval which approval Lessor will not unreasonably withhold and shall be subject to any applicable governmental laws, ordinances, and regulations and in compliance with Lessor's Sign Criteria as set forth in Exhibit E hereto and made a part hereof. Lessee shall remove all such signs and graphics prior to the termination of this Lease. Such installations and removals shall be made in a manner as to avoid damage or defacement of the Premises; and Lessee shall repair any damage or defacement, including without limitation, discoloration caused by such installation or removal. Lessor shall have the right, at its option, to deduct from the Security Deposit such sums as are reasonably necessary to remove such signs, including, but not limited to, the reasonable costs and expenses associated with any repairs necessitated by such removal. Notwithstanding the foregoing, in no event shall any: (a) neon, flashing or moving sign(s) or (b) sign(s) which shall interfere with the visibility of any sign, awning, canopy, advertising matter, or decoration of any kind of any other business or occupant of the Building or the Park be permitted hereunder. Lessee further agrees to maintain any such sign, awning, canopy, advertising matter, lettering, decoration or other thing as may be approved in good condition and repair at all times. 33. MORTGAGEE PROTECTION: Upon any breach or default on the part of Lessor, Lessee will give written notice by registered or certified mail to any beneficiary of a deed of trust or mortgagee of a mortgage covering the Premises who has provided Lessee with notice of their interest together with an address for receiving notice, and shall offer such beneficiary or mortgagee a reasonable time to perform and to cure the default (which, in no event shall be more than ninety (90) days), including time to obtain possession of the Premises by power of sale or a judicial foreclosure, if such should prove necessary to effect a cure. If such breach or default cannot be cured within such time period, then such additional time as may be necessary will be given to such beneficiary or mortgagee to effect such cure so long as such beneficiary or mortgagee has commenced the cure within the original time period and thereafter diligently pursues such cure to completion, in which event this Lease shall not be terminated while such cure is being diligently pursued. Lessee agrees that each lender to whom this Lease has been assigned by Lessor is an 16 17 express third party beneficiary hereof. Lessee shall not make any prepayment of Rent more than one (1) month in advance without the prior written consent of each such lender. Lessee waives the collection of any deposit from such lender(s) or any purchaser at a foreclosure sale of such lender(s)' deed of trust unless the lender(s) or such purchaser shall have actually received and not refunded the deposit. Lessee agrees to make all payments under this Lease to the lender with the most senior encumbrance upon receiving a direction, in writing, to pay said amounts to such lender. Lessee shall comply with such written direction to pay without determining whether an event of default exists under such lender's loan to Lessor. 34. QUITCLAIM: Upon any termination of this Lease, Lessee shall, at Lessor's request, execute, have acknowledged and deliver to Lessor a quitclaim deed of Lessee's interest in and to the Premises. 35. MODIFICATIONS FOR LENDER: If, in connection with obtaining financing for the Premises or any portion thereof, Lessor's lender shall request reasonable modification(s) to this Lease as a condition to such financing, Lessee shall not unreasonably withhold, delay or defer its consent thereto, provided such modifications do not materially adversely affect Lessee's rights hereunder or the use, occupancy or quiet enjoyment of Lessee hereunder. 36. WARRANTIES OF LESSEE: Lessee hereby warrants and represents to Lessor, for the express benefit of Lessor, that Lessee has undertaken a complete and independent evaluation of the risks inherent in the execution of this Lease and the operation of the Premises for the use permitted hereby, and that, based upon said independent evaluation, Lessee has elected to enter into this Lease and hereby assumes all risks with respect thereto. Lessee hereby further warrants and represents to Lessor, for the express benefit of Lessor, that in entering into this Lease, Lessee has not relied upon any statement, fact, promise or representation (whether express or implied, written or oral) not specifically set forth herein in writing and that any statement, fact, promise or representation (whether express or implied, written or oral) made at any time to Lessee, which is not expressly incorporated herein in writing, is hereby waived by Lessee. 37. COMPLIANCE WITH AMERICANS WITH DISABILITIES ACT: Lessor and Lessee hereby agree and acknowledge that the Premises, the Building and/or the Park may be subject to the requirements of the Americans with Disabilities Act (the "ADA"), a federal law codified at 42 U.S.C. 12101 et seq, including, but not limited to Title III thereof, all regulations and guidelines related thereto, and any amendments thereof. Any Tenant Improvements to be constructed hereunder shall be in compliance with the requirements of the ADA, and all costs incurred for purposes of compliance therewith shall be a part of and included in the costs of the Tenant Improvements. Lessee shall be responsible for disclosing all relevant information to Lessor regarding its business operations and uses of the Premises that will allow Lessor to construct the Tenant Improvements in compliance with the requirements of ADA. Except for construction of the Tenant Improvements, Lessee shall be responsible at its sole cost and expense for compliance with the requirements of ADA in the Premises. If any barrier removal work or other work is required in the Building, the Common Area or the Park under Title III of the ADA, then such work shall be performed by Lessor; provided, however, if such work is required under the ADA as a result of Lessee's use of the Premises by or on behalf of Lessee, then such work shall be performed by Lessor at the sole cost and expense of Lessee. If ADA work would be required in the Building, the Common Area, or the Park due to any work or alteration to the Premises by Lessee, Lessor shall be entitled to withhold its consent to such work or alteration to the Premises pursuant to Paragraph 10, unless Lessee shall also agree to pay for such ADA work to the Building, the Common Area or the Park. Except as otherwise provided in this provision, Lessee shall be responsible at its sole cost and expense for fully and faithfully complying with all applicable requirements of the ADA. 38. BROKERAGE COMMISSION: Lessee hereby represents and warrants to Lessor that Lessee's sole contact with Lessor or with the Premises in connection with this Lease has been directly with Lessor and the Broker (as set forth on Page 1), and that no other broker or finder can properly claim a right to a commission or a finder's fee based upon contacts between the claimant and Lessee. Lessee shall indemnify, defend by counsel acceptable to Lessor, protect and hold Lessor harmless from and against any loss, liability, suit, judgment, reasonable cost or expense, including, but not limited to, experts' and attorneys' fees and costs, arising from or relating to any claim for a fee or commission by any broker or finder in connection with the Premises and this Lease other than Broker, if any. 17 18 IN WITNESS WHEREOF, this Lease is executed on the date and year first written above. LESSOR: PRINCIPAL MUTUAL LIFE INSURANCE COMPANY By: /s/ Kurt D. Schaeffer ------------------------------------------ Title: Assistant Director, Commercial Real Estate ------------------------------------------ By: /s/ Ronald B. Franklin ------------------------------------------ Title: Director, Commercial Real Estate ------------------------------------------ Loan Administration Date: ------------------------------------------ LESSEE: DENSE-PAC MICROSYSTEMS, INC. A CALIFORNIA CORPORATION By: /s/ William M. Stowell ------------------------------------------ Title: Chief Financial Officer ------------------------------------------ Date: July 25, 1995 ------------------------------------------ 18 19 ADDENDUM I TO LEASE LEASE DATED: June 19, 1995 LESSEE: Dense-Pac Microsystems, Inc. a California Corporation LESSOR: PRINCIPAL MUTUAL LIFE INSURANCE COMPANY OPTION TO EXTEND THE LEASE TERM ------------------------------- ("Extension Option") 1. Grant of Option; Exercise. Provided Lessee has not received notice of default in the performance of any of its obligations under the Lease referenced above and failed to cure the same as of the date the option is exercised, Lessee shall have the right, at its option, to extend the term of the Lease for an additional five (5) years ("Extended Term"). The Lease of the Premises during the Extended Term shall be upon the same terms, covenants and conditions as are set forth in the Lease, other than the Base Rent, the term of the Lease and options. If Lessee elects to extend the Lease Term, Lessee shall deliver to Lessor written notice thereof ("Exercise Notice") no earlier than nine (9) months prior to the expiration of the initial term of the Lease and no later than six (6) months prior to the expiration of the initial term of the Lease. If Lessor has not received written notice of Lessee's exercise of this option by 5:00 p.m., Pacific Time on the date which is one hundred eighty (180) days prior to the expiration of the initial lease term, the Lease shall automatically terminate upon the expiration of the initial lease term. 2. Initial Rent During Option Term. If Lessee has timely exercised the Extension Option, monthly Rent commencing on the first day of the Extended Term shall be the fair market rent for the Premises, inclusive of market increase(s), if any, as of the date of the commencement of the Extended Term ("Fair Rent Value"). 3. Fair Rental Value. If Lessor and Lessee are unable to agree on the Fair Rental Value of the Premises within ten (10) business days after Lessee has notified Lessor of its exercise of the Extension Option, then Lessor and Lessee shall each appoint a real estate appraiser with at least 5 year's full time commercial appraiser experience in the area in which the Premises are located to appraise and set the Fair Rental Value of the Premises subject to paragraphs 3 and 4 of this Addendum I. If Lessor or Lessee fail to appoint an appraiser within 10 days after the other party has given notice of the name of its appraiser, the single appraiser appointed shall be the sole appraiser and shall set the Fair Rental Value of the Premises. If the two appraisers are appointed by the parties in this paragraph, they shall meet promptly in an attempt to set the Fair Rental Value. If they are unable to agree within 30 days after the second appraiser has been appointed, they shall attempt to elect a third appraiser meeting the qualifications stated herein within 10 days after the last day the two appraisers were given to set the Fair Rental Value. If they are unable to agree on the third appraiser, either of the parties to this Lease, by giving 10 days' notice to the other party, can apply to the president of the local real estate board, or to the presiding judge of the Superior Court of Los Angeles County for the selection of a third appraiser who meets the qualifications by paying one-half of the cost of appointing a third appraiser and paying the third appraiser's fee. The third appraiser, however selected, shall be a person who has not previously acted in any capacity for either party. Within fifteen (15) days after selection of the third appraiser, a majority of the appraisers shall set the Fair Rental Value. If a majority of the appraisers are unable to set the Fair Rental Value within the stipulated period of time, the three appraisals shall be added together and their total divided by 3; the resulting quotient shall be the Fair Rental Value for the Premises. 4. Rent Increases. The Fair Rental Value determination, as agreed upon by Lessor and Lessee, or determined pursuant to paragraph 3 of this Addendum I, shall include market rental increase(s), if any, as determined by the prevailing market method, e.g., Consumer Price Index. In no event shall any rental increase determination cause the Base Rent to decrease from that Base Rent in effect at the beginning of the Extended Term. 5. Broker Commission. Lessor shall have no obligation whatsoever to compensate any real estate broker in the Lessee's Extension Option. The Lessor would expect to conduct all Extension Option discussions directly with the Lessee. If for any reason the Lessee has outside real estate consulting services provided to the Lessee, then any commission consideration shall be paid directly by Lessee to the outside real estate brokerage consulting services. Lessor's Initials: Lessee's Initials - ------------------ ----------------- 20 ADDENDUM II EARLY POSSESSION AGREEMENT Reference is made to that Lease dated June 19, 1995 (the "Lease") by and between Principal Mutual Life Insurance Company ("Lessor") and Dense-Pac Microsystems, Inc., a California Corporation ("Lessee") of approximately 21,346 square feet of space located at 7321 Lincoln Way, Garden Grove, California (the "Premises"). Lessee may occupy the Premises commencing on the latter of July 1, 1995 or mutual execution of this agreement provided that the Lease is signed by the Lessee on or before June 30, 1995, at $8,325.59 per month Base Rent described in the Lease plus its Triple Net Operating Expense charges until the Commencement Date of the Lease. Lessee shall not interfere with Lessor's construction of the Tenant Improvements as agreed in the Lease. Except as set forth in this Early Possession Agreement, Lessee shall perform all the terms and conditions of the above-referenced Lease. Unless and until this Lease and Early Possession Agreement are executed by the Lessor and Lessee, the previous Lease by and between Lincoln Technology Center Associates Limited and Patrician Associates, Inc. as "Lessor" and Dense Pac Development, Inc., a California Corporation as "Lessee" dated April 10, 1985, shall remain in effect, including all rent obligations. Notwithstanding any provision of this Early Possession Agreement, if an event which would have been an event of default under the Lease occurs at any time during the term of the Early Occupancy Period, the Commencement Date of the Lease shall be deemed to be the first date of the Early Occupancy Period and any and all monies, including Base Rent at the initial rate set forth in the Lease, which would have been paid by Lessee to Lessor shall become immediately due and payable by Lessee to Lessor. LESSOR: PRINCIPAL MUTUAL LIFE INSURANCE COMPANY By: /s/ Kurt D. Schaeffer ------------------------------------------ By: /s/ Ronald B. Franklin ------------------------------------------ Date: ---------------------------------------- LESSEE: DENSE-PAC MICROSYSTEMS, INC. A CALIFORNIA CORPORATION By: /s/ William M. Stowell --------------------------------------- Title: Chief Financial Officer --------------------------------------- Date: July 25, 1995 --------------------------------------- EX-10.3 3 DENSE-PAC -- 1996 STOCK OPTION PLAN 1 EXHIBIT 10.3 DENSE-PAC MICROSYSTEMS, INC. 1996 STOCK OPTION PLAN 1. PURPOSE The purpose of the Dense-Pac Microsystems, Inc. 1996 Stock Option Plan (the "Plan") is to further the interests of Dense-Pac Microsystems, Inc. (the "Company") and its Subsidiaries by strengthening the desire of Employees to continue their relationship with the Company and its Subsidiaries and by inducing individuals to become Employees of the Company and its Subsidiaries through stock options to be granted hereunder. Options granted under the Plan are either options intending to qualify as "incentive stock options" within the meaning of Section 422 of the Code or non-qualified stock options. 2. DEFINITIONS Whenever used herein the following terms shall have the following meanings, respectively: (a) "Board" shall mean the Board of Directors of the Company. (b) "Code" shall mean the Internal Revenue Code of 1986, as amended. (c) "Committee" shall mean a Committee of at least two directors appointed by the Board, or if no such committee has been appointed reference to "Committee" shall be deemed to refer to the Board. (d) "Common Stock" shall mean the Company's Common Stock, no par value per share, as described in the Company's Articles of Incorporation, as amended. (e) "Company" shall mean Dense-Pac Microsystems, Inc., a California corporation. (f) "Employee" shall mean in connection with Non-Qualified Options, any officer, employee, consultant or advisor of the Company or any Subsidiary or Parent Corporation of the Company, and any director of the Company who is not an employee of the Company or any Subsidiary or Parent Corporation of the Company, it being understood that the Committee may in its discretion also grant Options to induce individuals to become and remain as Employees and that such persons, for purposes of receiving Non-Qualified Options hereunder, shall be deemed "Employees." In connection with Incentive Options under this Plan, the term Employee shall mean any individual who is employed, within the meaning of Section 3401 of the Code, by the Company or any Subsidiary or Parent Corporation of the Company. 2 (g) "Fair Market Value Per Share" of the Company's Common Stock shall mean if the Company's Common Stock is publicly traded the mean between the highest and lowest quoted selling prices of the Common Stock on the date of the grant of the Option or, if not available, the mean between the bona fide bid and asked prices of the Common Stock on the date of the grant of the Option. In any situation not covered above or if there were no sales on the date of the grant of an Option, the Fair Market Value Per Share shall be determined by the Committee in good faith based on uniform principles consistently applied. (h) "Incentive Option" shall mean an Option granted under the Plan which is designated as and qualifies as an incentive stock option within the meaning of Section 422 of the Code. (i) "Non-Qualified Option" shall mean an Option granted under the Plan which is designated as a non-qualified stock option or which does not qualify as an incentive stock option within the meaning of Section 422 of the Code. (j) "Option" shall mean an Incentive Option or a Non-Qualified Option. Each Option shall be evidenced by a written agreement executed by the Company which shall set forth the terms and conditions of such Option. (k) "Optionee" shall mean any Employee who has been granted an Option under the Plan. (l) "Parent Corporation" shall have the meaning set forth in Section 425(e) of the Code. (m) "Permanent Disability" shall mean termination of employment with the Company or any Subsidiary or Parent Corporation of the Company with the consent of the Company or such Subsidiary by reason of permanent and total disability within the meaning of Section 22(e)(3) of the Code. (n) "Plan" shall mean the Dense-Pac Microsystems, Inc. 1996 Stock Option Plan, as from time to time amended. (o) "Subsidiary" shall have the meaning set forth in Section 425(f) of the Code. 3. ADMINISTRATION (a) The Plan shall be administered either by the Board or, in the discretion of the Board, by a Committee. The Board may from time to time appoint members of the Committee in substitution for or in addition to members previously appointed and may fill vacancies. (b) Any action of the Committee with respect to the administration of the Plan shall be taken by majority vote or by unanimous written consent of its members. 2 3 (c) Subject to the provisions of the Plan, the Committee shall have the authority to construe and interpret the Plan, to define the terms used herein, to determine the Optionees, the time or times an Option may be exercised and the number of shares which may be exercised at any one time, to prescribe, amend and rescind rules and regulations relating to the Plan, to approve and determine the duration of leaves of absence which may be granted to participants without constituting a termination of their employment for purposes of the Plan, and to make all other determinations necessary or advisable for the administration of the Plan. The Committee's authority shall include, without limitation, the right, in its discretion, to accelerate the exercisability of Options or reprice or exchange Options with the consent of the Optionee. All determinations and interpretations made by the Committee shall be conclusive and binding on all Employees and on their guardians, legal representatives and beneficiaries. (d) The Company will indemnify and hold harmless the members of the Board and the Committee from and against any and all liabilities, costs and expenses incurred by such persons as a result of any act, or omission to act, in connection with the performance of such persons' duties, responsibilities and obligations under the Plan, other than such liabilities, costs and expenses as may result from the gross negligence, bad faith, willful misconduct and/or criminal acts of such persons. 4. NUMBER OF SHARES SUBJECT TO PLAN The stock to be offered under the Plan shall consist of up to 2,000,000 shares of the Company's Common Stock. If any Option granted hereunder shall expire or terminate for any reason without having been exercised in full, the unpurchased shares subject thereto shall again be available for purposes of this Plan. 5. ELIGIBILITY AND PARTICIPATION (a) The Committee shall determine the Employees to whom Options shall be granted, the time or times at which such Options shall be granted and the number of shares to be subject to each Option. An Employee who has been granted an Option may, if he is otherwise eligible, be granted an additional Option or Options if the Committee shall so determine. An Employee may be granted Incentive Options or Non-Qualified Options or both under the Plan. (b) In no event shall the aggregate fair market value (determined as of the time an Incentive Option is granted) of shares subject to Incentive Options held by an Optionee (granted under the Plan or under any other plan of the Company) that first become exercisable in any calendar year exceed $100,000. The portion of any purported Incentive Option which exceeds such limitation shall be deemed to be a Non-Qualified Option. 6. PURCHASE PRICE The purchase price of each share covered by an Option shall be determined by the Committee on the date of grant; provided, 3 4 however, that the purchase price of each share covered by each Incentive Option shall not be less than 100% of the Fair Market Value Per Share of the Common Stock of the Company on the date the Incentive Option is granted; and provided, further, that if at the time an Incentive Option is granted the Optionee owns or would be considered to own by reason of Section 424(d) of the Code more than 10% of the total combined voting power of all classes of stock of the Company or any Subsidiary or Parent Corporation of the Company, the purchase price of the shares covered by such Incentive Option shall not be less than 110% of the Fair Market Value Per Share of the Common Stock on the date the Incentive Option is granted. 7. DURATION OF OPTIONS The expiration date of an Option shall not exceed 10 years from the date on which the Option was granted, and shall be subject to earlier termination as provided herein; provided, however, that if at the time an Incentive Option is granted the Optionee owns or would be considered to own by reason of Section 424(d) of the Code more than 10% of the total combined voting power of all classes of stock of the Company or any Subsidiary or Parent Corporation of the Company, such Incentive Option shall expire not more than 5 years from the date the Incentive Option is granted. 8. EXERCISE OF OPTIONS An Option shall be exercisable in installments or otherwise upon such terms as the Committee shall in its discretion determine. An Optionee may purchase less than the total number of shares for which the Option is exercisable, provided that the exercise of an Option shall not include any fractional shares. As a condition to the exercise, in whole or in part, of any Option, the Committee may in its sole discretion require the Optionee to pay, in addition to the purchase price of the shares covered by the Option, an amount equal to any federal, state and local taxes that the Committee has determined are required to be paid in connection with the exercise of such Option in order to enable the Company to claim a deduction or otherwise. Furthermore, if any Optionee disposes of any shares of stock acquired by exercise of an Incentive Option prior to the expiration of either of the holding periods specified in Section 422(a)(1) of the Code, the Optionee shall pay to the Company, or the Company shall have the right to withhold from any payments to be made to the Optionee, an amount equal to any federal, state and local taxes that the Committee has determined are required to be paid in connection with the exercise of such Option in order to enable the Company to claim a deduction or otherwise. 9. METHOD OF EXERCISE (a) To the extent that the right to purchase shares has accrued, Options may be exercised from time to time by giving written notice to the Company stating the number of shares with respect to which the Option is being exercised, accompanied by payment in full of the purchase price for the number of shares being purchased and, if applicable, any federal, state or local 4 5 taxes required to be paid in accordance with the provisions of Section hereof. (b) Payment of the purchase price for any shares pursuant to the exercise of an Option may be made in cash or by check or, where expressly approved for the Optionee by the Committee, in its discretion, and where permitted by law: (i) by cancellation of indebtedness of the Company to the Optionee; (ii) by surrender of shares of Common Stock that are owned by the Optionee; (iii) by tender of a full recourse promissory note, which note shall be secured by the shares being purchased, contain such terms as may be approved by the Committee and bear interest at a rate sufficient to avoid imputation of income under Sections 483 and 1274 of the Code; (iv) by waiver of compensation due or accrued to the Optionee for services rendered; (v) provided that a public market for the Company's Common Stock exists: (1) through a "same day sale" commitment from the Optionee and a broker-dealer that is a member of the National Association of Securities Dealers (an "NASD Dealer") whereby the Optionee irrevocably elects to exercise the Option and to sell a portion of the shares so purchased to pay for the purchase price, and whereby the NASD Dealer irrevocably commits to forward the purchase price directly to the Company; or (2) through a "margin" commitment from the Optionee and a NASD Dealer whereby the Optionee irrevocably elects to exercise the Option and to pledge the shares so purchased to the NASD Dealer in a margin account as security for a loan from the NASD Dealer in the amount of the purchase price, and whereby the NASD Dealer irrevocably commits to forward the purchase price directly to the Company; or (vi) by any combination of the foregoing. If payment is made with shares of Common Stock, the Optionee, or other person entitled to exercise the Option, shall deliver to the Company certificates representing the number of shares of Common Stock in payment for the shares being purchased, duly endorsed for transfer to the Company and, if requested by the Committee, a representation and warranty in writing that he has good and marketable title to the shares represented by the certificate(s), free and clear of all liens and encumbrances. The value of the shares of Common Stock tendered in payment for the 5 6 shares being purchased shall be their Fair Market Value Per Share on the date of the Optionee's exercise. (c) Notwithstanding the foregoing, the Company shall have the right to postpone the time of delivery of the shares for such period as may be required for it to comply, with reasonable diligence, with any applicable listing requirements of any national securities exchange or any federal, state or local law. If an Optionee, or other person entitled to exercise an Option, fails to accept delivery of or fails to pay for all or any portion of the shares requested in the notice of exercise, upon tender of delivery thereof, the Committee shall have the right to terminate his Option with respect to such shares. 10. NON-TRANSFERABILITY OF OPTIONS No Option granted under the Plan shall be assignable or transferable by the Optionee, either voluntarily or by operation of law, otherwise than by will or the laws of descent and distribution, and shall be exercisable during his lifetime only by the Optionee. 11. CONTINUANCE OF EMPLOYMENT Nothing contained in the Plan or in any Option granted under the Plan shall confer upon any Optionee any rights with respect to the continuation of his status as an Employee of the Company or any Subsidiary or Parent Corporation of the Company or interfere in any way with the right of the Company or any Subsidiary or Parent Corporation of the Company at any time to terminate such relationship or to increase or decrease the compensation of the Optionee from the rate in existence at the time of the grant of an Option. 12. TERMINATION OF EMPLOYEE STATUS OTHER THAN BY DEATH OR PERMANENT DISABILITY Except as the Committee may determine otherwise with respect to any Non-Qualified Options granted hereunder, if an Optionee ceases to be an Employee for any reason other than his death or Permanent Disability, any Options granted to him under the Plan shall terminate not later than three months from the date on which such Optionee ceases to be an Employee unless such Optionee has been rehired by the Company and is an Employee on such date. Until the termination of the Option, the Optionee may exercise any Option granted to him but only to the extent such Option was exercisable on the date he ceased to be an Employee and provided that such Option has not expired or otherwise terminated as provided herein. A leave of absence approved in writing by the Committee shall not be deemed a termination for purposes of this Section, but no Option may be exercised during any such leave of absence, except during the first 90 days thereof. The fact that the Optionee may receive payment from the Company or any Subsidiary of the Company after termination of Employee status for vacation pay, for services rendered prior to termination, for salary in lieu of notice, or for other benefits shall not affect the termination date. 6 7 13. DEATH OR PERMANENT DISABILITY OF OPTIONEE Except as the Committee may determine otherwise with respect to any Non-Qualified Options granted hereunder, if an Optionee shall die at a time when he is an Employee or if the Optionee shall cease to be an Employee by reason of Permanent Disability, any Options granted to him under this Plan shall terminate not later than one year after the date of his death or termination of Employee status due to Permanent Disability unless by its terms it shall expire before such date or otherwise terminate as provided herein, and shall only be exercisable to the extent that it would have been exercisable on the date of his death or termination due to Permanent Disability. In the case of death, the Option may be exercised by the person or persons to whom the Optionee's rights under the Option shall pass by will or by the laws of descent and distribution. 14. STOCK PURCHASE NOT FOR DISTRIBUTION Each Optionee shall, by accepting the grant of an Option under the Plan, represent and agree, for himself and his transferees by will or the laws of descent and distribution, that all shares of stock purchased upon exercise of the Option will be received and held without a view to distribution except as may be permitted by the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. After each notice of exercise of any portion of an Option, if requested by the Committee, the person entitled to exercise the Option must agree in writing that the shares of stock are being acquired in good faith without a view to distribution. 15. PRIVILEGES OF STOCK OWNERSHIP No person entitled to exercise any Option granted under the Plan shall have any of the rights or privileges of a shareholder of the Company with respect to any shares of Common Stock issuable upon exercise of such Option until such person has become the holder of record of such shares. No adjustment shall be made for dividends or distributions of rights in respect of such shares if the record date is prior to the date on which such person becomes the holder of record, except as provided in Section 16 hereof. 16. ADJUSTMENTS (a) If the number of outstanding shares of Common Stock of the Company are increased or decreased, or if such shares are exchanged for a different number or kind of shares or securities of the Company through reorganization, merger, recapitalization, reclassification, stock dividend, stock split, combination of shares, or other similar transaction, the aggregate number of shares of Common Stock subject to the Plan as provided in Section hereof and the shares of Common Stock subject to issued and outstanding Options under the Plan shall be appropriately and proportionately adjusted by the Committee. Any such adjustment in the outstanding Options shall be made without change in the aggregate purchase price applicable to the unexercised portion of 7 8 the Option but with an appropriate adjustment in the price for each share or other unit of any security covered by the Option. (b) Notwithstanding the provisions of subsection (a) of this Section, the Plan and each outstanding Option shall terminate on the effective date of the dissolution or liquidation of the Company or any reorganization, merger or consolidation with one or more corporations or entities as a result of which the Company is not the surviving corporation, or any sale of all or substantially all the assets of the Company, or the sale of more than 80% of the then outstanding Common Stock, unless the surviving or acquiring corporation or other entity agrees to assume all outstanding Options; provided that the Committee may, in its sole discretion, accelerate the vesting of any outstanding Option or give notice of such event to Optionees prior to the effective date of such event. (c) Adjustments under this Section shall be made by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. No fractional shares of stock shall be issued under the Plan or in connection with any such adjustment. 17. AMENDMENT AND TERMINATION OF PLAN (a) The Board of Directors of the Company may from time to time, with respect to any shares at the time not subject to Options, suspend or terminate the Plan or amend or revise the terms of the Plan; provided that any amendment of the Plan shall be approved by the shareholders of the Company if the amendment would (i) increase the number of shares of Common Stock which may be issued under the Plan, except as permitted under the provisions of Section hereof, or (ii) materially modify the requirements as to eligibility for participation in the Plan. (b) No amendment, suspension or termination of the Plan shall, without the consent of the Optionee, alter or impair any rights or obligations under any Option theretofore granted to such Optionee under the Plan. (c) The terms and conditions of any Option granted to an Optionee under the Plan may be modified or amended only by a written agreement executed by the Optionee and the Company. 18. EFFECTIVE DATE OF PLAN This Plan shall become effective upon adoption by the Board of Directors of the Company and approval by the Company's shareholders; provided, however, that prior to approval of the Plan by the Company's shareholders, but after adoption by the Board of Directors, Options may be granted under the Plan subject to obtaining the shareholders' approval of the adoption of the Plan. Notwithstanding the foregoing, shareholders' approval must occur no later than 12 months after the date of adoption of the Plan by the Board of Directors. 8 9 19. TERM OF PLAN No Option shall be granted pursuant to the Plan after 10 years from the earlier of the date of adoption of the Plan by the Board of Directors of the Company or the date of approval of the Plan by the Company's shareholders. The Plan was adopted by the Board on January 17, 1996. The Plan was approved by the shareholders on , 1996. 9 EX-10.10 4 MANAGEMENT BONUS PLAN 1 EXHIBIT 10.10 MANAGEMENT BONUS PLAN For Fiscal Year Ending February 28, 1997 The participants in the Management Bonus Plan are the officers of the Company. Each participant shall receive a bonus in an amount not to exceed 50% of such participant's base salary. The bonus shall be an amount equal to the sum of: (i) 2% of base salary for every 12 1/2% incremental increase in fiscal year 1997 bookings over fiscal year 1996 bookings, up to a maximum 15% of base salary; (ii) 2% of base salary for every 12 1/2% incremental increase in fiscal year 1997 shipments over fiscal year 1996 shipments, not to exceed 15% of base salary; and (iii) 2% of base salary for every 12 1/2% incremental increase in income before taxes for fiscal year 1997 over fiscal year 1996. The term "base salary" shall refer to each individual's base salary for the fiscal year prior to any adjustments required by the Company's variable compensation plan. EX-23.1 5 DELOITTE & TOUCHE CONSENT 1 Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33 - 6659, 33-29615, 33-44807 and 33-72922 on Form S-8 and in Registration Statement Nos. 33-87704 and 333-1847 on Form S-3 of our report, dated May 3, 1996, appearing in this Annual Report on Form 10-KSB of Dense-Pac Microsystems, Inc. for the year ended February 29, 1996. /s/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP Costa Mesa, California May 28, 1996 EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM YEAR-END REPORT, FORM 10-KSB FOR YEAR ENDING FEBRUARY 29, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-KSB FOR YEAR-END FEBRUARY 29, 1996. 12-MOS FEB-29-1996 MAR-01-1995 FEB-29-1996 4,579,840 0 3,614,822 40,000 5,151,106 13,742,843 5,089,217 1,640,357 17,668,013 2,617,239 0 0 0 15,795,004 0 17,668,013 18,006,091 18,006,091 12,935,789 16,233,255 0 40,000 224,355 1,548,481 (149,200) 1,697,681 0 0 0 1,697,681 .11 .11
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