-----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, D4hBXROvouh/gFFGYRk1H/UULCq58gpX+eAhdzrA9Vmu++CTCip+vCBP1rYCtZ31 vIsofqPZdNQN8W6PfQmDpg== 0000891618-95-000568.txt : 19951002 0000891618-95-000568.hdr.sgml : 19951002 ACCESSION NUMBER: 0000891618-95-000568 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19950630 FILED AS OF DATE: 19950928 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: OCTEL COMMUNICATIONS CORP CENTRAL INDEX KEY: 0000792723 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 770029449 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16588 FILM NUMBER: 95576802 BUSINESS ADDRESS: STREET 1: 890 TASMAN DR CITY: MILPITAS STATE: CA ZIP: 95035 BUSINESS PHONE: 4083212000 10-K 1 FORM 10-K FOR FISCAL YEAR ENDED JUNE 30, 1995 1 As filed with the Securities and Exchange Commission on September 28, 1995 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K /X/ Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [Fee Required] For the fiscal year ended June 30, 1995 or / / Transition report pursuant to section 13 or 15(d) of Securities Exchange Act of 1934 [No Fee Required] For the transition period from ________ to ________ Commission file number 0-16588 OCTEL COMMUNICATIONS CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 77-0029449 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1001 Murphy Ranch Road Milpitas, California 95035-7912 (Address of principal executive offices) Registrant's telephone number, including area code, is (408) 321-2000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Common Share Purchase Rights (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ The aggregate market value of the voting stock held by nonaffiliates of the registrant as of September 19, 1995 was $638,165,602 based upon the last sale price reported for such date on The Nasdaq National Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the registrant have been excluded because such persons may be deemed to be affiliates. This determination is not necessarily conclusive. The number of shares of the registrant's Common Stock outstanding as of September 19, 1995 was 24,593,596. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Annual Meeting of Stockholders of Octel Communications Corporation tentatively scheduled to be held on November 16, 1995 are incorporated by reference in Part III of this Report on Form 10-K. 2 TABLE OF CONTENTS
PAGE ---- PART I ........................................................................................ 4 ITEM 1. BUSINESS................................................................................ 4 Introduction............................................................................. 4 Corporate Strategy....................................................................... 5 Customer Base............................................................................ 7 Products................................................................................. 8 Sales, Customer Support and Warranties................................................... 10 Backlog.................................................................................. 11 Competition.............................................................................. 12 Manufacturing............................................................................ 14 Research and Development................................................................. 14 Government Regulation.................................................................... 15 Patents, Copyrights, Trademarks and Technology Licenses.................................. 16 Employees................................................................................ 17 ITEM 2. PROPERTIES.............................................................................. 17 ITEM 3. LEGAL PROCEEDINGS....................................................................... 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................................... 18 EXECUTIVE OFFICERS OF OCTEL COMMUNICATIONS CORPORATION.................................................. 18 PART II ........................................................................................ 20 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..................................................................... 20 ITEM 6. SELECTED FINANCIAL DATA................................................................. 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................................... 21 Basis of Presentation................................................................... 21 Results of Operations - Annual.......................................................... 21 Net Revenues............................................................................ 21 Cost of Systems and Services............................................................ 23 Research and Development................................................................ 24 Selling, General and Administrative..................................................... 24 Non-recurring Charge for Acquired In-process Research and Development................... 25 Integration Costs....................................................................... 25 Interest and Other Income (Expense), Net................................................ 25
2 3 TABLE OF CONTENTS (CONTINUED)
PAGE ---- Income Taxes..................................................................................... 25 Dividends........................................................................................ 26 Results of Operations - Quarterly ............................................................... 26 Liquidity and Capital Resources.................................................................. 27 Factors That May Affect Future Results of Operations............................................. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................. 30 Index to Consolidated Financial Statements..................................................... 30 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..................................................... 50 PART III ........................................................................................ 50 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...................................... 50 ITEM 11. EXECUTIVE COMPENSATION.................................................................. 50 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.............................................................................. 50 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................................... 50 PART IV ........................................................................................ 50 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K................................................................................ 50 (a) 1. Consolidated Financial Statements and Financial Statement Schedule...................................................................... 50 2. Exhibits...................................................................... 51 (b) Reports on Form 8-K................................................................ 52 (c) Exhibits........................................................................... 52 (d) Financial Statement Schedule....................................................... 52 SIGNATURES ...................................................................................... 53
3 4 PART I ITEM 1. BUSINESS Octel Communications Corporation (Octel or the Company) is a world leader in voice processing technology, with a market share estimated by Dataquest to be approximately 23%. Octel's voice processing technology integrates with both telephone and data networks. The Company's broad array of products and services allows users to communicate more effectively by making it simple to deliver and exchange information over world-wide communications networks. Over 29 million Octel mailboxes have been deployed in over 40 countries. The Company sells and supports hardware and software and is a major provider of voice messaging services in both the public and private sectors. The Company's products and services enable people to send voice and fax messages to each other and to have their telephones and fax calls answered by a voice mail system. Octel's 18,000 customers include many small and medium-sized businesses, large international corporations (including over 70% of the Fortune 50), universities, governments, major telephone companies and many major cellular providers worldwide. The Company was reincorporated in Delaware in December 1989 as the successor to a California corporation and a related corporation and research and development limited partnership first formed in 1982. INTRODUCTION Over the past few years, the communications environment has broadened substantially. The demand for communications has created many different options such as voice messaging, telephone answering, telecommunications, fax, paging, overnight couriers, radio systems, postal delivery systems and the Internet for both business and personal use. Because of information's great importance, communication tools are more pervasive and important in people's lives than ever before. The Company's customers use voice messaging technology to meet a number of objectives, including increased efficiency, improved customer service, enhanced business competitiveness, increased operating flexibility and greater employee productivity. Voice messaging allows the user to be accessible 24 hours a day. With fax processing capabilites, subscribers can efficiently receive, store, retrieve and redirect fax documents using any touch-tone phone. Voice messaging has a number of advantages over electronic mail (e-mail) and other communication mediums. Voice messaging: - - TAKES ADVANTAGE OF THE ACCESSABILITY OF THE TELEPHONE TO SEND AND RECEIVE MESSAGES. Users can send or listen to voice messages from nearly any telephone at any time. E-mail requires that users have access to a computer. Computer access while traveling or at home can be inconvenient or not readily available. - - IS SIMPLE, FAST AND CONVENIENT. Speech is one of our most basic skills. Voice messaging allows users to take advantage of this skill and to convey emotions, humor, subtlety and nuance in a message-characteristics that are much more difficult to duplicate in a written format. Furthermore, voice messages are quick and easy to create and send. - - DOESN'T REQUIRE A "REAL-TIME" SCHEDULE. With messaging, one party sends a message when it is convenient for them; the receiving party (or group) listens to the message and responds at their convenience. There is no need to arrange for a time that is mutually convenient for all parties, and so communications need not be deferred until everyone is available. This ability is especially useful when traveling or messaging across time zones. - - IS IDEALLY SUITED FOR MESSAGING TO GROUPS. In the developed parts of the world, nearly everyone has a telephone. In developing regions, many people are gaining access to phone lines through wireless services. As a result, a single voice message can be distributed to a broad audience. 4 5 - - USES FIXED LINE AND WIRELESS TELEPHONE NETWORKS TO SEND AND RECEIVE MESSAGES. These networks are generally more pervasive and reliable than data communications networks such as the Internet, on-line services and in-house networks. Voice messaging is increasingly available to small businesses and homes via telephone and cellular providers. Despite these advances, it is still difficult to connect incompatible systems internally and externally and to interconnect global sites. The Company believes this has been a barrier to effective messaging. Over the past three years, the Company has endeavored to develop a network that would allow seamless voice messaging among disparate systems and ultimately allow messaging to anyone with a telephone number and networking capability. With the introduction of OcteLink services in July 1995, the barrier to effective messaging is being overcome. Using OcteLink provides ubiquitous message exchange regardless of the voice processing system used or its location. CORPORATE STRATEGY Broad Product Line After becoming a publicly traded company in 1988, Octel pursued a strategy of both vertical and horizontal integration. Having developed the broadest range of voice processing systems in the industry, Octel acquired several companies which expanded the range of its product and service offerings. In 1992, the Company merged with the PC Products Division (OPCPD, formerly Compass), a software developer and marketer of personal computer (PC) based voice processing systems. In 1992, the Company also acquired Octel Network Services (ONS, formerly Tigon), from Ameritech, a Regional Bell Operating Company (RBOC) based in Chicago, Illinois. ONS specializes in the outsourcing and management of voice messaging systems. In March 1994, the Company merged with VMX, Inc. (VMX), a designer, manufacturer and marketer of integrated voice mail systems and software products. The VMX product lines were integrated with Octel's product line in early fiscal 1996. As part of the merger, the Company also acquired VMX's subsidiary, Rhetorex, a designer and manufacturer of voice processing components for PCs including board-level hardware and operating system software. The Company has also acquired certain intellectual and personal property from other companies such as its fiscal 1992 acquisition of a provider of interactive voice response technology in Israel and its fiscal 1995 acquisition of certain assets of a French software company which provides voice processing solutions for the Voice Information Services (VIS) marketplace. The key strengths of Octel's broad product and service offerings are its: - - LARGE INSTALLED BASE/GLOBAL PRESENCE: With over 45,000 systems installed at more than 18,000 customers in over 40 countries, Octel has a large installed base from which it may derive future revenues in the form of upgrade options, replacement products and new technology enhancements. - - BROAD PRODUCT LINE: Octel's solutions meet the needs of emerging companies, small- to medium-sized businesses with satellite offices and branch offices, and multinational corporations with large branch offices and subsidiaries worldwide. Recently, the Company consolidated its Octel and VMX products into a single product family called the Octel Overture Message Server family. These products are scalable, designed for multi-application environments and support the most widely deployed messaging software in the world. In addition to the Overture product family, the Company also designs and sells the Sierra system, which is a multi-application voice information processing system specifically designed to meet the special needs of telephone companies and other VIS customers. - - COMPATIBILITY WITH PUBLIC BRANCH EXCHANGE (PBX) SYSTEMS: Octel's voice messaging systems work with nearly every brand of PBX system in the world. 5 6 - - UPGRADEABILITY: Octel's voice messaging solutions enable businesses of all sizes to protect their technology investments and to expand and grow as their needs change. For example, customers who invested in Octel's original Aspen system eleven years ago can migrate to one of the new Octel Overture Message Servers without losing some important resources - their voice mail database information, applications, software features, voice recordings and messages. Furthermore, Octel's Capacity On Demand (COD) software allows customers to enable additional message storage hours, system mailboxes and fax capabilities on an as-needed basis. - - ENTERPRISE-WIDE NETWORKING: As corporations move toward distributed, enterprise-wide information systems, networking capabilities become even more crucial. Via OctelNet, the Company's networking software application, Octel customers on Octel systems at different locations can exchange messages. Via "digital networking," customers can use their existing Local Area Network (LAN) and Wide Area Network (WAN) infrastructure to transfer voice messages between users. This serves to improve speed and voice quality while leveraging existing technology investments to reduce costs. In the future, it is anticipated that the integration of voice on the information superhighway will allow voice and fax messages to be accessed, manipulated and transferred just like any other digital data by devices of all types - from desktop computers to personal digital assistants. The Company's Digital Networking, announced in March 1995, represents a key component of Octel's vision to bring voice processing to enterprise networks worldwide. Octel is continuing to enhance its product lines and plans to introduce digital networking on all product platforms in the next few years. - - OCTEL NETWORK SERVICES: ONS is the largest voice messaging outsourcing organization in the world. It performs millions of messaging transactions for approximately 900,000 end users from more than 600 customers on a daily basis. An increasing number of the Company's GBS and VIS customers are recognizing the benefits of outsourcing the management of their voice mail networks. ONS provides complete voice mail network management, disaster recovery, voice processing services, operations management, systems administration and project management. - - STRONG DISTRIBUTION PARTNERS: Octel has a strong distribution network to reach corporations, governments and institutions through a combination of direct sales, independent distributors and original equipment manufacturers (OEMs) in the United States and international markets. - - COMPLETE SOLUTION: The Company competes in two major markets: Global Business Solutions (GBS) for corporations, institutions and governments and VIS for service providers. Furthermore, Octel provides software, hardware, outsourcing and customer services and support to customers in both GBS and VIS markets giving the Company a broad infrastructure to support customers' voice messaging needs globally. Octel's Messaging Strategy In July 1995, Octel introduced OcteLink, a revolutionary new form of global voice message exchange. Octel's ultimate goal is to link all voice messaging systems and services together over the telephone network so that anyone, anywhere with access to a telephone and networking capability - regardless of protocol, system size or geographic location - will be able to send a voice message to anyone else. Octel has developed a two-pronged approach to address this global messaging strategy: - - First, Octel is developing "unified messaging" products for voice, fax and e-mail messaging. Unified messaging essentially unites voice, fax and e-mail messaging together in a client/server architecture using standard PC and LAN technology. This integration brings together several discrete technologies into a single mailbox that provides user access from a telephone or a PC. In May 1995, Octel announced the first component of its unified messaging technology. Octel's first implementation of unified messaging will be available on Microsoft Exchange, a LAN-based, enterprise-wide messaging architecture. - - Second, Octel's goal is to expand the messaging network beyond traditional user boundaries. Octel has developed OcteLink - the world's first "messaging post office" that allows the interconnection of virtually any voice mail system, regardless of protocol, system size or geographic location. OcteLink's global message 6 7 exchange is intended to make it easier to send or receive voice mail, fax and, in the future, e-mail messages. This global messaging network is designed to link commercial, residential and institutional customers worldwide. Strategic Business Units Octel has historically focused on two principal customer markets: Global Business Solutions (formerly Customer Premise Equipment) and Voice Information Services. At the same time, the Company continued to broaden its product line to address these markets. Accordingly, in fiscal 1995, the Company's management was reorganized to center on three Strategic Business Units which are focused on serving the specific needs of the respective markets: Global Business Solutions (GBS). GBS markets include small to large corporations, institutions and government agencies worldwide. Octel's GBS group provides a wide range of voice messaging hardware, software and services to a number of these customers. Product sales to the corporate market include proprietary systems designed to meet the communications needs of mid-sized to large-sized domestic and international corporations, PC-based voice messaging systems for small businesses from OPCPD and components to Value Added Resellers (VARs) and OEMs from the Company's Rhetorex subsidiary. Voice Information Services (VIS). Octel's VIS group provides a wide range of voice processing hardware, software and services to voice information service providers such as RBOCs, independent telephone companies, wireless communications companies and service bureaus around the world. The VIS group also pursues opportunities in the international market for "virtual telephone" applications. Such applications use the voice mailbox as a substitute for simultaneous communication in those countries in which basic telephone service is difficult or costly to obtain. Both the GBS and VIS business units provide services to customers including maintenance, spares and support, educational and consulting services. Maintenance, spares and support operates a 24-hour Customer Services Center in San Jose, California focused on providing domestic GBS customers the highest "system availability" utilizing the latest call center technology and training. Educational Services offers both classroom-based and computer-based training programs in the United States and Europe that allow customers to leverage their investments in the Company's products. Consulting Services offers fee-based services to design and develop sophisticated call processing business solutions for both GBS and VIS customers. Services. This strategic business unit is comprised of ONS and OcteLink and sells to customers in both the GBS and the VIS markets. The Company's ONS division is a leading provider of voice information processing services and private network management to organizations wishing to outsource their voice processing needs. ONS operates its own independent voice processing network that spans the United States and provides international links to Canada, Europe, Japan and Australia. OcteLink is a global message exchange intended to make it easier to send or receive voice mail, fax and, in the future, e-mail messages. This global messaging network is designed to link commercial, residential and institutional customers worldwide. CUSTOMER BASE By the end of fiscal 1995, Octel had an installed base of over 45,000 systems in more than 40 countries, representing a total of over 29 million mailboxes. No single customer accounted for more than 10% of the Company's total net revenues for fiscal 1995, 1994 or 1993. The Company's GBS customers account for over 9 million mailboxes worldwide. Corporate customers include over 35 companies in the Fortune 50 group, including Amoco, General Electric, Hewlett-Packard and Prudential Insurance. The Company's VIS customers are comprised of 130 service providers in 25 countries, including six of the seven RBOCs and all major Canadian telephone companies. In Europe, Octel is strong in providing voice processing services to Europe's Global System for Mobile Communications (GSM) cellular network and its 7 8 emerging business and residential markets. VIS customers include AT&T Wireless (formerly McCaw Cellular), Cambridge Cable, Leicester Cable, Mannesmann Mobilfunk (Germany), New Zealand Telecom, Piltel (Philippines), Radiolinja (Finland), Telcel (Mexico), Telecom Italia (formerly SIP), U.S. West and Vodacom (South Africa). Octel has more than 20 million mailboxes deployed with over 15 million subscribers in the VIS market. PRODUCTS Octel's broad product family ranges from two-port systems for as few as 20 subscribers to 432-port systems for up to 120,000 subscribers in certain VIS applications. GBS Products Octel recently consolidated all Octel and VMX products into a single product family with increased functionality and COD software via the introduction of the Octel Overture family of message servers. These message servers consolidate eleven different products into a family of five servers and three software products designed to provide customers with better price/performance, greater flexibility for system expansion, enhanced management tools and Octel's 24-hour-per-day, seven-day-per-week service and support. The new Octel Overture product line offers common features, one of two caller interfaces for those calling into an Octel system, a common pricing arrangement and a common networking scheme via the OctelNet protocols and the new OcteLink global messaging networks. The GBS offering currently includes the Octel Overture PC, Overture 200, Overture 250, Overture 300 and Overture 350. Overture products feature one of the following user interfaces: Octel Overture PC offers the Performer interface; Octel Overture 200 and 300 products offer the Serenade interface; Octel Overture 250 and 350 products offer the Aria interface. - - OCTEL OVERTURE PC (formerly Call Performer Plus) is a PC-based system designed for small branch offices and remote sites. - - OCTEL OVERTURE 200 (formerly the VMX 200) is a mid-level system designed for small-to-medium-sized offices and branch sites. - - OCTEL OVERTURE 250 (new product announced in July 1995 which replaces Branch, Aspen and Maxum) is a mid-level system designed for medium-sized businesses or large branch offices in the U.S., Canada and the United Kingdom. - - OCTEL OVERTURE 300 (formerly the VMX 300) is a mid- to high-end system designed for larger companies or institutions worldwide. - - OCTEL OVERTURE 350 (formerly the Aspen XC1000) is a high-end system designed for Fortune 500 companies in the United States and Canada. - - SOFTWARE SETS: Overture software products are now called Aria (replaces Aspen); Serenade (replaces D.I.A.L.) and Performer. 8 9 System models and specifications include the following:
Number of Number Hours of Model Subscribers Served (1) of Ports Message Storage ----- ---------------------- -------- --------------- Overture PC 2,000+ 4 - 16 12+ Overture 200 up to 5,000 4 - 64 5 - 540 Overture 250 up to 15,000 4 - 72 5 - 485 Overture 300 up to 10,000 4 - 128 5 - 1,085 Overture 350 up to 30,000 12 - 144 5 - 725
- ------------------ (1) The number of users actually supported will depend upon the specific customer application. As Octel focuses on high value software applications, the Company will be shifting the value of its GBS product offerings from hardware to software. An example of this software focus is COD, a feature that provides lower entry costs and greater scalability. With it, users can easily and cost-effectively expand the capacity of their message servers as their needs change. Octel has developed integrations which permit its systems to be compatible with, and to communicate directly with, virtually all major brands of PBX telephone systems, central office switches and cellular telephone switches. Integration enables the customer's voice information processing systems to exchange data with telephone switches from different manufacturers. Integration is necessary to permit several important voice processing features. It allows the caller to reach a subscriber's mailbox directly without dialing the subscriber's extension or mailbox number and allows message notification at the subscriber's telephone. VIS Products Octel's high-capacity Sierra platform is designed to meet the special needs of RBOC and independent telephone companies and other VIS providers by supporting multiple voice processing applications from within a single platform. Sierra is designed to be expandable to suit market growth and be capable of handling a very large number of subscribers. Sierra is also designed to meet Bellcore's Network Equipment Building Systems (NEBS) standards. When configured into a three-unit cluster, the Sierra currently supports up to 120,000 subscribers, 432 ports and 2,016 message storage hours. Client/Server Architecture for Integrated Messaging. In order to make its VIS product line more complete, Octel intends to expand the benefits, performance and capabilities of its Sierra platform with a next-generation client/server architecture, scheduled for first-phase release in fiscal 1996. This first phase release is intended to allow VIS service providers to build voice messaging "networks" that support millions of messaging subscribers on a single platform. Unlike closed architectures that inhibit the integration of new technologies into networks, Octel's open architecture will be designed to provide for flexible, integrated service creation for adding multiple new technologies or network platforms. It will offer faster and less expensive service creation for large subscriber bases, enabling service providers to create customized applications more easily for various countries or communities of interest. The architecture will consist of a UNIX/RISC-based application that serves as a dedicated service creation environment, a new back-end database server for running the new application and a specialized Sierra Media Server that will store and process voice and fax messages. All of the stand-alone elements are based on object-oriented technology - thereby providing developers with an easy to use point-and-click graphical environment that makes application development far easier. Octel's new client/server architecture will offer: 9 10 - - an open, flexible service creation environment - - scalable integrated services - - seamless, transparent network offerings - - high-performance client/server database The Company believes that the timely introduction and market acceptance of its next-generation client/server architecture is a key factor in determining the Company's success in the VIS market, and the Company is focusing significant resources and talent on developing and bringing products using this architecture to market. However, there can be no assurance that introduction of products using this architecture will not be delayed, allowing competitors to gain a market share advantage, or that such products will be successful in the marketplace. Services ONS. ONS is the largest voice messaging outsourcing organization in the world. ONS operates its own independent voice processing network that spans the United States and provides international links to Canada, Europe, Japan and Australia. ONS performs millions of messaging transactions for approximately 900,000 end users from more than 600 customers on a daily basis. An increasing number of the Company's GBS and VIS customers are recognizing the benefits of outsourcing the management of their voice mail networks. Some of the reasons companies are outsourcing include the customer's desire to focus on its core business, manage risk, control costs, improve overall quality, provide a guaranteed service level or to respond to a lack of internal resources. ONS provides complete voice mail network management, disaster recovery, voice processing services, operations management, systems administration and project management. OcteLink. In July 1995, Octel Services introduced OcteLink, the world's first network that interconnects virtually any voice messaging system with networking capability, regardless of protocol, system size or geographic location. OcteLink makes possible a global network and an administrative, service and support infrastructure that enables customers to link their voice processing and other messaging systems to Octel's network easily. Messages are sent to an OcteLink hub or "messaging post office" that processes and forwards the message to the appropriate recipient. The OcteLink hubs are connected via high-speed, digital data links designed for high-quality, rapid transport of messages. These post office hubs connect voice processing and other messaging systems, sort traffic and efficiently direct each message to its destination. The hub acts as a multimedia gateway - accepting voice, fax and, in the future, e-mail with delivery based on the recipient's terminal of choice: telephone (hard-wired or cellular), PC, personal digital assistant (PDA), laptop or fax machine. Like the Internet, OcteLink is based upon a strong existing infrastructure. In Octel's case, the network foundation is its private telecommunications network service: ONS, the world's largest voice mail service and outsourcing organization. OcteLink currently supports OctelNet, Octel analog and Audio Messaging Interchange Specifications (AMIS) messaging. Support for the Internet as a delivery network and additional voice mail and communications protocols is planned for the future. Octel will also make its protocols available to other vendors under licensing arrangements so that messages can be transmitted more easily. Although the Company believes OcteLink is a viable global messaging network, there is currently no reliable data regarding the demand for such services in multiple customer segments. Furthermore, there is no assurance that demand for a global messaging network will not be slow to materialize or that potential competitors will not successfully introduce alternative solutions to OcteLink that achieve better market acceptance. SALES, CUSTOMER SUPPORT AND WARRANTIES The Company sells and supports its voice processing systems through direct sales, independent distributors, VARs and OEM providers. This strategy reduces Octel's dependence on any single sales channel and is designed to improve market coverage and customer satisfaction for the Company's products. Direct sales operations in the United States are conducted from approximately 40 field offices and international direct sales operations are conducted from 11 10 11 offices. The Company's domestic GBS sales force is structured into four geographic areas, with each group responsible for sales - distributor, direct, and national account - within its area. A separate sales force is focused on opportunities in the domestic VIS market. Sales outside the United States are structured into three geographic territories - Canada, Europe and Intercontinental, which includes Asia-Pacific and Latin America. The Company believes that its network of distributors, VARs and OEM providers represents an important part of its overall sales strategy and that the loss of, or changes in the relationship with, or performance by, one or more of these sales channels could have an adverse effect on the Company's revenues and operating results. Distributors purchase products at discounts and, accordingly, the Company's operating margins can vary depending upon the mix between distributor and direct sales in any particular operating period. The Company anticipates that this mix will fluctuate in future operating periods. The Company offers a leasing alternative to its customers through its leasing division, Octel Capital. Customers who wish to lease the Company's products may do so using financing options available through the Company's sales organization. Sales outside the United States were approximately 25%, 24% and 24% of net revenues for fiscal 1995, 1994 and 1993, respectively. In fiscal 1995 and 1994, the majority of international sales were made in the United Kingdom and Canada. In fiscal 1993, the Company had substantial sales in Italy and the United Kingdom, as well as in Canada. In fiscal 1994, the Company formed wholly owned subsidiaries in Japan and Hong Kong to sell to customers in Japan and other Asia-Pacific countries. In addition, in December 1993, the Company and Alcatel Austria AG signed a joint product development and distribution agreement, pursuant to which Alcatel distributes and supports the Company's voice information processing products outside the United States and Canada. The Company's Customer Services Organization includes field engineers, customer support specialists and applications consultants who together provide installation and implementation assistance to end-user customers and distributors. This organization also administers technical software courses, system maintenance courses and customer support courses. The Company provides a warranty for parts and labor on its products which is generally for 12 months from date of shipment (or, if the Company installs the product, generally for 12 months from the date of installation). The Company maintains and services its products on a contractual basis after the initial product warranty has expired. Warranty and post-warranty service is provided directly to customers from Octel's district sales offices and through distributors, supplemented by major Octel support centers in California, the United Kingdom and Ontario, Canada. The Company maintains inventories of spare parts at a number of locations in the United States and internationally, including all Octel facilities and distributor locations, in order to provide prompt service. The Company operates a telephone support center 24 hours per day in San Jose, California to respond to requests for problem definition and resolution. ONS provides network management solutions throughout the United States to large corporate customers and selected foreign locations of its domestic customers, federal, state and local governments and not-for-profit organizations. Customers may choose to outsource their voice processing requirements completely through ONS rather than buy or lease equipment. ONS also provides services to Ameritech, the RBOC in the midwestern section of the United States. Through international marketing partners, ONS provides access from Australia, Europe and Japan to its voice processing network. ONS also provides complete voice processing services on a private-label basis for resale by VIS providers. BACKLOG The Company's backlog at June 30, 1995 was $74.4 million compared to $72.2 million at June 30, 1994. The Company measures its backlog as confirmed orders for equipment, maintenance contracts and Octel Network Services for the next six months. An increasing portion of the backlog is from the services business, which is more predictable and reduces dependence from quarter to quarter on systems business. Because of the possibility of customer changes in delivery schedules or cancellation of orders, the Company's backlog as of any particular date may 11 12 not be indicative of actual revenues for any future period. The Company believes that its backlog on a quarterly basis will not generally be large enough to assure that its revenue targets for a particular quarter will be met. Furthermore, a large percentage of any quarter's shipments are booked in the last month of the quarter. Consequently, quarterly revenues and operating results will depend on the volume and timing of new orders received during a quarter, which are difficult to forecast. This is particularly true in the VIS marketplace, where sales orders are generally larger. Fourth quarter revenues are typically enhanced by sales incentives provided to employees and promotion programs for customers, while first quarter sales are traditionally not as strong. This seasonal pattern is likely to continue. COMPETITION The voice information processing industry is highly competitive and the Company believes that competition from new and existing competitors will continue to intensify. The Company competes with different companies in the different customer markets it serves and the principal competitive factors vary depending on the customer market. The Company believes that competition to date for the sale of voice information processing systems in its principal customer markets has been based on product features, system performance, product quality and reliability, price, service and post-sales support, and marketing and distribution capabilities. The Company believes that it competes favorably with respect to these competitive factors. Global Business Solutions In the corporate and institutional markets, Octel competes primarily with two types of companies: PBX manufacturers including AT&T, Northern Telecom Limited and Siemens Rolm Communications, Inc.; and independent voice processing manufacturers, such as Centigram Communications Corporation, as well as PC-based system suppliers, including Active Voice Corporation and Applied Voice Technology, Inc. (AVT). The PBX manufacturers sell voice processing products that integrate principally with their own PBXs. These companies have considerably greater financial, technical, marketing and sales resources than the Company, and may have a competitive advantage when customers are purchasing a voice processing system at the same time they are purchasing a new PBX. They also benefit from the large installed base of their own brands of PBXs. PBX manufacturers have intensified their competitiveness by focusing on low prices, providing single source procurement and by selling voice processing equipment as a PBX peripheral device with limited, core voice processing functionality such as telephone answering and voice mail. The Company believes that its competitive strengths compared to these PBX manufacturers are its multi-application voice processing systems, the broad set of features incorporated into the Company's products, including its multiple technology applications such as fax processing, a more friendly user interface, the ability to integrate with the PBXs of multiple manufacturers and networking. The Company also believes that development and delivery of customer applications will increase in importance as a competitive factor as customers demand not only core voice processing functionality, such as telephone answering and voice messaging, but also IVR, fax, audiotex and integration with computer networks. The independent voice processing manufacturers (including Centigram, AVT and Active Voice) also offer multiple integrations with PBXs. The Company believes that its competitive strengths compared to these companies are its large installed base, strong support organization, broad set of features, strong financial condition and substantial cumulative investment in research and development. The Company also believes that its direct and distributor channels of distribution allow it to compete favorably with companies with only one channel of distribution. Furthermore, the Company believes that its application generators and application development specialists represent an opportunity to provide applications tailored to meet the needs of vertical and horizontal markets as well as providing unique solutions for individual customers. Indirect competitors may be able to compete more directly with the Company in selling to larger corporate customers and VIS providers by increasing system capacities and adding new system capabilities and applications. To the extent the Company markets additional applications that enable interaction with host computers, suppliers of such other systems as interactive voice response systems will become more direct competitors. 12 13 The Company expects that new or enhanced products will be offered by its principal existing competitors and new competitors, including large domestic and international telecommunications and computer companies. The Company also expects that computer software vendors such as Novell, Inc., Lotus Development Corporation (a subsidiary of IBM) and Microsoft Corporation will continue to develop enhanced messaging and networking software with voice and data information processing applications. A large number of voice processing companies compete primarily in the market for smaller capacity systems (fewer than 16 ports) that are typically sold to smaller customers or to small offices of larger companies; however, some of these companies also use success in the smaller capacity systems market to penetrate the large capacity systems market. Some of these competitors primarily emphasize their automated attendant and call processing capabilities, while others focus on voice messaging applications. In addition, a number of companies produce personal computer add-on cards and software primarily aimed at specialized applications or small user groups. The primary competitors for the Company's PC products include other PC-based system suppliers including Active Voice and AVT. Certain PBX manufacturers, including AT&T and Northern Telecom, also offer competitive products to small businesses which are generally tailored to a specific brand of PBX. The market for smaller capacity systems is characterized by intense competition on price and sales coverage. The Company believes that as smaller businesses become more familiar with voice processing and its benefits, enhanced feature content will become increasingly important for small capacity systems. The Company believes that its PC-based products compete favorably against products from other PC-based vendors and PBX manufacturers because of their feature set and the Company's extensive dealer network. Competitors in the international corporate and institutional market segment vary by country and include both United States and foreign companies. In the past, international competition was less significant as markets outside of North America were less developed and competitors were in the early stages of developing their business strategies. As the international markets have developed, competition from traditional competitors as well as local start-up companies has increased. These competitors are primarily in the market for smaller capacity systems, which present competitive risks similar to those discussed above. Octel believes that factors in its favor in international markets are the broad set of features in its existing products, including its multiple technology applications, its large installed base of multinational companies and its strong financial condition. The Company's international competitive position also benefits from the distribution alliances that the Company has established with nearly 20 organizations, including Alcatel NV, a division of Alcatel Alsthom, Bull S.A., Telefon AB LM Ericsson, Hitachi, Italtel, J.S. Telecom, Mercury Communications, a subsidiary of the Cable & Wireless Group, and Siemens AG. Voice Information Services In the VIS market, Octel currently competes with Boston Technology, Centigram, Comverse, Digital Sound, Ericsson, Glenayre, Tecnomen and Unisys. Octel anticipates that this list of competitors will continue to change and evolve and that other competitors, potentially including the RBOCs, may enter the market in the future. Other telecommunications and computer companies, including some large companies that currently supply network and corporate infrastructure equipment to the RBOCs and some companies with greater financial and technical resources than the Company, are expected to enter the VIS market. In addition, although currently barred from such activities by governmental regulations stemming from the breakup of AT&T in 1984, the RBOCs may be allowed to manufacture their own voice processing equipment at some time in the future. The Company believes that specific product requirements are becoming clearer as the RBOCs and other telephone companies are gaining more experience with VIS. The Company continues to develop enhancements to its Sierra product to address what the Company believes are the emerging requirements of the telephone companies and other service providers. However, there can be no assurance that product requirements will not change as this market develops or that other companies will not be faster or more successful in bringing comparable products to market. The Company believes that the key competitive factors in the VIS market are likely to depend on the method of implementing voice information services used by the specific VIS provider. In this market, the Company believes it benefits from its greater experience in providing voice processing systems, its installed base and the reliability, capacity and broad feature functionality of its products. In addition, against certain competitors, the Company competes favorably on the basis of its strong financial condition and its limited reliance on any single customer for its viability. 13 14 Competition in the international VIS market has primarily come from those companies based in and currently competing in the United States. As in the international GBS market, the primary competitors in international VIS markets may change as the market for voice information services develops and additional vendors are attracted. The Company believes that its strengths in the domestic VIS market will be valuable to the Company in international VIS markets. Current competitors or new market entrants in both the GBS and VIS markets may introduce and commercially deliver new products with features and expanded capabilities that could adversely affect the competitive position of the Company's systems in some or all of its markets. In order to maintain its competitive position, the Company must continue to develop and market new products successfully and enhance its existing products, and there is no assurance that the Company will be able to do so. Increased competitive pressures could result in intensified price competition in the Company's markets, which would adversely affect the Company's net revenues and net income. ONS ONS competes both with other voice processing service providers and with equipment manufacturers. Other services suppliers include independent companies such as VoiceCom and VoiceTel. ONS also competes with equipment manufacturers if the customer is uncertain whether to outsource its voice processing through a service provider such as ONS or purchase equipment from a manufacturer. In situations where a customer's capital budget is constrained or resources to manage systems are not present, ONS' service solutions become attractive as compared to equipment purchases. The Company believes that ONS competes favorably in the outsourcing market because of its proven experience in the business of providing outsourcing services as Tigon Corporation, years of network development and management and Octel's strong consolidated financial position. MANUFACTURING The Company's manufacturing operations consist primarily of final assembly and extensive test and quality control of materials, components, subassemblies and systems. Most of the Company's high-end hardware and software product designs are proprietary, except for some peripheral products. Low-end products, such as PC products, are designed with a more open architecture. The Company currently manufactures its products in San Jose, California. The Company presently uses third parties to perform printed circuit board assembly and sheet metal fabrication. Although the Company generally uses standard parts and components for its products, certain components, including power supplies, disk drives and certain semiconductors, are presently available only from a single source or from limited sources. The Company, to date, has been able to obtain adequate supplies of these components in a timely manner from existing sources or, when necessary, from alternative sources of supply. There can be no assurance, however, that such supplies will be available in the future or, if such supplies are available, that they will be available at reasonable prices. The inability to develop such alternative sources if and as required in the future, or to obtain sufficient sole or limited source components as required, would adversely affect the Company's total net revenues and net income. RESEARCH AND DEVELOPMENT The Company believes that the continued timely development of new products and enhancements to its existing products is essential to maintaining the Company's market position, and this effort requires a high level of expenditures by the Company for research and development. The Company has continued to improve the features, capabilities, capacity and price/performance of its product line while maintaining compatibility with its customers' existing installations. The Company is currently involved in the development of new products and enhancements to its existing products to increase performance, reliability and manufacturability. The Company must continue to retain skilled research and development personnel, particularly software and hardware engineers who are generally in short supply. The Company, from time to time, has purchased and anticipates that it will continue to purchase technology from third parties. 14 15 The Company releases performance enhancements and new features for its products on an ongoing basis. As the functionality of the Company's systems increases, the complexity of the software will also increase. Although the Company performs rigorous testing prior to releasing its product designs, products as complex as the Company's often contain undetected errors or "bugs" when first released, and these errors are discovered only after the product has been used by many different customers and in varying applications. Because of the importance the Company places on product reliability, the Company has from time to time temporarily delayed product shipments to complete "debugging" efforts. In addition, the Company has been required, in a few instances and primarily for VIS customers, to write custom software and to make design modifications to satisfy customer application requirements. Identifying and correcting errors and making required design modifications typically is expensive and time-consuming and the Company expects such modifications to increase in complexity with the increasing sophistication of the Company's products. Despite extensive testing, there can be no assurance that errors will not cause delays in product introductions and shipments, require design modifications or impair customer satisfaction, which could adversely affect operating results. During fiscal 1995, 1994 and 1993, the Company spent $74.6 million, $58.3 million and $44.4 million, respectively, on research and development. The Company expects to continue to increase expenditures on research and development in fiscal 1996 in absolute terms and these expenses could increase as a percentage of total net revenues. During fiscal 1995, 1994 and 1993, the Company entered into development contracts with certain customers whereby the Company performed development work on applications software using customer funds. During fiscal 1995, $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was recognized as revenue and $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was charged to cost of sales for projects completed. No internal software development costs have been capitalized to date under the provisions of Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." Prior to the merger of Octel and VMX, VMX had capitalized certain software development costs and incurred annual amortization expense. In March 1994, in connection with the VMX merger, the Company incurred a one-time pre-tax charge to cost of sales of $1.1 million to write off certain capitalized software development costs to conform accounting practices. GOVERNMENT REGULATION Voice messaging services and telecommunications equipment manufacturing are regulated almost exclusively at the federal level, if at all. Other than routine equipment registration for devices attached to the public switched telephone network, the Company is not subject to federal telecommunications regulations. State regulatory authorities have sought to regulate some aspects of intrastate telephone answering and voice messaging services offered by telephone companies and may seek in the future to regulate such services offered by independent service providers such as the Company. At present, however, the Company is not subject to such state regulation. The activities of the RBOCs are subject to ongoing oversight by the United States District Court for the District of Columbia under the terms of the 1984 consent decree governing the breakup of AT&T. The consent decree imposed certain "line of business" restrictions which, among other things, prevent the RBOCs from offering voice messaging services that originate in one Local Access and Transport Area (LATA) and terminate in another LATA without prior approval of the District Court. The consent decree also prohibits the RBOCs from manufacturing telecommunications equipment. The RBOCs are allowed to provide customer premise equipment (CPE) and to acquire both CPE and telecommunications equipment for their own use. The RBOCs may only offer voice messaging and related services using equipment purchased or leased from unaffiliated companies such as Octel. In offering voice messaging and other "enhanced" services within LATAs, the RBOCs are also subject to various regulatory requirements of the Federal Communications Commission adopted to ensure nondiscriminatory access to RBOC customers and deter cross-subsidization by the RBOCs. These restrictions on the RBOCs may change in the near future because of legislation pending in the United States Congress. As of August 1995, two separate bills had passed both the House and the Senate, H.R. 1555 and S. 652, respectively. The legislation would supersede the consent decree and permit the RBOCs to manufacture telecommunications equipment and to provide inter-exchange services after complying with requirements to open their telephone networks and markets to competition. It would also allow the RBOCs to collaborate or enter royalty 15 16 agreements with telecommunications equipment manufacturers such as the Company upon satisfaction of statutory requirements. While the legislation, in some form, is expected to become law, its passage is by no means certain. PATENTS, COPYRIGHTS, TRADEMARKS AND TECHNOLOGY LICENSES The Company relies on a combination of patent, copyright, trade secret and trademark law, licensing and technical measures to protect its intellectual property. There can be no assurance that the Company's efforts to protect its intellectual property will be successful. The Company holds 31 United States patents and has 13 patent applications pending in the United States. The Company's issued patents expire on dates ranging from 2002 to 2010. The Company also has patent applications pending in many foreign countries. There can be no assurance that the Company will be able to protect its technology or that competitors will not be able to develop similar technology independently. No assurance can be given that patents will be issued from any applications filed by the Company or that, if patents are issued, the claims allowed will be sufficiently broad to protect the Company's technology. In addition, no assurance can be given that any patents issued to the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to the Company. In spite of the possible strength of the Company's existing and future patents, the Company believes that patents are of less significance in its industry than such factors as innovation, technological expertise and distribution strength. The Company licenses technology from Northern Telecom, Mitel Corporation and ROLM to facilitate integration of Octel's products with those manufacturers' PBXs. The Northern Telecom license is perpetual, the Mitel license expires in 1998 and the ROLM license expires in 2004. Royalty payments on these licenses are not material. A number of companies, including competitors of the Company, hold patents in the same general area as the technology used by the Company. The Company has from time to time been notified and may be notified in the future that its products may be infringing certain patents and other intellectual property rights of others. In April 1992, the Company filed suit, in United States District Court in Northern California, against Theis Research, Inc. ("Theis") for declaratory judgment that the Company's products do not infringe three patents of Theis and that those patents are invalid. In November 1992, Theis filed a counterclaim against the Company alleging infringement of seven of Theis' patents. Subsequently, Theis dismissed with prejudice the claims as to all but four of the patents. During the first quarter of fiscal 1995, the Company engaged in a jury trial regarding infringement of the three remaining patents and the defense of patent invalidity. In October 1994, the jury returned a verdict finding, among other things, that Octel was correct in its claim that the three patents at issue were invalid. Post-trial motions are pending and, if no settlement between the parties is reached, it is anticipated that Theis will appeal the verdict. In January 1994, Gilbarco, Inc. ("Gilbarco") filed suit in the U.S. District Court for the District of Colorado against the Company and one of the Company's telephone company customers, U.S. West, alleging infringement of a Gilbarco patent and seeking unspecified damages. The Company filed an answer to the complaint denying any infringement of the patent and raising several affirmative defenses, including an assertion that the patent is invalid and unenforceable. In September 1994, the claims asserted against the Company were transferred to the U.S. District Court for the Northern District of California and those claims asserted against U.S. West were stayed and administratively closed pending the outcome of the California action. Fact discovery in the case has been completed, expert discovery is scheduled for completion in December 1995 and a trial date has been set for March 19, 1996. The Company is currently planning to file one or more motions before the trial which could dispose of some or all of the claims asserted against it. The Company believes, based upon information currently available, including consultations with patent counsel, that the Company is not infringing any valid patents of Theis or Gilbarco. The Company will vigorously defend the patent infringement claims and any related claims for compensatory damages. While litigation is inherently uncertain, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position. 16 17 The Company is currently evaluating several additional claims of third parties. Based in part on industry practice and in part on discussions with certain of such third parties, the Company believes that in most cases any necessary licenses or rights could be obtained on commercially reasonable terms. However, no assurance can be given that future licenses will be obtained on acceptable terms, that costly litigation will not occur or that the Company will receive a favorable decision in any litigation that may ensue. The failure to obtain necessary licenses or other rights, or litigation arising out of such claims, could have a material adverse affect on the Company's operations. Octel, Octel Communications, the Octel logo, OctelNet, Aspen, Branch, Call Performer Plus, D.I.A.L., Maxum, Sierra, Tigon and VMX are registered trademarks of the Company. Aria, Digital Networking, OcteLink, Octel Overture Message Server, Overture, Octel Overture PC, Octel Overture 200, Octel Overture 250, Octel Overture 300, Octel Overture 350 and Serenade are trademarks of the Company. All other product names are trademarks which belong to their respective owners. EMPLOYEES The Company's success depends in part upon the continued contribution of its officers and key personnel, many of whom would be difficult to replace. If certain of these people were to leave the Company, the Company's operating results could be adversely affected. At June 30, 1995, the Company employed approximately 2,700 people on a full-time basis. During fiscal 1996 the Company intends to hire additional personnel, especially in the international arena. Many of the Company's employees are highly skilled, and the Company's continued growth and success will depend in part upon its ability to attract and retain such employees, who are in great demand, and on the ability of the Company's officers and key employees to manage successfully the growth of the Company through use of appropriate management information systems and controls. The Company has never had a work stoppage, no employees are represented by a labor organization and the Company considers its employee relations to be good. ITEM 2. PROPERTIES The Company currently conducts all headquarter operations, except manufacturing and customer support, in a newly constructed, five building, 375,000 square foot campus and an adjacent 44,000 square foot leased building in Milpitas, California. Manufacturing and customer support operations are conducted in two leased buildings in San Jose, California totaling 170,000 square feet. These three leases expire at various dates ranging from 1997 to 1999. The Company is nearing completion of the integration of the VMX customer support facilities in San Jose. Integration of VMX's Dallas, Texas manufacturing facilities is expected to be completed during the first quarter of fiscal 1996. Movement of these operations to San Jose began in June 1995. Previously existing leases have either been terminated or subleases are being pursued. The Company also leases over 40 sales and customer support offices throughout the United States totaling 272,000 square feet. These leases expire at various dates through 2000. The aggregate monthly rental expense for leased property in the United States, excluding OPCPD, ONS and Rhetorex, is approximately $479,000, of which approximately 44% was for facilities near the Milpitas campus. OPCPD conducts all activities from a 35,000 square foot leased building in Sarasota, Florida with a monthly rental expense of $42,000. The OPCPD lease expires in 2005. ONS' principal offices are located in five buildings in Dallas, Texas and consist of approximately 108,000 square feet under leases which expire in 1997 and 1998. ONS also leases an additional 53,000 square feet of space for 24 operations centers and sales offices throughout the United States. The aggregate monthly rental expense for all of ONS' facilities is approximately $170,000, of which approximately 52% is for facilities at or near the Dallas offices. Rhetorex conducts all activities from a 16,000 square foot leased building in Campbell, California with a monthly rental expense of $16,000. This lease expires in 1997. The Company leases six offices in Canada totaling 17,000 square feet at a monthly rental expense of approximately $22,000. The Company also leases 37,000 square feet in four cities in the United Kingdom at an aggregate monthly rental expense of $104,000. Octel also has two offices in France totaling 15,000 square feet with a monthly rental expense of approximately $32,000. Additionally, the Company leases four offices in Germany, Israel, Japan and Hong Kong for total monthly rental expense of approximately $48,000. These leases expire at various dates and the Company expects to be able to renew or replace such leases at the end of their terms on a commercially reasonable basis. 17 18 On July 6, 1995, the Company entered into a one-year operating lease for a parcel of undeveloped land adjacent to its Milpitas, California campus on which additional offices may be constructed over the next three years. Monthly rent expense varies based upon the London interbank offering rate (LIBOR). See Note 14 to the consolidated financial statements. The Company expects that it may require additional sales and customer support locations during fiscal 1996 and believes that suitable space will be available as needed on commercially reasonable terms. ITEM 3. LEGAL PROCEEDINGS See "Patents, Copyrights, Trademarks and Technology Licenses" in Item 1 above. 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 1995. EXECUTIVE OFFICERS OF OCTEL COMMUNICATIONS CORPORATION The executive officers of the Company and their respective ages as of July 31, 1995 are as follows:
NAME AGE POSITION - ------------------------------------- ------- ------------------------------------------------------------------ Robert Cohn 46 Chairman of the Board, President and Chief Executive Officer W. Michael West 45 Vice Chairman David Ladd 48 Executive Vice President and Chief Technology Officer Donald L. Campodonico 50 Senior Vice President Charles E. Levine 42 Senior Vice President Edward Mattiuz 56 Senior Vice President Margaret Norton 41 Senior Vice President Carol Snell 45 Senior Vice President Derek S. Daley 40 Vice President, General Counsel and Secretary Bruce Simpson 38 Vice President John R. Viera 46 Vice President
Mr. Cohn, a founder of the Company, served as its President and Chief Executive Officer from the Company's inception in 1982 until October 1990, and then resumed those positions in November 1993. Mr. Cohn has served as a director from the Company's inception and, in June 1990, the Board of Directors appointed Mr. Cohn Chairman of the Board. Prior to founding the Company, he was employed by Acurex Corporation, a manufacturer of microprocessor-based measurement and control systems, from 1979 to 1982. From 1976 to 1979, he was employed by McKinsey & Co., Inc., a management consulting company. Mr. Cohn holds a B.S. in Mathematics and Computer Science from the University of Florida and an M.B.A. from Stanford University. Mr. Cohn is also a director of Global Village Communication, Inc., a manufacturer of communications hardware and software for personal computers. Mr. West serves as Vice Chairman for the Company. He joined the Company in September 1986 as Executive Vice President and was responsible for sales and customer service. From 1979 to September 1986, Mr. West was employed by ROLM, serving for three years during this period as President of an operating subsidiary of ROLM and then as General Manager of its National Sales Division. Mr. West attended Southern Illinois University. Mr. Ladd joined the Company in March 1994 as Executive Vice President following the Company's merger with VMX, Inc. and, as Chief Technology Officer, is responsible for research and development. At VMX, Mr. Ladd served as Executive Vice President and a director from July 1988 until March 1994. Prior to joining VMX, Mr. Ladd served as President and Executive Vice President of OPCOM, a manufacturer of call processing systems that was merged into 18 19 a wholly owned subsidiary of VMX in July 1988. Mr. Ladd holds a B.A. in Engineering Physics from the University of California-Berkeley and an M.A. in Mathematics from the Stevens Institute of Technology. Mr. Campodonico joined the Company in July 1987 as its Director of Manufacturing and is now Senior Vice President, Operations. He is responsible for manufacturing, information systems and corporate quality. Prior to joining the Company, he was employed by ROLM, serving for two years as Vice President of Operations. Mr. Campodonico holds a B.S. in Business Administration and an M.B.A. from San Francisco State University. Mr. Levine joined the Company in December 1994 as Vice President and General Manager of Octel Services. Mr. Levine was subsequently named Senior Vice President and General Manager of Octel Services. Prior to joining Octel, Mr. Levine served as President and CEO of CFT Systems and as Products and Services Vice President of AT&T's General Business Systems Division. Mr. Levine has also held executive marketing positions with General Electric and Procter & Gamble. Mr. Levine graduated from Trinity College with a major in Economics and received his M.B.A. from Northwestern University. Mr. Mattiuz joined the Company in March 1994 in connection with the VMX merger. He is currently Senior Vice President of worldwide field operations. Prior to joining Octel, Mr. Mattiuz held executive positions with VMX, Inc., Conveyant Systems, Inc., CXC Corporation and Northern Telecom. Mr. Mattiuz holds a B.S. degree in electrical engineering from the University of Ottawa, Canada and has completed numerous management development programs from Harvard, Columbia and Harbridge House. Ms. Norton joined the Company in February 1988 as a Group Product Manager in Customer Premise Equipment (now GBS) Marketing and was subsequently promoted to Director of CPE Marketing, Vice President of Marketing, to Vice President and General Manager of VIS and Senior Vice President and General Manager, VIS, the position she now holds. She holds a B.A. in Economics from the University of Arizona and an M.B.A. from the University of Connecticut. Ms. Snell joined the Company in August 1994 and now serves as Senior Vice President and General Manager, GBS, where she is responsible for products and services to corporations, institutions and government. Prior to joining the Company, Ms. Snell was President and Chief Executive Officer of Aristacom International, Inc. from August 1993 to April 1994 and prior to that was co-founder and Senior Vice President, Worldwide Operations for Aspect Telecommunications Corporation for eight years. Ms. Snell holds a B.S. in Business from the University of North Carolina. Mr. Daley joined the Company in August 1988 as its General Counsel, was elected Vice President in September 1989 and became Secretary of the Company in October 1990. He is responsible for internal legal matters, legal compliance and supervision of outside law firms employed by the Company. Prior to joining the Company, Mr. Daley was an associate and then a partner in the law firm of Wilson, Sonsini, Goodrich & Rosati from September 1985 to September 1988, and an associate with the law firm of Brobeck, Phleger & Harrison from September 1980 to September 1985. Mr. Daley holds a B.S. in History and a J.D. from Stanford University. Mr. Simpson joined the Company in conjunction with the October 1992 acquisition of Tigon Corporation (now ONS). Mr. Simpson now serves as President of ONS. Previously, Mr. Simpson served eighteen months as Vice President of Finance and Administration for Tigon. Before joining Tigon, he was Controller for Ameritech Development Corporation in Chicago, Illinois. Mr. Simpson holds an M.B.A. and a B.S. in Accounting from Northern Illinois University and is a Certified Public Accountant. Mr. Viera joined the Company in February 1989 as Director of Organizational Planning and was subsequently promoted to Director of Compensation, Director of Human Resources and Vice President, Human Resources, the position he now holds. He holds a B.S. in Business Administration from Golden Gate University and an M.S. in Counseling Psychology from California State University, Hayward and is a certified Senior Human Resources Professional by the International Human Resources Professional Society. The Company is currently recruiting for a Chief Financial Officer. 19 20 All officers serve at the discretion of the Board of Directors. There are no family relationships between directors or executive officers of the Company. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Octel Communications Corporation Common Stock is traded on the over-the-counter market and is quoted on The Nasdaq National Market under the symbol OCTL. As of June 30, 1995, there were approximately 3,194 stockholders of record. The following table sets forth for the periods indicated the high and low closing prices for Octel's Common Stock as reported by The Nasdaq National Market.
Fiscal year 1995 High Low --------------------------------------------------------- ------- ------- Fourth quarter ended June 30, 1995 $29 1/4 $18 7/8 Third quarter ended March 31, 1995 23 1/2 20 Second quarter ended December 31, 1994 21 5/8 18 3/8 First quarter ended September 30, 1994 24 1/4 16 1/8 Fiscal year 1994 High Low --------------------------------------------------------- ------- ------- Fourth quarter ended June 30, 1994 $26 1/4 $16 1/2 Third quarter ended March 31, 1994 30 23 Second quarter ended December 31, 1993 28 1/2 23 1/4 First quarter ended September 30, 1993 24 3/4 19 1/4
The Company has not paid cash dividends on its Common Stock to date and does not plan to pay cash dividends to its stockholders in the foreseeable future. The Company believes factors such as quarter-to-quarter variances in financial results and announcements of new products and new orders by the Company or its competitors could cause the market price of the Company's Common Stock to fluctuate substantially. In addition, the stock prices for many high technology companies typically experience extreme price fluctuations, which often are not related to changes in the operating performance of the specific companies. Broad market fluctuations as well as general economic conditions, such as a recessionary period or high interest rates, may adversely affect the market price of the Company's Common Stock. Both the Company's Common Stock and the stock market generally are at or near historic highs and there can be no assurance that such valuations will continue or increase. 20 21 ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED JUNE 30, -------------------------------------------------------------------------- (In thousands, except per share amounts) 1995 1994 1993 1992 1991 --------- -------- -------- -------- -------- STATEMENT OF INCOME DATA Total net revenues ............................. $472,592 $406,225 $338,478 $262,732 $218,494 Operating income ............................... 42,745(1) 18,813(2) 37,122 29,526 16,573 Net income ..................................... 31,132(1) 13,543(2) 29,567 26,383 13,482 Net income per common and equivalent share: Primary ..................................... $ 1.26(1) $ 0.54(2) $ 1.19 $ 1.08 $ 0.58 Fully diluted ............................... $ 1.21(1) $ 0.54(2) $ 1.19 $ 1.08 $ 0.58 Weighted average common and equivalent shares outstanding: Primary ..................................... 24,724 25,096 24,869 24,424 23,204 Fully diluted ............................... 25,728 25,096 24,869 24,424 23,204 BALANCE SHEET DATA Working capital ............................... $123,392 $132,773 $146,978 $162,171 $135,086 Total assets .................................. 368,276 346,128 297,383 251,955 204,780 Long-term obligations ......................... 602 1,400 1,985 409 538 Stockholders' equity .......................... 274,943 256,192 229,681 202,386 167,903
- -------------------------- (1) Includes non-recurring charges for the write-off of in-process research and development of $4.7 million ($3.2 million net of taxes) and integration costs of $2.8 million ($1.9 million net of taxes). (2) Includes total non-recurring charges for the VMX merger and integration costs of $24.1 million ($18.8 million net of taxes). ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BASIS OF PRESENTATION Effective March 31, 1994, Octel consummated a business combination with VMX which was accounted for as a pooling of interests. VMX provides integrated messaging and call processing systems, software and services that combine voice, data and image for business communications worldwide. To effect the combination, approximately 5.4 million shares of Octel's Common Stock were issued in exchange for all of the outstanding Common Stock of VMX. The net assets of VMX amounted to approximately $45.1 million at March 31, 1994. The financial information presented herein has been restated to include the accounts and operations of VMX for all periods. RESULTS OF OPERATIONS - ANNUAL Net Revenues The Company derives revenues from the sale of systems, license fees and performance of services. Systems revenues consist of equipment, upgrades and expansions sold to corporations and other institutions, as well as telephone and cellular companies. Services revenues consist of a range of voice processing and network management services provided by ONS, particularly to customers in the residential market through an RBOC and voice services market, service contracts, applications development products, the sale of spares, licenses and hardware repair and maintenance. 21 22
Increase (Decrease) Year Ended June 30, From Prior Year --------------------------------------- ------------------- 1995 1994 1993 1995 1994 --------- --------- ---------- ---- ---- (Dollars in millions) Systems $ 314.3 $ 292.1 $ 254.9 8% 15% Services and license 158.3 114.1 83.6 39% 36% --------- --------- ---------- Total net revenues $ 472.6 $ 406.2 $ 338.5 16% 20% ========= ========= ==========
Percentage of Total Net Revenues - -------------------------------- Systems 67% 72% 75% (5%) (3%) Services and license 33% 28% 25% 5% 3%
The growth in total net revenues since fiscal 1993 resulted from increases in the volume of services revenues generated by ONS, spares and maintenance and the sale of systems to new and existing customers and the sale of upgrades and expansions. Total domestic net revenues for fiscal 1995 were $353.6 million compared to $308.8 million in fiscal 1994, an increase of 15%. International net revenues totaled $119.0 million for fiscal 1995 compared to $97.4 million in fiscal 1994, an increase of 22%. Domestic and international net revenues for fiscal 1993 were $257.8 million and $80.7 million, respectively. International sales were primarily to customers in Europe and Canada and, to a lesser extent, New Zealand, Japan, Hong Kong and China. Total GBS net revenues grew by 11% compared to fiscal 1994. Domestic net revenue growth was 12% and international revenues grew 6%. The increases are due to greater sales of high-end systems offset by fewer low-end systems sales compared to fiscal 1994. During fiscal 1995, international GBS sales were generally made through the Company's direct sales force and distributors, principally in the United Kingdom and Canada. The GBS market continues to be dependent upon the following: purchases by existing customers of expansions and upgrades to support expanding corporate voice messaging networks; purchases of new, integrated applications such as fax processing by large organizations; sales to small business or branch offices of large companies of less expensive voice messaging equipment; and purchases by large organizations that have already adopted competitive voice processing technology switching to the Company's products. Total VIS net revenues grew by 2% compared to fiscal 1994. Domestic net revenue decreased 4% whereas international revenues grew 9%. In the United States, the Company continues to sell to customers who provide telephone answering services, which is experiencing slower growth than other VIS markets. Furthermore, the Company experienced a decline in VIS market share from fiscal 1994 to fiscal 1995. The Company continues to believe that the residential and cellular voice messaging markets are large market opportunities. The Company and its VIS customers, including the cellular companies, are working jointly to develop programs to address these markets, however, there can be no assurance that future declines in market share will not occur. International VIS sales were primarily made through the Company's direct sales force. The Company's operations in the United Kingdom made a significant contribution to international revenues as a result of new opportunities which were realized during the year, however, this increase was offset by a decrease in Canada's VIS revenues which were adversely affected by a capital spending freeze at one of Canada's largest VIS providers. International VIS net systems revenues decreased slightly in fiscal 1994 as compared to fiscal 1993 due principally to large systems sales in Italy in fiscal 1993 which were not repeated in fiscal 1994. Net services and license revenues increased as a result of growth in ONS revenues of 58% compared to fiscal 1994 that resulted from increased services provided to one of the RBOCs which provides residential services and from other new accounts added during the year. Higher spares and hardware maintenance revenues due to the increased installed base also contributed to the overall increase in net service revenues. In recent years, services and license revenues have experienced significant growth in absolute dollars and as a percentage of net revenues. There can be no assurance that such growth will be sustained or continue. 22 23 Systems sales orders from VIS customers are generally larger than GBS sales and VIS customers do not follow consistent buying patterns; therefore, net revenue volume and mix in future periods could be affected by the extent and timing of new orders from VIS customers. In addition, the Company continues to monitor trends in the general economy that have previously imposed budgetary constraints and, therefore, adversely affected the ordering process of customers. The Company cannot predict how future domestic and international economic trends may affect sales orders. The Company may establish additional subsidiaries or joint ventures in the future in those countries where it believes significant sales opportunities exist. Extensive effort is required in the local government approval processes before the Company's new products or modifications to existing products can be sold and installed in each country. This work was completed in several countries during fiscal 1995. Local government approvals for other selected countries are in process. Cost of Systems and Services
Increase (Decrease) Year Ended June 30, From Prior Year --------------------------------------- ------------------- 1995 1994 1993 1995 1994 --------- --------- ---------- ---- ---- (Dollars in millions) Cost of systems $ 103.5 $ 89.4 $ 74.9 16% 19% Cost of services 89.8 72.4 54.5 24% 33% --------- --------- ---------- Total cost of sales $ 193.3 $ 161.8 $ 129.4 19% 25% ========= ========= =========
Percentage of Net Revenues - -------------------------- Cost of systems 33% 31% 29% 2% 2% Cost of services 57% 63% 65% (6%) (2%) Total cost of sales 41% 40% 38% 1% 2%
Total cost of sales as a percentage of total net revenues increased from fiscal 1994 to fiscal 1995 due to the continued growth of services and license revenues, which have a higher cost structure than systems sales, and to an increase in the cost of systems. The increase as a percentage of total net revenues from fiscal 1993 to fiscal 1994 was primarily due to non-recurring costs incurred to conform VMX's accounting practices to the Company's. This negative effect was partially offset by the effects of revenue transactions for which costs were previously expensed due to uncertainty of revenue recognition and a favorable mix in the configuration of high-end products. The increase in cost of systems as a percentage of total systems revenues from fiscal 1994 to fiscal 1995 was due primarily to product mix changes. The increase from fiscal 1993 to fiscal 1994 was due primarily to non-recurring costs of $2.2 million incurred to conform VMX's accounting practices to the Company's. The decrease in cost of services as a percentage of total services and license revenues since fiscal 1993 is primarily attributable to the increase in ONS revenues, which have a lower cost structure as a percentage of services and license revenues than hardware repair and maintenance. During fiscal 1995, 1994 and 1993, the Company used sales promotions and pricing programs, including price reductions and discounts, to stimulate demand for the Company's products. If the Company is required to respond to economic or competitive pressures through similar programs in the future, cost of systems and services could increase as a percentage of total net revenues. 23 24 Research and Development
Increase Year Ended June 30, From Prior Year --------------------------------------- -------------------- 1995 1994 1993 1995 1994 --------- --------- ---------- ---- ---- (Dollars in millions) Expenses $ 74.6 $ 58.3 $ 44.4 28% 31% Percentage of total net revenues 16% 14% 13% 2% 1%
The increase in research and development expenses in absolute dollars and as a percentage of total net revenues is due to the Company's increased spending on the development of new products, projects to meet customer commitments, the adaptation of existing products and technology for international markets, and the continued commitment to enhancements to existing products. Fiscal 1995 expenses also reflect research and development expenses incurred by the development facility acquired by the Company in August 1994. Additionally, the Company incurred a one-time charge of approximately $1.2 million during fiscal 1995 related to a cancelled contract for software development. During fiscal 1995, 1994 and 1993, the Company entered into development contracts with certain customers whereby the Company performed development work on applications software using customer funds. During fiscal 1995, $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was recognized as revenue and $1.0 million ($0.8 million in fiscal 1994 and $0.3 million in fiscal 1993) was charged to cost of sales for projects completed. No internal software development costs have been capitalized to date under the provisions of Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." See Note 2 to consolidated financial statements. The Company expects to continue to increase expenditures on research and development in fiscal 1996 in absolute terms and these expenses could increase as a percentage of total net revenues. Selling, General and Administrative
Increase (Decrease) Year Ended June 30, From Prior Year ------------------------------------------ ------------------- 1995 1994 1993 1995 1994 ------------ ------------ ------------- ---- ---- (Dollars in millions) Expenses $ 154.3 $ 149.0 $ 127.6 4% 17% Percentage of total net revenues 33% 37% 38% (4%) (1%)
The increases in selling, general and administrative expenses resulted primarily from payroll related expenses for employees hired to support the growth of the Company's worldwide operations. The increases in fiscal 1995 were partially offset by a reduction in legal expenses related to ongoing patent litigation incurred during fiscal 1994, the absence of costs related to the departure of the prior CEO which were incurred during fiscal 1994 and reduced occupancy costs due to the consolidation of certain office facilities in fiscal 1995. Selling, general and administrative expenses declined as a percentage of total net revenues due to the factors discussed above and the Company's continued monitoring of expenses and employment of cost control measures. Since fiscal 1994, the Company has continued to redeploy resources to support the faster growing business segments, including the hiring of employees to support new 24 25 international subsidiaries and international sales opportunities. Since the merger with VMX, the Company has analyzed organizational and operational synergies that can be achieved and began to realize the benefits from those synergies in fiscal 1995. The Company believes that additional selling, general and administrative expenses will be required to maintain its competitive position, including expanded international sales activities, and expects that these expenses will increase in absolute terms and could increase as a percentage of total net revenues. Additionally, the Company is currently involved in patent litigation that may cause an increase in legal expenses in the future. See "Business - Patents, Copyrights, Trademarks and Technology Licenses." Non-recurring Charge for Acquired In-process Research and Development In August 1994, the Company purchased certain intellectual property and fixed assets from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed in the first quarter of fiscal 1995. Integration Costs In connection with the VMX merger in fiscal 1994, the Company recorded $18.3 million for integration costs related to the consolidation of facilities and personnel. In fiscal 1995, an additional $2.8 million of integration costs were incurred which related primarily to literature design for name change and other modifications to literature for the merged Company and the consolidation of processes and computer systems of the merged Company. Interest and Other Income (Expense), Net Interest and other income (expense), net for fiscal 1995 increased $4.4 million from fiscal 1994 and for fiscal 1994 decreased $5.8 million from fiscal 1993. These changes were due primarily to merger related expenses of $3.6 million incurred in fiscal 1994. Since fiscal 1993, the Company has realized lower interest income due to lower interest rates and lower average cash and cash equivalent and short-term investment balances and had smaller realized gains on sales of short-term investments. During fiscal 1995, there were net foreign exchange gains of $0.8 million compared to losses of $0.4 million in fiscal 1994 and gains of $0.2 million in fiscal 1993. Other expenses in fiscal 1994 included one-time costs related to the merger with VMX for which no such expenses were incurred in fiscal 1995. Other expenses in fiscal 1993 included one-time costs associated with the acquisition of one of the Company's subsidiaries. Other expenses in each fiscal year included costs of the Company's foreign exchange hedging program and fees paid to the Company's investment advisors. The Company continues to utilize its hedging program to mitigate the foreign exchange financial exposure of foreign currency transactions. Income Taxes The effective tax rate for fiscal 1995 was 32% compared to 22% in fiscal 1994 and 28% in fiscal 1993. The lower effective tax rate in fiscal 1994 was attributable to a combination of factors. First, various tax assets of VMX that had been fully reserved were recognized as a tax benefit. Additionally, the retroactive reinstatement of the U.S. research and development credit for the fiscal year ended June 30, 1993 had a favorable impact on the effective tax rate in fiscal 1994. During the third quarter of fiscal 1993, but effective July 1, 1992, the Company changed its method of accounting for income taxes to the liability method required by Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Prior to this date the Company used the deferred method of accounting for income taxes under APB No. 11. As permitted by SFAS No. 109, no financial statements for periods prior to July 1, 1992 were restated. Results for the first quarter of fiscal 1993 were previously restated to include a charge of $115,000, representing the cumulative effect, as of July 1, 1992, of this change in accounting for income taxes. Other immaterial adjustments (netting to $115,000) were made to the tax provision in the first quarter of fiscal 1993 to reflect the change to SFAS No. 109. No adjustments to the second quarter results of fiscal 1993 were necessary. See Note 13 to the Consolidated Financial Statements. 25 26 Dividends The Company has not paid cash dividends on its Common Stock to date and does not plan to pay cash dividends to its stockholders in the foreseeable future. The Company presently intends to retain any earnings to finance its business and to repurchase shares of its Common Stock under a program approved by the Board of Directors. See "Liquidity and Capital Resources." RESULTS OF OPERATIONS - QUARTERLY The following table presents unaudited quarterly operating results and certain items as a percentage of total net revenues for the Company's four quarters in fiscal 1995. The Company believes that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the selected quarterly information. This information should be read in conjunction with the consolidated financial statements included elsewhere herein. The operating results for any quarter are not necessarily indicative of results for any subsequent period.
FISCAL QUARTER ENDED - ------------------------------------------------------------------------------------------------------------------------------- SEPT. 30, 1994 DEC. 31, 1994 MARCH 31, 1995 JUNE 30, 1995 - ------------------------------------------------------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA - UNAUDITED) Net revenues: Systems .............................. $ 69,901 66% $ 78,542 68% $ 74,653 65% $ 91,247 67% Services and license ................. 35,844 34% 37,698 32% 40,389 35% 44,318 33% - ------------------------------------------------------------------------------------------------------------------------------- Total net revenues ................ 105,745 100% 116,240 100% 115,042 100% 135,565 100% Costs and expenses: Cost of systems ...................... 21,537 20% 25,970 22% 25,981 23% 30,053 22% Cost of services ..................... 20,591 19% 21,731 19% 23,391 20% 24,074 18% Research and development ............. 17,538 17% 18,018 16% 18,786 16% 20,302 15% Selling, general and administrative .. 36,331 34% 37,388 32% 37,724 33% 42,859 32% Non-recurring charge for in-process research and development............ 4,725 4% -- -- -- -- -- -- Integration costs .................... 250 -- 759 1% 1,252 1% 587 -- - ------------------------------------------------------------------------------------------------------------------------------- Total costs and expenses .......... 100,972 95% 103,866 89% 107,134 93% 117,875 87% - ------------------------------------------------------------------------------------------------------------------------------- Operating income ........................ 4,773 5% 12,374 11% 7,908 7% 17,690 13% Interest and other income, net .......... 841 1% 685 1% 683 1% 678 1% - ------------------------------------------------------------------------------------------------------------------------------- Income before income taxes .............. 5,614 5% 13,059 11% 8,591 7% 18,368 14% Provision for income taxes .............. 1,800 2% 4,300 4% 2,500 2% 5,900 4% - ------------------------------------------------------------------------------------------------------------------------------- Net income ............................ $ 3,814 4% $ 8,759 8% $ 6,091 5% $ 12,468 9% =============================================================================================================================== Net income per common and equivalent share: Primary and fully diluted............. $ 0.15 $ 0.36 $ 0.25 $ 0.50 - ------------------------------------------------------------------------------------------------------------------------------- Number of shares used in calculation: Primary and fully diluted............. 25,132 24,428 24,729 24,838 ===============================================================================================================================
Percentage amounts may not total due to rounding. Lower total net revenues in the first quarter compared to the prior and subsequent quarters are due primarily to a historically slow summer both domestically and internationally. The increase in fourth quarter net revenues compared to prior quarters resulted from special promotions for existing and new products introduced during the third quarter of fiscal 1995. Cost of systems, as a percentage of total net revenues, increased throughout the year primarily as a result of higher systems costs related to changes in product mix, whereas cost of services as a percentage of total net revenues remained relatively flat throughout the year. 26 27 Operating margin for the first quarter was affected by the lower revenues discussed above combined with the non-recurring charge for acquired in-process research and development. Excluding the non-recurring charge, operating margin for the first quarter would have been 9 percent. Third quarter operating margin was affected by higher integration costs as the Company continues to finalize the consolidation of VMX operations. Fourth quarter operating margin was affected by higher revenue, a favorable product mix and significant efforts to reduce expense growth. The quarterly effective tax rates reflect the provision required for the annual rate of 32%. The Company believes that its backlog on a quarterly basis will not generally be large enough to assure that its revenue targets for a particular quarter will be met. Furthermore, a large percentage of any quarter's shipments have historically been booked in the last month of the quarter. Consequently, quarterly revenues and operating results will depend on the volume and timing of new orders received during a quarter, which is difficult to forecast. This is particularly true in the VIS market, where sales orders are generally larger. The Company offers products with base system list prices from approximately $11,000 to over $1,250,000 depending on customer configurations and requirements, and generally has a higher gross margin on its fully configured products. The Company provides discounts to distributors and generally has a higher gross margin on direct sales. In addition, the Company's services and license revenues generally have lower gross margins than systems gross margins. As a result, the Company's revenues and gross margins will be affected by the product, service and channel mix and timing of orders it receives. In addition, because the Company recognizes revenues on sales to distributors and customers which have previously installed the Company's product at the time of shipment and on certain direct sales to end users at the time of installation, quarterly revenues can also fluctuate depending on the customer installation schedules for direct sales at the end of a quarter. Installation on direct sales typically occurs within five weeks of shipment. The Company has not experienced any significant returns by customers of any of its products. Fourth quarter total net revenues are typically enhanced by sales incentives to employees and promotional programs for customers; as a result, first quarter sales are typically less than fourth quarter sales. The Company anticipates that this trend will continue in the first quarter of fiscal 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's cash and equivalents and short-term investments decreased to $52.6 million at June 30, 1995 from $86.4 million at June 30, 1994 and $100.4 million at June 30, 1993. Cash flows from operations resulted in net cash provided of $46.8 million in fiscal 1995, $49.4 million in fiscal 1994 and $39.8 million in fiscal 1993. In fiscal 1995, cash from operations resulted primarily from net income of $31.1 million, which included $30.7 million of non-cash expenses for depreciation and amortization, offset by an increase in accounts receivable of $24.0 million. The increase in accounts receivable is due primarily to an increase in fourth quarter total net revenues of $19.0 million compared to the same quarter of fiscal 1994. The primary uses of cash during fiscal 1995 were investment in property, plant and equipment of $56.9 million ($58.6 million and $30.8 million in fiscal 1994 and 1993, respectively) and the repurchase of Common Stock for approximately $28.4 million ($5.8 million and $13.1 million in fiscal 1994 and 1993, respectively) under the Company's stock repurchase program, both of which aim to increase return to investors as compared to the return which would be earned by investing the cash and generating interest at the low rates available during fiscal 1995. As of June 30, 1995, the Company had invested $48.7 million in the purchase of land and the development of the Company's new corporate offices on that land. The Company now occupies those facilities. Effective July 6, 1995, the Company entered into a one-year operating lease agreement to lease undeveloped land on which additional offices may be constructed adjacent to the existing corporate offices over the next three years under a similar leasing arrangement. Under the terms of the operating lease, the Company is contingently liable under a 97% first-loss clause for up to $9.9 million at July 6, 1996. See Note 14 to the consolidated financial statements. The Company also expects to purchase additional equipment and make certain leasehold improvements during fiscal 1996; however, spending levels are not expected to be at the levels they were in fiscal 1995 and 1994 because of the completion of the new corporate offices. The Company anticipates that its property and equipment investments will eventually result in greater efficiencies and increased flexibility for the Company. 27 28 In connection with the VMX merger, the Company recorded integration costs of $18.3 million in fiscal 1994. In addition to the integration costs recorded in fiscal 1994, the Company incurred additional merger-related integration costs during fiscal 1995 of $2.8 million, which have been charged to operations. The charges were recorded based on decisions made by management to consolidate certain facilities and personnel. As of June 30, 1995, the balance of expected future cash expenditures was approximately $4.6 million and was recorded in "Accrued and Other Liabilities." The majority of this amount will be spent during the first quarter of fiscal 1996 as consolidation of the Company's manufacturing facilities is completed. Remaining integration charges are expected to be immaterial. The integration charges are the primary reason for the decrease in working capital from fiscal 1993 to fiscal 1994. In July 1994, the Company's Board of Directors approved the repurchase of up to 3.5 million shares of its Common Stock over a period of approximately two years. During fiscal 1995, the Company repurchased approximately 1.3 million shares of its Common Stock at an average per share price of $22. The Company expects to continue to repurchase its Common Stock under this program if warranted by market conditions. In August 1994, the Company purchased certain intellectual and personal property from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed during the first quarter of fiscal 1995. The full amount of the purchase price was paid during fiscal 1995. The Company anticipates that cash flows from operations, existing cash and equivalents balance, short-term investment balance and its existing $30 million bank revolving line of credit will be adequate to meet the Company's cash requirements through the end of fiscal 1996. FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS The Company believes that in the future its results of operations could be affected by factors such as market acceptance of new products and upgrades, growth in the worldwide voice processing market, competition, expansion of services by its VIS customers, the outcome of litigation and changes in general economic conditions in any of the countries in which the Company does business. The Company believes that the successful introduction of new and enhanced products and services will be essential for it to maintain or improve its competitive position. In July 1995, the Company introduced OcteLink - a global "messaging post office" that could eventually allow the interconnection of virtually any voice messaging system with networking capability, regardless of protocol, system size or geographic location. Revenues from OcteLink are expected to commence during the latter part of the second quarter of fiscal 1996 but are not expected to be material for the fiscal year and the Company expects to incur additional research and development expenditures to launch OcteLink. Although the Company believes OcteLink is a viable global messaging network, there is currently no reliable data regarding the demand for such services in multiple customer segments. Furthermore, there is no assurance that demand for a global messaging network will not be slow to materialize or that potential competitors will not successfully introduce alternative solutions to OcteLink that achieve better market acceptance. Additionally, the Company introduced the Overture Family of message servers in July 1995. The Overture 250 is a new product which is a mid-level system designed for medium-sized businesses and large branch offices. Although the Company anticipates a favorable reception of the Overture 250 into the marketplace, there can be no assurance that it will be successful in generating additional sales. Furthermore, the Company is developing "unified messaging" products for voice, fax and electronic mail messaging. Unified messaging essentially unites voice, fax and e-mail together in a client/server architecture that uses standard PC and LAN technology. This integration brings together several discrete technologies into a single mailbox that provides user access from a telephone or a PC. In May 1995, Octel announced the first component of its unified messaging technology that will be available on Microsoft Exchange, a LAN-based, enterprise-wide messaging architecture. Current expectations are for revenue to commence in fiscal 1997; however, there can be no assurance that the product introduction will be successful in the marketplace or that it will not be delayed, thereby reducing future expected revenues or resulting in additional expenses to bring the product to market. The timely introduction and market acceptance of the Company's next-generation client/server architecture for its Sierra platform is a key factor in determining the Company's success in the VIS market, and the Company is focusing 28 29 significant resources and talent on developing and bringing products using this architecture to market. The new architecture is scheduled for first-phase release in fiscal 1996, however, there can be no assurance that introduction of products using this architecture will not be delayed, allowing competitors to gain a market share advantage, or that such products will be successful in the marketplace, thereby resulting in additional expenses to bring the product to market or reducing future expected revenues. The integration of certain operations as a result of the VMX merger continues to require the dedication of management resources which may temporarily distract attention from the day-to-day business of the Company. The Company has executed a plan to reduce expenses by eliminating duplicate facilities - particularly sales offices - employees and other expenses. These efforts are expected to continue through the first quarter of fiscal 1996 as the consolidation of the Company's manufacturing and support facilities is completed. There can be no assurance that Octel will be able to reduce expenses in this fashion, that there will not be high costs associated with such activities, that such reductions will not result in a decrease in revenues or that there will not be other material adverse effects of such activities. Although it believes there are opportunities to gain from synergies resulting from the VMX merger, the Company cannot determine the ultimate effect that the continued integration of Octel and VMX will have on revenues, earnings or the Common Stock price. During the latter half of fiscal 1995, the Company adopted a new, capacity-based pricing approach for its largest GBS system, the XC-1000. This pricing approach was also adopted for other Overture system sales beginning in fiscal 1996. This approach allows customers to purchase systems with only part of the equipment's capacity enabled and then have additional capacity enabled in the future upon payment of additional fees. While the Company believes that this approach will make it more competitive, there can be no assurance that this approach will be successful in winning additional sales or will not defer revenue that might have otherwise been earned earlier. Difficulties in implementing this approach, delays or adverse results due to renegotiation of sales and distribution agreements to accommodate capacity-based pricing, deferral of revenue or the failure to generate additional sales could have an adverse effect on the Company's results of operations. Due to the factors noted above and elsewhere in management's discussion and analysis of financial condition and results of operations, the Company's future earnings and Common Stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue or earnings from the levels anticipated by securities analysts could have an immediate and significant effect on the trading price of the Company's Common Stock in any given period. Additionally, the Company may not learn of such shortfalls until late in a fiscal quarter, which could result in an even more immediate and adverse effect on the trading price of the Company's Common Stock. Both the Company's Common Stock and the stock market generally are at or near historic highs and there can be no assurance that such valuations will continue or increase. Finally, the Company participates in a highly dynamic industry which often results in volatility of the Company's Common Stock price. The Company has been and may in the future continue to be required to litigate enforcement of its intellectual property or commercial rights or to defend itself in litigation arising out of claims by third parties. Such litigation, even if the Company is ultimately victorious, can be extremely expensive and may have a material adverse effect on the Company's results of operations in any particular period. Litigation may also occupy management resources that would otherwise be available to address other aspects of the Company's business. See "Business - Patents, Copyrights, Trademarks and Technology Licenses." 29 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENT
Page ---- Financial Statements: Consolidated Balance Sheets................................... 31 Consolidated Statements of Income............................. 32 Consolidated Statements of Stockholders' Equity............... 33 Consolidated Statements of Cash Flows......................... 34 Notes to Consolidated Financial Statements.................... 35 Independent Auditors' Report.................................. 49 Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts.............. 54
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable. 30 31 CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
JUNE 30, 1995 1994 --------- --------- Current assets: Cash and equivalents $ 24,521 $ 17,889 Short-term investments 28,054 68,463 Accounts receivable, net of allowance for doubtful accounts of $2,938 and $2,665 110,679 90,013 Accounts receivable from related parties 6,270 2,159 Inventories 31,151 28,920 Prepaid expenses and other 15,448 13,865 --------- --------- Total current assets 216,123 221,309 Property, plant and equipment, net 128,753 95,076 Deposits and other assets 23,400 29,743 --------- --------- Total $ 368,276 $ 346,128 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade payables $ 21,157 $ 16,250 Accrued compensation and employee benefits 28,188 25,010 Income taxes payable 7,921 2,616 Accrued and other liabilities 35,465 44,660 --------- --------- Total current liabilities 92,731 88,536 Long-term obligations 602 1,400 Commitments and contingencies (Notes 2, 9, 10, 14, 16 and 18) -- -- Stockholders' equity: Preferred stock, $.001 par value--authorized 5.0 million shares; none outstanding -- -- Common stock, $.001 par value--authorized, 50.0 million shares; outstanding: 1995, 23.8 million shares, 1994, 24.2 million shares 183,193 174,356 Notes receivable from employees (1,347) -- Retained earnings 96,039 82,736 Unrealized loss on marketable securities (net of deferred taxes of $86 and $330) (94) (540) Accumulated translation adjustments (501) (360) Treasury stock at cost: 1995, 0.1 million shares, 1994, none (2,347) -- --------- --------- Total stockholders' equity 274,943 256,192 --------- --------- Total $ 368,276 $ 346,128 ========= =========
See notes to consolidated financial statements. 31 32 CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED JUNE 30, ------------------------------------ 1995 1994 1993 ---- ---- ---- NET REVENUES: Systems $314,343 $ 292,090 $254,860 Services and license 158,249 114,135 83,618 -------- --------- -------- Total net revenues 472,592 406,225 338,478 COSTS AND EXPENSES: Cost of systems 103,541 89,423 74,856 Cost of services 89,787 72,379 54,521 Research and development 74,644 58,325 44,420 Selling, general and administrative 154,302 149,027 127,559 Non-recurring charge for in-process research and development 4,725 -- -- Integration costs 2,848 18,258 -- -------- --------- -------- Total costs and expenses 429,847 387,412 301,356 -------- --------- -------- Operating income 42,745 18,813 37,122 Interest and other income (expense), net 2,887 (1,470) 4,294 -------- --------- -------- Income before income taxes and cumulative effect of accounting change 45,632 17,343 41,416 Provision for income taxes 14,500 3,800 11,734 -------- --------- -------- Income before cumulative effect of accounting change 31,132 13,543 29,682 Cumulative effect of accounting change -- -- 115 -------- --------- -------- NET INCOME $ 31,132 $ 13,543 $ 29,567 ======== ========= ======== INCOME PER COMMON AND EQUIVALENT SHARE: Primary: Income before cumulative effect of accounting change $ 1.26 $ 0.54 $ 1.19 Cumulative effect of accounting change -- -- -- -------- --------- -------- NET INCOME $ 1.26 $ 0.54 $ 1.19 ======== ========= ======== Fully diluted: Income before cumulative effect of accounting change $ 1.21 $ 0.54 $ 1.19 Cumulative effect of accounting change -- -- -- -------- --------- -------- NET INCOME $ 1.21 $ 0.54 $ 1.19 ======== ========= ======== Weighted average number of common and equivalent shares used in computation: Primary 24,724 25,096 24,869 ======== ========= ======== Fully diluted 25,728 25,096 24,869 ======== ========= ========
See notes to consolidated financial statements. 32 33 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
UNREALIZED NOTES GAIN (LOSS) RECEIVABLE ON ACCUMULATED COMMON STOCK FROM SALE DEFERRED RETAINED MARKETABLE TRANSLATION SHARES AMOUNT OF STOCK COMPENSATION EARNINGS SECURITIES ADJUSTMENTS TOTAL - ------------------------------------------------------------------------------------------------------------------------------ Balances, June 30, 1992 22,777,556 $149,429 $ (162) $ (271) $ 53,231 -- $ 159 $ 202,386 Pooling of interests adjustments 456,320 353 -- -- 37 -- -- 390 Sale of common stock under Employee Stock Purchase Plan 251,645 4,037 -- -- -- -- -- 4,037 Sale of common stock, net of stock surrendered 375,993 3,524 -- -- (35) -- -- 3,489 Proceeds from sale of put warrants -- 977 -- -- -- -- -- 977 Repurchases of common stock - - retired (603,951) (3,625) -- -- (9,478) -- -- (13,103) Deferred compensation amortization -- -- -- 216 -- -- -- 216 Tax benefit of stock option transactions -- 2,175 -- -- -- -- -- 2,175 Payment on notes receivable -- -- 106 -- -- -- -- 106 Translation adjustments -- -- -- -- -- -- (559) (559) Net income -- -- -- -- 29,567 -- -- 29,567 - ------------------------------------------------------------------------------------------------------------------------------ Balances, June 30, 1993 23,257,563 156,870 (56) (55) 73,322 -- (400) 229,681 Sale of common stock under Employee Stock Purchase Plan 326,860 5,224 -- -- -- -- -- 5,224 Sale of common stock, net of stock surrendered 817,921 11,256 -- -- (121) -- -- 11,135 Repurchases of common stock - - retired (232,000) (1,759) -- -- (4,008) -- -- (5,767) Deferred compensation amortization -- -- -- 55 -- -- -- 55 Tax benefit of stock option transactions -- 2,765 -- -- -- -- -- 2,765 Payment on notes receivable -- -- 56 -- -- -- -- 56 Unrealized loss on marketable securities -- -- -- -- -- $(540) -- (540) Translation adjustments -- -- -- -- -- -- 40 40 Net income -- -- -- -- 13,543 -- -- 13,543 - ------------------------------------------------------------------------------------------------------------------------------ Balances, June 30, 1994 24,170,344 174,356 -- -- 82,736 (540) (360) 256,192 Sale of common stock under Employee Stock Purchase Plan 369,026 5,966 -- -- -- -- -- 5,966 Sale of common stock, net of stock surrendered 593,090 6,870 -- -- -- -- -- 6,870 Repurchases of common stock - - retired (1,200,600) (8,207) -- -- (17,829) -- -- (26,036) Repurchases of common stock - - held in treasury (105,000) (733) -- -- (1,614) -- -- (2,347) Proceeds from sale of put warrants -- 1,768 -- -- -- -- -- 1,768 Tax benefit of stock option transactions -- 2,440 -- -- -- -- -- 2,440 Notes receivable from employees -- -- (1,347) -- -- -- -- (1,347) Unrealized gain on marketable securities -- -- -- -- -- 446 -- 446 Translation adjustments -- -- -- -- -- -- (141) (141) Net income -- -- -- -- 31,132 -- -- 31,132 - ------------------------------------------------------------------------------------------------------------------------------ Balances, June 30, 1995 23,826,860 $182,460 $(1,347) -- $94,425 $(94) $(501) $274,943 ==============================================================================================================================
See notes to consolidated financial statements. 33 34 CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED JUNE 30, ---------------------------------------- 1995 1994 1993 -------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 31,132 $ 13,543 $ 29,567 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 30,660 34,219 22,287 Amortization of premium on marketable securities 187 294 -- Deferred income taxes 1,537 (13,909) 1,948 Deferred compensation -- 55 216 Purchased in-process research and development 4,725 -- -- Changes in assets and liabilities: Accounts receivable (24,005) (13,572) (20,891) Inventories (1,946) (449) 1,438 Prepaid expenses and other (2,381) (1,633) (239) Trade payables 4,866 46 (1,441) Accrued compensation and employee benefits 3,052 4,860 3,507 Accrued and other liabilities (1,023) 25,964 3,451 -------- --------- --------- Net cash provided by operating activities 46,804 49,418 39,843 -------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Sales of common stock under employee stock plans, net 11,618 16,480 7,543 Repurchases of common stock (28,383) (5,767) (13,103) Proceeds from sale of financial instruments-put warrants 1,768 -- 977 Issuance of common stock -- -- 18 Payment on notes receivable -- 56 106 Repayment of long-term obligations (831) (605) (1,257) -------- --------- --------- Net cash provided by (used for) financing activities (15,828) 10,164 (5,716) -------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of short-term investments (37,516) (128,869) (256,016) Sales and maturities of short-term investments 78,421 133,115 250,965 Property, plant and equipment additions, net (56,857) (58,648) (30,775) Changes in deposits and other assets (2,537) (13,970) (15,576) Acquisition of intellectual and personal property (5,061) -- -- Net cash used in business acquisitions -- -- (9,391) -------- --------- --------- Net cash used for investing activities (23,550) (68,372) (60,793) EFFECT OF EXCHANGE RATE CHANGES ON CASH (794) 103 214 -------- --------- --------- NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 6,632 (8,687) (26,452) CASH AND EQUIVALENTS: Beginning of year 17,889 26,576 53,028 -------- --------- --------- End of year $ 24,521 $ 17,889 $ 26,576 ======== ========= =========
See notes to consolidated financial statements 34 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION The Company designs, manufactures and markets voice information processing systems. The Company also provides voice processing and networking services. The consolidated financial statements include the Company and its wholly owned subsidiaries. Intercompany balances and transactions are eliminated in consolidation. Certain prior years' costs previously reported as selling, general and administrative have been reclassified to cost of services to conform to the fiscal 1995 presentation. 2. SIGNIFICANT ACCOUNTING POLICIES Cash equivalents Cash equivalents consist of all highly liquid debt instruments purchased with a maturity of three months or less. Short-term investments In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). The Company adopted the provisions of SFAS 115 for investments held as of June 30, 1994. Under the provisions of SFAS 115, the Company has classified its investments in certain debt securities as "available-for-sale." Such investments are recorded at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to "Interest and other income (expense), net." The cost of securities sold is based upon the specific identification method. In accordance with the provisions of SFAS 115, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect as of June 30, 1994 of adopting SFAS 115 was to decrease stockholders' equity by $0.5 million to reflect the net unrealized loss on investments classified as "available-for-sale" and previously recorded at cost. See Note 3. Foreign currency translation The Company's foreign subsidiaries operate using local functional currencies, except for Israel, which uses the U.S. Dollar as its functional currency. Accordingly, assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are accumulated as a separate component of stockholders' equity. Realized and unrealized gains and losses on foreign currency transactions and hedge contracts are included in interest and other income (expense), net. Financial instruments and risk concentration The forward hedge contracts discussed above require the Company to exchange currencies at rates agreed upon at the inception of the contracts. Although the gross amounts are used to express the volume of these transactions, the amounts potentially subject to credit risk are limited to the difference between the counterparty's obligation and the obligation of the Company. The contracts do not subject the Company to significant market risk from exchange rate movements because the contracts offset foreign currency balances and transactions being hedged. The Company maintains policies for entering into foreign exchange contracts and investments. Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash equivalents, short-term investments, accounts receivable and financial instruments used in hedging activities. The Company's cash equivalents and short-term investments are primarily in U.S. government obligations and municipal notes and bonds that have maturities ranging from 1995 through 2003. The Company believes no significant concentration of credit risk exists with respect to these financial instruments. Balances due from international 35 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) customers account for 32 percent of the total accounts receivable at June 30, 1995 (35 percent at June 30, 1994). Additionally, distributors and VIS customers comprise 13 percent and 38 percent of total accounts receivable, respectively (18 percent and 40 percent in 1994, respectively). Generally, the Company requires no collateral from customers. The Company believes that any credit risks are substantially mitigated by the Company's credit evaluation process. Fair value of financial instruments For certain of the Company's financial instruments, including cash and equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses, the carrying amounts approximate fair value due to their short maturities. Consequently, such instruments are not included in the following table. The following table provides information regarding the estimated fair values of off balance sheet financial instruments determined based on quoted market prices of comparable instruments (in thousands):
JUNE 30, 1995 JUNE 30, 1994 ----------------------- ----------------------- NOTIONAL ESTIMATED NOTIONAL ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE -------- ---------- -------- ---------- Forward exchange contracts: Sell foreign currency $10,112 $10,097 $ 17,917 $17,763 Buy foreign currency $ 3,174 $ 3,184 $ -- $ --
Inventories Inventories are stated at the lower of cost (first-in, first-out) or market. Development costs Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed." The Company has not capitalized any software development costs, as the Company's current process for developing this software is essentially completed concurrently with the establishment of technological feasibility. In connection with the VMX merger, certain costs formerly capitalized by VMX were written off to conform accounting practices during fiscal 1994. In fiscal 1995, 1994 and 1993, the Company entered into contracts for funded software development projects. These contracts are contractual services as defined by Statement of Financial Accounting Standards No. 68, "Research and Development Arrangements." The Company defers development costs and revenue for these projects and such deferred costs are expensed to cost of sales when the related revenue is recognized. The Company maintains all rights related to the funded projects. During fiscal 1995, the Company incurred a one-time charge of approximately $1.2 million related to a cancelled contract for software development. As of June 30, 1995, all current projects are expected to be completed substantially in accordance with the related contract. As of June 30, 1995, $0.5 million of costs related to these contracts were deferred ($2.9 million and $1.9 million at June 30, 1994 and 1993, respectively). Prepayments recorded as a liability were $0.2 million at June 30, 1995 ($1.0 million and $0.1 million were recorded at June 30, 1994 and 1993, respectively). In fiscal year 1995, $1.0 million was expensed to cost of sales and $1.0 million recognized as revenue for contracts ($0.8 million was expensed to cost of sales and recognized as revenue in 1994 and $0.3 million was expensed to cost of sales and recognized as revenue in 1993). 36 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Acquired in-process research and development In August 1994, the Company purchased certain intellectual and personal property from another company for $5.1 million. Of the total purchase price, $4.7 million was allocated to in-process research and development and $0.4 million was allocated to property and equipment. The in-process research and development was expensed in the first quarter of fiscal 1995. Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: Buildings 40 years Machinery & equipment 2 - 10 years Furniture & fixtures 5 years Leasehold improvements Life of lease
Intangible assets Goodwill represents the excess of acquisition cost, including reserves for certain acquisition-related expenses, over the fair value of the net assets acquired and was being amortized on a straight-line basis over ten years. Goodwill of $1.7 million was included in the balance sheet caption "Deposits and other assets" as of June 30, 1994. During fiscal 1995, the balance in Goodwill was eliminated in connection with the reversal of remaining acquisition reserves that were no longer required. The Company has acquired various technology licenses and enters into other agreements requiring pre-payments. The cost of the licenses and other agreements is amortized from the date that the related product is commercially available over periods based on anticipated future revenue streams from the related products not exceeding 36 months. As of June 30, 1995 and 1994, $2.5 million and $3.3 million, respectively, were included in the balance sheet caption "Deposits and other assets" for such assets. Revenue recognition Revenue is recognized upon shipment to distributors and upon installation for end users. Revenue is also recognized upon shipment to end users for orders from businesses which have previously installed the Company's products, and upon shipment of upgrades and expansions to larger capacity systems. Revenues on service contracts are primarily recognized ratably over the contract period. Returns and allowances The Company does not generally reserve for returns because, historically, the Company has not experienced any significant returns of any of its products by customers. Warranty costs The Company warrants its products for one year after delivery to the purchaser or after Company performed installation. Provision for estimated warranty costs is recorded at the time of sale. Income taxes Effective July 1, 1992, the Company adopted SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and 37 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. As permitted by SFAS No. 109, the Company elected to record the cumulative effect of adopting this pronouncement as a change in accounting principle as of July 1, 1992, the result of which was a reduction in fiscal 1993 net income of $0.1 million. This charge represents the writedown of net deferred tax assets and liabilities from the tax rates in effect when they arose to current statutory tax rates. Net income per common and equivalent share Primary and fully diluted net income per common and equivalent share are computed based upon the weighted average number of common and equivalent shares from stock options and put warrants (using the treasury stock method) and shares subscribed under the Employee Stock Purchase Plan. 3. INVESTMENTS At June 30, 1995, all cash equivalents and short-term investments were considered available-for-sale securities and consisted of the following (in thousands):
UNREALIZED UNREALIZED ACCRUED ESTIMATED COST GAINS LOSSES INTEREST FAIR VALUE ------- ---------- ---------- -------- ---------- U.S. Government securities $12,117 $ -- $(180) $ (82) $11,855 Municipal notes/bonds 22,200 41 (41) (376) 21,824 ------- ----- ----- -------- ------- $34,317 $ 41 $(221) $ (458) $33,679 ======= ===== ===== ======== =======
At June 30, 1994, all cash equivalents and short-term investments were considered available-for-sale securities and consisted of the following (in thousands):
UNREALIZED UNREALIZED ACCRUED ESTIMATED COST GAINS LOSSES INTEREST FAIR VALUE ------- ---------- ---------- -------- ---------- U.S. Government securities $ 9,803 $ 9 $(455) $ (103) $ 9,256 Municipal notes/bonds 60,598 17 (441) (891) 59,281 ------- ----- ----- -------- ------- $70,401 $ 26 $(896) $ (994) $68,537 ======= ===== ===== ======== =======
At June 30, 1995 and 1994, these securities were classified on the balance sheet as follows (in thousands):
1995 1994 ------- ------- Cash equivalents $ 6,083 $ 1,068 Short-term investments 28,054 68,463 ------- ------- $34,137 $69,531 ======= =======
The cost and estimated fair value of available-for-sale debt securities as of June 30, 1995, by contractual maturity, consisted of the following (in thousands): 38 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ESTIMATED COST FAIR VALUE --------- ---------- Due in one year or less $ 15,573 $ 15,457 Due in one to three years 14,778 14,476 Due thereafter 3,966 3,746 --------- ---------- $ 34,317 $ 33,679 ========= ========
For the year ended June 30, 1995, the Company had $212.3 million in proceeds from sales of available-for-sale investments, $0.3 million of gross realized gains and $0.4 million of gross realized losses on those sales. 4. BUSINESS COMBINATIONS -- POOLING OF INTERESTS METHOD VMX, Inc. On March 31, 1994, Octel Acquisition Corporation, a wholly owned subsidiary of Octel, was merged with and into VMX, Inc. (VMX), with VMX being the surviving corporation and a wholly owned subsidiary of Octel. In the transaction, approximately 5.4 million shares of Octel's common stock were issued in exchange for all of the outstanding common stock of VMX. The merger was accounted for as a pooling of interests, and accordingly, the accompanying financial statements have been restated to include the accounts and operations of VMX for all periods prior to the merger. Effective in the quarter ended March 31, 1994, VMX recorded $2.2 million in charges to operations to conform certain changes in estimates and accounting policies to those of Octel. VMX provided integrated messaging and call processing systems, software and services that combined voice, data and image for business communications, worldwide. Separate results of the combining entities for the periods prior to the merger were as follows (in thousands):
NINE MONTHS ENDED YEAR ENDED MARCH 31, 1994 JUNE 30, 1993 ----------------- ------------- NET REVENUES: Octel $ 216,662 $ 249,549 VMX 74,270 90,463 Less intercompany sales (1,233) (1,534) --------- --------- $ 289,699 $ 338,478 ========= ========= NET INCOME: Octel $ 16,724 $ 22,553 VMX 4,844 7,036 Intercompany transactions 10 (22) Merger related costs and adjustments (net of tax benefits) (18,755) -- --------- --------- $ 2,823 $ 29,567 ========= =========
In connection with the merger, approximately $3.6 million of merger expenses were incurred and charged to interest and other income (expense), net during the third quarter of fiscal 1994. These non-recurring expenses included investment banking fees of $2.6 million, legal and accounting fees of $0.6 million and other miscellaneous expenses of $0.4 million. Also in connection with the merger, the Company recorded integration costs in the third quarter of fiscal 1994 of $18.3 million related to costs associated with consolidating facilities and personnel. Included in such integration costs were building lease termination fees and moving costs in connection with redundant facilities, employee severance, 39 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) relocation expenses, and the write-off of leasehold improvements and assets impaired as a direct result of the merger. The balance in these reserves of $4.6 million at June 30, 1995 is included in "Accrued and other liabilities" on the balance sheet. Additional expenses of $2.8 million were incurred in fiscal 1995, relating primarily to literature design for name change and other modifications to literature for the merged company and the consolidation of processes and computer systems of the merged company. Rhetorex, Inc. In March 1993, the Company issued the equivalent of 346,218 shares of its Common Stock in exchange for all of the outstanding capital stock of Rhetorex, Inc. (Rhetorex), which has been accounted for as a pooling of interests. In addition the Company assumed Rhetorex stock options which represented options to purchase 3,779 shares of the Company's Common Stock subsequent to the transaction. Rhetorex designs and manufactures high performance voice processing components and software for personal computers. Compass Technology, Inc. Effective August 12, 1992, the Company consummated a business combination with Compass Technology, Inc. (now Octel PC Products Division (OPCPD)) which was accounted for as a pooling of interests. OPCPD develops and markets voice processing applications software for PC-based systems. To effect the combination, approximately 460,000 shares of common stock were issued in exchange for substantially all equity securities of OPCPD. The net assets of OPCPD amounted to $0.5 million at June 30, 1992. 5. BUSINESS COMBINATION -- PURCHASE METHOD On October 21, 1992, the Company acquired Tigon Corporation (now Octel Network Services (ONS)) from Ameritech. ONS is a provider of voice processing and networking services primarily in the United States. The purchase price of $12 million was paid in cash. The acquisition was accounted for as a purchase and the results of ONS' operations were combined with those of the Company from the date of acquisition. Goodwill of $7.5 million, representing the excess of acquisition cost, including reserves for certain acquisition related expenses, over the $10.3 million estimated fair value of the net assets acquired, was recorded at the date of acquisition, prior to the adoption of SFAS No. 109. As discussed in Note 13 below, the assets and liabilities assumed in the acquisition of ONS were remeasured in connection with the adoption of SFAS No. 109 by the Company. The gross balance of goodwill at June 30, 1994 was $ 2.1 million, which reflects the change for the SFAS No. 109 remeasurement and the final purchase price allocation adjustment of $1.3 million made prior to the end of the one year anniversary date of the acquisition. Goodwill amortization expense for fiscal 1995, 1994 and 1993 was $0.2 million, $0.3 million and $0.1 million respectively. During fiscal 1995, the balance in Goodwill was eliminated in connection with the reversal of remaining acquisition reserves that were no longer required. 6. INVENTORIES Inventories consist of (in thousands):
JUNE 30, ----------------------- 1995 1994 ----------------------- Finished goods $ 5,009 $ 5,864 Work-in-process 8,586 12,248 Raw materials 17,556 10,808 ------- ------- Total inventories $31,151 $28,920 ======= =======
7. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of (in thousands): 40 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, ------------------------- 1995 1994 ------------------------- Computers and electronic equipment $ 129,396 $ 85,545 Buildings 35,761 28,613 Furniture and fixtures 16,443 14,317 Land 12,258 12,258 Leasehold improvements 6,273 6,867 Other machinery and equipment 5,596 11,780 --------- --------- Total 205,727 159,380 Accumulated depreciation and amortization (76,974) (64,304) --------- --------- Property, plant and equipment, net $ 128,753 $ 95,076 ========= =========
8. ACCRUED AND OTHER LIABILITIES Accrued and other liabilities consist of (in thousands):
JUNE 30, -------------------- 1995 1994 -------------------- Unearned revenue and deposits $10,876 $ 9,240 Integration reserves 4,583 12,516 Warranty reserve 3,230 2,956 Amounts due to distributors 3,059 3,595 Reserves for acquisition related expenses -- 4,817 Other 13,717 11,536 ------- ------- Accrued and other liabilities $35,465 $44,660 ======= =======
Other liabilities primarily consist of property and sales taxes, amounts due to direct customers and other liabilities. 9. LINE OF CREDIT AND LETTERS OF CREDIT Effective June 1994, the Company obtained a $30 million bank revolving line of credit which also allows the Company to obtain standby letters of credit. Borrowings under the line are unsecured and bear interest at either an adjusted LIBOR rate plus one and one-quarter percent or the greater of the Bank's base rate or the Federal Funds Effective Rate plus one-half of one percent, at the Company's discretion upon borrowing the funds. Borrowings under the line are subject to certain financial covenants and restrictions on indebtedness, equity distributions, financial guarantees, business combinations and other related items. The Company was in compliance with these covenants and had no borrowings under this line as of June 30, 1995. The line expires in June 1996. At June 30, 1995, the Company had $1.8 million of stand-by letters of credit outstanding. The letters of credit are primarily to guarantee payments for inventory purchases and facility lease payments. The majority of the Letters of Credit are denominated in Japanese Yen, U.S. Dollars and French Francs and expire on various dates through July 1, 1998. 10. STOCKHOLDERS' EQUITY In July 1990, the Company's Board of Directors approved a common shares rights agreement and declared a dividend distribution, payable to stockholders of record on August 15, 1990, of one Common Stock purchase right for each outstanding share of its Common Stock. Initially, each right entitles the stockholder to buy one newly issued share of the Company's Common Stock at an exercise price of $80. The rights become exercisable (unless postponed by 41 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) action of the disinterested directors) on the earlier of: (1) ten days following a public announcement that a person or group has acquired, or obtained the right to acquire, beneficial ownership of 21% or more of the outstanding Common Stock or (2) ten days following the commencement or announcement of a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person or group of 21% or more of the Company's outstanding Common Stock. If the Company is acquired in a merger or other business combination transaction without approval by the Company's Board of Directors, each right not held by the acquiring person would entitle its holder to purchase $160 worth of the common stock of the acquiring company for $80. If any person or group acquires 21% or more of the Company's Common Stock without approval by the Company's Board of Directors, each right not held by the acquiring person would entitle its holder to purchase $160 worth of the Company's Common Stock for $80. The rights are redeemable at the Company's option for $0.01 per right. Additionally, the exercise price, number of rights and number of common shares that may be acquired are subject to adjustment from time to time to prevent dilution. The rights expire on July 31, 2000. At June 30, 1995 substantially all shares of Common Stock are subject to this agreement. Common Stock During fiscal 1992, a stock repurchase program was approved by the Board of Directors whereby the Company may repurchase such shares of its Common Stock on the open market as may reasonably be required for exercises under the 1985 Incentive Stock Option Plan and issuances under the 1987 Employee Stock Purchase Plan. In July 1994, the Company's Board of Directors approved the repurchase of up to 3.5 million shares of its Common Stock over a period of approximately two years. During fiscal 1995, 1994 and 1993, the Company repurchased 1,305,600 shares, 232,000 shares, and 603,951 shares, respectively. Average prices paid during these periods (exclusive of any put warrant proceeds) were $22 per share, $25 per share and $22 per share, respectively. As of June 30, 1995, approximately 1.8 million of the repurchased shares have been reissued under employee stock plans with the balance expected to be reissued under such plans in fiscal 1996. During fiscal 1993 and 1995, in connection with its stock repurchase program, the Company sold put warrants in a series of private placements, with the intention of reducing the cost of the stock repurchase program. The put warrants entitle the holder to sell one share of common stock to the Company for each warrant held, at a specified price, if the holder exercises the warrant. The activity for fiscal 1995, 1994 and 1993 is summarized as follows:
PUT WARRANTS OUTSTANDING ------------------------------------------------ CUMULATIVE NUMBER OF POTENTIAL PROCEEDS RECEIVED WARRANTS OBLIGATION ----------------- -------- ---------- June 30, 1992 -- -- -- Sales $ 977,000 500,000 $ 11,043,000 Expirations -- (200,000) (3,750,000) ---------- --------- ------------ June 30, 1993 977,000 300,000 7,293,000 Exercises -- (200,000) (5,143,000) Expirations -- (100,000) (2,150,000) ---------- --------- ------------ June 30, 1994 977,000 -- -- Sales 1,768,000 1,143,000 25,082,000 Exercises -- (383,000) (8,436,000) Expirations -- (500,000) (10,547,000) ---------- --------- ------------ June 30, 1995 $2,745,000 260,000 $ 6,099,000 ========== ========= ============
In November 1994, the Company increased the number of shares of Common Stock reserved for issuance under its 1987 Employee Stock Purchase Plan from 1,250,000 to 1,650,000. Eligible employees may authorize payroll 42 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) deductions of up to 10% of their compensation to purchase shares at the lower of 85% of the fair market value of the Common Stock as of the date of grant (first day of an offering period, or for newly hired employees, the date their participation begins) or the last day of the six-month offering period. In fiscal 1995, 369,000 shares were purchased at an average price of $16.17 (327,000 in fiscal 1994 at an average price of $15.98 and 252,000 in fiscal 1993 at an average price of $16.04). During fiscal 1994, the Company increased the number of shares of Common Stock reserved for issuance under its 1985 Incentive Stock Plan from 6,300,000 to 9,600,000. In November 1994, the Company increased shares of Common Stock reserved for issuance under the Directors' Stock Option Plan from 200,000 to 350,000. Under the plans, stock options may be granted to employees, consultants and directors to purchase Common Stock at not less than fair market value at the date of grant. Options become exercisable as determined by the Board of Directors, generally over five years. However, options granted after June 1, 1994 become exercisable over four years. Options granted before November 1988 expire ten years from date of grant, while those granted after that date expire five and one-half years from date of grant, or within six months after becoming fully exercisable, whichever is sooner. At June 30, 1995, a total of 957,541 shares were available for future grants under the plans. In June 1994, the Board of Directors approved a repricing of stock options for certain employees, excluding senior management and officers. The employees had the option of either maintaining their existing options or cancelling any options with exercise prices greater than $17.25 and receiving new options representing 90% of the options being cancelled. The new options' vesting commencement date was reset to June 22, 1994 and the new options will vest at the rate of 25% each year over four years. The options expire five and one-half years from the grant date. The vested options may only be exercised when the fair market value of the Company's Common Stock equals or exceeds the original option exercise price; however, after five years and three months from June 22, 1994, the options may be exercised regardless of the fair market value of the Company's Common Stock for up to three months. Options for up to 1,574,717 shares were qualified for the repricing. Under this repricing, options for approximately 1,253,000 shares were cancelled and options for approximately 1,120,000 shares were granted. Fiscal 1994 activity has been adjusted in the table below to reflect the repricing. Information regarding outstanding stock options is as follows:
SHARES PRICE PER SHARE TOTAL --------- --------------- ------------ Outstanding at June 30, 1992 3,995,808 $ .05 - 36.25 $ 51,751,035 Granted 2,022,418 11.25 - 27.25 43,628,690 Cancelled (314,800) .75 - 36.25 (4,964,760) Exercised (377,163) .50 - 22.88 (3,577,452) --------- -------------- ------------ Outstanding at June 30, 1993 5,326,263 .05 - 36.25 86,837,513 Granted 4,655,640 17.20 - 50.00 112,453,499 Cancelled (2,150,920) 2.50 - 36.25 (48,031,089) Exercised (825,595) .05 - 25.00 (11,386,983) --------- -------------- ------------ Outstanding at June 30, 1994 7,005,388 .05 - 50.00 139,872,940 Granted 1,276,830 16.25 - 29.13 27,055,260 Cancelled (854,770) .55 - 36.25 (17,942,164) Exercised (603,303) .05 - 25.00 (7,038,525) --------- -------------- ------------ Outstanding a June 30, 1995 6,824,145 $ .05 - 50.00 $141,947,511 ========= ============== ============
At June 30, 1995, options to purchase 2,195,647 shares were exercisable. 43 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) At June 30, 1995, the Company has reserved shares of Common Stock for issuance as follows: Issuance under Incentive Stock Plan and Directors' Stock Option Plan 7,781,686 Issuance under Employee Stock Purchase Plan 31,841 --------- 7,813,527 =========
During fiscal 1995, certain employees exercised stock options in exchange for notes. Notes receivable from the sale of stock bear interest at variable rates ranging from 6.62% to 7.43% and are due at various dates through 1998. The notes are secured, in part, by the stock issued upon exercise of the stock options. In October 1990, the Board of Directors authorized a restricted stock purchase of 60,000 shares for $.001 per share by an individual who was an officer of the Company. Deferred compensation, representing the difference between $.001 per share and the fair market value of the shares at the date of issuance, was amortized over the three-year vesting period. In fiscal 1994 and 1993, $55,000 and $216,000, of deferred compensation was amortized, respectively. 11. RELATED PARTY TRANSACTIONS During fiscal 1995, 1994 and 1993, the Company had sales of approximately $26.0 million, $28.4 million and $23.6 million, respectively, to companies in which a member of the Company's Board of Directors is also an officer and to a company that owned approximately 3.8 percent, 6.5 percent and 9.0 percent of the Company's Common Stock at June 30, 1995, 1994 and 1993, respectively. Amounts due from these companies at June 30, 1995 and 1994 were $6.3 million and $2.2 million, respectively. 12. INTEREST AND OTHER INCOME (EXPENSE), NET Interest and other income (expense), net consists of (in thousands):
1995 1994 1993 ------- ------- ------- Interest and investment income $ 2,514 $ 3,216 $ 3,915 Gain (loss) on sale of short-term investments, net (105) (11) 1,276 Interest expense (155) (267) (56) Foreign exchange gains (losses), net 774 (370) 210 Merger expenses -- (3,592) (439) Other expense, net (141) (446) (612) ------- ------- ------- Total interest and other income (expense), net $ 2,887 $(1,470) $ 4,294 ======= ======= =======
Cash payments for interest were $0.2 million, $0.3 million and $0.1 million in fiscal 1995, 1994 and 1993, respectively. 13. INCOME TAXES Effective July 1, 1992, the Company adopted SFAS No. 109. As permitted by SFAS No. 109, the Company elected to record the cumulative effect of adopting this pronouncement as a change in accounting principle as of July 1, 1992, the result of which was a reduction in fiscal 1993 net income of $0.1 million. In accordance with the provisions of SFAS No. 109, the assets acquired and liabilities assumed in the purchase of ONS in October 1992 were remeasured. The result of applying SFAS No. 109 to the purchase of ONS was to recognize deferred tax assets and deferred tax liabilities for the future tax consequences of the deductible and taxable temporary differences between the assigned fair values of the assets and liabilities and the tax bases. In addition, a deferred tax asset has been recognized for the tax benefit of ONS' net operating loss carryforwards existing at the date of acquisition. A valuation allowance was recognized to reduce the deferred tax asset to the amount more likely than not to be realized. Goodwill, originally recorded, was reduced by $6.8 million to the difference between the purchase 44 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) price and the values assigned to identifiable assets and liabilities, including deferred tax assets (net of valuation allowance) and deferred tax liabilities. In fiscal 1994, the final purchase price allocation adjustment was made (see Note 5) which had the effect of increasing deferred tax assets by approximately $0.9 million. As of June 30, 1995, the Company had net operating loss carryforwards of $11.8 million, resulting from the acquisition of ONS, that expire beginning in fiscal 1997 and ending in fiscal 2001. As mentioned above, a valuation allowance of $3.6 million has been recognized to offset the deferred tax assets related to those carryforwards by the tax effect of the amount of the net operating loss carryforwards which are not likely to be utilized. If realized, the tax benefit for those reserved items will be applied as a reduction of income tax expense. The major components of the Company's deferred tax assets and liabilities are as follows (in thousands):
JUNE 30, ------------------------- 1995 1994 --------- --------- DEFERRED TAX ASSETS: Reserves and accrued liabilities $ 7,179 $ 12,583 Accumulated depreciation 5,193 4,522 Net operating loss carryforwards acquired in purchase business combination 4,602 4,966 Accrued vacation 2,170 1,375 Technology purchase 1,830 -- Tax credit carryforwards 1,669 1,634 Accounts receivable allowance 1,438 1,012 Inventory capitalization 1,169 577 Profit in inventory 1,011 -- Accrued commissions and compensation 478 492 Other 258 724 --------- --------- Total gross deferred tax assets 26,997 27,885 Valuation allowance (3,637) (3,637) --------- --------- Deferred tax assets 23,360 24,248 --------- --------- DEFERRED TAX LIABILITIES: Deferred revenue (5,121) (3,524) Amortization of spare parts inventory (2,117) (2,781) State taxes (519) (523) Amortization of purchased software (51) (752) Profit in inventory -- (715) Other (945) (398) --------- --------- Total gross deferred tax liabilities (8,753) (8,693) --------- --------- Net deferred tax assets $ 14,607 $ 15,555 ========= =========
At June 30, 1995 and 1994, a net current deferred tax asset of $6.7 million and $7.5 million, respectively, has been included in the balance sheet caption "Prepaid expenses and other," and a net long-term deferred tax asset of $7.9 million and $8.1 million, respectively, has been included in the balance sheet caption "Deposits and other assets." 45 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Income before income taxes and cumulative effect of accounting change includes the following components:
1995 1994 1993 ------- ------- ------- Income before income taxes and cumulative effect of accounting change: Domestic $38,097 $14,375 $39,684 Foreign 7,535 2,968 1,732 ------- ------- ------- Total $45,632 $17,343 $41,416 ======= ======= =======
The provision for income taxes, attributable to income before income taxes and cumulative effect of accounting change, consists of:
1995 1994 1993 ------- ------- ------- Income tax provision (benefit) Current: Federal $ 9,588 $ 8,123 $ 6,210 State 2,429 3,313 2,148 Foreign 2,475 1,454 1,274 ------- ------- ------- Total current 14,492 12,890 9,632 ------- ------- ------- Deferred: Federal 26 (7,980) 1,773 State (18) (1,110) 329 ------- ------- ------- Total deferred 8 (9,090) 2,102 ------- ------- ------- Provision for income taxes $14,500 $ 3,800 $11,734 ======= ======= =======
The reconciliation of the statutory federal income tax rate to the effective tax rate is as follows:
1995 1994 1993 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 34.0% State income and franchise taxes net of federal income tax effect 3.4 8.2 4.6 Research tax credits (2.5) (8.3) -- Foreign Sales Corporation (2.2) (4.7) (2.8) Tax exempt income (1.7) (4.1) (1.0) Net operating loss carryforwards -- (6.0) (5.7) Other (0.2) 1.8 (0.8) ---- ---- ---- Effective tax rate 31.8% 21.9% 28.3% ==== ==== ====
Cash payments for income taxes were $5.7 million, $5.8 million and $13.1 million in fiscal 1995, 1994 and 1993, respectively. 14. LEASES Manufacturing and administrative facilities are leased under operating leases through 2005 with certain renewal options. At June 30, 1995, future minimum annual payments under operating leases are as follows (in thousands): 46 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1996 $11,251 1997 9,316 1998 8,375 1999 5,877 2000 3,057 Thereafter 3,704 ------- Total minimum lease payments $41,580 =======
Rent expense was $9.8 million, $12.3 million, and $11.2 million in fiscal 1995, 1994 and 1993, respectively. On July 6, 1995, the Company entered into a one year operating lease for a parcel of undeveloped land adjacent to its current campus on which additional offices may be constructed over the next three years. This lease provides for monthly payments which vary based on the London interbank offering rate (LIBOR) and requires the Company to maintain certain financial covenants similar to its credit facilities. Future minimum lease payments under this lease are not included in the above table. In addition, this lease provides the Company with the option at the end of the lease of either acquiring the property at its original cost or arranging for the property to be acquired. The Company is contingently liable to the lessor under a 97% first-loss clause for up to $9.9 million at July 6, 1996. 15. EXPORT SALES Export revenues to nonaffiliated customers primarily in Europe and Canada, and to a lesser extent in New Zealand, Japan, Hong Kong and China, aggregated $119.0 million in fiscal 1995. Export revenues were $97.4 million and $80.7 million in fiscal 1994 and 1993, respectively. 16. LITIGATION Theis Research, Inc. In April 1992, the Company filed suit, in California, against Theis Research, Inc. ("Theis") for declaratory judgment that the Company's products do not infringe three patents of Theis and that those patents are invalid. In November 1992, Theis filed a counterclaim against the Company alleging infringement of seven of Theis' patents. Subsequently, Theis dismissed with prejudice the claims as to all but four of the patents. During the first quarter of fiscal 1995, the Company engaged in a jury trial regarding infringement of the three remaining patents and the defense of patent invalidity. In October 1994, the jury returned a verdict finding, among other things, that Octel was correct in its claim that the three patents at issue were invalid. Post-trial motions are pending and, if no settlement between the parties is reached, it is anticipated that Theis will appeal the verdict. Gilbarco, Inc. In January 1994, Gilbarco, Inc. ("Gilbarco") filed suit in the U.S. District Court for the District of Colorado against the Company and one of the Company's telephone company customers, U.S. West, alleging infringement of a Gilbarco patent and seeking unspecified damages. The Company filed an answer to the complaint denying any infringement of the patent and raising several affirmative defenses, including an assertion that the patent is invalid and unenforceable. In September 1994, the claims asserted against the Company were transferred to the U.S. District Court for the Northern District of California and those claims asserted against U.S. West were stayed and administratively closed pending the outcome of the California action. Fact discovery in the case has been completed, expert discovery is scheduled for completion in December 1995 and a trial date has been set for March 19, 1996. The Company is currently planning to file one or more motions before the trial which could dispose of some or all of the claims asserted against it. 47 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company believes, based upon information currently available, including consultations with patent counsel, that the Company is not infringing any valid patents of Theis or Gilbarco. The Company will vigorously defend the patent infringement claims and any related claims for compensatory damages. Legal expenses related to ongoing patent litigation were approximately $0.9 million in fiscal 1995. While litigation is inherently uncertain, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position. 17. QUARTERLY RESULTS (unaudited) The following table presents unaudited quarterly operating results for each of the Company's eight fiscal quarters in the period ended June 30, 1995.
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) FISCAL 1995 Total net revenues $105,745 $116,240 $115,042 $135,565 Gross profit 63,617 68,539 65,670 81,438 Net income(1) 3,814 8,759 6,091 12,468 Net income per common and equivalent share: Primary and fully diluted(1) $ 0.15 $ 0.36 $ 0.25 $ 0.50 FISCAL 1994 Total net revenues $ 91,623 $100,879 $ 97,197 $116,526 Gross profit(2) 54,840 61,101 56,495 71,987 Net income (loss) 5,960 8,467 (11,604)(3) 10,720 Net income (loss) per common and equivalent share: Primary and fully diluted $ 0.24 $ 0.34 $ (0.49)(3) $ 0.43
- --------------- (1) Includes total non-recurring charges during the first quarter for in-process research and development and integration costs of $5.0 million ($3.4 million net of taxes) and integration costs in each of the subsequent quarters of $0.8 million, $1.3 million and $0.6 million, respectively ($0.5 million, $0.9 million and $0.4 million net of taxes, respectively). (2) Certain fiscal 1994 costs previously reported as selling, general and administrative expenses have been reclassified to cost of services to conform to the fiscal 1995 presentation. (3) Includes total non-recurring charges for the VMX merger and integration costs of $24.1 million ($18.8 million net of taxes). 48 49 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Octel Communications Corporation We have audited the accompanying consolidated balance sheets of Octel Communications Corporation and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1995. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying Index at Item 8. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Octel Communications Corporation and its subsidiaries as of June 30, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG PEAT MARWICK LLP Palo Alto, California July 25, 1995 49 50 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information regarding directors of the Company required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading "Election of Directors -- Nominees." The information regarding executive officers required by this Item is incorporated by reference to the section in Part I hereof entitled "Executive Officers of Octel Communications Corporation." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading "Security Ownership of Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the Proxy Statement for the Company's Annual Meeting of Stockholders, tentatively scheduled to be held on November 16, 1995, under the heading "Certain Transactions." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE See Index to Consolidated Financial Statements at Item 8 on page 30 of this report. 50 51 2. EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------ ----------- 3.0 Certificate of Incorporation of the Company. (1) 3.1 Bylaws of the Company. (1) 10.0* 1985 Incentive Stock Plan, as amended, and forms of Incentive Stock Option Agreement thereunder. (7) 10.1* 1987 Employee Stock Purchase Plan and form of Subscription Agreement. (5) 10.2* 1988 Directors' Stock Option Plan and form of Stock Option Agreement. (5) 10.3* Fiscal Year 1995 Executive Bonus Plan. 10.10 Interface License Agreement (IMS-Link Interface) dated December 2, 1983 between Northern Telecom Inc. and the Company. (2) 10.10A Interface License Agreement (Digital Set Interface) dated March 16, 1990 between Northern Telecom Inc. and the Company. (4) 10.10B License Agreement dated February 1, 1989 between Mitel Corporation and the Company. (4) 10.10C License Agreement dated August 1, 1990 between ROLM Systems and the Company. (4) 10.11 Form of Indemnification Agreement as entered into by the Company with its directors and officers. (3) 10.12 Amended and Restated Registration Rights Agreement dated March 12, 1987 between the Company and the holders of Series A, Series B, Series C and Series D Preferred Stock, as amended by the form of Amendment of Registration Rights Agreement with respect to Initial Public Offering. (2) 10.15 Credit Agreement dated June 30, 1994 between The First National Bank of Boston, Bank of America National Trust and Savings Association and the Company. (7) 10.16 Common Shares Rights Agreement dated as of July 25, 1990 between the Company and Bank of America NT & SA. (3) 10.17* Executive Officer Employment Letter -- David J. Ladd. (6) 10.18 Lease of Land Agreement dated July 6, 1995 between Sumitomo Bank Leasing and Finance, Inc. and the Company. 11.0 Statement re computation of 1995 per share earnings. 21.0 Subsidiaries of the Company. 23.0 Consent of Independent Auditors (KPMG Peat Marwick LLP). 24.0 Power of Attorney (see page 53). 27.0 Financial Data Schedule (EDGAR version only).
* Designates management contracts or compensatory plans, contracts or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K. (1) Incorporated by reference to the exhibit filed with the Company's Form 8-B filed with the Securities and Exchange Commission on February 12, 1990. (2) Incorporated by reference to the exhibit filed with the Company's Registration Statement on Form S-1 (No. 33-19777), as amended, which became effective February 26, 1988. (3) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990. (4) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. 51 52 (5) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992. (6) Incorporated by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994. (7) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during fiscal 1995. (c) EXHIBITS See Item 14(a) above. (d) FINANCIAL STATEMENT SCHEDULE See Item 14(a) above. 52 53 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. OCTEL COMMUNICATIONS CORPORATION Dated: September 28, 1995 By: /s/ ROBERT COHN ------------------------------------- Robert Cohn, Chairman of the Board, President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert Cohn and Derek S. Daley, jointly and severally, his attorneys-in-fact, each with the power of substitution, for the undersigned in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or any substitute or substitutes, may do or cause to be done by virtue hereof Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT COHN Chairman of the Board, President and Chief September 28, 1995 - ------------------------------ Executive Officer (Principal Executive (Robert Cohn) Officer) /s/ W. MICHAEL WEST Vice Chairman of the Board (Principal September 28, 1995 - ------------------------------ Financial Officer) (W. Michael West) /s/ HERZEL ASHKENAZI Vice President and Corporate Controller September 28, 1995 - ------------------------------ (Principal Accounting Officer) (Herzel Ashkenazi) /s/ ANSON M. BEARD, JR. Director September 28, 1995 - ------------------------------ (Anson M. Beard, Jr.) /s/ LEO J. CHAMBERLAIN Director September 28, 1995 - ------------------------------ (Leo J. Chamberlain) /s/ DEBORAH A. COLEMAN Director September 28, 1995 - ------------------------------ (Deborah A. Coleman) /s/ JOHN FREIDENRICH Director September 28, 1995 - ------------------------------ (John Freidenrich) /s/ ROBERT C. HAWK Director September 28, 1995 - ------------------------------ (Robert C. Hawk) /s/ NATHANIEL de ROTHSCHILD Director September 28, 1995 - ------------------------------ (Nathaniel de Rothschild) /s/ DAG TELLEFSEN Director September 28, 1995 - ------------------------------ (Dag Tellefsen)
53 54 OCTEL COMMUNICATIONS CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT BALANCE BEGINNING CHARGED TO AT END DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD ----------- --------- -------- ---------- --------- Year ended June 30, 1993: Allowance for doubtful accounts $2,677,000 $ 515,000 $ 827,000 $2,365,000 Warranty 2,376,000 4,119,000 3,957,000 2,538,000 Year ended June 30, 1994: Allowance for doubtful accounts $2,365,000 $ 607,000 $ 307,000 $2,665,000 Warranty 2,538,000 3,393,000 2,975,000 2,956,000 Year ended June 30, 1995: Allowance for doubtful accounts $2,665,000 $ 498,000 $ 225,000 $2,938,000 Warranty 2,956,000 5,816,000 5,542,000 3,230,000
54 55 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION PAGE - ------ ----------- ---- 3.0 Certificate of Incorporation of the Company. (1) 3.1 Bylaws of the Company. (1) 10.0* 1985 Incentive Stock Plan, as amended, and forms of Incentive Stock Option Agreement thereunder. (7) 10.1* 1987 Employee Stock Purchase Plan and form of Subscription Agreement. (5) 10.2* 1988 Director's Stock Option Plan and form of Stock Option Agreement. (5) 10.3* Fiscal Year 1995 Senior Employee and Management Bonus Plan. 57 10.10 Interface License Agreement (IMS-Link Interface) dated December 2, 1983 between Northern Telecom Inc. and the Company. (2) 10.10A Interface License Agreement (Digital Set Interface) dated March 16, 1990 between Northern Telecom Inc. and the Company. (4) 10.10B License Agreement dated February 1, 1989 between Mitel Corporation and the Company. (4) 10.10C License Agreement dated August 1, 1990 between ROLM Systems and the Company. (4) 10.11 Form of Indemnification Agreement as entered into by the Company with its directors and officers. (3) 10.12 Amended and Restated Registration Rights Agreement dated March 12, 1987 between the Company and the holders of Series A, Series B, Series C and Series D Preferred Stock, as amended by the form of Amendment of Registration Rights Agreement with respect to Initial Public Offering. (2) 10.15 Credit Agreement dated June 30, 1994 between The First National Bank of Boston, Bank of America National Trust and Savings Association and the Company. (7) 10.16 Common Shares Rights Agreement dated as of July 25, 1990 between the Company and Bank of America NT & SA. (3) 10.17* Executive Officer Employment Letter -- David J. Ladd. (6) 10.18 Lease of Land Agreement dated July 6, 1995 between Sumitomo Bank Leasing and Finance, Inc. and the Company. 61 11.0 Statement re computation of 1995 per share earnings. 169 21.0 Subsidiaries of the Company. 170 23.0 Consent of Independent Auditors (KPMG Peat Marwick LLP) 171 24.0 Power of Attorney (see page 53). 27.0 Financial Data Schedule (EDGAR version only).
* Designates management contracts or compensatory plans, contracts or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K. (1) Incorporated by reference to the exhibit filed with the Company's Form 8-B filed with the Securities and Exchange Commission on February 12, 1990. (2) Incorporated by reference to the exhibit filed with the Company Registration Statement on Form S-1 (No.33-197777), as amended, which became effective February 26, 1988. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990. 55 56 (4) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (5) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1992. (6) Incorporated by reference to the exhibit filed with the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994. (7) Incorporated by reference to the exhibit filed with the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994. 56 EX-10.3 2 SENIOR EMPLOYEE AND MANAGEMENT BONUS PLAN 1 Exhibit 10.3 TO: Participants DATE: November 1, 1994 FROM: Bob Cohn SUBJECT: FY95 SENIOR EMPLOYEE AND MANAGEMENT BONUS PLAN - ------------------------------------------------------------------------------- We have a new Senior Employee Bonus Plan. The purpose of this plan is to provide an incentive for key senior employees who are not in other incentive plans, and who are in a position to contribute significantly to our Company's success in meeting its financial targets, satisfying customers and achieving its key objectives. NEW DIRECTION The bonus plan for this fiscal year needed to change to reflect the new direction and changing needs of the Company. In our previous plan, the focus on personal objectives (equal to half of the overall bonus amount) created a situation whereby participants could complete their individual objectives, and even if the Company fell short of its business targets, the employee could still receive a substantial bonus. The personal objectives tended to be hard to define and measure, changed frequently during the plan year, and consumed a lot of energy that often didn't pay off. There was also no substantial upside potential for exceeding targets in the old plan or rewarding exceptional contributions. The new plan will more closely tie your incentive potential with the company financial objectives for FY95, and will contain up-side and down-side potential depending upon our performance as a team in meeting key objectives, and the results of a Customer Satisfaction Survey. In this new plan, there are three opportunities to increase your target bonus percent: if we out-perform financially, if we achieve our main Corporate Objectives, and if we make customers happy. The bonus calculation works like this: - -------------- ------------- ---------------------- ----------------------- Target Bonus Performance Corporate Objectives Customer Satisfaction Percent X Factor X Modifier X Modifier - -------------- ------------- ---------------------- -----------------------
The rest of this memo will describe in detail how each of these factors are calculated; but the idea is simple -- hit or exceed our financial targets, execute well so we achieve our Corporate objectives and make customers happy! PLAN COMPONENTS Target Bonus Percent Each participant in the plan is assigned a target bonus percentage (of base salary) based on his or her job level, performance history and external market norms. Your manager will notify you of your particular target for FY95. 2 Page 2 FY95 Bonus Plan Performance Factor The Company financial performance targets for FY95, as set by the Board of Directors, are as follows: $485M in revenue and $64.6M in operating income. The Performance Factor is the average of how we did in revenue and income versus plan. At the end of the year, the Performance Factor will be calculated according to the following formula: Actual Revenue Actual Operating Income Company -------------- + ----------------------- divided by 2 Performance Revenue Plan Operating Income Plan Level
The Performance Factor contains a 2:1 upside and downside slope. For example, if we do an average of 10% better than plan, the Performance Factor will increase by 20%. The Factor will be multiplied by your individual target bonus percentage so it can increase or decrease the bonus depending on how well we do. There is no maximum upside to this factor (even though the chart stops at 150% of plan). HOWEVER, NO BONUS WILL BE PAID IF REVENUE IS BELOW 90% OF PLAN OR OPERATING INCOME FALLS BELOW 85% OF PLAN, REGARDLESS OF ATTAINMENT OF BUSINESS OBJECTIVES OR CUSTOMER SATISFACTION PERFORMANCE GOALS. The incentive bonus pool will be funded as follows:
COMPANY PERFORMANCE PERFORMANCE FACTOR --------------- -------------- (up arrow) 150% (up arrow) 2.0 140 1.8 130 1.6 120 1.4 110 1.2 100 1.0 90 0.8 87.5 0.75 (less than)87.5 0
Let's look at a couple of examples of how the Performance Factor might be calculated: (1) If revenue is achieved at 105% of plan and operating income is achieved at 115% of plan, the Factor would be calculated as follows: 105% (revenue) + 115% (operating income) ---------------------------------------- = [220% divided by 2] = 110% = Factor of 1.3 2
3 Page 3 FY95 Bonus Plan (2) If revenue is achieved at 95% of plan and operating income is achieved at 85% of plan, the Factor would be calculated as follows: 95% (revenue) + 85% (operating income) -------------------------------------- = [180% divided by 2] = 90% = Factor of 0.8 2
Business Objective Modifier The Performance Factor above will be adjusted depending on how well we, as a company, achieve our five key business objectives. The incentive bonus pool could increase by a multiple up to 2.4 for over achievement or decrease by a multiple as low as 0.3 for under achievement. This part of the bonus plan will measure performance on the following objectives: - Achieve Q1 FY95/Q4 96 average gross margin of 64.4% - Reduce operating expenses by $4.0M to 47.9% for FY95 - Regain competitive position by completing projects - Improve customer satisfaction as measured by the customer satisfaction index - Lower our cost of doing business by achieving schedule of the QTC project, CS consolidation and Manufacturing consolidation. Attached are the slides on the Business Objective Modifer from Bob Cohn's November 1st Senior Staff presentation that outlines the measures for the objectives. Customer Satisfaction Modifier The bonus calculation will be further modified based upon input from our customers. We will be doing a survey shortly and again in mid 1995. If we improve from one survey to the next, the bonus will increase. The survey will measure satisfaction not just with failure-related service, but how the customer perceives us as a whole our sales people, our marketing folks, people who answer the phones, our credit and collections department, manufacturing, etc. It's quite broad. If customer satisfaction improves, your bonus will be modified upward by a multiple of 1.15. If ratings decline, your bonus will decrease by a multiplier of .85. In this way, we hope to focus more direct attention on improving overall customer satisfaction. The Customer Satisfaction Survey will focus on responses from our North American customers.1 We are also surveying customers from four CPE competitors and three VIS competitors. Octel's 1994 Customer Satisfaction Survey is targeted for kick-off on October 1, 1994. Results will be available 10 weeks after the survey begins. We plan to re-survey customers next June to measure our improvement. - -------- (1) The survey in future years will encompass all areas of the Company. Until the survey is global, the sentiment of our overseas customers will be factored in by the management of our international organizations. 4 Page 4 FY95 Bonus Plan EXAMPLES Once again, the bonus calculation works like this: - -------------- ------------- ---------------------- ----------------------- Target Bonus Performance Corporate Objectives Customer Satisfaction Percent X Factor X Modifier X Modifier - -------------- ------------- ---------------------- -----------------------
(1) Here is an example of how the plan would work if we were to OVER ACHIEVE our targets: Assumptions: - Individual Target Bonus = 20% of salary - Revenue vs. Plan = 115% - Operating Income vs. Plan = 105% - Performance Factor = 1.2 - Corporate Objectives Modifier = 1.5 - Customer Satisfaction Modifier = 1.15 20% x 1.2 x 1.5 x 1.15 = 41.4% x Base Salary = Bonus Payout (2) Here is an example if we were to MISS our targets: Assumptions: - Individual Target Bonus = 20% of salary - Revenue vs. Plan = 95% - Operating Income vs Plan = 85% - Performance Factor = 0.8 - Corporate Objectives Modifier = .3 - Customer Satisfaction Modifier = .85 20% x 0.8 x 0.3 x 0.85 = 4.8% x Base Salary = Bonus Payout CONCLUSION I hope you find that the bonus plan aligns everyone toward the same goals. Your bonus award is subject to the specific terms and conditions of the plan document to be mailed to you separately. Bonuses will be distributed as soon as practical after the close of the fiscal year. To be eligible to receive a bonus, you must be employed by the company on the last working day of the fiscal year. We appreciate your efforts and contributions on behalf of the Company and look forward to fiscal year 1995 as being a rewarding year for all of us. 5 Exhibit 10.18 LEASE OF THE LAND By and Between SUMITOMO BANK LEASING AND FINANCE, INC., A DELAWARE CORPORATION as Landlord and OCTEL COMMUNICATIONS CORPORATION, A DELAWARE CORPORATION as Tenant for Premises located in Milpitas, California THIS LEASE IS NOT INTENDED TO CONSTITUTE A TRUE LEASE FOR INCOME TAX PURPOSES. SEE SECTION 18.2 6 TABLE OF CONTENTS
Page ARTICLE 1 BASIC LEASE PROVISIONS 1.1 Date of Lease. . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Landlord . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.3 Tenant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.4 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.5 Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.6 Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.8 Base Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.9 Addresses for Notices. . . . . . . . . . . . . . . . . . . . . . 2 1.10 Wire Transfer Instructions . . . . . . . . . . . . . . . . . . . 2 ARTICLE 2 DEFINITIONS 2.1 Additional Rent. . . . . . . . . . . . . . . . . . . . . . . . . 3 2.2 Advance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.3 Base Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.4 City . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.5 Commitment Amount. . . . . . . . . . . . . . . . . . . . . . . . 3 2.6 Consolidated Tangible Net Worth. . . . . . . . . . . . . . . . . 3 2.7 Consolidated Total Assets. . . . . . . . . . . . . . . . . . . . 3 2.8 Consolidated Total Liabilities . . . . . . . . . . . . . . . . . 3 2.9 Default Rate . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.10 Entity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.11 ERISA Group. . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.12 Eurocurrency Reserve Requirements. . . . . . . . . . . . . . . . 4 2.13 Event of Default . . . . . . . . . . . . . . . . . . . . . . . . 4 2.14 Governmental Action. . . . . . . . . . . . . . . . . . . . . . . 4 2.15 Governmental Authority . . . . . . . . . . . . . . . . . . . . . 4 2.16 Guaranteed Residual Value. . . . . . . . . . . . . . . . . . . . 4 2.17 Initial Advance. . . . . . . . . . . . . . . . . . . . . . . . . 5 2.18 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.19 Landlord Affiliate . . . . . . . . . . . . . . . . . . . . . . . 5 2.20 Lease Investment Balance . . . . . . . . . . . . . . . . . . . . 5 2.21 Legal Requirements . . . . . . . . . . . . . . . . . . . . . . . 5 2.22 LIBOR Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.23 Multiemployer Plan . . . . . . . . . . . . . . . . . . . . . . . 5 2.24 Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.25 Official Records . . . . . . . . . . . . . . . . . . . . . . . . 6 2.26 Permitted Title Exceptions . . . . . . . . . . . . . . . . . . . 6 2.27 Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.28 Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.29 Real Estate Taxes. . . . . . . . . . . . . . . . . . . . . . . . 6 2.30 Rent Commencement Date . . . . . . . . . . . . . . . . . . . . . 6 2.31 Rent Payment Date. . . . . . . . . . . . . . . . . . . . . . . . 6 2.32 Required Permits . . . . . . . . . . . . . . . . . . . . . . . . 6 2.33 SBLF Deed of Trust . . . . . . . . . . . . . . . . . . . . . . . 7
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Page 2.34 Taking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.35 Tenant's Property. . . . . . . . . . . . . . . . . . . . . . . . 7 2.37 Terminology. . . . . . . . . . . . . . . . . . . . . . . . . . . 7 ARTICLE 3 DEMISE 3.1 Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 ARTICLE 4 TERM 4.1 Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.2 Holding Over . . . . . . . . . . . . . . . . . . . . . . . . . . 8 ARTICLE 5 RENT 5.1 Base Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 5.2 Proration. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 5.3 No Abatement of Rent . . . . . . . . . . . . . . . . . . . . . . 8 5.4 Delinquent Rent. . . . . . . . . . . . . . . . . . . . . . . . . 8 5.5 Additional Rent. . . . . . . . . . . . . . . . . . . . . . . . . 9 ARTICLE 6 TAXES 6.1 Real Estate Taxes. . . . . . . . . . . . . . . . . . . . . . . . 9 6.2 Personal Property Taxes. . . . . . . . . . . . . . . . . . . . . 10 6.3 Right to Contest . . . . . . . . . . . . . . . . . . . . . . . . 10 6.4 Additional Charges . . . . . . . . . . . . . . . . . . . . . . . 10 ARTICLE 7 INSURANCE 7.1 Liability Insurance. . . . . . . . . . . . . . . . . . . . . . . 11 7.2 Builders' Risk Insurance . . . . . . . . . . . . . . . . . . . . 11 7.3 All-Risk Insurance . . . . . . . . . . . . . . . . . . . . . . . 12 7.4 General Requirements . . . . . . . . . . . . . . . . . . . . . . 12 7.5 Waiver of Subrogation. . . . . . . . . . . . . . . . . . . . . . 13 7.6 Indemnity. . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 ARTICLE 8 USE 8.1 Use. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 8.2 Contest of Legal Requirements. . . . . . . . . . . . . . . . . . 15 ARTICLE 9 UTILITIES AND SERVICES 9.1 Services to the Premises . . . . . . . . . . . . . . . . . . . . 16
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Page ARTICLE 10 MAINTENANCE AND REPAIRS; SURRENDER OF THE PREMISES 10.1 Tenant Obligations . . . . . . . . . . . . . . . . . . . . . . . 16 10.2 Surrender of the Premises. . . . . . . . . . . . . . . . . . . . 16 ARTICLE 11 ASSIGNMENT BY LANDLORD 11.1 Further Mortgages or Encumbrances by Landlord. . . . . . . . . . 16 11.2 Landlord's Right to Sell . . . . . . . . . . . . . . . . . . . . 17 11.3 Transfer of Funds and Property . . . . . . . . . . . . . . . . . 17 ARTICLE 12 ASSIGNMENT AND SUBLEASING 12.1 Right to Assign. . . . . . . . . . . . . . . . . . . . . . . . . 17 12.2 Right to Sublet. . . . . . . . . . . . . . . . . . . . . . . . . 18 12.3 Mortgage by Tenant . . . . . . . . . . . . . . . . . . . . . . . 18 ARTICLE 13 EMINENT DOMAIN 13.1 Total or Substantial Taking. . . . . . . . . . . . . . . . . . . 18 13.2 Partial Taking . . . . . . . . . . . . . . . . . . . . . . . . . 18 13.3 Temporary Taking . . . . . . . . . . . . . . . . . . . . . . . . 18 13.4 Damages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 13.5 Notice and Execution . . . . . . . . . . . . . . . . . . . . . . 19 ARTICLE 14 DAMAGE OR DESTRUCTION 14.1 Casualty Insurance Proceeds. . . . . . . . . . . . . . . . . . . 19 ARTICLE 15 QUIET ENJOYMENT 15.1 Quiet Enjoyment. . . . . . . . . . . . . . . . . . . . . . . . . 19 ARTICLE 16 DEFAULT 16.1 Default. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 16.2 Contest by Tenant. . . . . . . . . . . . . . . . . . . . . . . . 21 16.3 Landlord's Remedies. . . . . . . . . . . . . . . . . . . . . . . 22 16.4 No Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 16.5 Effect of Assignment . . . . . . . . . . . . . . . . . . . . . . 23 16.6 Landlord Cure Right. . . . . . . . . . . . . . . . . . . . . . . 24 ARTICLE 17 TENANT'S OPTION TO PURCHASE OR TERMINATE 17.1 Option To Purchase Premises. . . . . . . . . . . . . . . . . . . 24 17.2 Termination Option . . . . . . . . . . . . . . . . . . . . . . . 26
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Page ARTICLE 18 MISCELLANEOUS 18.1 Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . 27 18.2 Form of Transaction: Certain Tax Matters . . . . . . . . . . . . 28 18.3 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 18.4 Severability of Provisions . . . . . . . . . . . . . . . . . . . 29 18.5 Entire Agreement: Amendment. . . . . . . . . . . . . . . . . . . 29 18.6 Memorandum of Lease of the Land. . . . . . . . . . . . . . . . . 29 18.7 Successors and Assigns . . . . . . . . . . . . . . . . . . . . . 29 18.8 Commissions. . . . . . . . . . . . . . . . . . . . . . . . . . . 29 18.9 Attorneys' Fees. . . . . . . . . . . . . . . . . . . . . . . . . 29 18.10 Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . 29 18.11 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . 30 18.12 Time Is of the Essence . . . . . . . . . . . . . . . . . . . . . 30 18.13 No Third Party Beneficiaries . . . . . . . . . . . . . . . . . . 30 18.14 Limitations on Recourse. . . . . . . . . . . . . . . . . . . . . 30 18.15 Estoppel Certificates. . . . . . . . . . . . . . . . . . . . . . 30 18.16 As-Is Lease. . . . . . . . . . . . . . . . . . . . . . . . . . . 30 18.17 Net Lease. . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 18.18 Landlord's Representations and Warranties. . . . . . . . . . . . 31 18.19 Tenant's Representations and Warranties. . . . . . . . . . . . . 31 18.20 Tenant's Waiver of Demand for Possession . . . . . . . . . . . . 35 18.21 Financial Reporting. . . . . . . . . . . . . . . . . . . . . . . 35 18.22 Regulation D Compensation. . . . . . . . . . . . . . . . . . . . 35 ARTICLE 19 INDEMNIFICATION 19.1 Tax Indemnity. . . . . . . . . . . . . . . . . . . . . . . . . . 36 19.2 Environmental Indemnity. . . . . . . . . . . . . . . . . . . . . 37 19.3 General Indemnity. . . . . . . . . . . . . . . . . . . . . . . . 37 ARTICLE 20 COVENANTS OF LANDLORD 20.1 Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 20.2 Land Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 20.3 Transfer of Property Interests . . . . . . . . . . . . . . . . . 39
iv 10 LEASE OF THE LAND THIS LEASE OF THE LAND ("Lease") by and between SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation ("Landlord"), and OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation ("Tenant"), is entered into as of the date set forth in Article 1 and shall be effective and binding upon the parties hereto as of such date. Capitalized terms used in this Lease shall have the definitions set forth in Article 2 or in the text of this Lease. In consideration of the Base Rent reserved herein, and the terms, covenants and conditions set forth below, Landlord and Tenant hereby agree as follows: ARTICLE 1 BASIC LEASE PROVISIONS 1.1 DATE OF LEASE: July 6, 1995. 1.2 LANDLORD: Sumitomo Bank Leasing and Finance, Inc., a Delaware corporation 1.3 TENANT: Octel Communications Corporation, a Delaware corporation. 1.4 LAND: That certain tract of land located in the City of Milpitas, County of Santa Clara, California, as more particularly described on Exhibit A attached hereto together with all easements, rights of way, appurtenances and other rights and benefits belonging or pertaining to such Land. Landlord makes no representations as to the accuracy of the description of the Land. 1.5 PREMISES: The Land and any improvements which Landlord may construct on the Land for Tenant. 1.6 TERM: The term of this Lease ("Term") shall commence on the Date of Lease set forth in Section 1.1 above and shall expire on July 5, 1996 ("Expiration Date"). The Term shall cease upon, and shall not refer to any period of time after, termination of this Lease 1 11 (whether pursuant to the terms of the Lease, by operation of law, or otherwise). 1.7 RENT COMMENCEMENT DATE: The rent commencement date ("Rent Commencement Date") shall be the Date of Lease. 1.8 BASE RENT: As described in Section 2.3. 1.9 ADDRESSES FOR NOTICES: LANDLORD: Sumitomo Bank Leasing and Finance, Inc. 277 Park Avenue New York, NY 10172 Attention: Chief Credit Officer With a copy to: Landels, Ripley & Diamond Hills Plaza 350 Steuart Street San Francisco, CA 94105-1250 Attention: Bruce W. Hyman, Esq. TENANT: Octel Communications Corporation 1001 Murphy Ranch Road Milpitas, CA 95035 Attention: Doug Hus, Treasury Manager With a copy to: Wilson, Sonsini, Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304 Attention: Bradford C. O'Brien, Esq. 1.10 WIRE TRANSFER INSTRUCTIONS: Morgan Guaranty Trust Company of New York ABA#021000238 For credit to The Sumitomo Bank, Limited A/C #631-28-256 Further credit to Sumitomo Bank Leasing and Finance, Inc. A/C No. 283572 This Article 1 is intended to supplement and/or summarize the provisions set forth in the balance of this Lease. If there is any conflict between any provisions contained in this Article 1 and the balance of this Lease, the balance of this Lease shall control. 2 12 ARTICLE 2 DEFINITIONS For purposes of this Lease, the following defined terms shall have the meanings set forth in this Article 2. 2.1 ADDITIONAL RENT. "Additional Rent" shall mean any amounts other than Base Rent payable by Tenant to Landlord or to other Entities on Landlord's behalf as required under this Lease, specifically including, but without limitation, payment of the Guaranteed Residual Value, break-funding costs of Landlord related to the Lease Investment Balance (as defined below) arising out of unscheduled payments or exercise of the Purchase Option pursuant to Section 17.1 below other than on a Rent Payment Date. 2.2 ADVANCE. "Advance" shall mean (i) the items and/or amounts described in Exhibit B; (ii) Real Estate Taxes; and (iii) any other payment paid by Landlord, as landlord under this Lease. 2.3 BASE RENT. "Base Rent" shall mean, as of a Rent Payment Date, that annual amount equal to the product obtained by multiplying the Lease Investment Balance (at the time of the relevant calculation) by the sum of the LIBOR Rate plus 45 basis points, which annual amount is then prorated on the basis of a 360 day year and the actual number of days elapsed. 2.4 CITY. "City" shall mean the City of Milpitas, California. 2.5 COMMITMENT AMOUNT. "Commitment Amount" shall mean TEN MILLION FIVE HUNDRED THOUSAND and no/100 Dollars ($10,500,000.00). 2.6 CONSOLIDATED TANGIBLE NET WORTH. "Consolidated Tangible Net Worth" shall mean at any date as of which the amount thereof shall be determined, the Consolidated Total Assets of Tenant and its subsidiaries minus (i) the sum of any amounts attributable to (a) goodwill, (b) intangible items such as unamortized debt discount and expense, patents, trade and service marks and names, copyrights and research and development expenses except prepaid expenses, (c) all reserves not already deducted from assets, (d) any write-up in the book value of assets resulting from any revaluation thereof subsequent to the date of the financial statements referred to in Section 18.21 hereof, and (e) the value of any minority interests in subsidiaries and minus (ii) Consolidated Total Liabilities. 2.7 CONSOLIDATED TOTAL ASSETS. "Consolidated Total Assets" shall mean at any date as of which the amount thereof shall be determined, all obligations that should, in accordance with generally accepted accounting principles, be classified as assets on the consolidated balance sheet of Tenant and its subsidiaries. 2.8 CONSOLIDATED TOTAL LIABILITIES. "Consolidated Total Liabilities" shall mean at any date as of which the amount thereof shall be determined, all obligations that should, in 3 13 accordance with generally accepted accounting principles, be classified as liabilities on the consolidated balance sheet of Tenant and its subsidiaries, including in any event all indebtedness. 2.9 DEFAULT RATE. "Default Rate" means with respect to the Lease Investment Balance, the one (1) month LIBOR Rate plus 245 basis points. Notwithstanding the foregoing, in the event that the foregoing Default Rate shall be in violation of any usury or similar law, then the Default Rate shall be reduced to the extent necessary to cause the Default Rate to comply with any usury or similar law. 2.10 ENTITY. "Entity" shall mean any person, corporation, partnership (general or limited), joint venture, association, limited liability company, joint stock company, trust or other business entity or organization. 2.11 ERISA GROUP. "ERISA Group" shall mean Tenant and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which are treated as a single employer under Section 414 of the Code. 2.12 EUROCURRENCY RESERVE REQUIREMENTS. "Eurocurrency Reserve Requirements" shall mean the aggregate (without duplication) of the rates (expressed as a decimal fraction) of reserve requirements in effect on such day (including, without limitation, basic, supplemental, marginal and emergency reserves under any regulations of the Board of Governors of the Federal Reserve System ("Board") or other Governmental Authority having jurisdiction with respect thereto) dealing with reserve requirements prescribed for eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of the Board) maintained by a member bank of the Federal Reserve System. 2.13 EVENT OF DEFAULT. "Event of Default" shall have the meaning set forth in Section 16.1. 2.14 GOVERNMENTAL ACTION: "Governmental Action" means all permits, authorizations, registrations, consents, approvals, waivers, exceptions, variances, orders, judgments, written interpretations, decrees, licenses, exemptions, publications, filings, notices to and declarations of or with, or required by, any Governmental Authority, or required by any applicable law, and shall include without limitation, all environmental and operating permits and licenses that are required for the full use, occupancy, zoning and operation of the Premises. 2.15 GOVERNMENTAL AUTHORITY: "Governmental Authority" means any nation or government, any state or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. 2.16 GUARANTEED RESIDUAL VALUE: "Guaranteed Residual Value" shall mean ninety-seven percent (97%) of the Lease Investment Balance. 4 14 2.17 INITIAL ADVANCE. Initial Advance shall mean the amounts described in Exhibit B pertaining to execution of this Lease. 2.18 LAND. "Land" shall have the meaning set forth in the Basic Lease Provisions. 2.19 LANDLORD AFFILIATE. "Landlord Affiliate" shall mean any entity which controls, is controlled by or is under the common control of Landlord. 2.20 LEASE INVESTMENT BALANCE. "Lease Investment Balance" shall mean, at the time in question, the aggregate amount of all Advances made by Landlord reduced by the following: (1) the aggregate of all amounts received by Landlord pursuant to the provisions of Article 13 (Eminent Domain), and Article 14 (Damage or Destruction), Section 16.3 (Landlord's Remedies), Section 17.1 (Option to Purchase Premises), and/or Section 17.2 (Termination Option); and (2) the aggregate of all amounts received by Landlord in respect of this Lease or any related agreement that are not otherwise applied to reduce the Lease Investment Balance and which constitute a repayment or reduction of the amounts placed at risk by the Landlord, excluding for purposes of this clause amounts paid as rent hereunder, reimbursement for expenses, fees and similar items incurred by Landlord and payable by Tenant to Landlord under the Lease and the SBLF Deed of Trust. 2.21 LEGAL REQUIREMENTS. "Legal Requirements" shall mean all statutes, codes, laws, acts, ordinances, orders, judgments, decrees, injunctions, rules, regulations, permits, licenses, authorizations, directions and requirements of all federal, state, county, municipal and other governments, departments, commissions, boards, courts, authorities, officials and officers, which now or at any time hereafter are applicable to this Lease or applicable to and enforceable against the Premises, any improvements or any part thereof, as applicable. 2.22 LIBOR RATE. "LIBOR Rate" shall mean, for each Borrowing Period (as defined below) the annualized rate determined by The Sumitomo Bank, Limited (the "Bank") as the rate that would be offered to Bank's San Francisco or New York office for U.S. dollar deposits in the London Interbank Market as quoted for the mid-morning average Libor Rate published by Reuters Monitoring Systems for the applicable Borrowing Period for the entire then outstanding principal balance hereof (rounded upwards to the next higher 1/16th of 1% if such quoted rate is not a multiple of 1/16) for deposits by the Bank of immediately available dollars in the London Interbank Market on the day two (2) Business Days preceding the first day of the term of that Borrowing Period. In the event the Reuters quote is not available, the British Banker's Association's Interest Settlement Rate should be used. "Borrowing Period" shall mean one (1) month, unless an alternate period of three (3), six (6) or nine (9) months is elected by Tenant at least three (3) days prior to the end of the previous Borrowing Period, provided, that Tenant may not elect a Borrowing Period which extends past the last day of the Term. 2.23 MULTIEMPLOYER PLAN. "Multiemployer Plan" means at any time an employee pension benefit plan within the meaning of Section 4001(a)(3) of ERISA to which any member 5 15 of the ERISA Group is then making or accruing an obligation to make contributions or has within the preceding five (5) plan years made contributions, including for these purposes any person which ceased to be a member of the ERISA Group during such five (5) year period. 2.24 NOTICE. "Notice" shall mean a written advice, request, demand or notification required or permitted by this Lease, as more particularly provided in Section 18.3. 2.25 OFFICIAL RECORDS. "Official Records" shall mean the official records of Santa Clara County, California. 2.26 PERMITTED TITLE EXCEPTIONS. "Permitted Title Exceptions" shall mean the following: (1) the exceptions set forth in Exhibit C; (2) any exceptions created or caused by Tenant or to which Tenant consents in writing; (3) taxes and assessments (excluding Landlord's Taxes as defined in Section 6.1 below) not yet due and payable; (4) the SBLF Deed of Trust; (5) all title defects, liens, encumbrances, deeds of trust, mortgages, rights-of-way, and restrictive covenants and conditions affecting the Land unless any of the foregoing arise as a result of Landlord's actions or with Landlord's written consent (unless such actions taken or consent given by Landlord are requested in writing by Tenant); and (6) this Lease. 2.27 PLAN. "Plan" means at any time an employee pension benefit plan (other than a Multiemployer Plan) which either (i) is maintained, or contributed to, by any member of the ERISA Group for employees of any member of the ERISA Group, or (ii) has at any time within the preceding five (5) years been maintained, or contributed to, by any person which was at such time a member of the ERISA Group for employees of any person which was at such time a member of the ERISA Group. 2.28 PREMISES. "Premises" shall have the meaning set forth in the Basic Lease Provisions. 2.29 REAL ESTATE TAXES. "Real Estate Taxes" shall have the meaning set forth in Section 6.1(b). 2.30 RENT COMMENCEMENT DATE. "Rent Commencement Date" shall have the meaning set forth in the Basic Lease Provisions. 2.31 RENT PAYMENT DATE. "Rent Payment Date" shall have the meaning set forth in Section 5.1. 2.32 REQUIRED PERMITS. "Required Permits" shall mean each and every building and development permit including, without limitation, demolition permits, site permits and addenda thereto (including, without limitation, foundation permits and structural permits), temporary and final occupancy permits and any other governmental or quasi-governmental approvals which must be issued by any governmental authority, department, commission, 6 16 board, official or officer as a condition precedent to construction and occupancy of any improvements. 2.33 SBLF DEED OF TRUST. "SBLF Deed of Trust" shall mean that certain deed of trust executed by Tenant in favor of Landlord of even date herewith. 2.34 TAKING. "Taking" shall have the meaning set forth in Section 13.1. 2.35 TENANT'S PROPERTY. "Tenant's Property" shall mean any process equipment, fixtures, furniture, furnishings, personal property or trade fixtures which are purchased or constructed with funds of Tenant and not purchased, paid for, or otherwise financed by Advances made by Landlord, whether or not installed upon the Land. 2.36 TERM. "Term" shall have the meaning set forth in the Basic Lease Provisions. 2.37 TERMINOLOGY. All personal pronouns used in this Lease shall include all other genders. The singular shall include the plural and the plural shall include the singular. Titles of Articles, Sections and Subsections in this Lease are for convenience only and neither limit nor amplify the provisions of this Lease, and all references in this Lease to Articles, Sections or Subsections shall refer to the corresponding Article, Section or Subsection of this Lease unless specific reference is made to the articles, sections or other subdivisions of another document or instrument. The word "days" or "business days" as used herein shall mean business days (i.e., excluding holidays when banks in California, New York and London (with respect to payment of Basic Rent and the determination of the LIBOR Rate) are generally closed for business and weekends) unless otherwise expressly stated. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with generally accepted accounting principles as in effect from time to time, applied on a basis consistent with the most recent audited consolidated financial statements of the Tenant and its subsidiaries delivered to Landlord. ARTICLE 3 DEMISE 3.1 PREMISES. Subject to the terms, covenants and conditions contained herein, Landlord hereby leases the Premises to Tenant, and Tenant hereby leases from Landlord, the Premises, together with all rights, privileges, easements and appurtenances relating to the Premises. 7 17 ARTICLE 4 TERM 4.1 TERM. The Term of this Lease is specified in Article 1. 4.2 HOLDING OVER. If Tenant remains in possession of the Premises after the expiration of the Term without executing a new lease, such holding over shall be construed as a tenancy from month-to-month, subject to all terms, covenants and conditions herein contained, and the Base Rent shall be calculated based upon the Default Rate and shall be required to be paid by Tenant during such holding over in the same manner as during the Term. ARTICLE 5 RENT 5.1 BASE RENT. Commencing upon the Rent Commencement Date and continuing thereafter throughout the Term, Tenant shall pay Base Rent to Landlord, or at such other place as Landlord may from time to time instruct. Tenant shall pay Base Rent by wire transfer. Landlord shall supply Tenant with such bank account information as Tenant shall require to enable payment by wire transfer of Federal funds or by ACH transfer to the account described in Section 1.10. Rental payments shall be payable monthly in arrears on the twentieth (20th) day of each successive month, except that the last installment of Base Rent shall be payable on the last day of the Term (each such date shall be a "Rent Payment Date"). No sooner than thirty (30) days or later than ten (10) days prior to the due date for any installment of Base Rent hereunder, Landlord shall deliver to Tenant a Notice indicating the exact dollar amount of the Base Rent that is due on such due date ("Invoice"). If Landlord fails to send the Invoice, Tenant shall pay the amount shown on the previous month's Invoice. 5.2 PRORATION. If the Term expires or is otherwise terminated on other than the twentieth (20th) day of a calendar month, then Base Rent shall be prorated for the period from the immediately preceding Rent Payment Date until the end of the Term on the basis of actual days elapsed and a three hundred sixty (360) day year. 5.3 NO ABATEMENT OF RENT. Except as a consequence of a reduction in the Lease Investment Balance or the terms of Section 13.1 (Total or Substantial Taking) and Section 13.2 (Partial Taking) Tenant shall not be entitled to any abatement, diminution, reduction, setoff or postponement of Base Rent as a consequence of any inconvenience to, interruption of, cessation of or loss of Tenant's use or enjoyment of the Premises or as a result of any reason whatsoever. 5.4 DELINQUENT RENT. Any Base Rent not paid on the due date shall accrue interest at the Default Rate from the date such Base Rent was originally due until the date such Base Rent is paid. All interest accrued on past due Base Rent shall be due and payable to Landlord at the time the Base Rent is paid, or upon demand by Landlord, if earlier. 8 18 5.5 ADDITIONAL RENT. Tenant agrees to pay all Additional Rent when it becomes due and payable under this Lease. ARTICLE 6 TAXES 6.1 REAL ESTATE TAXES. (a) Tenant shall pay, during the Term of this Lease, directly to the appropriate taxing authority all Real Estate Taxes (as defined below). If the Term expires or otherwise terminates at any time other than the beginning or end of a taxable year, Tenant's obligation to pay Real Estate Taxes shall be prorated on the basis of a 365-day year, so as to include only that portion of the taxable year which is a part of the Term. (b) Except to the extent that Real Estate Tax bills and statements are sent directly to Tenant by the taxing authority, upon receipt by Landlord of the tax bills or statements, Landlord will use reasonable efforts to promptly advise Tenant in writing of all Real Estate Taxes and shall deliver copies of all applicable tax bills or statements to Tenant. Tenant shall pay directly to the taxing authority all Real Estate Taxes prior to the later of (i) thirty (30) days after receipt by Tenant from Landlord of a copy of such bills and statements referred to above, or (ii) five (5) business days prior to delinquency. As used herein, the term "Real Estate Taxes" shall mean any and all taxes, governmental fees and similar charges or assessments levied or assessed against the improvements and/or the Land including, without limitation, ad valorem taxes and special assessments applicable to real property; provided, however, that Real Estate Taxes shall not include any Landlord Taxes (as defined below). Real Estate Taxes shall also include any and all documentary, transfer, sales, mortgage, recording or similar taxes imposed on Landlord or Tenant in connection with any sale of the Premises to a third party in accordance with this Lease following an Event of Default by Tenant or in a transaction to which Tenant is a party. As used herein, the term "Landlord Taxes" shall mean any and all franchise, gains, gift, succession, excess profits, gross receipts, revenue, estate, rental, income or similar taxes or taxes in lieu thereof imposed upon Landlord or any party other than Tenant (or an affiliate thereof) and any withholding tax imposed as a collection device for, in lieu of, or otherwise related to any of the foregoing without regard to whether such tax is required to be collected by Tenant and without regard to whether Tenant would be liable for such withholding tax in the event it failed to so withhold. For purposes of the foregoing, an income tax shall include, without limitation, any tax imposed under the United States Internal Revenue Code, as well as any tax which could qualify as an "income tax" under United States Treasury Regulation Section 1.901-2 (except to the extent any such statute or regulation is subsequently modified to include a tax or other governmental charge of a materially different type and nature from the taxes currently described therein) and any income tax which may be payable under the laws of any jurisdiction either now or in the future. Real Estate Taxes for any given tax year shall exclude assessment installments that are not due and payable during such tax year. 9 19 6.2 PERSONAL PROPERTY TAXES. Tenant shall pay directly to the appropriate taxing authorities prior to delinquency any and all taxes and assessments levied or assessed during the Term upon or against Tenant's furniture, equipment, trade fixtures and any other personal property in the Premises. 6.3 RIGHT TO CONTEST. Tenant shall not be required to pay any Real Estate Taxes or any other taxes for which Tenant is liable hereunder (including, without limitation, any taxes for which Tenant is required to indemnify Landlord under Section 19.1) (including penalties and interest), so long as (i) Tenant shall contest the same or the validity thereof by appropriate legal proceedings in such a manner to prevent the tax sale of any portion of the Premises and (ii) the position to be taken by Tenant pursuant to such contest would have a realistic possibility of success if litigated. For purposes of this Lease, Tenant may conclusively establish that a position to be taken in a contest would have a realistic possibility of success if litigated by providing to Landlord a letter from counsel stating an opinion to such effect. In the event of any such contest, Tenant shall, within thirty (30) days after the final determination thereof, pay and discharge the amounts determined to be due in accordance therewith and with the provisions of this Lease, together with any penalties, fines, interest, costs and expenses that may have accrued thereon or that may have resulted from Tenant's contest. Tenant also shall have a right to contest any taxes for which it is liable hereunder, but with regard to which the position to be taken pursuant to such contest would not have a realistic possibility of success if litigated, provided that Tenant pays such taxes on or prior to the date upon which such taxes are asserted to be due by the relevant governmental authority. Notwithstanding the foregoing provisions of this Section 6.3, Tenant shall have an unconditional right to contest (without prior payment) any taxes imposed by law upon Tenant rather than upon Landlord. Tenant's decision to pay any taxes prior to contesting its or another party's underlying liability therefore shall not be deemed to imply or suggest that the position to be taken in such contest would not have a realistic possibility of success if litigated. Landlord shall cooperate fully with Tenant in connection with the exercise of Tenant's right of contest contained herein, and in the event that applicable law shall require that Landlord, rather than Tenant, pursue legal proceedings for such contest, Landlord will initiate and pursue such contest upon Tenant's request and in accordance with Tenant's instructions (including, without limitation, Tenant's instructions as to the selection of legal counsel and matters of strategy or settlement); provided, however, that Landlord shall not be subject to any liability for the payment of any costs or expenses in connection with any such contest or proceedings, and Tenant will indemnify and save harmless Landlord from any such costs and expenses (including, without limitation, reasonable attorneys' fees, costs of court and appraisal costs), reimbursing Landlord therefor upon demand (or paying such costs and expenses directly when due, all as directed by Landlord). Tenant shall be entitled to any refund of any taxes and penalties or interest from any governmental authority to the extent the refund represents monies paid to the governmental authority by Tenant or paid by Landlord and reimbursed by Tenant. 6.4 ADDITIONAL CHARGES. All payments made by Tenant under this Lease shall be made free and clear of, and without reduction or withholding for or on account of, any 10 20 present or future taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed pursuant to any Legal Requirement, excluding, however, any Landlord Taxes (all such nonexcluded taxes, levies, imposts, deductions, charges or withholdings being hereinafter called "Additional Charges"). Tenant shall be responsible for the payment of any such Additional Charges; and if any such Additional Charges are required to be withheld from any amounts payable to Landlord hereunder, then the amounts so payable to Landlord shall be increased by an amount ("Additional Amount") necessary to yield to Landlord (after payment of all Additional Charges) the Base Rent and other amounts payable hereunder at the rates or in the amounts specified in this Lease. Whenever any Additional Charges are required to be withheld by Tenant, such Additional Charges shall be deducted or withheld by Tenant, and shall be paid by Tenant to the appropriate governmental authority in accordance with applicable Legal Requirements. As promptly as possible thereafter, Tenant shall send to Landlord for its own account a copy of an original official receipt (or other evidence of payment) received by Tenant showing payment thereof. If Tenant is required to pay Landlord any Additional Amount, Landlord shall use its best efforts (consistent with its internal policy and legal and regulatory restrictions) to change its jurisdiction if the making of such a change would avoid the need for, or reduce to the greatest extent possible the amount of, any such Additional Amount which may thereafter accrue and would not, in the reasonable judgment of Landlord be otherwise disadvantageous to Landlord. If Landlord subsequently receives a refund of any Additional Amounts, or if such Additional Amounts result in a net benefit to Landlord, the amount of such refund or net benefit shall be paid to Tenant within 30 days of the receipt of such refund or net benefit; provided, however, that the payment to Tenant shall not exceed the Additional Amount to which the refund or net benefit relates. The agreements in this Section 6.4 shall survive the termination of this Lease with respect to any Additional Charges that become due during the Term. ARTICLE 7 INSURANCE 7.1 LIABILITY INSURANCE. At all times during the Term, Tenant shall obtain at Tenant's sole cost and expense a policy or policies of comprehensive general liability insurance on an "occurrence" basis against claims for "personal injury" liability, including bodily injury, death or property damage liability. The liability insurance policy shall contain coverage limits no less than the following: (1) Three Million Dollars ($3,000,000) per person; (2) Five Million Dollars ($5,000,000) per incident; and (3) One Million Dollars ($1,000,000) for property damage. 7.2 BUILDERS' RISK INSURANCE. With respect to any improvements which may be under construction and not yet covered by insurance under the terms of Section 7.3, Tenant shall maintain or cause to be maintained a policy or policies of builders' risk insurance in an amount equal to the value upon completion of the work (exclusive of land, foundation, excavation, grading, landscaping, architectural and development fees and other items customarily excluded from such coverage), insuring against the risks customarily insured 11 21 against under such insurance, including fire, vandalism, malicious mischief, sprinkler leakage, lightning, and windstorm. 7.3 ALL-RISK INSURANCE. With respect to any improvement now or hereafter situated on the Land, prior to the termination of the builders' risk insurance required by Section 7.2, and at all times thereafter, Tenant shall, at Tenant's sole cost and expense, obtain and maintain, or cause to be obtained and maintained, (a) a policy or policies of all-risk insurance covering the improvements, providing coverage against loss or damage by fire, vandalism, malicious mischief, sprinkler leakage, lightning, windstorm, and other insurable perils, as, under good insurance practice, from time to time are insured against under all-risk coverage for properties of similar character, age and location in an amount or amounts not less than one hundred percent (100%) of the then actual replacement cost (exclusive of land, foundation, excavations, grading, landscaping, architectural and development fees and other items customarily excluded from such coverage and without any deduction for depreciation); (b) standard earthquake coverage, with a deductible not to exceed ten percent (10%) of the insured amount; and (c) standard flood coverage. Provided, however Tenant may elect not to obtain earthquake insurance, in which case Tenant shall covenant to pay the cost of repairing damage to the improvements caused by an earthquake. 7.4 GENERAL REQUIREMENTS. The insurance required under this Article 7 may be furnished under a "primary" policy and an "umbrella" policy or policies. Landlord shall be named as an additional insured under Tenant's policy of insurance required under Section 7.1; and such policies shall contain an endorsement for cross-liability coverage. Tenant shall furnish Landlord with certificates from Tenant's insurers with respect to the insurance required to be carried hereunder on or before the date such insurance is required to be carried. The certificates shall state that such insurance is in full force and effect and that coverage will not be reduced below the amounts required under Section 7.1 or otherwise limited or cancelled without thirty (30) days' prior written notice to Landlord. Renewal certificates shall be furnished to Landlord not less than thirty (30) days prior to the expiration of each such policy, provided, however, that Tenant shall not be required to provide Landlord with such renewal certificates prior to the expiration of each such policy so long as (i) Tenant provides Landlord with reasonable assurances within ten (10) days prior to the expiration of each such policy that there will be no lapse in the insurance coverage provided under such policy, and (ii) Tenant provides Landlord with such renewal certificates within ten (10) days following the expiration of each such policy. Any blanket insurance policy or policies that insure Tenant against the risks and for the amounts herein specified shall be deemed to satisfy the obligation of Tenant hereunder, provided that any such policy of blanket insurance shall specify the amount of the total insurance allocated to the risks required to be insured hereunder and such allocated amount meets the requirements of this Article 7. All insurance required by this Article 7 shall be with an insurance company licensed to do business in the State of California with a general policyholder's rating, as rated by the most current available "Bests" Insurance Reports, and no less than A/III and non-contributing. 12 22 7.5 WAIVER OF SUBROGATION. Notwithstanding anything to the contrary contained herein, to the extent permitted by law and so long as any insurance coverage maintained by Tenant is not diminished by reason thereof, Tenant hereby (a) releases and waives any rights it may have against Landlord and its officers, agents and employees on account of any loss or damages occasioned to Tenant, its property or the Premises, and arising from any risk covered by any fire and extended coverage insurance maintained by Tenant, whether or not due to the negligence of Landlord, its agents, employees, contractors, licensees, invitees or other persons, and (b) waives on behalf of any insurer providing such insurance to Tenant any right of subrogation that any such insurer may have or acquire against Landlord or such persons by virtue of payment of any loss under such insurance. Tenant shall use its commercially reasonable efforts to cause its insurance policies to contain a waiver of subrogation clauses in accordance with the foregoing. 7.6 INDEMNITY. After receiving written notice from Landlord of a claim (failure to give such notice shall not relieve Tenant of its obligations hereunder unless as a direct result of failure to give such notice), Tenant shall protect, defend, indemnify, hold and save Landlord harmless from and against any and all losses, costs, liabilities or damages (including reasonable attorneys' fees and disbursements and court costs) arising by reason of: (i) any and all injury or death of persons or damage to property against which Tenant is obligated to maintain insurance for the benefit of Landlord pursuant to this Article 7; (ii) the failure to obtain the waiver of subrogation clause required by Section 7.5 hereof where such clause could have been obtained through the exercise of Tenant's commercially reasonable efforts; or (iii) the invalidation of such insurance policy required to be obtained by Tenant hereunder by Tenant's insurer; provided this subsection (iii) shall not apply to the extent Landlord actually receives insurance for the aforesaid losses, costs, liabilities or damages (including reasonable attorneys' fees and disbursements and court costs but excluding costs, fees or premiums paid by Landlord in connection with such insurance) or to the extent recovery of insurance proceeds is prevented by Landlord's gross negligence. Tenant's duty to indemnify Landlord under this Section 7.6 shall survive the expiration or earlier termination of this Lease with respect to events occurring during the Term. Landlord agrees to cooperate with Tenant in the defense of any claim undertaken by Tenant pursuant to this Section. ARTICLE 8 USE 8.1 USE. (a) PERMITTED. Tenant may use the Premises for any lawful purpose. (b) ENVIRONMENTAL COMPLIANCE. 1) DEFINED TERMS. The term "Applicable Environmental Laws" shall mean any applicable laws, regulations or ordinances pertaining to health or the environment, including, without limitation, the Comprehensive Environmental Response, 13 23 Compensation, and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986 or otherwise (as amended, hereinafter called "CERCLA"), the Resource Conservation and Recovery Act of 1976, as amended by the Used Oil Recycling Act of 1980, the Solid Waste Disposal Act Amendments of 1980, the Hazardous and Solid Waste Amendments of 1984 or otherwise (as amended, hereinafter called "RCRA"), and the California Health & Safety Code Section 25501(j). The terms "hazardous substance" and "release" as used in this Lease shall have the meanings specified in CERCLA, and the terms "solid waste" and "disposal" (or "disposed") shall have the meanings specified in RCRA; provided, in the event either CERCLA or RCRA is amended or superseded by other laws so as to broaden the meaning of any term defined thereby, such broader meaning shall apply subsequent to the effective date of such amendment or other laws: and, provided further, to the extent that the laws of the State of California establish a meaning for "hazardous substance", "release", "solid waste", or "disposal" which is broader than that specified in either CERCLA or RCRA, such broader meaning shall apply. 2) TENANT'S COVENANTS. Tenant will not cause or permit the Premises to be in violation of, or do anything or permit anything to be done which subjects Landlord, Tenant or the Premises to any remedial obligations relating to the Premises under or which creates a valid claim or cause of action against Landlord, Tenant (which relates to the Premises) or the Premises under, any Applicable Environmental Laws, including, without limitation, CERCLA, RCRA, and the California Health and Safety Code 25501(j), assuming disclosure to the applicable governmental authorities of all relevant facts, conditions and circumstances, if any, pertaining to the Premises and Tenant will promptly notify Landlord in writing of any existing, pending or threatened investigation, claim or inquiry of which Tenant has knowledge by any governmental authority in connection with any Applicable Environmental Laws. Tenant shall obtain any permits, licenses or similar authorizations to construct, occupy, operate or use any improvements, fixtures and equipment at any time located on the Premises by reason of any Applicable Environmental Laws. Tenant will not use the Premises in a manner which will result in the disposal or other release of any hazardous substance or solid waste on or to the Premises in violation of Applicable Environmental Law and covenants and agrees to keep or cause the Premises to be kept free of any hazardous substance, solid waste or environmental contaminants (including, without limitation, arsenic in soil and friable asbestos and any substance containing asbestos deemed hazardous by any Applicable Environmental Law) to the extent required by Applicable Environmental Law, and to remove the amounts of the same (or if removal is prohibited by law, to take whatever action is required by law) promptly upon discovery at Tenant's sole expense to the extent required by Applicable Environmental Law. Tenant shall promptly notify Landlord in writing of any disposal or other release of any hazardous substance, environmental contaminants or solid wastes on or to the Premises in violation of Applicable Environmental Law. In the event Tenant fails to comply with or perform any of the foregoing covenants and obligations, after thirty (30) days' prior written Notice to Tenant, Landlord may, but shall be under no obligation to, cause the Premises to be freed from such hazardous substance, solid waste or environmental contaminants (or if removal is prohibited by law, to take whatever action is required by law) to the extent required by Applicable Environmental 14 24 Law and the reasonable cost of the removal or such other action shall be a demand obligation owing by Tenant to Landlord pursuant to this Lease. Notwithstanding the foregoing, Landlord shall have no right to cause the removal of such materials and no Event of Default (or default) shall be deemed to have occurred under this Lease so long as Tenant both: (1) is diligently and in good faith proceeding to comply with Tenant's obligation to remove such amounts of such materials; and (2) has the financial ability to so comply. Subject to the foregoing, Tenant grants to Landlord and Landlord's agents and employees access to the Premises, and the license to remove such hazardous substance, solid waste or environmental contaminants (or if removal is prohibited by law, to take whatever action is required by law to the extent required by Applicable Environmental Law); and except for Landlord's willful misconduct or gross negligence, agrees to indemnify and save Landlord harmless from all reasonable costs and expenses involved and from all claims (including consequential damages) asserted or proven against Landlord by any party in connection therewith. Upon Landlord's reasonable request for "good cause" (defined below), at any time and from time to time during the Term, Tenant will provide at Tenant's sole expense an inspection or audit of the Premises from an engineering or consulting firm approved by Landlord, indicating the presence or absence of any hazardous substance, solid waste or environmental contaminants located on the Premises. If Tenant fails to provide same after sixty (60) days' notice, Landlord may order same, and Tenant grants to Landlord and Landlord's employees and agents access to the Premises and a license to undertake any testing reasonably required to obtain such inspection or audit. The reasonable cost of obtaining such inspection or audit and any expenses incurred by Landlord in connection therewith, shall be a demand obligation owing by Tenant to Landlord pursuant to this Lease. For purposes of this Section 8.1(b)(2), "good cause" shall mean that Landlord shall have reasonable grounds to believe that release or disposal of hazardous substances or solid wastes in violation of Applicable Environmental Law has occurred on the Premises. (c) COMPLIANCE WITH LEGAL REQUIREMENTS. Tenant shall at all-times comply with all material Legal Requirements applicable to the Land or any improvements now or hereafter situated on the Land and/or the use thereof. 8.2 CONTEST OF LEGAL REQUIREMENTS. Tenant shall have the right at its sole cost and expense to contest the validity of any Legal Requirements applicable to the Premises by appropriate proceedings diligently conducted in good faith; and upon the request of Tenant and at Tenant's sole cost and expense, Landlord will join and cooperate with Tenant in such proceedings. Subject to Section 6.3, and any other provision of this Lease to the contrary notwithstanding, Tenant's right to contest Legal Requirements must be exercised in such a manner as to avoid any exposure of the Premises or any part thereof to foreclosure or execution sale or exposure of Landlord to civil or criminal penalties arising from Tenant's non-compliance with such Legal Requirements. Tenant shall defend and indemnify Landlord against, and hold Landlord harmless from, any and all liability, loss, cost, damage, injury or expense (including, without limitation, attorneys' fees and costs) which Landlord may sustain or suffer by reason of Tenant's failure or delay in complying with, or Tenant's contest of, any such Legal Requirements (or Landlord's contest, if requested in writing by Tenant), and 15 25 Tenant's duty to indemnify Landlord under this Section 8.2 shall survive the expiration or earlier termination of this Lease. ARTICLE 9 UTILITIES AND SERVICES 9.1 SERVICES TO THE PREMISES. At Tenant's sole cost and expense, Tenant shall make its own arrangements for the provision of all utilities and services to be provided to or consumed on the Premises, including, without limitation, air conditioning and ventilation, service contracts, heating, electric power, telephone, water (both domestic and fire protection), sanitary sewer, storm drain, natural gas and janitorial services, including for the installation, maintenance and repair of service lines and meters to measure Tenant's consumption of such utilities. ARTICLE 10 MAINTENANCE AND REPAIRS; SURRENDER OF THE PREMISES 10.1 TENANT OBLIGATIONS. Landlord shall have no obligation to maintain the Premises. Tenant shall at all times and at Tenants' sole cost and expense maintain the Premises in good repair, normal wear and tear and casualty excepted. 10.2 SURRENDER OF THE PREMISES. Except as provided in Section 17.1 below, upon the expiration or earlier termination of the Term, Tenant shall surrender the Premises to Landlord in its then "AS-IS" condition, including, without limitation, any condition resulting from: (i) wear and tear; (ii) obsolescence and damage by fire or other casualty, act of God or the elements; (iii) damage that is caused by Landlord, its agents, employees or contractors; and (iv) any improvements, in, to or of the Premises or on the Land which are not Tenant's Property which Tenant may elect to remain on the Land or the Premises. Title to all Tenant's Property, shall be and remain in Tenant, and at any time during the Term of this Lease, the same may be removed by Tenant, or, at Tenant's abandonment or written election, surrender with the Premises, in which event title to such surrendered property shall, if Landlord so elects in Landlord's sole discretion, be deemed transferred to Landlord. Any of such property that is not removed from the Premises on or prior to the expiration or early termination of this Lease shall be considered abandoned and Landlord may deal with it as Landlord elects. ARTICLE 11 ASSIGNMENT BY LANDLORD 11.1 FURTHER MORTGAGES OR ENCUMBRANCES BY LANDLORD. Except for the SBLF Deed of Trust (which is hereby approved by Tenant), Landlord shall not cause or create any mortgages, deeds of trust, encumbrances or exception to exist with respect to the Premises at any time. 16 26 11.2 LANDLORD'S RIGHT TO SELL. Landlord may not transfer all or any portion of its right, title and interest in the Premises; provided, however that nothing contained in this Lease shall be deemed in any way to limit, restrict or otherwise affect the right of Landlord at any time and from time to time to sell or transfer all but not less than all of its right, title and estate in the Premises to: (1) a Landlord Affiliate or another financial institution (excluding, however, a non-substantive entity that is formed specifically for purposes of owning the Premises subject to this Lease and has no other substantive operations or which is a special purpose entity under the provisions of EITF 90-15) with a capitalization in excess of $50,000,000; or (2) if an Event of Default has occurred and is continuing at the time of such sale or transfer, to any Entity. Any sale or transfer by Landlord whatsoever shall by its express terms recognize and confirm the right of possession of Tenant to the Premises and Tenant's other rights arising out of this Lease shall not be affected or disturbed in any way by any such sale, transfer, assignment or conveyance (except for any disturbance resulting from a foreclosure sale conducted pursuant to the laws of the State of California at which independent third party bids were permitted pursuant to the SBLF Deed of Trust), and any transferee shall expressly assume in writing all obligations of Landlord to be performed following the date of transfer. 11.3 TRANSFER OF FUNDS AND PROPERTY. At each time Landlord sells, assigns, transfers or conveys the entire right, title and estate of Landlord in the Premises and in this Lease, Landlord shall turn over to the transferee any funds or other property then held by Landlord under this Lease and thereupon all the liabilities and obligations on the part of the Landlord under this Lease arising after the effective date of such sale, assignment, transfer or conveyance shall terminate as to the transferor and be binding upon the transferee. ARTICLE 12 ASSIGNMENT AND SUBLEASING 12.1 RIGHT TO ASSIGN. (a) TENANT'S RIGHT. Provided that there is not an Event of Default under this Lease which is continuing and uncured or if there is such an Event of Default, provided that Tenant cures the Default in connection with the assignment, Tenant shall have the right, at any time and from time to time during the Term, to assign all or any portion of its right, title and estate in the Premises and in this Lease without approval by Landlord. Any such assignee, immediate or remote, shall have the same right of assignment. Any such assignment shall be evidenced by a written instrument, properly executed and acknowledged by all parties thereto and, at Tenant's election, duly recorded in the Official Records, wherein and whereby the assignee assumes all of the obligations of Tenant under this Lease. Notwithstanding any such assignment and assumption or any sublease permitted under Section 12.2 hereof, Tenant shall remain primarily liable for all obligations and liabilities on the part of Tenant theretofore or thereafter arising under this Lease. 17 27 (b) NOTICE. Tenant shall, promptly after execution of each assignment, notify Landlord of the name and mailing address of the assignee and shall, on demand, permit Landlord to examine and copy the assignment agreement. 12.2 RIGHT TO SUBLET. (a) TENANT'S RIGHT. Tenant shall have the right, at any time and from time to time during the Term, to sublet all or any portion of the Premises and to extend, modify or renew any sublease without the approval of Landlord. (b) NOTICE. Tenant shall, promptly after execution of each sublease, notify Landlord of the name and mailing address of the subtenant and shall, on demand, permit Landlord to examine and copy the sublease. 12.3 MORTGAGE BY TENANT. Tenant shall not have the right to mortgage, pledge or otherwise encumber all or any portion of the right, title and estate of Tenant in the Premises or in this Lease, without the consent of Landlord. ARTICLE 13 EMINENT DOMAIN 13.1 TOTAL OR SUBSTANTIAL TAKING. If title or access is taken for any public or quasi-public use, or under any statute or by right of condemnation or eminent domain, or by sale in lieu thereof (a "Taking") with respect to all of the Premises, or if title to so much of the Premises or access thereto is Taken, or if the Premises or access thereto is damaged, blocked or impaired by the Taking, so that, in Tenant's reasonable discretion, the Premises or access thereto, even after a reasonable amount of reconstruction thereof, will no longer be suitable for the conduct of Tenant's (and/or Tenant's subtenants') business, then in any such event, this Lease shall terminate on the date of such Taking. 13.2 PARTIAL TAKING. If any part of the Premises, or access thereto, shall be Taken, and the Premises or the remaining part thereof and access thereto will be, in Tenant's reasonable discretion, suitable for the conduct of Tenant's (and/or Tenant's subtenants') business in a manner consistent with the conduct of such business prior to such Taking, all of the terms, covenants and conditions of this Lease shall continue, except that Base Rent shall be adjusted to reflect the decreased Lease Investment Balance remaining after application thereto of the award made to Landlord for such Taking. 13.3 TEMPORARY TAKING. If the whole or any part of the Premises is Taken for temporary use or occupancy, this Lease shall not terminate by reason thereof and Tenant shall continue to pay, in the manner and at the times herein specified, the full amount of the Base Rent payable by Tenant hereunder, and, except only to the extent that Tenant may be prevented from so doing by reason of such Taking, Tenant shall continue to perform and observe all of the other terms, covenants and conditions hereof on the part of Tenant to be performed and observed, as though the Taking had not occurred. In the event of any such 18 28 temporary Taking, Tenant shall be entitled to receive the entire amount of the award made for the Taking, whether paid by way of damages, rent or otherwise. If the temporary Taking is for a term in excess of thirty (30) days, then the Taking shall be treated as a permanent Taking and be governed by Sections 13.1 or 13.2, as applicable. 13.4 DAMAGES. The compensation attributable to the Premises (in each case the compensation or value shall be determined as of the date of the Taking) awarded or paid upon any Taking (other than a temporary Taking, which shall be governed by Section 13.3), whether awarded to Landlord, Tenant, or both of them, shall be held by Landlord to be applied against the Lease Investment Balance, including all accrued and unpaid Base Rent and Additional Rent. Any compensation in excess of the Lease Investment Balance plus all accrued and unpaid Base Rent and Additional Rent shall be paid to Tenant. 13.5 NOTICE AND EXECUTION. Immediately upon service of process upon Landlord or Tenant in connection with any Taking relating to the Premises or any portion thereof or access thereto, each party shall give the other Notice thereof. Each party agrees to execute and deliver to the other all instruments that may be required to effectuate the provisions of this Article 13. Tenant reserves the right to appear in and to contest any proceedings in connection with any such Taking. Tenant shall immediately reimburse Landlord on demand for all reasonable out-of-pocket costs and expenses incurred by Landlord in complying with Landlord's obligations under this Section 13.5. ARTICLE 14 DAMAGE OR DESTRUCTION 14.1 CASUALTY INSURANCE PROCEEDS. In the event of any casualty, the proceeds of any insurance policies maintained by Tenant pursuant to Section 7.2 or 7.3 shall be held, applied and dealt with as follows: (a) Any proceeds (per occurrence) of such policies attributable to the Premises shall be paid as follows: (1) to Landlord (but only to the extent of the then-existing Lease Investment Balance); and (2) with any remaining excess to be paid to Tenant. (b) Any insurance proceeds paid to Landlord under this Article 14 shall reduce the Lease Investment Balance by a like amount. ARTICLE 15 QUIET ENJOYMENT 15.1 QUIET ENJOYMENT. Landlord covenants to secure to Tenant the quiet possession of the Premises for the full Term against all persons claiming the same, by, through or in the right of Landlord, subject to Landlord's rights and remedies under Article 16 upon an Event of Default by Tenant. The existence of any Permitted Title Exceptions shall not be 19 29 deemed to constitute a breach of Landlord's obligations hereunder. Tenant shall, immediately upon demand, reimburse Landlord for all reasonable costs, expenses and damages incurred or paid by Landlord in the performance of Landlord's obligations under this Article 15 (except for any costs, expenses or damages arising from any Landlord liens or Landlord's willful breach of this Lease). ARTICLE 16 DEFAULT 16.1 DEFAULT. Each of the following events shall constitute an event of default ("Event of Default") by Tenant: (a) FAILURE TO PAY BASE RENT. Tenant's failure to pay any Base Rent within five (5) days after the due date. (b) FAILURE TO PAY ADDITIONAL RENT. Tenant's failure to pay any Additional Rent which is due to Landlord within five (5) days after the due date under this Lease (which due date shall be the date of Tenant's receipt of Notice from Landlord that such Additional Rent is due). (c) FAILURE TO CARRY INSURANCE. Tenant's failure to carry any policy of insurance required by Article 7, and Tenant shall not cure such failure prior to ten (10) days after written notice thereof is sent to Tenant. If such failure is susceptible of cure but cannot with reasonable diligence be cured within such ten day period, and if Tenant shall promptly have commenced to cure the same and shall thereafter prosecute the curing thereof with reasonable diligence, the period within which such failure may be cured shall be extended for such further period (not to exceed an additional ten days beyond the initial ten days cure period) as shall be reasonably necessary for the curing thereof. (d) INSOLVENCY. Subject to Section 16.2, the occurrence of: (i) an assignment by Tenant for the benefit of creditors generally; or (ii) the filing of a voluntary or involuntary petition by or against Tenant under any present or future applicable federal, state or other statute or law having for its purpose the adjudication of Tenant as a bankrupt; (iii) the appointment of a receiver, liquidator or trustee for all or a substantial portion of the Premises by reason of the insolvency or alleged insolvency of Tenant; or (iv) the taking of possession by any department of city, county, state or federal government, or any officer thereof duly authorized, of all or a substantial portion of the Premises by reason of the insolvency or alleged insolvency of Tenant; and Tenant's failure to timely give any Notice it is permitted to give pursuant to Section 16.2 (or, in the event Tenant gives timely Notice and pursues a contest under Section 16.2, Tenant's failure to finally prevail in the contest). (e) DEFAULT IN PAYMENT FOR OTHER CREDIT FACILITY. Tenant's failure to make any payment required of Tenant in connection with any other credit facility of Tenant, 20 30 which payment default is not cured within any applicable notice and cure period provided by such credit facility. (f) DEFAULT IN PAYMENT OF LEASE INVESTMENT BALANCE. Failure of Tenant to pay to Landlord the Lease Investment Balance at the end of the Term or upon an Event of Default, unless Tenant has elected its option to purchase or terminate under Article 17 obligations thereunder. (g) DEFAULT IN COMPLETION OF PURCHASE OPTION OR PAYMENT OF GUARANTEED RESIDUAL VALUE. Failure of Tenant to complete the Purchase Option after election (or deemed election) to do so, or failure of Tenant to perform all of its obligations pursuant to the Termination Option if Tenant has elected to exercise the Termination Option (and has not rescinded its election to exercise such option) set forth in Section 17.2, including, without limitation, the obligations to make the payments required pursuant to Sections 17.2(b), (d) and (e). (h) FINANCIAL COVENANTS. Tenant's failure at any time during the Term of the Lease, subject to quarterly compliance (as measured on the last day of each fiscal quarter of Tenant) to comply with the following Financial Covenants: (i) Profitability. (1) Tenant shall not in any fiscal quarter have an operating and/or net loss on a consolidated basis greater than five percent (5%) of Tenant's Consolidated Tangible Net Worth as of the end of such fiscal quarter; and (2) Tenant shall not have an operating and/or net loss on a consolidated basis in any two (2) consecutive fiscal quarters as measured quarterly for that fiscal quarter and the immediately preceding fiscal quarter. (ii) Leverage Ratio. Tenant shall maintain a ratio of Consolidated Total Liabilities (including the undrawn amount of all outstanding letters of credit) to Consolidated Tangible Net Worth not to exceed 0.75:1.00. (iii) Consolidated Tangible Net Worth. Tenant shall maintain Consolidated Tangible Net Worth of at least $231,000,000, plus (a) a minimum of 80% of quarterly net income (after taxes) for each fiscal quarter after June 30, 1994 in which net income shall be positive, plus (b) 100% of any new equity raised after June 30, 1994, minus (c) 100% of the cost of repurchases by Tenant of its capital stock after June 30, 1994 in an aggregate amount of up to $40,000,000, and minus (d) 50% of the cost of such repurchases in excess of $40,000,000 but less than $60,000,000. 16.2 CONTEST BY TENANT. If upon the filing of any involuntary petition of the type described in Section 16.1(d) or upon the appointment of a receiver, other than a receiver 21 31 appointed in any voluntary proceeding referred to in Section 16.1(d), or the taking of possession of all or a substantial portion of the Premises by any department of the city, county, state or federal government, or any officer thereof duly authorized, by reason of the alleged insolvency of Tenant without the consent or over the objection of Tenant, should Tenant desire to contest the same in good faith, Tenant shall, within ninety (90) days after the filing of the petition or after the appointment or taking of possession, give Notice to Landlord that Tenant proposes to make the contest, and the same shall not constitute an Event of Default so long as Tenant shall prosecute the proceedings with due diligence and no part of the Premises shall be exposed to sale by reason of the continuance of the contest. 16.3 LANDLORD'S REMEDIES. Landlord shall have the remedies specified below: (a) CONTINUE LEASE. In connection with an Event of Default, Landlord shall have the right to enforce, by suit or otherwise, all other covenants and conditions hereof to be performed or complied with by Tenant and to exercise all other remedies permitted by Section 1951.2 or 1951.4 of the California Civil Code whichever is applicable, or any amendments thereof. Landlord has the remedy described in California Civil Code Section 1951.2 or 1951.4 (Landlord may continue the Lease in effect after Tenant's breach and abandonment and recover Base Rent as it becomes due, if Tenant has right to sublet or assign, subject only to reasonable limitation or Landlord may terminate the Lease and collect damages). Upon application by Landlord, a receiver may be appointed to take possession of the Premises and exercise all rights granted to Landlord as set forth in this Section 16.3. (b) TERMINATE LEASE. In connection with an Event of Default, Landlord may terminate this Lease, by giving Tenant Notice thereof, at any time after the occurrence of such Event of Default and whether or not Landlord has also exercised any right under Section 16.2. In such event Tenant shall be obligated to purchase the Premises for an amount equal to the Purchase Price described in the Purchase Option contained in Section 17.1 below (that is, all accrued Base Rent, Additional Rent and the Lease Investment Balance). Landlord shall also have its other remedies at law (including its rights under the SBLF Deed of Trust), provided, however, that Tenant's obligation to purchase the Premises pursuant to Section 17.2 shall survive any termination of this Lease up through the date of foreclosure sale under the SBLF Deed of Trust. (c) LANDLORD'S CONTINUING OBLIGATION TO SELL. Except in the case of a foreclosure under the SBLF Deed of Trust, in the event Landlord obtains possession of the Premises pursuant to the terms of this Lease (because of Tenant's default, Lease expiration, or otherwise), Landlord shall be under a continuing obligation to use its commercially reasonable efforts to sell the Premises to one or more unrelated third parties; provided, however, that Landlord shall not be required to sell or attempt to sell any portion of the Premises (i) in a manner, or under circumstances, that could materially impair Landlord's ability to enforce any of its rights or remedies under this Lease (as determined in Landlord's sole discretion exercised in good faith) or (ii) at a time when market conditions render it 22 32 inadvisable to sell or attempt to sell the Premises (as determined in Landlord's sole discretion exercised in good faith). Upon the occurrence of any such sale Landlord shall be obligated to pay to Tenant any excess of the amount realized by Landlord in connection with such sale over the Purchase Price (defined below). For purposes of the preceding sentence, the amount realized by Landlord upon a sale of the Premises shall be net of Landlord's reasonable sale expenses and other expenses reasonably incurred by Landlord to consummate such sale. Landlord's obligation to pay such excess to Tenant shall survive any termination of this Lease. Tenant agrees that the Landlord will be deemed to be acting in good faith if it refuses to sell its interest for less than the excess of the Lease Investment Balance over the Guaranteed Residual Value. In the event there is a foreclosure sale under the SBLF Deed of Trust, then the party acquiring the property sold at such foreclosure sale (the "Purchaser") shall have the option to purchase the fee simple interest in all, but not less than all, of the then-existing Premises owned by Landlord on the following terms: (i) such option to purchase must be exercised by written notice delivered to Landlord no later than thirty (30) days following the date of completion of the foreclosure sale, as evidenced by the recordation of a deed conveying such property so sold at foreclosure by the trustee under the SBLF Deed of Trust; (ii) the purchase price for the fee simple interest in the then-existing Premises shall be the Purchase Price set forth in Section 17.1(a) of the Lease (as adjusted to take into account all reductions in the Lease Investment Balance resulting from payments received by Landlord, including proceeds received by Landlord as a result of the foreclosure sale); and (iii) the purchase and sale of the then-existing Premises shall be consummated in the manner described in Section 17.1(c) of the Lease. In the event such Purchaser fails to timely exercise the foregoing purchase option, the purchase option shall expire and Landlord shall thereafter have no further obligation to sell the then-existing Premises. 16.4 NO WAIVER. No failure by Landlord or Tenant to insist upon the strict performance of any term, covenant or condition of this Lease or to exercise any right or remedy consequent upon a breach thereof and no acceptance of full or partial Base Rent or Additional Rent during the continuance of any breach shall constitute a waiver of any such breach or of the term, covenant, or condition. No term, covenant or condition of this Lease to be performed or complied with by Tenant or Landlord, and no breach thereof, shall be waived, terminated, altered or modified except by a written instrument executed by Landlord and Tenant. No waiver of any breach shall affect or alter this Lease, but each and every term, covenant, and condition of this Lease shall continue in full force and effect with respect to any other then existing subsequent breach thereof. 16.5 EFFECT OF ASSIGNMENT. Notwithstanding an Entity's prior assignment or transfer of its interest as Tenant under this Lease, so long as Landlord has been given Notice of such assignment pursuant to Sections 12.1 and 18.3, Landlord shall give such Entity copies of all Notices required by this Article 16 in connection with any Event of Default, and such Entity shall have the period granted hereunder to Tenant to cure such Event of Default, unless such Entity shall have been released from all obligations arising under this Lease. Landlord 23 33 may not assert any rights against such Entity in the absence of such Notice and opportunity to cure, so long as Landlord has been given Notice of such assignment pursuant to Sections 12.1 and 18.3. 16.6 LANDLORD CURE RIGHT. If Tenant fails to perform any covenant or agreement to be performed by Tenant under this Lease, and if the failure or default continues for thirty (30) days after Notice to Tenant (except for emergencies and except for payment of any lien or encumbrance threatening the imminent sale of the Premises or any portion thereof, in which case payment or cure may be made as soon as necessary to minimize the damage to person or property caused by such emergency or to prevent any such sale), Landlord may, but shall have no obligation to, pay the same and cure such default on behalf of and at the expense of Tenant and do all reasonably necessary work and make all reasonably necessary payments in connection therewith including, but not limited to, the payment of reasonable attorneys' fees and disbursements incurred by Landlord. Notwithstanding the foregoing, Landlord shall have no right to cure any such failure to perform by Tenant so long as Tenant: (1) is diligently and in good faith attempting to cure such matter and prosecuting such cure to completion; (2) has the financial ability to so comply; and (3) commenced cure of such matter within thirty (30) days after Tenant's receipt of Notice thereof from Landlord. Failure by Tenant to comply with the above shall allow Landlord to commence in a reasonable and customary manner and in good faith to attempt to cure such matter. Upon demand, Tenant shall reimburse Landlord for the reasonable amount so paid, together with interest at the Default Rate from the date incurred until the date repaid. ARTICLE 17 TENANT'S OPTION TO PURCHASE OR TERMINATE 17.1 OPTION TO PURCHASE PREMISES. (a) PURCHASE OPTION. On any Rent Payment Date during the Term Tenant shall have the option ("Purchase Option") to purchase all of the then-existing Premises. The purchase price ("Purchase Price") for the Premises shall be the sum of accrued and unpaid Base Rent, any accrued and unpaid Additional Rent, plus the Lease Investment Balance. (b) PURCHASE OPTION EXERCISE NOTICE. If Tenant desires to exercise the Purchase Option, Tenant shall deliver to Landlord thirty (30) days prior written notice ("Purchase Option Exercise Notice") of Tenant's election. If Tenant does not exercise the Termination Option as provided in Section 17.2 below it shall be deemed to have exercised the Purchase Option. (c) TRANSFER. If Tenant exercises the Purchase Option, the purchase and sale of the Premises shall be consummated as follows: (i) Landlord shall grant and convey the Premises to Tenant, its authorized agent or assignee, pursuant to a duly executed and acknowledged assignment and 24 34 assumption of leasehold interest (as to the Land) and a grant deed as to the Premises (collectively herein the "Deed"), free and clear of all title defects, liens, encumbrances, deeds of trust, mortgages, rights-of-way and restrictive covenants or conditions, of record, placed against the Premises by Landlord except for the Permitted Title Exceptions (excluding the SBLF Deed of Trust), and any UCC-1 filed or recorded which evidence security interests encumbering the Premises or any part thereof in favor of SBLF, which security interests SBLF shall cause to be released so that they no longer affect the Premises). (ii) The Purchase Price shall be paid upon delivery of the Deed and any other documents reasonably requested by Tenant to evidence the transfer of the Premises subject to the Permitted Title Exceptions (excluding the SBLF Deed of Trust, and any UCC-1 filed or recorded which evidence security interests encumbering the Premises or any part thereof in favor of SBLF, which security interests SBLF shall cause to be released so that they no longer affect the Premises) ("Additional Documents"). In the event that Tenant elects to assign the Purchase Option pursuant to Section 17.1(d) below, and Tenant's assignee pays an amount less than the Purchase Price for the Premises, Tenant shall pay to Landlord any excess of the Purchase Price over the amount paid by such assignee. Landlord shall deliver the Deed and the Additional Documents to Tenant on the date for closing specified by Tenant in the Purchase Option Exercise Notice. The closing shall take place at the location and in the manner reasonably set forth by Tenant in the Purchase Option Exercise Notice; provided that the date of closing shall occur no later than the last day of the Term of the Lease. (iii) If Landlord shall fail to cause title to be in the condition required in Section 17.1(c)(i) above within the time herein prescribed for the delivery of the Deed, then Tenant shall have the right (in addition to all other rights provided by law) by a written notice to Landlord: (1) to extend the time in which Landlord shall clear title and deliver the Deed and Additional Documents, during which extension this Lease shall remain in full force and effect, except Tenant shall be released from its obligation to pay Base Rent during the extension; (2) to accept delivery of the Deed and Additional Documents subject to such title defects, liens, encumbrances, deeds of trust, mortgages, rights-of-way and restrictive covenants or conditions specified and set forth in the Deed and not cleared by Landlord; (3) to rescind, by notice to Landlord and without any penalty or liability therefor, any and all obligations Tenant may have under and by virtue of the Purchase Option or the exercise thereof, whereupon this Lease shall remain in full force and effect; (4) if the title exception is curable by the payment of money, Tenant may make such payment and such payment shall be a credit against the Purchase Price in favor of Tenant. (iv) Base Rent shall be prorated and paid and all Additional Rent which is then due and payable shall be paid as of the date title to the Premises is vested of record in Tenant. Tenant shall pay the escrow fees; the recorder's fee for recording the Deed; the premium for the title insurance policy; all documentary transfer taxes; Tenant's attorneys' fees; Landlord's reasonable attorneys' fees; all other costs and expenses incurred by Tenant in consummating the transfer of the Premises; and all reasonable expenses (except as specified 25 35 in the next sentence) incurred by Landlord in consummating the transfer of the Premises pursuant to this Section 17.1. Landlord shall pay the costs and expenses of clearing title as required by Section 17.1(c)(i). (d) ASSIGNMENT. Tenant shall have the right, without Landlord's consent, to assign this Purchase Option, in whole, to any Entity at any time, whether or not Tenant also assigns its interest in the Lease. 17.2 TERMINATION OPTION. (a) NOTICE. Provided that no Event of Default has occurred and is continuing, unless Tenant has notified Landlord prior to such date that it elects the Purchase Option, Tenant may, on the date which is four (4) months prior to the expiration of the Term, exercise an option ("Termination Option") to sell the Premises; provided, however that at any time Tenant can rescind its election to exercise its Termination Option if it then exercises its Purchase Option pursuant to Section 17.1 above. The four (4) month period is referred to herein as the "Sales Period". (b) TERMINATION OPTION. After giving the notice set forth in section (a) above Tenant shall then use its best efforts to sell the Premises for cash to a third party purchaser (who is not an affiliate of Tenant within the meaning of Rule 405 under the Securities Act of 1933) and, if the Premises are not conveyed to such purchaser prior to the expiration of the Term, Tenant shall have no further right to sell the Premises and Landlord may, at its option either allow the Tenant to holdover pursuant to Section 4.2 above, or terminate the Lease in which case Tenant shall immediately vacate the Premises, and quitclaim all interest of Tenant, if any, therein to Landlord, and pay to Landlord the Guaranteed Residual Value as provided in Section 17.2(d) below. (c) TERMINATION OPTION PROCEDURES. In the event that Tenant elects the Termination Option, Tenant shall use its best efforts throughout the Sales Period to obtain a purchaser (who is not an affiliate of Tenant as described above) for the Premises. Tenant shall have the exclusive right to market the Premises during the first three (3) months of the Sales Period (the "Exclusive Period"). Landlord may direct Tenant to hire and pay for no more than one (1) commission sales agent after the expiration of the Exclusive Period. Except as otherwise provided below, any sale by Tenant shall be for the highest cash bid submitted to Tenant, including any cash bid submitted by Landlord. The determination of the highest bid shall be made by Landlord prior to the end of the Sales Period. After the end of the Exclusive Period, Landlord may accept any bid solicited by Landlord, Tenant or its agent, in which case Tenant's sales effort may be suspended until the earlier of the closing of such sale on the last day of the Term or revocation or rejection of such cash bid. Notwithstanding the above provisions, Tenant may (i) accept during the Exclusive Period any cash bid (net of expenses of sale) which exceeds the Lease Investment Balance, and (ii) rescind the Termination Option at any time so long as it is exercising its Purchase Option, which shall be prior and superior to an accepted offer from a third party. If Landlord undertakes any sales efforts, Tenant shall 26 36 promptly reimburse Landlord for any reasonable charges, costs and expenses incurred in such effort, including any commissions, allocated time charges, costs and expenses of internal counsel, external counsel or other attorneys' fees. (d) PAYMENTS UNDER TERMINATION OPTION. If Tenant elects the Termination Option, Tenant shall pay to Landlord on the last day of the Term in immediately available funds any Base Rent or Additional Rent due and owing under the Lease. Except as provided in Section 17.2(e), the proceeds (the "Proceeds") of any sale of the Premises pursuant to the Termination Option shall be paid to Landlord upon any such sale without deductions, and not later than the expiration of the Lease Term. If the Premises are not sold and conveyed to a purchaser in exchange for Proceeds on or before the expiration of the Lease Term, then on the expiration of the Lease Term, Tenant shall pay to Landlord in immediately available funds an amount equal to the then Guaranteed Residual Value. (e) PROCEDURES UPON SALE UNDER THE TERMINATION OPTION. Any sale pursuant to the Termination Option shall be consummated on the last day of the Term. To the extent the Proceeds exceed the Lease Investment Balance, such excess shall be paid out of escrow to Tenant. Upon payment to Landlord of all amounts due it under this Lease, Landlord shall execute and deliver to the purchaser of the Premises a grant deed in the same manner and subject to the same conditions and obligations as are set forth in Section 17.1(c) above and have the same obligation to deliver title and remove exceptions as set forth in said Section. Except as provided in the second sentence of this subparagraph, the Proceeds shall be applied first to the Lease Investment Balance, Tenant shall reimburse Landlord for the difference between the Lease Investment Balance (calculated immediately prior to receipt of the Proceeds) and the Proceeds, up to the amount of the Guaranteed Residual Value, and Landlord shall have no claim whatsoever to the Proceeds in excess of such amount upon receipt of such Proceeds. ARTICLE 18 MISCELLANEOUS 18.1 RELATIONSHIP. Neither this Lease nor any agreements or transactions contemplated hereby shall in any respect be interpreted, deemed or construed as constituting Landlord and Tenant as partners or joint venturers, one with the other, or as creating any partnership, joint venture, association or, except as set forth in Section 18.2 below, any other relationship other than that of landlord and tenant: and, except as set forth in Section 18.2 below, both Landlord and Tenant agree not to make any contrary assertion, contention, claim or counterclaim in any action, suit or other legal proceeding involving either Landlord or Tenant or the subject matter of this Lease. 27 37 18.2 FORM OF TRANSACTION: Certain Tax Matters. (a) Landlord and Tenant hereby agree and declare that the transactions contemplated by this Lease are intended to constitute, both as to matters of form and substance: (i) an operating lease for financial accounting purposes, and (ii) a financing arrangement (and not a "true lease") for purposes of Federal, state and local income, property or other forms of tax. Accordingly, and notwithstanding any other provision of this Lease to the contrary, Landlord and Tenant agree and declare that (A) the transactions contemplated hereby are intended to have a dual, rather than single, form and (B) all references in this Lease to the "Lease" of the Premises which fail to reference such dual form do so as a matter of convenience only and do not reflect the intent of Landlord and Tenant as to the true form of such arrangements. (b) Landlord and Tenant agree that, in accordance with their intentions and the substance of the transactions contemplated hereby, Tenant (and not Landlord) shall be treated as the owner of the Premises for Federal, state, local income and property tax purposes and this Lease shall be treated as a financing arrangement. Tenant shall be entitled to take any deduction, credit allowance or other reporting, filing or other tax position consistent with such characterizations. Landlord shall not file any Federal, state or local income tax returns, reports or other statements in a manner which is inconsistent with the foregoing provisions of this Section 18.2. (c) Tenant acknowledges that it has retained accounting, tax and legal advisors to assist it in structuring this Lease and Tenant is not relying on any representations of Landlord regarding the proper treatment of this transaction for accounting, income tax or any other purpose. 18.3 NOTICES. Each Notice shall be in writing and shall be sent by personal delivery, overnight courier (charges prepaid or billed to the sender) or by the deposit of such with the United States Postal Service, or any official successor thereto, designated as registered or certified mail, return receipt requested, bearing adequate postage and in each case addressed as provided in the Basic Lease Provisions. Each Notice shall be effective upon being personally delivered or actually received. The time period in which a response to any such Notice must be given or any action taken with respect thereto shall commence to run from the date of personal delivery or receipt of the Notice by the addressee thereof, as reflected on the return receipt of the Notice. Rejection or other refusal to accept shall be deemed to be receipt of the Notice sent. By giving to the other party at least thirty (30) days' prior Notice thereof, either party to this Lease shall have the right from time to time during the Term of this Lease to change the address(es) thereof and to specify as the address(es) thereof any other address(es) within the continental United States of America. 28 38 18.4 SEVERABILITY OF PROVISIONS. If any term, covenant or condition of this Lease shall be invalid or unenforceable, the remainder of this Lease, or the application of such term, covenant or condition to Entities or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby. 18.5 ENTIRE AGREEMENT: AMENDMENT. This Lease constitutes the entire agreement of Landlord and Tenant with respect to the subject matter hereof. Neither this Lease nor any provision hereof may be changed, waived, discharged or terminated orally, but only by an instrument in writing signed by the party against whom enforcement of the change, waiver, discharge or termination is sought. 18.6 MEMORANDUM OF LEASE OF THE LAND. Neither party shall record this Lease. However, concurrently with the execution of this Lease, Landlord and Tenant have executed a Memorandum of Lease of the Land ("Memorandum of Lease") in the form attached hereto as Exhibit D and by this reference made a part hereof, which Memorandum of Lease shall be promptly recorded in the Official Records. 18.7 SUCCESSORS AND ASSIGNS. Subject to Articles 11 and 12, this Lease shall inure to the benefit of and be binding upon Landlord and Tenant and their respective heirs, executors, legal representatives, successors and assigns. Whenever in this Lease a reference to any Entity is made, such reference shall be deemed to include a reference to the heirs, executors, legal representatives, successors and assigns of such Entity. 18.8 COMMISSIONS. Landlord and Tenant each represent and warrant that neither has dealt with any broker in connection with this transaction and that no real estate broker, salesperson or finder has the right to claim a real estate brokerage, salesperson's commission or finder's fee by reason of contact between the parties brought about by such broker, salesperson or finder. Each party shall hold and save the other harmless of and from any and all loss, cost, damage, injury or expense arising out of or in any way related to claims for real estate broker's or salesperson's commissions or fees based upon allegations made by the claimant that it is entitled to such a fee from the indemnified party arising out of contact with the indemnifying party or alleged introductions of the indemnifying party to the indemnified party. 18.9 ATTORNEYS' FEES. In the event any action is brought by Landlord or Tenant against the other to enforce or for the breach of any of the terms, covenants or conditions contained in this Lease, the prevailing party shall be entitled to recover reasonable attorneys' fees to be fixed by the court, together with costs of suit therein incurred. Tenant shall pay the reasonable attorneys' fees incurred by Landlord for the review and negotiation of this Lease. 18.10 GOVERNING LAW. This Lease and the obligations of the parties hereunder shall be governed by and interpreted, construed and enforced in accordance with the laws of the State of California. 29 39 18.11 COUNTERPARTS. This Lease may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall comprise but a single instrument. 18.12 TIME IS OF THE ESSENCE. Time is of the essence of this Lease, and of each provision hereof. 18.13 NO THIRD PARTY BENEFICIARIES. This Lease is entered into by Landlord and Tenant for the sole benefit of Landlord and Tenant. There are no third party beneficiaries to this Lease. 18.14 LIMITATIONS ON RECOURSE. Except for the gross negligence or willful misconduct of Landlord, the obligations of Tenant and Landlord under this Lease shall be without recourse to any partner, officer, trustee, beneficiary, shareholder, director or employee of Tenant or Landlord. Landlord's liability to Tenant for any default by Landlord under this Lease: (1) shall be limited to Landlord's equity in the Premises; and (2) shall extend to any actual damages of Tenant, but shall not extend to any foreseeable and unforeseeable consequential damages. 18.15 ESTOPPEL CERTIFICATES. Within thirty (30) days after request therefor by either party, the non-requesting party shall deliver, in recordable form, a certificate to any proposed mortgagee, purchaser, sublessee or assignee and to the requesting party, certifying (if such be the case) that this Lease is in full force and effect, the date of Tenant's most recent payment of Base Rent, that, to the best of its knowledge, the non-requesting party has no defenses or offsets outstanding, or stating those claimed, and any other information reasonably requested. Failure to deliver said statement in time shall be conclusive upon the non-requesting party that: (a) this Lease is in full force and effect, without modification except as may be represented by the requesting party; (b) there are no uncured defaults in the requesting party's performance and the non-requesting party has no right of offset, counterclaim or deduction against the non-requesting party's obligations hereunder; (c) no more than one month's Base Rent has been paid in advance; and (d) any other matters reasonably requested in such certificate. 18.16 AS-IS LEASE. Landlord makes no representations or warranties concerning the condition, suitability or any other matters relating to the Premises, and Tenant hereby acknowledges that Tenant leases the Premises from Landlord on an "as is" basis. 18.17 NET LEASE. Except for Landlord's Taxes or as otherwise provided in this Lease, Tenant agrees that this Lease is an absolute net Lease, and the Base Rent called for hereunder shall be paid as required net of all expenses associated with the Premises, including without limitation, Real Estate Taxes and insurance premiums for the insurance required to be carried hereunder, and all other reasonable and customary costs and expenses incurred by Landlord and owed to independent third parties, in connection with the Premises or this Lease, all of which shall be paid or reimbursed by Tenant unless otherwise specifically provided 30 40 herein. Tenant agrees to reimburse Landlord, within five (5) business days following receipt of any written demand therefor, for all reasonable and customary fees, late charges, title endorsement and other costs and expenses charged to Landlord which accrue during any period. 18.18 LANDLORD'S REPRESENTATIONS AND WARRANTIES. Landlord hereby represents and warrants that: (a) Landlord has the full right and authority to enter into this Lease, consummate the sale, transfers and assignments contemplated herein and otherwise perform its obligations under this Lease; (b) the person or persons signatory to this Lease and any document executed pursuant hereto on behalf of such party have full power and authority to bind such party; and (c) the execution and delivery of this Lease and the performance of such party's obligations hereunder do not and shall not result in the violation of its organizational documents or any material contract or agreement to which such party may be a party. 18.19 TENANT'S REPRESENTATIONS AND WARRANTIES. Tenant hereby represents and warrants to Landlord that: (a) CORPORATE STATUS. Tenant (i) is a duly organized and validly existing corporation in good standing under the laws of the State of Delaware, and (ii) has duly qualified and is authorized to do business and is in good standing in all jurisdictions where the failure to do so might have a material adverse effect on it or its properties. (b) CORPORATE POWER AND AUTHORITY. Tenant has the corporate power and authority to execute, deliver and carry out the terms and provisions of the Lease and the SBLF Deed of Trust ("Operative Documents") to which it is or will be a party and has taken all necessary corporate action to authorize the execution, delivery and performance of the Operative Documents to which it is a party and has duly executed and delivered each Operative Document required to be executed and delivered by it and, assuming the due authorization, execution and delivery thereof on the part of each other party thereto, each such Operative Document constitutes a legal, valid and binding obligation, enforceable in accordance with their respective terms except as limited by bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally, and except as the remedy of specific performance or of injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought and except as otherwise stated in the opinion of Tenant's counsel delivered to Landlord in connection with the execution and delivery of this Lease. (c) NO VIOLATION. Neither the execution, delivery and performance by Tenant of the Operative Documents to which it is or will be a party nor compliance with the terms and 31 41 provisions thereof, nor the consummation by the Tenant of the transactions contemplated therein (i) will result in a violation by the Tenant of any applicable provision of any law, statute, rule, regulation, order, writ, injunction or decree of any court or governmental instrumentality having jurisdiction over the Tenant or the Premises that would materially adversely affect (x) the validity or enforceability of the Operative Documents to which the Tenant is a party, or the title to, or value or condition of, the Premises, or (y) to the best of the Tenant's knowledge, the consolidated financial position, business or consolidated results of operations of the Tenant or the ability of the Tenant to perform its obligations under the Operative Documents, (ii) will conflict with or result in any breach which would constitute a default under, or (other than pursuant to the Operative Documents) result in the creation or imposition of (or the obligation to create or impose) any lien upon any of the property or assets of the Tenant pursuant to the terms of any indenture, loan agreement or other agreement for borrowed money to which the Tenant is a party or by which it or any of its property or assets is bound or to which it may be subject (other than Permitted Exceptions), or (iii) will violate any provision of the certificate of incorporation or by-laws of the Tenant. (d) LITIGATION. Except as disclosed in Exhibit E, there are no actions, suits or proceedings pending or, to the knowledge of the Tenant, threatened (i) that are reasonably likely to have a material adverse effect on the Premises or on the businesses, operations, financial condition or material assets of the Tenant, or (ii) that question the validity of the Operative Documents or the rights or remedies of the Landlord with respect to the Tenant or the Premises under the Operative Documents. (e) GOVERNMENTAL APPROVALS. Except as disclosed in Exhibit F, no Governmental Action by any Governmental Authority having jurisdiction over the Tenant, or the Premises is required to authorize or is required in connection with (i) the execution, delivery and performance by the Tenant of any Operative Document to which it is a party, or (ii) the legality, validity, binding-effect or enforceability against the Tenant of any Operative Document to which it is a party. (f) INVESTMENT COMPANY ACT. Tenant is not an "investment company" or a company "controlled" by an "investment company," within the meaning of the Investment Company Act of 1940 as amended. (g) PUBLIC UTILITY HOLDING COMPANY ACT. Tenant is not a "holding company" or a "subsidiary company," or an "affiliate" of a "holding company" or of a "subsidiary company" of a "holding company", within the meaning of the Public Utility Company Act of 1935, as amended. (h) PROVIDED INFORMATION. The information and materials which were provided by Tenant to the Landlord prior to the Date of Lease are true and accurate in all material respects on the date as of which such information and materials are dated or certified and are not incomplete by omitting to state any fact necessary to make such information (taken as a whole) 32 42 not misleading at such time in light of the circumstances under which such information was provided. (i) TAXES. All United States Federal income tax returns and all other tax returns which are required to have been filed have been or will be filed by or on behalf of the Tenant by the respective due dates, including extensions, and all taxes due with respect to the Tenant pursuant to such returns or pursuant to any assessment received by the Tenant have been or will be paid. The charges, accruals and reserves on the books of the Tenant in respect of taxes or other governmental charges are, in the opinion of the Tenant adequate. (j) COMPLIANCE WITH ERISA. Each member of the ERISA Group has fulfilled its obligations under the minimum funding standards of the Employee Retirement Income Security Act of 1974, as amended from time to time ("ERISA") and the Internal Revenue Code of 1986, as amended from time to time (the "Code") with respect to each Plan and is in compliance in all material respects with the presently applicable provisions of ERISA and the Code with respect to each Plan. No member of the ERISA Group has (i) sought a waiver of the minimum funding standard under Section 412 of the Code in respect of any Plan, (ii) failed to make any contribution or payment to any Plan or Multiemployer Plan, or made any amendment to any Plan, which has resulted or could result in the imposition of a lien or the posting of a bond or other security under ERISA or the Code, or (iii) incurred any liability under Title IV of ERISA other than a liability to the Pension Benefit Guaranty Corporation (the "PBGC") for premiums under Section 4007 of ERISA. No "Plan Termination Event" has occurred with respect to any Plan. No member of the ERISA Group has any knowledge of any event that could result in a liability of any such member to the PBGC, whether under a Plan, a Multiemployer Plan, or otherwise. There have not been any nor are there now existing any events or conditions that would permit any Plan to be terminated under circumstances that would cause the lien provided under Section 4068 of ERISA to attach to the material assets of the Tenant or the ERISA Group. The value of the Plans' benefits guaranteed under Title IV of ERISA on the date hereof does not exceed the value of such Plans' assets allocable to such benefits as of the date of this Lease. No member of the ERISA Group has incurred any "withdrawal liability" within the meaning of Title IV of ERISA with respect to a Multiemployer Plan. No "Prohibited Transaction" within the meaning of Section 406 of ERISA exists or will exist with respect to any Plan upon the execution and delivery of this Lease or any Operative Document. (k) ENVIRONMENTAL LAWS. To the best of Tenant's knowledge, except as disclosed in Exhibit G, the Tenant is in compliance with all Environmental Laws relating to pollution and environmental control in all domestic jurisdictions in which all real property of the Tenant, including the Land, are located, other than those the non-compliance with which would not have a material adverse effect on such real property including the Land, or the consolidated results of operations, business, or consolidated financial position of the Tenant. (l) OFFER OF SECURITIES, ETC. Neither the Tenant nor any person authorized to act on the Tenant's behalf has, directly or indirectly, offered any interest in the Premises or any other 33 43 interest similar thereto (the sale or offer of which would be integrated with the sale or offer of such interest in the Premises), for sale to, or solicited any offer to acquire any of the same from, any person other than the Landlord and other "accredited investors" (as defined in Regulation D of the Securities and Exchange Commission). (m) FINANCIAL STATEMENTS. (i) The submitted financial statements, copies of which have been delivered to the Landlord, present fairly in all material respects, in conformity with generally accepted accounting principles, the financial position of the Tenant as of such date and its results of operations and cash flows for such fiscal year. (ii) The unaudited consolidated statement of financial position of the Tenant as of March 31, 1995 and the related unaudited consolidated statements of income, and cash flows for the year to date, copies of which have been delivered to Landlord, present fairly in all material respects, in conformity with generally accepted accounting principles applied on a basis substantially consistent with the financial statements referred to in clause (i) of this subsection (m), the consolidated financial position of the Tenant as of such date and its consolidated results of operations and cash flows for such year-to-date period (subject to normal year-end adjustments). (n) PREMISES. To the best of Tenant's knowledge, the Premises will comply in all material respects with all material requirements of law (including, without limitation, all zoning and land use laws and environmental laws) and insurance requirements. (o) TITLE. The Grant Deed will be in form and substance sufficient to convey good and marketable title to the Premises in fee simple, subject only to Permitted Exceptions. (p) FLOOD HAZARD AREAS. To the best of Tenant's knowledge, except as otherwise identified on the survey delivered to Landlord, no portion of the Premises are located in an area identified as a special flood hazard area by the Federal Emergency Management Agency or other applicable agency. If the Premises are located in an area identified as a special flood hazard area by the Federal Emergency Management Agency or other applicable agency, then flood insurance has been obtained for the Premises in accordance with Article 7 and in accordance with the National Flood Insurance Act of 1968, as amended. (q) LEASE. Upon the execution and delivery of this Lease, (i) the Tenant will have unconditionally accepted the Premises (provided that nothing contained herein shall be deemed a waiver by the Tenant of any right of action against persons with respect to title to and condition of the Premises on the Date of Lease other than the Landlord) and will have good and marketable title to a valid and subsisting leasehold interest in the Premises, subject only to Permitted Exceptions, (ii) no right of offset will exist with respect to any Rent or other sums payable under this Lease, and (iii) no Rent under this Lease will have been prepaid. 34 44 (r) TITLE TO PROPERTIES. The Tenant has good and marketable title to all of its material assets reflected on the balance sheets in the submitted financial statements, except for such material assets as has been disposed of in the ordinary course of business, and all such material assets are free and clear of any lien, except as reflected in said submitted financial statements and/or notes thereto or as otherwise permitted by the provisions hereof or under the Operative Documents, and except for Permitted Exceptions. The Tenant has such trademarks, trademark rights, trade names, trade name rights, franchises, copyrights, patents, patent rights and licenses as to allow it to conduct its business as now operated, without known conflict with the rights of others. (s) DEFAULTS. To the best of Tenant's knowledge, the Tenant is not in material default under (and no event has occurred which with the lapse of time or notice or action by a third party could result in a default under, nor has Tenant received written notice of any event of default which has not been cured, under any instrument evidencing any debt or under any agreement relating thereto or any indenture, mortgage, deed of trust, security agreement, lease, franchise or other agreement or other instrument to which any such person is a party or by which any such person or any of its material assets is subject to or bound. (t) USE OF ADVANCE. No part of any Advance will be used directly or indirectly for the purpose of purchasing or carrying, or for payment in full or in part of debt that was incurred for the purposes of purchasing or carrying, any margin security as such term is defined in Section 207.2 of Regulation G of the Board of Governors of the Federal Reserve System (12 C.F.R., Chapter II, Part 207). 18.20 TENANT'S WAIVER OF DEMAND FOR POSSESSION. Tenant waives any demand for possession of the Premises and any demand for payment of Base Rent and notice of intent to re-enter the Premises, or of intent to terminate this Lease, and waives any and every other notice or demand prescribed by any applicable statutes or laws. 18.21 Financial Reporting. Tenant shall provide to Landlord: (1) annually, within ninety (90) days after the end of each of Tenant's fiscal years during the Term, annual audited financial statements (including balance sheet, income statements, and cash flow statements) of Tenant, (2) quarterly, within forty-five (45) days after the end of each of Tenant's fiscal quarters during the Term, quarterly unaudited financial statements (including balance sheet, income statements, and cash flow statements) of Tenant, and (3) as well as an officer's certificate delivered every reporting period stating that no Event of Default has occurred under the Lease in the form attached as Exhibit H. 18.22 REGULATION D COMPENSATION. For so long as the Landlord is required to maintain reserves against Eurocurrency Liabilities (or any other category of liabilities which include deposits by reference to which the LIBOR Rate is determined or any category of extensions of credit or other assets which includes loans by a non-United States office of the Landlord to United States residents), and, as a result, the cost to the Landlord (or its funding office) of making or maintaining its Advances is increased, then the Landlord may require the 35 45 Tenant to pay, contemporaneously with each payment of Base Rent, an additional amount at a rate per annum up to but not exceeding the excess of (i) (A) the applicable LIBOR Rate divided by (B) one minus the Eurocurrency Reserve Requirements, over (ii) the applicable LIBOR Rate. In the event that the Landlord wishes to require payment of such additional amount, the Landlord (x) shall so notify the Tenant, in which case such additional Base Rent shall be payable to the Landlord at the place indicated in such notice with respect to each Borrowing Period commencing at least three Business Days after the giving of such notice and (y) shall furnish to the Tenant at least five Business Days prior to each date on which Base Rent is payable a certificate setting forth the amount to which it is then entitled under this Section 18.22 (which shall be consistent with it's good faith estimate of the level at which the related reserves are maintained by it). Each such certificate shall be accompanied by such information as the Tenant may reasonably request as to the computation set forth therein. ARTICLE 19 INDEMNIFICATION 19.1 TAX INDEMNITY. Notwithstanding anything in Article 6 to the contrary, Tenant shall protect and defend Landlord from and against all criminal prosecution regarding and shall indemnify and hold Landlord harmless from and against any and all losses, costs, liabilities or damages (including reasonable attorneys' fees and disbursements and court costs) arising by reason of: (a) Any and all U.S. Federal, state or local income taxes imposed upon Landlord in consequence of Landlord being treated as the owner or lessor of the Premises (or any part thereof) for such tax purposes; provided Landlord has fully complied with Section 18.2; (b) Any and all taxes imposed upon Tenant (except to the extent of Landlord's Taxes or to the extent that such taxes are imposed upon Tenant as a result of Landlord's failure to comply with its obligations under this Lease); (c) Any and all taxes required to be withheld from payments made by Tenant to a third party not related to or affiliated with Landlord; (d) Any and all Real Estate Taxes; (e) Any and all taxes owed by Landlord (other than Landlord Taxes) as a result of payment made by Tenant to Landlord pursuant to Tenant's indemnity obligations under this Section 19.1; and (f) Any and all costs, liabilities or damages (including reasonable attorneys' fees) incurred by Landlord in obtaining indemnification payments from Tenant under the provisions of this Section 19.1. 36 46 Tenant's obligation to reimburse or indemnify Landlord for any taxes, governmental fees, penalties, interest or other supplemental tax charges under this Lease shall be reduced by the value of any related or offsetting tax benefits derived or realized by Landlord. Tenant's duty to indemnify Landlord under this Section 19.1 shall apply only to taxes arising during the Term (whether or not due and payable at the conclusion of the Term), but shall otherwise survive the expiration or earlier termination of this Lease. 19.2 ENVIRONMENTAL INDEMNITY. Tenant agrees to indemnify and hold Landlord harmless from and against, and to reimburse Landlord with respect to, any and all claims, demands, causes of action, losses, damages, liabilities, costs and expenses (including attorneys' fees and court costs), fines and/or penalties of any and every kind or character, known or unknown, fixed or contingent, asserted or potentially asserted against or incurred by Landlord at any time and from time to time by reason of, in connection with or arising out of (A) the failure of Tenant to perform any obligation herein required to be performed by Tenant regarding Applicable Environmental Laws, (B) any violation of any Applicable Environmental Law by Tenant or with respect to the Premises or any disposal or other release by Tenant or with respect to the Premises of any hazardous substance, environmental contaminants or solid waste on or to the Premises, whether or not resulting in a violation of any Applicable Environmental Law, (C) any act, omission, event or circumstance by Tenant or with respect to the Premises which constitutes or has constituted violation of any Applicable Environmental Law with respect to the Premises, regardless of whether the act, omission, event or circumstance constituted a violation of any Applicable Environmental Law at the time of its existence or occurrence, and (D) except to the extent of Landlord's gross negligence or willful misconduct, any and all claims or proceedings (whether brought by private party or governmental agencies) for bodily injury, property damage, abatement or remediation, environmental damage or impairment or any other injury or damage resulting from or relating to any hazardous or toxic substance or contaminated material located upon or migrating into, from or through the Premises (whether or not the release of such materials was caused by Tenant, a subtenant, a prior owner of the Premises or any other Entity) which Landlord may incur. Tenant's duty to indemnify Landlord under this Section 19.2 shall survive the expiration or earlier termination of the Lease with respect to events occurring during or prior to the Term or after the Term while Landlord has record title to and Tenant is occupying the Premises, but shall terminate as to events occurring wholly after Tenant is in default under the Lease and is no longer in possession of the Premises. 19.3 GENERAL INDEMNITY. Except to the extent of Landlord's gross negligence or willful misconduct, Tenant shall defend, indemnify, and hold Landlord harmless from and against any and all losses, costs, expenses, liabilities, claims, causes of action and damages of all kinds that may result to Landlord, including reasonable attorneys' fees and disbursements incurred by Landlord, arising because of any failure by Tenant to perform any of its obligations under this Lease. Tenant's duty to indemnify Landlord under this Lease shall survive the expiration or earlier termination of this Lease. 37 47 ARTICLE 20 COVENANTS OF LANDLORD 20.1 TITLE. In the event Tenant so requests in writing (and so long as either Tenant agrees to indemnify Landlord to Landlord's satisfaction from any liabilities or obligations in connection therewith, or Landlord does not incur any liabilities or obligations in connection therewith), Landlord shall execute all documents, instruments and agreements reasonably requested by Tenant in order to accomplish any of the following in the manner reasonably requested by Tenant and within the time parameters reasonably requested by Tenant: (1) remove exceptions to title to or affecting the Premises; (2) create exceptions to title (including, without limitation, easements and rights of way) to or affecting the Premises; or (3) modify any then-existing exception to title. Tenant shall promptly reimburse Landlord for, or at Landlord's request, pay directly in advance, all reasonable costs, expenses and other amounts incurred or required to be expended by Landlord in order to comply with Tenant's requests made in accordance with the preceding sentence, and the failure of Tenant to reimburse or pay any such amounts shall result in the suspension of Landlord's obligations under such sentence with respect to that particular request until the amounts required to be paid by Tenant under this sentence have been paid. 20.2 LAND USE. Except where requested by Tenant pursuant to this Section 20.2, Landlord shall not cause or give its written consent to any land use or zoning change affecting the Premises or any changes of street grade. In the event Tenant so requests in writing (and so long as either Tenant agrees to indemnify Landlord to Landlord's satisfaction, from any liabilities or obligations in connection therewith, or Landlord does not incur any liabilities or obligations in connection therewith), Landlord shall execute all documents, instruments and agreements reasonably requested by Tenant in order to accomplish any of the following in the manner reasonably requested by Tenant and within the time parameters reasonably requested by Tenant: (1) cause a change in any land use restriction or law affecting the Premises; (2) cause a change in the zoning affecting the Premises; or (3) cause a change in the street grade with respect to any street in the vicinity of the Premises. Tenant shall promptly reimburse Landlord for, or at Landlord's request, pay directly in advance, all reasonable costs, expenses and other amounts incurred or required to be expended by Landlord in order to comply with Tenant's requests made in accordance with the preceding sentence, and the failure of Tenant to reimburse or pay any such amounts shall result in the suspension of Landlord's obligations under such sentence with respect to that particular request until the amounts required to be paid by Tenant under this sentence have been paid. 38 48 20.3 TRANSFER OF PROPERTY INTERESTS. Except as requested by Tenant pursuant to this Lease, Landlord shall not transfer to any third party any rights inuring to or benefits associated with the Premises (including, without limitation, zoning rights, development rights, air space rights, mineral, oil, gas or water rights). Nothing in this Section 20.3 shall limit Landlord's right to transfer Landlord's interest in this Lease to a third party or its rights to transfer the Premises, pursuant to Section 11.2; provided that as to a transfer under Section 11.2 any purchaser of Landlord's interest in the Premises shall be bound by the terms of this Lease, including without limitation the terms of this Section 20.3). [Signatures begin on next page.] 39 49 IN WITNESS WHEREOF, the parties hereto have duly executed this Lease as of the day and year first above written. TENANT: OCTEL COMMUNICATIONS CORPORATION, a Delaware Corporation By /s/ M. Marshall West ------------------------------ Name M. Marshall West ------------------------------ Its Vice Chairman ------------------------------ (Signatures continued on next page) 40 50 LANDLORD: SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation By /s/ William M. Ginn -------------------------------- Name William M. Ginn -------------------------------- Its President -------------------------------- Dated: , 1995 --------------------- 41 51 Exhibit A DESCRIPTION OF THE LAND All that certain Real Property in the City of Milpitas, County of Santa Clara, State of California, being all of Parcel 1 as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 and a portion of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14, described as follows: Beginning at a point on the Southwesterly right-of-way line of Murphy Ranch Road at the Easterly corner of Parcel 1, as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4; Thence along said right-of-way line the following four courses: North 33 degrees 17'44" West 87.74 feet to the beginning of a curve to the left; Along said curve having a radius of 2370.00 feet through a central angle of 7 degrees 08'55" an arc distance of 295.70 feet; North 40 degrees 26'39" West 708.15 feet to the beginning of curve to the right; Along said curve having a radius of 830.00 feet through a central angel of 0 degrees 41'54" an arc distance of 10.12 feet; Thence South 52 degrees 22'26" West 678.21 feet to the Southwesterly line of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14; Thence along said Southwesterly line of said Parcel 1 and the Southwesterly and Southeasterly line of Parcel 1 shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 the following five courses: South 41 degrees 07'49" East 286.15 feet to the beginning of a curve to the left; Along said curve having a radius of 560.00 feet through a central angle of 33 degrees 46'49" an arc distance of 330.16 feet to a point of reverse curvature; Along a curve to the right having a radius of 500.00 feet through a central angle of 33 degrees 50'40" an arc distance of 295.35 feet to a point of compound curvature; Along a curve to the right having a radius of 1000.00 feet through a central angle of 7 degrees 00'59" an arc distance of 122.46 feet and North 66 02'22" East 484.64 feet to the Point of Beginning. Together with those rights to plant, cultivate, irrigate, harvest and retain crops and to construct, maintain, use, repair, replace and re-new fences, roads, streets, earth fills, sewers, water pipes, gas pipes, electric power lines, telephone lines and telegraph lines as disclosed by the Deed to the City and County of San Francisco, A Municipal Corporation, recorded 52 March 19, 1951 in Book 2174 at Page 389, Official Records of Santa Clara County, excluding therefrom any portion thereof lying Northeasterly of the Southwesterly line of Magnolia Drive as shown on the hereinabove Parcel Maps. 2 53 Exhibit B CLOSING COSTS AND FEES TO BE INCLUDED IN INITIAL ADVANCE The following items shall be included in the definition of the Initial Advance under Section 2.10 of the Lease: 1. Arrangement fee (SBLF) 101,969.89 2. Fees to Landels, Ripley & Diamond 32,750.00 3. Fees to Wilson, Sonsini 45,000.00 4. Appraisal Fee 4,000.00 5. Fees to Title Company 25,738.60 6. Transfer Taxes 10,849.00 7. Acquisition Cost 9,862,681.00 8. Other Misc. Fees and Costs 114,000.00 Total $10,196,988.49
54 Exhibit C PERMITTED TITLE EXCEPTIONS 1. Taxes for the fiscal year 1995-96, a lien not yet payable. 2. Diagram Assessment No. 20 collected with the County Taxes under Act of 1915. 3. Diagram Assessment No. 8a-2 collected with the County Taxes under Act of 1915. 4. The lien of Supplemental taxes, if any, assessed as a result of transfer of interest and/or new construction, said supplemented taxes being assessed pursuant to Chapter 3.5 commencing with Section 75 of California Revenue and Taxation code, for which no Notice of Assessment has been issued, as of the date hereof. 5. The right of Ingress and Egress, the right to cut any and all existing fences and to install gates therein at such point as maybe necessary for the convenience of the City and use of said Parcel of real property, and the right to protect pipes and other structures of improvements of the City by means of fences or otherwise as provided for in the Deed to the City and County of San Francisco, a municipal corporation recorded March 19, 1951 in Book 2174 at page 389, Official Records. 6. An easement affecting the portion of said land and for the purposes stated herein, an incidental purposes. In Favor of: The City of Milpitas, a municipal corporation For: Public Service Utility Purposes Recorded: August 4, 1983 in Book H780 at Page 57 Official Records Affects: The Northeasterly 10 feet of said Land. 7. An Agreement, affecting said land, for the purposes, stated herein, upon the terms, covenants and conditions refereed to therein, between the parties named herein, between the parties named herein For: Subdivision Improvement Agreement Dated: July 19, 1983 Executed By: City of Milpitas, a municipal corporation, The Redevelopment Agency of the City of Milpitas, and John Arrillaga, Trustee, or his successor trustee UTA dated July 20, 1977 (John Arrillaga Separate Property Trust) as amended and Richard T. Peery, Trustee, or his successor trustee UTA dated July 20, 1977 (Richard T. Peery, Trustee, or his successor trustee UTA dated July 20, 1977 (Richard T. Peery Separate Property Trust) as amended. Recorded: October 14, 1983 in Book H985 at Page 2143 Official Records. 55 8. The terms, covenants and provisions of Redevelopment Project No. 1, as amended Milpitas Redevelopment Agency executed by The City of Milpitas, recorded November 16, 1984 in Book J043 Page 665, Official Records. 9. An Easement affecting the portion of said land and for the purposes stated herein, and incidental purposes, In Favor Of: City of Milpitas, a Municipal Corporation For: Public Service facilities, including poles, underground wires, conduits, storm sewers, sanitary sewers, water mains, public utilities and appurtenances Recorded: September 30, 1986 in Book J863 at Page 867 Official Records. Affects: The Northeasterly 10 feet of said Land. 2 56 Exhibit D (MEMORANDUM OF LEASE OF THE LAND) RECORDING REQUESTED BY, AND WHEN RECORDED, RETURN TO: ___________________________ ___________________________ ___________________________ Attention: ____________________, Esq. MEMORANDUM OF LEASE OF THE LAND THIS MEMORANDUM OF LEASE OF THE LAND ("Memorandum of Lease") is executed as of July 6, 1995, by and between SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation ("Landlord"), and OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation ("Tenant"). RECITALS WHEREAS, Landlord and Tenant have executed that certain lease ("Lease") dated as of July 6, 1995, covering a leasehold interest in certain land located on the real property located in the City of Milpitas, Santa Clara County, California as more particularly described in Schedule 1 attached hereto and incorporated herein by this reference ("Land") and the improvements which may come to be located on said Land (the Land and improvements are referred to herein as the "Premises"); and WHEREAS, Landlord and Tenant desire to record notice of the Lease in the real estate records of Santa Clara County, California: NOW, THEREFORE, in consideration of the foregoing, Landlord and Tenant hereby declare as follows: 1. Demise. Landlord hereby leases the Premises to Tenant and Tenant hereby leases the Premises from Landlord, subject to the terms, covenants and conditions contained in the Lease. 2. Expiration Date. The term of the Lease ("Term") shall commence with respect to the Premises on the date hereof and shall expire on July 5, 1995. 1 57 3. Option to Purchase. Tenant has an option to purchase the Premises, as more particularly described in the Lease, at any time during the Term (including any extension thereof). 4. Restrictions on Encumbrances. Landlord is prohibited from recording against the Premises liens (including, without limitation, deeds of trust), encumbrances, and other matters that would constitute exceptions to title, and from amending or modifying any of the foregoing that may exist now or during the Term, as more particularly described in the Lease. 5. Restrictions on Transfers by Landlord. Subject to certain exceptions, Landlord may transfer its interest in the Premises to a third party subject to the restrictions which are set forth with more particularity in the Lease. 6. Counterparts. This Memorandum of Lease may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall comprise but a single instrument. IN WITNESS WHEREOF, Landlord and Tenant have executed this Memorandum of Lease as of the date and year first written above. TENANT: OCTEL COMMUNICATIONS CORPORATION, a Delaware Corporation By -------------------------------------- Name -------------------------------------- Its -------------------------------------- (Signatures continued on next page) 2 58 LANDLORD: SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation By ----------------------------------- Name --------------------------------- Its ---------------------------------- 3 59 Schedule 1 to Exhibit D All that certain Real Property in the City of Milpitas, County of Santa Clara, State of California, being all of Parcel 1 as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 and a portion of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14, described as follows: Beginning at a point on the Southwesterly right-of-way line of Murphy Ranch Road at the Easterly corner of Parcel 1, as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4; Thence along said right-of-way line the following four courses: North 33 degrees 17'44" West 87.74 feet to the beginning of a curve to the left; Along said curve having a radius of 2370.00 feet through a central angle of 7 degrees 08'55" an arc distance of 295.70 feet; North 40 degrees 26'39" West 708.15 feet to the beginning of curve to the right; Along said curve having a radius of 830.00 feet through a central angle of 0 degrees 41'54" an arc distance of 10.12 feet; Thence South 52 degrees 22'26" West 678.21 feet to the Southwesterly line of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14; Thence along said Southwesterly line of said Parcel 1 and the Southwesterly and Southeasterly line of Parcel 1 shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 the following five courses: South 41 degrees 07'49" East 286.15 feet to the beginning of a curve to the left; Along said curve having a radius of 560.00 feet through a central angle of 33 degrees 46'49" an arc distance of 330.16 feet to a point of reverse curvature; Along a curve to the right having a radius of 500.00 feet through a central angle of 33 degrees 50'40" an arc distance of 295.35 feet to a point of compound curvature; Along a curve to the right having a radius of 1000.00 feet through a central angle of 7 degrees 00'59" an arc distance of 122.46 feet and North 66 degrees 02'22" East 484.64 feet to the Point of Beginning. Together with those rights to plant, cultivate, irrigate, harvest and retain crops and to construct, maintain, use, repair, replace and re-new fences, roads, streets, earth fills, sewers, water pipes, gas pipes, electric power lines, telephone lines and telegraph lines as disclosed by the Deed to the City and County of San Francisco, A Municipal Corporation, recorded March 19, 1951 in Book 2174 at Page 389, Official Records of Santa Clara County, excluding therefrom any portion thereof lying Northeasterly of the Southwesterly line of Magnolia Drive as shown on the hereinabove Parcel Maps. 60 Exhibit E LIST OF LITIGATION 1. Theis Research, Inc. Tenant (the "Company") and Northern Telecom were engaged in a jury trial versus Theis Research, Inc. (Theis) in the Northern District of California during the first quarter of fiscal 1995. The trial centered on Theis' allegation that Octel and Northern Telecom were infringing three patents held by Theis. In October 1994, the jury returned a verdict of finding, among other things, that Octel and Northern Telecom were correct in their claim that the three patents at issue were invalid. Post-trial motions are pending, and, if no settlement between the parties is reached, it is anticipated that Theis will appeal the verdict. 2. Gilbarco Inc. In January 1994, Gilbarco Inc. (Gilbarco) filed suit in the U.S. District Court for the District of Colorado against the Company and one of its telephone company customers, U.S. West, alleging infringement of a United States patent and seeking unspecified damages. The Company filed an answer to the complaint denying any infringement and asserting several affirmative defenses, including an assertion that the patent is invalid and unenforceable. In September 1994, the claims asserted against the company were transferred to the U.S. District Court for the Northern District of California and those claims asserted against U.S. West were stayed and administratively closed pending the outcome of the California action. Fact discovery in the case is substantially complete and a trial date has been set for October 16, 1995. The Company is currently planning to file one or more motions before the trial which could dispose of some or all of the claims asserted against it. The Company believes, based on information currently available, that the Company is not infringing any valid patents of Gilbarco. The Company will vigorously defend the patent infringement claims and any related claims for compensatory damages. While litigation is inherently uncertain, the Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position. 1 61 Exhibit F LIST OF GOVERNMENTAL APPROVALS None. 62 Exhibit G LIST OF ENVIRONMENTAL LAWS None. 63 Exhibit H FORM OF OFFICERS' CERTIFICATE The undersigned, ____________________ of OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation hereby certifies that as of the date hereof the lease dated July 6, 1995 by and between SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation, as Landlord and OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation, as Tenant is in full force and effect, and Tenant is not in default thereunder. Date: ____________________ _________________________ EX-10.18 3 LEASE OF LAND AGREEMENT DATED JULY 6, 1995 1 Exhibit 10.18 Recording Requested By And When Recorded Return To: Landels, Ripley & Diamond 350 Steuart Street San Francisco, CA 94105-1250 Attention: Bruce W. Hyman, Esq. =============================================================================== =============================================================================== OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation as Trustor, to CHICAGO TITLE INSURANCE COMPANY, a California corporation, as Trustee, for the benefit of SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation, as Beneficiary =============================================================================== =============================================================================== DEED OF TRUST, FINANCING STATEMENT, SECURITY AGREEMENT AND FIXTURE FILING (WITH ASSIGNMENT OF RENTS AND LEASES) =============================================================================== Dated: July 6, 1995 =============================================================================== =============================================================================== This instrument is a Deed of Trust, Financing Statement, Security Agreement and Fixture Filing (with Assignment of Rents and Leases) of both real and personal property, including fixtures. This instrument contains provisions accelerating the obligations hereby secured upon certain sales or further encumbrances of the property hereby covered. 2 Exhibit 10.18 T A B L E O F C O N T E N T S
Section Page - ------- ---- GRANTING CLAUSES GRANTING CLAUSE FIRST Land ..................................................................... 2 GRANTING CLAUSE SECOND Improvements ............................................................. 3 GRANTING CLAUSE THIRD Equipment ................................................................ 4 GRANTING CLAUSE FOURTH Other and After Acquired Property ........................................ 5 GRANTING CLAUSE FIFTH Proceeds and Awards ...................................................... 6 ARTICLE I. COVENANTS OF TRUSTOR SECTION 1.01. Insurance ............................................... 6 (a) Casualty Insurance ...................................... 6 SECTION 1.02. Damage and Destruction .................................. 7 (a) Trustor's Obligations ................................... 7 (b) Beneficiary's Rights; Application of Proceeds ........... 7 (c) Effect on the Indebtedness .............................. 8 SECTION 1.03. Condemnation ............................................ 8 (a) Trustor's Obligations; Proceedings ...................... 8 (b) Beneficiary's Rights to Proceeds ........................ 9 (c) Application of Proceeds - Total Taking .................. 9 (d) Application of Proceeds - Partial Taking ................ 10 (e) Right to Participate .................................... 10 (f) Effect on the Obligations ............................... 11 ARTICLE II. ADDITIONAL ADVANCES; EXPENSES; INDEMNITY SECTION 2.01. Additional Advances and Disbursements ................... 11 SECTION 2.02. Other Expenses .......................................... 12 SECTION 2.03. Indemnity ............................................... 13
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Section Page - ------- ---- ARTICLE III. DEFAULTS AND REMEDIES SECTION 3.01. Events of Default ....................................... 14 SECTION 3.02. Remedies ................................................ 14 SECTION 3.03. Trustor's Personal Property and Trade Fixtures .......... 18 SECTION 3.04. Expenses ................................................ 18 SECTION 3.05. Rights Pertaining to Sales .............................. 18 SECTION 3.06. Application of Proceeds ................................. 21 SECTION 3.07. Additional Provisions as to Remedies .................... 22 SECTION 3.08. Waiver of Rights and Defenses ........................... 24 SECTION 3.09. Exercise by Trustee ..................................... 27 ARTICLE IV. DEFEASANCE SECTION 4.01. Defeasance .............................................. 28 ARTICLE V. ADDITIONAL PROVISIONS SECTION 5.01. Provisions as to Payments, Advances ..................... 28 SECTION 5.02. Usury Savings Clause .................................... 29 SECTION 5.03. Separability ............................................ 29 SECTION 5.04. Notices ................................................. 29 SECTION 5.05. No Merger ............................................... 31 SECTION 5.06. Applicable Law .......................................... 31 SECTION 5.07. Provisions as to Covenants and Agreements ............... 31 SECTION 5.08. Matters to be in Writing ................................ 31 SECTION 5.09. Construction of Provisions .............................. 31 SECTION 5.10. Successors and Assigns .................................. 33 SECTION 5.11. Request for Notice ...................................... 33 SECTION 5.12. Fixture Filing .......................................... 33 SECTION 5.13. Entire Agreement ........................................ 33 ARTICLE VI.
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Section Page - ------- ---- PROVISIONS AS TO TRUSTEE SECTION 6.01. Trustee's Appointment ................................... 34 ARTICLE VII. SPECIAL PROVISIONS SECTION 7.01. Defeasance and Release .................................. 35 SECTION 7.02. Subordination ........................................... 35 SECTION 7.03. Counterparts ............................................ 35 EXHIBIT A - Property Description
-3- 5 Exhibit 10.18 THIS DEED OF TRUST, FINANCING STATEMENT, SECURITY AGREEMENT and FIXTURE FILING (WITH ASSIGNMENT OF RENTS AND LEASES) ("Deed of Trust") is made this 6th day of July, 1995, by OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation ("Trustor"), whose address is 1001 Murphy Ranch Road, Milpitas, California, 95035 to CHICAGO TITLE INSURANCE COMPANY, a corporation organized and existing under the laws of the State of California ("Trustee") for the benefit of SUMITOMO BANK LEASING AND FINANCE, INC., a corporation having its mailing address at 277 Park Avenue, New York, New York 10172 ("Beneficiary"). W I T N E S S E T H : WHEREAS, Concurrently herewith Beneficiary is entering into a master lease of even date of the property more particularly described in Exhibit A attached hereto, with Trustor for the purpose of financing the acquisition of certain land that is part of the Mortgaged Property (as defined below) and leasing such land to Trustor (the "Lease"). Pursuant to the terms of the Lease, Beneficiary is obligated to finance the acquisition of the Land in an amount up to, but not to exceed, $10,196,988.49, including capitalized expenses, interest and fees which is to be repaid to Beneficiary pursuant to the terms of the Lease. WHEREAS, the total indebtedness and liabilities that are to be secured by this Deed of Trust shall be as follows: i) all amounts payable by Trustor under and in connection with the Lease and under any other document or instrument executed by Trustor, securing, evidencing or relating to the Lease or any of the security therefor, (the Lease and such other documents and instruments being hereinafter collectively referred to as the "Transaction Documents"), in each case as the same may be modified, amended, or supplemented from time to time including but not limited to Base Rent and Additional Rent, as defined in the Lease, all sums Beneficiary may advance, pay or incur under or in connection with the Lease or any other sums advanced by Trustee or Beneficiary for the benefit of Trustor under the Lease; ii) all amounts payable by Trustor, under or in connection with this Deed of Trust, as the same may be amended, modified or supplemented from time to time, 6 including all sums, amounts and expenses which Trustee or Beneficiary may advance, pay or incur in connection with or any other sums advanced by Trustee or Beneficiary for the protection of its security interests under the Transaction Documents; and iii) any other indebtedness, obligation or agreement of Trustor when evidenced or set forth in a document or instrument executed by Trustor reciting that it is secured by this Deed of Trust; (all such amounts, obligations and liabilities described in (i) through (iii) being hereinafter collectively referred to as the "Obligations"); and WHEREAS, it has been agreed that the payment and performance of the Obligations shall be secured by a conveyance of certain property as hereinafter described; and NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and in order to secure the due and punctual payment in full by Trustor, whether at stated maturity, by acceleration or otherwise, and performance of the Obligations, Trustor does hereby, give, grant, bargain, sell, warrant, mortgage, transfer, grant a security interest in, set over, deliver, confirm and convey unto Trustee, in trust, with power of sale and right of entry as hereinbelow provided, upon the terms and conditions of this Deed of Trust, the following property described in Granting Clauses FIRST through SIXTH below: GRANTING CLAUSES All the estate, right, title and interest of Trustor, whether now owned or hereafter acquired, in, to and under, or derived from: GRANTING CLAUSE FIRST Land -2- 7 All those certain lots, pieces or parcels of land located in the City of Milpitas, the County of Santa Clara and the State of California, as more particularly described in Exhibit A attached hereto, as the description of the same may be amended, modified or supplemented from time to time, all rights, title and interest of Trustor therein, including Trustor's right, title and interest in said real property, including such interests under the Lease, and including Trustor's options to purchase said real property under Article 17.1 of the Lease and all and singular reversions or remainders in and to said land and the tenements, hereditaments, transferable entitlements and development rights, easements (in gross and/or appurtenant) existing as of the date hereof or arising thereafter, agreements, rights-of-way or use rights (including alley, drainage, horticultural, mineral, mining, water, oil and gas rights and any other rights to produce or share in the production of anything therefrom or attributable thereto), privileges, royalties and appurtenances to said land, now or hereafter belonging or in anyway appertaining thereto, including any such right, title, interest in, to or under any agreement or right granting, conveying or creating, for the benefit of said land, any easement, right or license in any way affecting said land and/or other land and in, to or under any streets, ways, alleys, vaults, gores or strips of land adjoining said land or any parcel thereof, or in or to the air space over said land, all rights of ingress and egress with respect to said land, and all claims or demands of Trustor, either at law or in equity, in possession or expectancy, of, in or to the same (all of the foregoing hereinafter collectively referred to as the "Land"). GRANTING CLAUSE SECOND Improvements All buildings, structures, facilities, landscaping and other improvements now or hereafter located on the Land, and all building material, building equipment, supplies and fixtures of every kind and nature now or hereafter located on the Land or attached to, contained in or used in connection with any such buildings, structures, facilities, landscaping or other improvements, and all appurtenances and additions thereto and betterments, renewals, substitutions and replacements thereof, -3- 8 (all of the foregoing hereinafter collectively referred to as the "Improvements"). GRANTING CLAUSE THIRD Equipment To the extent that the same are not Improvements, all machinery, apparatus, goods, equipment, materials, building materials, fittings, chattels and tangible personal property, and all appurtenances and additions thereto and betterments, renewals, substitutions and replacements thereof, wherever situated, and now or hereafter located on, attached to, contained in or used or usable in connection with the properties referred to in Granting Clause FIRST, SECOND or FIFTH, or placed on any part thereof, though not attached thereto, but excluding any and all trade fixtures and other items of personal property now or hereafter installed or used by Trustor in connection with the operation of its business in the Improvements (all of the foregoing hereinafter collectively referred to as the "Equipment"), including without limitation all screens, awnings, shades, blinds, curtains, draperies, carpets, rugs, furniture and furnishings, heating, lighting, air conditioning, refrigerating, incinerating and/or compacting plants, systems and equipment, hoists, stoves, ranges, vacuum and other cleaning systems, call systems, sprinkler systems and other fire prevention and extinguishing apparatus and materials, motors, machinery, pipes, ducts, conduits, dynamos, engines, compressors, generators, boilers, stokers, furnaces, pumps, tanks, appliances, equipment and fittings (the Land, the Improvements and the Equipment hereinafter collectively referred to as the "Premises"); all contract rights of Trustor in construction contracts, plans and specifications, and architects' agreements arising out of the improvements of the Premises, all permits, licenses, franchises, certificates and other rights and privileges obtained in connection with the Premises; all names under which the Land and Improvements may at any time be operated or known (provided that nothing herein shall give Beneficiary the right to use the name or any derivative of the name of Trustor without the consent of Trustor), and all proceeds, substitutions and replacements of all of the foregoing. Trustor hereby grants to Trustee and Beneficiary, a security interest in and to all of Trustor's -4- 9 present and future "equipment" (as defined in the Uniform Commercial Code of the State of California), to the extent that such equipment is located on or used in connection with the Premises, that may be hereafter acquired by Trustor, and Trustee and Beneficiary shall have, in addition to all rights and remedies provided herein and in the Transaction Documents, all of the rights and remedies of a "secured party" under said Uniform Commercial Code. This Deed of Trust constitutes and shall be deemed to be a "security agreement" for all purposes of said Uniform Commercial Code. It is agreed that all Equipment is part and parcel of the Land and the Improvements and appropriated to the use thereof and, whether affixed to the Land and/or the Improvements or not, shall, for purposes of this Deed of Trust be deemed conclusively to be real estate and mortgaged or otherwise conveyed or encumbered hereby. GRANTING CLAUSE FOURTH Other and After Acquired Property Any and all moneys, goods, accounts, chattel paper, general intangibles, documents, instruments, contract rights and other real and personal property (including property exchanged therefor), of every kind and nature, which may from time to time be subjected to the lien hereof by Trustor through a supplement or amendment to this Deed of Trust, or which may come into the possession of or be subject to the control of Trustee or Beneficiary pursuant to this Deed of Trust, it being the intention and agreement of Trustor that all such property shall thereupon be subject to the lien and security interest of this Deed of Trust as if such property were specifically described in this Deed of Trust and conveyed or encumbered hereby or pursuant hereto, and Trustee and Beneficiary are hereby authorized to receive any and all such property as security hereunder, subject to the provisions of this Deed of Trust. -5- 10 GRANTING CLAUSE FIFTH Proceeds and Awards All unearned premiums, accrued, accruing or to accrue under insurance policies now or hereafter obtained by Trustor, all proceeds (including funds, accounts, deposits, instruments, general intangibles, notes or chattel paper) of the conversion, voluntary or involuntary, of any of the property described in these Granting Clauses into cash or other liquidated claims, including proceeds of hazard, title and other insurance and proceeds received pursuant to any sales or rental agreements of Trustor in respect of the property described in these Granting Clauses, and all judgments, damages, awards, settlements and compensation (including interest thereon) heretofore or hereafter made to the present and all subsequent owners of the Premises and/or any other property or rights conveyed or encumbered hereby for any injury to or decrease in the value thereof for any reason, or by any governmental or other lawful authority for the taking by eminent domain, condemnation or otherwise of all or any part thereof, including awards for any change of grade of streets (the Premises and all other property and rights described in Granting Clauses THIRD, FOURTH and FIFTH, hereinafter sometimes collectively referred to as the "Mortgaged Property"). TO HAVE AND TO HOLD, all and singular the Mortgaged Property, whether now owned or leased or hereafter acquired and whether now or hereafter existing, together with all rights, privileges and appurtenances thereunto belonging, unto Trustee and Beneficiary, forever, for the uses and purposes herein set forth, subject however to the provisions of Article VI hereof. AND Trustor covenants with and represents, warrants to and agrees with Trustee and Beneficiary as follows: COVENANTS OF TRUSTOR Insurance. (a) Casualty Insurance. Trustor will keep the Premises insured at all times at no cost to Beneficiary for the -6- 11 benefit of Trustee and Beneficiary to the extent and in the manner described in the Lease and for the coverages described in the Lease, naming Trustee and Beneficiary as loss payees or additional insureds, as appropriate. Damage and Destruction. (a) Trustor's Obligations. In the event of any material damage to or loss or material destruction of the Land or Improvements, Trustor shall promptly notify Beneficiary of such event. (b) Beneficiary's Rights; Application of Proceeds. In the event that any portion of the Land or Improvements is so damaged, destroyed or lost, and any such damage, destruction or loss is covered, in whole or in part, by insurance described in Section 1.01, then the following provisions shall apply: (1) If an Event of Default has occurred hereunder and is continuing, (i) Beneficiary may, but shall not be obligated to, make proof of loss if not made promptly by Trustor, and Beneficiary is hereby authorized and empowered by Trustor to settle, adjust or compromise any claims for damage, destruction or loss thereunder unless the proposed amount of proceeds from such claims exceeds the then outstanding amount of the Obligations, and (ii) each insurance company concerned is hereby authorized and directed to make payment therefor directly to Beneficiary, to be applied, at Beneficiary's option, to the Obligations then secured hereby, in such order as Beneficiary may determine in its sole discretion. Unless otherwise required by law, such application to the Obligations by Beneficiary of such payments shall not, by itself, cure or waive any Event of Default hereunder or notice of default under this Deed of Trust or any other Transaction Document or invalidate any act done pursuant to such notice. (2) If no Event of Default hereunder has occurred and is continuing, and if such proceeds are reasonably expected to be $100,000 or less, Trustor shall be entitled to receive all such proceeds provided that Trustor applies such proceeds to the restoration, replacement, and rebuilding of that portion of the -7- 12 Land or Improvements so damaged, destroyed or lost in accordance with the provisions of the Lease. (3) If such proceeds are reasonably expected to exceed $100,000 and if an Event of Default has not occurred hereunder or has occurred but is not continuing, then if Trustor elects not to restore the damage, the insurance proceeds shall be paid to the Beneficiary and applied to the reduction of the Obligations. (c) Effect on the Indebtedness. Any reduction in the Obligations resulting from the application to the Obligations of insurance proceeds shall be deemed to take effect only on the date of receipt by Beneficiary of such proceeds and the application of such proceeds to the Obligations; provided that if prior to the receipt by Beneficiary of such proceeds, the Mortgaged Property shall have been sold on foreclosure of this Deed of Trust, or shall have been transferred by deed in lieu of foreclosure of this Deed of Trust, notwithstanding any limitation on Trustor's liability contained herein or the other Transaction Documents, Beneficiary shall have the right to receive the same to the extent of any deficiency following such sale or conveyance, together with attorneys' fees and disbursements incurred by Trustee and Beneficiary in connection with the collection thereof. After payment in full of all Obligations, any excess insurance proceeds shall be delivered to Trustor for disposition in the manner set forth in the Lease. Condemnation. (a) Trustor's Obligations; Proceedings. Trustor, promptly upon obtaining knowledge of any pending or threatened institution of any proceedings for the condemnation of the Land or Improvements, or any part thereof or interest therein, or of any right of eminent domain, or of any other proceedings arising out of injury or damage to or decrease in the value of the Land or Improvements (including a change in grade of any street), or any part thereof or interest therein (collectively referred to herein as "Condemnation"), will notify Beneficiary of the threat or pendency thereof and the following provisions shall apply: -8- 13 (b) Beneficiary's Rights to Proceeds. If the amount of all compensation, awards, proceeds and other payments or relief in connection with such condemnation, including without limitation proceeds of sale in lieu of Condemnation, made or granted to Trustor (collectively the "Proceeds") is reasonably expected to be in excess of $100,000, all Proceeds and all judgments, decrees and awards for injury or damage to the Land and Improvements are hereby assigned to Beneficiary and shall be paid to Beneficiary to be held and disbursed as hereinafter set forth. Trustor agrees to execute and deliver such further assignments thereof as Beneficiary may request to effectuate the foregoing and authorizes Beneficiary to collect and receive the same for disbursement as hereinafter set forth. (c) Application of Proceeds - Total Taking. In the event of a Condemnation of all or substantially all of the Land and Improvements or, without regard to the portion of the Land and Improvements subject to Condemnation, if an Event of Default shall have occurred hereunder and be continuing: (1) Beneficiary shall be entitled to all Proceeds of such Condemnation made or granted to Trustor (but not to any compensation, award or other payment or relief made or granted for the benefit of tenants of the Improvements) and, if an Event of Default shall have occurred and be continuing shall be entitled, at Beneficiary's option, to commence, appear in and prosecute in its own name any action or proceedings. All such Proceeds shall be deemed assigned to Beneficiary to the extent of any sums then secured by this Deed of Trust, and Trustor agrees to execute such further assignments of the Proceeds as Beneficiary or Trustee may require. (2) Beneficiary shall apply all such Proceeds, after deducting therefrom all costs and expenses (regardless of the particular nature thereof and whether incurred with or without suit), including reasonable attorneys' fees, incurred by it in connection with the collection of such Proceeds, to the Obligations secured by this Deed of Trust, in such order as Beneficiary may determine in its sole discretion. Unless otherwise required by applicable law, such application or release shall not, by itself, cure or waive any Event of Default hereunder or notice of default under this Deed of Trust or any -9- 14 other Transaction Document or invalidate any act done pursuant to such notice. After payment in full of all Obligations, any excess Proceeds shall be delivered to Trustor for disposition in the manner set forth in the Lease. (d) Application of Proceeds - Partial Taking. If an Event of Default shall not have occurred hereunder and be continuing and in the event of a Condemnation of less than all or substantially all of the Land and/or Improvements, the following provisions shall apply: (1) In the event that such Proceeds are in an amount less than $100,000, Trustor shall be entitled to receive all such Proceeds provided that Trustor applies such Proceeds to the payment of the costs and expenses of repairing and restoring the Land and Improvements. (2) In the event that such Proceeds are in the amount of $100,000 or more, the Proceeds shall be paid to and shall be disbursed by Beneficiary in the same manner, for the same purposes and subject to the same requirements as are applicable to insurance proceeds pursuant to the provisions hereof. (e) Right to Participate. If an Event of Default shall have occurred and be continuing hereunder Beneficiary shall have the right to settle, adjust or compromise any claim in connection with a Condemnation of the Land and/or Improvements in its sole discretion. If an Event of Default shall not have occurred hereunder or has occurred but is not continuing then: (A) Trustor may settle, adjust or compromise any claim which is reasonably expected to be in an amount less than $100,000; and (B) with respect to any claim which is reasonably expected to be in the amount of $100,000 or more, Beneficiary and Trustor shall each consult and cooperate with the other and each shall be entitled to participate in all meetings and negotiations with respect to the settlement of such claim. Trustor at its expense shall deliver to Beneficiary copies of all papers served in connection with such Condemnation. Any adjustment or settlement by Trustor of any claim which is in an amount in excess of $100,000 shall be subject to the reasonable approval of Beneficiary. -10- 15 (f) Effect on the Obligations. Notwithstanding any condemnation, taking or other proceeding referred to in this Section causing injury to or decrease in value of the Premises (including a change in grade of any street), or any interest therein, Trustor shall continue to pay and perform the Obligations as provided herein. Any reduction in the Obligations resulting from the application to the Obligations of any proceeds, judgments, decrees or awards pursuant to Section 1.03(b), (c) or (d) shall be deemed to take effect only on the date of receipt by Beneficiary of such proceeds, judgments, decrees or awards and their application against the Obligations; provided that if prior to the receipt by Beneficiary of such proceeds, judgments, decrees or awards the Mortgaged Property shall have been sold on foreclosure of this Deed of Trust, or shall have been transferred by deed in lieu of foreclosure of this Deed of Trust, Beneficiary shall have the right to receive the same to the extent of any deficiency following such sale, with legal interest thereon together with attorneys' fees and disbursements incurred by Trustee and Beneficiary in connection with the collection thereof. I. ADDITIONAL ADVANCES; EXPENSES; INDEMNITY Additional Advances and Disbursements. Trustor agrees that if an Event of Default occurs hereunder and is continuing then Trustee and/or Beneficiary shall have the right, but not the obligation, in Trustor's name or in its or their own name, and without notice to Trustor to exercise any and all rights and remedies of the landlord under the Lease, and, for such purpose, Trustor expressly grants to Trustee and Beneficiary, in addition and without prejudice to any other rights and remedies hereunder, the right to enter upon and take possession of the Premises in accordance with applicable law to such extent and as often as either of them may deem necessary or desirable. Except as otherwise provided by law, no such exercise shall be deemed to have cured such Event of Default with respect thereto. All reasonable sums advanced and all reasonable expenses incurred by -11- 16 Trustee and/or Beneficiary in connection with such exercise, and all other reasonable sums advanced or expenses incurred by Beneficiary hereunder or under applicable law (whether required or optional and whether indemnified hereunder or not) shall be part of the Obligations, shall bear interest at the Default Rate (as defined in Section 2.6 of the Lease) from the date of disbursement until paid and shall be secured by this Deed of Trust. Trustee and/or Beneficiary, upon making any such advance, shall be subrogated to all of the rights of the person receiving such advance. Other Expenses. (a) Trustor will pay or, on demand, reimburse Trustee and Beneficiary for the payment of, all recording and filing fees, abstract fees, title insurance premiums and fees, Uniform Commercial Code search fees, escrow fees, reasonable attorneys' fees and disbursements and all other reasonable costs and expenses incurred by Trustor, Trustee and/or Beneficiary in connection with the granting, closing and enforcement (including the preparation of the Transaction Documents) of the transactions contemplated hereunder or under the other Transaction Documents, or otherwise attributable or chargeable to Trustor as owner of the Mortgaged Property. Notwithstanding anything to the contrary contained herein in this Section 2.02(a), the provisions of this Section 2.02(a) shall not be deemed or construed to authorize Beneficiary to undertake, exercise or perform any action in the administration of the transactions contemplated hereunder not otherwise (i) authorized by the terms of this Deed of Trust or the Transaction Documents or (ii) permitted under applicable law to be undertaken, exercised or performed by a trust deed beneficiary to protect the security afforded by a deed of trust upon real property. (b) Trustor will pay or, on demand, reimburse Trustee and Beneficiary for the payment of any reasonable costs or expenses (including attorneys' fees and disbursements) incurred or expended in connection with or incidental to (i) any Event of Default by Trustor or (ii) the exercise or enforcement by or on behalf of Trustee and/or Beneficiary of any of their rights or remedies or Trustor's obligations under this Deed of Trust or under the other Transaction Documents, including the enforcement, -12- 17 compromise or settlement of this Deed of Trust or the Obligations or the defense or assertion of the rights and claims of Trustee and Beneficiary hereunder in respect thereof, by litigation or otherwise. Indemnity. (a) Trustor agrees to indemnify and hold harmless Trustee and Beneficiary from and against any and all losses, liabilities, suits, obligations, fines, damages, judgments, penalties, claims, charges, costs and expenses (including attorneys' fees and disbursements) which may be imposed on, incurred or paid by or asserted against Trustee and/or Beneficiary by reason or on account of, or in connection with, (i) any willful misconduct of Trustor or any Event of Default by Trustor hereunder, (ii) Trustee's and/or Beneficiary's good faith and commercially reasonable exercise of any of their rights and remedies, or the performance of any of their duties, hereunder or under the other Transaction Documents to which Trustor is a party, (iii) the construction, reconstruction or alteration of the Premises by Trustor, (iv) any negligence of Trustor, or any negligence or willful misconduct of any lessee of the Premises, or any of their respective agents, contractors, subcontractors, servants, employees, licensees or invitees, or (v) any accident, injury, death or damage to any person or property occurring in, on or about the Premises or any street, drive, sidewalk, curb or passageway adjacent thereto, in each case of (i) through (v) above, except for the willful misconduct or gross negligence of the indemnified person, or any of its agents, contractors, subcontractors, servants, employees, licensees or invitees. Any amount payable to Trustee, Beneficiary or counsel for Beneficiary under this Section 2.03 shall be due and payable within five (5) days after demand therefor and receipt by Trustor of a statement from Trustee, Beneficiary and/or counsel for Beneficiary setting forth in reasonable detail the amount claimed and the basis therefor, and such amounts shall bear interest at the Default Rate (as defined in Section 2.6 of the Lease) from and after the date such amounts are paid by counsel for Beneficiary, Beneficiary or Trustee until paid in full by Trustor. (b) Trustor's obligations under this Section shall not be affected by the absence or unavailability of insurance -13- 18 covering the same or by the failure or refusal by any insurance carrier to perform any obligation on its part under any such policy of covering insurance. If any claim, action or proceeding is made or brought against Trustee and/or Beneficiary which is subject to the indemnity set forth in this Section, Trustor shall resist or defend against the same, if necessary in the name of Trustee and/or Beneficiary, by attorneys for Trustor's insurance carrier (if the same is covered by insurance) or otherwise by attorneys approved by Beneficiary. Notwithstanding the foregoing, Trustee and Beneficiary, in their discretion, may engage their own attorneys to resist or defend, or assist therein, and Trustor shall pay, or, on demand, shall reimburse Trustee and Beneficiary for the payment of, the reasonable fees and disbursements of said attorneys. DEFAULTS AND REMEDIES Events of Default. The term "Event of Default", as used in this Deed of Trust, shall mean the occurrence of an "Event of Default" under the Lease. Remedies. Upon the occurrence of any one or more Events of Default subject to Article VII and Section 3.03 below, Trustee and/or Beneficiary may (but shall not be obligated), in addition to any rights or remedies available to them hereunder or under the other Transaction Documents, take such action personally or by their agents or attorneys, with or without entry, and without notice, demand, presentment or protest (each and all of which are hereby waived to the extent permitted by law) as they deem necessary or advisable to protect and enforce Beneficiary's rights and remedies against Trustor and in and to the Mortgaged Property, including the following actions, each of which may, subject to Section 3.03 hereof, be pursued concurrently or otherwise, at such time and in such order as Trustee and/or Beneficiary may determine, in their sole discretion, without impairing or otherwise affecting its or their other rights or remedies: (a) declare the entire balance of the Obligations (including the entire principal balance thereof, all accrued and unpaid interest and any premium thereon and all other such sums secured hereby) to be immediately due and payable and upon any -14- 19 such declaration the entire unpaid balance of the Obligations shall become and be immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by Trustor anything in the Transaction Documents to the contrary notwithstanding; or (b) institute a proceeding or proceedings, judicial or otherwise, for the complete foreclosure of this Deed of Trust under any applicable provision of law; or (c) institute a proceeding or proceedings for the partial foreclosure of this Deed of Trust under any applicable provision of law for the portion of the Obligations then due and payable, subject to the lien of this Deed of Trust continuing unimpaired and without loss of priority so as to secure the balance of the Obligations not then due and payable; or (d) cause any or all of the Mortgaged Property to be sold under the power of sale granted by this Deed of Trust or any of the other Transaction Documents in any manner permitted by applicable law. For any sale under the power of sale granted by this Deed of Trust, Trustee or Beneficiary must record and give all notices required by law and then, upon the expiration of such time as is required by law, may sell the Mortgaged Property, and all estate, right, title, interest, claim and demand of Trustor therein, and all rights of redemption thereof, at one or more sales, as an entirety or in parcels, with such elements of real and/or personal property (and, to the extent permitted by applicable law, may elect to deem all of the Mortgaged Property to be real property for purposes thereof), and at such time or place and upon such terms as Trustee and Beneficiary may determine and shall execute and deliver to the purchaser or purchasers thereof a deed or deeds conveying the property sold, but without any covenant or warranty, express or implied, and the recitals in the deed or deeds of any facts affecting the regularity or validity of the sale will be conclusive against all persons. In the event of a sale, by foreclosure or otherwise, of less than all of the Mortgaged Property, this Deed of Trust shall continue as a lien and security interest on the remaining portion of the Mortgaged Property; or -15- 20 (e) institute an action, suit or proceeding in equity for the specific performance of any of the provisions contained in the Transaction Documents; or (f) apply for the appointment of a receiver, custodian, trustee, liquidator or conservator of the Mortgaged Property, to be vested with the fullest powers permitted under applicable law, as a matter of right and without regard to or the necessity to disprove the adequacy of the security for the Obligations or the solvency of Trustor or any other person liable for the payment of the Obligations, and Trustor and each other person so liable waives or shall be deemed to have waived such necessity and consents or shall be deemed to have consented to such appointment; or (g) subject to the provisions and restrictions of any applicable law, enter upon the Premises, and exclude Trustor and its agents and servants wholly therefrom, without liability for trespass, damages or otherwise, and take possession of all books, records and accounts relating thereto and all other Mortgaged Property but not as to Trustor's business conducted thereon and Trustor agrees to surrender possession of the Mortgaged Property and of such books, records and accounts to Trustee or Beneficiary on demand after the happening of any Event of Default; and having and holding the same may use, operate, manage, preserve, control and otherwise deal therewith, either personally or by its superintendents, managers, agents, servants, attorneys or receivers, without interference from Trustor; and upon each such entry and from time to time thereafter may, at the expense of Trustor and the Mortgaged Property, without interference by Trustor and as Beneficiary may reasonably deem advisable to protect the value thereof, (i) either by purchase, repair or construction, maintain and restore the Premises, (ii) insure or reinsure the same, (iii) make all necessary or proper repairs, renewals, replacements, alterations, additions, betterments and improvements thereto and thereon, and (iv) in every such case in connection with the foregoing have the right to exercise all rights and powers of Trustor with respect to the Mortgaged Property, either in Trustor's name or otherwise, including the right to make, terminate, cancel, enforce or modify leases, obtain and evict tenants and subtenants on such terms as -16- 21 Beneficiary shall deem advisable and to take any actions described in subsection (i) of this Section; or (h) subject to the provisions and restrictions of any applicable law, may, with or without the entrance upon the Premises, collect, receive, sue for and recover in its own name all Rents and cash collateral derived from the Premises, and after deducting therefrom all reasonable costs, expenses and liabilities of every character incurred by Trustee and/or Beneficiary in collecting the same and in using, operating, managing, preserving and controlling the Premises, and otherwise in exercising Trustee's and/or Beneficiary's rights under subsection (g) of this Section, including all amounts necessary to pay taxes, assessments, insurance premiums and other reasonable charges in connection with the Premises, as well as reasonable compensation for the services of Trustee and Beneficiary and their respective attorneys, agents and employees, to apply the remainder as provided in Section 3.06; or (i) release any portion of the Mortgaged Property for such consideration as Beneficiary may require without, as to the remainder of the Mortgaged Property, in any way impairing or affecting the lien or priority of this Deed of Trust, or improving the position of any subordinate lienholder with respect thereto, except to the extent that the Obligations shall have been reduced by the actual monetary consideration, if any, received by Trustee and/or Beneficiary for such release, and may accept by assignment, pledge or otherwise any other property in place thereof as Trustee and/or Beneficiary may require without being accountable for so doing to any other lienholder; or (j) may take all actions permitted under the Uniform Commercial Code of the State of California; or (k) may take any other action, or pursue any other right or remedy, as Trustee and/or Beneficiary may have under applicable law, and Trustor does hereby grant the same to Trustee and Beneficiary. In the event that Trustee and/or Beneficiary shall exercise any of the rights or remedies set forth in subsections (g) and (h) of this Section, neither Trustee nor Beneficiary shall be -17- 22 deemed to have entered upon or taken possession of the Mortgaged Property except upon the exercise of its option to do so, evidenced by its demand and overt act for such purpose, nor shall it be deemed a beneficiary or mortgagee in possession by reason of such entry or taking possession, unless applicable law requires that it be deemed to be a beneficiary or mortgagee in possession. Neither Trustee nor Beneficiary shall be liable to account for any action taken pursuant to any such exercise other than for rents actually received by such party, nor liable for any loss sustained by Trustor resulting from any failure to let the Premises, or from any other act or omission of Trustee and/or Beneficiary, except to the extent such loss is caused by the willful misconduct or bad faith of such party or such liability may not be waived under applicable law. Trustor hereby consents to, ratifies and confirms the exercise by Trustee and/or Beneficiary of said rights and remedies. Trustor's Personal Property and Trade Fixtures. Trustor shall be entitled up to ten (10) days after the consummation of a foreclosure sale hereunder to enter the Mortgaged Property during normal business hours for the purpose of removing its personal property and trade fixtures therefrom at its expense, provided that it repairs only damage to the Mortgaged Property caused by such removal. Expenses. If any action is commenced to foreclose this Deed of Trust, or to enforce any other remedy of Trustee and/or Beneficiary under any of the Transaction Documents, whether such action is judicial or pursuant to the power of sale contained herein or otherwise, there shall be added to the Obligations secured by this Deed of Trust all reasonable costs and expenses, including reasonable attorney's fees, plus interest thereon at the Default Rate (as defined in Section 2.6 of the Lease) until paid, in the commencement and prosecution of such action, whether or not such action results in a foreclosure sale, foreclosure or other judicial decree or judgment. Rights Pertaining to Sales. Subject to the provisions or other requirements of law, the following provisions shall apply to any sale or sales of the Mortgaged Property under or by virtue of this Article III, whether made under the power of sale -18- 23 herein granted or by virtue of judicial proceedings or of a judgment or decree of foreclosure and sale: (a) Trustee, at the request of Beneficiary, may conduct any number of sales from time to time. The power of sale set forth in Section 3.02(d) hereof shall not be exhausted by any one or more such sales as to any part of the Mortgaged Property which shall not have been sold, nor by any sale which is not completed or is defective in Trustee's or Beneficiary's opinion, until the Obligations shall have been paid in full. (b) Any sale may be postponed or adjourned by public announcement at the time and place appointed for such sale or for such postponed or adjourned sale without further notice. (c) After each sale, Trustee, or an officer of any court empowered to do so, shall execute and deliver to the purchaser or purchasers at such sale a good and sufficient instrument or instruments granting, conveying, assigning and transferring all right, title and interest of Trustor in and to the Mortgaged Property and rights sold and shall receive the proceeds of said sale or sales and apply the same as herein provided. Trustee is hereby appointed the true and lawful attorney-in-fact of Trustor, which appointment is irrevocable and shall be deemed to be coupled with an interest, in Trustor's name and stead, to make all necessary conveyances, assignments, transfers and deliveries of the property and rights so sold, and for that purpose Trustee may execute all necessary instruments of conveyance, assignment, transfer and delivery, and may substitute one or more persons with like power, Trustor hereby ratifying and confirming all that said attorney or such substitute or substitutes shall lawfully do by virtue thereof. Nevertheless, Trustor, if requested by Trustee or Beneficiary, shall ratify and confirm any such sale or sales by executing and delivering to Trustee or such purchaser or purchasers all such instruments as may be advisable, in Trustee's or Beneficiary's judgment, for the purposes as may be designated in such request. (d) Any and all statements of fact or other recitals made in any of the instruments referred to in subsection (c) of this Section given by Trustee and/or Beneficiary as to nonpayment of the Obligations, or as to the occurrence of any Event of -19- 24 Default, or as to Beneficiary having declared all or any of the Obligations to be due and payable, or as to the request to sell, or as to notice of time, place and terms of sale and of the property or rights to be sold having been duly given, or as to the refusal, failure or inability to act of Trustee, or as to the appointment of any substitute or successor Trustee, or as to any other act or thing having been duly done by Trustor, Beneficiary, or by such Trustee, shall be taken as conclusive and binding against all persons as to evidence of the truth of the facts so stated and recited. Trustee and/or Beneficiary may appoint or delegate any one or more persons as agent to perform any act or acts necessary or incident to any sale so held, including the posting of notices and the conduct of sale, but in the name and behalf of Trustee or Beneficiary, as applicable. (e) The receipt of Trustee for the purchase money paid at any such sale, or the receipt of any other person authorized to receive the same, shall be sufficient discharge therefor to any purchaser of any property or rights sold as aforesaid, and no such purchaser, or its representatives, grantees or assigns, after paying such purchase price and receiving such receipt, shall be bound to see to the application of such purchase price of any part thereof upon or for any trust or purpose of this Deed of Trust or, in any manner whatsoever, be answerable for any loss, misapplication or non-application of any such purchase money, or part thereof, or be bound to inquire as to the authorization, necessity, expediency or regularity of any such sale. (f) Any such sale or sales shall operate to divest all of the estate, right, title, interest, claim and demand whatsoever, whether at law or in equity, of Trustor in and to the properties and rights so sold, and shall be a perpetual bar both at law and in equity against Trustor and any and all persons claiming or who may claim the same, or any part thereof or any interest therein, by, through or under Trustor to the fullest extent permitted by applicable law. (g) Upon any such sale or sales, Beneficiary may bid for and acquire the Mortgaged Property and, in lieu of paying cash therefor, may make settlement for the purchase price by crediting against the Obligations the amount of the bid made -20- 25 therefor, after deducting therefrom the expenses of the sale, the cost of any enforcement proceeding hereunder and any other sums which Trustee or Beneficiary is authorized to deduct under the terms hereof, to the extent necessary to satisfy such bid. (h) In the event that Trustor, or any person claiming by, through or under Trustor, shall transfer or refuse or fail to surrender possession of the Mortgaged Property after any sale thereof, then Trustor, or such person shall be deemed a tenant at sufferance of the purchaser at such sale, subject to eviction by means of forcible entry and detainer proceedings, or subject to any other right or remedy available hereunder or under applicable law. (i) Upon any such sale, it shall not be necessary for Trustee, Beneficiary or any public officer acting under execution or order of court to have present or constructively in its possession any of the Mortgaged Property. (j) In the event of any sale referred to in this Section, the entire Obligations, if not previously due and payable, immediately thereupon shall, notwithstanding anything to the contrary herein or in the other Transaction Documents, become due and payable. (k) In the event a foreclosure hereunder shall be commenced by Trustee at the request of Beneficiary, Trustee or Beneficiary may at any time before the sale of the Mortgaged Property abandon the sale, and may, subject to Article VII hereof, institute suit for the collection of the Obligations and for the foreclosure of this Deed of Trust, or in the event that Trustee or Beneficiary should institute a suit for collection of the Obligations, and for the foreclosure of this Deed of Trust, Beneficiary may at any time before the entry of final judgment in said suit dismiss the same and sell or require Trustee to sell the Mortgaged Property in accordance with the provisions of this Deed of Trust. Application of Proceeds. The purchase money, proceeds or avails of any sale referred to in Section 3.05, together with any other sums which may be held by Trustee or Beneficiary hereunder, whether under the provisions of this Article III or -21- 26 otherwise, shall, except as herein expressly provided to the contrary, be applied as follows: First: To the payment of the costs and expenses of any such sale, including compensation to Trustee and/or Beneficiary, their agents and counsel, and of any judicial proceeding wherein the same may be made, and of all expenses, liabilities and advances made or incurred by Trustee and/or Beneficiary hereunder, together with interest thereon as provided herein, and all taxes, assessments and other charges, except any taxes, assessments or other charges subject to which the Mortgaged Property shall have been sold. Second: To the payment in full of the Obligations (including interest and fees) in such order as Beneficiary may elect. Third: To the payment of any other sums secured hereunder or required to be paid by Trustor pursuant to any provision of the Transaction Documents. Fourth: To the payment of the surplus, if any, to whomsoever may be lawfully entitled to receive the same. Additional Provisions as to Remedies. (a) No right or remedy herein conferred upon or reserved to Trustee or Beneficiary is intended to be exclusive of any other right or remedy, and each and every such right or remedy shall be cumulative and continuing, shall be in addition to every other right or remedy given hereunder, or under the other Transaction Documents or now or hereafter existing at law or in equity, and may be exercised from time to time and as often as may be deemed expedient by Trustee or Beneficiary. (b) No delay or omission by Trustee or Beneficiary to exercise any right or remedy hereunder upon any default or Event of Default shall impair such exercise, or be construed to be a waiver of any such default or Event of Default or an acquiescence therein. -22- 27 (c) The failure, refusal or waiver by Trustee or Beneficiary of its right to assert any right or remedy hereunder upon any default or Event of Default or other occurrence shall not be construed as waiving such right or remedy upon any other or subsequent default or Event of Default or other occurrence. (d) Neither Trustee nor Beneficiary shall have any obligation to pursue any rights or remedies they may have under any other agreement prior to pursuing their rights or remedies hereunder or under the other Transaction Documents. (e) No recovery of any judgment by Trustee or Beneficiary and no levy of an execution upon the Mortgaged Property or any other property of Trustor shall affect, in any manner or to any extent, the lien of this Deed of Trust upon the Mortgaged Property, or any liens, rights, powers or remedies of Trustee or Beneficiary hereunder, and such liens, rights, powers and remedies shall continue unimpaired as before. (f) Beneficiary may resort or cause Trustee to resort to any security given by this Deed of Trust or any other security now given or hereafter existing to secure the Obligations, in whole or in part, in such portions and in such order as Beneficiary may deem advisable, and no such action shall be construed as a waiver of any of the liens, rights or benefits granted hereunder. (g) Acceptance of any payment after the occurrence of any default or Event of Default shall not be deemed a waiver or a cure of such default or Event of Default, and acceptance of any payment less than any amount then due shall be deemed an acceptance on account only. (h) In the event that Trustee or Beneficiary shall have proceeded to enforce any right or remedy hereunder by foreclosure, sale, entry or otherwise, and such proceeding shall be discontinued, abandoned or determined adversely for any reason, then Trustor, Trustee and Beneficiary shall be restored to their former positions and rights hereunder with respect to the Mortgaged Property, subject to the lien hereof. -23- 28 (i) In every instance when a receiver is appointed with respect to all or any portion of the Mortgaged Property pursuant to Section 3.02(f) above or otherwise, at Beneficiary's discretion, the receiver shall be authorized, among other such duties and powers as may be ordered or granted by the court, to take possession of the Mortgaged Property; to manage, control and protect the Mortgaged Property; to collect the rents, issues, profits, revenues, earnings and income arising therefrom, and to apply the same toward the payment of reasonable expenses, including reasonable management and operating expenses, taxes, assessments, utilities, mortgage payments and insurance premiums of or in connection with the Mortgaged Property; to maintain the Mortgaged Property in a reasonable state of repair so that there will be no excessive depreciation or devaluation thereof arising from lack of prudent management; to enter into such lease agreements or rental agreements with new tenants for the Mortgaged Property as such receiver deems reasonable and prudent; to amend, extend or renew existing leases upon such terms as such receiver deems reasonable and prudent; to, if necessary, retain a property management firm to assist in such duties upon such terms as such receiver deems reasonable and appropriate; and to take such other action as is necessary in order to provide services to the tenants under any existing or future leases or as is necessary to accomplish any of the foregoing. Waiver of Rights and Defenses. To the full extent Trustor may lawfully do so, Trustor agrees with Beneficiary as follows: (a) Trustor will not at any time, insist on, plead, claim or take the benefit or advantage of any statute or rule of law now or hereafter in force providing for any appraisement, valuation, stay, extension, moratorium or redemption, or of any statute of limitations, and Trustor, for itself and its heirs, devises, representatives, successors and assigns, and for any and all persons ever claiming an interest in the Mortgaged Property (other than Beneficiary) hereby, to the extent permitted by applicable law, waives and releases all rights of redemption, valuation, appraisement, notice of intention to mature or declare due the whole of the Obligations, and all rights to a marshalling of the assets of Trustor, including the Mortgaged Property, or to a sale in inverse order of alienation, in the event of -24- 29 foreclosure of the liens and security interests created hereunder. (b) Trustor shall not have or assert any right under any statute or rule of law pertaining to any of the matters set forth in subsection (a) of this Section, to the administration of estates of decedents or to any other matters whatsoever to defeat, reduce or affect any of the rights or remedies of Trustee and Beneficiary hereunder, including the rights of Trustee and/or Beneficiary hereunder to a sale of the Mortgaged Property for the collection of the Obligations without any prior or different resort for collection, or to the payment of the Obligations out of the proceeds of sale of the Mortgaged Property in preference to any other person. (c) If any statute or rule of law referred to in this Section and now in force, of which Trustor or any of its representatives, successors or assigns and such other persons claiming any interest in the Mortgaged Property might take advantage despite this Section, shall hereafter be repealed or cease to be in force, such statute or rule of law shall not thereafter be deemed to preclude the application of this Section. (d) Trustor shall not be relieved of its obligation to pay the Obligations at the time and in the manner provided herein and in the other Transaction Documents, nor shall the lien or priority of this Deed of Trust or any other Transaction Documents be impaired by any of the following actions, non-actions or indulgences by Trustee or Beneficiary: (i) any failure or refusal by Trustee or Beneficiary to comply with any request by Trustor (X) to consent to any action by Trustor or (Y) to take any action to foreclose this Deed of Trust or otherwise enforce any of the provisions hereof or of the other Transaction Documents; (ii) any release, regardless of consideration, of the whole or any part of the Mortgaged Property or any other security for the Obligations, or any person liable for payment of the Obligations; -25- 30 (iii) any waiver by Beneficiary of compliance by Trustor with any provision of this Deed of Trust or the other Transaction Documents, or consent by Beneficiary to the performance by Trustor of any action which would otherwise be prohibited thereunder, or to the failure by Trustor to take any action which would otherwise be required hereunder or thereunder; and (iv) any agreement or stipulation between Trustee or Beneficiary and Trustor, or, with or without Trustor's consent, between Trustee or Beneficiary and any subsequent owner or owners of the Mortgaged Property or any other security for these Obligations, renewing, extending or modifying the time of payment or the terms of this Deed of Trust or any of the other Transaction Documents (including a modification of any interest rate), and in any such event Trustor shall continue to be obligated to pay the Obligations at the time and in the manner provided herein and in the other Transaction Documents, as so renewed, extended or modified, unless expressly released and discharged by Beneficiary. (e) Regardless of consideration, and without the necessity for any notice to or consent by the holder of any subordinate lien, encumbrance, right, title or interest in or to the Mortgaged Property, Beneficiary may release any person at any time liable for the payment of the Obligations or any portion thereof or any part of the security held for the Obligations and may extend the time of payment or otherwise modify the terms of this Deed of Trust or of any of the Transaction Documents, without in any manner impairing or affecting this Deed of Trust, as so extended and modified, as security for the Obligations over any such subordinate lien, encumbrance, right, title or interest. Beneficiary may resort for the payment of the Obligations to any other security held by Beneficiary (or any trustee for the benefit of Beneficiary) in such order and manner as Beneficiary in its discretion, may elect. Beneficiary may take or cause to be taken action to recover the Obligations, or any portion thereof, or to enforce any provision hereof or of the other Transaction Documents without prejudice to the right of Beneficiary thereafter to foreclose or cause to be foreclosed this Deed of Trust. Beneficiary shall not be limited exclusively -26- 31 to the right and remedies herein stated but shall be entitled to every additional right and remedy now or hereafter afforded by law or equity. The rights of Trustee and Beneficiary under this Deed of Trust shall be separate, distinct and cumulative and none shall be given effect to the exclusion of the others. No act of Trustee and/or Beneficiary shall be construed as an election to proceed under any one provision herein to the exclusion of any other provision. Exercise by Trustee. Notwithstanding anything herein to the contrary, Trustee (a) shall not exercise, or waive the exercise of, any of its rights or remedies under this Article (other than its right to reimbursement) except upon the request of Beneficiary, and (b) shall exercise, or waive the exercise of, any or all of such rights or remedies upon the request of Beneficiary and at the direction of Beneficiary as to the manner of such exercise or waiver, provided that Trustee shall have the right to decline to follow any of such request or direction if Trustee shall be advised by counsel that the action or proceeding, or manner thereof, so directed may not lawfully be taken or waived. SECTION 3.10. Rights of Beneficiary. Notwithstanding anything contained herein to the contrary, Beneficiary shall not be entitled to exercise its remedies under Article III hereof upon any failure by Trustor to perform any of its obligations hereunder unless and until an Event of Default has occurred under Section 3.01 hereof. -27- 32 DEFEASANCE Defeasance. If all of the Obligations shall be paid as the same become due and payable, then and in that event only all rights hereunder shall terminate and the Mortgaged Property shall become wholly released and cleared of the liens, security interests, conveyances and assignments evidenced hereby, upon receipt by Beneficiary of payment of all Obligations secured hereby. In such event Trustee shall at the request of the Trustor, promptly deliver to Trustor, in recordable form, all such documents as shall be necessary to release the Mortgaged Property from the liens, security interests, conveyances and assignments created or evidenced hereby. Notwithstanding anything in the preceding sentence to the contrary, Trustee shall so release the Mortgaged Property only upon the direction of Beneficiary. I. ADDITIONAL PROVISIONS Provisions as to Payments, Advances. (a) To the extent that any part of the Obligations is used to pay indebtedness secured by any outstanding lien, security interest, charge or encumbrance against the Mortgaged Property that is superior to this Deed of Trust, or to pay in whole or in part the purchase price therefor, Trustee and Beneficiary shall be subrogated to any and all rights, security interests and liens held by any owner or holder of the same, whether or not the same are released. Trustor agrees that, in consideration of such payment by Trustee or Beneficiary, effective upon such payment Trustor shall and hereby does waive and release all demands, defenses and causes of action for offsets and payments with respect to the same. (b) Any payment made under this Deed of Trust by any person at any time liable for the payment of the Obligations, or by any subsequent owner of the Mortgaged Property or by any person or entity that might be prejudiced in the event of a -28- 33 failure to make such payment, or by any partner, stockholder, officer or director thereof, shall be deemed, as between Trustee or Beneficiary and all such persons, to have been made on behalf of all such persons. Usury Savings Clause. All agreements in this Deed of Trust and in the other Transaction Documents are expressly limited so that in no contingency or event whatsoever, whether by reason of advancement or acceleration of maturity of the Obligations, or otherwise, shall the amount paid or agreed to be paid hereunder for the use, forbearance or detention of money exceed the highest lawful rate permitted under applicable usury laws, if any. If, from any circumstance whatsoever, fulfillment of any provision of the Transaction Documents, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by law which a court of competent jurisdiction may deem applicable hereto, then, ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity and if, from any circumstance whatsoever, Beneficiary shall ever receive as interest an amount which would exceed the highest lawful rate, the receipt of such excess shall be deemed a mistake and shall be cancelled automatically or, if theretofore paid, such excess shall be credited against the Obligations to which the same may lawfully be credited, and any portion of such excess not capable of being so credited shall be rebated to Trustor. Separability. If all or any portion of any provision of this Deed of Trust or the other Transaction Documents shall be held to be invalid, illegal or unenforceable in any respect, then such invalidity, illegality or unenforceability shall not affect any other provision hereof or thereof, and such provision shall be limited and construed in such jurisdiction as if such invalid, illegal or unenforceable provision or portion thereof were not contained herein or therein. Notices. Any notice, demand, consent, approval, direction, agreement or other communication (any "Notice") required or permitted hereunder or under the other Transaction Documents shall be in writing and shall be validly given and effectively served if mailed by United States mail, first class or certified mail, return receipt requested, postage prepaid, or -29- 34 by hand delivery by a recognized courier service, or by next day delivery by recognized overnight courier service, courier charges prepaid: (a) If to Trustor: Octel Communications Corporation 1001 Murphy Ranch Road Milpitas, CA 95035 Attn: Doug Hus With a copy to: Wilson, Sonsini, Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304 Attn: Bradford C. O'Brien, Esq. (b) If to Beneficiary: Sumitomo Bank Leasing and Finance Inc. 277 Park Avenue New York, NY 10172 Attn: Chief Credit Officer With a copy to: Landels, Ripley & Diamond 350 Steuart Street San Francisco, CA 94105-1250 Attention: Bruce W. Hyman, Esq. Any Notice shall be deemed to have been validly given and effectively served hereunder three (3) days after so mailed. Any person shall have the right to specify, from time to time, as its address or addresses for purposes of this Deed of Trust, any other address or addresses. Such Notice of change of address or addresses shall be effective only upon actual receipt. -30- 35 No Merger. If both the lessor's and the lessee's interest under the Lease or any other lease shall at any time become vested in any one person, this Deed of Trust and the lien and security interest created hereby shall not be destroyed or terminated by the application of the doctrine of merger and, in such event, Trustee and Beneficiary shall continue to have and enjoy all of the rights and privileges of Trustee and Beneficiary hereunder as to each separate estate. Applicable Law. This Deed of Trust shall be governed by, and construed in accordance with, the law of the State of California. Provisions as to Covenants and Agreements. All of Trustor's covenants and agreements hereunder shall run with the land and time is of the essence with respect thereto. Matters to be in Writing. This Deed of Trust cannot be altered, amended, modified, terminated or discharged except in a writing signed by the party against whom enforcement of such alteration, amendment, modification, termination or discharge is sought. No waiver, release or other forbearance by Trustee or Beneficiary will be effective against Trustee or Beneficiary unless it is in a writing signed by Beneficiary, and then only to the extent expressly stated. Construction of Provisions. The following rules of construction shall be applicable for all purposes of this Deed of Trust and all documents or instruments supplemental hereto, unless the context otherwise requires: (a) All references herein to numbered Articles or Sections or to lettered Exhibits are references to the Articles and Sections hereof and the Exhibits annexed to this Deed of Trust, unless expressly otherwise designated in context. (b) The terms "include", "including" and similar terms shall be construed as if followed by the phrase "without being limited to." (c) The term "knowledge" or "to best of knowledge" when and if used in connection with a representation or warranty -31- 36 made by Trustor means that Trustor and/or the representatives of Trustor have interviewed such persons, representatives, and responsible employees of Trustor, of the constituent general partners of Trustor and of the constituent general partners of such general partners, as may be applicable, as such representatives have determined are likely, in the ordinary course of their respective duties, to have knowledge of the matters set forth herein. (d) The terms "Mortgaged Property" and "Premises" shall be construed as if followed by the phrase "or any part thereof." (e) The term "Obligations" shall be construed as if followed by the phrase "or any other sums secured hereby, or any part thereof." (f) Words of masculine, feminine or neuter gender shall mean and include the correlative words of the other genders, and words importing the singular number shall mean and include the plural number, and vice versa. (g) The term "person" shall include natural persons, firms, partnerships, corporations and any other public and private legal entities. (h) The term "provisions," when used with respect hereto or to any other document or instrument, shall be construed as if preceded by the phrase "terms, covenants, agreements, requirements, conditions and/or." (i) All Article, Section and Exhibit captions herein are used for convenience and reference only and in no way define, limit or describe the scope or intent of, or in any way affect, this Deed of Trust. (j) The cover page of and all recitals set forth in, and all Exhibits to, this Deed of Trust are hereby incorporated in this Deed of Trust. -32- 37 (k) All obligations of Trustor hereunder shall be performed and satisfied by or on behalf of Trustor at Trustor's sole cost and expense. (l) The term "Lease" shall mean "tenancy, subtenancy, lease or sublease," the term "lessor" shall mean "landlord, sublandlord, owner, lessor and sublessor" and the terms "lessee" or "tenant" shall mean "tenant, subtenant, lessee and sublessee." SECTION 5.10. Successors and Assigns. The provisions hereof shall be binding upon Trustor and the heirs, devises, representatives, successors and assigns of Trustor, including successors in interest of Trustor, in and to all or any part of the Mortgaged Property, and shall inure to the benefit of Trustee, Beneficiary and their respective heirs, successors, substitutes and assigns. All references in this Deed of Trust to Trustor, Trustee or Beneficiary shall be construed as including all of such other persons with respect to the person referred to. Where two or more persons have executed this Deed of Trust, the obligations of such persons shall be joint and several except to the extent the context clearly indicates otherwise. SECTION 5.11. Request for Notice. Pursuant to California Government Code Section 27321.5(b), Trustor hereby requests that a copy of any notice of default and a copy of any notice of sale given pursuant to this Deed of Trust be mailed to Trustor at the address set forth herein above. SECTION 5.12. Fixture Filing. Portions of the Mortgaged Property are goods which are or are to become fixtures relating to the Land and/or the Premises, and Trustor covenants and agrees that the filing of this Deed of Trust in the real estate records of the county where the Premises are located shall also operate from the time of filing as a fixture filing in accordance with Section 9313 of the California Uniform Commercial Code. SECTION 5.13. Entire Agreement. This Deed of Trust together with the related Transaction Documents contains the entire agreement between Trustor, Beneficiary and Trustee with regard to the rights and obligations of the Trustor, Beneficiary and Trustee in connection with the financing transaction contemplated herein. -33- 38 PROVISIONS AS TO TRUSTEE Trustee's Appointment. Trustee accepts this Trust when this Deed of Trust, duly executed and acknowledged, is made public record as provided by law. Trustee may resign by an instrument in writing addressed to Beneficiary, or Trustee may be removed at any time with or without cause by an instrument in writing executed by Beneficiary and duly recorded. In case of the death, resignation, removal or disqualification of Trustee or if for any reason Beneficiary shall deem it desirable to appoint a substitute or successor trustee to act instead of Trustee herein named or any substitute or successor Trustee, then Beneficiary shall have the right and is hereby authorized and empowered to appoint a successor Trustee, or a substitute Trustee, without other formality than appointment and designation in writing executed and acknowledged by Beneficiary and the recordation of such writing in the office where this Deed of Trust is recorded, and the authority hereby conferred shall extend to the appointment of other successor and substitute Trustees successively until the Obligations are paid in full or until the Mortgaged Property are sold hereunder. Such appointment and designation by Beneficiary shall be full evidence of the right and authority to make the same and of all facts therein recited. If such appointment is executed on behalf of Beneficiary by an officer of Beneficiary, such appointment shall be conclusively presumed to be executed with authority and shall be valid and sufficient without proof of any action by the Trustee or any superior officer of Beneficiary. Upon the making of such appointment and designation, all of the estate and title of Trustee in the Mortgaged Property shall vest in the named successor or substitute Trustee and it shall thereupon succeed to and shall hold, possess and execute all the rights, powers, privileges, immunities and duties herein conferred upon Trustee; but, nevertheless, upon the written request of Beneficiary or of the successor or substitute Trustee, Trustee ceasing to act shall execute and deliver an instrument transferring to such successor or substitute Trustee all of the estate and title in the Mortgaged Property of Trustee so ceasing to act, together with all the rights, powers, privileges, immunities and duties herein conferred upon Trustee, and shall duly assign, transfer and deliver any of the properties and moneys held by said Trustee -34- 39 hereunder to said successor or substitute Trustee. All references herein to Trustee shall be deemed to refer to Trustee (including any successor or substitute, appointed and designated, as herein provided) from time to time acting hereunder. Trustor hereby ratifies and confirms any and all acts which Trustee herein named or its successor or successors, substitute or substitutes, in this Deed of Trust, shall do lawfully by virtue hereof. I. SPECIAL PROVISIONS Defeasance and Release. If the Obligations shall be paid in full then this Deed of Trust shall be reconveyed by the Trustee at the expense of Trustor upon the Trustor's written request. Upon the reconveyance of this Deed of Trust, the Trustee, on the written request and at the expense of the Trustor, will execute and deliver such proper instruments of release and satisfaction as may reasonably be requested to evidence such release, and any such instrument, when duly executed by the Trustee and duly recorded in the places where this Deed of Trust is recorded, shall conclusively evidence the reconveyance of this Deed of Trust. Subordination. Provided no Event of Default or event which would constitute an Event of Default but for the passage of time or the giving of notice, or both, Beneficiary agrees to subordinate the lien of this Deed of Trust to any easements created by Trustor under Section 20.1 of the Lease, provided Trustor reimburses Beneficiary for all costs and expenses incurred in connection therewith. Counterparts. This Deed of Trust may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall comprise but a single instrument. [Signatures begin on next page.] -35- 40 IN WITNESS WHEREOF, the undersigned have executed this Deed of Trust the day first set forth above. "Trustor" OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation By: ____________________________ Its: ____________________________ [All Signatures must be acknowledged] -36- 41 Exhibit 10.18 Exhibit "A" LEGAL DESCRIPTION All that certain Real Property in the City of Milpitas, County of Santa Clara, State of California, being all of Parcel 1 as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 and a portion of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14, described as follows: Beginning at a point on the Southwesterly right-of-way line of Murphy Ranch Road at the Easterly corner of Parcel 1, as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4; Thence along said right-of-way line the following four courses: North 33 degree 17'44" West 87.74 feet to the beginning of a curve to the left; Along said curve having a radius of 2370.00 feet through a central angle of 7 08'55" an arc distance of 295.70 feet; North 40 degree 26'39" West 708.15 feet to the beginning of curve to the right; Along said curve having a radius of 830.00 feet through a central angle of 0 degree 41'54" an arc distance of 10.12 feet; Thence South 52 degree 22'26" West 678.21 feet to the Southwesterly line of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14; Thence along said Southwesterly line of said Parcel 1 and the Southwesterly and Southeasterly line of Parcel 1 shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 the following five courses: South 41 degree 07'49" East 286.15 feet to the beginning of a curve to the left; Along said curve having a radius of 560.00 feet through a central angle of 33 46'49" an arc distance of 330.16 feet to a point of reverse curvature; Along a curve to the right having a radius of 500.00 feet through a central angel of 33 degree 50'40" an arc distance of 295.35 feet to a point of compound curvature; Along a curve to the right having a radius of 1000.00 feet through a central angle of 7 degree 00'59" an arc distance of 122.46 feet and North 66 degree 02'22" East 484.64 feet to the Point of Beginning. Together with those rights to plant, cultivate, irrigate, harvest and retain crops and to construct, maintain, use, repair, replace and re-new fences, roads, streets, earth fills, sewers, water pipes, gas pipes, electric power lines, telephone lines and telegraph lines as disclosed by the Deed to the -37- 42 City and County of San Francisco, A Municipal Corporation, recorded March 19, 1951 in Book 2174 at Page 389, Official Records of Santa Clara County, excluding therefrom any portion thereof lying Northeasterly of the Southwesterly line of Magnolia Drive as shown on the hereinabove Parcel Maps. -38- 43 STATE OF CALIFORNIA ) ) ss. COUNTY OF ) On the __ day of ___________, 1995, before me, the undersigned, a Notary Public in and for said State, personally appeared _______________ and ____________________, personally known to me or proved to me on the basis of satisfactory evidence to be the person(s) whose name(s) is/are subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their authorized capacity(ies), and that by his/her/their signature(s) on the instrument the person(s) or the entity upon behalf of which the person(s) acted, executed the instrument. WITNESS my hand and official seal. _____________________________ Notary Public (SEAL) -39- 44 Exhibit 10.18 RECORDING REQUESTED BY, AND WHEN RECORDED, RETURN TO: Sumitomo Bank Leasing and Finance, Inc. c/o Landels, Ripley & Diamond 350 Steuart Street San Francisco, CA 94105 Attention: Bruce W. Hyman, Esq. MEMORANDUM OF LEASE OF THE LAND THIS MEMORANDUM OF LEASE OF THE LAND ("Memorandum of Lease") is executed as of July 6, 1995, by and between SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation ("Landlord"), and OCTEL COMMUNICATIONS CORPORATION, a Delaware corporation ("Tenant"). RECITALS WHEREAS, Landlord and Tenant have executed that certain lease ("Lease") dated as of July 6, 1995, covering a leasehold interest in certain land located on the real property located in the City of Milpitas, Santa Clara County, California as more particularly described in Schedule 1 attached hereto and incorporated herein by this reference ("Land") and the improvements which may come to be located on said Land (the Land and improvements are referred to herein as the "Premises"); and WHEREAS, Landlord and Tenant desire to record notice of the Lease in the real estate records of Santa Clara County, California: NOW, THEREFORE, in consideration of the foregoing, Landlord and Tenant hereby declare as follows: 1. Demise. Landlord hereby leases the Premises to Tenant and Tenant hereby leases the Premises from Landlord, subject to the terms, covenants and conditions contained in the Lease. 45 2. Expiration Date. The term of the Lease ("Term") shall commence with respect to the Premises on the date hereof and shall expire on July 5, 1996. 3. Option to Purchase. Tenant has an option to purchase the Premises, as more particularly described in the Lease, at any time during the Term (including any extension thereof). 4. Restrictions on Encumbrances. Landlord is prohibited from recording against the Premises liens (including, without limitation, deeds of trust), encumbrances, and other matters that would constitute exceptions to title, and from amending or modifying any of the foregoing that may exist now or during the Term, as more particularly described in the Lease. 5. Restrictions on Transfers by Landlord. Subject to certain exceptions, Landlord may transfer its interest in the Premises to a third party subject to the restrictions which are set forth with more particularity in the Lease. 6. Counterparts. This Memorandum of Lease may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall comprise but a single instrument. IN WITNESS WHEREOF, Landlord and Tenant have executed this Memorandum of Lease as of the date and year first written above. TENANT: OCTEL COMMUNICATIONS CORPORATION, a Delaware Corporation By _________________________________ Name_________________________________ Its _________________________________ (Signatures continued on next page) 2 46 LANDLORD: SUMITOMO BANK LEASING AND FINANCE, INC., a Delaware corporation By _________________________________ Name_________________________________ Its _________________________________ (Signatures continued on next page) 3 47 Exhibit 10.18 Schedule 1 LEGAL DESCRIPTION All that certain Real Property in the City of Milpitas, County of Santa Clara, State of California, being all of Parcel 1 as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 and a portion of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14, described as follows: Beginning at a point on the Southwesterly right-of-way line of Murphy Ranch Road at the Easterly corner of Parcel 1, as shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4; Thence along said right-of-way line the following four courses: North 33(degree)17'44" West 87.74 feet to the beginning of a curve to the left; Along said curve having a radius of 2370.00 feet through a central angle of 7(degree)08'55" an arc distance of 295.70 feet; North 40(degree)26'39" West 708.15 feet to the beginning of curve to the right; Along said curve having a radius of 830.00 feet through a central angel of 0(degree)41'54" an arc distance of 10.12 feet; Thence South 52(degree)22'26" West 678.21 feet to the Southwesterly line of Parcel 1 as shown on that certain Parcel Map filed in Book 584 of Maps at Pages 13 and 14; Thence along said Southwesterly line of said Parcel 1 and the Southwesterly and Southeasterly line of Parcel 1 shown on that certain Parcel Map filed in Book 535 of Maps at Pages 3 and 4 the following five courses: South 41(degree)07'49" East 286.15 feet to the beginning of a curve to the left; Along said curve having a radius of 560.00 feet through a central angle of 33(degree)46'49" an arc distance of 330.16 feet to a point of reverse curvature; Along a curve to the right having a radius of 500.00 feet through a central angel of 33(degree)50'40" an arc distance of 295.35 feet to a point of compound curvature; Along a curve to the right having a radius of 1000.00 feet through a central angle of 7(degree)00'59" an arc distance of 122.46 feet and North 66(degree)02'22" East 484.64 feet to the Point of Beginning. 4 48 Together with those rights to plant, cultivate, irrigate, harvest and retain crops and to construct, maintain, use, repair, replace and re-new fences, roads, streets, earth fills, sewers, water pipes, gas pipes, electric power lines, telephone lines and telegraph lines as disclosed by the Deed to the City and County of San Francisco, A Municipal Corporation, recorded March 19, 1951 in Book 2174 at Page 389, Official Records of Santa Clara County, excluding therefrom any portion thereof lying Northeasterly of the Southwesterly line of Magnolia Drive as shown on the hereinabove Parcel Maps. 5 EX-11 4 COMPUTATION OF 1995 EARNINGS PER SHARE 1 Exhibit 11.0 OCTEL COMMUNICATIONS CORPORATION AND SUBSIDIARIES STATEMENT RE COMPUTATION OF EARNINGS PER SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED JUNE 30, ------------------------------------------ 1995 1994 1993 ------- ------- ------- PRIMARY NET INCOME PER SHARE Net income $31,132 $13,543 $29,567 ======= ======= ======= Weighted average shares outstanding 23,703 23,609 23,242 Dilutive effect of outstanding stock options (as determined by the application of the treasury stock method) 1,021 1,487 1,627 ------- ------- ------- 24,724 25,096 24,869 ======= ======= ======= Primary diluted net income per common and equivalent share $ 1.26 $ 0.54 $ 1.19 ======= ======= ======= FULLY DILUTED NET INCOME PER SHARE Net income $31,132 $13,543 $29,567 ======= ======= ======= Weighted average shares outstanding 23,703 23,609 23,242 Dilutive effect of outstanding stock options (as determined by the application of the treasury stock method) 2,025 1,487 1,627 ------- ------- ------- 25,728 25,096 24,869 ======= ======= ======= Fully diluted net income per common and equivalent share $ 1.21 $ 0.54 $ 1.19 ======= ======= =======
EX-21 5 SUBSIDIARIES OF THE COMPANY 1 Exhibit 21.0 OCTEL COMMUNICATIONS CORPORATION SUBSIDIARIES OF THE COMPANY 1. OCTEL COMMUNICATIONS LIMITED 8. OCTEL PC PRODUCTS DIVISION ADDRESS: Octel House, Ancells Road (FORMERLY COMPASS TECHNOLOGY) Fleet, Hampshire GU23 8UN ADDRESS: 1819 Main Street England Sarasota, Florida 34236 2. OCTEL COMMUNICATIONS SERVICES LIMITED 9. OCTEL NETWORK SERVICES (FORMERLY ADDRESS: Octel House, Ancells Road THE TIGON CORPORATION) Fleet, Hampshire GU13 8UN ADDRESS: 17080 Dallas Parkway England Dallas, Texas 75248-1986 3. OCTEL COMMUNICATIONS S.A. 10. OCTEL COMMUNICATIONS K.K. ADDRESS: 21 Boulevard de la Madeleine ADDRESS: Aoyama Bldg. Immeuble des Trois Quartiers 2-3 Kita-aoyama 1-chome Cedex, Paris F-75001 Minato-ku, Tokyo France Japan 4. OCTEL COMMUNICATIONS GmbH 11. OCTEL COMMUNICATIONS PACIFIC, LTD. ADDRESS: Garmischer Strasse 10 ADDRESS: 35th Floor, Central Plaza D-80339 Munich 18 Harbor Road, Wanchai Germany Hong Kong 5. OCTEL COMMUNICATIONS CANADA INC. 12. RHETOREX, INCORPORATED ADDRESS: 181 Bay Street, Suite 2100 ADDRESS: 200 East Hacienda Ave. Toronto, Ontario Campbell, California 95008 M5J2T3 Canada 6. OCTEL COMMUNICATIONS (ISRAEL) LTD. 13. RHETOREX EUROPE LIMITED ADDRESS: 1-C Yoni Netanyahu ADDRESS: Suite M1, Ground Floor Or-Yehud 60376 North Wing, Centennial Court Israel Easthampstead Road, Bracknell Berkshire RG12 1JA England 7. OCTEL COMMUNICATIONS INTERNATIONAL CORPORATION AGENT'S ADDRESS: 5 Kronprindsens Gade P.O. Box 8560 Charlotte Amalie, St. Thomas U.S. Virgin Islands 00801
EX-23 6 CONSENT OF INDEPENDENT AUDITORS 1 Exhibit 23.0 CONSENT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Octel Communications Corporation We consent to incorporation by reference in the registration statements Nos. 33-22121, 33-33568 and 33-38888 on Form S-3 and Nos. 33-26343, 33-49046 and 33-56510 on Form S-8 of Octel Communications Corporation and subsidiaries of our report dated July 25, 1995, relating to the consolidated balance sheets of Octel Communications Corporation and subsidiaries as of June 30, 1995 and 1994, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three year period ended June 30, 1995, and the related schedule, which report appears in the Octel Communications Corporation Annual Report on Form 10-K for fiscal year 1995. /s/ KPMG PEAT MARWICK LLP Palo Alto, California September 28, 1995 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 U.S. Dollars YEAR JUN-30-1995 JUN-30-1995 1 24,521 28,054 119,887 (2,938) 31,151 216,123 205,727 (76,974) 368,276 92,731 0 183,193 0 0 91,750 368,276 314,343 472,592 103,541 193,328 233,477 0 155 45,632 14,500 31,132 0 0 0 31,132 1.26 1.21
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